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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-QSB

(Mark one)

ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006

OR

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______

Commission file number: 000-50828

THIRD CENTURY BANCORP
(Exact name of small business issuer as specified in its charter)

Indiana
20-0857725
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)


80 East Jefferson Street
Franklin, Indiana 46131
(Address of principal executive offices)

(317) 736-7151
(Issuer’s telephone number)

Check whether the Issuer (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 twelve months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such requirements for the past 90 days.
YES ý  NO o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES o  NO ý 

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: October 31, 2006 - 1,653,125 common shares

Transitional Small Business Disclosure Format (Check one): Yes o No ý 


THIRD CENTURY BANCORP
FORM 10-QSB

INDEX

   
Page No.
 
     
3
     
 
3
 
4
 
5
 
6
 
7
     
10
16
     
16
     
16
16
16
16
16
16
     
 
17
     
E-1
     
   




PART I.    FINANCIAL INFORMATION
Item 1.  Financial Statements

THIRD CENTURY BANCORP
Consolidated Condensed Balance Sheets

           
 
  
As of
  
As of
  
 
  
September 30, 2006
(Unaudited)
  
December 31, 2005
 
  
Assets
 (in thousands)
Cash and due from banks
  
$
411
  
$
602
  
Interest-earning demand deposits
    
6,042
    
7,251
  
Cash and cash equivalents
    
6,453
    
7,853
  
Interest-earning time deposits
    
--
    
200
  
Held to maturity securities
    
5,569
    
9,210
  
Loans, net of allowance for loan losses of $935 and $926
    
112,634
    
105,557
  
Premises and equipment
    
4,343
    
2,897
  
Federal Home Loan Bank stock
    
1,205
    
1,041
  
Interest receivable
    
670
    
592
  
Other assets
    
658
    
797
  
Total assets
  
$
131,532
  
$
128,147
  
               
Liabilities
          
Deposits
          
Demand
  
$
11,474
  
$
10,215
  
Savings, NOW and money market
    
39,065
    
44,264
  
Time
    
36,702
    
34,129
  
Total deposits
    
87,241
    
88,608
  
Federal Home Loan Bank advances
    
24,100
    
16,500
  
Other liabilities
    
559
    
486
  
Total liabilities
    
111,900
    
105,594
  
               
Commitments and Contingencies
              
               
Equity Contributed by ESOP
    
295
    
203
  
             
Stockholders' Equity
              
Preferred stock, without par value, authorized and unissued
2,000,000 shares
    
--
    
--
  
Common stock, without par value
              
Authorized - 20,000,000 shares
            
Issued and outstanding - 1,653,125 shares
    
13,630
    
14,290
  
Unearned RRP shares
   
--
    
(778
)
Retained earnings
    
5,707
    
8,838
  
Total stockholders' equity
    
19,337
    
22,350
  
Total liabilities and stockholders’ equity
  
$
131,532
  
$
128,147
  


See notes to consolidated condensed financial statements.

3

THIRD CENTURY BANCORP
Consolidated Condensed Statements of Income
(Unaudited)

   
Three Months Ended
September 30,
  
Nine Months Ended
September 30,
  
   
2006
  
2005
  
2006
  
2005
  
   
(dollars in thousands, except per share amounts)
  
Interest Income
                          
Loans receivable
  
$
1,882
  
$
1,615
  
$
5,378
  
$
4,702
  
Investment securities
    
66
    
103
    
237
    
248
  
Federal Home Loan Bank stock
    
13
    
11
    
39
    
31
  
Interest-earning deposits
    
51
    
32
    
131
    
132
  
Total interest income
    
2,012
    
1,761
    
5,785
    
5,113
  
                           
Interest expense
                          
Deposits
    
563
    
396
    
1,561
    
1,071
  
Federal Home Loan Bank advances
    
278
    
167
    
662
    
490
  
Total interest expense
    
841
    
563
    
2,223
    
1,561
  
                           
Net interest income
    
1,171
    
1,198
    
3,562
    
3,552
  
Provision for loan losses
    
15
    
---
    
45
    
(20
)
Net interest income after provision for loan losses
    
1,156
    
1,198
    
3,517
    
3,572
  
                           
Other income
                          
Service charges on deposit accounts
    
73
    
57
    
217
    
155
  
Other service charges and fees
    
70
    
63
    
227
    
192
  
Net gains on loan sales
    
16
    
22
    
61
    
64
  
Other income
    
56
    
73
    
183
    
136
  
Total other income
    
215
    
215
    
688
    
547
  
                           
Other expenses
                          
Salaries and employee benefits
    
738
    
734
    
2,203
    
2,190
  
Net occupancy and equipment expenses
    
150
    
116
    
388
    
340
  
Data processing fees
    
102
    
88
    
312
    
287
  
Professional Services
    
34
    
9
    
87
    
110
  
ATM Expense
    
34
    
30
    
93
    
82
  
Other expenses
    
180
    
189
    
525
    
530
  
Total other expenses
    
1,238
    
1,166
    
3,608
    
3,539
  
                           
Income before income tax
    
133
    
247
    
597
    
580
  
Income tax expense
    
52
    
102
    
235
    
234
  
                           
Net income
  
$
81
  
$
145
  
$
362
  
$
346
  
                           
Weighted average common shares - basic
    
1,487
    
1,518
    
1,478
    
1,525
  
Weighted average common shares- diluted
    
1,487
    
1,519
    
1,480
    
1,525
  
Earnings per share - basic
  
$
0.05
  
$
0.10
  
$
0.24
  
$
0.23
  
Earnings per share - diluted
  
$
0.05
  
$
0.10
  
$
0.24
  
$
0.23
  
Dividends declared per share
  
$
0.04
  
$
0.04
  
$
0.12
  
$
0.12
  
Return of capital declared per share
    
--
    
--
  
$
2.00
    
--
  

See notes to consolidated condensed financial statements.

4

THIRD CENTURY BANCORP
Consolidated Condensed Statement of Stockholders’ Equity
(Unaudited)
(Dollar amounts in thousands)


   
Common Stock
               
   
Shares
      
Unearned
  
Retained
      
   
Outstanding
  
Amount
  
RRP shares
  
Earnings
  
Total
  
Balances, January 1, 2006
    
1,653,125
  
$
14,290
  
$
(778
)
$
8,838
  
$
22,350
  
Net and comprehensive income
   
--
    
--
    
--
    
362
    
362
  
Reclassification of unearned compensation upon adoption
of SFAS 123 (R)
    
--
    
(778
)
  
778
    
--
    
--
  
Amortization of RRP
    
--
    
118
    
--
    
--
    
118
  
Return of capital paid ($2.00 per share)
    
--
    
--
    
--
    
(3,306
)
  
(3,306
)
Dividends paid ($.12 per share outstanding)
    
--
    
--
    
--
    
(187
)
  
(187
)
Balance, September 30, 2006
    
1,653,125
 
$
13,630
  
$
--
  
$
5,707
  
$
19,337
  

See notes to consolidated condensed financial statements.


5


THIRD CENTURY BANCORP
Consolidated Condensed Statements of Cash Flows
(Unaudited)
   
Nine Months Ended September 30,
  
   
2006
  
2005
  
   
(in thousands)
  
Operating Activities
              
Net income
  
$
362
  
$
346
  
Adjustments to reconcile net income to net cash provided by operating activities
              
Provision for loan losses
    
45
    
(20
)
Depreciation
    
146
    
138
  
Investment securities (accretion) amortization, net
    
(16
)
  
(17
)
Capitalization of mortgage servicing rights
    
(36
)
  
(35
)
Gain on sale of loans
    
(61
)
  
(64
)
Loans originated for sale in the secondary market
    
(3,628
)
  
(1,661
)
Proceeds from sale of loans in the secondary market
    
3,689
    
1,725
  
RRP compensation expense
    
118
    
45
  
ESOP compensation expense
    
92
    
104
  
Net change in
              
Interest receivable
    
(77
)
  
(137
)
Other assets
    
175
    
(105
)
Other liabilities
    
72
    
310
  
Net cash provided (used) by operating activities
    
881
    
629
  
               
Investing Activities
              
Purchases of FHLB stock
    
(164
)
  
(22
)
Purchases of securities held to maturity
    
(1,900
)
  
(8,256
)
Proceeds from maturities of securities held to maturity
    
5,557
    
8,456
  
Purchase of interest-bearing time deposits
    
--
    
(200
)
Proceeds from maturities of interest-bearing time deposits
    
200
    
200
  
Net changes in loans
    
(7,122
)
  
(4,678
)
Purchases of premises and equipment
    
(1,593
)
  
(751
)
Net cash provided (used) by investing activities
    
(5,022
)
  
(5,251
)
               
Financing Activities
              
Net change in
              
Demand and savings deposits
    
(3,939
)
  
(1,057
)
Certificate of deposits
    
2,573
    
(905
)
Cash dividend on common stock
    
(187
)
  
(186
)
Return of capital dividend on common stock
    
(3,306
)
  
--
  
Purchase of RRP shares
    
--
    
(328
)
Proceeds from FHLB advances
    
18,200
    
2,000
  
Payments on FHLB advances
    
(10,600
)
  
(1,000
)
Net cash provided (used) by financing activities
    
2,741
    
(1,476
)
                     
Net Change in Cash and Equivalents
    
(1,400
)
  
(6,098
)
               
Cash and Cash Equivalents, Beginning of Period
    
7,853
    
12,057
  
               
Cash and Cash Equivalents, End of Period
  
$
6,453
  
$
5,959
  
Additional Cash Flows Information
              
Interest paid
  
$
2,155
  
$
1,536
  
Income tax paid (net of refunds)
  
$
280
  
$
113
  
               
               
               
See notes to consolidated condensed financial statements.
              

6

THIRD CENTURY BANCORP
Notes to Unaudited Consolidated Condensed Financial Statements

Third Century Bancorp (Third Century) is an Indiana corporation that was formed on March 15, 2004 for the purpose of owning all of the capital stock of Mutual Savings Bank (Mutual or Bank) following the completion of Mutual’s mutual-to-stock conversion. Third Century offered for sale 1,653,125 shares of its common stock at $10.00 per share in a public offering to eligible depositors that was completed on June 14, 2004. On June 29, 2004, Third Century purchased all of the capital stock issued by Mutual. Prior to that date, Third Century had no assets or liabilities.
 
The activities of Third Century are primarily limited to holding the stock of Mutual. Mutual conducts business primarily in Johnson County and surrounding counties. Mutual attracts deposits from the general public and originates loans for consumer, residential and commercial purposes. Mutual’s profitability is significantly dependent on net interest income, which is the difference between interest income generated from interest-earning assets (i.e. loans and investments) and the interest expense paid on interest-bearing liabilities (i.e. customer deposits and borrowed funds). Net interest income is affected by the relative amount of interest-earning assets and interest-bearing liabilities and the interest received or paid on these balances. The level of interest paid or received by Mutual can be significantly influenced by a number of factors, such as governmental monetary policy, competition within our market area and the performance of the national and local economies.
 
Mutual also owns one subsidiary, Mutual Financial Services, Inc. (Financial), which is engaged primarily in mortgage life insurance sales and servicing.
 
Note 1: Basis of Presentation
 
The accompanying unaudited consolidated condensed financial statements were prepared in accordance with instructions for Form 10-QSB and, therefore, do not include information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. Accordingly, these financial statements should be read in conjunction with the consolidated financial statements and notes thereto of Mutual for the fiscal year ended December 31, 2005 included in Third Century’s Annual Report filed as an attachment to its 10-KSB. However, in the opinion of management, all adjustments (consisting of only normal recurring accruals) which are necessary for a fair representation of the financial statements have been included. The results of operations for the nine-month period ended September 30, 2006, are not necessarily indicative of the results which may be expected for the entire year.
 
The consolidated condensed balance sheet of Third Century as of December 31, 2005 has been derived from the audited consolidated balance sheet of Third Century as of that date.
 
Note 2: Change in Accounting Principle
 
Effective January 1, 2006, Third Century adopted Statement of Financial Accounting Standards No.123(R), Share−Based Payment ("SFAS 123(R)"). SFAS 123(R) addresses all forms of share−based payment awards, including shares under employee stock purchase plans, stock options, restricted stock, and stock appreciation rights. SFAS 123(R) requires all share-based payments to be recognized as expense, based upon their fair values, in the financial statements over the vesting period of the awards. Third Century has elected the modified prospective application and, as a result, has recorded no compensation expense as all outstanding options were fully vested at December 31, 2005. Prior to the adoption of SFAS 123(R), Third Century accounted for its stock options in accordance with Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees.” All options were granted with an exercise price equal to the fair value of the stock at the date of grant and accordingly, no compensation expense was recognized. Certain disclosures required by SFAS 123(R) have been omitted due to their immaterial nature. Prior to the adoption of SFAS 123(R), unearned compensation related to the RRP shares was classified as a separate component of stockholders’ equity. In accordance with SFAS 123(R), on January 1, 2006, the balance in unearned compensation was reclassified to the appropriate equity accounts.

7


The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value provisions of SFAS No. 123, Accounting for Stock-Based Compensation. Amounts are in thousands, except for per share data.

   
Three Months
Ended
  
Nine Months
Ended
  
   
September 30, 2005
  
September 30, 2005
  
Net income, as reported
  
$
145
  
$
346
  
Less: Total stock-based compensation cost determined under the fair value based method, net of income taxes
    
(571
)
  
(571
)
Pro-forma net loss
  
$
(426
)
$
(225
)
Basic as reported
  
$
0.10
  
$
0.23
  
Proforma basic earnings per share
  
$
(0.28
)
$
(0.15
)
Diluted earnings per share as reported
  
$
0.10
  
$
0.23
  
Basic and diluted pro-forma
  
$
0.12
  
$
(0.15
)

Note 3. Stock Option Plan
 
Pursuant to the Plan, options may be issued which are defined as incentive stock options or as non-qualified stock options. Incentive stock options are intended to qualify under the provisions of Internal Revenue Code Section 422 (“IRC”), which include, among other things, a requirement that the option price is not less than the fair value of the shares as of the date of grant. Non-qualified stock options are those that do not meet the requirements of the provisions of the IRC, and, accordingly, may contain terms that are different from those in place for incentive stock options. During the third quarter of 2005, Third Century awarded 146,300 options to employees and non-employee directors at an exercise price of $13.10 which equaled the market price for the stock as of the date of the grant. As a result of the capital restructuring through the $2.00 return of capital dividend, the exercise price of the options was adjusted to $11.10. In accordance with SFAS 123(R), a comparison of the fair value of the modified award was made to the fair value of the original award and it was determined that no incremental value was transferred as a result of the modification and no compensation expense was recognized. These options were immediately vested. Through the nine months ending September 30, 2006, there was no activity related to the option plan.
 
Note 4: Principles of Consolidation
 
The consolidated financial statements include the accounts of Third Century, Mutual and Financial. All significant intercompany balances and transactions have been eliminated in the accompanying consolidated financial statements.
 
Note 5: Earnings Per Share
 
Earnings per share is computed based upon the weighted average common shares outstanding during the period. Unearned ESOP shares and unearned RRP shares are not considered outstanding for the earnings per share calculation. The following table presents the factors used in the earnings per share computation for the three and nine months ending September 30, 2006 and September 30, 2005:
 
   
Three Months
Ended
September 30,
  
Three Months
Ended
September 30,
  
Nine Months
Ended
September 30,
  
Nine Months
Ended
September 30,
  
   
2006
  
2005
  
2006
  
2005
  
Basic:
                          
Net income
  
$
81
  
$
145
  
$
362
  
$
346
  
 
                          
Weighted average common shares outstanding
    
1,487
   
1,518
    
1,478
    
1,525
  
                           
Basic earnings per common share
  
$
0.05
  
$
0.10
  
$
0.24
  
$
0.23
  
                           
 
 
8
 

                   
Diluted:
                          
Net Income
  
$
81
  
$
145
  
$
362
  
$
346
  
                           
Weighted average common shares outstanding
    
1,487
   
1,518
    
1,478
    
1,525
  
Add: Dilutive effects of assumed exercises of stock options
    
--
   
1
    
2
   
--
  
                           
Average shares and dilutive potential common shares
    
1,487
   
1,519
   
1,480
   
1,525
 
 
                          
Diluted earnings per common share
  
$
0.05
  
$
0.10
  
$
0.24
  
$
0.23
  


 
Note 6: Effect of Recent Accounting Pronouncements
 
The FASB has issued a proposed amendment to SFAS No. 128, Earnings Per Share, to clarify guidance for mandatory convertible instruments, the treasury stock method, contingently issuable shares, and contracts that may be settled in cash or share. The primary impact on Third Century of the proposed Statement is the change to the treasury stock method for year-to-date diluted earnings per share.
 
Currently, SFAS No. 128 requires that the number of incremental shares included in the denominator be determined by computing a year-to-date weighted average of the number of incremental shares included in each quarterly diluted EPS computation. Under the proposed amendment to SFAS 128, the number of incremental shares included in year-to-date diluted earnings per share would be computed using the average market price of common shares for the year-to-date period, independent of the quarterly computations. This computational change is not expected to have a significant impact on the Third Century’s diluted earnings per share.
 
In March 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 156. This Statement amends SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities.
 
SFAS No. 156 requires an entity to initially recognize a servicing asset or servicing liability at fair value each time it undertakes an obligation to service a financial asset by entering into a servicing contract in other specific situations.
 
In addition, SFAS No. 156 permits an entity to choose either of the following subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities:
 
 
·
Amortization method—Amortize servicing assets or servicing liabilities in proportion to and over the period of estimated net servicing income or net servicing loss and assess servicing assets or servicing liabilities for impairment or increased obligation based on fair value at each reporting date.
     
 
·
Fair value measurement method—Measure servicing assets or servicing liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur.
 
SFAS No. 156 is effective at the beginning of an entity’s first fiscal year that begins after September 15, 2006 and should be applied prospectively for recognition and initial measurement of servicing assets and servicing liabilities. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including interim financial statements, for any period of that fiscal year.
 
Third Century did not early adopt SFAS No. 156 on January 1, 2006. Management is currently evaluating the effect of adoption of this Statement on Third Century’s financial condition or results of operations.
 

9

Note 7. Construction of Franklin Central Branch
 
In August 2005, Mutual Savings Bank purchased land in Franklin Township, which is located in southeastern Marion County, for $407,550. Construction of a new branch, to be known as the Franklin Central Branch, began in the fourth quarter of 2005. The board of Mutual awarded a contract to Waugh Company for the construction of the Franklin Central Branch in southeast Marion County. In addition, the Bank entered into contracts with Diebold, Inc., a vendor who provides ATM, vault and teller equipment, and PrinceAlexander, an architectural firm, to perform work for and provide services to the Franklin Central Branch project. These contracts represented estimated construction costs to the Bank as follows:
 
Land acquisition
 
$
407,550
  
Waugh & Company
  
$
766,322
  
Diebold, Inc.
  
$
92,179
  
PrinceAlexander
  
$
67,688
  
Total
  
$
1,333,739
  
         
The Franklin Central Branch opened for business on June 1, 2006.

Note 8. Reclassifying Entries to the Consolidated Condensed Financial Statements
 
Reclassifications to the consolidated condensed income statements for the three and nine months ended September 30, 2005 were made to conform to the consolidated condensed income statement presentation of the three and nine months ended September 30, 2006.
 

Item 2.  Management’s Discussion and Analysis or Plan of Operations

Forward Looking Statements

This Quarterly Report on Form 10-QSB (“Form 10-QSB”) contains statements which constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements appear in a number of places in this Form 10-QSB and include statements regarding the intent, belief, outlook, estimate or expectations of Third Century (as defined in the notes to the consolidated condensed financial statements), its directors or its officers primarily with respect to future events and the future financial performance of Third Century. Readers of the Form 10-QSB are cautioned that any such forward looking statements are not guarantees of future events or performance and involve risks and uncertainties, and that actual results may differ materially from those in the forward looking statements as a result of various factors. The accompanying information contained in this Form 10-QSB identifies important factors that could cause such differences. These factors include changes in interest rates; loss of deposits and loan demand to other financial institutions; substantial changes in financial markets; changes in real estate values and the real estate market; or regulatory changes, as discussed further below:
 
(a) Regulatory Risk. The banking industry is heavily regulated. These regulations are intended to protect depositors, not shareholders. Third Century and Mutual are subject to regulation and supervision by the Indiana Department of Financial Institutions, Federal Deposit Insurance Corporation, and the Board of Governors of the Federal Reserve System. The burden imposed by federal and state regulations puts banks at a competitive disadvantage compared to less regulated competitors such as finance companies, mortgage banking companies and leasing companies. The banking industry continues to lose market share to competitors.
 
(b) Legislation. Because of concerns relating to the competitiveness and the safety and soundness of the industry, Congress continues to consider a number of wide-ranging proposals for altering the structure, regulation, and competitive relationships of the nation’s financial institutions. Management cannot predict whether or in what form any of these proposals will be adopted or the extent to which the business of Third Century or Mutual may be affected thereby.

10

(c) Credit Risk. One of the greatest risks facing lenders is credit risk, that is, the risk of losing principal and interest due to a borrower’s failure to perform according to the terms of a loan agreement. While management attempts to provide an allowance for loan losses at a level adequate to cover probable incurred losses based on loan portfolio growth, past loss experience, general economic conditions, information about specific borrower situations, and other factors (all as discussed below in Critical Accounting Policies--Allowance for Loan Losses), future adjustments to reserves may become necessary, and net income could be significantly affected, if circumstances differ substantially from assumptions used with respect to such factors.
 
(d) Exposure to Local Economic Conditions. Mutual’s primary market area for deposits and loans encompasses Johnson County, in central Indiana. A substantial percent of the Bank’s business activities are within this area. This concentration exposes the Bank to risks resulting from changes in the local economy. A dramatic drop in local real estate values would, for example, adversely affect the quality of the Bank’s loan portfolio.
 
(e) Interest Rate Risk. Third Century’s earnings depend to a great extent upon the level of net interest income, which is the difference between interest income earned on loans and investments and the interest expense paid on deposits and other borrowings. Interest rate risk is the risk that the earnings and capital will be adversely affected by changes in interest rates.
 
(f) Competition. The activities of Third Century and Mutual in the geographic market served involve competition with other banks as well as with other financial institutions and enterprises, many of which have substantially greater resources than those available to Third Century. In addition, non-bank competitors are generally not subject to the extensive regulation applicable to Third Century and Mutual.

Critical Accounting Policies

Generally accepted accounting principles are complex and require management to apply significant judgments to various accounting, reporting and disclosure matters. Management of Third Century must use assumptions and estimates to apply these principles where actual measurement is not possible or practical. For a complete discussion of Third Century’s significant accounting policies, see Note 1 to the Consolidated Financial Statements as of December 31, 2005. Certain policies are considered critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such estimates may have a significant impact on the financial statements. Management has reviewed the application of these policies with the Audit Committee of Third Century’s Board of Directors. Those policies include the following:
 
Allowance for Loan Losses

The allowance for loan losses represents management’s estimate of probable losses inherent in the Bank’s loan portfolios. In determining the appropriate amount of the allowance for loan losses, management makes numerous assumptions, estimates and assessments.
 
The strategy also emphasizes diversification on an industry and customer level, regular credit quality reviews and quarterly management reviews of large credit exposures and loans experiencing deterioration of credit quality.
 
Mutual’s allowance consists of three components: probable losses estimated from individual reviews of specific loans, probable losses estimated from historical loss rates, and probable losses resulting from economic or other deterioration above and beyond what is reflected in the first two components of the allowance.
 
 

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Larger commercial loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, reserves are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to Mutual. Included in the review of individual loans are those that are impaired as provided in SFAS No. 114, Accounting by Creditors for Impairment of a Loan. Any allowances for impaired loans are determined by the present value of expected future cash flows discounted at the loan’s effective interest rate or fair value of the underlying collateral. Mutual evaluates the collectibility of both principal and interest when assessing the need for a loss accrual. Historical loss rates are applied to other commercial loans not subject to specific reserve allocations.
 
Homogenous smaller balance loans, such as consumer installment and residential mortgage loans are not individually risk graded. Reserves are established for each pool of loans based on the expected net charge-offs for one year. Loss rates are based on the average net charge-off history by loan category.
 
Historical loss rates for commercial and consumer loans may be adjusted for significant factors that, in management’s judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs and nonaccrual loans), changes in mix, asset quality trends, risk management and loan administration, changes in the internal lending policies and credit standards, collection practices and examination results from bank regulatory agencies and the Bank’s internal loan review.
 
An unallocated reserve is maintained to recognize the imprecision in estimating and measuring loss when evaluating reserves for individual loans or pools of loans. Allowances on individual loans are reviewed quarterly and historical loss rates are reviewed annually and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience.
 
Mutual’s primary market area for lending is Johnson County, Indiana. When evaluating the adequacy of the allowance, consideration is given to this regional geographic concentration and the closely associated effect changing economic conditions have on Mutual’s customers.
 
Mortgage Servicing Rights
 
Mortgage servicing rights (MSRs) associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. For purposes of measuring impairment, the servicing rights are compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates. Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets.
 
Comparison of Financial Condition at September 30, 2006 and at December 31, 2005
 
Total assets increased $3.4 million or 2.64% to $131.5 million at September 30, 2006 from $128.1 million at December 31, 2005. Total net loans outstanding grew by $7.0 million or 6.70% to $112.6 million at September 30, 2006 from $105.6 million at December 31, 2005. The majority of the loan originations consisted of adjustable rate, one-to-four family, mortgage loans that have a fixed rate for the first five years ($4.6 million or 289.96%) and commercial construction loans ($1.8 million or 40.29%). Cash and cash equivalents decreased $1.4 million or 17.83% and held to maturity securities decreased $3.6 million or 39.53% to fund loan growth through September 30, 2006.
 
Total liabilities increased by $6.3 million or 5.97% to $111.9 million at September 30, 2006 from $105.6 million at December 31, 2005. The Bank paid off $10.6 million in advances and borrowed an additional $18.2 million to meet its daily operational cash flow needs, which resulted in a net increase in Federal Home Loan Bank advances of $7.6 million or 46.06%. Total deposits decreased $1.4 million or 1.54% to $87.2 million at September 30, 2006 from $88.6 million at December 31, 2005. The majority of the decrease in deposits was in money market savings accounts (decreased $2.3 million or 13.13%) and NOW checking accounts (decreased $2.1 million or 11.93%). These decreases were offset by an increase in time deposits of $2.6 million or 7.54%, which was primarily due to the introduction of certificates of deposit with maturities of eleven and twenty-two months.

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Total stockholders’ equity decreased to $19.3 million at September 30, 2006 from $22.4 million at December 31, 2005, representing a decrease of $3.1 million or 13.48%. The $3.3 million return of capital was recognized by the Third Century as a reduction of retained earnings as of March 16, 2006 and represented a significant portion of the decrease. The equity contributed by the ESOP increased $92,000 to $295,000 at September 30, 2006 from $203,000 at December 31, 2005. Third Century paid year-to-date cash dividends, exclusive of the return of capital dividend, of $187,000.

Comparison of Operating Results for the Three Months Ended September 30, 2006 and 2005
 
General. Net income for the quarter ended September 30, 2006 was $81,000 compared to net income of $145,000 for the quarter ended September 30, 2005. Net interest income decreased $27,000 or 2.25% while other expense increased by $72,000 or 6.17%. See the following subsections for further discussion of these changes.
 
Interest Income. Interest income for the quarter ended September 30, 2006 was $2.0 million compared to $1.8 million for the quarter ended September 30, 2005. The increase during the comparative periods reflected an increase of $251,000, which consisted primarily of an increase in interest income from loans by $267,000 or 16.53%.
 
Average interest-earning assets for the quarter ended September 30, 2006 was $125.7 million, which represented an increase of $2.0 million or 1.58%, from the quarter ended September 30, 2005. The yield on those assets increased to 6.40% at September 30, 2006 from 5.69% at September 30, 2005. The average yield on loans increased by 54 basis points, the average yield on interest-earning deposits increased 160 basis points and the average yield on investments increased 65 basis points. The average balances for loans increased $7.5 million to $112.6 million. The average balances for interest-earning deposits decreased $102,000 to $5.6 million and the average balances for investments decreased $5.3 million to $6.3 million at September 30, 2006.
 
Interest Expense. Interest expense for the quarter ended September 30, 2006 was $841,000 compared to $563,000 for the quarter ended September 30, 2005, an increase of $278,000 or 49.38%. Average interest-bearing liabilities increased to $99.3 million for the quarter ended September 30, 2006 from $95.2 million for the quarter ended September 30, 2005, with the average interest rate increasing to 3.38% for the quarter ended September 30, 2006 from 2.37% for the quarter ended September 30, 2005.
 
Net Interest Income. Net interest income of $1.2 million for the quarter ended September 30, 2006 reflects a $27,000 or 2.25% decrease from the net interest income before provision for loan losses for the quarter ended September 30, 2005.
 
Provision for Loan Losses. Mutual recorded a provision for loan losses of $15,000 during the quarter ended September 30, 2006, while no provision was recorded during the quarter ended September 30, 2005. In evaluating the adequacy of loan loss allowances, management considers factors such as delinquency trends, portfolio compositions, past loss experience and other factors such as general economic conditions. During the past year, Mutual’s nonperforming assets decreased to $63,000 at September 30, 2006 from $85,000 at September 30, 2005 and the percentage of nonperforming assets to total assets decreased to 0.05% from 0.07% for the same respective time periods. Mutual recorded net charge offs of $11,000 for the quarter ended September 30, 2006 and $40,000 for the quarter ended September 30, 2005.
 
Other Income. Total other income was $215,000 for the quarters ended September 30, 2006 and 2005. Income from fiduciary services decreased $17,000 or 44.07% to $22,000 for the quarter ended September 30, 2006 while service charges on deposit accounts increased $16,000 or 28.07% to $73,000 for the quarter ended September 30, 2006. The decrease in income from fiduciary services was due to an estate fee collected in July 2005 of approximately $24,000. The increase in service charges on deposit accounts was due to the changes made to the Bank’s deposit fee structure.

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Other Expense. Total other expense for each of the quarters ended September 30, 2006 and 2005 was $1.2 million. The category increased $72,000 or 6.17% between the two reporting periods. Net occupancy and equipment expenses increased $34,000 or 29.31% to $150,000 for the quarter ended September 30, 2006. The Bank started recording depreciation and utility expenses for its Franklin Central Branch, which opened June 1, 2006. In addition, Mutual upgraded the landscaping at its Trafalgar and Main Street locations and increased real estate taxes due to an increase in rates and taxable property.
 
Professional services increased $25,000 or 277.78% to $34,000 for the quarter ended September 30, 2006 from $9,000 for the quarter ended September 30, 2005. In 2005, an adjustment was made to decrease management’s estimate used to accrue audit fees.
 
Data processing fees increased $14,000 or 15.91% to $102,000 for the quarter ended September 30, 2006 from $88,000 for the quarter ended September 30, 2005 as a result of increased billings.
 
Income Taxes. Mutual recognized income tax expense of $52,000 for the quarter ended September 30, 2006, as compared to $102,000 for the quarter ended September 30, 2005, which represents a decrease in the effective tax rate to 39.10% at September 30, 2006 from 41.30% at September 30, 2005.

Comparison of Operating Results for the Nine Months Ended September 30, 2006 and 2005
 
General. Net income for the nine months ended September 30, 2006 was $362,000 compared to net income of $346,000 for the nine months ended September 30, 2005. Net interest income increased $10,000 or 0.28%, other income increased $141,000 or 25.78%, and other expense increased by $69,000 or 1.95%. See the following subsections for further discussion of these changes.
 
Interest Income. Interest income for the nine months ended September 30, 2006 was $5.8 million compared to $5.1 million for the nine months ended September 30, 2005. The increase during the comparative periods reflected an increase of $672,000, which consisted primarily of an increase in interest income on loans by $676,000 or 14.38%. This increase was offset by a decrease of $11,000 or 4.44% in investment income.
 
Average interest-earning assets for the nine months ended September 30, 2006 was $124.4 million, which represented an increase of $2.2 million or 1.78% from the $122.2 million for the nine months ended September 30, 2005. The average yield on those assets increased to 6.20% for the nine months ended September 30, 2006 from 5.58% for the nine months ended September 30, 2005. The average yield on loans increased by 36 basis points, the average yield on interest-earning deposits increased 140 basis points and the average yield on investments increased 97 basis points. The average balances for loans increased $8.2 million to $110.6 million while the average balances for interest-earning deposits decreased $2.9 million to $5.0 million and investments decreased $2.8 million to $7.7 million at September 30, 2006.
 
Interest Expense. Interest expense for the nine months ended September 30, 2006 was $2.2 million compared to $1.6 million for the nine months ended September 30, 2005, an increase of $662,000 or 42.41%. Average interest-bearing liabilities increased to $95.9 million for the nine months ended September 30, 2006 from $94.4 million for the nine months ended September 30, 2005, with the average interest rate increasing to 3.09% for the nine months ended September 30, 2006 from 2.20% for the nine months ended September 30, 2005.
 
Net Interest Income. Net interest income of $3.6 million for the nine months ended September 30, 2006 reflects a $10,000 or 0.28% change from the net interest income for the nine months ended September 30, 2005.
 

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Provision for Loan Losses. Mutual Savings Bank recorded a provision for loan losses of $45,000 during the nine months ended September 30, 2006, while a $20,000 negative provision was made during the nine months ended September 30, 2005. In evaluating the adequacy of loan loss allowances, management considers factors such as delinquency trends, portfolio compositions, past loss experience and other factors such as general economic conditions. During the past year, Mutual’s nonperforming assets decreased to $63,000 at September 30, 2006 from $85,000 at September 30, 2005 and the percentage of nonperforming assets to total assets decreased to 0.05% from 0.07% for the same respective time periods. Mutual recorded net charge offs of $36,000 for the nine months ended September 30, 2006 and $53,000 for the nine months ended September 30, 2005.
 
Other Income. Total other income was $688,000 for the nine months ended September 30, 2006 and $547,000 for the nine months ended September 30, 2005, which represented an increase of $141,000 or 25.78%. Service charges on deposit accounts increased $62,000 or 40.00% to $217,000 for the nine months ended September 30, 2006 from $155,000 for the nine months ended September 30, 2005. This increase resulted from Mutual implementing changes to its deposit fee structure.
 
Other income increased $47,000 or 34.56% to $183,000 for the nine months ended September 30, 2006 from $136,000 for the nine months ended September 30, 2005. This category included gains and losses on the sale of REO properties. For the nine months ended September 30, 2006, the Bank recorded a gain on the sale of a REO property for $20,000 while the Bank recorded a loss of $19,000 on the sale of a REO property during the nine months ended June 30, 2005.
 
Other service charges and fees increased $35,000 or 18.23% to $227,000 for the nine months ended September 30, 2006 from $192,000 for the nine months ended September 30, 2005. Commercial loan fees increased $11,000 or 38.14% to $41,000 for the nine months ended September 30, 2006. In addition, commissions and fees collected on funds provided to immediately clear monetary instruments drawn on the Bank through Travelers Express increased $10,000 or 142.47%. ATM fees increased to $90,000 for the nine months ended September 30, 2006 from $81,000 for the nine months ended September 30, 2005, which represented an increase of $9,000 or 11.55%.
 
Other Expense. Total other expense for the nine months ended September 30, 2006 and 2005 was $3.6 million. Net occupancy and equipment expenses increased $48,000 or 14.12% to $388,000 for the nine months ended September 30, 2006. The Bank started recording depreciation and utility expenses for its Franklin Central Branch, which opened June 1, 2006. In addition, Mutual upgraded the landscaping at its Trafalgar and Main Street locations and increased real estate taxes due to an increase in rates and taxable property.
 
Data processing fees increased $25,000 or 8.71% to $312,000 for the nine months ended September 30, 2006 from $287,000 for the nine months ended September 30, 2005 as a result of increased billings.
 
Income Taxes. Mutual recognized income tax expense of $235,000 for the nine months ended September 30, 2006, as compared to $234,000 for the nine months ended September 30, 2005, which represents a decrease in the effective tax rate to 39.36% at September 30, 2006 from 40.34% at September 30, 2005.

Other

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


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Item 3.     Controls and Procedures

A. Evaluation of disclosure controls and procedures. Third Century’s chief executive officer and chief financial officer, after evaluating the effectiveness of Third Century’s disclosure controls and procedures (as defined in Sections 13a-15(e) and 15d-15(e) of regulations promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the most recent fiscal quarter covered by this quarterly report (the “Evaluation Date”), have concluded that as of the Evaluation Date, Third Century’s disclosure controls and procedures were effective in ensuring that information required to be disclosed by Third Century in reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
 
B. Changes in internal control over financial reporting. There were no changes in Third Century’s internal control over financial reporting identified in connection with Third Century’s evaluation of controls that occurred during Third Century’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, Third Century’s internal control over financial reporting.

PART II.   OTHER INFORMATION

Item 1.  Legal Proceedings

Third Century, from time to time, is a party to routine litigation, which arises in the normal course of business, such as claims to enforce liens, condemnation proceedings on properties in which Mutual Savings Bank holds security interests, claims involving the making and servicing of real property loans, and other issues incident to the business of Third Century. There were no lawsuits pending or known to be contemplated against Third Century at September 30, 2006 that would have a material effect on Third Century’s operations or income.
 
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
 
None.

Item 3.  Defaults Upon Senior Securities
 
None.

Item 4.  Submission of Matters to a Vote of Security Holders
 
None.

Item 5.  Other Information
 
None.

Item 6.  Exhibits
 
The exhibits filed as part of this Form 10-QSB are listed in the Exhibit Index, which is incorporated by this reference.


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Signatures

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

 
THIRD CENTURY BANCORP
  
       
Date: November 13, 2006
By:
  /s/ Robert D. Heuchan
  
   
Robert D. Heuchan
President and Chief Executive Officer
  
       
 
By:
  /s/ Debra K. Harlow
  
   
Debra K. Harlow
Chief Financial Officer
  
       



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Exhibit Index

Exhibit No.
Description
  
     
Rule 13a-14(a) Certification of Robert D. Heuchan, President and Chief Executive Officer
  
Rule 13a-14(a) Certification of Debra K. Harlow, Vice President and Chief Financial Officer
  
Section 1350 Certification of Robert D. Heuchan
  
Section 1350 Certification of Debra K. Harlow
  



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