10-Q 1 ucb10q_0512.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO Commission file number: 000-23543 UNION COMMUNITY BANCORP (Exact name of registrant specified in its charter) Indiana 35-2025237 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 221 East Main Street Crawfordsville, Indiana 47933 (Address of principal executive offices, including Zip Code) (765) 362-2400 (Registrant's telephone number, including area code) 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 report), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] The number of shares of the Registrant's common stock, without par value, outstanding as of March 31, 2005 was 1,939,000. Union Community Bancorp Form 10-Q Index Page No. -------- FORWARD LOOKING STATEMENT 3 PART I. FINANCIAL INFORMATION 4 Item 1. Financial Statements 4 Consolidated Condensed Balance Sheets 4 Consolidated Condensed Statements of Income 5 Consolidated Condensed Statement of Shareholders' Equity 6 Consolidated Condensed Statements of Cash Flows 7 Notes to Unaudited Consolidated Condensed Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 3. Quantitative and Qualitative Disclosures about Market Risk 12 Item 4. Controls and Procedures 12 PART II. OTHER INFORMATION Item 1. Legal Proceedings 13 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 13 Item 3. Defaults Upon Senior Securities 13 Item 4. Submission of Matters to a Vote of Security Holders 13 Item 5. Other Information 13 Item 6. Exhibits 13 SIGNATURES 14 CERTIFICATIONS 15 2 FORWARD LOOKING STATEMENT This Quarterly Report on Form 10-Q ("Form 10-Q") contains statements which 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 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. 3 PART I FINANCIAL INFORMATION Item 1. Financial Statements

See notes to consolidated condensed financial statements. 5

See notes to consolidated condensed financial statements. 6

See notes to consolidated condensed financial statements. 7 UNION COMMUNITY BANCORP AND SUBSIDIARY Notes to Unaudited Consolidated Condensed Financial Statements Note 1: Basis of Presentation The consolidated financial statements include the accounts of Union Community Bancorp, an Indiana corporation (the "Company") and its wholly owned subsidiary, Union Federal Savings and Loan Association, a federally chartered savings and loan association ("Union Federal"). A summary of significant accounting policies is set forth in Note 1 of Notes to Consolidated Financial Statements included in the 2004 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 March 31, 2005, and for the three months ended March 31, 2005 and 2004, 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 ended March 31, 2005, are not necessarily indicative of the results which may be expected for the entire year. The consolidated condensed balance sheet of the Company as of December 31, 2004 has been derived from the audited consolidated balance sheet of the Company as of that date. Note 2: 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 97,175 shares of common stock at $18.15 per share were outstanding at March 31, 2005, but were not included in the computation of diluted earnings per share because the option price was greater than the average market price of the common shares. 8 Note 3: Stock Options The Company has a stock-based employee compensation plan, which is described more fully in the Notes to Financial Statements included in the December 31, 2004 Annual Report to shareholders. The Company accounts for this plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the grant date. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

In December, 2004, the Financial Accounting Standards Board (FASB) issued an amendment to SFAS 123 (SFAS 123R) which eliminates the ability to account for share-based compensation transactions using Accounting Principles Board Opinion No. 25 and generally requires that such transactions be accounted for using a fair value-based method. SFAS 123R will be effective for the Company beginning January 1, 2006. SFAS123R applies to all awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date. The cumulative effect of initially applying this Statement, if any, is recognized as of the required effective date. As of the required effective date, the Company will apply SFAS 123R using either the modified version of prospective application or the modified version of retrospective application. Under prospective transition method, compensation cost is recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under SFAS 123 for either recognition or pro forma disclosures. For periods before the required effective date, a company may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by SFAS 123. The Company is currently evaluating the effect of the recognition and measurement provisions of SFAS 123R but believes the adoption of SFAS 123R will not result in a material impact on the Company's results of operations or financial condition. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations General The Company was organized in September 1997. On December 29, 1997, it acquired the common stock of Union Federal upon the conversion of Union Federal from a federal mutual savings and loan association to a federal stock savings and loan association. The Company acquired Montgomery Financial Corporation ("Montgomery") in a transaction that closed on January 2, 2002. In the transaction, Montgomery was merged with and into the Company, and Montgomery Savings, a federally chartered thrift, was merged with and into Union Federal. Following the merger, MSA Service Corp. became a subsidiary of Union Federal until it was dissolved in 2004. Union Federal was organized as a state-chartered savings and loan association in 1913. Union Federal conducts its business from its main office located in Crawfordsville, Indiana. In addition, Union Federal has two additional branch offices in Crawfordsville and branch offices in Covington, Williamsport and Lafayette, Indiana. Four of the above mentioned branch offices were added in connection with the acquisition of Montgomery. 9 Union Federal offers a variety of lending, deposit and other financial services to its retail and commercial customers. Union Federal's principal business consists of attracting deposits from the general public and originating fixed-rate and adjustable-rate loans secured primarily by first mortgage liens on one- to four-family residential real estate. Union Federal's deposit accounts are insured up to applicable limits by the Savings Association Insurance Fund of the Federal Deposit Insurance Corporation. Union Federal offers a number of financial services, which include: (i) residential real estate loans; (ii) multi-family loans; (iii) commercial real estate loans; (iv) construction loans; (v) home improvement loans and consumer loans, including single-pay loans, loans secured by deposits, installment loans and commercial loans; (vi) money market demand accounts; (vii) passbook savings accounts; and (viii) certificates of deposit. Union Federal previously had two wholly-owned subsidiaries. MSA Service Corp. ("MSA") engaged in real estate development for the construction of a seven-unit condominium project located in Crawfordsville, Indiana. Union Federal's investment in MSA was excluded from the calculation of regulatory capital under OTS regulations. During the second quarter of 2004, MSA's condominium development was completed and the remaining assets of MSA were transferred to Union Federal. Effective as of June 23, 2004, MSA was dissolved. Union Federal also owns UFS Service Corp. ("UFS"), whose sole asset was its investment in Pedcor 1993, which is an Indiana limited partnership that was established to organize, build, own, operate and lease a 48-unit apartment complex in Crawfordsville, Indiana, known as Shady Knoll II Apartments (the "Project"). UFS did not engage in any activity or hold any assets other than its investment in Pedcor. During the second quarter of 2004, the assets and liabilities of UFS were transferred to Union Federal and Union Federal is in the process of voluntarily dissolving UFS. Union Federal'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 Union Federal's non-interest income, including fee income and service charges, and the level of its non-interest expenses, including general and administrative expenses. Critical Accounting Policies Note 1 of the Notes to Consolidated Financial Statements, presented on pages 26 through 29 of the 2004 Annual Report to Shareholders filed on March 29, 2005 with the Company's Form 10-K for the year ended December 31, 2004, contains a summary of the Company's significant accounting policies. 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 the foreclosed assets and real estate held for development, and the valuation of intangible assets. Allowance for loan losses The allowance for loan losses is a significant estimate that can and does change based on management's assumptions about specific borrowers and current general economic and business conditions, among other factors. Management reviews the adequacy of the allowance for loan losses at least on a quarterly basis. The evaluation includes a review of payment performance, adequacy of collateral and financial condition of all major borrowers. A review of all nonperforming loans and other identified problem loans is performed and the probability of collecting all amounts due thereunder is determined. In addition, changes in the composition of the loan portfolio, the total outstanding loans and past loss experience are reviewed to determine the adequacy of the allowance for loan losses. Current economic and market conditions and potential negative changes to economic conditions are also reviewed in determining possible loan losses. Although it is the intent of management to fully evaluate and estimate the potential effects of economic and market conditions, changes in the conditions are susceptible to significant changes beyond those projected. A worsening or protracted economic decline beyond management's projections would increase the likelihood of additional losses due to the additional credit and market risk and could create the need for additional loss reserves. Foreclosed assets and real estate held for development Foreclosed assets and real estate held for development are carried at the lower of cost or fair value less estimated selling costs. Management estimates the fair value of the properties based on current appraisal information. Reviews of estimated fair value are performed on at least an annual basis. Economic environment, market conditions and the real estate market are continually monitored and decreases in the carried value are written down through current operations when any of these factors indicate a decrease to the market value of the assets. Future worsening or protracted economic conditions and a decline in the real estate market would increase the likelihood of a decline in property values and could create the need for future write downs of the properties held. 10 Intangible assets Management periodically assesses the impairment of its goodwill and the recoverability of its core deposit intangible. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. If actual external conditions and future operating results differ from management's judgments, impairment and/or increased amortization charges may be necessary to reduce the carrying value of these assets to the appropriate value. A review of the fair value of the Company's goodwill and core deposit intangible was performed in the fourth quarter of 2004 and it was management's opinion that there was no impairment to these intangible assets as of the date of the review. Financial Condition Total assets increased $4.4 million to $261.3 million at March 31, 2005 from $256.9 million at December 31, 2004. Net loans increased $5.9 million to $222.9 million at March 31, 2005. Cash and cash equivalents decreased $1.1 million from December 31, 2004 to March 31, 2005. Investment securities available for sale decreased $42,000 during the three month period. Premises and equipment decreased $70,000 to $4.1 million at March 31, 2005. In connection with the Montgomery acquisition, the balance of goodwill and core deposit intangibles are $2.4 million and $299,000 respectively. Goodwill is reviewed annually for impairment and core deposit intangibles are being amortized. Deposits decreased by $827,000 to $187.6 million and borrowed funds increased by $5.0 million to $37.9 million during the first quarter of 2004. These borrowings were primarily used to fund loan growth. Shareholders' equity increased $219,000 to $33.7 million at March 31, 2005. The increase was primarily due to net income for the three months ended March 31, 2005 of $289,000, Employee Stock Ownership Plan shares earned of $39,000, unearned compensation amortization of $28,000, stock options exercised of $162,000 offset by unrealized loss on available for sale securities of $25,000 and cash dividends of $274,000. Comparison of Operating Results for the Three Months Ended March 31, 2005 and 2004 Net income decreased $155,000 from $444,000 for the three months ended March 31, 2004 to $289,000 for the three months ended March 31, 2005. The return on average assets for the three months ended March 31, 2005 was .45% compared to .68% for the comparable period in 2004. The return on average equity for the three months ended March 31, 2005 was 4.26% compared to 3.44% for the comparable period in 2004. For the three months ended March 31, 2005, interest income was $3.5 million as compared to $3.6 million for the three months ended March 31, 2004, a decrease of $65,000. Interest income decreased primarily due to a decrease in the yield on interest-earning assets from 5.82% during the 2004 period to 5.81% during the 2005 period and a decrease in average interest-earning assets from $244.3 million at March 31, 2004 to $240.4 million at March 31, 2005. The decrease in average interest-earning assets was due to a decrease in other investment securities of $2.5 million and a decrease in loans receivable of $1.5 million. For the three months ended March 31, 2005, interest expense was $1,622,000 as compared to $1,598,000 for the three months ended March 31, 2004. Interest expense increased primarily due to an increase in the cost of interest-bearing liabilities from 2.90% during the 2004 period to 2.96% during the 2005 period partially offset by a decrease in average interest-bearing liabilities from $220.5 million at March 31, 2004 to $219.1 million at March 31, 2005. The amortization of purchase accounting adjustments reduced interest expense by $27,000 in both the 2004 and 2005 reporting periods. The provision for loan losses for the three months ended March 31, 2005 was $60,000 as compared to $110,000 for the comparable period in 2004. During the three month period ending March 31, 2004 a charge to the loan loss reserve was made in the amount of $135,000 to write down a participation loan secured by a nursing home. Upon review of the loan portfolio including classified loans it was determined the balance in the allowance for loan losses was adequate at March 31, 2005. Total other income decreased by $58,000 from $159,000 for the three months ended March 31, 2004 to $101,000 for the 2005 month period due to the recognition of losses related to investments in limited partnerships offset by increases in service charges on deposit accounts and other fee income. Due to the operating results of the limited partnerships, equity in losses of the limited partnerships increased to $114,000 for the three months ended March 31, 2005 as compared to no losses recorded in the first quarter of 2004. In addition to recording the equity in the losses of these limited partnerships, the Company receives low income housing income tax credits. Based on expected occupancy percentages, the Company expects to receive full tax credits by 2006. Increases in services charges on deposit accounts of $29,000 and other income of $27,000 were primarily due to increases in services offered and other miscellaneous fees. Other expenses increased $92,000 from $1,389,000 for the three months ended March 31, 2004 to $1,481,000 for the comparable period in 2005. Expenses increased primarily due to an increase in salaries and employee benefits of $94,000. This increase was due to an increase in employee salaries based on the annual reviews and normal increases in the cost of benefits, primarily medical insurance, provided to employees. 11 Asset Quality Union Federal currently classifies loans as special mention, substandard, doubtful and loss to assist management in addressing collection risks and pursuant to regulatory requirements which are not necessarily consistent with generally accepted accounting principles. 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 Union Federal's credit position at some future date. Substandard loans represent credits characterized by the distinct possibility that some loss will be sustained if deficiencies 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. At March 31, 2005 Union Federal had $3.5 million in classified loans as compared to $3.8 million at December 31, 2004. Union Federal had $1.5 million and $1.8 million in loans classified as special mention as of March 31, 2005 and December 31, 2004 respectively. In addition, Union Federal had $1.6 million and $1.7 million of loans classified as substandard at March 31, 2005 and December 31, 2004, respectively. At both March 31, 2005 and at December 31, 2004, $325,000 in loans was classified as doubtful and no loans were classified as loss for either period end. At March 31, 2005 and December 31, 2004 all of the substandard and doubtful loans totaling $1,973,000 and $2,050,000, respectively, were non-accrual loans. The allowance for loan losses was $960,000 or .43% of loans at March 31, 2005 as compared to $910,000 or .42% of loans at December 31, 2004. Liquidity and Capital Resources The standard measure of liquidity for savings associations is the ratio of cash and eligible investments to a certain percentage of net withdrawable savings accounts and borrowings due within one year. The minimum required ratio is currently set by the Office of Thrift Supervision regulation at 4%. As of March 31, 2005, Union Federal had liquid assets of $12.4 million and a liquidity ratio of 5.6%. 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. Item 3. Quantitative and Qualitative Disclosures About Market Risk Presented below, as of December 31, 2004 and 2003, is the most recent available analyses performed by the OTS of Union Federal's interest rate risk as measured by changes in net portfolio value ("NPV") for instantaneous and sustained parallel shifts in the yield curve, in 100 basis point increments.

Management believes that at March 31, 2005, there have been no material changes in market interest rates or in the Company's interest rate sensitive instruments which would cause a material change in the market risk exposures which affect the quantitative and qualitative risk disclosures as presented on pages 18-20 of the Company's 2004 Annual Report to Shareholders filed with the Company's Annual Report on Form 10-K for the period ended December 31, 2004. Item 4. Controls and Procedures (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), 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 were adequate and are designed to ensure that material information relating to the Company would be made known to such officers by others within the Company on a timely basis. 12 (b) Changes in internal controls. There were no significant 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 Item 1. Legal Proceedings 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 2. Unregistered Sales of Equity Securities and Use of Proceeds None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders No matter was submitted to a vote of the Company's shareholders during the first quarter of 2004. Item 5. Other Information None. Item 6. Exhibits Exhibits 31(1) Certification required by 17 C.F.R. ss. 240.13a-14(a) 31(2) Certification required by 17 C.F.R. ss. 240.13a-14(a) 32 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 13 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. UNION COMMUNITY BANCORP Date: May 16, 2005 /s/ Alan L. Grimble --------------------------------------- Alan L. Grimble Chief Executive Officer Date: May 16, 2005 /s/ J. Lee Walden --------------------------------------- J. Lee Walden Chief Financial Officer 14

UNION COMMUNITY BANCORP 10-Q