ITEM 1. BUSINESS.
GENERAL
Indian River Banking Company ("Indian River") was incorporated under the laws of the State of Florida in January 1989 to be the holding company for Indian River National Bank ("Indian River Bank"), and acquired all of the shares of Indian River Bank in April 1989. Indian River has four subsidiaries, Indian River Bank, a national banking association, Indian River Title Company, LLC, IRNB Insurance Services LLC, and Indian River Capital Trust I. Indian River Bank commenced operations in March 1985, and currently operates out of four branches in Indian River County and four branches in Brevard County. Indian River Bank seeks to provide a high level of personal service and a sophisticated menu of products to individuals and to small and medium sized businesses. While Indian River Bank offers a full range of services to a wide array of depositors and borrowers, it has chosen the small and medium sized businesses, professionals and individual retail customers as its primary target market. Indian River Bank believes that as financial institutions grow and are merged with or acquired by larger institutions with headquarters that are far away from the local customer base, the local business and individual is further removed from the point of decision making. Indian River Bank attempts to place the customer contact and the ultimate decision on products and credits as close together as possible.
Indian River has elected to become a "financial holding company" under the Gramm Leach Bliley Act and the regulations promulgated under that act. As a financial holding company, Indian River is able to engage in activities which law, regulation or order determines are financial in nature, or which are incidental or complementary to those activities. Indian River has established IRNB Insurance Services, LLC to engage in insurance agency activities, particularly those related to fixed annuities and life agency activities. Currently, there are no definitive plans or agreements to engage in other activities which are financial in nature. We cannot be sure that we will engage in other financial activities, or that we will be successful or profitable in these activities.
Indian River Bank expects to continue its expansion of operations by opening its eighth branch, its fourth in Brevard County. The new branch opened in February 2003. There can be no assurance that it will be profitably operated or that it will add to earnings.
LENDING ACTIVITIES
Indian River Bank offers a full spectrum of lending services to its customers, including commercial loans, lines of credit, residential mortgages, home equity loans, personal loans, auto loans and financing arrangements for personal equipment and business equipment. Loan terms, including interest rates, loan to value ratios, and maturities, are tailored as much as possible to meet the needs of the borrower within regulatory requirements and bank policy. A special effort is made to keep loan products as flexible as possible within the guidelines of prudent banking practices in terms of interest rate risk and credit risk.
The primary factors taken into consideration by Indian River Bank when considering loan requests are the cash flow and financial condition of the borrower, the value of the underlying collateral, if any, and the character and integrity of the borrower. These factors are evaluated in a number of ways including an analysis of financial statements, credit reviews, trade reviews, and visits to the borrower's place of business. The bank has implemented a comprehensive loan policy and procedures manual to provide its loan officers with term, collateral, loan-to-value and pricing guidelines. The policy manual and sound credit analysis, together with thorough review by the Bank Loan Committee, have resulted in a profitable loan portfolio, with minimal non-performing assets.
Loan business is generated primarily through referrals and direct-calling efforts. Referrals of loan business come from directors, shareholders, current customers and professionals such as lawyers, accountants and financial intermediaries.
At December 31, 2002, Indian River Bank's statutory lending limit to any single borrower was $5.3 million subject to certain exceptions provided under applicable law. As of December 31, 2002, Indian River Bank's credit exposure to its largest borrower was $4.1 million.
Commercial Loans. Commercial loans are written for any business purpose, including the financing of plant and equipment, the carrying of accounts receivable, contract administration, and the acquisition and construction of real estate projects. Special attention is paid to the commercial real estate market which is particularly stable and active in the Indian River and Brevard County area. Indian River Bank's commercial loan portfolio reflects a diverse group of borrowers with no concentration in any borrower, or group of borrowers.
As part of its internal loan review process, Indian River Bank's Loan Committee, comprised of loan officers and staff, reviews consumer loans two payments past due, commercial loans thirty days past due, loans on the Watch List, loans rated special mention, substandard, or doubtful, and other loans of concern at least quarterly. Loan reviews are reported to the Audit and Examining Committee with any adversely rated changes specifically mentioned. All other loans with their respective risk ratings are reported monthly to Indian River Bank's Board of Directors. The Examining (Audit) Committee coordinates periodic documentation and internal control reviews by outside vendors to complement loan reviews.
Residential Mortgage and Home Equity Loans. The strong local economy provides for a large and active real estate market for the construction and sale of new residential property and sale of existing housing. Indian River Bank provides financing for the construction and acquisition of residential property throughout its market area. Indian River Bank has availed itself of the services of mortgage brokers and programs offered by the Federal Home Loan Bank of Atlanta in an effort to offer as many long-term and low interest rate mortgage products as possible. In addition, Indian River Bank has developed a competitive home equity line of credit product for the use of its customers. This product offers the customer the ability to use the line of credit flexibility features to manage their own credit needs on an on-going basis. Indian River Bank sells loans which it originates for the secondary market to private investors and government sponsored associations.
Other Loans. Loans are considered for any worthwhile personal or business purpose on a case-by-case basis, such as the financing of equipment, receivables, contract administration expenses, land acquisition and development, and automobile financing.
INVESTMENT ACTIVITIES
The investment policy of Indian River Bank is an integral part of its overall asset/liability management program. The purpose of the investment policy is to establish a portfolio which will provide liquidity necessary to facilitate funding of loans and to cover deposit fluctuations while at the same time achieving a satisfactory return on the funds invested. Indian River Bank seeks to maximize earnings from its investment portfolio consistent with the safety and liquidity of those investment assets.
The securities in which Indian River Bank may invest are subject to regulation and, for the most part, are limited to securities which are considered investment grade securities. In addition, Indian River Bank's internal investment policy restricts investments to the following categories: U.S. Treasury securities; obligations of U.S. government agencies, investment grade obligations of U.S. private corporations, mortgage-backed securities, including securities issued by Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation; and securities of states and political subdivisions, all of which must be considered investment grade by a recognized rating service.
BROKERAGE ACTIVITIES
Indian River Bank offers brokerage services through FiServe Investor Services, Inc, member NASD & SIPC, a third party vendor. Brokerage services provided by FiServe include a full line of investment products, including the purchase and sale of mutual funds, annuities, stocks, bonds, term life insurance, cash management accounts, IRA's, and many other products and services.
The manager of brokerage services for Indian River Bank is a licensed securities representative through the NASD and is a dual employee of both FiServe and Indian River Bank. In such capacity, he must comply with all applicable rules and regulations of the FDIC, the SEC and the National Association of Securities Dealers, SIPC and the OCC. Fees and commissions earned by the brokerage services department are paid monthly by FiServe directly to Indian River Bank.
The customer base of the brokerage department is made up of approximately 99% percent individuals, with the remainder consisting of investment clubs and other accounts. As of December 31, 2002, there were approximately 1,020 open brokerage accounts.
SOURCES OF FUNDS
Deposits. Deposits obtained through bank offices have traditionally been the principal source of Indian River Bank's funds for use in lending and for other general business purposes. At December 31, 2002 total deposits in the bank amounted to $364.9 million. Certificates of deposit and savings deposits, representing 67.5% of the deposit base, are Indian River Bank's primary source of deposit funds.
In order to better serve the needs of its customers, Indian River Bank offers several types of deposit accounts in addition to standard savings, checking, and NOW accounts. Special deposit accounts include Personal Checking and Small Business Checking. Personal Checking requires no minimum balance and has no monthly fee, per check charge, or activity limit, and checks are truncated. Small Business Checking allows a small business to have up to 300 items per month at no cost and then a $0.25 per item charge thereafter during the period. Indian River Bank also offers lockbox services payments processing for many businesses including homeowners associations.
Bills have been introduced in each of the last three Congresses which would permit banks to pay interest on checking and demand deposit accounts established by businesses, a practice which is currently prohibited by regulation. If the legislation effectively permitting the payment of interest on business demand deposits is enacted, of which there can be no assurance, it is likely that we may be required to pay interest on some portion of our noninterest bearing deposits in order to compete against other banks. As a significant portion of our deposits are non-interest bearing demand deposits established by businesses, payment of interest on these deposits could have a significant negative impact on our net income, net interest income, interest margin, return on assets and equity, and other indices of financial performance. We expect that other banks would be faced with similar negative impacts. We also expect that the primary focus of competition would continue to be based on other factors, such as quality of service.
Borrowing. Indian River has established various borrowing arrangements in order to provide management with additional sources of liquidity and funding, thereby increasing flexibility. Indian River has total borrowings, consisting primarily of securities sold under agreements to repurchase and FHLB advances, of $57.3 million at December 31, 2002. In addition, Indian River has available credit of $25.7 million under federal funds lines of credit and in excess of $4.3 million available under its line with the Federal Home Loan Bank of Atlanta. Management believes that Indian River currently has adequate liquidity available to respond to anticipated liquidity demands.
COMMUNITY REINVESTMENT ACT
Indian River Bank is committed to serving the banking needs of the communities it serves, including low and moderate income areas, and is a supporter of the Community Reinvestment Act. There are several ways in which Indian River Bank attempts to fulfill this commitment, including working with economic development agencies, undertaking special projects, and becoming involved with neighborhood outreach programs.
Indian River Bank has contacts with state and city agencies that assist in the financing of affordable housing developments as well as with groups which promote the economic development of low and moderate income individuals. Indian River Bank has computer software to geographically code all types of accounts to track business development and performance by census tract and to assess market penetration in low and moderate income neighborhoods within the primary service area. Indian River Bank is a registered Small Business Administration lender.
Indian River encourages its directors and officers to participate in community, civic and charitable organizations. Management and members of the Board of Directors periodically review the various Community Reinvestment Act activities of Indian River Bank, including the advertising program and geocoding of real estate loans by census tract data which specifically focuses on low income neighborhoods, its credit granting process with respect to business prospects generated in these areas, and its involvement with community leaders on a personal level.
COMPETITION
In attracting deposits and making loans, Indian River Bank encounters competition from other institutions, including larger commercial banking organizations, savings banks, credit unions, other financial institutions and non-bank financial service companies serving Indian River and Brevard counties and adjoining areas. Financial and non-financial institutions not located in the market are also able to reach persons and entities based in the market through mass marketing, the internet, telemarketing, and other means. The principal methods of competition include the level of loan interest rates, interest rates paid on deposits, efforts to obtain deposits, range of services provided and the quality of these services. Our competitors include several major financial companies whose substantially greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. In light of the deregulation of the financial service industry and the absence of interest rate controls on deposits, we anticipate continuing competition from all of these institutions in the future. Additionally, as a result of legislation which reduced restrictions on interstate banking and widened the array of companies that may own banks, Indian River Bank may face additional competition from institutions outside the Florida market and outside the traditional range of bank holding companies which may take advantage of such legislation to acquire or establish banks or branches in Indian River Bank's market. There can be no assurance that we will be able to successfully meet these competitive challenges.
In addition to offering competitive rates for its banking products and services, our strategy for meeting competition has been to concentrate on specific segments of the market for financial services, particularly small business and individuals, by offering such customers customized and personalized banking services. Although there are other small banks offering personalized banking services in Indian River Bank's primary service area, we believe that Indian River Bank is one of few such banks offering flexible credit accommodations to small businesses.
We believe that active participation in civic and community affairs is an important factor in building our reputation and, thereby, attracting customers.
EMPLOYEES
As of February 18, 2003, Indian River Bank had 150 full-time equivalent employees. Indian River Title Company LLC had 3 employees as of February 18, 2003. Indian River has no employees who are not also employees of Indian River Bank or Indian River Title Company LLC. Such employees are not represented by any collective bargaining unit, and we believe our employee relations are good. Indian River Bank maintains a benefit program which includes health and dental insurance, life and long-term disability insurance, and a 401(k) plan for substantially all full-time employees.
SUPERVISION AND REGULATION
INDIAN RIVER
Indian River is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, (the "Act") and is subject to supervision by the Federal Reserve Board. As a bank holding company, Indian River is required to file with the Federal Reserve Board an annual report and such other additional information as the Federal Reserve Board may require pursuant to the Act. The Federal Reserve Board may also make examinations of Indian River and each of its subsidiaries.
The Gramm Leach Bliley Act allows a bank holding company to certify status as a financial holding company, which allows a company to engage in activities that are financial in nature, that are incidental to such activities, or are complementary to such activities. The Gramm Leach Bliley Act enumerates certain activities that are deemed financial in nature, such as underwriting insurance or acting as an insurance principal, agent or broker, underwriting, dealing in or making markets in securities, and engaging in merchant banking under certain restrictions. It also authorizes the Federal Reserve Board to determine by regulation what other activities are financial in nature or incidental or complementary thereto. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized under the FDIC Improvement Act prompt corrective action provisions, is well managed and has at least a satisfactory rating under the Community Reinvestment Act. Indian River has elected to be a financial holding company.
The Act requires approval of the Federal Reserve Board for, among other things, the acquisition by a bank holding company of control of more than five percent (5%) of the voting shares, or substantially all the assets, of any bank or the merger or consolidation by a bank holding company with another bank holding company. The Act also generally permits the acquisition by a bank holding company of control, or substantially all the assets, of any bank located in a state other than the home state of the bank holding company, except where the bank has not been in existence for the minimum period of time required by state law, but if the bank is at least 5 years old, the Federal Reserve Board may approve the acquisition.
Under current law, with certain limited exceptions, a bank holding company is prohibited from acquiring control of any voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking or managing or controlling banks or furnishing services to or performing service for its authorized subsidiaries. A bank holding company may, however, engage in or acquire an interest in a company that engages in activities which the Federal Reserve Board has determined by order or regulation to be so closely related to banking or managing or controlling banks as to be properly incident thereto. In making such a determination, the Federal Reserve Board is required to consider whether the performance of such activities can reasonably be expected to produce benefits to the public, such as convenience, increased competition or gains in efficiency, which outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The Federal Reserve Board is also empowered to differentiate between activities commenced de novo and activities commenced by the acquisition, in whole or in part, of a going concern. Some of the activities that the Federal Reserve Board has determined by regulation to be closely related to banking include making or servicing loans, performing certain data processing services, acting as a fiduciary or investment or financial advisor, and making investments in corporations or projects designed primarily to promote community welfare.
As a financial holding company, no prior regulatory approval will be required for Indian River to acquire a company, other than a bank or savings association, engaged in most activities permitted under the Gramm Leach Bliley Act, as discussed above.
Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or any of its subsidiaries, or investments in their stock or other securities, and on the taking of their stock or securities as collateral for loans to any borrower. Further, a holding company and any subsidiary bank are prohibited from engaging in certain tie-in arrangements in connection with the extension of credit. A subsidiary bank may not extend credit, lease or sell property, or furnish any services, or fix or
vary the consideration for any of the foregoing, on the condition that: (a) the customer obtain or provide some additional credit, property or services from or to such bank other than a loan, discount, deposit or trust service; (b) the customer obtain or provide some additional credit, property or service from or to the company or any other subsidiary of the company; or (c) the customer not obtain some other credit, property or service from competitors, except for reasonable requirements to assure the soundness of credit extended.
The Federal Reserve has also adopted capital guidelines for bank holding companies that are substantially the same as the requirements applying to national banks.
INDIAN RIVER BANK
Indian River Bank is a national banking association. Its deposit accounts are insured by the Bank Insurance Fund of the FDIC up to the maximum legal limits of the FDIC and it is subject to regulation, supervision and regular examination by the Office of the Comptroller of the Currency and the FDIC. The regulations of these various agencies govern most aspects of Indian River Bank's business, including required reserves against deposits, loans, investments, mergers and acquisitions, borrowings, dividends and location and number of branch offices. The laws and regulations governing Indian River Bank generally have been promulgated to protect depositors and the deposit insurance funds, and not for the purpose of protecting stockholders.
Competition among commercial banks, savings and loan associations, and credit unions has increased following enactment of legislation which greatly expanded the ability of banks and bank holding companies to engage in interstate banking or acquisition activities. The Gramm Leach Bliley Act will allow a wider array of companies to own banks, which could result in companies with resources substantially in excess of Indian River's entering into competition with Indian River and Indian River Bank.
Banking is a business which depends on interest rate differentials. In general, the differences between the interest paid by a bank on its deposits and its other borrowings and the interest received by a bank on loans extended to its customers and securities held in its investment portfolio constitute the major portion of Indian River Bank's earnings. Thus, the earnings and growth of Indian River Bank will be subject to the influence of economic conditions in general, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve Board which regulates the supply of money through various means including open market dealings in United States government securities. The nature and timing of changes in such policies and their impact on Indian River Bank cannot be predicted.
Branching and Interstate Banking. The federal banking agencies are authorized to approve interstate bank merger transactions without regard to whether such transaction is prohibited by the law of any state, unless the home state of one of the banks has opted out of the interstate bank merger provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 by adopting a law after the date of enactment of the Riegle-Neal Act and prior to June 1, 1997 which applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. Interstate acquisitions of branches are permitted only if the law of the state in which the branch is located permits such acquisitions. Such interstate bank mergers and branch acquisitions are also subject to the nationwide and statewide insured deposit concentration limitations described in the Riegle-Neal Act.
The Riegle-Neal Act authorizes the federal banking agencies to approve interstate branching de novo by national and state banks in states which specifically allow for such branching. Florida has enacted laws which permit interstate acquisitions of banks and bank branches and permit out-of-state banks to establish de novo branches.
Capital Adequacy Guidelines. The Federal Reserve Board and the OCC have adopted risk-based capital adequacy guidelines pursuant to which they assess the adequacy of capital in examining and supervising banks and bank holding companies and in analyzing bank regulatory applications. Risk-based capital requirements determine the adequacy of capital based on the risk inherent in various classes of assets and off-balance sheet items.
National banks are expected to meet a minimum ratio of total qualifying capital, defined as the sum of core capital (Tier 1) and supplementary capital (Tier 2), to risk weighted assets of 8%. At least half of this amount (4%) should be in the form of core capital.
Tier 1 Capital generally consists of the sum of common stockholders' equity and perpetual preferred stock (subject in the case of the latter to limitations on the kind and amount of such stock which may be included as Tier 1 Capital), less goodwill, without adjustment for changes in the market value of securities classified as "available for sale" in accordance with FAS 115. Tier 2 Capital consists of the following: hybrid capital instruments; perpetual preferred stock which is not otherwise eligible to be included as Tier 1 Capital; term subordinated debt, intermediate-term preferred stock; and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics, with the categories ranging from 0%, requiring no risk-based capital, for assets such as cash and certain U.S. government and agency securities, to 100% for the bulk of assets which are typically held by a bank or holding company, including certain multi-family residential and commercial real estate loans, commercial business loans and consumer loans. Residential first mortgage loans on one to four family residential real estate and certain seasoned multi-family residential real estate loans, which are not 90 days or more past-due or non-performing and which have been made in accordance with prudent underwriting standards are assigned a 50% level in the risk-weighing system, as are certain privately-issued mortgage-backed securities representing indirect ownership of such loans. Off-balance sheet items also are adjusted to take into account certain risk characteristics.
In addition to the risk-based capital requirements, the OCC has established a minimum 3.0% Leverage Capital Ratio (Tier 1 Capital to total adjusted assets) requirement for the most highly-rated banks, with an additional cushion of at least 100 to 200 basis points for all other banks, which effectively increases the minimum Leverage Capital Ratio for such other banks to 4.0% - 5.0% or more. The highest-rated banks are those that are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, good earnings and, in general, those which are considered a strong banking organization. A bank having less than the minimum Leverage Capital Ratio requirement shall, within 60 days of the date as of which it fails to comply with such requirement, submit a reasonable plan describing the means and timing by which a bank shall achieve its minimum Leverage Capital Ratio requirement. A bank which fails to file such plan is deemed to be operating in an unsafe and unsound manner, and could subject that bank to a cease-and-desist order. Any insured depository institution with a Leverage Capital Ratio that is less than 2.0% is deemed to be operating in an unsafe or unsound condition pursuant to Section 8(a) of the Federal Deposit Insurance Act (the "FDIA") and is subject to potential termination of deposit insurance. However, such an institution will not be subject to an enforcement proceeding solely on account of its capital ratios, if it has entered into and is in compliance with a written agreement to increase its Leverage Capital Ratio and to take such other action as may be necessary for the institution to be operated in a safe and sound manner. The capital regulations also provide, among other things, for the issuance of a capital directive, which is a final order issued to a bank that fails to maintain minimum capital or to restore its capital to the minimum capital requirement within a specified time period. A capital directive is enforceable in the same manner as a final cease-and-desist order.
Prompt Corrective Action. Under Section 38 of the FDIA, each federal banking agency is required to implement a system of prompt corrective action for institutions which it regulates. The federal banking agencies have promulgated substantially similar regulations to implement the system of prompt corrective action established by Section 38 of the FDIA. Under the regulations, a bank shall be deemed to be: (i) "well capitalized" if it has a Total Risk Based Capital Ratio of 10.0% or more, a Tier 1 Risk Based Capital Ratio of 6.0% or more, a Leverage Capital Ratio of 5.0% or more and is not subject to any written capital order or directive; (ii) "adequately capitalized" if it has a Total Risk Based Capital Ratio of 8.0% or more, a Tier 1 Risk Based Capital Ratio of 4.0% or more and a Tier 1 Leverage Capital Ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized;" (iii) "undercapitalized" if it has a Total Risk Based Capital Ratio that is less than 8.0%, a Tier 1 Risk based Capital Ratio that is less than 4.0% or a Leverage Capital Ratio that is less than 4.0% (3.0% under certain circumstances); (iv) "significantly undercapitalized" if it has a Total Risk Based Capital Ratio that is less than 6.0%, a Tier 1 Risk Based Capital Ratio that is less than 3.0% or a Leverage Capital Ratio that is less than 3.0%; and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%.
An institution generally must file a written capital restoration plan which meets specified requirements with an appropriate federal banking agency within 45 days of the date the institution receives notice or is deemed to have notice
that it is undercapitalized, significantly undercapitalized or critically undercapitalized. A federal banking agency must provide the institution with written notice of approval or disapproval within 60 days after receiving a capital restoration plan, subject to extensions by the applicable agency.
An institution which is required to submit a capital restoration plan must concurrently submit a performance guaranty by each company that controls the institution. A guaranty is limited to the lesser of (i) an amount equal to 5.0% of the institution's total assets at the time the institution was notified or deemed to have notice that it was undercapitalized or (ii) the amount necessary at such time to restore the relevant capital measures of the institution to the levels required for the institution to be classified as adequately capitalized. A guaranty expires after the federal banking agency notifies the institution that it has remained adequately capitalized for each of four consecutive calendar quarters. An institution which fails to submit a written capital restoration plan within the requisite period, including any required performance guaranty, or fails in any material respect to implement a capital restoration plan, shall be subject to the restrictions in Section 38 of the FDIA which are applicable to significantly undercapitalized institutions.
A "critically undercapitalized institution" is to be placed in conservatorship or receivership within 90 days unless the FDIC formally determines that forbearance from such action would better protect the deposit insurance fund. Unless the FDIC or other appropriate federal banking regulatory agency makes specific further findings and certifies that the institution is viable and is not expected to fail, an institution that remains critically undercapitalized on average during the fourth calendar quarter after the date it becomes critically undercapitalized must be placed in receivership. The general rule is that the FDIC will be appointed as receiver within 90 days after a bank becomes critically undercapitalized unless extremely good cause is shown and an extension is agreed to by the federal regulators. In general, good cause is defined as capital which has been raised and is imminently available for infusion into a bank except for certain technical requirements which may delay the infusion for a period of time beyond the 90 day time period.
Immediately upon becoming undercapitalized, an institution shall become subject to the provisions of Section 38 of the FDIA, which (i) restrict payment of capital distributions and management fees; (ii) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (iii) require submission of a capital restoration plan; (iv) restrict the growth of the institution's assets; and (v) require prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the deposit insurance fund, subject in certain cases to specified procedures. These discretionary supervisory actions include: requiring the institution to raise additional capital; restricting transactions with affiliates; requiring divestiture of the institution or the sale of the institution to a willing purchaser; and any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions.
Additionally, under Section 11(c)(5) of the FDIA, a conservator or receiver may be appointed for an institution where: (i) an institution's obligations exceed its assets; (ii) there is substantial dissipation of the institution's assets or earnings as a result of any violation of law or any unsafe or unsound practice; (iii) the institution is in an unsafe or unsound condition; (iv) there is a willful violation of a cease-and-desist order; (v) the institution is unable to pay its obligations in the ordinary course of business; (vi) losses or threatened losses deplete all or substantially all of an institution's capital, and there is no reasonable prospect of becoming "adequately capitalized" without assistance; (vii) there is any violation of law or unsafe or unsound practice or condition that is likely to cause insolvency or substantial dissipation of assets or earnings, weaken the institution's condition, or otherwise seriously prejudice the interests of depositors or the insurance fund; (viii) an institution ceases to be insured; (ix) the institution is undercapitalized and has no reasonable prospect that it will become adequately capitalized, fails to become adequately capitalized when required to do so, or fails to submit or materially implement a capital restoration plan; or (x) the institution is critically undercapitalized or otherwise has substantially insufficient capital.
Regulatory Enforcement Authority. Federal banking law grants substantial enforcement powers to federal banking regulators. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions against banking organizations and
institution-affiliated parties. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.
Deposit Insurance Premiums. The FDIA establishes a risk based deposit insurance assessment system. Under applicable regulations, deposit premium assessments are determined based upon a matrix formed utilizing capital categories - well capitalized, adequately capitalized and undercapitalized - defined in the same manner as those categories are defined for purposes of Section 38 of the FDIA. Each of these groups is then divided into three subgroups which reflect varying levels of supervisory concern, from those which are considered healthy to those which are considered to be of substantial supervisory concern. The matrix so created results in nine assessment risk classifications, with rates ranging from 0.04% of insured deposits for well capitalized institutions having the lowest level of supervisory concern, to 0.31% of insured deposits for undercapitalized institutions having the highest level of supervisory concern. In general, while the Bank Insurance Fund of the FDIC ("BIF") maintains a reserve ratio of 1.25% or greater, no deposit insurance premiums are required. When the BIF reserve ratio falls below that level, all insured banks would be required to pay premiums
ITEM 2.
ITEM 2. PROPERTIES.
The executive offices of Indian River and Indian River Bank, and the main office of Indian River Bank are located at 958 20th Place, Vero Beach, Florida, in a 12,000 square foot, two-story masonry building. Indian River owns the building. Indian River owns the buildings which house Indian River Bank's Loan Center and the South Sebastian Branch. The Loan Center is located at 929 21st Street, Vero Beach in a 10,000 square foot masonry building. The Loan Center site also houses a six lane drive through banking facility. The South Sebastian branch is located at 816 US 1, Sebastian, Florida, in a 4,000 square foot brick building, and has one drive through lane.
Indian River leases the properties housing its remaining branches and the Operations Center. The Roseland branch, located at 13600 US 1, Unit 14, Sebastian, Florida, in a 2,600 square foot masonry building is leased under a six year lease which terminates in February 2007, and has a current annual rent of $37,835, subject to annual increase based on the consumer price index (the "CPI"). The Plantation branch, located at 6600 20th Street, Vero Beach, Florida, consists of 2,875 square feet in a masonry building and three drive through lanes. The property is occupied under a fifteen year lease, terminating in October 2007, at a current annual rent of $37,005, subject to annual increase based on the CPI, with a maximum increase of 5% annually. The Palm Bay branch, located at 5240 Babcock Street, NE, Palm Bay, Florida, consists of 5,000 square feet in a masonry building and three drive through lanes. The property is occupied under a three year lease, terminating in October 2003, at a current annual rent of $72,230, subject to annual increase based on the CPI, with a 5% maximum annual increase. Indian River has two three year renewal options. The Gateway Office, located at 1421 Gateway Drive, Melbourne, Florida, is a 2,500 square foot stand alone masonry building with three drive through lanes. The property is occupied under a ten year lease, terminating in 2009, at a current annual rent of $44,378, subject to annual increase based on the CPI with an 8% maximum annual increase. Indian River has two five year renewal options. The Rockledge branch, located at 3300 Murrell Road, Rockledge, Brevard County, Florida, is a 2,500 square foot stand alone masonry building with three drive through lanes. The property is occupied under a ten year lease terminating in 2011 at a current annual rental of $60,239, subject to annual increase based on the CPI with an 8% maximum annual increase. Indian River has two five year renewal options. The Operations Center, located at 3895 39th Square, Vero Beach, Indian River County, Florida, is occupied under a three year lease, terminating in November 2005. Indian River has three three-year renewal options. The Operations Center consists of approximately 10,300 square feet in a frame building. The current annual rental is $90,242, subject to annual increase based on the CPI, with a 2% minimum annual increase and a 5% maximum annual increase. The Sarno branch, Indian River's newest branch opening in the first quarter 2003, is located at 3000 Sarno Road, Melbourne, Brevard County, Florida. It is a 5,700 square foot stand alone wood frame and stucco building with three drive through lanes. The property is occupied under a fifteen year lease terminating in January 2018 at a current annual rental of $117,660, subject to annual increase based on the CPI. Indian River Title Company is located at 916 20th Place, Vero Beach, Indian River County, Florida. It is a 700 square foot stucco building. The property is occupied under a one year lease, with guaranteed three consecutive years of renewal. The current annual rent is $11,556, subject to an annual increase of 3%.
Management believes the existing facilities are adequate for Indian River's business as presently conducted.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
Indian River and Indian River Bank are involved from time to time in routine legal proceedings occurring in the ordinary course of business. In the opinion of management, the final disposition of these matters will not have a material adverse effect on Indian River's financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2002.
PART II
ITEM 5.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
As of December 31, 2002, there were 1,966,378 shares of common stock outstanding, held of record by approximately 869 shareholders. On February 14, 2003, Indian River paid a 10% stock dividend to shareholders of record on January 31, 2003, increasing the number of outstanding shares of common stock to 2,162,631, after adjustment for the elimination of fractional shares.
As of December 31, 2002, there were outstanding options to purchase 162,200 shares of common stock pursuant to Indian River's stock option plans, of which 130,901 were presently exercisable.
There does not currently exist an organized public trading market for shares of Indian River common stock. Trading in the common stock has been sporadic and consists mainly of private trades conducted without brokers. The table below shows information relating to Indian River's share price history for the past two fiscal years and through January 2003. Prices have been adjusted to reflect the 10% stock dividends paid in February 2001, January 2002 and February 2003. High and low sales prices reflect trades known to Indian River, and do not necessarily reflect all trades which occurred. Since October 2001, when Indian River ceased acting as its own transfer agent, we are aware of only a small percentage of the prices at which transactions occur. There are other trades of which we are either not aware, or for which we are not aware of the price. These trades and transactions do not necessarily reflect the intrinsic or market values of the common stock.
2003 2002 2001 -------------------- ------------------- ----------------- Period Ended HIGH LOW HIGH LOW HIGH LOW --------- -------- -------- -------- ------- -------- March 31 $36.37 $36.37 $27.27 $23.64 $22.50 $21.27 June 30 $27.27 $24.55 $22.09 $21.27 September 30 $29.09 $27.27 $22.09 $20.45 December 31 $29.09 $27.27 $22.09 $21.68
Dividends. Holders of the common stock are entitled to receive dividends as and when declared by the Board of Directors. Indian River has paid stock dividends for each of the last twelve years and currently intends to continue the payment of such dividends. Indian River has not paid cash dividends during such period, electing to retain earnings to support growth, and currently expects that it will continue to retain earnings to support growth. Future dividends will depend primarily upon Indian River Bank's earnings, financial condition, and need for funds, as well as governmental policies and regulations applicable to Indian River and Indian River Bank. There can be no assurance, however, that Indian River and Indian River Bank will continue to have earnings at a level sufficient to support the payment of dividends or that either entity will in the future elect to pay dividends. As Indian River Bank is the primary
source of funds for payment of dividends by Indian River, the inability of Indian River Bank to pay dividends could adversely affect the ability of Indian River to pay dividends.
Regulations of the OCC place a limit on the amount of dividends Indian River Bank may pay without prior approval. Prior approval of the OCC is required to pay dividends which exceed Indian River Bank's net profits for the current year plus its retained net profits for the preceding two calendar years, less required transfers to surplus. At December 31, 2002, the amount available for the payment of dividends by Indian River Bank without prior approval was approximately $9 million. The Federal Reserve and the OCC also have authority to prohibit a bank from paying dividends if the Federal Reserve or the OCC deems such payment to be an unsafe or unsound practice.
The Federal Reserve has established guidelines with respect to the maintenance of appropriate levels of capital by registered bank holding companies. Compliance with such standards, as presently in effect, or as they may be amended from time to time, could possibly limit the amount of dividends that Indian River may pay in the future. In 1985, the Federal Reserve issued a policy statement on the payment of cash dividends by bank holding companies. In the statement, the Federal Reserve expressed its view that a 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 holding company's financial health, such as by borrowing.
As a depository institution, the deposits of which are insured by the FDIC, Indian River Bank may not pay dividends or distribute any of its capital assets while it remains in default on any assessment due the FDIC. Indian River Bank is not currently in default under any of its obligations to the FDIC.
Recent Sales of Unregistered Securities. During 2001, Indian River issued 346 shares of common stock (as adjusted for the 10% stock dividend in February 2003) which were not registered under the Securities Act of 1933 to 36 non-officer employees of Indian River as awards under a stock grant program. The stock grant program awards one share of common stock for each year of service to employees upon their anniversary date, commencing with their fifth anniversary. No cash consideration or other property was received for the awards, which if considered sales, are exempt under Section 4(2) of the Securities Act.
At September 30, 2002, the Indian River's new wholly owned statutory business trust, Indian River Capital Trust I (the "Trust"), issued $7.0 million of floating rate preferred capital securities to a third party. The Trust invested the proceeds in an equivalent amount of junior subordinated debt securities of Indian River bearing an interest rate equal to the coupon rate on the securities issued by the Trust. After the payment of placement fees, Indian River received an aggregate of $6,790,000 from these transactions. The net proceeds received by Indian River will be used for the general corporate purposes of Indian River and Indian River Bank, including supporting continued expansion activities through the establishment and/or acquisition of additional branch offices and possible corporate acquisitions. The subordinated debt securities, which are the sole assets of the Trust, are subordinate and junior in right of payment to all present and future senior debt (as defined in the indenture) and certain other financial obligations of Indian River. Indian River and the Trust issued these securities in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table shows selected historical consolidated financial data for Indian River. You should read it in connection with the Company's audited consolidated financial statements for the years ended December 31, 2002, 2001, 2000, 1999, and 1998.
(1) Per share data and average weighted shares have been adjusted to reflect 10% stock dividends paid in each year through 2003, and to reflect the two for one stock split in the form of a dividend paid in March 2000.
(2) Represents the return on average stockholders' equity including, in average stockholders' equity, unrealized gains and losses on securities available for sale of $2.3 million, $1.0 million, ($1.6 million), ($319 thousand), and $582 thousand in 2002, 2001, 2000, 1999, and 1998. If the return on average stockholders' equity were calculated without including these unrealized gains and losses, then it would be 18.47%, 15.18%, 14.61%, 13.98%, and 17.20% for the years ended December 31, 2002, 2001, 2000, 1999, and 1998.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Indian River is a financial holding company for Indian River Bank and is headquartered in Vero Beach, Florida. Indian River Bank is a growing community bank serving individuals and small to medium sized businesses with special focus on real estate related lending and the professional community. Indian River Bank operates four branches in Indian River County and four branches in Brevard County. Indian River Bank offers deposit accounts and associated services to businesses and individuals and makes loans and invests in qualified securities. In addition, Indian River Bank's income includes fees on deposit accounts and loans.
Forward-looking statements. This management's discussion and analysis and other portions of this report contain forward-looking statements within the meaning of the Securities Exchange Act of 1934, as amended, including statements of goals, intentions, and expectations as to future trends, plans, events or results of Company operations and policies and regarding general economic conditions. In some cases, forward looking statements can be identified by use of words such as "may," "will," "anticipates," believes," "expects," "plans," "estimates," "potential, "continue," "should" and similar words or phrases. These statements are based upon current and anticipated economic conditions, nationally and in the Company's market, interest rates and interest rate policy, competitive factors, and other conditions which by their nature, are not susceptible to accurate forecast, and are subject to significant uncertainty. Because of these uncertainties and the assumptions on which this discussion and the forward-looking statements are based, actual future operations and results in the future may differ materially from those indicated herein. Readers are cautioned against placing undue reliance on any such forward-looking statements. The Company does not undertake to update any forward-looking statements to reflect occurrences or events which may not have been anticipated as of the date of such statements.
RESULTS OF OPERATIONS
2002 COMPARED TO 2001
NET INCOME. Indian River had income before income taxes of $8.9 million for the year ended December 31, 2002 compared to $5.8 million for the year ended December 31, 2001. Net income totaled $5.5 million for the year ended December 31, 2002, an increase of $1.8 million or 50.2% compared to net income in 2001. Basic earnings per share were $2.57 in 2002 compared to $1.72 in 2001 (as adjusted for 10% stock dividends in February 2003 and January 2002). Return on average equity was 17.8% for the year ended December 31, 2002, as compared to 14.6% for the year ended December 31, 2001. Return on average assets for 2002 was 1.3% as compared to 1.0% for 2001.
NET INTEREST INCOME. Net interest income is the difference between interest income on earning assets and interest expense on deposits and other borrowed funds. Net interest income for the year ended December 31, 2002 totaled $16.3 million compared to $13.3 million in 2001, reflecting an increase of $3.0 million or 22.3%. Total interest income totaled $25.5 million in 2002 compared to $26.0 million in 2001. This decrease was primarily the result of decreases of $747 thousand in interest and fees on loans. The increase in average outstanding loan balances from $210.5 million in 2001 to $224.5 million in 2002 was offset by a decrease in the average loan rates earned, which decreased to 7.52% in 2002 from 8.37% in 2001. Interest expense for 2002 decreased by $3.5 million from 2001. The decrease in interest expense was due to a decrease in the average rate paid to 2.74% in 2002 from 4.33% in 2001. This decrease of rates paid offset an increase in average interest-bearing deposits and other borrowed funds of approximately $43.2 million. The decrease in rates paid was partially the result of prior time deposit specials at a higher rate that did not mature until 2002; those that renewed did so at the current lower market rate.
The average yield on earning assets for the year ended December 31, 2002, was 6.41% compared to 7.53% in 2001. The average rate paid on interest bearing liabilities in 2002 was 2.74% compared to 4.33% in 2001. The average time deposit rate paid decreased from 5.56% in 2001 to 3.53% in 2002. The average interest rate paid on other borrowed funds in 2002 was 3.44% compared to 4.53% in 2001. Net interest margin is the ratio of net interest income to average earning assets. For the year ended 2002, net interest margin was 4.09% compared to 3.85% for the year ended December 31, 2001. The following table illustrates the analysis of Indian River's average balances, yields and changes in net interest income for the fiscal years indicated.
PROVISION FOR LOAN LOSSES. The provisions for loan losses added $620 thousand to the allowance for loan losses in 2002 compared to $600 thousand in 2001. Total charge-offs, net of recoveries, were approximately $181 thousand in 2002 and $233 thousand in 2001.
NON-INTEREST INCOME. Non-interest income for the year ended December 31, 2002 was $5.0 million compared to $3.9 million in 2001, an increase of $1.1 million or approximately 27.41%. The increase in deposit fee income of $220 thousand, or 13.32% over 2001 levels, resulted primarily from the increased volume of accounts and Indian River Bank's branches opened in 2001. The increase in gains on sale of securities of $591 thousand, or 267%, over 2001 levels reflected Indian River's decision to decrease the percentage of corporate bonds held to less than 10% of the total investment portfolio, electing to purchase mortgage backed securities and CMO's. See investment activity section under financial condition.
NON-INTEREST EXPENSE. Total non-interest expense for the year ended December 31, 2002 of $11.8 million reflected an increase of approximately $0.9 million, or 8.91%, primarily as a result of increase in personnel costs and other operating expenses. Salaries and benefits expense increased by $0.4 million, or 7.15%, in 2002, to $6.0 million compared to $5.6 million in 2001. The increase in salary and benefits expense in 2002 is primarily due to the hiring of additional staff to support the growth of Indian River. Non interest expense in 2001 included nonrecurring non-interest expenses of approximately $357 thousand after taxes relating to payment in connection with the resignation of a former officer. Occupancy and equipment expense of $1.6 million increased in 2002 by $0.1 million, or 5.14%, as compared to 2001. Other operating expenses of $4.3 million increased by $0.5 million, or 13.00%, in 2002.
TAXES ON INCOME. Income tax expense totaled $3.3 million for 2002 compared to income tax expense of $2.1 million in 2001.
2001 COMPARED TO 2000
NET INCOME. Indian River had income before income taxes of $5.8 million for the year ended December 31, 2001 compared to $4.1 million for the year ended December 31, 2000. Net income totaled $3.7 million the year ended December 31, 2001, an increase of $1.1 million or 39.9% compared to net income in 2000. Basic earnings per share were $1.72 in 2001 compared to $1.37 in 2000 (as adjusted for 10% stock dividends in February 2003, January 2002 and February 2001). Return on average equity was 14.6% for the year ended December 31, 2001, as compared to 16.0% for the year ended December 31, 2000. The decline in return on equity during 2001 as compared to 2000 in part reflects the sale in the fourth quarter of 2000 of 207,828 shares of common stock, for gross proceeds of approximately $5.1 million. Return on average assets for 2001 was 1.02% as compared to 0.85% for 2000.
NET INTEREST INCOME. Net interest income is the difference between interest income on earning assets and interest expense on deposits and other borrowed funds. During 2001 net interest income, rates earned on loans and investments and rates paid on deposits and other borrowings were impacted by the activities of the Federal Reserve in lowering market interest rate benchmarks on eleven occasions, by an aggregate of 475 basis points. Net interest income for the year ended December 31, 2001 totaled $13.3 million compared to $11.5 million in 2000, reflecting an increase of $1.8 million or 16.02%. Total interest income totaled $26.0 million in 2001 compared to $24.0 million in 2000. This increase was primarily the result of increases of $1.6 million in interest and fees on loans. The increase in earnings on loans was due to an increase in average outstanding loan balances from $180.7 million in 2000 to $210.5 million in 2001, offsetting a decrease in the average loan rates earned, which decreased to 8.37% in 2001 from 8.84% in 2000. Interest expense for 2001 increased by $193 thousand from 2000. The increase in interest expense was due to an increase in average interest-bearing deposits and other borrowed funds of approximately $39.4 million, offsetting a decrease in the average rate paid to 4.33% in 2001 from 4.93% in 2000.
The average yield on earning assets for the year ended December 31, 2001, was 7.53% compared to 8.17% in 2000. The average rate paid on interest bearing liabilities in 2001 was 4.33% compared to 4.93% in 2000. The average interest rate paid on other borrowed funds in 2001 was 4.53% compared to 6.50% in 2000. Yields on savings accounts and certificates of deposits have not dropped as dramatically as market deposit rates in general due to certificate of deposit specials which were offered in 2000 and 2001 before the decline in market rates and also, a savings account special offered in connection with the opening of the Rockledge branch in April 2001, with a rate of 4.89% guaranteed until April 2002. Net interest margin is the ratio of net interest income to average earning assets. For the year ended
2001, net interest margin was 3.85% compared to 3.91% for the year ended December 31, 2000. The following table illustrates the analysis of Indian River's average balances, yields and changes in net interest income for the fiscal years indicated.
PROVISION FOR LOAN LOSSES. The provisions for loan losses added $600 thousand to the allowance for loan losses in 2001 compared to $660 thousand in 2000. Total charge-offs, net of recoveries, were approximately $234 thousand in 2001 and $111 thousand in 2000.
NON-INTEREST INCOME. Non-interest income for the year ended December 31, 2001 was $3.9 million compared to $2.6 million in 2000, an increase of $1.3 million or approximately 54.03%. The increase in deposit fee income of $319 thousand, or 23.82% over 2000 levels, resulted primarily from the increased volume of accounts and Indian River Bank's branches opened in 2000 and 2001. The increase in gains on loans held for sale of $674 thousand or 96.81% over 2000 levels reflected the high level of mortgage lending activity resulting from the significant decline in interest rates during 2001. Declines in mortgage lending and refinancing activity, which may result from a period of stable or increasing interest rates, may have an adverse affect on the volume of loans sold and gains therefrom in future periods. Also, positively affecting non interest income in 2001 was the $221,000 in gains on the sale of securities, an increase of $209,000, or 1,674%, from 2000. See investment activity section below.
NON-INTEREST EXPENSE. Total non-interest expense for the year ended December 31, 2001 of $10.9 million reflected an increase of approximately $1.6 million, or 16.58%, primarily as a result of increase in personnel costs and other operating expenses. Salaries and benefits expense increased by $1.0 million, or 23.12%, in 2001, to $5.6 million compared to $4.6 million in 2000. Occupancy and equipment expense of $1.5 million stayed the same for 2001 as compared to 2000. The increase in salary and benefits expense was in part a result of the establishment and staffing of the Rockledge branch, Indian River Bank's seventh, during 2001 and payments in connection with the resignation of a former officer. Other operating expenses of $3.8 million increased by $0.6 million or 17.75% in 2001. This was due in part to a $327 thousand increase in service bureau cost. The higher costs reflect an increase in number of accounts and additional services, such as internet banking, bill pay, and ATM online transactions.
TAXES ON INCOME. Income tax expense totaled $2.1 million for 2001 compared to income tax expense of $1.4 million in 2000.
COMPARISON OF AVERAGE BALANCES, INTEREST AND YIELDS
The following tables provides certain information relating to Indian River's average consolidated statements of financial condition and reflects the interest income on interest-earning assets and interest expense of interest-bearing liabilities for the periods indicated and the average yields earned and rates paid for the periods indicated. These yields and costs are derived by dividing income or expense by the average daily balance of the related assets or liabilities for the periods presented. Non-accrual loans have been included in the average balances of loans receivable.
(1) Includes investment securities and Federal Reserve Bank, Fed Home Loan Bank, and IBB stock. Yields on securities available for sale have been calculated on the basis of historical cost and do not give effect to changes in fair value of such securities, which are reflected as a component of stockholder's equity.
(2) Includes loans for which the accrual of interest has been suspended.
COMPARISON OF AVERAGE BALANCES, INTEREST AND YIELDS (CONTINUED)
(1) Includes investment securities and Federal Reserve Bank, Fed Home Loan Bank, and IBB stock. Yields on securities available for sale have been calculated on the basis of historical cost and do not give effect to changes in fair value of such securities, which are reflected as a component of stockholder's equity.
(2) Includes loans for which the accrual of interest has been suspended.
RATE/VOLUME ANALYSIS OF NET INCOME
The following table sets forth certain information regarding changes in interest income and interest expense of Indian River for the periods indicated. For each category of interest-earning assets and interest-bearing liability, information is provided on changes attributable to: (i) changes in volume (changes in volume multiplied by the prior period's rate); (ii) changes in rates (change in rate multiplied by the prior period's volume) and (iii) changes in rate-volume (change in rate multiplied by the changes in volume).
FINANCIAL CONDITION
Total assets were $458.2 million at December 31, 2002 compared to $389.1 million as of December 31, 2001. This represented an increase of 17.80%. Average earning assets for 2002 were $398.2 million, an increase of 15.14% from the 2001 average of $345.8 million.
Total net loans, excluding loans held for sale, increased by $21.5 million, or 10.36%, to $229.6 million at December 31, 2002 compared to $208.0 million at December 31, 2001. Loans held for sale increased $7.4 million, or 127.56%, reflecting increased mortgage activity and refinancing during the declining rate environment. Investment securities and federal funds sold increased to $189.5 million, a 22.85% increase from the $154.3 million as of December 31, 2001. Total deposits increased by 14.46% to $364.9 million.
INVESTMENT ACTIVITY. The securities portfolio represented approximately 41.12% and 37.07% of the Bank's assets as of December 31, 2002 and 2001, respectively. During 2002, Indian River's investment securities portfolio increased by $44.3 million, or 30.70%. This increase in the securities portfolio reflects management's commitment to increasing the level of earning assets, enhances our liquidity level, and is a function of deposit growth and additional borrowings in excess of the loan funding and operational requirements of the Bank. The before tax unrealized gain on securities available for sale at December 31, 2002 was $3.6 million as compared to $1.6 million at December 31, 2001, an increase of $2.0 million. The increase in value is primarily a result of the decline in market interest rates and the related increase of the market value of fixed rate bonds. In 2002, Indian River also undertook to restructure portfolio composition to reduce both credit and interest rate risk. Accordingly, the Company's exposure to corporate securities was reduced. Additionally, the Company's holdings of U.S. Government agency securities were reduced. Proceeds from these sales along with additional liquidity were reinvested in mortgage-backed instruments, both PAC CMO's (Planned Amortization Class - Collateralized Mortgage Obligations) and in adjustable rate mortgage securities. The PAC CMO investments were selected to provide anticipated consistent cash flows over shorter periods of time than the securities that were sold. As a result of the sale of the corporate bonds, the Bank has recognized gains in 2002. As of December 31, 2002, there were no issuers, other than the U.S. Government and its corporations and agencies, whose securities owned by Indian River
had a book or market value exceeding ten percent of Indian River's stockholders' equity.
The following table provides information regarding the composition of Indian River's investment portfolio at the dates indicated. See Note 3 to the Consolidated Financial Statements for additional information regarding the securities portfolio.
The following table sets forth the projected maturities of the components of the Bank's securities portfolio as of December 31, 2002 and the weighted average yields on a non-tax-equivalent basis. The table assumes estimated fair values for available-for-sale securities and amortized cost for held to maturity securities:
LOAN PORTFOLIO. The following table shows the composition of Indian River's loan portfolio by type of loan at the dates indicated.
LOAN MATURITY. The following table sets forth the term to contractual maturity of Indian River Bank's loan portfolio at December 31, 2002. Loans which have adjustable rates and fixed rates are all shown in the period of contractual maturity. Demand loans, loans having no contractual maturity and overdrafts are reported as due in one year or less.
Fixed rate loans due after one year total approximately $51.9 million and adjustable rate loans due after one year total approximately $153.7 million. See Note 4 to the Consolidated Financial Statements for additional information regarding the composition of the loan portfolio.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is a valuation reserve established by management in an amount it deems adequate to provide for losses in the 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 and expected economic conditions and their impact on the existing loan portfolio.
The allowance for loan losses is increased by provisions for loan losses charged to expense. Charge-offs of loan amounts determined by management to be uncollectible or impaired decrease the allowance, and recoveries of previous charge-offs are added to the allowance.
Calculating the allowance for loan losses is divided into three primary allocation groups: (1) specific allocation loans, (2) past due / problem loans and (3) all other passing grade loans. For specific allocation loans, the bank has determined a reserve amount to set aside which it believes is sufficient to cover a collateral shortfall. Problem loans are identified by the Loan Officer, Loan Review, Asset Liability Committee or by the Examiners. Those loans identified as problem loans are assigned a risk grade. Loans graded special mention are multiplied by an inherent loss factor of 5% to determine the amount to be reserved. Loans graded substandard are multiplied by a loss factor of 10%, loans graded doubtful are multiplied by a loss factor of 50% and loans graded loss are multiplied by a loss factor of 100%. Inherent losses in past due loans are graded based on the number of days which the loan is past due, and are multiplied by the same loss factors as problem loans. Loans past due 30-59 are multiplied by a loss factor of 5%, loans past due 60-89 days are multiplied by 10% and loans past due 90 days are multiplied by a loss factor of 50%. All other loans are graded pass and are categorized into six loan groups (real estate loans are further sub-categorized) and multiplied by an historical experience factor to determine the appropriate level of the allowance for loan losses. Due to Indian River's low loss history, the historical experience factors are based on the FDIC quarterly banking profile report for all institutions. Indian River feels that these factors are better indication of overall loan performance in the nation. In addition to historical experience factors, Indian River also provides for losses due to economic factors, concentration of credit and portfolio composition changes.
At December 31, 2002, the allowance for losses was $3.3 million or 1.40% of loans outstanding compared to $2.8 million or 1.34% of loans outstanding as of December 31, 2001, an increase of $439 thousand. This increase is attributable primarily to an increase in total loans outstanding. At December 31, 2002, non-accrual loans increased by $546 thousand, or 410.53%, to $678 thousand compared to $133 thousand at December 31, 2001. This increase is primarily due to one commercial real estate loan for $585 thousand. A specific loan loss reserve of $100 thousand has been allocated to this loan. The allowance for loan losses coverage of non-accrual loans was 481% at December 31, 2002 compared to coverage of 2120% at December 31, 2001. See Note 1 to the Consolidated Financial Statements for additional information regarding the allowance for loan losses.
The following table sets forth activity in the allowance for loan losses for the periods indicated.
The following table allocates the allowance for loan losses by loan category. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.
(1) Represents the percent of loans in category to gross loans.
NON-PERFORMING ASSETS. Indian River Bank's non-performing assets, which are comprised of loans delinquent 90 days or more, non-accrual loans, and other real estate owned ("OREO"), totaled $738 thousand at December 31, 2002 compared to $290 thousand at December 31, 2001. The percentage of non-performing assets to total assets was 0.17% at December 31, 2002 compared to 0.07% December 31, 2001.
Non-performing loans constituted all of the non-performing assets at December 31, 2002 and December 31, 2001. Non-performing loans at December 31, 2002 consist of loans in non-accrual status in the amount of $678 thousand and loans past due over ninety days of $60 thousand compared to non-accrual loans of $133 thousand and loans past due over ninety days of $157 thousand at December 31, 2001.
Indian River Bank owned no other real estate owned at either December 31, 2002 or 2001. Generally, Indian River Bank would evaluate the fair value of each OREO property annually. These evaluations may be appraisals or other market studies. Credit card loans are placed on non accrual when they are 180 days delinquent. All other consumer and commercial loans are placed on nonaccrual at 90 days or when determined to be uncollectible by management.
The following table shows the amounts of non-performing assets at the dates indicated.
At December 31, 2002, there were no performing loans considered potential problem loans, defined as loans which are not included in the past due, nonaccrual or restructured categories, but for which known information about possible credit problems causes management to have serious doubts as to the ability of the borrowers to comply with the present loan repayment terms. For the year ended December 31, 2002, $37 thousand in gross interest income would have been recorded if the $678 thousand of nonaccrual loans had been accruing interest throughout the period.
RELATED PARTY TRANSACTIONS. At December 31, 2002 the aggregate loans to directors of the Bank and their related interests and executive officers totaled approximately $4.7 million. During the year $2.9 million in new loans and advances was extended and $2.0 million was paid on these loans to related parties.
DEPOSITS AND OTHER BORROWINGS. The principal sources of funds for Indian River Bank are core deposits (demand deposits, NOW accounts, money market accounts, savings accounts and certificates of deposit less than $100,000) from the local market areas surrounding the bank's offices. The bank's deposit base includes transaction accounts, time and savings accounts and accounts which customers use for cash management and which provide the bank with a source of fee income and cross-marketing opportunities as well as a low-cost source of funds. Time and savings accounts, including money market deposit accounts, also provide a relatively stable and low-cost source of funding.
The following table reflects Indian River Bank's deposits by category for the periods indicated.
The following table indicates the amount of the Bank's certificates of deposit of $100,000 or more by time remaining until maturity as of December 31, 2002. See Note 7 to the Consolidated Financial Statements for additional information regarding Indian River's time deposits.
December 31, 2002 ----------------- (Dollars in Thousands)
Due In 3 months or less $ 9,801 Over 3 through 6 months 6,203 Over 6 through 12 months 16,776 Over 12 months 10,971 --------- Total $ 43,751 =========
The following table provides information regarding Indian River Bank's short-term borrowings for the periods indicated. See Note 9 to the Consolidated Financial Statements for additional information regarding Indian River Bank's borrowings.
ASSET/LIABILITY MANAGEMENT AND QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest rate risk is that portion of the variation in the Company's performance attributable to changes in interest rates. Management closely monitors the Company's exposure to how changes in market conditions can impact the Indian River's future performance and considers strategies to reduce any negative results.
Interest rate risk takes place because of unbalanced changes in interest income and expense, and asset and liability market value when rates change. The imbalances flow through to create variability in net interest income, net income, and the market value of equity. The ultimate cause of interest rate risk is a repricing mismatch between the assets and liabilities on the Company's balance sheet and, if relevant, off-balance sheet positions.
Indian River's exposure to interest rate risk is managed primarily through the Company's strategy of selecting the types and terms of interest-earning assets and interest-bearing liabilities which generate favorable earnings, while limiting potential negative effects of changes in market interest rates. Since Indian River's primary source of interest-bearing liabilities is customer deposits, the ability to manage the types and terms of such deposits may be somewhat limited by customer preferences in the market areas served by the Company. Borrowings, which include FHLB advances, short-term borrowings and long-term borrowings, are generally structured with specific terms which in management's judgment, when aggregated with the terms for outstanding deposits and matched with interest-earning assets, mitigate Indian River's exposure to interest rate risk. The rates, terms and interest rate indices of Indian River's interest-earning assets result primarily from the Company's strategies of investing in loans and securities which permit the Company to limit its exposure to interest rate risk, together with credit risk, while achieving a positive interest rate spread from the difference between the income earned on interest-earning assets and the cost of interest-bearing liabilities.
Liquidity management enables us to maintain sufficient cash flow to fund operations and to meet financial obligations to depositors and borrowers. Indian River Bank's liquidity is enhanced by its ability to attract and retain deposits and by principal and interest payments on loans and maturing securities in the investment portfolio. Indian River Bank's core deposit base, consisting of demand deposits, money market, and savings accounts supplemented by other deposits of varying maturities and rates, contributes to liquidity. Our liquidity position, those assets invested in federal funds, mortgage backed securities, and obligations of the U.S. Government, its agencies and sponsored entities available for sale, of $166.5 million at December 31, 2002, reflected an increase of $85.2 million from December 31, 2001, or 95.5%. Funds available through short-term borrowings and asset maturities are considered adequate to meet all current needs. At December 31, 2002, Indian River had available credit of $25.7 million under lines of credit with correspondent banks. Although management believes that the liquidity position is adequate, increased loan demand could have an adverse impact on liquidity. Indian River Bank also has available credit of $4.3 million under its line with the Federal Home Loan Bank of Atlanta. This line may be utilized as a supplementary source of funding growth for the Bank. In addition, the Asset Liability Management Committee has established minimum standards and key ratios of asset quality and performance. These standards and ratios provide the framework for guidance and measurement. Management evaluates these standards and ratios on an ongoing basis.
In addition to periodic gap reports comparing the sensitivity of interest-earning assets and interest-bearing liabilities to changes in interest rates, management uses a quarterly model which measures Indian River's exposure to interest rate risk. The model calculates the present value of assets, liabilities, off-balance sheet financial instruments and equity at current interest rates, and at hypothetical higher and lower interest rates at various intervals. The present value of each major category of financial instrument is calculated by the model using estimated cash flows based upon weighted average contractual rates and terms at discount rates representing the estimated current market interest rate for similar financial instruments. The resulting present value of longer term fixed-rate financial instruments are more sensitive to change in a higher or lower market interest rate scenario, while adjustable-rate financial instruments largely reflect only a change in present value representing the difference between the contractual and discounted rates until the next interest rate repricing opportunity.
The following table presents Indian River's exposure over the subsequent twelve month periods to immediate, hypothetical changes in interest rates at the dates indicated:
As the table indicates, the Bank is susceptible to lower earnings in a rising rate environment and will experience slightly higher earnings in a declining rate situation. The Bank has a negative GAP position which is reflected in the table.
Indian River has been in a liability sensitive position during 2001 and 2002, which is reflected in the above tables. The Company has developed strategies to bring the balance sheet into a more neutral position and will continue to implement these actions in 2003, although there can be no assurance that we will be successful in implementing such strategies, or that they will be appropriate strategies in light of future events and circumstances. The Company is sensitive to the economic environment and will restructure the repricing characteristics in a gradual manner to minimize major asset purchases at the bottom of the rate cycle.
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or repricing periods, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the loan. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables. Finally, the ability of many borrowers to service their debt may decrease in the event of a significant interest rate increase.
In addition, the previous table does not necessarily indicate the impact of general interest rate movements on Indian River's net interest income because the repricing of certain categories of assets and liabilities are subject to competitive and other pressures beyond the Company's control. As a result, certain assets and liabilities indicating as maturing or otherwise repricing within a stated period may in fact mature or reprice at different times and at different volumes.
Management uses the model to ascertain general levels of risk and to consider specific strategies to mitigate that risk.
The following table reflects the shorter of the maturity or repricing date as of December 31, 2002.
The amount of assets and liabilities shown which re-price or mature during a particular period were determined in accordance with the earlier of term to re-pricing or the contractual terms of the asset or liability. Indian River Bank has assumed that its savings, interest checking, and money market accounts re-price daily. At December 31, 2002, the bank's one-year interest sensitivity gap (the difference between the amount of interest-earning assets and interest bearing liabilities, anticipated by the bank, based on certain assumptions, to mature or re-price within one year) as a percentage to total assets was -22.80%. This negative gap position means the bank had $104.5 million more liabilities than assets re-pricing within one year. This generally indicates that in a period of increasing interest rates, the bank's net interest income may be negatively affected. Conversely, in a declining interest rate environment, the bank's net interest income may increase. However, this approach assumes that all re-pricing assets and liabilities will re-price the same way. Historical data indicates that certain deposit liabilities such as interest checking, savings, and money market deposits do not re-price the same way as other products and interest gap analysis tend to be more accurate when adjusted to reflect such behavior. No adjustments are included in the table presented. Indian River also monitors its exposure to changes in interest rates using models which measure the impact of assumed changes.
CAPITAL ADEQUACY. Total stockholders' equity was $34.8 million at December 31, 2002 compared to $27.7 million at December 31, 2001. The change represents an increase of $7.1 million or 25.80%. This change is a result of earnings of $5.5 million, net unrealized holding gains on investment securities of $1.3 million, and stock issued of $0.3 million in 2002.
At December 31, 2002, Indian River Bank's ratio of Tier 1 capital to total average assets equaled 7.40%, which exceeded the minimum leverage capital ratio of 4.00% by 3.40% and the minimum leverage ratio for "well capitalized" banks of 5.00% by 2.40%.
The ratio of Indian River's average equity to average assets for the years ended December 31, 2002, 2001 and 2000 was 7.39%, 6.96% and 5.32%, respectively.
Indian River monitors its capital levels and those of Indian River Bank in light of regulatory guidelines and requirements, and the anticipated nature and level of growth in assets. The ability of Indian River Bank to continue growth is dependent on its ability to increase its regulatory capital levels, through retained earnings, holding company borrowing, or the issuance of additional equity or debt securities. In the event that Indian River is unable to obtain additional capital on a timely basis, the growth of Indian River and Indian River Bank may be curtailed, and they could be required to reduce their level of assets in order to maintain compliance with regulatory capital requirements. Under those circumstances net income and the rate of growth of net income may be adversely affected. Indian River does not currently anticipate the inability to maintain compliance with regulatory capital requirements.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and Notes thereto have been prepared in accordance with accounting principles, generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations. Unlike most industrial companies, nearly all of our assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on our performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods or services.
IMPACT OF NEW ACCOUNTING STANDARDS
Recently issued accounting standards are not expected to materially affect Indian River's financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Please refer to Item 7 of this report, "Management's Discussion and Analysis", under the caption "Asset/Liability Management and Quantitative and Qualitative Disclosures about Market Risk."
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders Indian River Banking Company Vero Beach, Florida
We have audited the accompanying consolidated balance sheets of Indian River Banking Company and subsidiaries (the "Bank") as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the each of the three years in the period ended December 31, 2002. These consolidated financial statements are the responsibility of the Bank's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Indian River Banking Company and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.
/s/ McGladrey & Pullen, LLP
Fort Lauderdale, Florida January 27, 2003
INDIAN RIVER BANKING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2002 AND 2001
See Notes to Consolidated Financial Statements.
INDIAN RIVER BANKING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
See Notes to Consolidated Financial Statements
INDIAN RIVER BANKING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
See Notes to Consolidated Financial Statements.
Accumulated Other Total Retained Comprehensive Stockholders' Comprehensive Earnings Income (Loss) Equity Income (Loss) - --------------------------------------------------------------------------- $ 5,876 $ (1,604) $ 13,592
(1,366) -- --
(4) -- (4)
-- -- --
-- -- 39
-- -- 5,074
2,631 -- 2,631 $ 2,631
-- 1,869 1,869 1,869 ------- $ 4,500 - --------------------------------------------------------------- ======= 7,137 265 23,201
(2,337) -- --
(4) -- (4)
-- -- 84
-- -- 8
3,682 -- 3,682 $ 3,682
-- 733 733 733 ------- $ 4,414 - --------------------------------------------------------------- ======= 8,478 998 27,704 (4,599) -- -- (8) -- (8) -- -- 236 -- -- 104
5,531 -- 5,531 $ 5,531
-- 1,282 1,282 1,282 ------- $ 6,814 - --------------------------------------------------------------- ======= 9,402 2,280 34,849 (6,423) -- -- - ---------------------------------------------------- $ 2,979 $ 2,280 $ 34,849 ====================================================
INDIAN RIVER BANKING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
See Notes to Consolidated Financial Statements (Additional cash flow information - - Note 19).
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business: Indian River Banking Company and its wholly-owned subsidiaries (collectively referred to as the "Bank") provide a full range of banking services to individual and corporate customers through its various locations in Indian River and Brevard Counties in Florida. Segment information is not presented since all of the Bank's revenue is attributed to a single reportable segment. The Bank is subject to competition from other financial institutions and nonfinancial institutions providing financial products. Indian River Banking Company is a financial holding company incorporated in the State of Florida.
Principles of consolidation: The accompanying consolidated financial statements include the accounts of Indian River Banking Company ("Indian River") and its wholly-owned subsidiaries, Indian River National Bank ("Indian River Bank"), a federally-chartered independent community bank, Indian River Title Company, LLC, IRNB Insurance Services, LLC, and Indian River Capital Trust I, collectively referred to as the "Bank". All significant intercompany accounts and transactions have been eliminated in consolidation.
Basis of accounting: The consolidated financial statements have been prepared in conformity with generally accepted accounting principles generally accepted in the United States of America and general practice within the banking industry. In preparing the consolidated financial statements, the Bank's management is required to make estimates and assumptions which significantly 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. Significant estimates, which are particularly susceptible to change in a short period of time, include the determination of the allowance for loan losses and the fair value of securities. Actual results could differ from those estimates.
Cash and cash equivalents: Cash and cash equivalents include cash on hand, amounts due from banks (including cash items in process of clearing), and federal funds sold. For purposes of reporting cash flows, loans and deposits are reported net. The Bank maintains amounts due from banks which, at times, may exceed federally-insured limits. The Bank has not experienced any losses in such accounts.
Investment in debt securities: Management determines the appropriate classification of securities as each individual security is acquired. In addition, the appropriateness of such classification is reassessed at each balance sheet date. The Bank's classifications of debt securities and related accounting policies are as follows:
Securities held to maturity: Held to maturity securities are those securities which the Bank has the ability and intent to hold until maturity. All other securities not included in held to maturity are classified as available-for-sale. Held to maturity securities are reported at amortized cost. The amortization of premiums and accretion of discounts, computed by the interest method over their contractual lives, are recognized in interest income.
Available-for-sale securities: Securities classified as available-for-sale are those debt securities that the Bank intends to hold for an indefinite period of time but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Bank's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Securities available-for-sale are carried at fair value. Unrealized gains or losses, net of the related deferred tax effect, are reported as a separate component of accumulated other comprehensive income. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. The amortization of premiums and accretion of discounts, computed by the interest method over their contractual lives, are recognized in interest income.
Loans held for sale: Loans held for sale are carried at the lower of cost or market value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
Loans and allowance for loan losses: Loans are stated at the amount of unpaid principal, reduced by unearned discounts and fees and an allowance for loan losses.
Loan origination and commitment fees and certain direct loan origination costs are being deferred and amortized, using the interest method, as an adjustment of the related loan's yield. The Bank is amortizing these amounts over the contractual lives of the loans, adjusted for prepayments. Commitment fees which are based upon a percentage of a customer's unused line of credit and fees related to standby letters of credit are recognized over the commitment period.
Interest on loans is recognized over the terms of the loans and is calculated using the simple-interest method on principal amounts outstanding. For impaired loans, accrual of interest is generally discontinued when, in the opinion of management, there is an indication that the borrower may be unable to make payments as they become due. Interest on these loans is recognized only when actually paid by the borrower if collection of the principal is likely to occur. Accrual of interest is generally resumed when the customer is current on all principal and interest payments.
The allowance for loan losses is maintained to provide for estimated losses in the loan portfolio that have been incurred as of the balance sheet date. In establishing the allowance, management (1) makes specific allocations for certain non-performing loans based on management's estimates of collateral shortfall, (2) applies loss factor percentages to the balances of identified loans in each category of problem and past due loans, and (3) applies loss factor percentages to balances of performing loans in each category of loans. Loss factor percentages are determined taking into consideration the risk characteristics of the loan portfolio, past charge-off experience of the Bank and its peer group, general economic conditions, and other factors that warrant current recognition. While management uses the best information available to make its evaluation, the allowance could change materially within the next year if there are significant changes in economic conditions.
As adjustments to the allowance for loan losses become necessary, they are reflected as a provision for loan losses in current-period earnings. Actual loan charge-offs are deducted from and subsequent recoveries are added to the allowance.
A loan is considered to be impaired when it is probable that the Bank will be unable to collect all principal and interest amounts according to the contractual terms of the loan agreement. Under this definition, management considers loans that have been placed on nonaccrual status or which have been renegotiated in a troubled debt restructuring to be impaired. Larger groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The allowance for loan losses related to loans identified as impaired is based on discounted expected future cash flows (using the loan's initial effective interest rate), the observable market value of the loan, or the estimated fair value of the collateral for certain collateral dependent loans.
Transfers of financial assets: Transfers of financial assets are accounted for as sales only when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank, (2) the transferee obtains the right to pledge or exchange the assets it received, and no condition both constrains the transferee from taking advantage of its right to pledge or exchange and provides more that a modest benefit to the transferor, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Credit related financial instruments: In the ordinary course of business, the Bank has entered into commitments to extend credit, including commitments under standby letters of credit. Such financial instruments are recorded when they are funded.
Bank premises and equipment: Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using accelerated and straight-line methods over the following estimated useful lives:
Years ----------- Land improvements 3 - 20 Buildings and improvements 5 - 39 Leasehold improvements 5 - 15 Furniture, fixtures and equipment 3 - 10
Income taxes: Indian River and its subsidiaries file consolidated income tax returns. Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences, and operating loss or tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the amounts of assets and liabilities recorded for income tax and financial reporting purposes. Deferred tax assets are reduced by a valuation allowance when management determines that it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Other revenue recognition: Revenue from insurance, realty, trust and services and services charges and fees on customer deposits is recognized as the services are provided.
Stock-based compensation: The Bank has three stock-based employee compensation plans, which are described more fully in Note 10. The Bank accounts for those plans using the intrinsic value method provided under APB Opinion No. 25, Accounting for Stock Issued to Employees. Generally, the Bank has recognized no compensation cost for stock options granted, as all options granted had an exercise price equal to the estimated market value of the underlying common stock on the date of grant. Option holders may elect a "cashless exercise" of their vested options, under which they receive shares of common stock with a fair value equal to the intrinsic value of the options at the date of exercise, without any payment. Those option awards expected to be exercised via this cashless exercise are accounted for as variable plan awards and, as such, the Bank recognizes compensation expense equal to the change in the intrinsic value of such options during the period. The following table illustrates the effect on net income and earnings per share if the Bank had applied fair value recognition provisions to stock-based employee compensation.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Earnings per share: Basic earnings per-share amounts are computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding adjusted for stock dividends and splits occurring subsequent to year-end (the denominator). Diluted earnings per-share amounts assume the conversion, exercise or issuance of all potential common stock instruments unless the effect is to reduce the loss or increase the income per common share from continuing operations, and is determined using the treasury stock method.
Fair value of financial instruments: The Bank discloses fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial assets and liabilities have been excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Bank.
The fair value estimates presented are based on pertinent information available to management as of December 31, 2002 and 2001. Although management is not aware of any factors that would significantly affect the estimated fair value amount, such amounts have not been comprehensively revalued for purposes of these financial statements since these dates and therefore, current estimates of fair value may differ significantly from the amounts presented in these financial statements.
Reclassification: Certain amounts in the Consolidated Statements of Income for year ended December 2001 have been reclassified to conform to classifications for year ended December 31, 2002.
Recently issued accounting standards: Recently issued accounting standards are not expected to materially affect the Bank's financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2. CASH AND DUE FROM BANKS
The Bank is required to maintain reserve balances in cash or with the Federal Reserve Bank, based on a percentage of certain deposits. The total required reserve balances as of December 31, 2002 and 2001 were approximately $4.6 million and $4.2 million respectively.
NOTE 3. INVESTMENT SECURITIES
Securities held to maturity: The amortized cost and fair values of securities held to maturity as of December 31, 2002 and 2001 are summarized as follows.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3. INVESTMENT SECURITIES (CONTINUED)
The amortized cost and fair values of securities held to maturity at December 31, 2002, by contractual maturity, are shown below. Mortgage-backed securities are excluded from the maturity categories because they are not due at a single due date. In addition, mortgage-backed securities may mature earlier than their contractual maturities because of prepayments.
Estimated (Dollars in Thousands) Amortized Market Cost Value ---------------------------- Due less than ten years $ 635 $ 635 Due after ten years 5,293 5,545 Mortgage-backed securities 3,814 3,803 ---------------------------- $ 9,742 $ 9,983 ===========================
Securities available-for-sale: The amortized cost and fair values of securities available-for-sale as of December 31, 2002 and 2001 are summarized as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3. INVESTMENT SECURITIES (CONTINUED)
The amortized cost and fair values of securities available for sale at December 31, 2002, by contractual maturity, are shown below. Mortgage-backed securities are excluded from the maturity categories because they are not due at a single due date. In addition, mortgage-backed securities may mature earlier than their contractual maturities because of prepayments.
Estimated Amortized Market (Dollars in Thousands) Cost Value -------------------------
Due in less than one year $ 2,496 $ 2,512 Due after one year through five years 29,022 30,390 Due after five years through ten years 5,012 5,217 Mortgage-backed securities 136,234 138,264 ------------------------- $ 172,764 $ 176,383 ========================
Securities available for sale with a carrying amount of $33.1 million and $40.2 million at December 31, 2002 and 2001, respectively, were pledged as collateral on public deposits, various lines of credit (see Note 9), repurchase agreements, and for other purposes as required or permitted by law.
Gross gains of $813 thousand, $222 thousand, and $12 thousand were realized from the sale of securities available for sale in the years ended December 31, 2002, 2001 and 2000, respectively. The income tax impact of these gains was $305 thousand, $83 thousand and $4 thousand for the years ended December 31, 2002, 2001 and 2000, respectively.
Unrealized gains (losses) on securities available for sale for the years ended December 31, 2002, 2001 and 2000 are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3. INVESTMENT SECURITIES (CONTINUED)
Other securities consist primarily of nonmarketable equity securities as follows at December 31, 2002 and 2001:
(Dollars in Thousands) 2002 2001 ----------------------- Federal Reserve Bank stock $ 182 $ 182 Federal Home Loan Bank stock 2,178 1,707 Other securities 10 10 ----------------------- $ 2,370 $ 1,899 =======================
The Bank, as a member of the Federal Home Loan Bank ("FHLB") system, is required to maintain an investment in capital stock of the FHLB in an amount equal to the greater of 1% of its outstanding home loans or 5% of advances from the FHLB. No ready market exists for the FHLB stock, and it has no quoted market value.
NOTE 4. LOANS
The composition of loans is as follows at December 31, 2002 and 2001:
(Dollars in Thousands) 2002 2001 -------------------------- Real estate: Construction and land development $ 45,913 $ 32,778 Farmland 3,181 2,943 One to four family residential 87,841 74,917 Multifamily residential 2,506 3,521 Nonfamily, nonresidential 64,458 62,660 Agriculture 1,788 2,455 Commercial and industrial 13,257 14,948 Consumer 11,645 14,421 Other 2,262 2,225 --------------------------
232,851 210,868 Unearned discounts and loan fees (4) (5) -------------------------- $ 232,847 $ 210,863 ==========================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4. LOANS (CONTINUED)
The Bank's recorded investment in impaired loans for which a specific allowance was recognized was $585 thousand and $133 thousand at December 31, 2002 and 2001, respectively. The specific allowance associated with these loans was $100 thousand and $50 thousand at December 31, 2002 and 2001, respectively. The average recorded investment in impaired loans during 2002 and 2001 was $316 thousand and $148 thousand, respectively. Interest income recognized on impaired loans, recognized for cash payments received in 2002, 2001 and 2000 was not significant.
Loans on non-accrual status totaled $678 thousand and $133 thousand at December 31, 2002 and 2001, respectively. Loans past due 90 days or more and still accruing interest totaled $60 thousand and $157 thousand at December 31, 2002 and 2001, respectively.
NOTE 5. ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses for the years ended December 31, 2002, 2001 and 2000 are as follows:
(Dollars in Thousands) 2002 2001 2000 --------------------------------- Balance, beginning $ 2,820 $ 2,453 $ 1,904 Provision for loan losses 620 600 660 Loans charged off (226) (267) (153) Recoveries of amounts charged off 45 34 42 --------------------------------- Balance, ending $ 3,259 $ 2,820 $ 2,453 =================================
NOTE 6. BANK PREMISES AND EQUIPMENT
The major classes of bank premises and equipment and the total accumulated depreciation are as follows:
(Dollars in Thousands) December 31, ------------------- 2002 2001 ------------------- Land and improvements $ 1,699 $ 1,691 Buildings and improvements 1,528 1,423 Leasehold improvements 708 701 Furniture, fixtures and equipment 4,798 4,297 ------------------- 8,733 8,112 Less accumulated depreciation and amortization 4,649 4,060 ------------------- $ 4,084 $ 4,052 ===================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7. TIME DEPOSITS
At December 31, 2002, the scheduled maturities of time deposits are as follows:
(Dollars in Thousands)
Year Ending December 31, Amount - ------------------------------------------------------ 2003 $ 91,443 2004 27,463 2005 4,033 2006 2,951 2007 4,077 Thereafter 238 --------- $ 130,205 =========
NOTE 8. INCOME TAXES
The net deferred tax effects of the primary temporary differences are as shown in the following table:
-------------------- (Dollars in Thousands) December 31, -------------------- 2002 2001 -------------------- Deferred tax assets: Loan loss allowances $ 1,120 $ 970 Other 110 17 -------------------- Total deferred tax assets 1,230 987 -------------------- Deferred tax liabilities: Unrealized gain on available-for-sale securities (1,339) (586) Other (80) (55) -------------------- Total deferred tax liabilities (1,419) (641) -------------------- Net deferred tax assets (liabilities) $ (189) $ 346 ====================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8. INCOME TAXES (CONTINUED)
The provision for income taxes charged to operations for the years ended December 31, 2002, 2001 and 2000 consists of the following:
(Dollars in Thousands) December 31, -------------------------------------- 2002 2001 2000 -------------------------------------- Current tax expense Federal $ 3,055 $ 1,894 $ 1,377 State 486 326 243 Deferred tax expense (218) (109) (192) -------------------------------------- $ 3,323 $ 2,111 $ 1,428 ======================================
The provision for income taxes differs from the amount of income tax determined by applying the U. S. federal income tax rate to pretax income as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9. BORROWINGS AND PLEDGED ASSETS
Fed Funds Purchased and Securities Sold under Repurchase Agreements:
Indian River Bank had $5 million of overnight advances under the line of credit with the Federal Home Loan Bank at December 31, 2002 and no advances as of December 31, 2001, in addition to the advances discussed above.
Indian River Bank also has lines of credit of $30 million available for federal funds purchases with other correspondent banks. There were $4.3 million of advances at December 31, 2002 and no advances at December 31, 2001.
Indian River Bank has pledged securities with a carrying amount of approximately $22.6 million as collateral for repurchase agreements at December 31, 2002, with borrowings of $2.4 million and $13.2 million at December 31, 2002 and 2001, respectively.
Guaranteed preferred beneficial interests in Company's subordinated debentures:
On September 30, 2002, a wholly-owned statutory business trust established by the Company issued $7 million in guaranteed preferred beneficial interest in the trust ("trust-preferred securities"). The sole assets of the statutory business trust are a series of subordinated debentures of the Company in the amount of $7 million and related payments. The Company has fully and unconditionally guaranteed the statutory business trust's obligations under the trust-preferred securities, to the extent set forth in the guarantee agreement.
The subordinated debentures are unsecured and subordinate to all senior debt (as defined) of the Company. The subordinated debentures bear interest at a variable rate of 3 months LIBOR plus 3.45%, 5.34% for the quarterly period ended December 31, 2002, and mature on November 7, 2032. They are redeemable in whole or in part on or after November 7, 2007. The trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures at their maturity or earlier redemption.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9. BORROWINGS AND PLEDGED ASSETS (CONTINUED)
Other borrowings consist of the following at December 31, 2002 and 2001:
(Dollars in Thousands)
(a) Indian River Bank has a secured line of credit with the Federal Home Loan Bank under which Indian River Bank can borrow up to a specified percentage of pledged assets or approximately $4.3 million at December 31, 2002. Advances under the line are collateralized by residential first mortgage loans with a balance of approximately $63.9 million at December 31, 2002 and Indian River Bank's stock in the Federal Home Loan Bank in the amount of $2.2 million at December 31, 2002.
The aggregate amounts of other borrowings and trust-preferred securities maturing in future years (based on the outstanding balance and interest rates as of December 31, 2002) are as follows: 2003 $286 thousand; 2004 $285 thousand; after 2007 $45.0 million.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10. STOCK BASED COMPENSATION
Under the terms of the 1999 Stock Option Plan, options to purchase shares of Indian River's common stock may be granted to directors and key officers/employees at a price that is not less than the fair market value of such stock at the date of the grant. Options granted to employees under the plan may be designated as incentive stock options. All options expire no more than ten years from the date of the grant, or three months after an employee's termination. In accordance with the plan, the aggregate number of shares for which options may be granted, the number of shares covered for each outstanding option, and the exercise price per share for each such option shall be proportionately adjusted for the payment of stock dividends or similar adjustments to the number of shares of common stock effected without the receipt of consideration by Indian River. At December 31, 2002, the number of shares eligible to be issued under the Plan was 366,025, and approximately 163,000 shares remained available for granting.
In December 1999, the Board of Directors adopted the Director Fee Stock Option Plan, under which each director is entitled to receive options to purchase shares of common stock in lieu of cash compensation for attendance at committee meetings. Options granted have an exercise price equal to the fair value of the common stock at the date of grant.
In 2001, Indian River adopted the Employee Tenure Stock Grant Plan, under which non-executive officer employees are granted one share of common stock for each year of service upon the anniversary date of their employment with Indian River, commencing with their fifth anniversary. In 2001, 315 shares of stock were granted. In 2002, 5,500 shares of common stock were authorized for issuance under this plan and 426 were granted.
A summary of the options activity for the years ended December 31, 2002, 2001 and 2000 is presented below (after adjusting for 10% stock dividends in 2002, 2001 and 2000, a 2 for 1 stock split effective March 31, 2000, and a 10% stock dividend declared in January 2003).
WEIGHTED-AVERAGE SHARES EXERCISE PRICE ---------------------------------
Outstanding at December 31, 1999 142,913 $ 13.23 Granted 59,151 16.36 Exercised (16,339) 12.35 Forfeited (825) 11.68 --------------------------------- Outstanding at December 31, 2000 184,900 14.32 Granted 51,355 19.53 Exercised (84,266) 13.79 Forfeited (6,271) 15.25 --------------------------------- Outstanding at December 31, 2001 145,718 16.68 Granted 39,432 23.92 Exercised (19,030) 13.62 Forfeited (3,920) 16.25 --------------------------------- Outstanding at December 31, 2002 162,200 $ 18.41 =================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10. STOCK BASED COMPENSATION (CONTINUED)
At December 31, 2002, the total options outstanding and exercisable were as follows:
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2002, 2001, and 2000, respectively: risk-free interest rates of 4.8%, 5.1%, and 6.4%, no dividends and expected lives of 8 years, 7 years, and 7 years. Volatility was assumed to be zero because there is currently no market for Indian River's stock. The weighted-average fair value of options granted during 2002, 2001, and 2000 were $7.67, $6.71, and $5.77, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11. EARNINGS PER SHARE
Following is information about the computation of the earnings per share data for the years ended December 31, 2002, 2001 and 2000 (after adjusting for 10% stock dividends in 2002, 2001 and 2000, a 2 for 1 stock split effective March 31, 2000 and a 10% stock dividend declared in January 2003):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12. RELATED PARTY TRANSACTIONS
Some of the directors of the Bank are also owners or executive officers in other business organizations. The Bank has made loans to these individuals and related companies, as well as to officers of the Bank which, in the opinion of management, are on the same terms as comparable transactions with others. Aggregate loans to these related parties totaled approximately $4.7 million and $3.8 million at December 31, 2002 and 2001, respectively. Aggregate borrowings on these loans totaled $2.9 million and repayments totaled $2.0 million for the year ended December 31, 2002. Commitments to extend additional credit to these related parties totaled approximately $2.6 million and $1.8 million at December 31, 2002 and 2001, respectively.
NOTE 13. LEASES
The Bank leases various office facilities under operating leases expiring through 2012. Several of these leases have one or more options to renew for periods of three to five years each. Several of these leases provide for increases in rent in accordance with changes in the Consumer Price Index.
Future minimum rental payments required under the operating leases at December 31, 2002 were as follows:
(Dollars in Thousands) Year Ending December 31, Amount - ------------------------------------------------- 2003 $ 436 2004 389 2005 383 2006 297 2007 260 Thereafter 1,457 ------- $ 3,222 =======
Total rent expense (including basic operating expenses) recorded by the Bank for the years ended December 31, 2002, 2001 and 2000, was $361 thousand, $378 thousand and $311 thousand, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14. OTHER OPERATING EXPENSES
A summary of other operating expenses is as follows for the years ended December 31, 2002, 2001 and 2000:
(Dollars in Thousands) 2002 2001 2000 ------------------------------ Data processing $1,317 $1,288 $ 875 Advertising and business development 598 206 313 Professional fees 294 298 138 Supplies and postage 465 595 414 Directors' fees 228 165 166 Miscellaneous 1,373 1,231 1,306 ------------------------------ $4,275 $3,783 $3,212 ==============================
NOTE 15. SALARY SAVINGS 401(K) PLAN
The Bank sponsors a Salary Savings 401(k) Plan under which the Bank may elect to make discretionary contributions as may be determined by the Board of Directors. The Bank contributed $121 thousand, $106 thousand, and $82 thousand for the years ended December 31, 2002, 2001, and 2000, respectively.
NOTE 16. RESTRICTIONS ON RETAINED EARNINGS AND REGULATORY MATTERS
Indian River Bank is subject to the dividend restrictions set forth by the Office of the Comptroller of the Currency ("OCC"). Under such restrictions, the Bank may not, without the prior approval of the OCC, declare dividends in excess of the sum of the current year's earnings (as defined) plus the retained earnings (as defined) from the prior two years. The dividends, as of December 31, 2002, that the Bank could declare, without the approval of the OCC, amounted to approximately $9 million.
Indian River (on a consolidated basis) and Indian River Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Indian River and Indian River Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require Indian River and Indian River Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets (all as defined in the regulations). Management believes Indian River and Indian River Bank meet all capital adequacy requirements to which they are subject as of December 31, 2002.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16. RESTRICTIONS ON RETAINED EARNINGS AND REGULATORY MATTERS (CONTINUED)
As of December 31, 2002, the most recent notification from the OCC categorized Indian River Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed Indian River Bank's category.
Indian River's and Indian River Bank's actual capital amounts and ratios as of December 31, 2002 and 2001 are also presented in the table.
If Indian River Bank fails to remain categorized as well capitalized, Indian River's designation as a financial holding company may be lost.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Bank, in the normal course of business, is a party to financial instruments with off-balance-sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized on the balance sheet. The contractual amounts of these instruments reflect the Bank's involvement in particular classes of financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by the counterparty to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
These commitments were as follows at December 31, 2002 and 2001:
(Dollars in Thousands) 2002 2001 -------------------------- Commitments to extend credit $ 55,436 $ 41,955 Credit card arrangements 3,968 4,000 Standby letters of credit 863 2,029 -------------------------- $ 60,267 $ 47,984 ==========================
Commitments to extend credit: Commitments to extend credit are commitments to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if any, is based on management's credit evaluation of the counterparty. Collateral held varies, but may include cash, accounts receivable, inventory, property, plant and equipment, and residential and commercial real estate.
Standby letters of credit: Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees generally have terms of one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds collateral, which may include accounts receivable, inventory, equipment, and real estate, supporting those commitments if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Bank would be required to fund the commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount shown in the summary above. If the commitment is funded the Bank would be entitled to seek recovery from the customer. At December 31, 2002 and 2001 no amounts have been recorded as liabilities for the Bank's potential obligations under these guarantees.
Credit card arrangements: Credit card arrangements represent unsecured commitments to extend credit, which may be terminated by the Bank.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18. CONCENTRATIONS OF RISK
Most of the Bank's business activity is with customers located within its primary market area, which generally includes Central Florida. Included in the Bank's loan portfolio (see Note 4) is a concentration of loans related to real estate, a significant portion of which relates to residential real estate. A substantial portion of its debtors' abilities to honor their contracts is dependent upon the local economy. The economy of the Bank's primary market area is not heavily dependent on any individual economic sector.
Concentration by institution: The Bank also has a substantial concentration of funds with two banks at December 31, 2002. Such concentration consisted of federal funds sold and a deposit account balance that totaled $10.5 million and $18.8 million, at December 31, 2002 and 2001, respectively. The Bank has not experienced any losses on such accounts.
NOTE 19. ADDITIONAL CASH FLOW INFORMATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Bank in estimating the fair value of its financial instruments:
Cash and cash equivalents: The carrying amounts reported in the consolidated balance sheets for cash and short-term instruments approximated their fair values.
Investment securities (including mortgage-backed securities): Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Loans receivable: For variable-rate loans that re-price frequently and with no significant change in credit risk, values are based on carrying values. Fair values for other loans are estimated based on discounted cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. Management believes that the allowance for loan losses is an appropriate indication of the applicable credit risk associated with determining the fair value of its loan portfolio and the allowance has been deducted from the estimate fair value of loans.
Accrued interest receivable: The carrying amount of accrued interest receivable approximates its fair value.
Deposit liabilities: The fair values of demand deposits and passbook savings equal their carrying amounts which represent the amount payable on demand. The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair value at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Other borrowings and trust preferred securities: The fair value of borrowings with variable interest rates approximates their recorded book value due to interest rates that are near market rates. Fair values for fixed-rate borrowings are estimated using a discounted cash flow calculation that applies interest rates currently available on similar borrowings to a schedule of aggregated expected monthly payments due on those borrowings.
Other liabilities: The carrying amount of other liabilities approximates their fair value.
Commitments to extend credit and other off-balance-sheet financial instruments: Consideration of the fair value of commitments to extend credit and letters of credit is based on fees charged to enter into similar agreements. Since the fees charged by the Bank are nominal, the estimate of fair value is negligible.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Following is a summary of the carrying amounts and approximate fair values of the Bank's financial instruments at December 31, 2002 and 2001:
NOTE 21. STOCK ISSUANCE
Indian River offered to sell up to 300,000 newly issued shares of common stock at a price of $25 per share during 2000. Proceeds of $5,195,700 from the sale of 207,828 shares, less issuance costs of $121,739, are included in the financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 22. PARENT COMPANY ONLY FINANCIAL STATEMENTS
Condensed financial statements for Indian River Banking Company only are presented below:
INDIAN RIVER BANKING COMPANY PARENT COMPANY ONLY BALANCE SHEETS DECEMBER 31, 2002 AND 2001
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 22. PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
INDIAN RIVER BANKING COMPANY PARENT COMPANY ONLY STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
NOTE 23. SUBSEQUENT STOCK DIVIDEND
The number of shares outstanding and the related stockholders' equity accounts have been retroactively adjusted in the accompanying balance sheet as of December 31, 2002 to reflect a 10% stock dividend declared January 15, 2003.
NOTE 24. LEGAL CONTINGENCIES
Various legal claims arise from time to time in the normal course of business, which, in the opinion of management, will have no material effect on the Bank's consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 25. QUARTERLY DATA (UNAUDITED)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item is incorporated by reference to the material appearing at pages 6 to 7, 12 and 16 of Indian River's definitive proxy statement for the Annual Meeting of Shareholders to be held on April 30, 2003 under the captions "Election of Directors - Nominees for Election as Directors, and "- Executive Officers who are not Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934".
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference to the material appearing at pages 8 to 15 of Indian River's definitive proxy statement for the Annual Meeting of Shareholders to be held on April 30, 2003, under the captions "Directors' Compensation", "Executive Compensation", "Report of the Compensation Committee, and Stock Performance Comparison.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Securities Authorized for Issuance Under Equity Compensation Plans. The following table sets forth information regarding options and other securities issuable and issued under our plans under which stock options or other equity based compensation may be granted.
(1) Reflects the 1995 and 1999 Stock Option Plan described further in Note 10 to the Consolidated Financial Statements and in response to Item 11.
(2) Reflect options granted under the Directors Fee Stock Options Plan (the Director). No specific number of shares has been reserved for future issuances under the Director Plan. Under the Plan, every three years, the directors are granted options to purchase an aggregate of 2,100 shares for committee service for the upcoming three year period.
(3) Represents shares available for issuance under the Employee Tenure Stock Grant Plan. This plan annually awards one share of common stock for each year of service to non executive officer employees upon the anniversary date of their employment with Indian River, commencing with their fifth anniversary. The Board of Directors may terminate the plan at any time.
The other information required by this Item is incorporated by reference to the material appearing at pages 4 to 5 of Indian River's definitive proxy statement for the Annual Meeting of Shareholders to be held on April 30, 2003 under the caption "Voting Securities and Principal Shareholders".
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference to the material appearing at page 13 of Indian River's definitive proxy statement for the Annual Meeting of Shareholders to be held on April 30, 2003 under the caption "Certain Relationships and Related Transactions".
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
Within the ninety days prior to the filing of this report, Indian River's management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of Indian River's disclosure controls and procedures, as defined in Rule 13a-14 under the Securities Exchange Act of 1934. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that Indian River's disclosure controls and procedures were adequate. There were no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in Indian River's internal controls or in other factors subsequent to the date of the evaluation that would significantly affect those controls.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
Consolidated Balance Sheets at December 31, 2001 and 2002 Consolidated Statements of Income for the years ended December 31, 2000, 2001 and 2002 Consolidated Statements of Cash Flows for the years ended December 31, 2000, 2001 and 2002 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2000, 2001 and 2002 Notes to the Consolidated Financial Statements Report of Independent Auditors
(2) Financial Statement Schedules
All financial statement schedules have been omitted as the required information is either inapplicable or included in the consolidated financial statements or related notes.
(3) Exhibits
Exhibit No. Description of Exhibits - ----------- ----------------------- 3(a) Articles of Incorporation of Indian River, as amended (1) 3(b) Bylaws of Indian River (1) 4(a) Indenture, dated as of September 30, 2002 between Indian River Banking Company and Wells Fargo Bank, National Association, as trustee (2) 4(b) Amended and Restated Declaration of Trust, dated as of September 30, 2002 among Indian River Banking Company, Wells Fargo Bank, National Association as Property Trustee, and Paul A. Beindorf, Diana L. Walker and Phillip L. Tasker as Administrative Trustees (2) 4(c) Guarantee Agreement dated as of September 30, 2002, between Indian River Banking Company and Wells Fargo Bank, National Association, as trustee (2) 10(a) Indian River 1999 Stock Option Plan (3) 10(b) Employment Agreement between Indian River National Bank and Paul A. Beindorf 10(c) Employment Agreement between Indian River National Bank and Jeffrey R. Morton 10(d) Change in Control Agreement between Indian River Banking Company, Indian River National Bank and Diana L. Walker 11 Statement of Computation of Per Share Earnings See Note 11 to the Consolidated Financial Statements 21 Subsidiaries of the Registrant 23 Consent of McGladrey & Pullen, LLP, Independent Auditors 99(a) Certification of Paul A. Beindorf 99(b) Certification of Phillip L. Tasker
- --------------------------
(1) Incorporated by reference to exhibit of same number to Indian River's registration statement on Form SB-2 (No. 333-36688)
(2) Not filed in accordance with the provisions of Item 601(b)(4)(iii) of Regulation SK. Indian River agrees to provide a copy of these documents to the Commission upon request.
(3) Incorporated by reference to exhibit 10(d) to Indian River's registration statement on Form SB-2 (No. 333-36688)
(B) REPORTS ON FORM 8-K
On October 18, 2002, Indian River filed a report on Form 8-K, under Item 5, disclosing the issuance of a press release announcing third quarter earnings.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
INDIAN RIVER BANKING COMPANY
Dated March 3, 2003 By: /s/ Paul A. Beindorf ----------------------------- Paul A. Beindorf, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
CERTIFICATION
I, Paul A. Beindorf, certify that:
1. I have reviewed this annual report on Form 10-K of Indian River Banking Company;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 3, 2003 /s/ Paul A. Beindorf -------------------- President and Chief Executive Officer
CERTIFICATION
I, Phillip L. Tasker, certify that:
1. I have reviewed this annual report on Form 10-K of Indian River Banking Company;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 3, 2003 /s/ Phillip L. Tasker --------------------- Treasurer and Chief Financial Officer