| AMERIANA BANCORP Item 1A Risk Factors An investment in shares of our common stock involves various risks |
| Before deciding to invest in our common stock, you should carefully consider the risks described below in conjunction with the other information in this Form 10-K, including the items included as exhibits |
| Our business, financial condition and results of operations could be harmed by any of the following risks or by other risks that have not been identified or that we may believe are immaterial or unlikely |
| The value or market price of our common stock could decline due to any of these risks |
| The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements |
| A significant percentage of our assets are invested in lower yielding investments, which has contributed to our low profitability |
| Our results of operations are substantially dependant on our net interest income, which is the difference between the interest income earned on our interest-earning assets and the interest expense paid on our interest-bearing liabilities |
| The low interest-rate environment that existed in 2001 through mid-2004 led to the refinancing of a substantial portion of our one- to four-family loans |
| These loans were subsequently sold to minimize the potential interest rate risk associated with maintaining such long-term low-interest loans in portfolio |
| The proceeds from such loans sales were invested in government agency securities |
| Additionally, during such period, our residential loan production decreased due to reduced demand in our market area |
| Accordingly, at December 31, 2005, 37dtta5prca of our assets were invested in investment and mortgage-backed securities |
| To counteract this, in 2004, we devoted more resources towards loan production, specifically residential and commercial real estate lending, with the goal of investing a greater proportion of our assets in loans |
| We have also made efforts to reduce our cost of funds, through more disciplined and effective pricing strategies, and to reduce our operating expenses, by reducing staffing levels and freezing our pension plan in June 2004 |
| Together, these efforts are designed to increase our net interest income |
| There can be no assurance, however, that we will be able to increase the origination of loans, successfully reduce our cost of funds or operating expenses or that we will be able to successfully implement this strategy |
| Certain interest rate movements may hurt our earnings |
| Interest rates have recently been at historically low levels |
| However, since June 30, 2004, the US Federal Reserve has increased its target for the federal funds rate fifteen times, from 1dtta00prca to 4dtta75prca |
| While these short-term market interest rates (which we use as a guide to price our deposits) have increased, longer-term market interest rates (which we use as a guide to price our longer-term loans) have not |
| This “flattening” of the market yield curve has resulted in our interest rate spread declining from 3dtta08prca at December 31, 2003 to 2dtta42prca at December 31, 2005 and net interest margin declining from 3dtta24prca for the year ended December 31, 2003 to 2dtta57prca for the year ended December 31, 2005 |
| If short-term interest rates continue to rise, and if rates on our deposits and borrowings continue to reprice upwards faster than the rates on our long-term loans and investments, we would experience further compression of our interest rate spread and net interest margin, which would have a negative effect on our profitability |
| Our increased emphasis on commercial and construction lending may expose us to increased lending risks |
| At December 31, 2005, our loan portfolio consisted of dlra68dtta5 million, or 31dtta0prca of commercial real estate loans, dlra44dtta8 million, or 20dtta3prca of construction loans and dlra8dtta0 million, or 3dtta6prca of commercial business loans |
| We intend to continue to increase our emphasis on the origination of commercial and construction lending |
| However, these types of loans generally expose a lender to greater risk of non-payment and loss than one- to four-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property, the income stream of the borrowers and, for construction loans, the accuracy of the estimate of the property’s value at completion of construction and the estimated cost of construction |
| Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans |
| Commercial business loans expose us to additional risks since they typically are made on the basis of the borrower’s ability to make repayments from the cash flow of the borrower’s business and are secured by non-real estate collateral that may depreciate over time |
| In addition, since such loans generally entail greater risk than one- to four-family residential mortgage loans, we may need to increase our allowance for loan losses in the future to account for the likely increase in probable incurred credit losses associated with the growth of such loans |
| Also, many of our commercial and construction borrowers have more than one loan outstanding with us |
| Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan |
| (29) ______________________________________________________________________ [56]Table of Contents Our relatively high level of non-performing loans and classified assets expose us to increased lending risks |
| Further, our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio |
| At December 31, 2005, our non-performing loans totaled dlra2dtta6 million, representing 1dtta16prca of total loans |
| In addition, loans that we have classified as either substandard, doubtful or loss totaled dlra15dtta8 million, representing 7dtta2prca of total loans |
| If these loans do not perform according to their terms and the collateral is insufficient to pay any remaining loan balance, we may experience loan losses, which could have a material effect on our operating results |
| Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety |
| We believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date |
| However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results |
| In evaluating the adequacy of our allowance for loan losses, we consider numerous quantitative factors, including our historical charge-off experience, growth of our loan portfolio, changes in the composition of our loan portfolio and the volume of delinquent and classified loans |
| In addition, we use information about specific borrower situations, including their financial position and estimated collateral values, to estimate the risk and amount of loss for those borrowers |
| Finally, we also consider many qualitative factors, including general and economic business conditions, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters, which are by nature more subjective and fluid |
| Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers’ abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors |
| Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses may vary from our current estimates |
| At December 31, 2005, our allowance for loan losses as a percentage of total loans was 1dtta28prca |
| Our regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs, net of recoveries |
| Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations |
| Our cost of operations is high relative to our assets |
| Our failure to maintain or reduce our operating expenses costs could hurt our profits |
| Our operating expenses, which consist primarily of salaries and employee benefits, occupancy, furniture and equipment expense, professional fees and data processing expense, totaled dlra14dtta5 million for the year ended December 31, 2005 compared to dlra13dtta4 million for the year ended December 31, 2004 |
| Our efficiency ratio totaled 104dtta40prca for the year ended December 31, 2005 compared to 90dtta87prca for the year ended December 31, 2004 |
| We have made a concerted effort to control our expenses and operate more efficiently, through such actions as reducing personnel and freezing of our pension plan |
| Strong competition within our market area could hurt our profits and slow growth |
| We face intense competition both in making loans and attracting deposits |
| This competition has made it more difficult for us to make new loans and has occasionally forced us to offer higher deposit rates |
| Price competition for loans and deposits might result in us earning less on our loans and paying more on our deposits, which reduces net interest income |
| According to the Federal Deposit Insurance Corporation, as of June 30, 2005, we held 35dtta0prca of the deposits in Henry County, Indiana, which was the largest market share of deposits out of the four financial institutions that held deposits in this county |
| We also held 11dtta9prca of the deposits in Hancock County, Indiana, which was the 4^th largest market share of deposits out of the ten financial institutions that held deposits in this county |
| Some of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide |
| We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry |
| Our profitability depends upon our continued ability to compete successfully in our market area |
| (30) ______________________________________________________________________ [57]Table of Contents If we do not achieve profitability on our new branch, it may negatively impact our earnings |
| We opened our McCordsville branch office in February 2004 |
| Numerous factors contribute to the performance of a new branch, such as a suitable location, qualified personnel and an effective marketing strategy |
| Additionally, it takes time for a new branch to generate significant deposits and make sufficient loans to produce enough income to offset expenses, some of which, like salaries and occupancy expense, are relatively fixed costs |
| We expect that it may take a period of time before the new branch office can become profitable |
| During this period, operating this new branch office may negatively impact our net income |
| If the value of real estate in central Indiana were to decline materially, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on us |
| With most of our loans concentrated in central Indiana, a decline in local economic conditions could adversely affect the value of the real estate collateral securing our loans |
| A decline in property values would diminish our ability to recover on defaulted loans by selling the real estate collateral, making it more likely that we would suffer losses on defaulted loans |
| Additionally, a decrease in asset quality could require additions to our allowance for loan losses through increased provisions for loan losses, which would hurt our profits |
| Also, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are more geographically diverse |
| Real estate values are affected by various factors in addition to local economic conditions, including, among other things, changes in general or regional economic conditions, governmental rules or policies and natural disasters |
| Our business is subject to the success of the local economy in which we operate |
| Because the majority of our borrowers and depositors are individuals and businesses located and doing business in central Indiana our success significantly depends to a significant extent upon economic conditions in central Indiana |
| Adverse economic conditions in our market area could reduce our growth rate, affect the ability of our customers to repay their loans and generally affect our financial condition and results of operations |
| Conditions such as inflation, recession, unemployment, high interest rates, short money supply, scarce natural resources, international disorders, terrorism and other factors beyond our control may adversely affect our profitability |
| We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies |
| Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in Indiana could adversely affect the value of our assets, revenues, results of operations and financial condition |
| Moreover, we cannot give any assurance we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur |
| The trading history of our common stock is characterized by low trading volume |
| Our common stock may be subject to sudden decreases |
| Although our common stock trades on Nasdaq National Market, it has not been regularly traded |
| We cannot predict whether a more active trading market in our common stock will occur or how liquid that market might become |
| A public trading market having the desired characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace of willing buyers and sellers of our common stock at any given time, which presence is dependent upon the individual decisions of investors, over which we have no control |
| The market price of our common stock may be highly volatile and subject to wide fluctuations in response to numerous factors, including, but not limited to, the factors discussed in other risk factors and the following: • actual or anticipated fluctuations in our operating results; • changes in interest rates; • changes in the legal or regulatory environment in which we operate; • press releases, announcements or publicity relating to us or our competitors or relating to trends in our industry; • changes in expectations as to our future financial performance, including financial estimates or recommendations by securities analysts and investors; • future sales of our common stock; (31) ______________________________________________________________________ [58]Table of Contents • changes in economic conditions in our marketplace, general conditions in the US economy, financial markets or the banking industry; and • other developments affecting our competitors or us |
| These factors may adversely affect the trading price of our common stock, regardless of our actual operating performance, and could prevent you from selling your common stock at or above the price you desire |
| In addition, the stock markets, from time to time, experience extreme price and volume fluctuations that may be unrelated or disproportionate to the operating performance of companies |
| These broad fluctuations may adversely affect the market price of our common stock, regardless of our trading performance |
| We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations |
| Ameriana Bank and Trust, SB is subject to extensive regulation, supervision and examination by the Indiana Department of Financial Institutions, its chartering authority, and by the Federal Deposit Insurance Corporation, as insurer of its deposits |
| Ameriana Bancorp is subject to regulation and supervision by the Federal Reserve Board |
| Such regulation and supervision govern the activities in which an institution and its holding company may engage, and are intended primarily for the protection of the insurance fund and for the depositors and borrowers of Ameriana Bank and Trust, SB The regulation and supervision by the Indiana Department of Financial Institutions and the Federal Deposit Insurance Corporation are not intended to protect the interests of investors in Ameriana Bancorp common stock |
| Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses |
| Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations |
| Provisions of our articles of incorporation, bylaws and Indiana law, as well as state and federal banking regulations, could delay or prevent a takeover of us by a third party |
| Provisions in our articles of incorporation and bylaws and the corporate law of the State of Indiana could delay, defer or prevent a third party from acquiring us, despite the possible benefit to our shareholders, or otherwise adversely affect the price of our common stock |
| These provisions include: supermajority voting requirements for certain business combinations; the election of directors to staggered terms of three years; and advance notice requirements for nominations for election to our board of directors and for proposing matters that shareholders may act on at shareholder meetings |
| In addition, we are subject to Indiana laws, including one that prohibits us from engaging in a business combination with any interested shareholder for a period of five years from the date the person became an interested shareholder unless certain conditions are met |
| These provisions may discourage potential takeover attempts, discourage bids for our common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of, our common stock |
| These provisions could also discourage proxy contests and make it more difficult for you and other shareholders to elect directors other than the candidates nominated by our Board |