ITEM 1. BUSINESS
INFORMATION REGARDING BANCSHARES
DESCRIPTION OF BUSINESS
First Decatur Bancshares, Inc. ("Bancshares") , a Delaware corporation, was organized on February 28, 1980 and is a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the "BHCA"). Bancshares owns all of the outstanding capital stock of the First National Bank of Decatur ("Decatur Bank"), FirsTech, Inc. ("FirsTech") and First Shelby Financial Group, Inc. ("First Shelby"). First Shelby owns all of the capital stock of the First Trust Bank of Shelbyville ("Shelby Bank"). The Decatur Bank, FirsTech, First Shelby and the Shelby Bank are referred to as the "Subsidiaries."
The principal activity of Bancshares is the ownership and management of the Subsidiaries. The Board of Directors of Bancshares establishes corporate policy, strategy and goals for Decatur Bank , Shelby Bank and FirsTech.
Substantially all of the income of Bancshares is derived from dividends received from its subsidiaries. The amount of dividends payable by the Decatur Bank and Shelby Bank are subject to certain regulatory restrictions. See "Supervision and Regulation."
At December 31, 1996, Bancshares had consolidated total assets of approximately $394.1 million and stockholders' equity of $48.5 million. Bancshares had consolidated total revenue of $35.2 million and net income of $4.5 million for the year ended December 31, 1996. Refer to Note 17 - "Business Industry Segments" of the Notes to the Consolidated Financial Statements for financial information relating to Bancshare's industry segments.
ACQUISITIONS AND MERGERS
On April 1, 1996, Bancshares completed the acquisition of First Shelby and its subsidiary bank, Shelby Bank. As a result of the transaction, First Shelby became a wholly owned subsidiary of Bancshares, and each share of First Shelby Common Stock outstanding immediately prior to the merger was converted into 45.68 shares of Bancshares Common Stock. Bancshares issued 695,852 shares of its common stock in exchange for all of the issued and outstanding shares of First Shelby. Cash of approximately $125,000 was paid to one First Shelby dissenting shareholder for 5,481 shares. No other cash, except for fractional shares, was paid in the transaction.
The pooling-of-interest method of accounting for business combinations was used to account for this transaction. Accordingly, the results of operations and financial position of Bancshares and First Shelby have been combined as if the combination had been in effect for all periods presented.
LOCAL MARKET AND ECONOMY
Decatur is the largest city in Macon County, Illinois and is a major manufacturing center in Central Illinois. Jobs in the manufacturing sector are divided among 10 major employers: Caterpillar, Archer Daniels Midland, Co., A. E. Staley Mfg. Co., Bridgestone/Firestone, Wagner Castings Co.,
Mueller Co., Zexel Illinois, Inc., PPG Industries Inc., Taylor Pharmacal Co., and A. W. Cash Valve. The largest employers of non-manufacturing sector jobs are the Decatur School District, two local hospitals, and Illinois Power Company.
Because a substantial number of employees work for companies that are under union labor contracts, labor discord and unrest have an impact on the local economy along with swings in the national economy which effect levels of employment. During the last three years, the three largest employers, Caterpillar, A. E. Staley Mfg. Co. and Bridgestone/Firestone have been in prolonged strikes. All three of these labor disputes are currently settled and the workers are in the process of going back to work or are taking early retirement if eligible. This labor unrest has not been as disruptive to the local economy as one might expect because most strikers continued to receive union strike benefits. In addition, many of the replacement and temporary workers were drawn from the local employment pool which maintained or increased the number of dollars flowing through the local economy.
With Caterpillar employment levels somewhat dependent on international sales and Bridgestone/Firestone and Wagner Castings Co. employment levels dependent on the production and sales to the U.S. automobile market, Bancshares' management carefully monitors what is happening in those particular industries. The agri-businesses of Archer Daniels Midland Co. and A. E. Staley Mfg. Co. are not effected by adverse conditions in any one segment of the economy to the extent that the other manufacturing industries are affected.
BANKING SUBSIDIARIES
The Decatur Bank is a national banking association located in Decatur, Illinois. It is operated as a community bank -- a locally-owned and operated financial institution that uses professional, highly motivated employees to provide individualized, quality services with personal, "hometown" attention. The Shelby Bank is an Illinois banking corporation located in Shelbyville, Illinois.
The Decatur Bank and the Shelby Bank offer a full range of financial services to commercial, industrial, and individual customers. These services include demand, savings and time deposit accounts and programs, including individual retirement accounts and interest and non-interest bearing checking accounts; commercial, consumer, agricultural and real estate lending, including installment loans and personal lines of credit; safe deposit and night depository services; farm management; and additional services tailored to the needs of individual customers. In addition, the Decatur Bank and the Shelby Bank offer an array of non-deposit investment products including mutual funds, annuities and discount brokerage. The Decatur Bank and the Shelby Bank also operate full service trust departments.
Principal sources of income are interest and fees on loans and investments, trust fees and service fees. Its principal expenses are interest paid on deposits and general operating expenses.
LENDING ACTIVITIES
The lending activities of Bancshares are separated into three lending areas: commercial/ agricultural, consumer and real estate. Loans are primarily originated by the lending officers at the Decatur Bank and the Shelby Bank. Loan applications that exceed the loan approval authority of the lending officers are sent to a Loan Committee. Each Bank has a Loan Committee. The Loan Committees review and approve loans up to the Bank's legal lending limit, monitor concentrations of
credit, problem and past due loans and charge-offs of uncollectible loans, and formulate recommendations regarding loan policy modifications, loan classifications and loan charge-offs. In addition, Bancshares maintains a separate loan review department. The loan review department is responsible for monitoring loan activities and ensuring that loan policies and authorities are complied with by loan officers.
Bancshares maintains conservative loan policies and underwriting practices in order to address and manage loan risks. These policies and practices include (i) granting loans on a sound and collectible basis, (ii) investing funds profitably for the benefit of the shareholders and the protection of the depositors, (iii) serving the legitimate needs of the community and the general market area while obtaining a balance between maximum yield and minimum risk, (iv) ensuring that primary and secondary sources of repayment are adequate in relation to the amount of the loan, (v) administering loan policies through a directors loan committee, (vi) developing and maintaining adequate diversification of the loan portfolio as a whole and of the loans within each category, (vii) ensuring that each loan is properly documented and, if appropriate, secured or guaranteed by government agencies, and that insurance coverage is adequate, especially with respect to certain agricultural loans because of the risks of poor weather, and (viii) developing and applying adequate collection procedures.
Bancshares' commercial loans include secured and unsecured loans, including real estate loans, to individuals and companies for a myriad of business purposes and to governmental units within the market area of the Decatur Bank and the Shelby Bank. Bancshares does not have a concentration of commercial loans in any single industry or business. As of December 31, 1996, Bancshares had commercial loans of approximately $47.3 million (23.2% of the loan portfolio), which includes $7.8 million in agricultural credits, $11.7 million in construction loans and $2.0 million in loans to tax exempt entities.
Bancshares' consumer loans include secured and unsecured loans for personal, family or household purposes, such as automobile installment loans and personal lines of credit. The consumer lending officers also handle some business loans for fleet vehicles and small equipment purchases as well as floor plan loans for both new and used automobile dealers. In addition, home equity loans and some home improvement loans are also granted. As of December 31, 1996, Bancshares had consumer installment loans of approximately $72.4 million, which represents approximately 35.5% of the loan portfolio.
Bancshares' real estate lending activities consist of residential mortgage lending. In addition, the Decatur Bank offers 15 to 30 year mortgages which it sells in the secondary market to the Federal National Mortgage Association ("FNMA"). The Decatur Bank retains servicing rights on loans sold to FNMA. As of December 31, 1996, Bancshares had loans totaling approximately $84.2 million for residential real estate purposes, which represents 41.3% of the total loan portfolio. In addition, the Decatur Bank sold $10.4 million of residential mortgages in the secondary market during 1996. Mortgage loans serviced for FNMA totaled $64.9 million as of December 31, 1996.
DEPOSITS AND FINANCIAL SERVICE
The principal deposit services offered by Bancshares are demand, savings and time deposit accounts and programs, which include interest and non-interest bearing demand deposits and individual retirement accounts. During 1996, total average deposits of Bancshares were approximately $313.1 million, consisting of average demand deposits of $111.9 million, average savings deposits of $46.1 million, and average time deposits of $155.1 million.
To attract and retain stable depositors, Bancshares markets various programs such as Classic Ones and Senior Savers, which assist senior citizens in their banking needs, and FirstCheque, a "debit card" or "check card". In addition, Bancshares has offered discount brokerage services since 1985.
Bancshares' trust departments are among the largest in the Central Illinois market with 880 trust accounts under management as of December 31, 1996. The trust department provides a full complement of asset management services for individuals and companies. The trust departments had assets under management of approximately $320.0 million at December 31, 1996.
Bancshares also provides farm management, farm consultation, farm appraisal and farm real estate brokerage services through its farm management departments. At December 31, 1996, the farm management departments served 192 clients with 203 farms as well as managed or directed approximately 42,000 acres of farmland in Macon County, Illinois, Shelby County, Illinois and surrounding counties.
COMPETITION
The activities in which Bancshares engages are highly competitive. Bancshares primarily serves a market area consisting of Macon County, Illinois, Shelby County, Illinois and surrounding communities. Within this market area, each activity engaged in by Bancshares involves competition with other banks, as well as with non-banking financial institutions and non-financial enterprises. Bancshares estimates its share of the savings deposit base to be approximately 25% in Macon County and 24% in Shelby County and estimates its share of the loan market to be approximately 25% in Macon County and 11% in Shelby County. Bancshares encounters active competition to obtain deposits and make loans, in the scope and types of services offered, in interest rates paid on time deposits and charged on loans, in providing discount brokerage, trust, investment, and farm management services and other aspects of banking.
FISCAL AND MONETARY POLICIES
The commercial banking business is affected not only by general economic conditions, but also by the fiscal and monetary policies of the Federal Reserve Board. Changes in the discount rate on Federal Reserve member bank borrowings, availability of borrowings at the Federal Reserve "discount window", open market operations, the imposition of and changes in reserve requirements against member banks' deposits, the imposition of and changes in reserve requirements against certain borrowings by member banks and their affiliates, and the placing of limits on interest rates which member banks may pay on time and savings deposits are some of the instruments of fiscal and monetary policy available to the Federal Reserve Board. Fiscal and monetary policies influence to a significant extent the overall growth of bank loans, investments and deposits and the interest rates charged on loans or paid on time and savings deposits. The nature of future monetary policies and the effect of such policies on the future business and earnings of Bancshares, the Decatur Bank and the Shelby Bank cannot be predicted.
EMPLOYEES
As of December 31, 1996, Bancshares had a total of 273 employees, consisting of 226 full-time employees and 47 part-time employees. None of the employees are represented by any union or similar group.
INFORMATION REGARDING FIRSTECH
DESCRIPTION OF BUSINESS
In 1988 Bancshares organized FirsTech, which is a remittance processing and collecting company. FirsTech provides, primarily to utility companies, the following services: remittance processing (which is also known as lock box processing), remittance collecting (which is also known as mechanized agent processing or MAPS), disaster recovery, and automated clearing house transactions. For the years ended December 31, 1996, 1995 and 1994, FirsTech accounted for $6,230,000 (17%), $9,661,000 (26%) and $8,617,000 (25%), respectively, of the consolidated total revenues of Bancshares (prior to the elimination on a consolidated basis of inter-company transactions) and accounted for $774,000 (11%), $1,396,000 (22%) and $1,298,000 (20%), respectively, of the consolidated income before income tax of Bancshares.
FirsTech provides remittance processing services for three companies. These remittance processing services are provided at FirsTech's Decatur, Illinois and Hammond, Indiana processing centers. For 1996, remittance processing for these companies accounted for approximately 59% of the total revenue of FirsTech.
FirsTech provides remittance collection services for thirteen companies. These services are provided at FirsTech's Decatur processing facility. In addition, many businesses, primarily banks and supermarkets, located throughout the states of Illinois, Indiana and Florida act as agents of FirsTech in collecting bills for the above-noted companies. In 1996, the remittance collection business for these companies accounted for approximately 34% of the total revenue of FirsTech.
FirsTech's contracts to process payments for Ameritech, Inc. expired in 1996 and were not renewed. The loss of Ameritech, Inc. was the main contributor to the decrease in FirsTech's total revenue and net income. FirsTech provided both remittance processing and remittance collection services for Ameritech, Inc. For the years ended December 31, 1996, 1995 and 1994 these services represented approximately 26%, 61% and 58%, respectively, of FirsTech's total revenue and approximately 5%, 16% and 15%, respectively, of total consolidated revenue of Bancshares.
COMPETITION
FirsTech competes in the remittance processing and collection business with companies that range from large national companies to small, local businesses. In addition, many companies do their own remittance processing rather than out-sourcing the work to an independent processor such as FirsTech. The principal methods of competition in the remittance processing industry are pricing of services, use of technology and quality of service.
SUPERVISION AND REGULATION
GENERAL
Bank holding companies and banks are extensively regulated under federal and state laws and regulations. As a result, the business, financial condition and prospects of Bancshares and its subsidiaries can be affected not only by management decisions and general economic conditions, but also by applicable statutes and regulations and other regulatory pronouncements and policies adopted
by regulatory agencies with authority over Bancshares and its subsidiaries. The effect of such statutes, regulations and other pronouncements and policies can be significant, cannot be predicted with a high degree of certainty and can change over time. The following information describes the material state and federal statutory and regulatory provisions affecting the businesses of Bancshares, First Shelby, Decatur Bank and Shelby Bank, and such discussion is qualified in its entirety by reference to such statutes and regulations. These laws and regulations are generally designed for the protection of bank depositors and not the shareholders of Bancshares.
Bancshares and First Shelby are currently registered as "bank holding companies" with the Federal Reserve Board. As such, Bancshares and First Shelby currently are subject to supervision by the Federal Reserve Board under the BHCA. Bank holding companies are required to file with the Federal Reserve Board periodic reports and such additional information as the Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve Board examines Bancshares and First Shelby, and may examine their affiliated financial institutions.
Shelby Bank is an Illinois state bank chartered under the Illinois Banking Act. Shelby Bank is subject to regulation, supervision and examination by the Office of Banks and Real Estate, State of Illinois, under the Illinois Banking Act and by the Federal Deposit Insurance Corporation ("FDIC") under the provisions of the Federal Deposit Insurance Act. The FDIC and the Office of Banks and Real Estate regularly examine such areas as reserves, loans, investments, management practices and other aspects of Shelby Bank's operations. In addition to these regular examinations, Shelby Bank must furnish to the FDIC and the Office of Banks and Real Estate quarterly reports containing a full and accurate statement of affairs. The deposits of Shelby Bank are insured by the Bank Insurance Fund (the "BIF") which is administered by the FDIC.
Decatur Bank is a national bank chartered under the banking laws of the United States. Decatur Bank is a member bank of the Federal Reserve System and its deposits are insured by the BIF of the FDIC. Decatur Bank's operations are also subject to the regulations of the Office of the Comptroller of the Currency (the "OCC"), the Federal Reserve Board and the FDIC. The OCC is the primary supervisory authority regulating Decatur Bank. The OCC regularly examines such areas as reserves, loans, investments, management practices and other aspects of Decatur Bank's operations. In addition to these regular examinations, Decatur Bank must furnish to the OCC and FDIC quarterly reports containing a full and accurate statement of affairs.
COMMUNITY REINVESTMENT ACT
In 1977 Congress enacted the Community Reinvestment Act (the "CRA") to encourage banks and thrifts to help meet the credit needs of their entire communities, including low- and moderate-income neighborhoods, consistent with safe and sound lending practices. On April 19, 1995, Federal banking agencies adopted a new rule amending the CRA. The new CRA rule will be phased in over a period of time and become fully effective July 1, 1997. All institutions will be evaluated under new CRA performance tests which will include the following: (I) the lending test, which will evaluate an institution's record of helping to meet its assessment area's credit needs through its lending activities by evaluating home mortgage, small business and community development lending; (ii) an investment test, which will evaluate a financial institution's record of meeting assessment area credit needs through qualified investments within its assessment area; and (iii) a service test, by which the FDIC will analyze the availability and effectiveness of a financial institution's system for delivering retail banking services and the extent and innovativeness of its community development services.
The FDIC will assign a rating of outstanding, satisfactory, needs to improve or substantial noncompliance, depending upon an institution's performance under each of the tests. Regulatory agencies will take into account a financial institution's rating when evaluating various types of applications, such as applications for branches, office relocations, mergers, consolidations, and purchase and assumption transactions, and may deny or condition approval of an application on the basis of an unsatisfactory CRA rating. In reviewing applications by bank holding companies, the Federal Reserve Board takes into account the record of compliance of a holding company's subsidiary banking institutions with the CRA. The Decatur Bank and the Shelby Bank were assigned composite ratings of "outstanding" and "satisfactory," respectively, in their most recent CRA examinations.
DEPOSIT INSURANCE
Deposits of the Decatur Bank and the Shelby Bank are insured by the FDIC under the BIF. The FDIC also maintains the Savings Association Insurance Fund (the "SAIF), which primarily insures savings association deposits. Applicable law requires that the SAIF and BIF funds each achieve and maintain a ratio of insurance reserves to total deposits equal to 1.25%. The BIF reached this 1.25% reserve level during 1995, and the FDIC announced a reduction in BIF premiums for most banks. Based on this reduction, the highest rated institutions (approximately 92 percent of the nearly 11,000 BIF-insured banks) paid the statutory minimum of $2,000 for FDIC insurance during 1996. Rates for all institutions were reduced by $.04 per $100 of deposits, leaving a premium range of $.00 (the statutory minimum applies) to $.27 per $100 instead of the previous $.04 to $.31 per $100.
CAPITAL ADEQUACY
Refer to Note 14 - "Regulatory Capital" of the Notes to the Consolidated Financial Statements for a discussion of Capital Adequacy as well as a summary of ratios at December 31, 1996.
DIVIDENDS
Bancshares' stockholders are entitled to receive such dividends as are declared by the Board of Directors, which considers payment of dividends quarterly. While Bancshares anticipates paying quarterly dividends in the future, the timing and amount of dividends will depend upon the earnings, capital requirements and financial condition of Bancshares as well as general economic conditions and other relevant factors affecting Bancshares. The ability of the Company to pay dividends is dependent upon its receipt of dividends from the Decatur Bank, the Shelby Bank and FirsTech.
The Decatur Bank may not pay a dividend in any calendar year in excess of its net profits for the current year plus its adjusted retained profits for the two prior years, unless it obtains OCC approval. Net profits from which dividends may be paid must be adjusted for losses and the amount of statutory bad debts in excess of the balance of the Bank's allowance for possible credit losses. As of January 1, 1997, Decatur Bank had approximately $4.3 million legally available to pay dividends without prior approval of the OCC, provided Decatur Bank maintains adequate capital.
Under the Illinois Banking Act, Shelby Bank may not declare dividends except out of net profits and unless Shelby Bank has transferred to surplus at least one-tenth of its net profits since the date of the declaration of the last preceding dividend, until the amount of its surplus is at least equal to its capital. Net profits under the Illinois Banking Act must be adjusted for losses and bad debts. As of January 1, 1997, Shelby Bank had approximately $10.3 million available to pay dividends.
Additionally, the payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations. Bancshares and its subsidiaries will be unable to pay dividends in an amount which would reduce its capital below the amount required by the FDIC. Banking regulators also have the authority to prohibit the payment of any dividends by Bancshares or any of its subsidiaries if it is determined the distribution would constitute an unsafe or unsound practice.
ACQUISITIONS AND EXPANSION
The BHCA requires Bancshares to obtain the prior approval of the Federal Reserve Board before merging with or consolidating into another bank holding company, acquiring substantially all the assets of any bank or bank holding company or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank or bank holding company. In its approval process, the Federal Reserve Board is required to weigh the expected benefit to the public, such as greater convenience and increased competition, against the risks of possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The Federal Reserve Board also gives consideration to compliance with the CRA, including the rating assigned by the FDIC.
The BHCA prohibits Bancshares, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. Bancshares, however, may engage in, and may own shares of companies engaged in, certain businesses determined by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The BHCA does not place territorial restrictions on the activities of non-bank subsidiaries of bank holding companies.
Traditionally, all banks in Illinois have been restricted as to the number and geographic location of branches which they could establish. Effective June 7, 1993, the Illinois Banking Act was amended to expand the branching rights of all banks located in Illinois. The Illinois Banking Act now permits banks in Illinois to maintain any number of branches anywhere within the State of Illinois, without regard to any numeric, geographic or home office protection limits.
On September 29, 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Branching Act") was enacted. Since September 29, 1995, the Branching Act has permitted bank holding companies that are adequately capitalized and adequately managed to acquire banks located in any other state, provided that the acquisition does not result in the bank holding company controlling more than 10% of the deposits in the United States, or 30% or more of the deposits in the state in which the bank to be acquired is located. The Branching Act also allows interstate branching and merging of existing banks beginning June 1, 1997. States may elect to prohibit interstate branching and merger transactions if they enact legislation before June 1, 1997, that applies equally to all out-of-state banks and expressly prohibits mergers involving out-of-state banks. This state "opt out" provision does not apply to bank holding company acquisitions. The State of Illinois has enacted legislation opting in the Branching Act effective June 1, 1997.
As a result of the Branching Act, Bancshares is currently permitted to acquire banks located in any state outside Illinois and any organization located outside Illinois is permitted to acquire Bancshares. These provisions should not materially affect Bancshares because Illinois law, for several
years, has permitted institutions located in any state of the United States to acquire banks or bank holding companies within Illinois subject to the ability of Illinois institutions to acquire banks and bank holding companies in such other state on similar conditions as Illinois law. The fact that Illinois has decided to permit interstate branching beginning June 1, 1997, means that if Bancshares did acquire an institution outside Illinois, Bancshares could, if it deemed it appropriate, convert such institution's offices into branches of the Decatur Bank or any other banking subsidiary then in existence. Bancshares, however, does not have any current plans to acquire any banking organization located outside the state of Illinois.
ITEM 2.

ITEM 2. PROPERTIES
Bancshares principal executive offices are located at 130 North Water Street, Decatur, Illinois, which is also the main banking office of the Decatur Bank. The building consists of a three story office building containing approximately 10,000 square feet of office space, all of which is utilized by the Decatur Bank. The Decatur Bank owns the building and the surrounding parking lots.
In addition, the Decatur Bank owns the land and building for five branch office facilities. Three of the branch offices are located in Decatur and two of the branch offices are located in Mt. Zion, Illinois, which is approximately ten miles from the main office of the Decatur Bank.
FirsTech's business activities are conducted from operations centers located at 124 North Franklin Street, Decatur, Illinois and 5131 Hohman Avenue, Hammond, Indiana. These two centers consist of approximately 4,800 square feet and 6,850 square feet, respectively, of office space. The Franklin Street facility is owned by Bancshares, while the Hammond facility is leased by FirsTech.
Shelby Bank has its main office at 200 West Main Street, Shelbyville, Illinois, which is comprised of approximately 12,600 square feet and is owned by the Shelby Bank. The Shelby Bank operates three drive-in lanes at this main office.
The Shelby Bank also operates a branch office facility in Johnston's IGA Supermarket in Shelbyville, Illinois. The Shelby Bank leases approximately 420 square feet of space for this branch facility, which was opened in March 1981.
Bancshares and its subsidiaries believe that its facilities are adequate to serve its present needs.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
Bancshares, the Decatur Bank, FirsTech, First Shelby and the Shelby Bank are from time to time a party to legal proceedings in the ordinary course of business that are incident to the business of banking. Neither Bancshares nor any of its Subsidiaries is engaged in any legal proceedings of a material nature at the present time.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Shares of Bancshares Common Stock are not traded on any national or regional securities exchange; however, Bancshares Common Stock is listed in the "pink sheets" maintained by the National Quotation Bureau. Trades have been small and infrequent through this listing. Other than trades in which Bancshares was involved, management of Bancshares has no knowledge of the sales prices of trades in Bancshares Common Stock. Based on transactions Bancshares has been involved in, the price for Bancshares Common Stock has been between $20.00 and $21.00 per share for the last two years. The source of this information is from privately negotiated transactions (not involving any broker or dealer) of which Bancshares has been a party.
Following is a listing of sales of unregistered securities for the last 3 years:
# of Price per Date Amount Shares Share Purchaser Relationship - ------------------------------------------------------------------------------ 3/03/94 $201,094 12,187 $16.50 First Decatur & Co. ESOP Purchase 10/08/94 17,500 1,000 17.50 William T. Eichenauer Bancshares Director 3/08/95 201,260 10,063 20.00 First Decatur & Co. ESOP Purchase 3/08/95 10,000 500 20.00 J. Gerald Demirjian Bancshares Director 3/14/95 10,000 500 20.00 Tom Sloan Bancshares Director 7/18/95 1,300 65 20.00 A.G. Edwards None 3/15/96 114,744 5,464 21.00 First Decatur & Co. ESOP Purchase 4/30/96 10,500 500 21.00 Shirley Hamilton None 4/30/96 10,500 500 21.00 Lawrence Hamilton None 5/03/96 31,500 1500 21.00 Tom Sloan Bancshares Director 5/03/96 21,000 1000 21.00 Fred L. Kenney Bancshares Director 12/04/96 105,000 5000 21.00 Tom Sloan Bancshares Director ------------------ Total 734,398 38,279 ------------------ ------------------
As of December 31, 1996, Bancshares had approximately 353 stockholders of record. Bancshares declared and paid quarterly cash dividends at an annual dividend rate of $0.44 per share in 1996 and $0.40 per share in 1995. See "Supervision and Regulation" and Note 13 -"Restriction on Dividends" of the Notes to the Consolidated Financial Statements for a discussion of certain dividend constraints.
ITEM 6.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is intended to provide a better understanding of the consolidated financial condition and results of operations of Bancshares and its subsidiaries as of December 31, 1996 and 1995 and for each of the years in the three year period ended December 31, 1996. This discussion and analysis should be read in conjunction with the consolidated financial statements, related notes and selected financial data appearing elsewhere in this report.
On April 1, 1996, Bancshares completed the acquisition of First Shelby and the Shelby Bank. As a result of the merger, First Shelby and the Shelby Bank became wholly owned subsidiaries of Bancshares. The acquisition was accounted for as a pooling of interests and, accordingly, the financial condition and results of operations of Bancshares and First Shelby have been combined as if the combination had been in effect for each of the periods presented.
RESULTS OF OPERATIONS
Bancshares recorded net income of $4,519,924 for 1996, an increase of 5.3% over 1995. On a per share basis, net income was $1.56 in 1996, up 5.4% from $1.48 in 1995. From 1994 to 1995, net income decreased 3.1% and net income per share decreased $0.05 or 3.3%. The increase in net income and net income per share in 1996 is attributed to an increase in interest income and a reduction in other expenses offset by a reduction in other income. The decrease in net income and net income per share in 1995 is primarily attributed to a decrease in net interest income. See further discussion in "--Net Interest Income", "--Other Income", and "--Other Expenses" below.
NET INTEREST INCOME
The largest source of operating revenue for Bancshares is net interest income. Net interest income represents the difference between total interest income earned on earning assets and total interest expense paid on interest-bearing liabilities. The amount of interest income is dependent upon many factors including the volume and mix of earning assets, the general level of interest rates and the dynamics of changes in interest rates. The cost of funds necessary to support earning assets varies with the volume and mix of interest bearing liabilities and the rates paid to attract and retain such funds.
For purposes of this discussion and analysis, the interest earned on tax-exempt assets is adjusted to an amount comparable to interest subject to normal income taxes. The adjustment is referred to as the tax equivalent ("TE") adjustment.
Bancshares average balances, interest income and expense and rates earned or paid for major balances are set forth in the following table (in thousands):
TABLE 1 DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES AND NET YIELDS
(1) Loans are net of the allowance for loan losses. Nonaccrual loans are included in totals. (2) Loan fees of approximately $283,000, $292,000 and $309,000 in 1996, 1995 and 1994, respectively, are included in loan interest. (3) Full tax equivalent yields on tax-exempt loans and securities have been calculated using a 34% tax rate.
Changes in net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. The following table summarizes the approximate relative contribution of changes in average volume and interest rates to changes in net interest income (TE) for the past two years (in thousands). The rate/volume variance has been allocated in the table to the volume and rate variances according to the ratio of the absolute value of each of the totals. There are no out-of-period items or adjustments which should have been excluded.
TABLE 2 ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE
(1) Full tax equivalent yields on tax exempt loans and securities have been calculated using a 34% tax rate.
On a tax equivalent basis, net interest income increased $525,000 or 4% in 1996, compared to a decrease of $513,000 or 4% in 1995. As set forth in Table 2, the improvement in net interest income in 1996 was mainly due to increases in the volume of earning assets and interest rates associated with these earning assets, primarily loans, offset primarily by an increase in time deposit rates. In 1995 the decrease in net interest income was largely due to the increases in the volume of time deposits and interest rate on these time deposits, offset by increases in the volume of taxable securities and increased rates associated with these taxable securities and loans.
Interest income on loans increased $667,000 from 1995 to 1996 due to an increase in volume ($313,000) and an increase in rates ($354,000). The increase in volume is the result of an increase in total average loans of $3,524,000 from 1995 to 1996. The majority of this increase is attributed to commercial and industrial loans as a result of an increase in major building projects and real estate loans as a result of keeping loans in-house versus utilization of the secondary market for mortgage loans. Loan interest income increased $665,000 from 1994 to 1995 primarily due to an increase in rates. The rate increase in both 1996 and 1995 is due to a 250 basis point increase in short-term market rates in early 1995. The overall rise in market rates allowed Bancshares to earn higher interest on loans.
Interest income on taxable securities increased $335,000 from 1995 to 1996 due to an increase in security volume. Interest income on taxable securities increased $822,000 from 1994 to 1995 due to an increase in volume ($508,000) and an increase in rates ($314,000). The increase in volumes for both years is the result of an increase in deposits on hand available for investing. The increase in rates during 1995 is the result of the 1995 short term market rate increase which allowed Bancshares to obtain better returns on their investments.
Interest income on Federal funds sold decreased $235,000 from 1995 to 1996 due to a decrease in volume. The average balance of Federal funds sold declined $3,645,000 during 1996 primarily due to increased liquidity needs as a result of loan growth. Interest income on Federal funds
sold increased $401,000 from 1994 to 1995 due to an increase in volume ($282,000) and an increase in rates ($119,000). The increase in volume is the result of an increase in deposits on hand. The increase in rates is the result of the 1995 short term market rate increase.
Interest expense on interest bearing demand deposits decreased $204,000 from 1995 to 1996 and decreased $249,000 from 1994 to 1995. The decreases in both years is due to changes in volumes. Average interest bearing deposits decreased $5,969,000 from 1995 to 1996 and $9,182,000 from 1994 to 1995. This change is attributed to the rise in market rates in 1995. As a result of the interest rate increase, depositors moved money out of interest bearing demand accounts into more favorable time deposit accounts.
Interest expense on time deposits increased $216,000 from 1995 to 1996 primarily due to an increase in rates. Interest expense increased $2,318,000 from 1994 to 1995 due to an increase in volume ($702,000) and an increase in rates ($1,616,000). The increase in rates for both years is the result of the 1995 market rate increase. Also, as a result of the increase in market rates, depositors moved money out of interest bearing demand accounts into time deposit accounts for more favorable rates.
PROVISION FOR LOAN LOSSES
Asset quality, particularly in the loan area, continues to be an important concern of Bancshares' management. Both the Decatur Bank and the Shelby Bank maintain a separate loan review department which continuously reviews problem and significant loans and the adequacy of the allowance for loan losses. Separate loan committees of the board of directors at the Decatur Bank and Shelby Bank meet at least quarterly to review past due loans and problem credits, lending policies and practices and results of the loan review department's analyses.
The provision for loan losses in 1996 was $310,000 compared to $275,000 in 1995 and $300,000 in 1994. The provision for loan losses has remained relatively constant, as net charge-offs and potential problem loans have also remained constant. For information on loss experience and nonperforming loans see the "Nonperforming Assets" and "Allowance for Loan Losses and Impaired Loans" sections below.
OTHER INCOME
An important source of Bancshares's revenue is derived from other income. The following table sets forth the major components of other income for the last three years (in thousands):
TABLE 3 OTHER INCOME
Remittance processing and collecting income generated by FirsTech decreased by $3,340,000 or 37% during 1996 as compared to an increase of $969,000 or 12% during 1995. The decrease in 1996 is the result of the loss of the Ameritech contracts. FirsTech's contracts to process payments for this Ameritech expired in 1996 and were not renewed. See Note 17 - "Business Industry Segments" of the Notes to the Consolidated Financial Statements for further explanation. The increase during 1995 is attributed to an increase in the number of items processed and the addition of five remittance collection customers in 1995.
Service charges on deposit accounts increased $83,000 or 8% in 1996. This increase is primarily attributed to the Decatur Bank increasing fees for non-sufficient funds checks from $18 to $20 during 1996.
Loan service fees increased $130,000 or 80% in 1996. This increase is mainly attributed to the adoption of Statement of Financial Accounting Standards ("SFAS") No. 122, Accounting for Mortgage Servicing Rights. The income recognized during 1996 due to the implementation of this accounting standard was $101,000. For a complete explanation of SFAS No. 122 refer to Note 7 - "Loan Servicing" of the Notes to Consolidated Financial Statements.
Net gains on loan sales decreased $23,000 or 16% in 1996, compared to a $28,000 or 25% increase in 1995. The Decatur Bank sells residential mortgage loans in the secondary market to FNMA. All loans are sold without recourse and with normal servicing fees being retained. The fluctuation in income is based on the fluctuation in the volume of loans sold to FNMA. Loans sold to FNMA represented $10,357,000, $15,932,000 and $10,328,000 in 1996, 1995, and 1994, respectively. Refer to the "Financial Condition -- Loans" section below for further explanation.
Other income increased $279,000 or 47% in 1996. This increase is mainly attributed to an increase in brokerage commissions within the investment department of Decatur Bank and an increase in Automated Teller Machine ("ATM") fees. ATM fee increases were attributed to additional usage as well as the installation of a new drive thru machine during 1996.
OTHER EXPENSE
The major categories of other expense include salaries and employee benefits, occupancy and equipment expenses and other operating expenses associated with the day-to-day operations of Bancshares. The following table sets forth the major components of other expense for the last three years (in thousands):
TABLE 4 OTHER EXPENSES
Salaries and employee benefits decreased $1,866,000 or 19% in 1996. The decrease in 1996 is the result of the loss of the Ameritech contracts. FirsTech's contracts to process payments for Ameritech expired in 1996 and were not renewed. FirsTech's average number of employees decreased from 167 in 1995 to 116 in 1996. The increase of $554,000 or 6% in 1995 was the result of increased processing volume for FirsTech. FirsTech's average number of employee's in 1994 was 139. See Note 17 - "Business Industry Segments" of the Notes to the Consolidated Financial Statements for further explanation.
Net occupancy expenses increased $172,000 or 17% in 1995. This increase is attributed to additional depreciation expense associated with equipment acquisitions of $4,645,000 during 1995.
Data processing fees decreased $191,000 or 34% in 1996, compared to a decrease of $245,000 or 30% in 1995. The decrease in both years is attributed to the acquisition of a new in-house computer system for the Decatur Bank and new image equipment and software for FirsTech in 1995. These systems allow for less expensive processing than the previous third party processor.
Service charges decreased $333,000 or 31% in 1996, compared to an increase of $191,000 or 21% during 1995. The decrease in 1996 is attributed to a reduction in the number of items processed by FirsTech as the result of the loss of the Ameritech contracts. The 1995 increase is attributed to an increase in the number of items processed by FirsTech.
Deposit and other insurance expense decreased $340,000 or 60% in 1996, compared to a decrease of $308,000 or 35% in 1995. The decrease in both years is due to a reduction in the FDIC assessment rate from 23 cents to 0 cents per $100 of deposits as of June 1, 1995. In 1994, deposit insurance premiums were assessed at the rate of 23 cents per $100 of deposits.
Supplies decreased $307,000 or 40% in 1996, compared to an increase on $132,000 or 21% in 1995. The decrease in 1996 and the increase in 1995 are attributed to the acquisition of a new in-house computer system for the Decatur Bank and new image equipment and software to FirsTech. The increase in 1995 was due to the initial purchase of supplies to supplement the purchase of the equipment. The decrease in 1996 is due to increased efficiencies in technology.
Professional fees increased $275,000 or 63% in 1996, compared to an increase of $136,000 or 46% in 1995. The increase in 1996 is mainly attributed to the acquisition of First Shelby. The increase in 1995 is attributed to expenses associated with an acquisition that did not consummate and expenses incurred by FirsTech for professional marketing/sales assistance.
Postage expenses decreased $89,000 or 20% in 1996 as a result of the loss of a major contract by FirsTech.
INCOME TAXES
Income tax expense increased $234,000 in 1996 and decreased $108,000 in 1995. Bancshares' effective tax rate (income tax expense divided by income before taxes) was 33.3% in 1996, 32.0% in 1995 and 32.4% in 1994. Higher income tax expense in 1996 was principally due to the increase in pre-tax earnings. The lower income tax expense in 1995 was principally due to the decrease in pre-tax earnings.
FINANCIAL CONDITION
Bancshares assets grew $11,174,000 or 2.9% from December 31, 1995 to December 31, 1996. Growth occurred primarily in cash and cash equivalents ($10,015,000) and loans ($10,765,000), offset by a decrease in investment securities ($6,621,000) and premises and equipment ($2,406,000). The growth in total assets was funded by an increase in short-term borrowings ($11,986,000).
CASH AND CASH EQUIVALENTS
Cash and cash equivalents increased $10,015,000 from December 31, 1995 to December 31, 1996. This change occurred due to an increase in federal funds sold offset by a reduction in cash and due from banks. Federal funds sold increased $14,735,000, while cash and due from banks decreased $4,720,000 during 1996. Refer to the "Consolidated Statement of Cash Flows" in the Consolidated Financial Statements for details representing this increase. Federal funds sold are of a short-term nature and provide the needed liquidity to fund loan growth and security acquisitions.
SECURITIES
Bancshares' overall investment goal is to maximize earnings while maintaining liquidity in securities having minimal credit risk. The types and maturities of securities purchased are primarily based on the Bancshares' current and projected liquidity and interest rate sensitivity positions. The following table sets forth the year-end book values of securities for the last three years (in thousands):
TABLE 5 COMPOSITION OF SECURITIES
SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities" requires that all debt and equity securities be classified as held-to-maturity, available-for-sale or trading. Securities that Bancshares has the ability and intent to hold to maturity are classified as held-to-maturity and are carried at amortized cost. Securities that may be sold as part of liquidity management, interest rate risk strategies or in response to or in anticipation of changes in interest rates and prepayment risk, or for other similar factors, are classified as available-for-sale and are carried at market value with unrealized gains and losses reported as a separate component of stockholders' equity.
SFAS No. 115 essentially eliminates the ability to transfer investment securities from held-to-maturity to available-for-sale. Also, SFAS No. 115 only allows for the sale of securities in the held-to-maturity category in extreme circumstances, such as significant deterioration in the issuer's creditworthiness. Therefore, prudent management of the investment portfolio according to SFAS No. 115 should provide for a greater than adequate level of investment securities to be available for sale in the event of unforeseen occurrences such as a significant swing in interest rates or a sudden increase in loan demand or deposit withdrawals.
On November 15, 1995, the Financial Accounting Standards Board ("FASB") issued a special report on the implementation of SFAS No. 115. As part of the application of the Special Report, companies were allowed a one-time opportunity to reclassify securities, including securities classified as held-to-maturity. In accordance with the Special Report, Bancshares transferred $29.6 million of its taxable securities classified as held-to-maturity to available-for-sale. The transfer was made to provide greater flexibility in managing the investment portfolio. At the date of transfer, the securities had an aggregate market value of $29.4 million.
The book value of investment securities decreased by $6,620,000 from December 31, 1995 to December 31, 1996 and increased $9,534,000 from December 31, 1994 to December 31, 1995. The decrease in 1996 was mainly due to an increase in loan demand. During 1996, Bancshares purchased $26,833,000 ($23,687,000 classified as available-for-sale), sold $2,983,000 of securities classified as available-for-sale, and had $29,641,000 ($16,782,000 classified as available-for-sale) mature. The increase in 1995 was due mainly to the decrease in loan demand. During 1995, Bancshares purchased $45,577,000 ($40,084,000 classified as available-for-sale), sold $11,187,000 of securities classified as available-for-sale, and had $26,494,000 ($18,505,000 classified as available-for-sale) mature. Refer to Note 4 - "Investment Securities" of the Notes to the Consolidated Financial Statements for additional information on sales of securities.
As of December 31, 1996, Bancshares held $21,819,000 ($6,994,000 classified as available-for-sale) of mortgage-backed securities. These securities are issued by U.S. Government agencies or one of its sponsored enterprises and are guaranteed or insured by the issuing agency. Of the total mortgage-backed securities, $5,000,000 was invested in CMO PAC's, of which all had ratings of AAA by one or more of the rating agencies. Additionally, Bancshares investments in CMO PAC's are agency-backed.
Mortgage-backed securities are subject to prepayments and changing yields. These prepayments, which have increased in recent years as underlying mortgages have been refinanced at lower interest rates as well as interest rate changes on adjustable rate mortgage-backed securities, could have an effect on Bancshares' asset/liability management strategy.
With the exception of securities of the U.S. Treasury and other U.S. Government agencies and corporations, Bancshares did no hold any securities of a single issuer, payable from and secured by the same source of revenue or taxing authority, the book value of which exceeded 10 percent of stockholders' equity at December 31, 1996.
The contractual maturity of Bancshares' securities as of December 31, 1996, are presented in the following table along with the weighted average yields (TE) (dollars in thousands). Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
TABLE 6 SECURITY MATURITIES
The net unrealized gain on securities available-for-sale at December 31, 1996, which is recorded as an increase in stockholders' equity, is $133,000, net of deferred taxes of $79,000. At December 31, 1995, Bancshares had a net unrealized gain on securities available-for-sale recorded in stockholders' equity of $415,000, net of deferred taxes of $233,000.
LOANS
The loan portfolio is the largest category of the Bancshares' earning assets. Bancshares management was not aware of any loan concentration exceeding 10% which is not otherwise disclosed as a category of loans. The following table summarizes the composition of the loan portfolio for the last five years (in thousands):
TABLE 7 COMPOSITION OF LOANS
Total loans increased by $10,765,000 from December 31, 1995 to December 31, 1996, primarily due to large increases in commercial and industrial loans, real estate loans and construction loans. Commercial and industrial loans increased by $3,756,000 due to increases in major building
projects under construction and increased demand. Real estate loans increased by $4,924,000 primarily due to a decrease in the utilization of the secondary market for mortgage loans. In 1996, Bancshares sold $10,357,000 of mortgage loans to FNMA compared to $15,932,000 in 1995. Construction loans increased by $1,444,000 due to increased activity in the residential construction market.
Bancshares continues to sell residential mortgage loans in the secondary market to FNMA. Since loans are sold to FNMA on the same day as the loan closes, Bancshares does not carry any loans held for sale in the loan portfolio. All loans are sold without recourse and with normal servicing fees being retained. The decision to sell loans to FNMA in the future will depend on the availability of funds, liquidity needs, and the return available.
Total loans decreased by $5,557,000 from December 31, 1994 to December 31, 1995, primarily due to large decreases in commercial and industrial loans and real estate loans, offset by an increase in construction loans. Commercial and industrial loans decreased by $7,420,000 from major paydowns on large projects and decreased demand. Real estate loans decreased by $5,533,000 primarily due to an increase in the utilization of the secondary market for mortgage loans as explained above. Construction loans increased by $3,481,000 due to an increase in the residential construction loan market.
The maturity distribution and interest rate sensitivity of loans at December 31, 1996 are set forth below (in thousands):
TABLE 8 LOAN MATURITY DISTRIBUTION AND INTEREST RATE SENSITIVITY OF SELECTED LOAN TYPES
NONPERFORMING ASSETS
Nonperforming assets include nonaccrual loans, loans where scheduled payments are 90 days or more past due and other real estate owned. Bancshares places loans on nonaccrual status when management believes, after considering the borrower's financial condition and other relevant factors, that future collection of principal or interest in accordance with contractual terms may be doubtful. Loans 90 days or more past due are transferred to nonaccrual status unless they are well secured and in the process of collection. Other real estate owned includes properties acquired through foreclosure or deed in lieu of foreclosure. The properties are recorded at the lower of the book value of the loan or fair value, less estimated costs to sell. Other real estate owned at December 31, 1996 and 1995 was immaterial.
The following table sets forth the aggregate amount of the Company's nonperforming assets for the last five years (in thousands):
TABLE 9 NONPERFORMING ASSETS
December 31 -------------------------------------------------- 1996 1995 1994 1993 1992 ------ ------ ------ ------ ------ Nonaccrual loans $ 173 $ 69 $ 23 $ 183 $ 177 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Loans past due 90 days or more 650 372 365 131 75 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Restructured loans 0 0 0 0 0 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Nonperforming loans to loans 0.41% 0.23% 0.20% 0.17% 0.15% ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Bancshares' management believes that nonperforming and potential problem loans are appropriately identified and monitored, based on extensive analysis performed by internal loan review personnel, management and the board of directors. Historically, there has not been a significant amount of loans charged off which had not been previously identified as problem loans.
There were no other interest bearing assets which would be required to be disclosed as being nonperforming if such other assets were loans. Interest income that would have been recorded in 1996 if non-accrual loans had been performing according to original loan terms and interest income on non-accrual loans that was included in 1996 interest income were immaterial.
At December 31, 1996, Bancshares had approximately $1,502,000 in potential problem loans. Potential problem loans are those loans identified by management that are worthy of special attention, and although currently performing, may have some underlying weaknesses. Potential problem loans of $1,083,000 existed at December 31, 1995. Of the potential problem loans outstanding at December 31, 1996 and 1995, there were no individually significant problem loans and no specific industry concentration.
Bancshares adopted SFAS No. 114 and No. 118, "Accounting by Creditors for an Impairment of a Loan" and "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures" on January 1, 1995. These Statements require that impaired loans that are within the scope of these Statements be measured at the present value of expected future cash flows discounted at the loan's effective interest rate, or as a practical expedient, at the loan's observable market price or fair value of the collateral, if the loan is collateral dependent. A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the note. The adoption of these Statements did not have a material impact on Bancshares' financial position or results of operations. In addition, the amount of impaired loans outstanding at December 31, 1996, and December 31, 1995 were immaterial.
ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS
The allowance for loan losses is maintained at a level management believes to be adequate to provide for known and potential risks inherent in the loan portfolios. On a quarterly basis, management assesses the adequacy of the allowance for loan losses. Management's evaluation of the adequacy of the allowance considers such factors as prior loss experience, loan delinquency levels and trends, loan portfolio growth and reviews of impaired loans and the value of underlying collateral securing these loans. The analysis of the commercial and industrial loan portfolio includes assessments based on historic loan losses and current quality grades of specific credits, current delinquent and non-performing loans, current economic conditions, growth in the portfolio and the results of recent internal loan reviews, audits and regulatory examinations. For the review of the adequacy of the allowance for loan losses for real estate loans, assessments are based on current economic conditions and real estate values, historic loan losses and current quality grades of specific credits, recent growth and current delinquent and non-performing loans. The adequacy of the allowance for loan losses as it pertains to the consumer loan portfolio is based on the assessments of current economic conditions, historic loan losses and the mix of loans, recent growth and the current delinquent and non-performing loans.
Although the risk of non-payment for any reason exists with respect to all loans, certain other more specific risks are associated with each type of loan. The primary risks associated with commercial and industrial loans are quality of the borrower's management and the impact of national and local economic factors. Currently the business atmosphere remains stable for the local economy in the Decatur, Macon County and Shelby County areas. Risks associated with real estate loans include concentrations of loans in a loan type, such as residential real estate, decline in real estate values and a sudden rise in interest rates. Individual loans face the risk of a borrower's unemployment as a result of deteriorating economic conditions or renewed contract differences between unions and management of several large companies in Bancshares' market area. Bancshares's strategy with respect to addressing and managing these types of risks is for Bancshares to follow its loan policies and underwriting criteria.
A provision for loan losses is charged to income to increase the allowance to a level deemed to be adequate based on management's evaluation. When a loan or a part thereof is considered by management to be uncollectible, a charge is made against the allowance. Recoveries of previously charged-off loans are credited back to the allowance. The following table summarizes the changes in the allowance for loan losses for the last five years (in thousands):
TABLE 10 ALLOWANCE FOR LOAN LOSSES
For many years, Bancshares has minimized credit risk by adhering to sound underwriting and credit review policies. These policies are reviewed at least annually, and changes are approved by the board of directors. Senior management is actively involved in business development efforts and maintenance and monitoring of credit underwriting and approval.
Management believes the allowance for loan losses is adequate to absorb probable loan losses and that the policies and procedures in place to identify and monitor loans for potential losses are satisfactory.
The following table sets forth an allocation of the Bancshares' allowance for loan losses for the last five years (in thousands):
TABLE 11 ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
The percentages of allocation of the allowance for loan losses among the various categories of loans have remained relatively steady for the last five years due to the various loan markets remaining stable. The unallocated portion of the allowance for loan losses represents the amount that management feels is necessary to cover any adverse impact on the loan portfolio in the event of a decline in the real estate or commercial market resulting from labor/management issues or other causes.
PREMISES AND EQUIPMENT
Premises and equipment decreased $2,406,000 or 19% from December 31, 1995 to December 31, 1996. This decrease is attributed to the disposal of $1,514,000 in equipment by FirsTech and total depreciation of $1,720,000 offset by purchases of $828,000 during 1996. The majority of purchases in 1996 were made by Decatur Bank and were comprised of numerous nonmajor items.
The net balance in premises and equipment increased $2,843,000 from December 31, 1994 to December 31, 1995. This increase is attributed to acquisitions of $4,666,000 offset by depreciation of $1,823,000. The majority of acquisitions in 1995 relate to a new in-house computer system and image equipment and software.
OTHER ASSETS
Other assets decreased by $533,000 from December 31, 1995 to December 31, 1996. This decrease is mainly attributed to the decrease in accounts receivable due to FirsTech as a result of the loss of the major customer of FirsTech.
DEPOSITS
Funding of Bancshares' earning assets is substantially provided by a combination of consumer, commercial and public fund deposits. The following table summarizes the composition of major deposit categories for the last three years (in thousands):
TABLE 12 AVERAGE BALANCE AND WEIGHTED AVERAGE RATE OF DEPOSITS
From 1994 to 1996, total average deposits have remained relatively constant; however, within the specific deposit types, Bancshares has experienced a decline in demand deposits with an offsetting increase in savings and time deposits. This change is attributed to a general rise in market interest
rates associated with savings and time deposits. Refer to "Results of Operations - Net Interest Income" for an explanation of this change in interest rates.
The following table sets forth the maturity distribution of time deposits of $100,000 or more at December 31, 1996 (in thousands):
TABLE 13 MATURITY DISTRIBUTION OF TIME DEPOSITS > $100,000
3 months or less $31,197 3 to 6 months 8,463 6 to 12 months 10,572 Over 12 months 3,908 --------- Total $54,140 --------- ---------
SHORT-TERM BORROWINGS
Short-term borrowings consist of securities sold under agreements to repurchase, federal funds purchased, Federal Home Loan Bank ("FHLB") advances and U.S. Treasury demand notes. Refer to Note 9 - "Short-Term Borrowings" of the Notes to Consolidated Financial Statements for further explanation of short-term borrowings.
OTHER LIABILITIES
The decrease in other liabilities of $889,000 from December 31, 1995 to December 31, 1996 was due to several factors. The loss of the major customer of FirsTech resulted in various accruals decreasing approximately $415,000. In addition, the deferred taxes associated with securities available for sale decreased approximately $150,000. The majority of the remaining decrease is associated with the income tax payable accounts.
Other liabilities increased approximately $1,038,000 from December 31, 1994 to December 31, 1995. The majority of this increase is attributed to the increase in accrued interest payable.
CAPITAL
Total stockholders' equity rose $2,614,000 or 5.7% from December 31, 1995 to December 31, 1996. The increase is mainly attributed to net income of $4,520,000 less cash dividends of $1,277,000 and a reduction in the unrealized gain on securities available for sale of $282,000, net of deferred taxes. Treasury stock has been reacquired for the specific purpose of distributing shares to Bancshares' ESOP. Approximately 13,541 shares of treasury stock were reacquired in 1996.
Total stockholders' equity rose $4,511,000 or 10.9% from December 31, 1994 to December 31, 1995. The increase is mainly attributed to net income of $4,293,000 less cash dividends of $1,157,000 and an increase in the unrealized gain on securities available for sale of $1,320,000, net of deferred taxes.
Financial institutions are required by regulatory agencies to maintain minimum levels of capital based on asset size. Currently, Bancshares is required to maintain adequate capital based on two
measurements used by Bancshares's primary regulator: the total assets leverage ratio and the risk-weighted assets ratio. Refer to Note 14 - "Regulatory Capital" of the Notes to Consolidated Financial Statements for a summary of Bancshares key capital ratios.
INFLATION AND CHANGING PRICES
Changes in interest rates and Bancshares's ability to react to interest rate fluctuations have a much greater impact on its balance sheet and net interest income than inflation. A review of net interest income, liquidity and rate sensitivity should assist in the understanding of how well Bancshares is positioned to react to changes in interest rates.
LIQUIDITY
Liquidity management in banking involves the ability to generate funds to support asset growth and meet cash flow requirements of customers and other obligations. Cash flows fluctuate with changes in economic conditions, current interest rate trends and as a result of management strategies and programs. Bancshares was able to adequately fund asset growth and meet liquidity needs in 1996. At December 31, 1996, federal funds sold and securities having contractual maturities of one year or less totaled $43.3 million. Bancshares's immediate liquidity needs have historically been met by federal funds sold and cash flows from securities. Other sources of potential liquidity include the sale of securities classified as available-for-sale, borrowings under informal federal funds lines with correspondent banks and advances with the FHLB.
Refer to the "Consolidated Statement of Cash Flows" in the Consolidated Financial Statements for details of net cash provided by operating activities, net cash used by investing activities and net cash provided by financing activities.
INTEREST RATE RISK
Bancshares seeks to maximize its net interest margin within an acceptable level of interest rate risk. Interest rate risk can be defined as the amount of forecasted net interest income that may be gained or lost due to favorable or unfavorable movements in interest rates. Interest rate risk, or sensitivity, arises when the maturity or repricing characteristics of assets differ significantly from the maturity or repricing characteristics of liabilities. A principal objective of Bancshares' asset/liability management effort is to balance the various factors that generate interest rate risk, thereby maintaining the interest rate sensitivity within acceptable risk levels.
A traditional measurement of interest rate sensitivity is known as "gap" analysis, which measures the cumulative differences between the amounts of assets and liabilities maturing or repricing at various time intervals. The following table sets forth Bancshares's interest rate repricing gaps at December 31, 1996 (in thousands):
TABLE 14 GAP TABLE
0 - 3 3 - 12 Over one months months year Total --------------------------------------------------- Loans $ 44,793 $ 21,924 $ 133,178 $ 199,895 Securities 9,691 17,910 103,541 131,142 Federal funds sold 15,770 15,770 --------------------------------------------------- Total earning assets 70,254 39,834 236,719 346,807 ---------------------------------------------------
Interest bearing demand deposits and savings 109,282 109,282 Time deposits 60,239 67,674 28,294 156,207 Federal funds purchased and securities sold under repurchase agreements 16,969 16,969 FHLB advances 2,500 2,500 U.S. Treasury demand notes 2,333 2,333 --------------------------------------------------- Total interest bearing liabilities 191,323 67,674 28,294 287,291 ---------------------------------------------------
Net asset (liability) gap $(121,069) $ (27,840) $ 208,425 $ 59,516 --------------------------------------------------- --------------------------------------------------- Cumulative asset (liability) gap $(121,069) $(148,909) $ 59,516 --------------------------------------------------- --------------------------------------------------- Repricing gap 0.37 0.59 8.37 1.21 --------------------------------------------------- --------------------------------------------------- Cumulative repricing gap 0.37 0.43 1.21 --------------------------------------------------- ---------------------------------------------------
At December 31, 1996, the table above reflects that Bancshares is liability sensitive due to the level of interest bearing demand deposits and savings which are generally subject to immediate withdrawal and are repriceable at any time. As such, the effect of an increase in the prime rate of 100 basis points would decrease net interest income by approximately $1,211,000 (annualized) in 90 days and $1,489,000 in 12 months assuming no management intervention. A fall in the interest rates would have the opposite effect for the same period. In analyzing interest rate sensitivity, Bancshares' management considers these differences and incorporates other assumptions and factors, such as balance sheet growth and prepayments, to better measure interest rate risk.
While the gap analysis provides an indication of interest rate sensitivity, experience has shown that it does not fully capture the true dynamics of interest rate changes. Essentially, the analysis presents only a static measurement of asset and liability volumes based on contractual maturity, cash flow estimates or repricing opportunity. It fails to reflect the differences in the timing and degree of repricing of assets and liabilities due to interest rate changes. In analyzing interest rate sensitivity, management considers these differences and incorporates other assumptions and factors, such as balance sheet growth and prepayments, to better measure interest rate risk.
CAPITAL RESOURCES
At December 31, 1996, Bancshares had no material commitments for capital expenditures.
NEW ACCOUNTING PRONOUNCEMENTS
During 1995, the FASB issued SFAS No. 122, "Accounting for Mortgage Servicing Rights". SFAS No. 122 pertains to mortgage banking enterprises and financial institutions that conduct operations that are substantially similar to the primary operations of mortgage banking enterprises. SFAS No. 122 eliminates the accounting distinction between mortgage servicing rights that are acquired through loan origination activities and those acquired through purchase transactions. Under SFAS No. 122, if a mortgage banking enterprise sells or securitizes loans and retains the mortgage
servicing rights, the enterprise must allocate the total cost of the mortgage loans to the mortgage servicing rights and the loans (without the rights) based on their relative fair values if it is practicable to estimate those fair values. If it is not practicable, the entire cost should be allocated to the mortgage loans and no cost should be allocated to the mortgage service rights. An entity would measure impairment of mortgage servicing rights and loans based on the excess of the carrying amount of the mortgage servicing rights portfolio over the fair value of that portfolio.
SFAS No. 122 is to be applied prospectively in fiscal years beginning after December 15, 1995, to transactions in which an entity acquires mortgage servicing rights and to impairment evaluations of all capitalized mortgage servicing rights. The adoption of SFAS No. 122 by Bancshares resulted in $101,000 of mortgage servicing rights being capitalized, net of amortization.
The FASB has issued SFAS No. 123, "Accounting for Stock-based Compensation". SFAS No. 123 establishes a fair value based method of accounting for stock-based compensation plans. The FASB encourages all entities to adopt this method for accounting for all arrangements under which employees receive shares of stock or other equity instruments of the employer, or the employer incurs liabilities to employees in amounts based on the price of its stock.
Due the extremely controversial nature of this project, SFAS No. 123 permits a company to continue the accounting for stock-based compensation prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". If a company elects that option, pro forma disclosures of net income (and EPS, if presented) are required in the notes to the financial statements as if the provisions of SFAS No. 123 had been used to measure stock-based compensation. The disclosure requirements of Opinion No. 25 have been superseded by the disclosure requirements of this Statement. Once an entity adopts the fair value based method of accounting for these transactions, that election cannot be reversed.
Equity instruments granted or otherwise transferred directly to an employee by a principal stockholder are stock-based employee compensation to be accounted for in accordance with either Opinion No. 25 or SFAS No. 123 unless the transfer clearly is for a purpose other than compensation. The accounting requirements of SFAS No. 123 became effective for transactions entered into in fiscal years beginning after December 31, 1995, and the disclosure requirements became effective for financial statements for fiscal years beginning after December 15, 1995. Pro forma disclosures required for entities that elect to continue to measure compensation cost using Opinion No. 25 must include the effects of all awards granted in fiscal years beginning after December 15, 1994. During the initial phase-in period, the effects of applying this Statement are not likely to be representative of the effects on reported net income for future years because options vest over several years and additional awards generally are made each year.
Bancshares elected to continue to measure compensation costs using Opinion No. 25. There were no pro forma disclosures required pursuant to SFAS No. 123 as no awards were granted in 1995 or 1996.
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", breaks new ground in resolving long-standing questions about whether transactions should be accounted for as secured borrowing or as sales. The Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are considered secured borrowings.
A transfer of financial assets in which the transferor surrenders control over those assets is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. The transferor has surrendered control over transferred assets only if all of the following conditions are met:
- The transferred assets have been isolated from the transferor - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership.
- Each transferee obtains the right - free of conditions that constrain it from taking advantage of that right - to pledge or exchange the transferred assets, or the transferee is a qualifying special-purpose entity and the holders of beneficial interest in that entity have the right - free of conditions that constrain them from taking advantage of that right - to pledge or exchange those interests.
- The transferor does not maintain effective control over the transferred assets through an agreement that both entities and obligates the transferor to repurchase or redeem them before their maturity, or an agreement that entitles the transferor to repurchase or redeem transferred assets are not readily obtainable.
This Statement provides detailed measurement standards for assets and ilabilities included in these transactions. It also includes implementation guidance for assessing isolation of transferred assets and for accounting for transfers of partial interest, servicing of financial assets, securitization, transfers or sales type and direct financing lease receivables, securities lending transactions, repurchase agreements, "wash sales," loan syndications and participation, risk participation in banker's acceptances, factoring arrangements, transfers of receivables with recourse and extinguishment of liabilities.
The Statement supersedes FASB Statements No. 76, "Extinguishment of Debt" and No. 77, "Reporting by Transferors for Transfers of Receivables with Recourse" and No. 122, "Accounting for Mortgage Servicing Rights", and amends FASB Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities", in addition to clarifying or amending a number of other statements and technical bulletins. Except as amended by Statement No. 127, this Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996 and is to be applied prospectively. Earlier or retroactive application is not permitted.
The FASB was made aware that the volume of certain transactions and the related changes to information systems and accounting processes that are necessary to comply with the requirements of Statement No. 125 would make it extremely difficult, if not impossible, for some affected enterprises to apply the transfer and collateral provisions of Statement No. 125 to those transactions as soon as January 1, 1997. As a result, SFAS No. 127 defers for one year the effective date (a) of paragraph 15 of Statement No. 125 and (b) for repurchase agreement, dollar-roll, securities lending, and similar transactions, of paragraphs 9-12 and 237(b) of Statement No. 125.
Statement No. 127 provides additional guidance on the types of transactions for which the effective date of Statement No. 125 has been deferred. It also requires that if it is not possible to determine whether a transfer occurring during calendar-year 1997 is part of a repurchase agreement, dollar-roll, securities lending, or similar transaction, then paragraphs 9-12 of Statement No. 125 should be applied to that transfer. All provisions of Statement No. 125 should continue to be applied prospectively, and earlier or retroactive application is not permitted.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS
INDEPENDENT AUDITOR'S REPORT
To the Stockholders and Board of Directors First Decatur Bancshares, Inc. Decatur, Illinois
We have audited the consolidated balance sheet of First Decatur Bancshares, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements described above present fairly, in all material respects, the consolidated financial position of First Decatur Bancshares, Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles.
As discussed in the notes to the consolidated financial statements, the Company changed its method of accounting for investment securities in 1994.
/s/ GEO. S. OLIVE & CO. LLC
Decatur, Illinois January 31, 1997
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET
DECEMBER 31 1996 1995 - ------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 32,817,670 $ 37,537,548 Federal funds sold 15,770,000 1,035,000 ---------------------------- Cash and cash equivalents 48,587,670 38,572,548 Investment securities Available for sale 94,352,502 91,183,441 Held to maturity 36,790,361 46,580,086 ---------------------------- Total investment securities 131,142,863 137,763,527 Loans 199,895,080 189,130,209 Allowance for loan losses (3,381,519) (3,355,735) ---------------------------- Net loans 196,513,561 185,774,474 Premises and equipment 10,166,047 12,572,233 Other assets 7,712,720 8,266,287 ---------------------------- Total assets $394,122,861 $382,949,069 ---------------------------- ----------------------------
LIABILITIES Deposits Noninterest bearing $ 54,672,633 $ 54,071,674 Interest bearing 265,489,458 268,637,996 ---------------------------- Total deposits 320,162,091 322,709,670 ----------------------------
Federal funds purchased and securities sold under repurchase agreements 16,969,492 8,981,455 Federal Home Loan Bank advances 2,500,000 U.S. Treasury demand notes 2,332,708 824,880 Other liabilities 3,664,260 4,553,158 ---------------------------- Total liabilities 345,628,551 337,069,163 ---------------------------- COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY Preferred stock, no par value Authorized and unissued -- 200,000 shares Common stock, $.01 par value Authorized-- 5,000,000 shares Issued 2,909,397 shares, of which 22,361 shares and 8,820 shares were held as treasury stock 29,094 29,094 Capital surplus 7,853,637 7,852,780 Paid-in capital--phantom stock 145,862 91,403 Retained earnings 40,797,815 37,665,237 Net unrealized gain on securities available for sale 132,666 415,031 ---------------------------- 48,959,074 46,053,545 Treasury stock, at cost (464,764) (173,639) ---------------------------- Total stockholders' equity 48,494,310 45,879,906 ---------------------------- Total liabilities and stockholders' equity $394,122,861 $382,949,069 ---------------------------- ----------------------------
See notes to consolidated financial statements.
FIRST DECATUR BANCSHARES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME
YEAR ENDED DECEMBER 31 1996 1995 1994 - ------------------------------------------------------------------------------- INTEREST INCOME Loans receivable Taxable $16,646,331 $15,972,588 $15,308,707 Tax exempt 116,411 120,716 120,254 Investment securities Taxable 7,609,289 7,274,008 6,451,721 Tax exempt 645,095 630,966 721,128 Federal funds sold 421,399 656,422 254,760 Other interest income 28,609 24,454 42,275 ---------------------------------------------- Total interest income 25,467,134 24,679,154 22,898,845 ---------------------------------------------- INTEREST EXPENSE Deposits 11,164,465 11,047,079 8,821,942 Federal funds purchased and securities sold under repurchase agreements 293,105 206,442 224,655 Federal Home Loan Bank advances 77,471 U.S. Treasury demand notes 83,587 97,571 58,174 ---------------------------------------------- Total interest expense 11,618,628 11,351,092 9,104,771 ---------------------------------------------- NET INTEREST INCOME 13,848,506 13,328,062 13,794,074 Provision for loan losses 310,000 275,000 300,000 ---------------------------------------------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 13,538,506 13,053,062 13,494,074 ---------------------------------------------- OTHER INCOME Remittance processing income 5,747,797 9,088,188 8,119,038 Fiduciary activities 1,534,915 1,457,428 1,381,629 Service charges on deposit accounts 1,127,468 1,045,197 1,030,473 Loan servicing fees 293,163 163,082 155,223 Net realized gains (losses) on sales of securities available for sale (7,868) 7,517 18,514 Net gains on loan sales 117,802 140,626 113,085 Other income 873,485 594,069 560,249 ---------------------------------------------- Total other income 9,686,762 12,496,107 11,378,211 ---------------------------------------------- OTHER EXPENSES Salaries and employee benefits 8,164,051 10,029,611 9,475,956 Net occupancy expenses 1,141,855 1,205,878 1,034,298 Equipment expenses 2,482,713 2,357,865 2,182,890 Data processing fees 369,662 561,318 806,218 Service charges from corresponding banks 756,001 1,089,293 898,497 Deposit and other insurance expense 222,768 563,391 870,669 Supplies 466,647 774,406 641,104 Professional fees 709,444 433,667 297,994 Postage 362,334 451,066 446,473 Other expenses 1,776,332 1,769,697 1,657,835 ---------------------------------------------- Total other expense 16,451,807 19,236,192 18,311,934 ---------------------------------------------- INCOME BEFORE INCOME TAX 6,773,461 6,312,977 6,560,351 Income tax expense 2,253,537 2,019,717 2,127,879 ---------------------------------------------- NET INCOME $4,519,924 $4,293,260 $4,432,472 ---------------------------------------------- ---------------------------------------------- NET INCOME PER SHARE $1.56 $1.48 $1.53 WEIGHTED AVERAGE SHARES OUTSTANDING 2,900,533 2,901,477 2,904,495
See notes to consolidated financial statements.
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of First Decatur Bancshares, Inc. ("Company"), and its wholly owned subsidiaries, The First National Bank of Decatur ("Decatur Bank"), FirsTech, Inc. ("FirsTech"), and First Shelby Financial Group, Inc. ("First Shelby") and First Shelby's wholly owned subsidiary, First Trust Bank of Shelbyville ("Shelby Bank"), conform to generally accepted accounting principles and reporting practices followed by the banking industry. The more significant of the policies are described below.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statement and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
The Company is a holding company whose principal activity is the ownership and management of the subsidiaries. Decatur Bank operates under a national charter and provides full banking services, including trust services. As a national bank, Decatur Bank is subject to regulation by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation ("FDIC"). Shelby Bank operates under a state bank charter and provides full banking services, including trust services. As a state bank, Shelby Bank is subject to regulation by the Office of Banks and Real Estate, State of Illinois and the FDIC.
The Banks generate commercial, mortgage and consumer loans and receive deposits from customers located primarily in Central Illinois. The Banks' loans are generally secured by specific items of collateral including real property, consumer assets and business assets. FirsTech is a remittance processing company that provides various remittance processing services for several large utility companies.
CONSOLIDATION--The consolidated financial statements include the accounts of the Company and the subsidiaries after elimination of all material intercompany transactions and accounts.
INVESTMENT SECURITIES--Debt securities are classified as held to maturity when the Company has the positive intent and ability to hold the securities to maturity. Securities held to maturity are carried at amortized cost. Debt securities not classified as held to maturity are classified as available for sale. Securities available for sale are carried at fair value with unrealized gains and losses reported separately in stockholders' equity, net of tax.
Amortization of premiums and accretion of discounts are recorded as interest income from securities. Realized gains and losses are recorded as net security gains. Gains and losses on sales of securities are determined on the specific-identification method.
On January 1, 1994, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 115, ACCOUNTING OF CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES, and investment securities with a carrying value of $48,893,080 were reclassified as available for sale. This reclassification resulted in an increase to stockholders' equity, net of taxes, of $487,829.
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MORTGAGE SERVICING RIGHTS on originated loans are capitalized by allocating the total cost of the mortgage loans between the mortgage servicing rights and the loans based on their relative fair values. Capitalized servicing rights are amortized in proportion to and over the period of estimated servicing revenues.
LOANS are carried at the principal amount outstanding. Interest income is accrued on the principal balances of loans, except for installment loans with add-on interest, for which a method that approximates the level yield method is used. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrowers may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received.
ALLOWANCE FOR LOAN LOSSES is maintained to absorb loan losses based on management's continuing review and evaluation of the loan portfolios and its judgment as to the impact of economic conditions on the portfolios. The evaluation by management includes consideration of past loss experience, changes in the composition of the portfolios, the current condition and amount of loans outstanding, and the probability of collecting all amounts due. Impaired loans are measured by the present value of expected future cash flows, or the fair value of the collateral of the loan, if collateral dependent.
The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. Management believes that, as of December 31, 1996, the allowance for loan losses is adequate based on information currently available. A worsening or protracted economic decline in the area within which the Company operates would increase the likelihood of additional losses due to credit and market risks and could create the need for additional loss reserves.
PREMISES AND EQUIPMENT are carried at cost net of accumulated depreciation. Depreciation is computed using primarily the straight-line method based principally on the estimated useful lives of the assets. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on dispositions are included in current operations.
INTANGIBLE ASSETS are being amortized on a straight-line basis over fifteen years. Such assets are periodically evaluated as to the recoverability of their carrying value.
TREASURY STOCK is stated at cost. Cost is determined by the first-in, first-out method.
INCOME TAX in the consolidated statement of income includes deferred income tax provisions or benefits for all significant temporary differences in recognizing income and expenses for financial reporting and income tax purposes. The Company files consolidated income tax returns with its subsidiaries.
NET INCOME PER SHARE has been computed based upon the weighted average common shares outstanding during each year.
RECLASSIFICATIONS of certain amounts in the 1995 and 1994 consolidated financial statements have been made to conform to the 1996 presentation.
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. BUSINESS COMBINATION
On April 1, 1996, the Company consummated a business combination with First Shelby. The Company issued 695,852 shares of common stock in exchange for the outstanding shares of First Shelby common stock. The pooling-of-interest method of accounting for business combinations was used to account for the transaction. Accordingly, the consolidated balance sheet as of December 31, 1995 and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the years ended December 31, 1995 and 1994, of the Company and First Shelby have been combined as if the combination had been in effect for each of the periods presented.
For the three month period ended March 31, 1996, the Company and First Shelby had total interest and other income of $7,778,736 and $1,150,385, and net income of $947,531 and $184,444, respectively. In addition, the Company and First Shelby paid dividends totaling $243,121 and $77,151, respectively, and the Company also had net treasury stock sales of $10,992.
Presented below is the combined condensed financial information for the Company and First Shelby.
PRO FORMA COMBINED CONDENSED STATEMENTS OF INCOME
PRO FORMA YEAR ENDED DECEMBER 31, 1995 COMPANY FIRST SHELBY COMBINED - ------------------------------------------------------------------------------- Total interest income $20,382,729 $4,296,425 $24,679,154 Total interest expense 9,254,790 2,096,302 11,351,092 ------------------------------------------ Net interest income 11,127,939 2,200,123 13,328,062 Provision for loan losses 275,000 275,000 ------------------------------------------ Net interest income after provision for loan losses 10,852,939 2,200,123 13,053,062 Total other income 12,180,340 315,767 12,496,107 Total other expenses (17,669,371) (1,566,821) (19,236,192) ------------------------------------------ Income before income tax 5,363,908 949,069 6,312,977 Income tax expense 1,840,921 178,796 2,019,717 ------------------------------------------ Net income $3,522,987 $770,273 $4,293,260 ------------------------------------------ ------------------------------------------
PRO FORMA YEAR ENDED DECEMBER 31, 1994 COMPANY FIRST SHELBY COMBINED - ------------------------------------------------------------------------------- Total interest income $18,816,339 $4,082,506 $22,898,845 Total interest expense 7,303,192 1,801,579 9,104,771 ------------------------------------------ Net interest income 11,513,147 2,280,927 13,794,074 Provision for loan losses 300,000 300,000 ------------------------------------------ Net interest income after provision for loan losses 11,213,147 2,280,927 13,494,074 Total other income 11,058,685 319,526 11,378,211 Total other expenses (16,732,570) (1,579,364) (18,311,934) ------------------------------------------ Income before income tax 5,539,262 1,021,089 6,560,351 Income tax expense 1,922,408 205,471 2,127,879 ------------------------------------------ Net income $3,616,854 $815,618 $4,432,472 ------------------------------------------ ------------------------------------------
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. RESTRICTION ON CASH AND DUE FROM BANKS
The Banks are required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank. The reserve required at December 31, 1996, was $4,571,000.
4. INVESTMENT SECURITIES
----------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR DECEMBER 31 COST GAINS LOSSES VALUE - -------------------------------------------------------------------------------- Available for sale U.S. Treasury $ 32,416,906 $ 261,241 $ (99,222) $ 32,578,925 Federal agencies 54,686,279 249,647 (156,707) 54,779,219 Mortgage-backed securities 7,037,536 35,867 (79,045) 6,994,358 ----------------------------------------------------- Total available for sale 94,140,721 546,755 (334,974) 94,352,502 ----------------------------------------------------- Held to maturity U.S. Treasury 5,204,084 37,927 (14,339) 5,227,672 Federal agencies 2,756,587 14,935 (10,057) 2,761,465 State and municipal 14,004,848 235,232 (45,714) 14,194,366 Mortgage-backed securities 14,824,842 118,841 (107,503) 14,836,180 ----------------------------------------------------- Total held to maturity 36,790,361 406,935 (177,613) 37,019,683 ----------------------------------------------------- Total investment securities $130,931,082 $953,690 $(512,587) $131,372,185 ----------------------------------------------------- -----------------------------------------------------
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR DECEMBER 31 COST GAINS LOSSES VALUE - -------------------------------------------------------------------------------- Available for sale U.S. Treasury $ 32,063,528 $ 464,639 $ (79,008) $ 32,449,159 Federal agencies 52,428,739 466,342 (147,629) 52,747,452 Mortgage-backed securities 6,042,745 35,942 (91,857) 5,986,830 ----------------------------------------------------- Total available for sale 90,535,012 966,923 (318,494) 91,183,441 ----------------------------------------------------- Held to maturity U.S. Treasury 11,032,365 114,729 (38,829) 11,108,265 Federal agencies 4,565,286 49,717 (9,069) 4,605,934 State and municipal 12,207,269 254,268 (57,252) 12,404,285 Mortgage-backed securities 18,775,166 221,698 (58,376) 18,938,488 ----------------------------------------------------- Total held to maturity 46,580,086 640,412 (163,526) 47,056,972 ----------------------------------------------------- Total investment securities $137,115,098 $1,607,335 $(482,020) $138,240,413 ----------------------------------------------------- -----------------------------------------------------
The amortized cost and fair value of securities held to maturity and available for sale at December 31, 1996, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
HELD TO MATURITY AVAILABLE FOR SALE ----------------------------------------------------- AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE - -------------------------------------------------------------------------------- Within one year $ 4,023,914 $ 4,045,598 $19,639,335 $19,667,188
One to five years 11,771,633 11,902,320 61,466,004 61,688,756
Five to ten years 4,213,424 4,271,429 4,997,846 5,001,890
After ten years 1,956,548 1,964,156 1,000,000 1,000,310 ----------------------------------------------------- 21,965,519 22,183,503 87,103,185 87,358,144 Mortgage-backed securities 14,824,842 14,836,180 7,037,536 6,994,358 ----------------------------------------------------- Totals $36,790,361 $37,019,683 $94,140,721 $94,352,502 ----------------------------------------------------- -----------------------------------------------------
Securities with a carrying value of approximately $75,039,000 and $72,901,000 were pledged at December 31, 1996 and 1995 to secure certain deposits and for other purposes as permitted or required by law.
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Proceeds from sales of securities available for sale during 1996, 1995 and 1994 were $2,983,125, $11,186,551, and $12,011,251. Gross gains of $3,527, $25,563, and $79,245; and gross losses of $11,395, $18,046, and $60,731 were realized on those sales.
There were no sales of securities held to maturity in 1996, 1995, or 1994.
In December 1995, the Company transferred certain securities from held to maturity to available for sale in accordance with a transition reclassification allowed by the Financial Accounting Standards Board. Such securities had a carrying value of $29,576,613 and a fair value of $29,440,772. There were no securities transferred between classifications during 1996.
With the exception of securities of the U.S. Treasury and other U.S. Government agencies and corporations, the Company did not hold any securities of a single issuer, payable from and secured by the same source of revenue or taxing authority, the book value of which exceed 10% of stockholders' equity at December 31, 1996.
5. LOANS AND ALLOWANCE
DECEMBER 31 1996 1995 - ------------------------------------------------------------------------------- Commercial and industrial loans $ 25,742,303 $ 21,985,664 Real estate loans 84,220,073 79,295,603 Construction loans 11,658,518 10,215,131 Agricultural production financing and other loans to farmers 7,836,475 7,453,035 Individuals' loans for household and other personal expenditures and other loans 72,377,114 73,897,978 Tax-exempt loans 2,033,154 2,056,218 --------------------------- 203,867,637 194,903,629 Unearned interest on loans (3,972,557) (5,773,420) --------------------------- Total loans $199,895,080 $189,130,209 --------------------------- ---------------------------
YEAR ENDED DECEMBER 31 1996 1995 1994 - -------------------------------------------------------------------------------- Allowance for loan losses Balances, January 1 $3,355,735 $3,375,252 $3,258,993 Provision for losses 310,000 275,000 300,000 Recoveries on loans 178,652 189,115 285,830 Loans charged off (462,868) (483,632) (469,571) ------------------------------------------------ Balances, December 31 $3,381,519 $3,355,735 $3,375,252 ------------------------------------------------ ------------------------------------------------
The amounts of impaired loans outstanding at December 31, 1996 and 1995 and during 1996 and 1995 were immaterial.
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Banks have entered into transactions with certain directors, executive officers, significant stockholders and their affiliates or associates (related parties). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features. The aggregate amount of loans, as defined, to such related parties were as follows:
Balances, January 1, 1996 $1,197,000 Changes in composition of related parties 1,233,000 New loans, including renewals 975,000 Payments, etc., including renewals (523,000) ---------- Balances, December 31, 1996 $2,882,000 ---------- ----------
6. PREMISES AND EQUIPMENT
DECEMBER 31 1996 1995 - -------------------------------------------------------------------------------- Land $ 1,655,652 $ 1,655,652 Buildings and improvements 8,452,756 8,496,285 Equipment 13,216,922 15,189,281 ------------------------------ Total cost 23,325,330 25,341,218 Accumulated depreciation (13,159,283) (12,768,985) ------------------------------ Net $10,166,047 $12,572,233 ------------------------------ ------------------------------
7. LOAN SERVICING
Mortgage loans serviced for others are not included in the accompanying consolidated balance sheet. The unpaid principal balances of mortgage loans serviced for others totaled $64,902,000, $65,510,000, and $61,811,000 at December 31, 1996, 1995, and 1994.
In 1996, the Company adopted SFAS No. 122, ACCOUNTING FOR MORTGAGE SERVICING RIGHTS. This Statement requires the capitalization of retained mortgage servicing rights on originated or purchased loans by allocating the total cost of the mortgage loans between the mortgage servicing rights and the loans (without the servicing rights) based on their relative fair values. SFAS No. 122 was superseded during 1996 by SFAS No. 125, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES. SFAS No. 125 (as did SFAS No. 122) requires the assessment of impairment of capitalized mortgage servicing rights and requires that impairment be recognized through a valuation allowance based on the fair value of those rights. The aggregate fair value of capitalized mortgage servicing rights at December 31, 1996, totaled $101,279. Comparable market values and a valuation model that calculates the present value of future cash flows were used to estimate fair value. For purposes of measuring impairment, risk characteristics including product type, investor type, and interest rates, were used to stratify the originated mortgage servicing rights.
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31 1996 - -------------------------------------------------------------------------------- Mortgage Servicing Rights Balances, January 1 $ 0 Servicing rights capitalized 103,567 Amortization of servicing rights (2,288) ---------- Balances, December 31 $101,279 ----------- -----------
8. DEPOSITS
DECEMBER 31 1996 1995 - -------------------------------------------------------------------------------- Demand deposits $115,582,157 $121,143,547 Savings deposits 48,372,908 46,366,794 Certificates and other time deposits of $100,000 or more 54,139,966 50,297,887 Other certificates and time deposits 102,067,060 104,901,442 -------------------------- Total deposits $320,162,091 $322,709,670 -------------------------- --------------------------
Certificates and other time deposits maturing in years ending December 31, 1997 $127,913,407 1998 21,673,825 1999 5,544,937 2000 927,308 2001 147,549 ------------ $156,207,026 ------------ ------------
9. SHORT-TERM BORROWINGS
Securities sold under agreements to repurchase totaled $16,324,492 and $8,342,048 at December 31, 1996 and 1995, and consist of obligations of the Company to other parties. The obligations are secured by various investment securities and such collateral is held by various institutions in safekeeping. The maximum amount of outstanding agreements at any month-end during 1996 and 1995 totaled $17,469,463 and $12,017,198 and the daily average of such agreements totaled $10,329,748 and $8,052,496. The agreements at December 31, 1996, mature in 1997.
Federal Home Loan Bank ("FHLB") advances, 5.8%, due January 7, 1997 are secured by first-mortgage loans. FHLB advances are subject to restrictions or penalties in the event of prepayment.
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. STOCKHOLDERS' EQUITY
The Company has an employee stock option plan ("Plan") which is accounted for in accordance with Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES and related interpretations. Under this plan, the Company grants selected key officers stock option awards which vest and become fully exercisable after the fifth anniversary of date of the grant. Stock options granted under this plan shall expire ten years from date of grant. At December 31, 1996, there were options (not intended to be incentive stock options) for 18,450 shares outstanding. These options were granted on December 31, 1993, with an exercise price of $16.67 per share and a remaining contractual life of seven years. No shares have been exercised pursuant to the Plan and no shares are vested or exercisable at December 31, 1996, 1995, and 1994.
The Company adopted a deferred compensation plan for nonemployee directors of the Company effective June 30, 1994. According to the plan, a participating director may defer directors fees in a fixed income fund or, alternatively, in the form of "phantom stock units." A deferred compensation account, for those directors electing to receive phantom stock, shall be credited with phantom stock units. Phantom stock units shall also be increased by any stock dividends or stock splits declared by the Company. At December 31, 1996 and 1995, $145,862 and $91,403 had been deferred and credited to equity from this plan, which represented 7,331 and 4,717 phantom stock units.
On March 8, 1994, the stockholders approved an amendment to the Certificate of Incorporation of the Company to increase the number of authorized shares of common stock from 2,000,000 to 5,000,000 shares. Also, on March 8, 1994, the Company's Board of Directors declared a three-for-two stock split of its common stock to the stockholders. The stock split was affected by a stock distribution on April 4, 1994, and resulted in an increase of 969,798 common shares
11. INCOME TAX
YEAR ENDED DECEMBER 31 1996 1995 1994 - -------------------------------------------------------------------------------- Income tax expense (benefit) Currently payable Federal $2,328,323 $1,907,430 $2,087,704 State 44,985 106,745 200,065 Deferred Federal (119,771) 5,542 (159,890) ------------------------------------ Total income tax expense $2,253,537 $2,019,717 $2,127,879 ------------------------------------ ------------------------------------ Reconciliation of federal statutory to actual tax expense Federal statutory income tax at 34% $2,302,977 $2,146,412 $2,230,519 Tax exempt interest (258,912) (223,556) (251,881) Nondeductible expenses 161,301 35,366 68,621 Effect of state income taxes 29,690 70,452 132,042 Other 18,481 (8,957) (51,422) ------------------------------------ Actual tax expense $2,253,537 $2,019,717 $2,127,879 ------------------------------------ ------------------------------------
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A cumulative net deferred tax liability is included in other liabilities. The components are as follows:
The income tax expense (benefit) attributed to net gains or losses on sales of securities available for sale during 1996, 1995, and 1994 was approximately $(2,700), $2,600, and $6,000.
12. COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business there are outstanding commitments and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying financial statements. The Banks' exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Banks use the same credit policies in making such commitments as they do for instruments that are included in the consolidated balance sheet.
Financial instruments whose contract amount represents credit risk as of December 31 were as follows:
1996 1995 - -------------------------------------------------------------------------------- Commitments to extend credit $50,191,000 $44,963,000 Standby letters of credit 7,594,000 2,803,000
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Banks evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Banks' upon extension of credit, is based on management's credit evaluation. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance of a customer to a third party.
The Company and subsidiaries are also subject to claims and lawsuits which arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position of the Company.
13. RESTRICTION ON DIVIDENDS
Without prior approval of the Comptroller of the Currency, Decatur Bank is restricted by national banking laws as to the maximum amount of dividends it can pay in any calendar year to Decatur Bank's retained net profits (as defined) for that year and the two preceding years. At January 1, 1997, Decatur Bank had available retained earnings of approximately $4,290,000 for the payment of dividends without obtaining prior regulatory approval.
Without prior approval, Shelby Bank is restricted by Illinois law and regulations of the Office of Banks and Real Estate, State of Illinois, and the FDIC as to the maximum amount of dividends it can pay to its parent to the balance of the retained earnings account, adjusted for defined bad debts. At January 1, 1997, Shelby Bank had available retained earnings of approximately $10,278,000 for the payment of dividends.
As a practical matter, the Banks restrict dividends to a lesser amount because of their goal to maintain a strong capital structure.
14. REGULATORY CAPITAL
The Company and Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate actions by the regulatory agencies that, if undertaken, could have a material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Banks must meet specific capital guidelines that involve quantitative measures of the Company's and Banks' assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's and Banks' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 1996, the management of the Company believes that it meets all capital adequacy requirements to which it is subject. The most recent notification from the regulatory agencies categorized the Company and Banks as well capitalized under the regulatory framework for prompt corrective action. There have been no conditions or events since that notification that management believes have changed this categorization.
The Company's and Banks' actual and required capital amounts and ratios are as follows:
1 As defined by regulatory agencies
15. EMPLOYEE BENEFIT PLANS
The Company's defined benefit pension plan covers substantially all of Decatur Bank's and FirsTech's employees. Employees accrue a benefit of 2.75% per year based on current year compensation. The Company's general funding policy is to contribute amounts deductible for federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. Pension expense was $60,632, $58,683, and $66,638 for 1996, 1995 and 1994, respectively.
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth the plan's funded status and amounts recognized in the consolidated balance sheet:
Decatur Bank and FirsTech have a retirement savings 401(k) plan in which substantially all employees may participate. Under this plan, employees are able to make payroll deferrals not to exceed 15% of a participant's compensation. No matching contributions are made by the Company.
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Decatur Bank and FirsTech also have an Employee Stock Ownership Plan covering substantially all employees. The cost of the plan is borne by Decatur Bank and FirsTech through contributions to an Employee Stock Ownership Trust in amounts determined by the Board of Directors. The contributions to the plan in 1996, 1995, and 1994 were $156,000, $145,000, and $180,000, respectively.
Shelby Bank has a profit sharing plan covering substantially all employees. Profit sharing expense for this plan was $44,948, $48,215, and $43,099 for 1996, 1995 and 1994, respectively.
16. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instrument:
CASH AND CASH EQUIVALENTS -- The fair value of cash and cash equivalents approximates carrying value.
INVESTMENT SECURITIES -- Fair values are based on quoted market prices.
LOANS -- For both short-term loans and variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value for other loans is estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.
INTEREST RECEIVABLE/PAYABLE -- The fair values of interest receivable/payable approximates carrying values.
DEPOSITS -- The fair values of demand and savings accounts are equal to the amount payable on demand at the balance sheet date. The carrying amounts for variable rate, fixed-term certificates and other time deposits approximate their fair values at the balance sheet date. Fair values for fixed-rate certificates and other time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on such time deposits.
FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER REPURCHASE AGREEMENTS--Federal funds purchased and securities sold under repurchase agreements are short-term borrowing arrangements. The rates at December 31, 1996 and 1995 approximate market rates, thus, the fair value approximates carrying value.
U.S. TREASURY DEMAND NOTES -- The fair value of U.S. Treasury demand notes approximates carrying value.
FHLB ADVANCES -- The fair value of these borrowings approximates carrying value as the advances are short-term borrowing arrangements.
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OFF-BALANCE SHEET COMMITMENTS -- Commitments include commitments to extend credit and standby letters of credit and are generally of a short-term nature. The fair value of such commitments are based on fees currently charged to enter into similar arrangements, taking into account the remaining terms of the agreements and the counterparties' credit standing.
The estimated fair values of the Company's financial instruments are as follows:
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. BUSINESS INDUSTRY SEGMENTS
The Company currently operates in two industry segments. The primary business involves providing the typical banking services of generating loans and receiving deposits from customers. The Company also provides remittance processing and remittance collection services. The following is a summary of selected data for the various business segments:
(1) Excludes dividend income received from subsidiaries.
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information related to services or transfers between business segments is not reflected because such items are immaterial.
Total revenue from one major customer (defined as a customer who provided in excess of ten percent of total consolidated revenue) in the remittance services segment approximated 5%, 16%, and 15% of total consolidated revenue in 1996, 1995, and 1994, respectively. FirsTech's contracts to process payments for this major customer expired in 1996 and were not renewed. The loss of these significant contracts was the main contributor to the decrease in income before income tax for 1996 for FirsTech of approximately $622,000.
18. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY)
Presented below is condensed financial information as to financial position, results of operations and cash flows of the Company:
CONDENSED BALANCE SHEET DECEMBER 31 1996 1995 - -------------------------------------------------------------------------------- ASSETS Cash $ 116,135 $ 263,671 Investment in Banks 41,956,712 39,376,991 Investment in FirsTech 5,060,941 4,746,431 Other assets 1,387,984 1,522,983 -------------------------- Total assets $48,521,772 $45,910,076 -------------------------- -------------------------- LIABILITIES $ 27,462 $ 30,170 STOCKHOLDERS' EQUITY 48,494,310 45,879,906 --------------------------
Total liabilities and stockholders' equity $48,521,772 $45,910,076
FIRST DECATUR BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED STATEMENT OF INCOME
YEAR ENDED DECEMBER 31 1996 1995 1994 - --------------------------------------------------------------------------------
INCOME Dividends from Banks $1,367,709 $1,009,659 $ 923,298 Dividends from FirsTech 159,078 242,520 220,686 Other income 145,951 140,191 140,247 --------------------------------------- Total income 1,672,738 1,392,370 1,284,231 --------------------------------------- EXPENSES 328,713 97,813 60,440 --------------------------------------- Income before income tax and equity in undistributed income of subsidiaries 1,344,025 1,294,557 1,223,791 Income tax expense 690 3,042 4,658 --------------------------------------- Income before equity in undistributed income of subsidiaries 1,343,335 1,291,515 1,219,133 Equity in undistributed income of subsidiaries 3,176,589 3,001,745 3,213,339 --------------------------------------- NET INCOME $4,519,924 $4,293,260 $4,432,472 --------------------------------------- ---------------------------------------
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information concerning each person who is currently a director of Bancshares and each person who is currently an executive officer of Bancshares:
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
The executive officers of Bancshares do not receive compensation from Bancshares in their capacities as officers thereof, but instead receive compensation in their capacities as officers of the Decatur Bank, FirsTech and the Shelby Bank.
ANNUAL COMPENSATION
The following table sets forth compensation for the years presented for services in all capacities for Bancshares, the Decatur Bank, FirsTech and the Shelby Bank by the President of Bancshares and the three executive officers who earned greater than $100,000 in salary and bonus during the fiscal
year ended December 31, 1996. No other executive officer of Bancshares or its subsidiaries earned greater than $100,000 in salary and bonus during the fiscal year ended December 31, 1996.
(1) None of the named executive officers received any perquisites or other personal benefits, securities or property in an amount exceeding 10% of his salary and bonus during the period listed.
(2) All allocations to Bancshares Employee Stock Ownership Plan (the "ESOP") referenced in this column represents allocations determined in the current year for service in the prior year. Bancshares has not finalized the allocations to the ESOP accounts for service in 1996.
(3) Includes $10,542.21 in allocations to Mr. Luttrell's account under the ESOP and $3,810 in term life insurance premiums paid.
(4) Includes $5,583.06 in allocations to Mr. Brahier's account under the ESOP and $365.20 in term life insurance premiums paid.
(5) Mr. Graves gave his resignation in December, effective January 10, 1997.
(6) Includes $5,125.26 in allocations to Mr. Grave's account under the ESOP and $132.60 in term life insurance premiums paid.
(7) Represents Mr. Tates allocation of the Shelby Bank Profit Sharing Plan.
The following table shows for each of the named executives the number and value of unexercised stock options at the end of fiscal year 1996.
(1) Based upon an assumed fair market value of a share of Bancshares Common Stock at December 31, 1996 of $21.00.
No stock options were granted or exercised during the 1996 fiscal year. None of the issued options were exercisable at December 31, 1996.
RETIREMENT INCOME PLAN
Bancshares maintains The First National Bank of Decatur Retirement Income Plan ("RIP"). The RIP is a non-contributory, defined benefit plan for substantially all of the employees of the Decatur Bank and FirsTech. To be eligible to participate in the RIP an employee must have completed one year of full-time service. The amount of a participant's pension benefit depends primarily on years of employment, age at retirement, death or disability and annual compensation levels. Eligible employees accrue an annual pension benefit of 2.75% of their annual compensation. The normal retirement pension equals the sum of such annual pension benefits. Participants become fully vested in their accrued pension benefits after five years of participation in the RIP. The RIP is not integrated with Social Security. Payment of vested pension benefits normally begins at age 65 (the normal retirement age) but an early retirement benefit at a reduced level may be paid if a participant is at least 55 years of age with 5 years of service. In addition, a disability benefit will be paid before age 65 if a participant's employment is terminated by reason of a disability and participant is at least 50 years of age with 15 years of service before termination.
As of December 31, 1996, the estimated annual pension benefits payable upon retirement at age 65 for the executive officers named above in the Summary Compensation Table are as follows: $84,000 for Mr. Luttrell, $77,000 for Mr. Brahier, $24,000 for Mr. Graves and $0 for Jack Tate. Mr. Graves gave his resignation in December, effective January 10, 1997. These estimates are based on the assumptions that each of the officers, except Mr. Graves, will remain as employees of Bancshares until age 65 without an increase from 1996 levels in the compensation included for purposes of the RIP and that the annual benefit rate remains 2.75% of total annual compensation.
DIRECTOR COMPENSATION
During 1996, Tom R. Dickes, Chairman of the Board of Bancshares, received a monthly retainer of $2,583.33. He did not receive any other compensation for board meetings attended. All other non-employee directors of Bancshares received a monthly retainer of $416.66 in 1996. In addition, for each regular monthly Bancshares board meeting attended, each non-employee director
received $350; and for each special board meeting of Bancshares, the Decatur Bank or FirsTech attended and for each committee meeting of Bancshares, the Decatur Bank or FirsTech attended, each non-employee director received $175. Directors of Bancshares who are directors of the Decatur Bank and FirsTech do not receive any additional compensation for regular monthly meetings of the boards of the Decatur and FirsTech. Employee directors do not receive any compensation for serving as directors.
In lieu of receiving cash payments for attendance at board and committee meetings, non-employee directors of Bancshares may participate in a deferred directors compensation program which was adopted June 30, 1994. Under the plan, a non-employee director may defer director fees into a fixed income fund maintained by the trust department of the Decatur Bank or, alternatively, may receive phantom stock units in lieu of directors fees. Bancshares maintains a record of the number of phantom stock units each participating director acquires through the deferral fees. Phantom stock units are purchased at a price equal to the market price of Bancshares Common Stock based upon the most recent purchase of stock by Bancshares. Each participating director's account is increased by an amount equal to any stock dividend or stock split declared and paid by Bancshares. At December 31, 1996, 7 non-employee directors had deferred an aggregate of $145,852 in directors fees, which represented 7,331 phantom stock units.
During 1996, directors of the Shelby Bank received $600 for each regular monthly board meeting attended and $400 for each special board meeting attended. In addition, there is a $3,500 annual retainer fee for members of the Loan Committee and Audit Committee. Jack L. Tate and Robert M. Pancoast each received a $1,000 annual retainer fee as Chairmen of the Loan and Trust Advisory Committees, respectively.
Bancshares maintains a compensation committee consisting of six members of the Board of Directors. The following directors are members of the compensation committee: Tom Dickes, John Luttrell, Gary Likins, William Penhallegon, Fred Kenney and Gale Zacheis. Mr. Luttrell is the only executive officer who is a member of the committee. He does not serve as director of any other entity whose executive officers are members of Bancshares' compensation committee.
EMPLOYMENT CONTRACTS
Bancshares and the Decatur Bank have entered into individual employment agreements with Messrs. Brahier and Luttrell. The agreements were made as of June 1, 1987 for an initial term of employment through December 31, 1989 and successive three-year periods thereafter. The current period expired December 31, 1995. Neither Bancshares nor either employee has delivered notice terminating such agreements; accordingly, the agreements will continue for an additional three-year period until December 31, 1998, unless sooner terminated by their respective terms. The employment agreements set forth the monthly salary and general benefits to be provided Messrs. Brahier and Luttrell. The employment agreements are terminable by the employee upon 30 days' notice to Bancshares. Bancshares may terminate the employment agreement for cause, such as fraud or illegal acts, and upon 30 days' written notice, without cause. If the employee is terminated without cause, the Decatur Bank is required to pay the employee a severance payment equal to two times the employee's then current annual salary. Messrs. Brahier and Luttrell also are entitled to receive such severance payment amount in the event of involuntary termination due to a permanent disability.
In the event the employment agreement with Mr. Brahier or Mr. Luttrell is involuntarily terminated within two years of a change in control of the Decatur Bank, either terminated employee is entitled to receive a lump sum cash payment equal to 200% of such employee's then current base salary. A change in control is defined in the employment agreements as the acquisition of 40% or more of the voting control of the Decatur Bank by any one person or group or a change in the majority of the board of directors following a successful tender offer, merger or other business combination.
Bancshares and Shelby Bank have entered into an agreement with Messr. Tate. The agreement provides that Messr. Tate will be employed by the Shelby Bank in his current positions for a five year period at an agreed upon salary and benefits. The employee may be terminated with or without cause; however, if the employee is terminated without cause the Shelby Bank is required to pay the employee a severance payment equal to what the employee would have been paid under the term of the agreement and is required to allow the employee to continue to participate in all employee benefit plans as if the employee continued to be an employee of the Shelby Bank for the remaining term of the five-year period. During the term of the agreement and for a five-year period after the employee's employment is terminated ("Noncompete Period"), the employee has agreed not to compete with Bancshares within a 60-mile radius around the Shelby Bank. However, if a Change in Control relating to Bancshares or the Shelby Bank occurs, the employee will not be subject to the noncompetition provisions except that the employee will be subject to such noncompete provision during such part of the Noncompete Period the employee is paid monthly compensation equal to the employee's most recent salary. The agreement defines the term "Change in Control" to mean the acquisition by one entity, person or group (other than an entity in which Bancshares holds more than 50% of the voting stock) of 40% or more of the voting stock of Bancshares or the Shelby Bank or a change in the majority of the board of directors of Bancshares or the Shelby Bank after a successful tender offer, merger or other business combination, excluding any merger or other business combination with any entity in which Bancshares holds more than 50% of the voting stock of such entity.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding Bancshares' Common Stock beneficially owned on December 31, 1996 with respect to all persons known to Bancshares to be the beneficial owner of more than five percent of Bancshares' Common Stock, each director and nominee, each executive officer named in the Summary Compensation Table and all directors and executive officers of Bancshares as a group.
NAME OF BENEFICIAL OWNER NUMBER OF % OF SHARES CLASS (1) - ----------------------------------------------------------- ------------ 5% STOCKHOLDERS:
CEDE & Co. 249,431(2) 8.64%
P.O. Box 20
Bowling Green Station
New York, NY 10274
The First National Bank of Decatur, as Trustee 595,167(3) 20.62%
130 North Water Street
Decatur, IL 62523
DIRECTORS:
Milton J. Brahier 6,459(4) *
J. Gerald Demirjian 500 *
Tom R. Dickes 154,326(5) 5.35%
William T. Eichenauer 1,000 *
Larry D. Haab 3,600 *
Fred L. Kenney 1,330(6) *
Gary S. Likins 600 *
John W. Luttrell 29,637(7) 1.03%
Robert M. Pancoast 20,225 *
William E. Penhallegon 9,242(8) *
Tom Sloan 8,636 *
Jack L. Tate 33,500 1.16%
H. Gale Zacheis, M.D. 3,900(9) *
DIRECTORS AS A GROUP (13 PERSONS) 272,955 9.45%
* Less than one percent.
(1) Based upon 2,887,036 issued and outstanding shares of Bancshares Common Stock at December 31, 1996.
(2) CEDE & Co. holds such shares as nominee for Midwest Clearing House, a clearing operation or brokerage firms. Bancshares does not have any additional information regarding the ownership of such shares.
(3) Includes 130,325 shares held as trustee of Bancshares's ESOP and 464,842 shares held as trustee of other individual trusts, none of which beneficially holds five percent or more of Bancshares Common Stock.
(4) Includes 2,100 shares held in an individual retirement account, 1,800 shares held in joint tenancy with his spouse and 2,559 shares (rounded to nearest whole share) in the ESOP.
(5) Includes 133,526 shares held individually and 20,800 shares held by spouse individually.
(6) Includes 330 shares held individually and 1,000 shares held in joint tenancy with his spouse.
(7) Includes 12,150 shares held individually, 3,471 shares held in an individual retirement account, 11,616 shares (rounded to nearest whole share) in the ESOP and 2,400 shares held by his spouse individually.
(8) Includes 8,942 shares held individually and 300 shares held by his spouse individually.
(9) Includes 3,300 shares held individually and 600 shares held by his spouse individually.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Since January 1, 1994, the Decatur Bank has paid Christy-Foltz Inc. a total of approximately $72,700 for construction services in connection with remodeling and repairing the Decatur Bank's offices. Tom R. Dickes, Chairman of the Board of Bancshares, is a shareholder and Chairman of the Board of Christy-Foltz Inc.
Mr. Kenney is an attorney for Winters, Featherstun, Gaumer, Kenney, Postlewait and Stocks, a law firm in Decatur, Illinois. Bancshares does not use the services of this law firm.
Mr. Pancoast owns and operates Shelbyville Abstract and Title Corporation, a real estate abstract and title company located in Shelbyville, Illinois, which does real estate work for the Shelby Bank. Shelby Bank utilizes Shelbyville Abstract and Title Corporation, along with other local abstract and title companies, for its real estate work. Bancshares intends to increase the real estate lending activities of the Shelby Bank.
The Decatur Bank and the Shelby Bank has made loans to its directors, officers and employees in the ordinary course of business. Such loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time the loan was originated for comparable transactions with non-affiliated persons and do not, in the opinion of Bancshares, involve more than the normal risk of collectibility or present any other unfavorable features. As of December 31, 1996, the Decatur Bank and the Shelby Bank had an aggregate of approximately $2.9 million of outstanding loans to its directors and executive officers and their affiliates.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Financial Statement Schedules
The following consolidated financial statements and financial statement schedules of the registrant are filed as part of this document under Item 8, Financial Statements:
Consolidated Balance Sheet - December 31, 1996 and 1995
Consolidated Statement of Income - For the Years Ended December 31, 1996, 1995 and 1994
Consolidated Statement of Changes in Stockholders' Equity - For the Years Ended December 31, 1996, 1995 and 1994
Consolidated Statement of Cash Flows - For the Years Ended December 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements - For the Years Ended December 31, 1996, 1995 and 1994
(b) Reports on Form 8-K
There were no reports on Form 8-K filed by the registrant during the quarter ended December 31, 1996.
(c) Exhibits
The exhibits required by Item 601 of Regulation S-K and filed herewith are listed in the Exhibit Index which follows the Signature Page and immediately precedes the exhibits filed.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FIRST DECATUR BANCSHARES, INC.
By: /s/ John W. Luttrell 3/21/97 ------------------------------- ------- John W. Luttrell, President and Date Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated.
By: /s/ John W. Luttrell 3/21/97 By: /s/ Tom R. Dickes 3/21/97 ---------------------------- ------- ----------------------- ------- John W. Luttrell, President Date Tom R. Dickes, Chairman Date and Chief Executive Officer of the Board
By: /s/ Craig A. Wells 3/21/97 ---------------------------- ------- Craig A. Wells, Principal Date Financial Officer and Controller
By: /s/ Milton J. Brahier 3/21/97 By: /s/ Gerald Demirjian 3/21/97 ---------------------------- ------- ------------------------- ------- Milton J. Brahier, Director Date Gerald Demirjian, Director Date
By: /s/ William Eichenauer 3/21/97 By: /s/ Larry D. Haab 3/21/97 ---------------------------- ------- ------------------------- ------- William Eichenauer, Director Date Larry D. Haab, Director Date
By: /s/ Fred L. Kenney 3/21/97 By: /s/ Gary S. Likins 3/21/97 ---------------------------- ------- ------------------------- ------- Fred L. Kenney, Director Date Gary S. Likins, Director Date
By: /s/ William E. Penhallegon 3/21/97 By: /s/ Tom Sloan 3/21/97 ---------------------------- ------- ------------------------- ------- William E. Penhallegon, Date Tom Sloan, Director Date Director
By: /s/ Jack L. Tate 3/21/97 By: /s/ H. Gale Zacheis 3/21/97 ---------------------------- ------- ------------------------- ------- Jack L. Tate, Director Date H. Gale Zacheis, M.D., Date Director
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.
Bancshares Annual Report to Stockholders and Proxy Statement have been supplied supplementally to the Commission.
EXHIBIT INDEX