Item 1. Business - ------- -------- General
Lincoln Bancorp (the "Holding Company") is an Indiana corporation organized in September 1998 to become a savings and loan holding company upon its acquisition of all the issued and outstanding capital stock of Lincoln Federal Savings Bank ("Lincoln Federal" or the "Bank" and together with the Holding Company, the "Company") in connection with the Bank's conversion from mutual to stock form. The Holding Company became the Bank's holding company on December 30, 1998. The principal asset of the Holding Company currently consists of 100% of the issued and outstanding shares of capital stock, $.01 par value per share, of the Bank. Lincoln Federal was originally organized in 1884 as Ladoga Federal Savings and Loan Association ("Ladoga Federal"), located in Ladoga, Indiana. In 1979, Ladoga Federal merged with Plainfield First Federal Savings and Loan Association, a federal savings and loan association located in Plainfield, Indiana which was originally organized in 1896. Following the merger, the Bank changed its name to Lincoln Federal Savings and Loan Association and, in 1984, adopted its current name, Lincoln Federal Savings Bank. On September 26, 2000, the Company acquired Citizens Bancorp ("Citizens"), the holding company of Citizens Savings Bank of Frankfort ("Citizens Savings"), a federally chartered savings bank. Citizens was merged into the Company and Citizens Savings was merged into the Bank. Citizens Loan and Service Corporation ("CLSC"), an Indiana corporation and wholly-owned subsidiary of Citizens Savings, continues as a subsidiary of the Bank. See Consolidated Financial Statements -- Note 2. At December 31, 2002, Lincoln Federal conducted its business from nine full service offices located in Hendricks, Montgomery, Clinton, Johnson and Morgan Counties, Indiana, with its main office located in Plainfield. Lincoln Federal opened its newest office in Greenwood, Indiana, on October 14, 2002. The Bank's principal business consists of attracting deposits from the general public and originating fixed-rate and adjustable-rate loans secured primarily by first mortgage liens on one- to four-family residential real estate. Lincoln Federal's deposit accounts are insured up to applicable limits required by the SAIF of the FDIC.
Lincoln Federal offers a number of financial services, including: (i) one- to four-family residential real estate loans; (ii) commercial real estate loans; (iii) real estate construction loans; (iv) land loans; (v) multi-family residential loans; (vi) consumer loans, including home equity loans and automobile loans; (vii) commercial loans; (viii) money market demand accounts ("MMDAs"); (ix) savings accounts; (x) checking accounts; (xi) NOW accounts; and (xii) certificates of deposit.
Lending Activities
The Bank has historically concentrated its lending activities on the origination of loans secured by first mortgage liens for the purchase, construction or refinancing of one- to four-family residential real property. One- to four-family residential mortgage loans continue to be the major focus of Lincoln Federal's loan origination activities, representing 44.6% of its total loan portfolio at December 31, 2002. Lincoln Federal also offers commercial real estate loans, real estate construction loans and consumer loans. To a lesser extent, Lincoln Federal also offers multi-family loans, land loans and commercial operating loans. Commercial real estate loans totaled approximately 21.4% of the Bank's total loan portfolio, and real estate construction loans totaled approximately 13.3% of Lincoln Federal's total loans as of December 31, 2002. Consumer loans were 11.7% of the loan portfolio at December 31, 2002.
Loan Portfolio Data. The following table sets forth the composition of Lincoln Federal's loan portfolio (including loans held for sale) by loan type and security type as of the dates indicated, including a reconciliation of gross loans receivable after consideration of the allowance for loan losses, deferred loan fees and loans in process.
The following table sets forth certain information at December 31, 2002, regarding the dollar amount of loans maturing in Lincoln Federal's loan portfolio based on the contractual terms to maturity. Demand loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less. This schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses. Management expects prepayments will cause actual maturities to be shorter.
The following table sets forth, as of December 31, 2002, the dollar amount of all loans due after one year that have fixed interest rates and floating or adjustable interest rates.
Due After December 31, 2003 --------------------------------------- Fixed Rates Variable Rates Total ----------- -------------- ---------- (In thousands) Real estate mortgage loans: One- to four-family residential loans ............ $118,208 $ 46,725 $164,933 Multi-family loans ............. 2,325 3,228 5,553 Commercial real estate loans ... 50,968 19,320 70,288 Construction loans ............. 14,230 -- 14,230 Land loans ..................... 3,666 -- 3,666 Commercial ....................... -- 11,793 11,793 Consumer Loans: Installment loans .............. 7,331 -- 7,331 Loans secured by deposits ...... 292 -- 292 Home equity loans and second mortgages ......... 7,768 26,716 34,484 -------- -------- -------- Total Consumer Loans ......... 15,391 26,716 42,107 -------- -------- -------- Total Loans ................ $204,788 $107,782 $312,570 ======== ======== ========
One- to Four-Family Residential Loans. Lincoln Federal's primary lending activity consists of the origination of one- to four-family residential mortgage loans secured by property located in its primary market area. Lincoln Federal generally does not originate one- to four-family residential mortgage loans if the ratio of the loan amount to the lesser of the current cost or appraised value of the property (the "Loan-to-Value Ratio") exceeds 95%. Lincoln Federal requires private mortgage insurance on loans with a Loan-to-Value Ratio in excess of 80%. The cost of such insurance is factored into the annual percentage rate on such loans.
Lincoln Federal's underwriting criteria for one- to four-family residential loans include the value of the underlying collateral, such as the income, debt-to-income ratio, stability of earnings and past credit history of a potential borrower, in making credit decisions. These underwriting criteria are based upon FHLMC lending guidelines. The Bank originates fixed-rate loans which provide for the payment of principal and interest over a period of up to 30 years.
Lincoln Federal also offers adjustable-rate mortgage ("ARM") loans pegged to the one-, three- and five-year U.S. Treasury securities yield adjusted to a constant maturity. Lincoln Federal no longer offers adjustable rate loans with interest rates pegged to the 11th District Cost of Funds Index ("COFI") because COFI adjusts less rapidly to changes in interest rates compared to other indices. Lincoln Federal may offer discounted initial interest rates on ARM loans, but requires that the borrower qualify for the loan at the fully-indexed rate (the index rate plus the margin). A substantial portion of the ARM loans in the Bank's portfolio at December 31, 2002 provide for maximum rate adjustments per year and over the life of the loan of 2% and 6%, respectively. Lincoln Federal's residential ARM loans are amortized over terms up to 30 years.
In two separate transactions in August 1997 and April 1998, Lincoln Federal securitized approximately $41.1 million of the COFI loans in its portfolio and sold the resulting mortgage-backed securities on the secondary market. In June 1998 Lincoln Federal sold in a direct, whole-loan sale to a private investor an additional $19.3 million of COFI loans. Following the closing of this whole-loan sale, the amount of COFI loans in Lincoln Federal's portfolio was reduced to $4.8 million. Lincoln Federal also pooled $75.0 million of fixed-rate one- to four-family residential loans into FHLMC mortgage-backed securities. Lincoln Federal sold on the secondary market $34.3 million of these securities which were backed by lower-yielding, fixed-rate loans. Lincoln Federal makes certain fixed-rate one- to four-family residential loans with the intent of pooling these loans into FHLMC mortgage-backed securities. During 2002 and 2000, Lincoln Federal securitized $18.2 and $5.0 million, respectively. No loans were securitized during 2001. At December 31, 2002, Lincoln Federal continued to hold in its investment portfolio approximately $22.8 million (amortized cost) of these securities that are backed by higher-yielding, fixed-rate mortgage loans that it originated.
With the exception of the loans that were securitized during 1997 and 1998 and in the whole-loan sale in 1998, Lincoln Federal determines when it originates a one- to four-family residential loan whether it intends to hold the loan until maturity or sell it in the secondary market. Lincoln Federal generally securitizes or sells on the secondary market all of the fixed-rate loans that it originates with terms of 15 or more years that are written to FHLMC standards, and retains in its loan portfolio any loans that it originates that are not written to FHLMC standards. During the fourth quarter of 2002, the Bank amended its policy and stopped selling fixed-rate loans with maturity of 15 years or less. Lincoln Federal retains the servicing rights on nearly all the loans that it sells.
ARM loans decrease the risk associated with changes in interest rates by periodically repricing, but involve other risks because, as interest rates increase, the underlying payments by the borrower also increase, thus increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustments of the contractual interest rate are also limited by the maximum periodic and lifetime interest rate adjustment permitted by the loan documents, and, therefore, is potentially limited in effectiveness during periods of rapidly rising interest rates. At December 31, 2002, approximately 28.3% of Lincoln Federal's one- to four-family residential loans had adjustable rates of interest.
All of the one- to four-family residential mortgage loans that Lincoln Federal originates include "due-on-sale" clauses, which give Lincoln Federal the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not repaid. However, Lincoln Federal occasionally permits assumptions of existing residential mortgage loans on a case-by-case basis.
At December 31, 2002, approximately $168.1 million, or 44.6% of Lincoln Federal's portfolio of loans, consisted of one- to four-family residential loans. Approximately $1.4 million, or .9% of total residential loans, were included in non-performing assets as of that date.
Commercial Real Estate and Multi-Family Loans. Lincoln Federal's commercial real estate loans are secured by churches, warehouses, office buildings, hotels and other commercial properties. Lincoln Federal generally issues commercial real estate loans as five-year balloon loans amortized over a 15- or 20-year period, with an adjustable interest rate indexed primarily to the prime rate. At December 31, 2002 Lincoln Federal had $42.6 million in outstanding balloon loans secured by commercial and multi-family real estate. Lincoln Federal generally requires a Loan-to-Value Ratio of at least 80% on commercial real estate loans, although it may make loans with a higher Loan-to-Value Ratio on loans secured by owner-occupied commercial real estate or by multi-family residential properties.
Commercial real estate loans generally are larger than one- to four-family residential loans and involve a greater degree of risk. Commercial real estate loans often involve large loan balances to single borrowers or groups of related borrowers. Payments on these loans depend to a large degree on results of operations and management of the properties and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. Accordingly, the nature of the loans makes them more difficult for management to monitor and evaluate. In addition, balloon loans may involve a greater degree of risk to the extent the borrower is unable to obtain financing or cannot repay the loan when the loan matures and the balloon payment is due.
At December 31, 2002 Lincoln Federal's largest commercial real estate borrower had a single loan outstanding in the amount of $2.9 million which was secured by a medical office complex located in Noblesville, Indiana. At December 31, 2002, approximately $80.8 million, or 21.4% of Lincoln Federal's total loan portfolio, consisted of commercial real estate loans. On the same date, there were no commercial real estate loans included in non-performing assets.
At December 31, 2002, approximately $5.6 million, or 1.5% of Lincoln Federal's total loan portfolio, consisted of mortgage loans secured by multi-family dwellings (those consisting of more than four units). Lincoln Federal writes multi-family loans on terms and conditions similar to its commercial real estate loans. The largest multi-family loan as of December 31, 2002 was $1.0 million and was secured by an apartment complex in Indianapolis, Indiana. On the same date, there were no multi-family loans included in non-performing assets.
Multi-family loans, like commercial real estate loans, involve greater risk than do residential loans. Also, the loan-to-one-borrower limitation restricts Lincoln Federal's ability to make loans to certain developers of apartment complexes and other multi-family units.
Construction Loans. Lincoln Federal offers construction loans to developers for the acquisition and development of residential and nonresidential real estate and to builders of one- to four-family residential properties. A significant portion of these loans are made on a speculative basis (i.e., before the builder/developer obtains a commitment from a buyer). At December 31, 2002, approximately $50.1 million, or 13.3% of Lincoln Federal's total loan portfolio, consisted of construction loans. Of these loans, approximately $9.2 million were for the acquisition and development of residential housing developments, $15.9 million financed the construction of one- to four-family residential properties and $25.0 million financed the construction of commercial real estate. As of December 31, 2002, Lincoln Federal's largest construction loan relationship had a balance of $3.0 million and was secured by an assisted living complex located in Plainfield, Indiana. Also on that date, $54,000 of construction loans were included in non-performing assets.
Construction loans on residential properties where the borrower has entered into a verifiable sales contract to a non-related party to purchase the completed home may be made with a maximum Loan-to-Value Ratio of the lesser of 90% of the price stipulated in the sales contract or 80% of the appraised value of the property. With respect to residential properties constructed on a speculative basis, Lincoln Federal generally requires a Loan-to-Value Ratio of 75% of the "as completed" appraised value of the property. Although speculative loans make up a significant percentage of Lincoln Federal's construction loan portfolio, Lincoln Federal generally will finance only one speculative construction project per builder. Residential construction loans are generally written with a fixed rate of interest and for an initial term of six months. Lincoln Federal generally offers construction loans on commercial land development projects with a maximum Loan-to-Value Ratio of 75% of the appraised value of the property or 80% of the property's cost plus 80% of the cost of verifiable improvements to the property. The term of construction loans on commercial real estate properties generally do not exceed 24 months.
Construction loans provide a comparable, and in some cases higher, yield than a conventional mortgage loan, however, they also involve a higher degree of risk. For example, if a project is not completed and the borrower defaults, Lincoln Federal may have to hire another contractor to complete the project at a higher cost. Also, a project may be completed, however, it may not be salable, which might cause the borrower to default on the loan and require Lincoln Federal take title to the project.
Land Loans. At December 31, 2002, approximately $6.1 million, or 1.6% of Lincoln Federal's total loan portfolio, consisted of mortgage loans secured by undeveloped real estate. Lincoln Federal requires a maximum Loan-to-Value Ratio of 65% of the appraised value of the land or 90% of the cost of the undeveloped land for pre-development land acquisition loans. Lincoln Federal writes these loans for a maximum term of 12 months. At December 31, 2002, the Bank's largest land loan relationship totaled $1.8 million and was secured by a subdivision located in Plainfield, Indiana. At December 31, 2002, land loans in the amount of $206,000 were included in non-performing assets.
Land loans present greater risk than conventional loans since land development borrowers who are over budget may divert the loan funds to cover cost-overruns rather than direct them toward the purpose for which such loans were made. In addition, land loans are more difficult to monitor than conventional mortgage loans. As such, a defaulting borrower could cause Lincoln Federal to take title to partially improved land that is unmarketable without further capital investment.
Consumer Loans. Lincoln Federal's consumer loans consist of variable- and fixed-rate home equity loans; lines of credit; automobile, recreational vehicle, boat and motorcycle loans; and loans secured by deposits. Lincoln Federal generally does not make indirect consumer loans. Consumer loans generally have shorter terms and higher yields than permanent residential mortgage loans. At December 31, 2002, Lincoln Federal's consumer loans aggregated approximately $43.9 million, or 11.7% of Lincoln Federal's total loan portfolio. Included in consumer loans at December 31, 2002 were $26.9 million of variable-rate home equity lines of credit. These variable-rate loans improve Lincoln Federal's exposure to interest rate risk.
Lincoln Federal's home equity lines of credit and fixed-term loans are generally written for up to 95% of the available equity (the appraised value of the property less any first mortgage amount) if Lincoln Federal holds the first mortgage, and up to 90% of the available equity if Lincoln Federal does not hold the first mortgage. Lincoln Federal's home equity and second mortgage loans were $35.2 million, or 9.4% of total loans at December 31, 2002. Lincoln Federal generally will write automobile loans for up to 100% of the acquisition price for a new automobile and up to the NADA retail value for a used automobile. New car loans are written for terms of up to 60 months and used car loans are written for terms up to 48 months, depending on the age of the car. Loans for recreational vehicles and boats are written for no more than 80% of the purchase price or "verified value," whichever is less, for a maximum term of 120 months and 84 months, respectively. Motorcycle loans are written for no more than 75% of the purchase price or "verified value" with a term not to exceed 48 months. All of Lincoln Federal's consumer loans have a fixed rate of interest except for home equity lines of credit, which are offered at a variable rate. At December 31, 2002, consumer loans in the amount of $330,000 were included in non-performing assets.
Consumer loans may entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or are secured by rapidly depreciable assets, such as automobiles. Further, any repossessed collateral under a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance. In addition, consumer loan collections depend on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.
Commercial Loans. Lincoln Federal offers commercial loans, which consist primarily of loans to businesses that are secured by assets other than real estate. As of December 31, 2002, commercial loans amounted to $22.4 million. Commercial loans generally bear greater risk than residential mortgage loans, depending on the ability of the underlying enterprise to repay the loan. Although commercial loans have not historically comprised a large portion of Lincoln Federal's loan portfolio, Lincoln Federal has increased the amount of loans it has made to small businesses in order to increase its rate of return and diversify its portfolio. As of December 31, 2002, $59,000 of Lincoln Federal's commercial loans were included in nonperforming assets.
Origination, Purchase and Sale of Loans. Historically, Lincoln Federal has confined its loan origination activities primarily to Hendricks, Montgomery, Clinton, Johnson and Morgan Counties. Lincoln Federal may from time to time make mortgage loans secured by property located outside of Indiana. Lincoln Federal's loan originations are generated from referrals from existing customers, real estate brokers, and newspaper and periodical advertising.
Lincoln Federal's loan approval process is intended to assess the borrower's ability to repay the loan, the viability of the loan and the adequacy of the value of the property that will secure the loan. To assess the borrower's ability to repay, the Bank evaluates the employment and credit history and information on the historical and projected income and expenses of its borrowers.
Lincoln Federal generally requires appraisals on all real property securing its first-mortgage loans and requires title insurance and a valid lien on the mortgaged real estate. Appraisals for all real property securing first-mortgage loans are performed by independent appraisers who are state-licensed. Lincoln Federal requires fire and extended coverage insurance in amounts at least equal to the principal amount of the loan and also requires flood insurance to protect the property, which secures its interest, if the property is in a flood plain. Lincoln Federal also generally requires private mortgage insurance for all residential mortgage loans with Loan-to-Value Ratios of greater than 80%. Lincoln Federal generally requires escrow accounts for insurance premiums and taxes for residential mortgage loans that it originates.
Lincoln Federal's underwriting standards for consumer loans are intended to protect against some of the risks inherent in making consumer loans. Borrower character, paying habits, length of employment and financial strengths are important considerations.
Lincoln Federal occasionally purchases participation interests in loans originated by other financial institutions in order to diversify its portfolio, supplement local loan demand and to obtain more favorable yields. The participations that Lincoln Federal purchases normally represent a portion of residential or commercial real estate loans originated by other Indiana financial institutions, most of which are secured by property located in Indiana. As of December 31, 2002, Lincoln Federal had $30.0 million of loan participations in its asset portfolio.
The following table shows loan origination and repayment activity for Lincoln Federal during the periods indicated:
Lincoln Federal's total loan originations during the year ended December 31, 2002 totaled $256.8 million, compared to $160.8 million during the year ended December 31, 2001, and $101.8 million during the year ended December 31, 2000.
Origination and Other Fees. Lincoln Federal realizes income from late charges, checking account service charges, loan servicing fees and fees for other miscellaneous services. Late charges are generally assessed if a loan payment is not received within a specified number of days after it is due. The grace period depends on the individual loan documents. The Bank also receives a loan servicing fee of 1/4% on fixed-rate loans and 3/8% on ARM loans that it services for others.
Non-Performing and Problem Assets
After a mortgage loan becomes 17 days past due, Lincoln Federal delivers a delinquency notice to the borrower. When loans are 30 to 60 days in default, Lincoln Federal sends additional delinquency notices and telephone calls are placed with the borrower to establish an acceptable repayment schedule. When loans become 60 days in default, Lincoln Federal again contacts the borrower to establish an acceptable repayment schedule. When a mortgage loan is 90 days delinquent, Lincoln Federal will have either entered into a workout plan with the borrower or referred the matter to its attorney for collection. Management is authorized to commence foreclosure proceedings for any loan upon making a determination that it is prudent to do so.
Lincoln Federal reviews mortgage loans on a regular basis and places one- to four-family residential loans on a non-accrual status when they become 120 days delinquent. Other loans are placed on a non-accrual status when they become 90 days delinquent. Generally, when loans are placed on a non-accrual status, unpaid accrued interest is written off.
Non-performing Assets. At December 31, 2002, $2.3 million, or .43%, of Lincoln Federal's total assets, were non-performing (non-performing loans and non-accruing loans) compared to $1.7 million, or .34%, of its total assets at December 31, 2001. At December 31, 2002, residential loans accounted for $1.4 million of Lincoln Federal's non-performing assets, construction loans accounted for $54,000 of its non-performing assets, land loans accounted for $206,000 of its non-performing assets, commercial loans accounted for $59,000 of its non-performing assets, and consumer loans accounted for $330,000 of non-performing assets. Lincoln Federal had real estate owned ("REO") properties in the amount of $213,000 as of December 31, 2002.
The table below sets forth the amounts and categories of Lincoln Federal's non-performing assets (non-performing loans, foreclosed real estate and troubled debt restructurings) for the last five years. It is Lincoln Federal's policy that earned but uncollected interest on all loans be reviewed monthly to determine if any portion thereof should be classified as uncollectible for any loan past due in excess of 90 days. Lincoln Federal deems any delinquent loan that is 90 days or more past due to be a non-performing asset.
Interest income of $140,000 for the year ended December 31, 2002, was recognized on the non-performing loans summarized above. Interest income of $170,000 for the year ended December 31, 2002, would have been recognized under the original loan terms of these loans.
At December 31, 2002, Lincoln Federal held loans delinquent from 30 to 89 days totaling $9.7 million. As of that date, Lincoln Federal was not aware of any other loans in which borrowers were experiencing financial difficulties and was not aware of any assets that would need to be disclosed as non-performing assets.
Delinquent Loans. The following table sets forth certain information at December 31, 2002, 2001 and 2000, relating to delinquencies in Lincoln Federal's portfolio. Delinquent loans that are 90 days or more past due are considered non-performing assets.
Classified Assets. Federal regulations and Lincoln Federal's Asset Classification Policy provide for the classification of loans and other assets such as debt and equity securities considered by the OTS to be of lesser quality as "substandard," "doubtful" or "loss" assets. An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.
An insured institution is required to establish general allowances for loan losses in an amount deemed prudent by management for loans classified substandard or doubtful, as well as for other problem loans. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as "loss," it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount. An institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS which can order the establishment of additional general or specific loss allowances.
Lincoln Federal regularly reviews its loan portfolio to determine whether any loans require classification in accordance with applicable regulations. Lincoln Federal's classified assets are made up entirely of non-performing assets.
Allowance for Loan Losses
The allowance for loan losses is maintained through the provision for loan losses, which is charged to earnings. The allowance for loan losses is determined in conjunction with Lincoln Federal's review and evaluation of current economic conditions (including those of its lending area), changes in the character and size of its loan portfolio, loan delinquencies (current status as well as past and anticipated trends) and adequacy of collateral securing loan delinquencies, historical and estimated net charge-offs, and other pertinent information derived from a review of the loan portfolio. In management's opinion, Lincoln Federal's allowance for loan losses is adequate to absorb probable losses inherent in the loan portfolio at December 31, 2002. However, there can be no assurance that regulators, when reviewing the Bank's loan portfolio in the future, will not require increases in its allowances for loan losses or that changes in economic conditions will not adversely affect its loan portfolio.
Summary of Loan Loss Experience. The following table analyzes changes in the allowance during the past five fiscal years ended December 31, 2002.
Allocation of Allowance for Loan Losses. The following table presents an analysis of the allocation of Lincoln Federal's allowance for loan losses at the dates indicated. At December 31,
Investments
Investments. The Bank has adopted an investment policy that authorizes investments in U.S. Treasury securities, securities guaranteed by the Government National Mortgage Association ("GNMA"), securities issued by agencies of the U.S. Government, mortgage-backed securities issued by the FHLMC or the Federal National Mortgage Association ("FNMA") and in highly-rated mortgage-backed securities, collateralized mortgage obligations and investment-grade corporate debt securities. This policy permits the Bank's management to react quickly to market conditions. Most of the securities in its portfolio are considered available-for-sale. At December 31, 2002, Lincoln Federal's investment portfolio consisted of investments in mortgage-backed securities, corporate securities, federal agency securities, municipal securities, FHLB stock, an investment in Pedcor Investments - 1987 - I, L.P., an investment in Bloomington Housing Associates, L.P., and an investment in an insurance company. See "-Investments in Multi-Family, Low- and Moderate-Income Housing Projects" and "Service Corporation Subsidiary." At December 31, 2002, approximately $110.7 million, or 21.2%, of Lincoln Federal's total assets consisted of such investments. The Bank also had $24.9 million in interest-earning deposits with the FHLB-Indianapolis and other financial institutions as of that date. As of that date, Lincoln Federal also had pledged as collateral, investment securities with a carrying value of $25.3 million, all of which are mortgage-backed securities.
Investment Securities. The following table sets forth the amortized cost and the market value of Lincoln Federal's investment portfolio at the dates indicated.
The following table sets forth the amount of investment securities (excluding mortgage-backed securities and marketable equity securities) which mature during each of the periods indicated and the weighted average yields for each range of maturities at December 31, 2002.
At December 31, 2002, Lincoln Federal had no corporate investments which exceeded 10% of its equity capital.
Mortgage-backed Securities. The following table sets forth the composition of Lincoln Federal's mortgage-backed securities portfolio at December 31, 2002 and 2001.
At December 31, 2002, mortgage-backed securities having an amortized cost of $3,000,000 mature in five to ten years and have a weighted average yield of 6.84% and mortgage-backed securities having an amortized cost of $41,971,000 mature after ten years and have a weighted average yield of 6.27%.
At December 31, 2001, mortgage-backed securities having an amortized cost of $3,210,000 mature in five to ten years and have a weighted average yield of 6.66% and mortgage-backed securities having an amortized cost of $55,049,000 mature after ten years and have a weighted average yield of 6.45%.
The following table sets forth the changes in Lincoln Federal's mortgage-backed securities portfolio for the years ended December 31, 2002, 2001 and 2000.
Investments in Multi-Family, Low- and Moderate-Income Housing Projects. Lincoln Federal has an investment in Pedcor Investments - 1987 - I, L.P. ("Pedcor"), an Indiana limited partnership that was organized to construct, own and operate a 208-unit apartment complex in Indianapolis, Indiana (the "Pedcor Project"). The Pedcor Project, which is operated as a multi-family, low- and moderate-income housing project, has been completed and is performing as planned. At the inception of the Pedcor Project in August 1988, Lincoln Federal committed to invest $2.7 million in Pedcor. In January 1998, the final payment pursuant to this commitment had been made and no additional funds are required for the Pedcor Project.
Lincoln Federal holds a separate investment in a multi-family, low- and moderate-income housing project through its wholly-owned subsidiary, LF Service Corp. ("LF"). LF has invested in Bloomington Housing Associates, L.P. ("BHA"), which is an Indiana limited partnership that was organized to construct, own and operate a 130-unit apartment complex in Bloomington, Indiana (the "BHA Project"). Development of the BHA Project has been completed and the project is performing as planned. LF committed to invest approximately $4.9 million in BHA at the inception of the Bloomington Project in August 1992. Through December 31, 2002, LF had invested cash of approximately $4.7 million in BHA with one additional annual capital contribution remaining to be paid in January 2003 of $249,000.
A low- and moderate-income housing project qualifies for certain federal income tax credits if (i) it is a residential rental property, (ii) the units are used on a nontransient basis, and (iii) 20% or more of the units in the project are occupied by tenants whose incomes are 50% or less of the area median gross income, adjusted for family size, or alternatively, at least 40% of the units in the project are occupied by tenants whose incomes are 60% or less of the area median gross income. Qualified low income housing projects generally must comply with these and other rules for fifteen years, beginning with the first year the project qualified for the tax credit, or some or all of the tax credit together with interest may be recaptured. The tax credit is subject to the limitations on the use of general business credit, but no basis reduction is required for any portion of the tax credit claimed. As of December 31, 2002, 86% of the units in the Pedcor Project and the Bloomington Project were occupied and each project complied with the low income occupancy requirements described above.
Lincoln Federal has received tax credits of $374,000 from the operation of the Bloomington Project for the year ended December 31, 2002. The tax credits from the BHA project will be available through 2007. Although Lincoln Federal has reduced income tax expense by the full amount of the tax credit available each year, it has not been able to fully utilize available tax credits to reduce income taxes payable because it may not use tax credits that would reduce its regular corporate tax liability below its alternative minimum tax liability. Lincoln Federal may carry forward unused tax credits for a period of fifteen years and management believes that it will be able to utilize available tax credits. Additionally, Pedcor and BHA have incurred operating losses in the early years of their operations primarily due to accelerated depreciation of assets. Lincoln Federal has accounted for its investment in Pedcor, and LF has accounted for Lincoln Federal's investment in BHA, on the equity method. Accordingly, Lincoln Federal and LF have each recorded their share of these losses as reductions to their investments in Pedcor and BHA, respectively. At December 31, 2002, Lincoln Federal had no remaining investment on the books for Pedcor, and LF's investment in BHA was $1.4 million.
The following summarizes Lincoln Federal's equity in Pedcor's losses and tax credits and LF's equity in BHA's losses and tax credits recognized in Lincoln Federal's consolidated financial statements.
Sources of Funds
General. Deposits have traditionally been Lincoln Federal's primary source of funds for use in lending and investment activities. In addition to deposits, Lincoln Federal derives funds from scheduled loan payments, investment maturities, loan prepayments, retained earnings, income on earning assets and borrowings. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, market conditions and levels of competition. Borrowings from the FHLB of Indianapolis have been used to compensate for reductions in deposits or deposit inflows at less than projected levels.
Deposits. Lincoln Federal attracts deposits principally from within Hendricks, Montgomery, Clinton, Johnson and Morgan Counties through the offering of a broad selection of deposit instruments, including passbook accounts, NOW accounts, variable rate money market accounts, fixed-term certificates of deposit, individual retirement accounts and savings accounts. Lincoln Federal does not actively solicit or advertise for deposits outside of Hendricks, Montgomery, Clinton, Johnson and Morgan Counties, and substantially all of Lincoln Federal's depositors are residents of those counties. Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds remain on deposits and the interest rate. Although the Bank may sometimes accept brokered deposits and bids for public deposits, it held only $.5 million and $19.7 million of such funds, or .2% and 7.3% of its total deposits, at December 31, 2002. Lincoln Federal periodically runs specials on certificates of deposit with specific maturities.
Lincoln Federal establishes the interest rates paid, maturity terms, service fees and withdrawal penalties on a periodic basis. Determination of rates and terms are predicated on funds acquisition and liquidity requirements, rates paid by competitors, growth goals, and applicable regulations. Lincoln Federal relies, in part, on customer service and long-standing relationships with customers to attract and retain its deposits. The Bank also closely prices its deposits to the rates offered by its competitors.
Approximately 56.3% of Lincoln Federal's deposits consist of certificates of deposit, which generally have higher interest rates than other deposit products that it offers. Certificates of deposit have increased 6.5% during the year ended December 31, 2002. Money market savings accounts represent 19.9% of Lincoln Federal's deposits and have grown 5.7% during the year ended December 31, 2002. Non-interest bearing demand accounts have grown $4.1 million, or 44.0%, during the year ended December 31, 2002. Lincoln Federal offers special rates on certificates of deposit with maturities that fit its asset and liability strategies.
The flow of deposits is influenced significantly by general economic conditions, changes in money market and other prevailing interest rates and competition. The variety of deposit accounts that Lincoln Federal offers has allowed it to compete effectively in obtaining funds and to respond with flexibility to changes in consumer demand. Lincoln Federal has become more susceptible to short-term fluctuations in deposit flows as customers have become more interest rate conscious. Lincoln Federal manages the pricing of its deposits in keeping with its asset/liability management and profitability objectives. Based on its experience, management believes that Lincoln Federal's savings accounts, NOW and MMDAs are relatively stable sources of deposits. However, the ability to attract and maintain certificates of deposit, and the rates Lincoln Federal pays on these deposits, have been and will continue to be significantly affected by market conditions.
An analysis of Lincoln Federal's deposit accounts by type and maturity at December 31, 2002, is as follows:
The following table sets forth by various interest rate categories the composition of Lincoln Federal's time deposits at the dates indicated:
At December 31, -------------------------------- 2002 2001 2000 -------- ------- ------- (In Thousands) Less than 2.00%.......... $ 26,989 $ 249 $ -- 2.00 to 2.99%............ 34,303 7,915 -- 3.00 to 3.99%............ 35,170 30,529 65 4.00 to 4.99%............ 25,908 41,641 20,347 5.00 to 5.99%............ 23,863 32,795 49,433 6.00 to 6.99%............ 5,886 29,408 86,371 7.00 to 7.99%............ 79 360 514 -------- -------- -------- Total................. $152,198 $142,897 $156,730 ======== ======== ========
The following table represents, by various interest rate categories, the amounts of time deposits maturing during each of the three years following December 31, 2002. Matured certificates, which have not been renewed as of December 31, 2002, have been allocated based upon certain rollover assumptions.
Amounts at December 31, 2002 Maturing In ----------------------------------------------- One Year Two Three Greater Than or Less Years Years Three Years -------- ------- ------- ------------ (In thousands)
Less than 2.00%......... $26,300 $ 689 $ -- $ -- 2.00 to 2.99%........... 21,041 11,304 1,958 -- 3.00 to 3.99%........... 7,841 22,014 4,309 1,005 4.00 to 4.99%........... 12,797 5,656 2,508 4,947 5.00 to 5.99%........... 6,272 7,993 831 8,767 6.00 to 6.99%........... 2,866 1,099 1,146 776 7.00 to 7.99%........... 74 -- -- 5 ------- ------- ------- ------- Total............... $77,191 $48,755 $10,752 $15,500 ======= ======= ======= =======
The following table indicates the amount of Lincoln Federal's other certificates of deposit of $100,000 or more by time remaining until maturity as of December 31, 2002.
At December 31, 2002 -------------------- Maturity Period (In thousands)
Three months or less .......................... $19,951 Greater than three months through six months... 2,343 Greater than six months through twelve months.. 5,267 Over twelve months ............................ 11,943 ------- Total ................................... $39,504 =======
Total deposits at December 31, 2002 were approximately $270.4 million, compared to approximately $252.1 million at December 31, 2001. Lincoln Federal's deposit base depends somewhat upon the manufacturing sector of Hendricks, Montgomery, Clinton, Johnson and Morgan Counties. Although the manufacturing sector in these counties is relatively diversified and does not significantly depend upon any industry, a loss of a material portion of the manufacturing workforce could adversely affect Lincoln Federal's ability to attract deposits due to the loss of personal income attributable to the lost manufacturing jobs and the attendant loss in service industry jobs.
In the unlikely event of the Bank's liquidation, all claims of creditors (including those of deposit account holders, to the extent of their deposit balances) would be paid first followed by distribution of the liquidation account to certain deposit account holders, with any assets remaining thereafter distributed to the Holding Company as the sole shareholder of Lincoln Federal.
Borrowings. Lincoln Federal focuses on generating high quality loans and then seeking the best source of funding from deposits, investments or borrowings. At December 31, 2002, Lincoln Federal had borrowings in the amount of $163.0 million from the FHLB of Indianapolis which bear fixed and variable interest rates and which are due at various dates through 2012. Lincoln Federal is required to maintain eligible loans and investment securities in its portfolio of at least 145% and 115%, respectively, of outstanding advances as collateral for advances from the FHLB of Indianapolis. As an additional funding source, Lincoln Federal has also sold securities under repurchase agreements. Lincoln Federal had no outstanding securities sold under repurchase agreement at December 31, 2002. Lincoln Federal does not anticipate any difficulty in obtaining advances and other borrowings appropriate to meet its requirements in the future.
The following table presents certain information relating to Lincoln Federal's borrowings at or for the years ended December 31, 2002, 2001 and 2000.
Service Corporation Subsidiaries
OTS regulations permit federal savings associations to invest in the capital stock, obligations or other specified types of securities of subsidiaries (referred to as "service corporations") and to make loans to such subsidiaries and joint ventures in which such subsidiaries are participants in an aggregate amount not exceeding 2% of the association's assets, plus an additional 1% of assets if the amount over 2% is used for specified community or inner-city development purposes. In addition, federal regulations permit associations to make specified types of loans to such subsidiaries (other than special purpose finance subsidiaries) in which the association owns more than 10% of the stock, in an aggregate amount not exceeding 50% of the association's regulatory capital if the association's regulatory capital is in compliance with applicable regulations. A savings association that acquires a non-savings association subsidiary, or that elects to conduct a new activity within a subsidiary, must give the FDIC and the OTS at least 30 days advance written notice. The FDIC may, after consultation with the OTS, prohibit specified activities if it determines such activities pose a serious threat to the SAIF. Moreover, a savings association must deduct from capital, for purposes of meeting the core capital, tangible capital and risk-based capital requirements, its entire investment in and loans to a subsidiary engaged in activities not permissible for a national bank (other than exclusively agency activities for its customers or mortgage banking subsidiaries).
Lincoln Federal currently owns three subsidiaries, LF Service Corp. ("LF"), Citizens Loan and Service Corporation ("CLSC") and LF Portfolio ("Portfolio"). LF's assets consist of an investment in Family Financial Life Insurance Company ("Family Financial") and in BHA. See "- Investments in Low- and Moderate-Income Housing Projects." LF received regulatory approval in February 1998 to invest in Family Financial, an Indiana stock insurance company. In May 1998, LF acquired a 16.7% interest in Family Financial for $650,000. Fifty percent of the common stock of Family Financial is held by Consortium Partners, a Louisiana general partnership.
Family Financial primarily engages in retail sales of mortgage and credit insurance products in connection with loans originated by Lincoln Federal's constituent shareholder financial institutions. Products offered by Family Financial include group and individual term mortgage life insurance, group mortgage disability insurance, group accidental death insurance, group credit life insurance, and group credit accident and disability insurance policies. Family Financial also markets a variety of tax-deferred annuity contracts which are wholly reinsured by other insurance companies. LF expects to receive (1) dividends paid on Family Financial shares owned directly by it, (2) a pro rata allocation of dividends received on shares held by Consortium Partners, which are divided among the partners based on the actuarially determined value of Family Financial's various lines of insurance generated by customers of these partners, and (3) commissions on sales of insurance products made to customers. For the period ended December 31, 2002, Lincoln Federal received dividends of $19,000 from Family Financial.
CLSC primarily engages in the purchase and development of tracts of undeveloped land. Because CLSC engages in activities that are not permissible for a national bank, OTS regulations prohibit Lincoln Federal from including its investment in CLSC in its calculation of regulatory capital. CLSC purchases undeveloped land, constructs improvements and infrastructure on the land, and then sells lots to builders, who construct homes for sale to home buyers. CLSC ordinarily receives payment when title is transferred.
CLSC owns a 104-acre tract of contiguous land on which it is presently developing 59 acres. The 59 acres that are presently being developed includes 64 building lots known as the Southridge Addition, and 89 building lots known as the Meadow Brook Addition. Both of these Additions have been annexed into the Town of Frankfort, Indiana. Phase I of the development includes 33 completed lots in the Southridge Addition, of which 27 lots have been sold and on which 27 houses have either been completed or are under construction, and 26 lots in the Meadow Brook Addition, of which 19 lots have been sold and on which 19 houses have either been completed or are under construction. The Southridge lots have been priced generally from $19,000 to $23,000 each, with completed homes selling generally from $90,000 to $120,000, and the Meadow Brook lots have been priced generally from $22,000 to $27,000 with completed homes expected to sell generally from $100,000 to $150,000. CLSC has delayed plans to complete the development of the remaining 31 lots in the Southridge Addition at this time. Phase II and Phase III of the Meadow Brook development, consisting of approximately 63 lots, are still in the design stage.
CLSC also owns a 20-acre parcel of land, known as the Mann tract, and a 25-acre parcel known as the Chalfie tract. The development of this land, which is part of the 104-acre tract discussed above, is not currently under consideration. The Mann tract is presently being leased for farming purposes. CLSC has no present intentions to acquire additional land for development purposes.
CLSC incurred a loss of $11,000 for the year ended December 31, 2002. CLSC incurred a loss of $28,000 for 2001 and a loss of $1,000 for 2000. At December 31, 2002, Lincoln had an investment in CLSC of $677,000 and loans outstanding to CLSC of approximately $105,000 with an interest rate set at the prime rate. The Holding Company's consolidated statements of income included elsewhere herein include the operations of CLSC. All intercompany balances and transactions have been eliminated in the consolidation.
Portfolio is a Delaware corporation domiciled in Nevada. Portfolio holds and manages a significant portion of Lincoln Federal's investment portfolio. As of December 31, 2002, Portfolio had investments available for sale and interest-bearing deposits of $105.8 million, total assets of $106.6 million, and during the fiscal year ended December 31, 2002, had net income of $1.2 million.
Employees
As of December 31, 2002, the Company employed 116 persons on a full-time basis and 14 on a part-time basis. None of the Company's employees are represented by a collective bargaining group and management considers employee relations to be good.
Employee benefits for the Company's full-time employees include, among other things, an employee stock ownership plan, a Pentegra Group (formerly known as Financial Institutions Retirement Fund) defined benefit pension plan, which is a noncontributory, multiple-employer comprehensive pension plan (the"Pension Plan"), and hospitalization/major medical insurance, long-term disability insurance, life insurance, and participation in the Lincoln Federal 401(k) Plan, which is administered by Pentegra Group.
The Company considers its employee benefits to be competitive with those offered by other financial institutions and major employers in its area. See "Executive Compensation and Related Transactions of Lincoln Federal."
COMPETITION
Lincoln Federal originates most of its loans to and accepts most of its deposits from residents of Hendricks, Montgomery, Clinton, Johnson and Morgan Counties, Indiana. Lincoln Federal is subject to competition from various financial institutions, including state and national banks, state and federal savings associations, credit unions, and certain nonbanking consumer lenders that provide similar services in those counties with significantly larger resources than are available to Lincoln Federal. Lincoln Federal also competes with money market funds with respect to deposit accounts and with insurance companies with respect to individual retirement accounts.
The primary factors influencing competition for deposits are interest rates, service and convenience of office locations. Lincoln Federal competes for loan originations primarily through the efficiency and quality of the services that it provides borrowers and through interest rates and loan fees charged. Competition is affected by, among other things, the general availability of lendable funds, general and local economic conditions, current interest rate levels, and other factors that management cannot readily predict.
REGULATION
General
As a federally chartered, SAIF-insured savings association, Lincoln Federal is subject to extensive regulation by the OTS and the FDIC. For example, Lincoln Federal must obtain OTS approval before it may engage in certain activities and must file reports with the OTS regarding its activities and financial condition. The OTS periodically examines Lincoln Federal's books and records and, in conjunction with the FDIC in certain situations, has examination and enforcement powers. This supervision and regulation are intended primarily for the protection of depositors and federal deposit insurance funds. A savings association must pay a semi-annual assessment to the OTS based upon a marginal assessment rate that decreases as the asset size of the savings association increases, and which includes a fixed-cost component that is assessed on all savings associations. The assessment rate that applies to a savings association depends upon the institution's size, condition, and the complexity of its operations. During 2002, Lincoln Federal's latest semi-annual assessment was $54,000.
Lincoln Federal is also subject to federal and state regulation as to such matters as loans to officers, directors, or principal shareholders, required reserves, limitations as to the nature and amount of its loans and investments, regulatory approval of any merger or consolidation, issuances or retirements of Lincoln Federal's securities, and limitations upon other aspects of banking operations. In addition, Lincoln Federal's activities and operations are subject to a number of additional detailed, complex and sometimes overlapping federal and state laws and regulations. These include state usury and consumer credit laws, state laws relating to fiduciaries, the Federal Truth-In-Lending Act and Regulation Z, the Federal Equal Credit Opportunity Act and Regulation B, the Fair Credit Reporting Act, the Community Reinvestment Act, anti-redlining legislation, antitrust laws and regulations protecting the confidentiality of consumer financial information.
Savings and Loan Holding Company Regulation
The Holding Company is regulated as a "non-diversified savings and loan holding company" within the meaning of the Home Owners' Loan Act, as amended (the "HOLA"), and subject to regulatory oversight of the Director of the OTS. As such, the Holding Company is registered with the OTS and is thereby subject to OTS regulations, examinations, supervision and reporting requirements. As a subsidiary of a savings and loan holding company, Lincoln Federal is subject to certain restrictions in its dealings with the Holding Company and with other companies affiliated with the Holding Company.
In general, the HOLA prohibits a savings and loan holding company, without obtaining the prior approval of the Director of the OTS, from acquiring control of another savings association or savings and loan holding company or retaining more than 5% of the voting shares of a savings association or of another holding company which is not a subsidiary. The HOLA also restricts the ability of a director or officer of the Holding Company, or any person who owns more than 25% of the Holding Company's stock, from acquiring control of another savings association or savings and loan holding company without obtaining the prior approval of the Director of the OTS.
The Holding Company currently operates as a unitary savings and loan holding company. Prior to the enactment of the Gramm-Leach-Bliley Act (the "GLB Act") in November of 1999, there were no restrictions on the permissible business activities of a unitary savings and loan holding company. The GLB Act included a provision that prohibits any new unitary savings and loan holding company, defined as a company that acquires a thrift after May 4, 1999, from engaging in commercial activities. This provision also includes a grandfather clause, however, that permits a company that was a savings and loan holding company as of May 4, 1999, or had an application to become a savings and loan holding company on file with the OTS as of that date, to acquire and continue to control a thrift and to continue to engage in commercial activities. Because the Holding Company qualifies under this grandfather provision, the GLB Act did not affect the Holding Company's authority to engage in diversified business activities.
Notwithstanding the above rules as to permissible business activities of unitary savings and loan holding companies, if the savings association subsidiary of such a holding company fails to meet the Qualified Thrift Lender ("QTL") test, then such unitary holding company would be deemed to be a bank holding company subject to all of the provisions of the Bank Holding Company Act of 1956 and other statutes applicable to bank holding companies, to the same extent as if the Holding Company were a bank holding company and Lincoln Federal were a bank. See "-Qualified Thrift Lender." At December 31, 2002, Lincoln Federal's asset composition was in excess of that required to qualify as a Qualified Thrift Lender.
If the Holding Company were to acquire control of another savings association other than through a merger or other business combination with Lincoln Federal, the Holding Company would thereupon become a multiple savings and loan holding company. Except where such acquisition is pursuant to the authority to approve emergency thrift acquisitions and where each subsidiary savings association meets the QTL test, the activities of the Holding Company and any of Lincoln Federal's subsidiaries (other than Lincoln Federal or other subsidiary savings associations) would thereafter be subject to further restrictions. The HOLA provides that, among other things, no multiple savings and loan holding company or subsidiary thereof which is not a savings association shall commence or continue for a limited period of time after becoming a multiple savings and loan holding company or subsidiary thereof, any business activity other than (i) furnishing or performing management services for a subsidiary savings association, (ii) conducting an insurance agency or escrow business, (iii) holding, managing, or liquidating assets owned by or acquired from a subsidiary savings association, (iv) holding or managing properties used or occupied by a subsidiary savings association, (v) acting as trustee under deeds of trust, (vi) those activities in which multiple savings and loan holding companies were authorized (by regulation) to directly engage on March 5, 1987, or (vii) those activities authorized by the Federal Reserve Board (the "FRB") as permissible for bank holding companies, unless the Director of the OTS by regulation prohibits or limits such activities for savings and loan holding companies. Those activities described in (vii) above must also be approved by the Director of the OTS before a multiple savings and loan holding company may engage in such activities.
The Director of the OTS may also approve acquisitions resulting in the formation of a multiple savings and loan holding company which controls savings associations in more than one state, if the multiple savings and loan holding company involved controls a savings association which operated a home or branch office in the state of the association to be acquired as of March 5, 1987, or if the laws of the state in which the association to be acquired is located specifically permit associations to be acquired by state-chartered associations or savings and loan holding companies located in the state where the acquiring entity is located (or by a holding company that controls such state-chartered savings associations). Also, the Director of the OTS may approve an acquisition resulting in a multiple savings and loan holding company controlling savings associations in more than one state in the case of certain emergency thrift acquisitions.
Indiana law permits federal and state savings association holding companies with their home offices located outside of Indiana to acquire savings associations whose home offices are located in Indiana and savings association holding companies with their principal place of business in Indiana ("Indiana Savings Association Holding Companies") upon receipt of approval by the Indiana Department of Financial Institutions. Moreover, Indiana Savings Association Holding Companies may acquire savings associations with their home offices located outside of Indiana and savings association holding companies with their principal place of business located outside of Indiana upon receipt of approval by the Indiana Department of Financial Institutions.
No subsidiary savings association of a savings and loan holding company may declare or pay a dividend or make a capital distribution on its permanent or nonwithdrawable stock unless it first gives the Director of the OTS 30 days advance notice of such declaration and payment. Any dividend declared during such period or without giving notice shall be invalid.
Federal Home Loan Bank System
Lincoln Federal is a member of the FHLB system, which consists of 12 regional banks. The Federal Housing Finance Board ("FHFB"), an independent agency, controls the FHLB System including the FHLB of Indianapolis. The FHLB System provides a central credit facility primarily for member financial institutions. At December 31, 2002, Lincoln Federal's investment in stock of the FHLB of Indianapolis was $8.2 million. For the fiscal year ended December 31, 2002, the FHLB of Indianapolis paid approximately $490,000 in dividends to Lincoln Federal.
All 12 FHLB's are required to provide funds to establish affordable housing programs through direct loans or interest subsidies on advances to members to be used for lending at subsidized interest rates for low- and moderate-income, owner-occupied housing projects, affordable rental housing, and certain other community projects. These contributions and obligations could adversely affect the value of FHLB stock in the future. A reduction in the value of such stock may result in a corresponding reduction in Lincoln Federal's capital.
The FHLB of Indianapolis serves as a reserve or central bank for its member institutions. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes advances to members in accordance with policies and procedures established by the FHLB and the Board of Directors of the FHLB of Indianapolis.
All FHLB advances must be fully secured by sufficient collateral as determined by the FHLB. Eligible collateral includes first mortgage loans not more than 90 days delinquent or securities evidencing interests therein, securities (including mortgage-backed securities) issued, insured or guaranteed by the federal government or any agency thereof, cash or FHLB deposits, certain small business and agricultural loans of smaller institutions and real estate with readily ascertainable value in which a perfected security interest may be obtained. Other forms of collateral may be accepted as additional security or, under certain circumstances, to renew outstanding advances. All long-term advances are required to provide funds for residential home financing and the FHLB has established standards of community service that members must meet to maintain access to long-term advances.
Interest rates charged for advances vary depending upon maturity, the cost of funds to the FHLB of Indianapolis and the purpose of the borrowing.
Insurance of Deposits
Deposit Insurance. The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of banks and thrifts and safeguards the safety and soundness of the banking and thrift industries. The FDIC administers two separate insurance funds, the BIF for commercial banks and state savings banks and the SAIF for savings associations such as Lincoln Federal and banks that have acquired deposits from savings associations. The FDIC is required to maintain designated levels of reserves in each fund.
Assessments. The FDIC is authorized to establish separate annual assessment rates for deposit insurance for members of the BIF and members of the SAIF. The FDIC may increase assessment rates for either fund if necessary to restore the fund's ratio of reserves to insured deposits to the target level within a reasonable time and may decrease these rates if the target level has been met. The FDIC has established a risk-based assessment system for both SAIF and BIF members. Under this system, assessments vary depending on the risk the institution poses to its deposit insurance fund. An institution's risk level is determined based on its capital level and the FDIC's level of supervisory concern about the institution.
In addition to the assessment for deposit insurance, savings institutions are required to pay on bonds issued in the late 1980s by the Financing Corporation ("FICO"), which is a federally-chartered corporation that was organized to provide some of the financing to resolve the thrift crisis in the 1980s. During 1998, FICO payments for SAIF members approximated 6.10 basis points, while BIF members paid 1.22 basis points. By law, payments on FICO obligations have been shared equally between BIF members and SAIF members since January 1, 2000. Legislation is pending before Congress that would increase the deposit insurance assessments paid by all financial institutions, including Lincoln Federal.
Although Congress has considered merging the SAIF and the BIF, until then, savings associations with SAIF deposits may not transfer deposits into the BIF system without paying various exit and entrance fees. Such exit and entrance fees need not be paid if a SAIF institution converts to a bank charter or merges with a bank, as long as the resulting bank continues to pay applicable insurance assessments to the SAIF, and as long as certain other conditions are met.
Savings Association Regulatory Capital
Currently, savings associations are subject to three separate minimum capital-to-assets requirements: (i) a leverage limit, (ii) a tangible capital requirement, and (iii) a risk-based capital requirement. The leverage limit requires that savings associations maintain "core capital" of at least 3% of total assets. Core capital is generally defined as common shareholders' equity (including retained income), noncumulative perpetual preferred stock and related surplus, certain minority equity interests in subsidiaries, qualifying supervisory goodwill, purchased mortgage servicing rights and purchased credit card relationships (subject to certain limits) less nonqualifying intangibles. The OTS requires a core capital level of 3% of total adjusted assets for savings associations that receive the highest rating for safety and soundness, and 4% to 5% for all other savings associations. Under the tangible capital requirement, a savings association must maintain tangible capital (core capital less all intangible assets except purchased mortgage servicing rights which may be included after making the above-noted adjustment in an amount up to 100% of tangible capital) of at least 1.5% of total assets. Under the risk-based capital requirements, a minimum amount of capital must be maintained by a savings association to account for the relative risks inherent in the type and amount of assets held by the savings association. The risk-based capital requirement requires a savings association to maintain capital (defined generally for these purposes as core capital plus general valuation allowances and permanent or maturing capital instruments such as preferred stock and subordinated debt, less assets required to be deducted) equal to 8.0% of risk-weighted assets. Assets are ranked as to risk in one of four categories (0-100%). A credit risk-free asset, such as cash, requires no risk-based capital, while an asset with a significant credit risk, such as a non-accrual loan, requires a risk factor of 100%. Moreover, a savings association must deduct from capital, for purposes of meeting the core capital, tangible capital and risk-based capital requirements, its entire investment in and loans to a subsidiary engaged in activities not permissible for a national bank (other than exclusively agency activities for its customers or mortgage banking subsidiaries). At December 31, 2002, Lincoln Federal was in compliance with all capital requirements imposed by law.
The OTS issued a final rule in 1993 which set forth a methodology for calculating an interest rate risk component to be used by savings associations in calculating regulatory capital. The OTS has delayed the implementation of this rule, however, and in 2002 deleted this interest rate risk component from capital requirements applicable to savings associations. The OTS has also revised its standards regarding the management of interest rate risk to include summary guidelines to assist savings associations in determining their exposures to interest rate risk. If an association is not in compliance with the capital requirements, the OTS is required to prohibit asset growth and to impose a capital directive that may restrict, among other things, the payment of dividends and officers' compensation. In addition, the OTS and the FDIC generally are authorized to take enforcement actions against a savings association that fails to meet its capital requirements. These actions may include restricting the operating activities of the association, imposing a capital directive, cease and desist order, or civil money penalties, or imposing harsher measures such as appointing a receiver or conservator or forcing the association to merge into another institution.
Prompt Corrective Regulatory Action
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FedICIA") requires, among other things, that federal bank regulatory authorities take "prompt corrective action" with respect to institutions that do not meet minimum capital requirements. For these purposes, FedICIA establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At December 31, 2002, Lincoln Federal was categorized as "well capitalized," meaning that its total risk-based capital ratio exceeded 10%, its Tier I risk-based capital ratio exceeded 6%, its leverage ratio exceeded 5%, and it was not subject to a regulatory order, agreement or directive to meet and maintain a specific capital level for any capital measure.
The FDIC may order savings associations which have insufficient capital to take corrective actions. For example, a savings association which is categorized as "undercapitalized" would be subject to growth limitations and would be required to submit a capital restoration plan, and a holding company that controls such a savings association would be required to guarantee that the savings association complies with the restoration plan. "Significantly undercapitalized" savings associations would be subject to additional restrictions. Savings associations deemed by the FDIC to be "critically undercapitalized" would be subject to the appointment of a receiver or conservator.
Dividend Limitations
The OTS also restricts the amount of "capital distributions" that may be made by savings associations. The regulation defines a capital distribution as a distribution of cash or other property to a savings association's owners, made on account of their ownership. This definition includes a savings association's payment of cash dividends to shareholders, or any payment by a savings association to repurchase, redeem, retire, or otherwise acquire any of its shares or debt instruments that are included in total capital, and any extension of credit to finance an affiliate's acquisition of those shares or interests. The amended regulation does not apply to dividends consisting only of a savings association's shares or rights to purchase such shares.
The regulation exempts certain savings associations from filing either a notice or an application with the OTS before making any capital distribution and requires a savings association to file an application for approval of a proposed capital distribution with the OTS if the association is not eligible for expedited treatment under OTS's application processing rules, or the total amount of all capital distributions, including the proposed capital distribution, for the applicable calendar year would exceed an amount equal to the savings association's net income for that year to date plus the savings association's retained net income for the preceding two years (the "retained net income standard"). Based on Lincoln Federal's retained net income standard at December 31, 2002, Lincoln Federal would be required to file an application with the OTS before making any capital distributions. A savings association must also file an application for approval of a proposed capital distribution if, following the proposed distribution, the association would not be at least adequately capitalized under the OTS prompt corrective action regulations, or if the proposed distribution would violate a prohibition contained in any applicable statute, regulation, or agreement between the association and the OTS or the FDIC.
The regulation requires a savings association to file a notice of a proposed capital distribution in lieu of an application if the association or the proposed capital distribution do not meet the conditions described above, and: (1) the savings association will not be at least well capitalized (as defined under the OTS prompt corrective action regulations) following the capital distribution; (2) the capital distribution would reduce the amount of, or retire any part of the savings association's common or preferred stock, or retire any part of debt instruments such as notes or debentures included in the association's capital under the OTS capital regulation; or (3) the savings association is a subsidiary of a savings and loan holding company. Because Lincoln Federal is a subsidiary of a savings and loan holding company, this latter provision requires, at a minimum, that Lincoln Federal file a notice with the OTS 30 days before making any capital distributions to the Holding Company.
In addition to these regulatory restrictions, Lincoln Federal's Plan of Conversion imposes additional limitations on the amount of capital distributions it may make to the Holding Company. The Plan of Conversion requires Lincoln Federal to establish and maintain a liquidation account for the benefit of Eligible Account Holders and Supplemental Eligible Account Holders and prohibits Lincoln Federal from making capital distributions to the Holding Company if its net worth would be reduced below the amount required for the liquidation account.
Limitations on Rates Paid for Deposits
Regulations promulgated by the FDIC pursuant to FedICIA place limitations on the ability of insured depository institutions to accept, renew or roll over deposits by offering rates of interest which are significantly higher than the prevailing rates of interest on deposits offered by other insured depository institutions having the same type of charter in the institution's normal market area. Under these regulations, "well-capitalized" depository institutions may accept, renew or roll such deposits over without restriction, "adequately capitalized" depository institutions may accept, renew or roll such deposits over with a waiver from the FDIC (subject to certain restrictions on payments of rates) and "undercapitalized" depository institutions may not accept, renew or roll such deposits over. The regulations contemplate that the definitions of "well-capitalized," "adequately-capitalized" and "undercapitalized" will be the same as the definition adopted by the agencies to implement the corrective action provisions of FedICIA. Management does not believe that these regulations will have a materially adverse effect on Lincoln Federal's current operations.
Liquidity
The Financial Regulatory Relief and Economic Efficiency Act of 2000 repealed the former statutory requirement that all savings associations maintain an average daily balance of liquid assets in a minimum amount of not less than 4% or more than 10% of their withdrawable accounts plus short-term borrowings. The OTS adopted an interim final rule in March 2001 that implemented this revised statutory requirement, although savings associations remain subject to the OTS regulation that requires them to maintain sufficient liquidity to ensure their safe and sound operation.
Safety and Soundness Standards
The federal banking agencies have adopted final safety and soundness standards for all insured depository institutions. The standards, which were issued in the form of guidelines rather than regulations, relate to internal controls, information systems, internal audit systems, loan underwriting and documentation, compensation, interest rate exposure, asset quality and earnings standards. In general, the standards are designed to assist the federal banking agencies in identifying and addressing problems at insured depository institutions before capital becomes impaired. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan. Failure to submit a compliance plan may result in enforcement proceedings.
Real Estate Lending Standards
OTS regulations require savings associations to establish and maintain written internal real estate lending policies. Each association's lending policies must be consistent with safe and sound banking practices and be appropriate to the size of the association and the nature and scope of its operations. The policies must establish loan portfolio diversification standards; establish prudent underwriting standards, including loan-to-value limits, that are clear and measurable; establish loan administration procedures for the association's real estate portfolio; and establish documentation, approval, and reporting requirements to monitor compliance with the association's real estate lending policies. The association's written real estate lending policies must be reviewed and approved by the association's Board of Directors at least annually. Further, each association is expected to monitor conditions in its real estate market to ensure that its lending policies continue to be appropriate for current market conditions.
Loans to One Borrower
Under OTS regulations, Lincoln Federal may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. Additional amounts may be lent, not in excess of 10% of unimpaired capital and surplus, if such loans or extensions of credit are fully secured by readily marketable collateral, including certain debt and equity securities but not including real estate. In some cases, a savings association may lend up to 30% of unimpaired capital and surplus to one borrower for purposes of developing domestic residential housing, provided that the association meets its regulatory capital requirements and the OTS authorizes the association to use this expanded lending authority. Lincoln Federal has established an "in-house" lending limit of $3 million to a single or related group of borrowers, which is significantly lower than the regulatory lending limit described above. Any loan that exceeds this "in-house" lending limit up to the regulatory lending limit must first be approved by Lincoln Federal's board of directors. Lincoln Federal did not have any loans or extensions of credit to a single or related group of borrowers in excess of its regulatory lending limits at December 31, 2002. Management does not believe that the loans-to-one-borrower limits will have a significant impact on Lincoln Federal's business operations or earnings.
Qualified Thrift Lender
Savings associations must meet a QTL test that requires the association to maintain an appropriate level of qualified thrift investments ("QTIs") (primarily residential mortgages and related investments, including certain mortgage-related securities) and otherwise to qualify as a QTL. The required percentage of QTIs is 65% of portfolio assets (defined as all assets minus intangible assets, property used by the association in conducting its business and liquid assets equal to 10% of total assets). Certain assets are subject to a percentage limitation of 20% of portfolio assets. In addition, savings associations may include shares of stock of the FHLBs, FNMA, and FHLMC as QTIs. Compliance with the QTL test is determined on a monthly basis in nine out of every twelve months. As of December 31, 2002, Lincoln Federal was in compliance with its QTL requirement, with approximately 71.9% of its assets invested in QTIs.
A savings association which fails to meet the QTL test must either convert to a bank (but its deposit insurance assessments and payments will be those of and paid to the SAIF) or be subject to the following penalties: (i) it may not enter into any new activity except for those permissible for a national bank and for a savings association; (ii) its branching activities shall be limited to those of a national bank; and (iii) it shall be bound by regulations applicable to national banks respecting payment of dividends. Three years after failing the QTL test the association must dispose of any investment or activity not permissible for a national bank and a savings association. If such a savings association is controlled by a savings and loan holding company, then such holding company must, within a prescribed time period, become registered as a bank holding company and become subject to all rules and regulations applicable to bank holding companies (including restrictions as to the scope of permissible business activities).
Acquisitions or Dispositions and Branching
The Bank Holding Company Act specifically authorizes a bank holding company, upon receipt of appropriate regulatory approvals, to acquire control of any savings association or holding company thereof wherever located. Similarly, a savings and loan holding company may acquire control of a bank. Moreover, federal savings associations may acquire or be acquired by any insured depository institution. Regulations promulgated by the FRB restrict the branching authority of savings associations acquired by bank holding companies. Savings associations acquired by bank holding companies may be converted to banks if they continue to pay SAIF premiums, but as such they become subject to branching and activity restrictions applicable to banks.
Subject to certain exceptions, commonly-controlled banks and savings associations must reimburse the FDIC for any losses suffered in connection with a failed bank or savings association affiliate. Institutions are commonly controlled if one is owned by another or if both are owned by the same holding company. Such claims by the FDIC under this provision are subordinate to claims of depositors, secured creditors, and holders of subordinated debt, other than affiliates.
The OTS has adopted regulations which permit nationwide branching to the extent permitted by federal statute. Federal statutes permit federal savings associations to branch outside of their home state if the association meets the domestic building and loan test in ss. 7701(a)(19) of the Code or the asset composition test of ss. 7701(c) of the Code. Branching that would result in the formation of a multiple savings and loan holding company controlling savings associations in more than one state is permitted if the law of the state in which the savings association to be acquired is located specifically authorizes acquisitions of its state-chartered associations by state-chartered associations or their holding companies in the state where the acquiring association or holding company is located. Moreover, Indiana banks and savings associations are permitted to acquire other Indiana banks and savings associations and to establish branches throughout Indiana.
Finally, The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act") permits bank holding companies to acquire banks in other states and, with state consent and subject to certain limitations, allows banks to acquire out-of-state branches either through merger or de novo expansion. The State of Indiana enacted legislation establishing interstate branching provisions for Indiana state-chartered banks consistent with those established by the Riegle-Neal Act (the "Indiana Branching Law"). The Indiana Branching Law, which became effective in 1996, authorizes Indiana banks to branch interstate by merger or de novo expansion, provided that such transactions are not permitted to out-of-state banks unless the laws of their home states permit Indiana banks to merge or establish de novo banks on a reciprocal basis.
Transactions with Affiliates
Lincoln Federal is subject to Sections 22(h), 23A and 23B of the Federal Reserve Act, which limits credit transactions between a bank or savings association and its executive officers and its affiliates. These provisions also prescribe terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices, and restrict the types of collateral security permitted in connection with a bank's extension of credit to an affiliate.
Federal Securities Law
The shares of Common Stock of the Holding Company have been registered with the SEC under the 1934 Act and, as a result, the Holding Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the 1934 Act and the rules of the SEC thereunder. After three years following Lincoln Federal's conversion to stock form, if the Holding Company has fewer than 300 shareholders, it may deregister its shares under the 1934 Act and cease to be subject to the foregoing requirements.
Shares of Common Stock held by persons who are affiliates of the Holding Company may not be resold without registration unless sold in accordance with the resale restrictions of Rule 144 under the 1933 Act. If the Holding Company meets the current public information requirements under Rule 144, each affiliate of the Holding Company who complies with the other conditions of Rule 144 (including those that require the affiliate's sale to be aggregated with those of certain other persons) would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of (i) 1% of the outstanding shares of the Holding Company or (ii) the average weekly volume of trading in such shares during the preceding four calendar weeks.
Sarbanes-Oxley Act of 2002
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"). The Sarbanes-Oxley Act represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. The Sarbanes-Oxley Act is applicable to all companies with equity or debt securities registered under the Securities Exchange Act of 1934. In particular, the Sarbanes-Oxley Act establishes: (i) new requirements for audit committees, including independence, expertise, and responsibilities; (ii) additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company; (iii) new standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for the reporting company and their directors and executive officers; and (v) new and increased civil and criminal penalties for violation of the securities laws. Many of the provisions became effective immediately while other provisions become effective over a period of 30 to 270 days and are subject to rulemaking by the Securities and Exchange Commission. Although the Holding Company anticipates that additional expense will be incurred to comply with the provisions of the Sarbanes-Oxley Act and the resulting regulations, management does not expect that such compliance will have a material impact on our results of operations or financial condition.
Community Reinvestment Act Matters
Federal law requires that ratings of depository institutions under the Community Reinvestment Act of 1977 ("CRA") be disclosed. The disclosure includes both a four-unit descriptive rating -- outstanding, satisfactory, needs to improve, and substantial noncompliance -- and a written evaluation of an institution's performance. Each FHLB is required to establish standards of community investment or service that its members must maintain for continued access to long-term advances from the FHLBs. The standards take into account a member's performance under the CRA and its record of lending to first-time home buyers. The OTS has designated Lincoln Federal's record of meeting community credit needs as satisfactory.
Predatory Lending
The Federal Reserve Board issued a regulation that became effective on October 1, 2002 that is aimed at curbing "predatory lending." The term "predatory lending" encompasses a variety of practices, but the term generally is used to refer to abusive lending practices involving fraud, deception or unfairness. Predatory lending typically involves one or more of the following: (i) making unaffordable loans based on the assets of the borrower rather than on the borrower's ability to repay an obligation ("asset-based lending"); (ii) inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced ("loan flipping"); or (iii) engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated borrower. The Federal Reserve Board's new regulation, which amends Regulation Z, broadens the scope of loans subject to the protections of the Home Ownership and Equity Protection Act of 1994 ("HOEPA"). Among other things, the regulation brings within the scope of HOEPA first-lien mortgage loans with interest rates that are at least 8 percentage points above Treasury securities having a comparable maturity. In addition, the regulation requires that the cost of optional insurance and similar debt protection products paid by a borrower at closing be included in calculating the finance charge paid by the borrower. HOEPA coverage is triggered if such finance charges exceed 8 percent of the total loan. Finally, the regulation restricts creditors from engaging in repeated refinancings of their own HOEPA loans over a short time period when the transactions are not in the borrower's interest. Lenders that violate the rules face cancellation of loans and penalties equal to the finance charges paid. The Association is unable at this time to determine the impact that these new regulations, or any similar state predatory lending regulations, may have on its financial condition or results of operation.
USA Patriot Act of 2001
On October 26, 2001, President Bush signed the USA Patriot Act of 2001. The Patriot Act is intended is to strengthen U.S. law enforcement's and the intelligence communities' abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Act on financial institutions of all kinds is significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency laws. On July 23, 2002, the Treasury Department proposed regulations requiring institutions to incorporate into their written money laundering plans a board-approved customer identification program implementing reasonable procedures for: (i) verifying the identity of any person seeking to open an account, to the extent reasonable and practicable; (ii) maintaining records of the information used to verify the person's identity; and (iii) determining whether the person appears on any list of known or suspected terrorists or terrorist organizations. The Association does not anticipate that these requirements will materially affect its operations.
TAXATION
Federal Taxation
Historically, savings associations, such as Lincoln Federal, have been permitted to compute bad debt deductions using either the bank experience method or the percentage of taxable income method. However, for years beginning after December 31, 1995, no savings association may use the percentage of taxable income method of computing its allowable bad debt deduction for tax purposes. Instead, all savings associations are required to compute their allowable deduction using the experience method. As a result of the repeal of the percentage of taxable income method, reserves taken after 1987 using the percentage of taxable income method generally must be included in future taxable income over a six-year period, although a two-year delay may be permitted for associations meeting a residential mortgage loan origination test. Lincoln Federal does not have any reserves taken after 1987 that must be recaptured. In addition, the pre-1988 reserve, for which no deferred taxes have been recorded, need not be recaptured into income unless (i) the savings association no longer qualifies as a bank under the Code, or (ii) the savings association pays out excess dividends or distributions. Although Lincoln Federal does have some reserves from before 1988, Lincoln Federal is not required to recapture these reserves.
Depending on the composition of its items of income and expense, a savings association may be subject to the alternative minimum tax. A savings association must pay an alternative minimum tax on the amount (if any) by which 20% of alternative minimum taxable income ("AMTI"), as reduced by an exemption varying with AMTI, exceeds the regular tax due. AMTI equals regular taxable income increased or decreased by certain tax preferences and adjustments, including depreciation deductions in excess of that allowable for alternative minimum tax purposes, tax-exempt interest on most private activity bonds issued after August 7, 1986 (reduced by any related interest expense disallowed for regular tax purposes), the amount of the bad debt reserve deduction claimed in excess of the deduction based on the experience method and 75% of the excess of adjusted current earnings over AMTI (before this adjustment and before any alternative tax net operating loss). AMTI may be reduced only up to 90% by net operating loss carryovers, but alternative minimum tax paid can be credited against regular tax due in later years.
For federal income tax purposes, Lincoln Federal has been reporting its income and expenses on the accrual method of accounting. Lincoln Federal's federal income tax returns were audited in 2000 and no adjustments were made.
State Taxation
Lincoln Federal is subject to Indiana's Financial Institutions Tax ("FIT"), which is imposed at a flat rate of 8.5% on "apportioned adjusted gross income." "Apportioned adjusted gross income," for purposes of FIT, begins with taxable income as defined by Section 63 of the Code and, thus, incorporates federal tax law to the extent that it affects the computation of taxable income. Federal taxable income is then adjusted by several Indiana modifications. Other applicable state taxes include generally applicable sales and use taxes plus real and personal property taxes.
Lincoln Federal's state income tax returns have not been audited in recent years.
Item 2.
Item 2. Properties. - ------- -----------
The following table provides certain information with respect to Lincoln Federal's offices as of December 31, 2002:
Lincoln Federal owns computer and data processing equipment which it uses for transaction processing, loan origination, and accounting. The net book value of Lincoln Federal's electronic data processing equipment was approximately $337,000 at December 31, 2002.
Lincoln Federal currently operates nine automatic teller machines ("ATMs"), with one ATM located at its main office and each of its branch offices. Lincoln Federal's ATMs participate in the Star(R) network.
Lincoln Federal has also contracted for the data processing and reporting services of Aurum Technologies, located in Plano, Texas. The cost of these data processing services is approximately $65,000 per month.
Lincoln Federal has contracted for items processing with DCM, Inc. The cost of these processing services is approximately $12,000 per month.
Item 3.
Item 3. Legal Proceedings. - ------- ------------------
Although the Holding Company and Lincoln Federal are involved, from time to time, in various legal proceedings in the normal course of business, there are no material legal proceedings to which they presently are a party or to which any of the Holding Company's or Lincoln Federal's property is subject.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders. - ------- ----------------------------------------------------
No matter was submitted to a vote of the Company's shareholders during the quarter ended December 31, 2002.
Item 4.5. Executive Officers of the Registrant. - --------- -------------------------------------
The executive officers of the Holding Company are identified below. The executive officers are elected annually by the Holding Company's Board of Directors and the Bank's Board of Directors.
T. Tim Unger (age 62) has been Chairman of the Board, President and Chief Executive Officer of the Holding Company since December 1998. Mr. Unger also serves as the President and Chief Executive Officer of the Bank since January 1996. Before joining the Company, Mr. Unger served as President and Chief Executive Officer of Summit Bank of Clinton County from 1989 through 1995. Mr. Unger has served the banking industry since 1966.
John M. Baer (age 54) has served as the Holding Company's Secretary and Treasurer since December 1998 and as Lincoln Federal's Senior Vice President, Chief Financial Officer, Secretary and Treasurer since June 1997. Before working for the Company, Mr. Baer served as Vice President and Chief Financial Officer of the Community Bank Group of Bank One in Indianapolis, Indiana from June 1996 through June 1997. From October 1989 through June 1996 he served as Senior Vice President and Chief Financial Officer of Bank One, Merrillville, NA, in Merrillville, Indiana. Mr. Baer has served the banking industry since 1978.
Paul S. Siebenmorgan (age 53) has served as the Holding Company's Vice President since January 2002 and as the Bank's Senior Vice President and Chief Lending Officer since May 2000. Prior to joining the Company, Mr. Siebenmorgan served as Executive Vice President of Lakeland Financial Corporation and Lake City Bank.
Rebecca J. Morgan (age 52) has served as the Holding Company's Vice President since January 2002 and as the Bank's Senior Vice president and Retail Sales Manager since June 1999. Prior to joining the Company, Ms. Morgan was Senior Vice President and a Retail Sales Manager for First of America Bank.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters. - ------- ----------------------------------------------------------------------
The information required by this item is contained in the material under the heading "Shareholder Information" on page 46 of the Holding Company's 2002 Shareholder Annual Report (the "Shareholder Annual Report"), which is incorporated herein by this reference.
Item 6.
Item 6. Selected Financial Data. - ------- ------------------------
The information required by this item is contained in the material under the heading "Selected Consolidated Financial Data of Lincoln Bancorp and Subsidiary" on pages 3 and 4 of the Shareholder Annual Report, which is incorporated herein by this reference.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results - ------- ------------------------------------------------------------------------ of Operation. - -------------
The information required by this item is contained on pages 4 through 19 of the Shareholder Annual Report, which is incorporated herein by this reference.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk - -------- ----------------------------------------------------------
The information required by this item is contained on pages 17 through 19 of the Shareholder Annual Report, which is incorporated herein by this reference.
Item 8.
Item 8. Financial Statements and Supplementary Data. - ------- --------------------------------------------
The Holding Company's Consolidated Financial Statements and Notes thereto contained on pages 20 through 44 in the Shareholder Annual Report are incorporated herein by reference. The Company's unaudited quarterly results of operations contained on page 17 in the Shareholder Annual Report are incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and - -------- ---------------------------------------------------------------------- Financial Disclosure. - ---------------------
Not applicable.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant. - -------- ---------------------------------------------------
The information required by this item with respect to directors is contained on pages 2 through 5 and page 13 of the Holding Company's Proxy Statement for its 2003 Annual Shareholder Meeting (the "2003 Proxy Statement"), which is incorporated herein by this reference. Information concerning the Holding Company's executive officers is included in Item 4.5 in Part I of this report.
Item 11.
Item 11. Executive Compensation. - -------- -----------------------
The information required by this item is contained on pages 6 through 12 of the 2003 Proxy Statement, which is incorporated herein by this reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management. - -------- ---------------------------------------------------------------
The information required by this item is contained on pages 1 through 4 of the 2003 Proxy Statement, which is incorporated herein by this reference.
The following table provides information, as of December 31, 2002, regarding the securities authorized for issuance under the Company's equity compensation plans.
Item 13.
Item 13. Certain Relationships and Related Transactions. - -------- -----------------------------------------------
The information required by this item is contained on page 10 of the 2003 Proxy Statement, which is incorporated herein by this reference.
Item 14.
Item 14. Controls and Procedures. - -------- ------------------------
Within the 90-day period prior to the filing date of this report, an evaluation was carried out under the supervision and with the participation of the Holding Company's management, including its Chief Executive Officer and the Holding Company's Treasurer, of the effectiveness of the Holding Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934). Based on their evaluation, the Holding Company's Chief Executive Officer and Treasurer have concluded that the Holding Company's disclosure controls and procedures are, to the best of their knowledge, effective to ensure that information required to be disclosed by the Holding Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Subsequent to the date of this evaluation, there were no significant changes in the Holding Company's internal controls or in other factors that could significantly affect its internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. - -------- -----------------------------------------------------------------
(a) List the following documents included in the financial statements filed as part of the report:
(b) Reports on Form 8-K.
The Holding Company filed no reports on Form 8-K during the quarter ended December 31, 2002.
(c) The exhibits filed herewith or incorporated by reference herein are set forth on the Exhibit Index on page E-1. Included in those exhibits is an executive compensation plan and arrangement which is identified as Exhibits 10(2), 10(3), 10(4), 10(7), 10(8), 10(11) and 10(12).
(d) All schedules are omitted as the required information either is not applicable or is included in the Consolidated Financial Statements or related notes.
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on behalf of the undersigned, thereto duly authorized.
LINCOLN BANCORP
Date: March 28, 2003 By: /s/ T. Tim Unger ------------------------------------ T. Tim Unger, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on this 28th day of March 2003.
Signatures Title Date ---------------------------------- ----------------------- --------------
(1) Principal Executive Officer: ) ) ) /s/ T. Tim Unger ) ---------------------------------- President and ) T. Tim Unger Chief Executive Officer ) ) ) ) (2) Principal Financial and Accounting ) Officer: ) ) /s/ John M. Baer ) ---------------------------------- Secretary and Treasurer ) John M. Baer ) March 28, 2003 ) ) ) (3) The Board of Directors: ) ) ) /s/ Lester N. Bergum, Jr. Director ) ---------------------------------- ) Lester N. Bergum, Jr. ) ) ) /s/ Dennis W. Dawes Director ) ---------------------------------- ) Dennis W. Dawes ) ) ) /s/ W. Thomas Harmon Director ) ---------------------------------- ) W. Thomas Harmon ) ) ) /s/ Jerry R. Holifield Director ) ---------------------------------- ) Jerry R. Holifield ) ) ) /s/ David E. Mansfield Director ) ---------------------------------- ) David E. Mansfield ) ) ) March 28, 2003 /s/ John C. Milholland Director ) ---------------------------------- ) John C. Milholland ) ) ) /s/ T. Tim Unger Director ) ---------------------------------- ) T. Tim Unger ) ) ) /s/ John L. Wyatt Director ) ---------------------------------- ) John L. Wyatt ) )
CERTIFICATION
I, T. Tim Unger, certify that:
1. I have reviewed this annual report on Form 10-K of Lincoln Bancorp;
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; and
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 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 officers 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 officers and I have indicated in this annual report whether 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 28, 2003 /s/ T. Tim Unger -------------------------------------------- T. Tim Unger President and Chief Executive Officer
CERTIFICATION
I, John M. Baer, certify that:
1. I have reviewed this annual report on Form 10-K of Lincoln Bancorp;
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; and
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 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 officers 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 officers and I have indicated in this annual report whether 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 28, 2003 /s/ John M. Baer -------------------------------------------- John M. Baer Secretary and Treasurer
CERTIFICATION
By signing below, each of the undersigned officers hereby certifies pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to his or her knowledge, (i) this report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and (ii) the information contained in this report fairly presents, in all material respects, the financial condition and results of operations of Lincoln Bancorp.
Signed this 28th day of March 2003.
/s/ John M. Baer /s/ T. Tim Unger - -------------------------------------- ---------------------------------------- John M. Baer T. Tim Unger Secretary and Treasurer President and Chief Executive Officer