Form 10-KSB for Blue River Bancshares, Inc. filed on March 31, 1999



                    U.S. SECURITIES AND EXCHANGE COMMISSION
                             Washington D.C. 20549

                                  FORM 10-KSB

        [X]     Annual report under Section 13 or 15(d) of the
                Securities Exchange Act of 1934 for the fiscal
                year ended December 31, 1998.

        [ ]     Transition report under Section 13 or 15 (d) of The
                Securities Exchange Act of 1934 for the transition
                period from ______to _____


                         COMMISSION FILE NUMBER 0-24501

                            ------------------------

                          BLUE RIVER BANCSHARES, INC.
           ---------------------------------------------------------
                 (Name of small business issuer in its charter)

               Indiana                                      35-2016637
     ------------------------------                     ------------------
    (State or other jurisdiction of                      (I.R.S.Employer
    incorporation or organization)                      Identification No.)


                29 E. Washington St., Shelbyville, Indiana 46176
              -------------------------------------------- -----
              (Address of principal executive offices)   (Zip Code)

                    Issuer's telephone number (317) 398-9721
                                               -------------

       Securities to be registered under Section 12 (b) of the Act: None.

          Securities to be registered under Section 12 (g) of the Act:

                          Common Stock, No Par Value
                ------------------------------------------------
                                (Title of class)

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Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15 (d) of the Securities Exchange Act during the past 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.
Yes  X   No
    ---     ---

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB. [X]

State issuer's net interest income for the six months ended December 31, 1998:
$2,004,000.

State the aggregate market value of the voting and non-voting common stock held
by non-affiliates computed by reference to the price at which the stock was
sold, or the average bid and asked price of such common stock, as of a specified
date within the past 60 days (See definition of affiliate in Rule 12b-2 of the
Exchange Act): The aggregate market value of the voting common stock of the
issuer held by non-affiliates, based upon the price of a share of common stock
as quoted on the Small-Cap Issues Market of NASDAQ on February 26, 1999 was
$10,796,373.

State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 1,490,870.

DOCUMENTS INCORPORATED BY REFERENCE. If the following documents are incorporated
by reference, briefly describe them and identify the part of the Form 10-KSB
(e.g. Part I, Part II, etc.) into which the document is incorporated: (1) any
annual report to security holders; (2) any proxy or information statement; (3)
any prospectus filed pursuant to Rule 424(b) or (c) of the Securities Act of
1933 ("Securities Act"). The listed documents should be clearly described for
identification purposes (e.g. annual report to security holders for fiscal year
ended December 31, 1998). The Registrant's Proxy Statement for the Annual
Meeting of Shareholders to be held May 27, 1999 is incorporated by reference
into Part III hereof, and the Annual Report of Shareholders for the year ended
December 31, 1998 is incorporated by reference into Part II hereof.

Transitional Small Business Disclosure Format: Yes      No  X
                                                   ---     ---

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Form 10-KSB Table of Contents

Part I                                                                      Page

     Item  1 - Description of Business.......................................  4

     Item  2 - Legal Proceedings............................................. 21

     Item  3 - Description of Properties..................................... 21

     Item  4 - Submission of Matters to a Vote of Security Holders........... 22

Part II

     Item  5 - Market for Common Equity and Related Stockholder Matters...... 22

     Item  6 - Management's Discussion and Analysis or Results of Operation
                   Results of Operation...................................... 23

     Item  7 - Financial Statements.......................................... 23

     Item  8 - Changes in and Disagreements with Accountants on Accounting
                   and financial Disclosure.................................. 23

Part III

     Item  9 - Directors, Executive Officers, Promoters and Control Persons:
                   Compliance with Section 16(a) of the Exchange Act......... 23

     Item 10 - Executive Compensation........................................ 23

     Item 11 - Security Ownership of Certain Beneficial Owners and
                    Management............................................... 23

     Item 12 - Certain Relationships and Related Transactions................ 24

     Item 13 - Exhibits, Financial Statements Schedules and
                    Reports on Form 8-K...................................... 24


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                                    Part I.

ITEM 1.  DESCRIPTION OF BUSINESS

General

Blue River Bancshares, Inc. (the "Successor", "Company" or "Blue River") was
organized on March 18, 1997 for the purpose of acquiring or forming a bank to be
headquartered in Shelbyville, Indiana. On February 5, 1998, the Company entered
into an Agreement of Affiliation and Merger (the "Merger Agreement") with Shelby
County Bancorp ("SCB" or the "Predecessor") and Shelby County Savings Bank (the
"Bank") pursuant to which the Company would acquire the Bank through the merger
of SCB into the Company (the "Merger").

On June 26, 1998, the Successor completed a successful public offering of
1,500,000 new common shares at a price of $12 per share and acquired the Bank
pursuant to the Merger Agreement.

In December 1998, the Bank announced its intention to expand into the Fort
Wayne, Indiana market. These operations will be conducted as First Community
Bank of Fort Wayne. The Bank has filed the necessary application with its
primary banking regulator and expects to begin operations in the second quarter
of 1999, subject to approval of the application.

All of the financial institutions in Shelby County, Indiana, except for the
Bank, are affiliated either with large out-of-state holding companies or with
medium-sized holding companies headquartered outside of Shelby County. The three
largest financial institutions in Fort Wayne, Indiana have been acquired by
other financial institutions headquartered outside of Fort Wayne, Indiana.
Accordingly, management of the Company believes that a locally-managed bank
located in Shelbyville and Fort Wayne can attract those customers who prefer to
conduct business with a local institution that demonstrates an active interest
in their business and personal financial affairs and can provide timely
responses and personal attention by its executive officers. The Company intends
for the Bank to continue to maintain a strong commitment to community banking.

At the closing of the Merger, the Bank's name changed to "Shelby County Bank."
The Bank's offices are located in the Indiana cities of Shelbyville, Morristown
and St. Paul in Shelby County. The retail strategy of the Bank is to offer,
primarily in Shelby County and Allen County, a wide range of basic banking
products and services that are reasonably priced and easily understood by the
customer. The Bank's commercial strategy centers on small to medium-sized
businesses.

The Company's business strategy is aimed at making the Bank's operations more
like a commercial bank than a traditional thrift. In this regard, the Company's
business strategy for the Bank includes the following:

       o   Increase the volume of commercial lending. The Company has expanded
           the types of commercial products offered by the Bank to include
           commercial loans secured by equipment, inventory, accounts
           receivables and real estate and loans to individuals and
           organizations in the agricultural industry in the Bank's primary
           market area.

       o   Establish a mortgage secondary market operation. The Company believes
           a secondary market operation will enhance fee income, improve
           asset/liability management and increase liquidity. The Company
           believes this will enable the Bank to improve net interest income and
           the Bank's interest rate sensitivity by selling a portion of the
           Bank's lower yielding fixed-rate mortgages and increasing the volume
           of adjustable rate and balloon mortgages and higher yielding
           shorter-term commercial and consumer loans.

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       o   Increase the volume of consumer lending. The Bank has begun
           purchasing indirect auto loans through a select group of dealers that
           are located in the Bank's primary market area and that are well-
           known to the management of the Company. The Bank is also
           "cross-selling" the Bank's consumer loan products, including home
           equity loans, to its existing mortgage and other customers.

       o   Increase deposits. The Bank has expanded its mix of checking account
           products which are designed to meet the diverse needs of businesses
           and individuals and lower the cost of funding the loans made by the
           Bank.


Regulatory Matters at the Bank Prior to Acquisition

In April and May, 1998 and prior to the acquisition of the Bank by the Company,
the Office of Thrift Supervision ("OTS") conducted a regularly scheduled
examination of the Bank. Concurrently with this examination, the Company updated
and expanded its own review of the portfolio with the assistance of Pyramid
Business Consultants ("Pyramid"), a financial institutions consulting firm.

On May 6, 1998, the Bank received a letter from the OTS indicating that the
former Board of Directors of the Bank had failed to establish systems necessary
to prudently conduct commercial real estate and commercial lending and that such
lending should cease until certain corrective action is taken and approval to
resume commercial real estate and commercial lending has been obtained from the
OTS. The OTS noted several supervisory concerns including loan documents which
failed to clearly establish repayment terms, loans priced below market rates and
extended maturities at fixed rates, failure to perform and document proper
credit analysis and reliance on overstated collateral values. In connection with
the OTS exam, the Bank made an additional provision to its allowance for loan
losses reserve of $375,000 for the quarter ended March 31, 1998. This provision
was consistent with the estimates of the Company. In compliance with the OTS
letter, the Bank determined to cease all such lending while the transaction was
pending and until approval to re-establish such lending was granted by the OTS.

The Company implemented a four-step strategy intended to facilitate removal of
the restrictions on commercial real estate and commercial lending at the time of
the closing of the Merger. First, the Company hired a Chief Credit Officer of
the Bank with responsibilities for commercial lending in addition to the Bank's
other lending activities. The Chief Credit Officer replaced the officer of the
Bank who was responsible for commercial lending. In addition, all former Bank
directors were replaced by the Company's directors. Second, the Company engaged
Pyramid to conduct reviews of the commercial real estate and commercial loan
portfolio. Third, the Company, in consultation with Pyramid, drafted and
implemented a comprehensive loan policy for the Bank which specifically
addresses the concerns expressed by the OTS. Fourth, the Company responded to
the OTS with respect to the corrective action to be taken by the Company as a
result of the OTS' most recent safety and soundness examination of the Bank.

On June 26, 1998 (the effective date of the Merger), the OTS lifted the
restrictions on commercial real estate and commercial lending at the Bank.
Following the Merger, the Bank, with the assistance of Pyramid, completed its
comprehensive review of the commercial loan portfolio which resulted in certain
credits being restructured, redocumented and recollateralized.

Environmental Matters Relating to St. Paul Property

In August 1993, the Bank discovered the presence of petroleum compounds in both
the soil and groundwater underlying the property at the St. Paul branch of the
Bank. A portion of the property was the site of a former gasoline station. The
Bank engaged an environmental remediation firm to remove the "free product"
(i.e., gasoline) which was floating on top of the water table at the St. Paul
site. The cost of this clean-up work was approximately $10,000. On April 13,
1995, the Bank sold a portion of the St. Paul property to a resident of St.
Paul, Indiana for nominal consideration. The Bank apprised the buyer of the
environmental matters relating to the real estate sold, and the buyer released
and indemnified the Bank from all future liability connected with environmental
conditions on this property. There can be no assurance that a third party will
not make a claim against the Bank with respect to the contamination on or
originating from this portion of the St. Paul property or that if such a claim
were made that the

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indemnification of the Bank by the buyer of the property would be sufficient to
reimburse the Bank for any damages relating to such claim.

With respect to the portion of the St. Paul property still owned by the Bank, in
early 1996, the Bank discovered the presence of diesel or fuel oil and gasoline
constituents in the groundwater. In early 1997, a heating oil storage tank was
removed from the ground and the area was remediated by excavating the soil
surrounding the location of the tank and replacing it with granular fill
material. The tank removal and remediation was performed by an environmental
remediation firm engaged by the Bank.

Prior to the acquisition, the Bank agreed with the Company in April, 1998 to
begin the process of submitting the St. Paul branch location into Indiana's
Voluntary Remediation Program (the "VRP"). Again, the Bank engaged an
environmental consultant to assist it in this process. After performing
preliminary testing, the consultant informed the Bank that remediation would be
necessary to remove diesel or fuel oil and gasoline constituents in the
groundwater. The consultant estimated the remediation and costs associated with
the VRP to be $157,920 plus any costs incurred by the Indiana Department of
Environmental Management ("IDEM") which were believed to be immaterial. The Bank
charged to expense approximately $150,000 in its income statement for the period
ended March 31, 1998.

The Bank is in the process of applying to IDEM to enter the site in the VRP. In
contemplation of entering the VRP the Bank's environmental consultant, during
the Summer of 1998 and following the Merger, performed additional testing on the
portion of the St. Paul property still owned by the Bank. These tests confirmed
the presence of diesel or fuel oil and gasoline constituents in the groundwater.
The Bank intends to remediate the discovered contamination prior to entering the
VRP. Assuming successful completion of the VRP, as the program currently exists,
is interpreted and is applied, which may include further remediation of the
site, IDEM will issue a Certificate of Completion (which is recorded) and the
Governor of the State of Indiana will issue a Covenant Not to Sue.

Additionally, IDEM and the U.S. Environmental Protection Agency ("EPA") have a
Memorandum of Agreement that provides in substance that once a Certificate of
Completion has been issued by IDEM, unless the site poses an immediate and
substantial threat to human health and the environment, EPA will not plan or
anticipate any federal action under the Superfund law. Based upon the extent of
the contamination found during the Summer of 1998, the Bank's environmental
consultant revised its estimate for completion of the project. On November 17,
1998 the Bank's environmental consultant estimated that the total cost for
completion of the VRP, including the remediation prior to entering the VRP, is
$238,000 plus any costs incurred by IDEM which are believed to be immaterial.
The additional cost associated with the VRP have been added to the Company's
goodwill resulting from the Merger and will be amortized over a 15 year period.
There can be no assurance that the Bank will successfully complete the VRP or
that the cost relating to the VRP will not exceed $238,000 plus any costs
incurred by IDEM which are believed to be immaterial. Even if the Bank
successfully completes the VRP, there can be no assurance that a
non-governmental entity or person will not make a claim against the Bank with
respect to the environmental matters relating to the St. Paul property.

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Market Area

Shelby County is in the top one-third out of 92 counties in the State of Indiana
in terms of personal income and population growth from 1990 through 1995 based
on estimates of the Ball State University's Bureau of Business Research. The
Bank's primary service area is Shelby County which is located approximately 25
miles southeast of Indianapolis, Indiana. Management of the Company believes
that this community has an expanding and diverse economic base, which includes a
wide range of small to medium-sized businesses engaged in manufacturing,
services and retail. The Company intends for the Bank to market extensively to
companies in the Shelby County area with annual sales of up to $2.0 million. The
Shelby County Chamber of Commerce has indicated that approximately 990 of the
estimated 1,100 companies in Shelby County have annual sales of $2.0 million or
less. As of December 31, 1998, the preliminary unemployment rate for Shelby
County was 3.2%, compared with the statewide average for 1998 of approximately
3.1%, according to the Bureau of Labor Statistics.

The Fort Wayne Bank's primary service area will be Allen County, Indiana,
including Fort Wayne and its suburbs. Fort Wayne, Indiana is within a 250-mile
radius of 17% of the total United States population. Allen County covers 659
square miles and ranks second in population out of Indiana's 93 counties. As of
July 1998, Allen County had approximately 10,300 businesses and an unemployment
rate of approximately 3.0%. This community has an expanding and diverse economic
base, which includes a wide range of small to medium-sized businesses engaged in
manufacturing, services and retail.

Allen County is a significant banking market in Indiana. Total deposits in Allen
County, including banks, thrifts and credit unions, were approximately $4.8
billion as of June 30, 1998, the latest date for which data are available.

The Company's  address is 29 East Washington  Street,  P.O. Box 927,
Shelbyville,  Indiana 46176 and its telephone number is (317) 398-9721.

Service Corporation Subsidiary

OTS regulations permit federal savings associations to invest in the capital
stock, obligations, or other specified types of securities of subsidiaries
(referred to as "service corporations") and to make loans to such subsidiaries
and joint ventures in which such subsidiaries are participants in an aggregate
amount not exceeding 2% of an association's assets, plus an additional 1% of
assets if the amount over 2% is used for specified community or inner-city
development purposes. In addition, federal regulations permit associations to
make specified types of loans to such subsidiaries (other than special-purpose
finance subsidiaries), in which the association owns more than 10% of the stock,
in an aggregate amount not exceeding 50% of the association's regulatory capital
if the association's regulatory capital is in compliance with applicable
regulations. FIRREA requires a savings association that acquires a non-savings
association subsidiary, or that elects to conduct a new activity within a
subsidiary, to give the Federal Deposit Insurance Corporation ("FDIC") and the
OTS at least 30 days advance written notice. The FDIC may, after consultation
with the OTS, prohibit specific activities if it determines such activities pose
a serious threat to the Savings Association Insurance Fund (the "SAIF").
Moreover, FIRREA requires savings associations to deduct from capital, for
purposes of meeting the core capital, tangible capital, and risk-based capital
requirements, their entire investment in and loans to a subsidiary engaged in
activities not permissible for a national bank (other than exclusively agency
activities for its customers or mortgage banking subsidiaries).

The Bank wholly owns two subsidiaries. First Tier One Corporation, an Indiana
corporation, holds common stock issued by Intrieve, Inc., the Bank's data
processing provider. Through March 1994, it offered tax-deferred annuity
products. The Shelby Group, Inc., an Indiana Corporation ("TSGI"), offered a
full line of insurance products, including health, life, auto and medical
insurance. The Bank ceased the operations of TSGI as of November 1, 1996.

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Employees

As of December 31, 1998, the Bank employed 39 persons on a full-time basis and 7
persons on a part-time basis and the Company employed 6 persons on a part-time
basis and 0 persons on a full-time basis. None of the Bank's employees are
represented by a collective bargaining group.

Management of the Bank considers its employee relations to be good.

Competition

The Company and the Bank face strong competition for deposits, loans and other
financial services from numerous Indiana and out-of-state banks, thrifts, credit
unions and other financial institutions as well as other entities which provide
financial services, including consumer finance companies, securities brokerage
firms, mortgage brokers, equipment leasing companies, insurance companies,
mutual funds, and other lending sources and investment alternatives. Some of the
financial institutions and financial services providers with which the Bank
competes are not subject to the same degree of regulation as the Bank. Many of
the financial institutions aggressively compete for business in the Bank's
market areas. Many of these competitors have been in business for many years,
have established customer bases, have substantially higher lending limits than
the Bank, and are larger and will be able to offer certain services that the
Bank does not expect to provide in the foreseeable future, including home
electronic banking services and international banking services. In addition,
most of these entities have greater capital resources than the Bank, which,
among other things, may allow them to price their services at levels more
favorable to the customer and to provide larger credit facilities than could the
Bank.

Taxation

Federal Taxation. The Company and the Bank will file a consolidated federal
income tax return on the accrual basis for each calendar year ending December
31. The consolidated federal income tax return has the effect of eliminating
intercompany distributions, including dividends, in the computation of
consolidated taxable income. Income of the Company generally would not be taken
into account in determining the bad debt deduction allowed to the Bank,
regardless of whether a consolidated tax return is filed. However, certain
"functionally related" losses of the Company would be required to be taken into
account in determining the permitted bad debt deduction which, depending upon
the particular circumstances, could reduce the bad debt deduction. The Bank's
federal income tax returns have not been audited in the last five years.

Historically, savings associations, such as the Bank, have been permitted to
compute bad debt deductions using either the bank experience method or the
percentage of taxable income method. However, for years beginning after December
31, 1995, the Bank is no longer able to use the percentage of taxable income
method of computing its allocable tax bad debt deduction. The Bank is required
to compute its allocable deduction using the experience method. As a result of
the repeal of the percentage of taxable income method, reserves taken after 1987
using the percentage of taxable income method generally must be included in
future taxable income over a six-year period, although a two-year delay may be
permitted for institutions meeting a residential mortgage loan origination test.
In addition, the pre-1988 reserve, in which no deferred taxes have been
recorded, will not have to be recaptured into income unless (i) the Bank no
longer qualifies as a bank under the Internal Revenue Code of 1986, as amended
(the "Code"), or (ii) excess dividends are paid out by the Bank.

Depending on the composition of its items of income and expense, a savings
institution may be subject to the alternative minimum tax. A savings institution
must pay an alternative minimum tax equal to the amount (if any) by which 20% of
alternative minimum taxable income ("AMTI"), as reduced by an exemption varying
with AMTI, exceeds the regular tax due. AMTI equals regular taxable income
increased or decreased by certain tax preferences and adjustments, including
depreciation deductions in excess of that allowable for alternative minimum tax
purposes, tax-exempt interest on most private activity bonds issued after August
7, 1986 (reduced by any related interest expense disallowed for regular tax
purposes), the amount of the bad debt reserve deduction claimed in excess of the
deduction based on the experience method and 75% of the excess of adjusted
current earnings over AMTI (before this adjustment and before any alternative
tax net operating loss). AMTI may be reduced only up to 90% by net

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operating loss carryovers, but alternative minimum tax paid that is attributable
to most preferences (although not to post-August 7, 1986 tax-exempt interest)
can be credited against regular tax due in later years.

On August 20, 1996, the "Small Business Job Protection Act of 1996" was passed
into law. One provision of this act repeals the special bad debt reserve method
for thrift institutions currently provided for in Section 593 of the Code The
provision requires thrifts to recapture any reserves accumulated after 1987 but
generally forgives taxes owed. Thrift institutions have been given six years to
account for the recaptured excess reserves, beginning with the first taxable
year after 1995, and are permitted to delay the timing of this recapture for one
or two years subject to whether they meet certain residential loan test
requirements.

Income of the Bank appropriated to bad debt reserves and deducted for federal
income tax purposes is not available for payment of cash dividends or other
distributions to the Company without the payment of federal income taxes by the
Bank on the amount of such income deemed removed from the reserves at the
then-current income tax rate. At December 31, 1998, approximately $1.1 million
of the Bank's retained income represented bad debt deductions for which no
federal income tax provision had been made.

State Taxation. The Bank is subject to Indiana's Financial Institutions Tax
("FIT"), which is imposed at a flat rate of 8.5% on "adjusted gross income."
"Adjusted gross income," for purposes of FIT, begins with taxable income as
defined by Section 63 of the Code, and thus, incorporates federal tax law to the
extent that it affects the computation of taxable income. Federal taxable income
is then adjusted by several Indiana modifications. Other applicable state taxes
include generally applicable sales and use taxes plus real and personal property
taxes.

The Bank's state income tax returns have not been audited in the last five
years.

Current Accounting Issues

In June 1998, SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities was issued and is effective for all fiscal quarters of all fiscal
years beginning after June 15, 1999. This statement establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial condition and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as a fair value hedge, a cash flow hedge, or a hedge of
foreign currency exposure. The accounting for changes in the fair value of a
derivative (that is, gains and losses) depends on the intended use of the
derivative and the resulting designation. Management has not yet fully evaluated
the effect of the new standard if any, on the financial statements.

The acquisition of SCB and the Bank by the Company was accounted for by using
the purchase method of accounting. Under the purchase method of accounting, all
of the assets and liabilities of SCB and the Bank acquired by the Company will
be adjusted to their estimated fair market value as of the acquisition date, and
the resultant discounts and premiums will be accreted into or amortized against
income over the expected economic lives of the related assets and liabilities.
The purchase price for the Predecessor and the Bank will exceed the net fair
value of the assets acquired and the liabilities assumed in the acquisition of
SCB and the Bank by at least $3.2 million. The difference will be recorded as
goodwill on the Company's consolidated financial statements and will be
amortized against income over fifteen years using the straight-line method.

Year 2000 Compliance

The Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. The Bank's computer
programs and those of third-party computer related providers may recognize a
date using "00" as the year 1900 rather than the year 2000. This situation could
result in system failures or miscalculations causing disruption of operations
that could affect the ability of the Bank to operate effectively and service
customers.

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I.       THE BANK'S STATE OF READINESS

The Bank is preparing for the year 2000 by testing and evaluating both its
information technology (IT) and non-information technology systems. The Bank
does not have any mission critical processes that are dependent on non-IT
systems. The non-IT systems, such as the telephone system, are either currently
compliant or are expected to be compliant in the fiscal year 1999. The IT
systems used by the Bank have been or are being tested. The components of the IT
systems being examined are: personal computers (hardware and software), data
service bureau, and other service providers.

In 1998, a comprehensive project plan to address the Year 2000 issue as it
relates to the Bank's operation was developed, approved by the Board of
Directors and implemented. The scope of the plan includes phases of Awareness,
Assessment, Renovation, Validation, and Implementation as defined by federal
banking regulatory agencies. The Bank's project team consists of key members of
the technology staff, representatives of functional business units, and senior
management. The project team estimates that the Bank's Year 2000 readiness
project is 75% complete and that activities involved in assessing external risks
and operational issues are 90% complete overall. The following table provides a
summary of the current status of the five phases involved in Year 2000 readiness
and a projected timetable for completion as of December 31, 1998:

                                     PERCENTAGE   PROJECTED
               PROJECT PHASE         COMPLETED    COMPLETION       COMMENTS
               -------------         ----------   ----------       --------
               Awareness               100%                        Completed
               Assessment              100%                        Completed
               Renovation               90%       March 31, 1999
               Validation               75%       March 31, 1999
               Implementation           50%       June 30, 1999

An assessment of the impact of the Year 2000 issue on the Bank's computer
systems has been completed. The scope of the project also includes other
operational and environmental systems since they may be impacted if embedded
computer chips control the functionality of those systems. From the assessment,
the Bank has identified and prioritized those systems deemed to be mission
critical or those that have a significant impact on normal operations.

The Bank relies on third party vendors and service providers for its data
processing capabilities and to maintain its computer systems. Formal
communications with these providers were initiated in 1998 to assess the Year
2000 readiness of their products and services. Their progress in meeting their
targeted schedules is being monitored for any indication that they may not be
able to address the problems in time. Thus far, responses indicate that most of
the significant providers currently have compliant versions available or are
well into the renovation and testing phases with completion schedule for the
first quarter of 1999.

Additionally, the Bank has implemented a plan to manage the potential risk
imposed by the impact of the Year 2000 issue on its major customers. Formal
communications were initiated, and the assessment was significantly completed by
December 31, 1998.

II.      THE COSTS TO ADDRESS THE BANK'S YEAR 2000 ISSUES

The Bank has thus far primarily used and expects to continue to primarily use
internal resources to implement its readiness plan and to upgrade or replace and
test systems affected by the Year 2000 issue. The total cost to the Bank of
those Year 2000 compliance activities has not been and is not anticipated to be
material to its financial position or results of operations in any given year.
In total, the Bank estimates that its costs, excluding personnel expenses, for
Year 2000 remediation and testing of its computer systems will amount to less
than $60,000 over the eighteen month period from 1998 through 2000. Not included
in this estimate is the cost to replace fully depreciated systems during


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this period, which occurs in the normal course of business and is not directly
attributable to the Year 2000 issue.

The costs and the estimated timing in which the Bank plans to complete the Year
2000 readiness activities are based on management's best estimates, which were
derived using numerous assumptions of future events including the continued
availability of certain resources, third party readiness plans and other
factors. The Bank can make no guarantee that these estimates will be achieved,
and actual results could differ from such plans.

III.     THE RISKS OF THE BANK'S YEAR 2000 ISSUES

The Bank is substantially dependent upon the services of Intrieve, Incorporated
of Cincinnati, Ohio. Intrieve is a provider of data processing services for
financial institutions throughout the United States. Intrieve is concentrating
on Year 2000 preparedness, including a recent migration to a new processing
system upon which testing is currently being conducted. A proxy test was
concluded in October 1998 with results soon to be released to client
institutions for their review. The Bank continues to monitor the Intrieve
efforts related to Year 2000 compliance due to the potential risk to the Bank in
the failure of Intrieve to realize Year 2000 preparedness.

The Bank has established parameters and processes for management to identify
material customers, evaluate their preparedness, assess their credit risk and
implement controls to manage the risk arising from their failure to properly
address Year 2000 technology issues. The Bank faces increased credit and
liquidity risk when customers encounter Year 2000 related problems. Customers
that must be evaluated and monitored are those that, if adversely impacted by
Year 2000 technology issues, represent a significant financial exposure to the
Bank in terms of either credit loss or liquidity. The organizations that have
been identified as material customers of the Bank will be monitored because of
their reliance on technology for their successful business operations.

Failure of borrowers, or servicers to address Year 2000 problems may increase
credit risk to the Bank through the inability of these parties to meet the terms
of their contracts and make timely payments of principal and interest to the
Bank. Liquidity risk may result if depositors, or lenders experience Year 2000
related business disruption or operational failures and are unable to provide
funds or fulfill funding commitments to the Bank.

IV.      THE BANK'S CONTINGENCY PLAN

Realizing that some disruption may occur despite its best efforts, the Bank is
in the process of developing contingency plans for each critical system in the
event that one or more of those systems fail. While this is an ongoing process,
the Bank expects to have the plan substantially documented by March 31, 1999.


                                       11
<PAGE>

                           SUPERVISION AND REGULATION

General

Financial institutions and their holding companies are extensively regulated
under federal and state law. Consequently, the growth and earnings performance
of the Company and the Bank can be affected not only by management decisions and
general economic conditions, but also by the statutes administered by, and the
regulations and policies of, various governmental regulatory authorities. Those
authorities include, but are not limited to, Federal Board of Govenors of The
Federal Reserve Bank (the "Federal Reserve"), the OTS, the Federal Deposit
Insurance Corporation (the "FDIC"), the Indiana Department of Financial
Institution (the "Department"), the Securities and Exchange Commission (the
"Commission"), the Internal Revenue Service and state taxing authorities. The
effect of such statutes, regulations and policies can be significant, and cannot
be predicted with a high degree of certainty.

Federal and state laws and regulations generally applicable to financial
institutions and their holding companies regulate, among other things, the scope
of business, investments, reserves against deposits, capital levels relative to
operations, lending activities and practices, the nature and amount of
collateral for loans, the establishment of branches, mergers, consolidations and
dividends. The system of supervision and regulation applicable to the Company
and the Bank establishes a comprehensive framework for their respective
operations and is intended primarily for the protection of the FDIC's deposit
insurance funds, the depositors of the Bank and the public, rather than
shareholders of the Bank or the Company.

Federal law and regulations, including provisions added by the Federal Deposit
Insurance Corporation Improvements Act (the "FDICIA") and regulations
promulgated thereunder, establish supervisory standards applicable to the
operation, management and lending activities of the Bank, including internal
controls, loan documentation, credit underwriting, interest rate exposure, asset
growth, compensation and loan-to-value ratios for loans secured by real
property. The Bank will continue to comply with these requirements, and in some
cases may apply more restrictive standards.

The following references to statutes and regulations are intended to summarize
material effects of certain government regulation on the business of the Company
and the Bank. Any change in government regulation may have a material adverse
effect on the Company, the Bank and their operations.

Regulation of the Company under HOLA

As the holding company for the Bank, the Company is regulated as a
"non-diversified savings and loan holding company" within the meaning of Home
Owners Loan Act (the "HOLA"), and subject to regulatory oversight of the
Director of the OTS. As such, the Company is subject to OTS regulations,
examinations, supervision and reporting requirements. As a subsidiary of a
savings and loan holding company, the Bank is subject to certain restrictions in
its dealings with the Company and with other companies affiliated with the
Company.

In general, the HOLA prohibits a savings and loan holding company, without prior
approval of the Director of the OTS, from acquiring control of another savings
association or savings and loan holding company or retaining more than 5% of the
voting shares of a savings association or of another holding company which is
not a subsidiary. The HOLA will restrict the ability of a director or officer of
the Company, or any person who owns more than 25% of the Company's common stock,
from acquiring control of another savings association or savings and loan
holding company without obtaining the prior approval of the Director of the OTS.

OTS regulations generally do not restrict the permissible business activities of
a unitary savings and loan holding company.

Notwithstanding the above rules as to permissible business activities of unitary
savings and loan holding companies, if the savings association subsidiary of
such a holding company fails to meet the QTL test, then such unitary holding

                                       12
<PAGE>

company would become subject to the activities restrictions applicable to
multiple holding companies. (Additional restrictions on securing advances from
the Federal Home Loan Bank (the "FHLB") also apply.) At December 31, 1998, the
Bank's asset composition was in excess of that required to qualify as a
Qualified Thrift Lender.

If the Company were to acquire control of another savings association other than
through a merger or other business combination with the Bank, the Company would
thereupon become a multiple savings and loan holding company. Except where such
acquisition is pursuant to the authority to approve emergency thrift
acquisitions and where each subsidiary savings association meets the QTL test,
the activities of the Company and any of its subsidiaries (other than the Bank
or other subsidiary savings associations) would thereafter be subject to further
restrictions. The HOLA provides that, among other things, no multiple savings
and loan holding company or subsidiary thereof which is not a savings
association shall commence or continue for a limited period of time after
becoming a multiple savings and loan holding company or subsidiary thereof, any
business activity other than (i) furnishing or performing management services
for a subsidiary savings association, (ii) conducting an insurance agency or
escrow business, (iii) holding, managing, or liquidating assets owned by or
acquired from a subsidiary savings association, (iv) holding or managing
properties used or occupied by a subsidiary savings association, (v) acting as
trustee under deeds of trust, (vi) those activities previously directly
authorized by the FSLIC by regulation as of March 5, 1987, to be engaged in by
multiple holding companies, or (vii) those activities authorized by the Federal
Reserve as permissible for bank holding companies, unless the Director of the
OTS by regulation prohibits or limits such activities for savings and loan
holding companies. Those activities described in (vii) above must also be
approved by the Director of the OTS before a multiple holding company may engage
in such activities.

The Director of the OTS may also approve acquisitions resulting in the formation
of a multiple savings and loan holding company which controls savings
associations in more than one state, if the multiple savings and loan holding
company involved controls a savings association which operated a home or branch
office in the state of the association to be acquired as of March 5, 1987, or if
the laws of the state in which the association to be acquired is located
specifically permit associations to be acquired by state-chartered associations
or savings and loan holding companies located in the state where the acquiring
entity is located (or by a holding company that controls such state-chartered
savings associations). Also, the Director of the OTS may approve an acquisition
resulting in a multiple savings and loan holding company controlling savings
associations in more than one state in the case of certain emergency thrift
acquisitions.

Indiana law permits federal and state savings association holding companies with
their home offices located outside of Indiana to acquire savings associations
whose home offices are located in Indiana and savings association holding
companies with their principal place of business in Indiana ("Indiana Savings
Association Holding Companies") upon receipt of approval by the Department.
Moreover, Indiana Savings Association Holding Companies may acquire savings
associations with their home offices located outside of Indiana and savings
association holding companies with their principal place of business located
outside of Indiana upon receipt of approval by the Department.

No subsidiary savings association of a savings and loan holding company may
declare or pay a dividend on its permanent or nonwithdrawable stock unless it
first gives the Director of the OTS 30 days advance notice of such declaration
and payment. Any dividend declared during such period or without giving notice
shall be invalid.

Regulation of the Bank

As a federally chartered, SAIF-insured savings association, the Bank is subject
to extensive regulation by the OTS and the FDIC. For example, the Bank must
obtain OTS approval before it may engage in certain activities and must file
reports with the OTS regarding its activities and financial condition. The OTS
periodically examines the Bank's books and records and, in conjunction with the
FDIC in certain situations, has examination and enforcement powers. This
supervision and regulation are intended primarily for the protection of
depositors and federal deposit insurance funds. The Bank's semi-annual
assessment owed to the OTS, which is based upon a specified percentage of
assets, is approximately $10,000.

The activities of the Bank are governed by the HOLA and, in certain respects,
the Federal Deposit Insurance Act, as amended (the "FDI Act"). The Director of
the OTS is authorized to promulgate regulations to ensure the safe and

                                       13
<PAGE>

sound operation of savings associations and may impose various requirements and
restrictions on the activities of savings associations.

Federal Home Loan Bank System. The Bank is a member of the FHLB of Indianapolis.
The FHLB System consists of 12 regional FHLBs. Each FHLB serves as a reserve or
central bank for its members within its assigned region. It is funded primarily
from funds deposited by savings associations and proceeds derived from the sale
of consolidated obligations of the FHLB System. It makes loans to members (i.e.,
advances) in accordance with policies and procedures established by the Board of
Directors of the FHLB. All FHLB advances must be fully secured by sufficient
collateral as determined by the FHLB. The Federal Housing Finance Board, an
independent agency, controls the FHLB System, including the FHLB of
Indianapolis.

As a member, the Bank is required to purchase and maintain stock in the FHLB of
Indianapolis in an amount equal to at least 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts, or similar obligations at
the beginning of each year. At December 31, 1998, the Bank's investment in stock
of the FHLB of Indianapolis was $1,357,800. The FHLB imposes various limitations
on advances such as limiting the amount of certain types of real estate-related
collateral to 30% of a member's capital and limiting total advances to a member.
Interest rates charged for advances vary depending upon maturity, the cost of
funds to the FHLB of Indianapolis and the purpose of the borrowing.

The FHLBs are required to provide funds for the resolution of troubled savings
associations and to contribute to affordable housing programs through direct
loans or interest subsidies on advances targeted for community investment and
low- and moderate-income housing projects. These contributions have adversely
affected the level of FHLB dividends paid and could continue to do so in the
future. For the period from July 1, 1998 to December 31, 1998, dividends paid by
the FHLB of Indianapolis to the Bank totaled approximately $57,000 for an annual
rate of 8.0%.

Savings Association Regulatory Capital. Currently, savings associations are
subject to three separate minimum capital-to-assets requirements: (i) a leverage
limit, (ii) a tangible capital requirement, and (iii) a risk-based capital
requirement. The leverage limit requires that savings associations maintain
"core capital" of at least 4% of total assets. Core capital is generally defined
as common shareholders' equity (including retained income), noncumulative
perpetual preferred stock and related surplus, certain minority equity interests
in subsidiaries, certain non-withdrawable accounts, qualifying supervisory
goodwill, purchased mortgage servicing rights and purchased credit card
relationships (subject to certain limits) less nonqualifying intangibles. Under
the tangible capital requirement, a savings association must maintain tangible
capital (core capital less all intangible assets except purchased mortgage
servicing rights which may be included after making the above-noted adjustment
in an amount up to 100% of tangible capital) of at least 1.5% of total assets.
Under the risk-based capital requirements, a minimum amount of capital must be
maintained by a savings association to account for the relative risks inherent
in the type and amount of assets held by the savings association. The risk-based
capital requirement requires a savings association to maintain capital (defined
generally for these purposes as core capital plus general valuation allowances
and permanent or maturing capital instruments such as preferred stock and
subordinated debt less assets required to be deducted) equal to 8.0% of
risk-weighted assets. Assets are ranked as to risk in one of four categories (0
to 100%). A credit risk-free asset, such as cash, requires no risk-based
capital, while an asset with a significant credit risk, such as a non-accrual
loan, requires a risk factor of 100%. Moreover, a savings association must
deduct from capital, for purposes of meeting the core capital, tangible capital
and risk-based capital requirements, its entire investment in and loans to a
subsidiary engaged in activities not permissible for a national bank (other than
exclusively agency activities for its customers or mortgage banking
subsidiaries). At December 31, 1998, the Bank was in compliance with all capital
requirements imposed by law.


The OTS has promulgated a rule which sets forth the methodology for calculating
an interest rate risk component to be used by savings associations in
calculating regulatory capital. The OTS has delayed the implementation of this
rule, however. The rule requires savings associations with "above normal"
interest rate risk (institutions whose portfolio equity would decline in value
by more than 2% of assets in the event of a hypothetical 200-basis-point move in
interest rates) to maintain additional capital for interest rate risk under the
risk-based capital framework.

                                       14
<PAGE>

The following is a summary of the Bank's regulatory capital and capital
requirements at December 31, 1998:


                                             Tangible    Core    Total Risk
              (Dollars in thousands)         Capital    Capital     Based
                                             --------   -------  -----------
              Regulatory capital............   $9355      $9355     $10105
              Minimum capital requirement...    1902       3804       6738
              Excess capital................   $7453      $5551      $3367
                                               =====      =====      =====
              Regulatory capital ratio......     7.4%       7.4%      12.0%
              Minimum capital ratio.........     1.5%       3.0%       8.0%

If an association is not in compliance with the capital requirements, the OTS is
required to prohibit asset growth and to impose a capital directive that may
restrict, among other things, the payment of dividends and officers'
compensation. In addition, the OTS and the FDIC generally are authorized to take
enforcement actions against a savings association that fails to meet its capital
requirements. These actions may include restricting the operations activities of
the association, imposing a capital directive, cease and desist order, or civil
money penalties, or imposing harsher measures such as appointing a receiver or
conservator or forcing the association to merge into another institution.

Dividend Limitations. An OTS regulation imposes limitations upon all "capital
distributions" by savings associations, including cash dividends, payments by an
association to repurchase or otherwise acquire its shares, payments to
shareholders of another institution in a cash-out merger and other distributions
charged against capital. The regulation establishes a three-tiered system of
regulation, with the greatest flexibility being afforded to well-capitalized
associations. A savings association which has total capital (immediately prior
to and after giving effect to the capital distribution) that is at least equal
to its fully phased-in capital requirements would be a Tier 1 institution ("Tier
1 Institution"). An association that has total capital at least equal to its
minimum capital requirements, but less than its fully phased-in capital
requirements, would be a Tier 2 institution ("Tier 2 Institution"). An
institution having total capital that is less than its minimum capital
requirements would be a Tier 3 institution ("Tier 3 Institution"). However, an
institution which otherwise qualifies as a Tier 1 Institution may be designated
by the OTS as a Tier 2 Institution or Tier 3 Institution if the OTS determines
that the institution is "in need of more than normal supervision." The Bank is
currently a Tier 1 Institution.

A Tier 1 Institution may, after prior notice but without the approval of the
OTS, make capital distributions during a calendar year up to the greater of (a)
100% of its net income to date during the calendar year plus the amount that
would reduce by one-half its "surplus capital ratio" at the beginning of the
calendar year (the smallest excess over its capital requirements), or (b) 75% of
its net income over the most recent four-quarter period. Any additional amount
of capital distributions would require prior regulatory approval.

The OTS has proposed revisions to these regulations which would permit savings
associations to declare dividends in amounts which would assure that they remain
adequately capitalized following the dividend declaration. Savings associations
in a holding company system which are rated CAMELS 1 or 2 and which are not in
troubled condition would need to file a prior notice with the OTS concerning
such dividend declaration.

Liquidity. For each calendar quarter, the Bank is required to maintain an
average daily balance of liquid assets (cash, certain time deposits, bankers'
acceptances, specified United States Government, state or federal agency
obligations, shares of certain mutual funds and certain corporate debt
securities and commercial paper) equal to an amount not less than a specified
percentage of its net withdrawable deposit accounts plus short-term borrowings.
This liquidity requirement may be changed from time to time by the OTS to any
amount within the range of 4% to 10% depending upon economic conditions and the
savings flows of member institutions. The OTS recently reduced the level of
liquid assets that must be held by a savings association from 5% to 4% of the
associations' net withdrawable accounts plus short-term borrowings based upon
the average daily balance of such liquid assets for each quarter of the
associations's fiscal year. The OTS may impose monetary penalties upon savings
associations

                                       15
<PAGE>

that fail to comply with those liquidity requirements. The OTS eliminated the
requirement that each savings association maintain an average daily balance of
short-term liquid assets of 1% of the total of its net withdrawable deposit
accounts and short-term borrowings during the preceding calendar month. The
daily average liquidity as reported to the OTS for December, 1998 was 20.2%
which exceeded the then-applicable 5% liquidity requirement. The Bank has never
been subject to monetary penalties for failure to meet its liquidity
requirements.

Real Estate Lending Standards. OTS regulations require savings associations to
establish and maintain written internal real estate lending policies. Each
association's lending policies must be consistent with safe and sound banking
practices and appropriate to the size of the association and the nature and
scope of its operations. The policies must establish loan portfolio
diversification standards; establish prudent underwriting standards, including
loan-to-value limits, that are clear and measurable; establish loan
administration procedures for the association's real estate portfolio; and
establish documentation, approval, and reporting requirements to monitor
compliance with the association's real estate lending policies. The
association's written real estate lending policies must be reviewed and approved
by the association's Board of Directors at least annually. Further, each
association is expected to monitor conditions in its real estate market to
ensure that its lending policies continue to be appropriate for current market
conditions.

Loans to One Borrower. The Bank may not make a loan or extend credit to a single
or related group of borrowers in excess of 15% of its unimpaired capital and
surplus. Additional amounts may be lent, not in excess of 10% of unimpaired
capital and surplus, if such loans or extensions of credit are fully secured by
readily marketable collateral, including certain debt and equity securities but
not including real estate. In some cases, a savings association may lend up to
30 percent of unimpaired capital and surplus to one borrower for purposes of
developing domestic residential housing, provided that the association meets its
regulatory capital requirements and the OTS authorizes the association to use
this expanded lending authority. At December 31, 1998, the Bank did not have any
loans or extensions of credit to a single or related group of borrowers in
excess of its lending limits.

Qualified Thrift Lender. Savings associations must meet a QTL test. If the Bank
maintains an appropriate level of qualified thrift investments ("QTIs")
(primarily residential mortgages and related investments, including certain
mortgage-related securities) and otherwise qualify as a QTL, the Bank will
continue to enjoy full borrowing privileges from the FHLB of Indianapolis. The
required percentage of QTIs is 65% of portfolio assets (defined as all assets
minus intangible assets, property used by the association in conducting its
business and liquid assets equal to 20% of total assets). In addition, savings
associations may include shares of stock of the FHLBs, FNMA, and FHLMC as QTIs.
Compliance with the QTL test is determined on a monthly basis in nine out of
every twelve months. As of December 31, 1998, the Bank was in compliance with
its QTL requirement, with approximately 89.8% of its assets invested in QTIs.

A savings association which fails to meet the QTL test must either convert to a
bank (but its deposit insurance assessments and payments will be those of and
paid to the SAIF) or be subject to the following penalties: (i) it may not enter
into any new activity except for those permissible for a national bank and for a
savings association; (ii) its branching activities shall be limited to those of
a national bank; (iii) it shall not be eligible for any new FHLB advances; and
(iv) it shall be bound by regulations applicable to national banks respecting
payment of dividends. Three years after failing the QTL test the association
must (i) dispose of any investment or activity not permissible for a national
bank and a savings association and (ii) repay all outstanding FHLB advances. If
such a savings association is controlled by a savings and loan holding company,
then such holding company must, within a prescribed time period, become
registered as a bank holding company and become subject to all rules and
regulations applicable to bank holding companies (including restrictions as to
the scope of permissible business activities).

Branching. The rules of the OTS on branching by federally-chartered savings
associations permit nationwide branching to the extent allowed by federal
statute. This permits federal savings associations with interstate networks to
diversify their loan portfolio and lines of business. The OTS authority
pre-empts any state law purporting to regulate branching by federal savings
associations.

Insurance of Deposits. The FDIC is an independent federal agency that insures
the deposits, up to prescribed statutory limits, of banks and thrifts and
safeguards the safety and soundness of the banking and thrift industries.

                                       16
<PAGE>

The FDIC administers two separate insurance funds, the Bank Insurance Fund (the
"BIF") for commercial banks and state savings banks and the SAIF for savings
associations such as the Bank and banks that have acquired deposits from savings
associations. The FDIC is required to maintain designated levels of reserves in
each fund. As of September 30, 1996, the reserves of the SAIF were below the
level required by law, primarily because a significant portion of the
assessments paid into the SAIF have been used to pay the cost of prior thrift
failures, while the reserves of the BIF met the level required by law in May
1995. However, on September 30, 1996, provisions designed to recapitalize the
SAIF and eliminate the premium disparity between the BIF and SAIF were signed
into law.

The FDIC is authorized to establish separate annual assessment rates for deposit
insurance for members of the BIF and members of the SAIF. The FDIC may increase
assessment rates for either fund if necessary to restore the fund's ratio of
reserves to insured deposits to the target level within a reasonable time and
may decrease these rates if the target level has been met. The FDIC has
established a risk-based assessment system for both SAIF and BIF members. Under
this system, assessments vary depending on the risk the institution poses to its
deposit insurance fund. An institution's risk level is determined based on its
capital level and the FDIC's level of supervisory concern about the institution.

On September 30, 1996, President Clinton signed into law legislation which
included provisions designed to recapitalize the SAIF and eliminate the
significant premium disparity between the BIF and the SAIF. Under the new law,
the Bank was charged a one-time special assessment equal to $.657 per $100 in
assessable deposits at March 31, 1995. The Bank recognized this one-time
assessment as a non-recurring operating expense of $332,000 ($200,000 after tax)
during the three-month period ending September 30, 1996, and the Bank paid this
assessment in November 1996. The assessment was fully deductible for both
federal and state income tax purposes. Beginning January 1, 1997, the Bank's
annual deposit insurance premium was reduced from .23% to .0644% of total
assessable deposits. On August 30, 1998, the Bank's annual deposit insurance
premium was increased to .10% of total assessable deposits. BIF institutions pay
lower assessments than comparable SAIF institutions because BIF institutions pay
only 20% of the rate being paid by SAIF institutions on their deposits with
respect to obligations issued by the federally-chartered corporation which
provided some of the financing to resolve the thrift crisis in the 1980's
("FICO"). The 1996 law also provides for the merger of the SAIF and the BIF by
1999, but not until such time as bank and thrift charters are combined. Until
the charters are combined, savings associations with SAIF deposits may not
transfer deposits into the BIF system without paying various exit and entrance
fees, and SAIF institutions will continue to pay higher FICO assessments. Such
exit and entrance fees need not be paid if a SAIF institution converts to a bank
charter or merges with a bank, as long as the resulting bank continues to pay
applicable insurance assessments to the SAIF, and as long as certain other
conditions are met.

Prompt Corrective Action. FDICIA establishes a system of prompt corrective
action to resolve the problems of undercapitalized institutions. Under this
system, federal depository institution regulators are required to take certain
mandatory supervisory actions, and may take certain discretionary supervisory
actions against undercapitalized institutions, the severity of which depends
upon the institution's degree of capitalization. In addition, subject to a
narrow exception, FDICIA generally requires the federal depository institution
regulators to appoint a receiver or conservator for an institution that is
critically undercapitalized.

As mandated by FDICIA, the federal banking regulators have specified by
regulation the relevant capital measures at which an insured depository
institution is deemed well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. Pursuant to the FDIC's regulations implementing the prompt
corrective action provisions of FDICIA, a bank will be deemed to be: (i) well
capitalized if the bank has a total risk-based capital ratio of 10% or greater,
Tier 1 risk-based capital ratio of 6% or greater and leverage ratio of 5% or
greater; (ii) adequately capitalized if the bank has a total risk-based capital
ratio of 8% or greater, Tier 1 risk-based capital ratio of 4% or greater and
leverage ratio of 4% or greater (3% for the most highly rated banks); (iii)
undercapitalized if the bank has a total risk-based capital ratio of less than
8%, or Tier 1 risk-based capital ratio of 4% or greater and leverage ratio of
less than 4% (less than 3% for the most highly rated banks); (iv) significantly
undercapitalized if the bank has a total risk-based capital ratio of less than
6%, Tier 1 risk-based capital ratio of less than 3% or leverage ratio of less
than 3%; and (v) critically undercapitalized if the bank has a ratio of tangible
equity to total assets of 2% or less. As of the last regulatory examination,
April 30, 1998, the Predecessor was considered

                                       17
<PAGE>

to be "adequately capitalized". The level of capital at December 31, 1998, is
such that the Bank is considered "well capitalized". The Bank was not subject to
regulatory order, agreement or directive to meet and maintain a specific level
for any capital measure.

Subject to certain exceptions, these capital ratios are generally determined on
the basis of Call Reports submitted by each depository institution and the
reports of examination by each institution's appropriate federal depository
institution regulatory agency.

Depending upon the capital category to which an institution is assigned, the
regulators' corrective powers include: requiring the submission of a capital
restoration plan (which must include a holding company guarantee of
performance); placing limits on asset growth and restrictions on activities;
requiring the institution to issue additional capital stock (including
additional voting stock) or to be acquired; restricting transactions with
affiliates; restricting the interest rate the institution may pay on deposits;
ordering a new election of directors of the institution; requiring that senior
executive officers or directors be dismissed; prohibiting the institution from
accepting deposits from correspondent banks; requiring the holding company to
divest certain subsidiaries including the institution; requiring the institution
to divest certain subsidiaries; prohibiting the payment of principal or interest
on subordinated debt; and ultimately, appointing a receiver or conservator for
the institution.

In general, a depository institution may be reclassified to a lower category
than is indicated by its capital position if the appropriate federal depository
institution regulatory agency determines the institution to be otherwise in an
unsafe or unsound condition or to be engaged in an unsafe or unsound practice.
This could include a failure by the institution, following receipt of a
less-than-satisfactory rating on its most recent examination report, to correct
the deficiency.

Insider Transactions. The Bank is subject to certain restrictions imposed by the
Federal Reserve Act ("FRA") on any extensions of credit to the Company or its
subsidiaries, on investments in the stock or other securities of the Company or
its subsidiaries, and the acceptance of the stock or other securities of the
Company or its subsidiaries as collateral for loans. These restrictions limit
the aggregate amount of transactions with any individual affiliate to 10% of the
Bank's capital and surplus, limit the aggregate amount of transactions with all
affiliates to 20% of the Bank's capital and surplus, require that loans and
certain other extensions of credit be secured by collateral in certain specified
amounts and types, generally prohibit the purchase of low quality assets from
affiliates and generally require that certain transactions with affiliates,
including loans and asset purchases, be on terms and under circumstances,
including credit standards, that are substantially the same or at least as
favorable to the Bank as those prevailing at the time for comparable
transactions with nonaffiliated individuals or entities.

Also, the FRA prescribes certain limitations and reporting requirements on
extensions of credit by the Bank to its directors and executive officers, to
directors and executive officers of the Company and its subsidiaries, to
principal shareholders of the Company and its subsidiaries, to principal
shareholders of the Company and to "related interests" of such directors,
officers and principal shareholders. Among other things, the FRA, and the
regulations thereunder, require such loans to be made on substantially the same
terms as those offered to unaffiliated individuals, place limits on the amount
of loans the Bank may extend to such individuals and require certain approval
procedures to be followed. In addition, such legislation and regulations may
affect the terms upon which any person becoming a director or officer of the
Company or one of its subsidiaries or a principal shareholder of the Company may
obtain credit from banks with which the Bank maintains a correspondent
relationship.

Limitations on Rates Paid for Deposits. Regulations promulgated by the FDIC
pursuant to FDICIA limit the ability of insured depository institutions to
accept, renew or roll over deposits by offering rates of interest which are
significantly higher than the prevailing rates of interest on deposits offered
by other insured depository institutions having the same type of charter in the
institution's normal market area. Under these regulations, "well-capitalized"
depository institutions may accept, renew or roll such deposits over without
restriction, "adequately capitalized" depository institutions may accept, renew
or roll such deposits over with a waiver from the FDIC (subject to certain
restrictions on payments of rates) and "undercapitalized" depository
institutions may not accept, renew or roll such deposits over. The regulations
contemplate that the definitions of "well capitalized," "adequately capitalized"
and "undercapitalized" will be the same as the definition adopted by the
agencies to implement the corrective action

                                       18
<PAGE>

provisions of FDICIA. The Bank does not believe that these regulations will have
a materially adverse effect on its current operations.

Community Reinvestment Act Matters. Federal law requires that ratings of
depository institutions under the Community Reinvestment Act of 1977 ("CRA") be
disclosed. The disclosure includes both a four-unit descriptive rating
(outstanding, satisfactory, needs to improve, and substantial noncompliance) and
a written evaluation of an institution's performance. Each FHLB is required to
establish standards of community investment or service that its members must
maintain for continued access to long-term advances from the FHLBs. The
standards take into account a member's performance under the CRA and its record
of lending to first-time home buyers. The OTS has designated the Bank's record
of meeting community credit needs as satisfactory.

Safety and Soundness Standards. On July 10, 1995, the FDIC, the OTS, the Federal
Reserve and the Office of the Comptroller of the Currency published final
guidelines implementing the FDICIA requirement that the federal banking agencies
establish operational and managerial standards to promote the safety and
soundness of federally insured depository institutions. The guidelines, which
took effect on August 9, 1995, establish standards for internal controls,
information systems, internal audit systems, loan documentation, credit
underwriting, interest rate exposure, asset growth and compensation, fees and
benefits, and specifically prohibit, as an unsafe and unsound practice,
excessive compensation that could lead to a material loss to an institution. The
federal banking agencies also adopted asset quality and earnings standards that
were added to the safety and soundness guidelines effective October 1, 1996. If
an institution fails to comply with any of the standards set forth in the
guidelines, the institution's primary federal regulator may require the
institution to submit a plan for achieving and maintaining compliance. Failure
to submit an acceptable compliance plan, or failure to adhere to a compliance
plan that has been accepted by the appropriate regulator, would constitute
grounds for further enforcement action.

Consumer Banking. The Bank's business will include making a variety of types of
loans to individuals. In making these loans, the Bank will be subject to state
usury and regulatory laws and to various federal statutes, such as the Equal
Credit Opportunity Act, Fair Credit Reporting Act, Truth in Lending Act, Real
Estate Settlement Procedures Act and Home Mortgage Disclosure Act, and the
regulations promulgated thereunder, which prohibit discrimination, specify
disclosures to be made to borrowers regarding credit and settlement costs and
regulate the mortgage loan servicing activities of the Bank, including the
maintenance and operation of escrow accounts and the transfer of mortgage loan
servicing. The Riegle Act imposed new escrow requirements on depository and
non-depository mortgage lenders and services under the National Flood Insurance
Program. See "Supervision and Regulation -- Regulatory Developments." In
receiving deposits, the Bank will be subject to extensive regulation under state
and federal law and regulations, including the Truth in Savings Act, the
Expedited Funds Availability Act, the Bank Secrecy Act, the Electronic Funds
Transfer Act and the FDI Act. Violation of these laws could result in the
imposition of significant damages and fines upon the Bank, its directors and
officers.


Regulatory Developments

In 1994, the Congress enacted two major pieces of banking legislation, the
Riegle Community Direction Act (the "Riegle Act") and the Riegle-Neal Interstate
Banking and Branching Efficiency Act (the "Riegle-Neal Act"). The Riegle Act
addressed such varied issues as the promotion of economic revitalization of
defined urban and rural "qualified distressed communities" through special
purpose "Community Development Financial Institutions," the expansion of
consumer protection with respect to certain loans secured by a consumer's home
and reverse mortgages and reductions in compliance burdens regarding Currency
Transaction Reports, in addition to reform of the National Flood Insurance
Program, the promotion of a secondary market for small business loans and leases
and mandating specific changes to reduce regulatory impositions on depository
institutions and holding companies.

The Riegle-Neal Act substantially changed the geographic constraints applicable
to the banking industry. Effective September 29, 1995, the Riegle-Neal Act
allows bank holding companies to acquire banks located in any state in the
United States without regard to geographic restrictions or reciprocity
requirements imposed by state law, but subject to certain conditions, including
limitations on the aggregate amount of deposits that may be held by the
acquiring holding company and all of its insured depository institution
affiliates. Effective June 1, 1997 (or earlier if expressly

                                       19
<PAGE>

authorized by applicable state law), the Riegle-Neal Act allows banks to
establish interstate branch networks through acquisitions of other banks,
subject to certain conditions, including certain limitations on the aggregate
amount of deposits that may be held by the surviving bank and all of its insured
depository institution affiliates. The establishment of de novo interstate
branches or the acquisition of individual branches of a bank in another state
(rather than the acquisition of an out-of-state bank in its entirety) is allowed
by the Riegle-Neal Act only if specifically authorized by state law. The
legislation allowed individual states to "opt-out" of certain provisions of the
Riegle-Neal Act by enacting appropriate legislation prior to June 1, 1997.

Effective March 14, 1996, Indiana "opted in" to the interstate branching
provisions of the Riegle-Neal Act. The Indiana legislation authorizes, subject
to certain approval and other requirements, Indiana-chartered banks to establish
branches in states other than Indiana and out-of-state banks to establish
branches in Indiana. Indiana and out-of-state banks are authorized to establish
branches either by acquisition or de novo.

FDIC regulations, which became effective April 1, 1996, impose certain
limitations (and in certain cases, prohibitions) on (i) "golden parachute"
severance payments by troubled depository institutions, their subsidiaries and
affiliated holding companies to institution-affiliated parties (primarily
directors, officers, employees or principal shareholders of the institution),
and (ii) indemnification payments by a depository institution, their
subsidiaries and affiliated holding companies, regardless of financial
condition, to institution-affiliated parties. The FDIC regulations impose
limitations on indemnification payments which could restrict, in certain
circumstances, payments by the Company or the Bank to their respective directors
or officers otherwise permitted under Indiana state law.

The FDIC includes, in its evaluations of a bank's capital adequacy, an
assessment of the bank's exposure to declines in the economic value of the
bank's capital due to changes in interest rates. On June 26, 1996, the FDIC,
along with the Office of the Comptroller of the Currency and the Federal
Reserve, issued a joint policy statement to provide guidance on sound practices
for managing interest rate risk. The statement sets forth the factors the
federal regulatory examiners will use to determine the adequacy of a bank's
capital for interest rate risk. These qualitative factors include the adequacy
and effectiveness of the bank's internal interest rate risk management process
and the level of interest rate exposure. Other qualitative factors that will be
considered include the size of the bank, the nature and complexity of its
activities, the adequacy of its capital and earnings in relation to the bank's
overall risk profile, and its earning exposure to interest rate movements. The
interagency supervisory policy statement describes the responsibilities of a
bank's board of directors in implementing a risk management process and the
requirements of the bank's senior management in ensuring the effective
management of interest rate risk. Further, the statement specifies the elements
that a risk management process must contain.

In August, 1996, the Federal Reserve and the FDIC issued final regulations
further revising their risk-based capital standards to include a supervisory
framework for measuring market risk. The effect of the new regulations is that
any bank holding company or bank which has significant exposure to market risk
must measure such risk using its own internal model, subject to the requirements
contained in the regulations, and must maintain adequate capital to support that
exposure.

The new regulations apply to any bank holding company or bank whose trading
activity equals 10% or more of its total assets, or whose trading activity
equals $1 billion or more. Examiners may require a bank holding company or bank
that does not meet the applicability criteria to comply with the capital
requirements if necessary for safety and soundness purposes.

The new regulations contain supplemental rules to determine qualifying and
excess capital, calculate risk-weighted assets, calculate market risk equivalent
assets and calculate risk-based capital ratios adjusted for market risk.

Safety and soundness guidance on the risks posed to financial institutions by
the Year 2000 Problem has been issued by the Federal Institutions Examination
Council, whose members include the OTS, the FDIC and the Federal Reserve Board.
The guidance underscores that Year 2000 preparation is not only an information
systems issue, but also an enterprise-wide challenge that must be addressed at
the highest level of a financial institution. The guidance sets out the
responsibilities of senior management and boards of directors in managing their
Year 2000 projects. Among the responsibilities of institution managers and
directors is that of managing the internal and external risks

                                       20
<PAGE>

presented by providers of data-processing products and services, business
partners, counterparties and major loan customers. Under the guidance, senior
management must provide the board of directors with status reports, at least
quarterly, on efforts to reach Year 2000 goals both internally and by the
institution's major vendors. Senior managers and directors must allocate
sufficient resources to ensure that high priority is given to seeing that
remediation plans are fulfilled, and that the project receives the quality
personnel and timely support it requires. The guidance does not require
financial institutions to obtain Year 2000 certification from their vendors.
Rather, an institution must implement its own internal testing or verification
processes for vendor products and services to ensure that its different computer
systems function properly together.

Additional legislation and administrative actions affecting the banking industry
are being considered and in the future may be considered by the United States
Congress, state legislatures and various regulatory agencies, including those
referred to above. It cannot be predicted with certainty whether such
legislation or administrative action will be enacted or the extent to which the
banking industry in general or the Company and the Bank in particular would be
affected thereby.


ITEM 2.  LEGAL PROCEEDINGS

Neither the Company, the Bank, nor the Bank's service corporation subsidiaries
is a party to any material pending legal proceeding.


ITEM 3.  DESCRIPTION OF PROPERTIES

At December 31, 1998, the Bank conducted its business from its main office at 29
East Washington Street, Shelbyville, Indiana, and three branch offices. All four
offices are full-service offices. The Main Office in Shelbyville, the Rampart
Office in Shelbyville and the St. Paul Office are either owned by the Bank or
the Company and the Morristown Office is leased.

The following table provides certain information with respect to the Bank's
offices as of December 31, 1998:
<TABLE>
<CAPTION>
                                                        Net Book Value        Approximate
                                     Year Opened         of Property,            Square
     Description and Address         or Acquired      Furniture & Fixtures       Footage
     -----------------------         -----------      --------------------    ------------
    <S>                                 <C>             <C>                       <C>
    Shelbyville Main Office
      29 East Washington Street         1975            $     935,862             15,000
    Shelbyville Rampart Office
      34 Rampart Street                 1995            $     854,884              3,000
    Morristown Office
      127 East Main Street              1995            $      47,901              1,800
    St.  Paul Office
      105 County Line Road              1989            $      27,566              1,476
</TABLE>

In the opinion of management, the Bank's properties are adequately covered by
insurance.

                                       21
<PAGE>

The Bank has two ATMs, one of which is located at its main office and the other
which is located at its Rampart office. The Bank's ATMs are on the INTRIEVE INC.
interchange system and participate in the nationwide CIRRUS ATM network.

The Bank owns computer and data processing equipment which is used for
transaction processing, accounting, financial forecasting, and loan document
preparation. The net book value of electronic data processing equipment owned by
the Bank was $127,434 at December 31, 1998.

The Bank also has contracted for the data processing and reporting services of
Intrieve. The Bank's service corporation subsidiary owns common stock of
Intrieve having a book value of $15,000. The cost of these data processing
services is approximately $18,000 per month.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders of the Registrant during
the fourth quarter of 1998.


                                    Part II.

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS

In conjunction with a public offering of common stock completed in the second
quarter of 1998, Blue River obtained approval for quotation on the National
Association of Securities Dealers Automated Quotation System Small-Cap Market
("NASDAQ") under the symbol "BRBI."

At December 31, 1998, there were 1,490,870 shares of Blue River common stock
outstanding.

The following table sets forth the high and low sale prices for Blue River
common stock for the quarters during the years indicated, as reported by NASDAQ.
Such over-the-counter quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission, and may not necessarily represent actual
transactions.

                SALE PRICE PER SHARE
               -----------------------

                                     1998
                                    -------
       Quarter                   High       Low
       ------                    ----       ---
    Second Quarter.............. 12.250     11.375

    Third Quarter............... 11.875      8.000

    Fourth Quarter.............. 10.000      6.875

Blue River did not declare any dividend on its shares of common stock during
1998. Future dividend payments by Blue River are subject to regulatory and legal
limitations and may be dependent upon dividends paid by the Bank.

                                       22
<PAGE>

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR RESULTS OF OPERATION

         Pages 27 through 46, inclusive, of Blue River's Annual Report to
         Shareholders for the year ended December 31, 1998 is incorporated
         herein by reference in regard to this item.

ITEM 7.  FINANCIAL STATEMENTS

         Pages 47 through 74, inclusive, of Blue River's Annual Report to
         Shareholders for the year ended December 31, 1998 is incorporated
         herein by reference in regard to this item.


ITEM 8.  CHANGE IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND
               FINANCIAL DISCLOSURE

         None.




                                   Part III.

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
               COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

       This information is omitted from this report pursuant to General
       Instruction E. (3) of Form 10-KSB as Blue River intends to file with the
       Commission its definitive Proxy statement pursuant to Regulation 14A of
       The Securities Exchange Act of 1934, as amended, not later than 120 days
       after December 31, 1998

ITEM 10. EXECUTIVE COMPENSATION

       This information is omitted from this report pursuant to General
       Instruction E. (3) of Form 10-KSB as Blue River intends to file with the
       Commission its definitive Proxy statement pursuant to Regulation 14A of
       The Securities Exchange Act of 1934, as amended, not later than 120 days
       after December 31, 1998

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

       This information is omitted from this report pursuant to General
       Instruction E. (3) of Form 10-KSB as Blue River intends to file with the
       Commission its definitive Proxy statement pursuant to Regulation 14A of
       The Securities Exchange Act of 1934, as amended, not later than 120 days
       after December 31, 1998


                                       23
<PAGE>

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

       This information is omitted from this report pursuant to General
       Instruction E. (3) of Form 10-KSB as Blue River intends to file with the
       Commission its definitive Proxy statement pursuant to Regulation 14A of
       The Securities Exchange Act of 1934, as amended, not later than 120 days
       after December 31, 1998

ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)     The following Exhibits are being filed as part of this Registration
        Statement:

        3(i)*      Articles of Incorporation

        3(ii)      By-Laws

        10.01**    Amended and restated Employment Agreement dated August 11,
                   1997 between Registrant and Robert C. Reed

        10.02**    Registrant's 1998 Directors' Stock Option Plan

        10.03**    Registrant's 1998 Key Employees' Stock Option Plan

        10.04***   Termination Agreement dated February 5, 1998 between
                   Registrant, the Bank and Rodney L Meyerholtz

        13         The Annual Report to Shareholders of the Company for the year
                   ended December 31, 1998 (Except for the pages and information
                   thereof expressly incorporated by reference in this Form
                   10-KSB, the Annual Report to Shareholders is provided solely
                   for the information of the Securities and Exchange Commission
                   and is not deemed "filed" as part of this Form 10-KSB).

        21         Subsidiaries of the Registrant

        27         Financial Data Schedule

*      Incorporated by reference to Registrant's Amendment No. 3 to the
       Registration Statement on Form SB-2, File No. 333-48269 filed June 22,
       1998.

**     Incorporated by reference to Registrant's Amendment No. 1 to the
       Registration Statement on Form SB-2, File No. 333-48269 filed June 8,
       1998

***    Incorporated by reference to Registrant's Registration Statement on Form
       SB-2, File No. 333-48269 filed March 19, 1998

(b)    On December 29, 1998 the Company filed Form 8-K report the Bank's
       intention to begin banking operations in Fort Wayne, Indiana through
       First Community Bank of Fort Wayne.

                                       24
<PAGE>

                                  SIGNATURES

In accordance with Section 15 (d) of the Securities Exchange Act of 1934, the
Registrant has caused this report to be signed on its behalf of the undersigned,
there unto duly authorized.



                                      Blue River Bancshares, Inc.
                                      (Registrant)

Date:      March 30, 1999             By:     /s/ Robert C. Reed
                                      -------------------------------------
                                      Robert C. Reed
                                      President & Chief Executive Officer

Date:      March 30, 1999             By:     /s/ Stephen R. Cartwright
                                      -------------------------------------
                                      Stephen R. Cartwright
                                      Vice President & Chief Credit Officer

Date:      March 30, 1999             By:     /s/ Bradley A. Long
                                      -------------------------------------
                                      Bradley A. Long
                                      Vice President & Treasurer

Date:      March 30, 1999             By:     /s/ Steven R. Abel
                                      -------------------------------------
                                      Steven R. Abel
                                      Chairman of the Board, Director

Date:      March 30, 1999             By:     /s/ D. Warren Robison
                                      -------------------------------------
                                      D. Warren Robison
                                      Senior Vice President & Secretary,
                                      Director

Date:      March 30, 1999             By:     /s/ Wendell L. Bernard
                                      -------------------------------------
                                      Wendell L. Bernard
                                      Director

Date:      March 30, 1999             By:     /s/ Ralph W. Van Natta
                                      -------------------------------------
                                      Ralph W. Van Natta
                                      Director



                                       25