UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2005 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to______________ Commission File Number: 0-23636 EXCHANGE NATIONAL BANCSHARES, INC. (Exact name of registrant as specified in its charter) MISSOURI 43-1626350 (State or other jurisdiction of (I.R.S. Employer of incorporation or organization) Identification No.) 132 EAST HIGH STREET, JEFFERSON CITY, MISSOURI 65101 (Address of principal executive offices) (Zip Code) (573)761-6100 (Registrant's telephone number,including area code) N/A (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No Indicate by check mark whether the registrant is an accelerated filer (as defined in rule 12b-2 of the Exchange Act). [X] Yes [ ] No Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). [ ] Yes [X] No As of November 9, 2005, the registrant had 4,169,847 shares of common stock, par value $1.00 per share, outstanding. Page 1 of 49 pages Index to Exhibits located on page 45
PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) <TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, 2005 2004 --------------- --------------- <S> <C> <C> ASSETS Loans: Commercial $ 275,458,035 $ 249,497,691 Real estate - construction 138,076,764 65,075,185 Real estate - mortgage 346,456,673 284,309,203 Consumer 37,993,464 37,985,508 Unamortized loan origination fees and costs, net (414,818) (230,957) --------------- --------------- 797,570,118 636,636,630 Less allowance for loan losses 8,792,999 7,495,594 --------------- --------------- Loans, net 788,777,119 629,141,036 Investments in available for sale debt and equity securities, at fair value 212,481,981 171,717,635 Federal funds sold 54,121,886 41,603,952 Cash and due from banks 31,160,201 24,104,458 Premises and equipment 32,133,628 21,276,387 Accrued interest receivable 7,185,067 5,289,083 Mortgage servicing rights 1,560,406 1,605,930 Goodwill 40,323,775 25,196,736 Core deposit intangible 5,062,157 798,132 Cash surrender value - life insurance 1,638,278 106,218 Other assets 5,316,232 3,034,703 --------------- --------------- Total assets $ 1,179,760,730 $ 923,874,270 =============== =============== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Demand deposits $ 134,825,932 $ 98,156,124 Time deposits 774,657,576 628,493,352 --------------- --------------- Total deposits 909,483,508 726,649,476 Federal funds purchased and securities sold under agreements to repurchase 64,212,880 34,515,323 Interest-bearing demand notes to U.S. Treasury 1,431,790 897,470 Subordinated notes 49,486,000 25,774,000 Other borrowed money 52,216,826 39,524,747 Accrued interest payable 3,046,639 1,795,267 Other liabilities 3,876,904 2,947,204 --------------- --------------- Total liabilities 1,083,754,547 832,103,487 Stockholders' equity: Common stock - $1 par value; 15,000,000 shares authorized; 4,298,353 issued 4,298,353 4,298,353 Surplus 22,030,074 22,014,894 Retained earnings 72,698,882 67,716,511 Accumulated other comprehensive income (loss), net of tax (368,617) 393,534 Treasury stock, 128,506 shares at cost (2,652,509) (2,652,509) --------------- --------------- Total stockholders' equity 96,006,183 91,770,783 --------------- --------------- Total liabilities and stockholders' equity $ 1,179,760,730 $ 923,874,270 =============== =============== </TABLE> See accompanying notes to unaudited condensed consolidated financial statements. 2
EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------- ------------------------- 2005 2004 2005 2004 ------------ ----------- ----------- ----------- <S> <C> <C> <C> <C> Interest income: Interest and fees on loans $13,577,646 $ 8,955,054 $35,140,273 $25,772,399 Interest on debt securities: Taxable 1,493,402 982,617 3,959,616 3,057,169 Nontaxable 412,270 333,364 1,160,712 963,803 Interest on federal funds sold 314,308 86,651 800,468 231,529 Interest on interest-bearing deposits 7,952 4,454 28,454 14,179 Dividends on equity securities 57,105 42,171 187,801 111,429 ----------- ----------- ----------- ----------- Total interest income 15,862,683 10,404,311 41,277,324 30,150,508 ----------- ----------- ----------- ----------- Interest Expense: NOW accounts 559,041 194,459 1,344,402 538,988 Savings 84,307 80,157 236,196 242,474 Money market accounts 1,017,955 373,740 2,488,617 745,372 Certificates of deposit: $100,000 and over 920,511 472,958 2,352,206 1,403,341 Other time deposits 2,396,624 1,429,004 6,167,131 4,377,439 Federal funds purchased and securities sold under agreements to repurchase 434,293 208,643 1,018,112 564,503 Subordinated notes 772,307 283,881 1,921,916 577,533 Federal Home Loan borrowings 516,008 414,220 1,415,560 1,080,364 Other borrowings 5,591 1,676 13,870 64,386 ----------- ----------- ----------- ----------- Total interest expense 6,706,637 3,458,738 16,958,010 9,594,400 ----------- ----------- ----------- ----------- Net interest income 9,156,046 6,945,573 24,319,314 20,556,108 Provision for loan losses 260,500 160,500 733,667 606,500 ----------- ----------- ----------- ----------- Net interest income after provision for loan losses 8,895,546 6,785,073 23,585,647 19,949,608 </TABLE> Continued on next page 3
EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- --------------------------- 2005 2004 2005 2004 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Noninterest income: Service charges on deposit accounts $ 1,251,632 $ 771,533 $ 2,951,310 $ 2,291,653 Trust department income 165,376 147,309 595,341 518,303 Loss on sales and calls of debt securities - (10,149) - (7,612) Mortgage loan servicing fees, net 101,159 125,218 317,958 339,642 Gain on sale of mortgage loans 200,936 170,705 507,523 633,006 Other 292,084 166,914 767,590 594,007 ------------ ------------ ------------ ------------ Total noninterest income 2,011,187 1,371,530 5,139,722 4,368,999 ------------ ------------ ------------ ------------ Noninterest expense: Salaries and employee benefits 3,899,655 2,811,628 10,220,156 8,387,805 Occupancy expense 431,801 287,162 1,107,907 837,822 Furniture and equipment expense 545,208 510,526 1,591,436 1,453,310 Advertising and promotion 216,586 143,159 574,254 385,681 Postage, printing and supplies 287,863 178,816 706,885 566,142 Legal, examination, and professional fees 400,997 173,947 985,241 606,425 Amortization of intangible assets 329,893 53,778 531,199 161,334 Processing expense 223,671 91,366 508,097 287,942 Other 733,081 927,121 2,079,695 2,154,014 ------------ ------------ ------------ ------------ Total noninterest expense 7,068,755 5,177,503 18,304,870 14,840,475 ------------ ------------ ------------ ------------ Income before income taxes 3,837,978 2,979,100 10,420,499 9,478,132 Income taxes 1,186,307 923,366 3,186,411 2,999,631 ------------ ------------ ------------ ------------ Net income $ 2,651,671 $ 2,055,734 $ 7,234,088 $ 6,478,501 ============ ============ ============ ============ Basic earning per share $ 0.64 $ 0.49 $ 1.73 $ 1.55 Diluted earnings per share $ 0.63 $ 0.49 $ 1.72 $ 1.54 Weighed average shares of common stock outstanding Basic 4,169,847 4,169,847 4,169,847 4,169,847 Diluted 4,196,929 4,201,432 4,198,179 4,205,929 Dividends per share: Declared $ 0.18 $ 0.18 $ 0.54 $ 0.54 Paid $ 0.18 $ 0.18 $ 0.54 $ 0.54 </TABLE> See accompanying notes to unaudited condensed consolidated financial statements. 4
EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, -------------------------------- 2005 2004 -------------- ------------- <S> <C> <C> Cash flow from operating activities: Net income $ 7,234,088 $ 6,478,501 Adjustments to reconcile net income to net cash cash provided by operating activities: Provision for loan losses 733,667 606,500 Depreciation expense 1,274,082 1,163,300 Net amortization of debt securities premiums and discounts 562,590 1,069,620 Amortization of intangible assets 531,199 161,334 Increase in accrued interest receivable (647,165) (193,459) Increase in cash surrender value - life insurance (27,240) (4,159) (Increase) decrease in other assets (287,743) 37,819 Increase (decrease) in accrued interest payable 1,053,988 (92,409) Increase (decrease) in other liabilities 405,951 (2,185,059) Loss on sales and calls of debt securities - 7,612 Origination of mortgage loans for sale 30,243,789) (32,058,389) Proceeds from the sale of mortgage loans held for sale 30,751,312 32,691,395 Gain on sale of mortgage loans (507,523) (633,006) Loss on disposition of premises and equipment 924 4,822 Other, net 15,180 15,180 ------------- ------------- Net cash provided by operating activities 10,849,521 7,069,602 Cash flow from investing activities: Net increase in loans (33,112,348) (31,954,969) Purchase of available-for-sale debt securities (481,242,069) (257,866,701) Proceeds from maturities of available-for-sale debt securities 443,465,782 234,016,986 Proceeds from calls of available-for-sale debt securities 20,272,500 33,657,425 Proceeds from sales of available-for-sale debt securities 1,071,803 10,304,331 Acquisition of subsidiary, net of cash and cash equivalents acquired (21,800,539) - Purchase of premises and equipment (5,012,950) (3,213,705) Proceeds from sales of other real estate owned and repossessions 1,760,374 410,643 ------------- ------------- Net cash used in investing activities (74,597,447) (14,645,990) ------------- ------------- </TABLE> Continued on next page 5
EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (Unaudited) <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 2005 2004 -------------- -------------- <S> <C> <C> Cash flow from financing activities: Net increase in demand deposits $ 12,409,368 $ 11,036,567 Net increase in interest-bearing transaction accounts 12,400,805 28,650,258 Net increase (decrease) in time deposits 8,413,174 (16,982,405) Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase 28,691,634 (39,004,415) Net increase in interest-bearing demand notes to U.S. Treasury 513,351 366,230 Proceeds from subordinated notes 23,712,000 25,774,000 Proceeds from Federal Home Loan Bank borrowings 3,500,000 17,000,000 Repayment of Federal Home Loan Bank borrowings (4,067,012) (885,197) Repayment of other borrowed money - (17,950,568) Cash dividends paid (2,251,717) (2,251,717) ------------ ------------ Net cash provided by financing activities 83,321,603 5,752,753 Net increase (decrease) in cash and cash equivalents 19,573,677 (1,823,635) Cash and cash equivalents, beginning of period 65,708,410 57,044,915 ------------ ------------ Cash and cash equivalents, end of period $ 85,282,087 $ 55,221,280 ============ ============ Supplemental disclosure of cash flow information - Cash paid during period for: Interest $ 15,904,022 $ 9,686,809 Income taxes 2,620,000 5,352,761 Supplemental schedule of noncash investing activities - Other real estate and repossessions acquired in settlement of loans $ 3,265,115 $ 498,734 </TABLE> See accompanying notes to unaudited condensed consolidated financial statements. 6
EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Nine Months Ended September 30, 2005 and 2004 The accompanying unaudited condensed consolidated financial statements include all adjustments that in the opinion of management are necessary in order to make those statements not misleading. Certain amounts in the 2004 condensed consolidated financial statements have been reclassified to conform to the 2005 condensed consolidated presentation. Such reclassifications have no effect on previously reported net income or stockholders' equity. Operating results for the period ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. It is suggested that these unaudited condensed consolidated interim financial statements be read in conjunction with our Company's audited consolidated financial statements included in its 2004 Annual Report to Shareholders under the caption "Consolidated Financial Statements" and incorporated by reference into its Annual Report on Form 10-K for the year ended December 31, 2004 as Exhibit 13. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed and omitted. Our Company believes that these financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly our Company's consolidated financial position as of September 30, 2005 and December 31, 2004 and the consolidated statements of earnings for the three and nine periods ended September 30, 2005 and 2004 and cash flows for the nine months ended September 30, 2005 and 2004. ACQUISITION On May 2, 2005 our Company acquired 100 percent of the outstanding common shares of Bank 10 from Drexel Bancshares, Inc. of Belton, Missouri. Accordingly, the results of operations of Bank 10 have been included in the condensed consolidated financial statements since the date of acquisition. Bank 10 has branches in Belton, Drexel, Independence, Harrisonville, and Raymore, Missouri. As a result of this acquisition our Company has expanded our presence in the Kansas City, Missouri metropolitan market. The purchase price payable to Drexel Bancshares, Inc. for Bank 10 was cash aggregating $34,020,000. $23,000,000 of the purchase price was provided from the issuance of subordinated notes with the balance being paid from cash and liquid assets on hand. 7
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. <TABLE> <CAPTION> AT MAY 2, 2005 -------------- <S> <C> Cash and cash equivalents $ 12,219,465 Loans, net 130,522,517 Investments in available for sale debt and equity securities, at fair value 26,080,340 Premises and equipment 7,119,297 Core deposit intangible 4,795,224 Goodwill 15,127,039 ------------- Other assets 2,773,923 Total assets acquired 198,637,805 Deposits 149,610,685 Securities sold under agreements to repurchase 1,005,923 Other borrwed money 13,280,060 Other liabilities 721,133 ------------- Total liabilities acquired 164,617,801 ------------- Net assets acquired $ 34,020,004 ============= </TABLE> The $4,795,224 core deposit intangible has been assigned an 8 year useful life. The $15,127,039 of goodwill is expected to be deductible for income tax purposes. A summary of unaudited pro forma combined financial information for the three-month period ended September 30, 2004 and nine-month periods ended September 30, 2005 and 2004 for our Company and Bank 10 as if the transaction had occurred on January 1, 2004 follows. These pro forma presentations do not include any expense reductions that may result from the acquisition. <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ------------------ -------------------------------------- 2004 2005 2004 ------------------ -------------------------------------- <S> <C> <C> <C> Net interest income $ 8,343,912 $ 26,052,171 $ 24,872,476 Net income 2,250,503 7,478,232 7,170,986 Basic earnings per share $ 0.54 $ 1.79 $ 1.72 Diluted earnings per share $ 0.54 $ 1.78 $ 1.70 </TABLE> 8
EARNINGS PER SHARE The following table reflects, for the three-month and nine-month periods ended September 30, 2005 and 2004, the numerators (net income) and denominators (average shares outstanding) for the basic and diluted net income per share computations: <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- --------------------------- 2005 2004 2005 2004 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Net income, basic and diluted $ 2,651,671 $ 2,055,734 $ 7,234,088 $ 6,478,501 ============ ============ ============ ============ Average shares outstanding 4,169,847 4,169,847 4,169,847 4,169,847 Effect of dilutive stock options 27,082 31,585 28,332 36,082 ------------ ------------ ------------ ------------ Average shares outstanding including dilutive stock options 4,196,929 4,201,432 4,198,179 4,205,929 ============ ============ ============ ============ Basic earning per share $ 0.64 $ 0.49 $ 1.73 $ 1.55 Diluted earnings per share $ 0.63 $ 0.49 $ 1.72 $ 1.54 </TABLE> 9
Our Company accounts for its stock option plan in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS No. 123, establish accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As permitted by existing accounting standards, our Company has elected to continue to apply the provision of APB Opinion No. 25, as described above, and has adopted only the disclosure requirements of SFAS No. 123, as amended by SFAS No. 148. See Impact of New Accounting Pronouncements in this report for further discussion of this issue. The following table illustrates, for the three-month and nine-month periods ended September 30, 2005 and 2004, the effect on net income if the fair-value-based method had been applied to all outstanding and unvested awards in each period: <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------ ------------------------------ 2005 2004 2005 2004 ------------- ------------- ------------- ------------- <S> <C> <C> <C> <C> Net income: As reported $ 2,651,671 $ 2,055,734 $ 7,234,088 $ 6,478,501 Add total stock-based employee compensation expense included in reported net income, net of tax - - - - Deduct total stock-based employee compensation expense determined under fair-value-based method for all awards, net of tax (35,700) (34,058) (107,099) (102,171) ------------- ------------- ------------- ------------- Pro forma net income $ 2,615,971 $ 2,021,676 $ 7,126,989 $ 6,376,330 ============= ============= ============= ============= Pro forma earnings per common share: As reported basic $ 0.64 $ 0.49 $ 1.73 $ 1.55 Pro forma basic 0.63 0.48 1.71 1.53 As reported diluted 0.63 0.49 1.72 1.54 Pro forma diluted 0.62 0.48 1.70 1.52 </TABLE> 10
COMPREHENSIVE INCOME For the three-month and nine-month periods ended September 30, 2005 and 2004, unrealized holding gains and losses on investments in debt and equity securities available-for-sale were our Company's only other comprehensive income component. Comprehensive income for the three-month and nine-month periods ended September 30, 2005 and 2004 is summarized as follows: <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------- --------------------------- 2005 2004 2005 2004 ----------- ----------- ----------- ------------ <S> <C> <C> <C> <C> Net income $ 2,651,671 $ 2,055,734 $ 7,234,088 $ 6,478,501 Other comprehensive income (loss): Net unrealized holding gains (losses) on investments in debt and equity securities available-for-sale, net of taxes (434,674) 1,192,322 (762,151) (615,420) Adjustment for net securities gains realized in net income, net of applicable income taxes - 6,597 - 4,948 ----------- ----------- ----------- ------------ Total other comprehensive income (loss) (434,674) 1,198,919 (762,151) (610,472) ----------- ----------- ----------- ------------ Comprehensive income $ 2,216,997 $ 3,254,653 $ 6,471,937 $ 5,868,029 =========== =========== =========== ============ </TABLE> INTANGIBLE ASSETS The gross carrying amount and accumulated amortization of our Company's amortizable core deposit intangible asset as of September 30, 2005 and December 31, 2004 is as follows: <TABLE> <CAPTION> SEPTEMBER 30, 2005 DECEMBER 31, 2004 --------------------------------- --------------------------------- Gross Carrying Accumulated Gross Carrying Accumulated Amount Amortization Amount Amortization ---------------- -------------- ---------------- -------------- <S> <C> <C> <C> <C> Core deposit intangible $ 7,060,224 (1,998,067) 2,265,000 (1,466,868) ================ ============== ================ ============== </TABLE> The aggregate amortization expense of core deposit intangible subject to amortization for the three-month and nine-month periods ended September 30, 2005 and 2004 is as follows: <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------------- --------------------------------- 2005 2004 2005 2004 ---------------- -------------- ---------------- -------------- <S> <C> <C> <C> <C> Aggregate amortization expense $ 329,893 53,778 $ 531,199 161,334 ================ ============== ================ ============== </TABLE> 11
The estimated amortization expense for the next five years is as follows: <TABLE> <S> <C> Estimated amortization expense: For year ending 2005 $ 806,896 For year ending 2006 1,032,583 For year ending 2007 922,337 For year ending 2008 701,443 For year ending 2009 626,111 </TABLE> Our Company's mortgage servicing rights are amortized in proportion to the related estimated net servicing income over the estimated lives of the related mortgages, which is seven years. Changes in mortgage servicing rights, net of amortization, for the periods indicated were as follows: <TABLE> <CAPTION> SEPTEMBER 30, --------------------------------- 2005 2004 ------------- ----------- <S> <C> <C> Balance, beginning of period $ 1,605,930 1,591,289 Originated mortgage servicing rights 294,888 347,592 Amortization (340,412) (313,613) ------------- ----------- Balance, end of period $ 1,560,406 1,625,268 ============= =========== Mortgage loans serviced $ 219,336,200 214,569,000 ============= =========== Mortgage servicing rights as a percentage of loans serviced 0.71% 0.76% ============= =========== </TABLE> The estimated amortization expense of mortgage servicing rights for the next five years is as follows: <TABLE> <S> <C> Estimated amortization expense: For year ending 2005 $ 454,000 For year ending 2006 454,000 For year ending 2007 454,000 For year ending 2008 198,000 For year ending 2009 -0- </TABLE> 12
Our Company's goodwill associated with the purchase of subsidiaries by reporting segments for the periods ended September 30, 2005 and December 31, 2004 is summarized as follows: <TABLE> <CAPTION> SEPTEMBER 30, 2005 ----------------------------------------------------------- CITIZENS THE EXCHANGE UNION STATE OSAGE NATIONAL BANK BANK AND VALLEY OF JEFFERSON TRUST OF BANK OF CITY CLINTON WARSAW BANK 10 TOTAL ------------- ----------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> Goodwill associated with the purchase of subsidiaries $ 4,382,098 16,701,762 4,112,876 15,127,039 40,323,775 ============= =========== ========== ========== ========== </TABLE> <TABLE> <CAPTION> DECEMBER 31, 2004 ----------------------------------------------------------------------------- CITIZENS THE EXCHANGE UNION STATE OSAGE NATIONAL BANK BANK AND VALLEY OF JEFFERSON TRUST OF BANK OF CITY CLINTON WARSAW TOTAL ------------- ----------- --------- ---------- <S> <C> <C> <C> <C> Goodwill associated with the purchase of subsidiaries $ 4,382,098 16,701,762 4,112,876 25,196,736 ============= =========== ========= ========== </TABLE> 13
DEFINED BENEFIT RETIREMENT PLAN The Exchange National Bank of Jefferson City provides a noncontributory defined benefit pension plan in which all full-time employees become participants upon the later of the completion of one year of qualified service or the attainment of age 21, and in which they continue to participate as long as they continue to be full-time employees, until their retirement, death, or termination of employment prior to normal retirement date. The normal retirement benefits provided under the plan vary depending upon the participant's rate of compensation, length of employment, and social security benefits. Retirement benefits are payable for life, but not less than ten years. Plan assets consist of U.S. Treasury and government agency securities, corporate common stocks and bonds, real estate mortgages, and demand deposits. Disclosure information is based on a measurement date of November 1 for the corresponding year. The following table represents the components of the net periodic pension costs for the three and nine-month periods ended September 30, 2005 and 2004: <TABLE> <CAPTION> ESTIMATED ACTUAL 2005 2004 --------- ---------- <S> <C> <C> Service cost - benefits earned during the year $ 308,105 $ 292,059 Interest cost on projected benefit obligations 245,214 242,384 Expected return on plan assets (369,604) (374,586) Net amortization and deferral (26,632) (35,512) Recognized net gains - (6,695) --------- ---------- Net periodic pension cost - annual $ 157,083 $ 117,650 ========= ========== Net periodic pension cost - three months ended September 30 (actual) $ 39,271 $ 31,615 ========= ========== Net periodic pension cost - nine months ended September 30 (actual) $ 117,812 $ 94,845 ========= ========== </TABLE> Our Company does not expect to make any contribution to the plan during 2005. 14
SEGMENTS Through the respective branch network, Exchange National Bank, Citizens Union State Bank, Osage Valley Bank, and Bank 10 provide similar products and services in four defined geographic areas. The products and services offered include a broad range of commercial and personal banking services, including certificates of deposit, individual retirement and other time deposit accounts, checking and other demand deposit accounts, interest checking accounts, savings accounts and money market accounts. Loans include real estate, commercial, installment and other consumer loans. Other financial services include automatic teller machines, trust services, credit related insurance, and safe deposit boxes. The revenues generated by each business segment consist primarily of interest income, generated from the loan and debt and equity security portfolios, and service charges and fees, generated from the deposit products and services. The geographic areas are defined to be communities surrounding Jefferson City, Clinton, Warsaw and Belton, Missouri. The products and services are offered to customers primarily within their respective geographical areas. The business segments results that follow are consistent with our Company's internal reporting system which is consistent, in all material respects, with accounting principles generally accepted in the United States of America and practices prevalent in the banking industry. 15
<TABLE> <CAPTION> SEPTEMBER 30, 2005 ----------------------------------------------------------------------------------------------------- THE EXCHANGE NATIONAL BANK OF CITIZENS UNION OF JEFFERSON STATE BANK AND OSAGE VALLEY CORPORATE AND CITY TRUST OF CLINTON BANK OF WARSAW BANK 10 OTHER TOTAL ---------------- ------------------ -------------- -------------- ------------- -------------- <S> <C> <C> <C> <C> <C> <C> Balance sheet information Loans, net of allowance for loan losses $ 376,048,969 $ 228,409,969 $ 52,439,717 $ 131,878,464 $ - $ 788,777,119 Debt and equity Securities 104,494,086 38,834,169 36,091,924 31,575,802 1,486,000 212,481,981 Goodwill 4,382,098 16,701,762 4,112,876 15,127,039 - 40,323,775 Intangible assets - 636,798 - 4,425,359 - 5,062,157 Total assets 549,976,692 329,255,538 98,116,772 200,089,109 2,322,619 1,179,760,730 Deposits 414,736,647 269,454,020 79,838,239 151,235,965 (5,781,363) 909,483,508 Stockholders' equity $ 50,665,216 $ 42,009,646 $ 10,009,739 $ 34,875,142 (41,553,560) $ 96,006,183 ================ ================== ============== ============== ============= ============== </TABLE> <TABLE> <CAPTION> DECEMBER 31, 2004 --------------------------------------------------------------------------------------- THE EXCHANGE NATIONAL BANK CITIZENS UNION OF JEFFERSON STATE BANK AND OSAGE VALLEY CORPORATE AND CITY TRUST OF CLINTON BANK OF WARSAW OTHER TOTAL -------------- ------------------ -------------- ------------- -------------- <S> <C> <C> <C> <C> <C> Balance sheet information Loans, net of allowance for loan losses $ 366,749,286 $ 213,808,231 $ 48,583,519 $ - $ 629,141,036 Debt and equity Securities 99,466,264 36,449,804 35,027,567 774,000 171,717,635 Goodwill 4,382,098 16,701,762 4,112,876 - 25,196,736 Intangible assets - 798,132 - - 798,132 Total assets 513,839,636 311,756,271 97,507,515 770,848 923,874,270 Deposits 406,897,725 256,351,275 81,077,272 (17,676,796) 726,649,476 Stockholders' equity $ 49,643,120 $ 39,954,448 $ 9,654,137 $ (7,480,922) $ 91,770,783 ============== ================== ============== ============= =============== </TABLE> 16
<TABLE> <CAPTION> THREE MONTHS ENDED SEPTEMBER 30, 2005 ----------------------------------------------------------------------------------------------------- THE EXCHANGE NATIONAL BANK OF CITIZENS UNION OF JEFFERSON STATE BANK AND OSAGE VALLEY CORPORATE AND CITY TRUST OF CLINTON BANK OF WARSAW BANK 10 OTHER TOTAL ----------------- ------------------ -------------- -------------- -------------- ------------- <S> <C> <C> <C> <C> <C> <C> Statement of earnings: - - - - - - Total interest income $ 7,385,816 $ 4,253,749 $ 1,189,612 $ 3,010,549 $ 22,957 $15,862,683 Total interest expense 3,038,120 1,535,350 566,348 806,968 759,851 6,706,637 ----------- ----------- ----------- ----------- ----------- ----------- Net interest income 4,347,696 2,718,399 623,264 2,203,581 (736,894) 9,156,046 Provision for loan losses 150,000 100,000 10,500 - - 260,500 Noninterest income 962,434 471,212 142,425 456,897 (21,781) 2,011,187 Noninterest expense 2,804,965 1,980,370 468,353 1,711,758 103,309 7,068,755 Income taxes 751,300 336,846 74,228 318,873 (294,940) 1,186,307 ----------- ----------- ----------- ----------- ----------- ----------- Net income (loss) $ 1,603,865 $ 772,395 $ 212,608 $ 629,847 $ (567,044) $ 2,651,671 =========== =========== =========== =========== =========== =========== </TABLE> <TABLE> <CAPTION> THREE MONTHS ENDED SEPTEMBER 30, 2004 ------------------------------------------------------------------------------------- THE EXCHANGE NATIONAL BANK CITIZENS UNION OF JEFFERSON STATE BANK AND OSAGE VALLEY CORPORATE AND CITY TRUST OF CLINTON BANK OF WARSAW OTHER TOTAL ----------------- ------------------ -------------- -------------- ------------ <S> <C> <C> <C> <C> <C> Statement of earnings: Total interest income $ 5,918,842 $ 3,389,362 $ 1,087,712 $ 8,395 $10,404,311 Total interest expense 1,973,396 832,989 403,318 249,035 3,458,738 ----------- ----------- ----------- ----------- ----------- Net interest income 3,945,446 2,556,373 684,394 (240,640) 6,945,573 Provision for loan losses 75,000 75,000 10,500 - 160,500 Noninterest income 907,290 389,161 97,883 (22,804) 1,371,530 Noninterest expense 2,885,627 1,819,326 424,921 47,629 5,177,503 Income taxes 606,050 324,505 101,391 (108,580) 923,366 ----------- ----------- ----------- ----------- ----------- Net income (loss) $ 1,286,059 $ 726,703 $ 245,465 $ (202,493) $ 2,055,734 =========== =========== =========== =========== =========== </TABLE> 17
<TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, 2005 ----------------------------------------------------------------------------------------- THE EXCHANGE NATIONAL BANK CITIZENS UNION OF JEFFERSON STATE BANK AND OSAGE VALLEY CORPORATE AND CITY TRUST OF CLINTON BANK OF WARSAW BANK 10 OTHER TOTAL ------------- ---------------- -------------- ----------- ------------- ------------ <S> <C> <C> <C> <C> <C> <C> Statement of earnings: Total interest income $ 20,939,384 $ 12,054,443 $ 3,507,457 $ 4,719,373 $ 56,667 $ 41,277,324 Total interest expense 8,107,399 4,078,417 1,570,217 1,406,170 1,795,807 16,958,010 ------------- ------------ ------------ ----------- ----------- ------------ Net interest income 12,831,985 7,976,026 1,937,240 3,313,203 (1,739,140) 24,319,314 Provision for loan losses 450,000 250,000 31,500 2,167 - 733,667 Noninterest income 2,848,791 1,233,627 363,541 754,117 (60,354) 5,139,722 Noninterest expense 8,207,836 5,706,328 1,347,651 2,712,541 330,514 18,304,870 Income taxes 2,242,100 986,869 248,423 438,109 (729,090) 3,186,411 ------------- ------------ ------------ ----------- ----------- ------------ Net income (loss) $ 4,780,840 $ 2,266,456 $ 673,207 $ 914,503 $(1,400,918 $ 7,234,088 ============= ============ ============ =========== =========== ============ </TABLE> <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, 2004 ---------------------------------------------------------------------------- THE EXCHANGE NATIONAL BANK CITIZENS UNION OF JEFFERSON STATE BANK AND OSAGE VALLEY CORPORATE AND CITY TRUST OF CLINTON BANK OF WARSAW OTHER TOTAL ------------- ---------------- -------------- ------------- ------------ <S> <C> <C> <C> <C> <C> Statement of earnings: Total interest income $ 17,170,080 $ 9,769,148 $ 3,227,069 $ (15,789) $ 30,150,508 Total interest expense 5,338,561 2,520,571 1,205,613 529,655 9,594,400 ------------- ----------- ---------- ----------- ------------ Net interest income 11,831,519 7,248,577 2,021,456 (545,444) 20,556,108 Provision for loan losses 350,000 225,000 31,500 - 606,500 Noninterest income 2,931,787 1,214,069 289,477 (66,334) 4,368,999 Noninterest expense 8,374,690 4,994,407 1,271,807 199,571 14,840,475 Income taxes 1,950,100 1,040,347 292,864 (283,680) 2,999,631 ------------- ----------- ---------- ---------- ------------ Net income (loss) $ 4,088,516 $ 2,202,892 $ 714,762 $ (527,669) $ 6,478,501 ============= =========== ========== =========== ============ </TABLE> 18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE STATEMENTS MADE IN THIS REPORT ON FORM 10-Q ARE FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE WORDS "SHOULD", "EXPECT", "ANTICIPATE", "BELIEVE", "INTEND", "MAY", "HOPE", "FORECAST" AND SIMILAR EXPRESSIONS MAY IDENTIFY FORWARD LOOKING STATEMENTS. IN PARTICULAR, STATEMENTS CONCERNING OUR COMPANY'S ABILITY TO EXPAND ITS PRESENCE IN THE KANSAS CITY, MISSOURI METROPOLITAN MARKET, CONCERNING OUR EXPECTED CONTRIBUTIONS TO ANY OF OUR BANK'S BENEFIT PLANS, CONCERNING OUR AMORTIZATION OF CORE DEPOSIT INTANGIBLES OR OTHER ASSETS, THAT THE PERIODIC REVIEW OF OUR LOAN PORTFOLIO KEEPS MANAGEMENT INFORMED OF POSSIBLE LOAN PROBLEMS AND THAT THE ALLOWANCE FOR LOAN LOSSES ADEQUATELY COVERS ANY EXPOSURE ON SPECIFIC CREDITS ARE ALL FORWARD-LOOKING STATEMENTS. OUR COMPANY'S ACTUAL RESULTS, FINANCIAL CONDITION, OR BUSINESS COULD DIFFER MATERIALLY FROM ITS HISTORICAL RESULTS, FINANCIAL CONDITION, OR BUSINESS, OR FROM THE RESULTS OF OPERATIONS, FINANCIAL CONDITION, OR BUSINESS CONTEMPLATED BY SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT MAY CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY THE FORWARD LOOKING STATEMENTS HEREIN INCLUDE MARKET CONDITIONS AS WELL AS CONDITIONS SPECIFICALLY AFFECTING THE BANKING INDUSTRY GENERALLY AND FACTORS HAVING A SPECIFIC IMPACT ON OUR COMPANY INCLUDING, BUT NOT LIMITED TO, FLUCTUATIONS IN INTEREST RATES AND IN THE ECONOMY; THE IMPACT OF LAWS AND REGULATIONS APPLICABLE TO OUR COMPANY AND CHANGES THEREIN; COMPETITIVE CONDITIONS IN THE MARKETS IN WHICH OUR COMPANY CONDUCTS ITS OPERATIONS, INCLUDING COMPETITION FROM BANKING AND NON-BANKING COMPANIES WITH SUBSTANTIALLY GREATER RESOURCES THAN OUR COMPANY, SOME OF WHICH MAY OFFER AND DEVELOP PRODUCTS AND SERVICES NOT OFFERED BY OUR COMPANY; AND THE ABILITY OF OUR COMPANY TO RESPOND TO CHANGES IN TECHNOLOGY. ADDITIONAL FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES WERE DISCUSSED UNDER THE CAPTION "FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS, FINANCIAL CONDITION, OR BUSINESS," IN OUR COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2004, AS WELL AS THOSE DISCUSSED ELSEWHERE IN OUR COMPANY'S REPORTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. 19
OVERVIEW This overview of management's discussion and analysis highlights selected information in this report and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources and critical accounting estimates, you should carefully read this entire report. These have an impact on our Company's financial condition and results of operation. BUSINESS STRATEGY: In 1865, The Exchange National Bank of Jefferson City opened for business serving the loan and deposit needs of citizens living in Missouri's State Capitol of Jefferson City. Leveraging off of its strong equity position, Exchange National Bank's Board of Directors established Exchange National Bancshares, Inc., a multi-bank holding company on October 23, 1992. On April 7, 1993, Exchange National Bancshares, Inc. acquired The Exchange National Bank of Jefferson City. On November 3, 1997, our Company acquired Union State Bancshares, Inc. and its wholly-owned subsidiary, Union State Bank and Trust of Clinton, Missouri. Following the May 4, 2000 acquisition of Calhoun Bancshares, Inc. by Union State Bank, Calhoun Bancshares' wholly-owned subsidiary, Citizens State Bank of Calhoun, merged into Union State Bank. The surviving bank in this merger is called Citizens Union State Bank & Trust. On January 3, 2000, our Company acquired Mid Central Bancorp, Inc., and Mid Central's wholly-owned subsidiary, Osage Valley Bank of Warsaw, Missouri. On June 16, 2000, our Company acquired CNS Bancorp, Inc. and its subsidiary, City National Savings Bank, FSB, Jefferson City, Missouri. City National subsequently was merged into Exchange National Bank. On June 26, 2003 our Company purchased the Springfield, Missouri branch of Missouri State Bank. Following the purchase, this branch was merged into Citizens Union State Bank and Trust. Finally, on May 2, 2005, our Company acquired Bank 10 of Belton, Missouri. MATERIAL CHALLENGES AND RISKS: Our Company may experience difficulties managing growth and effectively integrating newly established branches. As part of our general strategy, our Company may continue to acquire banks and establish de novo branches that we believe provide a strategic fit. To the extent that our Company does grow, there can be no assurances that we will be able to adequately and profitably manage such growth. The successes of our Company's growth strategy will depend primarily on the ability of our banking subsidiaries to generate an increasing level of loans and deposits at acceptable risk levels and on acceptable terms without significant increases in non-interest expenses relative to revenues generated. Our Company's financial performance also depends, in part, on our ability to manage various portfolios and to successfully introduce additional financial products and services. Furthermore, the success of our Company's growth strategy will depend on our ability to maintain sufficient regulatory capital levels and on general economic conditions that are beyond our control. REVENUE SOURCE: Through the respective branch network, Exchange National Bank, Citizens Union State Bank, Osage Valley Bank, and Bank 10 provide similar products and 20
services in four defined geographic areas. The products and services offered include a broad range of commercial and personal banking services, including certificates of deposit, individual retirement and other time deposit accounts, checking and other demand deposit accounts, interest checking accounts, savings accounts, and money market accounts. Loans include real estate, commercial, installment, and other consumer loans. Other financial services include automatic teller machines, trust services, credit related insurance, and safe deposit boxes. The revenues generated by each business segment consist primarily of interest income, generated primarily from the loan and debt and equity security portfolios, and service charges and fees, generated from the deposit products and services. The geographic areas are defined to be communities surrounding Jefferson City, Clinton, Warsaw, and Belton, Missouri. The products and services are offered to customers primarily within their respective geographical areas. The business segment results are consistent with our Company's internal reporting system which is consistent, in all material respects, with generally accepted accounting principles and practices prevalent in the banking industry. Much of our Company's business is commercial, commercial real estate development, and mortgage lending. Our Company has experienced continued strong loan demand in the communities within which we operate even during economic slowdowns. Our Company's income from mortgage brokerage activities is directly dependent on mortgage rates and the level of home purchases and refinancing. Our Company's primary source of revenue is net interest income derived primarily from lending and deposit taking activities. A secondary source of revenue is investment income. Our Company also derives income from trust, brokerage, credit card and mortgage banking activities and service charge income. Our Company has prepared the unaudited condensed consolidated financial statements in this report in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). In preparing the consolidated financial statements in accordance with U.S. GAAP, our Company makes estimates and assumptions that affect the reported amount of assets and liabilities, 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. There can be no assurances that actual results will not differ from those estimates. We have identified the accounting policy related to the allowance for loan losses as critical to the understanding of our Company's results of operations, since the application of this policy requires significant management assumptions and estimates that could result in materially different amounts being reported if conditions or underlying circumstances were to change. The impact and any associated risks related to these policies on our business operations are discussed in the "Lending and Credit Management" section below. 21
RESULTS OF OPERATIONS Net income for the three months ended September 30, 2005 of $2,652,000 increased $596,000 when compared to the third quarter of 2004. Diluted earnings per common share for the third quarter of 2005 of $0.63 increased 14 cents or 28.6% when compared to the third quarter of 2004. Net income for the nine months ended September 30, 2005 of $7,234,000 increased $756,000 when compared to the third quarter of 2004. Diluted earnings per common share for the third quarter of 2005 of $1.72 increased 18 cents or 11.7% when compared to the third quarter of 2004. The net interest income contribution of the Bank 10 acquisition discussed below represents Bank 10's actual net interest income for the periods reduced by the interest expense on $23,712,000 of subordinated notes and the imputed interest expense on the approximately $11,020,000 of cash used in the transaction. The imputed interest expense on the cash used is calculated using the average federal funds sold rate for the applicable periods. Net interest income (on a tax equivalent basis) was $9,399,000, or 3.53% of average earning assets, for the three months ended September 30, 2005, compared to $7,114,000, or 3.40% of average earning assets, for the same period in 2004. Approximately, $1,731,000 of the $2,285,000 increase in net interest income for the three months ended September 30, 2005 as compared to the same period in 2004 is related to the acquisition. The balance of the increase in net interest income was the result of an increase in average interest-earning assets and an increase in net interest margin. Net interest income (on a tax equivalent basis) was $24,947,000, or 3.41% of average earning assets, for the nine months ended September 30, 2005, compared to $21,042,000, or 3.39% of average earning assets, for the same period in 2004. Approximately, $2,545,000 of the $3,905,000 increase in net interest income for the nine months ended September 30, 2005 as compared to the same period in 2004 is related to the acquisition of Bank 10. The balance of the increase in net interest income was the result of an increase in average interest-earning assets and an increase in net interest margin. Average interest-earning assets for the three months ended September 30, 2005 were $1,054,992,000, an increase of $225,890,000 or 27.3%, compared to average interest-earning assets of $829,102,000 for the same period of 2004. The acquisition of Bank 10 represents approximately $165,712,000 of the increase in interest-earning assets. In addition to the increase due to the acquisition, average loans outstanding increased approximately $52,041,000. The yield on average interest-earning assets increased to 6.06% for the three month period ended September 30, 2005 compared to 5.06% for the same period in 2004. The rate paid on interest-bearing liabilities also increased to 2.85% in 2005 compared to 1.94% in 2004. Average interest-earning assets for the nine months ended September 30, 2005 were $977,483,000, an increase of $151,064,000 or 18.3%, compared to average interest-earning assets of $826,419,000 for the same period of 2004. The acquisition of Bank 10 represents 22
approximately $92,989,000 of the increase in interest-earning assets. In addition to the increase due to the acquisition, average loans outstanding increased approximately $55,870,000. The yield on average interest-earning assets increased to 5.73% for the nine month period ended September 30, 2005 compared to 4.94% for the same period in 2004. The rate paid on interest-bearing liabilities also increased to 2.65% in 2005 compared to 1.80% in 2004. THREE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2004 Our Company's primary source of earnings is net interest income, which is the difference between the interest earned on interest earning assets and the interest paid on interest bearing liabilities. Net interest income on a fully taxable equivalent basis increased $2,285,000 or 32.1% to $9,399,000 or 3.53% of average earning assets for the third quarter of 2005 compared to $7,114,000 or 3.40% of average earning assets for the same period of 2004. The provision for loan losses was $260,000 and $160,000 the three months ended September 30, 2005 and 2004 respectively. The increase in the provision for loan losses reflects a higher level of charge-offs during the third quarter of 2005 compared to 2004 as well as an increase in loan balances. Net charge-offs were $845,000 for the third quarter of 2005 compared to $48,000 for the third quarter of 2004. See Lending and Credit Management in this report for further discussion of third quarter 2005 charge-offs. 23
Noninterest income and noninterest expense for the three-month periods ended September 30, 2005 and 2004 were as follows: (DOLLARS EXPRESSED IN THOUSANDS) <TABLE> <CAPTION> THREE MONTHS ENDED SEPTEMBER 30, INCREASE (DECREASE) -------------------------- -------------------------- 2005 2004 AMOUNT % ----------- ------------ ----------- ----- <S> <C> <C> <C> <C> NONINTEREST INCOME Service charges on deposit accounts $ 1,252 $ 772 $ 480 62.2% Trust department income 165 147 18 12.2 Net gain (loss) on sales of calls of debt securities - (10) 10 100.0 Mortgage loan servicing fees, net 101 125 (24) (19.2) Gain on sale of mortgage loans 201 171 30 17.5 Other 292 167 125 74.9 ----------- ------------ ----------- ----- $ 2,011 $ 1,372 $ 639 46.6% =========== ============ =========== ===== NONINTEREST EXPENSE Salaries and employee benefits $ 3,899 $ 2,812 $ 1,087 38.7% Occupancy expense 432 287 145 50.5 Furniture and equipment expense 545 511 34 6.7 Advertising and promotion 217 143 74 51.7 Postage, printing and supplies 288 179 109 60.9 Legal, examination, and professional fees 401 174 227 130.5 Amortization - CDI 330 54 276 511.1 Processing expense 224 91 133 146.2 Other 733 927 (194) (20.9) ----------- ------------ ----------- ----- $ 7,069 $ 5,178 $ 1,891 36.5% =========== ============ =========== ===== </TABLE> Noninterest income increased $639,000 or 46.6% to $2,011,000 for the third quarter of 2005 compared to $1,372,000 for the same period of 2004. The acquisition of Bank 10 contributed $457,000 of the increase in noninterest income during the third quarter. Excluding income due to the acquisition, service charges on deposit accounts increased $65,000 or 8.4% as a result of increased overdraft and insufficient check fee income, ATM fee income, and debit card fee income. Gain on sale of mortgage loans increased $30,000 or 17.5% due to recognition of higher funding gains recognized on sale of mortgage loans. The dollar volume of mortgage loans sold was consistent for the two periods at approximately $11,000,000. Other noninterest income increased $83,000 or 49.7% due to the receipt in 2004 of a refund of vendor charges that incurred in prior years. 24
Noninterest expense increased $1,891,000 or 36.5% to $7,069,000 for the third quarter of 2005 compared to $5,178,000 for the third quarter of 2004. Approximately $1,712,000 of the increase in noninterest expense is attributed to the acquisition of Bank 10. Excluding costs associated with the acquisition, salaries and benefits increased $258,000 or 9.2%, occupancy expense increased $37,000 or 12.9%, advertising and promotion increased $26,000 or 18.2%, legal, examination, and professional fees increased $142,000 or 81.6%, processing expense increased $58,000 or 63.7% and other noninterest expense decreased $340,000 or 36.7%. The increase in salaries and employees benefits represents normal salary increases and additional hires as well as increased health care costs. The increase in occupancy expense reflects additional costs associated with two new branch facilities. The increase in advertising and promotion reflects additional advertising and promotion in new market areas. The increase in legal, examination, and professional fees reflects increases in accruals to cover expected costs associated with Sarbanes-Oxley compliance, internal audit and benefit consulting. The increase in processing expense is related to costs associated with switching to a new ATM network. These costs include one-time conversion costs as well as higher monthly costs. The decrease in other noninterest expense reflects a $318,000 IRS settlement that was paid in the third quarter 2004 related to income that had been deferred for tax purposes but not for financial reporting. Income taxes as a percentage of earnings before income taxes as reported in the condensed consolidated financial statements were 30.9% for the third quarter of 2005 compared to 31.0% for the third quarter of 2004. The reduction in the effective tax rate is due to an increase in tax-exempt income as a percentage of total income in the current year. NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2004 Our Company's primary source of earnings is net interest income, which is the difference between the interest earned on interest earning assets and the interest paid on interest bearing liabilities. Net interest income on a fully taxable equivalent basis increased $3,905,000 or 18.6% to $24,947,000 or 3.41% of average earning assets for the nine months of 2005 compared to $21,042,000 or 3.39% of average earning assets for the same period of 2004. The provision for loan losses was $734,000 and $607,000 for the nine months ended September 30, 2005 and 2004 respectively. The increase in the provision for loan losses reflects a high level of charge-offs during the current year compared to the prior year. 25
Noninterest income and noninterest expense for the nine-month periods ended September 30, 2005 and 2004 were as follows: (DOLLARS EXPRESSED IN THOUSANDS) <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, INCREASE (DECREASE) -------------------------- -------------------------- 2005 2004 AMOUNT % ----------- ------------ ----------- ----- <S> <C> <C> <C> <C> NONINTEREST INCOME Service charges on deposit accounts $ 2,951 $ 2,292 $ 659 28.8% Trust department income 595 518 77 14.9 Net gain (loss) on sales of calls of debt securities - (8) 8 100.0 Mortgage loan servicing fees, net 318 340 (22) (6.5) Gain on sale of mortgage loans 508 633 (125) (19.7) Other 768 594 174 29.3 ----------- ------------ ----------- ----- $ 5,140 $ 4,369 $ 771 17.6% =========== ============ =========== ===== NONINTEREST EXPENSE Salaries and employee benefits $10,220 $ 8,388 $ 1,832 21.8% Occupancy expense 1,108 838 270 32.2 Furniture and equipment expense 1,592 1,453 139 9.6 Advertising and promotion 574 386 188 48.7 Postage, printing and supplies 707 566 141 24.9 Legal, examination, and professional fees 985 606 379 62.5 Amortization - CDI 531 161 370 229.8 Processing expense 508 288 220 76.4 Other 2,080 2,154 (74) (3.4) ----------- ------------ ----------- ----- $18,305 $ 14,840 $ 3,465 23.3% =========== ============ =========== ===== </TABLE> Noninterest income increased $771,000 or 17.6% to $5,140,000 for the nine months of 2005 compared to $4,369,000 for the same period of 2004. $754,000 of the increase in noninterest income resulted from the acquisition of Bank 10. Excluding noninterest income associated with the acquisition, service charge income decreased $26,000 or 1.1%. Trust department income increased $77,000 or 14.9% when compared to the same period in 2004 due primarily to a large distribution fee collected during 2005. Gain on sales of mortgage loans decreased $125,000 or 19.7% due to a decrease in volume of loans originated and sold to the secondary market from approximately $32,058,000 in the first nine months of 2004 to approximately $30,244,000 for the first nine months of 2005. The decrease reflects both lower mortgage servicing rights recorded and lower funding gains recognized on the sales. 26
Noninterest expense increased $3,465,000 or 23.3% to $18,305,000 for the first nine months of 2005 compared to $14,840,000 for the same period of 2004. Approximately $2,713,000 of the increase in noninterest expense is attributed to the acquisition of Bank 10. Excluding costs associated with the acquisition, salaries and benefits increased $456,000 or 5.4%, occupancy expense increased $103,000 or 12.3%, advertising and promotion increased $109,000 or 28.2%, legal, examination, and professional fees increased $273,000 or 45.0%, processing expense increased $91,000 or 31.6% and other noninterest expense decreased $308,000 or 14.3%. The increase in salaries and benefits reflects normal salary increases, additional hires and higher health insurance premiums. The increases in occupancy expense and furniture and equipment expense primarily reflect additional costs associated with two new branch facilities. The increase in advertising and promotion expense reflects additional advertising and promotion in new market areas. The increase in legal, examination, and professional fees reflects additional costs incurred with the acquisition and higher audit costs associated with Sarbanes-Oxley compliance, internal audit and benefit consulting. The increase in processing expense is related to costs associated with switching to a new ATM network. The decrease in other noninterest expense reflects a $318,000 IRS settlement that was paid in the third quarter 2004 related to income that had been deferred for tax purposes but not for financial reporting. Income taxes as a percentage of earnings before income taxes as reported in the condensed consolidated financial statements were 30.6% for the first nine months of 2005 compared to 31.6% for the same period of 2004. The reduction in the effective tax rate is due to an increase in tax-exempt income as a percentage of total income in the current year. NET INTEREST INCOME Fully taxable equivalent net interest income increased $2,285,000 or 32.1% and $3,905,000 or 18.6% respectively for the three and nine month periods ended September 30, 2005 compared to the same periods in 2004. The increase in net interest income for the periods ended September 30, 2005 compared to the periods ended September 30, 2004 was the result of increased earning assets. 27
The following table presents average balance sheets, net interest income, average yields of earning assets, and average costs of interest bearing liabilities on a fully taxable equivalent basis for the three month periods ended September 30, 2005 and 2004. (DOLLARS EXPRESSED IN THOUSANDS) <TABLE> <CAPTION> THREE MONTHS ENDED THREE MONTHS ENDED SEPTEMBER 30, 2005 SEPTEMBER 30, 2004 ---------------------------------- -------------------------------- INTEREST RATE INTEREST RATE AVERAGE INCOME/ EARNED/ AVERAGE INCOME/ EARNED/ BALANCE EXPENSE/1/ PAID/1/ BALANCE EXPENSE/1/ PAID/1/ ------------ ---------- -------- ----------- ---------- ------- <S> <C> <C> <C> <C> <C> <C> ASSETS Loans:/2/ Commercial $ 271,383 $ 4,504 6.58% $ 234,451 $ 3,384 5.73% Real estate 481,297 8,275 6.82 334,966 4,831 5.72 Consumer 37,864 828 8.68 36,982 760 8.15 Investment securities:/3/ U.S Treasury and U.S. Gov't Agencies 170,148 1,419 3.31 161,157 983 2.42 State and municipal 51,690 700 5.37 32,392 482 5.90 Other 7,227 57 3.13 5,538 42 3.01 Federal funds sold 34,345 314 3.63 22,153 87 1.56 Interest-bearing deposits 1,038 8 3.06 1,463 4 1.08 ------------ ---------- ----------- ---------- Total interest earning assets 1,054,992 16,105 6.06 829,102 10,573 5.06 All other assets 119,875 77,954 Allowance for loan losses (9,260) (8,692) ------------ ----------- Total assets $ 1,165,607 $ 898,364 ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY NOW accounts $ 134,709 $ 559 1.65% $ 110,422 $ 195 0.70% Savings 58,658 84 0.57 55,578 80 0.57 Money market 154,386 1,018 2.62 93,982 374 1.58 Deposits of $100 and over 114,478 920 3.19 82,725 473 2.27 Other time deposits 313,517 2,397 3.03 241,677 1,428 2.34 ------------ ---------- ----------- ---------- Total time deposits 775,748 4,978 2.55 584,384 2,550 1.73 Federal funds purchased and securities sold under agreements to repurchase 54,525 434 3.16 59,968 209 1.38 Interest-bearing demand notes to US Treasury 677 6 3.52 654 2 1.21 Subordinated notes 49,486 772 6.19 25,774 284 4.37 Other borrowed money 52,396 516 3.91 38,262 414 4.29 ------------ ---------- ----------- ---------- Total interest-bearing liabilities 932,832 6,706 2.85 709,042 3,459 1.94 Demand deposits 129,622 93,370 Other liabilities 7,184 5,727 ------------ ----------- Total liabilities 1,069,638 808,139 Stockholders' equity 95,969 90,225 ------------ ----------- Total liabilities and stockholders' equity $ 1,165,607 $ 898,364 ============ =========== Net interest income $ 9,399 $ 7,114 ========== ========== Net interest margin/4/ 3.53% 3.40% ==== ==== </TABLE> /1/ Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate. Such adjustments were $243,000 in 2005 and $169,000 in 2004. /2/ Non-accruing loans are included in the average amounts outstanding. /3/ Average balances based on amortized cost. /4/ Net interest income divided by average total interest earning assets. 28
The following table presents average balance sheets, net interest income, average yields of earning assets, and average costs of interest bearing liabilities on a fully taxable equivalent basis for the nine month periods ended September 30, 2005 and 2004. <TABLE> <CAPTION> NINE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, 2005 SEPTEMBER 30, 2004 ---------------------------------- -------------------------------- INTEREST RATE INTEREST RATE AVERAGE INCOME/ EARNED/ AVERAGE INCOME/ EARNED/ BALANCE EXPENSE/1/ PAID/1/ BALANCE EXPENSE/1/ PAID/1/ ------------ ---------- -------- ----------- ---------- ------- <S> <C> <C> <C> <C> <C> <C> ASSETS Loans:/2/ Commercial $ 260,333 $ 12,393 6.36% $ 224,145 $ 9,463 5.62% Real estate 424,908 20,577 6.47 330,650 14,084 5.67 Consumer 37,124 2,259 8.14 38,057 2,267 7.94 Investment securities:/3/ U.S Treasury and U.S. Gov't Agencies 168,682 3,886 3.08 172,247 3,057 2.36 State and municipal 42,669 1,774 5.56 30,718 1,407 6.10 Other 6,613 188 3.80 4,984 112 2.99 Federal funds sold 35,565 800 3.01 23,509 232 1.31 Interest-bearing deposits 1,589 28 2.36 2,109 14 0.88 ------------ ---------- ----------- ---------- Total interest earning assets 977,483 41,905 5.73 826,419 30,636 4.94 All other assets 101,138 76,352 Allowance for loan losses (8,547) (8,529) ------------ ----------- Total assets $ 1,070,074 $ 894,242 ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY NOW accounts $ 130,778 $ 1,344 1.37% $ 116,481 $ 539 0.62% Savings 55,323 236 0.57 56,638 242 0.57 Money market 140,555 2,489 2.37 80,144 745 1.24 Deposits of $100 and over 103,412 2,352 3.04 85,207 1,404 2.20 Other time deposits 286,226 6,167 2.88 247,856 4,378 2.35 ------------ ---------- ----------- ---------- Total time deposits 716,294 12,588 2.35 586,326 7,308 1.66 Federal funds purchased and securities sold under agreements to repurchase 50,368 1,018 2.70 68,681 565 1.10 Interest-bearing demand notes to US Treasury 700 14 2.67 647 4 0.82 Subordinated debentures 42,972 1,922 5.98 25,774 577 2.98 Other borrowed money 46,626 1,416 4.06 26,943 1,140 5.64 ------------ ---------- ----------- ---------- Total interest-bearing liabilities 856,960 16,958 2.65 708,371 9,594 1.80 Demand deposits 112,934 89,924 Other liabilities 6,178 5,926 ------------ ----------- Total liabilities 976,072 804,221 Stockholders' equity 94,002 90,021 ------------ ----------- Total liabilities and stockholders' equity $ 1,070,074 $ 894,242 ============ =========== Net interest income $ 24,947 $ 21,042 ========== =========== Net interest margin/4/ 3.41% 3.39% ==== ==== </TABLE> /1/ Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate. Such adjustments were $628,000 in 2005 and $485,000 in 2004. /2/ Non-accruing loans are included in the average amounts outstanding. /3/ Average balances based on amortized cost. /4/ Net interest income divided by average total interest earning assets. 29
The following table presents, on a fully taxable equivalent basis, an analysis of changes in net interest income resulting from changes in average volumes of earning assets and interest bearing liabilities and average rates earned and paid. The change in interest due to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the absolute dollar amounts of change in each. (DOLLARS EXPRESSED IN THOUSANDS) <TABLE> <CAPTION> THREE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2004 ------------------------------------- CHANGE DUE TO TOTAL ----------------------- CHANGE VOLUME /3/ RATE /4/ ------ ---------- -------- <S> <C> <C> <C> INTEREST INCOME ON A FULLY TAXABLE EQUIVALENT BASIS: Loans:/1/ Commercial $1,120 574 546 Real estate /2/ 3,444 2,391 1,053 Consumer 68 18 50 Investment securities:/3/ U.S Treasury and U.S. Gov't Agencies 436 58 378 State and municipal /2/ 218 264 (46) Other 15 14 1 Federal funds sold 227 67 160 Interest-bearing deposits 4 (1) 5 ------ ----- ----- Total interest income 5,532 3,385 2,147 INTEREST EXPENSE: NOW accounts $ 364 51 313 Savings 4 4 -- Money market 644 318 326 Deposits of $100 and over 447 218 229 Other time deposits 969 487 482 Federal funds purchased and securities sold under agreements to repurchase 225 (21) 246 Interest-bearing demand notes of U.S. Treasury 4 - 4 Subordinated debentures 488 336 152 Other borrowed money 102 142 (40) ------ ----- ----- Total interest expense 3,247 1,535 1,712 ------ ----- ----- Net interest income on a fully taxable equivalent basis $2,285 1,850 435 ====== ===== ===== </TABLE> /1/ Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate. Such adjustments were $243,000 in 2005 and $169,000 in 2004. /2/ Non-accruing loans are included in the average amounts outstanding. /3/ Change in volume multiplied by yield/rate of prior period. /4/ Change in yield/rate multiplied by volume of prior period. 30
The following table presents, on a fully taxable equivalent basis, an analysis of changes in net interest income resulting from changes in average volumes of earning assets and interest bearing liabilities and average rates earned and paid. The change in interest due to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the absolute dollar amounts of change in each. (DOLLARS EXPRESSED IN THOUSANDS) <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2004 ------------------------------------- CHANGE DUE TO TOTAL ----------------------- CHANGE VOLUME /3/ RATE /4/ -------- ---------- -------- <S> <C> <C> <C> INTEREST INCOME ON A FULLY TAXABLE EQUIVALENT BASIS: Loans:/1/ Commercial $ 2,930 1,636 1,294 Real estate /2/ 6,493 4,387 2,106 Consumer (8) (57) 49 Investment securities:/3/ U.S Treasury and U.S. Gov't Agencies 829 (64) 893 State and municipal /2/ 367 506 (139) Other 76 43 33 Federal funds sold 568 162 406 Interest-bearing deposits 14 (4) 18 -------- ----- ----- Total interest income 11,269 6,609 4,660 INTEREST EXPENSE: NOW accounts $ 805 73 732 Savings (6) (6) -- Money market 1,744 793 951 Deposits of $100 and over 948 341 607 Other time deposits 1,789 740 1,049 Federal funds purchased and securities sold under agreements to repurchase 453 (185) 638 Interest-bearing demand notes of U.S. Treasury 10 -- 10 Subordinated debentures 1,345 539 806 Other borrowed money 276 664 (388) -------- ----- ----- Total interest expense 7,364 2,959 4,405 -------- ----- ----- Net interest income on a fully taxable equivalent basis $ 3,905 3,650 255 ======== ===== ===== </TABLE> /1/ Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate. Such adjustments were $628,000 in 2005 and $485,000 in 2004. /2/ Non-accruing loans are included in the average amounts outstanding. /3/ Change in volume multiplied by yield/rate of prior period. /4/ Change in yield/rate multiplied by volume of prior period. 31
LENDING AND CREDIT MANAGEMENT Interest earned on the loan portfolio is a primary source of interest income for our Company. Net loans represented 66.8% of total assets as of September 30, 2005 compared to 68.1% as of December 31, 2004 and 68.5% as of September 30, 2004. Lending activities are conducted pursuant to written loan policies approved by our Banks' Boards of Directors. Larger credits are reviewed by our Banks' Discount Committees. These committees are comprised of members of senior management. Our Company generally does not retain long-term fixed rate residential mortgage loans in its portfolio. Fixed rate loans conforming to standards required by the secondary market are offered to qualified borrowers, but are not funded until our Company has a non-recourse purchase commitment from the secondary market at a predetermined price. At September 30, 2005, our Company was servicing approximately $219,336,000 of loans sold to the secondary market. Mortgage loans retained in our Company's portfolio generally include provisions for rate adjustments at one to three year intervals. Commercial loans and real estate construction loans generally have maturities of less than one year. Installment loans to individuals are primarily fixed rate loans with maturities from one to five years. The provision for loan losses is based on management's evaluation of the loan portfolio in light of national and local economic conditions, changes in the composition and volume of the loan portfolio, changes in the volume of past due and nonaccrual loans, value of underlying collateral and other relevant factors. The allowance for loan losses which is reported as a deduction from loans is available for loan charge-offs. This allowance is increased by the provision charged to expense and is reduced by loan charge-offs net of loan recoveries. Management formally reviews all loans in excess of certain dollar amounts (periodically established) at least annually. In addition, on a monthly basis, management reviews past due, "classified", and "watch list" loans in order to classify or reclassify loans as "loans requiring attention," "substandard," "doubtful," or "loss". During that review, management also determines which loans should be considered to be "impaired". Management follows the guidance provided in Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, (SFAS 114) in identifying and measuring loan impairment. If management determines that it is probable that all amounts due on a loan will not be collected under the original terms of the loan agreement the loan is considered to be impaired. Once a loan has been identified as impaired management generally measures impairment based upon the fair value of the underlying collateral. Management believes, but there can be no assurance, that these procedures keep management informed of possible problem loans. Based upon these procedures, both the allowance and provision for loan losses are adjusted to maintain the allowance at a level considered adequate by management for probable losses inherent in the loan portfolio. 32
The allowance for loan losses was decreased by net loan charge-offs of $2,000, $48,000, and $854,000 for the first, second, and third quarters of 2005 compared to $57,000, $15,000, and $48,000 for the first, second, and third quarters of 2004. The allowance for loan losses was increased by a provision charged to expense of $236,000 for the first quarter of 2005, $237,000 for the second quarter of 2005, and $260,000 for the third quarter of 2005. That compares to a provision of $236,000 for the first quarter of 2004, $210,000 for the second quarter of 2004, and $160,000 for the third quarter of 2004. The $854,000 charge-off during the third quarter of 2005 is primarily represented by a $448,000 charge-off on an auto dealership, a $217,000 charge-off on a real estate foreclosure and a $110,000 commercial loan charge-off. Management had previously allocated $667,000 of the allowance for loan losses to these particular credits. The balance of the allowance for loan losses was $8,793,000 at September 30, 2005 compared to $7,496,000 at December 31, 2004 and $8,754,000 at September 30, 2004. $1,418,000 of the increase in the allowance for loan losses represents the balance of Bank 10's allowance acquired in the acquisition. The allowance for loan losses as a percent of outstanding loans was 1.10% at September 30, 2005 compared to 1.18% at December 31, 2004 and 1.42% at September 30, 2004. The decrease in the allowances for loan losses as a percent of outstanding loans reflects both the increase in loan balances as a result of the Bank 10 acquisition as well as the charge-off of loans for which management had made previous provisions in the allowance. 33
Nonperforming loans, defined as loans on nonaccrual status, loans 90 days or more past due and still accruing, and restructured loans totaled $6,762,000 or 0.85% of total loans at September 30, 2005 compared to $6,092,000 or 0.96% of total loans at December 31, 2004. Detail of those balances plus other real estate and repossessions is as follows: (DOLLARS EXPRESSED IN THOUSANDS) <TABLE> <CAPTION> SEPTEMBER 30, 2005 DECEMBER 31, 2004 --------------------------- ------------------------ % OF GROSS % OF GROSS BALANCE LOANS BALANCE LOANS ------- ---------- ------- ---------- <S> <C> <C> <C> <C> Nonaccrual loans: Commercial $ 5,563 0.70 % $ 4,213 0.67 % Real estate Construction 15 - - - Mortgage 841 0.11 1,246 0.20 Consumer 55 0.01 30 - ------- ---------- ------- ---------- 6,474 0.82 5,489 0.87 ------- ---------- ------- ---------- Loans contractually past-due 90 days or more and still accruing: Commercial 142 0.02 12 - Real estate Construction - - - - Mortgage 94 0.01 591 0.09 Consumer 52 0.01 - - ------- ---------- ------- ---------- 288 0.04 603 0.09 ------- ---------- ------- ---------- Restructured loans - - - - ------- ---------- ------- ---------- Total nonperforming loans 6,762 0.86 % 6,092 0.96 % ========== ========== Other real estate 1,577 30 Repossessions - 42 ------- ------- Total nonperforming assets $ 8,339 $ 6,164 ======= ======= </TABLE> The allowance for loan losses was 130.05% of nonperforming loans at September 30, 2005 compared to 123.05% of nonperforming loans at December 31, 2004. The $1,350,000 increase in commercial nonaccrual loans is primarily represented by one large commercial loan to a retail auto dealer. The increase in other real estate owned primarily reflects the foreclosures on one large residential property of approximately $1,236,000 and one commercial property of $212,000. It is our Company's policy to discontinue the accrual of interest income on loans when the full collection of interest or principal is in doubt, or when the payment of interest or principal has become contractually 90 days past due unless the obligation is both well secured and in the process of collection. A loan remains on nonaccrual status until the loan is current as to payment of both principal and interest and/or the borrower demonstrates the ability to pay and remain current. Interest on loans on nonaccrual status at September 30, 2005 and 2004, which would have been recorded under the original terms of those loans, was approximately $489,000 and $350,000 for the nine months ended September 30, 2005 and 2004, respectively. Approximately $43,000 and $50,000 was actually recorded as interest income on such loans for the nine months ended September 30, 2005 and 2004, respectively. 34
A loan is considered impaired when it is probable a creditor will be unable to collect all amounts due - both principal and interest - according to the contractual terms of the loan agreement. In addition to nonaccrual loans included in the table above, which were considered impaired, management has identified one additional commercial loan of approximately $142,000 as being impaired at September 30, 2005. The average balance of nonaccrual and other impaired loans for the first nine months of 2005 was approximately $5,807,000. At September 30, 2005 the portion of the allowance for loan losses allocated (both asset-specific and percentage) to impaired loans was $1,485,000 compared to $1,681,000 at December 31, 2004. The balance of impaired loans with no specific loan loss allocations was approximately $5,014,000 at September 30, 2005 compared to approximately $5,225,000 at December 31, 2004. As of September 30, 2005 and December 31, 2004 approximately $21,139,000 and $12,879,000 of loans not included in the nonaccrual table above or identified by management as being impaired were classified by management as having more than normal risk which raised doubts as to the ability of the borrower to comply with present loan repayment terms. The increase in loans having more than normal risk is primarily represented by two large commercial real estate credits. These two credits had documentation exceptions causing them to be classified by regulatory authorities as substandard and special mention. The loans are well secured and performing in accordance with the terms of the loan agreements. In addition to the classified list, our Company also maintains an internal watch list of loans, which for various reasons, not all related to credit quality, management is monitoring more closely than the average loan in the portfolio. Loans may be added to this list for reasons that are temporary and correctable, such as the absence of current financial statements of the borrower, or a deficiency in loan documentation. Other loans are added as soon as any problem is detected which might affect the borrower's ability to meet the terms of the loan. This could be initiated by the delinquency of a scheduled loan payment, a deterioration in the borrower's financial condition identified in a review of periodic financial statements, a decrease in the value of the collateral securing the loan, or a change in the economic environment within which the borrower operates. Once the loan is placed on our Company's watch list, its condition is monitored closely. Any further deterioration in the condition of the loan is evaluated to determine if the loan should be assigned to a higher risk category. The allowance for loan losses is available to absorb probable loan losses regardless of the category of loan to be charged off. The allowance for loan losses consists of three components: asset-specific reserves, reserves based on expected loss estimates, and unallocated reserves. The asset-specific component applies to loans evaluated individually for impairment and is based on management's best estimate of discounted cash repayments and proceeds from liquidating collateral. The actual timing and amount of repayments and the ultimate realizable value of the collateral may differ from management's estimate. The expected loss component is generally determined by applying percentages to pools of loans by asset type. These pre-established percentages are based upon standard bank regulatory classification percentages as well as average historical loss percentages. These expected loss estimates are sensitive to changes in delinquency status, realizable value of collateral, and other risk factors. 35
The unallocated portion of the allowance is based on management's evaluation of conditions that are not directly reflected in the determination of the asset-specific component and the expected loss component discussed above. The evaluation of inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they may not be identified with specific problem credits or portfolio segments. Conditions evaluated in connection with the unallocated portion of the allowance include general economic and business conditions affecting our key lending areas, credit quality trends (including trends in substandard loans expected to result from existing conditions), collateral values, specific industry conditions within portfolio segments, bank regulatory examination results, and findings of our internal loan review department. The underlying assumptions, estimates and assessments used by management to determine these components are continually evaluated and updated to reflect management's current view of overall economic conditions and relevant factors impacting credit quality and inherent losses. Changes in such estimates could significantly impact the allowance and provision for credit losses. Our Company could experience credit losses that are different from the current estimates made by management. At September 30, 2005, management allocated $6,685,000 of the $8,793,000 total allowance for loan losses to specific loans and loan categories and $2,108,000 was unallocated. Considering the size of several of our Company's lending relationships and the loan portfolio in total, management believes that the September 30, 2005 allowance for loan losses is adequate. Our Company does not lend funds for the type of transactions defined as "highly leveraged" by bank regulatory authorities or for foreign loans. Our Company does not have any interest-earning assets which would have been included in nonaccrual, past due, or restructured loans if such assets were loans. FINANCIAL CONDITION Total assets increased $255,887,000 or 27.7% to $1,179,761,000 at September 30, 2005 compared to $923,874,000 at December 31, 2004. Total liabilities increased $251,652,000 or 30.2% to $1,083,755,000. Stockholders' equity increased $4,235,000 or 4.6% to $96,006,000. The increase in both total assets and total liabilities is primarily the result of our Company's acquisition of Bank 10 and issuance of additional subordinated debentures. A discussion of the Bank 10 transaction may be found in the section of this report titled "Overview - Recent Events - Bank 10 Transaction." Loans increased $160,933,000 to $797,570,000 at September 30, 2005 compared to $636,637,000 at December 31, 2004. Approximately $133,309,000 of the increase in loans reflects loans of Bank 10. Excluding loans acquired in the acquisition of Bank 10, commercial loans increased $14,695,000; real estate construction loans increased $27,052,000; real estate mortgage loans decreased $11,146,000; and consumer loans decreased $2,977,000. The increase in commercial loans and real estate construction loans represents continued strong loan demand, especially in the Jefferson City market. The decrease in real estate mortgage loans is primarily represented by the payoff of one large commercial real estate loan that was refinanced in the 36
commercial finance market. The decrease in consumer loans was also due to the payoff of one very large personal consumer credit. Investment in debt securities classified as available-for-sale increased $40,764,000 or 23.7% to $212,482,000 at September 30, 2005 compared to $171,718,000 at December 31, 2004. Investments classified as available-for-sale are carried at fair value. $29,223,000 of the increase reflects securities of Bank 10. During 2005 the market valuation account decreased $1,185,000 to ($580,000) to reflect the fair value of available-for-sale investments at September 30, 2005 and the net after tax decrease resulting from the change in the market valuation adjustment of $762,000 decreased the stockholders' equity component to ($369,000) at September 30, 2005. At December 31, 2004 the market valuation account for the available-for-sale investments of $605,000 increased the amortized cost of those investments to their fair value on that date and the net after tax increase resulting from the market valuation adjustment of $394,000 was reflected as a separate positive component of stockholders' equity. Cash and cash equivalents, which consist of cash and due from banks and Federal funds sold, increased $19,574,000 or 29.8% to $85,282,000 at September 30, 2005 compared to $65,708,000 at December 31, 2004. Approximately $6,730,000 of the increase represents cash and cash equivalents of Bank 10. Further discussion of this increase may be found in the section of this report titled "Sources and Uses of Funds". Premises and equipment increased $10,858,000 or 51.0% to $32,134,000 at September 30, 2005 compared to $21,276,000 at December 31, 2004. The increase reflects $7,119,000 of premises and equipment acquired in the Bank 10 transaction and purchases of premises and equipment of $5,012,000 offset by depreciation expense of $1,274,000. The purchase of premises and equipment primarily reflects construction costs and equipment purchases for two additional branches located in Branson and Lee's Summit, Missouri. Goodwill increased $15,127,000 or 60.0% to 40,324,000 at September 30, 2005 compared to $25,197,000 at December 31, 2004. The increase reflects the difference between the purchase price of Bank 10 and the fair value of the identifiable net assets acquired. Core deposit intangible increased $4,264,000 or 534.2% to $5,062,000 at September 30, 2005 compared to $798,000 at December 31, 2004. The increase reflects a core deposit intangible of $4,795,000 recorded as part of the Bank 10 acquisition. This intangible asset is being amortized on an accelerated basis over an estimated life of eight years. Additional discussion of intangible assets can be found in the "Intangible Assets" section that follows. Total deposits increased $182,835,000 or 25.2% to $909,484,000 at September 30, 2005 compared to $726,649,000 at December 31, 2004. $151,236,000 of the increase represents deposits of Bank 10. The balance of the increase primarily reflects increased public fund deposits. Federal funds purchased and securities sold under agreements to repurchase increased $29,698,000 or 86.0% to $64,213,000 at September 30, 2005 compared to $34,515,000 at 37
December 31, 2004. $911,000 of the increase represents securities sold under agreements to repurchase of Bank 10. The balance represents an increase in public fund repurchase agreements. Subordinated notes increased $23,712,000 or 92.0% to $49,486,000 at September 30, 2005 compared to $25,774,000 at December 31, 2004. Our Company issued $23,712,000 of subordinated notes in March 2005. The proceeds were used to provide part of the finding for the acquisition of Bank 10. Other borrowed money increased $12,692,000 or 32.1% to $52,217,000 at September 30, 2005 compared to $39,525,000 at December 31, 2004. The increase reflects $13,259,000 of Federal Home Loan Bank advances acquired in the Bank 10 acquisition reduced by regular amortizing payments due on Federal Home Loan Bank advances. The increase in stockholders' equity reflects net income of $7,234,000 less dividends declared of $2,252,000 and ($762,000) change in unrealized holding losses, net of taxes, on investment in debt and equity securities available-for-sale. No material changes in our Company's liquidity or capital resources have occurred since December 31, 2004. LIQUIDITY The role of liquidity management is to ensure funds are available to meet depositors' withdrawal and borrowers' credit demands while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in the supply of those funds. Liquidity to meet the demands is provided by maturing assets, short-term liquid assets that can be converted to cash and the ability to attract funds from external sources, principally depositors. Due to the nature of services offered by our Company, management prefers to focus on transaction accounts and full service relationships with customers. Management believes it has the ability to increase deposits at any time by offering rates slightly higher than the market rate. Our Banks' Asset/Liability Committees (ALCO), primarily made up of senior management, have direct oversight responsibility for our Company's liquidity position and profile. A combination of daily, weekly and monthly reports provided to management detail the following: internal liquidity metrics, composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, available pricing and market access to the financial markets for capital and exposure to contingent draws on our Company's liquidity. Our Company has a number of sources of funds to meet liquidity needs on a daily basis. The deposit base, consisting of consumer and commercial deposits and large dollar denomination ($100,000 and over) certificates of deposit, is a source of funds. Other sources of funds available to meet daily needs include the sales of securities under agreements to repurchase and funds made available under a treasury tax and loan note agreement 38
with the federal government. Also, the Banks are members of the Federal Home Loan Bank of Des Moines (FHLB). As members of the FHLB, the Banks have access to credit products of the FHLB. At September 30, 2005, the amounts of available credit from the FHLB totaled $110,489,000. As of September 30, 2005, the Banks had $52,217,000 in outstanding borrowings with the FHLB. The Banks have federal funds purchased lines with correspondent banks totaling $45,000,000 and agreements with unaffiliated banks to sell and repurchase securities of $10,000,000. Finally, our Company has a $20,000,000 line of credit with a correspondent bank. This line of credit had no balance in use as of September 30, 2005. SOURCES AND USES OF FUNDS For the nine months ended September 30, 2005 and 2004, net cash provided by operating activities was $10,849,000 and $7,070,000, respectively. $756,000 of the increase in net cash provided by operating activities reflects a higher level of net income. Approximately $2,733,000 reflects a decrease in income tax payments. Our Company paid $2,620,000 in income taxes for the nine-month period ended September 30, 2005 compared to $5,353,000 for the nine-month period ended September 30, 2004. The higher income tax payment in 2004 reflects taxes paid as a result of an IRS settlement related to income that had been deferred for tax purposes but not for financial reporting. Net cash used in investing activities was $74,597,000 in 2005 versus $14,646,000 in 2004. The primary increase in cash used in investing activities reflects our Company's purchase of Bank 10. The cash used in this purchase, net of cash and cash equivalents acquired, was $21,801,000. In addition, $1,799,000 more cash was used for purchase of premises and equipment in 2005 versus 2004. Net cash used in securities investment activities was $16,432,000 in 2005 compared to net cash provided of $20,112,000 for the same period of 2004. Net cash provided by financing activities was $83,322,000 in 2005 versus $5,753,000 in 2004. Increases in deposits accounted for approximately $33,223,000 of the cash provided by financing activities in 2005 and approximately $22,704,000 in 2004. An additional $23,712,000 of cash was provided by the issuance of subordinated debentures. The proceeds from the issuance of these subordinated debentures were used to finance as part of the purchase of Bank 10. During the same period of 2004 our Company issued $25,774,000 of subordinated debentures and used those proceeds to reduce other borrowed money by $17,951,000. Securities sold under agreements to repurchase increased $28,691,000 in 2005 compared to a $39,004,000 decrease during the same period of 2004. IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS In November 2003, the Emerging Issues Tasks Force (EITF) reached a consensus on certain disclosure requirements under EITF Issue No 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The disclosure requirements apply to investment in debt and marketable equity securities that are accounted under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Effective for fiscal years ending after December 15, 2003, companies are required to disclose information about debt or marketable equity securities with market values below carrying values. Our Company has adopted the disclosure requirements of EITF Issue No. 03-1 and they are included in Note 5 of 39
our audited consolidated financial statements included in our 2004 Annual Report to Shareholders under the caption "Consolidated Financial Statements" and incorporated by reference in our Annual Report on Form 10-K for the year ended December 31, 2004. In March 2004, the Emerging Issues Task Force, (EITF) came to a consensus regarding EITF 03-1. Securities in scope are those subject to SFAS 115. The EITF adopted a three-step model that requires management to determine if impairment exists, decide whether it is other than temporary, and record other than temporary losses in earnings. In September 2004, the FASB approved a Staff Position to delay the requirement to record impairment losses under EITF 03-1, but broadened the delay's scope to include additional types of securities. As proposed, the delay would have applied only to those debt securities described in paragraph 16 of EITF 03-1. The approved delay applies to all securities within the scope of EITF 03-1 and is expected to end when new guidance is issued and comes into effect. In December 2003, the Accounting Standards Executive Committee, (AcSEC) issued SOP 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer, effective for loans acquired in fiscal years beginning after December 15, 2004. The scope of SOP 03-3 applies to "problem" loans that have been acquired, either individually in a portfolio, in an acquisition. These loans must have evidence of credit deterioration and the purchaser must not expect to collect contractual cash flows. SOP 03-3 updates Practice Bulletin (PB) No. 6, Amortization of Discounts on Certain Acquired Loans, for more recently issued literature, including FASB Statements No. 114, Accounting by Creditors for Impairment of a Loan; No. 115, Accounting for Certain Investments in Debt and Equity Securities; and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Additionally, it addresses FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, which requires that discounts be recognized as an adjustment of yield over a loan's life. SOP 03-3 states that an institution may no longer display discounts on purchased loans within the scope of SOP 03-3 on the balance sheet and may not carry over the allowance for loan losses related to such loans. For those loans within the scope of SOP 03-3, this Statement clarifies that a buyer cannot carry over the seller's allowance for loan losses for the acquisition of loans with credit deterioration. Loans acquired with evidence of deterioration in credit quality since origination will need to be accounted for under a new method using an income recognition model. This prohibition also applies to purchases of problem loans not included in a purchase business combination, which would include syndicated loans purchased in the secondary market and loans acquired in portfolio sales. The application of SOP 03-3 did not have a material effect on our Company's financial statements with the acquisition of Bank 10. In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No 123 (Revised 2004), Share-Based Payment. This Statement addresses the accounting for transactions in which an entity exchanges its equity instruments for goods or services. The Statement eliminates the ability to account for share-based compensation transactions using APB Opinion No. 25, Accounting for Stock Issued to Employees, and generally requires instead that such transactions be accounted for using a fair-value-based 40
method. For public entities, the cost of employee services received in exchange for an award of equity instruments, such as stock options, will be measured based on the grant-date fair value of those instruments, and that cost will be recognized over the period during which an employee is required to provide service in exchange for the award (usually the vesting period). This Statement is effective for public entities as of the beginning of the first annual reporting period that begins after September 15, 2005 and will be effective for our Company as of January 1, 2006. See the note to condensed consolidated financial statements titled Earnings per Share for the pro forma net income and net income per share amounts for the quarters ended September 30, 2005 and 2004 as if we had used a fair value based method similar to the methods required under SFAS 123R to measure compensation expense for employee stock incentive awards. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our Company's exposure to market risk is reviewed on a regular basis by our Banks' Asset/Liability Committees and Boards of Directors. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income. Management realizes certain risks are inherent and that the goal is to identify and minimize those risks. Tools used by our Banks' management include the standard GAP report subject to different rate shock scenarios. At September 30, 2005, the rate shock scenario models indicated that annual net interest income could decrease or increase by as much as 7.5% should interest rates rise or fall, respectively, within 200 basis points from their current level over a one year period compared to 13.1% at December 31, 2004. However there are no assurances that the change will not be more or less than this estimate. Management further believes this is an acceptable level of risk. ITEM 4. CONTROLS AND PROCEDURES Our Company's management has evaluated, with the participation of our principal executive and principal financial officers, the effectiveness of our disclosure controls and procedures as of September 30, 2005. Based upon and as of the date of that evaluation, our principal executive and principal financial officers concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported as and when required. It should be noted that any system of disclosure controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any system of disclosure controls and procedures is based in part upon assumptions about the likelihood of future events. Because of these and other inherent limitations of any such system, there can be no assurance that any design will always succeed in achieving its stated goals under all potential future conditions, regardless of how remote. 41
There has been no change in our Company's internal control over financial reporting that occurred during the fiscal quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 42
PART II - OTHER INFORMATION <TABLE> <S> <C> Item 1. Legal Proceedings None Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits </TABLE> <TABLE> <CAPTION> Exhibit No. Description - ----------- ----------- <S> <C> 3.1 Articles of Incorporation of our Company (filed as Exhibit 3(a) to our Company's Registration Statement on Form S-4 (Registration No. 33-54166) and incorporated herein by reference). 3.2 Bylaws of our Company (filed as Exhibit 3.2 to our Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002 (Commission file number 0-23636) and incorporated herein by reference). 4 Specimen certificate representing shares of our Company's $1.00 par value common stock (filed as Exhibit 4 to our Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999 (Commission file number 0-23636) and incorporated herein by reference). 31.1 Certificate of the Chief Executive Officer of our Company pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certificate of the Chief Financial Officer of our Company pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certificate of the Chief Executive Officer of our Company pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certificate of the Chief Financial Officer of our Company pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 </TABLE> 43
SIGNATURES Pursuant to the requirements 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. EXCHANGE NATIONAL BANCSHARES, INC. <TABLE> <CAPTION> Date - ---------------- <S> <C> /s/ James E. Smith ------------------------------------------------- November 9, 2005 James E. Smith, Chairman of the Board and Chief Executive Officer (Principal Executive Officer) /s/ Richard G. Rose ------------------------------------------------- November 9, 2005 Richard G. Rose, Treasurer (Principal Financial Officer and Principal Accounting Officer) </TABLE> 44
EXCHANGE NATIONAL BANCSHARES, INC. INDEX TO EXHIBITS September 30, 2005 Form 10-Q <TABLE> <CAPTION> Exhibit No. Description Page No. - ----------- ----------- -------- <S> <C> <C> 3.1 Articles of Incorporation of our Company (filed as Exhibit 3(a) ** to our Company's Registration Statement on Form S-4 (Registration No. 33-54166) and incorporated herein by reference). 3.2 Bylaws of our Company (filed as Exhibit 3.2 to our Company's ** Annual Report on Form 10-K for the fiscal year ended December 31, 2002 (Commission file number 0-23636) and incorporated herein by reference). 4 Specimen certificate representing shares of our Company's $1.00 ** par value common stock (filed as Exhibit 4 to our Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999 (Commission file number 0-23636) and incorporated herein by reference). 31.1 Certificate of the Chief Executive Officer of our Company 46 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certificate of the Chief Financial Officer of our Company 47 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certificate of the Chief Executive Officer of our Company 48 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certificate of the Chief Financial Officer of our Company 49 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 </TABLE> - ---------- ** Incorporated by reference. 45