ITEM 1. BUSINESS.
BUSINESS
GENERAL
River Valley Bancorp (the “Holding Company” or “River Valley” and together with the “Bank,” the “Company”), an Indiana corporation, was formed in 1996 for the primary purpose of purchasing all of the issued and outstanding common stock of River Valley Financial Bank (formerly Madison First Federal Savings and Loan Association; hereinafter “River Valley Financial” or the “Bank”) in its conversion from mutual to stock form. The conversion offering was completed on December 20, 1996. On December 23, 1996, the Company utilized approximately $3.0 million of the net conversion proceeds to purchase 95.6% of the outstanding common shares of Citizens National Bank of Madison (“Citizens”), and River Valley Financial and Citizens merged on November 20, 1997.
The activities of the Holding Company have been limited primarily to holding the stock of River Valley Financial, which was organized in 1875 under the laws of the United States of America and which continues today under charter from the State of Indiana. River Valley Financial, which provides banking services in a single significant business segment, conducts operations from its 12 full-service office locations in Clark, Floyd, Jackson, Jennings and Jefferson Counties, Indiana, and Carroll County, Kentucky, and offers a variety of deposit and lending services to consumer and commercial customers.
The Bank historically has concentrated its lending activities on the origination of loans secured by first mortgage liens for the purchase, construction, or refinancing of one- to four-family residential real property. One- to four-family residential mortgage loans continue to be the major focus of the Bank’s loan origination activities, representing 43.7% of the Bank’s total loan portfolio at December 31, 2012. The Bank identified loans totaling $394,000 as held for sale at December 31, 2012. The Bank also offers multi-family mortgage loans, nonresidential real estate loans, land loans, construction loans, non-mortgage commercial loans and consumer loans. The Bank’s primary market areas have been Jefferson, Floyd and Clark Counties in southeastern Indiana and adjacent Carroll and Trimble Counties in Kentucky.
In November 2012, the Company completed its acquisition of Dupont State Bank, an Indiana commercial bank wholly owned by Citizens Union Bancorp of Shelbyville, Inc. In conjunction with the acquisition, River Valley Financial merged with and into Dupont State Bank, which changed its name to River Valley Financial Bank, effecting the conversion of the Bank from a federally chartered thrift to a state chartered commercial bank. This acquisition has expanded the Bank’s branch network to North Vernon, Seymour and Dupont, Indiana, adding a presence in Jackson and Jennings Counties, Indiana, resulting in a total of 12 branches across southeast Indiana and northern Kentucky that will offer a wide range of consumer and commercial community banking services.
Until July 2011, the Holding Company and River Valley Financial were subject to regulation, supervision and examination by the Office of Thrift Supervision (“OTS”), but the Dodd-Frank Wall Street Reform and Consumer Protection Act eliminated the regulatory authority of the OTS and reallocated its functions. Thereafter, the Holding Company was subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve (“Federal Reserve”), and River Valley Financial was subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC”).
As a result of the November 2012 conversion of the Bank to a state chartered bank, the Bank will be subject to regulation, supervision and examination by the Indiana Department of Financial Institutions (“DFI”), instead of the OCC. The Bank will continue to be regulated by the FDIC, and the Holding Company will continue to be regulated by the Federal Reserve.
For ease of reference throughout this Annual Report on Form 10-K, references to the DFI are intended to include a reference to the OTS and/or the OCC, as the predecessors in thrift regulation and supervision, as the context and the time period requires.
Deposits in River Valley Financial are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. The Bank is also a member of the Federal Home Loan Bank (“FHLB”) system, and in particular the Federal Home Loan Bank of Indianapolis, which is one of twelve regional banks comprising the system.
The Company’s internet address is www.rvfbank.com. The Company makes available all filings with the Securities and Exchange Commission via its internet website.
LOAN PORTFOLIO DATA
The following table sets forth the composition of the Bank’s loan portfolio as of December 31, 2012, 2011, 2010, 2009 and 2008 by loan type as of the dates indicated, including a reconciliation of gross loans receivable after consideration of the allowance for loan losses, deferred loan origination costs and loans in process. Historical data in this table and others reporting loan portfolio data has been restated in some cases to conform to certain loan recategorizations employed as of December 31, 2012.
The following table sets forth certain information at December 31, 2012, regarding the dollar amount of loans maturing in the Bank’s loan portfolio based on the contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less. This schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses. Management expects prepayments will cause actual maturities to be shorter.
The following table sets forth, as of December 31, 2012, the dollar amount of all loans due after one year that have fixed interest rates and floating or adjustable interest rates.
Residential Loans. Residential loans consist primarily of one- to four-family residential loans. Approximately $137.4 million, or 43.7% of the Bank’s portfolio of loans, at December 31, 2012, consisted of one- to four-family residential loans, of which approximately 88.4% had adjustable rates.
The Bank currently offers adjustable rate one- to four-family residential mortgage loans (“ARMs”) which adjust annually and are indexed to the one-year U.S. Treasury securities yields adjusted to a constant maturity. Some of the Bank’s residential ARMs are originated at a discount or “teaser” rate which is generally 150 to 175 basis points below the “fully indexed” rate. These ARMs then adjust annually to maintain a margin above the applicable index, subject to maximum rate adjustments discussed below. The Bank’s ARMs have a current margin above such index of 3-3.5% for owner-occupied properties and 3.5-5% for non-owner-occupied properties. A substantial portion of the ARMs in the Bank’s portfolio at December 31, 2012 provide for maximum rate adjustments per year and over the life of the loan of 2% and 6%, respectively, although the Bank has originated residential ARMs which provide for maximum rate adjustments per year and over the life of the loan of 1% and 4%, respectively. The Bank’s ARMs generally provide for interest rate minimums equal to, or up to 1% below the origination rate. The Bank’s residential ARMs are amortized for terms up to 30 years.
Adjustable rate loans decrease the risk associated with changes in interest rates but involve other risks, primarily because as interest rates rise, the payments by the borrowers may rise to the extent permitted by the terms of the loan, thereby increasing the potential for default. Also, adjustable rate loans have features which restrict changes in interest rates on a short-term basis and over the life of the loan. At the same time, the market value of the underlying property may be adversely affected by higher interest rates.
The Bank currently offers fixed rate one- to four-family residential mortgage loans which provide for the payment of principal and interest over periods of 10 to 30 years. At December 31, 2012, approximately 11.6% of the Bank’s one- to four-family residential mortgage loans had fixed rates. The Bank currently underwrites a portion of its fixed rate residential mortgage loans for potential sale to the Federal Home Loan Mortgage Corporation (the “FHLMC”). The Bank retains all servicing rights on the residential mortgage loans sold to the FHLMC. At December 31, 2012, the Bank had approximately $96.0 million of fixed rate residential mortgage loans which were sold to the FHLMC and for which the Bank provides servicing. In conjunction with the acquisition of Dupont State Bank, the Bank also holds servicing rights for a portfolio of $17.6 million in FNMA loans.
The Bank generally does not originate one-tofour-family residential mortgage loans if the ratio of the loan amount to the lesser of the current cost or appraised value of the property (the “Loan-to-Value Ratio”) exceeds 95% and generally does not originate one- to four-family residential ARMs if the Loan-to-Value Ratio exceeds 90%. The Bank generally requires private mortgage insurance on all fixed rate conventional one- to four-family residential real estate mortgage loans with Loan-to-Value Ratios in excess of 80%. The cost of such insurance is factored into the annual percentage yield on such loans, and is not automatically eliminated when the principal balance is reduced over the term of the loan. During 2012 the Bank originated and retained $3.6 million of fixed rate one- to four-family residential mortgage loans. Typically, these loans would be sold into the secondary market, however, the majority of these loans were originated to existing customers and were retained, rather than sold, due to tightened lending standards in the secondary market.
Substantially all of the one- to four-family residential mortgage loans that the Bank originates include “due-on-sale” clauses, which give the Bank the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not repaid.
At December 31, 2012, the Bank had outstanding approximately $15.2 million of home equity loans, with unused lines of credit totaling approximately $22.3 million. As of December 31, 2012 all home equity loans were performing loans. The Bank’s home equity lines of credit are adjustable rate lines of credit tied to the prime rate and are amortized based on a 10- to 20-year maturity. The Bank generally allows a maximum 85% Loan-to-Value Ratio for its home equity loans (taking into account any other mortgages on the property). Payments on such home equity loans are equal to 1.5% of the outstanding principal balance per month, or on newer home equity loans, to the interest accrued at the end of the period.
The Bank also offers standard second mortgage loans, which are adjustable rate loans tied to the U.S. Treasury securities yields adjusted to a constant maturity with a current margin above such index of 3.5-4%. The Bank’s second mortgage loans have maximum rate adjustments per year and over the terms of the loans equal to 2% and 6%, respectively. The Bank’s second mortgage loans have terms of up to 30 years.
At December 31, 2012, $2.7 million of one- to four-family residential mortgage loans, or .9% of total loans, were included in the Bank’s non-performing assets.
Multi-family Loans. At December 31, 2012, approximately $20 million, or 6.4% of the Bank’s total loan portfolio, consisted of mortgage loans secured by multi-family dwellings (those consisting of more than four units). The Bank writes multi-family loans on terms and conditions similar to its nonresidential real estate loans. The largest multi-family loan in the Bank’s portfolio as of December 31, 2012 was $3.1 million and was secured by an apartment building in Jeffersonville, Indiana. At December 31, 2012, $1.1 million of multi-family loans, or 0.4% of total loans, were included in the Bank’s non-performing assets.
Multi-family loans, like nonresidential real estate loans, involve a greater risk than residential loans. See “Nonresidential Real Estate Loans” below. Also, the loan-to-one borrower limitations restrict the ability of the Bank to make loans to developers of apartment complexes and other multi-family units.
Construction Loans. The Bank offers construction loans with respect to residential and nonresidential real estate and, in certain cases, to builders or developers constructing such properties on a speculative basis (i.e., before the builder/developer obtains a commitment from a buyer).
Generally, construction loans are written as twelve-month loans, either fixed or adjustable, with interest calculated on the amount disbursed under the loan and payable on a semi-annual or monthly basis. The Bank generally requires an 80% Loan-to-Value Ratio for its construction loans, although the Bank may permit an 85% Loan-to-Value Ratio for one- to four-family residential construction loans. Inspections are generally made prior to any disbursement under a construction loan, and the Bank does not typically charge commitment fees for its construction loans.
At December 31, 2012, $10.8 million, or 3.4% of the Bank’s total loan portfolio, consisted of construction loans. The largest construction loan at December 31, 2012 totaled $2.3 million. . At December 31, 2012, $413,000 of construction loans, or 0.1% of total loans, were included in the Bank’s non-performing assets. While providing the Bank with a comparable, and in some cases higher, yield than a conventional mortgage loan, construction loans involve a higher level of risk. For example, if a project is not completed and the borrower defaults, the Bank may have to hire another contractor to complete the project at a higher cost. Also, a project may be completed, but may not be saleable, resulting in the borrower defaulting and the Bank taking title to the project.
Nonresidential Real Estate Loans. At December 31, 2012, $106.4 million, or 33.8% of the Bank’s total loan portfolio, consisted of nonresidential real estate loans and land used for agricultural production. Nonresidential real estate loans are primarily secured by real estate such as churches, farms and small business properties. The Bank generally originates nonresidential real estate as adjustable rate loans of varying rates with lock-in terms of up to 10 years indexed to the one-year U.S. Treasury securities yields adjusted to a constant maturity, written for maximum terms of 30 years. The Bank’s adjustable rate nonresidential real estate loans have maximum adjustments per year and over the life of the loan of 2% and 6%, respectively, and interest rate minimums of 1% below the origination rate. The Bank generally requires a Loan-to-Value Ratio of up to 80%, depending on the nature of the real estate collateral.
The Bank underwrites its nonresidential real estate loans on a case-by-case basis and, in addition to its normal underwriting criteria, evaluates the borrower’s ability to service the debt from the net operating income of the property. As of December 31, 2012, the Bank’s largest nonresidential real estate loan, for a church in Jeffersonville, Indiana, was $4.4 million. Nonresidential real estate loans in the amount of $1.7 million, or 0.5% of total loans, were included in non-performing assets at December 31, 2012.
Loans secured by nonresidential real estate generally are larger than one- to four-family residential loans and involve a greater degree of risk. Nonresidential real estate loans often involve large loan balances to single borrowers or groups of related borrowers. Payments on these loans depend to a large degree on results of operations and management of the properties and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. Accordingly, the nature of the loans makes them more difficult for management to monitor and evaluate.
Land Loans. At December 31, 2012, approximately $15.7 million, or 5.0% of the Bank’s total loan portfolio, consisted of mortgage loans secured by developed and undeveloped real estate. The Bank’s land loans are generally written on terms and conditions similar to its nonresidential real estate loans. Some of the Bank’s land loans are land development loans, i.e., the proceeds of the loans are used for improvements to the real estate such as streets and sewers. At December 31, 2012, the Bank’s largest land loan, a development loan secured by residential building lots in Clark and Floyd Counties Indiana, totaled $2.1 million. Non-performing land loans in the amount of $4.4 million were included in total non-performing assets as of December 31, 2012, representing 1.4% of total loans. Land loans are more risky than conventional loans since land development borrowers who are over budget may divert the loan funds to cover cost over-runs rather than direct them toward the purpose for which such loans were made. In addition, those loans are more difficult to monitor than conventional mortgage loans. As such, a defaulting borrower could cause the Bank to take title to partially improved land that is unmarketable without further capital investment.
Commercial Loans. At December 31, 2012, $19.5 million, or 6.2% of the Bank’s total loan portfolio, consisted of non-mortgage commercial loans. The Bank’s commercial loans are written on either a fixed rate or an adjustable rate basis with terms that vary depending on the type of security, if any. At December 31, 2012, approximately $19.0 million, or 97.4%, of the Bank’s commercial loans were secured by collateral, generally in the form of equipment, inventory, crops or, in some cases as an abundance of caution, real estate. The Bank’s adjustable rate commercial loans are generally indexed to the prime rate with varying margins and terms depending on the type of collateral securing the loans and the credit quality of the borrowers. At December 31, 2012, the largest commercial loan was $1.9 million, representing a large agricultural operation. As of the same date, commercial loans totaling $567,000, or 0.2% of total loans, were included in non-performing assets.
Commercial loans tend to bear somewhat greater risk than residential mortgage loans, depending on the ability of the underlying enterprise to repay the loan. Further, they are frequently larger in amount than the Bank’s average residential mortgage loans.
Consumer Loans. The Bank’s consumer loans, consisting primarily of auto loans, home improvement loans, unsecured installment loans, loans secured by deposits and mobile home loans, aggregated approximately $4.9 million at December 31, 2012, or 1.6% of the Bank’s total loan portfolio. The Bank originates consumer loans to meet the needs of its customers and to assist in meeting its asset/liability management goals, although demand for these types of loans has steadily decreased over the past few years. All of the Bank’s consumer loans, except loans secured by deposits, are fixed rate loans with terms that vary from six months (for unsecured installment loans) to 66 months (for home improvement loans and loans secured by new automobiles). At December 31, 2012, $4.0 million of the Bank’s $4.9 million consumer loans were secured by collateral.
The Bank’s loans secured by deposits are made in amounts up to 90% of the current account balance and accrue at a rate of 2% over the underlying passbook or certificate of deposit rate.
The Bank offers only direct automobile loans that provide the loan directly to a consumer.
Consumer loans may entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles. Further, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance. In addition, consumer loan collections depend upon the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. At December 31, 2012, consumer loans amounting to $16,000 were included in non-performing assets.
Origination, Purchase and Sale of Loans.
The Bank underwrites fixed rate residential mortgage loans for potential sale to the FHLMC on a servicing-retained basis. Loans originated for sale to the FHLMC in the secondary market are originated in accordance with the guidelines established by the FHLMC and are sold promptly after they are originated. The Bank receives a servicing fee of one-fourth of 1% of the principal balance of all loans serviced. At December 31, 2012, the Bank serviced $96.0 million in loans sold to the FHLMC. In conjunction with the acquisition of Dupont State Bank, the Bank acquired servicing rights for $17.6 million of Federal National Mortgage Association loans (FNMA).
The Bank focuses its loan origination activities primarily on Jefferson, Clark and Floyd Counties in Indiana and Trimble, Carroll, and Jefferson Counties in Kentucky, with some activity in the areas adjacent to these counties. With the acquisition of Dupont State Bank, the Bank will engage in loan origination activities in Jackson and Jennings Counties in Indiana as well. At December 31, 2012, the Bank held loans totaling approximately $73.2 million that were secured by property located outside of Indiana. The Bank’s loan originations are generated from referrals from existing customers, real estate brokers and newspaper and periodical advertising. Loan applications are taken at any of the Bank’s 12 full-service offices.
The Bank’s loan approval processes are intended to assess the borrower’s ability to repay the loan, the viability of the loan and the adequacy of the value of the property that will secure the loan. To assess the borrower’s ability to repay, the Bank evaluates the employment and credit history and information on the historical and projected income and expenses of its borrowers.
Under the Bank’s lending policy, a loan officer may approve mortgage loans up to $150,000, a Senior Loan Officer may approve mortgage loans up to $417,000 and the President may approve mortgage loans up to $500,000. All other mortgage loans must be approved by at least four members of the Bank’s Board of Directors. The lending policy further provides that loans secured by readily marketable collateral, such as stock, bonds and certificates of deposit may be approved by a Loan Officer for up to $150,000, by a Senior Loan Officer for up to $300,000 and by the President up to $400,000. Loans secured by other non-real estate collateral may be approved by a Loan Officer for up to $50,000, by a Senior Loan Officer up to $100,000 and by the President up to $200,000. Finally, the lending policy provides that unsecured loans may be approved by a Loan Officer up to $15,000 or up to $25,000 by a Senior Loan Officer or up to $50,000 by the President. All other unsecured loans or loans secured by non-real estate collateral must be approved by at least four members of the Bank’s Board of Directors.
The Bank generally requires appraisals on all real property securing its loans and requires an attorney’s opinion or title insurance and a valid lien on the mortgaged real estate. Appraisals for all real property securing mortgage loans are performed by independent appraisers who are state-licensed. The Bank requires fire and extended coverage insurance in amounts at least equal to the principal amount of the loan and also requires flood insurance to protect the property securing the loan if the property is in a flood plain. The Bank also generally requires private mortgage insurance only on fixed rate residential mortgage loans with Loan-to-Value Ratios of greater than 80%. The Bank does not typically require escrow accounts for insurance premiums or taxes, however, in 2010, due to changes in Regulation Z relative to “high priced mortgages,” the Bank began requiring that certain borrowers escrow for both property taxes and hazard insurance. Under Regulation Z, a “high priced mortgage” is any first mortgage that is 1.5% over the index rate or any second mortgage that is 3.5% over the index rate.
The Bank’s underwriting standards for consumer and commercial loans are intended to protect against some of the risks inherent in making such loans. Borrower character, paying habits and financial strengths are important considerations.
The Bank occasionally purchases and sells participations in commercial loans, nonresidential real estate and multi-family loans to or from other financial institutions. At December 31, 2012, the Bank held $3.0 million in participation loans in its loan portfolio, all a result of the acquisition of Dupont State Bank.
The following table shows loan disbursement and repayment activity for the Bank during the periods indicated.
(1)
Other items consist of amortization of deferred loan origination costs, the provision for losses on loans, net charges to the allowance for loan losses, and restructured debt.
Origination and Other Fees. The Bank realizes income from loan origination fees, loan servicing fees, late charges, checking account service charges and fees for other miscellaneous services. Late charges are generally assessed if payment is not received within a specified number of days after it is due. The grace period depends on the individual loan documents.
NON-PERFORMING AND PROBLEM ASSETS
Mortgage loans are reviewed by the Bank on a regular basis and are placed on a nonaccrual status when management determines that the collectibility of the interest is less than probable or collection of any amount of principal is in doubt. Generally, when loans are placed on nonaccrual status, unpaid accrued interest is written off, and further income is recognized only to the extent received. The Bank delivers delinquency notices with respect to all mortgage loans contractually past due 10 days. When loans are 16 days in default, personal contact is made with the borrower to establish an acceptable repayment schedule. Management is authorized to commence foreclosure proceedings for any loan upon making a determination that it is prudent to do so.
Commercial and consumer loans are treated similarly. Interest income on consumer, commercial and other non-mortgage loans is accrued over the term of the loan except when serious doubt exists as to the collectibility of a loan, in which case accrual of interest is discontinued and the loan is written-off, or written down to the fair value of the collateral securing the loan. It is the Bank’s policy to recognize losses on these loans as soon as they become apparent.
Non-performing Assets. At December 31, 2012, $10.9 million, or 2.3% of consolidated total assets, were non-performing loans compared to $9.9 million, or 2.4% of consolidated total assets, at December 31, 2011. The balance of non-performing assets was real estate owned (REO), comprised of real estate taken during forclosure proceedings, held at December 31, 2012, in the amount of $1.6 million, as compared to $2.5 million at December 31, 2011. Troubled debt restructured that is non-performing at the time of restructuring is required to be inclued as a non-performing asset until certain requirements for payment and borrower viability are met. Non-performing assets are also discussed in Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation.
The following table sets forth the amounts and categories of the Bank’s non-performing assets (non-performing loans, non-performing troubled debt restructured, and foreclosed real estate) and troubled debt restructurings for the last three years. It is the policy of the Bank that all earned but uncollected interest on all past due loans is reviewed monthly to determine what portion of it should be classified as uncollectible for loans past due in excess of 90 days. Uncollectible interest is written off monthly.
At December 31, 2012, the Bank held loans delinquent from 30 to 89 days totaling $2.6 million. As of that date, management was not aware of any other assets that would need to be disclosed as non-performing assets.
Delinquent Loans. The following table sets forth certain information at December 31, 2012, 2011, and 2010 relating to delinquencies in the Bank’s portfolio. Delinquent loans that are 90 days or more past due are considered non-performing assets. For the period ending December 31, 2012, delinquent purchased credit impaired loans with a fair value of $2.5 million were excluded from the table below.
Classified Assets. The Bank’s Asset Classification Policy provides for the classification of loans and other assets such as debt and equity securities of lesser quality as “special mention,” “substandard,” “doubtful,” or “loss” assets. An asset is treated as a “special mention” when the assets are currently protected but have credit weaknesses that warrant a higher degree of attention from management. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the Bank will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.
An insured institution is required to establish general allowances for loan losses in an amount deemed prudent by management for loans classified substandard or doubtful, as well as for other problem loans. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount.
The Bank regularly reviews its loan portfolio to determine whether any loans require classification in accordance with applicable regulation. Not all of the Bank’s classified assets constitute non-performing assets, although the balances of non-performing loans as a percent of total classified is higher than in prior years. Historically, management has been conservative in its listing of assets as classified, especially in comparison to peer classification of similar assets and to actual delinquency status. Whereas classified loans for the Bank historically have been a conservative list of loans warranting scrutiny, in 2011 and 2012 the classified list has become weighted heavily by loans and relationships in the lengthy process of foreclosure. The mating of the conservative approach in monitoring problem loans and loans lingering due to foreclosure has created a larger than historical balance of classified assets. As a result, the Bank remains somewhat higher than peer on balances of loans classified.
The classification of assets listing is evaluated monthly by a committee comprised of lending personnel, the Bank Chief Executive Officer, the Chief Financial Officer, Loan Review personnel, the Collection Officer, and the Bank’s Internal Auditor. The list encompasses entire relationships, rather than single problem loans, and removal of loans from the list is only approved by the committee upon demonstrated performance by the borrower.
At December 31, 2012, the Bank’s classified assets, were as follows:
Regulatory definition requires that total classified assets include classified loans, which at December 31, 2012 included $16.3 million as substandard and $3.2 million as doubtful, other real estate owned as a result of foreclosure or other legal proceedings of $1.6 million, also considered substandard, and two below-investment grade corporate securities, considered substandard, totaling $1.2 million. Detail of classified loans by loan segment is provided in Footnote 6 to the Consolidated Financial Statements presented later in this Report on Form 10-K.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained through the provision for loan losses, which is charged to earnings. The provision for loan losses is determined in conjunction with management’s review and evaluation of current economic conditions (including those of the Bank’s lending area), changes in the character and size of the loan portfolio, loan delinquencies (current status as well as past and anticipated trends) and adequacy of collateral securing loan delinquencies, historical and estimated net charge-offs and other pertinent information derived from a review of the loan portfolio. In management’s opinion, the Bank’s allowance for loan losses is adequate to absorb probable incurred losses from loans at December 31, 2012. However, there can be no assurance that regulators, when reviewing the Bank’s loan portfolio in the future, will not require increases in its allowances for loan losses or that changes in economic conditions will not adversely affect the Bank’s loan portfolio.
Summary of Loan Loss Experience. The following table analyzes changes in the allowance during the five years ended December 31, 2012. Additional detail about loan loss experience is presented in Footnote 6 to the Consolidated Financial Statements presented in this Report on Form 10-K.
Allocation of Allowance for Loan Losses. The following table presents an analysis of the allocation of the Bank’s allowance for loan losses at the dates indicated. Decreases seen in the “unallocated” category reflect more precise allocation of loan types and concentrations within the revised methodology.
INVESTMENTS AND MORTGAGE-BACKED SECURITIES
Investments. The Bank’s investment portfolio (excluding mortgage-backed securities) consists of U.S. government and agency obligations, corporate bonds, municipal securities and Federal Home Loan Bank (“FHLB”) stock. At December 31, 2012, total investments in the portfolio, as defined above and including mortgage-backed securities, had a combined carrying value of approximately $118.4 million, or 25.0%, of the consolidated total assets.
Investments reported in the financial statements of the Company are held both at the Bank level and at the Bank’s Nevada subsidiaries. All Company investments are available for sale, but the intent of the Company is to hold investments to maturity. Liquidity is met through a combination of deposit growth, borrowing from the Federal Home Loan Bank of Indianapolis, and if needed, sale of investments held at the Bank level. Securities held through the Nevada subsidiaries are held primarily for investment purposes. Securities held at the Bank level are held primarily for liquidity purposes. In 2011, liquidity needs were met primarily through deposit growth and the same held true for 2012. Sales of investments over the last 18 months have been made primarily to take advantage of gain positions on short-term investments, especially those expected to be called in the near future, while funds from maturing investments were reinvested primarily into high quality mortage-backed securities and long term municipals.
The portfolio increased by $9.1 million from December 31, 2011 to the same date in 2012, as $5.0 million of U.S. government and agency securities, most at yields of less than 2%, were purchased at the Nevada subsidiary level. Also,at the Nevada subsidiary level, $18.5 million in purchases of high quality mortgage and asset-backed securities were offset by reductions for a slight overall increase of $1.3 million. Offsetting the purchase were decreases, primarily $10.9 of periodic paydown on these investments while the remainder represented sales and maturities, as the Company took advantage of high gains on sale to offset extraordinary expenses associated with the acquisition of Dupont State Bank. The acquisition of Dupont State Bank included $12.1 million in available-for-sale securities, primarily U.S. government and agency securities and asset-backed securities. During the fourth quarter $5.2 million of these securities were sold to repay Federal Home Loan Bank of Indianapolis advances, and improve the net margin of the Company. Municipal securities, managed at the Nevada subsidiary level, increased slightly for the year. The carrying value of the two trust preferred investments held by the Company, considered to be of higher risk than most investments, improved from $1.1 million as of December 31, 2011 to $1.2 million as of December 31, 2012. The net unrealized gain on the portfolio was $2.9 million at December 31, 2012 and $2.8 million at December 31, 2011.
The following table sets forth the amortized cost and the market value of the Bank’s investment portfolio, excluding mortgage-backed investments, at the dates indicated.
The following table sets forth the amount of investment securities (excluding FHLB stock and mortgage-backed investments) which mature during each of the periods indicated and the weighted average yields for each range of maturities at December 31, 2012.
Mortgage-Backed Securities. The Bank maintains a portfolio of mortgage-backed pass-through securities in the form of FHLMC, FNMA and Government National Mortgage Association (“GNMA”) participation certificates. Mortgage-backed pass-through securities generally entitle the Bank to receive a portion of the cash flows from an identified pool of mortgages and gives the Bank an interest in that pool of mortgages. FHLMC, FNMA and GNMA securities are each guaranteed by its respective agencies as to principal and interest.
Although mortgage-backed securities generally yield less than individual loans originated by the Bank, they present less credit risk. Because mortgage-backed securities have a lower yield relative to current market rates, retention of such investments could adversely affect the Bank’s earnings, particularly in a rising interest rate environment. The mortgage-backed securities portfolio is generally considered to have very low credit risk because the securities are guaranteed as to principal repayment by the issuing agency.
In addition, the Bank has purchased adjustable rate mortgage-backed securities as part of its effort to reduce its interest rate risk. In a period of declining interest rates, the Bank is subject to prepayment risk on such adjustable rate mortgage-backed securities. The Bank attempts to mitigate this prepayment risk by purchasing mortgage-backed securities at or near par. If interest rates rise in general, the interest rates on the loans backing the mortgage-backed securities will also adjust upward, subject to the interest rate caps in the underlying mortgage loans. However, the Bank is still subject to interest rate risk on such securities if interest rates rise faster than 1% to 2% maximum annual interest rate adjustments on the underlying loans.
At December 31, 2012, the Bank had mortgage-backed securities with a carrying value of approximately $36.0 million, all of which were classified as available for sale. These mortgage-backed securities may be used as collateral for borrowings and, through repayments, as a source of liquidity.
The following table sets forth the amortized cost and market value of the Bank’s mortgage-backed securities at the dates indicated.
The following table sets forth the amount of mortgage-backed securities which mature during each of the periods indicated and the weighted average yields for each range of maturities at December 31, 2012.
The following table sets forth the changes in the Bank’s mortgage-backed securities portfolio at amortized cost for the years ended December 31, 2012, 2011, and 2010.
SOURCES OF FUNDS
General. Deposits have traditionally been the Bank’s primary source of funds for use in lending and investment activities. In addition to deposits, the Bank derives funds from scheduled loan payments, investment maturities, loan prepayments, retained earnings, income on earning assets, and borrowings. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, market conditions, and levels of competition. Borrowings from the FHLB of Indianapolis and other sources of wholesale funding may be used in the short term to compensate for reductions in deposits or deposit inflows at less than projected levels.
Deposits. Deposits are attracted through the offering of a broad selection of deposit instruments including fixed rate certificates of deposit, NOW, MMDAs and other transaction accounts, individual retirement accounts and savings accounts. The Bank actively solicits and advertises for deposits in Jefferson, Clark, Floyd, Jackson and Jennings Counties in Indiana and in Trimble and Carroll County, Kentucky. Deposits will come from all of our market areas. Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds remain on deposit and the interest rate. The Bank does not pay a fee for any deposits it receives.
Interest rates paid, maturity terms, service fees and withdrawal penalties are established by the Bank on a periodic basis. Determination of rates and terms are predicated on funds acquisition and liquidity requirements, rates paid by
competitors, growth goals and applicable regulations. The Bank relies, in part, on customer service and long-standing relationships with customers to attract and retain its deposits, but also closely prices its deposits in relation to rates offered by its competitors.
The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition. The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. The Bank has become more susceptible to short-term fluctuations in deposit flows as customers have become more interest rate conscious. The Bank manages the pricing of its deposits in keeping with its asset/liability management and profitability objectives. Historically, NOW and MMDAs have been relatively stable sources of deposits. During 2012, the single largest item impacting deposit levels was the acquisition of Dupont State Bank and the $78.3 million in deposits acquired. That deposit base was comprise of maturity deposits totaling $39.1 million, interest bearing transactional deposits totaling $28.3 million and noninterest-bearing deposits totaling $10.9 million. Other than the impact of the acquisition, the Company saw little change overall in the amount of deposits year to year. There was, however, a change in the mix of pre-merger deposits as approximately $10.0 million in maturity deposits shifted to transactional deposit accounts, some into noninterest bearing accounts. Taking into consideration the impact of the acquisition on deposits in total, transactional deposits, primarily NOW and MMDA accounts, increased significantly from $185.1 million at December 31, 2011 to $234.8 million at December 31, 2012, an increase of $49.7 million, or 26.9%.
The ability of the Bank to attract and maintain certificates of deposit, and the rates paid on these deposits, have been and will continue to be significantly affected by market conditions. Due primarily to the acquisition, and despite the shift from maturity deposits to transactional deposits, certificate of deposit balances increased $29.3 million, or 24.4%, from the balance of $120.1 million as of December 31, 2011 to $149.4 million at December 31, 2012. As certificates of deposit repriced and new certificates were added, the lower interest rates for these items caused a significant decline in the cost of deposits. As a result, cost of deposits for the year ended December 31, 2012 was 0.94% as compared to 1.28% for the year ended December 31, 2011, a drop of 34 basis points, period to period. This change resulted in a weighted average rate for deposits of 0.72% at December 31, 2012, a decline of 33 basis points from the 1.05% at December 31, 2011.
An analysis of the Company’s deposit accounts by type, maturity and rate at December 31, 2012 is as follows:
The following table sets forth, by various interest rate categories, the composition of time deposits of the Bank at the dates indicated:
The following table represents, by various interest rate categories, the amounts of time deposits maturing during each of the three years following December 31, 2012. Matured certificates, which have not been renewed as of December 31, 2012, have been allocated based upon certain rollover assumptions.
The following table indicates the amount of the Bank’s jumbo and other certificates of deposit of $100,000 or more by time remaining until maturity as of December 31, 2012.
The following table sets forth the dollar amount of savings deposits in the various types of deposits offered by the Bank at the dates indicated, and the amount of increase or decrease in such deposits as compared to the previous period.
Borrowings. The Bank focuses on generating high quality loans and then seeks the best source of funding from deposits, investments, or borrowings. The Bank had $42.5 million in FHLB advances at December 31, 2012, as compared to $58.0 million held at the same point in 2011. The average rates paid on those borrowings, however, increased 28 basis points across the period, from 3.55% as of December 31, 2011 to 3.83% as of December 31, 2012, as the Company prepaid $12.5 million in advances. The Bank does not anticipate any difficulty in obtaining advances appropriate to meet its requirements in the future. During the fiscal year the Bank prepaid $12.5 million in FHLB advances with a prepayment penalty of $392,000. With the acquisition of Dupont State Bank and availability of additional cash and investments, the Bank chose to restructure a portion of its liabilities by selling $5.2 million in available-for-sale securities at a gain of $385,000. The net effect allowed for an improvement of the overall net interest margin as the Bank prepaid higher costing borrowings by selling lower yielding investments at a profit.
The following table presents certain information relating to the Company’s borrowings at or for the years ended December 31, 2012, 2011 and 2010.
SUBSIDIARIES
The Bank’s wholly-owned subsidiary, Madison 1st Service Corporation, which was incorporated under the laws of the State of Indiana on July 3, 1973, currently holds land but does not otherwise engage in significant business activities. During 2005, the Bank established in Nevada three new subsidiaries, including RVFB Investments, Inc., RVFB Holdings, Inc. and RVFB Portfolio, LLC, to hold and manage a significant portion of the Bank’s investment portfolio. Income from the Nevada investment subsidiaries increased from $1.9 million for the year ended December 31, 2011 to $2.2 million for the same period in 2012, an increase of 15.8%.
FINANCING SUBSIDIARY
In 2003, the Company formed the “RIVR Statutory Trust I,” a statutory trust formed under Connecticut law, and filed a Certificate of Trust with the Secretary of the State of Connecticut. The sole purpose of the Trust is to issue and sell certain securities representing undivided beneficial interests in the assets of the Trust and to invest the proceeds thereof in certain debentures of the Company.
EMPLOYEES
As of December 31, 2012, the Bank employed 116 persons on a full-time basis and 9 persons on a part-time basis. None of the employees is represented by a collective bargaining group. Management considers its employee relations to be good.
COMPETITION
The Bank originates most of its loans to and accepts most of its deposits from residents of Jefferson, Jackson, Jennings, Floyd and Clark Counties, Indiana and Carroll County, KY. The Bank is subject to competition from various financial institutions, including state and national banks, state and federal savings associations, credit unions and certain non-banking consumer lenders that provide similar services in these counties. Some of these institutions have significantly larger resources available to them than does the Bank. In total, there are 23 banks and approximately 8 credit unions located in the six county market area, including the Bank.The Bank also competes with money market funds and brokerage accounts with respect to deposit accounts and with insurance companies with respect to individual retirement accounts.
The primary factors influencing competition for deposits are interest rates, service and convenience of office locations. The Bank competes for loan originations primarily through the efficiency and quality of services it provides borrowers and through interest rates and loan fees charged. Competition is affected by, among other things, the general availability of lendable funds, general and local economic conditions, current interest rate levels and other factors that are not readily predictable.
REGULATION AND SUPERVISION
GENERAL
The Bank is subject to examination, supervision and regulation by the Indiana Department of Financial Institutions (“DFI”), and the Federal Deposit Insurance Corporation (the “FDIC”). The Holding Company is a bank holding company, subject to oversight by the Board of Governors of the Federal Reserve System (“Federal Reserve”).
This discussion will summarize the effect of existing and probable governmental regulations on the operations of the Holding Company and the Bank as a bank holding company and a state commercial bank, respectively.
BANK HOLDING COMPANY REGULATION
As a registered bank holding company for the Bank, the Holding Company is subject to the regulation and supervision of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (“BHCA”). Bank holding companies are required to file periodic reports with and are subject to periodic examination by the Federal Reserve.
Under the BHCA, without the prior approval of the Federal Reserve, the Holding Company may not acquire direct or indirect control of more than 5% of the voting stock or substantially all of the assets of any company, including a bank, and may not merge or consolidate with another bank holding company. In addition, the Holding Company is generally prohibited by the BHCA from engaging in any nonbanking business unless such business is determined by the Federal Reserve to be so closely related to banking as to be a proper incident thereto. Under the BHCA, the Federal Reserve has the authority to require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve's determination that such
activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.
Under the Dodd-Frank Act, a bank holding company is expected to serve as a source of financial and managerial strength to its subsidiary banks. Pursuant to this requirement, a bank holding company should stand ready to use its resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity. This support may be required by the Federal Reserve at times when the Holding Company may not have the resources to provide it or, for other reasons, would not be inclined to provide it. Additionally, under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), a bank holding company is required to provide limited guarantee of the compliance by any insured depository institution subsidiary that may become “undercapitalized” (as defined in the statute) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency.
GRAMM-LEACH-BLILEY ACT
Under the Gramm-Leach-Bliley Act (“Gramm-Leach”), bank holding companies are permitted to offer their customers virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. In order to engage in these new financial activities, a bank holding company must qualify and register with the Federal Reserve as a “financial holding company” by demonstrating that each of its bank subsidiaries is well capitalized, well managed and has at least a satisfactory rating under the Community Reinvestment Act. Gramm-Leach established a system of functional regulation, under which the federal banking agencies regulate the banking activities of financial holding companies, the U.S. Securities and Exchange Commission regulates their securities activities and state insurance regulators regulate their insurance activities. The Holding Company has no current intention to elect to become a financial holding company under Gramm-Leach.
Under Gramm-Leach, federal banking regulators adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties. The privacy provisions of Gramm-Leach affect how consumer information is transmitted through diversified financial services companies and conveyed to outside vendors. The Holding Company does not disclose any nonpublic information about any current or former customers to anyone except as permitted by law and subject to contractual confidentiality provisions which restrict the release and use of such information.
STATE COMMERCIAL BANK REGULATION
As an Indiana commercial bank, the Bank is subject to federal regulation and supervision by the FDIC and to state regulation and supervision by the DFI. The Bank’s deposit accounts are insured by the Deposit Insurance Fund (“DIF”), which is administered by the FDIC.
Both federal and Indiana law extensively regulate various aspects of the banking business such as reserve requirements, truth-in-lending and truth-in-savings disclosures, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations.
STATE BANK ACTIVITIES
Under federal law, as implemented by regulations adopted by the FDIC, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law, as implemented by FDIC regulations, also prohibits FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the bank meets, and could continue to meet, its minimum regulatory capital requirements and the FDIC determines that the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member. Impermissible investments and activities must be divested or discontinued within certain time frames set by the FDIC. It is not expected that these restrictions will have a material impact on the operations of the Bank.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the FHLB system, which consists of 12 regional banks. The Federal Housing Finance Board (“FHFB”), an independent agency, controls the FHLB system, including the FHLB of Indianapolis. The FHLB system provides a central credit facility primarily for member financial institutions. At December 31, 2012, the
Bank’s investment in stock of the FHLB of Indianapolis was $4.6 million. For the fiscal year ended December 31, 2012, the FHLB of Indianapolis paid approximately $132,000 in cash dividends to the Bank. Annualized, this income would have a rate of 3.08%. The rate paid during the period ended December 31, 2012 was higher than the 2.56% paid for the period ended December 31, 2011, primarily due to improvement in the financial condition of the FHLB of Indianapolis in the last few years. All 12 FHLBs are required to provide funds to establish affordable housing programs through direct loans or interest subsidies on advances to members to be used for lending at subsidized interest rates for low-and moderate-income, owner-occupied housing projects, affordable rental housing, and certain other community projects. These contributions and obligations could adversely affect the value of FHLB stock in the future. A reduction in the value of such stock may result in a corresponding reduction in the Bank’s capital.
The FHLB of Indianapolis serves as a reserve or central bank for its member institutions. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB system. It makes advances to members in accordance with policies and procedures established by the FHLB and the Board of Directors of the FHLB of Indianapolis. Interest rates charged for advances vary depending upon maturity, the cost of funds to the FHLB of Indianapolis and the purpose of the borrowing.
All FHLB advances must be fully secured by sufficient collateral as determined by the FHLB. Eligible collateral includes first mortgage loans not more than 90 days delinquent or securities evidencing interests therein, securities (including mortgage-backed securities) issued, insured or guaranteed by the federal government or any agency thereof, cash or FHLB deposits, certain small business and agricultural loans of smaller institutions and real estate with readily ascertainable value in which a perfected security interest may be obtained. Other forms of collateral may be accepted as additional security or, under certain circumstances, to renew outstanding advances. All long-term advances are required to provide funds for residential home financing, and the FHLB has established standards of community service that members must meet to maintain access to long-term advances.
At December 31, 2012 the Bank had $42.5 million in such borrowings, with an additional $59.5 million available, previously approved by the Board of Directors.
FEDERAL RESERVE SYSTEM
The Federal Reserve requires all depository institutions to maintain noninterest bearing reserves at specified levels against their transaction accounts, which are primarily checking and NOW accounts, and non-personal time deposits. The effect of these reserve requirements is to increase the Bank’s cost of funds. At December 31, 2012, the Bank was in compliance with its reserve requirements.
INSURANCE OF DEPOSITS
Deposits in the Bank are insured by the Deposit Insurance Fund of the FDIC up to a maximum amount, which is generally $250,000 per depositor, subject to aggregation rules. The Dodd-Frank Act extended unlimited insurance on non-interest bearing accounts through December 31, 2012. Under this program, traditional non-interest demand deposit (or checking) accounts that allow for an unlimited number of transfers and withdrawals at any time, whether held for a business, individual, or other type of depositor, were covered. Later, Congress added Lawyers’ Trust Accounts (IOLTA) to this unlimited insurance protection through December 31, 2012. Because this program expired on December 31, 2012, there is no longer unlimited insurance coverage for non-interest bearing transaction accounts. Deposits held in non-interest bearing transaction accounts are now aggregated with interest bearing deposits the owner may hold in the same ownership category, and the combined total is insured up to $250,000.
The Bank is subject to deposit insurance assessments by the FDIC pursuant to its regulations establishing a risk-related deposit insurance assessment system, based upon the institution’s capital levels and risk profile. Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk-weighted categories based on supervisory evaluations, regulatory capital levels, and certain other factors, with less risky institutions paying lower assessments. An institution’s initial assessment rate depends upon the category to which it is assigned. There are also adjustments to a bank’s initial assessment rates based on levels of long-term unsecured debt, secured liabilities in excess of 25% of domestic deposits and, for certain institutions, brokered deposit levels. Under the rules in effect through March 31, 2011, initial assessments ranged from 12 to 45 basis points of assessable deposits, and the Bank paid assessments at the rate of 3.05 basis points for each $100 of insured deposits. However, pursuant to FDIC rules adopted under the Dodd-Frank Act, effective April 1, 2011, initial assessments ranged from 5 to 35 basis points of the institution’s total assets minus its tangible equity. The Bank paid deposit insurance assessments at the rate of 2.25 basis points for each $100 of insured deposits during the year ended December 31, 2012. No institution may pay a dividend if it is in default of the federal deposit insurance assessment.
The Bank is also subject to assessment for the Financing Corporation (FICO) to service the interest on its bond obligations. The amount assessed on individual institutions, including the Bank, by FICO is in addition to the amount paid for deposit insurance according to the risk-related assessment rate schedule. These assessments will continue
until the FICO bonds are repaid between 2017 and 2019. During 2012, the FICO assessment rate was 0.66 basis points for each $100 of the same assessment bases applicable to the FDIC assessment. For the first quarter of 2013, the FICO assessment rate is 0.64 basis points. The Bank expensed deposit insurance assessments (including the FICO assessments) of $362,000 during the year ended December 31, 2012. Future increases in deposit insurance premiums or changes in risk classification would increase the Bank’s deposit related costs.
On December 30, 2009, banks were required to pay the fourth quarter FDIC assessment and to prepay estimated insurance assessments for the years 2010 through 2012 on that date. The prepayment did not affect the Bank’s earnings on that date. The Bank paid an aggregate of $1.9 million in premiums on December 30, 2009, $1.6 million of which constituted prepaid premiums.
Under the Dodd-Frank Act, the FDIC is authorized to set the reserve ratio for the Deposit Insurance Fund at no less than 1.35%, and must achieve the 1.35% designated reserve ratio by September 30, 2020. The FDIC must offset the effect of the increase in the minimum designated reserve ratio from 1.15% to 1.35% on insured depository institutions of less than $10 billion, and may declare dividends to depository institutions when the reserve ratio at the end of a calendar quarter is at least 1.5%, although the FDIC has the authority to suspend or limit such permitted dividend declarations. In December, 2010, the FDIC adopted a final rule setting the designated reserve ratio for the deposit insurance fund at 2% of estimated insured deposits.
On October 19, 2010, the FDIC proposed a comprehensive long-range plan for deposit insurance fund management with the goals of maintaining a positive fund balance, even during periods of large fund losses, and maintaining steady, predictable assessment rates throughout economic and credit cycles. The FDIC determined not to increase assessments in 2011 by 3 basis points, as previously proposed, but to keep the current rate schedule in effect. In addition, the FDIC proposed adopting a lower assessment rate schedule when the designated reserve ratio reaches 1.15% so that the average rate over time should be about 8.5 basis points. In lieu of dividends, the FDIC proposed adopting lower rate schedules when the reserve ratio reaches 2% and 2.5%, so that the average rates will decline about 25 percent and 50 percent, respectively.
Under the Dodd-Frank Act, the assessment base for deposit insurance premiums was changed from adjusted domestic deposits to average consolidated total assets minus average tangible equity, affecting assessments for the last two quarters of 2011, as well as future assessments. Tangible equity for this purpose means Tier 1 capital. Since this is a larger base than adjusted domestic deposits, assessment rates are expected to be lower for the Bank as a result of these changes, which were first reflected in invoices due September 30, 2011. The new FDIC rule to implement the revised assessment requirements includes rate schedules scaled to the increase in the assessment base, including schedules that will go into effect when the reserve ratio reaches 1.15%, 2% and 2.5%. The FDIC staff has projected that the new rate schedules will be approximately revenue neutral.
The schedule would reduce the initial base assessment rate in each of the four risk-based pricing categories.
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For small Risk Category I banks, the rates would range from 5-9 basis points.
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The proposed rates for small institutions in Risk Categories II, III and IV would be 14, 23 and 35 basis points, respectively.
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For large institutions and large, highly complex institutions, the proposed rate schedule ranges from 5 to 35 basis points.
There are also adjustments made to the initial assessment rates based on long-term unsecured debt, depository institution debt, and brokered deposits. The Bank’s assessment rate reflected in its invoices for the 2012 quarters was 2.25 basis points for each $100 of average consolidated assets less average tangible equity.
The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.
The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe and unsound condition to continue operations or has violated any applicable law, regulation, order or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital.
CAPITAL REQUIREMENTS
The Federal Reserve and the FDIC have issued substantially similar risk-based and leverage capital guidelines that are applicable to the Bank. These guidelines require a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities such as standby letters of credit) of 8%. At least half of the total
required capital must be “Tier 1 capital,” consisting principally of common stockholders’ equity, noncumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less certain goodwill items. The remainder (“Tier 2 capital”) may consist of a limited amount of subordinated debt and intermediate-term preferred stock, certain hybrid capital instruments and other debt securities, cumulative perpetual preferred stock, and a limited amount of the allowance for loan losses.
In addition to the risk-based capital guidelines, the Bank is subject to a Tier 1 (leverage) capital ratio which requires a minimum level of Tier 1 capital to adjusted average assets of 3% in the case of financial institutions that have the highest regulatory examination ratings and are not contemplating significant growth or expansion. All other institutions are expected to maintain a ratio of at least 1% to 2% above the stated minimum. Pursuant to the regulations, banks must maintain capital levels commensurate with the level of risk, including the volume and severity of problem loans, to which they are exposed.
The Dodd-Frank Act requires the Federal Reserve to set minimum capital levels for bank holding companies that are as stringent as those required for insured depository subsidiaries; provided, however, that bank holding companies with less than $500 million in assets are exempt from these capital requirements. The legislation also established a floor for capital of insured depository institutions that cannot be lower than the standards in effect today, and directs the federal banking regulators to implement new leverage and capital requirements within 18 months that take into account off-balance sheet activities and risks, including risks related to securitized products and derivatives.
See Footnote 16 to the Consolidated Financial Statements, which shows that, at December 31, 2012, the Bank’s capital exceeded all regulatory capital requirements. At December 31, 2012, the Bank was categorized as well capitalized.
Banking regulators may change these requirements from time to time, depending on the economic outlook generally and the outlook for the banking industry. The Company is unable to predict whether and when higher capital requirements would be imposed and, if so, to what levels and on what schedule.
PROMPT CORRECTIVE REGULATORY ACTION
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) requires, among other things, that federal bank regulatory authorities take “prompt corrective action” with respect to institutions that do not meet minimum capital requirements. For these purposes, FDICIA establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. At December 31, 2012, the Bank was categorized as “well capitalized,” meaning that its total risk-based capital ratio exceeded 10%, its Tier I risk-based capital ratio exceeded 6%, its leverage ratio exceeded 5%, and it was not subject to a regulatory order, agreement or directive to meet and maintain a specific capital level for any capital measure.
The FDIC may order institutions which have insufficient capital to take corrective actions, including, among other things, submitting a capital restoration plan, limiting asset growth, placing restrictions on activities, requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired, restricting transactions with affiliates and prohibiting the payment of principal or interest on subordinated debt. Institutions deemed by the FDIC to be “critically undercapitalized” would be subject to the appointment of a receiver or conservator.
DIVIDEND LIMITATIONS
The Holding Company is a legal entity separate and distinct from the Bank. The primary source of the Holding Company’s cash flow, including cash flow to pay dividends on the Holding Company’s Common Stock, is the payment of dividends to the Holding Company by the Bank. Under Indiana law, the Bank may pay dividends of so much of its undivided profits (generally, earnings less losses, bad debts, taxes and other operating expenses) as is considered expedient by the Bank’s Board of Directors. However, the Bank must obtain the approval of the DFI for the payment of a dividend if the total of all dividends declared by the Bank during the current year, including the proposed dividend, would exceed the sum of retained net income for the year to date plus its retained net income for the previous two years. For this purpose, “retained net income” means net income as calculated for call report purposes, less all dividends declared for the applicable period.
The FDIC has the authority to prohibit the Bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the Bank. In addition, under Federal Reserve supervisory policy, a bank holding company generally should not maintain its existing rate of cash dividends on common shares unless (i) the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and (ii) the prospective rate of earnings retention appears consistent with the organization’s capital needs, assets, quality, and overall financial condition. The Federal Reserve
issued a letter dated February 24, 2009, to bank holding companies providing that it expects banks holding companies to consult with it in advance of declaring dividends that could raise safety and soundness concerns (i.e., such as when the dividend is not supported by earnings or involves a material increase in the dividend rate) and in advance of repurchasing shares of common or preferred stock.
LOANS TO ONE BORROWER
Under Indiana law, the Bank may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. Additional amounts may be lent, not in excess of 10% of unimpaired capital and surplus, if such loans or extensions of credit are fully secured by readily marketable collateral, including certain debt and equity securities but not including real estate. At December 31, 2012, the Bank did not have any loans or extensions of credit to a single or related group of borrowers in excess of its lending limits.
ACQUISITIONS OR DISPOSITIONS AND BRANCHING
Branching by the Bank requires the approval of the DFI. Under current law, Indiana chartered banks may establish branches throughout the state and in other states, subject to certain limitations. Congress authorized interstate branching, with certain limitations, beginning in 1997. Indiana law authorizes an Indiana bank to establish one or more branches in states other than Indiana through interstate merger transactions and to establish one or more interstate branches through de novo branching or the acquisition of a branch. The Dodd-Frank Act permits the establishment of de novo branches in states where such branches could be opened by a state bank chartered by that state. The consent of the state is no longer required.
DODD-FRANK ACT
On July 21, 2010, President Obama signed into law the Dodd-Frank Act, which significantly changes the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes provisions affecting large and small financial institutions alike, including several provisions that will profoundly affect how community banks, thrifts, and small bank and thrift holding companies, such as River Valley Bancorp, will be regulated in the future. Among other things, these provisions abolish the Office of Thrift Supervision (the “OTS”) and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of federal deposit insurance coverage, impose new capital requirements on bank and thrift holding companies, and impose limits on debit card interchange fees charged by large banks (commonly known as the Durbin Amendment).
The Dodd-Frank Act created a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach Bliley Act, and certain other statutes. In July 2011, many of the consumer financial protection functions formerly assigned to the federal banking and other designated agencies transferred to the CFBP. The CFBP has a large budget and staff, and has the authority to implement regulations under federal consumer protection laws and enforce those laws against financial institutions. The CFPB will have examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by the federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive or abusive practice in connection with the offering of consumer financial products. Additionally, this bureau is authorized to collect fines and provide consumer restitution in the event of violations, engage in consumer financial education, track consumer complaints, request data, and promote the availability of financial services to underserved consumers and communities. Moreover, the Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB.
The CFPB has indicated that mortgage lending is an area of supervisory focus and that it will concentrate its examination and rulemaking efforts on the variety of mortgage-related topics required under the Dodd-Frank Act, including steering consumers to less-favorable products, discrimination, abusive or unfair lending practices, predatory lending, origination disclosures, minimum mortgage underwriting standards, mortgage loan originator compensation, and servicing practices. The CFPB recently published several final regulations impacting the mortgage industry, including rules related to ability-to-pay, mortgage servicing, escrow accounts, and mortgage loan originator compensation. The ability-to-repay rule makes lenders liable if they fail to assess ability to repay under a prescribed test, but also creates a safe harbor for so called “qualified mortgages.” The “qualified mortgages” standards include a tiered cap structure that places limits on the total amount of certain fees that can be charged on a loan, a 43% cap on
debt-to-income (i.e., total monthly payments on debt to monthly gross income), exclusion of interest-only products, and other requirements. The 43% debt-to-income cap does not apply for the first seven years the rule is in effect for loans that are eligible for sale to Fannie Mae or Freddie Mac or eligible for government guarantee through the FHA or the Veterans Administration. Failure to comply with the ability-to-repay rule may result in possible CFPB enforcement action and special statutory damages plus actual, class action, and attorneys fees damages, all of which a borrower may claim in defense of a foreclosure action at any time. The Company’s management is currently assessing the impact of these requirements on its mortgage lending business.
In addition, the Federal Reserve and other federal bank regulatory agencies have issued a proposed rule under the Dodd-Frank Act that would exempt “qualified residential mortgages” from the securitization risk retention requirements of the Dodd-Frank Act. The final definition of what constitutes a “qualified residential mortgage” may impact the pricing and depth of the secondary market into which we may sell mortgages we originate. At this time, we cannot predict the content of final CFPB and other federal agency regulations or the impact they might have on the Company’s financial results. The CFPB’s authority over mortgage lending, and its authority to change regulations adopted in the past by other regulators (i.e., regulations issued under the Truth in Lending Act, for example), or to rescind or ignore past regulatory guidance, could increase the Company’s compliance costs and litigation exposure.
The January 25, 2013 decision of the D.C. Circuit Court of Appeals invalidating recess appointments to the National Labor Relations Board, calls into question the recess appointment of Richard Cordray as head of the CFPB. What impact this potentially invalid appointment will have on the CFPB regulations promulgated in January, 2013 or actions taken prior to that time is undetermined at this time. The decision may also play a part in determining whether new legislation will be passed respecting the structure and funding of the CFPB, and whether Director Cordray will be appointed when his current term expires. Though it is not possible to predict the outcome of the recess appointment controversy, the decision will have implications for the Company and the Bank with respect to regulations that apply to them and to competition from other entities that may or may not be subject to regulations promulgated by the CFPB
The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, many of which may have an impact on the operating environment of the Company in substantial and unpredictable ways. Consequently, the Dodd-Frank Act is expected to increase our cost of doing business, it may limit or expand our permissible activities, and it may affect the competitive balance within our industry and market areas. The nature and extent of future legislative and regulatory changes affecting financial institutions, including as a result of the Dodd-Frank Act, is very unpredictable at this time. The Company’s management continues to actively monitor the implementation of the Dodd-Frank Act and the regulations promulgated thereunder and assess its probable impact on the business, financial condition, and results of operations of the Company. However, the ultimate effect of the Dodd-Frank Act on the financial services industry in general, and the Company in particular, remains uncertain.
INTERCHANGE FEES FOR DEBIT CARDS
Under the Dodd-Frank Act, interchange fees for debit card transactions must be reasonable and proportional to the issuer’s incremental cost incurred with respect to the transaction plus certain fraud related costs. Although institutions with total assets of less than $10 billion are exempt from this requirement, competitive pressures may require smaller depository institutions to reduce fees with respect to these debit card transactions.
TRANSACTIONS WITH AFFILIATES
Under Indiana law, the Bank is subject to Sections 22(h), 23A and 23B of the Federal Reserve Act, which restrict financial transactions between banks and affiliated companies, such as the Bancorp. The statute limits credit transactions between a bank and its executive officers and its affiliates, prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices, and restricts the types of collateral security permitted in connection with a bank's extension of credit to an affiliate.
FEDERAL SECURITIES LAW
The shares of Common Stock of the Holding Company have been registered with the SEC under the Securities Exchange Act (the “1934 Act”). The Holding Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the 1934 Act and the rules of the SEC thereunder. If the Holding Company has fewer than 300 shareholders, it may deregister its shares under the 1934 Act and cease to be subject to the foregoing requirements.
Shares of Common Stock held by persons who are affiliates of the Holding Company may not be resold without registration unless sold in accordance with the resale restrictions of Rule 144 under the Securities Act of 1933. If the Holding Company meets the current public information requirements under Rule 144, each affiliate of the Holding
Company who complies with the other conditions of Rule 144 (including those that require the affiliate’s sale to be aggregated with those of certain other persons) would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of (i) 1% of the outstanding shares of the Holding Company or (ii) the average weekly volume of trading in such shares during the preceding four calendar weeks.
Under the Dodd-Frank Act, beginning in 2013, the Holding Company will be required to provide its shareholders an opportunity to vote on the executive compensation payable to its named executive officers and on golden parachute payments made in connection with mergers or acquisitions. These votes will be non-binding and advisory. Beginning in 2013, the Holding Company must also permit shareholders to determine on an advisory basis whether such votes should be held every one, two, or three years.
COMMUNITY REINVESTMENT ACT MATTERS
Federal law requires that ratings of depository institutions under the Community Reinvestment Act of 1977 (“CRA”) be disclosed. The disclosure includes both a four-unit descriptive rating (specifically, outstanding, satisfactory, needs to improve, and substantial noncompliance) and a written evaluation of an institution’s performance. Each FHLB is required to establish standards of community investment or service that its members must maintain for continued access to long-term advances from the FHLBs. The standards take into account a member’s performance under the CRA and its record of lending to first-time home buyers. As of the date of its most recent regulatory examination, the Bank was rated “satisfactory” with respect to its CRA compliance.
OTHER FUTURE LEGISLATION AND CHANGE IN REGULATIONS
Various other legislation, including proposals to expand or contract the powers of banking institutions and bank holding companies, is from time to time introduced. This legislation may change banking statutes and the operating environment of the Holding Company and the Bank in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. The Holding Company cannot accurately predict whether any of this potential legislation will ultimately be enacted, and, if enacted, the ultimate effect that it, or implementing regulations, would have upon the financial condition or results of operations of the Holding Company or the Bank.
TAXATION
FEDERAL TAXATION
For federal income tax purposes, the Company has been reporting its income and expenses on the accrual method of accounting. The Holding Company and the Bank file a consolidated federal income tax return for each fiscal year ending December 31. The Company’s federal income tax returns have not been audited in recent years.
STATE TAXATION
The Company is subject to Indiana’s Financial Institutions Tax (“IFIT”), which is imposed at a flat rate of 8.5% on apportioned “adjusted gross income.” “Adjusted gross income,” for purposes of IFIT, begins with taxable income as defined by Section 63 of the Code and, thus, incorporates federal tax law to the extent that it affects the computation of taxable income. Federal taxable income is then adjusted by several Indiana modifications. Other applicable state taxes include generally applicable sales and use taxes plus real and personal property taxes. The Company’s state income tax returns have not been audited in recent years.
The Company is subject to Kentucky’s Bank Franchise Tax (“KBFT”), which is imposed at a flat rate of 1.1% on apportioned “net capital.” For purposes of the KBFT, “net capital” is determined by (1) adding together the Company’s paid-in capital stock, surplus, undivided profits, capital reserves, net unrealized gains or losses on certain securities, and cumulative foreign currency translation adjustments and (2) deducting from the total an amount equal to the same percentage of the total as the book value of U.S. obligations and Kentucky obligations bears to the book value of the total assets of the Company. “Kentucky obligations” are all obligations of the state, counties, municipalities, taxing districts, and school districts that are exempt from taxation under Kentucky law. Other applicable state taxes include generally applicable sales and use taxes as well as Kentucky bank deposit and local deposit taxes which are generally imposed on the Company with respect to the deposits of Kentucky resident individuals at rates of .001% and .025%, respectively.
ITEM 1A.
ITEM 1A. RISK FACTORS.
Not applicable.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES.
The following table provides certain information with respect to the Bank’s offices as of December 31, 2012.
In addition to the assets owned by the Bank, Madison First Services, a subsidiary of the Bank, owns two pieces of land, one in Madison, Indiana and the second in Charlestown, Indiana, both held for future expansion of the Company. Total book value of this land at December 31, 2012 was $427,000.
The Bank owns computer and data processing equipment which is used for transaction processing, loan origination, and accounting. The net book value of electronic data processing equipment owned by the Bank was approximately $503,000 at December 31, 2012.
The Bank operates 16 automated teller machines (“ATMs”), one at each office location, except for Dupont and 233 East Main St. (the main office has two), one at Hanover College, in Hanover, Indiana, one in the Big Lots parking lot in Madison, one at the Clark County Jail in Jeffersonville, Indiana, and one at Butler Mall in Carrolton, Kentucky. The Bank’s ATMs participate in the Passport® network.
The Bank performs its own data processing and reporting services.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
Neither the Holding Company nor the Bank is a party to any pending legal proceedings, other than routine litigation incidental to the Holding Company’s or the Bank’s business.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
ITEM 4.5. EXECUTIVE OFFICERS OF THE REGISTRANT.
The executive officers of the Holding Company are identified below. The executive officers of the Bank are elected annually by the Holding Company’s Board of Directors.
Matthew P. Forrester (age 56) has served as the Bank and Holding Company President and Chief Executive Officer since October 1999. Prior to that, Mr. Forrester served as Senior Vice President, Treasurer and Chief Financial Officer for Home Loan Bank and its holding company, Home Bancorp, in Fort Wayne, Indiana. Prior to joining Home Loan Bank, Mr. Forrester was an examiner for the Indiana Department of Financial Institutions. Mr. Forrester also serves as a Director of the Federal Home Loan Bank of Indianapolis.
Lonnie D. Collins (age 64) has served as Secretary of the Bank since September 1994 and as Secretary of the Holding Company since 1996. Mr. Collins has also practiced law since October 1975 and has served as the Bank’s outside counsel since 1980.
Vickie L. Grimes (age 57) has served as Vice President - Finance since May of 2007. Prior to that she acted as Controller for the Bank from September of 2006 until May of 2007. She also served as the Bank’s Internal Auditor from 2003 to September 2006, and as an accountant with the Bank from 2000 to 2003. Prior to that, she served as the Accounting Manager for a financial institution in Pueblo, Colorado.
Anthony D. Brandon (age 41) has served as Executive Vice President since July 29, 2005, and as Vice President of Loan Administration of the Bank since September of 2001. Prior to his appointment as Executive Vice President, he served as Vice President of Loan Administration. Prior to joining the Bank, he served as President of Republic Bank of Indiana.
Mark A. Goley (age 57) has served as Vice President of Loan Services since 1997. From 1989 to 1997, he served as Senior Loan Officer for Citizens.
William H. Hensler (age 49) has served as Vice President - Wealth Management since June of 2006. Prior to joining the Bank he served as a financial consultant with Hilliard Lyons.
John Muessel (age 60) has served as Vice President - Trust Officer since April of 2002. Prior to joining the Bank, he served as Trust Officer of National City Bank of Indiana.
Robert E. Kleehamer (age 70) has served as Senior Vice President - Business Development since October 2009 and was named an executive officer of the Holding Company in April 2010. From June 2008 to October 2009, he served as Vice President for the Bank in the same position. Prior to joining the Bank, he was Area President for First Harrison Bank, and President and organizing director of Hometown National Bank, a de novo bank opened in March of 1997, later sold to First Harrison Bank.
PART II
ITEM 5.
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information and Dividends
There were 1,524,872 common shares of River Valley Bancorp outstanding at February 22, 2013, held of record by approximately 306 shareholders. The number of shareholders does not reflect the number of persons or entities who may hold stock in nominee or “street name.” Since December 1996, the Company’s common shares have been listed on The NASDAQ Capital Market (formerly called the NASDAQ SmallCap Market) (“NASDAQ”), under the symbol “RIVR.” On December 26, 2003, the shares of River Valley underwent a 2-for-1 stock split in order to create a more liquid market for the stock.
Presented below are the high and low sale prices for the Holding Company’s common shares, as well as cash distributions paid thereon since January 2010. Such sales prices do not include retail financial markups, markdowns or commissions. Information relating to sales prices has been obtained from NASDAQ.
The high and low sale prices for the Holding Company’s common shares between December 31, 2012 and February 22, 2013, were $17.15 and $20.00, respectively.
Under Indiana law, the Bank may pay dividends of so much of its undivided profits (generally, earnings less losses, bad debts, taxes and other operating expenses) as is considered expedient by the Bank’s Board of Directors. However, the Bank must obtain the approval of the Indiana Department of Financial Institutions for the payment of a dividend if the total of all dividends declared by the Bank during the current year, including the proposed dividend, would exceed the sum of retained net income for the year to date plus its retained net income for the previous two years. For this purpose, “retained net income” means net income as calculated for call report purposes, less all dividends declared for the applicable period. In addition, the Bank may not pay a dividend if it would reduce its regulatory capital below the amount required for the liquidation account (which was established for the purpose of granting a limited priority claim on the assets of River Valley Financial, in the event of a complete liquidation, to those members of River Valley Financial before its conversion from mutual to stock form who continue to maintain a savings account at River Valley Financial).
The FDIC has the authority to prohibit the Bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the Bank.
Any dividend distributions by the Bank to the Holding Company in excess of current or accumulated earnings and profits will be treated for federal income tax purposes as a distribution from the Bank’s accumulated bad debt reserves, which could result in increased federal income tax liability for the Bank.
Since the Holding Company has no independent operation or other subsidiaries to generate income, its ability to accumulate earnings for the payment of cash dividends to its shareholders directly depends upon the ability of the Bank to pay dividends to the Holding Company and upon the earnings on its investment securities.
Generally, there is no Federal Reserve regulatory restriction on the payment of dividends by the Holding Company unless there is a determination by the Federal Reserve that there is reasonable cause to believe that the payment of dividends constitutes a serious risk to the financial safety, soundness or stability of the Bank. In addition, under Federal Reserve supervisory policy, a bank holding company generally should not maintain its existing rate of cash dividends on common shares unless (i) the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and (ii) the prospective rate of earnings retention appears
consistent with the organization’s capital needs, assets, quality, and overall financial condition. However, the Federal Reserve issued a letter dated February 24, 2009, to bank holding companies providing that it expects banks holding companies to consult with it in advance of declaring dividends that could raise safety and soundness concerns (i.e., such as when the dividend is not supported by earnings or involves a material increase in the dividend rate) and in advance of repurchasing shares of common or preferred stock. Indiana law, moreover, would prohibit the Holding Company from paying a dividend, if, after giving effect to the payment of that dividend, the Holding Company would not be able to pay its debts as they become due in the usual course of business or the Holding Company’s total assets would be less than the sum of its total liabilities plus preferential rights of holders of preferred stock, if any.
In November 2009, the Company issued 5,000 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A. For so long as any of these preferred shares remain outstanding, no dividend or distribution shall be declared or paid on the Company’s common stock unless all accrued and unpaid dividends on the preferred shares have been or will be first paid in full.
Equity Compensation Plans
The “Equity Compensation Plan Information” contained in Part III, Item 12 of this Annual Report on Form 10-K is incorporated herein by reference.
Issuer Purchases of Equity Securities
There were no shares repurchased during the three-month period ending December 31, 2012.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The following tables set forth certain information concerning the consolidated financial condition, earnings, and other data regarding River Valley at the dates and for the periods indicated. The following selected financial data is qualified by reference to and should be read in conjunction with the Consolidated Financial Statements, including the Notes thereto, presented in Item 8 - Financial Statements and Supplementary Data and in Item 7
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.
General
As discussed previously, the Holding Company was incorporated for the primary purpose of owning all of the outstanding shares of River Valley Financial. As a result, the discussion that follows focuses on River Valley Financial’s financial condition and results of operations for the periods presented. The following discussion and analysis of the financial condition as of December 31, 2012, and results of operations for periods prior to that date, should be read in conjunction with the Consolidated Financial Statements and the Notes thereto, included in Item 8 of this Annual Report on Form 10-K.
In addition to the historical information contained herein, the following discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements appear in a number of places in this Form 10-K and include statements regarding the intent, belief, outlook, estimate or expectations of the Company, its directors or its officers, primarily with respect to future events and the future financial performance of the Company. Readers are cautioned that any such forward-looking statements are not guarantees of future events or performance and involve risks and uncertainties. The Company’s operations and actual results could differ significantly from those discussed in the forward-looking statements. Some of the factors that could cause or contribute to such differences are discussed herein but also include, but are not limited to, changes in the economy and interest rates in the nation and River Valley Financial’s general market area; loss of deposits and loan demand to other financial institutions; substantial changes in financial markets; changes in real estate values and the real estate market; regulatory changes; or turmoil and government intervention in the financial services industry. The forward-looking statements contained herein include those with respect to the effect future changes in interest rates may have on financial condition and results of operations, and management’s opinion as to the effect on the Company’s consolidated financial position and results of operations of recent accounting pronouncements not yet in effect.
Effect of Current Events
The level of turmoil in the financial services industry continues to present unusual risks and challenges for the Company, as described below:
The Current Economic Environment. We continue to operate in a challenging and uncertain economic environment, including generally uncertain national conditions and local conditions in our markets. Overall economic growth continues to be slow and national and regional unemployment rates remain at elevated levels. The risks associated with our business become more acute in periods of a slow economic growth and high unemployment. Many financial institutions continue to be affected by an uncertain real estate market. While we continue to take steps to decrease and limit our exposure to problem loans, we nonetheless retain direct exposure to the residential and commercial real estate markets, and we are affected by these events.
Our loan portfolio includes commercial real estate loans, residential mortgage loans, and construction and land development loans. Declines in real estate values, home sales volumes and financial stress on borrowers as a result of the uncertain economic environment, including job losses, could have an adverse effect on our borrowers or their customers, which could adversely affect our financial condition and results of operations. In addition, the current level of low economic growth on a national scale, the occurrence of another national recession, or a deterioration in local economic conditions in our markets could drive losses beyond that which is provided for in our allowance for loan losses and result in the following other consequences: increases in loan delinquencies, problem assets and foreclosures may increase; demand for our products and services may decline; deposits may decrease, which would adversely impact our liquidity position; and collateral for our loans, especially real estate, may decline in value, in turn reducing customers’ borrowing power, and reducing the value of assets and collateral associated with our existing loans.
Impact of Recent and Future Legislation. Over the last four and one-half years, Congress and the Treasury Department have adopted legislation and taken actions to address the disruptions in the financial system, declines in the housing market and the overall regulation of financial institutions and the financial system. See Part I, Item 1 - Regulation and Supervision - Dodd-Frank Act for a description of recent significant legislation and regulatory actions affecting the financial industry. The Dodd-Frank Act is expected to increase our cost of doing business, it may limit or expand our permissible activities, and it may affect the competitive balance within our industry and market areas. The Company’s management continues to actively monitor the implementation of the Dodd-Frank Act and the regulations promulgated thereunder and assess its probable impact on the business, financial condition, and results of operations of the Company. However, the ultimate effect of the Dodd-Frank Act on the financial services industry in general, and the Company in particular, continues to be uncertain.
New Proposed Capital Rules. On June 7, 2012, the Federal Reserve approved proposed rules that would substantially amend the regulatory risk-based capital rules applicable to the Bank. The FDIC and the OCC subsequently approved these proposed rules on June 12, 2012. The proposed rules implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. “Basel III” refers to two consultative documents released by the Basel Committee on Banking Supervision in December 2009, the rules text released in December 2010, and loss absorbency rules issued in January 2011, which include significant changes to bank capital, leverage and liquidity requirements. The proposed rules received extensive comments during a comment period that ran through October 2012. In November 2012, the federal bank regulatory agencies jointly stated that they do not expect any of the proposed rules to become effective on the original target date of January 1, 2013. Basel III specified that banks should be compliant with the new capital requirements by January 2015, but on January 6, 2013, the restrictions were eased to provide for annual increases that would result in full compliance in 2019.
The proposed rules include new risk-based capital and leverage ratios, which would be phased in from 2013 to 2019, and would refine the definition of what constitutes “capital” for purposes of calculating those ratios. The proposed new minimum capital level requirements applicable to the Bank under the proposals would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. The proposed rules would also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase by that amount each year until fully implemented in January 2019. An institution would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations would establish a maximum percentage of eligible retained income that could be utilized for such actions.
Basel III provided discretion for regulators to impose an additional buffer, the “countercyclical buffer,” of up to 2.5% of common equity Tier 1 capital to take into account the macro-financial environment and periods of excessive credit growth. However, the proposed rules permit the countercyclical buffer to be applied only to “advanced approach banks” ( i.e. , banks with $250 billion or more in total assets or $10 billion or more in total foreign exposures), which currently excludes the Bank. The proposed rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that will no longer qualify as Tier 1 capital, some of which would be phased out over time.
The federal bank regulatory agencies also proposed revisions to the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels begin to show signs of weakness. These revisions would take effect January 1, 2015. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions would be required to meet the following increased capital level requirements in order to qualify as “well capitalized:” (i) a new common equity Tier 1 capital ratio of 6.5%; (ii) a Tier 1 capital ratio of 8% (increased from 6%); (iii) a total capital ratio of 10% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 5% (increased from 4%).
The proposed rules set forth certain changes for the calculation of risk-weighted assets, which we would be required to utilize beginning January 1, 2015. The standardized approach proposed rule utilizes an increased number of credit risk exposure categories and risk weights, and also addresses: (i) a proposed alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act Act; (ii) revisions to recognition of credit risk mitigation; (iii) rules for risk weighting of equity exposures and past due loans; (iv) revised capital treatment for derivatives and repo-style transactions; and (v) disclosure requirements for top-tier banking organizations with $50 billion or more in total assets that are not subject to the “advance approach rules” that apply to banks with greater than $250 billion in consolidated assets.
Based on our current capital composition and levels, we believe that we would be in compliance with the requirements as set forth in the proposed rules if they were presently in effect.
Changes in Insurance Premiums. The FDIC insures the Bank’s deposits up to certain limits. Current economic conditions have increased expectations for bank failures. The FDIC takes control of failed banks and ensures payment of deposits up to insured limits using the resources of the Deposit Insurance Fund. The FDIC charges us premiums to maintain the Deposit Insurance Fund. The FDIC has set the Deposit Insurance Fund long-term target reserve ratio at 2% of insured deposits. Due to recent bank failures, the FDIC insurance fund reserve ratio has fallen below the statutory minimum. The FDIC has implemented a restoration plan beginning January 1, 2009, that is intended to return the reserve ratio to an acceptable level. Further increases in premium assessments are also possible and would increase the Company’s expenses. Effective with the June 2011 reporting period, the FDIC changed the assessment
from a deposit-based assessment to an asset-based assessment, and reevaluated the base rate assessed to financial institutions. As a result of these changes, the Company experienced a decrease in premiums. However, increased assessment rates and special assessments could have a material impact on the Company’s results of operations.
The Soundness of Other Financial Institutions Could Adversely Affect Us. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. Many of these transactions expose us to credit risk in the event of default by our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations or earnings.
Difficult Market Conditions Have Adversely Affected Our Industry. We are particularly exposed to downturns in the U.S. housing market. Dramatic declines in the housing market over the past five years, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage loans and securities and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities, major commercial and investment banks, and regional financial institutions. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have continued to observe tight lending standards, including with respect to other financial institutions, although there have been signs that lending is increasing. These market conditions have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence and increased market volatility. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on the Company and others in the financial institutions industry. In particular, the Company may face the following risks in connection with these events:
·
We are experiencing, and expect to continue experiencing increased regulation of our industry, particularly as a result of the Dodd-Frank Act and the CFPB. Compliance with such regulation is expected to increase our costs and may limit our ability to pursue business opportunities
·
Our ability to assess the creditworthiness of our customers may be impaired if the models and approach we use to select, manage and underwrite our customers become less predictive of future behaviors.
·
The process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic predictions might impair the ability of our borrowers to repay their loans, which may no longer be capable of accurate estimation which may, in turn, impact the reliability of the process.
·
Our ability to borrow from other financial institutions on favorable terms or at all could be adversely affected by further disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations.
·
Competition in our industry could intensify as a result of the increasing consolidation of financial services companies in connection with current market conditions.
·
We may be required to pay significantly higher deposit insurance premiums because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.
In addition, the Federal Reserve Bank has been injecting vast amounts of liquidity into the banking system to compensate for weaknesses in short-term borrowing markets and other capital markets. A reduction in the Federal Reserve’s activities or capacity could reduce liquidity in the markets, thereby increasing funding costs to the Company or reducing the availability of funds to the Company to finance its existing operations.
Concentrations of Real Estate Loans Could Subject the Company to Increased Risks in the Event of a Real Estate Recession or Natural Disaster. A significant portion of the Company’s loan portfolio is secured by real estate. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A weakening of the real estate market in our primary market area could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. Historically, Indiana and Kentucky have experienced, on occasion, significant natural disasters, including tornadoes and floods. The availability of insurance for losses for such catastrophes is limited. Our operations could also be interrupted by such natural disasters. Acts of nature, including tornadoes and floods, which may cause uninsured damage and other loss of value
to real estate that secures our loans or interruption in our business operations, may also negatively impact our operating results or financial condition.
We are subject to cybersecurity risks and may incur increasing costs in an effort to minimize those risks. Our business employs systems and a website that allow for the secure storage and transmission of customers’ proprietary information. Security breaches could expose us to a risk of loss or misuse of this information, litigation and potential liability. We may not have the resources or technical sophistication to anticipate or prevent rapidly evolving types of cyber attacks. Any compromise of our security could result in a violation of applicable privacy and other laws, significant legal and financial exposure, damage to our reputation, and a loss of confidence in our security measures, which could harm our business.
Critical Accounting Policies
Note 1 to the Consolidated Financial Statements contains a summary of the Company’s significant accounting policies for the year ended December 31, 2012. Certain of these policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management believes that its critical accounting policies include determining the allowance for loan losses, analysis of other-than-temporary impairment on available-for-sale investments, and the valuation of mortgage servicing rights.
Allowance For Loan Losses
The allowance for loan losses is a significant estimate that can and does change based on management’s assumptions about specific borrowers and current economic and business conditions, among other factors. Management reviews the adequacy of the allowance for loan losses on at least a quarterly basis. The evaluation by management includes consideration of past loss experience, changes in the composition of the loan portfolio, the current economic condition, the amount of loans outstanding, identified problem loans, and the probability of collecting all amounts due.
The allowance for loan losses represents management’s estimate of probable losses inherent in the Company’s loan portfolios. In determining the appropriate amount of the allowance for loan losses, management makes numerous assumptions, estimates and assessments.
The Company’s strategy for credit risk management includes conservative, centralized credit policies, and uniform underwriting criteria for all loans as well as an overall credit limit for each customer significantly below legal lending limits. The strategy also emphasizes diversification on a geographic, industry and customer level, regular credit quality reviews and quarterly management reviews of large credit exposures and loans experiencing deterioration of credit quality.
The Company’s allowance consists of three components: probable losses estimated from individual reviews of specific loans, probable losses estimated from historical loss rates, and probable losses resulting from economic or other deterioration above and beyond what is reflected in the first two components of the allowance.
Larger commercial loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, reserves are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Company. Included in the review of individual loans are those that are considered impaired. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent. Any allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or fair value of the underlying collateral. The Company evaluates the collectibility of both principal and interest when assessing the need for a loss accrual. Historical loss rates are applied to other commercial loans not subject to specific reserve allocations.
Homogenous loans, such as consumer installment and residential mortgage loans, are not individually risk graded. Rather, standard credit scoring systems are used to assess credit risks. Reserves are established for each pool of loans based on the expected net charge-offs for one year. Loss rates are based on the average net charge-off history by loan category.
Historical loss rates for loans may be adjusted for significant factors that, in management’s judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs and nonaccrual loans), changes in mix, asset quality trends, risk management and loan administration, changes in the internal lending policies and credit standards, collection practices and examination results from bank regulatory agencies and the Company’s internal loan review. The portion of the allowance that is related to certain qualitative factors not specifically related to any one loan type is considered the unallocated portion of the reserve.
Allowances on individual loans and historical loss rates are reviewed quarterly and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience.
The Company’s primary market area for lending has been comprised of Clark, Floyd and Jefferson Counties in southeastern Indiana and portions of northeastern Kentucky adjacent to that market. With the acquisition of Dupont, the Company’s market area will include Jackson and Jennings Counties in Indiana. When evaluating the adequacy of the allowance, consideration is given to this regional geographic concentration and the closely associated effect changing economic conditions have on the Company’s customers.
Other-Than-Temporary Impairment
The Company evaluates all securities on a quarterly basis, and more frequently when economic conditions warrant additional evaluations, for determining if an other-than-temporary impairment (OTTI) exists pursuant to guidelines established by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), in ASC 320. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial conditions and near-term prospects of the issuer, and the ability and intent of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies or government-sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of review of the issuer’s financial condition.
If management determines that an investment experienced an OTTI, management must then determine the amount of the OTTI to be recognized in earnings. The Company’s consolidated statement of income would reflect the full impairment (that is, the difference between the security’s amortized cost basis and fair value) on debt securities that the Company intends to sell or would more likely than not be required to sell before the expected recovery of the amortized cost basis. For securities that management has no intent to sell, and it is not more likely than not that the Company will be required to sell prior to recovery, only the credit loss component of the impairment would be recognized in earnings, while the noncredit loss would be recognized in accumulated other comprehensive income. The credit loss component recognized in earnings is identified as the amount of principal cash flows not expected to be received over the remaining term of the security as projected based on cash flow projections. The Company did not record any other-than-temporary impairment during the year ended December 31, 2012.
Valuation of Mortgage Servicing Rights
The Company recognizes the rights to service mortgage loans as separate assets in the consolidated balance sheet. Under the servicing assets and liabilities accounting guidance (ASC 860-50), servicing rights resulting from the sale or securitization of loans originated by the Company are initially measured at fair value at the date of transfer. Mortgage servicing rights are subsequently carried at the lower of the initial carrying value, adjusted for amortization, or fair value. Mortgage servicing rights are evaluated for impairment based on the fair value of those rights. Factors included in the calculation of fair value of the mortgage servicing rights include estimating the present value of future net cash flows, market loan prepayment speeds for similar loans, discount rates, servicing costs, and other economic factors. Servicing rights are amortized over the estimated period of net servicing revenue. It is likely that these economic factors will change over the life of the mortgage servicing rights, resulting in different valuations of the mortgage servicing rights. The differing valuations will affect the carrying value of the mortgage servicing rights on the consolidated balance sheet as well as the income recorded from loan servicing in the consolidated income statement. As of December 31, 2012, mortgage servicing rights had a carrying value of $679,000.
Discussion of Changes in Financial Condition from December 31, 2011 to December 31, 2012
At December 31, 2012, the Company’s consolidated assets totaled $472.9 million, an increase of $66.2 million, or 16.3%, from the December 31, 2011 total. In addition, the Company’s consolidated liabilities also increased from $373.7 million at December 31, 2011to $437.3 million at December 31, 2012. The increases were primarily due to the acquisition of Dupont State Bank as the Company added $52.1 million in loans to its balance sheet, $12.1 million in available-for-sale securities, $78.3 million in deposits, $3.5 million in net cash and cash equivalents, and other lesser items. Additionally, the Company prepaid $12.5 million in Federal Home Loan Bank advances during 2012 using the liquidity generated from the acquisition of Dupont State Bank and related sales of investment securities. The penalties recognized on the prepayment of Federal Home Loan Bank advances was in part offset by the gains recognized on the investment sales. The result of these transactions should have a positive impact on the profit of the Company going forward as borrowings typically carry a higher cost than traditional deposits.
Liquidity for the Company continued to be strong, with the balances in cash and cash equivalents at $19.2 million as of December 31, 2012, as compared to balances of $18.7 million as of December 31, 2011.
With limited loan demand and the acquisition of Dupont State Bank, investment securities available for sale increased $9.1 million, or 8.7%, for the twelve month period, from $104.7 million at December 31, 2011 to $113.8 million as of December 31, 2012. Investments reported in the financial statements of the Company are held both at the Bank level and at the Bank’s Nevada subsidiaries, and all are available for sale. For the period, agency investments increased a total of $5.5 million, from $37.9 million at December 31, 2011 to $43.4 million at the same point in 2012. Government-sponsored enterprise (GSE) residential mortgage-backed and other asset-backed agency securities increased only slightly over the period by $1.3 million, or 3.7%, as the Company sold investment securities to take advantage of gain positions and to offset acquisition expenses and prepayment penalties on borrowings. Municipal investments increased by $2.5 million, representing a percentage increase period to period of 8.7%, from $28.7 million at December 31 2011 to $31.2 million at December 31, 2012. Corporate investments decreased by $200,000 during the twelve-month period, rounding out the overall increase in investment levels, period to period.
The Company evaluates all investments for other than temporary impairment quarterly. The twelve-month period ended December 31, 2012 brought continued scrutiny of the Company’s investments and in particular of asset quality and changes in the fair values of the individual investments. The Company’s securities are valued at fair value by a pricing service whose prices can be corroborated by recent security trading activities. The Company’s portfolio is comprised of the following types of investments.
Agency investments, which includes AAA-rated Federal Home Loan Mortgage Corp. (FHLMC), Federal National Mortgage Association (FNMA) and Federal Home Loan Bank (FHLB) investments, at an average tax equivalent yield of 1.79%, were at a net unrealized gain position at December 31, 2012. No agency investments were at an unrealized loss position for 12 consecutive months or more. The total carrying value of $43.4 million represents 38.1% of the total investment portfolio. Agency investments are primarily held at the Bank level, for liquidity purposes.
Collateralized mortgage obligations, which includes governmentally guaranteed FNMA, FHLMC, and Government National Mortgage Association (GNMA) REMICs, at an average tax equivalent yield of 2.54%, were at a net unrealized gain position at December 31, 2012. No collateralized mortgage obligation investments were at an unrealized loss position for 12 consecutive months or more. The total carrying value of $22.2 million represents 19.5% of the total investment portfolio.
Government-sponsored enterprise (GSE) residential mortgage-backed securities, which includes governmentally guaranteed FNMA, GNMA, and FHLMC Gold pools, at an average tax equivalent yield of 2.45%, were at a net unrealized gain position at December 31, 2012. No mortgage-backed investments were at an unrealized loss position for 12 consecutive months or more. The total carrying value of $13.9 million represents 12.2% of the total investment portfolio.
Municipal securities from a variety of sources, with an average tax equivalent yield of 5.44%, were at a net unrealized gain position at December 31, 2012. The portfolio is comprised of both general obligation (GO) bonds and revenue bonds. No municipal investments were at an unrealized loss position for 12 consecutive months or more. The total carrying value of $31.2 million represents 27.4% of the total investment portfolio.
Corporate investments, comprised of four “A2” or higher rated corporate bonds (Moody’s rated), were at a net unrealized gain at December 31, 2012, and two inactively traded trust preferred issues, with a total average tax equivalent yield of 1.56%, were at a net unrealized loss position at December 31, 2012. Both trust preferred investments have been at an unrealized loss for 12 consecutive months or more. The four corporate bonds were
purchased in the third quarter of 2011 and were at a continuous loss position for the remainder of 2011, but the corporate investments rallied to a gain position by the end of 2012. The trust preferred issues remained at a loss position for the entirety of 2012. Because the Company expects full repayment of these investments, does not intend to sell the investments prior to maturity, and because it is not “more likely than not” that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2012. Total corporate and other investments, with total carrying value of $3.2 million, represent 2.8% of the total investment portfolio. Both issues of trust preferred securities represent some potential risk to the Company simply by virtue of their attributes. They are discussed individually below.
The ALESCO 9A class A2A (ALESCO 9A) investment and the Preferred Term Security XXVII, LTD class A-1 (PRETSL XXVII) investment are both thinly traded. Both issues are backed by financial institutions and insurance companies, and the current pricing reflects inactivity in the markets for trust preferred issues. As the national economic woes have continued some of the underlying financial institutions have defaulted on or deferred interest payments. Some curing of these defaults has occurred as conditions improve. While these defaults/deferrals may negatively affect the lower tranches of the issues, the Bank holds the top tranche of PRETSL XXVII and the second highest tranche of ALESCO 9A. The collateralization levels on these issues are still more than adequate for the Bank to be protected. Both cash flow and other analysis, performed by independent third party analysts, and reviewed by management, indicate that it is more than likely that these investments will continue to maturity, and are thus only temporarily impaired. Cash flow analysis indicates that full payment of the tranches held by the Bank is expected by maturity, if not before.
In November 2007, the Company purchased $1.0 million face value of ALESCO 9A trust preferred stock at a price of $88.81 ($888,100). At December 31, 2012, this investment was priced by a third party pricing service and was carried on the Company’s books at a market value of $438,000 and at an amortized cost on that date of $903,000. The net unrealized loss on this investment at December 31, 2012 was $465,000. These figures as of December 31, 2011 were: market value of $488,000, amortized cost of $900,000, and net unrealized loss of $412,000, indicating improvement period to period. 2011 levels were all improvements over 2010, indicating a trend of improvement in the investment. The Company has reviewed the pricing analytics reports for this investment and has determined that the decline in the market price of this investment is temporary and indicates thin trading activity, rather than a true decline in the value of the investment. Factors considered in reaching this determination included the class or “tranche” held by the Company, A2A, the projected cash flows as of December 31, 2012, which indicate that the Company will receive all contractual payments on or before maturity, and the current collateral position of the tranche, 122.0%, which while below the trigger collateralization of 146.20%, still reflects sufficient coverage for the tranche. The interest coverage ratio is 276.32%, on a trigger amount of 125.00%, indicating strong coverage for interest payments to the “A” tranche. Because the Company does not intend to sell this investment and because it is not “more likely than not” that the Company will be required to sell this investment before recovery of its amortized cost basis, which may be maturity, the Company does not consider this investment to be other-than-temporarily impaired at December 31, 2012.
In February 2008, the Company purchased $1.0 million face value of PRETSL XXVII trust preferred stock at a price of $90.00 ($900,000). At December 31, 2012, this investment was priced by a third party pricing service and was carried on the Company’s books at a market value of $759,000 and at an amortized cost on that date of $815,000. The net unrealized loss on this investment at December 31, 2012 was $56,000. These figures as of December 31, 2011 were: market value of $603,000, amortized cost of $862,000, and net unrealized loss of $259,000, indicating improvement period to period. The investment has received quarterly pay down of principal for the entire period the Company has held the investment. The Company has reviewed the pricing analytics reports for this investment and has determined that the decline in the market price of this investment is temporary and indicates thin trading activity, rather than a true decline in the value of the investment. Factors considered in reaching this determination included the class or “tranche” held by the Company, A-1, the current collateral position of the tranche, 157.0%, and the projected cash flows as of December 31, 2012, which indicate that the Company will receive all contractual payments on or before maturity. Because the Company does not intend to sell this investment and because it is not “more likely than not” that the Company will be required to sell this investment before recovery of its amortized cost basis, which may be maturity, the Company does not consider this investment to be other-than-temporarily impaired at December 31, 2012.
For the twelve-month period ended December 31, 2012, net loans, excluding loans held for sale, increased from $253.1 million at December 31, 2011 to $305.6 million at December 31, 2012, primarily due to the purchase of Dupont State Bank and the $52.1 million in loans that came with that purchase. The loans acquired from Dupont State Bank were adjusted to fair value at the time of acquisition.
The difficult lending environment and sluggish economy continued to affect loan production with little increase in the
portfolio outside of the Dupont State Bank acquisition. Foreclosures continued at a lesser level than prior years, as $2.0 million of real estate collateral for non-performing loans transferred to real estate owned and held for sale (REO). Real estate owned as a result of foreclosure at December 31, 2012 totaled $1.6 million as compared to $2.5 million at the same point in 2011, a decrease of $900,000, or 36.0% period to period. The Company closely monitors the values of these properties, and additional charge downs were taken as necessary based on current fair value information such as appraisal data and pending sales offers. Write down of REO for, the twelve-month period ended December 31, 2012 was $300,000 as compared to $614,000 for the year ending December 31, 2011.
Sales of loan into the secondary market continued to be strong during 2012 and increased from the 2011 levels which were strong also. Proceeds from sales for 2012 were $33.4 million as compared to proceeds of $24.5 million for 2011. Sales into the secondary market are an important source of noninterest income for the Company and helped offset the costs associated with the acquisition of Dupont State Bank and the write-downs on the carrying value of real estate held for sale.
The Company’s consolidated allowance for loan losses totaled $3.6 million at December 31, 2012, as compared to $4.0 million at December 31, 2011. Provision expense of $1.4 million for 2012 was offset by net charge-offs of $1.8 million. This compared to provision expense for 2011 of $2.8 million and net charge-offs of $2.6 million. Net charge-offs for the year ended December 31, 2012 were comprised of properties that have labored through the foreclosure process, most for as long as two to three years, and included the charge-off of approximately $1.0 million of specific reserves at December 31, 2011. In addition, net charge-offs included approximately $902,000 for partial charge-offs as a result of the Company’s ongoing evaluation of problem loans and the related collateral values. The allowance for loan losses represented 1.15% of total loans as of December 31, 2012 as compared to 1.56% as of December 31, 2011. The allowance for loan losses, as a percentage of loans, declined primarily due to a reduction in specific reserves and the increase in loans outstanding. At December 31, 2012, specific reserves totaled $794,000 as compared to $1.4 million at December 31, 2011. In addition, loans increased approximately $52.0 million from December 31, 2011 to December 31, 2012 due primarily to loans added in the Dupont State Bank acquisition. These loans were recorded at fair value at acquisition and totaled $50.5 million at December 31, 2012.
Delinquency 30 or more days past due as of December 31, 2012 was $5.6 million, or 1.8% of total loans, as compared to $10.8 million, or 4.3%, at December 31, 2011. The 2012 decrease was due primarily to culmination of lengthy loan foreclosures that resulted in the real estate held for sale discussed above, and on greatly improved delinquency trends throughout the year. Average delinquency for the fiscal year 2012 was 3.00% as compared to 4.49% for the same period in 2011. The 2012 average delinquency rate was the lowest since 2008.
Non-performing loans (defined as loans delinquent greater than 90 days and loans on nonaccrual status) as of December 31, 2012 were $10.9 million, compared to $9.9 million at December 31, 2011. Non-performing loans as a percent of net loans were 3.55% and 3.90%, respectively, for those periods. The total of non-performing loans and loans performing under a troubled debt restructuring agreement as of December 31, 2012 was $14.7 million, or 4.82% of net loans. This compares to $16.8 million and 6.64% of net loans at the same date in 2011. Non-performing levels are primarily comprised of loans in the lengthy process of foreclosure or debt that has been restructured.
As a significant part of its management of delinquent loans, the Bank continued to focus on the analysis of problem loans and adjustments of those loans to fair value through the establishment of specific valuation allowances or partial charge off of loan balances. In addition to the $902,000 in partial charge-offs mentioned above, as of December 31, 2012, the Bank had $794,000 in specific valuation allowances for potential losses. This compares to $1.4 million at the same point in 2011. The general reserve for loan losses was $2.8 million at December 31, 2012 as compared to $2.6 million at December, 31 2011. As a percent of loans outstanding on these dates, the general reserve was 0.89% of total loans as of December 31, 2012 and 1.00% as of the same date in 2011. This percentage declined primarily due to the increase in loans outstanding. As noted above, the increase in loans from December 31, 2011 to December 31, 2012 was primarily due to the acquisition of Dupont State Bank.
Risk due to growth in these economically challenging times was mitigated by selective underwriting of the borrower and in increasing requirements for amount and type of collateral securing the debt. The Bank is conservative in its lending practices and does not originate the type of loans publicized as “sub-prime” and therefore does not anticipate delinquencies other than those normally associated with the economic trends of the Bank’s market areas. As of December 31, 2012, those trends had improved locally, regionally, and nationally, with unemployment rates lower on average from the 2010 and 2011 rates.
Management believes the level of the allowance at December 31, 2012 to be adequate based upon historical experience, the volume and type of lending conducted by the Company and current delinquency levels. However, there can be no assurance that additions to such allowance will not be necessary in future periods, which could negatively affect the Company’s results of operations. Management is diligent in monitoring delinquent loans and in the analysis of the factors affecting the allowance.
Other significant changes in assets during the period included a $2.8 million increase in premises and equipment directly related to the acquisition of Dupont State Bank and a slight increase in the total of Federal Home Loan Bank stock of $369,000, from $4.2 million as of December 31, 2011 to $4.6 million as of that same date in 2012. This was also a result of the acquisition.
Deposits totaled $384.3 million at December 31, 2012, an increase of $79.0 million, or 25.9%, from total deposits of $305.2 million at December 31, 2011, primarily due to the $78.3 million in deposits acquired from Dupont State Bank. During the twelve-month period, the Company continued to see a shift from maturity and interest-bearing demand deposits, to noninterest-bearing accounts, as the average balance of noninterest-bearing transactional deposit accounts increased by $6.7 million, or 26.7%, period to period, while the average balance of interest-bearing accounts increased 6.0%, or $16.0 million. These shifts were mirrored in the balances acquired from Dupont State Bank with funds primarily held in noninterest-bearing transactional accounts. At period end, the change in balances from December 31, 2011 to December 31, 2012 included noninterest-bearing deposits which increased $16.0 million from $24.5 million to $40.5 million; interest-bearing demand deposit accounts which increased $33.7 million from $160.7 million to $194.4 million; and certificate of deposit accounts which increased $29.3 million, or 24.4%, from $120.1 million to $149.4 million.
As loan balances and loan demand decreased and deposit levels continued to increase, the challenge to the Company was to place excess funds in earning assets, while maintaining the flexibility to meet interest rate risk challenges and provide sufficient, accessible liquidity for the Company. During the twelve months ended December 31, 2012, the Company met this challenge by purchasing investments specific to those purposes and prepaying certain borrowings.
Amounts borrowed by the Company declined period to period from $65.2 million at December 31, 2011, to $49.7 million as of December 31, 2012. Advances from the Federal Home Loan Bank represent the largest portion of those balances at $42.5 million at December 31, 2012 as compared to $58.0 million at December 31, 2011. The decrease in the balances of advances held was primarily the result of the previously mentioned prepayment of $12.5 million in advances with the proceeds in part from sales of $5.2 million in available-for- sale securities. The net effect allowed for an improvement of the overall net interest margin as the Company prepaid the higher costing borrowings by selling lower yielding investments at a profit. The average cost of borrowings for the twelve-month period ended December 31, 2012 was 3.67% as compared to the cost of traditional deposits, 0.94%, for the same period. The Federal Home Loan Bank (FHLB) is the Company’s primary source of wholesale funding. The average rates paid on those borrowings increased 28 basis points across the period, from 3.55% as of December 31, 2011 to 3.83% as of December 31, 2012, directly a result of the accelerated prepayment mentioned. Borrowing costs of $2.3 million for the twelve months ended December 31, 2012 compared to $2.4 million for the same period in 2011.
Stockholders’ equity totaled $35.6 million at December 31, 2012, an increase of $2.6 million, or 8.0%, from the $33.0 million at December 31, 2011. The increase was primarily due to year-to-date earnings of $4.0 million which included a bargain purchase gain of $988,000 related to the acquisition of Dupont State Bank. The Company paid dividends totaling $1.6 million to preferred and common shareholders. Dividends to common shareholders for the twelve-month period were $.84 per share. During the fiscal year 2012, the Bank paid dividends to the Company totaling $2.0 million, the same amount as in the prior twelve-month period ended December 31, 2011. Dividends from the Bank to the Company are eliminated in consolidation.
The Bank is required to maintain minimum regulatory capital pursuant to federal regulations. At December 31, 2012, the Bank’s regulatory capital exceeded all applicable regulatory capital requirements.
Comparison of Results of Operations for the Years Ended December 31, 2012 and 2011
General
River Valley’s net income for the year ended December 31, 2012, totaled $4.0 million, a increase of $2.2 million, or 126.4%, from net income of $1.8 million reported for the same period in 2011. The change in income period to period was comprised of a variety of changes that occurred over the period, most obviously the $988,000 bargain purchase gain on the acquisition of Dupont State Bank in November of 2012. Total interest income decreased $202,000, or 1.14%, from $17.7 million for the twelve months ended December 31, 2011 to $17.5 million for the same period in 2012, as yields on interest-earning assets dropped. Offsetting the decrease in interest income was a more dramatic decrease in interest expense, with interest expense for the twelve months ended December 31, 2012 decreasing $823,000, or 14.1%, from $5.8 million for the twelve-month period in 2011 to $5.0 million for the sameperiod in 2012, as deposit and borrowing average costs of funds dropped from 1.74% for the twelve-month period ended December 31, 2011 to 1.43% for the same period in 2012. These changes continued to benefit the Company during the year, with net interest income of $12.5 million as compared to $11.9 million at the same point in 2011, an increase of $621,000, or 5.2%. Provision expense declined year to year, to $1.4 million for the twelve months ended December 31, 2012, as compared to $2.8 million for the same period a year before. The increase in noninterest
income came primarily from the $988,000 bargain purchase gain related to the acquistion of Dupont State Bank. Other significant factors affecting net income for the twelve-month period ended December 31, 2012 were strong income from the sale of loans into the secondary market, primarily to the Federal Home Loan Mortgage Corporation, offset by increases in salaries and benefits, as professional personnel were added, and increases in professional fees and other costs associated with acquisition activities of the Company.
With the increase in pre-tax income, income tax expense increased, with the effective tax rate for 2011 of 5.5% increasing to 17.6% for 2012. Income from municipal investments held at the Company’s Nevada subsidiaries and increases in the cash surrender value of Bank-owned life insurance continue to contribute to the effective tax rate as the percentage of non-taxable income to total income remains elevated.
Net Interest Income
Total interest income for the year ended December 31, 2012, was $17.5 million, a decrease of $202,000, or 1.14%, from the 2011 total of $17.7 million. The average balance of interest-earning assets outstanding year-to-year increased, by $22.7 million, or 6.09%, as loan receivables and available-for-sale investment balances increased.
The average balance of loans receivable for the twelve-month period ended December 31, 2012 increased 0.91%, or $2.4 million, over the same period in 2011. With a modest change in yields, 5.48% for the twelve months ended December 31, 2012 as compared to 5.63% for the same period in 2011, interest income from loans receivable decreased 1.8%, to $14.5 million for the year ending December 31, 2012, from $14.8 million for the year ending December 31, 2011.
The average balance of investments increased $21.0 million, from $89.2 million in 2011 to $110.2 million in 2012. Interest income on investment securities increased slightly from $2.7 million at December 31, 2011 to $2.8 million for the same period in 2012, as the increase in average balances was not able to overcome the dramatic decline in yields, with the average yield for 2012 of 2.54% as compared to 3.08% in 2011. As in 2011, the Company took advantage of gain positions on some investments with gain on sale for 2012 of $997,000 much higher than the $312,000 for the same period a year earlier. Investments held at the Bank level are held primarily for liquidity purposes, whereas longer termed asset-backed and municipal securities, used for investment purposes, are held at a Nevada subsidiary.
Interest-earning deposits held by the Company decreased slightly, period to period, with the average balance of those deposits being $15.2 million for 2012, as compared to $15.7 million for 2011, a negligible decrease. Income from interest-earning deposits was $35,000 for the period ended December 31, 2012 as compared to $34,000 for the period ended December 31, 2011.
For the period ending December 31, 2012, total interest expense was $5.0 million, a significant drop of $823,000, or 14.1%, from the $5.8 million for the period ended December 31, 2011. Interest expense for the Company is comprised of interest on funds deposited with the Company and expense on borrowings by the Company.
The average balance of total deposits increased from $295.0 million at December 31, 2011 to $326.6 million at December 31, 2012, an increase of $31.6 million, or 10.7%. The average balance of interest-bearing deposits increased from $270.0 million at December 31, 2011 to $286.1 million at December 31, 2012, an increase of $16.1 million, or 5.9%. The average cost of interest-bearing deposits dropped from 1.28% to 0.94%, 2011 to 2012, with total interest expense on deposits for the period ending December 31, 2012 at $2.7 million, down $779,000, or 22.5%, from the $3.5 million for the period ending December 31, 2011. While portions of the decrease in interest expense on deposits was due to downward adjustment of rates, portions of the decrease were due to changes in the mix of deposits, with customers moving their money to transactional accounts, rather than time accounts, in the current rate environment.
Over the same period, the cost of borrowings increased from 3.64% to 3.67%, however, the amount of interest expense decreased by $44,000, or 1.86%, as borrowings were repaid with excess funds from deposits. Total interest expense for borrowings for the period ended December 31, 2012 was $2.3 million, as compared to $2.4 million for the same period ended 2011.
In summary, during the period ending December 31, 2012, the cost of interest-bearing deposits and borrowings dropped to a greater extent than the yields on interest-earning assets, a benefit to net interest income in total. Net interest income for the period ending December 31, 2012 was $12.5 million, up $621,000, or 5.2%, from the $11.9 million for the same period ending December 31, 2011.
Provision for Losses on Loans
A provision for losses on loans is charged to income to bring the total allowance for loan losses to a level considered appropriate by management based upon historical experience, the volume and type of lending conducted by the
Company, the status of past due principal and interest payment, general economic conditions, particularly as such conditions relate to the Company’s market area, and other factors related to the collectibility of the Company’s loan portfolio. As a result of such analysis, management recorded a $1.4 million provision for losses on loans for the twelve months ended December 31, 2012, as compared to $2.8 million for the same period in 2011. The Company is diligent in assessing the status of problem loans, including those in the lengthy process of foreclosure. Delinquencies in total declined significantly as foreclosures pending during the last 12 to 18 months have been resolved, and new delinquencies remain controlled. The average delinquency rate for the fiscal year of 2012 was 3.00% as compared to 4.49% for fiscal year 2011.
Non-performing loans (defined as loans delinquent greater than 90 days and loans on nonaccrual status) plus troubled debt restructured as of December 31, 2012 were $14.7 million, compared to $16.8 million at December 31, 2011. Non-performing loans and troubled debt restructured as a percent of net loans were 4.82% and 6.64%, respectively, for those periods. Non-performing levels are primarily comprised of loans in the lengthy process of foreclosure or debt that has been restructured.
Of total non-performing loans, approximately $1.4 million have been past due for twelve months or more, have been reduced by partial charge-off of confirmed losses or protected by specific reserve allocations, and are in the lengthy process of work out or foreclosure. Non-performing loans of the Company average 298 days past due, emphasizing the fact that these are loans that have been moving slowly through the foreclosure process for a period of time. From time to time, the Company may be required to charge down loans that are performing loans because of collateral shortfalls identified through appraisal review or other methods. While management believes that the allowance for losses on loans is adequate at December 31, 2012, based upon the available facts and circumstances, there can be no assurance that the loan loss allowance will be adequate to cover losses on non-performing assets in the future.
Other Income
Other income increased by $2.8 million, or 91.8%, during the twelve months ended December 31, 2012 to $5.8 million, as compared to the $3.0 million reported for the same period in 2011. The increase was due primarily to a bargain purchase gain of $988,000 related to the acquisiton of Dupont State Bank in the fourth quarter of 2012. Net losses on other real estate owned, which includes fair value adjustments for those properties of $300,000, were $577,000 for the twelve-month period ended December 31, 2012, as compared to $750,000 for the same period in 2011, a change of $173,000. Other notable increases in other income included a significant increase in gains on the sale of available-for-sale securities, $997,000 for the twelve months ended December 31, 2012, as compared to $312,000 for the same period in 2011, and a noticeable increase in gains on the sale of loans into the secondary market, primarily to Freddie Mac, $1.2 million for the twelve months ended December 31, 2012, as compared to $730,000 for the same twelve months in 2011. Income from service charges, such as that for overdraft of deposit accounts, increased only slightly over the period, from $1.9 million for the twelve-month period ending December 31, 2011 to $2.1 million for the same period ending December 31, 2012. Income such as service charge and fee income is dependent upon consumer practices and somewhat upon regulatory pressures to reduce such fees. Unlike interest income, “Other Income” is not always readily predictable and is subject to variations depending on outside influences, including regulatory changes.
Other Expenses
Total other expenses increased $1.8 million, or 17.3%, from December 31, 2011 to December 31, 2012. Increases were experienced in several financial statement lines. The most significant financial statement changes, both increases and decreases, are as follows.
Salaries and employee benefits increased 12.1% period to period, from $5.3 million for the twelve months ended December 31, 2011 to $6.0 million for the same period in 2012. This reflects the addition of professional and branch personnel and increases in benefits, including health insurance increases.
A prepayment penalty to the Federal Home Loan Bank of Indianapolis in the amount of $392,000 was recognized in relation to the prepayment of $12.5 million of advances.
Acquisition costs increased $170,000 from $212,000 for the twelve months ended December 31, 2011 to $382,000 for the same period in 2012.
Other administrative costs, including business services, office supply costs, data processing fees, and net occupancy and equipment, increased for the twelve months ended December 31, 2012 as compared to the same period in 2011, reflecting the addition of new branches from the acquisition of Dupont State Bank.
Income Taxes
Tax expense of $859,000 was recorded for the twelve-month period ended December 31, 2012, as compared to $103,000 for the comparable period in 2011. For the 2012 period, the Company had pre-tax income of $4.9 million, as compared to $1.9 million for the 2011 period. The increase in taxable income as a percent of total income was responsible for the increase in the effective tax rate. The effective tax rate was 17.6% for the twelve-month period ended December 31, 2012, as compared to 5.5% for the same period in 2011. The tax calculations for both periods include the benefit of tax-exempt income from municipal investments and cash surrender life insurance, partially offset by the effect of nondeductible expenses.
Average Balance, Yield, Rate and Volume Data
The following table presents certain information relating to River Valley’s average balance sheet and reflects the average yield on interest-earning assets and the average cost of interest-bearing liabilities for the periods indicated. Such yields and costs are derived by dividing annual income or expense by the average daily balance of interest-earning assets or interest-bearing liabilities, respectively, for the years presented. Average balances are derived from daily balances, which include nonaccruing loans in the loan portfolio.
(1)
Includes securities available for sale at fair value.
(2)
Total loans less loans in process plus loans held for sale.
(3)
Includes Noninterest Demand Deposit Accounts of $31,464, $24,945 and $23,858.
(4)
Interest rate spread is calculated by subtracting weighted average interest rate cost from weighted average interest rate yield for the period indicated.
(5)
The net yield on weighted average interest-earning assets is calculated by dividing net interest income by weighted average interest-earning assets for the period indicated.
Rate/Volume Table
The following table describes the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have affected River Valley’s interest income and expense during the years indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) changes in rate (change in rate multiplied by prior year volume), and (iii) total changes in rate and volume. The combined effects of changes in both volume and rate, which cannot be separately identified, have been allocated proportionately to the change due to volume and the change due to rate:
Liquidity and Capital Resources
The Company’s principal sources of funds are deposits, loan and mortgage-backed securities repayments, maturities of securities, borrowings and other funds provided by operations. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and loan and mortgage-backed securities prepayments are more influenced by interest rates, general economic conditions and competition. The Company maintains investments in liquid assets based upon management’s assessment of (1) the need for funds, (2) expected deposit flows, (3) the yield available on short-term liquid assets and (4) the objectives of the asset/liability management program.
At December 31, 2012, the Bank had commitments to originate loans totaling $6.2 million and in addition, had undisbursed loans in process, unused lines of credit and standby letters of credit totaling $38.9 million.
At December 31, 2012, the Bank had $4.1 million in commitments to sell loans.
Federal regulations require the Bank to maintain sufficient liquidity to ensure its safe and sound operation. The Company considers the Bank’s liquidity and capital resources sufficient to meet outstanding short- and long-term needs.
The Company’s liquidity, primarily represented by cash and cash equivalents, is a result of the funds provided by or used in the Company’s operating, investing and financing activities. These activities are summarized below for the years ended December 31, 2012, 2011 and 2010:
The Bank is required by applicable law and regulation to meet certain minimum capital standards. Such capital standards include a Tier 1 capital requirement, a core capital requirement, and a risk-based capital requirement. See Footnote 16 to the Consolidated Financial Statements.
The Bank exceeded all of the regulatory capital requirements at December 31, 2012. The following table summarizes the regulatory capital requirements and regulatory capital of the Bank at December 31, 2012:
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and Notes thereto included herein have been prepared in accordance with generally accepted accounting principles, which require the Company to measure financial position and results of operations in terms of historical dollars, with the exception of investment and mortgage-backed securities available-for-sale, which are carried at fair value. Changes in the relative value of money due to inflation or recession are generally not considered.
In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the rate of inflation. While interest rates are greatly influenced by changes in the rate of inflation, they do not change at the same rate or in the same magnitude as the rate of inflation. Rather, interest rate volatility is based on changes in the expected rate of inflation, as well as changes in monetary and fiscal policies.
Off-Balance Sheet Arrangements
As of the date of this Annual Report on Form 10-K, the Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, change in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. The term “off-balance sheet arrangement” generally means any transaction, agreement, or other contractual arrangement to which any entity unconsolidated with the Company is a party and under which the Company has (i) any obligation arising under a guarantee contract, derivative instrument or variable interest; or (ii) a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable for Smaller Reporting Companies.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
River Valley Bancorp
December 31, 2012 and 2011
Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Stockholders
River Valley Bancorp
Madison, Indiana
We have audited the accompanying consolidated balance sheets of River Valley Bancorp as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for the years then ended. The Company's management is responsible for these financial statements. Our responsibility is to express an opinion on these consolidated 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing auditing procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Our audits also included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management and 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 River Valley Bancorp as of December 31, 2012 and 2011, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
/s/ BKD, LLP
Indianapolis, Indiana
March 19, 2013
River Valley Bancorp
Consolidated Balance Sheets
December 31, 2012 and 2011
See Notes to Consolidated Financial Statements
River Valley Bancorp
Consolidated Statements of Income
Years Ended December 31, 2012 and 2011
See Notes to Consolidated Financial Statements
River Valley Bancorp
Consolidated Statements of Comprehensive Income
Years Ended December 31, 2012 and 2011
See Notes to Consolidated Financial Statements
River Valley Bancorp
Consolidated Statements of Stockholders’ Equity
Years Ended December 31, 2012 and 2011
See Notes to Consolidated Financial Statements
River Valley Bancorp
Consolidated Statements of Cash Flows
Years Ended December 31, 2012 and 2011
See Notes to Consolidated Financial Statements
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Note 1:
Nature of Operations and Summary of Significant Accounting Policies
The accounting and reporting policies of River Valley Bancorp (Holding Company) and its wholly owned subsidiary, River Valley Financial Bank (Bank) and the Bank’s wholly owned subsidiaries, Madison 1st Service Corporation (First Service), RVFB Investments, Inc. (RVFB Investments), RVFB Holdings, Inc. (RVFB Holdings), and RVFB Portfolio, LLC (RVFB Portfolio) (collectively referred to as “Company”), conform to accounting principles generally accepted in the United States of America and reporting practices followed by the thrift industry. The more significant of the policies are described below.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
The Company is a bank holding company whose principal activity is the ownership and management of the Bank. Until November 9, 2012, the Bank operated under a federal thrift charter, and thereafter, as part of the acquisition and merger with Dupont State Bank, it converted to an Indiana state commercial bank. The Bank provides full banking services, in a single significant business segment. The Holding Company is regulated and supervised by the Board of Governors of the Federal Reserve System (Federal Reserve) and the Bank is regulated by the Indiana Department of Financial Institutions (DFI) and the Federal Deposit Insurance Corporation (FDIC).
The Bank generates commercial, mortgage and consumer loans and receives deposits from customers located primarily in southeastern Indiana and adjacent areas in Kentucky. The Bank’s loans are generally secured by specific items of collateral including real property, consumer assets and business assets.
Consolidation - The consolidated financial statements include the accounts of the Holding Company and its subsidiary, the Bank. The Bank currently owns four subsidiaries. First Service, which was incorporated under the laws of the State of Indiana on July 3, 1973, currently holds land and cash but does not otherwise engage in significant business activities. RVFB Investments, RVFB Holdings, and RVFB Portfolio were established in Nevada the latter part of 2005. They hold and manage a significant portion of the Bank’s investment portfolio. All significant inter-company balances and transactions have been eliminated in the accompanying consolidated financial statements.
Cash equivalents - The Company considers all liquid investments with original maturities of three months or less to be cash equivalents. At December 31, 2012 and 2011, cash equivalents consisted of cash accounts with other financial institutions and federal funds sold.
Effective July 21, 2010, the FDIC’s insurance limits were permanently increased to $250,000. At December 31, 2012, the Company’s cash accounts exceeded federally insured limits by approximately $12.7 million. Included in this amount is approximately $4.1 million with the Federal Reserve Bank and $1.8 million with the Federal Home Loan Bank of Indianapolis.
Pursuant to legislation enacted in 2010, the FDIC fully insured all noninterest-bearing transaction accounts beginning December 31, 2010 through December 31, 2012, at all FDIC-insured institutions. Beginning January 1, 2013, noninterest-bearing transaction accounts are subject to $250,000 FDIC insurance limit per covered institution.
Investment securities are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
For debt securities with fair value below amortized cost when the Company does not intend to sell a debt security, and it is more likely than not that the Company will not have to sell the security before recovery of
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
its cost basis, it recognizes the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment is amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.
The Company’s consolidated statement of operations as of December 31, 2012, would reflect the full impairment (that is, the difference between the security’s amortized cost basis and fair value) on debt securities that the Company intends to sell or would more likely than not be required to sell before the expected recovery of the amortized cost basis. For available-for-sale and held-to-maturity debt securities that management has no intent to sell, and it is not more likely than not that the Company will be required to sell prior to recovery, only the credit loss component of the impairment would be recognized in earnings, while the noncredit loss would be recognized in accumulated other comprehensive income. The credit loss component recognized in earnings is identified as the amount of principal cash flows not expected to be received over the remaining term of the security as projected based on cash flow projections. The Company did not record any other-than-temporary impairment during the years ended December 31, 2012 and 2011.
Loans held for sale are carried at the lower of aggregate cost or market. Market is determined using the aggregate method. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income based on the difference between estimated sales proceeds and aggregate cost.
Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or payoffs, are reported at their outstanding principal balances, adjusted for any charge-offs, the allowance for loan losses, any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term.
Discounts and premiums on purchased residential real estate loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Discounts and premiums on purchased consumer loans are recognized over the expected lives of the loans using methods that approximate the interest method.
Generally, loans are placed on nonaccrual status at 90 days past due and interest is considered a loss, unless the loan is well-secured and in the process of collection. Past due status is based on contractual terms of the loan. For all loan classes, the entire balance of the loan is considered past due if the minimum payment contractually required to be paid is not received by the contractual due date. For all loan classes, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.
Consistent with regulatory guidance, charge-offs on all loan segments are taken when specific loans, or portions thereof, are considered uncollectible. The Company’s policy is to promptly charge these loans off in the period the uncollectible loss is reasonably determined.
For all loan portfolio segments except one-to-four family residential properties and consumer, the Company promptly charges off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.
The Company charges off one-to-four family residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of one-to-four family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 180 days past due, and charge-down to the net realizable value when other secured loans are 120 days past due. Loans at these respective delinquency thresholds for which
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged off.
For all loan classes, when loans are placed on nonaccrual, or charged off, interest accrued but not collected is reversed against interest income. Subsequent payments on nonaccrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. In general, loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. However, for impaired loans and troubled debt restructured, which is included in impaired loans, the Company requires a period of satisfactory performance of not less than six months before returning a nonaccrual loan to accrual status.
When cash payments are received on impaired loans in each loan class, the Company records the payment as interest income unless collection of the remaining recorded principal amount is doubtful, at which time payments are used to reduce the principal balance of the loan. Troubled debt restructured loans recognize interest income on an accrual basis at the renegotiated rate if the loan is in compliance with the modified terms.
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical charge-off experience by segment. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the prior three years. Management believes the three-year historical loss experience methodology is appropriate in the current economic environment. Other adjustments (qualitative/environmental considerations) for each segment may be added to the allowance for each loan segment after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent. For impaired loans where the Company utilizes the discounted cash flows to determine the level of impairment, the Company includes the entire change in the present value of cash flows as provision expense.
Segments of loans with similar risk characteristics, including individually evaluated loans not determined to be impaired, are collectively evaluated for impairment based on the group’s historical loss experience
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment measurements.
Other-than-temporary impairment (“OTTI”) of an investment is evaluated at least quarterly pursuant to guidelines established by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), in ASC 320. If management determines that an investment experienced an OTTI, management determines the amount of the OTTI to be recognized in earnings. The Company’s consolidated statement of income would reflect the full impairment (that is, the difference between the security’s amortized cost basis and fair value) on debt securities that the Company intends to sell or would more likely than not be required to sell before the expected recovery of the amortized cost basis. For securities that management has no intent to sell, and it is not more likely than not that the Company will be required to sell prior to recovery, only the credit loss component of the impairment would be recognized in earnings, while the noncredit loss would be recognized in accumulated other comprehensive income. The credit loss component recognized in earnings is identified as the amount of principal cash flows not expected to be received over the remaining term of the security as projected based on cash flow projections.
Premises and equipment are carried at cost net of accumulated depreciation. Depreciation is computed using the straight-line method based principally on the estimated useful lives of the assets that range from three to forty years. Leasehold improvements are amortized over the shorter of the life of the lease or the life of the asset. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on dispositions are included in current operations.
Real estate held for sale is carried at fair value less estimated selling costs. When foreclosed assets are acquired, any required adjustment is charged to the allowance for loan losses. All subsequent activity is included in current operations.
Federal Home Loan Bank stock is a required investment for institutions that are members of the Federal Home Loan Bank system. The required investment in the common stock is based on a predetermined formula.
Mortgage servicing rights on originated loans that have been sold are initially recorded at fair value. Capitalized servicing rights are amortized in proportion to and over the period of estimated servicing revenues. Impairment of mortgage-servicing rights is assessed based on the fair value of those rights. Fair values are estimated using discounted cash flows based on a current market interest rate. For purposes of measuring impairment, the rights are stratified based on the predominant risk characteristics of the underlying loans. The predominant characteristic currently used for stratification is type of loan. The amount of impairment recognized is the amount by which the capitalized mortgage-servicing rights for a stratum exceed their fair value.
Intangible assets are being amortized on primarily an accelerated basis over a ten-year period. Such assets are periodically evaluated as to the recoverability of their carrying value.
Goodwill is tested annually for impairment. If the implied fair value of goodwill is lower than its carrying amount, a goodwill impairment is indicated and goodwill is written down to its implied fair value. Subsequent increases in goodwill value are not recognized in the financial statements.
Stock options - The Company has a stock-based employee compensation plan, which is described more fully in Note 18.
Income taxes - The Company accounts for income taxes in accordance with income tax accounting guidance (ASC 740, Income Taxes). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The phrase “more likely than not” means a likelihood of more than 50%; the terms “examined” and “upon examination” also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
The Company recognizes interest and penalties on income taxes as a component of income tax expense.
The Company files consolidated income tax returns with its subsidiaries.
The Company’s tax years still subject to examination by taxing authorities are years subsequent to 2008.
Earnings per share - Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during each period. Diluted earnings per share reflects additional potential common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method.
Comprehensive income consists of net income and other comprehensive income, net of applicable income taxes. Other comprehensive income includes unrealized appreciation (depreciation) on available-for-sale securities.
Reclassifications of certain amounts in the 2011 consolidated financial statements have been made to conform to the 2012 presentation.
Current economic conditions - The current protracted economic decline continues to present financial institutions with circumstances and challenges, which in some cases have resulted in large and unanticipated declines in the fair values of investments and other assets, constraints on liquidity and capital and significant credit quality problems, including severe volatility in the valuation of real estate and other collateral supporting loans.
At December 31, 2012, the Company held $122,155,000 in commercial real estate and land with approximately $106,433,000 of that total in loans collateralized by commercial and development real estate, primarily in the Floyd and Clark County, Indiana geographic area. Due to national, state and local economic conditions, values for commercial and development real estate have declined significantly, and the market for these properties is depressed. The accompanying financial statements have been prepared using values and information currently available to the Company.
Given the volatility of current economic conditions, the values of assets and liabilities recorded in the financial statements could change rapidly, resulting in material future adjustments in asset values, the allowance for loan losses and capital that could negatively impact the Company’s ability to meet regulatory capital requirements and maintain sufficient liquidity.
Note 2:
Acquisition
On November 9, 2012, the Company completed its acquisition of Dupont State Bank, an Indiana commercial bank wholly owned by Citizens Union Bancorp of Shelbyville, Inc. In conjunction with the acquisition, River Valley Financial Bank (Bank) merged with and into Dupont State Bank, which changed its name to River Valley Financial Bank, effecting the conversion of the Bank from a federally chartered thrift to a state chartered commercial bank. Under the terms of the acquisition, the Bank paid $5,700,000 for the stock of Dupont State Bank with a resulting bargain purchase gain, after application of purchase accounting
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
adjustments, of $988,000. The bargain gain was recorded as other income in the three-month period ended December 31, 2012. For the twelve-month period ended December 31, 2012, the Company had approximately $382,000 in costs relative to the acquisition. Acquisition expense for the same period ended December 31, 2011 was approximately $212,000. As a result of the acquisition, and the addition of two market areas, the Company will have an opportunity to expand both lending and deposit services. Cost savings are expected through economies of scale, and consolidation of operating centers.
Under the purchase method of accounting for purchases, the total purchase price is allocated to the net tangible and intangible assets based on their current estimated fair values as of the date of acquisition. Based on independent, third party valuation of the fair value of those assets acquired, and liabilities assumed, the purchase price for the Dupont State Bank acquisition was allocated as follows:
The fair value of the assets acquired includes loans with a fair value of $52,125,000. The gross principal and contractual interest due under the contracts is $53,982,000, of which $2,960,000 is expected to be uncollectible.
The contributed revenues and net income of the acquired business for the period from November 9, 2012 to December 31, 2012 is not available as separate financial information was not maintained.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The following unaudited pro forma summary presents consolidated information of the Company as if the business combination had occurred on January 1, 2012 and 2011:
The pro forma revenue and net income for the year ended December 31, 2012, excludes the bargain purchase gain of $988,000 recognized in 2012. In addition, the pro forma net income for the years ended December 31, 2012 and 2011, excludes acquisition expenses of $382,000 and $212,000, respectively.
Note 3:
Accounting for Certain Loans Acquired in a Transfer
The Company acquired loans in the acquisition of Dupont State Bank during the year ended December 31, 2012. Certain of the transferred loans had evidence of deterioration of credit quality since origination and it was probable that all contractually required payments would not be collected.
Loans purchased with evidence of credit deterioration, for which it is probable that all contractually required payments will not be collected, are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include deterioration of collateral value, past due status and/or nonaccrual status, and borrower credit scores. Purchased credit-impaired loans are accounted for under accounting guidance for loans and debt securities acquired with deteriorated credit quality (ASC 310-30) and are initially measured at fair value, which includes estimated future losses that may be incurred over the life of the loan. Accordingly, an allowance for credit losses related to these loans is not carried over at the acquisition date. Management utilized cash flows prepared by a third party in arriving at the discount for credit-impaired loans acquired in the transaction. Those cash flows included estimation of current key assumptions, such as default rates, severity, and prepayment speeds.
The carrying amount of those loans is included in the balance sheet amounts of loans receivable at December 31, 2012.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Accretable yield, or income expected to be collected is as follows:
Loans acquired during 2012 for which it was probable at acquisition that all contractually required payments would not be collected are as follows:
Note 4:
Restriction on Cash and Due from Banks
The Bank is required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank. The reserve required at December 31, 2012 was $1,727,000.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Note 5:
Investment Securities
The amortized cost and approximate fair values of securities as of December 31, 2012 and December 31, 2011 are as follows:
The amortized cost and fair value of available-for-sale securities at December 31, 2012, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
No securities were pledged at December 31, 2012 or at December 31, 2011 to secure FHLB advances. Securities with a carrying value of $18,826,000 and $14,562,000 were pledged at December 31, 2012 and 2011 to secure public deposits and for other purposes as permitted or required by law.
Proceeds from sales of securities available for sale at December 31, 2012 and December 31, 2011 were $24,162,000 and $10,201,000. Gross gains of $1,034,000 and $312,000 resulting from sales and calls of available-for-sale securities were realized during the respective periods. Losses totaling $37,000 were realized from sales and calls of available-for-sale securities during 2012. No losses were recorded from sales and calls of available-for-sale securities during 2011.
Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at December 31, 2012 and 2011, were $11,879,000 and $10,869,000, which is approximately 10.4% and 10.4% of the Company’s investment portfolio. Management has the ability and intent to hold securities with unrealized losses to recovery, which may be maturity. Based on evaluation of available evidence, including recent changes in market interest rates, management believes that any declines in fair values for these securities are temporary.
Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting credit portion of the loss recognized in net income and the noncredit portion of the loss would be recognized in accumulated other comprehensive income in the period the other-than-temporary impairment is identified.
The following tables show the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2012 and December 31, 2011:
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Federal Agencies
The unrealized losses on the Company’s investments in direct obligations of U.S. government agencies were primarily caused by interest rate changes. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2012.
State and Municipal
The unrealized losses on the Company’s investments in securities of state and political subdivisions were primarily caused by interest rate changes. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2012.
Government-Sponsored Enterprise (GSE) Residential Mortgage-Backed and Other Asset-Backed Agency Securities
The unrealized losses on the Company’s investment in residential mortgage-backed agency securities were primarily caused by interest rate changes. The Company expects to recover the amortized cost bases over the term of the securities. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2012.
Corporate Securities
The unrealized losses on the Company’s investment in corporate securities were due primarily to losses on two pooled trust preferred issues held by the Company. The two, ALESCO 9A and PRETSL XXVII, had unrealized losses at December 31, 2012 of $465,000 and $56,000, respectively. At December 31, 2011, the unrealized losses on these two investments were $412,000 and $259,000, respectively. These two securities are both “A” tranche investments (A2A and A-1 respectively) and have performed as agreed since purchase. The two are rated Ba2 and Baa3, respectively, by Moody’s indicating these securities are considered low medium-grade to below investment grade quality and credit risk. Both provide good collateral coverage at those tranche levels, providing protection for the Company. The Company has reviewed the pricing reports for these investments and has determined that the decline in the market price is not other than temporary and indicates thin trading activity rather than a true decline in the value of the investment. Factors considered in reaching this determination included the class or “tranche” held by the Company, the collateral coverage position of the tranches, limited number of deferrals and defaults on the issues, projected and actual cash flows and the credit ratings. These two investments represent 1.55% of the book value of the Company’s investment portfolio and approximately 1.1% of market value. The Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, and the Company expects to receive all contractual cash flows related to these investments. Based upon these factors, the Company has determined these securities are not other-than-temporarily impaired at December 31, 2012.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Note 6:
Loans and Allowance
The Company’s loan and allowance polices are discussed in Note 1 above.
The following table presents the breakdown of loans as of December 31, 2012 and December 31, 2011.
The risk characteristics of each loan portfolio class are as follows:
Construction
Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest-rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.
One-to-Four Family Residential and Consumer
With respect to residential loans that are secured by one-to-four family residences and are usually owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. This segment also includes residential loans secured by non-owner-occupied one-to-four family residences. Management tracks the level of owner-occupied residential loans versus non-owner-occupied loans as a portion of our recent loss history relates to these loans. Home equity loans are typically secured by a subordinate interest in one-to-four family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured, such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas, such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Nonresidential (including agricultural land), Land, and Multi-family Residential Real Estate
These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Nonresidential and multi-family residential real estate lending typically involves higher loan principal amounts, and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Nonresidential and multi-family residential real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s nonresidential and multi-family real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates these loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied real estate loans versus non-owner-occupied loans.
Commercial
Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
The following tables present the activity in the allowance for loan losses for the years ended December 31, 2012 and December 31, 2011, and information regarding the breakdown of the balance in the allowance for loan losses and the recorded investment in loans, both presented by portfolio class and impairment method, as of December 31, 2012 and December 31, 2011.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The following tables present the credit risk profile of the Company’s loan portfolio based on rating category as of December 31, 2012 and December 31, 2011. Loans acquired from Dupont State Bank have been adjusted to fair value for the period ending December 31, 2012.
Credit Quality Indicators
The Company categorizes loans into risk categories based on relevant information about the ability of the borrowers to service their debt, such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually on an ongoing basis by classifying the loans as to credit risk, assigning grade classifications. Loan grade classifications of special mention, substandard, doubtful, or loss are reported to the Company’s board of directors monthly. The Company uses the following definitions for credit risk grade classifications:
Pass: Loans not meeting the criteria below are considered to be pass rated loans.
Special Mention: These assets are currently protected, but potentially weak. They have credit deficiencies deserving a higher degree of attention by management. These assets do not presently exhibit a sufficient degree of risk to warrant adverse classification. Concerns may lie with cash flow, liquidity, leverage, collateral, or industry conditions. These are graded special mention so that the appropriate level of attention is administered to prevent a move to a “substandard” rating.
Substandard: By regulatory definition, “substandard” loans are inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged. These types of loans have well defined weaknesses that jeopardize the liquidation of the debt. A distinct possibility exists that the institution will sustain some loss if the deficiencies are not corrected. These loans are considered workout credits. They exhibit at least one of the following characteristics.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
·
An expected loan payment is in excess of 90 days past due (non-performing), or non-earning.
·
The financial condition of the borrower has deteriorated to such a point that close monitoring is necessary. Payments do not necessarily have to be past due.
·
Repayment from the primary source of repayment is gone or impaired.
·
The borrower has filed for bankruptcy protection.
·
The loans are inadequately protected by the net worth and cash flow of the borrower.
·
The guarantors have been called upon to make payments.
·
The borrower has exhibited a continued inability to reduce principal (although interest payment may be current).
·
The Company is considering a legal action against the borrower.
·
The collateral position has deteriorated to a point where there is a possibility the Company may sustain some loss. This may be due to the financial condition, improper documentation, or to a reduction in the value of the collateral.
·
Although loss may not seem likely, the Company has gone to extraordinary lengths (restructuring with extraordinary lengths) to protect its position in order to maintain a high probability of repayment.
·
Flaws in documentation leave the Company in a subordinated or unsecured position.
Doubtful: These loans exhibit the same characteristics as those rated “substandard,” plus weaknesses that make collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable and improbable. This would include inadequately secured loans that are being liquidated, and inadequately protected loans for which the likelihood of liquidation is high. This classification is temporary. Pending events are expected to materially reduce the amount of the loss. This means that the “doubtful” classification will result in either a partial or complete loss on the loan (write-down or specific reserve), with reclassification of the asset as “substandard,” or removal of the asset from the classified list, as in foreclosure or full loss.
The Company evaluates the loan risk grading system definitions and allowance for loan loss methodology on an ongoing basis. No significant changes were made to either during the past year.
The following tables present the Company’s loan portfolio aging analysis as of December 31, 2012 and December 31, 2011.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
At December 31, 2012 and December 31, 2011, there were no loans past due 90 days or more and accruing.
The following table presents the Company’s nonaccrual loans as of December 31, 2012 and December 31, 2011, which includes both nonperforming troubled debt restructured and loans contractually delinquent 90 days or more.
A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include non-performing commercial loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The following tables present information pertaining to the principal balances and specific valuation allocations for impaired loans, as well as the average balances of and interest recognized on impaired loans, as December 31, 2012:
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The following tables present information pertaining to the principal balances and specific valuation allocations for impaired loans, as well as the average balances of and interest recognized on impaired loans, as of December 31, 2011:
For 2012 and 2011, interest income recognized on a cash basis included above was immaterial.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Troubled Debt Restructurings
In the course of working with borrowers, the Company may choose to restructure the contractual terms of certain loans. In restructuring the loan, the Company attempts to work out an alternative payment schedule with the borrower in order to optimize collectibility of the loan. Any loans that are modified, whether through a new agreement replacing the old or via changes to an existing loan agreement, are reviewed by the Company to identify if a troubled debt restructuring (“TDR”) has occurred. A troubled debt restructuring occurs when, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay in line with its current financial status, and the restructuring of the loan may include the transfer of assets from the borrower to satisfy the debt, a modification of loan terms, or a combination of the two. If such efforts by the Company do not result in a satisfactory arrangement, the loan is referred to legal counsel, at which time foreclosure proceedings are initiated. At any time prior to a sale of the property at foreclosure, the Company may terminate foreclosure proceedings if the borrower is able to work out a satisfactory payment plan.
As a result of adopting the amendments in Accounting Standards Update No. 2011-02, the Company reassessed all restructurings that occurred on or after January 1, 2011 for identification as troubled debt restructurings. As a result of this reassessment, the Company did not identify as troubled debt restructurings any additional receivables for which the allowance for credit losses had previously been measured under a general allowance for credit losses methodology.
Nonaccrual loans, including TDRs that have not met the six month minimum performance criterion, are reported in this report as non-performing loans. For all loan classes, it is the Company’s policy to have any restructured loans which are on nonaccrual status prior to being restructured remain on nonaccrual status until six months of satisfactory borrower performance, at which time management would consider its return to accrual status. A loan is generally classified as nonaccrual when the Company believes that receipt of principal and interest is questionable under the terms of the loan agreement. Most generally, this is at 90 or more days past due.
The balance of nonaccrual restructured loans, which is included in total nonaccrual loans, was $7,693,000 at December 31, 2012. If the restructured loan is on accrual status prior to being restructured, it is reviewed to determine if the restructured loan should remain on accrual status. The balance of accruing restructured loans was $3,860,000 at December 31, 2012. Loans that are considered TDR are classified as performing, unless they are on nonaccrual status or greater than 90 days past due, as of the end of the most recent quarter. All TDRs are considered impaired by the Company, unless it is determined that the borrower has met the six month satisfactory performance period under the modified terms. On at least a quarterly basis, the Company reviews all TDR loans to determine if the loan meets this criterion.
With regard to determination of the amount of the allowance for credit losses, all accruing restructured loans are considered to be impaired. As a result, the determination of the amount of impaired loans for each portfolio segment within troubled debt restructurings is the same as detailed previously above.
At December 31, 2012, the Company had a number of loans that were modified in troubled debt restructurings and impaired. The modification of terms of such loans included one or a combination of the following: an extension of maturity, a reduction of the stated interest rate or a permanent reduction of the recorded investment in the loan.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The following tables present information regarding troubled debt restructurings by class as of December 31, 2012 and December 31, 2011, and new troubled debt restructuring for the years ended December 31, 2012 and December 31, 2011.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The following tables present information regarding newly restructured troubled debt by type of modification as of December 31, 2012 and December 31, 2011.
One loan totaling $43,000 identified and reported as TDR during the year ended December 31, 2012, was considered in default during the period. Three loans totaling $1.3 million, identified and reported as TDR during the year ended December 31, 2011, were considered in default during that period. The Company defines default in this instance as being either past due 90 days or more at the end of the quarter or in the legal process of foreclosure.
Financial impact of these restructurings was immaterial to the financials of the Company at December 31, 2012 and 2011.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Note 7:
Core Deposit Intangible Assets
The carrying basis of the recognized core deposit intangible was $542,000 at December 31, 2012 and the accumulated amortization of such intangible was $24,000 at that date.
Amortization expense for the years ended December 31, 2012 and December 31, 2011, was $20,000 and $3,000. Estimated amortization expense for each of the following five years is:
Note 8:
Premises and Equipment
Note 9:
Deposits
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Note 10:
Borrowings
Maturities by year for advances at December 31, 2012 are $2,000,000 in 2013, $5,000,000 in 2014, $12,750,000 in 2015, $19,750,000 in 2016, and $3,000,000 in 2018 and thereafter. The weighted-average interest rate at December 31, 2012 and 2011 was 3.83% and 3.55%, respectively.
The Federal Home Loan Bank advances are secured by loans totaling $206,795,000 at December 31, 2012. As of December 31, 2012, no securities were pledged for advances. Advances are subject to restrictions or penalties in the event of prepayment.
On March 13, 2003, the Company formed RIVR Statutory Trust I (Trust), a statutory trust formed under the laws of the State of Connecticut. On March 26, 2003, the Trust issued 7,000 Fixed/Floating Rate Capital Securities with a liquidation amount of $1,000 per Capital Security in a private placement to an offshore entity for an aggregate offering price of $7,000,000, and 217 Common Securities with a liquidation amount of $1,000 per Common Security to the Company for $217,000. The aggregate proceeds of $7,217,000 were used by the Trust to purchase $7,217,000 in Fixed/Floating Rate Junior Subordinated Deferrable Interest Debentures from the Company. The Debentures and the Common and Capital Securities have a term of 30 years, bear interest at the annual rate of 6.4% for five years and thereafter bear interest at the rate of the 3-Month LIBOR plus 3.15%. The Company has guaranteed payment of amounts owed by the Trust to holders of the Capital Securities.
Note 11:
Loan Servicing
Loans serviced for others are not included in the accompanying consolidated balance sheets. The risks inherent in mortgage servicing assets relate primarily to changes in prepayments that result from shifts in mortgage interest rates. The unpaid principal balances of mortgage and other loans serviced for others was $113.6 million as of December 31, 2012. That total included $17.6 million of Federal National Mortgage Association (FNMA) loans acquired from Dupont State Bank. No mortgage servicing rights were acquired with that portfolio of loans. The total of loans serviced for others as of December 31, 2011 was $96.3 million, comprised only of Federal Housing Loan Mortgage Corporation (FHLMC-“Freddie Mac”) loans. Mortgage servicing rights are included in other assets in the balance sheets.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The following summarizes the activity pertaining to mortgage servicing rights measured using the amortization method, along with the aggregate activity in related valuation allowances:
At December 31, 2011, a valuation allowance was necessary to adjust the cost basis of certain pools of the mortgage servicing rights asset to fair value. There was no allowance at December 31, 2012.
Note 12:
Income Tax
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The cumulative net deferred tax asset (liability) is included in the balance sheets in other assets and other liabilities, respectively. The components of the asset (liability) are as follows:
As of December 31, 2012, the Company had approximately $89,000 of alternative minimum tax credits available to offset future federal income taxes. The credits have no expiration date.
Retained earnings include approximately $2,100,000 for which no deferred income tax liability has been recognized. This amount represents an allocation of income to bad debt deductions as of December 31, 1987 for tax purposes only. Reduction of amounts so allocated for purposes other than tax bad debt losses or adjustments arising from carryback of net operating losses would create income for tax purposes only, which income would be subject to the then-current corporate income tax rate. The unrecorded deferred income tax liability on the above amount was approximately $714,000.
Note 13:
Commitments and Contingent Liabilities
In the normal course of business there are outstanding commitments and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying financial statements. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Bank uses the same credit policies in making such commitments as it does for instruments that are included in the consolidated balance sheets.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Financial instruments whose contract amount represents credit risk as of December 31 were as follows:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.
The Company and subsidiaries lease operating facilities under lease arrangements expiring 2015 through 2029. Rental expense included in the consolidated statements of income for the years ended December 31, 2012 and 2011 was $225,000 and $223,000, respectively.
Future minimum lease payments under the leases are:
The Company and Bank are also subject to claims and lawsuits which arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position of the Company.
Note 14:
Dividend and Capital Restrictions
As a state chartered commercial bank, under Indiana law, the Bank may pay dividends of so much of its undivided profits (generally, earnings less losses, bad debts, taxes and other operating expenses) as is considered expedient by the Bank’s Board of Directors. However, the Bank must obtain the approval of the DFI for the payment of a dividend if the total of all dividends declared by the Bank during the current year, including the proposed dividend, would exceed the sum of retained net income for the year to date plus its retained net income for the previous two years. For this purpose, “retained net income” means net income as calculated for call report purposes, less all dividends declared for the applicable period. Moreover, the Bank may not pay dividends that would reduce its capital below the amount of its liquidation account first established at the time it converted to stock form. The FDIC has the authority to prohibit the Bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the Bank. In addition, under Federal Reserve supervisory policy, a bank holding company generally should not maintain its existing rate of cash dividends on common shares unless (i) the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and (ii) the prospective rate of earnings retention appears consistent with the organization’s capital needs, assets, quality, and overall financial condition. The Federal Reserve issued a
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
letter dated February 24, 2009, to bank holding companies providing that it expects bank holding companies to consult with it in advance of declaring dividends that could raise safety and soundness concerns (i.e., such as when the dividend is not supported by earnings or involves a material increase in the dividend rate) and in advance of repurchasing shares of common or preferred stock. At December 31, 2012, the stockholders' equity of the Bank was $41,766,000, of which approximately $39,417,000 was restricted from dividend distribution to the Company.
Note 15:
Preferred Stock
During 2009, the Company raised $5,000,000 through a private placement of cumulative preferred stock. From the proceeds, $2,500,000 was contributed to the Bank. The preferred stock carries a liquidation value of $1,000 per share and pays dividends quarterly to shareholders at a rate of 7.25% per annum for the first five years. After the fifth year, the rate increases to 9% per annum and the Company has the option to redeem the preferred stock in whole or part at a price equal to the sum of the liquidation amount per share and any accrued and unpaid dividends, regardless of whether any dividends are actually declared.
Note 16:
Regulatory Capital
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Furthermore, the Bank’s regulators could require adjustments to regulatory capital not reflected in these financial statements.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital to average assets (as defined). The 2012 ratios reflect the change in the Bank's primary regulatory body and the related reporting. Management believes, as of December 31, 2012, that the Bank met all capital adequacy requirements to which it is subject.
As of December 31, 2012, the Bank was well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed any category from well capitalized.
The actual and required capital amounts and ratios of the Bank are as follows:
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Note 17:
Employee Benefits
The Bank provides pension benefits for substantially all of the Bank’s employees who were employed by the Bank prior to September 1, 2005, through its participation in a pension fund known as the Pentegra Group. The trustees of the Financial Institutions Retirement Fund administer the Pentegra Plan, employer identification number 13-5645888 and plan number 333. This plan operates as a multi-employer plan for accounting purposes and as a multiple-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. There are no collective bargaining agreements in place that require contributions to the Pentegra Plan. The Pentegra Plan is a single plan under Internal Revenue Code 413(c) and, as a result, all of the assets stand behind all of the liabilities.
The risks of participating in these multiemployer plans are different from single-employer plans in the following aspects:
1.
Assets contributed to the multiemployer plan by one employer may be used to provide benefits to employees of other participating employers.
2.
If a participating employer stops contributing to the plan, the unfunded obligations of the plan may be borne by the remaining participating employers.
3.
If the Company chooses to stop participating in some of its multiemployer plans, the Company may be required to pay those plans an amount based on the underfunded status of the plan, referred to as a withdrawal liability.
Pension expense related to this plan was $313,000 and $279,000 for the years ended December 31, 2012 and 2011. Funding status of the plan as of the beginning of the plan years for 2012 and 2011 (July 1st) was 106.71% and 86.47% respectively.
The most recent Pension Protection Act (PPA) zone status available, which was “green” in 2012 and 2011, is for the plan’s year-end at June 30, 2012, and June 30, 2011, respectively. The zone status is based on information the Company received from the plan and is certified by the plan’s actuary. Among other factors, plans in the red zone are generally less than 65 percent funded, plans in the yellow zone are less than 80 percent funded and plans in the green zone are at least 80 percent funded. The Pentegra Plan has not required and does not require a financial improvement plan (FIP) or a rehabilitation plan (RP). Finally, the number of employees covered by the Company’s multiemployer plans has not decreased by 5 percent from 2011 to 2012, thus not affecting the period-to-period comparability of the contributions for years 2011 and 2012.
Total contributions to the Pentegra Plan were $299,729,000 and $203,582,000 for the plan years ended June 30, 2011 and 2010, respectively. The Company’s contributions for the fiscal years ending December 31, 2012 and 2011 were $327,000 and $476,000, respectively. The Company’s contributions to the Pentegra Plan were not more than 5% of the total contributions to the plan. There have been no significant changes that affect the comparability of the 2011 and 2012 contributions.
The Bank has a retirement savings 401(k) plan in which substantially all employees may participate. Prior to 2009, the Bank provided a match for employee contributions for all contributing employees with a match of 50% for the first 6% of W-2 earnings for employees hired prior to September 1, 2005 and a match of 100% for the first 6% of W-2 earnings contributed for employees hired on or after September 1, 2005. Due to economic conditions, in October of 2009 the employer match for pre-2005 employees was discontinued and the match rate for post-2005 employees was reduced to 50% of the first 6% of W-2 earnings. In 2011, this plan was again amended, with the employer match increased to 75% of the first 6% of W-2 earnings, only on post-2005 employees. The Bank’s expense for the plan was $65,000 and $45,000 for the years ended December 31, 2012 and 2011.
The Bank has a supplemental retirement plan which provides retirement benefits to all directors. The Bank’s obligations under the plan have been funded by the purchase of key man life insurance policies, of which the Bank is the beneficiary. Expense recognized under the supplemental retirement plan totaled approximately $78,000 and $80,000 for the years ended December 31, 2012 and 2011.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The Company has an ESOP covering substantially all employees of the Company and Bank. All contributions to the ESOP are determined annually by the Board of Directors of the Company and Bank. Compensation expense was recorded based on the annual contributions to the ESOP. ESOP expense for the years ended December 31, 2012 and 2011 was $120,000 and $150,000, respectively. At December 31, 2012 the ESOP had 162,101(161,851 of common shares and 250 of preferred shares) allocated shares, no suspense shares and no committed-to-be released shares. At December 31, 2012 and 2011, the fair value of the 162,101 and 148,248 allocated shares held by the ESOP was $3,099,000 and $2,300,000, respectively.
The Company also has a Recognition and Retention Plan (RRP) which provides for the award and issuance of up to 95,220 shares of the Company’s stock to members of the Board of Directors and management. Over the life of the plan, the RRP has purchased 84,490 shares of the Company’s common stock in the open market and had 400 shares forfeited back into the fund. A total of 84,890 shares has all been awarded. Common stock awarded under the RRP vests ratably over a five-year period, commencing with the date of the award. Expense recognized under the RRP plan totaled approximately $24,000 and $29,000 for the years ended December 31, 2012 and 2011.
Unvested RRP shares at December 31, 2012:
Unearned compensation at December 31, 2012 related to RRP shares is $41,000 and will be recognized over a weighted average period of 3.7 years.
In December 2012, the Bank adopted the 2013 River Valley Financial Bank Incentive Plan (Incentive Plan). The Incentive Plan provides target incentive awards for the Bank’s Chief Executive Officer, Executive Vice President, Senior Officers, Vice Presidents, Internal Auditor, Compliance Officer, Executive Administrative Assistant, Loan Officers and Wealth Management Officers. Awards under this Incentive Plan will be earned as of December 31, 2013.
Note 18:
Stock Option Plan
The Company’s Incentive Stock Option Plan (the Plan), which is shareholder approved, permits the grant of stock options to its directors, officers and other key employees. The Plan authorized the grant of options for up to 238,050 shares of the Company’s common stock, which generally vest at a rate of 20 percent a year and have a 10-year contractual term. The Company believes that such awards better align the interests of its directors and employees with those of its shareholders. Option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant. Certain option awards provide for accelerated vesting if there is a change in control (as defined in the Plans). The Company generally issues shares from its authorized shares to satisfy option exercises.
The fair value of each option award is estimated on the date of grant using a binomial option valuation model that uses the assumptions related to expected volatility, expected term of the options awarded and the risk-free rate. Expected volatility is based on historical volatility of the Company’s stock and other factors. The Company uses historical data to estimate option exercise and employee termination within the valuation model. The expected term of options granted is derived from the output of the option valuation model and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. No grants were made in 2012 or 2011.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
A summary of option activity under the Plan as of December 31, 2012, and changes during the year then ended, is presented below:
There were 10,400 options exercised during the year ended December 31, 2012. There were no options exercised during the year ended December 31, 2011. Cash received from options exercised for the year ended December 31, 2012 was $140,000. There was no tax benefit realized from the options exercised in 2012.
As of December 31, 2012 and 2011, there was $6,000 and $12,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 0.75years.
For each twelve-month period ended 2012 and 2011, the Company recognized $6,000 of share-based compensation expense with a tax benefit of $3,000, for each period.
Note 19:
Related Party Transactions
The Bank has entered into transactions with certain directors, executive officers, significant stockholders and their affiliates or associates (related parties). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features.
The aggregate amount of loans, as defined, to such related parties were as follows:
Deposits from related parties held by the Bank at December 31, 2012 and 2011 totaled $1,747,000 and $1,673,000, respectively.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Note 20:
Earnings Per Share
Earnings per share have been computed based upon the weighted average common shares outstanding.
Net income for the year ending December 31, 2012 of $4,012,000 was reduced by $362,000 for dividends on preferred stock in the same period, to arrive at income available to common stockholders of $ 3,650,000. Net income for the year ending December 31, 2011 of $1,772,000 was reduced by $362,000 for dividends on preferred stock in the same period, to arrive at income available to common stockholders of $1,410,000.
Certain groups of options were not included in the computation of diluted earnings per share because the option price was greater than the average market price of the common shares. For the years ending December 31, 2012 and 2011, options to purchase 5,000 shares at an exercise price of $22.25 per share were outstanding and were not included in the computation of diluted earnings for those periods.
Note 21:
Disclosures About Fair Value of Financial Instruments
The Company recognizes fair values in accordance with Financial Accounting Standards Codification (ASC) Topic 820. ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1
Quoted prices in active markets for identical assets or liabilities
Level 2
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
Level 3
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities
Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Available-for-sale Securities
Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. The Company does not currently hold any Level 1 securities. If quoted market prices are not available, then fair values are estimated by using pricing models which utilize certain market information or quoted prices of securities with similar characteristics (Level 2). For securities where quoted prices, market prices of similar securities or pricing models which utilize observable inputs are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. Rating agency industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into calculations. Level 2 securities include residential mortgage-backed agency securities, federal agency securities, municipal securities and corporate bonds. Securities classified within Level 3 of the hierarchy include pooled trust preferred securities which are less liquid securities.
Fair value determinations for Level 3 measurements of securities are the responsibility of the VP of Finance. The VP of Finance contracts with a third party pricing specialist who generates fair value estimates on a quarterly basis. The VP of Finance’s office challenges the reasonableness of the assumptions used and reviews the methodology to ensure the estimated fair value complies with accounting standards generally accepted in the United States.
The following tables present the fair value measurements of assets and liabilities recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the ASC Topic 820 fair value hierarchy in which the fair value measurements fall at December 31, 2012 and 2011.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheets using significant unobservable (Level 3) inputs for the years ended December 31, 2012 and 2011.
There were no realized or unrealized gains or losses of Level 3 securities included in net income for the years ended December 31, 2012 and December 31, 2011.
At December 31, 2011, Level 3 securities included two pooled trust preferred securities. The fair value on these securities is calculated using a combination of observable and unobservable assumptions as a quoted market price is not readily available. Both securities remain in Level 3 at December 31, 2012. For the past two fiscal years, trading of these types of securities has only been conducted on a distress sale or forced liquidation basis, although some trading activity has occurred in recent months for instruments similar to the instruments held by the Company. As a result, the Company continues to measure the fair values using discounted cash flow projections and has included the securities in Level 3.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The following tables present the fair value measurements of assets and liabilities recognized in the accompanying balance sheets measured at fair value on a nonrecurring basis and the level within the ASC Topic 820 fair value hierarchy in which the fair value measurements fall at December 31, 2012 and 2011.
Following is a description of the valuation methodologies used for instruments measured at fair values on a nonrecurring basis and recognized in the accompanying balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy.
Impaired Loans (Collateral Dependent)
Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral dependent loans.
If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.
Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.
The Company considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value. Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by policy. Appraisals are reviewed for accuracy and consistency by loan review personnel and reported to management. Appraisers are selected from the list of approved appraisers maintained by management. The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral. These discounts and estimates are developed by loan review personnel by comparison to historical results.
Real Estate Held for Sale
Real estate held for sale is carried at the fair value less cost to sell and is periodically evaluated for impairment. Real estate held for sale recorded during the current accounting period is recorded at fair value less cost to sell and is disclosed as a nonrecurring measurement. Appraisals of real estate held for sale are obtained when the real estate is acquired and subsequently as deemed necessary by policy. Appraisals are reviewed for accuracy and consistency by loan review personnel and reported to management. Appraisers are
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
selected from the list of approved appraisers maintained by management. Real estate held for sale is classified within Level 3 of the fair value hierarchy.
The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring and nonrecurring fair value measurement and of how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.
Unobservable (Level 3) Inputs
The following table represents quantitative information about Level 3 fair value measurements:
Sensitivity of Significant Unobservable Inputs
The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement and of how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.
Securities Available for Sale - Pooled Trust Preferred Securities
Pooled trust preferred securities are collateralized debt obligations (CDOs) backed by a pool of debt securities issued by financial institutions. The collateral generally consists of trust-preferred securities and subordinated debt securities issued by banks, bank holding companies, and insurance companies. A full discounted cash flow analysis is used to estimate fair values and assess impairment for each security within this portfolio. A third party specialist with direct industry experience in pooled trust preferred security evaluations is engaged to provide assistance estimating the fair value and expected cash flows on this portfolio. The full cash flow analysis is completed by evaluating the relevant credit and structural aspects of each pooled trust preferred security in the portfolio, including collateral performance projections for each piece of collateral in the security, and terms of the security’s structure. The credit review includes an analysis of profitability, credit quality, operating efficiency, leverage, and liquidity using available financial and regulatory information for each underlying collateral issuer. The analysis also includes a review of historical industry default data, current/near term operating conditions, prepayment projections, credit loss assumptions, and the impact of macroeconomic and regulatory changes. Where available, actual trades of securities with similar characteristics are used to further support the value. The cumulative probability of default ranges from a low of 0.21% to 1.73%, and the estimates used for loss given default are 100%.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The significant unobservable inputs used in the fair value measurement of the Company’s pooled trust preferred securities are probability of default, estimated loss given default, discount rate, and recovery and prepayment rates. Significant increases (decreases) in any of those inputs in isolation could result in a significant change in the fair value measurement.
The following methods and assumptions were used to estimate the fair value of each class of financial instrument:
Cash and Cash Equivalents - The fair value of cash and cash equivalents approximates carrying value.
Loans Held for Sale - Fair values are based on quoted market prices.
Loans - The fair value for loans is estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.
FHLB Stock - Fair value of FHLB stock is based on the price at which it may be resold to the FHLB.
Interest Receivable/Payable - The fair values of interest receivable/payable approximate carrying values.
Deposits - The fair values of noninterest-bearing, interest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date. The carrying amounts for variable rate, fixed-term certificates of deposit approximate their fair values at the balance sheet date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on such time deposits.
Borrowings - The fair value of these borrowings are estimated using a discounted cash flow calculation, based on current rates for similar debt or as applicable, based on quoted market prices for the identical liability when traded as an asset.
Off-balance sheet Commitments - Commitments include commitments to originate mortgage and consumer loans and standby letters of credit and are generally of a short-term nature. The fair value of such commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The carrying amounts of these commitments, which are immaterial, are reasonable estimates of the fair value of these financial instruments.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The following tables present estimated fair values of the Company’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2012 and the fair values of the Company’s financial instruments at December 31, 2011.
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Note 22:
Condensed Financial Information (Parent Company Only)
Presented below is condensed financial information as to financial position, results of operations and cash flows of the Company:
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
Note 23:
Quarterly Results of Operations (Unaudited)
The increase in net income for the fourth quarter of 2012 as compared to the previous quarters was primarily due to the bargain purchase gain of $988,000 recognized in connection with the acquisition of Dupont State Bank on November 9, 2012.
Note 24:
Recent Accounting Pronouncements
FASB ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income
In February 2013, the FASB issued ASU 2013-02 to improve the transparency of reporting reclassifications out of accumulated other comprehensive income. Other comprehensive income includes gains and losses that are initially excluded from net income for an accounting period. Those gains and losses are later reclassified out of accumulated other comprehensive income into net income.
The ASU does not change the current requirements for reporting net income or other comprehensive income in financial statements. All of the information that the ASU requires is already required to be disclosed elsewhere in the financial statements under U.S. Generally Accepted Accounting Principles (U.S. GAAP).
The new amendments will require an organization to: (i) Present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income-but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period; and (ii) Cross-reference to other disclosures currently required under U.S. GAAP for other reclassification items (that are not required under U.S. GAAP) to be reclassified directly to net income in their entirety in the same reporting period. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is initially transferred to a balance sheet account (e.g., inventory for pension-related amounts) instead of directly to income or expense.
The amendments apply to all public and private companies that report items of other comprehensive income. Public companies are required to comply with these amendments for all reporting periods (interim and annual).
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
The amendments are effective for reporting periods beginning after December 15, 2012, for public companies. The Company will adopt the provisions of the ASU by the date required, and does not anticipate the ASU will have a material effect on its financial position or results of operations.
FASB ASU 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities
In January 2013, the FASB issued ASU 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. The Update clarifies the scope of transactions that are subject to the disclosures about offsetting.
The ASU clarifies that ordinary trade receivables and receivables are not in the scope of Accounting Standards Update No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. Specifically, Update 2011-11 applies only to derivatives, repurchase agreements and reverse purchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria contained in FASB Accounting Standards Codification or subject to a master netting arrangement or similar agreement.
Issued in December 2011, Update 2011-11 was the result of a joint project with the International Accounting Standards Board. Its objective was to improve transparency and comparability between U.S. GAAP and International Financial Reporting Standards by requiring enhanced disclosures about financial instruments and derivative instruments that are either (1) offset on the statement of financial position or (2) subject to an enforceable master netting arrangement or similar agreement.
The Board undertook this clarification project in response to concerns expressed by U.S. stakeholders about the standard’s broad definition of financial instruments After the standard was finalized, companies realized that many contracts have standard commercial provisions that would equate to a master netting arrangement, significantly increasing the cost of compliance at minimal value to financial statement users.
The amendments are effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. Required disclosures should be provided retrospectively for all comparative periods presented. The Company will adopt the provisions of the ASU by the date required, and does not anticipate the ASU will have a material effect on its financial position or results of operations.
FASB ASU 2012-04, Technical Corrections and Improvements
In October 2012, the FASB issued ASU 2012-04, Technical Corrections and Improvements. The amendments in this ASU make technical corrections, clarifications and limited-scope improvements to various Topics throughout the Codification.
This ASU is effective for public entities for fiscal periods beginning after December 15, 2012. Management does not anticipate the ASU will have a material effect on its financial position or results of operations.
FASB ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities
The eligibility criteria for offsetting are different in international financial reporting standards (IFRS) and U.S. generally accepted accounting principles (GAAP). Offsetting, otherwise known as netting, is the presentation of assets and liabilities as a single net amount in the statement of financial position (balance sheet). Unlike IFRS, U.S. GAAP allows companies the option to present net in their balance sheets derivatives that are subject to a legally enforceable netting arrangement with the same party where rights of set-off are only available in the event of default or bankruptcy.
To address these differences between IFRS and U.S. GAAP, in January 2011 the FASB and the IASB (the Boards) issued an exposure draft that proposed new criteria for netting, which were narrower than the current conditions in U.S. GAAP. Nevertheless, in response to feedback from their respective stakeholders, the Boards decided to retain their existing offsetting models. Instead, the Boards have issued common disclosure requirements related to offsetting arrangements to allow investors to better compare financial statements prepared in accordance with IFRS or U.S. GAAP.
The amendments to the FASB Accounting Standards Codification in this ASU require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to
River Valley Bancorp
Notes to Consolidated Financial Statements
December 31, 2012 and 2011
(Table Dollar Amounts in Thousands, Except Per Share Amounts)
understand the effect of those arrangements on its financial position. Coinciding with the release of ASU No. 2011-11, the IASB has issued Disclosures-Offsetting Financial Assets and Financial Liabilities (Amendments to IFRS 7). This amendment requires disclosures about the offsetting of financial assets and financial liabilities common to those in ASU No. 2011-11.
An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. If applicable the Company will provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Company will adopt the provisions of the ASU by the date required, and does not anticipate the ASU will have a material effect on its financial position or results of operations.
FASB ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs
The amendments included in this ASU change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. The application of fair value measurements are not changed as a result of this amendment. Some of the amendments provide clarification of existing fair value measurements requirements while other amendments change a particular principal or requirement for measuring fair value or disclosing information about fair value measurements. The amendments in this ASU are effective for annual periods beginning after December 31, 2012.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
There are no such changes and disagreements to report during the applicable period.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES.
Evaluation of disclosure controls and procedures. The Company’s Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures (as defined in Sections 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the most recent fiscal quarter covered by this annual report (the “Evaluation Date”), have concluded that as of the Evaluation Date, the Company’s disclosure controls and procedures were effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms and are designed to ensure that information required to be disclosed in those reports is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control over Financial Reporting. The management of River Valley Bancorp (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s system of internal control over financial reporting includes policies and procedures pertaining to the Company’s ability to record, process, and report reliable information. The system is designed to provide reasonable assurance to both management and the Board of Directors regarding the preparation and fair presentation of published financial statements.
The Company’s management assessed the effectiveness of internal control over financial reporting as of December 31, 2012. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on this assessment, management concluded that, as of December 31, 2012, the Company’s internal control over financial reporting is effective based on those criteria.
Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting identified in connection with the Company’s evaluation of controls that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION.
There is no information that was required to be disclosed on a Form 8-K during the fourth quarter but was not reported.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The information required by this item with respect to directors is incorporated by reference to the sections of the Holding Company’s Proxy Statement for its Annual Shareholder Meeting to be held on April 17, 2013 (the “2013 Proxy Statement”) with the caption “Proposal 1 - Election of Directors.” Information concerning the Registrant’s executive officers is included in Item 4.5 in Part I of this report. Information with respect to corporate governance is incorporated by reference to the section of the 2013 Proxy Statement with the caption “Corporate Governance.” Information regarding compliance with Section 16(a) of the Exchange Act is incorporated by reference to the section of the 2013 Proxy Statement captioned “Section 16(a) Beneficial Ownership Reporting Compliance.”
The Company has adopted a code of ethics that applies, among other persons, to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. A copy of that Code of Ethics was filed as an exhibit to the Company’s Form 10-K filed March 16, 2010, for the year ended December 31, 2009, and a link to that filing and to a copy of the Code of Ethics is posted at our website at http://www.rvfbank.com under “About Us - Stock Price & SEC Filings.” In addition, the Company will provide a copy, without charge, upon a request directed to Matthew P. Forrester, 430 Clifty Drive, P.O. Box 1590, Madison, Indiana 47250, (812) 273-4944 (fax).
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION.
The information required by this item with respect to executive compensation is incorporated by reference to the sections of the 2013 Proxy Statement with the captions “Proposal 1 - Election of Directors,” “Corporate Governance,” “Executive Compensation,” and “Compensation of Directors for 2012.”
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
Information required by this item is incorporated by reference to the sections of the 2013 Proxy Statement with the captions “Principal Holders of Common Stock” and “Proposal 1 - Election of Directors.”
The following table sets forth certain information pertaining to the Bank’s equity compensation plans:
Equity Compensation Plan Information
(1) River Valley Bancorp Stock Option Plan.
(2) The Company maintains the River Valley Bancorp Recognition and Retention Plan and Trust (“RRP”). As of December 31, 2012, 2,600 RRP shares had been granted to management but were not yet vested. In addition, 81,890 RRP shares granted to management were fully vested, and shares were issued to management in connection therewith. The Company is authorized to make awards of up to a total of 95,220 shares.
(3) The total in Column (b) includes only the weighted-average price of stock options, as the restricted shares awarded under the RRP plan have no exercise price.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The information required by this item is incorporated by reference to the sections of the 2013 Proxy Statement with the captions “Corporate Governance” and “Transactions with Certain Related Persons.”
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The information required by this item with respect to principal accounting fees and services is incorporated by reference to the sections of the 2013 Proxy Statement with the captions “Accountants,” and “Accountant’s Fees.”
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
The following documents are filed as part of this report:
1.
Financial Statements:
See “Contents” of Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K, which is incorporated herein by this reference.
2.
Financial Statement Schedules:
All schedules are omitted as the required information either is not applicable or is included in the Consolidated Financial Statements or related Notes contained in Item 8.
3.
Exhibits:
The exhibits listed in the Exhibit Index are filed with or incorporated herein by reference.
Copies of any Exhibits are available from the Company upon request by contacting Matthew P. Forrester, 430 Clifty Drive, P.O. Box 1590, Madison, Indiana 47250, (812) 273-4944 (fax).
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signatures
Title
Date
(1) Principal Executive Officer:
)
)
/s/ Matthew P. Forrester
)
March 19, 2013
Matthew P. Forrester
President and Chief Executive Officer
)
)
(2) Principal Financial and Accounting Officer:
)
)
/s/ Vickie L. Grimes
)
March 19, 2013
Vickie L. Grimes
Treasurer
)
)
(3) The Board of Directors:
)
)
/s/ Lonnie D. Collins
)
March 19, 2013
Lonnie D. Collins
Director
)
)
)
/s/ Matthew P. Forrester
)
March 19, 2013
Matthew P. Forrester
Director
)
)
)
/s/ Michael J. Hensley
)
March 19, 2013
Michael J. Hensley
Director
)
)
)
/s/ Fred W. Koehler
)
March 19, 2013
Fred W. Koehler
Director
)
)
)
/s/ L. Sue Livers
)
March 19, 2013
L. Sue Livers
Director
)
)
)
/s/ Charles J. McKay
)
March 19, 2013
Charles J. McKay
Director
)
EXHIBIT INDEX