LNCB Lincoln Bancorp Ind (MM)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

 

Commission file number: 000-25219

LINCOLN BANCORP

(Exact name of registrant as specified in its charter)

 

 

(317) 839-6539

(Registrant’s telephone number, including area code)

[None]

(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.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

The number of shares of the Registrant’s common stock, without par value, outstanding as of September 30, 2008 was 5,403,515.

 

LINCOLN BANCORP AND SUBSIDIARY

FORM 10-Q

INDEX

 

 

 

 

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q (“Form 10-Q”) contains statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements appear in a number of places in this Form 10-Q and include statements regarding the intent, belief, outlook, estimate or expectations of the Company (as defined in the notes to the consolidated condensed financial statements), its directors or its officers primarily with respect to future events and the future financial performance of the Company. Readers of this Form 10-Q are cautioned that any such forward-looking statements are made as of the date of this report and are not guarantees of future events or performance and involve risks and uncertainties, and that actual results may differ materially from those in the forward-looking statements as a result of various factors. The accompanying information contained in this Form 10-Q identifies important factors that could cause such differences. These factors include changes in interest rates; loss of deposits and loan demand to other financial institutions; substantial changes in financial markets; changes in real estate values and the real estate market; or regulatory changes. We do not undertake to update any forward-looking statement that we may make in this Form 10-Q.

 

 

PART I FINANCIAL INFORMATION

LINCOLN BANCORP AND SUBSIDIARY

Consolidated Condensed Balance Sheets

 

See notes to consolidated condensed financial statements.

 

 

LINCOLN BANCORP AND SUBSIDIARY

Consolidated Condensed Statements of Operations

(Unaudited)

See notes to consolidated condensed financial statements.

 

 

LINCOLN BANCORP AND SUBSIDIARY

Consolidated Condensed Statements of Comprehensive Income/Loss

(Unaudited)

 

 

See notes to consolidated condensed financial statements.

 

 

LINCOLN BANCORP AND SUBSIDIARY

Consolidated Condensed Statement of Shareholders’ Equity

For the Nine Months Ended September 30, 2008

(Unaudited)

 

See notes to consolidated condensed financial statements.

 

 

LINCOLN BANCORP AND SUBSIDIARY

Consolidated Condensed Statements of Cash Flows

(Unaudited)

 

 

 

See notes to consolidated condensed financial statements.

 

 

LINCOLN BANCORP AND SUBSIDIARY

Notes to Unaudited Consolidated Condensed Financial Statements

Note 1: Basis of Presentation  

The consolidated financial statements include the accounts of Lincoln Bancorp (the “Company”), its wholly owned subsidiary, Lincoln Bank, a state chartered commercial bank (“Lincoln” or the “Bank”), and Lincoln’s wholly owned subsidiaries, LF Service Corporation (“LF Service”) and Citizens Loan and Service Corporation (“CLSC”), both Indiana corporations, and LF Portfolio Services, Inc. (“LF Portfolio”), a Delaware corporation. A summary of significant accounting policies is set forth in Note 1 of Notes to Financial Statements included in the December 31, 2007 Annual Report to Shareholders. All significant intercompany accounts and transactions have been eliminated in consolidation.

The interim consolidated financial statements have been prepared in accordance with instructions to Form 10-Q, and therefore do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles.

The interim consolidated financial statements at September 30, 2008 and for the three months and nine months ended September 30, 2008 and 2007, have not been audited by independent accountants, but reflect, in the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for such periods. The results of operations for the three-month period and nine month periods ended September 30, 2008 are not necessarily indicative of the results that may be expected for the entire year. The consolidated condensed balance sheet of the Company as of December 31, 2007 has been derived from the audited consolidated balance sheet of the Company as of that date.

Reclassifications of certain amounts in the 2007 consolidated financial statements have been made to conform to the 2008 presentation.

Note 2: Investment Securities

Certain investment securities are reported in the consolidated financial statements at an amount less than their historical cost. Total fair value of these investments at September 30, 2008 and December 31, 2007 were $43,843,00 and $47,976,000, which is approximately 35.2% and 31.9% of the Company’s investment portfolio. These declines primarily resulted from continued increases in market interest rates from acquisition date of the securities. The unrealized losses in corporate obligations primarily relate to six variable-rate trust preferred debt securities; four are issued by regional and national financial institutions and two are pooled trust preferred debt securities.

The following tables show our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2008 and December 31, 2007:

 

 

 

 

 

 

 

 

 

The Company’s unrealized losses on corporate obligations relate primarily to its investment in trust preferred securities. The decline in value is attributable to temporary illiquidity and the financial crisis affecting these markets and not the expected cash flows of the individual securities. Due to the illiquidity in the market, it is unlikely that the Company would be able to recover its investment in these securities if the Company sold the securities at this time. The Company has analyzed the cash flow characteristics of the securities and this analysis included utilizing the most recent trustee reports and any other relevant market information including announcements of deferrals or defaults of trust preferred securities. Because the Company has the intent and ability to hold these securities until a recovery of fair value and has determined that there was no adverse change in the cash flow as viewed by a market participant, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2008.

At September 30, 2008, approximately 90% of the mortgage-backed securities in a loss position held by the Company were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae and Freddie Mac, institutions which the government has affirmed its commitment to support. Because the decline in market value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company has the intent and ability to hold these mortgage-backed securities until a recovery of fair value, which may be maturity, the Company does not consider these securities to be other-than-temporarily impaired at September 30, 2008

At September 30, 2008, the Company’s unrealized losses relating to municipal securities are attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company has the intent and ability to hold these municipal securities until a recovery of fair value, which may be maturity, the Company does not consider these securities to be other-than-temporarily impaired at September 30, 2008.

 

Note 3: Earnings Per Share  

Earnings per share have been computed based upon the weighted-average common shares outstanding. Unearned Employee Stock Ownership Plan shares have been excluded from the computation of average common shares outstanding.

 

 

 

 

 

Options to purchase 477,838 shares of common stock at exercise prices of $7.32 to $19.40 per share were outstanding at September 30, 2008, but were not included in the computation of diluted earnings per share because the options were anti-dilutive.

 

Options to purchase 131,000 shares of common stock at exercise prices of $17.58 to $19.15 per share were outstanding at September 30, 2007, but were not included in the computation of diluted earnings per share because the options were anti-dilutive.

Note 4: Disclosures About Fair Value of Assets and Liabilities

 

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157). FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. FAS 157 has been applied prospectively as of the beginning of the period.

FAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Available-for-sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include certain collateralized mortgage obligations, mortgage backed securities, corporate trust preferred

 

 

notes and certain municipal securities. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include certain trust preferred stock pools and structured government agency securities which are less liquid securities.

Loans Held for Sale

Loans held for sale are initially recorded at cost and evaluated for lower of cost or fair value at each reporting period. As of September 30, 2008 the fair value of loans held for sale approximated cost and as such no fair value disclosure is included on these loans in the tables below.

The following table presents the fair value measurements of assets and liabilities recognized in the accompanying balance sheet measured at fair value on a recurring basis and the level within the FAS 157 fair value hierarchy in which the fair value measurements fall at September 30, 2008.

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs for the period July 1, 2008 through September 30, 2008:

Realized and unrealized gains and losses included in net income for the period July 1, 2008, through September 30, 2008, are reported in the consolidated statements of income as follows:

				Operating Income			Other Income (Expense)
	Total gains and losses			$	-0-		$	-0-
	Change in unrealized gains or losses relating to assets    still held at the balance sheet date			$	-0-		$	-0-

 

 

 

 

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs for the period January 1, 2008 through September 30, 2008:

Realized and unrealized gains and losses included in net income for the period from January 1, 2008, through September 30, 2008, are reported in the consolidated statements of income as follows:

Following is a description of the valuation methodologies used for instruments measured at fair values on a non-recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

The following table presents the fair value measurements of assets and liabilities recognized in the accompanying balance sheet measured at fair value on a non-recurring basis and the level within the FAS 157 fair value hierarchy in which the fair value measurements fall at September 30, 2008 (In Thousands).

 

 

 

 

Impaired Loans

Loan impairment is reported when full payment under the contractual loan terms is not expected.  Impaired loans are carried at the present value of estimated future cash flows using the loan’s existing rate, or the fair value of collateral if the loan is collateral dependent.  Loans are evaluated for impairment quarterly.

During the first nine months of 2008, the Bank evaluated $9.9 million of loans for impairment and determined specific impairment on these loans totaling $2.3 million. Certain of these impaired loans were impaired for the first time, partially charged-off or re-evaluated, resulting in a remaining balance for these loans, net of specific allowance, of $7.6 million. This valuation would be considered Level 3.  Level 3 inputs for impaired loans included current and prior appraisals, discounting factors, the borrowers’ financial results and other considerations including expected cash flows.

Mortgage Servicing rights

Mortgage servicing rights are initially recorded at fair value and are subsequently reported at amortized cost and periodically evaluated for impairment as described in (SFAS) No. 156, Accounting for Servicing of Financial Assets-an amendment of FASB Statement No. 140. New mortgage servicing rights recorded during the current accounting period are recorded at fair value and are disclosed as a nonrecurring measurement.

Mortgage servicing rights recorded as an asset and into income during the three months ended September 30, 2008 totaled $3,000 and $55,000 for the six months ended September 30, 2008. Mortgage servicing rights do not trade in an active, open market with readily observable prices. Accordingly, fair values of new mortgage servicing rights are estimated using discounted cash flow models. Due to the nature of the valuation inputs, recording initial mortgage servicing rights are classified within Level 3 of the hierarchy.

Note 5: Recent Accounting Pronouncements

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements”. This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The standard is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued Staff Position (FSP) 157-2, Effective Date of FASB Statement No. 157. This FSP delays the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The impact of the adoption was not material.

In February 2006, FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Liabilities” (“SFAS 159”). Adoption of SFAS 159 is required for January 1, 2008. This statement allows, but does not require, companies to record certain assets and liabilities at their fair value. The fair value determination is made at the instrument level, so similar assets or liabilities could be partially accounted for using the historical cost method, while other similar assets or liabilities are accounted for using the fair value method. Changes in fair value are recorded through the income statement in subsequent periods. The statement provides for a one time opportunity to transfer existing assets and liabilities to fair value at the point of adoption with a cumulative effect adjustment recorded against equity. After adoption, the election to report assets or liabilities at fair value must be made at the point of their inception. The adoption of this statement did not have a material impact on the Company’s consolidated financial statements.

 

Financial Accounting Standards Board Statement No. 141 (SFAS 141R), “Business Combinations (Revised 2007),” was issued in December 2007 and replaces SFAS 141 which applies to all transactions and other events in which one entity obtains control over one or more other businesses. SFAS 141R requires an acquirer, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date. Contingent consideration is required to be recognized and measured at fair value on the date of acquisition rather than at a later date when the amount of that consideration may be determinable beyond a reasonable doubt. This fair value approach replaces the cost allocation process required under SFAS 141 whereby the cost of an acquisition was allocated to the individual asset acquired and liabilities assumed based on their estimated fair value. SFAS 141R requires acquirers to expense acquisition-related costs as incurred rather than allocating such costs to the assets acquired and liabilities assumed.

 

Under SFAS 141R, the requirements of SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” would have to be met in order to accrue for a restructuring plan in purchase accounting. Pre-acquisition contingencies are to be recognized at fair value, unless it is a non-contractual contingency that is not likely to materialize, in which case, nothing should be recognized in purchase accounting. Instead, that contingency would be subject to the probable and estimable recognition criteria under SFAS 5, “Accounting for Contingencies.” The Company is evaluating the requirements of SFAS 141R to determine if it will have a significant impact on the Company’s financial condition or results of operations. This statement is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 with early adoption prohibited.

Financial Accounting Standards Board Statement No. 160 (SFAS 160), “Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB Statement No. 51,” was issued in December 2007 and establishes accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 clarifies that a non-controlling interest in a subsidiary, which is sometimes referred to as a minority interest, is an ownership interest in the consolidated entity that should be reported as a component of equity in the consolidated financial statements. Among other requirements, SFAS 160 requires consolidated net income to be reported at amounts that are attributable to both the parent and the non-controlling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the non-controlling interest. SFAS 160 is effective for the Company on January 1, 2009 and is not expected to have a significant impact on the Company’s financial statements.

Financial Accounting Standards Board Statement No. 161 (SFAS 161), “Disclosures About Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133,” was issued in March 2008 and amends and expands the disclosure requirements of SFAS 133 to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedge items are accounted for under SFAS 133 and its related interpretations, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. To meet those objectives, SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. SFAS 161 is effective for the Company on January 1, 2009 and is not expected to have a significant impact on the Company’s financial statements.

 

Note 6 — Pending Acquisition

On September 3, 2008, the Company entered into a definitive agreement to be acquired by First Merchants Corporation. The agreement provides that shareholders of the Company will receive, at their election, either 0.7004 shares of First Merchants common stock, subject to possible upward or downward adjustment as provided in the Merger Agreement or $15.76 in cash. The number of shares of First Merchants common stock and the amount of cash payable in connection with the merger is subject to various limitations and prorations. The transaction value is estimated at approximately $75 million. The transaction is expected to close in the fourth quarter of 2008.

Due to the pending acquisition, at its October 21, 2008 meeting, the Board of Directors authorized the acceleration of vesting for certain option and recognition and retention incentive programs. This vesting will result in estimated expense to be recognized during the fourth quarter of 2008 totaling approximately $500,000.

In addition, the merger agreement affirmed certain employment and change of control contracts that are anticipated to be paid in conjunction with the completion of the merger. The expense related to the payment of these contracts is estimated to be $3.1 million and will be recognized in the fourth quarter of 2008 subject to the completion of the merger.

 

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

The Company was organized in September 1998. On December 30, 1998, it acquired the common stock of Lincoln upon the conversion of Lincoln from a federal mutual savings bank to a federal stock savings bank. The Bank converted from a federal thrift charter to a state commercial bank charter on November 1, 2006.

 

Lincoln Bank was originally organized in 1884 as Ladoga Federal Savings and Loan Association, located in Ladoga, Indiana. In 1979 Ladoga Federal merged with Plainfield First Federal Savings and Loan Association, a federal savings and loan association located in Plainfield, Indiana, which was originally organized in 1896. Following the merger, the Bank changed its name to Lincoln Federal Savings and Loan Association and, in 1984, adopted the name, Lincoln Federal Savings Bank. On September 1, 2003, the Bank adopted the name Lincoln Bank. On August 2, 2004, the Company acquired First Shares Bancorp, Inc., the holding company of First Bank, an Indiana commercial bank. First Shares was merged with and into the Company and immediately thereafter, First Bank was merged into Lincoln Bank. As noted above, the Bank converted from a federal thrift charter to a state commercial bank charter on November 1, 2006, and provides full banking services in a single significant business segment. As a state chartered bank, the Bank is subject to regulation by the Department of Financial Institutions, State of Indiana and the Federal Deposit Insurance Corporation.

Lincoln currently conducts its business from 17 full-service offices located in Hendricks, Johnson, Morgan, Clinton, Montgomery, and Brown Counties, Indiana, with its main office located in Plainfield. The Bank also has 2 loan production offices located in Carmel and Greenwood, Indiana. Lincoln offers a variety of lending, deposit and other financial services to its retail and commercial customers. The Bank’s principal business consists of attracting deposits from the general public and originating fixed-rate and adjustable-rate loans secured by commercial real estate, inventory, accounts receivable as well as first mortgage liens on one- to four-family residential real estate. Lincoln’s deposit accounts are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation. Lincoln offers a number of financial services, which include: (i) one-to-four-family residential real estate loans; (ii) commercial real estate loans; (iii) real estate construction loans; (iv) land loans; (v) multi-family residential loans; (vi) consumer loans, including home equity loans and automobile loans; (vii) commercial loans; (viii) money market demand accounts; (ix) savings accounts; (x) checking accounts; (xi) NOW accounts; (xii) certificates of deposit; and (xiii) financial planning.

Lincoln currently owns three subsidiaries. First, LF Service’s, assets consist of an investment in Bloomington Housing Associates, L.P. (“BHA”). BHA is an Indiana limited partnership that was organized to construct, own and operate a 130-unit apartment complex in Bloomington, Indiana (the “BHA Project”). Development of the BHA Project was completed in 1993 and the project is performing as planned. Second, Citizens Loan and Service Corporation (“CLSC”) primarily engages in the purchase and development of tracts of undeveloped land. Because CLSC engages in activities that are not permissible for a national bank, FDIC regulations prohibit Lincoln from including its investment in CLSC in its calculation of regulatory capital. CLSC purchases undeveloped land, constructs improvements and infrastructure on the land, and then sells lots for residential home construction. Third, LF Portfolio, which is located in Nevada, holds and manages a significant portion of Lincoln’s investment portfolio. As noted above, effective November 1, 2006, the Bank changed its charter from a federal savings bank charter to an Indiana commercial bank charter. Unlike federal savings banks, commercial banks are not permitted to participate in real estate development joint ventures. Under terms of the approval granted by the Federal Reserve Bank of Chicago the Company agreed to cause Lincoln Bank to conform the existing direct and indirect nonbanking activities and investments conducted by CLSC, including by divestiture if necessary, to the requirements of the Bank Holding Company Act within two years of the consummation of the charter conversion.

Lincoln’s results of operations depend primarily upon the level of net interest income, which is the difference between the interest income earned on interest-earning assets, such as loans and investments, and costs incurred with respect to interest-bearing liabilities, primarily deposits and borrowings. Results of operations also depend upon the level of Lincoln’s non-interest income, including fee income and service charges and the level of its non-interest expenses, including general and administrative expenses.

 

As noted in our 2007 Annual Report on Form 10-K, because we focus our business in central Indiana, an economic slowdown in this area could hurt our business. An economic slowdown could have the following consequences:

 

 

 

The Company has not experienced many of the challenges facing the banking industry as a whole due in large part to its policy of not investing in sub-prime mortgage loans or any (so-called “off-balance sheet”) activity related to the structuring and sale of such loans.  As the economy worsens some of the Company’s customers will experience stress, in some cases severe enough to impact their ability to repay loans in a timely manner. Our plan is to work closely with our customers to help them work through the stress if possible and, where necessary, to liquidate the credit.  Our policy of requiring prudent underwriting and the fact that Midwest property values have not been as severely impacted as other areas of the country should help mitigate the level of losses that the Company may incur. 

As previously announced, On September 2, 2008, Lincoln Bancorp (“Lincoln”) and First Merchants Corporation (“First Merchants”) jointly announced the signing of a definitive agreement (the “Merger Agreement”) pursuant to which Lincoln will be merged with and into First Merchants (the “Merger”). The Merger Agreement provides that upon the effective date of the Merger, each Lincoln shareholder will have the option of receiving 0.7004 shares of First Merchants common stock or $15.76 in cash for each share of Lincoln stock owned as of the effective date of the merger. However, no more than 3,576,417 shares of First Merchants' common stock and no more than $16,800,000 in cash may be paid to the Lincoln shareholders in the Merger, and there may be re-allocations of cash and stock to certain Lincoln shareholders if either threshold is exceeded. Based on the closing price of First Merchants’ common stock on September 2, 2008, the transaction has an estimated aggregate value between $74 million and $77 million, depending on the elections of shareholders. The transaction is expected to be a tax-free stock exchange for those Lincoln shareholders electing to receive First Merchants common stock. The Merger is expected to close December 31, 2008. The Agreement has been approved by the boards of directors of Lincoln and First Merchants. However, it is subject to certain other conditions, including the approval of the shareholders of Lincoln and the approval of regulatory authorities.

 

Critical Accounting Policies

Note 1 to the consolidated financial statements contains a summary of the Company’s significant accounting policies presented on pages 31 through 33 of the Annual Report to Shareholders for the year ended December 31, 2007, which was filed on Form 10-K with the Securities and Exchange Commission on March 14, 2008. Certain of these policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management believes that its critical accounting policies include determining the allowance for loan losses, the valuation of mortgage servicing rights, and the valuation of intangible assets.

Allowance for loan losses

The allowance for loan losses represents management’s estimate of probable losses inherent in the Company’s loan portfolios. In determining the appropriate amount of the allowance for loan losses, management makes numerous assumptions, estimates and assessments.

The Company’s strategy for credit risk management includes conservative, centralized credit policies, and uniform underwriting criteria for all loans as well as an overall credit limit for each customer below legal lending limits. The strategy also emphasizes diversification on a geographic, industry and customer level, regular credit quality reviews and quarterly management reviews of large credit exposures and loans experiencing deterioration of credit quality. A standard credit scoring system is used to assess credit risks during the loan approval process of all consumer loans while commercial loans are individually reviewed by a credit analyst with formal presentations to the Bank’s Loan Committee.

The Company’s allowance consists of three components. The Company estimates probable losses from individual reviews of specific loans and probable losses from historical loss rates. Also, factors affecting probable losses resulting from economic or environmental factors that may not be captured in the first two components of the allowance are considered.

Larger commercial loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, reserves are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Company. Included in the review of individual loans are those that are impaired as provided in SFAS No. 114, Accounting by Creditors for Impairment of a Loan . Any allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or fair value of the underlying collateral.

The Company evaluates the collectability of both principal and interest when assessing the need for a loss accrual. Estimated loss rates are applied to other commercial loans not subject to specific reserve allocations.

 

 

Homogenous loans, such as consumer installment and residential mortgage loans are not individually risk graded. Rather, standard credit scoring systems are used to assess credit risks. Loss rates are based on the average net charge-off estimated by loan category. Allowances on individual loans and historical loss rates are reviewed quarterly and adjusted as necessary based on changing borrower and/or collateral conditions.

The Company’s primary market area for lending is central Indiana. When evaluating the adequacy of the allowance, consideration is given to this regional geographic concentration and the closely associated effect changing economic conditions have on the Company’s customers. The Company has not substantively changed any aspect to its overall approach in the determination of the allowance for loan losses. There have been no material changes in assumptions or estimation techniques as compared to prior periods that impacted the determination of the current period allowance.

Mortgage servicing rights

The Company recognizes the rights to service sold mortgage loans as separate assets in the consolidated balance sheet. The total cost of loans when sold is allocated between loans and mortgage servicing rights based on the relative fair values of each. Mortgage servicing rights are subsequently carried at the lower of the initial carrying value, adjusted for amortization, or fair value. Mortgage servicing rights are evaluated for impairment based on the fair value of those rights.

Factors included in the calculation of fair value of the mortgage servicing rights include, estimating the present value of future net cash flows, market loan prepayment speeds for similar loans, discount rates, servicing costs, and other economic factors. Servicing rights are amortized over the estimated period of net servicing revenue. It is likely that these economic factors will change over the life of the mortgage servicing rights, resulting in different valuations of the mortgage servicing rights. The differing valuations will affect the carrying value of the mortgage servicing rights on the consolidated balance sheet as well as the amounts recorded in the consolidated income statement. See Note 4 for a discussion of (SFAS) No. 156, Accounting for Servicing of Financial Assets-an amendment of FASB Statement No. 140.

Intangible assets

As discussed more fully in management’s review of operating results below, the announced merger with First Merchants Corporation and the exchange ratio contained in the Merger Agreement triggered an evaluation of goodwill for impairment. This evaluation determined that goodwill recorded from previous acquisitions of the Corporation should be eliminated. As such, a charge against current earnings totaling $23,907,000 was recorded in the quarter ending September 30, 2008.

Financial Condition

Assets totaled $830.9 million at September 30, 2008, a decrease from December 31, 2007 of $58.4 million. The net decrease in assets occurred primarily in investment securities available for sale, down $26.0 million and total loans including loans held for sale, down $9.4 million. Also, as noted above, management reviewed its goodwill asset for impairment during the third quarter and determined that it was fully impaired. The decline in goodwill totaled $23.9 million. Investments declined as several callable securities were called as interest rates declined. The proceeds of these securities were used to offset reductions in certificates of deposit and money market deposits including public funds. The largest components of the decline in loans occurred in residential real estate mortgages, down $13.6 million and indirect consumer loans, down $8.8 million. Both of these declines are in line with management’s expectations. The majority of our fixed rate mortgage product is currently being sold in the secondary market and indirect activity has been substantially reduced due to competition. Home equity loans increased by $14.2 million and commercial loans increased by $2.7 million from December 31, 2007. The increase in home equity loans included $6.9 million of home equity loans referred by local, central Indiana, brokers with the customer and homes being located in central Indiana. As of September 30, 2008 this program has been curtailed as target goals for this channel were met. The allowance for loan losses increased since December 31, 2007. This was partially in reaction to an increase in nonperforming loans to 2.08% of total loans at September 30, 2008 from 1.22% at year end 2007.

 

 

Total deposits were $594.5 million at September 30, 2008, a decline of $61.9 million since December 31, 2007. The decline occurred primarily in money market deposits down $49.0 million and certificates of deposit, down $36.3 million. The decline in money market deposits was due to the outflow of public fund deposits as local governments paid bills as well as sought higher interest rate alternatives. Certificates of deposit were affected by less public fund deposits as well as management’s efforts to reduce single service certificate of deposit customers where wholesale funding presented a substantially attractive alternative. Growth occurred in noninterest-bearing and interest-bearing demand deposit accounts, up $1.5 million and $19.2 million, respectively, and savings accounts, up $2.5 million from December 31, 2007. Borrowings increased by $31.1 million from year end 2007 to $140.3 million at September 30, 2008 as wholesale borrowing costs declined below competitive rates for certain deposits as noted above.

Shareholders’ equity declined by $27.6 million from $99.0 million at December 31, 2007 to $71.4 million at September 30, 2008. The majority of the decline was the result of the net loss recorded. The net loss included $23.9 million in expense recorded as the result of the review of goodwill for impairment and the subsequent charge to fully impair goodwill on the Company’s books. Shareholder’s equity was also negatively impacted by recording the decline in the fair market value of available-for-sale securities as of September 30, 2008. Accumulated other comprehensive loss grew to $4.5 million at September 30, 2008 from a loss of $.4 million at December 31, 2007. Several “trust preferred” securities were responsible for a substantial amount of the increased loss in accumulated other comprehensive loss. The carrying value of these securities total $13.4 million with a market value of $7.9 million. Management has specifically reviewed these securities, along with other securities in a loss position, and determined, at this time, no other-than-temporary impairment exists. As of September 30, 2008 management has both the ability and the intent to hold these securities until recovery.  Management does classify these securities as “available-for-sale” under the definition of Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities so certain circumstances, such as changes in market interest rates and related changes in the security's prepayment risk, needs for liquidity (for example, due to the withdrawal of deposits, increased demand for loans), changes in the availability of and the yield on alternative investments or changes in funding sources and terms could change management’s assessment of its ability and intent to hold these securities.

Comparison of Operating Results for the Three Months Ended September 30, 2008 and 2007

Net loss for the quarter ended September 30, 2008 was $23.5 million, or $4.64 for both basic and diluted earnings per share. This compared to net income for the comparable period in 2007 of $521,000, or $.10 for both basic and diluted earnings per share. As noted above an impairment charge for goodwill was recorded during the period ending September 30, 2008 that totaled $23.9 million, after tax.

Net interest income for the second quarter of 2008 was $6,152,000 compared to $5,501,000 for the same period in 2007. Net interest margin improved to 3.11% for the three-month period ended September 30, 2008 compared to 2.69% for the same period in 2007. The average yield on earning assets declined only 83 basis points for the third quarter of 2008 compared to the same period in 2007 while the average cost of interest-bearing liabilities declined 141 basis points in 2008 compared to 2007. Interest rate spread increased from 2.22% for the quarter ending September 30, 2007 to 2.80% for the like quarter in 2008. Falling rates have allowed the Bank to benefit from a liability sensitive position. In addition, a more “normal”, positively sloped yield curve has allowed the Bank to support slightly longer asset maturities with cheaper, somewhat shorter term, liabilities. Our deposit environment has been one where competition has kept certain types of interest bearing deposit account costs higher than wholesale funding that has been available. We have deliberately reduced certain higher cost funding sources, primarily public fund certificates and certain single service customer certificate relationships in areas where competition seems irrational. As noted above, maturities of investments, a slight decline in loans and growth in certain other deposit categories has provided the funding for this strategy.

The Bank’s provision for loan losses for the third quarter of 2008 was $357,000 compared to $150,000 for the same period in 2007. The increase in the provision expense was primarily the result of continued concern about the economy and its effect on our borrowers as well as increases in nonperforming assets. Much of the nonperforming increase had been expected and taken into account in our large provision recorded in the first quarter of 2008. At this time, no charge-offs are deemed necessary for these credits. Non-performing loans to total loans at September 30, 2008 were 2.08% compared to 1.22% at December 31, 2007, while non-performing assets to total assets were 1.71% at September 30, 2008 compared to 0.95% at December 31, 2007. The allowance for loan losses as a percent of loans was 1.31% at September 30, 2008 and 1.02% at December 31, 2007. During the third quarter of 2008, the Bank incurred $230,000 in net charged off loans compared to net charged off loans in the same quarter of 2007 totaling $114,000. Although management believes the allowance for loan losses is appropriate to absorb probable future losses inherent in the portfolio as of September 30, 2008, further deterioration in either the economy or our borrowers’ individual financial conditions may necessitate additional provision expense in the future.

 

 

Other income for the three months ended September 30, 2008 was $1,727,000 compared to $1,577,000 for the same quarter of 2007 or a increase of $150,000 or 9.5%. The largest increase in noninterest income was service charges on deposits, up $103,000 to $724,000 or 16.6%. Our direct mail and premium marketing program has increased our transaction accounts and, as a result, our service charges have risen. This increase in accounts has also benefitted our point of sale income which increased $61,000 or 25.6% to $299,000 for the quarter ended September 30, 2008. One additional notable increase was gain on sale of loans which increased by $26,000 or 12.2% to $243,000. We continue to see steady production of traditional, conforming mortgage loans with the majority of those loans being sold into the secondary market. Smaller declines in other categories made up the remainder of the net increase noted above.

Other expenses were $30,846,000 for the three months ended September 30, 2008 compared to $6,331,000 for the like period of 2007. As noted above, the September 30, 2008 results include an impairment of goodwill charge that totaled $23,907,000. In addition, certain merger related expenses totaling $549,000 were recorded during the quarter ending September 30, 2008. Excluding these two expenses (the merger related expenses and the goodwill impairment) for comparison purpose, other expenses would have totaled $6,390,000 for the quarter ending September 30, 2008. This adjusted three month total would have been an increase of $59,000 over the same period ending September 30, 2007 or an increase of less than 1%.

Salaries and employee benefits increased $160,000 to $3,169,000 for the three months ended September 30, 2008 or 5.3% when compared the same period in 2007. This increase included an increase in salaries, commissions and overtime of $94,000. This increase represented normal annual increases as well as the addition of several new positions in key areas, including business development, brokerage, mortgage lending and commercial Lending. Full-time equivalent employees were 234 for the third quarter of 2008 compared to 228 for the same quarter in 2007.

Excluding merger related expenses of $549,000, professional fees declined by $149,000 from $329,000 for the quarter ending September 30, 2007 to $180,000 for the same quarter in 2008. Lower legal costs were responsible for this decline.

Other significant variances in other expenses for the three months ending September 30, 2008 compared to the three months ending September 30, 2007 included a $41,000 decline in marketing and advertising that resulted primarily from a change in vendors for certain marketing services. Equipment expense and occupancy expense also declined, by $40,000 and $37,000, respectively. Occupancy expense was affected by the receipt of real estate tax bills that had been delayed by local government agencies. Previous accruals were adjusted once these bills were received. Other expenses increased from $715,000 to $847,000 with the Federal Deposit Insurance premium making up the majority of this increase.

Income tax expense for the three months ended September 30, 2008 was $184,000. This compares to income tax expense of $76,000 for the quarter ended September 30, 2007. In addition to the goodwill impairment charge during the quarter ending September 30, 2008 and certain merger expenses not qualifying for a tax benefit, the difference between the actual rate recorded and the statutory rates was primarily due to permanent, non-taxable income recorded such as qualifying municipal interest and increases in cash value of life insurance.

Comparison of Operating Results for the Nine Months Ended September 30, 2008 and 2007

Net loss for the nine month period ended September 30, 2008 was $22,364,000, or $4.43 for both basic and diluted earnings per share. This compared to net income for the comparable period in 2007 of $899,000 or $.18 for basic and $0.17 for diluted earnings per share. As noted above, during the first quarter of 2007, the Bank began a strategy to restructure its balance sheet and, as a result, incurred a first quarter after-tax loss. The total year-to-date effect of the restructuring was a net loss of $909,000, or $.18 for both basic and diluted earnings per share.

The following table summarizes by quarter the final results of the restructuring transaction and the financial statement income line affected. No further transactions affected third quarter 2007 results.

Restructuring item		Included in income statement line			Year-to-date September 30, 2007			Quarter ending June 30, 2007			Quarter ending March 31, 2007
Loans– loss on mark-to market and reclassification to securities			Net gains (losses) on loans held for sale		$	(2,080,135	)	$	(752,776	)	$	(1,327,359	)
Loans securitized and sold –establish mortgage servicing right			Net gains (losses) on loans held for sale			296,352			296,352			-0-
Subtotal			Net gains (losses) on loans held for sale			(1,783,783	)		(456,424	)		(1,327,359	)
Sale of securitized mortgage loan security			Net realized gains (losses) on sales of securities			303,100			303,100			-0-
Gains (losses) on trading securities			Net realized gains (losses) on sales of securities			(356,053	)		62,670			(418,723	)
Income related to forward sale contract termination			Gain on termination of forward commitment			358,750			358,750			-0-
Subtotal of restructuring effect on pre-tax net income						(1,477,986	)		268,096			(1,746,082	)
Tax effect on above transactions						(568,668	)		103,276			(671,944	)
Net income effect of restructuring					$	(909,318	)	$	164,820		$	(1,074,138	)

 

 

 

 

 

Net interest income year-to-date through September 30, 2008 increased by $1,859,000 or 11.5% from $16,198,000 year-to-date 2007 to $18,057,000 year-to-date in 2008. Generally the Bank has been in a liability sensitive position and falling interest rates have allowed the Bank to re-price its liabilities at a faster rate than it has had to re-price its assets. Net interest margin increased to 3.02% for the six-month period ended September 30, 2008 compared to 2.62% for the same period in 2007. The average yield on earning assets decreased 54 basis points for the nine month period ending September 30, 2008 compared to the same period in 2007 while the average cost of interest-bearing liabilities decreased 108 basis points in 2008 compared to 2007. This improved interest rate spread from 2.15% for the 2007 period to 2.69% for the 2008 period, or 54 basis points.

The Bank’s provision for loan losses year-to-date through September 30, 2008 was $2,162,000 compared to $457,000 for the same period in 2007. A provision of $1,507,000 was taken during the first quarter of 2008. The increased provision in the first quarter of 2008 was made for several reasons. After the Bank reviewed annual financial statements of certain of its loan customers it was determined that the customers’ financial condition had declined and warranted downgrades of the credits.  These loans were primarily development and commercial real estate loans affected by the downturn in the economy.  The downgraded credits affected the outcome of the Bank’s consistently applied methodology for determining loan loss allowances and resulted in a required increase to the allowance for loan losses. Although management believes the allowance for loan losses is appropriate to absorb future losses inherent in the portfolio as of September 30, 2008, further deterioration in either the economy or our borrowers’ individual financial conditions may necessitate additional provision expense in the future.

Other income year-to-date through September 30, 2008 was $5,527,000 compared to income of $3,281,000 for the same period of 2007. As noted above the 2007 results are affected by a balance sheet restructuring that was initiated in the first quarter of 2007. Other income for the period ended September 30, 2007 included a net $1,478,000 of net losses related to the balance sheet restructuring discussed above. This is illustrated in the table presented above. Excluding the balance sheet restructuring charges other income would have increased $768,000 or 16.1%. The following comparisons have been adjusted for the 2007 restructuring effect where applicable. These are notable differences and are not meant to be an inclusive list of every change within total noninterest income. Net gains on sale of loans increased $206,000 to $1,033,000 for the nine month period ended September 30, 2008. We continue to sell the majority of our fixed rate mortgage production and realize gains on those sales. Service charges on deposit accounts and point of sale income have both been positively affected by our continued marketing program to attract new deposit customers. They increased by $255,000 and $193,000 respectively through the nine months ending September 30, 2008 as compared to the same period in 2007. We recognized gain on sales of securities totaling $70,000 as certain callable securities were called during the first quarter of 2008. This compares to gains of $14,000 on securities sold for the same period in 2007 after adjusting for the effect of the balance sheet restructuring. Loan servicing fees increased by $25,000 to $275,000 for the nine months ending September 30, 2008. This increase is due to the loans that were sold with servicing retained during the balance sheet restructuring in 2007. Other income increased from $558,000 in the nine months ending September 30, 2007 to $613,000 for same period in 2008. Various smaller increases made up this difference.

 

 

Other expenses for the nine month period ended September 30, 2008 were $43,647,000, an increase of $25,184,000 over the same period in 2007. As discussed above this includes the charge against earnings for the goodwill impairment totaling $23,907,000 and various merger related expenses included in professional fees totaling $549,000. Excluding these two items for comparative purposes, the goodwill impairment charge and the merger related expenses, other expenses would have totaled $19,191,000 for the period ending September 30, 2008. This total would compare to the same period in 2007 of $18,463,000 or an increase of $728,000 or 3.9%. Most of the increase was in salaries and employee benefit costs, up $624,000 or 6.8% for essentially the same reasons mentioned for the quarter and described above. Data processing costs increased $203,000 or 10.7% due to customer account growth and certain feature enhancements. Occupancy costs also increased from $1,769,000 to $1,852,000 primarily from the addition of new branches in Greenwood and Mooresville in high traffic areas to replace existing offices in those communities. Advertising and business development costs for the nine months ended September 30, 2008 decreased $151,000 to $727,000 for essentially the same reasons as discussed in the quarterly results above. Other expenses increased $182,000 to $2,288,000 for the period ended September 30, 2008 compared to the same period in 2007 and, as above, the majority of this increase was due to increased Federal Deposit Insurance Corporation insurance premium. Other, smaller differences made up the balance of the change in other expenses.

Income tax expense for the nine months ended September 30, 2008 was $138,000. This compares to income tax benefit of $340,000 for the nine months ending September 30, 2007. In addition to the goodwill impairment charge during the quarter ending September 30, 2008 and certain merger related expenses not qualifying for a tax benefit, the difference between the actual rate recorded and the statutory rates was primarily due to permanent, non-taxable income recorded such as qualifying municipal interest and increases in cash value of life insurance and the benefit of a low income housing tax credit for the 2007 period.

Asset Quality

The Company currently classifies loans as special mention, substandard, doubtful and loss to assist management in addressing collection risks and pursuant to regulatory requirements. Special mention loans represent credits that have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects or Lincoln’s credit position at some future date. Substandard loans represent credits characterized by the distinct possibility that some loss will be sustained if deficiencies on the loans are not corrected. Doubtful loans possess the characteristics of substandard loans, but collection or liquidation in full is doubtful based upon existing facts, conditions and values. A loan classified as a loss is considered uncollectible. Lincoln had $8.6 million and $13.7 million of loans classified as special mention as of September 30, 2008 and December 31, 2007, respectively. In addition, Lincoln had $27.2 million and $8.5 million of loans classified as substandard at September 30, 2008 and December 31, 2007, respectively. Loans classified as doubtful totaled $.2 million at September 30, 2008 and $.7 million at December 31, 2007. At September 30, 2008 and December 31, 2007 there were no loans classified as loss. The increases in classified loans occurred primarily in the first quarter of 2008 after loan officers of the Bank reviewed annual financial statements of certain of its loan customers as they became available and determined that the customers’ financial condition had declined and warranted downgrades of the credits.  These loans were primarily development and commercial real estate loans affected by the downturn in the economy.  Loans that were downgraded totaled over $30 million and spanned over a dozen relationships. Nonperforming assets of the Bank increased to $14.2 million at September 30, 2008 from $7.9 million at December 31, 2007. More than half of this increase was related to one specific relationship that had been considered in our analysis of the allowance for loan losses at March 31, 2008 and provided accordingly through additional provision at that time. We continue to monitor the status of this credit to work towards a successful resolution.

At September 30, 2008, and December 31, 2007, non-accrual loans were $10.3 million and $7.7 million, respectively. At September 30, 2008 and December 31, 2007, respectively, accruing loans delinquent 90 days or more totaled $2.9 million and $.2 million. A substantial portion of this increase was related to one specific relationship that had been considered in our analysis of the allowance for loan losses at March 31, 2008 and provided accordingly through additional provision at that time. At September 30, 2008 and December 31, 2007, the allowance for loan losses was $8.3 million and $6.6 million, respectively or 1.31% of total loans including loans held for sale at September 30, 2008 and 1.02% at December 31, 2007.

 

 

Liquidity and Capital Resources

The Company’s primary sources of funds are deposits, borrowings and the proceeds from principal and interest payments on loans. In addition, securities maturities and amortization of mortgage-backed securities are structured to provide a source of liquidity. Sales of loans and available for sale securities can also provide liquidity should the need arise. While maturities and scheduled amortization of loans and mortgage-backed securities are a predictable source of funds, deposit flows and mortgage and mortgage-backed securities prepayments are greatly influenced by general interest rates, economic conditions and competition. Liquidity management is both a daily and long-term function of the Company’s management strategy. In the event that the Company should require funds beyond its ability to generate them internally, additional funds are available through the use of FHLB advances, brokered deposits and federal funds purchased.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the subsidiary bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined).

Management believes, as of September 30, 2008, that the Company and the Bank meet all capital adequacy requirements to which they are subject. The Company and Bank’s actual capital amounts and ratios under the state charter are presented in the following table.

 

In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law. Pursuant to EESA, the U.S. Treasury will have the authority to, among other things, purchase up to $700 billion of mortgages, mortgaged-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. On October 14, 2008, the Department of the Treasury announced that it would purchase equity stakes in a wide variety of banks and thrifts using $250 billion of capital from the EESA funds under a program known as the Troubled Asset Relief Program Capital Purchase Program (the “TARP Capital Purchase Program”). The TARP Capital Purchase Program involves the purchase by the Treasury of preferred stock in financial institutions with warrants to purchase common stock. Also on October 14, 2008, the FDIC announced the Temporary Liquidity Guarantee Program, which provides for the guarantee of newly-issued senior unsecured debt of banks, thrifts and certain holding companies as well as full deposit insurance coverage for non-interest bearing deposit transaction accounts, regardless of dollar amount. Unlimited coverage for non-interest bearing transaction accounts under the Temporary Liquidity Guarantee Program is available for 30 days without charge and thereafter at a cost of 10 basis points per annum. The Company and the Bank are currently assessing their participation in the TARP Capital Purchase Program and the Temporary Liquidity Guarantee Program, and are consulting with First Merchants Corporation regarding such participation in light of the proposed merger of the Company and First Merchants Corporation, but they have not yet decided whether they will participate in either program.

Other

The Securities and Exchange Commission maintains a Web site that contains reports, proxy information statements, and other information regarding registrants that file electronically with the Commission, including the Company. The address is http://www.sec.gov.

 

 

An important component of Lincoln Bank’s asset/liability management policy includes examining the interest rate sensitivity of its assets and liabilities and monitoring the expected effects of interest rate changes on the economic value of its assets. An asset or liability is interest rate sensitive within a specific time period if it will mature or reprice within that time period. If Lincoln Bank’s assets mature or reprice more quickly or to a greater extent than its liabilities, economic value and net interest income would tend to increase during periods of rising interest rates, but decrease during periods of falling interest rates. Conversely, if Lincoln Bank’s assets mature or reprice more slowly or to a lesser extent than its liabilities, economic value and net interest income would tend to decrease during periods of rising interest rates but increase during periods of falling interest rates.

The Bank’s board of directors has delegated responsibility for the day-to-day management of interest rate risk to the Asset/Liability (“ALCO”) Committee. The ALCO Committee meets monthly to manage and review Lincoln Bank’s assets and liabilities. The ALCO Committee reviews interest rates for deposits and loan product pricing. The committee considers the Bank’s interest rate risk position, liquidity needs and competitive pricing.

Presented below, as of September 30, 2008 is an analysis showing the present value impact of changes in interest rates, assuming a comprehensive mark-to-market environment. Noninterest sensitive assets and liabilities such as cash, accounts receivable, fixed assets, and other liabilities are excluded from the analysis.

The same information as of December 31, 2007 is presented below.

 

 

 

(a)   Evaluation of disclosure controls and procedures . The Company’s chief executive officer and chief financial officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures (as defined in Sections 13a-15(e) and 15d-15(e) of the regulations promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the most recent fiscal quarter covered by this quarterly report (the “Evaluation Date”), have concluded that as of the Evaluation Date, the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and are designed to ensure that information required to be disclosed in those reports is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.

(b)   Changes in internal control over financial reporting . There were no changes in the Company’s internal control over financial reporting identified in connection with the Company’s evaluation of controls that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Although the Company and its subsidiaries are involved, from time to time, in various legal proceedings arising in the ordinary course of business, there are no material legal proceedings to which they are a party or to which their property is subject.

Item 1A. Risk Factors

There have been no material changes with respect to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

Not applicable

None

 

None

None

The response to this item is incorporated by reference from the attached Exhibit Index

 

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

EXHIBIT INDEX

 

 

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