UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended: December 31, 2005 |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ |
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Commission File Number 0-11244
GERMAN AMERICAN BANCORP
(Exact name of registrant as specified in its charter)
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INDIANA (State or other jurisdiction of incorporation or organization)
711 Main Street, Box 810, Jasper, Indiana (Address of Principal Executive Offices)
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35-1547518 (I.R.S. Employer Identification No.)
47546 (Zip Code)
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Registrant’s telephone number, including area code: (812) 482-1314
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
Common Shares, No Par Value Preferred Stock Purchase Rights
(Titles of Classes)
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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
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o Yes |
x No | ||||
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Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
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o Yes |
x No | ||||
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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
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x Yes |
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K:
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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer: | ||||||
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Large accelerated filer o |
Accelerated filer x |
Non-accelerated filer o | ||||
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). |
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The aggregate market value of the registrant’s common shares held by non-affiliates of the registrant, computed by reference to the price at which the common shares were last sold, as of June 30, 2005 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $133,094,000.
As of March 1, 2006, there were outstanding 11,006,684 common shares, no par value, of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement of German American Bancorp for the Annual Meeting of its Shareholders to be held April 27, 2006, to the extent stated herein, are incorporated by reference into Part III.
1
GERMAN AMERICAN BANCORP
ANNUAL REPORT ON FORM 10-K
For Fiscal Year Ended December 31, 2005
Table of Contents
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PART I |
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Item 1 |
Business |
3-5 |
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Item 1A. |
Risk Factors |
6-7 |
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Item 1B. |
Unresolved Staff Comments |
7 |
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Item 2. |
Properties |
7 |
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Item 3 |
Legal Proceedings |
7 |
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Item 4. |
Submission of Matters to a Vote of Security Holders |
7 |
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PART II |
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Item 5. |
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
8-9 |
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Item 6. |
Selected Financial Data |
10 |
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Item 7. |
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
11-28 |
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Item 7A. |
Quantitative and Qualitative Disclosures About Market Risk |
28-29 |
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Item 8. |
Financial Statements and Supplementary Data |
30-60 |
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Item 9. |
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
61 |
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Item 9A. |
Controls and Procedures |
61-62 |
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Item 9B. |
Other Information |
63 |
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PART III |
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Item 10. |
Directors and Executive Officers of the Registrant |
63 |
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Item 11. |
Executive Compensation |
63 |
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Item 12. |
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
63-64 |
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Item 13. |
Certain Relationships and Related Transactions |
64 |
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Item 14. |
Principal Accountant Fees and Services |
64 |
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PART IV |
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Item 15. |
Exhibits and Financial Statement Schedules |
65 |
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SIGNATURES |
66 | |
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INDEX OF EXHIBITS |
67-69 | |
2
Information included in or incorporated by reference in this Annual Report on
Form 10-K, our other filings with the Securities and Exchange Commission (the
“SEC”) and our press releases or other public statements, contain or
may contain “forward-looking statements” within the meaning of the
Private Securities Litigation Reform Act of 1995. Please refer to a discussion
of our forward- looking statements and associated risks in Item 1,
“Business – Forward-Looking Statements and Associated Risks” and
our discussion of risk factors in Item 1A, “Risk Factors” in this
Annual Report on Form 10-K. PART I Item 1. Business. General German American Bancorp (“the Company”) is a financial services holding company based in Jasper, Indiana. The Company’s Common Stock is traded on NASDAQ’s National Market System under the symbol GABC. The Company operates six affiliated community banks with 29 retail banking offices in the nine contiguous Southern Indiana counties of Daviess, Dubois, Gibson, Knox, Lawrence, Martin, Perry, Pike, and Spencer. The Company also operates a trust, brokerage and financial planning subsidiary, which operates from the banking offices of the bank subsidiaries, and two insurance agencies with five insurance agency offices throughout its market area. The Company’s lines of business include retail and commercial banking, mortgage banking, comprehensive financial planning, full service brokerage and trust administration, title insurance, and a full range of personal and corporate
insurance products. Financial and other information by segment is included in Note 16 – Segment Information of the Notes to the Consolidated Financial Statements included in Item 8 of this Report and is incorporated into this Item 1 by reference. Substantially all of the Company’s revenues are derived from customers located in, and substantially all of its assets are located in, the United States. During 2005, the Company expanded its business in the Tell City, Indiana market by acquiring the business of the former Peoples Community Bank. In addition, the Company completed its acquisition, effective as of January 1, 2006, of all of the stock of Stone City Bank of Bedford, Indiana and as a result now operates in the Bedford/Lawrence County banking market. For a description of these two acquisitions, see Note 18 to the consolidated financial statements included in Item 8 of this Report, which description is incorporated into this Item 1 by reference The Company also during 2005 purchased as an investment shares of common stock that represented 9.0% of the initial stock issue of Eclipse Bank, Inc., a new bank that commenced banking operations during 2005 in Saint Matthews, Kentucky (part of the Louisville, Kentucky banking market), and shares of common stock that represented 9.7% of the initial
stock issue of Symphony Bancorp, a bank holding company for Symphony Bank, a newly-chartered bank which commenced serving Hamilton County, Indiana, and northern Indianapolis, Indiana markets during 2005. The Company’s principal operating subsidiaries are described in the following table: 1) Name 2) Type of Business 3) Principal Office Location The German American Bank Commercial Bank Jasper, IN First American Bank Commercial Bank Vincennes, IN First Title Insurance Company Title Insurance Agency Vincennes, IN First State Bank, Southwest Indiana Commercial Bank Tell City, IN Peoples Bank Commercial Bank Washington, IN Citizens State Bank Commercial Bank Petersburg, IN Stone City Bank of Bedford, Indiana Commercial Bank Bedford, IN German American Insurance, Inc. Multi-Line Insurance Agency Petersburg, IN German American Financial Advisors & Trust Company Trust, Brokerage, Financial Planning Jasper, IN Competition
The industries in which the Company operates are highly competitive. The
Company’s subsidiary banks compete for commercial and retail banking
business within its core banking segment not only with financial institutions
that have offices in the same counties but also with financial institutions that
compete from other locations in Southern Indiana and elsewhere. The
Company’s subsidiaries compete with commercial banks, savings and loan
associations, savings banks, credit unions, production credit associations,
federal land banks, finance companies, credit card companies, personal loan
companies, investment brokerage firms, insurance agencies, insurance companies,
lease finance companies, money market funds, mortgage companies, and other
non-depository financial intermediaries. Many of these banks and other
organizations have substantially greater resources than the
Corporation. 3 Employees At March 1, 2006 the Company and its subsidiaries employed approximately 402 full-time equivalent employees. There are no collective bargaining agreements, and employee relations are considered to be good. Regulation and Supervision The Company is subject to the Bank Holding Company Act of 1956, as amended (“BHC Act”), and is required to file with the Board of Governors of the Federal Reserve System (“FRB”) annual reports and such additional information as the FRB may require. The FRB may also make examinations or inspections of the Company. Under FRB policy, the Company is expected to act as a source of financial strength to its bank subsidiaries and to commit resources to support them even in circumstances where the Company might not do so absent such an FRB policy. The Company’s six subsidiary banks are under the supervision of and subject to examination by the Indiana Department of Financial Institutions (“DFI”), and the Federal Deposit Insurance Corporation (“FDIC”). Regulation and examination by banking regulatory agencies are primarily for the benefit of depositors rather than shareholders. With certain exceptions, the BHC Act prohibits a bank holding company from engaging in (or acquiring direct or indirect control of more than 5 percent of the voting shares of any company engaged in) nonbanking activities. One of the principal exceptions to this prohibition is for activities deemed by the FRB to be "closely related to banking." Under current regulations, bank holding companies and their subsidiaries are permitted to engage in such banking-related business ventures as consumer finance; equipment leasing; credit life insurance; computer service bureau and software operations; mortgage banking; and securities brokerage. Under the BHC Act, certain well-managed and well-capitalized bank holding companies may elect to be treated as a “financial holding company” and, as a result, be permitted to engage in a broader range of activities that are “financial in nature” and in activities that are determined to be incidental or complementary to activities that are financial in nature. These activities include underwriting, dealing in and making a market in securities; insurance underwriting and agency activities; and merchant banking. Banks may also engage through financial subsidiaries in certain of the activities permitted for financial holding companies, subject to certain conditions. The Company has not elected to become a financial holding company and none of its subsidiary banks have elected to form financial subsidiaries. The Company's banks and their subsidiaries may generally engage in activities that are permissible activities for state chartered banks under Indiana banking law, without regard to the limitations that might apply to such activities under the BHC Act if the Company were to engage directly in such activities. Indiana law and the BHC Act restrict certain types of expansion by the Company and its bank subsidiaries. The Company and its subsidiaries may be required to apply for prior approval from (or give prior notice and an opportunity for review to) the FRB, the DFI, and/or other bank regulatory or other regulatory agencies, as a condition to the acquisition or establishment of new offices, or the acquisition (by merger or consolidation, purchase or otherwise) of the stock, business or properties of other banks or other companies. The earnings of commercial banks and their holding companies are affected not only by general economic conditions but also by the policies of various governmental regulatory authorities. In particular, the FRB regulates money and credit conditions and interest rates in order to influence general economic conditions, primarily through open-market operations in U.S. Government securities, varying the discount rate on bank borrowings, and setting reserve requirements against bank deposits. These policies have a significant influence on overall growth and distribution of bank loans, investments and deposits, and affect interest rates charged on loans and earned on investments or paid for time and savings deposits. FRB monetary policies have had a significant effect on the operating results of commercial banks in the past and this is expected to continue in the future. The general effect, if any, of such
policies upon the future business and earnings of the Company cannot accurately be predicted. The Company and its bank subsidiaries are required by law to maintain minimum levels of capital. These required capital levels are expressed in terms of capital ratios, known as the leverage ratio and the capital to risk-based assets ratios. The Company significantly exceeds the minimum required capital levels for each measure of capital adequacy. See Note 9 to the Company's consolidated financial statements that are presented in Item 8 of this Report, which Note 9 is incorporated herein by reference. 4
Also, federal regulations define five categories of financial institutions for
purposes of implementing prompt corrective action and supervisory enforcement
requirements of the Federal Deposit Insurance Corporation Improvements Act of
1991. The category to which the most highly capitalized institutions are
assigned is termed “well-capitalized.” Institutions falling into this
category must have a total risk-based capital ratio (the ratio of total capital
to risk-weighted assets) of at least 10%, a Tier 1 risk-based capital ratio (the
ratio of Tier 1, or “core”, capital to risk-weighted assets) of at
least 6%, a leverage ratio (the ratio of Tier 1 capital to total assets) of at
least 5%, and must not be subject to any written agreement, order or directive
from its regulator relative to meeting and maintaining a specific capital level.
On December 31, 2005, the Company had a total risk-based capital ratio of
11.27%, a Tier 1 risk-based capital ratio of 10.01% (based on Tier 1 capital of
$75,119,000 and total risk-weighted assets of $750,302,000), and a leverage
ratio of 8.01%. All of the Company's affiliate banks meet all of the
requirements of the “well-capitalized” category. In addition the
Company meets the requirements of the FRB to be considered a “well-capitalized”
bank holding company. Accordingly, the Company does not expect these regulations
to significantly impact operations.
The Company is a corporation separate and distinct from its bank and other
subsidiaries. Most of the Company’s revenues will be received by it in the
form of dividends, fees, and interest paid by its bank subsidiaries. These
subsidiaries are subject to statutory restrictions on their ability to pay
dividends. The FRB possesses enforcement powers over bank holding companies and
their non-bank subsidiaries that enable it to prevent or remedy actions that in
its view may represent unsafe or unsound practices or violations of applicable
statutes and regulations. Among these powers is the ability in appropriate cases
to proscribe the payment of dividends by banks and bank holding companies. The
FDIC and DFI possess similar enforcement powers over the respective bank
subsidiaries of the Company for which they have supervision. The “prompt
corrective action” provisions of federal banking law impose further
restrictions on the payment of dividends by insured banks which fail to meet
specified capital levels and, in some cases, their parent bank holding
companies. Internet Address; Internet Availability of SEC Reports. The Company's Internet address is www.germanamericanbancorp.com. The Company makes available, free of charge through the Investors section of its Internet website, its annual report on Form 10-K, its quarterly reports on Form 10-Q, its current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after those reports are filed with or furnished to the Securities and Exchange Commission (SEC). Forward-Looking Statements and Associated Risks. The Company from time to time in its oral and written communications makes statements relating to its expectations regarding the future. These types of statements are considered "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements can include statements about the Company’s net interest income or net interest margin; adequacy of allowance for loan losses and the quality of the Company’s loans, investment securities and other assets; simulations of changes in interest rates; litigation results; dividend policy; estimated cost savings, plans and objectives for future operations; and expectations about the Company’s financial and business performance and other business matters as well as economic and market conditions and trends. They often can be identified by the use of words like "expect," "may,"
“will,” “would,” "could," “should,” "intend," "project," "estimate," "believe" or "anticipate," or similar expressions.
The Company may include forward-looking statements in filings with the SEC, such
as this Form 10-K, in other written materials, and in oral statements made by
senior management to analysts, investors, representatives of the media, and
others. It is intended that these forward-looking statements speak only as of
the date they are made, and the Company undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which the forward-looking statement is made.
Readers are cautioned that, by their nature, forward-looking statements are
based on assumptions and are subject to risks, uncertainties, and other factors.
Actual results may differ materially from the expectations of the Company that
are expressed or implied by any forward-looking statement. The discussions in
Item 1A, “Risk Factors,” and in Item 7 of this Form 10-K,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," list some of the factors that could cause the Company's actual
results to vary materially from those expressed or implied by any
forward-looking statements. Other risks, uncertainties, and factors that could
cause the Company’s actual results to vary materially from those expressed
or implied by any forward-looking statement include the unknown future direction
of interest rates and the timing and magnitude of any changes in interest rates;
the effects of changes in competitive conditions; acquisitions of other
businesses by the Company and costs of integrations of such acquired businesses;
the introduction, withdrawal, success and timing of business initiatives and
strategies; changes in customer borrowing, repayment, investment and deposit
practices; changes in fiscal, monetary and tax policies; changes in financial
and capital markets; changes in general economic conditions, either nationally
or regionally, resulting in, among other things, credit quality deterioration;
the impact, extent and timing of technological changes; capital management
activities; actions of the Federal Reserve Board and legislative and regulatory
actions and reforms; changes in accounting principles and interpretations; the
inherent uncertainties involved in litigation and regulatory proceedings which
could result in the Company’s incurring loss or damage regardless of the
merits of the Company’s claims or defenses; and the continued availability
of earnings and excess capital sufficient for the lawful and prudent declaration
and payment of cash dividends. Investors should consider these risks,
uncertainties, and other factors in addition to those mentioned by the Company
in its other SEC filings from time to time when considering any forward-looking
statement. 5 Item 1A. Risk Factors While the Company has a history of profitability and operates in mature industries with capital that substantially exceeds the requirements of bank regulatory agencies, an investment in the common stock of the Company (like an investment in the equity securities of any business enterprise) is subject to investment risks and uncertainties. The following describes some of the principal risks and uncertainties to which the Company and its assets and business are subject; other risks are briefly identified in our cautionary statement that is included “Forward-Looking Statements and Associated Risks” in Part I, Item 1, “Business.” Although the Company seeks ways to manage these risks and uncertainties and to develop programs to control those that management can, the Company ultimately cannot predict the future. Future results may differ materially from past results, and from management's
expectations and plans. Asset Quality.
A significant source of risk for any bank or other enterprise that lends money
arises from the possibility that losses will be sustained because borrowers,
guarantors and related parties may fail (because of financial difficulties or
other reasons) to perform in accordance with the terms of their loan agreements.
In the case of the Company, many loans originated by the Company are secured,
but some loans are unsecured depending on the nature of the loan. With respect
to secured loans, the collateral securing the repayment of these loans includes
a wide variety of real and personal property that may be insufficient to cover
the obligations owed under such loans. Collateral values may be adversely
affected by changes in prevailing economic, environmental and other conditions,
including declines in the value of real estate, changes in interest rates,
changes in monetary and fiscal policies of the federal government, wide-spread
disease, terrorist activity, environmental contamination, natural disasters, and
other external events. The Company has adopted underwriting and credit
monitoring procedures and policies, including the establishment and review of
the allowance for loan losses and regular review of appraisals and borrower
financial statements, that management believes are appropriate to mitigate the
risk of loss by assessing the likelihood of nonperformance and the value of
available collateral, monitoring loan performance and diversifying the Company's
credit portfolio. Such policies and procedures, however, may not prevent
unexpected losses that could have a material adverse effect on the Company's
business, financial condition, results of operations or liquidity. For
additional information regarding the Company’s asset quality, see Part II,
Item 7 (“Management’s Discussion and Analysis of Financial Condition
and Results of Operations”).
Interest Rate Risk.
The Company's earnings depend largely on the relationship between the yield on
earning assets, primarily loans and investments, and the cost of funds,
primarily deposits and borrowings. This relationship, known as the interest rate
spread, is subject to fluctuation and is affected by economic and competitive
factors which influence interest rates, the volume and mix of interest-earning
assets and interest-bearing liabilities and the level of non-performing assets.
Fluctuations in interest rates affect the demand of customers for the Company's
products and services. The Company is subject to interest rate risk to the
degree that its interest-bearing liabilities reprice or mature more slowly or
more rapidly or on a different basis than its interest-earning assets.
Significant fluctuations in interest rates could have a material adverse effect
on the Company's business, financial condition, results of operations or
liquidity. For additional information regarding interest rate risk, see Part II,
Item 7A, "Quantitative and Qualitative Disclosures About Market
Risk."
Economic Conditions, Limited Geographic Diversification
.
The Company conducts business from offices that are exclusively located in nine
contiguous counties of Southern Indiana, from which substantially all of its
customer base is drawn. Because of the geographic concentration of its
operations and customer base, the Company's results depend largely upon economic
conditions in this area. Deterioration in economic conditions in this area could
adversely affect the quality of the Company's loan portfolio and the demand for
its products and services, and accordingly, could have a material adverse effect
on the Company's business, financial condition, results of operations or
liquidity. See also Part I, Item 1, "Business --- Competition." Competition.
The banking and financial services business in the Company's markets is highly
competitive. The Company competes in its geographic markets with regional,
national and international competitors that are much larger in total assets and
capitalization than the Company. In addition, new banks could be organized in
the Company’s market area which might bid aggressively for new business to
capture market share in these markets. Developments increasing the nature or
level of competition could have a material adverse effect on the Company's
business, financial condition, results of operations or liquidity. See also
"Competition," and "Supervision and Regulation of Banking
Activities." 6
Risks of Future Changes in Our Businesses and Capital Structure. The Company from time to time considers opportunities to expand the Company’s businesses by launching new internal business initiatives and by buying or investing in other businesses. The Company’s earnings and financial condition could be adversely affected to the extent that the acquisitions or other business initiatives and strategies are not successful (or take longer than expected to achieve expected results) and such initiative or strategies could even result in losses to the Company. The Company also from time to time engages in activities (such as repurchasing and issuing its capital stock or other securities, and utilizing the borrowing capacity of its parent company to borrow funds from third party lenders on short and long term bases) in order to manage its capital structure in a manner that it believes is most advantageous. These capital management activities, however, also carry
risks in the event that the Company’s business does not develop as expected or there are changes in the market for the Company’s common stock or in the capital and financial markets generally. Government Regulation, Legislative Changes, and Monetary Policy.
The Company and the banking industry are subject to extensive regulation and
supervision under federal and state laws and regulations. The restrictions
imposed by such laws and regulations limit the manner in which the Company
conducts its business, undertakes new investments and activities and obtains
financing. These regulations are designed primarily for the protection of the
deposit insurance funds and consumers and not to benefit the Company's
shareholders. Financial institution regulation has been the subject of
significant legislation in recent years and may be the subject of further
significant legislation in the future, none of which is in the control of the
Company. Significant new laws or changes in, or repeals of, existing laws
(including changes in federal or state laws affecting corporate taxpayers
generally or financial institutions specifically) could have a material adverse
effect on the Company's business, financial condition, results of operations or
liquidity. Further, federal monetary policy, particularly as implemented through
the Federal Reserve System, significantly affects credit conditions for the
Company, and any unfavorable change in these conditions could have a material
adverse effect on the Company's business, financial condition, results of
operations or liquidity. See also Part I, Item 1, “Business -- Supervision
and Regulation of Banking Activities."
Risk of Changes in Accounting Policies or Requirements or
Accounting Estimates or Judgments. The financial condition and results of operations of the Company that are presented in the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements, and selected financial data appearing elsewhere within this report, are, to a large degree, dependent upon the Company’s accounting policies. The selection of and application of these policies involve estimates, judgments and uncertainties that are subject to change, and the effect of any change in estimates or judgments that might be caused by future developments or resolution of uncertainties could be materially adverse to the Company’s reported financial condition and results of operations. See the discussion of critical accounting policies and estimates that the Company has determined to be the most susceptible to change in the near term that is included in the section captioned “Critical Accounting
Policies and Estimates” in Part II, Item 7 (“Management’s Discussion and Analysis of Financial Condition and Results of Operations”) for a complete discussion. In addition, authorities that prescribe accounting principles and standards for public companies from time to time change those principles or standards or adopt formal or informal interpretations of existing principles or standards, which changes or interpretations (to the extent applicable to the Company) could result in changes that would be materially adverse to the Company’s reported financial condition and results of operations. Item 1B. Unresolved Staff Comments. None. Item 2. Properties.
The Company conducts its operations from the main office building of The German
American Bank at 711 Main Street, Jasper, Indiana. The main office building
contains approximately 23,600 square feet of office space. The Company’s
subsidiaries conduct their operations from 33 other locations in Southern
Indiana. Item 3. Legal Proceedings. There are no material pending legal proceedings, other than routine litigation incidental to the business of the Company’s subsidiaries, to which the Company or any of its subsidiaries is a party or of which any of their property is the subject. Item 4. Submission of Matters to a Vote of Security Holders. There were no matters submitted during the fourth quarter of 2005 to a vote of security holders, by solicitation of proxies or otherwise. 7
Item 5. Market for Registrant’s Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.
Market and Dividend Information German American
Bancorp’s stock is traded on NASDAQ’s National Market System under the symbol
GABC. The quarterly high and low closing prices for the Company’s common stock as
reported by NASDAQ and quarterly cash dividends declared and paid are set forth in the
table below. All per share data are retroactively restated for all stock dividends. The Common Stock was
held of record by approximately 3,480 shareholders at March 1, 2006. Cash dividends paid to
the Company’s shareholders are primarily funded from dividends received by the
Company from its subsidiaries. The declaration and payment of future dividends will depend
upon the earnings and financial condition of the Company and its subsidiaries, general
economic conditions, compliance with regulatory requirements, and other factors.
8
Stock Repurchase Program Information The following table
sets forth information regarding the Company’s purchases of its common shares during
each of the three months ended December 31, 2005.
9
Item 6. Selected Financial Data. The following
selected data should be read in conjunction with the consolidated financial
statements and related notes that are included in Item 8 of this Report, and
“Management’s Discussion and Analysis of Financial Condition and
Results of Operations,” which is included in Item 7 of this Report (dollars
in thousands except per share data).
10 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. INTRODUCTION
German American Bancorp (“the Company”) is a financial services
holding company based in Jasper, Indiana. The Company’s Common Stock is
traded on NASDAQ’s National Market System under the symbol GABC. The
Company operates six affiliated community banks with 29 retail banking offices
in the nine contiguous Southern Indiana counties of Daviess, Dubois, Gibson,
Knox, Lawrence, Martin, Perry, Pike, and Spencer. The Company also operates a
trust, brokerage and financial planning subsidiary which operates from the
offices of the bank subsidiaries, and two insurance agencies with five agency
offices throughout its market area. The Company’s lines of business include
retail and commercial banking, mortgage banking, comprehensive financial
planning, full service brokerage and trust administration, title insurance, and
a full range of personal and corporate insurance products. The information in this Management’s Discussion and Analysis is presented as an analysis of the major components of the Company’s operations for the years 2003 through 2005 and its financial condition as of December 31, 2005 and 2004. This information should be read in conjunction with the accompanying consolidated financial statements and footnotes contained elsewhere in this report, and with the description of business included in Item 1 of this Report (including the cautionary disclosure regarding “Forward Looking Statements and Associated Risks”). Financial and other information by segment is included in Note 16 to the Company’s consolidated financial statements included in Item 8 of this Report and is incorporated into this Item 7 by reference. MANAGEMENT OVERVIEW
The Company’s level of net income increased 34% in 2005 compared with 2004.
The Company’s 2005 net income totaled $9,721,000, or $0.89 per share,
compared with $7,239,000, or $0.66 per share, for 2004. The Company’s
performance in 2004 was affected by the recording in the fourth quarter of 2004
a non-cash, other-than-temporary impairment charge of approximately $2.4 million
after-tax, or $0.23 per share, related to certain investments in Federal Home
Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage
Association (“FNMA”) preferred stock. Exclusive of the impairment
charge, 2004 earnings would have been $9,669,000, or $0.89 per share. In
addition to the effect of the securities impairment charge, the earnings
comparison of 2005 to 2004 was positively impacted by improvements in net
interest income of $974,000, as well as increases in the level of other
non-interest income. Non-interest income, excluding the impairment charge on
equity securities in 2004, increased by approximately $891,000 or 7% in 2005
compared to 2004. These increases were partially mitigated by increased
non-interest expense of $839,000, a significant portion of which relates to
increased employee health insurance costs, and increased income tax expense of
$2,339,000 ($1,087,000 excluding the tax effect of the impairment charge in
2004). The Company’s level of non-performing loans increased significantly during 2005 compared with year-end 2004. Most of this increase was identified during the second quarter of 2005 and previously reported. Non-performing loans totaled $15.7 at year end 2005 compared with $6.6 million as of year end 2004. The increase in non-performing loans was primarily attributable to three specific credit facilities. Although each of these credits had been internally adversely classified in previous periods, management determined these credits should be placed on non-accrual status during 2005 due to changes in circumstances with each borrower. For further discussion of non-performing loans refer to “RISK MANAGEMENT – Non-Performing Assets.” During 2005, the Company completed one in-market acquisition of a financial institution and has invested in minority interests in two de novo financial institutions in larger markets that are within a 150 mile radius of the Company’s primary market area. Subsequent to year end 2005, the Company also completed an additional acquisition of a financial institution in an adjacent market to its primary market area. This strategy of bank acquisitions and de novo investing has been undertaken to supplement organic growth within the Company’s primary markets. Management does expect to continue to pursue similar strategic acquisition and investing opportunities should opportunities become available. The statements of management's expectations and goals concerning the Company's future operations and performance that are set forth in this Management Overview and in other sections of this Item 7 are forward-looking statements, and readers are cautioned that these forward-looking statements are based on assumptions and are subject to risks, uncertainties, and other factors. Actual results may differ materially from the expectations of the Company that are expressed or implied by any forward-looking statement. The following discussion, as well as the discussions in Item 1 ("Business") entitled "Forward-Looking Statements and Associated Risks" and in Item 1A (“Risk Factors”) (which discussions are incorporated in this Item 7 by reference) lists some of the factors that could cause the Company's actual results to vary materially from those expressed or implied by any such forward-looking
statements. 11 MERGERS AND ACQUISITIONS On October 1, 2005 PCB Holding Company (“PCB”) merged with and into the Company, and PCB’s sole banking subsidiary, Peoples Community Bank, was merged into the Company’s subsidiary, First State Bank, Southwest Indiana. Peoples Community Bank operated two banking offices in Tell City, Indiana. PCB’s assets and equity (unaudited) as of September 30, 2005 totaled $34.6 million and $4.8 million, respectively. Under the terms of the merger, the shareholders of PCB received an aggregate of 257,029 shares of common stock of the Company valued at approximately $3.5 million and approximately $3.2 million of cash, representing a total transaction value of $6.7 million. This merger was accounted for under the purchase method of accounting. On January 1, 2006, Stone City Bancshares, Inc. (“Stone City”) merged with and into the Company, and as a result acquired all of the stock of Stone City’s sole banking subsidiary, Stone City Bank of Bedford, Indiana, which operates two banking offices in Bedford, Indiana. Stone City’s assets and equity as of December 31, 2005 totaled $61.2 million and $5.4 million, respectively. Under the terms of the merger, the shareholders of Stone City received aggregate cash payments of approximately $6.4 million and 349,468 common shares of the Company valued during at approximately $4.6 million, representing a total transaction value of approximately $11.0 million. This merger was accounted for under the purchase method of accounting. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The financial condition and results of operations for German American Bancorp presented in the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements, and selected financial data appearing elsewhere within this report, are, to a large degree, dependent upon the Company’s accounting policies. The selection of and application of these policies involve estimates, judgments and uncertainties that are subject to change. The critical accounting policies and estimates that the Company has determined to be the most susceptible to change in the near term relate to the determination of the allowance for loan losses, the valuation of mortgage servicing rights, the valuation of securities available for sale, and the valuation allowance on deferred tax assets and loss contingencies related to exposure from tax examinations. Allowance for Loan Losses The Company maintains an allowance for loan losses to cover probable incurred credit losses at the balance sheet date. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. A provision for loan losses is charged to operations based on management's periodic evaluation of the necessary allowance balance. Evaluations are conducted at least quarterly and more often if deemed necessary. The ultimate recovery of all loans is susceptible to future market factors beyond the Company's control. The Company has an established process to determine the adequacy of the allowance for loan losses. The determination of the allowance is inherently subjective, as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on other classified loans and pools of homogeneous loans, and consideration of past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors, all of which may be susceptible to significant change. The allowance consists of two components of allocations, specific and general. These two components represent the total allowance for loan losses deemed adequate to cover losses inherent in the loan portfolio. Commercial, agricultural and poultry loans are subject to a standardized grading process administered by an internal loan review function. The need for specific reserves is considered for credits when graded substandard or special mention, or when: (a) the customer’s cash flow or net worth appears insufficient to repay the loan; (b) the loan has been criticized in a regulatory examination; (c) the loan is on non-accrual; or, (d) other reasons where the ultimate collectibility of the loan is in question, or the loan characteristics require special monitoring. Specific allowances are established in cases where management has identified significant conditions or circumstances related to an individual credit that we believe indicates the loan is impaired. Specific allocations on impaired loans are determined by comparing the loan balance to the present value of expected cash flows or expected collateral
proceeds. Allocations are also applied to categories of loans not considered individually impaired but for which the rate of loss is expected to be greater than historical averages, including those graded substandard or special mention and non-performing consumer or residential real estate loans. Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values. 12
General allocations are made for other pools of loans, including non-classified
loans, homogeneous portfolios of consumer and residential real estate loans, and
loans within certain industry categories believed to present unique risk of
loss. General allocations of the allowance are primarily made based on a
five-year historical average for loan losses for these portfolios, judgmentally
adjusted for economic factors and portfolio trends. Due to the imprecise nature of estimating the allowance for loan losses, the Company’s allowance for loan losses includes a minor unallocated component. The unallocated component of the allowance for loan losses incorporates the Company’s judgmental determination of inherent losses that may not be fully reflected in other allocations, including factors such as economic uncertainties, lending staff quality, industry trends impacting specific portfolio segments, and broad portfolio quality trends. Therefore, the ratio of allocated to unallocated components within the total allowance may fluctuate from period to period. Mortgage Servicing Rights Valuation Mortgage servicing rights (MSRs) are recognized and included with other assets for the allocated value of retained servicing rights on loans sold. Servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights, using groupings of the underlying loans as to type and age. Fair value is determined based upon discounted cash flows using market-based assumptions. To determine the fair value of MSRs, the Company uses a valuation model that calculates the present value of estimated future net servicing income. In using this valuation method, the Company incorporates assumptions that market participants would use in estimating future net servicing income, which include estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, late fees, and float income. The Company periodically validates its valuation model by obtaining an independent valuation of its MSRs. The most significant assumption used to value MSRs is prepayment rate. In general, during periods of declining interest rates, the value of MSRs decline due to increasing prepayment speeds attributable to increased mortgage refinancing activity. Prepayment rates are estimated based on published industry consensus prepayment rates. Prepayments will increase or decrease in correlation with market interest rates, and actual prepayments generally differ from initial estimates. If actual prepayment rates are different than originally estimated, the Company may receive less mortgage servicing income, which could reduce the value of the MSRs. Other assumptions used in estimating the fair value of MSRs do not generally fluctuate to the same degree as prepayment rates, and therefore the fair value of MSRs is less sensitive to changes in these other assumptions. On a quarterly basis, the Company evaluates the possible impairment of MSRs based on the difference between the carrying amount and the current fair value of MSRs. For purposes of evaluating and measuring impairment, the Company stratifies its portfolios on the basis of certain risk characteristics, including loan type and age. If temporary impairment exists, a valuation allowance is established for any excess of amortized cost over the current fair value, by risk stratification, through a charge to income. If the Company later determines that all or a portion of the temporary impairment no longer exists for a particular strata, a reduction of the valuation allowance may be recorded as an increase to income. The Company annually reviews MSRs for other-than-temporary impairment and recognizes a direct write-down when the recoverability of a recorded valuation allowance is determined to be remote. In determining whether other-than-temporary impairment has occurred, the Company considers both historical and projected trends in interest rates, prepayment activity within the strata, and the potential for impairment recovery through interest rate increases. Unlike a valuation allowance, a direct-write down permanently reduces the carrying value of the MSRs and the valuation allowance, precluding subsequent recoveries.
As of December 31, 2005, the Company analyzed the sensitivity of its MSRs to
changes in prepayment rates. In estimating the changes in prepayment rates,
market interest rates were assumed to be increased and decreased by 1.0%. At
December 31, 2005 the Company’s MSRs had a fair value of $3,353,000 using a
weighted average prepayment rate of 12%. Assuming a 1.0% increase in market
interest rates the estimated fair value of MSRs would be $3,724,000 with a
weighted average prepayment rate of 9%. Assuming a 1.0% decline in market
interest rates the estimated fair value of MSRs would be $2,201,000 with a
weighted average prepayment rate of 26%. Securities Valuation
Securities available-for-sale are carried at fair value, with unrealized holding
gains and losses reported separately in accumulated other comprehensive income
(loss), net of tax. The Company obtains market values from a third party on a
monthly basis in order to adjust the securities to fair value. Additionally, all
securities are required to be written down to fair value when a decline in fair
value is other than temporary; therefore, future changes in the fair value of
securities could have a significant impact on the Company’s operating
results. In determining whether a market value decline is other than temporary,
management considers the reason for the decline, the extent of the decline and
the duration of the decline. See Note 2 in the accompanying Consolidated
Financial Statements for information regarding unrealized losses on the
securities. 13 In the fourth quarter of 2004, the Company recognized a $3.68 million non-cash pre-tax charge for the other-than-temporary decline in value on its FHLMC and FNMA floating rate preferred stock portfolio. The Company accounts for these securities in accordance with SFAS No. 115, which requires that if the decline in fair market value below cost is determined to be other-than-temporary, the unrealized loss must be recognized as expense in the income statement. During the quarter ended December 31, 2004, public disclosures regarding accounting practices at FNMA and a multi-billion dollar FNMA preferred stock issuance with a substantially different structure and higher yield than previous offerings had a detrimental effect on the fair value of both the FHLMC and FNMA preferred stock holdings. In connection with the preparation of the Company’s financial statements included elsewhere in this Report,
management in January 2005 concluded, as a result of the factors identified in the preceding sentence and the magnitude and length of time the market value had been below cost, that management could not forecast full recovery of the fair values of these securities in a reasonable time period. Accordingly, management determined to recognize the other-than-temporary impairment in the income statement for the fourth quarter of 2004 as an investment securities loss. There was no additional other-than-temporary impairment determined for year end 2005 on this segment or any segments of the Company’s securities portfolio. Income Tax Expense Income tax expense involves estimates related to the valuation allowance on deferred tax assets and loss contingencies related to exposure from tax examinations. A valuation allowance reduces deferred tax assets to the amount management believes is more likely than not to be realized. In evaluating the realization of deferred tax assets, management considers the likelihood that sufficient taxable income of appropriate character will be generated within carryback and carryforward periods, including consideration of available tax planning strategies. As of December 31, 2005, the Company has a deferred tax asset of $2.4 million representing various tax credit carryforwards. Based on the long carryforward periods available, management has assessed it more likely than not that these credits will be realized and no valuation allowance has been established on this asset. At December 31, 2005, the Company also has a deferred tax asset representing unrealized capital losses on equity securities. Should these capital losses be realized, management believes the Company
has the ability to generate sufficient capital gains to realize the tax benefit of the capital losses during the available carryforward period, including the use of tax planning strategies related to mortgage servicing rights, appreciated securities and appreciated FHLB stock. As a result, no valuation allowance has been established on this asset. Loss contingencies, including assessments arising from tax examinations and tax strategies, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. In considering the likelihood of loss, management considers the nature of the contingency, the progress of any examination or related protest or appeal, the opinions of legal counsel and other advisors, experience of the Company or other enterprises in similar matters, if any, and management’s intended response to any assessment. During the first quarter of 2005, the Company received notices of proposed assessments of unpaid financial institutions tax for the years 2001 and 2002 of approximately $691,000 ($456,000 net of federal tax), including interest and penalties of approximately $100,000. The Company filed a protest with the Indiana Department of Revenue contesting the proposed
assessments and intends to vigorously defend its position that the income of the Nevada subsidiaries is not subject to the Indiana financial institutions tax. Although there can be no such assurance, at this time management does not believe that it is probable that this potential assessment will result in additional tax liability. Therefore, no tax provision has been recognized for the potential assessment of additional financial institutions tax for 2001 and 2002 or for financial institutions tax with respect to any of the Nevada subsidiaries in any period subsequent to 2002, including the year ended December 31, 2005.
RESULTS OF OPERATIONS NET INCOME
Net income increased $2,482,000 or 34% to $9,721,000 or $0.89 per share in 2005
compared to $7,239,000 or $0.66 per share during 2004. The earnings increase was
largely attributable to a $2,430,000 after tax, or $0.23 per share,
other-than-temporary impairment charge on the Company’s portfolio of FHLMC
and FNMA preferred stocks. Excluding the effect of this other-than-temporary
impairment charge, net income for 2004 would have been $9,669,000 or $0.89 per
share. In addition to the effect of the securities impairment charge, the
earnings comparison of 2005 to 2004 was positively impacted by improvements in
net interest income of $974,000, as well as increases in the level of other
non-interest income. Non-interest income, excluding the impairment charge on
equity securities in 2004, increased by approximately $891,000 in 2005 compared
to 2004. These increases were partially mitigated by increased non-interest
expense of $839,000, a significant portion of which relates to increased
employee health insurance costs, and increased income tax expense of $2,339,000
($1,087,000 excluding the tax effect of the impairment charge in 2004).
14
Net income declined $929,000 or 11% to $7,239,000 or $0.66 per share in 2004
compared to $8,168,000 or $0.73 per share during 2003. The earnings decline was
directly attributable to a $2,430,000 after tax, or $0.23 per share,
other-than-temporary impairment charge on the Company’s portfolio of FHLMC
and FNMA preferred stocks. Excluding the effect of this other-than-temporary
impairment charge, net income for 2004 would have been $9,669,000 or $0.89 per
share. In comparing reported earnings for 2004 to 2003, the impairment charge
was mitigated to some degree by increased net interest income, increased trust
and investment product fees and insurance fees, and no net loss on the
extinguishment of borrowings during 2004. Also contributing to the lower level
of earnings in 2004 compared with 2003 was a decline in mortgage loan
originations and subsequent sales of mortgage loans and an increased provision
for loan losses. NET INTEREST INCOME Net interest income is the Company’s single largest source of earnings, and represents the difference between interest and fees realized on earning assets, less interest paid on deposits and borrowed funds. Several factors contribute to the determination of net interest income and net interest margin, including the volume and mix of earning assets, interest rates, and income taxes. Many factors affecting net interest income are subject to control by management policies and actions. Factors beyond the control of management include the general level of credit and deposit demand, Federal Reserve Board monetary policy, and changes in tax laws.
Net interest income increased $974,000 or 3% ($576,000 or 2% on a tax-equivalent
basis) in 2005 compared with 2004. Net interest margin is tax equivalent net
interest income expressed as a percentage of average earning assets. For 2005,
the net interest margin increased to 3.92% compared with 3.86% in 2004. The
Company’s increase in net interest income during 2005 compared with 2004
was largely attributable to the increase in the net interest margin. The
Company’s yield on earning assets increased to 6.03% during 2005 compared
with 5.79% for 2004. The increased yield on earning assets was primarily
attributable to higher short-term interest rates and an increased level of loans
outstanding during 2005 compared with 2004. The Company’s cost of funds
(expressed as a percentage of average earning assets) during 2005 was 2.10%
compared with 1.93% for 2004. The increase in the cost of funds was due to a
rise in short-term market interest rates tempered by an increased level of
non-maturity deposits including non-interest bearing demand accounts, less
reliance on time deposits and borrowings and a decline in interest rates on
outstanding borrowings from the Federal Home Loan Bank due to repayments of
higher-cost advances that were outstanding in 2004.
Net interest income increased during 2004 by $1,704,000 or 6% ($1,336,000 or 4%
on a tax equivalent basis) compared to 2003. For 2004, the net interest margin
increased to 3.86% compared with 3.61% in 2003. The Company’s increase in
net interest income in 2004 compared with 2003 was largely attributable to the
increased net interest margin that was largely driven by a decline in the
Company’s cost of funds. The Company’s cost of funds was reduced due
to a number of factors including the historically low level of interest rates
during 2003 and 2004 and the change in the mix of the deposit base to a higher
dependence on non-maturity deposits and less dependence on time deposits. Also
contributing to the lower cost of funds during 2004 was the repayment of higher
costing FHLB advances during 2003 in the Company’s mortgage banking
segment. 15 The following table
summarizes net interest income (on a tax-equivalent basis) for each of the past three
years. For tax-equivalent adjustments, an effective tax rate of 34% was used for all years
presented (1).
Average Balance Sheet
16
The following table sets forth for the periods indicated a summary of the
changes in interest income and interest expense resulting from changes in volume
and changes in rates:
Net Interest Income - Rate/Volume Analysis: See the Company’s
Average Balance Sheet and the discussions headed USES OF FUNDS, SOURCES OF FUNDS, and
“RISK MANAGEMENT – Liquidity and Interest Rate Risk Management” for further
information on the Company’s net interest income, net interest margin, and interest
rate sensitivity position.
PROVISION FOR LOAN
LOSSES The Company provides
for loan losses through regular provisions to the allowance for loan losses. The provision
is affected by net charge-offs on loans and changes in specific and general allocations
required on the allowance. Provisions for loan losses totaled $1,903,000, $2,015,000, and
$811,000 in 2005, 2004 and 2003, respectively. Loan loss provision
remained relatively stable during 2005 compared with 2004. While net charge-offs increased
in 2005, a portion of the increase in charge-offs was provided for prior to 2005. As
discussed in additional detail in the NON-PERFORMING ASSETS section of this Report,
non-performing loans increased in 2005 due primarily to three large commercial and
industrial credits for which loss allocations have been provided. Two of these loans were
internally classified prior to 2005. The provision for loan
losses increased by $1,204,000 during 2004 compared with 2003. The significant increase in
provision for loan losses during 2004 compared with 2003 was largely attributable to the
continued change in the composition of the Company’s loan portfolio toward a greater
concentration in commercial and agricultural loans and less concentration in residential
mortgage loans. Also contributing to the increased provision for loan losses was an
increase in specific allocations on internally classified loans and an overall higher
level of net charge-offs during 2004 compared with 2003. These provisions were
made at a level deemed necessary by management to absorb estimated, probable incurred
losses in the loan portfolio. A detailed evaluation of the adequacy of the allowance for
loan losses is completed quarterly by management, the results of which are used to
determine provisions for loan losses. Management estimates the allowance balance required
using past loan loss experience, the nature and volume of the portfolio, information about
specific borrower situations and estimated collateral values, economic conditions, and
other factors. Refer also to the section entitled CRITICAL ACCOUNTING POLICIES AND
ESTIMATES and “RISK MANAGEMENT – Lending and Loan Administration” for
further discussion of the provision and allowance for loan losses.
17
NON-INTEREST INCOME During 2005, all
categories of Non-interest Income increased. Non-interest Income for 2005 was $14,194,000,
an increase of $4,574,000 or 48%, as compared to $9,620,000 in 2004. Non-interest Income
for 2004 declined $3,314,000 or 26% as compared to $12,934,000 in 2003. The increase in
2005 and the decline in 2004 were predominantly attributable to an other-than-temporary
impairment charge on the Company’s FHLMC and FNMA preferred stock portfolio
recognized in the fourth quarter of 2004. Trust and Investment
Product Fees remained relatively stable in 2005 as compared to the prior year with a
slight increase of 2% following a 26% increase in 2004 from 2003. An increase in fees was
primarily attributable to increased production from the Company’s Trust and
Investment Advisory Services segment. Insurance Revenues
remained relatively stable for the year ended December 31, 2005 compared with
2004. Insurance Revenues increased 26% for 2004 as compared to the same period
of 2003. The increased Insurance Revenues were primarily the result of insurance
agency acquisitions completed in the third quarter of 2003. These acquisitions
significantly impacted the Company’s insurance revenues during 2004. For
more information on the business combination, see Note 18 to the Company’s
consolidated financial statements included in Item 8 of this Report. For the year ended
2005, Other Operating Income increased 30% as compared to the prior year. The increase was
partially due to an impairment recovery for mortgage servicing rights totaling $412,000 in
2005 compared with an impairment charge of $37,000 for 2004. Also contributing to the
increase in Other Operating Income for the year ended 2005 as compared to 2004 was the
gain on sale of a former branch facility of $313,000. Partially mitigating the positive
variance was an increased level of mortgage servicing rights amortization of $246,000 for
2005. For the year ended
2004, Other Operating Income increased 33%. The increase was partially attributable to an
increase in the cash surrender value of Company Owned Life Insurance. The Company
purchased $10.0 million of COLI during the third quarter of 2003. Also contributing to the
increase in Other Operating Income was a reduced amount of mortgage servicing right
impairment charges. During 2004, mortgage servicing right impairment charges were $37,000
as compared to $240,000 during 2003. Net Gains on Sales of
Loans and Related Assets increased 3% in 2005 following a decrease of 62% in 2004. Loan
sales for 2005, 2004, and 2003 were $64.1 million, $61.4 million and $181.2 million,
respectively. The Company recorded a
non-cash, other-than-temporary impairment charge of $3,682,000 ($2,430,000 after-tax)
related to certain investments in FHLMC and FNMA preferred stock in the fourth quarter of
2004. For further discussion of the other-than-temporary charge, see the MANAGEMENT
OVERVIEW, CRITICAL ACCOUNTING POLICIES AND ESTIMATES and USES OF FUNDS sections of this
Report as well as Note 2 to the Company’s consolidated financial statements included
in Item 8 of this Report.
18
NON-INTEREST EXPENSE For the year ended
2005, Non-interest Expense increased 3%. The increase was primarily due to an increase in
Salaries and Employee Benefits and Occupancy, Furniture and Equipment Expense. For the
year ended 2004, Non-interest Expense decreased 5% as compared to 2003. The decline was
primarily attributable to decreased Salaries and Employee Benefits and Occupancy Expense
and no Net Loss on Extinguishment of Borrowings during 2004, offset by an increase in
Professional Fees and Other Operating Expenses. In 2005, Salaries and
Employee Benefits Expense increased 4%. The increase was primarily attributable to
increased employee health insurance costs of $528,000. For the year ended 2004, Salaries
and Employee Benefits Expense remained relatively stable with a modest 1% decline. Occupancy, Furniture
and Equipment Expense increased 3% in 2005. The increase was primarily attributable to a
lowered amount of real estate and personal property tax expense recognized in 2004. In the
state of Indiana, counties reassessed real property in 2002 which carried over into 2003
and resulted in a delay of some tax billings until 2004. Due to the billing delay, the
Company adjusted property tax accruals and expense during 2004 which resulted in a lowered
amount of real estate and personal property tax expense. Partially mitigating the increase
during 2005 was a reduced amount of depreciation expense recognized for certain computer
network related fixed assets which fully depreciated in 2004. In 2004, Occupancy,
Furniture and Equipment Expense decreased 6% predominately attributable to a reduced level
of real estate and personal property tax expense as discussed above. During 2005 and 2004,
Professional Fees increased 1% and 38%, respectively. The increase in 2004 was primarily
the result of costs associated with ensuring the Company’s compliance with the
requirements of Section 404 of the Sarbanes Oxley Act. In 2005, Advertising and Promotion
decreased 12% which was the result of more directed marketing campaigns during the year.
Advertising and Promotion increased 4% in 2004 as compared to the prior year. The Company did not
recognize any Net Loss on Extinguishment of Borrowings during 2005 or 2004; during 2003
the Company’s mortgage banking segment prepaid $40 million of FHLB Advances which
resulted in a $1,898,000 net loss on extinguishment of borrowings. Other Operating
Expenses remained stable during 2005. For the year ended 2004, Other Operating Expenses
increased 10%. This increase in 2004 was primarily due to increased customer list
intangible amortization of $371,000 which resulted from the Company’s property and
casualty acquisition activity in the third quarter 2003. For further discussion of
intangible amortization, see Note 18 to the Company’s consolidated financial
statements included in Item 8 of this Report.
PROVISION FOR INCOME TAXES The Company records a
provision for current income taxes payable, along with a provision for deferred taxes
payable in the future. Deferred taxes arise from temporary differences, which are items
recorded for financial statement purposes in a different period than for income tax
returns. The Company’s effective tax rate was 25.5%, 12.1%, and 13.5%, respectively,
in 2005, 2004, and 2003. The higher effective tax rate in 2005 compared with both 2004 and
2003 was the result of higher levels of before tax net income combined with a lower level
tax-exempt investment income and a lower level of tax credits generated by investments in
affordable housing projects. The effective tax rate in all periods is lower than the
blended statutory rate of 39.6%. The lower effective rate in all periods primarily
resulted from the Company’s tax-exempt investment income on securities and loans,
income tax credits generated by investments in affordable housing projects, and income
generated by subsidiaries domiciled in a state with no state or local income tax. See Note
11 to the Company’s consolidated financial statements included in Item 8 of this
Report for additional details relative to the Company’s income tax provision.
19 Since December 31,
2001, the Company’s effective tax rate has been favorably impacted by Indiana
financial institution tax savings resulting from the Company’s formation of
investment subsidiaries in the state of Nevada by four of the Company’s banking
subsidiaries. The state of Nevada has no state or local income tax. During the first
quarter of 2005, the Company received notices of proposed assessments of unpaid Indiana
financial institutions tax for the years 2001 and 2002 of approximately $691,000 ($456,000
net of federal tax), including interest and penalties of approximately $100,000. The
Company filed a protest with the Indiana Department of Revenue contesting the proposed
assessments and intends to vigorously defend its position that the income of the Nevada
subsidiaries is not subject to the Indiana financial institutions tax. Although there can
be no such assurance, at this time management does not believe that it is probable that
this potential assessment will result in additional tax liability. Therefore, no tax
provision has been recognized for the potential assessment of additional financial
institutions tax for 2001 and 2002 or for financial institutions tax with respect to any
of the Nevada subsidiaries in any period subsequent to 2002, including 2005.
CAPITAL RESOURCES The Company and
affiliate banks are subject to regulatory capital requirements administered by federal
banking agencies. Capital adequacy guidelines and prompt corrective action regulations
involve quantitative measures of assets, liabilities, and certain off-balance sheet items
calculated under regulatory accounting practices. The prompt corrective action regulations
provide five classifications, including well-capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically undercapitalized, although
these terms are not used to represent overall financial condition. The Company and all
affiliate banks at year-end 2005 were categorized as well-capitalized as that term is
defined by applicable regulations. The Company has agreed with its
parent-company correspondent bank lender, JPMorgan Chase Bank, N.A., as a term of its
credit facilities with that lender (see “SOURCES OF FUNDS – Parent Company
Funding sources”, below) that it will maintain the capital ratios of the Company and
its affiliate banks at levels that would qualify it as well-capitalized as that term is
defined by the prompt corrective action regulations. See Note 9 to the Company’s
consolidated financial statements included in Item 8 of this Report for actual and
required capital ratios and for additional information regarding capital adequacy. The Company continues
to maintain a strong capital position. Shareholders’ equity totaled $82.3 million and
$83.7 million at December 31, 2005 and 2004, respectively. Total equity represented 8.7%
and 8.9%, respectively, of year-end total assets. The Company paid cash dividends of $6.1
million or $0.56 per share in 2005 and 2004. During 2005, the Company purchased 83,000
shares of its common stock under an on-going repurchase program and 440,747 in a privately
negotiated repurchase transaction at a total cost of $6.8 million. These repurchases were
the primary contributors in the decline in total shareholder’s equity.
USES OF FUNDS
LOANS Total loans at year-end
2005 increased $22.0 million or 3% compared with year-end 2004 including increases in each
category of loans. The Company’s commercial and industrial loans increased $5.4
million or 2% and agricultural based loans increased $1.8 million or 2% during 2005.
Consumer loans increased $6.7 million or 6% during 2005. Residential mortgage loans
increased $8.1 million or 9% during 2005. This increase reversed a trend over the past
several years and was due in large part to the acquisition of Peoples Community Bank
during the fourth quarter of 2005. Total loans at year-end
2004 increased $17.8 million or 3% compared with year-end 2003. The composition of the
loan portfolio continued a shift toward a commercial and agricultural base with less
concentration in residential mortgage loans during 2004. The Company’s commercial and
industrial loans increased $17.8 million or 6% and agricultural based loans increased $7.5
million or 8% during 2004. Consumer loans increased $8.1 million or 7% during 2004. The
increases in these categories were partially mitigated by the decline in the residential
mortgage loan portfolio. Residential mortgage loans declined $15.5 million or 14% during
2004 due primarily to the Company’s continued sale of a majority of residential loan
production into the secondary market. The Company’s loan
portfolio is diversified, with the heaviest concentration in commercial and industrial
loans. The composition of the loan portfolio remained relatively stable at year-end 2005
compared with year-end 2004. The largest concentration of loans continued to be in
commercial and industrial loans which comprised 49% of the total loan portfolio at
year-end 2005 compared with 50% in 2004. The Company’s commercial lending is extended
to various industries, including hotel, agribusiness and manufacturing, as well as health
care, wholesale, and retail services. The Company’s concentration in residential
mortgage loans has declined over the past several years with a modest increase in 2005
(due principally to the Peoples Community Bank acquisition discussed above).
20 The Company’s
policy is generally to extend credit to consumer and commercial borrowers in its primary
geographic market area in Southern Indiana. Commercial extensions of credit outside
this market area are generally concentrated in real estate loans within a 120 mile radius
of the Company’s primary market and are granted on a selective basis. The following table
indicates the amounts of loans (excluding residential mortgages on 1-4 family residences
and consumer loans) outstanding as of December 31, 2005 which, based on remaining
scheduled repayments of principal, are due in the periods indicated (dollars in
thousands).
INVESTMENTS The investment
portfolio is a principal source for funding the Company’s loan growth and other
liquidity needs of its subsidiaries. The Company’s securities portfolio consists of
money market securities, uncollateralized U.S. Treasury and federal agency securities,
municipal obligations of state and political subdivisions, asset- / mortgage-backed
securities issued by U.S. government agencies and other intermediaries, and corporate
investments. Money market securities include federal funds sold, interest-bearing balances
with banks, and other short-term investments. The composition of the year-end balances in
the investment portfolio is presented in Note 2 to the Company’s consolidated
financial statements included in Item 8 of this Report and in the table below:
21
The amortized cost of investment securities, including federal funds sold and
short-term investments, decreased $21.7 million at year-end 2005 compared with
year-end 2004. The majority of this decline during 2005 was the result of a
lower level of federal funds sold and short-term investments. At year-end 2004,
the level of federal funds sold and short-term investments was elevated from the
levels throughout 2004. This increased level resulted from the cash flow nature
of the Company's portfolio with its concentration in mortgage related securities
and the timing of reinvestment of this cash flow back into other types of
securities at year-end 2004. The Company has continued its strategy during 2005
of investing in mortgage related securities. The mortgage related securities
provide structured cash flows in what has continued to be a relatively low
longer term interest rate environment.
The Company's level of obligations of state and political subdivisions declined
$11.4 million or 26% during 2005 and $11.7 million or 21% in 2004. The decline
in obligations of state and political subdivisions has been primarily the result
of the Company's strategy to not invest in these traditionally longer-term
securities during periods of relatively low longer term interest rates. The
Company continues to believe that at the proper time, investment in
tax-advantaged obligations of state and political subdivisions is prudent.
However, in the relatively low longer term interest rate environment,
investments in these types of securities have not been undertaken.
The Company's equity portfolio at year-end 2005 included in the table above was
comprised of approximately $5.3 million of minority equity interests in
unaffiliated banking companies and approximately $12.1 million of floating rate
preferred stock issued to FHLMC and FNMA. For further discussion regarding the
investments in the unaffiliated banking companies refer to Item 1 - Business of
this Report. The Company's equity portfolio in prior periods disclosed in the table
above was primarily comprised of floating rate preferred stock issued by FHLMC
and FNMA. In the year ended December 31, 2004, the Company recognized a $3.68
million non-cash pre-tax charge for the other-than-temporary decline in value on
this floating rate preferred stock portfolio. The Company accounts for these
securities in accordance with SFAS No. 115, which requires that if the decline
in fair market value below cost is determined to be other-than-temporary, the
unrealized loss must be recognized as expense in the income statement. Refer
also to the sections entitled CRITICAL ACCOUNTING POLICIES AND ESTIMATES and
"RESULTS OF OPERATIONS - Non-Interest Income in this Report and Note 2 to the
Company's consolidated financial statements included in Item 8 of this Report
for further discussion of the equity securities portfolio and the
other-than-temporary impairment charge recognized during 2004.
The amortized cost of investment securities, including federal funds sold and
short-term investments, increased $2.1 million or 1% at year-end 2004 compared
with year-end 2003. The increase was directly related to the elevated level of
federal funds sold and short-term investments at year end 2004 as discussed
above. Overall there were modest declines in each other category of securities
at year-end 2004 compared with 2003. The Company’s
$181.2 million available-for-sale portion of the investment portfolio provides an
additional funding source for the liquidity needs of the Company’s subsidiaries and
for asset/liability management requirements. Although management has the ability to sell
these securities if the need arises, their designation as available-for-sale should not be
interpreted as an indication that management anticipates such sales. The amortized cost of
debt securities at December 31, 2005 are shown in the following table by expected
maturity. Asset- / mortgage-backed securities are based on estimated average lives.
Expected maturities will differ from contractual maturities because issuers may have the
right to call or prepay obligations. Equity securities do not have contractual maturities,
and are excluded from the table below.
22
Maturities and Average Yields of Securities at December 31, 2005: A tax-equivalent
adjustment using a tax rate of 34 percent was used in the above table. In addition to the
other uses of funds discussed previously, the Company had certain long-term contractual
obligations as of December 31, 2005. These contractual obligations primarily consisted of
long-term borrowings with the FHLB and JPMorgan Chase Bank, N.A., time deposits, and lease
commitments for certain office facilities. Scheduled principal payments on long-term
borrowings, time deposits, and future minimum lease payments are outlined in the table
below.
SOURCES OF FUNDS The Company’s
primary source of funding is its base of core customer deposits. Core deposits consist of
demand deposits, savings, interest-bearing checking, money market accounts, and
certificates of deposit of less than $100,000. Other sources of funds are certificates of
deposit of $100,000 or more, brokered deposits, overnight borrowings from other financial
institutions and securities sold under agreement to repurchase. The membership of the
Company’s affiliate banks in the Federal Home Loan Bank System (FHLB) provides a
significant additional source for both long and short-term collateralized borrowings. The
following pages contain a discussion of changes in these areas. The table below
illustrates changes between years in the average balances of all funding sources:
23
Maturities of certificates of deposit of $100,000 or more are summarized as
follows:
CORE DEPOSITS The Company’s
overall level of average core deposits has remained relatively stable during 2005 and
2004, with a decline of 2% in 2005 and an increase of 2% in 2004. The Company’s
ability to attract core deposits continues to be influenced by competition and the
interest rate environment, as well as the increased availability of alternative investment
products. Management believes that core deposits continue to represent a stable and viable
funding source for the Company’s operations. Demand, savings and
money market deposits have provided a growing source of funding for the company in each of
the periods reported. Average demand, savings and money market deposits totaled $415.8
million or 63% of core deposits in 2005 compared with $400.6 million or 60% in 2004 and
$356.6 million or 54% in 2003. These increases have contributed to the Company’s
increased net interest margin as was discussed in the “RESULTS OF OPERATIONS –
Net Interest Income” section of this Report. Other time deposits
consist of certificates of deposits in denominations of less than $100,000. These deposits
declined by 10% in both 2005 and 2004. Other time deposits comprised 37% of core deposits
in 2005 compared with 40% in 2004 and 46% in 2003.
OTHER FUNDING SOURCES Federal Home Loan Bank
advances and other borrowings represent the Company’s most significant source of
other funding for its bank subsidiaries. Average borrowed funds decreased $2.1 million or
2% during 2005 following a decline of $29.1 million or 22% in 2004. Borrowings comprised
12%, 12%, and 15% of total funding sources in 2005, 2004, and 2003, respectively. The
decline in average borrowed funds during 2005 and 2004 was primarily the result of
repayment of FHLB advances. Certificates of
deposits in denominations of $100,000 or more and brokered deposits are an additional
source of other funding for the Company’s bank subsidiaries. Large denomination
certificates and brokered deposits increased $9.5 million or 15% during 2005 following an
increase of $5.8 million or 10% in 2004. Large certificates and brokered deposits
comprised approximately 9% of total funding sources in 2005, and 7% in both 2004 and 2003.
These large certificates are used as both long-term and short-term funding sources. The bank subsidiaries
of the Company also utilize short-term funding sources from time to time. These sources
consist of overnight federal funds purchased from other financial institutions, secured
repurchase agreements that generally mature within one day of the transaction date, and
secured overnight variable rate borrowings from the FHLB. These borrowings represent an
important source of short-term liquidity for the bank subsidiaries of the Company.
Long-term debt is in the form of FHLB advances, which are secured by the pledge of certain
investment securities and residential mortgage loans. See Note 8 to the Company’s
consolidated financial statements included in Item 8 of this Report for further
information regarding borrowed funds.
PARENT COMPANY FUNDING SOURCES The Company is a
corporation separate and distinct from its bank and other subsidiaries. For information
regarding the financial condition, result of operations, and cash flows of the Company,
presented on a parent-company-only basis, see Note 17 to the Company’s consolidated
financial statements included in Item 8 of this Report. The Company uses funds
at the parent company level to pay dividends to its shareholders, to acquire or make other
investments in other businesses or their securities or assets, to repurchase its stock
from time to time, and for other general corporate purposes. The parent company does not
have access at the parent-company level to the deposits and certain other sources of funds
that are available to its bank subsidiaries to support their operations. Instead, the
parent company has historically derived most of its revenues from dividends paid to the
parent company by its bank subsidiaries. These subsidiaries are subject to statutory
restrictions on their ability to pay dividends to the parent company. The parent company
has in recent years supplemented the dividends received from its subsidiaries with
borrowings, which are discussed in detail below. On September 28, 2005
(but effective as of September 20, 2005), the Company and JPMorgan Chase Bank, N.A. (the
“Lender”) executed and delivered to each other an Amended and Restated Loan
Agreement (“Amended Agreement”), and the Company executed and delivered to the
Lender a $25 million Term Note and a $15 million Revolving Note pursuant to the Amended
Agreement to evidence its obligations for amounts that may from time to time be borrowed
thereunder. This Amended Agreement provides the parent company with an additional source
of liquidity and long-term financing.
24 Under the revolving
line of credit established by the Amended Agreement and evidenced by the Revolving Note,
the Company may borrow and re-borrow up to $15 million at any one time through September
20, 2006, at which time all amounts borrowed under the revolving line of credit will
become due and payable. As of December 31, 2005, the Company had $2.5 million outstanding
on its revolving line of credit. Of the $25 million
non-revolving term loan availability established by the Amended Agreement and evidenced by
the Term Note, the Lender advanced $18.5 million during 2005. The Lender advanced the
remaining $6.5 million available under the term loan to the Company in January 2006, which
advance was primarily used to fund the cash payment of the merger consideration for the
acquisition of Stone City Bancshares, Inc. The Company is obligated to make annual
principal reduction payments under the term loan of up to $2.5 million on each anniversary
date of the term loan, commencing in September 2007, in order to reduce the principal
balance owed under the term loan to $19 million by September 2009, and is obligated to pay
all remaining outstanding principal plus interest during September, 2010 (at maturity of
the term loan).
RISK MANAGEMENT The Company is exposed
to various types of business risk on an on-going basis. These risks include credit risk,
liquidity risk and interest rate risk. Various procedures are employed at the
Company’s affiliate banks to monitor and mitigate risk in their loan and investment
portfolios, as well as risks associated with changes in interest rates. Following is a
discussion of the Company’s philosophies and procedures to address these risks.
LENDING AND LOAN ADMINISTRATION Primary responsibility
and accountability for day-to-day lending activities rests with the Company’s
affiliate banks. Loan personnel at each bank have the authority to extend credit under
guidelines approved by the bank’s board of directors. Executive and board loan
committees active at each bank serve as vehicles for communication and for the pooling of
knowledge, judgment and experience of its members. These committees provide valuable input
to lending personnel, act as an approval body, and monitor the overall quality of the
banks’ loan portfolios. The Corporate Risk Management Committee, comprised of members
of the Company’s executive officers and board of directors, strive to ensure a
consistent application of the Company’s lending policies. The Company also maintains
a comprehensive risk-weighting and loan review program for its affiliate banks, which
includes quarterly reviews of problem loans, delinquencies and charge-offs. The purpose of
this program is to evaluate loan administration, credit quality, loan documentation and
the adequacy of the allowance for loan losses. The Company maintains
an allowance for loan losses to cover probable, incurred credit losses identified during
its loan review process. Management estimates the required level of allowance for loan
losses using past loan loss experience, the nature and volume of the portfolio,
information about specific borrower situations and estimated collateral values, economic
conditions, and other factors. Allocations of the allowance may be made for specific
loans, but the entire allowance is available for any loan that, in management’s
judgement, should be charged-off. Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is confirmed. The allowance for loan
losses is comprised of: (a) specific reserves on individual credits; (b) general reserves
for certain loan categories and industries, and overall historical loss experience; and
(c) unallocated reserves based on performance trends in the loan portfolios, current
economic conditions, and other factors that influence the level of estimated probable
losses. The need for specific reserves are considered for credits when: (a) the
customer’s cash flow or net worth appears insufficient to repay the loan; (b) the
loan has been criticized in a regulatory examination; (c) the loan is on non-accrual; or,
(d) other reasons where the ultimate collectibility of the loan is in question, or the
loan characteristics require special monitoring.
25 The following
table indicates the breakdown of the allowance for loan losses for the periods
indicated (dollars in thousands): The allowance for loan
losses at year-end 2005 increased to $9.3 million or 1.42% of total loans compared to $8.8
million or 1.40% of total loans at year-end 2004 and $8.3 million or 1.35% at year-end
2003. The increase in the allowance for loan losses was attributable to loan growth,
changes in specific allocations, and the allowance from an acquired subsidiary. As
discussed in additional detail in the NON-PERFORMING ASSETS section of this Report, the
increased level of non-performing assets was primarily attributable to three larger
commercial and industrial credits. Increased
net-charge-offs during 2005 compared with 2004 limited the amount of increase in the level
of allowance for loan losses at year-end 2005 compared with year-end 2004. A portion of
these increased net-charge-offs during 2005 was provided for in the significant increase
in provision for loan losses in 2004 compared with prior periods. The provision for loan
loss remained relatively stable during 2005, declining approximately $112,000, compared
with 2004 following an increase of $1.2 million in 2004 compared with 2003. Net charge-offs
increased to $1,678,000 or 0.26% of average outstanding loans during 2005. This level
compares to net charge-offs of $1,479,000 or 0.24% of average outstanding loans in 2004
and $847,000 or 0.14% of average outstanding loans in 2003. The increase in the level of
loan charge-offs in 2005 was attributable primarily to commercial and industrial loans,
but was not necessarily attributable to a particular segment within the commercial and
industrial portfolio. The increase in 2004 was attributable to a modestly higher level of
loan charge-offs coupled with a significant reduction in the level of recoveries of
previously charged-off loans. The trend in the
decline in residential mortgage loan allocations, indicated in the table above, has
resulted from the trend of declining net charge-offs and the lower concentration of this
type of loans. The unallocated component of the allowance for loan losses incorporates the
Company’s judgmental determination of inherent losses that may not be fully reflected
in other allocations, including factors such as economic uncertainties, lending staff
quality, industry trends impacting specific portfolio segments, and broad portfolio
quality trends. Therefore, the ratio of allocated to unallocated components within the
total allowance has fluctuated from period to period.
26
Please see “RESULTS OF OPERATIONS – Provision for Loan Losses”
and “CRITICAL ACCOUNTING POLICIES AND ESTIMATES – Allowance for Loan
Losses” for additional information regarding the allowance.
NON-PERFORMING ASSETS Non-performing assets
consist of: (a) non-accrual loans; (b) loans which have been renegotiated to provide for a
reduction or deferral of interest or principal because of deterioration in the financial
condition of the borrower; (c) loans past due 90 days or more as to principal or interest;
and, (d) other real estate owned. Loans are placed on non-accrual status when scheduled
principal or interest payments are past due for 90 days or more or when the
borrower’s ability to repay becomes doubtful. Uncollected interest accrued in the
current year is reversed against income at the time a loan is placed on non-accrual. Loans
are charged-off at 120 days past due, or earlier if deemed uncollectible. Exceptions to
the non-accrual and charge-off policies are made when the loan is well secured and in the
process of collection. The following table presents an analysis of the Company’s
non-performing assets. During 2005, the
Company, in accordance with its standard methodology for the identification of potential
problem credits, downgraded the internal risk classification on two large commercial
credit facilities and placed these credits along with one additional large commercial
credit on non-accrual status. The net effect of this activity has been to increase the
level of non-performing loans for the Company at year-end 2005 as compared with year-end
2004. The increased level at year-end 2004 as compared with 2003 was the result of one
commercial real estate credit that was resolved on terms consistent with management’s
expectations during the first quarter of 2005. The Company is closely
monitoring developments in the status of the three larger credit facilities that were
placed on non-accrual status during 2005. The first of these credits is a $1.1 million
loan to a manufacturing entity which has ceased operations. During the latter part of the
third quarter of 2005, the real estate and equipment of the manufacturing entity were sold
at auction. The sale is expected to be completed during the second quarter of 2006. The
indebtedness owed the Company on this credit is secured by a first priority lien on
substantially all of the borrower’s assets, including those sold at auction. The
second of these specific credits, which totals approximately $5.2 million, is extended to
a borrower operating two hotel facilities. This credit is secured by a first priority lien
on the hotel facilities. The borrower is currently operating the hotels and is actively
attempting to negotiate the sale of the facilities. The third of these specific credits,
which is extended to a borrower operating a retail grocery store chain, is a 10% interest
(the Company’s current balance is approximately $4.6 million) in a credit facility
that is led by Harris, N.A., Chicago, Illinois. The borrower, which filed for Chapter 11
bankruptcy relief on May 4, 2005, has submitted a plan of reorganization with the
bankruptcy court and it is anticipated, based on current available information, the plan
will be (subject to court approval after consideration of any objections to the plan)
confirmed by the end of the second quarter of 2006. Under the plan as filed with the
court, the Company would be paid approximately 90% of the amount owed to it, which is
consistent with the projected payment that the Company has assumed for purposes of
establishing a special allocation of possible loss for this credit as part of the
Company’s determination of its allowance for loan losses. The Company will
continue to assess the internal classification of these credits and the level of specific
allocation of the loan loss reserve attributable to these credits based upon the best
information that is available from time to time, including the status of the sale of the
manufacturing facility and of the hotel facilities, and developments in the grocery store
chain bankruptcy case. The increased level of
non-performing loans at year-end 2004 as compared with 2003 was the result of one
commercial real estate credit. This credit had successful resolution that allowed for its
removal from non-accrual status during the first quarter of 2005. Interest income
recognized on non-performing loans for 2005 was $395,000. The gross interest income that
would have been recognized in 2005 on non-performing loans if the loans had been current
in accordance with their original terms was $1,211,000. Loans are typically placed on
non-accrual status when scheduled principal or interest payments are past due for 90 days
or more, unless the loan is well secured and in the process of collection.
27 Loan impairment is
reported when full repayment under the terms of the loan is not expected. If a loan is
impaired, a portion of the allowance is allocated so that the loan is reported net, at the
present value of estimated future cash flows using the loan’s existing rate, or at
the fair value of collateral if repayment is expected solely from the collateral.
Commercial, agricultural and poultry loans are evaluated individually for impairment.
Smaller balance homogeneous loans are evaluated for impairment in total. Such loans
include real estate loans secured by one-to-four family residences and loans to
individuals for household, family and other personal expenditures. Individually evaluated
loans on non-accrual are generally considered impaired. Impaired loans, or portions
thereof, are charged off when deemed uncollectible. The total dollar amount of impaired
loans at December 31, 2005 was $13,286,000. For additional detail on impaired loans, see
Note 3 to the Company’s consolidated financial statements included in Item 8 of this
Report.
LIQUIDITY AND INTEREST RATE RISK MANAGEMENT Liquidity is a measure
of the ability of the Company’s subsidiary banks to fund new loan demand, existing
loan commitments and deposit withdrawals. The purpose of liquidity management is to match
sources of funds with anticipated customer borrowings and withdrawals and other
obligations to ensure a dependable funding base, without unduly penalizing earnings.
Failure to properly manage liquidity requirements can result in the need to satisfy
customer withdrawals and other obligations on less than desirable terms. The liquidity of
the parent company is dependent upon the receipt of dividends from its bank subsidiaries,
which are subject to certain regulatory limitations explained in Note 9 to the
Company’s consolidated financial statements included in Item 8 of this Report, as
enhanced by its ability to draw upon term financing arrangement and a line of credit
established by the parent company in September 2005 with a correspondent bank lender as
described under “SOURCES OF FUNDS – Parent Company Funding Sources”, above.
The affiliate banks’ source of funding is predominately core deposits, maturities of
securities, repayments of loan principal and interest, federal funds purchased, securities
sold under agreements to repurchase and borrowings from the Federal Home Loan Bank. Interest rate risk is
the exposure of the Company’s financial condition to adverse changes in market
interest rates. In an effort to estimate the impact of sustained interest rate movements
to the Company’s earnings, the Company monitors interest rate risk through
computer-assisted simulation modeling of its net interest income. The Company’s
simulation modeling monitors the potential impact to net interest income under various
interest rate scenarios. The Company’s objective is to actively manage its
asset/liability position within a one-year interval and to limit the risk in any of the
interest rate scenarios to a reasonable level of tax-equivalent net interest income within
that interval. Funds Management Committees at the holding company and each affiliate bank
monitor compliance within established guidelines of the Funds Management Policy. See Item
7A. Quantitative and Qualitative Disclosures About Market Risk section for further
discussion regarding interest rate risk.
OFF-BALANCE SHEET ARRANGEMENTS The Company has no
off-balance sheet arrangements other than stand-by letters of credit as disclosed in Note
14 to the Company’s consolidated financial statements included in Item 8 of this
Report.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. The Company’s
exposure to market risk is reviewed on a regular basis by the Asset/Liability Committees
and Boards of Directors of the holding company and its affiliate banks. Primary market
risks, which impact the Company’s operations, are liquidity risk and interest rate
risk, as discussed above. As discussed
previously, the Company monitors interest rate risk by the use of computer simulation
modeling to estimate the potential impact on its net interest income under various
interest rate scenarios. Another method by which the Company’s interest rate risk
position can be estimated is by computing estimated changes in its net portfolio value
(“NPV”). This method estimates interest rate risk exposure from movements in
interest rates by using interest rate sensitivity analysis to determine the change in the
NPV of discounted cash flows from assets and liabilities. NPV represents the market value
of portfolio equity and is equal to the estimated market value of assets minus the
estimated market value of liabilities. Computations are based on a number of assumptions,
including the relative levels of market interest rates and prepayments in mortgage loans
and certain types of investments. These computations do not contemplate any actions
management may undertake in response to changes in interest rates, and should not be
relied upon as indicative of actual results. In addition, certain shortcomings are
inherent in the method of computing NPV. Should interest rates remain or decrease below
current levels, the proportion of adjustable rate loans could decrease in future periods
due to refinancing activity. In the event of an interest rate change, prepayment levels
would likely be different from those assumed in the table. Lastly, the ability of many
borrowers to repay their adjustable rate debt may decline during a rising interest rate
environment.
28 The following table
provides an assessment of the risk to NPV in the event of sudden and sustained 1% and 2%
increases and decreases in prevailing interest rates. The table indicates that as of
December 31, 2005 the Company’s estimated NPV might be expected to increase in the
event of an increase in prevailing interest rates, and might be expected to decrease in
the event of a decrease in prevailing interest rates (dollars in thousands).
Interest Rate Sensitivity as of December 31, 2005 The above
discussion, and the portions of MANAGEMENT’S DISCUSSION AND ANALYSIS in
Item 7 of this Report that are referenced in the above discussion contains
statements relating to future results of the Company that are considered
“forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995. These statements relate to, among
other things, simulation of the impact on net interest income from changes in
interest rates. Actual results may differ materially from those expressed or
implied therein as a result of certain risks and uncertainties, including those
risks and uncertainties expressed above, those that are described in
MANAGEMENT’S DISCUSSION AND ANALYSIS in Item 7 of this Report, and those
that are described in Item 1 of this Report, “Business,” under the
caption “Forward-Looking Statements and Associated Risks,” which
discussions are incorporated herein by reference.
29
Item 8. Financial Statements and Supplementary Data.
Board of Directors and Shareholders We have audited the
accompanying consolidated balance sheets of German American Bancorp as of December 31,
2005 and 2004, and the related consolidated statements of income, changes in
shareholders’ equity, and cash flows for each of the three years in the period ended
December 31, 2005. These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial statements
based on our audits. We conducted our audits
in accordance with the standards of the Public Company Accounting Oversight Board (United
States). 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 German American Bancorp as of December 31, 2005 and
2004, and the results of its operations and its cash flows for each of the three years in
the period ended December 31, 2005 in conformity with U.S. generally accepted accounting
principles. We have also audited,
in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the effectiveness of the Company’s internal control over financial reporting
as of December 31, 2005, based on criteria established in Internal Control –
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated February 21, 2006 expressed an unqualified opinion
thereon.
30
See accompanying notes to consolidated financial statements.
31
See accompanying notes to consolidated financial statements.
32
See accompanying notes to consolidated financial statements.
33
See accompanying notes to consolidated financial statements.
34
NOTE 1 – Summary of Significant Accounting Policies
Description of Business and Basis of Presentation
Securities Premium amortization is
deducted from, and discount accretion is added to, interest income using the level yield
method without anticipating prepayments, except for mortgage-backed securities where
prepayments are anticipated. The cost of securities sold is computed on the identified
securities method. Securities are written down to fair value when a decline in fair value
is not considered temporary. In estimating other-than-temporary losses, management
considers: (1) the length of time and extent that fair value has been less than cost, (2)
the financial condition and near term prospects of the issuer, and (3) the Company’s
ability and intent to hold the security for a period sufficient to allow for any
anticipated recovery in fair value.
Loans Held for Sale Mortgage loans held for
sale are generally sold with servicing rights retained. The carrying value of mortgage
loans sold is reduced by the cost allocated to the servicing right. Gains and losses on
sales of mortgage loans are based on the difference between the selling price and the
carrying value of the related loan sold.
Loans Interest income is
discontinued on impaired loans and loans past due 90 days or more, unless the loan is well
secured and in process of collection. All interest accrued but not received for loans
placed on non-accrual is reversed against interest income. Interest received on such loans
is accounted for on the cash-basis or cost-recovery method, until qualifying for return to
accrual. Loans are returned to accrual status when all the principal and interest amounts
contractually due are brought current and future payments are reasonably assured.
35
NOTE 1 – Summary of Significant Accounting Policies (continued)
Allowance for Loan Losses The allowance consists
of specific and general components. The specific component relates to loans that are
individually classified as impaired or loans otherwise classified as substandard or
special mention. The general component covers non-classified loans and is based on
historical loss experience adjusted for current factors. Loan impairment is
reported when full repayment under the terms of the loan is not expected. If a loan is
impaired, a portion of the allowance is allocated so that the loan is reported net, at the
present value of estimated future cash flows using the loan’s existing rate, or at
the fair value of collateral if repayment is expected solely from the collateral.
Commercial, agricultural and poultry loans are evaluated individually for impairment.
Smaller balance homogeneous loans are evaluated for impairment in total. Such loans
include real estate loans secured by one-to-four family residences and loans to
individuals for household, family and other personal expenditures. Individually evaluated
loans on non-accrual are generally considered impaired. Impaired loans, or portions
thereof, are charged off when deemed uncollectible.
Federal Home Loan Bank (FHLB) Stock
Premises, Furniture and Equipment
Other Real Estate
Goodwill and Other Intangible Assets Other intangible assets
consist of core deposit and acquired customer relationship intangible assets. They are
initially measured at fair value and then are amortized on a straight-line method over
their estimated useful lives, which range from 7 to 10 years.
Company Owned Life Insurance
36
NOTE 1 – Summary of Significant Accounting Policies (continued)
Servicing Rights
Loss contingencies
Stock Compensation For options granted
during 2005, 2004 and 2003, the weighted-average fair values at grant date are $1.65,
$2.89 and $3.04, respectively. The fair value of options granted during 2005, 2004 and
2003 was estimated using the following weighted-average information: risk-free interest
rate of 3.41%, 2.79% and 2.56%, expected life of 3.4, 4.3 and 4.4 years, expected
volatility of stock price of 17%, 24% and 25%, and expected dividends of 3.56%, 3.20% and
3.11% per year.
Comprehensive Income
Income Taxes
Retirement Plans
37
NOTE 1 – Summary of Significant Accounting Policies (continued) Earnings Per Share Cash Flow Reporting
Fair Values of Financial Instruments
New Accounting Pronouncements
NOTE 2 – Securities The amortized cost,
gains and losses recognized in accumulated other comprehensive income (loss), and fair
value of Securities Available-for-Sale were as follows:
38
NOTE 2 – Securities (continued) The carrying
amount, unrecognized gains and losses and fair value of Securities
Held-to-Maturity were as follows: The amortized
cost and fair value of Securities at December 31, 2005 by contractual maturity
are shown below. Expected maturities may differ from contractual maturities
because some issuers have the right to call or prepay certain obligations with
or without call or prepayment penalties. Asset-backed, Mortgage-backed and
Equity Securities are not due at a single maturity date and are shown
separately.
Proceeds from the Sales of Securities are summarized below: The carrying value of
securities pledged to secure repurchase agreements, public and trust deposits, and for
other purposes as required by law was $116,683 and $94,995 as of December 31, 2005 and
2004, respectively.
39
NOTE 2 – Securities (continued) Below is a summary of
securities with unrealized losses as of year-end 2005 and 2004, presented by length of
time the securities have been in an unrealized loss position: Securities are written
down to fair value when a decline in fair value is not considered temporary. In estimating
other-than-temporary losses, management considers the length of time and extent that fair
value has been less than cost, the financial condition and near term prospects of the
issuer, and the Company’s ability and intent to hold the security for a period
sufficient to allow for any anticipated recovery in fair value. The Company had the intent
and ability to hold these securities for the foreseeable future, and the decline in fair
value was largely due to changes in market interest rates, therefore, the Company does not
consider these securities to be other-than-temporarily impaired. The Company’s
equity portfolio is primarily comprised of floating rate preferred stock issued by the
Federal Home Loan Mortgage Corporation (FHLMC) and Federal National Mortgage Association
(FNMA). In the year ended December 31, 2004, the Company recognized a $3.68 million
non-cash, pre-tax charge for the other-than-temporary decline in value on its floating
rate preferred stock portfolio. The Company accounts for these securities in accordance
with SFAS No. 115, which requires that if the decline in fair market value below cost is
determined to be other-than-temporary, the unrealized loss must be recognized as expense
in the income statement. During the quarter ended December 31, 2004, public disclosures
regarding accounting practices at FNMA and a multi-billion dollar FNMA preferred stock
issuance with a substantially different structure and higher yield than previous offerings
had a detrimental effect on the fair value of both the FHLMC and FNMA preferred stock
holdings. As a result of these factors and the magnitude and length of time the market
value had been below cost, management could not forecast full recovery of the fair values
in a reasonable time period and concluded that the preferred stock is other than
temporarily impaired. Accordingly, the other-than-temporary impairment was recognized in
the income statement as an investment securities loss. A portion of the
floating rate preferred stock portfolio has declined in value during 2005 and this decline
is considered to be largely due to changes in market interest rates. Based on the length
of time, extent and nature of this decline, as well as market performance subsequent to
December 31, 2005, the Company does not consider these securities to have additional
other-than-temporary impairment.
40
NOTE 3 – Loans
Certain directors, executive officers, and principal shareholders of the
Company, including their immediate families and companies in which they are
principal owners, were loan customers of the Company during 2005. A summary of
the activity of these loans follows:
NOTE 4 – Allowance for Loan Losses
A summary of the activity in the Allowance for Loan Losses follows:
41
NOTE 5 – Mortgage Banking The amount of loans
serviced by the Company for the benefit of others was $335,531 and $316,948 at December
31, 2005 and 2004. These loans are owned by outside parties and are not included in the
assets of the Company. Activity for
capitalized mortgage servicing rights and the related valuation allowance was as follows.
The net balance of mortgage servicing rights is included in Other Assets. The fair value of
servicing rights was $3,353 and $2,695 at December 31, 2005 and 2004. For purposes of
determining fair value, a discount rate of 9% was assumed at December 31, 2005 and 2004.
Weighted average prepayment speeds applied were 12% and 19% at December 31, 2005 and 2004.
Fair values were determined using a discounted cash-flow model.
NOTE 6 – Premises, Furniture, and Equipment Premises, furniture,
and equipment was comprised of the following classifications at December 31: Depreciation expense
was $2,131, $2,308 and $2,418 for 2005, 2004 and 2003, respectively.
NOTE 7 – Deposits At year-end 2005,
stated maturities of time deposits were as follows: Time deposits of $100
or more at December 31, 2005 and 2004 were $61,345 and $69,583.
42
NOTE 8 – FHLB Advances and Other Borrowed Money The Company’s
funding sources include Federal Home Loan Bank advances and repurchase agreements.
Information regarding each of these types of borrowings is as follows:
Repurchase agreements, which are classified as secured borrowings, generally
mature within one day of the transaction date. Repurchase agreements are
reflected at the amount of cash received in connection with the transaction. The
corporation may be required to provide additional collateral based on the value
of the underlying securities. At December 31, 2005, interest rates on the fixed rate long-term FHLB advances
ranged from 2.93% to 7.22% with a weighted average rate of 5.35%. Of the $48.1
million, $30.0 million or 62% of the advances contained options whereby the FHLB
may convert the fixed rate advance to an adjustable rate advance, at which time
the company may prepay the advance without penalty. The options on these
advances are subject to a variety of terms including LIBOR based strike rates. At December 31, 2004, interest rates on the fixed rate long-term FHLB advances
ranged from 2.50% to 7.22% with a weighted average rate of 5.93%. Of the $59.4
million, $50.0 million or 84% of the advances contained options whereby the FHLB
may convert the fixed rate advance to an adjustable rate advance, at which time
the company may prepay the advance without penalty. The options on these
advances are subject to a variety of terms including LIBOR based strike rates. At December 31, 2005, the long-term borrowings shown above includes $18.5
million outstanding on a $25.0 million term loan held at the Parent Company.
Interest on the term loan is based upon 90-day LIBOR plus 1.15%. The term loan
matures September 20, 2010. At December 31, 2005, the short-term borrowings
shown above includes $2.5 million outstanding on a $15.0 million line of credit
at the Parent Company. Interest on the line of credit is based upon 90-day LIBOR
plus 1.15%. The line of credit matures on September 20, 2006. Under the terms of
these notes, the Company and all of its bank subsidiaries must maintain a
"well-capitalized" status, and this status was maintained at December 31, 2005.
Scheduled principal payments on long-term borrowings at December 31, 2005 are as
follows:
43
NOTE 9 –
Stockholders’ Equity (share and per share amounts adjusted for stock
dividends) The Company and
affiliate banks are subject to regulatory capital requirements administered by federal
banking agencies. Capital adequacy guidelines and prompt corrective action regulations
involve quantitative measures of assets, liabilities, and certain off-balance sheet items
calculated under regulatory accounting practices. Capital amounts and classifications are
also subject to qualitative judgments by regulators about components, risk weightings, and
other factors, and the regulators can lower classifications in certain cases. Failure to
meet various capital requirements can initiate regulatory action that could have a direct
material effect on the financial statements. The prompt corrective
action regulations applicable to banks provide five classifications, including
well-capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized, although these terms are not used to
represent overall financial condition. If adequately capitalized, regulatory approval is
required to accept brokered deposits. If undercapitalized, capital distributions are
limited, as is asset growth and expansion, and plans for capital restoration are required. At December 31, 2005,
consolidated and affiliate bank actual capital and minimum required levels are presented
below:
44
NOTE 9 –
Stockholders’ Equity (continued) At December 31, 2004,
consolidated and affiliate bank actual capital and minimum required levels are presented
below: All of the
Company’s affiliate Banks at year-end 2005 and 2004 were categorized as
well-capitalized. There have been no conditions or events that management
believes have changed the classification of the Company’s affiliate Banks
under the prompt corrective action regulations since the last notification from
regulators. Regulations require the maintenance of certain capital levels at
each affiliate bank, and may limit the dividends payable by the affiliates to
the holding company, or by the holding company to its shareholders. At December
31, 2005 the affiliates had $16.3 million in retained earnings available for
dividends to the parent company without prior regulatory approval.
Equity Incentive Plans The Company
maintains two equity incentive plans under which stock options, restricted stock
awards, and other equity incentive awards can be granted. At December 31, 2005,
has reserved 620,144 shares of Common Stock (as adjusted for subsequent stock
dividends and subject to further customary anti-dilution adjustments) for the
purpose of issuance pursuant to outstanding and future grants of options and
other equity awards to officers, directors and other employees of the
Company. Options may
be designated as “incentive stock options” under the Internal Revenue
Code of 1986, or as nonqualified options. While the date after which options are
first exercisable is determined by the Stock Option Committee of the Company or,
in the case of options granted to directors, by the Board of Directors, no stock
option may be exercised after ten years from the date of grant (twenty years in
the case of nonqualified stock options). The exercise price of stock options
granted pursuant to the Plans must be no less than the fair market value of the
Common Stock on the date of the grant. The Plans
authorize an optionee to pay the exercise price of options in cash or in common
shares of the Company or in some combination of cash and common shares. An
optionee may tender already-owned common shares to the Company in exercise of an
option.
45
NOTE 9 –
Stockholders’ Equity (continued) On December 29, 2005,
the Stock Option Committee of the Company approved the accelerated vesting of all
currently outstanding unvested stock options awarded to recipients under its 1999 Long
Term Equity Incentive Plan effective December 29, 2005. The decision to accelerate the
vesting was made primarily to reduce non-cash compensation expense that German American
would have recorded in its income statement in future periods upon the adoption of FAS
123R in January 2006. The Stock Option Committee believed it was in the best interest of
the Company’s shareholders to accelerate the vesting of these Options to eliminate
compensation expense in future periods. This future expense was estimated to be $143. As a
result of the acceleration action, options to purchase up to 161,601 shares of common
stock became exercisable immediately. Without the acceleration, the options would have
vested on dates ranging from December 31, 2005 to August 29, 2010. Approximately 8,260
options or 5.1% of the accelerated options had exercise prices below the closing market
price at the time of acceleration (the “in-the-money options”). Without the
acceleration, in-the-money options would have vested at various times and would have been
fully vested by March 15, 2006. The Company expensed approximately $4 as a result of the
acceleration of the in-the-money stock options during the fourth quarter of 2005. In conjunction with the
acceleration of all vesting periods, the Stock Option Committee also took action to amend
all outstanding options to eliminate any obligation to grant new options in replacement of
shares tendered in payment of the exercise price of options, effective January 1, 2006.
All other terms and conditions applicable to Options, including the exercise prices and
exercise periods, remain unchanged. Changes in options
outstanding were as follows, as adjusted to reflect stock dividends:
Options outstanding at year-end 2005 are as follows: Options exercisable and
the weighted average exercise price at December 31, 2004 and 2003 were 238,212 at $16.08
and 185,759 at $15.73, respectively.
46
NOTE 9 –
Stockholders’ Equity (continued)
Employee Stock Purchase Plan The Company maintains
an Employee Stock Purchase Plan whereby eligible employees have the option to purchase the
Company’s common stock at a discount. The purchase price of the shares under this
plan is determined annually and shall be in the range from 85% to 100% of the fair market
value of such stock at either the beginning or end of the plan year. The plan provides for
the purchase of up to 542,420 shares of common stock, which the Company may obtain by
purchases on the open market or from private sources, or by issuing authorized but
unissued common shares. The Company purchased common shares on the open market in 2005,
2004, and 2003. Funding for the purchase of common stock was from employee contributions
and Company contributions. Company contributions totaled $63, $76, and $120 for 2005,
2004, and 2003. The plan is considered non-compensatory under APB No. 25, and as a result
no compensation expense is recorded and Company contributions are a reduction to
additional paid-in capital.
Stock Repurchase Plan On April 26, 2001 the
Company announced that its Board of Directors approved a stock repurchase program for up
to 607,754 of the outstanding Common Shares of the Company. Shares may be purchased from
time to time in the open market and in large block privately negotiated transactions. The
Company is not obligated to purchase any shares under the program, and the program may be
discontinued at any time before the maximum number of shares specified by the program are
purchased. As of December 31, 2005, the Company had purchased 334,965 shares under the
program. During December 2005
the Company completed the purchase, in a private unsolicited transaction not from or
through any broker or dealer, of a block of 440,747 shares of the Company’s issued
and outstanding common stock from a corporation currently in reorganization proceedings
under Chapter 11 of the United States Bankruptcy Code at a price of $12.50 per share. The
block purchase represented approximately 4% of the shares of the Company’s common
shares that were outstanding immediately prior to consummation of the purchase. The
Company’s Board of Directors specifically approved the block purchase, and such
purchase therefore will not reduce the number of shares authorized for repurchase under
the repurchase program described above.
NOTE 10 – Employee Benefit Plans The Company provides a
contributory trusteed 401(k) deferred compensation and profit sharing plan, which covers
substantially all full-time employees. The Company agrees to match certain employee
contributions under the 401(k) portion of the plan, while profit sharing contributions are
discretionary and are subject to determination by the Board of Directors. Company
contributions were $465, $495 and $1,137 for 2005, 2004, and 2003, respectively. The Company
self-insures employee health benefits. During the fourth quarter of 2005, the employees
from the Company’s most recent banking acquisition were not covered by the
Company’s self-insured health plan, but remained covered under their existing fully
insured health insurance program. As of the first quarter 2006, those employees were
brought into the Company’s self-insured health plan. Stop loss insurance covers
annual losses exceeding $75 per covered individual. Management’s policy is to
establish a reserve for claims not submitted by a charge to earnings based on prior
experience. Charges to earnings were $1,642, $1,145 and $868 for 2005, 2004, and 2003,
respectively. The Company maintains
deferred compensation plans for the benefit of certain directors and officers. Under the
plans, the Company agrees in return for the directors and officers deferring the receipt
of a portion of their current compensation, to pay a retirement benefit computed as the
amount of the compensation deferred plus accrued interest at a variable rate. Accrued
benefits payable totaled $3,409 and $3,577 at December 31, 2005 and 2004. Deferred
compensation expense was $322, $315 and $895 for 2005, 2004, and 2003. In conjunction with
the plans, the Company purchased life insurance on certain directors and officers. The Company acquired
through previous bank mergers a noncontributory defined benefit pension plan with benefits
based on years of service and compensation prior to retirement. The benefits under the
plan were suspended in 1998. During the years ended 2005 and 2003, there were no losses
incurred on partial settlements of the plan. During 2004, the Company incurred $52 on
partial settlements of the plan. The Company uses a September 30 measurement date for its
plan.
47
NOTE 10 –
Employee Benefit Plans (continued) Accumulated plan
benefit information for the Company’s plan as of December 31, 2005 and 2004 was as
follows:
Because the plan has been suspended, the projected benefits obligations and
accumulated benefit obligations are the same. The accumulated benefit obligation
for the defined benefit pension plan exceeds the fair value of the assets
included in the plan.
48
NOTE 10 –
Employee Benefit Plans (continued)
Assumptions Weighted-average
assumptions used to determine benefit obligations at year-end: The expected return on
plan assets was determined based upon rates that are expected to be available for future
reinvestment of earnings and maturing investments along with consideration given to the
current mix of plan assets.
Plan Assets The Company’s
defined benefit pension plan asset allocation at year-end 2005 and 2004 and target
allocation for 2006 by asset category are as follows: Plan benefits are
suspended. Therefore, the Company has invested predominantly in relatively short-term
investments over the past two years. No significant changes to investing strategies are
anticipated. The above mentioned
Equity Securities consist of the Company’s stock for all periods presented.
Contributions The Company expects to
contribute $61 to the pension plan during the fiscal year ending December 31, 2006.
Estimated Future Benefits The following benefit
payments, which reflect expected future service, are expected to be paid:
49
NOTE 11 – Income Taxes The Company
has $888 of general business credit carryforward, which will expire in years
2024 and 2025. The Company also has $1,519 of alternative minimum tax credit
carryforward, which under current tax law has no expiration period. The Company
has federal and state net operating loss carryforwards (acquired in the PCB
Holdings business combination) of $649 (federal) and $738 (state). These
carryforwards expire in 2025, and the use of these federal and state
carryforwards are each limited to $285 annually.
50
NOTE 11 – Income Taxes (continued) Under the Internal
Revenue Code, through 1996 Peoples Community Bank (which was acquired by and merged into
First State Bank in October 2005) and First Federal Bank (now First American Bank) were
allowed a special bad debt deduction related to additions to tax bad debt reserves
established for the purpose of absorbing losses. Subject to certain limitations, these
Banks were permitted to deduct from taxable income an allowance for bad debts based on a
percentage of taxable income before such deductions or actual loss experience. The Banks
generally computed its annual addition to its bad debt reserves using the percentage of
taxable income method; however, due to certain limitations in 1996, the Banks were only
allowed a deduction based on actual loss experience. Retained earnings at December 31,
2005, include approximately $2,995 for which no provision for federal income taxes has
been made. This amount represents allocations of income for allowable bad debt deductions.
Reduction of amounts so allocated for purposes other than tax bad debt losses will create
taxable income, which will be subject to the then current corporate income tax rate. It is
not contemplated that amounts allocated to bad debt deductions will be used in any manner
to create taxable income. The unrecorded deferred income tax liability on the above amount
at December 31, 2005 was approximately $1,018. Since December 31,
2001, the Company’s effective tax rate has been favorably impacted by Indiana
financial institution tax savings resulting from the Company’s formation of
investment subsidiaries in the state of Nevada by four of the Company’s banking
subsidiaries. The state of Nevada has no state or local income tax. During the first
quarter of 2005, the Company received notices of proposed assessments of unpaid Indiana
financial institutions tax for the years 2001 and 2002 of approximately $691 ($456 net of
federal tax), including interest and penalties of approximately $100. The Company filed a
protest with the Indiana Department of Revenue contesting the proposed assessments and
intends to vigorously defend its position that the income of the Nevada subsidiaries is
not subject to the Indiana financial institutions tax. Although there can be no such
assurance, at this time management does not believe that it is probable that this
potential assessment will result in additional tax liability. Therefore, no tax provision
has been recognized for the potential assessment of additional financial institutions tax
for 2001 and 2002 or for financial institutions tax with respect to any of the Nevada
subsidiaries in any period subsequent to 2002, including the year ended December 31, 2005.
NOTE 12 – Per Share Data Earnings and Diluted
Earnings per Share amounts have been retroactively computed as though shares issued for
stock dividends had been outstanding for all periods presented. The computation of
Earnings per Share and Diluted Earnings per Share are provided below: Stock options for
351,085, 253,913, and 177,974 shares of common stock were not considered in computing
diluted earnings per common share for 2005, 2004, and 2003, respectively, because they
were anti-dilutive.
51
NOTE 13 – Lease Commitments The total rental
expense for all leases for the years ended December 31, 2005, 2004, and 2003 was $175,
$213, and $165 respectively, including amounts paid under short-term cancelable leases. The following is a
schedule of future minimum lease payments:
NOTE 14 – Commitments and Off-balance Sheet Items In the normal course of
business, there are various commitments and contingent liabilities, such as commitments to
extend credit and commitments to sell loans, which are not reflected in the accompanying
consolidated financial statements. The Company’s exposure to credit loss in the event
of nonperformance by the other party to the financial instruments for commitments to make
loans and standby letters of credit is represented by the contractual amount of those
instruments. The Company uses the same credit policy to make commitments as it uses for
on-balance sheet items. The Company’s
exposure to credit risk for commitments to sell loans is dependent upon the ability of the
counter-party to purchase the loans. This is generally assured by the use of government
sponsored entity counterparts. These commitments are subject to market risk resulting from
fluctuations in interest rates. Commitments to sell loans are not mandatory (i.e., do not
require net settlement with the counter-party to cancel the commitment). Commitments and
contingent liabilities are summarized as follows, at December 31: The majority of
commercial operating lines and home equity lines are variable rate, while the majority of
other commitments to fund loans are fixed rate. Since many commitments to make loans
expire without being used, these amounts do not necessarily represent future cash
commitments. Collateral obtained upon exercise of the commitment is determined using
management’s credit evaluation of the borrower, and may include accounts receivable,
inventory, property, land and other items. The approximate duration of these commitments
is generally one year or less. At December 31, 2005
and 2004, respectively, the affiliate banks were required to have $3,581 and $4,982 on
deposit with the Federal Reserve, or as cash on hand. These reserves do not earn interest.
NOTE 15 – Non-cash Investing Activities See also Note 18
regarding purchase acquisitions.
52
NOTE 16 – Segment Information The Company’s
operations include four primary segments: core banking, mortgage banking, trust and
investment advisory services, and insurance operations. The core banking segment involves
attracting deposits from the general public and using such funds to originate consumer,
commercial, commercial real estate, and residential mortgage loans, primarily in the
affiliate banks’ local markets. The mortgage banking segment involves the origination
and purchase of single-family residential mortgage loans; the sale of such loans in the
secondary market; the servicing of mortgage loans for investors; and the operation of a
title insurance company. The trust and investment advisory services segment involves
providing trust, investment advisory, and brokerage services to customers. The insurance
segment offers a full range of personal and corporate property and casualty insurance
products, primarily in the affiliate banks’ local markets. The core banking
segment is comprised of five community banks with 27 retail banking offices. Net interest
income from loans and investments funded by deposits and borrowings is the primary revenue
of the five affiliate community banks comprising the core-banking segment. Revenues for
the mortgage-banking segment consist of net interest income from a residential real estate
loan portfolio funded primarily by wholesale sources, gains on sales of loans and gains on
sales of and capitalization of mortgage servicing rights (MSR), loan servicing income,
title insurance commissions and loan closing fees. The trust and investment advisory
services segment’s revenues are comprised primarily of fees generated by German
American Financial Advisors & Trust Company (“GAFA”). These fees are derived
by providing trust, investment advisory, and brokerage services to its customers. The
insurance segment consists of German American Insurance, Inc., which provides a full line
of personal and corporate insurance products as agent under five distinctive insurance
agency names from five offices; and German American Reinsurance Company, Ltd.
(“GARC”), which reinsures credit insurance products sold by the Company’s
five affiliate banks. Commissions derived from the sale of insurance products are the
primary source of revenue for the insurance segment. The following segment
financial information has been derived from the internal financial statements of German
American Bancorp, which are used by management to monitor and manage the financial
performance of the Company. The accounting policies of the four segments are the same as
those of the Company. The evaluation process for segments does not include holding company
income and expense. Holding company amounts are the primary differences between segment
amounts and consolidated totals, and are reflected in the Holding Company and Other column
below, along with amounts to eliminate transactions between segments.
53
NOTE 16 – Segment Information (continued)
54
NOTE 17 – Parent Company Financial Statements (continued) The condensed
financial statements of German American Bancorp are presented below:
CONDENSED BALANCE SHEETS
55
NOTE 17 – Parent Company Financial Statements (continued)
CONDENSED STATEMENTS OF CASH FLOWS
56
NOTE 18 – Business Combinations, Goodwill and Intangible Assets Information relating to
mergers and acquisitions for the three year period ended December 31, 2005, includes: Certain of the above
entities changed their name and/or have been merged into other subsidiaries of the
Corporation. Hoosierland Insurance
Agency, Inc. was accounted for as a purchase, with net assets acquired of $1,553. The
Company issued no stock in this transaction. The Company recorded customer list intangible
of $1,534 as a result of this transaction. The acquired company is included in operating
results beginning with the date of acquisition. Stafford-Williams
Insurance Agency, Inc. was accounted for as a purchase, with net assets acquired of $998.
The Company issued no stock in this transaction. The Company recorded customer list
intangible of $979 as a result of this transaction. The acquired company is included in
operating results beginning with the date of acquisition. On October 1, 2005, the
Company consummated a merger with PCB Holding Company (“PCB”). PCB was merged
with and into the Company, and PCB’s sole banking subsidiary, Peoples Community Bank,
was merged into the Company’s subsidiary, First State Bank, Southwest Indiana.
Peoples Community Bank operated two banking offices in Tell City, Indiana. PCB’s
assets and equity (unaudited) as of September 30, 2005 totaled $34.6 million and $4.8
million, respectively. Net loss (unaudited) totaled $586 for the nine-month period ended
September 30, 2005. Under the terms of the
merger, the shareholders of PCB received an aggregate of 257,029 shares of common stock of
the Company valued at approximately $3.5 million and approximately $3.2 million of cash,
representing a total transaction value of $6.7 million. This merger was
accounted for under the purchase method of accounting. The purchase resulted in
approximately $2,019 in goodwill and $443 in core deposit intangible. The core deposit
intangible is being amortized over 10 years. Goodwill will not be amortized but instead
evaluated periodically for impairment. As a result of the PCB
acquisition, on October 1, 2005 the Company acquired loans with evidence of credit
deterioration since origination (as defined in Statement of Position (SOP) 03-3) with an
outstanding principal balance of $982 and a net carrying amount of $826 at the acquisition
date. This net carrying amount is believed to approximate fair value and the cash flows
expected to be collected, net of accretable yield. At year end 2005, the outstanding
principal balance and carrying amount of these loans is not materially different from
acquisition date. Subsequent to the acquisition, the Company increased the allowance for
loan losses for these acquired loans by $89 and no allowance for loan losses was reversed. On January 1, 2006, the
Company consummated a merger with Stone City Bancshares, Inc. (“Stone City”)
Stone City was merged with and into the Company, and Stone City’s sole banking
subsidiary, Stone City Bank of Bedford, Indiana, will continue operations as an
independent, state chartered banking institution operating two banking offices in Bedford,
Indiana. Stone City’s assets and equity as of December 31, 2005 totaled $ 61.2
million and $5.4 million, respectively. Net loss totaled $332 for the year ended December
31, 2005. This net loss includes no provision for income taxes as Stone City had elected
under Internal Revenue Service Code to be an S Corporation. As such, in lieu of corporate
income taxes, the shareholders of Stone City were taxed on their proportionate share of
the Company’s taxable loss. Under the terms of the
merger, the shareholders of Stone City received aggregate cash payments of approximately
$6.4 million and 349,468 common shares of the Company valued at approximately $4.6
million, representing a total transaction value of approximately $11.0 million. This merger was
accounted for under the purchase method of accounting. The Company is in the process of
evaluating the purchase price allocation.
57
NOTE 18 – Business Combinations, Goodwill and Intangible Assets (continued) The changes in the
carrying amount of goodwill for the periods ended December 31, 2005 and 2004 were
classified as follows: Of the $3,813 carrying
amount of goodwill for December 31, 2005, $2,749 is allocated to the core banking segment
and $1,064 is allocated to the insurance segment. Of the $1,794 carrying amount of
goodwill for December 31, 2004, $730 is allocated to the core banking segment and $1,064
is allocated to the insurance segment.
Acquired intangible assets were as follows as of year end:
Amortization Expense was $433, $426, and $167 for 2005, 2004, and 2003.
Estimated amortization expense for each of the next five years is as follows:
58
NOTE 19 – Fair Values of Financial Instruments The estimated fair
values of the Company’s financial instruments are provided in the table below. Since
not all of the Company’s assets and liabilities are considered financial instruments,
some assets and liabilities are not included in the table. Because no active market exists
for a significant portion of the Company’s financial instruments, fair value
estimates were based on subjective judgments, and therefore cannot be determined with
precision. The carrying amounts of
cash, short-term investments, FHLB and other restricted stock, and accrued interest
receivable are a reasonable estimate of their fair values. The fair values of securities
are based on quoted market prices or dealer quotes, if available, or by using quoted
market prices for similar instruments. The fair value of loans held-for-sale is estimated
using commitment prices or market quotes on similar loans. The fair value of loans are
estimated by discounting future cash flows using the current rates at which similar loans
would be made for the average remaining maturities. The fair value of demand deposits,
savings accounts, money market deposits, short-term borrowings and accrued interest
payable is the amount payable on demand at the reporting date. The fair value of
fixed-maturity time deposits and long-term borrowings are estimated using the rates
currently offered on these instruments for similar remaining maturities. Commitments to
extend credit and standby letters of credit are generally short-term or variable rate with
minimal fees charged. These instruments have no carrying value, and the fair value is not
significant. The fair value of commitments to sell loans is the cost or benefit of
settling the commitments with the counter-party at the reporting date. At December 31,
2005 and 2004, none of the Company’s commitments to sell loans were mandatory, and
there is no cost or benefit to settle these commitments.
NOTE 20 – Other Comprehensive Income Other comprehensive
income components and related taxes were as follows:
59
NOTE 21 – Quarterly Financial Data (Unaudited) The following table
represents selected quarterly financial data for the Company: During the fourth
quarter 2004, the Company’s operating results were impacted by a $3.68 million
other-than-temporary impairment charge on the Company’s portfolio of FHLMC and FNMA
preferred stocks. See Note 2 to the consolidated financial statements for further
discussion of this charge.
60 Item 9. Changes in and
Disagreements with Accountants on Accounting and Financial Disclosure.
Not Applicable. Item 9A. Controls and
Procedures.
Disclosure Controls and Procedures
Changes in Internal Control over Financial Reporting in Most Recent Fiscal
Quarter
Management’s Report on Internal Control Over Financial Reporting Because of its inherent
limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over
financial reporting as of December 31, 2005. In making this assessment, management
used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment
and those criteria, management concluded that the Company maintained effective internal
control over financial reporting as of December 31, 2005. The Company’s
independent registered public accounting firm has issued their report on management’s
assessment of the Company’s internal control over financial reporting. That report
follows under the heading, Report of Independent Registered Public Accounting Firm on
Internal Control Over Financial Reporting.
61
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders We have audited
management’s assessment, included in the accompanying Management’s Report on
Internal Control Over Financial Reporting, that German American Bancorp maintained
effective internal control over financial reporting as of December 31, 2005, based on
criteria established in Internal Control—Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). German American
Bancorp’s management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal control over
financial reporting. Our responsibility is to express an opinion on management’s
assessment and an opinion on the effectiveness of the company’s internal control over
financial reporting based on our audit. We conducted our audit
in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over financial reporting was maintained
in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management’s assessment, testing and
evaluating the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinion. A company’s
internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company’s assets that could have
a material effect on the financial statements. Because of its inherent
limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate. In our opinion,
management’s assessment that German American Bancorp maintained effective internal
control over financial reporting as of December 31, 2005, is fairly stated, in all
material respects, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO). Also in our opinion, German American Bancorp maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2005, based on
criteria established in Internal Control—Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). We have also audited,
in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the consolidated balance sheets of German American Bancorp as of December 31,
2005 and 2004, and the related consolidated statements of income, changes in
shareholders’ equity, and cash flows for each of the three years in the period ended
December 31, 2005 and our report dated February 21, 2006 expressed an unqualified opinion
on those consolidated financial statements.
Indianapolis, Indiana
62
Item 9B. Other Information
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant.
Information relating to
directors and executive officers of the Corporation will be included under the caption
“Election of Directors” in the Company’s Proxy Statement for the Annual
Meeting of Shareholders to be held in April 2006, which will be filed within 120 days of
the end of the fiscal year covered by this Report (the “2006 Proxy Statement”),
which section is incorporated herein in partial response to this Item’s informational
requirements.
Section 16(a) Compliance. Information relating to Section 16(a) compliance will
be included in the 2006 Proxy Statement under the caption of “Section
16(a): Beneficial Ownership Reporting Compliance” and is incorporated
herein by reference.
Code of Business Conduct. The Corporation’s Board of Directors has adopted
a Code of Business Conduct, which constitutes a “code of ethics” as
that term is defined by SEC rules adopted under the Sarbanes-Oxley Act of 2002
(“SOA”). The Corporation has posted a copy of the Code of Business
Conduct on its Internet website (www.germanamericanbancorp.com). The Corporation
intends to satisfy its disclosure requirements under Item 10 of Form 8-K
regarding certain amendments to, or waivers of, the Code of Business Conduct, by
posting such information on its Internet website.
Audit Committee Identification. The Board of Directors of the Corporation has a
separately-designated standing audit committee established in accordance with
Section 3(a) (58) (A) of the Securities Exchange Act of 1934. The description of
the Audit Committee of the Board of Directors, and the identification of its
members, will be set forth in the 2006 Proxy Statement under the caption
“ELECTION OF DIRECTORS – Committees and Attendance”, which
section is incorporated herein by reference.
Audit Committee Financial Expert. The Board of Directors has determined that
none of its members who serve on the Audit Committee of the Board of Directors
is an “audit committee financial expert” as that term is defined by
SEC rules adopted under SOA. The Board of Directors has determined, however,
that the absence from its Audit Committee of a person who would qualify as an
audit committee financial expert does not impair the ability of its Audit
Committee to provide effective oversight of the Corporation’s external
financial reporting and internal control over financial reporting. In reaching
its determination that the members of the Audit Committee, as it is presently
constituted, have sufficient knowledge and experience to exercise effective
oversight without the addition of an audit committee financial expert, the Board
of Directors considered the knowledge gained by the current members of the Audit
Committee in connection with their prior years of service on the
Corporation’s Audit Committee. The Board of Directors also considered the
experience in financial and accounting matters that Mr. Steurer, Chairman of the
Board of JOFCO, Inc., a privately-held manufacturing company, has gained in
connection with his active supervision of the accounting and finance personnel
of that company. Mr. Steurer is a member of the Corporation’s Audit
Committee. Mr. Steurer is retiring from service as a director of the Corporation
effective at the annual meeting of shareholders in April 2006 including from
service as a member of the Audit Committee; however, the Board of Directors has
nominated Richard Forbes for election as a director of the Corporation at the
annual meeting and, assuming that Mr. Forbes is elected, the Board expects that
Mr. Forbes will be appointed to the Audit Committee. The Corporation believes
that Mr. Forbes will qualify, if and when elected and appointed, as an
“audit committee financial expert” as that term is defined by SEC
rules adopted under SOA, by reason of his experience as the current chief
executive officer and former chief financial officer of a subsidiary of a Fortune
500 company.
Item 11. Executive Compensation. Information relating to
compensation of the Corporation’s executive officers and directors will be included
under the captions “Executive Compensation” and “Election of Directors
— Compensation of Directors” in the 2006 Proxy Statement of the Corporation,
which sections are incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters. Information relating to
security ownership of certain beneficial owners and the directors and executive officers
of the Corporation will be included under the captions “Election of Directors”
and “Principal Owners of Common Shares” of the 2006 Proxy Statement of the
Corporation, which sections are incorporated herein by reference.
63
Equity Compensation Plan Information The Company maintains
three plans under which it has authorized the issuance of its Common Shares to employees
and non-employee directors as compensation: its 1992 Stock Option Plan (under which no new
grants may be made), its 1999 Long-Term Equity Incentive Plan, and its 1999 Employee Stock
Purchase Plan. Each of these three plans was approved by the requisite vote of the
Company’s common shareholders in the year of adoption by the Board of Directors. The
Company is not a party to any individual compensation arrangement involving the
authorization for issuance of its equity securities to any single person, other than
option agreements and restricted stock award agreements that have been granted under the
terms of one of the three plans identified above. The following table sets forth
information regarding these plans as of December 31, 2005:
Item 13. Certain Relationships and Related Transactions. Information responsive
to this Item 13 will be included under the captions “Executive Compensation —
Certain Business Relationships and Transactions” and “Executive Compensation
— Compensation Committee Interlocks and Insider Participation” of the 2006 Proxy
Statement of the Corporation, which sections are incorporated herein by reference.
Item 14. Principal Accountant Fees and Services. Information responsive to
this item 14 will be included in the 2006 Proxy Statement under the Caption
“Principal Accounting Fees and Services,” which section is incorporated herein
by reference.
64
PART IV
Item 15. Exhibits and Financial Statement Schedules
a) Financial Statements
The following items are included in Item 8 of this report:
b) Exhibits The Exhibits described
in the Exhibit List immediately following the “Signatures” page of this report
(which Exhibit List is incorporated herein by reference) are hereby filed as part of this
report.
c) Financial Statement Schedules
None.
65 Pursuant to the requirements
of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this
Report to be signed on its behalf by the undersigned thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
66 INDEX OF EXHIBITS Executive Compensation Plans and Arrangements* Exhibit No. Description 2.1 Agreement and Plan of Reorganization by and among the Registrant, First State Bank, Southwest Indiana, PCB Holding Company, and Peoples Community Bank, dated May 23, 2005, is incorporated by reference to Exhibit 2.1 to the Registrant's Registration Statement on Form S-4 filed with the SEC on July 19, 2005 (File No. 333-126704).** 2.2 Agreement and Plan of Reorganization by and among the Registrant and Stone City Bancshares, Inc., and joined in by the shareholders of Stone City Bancshares, Inc., dated October 25, 2005, is incorporated by reference from Exhibit 2 to the Registrant’s Current Report on Form 8-K filed October 31, 2005.** 3.1 Restatement of Articles of Incorporation of the Registrant is incorporated by reference from Exhibit 3.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2005. 3.2 Restated Bylaws of the Registrant, as amended April 22, 2004, is incorporated by reference from Exhibit 3.2 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004. 4.1 Rights Agreement dated April 27, 2000, is incorporated by reference from Exhibit 4.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2005. 4.2 No long-term debt instrument issued by the Registrant exceeds 10% of consolidated total assets or is registered. In accordance with paragraph 4 (iii) of Item 601(b) of Regulation S-K, the Registrant will furnish the Securities and Exchange Commission copies of long-term debt instruments and related agreements upon request. 4.3 Terms of Common Shares and Preferred Shares of the Registrant (included in Restatement of Articles of Incorporation) are incorporated by reference to Exhibit 3.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2005. X 10.1 The Registrant’s 1992 Stock Option Plan, as amended, is incorporated by reference from Exhibit 10.1 to the Registrant’s Registration Statement on Form S-4 filed October 14, 1998. X 10.2 Form of Director Deferred Compensation Agreement between The German American Bank and certain of its Directors is incorporated herein by reference from Exhibit 10.4 to the Registrant's Registration Statement on Form S-4 filed January 21, 1993 (the Agreement entered into by former director George W. Astrike, a copy of which was filed as Exhibit 10.4 to the Registrant's Registration Statement on Form S-4 filed January 21, 1993, is substantially identical to the Agreements entered into by the other Directors, some of whom remain directors of the Registrant.). The schedule following Exhibit 10.4 lists the Agreements with the other Directors and sets forth the material detail in which such Agreements differ from the
Agreement filed as Exhibit 10.4. X 10.3 The Registrant’s 1999 Long-Term Equity Incentive Plan is incorporated herein by reference from Appendix A to the Registrant’s definitive proxy statement for its 1999 annual meeting filed March 26, 1999. X 10.4 Basic Plan Document for the Registrant’s Nonqualified Savings Plan is incorporated by reference from Exhibit 10.4 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004.
67 Executive Compensation Plans and Arrangements* Exhibit No. Description X 10.5 Adoption Agreement for the Registrant’s Nonqualified Savings Plan dated August 17, 2004, is incorporated by reference from Exhibit 10.5 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004. X 10.6 First Amendment to the Registrant’s Nonqualified Savings Plan dated August 17, 2004, is incorporated by reference from Exhibit 10.6 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004. X 10.7 Form of Employee Stock Option Agreement (new grant, five-year expiration, five year 20% vesting) typically issued during 2005 and prior periods to executive officers and other key employees as incentives is incorporated by reference from Exhibit 10.7 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004. X 10.8 Form of Employee Stock Option Agreement (Replacement Grant) typically issued during 2005 and prior periods to persons who exercise other stock options using common shares as payment for the exercise price (one year vesting) is incorporated by reference from Exhibit 10.8 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004. X 10.9 Form of Non-Employee Director Stock Option Agreement (new grant, ten year expiration, no vesting) typically issued to non-employee members of the Board of Directors as part of annual director fee retainer (not Incentive Stock Option for tax purposes) is incorporated by reference from Exhibit 10.9 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004. X 10.10 Form of Employee Director Stock Option Agreement (new grant, ten year expiration, no vesting) typically issued to employee members of the Board of Directors as part of annual director fee retainer (intended to be Incentive Stock Option for tax purposes) is incorporated by reference from Exhibit 10.10 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004 . X 10.11 Description of Director Compensation Arrangements for 12 month period ending at 2005 Annual Meeting of Shareholders is incorporated by reference from Exhibit 10.11 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004. X 10.12 Description of Director Compensation Arrangements for 12 month period ending at 2006 Annual Meeting of Shareholders is incorporated by reference from the description contained in Item 1.01 to the Registrant's Current Report on Form 8-K filed May 4, 2005. X 10.13 Description of Executive Management Incentive Plan for 2004 (awards payable in 2005) is incorporated by reference from Exhibit 10.12 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004. X 10.14 Description of Executive Management Incentive Plan for 2005 (awards payable in 2006) is incorporated by reference from the description contained in Item 1.01 to the Registrant's Current Report on Form 8-K filed May 4, 2005. X 10.15 Description of Executive Management Incentive Plan for 2006 (awards payable in 2007) is incorporated by reference from the description contained in Item 1.01 to the Registrant's Current Report on Form 8-K filed February 17, 2006.
68 Executive Compensation Plans and Arrangements* Exhibit No. Description X 10.16 Executive Supplemental Retirement Income Agreement dated October 1, 1996, between First Federal Bank, F.S.B. and Bradley M. Rust is incorporated by reference from Exhibit 10.13 to the Registrant’s Annual Report on Form 10-K for its fiscal year ended December 31, 2002. X 10.17 Form of Restricted Stock Award Agreement that evidences the terms of awards of restricted stock grants and related cash entitlements granted under the 1999 Long-Term Equity Incentive Plan is incorporated by reference from Exhibit 99 to the Registrant's Current Report on Form 8-K filed February 17, 2006. X 10.18 Resolutions of Stock Option Committee of Board of Directors of the Registrant amending outstanding stock options by accelerating in full all vesting periods and exercise date restrictions and terminating replacement stock option privileges in connection with future option exercises, adopted by written consent effective December 29, 2005. 10.19 Amended and Restated Loan Agreement dated as of September 20, 2005, by and between JPMorgan Chase Bank, N.A., and the Registrant is incorporated by reference from Exhibit 99 to the Registrant's Current Report on Form 8-K filed September 30, 2005.** 10.20 Stock Purchase Agreement dated as of December 16, 2005 between the Registrant and Buehler Foods, Inc.** 21 Subsidiaries of the Registrant. 23 Consent of Crowe Chizek and Company LLC. 24 Power of Attorney. 31.1 Sarbanes-Oxley Act of 2002, Section 302 Certification for President and Chief Executive Officer. 31.2 Sarbanes-Oxley Act of 2002, Section 302 Certification for Senior Vice President (Principal Financial Officer). 32.1 Sarbanes-Oxley Act of 2002, Section 906 Certification for President and Chief Executive Officer. 32.2 Sarbanes-Oxley Act of 2002, Section 906 Certification for Senior Vice President (Principal Financial Officer).
*Exhibits that describe or evidence all management contracts or compensatory
plans or arrangements required to be filed as exhibits to this Report are
indicated by an “X” in this column. ** Certain exhibits to these documents have been omitted from the text filed with the SEC. The omitted information is considered immaterial from an investor's perspective. The Registrant will furnish supplementally a copy of any of any such omitted exhibit to the SEC upon request from the SEC. GERMAN AMERICAN BANCORP WILL FURNISH TO ANY SHAREHOLDER AS OF MARCH 1, 2006, A COPY OF ANY OF THE ABOVE-LISTED EXHIBITS UPON THE PAYMENT OF A CHARGE OF $.50 PER PAGE IN ORDER TO DEFRAY ITS EXPENSES IN PROVIDING SUCH EXHIBIT. SUCH REQUEST SHOULD BE ADDRESSED TO GERMAN AMERICAN BANCORP, ATTN: TERRI A. ECKERLE, SHAREHOLDER RELATIONS, P.O. BOX 810, JASPER, INDIANA, 47546.
69
PART II
2005
2004
High
Low
Cash
Dividend
High
Low
Cash
Dividend
Fourth Quarter
$13.64
$12.71
$0.140
$17.24
$15.95
$0.140
Third Quarter
$14.74
$13.30
$0.140
$17.75
$15.75
$0.140
Second Quarter
$15.21
$12.53
$0.140
$17.23
$15.80
$0.140
First Quarter
$15.98
$15.18
$0.140
$18.02
$16.81
$0.140
$0.560
$0.560
Transfer Agent:
UMB Bank, N.A.
Securities Transfer Division
P.O. Box 410064
Kansas City, MO 64141-0064
Contact: Shareholder Relations
(800) 884-4225
Shareholder
Information and
Corporate Office:
Terri A. Eckerle
German American Bancorp
P. O. Box 810
Jasper, Indiana 47547-0810
(812) 482-1314
(800) 482-1314
Period
Total
Number
Of Shares
(or Units)
PurchasedAverage Price
Paid Per Share
(or Unit)Total Number of Shares
(or Units) Purchases as Part
of Publicly Announced Plans
or ProgramsMaximum Number
(or Approximate Dollar
Value) of Shares (or Units)
that May Yet Be Purchased
Under the Plans or Programs(1)
October 2005
—
—
—
272,789
November 2005
—
—
—
272,789
December 2005
441,299
(2)(3)
$ 12.50
—
272,789
(1)
(2)
(3)
2005
2004
2003
2002
2001
Summary of Operations:
Interest Income
$ 50,197
$ 47,710
$ 50,619
$ 60,494
$ 71,069
Interest Expense
17,984
16,471
21,084
28,492
38,917
Net Interest Income
32,213
31,239
29,535
32,002
32,152
Provision for Loan Losses
1,903
2,015
811
1,115
660
Net Interest Income after Provision
For Loan Losses
30,310
29,224
28,724
30,887
31,492
Non-interest Income
14,194
9,620
(1)
12,934
9,509
9,772
Non-interest Expense
31,448
30,609
32,219
(2)
28,967
29,308
Income before Income Taxes
13,056
8,235
9,439
11,429
11,956
Income Tax Expense
3,335
996
1,271
1,987
2,763
Net Income
$ 9,721
$ 7,239
$ 8,168
$ 9,442
$ 9,193
Year-end Balances:
Total Assets
$ 946,467
$ 942,094
$ 925,946
$ 957,005
$ 1,015,111
Total Loans, Net of Unearned Income
651,956
629,793
611,866
610,741
657,166
Total Deposits
746,821
750,383
717,133
707,194
726,874
Total Long-term Debt
66,606
69,941
76,880
(2)
121,687
156,726
Total Shareholders' Equity
82,255
83,669
83,126
(3)
104,519
102,209
Average Balances:
Total Assets
$ 925,851
$ 927,528
$ 938,992
$ 1,000,167
$ 1,014,917
Total Loans, Net of Unearned Income
634,526
622,240
618,340
644,990
704,562
Total Deposits
730,220
731,467
711,310
718,763
718,160
Total Shareholders' Equity
84,479
82,558
87,703
(3)
103,301
100,232
Per Share Data (4):
Net Income
$ 0.89
$ 0.66
$ 0.73
(3)
$ 0.79
$ 0.76
Cash Dividends
0.56
0.56
0.53
0.51
0.48
Book Value at Year-end
7.73
7.68
7.60
(3)
8.72
8.44
Other Data at Year-end:
Number of Shareholders
3,494
3,219
3,198
3,299
3,314
Number of Employees
367
372
383
390
422
Weighted Average Number of Shares (4)
10,890,987
10,914,622
11,176,766
(3)
12,007,009
12,093,160
Selected Performance Ratios:
Return on Assets
1.05%
0.78%
0.87%
0.94%
0.91%
Return on Equity
11.51%
8.77%
9.31%
(3)
9.14%
9.17%
Equity to Assets
8.69%
8.88%
8.98%
(3)
10.92%
10.07%
Dividend Payout
62.83%
84.46%
73.26%
64.99%
63.98%
Net Charge-offs to Average Loans
0.26%
0.24%
0.14%
0.19%
0.22%
Allowance for Loan Losses to Loans
1.42%
1.40%
1.35%
1.36%
1.27%
Net Interest Margin
3.92%
3.86%
3.61%
3.67%
3.61%
(1)
In 2004, the Company recognized a $3.7 million non-cash pre-tax charge (which
reduced Non-interest Income) for the other-than-temporary decline in value of
its FHLMC and FNMA preferred stock portfolio.
(2)
In 2003, the Company prepaid $40.0 million of FHLB borrowings within its
mortgage banking segment. The prepayment fees associated with the extinguishment
of these borrowings totaled $1.9 million.
(3)
In March 2003, the Company purchased 1,110,444 (approximately 9% of the number
of shares that were then outstanding) of its common shares at $19.05 per share
pursuant to a self tender offer at a total cost, including fees and expenses
incurred in connection with the offer, of approximately $21.4 million.
(4)
Share and Per Share Data has been retroactively adjusted to give effect for
stock dividends and excludes the dilutive effect of stock options.
(Tax-equivalent basis/dollars in thousands)
Twelve Months Ended
December 31, 2005
Twelve Months Ended
December 31, 2004
Twelve Months Ended
December 31, 2003
Principal
Balance
Income/
Expense
Yield/
Rate
Principal
Balance
Income/
Expense
Yield/
Rate
Principal
Balance
Income/
Expense
Yield/
Rate
ASSETS
Federal Funds Sold and Other
Short-term Investments
$ 10,632
$ 316
2.97
%
$ 10,635
$ 129
1.21
%
$ 25,007
$ 270
1.08
%
Securities:
Taxable
161,499
5,954
3.69
%
161,601
5,455
3.38
%
159,618
5,023
3.15
%
Non-taxable
46,666
3,297
7.07
%
57,729
4,347
7.53
%
70,835
5,371
7.58
%
Total Loans and Leases (2)
634,526
41,860
6.60
%
622,240
39,407
6.33
%
618,340
41,951
6.78
%
TOTAL INTEREST
EARNING ASSETS
853,323
51,427
6.03
%
852,205
49,338
5.79
%
873,800
52,615
6.02
%
Other Assets
81,771
83,960
73,670
Less: Allowance for Loan Losses
(9,243
)
(8,637
)
(8,478
)
TOTAL ASSETS
$ 925,851
$ 927,528
$ 938,992
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-Bearing Demand Deposits
$ 137,318
$ 1,436
1.05
%
$ 121,173
$ 557
0.46
%
$ 110,544
$ 612
0.55
%
Savings Deposits
156,820
2,212
1.41
%
163,272
1,188
0.73
%
142,198
1,149
0.81
%
Time Deposits
314,420
9,741
3.10
%
330,898
10,002
3.02
%
354,703
12,236
3.45
%
FHLB Advances and
Other Borrowings
98,932
4,595
4.64
%
101,067
4,724
4.67
%
130,165
7,087
5.44
%
TOTAL INTEREST-BEARING
LIABILITIES
707,490
17,984
2.54
%
716,410
16,471
2.30
%
737,610
21,084
2.86
%
Demand Deposit Accounts
121,662
116,124
103,865
Other Liabilities
12,220
12,436
9,814
TOTAL LIABILITIES
841,372
844,970
851,289
Shareholders' Equity
84,479
82,558
87,703
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY
$ 925,851
$ 927,528
$ 938,992
NET INTEREST INCOME
$ 33,443
$ 32,867
$ 31,531
NET INTEREST MARGIN
3.92
%
3.86
%
3.61
%
(1)
Effective tax rates were determined as though interest earned on the Company's
investments in municipal bonds and loans was fully taxable.
(2)
Loans held-for-sale and non-accruing loans have been included in average loans.
Interest income on loans includes loan fees of $1,326, $1,442, and $1,340 for
2005, 2004, and 2003, respectively.
(Tax-Equivalent basis, dollars in thousands)
2005 compared to 2004
Increase/(Decrease) Due to(1)2004 compared to 2003
Increase/(Decrease) Due to(1)
Volume
Rate
Net
Volume
Rate
Net
Interest Income:
Federal Funds Sold and Other
Short-term Investments
$ —
$ 187
$ 187
$ (171
)
$ 30
$ (141
)
Taxable Securities
(3
)
502
499
63
369
432
Non-taxable Securities
(794
)
(256
)
(1,050
)
(987
)
(37
)
(1,024
)
Loans and Leases
788
1,665
2,453
263
(2,807
)
(2,544
)
Total Interest Income
(9
)
2,098
2,089
(832
)
(2,445
)
(3,277
)
Interest Expense:
Savings and Interest-bearing Demand
61
1,842
1,903
207
(223
)
(16
)
Time Deposits
(506
)
245
(261
)
(785
)
(1,449
)
(2,234
)
FHLB Advances and Other Borrowings
(99
)
(30
)
(129
)
(1,447
)
(916
)
(2,363
)
Total Interest Expense
(544
)
2,057
1,513
(2,025
)
(2,588
)
(4,613
)
Net Interest Income
$ 535
$ 41
$ 576
$ 1,193
$ 143
$ 1,336
(1)
The change in interest due to both rate and volume has been allocated to volume
and rate changes in proportion to the relationship of the absolute dollar
amounts of the change in each.
Non-interest Income (dollars in thousands)
Years Ended December 31,
% Change From
Prior Year
2005
2004
2003
2005
2004
Trust and Investment Product Fees
$
2,081
$
2,046
$
1,627
2
%
26
%
Service Charges on Deposit Accounts
3,723
3,537
3,391
5
4
Insurance Revenues
4,703
4,666
3,692
1
26
Other Operating Income
2,687
2,074
1,556
30
33
Subtotal
13,194
12,323
10,266
7
20
Net Gains on Sales of Loans and Related Assets
1,000
975
2,588
3
(62
)
Net Gain / (Loss) on Securities
—
(3,678
)
80
n/m
(1)
n/m
(1)
TOTAL NON-INTEREST INCOME
$ 14,194
$ 9,620
$ 12,934
48
(26
)
(1)
n/m = not meaningful
Non-interest Expense (dollars in thousands)
Years Ended December 31,
% Change From
Prior Year
2005
2004
2003
2005
2004
Salaries and Employee Benefits
$
18,511
$
17,814
$
18,062
4
%
(1
)%
Occupancy, Furniture and Equipment Expense
4,404
4,292
4,574
3
(6
)
FDIC Premiums
101
106
114
(5
)
(7
)
Data Processing Fees
1,322
1,186
1,126
11
5
Professional Fees
1,703
1,690
1,227
1
38
Advertising and Promotion
784
888
853
(12
)
4
Supplies
544
527
633
3
(17
)
Net Loss on Extinguishment of Borrowings
—
—
1,898
—
n/m
(1)
Other Operating Expenses
4,079
4,106
3,732
(1
)
10
TOTAL NON-INTEREST EXPENSE
$ 31,448
$ 30,609
$ 32,219
3
(5
)
(1)
n/m = not meaningful
Loan Portfolio
dollars in thousandsDecember 31,
2005
2004
2003
2002
2001
Residential Mortgage Loans
$ 102,891
$ 94,800
$ 110,325
$ 156,180
$ 227,502
Agricultural Loans
101,355
99,557
92,095
84,984
75,755
Commercial and Industrial Loans
319,241
313,798
296,019
254,024
230,792
Consumer Loans
129,587
122,888
114,816
116,987
123,840
Total Loans
653,074
631,043
613,255
612,175
657,889
Less: Unearned Income
(1,118
)
(1,250
)
(1,389
)
(1,434
)
(723
)
Subtotal
651,956
629,793
611,866
610,741
657,166
Less: Allowance for Loan Losses
(9,265
)
(8,801
)
(8,265
)
(8,301
)
(8,388
)
Loans, Net
$ 642,691
$ 620,992
$ 603,601
$ 602,440
$ 648,778
Ratio of Loans to Total Loans:
Residential Mortgage Loans
16
%
15
%
18
%
26
%
34
%
Agricultural Loans
15
%
16
%
15
%
14
%
12
%
Commercial and Industrial Loans
49
%
50
%
48
%
41
%
35
%
Consumer Loans
20
%
19
%
19
%
19
%
19
%
Totals
100
%
100
%
100
%
100
%
100
%
Within
One YearOne to Five
YearsAfter
Five YearsTotal
Commercial, Agricultural and Poultry
$ 145,384
$ 125,663
$ 149,549
$ 420,596
Interest Sensitivity
Fixed Rate
Variable Rate
Loans maturing after one year
$ 42,382
$ 232,830
Investment Portfolio, at Amortized Cost
dollars in thousandsDecember 31,
2005
%
2004
%
2003
%
Federal Funds Sold and Short-term Investments
$
5,287
3
%
$
24,354
11
%
$
3,804
2
%
U.S. Treasury and Agency Securities
13,631
7
4,060
2
4,112
2
Obligations of State and Political Subdivisions
31,759
16
43,125
20
54,838
25
Asset- / Mortgage-backed Securities
128,602
65
131,614
60
136,674
63
Corporate Securities
500
n/m
(1)
503
n/m
(1)
506
n/m
(1)
Equity Securities
17,350
9
15,149
7
16,808
8
Total Securities Portfolio
$ 197,129
100
%
$ 218,805
100
%
$ 216,742
100
%
(1)
n/m = not meaningful
Investment Securities, at Carrying Value
dollars in thousands
December 31,
2005
2004
2003
Securities Held-to-Maturity:
Obligations of State and Political Subdivisions
$ 8,684
$ 13,318
$ 17,417
Securities Available-for-Sale:
U.S. Treasury Securities and Obligations of
U.S. Government Corporations and Agencies
$ 13,492
$ 4,034
$ 4,090
Obligations of State and Political Subdivisions
23,527
30,621
38,579
Asset-/Mortgage-backed Securities
125,844
131,201
136,585
Corporate Securities
500
503
515
Equity Securities
17,787
15,317
16,024
Subtotal of Securities Available-for-Sale
181,150
181,676
195,793
Total Securities
$ 189,834
$ 194,994
$ 213,210
Within
One YearAfter One But
Within Five YearsAfter Five But
Within Ten YearsAfter Ten
Years
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
U.S. Treasuries and
Agencies
$ 505
1
.87%
$ 13,126
4
.28%
$ —
N/A
$ —
N/A
State and Political
Subdivisions
1,723
7
.85%
8,733
7
.75%
10,735
7
.36%
10,568
7
.50%
Asset-/Mortgage-backed
Securities
19,278
3
.19%
99,713
4
.01%
9,611
5
.38%
—
N/A
Corporate Securities
—
N/A
500
3
.42%
—
N/A
—
N/A
Totals
$ 21,506
3
.53%
$ 122,072
4
.30%
$ 20,346
6
.42%
$ 10,568
7
.50%
Contractual Obligations
dollars in thousandsPayments Due By Period
Total
Less Than 1 Year
1-3 Years
3-5 Years
More than 5 Years
Long-Term Borrowings
$ 66,606
$ 6,485
$ 9,985
$ 48,554
$ 1,582
Time Deposits
308,774
137,223
157,662
13,812
77
Lease Commitments
462
123
206
129
4
Total
$ 375,842
$ 143,831
$ 167,853
$ 62,495
$ 1,663
Funding Sources - Average Balances
dollars in thousandsDecember 31,
% Change From
Prior Year
2005
2004
2003
2005
2004
Demand Deposits
Non-interest Bearing
$ 121,662
$ 116,124
$ 103,865
5
%
12
%
Interest Bearing
137,318
121,173
110,544
13
10
Savings Deposits
66,091
65,757
61,295
1
7
Money Market Accounts
90,729
97,515
80,903
(7
)
21
Other Time Deposits
242,887
268,842
298,430
(10
)
(10
)
Total Core Deposits
658,687
669,411
655,037
(2
)
2
Certificates of Deposits of $100,000 or
more and Brokered Deposits
71,533
62,056
56,273
15
10
FHLB Advances and
Other Borrowings
98,932
101,067
130,165
(2
)
(22
)
Total Funding Sources
$ 829,152
$ 832,534
$ 841,475
—
(1
)
3 Months
or Less3 thru
6 Months6 thru
12 MonthsOver
12 MonthsTotal
December 31, 2005
$ 20,322
$ 4,652
$ 10,046
$ 26,325
$ 61,345
Under the Amended Agreement, Term Note, and Revolving Note, the Company is
obligated to pay the Lender interest on amounts advanced under the term loan and
the revolving loan based upon 90-day LIBOR plus 1.15% per annum.
The Amended Agreement includes usual and customary covenants and conditions,
including a covenant that requires that the Company maintain the capital ratios
of the Company and of its affiliate banks at levels that would be considered
“well-capitalized” under the prompt corrective action regulations of
the federal banking agencies. In addition, the Company agreed in the Amended
Agreement that it would maintain a consolidated ratio of (a) the sum of its
non-performing loans plus other real estate owned (real estate that is neither
used in the ordinary course of the business of the Company or its subsidiaries
nor held for future use) (OREO) to (b) the sum of the Company’s loans plus
OREO, of not greater 3.75% until September 30, 2006, and of not greater than
3.25% at September 30, 2006, and at all times thereafter. At December 31, 2005,
this ratio was 2.48%.
Allowance for Loan Losses
dollars in thousandsYears Ended December 31,
2005
2004
2003
2002
2001
Balance of allowance for possible
losses at beginning of period
$ 8,801
$ 8,265
$ 8,301
$ 8,388
$ 9,274
Loans charged-off:
Residential Mortgage Loans
238
292
360
437
637
Agricultural Loans
3
—
42
89
66
Commercial and Industrial Loans
1,278
904
571
183
659
Consumer Loans
624
654
658
876
990
Total Loans charged-off
2,143
1,850
1,631
1,585
2,352
Recoveries of previously charged-off Loans:
Residential Mortgage Loans
58
24
220
66
54
Agricultural Loans
53
11
56
2
191
Commercial and Industrial Loans
205
118
316
59
374
Consumer Loans
149
218
192
256
187
Total Recoveries
465
371
784
383
806
Net Loans recovered / (charged-off)
(1,678
)
(1,479
)
(847
)
(1,202
)
(1,546
)
Additions to allowance charged to expense
1,903
2,015
811
1,115
660
Allowance from Acquired Subsidiary
239
—
—
—
—
Balance at end of period
$ 9,265
$ 8,801
$ 8,265
$ 8,301
$ 8,388
Net Charge-offs to Average Loans Outstanding
0.26
%
0.24
%
0.14
%
0.19
%
0.22
%
Provision for Loan Losses to Average Loans Outstanding
0.30
%
0.32
%
0.13
%
0.17
%
0.09
%
Allowance for Loan Losses to Total Loans at Year-end
1.42
%
1.40
%
1.35
%
1.36
%
1.27
%
Residential Mortgage Loans
$ 710
$ 790
$ 839
$ 1,126
$ 1,958
Agricultural Loans
822
982
704
781
812
Commercial and Industrial Loans
6,486
5,906
5,358
4,687
3,487
Consumer Loans
1,127
1,043
1,158
1,140
921
Unallocated
120
80
206
567
1,210
Total Loans
$ 9,265
$ 8,801
$ 8,265
$ 8,301
$ 8,388
Non-performing Assets
dollars in thousandsDecember 31,
2005
2004
2003
2002
2001
Non-accrual Loans
$ 14,763
$ 5,750
$ 1,817
$ 1,773
$ 3,452
Past Due Loans (90 days or more)
944
831
962
1,095
916
Restructured Loans
—
—
—
365
367
Total Non-performing Loans
15,707
6,581
2,779
3,233
4,735
Other Real Estate
506
213
749
1,812
1,612
Total Non-performing Assets
$ 16,213
$ 6,794
$ 3,528
$ 5,045
$ 6,347
Non-performing Loans to Total Loans
2.41
%
1.04
%
0.45
%
0.53
%
0.72
%
Allowance for Loan Losses to Non-performing Loans
58.99
%
133.73
%
297.41
%
256.76
%
177.15
%
Net Portfolio
ValueNet Portfolio Value
as a % of Present Value
of Assets
Changes in Rates
$ Amount
% Change
NPV Ratio
Change
+2%
$ 114,713
0.12%
12.54%
33b.p.
+1%
115,062
0.42%
12.42%
21b.p.
Base
114,577
—
12.21%
—
-1%
112,620
-1.71%
11.87%
(34)b.p.
-2%
107,048
-6.57%
11.16%
(105)b.p.
Report of Independent Registered Public Accounting Firm on Financial
Statements
German American Bancorp
Jasper, Indiana
Indianapolis, Indiana
February 21, 2006
/s/ Crowe Chizek and Company LLC
Crowe Chizek and Company LLC
Consolidated Balance Sheets
Dollars in thousands, except per share data
December 31,
2005
2004
ASSETS
Cash and Due from Banks
$ 27,644
$ 23,312
Federal Funds Sold and Other Short-term Investments
5,287
24,354
Cash and Cash Equivalents
32,931
47,666
Securities Available-for-Sale, at Fair Value
181,150
181,676
Securities Held-to-Maturity, at Cost (Fair value of $8,811 and $13,636 on
December 31, 2005 and 2004, respectively)
8,684
13,318
Loans Held-for-Sale
1,901
3,122
Loans
653,074
631,043
Less: Unearned Income
(1,118
)
(1,250
)
Allowance for Loan Losses
(9,265
)
(8,801
)
Loans, Net
642,691
620,992
Stock in FHLB of Indianapolis and Other Restricted Stock, at Cost
14,095
13,542
Premises, Furniture and Equipment, Net
20,233
20,231
Other Real Estate
506
213
Goodwill
3,813
1,794
Intangible Assets
2,388
2,378
Company Owned Life Insurance
19,067
18,540
Accrued Interest Receivable and Other Assets
19,008
18,622
TOTAL ASSETS
$ 946,467
$ 942,094
LIABILITIES
Non-interest-bearing Demand Deposits
$ 130,383
$ 123,127
Interest-bearing Demand, Savings, and Money Market Accounts
307,664
305,341
Time Deposits
308,774
321,915
Total Deposits
746,821
750,383
FHLB Advances and Other Borrowings
105,394
95,614
Accrued Interest Payable and Other Liabilities
11,997
12,428
TOTAL LIABILITIES
864,212
858,425
SHAREHOLDERS' EQUITY
Preferred Stock, $10 par value; 500,000 shares authorized, no shares issued
—
—
Common Stock, no par value, $1 stated value; 20,000,000 shares authorized
10,643
10,898
Additional Paid-in Capital
63,784
66,817
Retained Earnings
9,391
5,778
Accumulated Other Comprehensive Income / (Loss)
(1,563
)
176
TOTAL SHAREHOLDERS' EQUITY
82,255
83,669
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$ 946,467
$ 942,094
End of period shares issued and outstanding
10,643,514
10,898,241
Consolidated Statements of Income
Dollars in thousands, except per share data
Years ended December 31,
2005
2004
2003
INTEREST INCOME
Interest and Fees on Loans
$ 41,751
$ 39,257
$ 41,781
Interest on Federal Funds Sold and Other Short-term Investments
316
129
270
Interest and Dividends on Securities:
Taxable
5,954
5,455
5,023
Non-taxable
2,176
2,869
3,545
TOTAL INTEREST INCOME
50,197
47,710
50,619
INTEREST EXPENSE
Interest on Deposits
13,389
11,747
13,997
Interest on FHLB Advances and Other Borrowings
4,595
4,724
7,087
TOTAL INTEREST EXPENSE
17,984
16,471
21,084
NET INTEREST INCOME
32,213
31,239
29,535
Provision for Loan Losses
1,903
2,015
811
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
30,310
29,224
28,724
NON-INTEREST INCOME
Trust and Investment Product Fees
2,081
2,046
1,627
Service Charges on Deposit Accounts
3,723
3,537
3,391
Insurance Revenues
4,703
4,666
3,692
Other Operating Income
2,687
2,074
1,556
Net Gains on Sales of Loans and Related Assets
1,000
975
2,588
Net Gain / (Loss) on Securities
—
(3,678
)
80
TOTAL NON-INTEREST INCOME
14,194
9,620
12,934
NON-INTEREST EXPENSE
Salaries and Employee Benefits
18,511
17,814
18,062
Occupancy Expense
2,396
2,121
2,354
Furniture and Equipment Expense
2,008
2,171
2,220
Data Processing Fees
1,322
1,186
1,126
Professional Fees
1,703
1,690
1,227
Advertising and Promotion
784
888
853
Supplies
544
527
633
Net Loss on Extinguishment of Borrowings
—
—
1,898
Other Operating Expenses
4,180
4,212
3,846
TOTAL NON-INTEREST EXPENSE
31,448
30,609
32,219
Income before Income Taxes
13,056
8,235
9,439
Income Tax Expense
3,335
996
1,271
NET INCOME
$ 9,721
$ 7,239
$ 8,168
Earnings per Share
$ 0.89
$ 0.66
$ 0.73
Diluted Earnings per Share
$ 0.89
$ 0.66
$ 0.73
Consolidated Statements of Changes in Shareholders' Equity
Dollars in thousands, except per share data
Common Stock
Additional
Paid-in
Retained
Accumulated
Other
Comprehensive
Total
Shareholders'
Shares
Amount
Capital
Earnings
Income
Equity
Balances, January 1, 2003
11,460,731
$ 11,461
$ 78,836
$ 12,298
$ 1,924
$ 104,519
Comprehensive Income:
Net Income
8,168
8,168
Changes in Unrealized Gain/(Loss) on
Securities Available for Sale, net
(1,747
)
(1,747
)
Change in Minimum Pension Liability
(169
)
(169
)
Total Comprehensive Income
6,252
Cash Dividends ($.53 per share)
(5,984
)
(5,984
)
Issuance of Common Stock for:
Exercise of Stock Options
14,807
15
555
(542
)
28
Director Stock Awards
15,939
16
288
304
5% Stock Dividend
520,233
520
8,740
(9,260
)
—
Employee Stock Purchase Plan
(120
)
(120
)
Purchase and Retirement of Common Stock
(1,078,828
)
(1,079
)
(20,767
)
(21,846
)
Purchase of Interest in Fractional Shares
(27
)
(27
)
Balances, December 31, 2003
10,932,882
10,933
67,532
4,653
8
83,126
Comprehensive Income:
Net Income
7,239
7,239
Changes in Unrealized Gain/(Loss) on
Securities Available for Sale, net
178
178
Change in Minimum Pension Liability
(10
)
(10
)
Total Comprehensive Income
7,407
Cash Dividends ($.56 per share)
(6,114
)
(6,114
)
Issuance of Common Stock for:
Exercise of Stock Options
9,359
9
25
34
Employee Stock Purchase Plan
(76
)
(76
)
Purchase and Retirement of Common Stock
(44,000
)
(44
)
(664
)
(708
)
Balances, December 31, 2004
10,898,241
10,898
66,817
5,778
176
83,669
Comprehensive Income:
Net Income
9,721
9,721
Changes in Unrealized Gain/(Loss) on
Securities Available for Sale, net
(1,711
)
(1,711
)
Change in Minimum Pension Liability
(28
)
(28
)
Total Comprehensive Income
7,982
Cash Dividends ($.56 per share)
(6,108
)
(6,108
)
Issuance of Common Stock for:
Exercise of Stock Options
11,991
12
36
48
Business Combination
257,029
257
3,241
3,498
Employee Stock Purchase Plan
(63
)
(63
)
Purchase and Retirement of Common Stock
(523,747
)
(524
)
(6,247
)
(6,771
)
Balances, December 31, 2005
10,643,514
$ 10,643
$ 63,784
$ 9,391
$ (1,563
)
$ 82,255
Consolidated Statements of Cash Flows
Dollars in thousands
Years Ended December 31,
2005
2004
2003
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income
$ 9,721
$ 7,239
$ 8,168
Adjustments to Reconcile Net Income to Net Cash from Operating Activities:
Net Amortization on Securities
524
1,042
2,134
Depreciation and Amortization
2,564
2,734
2,585
Amortization and Impairment of Mortgage Servicing Rights
301
504
660
Loans Originated for Sale
(62,886
)
(63,158
)
(169,538
)
Proceeds from Sales Of Loans Held-for-Sale
64,327
61,768
182,378
Loss in Investment in Limited Partnership
83
162
223
Provision for Loan Losses
1,903
2,015
811
Gain on Sales of Loans, net
(927
)
(959
)
(2,808
)
Loss / (Gain) on Securities, net
—
3,678
(80
)
Loss / (Gain) on Sales of Other Real Estate and Repossessed Assets
(73
)
(17
)
222
Loss / (Gain) on Disposition and Impairment of Premises and Equipment
(312
)
30
20
Loss on Extinguishment of Borrowings
—
—
1,898
Director Stock Awards
—
—
304
FHLB Stock Dividends
(287
)
(598
)
(482
)
Increase in Cash Surrender Value of Company Owned Life Insurance (COLI)
(527
)
(709
)
(432
)
Change in Assets and Liabilities:
Interest Receivable and Other Assets
905
(1,272
)
(531
)
Interest Payable and Other Liabilities
(865
)
(717
)
(125
)
Net Cash from Operating Activities
14,451
11,742
25,407
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from Maturities of Securities Available-for-Sale
54,565
36,745
140,227
Proceeds from Sales of Securities Available-for-Sale
—
1,986
18,239
Purchase of Securities Available-for-Sale
(57,004
)
(29,059
)
(135,116
)
Proceeds from Maturities of Securities Held-to-Maturity
4,639
4,095
3,420
Purchase of Loans
(8,490
)
(12,837
)
(5,570
)
Proceeds from Sales of Loans
12,260
2,894
2,644
Loans Made to Customers, net of Payments Received
343
(10,216
)
219
Proceeds from Sales of Other Real Estate
1,014
1,306
1,576
Property and Equipment Expenditures
(1,414
)
(1,328
)
(2,083
)
Proceeds from Sales of Property and Equipment
446
364
6
Purchase of Company Owned Life Insurance
—
—
(10,000
)
Acquire Banking Entities
1,000
—
—
Acquire Insurance Agencies
—
—
(2,513
)
Net Cash from Investing Activities
7,359
(6,050
)
11,049
CASH FLOWS FROM FINANCING ACTIVITIES
Change in Deposits
(31,431
)
33,250
9,939
Change in Short-term Borrowings
13,115
(10,006
)
25,047
Advances in Long-term Debt
36,500
4,500
8,000
Repayments of Long-term Debt
(41,835
)
(11,439
)
(54,705
)
Issuance of Common Stock
48
34
28
Purchase / Retire Common Stock
(6,771
)
(708
)
(21,846
)
Employee Stock Purchase Plan
(63
)
(76
)
(120
)
Dividends Paid
(6,108
)
(6,114
)
(5,984
)
Purchase of Interests in Fractional Shares
—
—
(27
)
Net Cash from Financing Activities
(36,545
)
9,441
(39,668
)
Net Change in Cash and Cash Equivalents
(14,735
)
15,133
(3,212
)
Cash and Cash Equivalents at Beginning of Year
47,666
32,533
35,745
Cash and Cash Equivalents at End of Year
$ 32,931
$ 47,666
$ 32,533
Cash Paid During the Year for:
Interest
$ 17,625
$ 16,813
$ 21,627
Income Taxes
3,210
786
1,026
Notes to the Consolidated Financial Statements
Dollars in thousands, except per share data
German American Bancorp operations are primarily comprised of
four business segments: core banking, mortgage banking, financial services and insurance
operations. The accounting and reporting policies of German American Bancorp and its
subsidiaries conform to U.S. generally accepted accounting principles. The more
significant policies are described below. The consolidated financial statements include
the accounts of the Company and its subsidiaries after elimination of all material
intercompany accounts and transactions. Certain prior year amounts have been reclassified
to conform with current classifications. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts and disclosures. Actual results
could differ from those estimates. Estimates susceptible to change in the near term
include the allowance for loan losses, other-than-temporary impairment of securities, the
fair value of mortgage servicing rights and financial instruments, the valuation allowance
on deferred tax assets and loss contingencies.
Securities classified as available-for-sale are securities that the Company
intends to hold for an indefinite period of time, but not necessarily until
maturity. These include securities that management may use as part of its
asset/liability strategy, or that may be sold in response to changes in interest
rates, changes in prepayment risk, or similar reasons. Equity Securities with
readily determinable fair values are classified as available-for-sale.
Securities held as available-for-sale are reported at market value with
unrealized gains or losses included as a separate component of equity, net of
tax. Securities classified as held-to-maturity are securities that the Company
has both the ability and positive intent to hold to maturity. Securities
held-to-maturity are carried at amortized cost.
Mortgage loans originated and intended for sale in the secondary market are carried at the
lower of cost or market value, in aggregate. Net unrealized losses, if any, are recorded
as a valuation allowance and charged to earnings.
Loans that management has the intent and ability to hold for the foreseeable
future or until maturity or pay-off are reported at the principal balance
outstanding, net of unearned interest, deferred loan fees and costs, and an
allowance for loan losses. Interest income is accrued on unpaid principal
balance and includes amortization of net deferred loan fees and costs over the
loan term without anticipating prepayments.
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
The allowance for loan losses is a valuation allowance for probable incurred credit
losses. Loan losses are charged against the allowance when management believes the
uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are
credited to the allowance. Management estimates the allowance balance required using past
loan loss experience, the nature and volume of the portfolio, information about specific
borrower situations and estimated collateral values, economic conditions, and other
factors. Allocations of the allowance may be made for specific loans, but the entire
allowance is available for any loan that, in management’s judgment, should be
charged-off.
The Bank is a member of the FHLB system. Members are required to own a certain
amount of stock based on the level of borrowings and other factors, and may
invest in additional amounts. FHLB stock is carried at cost, classified as a
restricted security, and periodically evaluated for impairment based on ultimate
recovery of par value. Both cash and stock dividends are reported as
income.
Land is carried at cost. Premises, furniture and equipment are stated at cost
less accumulated depreciation. Buildings and related components are depreciated
using the straight-line method with useful lives ranging from 10 to 40 years.
Furniture, fixtures and equipment are depreciated using the straight-line method
with useful lives ranging from 3 to 10 years.
Other Real Estate is carried at the lower of cost or fair value, less estimated
selling costs. Expenses incurred in carrying Other Real Estate are charged to
operations as incurred.
Goodwill results from prior business acquisitions and represents the excess of
the purchase price over the fair value of acquired tangible assets and
liabilities and identifiable intangible assets. Goodwill is not amortized, but
is assessed at least annually for impairment with any such impairment recognized
in the period identified.
The Company has purchased life insurance policies on certain directors and
executives. This life insurance is recorded at its cash surrender value or the amount that
can be realized.
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
Servicing rights are recognized and included with other assets for purchased rights and
for the allocated value of retained servicing rights on loans sold. Servicing rights are
expensed in proportion to, and over the period of, estimated net servicing revenues.
Impairment is evaluated based on the fair value of the rights, using groupings of the
underlying loans as to type and age, with any impairment of a grouping reported as a
valuation allowance. Fair value is determined based upon discounted cash flows using
market based assumptions.
Loss contingencies, including claims and legal actions arising in the ordinary course of
business, are recorded as liabilities when the likelihood of loss is probable and an
amount or range of loss can be reasonably estimated.
Compensation expense under stock options is reported, if applicable, using the intrinsic
value method. Under this method, no compensation expense is recognized for stock options
granted at or above fair market value. Compensation expense is recognized for stock option
modifications, if applicable. Financial Accounting Standard No. 123 requires pro forma
disclosures for companies that do not adopt its fair value accounting method for
stock-based employee compensation. Accordingly, the following pro forma information
presents net income and earnings per share had the Standard’s fair value method been
used to measure compensation cost for stock option plans.
2005
2004
2003
Net Income as Reported
$ 9,721
$ 7,239
$ 8,168
Compensation Expense Under Fair Value Method, Net of Tax
317
246
268
Pro forma Net Income
$ 9,404
$ 6,993
$ 7,900
Pro forma Earnings per Share
$ 0.86
$ 0.64
$ 0.71
Proforma Diluted Earnings per Share
$ 0.86
$ 0.64
$ 0.70
Earnings per Share as Reported
$ 0.89
$ 0.66
$ 0.73
Diluted Earnings per Share as Reported
$ 0.89
$ 0.66
$ 0.73
Comprehensive income consists of net income and other comprehensive income. Other
comprehensive income includes unrealized gains and losses on securities available for sale
and changes in minimum pension liability, which are also recognized as a separate
component of equity.
Deferred tax liabilities and assets are determined at each balance sheet date and are the result of
differences in the financial statement and tax bases of assets and liabilities. Income tax
expense is the amount due on the current year tax returns plus or minus the change in
deferred taxes. A valuation allowance, if needed, reduces deferred tax assets to the
amount expected to be realized.
Pension expense under the suspended defined benefit plan is the net of interest cost,
return on plan assets and amortization of gains and losses not immediately recognized.
Employee 401(k) and profit sharing plan expense is the amount of matching contributions.
Deferred compensation and supplemental retirement plan expense allocates the benefits over
years of service.
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
Earnings per share is based on net income divided by the weighted average number of shares
outstanding during the period. Diluted earnings per share shows the potential dilutive
effect of additional common shares issuable under stock options. Earnings per share is
retroactively restated for stock dividends.
The Company reports net cash flows for customer loan transactions, deposit transactions and
deposits made with other financial institutions. Cash and cash equivalents are defined to
include cash on hand, demand deposits in other institutions and Federal Funds Sold.
Fair values of financial instruments are estimated using relevant market
information and other assumptions, as more fully disclosed in Note 19. Fair
value estimates involve uncertainties and matters of significant judgment
regarding interest rates, credit risk, prepayments, and other factors,
especially in the absence of broad markets for particular items. Changes in
assumptions or in market conditions could significantly affect the estimates.
The fair value estimates of existing on- and off-balance sheet financial
instruments do not include the value of anticipated future business, or the
values of assets and liabilities not considered financial
instruments.
FAS 123R requires all public companies to record compensation cost for
share-based payments provided to employees in return for employee service. The
cost is measured at the fair value of the share-based payment awards when
granted, and this cost is expensed over the employee service period, which is
normally the vesting period of options or the period of participation in the
stock purchase plan. FAS 123R will apply to awards granted or modified on or
after January 1, 2006. Compensation cost will also be recorded for prior award
grants that vest after the date of adoption. The effect on results of operations
will depend on the level of future stock option grants, the future level of
participation and annual pricing under the employee stock purchase plan, the
calculation of the fair value of the stock option and purchase plan awards
granted in the future, as well as stock option vesting periods, and cannot
currently be predicted. All existing stock options are fully vested and will
result in no compensation expense after adoption. Employee stock purchase plan
participation from January 1, 2006 through the plan year end of August 16, 2006
is expected to result in approximately $52 of compensation expense in
2006.
Amortized
CostGross
Unrealized
GainsGross
Unrealized
LossesFair
Value
Securities Available-for-Sale:
2005
U.S. Treasury Securities and Obligations of
U.S. Government Corporations and Agencies
$ 13,631
$ 11
$ (150
)
$ 13,492
Obligations of State and Political Subdivisions
23,075
463
(11
)
23,527
Asset- / Mortgage-backed Securities
128,602
49
(2,807
)
125,844
Corporate Securities
500
—
—
500
Equity Securities
17,350
1,287
(850
)
17,787
Total
$ 183,158
$ 1,810
$ (3,818
)
$ 181,150
2004
U.S. Treasury Securities and Obligations of
U.S. Government Corporations and Agencies
$ 4,060
$ —
$ (26
)
$ 4,034
Obligations of State and Political Subdivisions
29,807
829
(15
)
30,621
Asset- / Mortgage-backed Securities
131,614
455
(868
)
131,201
Corporate Securities
503
—
—
503
Equity Securities
15,149
168
—
15,317
Total
$ 181,133
$ 1,452
$ (909
)
$ 181,676
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
Carrying
AmountGross
Unrecognized
GainsGross
Unrecognized
LossesFair
Value
Securities Held-to-Maturity:
2005
Obligations of State and Political Subdivisions
$ 8,684
$ 127
$ —
$ 8,811
2004
Obligations of State and Political Subdivisions
$ 13,318
$ 319
$ (1
)
$ 13,636
Amortized
Cost
Fair
Value
Securities Available-for-Sale:
Due in one year or less
$ 1,616
$ 1,613
Due after one year through five years
18,151
18,116
Due after five years through ten years
9,432
9,662
Due after ten years
8,007
8,128
Asset- / Mortgage-backed Securities
128,602
125,844
Equity Securities
17,350
17,787
Totals
$ 183,158
$ 181,150
Carrying
Amount
Fair
Value
Securities Held-to-Maturity:
Due in one year or less
$ 1,112
$ 1,116
Due after one year through five years
3,708
3,764
Due after five years through ten years
1,303
1,325
Due after ten years
2,561
2,606
Totals
$ 8,684
$ 8,811
2005
Available-
for-Sale
2004
Available-
for-Sale
2003
Available-
for-Sale
Proceeds from Sales and Calls
$ —
$
1,986
$
18,239
Gross Gains on Sales and Calls
—
5
126
Gross Losses on Sales and Calls
—
—
(46
)
Income Taxes on Gross Gains
—
2
43
Income Taxes on Gross Losses
—
—
(16
)
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
At December 31, 2005:
Less than 12 Months
12 Months or More
Total
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
U.S. Treasury Securities and Obligations of
Government Corporations and Agencies
$ 8,125
$ (105
)
$ 1,978
$ (45
)
$ 10,103
$ (150
)
Obligations of State and Political Subdivisions
—
—
444
(11
)
444
(11
)
Asset- / Mortgage-backed Securities
65,906
(1,419
)
58,586
(1,388
)
124,492
(2,807
)
Corporate Securities
—
—
—
—
—
—
Equity Securities
7,050
(850
)
—
—
7,050
(850
)
Total
$ 81,081
$ (2,374
)
$ 61,008
$ (1,444
)
$ 142,089
$ (3,818
)
At December 31, 2004:
Less than 12 Months
12 Months or More
Total
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
U.S. Treasury Securities and Obligations of
Government Corporations and Agencies
$ 2,534
$ (26
)
$ —
$ —
$ 2,534
$ (26
)
Obligations of State and Political Subdivisions
2,085
(16
)
—
—
2,085
(16
)
Asset- / Mortgage-backed Securities
74,038
(570
)
19,458
(298
)
93,496
(868
)
Corporate Securities
—
—
—
—
—
—
Equity Securities
—
—
—
—
—
—
Total
$ 78,657
$ (612
)
$ 19,458
$ (298
)
$ 98,115
$ (910
)
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
2005
2004
Loans were comprised of the following classifications at December 31:
Residential Mortgage Loans
$ 102,891
$ 94,800
Agricultural Loans
101,355
99,557
Commercial and Industrial Loans
319,241
313,798
Consumer Loans
129,587
122,888
Totals
$ 653,074
$ 631,043
Nonperforming loans were as follows at December 31:
Loans past due over 90 days and accruing and Restructured Loans
$ 944
$ 831
Non-accrual Loans
14,763
5,750
Totals
$ 15,707
$ 6,581
2005
2004
Information regarding impaired loans:
Year-end impaired loans with no allowance for loan losses allocated
$ 1,546
$ 905
Year-end impaired loans with allowance for loan losses allocated
11,740
4,618
Amount of allowance allocated to impaired loans
2,515
992
2003
Average balance of impaired loans during the year
10,465
4,400
$ 1,313
Interest income recognized during impairment
62
263
103
Interest income recognized on cash basis
52
243
102
Balance
January 1,
Changes
in PersonsDeductions
Balance
December 31,
2005
Additions
Included
Collected
Charged-off
2005
$ 23,869
$ 11,800
$ 3,854
$ (2,948
)
$ —
$ 36,575
2005
2004
2003
Balance as of January 1
$ 8,801
$ 8,265
$ 8,301
Provision for Loan Losses
1,903
2,015
811
Allowance from Acquired Subsidiary
239
—
—
Recoveries of Prior Loan Losses
465
371
784
Loan Losses Charged to the Allowance
(2,143
)
(1,850
)
(1,631
)
Balance as of December 31
$ 9,265
$ 8,801
$ 8,265
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
2005
2004
2003
Servicing Rights:
Beginning of Year
$ 3,399
$ 3,368
$ 2,694
Additions
707
643
1,687
Amortized to Expense
(713
)
(467
)
(420
)
Direct Write-downs
—
(145
)
(593
)
End of Year
$ 3,393
$ 3,399
3,368
Valuation Allowance:
Beginning of Year
$ 777
$ 885
$ 1,238
Additions Expensed
131
363
706
Reductions Credited to Expense
(543
)
(326
)
(466
)
Direct Write-downs
—
(145
)
(593
)
End of Year
$ 365
$ 777
$ 885
2005
2004
Land
$ 4,201
$ 3,947
Buildings and Improvements
23,914
23,256
Furniture and Equipment
16,014
15,158
Total Premises, Furniture and Equipment
44,129
42,361
Less: Accumulated Depreciation
(23,896
)
(22,130
)
Total
$ 20,233
$ 20,231
2006
$
137,223
2007
83,288
2008
74,374
2009
7,766
2010
6,046
Thereafter
77
Total
$ 308,774
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
December 31,
2005
2004
Long-term Advances from the Federal Home Loan Bank collateralized by
qualifying mortgages, investment securities, and mortgage-backed securities
$ 48,106
$ 59,366
Promissory Notes Payable
18,500
10,575
Long-term Borrowings
$ 66,606
69,941
Overnight Variable Rate Advances from Federal Home Loan Bank collateralized by
qualifying mortgages, investment securities, and mortgage-backed securities
$ 8,600
$ —
Federal Funds Purchased
7,271
—
Repurchase Agreements
20,417
25,673
Promissory Notes Payable
2,500
—
Short-term Borrowings
38,788
25,673
Total Borrowings
$ 105,394
$ 95,614
2006
$ 6,485
2007
5,317
2008
4,668
2009
10,026
2010
38,528
Thereafter
1,582
Total
$ 66,606
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
Actual
Minimum Required
For Capital
Adequacy Purposes:
Minimum Required
To Be Well-
Capitalized Under
Prompt Corrective
Action Regulations:
Amount
Ratio
Amount
Ratio
Amount
Ratio
Total Capital
(to Risk Weighted Assets)
Consolidated
$ 84,581
11.27
%
$ 60,024
8.00
%
N/A
N/A
German American Bank
36,911
10.99
%
26,857
8.00
$ 33,572
10.00
%
First American Bank
15,897
17.89
%
7,108
8.00
8,885
10.00
Peoples Bank
16,199
11.47
%
11,300
8.00
14,125
10.00
Citizens State Bank
10,570
11.23
%
7,529
8.00
9,411
10.00
First State Bank
11,326
14.09
%
6,431
8.00
8,039
10.00
Tier 1 Capital
(to Risk Weighted Assets)
Consolidated
$ 75,119
10.01
%
$ 30,012
4.00
%
N/A
N/A
German American Bank
32,822
9.78
%
13,429
4.00
$ 20,143
6.00
%
First American Bank
14,781
16.64
%
3,554
4.00
5,331
6.00
Peoples Bank
15,173
10.74
%
5,650
4.00
8,475
6.00
Citizens State Bank
9,638
10.24
%
3,764
4.00
5,647
6.00
First State Bank
10,415
12.96
%
3,215
4.00
4,823
6.00
Tier 1 Capital
(to Average Assets)
Consolidated
$ 75,119
8.01
%
$ 37,506
4.00
%
N/A
N/A
German American Bank
32,822
7.83
%
16,769
4.00
$ 20,961
5.00
%
First American Bank
14,781
12.51
%
4,724
4.00
5,906
5.00
Peoples Bank
15,173
7.89
%
7,690
4.00
9,612
5.00
Citizens State Bank
9,638
8.11
%
4,752
4.00
5,941
5.00
First State Bank
10,415
8.75
%
4,759
4.00
5,949
5.00
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
Actual
Minimum Required
For Capital
Adequacy Purposes:
Minimum Required
To Be Well-
Capitalized Under
Prompt Corrective
Action Regulations:
Amount
Ratio
Amount
Ratio
Amount
Ratio
Total Capital
(to Risk Weighted Assets)
Consolidated
$ 87,821
11.83
%
$ 59,386
8.00
%
N/A
N/A
German American Bank
37,180
10.85
27,402
8.00
$ 34,252
10.00
%
First American Bank
13,396
14.85
7,218
8.00
9,023
10.00
Peoples Bank
16,692
12.32
10,835
8.00
13,543
10.00
Citizens State Bank
12,528
12.06
8,309
8.00
10,386
10.00
First State Bank
6,636
10.72
4,954
8.00
6,192
10.00
Tier 1 Capital
(to Risk Weighted Assets)
Consolidated
$ 78,945
10.63
%
$ 29,693
4.00
%
N/A
N/A
German American Bank
33,510
9.78
13,701
4.00
$ 20,551
6.00
%
First American Bank
12,260
13.59
3,609
4.00
5,414
6.00
Peoples Bank
15,203
11.23
5,417
4.00
8,126
6.00
Citizens State Bank
11,345
10.92
4,154
4.00
6,232
6.00
First State Bank
5,949
9.61
2,477
4.00
3,715
6.00
Tier 1 Capital
(to Average Assets)
Consolidated
$ 78,945
8.50
%
$ 37,143
4.00
%
N/A
N/A
German American Bank
33,510
7.99
16,774
4.00
$ 20,968
5.00
%
First American Bank
12,260
9.50
5,159
4.00
6,449
5.00
Peoples Bank
15,203
7.80
7,792
4.00
9,740
5.00
Citizens State Bank
11,345
9.19
4,938
4.00
6,172
5.00
First State Bank
5,949
7.76
3,065
4.00
3,831
5.00
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
Number
of Options
Weighted-average
Exercise Price
Outstanding, beginning of 2003
344,936
$
14.56
Granted
101,587
17.99
Exercised
(66,660
)
13.81
Forfeited
(2,303
)
15.16
Expired
(430
)
21.34
Outstanding, end of 2003
377,130
15.61
Granted
87,685
17.36
Exercised
(32,608
)
13.00
Forfeited
(2,040
)
16.12
Expired
—
—
Outstanding, end of 2004
430,167
16.16
Granted
77,967
14.92
Exercised
(56,356
)
12.53
Forfeited
(3,521
)
15.42
Expired
(43,238
)
16.69
Outstanding, end of 2005
405,019
16.37
Outstanding
Exercisable
Range of
Exercise
PricesNumber
Weighted Average
Remaining
Contractual Life
(in years)Number
Weighted
Average
Exercise Price
$12.49 - $14.92
117,879
3.60
117,879
13.81
$15.29 - $17.55
127,162
3.26
127,162
16.53
$17.96 - $18.28
159,978
7.52
159,978
18.14
405,019
5.04
405,019
16.37
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
2005
2004
Changes in Benefit Obligation:
Obligation at beginning of year
$
859
$
936
Service cost
—
—
Interest cost
50
54
Benefits paid
(51
)
(200
)
Actuarial loss
22
42
Adjustment in cost of settlement
—
27
Obligation at end of year
880
859
Changes in Plan Assets:
Fair value at beginning of year
552
744
Actual return on plan assets
(27
)
8
Employer contributions
27
—
Benefits paid
(51
)
(200
)
Fair value at end of year
501
552
Funded Status:
Funded status at end of year
(379
)
(307
)
Unrecognized prior service cost
(2
)
(5
)
Unrecognized net loss
348
306
Unrecognized transition asset
(4
)
(5
)
Pension liability
$ (37
)
$ (11
)
Amounts recognized in the balance sheet consist of:
2005
2004
Accrued benefit cost
$ (37
)
$ (11
)
Minimum pension liability
(342
)
(296
)
Accumulated other comprehensive income
207
179
Net periodic pension expense for the years ended December 31, 2005, 2004, and
2003 was as follows:
2005
2004
2003
Interest cost
$
50
$
54
$
61
Expected return on assets
(24
)
(31
)
(38
)
Amortization of transition amount
(1
)
(2
)
(1
)
Amortization of prior service cost
(3
)
(3
)
(3
)
Recognition of net loss
31
29
34
Net periodic pension expense
$ 53
$ 47
$ 53
Additional Information
2005
2004
Increase in minimum liability included in other
comprehensive income
$ 28
$ 10
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
2005
2004
Discount rate
5.75%
6.00%
Rate of compensation increase
N/A
N/A(1)
Weighted-average assumptions used to determine net cost:
2005
2004
2003
Discount rate
6.00%
6.25%
6.50%
Expected return on plan assets
4.50%
5.00%
5.00%
Rate of compensation increase
N/A
N/A
N/A(1)
(1)
Benefits under the plan were suspended in 1998; therefore, the
weighted-average rate of increase in future compensation levels was not
applicable for all years presented.
Target
Allocation Percentage of Plan Assets
at Year-end
Asset Category
2006
2005
2004
Cash
30%
31%
1%
Certificate of Deposits
65%
62%
76%
Equity Securities
5%
7%
23%
Total
100%
100%
100%
Year
Benefits
2006
$ 39
2007
39
2008
37
2009
36
2010
40
2011-2015
232
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
The provision for income taxes consists of the following:
2005
2004
2003
Current Federal
$ 3,137
$ 1,666
$ 883
Current State
557
145
—
Deferred Federal
(202
)
(708
)
391
Deferred State
(157
)
89
(199
)
Change in Valuation Allowance
—
(196
)
196
Total
$ 3,335
$ 996
$ 1,271
Income tax expense is reconciled to the 34% statutory rate applied to pre-tax income as follows:
2005
2004
2003
Statutory Rate Times Pre-tax Income
$ 4,439
$ 2,800
$ 3,209
Add/(Subtract) the Tax Effect of:
Income from Tax-exempt Loans and Investments
(635
)
(845
)
(1,035
)
State Income Tax, Net of Federal Tax Effect
264
25
(2
)
Low Income Housing Credit
(392
)
(525
)
(520
)
Dividends Received Deduction
(128
)
(165
)
(183
)
Company Owned Life Insurance
(216
)
(241
)
(147
)
Other Differences
3
(53
)
(51
)
Total Income Taxes
$ 3,335
$ 996
$ 1,271
The net deferred tax asset at December 31 consists of the following:
2005
2004
Deferred Tax Assets:
Allowance for Loan Losses
$ 2,729
2,543
Deferred Compensation and Employee Benefits
1,604
1,596
Intangibles
45
40
Unused Tax Credits
2,407
3,337
Unrealized Capital Loss on Equity Securities
1,252
1,252
Unrealized Appreciation on Securities
651
—
Minimum Pension Liability
136
117
Net Operating Loss Carryforward
262
—
Other
224
244
Total Deferred Tax Assets
9,310
9,129
Deferred Tax Liabilities:
Depreciation
(658
)
(861
)
Leasing Activities, Net
(2,245
)
(3,227
)
Mortgage Servicing Rights
(1,193
)
(1,032
)
Investment in Low Income Housing Partnerships
(389
)
(372
)
Unrealized Appreciation on Securities
—
(188
)
FHLB Stock Dividends
(599
)
(540
)
Business Combination Fair Value Adjustments
(118
)
—
Other
(36
)
(263
)
Total Deferred Tax Liabilities
(5,238
)
(6,483
)
Valuation Allowance
(45
)
(45
)
Net Deferred Tax Asset
$ 4,027
$ 2,601
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
2005
2004
2003
Earnings per Share:
Net Income
$ 9,721
$ 7,239
$ 8,168
Weighted Average Shares Outstanding
10,890,987
10,914,622
11,176,766
Earnings per Share
$ 0.89
$ 0.66
$ 0.73
Diluted Earnings per Share:
Net Income
$ 9,721
$ 7,239
$ 8,168
Weighted Average Shares Outstanding
10,890,987
10,914,622
11,176,766
Stock Options, Net
4,668
33,509
45,577
Diluted Weighted Average Shares Outstanding
10,895,655
10,948,131
11,222,343
Diluted Earnings per Share
$ 0.89
$ 0.66
$ 0.73
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
Years Ending December 31:
Premises
2006
$
123
2007
120
2008
86
2009
79
2010
50
Thereafter
4
Total
$ 462
2005
2004
Commitments to Fund Loans:
Home Equity
$ 44,611
$ 40,158
Credit Card Lines
13,581
12,737
Commercial Operating Lines
74,351
51,826
Residential Mortgages
4,197
6,584
Total Commitments to Fund Loans
$ 136,740
$ 111,305
Commitments to Sell Loans
$ 8,591
$ 8,934
Standby Letters of Credit
$ 7,624
$ 6,245
2005
2004
2003
Loans Transferred to Other Real Estate
$ 1,280
$ 800
$ 834
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
Year Ended December 31, 2005
Core
BankingMortgage
BankingTrust and
Investment
Advisory
ServicesInsurance
Holding
Company
and
Other
Consolidated
Totals
Net Interest Income
$ 32,355
$ 554
$ 40
$ 38
$ (774
)
$ 32,213
Gain on Sales of Loans and
Related Assets
692
308
—
—
—
1,000
Net Gain/(Loss) on Securities
—
—
—
—
—
—
Servicing Income
—
945
—
—
(135
)
810
Trust and Investment Product
Fees
5
—
2,163
—
(87
)
2,081
Insurance Revenues
141
72
29
4,542
(81
)
4,703
Loss on Extinguishment of
Borrowings
—
—
—
—
—
—
Noncash Items:
Provision for Loan Losses
1,133
(80
)
—
—
850
1,903
MSR Amortization & Valuation
—
301
—
—
—
301
Provision for Income Taxes
6,025
131
134
335
(3,290
)
3,335
Segment Profit (Loss)
13,507
199
201
558
(4,744
)
9,721
Segment Assets
914,804
17,922
2,107
8,103
3,531
946,467
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
Year Ended December 31, 2004
Core
BankingMortgage
BankingTrust and
Investment
Advisory
ServicesInsurance
Holding
Company
and
OtherConsolidated
Totals
Net Interest Income
$ 31,279
$ 251
$ 32
$ 4
$ (327
)
$ 31,239
Gain on Sales of Loans and
Related Assets
583
392
—
—
—
975
Net Gain/(Loss) on Securities
(3,678
)
—
—
—
—
(3,678
)
Servicing Income
—
925
—
—
(154
)
771
Trust and Investment Product
Fees
4
—
2,129
—
(87
)
2,046
Insurance Revenues
76
60
53
4,598
(121
)
4,666
Loss on Extinguishment of
Borrowings
—
—
—
—
—
—
Noncash Items:
Provision for Loan Losses
2,250
(235
)
—
—
—
2,015
MSR Amortization & Valuation
—
504
—
—
—
504
Provision for Income Taxes
3,512
(26
)
106
305
(2,901
)
996
Segment Profit (Loss)
9,491
(39
)
159
646
(3,018
)
7,239
Segment Assets
904,633
24,928
2,200
7,959
2,374
942,094
Year Ended December 31, 2003
Core
BankingMortgage
BankingTrust and
Investment
Advisory
ServicesInsurance
Holding
Company
and
OtherConsolidated
Totals
Net Interest Income
$ 30,284
$ (622
)
$ 22
$ 10
$ (159
)
$ 29,535
Gain on Sales of Loans and
Related Assets
1,284
1,304
—
—
—
2,588
Net Gain/(Loss) on Securities
56
—
—
—
24
80
Servicing Income
—
893
—
—
(189
)
704
Trust and Investment Product
Fees
4
—
1,716
—
(93
)
1,627
Insurance Revenues
124
166
17
3,543
(158
)
3,692
Loss on Extinguishment of
Borrowings
—
1,898
—
—
—
1,898
Noncash Items:
Provision for Loan Losses
1,352
(541
)
—
—
—
811
MSR Amortization & Valuation
—
660
—
—
—
660
Provision for Income Taxes
4,515
(783
)
15
261
(2,737
)
1,271
Segment Profit (Loss)
11,579
(1,122
)
20
589
(2,898
)
8,168
Segment Assets
883,639
27,536
2,141
9,448
3,182
925,946
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
December 31,
2005
2004
ASSETS
Cash
$ 1,064
$ 1,012
Securities Available-for-Sale, at Fair Value
6,074
2,623
Loan, net
3,790
—
Investment in Subsidiary Banks and Bank Holding Company
90,257
86,285
Investment in Non-banking Subsidiaries
711
645
Furniture and Equipment
2,590
2,083
Other Assets
2,762
3,361
Total Assets
$ 107,248
$ 96,009
LIABILITIES
Promissory Notes Payable
$ 21,000
$ 10,500
Other Liabilities
2,186
1,840
Total Liabilities
23,186
12,340
SHAREHOLDERS' EQUITY
Common Stock
10,643
10,898
Additional Paid-in Capital
63,784
66,817
Retained Earnings
11,198
5,778
Accumulated Other Comprehensive Income (Loss)
(1,563
)
176
Total Shareholders' Equity(1)
84,062
83,669
Total Liabilities and Shareholders' Equity
$ 107,248
$ 96,009
CONDENSED STATEMENTS OF INCOME
Years ended December 31,
2005
2004
2003
INCOME
Dividends from Subsidiaries
Bank
$ 14,750
$ 7,675
$ 14,200
Nonbank
1,500
1,750
300
Dividend and Interest Income
(46
)
18
79
Fee Income from Subsidiaries
663
677
688
Securities Gains, Net
—
—
23
Other Income
49
1
54
Total Income
16,916
10,121
15,344
EXPENSES
Salaries and Benefits
4,109
3,602
5,463
Professional Fees
937
1,068
621
Occupancy and Equipment Expense
715
766
784
Interest Expense
669
287
165
Provision for Loan and Lease Losses
850
—
—
Other Expenses
621
552
532
Total Expenses
7,901
6,275
7,565
INCOME BEFORE INCOME TAXES AND EQUITY IN
UNDISTRIBUTED INCOME OF SUBSIDIARIES
9,015
3,846
7,779
Income Tax Benefit
2,857
2,301
2,656
INCOME BEFORE EQUITY IN UNDISTRIBUTED
INCOME OF SUBSIDIARIES
11,872
6,147
10,435
Equity in Undistributed Income of Subsidiaries
(344
)
1,092
(2,267
)
NET INCOME(1)
11,528
7,239
8,168
Other Comprehensive Income:
Unrealized Gain/(Loss) on Securities, Net
(1,711
)
178
(1,747
)
Changes in Minimum Pension Liability
(28
)
(10
)
(169
)
TOTAL COMPREHENSIVE INCOME
$ 9,789
$ 7,407
$ 6,252
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
Years ended December 31,
2005
2004
2003
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income
$ 11,528
$ 7,239
$ 8,168
Adjustments to Reconcile Net Income to Net Cash from Operations
Amortization on Securities
—
—
1
Depreciation
388
426
479
Gain on Sale of Securities, Net
—
—
(23
)
Director Stock Awards
—
—
72
Provision for Loan Losses
850
—
—
Change in Other Assets
427
719
(997
)
Change in Other Liabilities
235
(551
)
916
Equity in Undistributed Income of Subsidiaries
344
(1,092
)
2,267
Net Cash from Operating Activities
13,772
6,741
10,883
CASH FLOWS FROM INVESTING ACTIVITIES
Capital Contribution to Subsidiaries
—
—
(2,600
)
Purchase of Securities Available-for-Sale
(2,835
)
(2,024
)
—
Proceeds from Maturities of Securities Available-for-Sale
—
—
6,280
Property and Equipment Expenditures
(895
)
(143
)
(694
)
Proceeds from Sale of Property and Equipment
—
206
—
Acquire Banking Entities
(2,956
)
—
—
Purchase of Loans from Subsidiary Bank
(4,640
)
—
—
Net Cash from Investing Activities
(11,326
)
(1,961
)
2,986
CASH FLOWS FROM FINANCING ACTIVITIES
Change in Short-term Borrowings
2,500
—
—
Advances in Long-term Debt
27,000
2,500
8,000
Repayment of Long-term Debt
(19,000
)
—
—
Issuance of Common Stock
48
34
260
Purchase / Retire Common Stock
(6,771
)
(708
)
(21,846
)
Employee Stock Purchase Plan
(63
)
(76
)
(120
)
Dividends Paid
(6,108
)
(6,114
)
(5,984
)
Purchase of Interest in Fractional Shares
—
—
(27
)
Net Cash from Financing Activities
(2,394
)
(4,364
)
(19,717
)
Net Change in Cash and Cash Equivalents
52
416
(5,848
)
Cash and Cash Equivalents at Beginning of Year
1,012
596
6,444
Cash and Cash Equivalents at End of Year
$ 1,064
$ 1,012
$ 596
(1)
Parent Company Shareholders' Equity and Net Income differ from consolidated
Shareholders' Equity and Net Income due to an intercompany gain related to the
ownership reorganization of German American Insurance among the Company's
banking subsidiaries during 2005.
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
Business Combination
Date
AcquiredAccounting
Method
Hoosierland Insurance Agency, Inc., Jasper, Indiana
09/02/03
Purchase
Stafford-Williams Insurance Agency, Inc., Washington, Indiana
09/02/03
Purchase
PCB Holding Company
10/01/05
Purchase
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
2005
2004
Beginning of Year
$ 1,794
$ 1,794
Goodwill from acquisitions
2,019
—
End of Year
$ 3,813
$ 1,794
2005
Gross
Amount
Accumulated
Amortization
Core Banking
Core Deposit Intangible
$ 1,113
$ 681
Unidentified Branch Acquisition Intangible
257
192
Insurance
Customer List
2,838
947
Total
$ 4,208
$ 1,820
2004
Gross
Amount
Accumulated
Amortization
Core Banking
Core Deposit Intangible
$ 670
$ 670
Unidentified Branch Acquisition Intangible
257
175
Insurance
Customer List
2,838
542
Total
$ 3,765
$ 1,387
2006
$
467
2007
467
2008
467
2009
464
2010
313
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
December 31, 2005
December 31, 2004
Carrying
Value
Fair
Value
Carrying
Value
Fair
Value
Financial Assets:
Cash and Short-term Investments
$ 32,931
$ 32,931
$ 47,666
$ 47,666
Securities Available-for-Sale
181,150
181,150
181,676
181,676
Securities Held-to-Maturity
8,684
8,811
13,318
13,636
FHLB Stock and Other Restricted Stock
14,095
14,095
13,542
13,542
Loans, including Loans Held-for-Sale, Net
644,592
637,134
624,114
621,135
Accrued Interest Receivable
5,941
5,941
5,431
5,431
Financial Liabilities:
Demand, Savings, and Money Market Deposits
(438,047
)
(438,047
)
(428,468
)
(428,468
)
Other Time Deposits
(308,774
)
(302,911
)
(321,915
)
(320,128
)
Short-term Borrowings
(38,788
)
(38,788
)
(25,673
)
(25,673
)
Long-term Debt
(66,606
)
(67,907
)
(69,941
)
(73,239
)
Accrued Interest Payable
(1,764
)
(1,764
)
(1,406
)
(1,406
)
Unrecognized Financial Instruments:
Commitments to Extend Credit
—
—
—
—
Standby Letters of Credit
—
—
—
—
Commitments to Sell Loans
—
—
—
—
2005
2004
2003
Unrealized Holding Losses on
Securities Available-for-Sale
$ (2,551
)
$ (3,407
)
$ (2,567
)
Reclassification Adjustments for (Gains) and Losses
later Recognized in Income
—
3,678
(80
)
Net Unrealized Gains and (Losses)
(2,551
)
271
(2,647
)
Recognition of Minimum Pension Liability
(46
)
(17
)
(279
)
Tax Effect
858
(86
)
1,010
Other Comprehensive Income / (Loss)
$ (1,739
)
$ 168
$ (1,916
)
Notes to the Consolidated Financial Statements (continued)
Dollars in thousands, except per share data
Interest
Net Interest
Net
Earnings per Share
Income
Income
Income
Basic
Diluted
2005
First Quarter
$ 12,004
$ 7,999
$ 2,411
$ 0.22
$ 0.22
Second Quarter
12,172
7,975
2,408
0.22
0.22
Third Quarter
12,576
7,981
2,471
0.23
0.23
Fourth Quarter
13,445
8,258
2,431
0.22
0.22
2004
First Quarter
$ 11,776
$ 7,478
$ 1,952
$ 0.18
$ 0.18
Second Quarter
11,888
7,735
2,332
0.21
0.21
Third Quarter
11,957
7,900
2,376
0.22
0.22
Fourth Quarter
12,089
8,126
579
0.05
0.05
As of December 31, 2005, the Company carried out an evaluation, under the
supervision and with the participation of its principal executive officer and
principal financial officer, of the effectiveness of the design and operation of
its disclosure controls and procedures. Based on this evaluation, the
Company’s principal executive officer and principal financial officer
concluded that the Company’s disclosure controls and procedures are
effective in timely alerting them to material information required to be
included in the Company’s periodic reports filed with the Securities and
Exchange Commission. There are inherent limitations to the effectiveness of
systems of disclosure controls and procedures, including the possibility of
human error and the circumvention or overriding of the controls and procedures.
Accordingly, even effective systems of disclosure controls and procedures can
provide only reasonable assurances of achieving their control
objectives.
There was no change in the Company’s internal control over
financial reporting that occurred during the Company’s fourth fiscal
quarter of 2005 that has materially affected, or is reasonably likely to
materially affect, the Company’s internal control over financial
reporting.
The management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting as defined in
Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934.
The Company’s internal control over financial reporting is designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. The Company’s internal
control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of
the Company; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and
expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company; and
(iii) provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of the Company’s assets
that could have a material effect on the financial statements.
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
German American Bancorp
Jasper, Indiana
/s/ Crowe Chizek and Company LLC
Crowe Chizek and Company LLC
February 21, 2006
Plan Category
Number of Securities
to be Issued upon Exercise
of Outstanding Options,
Warrants or Rights
Weighted Average
Exercise Price of
Outstanding Options,
Warrants and Rights
Number of Securities
Remaining Available for
Future Issuance under
Equity Compensation
Plans (Excluding
Securities Reflected
in First Column)
Equity compensation plans approved by
security holders
405,019(a)
$ 16.37
747,324(a)
Equity compensation plans not approved
by security holders
—
—
—
Total
405,019
$ 16.37
747,324
(a)
Does not include any shares that employees may have
the right to purchase under the Employee Stock Purchase Plan in August 2006 in
respect of employee payroll deductions of participating employees that had
accumulated as of December 31, 2005 during the plan year that commenced in
August 2005. Although these employees have the right under this Plan to have
their accumulated payroll deductions applied to the purchase of Common Shares at
a discounted price in August 2006, the price at which such shares may be
purchased and the number of shares that may be purchased under that Plan at that
time is not presently determinable.
(b)
Represents 384,500 shares that the Company may in
the future issue to employees under the Employee Stock Purchase Plan (although
the Company typically purchases the shares needed for sale to participating
employees on the open market rather than issuing new issue shares to such
employees) and 362,824 shares that were available for grant or issuance at
December 31, 2005 under the 1999 Long-Term Equity Incentive Plan. Under the
Long-Term Equity Incentive Plan, the aggregate number of Common Shares available
for the grant of awards in any given fiscal year is equal to the sum of (i) one
percent of the number of Common Shares outstanding as of the last day of the
Corporation’s prior fiscal year, plus (ii) the number of Common Shares that
were available for the grant of awards, but were not granted, under the Plan in
any previous fiscal year. Under no circumstances, however, may the number of
Common Shares available for the grant of awards in any fiscal year under the
Long-Term Equity Incentive Plan exceed one and one-half percent of the Common
Shares outstanding as of the last day of the prior fiscal year. The 362,824
shares available at December 31, 2005 and included in the above table represent
only the carryover of shares that may be the subject of grants of awards under
the Long-Term Equity Incentive Plan in 2006 and future years; the Corporation
during 2006 and future years (in addition to this carryover amount) may grant an
additional 106,435 shares, representing one percent of the number of Common
Shares that were outstanding at December 31, 2005, under the Long-Term Equity
Incentive Plan.
For additional information regarding the Company’s equity
incentive plans and employee stock purchase plan, see Note 9 to the consolidated
financial statements in Item 8 of this Report.
German American Bancorp and Subsidiaries:
Page #
Report of Independent Registered Public Accounting Firm on Financial Statements
30
Consolidated Balance Sheets at December 31,
2005 and December 31, 2004
31
Consolidated Statements of Income, years
ended December 31, 2005, 2004, and 2003
32
Consolidated Statements of Changes in
Shareholders’ Equity, years ended
December 31, 2005, 2004, and 2003
33
Consolidated Statements of Cash Flows, years
ended December 31, 2005, 2004, and 2003
34
Notes to the Consolidated Financial
Statements
35-60
Date: March 10, 2006
GERMAN AMERICAN BANCORP
(Registrant)
By/s/Mark A. Schroeder
Mark A. Schroeder, President and
Chief Executive Officer
Date: March 10, 2006
By/s/Mark A. Schroeder
Mark A. Schroeder, President and Chief Executive
Officer (principal executive officer), Director
Date: March 10, 2006
By/s/Douglas A. Bawel
Douglas A. Bawel, Director
Date: March 10, 2006
By/s/Christina M. Ernst
Christina M. Ernst, Director
Date: March 13, 2006
By/s/William R. Hoffman
William R. Hoffman, Director
Date: March 10, 2006
By/s/U. Butch Klem
U. Butch Klem, Director
Date: March 12, 2006
By/s/J. David Lett
J. David Lett, Director
Date: March 13, 2006
By/s/Gene C. Mehne
Gene C. Mehne, Director
Date: March 11, 2006
By/s/Larry J. Seger
Larry J. Seger, Director
Date: March 11, 2006
By/s/Joseph F. Steurer
Joseph F. Steurer, Director
Date: March 13, 2006
By/s/C.L. Thompson
C.L. Thompson, Director
Date: March 13, 2006
By/s/Michael J. Voyles
Michael J. Voyles, Director
Date: March 10, 2006
By/s/Bradley M. Rust
Bradley M. Rust, Senior Vice President and
Chief Financial Officer