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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________ to __________________
COMMISSION FILE NUMBER: 001-15933
BLUE VALLEY BAN CORP
(Exact name of registrant as specified in its charter)
KANSAS 48-1070996
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11935 RILEY
OVERLAND PARK, KANSAS 66225-6128
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (913) 338-1000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
- ------------------- -----------------------------------------
Guarantee with respect to the Trust American Stock Exchange
Preferred Securities, $8.00 par
value, of BVBC Capital Trust I
Securities registered pursuant to Section 12(g) of the Act: None
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 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of 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. [X]
Indicate by checkmark whether the registrant is an accelerated filer.
Yes [ ] No [X]
As of February 28, 2005 the registrant had 2,335,071 shares of Common Stock
($1.00 par value) outstanding, of which 1,128,092 shares were held by
non-affiliates. The aggregate market value of the common shares of the
registrant held by non-affiliates, computed based on the June 30, 2004 closing
price of the stock, was approximately $30.5 million.
DOCUMENTS INCORPORATED BY REFERENCE
1. Part III - Proxy Statement for the 2005 Annual Meeting of Stockholders
BLUE VALLEY BAN CORP
FORM 10-K INDEX
Page No.
--------
PART I.
Item 1. Business 2
Item 2. Properties 14
Item 3. Legal Proceedings 15
Item 4. Submission of Matters to a Vote of Security Holders 15
PART II.
Item 5. Market for the Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities 16
Item 6. Selected Financial Data 17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 36
Item 8. Financial Statements and Supplementary Data 38
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 38
Item 9A. Controls and Procedures 39
Item 9B. Other Information 39
PART III.
Item 10. Directors and Executive Officers of the Registrant 40
Item 11. Executive Compensation 40
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 40
Item 13. Certain Relationships and Related Transactions 40
Item 14. Accountant Fees and Services 41
PART IV.
Item 15. Exhibits, Financial Statement Schedules 41
1
PART I
ITEM 1: BUSINESS
THE COMPANY AND SUBSIDIARIES
Blue Valley Ban Corp. ("Blue Valley" or the "Company") is a bank holding
company organized in 1989. In 2001, Blue Valley elected to become a financial
holding company and such status was granted. The Company's wholly-owned
subsidiary, Bank of Blue Valley (the "Bank") was also organized in 1989 to
provide banking services to closely-held businesses and their owners,
professionals and residents in Johnson County, Kansas, a high growth,
demographically attractive area within the Kansas City, Missouri - Kansas
Metropolitan Statistical Area (the "MSA"). The focus of Blue Valley has been to
take advantage of the current and anticipated growth in our market area as well
as to serve the needs of small and mid-sized commercial borrowers - customers
that we believe currently are underserved as a result of banking consolidation
in the industry generally and within our market specifically. In addition, Blue
Valley has established a national presence by originating residential mortgages
nationwide through the Bank's InternetMortgage.com website.
We have experienced significant internal growth since our inception. We
currently have six banking center locations in Johnson County, Kansas, including
our main office and a mortgage operations office in Overland Park, both of which
include lobby banking centers, full-service offices in Leawood, Olathe and
Shawnee, Kansas, and a supermarket banking facility in Leawood, Kansas.
Our lending activities focus on commercial lending and residential mortgage
origination services, and to a lesser extent, consumer lending and leasing. We
strive to identify, develop and maintain diversified lines of business which
provide acceptable returns on a risk-adjusted basis. Our primary lines of
business consist of commercial lending, commercial real estate lending,
construction lending, lease financing, residential real estate lending, consumer
lending, and home equity loans.
We also seek to develop lines of business which diversify our revenue
sources, increase our non-interest income and offer additional value-added
services to our customers. We develop these new or existing lines of business
while monitoring related risk factors. In addition to fees generated in
conjunction with our lending activities, we derive non-interest income by
providing mortgage origination services, deposit and cash management services,
investment brokerage services and trust services.
In addition to the Bank, we have four wholly-owned subsidiaries: Blue
Valley Building Corp., which owns the buildings and real property that comprise
our headquarters, mortgage operations facility and the Leawood banking center;
Blue Valley Insurance Services, Inc., an insurance agency created to offer
insurance products to our customers; and BVBC Capital Trust I and BVBC Capital
Trust II, which were created to offer the Company's trust preferred securities
and to purchase our junior subordinated debentures. On December 31, 2004, Blue
Valley Insurance Services, Inc. ceased operations as we decided not to further
pursue this line of business at this time.
OUR MARKET AREA
We operate primarily as a community bank, serving the banking needs of
small and medium-sized companies and individuals in the Kansas City MSA
generally, and in suburban Johnson County, in particular. Our trade area
generally consists of Johnson County, Kansas. We believe that coupling our
strategy of providing exceptional customer service and local decision making
with attractive market demographics has led to a rate of growth which exceeds
the national total asset and deposit growth rates of the banking industry as
well as the growth experienced locally by many of our competitors.
The income levels and growth rate of Johnson County, Kansas compare
favorably to national averages. Johnson County's population growth rate ranks in
the top 2% of counties nationally, and its per capita income ranks in the top 1%
of counties nationally. Johnson County is also a significant banking market in
the State of Kansas and in the Kansas City MSA. According to available industry
data, as of June 30, 2004, total deposits in Johnson
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County, including those of banks, thrifts and credit unions, were approximately
$11.3 billion, which represented 24.37% of total deposits in the state of Kansas
and 36.44% of total deposits in the Kansas City MSA.
As our founders anticipated, the trade area surrounding our main banking
facility in Overland Park, Kansas has become one of the most highly developed
retail areas in the Kansas City MSA. Our Olathe, Kansas branch is located
approximately 10 miles west of our main office. We opened our Olathe branch in
1994 when we acquired the deposits of a branch of a failed savings and loan
association. We made this acquisition because it was located in a contiguous
market area and we believed that it represented a stable deposit base. The
Shawnee, Kansas banking facility is approximately 20 miles northwest of our
headquarters location. We entered into the Shawnee, Kansas market in 1999 with
the opening of a grocery store branch. During the first quarter of 2001,
construction of our freestanding banking facility in Shawnee, Kansas was
completed and operations commenced, and then in 2004, we merged our Shawnee,
Kansas grocery store branch into our Shawnee, Kansas freestanding branch. The
Leawood, Kansas grocery branch is approximately 5 miles southeast of our
headquarters location. We opened our Leawood grocery branch during October of
2002 to provide us a physical presence and expand our market penetration in
Leawood. During the second quarter of 2004, we completed construction of our
freestanding banking facility in Leawood, Kansas and operations commenced.
During 2003 we acquired an office building approximately 1 mile northwest of our
headquarters location. At this location, we consolidated our mortgage operations
and opened a banking facility.
LENDING ACTIVITIES
Overview. Our principal loan categories include commercial, commercial real
estate, construction, leasing and residential mortgages. We also offer a variety
of consumer loans. Our primary source of interest income is interest earned on
our loan portfolio. As of December 31, 2004, our loans represented approximately
75.39% of our total assets, our legal lending limit to any one borrower was
$15.5 million, and our largest single borrower as of that date had outstanding
loans of $9.5 million.
We have been successful in expanding our loan portfolio because of the
commitment of our staff and the economic growth in our area of operation. Our
staff has significant experience in lending and has been successful in offering
our products to both potential customers and existing customers. We believe that
we have been successful in maintaining our customers because of our staff's
attentiveness to their financial needs and the development of professional
relationships with them. We strive to become a strategic business partner with
our customers, not just a source of funds.
We conduct our lending activities pursuant to the loan policies adopted by
our board of directors. These policies currently require the approval of our
loan committee of all commercial credits in excess of $600,000 and all real
estate credits in excess of $1.0 million. Credits up to $600,000 on commercial
loans and $1.0 million on real estate loans can be approved by the Bank's
President or a combination of two senior loan management officers. Our
management information systems and loan review policies are designed to monitor
lending sufficiently to ensure adherence to our loan policies. The following
table shows the composition of our loan portfolio at December 31, 2004.
3
LOAN PORTFOLIO
AS OF DECEMBER 31, 2004
-----------------------
AMOUNT PERCENT
-------- -------
(DOLLARS IN THOUSANDS)
Commercial ....................... $117,604 23.19%
Commercial real estate ........... 126,205 24.88
Construction ..................... 130,631 25.76
Residential real estate .......... 30,886 6.09
Leases ........................... 21,203 4.18
Consumer ......................... 48,950 9.65
Home equity ...................... 31,691 6.25
-------- ------
Total loans and leases ........ 507,170 100.00%
Less allowance for loan losses ... 7,333
--------
Loans receivable, net ............ $499,837
--------
Commercial loans. As of December 31, 2004, approximately $117.6 million, or
23.19%, of our loan portfolio represented commercial loans. The Bank has
developed a strong reputation in providing and servicing small business and
commercial loans. We have expanded this portfolio through the addition of
commercial lending staff, their business development efforts and our reputation.
Commercial loans have historically been a significant portion of our loan
portfolio and we expect to continue our emphasis on this loan category.
The Bank's commercial lending activities historically have been directed to
small and medium-sized companies in or near Johnson County, Kansas, with annual
sales generally between $100,000 and $20 million. The Bank's commercial
customers are primarily firms engaged in manufacturing, service, retail,
construction, distribution and sales with significant operations in our market
areas. The Bank's commercial loans are primarily secured by real estate,
accounts receivable, inventory and equipment, and the Bank may seek to obtain
personal guarantees for its commercial loans. As of December 31, 2004,
approximately 10.87% of our commercial loans had outstanding balances in excess
of $300,000, and these loans accounted for 66.72% of the total carrying value of
our commercial loan portfolio. The Bank primarily underwrites its commercial
loans on the basis of the borrowers' cash flow and ability to service the debt,
as well as the value of any underlying collateral and the financial strength of
any guarantors.
Approximately $9.3 million, or 7.87%, of our commercial loans are Small
Business Administration (SBA) loans, of which $6.8 million is government
guaranteed. The SBA guarantees the repayment of a portion of the principal on
these loans, plus accrued interest on the guaranteed portion of the loan. Under
the federal Small Business Act, the SBA may guarantee up to 85% of qualified
loans of $150,000 or less and up to 75% of qualified loans in excess of
$150,000, up to a maximum guarantee of $1.0 million. We are an active SBA lender
in our market area and have been approved to participate in the SBA Certified
Lender Program.
Commercial lending is subject to risks specific to the business of each
borrower. In order to address these risks, we seek to understand the business of
each borrower, place appropriate value on any personal guarantee or collateral
pledged to secure the loan, and structure the loan amortization to maintain the
value of any collateral during the term of the loan.
Commercial real estate loans. The Bank also makes loans to provide
permanent financing for retail and office buildings, multi-family properties and
churches. As of December 31, 2004, approximately $126.2 million, or 24.88%, of
our loan portfolio represented commercial real estate loans. Our commercial real
estate loans are underwritten on the basis of the appraised value of the
property, the cash flow of the underlying property, and the financial strength
of any guarantors.
Risks inherent in commercial real estate lending are related to the market
value of the property taken as collateral, the underlying cash flows and
documentation. Commercial real estate lending involves more risk than
residential lending because loan balances may be greater and repayment is
dependent on the borrower's operations.
4
We attempt to mitigate these risks by carefully assessing property values,
investigating the source of cash flow servicing the loan on the property and
adhering to our lending and underwriting policies and procedures.
Construction loans. Our construction loans include loans to developers,
home building contractors and other companies and consumers for the construction
of single-family homes, land development, and commercial buildings, such as
retail and office buildings and multi-family properties. As of December 31,
2004, approximately $130.6 million, or 25.76%, of our loan portfolio represented
real estate construction loans. The builder and developer loan portfolio has
been a consistent and profitable component of our loan portfolio over our
fifteen-year history. We attribute this success to our expertise, availability
and prompt service. The Bank's experience and reputation in this area have
grown, thereby enabling it to focus on relationships with a smaller number of
larger builders and increasing the total value of the Bank's real estate
construction portfolio. Construction loans are made to qualified builders to
build houses to be sold following construction, pre-sold houses and model
houses. These loans are generally underwritten based upon several factors,
including the experience and current financial condition of the borrowing
entity, amount of the loan to appraised value, and general conditions of the
housing market. Construction loans are also made to individuals for whom houses
are being constructed by builders with whom the Bank has an existing
relationship. Such loans are made on the basis of the individual's financial
condition, the loan to value ratio, the reputation of the builder, and whether
the individual will be pre-qualified for permanent financing.
Risks related to construction lending include assessment of the market for
the finished product, reasonableness of the construction budget, ability of the
borrower to fund cost overruns, and the borrower's ability to liquidate and
repay the loan at a point when the loan-to-value ratio is the greatest. We seek
to manage these risks by, among other things, ensuring that the collateral value
of the property throughout the construction process does not fall below
acceptable levels, ensuring that funds disbursed are within parameters set by
the original construction budget, and properly documenting each construction
draw.
Residential real estate loans. Our residential real estate loan portfolio
consists primarily of first and second mortgage loans on residential properties.
As of December 31, 2004, $30.9 million, or 6.09%, of our loan portfolio
represented residential mortgage loans. The terms of these loans typically
include 2-5 year balloon payments based on a 15 to 30 year amortization, and
accrue interest at a fixed or variable rate. By offering these products, we can
offer credit to individuals who are self-employed or have significant income
from partnerships or investments. These individuals are often unable to satisfy
the underwriting criteria permitting the sale of their mortgages into the
secondary market.
In addition, we also originate residential mortgage loans with the
intention of selling these loans in the secondary market. During 2004, we
originated approximately $883.4 million of residential mortgage loans, and we
sold approximately $857.6 million in the secondary market. We originate
conventional first mortgage loans through our internet website as well as
through referrals from real estate brokers, builders, developers, prior
customers and media advertising. We have offered customers the ability to apply
for mortgage loans and to pre-qualify for mortgage loans over the Internet since
1999. In 2001, we expanded our internet mortgage application capacity with the
acquisition of the internet domain name InternetMortgage.com and created a
separate National Mortgage division. The timing of this expansion allowed us to
establish this division in a relatively low-rate environment, and reap the
benefits of a significant increase in mortgage originations and refinancing
experienced from 2001 through 2003. While the volume of mortgage originations
and refinancing declined in 2004, we continued to take advantage of the national
presence established in previous years and originate residential mortgage loans
on our InternetMortgage.com website. The origination of a mortgage loan from the
date of initial application through closing normally takes 15 to 60 days. We
acquire forward commitments from investors on mortgage loans that we intend to
sell into the secondary market to reduce interest rate risk on mortgage loans to
be sold in the secondary market.
Our mortgage loan credit review process is consistent with the standards
set by traditional secondary market sources. We review appraised value and debt
service ratios, and we gather data during the underwriting process in accordance
with various laws and regulations governing real estate lending. Loans
originated by the Bank are sold with servicing released to increase current
income and reduce the costs associated with retaining servicing rights.
Commitments are obtained from the purchasing investor on a loan-by-loan basis on
a 30, 45 or 60-day delivery commitment. Interest rates are committed to the
borrower when a rate commitment is obtained from the investor. Loans are funded
by the Bank and purchased by the investor within 30 days following closing
pursuant to
5
commitments obtained at the time of origination. We sell conventional conforming
loans and all loans that are non-conforming as to credit quality to secondary
market investors for cash on a non-recourse basis. Consequently, foreclosure
losses on all sold loans are generally the responsibility of the investor and
not that of the Bank.
As with other loans to individuals, the risks related to residential
mortgage loans include primarily the value of the underlying property and the
financial strength and employment stability of the borrower. We attempt to
manage these risks by performing a pre-funding underwriting that consists of the
verification of employment and utilizes a detailed checklist of loan
qualification requirements, including the source and amount of down payments,
bank accounts, existing debt and overall credit.
Lease financing. Our lease portfolio includes capital leases that we have
originated and leases that we have acquired from brokers or third parties. As of
December 31, 2004, our lease portfolio totaled $21.2 million, or 4.18% of our
total loan portfolio, consisting of $15.2 million principal amount of leases
originated by us and $6.0 million principal amount of leases that we purchased.
We provide lease financing for a variety of equipment and machinery, including
office equipment, heavy equipment, telephone systems, tractor trailers and
computers. Lease terms are generally from three to five years. Management
believes this area is attractive because of its ability to provide a source of
both interest and fee income. Our leases are generally underwritten based upon
several factors, including the overall credit worthiness, experience and current
financial condition of the lessee, the amount of the financing to collateral
value, and general conditions of the market.
The primary risks related to our lease portfolio are the value of the
underlying collateral and specific risks related to the business of each
borrower. To address these risks, we attempt to understand the business of each
borrower, value the underlying collateral appropriately and structure the loan
amortization to ensure that the value of the collateral exceeds the lease
balance during the term of the lease.
Consumer loans. As of December 31, 2004, our consumer loans totaled $49.0
million, or 9.65% of our total loan portfolio. A substantial part of this amount
consisted of installment loans to individuals in our market area. Installment
lending offered directly by the Bank in our market area includes automobile
loans, recreational vehicle loans, home improvement loans, unsecured lines of
credit and other loans to professionals, people employed in education, industry
and government, as well as retired individuals and others. A significant portion
of our consumer loan portfolio consists of indirect automobile loans offered
through automobile dealerships located primarily in our trade area. As of
December 31, 2004, approximately $39.8 million, or 7.82%, of our loan portfolio
represented indirect installment loans. Our loans made through this program
generally represent loans to purchase new or late model automobiles. There are
currently 29 dealerships participating in this program.
Since 1999, we have offered customers the ability to apply for consumer
loans, personal lines of credit and overdraft protection lines of credit over
the Internet through our electronic banking services. To date, consumer loan
applications received over the Internet have not represented a material amount
of our consumer loan portfolio. Our consumer and other loans are underwritten
based on the borrower's income, current debt, past credit history, collateral,
and the reputation of the originating dealership with respect to indirect
automobile loans.
Consumer loans are subject to the same risks as other loans to individuals,
including the financial strength and employment stability of the borrower. In
addition, some consumer loans are subject to the additional risk that the loan
is not secured by collateral. For some of the loans that are secured, the
underlying collateral may be rapidly depreciating and not provide an adequate
source of repayment if we are required to repossess the collateral. We attempt
to mitigate these risks by requiring a down payment and carefully verifying and
documenting the borrower's credit quality, employment stability, monthly income,
and with respect to indirect automobile loans, understanding and documenting the
value of the collateral and the reputation of the originating dealership.
Home equity loans. As of December 31, 2004, our home equity loans totaled
$31.7 million, or 6.25% of our total loan portfolio. Home equity loans are
generally secured by second liens on residential real estate and are
underwritten in a similar manner as our consumer loans.
6
INVESTMENT ACTIVITIES
The objectives of our investment policy are to:
- secure the safety of principal;
- provide adequate liquidity;
- provide securities for use in pledging for public funds or repurchase
agreements; and
- maximize after-tax income.
We invest primarily in direct obligations of the United States, obligations
guaranteed as to principal and interest by the United States, obligations of
agencies of the United States and bank-qualified obligations of state and local
political subdivisions. In order to ensure the safety of principal, we typically
do not invest in mortgage-backed securities, corporate debt, or other securities
even though they are permitted by our investment policy. In addition, we enter
into federal funds transactions with our principal correspondent banks, and
depending on our liquidity position, act as a net seller or purchaser of these
funds. The sale of federal funds is effectively short-term loans from us to
other banks; while conversely, the purchase of federal funds is effectively
short-term loans from other banks to us.
DEPOSIT SERVICES
The principal sources of funds for the Bank are core deposits from the
local market areas surrounding the Bank's offices, including demand deposits,
interest-bearing transaction accounts, money market accounts, savings deposits
and time deposits of less than $100,000. Transaction accounts include
interest-bearing and non-interest-bearing accounts, which provide the Bank with
a source of fee income and cross-marketing opportunities as well as a low-cost
source of funds. Since 2001, the Bank has realized a significant level of
deposit growth from commercial checking accounts. While these accounts do not
earn interest, many of them receive an earnings credit on their average balance
to offset the cost of other services provided by the Bank. The Bank also offers
two types of short-term investment accounts. The Bank's money market account is
a daily access account that bears a higher rate than a personal interest-bearing
checking account and allows for limited check-writing ability. A significant
portion of our deposit growth during 2004 and 2003 has been attributable to our
Money Management Account, or "short-term parking account." The Money Management
Account provides a hybrid of the features available from a traditional money
market account and a traditional time deposit. The account requires a minimum
balance of $10,000 and allows for daily deposits but limits withdrawals to the
first day and the 15th day of each month. This account typically pays a tiered
rate of interest which is higher than a customer could receive on a traditional
money market account but lower than the rates generally available on time
deposits. We believe that the trade-off to depositors between higher interest
rates but more limited access to withdrawals has proven to be an attractive
product in our market areas and provides us with a more attractive source of
funds than other alternatives such as Federal Home Loan Bank borrowings, as it
provides us with the potential to cross-sell additional services to these
account holders. Time and savings accounts also provide a relatively stable
customer base and source of funding. Because of the nature and behavior of these
deposit products, management reviews and analyzes our pricing strategy in
comparison not only to competitor rates, but versus other alternative funding
sources to determine the most advantageous source. The Bank's Funds Management
policy also allows for acceptance of brokered deposits which can be utilized to
support the growth of the Bank. As of December 31, 2004, the Bank had $471,000
in brokered deposits, and the Bank does not anticipate brokered deposits
becoming a significant percentage of its deposit base; however, we continue to
evaluate their potential role in the Bank's overall funding and liquidity
strategies. In pricing deposit rates, management considers profitability, the
matching of term lengths with assets, the attractiveness to customers and rates
offered by our competitors.
7
INVESTMENT BROKERAGE SERVICES
In 1999, the Bank began offering investment brokerage services through an
unrelated broker-dealer. These services are currently offered at all of our
locations. Four individuals responsible for providing these services are joint
employees of the Bank and the registered broker-dealer. Investment brokerage
services provide a source of fee income for the Bank. In 2004, the amount of our
fee income generated from investment brokerage services was $326,000.
TRUST SERVICES
We began offering trust services in 1996. Until 1999, the Bank's trust
services were offered exclusively through the employees of an unaffiliated trust
company. The Bank hired a full-time officer in 1999 to develop the Bank's trust
business. Trust services are marketed to both existing Bank customers and new
customers. We believe that the ability to offer trust services as a part of our
complement of financial services to new customers of the Bank presents a
significant cross-marketing opportunity. The services currently offered by the
Bank's trust department include the administration of self-directed individual
retirement accounts, qualified retirement plans, and custodial and directed
trust accounts. As of December 31, 2004, the Bank's trust department
administered 229 accounts, with assets under management of approximately $118.1
million. Trust services provide the Bank with a source of fee income and
additional deposits. In 2004, the amount of our fee income from trust services
was $304,000.
COMPETITION
We encounter competition primarily in seeking deposits and in obtaining
loan customers. The level of competition for deposits in our market area and
nationally is high. Our principal competitors for deposits are other financial
institutions within a few miles of our locations including other banks, savings
institutions and credit unions. Competition among these institutions is based
primarily on interest rates offered, the quality of service provided, and the
convenience of banking facilities. Additional competition for depositors' funds
comes from U.S. government securities, private issuers of debt obligations and
other providers of investment alternatives for depositors.
We compete in our lending, investment brokerage and trust activities with
other financial institutions, such as banks and thrift institutions, credit
unions, automobile financing companies, mortgage companies, securities firms,
investment companies and other finance companies. Many of our competitors are
not subject to the same extensive federal regulations that govern bank holding
companies and federally insured banks and state regulations governing
state-chartered banks. As a result, these non-bank competitors have some
advantages over us in providing certain products and services. Many of the
financial institutions with which we compete are larger and possess greater
financial resources, name recognition and market presence.
EMPLOYEES
At December 31, 2004, the Bank had approximately 278 full-time employees.
Blue Valley, Blue Valley Building Corp., BVBC Capital Trust I, BVBC Capital
Trust II, Blue Valley Insurance Services, and Blue Valley Investment Corp. did
not have any employees. None of the Bank's employees are subject to a collective
bargaining agreement. We consider the Company's subsidiaries' relationship with
their employees to be excellent.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For each of our directors and our executive officers, we have set forth
below their ages as of December 31, 2004, and their principal positions.
8
Name Age Positions
- ---- --- ---------
Directors
Robert D. Regnier ......................... 56 President, Chief Executive Officer and Chairman of the
Board of Directors of Blue Valley; President, Chief
Executive Officer and Director of the Bank
Donald H. Alexander........................ 66 Director of Blue Valley and the Bank
Wayne A. Henry, Jr......................... 52 Director of Blue Valley
C. Ted McCarter............................ 68 Director of Blue Valley and Chairman of the Board of
Directors of the Bank
Thomas A. McDonnell........................ 59 Director of Blue Valley
Additional Directors of the Bank
Harvey S. Bodker........................... 69 Director of the Bank
Suzanne E. Dotson.......................... 58 Director of the Bank
Charles H. Hunter.......................... 62 Director of the Bank
Executive Officers who are not Directors
Mark A. Fortino............................ 38 Senior Vice President and Chief Financial Officer of
the Bank; Chief Financial Officer of Blue Valley
Ralph J. Schramp........................... 55 Senior Vice President - Commercial Lending and
Business Development for the Bank
Gary L. Sherrer............................ 64 Senior Vice President - Mortgage Division of the Bank
Sheila Stokes.............................. 43 Senior Vice President - Retail Division of the Bank
REGULATION AND SUPERVISION
Blue Valley and its subsidiaries are extensively regulated under both
federal and state laws. Laws and regulations to which Blue Valley and the Bank
are subject govern, among other things, the scope of business, investments,
reserve levels, 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. These laws and regulations are intended primarily
to protect depositors, not stockholders. Any change in applicable laws or
regulations may have a material effect on Blue Valley's business and prospects,
and legislative and policy changes may affect Blue Valley's operations. Blue
Valley cannot predict the nature or the extent of the effects on its business
and earnings that fiscal or monetary policies, economic controls or new federal
or state legislation may have in the future.
The following references to statutes and regulations affecting Blue Valley
and the Bank are brief summaries only and do not purport to be complete and are
qualified in their entirety by reference to the statutes and regulations.
APPLICABLE LEGISLATION
The enactment of legislation described below has significantly affected the
banking industry generally and will have an on-going effect on Blue Valley and
its subsidiaries.
GRAMM-LEACH-BLILEY ACT. The Gramm-Leach-Bliley Act was signed into law on
November 12, 1999. This major banking legislation expands the permissible
activities of bank holding companies such as Blue Valley by permitting them to
engage in activities, or affiliate with entities that engage in activities, that
are "financial in nature." Activities that the Act expressly deems to be
financial in nature include, among other things, securities and insurance
underwriting and agency, investment management and merchant banking. The Federal
Reserve and the Treasury Department, in cooperation with one another, determine
what additional activities are "financial in nature."
9
With certain exceptions, the Gramm-Leach-Bliley Act similarly expands the
authorized activities of subsidiaries of national banks. The provisions of the
Gramm-Leach-Bliley Act authorizing the expanded powers became effective March
11, 2000.
Bank holding companies that intend to engage in activities that are
"financial in nature" must elect to become "financial holding companies."
Financial holding company status is only available to a bank holding company if
all of its affiliated depository institutions are "well capitalized" and "well
managed," based on applicable banking regulations, and have a Community
Reinvestment Act rating of at least "a satisfactory record of meeting community
credit needs." Financial holding companies and banks may continue to engage in
activities that are financial in nature only if they continue to satisfy the
well capitalized and well managed requirements. Bank holding companies that do
not elect to be financial holding companies or that do not qualify for financial
holding company status may engage only in non-banking activities deemed "closely
related to banking" prior to adoption of the Gramm-Leach-Bliley Act.
The Act also calls for "functional regulation" of financial services
businesses in which functionally regulated subsidiaries of bank holding
companies will continue to be regulated by the regulator that ordinarily has
supervised their activities. As a result, state insurance regulators will
continue to oversee the activities of insurance companies and agencies, and the
Securities and Exchange Commission will continue to regulate the activities of
broker-dealers and investment advisers, even where the companies or agencies are
affiliated with a bank holding company. Federal Reserve authority to examine and
adopt rules regarding functionally regulated subsidiaries is limited.
The Gramm-Leach-Bliley Act imposed an "affirmative and continuing"
obligation on all financial service providers (not just banks and their
affiliates) to safeguard consumer privacy and requires federal and state
regulators, including the Federal Reserve and the FDIC, to establish standards
to implement this privacy obligation. With certain exceptions, the Act prohibits
banks from disclosing to non-affiliated parties any non-public personal
information about customers unless the bank has provided the customer with
certain information and the customer has had the opportunity to prohibit the
bank from sharing the information with non-affiliates. The new privacy
obligations became effective July 1, 2001.
The Gramm-Leach-Bliley Act has been and may continue to be the subject of
extensive rule making by federal banking regulators and others.
ECONOMIC GROWTH AND REGULATORY PAPERWORK REDUCTION ACT OF 1996. The
Economic Growth and Regulatory Paperwork Reduction Act of 1996 became law on
September 30, 1996. This Act streamlined the non-banking activities application
process for well-capitalized and well-managed bank holding companies by
permitting qualified bank holding companies to commence an approved non-banking
activity without prior notice to the Federal Reserve, although written notice is
required within 10 days after commencing the activity. Also, the Act reduced the
prior notice period to 12 days in the event of any non-banking acquisition or
share purchase, assuming the size of the acquisition does not exceed 10% of
risk-weighted assets of the acquiring bank holding company and the consideration
does not exceed 15% of a bank holding company's Tier 1 capital.
BANK HOLDING COMPANY REGULATION
Blue Valley is a registered bank holding company subject to periodic
examination by the Federal Reserve and required to file periodic reports of its
operations and such additional information as the Federal Reserve may require.
INVESTMENTS AND ACTIVITIES. A bank holding company must obtain approval
from the Federal Reserve before:
- Acquiring, directly or indirectly, ownership or control of any voting
shares of another bank or bank holding company if, after the
acquisition, it would own or control more than 5% of the shares of the
bank or bank holding company (unless it already owns or controls the
majority of the shares);
10
- Acquiring all or substantially all of the assets of another bank or
bank holding company; or
- Merging or consolidating with another bank holding company.
The Federal Reserve will not approve any acquisition, merger or
consolidation that would have a substantially anticompetitive result unless the
anticompetitive effects of the proposed transaction are clearly outweighed by a
greater public interest in meeting the convenience and needs of the community to
be served. The Federal Reserve also considers capital adequacy and other
financial and managerial factors in reviewing acquisitions or mergers.
With certain exceptions, a bank holding company is also prohibited from:
- Acquiring or retaining direct or indirect ownership or control of more
than 5% of the voting shares of any company that is not a bank or bank
holding company; and
- Engaging, directly or indirectly, in any business other than that of
banking, managing and controlling banks or furnishing services to
banks and their subsidiaries.
Bank holding companies may, however, engage in businesses found by the
Federal Reserve to be "financial in nature," as describe above. As a financial
holding company, Blue Valley is authorized to engage in the expanded activities
permitted under the Gramm-Leach-Bliley Act as long as it continues to qualify
for financial holding company status.
Finally, subject to certain exceptions, the Bank Holding Company Act and
the Change in Bank Control Act, and the Federal Reserve's implementing
regulations, require Federal Reserve approval prior to any acquisition of
"control" of a bank holding company, such as Blue Valley. In general, a person
or company is presumed to have acquired control if it acquires 10% of the
outstanding shares of a bank or bank holding company and is conclusively
determined to have acquired control if it acquires 25% or more of the
outstanding shares of a bank or bank holding company.
SOURCE OF STRENGTH. The Federal Reserve expects Blue Valley to act as a
source of financial strength and support for the Bank and to take measures to
preserve and protect the Bank in situations where additional investments in the
Bank may not otherwise be warranted. The Federal Reserve may require a bank
holding company to terminate any activity or relinquish control of a non-bank
subsidiary (other than a non-bank subsidiary of a bank) upon the Federal
Reserve's determination that the activity or control constitutes a serious risk
to the financial soundness or stability of any subsidiary depository institution
of the bank holding company. Further, federal bank regulatory authorities have
additional discretion to require a bank holding company to divest itself of any
bank or non-bank subsidiary if the agency determines that divestiture may aid
the depository institution's financial condition. Blue Valley Building Corp.,
BVBC Capital Trust I and BVBC Capital Trust II are Blue Valley's only active
direct subsidiaries that are not banks.
CAPITAL REQUIREMENTS. The Federal Reserve uses capital adequacy guidelines
in its examination and regulation of bank holding companies and banks. If the
capital falls below minimum guideline levels, a bank holding company, among
other things, may be denied approval to acquire or establish additional banks or
non-bank businesses. The Federal Reserve's capital guidelines establish a
risk-based requirement expressed as a percentage of total risk-weighted assets
and 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%, of which at least one-half must be Tier 1 capital
(which consists principally of stockholders' equity). The leverage requirement
consists of a minimum ratio of Tier 1 capital to total assets of 3%.
The risk-based and leverage standards presently used by the Federal Reserve
are minimum requirements, and higher capital levels may be required if warranted
by the particular circumstances or risk profiles of individual banking
organizations. Further, any banking organization experiencing or anticipating
significant growth would be expected to maintain capital ratios, including
tangible capital positions, which is Tier 1 capital less all intangible assets,
well above the minimum levels.
11
DIVIDENDS. The Federal Reserve has issued a policy statement concerning the
payment of cash dividends by bank holding companies. The policy statement
provides that a bank holding company experiencing earnings weaknesses should not
pay cash dividends exceeding its net income or which could only be funded in
ways that weakened the bank holding company's financial health, such as by
borrowing. Also, the Federal Reserve 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.
BANK REGULATIONS
The Bank operates under a Kansas state bank charter and is subject to
regulation by the Kansas Banking Department and the Federal Reserve Bank. The
Kansas Banking Department and the Federal Reserve Bank regulate or monitor all
areas of the Bank's operations, including capital requirements, issuance of
stock, declaration of dividends, interest rates, deposits, record keeping,
establishment of branches, acquisitions, mergers, loans, investments, borrowing,
security devices and procedures and employee responsibility and conduct. The
Kansas Banking Department places limitations on activities of the Bank including
the issuance of capital notes or debentures and the holding of real estate and
personal property and requires the Bank to maintain a certain ratio of reserves
against deposits. The Kansas Banking Department requires the Bank to file a
report annually showing receipts and disbursements of the Bank, in addition to
any periodic report requested.
DEPOSIT INSURANCE. The FDIC, through its Bank Insurance Fund, insures the
Bank's deposit accounts to a maximum of $100,000 for each insured depositor. The
FDIC, through its Savings Association Insurance Fund, insures certain deposit
accounts acquired by the Bank in 1994 from a branch of a failed savings
institution. These deposit accounts are insured to a maximum of $100,000 for
each insured depositor. The FDIC bases deposit insurance premiums on the
perceived risk each bank presents to its deposit insurance fund. In addition,
all Bank Insurance Fund-insured and Savings Association Insurance Fund-insured
institutions currently pay an assessment based on insured deposits to service
debt issued by the Financing Corporation, a federal agency established to
finance the recapitalization of the former Federal Savings and Loan Insurance
Corporation. The FDIC may terminate the deposit insurance of any insured
depository institution if the FDIC determines, after a hearing, that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, order, or any condition imposed in writing by, or
written agreement with, the FDIC. The FDIC may also suspend deposit insurance
temporarily during the hearing process for a permanent termination of insurance
if the institution has no tangible capital. Management is not aware of any
activity or condition that could result in termination of the deposit insurance
of the Bank.
CAPITAL REQUIREMENTS. The FDIC has established the following minimum
capital standards for state-chartered, insured non-member banks, such as the
Bank: (1) a leverage requirement consisting of a minimum ratio of Tier 1 capital
to total assets of 3%; and (2) a risk-based capital requirement consisting of a
minimum ratio of total capital to total risk-weighted assets of 8%, at least
one-half of which must be Tier 1 capital. These capital requirements are minimum
requirements, and higher capital levels may be required if warranted by the
particular circumstances or risk profiles of individual institutions.
The federal banking regulators also have broad power to take "prompt
corrective action" to resolve the problems of undercapitalized institutions. The
extent of the regulators' powers depends upon whether the institution in
question is "well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized" or "critically undercapitalized." Under the
prompt corrective action rules, an institution is:
- "Well-capitalized" if the institution has a total risk-based capital
ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or
greater, and a leverage ratio of 5% or greater, and the institution is
not subject to an order, written agreement, capital directive, or
prompt corrective action directive to meet and maintain a specific
capital level for any capital measure;
- "Adequately capitalized" if the institution has a total risk-based
capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of
4% or greater, and a leverage ratio of 4% or greater;
12
- "Undercapitalized" if the institution has a total risk-based capital
ratio that is less than 8%, a Tier 1 risk-based capital ratio that is
less than 4%, or a leverage ratio that is less than 4%;
- "Significantly undercapitalized" if the institution has a total
risk-based capital ratio that is less than 6%, a Tier 1 risk-based
capital ratio that is less than 3%, or a leverage ratio that is less
than 3%; and
- "Critically undercapitalized" if the institution has a ratio of
tangible equity to total assets that is equal to or less than 2%.
The federal banking regulators must take prompt corrective action with
respect to capital deficient institutions. Depending upon the capital category
to which an institution is assigned, the regulators' corrective powers include:
- Placing limits on asset growth and restrictions on activities,
including the establishing of new branches;
- Requiring the institution to issue additional capital stock (including
additional voting stock) or to be acquired;
- Restricting transactions with affiliates;
- Restricting the interest rate the institution may pay on deposits;
- Requiring that senior executive officers or directors be dismissed;
- Requiring the institution to divest subsidiaries;
- Prohibiting the payment of principal or interest on subordinated debt;
and
- Appointing a receiver for the institution.
Companies controlling an undercapitalized institution are also required to
guarantee the subsidiary institution's compliance with the capital restoration
plan subject to an aggregate limitation of the lesser of 5% of the institution's
assets at the time it received notice that it was undercapitalized or the amount
of the capital deficiency when the institution first failed to meet the plan.
The Federal Deposit Insurance Act generally requires the appointment of a
conservator or receiver within 90 days after an institution becomes critically
undercapitalized.
As of December 31, 2004, the Bank had capital in excess of the requirements
for a "well-capitalized" institution.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT. The Bank, having
over $500 million in total assets, is subject to numerous reporting requirements
of Section 112 of the Federal Deposit Insurance Corporation Act (FDICIA 112).
The primary purpose of FDICIA 112 is to provide a framework for early risk
identification in financial management through independent audits, more
stringent reporting requirements and an effective system of internal controls.
INSIDER TRANSACTIONS. The Bank is subject to restrictions on extensions of
credit to executive officers, directors, principal stockholders or any related
interest of these persons. Extensions of credit must be made on substantially
the same terms, including interest rates and collateral as the terms available
for third parties and must not involve more than the normal risk of repayment or
present other unfavorable features. The Bank is also subject to lending limits
and restrictions on overdrafts to these persons.
COMMUNITY REINVESTMENT ACT REQUIREMENTS. The Community Reinvestment Act
(CRA) of 1977 requires that, in connection with examinations of financial
institutions within their jurisdiction, the federal banking regulators must
evaluate the record of the financial institutions in meeting the credit needs of
their local communities, including
13
low and moderate income neighborhoods, consistent with the safe and sound
operation of those banks. These factors are also considered in evaluating
mergers, acquisitions and applications to open a branch or facility. In its most
recent CRA examination dated June 1, 2004, the Bank received a rating of
"Satisfactory."
STATE BANK ACTIVITIES. With limited exceptions, FDIC-insured state banks,
like the Bank, may not make or retain equity investments of a rate or in an
amount that are not permissible for national banks and also may not engage as a
principal in any activity that is not permitted for a national bank or its
subsidiary, respectively, unless the bank meets, and continues to meet, its
minimum regulatory capital requirements and the FDIC determines that the
activity would not pose a significant risk to the deposit insurance fund of
which the bank is a member.
REGULATIONS GOVERNING EXTENSIONS OF CREDIT. The Bank is subject to
restrictions on extensions of credit to Blue Valley and on investments in Blue
Valley's securities and using those securities as collateral for loans. These
regulations and restrictions may limit Blue Valley's ability to obtain funds
from the Bank for its cash needs, including funds for acquisitions and for
payment of dividends, interest and operating expenses. Further, the Bank Holding
Company Act and Federal Reserve regulations prohibit a bank holding company and
its subsidiaries from engaging in various tie-in arrangements in connection with
extensions of credit, leases or sales of property or furnishing of services.
RESERVE REQUIREMENTS. The Federal Reserve requires all depository
institutions to maintain reserves against their transaction accounts. Reserves
of 3% must be maintained against net transaction accounts of $7.0 million to
$47.6 million plus 10% must be maintained against that portion of net
transaction accounts in excess $47.6 million (subject to adjustment by the
Federal Reserve). The balances maintained to meet the reserve requirements
imposed by the Federal Reserve may be used to satisfy liquidity requirements.
OTHER REGULATIONS
Interest and various other charges collected or contracted for by the Bank
are subject to state usury laws and other federal laws concerning interest
rates. The Bank's loan operations are also subject to federal laws applicable to
credit transactions. The federal Truth in Lending Act governs disclosures of
credit terms to consumer borrowers. The Home Mortgage Disclosure Act of 1975
requires financial institutions to provide information to enable the public and
public officials to determine whether a financial institution is fulfilling its
obligation to help meet the housing needs of the community it serves. The Equal
Credit Opportunity Act prohibits discrimination on the basis of race, creed or
other prohibited factors in extending credit. The Fair Credit Reporting Act of
1978 governs the use and provision of information to credit reporting agencies.
The Fair Debt Collection Act governs the manner in which consumer debts may be
collected by collection agencies. The various federal agencies charged with the
responsibility of implementing these federal laws have adopted various rules and
regulations. The deposit operations of the Bank are also subject to the Right to
Financial Privacy Act, which imposes a duty to maintain confidentiality of
consumer financial records and prescribes procedures for complying with
administrative subpoenas of financial records, and the Electronic Funds Transfer
Act, and Regulation E issued by the Federal Reserve to implement that Act, which
govern automatic deposits to and withdrawals from the use of ATMs and other
electronic banking services.
ITEM 2: PROPERTIES
The Company's principal office occupies 2.40 acres of ground on the corner
of 119th and Riley streets in Overland Park, Kansas. The construction of the
building was completed in 1994 and consists of 38,031 square feet. The building
and land are subject to third-party mortgage indebtedness incurred in December
2004 in the original principal amount of $2.8 million. As of December 31, 2004,
the outstanding principal amount of this indebtedness was $2.8 million.
In 2001, our Olathe, Kansas banking center was moved to a more suitable
property occupying 0.41 acres of ground on the southwest corner of Santa Fe and
Ridgeview streets. The building consists of 2,580 square feet on the main floor,
plus basement storage. We still own the old banking center property which is on
the northwest corner of
14
Santa Fe and Ridgeview streets and occupies 0.94 acres of ground. That building
consists of 4,116 square feet and we are actively marketing this property for
sale.
Our facility in Shawnee, Kansas is located at Highway K-7 and 55th Street
and was completed during the first quarter of 2001. The building consists of
4,000 square feet and occupies 0.85 acres of land.
In January 2003, we purchased a 55,000 square foot building on 3.10 acres
of ground located on the northwest corner of College Boulevard and Lowell in
Overland Park, Kansas. The Bank consolidated its mortgage operations and
operates a small branch at this facility. The building and land are subject to
third-party mortgage indebtedness incurred in December 2004 in the original
principal amount of $4.7 million. As of December 31, 2004, the outstanding
principal amount of this indebtedness was $4.7 million.
During the second quarter of 2004 we opened a 7,000 square foot
full-service banking center within a two-story 20,000 square foot office
building on the corner of 135th Street and Mission Road in Leawood, Kansas. We
also operate a 400 square foot banking center in a grocery store at 135th Street
and Mission Road. The lease for this space bears a primary term through June,
2005.
In 1998, we purchased approximately 1.34 acres of undeveloped land on the
corners of K-68 and US 69 Highway in Louisburg, Kansas, just south of Johnson
County for potential future development as a full-service branch. We no longer
believe this market is strong enough to support another bank franchise and we
are actively marketing this property for sale.
ITEM 3: LEGAL PROCEEDINGS
On October 13th, 2004, we became a defendant in a lawsuit filed in the
United States District Court, Kansas District by one current mortgage loan
originator and twenty three former mortgage loan originators. The plaintiffs are
claiming that the Bank did not compensate them appropriately for overtime hours
worked in accordance with the Fair Labor Standards Act. While the plaintiffs'
claims total $5.6 million, we believe the Company has meritorious defenses to
the claims made and we intend to vigorously defend against these claims. In the
fourth quarter of 2004, the Company took a $550,000 charge recording a liability
for the estimated potential cost of this litigation. We currently do not
anticipate any significant additional financial impact from this litigation.
Other than this claim, there are no other pending legal proceedings that are
likely to have a material adverse effect on our consolidated financial
condition, results of operations or cash flows.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our stockholders, through the
solicitation of proxies or otherwise, during the fourth quarter of the fiscal
year covered by this report.
15
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
MARKET FOR COMMON STOCK
We are a reporting company under the Securities Exchange Act as a result of
a trust preferred securities offering we completed during July 2000. Shares of
our common stock have traded on the Over-The-Counter Bulletin Board since July
2002 under the symbol "BVBC." As of February 28, 2005, there were approximately
199 stockholders of record of our common stock. The following table sets forth
the high and low prices of the Company's common stock based on closing stock
price quotations provided by Yahoo.com. These prices reflect inter-dealer
prices, without retail mark-up, mark-down or commission and may not represent
actual transactions.
2004 2003
--------------- ---------------
Fiscal Period High Low High Low
- ------------- ------ ------ ------ ------
First $27.00 $25.10 $25.84 $20.53
Second 27.95 23.75 27.83 22.42
Third 27.00 26.00 29.82 26.34
Fourth 26.75 24.00 30.07 24.85
DIVIDENDS
Our board of directors declared cash dividends on our common stock as
follows:
DECLARATION DATE AMOUNT PER SHARE RECORD DATE PAY DATE
---------------- ---------------- ----------- --------
December 16, 2002 $0.10 December 31, 2002 January 15, 2003
December 15, 2003 $0.15 December 31, 2003 January 30, 2004
December 17, 2004 $0.20 December 31, 2004 January 31, 2005
Because our consolidated net income consists largely of the net income of
the Bank, our ability to pay dividends on our common stock is subject to our
receipt of dividends from the Bank. The ability of the Bank to pay dividends to
us, and our ability to pay dividends to our stockholders, is regulated by
federal banking laws. In addition, if we elect to defer interest payments on our
outstanding junior subordinated debentures, we will be prohibited from paying
dividends on our common stock during such deferral. At December 31, 2004,
approximately $12,695,000 of retained earnings were available for dividend
declaration without prior regulatory approval.
Our board of directors intends to declare future dividends subject to
limitations imposed by regulatory capital guidelines in addition to
consideration of the Company's profitability and liquidity.
16
ITEM 6: SELECTED FINANCIAL DATA
The following table presents our consolidated financial data as of and for
the five years ended December 31, 2004, and should be read in conjunction with
the consolidated financial statements and notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations," each
of which is included elsewhere in this Form 10-K. The selected statements of
condition and statements of income data, insofar as they relate to the five
years in the five-year period ended December 31, 2004, have been derived from
our audited consolidated financial statements.
AS OF AND FOR THE
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
SELECTED STATEMENT OF INCOME DATA
Interest income:
Loans, including fees .............................. $ 29,245 $ 28,293 $ 26,857 $ 27,921 $ 26,733
Federal funds sold and interest-bearing deposits ... 157 49 297 679 777
Securities ......................................... 2,301 2,070 3,405 4,541 3,607
---------- ---------- ---------- ---------- ----------
Total interest income ........................... 31,703 30,412 30,559 33,141 31,117
---------- ---------- ---------- ---------- ----------
Interest expense:
Interest-bearing demand deposits ................... 169 165 388 815 872
Savings and money market deposit accounts .......... 2,932 2,204 2,711 4,846 5,726
Other time deposits ................................ 7,297 6,935 7,759 9,775 7,555
Funds borrowed ..................................... 4,115 4,245 3,368 2,958 2,543
---------- ---------- ---------- ---------- ----------
Total interest expense .......................... 14,513 13,549 14,226 18,394 16,696
---------- ---------- ---------- ---------- ----------
Net interest income ............................. 17,190 16,863 16,333 14,747 14,421
Provision for loan losses ............................. 1,965 1,350 2,920 2,400 1,950
---------- ---------- ---------- ---------- ----------
Net interest income after provision for loan
losses ....................................... 15,225 15,513 13,413 12,347 12,471
---------- ---------- ---------- ---------- ----------
Non-interest income:
Loans held for sale fee income ..................... 10,358 19,866 16,690 6,931 1,154
NSF charges & service fees ......................... 1,326 1,283 1,026 836 655
Other service charges .............................. 1,115 924 821 796 963
Realized gain on available-for-sale securities ..... 524 -- 193 500 --
Other income ....................................... 617 463 281 203 284
---------- ---------- ---------- ---------- ----------
Total non-interest income ....................... 13,940 22,536 19,011 9,266 3,056
---------- ---------- ---------- ---------- ----------
Non-interest expense:
Salaries and employee benefits ..................... 16,670 19,670 16,437 10,063 5,856
Occupancy .......................................... 3,433 3,137 2,101 1,574 1,124
FDIC and other insurance ........................... 175 174 161 140 177
General & administrative ........................... 6,292 6,304 5,417 3,933 3,136
---------- ---------- ---------- ---------- ----------
Total non-interest expense ...................... 26,570 29,285 24,116 15,710 10,293
---------- ---------- ---------- ---------- ----------
Income before income taxes ......................... 2,595 8,764 8,308 5,903 5,234
Income tax provision ............................ 665 3,130 2,912 1,960 1,757
---------- ---------- ---------- ---------- ----------
Net income ...................................... $ 1,930 $ 5,634 $ 5,396 $ 3,943 $ 3,477
========== ========== ========== ========== ==========
PER SHARE DATA
Basic earnings ..................................... $ 0.84 $ 2.51 $ 2.48 $ 1.82 $ 1.62
Diluted earnings ................................... 0.82 2.43 2.40 1.77 1.59
Dividends .......................................... 0.20 0.15 0.10 -- --
Book value basic (at end of period) ................ 17.78 17.64 15.47 13.11 11.12
Weighted average common shares outstanding:
Basic ........................................... 2,302,564 2,244,930 2,178,803 2,165,030 2,141,523
Diluted ......................................... 2,360,061 2,320,840 2,252,929 2,222,166 2,191,305
Dividend payout ratio .............................. 23.80% 5.98% 4.04% --% --%
17
AS OF AND FOR THE
YEAR ENDED DECEMBER 31,
----------------------------------------------------
2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
SELECTED FINANCIAL CONDITION DATA
(AT END OF PERIOD):
Total securities .................................... $ 66,350 $106,036 $ 61,720 $ 78,032 $ 78,859
Total mortgage loans held for sale .................. 44,144 18,297 119,272 41,853 1,207
Total loans ......................................... 507,170 424,620 380,082 334,075 287,669
Total assets ........................................ 672,717 627,073 605,539 492,379 415,023
Total deposits ...................................... 522,646 470,495 423,787 394,245 338,221
Funds borrowed ...................................... 102,469 111,741 141,737 65,530 50,273
Total stockholders' equity .......................... 41,384 40,198 34,344 28,525 23,815
Trust assets under administration ................... 118,074 90,389 44,245 41,571 35,268
SELECTED FINANCIAL RATIOS AND OTHER DATA:
Performance Ratios:
Net interest margin (1) .......................... 2.91% 3.01% 3.35% 3.51% 4.35%
Non-interest income to average assets ............ 2.16 3.62 3.55 2.02 0.84
Non-interest expense to average assets ........... 4.11 4.71 4.51 3.43 2.84
Net overhead ratio (2) ........................... 1.96 1.08 0.95 1.41 2.00
Efficiency ratio (3) ............................. 85.35 74.33 68.23 65.42 58.89
Return on average assets (4) ..................... 0.30 0.91 1.01 0.86 0.96
Return on average equity (5) ..................... 4.69 14.85 17.34 15.26 16.84
Asset Quality Ratios:
Non-performing loans to total loans .............. 0.86% 0.72% 0.29% 0.92% 0.86%
Allowance for possible loan losses to:
Total loans ................................... 1.45 1.66 1.82 1.58 1.54
Non-performing loans .......................... 168.60 230.79 618.29 171.96 179.47
Net charge-offs to average total loans ........... 0.36 0.30 0.36 0.51 0.49
Non-performing loans to total assets ............. 0.65 0.50 0.18 0.62 0.60
Balance Sheet Ratios:
Loans to deposits ................................ 97.04% 90.25% 89.69% 84.74% 85.05%
Average interest-earning assets to average
interest-bearing liabilities .................. 114.38 114.61 115.64 114.50 113.30
Capital Ratios:
Total equity to total assets ..................... 6.15% 6.42% 5.67% 5.80% 5.74%
Total capital to risk-weighted assets ratio ...... 11.15 12.41 10.13 10.69 11.95
Tier 1 capital to risk-weighted assets ratio ..... 9.00 10.04 8.82 8.87 9.51
Tier 1 capital to average assets ratio ........... 8.45 8.31 7.74 7.17 7.47
Average equity to average assets ratio ........... 6.37 6.10 5.82 5.64 5.70
- ----------
(1) Net interest income, on a full tax-equivalent basis, divided by average
interest-earning assets.
(2) Non-interest expense less non-interest income divided by average total
assets.
(3) Non-interest expense divided by the sum of net interest income plus
non-interest income.
(4) Net income divided by average total assets.
(5) Net income divided by average common equity.
18
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following presents management's discussion and analysis of our
financial condition and results of operations as of the dates and for the
periods indicated. You should read this discussion in conjunction with our
"Selected Consolidated Financial Data," our consolidated financial statements
and the accompanying notes, and the other financial data contained elsewhere in
this report.
This report contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended. The Company
intends such forward-looking statements to be covered by the safe harbor
provisions for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995, and is including this statement for purposes of
those safe harbor provisions. Forward-looking statements, which are based on
certain assumptions and describe future plans, strategies and expectations of
the Company, can generally be identified by use of the words "believe,"
"expect," "intend," "anticipate," "estimate," "project," or similar expressions.
The Company is unable to predict the actual results of its future plans or
strategies with certainty. Factors which could have a material adverse effect on
the operations and future prospects of the Company include, but are not limited
to, fluctuations in market rates of interest and loan and deposit pricing; a
deterioration of general economic conditions or the demand for housing in the
Company's market areas; a deterioration in the demand for mortgage financing;
legislative or regulatory changes; adverse developments in the Company's loan or
investment portfolio; any inability to obtain funding on favorable terms; the
loss of key personnel; significant increases in competition; potential
unfavorable results of litigation, and the possible dilutive effect of potential
acquisitions or expansions. These risks and uncertainties should be considered
in evaluating forward-looking statements and undue reliance should not be placed
on such statements.
CRITICAL ACCOUNTING POLICIES
Please refer to Note 1 of our consolidated financial statements where we
present a listing and discussion of our most significant accounting policies.
After a review of these policies, we determined that accounting for the
allowance for loan losses, income taxes, and stock-based compensation are deemed
critical accounting policies because of the valuation techniques used, and the
sensitivity of certain financial statement amounts to the methods, as well as
the assumptions and estimates, underlying these policies. Accounting for these
critical areas requires the most subjective and complex judgments that could be
subject to revision as new information becomes available.
As presented in Note 1 and Note 3 to the consolidated financial statements,
the allowance for loan losses represents management's estimate of probable
credit losses inherent in the loan portfolio as of the balance sheet date. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available. The
adequacy of the allowance is analyzed monthly based on internal loan reviews and
qualitative measurements of our loan portfolio. Management assesses the adequacy
of the allowance for loan losses based upon a number of factors including, among
others:
- analytical reviews of loan loss experience in relationship to
outstanding loans and commitments;
- unfunded loan commitments;
- problem and non-performing loans and other loans presenting credit
concerns;
- trends in loan growth, portfolio composition and quality;
- appraisals of the value of collateral; and
- management's judgment with respect to current economic conditions and
their impact on the existing loan portfolio.
The Bank computes its allowance by assigning specific reserves to impaired
loans, plus a general reserve based on loss factors applied to the rest of the
loan portfolio. The specific reserve on impaired loans is computed as the amount
of the loan in excess of the present value of the estimated future cash flows
discounted at the loan's
19
effective interest rate, or based on the loan's observable market value or the
fair value of the collateral if the loan is collateral dependent. The general
reserve loss factors are determined based on such items as management's
evaluation of risk in the portfolio, local economic conditions, and historical
loss experience. To further assist in confirming the results of the
above-described allowance computation, during 1999, the Bank refined its risk
grading system by developing associated reserve factors for each risk grade.
The income tax amounts in Note 7 to the consolidated financial statements
reflect the current period income tax expense for all periods presented, as well
as future tax liabilities and benefits associated with differences in timing of
expenses and income recognition for book and tax accounting purposes. Our
current tax liability and expense amounts are determined using estimates and
these estimates are subject to review and possible revision by taxing
authorities.
We discuss our accounting for stock-based compensation in greater detail in
Note 1 to our consolidated financial statements. Included in Note 1 is the
effect on our net income in the event we change our accounting of stock options
to the guidance presented by Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation" from our current policy, which follows
Accounting Principles Board Opinion No. 25.
OVERVIEW
2004 was a challenging year for the Company. During the first half of the
year, the Company endured a low short term interest rate environment which
compressed our net interest margin. In addition, longer term interest rates
increased slightly and stabilized which curtailed mortgage refinancings. This
had an adverse effect on the mortgage origination side of our business,
resulting in lower origination volumes and declining fee income. In 2004 we
continued to grow loans and deposits at a robust pace and, associated with this
loan growth, we increased our provision for loan and lease losses. In addition,
accrued litigation costs, incremental costs associated with the opening of our
Leawood, Kansas banking center, and other costs weighed on our financial
performance. We expect some of these costs to be nonrecurring. During the second
half of 2004, we experienced an increase in our net interest margin as five 25
basis point increases in the prime lending rate had a positive effect and eased
the compression in our net interest margin. We expect that any further increases
in the prime lending rate will continue to have a positive effect on our net
interest margin.
Net income for 2004 was $1.9 million, a $3.7 million, or 65.75% decrease
from the $5.6 million earned in 2003. Diluted earnings per share decreased
66.26% to $0.82 for the year ended December 31, 2004 from $2.43 in the previous
year. The Company's returns on average assets and average stockholders' equity
for 2004 were 0.30% and 4.69%, compared to 0.91% and 14.85%, respectively, for
2003.
Net interest income for 2004 was $17.2 million compared to $16.9 million
earned during 2003. The increase of $327,000 or 1.93% was primarily the result
of an increase in earning assets.
The provision for loan losses in 2004 was $2.0 million compared to $1.4
million in 2003. The increase in the provision in 2004 was essentially the
result of an increase in loans, net charge-offs, and non-performing loans during
2004.
Non-interest income decreased 38.15% to $13.9 million in 2004 from $22.5
million in 2003. Increases in market interest rates and other demand factors
resulted in a significant industry-wide decline in the volume of residential
mortgage loans originated in 2004 compared to 2003, particularly refinancing
volume. We experienced a similar trend which resulted in lower origination fees
during 2004 than during 2003. Future market interest rate fluctuations and their
resultant impact on loans held for sale fee income are difficult to project or
quantify; however, it is likely that further increases in interest rates will
have a detrimental impact on mortgage loan refinancing and lower loans held for
sale fee income.
Total assets for the Company at December 31, 2004, were $672.7 million, an
increase of $45.6 million, or 7.27%, from $627.1 million at December 31, 2003.
Deposits and stockholders' equity at December 31, 2004 were $522.6 million and
$41.4 million, compared with $470.5 million and $40.2 million at December 31,
2003, increases of $52.2 million, or 11.08%, and $1.2 million, or 2.95%,
respectively.
20
Loans at December 31, 2004 totaled $507.2 million, an increase of $82.6
million, or 19.44%, compared to December 31, 2003. The loan to deposit ratio at
December 31, 2004 was 97.04% compared to 90.25% at December 31, 2003. The
increase in the loan to deposit ratio was due to loan growth which, on a
relative basis, outpaced deposit growth. Our funding philosophy for loans not
held for sale has been to primarily increase deposits from retail and commercial
deposit sources and secondarily use other borrowing sources as necessary to fund
loans within the limits of the Bank's capital base.
Historically, our ratio of total non-performing assets to total assets
reflects the Bank's conservative underwriting policies and aggressive management
of impaired loans and has resulted in low levels of nonaccrual loans. For the
five years ended December 31, 2004, our average year-end ratio of non-performing
loans to total loans was 0.82%. As of December 31, 2004, our ratio of
non-performing loans to total loans was 0.86%, which was slightly above the
historical average. Our non-performing credit relationships are regularly
reviewed and closely monitored. Our philosophy has been to value non-performing
loans at their estimated collectible value and to aggressively manage these
situations. Generally, the Bank maintains its allowance for loan losses in
excess of its non-performing loans. As of December 31, 2004, our ratio of
allowance for loan losses to non-performing loans was 168.60%, compared to
230.79% at December 31, 2003.
The average net charge-off ratio was 0.40% for the five years ended
December 31, 2004. Our net charge-off ratio for the year ended December 31, 2004
was 0.36%, which was below our historical average. The Bank continues to
aggressively manage defaults in the loan portfolio. Management intends to
vigorously pursue collection of all charged-off loans.
NET INTEREST INCOME
A primary component of our net income is our net interest income. Net
interest income is determined by the spread between the fully tax equivalent
(FTE) yields we earn on our interest-earning assets and the rates we pay on our
interest-bearing liabilities, as well as the relative amounts of such assets and
liabilities. FTE net interest margin is determined by dividing FTE net interest
income by average interest-earning assets.
Years ended December 31, 2004 and 2003. FTE net interest income for 2004
increased to $17.4 million from $17.2 million in 2003, a $221,000, or 1.29%,
increase.
FTE interest income for 2004 was $31.9 million, an increase of $1.2
million, or 3.86%, from $30.7 million in 2003, as a result of growth in earning
assets. Average interest earning assets increased $24.1 million, or 4.22%,
during 2004. Due to the increase in earning asset volume, loan interest and fee
income increased to $29.2 million in 2004 from $28.3 million in 2002, or 3.36%.
Interest income on investment securities increased by $125,000, or 5.27%, in
2004 compared to the prior year. The yield on average interest-earning assets
fell to 5.36%, as compared to 5.38% in 2003, a decline of 2 basis points.
Interest expense for 2004 was $14.5 million, up $964,000, or 7.11%, from
$13.5 million in 2003. The increase resulted from an increase in the level of
interest bearing liabilities, primarily interest-bearing deposits, as well as an
increase in the overall rate paid on our average interest-bearing liabilities.
Total average interest bearing liabilities increased $22.1 million or 4.44%
during 2004 mostly due to increases in money market and time deposits. The rate
paid on our total average interest bearing liabilities increased to 2.79% in
2004 compared to 2.72% in 2003, an increase of 7 basis points. This increase
resulted from increases in rates paid on savings deposits, money market
deposits, time deposits, and long-term debt.
Years ended December 31, 2003 and 2002. FTE net interest income for 2003
increased to $17.2 million from $16.7 million in 2002, a $487,000, or 2.92%,
increase.
FTE interest income for 2003 was $30.7 million, a decrease of $190,000, or
0.62%, from $30.9 million in 2002, primarily as a result of continued asset
repricing in the current low interest rate environment. The yield on average
interest-earning assets fell to 5.38%, as compared to 6.21% in 2002, a decline
of 83 basis points. Average interest earning assets increased $73.3 million, or
14.73%, during 2003. Due to the increase in earning asset
21
volume, loan interest and fee income increased to $28.3 million in 2003 from
$26.9 million in 2002, or 5.34%. Interest income on investment securities
decreased by $1.4 million, or 36.77%, in 2003 compared to the prior year. The
decline in market interest rates caused many of the securities in our portfolio
to be called. Generally, the resultant return in principal was reinvested at
lower yields; consequently, the overall impact on the portfolio has been a
decline in the yield in 2003 compared to the prior year. The effect of the
increase in earning assets was generally offset by the decrease in yield.
Interest expense for 2003 was $13.5 million, down $677,000, or 4.76%, from
$14.2 million in 2002. The decrease resulted from a decline in the rates paid on
our interest bearing liabilities, primarily interest-bearing deposits. Although
total average interest bearing liabilities increased $67.9 million or 15.76%
during 2003 mostly due to the increases in money market and time deposits and
FHLB borrowings, the rate on our total average interest bearing liabilities and
deposits decreased to 2.72% and 2.50%, respectively, in 2003 compared to 3.31%
and 3.08% in 2002, respectively, decreases of 59 and 58 basis points,
respectively.
Average Balance Sheets. The following table sets forth for the periods and
as of the dates indicated, information regarding our average balances of assets
and liabilities as well as the dollar amounts of interest income from
interest-earning assets and interest expense on interest-bearing liabilities and
the resultant rates or costs. Ratio, yield and rate information are based on
average daily balances where available; otherwise, average monthly balances have
been used. Nonaccrual loans are included in the calculation of average balances
for loans for the periods indicated.
AVERAGE BALANCES, YIELDS AND RATES
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------------
2004 2003 2002
--------------------------- --------------------------- ---------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
-------- -------- ------- -------- -------- ------- -------- -------- -------
(DOLLARS IN THOUSANDS)
ASSETS
Federal funds sold ........................ $ 15,077 $ 157 1.04% $ 5,500 $ 49 0.89% $ 18,171 $ 297 1.63%
Investment securities - taxable ........... 72,830 1,926 2.64 55,259 1,489 2.69 51,273 2,741 5.34
Investment securities - non-taxable (1) ... 8,206 569 6.93 12,885 881 6.84 14,526 1,007 6.93
Mortgage loans held for sale .............. 35,219 1,813 5.15 86,808 4,460 5.14 63,866 3,937 6.17
Loans, net of unearned discount and
fees (2) ............................... 463,833 27,432 5.91 410,593 23,833 5.80 349,879 22,920 6.55
-------- ------- -------- ------- -------- -------
Total earning assets ................ 595,165 31,897 5.36 571,045 30,712 5.38 497,715 30,902 6.21
-------- ------- -------- ------- -------- -------
Cash and due from banks - non-interest
bearing ................................ 21,152 30,453 22,910
Allowance for possible loan losses ........ (7,434) (7,592) (5,547)
Premises and equipment, net ............... 19,613 16,388 9,380
Other assets .............................. 17,366 12,129 10,546
-------- -------- --------
Total assets ........................ $645,862 $622,423 $535,004
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits-interest bearing:
Interest-bearing demand accounts ....... $ 28,268 $ 169 0.60% $ 26,415 $ 165 0.63% $ 29,779 $ 388 1.30%
Savings and money market deposits ...... 182,468 2,932 1.61 150,503 2,204 1.46 146,132 2,711 1.86
Time deposits .......................... 202,649 7,297 3.60 195,599 6,935 3.55 176,762 7,759 4.39
-------- ------- -------- ------- -------- -------
Total interest-bearing deposits ..... 413,385 10,398 2.52 372,517 9,304 2.50 352,673 10,858 3.08
-------- ------- -------- ------- -------- -------
Short-term borrowings ..................... 26,734 211 0.79 44,230 451 1.02 21,722 266 1.22
Long-term debt ............................ 80,226 3,904 4.87 81,499 3,794 4.66 55,993 3,102 5.54
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities ...................... 520,345 14,513 2.79 498,246 13,549 2.72 430,388 14,226 3.31
-------- ------- -------- ------- -------- -------
Non-interest bearing deposits ............. 79,171 81,269 69,550
Other liabilities ......................... 5,202 4,959 3,952
Stockholders' equity ...................... 41,144 37,949 31,114
-------- -------- --------
Total liabilities and
stockholders' equity ............. $645,862 $622,423 $535,004
======== ======== ========
FTE net interest income/spread ............ $17,384 2.57% $17,163 2.66% $16,676 2.90%
======= ==== ======= ==== ======= ====
FTE net interest margin ................... 2.91% 3.01% 3.35%
==== ==== ====
(1) Presented on a fully tax-equivalent basis assuming a tax rate of 34%.
For the three years ended December 31, 2004, 2003 and 2002, the tax
equivalency adjustment amounted to $194,000, $300,000, and 343,000,
respectively.
(2) Includes average balances and income from loans on nonaccrual status
22
Analysis of Changes in Net Interest Income Due to Changes in Interest Rates
and Volumes. The following table presents the dollar amount of changes in
interest income and interest expense for major components of interest-earning
assets and interest-bearing liabilities. It distinguishes between the increase
or decrease related to changes in balances and changes in interest rates. For
each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to:
- changes in volume, reflecting changes in volume multiplied by the
current period rate; and
- changes in rate, reflecting changes in rate multiplied by the prior
period volume.
CHANGES IN INTEREST INCOME AND EXPENSE VOLUME AND RATE VARIANCES
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
2004 COMPARED TO 2003 2003 COMPARED TO 2002
-------------------------- --------------------------
CHANGE CHANGE CHANGE CHANGE
DUE TO DUE TO TOTAL DUE TO DUE TO TOTAL
RATE VOLUME CHANGE RATE VOLUME CHANGE
------ ------- ------- ------- ------ -------
Federal funds sold $ 8 $ 100 $ 108 $ (135) $ (113) $ (248)
Investment securities -
taxable (28) 465 437 (1,359) 107 (1,252)
Investment securities -
non-taxable (1) 12 (324) (312) (14) (112) (126)
Mortgage loans held for
sale 8 (2,655) (2,647) (656) 1,179 523
Loans, net of unearned
discount 451 3,148 3,599 (2,611) 3,524 913
----- ------- ------- ------- ------ -------
Total interest income 451 734 1,185 (4,775) 4,585 (190)
----- ------- ------- ------- ------ -------
Interest-bearing demand
accounts (7) 11 4 (202) (21) (223)
Savings and money market
deposits 214 514 728 (571) 64 (507)
Time deposits 108 254 362 (1,492) 668 (824)
Short-term borrowings (102) (138) (240) (45) 230 185
Long-term debt 172 (62) 110 (495) 1,187 692
----- ------- ------- ------- ------ -------
Total interest expense 385 579 964 (2,805) 2,128 (677)
----- ------- ------- ------- ------ -------
Net interest income $ 66 $ 155 $ 221 $(1,970) $2,457 $ 487
===== ======= ======= ======= ====== =======
(1) Presented on a fully tax-equivalent basis assuming a tax rate of 34%.
PROVISION FOR LOAN LOSSES
We make provisions for loan losses in amounts management deems necessary to
maintain the allowance for loan losses at an appropriate level. During the year
ended December 31, 2004, we provided $2.0 million for loan losses, as compared
to $1.4 million for the year ended December 31, 2003, an increase of $615,000,
or 45.56%. During 2004, our provision for loan losses increased due to overall
growth in the loan portfolio as well as an increase in net charge-offs and
impaired loans. The loan portfolio increased 19.44% to $507.2 million in 2004
from $424.6 million at December 31, 2003. Total impaired loans increased 26.05%
to $12.8 million at December 31, 2004, with a related reserve of $1.8 million,
from $10.2 million at December 31, 2003, with a related reserve of $1.5 million.
Net charge-offs increased to $1.7 million in 2004 from $1.2 million in 2003.
During 2003, the provision decreased due to management's assessment of an
overall improvement in credit quality of the loan portfolio. The provision for
loan losses decreased to $1.3 million in 2003 from $2.9 million in 2002, or
53.77%, while the loan portfolio increased to $424.6 million in 2003 from $380.1
million in 2002, or 11.71%.
The allowance for loan losses as a percentage of loans was 1.45% at
December 31, 2004, as compared to 1.66% in 2003 and 1.82% in 2002. The decrease
in this percentage from December 31, 2003 was primarily due to
23
net charge-offs as well as modifications by management to the general reserve
factors applied to unimpaired loans. The general reserve factors are
periodically reviewed by management and during 2004 were lowered based on an
assessment of the Company's historical charge-off experience for certain loan
categories as well as improvements in the ability of the Company's loan review
process to identify credit quality deterioration on a timely basis. The general
reserve factor at December 31, 2004 was 1.13%. The general reserve factor at
December 31, 2003 was 1.34%, essentially unchanged from the factor as of
December 31, 2002 of 1.38%.
Overall, we increased the total balance of the allowance for loan losses in
2004 and 2003 based upon an analysis of several factors, including an analysis
of impaired loans, the general reserve factor analysis referred to in our
Critical Accounting Policies and changes in the loan mix. The allowance for loan
losses represents our best estimate of probable losses that have been incurred
as of the respective balance sheet dates.
NON-INTEREST INCOME
The following table describes the items of our non-interest income for the
periods indicated:
NON-INTEREST INCOME
YEAR ENDED DECEMBER 31
---------------------------
2004 2003 2002
------- ------- -------
(IN THOUSANDS)
Loans held for sale fee income ..................... $10,358 $19,866 $16,690
NSF charges and service fees ....................... 1,326 1,283 1,026
Other service charges .............................. 1,115 924 821
Realized gains on available for
sale securities, net ............................ 524 -- 193
Other income ....................................... 617 463 281
------- ------- -------
Total non-interest income ....................... $13,940 $22,536 $19,011
======= ======= =======
Non-interest income decreased to $13.9 million, or 38.14%, during 2004,
from $22.5 million during 2003. This decrease is attributable to a decrease in
loans held for sale fee income of $9.5 million. We experienced a decline in our
loans held for sale fee income due to a decline in residential mortgage
origination and refinancing resulting from higher interest rates. The volume of
closed residential mortgages fell to $883.4 million in 2004 from $1.5 billion
and $1.3 billion in 2003 and 2002, respectively. Sustainability of the level of
our loans held for sale fee income is primarily dependent upon the interest rate
environment, and secondarily dependent on our ability to develop new products
and alternative delivery channels. Other service charge income, which includes
trust services income, investment brokerage income, merchant bankcard processing
and debit card processing income, increased by $191,000 or 20.67% from 2003 to
2004. In 2004, we realized $524,000 of net gains on the sale of
available-for-sale securities. We took advantage of opportunities to mitigate
the risk of long-term rate volatility in our available-for-sale investment
portfolio and also provide a funding source for loan growth by selling some of
our longer-term bonds. Future growth of other non-interest income categories is
dependent upon new product development, and growth in our customer base.
Non-interest income increased to $22.5 million, or 18.54%, during 2003,
from $19.0 million during 2002. This increase is attributable to increases in
loans held for sale fee income of $3.2 million and NSF charges and services fees
of $257,000. We experienced growth in our loans held for sale income due to the
expansion of our national and local mortgage capabilities concurrent with
favorable conditions for residential mortgage origination and refinancing.
Mortgage originations and refinancing continued to flourish due to the low
interest rate environment which began in 2001 and persisted through 2003. The
volume of closed residential mortgages grew to over $1.5 billion in 2003 from
$1.3 billion and $640 million in 2002 and 2001, respectively. However, mortgage
rates increased modestly during the second half of 2003, and the volume of
mortgage refinancing activity declined dramatically. Other service charge
income, which includes trust services income, investment brokerage income,
merchant bankcard processing and debit card processing income, increased by
$103,000 or 12.54% from 2002 to 2003. In 2002, we took advantage of
opportunities to mitigate the risk of long-term rate volatility in our
available-
24
for-sale investment portfolio by selling some of our longer-term bonds. Due to
the yield environment when we sold the securities, we realized $193,000 of net
gains on the sales in 2002.
NON-INTEREST EXPENSE
The following table describes the items of our non-interest expense for the
periods indicated.
NON-INTEREST EXPENSE
YEAR ENDED DECEMBER 31
---------------------------
2004 2003 2002
------- ------- -------
(IN THOUSANDS)
Salaries and employee benefits ..... $16,670 $19,670 $16,437
Occupancy .......................... 3,433 3,137 2,101
FDIC and other insurance expense ... 175 174 161
General and administrative ......... 6,292 6,304 5,417
------- ------- -------
Total non-interest expenses ..... $26,570 $29,285 $24,116
======= ======= =======
Non-interest expense decreased 9.27% to $26.6 million during 2004, as
compared to $29.3 million in the prior year primarily due to a decrease in
salaries and employee benefits. Our salaries and employee benefits expense
decreased 15.25% to $16.7 million in 2004 from $19.7 million in 2003, mainly due
to a decline in incentive compensation related to mortgage origination activity,
which was partially offset by the increase in staffing costs from the opening of
our Leawood banking center as well as a $550,000 accrued expense recorded in
2004 to reflect the estimated potential cost of litigation related to claimed
violations of the Fair Labor Standards Act (see Item 3). Occupancy expenses
increased 9.43% to $3.4 million in 2004 from $3.1 million in 2003, primarily due
to the opening of our Leawood banking center in May 2004 and the incremental
costs associated with the operation of our College Boulevard facility for a full
year.
Non-interest expense increased to $29.3 million, or 21.43%, during 2003, as
compared to $24.1 million in the prior year. This increase is primarily
attributable to increases in salaries and employee benefits and occupancy
expenses, consistent with the Company's growth. Our salaries and employee
benefits expense increased to $19.7 million in 2003, or 19.66%, from $16.4
million in 2002, mainly due to volume-related growth in incentive compensation
related to mortgage origination activity as well as additional staff to
facilitate our growth. We manage our staffing levels to accommodate the volume
of our business. During 2003, FTEs fluctuated from approximately 257 to 313, and
ended the year at approximately 278. The fluctuations in our staffing levels
were primarily attributable to fluctuations in the volume of mortgage
originations during the year. Occupancy expenses increased to $3.1 million, or
49.30% in 2003, from $2.1 million in 2002, primarily due to the addition of our
7900 College facility and higher telecommunication and depreciation expenses
related to our growth and expansion. General and administrative expenses
increased $887,000 to $6.3 million in 2003, compared to $5.4 million in 2002,
principally due to increased marketing, postage/courier, and loan processing
fees associated with the increased volume in the Company's mortgage origination
departments.
INCOME TAXES
Our income tax expense during 2004 was $665,000, compared to $3.1 million
during 2003, and $2.9 million during 2002. The decrease in 2004 reflects our
lower earnings for the current fiscal year as well as the Company's recognition
of tax reserves provided in prior tax years. Our consolidated effective income
tax rates of 25.63%, 35.71% and 35.05% for the three years ended December 31,
2004, 2003, and 2002, respectively, varies from the statutory rate principally
due to the effects of state income taxes and interest income earned on our
municipal securities portfolio which is generally tax-exempt for federal income
tax purposes.
25
FINANCIAL CONDITION
Lending Activities. Our loan portfolio is a key source of income, and since
our inception, has been a principal component of our revenue growth. Our loan
portfolio reflects an emphasis on commercial and commercial real estate,
construction, lease financing, residential real estate, consumer and home equity
lending. We emphasize commercial lending to professionals, businesses and their
owners. Commercial loans and loans secured by commercial real estate accounted
for 48.07% of our total loans at December 31, 2004, 46.45% of our total loans at
December 31, 2003, and 43.40% of our total loans at December 31, 2002. These
loans increased at an 17.82% compound annual rate during the three-year period
ended December 31, 2004.
Loans were $507.2 million at December 31, 2004, an increase of $82.6
million, or 19.44%, compared to December 31, 2003. Loans at December 31, 2003
were $424.6 million, an increase of $44.5 million, or 11.71%, compared to
December 31, 2002. We funded our loan growth during 2004 by selling
available-for-sale securities and increasing deposits. The loan to deposit ratio
increased to 97.04%, compared to 90.25% at December 31, 2003, and 89.69% at
December 31, 2002.
We experienced increases in most loan categories during 2004. The growth of
our commercial, commercial real estate and residential real estate portfolios is
a result of the economic growth and development of our market area, coupled with
the efforts and experience of our lending staff. The Company targets consumer
lending lines of business in an effort to broadly diversify our risk across
multiple lines of business. Historically, a significant portion of the growth in
our personal lending lines was attributable to growth in our indirect automobile
loan portfolio. In 2004, sales officers cultivated additional dealer
relationships as well as additional business from existing dealers and our
indirect loan portfolio grew by $19.8 million or 98.82%. The growth, which began
in 2003, reversed a two-year decline when we encountered significant competition
from national finance companies offering below market rate financing incentives.
The following table sets forth the composition of our loan portfolio by
loan type as of the dates indicated. The amounts in the following table are
shown net of discounts and other deductions.
AS OF DECEMBER 31,
------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------------ ------------------ ------------------ ------------------ ------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
(DOLLARS IN THOUSANDS)
Commercial .............. $117,604 23.19% $109,818 25.86% $ 93,658 24.64% $ 85,311 25.54% $ 76,556 26.61%
Commercial real
estate ............... 126,205 24.88 87,438 20.59 71,295 18.76 63,756 19.08 42,267 14.69
Construction ............ 130,631 25.76 123,445 29.08 127,071 33.43 93,656 28.03 59,733 20.76
Lease financing ......... 21,203 4.18 22,175 5.22 22,600 5.95 24,221 7.25 25,302 8.81
Residential real
estate ............... 30,886 6.09 27,017 6.37 21,581 5.68 24,460 7.32 37,290 12.96
Consumer ................ 48,950 9.65 29,701 6.99 26,750 7.04 29,895 8.96 35,864 12.47
Home equity ............. 31,691 6.25 25,026 5.89 17,127 4.50 12,776 3.82 10,657 3.70
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans and
leases ............ 507,170 100.00% 424,620 100.00% 380,082 100.00% 334,075 100.00% 287,669 100.00%
====== ====== ====== ====== ======
Less allowance for
loan losses .......... 7,333 7,051 6,914 5,267 4,440
-------- -------- -------- -------- --------
Loans rece