HARRODSBURG FIRST FINANCIAL BANCORP, INC.
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Harrodsburg First Financial Bancorp, Inc., a Delaware corporation (the
"Company"), converted from a unitary savings and loan holding company to a bank
holding company effective July 15, 2001, and on the same date acquired a 56.27%
interest in Citizens Financial Bank, Inc. (Citizens), which is a newly organized
de novo Kentucky chartered commercial bank located in Glasgow, Kentucky. The
Company serves as the bank holding company for Citizens and for First Financial
Bank ("First Financial"), a federally chartered savings bank of which it is the
sole shareholder.
First Financial is subject to regulation by the Office of Thrift Supervision
("OTS") and Citizens is subject to examination and regulation by the Federal
Deposit Insurance Corporation and the Kentucky Department of Financial
Institutions. The primary activity of the Company is its investment in the stock
of First Financial and Citizens and monitoring their operations. Accordingly,
the information set forth in this report, including financial statements and
related data, relates primarily to the operations of First Financial and
Citizens.
First Financial was formed in 1961 as a federal mutual savings and loan
association and obtained insurance of accounts and became a member of the
Federal Home Loan Bank ("FHLB") of Cincinnati at that time. Upon its conversion
to stock form in September 1995, the Bank adopted the name First Federal Savings
Bank of Harrodsburg. Effective January 1, 2000, the Bank's name was changed to
First Financial Bank. First Financial operates through one full service office
in Harrodsburg, Kentucky, and two full service branch offices in Lawrenceburg,
Kentucky.
The executive offices of the Company and First Financial are located at 000
Xxxxx Xxxxxx Xxxxxx, Xxxxxxxxxxx, Xxxxxxxx 00000, and its telephone number is
(000) 000-0000. The executive offices of Citizens are located at 000 Xxxx Xxxxxx
Xxxxxx, Xxxxxxx, Xxxxxxxx, 00000 and its telephone number is (000) 000-0000.
MARKET AND DIVIDEND INFORMATION
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Market for the Common Stock
Since October 4, 1995, the Common Stock of the Company has been listed for
trading under the symbol "HFFB" on the National Association of Securities
Dealers, Inc. Automated Quotation ("NASDAQ") National Market. As of December 6,
2002, there were 1,334,016 shares of the Common Stock issued and outstanding,
held by approximately 500 stockholders of record, not including beneficial
owners in nominee or street name.
Dividends
The Company maintains a policy whereby it will pay a semi-annual cash dividend
payable as of the 15th day of each April and October or the first business day
thereafter if such day is not a business day, to stockholders of record as of
the last business day of the month following the end of such semi-annual period.
The regular semi-annual dividend of $0.30 per share was payable on October 15,
2002 to stockholders of record on September 28, 2002. The Board of Directors of
the Company periodically reviews its dividend policy. Any change in the
Company's dividend policy, as determined by the Board of Directors, will depend
on the Company's debt and equity structure, earnings, regulatory capital
requirements, and other factors, including economic conditions, regulatory
restrictions, and tax considerations. See Note 9 of Notes to Consolidated
Financial Statements for restrictions on the payment of cash dividends. For
further information on stock prices and dividends, see Stock Prices and
Dividends (page 3).
SELECTED FINANCIAL AND OTHER DATA
Financial Condition Data
At September 30,
----------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
(Dollars in Thousands)
----------------------------------------------------
Total Amount of:
Assets ........................... $153,052 $136,541 $117,393 $110,416 $109,919
Loans receivable, net ............ 113,352 105,081 100,881 89,062 85,272
Investments (1) .................. 21,328 17,450 10,994 11,240 14,966
Cash and interest-bearing deposits 12,448 10,896 3,031 8,350 8,074
Deposits ......................... 121,920 102,961 86,473 82,018 78,996
FHLB advances .................... 5,000 7,000 3,500
Minority interests ............... 1,662 1,849
Stockholders' equity ............. 22,066 22,305 25,241 26,220 28,982
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Number of:
Real estate loans outstanding .... 1,446 1,559 1,587 1,532 1,601
Deposit accounts ................. 10,909 10,535 10,026 9,574 9,590
Full service offices ............. 4 4 3 2 2
--------------------------
(1) Includes FHLB stock, and term deposits with the FHLB.
Operating Data
For the year ended September 30,
---------------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
(Dollars in Thousands)
---------------------------------------------------
Interest income ................ $ 8,737 $ 8,744 $ 8,051 $ 7,745 $ 7,778
Interest expense ............... 4,741 5,187 4,150 3,813 3,897
------- ------- ------- ------- -------
Net interest income ........ 3,996 3,557 3,901 3,932 3,881
Provision for loan losses ...... 241 39 15 35 96
------- ------- ------- ------- -------
Net interest income after
provision for loan losses . 3,755 3,517 3,886 3,897 3,785
Non-interest income ............ 486 178 113 116 122
Non-interest expense ........... 3,306 2,679 2,261 1,728 1,679
------- ------- ------- ------- -------
Income before income tax expense
and minority interests ..... 935 1,016 1,738 2,285 2,228
Income tax expense ............. (494) (394) (591) (777) (799)
Minority interests ............. 229 63
------- ------- ------- ------- -------
Net income ..................... $ 670 $ 685 $ 1,147 $ 1,508 $ 1,429
======= ======= ======= ======= =======
Basic earnings per share ....... $ .54 $ .52 $ .76 $ .94 $ .79
======= ======= ======= ======= =======
Diluted earnings per share ..... $ .54 $ .52 $ .76 $ .94 $ .79
======= ======= ======= ======= =======
2
Key Operating Ratios
At or for the year ended September 30,
-------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Performance Ratios:
Return on average assets (net income
dividend by average total assets) ... .46% .56% 1.02% 1.36% 1.31%
Return on average equity (net income
divided by average equity ........... 3.02 3.06 4.49 5.49 4.98
Average interest-earning assets to
average interest-bearing liabilities 116.00 123.25 128.80 133.86 136.40
Net interest rate spread .............. 2.34 1.95 2.46 2.43 2.30
Net yield on average interest-earning
assets .............................. 2.89 2.95 3.55 3.63 3.63
Dividend payout ....................... 110.90 108.63 113.08 87.74 102.38
Capital Ratios:
Average equity to average assets
(average equity divided by average
total assets) ....................... 15.32 18.16 22.64 24.80 26.31
Equity to assets at period end ........ 14.42 16.34 21.50 23.75 26.37
Asset Quality Ratios:
Net interest income after provision for
loan losses to total other expenses . 113.58 131.28 171.87 225.58 225.43
Non-performing loans to total loans ... .33 .21 .51 .32 .57
Non-performing loans to total assets .. .25 .16 .44 .25 .44
Stock Prices and Dividends
The following table sets forth the range of high and low sales prices for the
common stock as reported by the Wall Street Journal as well as dividends
declared in each quarter for 2002 and 2001. Such over-the-counter market
quotations reflect inter-dealer prices, without retail xxxx-up, xxxx-down, or
commission and may not necessarily represent actual transactions.
Quarterly Stock Information
Fiscal 2002 Fiscal 2001
---------------------------------- ------------------------------
Stock Price Range Stock Price Range
---------------------- -----------------------
Per Share Per Share
Quarter Low High Dividend Low High Dividend
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1st $ 10.82 $ 12.11 $ - $ 9.69 $ 12.88 $ -
2nd 11.00 12.03 .30 10.75 14.50 .30
3rd 11.00 13.52 - 11.00 13.00 --
4th 10.95 12.49 .30 10.00 13.00 .30
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$ .60 $ .60
======= ======
3
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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The Private Securities Litigation Reform Act of 1995 contains safe harbor
provisions regarding forward-looking statements. When used in this discussion,
the words "believes," "anticipates," "contemplates," "expects," and similar
expressions are intended to identify forward-looking statements. Such statements
are subject to certain risks and uncertainties, which could cause actual results
to differ materially from those projected. Those risks and uncertainties include
changes in interest rates, risks associated with the ability to control costs
and expenses, and general economic conditions. Harrodsburg First Financial
Bancorp, Inc. undertakes no obligation to publicly release the results of any
revisions to those forward looking statements, which may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
Harrodsburg First Financial Bancorp, Inc. ("Company") is a bank holding company
headquartered in Harrodsburg, Kentucky, which provides a full range of deposits
and traditional mortgage loan products through its wholly owned subsidiary,
First Financial Bank ("First Financial"), a federally chartered savings bank,
and Citizens Financial Bank, Inc. ("Citizens"), a state chartered commercial
bank, in which the Company has a 55.8% interest. All references to the Company
generally refer to the consolidated entity including First Financial and
Citizens, unless the context indicates otherwise. "Banks" refers to the combined
operations of First Financial and Citizens, unless the context indicates
otherwise.
Overview
On July 15, 2001, the Company converted from a unitary savings bank holding
company to a bank holding company, and on the same date acquired a 56.27%
interest in Citizens Financial Bank, Inc., which is a Kentucky chartered
commercial bank. The Company paid a cash price of $2,816,300 for its controlling
interest in Citizens. The acquisition was accounted for under the purchase
method of accounting. As a result of the transaction, the Company recorded
goodwill of $356,064 for the excess cost over the net assets acquired. The
Company has determined that goodwill is not impaired as of September 30, 2002.
The Company's investment in Citizens decreased to 55.8% in fiscal 2002 due to
Citizens issuance of 2,100 shares of stock in lieu of cash for rental of
Citizens banking office. Future rent is payable in cash.
For the fiscal year ended September 30, 2002, net income was $670,000 or $.54
cents per diluted share, as compared to $685,000 or $.52 cents per diluted share
for fiscal 2001. During the year assets increased $16.5 million to $153 million.
Net loans outstanding grew by 7.9% to $113.4 million and asset quality remains
strong. Net income decreased by 2.19% during the year or $15,000. Citizens, as a
startup venture has not yet achieved profitability. The Company's share of
Citizens loss was $(289,000) compared to $(81,000) for the year ended September
30, 2001, an increased loss of $(208,000). First Financial Bank's net income
increased by $206,000 for the year, primarily due to increases in cash surrender
value of the Bank's investment in life insurance.
Asset/Liability Management
Market Risk Analysis. The Banks, like many other financial institutions, are
vulnerable to an increase in rates to the extent that interest-bearing
liabilities generally mature or reprice more rapidly than interest-earning
assets. Historically, the lending activities of savings institutions, such as
First Financial, emphasized the origination of long-term, fixed rate loans
secured by single family residences, and the primary source of funds has been
deposits with substantially shorter maturities. While having interest-bearing
liabilities that reprice more frequently than interest-earning assets is
generally beneficial to net interest income during a period of declining
interest rates, such an asset/liability mismatch is generally detrimental during
periods of rising interest rates.
4
Historically, the lending activities of commercial banks, such as Citizens,
emphasized the origination of short to intermediate variable rate loans, secured
by various types of collateral that are more closely matched with the deposit
maturities and repricing of interest-earning assets occurs closer to the same
general time period.
To reduce the effect of interest rate changes on net interest income the Banks
have adopted various strategies to improve matching of interest-earning asset
maturities to interest-bearing liability maturities. The principal elements of
these strategies include:
o Originate one to four family residential mortgage loans with adjustable
rate features or fixed rate loans with short maturities;
o Lengthen the maturities of our liabilities when it would be cost effective
through the pricing and promotion of higher rate certificates of deposit
and utilization of FHLB advances or other borrowings;
o Attract low cost checking and transaction accounts, which tend to be less
interest rate sensitive when interest rates rise;
o Maintain interest-bearing deposits, federal funds, and U.S. government
securities with short to intermediate terms to maturities; and
o Maintain an investment portfolio that provides a stable cash flow, thereby
providing investable funds in varying interest rate cycles.
The Banks also monitor interest rate sensitivity through the use of a model,
which estimates the change in net portfolio value ("NPV") in the event of a
range of assumed changes in market interest rates. Net portfolio value is
defined as the current market value of assets, less the current market value of
liabilities, plus or minus the current value of off-balance sheet items. The
change in NPV measures the Banks' vulnerability to changes in interest rates by
estimating the change in the market value of assets, liabilities, and
off-balance sheet items as a result of an instantaneous change in the general
level of interest rates.
As market interest rates decrease, the average maturities of loans and
investment securities shorten due to quicker prepayments, causing an increase in
their value. Deposit accounts have only relatively minor movements in a
declining interest rate environment since they are primarily short-term in
nature, resulting in the value of deposits decreasing more quickly than the
value of assets increase.
The NPV models used by the OTS and the FDIC has certain shortcomings. Based on
the models, certain assumptions are made that may or may not actually reflect
how actual yields, and costs will react to market interest rates. For example,
the NPV models assume that the makeup of the Banks' interest rate sensitive
assets, and liabilities will remain constant over the period being measured.
Thus, although using such models can be instructive in providing an indication
of the Banks exposure to interest rate risk, the Banks cannot precisely forecast
the effects of a change in market interest rates. Additionally, the results
indicated by the models are likely to differ from actual results.
First Financial measures its interest rate risks, using the Office of Thrift
Supervision NPV method. The OTS defines the sensitivity measure as the change in
the NPV ratio with a 200 basis point shock. At September 30, 2002, if interest
rates increased by 200 basis points, First Financial's NPV ratio would be 14.62%
based on a 136 basis point decrease in its NPV. Additionally, if interest rates
decline by 100 basis points, First Financial's NPV ratio would be 16.13% based
on a 16 basis point increase in its NPV. Due to the abnormally low prevailing
rate environment, the OTS does not currently provide NPV estimates for 200 basis
point declines in interest rates.
The FDIC does not require a specific measurement tool for interest rate risk but
sets forth desirable interest rate risk management practices, including adequate
risk measurement systems. Citizens measures its exposure to rate movements using
a 200 up/down rate stock to determine 12 month impact on net interest margins
for assets and liabilities repricing in one year. As of June 30, 2002, if rates
increased 200 basis points, net interest margins would decline .01%. If rates
decreased 200 basis points net interest margins would decline by .05%.
5
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2002 and 2001
The Company's consolidated assets increased $16.5 million, or 12.1%, to $153
million at September 30, 2002. The increase in total assets is primarily due to
Citizens, whose total assets increased $15.9 million or 134.75%. Consolidated
interest bearing assets increased $13.8 million or 10.4%. Loans outstanding
increased $8.5 million. Other significant changes to interest bearing assets
include an increase in securities available-for-sale of $4.8 million and in time
deposits in other banks of $4.7 million. These increases in interest bearing
assets were offset primarily by a decrease in interest bearing demand accounts
of $2.7 million, securities held-to-maturity of $1.0 million, and decreases in
federal funds sold of $.6 million. Non-interest bearing assets increased by $2.7
million due primarily to the increase in cash surrender value of life insurance
of $2.6 million.
Securities available-for-sale increased $4.8 million at September 30, 2002 to
$17.3 million from $12.5 million at September 30, 2001. The decline in U.S.
government securities of $2.6 million was offset by the purchase of
mortgaged-backed securities of $8.0 million. Securities held-to-maturity
decreased by $1 million. The decrease was attributable to maturities of
securities during the year.
Loans receivable, net increased $8.3 million or 7.9% at September 30, 2002 to
$113.4 million from $105.1 million at September 30, 2001. The increase in
interest bearing loans was due to Citizens increase of $17.8 million, which was
offset by a decrease of $9.5 by First Financial. First Financial loans decreased
primarily due to decisions by management not to originate long-term fixed rate
loans at market rates below a certain yield. Significant changes in the mix of
loans includes an increase in commercial loans primarily secured by real estate
of $5.4 million, an increase in loans secured by farmland of $3.4 million and an
increase in commercial loans of $2.6 million. These increases were offset by
declines in residential loans secured by real estate of $4.2 million and real
estate construction and development loans of $1.9 million.
Total interest bearing liabilities increased $15.8 million or 14.4% at September
30, 2002 to $125.6 million from $109.8 million at September 30, 2001. The
increase in total interest bearing liabilities was primarily due to Citizens
increase in interest bearing and other deposits of $15.2 million with First
Financial's interest bearing and other deposits also increasing by $2.6 million.
These increases in interest bearing liabilities were offset by a decrease in
Federal Home Loan Bank advances of $2.0 million. Demand deposits increased $4.3
million to $22.4 million while certificates of deposits increased $14.7 million
to $99.5 million. These increases reflect management's success in attracting
deposit customers. Non-interest bearing liabilities increased by $1.1 million
primarily due to Citizens increase in non-interest bearing deposits of $1.1
million.
Stockholders' equity was $22.1 million at September 30, 2002 and decreased
approximately $239,000 from the balance at September 30, 2001. Net income of
$670,000 and an increase of $271,000 for ESOP shares released from collateral in
2002 were offset by the declaration of dividends of $742,000 and $390,000 of
unrealized losses on securities available-for-sale, net of tax. During the year
ended September 30, 2002, the Company repurchased $52,000 in common stock.
Average Balances, Interest, and Average Yields
Net interest income is affected by (i) the difference ("interest rate spread")
between rates of interest earned on interest-earning assets and rates of
interest paid on interest-bearing liabilities and (ii) the relative amounts of
interest-earning assets and interest-bearing liabilities. When interest-earning
assets approximate or exceed interest-bearing liabilities, any positive interest
rate spread will generate net interest income. Banks have traditionally used
interest rate spreads as a measure of net interest income. Certificates of
deposit constitute approximately 81.6% of the total deposits of the Banks and
generally pay higher rates of interest than core deposits. Certificates of
deposits were 82.3% of total deposits at September 30, 2001. The emphasis on
certificates of deposits may result in a higher average cost of deposits which
may adversely affect the interest rate spread. Another indication of an
institution's net interest income is its "net yield on interest-earning assets"
which is net interest income divided by average interest-earning assets. The
following table sets forth certain information relating to the average
interest-earning assets and interest-bearing liabilities of the Banks and
reflects the average yield on assets and average cost of liabilities for the
periods indicated. Such yields and costs are derived by dividing income or
expense by the average monthly balance of assets or liabilities, respectively,
for the periods presented. During the periods
6
indicated, nonaccruing loans are included in the net loan category. Average
balances are derived from month-end average balances. Management does not
believe that the use of month-end average balances instead of average daily
balances has caused any material difference in the information presented.
Year Ended September 30,
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2002 2001
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Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
----------- ----------- ------------ ---------- ---------- ------------
Interest-earning assets:
Loans receivable $109,011 $ 8,099 7.43% $102,989 $8,068 7.83%
Investment securities and other 1 29,215 638 2.18% 17,600 676 3.84%
----------- ----------- ----------- ----------
Total interest-earning assets 138,226 8,737 6.32% 120,589 8,744 7.25%
----------- ----------- ----------
Non-interest earning assets 6,571 2,723
----------- -----------
Total assets $144,797 $123,312
=========== ===========
Interest-bearing liabilities:
Deposits $115,540 $ 4,632 4.01% $ 91,671 4,848 5.29%
Borrowings 3,625 109 3.01% 6,167 339 5.50%
----------- ----------- ----------- ----------
Total interest-bearing
liabilities 119,165 4,741 3.98% 97,838 5,187 5.30%
----------- ----------
Non-interest bearing liabilities 1,691 2,618
----------- -----------
Total liabilities 120,856 100,456
Minority interests 1,755 464
Stockholders' equity 22,186 22,392
----------- -----------
Total liabilities and stock-
holders' equity $144,797 $123,312
=========== ===========
Non-interest income $ 3,996 $3,557
=========== ==========
Interest rate spread 2 2.34% 1.95%
============= =============
Net yield on interest-earnings
assets 3 2.89% 2.95%
============= =============
Ratio of average interest-earnings
assets to average interest-bearing
liabilities 116.00% 123.25%
============= =============
-------------------------------------
1 Includes interest-bearing overnight deposits with FHLB.
2 Interest-rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest bearing
liabilities
3 Net yield on interest-earning assets represents net interest income as a
percentage of average interest-earning assets.
7
Rate/Volume Analysis
The following table below sets forth certain information regarding changes in
interest income and interest expense of the Banks for the periods indicated. For
each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(changes in average volume multiplied by old rate); (ii) changes in rates
(changes in rate multiplied by old average volume); (iii) changes in rate-volume
(changes in rate multiplied by the change in average volume). Average balances
are derived from month-end balances. Management does not believe that the use of
month-end balances instead of average daily balances has caused any material
difference in the information presented.
Year Ended September 30,
--------------------------------------------
2002 vs. 2001
--------------------------------------------
Increase (Decrease) Due To
--------------------------------------------
Rate/
Volume Rate Volume Net
------- ------- ------- -------
Interest income:
Loans receivable .................... $ 471 $ (416) $ (24) $ 31
Investment securities 1 and other... 447 (292) (193) (38)
------- ------- ------- -------
Total ........................ $ 918 $ (708) $ (217) $ (7)
======= ======= ======= =======
Interest expense:
Deposits ............................ $ 1,263 $(1,173) $ (306) $ (216)
Borrowings .......................... (140) (153) 63 (230)
------- ------- ------- -------
Total ........................ $ 1,123 $(1,326) $ (243) $ (446)
======= ======= ======= =======
Net change in interest income .......... $ (205) $ 618 $ 26 $ 439
======= ======= ======= =======
-----------------------------------
1 Includes interest-earning overnight deposits with FHLB of Cincinnati.
8
COMPARISON OF THE RESULTS OF OPERATIONS FOR THE YEARS
ENDED SEPTEMBER 30, 2002 and 2001
Net Income. Net income decreased by $15,000 or 2.2% to $670,000 for the year
ended September 30, 2002 as compared to $685,000 for the year ended September
30, 2001. Net interest income increased by $439,000, non-interest income
increased by $309,000 and the minority ownerships share of Citizens loss
increased by $166,000. These increases in income were offset by increases in
non-interest expenses of $627,000, income tax expense of $99,000 and provisions
for loan losses of $202,000 primarily due to growth in Citizens' loan portfolio.
Net Interest Income. Net interest income for the year ended September 30, 2002
was $4.0 million. The increase in net interest income in fiscal 2002 compared to
2001 of $439,000 was due to a decrease in interest expense of $446,000 offset by
a decrease in interest income of $7,000. Interest income in 2002 was $8.7
million with an average yield of 6.32% compared to $8.7 million with an average
yield o 7.25% in 2001. The average balance of interest bearing assets for 2002
was $138.2 million compared to $120.6 million for 2001. The average balance of
interest bearing liabilities in 2002 was $119.2 million with an average cost of
funds of 3.98% compared to average balances of interest bearing liabilities in
2001 of $97.8 million with an average cost of funds of 5.30%.
Interest Income. Interest income was $8.7 million, or 6.32% of average
interest-earning assets, for the year ended September 30, 2002 compared to $8.7
million, or 7.25% over average interest earning assets, for the year ended
September 30, 2001. Interest income decreased by $7,000 or .1% from 2001 to
2002. While average yields on interest-earning assets decreased .93% from 2001
to 2002, average interest-earning assets increased by $17.6 million from 2001 to
2002. These offsetting changes resulted in the net decrease in interest income
of $7,000.
Interest Expense. Interest expense was $4.7 million, or 3.98% of average
interest-bearing liabilities, for the year ended September 30, 2002 as compared
to $5.2 million, or 5.30% of average interest-bearing liabilities, for fiscal
2001. While average interest-bearing liabilities increased by $21.3 million to
$119.2 million in fiscal 2002, the average rate paid on deposits declined by 128
basis points in fiscal 2002 and the average rate paid on borrowings declined by
249 basis points in fiscal 2002. The effect of the declines in rates paid on
deposits and borrowings was partially offset by increases in average balances of
deposits and borrowings. The changes resulted in a decrease in interest expense
in fiscal 2002 of $446,000 or 8.6% from fiscal 2001.
Provision for Losses on Loans. The provision for loan losses is charged to
operations to bring the total allowance for loan losses to a level that
represents management's best estimate of the losses inherent in the portfolio,
based on:
o historical experience;
o volume;
o type of lending conducted by the Banks;
o industry standards;
o the level and status of past due and non-performing loans;
o the general economic conditions in the Banks' lending areas; and
o other factors affecting the collectibility of the loans in the portfolio.
For the year ended September 30, 2002, the provision for loan losses increased
$201,900 to $241,400 compared to $39,500 for fiscal 2001. The increase in the
provision relates to Citizens growth in its loan portfolio. Citizens loan
portfolio increased $18 million to $20.9 million in fiscal 2002. This increase
was primarily comprised of increases in real estate secured loans with
commercial real estate loans increasing $10.4 million and 1-4 family residential
real estate loans increasing by $6.0 million. While Citizens does not have a
loss history, the Bank provides reserves for other factors discussed above.
The allowance for loan losses is maintained at a level that represents
management's best estimates of losses in the loan portfolio at the balance sheet
date. However, there can be no assurance that the allowance for losses will be
adequate to cover losses, which may be realized in the future and that
additional provisions for losses will not be required.
9
Non-Interest Income. Non-interest income was $487,000 and $178,000 for the years
ended September 30, 2002 and 2001, respectively. Other non-interest income
increased by $179,000 to $223,000, primarily due to increases in the Company's
bank owned life insurance cash surrender value of $147,000. The remainder of
other non-interest income was due to Citizens growth and related increases in
non-interest income of $44,000. Loan and other service fees increased by
$130,000 to $263,000. Citizens loan portfolio growth and related fees thereon
accounted for $100,000 of this increase.
Non-Interest Expense. Non-interest expense increased approximately $627,000 or
23.4% to $3.3 million for the year ended September 30, 2002. The increase was
primarily due to an increase of $353,000 in compensation and benefits, and
increase of $78,000 in occupancy expense, an increase of $54,000 in data
processing, an increase of $100,000 in other non-interest expenses and an
increase in state franchise taxes of $39,000. These increases are primarily due
to the acquisition of Citizens and its growth during the year with Citizens
total non-interest expenses increasing by $659,000 and First Financial's other
non-interest expenses decreasing by $26,000.
Income Tax Expense. The provision for income tax expense amounted to
approximately $494,000 and $395,000 for the years ended September 30, 2002 and
2001, respectively. The provision for income tax expense as a percentage of
income before income tax expenses amounted to 52.8% for the year ended September
30, 2002 and 38.8% for the year ended September 30, 2001. The increase in the
effective rate is attributable to a valuation allowance against Citizens net
deferred tax assets in the amount of $174,000.
Liquidity
The liquidity of the Company depends primarily on the dividends paid to it by
its bank subsidiaries. The payment of cash dividends by the Banks on their
common stock is limited by regulations of the OTS and the FDIC, which are tied
to their level of compliance with their regulatory capital requirements.
The Banks' primary source of funds are deposits and proceeds from principal and
interest payments of loans. Additional sources of liquidity are advances from
the FHLB of Cincinnati and other borrowings, such as Federal Funds purchased. At
September 30, 2002, First Financial had $5.0 million in advances from FHLB.
First Financial utilizes FHLB of Cincinnati borrowings during periods when
management believes that such borrowings provide a source of funds at a lower
cost than deposit accounts, and when they desire liquidity in order to help
expand the loan portfolio.
The Company's operating activities produced positive cash flows for the fiscal
years ended September 30, 2002 and 2001. Net cash from operating activities for
2002 totaled $806,000, as compared to $679,000 million for 2001. The increase in
operating cash flows in year 2002 results primarily from increased non cash loan
loss provisions.
Net cash used by investing activities for 2002 totaled $18.4 million, as
compared to $10.3 million for 2001.
Net cash from financing activities for the year ended September 30, 2002 totaled
$16.3 million, as compared to $17.5 million for 2001.
The Banks' most liquid assets are cash and cash-equivalents, which include
investments in highly liquid, short-term investments. At September 30, 2002 and
2001, cash and cash equivalents totaled $9.6 million and $10.8 million,
respectively.
At September 30, 2002, the Banks had $78.9 million in certificates of deposits
due within one year and $17.7 million due between one and three years.
Management believes, based on past experience, that the Banks will retain much
of the deposits or replace them with new deposits or borrowings. At September
30, 2002, the Banks had $1.6 million in outstanding commitments to originate
mortgages. The Banks intend to fund these commitments with short-term
investments and proceeds from loan repayments.
10
Impact of Inflation and Changing Prices
The consolidated financial statements and notes thereto presented herein have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the change in the relative purchasing
power of money over time and due to inflation. The impact of inflation is
reflected in the increased cost of the Company's operations. Unlike most
industrial companies, nearly all the assets and liabilities of the Company are
monetary in nature. As a result, interest rates have a greater impact on the
Company's performance than do the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same
extent as the price of goods and services.
New Accounting Pronouncements
In June of 2001 the Financial Accounting Standards Board (FASB) issued Statement
No. 141, "Business Combinations" and Statement No. 142, "Goodwill and Other
Intangible Assets." Statement No. 141 pertains to business combinations
initiated after June 30, 2001 and requires all business combinations after this
date to be accounted for using the purchase method of accounting. Statement No.
142 pertains to the accounting for goodwill and other intangible assets and is
effective for the Company beginning July 1, 2001. Under Statement No. 142,
goodwill recorded in Business Combinations after July 1, 2001 must be evaluated
for impairment at least on an annual basis. If it is determined that the
goodwill has been impaired, then the carrying value of goodwill must be reduced
for the impairment. The Company does not anticipate the effect of implementing
these statements to be material to its financial position or results of
operations.
11
[LOGO]
EKW XXXXXXX X. XXXXXXX, CPA
& ASSOCIATES, llp XXXXXXXX X. XXXXXX, CPA
CERTIFIED PUBLIC ACCOUNTANTS & XXXXXXX X. XXXXXXXXX, CPA
BUSINESS CONSULTANTS XXXXXX X. XXXXX, CPA
XXXXXXXXXXX X. LOVE, CPA
XXXXXXX X. XXXXXXX, CPA
XXXX X. XXXXX, CPA
XXX X. XXXXXX, CPA
XXXXX X. XXXXX, CPA
XXXX X. XXXXX, CPA
XXXXXXX C. N. XXXXXX, CPA
XXXXXXX X. XXXXX, CPA
XXXX X. XXXXXXXX, CPA
INDEPENDENT AUDITOR'S REPORT
Board of Directors
Harrodsburg First Financial Bancorp, Inc.
Harrodsburg, Kentucky
We have audited the accompanying consolidated balance sheet of Harrodsburg First
Financial Bancorp, Inc. and Subsidiaries (the Company) as of September 30, 2002,
and the related consolidated statements of income, changes in stockholders'
equity, and cash flows for the year then ended. These consolidated financial
statements are the responsibility of the management of Harrodsburg First
Financial Bancorp, Inc. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit. The consolidated financial
statements of the Company as of September 30, 2001, were audited by other
auditors whose report dated November 16, 2001, expressed an unqualified opinion
on those statements.
We conducted our audit in accordance with U.S. generally accepted auditing
standards. Those standards required that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statements presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Harrodsburg First
Financial Bancorp, Inc. and Subsidiaries as of September 30, 2002, and the
results of their operations and their cash flows for the year then ended in
conformity with U.S. generally accepted accounting principles.
/s/EKW & Associates, llp
Owensboro, Kentucky
October 24, 2002
12
000 Xxxx Xxxxx Xxxxxx - X.X. Xxx 0000 - Xxxxxxxxx, Xxxxxxxx - 42302-1824
PH: 000-000-0000 - Fax: 000-000-0000 - xxx.xxxxxx.xxx
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2002 and 2001
ASSETS 2002 2001
------------- -------------
Cash and due from banks $ 1,337,830 $ 1,180,469
Federal funds sold 418,000 964,000
Interest bearing deposits in banks 7,799,846 8,651,379
------------- -------------
Cash equivalents 9,555,676 10,795,848
Interest bearing deposits in banks 2,892,000 100,000
Securities available-for-sale at fair value 17,275,431 12,508,751
Securities held-to-maturity, fair value of
$2,261,119 and $3,280,067 for 2002 and
2001, respectively 2,221,053 3,235,300
Federal Home Loan Bank stock, at cost 1,831,400 1,705,800
Loans receivable, net 113,351,935 105,081,309
Accrued interest receivable 667,290 730,500
Premises and equipment, net 1,838,733 1,896,931
Cash surrender value of life insurance 2,646,941 --
Other assets 771,579 486,922
------------- -------------
Total assets $ 153,052,038 $ 136,541,361
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 121,920,471 $ 102,961,466
Advances from Federal Home Loan Bank 5,000,000 7,000,000
Advance payments by borrowers for taxes
and insurance 364 1,215
Deferred federal income tax 1,537,650 1,904,364
Dividends payable 401,975 404,150
Other liabilities 463,668 115,969
------------- -------------
Total liabilities 129,324,128 112,387,164
------------- -------------
Minority interests 1,661,699 1,848,807
------------- -------------
Stockholders' equity:
Common stock $0.10 par value,5,000,000 shares
authorized; 1,257,477 and 1,238,834 shares issued
and outstanding at September 30, 2002 and 2001,
respectively 218,213 218,213
Additional paid-in capital 21,283,692 21,237,991
Retained earnings, substantially restricted 10,906,419 10,978,953
Accumulated other comprehensive income 2,867,743 3,257,257
Treasury stock, 842,209 and 837,959 shares, at
cost, for 2002 and 2001, respectively (12,385,241) (12,333,701)
Unallocated employee stock ownership plan
(ESOP) shares (824,615) (1,053,323)
------------- -------------
Total stockholders' equity 22,066,211 22,305,390
------------- -------------
Total liabilities and stockholders'
equity $ 153,052,038 $ 136,541,361
============= =============
The accompanying notes are an integral part of the
consolidated financial statements.
13
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
for the years ended September 30, 2002 and 2001
2002 2001
----------- -----------
Interest income:
Interest on loans $ 8,098,705 $ 8,067,540
Interest and dividends on securities 335,724 439,413
Other interest income 302,325 237,171
----------- -----------
Total interest income 8,736,754 8,744,124
----------- -----------
Interest expense:
Interest on deposits 4,631,824 4,848,316
Interest on other borrowings 108,948 338,688
----------- -----------
Total interest expense 4,740,772 5,187,004
----------- -----------
Net interest income 3,995,982 3,557,120
Provision for loan losses 241,400 39,500
----------- -----------
Net interest income after provision
for loan losses 3,754,582 3,517,620
----------- -----------
Non-interest income:
Loan and other service fees, net 263,323 133,076
Other 223,358 44,638
----------- -----------
486,681 177,714
----------- -----------
Non-interest expense:
Compensation and benefits 1,832,063 1,478,947
Occupancy expenses, net 327,856 249,891
Federal and other insurance premiums 26,072 19,306
Data processing expenses 308,911 254,906
State franchise tax 150,763 115,694
Other operating expenses 660,634 560,707
----------- -----------
3,306,299 2,679,451
----------- -----------
Income before income tax expense and minority
interests 934,964 1,015,883
Income tax expense (493,877) (394,519)
Minority interests 228,780 63,176
----------- -----------
Net income $ 669,867 $ 684,540
=========== ===========
Basic earnings per common share $ .54 $ .52
=========== ===========
Diluted earnings per common share $ .54 $ .52
=========== ===========
Weighted average common shares outstanding
during the year 1,242,836 1,307,002
=========== ===========
Weighted average common shares after dilutive
effect outstanding during the year 1,242,836 1,307,002
=========== ===========
The accompanying notes are an integral part of the
consolidated financial statements.
14
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
for the years ended September 30, 2002 and 2001
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY UNALLOCATED TOCKHOLDERS'
STOCK CAPITAL EARNINGS INCOME STOCK ESOP SHARES EQUITY
--------- --------------------------- --------------------------------------- --------
Balance, September 30, 2000 $218,213 $ 21,215,999 $ 11,038,055 $ 2,700,651 $ (8,771,467) (1,160,600) 25,240,851
Comprehensive income:
Net income 684,540 684,540
Other comprehensive income,
net of tax unrealized gains
on securities 556,606 556,606
-----------
Total comprehensive income 1,241,146
Dividend declared (743,642) (743,642)
ESOP shares released in 2001 21,992 107,277 129,269
Purchase of 269,909 shares of
common stock (3,562,234) (3,562,234)
-------- ------------ ------------ ------------ ------------ ---------- ------------
Balance, September 30, 2001 218,213 21,237,991 10,978,953 3,257,257 (12,333,701) (1,053,323) 22,305,390
Comprehensive income:
Net income 669,867 669,867
Other comprehensive income,
net of tax unrealized gains
on securities (389,514) (389,514)
-----------
Total comprehensive income 280,353
Dividend declared (742,401) (742,401)
ESOP shares released in 2002 42,062 228,708 270,770
Purchase of 4,250 shares of
common stock (51,540) (51,540)
Decrease in ownership of
Subsidiary 3,639 3,639
-------- ------------ ------------ ------------ ------------ ---------- ------------
Balance, September 30, 2002 $218,213 $ 21,283,692 $ 10,906,419 $ 2,867,743 $(12,385,241) $ (824,615) $ 22,066,211
======== ============ ============ ============ ============ ========== ============
The accompanying notes are an integral part of the
consolidated financial statements.
15
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended September 30, 2002 and 2001
2002 2001
------------ ------------
Operating activities:
Net income $ 669,867 $ 684,540
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 241,400 39,500
Provision for depreciation 152,950 126,675
ESOP benefit expense 123,890 129,271
Amortization of loan fees (137,661) (99,355)
Amortization of investment premium (discount) 22,478 (128)
Loss on sale of fixed asset 2,191 896
FHLB stock dividend (84,500) (118,000)
Minority interest (228,780) (63,176)
Change in:
Accrued interest receivable 63,210 (74,443)
Interest payable (1,354) 33,919
Accrued liabilities (8,584) 45,380
Prepaid expenses (51,974) (35,766)
Cash surrender value of life insurance (146,941) --
Income taxes payable 189,877 9,519
------------ ------------
Net cash provided by operating activities 806,069 678,832
------------ ------------
Investing activities:
Net increase in loans (9,100,453) (4,140,187)
Purchase of securities, available-for-sale (24,168,355) (7,498,031)
Purchase of securities, held-to-maturity (2,508,125) (3,500,000)
Purchase of FHLB stock (41,100) --
Calls of securities, available-for-sale 18,546,073 --
Calls of securities, held-to-maturity 3,500,000 5,500,000
Principal repayments mortgage-backed securities 270,340 3,548
Purchase of certificates of deposit (2,792,000) (100,000)
Purchase of goodwill -- (356,065)
Purchase of fixed assets (96,943) (289,340)
Purchase of life insurance (2,500,000) --
Proceeds from sale of foreclosed assets 534,431 --
Additions to foreclosed assets (41,030) --
------------ ------------
Net cash used by investing
activities (18,397,162) (10,380,075)
------------ ------------
Financing activities:
Minority interests 186,707 1,911,983
Net increase in demand deposits,
NOW accounts and savings accounts 4,254,192 8,040,121
Net increase in certificates of deposit 14,704,813 8,448,214
Net decrease in custodial accounts (850) (86,764)
Purchase of treasury stock (51,540) (3,562,234)
Proceeds from FHLB borrowings 13,500,000 24,500,000
Payments of FHLB borrowings (15,500,000) (21,000,000)
Payments of dividends (742,401) (785,396)
------------ ------------
Net cash provided by financing
activities 16,350,921 17,465,924
------------ ------------
Continued
16
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
for the years ended September 30, 2002 and 2001
2002 2001
------------ ------------
Increase (decrease) in cash and
cash equivalents $ (1,240,172) $ 7,764,681
Cash and cash equivalents, beginning of year 10,795,848 3,031,167
------------ ------------
Cash and cash equivalents, end of year $ 9,555,676 $ 10,795,848
============ ============
Supplemental Disclosures:
Cash payments for:
Interest $ 4,739,418 $ 4,831,557
============ ============
Income taxes $ 683,754 $ 383,000
============ ============
Noncash investing and financing transactions:
Loans transferred to other real estate owned $ 726,087 $ --
============ ============
Loans to facilitate sale of real estate owned $ 263,366 $ --
============ ============
Total increase (decrease) in unrealized gain on
securities available-for-sale $ (590,173) $ 843,343
============ ============
The accompanying notes are an integral part of the
consolidated financial statements.
17
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Nature of Operations. Harrodsburg First Financial Bancorp, Inc. (Company)
is a corporation organized under the laws of Delaware. The Company's
Articles of Incorporation authorize the issuance of up to 500,000 shares of
preferred stock, which may be issued with certain rights and preferences.
As of September 30, 2002, no preferred stock has been issued.
On July 15, 2001, the Company converted from a unitary savings and loan
holding company to a bank holding company. The activities of the Company
are primarily limited to holding stock in two banks, First Financial Bank
(First Financial), a wholly owned subsidiary, and Citizens Financial Bank,
Inc. (Citizens), in which the Company acquired a 56.27% interest on July
15, 2001. At September 30, 2002, the Company owned 55.80% of the
outstanding stock of Citizens.
Citizens is a newly organized de novo Kentucky chartered commercial bank,
located in Glasgow, Kentucky, and is subject to examination and regulation
by the Federal Deposit Insurance Corporation ("FDIC")and the Kentucky
Department of Financial Institutions. First Financial is a federally
chartered stock savings bank and a member of the Federal Home Loan Bank
System.
The following is a summary of the Company's significant accounting policies
which have been consistently applied in the preparation of the accompanying
consolidated financial statements.
Basis of Presentation and Consolidation. The consolidated financial
statements include the accounts of the Company, First Financial, Citizens,
and First Financial's wholly owned subsidiary, Harrodsburg Savings & Loan
Service Corporation. All significant intercompany accounts and transactions
have been eliminated in consolidation.
Use of Estimates. In preparing consolidated financial statements in
conformity with generally accepted accounting principles, management is
required to make estimates and assumptions that affect the reported amounts
of assets and liabilities as of the date of the balance sheet and reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to
the determination of the allowance for loan losses and the valuation of
deferred tax assets.
Business. First Financial and Citizens conduct general banking business in
central Kentucky and western Kentucky, respectively, which primarily
consists of attracting deposits from the general public and applying those
funds to the origination of loans for residential, consumer and
nonresidential purposes. Primary deposit products are savings and term
certificate accounts and primary lending products are residential consumer
and commercial mortgage loans.
Cash and Cash Equivalents. For purposes of the consolidated statements of
cash flows, cash and cash equivalents include cash and balances due from
banks, federal funds sold and interest bearing deposits in banks, all of
which mature within ninety days.
Continued
18
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies, Continued
Interest-bearing Deposits in Banks. Interest-bearing deposits in banks
which are not cash equivalents mature within one year and are carried at
cost.
Securities. Debt securities that management has the positive intent and
ability to hold to maturity are classified as "held-to-maturity" and
recorded at amortized cost. Securities not classified as held-to-maturity,
including equity securities with readily determinable fair values, are
classified as "available-for-sale" and recorded at fair value, with
unrealized gains and losses excluded from earnings and reported in other
comprehensive income.
Purchase premiums and discounts are recognized in interest income using the
interest method over the terms of the securities. Declines in the fair
value of held-to-maturity and available-for-sale securities below their
costs that are deemed to be other than temporary are reflected in earnings
as realized losses. Gains and losses on the sale of securities are recorded
on the trade date and are determined using the specific identification
method.
Loans. First Financial and Citizens grant mortgage, commercial and consumer
loans to customers. A substantial portion of the loan portfolio is
represented by mortgage loans throughout central and western Kentucky. The
ability of debtors to honor their contracts is dependent upon the real
estate and general economic conditions in these areas.
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off generally are reported at
their outstanding unpaid principal balances adjusted for charge-offs, the
allowance for loan losses, and any deferred fees or costs on originated
loans. Interest income is accrued on the unpaid principal balance. Loan
origination fees, net of certain interest direct origination costs, are
deferred and recognized as an adjustment of the related loan yield using
the interest method.
The accrual of interest on mortgage and commercial loans is discontinued at
the time the loan is 90 days delinquent unless the credit is well-secured
and in process of collection. Other personal loans are typically charged
off no later than 180 days past due. In all cases, loans are placed on
nonaccrual or charged-off at an earlier date if collection of principal or
interest is considered doubtful.
All interest accrued but no collected for loans that are placed on
nonaccrual or charged off is reversed against interest income. The interest
on these loans is accounted for on the cash-basis or cost-recovery method,
until qualifying for return to accrual. Loans are returned to accrual
status when all the principal and interest amounts contractually due are
brought current and future payments are reasonably assured.
Allowance for Loan Losses. The allowance for loan losses is established
as losses are estimated to have occurred through a provision for loan
losses charged to earnings. Loan losses are charged against the allowance
Continued
19
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies, Continued
when management believes the uncollectibility of a loan balance is
confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management
and is based upon management's periodic review of the collectibility of the
loans in light of historical experience, the nature and volume of the loan
portfolio, adverse situations that may affect the borrower's ability to
repay, estimated value of any underlying collateral and prevailing economic
conditions. This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as more information
becomes available.
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Factors considered by management
in determining impairment include payment status, collateral value, and the
probability of collecting scheduled principal and interest payments when
due. Loans that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired. Management determines
the significance of payment delays and payment shortfalls on a case-by-case
basis, taking into consideration all of the circumstances surrounding the
loan and the borrower, including the length of the delay, the reasons for
the delay, the borrower's prior payment record, and the amount of the
shortfall in relation to the principal and interest owed. Impairment is
measured on a loan by loan basis for commercial and construction loans by
either the present value of expected future cash flows discounted at the
loan's effective interest rate, the loan's obtainable market price, or the
fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively
evaluated for impairment. Accordingly, the Company does not separately
identify individual consumer and residential loans for impairment
disclosures.
Office Premises and Equipment. Office premises and equipment are stated at
cost less accumulated depreciation. Depreciation is computed using the
straight line method and the double declining balance method over the
estimated useful lives of the related assets. The gain or loss on the sales
of property and equipment is recorded in the year of disposition.
Real Estate Owned. Real estate owned is generally comprised of property
acquired through foreclosure or deed in lieu of foreclosure. Foreclosed
real estate is initially recorded at fair value, net of selling expenses,
establishing a new cost basis. Expenses relating to holding property,
including interest expense, are not capitalized. These expenses are charged
to operations as incurred.
After foreclosure, valuations are periodically performed by management, and
the real estate is carried at the lower of carrying amount or fair value
less estimated selling expenses.
Continued
20
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies, Continued
Deposits. First Financial's deposits are insured by the Savings Association
Insurance Fund ("SAIF"), which is administered by the FDIC. Citizens
deposits are insured by the FDIC.
Income Taxes. The Company files a consolidated federal income tax return
with First Financial. Citizens files a separate federal income tax return.
The current income tax expense or benefit is allocated to each Corporation
included in the consolidated tax return based on their tax expense or
benefit computed in a separate return basis.
Income taxes are provided for the tax effects of the transactions reported
in the financial statements and consist of taxes currently due plus
deferred taxes related primarily to differences between the basis of
available-for-sale securities, allowance for loan losses, accumulated
depreciation, and Federal Home Loan Bank stock dividends received. The
deferred tax assets and liabilities represent the future tax return
consequences of those differences, which will either be taxable or
deductible when the assets and liabilities are recovered or settled.
Deferred tax assets and liabilities are reflected at income tax rates
applicable to the period in which the deferred tax assets or liabilities
are expected to be realized or settled. As changes in tax laws or rates are
enacted, deferred tax assts and liabilities are adjusted through the
provision for income taxes.
A valuation allowance is provided for net deferred tax assets of Citizens
to the extent that the value of net deductible temporary differences and
carryforward attributes exceeds management's estimates of taxes payable on
future taxable income.
Employee Stock Ownership Plan. Shares of common stock issued to the
Company's employee stock ownership plan (ESOP) are initially recorded as
unearned ESOP shares in the stockholders' equity at the fair value of the
shares at the date of the issuance of the plan. As shares are committed to
be released as compensation to employees, the Company reduces the carrying
value of the unearned shares and records compensation expense equal to the
current value of the shares.
Earnings Per Share. Earnings per common share is computed by dividing
income available to common shareholders by the weighted average number of
common shares outstanding during the period. Earnings per common share
assuming dilution reflects the potential dilution that could occur if
securities or other contract to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock,
that then shared in the earnings of the Company.
Reclassifications. Certain presentations of accounts previously reported
have been reclassified in these consolidated financial statements. Such
reclassifications had no effect on net income or retained earnings as
previously reported.
Continued
21
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Business Acquisition
On July 15, 2001, the Company acquired 56.27% of the voting shares of
Citizens Financial Bank, Inc. in Glasgow, Kentucky for a cash price of
$2,816,300. Citizens is a newly organized de novo bank, which began
operations on July 17, 2001. The acquisition of the controlling interest in
Citizens was accounted for under the purchase method of accounting. The
excess of the purchase price over the fair value of the underlying net
assets acquired of $356,604 was allocated to goodwill, which is expected to
be deductible for tax purposes. Goodwill results from pre-opening expenses
and the Company's purchase decision was primarily influenced by the
opportunity to participate in this start-up bank and its evaluation of the
west Kentucky market.
3. Investment Securities
The cost and estimated fair value of securities held as of September 30,
2002 and 2001 are summarized as follows:
2002
-----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
----------- ----------- ----------- -----------
Securities, available-for-sale:
Debt securities:
U.S. Government and federal agencies $ 4,920,934 $ 12,023 $ 670 $ 4,932,287
Mortgage-backed securities 7,928,933 104,992 -- 8,033,925
----------- ----------- ----------- -----------
12,849,687 117,015 670 12,966,212
Equity securities:
Federal Home Loan Mortgage Corpora-
tion, capital stock, 77,088 shares 75,482 4,233,737 -- 4,309,219
----------- ----------- ----------- -----------
$12,925,349 $ 4,350,752 $ 670 $17,275,431
=========== =========== =========== ===========
Securities, held-to-maturity:
Debt Securities:
U.S. Government and Federal agencies $ 2,007,209 $ 27,181 $ -- $ 2,034,390
Municipal bonds 213,724 12,885 -- 226,729
----------- ----------- ----------- -----------
$ 2,221,053 $ 40,066 $ -- $ 2,261,119
=========== =========== =========== ===========
2001
-----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
----------- ----------- ----------- -----------
Securities, available-for-sale:
Debt securities:
U.S. Government and Federal agencies $ 7,498,031 $ -- $ -- $ 7,498,031
Equity securities:
Federal Home Loan Mortgage Corpora-
tion, capital stock, 77,088 shares 75,482 4,935,238 5,010,720
----------- ----------- ----------- -----------
$ 7,573,513 $ 4,935,238 $ -- $12,508,751
=========== =========== =========== ===========
Securities, held-to-maturity:
Debt Securities:
U.S. Government and Federal agencies $ 3,000,000 $ 37,065 $ -- $ 3,037,065
Municipal bonds 213,724 6,588 -- 220,312
Mortgage-backed securities 21,576 1,114 -- 22,690
----------- ----------- ----------- -----------
$ 3,235,300 $ 44,767 $ -- $ 3,280,067
=========== =========== =========== ===========
Continued
22
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investment Securities, Continued
The amortized cost and estimated fair value of debt securities at September
30, 2002, by contractual maturity, are as follows:
Available-for-Sale
--------------------------
Estimated
Amortized Fair
Cost Value
----------- -----------
Due in one year or less $ 3,699,832 $ 3,699,162
Due after one year through five years 1,018,318 1,030,312
Due after five through ten years 202,784 202,813
----------- -----------
4,920,934 4,932,287
Mortgage-backed securities 7,928,933 8,033,925
----------- -----------
$12,849,867 $12,966,212
=========== ===========
Held-to-Maturity
--------------------------
Estimated
Amortized Fair
Cost Value
----------- ------------
Due in one year or less $ 39,991 $ 40,523
Due after one year through five years 1,064,959 1,069,314
Due after five through ten years 1,007,205 1,032,589
Due after ten years 108,898 118,693
----------- -----------
$ 2,221,053 $ 2,261,119
=========== ===========
For the year ended September 30, 2002, $3,500,000 was received from the
call of 7 debt securities backed by U.S. Government Agencies, which were
classified as held-to-maturity. For the year ended September 30, 2001,
$5,500,000 was received from the call of eleven debt securities backed by
U.S. Government Agencies, which were classified as held-to-maturity. There
were no sales or transfers of investments classified as held-to-maturity.
4. Loans Receivable
Loans receivable, net at September 30, 2002 and 2001, consists of the
following:
2002 2001
------------ ------------
Loans secured by first lien mortgages on real estate:
One-to-four residential property $ 75,990,363 $ 80,152,688
Multi-family residential property 2,418,612 2,540,563
Commercial properties 14,216,970 8,783,410
Construction 5,433,353 7,286,230
Agricultural 7,283,115 3,864,562
Continued
23
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Loans Receivable, Continued
2002 2001
------------ ------------
Consumer loans:
Home equity $ 2,665,705 $ 1,879,047
Home improvement and personal 2,177,443 1,760,723
Auto loans 770,570 155,445
Commercial 4,278,982 1,696,775
Loans secured by savings deposits 741,407 497,591
------------ ------------
115,976,520 108,617,034
Loans in process (1,553,616) (2,686,523)
Provisions for loan losses (632,024) (411,000)
Deferred loan origination fees (438,945) (438,202)
------------ ------------
Loans receivable, net $113,351,935 $105,081,309
============ ============
First Financial and Citizens provide an allowance to the extent considered
necessary to provide for losses that may be incurred upon the ultimate
realization of loans. The changes in the allowance for loan losses is
analyzed as follows:
Year Ended September 30,
-----------------------------
2002 2001
------------ ------------
Balance at beginning of period $ 411,000 $ 371,500
Additions charged to operations 241,400 39,500
Charge-offs (20,476) --
Recoveries 100 --
------------ ------------
Balance at end of period $ 632,024 $ 411,000
============ ============
The following is a summary of non-performing loans (in thousands) at
September 30, 2002 and 2001, respectively:
September 30,
------------------------------
2002 2001
------------ -------------
Non-accrual loans $ 41 $ -
Accruing loans past 90 days or more 334 222
------------ ------------
Total non-performing loan balances $ 375 $ 222
============ ============
At September 30, 2002 and 2001 the Company had identified no impaired loans
as defined by SFAS No. 114.
Loans to executive officers and directors, including loans to affiliated
companies of which executive officers and directors are principal owners,
and loans to members of the immediate family of such persons at September
30, 2002 and 2001 are summarized as follows:
September 30,
------------------------------
2002 2001
------------ -------------
Balance at beginning of period $ 321,059 $ 462,040
Additions during the year 758,719 34,301
Repayments (156,766) (175,282)
------------ ------------
Balance at end of period $ 923,012 $ 321,059
============ ============
Continued
24
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. Premises and Equipment
Premises and equipment cost and accumulated depreciation are as follows:
2002 2001
------------ ------------
Land, buildings and improvements $ 1,640,033 $ 1,607,527
Furniture, fixtures and equipment 1,293,223 1,266,228
------------ ------------
2,933,256 2,873,755
Less accumulated depreciation (1,094,523) (976,824)
------------ ------------
$ 1,838,733 $ 1,896,931
============ ============
Depreciation expense for the years ended September 30, 2002 and 2001 was
$152,951 and $126,675, respectively.
6. Deposits
Deposit account balances are summarized as follows:
September 30,
-----------------------------
2002 2001
------------ ------------
Demand deposit accounts, non-interest bearing $ 3,844,411 $ 3,276,514
Passbook accounts with a weighted average rate
of 2.01% and 2.79% at September 30, 2002 and
2001, respectively 7,193,462 6,776,358
NOW and MMDA deposits with a weighted average
rate of 1.41% and 2.52% at September 30, 2002
and 2001, respectively 11,408,583 8,139,392
------------ ------------
22,446,456 18,192,264
Certificate of deposits with a weighted average
interest rate of 3.98% and 5.61% at
September 30, 2002 and 2001, respectively 99,474,015 84,769,202
------------ ------------
Total deposits $121,920,471 $102,961,466
============ ============
Jumbo certificates of deposit (minimum
denomination of $100,000) $ 23,488,331 $ 16,549,734
============ ============
Certificates of deposit by maturity at September 30, 2002 and 2001 are as
follows:
September 30,
-----------------------------
2002 2001
------------ ------------
Within one year $ 78,955,000 $ 59,623,000
Over 1 to 3 years 17,729,000 21,078,000
Maturing in years thereafter 2,790,000 4,068,000
------------ ------------
$ 99,474,000 $ 84,769,000
============ ============
Continued
25
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Deposits, Continued
Certificates of deposit by maturity and interest rate category at September
30, 2002 (in thousands) are as follows:
Amount Due
-------------------------------------------------------------
Less Than After
One Year 1-2 Years 2-3 Years Years Total
--------- --------- --------- --------- ---------
2.00% or less $ 100 $ -- $ -- $ -- $ 100
2.01%--4.00% 59,158 4,965 1,666 $ 299 66,088
4.01%--6.00% 13,091 6,717 1,434 1,914 23,156
6.01%--8.00% 6,606 964 1,983 577 10,130
--------- --------- --------- --------- ---------
$ 78,955 $ 12,646 $ 5,083 $ 2,790 $ 99,474
========= ========= ========= ========= =========
Interest expense on deposits for the periods indicated is summarized as
follows:
Years ended September 30,
-----------------------------
2002 2001
------------ ------------
Money market and Now accounts $ 215,380 $ 247,728
Savings accounts 140,466 181,584
Certificates 4,275,978 4,419,004
------------ ------------
$ 4,631,824 $ 4,848,316
============ ============
First Financial maintains arrangements for clearing NOW and MMDA accounts
with Federal Home Loan Bank of Cincinnati (FHLB), and is required to
maintain adequate collected funds in its Demand Account to cover average
daily clearings. First Financial was in compliance with this requirement at
September 30, 2002 and 2001. In addition, at September 30, 2002, First
Financial had pledged $2,325,000 of its overnight deposits held by the FHLB
of Cincinnati to secure public deposits. The Company held deposits for
related parties of approximately $3,326,000.
7. Advances from Federal Home Loan Bank
The advances from the Federal Home Loan Bank consist of the following:
Maturity Interest September 30,
Date Rate 2002
-------- -------- -------------
12/24/02 2.15% $ 2,000,000
12/27/02 2.15% 2,000,000
03/07/11 5.20% 1,000,000
------------
$ 5,000,000
============
Continued
26
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Advances from Federal Home Loan Bank, Continued
A schedule of the principle payments due over the remaining term of the
notes as of September 30, 2002 follows:
Year Amount
---- ------
2003 $ 4,000,000
Due after five years 1,000,000
------------
$ 5,000,000
============
These borrowings are collateralized by qualified real estate first
mortgages and Federal Home Loan Bank stock held by First Financial, which
had a book value of $15,540,300 at September 30, 2002.
8. Income Taxes
The provision for income taxes for the periods indicated consist of the
following:
Years ended September 30,
-------------------------
2002 2001
---------- ---------
Federal income tax expense:
Current expense $ 467,936 $ 265,699
Deferred expense (benefit) 25,941 128,820
--------- ---------
$ 493,877 $ 394,519
========= =========
Deferred income taxes result from temporary differences in the recognition
of income and expenses for tax and financial statement purposes. The source
of these temporary differences and the tax effect of each are as follows:
Years ended September 30,
-------------------------
2002 2001
--------- ---------
Section 481 adjustment for bad debt recapture $ (32,411) $ 97,233
Deferred loan fee income (139) (9,194)
Depreciation 17,830 21,247
FHLB stock 28,730 40,120
Allowance for loan losses 10,755 (10,363)
Other, net (ESOP loan) 1,176 (10,223)
--------- ---------
Deferred expense (benefit) $ 25,941 $ 128,820
========= =========
For the periods indicated, total income tax expense differed from the
amounts computed by applying the U.S. federal income tax rate of 34% to
income before income taxes as follows:
Years ended September 30,
2002 2001
--------- ---------
Expected income tax expense at federal tax rate $ 317,888 $ 366,880
Valuation allowance 174,362 27,639
Other, net 1,627 --
--------- ---------
Total income tax expense $ 493,877 $ 394,519
========= =========
Effective income tax rate 52.8% 38.8%
========= =========
Continued
27
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Income Taxes, Continued
Deferred tax assets and liabilities as of September 30, 2002 and 2001
consisted of the following:
2002 2001
-------- --------
Deferred tax assets:
Net operating loss carryover for Citizens
Financial Bank $215,995 $ 27,639
Charitable contribution carryover for
Citizens Financial Bank 765 --
Deferred loan fee income 149,127 148,989
ESOP contributions 80,677 81,853
Allowance for loan losses 196,807 131,207
Start-up costs 133,510 --
Organizational costs 4,964 --
-------- --------
Total deferred tax assets 781,845 389,688
-------- --------
Deferred tax liabilities:
Section 481 adjustment for bad debt
recapture 64,823 97,233
FHLB stock 412,250 383,520
Fixed asset basis over tax basis 145,260 107,679
-------- --------
Total deferred tax liabilities 622,333 588,432
-------- --------
Valuation allowance of Citizens
Financial Bank 411,837 27,639
-------- --------
Net deferred tax liability $252,325 $226,383
======== ========
In addition to the net deferred tax liability at September 30, 2002 of
$252,325 outlined in the preceding table, the financial statements include
a deferred tax liability of $1,475,168 that was charged against the
unrealized gain on securities available-for-sale of $4,338,730. The net
unrealized gain totals $2,863,562 and is recorded as a separate component
of stockholders' equity. Citizens Financial Bank's net operating loss will
expire in the fiscal year ended 2021.
Included in retained earnings at September 30, 3002 and 2001 is
approximately $2,134,000 in bad debt reserves for which no deferred federal
income tax liability has been recorded. This amount represents allocations
of income to bad debt deductions for tax purposes only. Reduction of these
reserves for purposes other than for bad debt losses or adjustments arising
from carryback of net operating losses would create income for tax purposes
which be subject to the then-current corporate income tax rate. The
unrecorded deferred liability to these amounts was approximately
$1,408,500.
Continued
28
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Stockholders' Equity and Regulatory Capital
Regulatory Capital. First Financial's actual capital and its statutory
required capital levels at September 30, 2002 and 2001 are as follows (in
thousands):
To be Well
Capitalized
Under Prompt
For Capital Corrective
Adequacy Action
Purposes Provisions
Actual Required Required
---------------------- -------------------- ----------------------
Amount % Amount % Amount %
-------- --------- -------- ------- -------- -------
September 30, 2002
Tier 1 risk based capital $14,102 20.55% $2,745 4.0% $4,118 6.0%
Tangible capital $14,102 11.67% $1,813 1.5% N/A N/A
Total risk based capital $14,485 21.11% $5,491 8.0% $6,863 10.0%
Leverage capital $14,102 11.67% N/A N/A $6,043 5.0%
September 30, 2001
Tier 1 risk based capital $12,905 18.76% $2,752 4.0% $4,128 6.0%
Tangible capital $12,905 10.80% $1,792 1.5% N/A N/A
Total risk based capital $13,312 19.35% $5,504 8.0% $6,881 10.0%
Leverage capital $12,905 10.80% N/A N/A $5,975 5.0%
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") required each federal banking agency to implement prompt
corrective actions for institutions that it regulates. In response to this
requirement, OTS adopted final rules based upon FDICIA's five capital
tiers. The rules provide that a savings bank is "well capitalized" if its
total risk-based capital ratio is 10% or greater, its Tier 1 risk-based
capital ratio is 6% or greater, its leverage is 5% or greater and the
institution is not subject to a capital directive. Under this regulation,
First Financial was deemed to be "well capitalized" as of September 30,
2002 and 2001 based upon the most recent notifications from its regulators.
There are no conditions or events since those notifications that management
believed would change its classifications.
Citizens' actual and required capital amounts and ratios are as follows
(dollars in thousands):
To be Well
Capitalized
Under Prompt
For Capital Corrective
Adequacy Action
Purposes Provisions
------------------ ------------------
Actual Required Required
------------------------ ------------------ ------------------
Amount % Amount % Amount %
------------ ----------- -------- -------- -------- -------
September 30, 2002
Total risk-based capital
(to risk-weighted
assets) $ 3,994 19.68% $1,623 8.0% $2,030 10.0%
Tier I capital (to risk-
weighted assets) $ 3,752 18.49% $ 812 4.0% $1,218 6.0%
Tier I capital (to
adjusted total assets) $ 3,752 19.68% $1,038 4.0% $1,297 5.0%
Continued
29
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Stockholders' Equity and Regulatory Capital, Continued
To be Well
Capitalized
Under Prompt
For Capital Corrective
Adequacy Action
Purposes Provisions
------------------ ------------------
Actual Required Required
------------------------ ------------------ ------------------
Amount % Amount % Amount %
------------ ----------- -------- -------- -------- -------
September 30, 2001
Total risk-based capital
(to risk-weighted
assets) $ 4,233 94.34% $ 359 8.0% $ 449 10.0%
Tier I capital (to risk-
weighted assets) $ 4,228 94.23% $ 179 4.0% $ 269 6.0%
Tier I capital (to
adjusted total assets) $ 4,228 48.99% $ 345 4.0% $ 432 5.0%
Citizens is subject to various regulatory capital requirements administered
by its primary federal regulator, the FDIC. Failure to meet the minimum
regulatory capital requirements can initiate certain mandatory, and
possible additional discretionary actions by regulators, that if
undertaken, could have a direct material affect on Citizens and the
consolidated financial statements. Under the regulatory capital adequacy
guidelines and the regulatory framework for prompt corrective action,
Citizens must meet specific capital guidelines involving quantitative
measures of Citizens' assets, liabilities, and certain off-balance sheet
items as calculated under regulatory accounting practices. Citizens'
capital amounts and classification under the prompt corrective action
guidelines are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require Citizens to maintain minimum amounts and ratios of total risk-based
capital and Tier I capital to risk-weighted assets (as defined in the
regulations), and Tier I capital to adjusted total assets (as defined).
Management believes, as of September 30, 2002, that Citizens meets all the
capital adequacy requirements to which it is subject.
As of September 30, 2002, the most recent notification from the Federal
Deposit Insurance Corporation categorized Citizens as well capitalized
under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, an institution must maintain minimum total
risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth
above. There are no conditions or events since the notification that
management believes have changed the Bank's category.
Retained Earnings Restriction. Retained earnings at September 30, 2002
include tax bad debt reserves of approximately $2,134,000 accumulated prior
to September 30, 1988, for which no federal income tax has been provided.
These tax bad debt reserves are only taxable in certain circumstances, such
as if First Financial converted to an institution that did not qualify as a
bank for tax purposes.
Continued
30
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Stockholders' Equity and Regulatory Capital, Continued
Liquidation Account. Upon conversion to a capital stock savings bank,
eligible account holders who continued to maintain their deposit accounts
were granted priority in the event of the future liquidation of First
Financial through the establishment of a special "Liquidation Account" in
an amount equal to the consolidated net worth of First Financial at March
31, 1995. The liquidation account was $10,236,488 at March 31, 1995 and is
reduced in proportion to reductions in the balance of eligible account
holders as determined on each subsequent fiscal year end. The existence of
the liquidation account will not restrict the use or application of net
worth except with respect to the cash payment of dividends. The Bank may
not declare or pay a cash dividend on or repurchase any of its common stock
if the effect thereof would cause its regulatory capital to be reduced
below the amount required for the liquidation account.
Dividend Restrictions. The payment of cash dividends by First Financial and
Citizens on their common stock is limited by regulations of the OTS and
FDIC. Interest on savings accounts will be paid prior to payments of
dividends on common stock. Additional limitation on dividends declared or
paid, or repurchases of their stock are tied to both the Bank's and
Citizens' level of compliance with its regulatory capital requirements.
Required Stock Investment. As members of the Federal Home Loan Bank System,
First Financial and Citizens are required to maintain an investment in
capital stock of the FHLB in an amount equal to at least the greater of 1%
(0.15% after December 30, 2002) of outstanding loans and mortgage-backed
securities, or 5% of outstanding FHLB advances. First Financial and
Citizens met this requirement at September 30, 2002 and 2001.
10. Retirement Benefits
Retirements Benefits. First Financial maintains a dormant noncontributory
defined benefit pension plan (Pension Trust). The multi-employer pension
plan covers all full-time employees with one year of service who have
attained the age of 21. There was no pension expense for the years ended
September 30, 2002 and 2001.
Effective April 1, 1993, the Board of Directors of First Financial adopted
an employee pension benefit plan (referred to as a "401K Plan") as
described under the Employees' Retirement Income Security Act of 1974.
Under the Plan, First Financial is required to match 25% of employee
contributions up to a maximum of 1.5% of eligible compensation. The Plan
covers all full-time employees. First Financial contributed $13,980 and
$12,950 to the Plan for the years ended September 30, 2002 and 2001,
respectively.
Effective September 28, 2001, Citizens established a Simple 401(k) plan
under Section 408(P) of the Internal Revenue Code. All employees are
eligible to participate. Citizens will contribute a matching contribution
equal to the employees salary reduction contributions up to a limit of 3%
of the employee's compensation for the calendar year. During the year ended
September 30, 2002, Citizens contributed approximately $10,000 to the Plan.
Continued
31
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Retirement Benefits
Employee Stock Ownership Plan. In connection with the stock conversion
September 30, 1995, the Company established an internally leveraged ESOP
which covers substantially all full time employees of First Financial. The
ESOP borrowed $1,745,700 from the Company and purchased 174,570 shares of
common stock of the Company at the date of conversion. The loan is to be
repaid in annual installments over a 15 year period with interest, which is
based on the published prime rate per the Wall Street Journal as determined
annually on September 30 of each year.
First Financial makes annual contributions to the ESOP Trust equal to the
ESOP's debt service requirement less dividends, if any, received by the
ESOP which are used for debt service. The ESOP shares are pledged as
collateral on the debt. As the debt is repaid, shares are released from
collateral and allocated to active participants based on a formula
specified in the ESOP agreement.
ESOP compensation was $123,890 for the year ended September 30, 2002. For
fiscal year 2002, 10,915 shares were released from collateral and 11,955
shares were released for prepayments on the loan by ESOP participants. At
September 30, 2002, there were 82,461 unallocated ESOP shares having a fair
value of $915,317. ESOP compensation was $129,271 for the year ended
September 30, 2001. For 2001, 10,728 shares were released from collateral.
At September 30, 2001, there were 105,332 unallocated ESOP shares having a
fair value of $1,253,450.
Option Plan. On January 21, 1997, the stockholders of the Company approved
the establishment of the Harrodsburg First Financial Bancorp, Inc. 1996
Stock Option Plan. Under the Option Plan, the Company may grant either
incentive or non-qualified stock options to Directors and key employees for
an aggregate of 200,000 shares of the Company's common stock, with an
exercise price equal to the fair market value of the stock at the date of
the award. Upon exercise of the options, the Company may issue stock out of
authorized shares or purchase the stock in the open market. The option to
purchase shares expires ten years after the date of the grant. Effective
with the approval of the Option Plan, options to purchase 190,000 shares of
common stock were awarded to key employees and directors with an exercise
price of $16.50 per share. The options vest, and thereby become
exercisable, at the rate of 20% on the date of grant, January 21, 1997, and
20% annually thereafter. The Options become vested immediately in the case
of death or disability, or upon a change in the control of the Company.
A summary of option transactions for the years indicated are as follows:
Year ended September 30,
--------------------------------------------
2002 2001
------------------ ------------------
Option Number Option Number
Price of Units Price of Units
----- -------- ----- --------
Balance outstanding at beginning of year $13.00- 185,000 $13.00 195,000
$16.50
Granted - 16.50 10,000
Released - (20,000)
-------- -------
Balance outstanding at end of year $13.50- 185,000 185,000
======== =======
$16.50
Continued
32
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Retirement Benefits, Continued
Year ended September 30,
-----------------------------------------
2002 2001
------------------ -------------------
Option Number Option Number
Price of Unit Price of Units
----- ------- ----- --------
Shares exercisable 184,000 184,000
======== =======
Shares available for grant 15,000 15,000
======== =======
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, " Accounting for Stock-based Compensation," which was effective for
fiscal years beginning after December 15, 1995. The new standard defines a
fair value method of accounting for stock options and similar equity
instruments. Under the fair value method, compensation cost is measured at
the grant date, based on the fair value of the award and is recognized over
the service period, which is usually the vesting period.
Companies are not required to adopt the fair value method of accounting for
employee stock-based transactions, and may continue to account for such
transactions under Accounting Principles Based (APB) Opinion No. 25
"Accounting for Stock Issued to Employees." Under this method the
compensation cost is measured by the difference between the fair value of
the Company's stock at the date of the award, and the exercise price to be
paid by the employee. If a company chooses to report stock based
compensation under APB 25, they must disclose the pro forma net income and
earnings per share as if the Company had applied the new method of
accounting. Accordingly, the following table shows the Company's net income
and earnings per share on a pro forma basis as if the compensation costs
for the stock options awarded were accounted for in accordance with SFAS
No. 123 for the year ended September 30, 2002 and 2001, respectively.
Reported Per Consolidated
Financial Statements Pro Forma Amount
--------------------- ---------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Net income $ 669,867 $ 684,580 $ 663,212 $ 560,565
========= ========= ========= =========
Earnings per common share $ .54 $ .52 $ .53 $ .43
========= ========= ========= =========
Earning per common share
assuming dilution $ .54 $ .52 $ .53 $ .43
========= ========= ========= =========
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions:
2002 2001
------------ ------------
Dividend yield 2.4% 2.4%
Expected volatility .03% .03%
Expected life 10 10
Free interest rate 5.3% 5.3%
Continued
33
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Retirement Benefits, Continued
Employee Recognition Plan. On January 21, 1997, the stockholders of the
Company approved the establishment of the First Federal Savings Bank of
Harrodsburg Restricted Stock Plan (RSP). The objective of the RSP is to
enable the First Financial to attract and retain personnel of experience
and ability in key positions of responsibility. Those eligible to receive
benefits under the RSP will be such employees as selected by members of a
committee appointed by the Company's Board of Directors. The RSP is a
non-qualified plan that is managed through a separate trust. First
Financial can contribute sufficient funds to the RSP Trust for the purchase
of up to 85,000 shares of common stock.
Awards made to employees will vest 20% on each anniversary date of the
award. Shares will be held by the trustee and are voted by the RSP trustee
as directed by the participant for those shares earned or by the Committee
for those shares held, but unearned or unawarded. Any assets of the trust
are subject to the general creditors of the Company. All shares awarded
vest immediately in the case of a participant's death, disability, or upon
a change in control of the Company. The Company intends to expense RSP
awards over the years during which the shares are payable, based on the
fair market value of the common stock at the date of the grant to the
employee. As of September 30, 2002, no awards had been made under the RSP.
11. Financial Instruments with Off-Balance Sheet Risk and Significant Group
Concentrations of Credit Risk
First Financial and Citizens are parties to financial instruments with
off-balance sheet risk in the normal course of business to meet the
financing needs of its customers. These financial instruments include
mortgage commitments outstanding which amounted to approximately $3,161,000
plus unused lines of credit granted to customers totaling $4,556,000 at
September 30, 2002. Of the mortgage loan commitments at September 30, 2002,
approximately $222,599 were for fixed rate loans. At September 30, 2001,
mortgage commitments outstanding amounted to approximately $715,450, and
unused lines of credit amounted to $5,313,000.
The exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for loan commitments and consumer lines
of credit are represented by the contractual amount of those instruments.
First Financial and Citizens use the same credit policies in making
commitments and conditional obligations as they do for on-balance sheet
instruments. Since many of the loan commitments may expire without being
drawn upon, the total commitment amount does not necessarily represent
future requirements. They evaluate each customer's credit worthiness on a
case-by-case basis. The amount of collateral obtained upon extension of
credit is based on management's credit evaluation of the counter party.
Collateral held varies, but primarily includes residential real estate.
At September 30, 2002, the Bank held deposits in other financial
institutions of approximately $4,321,000 in excess of federally insured
amounts.
Continued
34
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Disclosures about Fair Value of Financial Instruments
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments"
extends the existing fair value disclosure practices for some instruments
by requiring all entities to disclose the fair value of financial
instruments (as defined), both assets and liabilities recognized and not
recognized in the statements of financial condition, for which it is
practicable to estimate fair value.
There are inherent limitations in determining fair value estimates, as they
relate only to specific data based on relevant information at that time. As
a significant percentage of the Bank's financial instruments do not have an
active trading market, fair value estimates are necessarily based on future
expected cash flows, credit losses, and other related factors. Such
estimates are accordingly, subjective in nature, judgmental and involve
imprecision. Future events will occur at levels different from that in the
assumptions, and such differences may significantly affect the estimates.
The statement excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate
fair value amounts presented do not represent the underlying value of the
Company. Additionally, the tax impact of the unrealized gains or losses has
not been presented or included in the estimates of fair value.
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments.
Cash and Cash Equivalents. The carrying amounts reported in the statement
of financial condition for cash and short-term instruments approximate
those assets' fair values.
Investment Securities. Fair values for investment securities are based on
quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments. No active market exists for the Federal Home Loan Bank capital
stock. The carrying value is estimated to be fair value since if First
Financial withdraws membership in the Federal Home Loan Bank, the stock
must be redeemed for face value.
Loans Receivable. The fair value of loans was estimated by discounting the
future cash flows using the current rates at which similar loans would be
made to borrowers with similar credit ratings and for the same remaining
maturities.
Deposits. The fair value of savings deposits and certain money market
deposits is the amount payable on demand at the reporting date. The fair
value of fixed-maturity certificates of deposit is estimated using the
rates currently offered for deposits of similar remaining maturities.
Loan Commitments and Unused Home Equity Lines of Credit. The fair value of
loan commitments and unused lines of credit is estimated by taking into
account the remaining terms of the agreements and the present
credit-worthiness of the counter parties.
Continued
35
HARRODSBURG FIRST FINANCIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Disclosures about Fair Value of Financial Instruments, Continued
The estimated fair value of the Company's financial instruments at
September 30, 2002 and 2001 are as follows:
September 30, 2002 September 30, 2001
------------------------------ -----------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------------- ------------- -------------- -------------
Assets
Cash and cash equivalents $ 8,347,676 $ 8,347,676 $ 10,795,848 $ 10,795,848
Securities available-for-sale 17,275,431 17,275,431 12,508,751 12,508,751
Securities held-to-maturity 4,052,453 4,092,519 4,941,100 4,985,867
Loans receivable, net 113,351,935 108,471,622 105,081,309 102,016,039
Liabilities
Deposits 121,920,471 122,752,276 102,961,466 103,912,471
FHLB advances 5,000,000 5,000,000 7,000,000 7,000,000
Unrecognized Financial
Instruments
Loan commitments $ 1,608,229 $ 715,450
Unused lines of credit 3,235,593 5,313,000
13. Stock Purchase
In fiscal years 2002 and 2001, the Company repurchased 4,250 of common
stock at a cost of $51,540 and 269,909 shares of common stock at a cost of
$3,652,233, respectively.
14. Subsequent Event
On October 15, 2002, the Company entered into an agreement to purchase
200,000 shares of unissued but authorized shares of Independence Bancorp at
$10 a share. The Company anticipates that the closing will occur on or
about December 31, 2002. The transaction is subject to regulatory approval,
which is pending, and the closing of the transaction prior to December 31,
2002.
The Company has $4,000,000 of time deposits at Independence at September
30, 2002.
36
