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 June 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 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 As of August 9, 2005, the registrant had 4,169,847 shares of common stock, par value $1.00 per share, outstanding. Page 1 of 47 pages Index to Exhibits located on page 43 1
PART I - FINANCIAL INFORMATION Item 1. Financial Statements EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) <TABLE> <CAPTION> JUNE 30, 2005 DECEMBER 31, 2004 --------------- ----------------- <S> <C> <C> ASSETS Loans: Commercial $ 269,502,034 $ 249,497,691 Real estate - construction 86,880,123 65,075,185 Real estate - mortgage 395,469,715 284,309,203 Consumer 38,283,781 37,985,508 Unamortized loan origination fees and costs, net (387,299) (230,957) --------------- ----------------- 789,748,354 636,636,630 Less allowance for loan losses 9,336,516 7,495,594 --------------- ----------------- Loans, net 780,411,838 629,141,036 Investments in available for sale debt and equity securities, at fair value 216,593,498 171,717,635 Federal funds sold 52,608,148 41,603,952 Cash and due from banks 27,389,616 24,104,458 Premises and equipment 30,679,747 21,276,387 Accrued interest receivable 7,300,290 5,289,083 Mortgage servicing rights 1,569,578 1,605,930 Goodwill 39,090,025 25,196,736 Core deposit intangible 5,096,826 798,132 Cash surrender value - life insurance 1,620,080 106,218 Other assets 4,058,159 3,034,703 --------------- ----------------- Total assets $ 1,166,417,805 $ 923,874,270 =============== ================= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Demand deposits $ 130,669,397 $ 98,156,124 Time deposits 787,458,356 628,493,352 --------------- ----------------- Total deposits 918,127,753 726,649,476 Federal funds purchased and securities sold under agreements to repurchase 43,891,974 34,515,323 Interest-bearing demand notes to U.S. Treasury 1,055,522 897,470 Subordinated notes 49,486,000 25,774,000 Other borrowed money 52,490,658 39,524,747 Accrued interest payable 2,785,216 1,795,267 Other liabilities 4,040,923 2,947,204 --------------- ----------------- Total liabilities 1,071,878,046 832,103,487 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 70,797,784 67,716,511 Accumulated other comprehensive income (loss), net of tax 66,057 393,534 Treasury stock, 128,506 shares at cost (2,652,509) (2,652,509) --------------- ----------------- Total stockholders' equity 94,539,759 91,770,783 --------------- ----------------- Total liabilities and stockholders' equity $ 1,166,417,805 $ 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 SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------------- -------------------------- 2005 2004 2005 2004 ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Interest income: Interest and fees on loans $11,826,533 $ 8,487,563 $21,562,627 $16,817,345 Interest on debt and equity securities: Taxable 1,344,608 1,057,675 2,466,214 2,074,552 Nontaxable 405,528 314,314 748,442 630,439 Interest on federal funds sold 233,508 81,746 486,160 144,878 Interest on interest-bearing deposits 4,580 3,519 20,502 9,725 Dividends on equity securities 72,506 39,527 130,696 69,258 ----------- ----------- ----------- ----------- Total interest income 13,887,263 9,984,344 25,414,641 19,746,197 ----------- ----------- ----------- ----------- Interest Expense: NOW accounts 429,816 173,120 785,361 344,529 Savings 80,644 81,935 151,889 162,317 Money market accounts 825,936 227,819 1,470,662 371,632 Certificates of deposit: $100,000 and over 811,613 424,893 1,431,695 864,573 Other time deposits 2,111,065 1,470,575 3,770,507 3,014,245 Federal funds purchased and securities sold under agreements to repurchase 315,697 188,542 583,819 355,860 Subordinated notes 746,544 252,736 1,149,609 293,652 Federal Home Loan borrowings 484,862 360,202 899,552 666,144 Other borrowings 4,929 1,447 8,279 62,710 ----------- ----------- ----------- ----------- Total interest expense 5,811,106 3,181,269 10,251,373 6,135,662 ----------- ----------- ----------- ----------- Net interest income 8,076,157 6,803,075 15,163,268 13,610,535 Provision for loan losses 237,667 210,500 473,167 446,000 ----------- ----------- ----------- ----------- Net interest income after provision for loan losses 7,838,490 6,592,575 14,690,101 13,164,535 </TABLE> Continued on next page 3
EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------------- -------------------------- 2005 2004 2005 2004 ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Noninterest income: Service charges on deposit accounts $ 1,019,169 $ 779,862 $ 1,699,678 $ 1,520,120 Trust department income 247,954 159,565 429,965 370,994 Brokerage income 50,748 20,614 91,310 41,509 Gain on sales and calls of debt securities - - - 2,537 Mortgage loan servicing fees, net 104,032 112,303 216,799 214,424 Gain on sale of mortgage loans 176,891 242,259 306,587 462,301 Other 198,397 236,211 384,196 385,584 ----------- ----------- ----------- ----------- Total noninterest income 1,797,191 1,550,814 3,128,535 2,997,469 ----------- ----------- ----------- ----------- Noninterest expense: Salaries and employee benefits 3,434,712 2,795,158 6,320,501 5,576,177 Occupancy expense 386,336 285,183 676,106 550,660 Furniture and equipment expense 541,999 478,116 1,046,228 942,784 Advertising and promotion 204,916 160,041 357,668 242,522 Postage, printing and supplies 254,871 211,970 419,022 387,326 Legal, examination, and professional fees 333,148 267,969 584,244 432,478 Other 1,104,875 792,272 1,832,346 1,531,025 ----------- ----------- ----------- ----------- Total noninterest expense 6,260,857 4,990,709 11,236,115 9,662,972 ----------- ----------- ----------- ----------- Income before income taxes 3,374,824 3,152,680 6,582,521 6,499,032 Income taxes 1,030,021 1,023,712 2,000,104 2,076,265 ----------- ----------- ----------- ----------- Net income $ 2,344,803 $ 2,128,968 $ 4,582,417 $ 4,422,767 =========== =========== =========== =========== Basic earning per share $ 0.56 $ 0.51 $ 1.10 $ 1.06 Diluted earnings per share $ 0.56 $ 0.51 $ 1.09 $ 1.05 Weighed average shares of common stock outstanding Basic 4,169,847 4,169,847 4,169,847 4,169,847 Diluted 4,198,333 4,203,766 4,198,808 4,207,944 Dividends per share: Declared $ 0.18 $ 0.18 $ 0.36 $ 0.36 Paid $ 0.18 $ 0.18 $ 0.36 $ 0.36 </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> SIX MONTHS ENDED JUNE 30, ------------------------------- 2005 2004 ------------- ------------- <S> <C> <C> Cash flow from operating activities: Net income $ 4,582,417 $ 4,422,767 Adjustments to reconcile net income to net cash cash provided by operating activities: Provision for loan losses 473,167 446,000 Depreciation expense 842,543 762,243 Net amortization of debt securities premiums and discounts 425,137 747,649 Amortization of intangible assets 201,306 107,556 Increase in accrued interest receivable (762,388) (124,682) Increase in cash surrender value - life insurance (9,042) (3,282) (Increase) decrease in other assets (349,526) 95,895 Increase (decrease) in accrued interest payable 792,565 (165,518) Increase in other liabilities 569,970 845,695 Gain on sales and calls of debt securities - (2,537) Origination of mortgage loans for sale (19,077,940) (27,807,405) Proceeds from the sale of mortgage loans held for sale 19,384,527 28,269,706 Gain on sale of mortgage loans (306,587) (462,301) Loss on disposition of premises and equipment 674 - Other, net 15,180 15,180 ------------- ------------- Net cash provided by operating activities 6,782,003 7,146,966 Cash flow from investing activities: Net increase in loans (21,907,593) (13,970,030) Purchase of available-for-sale debt securities (150,620,781) (146,499,286) Proceeds from maturities of available-for-sale debt securities 116,651,308 95,822,867 Proceeds from calls of available-for-sale debt securities 13,172,500 23,747,425 Proceeds from sales of available-for-sale debt securities 1,071,803 250,000 Acquisition of subsidiary, net of cash and cash equivalents acquired (21,798,564) - Purchase of premises and equipment (3,127,280) (2,267,381) Proceeds from sales of other real estate owned and repossessions 1,439,880 221,989 ------------- ------------- Net cash used in investing activities (65,118,727) (42,694,416) ------------- ------------- </TABLE> Continued on next page 5
EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (Unaudited) <TABLE> <CAPTION> SIX MONTHS ENDED JUNE 30, ----------------------------- 2005 2004 ------------ ------------ <S> <C> <C> Cash flow from financing activities: Net increase in demand deposits $ 8,252,832 $ 2,772,528 Net increase in interest-bearing transaction accounts 23,663,971 24,815,133 Net increase (decrease) in time deposits 10,283,788 (16,792,812) Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase 8,370,728 (9,999,729) Net increase in interest-bearing demand notes to U.S. Treasury 137,083 1,067,817 Proceeds from subordinated notes 23,712,000 25,774,000 Proceeds from Federal Home Loan Bank borrowings 3,500,000 15,000,000 Repayment of Federal Home Loan Bank borrowings (3,793,180) (588,699) Repayment of other borrowed money - (17,950,568) Cash dividends paid (1,501,144) (1,501,145) ------------ ------------ Net cash provided by financing activities 72,626,078 22,596,525 Net increase (decrease) in cash and cash equivalents 14,289,354 (12,950,925) Cash and cash equivalents, beginning of period 65,708,410 57,044,915 ------------ ------------ Cash and cash equivalents, end of period $ 79,997,764 $ 44,093,990 ============ ============ Supplemental disclosure of cash flow information - Cash paid during period for: Interest $ 9,450,543 $ 6,301,180 Income taxes 1,600,000 3,035,000 Supplemental schedule of noncash investing activities - Other real estate and repossessions acquired in settlement of loans $ 1,880,141 $ 419,204 </TABLE> See accompanying notes to unaudited condensed consolidated financial statements. 6
EXCHANGE NATIONAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Six Months Ended June 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 June 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 June 30, 2005 and December 31, 2004 and the consolidated statements of earnings for the three and six periods ended June 30, 2005 and 2004 and cash flows for the six months ended June 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 will be able to expand 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. Our company is in the process of obtaining third-party valuations of loans, deposits and the core deposit intangible asset; thus, the allocation of the purchase price is subject to refinement. <TABLE> <CAPTION> AT MAY 2, 2005 -------------- <S> <C> Cash and cash equivalents $ 12,221,439 Loans, net 131,716,517 Investments in available for sale debt and equity securities, at fair value 26,080,340 Premises and equipment 7,119,297 Core deposit intangible 4,500,000 Goodwill 13,893,289 Other assets 2,773,923 -------------- Total assets acquired 198,304,805 Deposits 149,277,685 Securities sold under agreements to repurchase 1,005,923 Other borrwed money 13,280,060 Other liabilities 721,134 -------------- Total liabilities acquired 164,284,802 -------------- Net assets acquired $ 34,020,003 ============== </TABLE> The $4,500,000 core deposit intangible has been assigned an estimated 8 year useful life subject to third party verification. The $13,893,289 of goodwill is expected to be deductible for income tax purposes. A summary of unaudited pro forma combined financial information for the three-month and six-month periods ended June 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 anticipated expense reductions that may result from the acquisition. <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, -------------------------------- -------------------------------- 2005 2004 2005 2004 -------------- -------------- -------------- -------------- <S> <C> <C> <C> <C> Net interest income $ 8,593,966 $ 8,000,759 $ 16,896,125 $ 15,994,652 Net income $ 2,403,826 2,256,013 4,695,768 4,679,123 Basic earnings per share $ 0.58 $ 0.54 $ 1.13 $ 1.12 Diluted earnings per share $ 0.57 $ 0.54 $ 1.12 $ 1.11 </TABLE> 8
EARNINGS PER SHARE The following table reflects, for the three-month and six-month periods ended June 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 SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------ ------------------------ 2005 2004 2005 2004 ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Net income, basic and diluted $2,344,803 $2,128,968 $4,582,417 $4,422,767 ========== ========== ========== ========== Average shares outstanding 4,169,847 4,169,847 4,169,847 4,169,847 Effect of dilutive stock options 28,521 33,919 29,234 38,097 ---------- ---------- ---------- ---------- Average shares outstanding including dilutive stock options 4,198,368 4,203,766 4,199,081 4,207,944 Basic earning per share $ 0.56 $ 0.51 $ 1.10 $ 1.06 Diluted earnings per share $ 0.56 $ 0.51 $ 1.09 $ 1.05 </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 six-month periods ended June 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 SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------------- ------------------------------- 2005 2004 2005 2004 ------------- ------------- ------------- ------------- <S> <C> <C> <C> <C> Net income: As reported $ 2,344,803 $ 2,128,968 $ 4,582,417 $ 4,422,767 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) (71,399) (68,113) ------------- ------------- ------------- ------------- Pro forma net income $ 2,309,103 $ 2,094,910 $ 4,511,018 $ 4,354,654 ============= ============= ============= ============= Pro forma earnings per common share: As reported basic $ 0.56 $ 0.51 $ 1.10 $ 1.06 Pro forma basic 0.55 0.50 1.08 1.04 As reported diluted 0.56 0.51 1.09 1.05 Pro forma diluted 0.55 0.50 1.07 1.03 </TABLE> 10
COMPREHENSIVE INCOME For the three-month and six-month periods ended June 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 six-month periods ended June 30, 2005 and 2004 is summarized as follows: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------------- --------------------------- 2005 2004 2005 2004 ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Net income $ 2,344,803 $ 2,128,968 $ 4,582,417 $ 4,422,767 Other comprehensive income (loss): Net unrealized holding gains (losses) on investments in debt and equity securities available-for-sale, net of taxes 739,264 (2,094,118) (327,477) (1,819,287) Adjustment for net securities gains realized in net income, net of applicable income taxes - - - (1,649) ----------- ----------- ----------- ----------- Total other comprehensive income (loss) 739,264 (2,094,118) (327,477) (1,820,936) ----------- ----------- ----------- ----------- Comprehensive income $ 3,084,067 $ 34,850 $ 4,254,940 $ 2,601,831 =========== =========== =========== =========== </TABLE> INTANGIBLE ASSETS The gross carrying amount and accumulated amortization of our Company's amortizable core deposit intangible asset as of June 30, 2005 and December 31, 2004 is as follows: <TABLE> <CAPTION> JUNE 30, 2005 DECEMBER 31, 2004 ----------------------------- ---------------------------- Gross Carrying Accumulated Gross Carrying Accumulated Amount Amortization Amount Amortization -------------- ------------ -------------- ------------ <S> <C> <C> <C> <C> Core deposit intangible $ 6,765,000 (1,668,174) 2,265,000 (1,466,868) ============== =========== ============== =========== </TABLE> The aggregate amortization expense of core deposit intangible subject to amortization for the three-month and six-month periods ended June 30, 2005 and 2004 is as follows: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------ ------------------- 2005 2004 2005 2004 ---------- ------ ---------- ------- <S> <C> <C> <C> <C> Aggregate amortization expense $ 147,528 53,778 $ 201,306 107,556 ========== ====== ========== ======= </TABLE> 11
The estimated amortization expense for the next five years is as follows: <TABLE> <S> <C> Estimated amortization expense: For year ending 2005 $ 590,112 For year ending 2006 777,612 For year ending 2007 764,352 For year ending 2008 628,932 For year ending 2009 628,932 </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> JUNE 30, --------------------------------- 2005 2004 ------------- ----------- <S> <C> <C> Balance, beginning of period $ 1,605,930 1,591,289 Originated mortgage servicing rights 183,824 245,940 Amortization (220,176) (212,221) ------------- ----------- Balance, end of period $ 1,569,578 1,625,008 ============= =========== Mortgage loans serviced $ 217,047,351 212,487,000 ============= =========== Mortgage servicing rights as a percentage of loans serviced 0.72% 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 $ 440,000 For year ending 2006 440,000 For year ending 2007 440,000 For year ending 2008 204,000 For year ending 2009 46,000 </TABLE> 12
Our Company's goodwill associated with the purchase of subsidiaries by reporting segments for the periods ended June 30, 2005 and December 31, 2004 is summarized as follows: <TABLE> <CAPTION> JUNE 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 13,893,289 39,090,025 ============= =========== ========= ========== ========== </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 six-month periods ended June 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 June 30 (actual) $ 39,271 $ 31,615 ========= ========= Net periodic pension cost - six months ended June 30 (actual) $ 78,542 $ 63,230 ========= ========= </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> JUNE 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> Balance sheet information Loans, net of allowance for loan losses $ 378,165,474 $ 222,704,782 $ 51,161,384 $ 128,380,198 $ - $ 780,411,838 Debt and equity securities 110,708,492 37,630,984 37,495,309 29,272,713 1,486,000 216,593,498 Goodwill 4,382,098 16,701,762 4,112,876 13,893,289 - 39,090,025 Intangible assets - 690,576 - 4,406,250 - 5,096,826 Total assets 547,573,344 319,269,709 97,172,165 200,288,694 2,113,893 1,166,417,805 Deposits 431,851,643 262,432,300 78,479,971 151,965,663 (6,601,824) 918,127,753 Stockholders' equity $ 50,283,174 $ 41,350,810 $ 9,955,772 $ 34,385,950 $ (41,435,947) $ 94,539,759 ============== ============== ============== ============== ============== ============== </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 JUNE 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 $ 6,977,560 $ 4,006,187 $ 1,173,086 $ 1,708,824 $ 21,606 $13,887,263 Total interest expense 2,657,604 1,341,438 518,246 599,202 694,616 5,811,106 ----------- ----------- ----------- ----------- ----------- ----------- Net interest income 4,319,956 2,664,749 654,840 1,109,622 (673,010) 8,076,157 Provision for loan losses 150,000 75,000 10,500 2,167 - 237,667 Noninterest income 1,017,283 378,843 125,741 297,220 (21,896) 1,797,191 Noninterest expense 2,719,329 1,989,499 448,707 1,000,783 102,539 6,260,857 Income taxes 795,400 300,338 88,067 119,236 (273,020) 1,030,021 ----------- ----------- ----------- ----------- ----------- ----------- Net income (loss) $ 1,672,510 $ 678,755 $ 233,307 $ 284,656 $ (524,425) $ 2,344,803 =========== =========== =========== =========== =========== =========== </TABLE> <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 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 $ 5,684,862 $ 3,242,855 $ 1,059,871 $ (3,244) $9,984,344 Total interest expense 1,760,980 819,826 393,509 206,954 3,181,269 ----------- ----------- ----------- ----------- ----------- Net interest income 3,923,882 2,423,029 666,362 (210,198) 6,803,075 Provision for loan losses 125,000 75,000 10,500 - 210,500 Noninterest income 1,050,441 412,748 101,044 (22,419) 1,550,814 Noninterest expense 2,795,712 1,654,828 428,369 111,800 4,990,709 Income taxes 668,400 380,973 94,839 (120,500) 1,023,712 ----------- ----------- ----------- ---------- ----------- Net income (loss) $ 1,385,211 $ 733,976 $ 233,698 $ (223,917) $ 2,128,968 =========== =========== =========== ========== =========== </TABLE> 17
<TABLE> <CAPTION> SIX MONTHS ENDED JUNE 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 $13,553,568 $ 7,800,694 $ 2,317,845 $ 1,708,824 $ 33,710 $25,414,641 Total interest expense 5,069,279 2,543,067 1,003,869 599,202 1,035,956 10,251,373 ----------- ----------- ----------- ----------- ----------- ----------- Net interest income 8,484,289 5,257,627 1,313,976 1,109,622 (1,002,246) 15,163,268 Provision for loan losses 300,000 150,000 21,000 2,167 - 473,167 Noninterest income 1,886,357 762,415 221,116 297,220 (38,573) 3,128,535 Noninterest expense 5,402,871 3,725,958 879,298 1,000,783 227,205 11,236,115 Income taxes 1,490,800 650,023 174,195 119,236 (434,150) 2,000,104 ----------- ----------- ----------- ----------- ----------- ----------- Net income (loss) $ 3,176,975 $ 1,494,061 $ 460,599 $ 284,656 $ (833,874) $ 4,582,417 =========== =========== =========== =========== =========== =========== </TABLE> <TABLE> <CAPTION> SIX MONTHS ENDED JUNE 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 $11,251,238 $ 6,379,786 $ 2,139,357 $ (24,184) $19,746,197 Total interest expense 3,365,165 1,687,582 802,295 280,620 6,135,662 ----------- ----------- ----------- ----------- ----------- Net interest income 7,886,073 4,692,204 1,337,062 (304,804) 13,610,535 Provision for loan losses 275,000 150,000 21,000 - 446,000 Noninterest income 2,024,497 824,908 191,594 (43,530) 2,997,469 Noninterest expense 5,489,063 3,175,081 846,886 151,942 9,662,972 Income taxes 1,344,050 715,842 191,473 (175,100) 2,076,265 ----------- ----------- ----------- ----------- ----------- Net income (loss) $ 2,802,457 $ 1,476,189 $ 469,297 $ (325,176) $ 4,422,767 =========== =========== =========== =========== =========== </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 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 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, 20
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 which follow 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 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 to be 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 June 30, 3005 of $2,345,000 increased $216,000 when compared to the second quarter of 2004. Diluted earnings per common share for the second quarter of 2005 of $0.56 increased 5 cents or 9.8% when compared to the second quarter of 2004. Net income for the six months ended June 30, 2005 of $4,582,000 increased $159,000 when compared to the second quarter of 2004. Diluted earnings per common share for the second quarter of 2005 of $1.09 increased 4 cents or 3.81% when compared to the second quarter of 2004. Net interest income (on a tax equivalent basis) was $8,428,000, or 3.40% of average earning assets, for the three months ended June 30, 2005, compared to $6,958,000, or 3.32% of average earning assets, for the same period in 2004. Approximately, $1,110,000 of the $1,470,000 increase in net interest income for the three months ended June 30, 2005 as compared to the same period in 2004 is related to the acquisition. The balance was the result of an increase in average interest-earning assets partially offset by a decrease in net interest margin. Net interest income (on a tax equivalent basis) was $15,697,000, or 3.37% of average earning assets, for the six months ended June 30, 2005, compared to $13,926,000, or 3.38% of average earning assets, for the same period in 2004. Approximately, $1,110,000 of the $1,771,000 increase in net interest income for the six months ended June 30, 2005 as compared to the same period in 2004 is related to the acquisition. The balance was the result of an increase in average interest-earning assets partially offset by a decrease in net interest margin. Average interest-earning assets for the three months ended June 30, 2005 were $993,873,000, an increase of $154,114,000 or 18.35%, compared to average interest-earning assets of $839,759,000 for the same period of 2004. The acquisition of Bank 10 represents approximately $111,434,000 of the increase in interest-earning assets. In addition to the increase due to the acquisition, average loans outstanding increased approximately $56,103,000. The yield on average interest-earning assets increased to 5.75% for the three month period ended June 30, 2005 compared to 4.84% for the same period in 2004. However, the rate paid on interest-bearing liabilities also increased to 2.67% in 2005 compared to 1.77% in 2004. Average interest-earning assets for the six months ended June 30, 2005 were $938,087,000, an increase of $113,019,000 or 13.7%, compared to average interest-earning assets of $825,068,000 for the same period of 2004. The acquisition of Bank 10 represents approximately $56,025,000 of the increase in interest-earning assets. In addition to the increase due to the acquisition, average loans outstanding increased approximately $57,778,000. The yield on average interest-earning assets increased to 5.58% for the six month period ended June 30, 2005 compared to 4.88% for the same period in 2004. However, the rate paid on interest-bearing liabilities also increased to 2.53% in 2005 compared to 1.74% in 2004. 22
THREE MONTHS ENDED JUNE 30, 2005 COMPARED TO THREE MONTHS ENDED JUNE 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 $1,322,000 or 19.00% to $8,280,000 or 3.34% of average earning assets for the second quarter of 2005 compared to $6,958,000 or 3.32% of average earning assets for the same period of 2004. The provision for loan losses was $238,000 and $210,000 the three months ended June 30, 2005 and 2004 respectively. Noninterest income and noninterest expense for the three-month periods ended June 30, 2005 and 2004 were as follows: (DOLLARS EXPRESSED IN THOUSANDS) <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, INCREASE (DECREASE) -------------------- ------------------- 2005 2004 AMOUNT % -------- ------- --------- ------ <S> <C> <C> <C> <C> NONINTEREST INCOME Service charges on deposit accounts $ 1,019 $ 780 $ 239 30.6 % Trust department income 248 160 88 55.0 Brokerage income 51 21 30 142.9 Mortgage loan servicing fees, net 104 112 (8) (7.1) Gain on sale of mortgage loans 177 242 (65) (26.9) Other 198 236 (38) (16.1) -------- ------- --------- ----- $ 1,797 $ 1,551 $ 246 15.9 % ======== ======= ========= ===== NONINTEREST EXPENSE Salaries and employee benefits $ 3,435 $ 2,795 $ 640 22.9 % Occupancy expense 386 285 101 35.4 Furniture and equipment expense 542 478 64 13.4 Advertising and promotion 205 160 45 28.1 Postage, printing and supplies 255 212 43 20.3 Legal, examination, and professional fees 333 268 65 24.3 Other 1,105 793 312 39.3 -------- ------- --------- ----- $ 6,261 $ 4,991 $ 1,270 25.4 % ======== ======= ========= ===== </TABLE> 23
Noninterest income increased $246,000 or 15.9% to $1,797,000 for the second quarter of 2005 compared to $1,551,000 for the same period of 2004. The acquisition of Bank 10 contributed $297,000 of additional noninterest income during the second quarter. In addition to the income due to the acquisition, trust department income increased $88,000 or 55.0% when compared to the same period in 2004 due primarily to a large distribution fee collected during the quarter. Brokerage income increased $30,000 or 142.9% due to higher sales volume during the second quarter of 2005 compared to 2004. Gain on sales of mortgage loans decreased $65,000 or 26.9% due to a decrease in volume of loans originated and sold to the secondary market from approximately $14,775,000 in the second quarter of 2004 to approximately $9,960,000 for the second quarter of 2005. Other noninterest income decreased $54,000 or 22.9% due to the receipt in 2004 of a refund of vendor charges that incurred in prior years. Noninterest expense increased $1,270,000 or 25.4% to $6,261,000 for the second quarter of 2005 compared to $4,991,000 for the second quarter of 2004. Approximately $1,001,000 of the increase in noninterest expense is attributed to the acquisition of Bank 10. Excluding costs associated with the acquisition, salaries and benefits increased $93,000 or 3.3%, occupancy expense increased $42,000 or 14.7%, advertising and promotion increased $14,000 or 8.8%, legal, examination, and professional fees increased $44,000 or 16.4%, and other noninterest expense increased $76,000 or 9.6%. 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 and benefit consulting. The increase in other noninterest expense is primarily in the area of data processing expense with smaller increases in various other categories. Income taxes as a percentage of earnings before income taxes as reported in the condensed consolidated financial statements were 30.5% for the second quarter of 2005 compared to 32.5% for the second 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 as well as a reduction in the tax accrual rate to reflect the anticipated effective rate for the current year. SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 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 $1,622,000 or 11.65% to $15,548,000 or 3.34% of average earning assets for the six months of 2005 compared to $13,926,000 or 3.38% of average earning assets for the same period of 2004. The provision for loan losses was $473,000 and $446,000 for the six months ended June 30, 2005 and 2004 respectively. 24
Noninterest income and noninterest expense for the six-month periods ended June 30, 2005 and 2004 were as follows: (DOLLARS EXPRESSED IN THOUSANDS) <TABLE> <CAPTION> SIX MONTHS ENDED JUNE 30, INCREASE (DECREASE) ------------------- ------------------- 2005 2004 AMOUNT % ------- ------- --------- ------ <S> <C> <C> <C> <C> NONINTEREST INCOME Service charges on deposit accounts $ 1,700 $ 1,520 $ 180 11.8 % Trust department income 430 371 59 15.9 Brokerage income 91 41 50 122.0 Gain on sales and calls of debt securities - 2 (2) (100.0) Mortgage loan servicing fees, net 217 214 3 1.4 Gain on sale of mortgage loans 307 462 (155) (33.5) Other 384 387 (3) (0.8) ------- ------- ------- ------ $ 3,129 $ 2,997 $ 132 4.4 % ======= ======= ======= ====== NONINTEREST EXPENSE Salaries and employee benefits $ 6,320 $ 5,576 $ 744 13.3 % Occupancy expense 676 551 125 22.7 Furniture and equipment expense 1,046 943 103 10.9 Advertising and promotion 358 242 116 47.9 Postage, printing and supplies 419 387 32 8.3 Legal, examination, and professional fees 584 432 152 35.2 Other 1,833 1,532 301 19.6 ------- ------- ------- ------ $11,236 $ 9,663 $ 1,573 16.3 % ======= ======= ======= ====== </TABLE> Noninterest income increased $132,000 or 4.4% to $3,129,000 for the six months of 2005 compared to $2,997,000 for the same period of 2004. $297,000 additional noninterest income resulted from the acquisition of Bank 10. Excluding noninterest income associated with the acquisition, service charge income decreased $90,000 or 5.9%. This reflects a decrease in the amount of insufficient check fees collected by our banks. Trust department income increased $59,000 or 15.9% when compared to the same period in 2004 due primarily to a large distribution fee collected during the quarter. The $50,000 or 122.0% increase in brokerage income reflects higher sales volume during the second quarter of 2005 compared to 2004. Gain on sales of mortgage loans decreased $155,000 or 33.5% due to a decrease in volume of loans originated and sold to the secondary market from approximately $27,807,000 in the first six months of 2004 to approximately $19,078,000 for the first six months of 2005. 25
Noninterest expense increased $1,573,000 or 16.3% to $11,236,000 for the first six months of 2005 compared to $9,663,000 for the same period of 2004. Approximately $1,001,000 of the increase in noninterest expense is attributed to the acquisition of Bank 10. Excluding costs associated with the acquisition, salaries and benefits increased $197,000 or 3.5%, occupancy expense increased $66,000 or 12.0%, furniture and equipment expense increased $47,000 or 5.0%, advertising and promotion increased $85,000 or 35.1%, legal, examination, and professional fees increased $131,000 or 30.3%, and other noninterest expense increased $65,000 or 4.2%. 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 and benefit consulting. The increase in other noninterest expense is primarily in the area of data processing expense with smaller increases in various other categories. Income taxes as a percentage of earnings before income taxes as reported in the condensed consolidated financial statements were 30.4% for the first six months of 2005 compared to 31.9% 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 as well as a reduction in the tax accrual rate to reflect the anticipated effective rate for the current year. NET INTEREST INCOME Fully taxable equivalent net interest income increased $1,322,000 or 19.00% and $1,622,000 or 11.65% respectively for the three and six month periods ended June 30, 2005 compared to the same period in 2004. The increase in net interest income for the periods ended June 30, 2005 compared to the period ended June 30, 2004 was the result of increased earning assets. 26
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 June 30, 2005 and 2004. (DOLLARS EXPRESSED IN THOUSANDS) <TABLE> <CAPTION> THREE MONTHS ENDED THREE MONTHS ENDED JUNE 30, 2005 JUNE 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 $ 259,540 $ 4,131 6.38 % $ 224,742 $ 3,124 5.58 % Real estate 438,531 6,958 6.36 329,415 4,605 5.61 Consumer 36,724 767 8.38 37,164 768 8.29 Investment securities:(3) U.S Treasury and U.S. Gov't Agencies 176,832 1,345 3.05 188,065 1,058 2.26 State and municipal 42,077 579 5.52 30,783 459 5.98 Other 6,929 73 4.23 5,227 40 3.07 Federal funds sold 32,482 233 2.88 22,531 82 1.46 Interest-bearing deposits 758 5 2.65 1,832 3 0.66 ------------- ---------- --------- ---------- Total interest earning assets 993,873 14,091 5.69 839,759 10,139 4.84 All other assets 104,323 76,285 Allowance for loan losses (8,754) (8,554) ------------- --------- Total assets $ 1,089,442 $ 907,490 ============= ========= LIABILITIES AND STOCKHOLDERS' EQUITY NOW accounts $ 131,880 $ 430 1.31 % $ 118,934 $ 173 0.58 % Savings 56,792 81 0.57 57,658 82 0.57 Money market 141,731 826 2.34 77,577 228 1.18 Deposits of $100 and over 104,956 812 3.10 84,841 456 2.16 Other time deposits 292,308 2,110 2.90 248,912 1,439 2.32 ------------- ---------- --------- ---------- Total time deposits 727,667 4,259 2.35 587,922 2,378 1.62 Federal funds purchased and securities sold under agreements to repurchase 47,550 316 2.67 74,852 188 1.01 Interest-bearing demand notes to US Treasury 760 5 2.64 819 2 0.98 Subordinated debentures 49,486 746 6.05 4,248 253 3.91 Other borrowed money 47,907 485 4.06 53,037 360 4.61 ------------- ---------- --------- ---------- Total interest-bearing liabilities 873,370 5,811 2.67 720,878 3,181 1.77 Demand deposits 116,491 90,166 Other liabilities 6,293 5,980 ------------- --------- Total liabilities 996,154 817,024 Stockholders' equity 93,288 90,466 Total liabilities and ------------- --------- stockholders' equity $ 1,089,442 $ 907,490 ============= ========= Net interest income $ 8,280 $ 6,958 ========== ========== Net interest margin(4) 3.34 % 3.32 % ==== ==== </TABLE> (1) Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate. Such adjustments were $204,000 in 2005 and $155,000 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. 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 six month periods ended June 30, 2005 and 2004. <TABLE> <CAPTION> SIX MONTHS ENDED SIX MONTHS ENDED JUNE 30, 2005 JUNE 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 $ 254,717 $ 7,888 6.24 % $ 218,935 $ 6,080 5.57 % Real estate 396,245 12,303 6.26 328,469 9,253 5.65 Consumer 36,748 1,432 7.86 38,601 1,507 7.83 Investment securities:(3) U.S Treasury and U.S. Gov't Agencies 167,937 2,466 2.96 177,853 2,075 2.34 State and municipal 38,084 1,072 5.68 29,871 923 6.20 Other 6,302 131 4.19 4,709 69 2.94 Federal funds sold 36,185 486 2.71 24,194 145 1.20 Interest-bearing deposits 1,869 21 2.27 2,436 10 0.82 ------------- ---------- --------- ---------- Total interest earning assets 938,087 25,799 5.55 825,068 20,062 4.88 All other assets 91,614 75,539 Allowance for loan losses (8,185) (8,446) ------------- --------- Total assets $ 1,021,516 $ 892,161 ============= ========= LIABILITIES AND STOCKHOLDERS' EQUITY NOW accounts $ 128,780 $ 785 1.23 % $ 119,543 $ 345 0.58 % Savings 53,627 152 0.57 57,174 162 0.57 Money market 133,525 1,471 2.22 73,150 372 1.02 Deposits of $100 and over 97,788 1,432 2.95 86,461 930 2.16 Other time deposits 272,355 3,770 2.79 250,980 2,948 2.36 ------------- ---------- --------- ---------- Total time deposits 686,075 7,610 2.24 587,308 4,757 1.62 Federal funds purchased and securities sold under agreements to repurchase 48,256 584 2.44 73,086 356 0.98 Interest-bearing demand notes to US Treasury 711 8 2.27 643 2 0.62 Subordinated debentures 39,660 1,150 5.85 4,248 294 3.91 Other borrowed money 43,693 899 4.15 42,856 727 4.55 ------------- ---------- --------- ---------- Total interest-bearing liabilities 818,395 10,251 2.53 708,141 6,136 1.74 Demand deposits 104,452 88,182 Other liabilities 5,667 6,027 ------------- --------- Total liabilities 928,514 802,350 Stockholders' equity 93,002 89,811 Total liabilities and ------------- --------- stockholders' equity $ 1,021,516 $ 892,161 ============= ========= Net interest income $ 15,548 $ 13,926 ========== ========== Net interest margin(4) 3.34 % 3.38 % ==== ==== </TABLE> (1) Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate. Such adjustments were $385,000 in 2005 and $316,000 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, 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 JUNE 30, 2005 COMPARED TO THREE MONTHS ENDED JUNE 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 $ 1,007 520 487 Real estate (2) 2,353 1,671 682 Consumer (1) (9) 8 Investment securities:(3) U.S Treasury and U.S. Gov't Agencies 287 (66) 353 State and municipal (2) 120 157 (37) Other 33 15 18 Federal funds sold 151 47 104 Interest-bearing deposits 2 (3) 5 ------------ ----- ----- Total interest income 3,952 2,332 1,620 INTEREST EXPENSE: NOW accounts $ 257 21 236 Savings (1) (1) - Money market 598 274 324 Deposits of $100 and over 356 125 231 Other time deposits 671 277 394 Federal funds purchased and securities sold under agreements to repurchase 128 (90) 218 Interest-bearing demand notes of U.S. Treasury 3 - 3 Subordinated debentures 493 308 185 Other borrowed money 125 171 (46) ------------ ----- ----- Total interest expense 2,630 1,085 1,545 ------------ ----- ----- Net interest income on a fully taxable equivalent basis $ 1,322 1,247 75 ============ ===== ===== </TABLE> (1) Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate. Such adjustments were $204,000 in 2005 and $155,000 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. 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> SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 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 $ 1,808 1,061 747 Real estate (2) 3,050 2,039 1,011 Consumer (75) (72) (3) Investment securities:(3) U.S Treasury and U.S. Gov't Agencies 391 (121) 512 State and municipal (2) 149 237 (88) Other 62 27 35 Federal funds sold 341 97 244 Interest-bearing deposits 11 (2) 13 ------------ ----- ----- Total interest income 5,737 3,266 2,471 INTEREST EXPENSE: NOW accounts $ 440 29 411 Savings (10) (10) - Money market 1,099 455 644 Deposits of $100 and over 502 134 368 Other time deposits 822 266 556 Federal funds purchased and securities sold under agreements to repurchase 228 (155) 383 Interest-bearing demand notes of U.S. Treasury 6 - 6 Subordinated debentures 856 658 198 Other borrowed money 172 245 (73) ------------ ----- ----- Total interest expense 4,115 1,622 2,493 ------------ ----- ----- Net interest income on a fully taxable equivalent basis $ 1,622 1,644 (22) ============ ===== ===== </TABLE> (1) Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate. Such adjustments were $385,000 in 2005 and $316,000 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
LENDING AND CREDIT MANAGEMENT Interest earned on the loan portfolio is a primary source of interest income for our Company. Net loans represented 66.9% of total assets as of June 30, 2005 compared to 68.1% as of December 31, 2004 and 65.3% as of June 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 June 30, 2005, our Company was servicing approximately $217,047,000 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 what loans should be considered to be "impaired". 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. The allowance for loan losses was decreased by net loan charge-offs of $2,000 and $48,000 for the first and second quarter of 2005 compared to $57,000 and $15,000 for the first and second quarter of 2004. The allowance for loan losses was increased by a provision charged to expense of $236,000 for the first quarter of 2005 and $237,000 for the second quarter of 2005. That compares to a provision of $236,000 for the first quarter of 2004 and $210,000 for the second quarter of 2004. 31
The balance of the allowance for loan losses was $9,336,000 at June 30, 2005 compared to $7,496,000 at December 31, 2004 and $8,641,000 at June 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 1.18% at June 30, 2005 compared to 1.18% at December 31, 2004 and 1.45% at June 30, 2004. Nonperforming loans, defined as loans on nonaccrual status, loans 90 days or more past due and still accruing, and restructured loans totaled $5,095,000 or 0.65% of total loans at June 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> JUNE 30, 2005 DECEMBER 31, 2004 ---------------------- --------------------- % OF GROSS % OF GROSS BALANCE LOANS BALANCE LOANS ---------- ---------- --------- ---------- <S> <C> <C> <C> <C> Nonaccrual loans: Commercial $ 3,918 0.50% $ 4,213 0.67% Real estate Construction 142 0.02 - - Mortgage 914 0.12 1,246 0.20 Consumer 39 - 30 - ---------- ---- --------- ---- 5,013 0.64 5,489 0.87 ---------- ---- --------- ---- Loans contractual past-due 90 days or more and still accruing: Commercial - - 12 - Real estate Construction - - - - Mortgage 27 - 591 0.09 Consumer 55 0.01 - - ---------- ---- --------- ---- 82 0.01 603 0.09 ---------- ---- --------- ---- Restructured loans - - - - ---------- ---- --------- ---- Total nonperforming loans 5,095 0.65% 6,092 0.96% ==== ==== Other real estate 512 30 Repossessions - 42 ---------- --------- Total nonperforming assets $ 5,607 $ 6,164 ========== ========= </TABLE> The allowance for loan losses was 183.24% of nonperforming loans at June 30, 2005 compared to 123.05% of nonperforming loans at December 31, 2004. There has been no material change in the overall level of nonperforming assets since the prior year-end. 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 June 30, 2005 and 2004, which would have been recorded under the original terms of those loans, was approximately $370,000 and $243,000 for the six months ended June 30, 2005 and 2004, respectively. Approximately $8,000 32
and $38,000 was actually recorded as interest income on such loans for the six months ended June 30, 2005 and 2004, respectively. 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. The nonaccrual loans included in the table above were the only loans that management has identified as impaired at June 30, 2005. The average balance of nonaccrual loans for the first six months of 2005 was approximately $5,632,000. At June 30, 2005 the portion of the allowance for loan losses allocated to specific impaired loans was $1,486,000 compared to $1,681,000 at December 31, 2004. The balance of impaired loans with specific loan loss allocations was approximately $5,014,000 at June 30, 2005 compared to $5,501,000 at December 31, 2004. As of June 30, 2005 and December 31, 2004 approximately $12,085,000 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 special mention. However, the loans are well secured and performing in accordance with the terms of the loan agreement. In addition to the classified list, our Company also maintains an internal loan watch list of loans, which for various reasons, not all related to credit quality, management is monitoring more closely than the average loan 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 statistical loss factors and other risk indicators to pools of loans by asset type. These expected loss estimates are sensitive to changes in delinquency status, realizable value of collateral, and other risk factors. The underlying assumptions, estimates and assessments used by management to determine these 33
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 June 30, 2005, management allocated $7,704,000 of the $9,336,000 total allowance for loan losses to specific loans and loan categories and $1,632,000 was unallocated. Considering the size of several of our Company's lending relationships and the loan portfolio in total, management believes that the June 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 $242,543,000 or 26.25% to $1,166,418,000 at June 30, 2005 compared to $923,874,000 at December 31, 2004. Total liabilities increased $239,775,000 or 28.82% to $1,071,878,000. Stockholders' equity increased $2,769,000 or 3.02% to $94,540,000. 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 $153,112,000 to $789,748,000 at June 30, 2005 compared to $636,636,000 at December 31, 2004. Approximately $129,804,000 of the increase in loans reflects loans of Bank 10. Excluding loans acquired in the acquisition, commercial loans increased $9,096,000; real estate construction loans increased $21,805,000; real estate mortgage loans decreased $5,032,000; and consumer loans decreased $2,563,000. 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 commercial finance market. The decrease in consumer loans was also due to the payoff of one very large personal consumer credit. Investment in debt and equity securities classified as available-for-sale increased $44,876,000 or 26.13% to $216,593,000 at June 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 the increase reflects securities of Bank 10. During 2005 the market valuation account decreased $504,510 to $101,000 to reflect the fair value of available-for-sale investments at June 30, 2005 and the net after tax decrease resulting from the change in the market valuation adjustment of $327,000 decreased the stockholders' equity component to $66,000 at June 30, 2005. 34
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 $14,289,000 or 21.75% to $79,997,000 at June 30, 2005 compared to $65,708,000 at December 31, 2004. Approximately $14,145,000 represents cash and cash equivalents of Bank 10. Further discussion of this decrease may be found in the section of this report titled "Sources and Uses of Funds". Premises and equipment increased $9,403,000 or 44.20% to $30,679,000 at June 30, 2005 compared to $21,276,000 at December 31, 2004. The increase reflects $7,119,000 of premises and equipment acquired with Bank 10 and purchases of premises and equipment of $3,127,000 offset by depreciation expense of $842,000. The purchase of premises and equipment primarily reflects construction costs and equipment purchases for two additional branches. Goodwill increased $13,893,000 or 55.14% to 39,090,000 at June 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 $4,299,000 or 538.59% to $5,096,826 at June 30, 2005 compared to $798,132 at December 31, 2004. The increase reflects an estimated core deposit intangible of $4,500,000 recorded as part of the Bank 10 acquisition. This intangible asset will be amortized on an accelerated basis over an estimated life of eight years and is subject to a final valuation study. Additional discussion of intangible assets can be found in the "Intangible Assets" section that follows. Total deposits increased $191,478,000 or 26.35% to $918,128,000 at June 30, 2005 compared to $726,649,000 at December 31, 2004. $151,966,000 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 $9,377,000 or 27.17% to $43,892,000 at June 30, 2005 compared to $34,515,000 at December 31, 2004. $1,009,000 represents securities sold under agreements to repurchase of Bank 10. The balance represents an increase in public fund deposits. Subordinated notes increased $23,712,000 at June 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 fund the acquisition of Bank 10. Other borrowed money increased $12,966,000 or 32.80% to $52,491,000 at June 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 or Federal Home Loan Bank advances. 35
The increase in stockholders' equity reflects net income of $4,582,000 less dividends declared of $1,501,000 and ($327,000) 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 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 June 30, 2005, the amounts of available credit from the FHLB totaled $123,659,000. As of June 30, 2005, the Banks had $52,491,000 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 June 30, 2005. 36
SOURCES AND USES OF FUNDS For the six months ended June 30, 2005 and 2004, net cash provided by operating activities was $6,782,000 and $7,147,000, respectively. Net cash used in investing activities was $65,119,000 in 2005 versus $42,694,000 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 $21,799,000. Net cash provided by financing activities was $72,626,000 in 2005 versus $22,597,000 in 2004. Increases in deposits accounted for approximately $42,200,000 of the cash provided by financing activities in 2005 and approximately $10,795,000 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 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 $8,371,000 in 2005 compared to a $10,000,000 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 new 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, and SFAS No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations. 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 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, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. Securities in scope are those subject to SFAS 115 and SFAS 124. 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 issuing 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 Consensus that provides guidance for determining whether an investment's impairment is other than temporary and should be 37
recognized in income. The approved delay will apply 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. 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. SOP 03-3 did not have a material effect on our Company's financial statements. 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 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 June 15, 2005 and will be effective for our Company as of January 1, 2006. See the note to consolidated financial statements titled Earnings per Share for the pro forma net income and net income per share amounts for the quarters ended June 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. 38
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 June 30, 2005, the rate shock scenario models indicated that annual net interest income could decrease or increase by as much as 13% should interest rates rise or fall, respectively, within 200 basis points from their current level over a one year period compared to a like amount 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 June 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. There has been no change in our Company's internal control over financial reporting that occurred during the fiscal quarter ended June 30, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 39
PART II - OTHER INFORMATION 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 At the annual meeting of the shareholders of Exchange National Bancshares, Inc. held on June 8, 2005, the shareholders elected three Class I directors, namely, Charles G. Dudenhoeffer, Jr., Phil D. Freeman, and James E. Smith, to serve terms expiring at the annual meeting of shareholders in 2008 and ratified the Board of Directors selection of KPMG LLP as the Company's independent registered public accounting firm for the year ending December 31, 2005. Class III Directors, namely, Kevin Riley and David Turner, and Class II directors, namely, David R. Goller, James R. Loyd, and Gus S. Wetzel, II, continue to serve terms expiring at the annual meetings of shareholders in 2007 and 2006, respectively. The following is a summary of votes cast. No broker non-votes were received. <TABLE> <CAPTION> Withhold Authority For Against Abstentions --------- --------- ----------- <S> <C> <C> <C> Election of Directors: Charles Dudenhoeffer 3,428,000 33,984 N/A Phil Freeman 3,454,041 7,943 N/A James Smith 3,159,527 302,457 N/A Ratification of KPMG LLP as independent registered public accounting firm 3,364,294 59,765 37,925 </TABLE> Item 5. Other Information None 40
Item 6. Exhibits <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> 41
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. Date /s/ James E. Smith ----------------------------------------------- August 9, 2005 James E. Smith, Chairman of the Board and Chief Executive Officer (Principal Executive Officer) /s/ Richard G. Rose ----------------------------------------------- August 9, 2005 Richard G. Rose, Treasurer (Principal Financial Officer and Principal Accounting Officer) 42
EXCHANGE NATIONAL BANCSHARES, INC. INDEX TO EXHIBITS June 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 44 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certificate of the Chief Financial Officer of our Company 45 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certificate of the Chief Executive Officer of our Company 46 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certificate of the Chief Financial Officer of our Company 47 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 </TABLE> - -------------- ** Incorporated by reference. 43