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AMERIANA BANCORP – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Who We Are
Ameriana Bancorp (the "Company") is anIndiana chartered bank holding company organized in 1987 byAmeriana Bank (the "Bank"). The Company is subject to regulation and supervision by theFederal Reserve Bank . The Bank began banking operations in 1890. InJune 2002 , the Bank converted to anIndiana savings bank and adopted the name,Ameriana Bank and Trust , SB. InJuly 2006 , the Bank closed its Trust Department and adopted the name "Americana Bank , SB." OnJune 1, 2009 , the Bank converted to anIndiana commercial bank and adopted its present name, "Americana Bank ." The Bank is subject to regulation and supervision by theFDIC (the "FDIC"), and theIndiana Department of Financial Institutions (the "DFI"). Our deposits are insured to applicable limits by theDeposit Insurance Fund administered by theFDIC . References in this Form 10-K to "we," "us," and "our" refer toAmeriana Bancorp and/or the Bank, as appropriate. We are headquartered inNew Castle, Indiana . We conduct business through our main office at2118 Bundy Avenue ,New Castle, Indiana , through 12 branch offices located inNew Castle ,Middletown ,Knightstown ,Morristown ,Greenfield ,Anderson ,Avon ,McCordsville ,Fishers ,Carmel ,Westfield and <location value="LU/us.in.newine" idsrc="xmltag.org">New Palestine, Indiana, and through our loan production office inCarmel, Indiana . InDecember 2011 , lending personnel were relocated from theCarmel loan production office to the Bank'sIndianapolis metropolitan area banking centers. The Bank does not plan to renew theCarmel loan production office lease when it expires in June. The Bank has two wholly-owned subsidiaries,Ameriana Insurance Agency ("AIA") andAmeriana Financial Services, Inc. ("AFS"). AIA provides insurance sales from offices inNew Castle ,Greenfield andAvon, Indiana . OnJuly 1, 2009 , AIA purchased the book of business ofChapin-Hayworth Insurance Agency Inc. located inNew Castle, Indiana . AFS had offered insurance products through its ownership of an interest inFamily Financial Life Insurance Company ("Family Financial"),New Orleans, Louisiana , which offers a full line of credit-related insurance products. OnMay 22, 2009 , the Company announced that AFS had liquidated its 16.67% interest in Family Financial, and recorded a pre-tax gain of$192,000 from the transaction. AFS also operates a brokerage facility in conjunction withLPL Financial that provides non-bank investment product alternatives to its customers and the general public. A third Bank subsidiary,Ameriana Investment Management, Inc. ("AIMI"), had managed part of the Company's investment portfolio. Following a cost/benefit analysis, AIMI was liquidated effectiveDecember 31, 2009 , and the portfolio under management was transferred to the Bank. The Company holds a minority interest in a limited partnership, House Investments, organized to acquire and manage real estate investments which qualify for federal tax credits.
What We Do
The Bank is a community-oriented financial institution. Our principal business consists of attracting deposits from the general public and investing those funds primarily in mortgage loans on single-family residences, multi-family loans, construction loans, commercial real estate loans, and, to a lesser extent, commercial and industrial loans, small business loans, home improvement loans, and consumer loans. We have from time to time purchased loans and loan participations in the secondary market. We also invest in various federal and government agency obligations and other investment securities permitted by applicable laws and regulations, including mortgage-backed, municipal and equity securities. We offer customers in our market area time deposits with terms from three months to seven years, interest-bearing and noninterest-bearing checking accounts, savings accounts and money market accounts. Our primary source of borrowings is FHLB advances. Through our subsidiaries, we engage in insurance and investment and brokerage activities. Our primary source of income is net interest income, which is the difference between the interest income earned on our loan and investment portfolios and the interest expense incurred on our deposits and borrowing portfolios. Our loan portfolio typically earns more interest than the investment portfolio, and our deposits typically have a lower average rate than FHLB advances. Several factors affect our net interest income. These factors include the loan, investment, deposit, and borrowing portfolio balances, their composition, the length of their maturity, re-pricing characteristics, liquidity, credit, and interest rate risk, as well as market and competitive conditions. 36
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Financial Challenges and Expansion in Recent Years
To diversify the balance sheet and provide new avenues for loan and deposit growth, the Bank further expanded intoIndianapolis , adding three full-service offices in 2008 and 2009 in the suburban markets ofCarmel ,Fishers andWestfield . As a result, half of the banking centers are located inIndianapolis . These banking centers are focused on generating commercial lending and relationship business, where significant opportunities exist to win market share from smaller institutions lacking capital strength and resources, and large institutions that have concentrated on large business customers. Although the expansion strategy initially negatively affected earnings, the Bank's expansion into new markets is critical for its long-term sustainable growth. Additional expansion inIndianapolis , including construction of a new full-service banking center inPlainfield on property purchased by the Bank in early 2008, was put on hold primarily due to the economic environment. The economic climate became progressively difficult through most of 2008, as the world-wide financial crisis reached a peak in the second half of the year, and the subsequent economic recovery moved slowly through 2011. The severity of this environment and its consequences to the industry created many new formidable challenges for bankers. Executive Overview of 2011 The Company recorded net income of$1.1 million , or$0.38 per share, for 2011, compared to net income of$553,000 , or$0.19 per share, for 2010. The results for 2011 reflected an improvement in net interest income, but the Bank continued to be negatively impacted by high credit costs related to weak economic conditions, which were partly offset by gains realized on sales of investment securities. Following is additional summary information for the year: • Consistent with its capital contingency plan, the Company paid only a de minimis quarterly dividend of$0.01 per share, or$0.04 per share for the year. • The Company's tangible common equity ratio atDecember 31, 2011 was 7.73%. • AtDecember 31, 2011 , the Bank's tier 1 leverage ratio
was 9.23%, the tier 1 risk-based capital ratio was 12.32%, and the total risk-based capital ratio was 13.58%. All three ratios were considerably above the levels required under regulatory guidelines to be considered "well capitalized," and exceeded the higher standards established by the Board resolution addressed below. • A$485,000 , or 3.6% increase for 2011 in net interest income on a fully tax-equivalent basis was achieved with growth of only 0.6% in average earnings assets, as the net interest margin of 3.74% represented an 11 basis points improvement over 2010. The net interest margin improvement resulted mostly from a significant reduction in the Bank's average cost of deposits. • The Bank recorded a$1.4 million provision for loan
losses in 2011
compared to a$1.9 million provision in 2010 due to a
continuing,
but reduced elevated level of charge-offs and
non-performing loans
that resulted from weak economic conditions. • Total nonperforming loans of$8.8 million , or 2.79% of total loans atDecember 31, 2011 , represented a$2.4 million decrease from$11.2 million , or 3.54% of total loans atDecember 31, 2010 . • The allowance for loan losses was$4.1 million , or 1.30% of total loans atDecember 31, 2011 , compared with$4.2 million , or 1.33% of total loans atDecember 31, 2010 . • Other income of$5.6 million for 2011 was$22,000 lower than the total for the prior year. 37
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• The total for 2011 was reduced by a$1.0 million net loss from sales and write-downs of other real estate owned, that was$668,000 greater than the net loss for 2010, but 2011 benefited from$919,000 in gains on sales of investment securities, a$616,000 increase over 2010. • Gains on sales of loans and servicing rights of$225,000 for 2011 were$698,000 less than the total for 2010 that included a$560,000 gain from a bulk sale of$10.9 million of seasoned performing residential mortgage loans. • The 2011 totals for fees and service charges on
deposit accounts
and brokerage and insurance commissions reflected improvements over 2010 of 6.8% and 11.5%, respectively. • Other expense for 2011 of$17.0 million was$187,000 , or 1.1%, higher than 2010. • The 2011 total included a$135,000 increase in salaries and employee benefits that resulted primarily from higher incentive awards related to achievement of production goals, and a$124,000 increase in funding costs for the frozen
multi-employer
defined benefit retirement plan, partly offset by an$84,000 decrease in employee health insurance expense. • The Company had income before income taxes of $1.2
million for
2011, but recorded an income tax expense of only$21,000 ,
which was
due primarily to a significant amount of tax-exempt
bank-owned life
insurance.
The Company's total assets of
• Net loans receivable were$312.5 million atDecember 31, 2011 , a decrease of$206,000 from$312.7 million at the end of 2010. The lack of growth was due primarily to limited loan demand resulting from continuing weak economic conditions in the markets the Bank serves. • The composition of the portfolio changed in 2011, with a$5.5 million increase in commercial real estate loans and a$8.6 million increase in commercial loans, while the totals for residential real estate loans, construction loans, municipal loans and consumer loans all declined during the year. • Reflective of a low interest rate environment coupled with competitive pricing pressures, the 5.59% average yield on the loan portfolio for 2011 represented a 25 basis points decrease from 5.84% for 2010. • The$5.2 million growth in the investment securities portfolio during 2011 to$43.8 million resulted primarily from a$4.9 million increase in mortgage-backed securities to$39.7 million , or 90.6%, of the portfolio. • Other real estate owned of$7.5 million atDecember 31, 2011 represented a decrease of$1.5 million fromDecember 31, 2010 , with the addition of fourteen properties totaling$3.3 million , the sale of twelve properties with a total book value of$3.6 million , and$1.2 million in write-downs during the year. • Total deposits of$337.3 million atDecember 31, 2011 represented a decrease of$728,000 for the year, due to the elimination of all brokered certificates of deposit, which totaled$10.4 million at the prior year end. The Bank also experienced a significant change in the mix of deposits from the prior year end. Non-maturity deposits increased$21.8 million , or 13.2%, to$187.0 million , while certificates of deposit declined$22.5 million , or 13.0%, to$150.3 million . 38
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• The Bank achieved a 26 basis points reduction in the weighted average cost of total deposits to 0.79% atDecember 31, 2011 from 1.05% at the end of 2010. • Total borrowings were reduced by$2.0 million in 2011 to$49.8 million , or 14.8% of total deposits.
Regulatory Action
OnDecember 17, 2009 , following an off-site review by the Federal Reserve Bank ofChicago , the Board of Directors of the Company adopted a resolution agreeing to, among other things, seek and obtain the approval of theFederal Reserve Bank at least thirty days before taking any of the following actions: • The payment of corporate dividends; • The payment of interest on trust preferred securities beginning after the
interest payment dueDecember 15, 2009 ;
• Any increase in debt or issuance of trust preferred obligations; and
• The redemption of Company stock. OnJuly 26, 2010 , following a joint examination by and discussions with theFDIC and theIndiana Department of Financial Institutions , the Board of Directors of the Bank adopted a resolution agreeing to, among other things:
• Adopt a capital plan to increase its Tier 1 Leverage Ratio to 8.50% by
• Adopt a written plan to lower classified assets; • Formulate and implement a written profit plan;
• Receive prior written consent from the
Financial Institutions before declaring or paying any dividends; • Strive to reduce total holdings of bank-owned life insurance; and
• Furnish quarterly progress reports regarding the Bank's compliance with
all provisions of the resolution.
The Bank is currently in compliance with the provisions of the resolution.
Strategic Summary
The current economic downturn has created a challenging operating environment for all businesses, and, in particular, the financial services industry. Earnings pressure is expected to continue as the weak economy continues to cause stress on credit quality. Deposit acquisition continues to be competitive; however, the Bank's disciplined pricing has resulted in a significant reduction in its cost of deposits. The Bank's pricing strategies, combined with the low interest rate environment, has positively impacted interest rate spread and net interest income. Reducing noninterest expense has been a priority of Management, and the Bank has reduced noninterest expense through aggressive cost control measures including freezing hiring, job restructuring and eliminating certain discretionary expenditures. With the Bank's mantra of "Soundness. Profitability. Growth - in that order, no exceptions," the priorities, culture and risk strategy of the Bank are focused on asset quality and credit risk management. Despite the current economic pressures, as well as the industry's challenges related to compliance and regulatory requirements, tightened credit standards, and capital preservation, Management remains cautiously optimistic that business conditions will improve over the longer term and is steadfast in the belief that the Company is well positioned to grow and enhance shareholder value as this recovery occurs. 39
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With a community banking history stretching back over 120 years, the Bank has built its strong reputation with community outreach programs and being a workplace of choice. By combining its rich tradition with its ability to provide its customers with financial advice and solutions, the Bank will accomplish its mission by:
• being our customer's first choice for financial advice and solutions;
• informing and educating customers on the basics of money management; and
• understanding and meeting customer's financial needs
throughout
their life cycle. Serving customers requires the commitment of allAmeriana Bank associates to provide exceptional service and sound financial advice. We believe these qualities will differentiate us from our competitors and increase profitability and shareholder value.
To meet these long-term goals, we have undertaken the following strategies:
Build Relationships with Our Customers. Banking is essentially a transaction business. Nevertheless, numerous industry studies have shown that customers want a relationship with their bank and banker based on trust and sound advice. Based on this information, we are focusing our efforts on expanding customer relationships and improving our products and services per household. Achieve Superior Customer Service. Programs and initiatives have been implemented to deliver value-added services and amenities to support our corporate strategy andBrand Promise , which speak to our commitment to our customers. Customer satisfaction surveys are conducted after a new account is opened. Our evaluations include telephone as well as in-person surveys with both consumer loans and deposit customers, as well as other in-store performance metrics. We have enhanced our efforts to improve our customer service by developing a 3-Year Training and Development Plan and formalizing our service standards and job performance evaluations. Develop and Deliver Fully Integrated Financial Advice and Comprehensive Solutions to Meet Customer Life Events. The Bank's retail banking business has a full range of banking products, as well as affiliated insurance, brokerage and asset management services. Products and services are packaged and recommended around customer needs and "life events" such as planning for retirement, buying a home and saving for college education rather than traditional transaction accounts, savings and consumer loan products. Establish Strong Brand Awareness. We believe it is important to create a value proposition that is relevant, understood and valued by our customers. To differentiate the Bank among its competitors and support its premium service brand, Ameriana developed a brand strategy which surrounds the customer with 360 Degrees of Service. New logo, signage, facility design, web design, service training, marketing and public relations efforts were developed to support the brand strategy and brand concepts. Use Technology to Expand Our Customer Base. Ameriana utilizes a fully integrated, real-time information technology platform. We continuously seek opportunities to enhance our electronic delivery of products and services to our customers, and the Bank's technology plan has included upgrades to our ancillary support systems, such as business sweep products, cash management services, business remote item capture and on-line mortgage loan applications. In addition, the Bank has introduced mobile banking, mobile check deposit, FinanceWorks™ and other technology to remain competitive in its markets. Develop an Innovative Delivery System. We believe our banking centers must evolve into "Financial Stores" that showcase our financial products and offer our customers an environment and unique experience that is conducive to interacting with knowledgeableAmeriana Bank associates. Ameriana's strategy focuses on enhancing the customer experience and demonstrating our community banking spirit with value-added services, such as space for community meetings, business and financial planning seminars, community outreach programs and small special interest events. 40
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Increase Market Share in Existing Markets and Expand into New Markets. Tremendous opportunity exists to expand our products and services per household with existing customers, and attract new customers in both our existing and new markets. The Bank's expansion strategy inIndianapolis is well underway as a result of opening three well-situated locations inHamilton County in 2008 and 2009, located just north ofMarion County andIndianapolis . In addition, the Company purchased a site inPlainfield , which will enhance our presence on the west side ofIndianapolis and our existing office inAvon . Construction plans of thePlainfield office have been put on hold until the surrounding retail development is underway. The Bank will continue the strategy of acquiring additional locations for development of full-service banking centers to increase our footprint inMarion County and surroundingIndianapolis metropolitan area and to boost our visibility in this market.
Critical Accounting Policies
The accounting and reporting policies of the Company are maintained in accordance with accounting principles generally accepted inthe United States and conform to general practices within the banking industry. The Company's significant accounting policies are described in detail in the Notes to the Company's Consolidated Financial Statements. The preparation of financial statements in conformity with generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions, and such estimates and assumptions are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company's financial condition and results, and they require management to make estimates that are difficult, subjective or complex. Allowance for Loan Losses. The allowance for loan losses provides coverage for probable losses in the Company's loan portfolio. Management evaluates the adequacy of the allowance for credit losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management's estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge-offs. The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for noncommercial loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences and historical losses, adjusted for current trends, for each loan category or group of loans. The allowance for loan losses relating to impaired loans is based on the loan's observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan's effective interest rate. Regardless of the extent of the Company's analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors, including inherent delays in obtaining information regarding a customer's financial condition or changes in their unique business conditions, the subjective nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger, nonhomogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company's evaluation of risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment. Mortgage Servicing Rights. Mortgage servicing rights ("MSRs") associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising 41
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from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets. Valuation Measurements. Valuation methodologies often involve a significant degree of judgment, particularly when there are no observable active markets for the items being valued. Investment securities and residential mortgage loans held for sale are carried at fair value, as defined by FASB fair value guidance, which requires key judgments affecting how fair value for such assets and liabilities is determined. In addition, the outcomes of valuations have a direct bearing on the carrying amounts for goodwill and intangible assets. To determine the values of these assets and liabilities, as well as the extent to which related assets may be impaired, management makes assumptions and estimates related to discount rates, asset returns, prepayment rates and other factors. The use of different discount rates or other valuation assumptions could produce significantly different results, which could affect the Company's results of operations. Income Tax Accounting. We file a consolidated federal income tax return. The provision for income taxes is based upon income in our consolidated financial statements. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on our deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date. Under U.S. GAAP, a valuation allowance is required to be recognized if it is "more likely than not" that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax asset is highly subjective and dependent upon judgment concerning our evaluation of both positive and negative evidence, our forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. Positive evidence includes the existence of taxes paid in available carry-back years as well as the probability that taxable income will be generated in future periods, while negative evidence includes any cumulative losses in the current year and prior two years and general business and economic trends. AtDecember 31, 2011 andDecember 31, 2010 , we determined that our existing valuation allowance was adequate, largely based on available tax planning strategies and our projections of future taxable income. Any reduction in estimated future taxable income may require us to increase the valuation allowance against our deferred tax assets. Any required increase to the valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings. Positions taken in our tax returns may be subject to challenge by the taxing authorities upon examination. The benefit of an uncertain tax position is initially recognized in the financial statements only when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that is more likely than not of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. Differences between our position and the position of tax authorities could result in a reduction of a tax benefit or an increase to a tax liability, which could adversely affect our future income tax expense. We believe our tax policies and practices are critical accounting policies because the determination of our tax provision and current and deferred tax assets and liabilities have a material impact our net income and the carrying value of our assets. We believe our tax liabilities and assets are adequate and are properly recorded in the consolidated financial statements atDecember 31, 2011 . 42
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FINANCIAL CONDITION
Total assets increased by$134,000 to$429.8 million atDecember 31, 2011 from$429.7 million atDecember 31, 2010 , as balance sheet growth efforts were limited primarily by economic conditions that resulted in continuing weak loan demand. Cash and Cash Equivalents Cash and cash equivalents decreased$2.0 million to$9.7 million atDecember 31, 2011 from$11.7 million atDecember 31, 2010 . Cash on hand and in other institutions increased$2.5 million , or 68.9%, to$6.2 million atDecember 31, 2011 . This change was primarily due to a$2.3 million increase in our book balance for the noninterest-earning piece of ourFederal Reserve Bank account, which represents electronic deposits not yet credited. Interest-bearing deposits decreased$4.6 million , or 56.6%, to$3.5 million atDecember 31, 2011 , with the totals for both year end dates consisting almost totally of balances with the Federal Reserve Bank ofChicago .
Securities
Investment securities available for sale increased 13.6% to$43.8 million atDecember 31, 2011 from$38.6 million atDecember 31, 2010 . The increase was due primarily to purchases of mortgage-backed securities that exceeded the total for sales and principal repayments on mortgage-backed securities during 2011. Mortgage-backed securities purchases of$55.5 million , mostly offset by principal repayments and sales, resulted in an increase in the total fair value ofGinnie Mae and GSE mortgage-backed pass-through securities of$4.9 million to$39.7 million atDecember 31, 2011 . All mortgage-backed securities atDecember 31, 2011 are insured by eitherGinnie Mae , Fannie Mae or Freddie Mac. AtDecember 31, 2011 , all investments remained classified as available for sale. All of our investments are evaluated for other-than-temporary impairment, and such impairment, if any, is recognized as a charge to earnings. There were no other than temporarily impaired investment securities as ofDecember 31, 2011 . The following table identifies changes in the investment securities carrying values: (Dollars in thousands) 2011 2010 $ Change % ChangeDecember 31 :Ginnie Mae and GSE mortgage-backed pass-through securities $ 39,714 $ 29,436 $ 10,278 34.92 %Ginnie Mae collateralized mortgage obligations - 5,341 (5,341 ) (100.00 ) Municipal securities 2,351 2,164 187 8.64 Mutual funds 1,782 1,667 115 6.90 Totals $ 43,847 $ 38,608 $ 5,239 13.57 % The following table identifies the percentage composition of the investment securities: 2011 2010 2009 December 31:Ginnie Mae and GSE mortgage-backed pass-through securities 90.6 % 76.3 % 69.7 % Ginnie Mae collateralized mortgage obligations - 13.8 16.2 Municipal securities 5.3 5.6 9.6 Mutual funds 4.1 4.3 4.5 Totals 100.0 % 100.0 % 100.0 %
See Note 3 to the Consolidated Financial Statement for more information on investment securities.
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Loans
Net loans receivable totaled$312.5 million atDecember 31, 2011 , a decrease of$206,000 from$312.7 million atDecember 31, 2010 . The lack of portfolio growth was due primarily to the impact of the weak economy on loan demand, coupled with management's decision to sell a significant portion of new single-family mortgage loans in the secondary market. Residential real estate loans decreased$4.9 million to$164.4 million atDecember 31, 2011 , from$169.3 million atDecember 31, 2010 . New production involved a mix of owner-occupied single-family and investment property loans, as well as a blend of products that included both fixed-rate and a small number of variable-rate pricing. During 2011, the Bank originated$30.7 million in non-construction residential real estate loans, including home equity loans, and sold$8.5 million into the secondary market. Additionally, the Bank acquired a$798,000 interest in a participation loan for an apartment complex in theIndianapolis area. Commercial real estate loans increased$5.6 million to$100.1 million atDecember 31, 2011 , from$94.6 million atDecember 31, 2010 . Commercial loans and leases increased$8.6 million to$31.0 million atDecember 31, 2011 from$22.4 million atDecember 31, 2010 . The overall growth in these two categories of commercial loans for 2011 was reflective of greater demand resulting from improvement in the balance sheets of potential borrowers after sustaining the impact of weak economic conditions for several years. Non-construction commercial real estate loans totaling$10.0 million and$8.9 million in other commercial loans were added in 2011, with one purchase for$3.0 million of a loan to a construction company in the oil and gas industry. Construction loans decreased$6.7 million to$18.0 million during 2011, primarily as a result of a reduced emphasis on this product by the Bank that was due mostly to considerations related to the state of the economy. Construction loan originations in 2011 totaled$6.8 million , and included a$3.2 million loan for a medical office building and a$2.0 million loan for a Section 42 low income apartment complex. OnDecember 31, 2011 , the Bank had$740,000 in loans to local municipalities, compared to$2.7 million atDecember 31, 2010 . Municipal loans are usually added through a competitive bid process. New municipal loans totaled$590,000 for 2011. Consumer loans declined$1.1 million to$2.9 million atDecember 31, 2011 from$4.0 million atDecember 31, 2010 . This decrease reflected the impact of the economy on the Bank's lending growth objectives. The Bank originated$1.2 million of consumer loans in 2011. New loan volume in 2011 totaled$61.8 million , including purchases totaling$3.8 million , compared to$79.4 million in 2010 with no purchases. New residential loan originations and purchases, including$2.9 million of construction loans, decreased to$34.3 million in 2011 from$53.0 million in 2010. Commercial loan, commercial real estate, commercial construction and municipal loan additions in 2011 totaled$26.3 million , compared to$24.0 million in 2010. New consumer loans totaled$1.2 million in 2011 compared to$2.4 million in 2010. We generally retain loan servicing on loans sold. Loans we serviced for investors, primarily Freddie Mac, Fannie Mae and the Federal Home Loan Bank ofIndianapolis , totaled approximately$95.7 million atDecember 31, 2011 compared to$115.9 million atDecember 31, 2010 . The decrease was due primarily to weak new loan demand in 2011 that resulted in a net paydown in the Bank's portfolio of serviced one-to four-family residential mortgage loans. Loans sold that we service generate a steady source of fee income, with servicing fees ranging from 0.25% to 0.375% per annum of the loan principal amount.
Credit Quality
Nonperforming loans decreased$2.4 million to$8.8 million atDecember 31, 2011 from$11.2 million atDecember 31, 2010 . The decrease was primarily due to the payoff of two loans totaling$1.6 million on section 42 low income housing tax credit properties. 44
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We recorded net charge-offs of$1.5 million in 2011, compared to net charge-offs of$1.7 million in 2010. Total charge-offs were$1.6 million and$2.0 million in 2011 and 2010, respectively. Total recoveries in 2011 were$95,000 while total recoveries were$244,000 in 2010. The allowance for loan losses as a percent of loans was 1.30% atDecember 31, 2011 and 1.33% atDecember 31, 2010 . The significant reduction in nonperforming loans in the Bank's portfolio during 2011 supports the decrease in the allowance for loans losses to total loans ratio, and as a result of our review of collateral positions and historic loss ratios, management believes that the allowance for loan losses is adequate to cover all incurred and probable losses inherent in the portfolio atDecember 31, 2011 .
Premises and Equipment
Premises and equipment of
Stock in
The
Goodwill
Goodwill of$656,000 atDecember 31, 2011 represented a$7,000 increase fromDecember 31, 2010 and resulted from an acquisition of an insurance business.$457,000 of the total goodwill relates to deposits associated with a banking center acquired onFebruary 27, 1998 , and$199,000 is the result of three separate acquisitions of insurance businesses. The results of the Bank's impairment tests have reflected a fair value for the deposits at this banking center that exceeds the goodwill, and a fair value of the three insurance agency books of business purchased that exceeds the associated goodwill.
Cash Value of Life Insurance
We have investments in life insurance on employees and directors, with a balance or cash surrender value of$26.2 million and$25.4 million , respectively, atDecember 31, 2011 and 2010. The majority of these policies were purchased in 1999. Some policies with lower returns were exchanged in 2007 as part of a restructuring of the program. The nontaxable increase in cash surrender value of life insurance was$836,000 in 2011, compared to$875,000 in 2010.
Other Real Estate Owned
Other real estate owned of$7.5 million atDecember 31, 2011 represented a decrease of$1.5 million fromDecember 31, 2010 , with fourteen additions totaling$3.3 million and twelve sales of properties with an aggregate book value of$3.6 million during 2011. The additions included twelve single-family homes or building lots, a commercial building, and an operating golf course and residential real estate development project with a book value at itsJune 30, 2011 acquisition date of$2.0 million . The sales consisted of eight single-family properties, two commercial properties, the golf course with a book value of$1.1 million that was sold at a$121,000 gain, and an apartment complex with a book value of$1.7 million that was sold at a$72,000 gain. Write-downs of other real estate owned during 2011 totaled$1.2 million , of which$845,000 was related to a strip commercial center and$277,000 to an uncompleted apartment project, with both write-downs due to further deterioration of the property's market value during the year. 45
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Other Assets
Other assets were$9.9 million atDecember 31, 2011 , compared to$11.5 million atDecember 31, 2010 . The decrease of$1.6 million resulted primarily from the receipt of a$676,000 transfer related to the Bank's commercial sweep investment product, and a$612,000 reduction of our prepaidFDIC insurance premiums balance.
Deposits
The following table shows deposit changes by category:
(Dollars in thousands) December 31, 2011 2010 $ Change % Change Noninterest-bearing deposits $ 40,197 $ 34,769 $ 5,428 15.61 % Savings deposits 29,043 28,836 207 0.72 Interest-bearing checking 88,632 77,012 11,620 15.09 Money market deposits 29,084 24,551 4,533 18.46 Certificates $100,000 and more 42,610 44,481 (1,871 ) (4.21 ) Brokered Certificates - 10,363 (10,363 ) (100.00 ) Other certificates 107,684 117,966 (10,282 ) (8.72 ) Totals $ 337,250 $ 337,978 $ (728 ) (0.22 )% Nonmaturity deposits increased$21.8 million , or 13.2%, to$187.0 million atDecember 31, 2011 from$165.2 million atDecember 31, 2010 .$17.0 million of the 2011 increase related to checking accounts, noninterest-bearing and interest-bearing, and included a$1.2 million increase in public funds checking balances. The growth in retail nonmaturity deposits resulted primarily from the Bank's increased focus on sales activities coupled with its banking center expansion strategy, and the reaction of individuals to market conditions related to the depressed economic environment. Non-brokered certificates of deposit decreased$10.3 million , due to certain customers transferring their funds to non-maturity products, coupled with a result of Bank strategies that were designed to not pursue the retention of the more rate sensitive non-core deposits.$10.4 million in brokered certificates of deposit were added inDecember 2010 and an additional$6.1 million during the first two months of 2011, as they were found to be more attractive than other wholesale funding alternatives with regard to cost and collateral considerations.$5.2 million of the brokered certificates of deposit had 2011 maturities and$11.3 million had call options, and they were all subsequently replaced with core deposits in 2011.
Borrowings
Borrowings decreased$2.0 million to$49.8 million atDecember 31, 2011 from$51.8 million atDecember 31, 2010 , as the Bank had a$6.0 million long-termFederal Home Loan Bank note mature in February and added a$4.0 million short-termFederal Home Loan Bank borrowing in late December. AtDecember 31, 2011 , our borrowings consisted of FHLB advances totaling$32.0 million , one$7.5 million repurchase agreement, and subordinated debentures of$10.3 million . The subordinated debentures were issued onMarch 7, 2006 , and mature onMarch 7, 2036 . 46
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Yields Earned and Rates Paid
The following tables set forth the weighted average yields earned on interest-earning assets and the weighted average interest rates paid on the interest-bearing liabilities, together with the net yield on interest-earning assets. Yields are calculated on a tax-equivalent basis. The tax-equivalent adjustment was$72,000 ,$100,000 and$256,000 for the years endedDecember 31, 2011 , 2010 and 2009, respectively. Year Ended December 31, Weighted Average Yield: 2011 2010 2009 Loans 5.59 % 5.84 % 5.79 % Mortgage-backed pass through and collateralized mortgage obligations 3.16 3.83 4.70 Securities - taxable 3.57 3.67 4.15 Securities - tax-exempt 6.61 5.72 5.89 Other interest-earning assets 0.71 0.72 0.83 All interest-earning assets 5.04 5.40 5.38 Weighted Average Cost:
Demand deposits, money market deposit accounts, and savings
0.31 0.39 0.68 Certificates of deposit 1.66
2.12 2.84
3.52 4.01 4.11 All interest-bearing liabilities 1.37
1.83 2.38
Interest Rate Spread (spread between weighted average yield on all Interest-earning assets and all interest-bearing liabilities)
3.67
3.57 3.00
Net Tax Equivalent Yield (net interest income as a percentage of average interest-earning assets)
3.74 3.63 3.08 At December 31, Weighted Average Interest Rates: 2011
2010 2009
Loans 5.43 % 5.75 % 5.91 % Mortgage-backed pass through and collateralized mortgage obligations 2.66 3.01 4.35 Other securities - taxable 2.61 3.05 3.61 Other securities - tax-exempt 7.95 5.94 6.00 Other earning assets 1.51 0.93 0.77 Total interest-earning assets 5.05
5.31 5.52 Demand deposits, money market deposit accounts, and savings
0.23 0.38 0.45 Certificates of deposit 1.55
1.77 2.46
3.11 3.92 3.97 Total interest-bearing liabilities 1.22 1.57 2.04 Interest rate spread 3.83 3.74 3.48 47
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Rate/Volume Analysis
The following table sets forth certain information regarding changes in interest income, interest expense and net interest income for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (1) changes in volume (changes in volume multiplied by old rate) and (2) changes in rate (changes in rate multiplied by old volume). For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to the rate and the changes due to volume. No material amounts of loan fees or out-of-period interest are included in the table. Nonaccrual loans were not excluded in the calculations. The information shown below was adjusted for the tax-equivalent benefit of bank qualified non-taxable municipal securities and municipal loans. The tax equivalent adjustment was$72,000 ,$100,000 and$256,000 for the years endedDecember 31, 2011 , 2010 and 2009, respectively. Year Ended December 31, 2011 vs. 2010 2010 vs. 2009 Increase (Decrease) Increase (Decrease) Due to Changes in Due to Changes in Net Net Volume Rate Change Volume Rate Change (In thousands) Interest income: Loans $ (316 ) $ (782 ) $ (1,098 ) $ (1,072 ) $ 157 $ (915 ) Mortgage-backed securities 119 (233 ) (114 ) (773 ) (275 ) (1,048 ) Securities - taxable 2 (2 ) - (54 ) (9 ) (63 ) Securities - tax-exempt (58 ) 14 (44 ) (422 ) (4 ) (426 ) Other interest-earning assets 39 (2 ) 37
(42 ) (18 ) (60 )
Total interest-earning assets (214 ) (1,005 ) (1,219
) (2,363 ) (149 ) (2,512 )
Interest expense: Demand deposits and savings 53 (124 ) (71 ) (41 ) (355 ) (396 ) Certificates of deposits (121 ) (768 ) (889 ) (572 ) (1,253 ) (1,825 ) FHLB advances,Federal Reserve Bank discount window borrowings, repurchase agreement and subordinated debentures (516 ) (228 ) (744
) (798 ) (59 ) (857 )
Total interest-bearing liabilities $ (584 ) $ (1,120 ) $ (1,704 ) $ (1,411 ) $ (1,667 ) $ (3,078 )
Change in net interest income $ 370 $ 115 $ 485 $ (952 ) $ 1, 518 $ 566 Drafts Payable Drafts payable of$2.5 million atDecember 31, 2011 represented an increase of$938,000 from$1.6 million atDecember 31, 2010 . This difference will vary and is a function of the dollar amount of checks issued near period end and the time required for those checks to clear.
Other Liabilities
Other liabilities increased$670,000 to$5.7 million atDecember 31, 2011 , primarily due to a$153,000 increase in escrow balances for mortgage loans, and increases in accrued expenses and accounts payable related to normal operating expenses. Shareholders' Equity
Total shareholders' equity of
48
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Table of Contents RESULTS OF OPERATIONS 2011 Compared to 2010 Net income The Company recorded net income of$1.1 million for 2011, or$0.38 per diluted share, compared to net income of$553,000 , or$0.19 per diluted share, for 2010. This increase of$589,000 resulted primarily from an improvement in net interest income, and a significant reduction in the provision for loans losses for 2011. The following is a summary of changes in the components of net income for 2011 compared to 2010:
• The Company produced a
income, with growth of only 0.6% in average interest-earning
assets
that was limited by weak loan demand in 2011. The$513,000
increase in
net interest income,$485,000 on a tax-equivalent basis,
resulted
primarily from an improvement in net interest spread, as shown in the table below. • A provision for loan losses of$1.4 million was recorded during 2011,
compared to$1.9 million for the same period of 2010, a decrease of$548,000 . • Other income for 2011 was$5.6 million , or a decrease of$22,000 from the total for 2010. •$17.0 million in other expense for 2011 represented a$187,000 , or
1.1%, increase from$16.8 million for 2010. • The income tax expense of only$21,000 on$1.2 million of pre-tax income for 2011 resulted primarily from approximately$998,000 of tax-exempt income from bank-owned life insurance, municipal securities and municipal loans. The income tax benefit of$242,000 for 2010 resulted from approximately$1.1 million of tax-exempt income from bank-owned life insurance, municipal securities and municipal loans.
For a quarterly breakdown of earnings, see "Quarterly Data" under "Item 6. Selected Financial Data."
Net Interest Income
We derive the majority of our income from net interest income. The following table shows a breakdown of net interest income on a tax-equivalent basis for 2011 compared to 2010. The tax equivalent adjustment was$72,000 and$100,000 for the years endedDecember 31, 2011 and 2010, respectively, based on a tax rate of 34%. (Dollars in thousands) Years ended December 31, 2011 2010 Interest Yield/Rate Interest Yield/Rate Change Interest and fees on loans $ 17,421 5.59 % $ 18,519 5.84 % $ (1,066 ) Other interest income 1,445 2.30 1,566 2.85 (153 ) Total interest income 18,866 5.04 20,085 5.40 (1,219 ) Interest on deposits 3,225 1.05 4,185 1.40 (960 ) Interest on borrowings 1,645 3.52 2,389 4.01 (744 ) Total interest expense 4,870 1.37 6,574 1.83 (1,704 ) Net interest income $ 13,996 $ 13,511 $ 485 Net interest spread 3.67 % 3.57 % Net interest margin 3.74 % 3.63 % 49
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The 3.6% growth in net interest income on a tax-equivalent basis, as shown in the table above, was accomplished with an increase of 0.6% in average interest-earning assets, as the Bank benefited from certain market conditions in 2011 that allowed it to decrease its cost of funds, primarily through the repricing of deposit accounts in a relatively stable low interest rate environment. Our interest-bearing liabilities have shorter overall maturities and reprice more frequently to market conditions than our interest-earning assets. For a discussion on interest rate risk see "Interest Rate Risk."
The Company's net interest margin on a fully-tax equivalent basis increased 10 basis points to 3.73% for 2011 from 3.63% for 2010.
Tax-exempt interest for 2011 was$162,000 compared to$222,000 for 2010. Tax-exempt interest is primarily from bank-qualified municipal securities and municipal loans. Total interest income on a tax-equivalent basis of$18.9 million for 2011 represented a decrease of$1.2 million compared to$20.1 million for 2010. This reduction resulted primarily from a decrease in average interest-earning assets related to the Bank's balance sheet restructuring strategies. Total interest expense for 2011 decreased$1.7 million compared to 2010, as the Bank took advantage of market opportunities to reprice and sharply reduce its cost of interest-bearing deposits, and reduced total borrowings, also as part of its balance sheet restructuring strategy. For further information, see "- Financial Condition - Rate/Volume Analysis."
Provision for Loan Losses
The provision for loan losses represents the current period credit or cost associated with maintaining an appropriate allowance for loan losses. Periodic fluctuations in the provision for loan losses result from management's assessment of the adequacy of the allowance for loan losses. The allowance for loan losses is dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, assessment by management, third parties and banking regulators of the quality of the loan portfolio, the value of the underlying collateral on problem loans and the general economic conditions in our market area. We believe the allowance for loan losses is adequate to cover losses inherent in the loan portfolio as calculated in accordance with generally accepted accounting principles.
We had a provision for loan losses of
Other Income
The
• A
account relationships to
debit card fees that was due primarily to a 7.0% increase in the number of
checking accounts that resulted from the Bank's continuing focus on growing core deposit relationships;
• A
brokerage sales to
brokerage sales by the Bank's subsidiary,
Inc.; • Net gains on sales of available-for-sale securities increased$616,000
from
mortgage loan rates that resulted in higher market values of its mortgage-backed securities. 50
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• A
gain in 2010 from a bulk sale of
residential mortgage loans; • A$272,000 increase in rental income from OREO to$771,000 resulted
primarily from gross operating revenue for an
course acquired in mid-2011 and sold in December, the mid-2010 acquisition
of an
leasing of two high-end
offset by reduced income from a multi-family apartment complex in
Anderson, Indiana , that was held for all of 2010 and sold in mid-2011; • A$668,000 increase in the net loss from sales and write-downs of other
real estate owned to
primarily to
and a
market value of both properties during 2011, but were partly offset by a
and
• A
real estate qualifying for federal tax credits, from$142,000 for 2010 to$8,000 for 2011; Other Expense The Company recorded a$187,000 increase in total other expense to$17.0 million for 2011, compared to$16.8 million for 2010, due primarily to the following major differences: •$9.4 million for salaries and employee benefits for 2011, which was$135,000 , or 1.4%, higher than 2010, and due mostly to an increase in
incentive awards related primarily to the Bank's retail deposit goals and
sales goals for
in funding costs for the frozen multi-employer defined benefit retirement
plan, partly offset by an
expense. In light of the impact of poor economic conditions on the
earnings of the Company, management agreed to forego salary increases for
2011; • The$88,000 , or 5.7%, increase in net occupancy expense to$1.6 million related primarily to real estate tax expense. The expense for 2011 included a$28,000 increase in rent for a banking center that was related mostly to a real estate tax adjustment, whiled during 2010 the Bank benefited from a$35,000 refund of prior years' real estate taxes as a result of successfully contesting the assessment on one of the Bank's offices; • Other real estate owned expense of$1.0 million for 2011 was$53,000
higher than the total for 2010.
operating expenses on the
complex in
the
together provided
The increases above were offset in part by:
• A decrease of$77,000 in legal and professional fees that was due primarily to a lower expense recorded for legal fees related to problem loans, and a$25,000 recruiting fee that was incurred in the first nine
months of 2010, while no recruiting fees were incurred in 2011, offset in
part by$14,000 in fees resulting from the required conversion to eXtensible Business Reporting Language ("XBRL") forSEC financial reporting in 2011; and • A$111,000 decrease inFDIC insurance premiums and assessments that resulted from the new assessment methodology that became effective in the beginning of the second quarter of 2011. 51
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Income Tax Expense
We recorded income tax expense of$21,000 on pre-tax income of$1.2 million for 2011, compared to an income tax benefit of$242,000 on$311,000 of pre-tax income for 2010. Both years had a significant amount of tax-exempt BOLI income, and tax-exempt income from municipal loans and municipal securities. • We have a deferred state tax asset of$1.9 million that is primarily the result of operating losses sustained since 2003 for state tax purposes. We started recording a valuation allowance against our current period state income tax benefit in 2005 due to our concern that we may not be able to use more than the tax asset already recorded on the books without modifying the use of AIMI, our investment subsidiary, which was liquidated effectiveDecember 31, 2009 . Operating income from AIMI was not subject to state income taxes under state law, and is the primary reason for the tax asset. The valuation allowance was$1.1 million atDecember 31, 2011 . • The Company had a deferred federal tax asset of$4.6 million atDecember 31, 2011 , that was composed of$1.6 million of tax benefit from a net operating loss carryforward of$4.7 million ,$1.6 million related to temporary differences between book and tax income, and$1.4 million in tax credits. The federal loss carryforward expires in 2026, and the tax credits begin to expire in 2023. Included in the$1.4 million of tax credits available to offset future federal income tax are approximately$666,000 of alternative minimum tax credits which have no expiration date. Management believes that the Company will be able to utilize the benefits recorded for loss carryforwards and credits within the allotted time periods. • In addition to the liquidation of AIMI, the Bank has initiated several strategies designed to expedite the use of both the deferred state tax asset and the deferred federal tax asset. Through sales of$34.5 million of municipal securities and only one purchase sinceDecember 31, 2006 , that segment of the investment securities portfolio has been reduced to$2.4 million . The proceeds from these sales have been reinvested in taxable financial instruments. The Bank periodically evaluates a
sale/leaseback
transaction that could result in a taxable gain on its office properties, and also allow the Bank to convert nonearning assets to earnings assets that will produce taxable income.
Additionally, the
Bank is exploring options related to reducing its current investment in tax-exempt bank owned life insurance policies that involve the reinvestment of the proceeds in taxable financial instruments with a similar or greater risk-adjusted after-tax yield. Sales of banking centers not important to long-term growth objectives that would result in taxable gains and reduced operating expenses could be considered by the Bank. • The effective tax rate was 1.8% in 2011, which resulted from$1.2 million in pre-tax income with income tax of$21,000 , compared to an effective tax rate of (77.8)% for 2010 that resulted from$311,000 in pre-tax income coupled with a$242,000 income tax benefit. The primary difference in the effective tax rate and the statutory tax rates in both 2011 and 2010 relates to the cash value of life insurance, municipal loans and municipal securities income.
See Note 9 to the Consolidated Financial Statements for more information relating to income taxes
Liquidity and Capital Resources.
Liquidity is the ability to meet current and future obligations of a short-term nature. Historically, funds provided by operations, loan repayments and new deposits have been our principal sources of liquid funds. In addition, we have the ability to obtain funds through the sale of new mortgage loans, through borrowings from the FHLB system, and through the brokered certificates market. We regularly adjust the investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability program. The Company is a separate entity and apart from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for the payment of dividends declared for its shareholders, and the payment of interest on its subordinated debentures. At times, the Company has repurchased its 52
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stock. Substantially all of the Company's operating cash is obtained from subsidiary service fees and dividends. Payment of such dividends to the Company by the Bank is limited underIndiana law. Additionally, as part of a resolution adopted by the Board of Directors of the Bank onJuly 26, 2010 , the Bank cannot declare or pay any dividends without the prior written consent of theFDIC and theIndiana Department of Financial Institutions . See "-Regulatory Action." The Company believes that such restriction will not have an impact on the Company's ability to meet its ongoing cash obligations.
At
Certificates of deposit due within one year ofDecember 31, 2011 totaled$87.8 million , or 26.0% of total deposits. If these maturing certificates of deposit do not remain with us, other sources of funds must be used, including other certificates of deposit, brokered CDs, and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than currently paid on the certificates of deposit due on or beforeDecember 31, 2012 . However, based on past experiences we believe that a significant portion of the certificates of deposit will remain. We have the ability to attract and retain deposits by adjusting the interest rates offered. We held no brokered CDs atDecember 31, 2011 and$10.4 million atDecember 31, 2010 .
Our primary investing activities are the origination of loans and purchase of securities. In 2011, our loan originations totaled
Financing activities consist primarily of activity in deposit accounts, including brokered certificates of deposit, and FHLB advances. Deposit flows are affected by the overall level of interest rates, the interest rates and products we offer, and our local competitors and other factors. Deposit account balances decreased by$728,000 in 2011. We had FHLB advances of$32.0 million and$34.0 million atDecember 31, 2011 and 2010, respectively. The Bank is subject to various regulatory capital requirements set by theFDIC , including a risk-based capital measure. The Company is also subject to similar capital requirements set by theFederal Reserve Bank . The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. AtDecember 31, 2011 , both the Company and the Bank exceeded all of regulatory capital requirements and are considered "well capitalized" under regulatory guidelines.
Off-Balance-Sheet Arrangements
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded on our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers' requests for funding and take the form of loan commitments and lines of credit. See Note 4 of the Notes to Consolidated Financial Statements. We do not have any off-balance-sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented in this report have been prepared in accordance with generally accepted accounting principles. This requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. Virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or at the same rate as changes in the prices of goods and services, which are directly affected by inflation, although interest rates may fluctuate in response to perceived changes in the rate of inflation. 53
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