ITEM 1. Business.
GENERAL -------
Monroe Bancorp (the "Company") is a one-bank holding company formed as a general corporation under Indiana law in 1984. At December 31, 2005, on a consolidated basis the Company had total assets of $713.1 million, total loans of $525.5 million and total deposits of $576.2 million. The Company holds all of the outstanding stock of Monroe Bank (the "Bank"), which was formed in 1892. The Bank is the primary business activity of the Company.
The Bank, headquartered in Bloomington, Indiana, conducts business from 17 locations in Monroe, Hendricks, Hamilton, Jackson and Lawrence counties in Indiana. Approximately 75 percent of the Bank's business is in Monroe County and is concentrated in and around the city of Bloomington. However, the Company's anticipated continued development of additional banking business in Hendricks County, and other counties in the greater Indianapolis area, is expected to gradually reduce this concentration.
The Company, as a bank holding company, engages in commercial banking through the Bank. The Company may also engage in certain non-banking activities closely related to banking and own certain other business companies that are not banks, subject to applicable laws and regulations, although it has no current plans to do so.
As of December 31, 2005, the Bank had 228 full-time equivalent employees.
The Bank is a traditional community bank, which provides a variety of financial services to its customers, including:
o accepting deposits; o making commercial, mortgage and installment loans; o originating fixed rate residential mortgage loans for sale into the secondary market; o providing personal and corporate trust services; o providing investment advisory and brokerage services; and o providing fixed and variable annuities.
The majority of the Bank's revenue is derived from interest and fees on loans and investments, and the majority of its expense is interest paid on deposits and general and administrative expenses related to its business.
The Company has increased its annual dividend each year for 17 years. Based upon a closing price of $16.00 for the Company's stock on December 31, 2005, (MROE; listed on the Nasdaq National Market), the Company's $0.4745 dividend per share provided a dividend yield of 2.97 percent.
Management believes that the Company's culture of community involvement, outstanding service quality, and customer focus has played a significant role in the Company's growth and success. Management also believes that other significant factors contributing to the Company's growth include, but are not limited to, the attractiveness of the Company's primary markets, an involved Board that sets high performance standards and the increased use of incentive and commission compensation plans.
The Company focused much of its effort during 2005 in three areas. The first area of focus was loan growth. As a result of hiring of additional lenders and increased business development activity, total loans at December 31, 2005 were $525.5 million which was 10.1 percent greater than the December 31, 2004 total of $477.1 million. Most of the growth took place in commercial real estate, followed by loans secured by multi-family real estate and construction loans. Over half (64.6 percent) of the loan growth took place at the Bank's locations in Central Indiana (Hendricks and Hamilton counties). At year-end 2005, the Bank had total loans of $109.1 million at its Central Indiana locations, up from $77.8 million at year-end 2004.
The second area of focus was noninterest income growth. Noninterest income totaled $9.3 million for the year ended December 31, 2005 compared to $8.3 million for the previous year. Included in noninterest income are net realized and unrealized securities gains of $169,000 for 2005 and $432,000 for 2004. Excluding net realized and unrealized securities gains, noninterest income increased $1.2 million or 15.5 percent over 2004.
Categories contributing to this growth include service charges on deposit accounts which increased by $568,000 (19.1 percent), trust fees which increased by $169,000 (12.3 percent), gains on the sale of residential mortgages which increased by $185,000 (17.6 percent) and fees earned on the Bank's debit card program which increased by $143,000 (28.5 percent).
The third area of focus was improving asset quality. Considerable progress was made towards improving the Company's asset quality. At December 31, 2005, the Company had a 49.9 percent reduction in non-performing assets (nonaccrual loans, restructured loans and other real estate owned) and 90-day past due loans which are still accruing compared to the prior year-end. At December 31, 2005, non-performing assets and 90-day past due loans totaled $2.0 million (0.28 percent of total assets) compared to $4.1 million (0.64 percent of total assets) one year earlier. The Company also realized a significant improvement in net loans charged off. The Company's net charge-offs for 2005 were $749,000, which is a 34.5 percent reduction from the 2004 total of $1.1 million.
Company Goals - ------------- The Company's business strategies are focused on five major areas:
o increasing the growth rate of net interest income, o improving credit processes to ensure strong credit quality, o managing interest rate risk, o increasing the ratio of noninterest income to net interest income, and o increasing operating efficiency.
Achievement of the Company's financial objectives will require strong loan and deposit growth from the Bank's initiatives in Hendricks County and Hamilton County, two attractive markets in the greater Indianapolis area, as well as from its core markets in and around Monroe County.
Management will measure its overall success in terms of earnings per share growth rate, return on equity, the ratio of nonperforming loans to total loans, service quality and staff retention rates.
Competition - ----------- The Company's market area is highly competitive. In addition to competition from commercial banks (including certain larger regional banks) and savings associations, the Company also competes with numerous credit unions, finance companies, insurance companies, mortgage companies, securities and brokerage firms, money market mutual funds, loan production offices and other providers of financial services. The Company competes with these firms in terms of pricing, delivery channels, product features, service quality, responsiveness and other factors.
The Company also competes directly with a large number of financial service providers who do not have a physical presence in our markets (e.g., Citicorp) but have been successful in selling their services using technology and sophisticated target marketing techniques. We fully expect these companies to increase their future efforts to attract business from our very best customers.
The Company's success, in view of the substantial competition, is felt to be a result of factors such as its history of community involvement and support, commitment to outstanding customer service, awareness of and responsiveness to customer needs, and its attractive mix of high touch and high tech delivery channels. The impact of these factors can be seen in the success the Company has had in increasing its share of deposits in Monroe County.
The Company has been able to increase its deposit market share in the Monroe County market through competitive pricing, marketing and an emphasis on service. According to data published annually by the Federal Deposit Insurance Company (FDIC), all FDIC insured deposits held by financial institutions in Monroe County grew by $268.9 million, or 24.2 percent, during the five-year period between June 30, 2000 and June 30, 2005. During the same period, the Company was able to grow its deposits within Monroe County by $96.9 million (29.9 percent) and increase its market share from 29.2 percent in 2000 to 30.5 percent in 2005. Like many financial institutions, deposit growth over the last five years has not kept pace with the Company's growth in loans. In 2005, the Company addressed short-term liquidity needs by borrowing federal funds (short-term borrowings from other banks) and through the use of brokered certificates of deposit (CDs).
Available Information - --------------------- All reports filed electronically by the Company with the United States Securities and Exchange Commission (SEC), including the Annual Report on Form 10-K, quarterly reports on Form 10-Q, and current event reports on Form 8-K, as well as any amendments to those reports, are accessible at no cost on the Company's Web site at www.monroebank.com. These filings are also accessible on the SEC's Web site at www.sec.gov.
REGULATION AND SUPERVISION - --------------------------
Both the Company and the Bank operate in highly regulated environments and are subject to supervision and regulation by several governmental regulatory agencies, including the Board of Governors of the Federal Reserve (the "Federal Reserve"), The Federal Deposit Insurance Corporation (the "FDIC") and the Indiana Department of Financial Institutions (the "DFI"). The laws and regulations established by these agencies are generally intended to protect depositors, not shareholders. Changes in applicable laws, regulations, governmental policies, income tax laws and accounting principles may have a material effect on our business and prospects. The following summary is qualified by reference to the statutory and regulatory provisions discussed.
MONROE BANCORP - --------------
The Bank Holding Company Act. Because the Company owns all of the outstanding capital stock of the Bank, it is; registered as a bank holding company under the federal Bank Holding Company Act of 1956, is subject to periodic examination by the Federal Reserve, and is required to file periodic reports of its operations and any additional information that the Federal Reserve may require.
Investments, Control, and Activities. With some limited exceptions, the Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before acquiring another bank holding company or acquiring more than five percent of the voting shares of a bank (unless it already owns or controls the majority of such shares).
Bank holding companies are prohibited, with certain limited exceptions, from engaging in activities other than those of banking or of managing or controlling banks. They are also prohibited from acquiring or retaining direct or indirect ownership or control of voting shares or assets of any company which is not a bank or bank holding company, other than subsidiary companies furnishing services to or performing services for their subsidiaries, and other subsidiaries engaged in activities which the Federal Reserve Board determines to be so closely related to banking or managing or controlling banks as to be incidental to these operations. The Bank Holding Company Act does not place territorial restrictions on the activities of such nonbanking-related activities.
Effective as of March 11, 2001, the Gramm-Leach-Bliley Act allows bank holding companies which meet certain management, capital and CRA standards and which have elected to become a finance holding company to engage in a substantially broader range of nonbanking activities than was previously permissible, including insurance underwriting and agency, and underwriting and making merchant banking investments in commercial and financial companies. This act also removes various restrictions that previously applied to bank holding company ownership of securities firms and mutual fund advisory companies.
The Company does not currently plan to engage in any activity other than owning the stock of the Bank.
Dividends. The Federal Reserve's policy is that a bank holding company experiencing earnings weakness should not pay cash dividends exceeding its net income or which could only be funded in ways that weaken the bank holding company's financial health, such as by borrowing. Additionally, the Federal Reserve possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.
Source of Strength. In accordance with Federal Reserve Board policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances in which the Company might not otherwise do so.
MONROE BANK - -----------
General Regulatory Supervision. The Bank is an Indiana-chartered banking corporation subject to examination by the DFI. The DFI and the FDIC regulate or monitor virtually all areas of the Bank's operations. The Bank must undergo regular on-site examinations by the FDIC and DFI and must submit annual reports to the FDIC and the DFI.
Lending Limits. Under Indiana law, the total loans and extensions of credit by an Indiana-chartered bank to a borrower outstanding at one time and not fully secured may not exceed 15 percent of the bank's capital and unimpaired surplus. In addition, the total amount of outstanding loans and extensions of credit to any borrower outstanding at one time and fully secured by readily marketable collateral may not exceed ten percent of the unimpaired capital and unimpaired surplus of the bank (this limitation is separate from and in addition to the above limitation).
Deposit Insurance. Deposits in the Bank are insured by the FDIC up to a maximum amount, which is generally $100,000 per depositor subject to aggregation rules. The Bank is subject to deposit insurance assessment 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. The Bank is also subject to assessment for the Financial 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. Increases in deposit insurance premiums or changes in risk classification will increase the Bank's cost of funds, and it may not be able to pass these costs on to its customers.
Transactions with Affiliates and Insiders. The Bank is subject to limitations on the amount of loans or extensions of credit to, or investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements. Compliance is also required with certain provisions designed to avoid the taking of low quality assets. The Bank is also prohibited from engaging in certain transactions with certain affiliates and insiders unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.
Extensions of credit by the Bank to its executive officers, directors, certain principal shareholders, and their related interests must:
o be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties; and o not involve more than the normal risk of repayment or present other unfavorable features.
Dividends. Under Indiana law, the Bank may pay dividends from its undivided profits in an amount declared by its Board of Directors, subject to prior approval of the DFI if the proposed dividend, when added to all prior dividends declared during the current calendar year, would be greater than the current year's "net profits" and retained "net profits" for the previous two calendar years.
Federal law generally prohibits the Bank from paying a dividend to the Company if the depository institution would thereafter be undercapitalized. The FDIC may prevent an insured bank from paying dividends if the bank is in default of payment of any assessment due to the FDIC. In addition, payment of dividends by a bank may be prevented by the applicable federal regulatory authority if such payment is determined, by reason of the financial condition of such bank, to be an unsafe and unsound banking practice.
Branching and Acquisitions. Branching by the Bank requires the prior approval of the FDIC and the DFI. Under current law, Indiana chartered banks may establish branches throughout the state and in other states. 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.
Community Reinvestment Act. The Community Reinvestment Act requires that the FDIC evaluate the record of the Bank in meeting the credit needs of its local community, including low and moderate income neighborhoods. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could result in the imposition of additional requirements and limitations on the Bank.
Capital Regulations. The federal bank regulatory authorities have adopted risk-based capital guidelines for banks and bank holding companies that are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies and account for off-balance sheet items. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet commitments to four risk-weighted categories of 0 percent, 20 percent, 50 percent, or 100
percent, with higher levels of capital being required for the categories perceived as representing greater risk. The guidelines are minimums, and the federal regulators have noted that banks and bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios in excess of the minimums. Neither the Company nor the Bank has received any notice indicating that either is subject to higher capital requirements.
The federal bank regulatory authorities have also implemented a leverage ratio to supplement to the risk-based guidelines. The principal objective of the leverage ratio is to place a constraint on the maximum degree to which a bank holding company may leverage its equity capital base.
The Bank is also subject to the FDIC's "prompt corrective action" regulations, which implement a capital-based regulatory scheme designed to promote early intervention for troubled banks. This framework contains five categories of compliance with regulatory capital requirements, including "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." As of December 31, 2004, the Bank was qualified as "well capitalized." It should be noted that a bank's capital category is determined solely for the purpose of applying the FDIC's "prompt corrective action" regulations and that the capital category may not constitute an accurate representation of the bank's overall financial condition or prospects. The degree of regulatory scrutiny of a financial institution increases, and the permissible activities of the institution decrease, as it moves downward through the capital categories. Bank holding companies controlling financial institutions can be required to boost the institutions' capital and to partially guarantee the institutions' performance.
Other Regulations. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank's loan operations are also subject to federal and state laws applicable to credit transactions, such as the:
o Truth-In-Lending Act and state consumer protection laws, governing disclosures of credit terms and prohibitive certain practices with regard to consumer borrowers; o Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves; o Equal Credit Opportunity Act and other fair lending laws, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit; o Fair Credit Reporting Act of 1978 and Fair and Accurate Transactions Act of 2003, governing the use and provision of information to credit reporting agencies; o Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and o rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
The deposit operations of the Bank also are subject to the:
o Customer Information Security Guidelines. The federal bank regulatory agencies have adopted final guidelines (the "Guidelines") for safeguarding confidential customer information. The Guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors, to create a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazards to the security or integrity of such information; and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.
o Electronic Funds Transfer Act, and Regulation E. The Electronic Funds Transfer Act, which is implemented by Regulation E, governs automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of automated teller machines and other electronic banking service.
Check Clearing for the 21st Century Act. Effective October 28, 2004, the Board of Governors of the Federal Reserve System (the "Board") adopted final amendments to Regulation CC and its commentary to implement the Check Clearing for the 21st Century Act (the "Check 21 Act"). The Check 21 Act was enacted on October 28, 2003 and became effective on October 28, 2004.
To facilitate check truncation and electronic check exchange, the Check 21 Act authorizes a new negotiable instrument called a "substitute check" and provides that a properly prepared substitute check is the legal equivalent of the original check for all purposes. A substitute check is a paper reproduction of the original check that can be processed just like the original check. The Check 21 Act does not require any bank to create substitute checks or to accept checks electronically. The Board's amendments: (i) set forth the requirements of the Check 21 Act that apply to all banks, including those that choose not to create substitute checks; (ii) provide a model disclosure and model notices relating to substitute checks; and (iii) set forth bank endorsement and identification requirements for substitute checks. The amendments also clarify some existing provisions of the rule and commentary.
USA Patriot Act. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") is intended to strengthen the ability of U. S. Law Enforcement to combat terrorism on a variety of fronts. The potential impact of the USA Patriot Act on financial institutions is significant and wide-ranging. The USA Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires financial institutions to implement additional policies and procedures with respect to, or additional measures designed to address, any or all of the following matters, among others: money laundering and currency crimes, suspicious activities, customer identification verification, cooperation among financial institutions, and currency transaction reporting.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. Among other requirements, the Sarbanes-Oxley Act established: (i) new requirements for audit committees of public companies, including independence, expertise, and responsibilities; (ii) additional responsibilities regarding financial statements for the chief executive officers and chief financial officers of reporting companies; (iii) new standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for reporting companies regarding various matters relating to corporate governance, and (v) new and increased civil and criminal penalties for violation of the securities laws.
Enforcement Powers. Federal regulatory agencies may assess civil and criminal penalties against depository institutions and certain "institution-affiliated parties," including management, employees, and agents of a financial institution, as well as independent contractors and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution's affairs. In addition, regulators may commence enforcement actions against institutions and institution-affiliated parties. Possible enforcement actions include the termination of deposit insurance. Furthermore, regulators may issue cease-and-desist orders to, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by the regulator to be appropriate.
Effect of Governmental Monetary Policies. Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Bank's monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.
FORWARD-LOOKING STATEMENTS --------------------------
Portions of the information in this Form 10-K include certain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995) concerning the intent, belief, outlook, estimate or expectations of the Company and its subsidiaries, its directors, or its officers primarily with respect to future events or the future operations, performance, financial condition and likelihood of success of the Company and the Bank. You can identify these statements by use of terms such as "expect," "believe," "goal," "plan," "intend," "estimate," "may," "will" or similar words. These forward-looking statements are not guarantees of future events or performance and are based upon assumptions rather than historical or current facts. The forward-looking statements involve known and unknown risks, uncertainties and other factors that could cause our actual results to differ materially from those anticipated in the forward-looking statements. The factors which could cause a difference between actual results and those in the forward- looking statements include, but are not limited to, changes in interest rates; 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; or regulatory changes. Shareholders, potential investors and other readers are urged to consider these factors in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements.
Statistical Data. Selected Financial Data
Financial Highlights (dollar amounts in thousands, except share and per share data) - --------------------------------------------------------------------------------
(1) Net income divided by average total assets (2) Net income divided by average equity (3) Dividends per share divided by net income per share (4) Average equity divided by average total assets
Net Interest Income -------------------
The table on the following page presents information to assist in analyzing net interest income. The table of Average Balance Sheets and Interest Rates presents the major components of interest-earning assets and interest-bearing liabilities, related interest income and expense and the resulting yield or cost. For analytical purposes, interest income presented in the table has been adjusted to a tax-equivalent basis assuming a 40 percent tax rate. The tax-equivalent adjustment recognizes the income tax savings when comparing taxable and tax-exempt assets. Management believes a table of the changes in tax-equivalent rates and margin is more relevant because it better explains changes in after-tax net income.
Average Balance Sheets and Interest Rates (dollar amounts in thousands)
(1) Interest income on tax-exempt securities has been adjusted to a tax equivalent basis using a marginal income tax rate of 40% (2) Nonaccrual loans are included in average loan balances and loan fees are included in interest income. (3) Interest income adjustment to convert tax-exempt investment securities interest to fully tax equivalent basis using a marginal rate of 40%.
The following table presents net interest income components on a tax-equivalent basis and reflects changes between periods attributable to movement in either the average balance or average interest rate for both earning assets and interest-bearing liabilities. The volume differences were computed as the difference in volume between the current and prior year times the interest rate of the prior year, while the interest rate changes were computed as the difference in rate between the current and prior year items times the volume of the prior year. Volume/rate variances have been allocated on the basis of the absolute relationship between volume variances and rate variances. Nonaccrual loans were included in the average loan balances used in determining the yields.
Volume / Rate Analysis (dollar amounts in thousands) - --------------------------------------------------------------------------------
(1) The tax-equivalent adjustment is based on a marginal income tax rate of 40%.
Allowance for Loan Loss and Asset Quality -----------------------------------------
The following table presents activity in the allowance for loan losses during the years indicated. The Company's policy is to charge off loans when, in management's opinion, the loan is deemed uncollectible. However, management makes a concerted effort to collect charged off loans.
Analysis of Allowance for Loan Losses (dollar amounts in thousands) - --------------------------------------------------------------------------------
The allocation of the allowance for loan losses along with the percentage of each loan type to total loans outstanding is illustrated in the following table. The Company regards the allowance as a general allowance which is available to absorb losses from all loans.
Allocation of the Allowance for Loan Losses (dollar amounts in thousands) - --------------------------------------------------------------------------------
Nonperforming assets and their relative percentages to loan balances are presented in the table on the following page. The level of nonperforming loans is an important element in assessing asset quality and the relevant risk in the credit portfolio. Nonperforming loans include nonaccrual loans, restructured loans and loans delinquent 90 days or more and still accruing.
Loans are evaluated for nonaccrual status when payments are past due over 90 days or when management feels that there is a high probability that principal and interest are not fully collectible. Current year interest previously recorded but not deemed collectible is reversed and charged against current income. Interest income on these loans is then recognized after principal is collected. Loans significantly past due that are not well secured and in the process of collection are generally placed on nonaccrual status. Restructured loans are loans for which the contractual interest rate has been reduced or other concessions are granted to the borrower because of deterioration in the financial condition of the borrower resulting in the inability of the borrower to meet the original contractual terms of the loans. Another element associated with asset quality is other real estate owned (OREO), which represents properties acquired by the Company through loan defaults by customers.
Nonperforming Assets (dollar amounts in thousands) - --------------------------------------------------------------------------------
Interest income of $18,000 for the year ended December 31, 2005, was recognized on the nonaccruing and restructured loans listed in the table above, whereas, interest income of $125,000 would have been recognized under their original terms.
Potential Problem Loans - ----------------------- In addition to loans classified for regulatory purposes, management also designates certain loans for internal monitoring purposes in a watch category. Loans may be placed on management's watch list as a result of delinquent status, concern about the borrower's financial condition or the value of the collateral securing the loan, substandard classification during regulatory examinations, or simply as a result of management's desire to monitor more closely a borrower's financial condition and performance. Watch category loans may include loans with loss potential that are still performing and accruing interest and may be current under the terms of the loan agreements; however, management may have a significant degree of concern about the borrowers' ability to continue to perform according to the terms of the loans. Loss exposure on these loans is typically evaluated based primarily upon adequacy of the cash flow repaying the loan or the estimated liquidation value of the collateral securing these loans. Also, watch category loans may include credits which, although adequately secured and performing, have past delinquency problems or where unfavorable financial trends are exhibited by borrowers.
All watch list loans are subject to additional scrutiny and monitoring on a monthly or quarterly basis. The Company's philosophy encourages loan officers to identify borrowers that should be monitored in this fashion and believes this process ultimately results in the identification of problem loans in a more timely fashion.
Management has identified $6.2 million and $5.8 million of loans on its watch list which were not included in impaired or nonperforming loans at December 31, 2005 and 2004, respectively.
Noninterest Income and Expense ------------------------------
A comparative table and complete discussion of noninterest income and expense is contained in the 2005 Annual Report to Shareholders - Financial Review - Managements Discussion and Analysis on pages 14 to 16 under the caption "Other Income and Expense."
Financial Condition -------------------
Securities ----------
Held-to-maturity securities are those which the Company has both the positive intent and the ability to hold to maturity. They are reported at amortized cost. Available-for-sale securities are those which the Company may decide to sell if needed for liquidity, asset/liability management, or other reasons. Available-for-sale securities are reported at fair value, with unrealized gains and losses included in other comprehensive income, net of tax.
Trading securities consist of investments in various mutual funds held in grantor trusts formed by the Company related to the Monroe Bancorp Directors' Deferred Compensation Plan. The Company's obligations under the deferred compensation plan change in concert with the performance of the investments.
The tables on the following page summarize the carrying values of securities from December 31, 2003 through December 31, 2005. The maturity distribution of securities at December 31, 2005 is summarized by classification.
Securities (dollar amounts in thousands) - -------------------------------------------------------------------------------- December 31, ------------------------------ 2005 2004 2003 -------- -------- -------- Available for sale - ------------------ Government agencies .......... $ 53,447 $ 68,282 $ 48,471 State and municipal .......... 26,645 10,148 4,998 Mortgage-backed & asset-backed 30,443 17,567 9,600 Equity securities ............ 2,948 -- -- -------- -------- --------
Total available for sale 113,483 95,997 63,069
Held to Maturity - ---------------- Government agencies .......... 984 4,025 22,617 State and municipal .......... 1,365 6,461 17,170 Mortgage-backed & asset-backed 4 6 10 -------- -------- --------
Total held to maturity . 2,353 10,492 39,797
Trading securities - ------------------ Mutual funds ................ 3,408 3,223 3,329 -------- -------- -------- Total trading securities 3,408 3,223 3,329 -------- -------- --------
Total securities ... $119,244 $109,712 $106,195 ======== ======== ========
Securities Maturity Schedule at December 31, 2005 - -------------------------------------------------
(1) Mortgage-backed and asset-backed securities maturities are based on average life at the projected prepayment speed. (2) Equity securities and mutual funds have no maturities
Securities (continued) ----------------------
The majority of the securities portfolio is comprised government agency securities, and mortgage-backed obligations. Trading securities consist solely of mutual funds held in a grantor trust, established for the Monroe Bancorp Directors' and Executives' Deferred Compensation Plan.
The securities portfolio carries varying degrees of risk. Investments in government agency and mortgage-backed securities have little or no credit risk. Obligations of states and political subdivisions and corporate securities are the areas of highest potential credit exposure in the portfolio. This risk is minimized through the purchase of high quality investments. The Company's investment policy requires that general obligations of other states and political subdivisions and corporate bonds must have a rating of A or better when purchased. In-state general obligation municipals must be rated Baa or better. In-state revenue municipals must be rated A or better and out-of-state revenue municipals must be rated AA or better at the time of purchase. The vast majority of these investments maintained their original ratings at December 31, 2005. No securities of an individual issuer, excluding the U.S. Government and its agencies, exceed 10 percent of the Company's shareholders' equity as of December 31, 2005. The Company does not use off-balance sheet derivative financial instruments. As of December 31, 2005 and December 31, 2004, the securities portfolio held no structured notes.
Loans -----
The loan portfolio constitutes the major earning asset of the Company, and offers the best alternative for maximizing interest spread above the cost of funds. The Company's loan personnel have the authority to extend credit under guidelines established and approved by the Board of Directors. Any credit which exceeds the authority of the loan officer, but is under $2 million is forwarded to either the Company's Officers' Loan Committee or the Central Indiana Loan Committee for approval. The committees are comprised of the President/CEO, the Senior Vice President of Loans and several experienced loan officers. Individual credits exceeding $2 million are forwarded to the Board of Directors' loan committee for approval. This loan committee is comprised of seven board members, one of whom is the President/CEO. The loan committee not only acts as an approval body to ensure consistent application of the Company's loan policy, but also provides valuable insight through communication and pooling of knowledge, judgment, and experience of its members.
The Company's primary lending area generally includes Monroe, Lawrence, Jackson, Hendricks, Hamilton and contiguous counties in South Central Indiana. The Company extends out-of-area credit only to borrowers who are considered to be low risk, and then, only on a limited basis.
The following table reflects outstanding balances by loan type.
Loans Outstanding (dollar amounts in thousands) - --------------------------------------------------------------------------------
December 31, ---------------------------------------------------- 2005 2004 2003 2002 2001 -------- -------- -------- -------- -------- Commercial and industrial $ 89,850 $ 85,420 $ 81,989 $ 76,301 $ 72,640 Agricultural ............ 1,427 992 1,028 1,322 1,084 Real estate: One-to-four-family ... 100,493 105,339 105,455 111,297 119,709 Multi-family ......... 59,057 52,087 43,682 44,640 41,941 Commercial ........... 156,014 128,167 108,871 88,661 71,057 Construction ......... 68,066 61,828 40,560 27,471 28,013 Home equity .......... 27,479 25,390 21,044 17,927 13,637 Farm land ............ 3,216 1,450 1,538 1,270 1,256 Installment ............. 19,864 16,412 20,344 22,426 22,463 -------- -------- -------- -------- -------- Total loans ..... $525,466 $477,085 $424,511 $391,315 $371,800 ======== ======== ======== ======== ========
The following table presents the composition of the loan portfolio expressed as a percent of total loans.
December 31, ---------------------------------------------------- 2005 2004 2003 2002 2001 -------- -------- -------- -------- -------- Commercial and industrial 17.11 % 17.91 % 19.32 % 19.50 % 19.54 % Agricultural ............ 0.27 % 0.21 % 0.24 % 0.34 % 0.29 % Real estate: One-to-four-family ... 19.12 % 22.08 % 24.84 % 28.44 % 32.20 % Multi-family ......... 11.24 % 10.92 % 10.29 % 11.41 % 11.28 % Commercial ........... 29.69 % 26.86 % 25.65 % 22.66 % 19.11 % Construction ......... 12.95 % 12.96 % 9.55 % 7.02 % 7.53 % Home equity .......... 5.23 % 5.32 % 4.96 % 4.58 % 3.67 % Farm land ............ 0.61 % 0.30 % 0.36 % 0.32 % 0.34 % Installment ............. 3.78 % 3.44 % 4.79 % 5.73 % 6.04 % -------- -------- -------- -------- -------- Total .......... 100.00 % 100.00 % 100.00 % 100.00 % 100.00 % ======== ======== ======== ======== ========
The following table reflects the maturity schedule of loans. Also indicated are fixed and variable rate loans maturing after one year.
Loan Liquidity (dollar amounts in thousands) - --------------------------------------------------------------------------------
Loan Maturities at December 31, 2005 ------------------------------------------ 1 Year 1 - 5 Over 5 and Less Years Years Total -------- -------- -------- -------- Commercial and industrial ....... $ 43,299 $ 32,267 $ 15,711 $ 91,277 Real estate: One-to-four-family ......... 8,601 3,357 88,535 100,493 Multi-family ............... -- 4,140 54,917 59,057 Commercial ................. 9,329 17,785 128,900 156,014 Construction ............... 34,208 27,298 6,560 68,066 Home equity ................ -- 93 27,386 27,479 Farm land .................. 59 160 2,997 3,216 Installment ..................... 2,477 9,233 8,154 19,864 -------- -------- -------- -------- Total loans ........... $ 97,973 $ 94,333 $333,160 $525,466 ======== ======== ======== ========
Loans maturing after 1 year with: Fixed interest rates ........ $ 28,745 $ 72,800 Adjustable interest rates ... 65,588 260,360 -------- -------- $ 94,333 $333,160 ======== ========
Deposits --------
The Company offers a wide variety of deposit products and services to individual and commercial customers, such as noninterest-bearing and interest-bearing checking accounts, savings accounts, money market accounts, and certificates of deposit. The deposit base provides the major funding source for earning assets.
The following table shows the average amount of deposits and average rates of interest paid thereon for the years indicated.
Deposit Information (dollar amounts in thousands) - --------------------------------------------------------------------------------
Certificates of deposit and other time deposits of $100,000 or more mature as follows:
At December 31, ------------------------------ CD's over $100,000 2005 2004 2003 -------- -------- --------
3 months or less ..... $ 26,571 $ 35,910 $ 14,030 3 through 6 months ... 12,479 12,462 8,499 6 through 12 months .. 58,625 17,851 14,232 Over 12 months ....... 39,731 19,635 26,143 -------- -------- -------- $137,406 $ 85,858 $ 62,904 ======== ======== ========
Certificates of deposit of $100,000 or more totaled $137.4 million at December 31, 2005, which was an increase of $51.5 million over December 31, 2004. The Company began using brokered CDs as an alternative funding source in 2005. The majority of the increase in CDs of $100,000 or more was in brokered CDs, which were $49.7 million at December 31, 2005. While the Company's primary focus for 2006 will be on growing core deposits, management anticipates it will continue to use brokered CDs as an alternative funding source in the future.
Borrowings ----------
A detailed schedule of short-term borrowings follows:
Short-term Borrowings (dollar amounts in thousands) - --------------------------------------------------------------------------------
Repurchase agreements are borrowings, the majority of which mature daily, and are secured by U.S. Treasury and government agency obligations.
The Bank became a member of the Federal Home Loan Bank of Indianapolis ("FHLB") in 1997 and has the authority of the Company's Board of Directors to borrow up to $57 million from the FHLB. All current and any future borrowings are secured by a blanket collateral pledge of the Bank's one-to-four family residential loans and multi-family loans. Other borrowings, consisting of FHLB advances and loans sold under repurchase agreements, were $36.2 million and $38.6 million, as of December 31, 2005 and 2004, respectively. The FHLB borrowings accounted for the vast majority of other borrowings. The Company had a net decrease in borrowings from the FHLB of $4.2 million during 2005. The Company expects to primarily use deposit growth in the future as a source of loan funding and for general liquidity, but may continue to supplement this with additional FHLB advances.
Liquidity ---------
A table detailing the maturity and repricing of the Company's assets accompanied by a discussion of the Company's interest rate sensitivity and liquidity is presented in the 2005 Annual Report to Shareholders - Financial Review - Management's Discussion and Analysis on pages 10 to 12 under the caption "Interest Rate Sensitivity and Disclosures about Market Risk" and on pages 12 to 13 under the caption "Liquidity."
The following table details the main components of cash flows for the years ended December 31, 2005 and 2004.
Funding Uses and Sources (dollar amounts in thousands) - --------------------------------------------------------------------------------
Capital Adequacy ----------------
Management believes the Company and Bank met all the capital requirements as of December 31, 2005 and 2004, and the Bank was well-capitalized under the guidelines established by the banking regulators. To be well-capitalized, the Bank must maintain the prompt corrective action capital guidelines discussed in the "Capital Regulations" subsection of the "Regulation and Supervision" portion of this document. Consolidated capital amounts and ratios are presented in the following table. Bank capital levels are substantially similar.
At December 31, 2005 management was not aware of any current recommendations by banking regulatory authorities which, if they were to be implemented, would have, or are reasonably likely to have, a material effect on the Company's consolidated liquidity, capital resources or operations.
Capital (dollar amounts in thousands) - --------------------------------------------------------------------------------
ITEM 1A.
ITEM 1A. RISK FACTORS SLOWER THAN ANTICIPATED GROWTH IN THE BANK'S NEW BRANCHES COULD RESULT IN REDUCED NET INCOME
The Company has placed a strategic emphasis on expanding the branch network of the Bank. The Company opened a full service branch in Brownsburg, Hendricks County, Indiana in January of 2006 and anticipates opening a full service branch in Plainfield, Hendricks County, Indiana during the fourth quarter of 2006. Executing this strategy carries risks of slower than anticipated growth in the new branches. New branches require a significant investment of both financial and personnel resources. Lower than expected loan and deposit growth in the new branches could result in lower than expected revenues and net income generated by those investments. Opening new branches could result in more additional expenses than anticipated and divert resources from current core operations.
INABILITY TO HIRE OR RETAIN CERTAIN KEY PROFESSIONALS, MANAGEMENT AND STAFF COULD ADVERSELY AFFECT OUR REVENUES AND NET INCOME
The Company relies on key personnel to manage and operate its business, including major revenue generating functions such as the loan and deposit portfolios. The loss of key staff may adversely affect the Company's ability to maintain and manage these portfolios effectively, which could negatively affect the Company's revenues. In addition, loss of key personnel could result in increased recruiting and hiring expenses, which could cause a decrease in the Company's net income.
THE COMPANY IS SUBJECT TO INTEREST RATE RISK
The Company's earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Company's control, including general economic conditions and policies of various governmental and regulatory agencies. Changes in monetary policy, including changes in interest rates, could influence not only the interest the Company receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect the Company's ability to originate loans and obtain deposits and the fair value of the Company's financial assets and liabilities. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Company's net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
THE COMPANY'S ALLOWANCE FOR POSSIBLE LOAN LOSSES MAY BE INSUFFICIENT
The Company maintains an allowance for possible loan losses, which is a reserve established through a provision for possible loan losses charged to expense, that represents management's best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management's continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for possible loan losses inherently involves a high degree of subjectivity and requires management to make significant estimates of current credit risks and future trends, all of which may undergo material changes. In addition, bank regulatory agencies periodically review the Company's allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. If charge-offs in future periods exceed the allowance for possible loan losses, the Company will need additional provisions to increase the allowance for possible loan losses. Any increases in the allowance for possible loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on the Company's financial condition and results of operations.
THE COMPANY IS SUBJECT TO ENVIRONMENTAL LIABILITY RISK ASSOCIATED WITH LENDING ACTIVITIES
A significant portion of the Company's loan portfolio is secured by real property. During the ordinary course of business, the Company may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Company may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Company to incur substantial expenses
and may materially reduce the affected property's value or limit the Company's ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase the Company's exposure to environmental liability. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on the Company's financial condition and results of operations.
THE COMPANY IS SUBJECT TO EXTENSIVE GOVERNMENT REGULATION AND SUPERVISION
The Company, primarily through the Bank, is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors' funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect the Company's lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to additional costs, limit the types of financial services and products the Company may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Company's business, financial condition and results of operations.
THE COMPANY'S CONTROLS AND PROCEDURES MAY FAIL OR BE CIRCUMVENTED
Management regularly reviews and updates the Company's internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Company's controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company's business, results of operations and financial condition.
THE COMPANY'S INFORMATION SYSTEMS MAY EXPERIENCE AN INTERRUPTION OR BREACH IN SECURITY
The Company relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Company's customer relationship management, general ledger, deposit, loan and other systems. While the Company has policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of the Company's information systems could damage the Company's reputation, result in a loss of customer business, subject the Company to additional regulatory scrutiny, or expose the Company to civil litigation and possible financial liability, any of which could have a material adverse effect on the Company's financial condition and results of operations.
THE TRADING VOLUME IN THE COMPANY'S COMMON STOCK IS LESS THAN THAT OF OTHER LARGER FINANCIAL SERVICES COMPANIES
Although the Company's common stock is listed for trading on NASDAQ National Market, the trading volume in its common stock is less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of the Company's common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which
the Company has no control. Given the lower trading volume of the Company's common stock, significant sales of the Company's common stock, or the expectation of these sales, could cause the Company's stock price to fall.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2.
ITEM 2. PROPERTIES.
The Company, through the Bank, currently operates its business from its main office in downtown Bloomington, Indiana and from sixteen additional locations in Monroe, Jackson, Hendricks Hamilton and Lawrence counties in Indiana. The Company also has an operations center. Information about those locations is set forth in the table on the following page.
(1) Branch was placed in service January 16, 2006
The Company owns its main office. It owns eight of its other branch locations and leases space for eight branches. The Company also leases its Operations Center. The main office contains approximately 18,656 square feet of space, and is occupied solely by the Company. The Company's data processing center, bookkeeping, loan operations and deposit operations departments are located at the Operations Center.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
Except as set forth below, there are no material pending legal proceedings, other than routine litigation incidental to the business of the Company or the Bank, to which the Company or the Bank is a party or of which any of its property is subject. Further, there is no material legal proceeding in which any director, officer, principal shareholder, or affiliate of the Company, or any associate of such director, officer, principal shareholder or affiliate is a party, or has a material interest, adverse to the Company.
The Company is a creditor in two pending Chapter 11 cases filed by a real estate developer and his real estate development corporation. The Chapter 11 Trustee appointed in the bankruptcy cases filed a complaint in the Bankruptcy Court against the Company and 17 other named defendants seeking unspecified damages on theories of fraudulent transfer and preference. The Company and the Trustee have reached a settlement of the Trustee's claims against the Company for payment of the sum of $50,000, plus assignment of a promissory note payable by the Trustee to the Company in the principal amount of $20,000, subject to Bankruptcy Court approval. Most of the 17 other named defendants alleged cross claims against the Company for indemnification and those claims have been dismissed by the Bankruptcy Court for lack of jurisdiction. These other defendants may subsequently reassert their alleged indemnification claims against the Company in other forums. In addition, some of these other defendants have alleged certain other claims in other pending litigation or have threatened claims against the Bank. While the Company denies any liability for any of these claims, it is impossible to predict the outcome of any such pending litigation or potential future litigation or the full range of potential loss to the Company. Furthermore, on February 17, 2005, the loan officer who made the loans related to the claims and threatened claims was indicted by a federal grand jury. Based upon current facts and circumstances, it is not possible at this time to predict the effect that these proceedings will have on the financial statements of the Company. The Company has not recorded any liability in its December 31, 2005 financial statements for these matters.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted during the fourth quarter of 2005 to a vote of security holders, through the solicitation of proxies or otherwise.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITES.
The Company's common stock is quoted on the Nasdaq National Market under the symbol "MROE." The following table sets forth, for the periods indicated, the high and low sales prices for the Company's common stock as reported by the Nasdaq National Market:
2005 2004 Dividends Declared ------------------------------------------------------------------------- Quarter High Low High Low 2005 2004 ------------------------------------------------------------------------- First Quarter $ 16.50 $ 14.37 $ 14.95 $ 12.81 $0.1182 $0.1182 Second Quarter 15.45 13.34 15.35 14.36 0.1182 0.1182 Third Quarter 15.90 14.36 15.45 14.45 0.1182 0.1182 Fourth Quarter 16.08 14.09 16.76 14.72 0.1200 0.1182
In each quarter during 2005 and 2004, the Company declared and paid the cash dividends listed in the table above for a per share total of $ 0.4746 and $ 0.4728 for 2005 and 2004, respectively. Per share dividends paid prior to the stock dividend (paid on November 17, 2005) have been restated for the effect of the stock dividend. The Company has paid a regular cash dividend for over twenty-four consecutive years. The Company currently expects that comparable cash dividends will continue to be paid in the future.
Without prior approval, current regulations allow the Bank to pay dividends to the Company not exceeding net profits (as defined) for the current year plus those for the previous two years. The Bank normally restricts dividends to a lesser amount because of the need to maintain an adequate capital structure. Total shareholders' equity of the Bank at December 31, 2005 was $50.5 million of which $42.3 million was restricted from dividend distribution to the Company. The Company does not anticipate that this regulatory limitation will affect the future payment of dividends.
As of March 1, 2006, there were approximately 297 shareholders of record.
During 2005, one director exercised stock options. On February 17, 2005 the Company sold 5,500 shares of common stock at $12.045 per share, or an aggregate of $66,250 to David Baer pursuant to the exercise by Mr. Baer of a stock option. These shares were sold in a private placement pursuant to Section 4(2) of the Securities Act of 1933. Mr. Baer exchanged 4,207.56 shares of stock with a fair value of $15.7454 per share for a total of $66,250 for the option shares.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The information required under this item is incorporated by reference to pages 2 through 3 of the Company's 2005 Annual Report to Shareholders - Financial Review under the caption "Five-Year Financial Summary."
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The information required under this item is incorporated by reference to pages 4 through 18 of the Company's 2005 Annual Report to Shareholders - Financial Review under the caption "Management's Discussion and Analysis."
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required under this item is incorporated by reference to pages 10 through 12 of the Company's 2005 Annual Report to Shareholders - Financial Review - Management's Discussion and Analysis under the caption "Interest Rate Sensitivity and Disclosures about Market Risk."
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements and supplementary data required under this item are incorporated herein by reference to pages 20 through 42 of the Company's 2005 Annual Report to Shareholders - Financial Review.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls And Procedures
The Company's principal executive officer and principal financial officer have concluded that the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) based on their evaluation of these controls and procedures as required by Rule 13a-15(b) as of the end of the period covered by this Form 10-K are effective.
Management's Report on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company's internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2004. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment and those criteria, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2004.
The Company's independent registered public accounting firm has issued their report on management's assessment of the Company's internal control over financial reporting. That report follows under the heading, Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting.
Changes in Internal Controls
There have been no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation thereof, including any corrective actions with regard to significant deficiencies and material weaknesses.
Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Shareholders Monroe Bancorp Bloomington, Indiana
We have audited management's assessment, included in Management's Report on Internal Control over Financial Reporting, that Monroe Bancorp maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit includes obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Monroe Bancorp maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, Monroe Bancorp maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of December 31, 2005 and our report dated February 6, 2006 expressed an unqualified opinion thereon.
BKD, LLP
Indianapolis, Indiana February 6, 2006
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
On November 17, 2005, the Company's Board of Directors approved the Monroe Bancorp Directors' 2005 Deferred Compensation Plan (the "Directors' Plan") and the Monroe Bancorp Executives' 2005 Deferred Compensation Plan (the "Executives' Plan") (collectively referred to as the "Plans"), both effective January 1, 2005. Any duly elected member of Monroe Bancorp's Board of Directors is eligible to participate in the Directors' Plan. Designated executives in a select group of management or highly compensation employees are eligible to participate in the Executives' Plan. The Plans are administered by the Compensation Committee of the Board of Directors (the "Committee"). Under the Plans, directors may elect to defer receipt of all or part of their director fees and executives may elect to defer all or a portion of their base salary, annual bonus or other Committee designated compensation for personal retirement or financial planning. Deferral elections for a particular year must generally be made prior to the beginning of that year and are irrevocable once the year begins.
Deferrals are credited to a bookkeeping account maintained by the Committee. Participants are at all times 100% vested in their deferral accounts. Deferral accounts will be increased or decreased based on the increase or decrease in one or more "investment funds" established by the Committee for the Plans. Participants may elect which investment fund or funds will be used for this purpose for their own deferral accounts. Monroe Bancorp stock will be used for one investment fund.
Participants may elect to have their deferral accounts paid to them in either a single sum or installments. Payment will be made or commenced on a specified date (which may not be any sooner than two plan years after the year to which the deferral election relates) or upon termination of service as elected by the participants. Distributions are also made to a participant's designated beneficiary upon death. Benefit security for the Plans will be provided by a funded "rabbi" trust. Monroe Bancorp may terminate the Plans at any time; however, benefits will be paid as defined in the Plans.
A copy of the Directors' Plan is filed as Exhibit 10(xi) to this Form 10-K, a copy of the form of agreement under the Directors' Plan is filed as Exhibit 10(xiii) to this Form 10-K, copy of the Executives' Plan is filed as Exhibit 10(xii) to this Form 10-K, and a copy of the form of agreement under the Executives' Plan is filed as Exhibit 10(xiv) to this Form 10-K.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
In accordance with the provisions of General Instruction G to Form 10-K, the information required for the remainder of the required disclosures under Item 10 is not set forth herein because the Company intends to file with the Securities and Exchange Commission a definitive Proxy Statement pursuant to Regulation 14A not later than 120 days following the end of its 2005 fiscal year, which Proxy Statement will contain such information. The information required by Item 10 is incorporated herein by reference to such Proxy Statement.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
In accordance with the provisions of General Instruction G to Form 10-K, the information required for the remainder of the required disclosures under Item 11 is not set forth herein because the Company intends to file with the Securities and Exchange Commission a definitive Proxy Statement pursuant to Regulation 14A not later than 120 days following the end of its 2005 fiscal year, which Proxy Statement will contain such information. The information required by Item 11 is incorporated herein by reference to such Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS.
In accordance with the provisions of General Instruction G to Form 10-K, the information required for the remainder of the required disclosures under Item 12 is not set forth herein because the Company intends to file with the Securities and Exchange Commission a definitive Proxy Statement pursuant to Regulation 14A not later than 120 days following the end of its 2005 fiscal year, which Proxy Statement will contain such information. The information required by Item 12, with the exception of the table presented above, is incorporated herein by reference to such Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
In accordance with the provisions of General Instruction G to Form 10-K, the information required for the remainder of the required disclosures under Item 13 is not set forth herein because the Company intends to file with the Securities and Exchange Commission a definitive Proxy Statement pursuant to Regulation 14A not later than 120 days following the end of its 2005 fiscal year, which Proxy Statement will contain such information. The information required by Item 13 is incorporated herein by reference to such Proxy Statement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
In accordance with the provisions of General Instruction G to Form 10-K, the information required for the remainder of the required disclosures under Item 14 is not set forth herein because the Company intends to file with the Securities and Exchange Commission a definitive Proxy Statement pursuant to Regulation 14A not later than 120 days following the end of its 2005 fiscal year, which Proxy Statement will contain such information. The information required by Item 14 is incorporated herein by reference to such Proxy Statement.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
Page Number -----------
(a) 1. Financial Statements: Report of Independent Registered Public Accounting Firm...... 19 Consolidated balance sheets at December 31, 2005 and 2004................................ 20 Consolidated income statements, years ended December 31, 2005, 2004 and 2003.......................... 21 Consolidated statements of shareholders' equity, years ended December 31, 2005, 2004 and 2003.............. 22 Consolidated statements of cash flows, years ended December 31, 2005, 2004 and 2003.......................... 23 Notes to consolidated financial statements................... 24
(a) 2. Financial statement schedules: All schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or related notes.
(a) 3. Exhibits:
Exhibit No: Description of Exhibit: - ------------ ----------------------
3 (i) Monroe Bancorp Articles of Incorporation are incorporated by reference to registrant's Form 10 filed November 14, 2000.
3 (ii) Monroe Bancorp Bylaws are incorporated by reference to registrant's Form 10 filed November 14, 2000.
10 (i)* 1999 Directors' Stock Option Plan of Monroe Bancorp is incorporated by reference to registrant's Form 10 filed November 14, 2000.
10 (ii)* 1999 Management Stock Option Plan of Monroe Bancorp is incorporated by reference to registrant's Form 10 filed November 14, 2000.
10 (iii)* Deferred Compensation Trust for Monroe Bancorp is incorporated by reference to registrant's Form 10 filed November 14, 2000.
10 (iv)* Monroe County Bank Agreement for Supplemental Death or Retirement Benefits is incorporated by reference to registrant's Form 10 filed November 14, 2000.
10 (v)* Monroe Bancorp Thrift Plan as Amended and Restated January 1, 2001 is incorporated by reference to registrant's Form 10-Q filed November 13, 2002.
10 (vi)* Monroe Bancorp Employee Stock Ownership Plan as Amended and Restated January 1, 2001 is incorporated by reference to registrant's Form 10-Q filed November 13, 2002.
10 (vii)* Third Amendment to the Monroe Bancorp Employee Stock Ownership Plan is incorporated by reference to the registrant's Form 10-K filed March 29, 2004.
10(viii)* Monroe Bancorp Directors' Deferred Compensation Plan as Amended and Restated Effective January 1, 1999 and First and Second Amendments are incorporated by reference to the registrant's Form 10-K filed March 29, 2004.
10(ix)* Monroe Bancorp Executives' Deferred Compensation Plan as Amended and Restated Effective January 1, 1999 and First, Second and Third Amendments are incorporated by reference to the registrant's Form 10-K filed March 29, 2004.
10 (x)* Form of agreement under the 1999 Management Stock Option Plan of Monroe Bancorp is incorporated by reference to the registrant's Form 10-K filed March 14, 2005.
10 (xi)* Monroe Bancorp Directors' 2005 Deferred Compensation Plan is filed as part of this Form 10-K.
10 (xii)* Monroe Bancorp Executives' 2005 Deferred Compensation Plan is filed as part of this Form 10-K.
10 (xiii)* Form of agreement under the Monroe Bancorp Directors' 2005 Deferred Compensation Plan is filed as part of this Form 10-K.
10 (xiv)* Form of agreement under the Monroe Bancorp Executives' 2005 Deferred Compensation Plan is filed as part of this Form 10-K.
13 2005 Annual Report to Shareholders (except for the pages and information expressly incorporated by reference in this Form 10-K, the Annual Report to Shareholders is provided solely for the information of the Securities and Exchange Commission and is not deemed "filed" as part of this Form 10-K).
21 Subsidiaries of the Registrant.
23 Consent of Independent Registered Public Accounting Firm.
31(i) Certification for Annual Report on Form 10-K by Principal Executive Officer.
31(ii) Certification for Annual Report on Form 10-K by Principal Financial Officer.
32(i) Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32 (ii) Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Management contract or compensatory plan or arrangement
(b) Exhibits.
See the list of exhibits in Item 15(a)(3).
(c) Financial Statement Schedules.
All schedules are omitted as the required information either is not applicable or is included in the 2005 Annual Report to Shareholders or related notes.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 14th day of March 2006.
MONROE BANCORP
By: /s/ Mark D. Bradford -------------------------------------------- Mark D. Bradford, President, Chief Executive Officer, (Principal Executive Officer)
By: /s/ Gordon M. Dyott -------------------------------------------- Gordon M. Dyott Executive Vice President, Chief Financial Officer, (Principal Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title/Capacity - --------- -------------- Date - ----
/s/ Mark D. Bradford President, Chief Executive Officer - ------------------------------- (Principal Executive Officer) and Director Mark D. Bradford March 10, 2006
/s/ Gordon M. Dyott Executive Vice President, Chief Financial - ------------------------------- Officer (Principal Financial Officer) Gordon M. Dyott March 14, 2006
/s/ Kathryn E. Burns Vice President, Director of Finance - ------------------------------- (Principal Accounting Officer) Kathryn E. Burns March 14, 2006
/s/ Charles R. Royal, Jr Director, Chairman - ------------------------------- Charles R. Royal, Jr. March 7, 2006
/s/ James D. Bremner Director - ------------------------------- James D. Bremner March 8, 2006
/s/ Bradford J. Bomba, Jr., M.D. Director - ------------------------------- Bradford J. Bomba, Jr. M.D. March 7, 2006
/s/ Steven R. Crider Director - ------------------------------- Steven R. Crider March 8, 2006
/s/ Timothy D. Ellis Director - ------------------------------- Timothy D. Ellis March 7, 2006
/s/ Joyce Claflin Harrell Director - ------------------------------- Joyce Claflin Harrell March 7, 2006
/s/ Harry F. McNaught, Jr. Director - ------------------------------- Harry F. McNaught, Jr. March 9, 2006
/s/ Paul W. Mobley Director - ------------------------------- Paul W. Mobley March 10, 2006