EXHIBIT 13
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FIRST CAPITAL, INC.
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TABLE OF CONTENTS
Page
Letter to Stockholders................................................. 2
Selected Financial and Other Data...................................... 3-4
Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................ 5-12
Independent Auditor's Report........................................... 13
Consolidated Financial Statements...................................... 14-17
Notes to Consolidated Financial Statements............................. 18-37
Board of Directors..................................................... 38
Corporate Information.................................................. 39-40
BUSINESS OF THE COMPANY
First Capital, Inc. (the Company) is the holding company of First Federal
Bank, a Federal Savings Bank (the Bank). The Company became the holding company
for the Bank on December 31, 1999 in connection with the conversion of the
Bank's former mutual holding company, First Capital, Inc., MHC (the MHC) from
the mutual to stock form of organization and the simultaneous reorganization of
the Bank as a wholly-owned subsidiary of the Company (the Conversion and
Reorganization).
The Bank's deposit accounts are insured up to applicable legal limits by
the Federal Deposit Insurance Corporation through the Savings Association
Insurance Fund. The Bank is a member of the Federal Home Loan Bank System. The
Bank conducts its operations through its three offices in Xxxxxxxx County,
Indiana. The Bank's main office is located at 000 Xxxxxxx Xxxxx, X.X., Xxxxxxx,
Xxxxxxx. The telephone number is (000) 000-0000.
The Bank is a community-oriented financial institution offering traditional
financial services primarily to residents of Xxxxxxxx County, Indiana, and
contiguous counties. The Bank's primary business is attracting deposits from the
general public and using those funds to originate one-to-four family residential
mortgage loans. The Bank also originates multi-family and commercial real estate
loans secured by properties located in southern Indiana. To a lesser extent, the
Bank originates commercial and consumer loans.
1
FIRST CAPITAL, INC.
000 Xxxxxxx Xxxxx, X.X.
Xxxxxxx, Xxxxxxx 00000
September 23, 1999
Fellow shareholders of First Capital, Inc.
By any measure, this past year was exciting and rewarding for First Capital,
Inc. The most obvious measurement of our success was our ability to exceed our
financial objectives established at the beginning of our fiscal year. On
December 31, 1998, we completed a conversion from the mutual holding company to
the stock holding company form of organization and issued common stock in a
subscription offering which provided us with additional capital to support our
growth and the expansion of our banking services. From a strategic point of
view, a more important accomplishment was the announcement of the proposed
merger of First Capital, Inc. and HCB Bancorp of Palmyra, Indiana. We feel this
merger of equals, which we anticipate completing in early 2000, will enhance the
long-term performance of the Company.
Solid Earnings. Net income before taxes increased during the 1999 fiscal year
to $1.6 million from $1.5 million in 1998. Income after taxes rose by
approximately 4.6%. Fully diluted earnings per share increased to 77 cents per
share, a gain of 3 cents per share.
Outstanding Growth. First Capital, Inc. achieved asset growth of over 30%
during the past year. Net loans and securities grew during the year by over $30
million, deposits by almost $15 million and stockholders' equity by
approximately $7 million.
High Asset Quality. One of the most important aspects of a successful bank is
maintaining high-quality assets. As of June 30, 1999, First Capital, Inc. had no
non-performing assets. Clearly this level of non-performing assets cannot last
forever, particularly if economic conditions decline or weaken. However, we
believe we have policies and procedures in place designed to help maintain
delinquencies and loan losses to a minimum.
Local Advantage. As many large banks continue to buy and sell each other, we
have directed our efforts to expansion in our local market. The opening of our
new banking center in New Salisbury brings local banking back to that area.
Also, the proposed merger with HCB Bancorp will help consolidate these efforts.
The two banks currently have nine offices located within 25 miles of each other.
We believe the shareholders, customers and employees of both organizations will
benefit from this new partnership.
A Promising Outlook. The past year provided moderate levels of inflation,
nearly full employment and soaring consumer confidence. However, many economists
are viewing the coming year with caution. The Federal Reserve has already
responded to threats of inflation by raising interest rates. We believe First
Capital is in a strong position to withstand higher interest rates and increases
in unemployment should they occur.
On behalf of the Board of Directors and our entire staff, thank you for your
trust and confidence in our efforts. We will strive to earn your continued
support.
Sincerely,
J. Xxxxxx Xxxxxxxxx
Chairman and CEO
2
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SELECTED FINANCIAL AND OTHER DATA
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The financial data presented below is qualified in its entirety by the more
detailed financial data appearing elsewhere herein, including the Bank's audited
financial statements. The following tables set forth certain information
concerning the financial position and results of operations of the Bank at the
dates indicated.
FINANCIAL CONDITION DATA: At June 30,
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1999 1998 1997 1996 1995
-------------- ---------- ---------- -------- ---------
(In thousands)
Total assets $122,698 $93,958 $89,372 $81,317 $72,989
Loans receivable, net 83,887 74,887 69,909 63,365 59,174
Mortgage-backed securities, held to maturity 767 1,473 2,045 2,547 3,023
Other debt securities, held to maturity 8,480 1,580 4,023 5,267 4,403
Securities available for sale 20,205 4,849 3,684 2,135 603
Cash and interest bearing deposits (1) 2,611 6,135 5,039 5,385 3,485
Deposits 92,014 77,462 70,756 68,232 61,722
Advances from Federal Home Loan Bank 12,250 5,250 8,250 3,750 2,750
Stockholders' equity, substantially restricted 17,340 10,341 9,493 8,805 8,087
OPERATING DATA: Year Ended June 30,
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1999 1998 1997 1996 1995
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(In thousands)
Interest income $ 7,799 $ 6,860 $ 6,500 $ 5,997 $ 5,637
Interest expense 4,435 4,112 3,885 3,605 3,176
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Net interest income 3,364 2,748 2,615 2,392 2,461
Provision for loan losses 44 - - - 17
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Net interest income after provision
for loan losses 3,320 2,748 2,615 2,392 2,444
Non-interest income (2) 301 411 176 159 125
Non-interest expense (3) 1,987 1,612 1,854 1,200 1,140
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Income before income taxes 1,634 1,547 937 1,351 1,429
Income tax expense 632 589 131 501 526
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NET INCOME $ 1,002 $ 958 $ 806 $ 850 $ 903
===========================================================
PER SHARE DATA:
Net income - basic $ 0.78 $ 0.74 $ 0.63 $ 0.66 $ 0.71
Net income - diluted 0.77 0.74 0.62 0.65 0.70
Dividends to minority stockholders prior to conversion 0.14 0.27 0.27 0.27 0.27
Dividends following conversion 0.15 N/A N/A N/A N/A
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(1) Includes interest bearing deposits in other depository institutions.
(2) Includes one-time gain on sale of old main office building of $169,000 in
1998.
(3) Includes one-time SAIF insurance assessment of $403,000 in 1997.
3
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SELECTED FINANCIAL AND OTHER DATA - CONTINUED
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At June 30,
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1999 1998 1997 1996 1995
-------- ------ ------ ------ ------
SELECTED OTHER DATA:
Number of:
Mortgage loans outstanding 1,270 1,242 1,270 1,229 1241
Deposit accounts 8,688 7,783 7,181 6,744 6968
Offices 3 2 2 1 1
At and For Year Ended June 30,
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1999 1998 1997 1996 1995
-------- ------ ------ ------ ------
SELECTED FINANCIAL RATIOS:
Performance Ratios:
Return on assets (1) 0.95% 1.08% 0.96% 1.10% 1.25%
Return on average equity (2) 6.56% 9.56% 8.81% 10.00% 11.64%
Dividend payout ratio (3) 40.85% 36.74% 43.77% 41.19% 38.78%
Average equity to average assets 14.48% 11.30% 10.94% 11.02% 10.72%
Interest rate spread (4) 2.71% 2.72% 2.70% 2.59% 2.97%
Net interest margin (5) 3.37% 3.27% 3.27% 3.22% 3.51%
Non-interest expense to average assets 1.89% 1.82% 2.22% 1.56% 1.58%
Average interest earning assets to
average interest bearing liabilities 114.84% 111.29% 111.74% 113.10% 111.91%
Regulatory Capital Ratios:
Tier I - adjusted total assets 14.09% 11.01% 10.62% 10.83% 11.09%
Tier I - risk based 26.08% 18.33% 17.74% 19.55% 17.49%
Total risk-based 26.81% 19.15% 18.60% 20.71% 18.65%
Asset Quality Ratios:
Nonperforming loans as a percent of
loans receivable, net (6) - 0.17% 0.29% 0.16% 0.21%
Nonperforming assets as a
percent of total assets (7) - 0.14% 0.28% 0.12% 0.25%
Allowance for loan losses as a percent
of gross loans receivable 0.54% 0.67% 0.71% 0.79% 0.88%
Net charge-offs as a percent of
average outstanding loans 0.10% - - 0.02% 0.04%
Ratio of nonperforming assets to
total assets - 0.35% 0.14% 0.31% 0.14%
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(1) Net income divided by average assets.
(2) Net income divided by average equity.
(3) Dividend payout ratio is computed considering only the minority
shareholders' proportionate share of net income prior to conversion. Prior
to conversion on December 31, 1998, the majority shareholder, First
Capital, Inc., M.H.C., with the approval of the OTS, elected to waive the
receipt of dividends.
(4) Difference between weighted average yield on interest-earning assets and
weighted average cost of interest-bearing liabilities.
(5) Net interest income as a percentage of average interest-earning assets.
(6) Nonperforming loans consist of loans accounted for on a nonaccrual basis
and accruing loans 90 days or more past due.
(7) Nonperforming assets consist of nonperforming loans and real estate
acquired in settlement of loans, but exclude restructured loans.
4
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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General
First Capital, Inc. (the Company) is the parent to its wholly owned subsidiary,
First Federal Bank, a Federal Savings Bank (the Bank), a community-oriented
financial institution offering traditional financial services primarily to
residents of Xxxxxxxx County, Indiana, and contiguous counties. The Company has
no other material income other than that generated by the Bank. The Bank's
primary business is attracting deposits from the general public and using those
funds to originate one-to-four family residential mortgage loans. The Bank's
lending activity also includes multi-family residential loans, commercial real
estate and business loans and consumer loans. The Bank invests excess liquidity
primarily in interest bearing deposits with the Federal Home Loan Bank of
Indianapolis, U.S. government and agency securities, local municipal obligations
and, to a lesser extent, mortgage-backed securities.
Management's discussion and analysis of financial condition and results of
operations is intended to assist in understanding the financial condition and
results of operations of the Company and the Bank. The information contained in
this section should be read in conjunction with the consolidated financial
statements and the accompanying notes to consolidated financial statements
included elsewhere in this report.
Operating Strategy
The Bank's results of operations depend primarily on net interest income, which
is the difference between the income earned on its interest-earning assets, such
as loans and investments, and the cost of its interest-bearing liabilities,
consisting of deposits and, if utilized, borrowings from the Federal Home Loan
Bank of Indianapolis. The Bank's net income is also affected by, among other
things, fee income, provisions for loan losses, operating expenses and income
tax provisions. The Bank's results of operations are also significantly affected
by general economic and competitive conditions, particularly changes in market
interest rates, government legislation and policies concerning monetary and
fiscal affairs, housing and financial institutions and the intended actions of
the regulatory authorities.
The Bank's current business strategy is to operate as a well capitalized,
locally owned community bank. This strategy has been implemented in recent years
by controlling growth, emphasizing the origination of residential mortgage loans
in the Bank's primary market area, improving asset quality, controlling
operating expenses, and expanding customer services.
Safe Harbor Statement for Forward Looking Statements
This report may contain forward-looking statements within the meaning of the
federal securities laws. These statements are not historical facts, rather
statements based on the Company's current expectations regarding its business
strategies and their intended results and its future performance. Forward-
looking statements are preceded by terms such as "expects," "believes,"
"anticipates," "intends" and similar expressions.
Forward-looking statements are not guarantees of future performance. Numerous
risks and uncertainties could cause or contribute to the Company's actual
results, performance and achievements to be materially different from those
expressed or implied by the forward-looking statements. Factors that may cause
or contribute to these differences include, without limitation, general economic
conditions, including changes in market interest rates and changes in monetary
and fiscal policies of the federal government; legislative and regulatory
changes; the Company's ability to remedy any computer malfunctions that may
result from the advent of the Year 2000; and other factors disclosed
periodically in the Company's filings with the Securities and Exchange
Commission.
5
Because of the risks and uncertainties inherent in forward-looking statements,
readers are cautioned not to place undue reliance on them, whether included in
this report or made elsewhere from time to time by the Company or on its behalf.
The Company assumes no obligation to update any forward-looking statements.
Pending Merger
On July 19, 1999, the Company entered into an agreement and plan of merger with
HCB Bancorp (HCB), a bank holding company located in Palmyra, Indiana. HCB is
the parent company of Xxxxxxxx County Bank, a state-chartered commercial bank.
Terms of the agreement provide for an exchange of 15.5 shares of the Company's
common stock for each share of HCB common stock. At June 30, 1999, HCB had total
assets of $88.1 million and stockholders' equity of $12.1 million. The combined
company will have the leading market share in Xxxxxxxx County, Indiana, as
measured by total deposits. Management believes that the combined company will
be an effective competitor in its market area and will be well positioned to
offer superior community banking services. The merger is subject to regulatory
and stockholder approvals. See the accompanying notes to consolidated financial
statements for additional information.
Conversion and Stock Offering
On December 31, 1998, the MHC and Bank completed a conversion and stock offering
whereby the MHC was merged with and into the Bank with the Bank becoming a
wholly-owned subsidiary of the Company which offered common stock to certain
current and former depositor and borrower customers of the Bank in a
subscription offering. The Company issued 768,551 shares of common stock for
gross proceeds of $7,685,510 as a result of the offering. Total expenses in
connection with the conversion and offering amounted to $449,382 and were
charged against the proceeds from the offering.
The Company also issued 523,057 common shares in exchange for the 204,015 common
shares held by the public stockholders of the Bank pursuant to an exchange ratio
resulting in the public stockholders of the Bank owning in the aggregate
approximately 40.5% of First Capital, Inc. after the conversion and offering.
The conversion was accounted for as a pooling of interests and accordingly, the
June 30, 1998 balance sheet has been restated.
In connection with the conversion, the Bank has established a leveraged employee
stock ownership plan (ESOP) which acquired 8% of the common stock issued in the
offering (61,501 common shares) funded by a term loan from the Company. The Bank
will make annual contributions to the ESOP equal to the debt service
requirements of the term loan. The ESOP shares are pledged as collateral for the
loan and as the debt is repaid shares are released from collateral and allocated
to participants. The ESOP shares pledged as collateral are reported as unearned
ESOP shares in the balance sheet and the Company reports compensation cost equal
to the current fair value of the ESOP shares released from collateral. Dividends
on allocated ESOP shares are recorded as a reduction of retained earnings;
dividends on unallocated ESOP shares are not considered dividends for financial
reporting purposes.
Comparison of Financial Condition at June 30, 1999 and 1998
Total assets increased 30.6% from $94.0 million at June 30, 1998 to $122.7
million at June 30, 1999, primarily as a result of increases in investment
securities and loans receivable, net, which was funded primarily by the net
proceeds from the issuance of common stock in the conversion, growth in deposits
and an increase in advances from the Federal Home Loan Bank of Indianapolis.
Loans receivable, net, were $83.9 million at June 30, 1999, compared to $74.9
million at June 30, 1998, a 12.0% increase. The loan growth is attributable to a
16.7% growth in residential mortgage loans (includes residential construction
loans). Residential mortgage loans were $61.6 million at June 30, 1998, compared
to $71.9 million at June 30, 1999.
6
The investment in mortgage-backed securities held-to-maturity decreased from
$1.5 million at June 30, 1998 to $767,000 at June 30, 1999 as a result of
repayments of $702,000.
Other debt securities held to maturity, consisting of federal agency notes and
bonds, increased from $1.6 million at June 30, 1998 to $8.5 million at June 30,
1999. During the year ended June 30, 1999, the Company purchased other debt
securities of $8.5 million and had maturities of other debt securities with a
carrying value of $1.6 million.
Securities available for sale, consisting primarily of federal agency mortgage-
backed certificates, notes and bonds, increased $15.4 million from $4.8 million
at June 30, 1998 to $20.2 million at June 30, 1999 as a result of purchases of
$22.6 million and maturities and repayments of $6.5 million.
Cash and interest bearing deposits with banks decreased from $6.1 million at
June 30, 1998 to $2.6 million at June 30, 1999 as a result of the investment in
loans and investment securities.
Total deposits increased from $77.5 million at June 30, 1998 to $92.0 million at
June 30, 1999. The increase in deposits resulted primarily from growth in demand
and savings deposit accounts, which management attributes primarily to its
promotional efforts to attract lower cost accounts.
Total stockholders' equity increased from $10.3 million at June 30, 1998 to
$17.3 million at June 30, 1999 as a result of retained net income of $746,000
and net proceeds from issuance of common stock of $6.6 million.
Comparison of Operating Results for the Years Ended June 30, 1999 and 1998
Net Income. Net income was $1.0 million ($.77 per share diluted) for the year
ended June 30, 1999 compared to $958,000 ($.73 per share diluted) for the year
ended June 30, 1998. The results for 1998 included a one-time gain of $105,000,
net of tax, associated with the sale of the Bank's old main office property.
Excluding this one-time gain, net income increased $148,000 for 1999 compared to
1998 primarily from an increase in net interest income offset by an increase in
non-interest expenses.
Net Interest Income. Net interest income increased 22.4% from $2.7 million in
1998 to $3.4 million in 1999 as a result of the increase in interest-earning
assets during 1999 and a decrease in the average cost of funds in 1999 compared
to the same period in 1998.
Total interest income increased $938,000, or 13.7%, to $7.8 million for the year
ended June 30, 1999 compared to $6.9 million in the prior year as a result of a
higher balance of interest-earning assets. Interest on loans receivable
increased $286,000 and interest on investment securities increased $646,000 as a
result of a higher average balance in 1999. The average yield on interest-
earnings assets decreased from 8.16% in 1998 to 7.82% in 1999 primarily because
of lower market rates.
Total interest expense increased $323,000, or 7.8%, to $4.4 million for the year
ended June 30, 1999 compared to $4.1 million for the year ended June 30, 1998 as
a result of the growth in deposits and an increase in average borrowings from
the Federal Home Loan Bank. Both the average cost of deposits and borrowings
decreased during 1999 compared to 1998 as the average cost of interest bearing
liabilities decreased from 5.44% in 1998 to 5.11% in 1999. The decrease in the
average cost of deposits results from the growth in lower cost checking and
savings accounts.
7
Provision for Loan Losses. The provision for loan losses was $44,000 for the
year ending June 30, 1999. There was no provision for loan losses for the
comparable period in 1998 because the allowance for loan losses was considered
adequate based upon management's evaluation. Provisions for loan losses are
charges to earnings to maintain the total allowance for loan losses at a level
considered reasonable by management to provide for probable known and inherent
loan losses based on management's evaluation of the collectibility of the loan
portfolio, including the nature of the portfolio, credit concentrations, trends
in historical loss experience, specified impaired loans, and economic
conditions. The Bank made provisions of $44,000 for the year ended June 30, 1999
to increase the allowance for loan losses to an amount considered reasonable by
management based on quarterly evaluations. The Bank made provisions for loan
losses in 1999 due to an increase in commercial business and unsecured personal
loans, which possess a higher inherent risk of loss than one-to-four family
residential mortgage loans, and the net charge-offs of $78,000 during the year.
Although management uses the best information available, future adjustments to
the allowance may be necessary due to changes in economic, operating, regulatory
and other conditions that may be beyond the Bank's control. While the Bank
maintains its allowance for loan losses at a level which it considers adequate
to provide for estimated losses, there can be no assurance that further
additions will not be made to the allowance for loan losses and that actual
losses will not exceed the estimated amounts.
Non-interest income. Non-interest income decreased 26.7% to $301,000 for the
year ended June 30, 1999 compared to $411,000 for the year ended June 30, 1998.
The decrease is primarily the result of a one-time gain of $169,000 in 1998 from
the sale of the Bank's old main office property. Service charges on deposit
accounts increased $47,000 for 1999 compared to 1998 due to the growth in
transaction accounts during 1999.
Non-interest expense. Non-interest expense increased $376,000 for 1999 compared
to 1998. The increase results primarily from increases in compensation and
benefits and occupancy and equipment expenses. Compensation and benefits expense
increased $174,000 due to normal compensation increases and additional staff in
the loan department in 1999. Occupancy and equipment costs have increased in
1999 compared to 1998 as a result of increased depreciation charges on the new
main office facility and equipment and expenses related to the Year 2000 issue.
The Bank also experienced higher costs due to the opening of a new branch office
in New Salisbury, Indiana in March 1999. The Bank had been operating a temporary
facility in New Salisbury since November 1998.
Income tax expense. Income tax expense for the year ended June 30, 1999 was
$632,000, compared to $589,000 for the same period in 1998. The effective tax
rate for 1999 was 38.7% compared to 38.1% for 1998.
Liquidity and Capital Resources
The Bank's primary sources of funds are deposits and proceeds from loan
repayments and prepayments, and from the sale and maturity of securities. The
Bank may also borrow from the Federal Home Loan Bank of Indianapolis. While loan
repayments and maturities and sales of securities are predictable sources of
funds, deposit flows and mortgage prepayments are greatly influenced by market
interest rates, general economic conditions and competition. At June 30, 1999,
the Bank had cash and interest-bearing deposits with banks of $2.6 million and
securities available for sale with a fair value of $20.2 million. If the Bank
requires funds beyond its ability to generate them internally, it has additional
borrowing capacity with the FHLB of Indianapolis and collateral eligible for
repurchase agreements.
The Bank's primary investing activity is the origination of one-to-four family
mortgage loans and, to a lesser extent, consumer, multi-family, commercial real
estate and residential construction loans. The Bank also invests in U.S.
government and agency securities and mortgage-backed securities issued by U.S.
government agencies.
The Bank must maintain an adequate level of liquidity to ensure the availability
of sufficient funds to support loan growth and deposit withdrawals, to satisfy
financial commitments and to take advantage of investment opportunities. At June
30, 1999, the Bank had total commitments to extend credit of $10.4 million. See
Note 13 of Notes to Consolidated Financial Statements. At June 30, 1999, the
Bank had certificates of deposit scheduled to mature within one year of $21.4
million. Historically, the Bank has been able to retain a significant amount of
its deposits as they mature.
8
Current Office of Thrift Supervision (OTS) regulations require the Bank to
maintain an average daily balance of liquid assets (cash and eligible
investments) equal to at least 4.0% of the average daily balance of its net
withdrawable deposits and short-term borrowings. Historically, the Bank has
maintained liquidity levels in excess of regulatory requirements. At June 30,
1999, the Bank's liquidity was 9.5%.
The Bank is required to maintain specific amounts of capital pursuant to OTS
requirements. As of June 30, 1999, the Bank was in compliance with all
regulatory capital requirements which were effective as of such date with
tangible, core and risk-based capital ratios of 12.1%, 12.1% and 23.2%,
respectively.
Effect of Inflation and Changing Prices
The financial statements and related financial data presented herein have been
prepared in accordance with generally accepted accounting principles, which
generally require the measurement of financial position and operating results in
terms of historical dollars, without considering the changes in relative
purchasing power of money over time due to inflation. The primary impact of
inflation is reflected in the increased cost of the Bank's operations. Unlike
most industrial companies, virtually all the assets and liabilities of the
financial institution are monetary in nature. As a result, interest rates
generally have a more significant impact on the financial institutions
performance than do general levels of inflation. Interest rates do not
necessarily move in the same direction or to the same extent as the prices of
goods and services.
Market Risk Analysis
Qualitative Aspects of Market Risk. The Bank's principal financial
objective is to achieve long-term profitability while reducing its exposure to
fluctuating market interest rates. The Bank has sought to reduce the exposure of
its earnings to changes in market interest rates by attempting to manage the
mismatch between asset and liability maturities and interest rates. In order to
reduce the exposure to interest rate fluctuations, the Bank has developed
strategies to manage its liquidity, shorten its effective maturities of certain
interest-earning assets and decrease the interest rate sensitivity of its asset
base. Management has sought to decrease the average maturity of its assets by
emphasizing the origination of short-term commercial and consumer loans, all of
which are retained by the Bank for its portfolio. The Bank relies on retail
deposits as its primary source of funds. Management believes retail deposits,
compared to brokered deposits, reduce the effects of interest rate fluctuations
because they generally represent a more stable source of funds.
Quantitative Aspects of Market Risk. The Bank does not maintain a trading
account for any class of financial instrument nor does the Bank engage in
hedging activities or purchase high-risk derivative instruments. Furthermore,
the Bank is not subject to foreign currency exchange rate risk or commodity
price risk.
The Bank uses interest rate sensitivity analysis to measure its interest
rate risk by computing changes in NPV(net portfolio value) of its cash flows
from assets, liabilities and off-balance sheet items in the event of a range of
assumed changes in market interest rates. NPV represents the market value of
portfolio equity and is equal to the market value of assets minus the market
value of liabilities, with adjustments made for off-balance sheet items. This
analysis assesses the risk of loss in market risk sensitive instruments in the
event of a sudden and sustained 100 to 300 basis point increase or decrease in
market interest rates with no effect given to any steps that management might
take to counter the effect of that interest rate movement. Using data compiled
by the OTS, the Bank receives a report which measures interest rate risk by
modeling the change in NPV (net portfolio value) over a variety of interest rate
scenarios. This procedure for measuring interest rate risk was developed by the
OTS to replace the "gap" analysis (the difference between interest-earning
assets and interest-bearing liabilities that mature or reprice within a specific
time period).
9
The following table is provided by the OTS and sets forth the change in the
Bank's NPV at June 30, 1999, based on OTS assumptions, that would occur in the
event of an immediate change in interest rates, with no effect given to any
steps that management might take to counteract that change.
At June 30, 1999
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Net Portfolio Value Net Portfolio Value as a
---------------------------
Change Dollar Dollar Percent Percent of Present Value of Assets
In Rates Amount Change Change NPV Ratio Change
-------- ------ ------ ------ --------- ------
300bp $11,496 $(7,274) (38)% 10.09% (491)bp
200bp 14,271 (4,699) (25) 11.94 (306)bp
100bp 16,796 (2,174) (11) 13.64 (136)bp
--bp 18,970 - - 15.00 --bp
(100)bp 20,595 1625 9 15.93 93bp
(200)bp 22,250 3,280 17 16.83 183bp
(300)bp 24,329 5,359 28 17.94 294bp
The above table indicates that in the event of a sudden and sustained increase
in prevailing market interest rates, the Bank's NPV would be expected to
decrease, and that in the event of a sudden and sustained decrease in prevailing
market interest rates, the Bank's NPV would be expected to increase.
Certain assumptions utilized by the OTS in assessing the interest rate risk of
savings associations within its region were utilized in preparing the preceding
table. These assumptions relate to interest rates, loan prepayment rates,
deposit decay rates, and the market values of certain assets under differing
interest rate scenarios, among others.
As with any method of measuring interest rate risk, certain shortcomings are
inherent in the method of analysis presented in the foregoing table. For
example, although certain assets and liabilities may have similar maturities or
periods to repricing, they may react in different degrees to changes in market
interest rates. Also, the interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
interest rates on other types may lag behind changes in market rates.
Additionally, certain assets, such as adjustable-rate mortgage loans, have
features which restrict changes in interest rates on a short-term basis and over
the life of the asset. Further, in the event of a change in interest rates,
expected rates of prepayments on loans and early withdrawals from certificates
could deviate significantly from those assumed in calculating the table.
Year 2000 Issues
The Bank is a user of computers, computer software, and equipment utilizing
embedded microcontrollers that will be affected by the Year 2000 ("Y2K") issue.
The Y2K issue exists because many computer systems and applications use two-
digit date fields to designate a year. As the century date change occurs, date
sensitive systems may incorrectly recognize the year 2000. This inability to
recognize or properly treat the Y2K issue may cause systems to process financial
and operational information incorrectly. The Y2K issue presents several
potential risks to the Bank:
1. The banking transactions of the Bank's customers are processed by one or
more computer systems provided by a third-party service bureau. The failure
of one or more of those systems to function as a result of the Y2K date
change could result in the Bank's inability to properly process customer
transactions. If that were to occur, the Bank could lose customers to other
financial institutions, resulting in a loss of revenue.
2. A number of the Bank's borrowers utilize computers and computer software to
varying degrees in conjunction with the operation of their businesses. The
customers and suppliers of those businesses may utilize computers as well.
Should the Bank's borrowers, or the businesses on which they depend,
experience Y2K related computer problems, such borrowers' cash flow could
be disrupted, adversely effecting their ability to repay their loans with
the Bank.
10
3. Concern on the part of certain depositors that the Y2K related problems
could impair access to their deposit account balances following the Y2K
date change could result in the Bank experiencing a deposit outflow prior
to December 31, 1999.
4. The Bank contracts with several outside third parties for certain of its
data processing and account servicing functions. Should the systems of one
or more of those third parties fail to function properly after December 31,
1999, the Bank could be adversely affected.
5. Should the Y2K related problems occur which cause any of the Bank's
systems, or the systems of the third-party service bureau upon which the
Bank depends, to become inoperative, increased personnel costs could be
incurred if additional staff is required to perform functions that the
inoperative systems would have otherwise performed.
6. Certain utility services, such as electrical power and telecommunication
services, could be disrupted if those services experience Y2K related
problems. The Bank's Y2K contingency plan will address such possible
situations.
Management believes it is not possible to estimate the potential lost revenue
due to the Y2K issue, as the extent and longevity of such potential problems
cannot be predicted. The Bank adopted a Y2K Action Plan in November 1998 to
assess all systems to insure that they will function properly in the Y2K. This
process involves separate phases which include: awareness, assessment,
renovation, validation, and implementation.
During 1997, the Bank completed the systems assessment phase, identifying each
internal system that could potentially be affected by the Y2K issue. Those
systems include the Bank's in-house microcomputer systems and third-party
service bureau as well as equipment such as the alarm system, vault locks,
telephone system, etc., that may contain embedded microprocessors. For each such
system, an action plan was created to set forth the process for determining
whether or not the system is Y2K compliant. Those determinations involved
obtaining Y2K compliant certifications from vendors wherever possible, and by
the Bank conducting its own validation testing.
The Bank has identified major commercial borrowers to assess their Y2K readiness
and has requested information from those borrowers. As of June 30, 1999, the
Bank has received responses and evaluated those borrowers. All major commercial
borrowers identified have indicated that their Y2K preparedness is on schedule
or has been completed. Information necessary to assess Y2K readiness of new
commercial borrowers is obtained at the time of the loan application.
When the results of the Bank's validation testing programs have revealed that a
particular system is not Y2K compliant, a contingency plan is formulated to
either upgrade the system in order to meet the Y2K compliance requirements or
replace the system with one that is certified as Y2K compliant. The Bank is
currently in the validation and implementation phases of this process.
Other third parties upon which the Bank depends for processing include the
Bank's automated teller machine network processor, correspondent banks,
brokerage firms, and the pension plan administrator. These third parties have
indicated their compliance or intended compliance with the Y2K. Should the
testing of any third-party system or service reveal that such system or service
is not Y2K compliant, a specific deadline will be set by which time the system
or service must be brought into Y2K compliance. Should Y2K compliance not be
achieved by the specified deadlines, the Bank has developed a contingency plan
for each such external system or service. Those contingency plans document the
action the Bank will take for each such non-compliant system.
In certain cases, such as the potential loss of electrical power or
telecommunication services due to Y2K problems, testing by the Bank is either
not practical or not possible. In those cases, contingency plans will be
designed that specify how the Bank will deal with such potential situations. For
example, the Bank is considering the purchase or lease of an electrical power
generator with sufficient capacity to allow the Bank to maintain critical
functions in the event power from the electric utility is interrupted.
The Bank, as a federally chartered thrift institution, is regulated by the
Office of Thrift Supervision. The federal regulators have established specific
guidelines and time tables to follow in addressing the Y2K issue. The Bank is
currently in compliance with the federally mandated Y2K guidelines and time
tables.
11
As of June 30, 1999, the Bank is on schedule with its internal Y2K preparation
efforts. All internal systems identified in the assessment phase of the project
that are considered "mission critical" have been tested for Y2K compliance. The
Bank's in-house computer system, its most critical processing system, has been
certified by its respective hardware and software vendors as being Y2K
compliant. The Bank has begun testing the system for Y2K compatibility and the
testing to date has indicated that the system is Y2K compliant. All systems that
have been determined to be Y2K compliant will be retested during 1999 following
any material upgrades or enhancements. The Bank has replaced non-compliant
microcomputer equipment and has installed and tested the related software for
Y2K compliance. Other equipment containing embedded microprocessors have been
certified as Y2K compliant by the applicable vendors. The Bank's estimated total
cost to replace computer equipment, software programs, or other equipment
containing embedded microprocessors that were not Y2K compliant, is
approximately $65,000. As of June 30, 1999, approximately $42,000 has been
incurred. System maintenance or modification costs are being expensed as
incurred, while the cost of new hardware, software, or other equipment, is
capitalized and amortized over their estimated useful lives.
12
AVERAGE BALANCE SHEETS
The following table sets forth certain information for the periods indicated
regarding average balances of assets and liabilities as well as the total dollar
amounts of interest income from average interest earnings assets and interest
expense on average interest bearing liabilities and average yields and costs.
Such yields and costs for the periods indicated are derived by dividing income
or expense by the average balances of assets or liabilities, respectively, for
the periods presented. Average balances are derived from daily balances.
Year ended June 30,
--------------------------------------------------------------------
1999 1998
--------------------------------------------------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in thousands) Balance Interest Cost Balance Interest Cost
---------------------- -------- -------- ------- -------- -------- -------
Interest earning assets (1):
Mortgage loans $ 67,004 $5,467 8.16% $62,311 $5,214 8.37%
Consumer loans 7,352 662 9.00% 7,558 687 9.09%
Commercial business loans 4,204 366 8.71% 3,545 308 8.69%
-------- ------ ------- ------
Total loans 78,560 6,495 8.27% 73,414 6,209 8.46%
-------- ------ ------- ------
Investment securities (2) 17,667 1,124 6.36% 7,589 478 6.30%
Interest bearing deposits with banks 3,464 180 5.20% 3,057 173 5.66%
-------- ------ ------- ------
Total interest earning assets 99,691 7,799 7.82% 84,060 6,860 8.16%
-------- ------ ------- ------
Non-interest earning assets 5,697 4,621
-------- -------
Total assets $105,388 $88,681
-------- -------
-------- -------
Interest bearing liabilities:
Regular savings $ 5,560 $ 178 3.20% $ 4,678 $ 166 3.55%
Interest bearing demand deposits 25,021 1,015 4.06% 18,078 778 4.30%
Time deposits 48,696 2,824 5.80% 47,904 2,864 5.98%
-------- ------ ------- ------
Total deposits 79,277 4,017 5.07% 70,660 3,808 5.39%
-------- ------ ------- ------
FHLB advances 7,528 418 5.55% 4,874 304 6.24%
-------- ------ ------- ------
Total interest bearing liabilities 86,805 4,435 5.11% 75,534 4,112 5.44%
-------- ------ ------- ------
Non-interest bearing liabilities:
Non-interest bearing deposits 2,950 1,883
Other liabilities 370 1,247
-------- -------
Total liabilities 90,125 78,664
Stockholders' equity 15,263 10,017
-------- -------
Total liabilities and stockholders' $105,388 $88,681
equity -------- -------
-------- -------
Net interest income $3,364 $2,748
------ ------
------ ------
Interest rate spread 2.71% 2.72%
------- -------
------- -------
Net interest margin 3.37% 3.27%
------- -------
------- -------
Ratio of average interest earning assets
to average interest bearing liabilities 114.84% 111.29%
------- -------
------- -------
------------------------------------------------------------------------------------------------------------------------------------
(1) Does not include interest on loans 90 days or more past due.
(2) Includes mortgage-backed and other debt securities, securities classified as available for sale and Federal Home Loan Bank
stock.
13
RATE/VOLUME ANALYSIS
The following table sets forth the effects of changing rates and volumes on net
interest income and interest expense. Information is provided with respect to
(i) effects on interest income attributable to changes in volume (changes in
volume multiplied by prior rate); (ii) effects attributable to changes in rate
(changes in rate multiplied by prior volume); (iii) effects attributable to
changes in rate and volume (change in rate multiplied by changes in volume);
and (iv) the net change (the sum of the prior columns).
1999 Compared to 1998
Increase (Decrease) Due to
--------------------------------------
Rate/
Rate Volume Volume Net
---- ------ ------ ---
(In thousands)
Interest earning assets:
Mortgage loans (1) ($131) $ 394 ($10) $253
Consumer loans (1) (7) (18) - (25)
Commercial business loans (1) 1 57 - 58
------ ------- ----- -----
Total loans (137) 433 (10) 286
------ ------- ----- -----
Investment securities (2) 5 635 6 646
Interest bearing deposits with banks (14) 23 (2) 7
------ ------- ----- -----
Total net change in income
on interest earning assets (146) 1,091 (6) 939
------ ------- ----- -----
Interest bearing liabilities:
Interest bearing deposits (226) 463 (28) 209
FHLB advances (34) 166 (18) 114
------ ------- ----- -----
Total net change in expense (260) 629 (46) 323
on interest bearing liabilities ------ ------- ----- -----
Net change in net interest income $114 $462 $40 $616
===== ====== ===== =====
------------------------------------------------------------------------------------------------------------------------------------
(1) Does not include interest on loans 90 days or more past due.
(2) Includes mortgage-backed and other debt securities, securities classified as available for sale and Federal Home Loan Bank
stock.
14
Independent Auditor's Report
The Board of Directors
First Capital, Inc.
Corydon, Indiana
We have audited the accompanying consolidated balance sheets of First Capital,
Inc. and Subsidiary as of June 30, 1999 and 1998, and the related consolidated
statements of income, stockholders' equity and cash flows for the years then
ended. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of First Capital, Inc.
and Subsidiary as of June 30, 1999 and 1998, and the results of their operations
and their cash flows for the years then ended in conformity with generally
accepted accounting principles.
/s/ MONROE SHINE & CO., INC.
New Albany, Indiana
July 22, 1999
15
FIRST CAPITAL, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1999 AND 1998
1999 1998
------------- ------------
ASSETS
Cash and due from banks $ 929,524 $ 894,657
Interest bearing deposits with banks 1,681,356 5,239,904
Securities available for sale, at fair value 20,204,556 4,848,534
Securities held to maturity:
Mortgage-backed securities (fair value $742,635;
1998 $1,462,917) 766,819 1,472,972
Other debt securities (fair value $8,320,025; 1998 $1,573,450) 8,479,648 1,580,000
Loans receivable, net of allowance for loan losses of $481,619
in 1999 and $515,959 in 1998 83,886,960 74,887,358
Federal Home Loan Bank stock, at cost 662,500 588,800
Foreclosed real estate - 103,874
Premises and equipment 3,688,258 2,600,772
Accrued interest receivable:
Loans 430,707 432,274
Mortgage-backed securities 33,661 11,681
Other debt securities 452,806 88,244
Cash value of life insurance 1,085,824 1,038,340
Other assets 394,932 170,653
------------ -----------
Total Assets $122,697,551 $93,958,063
============ ===========
LIABILITIES
Deposits:
Non-interest bearing demand deposits $ 4,093,621 $ 3,146,552
Savings and interest bearing demand deposits 38,814,682 26,593,058
Time deposits 49,105,953 47,722,424
------------ -----------
Total deposits 92,014,256 77,462,034
Advances from Federal Home Loan Bank 12,250,000 5,250,000
Advance payments by borrowers for taxes and insurance 37,073 33,722
Accrued interest payable on deposits 470,352 372,845
Accrued expenses and other liabilities 586,206 498,527
------------ -----------
Total Liabilities 105,357,887 83,617,128
------------ -----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock of $.01 par value per share
Authorized 1,000,000 shares; none issued - -
Common stock of $.01 par value per share
Authorized 5,000,000 shares; issued 1,292,752 shares in 1999
(1,292,748 shares in 1998) 12,927 12,927
Additional paid-in capital 9,401,787 2,154,369
Retained earnings-substantially restricted 8,916,432 8,170,645
Accumulated other comprehensive income-net unrealized gain
(loss) on securities available for sale (407,222) 2,994
Unearned ESOP shares (584,260) -
------------ -----------
Total Stockholders' Equity 17,339,664 10,340,935
------------ -----------
Total Liabilities and Stockholders' Equity $122,697,551 $93,958,063
============ ===========
See notes to consolidated financial statements.
16
FIRST CAPITAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED JUNE 30, 1999 AND 1998
Accumulated
Additional Other Unearned
Common Paid-in Retained Comprehensive ESOP
Stock Capital Earnings Income (Loss) Shares Total
Balances at July 1, 1997 $12,888 $ 2,132,648 $ 7,354,737 $ (7,761) $ - $ 9,492,512
COMPREHENSIVE INCOME
Net income - - 958,452 - - 958,452
Other comprehensive income:
Change in unrealized loss on
securities available for sale,
net of deferred income tax
expense of $7,054 - - - 10,755 - 10,755
Less: reclassification adjustment - - - - - -
------------
Total comprehensive income 969,207
------------
Cash dividends to minority stockholders
of Bank - - (142,544) - - (142,544)
Exercise of stock options 39 21,721 - - - 21,760
-----------------------------------------------------------------------------------
Balances at June 30, 1998 12,927 2,154,369 8,170,645 2,994 - 10,340,935
COMPREHENSIVE INCOME
Net income - - 1,002,051 - - 1,002,051
Other comprehensive income:
Change in unrealized gain (loss)
on securities available for sale,
net of deferred income tax
benefit of $269,137 - - - (410,216) - (410,216)
Less: reclassification adjustment - - - - - -
------------
Total comprehensive income 591,835
------------
Cash dividends to minority stockholders
of Bank - - (71,405) - - (71,405)
Cash dividends ($0.15 per share) - - (184,859) - - (184,859)
Changes pursuant to conversion and
reorganization:
Cancellation of 769,470 shares held by
First Capital, Inc. , MHC and
merger with Bank (7,695) 12,877 - - - 5,182
Issuance of 707,050 common shares 7,071 6,614,047 - - - 6,621,118
Issuance of 61,501 common shares to
ESOP trust 615 614,395 - - (615,010) -
Exercise of stock options 9 5,750 - - - 5,759
Shares released by ESOP trust - 349 - - 30,750 31,099
-----------------------------------------------------------------------------------
Balances at June 30, 1999 $12,927 $ 9,401,787 $ 8,916,432 $(407,222) $(584,260) $17,339,664
===================================================================================
See notes to financial statements.
17
FIRST CAPITAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED JUNE 30, 1999 AND 1998
1999 1998
----------- -----------
INTEREST INCOME
Loans receivable:
Mortgage loans $5,467,632 $5,213,556
Consumer and other loans 1,027,820 995,710
Mortgage-backed securities 184,643 111,751
Other securities:
Federal agency 811,098 264,847
Municipal 19,966 9,363
Other 59,095 46,245
Federal Home Loan Bank dividends 48,509 45,653
Interest bearing deposits with banks 179,946 173,192
-----------------------
Total interest income 7,798,709 6,860,317
-----------------------
INTEREST EXPENSE
Deposits 4,016,573 3,808,317
Advances from Federal Home Loan Bank 417,995 303,551
-----------------------
Total interest expense 4,434,568 4,111,868
-----------------------
Net interest income 3,364,141 2,748,449
Provision for loan losses 44,000 -
-----------------------
Net interest income after provision for loan losses 3,320,141 2,748,449
NON-INTEREST INCOME
Loan fees and service charges 48,284 38,684
Gain on sale of premises and equipment - 169,087
Service charges on deposit accounts 170,620 123,806
Other income 82,304 79,205
-----------------------
Total non-interest income 301,208 410,782
-----------------------
NON-INTEREST EXPENSES
Compensation and benefits 1,032,773 858,303
Occupancy and equipment 398,177 309,943
Deposit insurance premiums 46,729 44,198
Other expenses 509,850 399,120
-----------------------
Total non-interest expenses 1,987,529 1,611,564
-----------------------
Income before income taxes 1,633,820 1,547,667
Income tax expense 631,769 589,215
-----------------------
Net Income $1,002,051 $ 958,452
=======================
Net income per common share, basic $ .78 $ .74
=======================
Net income per common share, diluted $ .77 $ .74
=======================
See notes to consolidated financial statements.
18
FIRST CAPITAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1999 AND 1998
1999 1998
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,002,051 $ 958,452
Adjustments to reconcile net income to
net cash provided by operating activities:
Gain on sale of premises and equipment - (169,087)
Amortization of premiums and accretion of discounts
on securities, net 6,320 12,228
Depreciation expense 200,929 174,935
Deferred income taxes 8,120 (9,321)
ESOP compensation expense 31,099 -
Increase in cash value of life insurance (47,484) (46,144)
Provision for loan losses 44,000 -
(Increase) decrease in accrued interest receivable (384,975) 7,506
Increase in accrued interest payable 97,507 165,352
Net change in other assets/liabilities 127,693 (162,280)
------------ ------------
Net Cash Provided By Operating Activities 1,085,260 931,641
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net (increase) decrease in interest bearing deposits in banks 3,558,548 (1,445,357)
Purchase of securities available for sale (22,556,441) (4,146,245)
Proceeds from maturities of securities available for sale 6,514,216 3,000,000
Purchase of securities held to maturity (8,475,000) -
Proceeds from maturities of securities held to maturity 1,580,000 2,440,000
Principal collected on mortgage-backed securities 702,110 562,574
Net increase in loans receivable (8,939,728) (5,082,056)
Purchase of Federal Home Loan Bank stock (73,700) (29,700)
Proceeds from sale of premises and equipment - 425,000
Purchase of premises and equipment (1,288,415) (590,828)
------------ ------------
Net Cash Used in Investing Activities (28,978,410) (4,866,612)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand and savings deposits 13,168,693 6,739,502
Net increase (decrease) in time deposits 1,383,529 (33,777)
Advances from Federal Home Loan Bank 10,000,000 8,500,000
Repayment of advances from Federal Home Loan Bank (3,000,000) (11,500,000)
Net proceeds from issuance of common stock 6,621,118 -
Exercise of stock options 5,759 21,760
Cash received from merger with First Capital, Inc. MHC 5,182 -
Cash dividends paid (256,264) (142,544)
------------ ------------
Net Cash Provided By Financing Activities 27,928,017 3,584,941
------------ ------------
Net Increase (Decrease) in Cash and Due From Banks 34,867 (350,030)
Cash and due from banks at beginning of year 894,657 1,244,687
------------ ------------
Cash and Due From Banks at End of Year $ 929,524 $ 894,657
============ ============
See notes on consolidated financial statements.
19
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999 AND 1998
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
First Capital, Inc. ("Company") was incorporated by First Federal Bank, a
Federal Savings Bank ("Bank") in September 1998 in connection with the
conversion from the mutual holding company form of organization to the
stock holding company form of organization. Upon consummation of the
conversion on December 31, 1998, the Company became the holding company for
the Bank and the former mutual holding company, First Capital, Inc., M.H.C.
("MHC"), was merged with and into the Bank. The conversion was accounted
for as a pooling of interests and, therefore, the 1999 consolidated
financial statements are based on the assumption the companies were
combined for the full year and the prior year financial statements have
been restated to give effect to the combination.
The Bank provides a variety of banking services to individuals and business
customers through three offices in southern Indiana. The Bank's primary
source of revenue is single-family residential loans.
Consolidation
The consolidated financial statements include the accounts of the Company
and the Bank. All material intercompany balances and transactions have been
eliminated in consolidation.
Statements of Cash Flows
For purposes of the statements of cash flows, the Bank has defined cash and
cash equivalents as those amounts included in the balance sheet caption
"Cash and due from banks."
Reclassifications
Certain prior year amounts have been reclassified to conform with current
year presentation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for loan losses and the
valuation of foreclosed real estate. In connection with the determination
of estimated losses on loan and foreclosed real estate, management obtains
appraisals for significant properties.
Securities Available for Sale
Securities available for sale consist of debt and equity securities and are
stated at fair value. Amortization of premium and accretion of discount are
recognized in interest income using the interest method over the remaining
period to maturity, adjusted for anticipated prepayments. Unrealized gains
and losses, net of tax, on securities available for sale are reported as a
separate component of stockholders' equity until realized. Realized gains
and losses on the sale of securities available for sale are determined
using the specific identification method.
20
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(1 - continued)
Securities Held to Maturity
Debt securities for which the Bank has the positive intent and ability to
hold to maturity are carried at cost, adjusted for amortization of premium
and accretion of discount using the interest method over the remaining
period to maturity, adjusted for anticipated prepayments. Mortgage-backed
securities represent participating interests in pools of long-term first
mortgage loans originated and serviced by issuers of the securities.
Loans
Loans receivable are stated at unpaid principal balances, less net deferred
loan fees and the allowance for loan losses. The Bank's real estate loan
portfolio consists primarily of long-term loans, collateralized by first
mortgages on single-family residences and multi-family residential
properties located in the southern Indiana area and commercial real estate
loans. In addition to real estate loans, the Bank makes commercial loans
and consumer loans.
Loan origination fees and certain direct costs of underwriting and closing
loans are deferred and the net fee or cost is recognized as an adjustment
to interest income over the contractual life of the loans using the
interest method.
The accrual of interest is discontinued on a loan when, in the judgment of
management, the probability of collection of interest is deemed to be
insufficient to warrant further accrual. The Bank does not accrue interest
on loans past due 90 days or more except when the estimated value of
collateral and collection efforts are deemed sufficient to ensure full
recovery. When a loan is placed on non accrual status, previously accrued
but unpaid interest is deducted from interest income.
Subsequent receipts on nonaccrual loans, including specific impaired loans
are recorded as a reduction of principal, and interest income is only
recorded once principal recovery is reasonably assured.
The allowance for loan losses is maintained at a level which, in
management's judgment, is adequate to absorb credit losses inherent in the
loan portfolio. The amount of the allowance is based on management's
evaluation of the collectibility of the loan portfolio, including the
nature of the portfolio, credit concentrations, trends in historical loss
experience, specified impaired loans, and economic conditions. Allowances
for impaired loans are generally determined based on collateral values or
the present value of estimated cash flows. The allowance is increased by a
provision for loan losses, which is charged to expense, and reduced by
charge-offs, net of recoveries. Changes in the allowance relating to
impaired loans are charged or credited to the provision for loan losses.
Because of uncertainties inherent in the estimation process, management's
estimate of credit losses inherent in the loan portfolio and the related
allowance may change in the near term.
21
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(1 - continued)
Foreclosed Real Estate
Foreclosed real estate is carried at the lower of fair value minus
estimated costs to sell or cost. Costs of holding foreclosed real estate
are charged to expense in the current period, except for significant
property improvements, which are capitalized. Valuations are periodically
performed by management and an allowance is established by a charge to non-
interest expense if the carrying value exceeds the fair value minus
estimated costs to sell. The net expense from operations of foreclosed real
estate held for sale is reported in non-interest expense.
Premises and Equipment
The Bank uses the straight line and accelerated methods of computing
depreciation at rates adequate to amortize the cost of the applicable
assets over their useful lives. Items capitalized as part of premises and
equipment are valued at cost. Maintenance and repairs are expensed as
incurred. The cost and related accumulated depreciation of assets sold, or
otherwise disposed of, are removed from the related accounts and any gain
or loss is included in earnings.
Income Taxes
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 accrued income and expenses for financial and income tax
reporting. 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.
Stock-Based Compensation
Under the provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, the Company will measure and recognize compensation cost
related to stock-based compensation plans using the intrinsic value method
and disclose the pro forma effect of applying the fair value method
contained in SFAS No. 123. Accordingly, no compensation costs will be
charged against earnings for stock options granted under the Company's
stock-based compensation plans.
Advertising
Advertising costs are charged to operations when incurred.
Comprehensive Income
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130 (SFAS 130), "Reporting Comprehensive Income." SFAS 130
establishes standards for reporting and presentation of comprehensive
income and its components in a full set of financial statements.
Comprehensive income consists of net income and net unrealized gains
(losses) on securities and is presented in the consolidated statements of
changes in stockholders' equity and comprehensive income. The statement
requires only additional disclosures in the consolidated financial
statements; it does not affect the Company's financial position, results of
operations or cash flows. Prior year financial statements have been
reclassified to conform to the requirements of SFAS 130.
22
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(2) PENDING MERGER
On July 19, 1999, the Company entered into an agreement and plan of merger
with HCB Bancorp (HCB), a bank holding company located in Palmyra, Indiana.
HCB is the parent company of Xxxxxxxx County Bank, a state-chartered
commercial bank. Terms of the agreement provide for an exchange of 15.5
shares of the Company's common stock for each share of HCB common stock.
The merger is subject to regulatory and stockholder approvals. At June 30,
1999, HCB had total assets of $88.1 million and stockholders' equity of
$12.1 million. HCB had net income of $491,000 for the six months ended June
30, 1999. HCB reported net income of $1,085,000 and $1,132,000 for the
years ended December 31, 1998 and 1997, respectively.
The following summarized operating data gives effect to the merger had it
occurred on July 1, 1997:
(In thousands, except per share data) 1999 1998
------- -------
Net interest income $7,052 $6,399
====== ======
Net income $2,018 $2,096
====== ======
Net income per common share, basic $ .80 $ .83
====== ======
Net income per common share, diluted $ .79 $ .82
====== ======
(3) DEBT AND EQUITY SECURITIES
Debt and equity securities have been classified in the balance sheets
according to management's intent. The Bank's investment in securities at
June 30, 1999 and 1998 is summarized as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
June 30, 1999:
Securities available for sale:
Securities:
FHLMC certificates $ 842,413 $ - $ 7,983 $ 834,430
GNMA certificates 3,740,569 - 88,582 3,651,987
-------------------------------------------------
4,582,982 - 96,565 4,486,417
-------------------------------------------------
Other debt securities:
Federal agency 14,000,000 - 481,113 13,518,887
Municipal 1,293,226 - 78,777 1,214,449
-------------------------------------------------
15,293,226 - 559,890 14,733,336
-------------------------------------------------
Mutual funds 1,002,670 - 17,867 984,803
-------------------------------------------------
Total securities available
for sale $20,878,878 $ - $674,322 $20,204,556
=================================================
Securities held to maturity:
Mortgage-backed securities:
FHLMC certificates $ 109,689 $ 590 $ 108 $ 110,171
GNMA certificates 286,140 - 12,142 273,998
FNMA certificates 370,990 1,267 13,791 358,466
-------------------------------------------------
766,819 1,857 26,041 742,635
-------------------------------------------------
Other debt securities:
Federal agency 8,479,648 - 159,623 8,320,025
-------------------------------------------------
Total securities held to
maturity $ 9,246,467 $1,857 $185,664 $ 9,062,660
=================================================
23
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(3 - continued)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
June 30, 1998:
Securities available for sale:
Mutual fund $ 843,576 $3,395 $ - $ 846,971
Federal agency debt securities 4,000,000 1,563 - 4,001,563
-----------------------------------------------
Total securities available
for sale $4,843,576 $4,958 $ - $4,848,534
===============================================
Securities held to maturity:
Mortgage-backed securities:
FHLMC certificates $ 683,762 $6,378 $ 2,012 $ 688,128
GNMA certificates 371,297 - 7,068 364,229
FNMA certificates 417,913 2,273 9,626 410,560
-----------------------------------------------
1,472,972 8,651 18,706 1,462,917
-----------------------------------------------
Other debt securities:
Federal agency 1,500,000 - 6,562 1,493,438
Municipal 80,000 12 - 80,012
-----------------------------------------------
1,580,000 12 6,562 1,573,450
-----------------------------------------------
Total securities held to
maturity $3,052,972 $8,663 $25,268 $3,036,367
===============================================
The amortized cost and fair value of debt securities as of June 30, 1999,
by contractual maturity, are shown below. Expected maturities of mortgage-
backed securities may differ from contractual maturities because the
mortgages underlying the obligations may be prepaid without penalty.
Securities Available for Sale Securities Held to Maturity
Amortized Fair Amortized Fair
Cost Value Cost Value
Due after five years through
ten years $11,655,000 $11,272,643 $8,479,648 $8,320,025
Due after ten years 3,638,226 3,460,693 - -
-------------------------------------------------------
15,293,226 14,733,336 8,479,648 8,320,025
Mortgage-backed securities 4,582,982 4,486,417 766,819 742,635
-------------------------------------------------------
$19,876,208 $19,219,753 $9,246,467 $9,062,660
=======================================================
Certain debt securities were pledged to secure advances from the Federal
Home Loan Bank at June 30, 1999. (See Note 7)
24
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(4) LOANS
Loans receivable at June 30, 1999 and 1998 consisted of the following:
1999 1998
---- ----
Real estate mortgage loans:
Residential $63,530,746 $57,825,501
Land 1,018,276 217,720
Residential construction 8,346,117 3,786,787
Commercial real estate 3,678,160 4,370,446
Commercial business loans 5,607,319 5,048,291
Consumer loans:
Home equity and second mortgage loans 964,382 777,649
Automobile loans 1,615,081 1,574,208
Loans secured by savings accounts 399,778 465,613
Other consumer loans 3,432,529 3,479,984
--------------------------
Gross loans receivable 88,592,388 77,546,199
--------------------------
Less:
Deferred loan origination fees, net 204,499 210,572
Undisbursed portion of loans in process 4,019,310 1,932,310
Allowance for loan losses 481,619 515,959
--------------------------
4,705,428 2,658,841
--------------------------
Loans receivable, net $83,886,960 $74,887,358
==========================
An analysis of the allowance for loan losses is as follows:
1999 1998
---- ----
Beginning balances $ 515,959 $ 518,645
Provision 44,000 -
Recoveries 156 -
Loans charged-off (78,496) (2,686)
--------------------------
Ending balances $ 481,619 $ 515,959
==========================
The Bank had no loans specifically classified as impaired at June 30, 1999.
At June 30, 1998, the Bank had loans amounting to $79,343 that were
specifically classified as impaired. The average recorded investment in
impaired loans amounted to $52,171 and $92,291 for 1999 and 1998,
respectively. The allowance for loan losses related to impaired loans
amounted to $54,566 at June 30, 1998. There was no interest income
recognized on impaired loans during 1999 and 1998, respectively.
The Bank has entered into loan transactions with certain directors,
officers and their affiliates (related parties). In the opinion of
management, such indebtedness was incurred in the ordinary course of
business on substantially the same terms as those prevailing at the time
for comparable transactions with other persons and does not involve more
than normal risk of collectibility or present other unfavorable features.
25
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(4 - continued)
The following table represents the aggregate activity for related party
loans which exceeded $60,000 in total:
Balance-July 1, 1998 $3,062,707
New loans 2,723,901
Payments (258,714)
----------
Balance-June 30, 1999 $5,527,894
==========
The Bank has purchased commercial paper from a corporation where a director
is considered a related party. In the opinion of management, these
transactions were made in the ordinary course of business on substantially
the same terms, including interest rate and collateral, as those prevailing
at the time for comparable transactions with unrelated parties. During the
fiscal years ended June 30, 1999 and 1998, the Bank granted approximately
$768,000 and $612,000, respectively, to customers of the dealership and
such loans had an aggregate outstanding balance of approximately $1.4
million and $1.6 million at June 30, 1999 and 1998, respectively.
(5) PREMISES AND EQUIPMENT
Premises and equipment consisted of the following:
1999 1998
---- ----
Land and land improvements $ 509,547 $ 379,547
Leasehold improvements 46,847 46,847
Office building 2,611,748 1,729,512
Furniture, fixtures and equipment 1,236,618 960,438
-----------------------
4,404,760 3,116,344
Less accumulated depreciation 716,502 515,572
-----------------------
Totals $3,688,258 $2,600,772
=======================
(6) DEPOSITS
The aggregate amount of time deposit accounts with balances of $100,000 or
more was approximately $12,789,000 and $11,002,000 at June 30, 1999 and
1998, respectively.
At June 30, 1999, scheduled maturities of time deposits were as follows:
Year ending June 30:
2000 $21,434,042
2001 12,871,571
2002 6,038,481
2003 4,845,618
2004 and thereafter 3,916,241
-----------
Total $49,105,953
===========
26
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(6 - continued)
The Bank held deposits of approximately $1,526,000 and $1,469,000 for
related parties at June 30, 1999 and 1998, respectively.
Deposit account balances in excess of $100,000 are not federally insured.
Interest expense on deposits is summarized as follows:
1999 1998
---- ----
Savings and demand deposits $1,192,648 $ 944,007
Time deposits 2,823,925 2,864,310
--------- ---------
$4,016,573 $3,808,317
========== ==========
(7) ADVANCES FROM FEDERAL HOME LOAN BANK
At June 30, 1999 and 1998, advances from the Federal Home Loan Bank were as
follows:
1999 1998
---- ----
Weighted Weighted
Average Average
Rate Amount Rate Amount
Advances maturing during the
year ending June 30:
Fixed rate advances:
1999 $ - 5.17% $4,500,000
2000 5.29% 1,000,000 -
2001 5.50% 1,000,000 -
2002 7.75% 750,000 7.75% 750,000
2004 5.55% 3,000,000 -
2008 5.17% 4,500,000 -
----------- ----------
10,250,000 5,250,000
----------- ----------
Adjustable rate advances:
2000 5.15% 2,000,000 -
----------- ----------
$12,250,000 $5,250,000
=========== ==========
The advances are secured under a blanket collateral agreement. At June 30,
1999, eligible collateral included conventional mortgage loans with a
carrying value of $54,101,269 and debt securities with a carrying value of
$27,251,772 which were pledged as security for the advances.
(8) LEASE COMMITMENT
On April 1, 1997, the Bank entered into a noncancellable sub-lease
agreement for a branch office for an initial lease term of eight years.
The sub-lessor has a fixed term lease with the owner with an initial term
expiring November 30, 2003.
27
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(8 - continued)
The following is a schedule by years of future minimum rental payments
required under this operating lease:
Year ending June 30:
2000 $12,690
2001 12,690
2002 12,690
2003 12,690
-------
Total minimum payments required $50,760
=======
Total minimum rental expense for all operating leases for xxxx of the years
ended June 30, 1999 and 1998 amounted to $12,690.
(9) INCOME TAXES
The components of income tax expense were as follows:
1999 1998
---- ----
Current $ 623,649 $ 598,536
Deferred 8,120 (9,321)
---------------------------
Totals $ 631,769 $ 589,215
===========================
Significant components of the Bank's deferred tax assets and liabilities as
of June 30, 1999 and 1998 were as follows:
1999 1998
---- ----
Deferred tax (assets) liabilities:
Depreciation $ 77,952 $ 65,634
Deferred loan fees 44,468 26,446
Deferred compensation plans (134,359) (127,170)
Allowance for loan losses (190,769) (204,371)
Post-1987 bad debt deduction 143,164 171,797
Unrealized gain (loss) on securities available for sale (267,098) 1,964
---------------------------
Net deferred tax asset $(326,642) $ (65,700)
===========================
The reconciliation of income tax expense with the amount which would have
been provided at the federal statutory rate of 34 percent follows:
1999 1998
---- ----
Provision at federal statutory tax rate $555,499 $526,207
State income tax-net of federal tax benefit 91,696 83,515
Tax exempt interest income (8,345) (8,813)
Increase in cash value of life insurance (16,145) (15,689)
Other 9,064 3,995
--------------------------
Totals $631,769 $589,215
==========================
Effective tax rate 38.7% 38.1%
==========================
28
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(9 - continued)
Prior to July 1, 1996, the Bank was permitted by the Internal Revenue Code
to deduct from taxable income an annual addition to a statutory bad debt
reserve subject to certain limitations. Retained earnings at June 30, 1999
includes approximately $909,000 of cumulative deductions for which no
deferred federal income tax liability has been recorded. Reduction of these
reserves for purposes other than tax bad debt losses or adjustments arising
from carryback of net operating losses would create income for tax purposes
subject to the then current corporate income tax rate. The unrecorded
deferred liability on these amounts was approximately $309,000 at June 30,
1999.
Federal legislation repealed the reserve method of accounting for bad debts
by qualified thrift institutions for tax years beginning after December 31,
1995. As a result, the Bank cannot use the percentage-of taxable-income
method to calculate the annual addition to the statutory bad debt reserve.
Instead, the Bank is required to compute its federal tax bad debt deduction
based on actual loss experience over a period of years. The legislation
required the Bank to recapture into taxable income over a six-year period
its post-1987 additions to the statutory bad debt reserve, thereby
generating additional tax liability. At June 30, 1999, the remaining
unamortized balance of the post-1987 reserves totaled $421,070 for which a
deferred tax liability of $143,164 has been recorded.
The legislation also provided that the Bank will not be required to
recapture its pre-1988 statutory bad debt reserves if it ceases to meet the
qualifying thrift definitional tests and if the Bank continues to qualify
as a "bank" under existing provisions of the Internal Revenue Code.
(10) EMPLOYEE BENEFIT PLANS
Defined Contribution Plan:
The Bank has a qualified contributory defined contribution plan available
to all eligible employees. The plan allows participating employees to make
tax-deferred contributions under Internal Revenue Code Section 401(k). The
Bank contributed $27,228 and $24,991 to the plan for 1999 and 1998,
respectively.
Employee Stock Ownership Plan:
On December 31, 1998, the Company established a leveraged employee stock
ownership plan (ESOP) covering substantially all employees. The ESOP trust
acquired 61,501 shares of Company common stock financed by a term loan with
the Company. The employer loan and the related interest income are not
recognized in the consolidated financial statements as the debt is serviced
from Company contributions. Dividends payable on allocated shares are
charged to retained earnings and are satisfied by the allocation of cash
dividends to participant accounts. Dividends payable on unallocated shares
are not considered dividends for financial reporting purposes. Shares held
by the ESOP trust are allocated to participant accounts based on the ratio
of the current year principal and interest payments to the total of the
current year and future years principal and interest to be paid on the
employer loan.
Compensation expense is recognized based on the average fair value of
shares released for allocation to participant accounts during the year with
a corresponding credit to stockholders' equity. Compensation expense
recognized for 1998 amounted to $31,099.
29
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(10 - continued)
Company common stock held by the ESOP trust at June 30, 1999 was as
follows:
Allocated shares 1,025
Shares committed to be released 2,050
Unearned shares 58,426
--------
Total ESOP shares 61,501
========
Fair value of unearned shares $657,293
========
(11) DEFERRED COMPENSATION PLANS
The Bank has a deferred compensation plan whereby certain officers will be
provided specific amounts of income for a period of fifteen years following
normal retirement. The benefits under the agreements become fully vested
after four years of service beginning with the effective date of the
agreements. The Bank accrues the present value of the benefits so the
amounts required will be provided at the normal retirement dates and
thereafter.
Assuming normal retirement, the benefits under the plan will be paid in
varying amounts between 1998 and 2022. The Bank is the owner and
beneficiary of insurance policies on the lives of these officers which may
provide funds for a portion of the required payments. The agreements also
provide for payment of benefits in the event of disability, early
retirement, termination of employment or death. At June 30, 1999 and 1998,
the accrued deferred compensation liability amounted to $218,821 and
$206,209, respectively. Deferred compensation expense for this plan was
$17,440 and $33,866 for 1999 and 1998, respectively.
The Bank also has a directors' deferred compensation plan whereby a
director defers into a retirement account a portion of his monthly director
fees for a specified period to provide a specified amount of income for a
period of fifteen years following normal retirement. The Bank also accrues
the interest cost on the deferred obligation so the amounts required will
be provided at the normal retirement dates and thereafter.
Assuming normal retirement, the benefits under the plan will be paid in
varying amounts between 1995 and 2037. The agreements also provide for
payment of benefits in the event of disability, early retirement,
termination of service or death. At June 30, 1999 and 1998, the accrued
deferred compensation liability for this plan amounted to $100,384 and
$94,845, respectively. Deferred compensation expense for this plan was
$10,571 and $16,633 for 1999 and 1998, respectively.
(12) STOCK-BASED COMPENSATION PLAN
The Company applies XXX Xx. 00 and related interpretations in accounting
for its stock-based compensation plans. In accordance with SFAS No. 123,
the Company elected to continue to apply the provisions of APB No. 25.
However, pro forma disclosures as if the Company adopted the compensation
cost recognition provisions of SFAS No. 123, are presented along with a
summary of the plans and awards.
30
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(12 - continued)
The Company has an incentive stock option plan that provides for issuance
of up to 51,298 shares of the Company's authorized but unissued common
stock to all employees, including any officer or employee-director. Under
the plan, the Company may grant both non-qualified and incentive stock
options. In the case of incentive stock options, the aggregate fair value
of the stock (determined at the time the incentive stock option is granted)
for which any optionee may be granted incentive options which are first
exercisable during any calendar year shall not exceed $100,000. Option
prices may not be less than the fair market value at the date of the grant.
Options granted vest ratably over five years and are exercisable in whole
or in part for a period up to ten years from the date of the grant. As of
June 30, 1999, only incentive stock options have been granted under the
plan.
The following is a summary of the Company's stock options as of June 30,
1999 and 1998, and the changes for the years then ended:
1999 1998
------------------- -------------------
Weighted Weighted
Average Average
Number of Exercise Number of Exercise
Shares Price Shares Price
Outstanding at beginning
of year 18,582 $6.07 19,775 $5.78
Granted 10,131 7.80 4,873 7.41
Exercised 923 6.24 3,911 5.56
Forfeited 4,376 7.02 2,155 6.24
------ ------
Outstanding at end of year 23,414 $6.69 18,582 $6.14
====== ======
Exercisable at end of year 5,216 $5.78 1,565 $6.24
====== ======
For options outstanding at June 30, 1999, the option price per share ranged
from $5.07 to $7.80 and the weighted average remaining contractual life of
the options was 2.4 years.
For purposes of providing the pro forma disclosures required under SFAS No.
123, the fair market value of stock options granted in fiscal year ended
June 30, 1999, 1998, 1997 and 1995 was estimated at the date of grant using
the Black-Scholes option pricing model. The Black-Scholes option pricing
model was originally developed for use in estimating the fair value of
traded options which have different characteristics from the Company's
employee stock options and require the use of highly subjective assumptions
which can materially affect the fair value estimate. As a result,
management believes that the Black-Scholes model may not necessarily
provide a reliable measure of the fair value of employee stock options.
The following assumptions were used for grants in fiscal year ended June
30, 1999 and 1998:
1999 1998
---- ----
Expected dividend yields 3.20% 3.78%
Risk-free interest rates 5.50% 5.50%
Expected volatility 10.09% 10.09%
Expected life of options 5 years 5 years
Weighted average fair value at grant date $ 1.00 $ 0.82
31
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(12 - continued)
Had compensation cost for the Company's stock-based compensation plans been
determined in accordance with the fair value based accounting method
provided by SFAS No. 123, the net income and net income per common share
for the years ended June 30, 1999 and 1998 would have been as follows:
(In thousands, except per share amounts) 1999 1998
---- ----
Pro forma net income $1,007 $ 958
Pro forma net income per share:
Basic $ 0.78 $0.74
Diluted $ 0.77 $0.73
(13) COMMITMENTS AND CONTINGENCIES
In the normal course of business, there are outstanding various commitments
and contingent liabilities, such as commitments to extend credit and legal
claims, which are not reflected in the financial statements.
Commitments under outstanding standby letters of credit totaled $224,000 at
June 30, 1999 and 1998.
The following is a summary of the commitments to extend credit at June 30,
1999:
1999 1998
---- ----
Loan commitments:
Fixed rate $ 685,125 $1,585,597
Adjustable rate 1,183,000 -
Undisbursed commercial and personal
lines of credit 4,393,796 1,628,128
Undisbursed portion of construction
loans in process 4,019,310 1,932,310
Other loans in process 159,603 249,893
----------- ----------
Total commitments to extend credit $10,440,834 $5,395,928
=========== ==========
(14) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Bank is a party 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 commitments to extend credit and
standby letters of credit. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amounts
recognized in the balance sheet.
The Bank's exposure to credit loss in the event of nonperformance by the
other party to the financial instruments for commitments to extend credit
and standby letters of credit is represented by the contractual notional
amount of those instruments (see Note 13). The Bank uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments.
32
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(14 - continued)
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The Bank evaluates
each customer's creditworthiness on a case-by-case basis. The amount and
type of collateral obtained, if deemed necessary by the Bank upon extension
of credit, varies and is based on management's credit evaluation of the
counterparty.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Standby letters
of credit generally have fixed expiration dates or other termination
clauses and may require payment of a fee. The credit risk involved in
issuing letters of credit is essentially the same as that involved in
extending loan facilities to customers. The Bank's policy for obtaining
collateral, and the nature of such collateral, is essentially the same as
that involved in making commitments to extend credit.
The Bank has not been required to perform on any financial guarantees
during the past two years. The Bank has not incurred any losses on its
commitments in either 1999 or 1998.
(15) STOCKHOLDERS' EQUITY
Capital Stock
On December 31, 1998, the MHC and Bank completed a conversion and stock
offering whereby the MHC was merged with and into the Bank with the Bank
becoming a wholly-owned subsidiary of the Company which offered common
stock to certain current and former depositor and borrower customers of the
Bank in a subscription offering. The Company issued 768,551 shares of
common stock (including 61,501 shares issued to the ESOP trust) for gross
proceeds of $7,685,510 as a result of the offering. Total expenses in
connection with the conversion and offering amounted to $449,382 and were
charged against the proceeds from the offering.
The Company also issued 532,057 common shares in exchange for the 204,015
common shares held by the public stockholders of the Bank pursuant to an
exchange ratio resulting in the public stockholders of the Bank owning in
the aggregate approximately 40.5% of First Capital, Inc. after the
conversion and offering.
Dividends
The payment of dividends by the Bank is subject to regulation by the Office
of Thrift Supervision (OTS). The Bank may not declare or pay a cash
dividend or repurchase any of its capital stock if the effect thereof would
cause the regulatory capital of the Bank to be reduced below regulatory
capital requirements imposed by the OTS or below the amount of the
liquidation account.
Liquidation Account
Upon completion of the conversion, the Bank established a liquidation
account in an amount equal to the amount of the cumulative dividends with
respect to the Bank's common stock waived by First Capital, Inc. MHC plus
59.5% of the Bank's stockholders' equity as of September 30, 1998 totaling
$7.5 million. The liquidation account is maintained for the benefit of
depositors as of the March 31, 1997 eligibility record date (or the
September 30, 1998 supplemental eligibility record date) who maintain their
deposits in the Bank after conversion.
33
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(15 - continued)
In the event of complete liquidation, and only in such an event, each
eligible depositor will be entitled to receive a liquidation distribution
from the liquidation account in the proportionate amount of the then
current adjusted balance for deposits held, before any liquidation
distribution may be made with respect to the stockholders. Except for the
repurchase of stock and payment of dividends by the Bank, the existence of
the liquidation account does not restrict the use or application of
retained earnings of the Bank.
(16) REGULATORY MATTERS
The Company and its subsidiary are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory-and possibly
additional disrectionary-actions by regulators that, if undertaken, could
have a direct material effect on the Company's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and its subsidiary must meet specific
capital guidelines that involved quantitative measures of the assets,
liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The capital amounts and classification are
also subject to quantitative judgments by the regulators about components,
risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and its subsidiary to maintain minimum amounts and
ratios (set forth in the table below) of total and Tier I capital (as
defined in the regulations) to risk-weighted assets (as defined), and Tier
I capital (as defined) to average assets (as defined). Management believes,
as of June 30, 1999, that the Company and its subsidiary meet all capital
adequacy requirements to which they are subject.
As of June 30, 1999, the most recent notification from the OTS categorized
the subsidiary bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the
subsidiary bank must maintain minimum total risk-based, Tier I risk-based,
and Tier I leverage ratios as set forth in the table below. There are no
conditions or events since that notification that management believes have
changed the institutions' categories.
The actual capital amounts and ratios are also presented in the table. No
amounts were deducted from capital for interest-rate risk in either year.
34
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(16 - continued)
Minimum To Be Well
Capitalized Under
Minimum For Capital Prompt Corrective
Actual Adequacy Purposes: Action Provisions:
Amount Ratio Amount Ratio Amount Ratio
(Dollars in thousands)
As of June 30, 1999:
Total capital (to risk
weighted assets):
Consolidated $17,822 26.81% $5,318 8.00% N/A
Bank $15,406 23.17% $5,318 8.00% $6,648 10.00%
Tier I capital (to risk
weighted assets):
Consolidated $17,340 26.08% $2,659 4.00% N/A
Bank $14,924 22.45% $2,659 4.00% $3,989 6.00%
Tier I capital (to adjusted
total assets):
Consolidated $17,340 14.09% $4,924 4.00% N/A
Bank $14,924 12.12% $3,693 3.00% $6,155 5.00%
Tangible capital (to adjusted
total assets):
Bank $14,924 12.12% $1,847 1.50% N/A
As of June 30, 1998:
Total capital (to risk
weighted assets):
Consolidated $10,802 19.15% $4,513 8.00% N/A
Bank $10,799 19.14% $4,513 8.00% $5,642 10.00%
Tier I capital (to risk
weighted assets):
Consolidated $10,341 18.33% $2,257 4.00% N/A
Bank $10,338 18.32% $2,257 4.00% $3,385 6.00%
Tier I capital (to adjusted
total assets):
Consolidated $10,341 11.01% $3,758 4.00% N/A
Bank $10,338 11.00% $2,819 3.00% $4,698 5.00%
Tangible capital (to adjusted
total assets):
Bank $10,338 11.00% $1,409 1.50% N/A
35
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(17) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value and estimated fair value of financial instruments at
June 30 are as follows:
1999 1998
---- ----
Carrying Fair Carrying Fair
Value Value Value Value
(In thousands)
Financial assets:
Cash and due from banks $ 930 $ 930 $ 895 $ 895
Interest bearing deposits in banks 1,681 1,681 5,240 5,240
Securities available for sale 20,205 20,205 4,849 4,849
Securities held to maturity 9,246 9,063 3,053 3,036
Loans receivable 84,369 88,388 75,403 75,789
Less: allowance for loan losses 482 482 516 516
------- ------- ------- -------
Loans receivable, net 83,877 87,906 74,887 75,273
------- ------- ------- -------
Federal Home Loan Bank stock 663 663 589 589
Financial liabilities:
Deposits 92,058 91,832 77,462 77,798
Advances from Federal Home
Loan Bank 12,250 11,708 5,250 4,960
Unrecognized financial instruments:
Commitments to extend credit - - - 24
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument for which it is practicable to
estimate that value:
Cash and Short-Term Investments
For short-term investments, including cash and due from banks and interest
bearing deposits with banks, the carrying amount is a reasonable estimate
of fair value.
Debt and Equity Securities
For debt securities, including mortgage-backed securities, the fair values
are based on quoted market prices. For restricted equity securities held
for investment, the carrying amount is a reasonable estimate of fair value.
Loans Receivable
The fair value of loans is 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.
36
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(17 - continued)
Deposits
The fair value of demand deposits, savings accounts, money market deposit
accounts and other transaction accounts is the amount payable on demand at
the balance sheet date. The fair value of fixed-maturity certificates of
deposit is estimated by discounting the future cash flows using the rates
currently offered for deposits of similar remaining maturities.
Borrowed Funds
The fair value of advances from Federal Home Loan Bank is estimated by
discounting the future cash flows using the current rates at which similar
loans with the same remaining maturities could be obtained.
Commitments to Extend Credit
The majority of commitments to extend credit would result in loans with a
market rate of interest if funded. The fair value of these commitments are
the fees that would be charged to customers to enter into similar
agreements. For fixed rate loan commitments, the fair value also considers
the difference between current levels of interest rates and the committed
rates.
(18) PARENT COMPANY CONDENSED FINANCIAL INFORMATION
Condensed financial information for First Capital, Inc. (parent company
only) for the year ended June 30, 1999 follows:
Balance Sheet
(In thousands)
Assets:
Cash and interest bearing deposits $ 2,818
Other assets 24
Investment in bank subsidiary 14,517
-------
$17,359
=======
Liabilities and Stockholders' Equity:
Other liabilities $ 19
Stockholders' equity 17,340
-------
$17,359
=======
37
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 1999 AND 1998
(18 - continued)
Statement of Income
(In thousands)
Interest income $ 48
Other operating expenses 80
------
Loss before income taxes and equity in
undistributed net income of subsidiary (32)
Income tax expense 2
------
Loss before equity in undistributed net
income of subsidiary (34)
Equity in undistributed net income of subsidiary 1,036
------
Net income $1,002
======
Statement of Cash Flows
(In thousands)
Operating Activities:
Net income $ 1,002
Adjustments to reconcile net income to cash
provided by operating activities:
Equity in undistributed net income of subsidiary (1,036)
ESOP compensation expense 31
Net change in other assets/liabilities (5)
-------
Net cash used by operating activities (8)
-------
Investing Activities:
Investment in bank subsidiary (3,616)
Financing Activities:
Proceeds from issuance of common stock 6,621
Exercise of stock options 6
Cash dividends paid (185)
-------
Net cash provided by financing activities 6,442
-------
Net increase in cash 2,818
Cash at beginning of year -
-------
Cash at end of year $ 2,818
=======
38
FIRST CAPITAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
JUNE 30, 1999 AND 1998
(19) SUPPLEMENTAL DISCLOSURE FOR EARNINGS PER SHARE
1999 1998
---- ----
Basic:
Earnings:
Net income $1,002,051 $ 958,452
========== ==========
Shares:
Weighted average common shares outstanding 1,291,900 1,291,063
========== ==========
Net income per common share, basic $ 0.78 $ 0.74
========== ==========
Diluted:
Earnings:
Net income $1,002,051 $ 958,452
========== ==========
Shares:
Weighted average common shares outstanding 1,291,900 1,291,063
Add: Dilutive effect of outstanding options 8,710 3,619
---------- ----------
Weighted average common shares outstanding, as adjusted 1,300,610 1,294,682
========== ==========
Net income per common share, diluted $ 0.77 $ 0.74
========== ==========
(20) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
1999 1998
---- ----
Cash payments for:
Interest $4,508,544 $3,946,516
Income taxes 673,045 486,206
Noncash investing activities:
Transfers from loans to real estate
acquired through foreclosure $ - $ 105,734
Proceeds from sales of foreclosed
real estate financed through loans 98,600 -
39
-------------------------------------------------------------------------------------------------------
BOARD OF DIRECTORS/OFFICERS
-------------------------------------------------------------------------------------------------------
Directors
Xxxxx X. Xxxxxxxxx Xxxx X. Xxxxxxxx
Chairman of the Board and Chief Executive Officer President of Xxxxx X. Xxxxxxxx Construction
Co., Inc. (a construction contractor)
Xxxxxx X. Xxxxx Xxxxxx X. Xxx
President and Publisher of X'Xxxxxx Publishing President and Chief Operating Officer
Company, Inc. (a newspaper publisher)
Xxxxxxx X. Xxxxxxx Xxxx X. Xxxxxxxxxxx
Right-of-way Supervisor for Xxxxx County REMC President and Sole Owner of Xxxxx Lumber Co.
(a rural electric utility) (a lumber retailer)
Xxxxxx X. Xxx
Business Manager for Xxxxxx Sales, Inc.
(a farm implement dealership)
Executive Officers
Xxxxx X. Xxxxxxxxx M. Xxxxx Xxxxxxxxx
Chairman of the Board and Chief Executive Officer Senior Vice President, Chief Financial Officer
and Treasurer
Xxxxxx X. Xxx Xxxx X. Xxxxxx
President and Chief Operating Officer Vice President of Operation and Secretary
40
--------------------------------------------------------------------------------------------------------------------
CORPORATE INFORMATION
--------------------------------------------------------------------------------------------------------------------
General Counsel Independent Auditors
Xxxxxxx & Xxxxxxxx Xxxxxx Shine & Co., Inc.
000 X. Xxxxxxx Xxxxxx 000 Xxxx Xxxxxx Xxxxxx
Xxxxxxx, Xxxxxxx 00000 Xxx Xxxxxx, Xxxxxxx 00000
Special Counsel Transfer Agent
Xxxxxxx, Xxxxxx & Xxxxxxxx LLP Registrar and Transfer Company
0000 Xxxxxxxxx Xxx., X.X. 00 Xxxxxxxx Xxxxx
Xxxxxxxxxx, X.X. 00000 Xxxxxxxx, Xxx Xxxxxx 00000
Common Shares
The common shares of the Company are traded on the Nasdaq SmallCap Market under
the symbol "FCAP." As of June 30, 1999, the Company has 1,063 stockholders of
record and 1,292,752 common shares outstanding. This does not reflect the number
of persons whose shares are in nominee or "street" name accounts through
brokers.
The following table lists quarterly market price and dividend information per
common share for the years ended June 30, 1999 and 1998. For periods before
December 31, 1998, the table reflects the price per share and dividend
information for First Federal Bank common stock divided by 2.5638, the exchange
ratio in connection with the Conversion and Reorganization on December 31, 1998.
As First Federal Bank common stock was not listed or quoted on an established
market before December 31, 1998, share price information for periods before that
date reflect trades known to management.
Market price
High Low Dividends End of period
Fiscal 1998:
Quarter ended September 30, 1997 $ 7.80 $7.80 $0.068 $7.80
Quarter ended December 31, 1997 7.80 7.80 0.068 7.80
Quarter ended March 31, 1998 7.80 7.80 0.068 7.80
Quarter ended June 30, 1998 7.80 7.80 0.068 7.80
Fiscal 1999:
Quarter ended September 30, 1998 8.60 7.80 0.068 8.60
Quarter ended December 31, 1998 8.60 7.80 0.068 8.60
Quarter ended March 31, 1999 10.94 8.50 0.070 8.88
Quarter ended June 30, 1999 11.81 8.88 0.080 8.75
Annual Meeting
The Annual Meeting of Stockholders will be held at 12:00 p.m., Wednesday,
November 17, 1999, at the office of the Bank, 000 Xxxxxxx Xxxxx, X.X., Xxxxxxx,
Xxxxxxx 00000.
41
General Inquiries and Reports
The Company is required to file an Annual Report on Form 10-KSB for its fiscal
year ended June 30, 1999 with the Securities and Exchange Commission. Copies of
this annual report and the Company's quarterly reports on Form 10-QSB may be
obtained without charge by contacting:
Xxxxx X. Xxxxxxxxx
Chairman of the Board and Chief Executive Officer
First Capital, Inc.
000 Xxxxxxx Xxxxx, X.X.
Xxxxxxx, Xxxxxxx 00000
(000) 000-0000
42
