10-Q 1 form10q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 2003 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 000-32643 INDIAN RIVER BANKING COMPANY ---------------------------- (Exact name of registrant as specified in its charter) Florida 59-2931518 ------- ---------- (State of other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 958 20th Place, Vero Beach, Florida 32960 ---------------------------------------- ----- (Address of principal executive offices) (Zip Code) 772.569.9200 ------------ (Registrant's telephone number, including area code) N/A --- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. |X| Yes | | No Indicate by check mark whether the registrant is an accelerated filer | | Yes |X| No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. As of October 31, 2003, the registrant had 2,187,402 shares of Common Stock outstanding. Part I Financial Information Item 1 - Financial Statements INDIAN RIVER BANKING COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands)

See Notes to Condensed Consolidated Financial Statements. 2 INDIAN RIVER BANKING COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (UNAUDITED) (In Thousands, Except Per Share Data) 2003 2002 -------------------------------------------------------------------------------- Interest income: Loans and fees on loans $4,006 $4,253 Investment securities and due from banks 1,648 2,167 Federal funds sold 3 14 ------ ------ 5,657 6,434 ------ ------ Interest expense: Deposits 1,469 1,738 Other 579 424 ----- ------ 2,048 2,162 ----- ------ NET INTEREST INCOME 3,609 4,272 Provision for loan losses 90 180 ------ ------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 3,519 4,092 ------ ------ Other income: Service charges and fees 650 448 Gain on sale of securities -- 62 Gain on sale of loans 589 347 Other 363 243 ------ ------ 1,602 1,100 ------ ------ Other expense: Salaries and benefits 1,597 1,561 Occupancy and equipment 483 408 Data processing 399 294 Other operating expenses 680 694 ----- ------ 3,159 2,957 ----- ------ INCOME BEFORE INCOME TAXES 1,962 2,235 Income taxes 710 838 ------ ------ NET INCOME $1,252 $1,397 ====== ====== Basic earnings per share $ 0.58 $ 0.65 ====== ====== Diluted earnings per share $ 0.56 $ 0.64 ====== ====== Dividends per share $ -- $ -- ====== ====== See Notes to Condensed Consolidated Financial Statements. 3 INDIAN RIVER BANKING COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (UNAUDITED) (In Thousands, Except Per Share Data) 2003 2002 ----------------------------------------------------------------------------- Interest income: Loans and fees on loans $12,229 $12,639 Investment securities and due from banks 5,746 6,484 Federal funds sold 42 119 ------- ------- 18,017 19,242 ------- ------- Interest expense: Deposits 4,695 5,894 Other 1,647 1,191 ------- ------- 6,342 7,085 ------- ------- NET INTEREST INCOME 11,675 12,157 Provision for loan losses 355 440 ------- ------- NET INTEREST INCOME AFTER PROVISION 11,320 11,717 FOR LOAN LOSSES ------- ------- Other income: Service charges and fees 1,821 1,273 Gain on sale of securities 167 813 Gain on sale of loans 1,822 1,034 Other 793 638 ------- ------- 4,603 3,758 ------- ------- Other expense: Salaries and benefits 5,140 4,404 Occupancy and equipment 1,398 1,174 Data processing 1,164 970 Other operating expenses 2,334 2,133 ------- ------- 10,036 8,681 ------- ------- INCOME BEFORE INCOME TAXES 5,887 6,794 Income taxes 2,177 2,552 ------- ------- NET INCOME $ 3,710 $ 4,242 ======= ======= Basic earnings per share $ 1.71 $ 1.98 ======= ======= Diluted earnings per share $ 1.65 $ 1.94 ======= ======= Dividends per share $ -- $ -- ======= ======= See Notes to Condensed Consolidated Financial Statements. 4 INDIAN RIVER BANKING COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (UNAUDITED) (In Thousands)

See Notes to Condensed Consolidated Financial Statements 5 INDIAN RIVER BANKING COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (UNAUDITED) (In Thousands) 2003 2002 -------------------------------------------------------------------------------- Cash Flows From Operating Activities Net income $ 3,710 $ 4,242 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 512 449 Provision for loan losses 355 440 Proceeds from sale of loans originated for resale 92,449 46,431 Origination of loans for resale (78,850) (43,071) Gain on sale of loans (1,822) (1,034) Stock-based compensation 49 8 Amortization of premiums and discounts, net 2,395 188 Gain on sale of securities (167) (813) Increase (decrease) in accrued interest receivable (178) 569 Increase in other assets (127) (246) Increase in other liabilities 270 462 -------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES 18,596 7,625 -------- -------- Cash Flows From Investing Activities Cash flows from securities, net (71,808) (23,151) Loan originations, net of collections (13,223) (16,430) Purchases of premises and equipment (723) (469) -------- -------- NET CASH USED BY INVESTING ACTIVITIES (85,754) (40,050) -------- -------- Cash Flows From Financing Activities Net increase in deposits 45,258 15,264 Net increase in other borrowings 13,622 9,824 Proceeds from exercise of stock options 296 97 Cash paid for fractional shares (13) (8) Proceeds from issuance of trust preferred securities -- 6,790 -------- -------- NET CASH PROVIDED BY FINANCING ACTIVITIES 59,163 31,967 -------- -------- NET DECREASE IN CASH AND CASH EQUIVALENTS (7,995) (458) Cash and cash equivalents: Beginning 19,857 23,367 -------- -------- Ending $ 11,862 $ 22,909 ======== ======== See Notes to Condensed Consolidated Financial Statements. 6 INDIAN RIVER BANKING COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION The accompanying condensed consolidated financial statements of Indian River Banking Company, which are unaudited, except for the condensed consolidated balance sheet at December 31, 2002, which is derived from the audited consolidated balance sheet at that date, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statement presentation. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine-month periods ended September 30, 2003, are not necessarily indicative of the results that may be expected for the full year. For further information, refer to Indian River Banking Company's consolidated financial statements and the notes thereto for the year ended December 31, 2002. The accompanying condensed consolidated financial statements include the accounts of Indian River Banking Company ("Indian River") and its wholly-owned subsidiaries, Indian River National Bank ("Indian River Bank"), a federally-chartered independent community bank and its wholly owned subsidiary Indian River National Real Estate, LLC, Indian River Title Company, LLC, IRNB Insurance Services, LLC, and Indian River Capital Trust I, collectively referred to as "Indian River". All significant intercompany accounts and transactions have been eliminated in consolidation. NOTE 2. INVESTMENT SECURITIES Securities held to maturity: The amortized cost and fair values of securities held to maturity as of September 30, 2003 and December 31, 2002 are summarized as follows.

7 Securities available for sale: The amortized cost and fair values of securities available for sale as of September 30, 2003 and December 31, 2002 are summarized as follows:

NOTE 3. LOANS The composition of net loans is as follows at September 30, 2003 and December 31, 2002:

Indian River's recorded investment in impaired loans for which a specific allowance was recognized was $147 thousand and $585 thousand at September 30, 2003 and December 31, 2002, respectively. The specific allowance associated with these loans was $40 thousand and $100 thousand at September 30, 2003 and December 31, 2002, respectively. The average recorded investment in impaired loans during the third quarter of 2003 was $36 thousand compared to $97 thousand for the comparable quarter in 2002. The average recorded investment in impaired loans for the first nine months of 2003 was $414 thousand compared to $293 thousand for the first nine months of 2002. Interest income recognized on impaired loans, recognized for cash payments during the third quarter and the first nine months of 2003 and 2002 was not significant. 8 NOTE 4. ALLOWANCE FOR LOAN LOSSES Activity in the allowance for loan losses for the three months ended September 30, 2003 and 2002 is as follows: (In Thousands) 2003 2002 ---- ---- Balance, beginning $ 3,352 $ 3,015 ---------------- ----------------- Charge-offs: Loans to individuals (16) (20) Credit Cards (15) (10) Other loans (34) (19) ---------------- ----------------- Total (65) (49) ---------------- ----------------- Recoveries: Loans to individuals 5 2 Credit Cards 2 -- Other loans 11 3 ---------------- ----------------- Total 18 5 ---------------- ----------------- Net charge-offs (47) (44) Provision for loan losses 90 180 ---------------- ----------------- Balance, ending $ 3,395 $ 3,151 ================ ================= Activity in the allowance for loan losses for the nine months ended September 30, 2003 and 2002 is as follows: (In Thousands) 2003 2002 ---- ---- Balance, beginning $ 3,259 $ 2,819 ---------------- ----------------- Charge-offs: 1-4 Family Real Estate (34) -- Nonfarm, nonresidential (62) -- Commercial and industrial (14) (2) Loans to individuals (35) (71) Credit Cards (44) (36) Other loans (76) (32) ---------------- ----------------- Total (265) (141) ---------------- ----------------- Recoveries: 1-4 Family Real Estate -- 6 Commercial and Industrial -- 1 Loans to individuals 17 20 Credit Cards 6 2 Other loans 23 4 ---------------- ----------------- Total 46 33 ---------------- ----------------- Net charge-offs (219) (108) Provision for loan losses 355 440 ---------------- ----------------- Balance, ending $ 3,395 $ 3,151 ================ ================= 9 NOTE 5. EARNINGS PER SHARE Basic earnings per-share amounts are computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding, adjusted for stock dividends and splits occurring subsequent to period-end (the denominator). Diluted earnings per-share amounts assume the conversion, exercise or issuance of all potential common stock instruments unless the effect is to reduce the loss or increase the income per common share from continuing operations. Diluted earnings per share are calculated using the Treasury Stock Method. Following is information about the computation of the earnings per share data for the three and nine months ended September 30, 2003 and 2002 respectively (after adjusting for 10% stock dividends in 2003 and 2002):

10 NOTE 6. OTHER BORROWINGS Other borrowings consist of the following at September 30, 2003 and December 31, 2002:

NOTE 7. STOCK DIVIDEND Stockholders' equity accounts have been retroactively adjusted in the accompanying balance sheet as of December 31, 2002 to reflect a 10% stock dividend declared in January 2003. NOTE 8. TRUST PREFERRED SECURITIES On September 30, 2002, a wholly-owned statutory business trust established by Indian River issued $7 million in guaranteed preferred beneficial interests in the trust ("trust-preferred securities"). The sole assets of the statutory business trust are a series of subordinated debentures of Indian River in the amount of $7 million and related payments. Indian River has fully and unconditionally guaranteed the statutory business trust's obligations under the trust-preferred securities, to the extent set forth in the guarantee agreement. The subordinated debentures are unsecured and subordinate to all senior debt (as defined) of Indian River. The subordinated debentures and the trust preferred securities bear interest at a variable rate of 3 month LIBOR plus 3.45%, 4.58% for the quarterly period ended September 30, 2003 and mature on November 7, 2032. They are redeemable in whole or in part on or after November 7, 2007. The trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures at their maturity or earlier redemption. 11 NOTE 9. STOCK BASED COMPENSATION Under the terms of the 1999 Stock Option Plan, options to purchase shares of Indian River's common stock may be granted to directors and key officers/employees at a price that is not less than the fair market value of such stock at the date of the grant. Options granted to employees under the plan may be designated as incentive stock options. All options expire no more than ten years from the date of the grant, or three months after an employee's termination. In accordance with the plan, the aggregate number of shares for which options may be granted, the number of shares covered for each outstanding option, and the exercise price per share for each such option shall be proportionately adjusted for the payment of stock dividends or similar adjustments to the number of shares of common stock effected without the receipt of consideration by Indian River. At September 30, 2003, the number of shares eligible to be issued under the Plan was 366,025 and approximately 130,000 shares remained available for granting. In December 1999, the Board of Directors adopted the Director Fee Stock Option Plan, under which each director is entitled to receive options to purchase shares of common stock in lieu of cash compensation for attendance at committee meetings. Options granted have an exercise price equal to the fair value of the common stock at the date of grant. The following is a summary of stock option transactions during the nine-month periods ended September 30, 2003 and 2002 (All options and option price per share information has been adjusted to reflect the stock dividend in 2002 and 2003): Weighted-Average Shares Exercise Price -------------------------------- Outstanding at December 31, 2001 145,718 $ 16.68 Granted 37,776 23.81 Exercised (5,951) 15.95 Forfeited (3,217) 18.55 -------------------------------- Outstanding at September 30, 2002 174,326 $ 18.28 ================================ Outstanding at December 31, 2002 162,200 $ 18.41 Granted 53,590 32.75 Exercised (15,052) 19.64 Forfeited (377) 30.64 -------------------------------- Outstanding at September 30, 2003 200,361 $ 22.13 ================================ Indian River accounts for its stock option plans using the intrinsic value method provided under APB Opinion No. 25, Accounting for Stock Issued to Employees. Generally, Indian River has recognized no compensation cost for stock options granted, as all options granted had an exercise price equal to the estimated market value of the underlying common stock on the date of grant. Option holders may elect a "cashless exercise" of their vested options, under which they receive shares of common stock with a fair value equal to the intrinsic value of the options at the date of exercise, without any payment. Those option awards expected to be exercised via this cashless exercise are accounted for as variable plan awards and, as such, Indian River recognizes compensation expense equal to the change in the intrinsic value of such options during the period. The following table illustrates the effect on net income and earnings per share if Indian River had applied fair value recognition provisions to stock-based employee compensation. 12 NOTE 9. STOCK BASED COMPENSATION (CONTINUED) The fair value of each option granted is estimated on the date of the grant using the Black-Scholes option-pricing model with the following assumptions for grants during 2003: risk-free interest rate of 4.9%, no dividends and expected lives of 8 years. Volatility was assumed to be zero because there is currently no active market for Indian River's stock. The weighted-average fair value of options granted during 2003 was $11.39.

13 NOTE 10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK Indian River, in the normal course of business, is a party to financial instruments with off-balance-sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amounts recognized on the balance sheet. The contractual amounts of these instruments reflect Indian River's involvement in particular classes of financial instruments. Indian River's exposure to credit loss in the event of nonperformance by the counterparty to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. Indian River uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Indian River evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by Indian River upon extension of credit, is based on management's credit evaluation of the counter party. Standby letters of credit are conditional commitments issued by Indian River to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. A summary of the amounts of Indian River's financial instruments, with off-balance sheet risk at September 30, 2003, follows: (In Thousands) 2003 ----------------- Commitments to extend credit $ 63,908 Credit card arrangements 4,161 Standby letters of credit 1,552 ----------------- $ 69,621 ================= 14 NOTE 11. ADDITIONAL CASH FLOW INFORMATION

NOTE 12. SUBSEQUENT EVENTS On October 15, 2003, Indian River declared a $0.50 per share cash dividend, payable on November 17, 2003 to shareholders of record on October 31, 2003. On October 22, 2003 Indian River entered into of a definitive agreement with Alabama National BanCorporation ("ANB") providing for the acquisition of Indian River by ANB. Under the agreement, Indian River shall be merged with and into ANB, and Indian River Bank will become a wholly owned subsidiary of ANB. Under the terms of the agreement, ANB will issue 0.9408 ANB common shares for each share of Indian River common stock, subject to upward adjustment in accordance with the Agreement, and subject to the ability to elect cash with respect to a portion of the outstanding shares. Options to purchase Indian River common stock will be converted into options to purchase ANB common stock. 15 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements -------------------------- Certain information contained in this discussion may include "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are generally identified by phrases such as "Indian River expects," "Indian River believes," "Indian River anticipates," may, should or words of similar import. Such forward-looking statements involve known and unknown risks including, but not limited to, changes in general economic and business conditions, interest rate fluctuations, competition within and from outside the banking industry, new products and services in the banking industry, risk inherent in making loans such as repayment risks and fluctuating collateral values, problems with technology utilized by the Indian River, changing trends in customer profiles and changes in laws and regulations applicable to Indian River. Although Indian River believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of Indian River will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. General ------- Indian River Banking Company ("Indian River") is a one-bank holding company for Indian River National Bank ("Indian River Bank") and is headquartered in Vero Beach, Florida. Indian River Bank is a growing community bank serving individuals and small to medium sized businesses with special focus on real estate related lending and the professional community. The Bank operates four branches in Indian River County and four branches in Brevard County. The Bank offers deposit accounts and associated services to businesses and individuals and makes loans and invests in qualified securities. In addition, the Bank's income includes fees on deposit accounts and loans, and gains from the sale of mortgage loans originated for sale in the secondary market. On October 22, 2003 Indian River entered into of a definitive agreement with Alabama National BanCorporation ("ANB") providing for the acquisition of Indian River by ANB. Under the agreement, Indian River shall be merged with and into ANB, and Indian River Bank will become a wholly owned subsidiary of ANB. Under the terms of the agreement, ANB will issue 0.9408 ANB common shares for each share of Indian River common stock, subject to upward adjustment in accordance with the Agreement, and subject to the ability to elect cash with respect to a portion of the outstanding shares. Options to purchase Indian River common stock will be converted into options to purchase ANB common stock. FINANCIAL CONDITION ------------------- Total Assets ------------ Indian River's total assets were $518.8 million at September 30, 2003, a 13.2% increase from $458.2 million at December 31, 2002. The increase in Indian River's asset base was due to deposit growth of $45.3 million and a $13.6 million increase in other borrowings. Investments ----------- Indian River's investment portfolio increased $65.5 million during the first nine months of 2003, primarily as a result of a $58.9 million growth in deposits and other borrowings. Net loans outstanding (both portfolio loans and loans held for sale) increased only $1.1 million during the same period. Portfolio loans were up $12.9 million, or 5.6% in the nine month period ending September 30, 2003 and loans held for sale declined $11.8 million, or 89.3% during the same period. Due to processing delays with purchasers at year-end 2002, Indian River had a significantly higher amount of loans held for sale outstanding than is normal. During the nine months ended September 30, 2003, the average daily balance of loans held for sale was $6.1 million compared to the $13.2 million outstanding on December 31, 2002. During the first nine months of 2003 Indian River originated $78.9 million of loans for sale, compared to $43.0 million during the comparable period in 2002. 16 During the first nine months of 2003 Indian River purchased $207.8 million in securities. In addition to funding growth, Indian River's existing investment securities generated $136.0 million in cash flow from sales, maturities, securities being called, and repayments on mortgage-backed securities. In investing excess funds in the current rate environment Indian River attempts to maximize return while minimizing possible adverse exposure to rising rates. In balancing these somewhat conflicting objectives, Indian River's purchases during the nine months ended September 30, 2003 were primarily weighted towards planned amortization class collateralized mortgage obligations, callable US Government agency securities and amortizing mortgage-backed securities with final maturities of ten years or less. These instruments should have the most stable average lives in the current rate environment. Indian River examines the investment portfolio's sensitivity to the effects of potential rising interest rates by monitoring overall portfolio duration. This is particularly critical during periods when excess cash results in significant purchases of investment securities. At September 30, 2003 the modified duration of Indian River's investment portfolio was 3.15 years compared to 2.54 years at December 31, 2002. Loans ----- Loans totaled $242.5 million at September 30, 2003, an increase of $12.9 million, or 5.6%, from December 31, 2002. Loan growth since December 31, 2002 was in one-to-four family residential real estate loans ($8.1 million, or a 9.2% increase), construction, land development and other land loans ($552 thousand, or a 1.2% increase) nonfarm, nonresidential real estate loans ($6.6 million or a 10.3% increase) and in agricultural related loans ($384 thousand or a 21.5% increase). Indian River experienced net loan repayments in farmland related loans ($-595 thousand or an 18.7% decrease) as well as in multi-family residential, commercial, consumer and other loans (-$2.0 million or a 6.8% decrease). Deposits -------- Indian River's deposits increased $45.3 million, or 12.4%, from $364.9 million at December 31, 2002 to $410.2 million at September 30, 2003. Increases occurred in NOW and money market accounts ($58.5 million, or 113.0%). The increase in NOW and money market account balances can be primarily attributed to a special money market rate that was offered with the opening of the new Sarno Road Branch, Indian River's eighth branch, during the first quarter of 2003 Indian River has implemented a deposit reclassification program to reduce the amount of reserves required to be maintained in accordance with Regulation D of the Federal Reserve. At September 30, 2003 Indian River had reclassified $41.7 million of demand deposit account balances and $40.9 million in NOW account balances as money market account balances. The deposit reclassification program was implemented on May 25th after notification to the Federal Reserve Bank of Atlanta and did not impact totals at December 31, 2002. Under Federal Reserve guidelines and subject to proper customer disclosure Indian River is able to sweep Demand deposit and NOW account balances into a corresponding money market account nightly as long as return sweeps do not exceed Federal Reserve limitations. Some of Indian River's demand deposit and NOW account balances are subject to a 10% reserve requirement while money market account balances are only subject to a 3% reserve requirement. Reclassification frees up additional non-earning assets for investment. In the nine months ended September 30, 2003, savings accounts increased $1.6 million, or 1.4%, while time deposit account balances decreased $12.1 million, or 9.3%. There was also a $2.7 million, or 4.1%, decrease in noninterest bearing demand deposits. This can be primarily attributed to the movement of over $10 million from a noninterest-bearing deposit to an overnight repurchase agreement account at the beginning of 2003. At year end 2002 the funds were moved out of the repurchase agreement account and into a noninterest bearing deposit account and moved back into a repurchase agreement account at the beginning of 2003. Stockholders' Equity -------------------- Total stockholders' equity increased by $1.4 million or 4.2%, during the first nine months of 2003. Net income of $3.7 million and option exercises of $296 thousand were offset by a $2.6 million decrease in accumulated other comprehensive income (loss). Accumulated other comprehensive income (loss) for Indian River consists of the net unrealized gain or loss on securities available for sale. 17 Results of Operations --------------------- FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 Net Income ---------- For the first nine months of 2003, Indian River recorded net income of $3.7 million. This was $532 thousand, or 12.5%, less than the $4.2 million in net income recorded for the first nine months of 2002. Basic earnings per share decreased $0.27 during the nine months ended September 30, 2003, to $1.71, compared to $1.98 per share during the comparable period of 2002 (as adjusted to reflect the 10% stock dividends in 2003 and 2002). Diluted earnings per share decreased from $1.94 to $1.65 during the first nine months of 2003, compared to the same period in 2002. Before the effect of gains from security transactions, the Indian River earned $3.6 million in the first nine months of 2003, compared to $3.7 million earned in the first nine months of 2002. During the first quarter of 2002, Indian River began restructuring its investment portfolio to reduce credit and interest rate risk and exposure to corporate securities, and as a result recognized an unusually high level of gains. Net interest income decreased $482 thousand, or 4.0%, for the first nine months of 2003 compared to the same period in 2002. Other income rose $845 thousand, or 22.5%, in the nine months ended September 30, 2003 compared to the comparable period in 2002. Indian River also noted an increase in other expenses of $1.4 million, or 15.6%, in the first nine months of 2003 compared to the prior period. The provision for loan losses decreased $85 thousand, or 19.3%. Net Interest Income ------------------- Net interest income decreased to $11.7 million for the first nine months of 2003 from $12.2 million for the same period in 2002. Both interest income and interest expenses fell during the nine months ended September 30, 2003 compared to same period in 2002. The $482 thousand, or 4.0%, decrease in net interest income was mainly the result of a $1.2 million, or 6.4% decrease in interest income exceeding the $743 thousand, or 10.5% decrease in interest expense. Yields on Indian River's interest-earning assets decreased by 149 basis points, and the rates paid on Indian River's interest-bearing liabilities decreased by 73 basis points. This resulted in a decrease in the interest rate spread to 2.94% for the first nine months of 2003 from 3.70% for the first nine months of 2002. Net interest margin also decreased to 3.29% from 4.14%. The ratio of average interest-earning assets to average interest-bearing liabilities for the first nine months of 2003 was 1.13, down slightly from the 1.18 for the first nine months of 2002. Total interest income for the first nine months of 2003 was $18.0 million compared to $19.2 million for the same period in 2002. The main factor in the $1.2 million, or 6.4%, decrease in interest income is due to the 149 basis point decrease in the average yields on interest-earning assets. This decrease more than offset the $82.9 million, or 21.1%, increase in average interest-earning assets. Indian River's average loans outstanding balance increased $22.5 million, or 10.2%, and the related yield decreased to 6.72% for the first nine months of 2003 from 7.65% in 2002. During the same period, average investment securities balances increased $65.0 million, or 40.2%, and the related yield decreased to 3.39% from 5.36%. Yields on investment securities were impacted more dramatically due to the increase in the total portfolio size from the first nine months of 2002. Additionally, the sale and call of investment securities during the first nine months of 2003 resulted in the reinvestment of the proceeds in lower yielding securities. Indian River's average federal funds sold decreased by $4.6 million, or 47.7% and the related yield decreased to 1.13% for the first nine months of 2003 from 1.66% in 2002. The decrease in yields on earning assets was partially offset by the 73 basis point decrease in average rates paid on deposits and other borrowings. 18 Total interest expense for the first nine months of 2003 was $6.3 million, a decrease of 10.5% from $7.1 million for the same period in 2002. The decrease in total expense can be attributed to the decrease in the related rates on deposits and other borrowings, which offset the $67.4 million, or 20.3%, increase in the average balances outstanding of interest-bearing liabilities for the first nine months of 2003 compared to the same period in 2002. The related average rate decreased to 2.13% for the first nine months of 2003 from 2.86% in 2002. The 35 basis point increase in rates on NOW and money market accounts reflect the deposit special offered in connection with the opening of the Sarno Road office in 2003. The average rate paid on certificates of deposit decreased to 2.79% for the first nine months of 2003, from 3.69% for the first nine months of 2002. Rates on other short term borrowings decreased from 2.08% in 2002 to 1.71% in 2003. Short term borrowings include federal funds purchased and overnight repurchase agreements. Rates on other long term borrowings decreased from 4.35% to 4.09%. Long term borrowings include Federal Home Loan Bank advances and trust preferred securities. The following table provides certain information relating to Indian River's average consolidated balance sheets and reflects the interest income on interest-earning assets and interest expense of interest-bearing liabilities for the periods indicated and the average yields earned and rates paid for the periods indicated. These yields and costs are derived by dividing income or expense by the average daily balance of the related assets or liabilities for the periods presented.

-------------------------- (1) Includes securities available for sale, securities held to maturity, other securities and interest-bearing deposits. Yields on securities available for sale have been calculated on the basis of historical cost and do not give effect to changes in fair value of such securities, which are reflected as a component of stockholder's equity. (2) Includes loans for which the accrual of interest has been suspended. 19 Other Income ------------ Other income increased by $845 thousand, or 22.5%, for the first nine months of 2003 compared to the same period of 2002. This increase was the result of a $548 thousand increase (+ 43.0%) in service charges and fees, a $788 thousand increase (+76.2%) in gains on the sale of loans, and an increase in other income of $155 thousand (+ 24.3%) that Indian River recognized during the first nine months of 2003 compared to the results for the first nine months of 2002. These increases were partially offset by a $646 thousand decrease (-79.5%) in gain on the sale of securities. The increase in service charge and fee income was primarily the result of the $76.1 million, or 22.1%, increase in deposits since September 2002. Most of this growth ($75.7 million or 99.5% of total deposit growth) has occurred in transactional related account types (demand deposits, NOW accounts and money market accounts) that generate fee income. Also contributing to this increase is an increase in fees earned on debit card transactions. These fees increased as a result of renegotiating a contract with a third party processor that allowed a greater percentage of network fees to be passed through to Indian River. As noted Indian River had a $788 thousand, or 76.2%, increase in gain on sale of loans, which is a result of the increase in 1-4 family real estate loans originated and then sold in the secondary market from approximately $43.1 million to $78.9 million. The gains and fees on mortgage loans held for sale are volatile as this source of income is highly sensitive to fluctuations in interest rates, consumer confidence, economic conditions nationally and in our market, and housing market conditions. Other Expenses -------------- Indian River's other expenses increased $1.4 million, or 15.6%, for the first nine months of 2003 compared to the same period in 2002. The increase was primarily the result of a $736 thousand, or 16.7%, increase in salaries and benefits. This is largely the result of the hiring of employees to staff the new Sarno Road Branch, which opened in February 2003. The new branch also has a loan operation department, requiring additional staff. Salaries and benefits expense was also negatively impacted by a significant increase in group hospitalization insurance premiums that went into effect in June 2002. These premiums were up $107 thousand (+46.9%) in the nine months ended September 30, 2003 compared to the same period in 2002. There was a $224 thousand, or 19.1% increase in occupancy and equipment expenses and a $194 thousand, or 20.0%, increase in data processing expense for the nine months ended September 30, 2003 compared to the same period 2002. These increases are primarily due to the opening of the Sarno Road Branch in early 2003. There was also a $201 thousand, or 9.42%, increase in other operating expenses, also due to the increase in advertising and public relation expenses associated with the opening of the Sarno Road Branch. Provision for Loan Losses ------------------------- Indian River makes provisions for loan losses in amounts deemed necessary to maintain the allowance for loan losses at an appropriate level as determined by management. At September 30, 2003, total nonperforming loans totaled $360 thousand, or 0.1% of total loans, compared to $738 thousand, or 0.3% of total loans at December 31, 2002. The decrease is primarily due to the resolution of one nonperforming loan totaling $585 thousand. The loan was sold without recourse to a private investor resulting in a $65 thousand chargeoff to Indian River. The allowance for loan losses is a valuation reserve established by management in an amount it deems adequate to provide for losses in the portfolio. Management assesses the adequacy of the allowance for loan losses based upon a number of factors including, among others: analytical reviews of loan loss experience in relationship to outstanding loans and commitments; unfunded loan commitments; problem and nonperforming loans and other loans presenting credit concerns; trends in loan growth, portfolio composition and quality; appraisals of the value of collateral; and management's judgment with respect to current and expected economic conditions and their impact on the existing loan portfolio. 20 The allowance for loan losses is increased by provisions for loan losses charged to expense. Charge-offs of loan amounts determined by management to be uncollectable decrease the allowance, and recoveries of previous charge-offs are added to the allowance. Calculating the allowance for loan losses is divided into three primary allocation groups: (1) specific allocation loans, (2) past due/problem loans and (3) all other passing grade loans. For specific allocation loans, the Bank has determined a reserve amount to set aside which it believes is sufficient to cover a collateral shortfall. As of September 30, 2003, Indian River had two loans with specific allocations in the aggregate amount of $40,000. Problem loans are identified by the Asset Liability Committee and are assigned a risk grade. Loans graded special mention are multiplied by an inherent loss factor of 5% to determine the amount to be reserved. Loans graded substandard are multiplied by a loss factor of 10%, loans graded doubtful are multiplied by a loss factor of 50% and loans graded loss are multiplied by a loss factor of 100%. Past due loans are graded based on the number of days which the loan is past due, and are multiplied by the same loss factors as problem loans. Loans past due 30-59 days are graded special mention, loans past due 60-89 days are graded substandard and loans past due 90 days or more are graded doubtful. As of September 30, 2003, 7.38% of the allowance for loan losses reflected specific loan allocations and past due/problem loans. All other loans are graded pass and are categorized into six loan groups (real estate loans are further sub-categorized) and multiplied by an historical experience factor to determine the appropriate level of the allowance for loan losses. Due to Indian River's low loss history, the historical experience factors are based on FDIC quarterly banking profile report as of June 30, 2003 for all institutions. Indian River feels that these factors are a better indication of overall loan performance in the nation. The third quarter 2003 factors are: 0.12% for real estate loans, 1.37% for all non real estate commercial loans, 5.83% for credit card loans, 3.00% for consumer loans, 0.46% for non-real estate agricultural loans, and 0.25% for other revolving loans. In addition to historical experience factors, Indian River also provides for losses due to economic factors, concentration of credit and portfolio composition changes. The following table allocates the allowance for loan losses by loan category, along with the percent of actual loans per category as of September 30, 2003 and December 31, 2002. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category. (In Thousands) September 30, 2003 December 31, 2002 --------------------------------------------- Amount % Amount % --------------------------------------------- Commercial, Agricultural $ 385 6 % $ 420 6 % Real estate construction 488 19 484 19 Real estate mortgage 1,682 70 1,617 69 Consumer, other 731 5 646 6 Unallocated 109 -- 92 -- -------- ------- --------- ------- Total Allowance for loan losses $ 3,395 100 % $ 3,259 100 % ======== ======= ========= ======= See Note 4, Allowance for Loan Losses, in the Notes to Unaudited Condensed Consolidated Financial Statements for additional information. Nonperforming Assets. Indian River Bank's nonperforming assets, which are comprised of loans delinquent 90 days or more, nonaccrual loans, and other real estate owned ("OREO"), totaled $378 thousand at September 30, 2003 compared to $738 thousand at December 31, 2002. The percentage of nonperforming assets to total assets decreased to 0.1% at September 30, 2003 from 0.2% at December 31, 2002. Nonperforming assets at September 30, 2003 consisted of nonaccrual loans in the amount of $356 thousand, loans past due over 90 days of $4 thousand, and other real estate owned of $18 thousand. Indian River did not have any other real estate owned as of December 31, 2002. Indian River evaluates the fair value of each OREO property annually. These evaluations may be appraisals or other market studies. 21 Indian River charges off credit card loans when they are 120 days delinquent. All other consumer and commercial loans are placed on nonaccrual at 90 days delinquent or when determined uncollectable by management. The following table allocates the nonperforming loans by loan type. (In Thousands) Nonaccrual Loans September 30, 2003 December 31, 2002 ------------------------------------------------------------------------------ Amount % Amount % ---------- ------------ --------- ---------- Real estate mortgage $ 356 100 % $ 678 100 % ========== ============ ========= ========== Accrual Loans - past due 90 days or more September 30, 2003 December 31, 2002 ------------------------------------------------------------------------------ Amount % Amount % ---------- ------------ --------- ---------- Real estate mortgage -- $ 39 65 % Installment -- 21 35 % Credit cards $ 4 100 % -- -- ---------- ------------ --------- ---------- $ 4 100 % $ 60 100 % ========== ============ ========= ========== For the nine months ended September 30, 2003, $9 thousand in gross interest income would have been recorded if the $360 thousand of nonaccrual loans had been accruing interest throughout this period. At September 30, 2003, there were no performing loans considered potential problem loans, defined as loans which are not included in the past due, nonaccrual or restructured categories, but for which known information about possible credit problems causes management to have serious doubt as to the ability of the borrowers to comply with the present loan repayment terms. Income Tax ---------- Indian River's income tax was $2.2 million, or 37.0% of income before taxes, for the first nine months of 2003 and $2.6 million or 37.6% of income before income taxes, for the same period in 2002. FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 Net Income ---------- For the third quarter of 2003, Indian River recorded net income of $1.3 million. This was $145 thousand or 10.4%, less than the $1.4 million in net income recorded for the third quarter of 2002. Basic earnings per share decreased $0.07 during the three months ended September 30, 2003, to $0.58, compared to $0.65 per share during the comparable period of 2002 (as adjusted to reflect the 10% stock dividends in 2003 and 2002). Diluted earnings per share decreased from $0.64 to $0.56 during the third quarter of 2003, compared to the same period in 2002. Net interest income declined $663 thousand or 15.5%, in the third quarter of 2003 compared to the same period in 2002. Also impacting results in the three months ended September 30, 2003 compared to the same period in 2002 was an increase in other income of $502 thousand, or 45.6%, a decrease in the provision for loan losses of $90 thousand or 50.0%, an increase in other expenses of $202 thousand, or 6.8%. There was a corresponding decrease in taxes on income of $128 thousand, or 15.3%. 22 Net Interest Income ------------------- Net interest income declined to $3.6 million in the third quarter of 2003 from $4.3 million for the same period in 2002. The $663 thousand or 15.5%, decrease in net interest income was the result of a $777 thousand, or 12.1% decrease in interest income exceeding the $114 thousand or 5.3% reduction in interest expense. Yields on Indian River's interest-earning assets decreased by 189 basis points, and the rates paid on Indian River's interest-bearing liabilities decreased by only 58 basis points. This resulted in a decrease in the interest rate spread to 2.54% for the third quarter of 2003 from 3.85% earned in the third quarter of 2002. Net interest margin also decreased to 2.88% from 4.25%. The ratio of average interest-earning assets to average interest-bearing liabilities in the third quarter of 2003 was 1.21, compared with the 1.18 in the third quarter of 2002. Total interest income for the third quarter of 2003 was $5.7 million compared to $6.4 million for the same period in 2002. The main factor in the $777 thousand, or 12.1%, decrease in interest income is due to the 189 basis point decrease in the average yields on interest-earning assets. This decrease more than offset the $98.8 million, or 24.8%, increase in average interest-earning assets. Contributing to the overall decline in average yields was a shift in the composition of earning assets. In the third quarter of 2003, average loans comprised 49.9% of earning assets. During the comparable period in 2002 loans averaged 56.7%. Indian River's average loans increased $22.3 million, or 9.9% during the third quarter of 2003 compared to the same period in 2002 and the related yield decreased to 6.40% for the third quarter of 2003 from 7.47% in 2002. During the same period, average investment securities increased $78.4 million, or 46.3%, and the related yield decreased to 2.63% from 5.07%. Yields on investment securities were impacted more dramatically due to the increase in the size of the total portfolio in the three months ended September 30, 2003 compared to the comparable period in 2002. Additionally, the increase in principal payments received during 2003 resulted in the reinvestment of the proceeds in lower yielding securities. Indian River's average federal funds sold decreased by $2.0 million, or 59.1% and the related yield decreased to 0.96% in the third quarter of 2003 from 1.66% in 2002. The decrease in yields on earning assets was partially offset by the 76 basis point decrease in average rates paid on deposits and other borrowings. Total interest expense for the three months ended September 30, 2003 was $2.0 million, a decrease of 5.3% from $2.2 million for the same period in 2002. The decrease in total expense can be attributed to the decrease in the related rates on deposits and other borrowings, which offset the $75.9 million, or 22.6%, increase in the average balances outstanding of interest-bearing liabilities in the third quarter of 2003 compared to the same period in 2002. The related rate decreased to 1.97% for the three months ended September 30, 2003 from 2.55% in 2002. The 50 basis point increase in rates on NOW and money market accounts reflect the deposit special offered in connection with the opening of the Sarno Road office. The average rate paid on certificates of deposit decreased to 2.59% in the third quarter of 2003 from 3.29% in the third quarter of 2002. Rates on other short term borrowings decreased from 2.30% in 2002 to 1.60% in 2003. Short term borrowings include federal funds purchased and overnight repurchase agreements. Rates on other long term borrowings decreased from 4.39% to 4.11%. Long term borrowings include Federal Home Loan Bank advances and trust preferred securities. 23 The following table provides certain information relating to Indian River's average consolidated balance sheets and reflects the interest income on interest-earning assets and interest expense of interest-bearing liabilities for the periods indicated and the average yields earned and rates paid for the periods indicated. These yields and costs are derived by dividing income or expense by the average daily balance of the related assets or liabilities for the periods presented.

------------------------ (1) Includes securities available for sale, securities held to maturity, other securities and interest-bearing deposits. Yields on securities available for sale have been calculated on the basis of historical cost and do not give effect to changes in fair value of such securities, which are reflected as a component of stockholder's equity. (2) Includes loans for which the accrual of interest has been suspended. 24 Other Income ------------ Other income increased by $502 thousand, or 45.6%, in the three months ended September 30, 2003 compared to the same period of 2002. This increase was the result of a 45.1% ($202 thousand) increase in service charges and fees on deposit accounts in the third quarter of 2003 compared to the same period in 2002 and a $242 thousand (+69.7%) increase in gains on the sale of loans during the same period. These increases were partially offset by a $62 thousand decline in gains on the sale of securities in the same period in 2002. As noted in the discussion of results for the nine months ended September 30, 2003, the increase in service charge and fee income was primarily the result of the $76.1 million, or 22.1%, increase in deposits since September 2002. Most of this growth ($75.7 million or 95.5% of total deposit growth) has occurred in transactional related account types (demand deposits, NOW accounts and money market accounts) that generate fee income. Also contributing to this increase is an increase in fees earned on debit card transactions. These fees increased as a result of renegotiating a contract with a third party processor that allowed a greater percentage of network fees to be passed through to Indian River. Indian River had a $242 thousand or 69.7%, increase in gain on sale of loans, which is a result of the increase in 1-4 family real estate loans originated and then sold in the secondary market. The gains and fees on mortgage loans held for sale are volatile as this source of income is highly sensitive to fluctuations in interest rates, consumer confidence, economic conditions nationally and in our market, and housing market conditions. Other Expenses -------------- Indian River's other expenses increased by $202 thousand, or 6.8%, in the third quarter of 2003 compared to the same period in 2002. The increase was primarily the result of a $36 thousand, or 2.3%, increase in salaries and benefits. There was a $75 thousand, or 18.4%, increase in occupancy and equipment expense, again primarily due to the opening of the new Sarno Road Branch. There was a $105 thousand, or 35.7%, increase in data processing expense for the three months ended September 30, 2003 compared to the same period 2002. The rise in data processing fees can be attributed to the increase in deposit account balances and the cost associated with servicing additional accounts. Income Tax ---------- Indian River's income tax was $710 thousand, or 36.2% of income before taxes, in the third quarter of 2003 and $838 thousand or 37.5% of income before taxes, for the same period in 2002. Liquidity --------- Liquidity management enables us to maintain sufficient cash flow to fund operations and to meet financial obligations to depositors and borrowers. Indian River's liquidity is enhanced by its ability to attract and retain deposits and by principal and interest payments on loans and maturing securities in the investment portfolio. Indian River's core deposit base, consisting of demand deposits, money market, and savings accounts supplemented by other deposits of varying maturities and rates, contributes to liquidity. Our liquidity position, those assets invested in federal funds and securities available for sale of $244.5 million at September 30, 2003, reflected an increase of $67.2 million from December 31, 2002, or 37.9%. Funds available through short-term borrowing and asset maturities are considered adequate to meet all current needs. At September 30, 2003, Indian River had available credit of $26.1 million under lines of credit at correspondent banks. Although management believes that the liquidity position is adequate, increased loan demand could have an adverse impact on liquidity. Indian River also has a $57.9 million borrowing line with the Federal Home Loan Bank of Atlanta. The outstanding balance on this line decreased to $38.3 million as of September 30, 2003, from $38.6 at December 31, 2002. This line has been utilized by Indian River as a funding source at a lower cost, by locking in borrowings at lower rates. In addition, the Asset/Liability Management Committee has established minimum standards and key ratios of asset quality and performance. These standards and ratios provide the framework for guidance and measurement. Management evaluates these standards and ratios on an ongoing basis. 25 Capital Resources ----------------- In the first nine months of 2003, total stockholders' equity increased $1.4 million, or 4.2%, as a result of earnings and option exercises which were partially offset by a decrease in accumulated other comprehensive income. Earnings contributed $3.7 million to stockholders' equity for the nine month period. Accumulated other comprehensive losses decreased stockholders' equity by $2.6 million during this nine month period. Bank holding companies are required to maintain capital ratios in accordance with guidelines adopted by the Federal Reserve Board of Governors ("FRB"). The guidelines are commonly known as Risk-Based Capital Guidelines. On September 30, 2003, Indian River exceeded all capital requirements, having a total risk-based capital ratio of 14.4%, a Tier 1 risk-based capital ratio of 13.3%, and a leverage ratio of 8.5%. These ratios have increased in part due to the issuance of $7 million aggregate liquidation amount of trust preferred securities, which are included in Tier 1 capital. See Note 8 to the Unaudited Consolidated Financial Statements for additional information. As of September 30, 2003, Indian River Bank also met the criteria for categorization as a "well-capitalized" institution under the prompt corrective action rules promulgated under the Federal Deposit Insurance Act, having total and tier 1 risk based capital ratios of 12.0% and 11.0%, and a leverage ratio of 7.0%. Designation of the Bank as a "well-capitalized" institution under these regulations does not constitute a recommendation or endorsement of Indian River Bank by Federal bank regulators. Effects of Inflation -------------------- The condensed consolidated financial statements and related financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America and practices within the banking industry which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Item 3 - Quantitative and Qualitative Disclosures About Market Risk. Interest rate risk is that portion of the variation in Indian River's performance attributable to changes in interest rates. Management closely monitors Indian River's exposure to how changes in market conditions can impact the Indian River's future performance and considers strategies to reduce any negative results. Interest rate risk takes place because of unbalanced changes in interest income and expense, and asset and liability market value when rates change. The imbalances flow through to create variability in net interest income, net income, and the market value of equity. The ultimate cause of interest rate risk is a repricing mismatch between the assets and liabilities on Indian River's balance sheet and, if relevant, off-balance sheet positions. Indian River's exposure to interest rate risk is managed primarily through the Company's strategy of selecting the types and terms of interest-earning assets and interest-bearing liabilities which generate favorable earnings, while limiting potential negative effects of changes in market interest rates. Since Indian River's primary source of interest-bearing liabilities is customer deposits, the ability to manage the types and terms of such deposits may be somewhat limited by customer preferences in the market areas served by the Company. Borrowings, which include FHLB advances, short-term borrowings and long-term borrowings, are generally structured with specific terms which in management's judgment, when aggregated with the terms for outstanding deposits and matched with interest-earning assets, mitigate Indian River's exposure to interest rate risk. The rates, terms and interest rate indices of Indian River's interest-earning assets result primarily from the Company's strategies of investing in loans and securities which permit the Company to limit its exposure to interest rate risk, together with credit risk, while achieving a positive interest rate spread from the difference between the income earned on interest-earning assets and the cost of interest-bearing liabilities. 26 In addition to periodic gap reports comparing the sensitivity of interest-earning assets and interest-bearing liabilities to changes in interest rates, management uses a quarterly model which measures Indian River's exposure to interest rate risk. The model calculates the present value of assets, liabilities, off-balance sheet financial instruments and equity at current interest rates, and at hypothetical higher and lower interest rates (but not below 0%) at various intervals. The present value of each major category of financial instrument is calculated by the model using estimated cash flows based upon weighted-average contractual rates and terms at discount rates representing the estimated current market interest rate for similar financial instruments. The resulting present value of longer term fixed-rate financial instruments are more sensitive to change in a higher or lower market interest rate scenario, while adjustable-rate financial instruments largely reflect only a change in present value representing the difference between the contractual and discounted rates until the next interest rate repricing opportunity. The following table presents Indian River's exposure over the subsequent twelve month periods to immediate, hypothetical changes in interest rates at the dates indicated:

As the table indicates, the Bank is susceptible to lower earnings in a rising rate environment and will experience slightly higher earnings in a declining rate situation. The Bank has a negative GAP position which is reflected in the table. The improvement in a 100 basis point declining rate scenario is a result of two factors: (1) the Bank's cost of funds has declined to the point that in the hypothetical downward shifts contemplated in the table, much of the bank's deposits would not earn any interest which would further reduce the cost of funds and (2) the Bank's projected loan growth has increased to the point that increased interest income would exceed the effects of accelerated repayments of loans and investments that are inherent in significant downward shifts in market rates. In a rising rate environment the Bank would be susceptible to lower net interest income (and consequently to lower net income) due to funding costs rising faster than the Bank's ability to reprice earning assets resulting in margin compression. In a 200 basis point declining rate scenario, the cost of the Bank's non-fixed term liabilities would drop to zero. However, a significant portion of the Bank's earning assets would experience accelerated repayment/refinancing and those cash flows would have to be reinvested at very low rates. A significant immediate increase in rates would slow down anticipated cash flows from both the loan and investment portfolios resulting less interest income from reinvesting those cash flows at higher rates. The table also indicates that the Bank would experience a significant change in the market value of portfolio equity in the event of an immediate dramatic increase in interest rates. The Bank has experienced significant deposit growth (+$45.3 million) in the nine months ended September 30, 2003 while loan growth has been essentially flat (+$1.1 million). This situation combined with considerable cash flows from the investment portfolio ($142.8 million in the nine months ended September 30, 2003) has resulted in sizeable purchase transactions in investment securities to reinvest liquidity. During the nine months ended September 30, 2003, the Bank has made $208.8 million in security purchases which represents 82.2% of the security portfolio. Although these purchases were made at current market rates, a sudden, dramatic increase in market rates would result in a similar decrease in the market value of the investment portfolio and the subsequent impact on the Bank's equity in mark-to-market accounting. The Bank monitors this impact monthly and implements ongoing strategies to decrease portfolio duration which is a measure of the mark-to-market volatility. At September 30, 2003, the duration of the available for sale securities portfolio was 2.98 years. The Bank's goal is maintain portfolio duration at or below 3.00 years. Mark-to-market accounting and related adjustments have no impact upon regulatory capital measurements. 27 Indian River has been in a liability sensitive position during 2003 and 2002, which is reflected in the above tables. The nature of Indian River's current asset and liability structure is such that it will be liability sensitive for the foreseeable future. Indian River monitors its GAP position and interest sensitivity position monthly to insure they stay within the established ranges. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or repricing periods, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the loan. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables. Finally, the ability of many borrowers to service their debt may decrease in the event of a significant interest rate increase. In addition, the previous table does not necessarily indicate the impact of general interest rate movements on Indian River's net interest income because the repricing of certain categories of assets and liabilities are subject to competitive and other pressures beyond the Company's control. As a result, certain assets and liabilities indicating as maturing or otherwise repricing within a stated period may in fact mature or reprice at different times and at different volumes. Management uses the model to ascertain general levels of risk and to consider specific strategies to mitigate that risk Item 4 - Controls and Procedures Indian River's management, under the supervision and with the participation of Indian River's Chief Executive Officer and Chief Financial Officer, evaluated, as of the last day of the period covered by this report, the effectiveness of the design and operation of Indian River's disclosure controls and procedures, as defined in Rule13a-15(e) under the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that Indian River's disclosure controls and procedures were adequate. There were no changes in the Company's internal control over financial reporting (as defined in Rule 13a-15 under the Securities Act of 1934) during the quarter ended September 30, 2003 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 28 PART II OTHER INFORMATION ITEM 1 LEGAL PROCEEDINGS From time to time the Company is a participant in various legal proceedings incidental to its business. In the opinion of management, the liabilities (if any) resulting from such legal proceedings will not have a material effect on the financial position of the Company. ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS None. ITEM 3 DEFAULTS UPON SENIOR SECURITIES None. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 2 Agreement and Plan of Merger (1) 3(a) Articles of Incorporation of Indian River, as amended (2) 3(b) Bylaws of Indian River (2) 4(a) Indenture, dated as of September 30, 2002 between Indian River Banking Company and Wells Fargo Bank, National Association, as trustee (3) 4(b) Amended and Restated Declaration of Trust, dated as of September 30, 2002 among Indian River Banking Company, Wells Fargo Bank, National Association as Property Trustee, and Paul A. Beindorf, Diana L. Walker and Phillip L. Tasker as Administrative Trustees (3) 4(c) Guarantee Agreement dated as of September 30, 2002, between Indian River Banking Company and Wells Fargo Bank, National Association, as trustee (3) 10(a) Indian River 1999 Stock Option Plan (4) 10(b) Employment Agreement between Indian River National Bank and Paul A. Beindorf (5) 10(c) Employment Agreement between Indian River National Bank and Jeffrey R. Morton (5) 10(d) Change in Control Agreement between Indian River Banking Company, Indian River National Bank and Diana L. Walker (5) 11 Statement of Computation of Per Share Earnings Please refer to Note 5 to the Condensed Consolidated Financial Statements 21 Subsidiaries of the Registrant 31(a) Certification of Paul A. Beindorf 31(b) Certification of Phillip L. Tasker 32(a) Certification of Paul A. Beindorf 32(b) Certification of Phillip L. Tasker -------------------------- (1) Incorporated by reference to Exhibit 2.1 to Indian River's Current Report n Form 8-K filed on October 23, 2003. (2) Incorporated by reference to exhibit of same number to Indian River's registration statement on Form SB-2 (No. 333-36688) (3) Not filed in accordance with the provisions of Item 601(b)(4)(iii) of Regulation SK. Indian River agrees to provide a copy of these documents to the Commission upon request. 29 (4) Incorporated by reference to exhibit 10(d) to Indian River's registration statement on Form SB-2 (No. 333-36688) (5) Incorporated by reference to exhibit of same number to Indian River's Annual Report on Form 10-K for the year ended December 31, 2002. (b) Reports on Form 8-K On July 17, 2003, Indian River filed a report on Form 8-K, under Item 5, 9 and 12 thereof, reporting earnings for the quarter ended June 30, 2003 On October 15, 2003, Indian River filed a report on Form 8-K, under Item 5and 9 thereof, reporting earnings for the quarter ended September 30, 2003. On October 16, 2003, Indian River filed a report on Form 8-K, under Item 9 thereof, reporting declaration of a cash dividend. On October 23, 2003, Indian River filed a report on Form 8-K, under Item 5 and 9 thereof, reporting the execution of a definitive merger agreement. 30 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. INDIAN RIVER BANKING COMPANY (Registrant) November 6, 2003 By: /s/ Paul A. Beindorf ---------------------------------------- Paul A. Beindorf, President and Chief Executive Officer November 6, 2003 By: /s/ Phillip Tasker ---------------------------------------- Phillip Tasker, Chief Financial Officer 31

INDIAN RIVER BANKING COMPANY 10-Q