================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2006
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 0-26570
1ST INDEPENDENCE FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 61-1284899
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
104 South Chiles Street
Harrodsburg, Kentucky 40330-1620
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (502)753-0500
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 whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large accelerated filer |_| Accelerated filer |_| Non-accelerated filer |X|
Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
The registrant had 1,977,658 shares of common stock outstanding at July
28, 2006.
================================================================================
1st INDEPENDENCE FINANCIAL GROUP, INC.
FORM 10-Q
For the Quarter Ended June 30, 2006
INDEX
Part I - Financial Information
Item 1. Financial Statements Page Number
-----------
Condensed Consolidated Balance Sheets as of June 30, 2006
(unaudited) and December 31, 2005 3
Condensed Consolidated Statements of Operations for the three
months and six months ended June 30, 2006 and 2005 (unaudited) 4
Condensed Consolidated Statements of Comprehensive Income (Loss)
for the three months and six months ended June 30, 2006 and 2005
(unaudited) 5
Condensed Consolidated Statements of Cash Flows for the six
months ended June 30, 2006 and 2005 (unaudited) 6
Notes to Condensed Consolidated Financial Statements (unaudited) 7-10
Item 2. Management's Discussion and Analysis of Financial Condition 11-16
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
Item 4. Controls and Procedures 17
Part II - Other Information
Item 1. Legal Proceedings 18
Item 1A. Risk Factors 18-24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 6. Exhibits 24
Signatures 25
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Condensed Consolidated Balance Sheets
(in thousands except share data)
(Unaudited)
June 30, December 31,
2006 2005
--------------- --------------
Assets
Cash and and due from banks $ 4,857 $ 4,327
Interest-bearing demand deposits 6,092 5,886
Federal funds sold 8,666 11,350
--------------- --------------
Cash and cash equivalents 19,615 21,563
Inerest-bearing deposits - 100
Available-for-sale securities at fair value 16,184 16,140
Held-to-maturity securities, fair value of $1,892 and
$1,974 at June 30, 2006 and December 31, 2005, respectively 1,903 1,975
Loans held for sale 2,116 1,278
Loans, net of allowance for loan losses of $3,025 and
$2,911 at June 30, 2006 and December 31, 2005, respectively 280,516 266,978
Premises and equipment, net 8,230 8,215
Federal Home Loan Bank (FHLB) stock 2,272 2,688
Bank owned life insurance 3,334 3,235
Goodwill 11,142 11,142
Interest receivable and other assets 3,337 2,873
--------------- --------------
Total assets $ 348,649 $ 336,187
=============== ==============
Liabilities and Stockholders' Equity
Liabilities
Deposits
Demand $ 21,472 $ 15,570
Savings, NOW and money market 59,150 51,167
Time 191,223 197,586
--------------- --------------
Total depositsotal deposits 271,845 264,323
Short-term borrowings 25,655 18,747
Long-term debt 10,279 13,279
Interest payable and other liabilities 1,509 1,577
--------------- --------------
Total liabilitiesl liabilities 309,288 297,926
--------------- --------------
Commitments and contingencies - -
Stockholders' equity
Preferred stock, $0.10 par value, 500,000 shares authorized, no
shares issued or outstanding - -
Common stock, $0.10 par value, 5,000,000 shares authorized,
1,977,658 shares and 1,951,408 shares outstanding at
June 30, 2006 and December 31, 2005, respectively 294 292
Additional paid-in capital 39,605 39,236
Retained earnings 14,662 13,849
Unearned ESOP compensation (317) (380)
Unearned compensation on restricted stock - (24)
Accumulated other comprehensive (loss) (308) (137)
Treasury stock, at cost, common,
969,835 shares and 969,835 shares at June 30, 2006 and
December 31, 2005, respectively (14,575) (14,575)
--------------- --------------
Total stockholders' equity 39,361 38,261
--------------- --------------
Total liabilities and stockholders' equity $ 348,649 $ 336,187
=============== ==============
See notes to condensed consolidated financial statements.
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Condensed Consolidated Statements of Operations
(in thousands except per share data)
(Unaudited) (Unaudited)
Three months ended June 30, Six months ended June 30,
---------------------------- -------------------------
2006 2005 2006 2005
----------- ---------- -------- ----------
Interest and dividend income
Interest and fees on loans $ 5,229 $ 4,044 $ 10,088 $ 7,797
Interest on securities
Taxable 160 180 314 371
Tax exempt 46 26 91 52
Interest on federal funds sold 88 84 150 143
Dividends 40 35 81 67
Interest on deposits with financial institutions 74 29 134 53
----------- ---------- -------- ----------
Total interest and dividend income 5,637 4,398 10,858 8,483
----------- ---------- -------- ----------
Interest expense
Deposits 2,531 1,620 4,734 3,030
FHLB advances 176 133 410 297
Other 179 149 352 295
----------- ---------- -------- ----------
Total interest expense 2,886 1,902 5,496 3,622
----------- ---------- -------- ----------
Net interest income 2,751 2,496 5,362 4,861
Provision for loan losses 31 - 112 202
----------- ---------- -------- ----------
Net interest income after provision for loan losses 2,720 2,496 5,250 4,659
----------- ---------- -------- ----------
Noninterest income
Service charges 144 99 246 160
Gain on loan sales 218 328 426 537
Increase in cash value of life insurance 49 47 98 93
Net realized gains on sales of available-for-sale
securities - - - 5,012
Other 68 168 149 329
----------- ---------- -------- ----------
Total noninterest income 479 642 919 6,131
----------- ---------- -------- ----------
Noninterest expense
Salaries and employee benefits 1,122 1,247 2,270 2,722
Net occupancy 405 352 799 701
Data processing fees 191 151 377 284
Professional fees 186 225 302 480
Marketing 24 25 56 58
Other 360 436 739 1,050
----------- ---------- -------- ----------
Total noninterest expense 2,288 2,436 4,543 5,295
----------- ---------- -------- ----------
Income from continuing operations before income
taxes and minority interest 911 702 1,626 5,495
Income tax expense from continuing operations 284 216 505 1,902
----------- ---------- -------- ----------
Income from continuing operations before minority
interest and discontinued operations 627 486 1,121 3,593
Income from subsidiary held for disposal - - - 6
Income tax expense from subsidiary held for disposal - - - 2
----------- ---------- -------- ----------
Income before minority interest 627 486 1,121 3,597
Minority interest in (income) of consolidated subsidiary and
subsidiary held for disposal - (3) - (5)
----------- ---------- -------- ----------
Net income $ 627 $ 483 $ 1,121 $ 3,592
=========== ========== ======== ==========
Income per share from continuing operations
Basic $0.32 $0.26 $0.58 $1.92
Diluted 0.32 0.25 0.58 1.87
Income per share from subsidiary held for disposal
Basic $0.00 $0.00 $0.00 $0.00
Diluted 0.00 0.00 0.00 0.00
Net income per share
Basic $0.32 $0.26 $0.58 $1.91
Diluted 0.32 0.25 0.58 1.87
Weighted average shares outstanding
Basic 1,936 1,883 1,928 1,876
Diluted 1,953 1,917 1,949 1,919
Cash dividends declared per share $0.08 $0.08 $0.16 $0.24
See notes to condensed consolidated financial statements.
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Condensed Consolidated Statements of Comprehensive Income (Loss)
(in thousands)
(Unaudited) (Unaudited)
Three months ended June 30, Six months ended June 30,
--------------------------- --------------------------
2006 2005 2006 2005
--------- ----------- ----------- ----------
Net income $ 627 $ 483 $ 1,121 $ 3,592
Other comprehensive income, net of tax
Change in unrealized gains and losses on
available-for-sale securities (132) 98 (171) (490)
Less reclassification adjustment for realized gains
included in net income - - - 3,308
--------- ----------- ----------- ----------
Other comprehensive income (loss) (132) 98 (171) (3,798)
--------- ----------- ----------- ----------
Comprehensive income (loss) $ 495 $ 581 $ 950 $ (206)
========= =========== =========== ==========
See notes to condensed consolidated financial statements.
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
Six months ended June 30,
-----------------------------
2006 2005
------------ -----------
Cash Flows from Operating Activities:
Net income $ 1,121 $ 3,592
Adjustments to reconcile net income to net cash provided by (used in)
operations:
Depreciation 363 313
Provision for loan losses 112 202
Gain on loan sales (426) (537)
Origination of loans held for sale (24,824) (31,612)
Proceeds from loans held for sale 24,412 31,519
Compensation expense on stock options 26 -
ESOP compensation 87 101
Amortization of unearned compensation on restricted stock 6 2
Amortization of premiums and discounts on securities 19 71
Deferred income taxes - 342
FHLB stock dividend (59) (46)
Amortization of loan fees (166) (162)
Amortization of intangibles, net 130 203
Net realized (gains) on available-for-sale securities - (5,012)
Loss on sale of premises and equipment - 18
Minority interest in income from subsidiary held for disposal - 5
Increase in cash value of life insurance (98) (93)
(Income) from subsidiary held for disposal - (4)
Changes in:
(Increase) in interest receivable and other assets (419) (413)
Increase in interest payable and other liabilities 129 303
------------ -----------
Net cash provided by (used in) operating activities 413 (1,208)
------------ -----------
Cash Flows from Investing Activities:
Purchases of available-for-sale securities (1,491) -
Proceeds from maturities of interest-bearing deposits 100 -
Proceeds from maturities of available-for-sale securities 1,168 2,568
Proceeds from sales of available-for-sale securities - 5,088
Proceeds from maturities of held-to-maturity securities 68 165
Net (increase) in loans (13,764) (24,466)
Purchases of premises and equipment (379) (3,101)
Proceeds from sale of FHLB stock 476 -
Proceeds from sale of subsidiary - 2,300
------------ -----------
Net cash (used in) investing activities (13,822) (17,446)
------------ -----------
Cash Flows from Financing Activities:
Net increase in deposits 7,522 22,805
Net increase (decrease) in short-term borrowings 6,908 (4,686)
Repayment of long-term debt (3,000) -
Proceeds from exercise of stock options 339 292
Cash dividends paid (308) (450)
------------ -----------
Net cash provided by financing activities 11,461 17,961
------------ -----------
Net (decrease) in cash and cash equivalents (1,948) (693)
Cash and cash equivalents at beginning of period 21,563 9,946
------------ -----------
Cash and cash equivalents at end of period $ 19,615 $ 9,253
============ ===========
Supplemental Cash Flow Information:
Interest paid $ 5,430 $ 3,503
Income taxes paid 705 980
Net increase in cash and cash equivalents of discontinued
operations (revised see note 8)
Net cash (used in) operating activities - (5)
Net cash provided by investing activities - 1,647
Net cash (used in) financing activities - (361)
------------ -----------
Net increase in cash and cash equivalents of discontinued operations - 1,281
------------ -----------
Real estate acquired in settlement of loans 181 33
See notes to condensed consolidated financial statements.
1st INDEPENDENCE FINANCIAL GROUP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of 1st
Independence Financial Group, Inc. (the "Company") are presented in accordance
with the requirements of Form 10-Q and accounting principles generally accepted
in the United States of America for interim financial information. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. These condensed consolidated financial statements and
notes thereto included in this report should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
Form 10-KSB annual report for the year ended December 31, 2005 filed with the
United States Securities and Exchange Commission. In the opinion of management,
all adjustments necessary to make the financial statements not misleading and to
fairly present the financial position, results of operations and cash flows for
the reporting interim periods have been made and were of a normal recurring
nature. The results of operations for the period are not necessarily indicative
of the results to be expected for the full year. The condensed consolidated
balance sheet of the Company as of December 31, 2005 has been derived from the
audited consolidated balance sheet of the Company as of that date.
The unaudited condensed financial statements include the accounts of the Company
and its wholly-owned subsidiary, 1st Independence Bank, Inc. (the "Bank"), 1st
Independence Mortgage, a division of the Bank and for periods prior to its sale
on January 28, 2005, the Company's majority-owned subsidiary Citizens Financial
Bank, Inc. ("Citizens"). As a result of the Company's sale of Citizens, the
assets, liabilities, results of operations and cash flows of Citizens have been
reported separately as discontinued operations in the Company's condensed
consolidated financial statements and previously reported amounts have been
reclassified to consistently present the discontinued operations.
2. Stock-Based Compensation
At June 30, 2006, the Company had two stock-based compensation plans. Prior to
the first half of 2006, as permitted by Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"),
the Company followed the provisions of Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees," and related Interpretations in
accounting for its stock option plans under the intrinsic value based method.
Accordingly, no stock-based compensation expense was recognized for the three
months and six months ended June 30, 2005 for stock options issued under the
plans as all stock options granted under the plans had an exercise price equal
to the market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income and basic and diluted net
income per share had compensation expense been determined based on the fair
value of the stock options at the grant date consistent with the provisions of
SFAS No. 123 (in thousands except per share data):
Three months ended
June 30, 2005
------------------
Net income as reported $483
Less total stock-based employee compensation expense
(including forfeitures of $45) determined under fair value
method for all awards, net of related tax effects (40)
----
Pro forma net income $523
====
Basic net income per share
As reported $0.26
Pro forma 0.28
Diluted net income per share
As reported $0.25
Pro forma 0.27
Six months ended
June 30, 2005
-----------------
Net income as reported $3,592
Less total stock-based employee compensation expense
(including forfeitures of $45) determined under fair value
method for all awards, net of related tax effects (38)
------
Pro forma net income $3,630
======
Basic net income per share
As reported $1.91
Pro forma 1.93
Diluted net income per share
As reported $1.87
Pro forma 1.89
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No.123R, "Share-Based Payment"
("SFAS 123R"). This Statement requires expensing of stock options and other
share-based payments over the related vesting period and supersedes FASB's
earlier rule (the original SFAS 123) that had allowed companies to choose
between expensing stock options and showing pro forma disclosure only. SFAS 123R
permits companies to adopt its requirements using either a "modified
prospective" method, or a "modified retrospective" method. Under the "modified
prospective" method, compensation cost is recognized in the financial statements
beginning with the effective date, based on the requirements of SFAS 123R for
all share-based payments granted after that date, and based on the requirements
of SFAS 123 for all unvested awards granted prior to the effective date of SFAS
123R. Under the "modified retrospective" method, the requirements are the same
as under the "modified prospective" method but this method also permits entities
to restate financial statements of previous periods based on proforma
disclosures made in accordance with SFAS 123. Beginning in January 2006, the
Company adopted the Statement as required and elected the "modified prospective"
method and thus has not restated prior financial statements. For the three
months and six months ended June 30, 2006, the Company recorded $8,000 and
$26,000, respectively, in employee stock-based compensation expense, which is
included in salaries and employee benefits. As of June 30, 2006, there was
$39,000 of unrecognized stock-compensation expense for previously granted
unvested options that will be recognized over a weighted-average period of 1.6
years.
3. Allowance for Loan Losses
An analysis of the changes in the allowance for loan losses for the six months
ended June 30 follows (in thousands):
2006 2005
---- ----
Beginning balance $2,911 $2,549
Provision for loan losses 112 202
Loans charged off (1) (6)
Recoveries 3 12
------ ------
Ending balance $3,025 $2,757
====== ======
4. Net Income Per Share Computations
The following is a reconciliation of the numerator and denominator of the basic
and diluted per share computations (in thousands except per share data):
Three months ended
June 30,
2006 2005
---- ----
Income (numerator) amounts used for basic and diluted per share computations:
Income from continuing operations $627 $486
==== ====
Income from discontinued operations $ - $ -
==== ====
Net income $627 $483
==== ====
Shares (denominator) used for basic per share computations:
Weighted average shares of common stock outstanding 1,936 1,883
===== =====
Shares (denominator) used for diluted per share computations:
Weighted average shares of common stock outstanding 1,936 1,883
Plus: dilutive effect of stock options 17 34
----- -----
Adjusted weighted average shares 1,953 1,917
===== =====
Basic net income per share data:
Income from continuing operations $0.32 $0.26
===== =====
Income from discontinued operations $ - $ -
===== =====
Net income $0.32 $0.26
===== =====
Diluted net income per share data:
Income from continuing operations $0.32 $0.25
===== =====
Income from discontinued operations $ - $ -
===== =====
Net income $0.32 $0.25
===== =====
Six months ended
June30,
2006 2005
---- ----
Income (numerator) amounts used for basic and diluted per share computations:
Income from continuing operations $1,121 $3,593
====== ======
Income from discontinued operations $ - $ 4
====== ======
Net income $1,121 $3,592
====== ======
Shares (denominator) used for basic per share computations:
Weighted average shares of common stock outstanding 1,928 1,876
===== =====
Shares (denominator) used for diluted per share computations:
Weighted average shares of common stock outstanding 1,928 1,876
Plus: dilutive effect of stock options 21 43
----- -----
Adjusted weighted average shares 1,949 1,919
===== =====
Basic net income per share data:
Income from continuing operations $0.58 $1.92
===== =====
Income from discontinued operations $ - $ -
===== =====
Net income $0.58 $1.91
===== =====
Diluted net income per share data:
Income from continuing operations $0.58 $1.87
===== =====
Income from discontinued operations $ - $ -
===== =====
Net income $0.58 $1.87
===== =====
Options to purchase 17,000 common shares for the three months ended June 30,
2006 and 7,500 common shares for the six months ended June 30, 2006 were
excluded from the diluted calculations above because the exercise prices on the
options were greater than the average market price for the period.
5. Contingencies
The Company is a defendant in a lawsuit that asserts that the Company made
certain material misrepresentations in connection with certain statements made
in connection with its offer to purchase up to 300,000 shares of stock in a
tender offer in May 2003. The plaintiffs are seeking to recover damages in
connection with the shares they sold in the tender offer and attorneys fees.
Based upon the advice of counsel, management records an estimate of the amount
of ultimate expected loss for litigation, if any. Management has not recorded a
loss provision for this litigation as, after discussion with legal counsel,
management believes the ultimate results of this litigation will not have a
material adverse effect on the Company's financial position, results of
operations or cash flows. Events could occur that could cause the estimate of
ultimate loss to differ materially in the near term. Reference is made to Part
II, Item 1 of this report on Form 10-Q for additional information.
6. Recently Issued Accounting Standards
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No.123R, "Share-Based Payment"
("SFAS 123R"). This Statement required expensing of stock options and other
share-based payments over the related vesting period beginning in 2005, and
superseded FASB's earlier rule (the original SFAS 123) that had allowed
companies to choose between expensing stock options and showing pro forma
disclosure only. The Statement required that public entities apply SFAS 123R as
of the first interim or annual reporting period that began after June 15, 2005.
However, in April 2005 the United States Securities and Exchange Commission
issued a rule that revised the required date of adoption under SFAS 123R. The
new rule allowed for public entities to adopt the provisions of SFAS 123R at the
beginning of the first fiscal year beginning after June 15, 2005. The Company
adopted the Statement in the first quarter of 2006 as required and the effects
of initial adoption were immaterial. See note 2, "Stock-Based Compensation" to
this report for additional information.
7. Completion of Subsidiary Disposal
On January 28, 2005 the Company completed the sale of its entire interest in its
majority owned subsidiary, Citizens Financial Bank, Inc., to Porter Bancorp,
Inc. for $2.3 million, pursuant to a Stock Purchase Agreement, dated as of
October 22, 2004, between Porter Bancorp, Inc. and the Company. In a related
transaction, on January 28, 2005, the Company's subsidiary bank, 1st
Independence Bank, Inc., purchased a commercial building located in Louisville,
Kentucky, for $2.3 million from Ascencia Bank, Inc., an affiliate of Porter
Bancorp, Inc. See note 4, "Completion of Subsidiary Disposal" to the
consolidated financial statements included in the Company's Form 10-KSB for the
year ended December 31, 2005 for additional information.
8. Revised Cash Flows of Discontinued Operations
In 2005 the Company has separately disclosed the operating, investing and
financing portions of the cash flows attributable to its discontinued
operations, which in prior periods were reported on a combined basis as a single
amount.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This section should be read in conjunction with the condensed consolidated
financial statements and notes thereto included in Item 1 of Part I of this
report in addition to the consolidated financial statements of the Company and
the notes thereto included in the Company's Form 10-KSB for the year ended
December 31, 2005, including note 1 which describes the Company's significant
accounting policies including its use of estimates. See the caption entitled
"Application of Critical Accounting Policies" in this section for further
information.
Forward-Looking Statements
The following discussion contains statements which are forward-looking rather
than historical fact. These forward-looking statements are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995
and involve known and unknown risks, uncertainties and other factors, which may
cause the Company's actual results to be materially different from any future
results, performance or achievements expressed or implied by such
forward-looking statements. Such statements are subject to certain risks and
uncertainties including among other things, changes in economic conditions in
the market areas the Company conducts business, changes in policies by
regulatory agencies, fluctuations in interest rates, demand for loans in the
market areas the Company conducts business, competition that could cause actual
results to differ materially from historical earnings and those presently
anticipated or projected and other risks as detailed in the Company's various
filings with the United States Securities and Exchange Commission. The Company
wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made.
General
The Company provides commercial and retail banking services, including
commercial real estate loans, one-to-four family residential mortgage loans via
1st Independence Mortgage, home equity loans and lines of credit and consumer
loans as well as certificates of deposit, checking accounts, money-market
accounts and savings accounts within its market area. At June 30, 2006, the
Company had total assets, deposits and stockholders' equity of $348.6 million,
$271.8 million, and $39.4 million, respectively. The Company's business is
conducted principally through the Bank. Unless otherwise indicated, all
references to the Company refer collectively to the Company and the Bank.
The Company is currently a defendant in a lawsuit that asserts that the Company
made certain material misrepresentations in connection with its offer to
purchase up to 300,000 shares of stock in a tender offer in May 2003. The
plaintiffs are seeking to recover damages in connection with the shares they
sold in the tender offer and attorneys fees. Based upon the advice of counsel,
management records an estimate of the amount of ultimate expected loss for
litigation, if any. Management has not recorded a loss provision for this
litigation as, after discussion with legal counsel, management believes the
ultimate result of this litigation will not have a material adverse effect on
the Company's financial position, results of operations or cash flows. Events
could occur that could cause the estimate of ultimate loss to differ materially
in the near term.
In January 2005, the Company sold its 55.8% interest in Citizens Financial Bank,
Inc., Glasgow, Kentucky ("Citizens") to Porter Bancorp, Inc., Shepherdsville,
Kentucky ("Porter Bancorp") for $2.3 million. The sale of Citizens reflected the
Company's revised strategic plan to exit the south central Kentucky market and
to focus on the growing markets of southern Indiana, central Kentucky, and
greater Louisville, Kentucky.
Application of Critical Accounting Policies
The discussion and analysis of the Company's financial condition and results of
operation is based upon the Company's unaudited condensed consolidated financial
statements, which have been prepared in conformity with accounting principles
generally accepted in the United States of America for interim financial
information and with the instructions for Form 10-Q. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. The Company's most critical accounting policies require
the use of estimates relating to other than temporary impairment of securities,
the allowance for loan losses and the valuation of goodwill. See the caption
entitled "Critical Accounting Policies" in the Management's Discussion and
Analysis of Financial Condition and Results of Operations section of the
Company's Form 10-KSB for the year ended December 31, 2005 for additional
information.
Overview
Net income for the quarter ended June 30, 2006 was $627,000 or $0.32 per diluted
share compared to $483,000 or $0.25 per diluted share for the comparable period
in 2005. Net income for the six months ended June 30, 2006 was $1,121,000 or
$0.58 per diluted share compared to $3,592,000 or $1.87 per diluted share for
the comparable period in 2005. The decrease in net income and net income per
diluted share for the six-month period was primarily due to after tax securities
gains of $3,308,000 taken in the first quarter of 2005. Partially offsetting
this factor was an increase in net interest income of $331,000 after taxes, an
after tax charge of $235,000 recorded in the first quarter of 2005 for severance
expenses related to the retirement of the Company's former Chairman and Chief
Executive Officer and the decrease of $59,000 after taxes in the provision for
loan losses in the first half of 2006 compared to the first half of 2005. Other
factors were decreased professional fees and other noninterest expense items.
The increase in net income and net income per diluted share for the quarter was
primarily due to an increase in net interest income of $168,000 after taxes.
Partially offsetting this factor was an increase of $21,000 after taxes in the
provision for loan losses in the second quarter of 2006 compared to the same
period in 2005 while decreases in noninterest income and noninterest expenses
which are described more fully in following sections accounted for most of the
remaining net change.
Results of Operations
Net Interest Income
Net interest income is the most significant component of the Company's revenues.
Net interest income is the difference between interest income on
interest-earning assets (primarily loans and investment securities) and interest
expense on interest-bearing liabilities (deposits and borrowed funds). Net
interest income depends on the volume and rate earned on interest-earning assets
and the volume and rate paid on interest-bearing liabilities.
Net interest income was $2.8 million and $5.4 million, respectively, for the
three months and six months ended June 30, 2006, an increase of $0.3 million or
10% and $0.5 million or 10%, respectively, from $2.5 million and $4.9 million,
respectively, for the comparable periods of 2005. On an annualized basis, the
net interest spread and net interest margin were 3.08% and 3.50%, respectively,
for the current quarter, compared to 2.93% and 3.32% for the same period of
2005. For the six months ended June 30, 2006 the net interest spread and net
interest margin were 3.08% and 3.47%, respectively, compared to 3.13% and 3.41%
for the first half of 2005. The increases in the net interest margin was
primarily due to a slower increase in interest rates on interest-bearing
liabilities compared to the rates on interest-earning assets and increases in
volume. Changes in volume resulted in an increase in net interest income of $0.1
million and $0.6 million for the second quarter and first half of 2006 compared
to the same periods in 2005, and changes in interest rates and the mix resulted
in an increase in net interest income of $0.2 million for the three months ended
June 30, 2006 and a decrease in net interest income of $0.1 million for the
first half of 2006 versus the comparable periods in 2005.
The Bank, like many other financial institutions, is vulnerable to an increase
in interest rates to the extent that interest-bearing liabilities mature or
reprice more rapidly than interest-earning assets. Historically, the lending
activities of commercial banks emphasized the origination of short to
intermediate term variable rate loans that are more closely matched with the
deposit maturities and repricing of interest-bearing liabilities which occur
closer to the same general time period. While having interest-bearing
liabilities that reprice more frequently than interest-earning assets is
generally beneficial to net interest income during periods of declining interest
rates, it is generally detrimental during periods of rising interest rates.
To reduce the effect of interest rate changes on net interest income, the Bank
has adopted various strategies to improve matching interest-earning asset
maturities to interest-bearing liability maturities. The principal elements of
these strategies include; originating variable rate commercial loans that
include interest rate floors; originating one-to-four family residential
mortgage loans with adjustable rate features, or fixed rate loans with short
maturities; maintaining interest-bearing demand deposits, federal funds sold,
and U.S. government securities with short to intermediate term maturities;
maintaining an investment portfolio that provides stable cash flows, thereby
providing investable funds in varying interest rate cycles; lengthening the
maturities of our time deposits and borrowings when it would be cost effective;
and attracting low cost checking and transaction accounts, which tend to be less
interest rate sensitive when interest rates increase.
The Bank measures its exposure to changes in interest rates using an overnight
upward and downward shift (shock) in the Treasury yield curve. As of June 30,
2006, if interest rates increased 200 basis points and decreased 200 points,
respectively, the Bank's net interest income would increase by 2.1% and decrease
by 2.8%, respectively.
Provision for Loan Losses
The provision for loan losses was $31,000 and $112,000 for the three months and
six months ended June 30, 2006, compared to $0 and $202,000 for the same periods
in 2005. Nonperforming loans were $1.3 million at June 30, 2006 and $1.3 million
at December 31, 2005, or 0.45% and 0.48%, respectively, of total loans. The
allowance for loan losses was $3.0 million and $2.9 million at June 30, 2006 and
December 31, 2005, or 1.07% and 1.08%, respectively, of total loans.
The Company maintains the allowance for loan losses at a level that it considers
to be adequate to provide for credit losses inherent in its loan portfolio.
Management determines the level of the allowance by performing a quarterly
analysis that considers concentrations of credit, past loss experience, current
economic conditions, the amount and composition of the loan portfolio (including
nonperforming and potential problem loans), estimated fair value of underlying
collateral, loan commitments outstanding, and other information relevant to
assessing the risk of loss inherent in the loan portfolio. As a result of
management's analysis, a range of the potential amount of the allowance for loan
losses is determined.
The Company will continue to monitor the adequacy of the allowance for loan
losses and make additions to the allowance in accordance with the analysis
referred to above. Because of uncertainties inherent in estimating the
appropriate level of the allowance for loan losses, actual results may differ
from management's estimate of credit losses and the related allowance.
Noninterest Income
Noninterest income was $0.5 million for the three months ended June 30, 2006,
compared to $0.6 million for the same period in 2005 and $0.9 million for the
six months ended June 30, 2006, compared to $6.1 million for the first half of
2005. The significant decrease in noninterest income for the six-month period in
2006 compared to the same period in 2005 resulted primarily from a $5.0 million
gain on sale of Federal Home Loan Mortgage Corporation ("FHLMC") preferred stock
recorded in the first quarter of 2005. The gain on loan sales was decreased due
to a slow down in secondary market mortgage activity and lower margins in the
second quarter of 2006 compared to the same period in 2005. The gain on loan
sales was $218,000 for the three months ended June 30, 2006, compared to
$328,000 for the comparable period in 2005 and $426,000 for the first half of
2006 compared to $537,000 for the first half of 2005. Service charge income was
$144,000 for the three months ended June 30, 2006, compared to $99,000 for the
comparable period in 2005 and $246,000 for the first half of 2006 compared to
$160,000 for the first half of 2005. The Company continues to evaluate its
deposit product offerings with the intention of continuing to expand its
offerings to the consumer and business depositor. During March 2005, the Bank
began offering products which include overdraft privileges on certain individual
deposit products and cash management services for business depositors. Both of
these products are fee-based and should result in further increases in service
charge income. The Bank also introduced a new deposit product known as "ATM
Advantage" during September 2005. This product offers unlimited use of
competitor's ATM networks with reimbursement of all foreign and surcharge fees.
The product does not pay interest but requires a minimum balance to avoid a
monthly service charge. This product could reduce service charge income but the
effect would be offset by more noninterest bearing deposits which should
contribute to additional net interest income. Factors contributing to the
decrease in other noninterest income for both the second quarter and six-month
period was the Company's decision to exit the title insurance business at the
end of November 2005 and a decrease in fees due to reduced activity relating to
secondary market mortgage lending and effecting the six-month period only was a
one time gain of $32,000 on long-term portfolio loans sold in the first quarter
of 2005. The Company's title insurance company had approximately $81,000 and
$131,000 of title insurance revenue for the three months and six months ended
June 30, 2005, respectively.
Noninterest Expense
Noninterest expense was $2.3 million for the quarter ended June 30, 2006
compared to $2.4 million the same period in 2005 and $4.5 million for the six
months ended June 30, 2006 compared to $5.3 million for the first half of 2005.
Contributing to the decrease was a decrease in salaries and employee benefits
due to the $356,000 which the Company accrued during the first quarter of 2005
for the severance expense relating to the retirement of the Company's former
Chairman and Chief Executive Officer, a reduction in the commissions related to
reduced activity in mortgage loan sales and a reduction in professional fees in
the first six months of 2006 compared to the first six months of 2005 due to a
reduced amount of services required. Other factors impacting the six-month
period only included a higher level of other noninterest expenses in the first
quarter of 2005 primarily related to integration items associated with the
merger with Independence Bancorp, the Citizens disposal in January 2005 and the
expenses relating to the title insurance company that was sold which was
previously mentioned. Partially offsetting those factors was an increase in net
occupancy expenses due to the Bank's purchase of a building, located in
Louisville, Kentucky to accommodate expansion. In April 2005, the Bank moved its
finance and accounting, loan and deposit operations, and mortgage banking
operations into the building and in November 2005 established a full service
branch at this location. An additional factor offsetting the overall decrease in
noninterest expenses was an increase in data processing expenses which was
primarily due to the growth of the Bank's services and its commitment to
upgrade systems productivity and the effects of a refund received in the first
quarter of 2005 from a previous third party data processing company of the Bank.
Income Tax Expense (Benefit)
The effective income tax rate on income from continuing operations was 31.2% for
the three months ended June 30, 2006 compared to 30.8% for the same period in
2005 and 31.1% for the first six months of 2006 compared to 34.6% for the first
half of 2005. The decrease in the effective tax rate for the six-month period is
primarily due to an increase in the percentage of tax exempt interest income.
Financial Condition
The Company's total assets were $348.6 million at June 30, 2006 compared to
$336.2 million at December 31, 2005, an increase of 12.4 million or 3.7%. Net
loans increased $13.5 million, loans held for sale went up $0.8 million and
interest receivable and other assets increased $0.5 million while cash and cash
equivalents decreased $1.9 million and Federal Home Loan Bank ("FHLB") stock
went down $0.4 million.
Net loans were $280.5 million at June 30, 2006, compared to $267.0 million at
December 31, 2005, an increase of $13.5 million or 5.1%. The increases in loans
were in the real estate construction and real estate commercial loan portfolios,
which increased $15.2 million or 29% and $2.6 million or 6%, respectively. The
increases were primarily a result of lending activity in the Louisville,
Kentucky metro market. All loan categories increased or remained the same as a
percentage of total loans, except residential real estate loans, which decreased
from approximately 48% to 43% of total loans and commercial loans which
decreased from 9% to 8% of total loans. The decrease in residential real estate
loans as a percentage of total loans is primarily due to those loans now being
sold in the secondary market through 1st Independence Mortgage, a division of
the Bank, rather than being retained for the Company's loan portfolio. The
Company continues to identify opportunities to cross sell its other products,
including home equity and consumer loans for its loan portfolio resulting from
customer relationships established through the origination of loans by 1st
Independence Mortgage.
Deposits increased $7.5 million or 2.8% to $271.8 million at June 30, 2006
compared to $264.3 million at December 31, 2005. This increase was largely
attributable to increases in savings, NOW and money market deposits of $8.0
million and demand deposits of $5.9 million which more than offset a $6.4
million decrease in time deposits. The increase in savings, NOW and money market
deposits resulted primarily from the effects of a general marketing campaign
during the first nine months of 2005 focusing on existing products and print
advertisements only. As previously mentioned, during September 2005 the Company
introduced a new deposit product known as "ATM Advantage" as part of its efforts
to continue to grow core deposits. This new product offers unlimited use of
competitor's ATM networks with reimbursement of all foreign and surcharge fees.
The product does not pay interest but requires a minimum balance to avoid a
monthly service charge.
Short-term borrowings increased $7.0 million or 36.8% to $25.7 million at June
30, 2006, compared to $18.7 million at December 31, 2005. The Company uses
short-term borrowings, primarily short-term FHLB advances, to fund short-term
liquidity needs and manage net interest margin.
Off-Balance Sheet Arrangements
In the normal course of operations, the Company engages in financial
transactions that contain credit, interest rate, and liquidity risk that are not
recorded in the financial statements such as loan commitments and performance
letters of credit. As of June 30, 2006, unused loan commitments and performance
letters of credit were $66,205,000 and $2,339,000, respectively.
Since many of the unused loan commitments are expected to expire or be only
partially used, the total amount of commitments does not necessarily represent
future cash requirements.
Liquidity and Capital Resources
Liquidity to meet borrowers' credit and depositors' withdrawal demands is
provided by maturing assets, short-term liquid assets that can be converted to
cash and the ability to attract funds from depositors. Additional sources of
liquidity include brokered deposits, advances from the FHLB and other short-term
borrowings, such as federal funds purchased and securities sold under repurchase
agreements.
At June 30, 2006 and December 31, 2005, brokered deposits were $42.9 million and
$59.6 million, respectively. The weighted average cost and maturity of brokered
deposits were 4.43% and four months at June 30, 2006 compared to 3.90% and nine
months at December 31, 2005. The Company plans to continue using brokered
deposits for the foreseeable future to support loan demand when pricing for
brokered deposits is more favorable than short-term borrowings.
At June 30, 2006 and December 31, 2005, the Bank had total FHLB advances
outstanding of $26.0 million and $22.0 million, respectively, with $1.0 million
and $4.0 million, respectively, included in long-term debt in the accompanying
condensed consolidated balance sheet and the remaining amount included in
short-term borrowings. Additionally, the Bank had $35.0 million of unused
commitments under its line of credit with the FHLB and sufficient collateral to
borrow an additional $55.0 million.
The Company's liquidity depends primarily on dividends paid to it as sole
shareholder of the Bank. At June 30, 2006, the Bank may pay up to $6.7 million
in dividends to the Company without regulatory approval, subject to the ongoing
capital requirements of the Bank.
The Company has $9.3 million of subordinated debentures outstanding, which are
included in long-term debt in the accompanying condensed consolidated balance
sheet with $4.1 million of the debentures being variable rate obligations with
interest rates that reprice quarterly, and are tied to the three-month London
Interbank Offering Rate ("LIBOR") plus 3.15%. At June 30, 2006 the rate on the
variable rate obligations was 8.61%. The remaining $5.2 million of debentures
carry a fixed interest rate of 6.4% until March 26, 2008 when the debentures
become variable rate obligations that reprice quarterly at the three-month LIBOR
rate plus 3.15%.
Stockholders' equity increased $1.1 million from $38.3 million at December 31,
2005 to $39.4 million at June 30, 2006. The significant drivers of the change
were net income of $1.1 million, cash dividends declared of $0.3 million ($0.16
per share), an increase of $0.5 million relating to stock option and ESOP plan
transactions and an increase of $0.2 million in accumulated other comprehensive
loss.
Bank holding companies and their subsidiary banks are required by regulators to
meet risk based capital standards. These standards, or ratios, measure the
relationship of capital to a combination of balance sheet and off-balance sheet
risks. The following table presents these ratios as of June 30, 2006 and
December 31, 2005 for the Consolidated Company and the Bank along with the
regulator's minimum ratio to be considered well capitalized.
To Be Well
June 30, 2006 December 31, 2005 Capitalized
------------- ----------------- -----------
Total risk-based capital to risk-weighted assets
Consolidated company 14.7% 15.1% 10.0%
Bank 13.4 13.6 10.0
Tier 1 capital to risk-weighted assets
Consolidated company 13.6 13.1 6.0
Bank 12.3 12.5 6.0
Tier 1 capital to average assets
Consolidated company 11.2 10.2 5.0
Bank 10.2 9.7 5.0
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Information required by this item is included in Item 2, "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), the Company's management carried out an evaluation, with
the participation of the Company's Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the Company's disclosure controls and
procedures as of the end of the quarter ended June 30, 2006. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures are effective to ensure
that information required to be disclosed by the Company in its reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the United States Securities and
Exchange Commission's rules and forms.
(b) Changes in Internal Control over Financial Reporting
There have not been any changes in the Company's internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act)
during the quarter ended June 30, 2006 that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
The Company, from time to time, is a party to ordinary routine litigation, which
arises in the normal course of business, such as claims to enforce liens,
condemnation proceedings on properties in which the Company holds security
interests, claims involving the making and servicing of real property loans, and
other issues incident to its business. Except as discussed below, there were no
potentially material lawsuits or other legal proceedings pending or known to be
contemplated against the Company at March 31, 2006.
On or about May 28, 2004, a complaint was filed in the Circuit Court of Anderson
County in the Commonwealth of Kentucky by Larry Sutherland, Judy Sutherland,
John Henry Disponett, Brenda Disponett, Todd Hyatt, Lois Ann Disponett, Sue
Saufley, and Hugh Coomer. Soon thereafter, an amended complaint was filed which
added Lois Hawkins and Norma K. Barnett as plaintiffs. The lawsuit arises from
offers to purchase securities made by the Company in connection with an offer to
purchase up to 300,000 shares of its stock in a tender offer on or about May 28,
2003. The Plaintiffs allege that the Company made certain material
misrepresentations in connection with certain statements made in the tender
offer. The Plaintiffs are seeking to recover compensatory and punitive damages
in connection with the shares it sold in the tender offer and their attorneys'
fees. Discovery in the matter is currently underway and a trial date has not
been set. On April 14, 2006 a partial summary judgment was entered against the
plaintiffs. In the partial summary judgment, the Circuit Court held that the
only remedy available to the plaintiffs is the return of the stock upon the
tender of the consideration received by the plaintiffs in exchange for the
stock. Based upon the advice of counsel, management records an estimate of the
amount of ultimate expected loss for litigation, if any. Management, after
discussion with legal counsel, believes the ultimate result of this litigation
will not have a material adverse effect on the Company's financial position,
results of operations or cash flows. However, events could occur that could
cause any estimate of ultimate loss to differ materially in the near term.
Item 1A. Risk Factors
Risks Related to our Business
We are subject to extensive regulation that could limit or restrict our
activities and impose financial requirements or limitations on the conduct of
our business, which limitations or restrictions could adversely affect our
profitability.
As a bank holding company, we are primarily regulated by the Board of
Governors of the Federal Reserve System. Our subsidiary is primarily
regulated by the FDIC and the Kentucky Office of Financial Institutions.
Our compliance with Federal Reserve Board, FDIC and Kentucky
banking regulations is costly. A failure to comply with the banking
regulations may limit our growth and restrict certain of our activities,
including payment of dividends, mergers and acquisitions, investments,
loans and interest rates charged, interest rates paid on deposits and
locations of offices. We are also subject to the capital requirements of
our regulators.
The laws and regulations applicable to the banking industry could change at
any time, and we cannot predict the effects of these changes on our
business and profitability. Because government regulation greatly affects
our business and financial results, our cost of compliance could adversely
affect our ability to operate profitably and a failure to comply could
limit our ability to implement our business strategy.
Our business strategy includes the continuation of growth plans, and our
financial condition and results of operations could be negatively affected if we
fail to grow.
We have grown rapidly in terms of branch expansion, total assets, net
loans, and deposits. We may not be able to continue to grow at the same
rate that we have grown in the past. We currently serve our customers
through a network of eight banking offices, consisting of two full-service
banking locations in Louisville, Kentucky, and one full-service banking
location in each of New Albany, Jeffersonville, and Clarksville, Indiana.
We also have one full-service banking location in Harrodsburg, Kentucky,
Lawrenceburg, Kentucky, and Marengo, Indiana. Our business strategy calls
for continued expansion and the opening of additional branches during the
next three to five years. We have not yet attempted to establish branches
in any of the other counties in Kentucky or southern Indiana. Our branch
expansion strategy entails other risks, including:
o the entrance into new markets where we lack experience;
o the experience of unexpected competition;
o the introduction of new products and services into our business
with which we have no prior experience;
o the time and costs of evaluating new markets, hiring
experienced local management and opening new offices;
o the ability to implement and improve our operational, credit,
financial, management and other internal risk controls and
processes and our reporting systems and procedures;
o the ability to manage a growing number of client relationships;
o the ability to recruit and retain additional experienced
bankers to accommodate growth;
o the ability to maintain controls and procedures sufficient to
accommodate an increase in expected loan volume and
infrastructure;
o the diversion of our management's attention from our existing
businesses as a result of our growth strategy;
o the additional expenditures our asset growth may require to
expand our administrative and operational infrastructure; and
o the ability to maintain cost controls and asset quality while
attracting additional loans and deposits on favorable terms.
The occurrence of any of these factors could have an adverse effect on our
financial condition. We can provide no assurance that we will be able to
overcome the risks associated with growth or any other problems encountered
in executing our growth strategy.
Our recent results do not indicate our future results, and may not provide
guidance to assess the risk of an investment in our common stock.
We are unlikely to sustain our historical rate of growth, and may not even
be able to expand our business at all. Further, our recent growth may
distort some of our historical financial ratios and statistics. In the
future, we may not have the ability to find suitable expansion
opportunities. Various factors, such as economic conditions, regulatory and
legislative considerations and competition, may also impede or prohibit our
ability to expand our market presence. If we are not able to successfully
grow and expand our business, our financial condition and results of
operations could be adversely affected.
Our business would be harmed if we lost the services of any of our senior
management team and are unable to recruit or retain suitable replacements.
We believe that our success to date and our prospects for future success
depend significantly on the efforts of our senior management team, which
includes N. William White, our President and Chief Executive Officer, R.
Michael Wilbourn, our Executive Vice President and Chief Financial Officer,
Gregory A. DeMuth, our Executive Vice President and the Chief Lending
Officer of the Bank, David M. Hall, our Executive Vice President and
Executive Vice President-Retail Banking of the Bank, Kathy Beach, our
Executive Vice President and Chief Operations Officer and certain of our
senior bankers. We have $0.5 million of key-man life insurance on both Mr.
White and Mr. Wilbourn. There is no assurance, however, that $0.5 million
would be enough to compensate us for the loss of Mr. White or Mr. Wilbourn.
We do not have key-man insurance on any other officer of the Company or the
Bank. In addition to their skills and experience as bankers, these persons
provide us with extensive community ties upon which our competitive
strategy is based.
A significant portion of our loan portfolio is secured by real estate, and
events that negatively impact the real estate market could hurt our business.
A significant portion of our loan portfolio is secured by real estate. The
real estate collateral in each case provides an alternate source of
repayment in the event of default by the borrower and may deteriorate in
value during the time the credit is extended. A weakening of the real
estate market in our market areas could result in an increase in the number
of borrowers who default on their loans and a reduction in the value of the
collateral securing their loans, which in turn could have an adverse effect
on our profitability and asset quality. If we are required to liquidate the
collateral securing a loan to satisfy the debt during a period of reduced
real estate values, our earnings and capital could be adversely affected.
Acts of nature, including hurricanes, tornados, earthquakes, fires and
floods, which may cause uninsured damage and other loss of value to real
estate that secures these loans, may also negatively impact our financial
condition. Additionally, a slowdown in real estate activity in the markets
we serve may also negatively impact our financial condition.
An economic downturn, either nationally or in the local market area, could
adversely affect our financial condition, results of operations and cash flows.
Deterioration in local, regional, national or global economic conditions
could result in, among other things, an increase in loan delinquencies, a
change in the housing turnover rate or a reduction in the level of
available wholesale deposits. If the communities in which we operate do not
grow, or if the prevailing local or national economic conditions are
unfavorable, our business strategy may not succeed. A weakening of the
employment market in our primary market area could result in an increase in
the number of borrowers who default on their loans. Further, the banking
industry is affected by general economic conditions such as inflation,
interest rates, recession, unemployment and other factors beyond our
control. Moreover, we cannot give any assurance that we will benefit from
any market growth or favorable economic conditions in our primary market
areas even if they do occur.
Our cost of funds for banking operations may increase as a result of general
economic conditions, interest rates and competitive pressures.
Our cost of funds for banking operations may increase as a result of
general economic conditions, interest rates and competitive pressures. In
the past, the Bank has relied heavily on brokered certificates of deposits
and borrowings for the funds necessary for banking operations. As a general
matter, deposits are a cheaper source of funds than brokered certificates
of deposit or borrowings, because interest rates paid for deposits are
typically less than interest rates charged for brokered certificates of
deposit or borrowings. Our business strategy includes funding more of our
operations with deposits; however, we cannot provide any assurances that we
will be able attract sufficient deposits.
Competition from other financial institutions and others may adversely affect
our profitability.
The banking business generally, and because of its desirability and the
opportunities for growth, the Louisville, Kentucky and southern Indiana
market area in particular, is highly competitive, and we experience strong
competition from many other financial institutions. We compete with
commercial banks, credit unions, savings and loan associations, mortgage
banking firms, consumer finance companies, securities brokerage firms,
insurance companies, money market funds and other financial institutions,
which operate in our primary market area and elsewhere.
We compete with these institutions to make loans and to attract new
customers and in pricing loans and deposits. Many of our competitors are
well-established and much larger financial institutions and can offer
customers more attractive pricing terms. While we believe we can and do
successfully compete with these other financial institutions in our
markets, we may face a competitive disadvantage as a result of our smaller
size.
We also compete with private lenders, mezzanine and venture capital firms
and angel investors in some of our lending divisions, including our
community redevelopment lending and mezzanine financing divisions. Many of
these competitors are subject to minimal or no regulation and may be able
to make accommodations for customers that we are unable to make.
We are currently subject to claims regarding the merger of Independence Bancorp
with Harrodsburg First Financial Bancorp, Inc. that could result in substantial
defense, judgment or settlement costs.
On or about May 28, 2004, a complaint was filed in the Circuit Court of
Anderson County in the Commonwealth of Kentucky by Larry Sutherland, Judy
Sutherland, John Henry Disponett, Brenda Disponett, Todd Hyatt, Lois Ann
Disponett, Sue Saufley, and Hugh Coomer. Soon thereafter, an amended
complaint was filed which added Lois Hawkins and Norma K. Barnett as
plaintiffs. The lawsuit arises from offers to purchase securities made by
us in connection with an offer to purchase up to 300,000 shares of our
stock in a tender offer on or about May 28, 2003. The Plaintiffs allege
that we made certain material misrepresentations in connection with certain
statements made in the tender offer. The Plaintiffs are seeking to recover
compensatory and punitive damages in connection with the shares they sold
in the tender offer and their attorneys' fees. Discovery in the matter is
currently underway and a trial date has not been set.
On April 14, 2006 a partial summary judgment was entered against the
plaintiffs. In the partial summary judgment, the Circuit Court held that
the only remedy available to the plaintiffs is the return of the stock upon
the tender of the consideration received by the Plaintiffs in exchange for
the stock. If we are ultimately unsuccessful in this litigation, it may
have a negative effect on our results of operations or cash flows.
Risks Related to Our Industry
Our profitability is vulnerable to interest rate fluctuations.
Most of our assets and liabilities are monetary in nature, and thus subject
us to significant risks from changes in interest rates. Consequently, our
results of operations can be significantly affected by changes in interest
rates and our ability to manage interest rate risk. Changes in market
interest rates, or changes in the relationships between short-term and
long-term market interest rates, or changes in the relationship between
different interest rate indices can affect the interest rates charged on
interest-earning assets differently than the interest paid on
interest-bearing liabilities. This difference could result in an increase
in interest expense relative to interest income or a decrease in interest
rate spread. In addition to affecting our profitability, changes in
interest rates can impact the valuation of our assets and liabilities. A
discussion of how we measure our exposure to interest rate changes is
provided in Part I, Item II of this Form 10-Q.
We could suffer loan losses from a decline in credit quality.
We could sustain losses if borrowers, guarantors or related parties fail to
perform in accordance with the terms of their loans. We have adopted
underwriting and credit monitoring procedures and policies, including the
establishment and review of the allowance for credit losses, that we
believe are appropriate to minimize this risk by assessing the likelihood
of nonperformance, tracking loan performance and diversifying our credit
portfolio. These policies and procedures, however, may not prevent
unexpected losses that could materially adversely affect our results of
operations and financial condition.
If our allowance for loan losses is not sufficient to cover actual loan
losses, our earnings could decrease.
We manage our credit exposure through careful monitoring of loan applicants
and loan concentrations in particular industries, and through loan approval
and review procedures. We have established an evaluation process designed
to determine the adequacy of our allowance for loan losses. While this
evaluation process uses historical and other objective information, the
classification of loans and the establishment of loan losses is an estimate
based on experience, judgment and expectations regarding our borrowers, the
economies in which we and our borrowers operate, as well as the judgment of
our regulators.
There is no precise method of predicting loan losses, so we cannot assure
you that our loan loss allowance will be sufficient to absorb future loan
losses or prevent a material adverse effect on our business, financial
condition or results of operations.
Failure to achieve and maintain effective internal controls in accordance with
Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on
our ability to report our financial results timely and accurately and on our
stock price.
Section 404 of the Sarbanes-Oxley Act requires annual assessments of the
effectiveness of our internal controls over financial reporting and a
report by our independent registered public accounting firm addressing
these assessments. We are required to complete our initial assessment by
the filing of our Form 10-K for the year ended December 31, 2007. During
the course of our assessment, we may identify deficiencies in our internal
controls over financial reporting which we may not be able to remediate in
time to meet this deadline. A failure to maintain adequate internal
controls may result in material misstatements in our financial statements
and a failure to meet our reporting obligations. As result investors may
lose confidence in our reported financial information and our stock price
could decline.
Our operations could be interrupted if our network or computer systems fail or
experience a security breach.
Our computer systems and network infrastructure could be vulnerable to
unforeseen problems. Our operations are dependent upon our ability to
protect our computer equipment against damage from fire, power loss,
telecommunications failure or a similar catastrophic event. Any damage or
failure that causes an interruption in our operations could result in a
loss of customers and thereby have a material adverse effect on our
business, operating results and financial condition.
Risks Relating to an Investment in Our Common Stock
Additional growth may require us to raise additional capital in the future, but
that capital may not be available when it is needed, which could adversely
affect our financial condition and results of operations.
We are required by federal and state regulatory authorities to maintain
adequate levels of capital to support our operations. We anticipate that
our current capital resources will satisfy our capital requirements for the
foreseeable future. We may at some point, however, need to raise additional
capital to support our continued growth. Our ability to raise capital, if
needed, will depend on conditions in the capital markets at that time,
which are outside our control, and on our financial performance.
Accordingly, we cannot assure you of our ability to raise capital, if
needed, on terms acceptable to us. If we cannot raise capital when needed,
our ability to implement our business strategy could be materially
impaired.
Our stock price may fluctuate and be volatile.
The prices at which our common stock has traded may not be indicative of
future market prices. The trading price of our common stock has, in the
past, and could continue in the future to fluctuate significantly.
Volatility in our stock price could result from the following factors,
among others:
o variations in quarterly operating results;
o changes in financial estimates by securities analysts;
o the operating and stock price performance of other companies in
the banking industry; and
o general stock market or economic conditions.
The stock market in recent years has experienced price and volume
fluctuations that have often been unrelated or disproportionate to the
operating performance of affected companies.
Our ability to pay dividends is limited, and we may be unable to pay future
dividends if we decide to do so.
Our ability to continue our current dividends is limited by regulatory
restrictions, by the bank's ability to pay dividends to us based on its
capital position and profitability, and by our need to maintain sufficient
capital to support the bank's operations. The ability of the bank to pay
dividends to us is limited by its obligations to maintain sufficient
capital and by other restrictions on its dividends that are applicable to
banks that are regulated by the FDIC. If the bank does not satisfy these
regulatory requirements it will be unable to pay dividends to us and we
will be unable to pay dividends on our common stock to you.
The holders of our junior subordinated debentures have rights that are senior
to those of our common shareholders.
At the time of the merger of Harrodsburg First Financial Bancorp and
Independence Bancorp, Harrodsburg First Financial Bancorp had $5.2 million
of trust preferred securities outstanding and Independence Bancorp had $4.1
million of trust preferred securities outstanding. Payments of the
principal and interest on the trust preferred securities are conditionally
guaranteed by us. Further, the accompanying junior subordinated debentures
that were issued by Harrodsburg First Financial Bancorp and Independence
Bancorp are senior to our shares of common stock. As of June 30, 2006, we
had approximately $9.3 million of junior subordinated debentures
outstanding. We have the right to defer payment of interest on the junior
subordinated debentures for a period not exceeding 20 consecutive quarters.
If we defer, or fail to make, interest payments on the junior subordinated
debentures, we will be prohibited, subject to certain exceptions, from
paying cash dividends on our common stock until we pay all deferred
interest and resume interest payments on the junior subordinated
debentures.
We have implemented anti-takeover devices that could make it more difficult for
another company to purchase us, even though such a purchase may increase
shareholder value.
In many cases, shareholders would receive a premium for their shares if we
were purchased by another company. However, state and federal law and our
certificate of incorporation and bylaws make it difficult for anyone to
purchase us without approval of our board of directors. For example, our
articles of incorporation divide the board of directors into three classes
of directors serving staggered three-year terms with approximately
one-third of the board of directors elected at each annual meeting of
shareholders. The classification of directors makes it more difficult for
shareholders to change the composition of the board of directors. As a
result, at least two annual meetings of shareholders would be required for
the shareholders to change a majority of the directors, whether or not a
change in the board of directors would be beneficial and whether or not a
majority of shareholders believe that such a change would be desirable. In
addition, our certificate of incorporation provides that in no event shall
any record owner of any outstanding common stock which is beneficially
owned, directly or indirectly, by a person who beneficially owns in excess
of 10% of the then outstanding shares of common stock be entitled or
permitted to any vote with respect to the shares held in excess of the 10%
limit. Consequently, a takeover attempt may prove difficult, and
shareholders may not realize the highest possible price for their
securities.
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of Stockholders (the "Meeting"), held May 18,
2006, the following matters were submitted for a vote by the security holders:
Election of the persons named below as directors:
Votes cast for Votes withheld
-------------- --------------
For a three-year term:
Stephen R. Manecke 1,606,296 79,274
Dr. Ronald L. Receveur 1,487,650 79,274
W. Dudley Shryock 1,543,493 79,274
H. Lowell Wainwright, Jr. 1,541,072 79,274
In addition, the terms of Matthew C. Chalfant, Jack L. Coleman, Jr.,
James W. Dunn, Thomas Les Letton, Charles L. Moore II, and N. William
White as directors continued following the meeting. Mr. Dunn's term was to
expire at the 2008 Annual Meeting, however in January 2006 Mr. Dunn
announced his resignation from the Board of Directors effective
June 30, 2006.
Approval of the 1st Independence Restricted Stock Plan. There were
841,850 votes for and 402,458 votes against and 44,867 abstentions.
Ratification of the appointment of BKD, LLP as the Company's
independent registered public accounting firm for the year ending
December 31, 2006. There were 1,616,969 votes for and 500 votes against
and 6,795 abstentions.
Item 6. Exhibits
(a) Exhibits
31.1 Rule 13a-14(a) / 15d-14(a) Certification of Principal
Executive Officer ("Section 302 Certifications").
31.2 Rule 13a-14(a) / 15d-14(a) Certification of Principal
Financial Officer ("Section 302 Certifications").
32.1 Section 1350 Certifications ("Section 906
Certifications").
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
1st INDEPENDENCE FINANCIAL GROUP, INC.
By: /s/ R. Michael Wilbourn
-----------------------
R. Michael Wilbourn
Executive Vice President
and Chief Financial Officer
Date: August 1, 2006
Exhibit Index
Exhibit
Number Description
31.1 Rule 13a-14(a) / 15d-14(a) Certification of Principal
Executive Officer ("Section 302 Certifications").
31.2 Rule 13a-14(a) / 15d-14(a) Certification of Principal
Financial Officer ("Section 302 Certifications").
32.1 Section 1350 Certifications ("Section 906
Certifications").