Unassociated Document
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
FORM 10-K
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended:  December 31, 2008
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 0-11244
 
 
GERMAN AMERICAN BANCORP, INC. 

 (Exact name of registrant as specified in its charter)

INDIANA
 
35-1547518
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

711 Main Street, Box 810, Jasper, Indiana
 
47546
(Address of Principal Executive Offices)
  
(Zip Code)

Registrant’s telephone number, including area code:  (812) 482-1314
 
Securities registered pursuant to Section 12 (b) of the Act
Title of Each Class
 
Name of each exchange on which registered
Common Shares, No Par Value
 
The NASDAQ Stock Market LLC
Preferred Stock Purchase Rights
  
 

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   ¨  Yes  þ No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   ¨  Yes  þ No

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.   þ  Yes   ¨ No
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K:     ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer, or a smaller reporting company:
 
Large accelerated filer ¨
Accelerated filer þ
Non-accelerated filer ¨
Smaller reporting company q

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).   ¨ Yes    þ No
 
The aggregate market value of the registrant’s common shares held by non-affiliates of the registrant, computed by reference to the price at which the common shares were last sold, as of June 30, 2008 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $119,841,000.  This calculation does not reflect a determination that persons are affiliates for any other purposes.
 
As of February 24, 2009, there were outstanding 11,030,288 common shares, no par value, of the registrant.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement of German American Bancorp, Inc., for the Annual Meeting of its Shareholders to be held May 14, 2009, to the extent stated herein, are incorporated by reference into Part III.
 

 
GERMAN AMERICAN BANCORP, INC.
ANNUAL REPORT ON FORM 10-K
For Fiscal Year Ended December 31, 2008

Table of Contents

PART I
     
       
Item 1.
Business
 
3-7
       
Item 1A.
Risk Factors
 
8-11
       
Item 1B.
Unresolved Staff Comments
 
11
       
Item 2.
Properties
 
11
       
Item 3.
Legal Proceedings
 
11
       
Item 4.
Submission of Matters to a Vote of Security Holders
 
11
       
PART II
     
       
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
12-13
       
Item 6.
Selected Financial Data
 
14
       
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
15-30
       
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
 
30
       
Item 8.
Financial Statements and Supplementary Data
 
31-65
       
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
66
       
Item 9A.
Controls and Procedures
 
66
       
Item 9B.
Other Information
 
66
       
PART III
     
       
Item 10.
Directors and Executive Officers of the Registrant
 
67
       
Item 11.
Executive Compensation
 
67
       
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
67-68
       
Item 13.
Certain Relationships and Related Transactions
 
68
       
Item 14.
Principal Accountant Fees and Services
 
68
       
PART IV
     
       
Item 15.
Exhibits and Financial Statement Schedules
 
69
       
SIGNATURES
 
70
       
INDEX OF EXHIBITS
  
71-73
 
2

 
Information included in or incorporated by reference in this Annual Report on Form 10-K, our other filings with the Securities and Exchange Commission and our press releases or other public statements, contain or may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  Please refer to a discussion of our forward- looking statements and associated risks in Item 1, “Business – Forward-Looking Statements and Associated Risks” and our discussion of risk factors in Item 1A, “Risk Factors” in this Annual Report on Form 10-K.

PART I
 
Item 1. Business.
 
General.

German American Bancorp, Inc. is a financial services holding company based in Jasper, Indiana.  The Company’s Common Stock is traded on NASDAQ’s Global Select Market under the symbol GABC.  The principal subsidiary of German American Bancorp, Inc., is its banking subsidiary, German American Bancorp, which operates through 28 retail banking offices in the ten contiguous Southern Indiana counties of Daviess, Dubois, Gibson, Knox, Lawrence, Martin, Monroe, Perry, Pike, and Spencer.  German American Bancorp, Inc., also owns a trust, brokerage, and financial planning subsidiary, which operates from the banking offices of the bank subsidiary and a full line property and casualty insurance agency with seven insurance agency offices throughout its market area.

Throughout this report, when we use the term “Company”, we will usually be referring to the business and affairs (financial and otherwise) of the Company and its consolidated subsidiaries as a whole.  Occasionally, we will refer to the term “parent company” or “holding company” when we mean to refer to only German American Bancorp, Inc.

The Company’s lines of business include retail and commercial banking, mortgage banking, comprehensive financial planning, full service brokerage and trust administration, and a full range of personal and corporate insurance products.  Financial and other information by segment is included in Note 16 – Segment Information of the Notes to the Consolidated Financial Statements included in Item 8 of this Report and is incorporated into this Item 1 by reference.  Substantially all of the Company’s revenues are derived from customers located in, and substantially all of its assets are located in, the United States.

Subsidiaries.

The Company’s principal operating subsidiaries are described in the following table:

1)  Name
 
2)  Type of Business
 
3)  Principal Office Location
German American Bancorp
 
Commercial Bank
 
Jasper, IN
German American Insurance, Inc.
 
Multi-Line Insurance Agency
 
Jasper, IN
German American Financial Advisors & Trust Company
  
Trust, Brokerage, Financial Planning
  
Jasper, IN

Two of these subsidiaries (German American Bancorp and German American Insurance, Inc.) do business in the various communities served by the Company under distinctive trade names that relate to the names under which the Company (or a predecessor) has done banking or insurance business with the public in those communities in prior years.

Competition.

The industries in which the Company operates are highly competitive. The Company’s subsidiary bank competes for commercial and retail banking business within its core banking segment not only with financial institutions that have offices in the same counties but also with financial institutions that compete from other locations in Southern Indiana and elsewhere.  The Company’s subsidiaries compete with commercial banks, savings and loan associations, savings banks, credit unions, production credit associations, federal land banks, finance companies, credit card companies, personal loan companies, investment brokerage firms, insurance agencies, insurance companies, lease finance companies, money market funds, mortgage companies, and other non-depository financial intermediaries.  Many of these banks and other organizations have substantially greater resources than the Company.

Employees.

At February 28, 2009 the Company and its subsidiaries employed approximately 342 full-time equivalent employees.  There are no collective bargaining agreements, and employee relations are considered to be good.
 
3

 
Regulation and Supervision.

The Company is subject to regulation and supervision by the Board of Governors of the Federal Reserve System (“FRB”) under the Bank Holding Company Act of 1956, as amended (“BHC Act”), and is required to file with the FRB annual reports and such additional information as the FRB may require.  The FRB may also make examinations or inspections of the Company. Under FRB policy, the Company is expected to act as a source of financial strength to its bank subsidiary, and to commit resources to support that subsidiary, even in circumstances where the Company might not do so absent such an FRB policy.

The Company’s subsidiary bank is under the supervision of and subject to examination by the Indiana Department of Financial Institutions (“DFI”), and the Federal Deposit Insurance Corporation (“FDIC”).  Regulation and examination by banking regulatory agencies are primarily for the benefit of depositors rather than shareholders.

With certain exceptions, the BHC Act prohibits a bank holding company from engaging in (or acquiring direct or indirect control of more than 5 percent of the voting shares of any company engaged in) nonbanking activities.  One of the principal exceptions to this prohibition is for activities deemed by the FRB to be “closely related to banking.”  Under current regulations, bank holding companies and their subsidiaries are permitted to engage in such banking-related business ventures as consumer finance; equipment leasing; credit life insurance; computer service bureau and software operations; mortgage banking; and securities brokerage.

Under the BHC Act, certain well-managed and well-capitalized bank holding companies may elect to be treated as a “financial holding company” and, as a result, be permitted to engage in a broader range of activities that are “financial in nature” and in activities that are determined to be incidental or complementary to activities that are financial in nature.  These activities include underwriting; dealing in and making a market in securities; insurance underwriting and agency activities; and merchant banking. Banks may also engage through financial subsidiaries in certain of the activities permitted for financial holding companies, subject to certain conditions.  The Company has not elected to become a financial holding company and its subsidiary bank has not elected to form financial subsidiaries.

The Company's bank subsidiary and that bank’s subsidiaries may generally engage in activities that are permissible activities for state chartered banks under Indiana banking law, without regard to the limitations that might apply to such activities under the BHC Act if the Company were to engage directly in such activities at the parent company level or through parent company subsidiaries that were not also bank subsidiaries.

Indiana law and the BHC Act restrict certain types of expansion by the Company and its bank subsidiary.   The Company and its subsidiaries may be required to apply for prior approval from (or give prior notice and an opportunity for review to) the FRB, the DFI, and/or other bank regulatory or other regulatory agencies, as a condition to the acquisition or establishment of new offices, or the acquisition (by merger or consolidation, purchase or otherwise) of the stock, business or properties of other banks or other companies.

The earnings of commercial banks and their holding companies are affected not only by general economic conditions but also by the policies of various governmental regulatory authorities.  In particular, the FRB regulates money and credit conditions and interest rates in order to influence general economic conditions, primarily through open-market operations in U.S. Government securities, varying the discount rate on bank borrowings, and setting reserve requirements against bank deposits.  These policies have a significant influence on overall growth and distribution of bank loans, investments and deposits, and affect interest rates charged on loans and earned on investments or paid for time and savings deposits.  FRB monetary policies have had a significant effect on the operating results of commercial banks in the past and this is expected to continue in the future.  The general effect, if any, of such policies upon the future business and earnings of the Company cannot accurately be predicted.

The Company and its bank subsidiary are required by law to maintain minimum levels of capital.  These required capital levels are expressed in terms of capital ratios, known as the leverage ratio and the capital to risk-based assets ratios.  The Company and its bank subsidiary each exceeded the minimum required capital levels for each measure of capital adequacy as of December 31, 2008.  See Note 9 to the Company's consolidated financial statements that are presented in Item 8 of this Report, which Note 9 is incorporated herein by reference.

Also, federal regulations define five categories of financial institutions for purposes of implementing prompt corrective action and supervisory enforcement requirements of the Federal Deposit Insurance Corporation Improvements Act of 1991.  The category to which the most highly capitalized institutions are assigned is termed “well-capitalized.”  Institutions falling into this category must have a total risk-based capital ratio (the ratio of total capital to risk-weighted assets) of at least 10%, a Tier 1 risk-based capital ratio (the ratio of Tier 1, or “core”, capital to risk-weighted assets) of at least 6%, a leverage ratio (the ratio of Tier 1 capital to total assets) of at least 5%, and must not be subject to any written agreement, order, or directive from its regulator relative to meeting and maintaining a specific capital level.  On December 31, 2008, the Company had a total risk-based capital ratio of 11.42%, a Tier 1 risk-based capital ratio of 9.37% (based on Tier 1 capital of $89,507,000 and total risk-weighted assets of $954,833,000), and a leverage ratio of 7.54%. The Company’s affiliate bank met all of the requirements of the “well-capitalized” category.  In addition the Company meets the requirements of the FRB to be considered a “well-capitalized” bank holding company.  Accordingly, the Company does not expect these regulations to significantly impact operations.
 
4

 
The parent company is a corporation separate and distinct from its bank and other subsidiaries.  Most of the parent company’s revenues historically have been comprised of dividends, fees, and interest paid to it by its bank subsidiary, and this is expected to continue in the future. This subsidiary is subject to statutory restrictions on its ability to pay dividends. The FRB possesses enforcement powers over bank holding companies and their non-bank subsidiaries that enable it to prevent or remedy actions that in its view may represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability in appropriate cases to proscribe the payment of dividends by banks and bank holding companies. The FDIC and DFI possess similar enforcement powers over the bank subsidiary. The “prompt corrective action” provisions of federal banking law impose further restrictions on the payment of dividends by insured banks which fail to meet specified capital levels and, in some cases, their parent bank holding companies.

Federal Deposit Insurance Assessments.

The deposits of the Company’s bank subsidiary are insured up to applicable limits by the Deposit Insurance Fund, or the DIF, of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank's capital level and supervisory rating.

Effective January 1, 2007, the FDIC imposed deposit assessment rates based on the risk category of the bank subsidiary.  Risk Category I is the lowest risk category while Risk Category IV is the highest risk category.  Because of favorable loss experience and a healthy reserve ratio in the Bank Insurance Fund, or the BIF, of the FDIC, well-capitalized and well-managed banks, have in recent years paid minimal premiums for FDIC insurance. With the additional deposit insurance, a deposit premium refund, in the form of credit offsets, was granted to banks that were in existence on December 31, 1996 and paid deposit insurance premiums prior to that date.  For 2008, the Company’s subsidiary bank utilized the credits to offset a majority of its 2007 FDIC insurance assessment.

For 2007 and 2008, the Company’s subsidiary bank qualified for the best rating, Risk Category I.  For banks under $10 billion in total assets in Risk Category I, the 2007 and 2008 deposit assessment ranged from 5 to 7 basis points of total qualified deposits. The actual assessment is dependent upon certain risk measures as defined in the final rule.

On October 16, 2008, the FDIC published a restoration plan designed to replenish the Deposit Insurance Fund over a period of five years and to increase the deposit insurance reserve ratio, which decreased to 1.01% of insured deposits on June 30, 2008, to the statutory minimum of 1.15% of insured deposits by December 31, 2013.  In order to implement the restoration plan, the FDIC proposes to change both its risk-based assessment system and its base assessment rates.  For the first quarter of 2009 only, the FDIC increased all FDIC deposit assessment rates by 7 basis points. These new rates range from 12 to 14 basis points for Risk Category I institutions to 50 basis points for Risk Category IV institutions.

Under the FDIC's restoration plan, the FDIC proposes to establish new initial base assessment rates that will be subject to adjustment as described below.  Beginning April 1, 2009, the base assessment rates would range from 10 to 14 basis points for Risk Category I institutions to 45 basis points for Risk Category IV institutions.

Changes to the risk-based assessment system would include increasing premiums for institutions that rely on excessive amounts of brokered deposits, increasing premiums for excessive use of secured liabilities (including Federal Home Loan Bank advances), lowering premiums for smaller institutions with very high capital levels, and adding financial ratios and debt issuer ratings to the premium calculations for banks with over $10 billion in assets, while providing a reduction for their unsecured debt.

Either an increase in the Risk Category of the Company’s bank subsidiary or adjustments to the base assessment rates could result in a material increase in our expense for federal deposit insurance.

In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation (FICO), a mixed-ownership government corporation established to recapitalize a predecessor to the Deposit Insurance Fund. The current annualized assessment rate is 1.14 basis points, or approximately .285 basis points per quarter. These assessments will continue until the Financing Corporation bonds mature in 2019.
 
5

 
Recent Legislative and Regulatory Developments.

In response to unprecedented market turmoil, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted on October 3, 2008.  EESA authorizes the U.S. Treasury Department to provide up to $700 billion in funding for the financial services industry. Pursuant to the EESA, the Treasury was initially authorized to use $350 billion for the Troubled Asset Relief Program (“TARP”).  Of this amount, Treasury allocated $250 billion to the TARP Capital Purchase Program (“CPP”).  On January 15, 2009, the second $350 billion of TARP monies was released to the Treasury. The Secretary's authority under TARP expires on December 31, 2009 unless the Secretary certifies to Congress that an extension is necessary, provided that his authority may not be extended beyond October 3, 2010.

EESA temporarily raised the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. The temporary increase in deposit insurance coverage became effective on October 3, 2008.  EESA provides that the basic deposit insurance limit will return to $100,000 after December 31, 2009.

On October 14, 2008, the FDIC announced the Temporary Liquidity Guarantee Program (“TLGP”). The final rule was adopted on November 21, 2008. The FDIC stated that its purpose is to strengthen confidence and encourage liquidity in the banking system by guaranteeing newly issued senior unsecured debt of banks of 31 days or greater, thrifts, and certain holding companies, and by providing full deposit insurance coverage of all transaction accounts, regardless of dollar amount. Inclusion in the program was voluntary.  Participating institutions are assessed fees based on a sliding scale, depending on length of maturity. Shorter-term debt has a lower fee structure and longer-term debt has a higher fee. The range is from 50 basis points on debt of 180 days or less, and a maximum of 100 basis points for debt with maturities of one year or longer, on an annualized basis. A 10-basis point surcharge is added to a participating institution's current insurance assessment in order to fully cover all transaction accounts.  The Company’s bank subsidiary elected to participate in both parts of the TLGP.

Status of the Company's Opportunity to Obtain Additional Equity Capital Under EESA.

In November 2008, the Company applied to participate in the CPP.  By letter dated January 26, 2009, the Treasury Department advised the Company that the application had been accepted, and the Treasury Department offered to invest up to $25 million in newly issued shares of preferred stock of the Company under the terms and conditions of the CPP.  As part of its investment, the Treasury Department also would receive warrants to purchase common stock of the Company having an aggregate market price of 15% of the investment amount.  Under the terms of the Company's approval to participate in the CPP, the Company was required to close upon the investment transaction within 30 days of the date of the January 26 letter.

During the thirty-day closing period established by the Treasury Department letter, the Company's Board of Directors authorized a special committee of the Board to further evaluate not only the possible CPP investment plan but also an alternative plan to augment the Company's regulatory capital.  After further evaluation, the special committee determined that proceeding with an alternative capital plan was in the best interests of the Company and that the Company should defer taking any action to close upon the financing available to it under the CPP.  Accordingly, the Company on February 20, 2009 requested that the Treasury Department indefinitely postpone the Company's closing under the CPP.  The Company’s Board of Directors on March 2, 2009, ratified the committee’s determination to postpone the closing of the CPP financing, and determined that the Company should decline participation in the CPP and should advise the Treasury Department that it was withdrawing its CPP application. On March 3, 2009, the Company advised the Treasury Department to this effect.
 
Internet Address; Internet Availability of SEC Reports.
 
The Company's Internet address is www.germanamericanbancorp.com.
 
The Company makes available, free of charge through the Shareholder Information section of its Internet website, a link to the Internet website of the Securities and Exchange Commission (SEC) by which the public may view the Company’s annual report on Form 10-K, its quarterly reports on Form 10-Q, its current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after those reports are filed with or furnished to the SEC.
 
6

 
Forward-Looking Statements and Associated Risks.

The Company from time to time in its oral and written communications makes statements relating to its expectations regarding the future.  These types of statements are considered “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.   Such forward-looking statements can include statements about the Company’s net interest income or net interest margin; adequacy of allowance for loan losses, and the quality of the Company’s loans, investment securities and other assets; simulations of changes in interest rates; litigation results; dividend policy; estimated cost savings, plans and objectives for future operations; and expectations about the Company’s financial and business performance and other business matters as well as economic and market conditions and trends. All statements other than statements of historical fact included in this report, including statements regarding our financial position, business strategy and the plans and objectives of our management for future operations, are forward-looking statements.  When used in this report, words such as “anticipate”, “believe”, “estimate”, “expect”, “intend”, and similar expressions, as they relate to us or our management, identify forward-looking statements.
 
Such forward-looking statements are based on the beliefs of our management, as well as assumptions made by and information currently available to our management, and are subject to risks, uncertainties, and other factors.
 
Actual results may differ materially and adversely from the expectations of the Company that are expressed or implied by any forward-looking statement.  The discussions in Item 1A, “Risk Factors,” and in Item 7 of this Form 10-K, “Management's Discussion and Analysis of Financial Condition and Results of Operations,” list some of the factors that could cause the Company's actual results to vary materially from those expressed or implied by any forward-looking statements.  Other risks, uncertainties, and factors that could cause the Company’s actual results to vary materially from those expressed or implied by any forward-looking statement include but not limited to:
 
 
·
the unknown future direction of interest rates and the timing and magnitude of any changes in interest rates;
 
 
·
changes in competitive conditions;
 
 
·
the introduction, withdrawal, success and timing of asset/liability management strategies or of mergers and acquisitions and other business initiatives and strategies;
 
 
·
changes in customer borrowing, repayment, investment and deposit practices;
 
 
·
changes in fiscal, monetary and tax policies;
 
 
·
changes in financial and capital markets;
 
 
·
continued deterioration in general economic conditions, either nationally or locally, resulting in, among other things, credit quality deterioration;
 
 
·
capital management activities, including possible future sales of new securities, or possible repurchases or redemptions by the Company of outstanding debt or equity securities;
 
 
·
factors driving impairment charges on investments;
 
 
·
the impact, extent and timing of technological changes;
 
 
·
litigation liabilities, including related costs, expenses, settlements and judgments, or the outcome of matters before regulatory agencies, whether pending or commencing in the future;
 
 
·
actions of the Federal Reserve Board;
 
 
·
changes in accounting principles and interpretations;
 
 
·
actions of the Department of the Treasury and the Federal Deposit Insurance Corporation under the EESA and the Federal Deposit Insurance Act and other legislative and regulatory actions and reforms; and
 
 
·
the continued  availability of earnings and excess capital sufficient for the lawful and prudent declaration and payment of cash dividends.
 
Such statements reflect our views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to the operations, results of operations, growth strategy and liquidity of the Company.  Readers are cautioned not to place undue reliance on these forward-looking statements.  It is intended that these forward-looking statements speak only as of the date they are made. We do not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect future events or circumstances or to reflect the occurrence of unanticipated events.
 
7

 
Item 1A. Risk Factors.

While we have a history of profitability and operate with capital that exceeds the requirements of bank regulatory agencies, the financial services industry in which we operate has been adversely affected by the current economic emergency conditions.  Further, an investment in our common stock (like an investment in the equity securities of any business enterprise) is subject to other investment risks and uncertainties.  The following describes some of the principal risks and uncertainties to which our industry in general, and we and our assets and businesses specifically, are subject; other risks are briefly identified in our cautionary statement that is included under the heading “Forward-Looking Statements and Associated Risks” in Part I, Item 1, “Business.”  Although we seek ways to manage these risks and uncertainties and to develop programs to control those that we can, we ultimately cannot predict the future.  Future results may differ materially from past results, and from our expectations and plans.

Risks Related to the Financial Services Industry Including Recent Market, Legislative and Regulatory Events

Difficult national market conditions have adversely affected our industry.

Declines in the housing market over the past few years, falling home prices and increasing foreclosures, unemployment and under-employment have negatively impacted the credit performance of loans that were related to real estate and resulted in significant write-downs of asset values by many financial institutions.  These write-downs have caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail.  Reflecting concern about the stability of the financial markets, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions.  This market turmoil and tightening of credit have on a national basis generally led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity.   These conditions can place downward pressure on the credit worthiness of bank customers and their inclinations to borrow.  A continued or worsening disruption and volatility could negatively impact customers' ability to seek new loans or to repay existing loans.  The personal wealth of many borrowers and guarantors could be negatively impacted by the recent severe market declines.   To date, the impact of these adverse conditions in the primary market areas of Southern Indiana that we serve has generally not been as severe as in other areas of Indiana and the United States.  If current levels of market disruption and volatility worsen in our primary service areas, however, we could experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.

There can be no assurance that recently enacted legislation will stabilize the U.S. financial system.

The U.S. Treasury and banking regulators are implementing a number of programs under the Emergency Economic Stabilization Act of 2008 and otherwise to address capital and liquidity issues in the banking system.  There can be no assurance as to the actual impact that these programs will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of these programs to stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, or access to credit.  We may be required to pay higher FDIC premiums than those published for 2009 because market developments have impacted the deposit insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.  See Part I, Item 1,  “Business — Federal Deposit Insurance Assessments," for more information.

We operate in a highly regulated environment and changes in laws and regulations to which we are subject may adversely affect our results of operations.
 
The banking industry in which we operate is subject to extensive regulation and supervision under federal and state laws and regulations.  The restrictions imposed by such laws and regulations limit the manner in which we conduct our business, undertake new investments and activities and obtain financing. These regulations are designed primarily for the protection of the deposit insurance funds and consumers and not to benefit our shareholders.  Financial institution regulation has been the subject of significant legislation in recent years and may be the subject of further significant legislation, none of which is in our control.  Significant new laws or changes in, or repeals of, existing laws (including changes in federal or state laws affecting corporate taxpayers generally or financial institutions specifically) could have a material adverse effect on our business, financial condition, results of operations or liquidity. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions, and any unfavorable change in these conditions could have a material adverse effect on our business, financial condition, results of operations or liquidity.
 
8

 
Additional Risks Related to Our Operations and Business and Financial Strategies
 
If our actual loan losses exceed our estimates, our earnings and financial condition will be impacted.
 
A significant source of risk for any bank or other enterprise that lends money arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail (because of financial difficulties or other reasons) to perform in accordance with the terms of their loan agreements.  In our case, we originate many loans that are secured, but some loans are unsecured depending on the nature of the loan. With respect to secured loans, the collateral securing the repayment of these loans includes a wide variety of real and personal property that may be insufficient to cover the obligations owed under such loans, due to adverse changes in collateral values caused by changes in prevailing economic, environmental and other conditions, including declines in the value of real estate and other external events.
 
We could be adversely affected by changes in interest rates.
 
Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions, demand for loans, securities and deposits, and policies of various governmental and regulatory agencies and, in particular, the monetary policies of the Board of Governors of the Federal Reserve System.  If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.  Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition, results of operations, and cash flows.
 
Our success is tied to the economic vitality of our Southern Indiana markets.
 
We conduct business from offices that are exclusively located in ten contiguous counties of Southern Indiana, from which substantially all of our customer base is drawn.  Because of the geographic concentration of our operations and customer base, our results depend largely upon economic conditions in this area.   To date, the impact of the nation's adverse economic conditions in the primary market areas of Southern Indiana  that we serve has generally not been as severe as in other areas of Indiana and the United States.  If current levels of market disruption and volatility worsen in our primary service areas, however, the quality of our loan portfolio, and the demand for our products and services, could be adversely affected, and this could have a material adverse effect on our business, financial condition, results of operations or liquidity.
 
We face substantial competition.
 
The banking and financial services business in our markets is highly competitive. We compete with much larger regional, national, and international competitors, including competitors that have no (or only a limited number of) offices physically located within our markets.  In addition, new banks could be organized in our market area which might bid aggressively for new business to capture market share in these markets.   Developments increasing the nature or level of our competition, or decreasing the effectiveness by which we compete, could have a material adverse effect on our business, financial condition, results of operations or liquidity.  See also Part I, Item 1, of this report, “Business— Competition,” and “Business  —Regulation and Supervision.”
 
The manner in which we report our financial condition and results of operations may be affected by accounting changes.
 
Our financial condition and results of operations that are presented in our consolidated financial statements, accompanying notes to the consolidated financial statements, and selected financial data appearing in this report, are, to a large degree, dependent upon our accounting policies.  The selection of and application of these policies involve estimates, judgments and uncertainties that are subject to change, and the effect of any change in estimates or judgments that might be caused by future developments or resolution of uncertainties could be materially adverse to our reported financial condition and results of operations.  In addition, authorities that prescribe accounting principles and standards for public companies from time to time change those principles or standards or adopt formal or informal interpretations of existing principles or standards.  Such changes or interpretations (to the extent applicable to us) could result in changes that would be materially adverse to our reported financial condition and results of operations.
 
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.
 
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of securities or loans and other sources could have a substantial negative effect on our liquidity.  Our access to funding sources in amounts adequate to finance our activities or the terms of which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general.  Although we have historically been able to replace maturing deposits and borrowings as necessary, we might not be able to replace such funds in the future if, among other things, our results of operations or financial condition or the results of operations or financial condition of our lenders or market conditions were to change.
 
9

 
The value of securities in our investment securities portfolio may be negatively affected by continued disruptions in securities markets.
 
The market for investment securities has become extremely volatile over the past twelve months. Volatile market conditions may detrimentally affect the value of securities that we hold in our investment portfolio, such as through reduced valuations due to the perception of heightened credit and liquidity risks. There can be no assurance that declines in market value associated with these disruptions will not result in other than temporary impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.
 
The soundness of other financial institutions could adversely affect us.
 
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions.  Financial services companies are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients.  As a result, defaults by, or even rumors or questions about, one or more financial services companies, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions.  Many of these transactions expose us to credit risk in the event of default of our counterparty or client.   In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount due us.
 
We are dependent on key personnel and the loss of one or more of those key personnel could harm our business.
 
Competition for qualified employees and personnel in the financial services industry (including banking personnel, trust and investments personnel, and insurance personnel)  is intense and there are a limited number of qualified persons with knowledge of and experience in our local Southern Indiana markets.  Our success depends to a significant degree upon our ability to attract and retain qualified loan origination executives, sales executives for our trust and investment products and services, and sales executives for our insurance products and services.   We also depend upon the continued contributions of our management personnel, and in particular upon the abilities of our senior executive management, and the loss of the services of one or more of them could harm our business.
 
Our controls and procedures may fail or be circumvented.
 
Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures.  Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations, cash flows and financial condition.
 
We are subject to security and operational risks relating to our use of technology that could damage our reputation and our business.
 
We rely heavily on communications and information systems to conduct our business.  Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems.  The occurrence of any failures, interruptions or security breaches of information systems used to process customer transactions could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability.
 
We face risks associated with acquisitions or mergers.
 
We may pursue acquisition or merger opportunities in the future.  Risks commonly encountered in merger and acquisitions include, among other things, difficulty of integrating the operations, systems and personnel of acquired companies and branches; potential disruption of our ongoing business; potential diversion of our management's time and attention; potential exposure to unknown or contingent liabilities of the acquired or merged company; exposure to potential asset quality issues of the acquired or merged company; possible loss of key employees and customers of the acquired or merged company; difficulty in estimating the value of the acquired or merged company; and environmental liability with acquired loans, and their collateral, or with any real estate.  We may not be successful in overcoming these risks or any other problems encountered in connection with mergers or acquisitions.
 
10


We are exposed to risk of environmental liabilities with respect to properties to which we take title.
 
In the course of our business, we may own or foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties (including liabilities for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination), or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property.

Item 1B. Unresolved Staff Comments.   None.
 
Item 2. Properties.

The Company’s executive offices are located in the main office building of its bank subsidiary, German American Bancorp, at 711 Main Street, Jasper, Indiana.  The main office building contains approximately 23,600 square feet of office space.  The Company’s subsidiaries conduct their operations from 34 other locations in Southern Indiana.
 
Item 3. Legal Proceedings.

There are no material pending legal proceedings, other than routine litigation incidental to the business of the Company’s subsidiaries, to which the Company or any of its subsidiaries is a party or of which any of their property is the subject.
 
Item 4. Submission of Matters to a Vote of Security Holders.

There were no matters submitted during the fourth quarter of 2008 to a vote of security holders, by solicitation of proxies or otherwise.
 
11

 
PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market and Dividend Information

German American Bancorp, Inc.’s stock is traded on NASDAQ’s Global Select Market under the symbol GABC.  The quarterly high and low closing prices for the Company’s common stock as reported by NASDAQ and quarterly cash dividends declared and paid are set forth in the table below.
 
         
2008
               
2007
       
               
Cash
               
Cash
 
   
High
   
Low
   
Dividend
   
High
   
Low
   
Dividend
 
                                     
Fourth Quarter
  $ 12.90     $ 10.65     $ 0.140     $ 14.00     $ 12.12     $ 0.140  
Third Quarter
  $ 13.60     $ 11.00     $ 0.140     $ 14.09     $ 11.91     $ 0.140  
Second Quarter
  $ 13.23     $ 11.39     $ 0.140     $ 14.45     $ 13.10     $ 0.140  
First Quarter
  $ 13.29     $ 11.31     $ 0.140     $ 14.50     $ 13.22     $ 0.140  
                    $ 0.560                     $ 0.560  

The Common Stock was held of record by approximately 3,686 shareholders at February 10, 2009.

Cash dividends paid to the Company’s shareholders are primarily funded from dividends received by the parent company from its bank subsidiary.  The declaration and payment of future dividends will depend upon the earnings and financial condition of the Company and its subsidiaries, general economic conditions, compliance with regulatory requirements affecting the ability of the bank subsidiary to declare dividends, and other factors.

Transfer Agent:
Computershare
 
Shareholder
Terri A. Eckerle
 
Priority Processing
 
Information and
German American Bancorp, Inc
 
250 Royall St
 
Corporate Office:
P. O. Box 810
 
Canton, MA  02021
   
Jasper, Indiana  47547-0810
 
Contact: Shareholder Relations
   
(812) 482-1314
 
(800) 884-4225
   
(800) 482-1314

Stock Performance Graph

The following graph compares the Company’s five-year cumulative total returns with those of the Russell 2000 Stock Index, Russell Microcap Stock Index, and the Indiana Bank Peer Group.  The Indiana Bank Peer Group (which is a custom peer group identified by Company management) includes all Indiana-based commercial bank holding companies (excluding companies owning thrift institutions that are not regulated as bank holding companies) that have been in existence as commercial bank holding companies throughout the five-year period ended December 2008, the stocks of which have been traded on an established securities market (NYSE, AMEX, NASDAQ) throughout that five-year period.  The companies comprising the Indiana Bank Peer Group for purposes of the December 2008 comparison were:  1st Source Corp., Community Bank Shares of IN, First Financial Corp., First Merchants Corp., Integra Bank Corp., Irwin Financial Corp., Lakeland Financial Corp., MainSource Financial Group, Old National Bancorp, Indiana Community Bancorp, Horizon Bancorp, Monroe Bancorp, and Tower Financial Corp. The returns of each company in the Indiana Bank Peer Group have been weighted to reflect the company’s market capitalization.  The Russell 2000 Stock Index, which is designed to measure the performance of the small-cap segment of the U.S. equity universe, is a subset of the Russell 3000 Index (which measures the performance of the largest 3000 U.S. companies) that includes approximately 2,000 of the smallest securities in that index based on a combination of their market cap and current index membership, and is annually reconstituted at the end of each June.  The Company’s stock was included in the Russell 2000 through June 2005.  The Russell Microcap Stock Index is an index representing the smallest 1,000 securities in the small-cap Russell 2000 Index plus the next 1,000 securities, which is also annually reconstituted at the end of each June.  The Company’s stock is currently included in the Russell Microcap Index.
 
12



Stock Repurchase Program Information
 
The following table sets forth information regarding the Company's purchases of its common shares during each of the three months ended December 31, 2008.
 
Period
 
Total
Number
Of Shares
(or Units)
Purchased
   
Average Price
Paid Per Share
(or Unit)
   
Total Number of Shares
(or Units) Purchased as Part
of Publicly Announced Plans
or Programs
   
Maximum Number
(or Approximate Dollar
Value) of Shares (or Units)
that May Yet Be Purchased
Under the Plans or Programs (1)
 
                         
October 2008
 
   
   
   
272,789
 
November 2008
 
   
   
   
272,789
 
December 2008
 
   
   
   
272,789
 
 
(1)  On April 26, 2001, the Company announced that its Board of Directors had approved a stock repurchase program for up to 607,754 of its outstanding common shares, of which the Company had purchased 334,965 common shares through December 31, 2008 (both such numbers adjusted for subsequent stock dividends).  The Board of Directors established no expiration date for this program. The Company purchased no shares under this program during the quarter ended December 31, 2008.
 
13


Item 6.  Selected Financial Data.

The following selected data should be read in conjunction with the consolidated financial statements and related notes that are included in Item 8 of this Report, and “Management's Discussion and Analysis of Financial Condition and Results of Operations,” which is included in Item 7 of this Report (dollars in thousands, except per share data).

   
2008
   
2007
   
2006
   
2005
   
2004
 
Summary of Operations:
                             
Interest Income
  $ 67,845     $ 72,261     $ 63,594     $ 50,197     $ 47,710  
Interest Expense
    26,908       33,646       27,398       17,984       16,471  
Net Interest Income
    40,937       38,615       36,196       32,213       31,239  
Provision for Loan Losses
    3,990       3,591       925       1,903       2,015  
Net Interest Income after Provision
                                       
For Loan Losses
    36,947       35,024       35,271       30,310       29,224  
Non-interest Income
    18,210       15,704       15,993       14,502       9,620  
Non-interest Expense
    36,716       37,221       37,059       31,756       30,609  
Income before Income Taxes
    18,441       13,507       14,205       13,056       8,235  
Income Tax Expense
    5,638       4,102       3,984       3,335       996  
Net Income
  $ 12,803     $ 9,405     $ 10,221     $ 9,721     $ 7,239  
                                              
Year-end Balances:
                                       
Total Assets
  $ 1,190,828     $ 1,131,710     $ 1,093,424     $ 946,467     $ 942,094  
Total Loans, Net of Unearned Income
    890,436       867,721       796,259       651,956       629,793  
Total Deposits
    941,750       877,421       867,618       746,821       750,383  
Total Long-term Debt
    105,608       86,786       68,333       66,606       69,941  
Total Shareholders’ Equity
    105,174       97,116       92,391       82,255       83,669  
                                              
Average Balances:
                                       
Total Assets
  $ 1,174,583     $ 1,114,140     $ 1,029,838     $ 925,851     $ 927,528  
Total Loans, Net of Unearned Income
    880,630       840,849       715,260       634,526       622,240  
Total Deposits
    922,137       889,736       814,440       730,220       731,467  
Total Shareholders’ Equity
    99,711       93,677       88,451       84,479       82,558  
                                             
Per Share Data (1):
                                       
Net Income
  $ 1.16     $ 0.85     $ 0.93     $ 0.89     $ 0.66  
Cash Dividends
    0.56       0.56       0.56       0.56       0.56  
Book Value at Year-end
    9.54       8.81       8.39       7.73       7.68  
                                             
Other Data at Year-end:
                                       
Number of Shareholders
    3,684       3,647       3,438       3,494       3,219  
Number of Employees
    348       371       397       367       372  
Weighted Average Number of Shares (1)
    11,029,519       11,009,536       10,994,739       10,890,987       10,914,622  
                                             
Selected Performance Ratios:
                                       
Return on Assets
    1.09 %     0.84 %     0.99 %     1.05 %     0.78 %
Return on Equity
    12.84 %     10.04 %     11.56 %     11.51 %     8.77 %
Equity to Assets
    8.83 %     8.58 %     8.45 %     8.69 %     8.88 %
Dividend Payout
    48.25 %     65.65 %     60.29 %     62.83 %     84.46 %
Net Charge-offs to Average Loans
    0.29 %     0.32 %     0.50 %     0.26 %     0.24 %
Allowance for Loan Losses to Loans
    1.07 %     0.93 %     0.90 %     1.42 %     1.40 %
Net Interest Margin
    3.82 %     3.83 %     3.96 %     3.92 %     3.86 %
 
(1)
Share and Per Data excludes the dilutive effect of stock options.
 
Year to year financial information comparability is affected by the purchase accounting treatment for mergers and acquisitions.
 
14

 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

INTRODUCTION


German American Bancorp, Inc. is a financial services holding company based in Jasper, Indiana. The Company’s Common Stock is traded on NASDAQ’s Global Select Market, under the symbol GABC.  The principal subsidiary of German American Bancorp, Inc., is its banking subsidiary, German American Bancorp, which operates through 28 retail banking offices in the ten contiguous Southern Indiana counties of Daviess, Dubois, Gibson, Knox, Lawrence, Martin, Monroe, Perry, Pike, and Spencer.  German American Bancorp, Inc., also owns a trust, brokerage, and financial planning subsidiary, which operates from the banking offices of the bank subsidiary, and full line property and casualty insurance agency with seven insurance agency offices throughout its market area.

Throughout this Management’s Discussion and Analysis, as elsewhere in this report, when we use the term “Company”, we will usually be referring to the business and affairs (financial and otherwise) of the Company and its subsidiaries and affiliates as a whole.  Occasionally, we will refer to the term “parent company” or “holding company” when we mean to refer to only German American Bancorp, Inc.

The information in this Management’s Discussion and Analysis is presented as an analysis of the major components of the Company’s operations for the years 2006 through 2008 and its financial condition as of December 31, 2008 and 2007.  This information should be read in conjunction with the accompanying consolidated financial statements and footnotes contained elsewhere in this report and with the description of business included in Item 1 of this Report (including the cautionary disclosure regarding “Forward Looking Statements and Associated Risks”).  Financial and other information by segment is included in Note 16 to the Company’s consolidated financial statements included in Item 8 of this Report and is incorporated into this Item 7 by reference.

The statements of management's expectations and goals concerning the Company's future operations and performance that are  set forth in the following Management Overview and in other sections of this Item 7 are forward-looking statements, and readers are cautioned that these forward-looking statements are based on assumptions and are subject to risks, uncertainties, and other factors.  Actual results may differ materially from the expectations of the Company that is expressed or implied by any forward-looking statement.  This Item 7, as well as the discussions in Item 1 (“Business”) entitled “Forward-Looking Statements and Associated Risks” and  in Item 1A (“Risk Factors”) (which discussions are incorporated in this Item 7 by reference) list some of the factors that could cause the Company's actual results to vary materially from those expressed or implied by any such forward-looking statements.
 
MANAGEMENT OVERVIEW

The Company’s net income increased $3,398,000 or 36% to $12,803,000 or $1.16 per share in 2008 compared to $9,405,000 or $0.85 per share in 2007.  The Company’s strong annual operating performance during 2008 was driven by successive record quarterly earnings in each quarter of 2008.  Current year earnings were positively affected by increases within the Company’s net interest income and non-interest income and a modestly lower level of non-interest expenses.  The improvement in the level of net interest income was largely attributable to balance sheet growth which included loan growth of approximately 3% and deposit growth of 7%.  The Company experienced 16% growth in non-interest income while lowering non-interest expense by 1% during 2008 compared with 2007.  The reduction in non-interest expense was attributable to a 4% reduction in salaries and employee benefit expense attributable to a decrease of approximately 7% of full-time equivalent employees during 2008.  This reduction in staffing levels was principally due to actions taken as a result of the Company’s previously-announced formal review of operating effectiveness and efficiency.  Management believes that this decrease in staffing levels in relation to current operations is sustainable and therefore will be of continuing benefit to earnings in future years.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES


The financial condition and results of operations for German American Bancorp, Inc. presented in the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements, and selected financial data appearing elsewhere within this report, are, to a large degree, dependent upon the Company’s accounting policies.  The selection of and application of these policies involve estimates, judgments and uncertainties that are subject to change.  The critical accounting policies and estimates that the Company has determined to be the most susceptible to change in the near term relate to the determination of the allowance for loan losses, the valuation of securities available for sale, and the valuation allowance on deferred tax assets.
 
15

 
Allowance for Loan Losses

The Company maintains an allowance for loan losses to cover probable incurred credit losses at the balance sheet date.  Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.  Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.  A provision for loan losses is charged to operations based on management's periodic evaluation of the necessary allowance balance.  Evaluations are conducted at least quarterly and more often if deemed necessary.  The ultimate recovery of all loans is susceptible to future market factors beyond the Company's control.

The Company has an established process to determine the adequacy of the allowance for loan losses. The determination of the allowance is inherently subjective, as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on other classified loans and pools of homogeneous loans, and consideration of past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors, all of which may be susceptible to significant change.  The allowance consists of two components of allocations, specific and general.  These two components represent the total allowance for loan losses deemed adequate to cover losses inherent in the loan portfolio.

Commercial and agricultural loans are subject to a standardized grading process administered by an internal loan review function.  The need for specific reserves is considered for credits when graded substandard or special mention, or when: (a) the customer’s cash flow or net worth appears insufficient to repay the loan; (b) the loan has been criticized in a regulatory examination; (c) the loan is on non-accrual; or, (d) other reasons where the ultimate collectibility of the loan is in question, or the loan characteristics require special monitoring.  Specific allowances are established in cases where management has identified significant conditions or circumstances related to an individual credit that we believe indicates the loan is impaired.  Specific allocations on impaired loans are determined by comparing the loan balance to the present value of expected cash flows or expected collateral proceeds.  Allocations are also applied to categories of loans not considered individually impaired but for which the rate of loss is expected to be greater than historical averages, including those graded substandard or special mention and non-performing consumer or residential real estate loans.  Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values.

General allocations are made for other pools of loans, including non-classified loans, homogeneous portfolios of consumer and residential real estate loans, and loans within certain industry categories believed to present unique risk of loss.  General allocations of the allowance are primarily made based on a five-year historical average for loan losses for these portfolios, judgmentally adjusted for economic factors and portfolio trends.

Due to the imprecise nature of estimating the allowance for loan losses, the Company’s allowance for loan losses includes a minor unallocated component.  The unallocated component of the allowance for loan losses incorporates the Company’s judgmental determination of inherent losses that may not be fully reflected in other allocations, including factors such as economic uncertainties, lending staff quality, industry trends impacting specific portfolio segments, and broad portfolio quality trends.    Therefore, the ratio of allocated to unallocated components within the total allowance may fluctuate from period to period.

Securities Valuation

Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported separately in accumulated other comprehensive income (loss), net of tax.  The Company obtains market values from a third party on a monthly basis in order to adjust the securities to fair value.  Equity securities that do not have readily determinable fair values are carried at cost.  Additionally, all securities are required to be written down to fair value when a decline in fair value is other than temporary; therefore, future changes in the fair value of securities could have a significant impact on the Company’s operating results.  In determining whether a market value decline is other-than-temporary, management considers the reason for the decline, the extent of the decline and the duration of the decline.  As of December 31, 2008, gross unrealized losses on the securities available-for-sale portfolio totaled approximately $323,000.

Income Tax Expense

Income tax expense involves estimates related to the valuation allowance on deferred tax assets and loss contingencies related to exposure from tax examinations.

A valuation allowance reduces deferred tax assets to the amount management believes is more likely than not to be realized.  In evaluating the realization of deferred tax assets, management considers the likelihood that sufficient taxable income of appropriate character will be generated within carryback and carryforward periods, including consideration of available tax planning strategies.
 
16

 
Tax related loss contingencies, including assessments arising from tax examinations and tax strategies, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.  In considering the likelihood of loss, management considers the nature of the contingency, the progress of any examination or related protest or appeal, the views of legal counsel and other advisors, experience of the Company or other enterprises in similar matters, if any, and management’s  intended response to any assessment.

RESULTS OF OPERATIONS


NET INCOME

Net income increased $3,398,000 or 36% to $12,803,000 or $1.16 per share in 2008 compared to $9,405,000 or $0.85 per share in 2007.  The increase in earnings in 2008 compared with 2007 was attributable to improvement in net interest income, non-interest income, and non-interest expense, partially offset by a higher provision for loan losses.

Net income declined $816,000 or 8% to $9,405,000 or $0.85 per share in 2007 compared to $10,221,000 or $0.93 per share in 2006.  The decline in earnings during 2007 compared with 2006 was largely the result of an increase in the provision for loan losses.  Partially mitigating the increased provision was an increase in net interest income.

NET INTEREST INCOME

Net interest income is the Company’s single largest source of earnings, and represents the difference between interest and fees realized on earning assets, less interest paid on deposits and borrowed funds.  Several factors contribute to the determination of net interest income and net interest margin, including the volume and mix of earning assets, interest rates, and income taxes.  Many factors affecting net interest income are subject to control by management policies and actions.  Factors beyond the control of management include the general level of credit and deposit demand, Federal Reserve Board monetary policy, and changes in tax laws.

Net interest income increased $2,322,000 or 6% (an increase of $2,320,000 or 6% on a tax-equivalent basis) for the year ended 2008 compared with 2007.  The increase in net interest income was primarily attributable to an increased level of average earning assets for the year ended 2008 compared with 2007.  Average earning assets totaled $1.086 billion during 2008 compared with $1.023 billion during 2007. During 2008, average loans outstanding totaled $880.6 million, an increase of $39.8 million or 5%, compared to the $840.8 million in average loans outstanding during 2007.  Average commercial and agricultural loans totaled $639.4 million, an increase of $50.4 million or 9% during 2008 compared with 2007.  Average residential mortgage loans and consumer loans totaled $241.2 million during 2008 representing a decline of $10.6 million or 4% from 2007.

For 2008, the net interest margin remained relatively stable at 3.82% compared to 3.83% during 2007.  Net interest margin is tax equivalent net interest income expressed as a percentage of average earning assets.  The Company’s yield on earning assets totaled 6.30% compared with a cost of funds (expressed as a percentage of average earning assets) of 2.48% netting to a net interest margin of 3.82% for the year ended December 31, 2008.  The Company’s yield on earning assets was 7.12% compared with a cost of funds of 3.29% netting to a net interest margin of 3.83% for the year ended December 31, 2007.

Net interest income increased $2,419,000 or 7% (an increase of $1,953,000 or 5% on a tax-equivalent basis) for the year ended 2007 compared with 2006.  The increase in net interest income was primarily attributable to an increased level of average earning assets for the year ended 2007 compared with 2006.  The higher level of earning assets was primarily attributable to an increase in the average level of loans outstanding, and in particular a higher level of average commercial and agricultural loans.  Average earning assets totaled $1.023 billion during 2007 compared with $941.6 million during 2006.

For 2007, the net interest margin decreased to 3.83% compared to 3.96% during 2006.  The Company’s yield on earning assets totaled 7.12% compared with a cost of funds of 3.29% netting to a net interest margin of 3.83% for the year ended December 31, 2007.  The Company’s yield on earning assets was 6.87% compared with a cost of funds of 2.91% netting to a net interest margin of 3.96% for the year ended December 31, 2006.

17

 
The following table summarizes net interest income (on a tax-equivalent basis) for each of the past three years.  For tax-equivalent adjustments, an effective tax rate of 34% was used for all years presented (1).

Average Balance Sheet
(Tax-equivalent basis / dollars in thousands)

   
Twelve Months Ended
   
Twelve Months Ended
   
Twelve Months Ended
 
   
December 31, 2008
   
December 31, 2007
   
December 31, 2006
 
                                                       
   
Principal
   
Income /
   
Yield /
   
Principal
   
Income /
   
Yield /
   
Principal
   
Income /
   
Yield /
 
   
Balance
   
Expense
   
Rate
   
Balance
   
Expense
   
Rate
   
Balance
   
Expense
   
Rate
 
                                                       
ASSETS
                                                     
Federal Funds Sold and Other
                                                     
Short-term Investments
  $ 35,065     $ 593       1.69 %   $ 9,626     $ 478       4.96 %   $ 10,971     $ 545       4.97 %
                                                                         
Securities:
                                                                       
Taxable
    152,709       8,007       5.24 %     149,108       6,992       4.69 %     174,007       7,763       4.46 %
Non-taxable
    18,061       1,164       6.44 %     23,913       1,423       5.95 %     41,312       2,721       6.59 %
Total Loans and Leases (2)
    880,630       58,669       6.66 %     840,849       63,958       7.61 %     715,260       53,621       7.50 %
                                                                         
TOTAL INTEREST
                                                                       
EARNING ASSETS
    1,086,465       68,433       6.30 %     1,023,496       72,851       7.12 %     941,550       64,650       6.87 %
                                                                         
Other Assets
    97,275                       98,389                       97,570                  
Less: Allowance for Loan Losses
    (9,157 )                     (7,745 )                     (9,282 )                
                                                                         
TOTAL ASSETS
  $ 1,174,583                     $ 1,114,140                     $ 1,029,838                  
                                                                         
LIABILITIES AND
                                                                       
SHAREHOLDERS’ EQUITY
                                                                       
Interest-bearing Demand Deposits
  $ 212,467     $ 3,440       1.62 %   $ 153,033     $ 3,280       2.14 %   $ 140,786     $ 2,625       1.86 %
Savings Deposits
    209,593       3,407       1.63 %     177,001       4,858       2.74 %     174,095       4,263       2.45 %
Time Deposits
    359,115       14,365       4.00 %     425,878       19,151       4.50 %     369,800       14,441       3.91 %
FHLB Advances and
                                                                       
Other Borrowings
    138,887       5,696       4.10 %     117,084       6,357       5.43 %     113,559       6,069       5.34 %
                                                                         
TOTAL INTEREST-BEARING
                                                                       
LIABILITIES
    920,062       26,908       2.92 %     872,996       33,646       3.85 %     798,240       27,398       3.43 %
                                                                         
Demand Deposit Accounts
    140,962                       133,824                       129,759                  
Other Liabilities
    13,848                       13,643                       13,388                  
TOTAL LIABILITIES
    1,074,872                       1,020,463                       941,387                  
                                                                         
Shareholders’ Equity
    99,711                       93,677                       88,451                  
                                                                         
TOTAL LIABILITIES AND
                                                                       
SHAREHOLDERS’ EQUITY
  $ 1,174,583                     $ 1,114,140                     $ 1,029,838                  
                                                                         
NET INTEREST INCOME
          $ 41,525                     $ 39,205                     $ 37,252          
                                                                         
NET INTEREST MARGIN
                    3.82 %                     3.83 %                     3.96 %
 
(1)
Effective tax rates were determined as though interest earned on the Company’s investments in municipal bonds and loans was fully taxable.
 
(2)
Loans held-for-sale and non-accruing loans have been included in average loans. Interest income on loans includes loan fees of $127, $806, and $1,727 for 2008, 2007, and 2006, respectively.
 
18

 
The following table sets forth for the periods indicated a summary of the changes in interest income and interest expense resulting from changes in volume and changes in rates:

Net Interest Income – Rate / Volume Analysis
(Tax-Equivalent basis, dollars in thousands)

   
2008 compared to 2007
   
2007 compared to 2006
 
   
Increase / (Decrease) Due to (1)
   
Increase / (Decrease) Due to (1)
 
   
Volume
   
Rate
   
Net
   
Volume
   
Rate
   
Net
 
Interest Income:
                                   
Federal Funds Sold and Other
                                   
Short-term Investments
  $ 597     $ (482 )   $ 115     $ (67 )   $     $ (67 )
Taxable Securities
    172       843       1,015       (1,153 )     382       (771 )
Non-taxable Securities
    (370 )     111       (259 )     (1,056 )     (242 )     (1,298 )
Loans and Leases
    2,922       (8,211 )     (5,289 )     9,542       795       10,337  
Total Interest Income
    3,321       (7,739 )     (4,418 )     7,266       935       8,201  
                                                 
Interest Expense:
                                               
Savings and Interest-bearing Demand
    1,921       (3,212 )     (1,291 )     344       906       1,250  
Time Deposits
    (2,808 )     (1,978 )     (4,786 )     2,356       2,354       4,710  
FHLB Advances and Other Borrowings
    1,059       (1,720 )     (661 )     190       98       288  
Total Interest Expense
    172       (6,910 )     (6,738 )     2,890       3,358       6,248  
                                                 
Net Interest Income
  $ 3,149     $ (829 )   $ 2,320     $ 4,376     $ (2,423 )   $ 1,953  

(1)    The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the  relationship of the absolute dollar amounts of the change in each.

See the Company’s Average Balance Sheet and the discussions headed USES OF FUNDS, SOURCES OF FUNDS, and “RISK MANAGEMENT – Liquidity and Interest Rate Risk Management” for further information on the Company’s net interest income, net interest margin, and interest rate sensitivity position.

PROVISION FOR LOAN LOSSES

The Company provides for loan losses through regular provisions to the allowance for loan losses.  The provision is affected by net charge-offs on loans and changes in specific and general allocations required on the allowance for loan losses.  Provisions for loan losses totaled $3,990,000, $3,591,000, and $925,000 in 2008, 2007, and 2006, respectively.

The level of provision increased by $399,000 or 11% in 2008 compared with 2007.  The increase in provision was largely attributable to an increased level of non-performing loans in 2008 and overall growth in the Company’s loan portfolio.  The level of provision for loan losses totaled 0.45% of average outstanding loans during 2008 while net charge-offs represented 0.29% of average loans outstanding during 2008.  Accordingly, the Company’s allowance for loan losses increased to 1.07% of total loans at year-end 2008 compared with 0.93% at year-end 2007.

The increased level of provision for loan losses during 2007 compared with 2006 was largely attributable to a write-down of a single non-performing credit facility secured by two hotel properties and growth within the Company’s loan portfolio.  An additional contributing factor to the elevated levels of provision during the year ended December 31, 2007 compared with 2006 was the settlement of a large non-performing credit in 2006.  The specific allocation to this credit as of year end 2005 exceeded the level of charge-off actually incurred during 2006 by approximately $450,000.

Provisions for loan losses in all periods were made at a level deemed necessary by management to absorb estimated, probable incurred losses in the loan portfolio.  A detailed evaluation of the adequacy of the allowance for loan losses is completed quarterly by management, the results of which are used to determine provisions for loan losses.  Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Refer also to the sections entitled CRITICAL ACCOUNTING POLICIES AND ESTIMATES and “RISK MANAGEMENT – Lending and Loan Administration” for further discussion of the provision and allowance for loan losses.
 
19


NON-INTEREST INCOME

During 2008, Non-interest Income increased $2,506,000 or 16% compared with 2007.  The increase was realized in all categories with the exception of Trust and Investment Product Fees.  During 2007, Non-interest Income declined $289,000 or 2% compared with 2006.  The decline was primarily attributable to Net Gain (Loss) on Securities largely offset by increases in Trust and Investment Product Fees, Service Charges on Deposit Accounts, and Insurance Revenues.
         
% Change From
 
Non-interest Income (dollars in thousands)
 
Years Ended December 31,
   
Prior Year
 
   
2008
   
2007
   
2006
   
2008
   
2007
 
Trust and Investment Product Fees
  $ 2,288     $ 2,590     $ 2,210       (12 )%     17 %
Service Charges on Deposit Accounts
    4,920       4,361       3,901       13       12  
Insurance Revenues
    6,306       5,794       5,094       9       14  
Other Operating Income
    3,203       2,817       2,920       14       (4 )
Subtotal
    16,717       15,562       14,125       7       10  
Net Gains on Sales of Loans and Related Assets
    1,399       822       917       70       (10 )
Net Gain (Loss) on Securities
    94       (680 )     951       n/m (1)     n/m (1)
TOTAL NON-INTEREST INCOME
  $ 18,210     $ 15,704     $ 15,993       16       (2 )
 
(1)     n/m = not meaningful

Trust and Investment Product Fees totaled $2,288,000 during the year ended December 31, 2008 representing a decline of $302,000 or 12% from 2007, while Trust and Investment Product Fees increased $380,000 or 17% during 2007 as compared to 2006.  These changes were driven by varying levels of brokerage commission revenue.

Service Charges on Deposit Accounts totaled $4,920,000 during the year ended December 31, 2008 representing an increase of $559,000 or 13% over 2007.  The increase was attributable to a combination of increased gross fees and a reduced level of refunded and waived fees.  Service Charges on Deposit Accounts increased $460,000 or 12% during 2007 as compared to 2006.  These increases were largely attributable to increased usage and fees associated with the Company’s overdraft protection service program.

During the year ended December 31, 2008, Insurance Revenues totaled $6,306,000 which was an increase of $512,000 or 9% compared to 2007.  The increase was largely attributable to an increase in contingency revenue at the Company’s property and casualty insurance subsidiary, German American Insurance.  Insurance Revenues increased $700,000 or 14% during 2007 as compared 2006.  The increase in Insurance Revenues during 2007 was attributable primarily to commission income from Keach and Grove Insurance, Inc. which was acquired October 1, 2006 and thereby not included in the Company results during the first nine months of 2006.

During the year ended December 31, 2008, the net gain on sale of residential loans totaled $1,399,000, an increase of $577,000 or 70% over the gain of $822,000 recognized in the year ended December 31, 2007.  The increase was largely attributable to higher levels of residential loan sales during 2008 compared with 2007.  Net Gains on Sales of Loans and Related Assets declined $95,000 or 10% during 2007 compared with 2006 primarily due to the sale of the Company’s mortgage servicing rights portfolio during 2006 at a gain of $198,000.  Loan sales for 2008, 2007, and 2006 totaled $108.0 million, $67.0 million, and $55.6 million, respectively.

The Company recognized a net gain on securities of $94,000 during the year ended December 31, 2008.  The Company recognized gains on securities sold of $1,031,000 during 2008 and other-than-temporary impairment expense of $937,000 on its portfolio of non-controlling investments in other banking organizations.  During 2007, the Company recognized a $680,000 net loss on securities related to its portfolio of non-controlling investments in other banking organizations.  The net loss resulted from the sale of one of the investment holdings at a modest gain and the recognition of an other-than-temporary impairment charge in connection with the valuation of other holdings within the portfolio.  During 2006, the Company recognized a gain of $951,000 on the sale of its portfolio of FHLMC and FNMA preferred stock.

20

 
NON-INTEREST EXPENSE

During the year ended December 31, 2008, Non-interest Expense totaled $36,716,000, a decline of $505,000 or 1% from the year ended 2007.  During 2007, Non-interest Expense remained stable with a less than 1% increase as compared with 2006.

                     
% Change From
 
Non-interest Expense (dollars in thousands)
 
Years Ended December 31,
   
Prior Year
 
   
2008
   
2007
   
2006
   
2008
   
2007
 
Salaries and Employee Benefits
  $ 20,786     $ 21,671     $ 21,491       (4 )%     1 %
Occupancy, Furniture and Equipment Expense
    5,677       5,379       4,988       6       8  
FDIC Premiums
    208       103       108       102       (5 )
Data Processing Fees
    1,493       1,370       1,646       9       (17 )
Professional Fees
    1,670       1,418       1,786       18       (21 )
Advertising and Promotion
    1,078       957       940       13       2  
Supplies
    570       625       619       (9 )     1  
Intangible Amortization
    889       894       698       (1 )     28  
Other Operating Expenses
    4,345       4,804       4,783       (10 )     1  
TOTAL NON-INTEREST EXPENSE
  $ 36,716     $ 37,221     $ 37,059       (1 )     1  

Salaries and Employee Benefits totaled $20,786,000 during the year ended December 31, 2008 representing a decline of $885,000 or 4% from the year ended December 31, 2007.  The decline was largely attributable to a decrease of approximately 28 full-time equivalent employees, or 7% of total FTEs, during the year ended December 31, 2008 compared with year ended 2007.  Salaries and Employee Benefits expense increased $180,000 or 1% during 2007 compared with 2006.

Occupancy, Furniture and Equipment Expense totaled $5,677,000 during the year ended December 31, 2008 representing an increase of $298,000 or 6% from the year ended 2007. The increases were largely attributable to higher levels of furniture, fixtures and equipment depreciation.   Occupancy, Furniture and Equipment Expense increased $391,000 or 8% during 2007 compared with 2006.  This increase was primarily attributable to the opening of a branch bank facility in Bloomington, Indiana during the first quarter of 2007 and an insurance agency acquisition during the fourth quarter of 2006.
 
Professional Fees increased $252,000 or 18% during 2008 compared with 2007.  The increases were due primarily to professional fees associated with the Company’s formal review of effectiveness and efficiency.   Professional Fees decreased $368,000 or 21% during 2007 compared with 2006.  The decline in 2007 was largely due to an elevated level of professional fees in 2006 associated with a core processing computer conversion at the Company’s banking subsidiary.
 
Other Operating Expenses decreased $459,000 or 10% during 2008 compared with 2007.  The decline in costs was primarily attributable to a lower level of collection costs and a lower level of losses associated with fraudulent ATM and debit card transactions.  Intangible Amortization increased $196,000 or 28% during 2007 compared to 2006 due to an insurance agency acquisition during the fourth quarter of 2006.
 
The FDIC charges insured financial institutions premiums to maintain the Deposit Insurance Fund at a certain level.  See Part I, Item 1, "Business – Federal Deposit Insurance Assessments."  On October 16, 2008, the FDIC published a restoration plan designed to replenish the Deposit Insurance Fund over a period of five years and to increase the deposit insurance reserve ratio.   In order to implement the restoration plan, the FDIC proposes to change both its risk-based assessment system and its base assessment rates.  Either an increase in the Risk Category of our bank subsidiary, or adjustments to the base assessment rates, could materially increase our deposit insurance premiums and assessments.

PROVISION FOR INCOME TAXES

The Company records a provision for current income taxes payable, along with a provision for deferred taxes payable in the future.  Deferred taxes arise from temporary differences, which are items recorded for financial statement purposes in a different period than for income tax returns.  The Company’s effective tax rate was 30.6%, 30.4%, and 28.0%, respectively, in 2008, 2007, and 2006.  The effective tax rate in all periods is lower than the blended statutory rate of 39.6%.  The lower effective rate in all periods primarily resulted from the Company’s tax-exempt investment income on securities and loans, income tax credits generated by investments in affordable housing projects, and income generated by subsidiaries domiciled in a state with no state or local income tax.  See Note 11 to the Company’s consolidated financial statements included in Item 8 of this Report for additional details relative to the Company’s income tax provision.
 
21

 
CAPITAL RESOURCES


The Company and its affiliate bank are subject to regulatory capital requirements administered by federal banking agencies.  Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices.  The prompt corrective action regulations provide five classifications, including well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition.  The Company and its affiliate bank at year-end 2008 were categorized as well-capitalized as that term is defined by applicable regulations.  See Note 9 to the Company’s consolidated financial statements included in Item 8 of this Report for actual and required capital ratios and for additional information regarding capital adequacy.

The Company continues to maintain a strong capital position.  Shareholders’ equity totaled $105.2 million and $97.1 million at December 31, 2008 and 2007, respectively.  Total equity represented 8.8% and 8.6%, respectively, of year-end total assets.  The Company paid cash dividends of $6.2 million or $0.56 per share in 2008 and 2007.  The increase in shareholders’ equity during 2008 compared with 2007 was primarily the result of increased retained earnings of $6.3 million and a change in the unrealized gain on available-for-sale securities of $1.6 million.

In November 2008, the Company applied to participate in the Capital Purchase Program established by the United States Treasury Department under the Emergency Economic Stabilization Act of 2008.  By letter dated January 26, 2009, the Treasury Department advised the Company that the application had been accepted, and the Treasury Department offered to invest up to $25 million in newly issued shares of preferred stock of the Company under the terms and conditions of the CPP.  As part of its investment, the Treasury Department also would receive warrants to purchase common stock of the Company having an aggregate market price of 15% of the investment amount.  Under the terms of the Company's approval to participate in the CPP, the Company was required to close upon the investment transaction within 30 days of the date of the January 26 letter.

During the thirty-day closing period established by the Treasury Department letter, the Company's Board of Directors authorized a special committee of the Board to further evaluate not only the possible CPP investment plan but also an alternative plan to augment the Company's regulatory capital.  After further evaluation, the special committee determined that proceeding with an alternative capital plan was in the best interests of the Company and that the Company should defer taking any action to close upon the financing available to it under the CPP.  Accordingly, the Company, on February 20, 2009, requested that the Treasury Department indefinitely postpone the Company's closing under the CPP. The Company’s Board of Directors on March 2, 2009, ratified the committee’s determination to postpone the closing of the CPP financing, and determined that the Company should decline participation in the CPP and should advise the Treasury Department that it was withdrawing its CPP application. On March 3, 2009, the Company advised the Treasury Department to this effect.

USES OF FUNDS

 
LOANS

Total loans at year-end 2008 increased $21.9 million or 3% compared with year-end 2007.  Commercial and industrial loans increased $48.2 million or 11% during 2008, while agricultural loans decreased $5.7 million or 3%, residential mortgage loans decreased $16.8 million or 14%, and consumer loans declined $3.8 million or 3% during 2008.  The decrease in residential mortgage loans was the result of a declining interest rate environment during 2008 and the sale of the majority of the Company’s fixed rate residential mortgage production into the secondary market rather than hold in its portfolio.

Total loans at year-end 2007 increased $72.0 million or 9% compared with year-end 2006.  Commercial and industrial loans increased $54.8 million or 14%, agricultural loans increased $16.7 million or 11%, and residential mortgage loans increased $2.2 million or 2% during 2007 while consumer loans declined $1.7 million or 1% during 2007.

The composition of the loan portfolio shifted modestly at year-end 2008 compared with year-end 2007 with the heaviest concentration in commercial and industrial loans which comprised 57% of the total loan portfolio at year-end 2008, compared with 53% in 2007.  The Company’s commercial lending is extended to various industries, including hotel, agribusiness and manufacturing, as well as health care, wholesale, and retail services.
 
22


Loan Portfolio
 
December 31,
 
(dollars in thousands)
 
2008