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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003.
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________________ to____________________
Commission file number 0-18342
Bremer Financial Corporation
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Minnesota 41-0715583
------------------------------- ----------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
445 Minnesota St., Suite 2000, St. Paul, MN 55101-2107
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(651) 227-7621
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Not applicable.
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
------ ------
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes No X
------ ------
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
As of June 30, 2003, there were 1,200,000 shares of class A common
stock and 10,800,000 shares of class B common stock outstanding.
BREMER FINANCIAL CORPORATION AND SUBSIDIARIES
FINANCIAL HIGHLIGHTS
(dollars in thousands, except per share amounts)
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
2003 2002 Change 2003 2002 Change
---- ---- ------ ---- ---- ------
Operating Results:
Total interest income $ 69,059 $ 74,878 (7.77)% $ 137,904 $150,243 (8.21)%
Total interest expense 22,642 26,081 (13.19) 45,410 53,654 (15.37)
------ ------ ------ ------ ------ ------
Net interest income 46,417 48,797 (4.88) 92,494 96,589 (4.24)
Provision for credit losses 2,678 2,927 (8.51) 6,156 6,864 (10.31)
----- ----- ----- ----- ----- ------
Net interest income after provision for
credit losses 43,739 45,870 (4.65) 86,338 89,725 (3.77)
Noninterest income 22,460 16,738 34.19 45,265 36,047 25.57
Noninterest expense 42,293 38,235 10.61 83,179 76,439 8.82
------ ------ ----- ------ ------ ----
Income before income tax expense 23,906 24,373 (1.92) 48,424 49,333 (1.84)
Income tax expense 8,519 8,199 3.90 16,849 16,649 1.20
----- ----- ---- ------ ------ ----
Net income $ 15,387 $ 16,174 (4.87)% $ 31,575 $ 32,684 (3.39)%
========== ========== ===== ========== ======== =====
Net income per share $ 1.28 $ 1.35 (4.87)% $ 2.63 $ 2.72 (3.39)%
Dividends paid per share 0.45 0.40 12.50 0.90 0.80 12.50
Tax equivalent net interest income $ 48,415 $ 50,846 (4.78)% $ 96,486 $100,735 (4.22)%
Net charge-offs 1,633 923 77.10 2,640 3,195 (17.36)
Selected Financial Ratios:
Return on average assets (1) 1.16 % 1.32 % (0.16) 1.22 % 1.34 % (0.12)
Return on average equity (1) 13.83 15.91 (2.08) 14.36 16.34 (1.98)
Average realized equity to average assets (1) 8.42 8.19 0.23 8.51 8.21 0.30
Net interest margin (2) 3.93 4.45 (0.52) 4.02 4.43 (0.41)
Operating efficiency ratio (2)(3) 59.62 55.64 4.25 59.90 55.92 4.12
Net charge-offs to average loans and leases 0.17 0.11 0.06 0.14 0.19 (0.05)
June 30 June 30 December 31
2003 2002 2002 Change
---- ---- ---- ------
Balance Sheet Data:
Total assets $5,442,812 $5,074,159 7.27 % $5,259,543 3.48 %
Securities (4) 1,193,827 1,122,754 6.33 1,126,501 5.98
Loans and leases (5) 3,847,939 3,613,731 6.48 3,679,669 4.57
Total deposits 3,760,254 3,620,640 3.86 3,750,329 0.26
Short-term borrowings 677,422 531,978 27.34 511,476 32.44
Long-term debt 415,425 335,930 23.66 417,678 (0.54)
Mandatorily redeemable preferred securities 76,500 76,500 - 76,500 -
Total shareholders' equity and redeemable
Class A common stock 452,516 416,906 8.54 434,096 4.24
Per share book value of common stock 37.71 34.74 8.54 36.17 4.24
Asset Quality:
Reserve for credit losses $ 62,315 $ 57,385 8.59 % $ 58,799 5.98 %
Nonperforming assets 33,834 30,062 12.55 31,910 6.03
Nonperforming assets to total loans, leases
and OREO 0.88 % 0.83 % 0.05 0.87 % 0.01
Reserve to nonperforming loans and leases 203.91 204.05 (19.87) 202.02 (17.84)
Reserve to total loans and leases 1.62 1.59 0.03 1.60 0.02
- ----------
(1) Calculation includes shareholders' equity and redeemable class A common stock.
(2) Tax-equivalent basis.
(3) Calculation excludes nonrecurring gains and losses, other nonrecurring noninterest income and amortization of intangibles.
(4) Includes securities held-to-maturity and securities available-for-sale.
(5) Net of unearned discount and includes nonaccrual loans and leases.
BREMER FINANCIAL CORPORATION AND SUBSIDIARIES
SUMMARY BALANCE SHEET AND INCOME STATEMENT
(dollars in thousands)
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
Average Average Average Average
Average Rate/ Average Rate/ Average Rate/ Average Rate/
Balance Yield (1) Balance Yield (1) Balance Yield (1) Balance Yield (1)
------- --------- ------- --------- ------- --------- ------- ---------
Summary Average Balance Sheet:
Total loans and leases (2) $3,775,010 6.26 % $3,506,043 7.08 % $3,715,534 6.34 % $3,461,812 7.19 %
Total securities (3) 1,152,295 4.21 1,050,120 5.70 1,116,217 4.50 1,097,911 5.66
Total other earning assets 11,824 2.54 24,215 2.02 14,257 1.81 21,363 2.00
------ ------ ------ ------
Total interest earning assets (4) $4,939,129 5.77 % $4,580,378 6.74 % $4,846,008 5.90 % 4,581,086 6.80 %
Total noninterest earning assets 361,968 329,088 365,836 333,611
------- ------- ------- -------
Total assets $5,301,097 $4,909,466 $5,211,844 $4,914,697
========== ========== ========== ==========
Noninterest bearing deposits $ 641,834 $ 554,166 $ 631,626 $ 549,336
Interest bearing deposits 3,069,224 1.71 % 3,077,869 2.31 % 3,061,457 1.77 % 3,100,405 2.41 %
Short-term borrowings 590,301 1.31 396,676 1.58 520,480 1.31 387,121 1.60
Long-term debt 415,508 5.60 337,356 5.92 416,340 5.61 338,653 5.94
Mandatorily redeemable preferred
securities 76,500 9.40 76,500 9.40 76,500 9.45 76,500 9.45
------ ------ ------ ------
Total interest bearing liabilities $4,151,533 2.19 % $3,888,401 2.69 % $4,074,777 2.25 % $3,902,679 2.77 %
Other noninterest bearing liabilities 61,227 59,029 61,985 59,123
Minority interest 150 150 150 150
Total shareholders' equity and
redeemable Class A common stock 446,353 407,720 443,306 403,409
------- ------- ------- -------
Total liabilities and equity $5,301,097 $4,909,466 $5,211,844 $4,914,697
========== ========== ========== ==========
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
2003 2002 $ Change % Change 2003 2002 $ Change % Change
---- ---- -------- -------- ---- ---- -------- --------
Summary Income Statement:
Total interest income $ 69,059 $74,878 $ (5,819) (7.77)% $ 137,904 $150,243 $ (12,339) (8.21)%
Total interest expense 22,642 26,081 (3,439) (13.19) 45,410 53,654 (8,244) (15.37)
------ ------ ------ ------ ------ ------
Net interest income 46,417 48,797 (2,380) (4.88) 92,494 96,589 (4,095) (4.24)
Provision for credit losses 2,678 2,927 (249) (8.51) 6,156 6,864 (708) (10.31)
----- ----- ---- ----- ----- ----
Net interest income after provision
for credit losses 43,739 45,870 (2,131) (4.65) 86,338 89,725 (3,387) (3.77)
Service charges 7,634 7,117 517 7.26 14,732 13,758 974 7.08
Insurance 1,786 2,262 (476) (21.04) 4,024 4,670 (646) (13.83)
Trust 2,444 2,404 40 1.66 4,784 4,801 (17) (0.35)
Brokerage 1,345 1,332 13 0.98 2,582 2,718 (136) (5.00)
Gain on sale of loans 6,208 1,938 4,270 220.33 10,520 4,301 6,219 144.59
Gain on sale of securities 1,637 326 1,311 NM 5,839 1,926 3,913 203.17
Other 1,406 1,359 47 NM 2,784 3,873 (1,089) (28.12)
----- ----- -- ----- ----- ------
Total noninterest income 22,460 16,738 5,722 34.19 45,265 36,047 9,218 25.57
Salaries and wages 19,599 17,941 1,658 9.24 37,887 35,435 2,452 6.92
Employee benefits 6,100 4,559 1,541 33.80 12,271 9,422 2,849 30.24
Occupancy 2,801 2,573 228 8.86 5,590 5,146 444 8.63
Furniture and equipment 2,570 2,341 229 9.78 5,072 4,747 325 6.85
Data processing fees 2,498 2,341 157 6.71 4,983 4,520 463 10.24
FDIC premiums and examination fees 439 438 1 0.23 876 886 (10) (1.13)
Amortization of intangibles 716 745 (30) (4.02) 1,433 1,493 (60) (4.02)
Other 7,570 7,297 274 3.76 15,067 14,790 277 1.87
----- ----- --- ------ ------ ---
Total noninterest expense 42,293 38,235 4,058 10.61 83,179 76,439 6,740 8.82
------ ------ ----- ------ ------ -----
Income before income tax expense 23,906 24,373 (467) (1.92) 48,424 49,333 (909) (1.84)
Income tax expense 8,519 8,199 320 3.90 16,849 16,649 200 1.20
----- ----- --- ------ ------ ---
Net income $ 15,387 $16,174 $ (787) (4.87)% $ 31,575 $ 32,684 $ (1,109) (3.39)%
========== ======= ====== ======== ======== ========
- -------------------------------
(1) Calculation is based on interest income including $1,998 and $2,049 for the three months ending June 2003 and June 2002
and $3,992 and $4,146 for the six months ending June 2003 and June 2002 to adjust to a fully taxable basis using the
federal statutory rate of 35%.
(2) Net of unearned discount and includes nonaccrual loans and leases.
(3) Excluding net unrealized gain (loss) on securities available-for-sale.
(4) Before deducting the reserve for credit losses.
BREMER FINANCIAL CORPORATION
FORM 10-Q
QUARTER ENDED JUNE 30, 2003
INDEX
PART I -- FINANCIAL INFORMATION Page
----
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of 13
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosure About 25
Market Risk
Item 4. Controls and Procedures 26
PART II -- OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 27
Exhibit 12.1 Statement Regarding Computation of Ratio of
Earnings to Fixed Charges
Exhibit 31.1 Certification of Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
Exhibit 31.2 Certification of Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Exhibit 32.2 Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
1
Forward-Looking Statements
Certain statements in this Form 10-Q constitute "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21B of the Securities Exchange Act of 1934, as amended ("Exchange Act").
For this purpose, any statements contained herein or incorporated herein that
are not statements of historical fact may be deemed to be forward-looking
statements. Without limiting the foregoing, the words "believes," "anticipates,"
"plans," "intends," "expects" and similar expressions are intended to identify
forward-looking statements. Because these forward-looking statements involve
risk and uncertainties, there are important factors, including the factors
discussed in "Risk Factors" filed with the Annual Report on Form 10-K as Exhibit
99.1 on March 21, 2003, and as amended on Form 10K/A filed on May 13, 2003, that
could cause actual results to differ materially from those expressed or implied
by these forward-looking statements.
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
BREMER FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
June 30, December 31,
2003 2002
---- ----
(unaudited)
Assets
Cash and due from banks $ 210,251 $ 256,900
Interest bearing deposits 4,255 4,185
Investment securities available-for-sale 234,567 196,773
Mortgage-backed securities available-for-sale 794,770 766,315
------- -------
Total securities available-for-sale 1,029,337 963,088
Investment securities held-to-maturity (fair
value: 06/30/03 - $175,831, 12/31/02 - $171,233) 164,490 163,413
Loans and leases 3,848,195 3,680,122
Reserve for credit losses (62,315) (58,799)
Unearned discount (256) (453)
---- ----
Net loans and leases 3,785,624 3,620,870
Interest receivable 31,543 33,854
Premises and equipment, net 84,686 82,152
Goodwill 84,226 85,148
Other intangibles 19,456 21,025
Other assets 28,944 28,908
------ ------
Total assets $5,442,812 $5,259,543
========== ==========
Liabilities and Shareholders' Equity
Noninterest bearing deposits $ 709,784 $ 724,102
Interest bearing deposits 3,050,470 3,026,227
--------- ---------
Total deposits 3,760,254 3,750,329
Federal funds purchased and repurchase agreements 438,808 449,970
Other short-term borrowings 238,614 61,506
Long-term debt 415,425 417,678
Company obligated mandatorily redeemable
preferred securities of subsidiary trusts
holding junior subordinated debentures 76,500 76,500
Accrued expenses and other liabilities 60,545 69,314
------ ------
Total liabilities 4,990,146 4,825,297
Minority interests 150 150
Redeemable class A common stock, 960,000 shares
issued and outstanding 36,201 34,728
Shareholders' equity
Common stock
Class A, no par, 12,000,000 shares authorized;
240,000 shares issued and outstanding 57 57
Class B, no par, 10,800,000 shares authorized,
issued and outstanding 2,562 2,562
Retained earnings 409,111 389,998
Accumulated other comprehensive income 4,585 6,751
----- -----
Total shareholders' equity 416,315 399,368
------- -------
Total liabilities and shareholders' equity $5,442,812 $5,259,543
========== ==========
See notes to consolidated financial statements.
3
BREMER FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)
For the Three Months Ended For the Six Months Ended
June 30, June 30,
-------- --------
2003 2002 2003 2002
---- ---- ---- ----
Interest income
Loans and leases, including fees $ 58,065 $ 61,108 $ 115,197 $ 121,870
Securities
Taxable 8,679 11,197 18,091 23,065
Tax-exempt 2,240 2,451 4,488 5,096
Federal funds sold 22 85 58 142
Other 53 37 70 70
----- ----- ------ ------
Total interest income 69,059 74,878 137,904 150,243
Interest expense
Deposits 13,123 17,744 26,860 37,028
Federal funds purchased and repurchase agreements 1,382 1,385 2,657 2,676
Other short-term borrowings 541 175 714 395
Long-term debt 5,802 4,983 11,592 9,968
Company obligated mandatorily redeemable
preferred securities of subsidiary trusts
holding junior subordinated debentures 1,794 1,794 3,587 3,587
----- ----- ----- -----
Total interest expense 22,642 26,081 45,410 53,654
------ ------ ------ ------
Net interest income 46,417 48,797 92,494 96,589
Provision for credit losses 2,678 2,927 6,156 6,864
----- ----- ----- -----
Net interest income after provision for credit losses 43,739 45,870 86,338 89,725
Noninterest income
Service charges 7,634 7,117 14,732 13,758
Insurance 1,786 2,262 4,024 4,670
Trust 2,444 2,404 4,784 4,801
Brokerage 1,345 1,332 2,582 2,718
Gain on sale of loans 6,208 1,938 10,520 4,301
Gain on sale of securities 1,637 326 5,839 1,926
Other 1,406 1,359 2,784 3,873
----- ----- ----- -----
Total noninterest income 22,460 16,738 45,265 36,047
Noninterest expense
Salaries and wages 19,599 17,941 37,887 35,435
Employee benefits 6,100 4,559 12,271 9,422
Occupancy 2,801 2,573 5,590 5,146
Furniture and equipment 2,570 2,341 5,072 4,747
Data processing fees 2,498 2,341 4,983 4,520
FDIC premiums and examination fees 439 438 876 886
Amortization of intangibles 716 745 1,433 1,493
Other 7,570 7,297 15,067 14,790
----- ----- ------ ------
Total noninterest expense 42,293 38,235 83,179 76,439
------ ------ ------ ------
Income before income tax expense 23,906 24,373 48,424 49,333
Income tax expense 8,519 8,199 16,849 16,649
----- ----- ------ ------
Net income $ 15,387 $ 16,174 $ 31,575 $ 32,684
======== ======== ======== ========
Per common share amounts:
Net income-basic and diluted $ 1.28 $ 1.35 $ 2.63 $ 2.72
Dividends paid 0.45 0.40 0.90 0.80
See notes to consolidated financial statements.
4
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(unaudited)
(in thousands, except per share amounts)
Accumulated
Common Stock Other
------------ Comprehensive Comprehensive Retained
Class A Class B Income (Loss) Income Earnings Total
------- ------- ------------- ------ -------- -----
For the Six Months Ended June 30, 2002
Balance, December 31, 2001 $57 $2,562 $4,603 $351,497 $358,719
Comprehensive income
Net income $32,684 32,684 32,684
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains arising during the period,
net of tax 5,066 5,066
Less: Reclassified adjustment for gains included
in income, net of tax (1,156) (1,156)
------ ------
Other comprehensive income 3,910 3,910 3,910
-----
Comprehensive income $36,594
=======
Dividends, $.80 per share (9,600) (9,600)
Allocation of net income in excess of dividends and other
comprehensive income to redeemable class A common stock (313) (1,846) (2,159)
--- ----- ---- ------ ------
Balance, June 30, 2002 $57 $2,562 $8,200 $372,735 $383,554
=== ====== ====== ======== ========
For the Six Months Ended June 30, 2003
Balance, December 31, 2002 $57 $2,562 $6,751 $389,998 $399,368
Comprehensive income
Net income $31,575 31,575 31,575
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding losses arising during the period,
net of tax 1,149 1,149
Less: Reclassified adjustment for gains included
in income, net of tax (3,503) (3,503)
------ ------
Other comprehensive income (2,354) (2,354) (2,354)
------
Comprehensive income $29,221
=======
Dividends, $.90 per share (10,800) (10,800)
Allocation of net income in excess of dividends and other
comprehensive income to redeemable class A common stock 188 (1,662) (1,474)
--- ----- --- ------ ------
Balance, June 30, 2003 $57 $2,562 $4,585 $409,111 $416,315
=== ====== ====== ======== ========
See notes to consolidated financial statements.
5
BREMER FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For the Six Months
Ended June 30,
--------------
2003 2002
---- ----
Cash flows from operating activities
Net income $ 31,575 $ 32,684
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for credit losses 6,156 6,864
Depreciation and amortization 8,502 6,769
Gain on sale of securities (5,839) (1,926)
Loss (gain) on sale of other real estate owned, net 21 (159)
Other assets and liabilities, net (8,110) 30,982
Gain on sale of loans 10,520 4,301
Proceeds from loans originated for sale 412,481 187,643
Loans originated for sale (400,499) (173,148)
-------- --------
Net cash provided by operating activities 54,807 94,010
Cash flows from investing activities
Interest bearing deposits, net (70) 75
Purchases of mortgage-backed securities (340,035) (209,453)
Purchases of available-for-sale investment securities (71,074) (74,411)
Purchases of held-to-maturity securities (13,236) (9,025)
Proceeds from maturities of mortgage-backed securities 190,415 158,026
Proceeds from maturities of available-for-sale investment securities 11,752 77,919
Proceeds from maturities of held-to-maturity securities 12,159 19,111
Proceeds from sales of mortage-backed securities 115,170 -
Proceeds from sales of available-for-sale investment securities 29,440 125,167
Proceeds from sales of other real estate owned 1,411 573
Loans and leases, net (193,412) (136,883)
Purchase of premises and equipment (6,794) (4,525)
------ ------
Net cash used in investing activities (264,274) (53,426)
Cash flows from financing activities
Noninterest bearing deposits, net (14,318) (79,927)
Savings, NOW and money market accounts, net 193,453 (62,641)
Certificates of deposits, net (169,210) (42,810)
Federal funds purchased and repurchase agreements,net (11,162) 46,216
Other short-term borrowings, net 177,108 36,850
Repayments of long-term debt (2,253) 20,007
Common stock dividends paid (10,800) (9,600)
------- ------
Net cash provided by (used in) financing activities 162,818 (91,905)
------- -------
Net decrease in cash and due from banks (46,649) (51,321)
Cash and due from banks at beginning of period 256,900 213,101
------- -------
Cash and due from banks at end of period $ 210,251 $161,780
========= ========
Supplemental disclosures of cash flow information
Cash paid during the year for interest $ 48,261 $60,258
Cash paid during the year for income taxes 10,359 11,707
See notes to consolidated financial statements.
6
BREMER FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note A: Financial Statements
The condensed financial statements included herein have been prepared by Bremer
Financial Corporation (the "Company") pursuant to the rules and regulations of
the Securities and Exchange Commission and have not been audited by independent
auditors. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been condensed or omitted pursuant
to such rules and regulations, although the Company believes that the
disclosures are adequate to make the information presented not misleading.
Note B: General
The consolidated financial statements include the accounts of Bremer Financial
Corporation and subsidiaries. All material intercompany transactions and
balances are eliminated in consolidation. The Company has not changed its
accounting policies from those stated for the year ended December 31, 2002
included in its Annual Report on Form 10-K for that year filed on March 21,
2003, and amended on Form 10K/A filed on May 13, 2003.
Note C: Interim Period Adjustments
The consolidated financial statements contained herein reflect all adjustments
which are, in the opinion of management, of a normal recurring nature and are
necessary for a fair statement of the financial position, results of operations,
and cash flows for the unaudited interim periods. The results of operations for
the interim periods are not necessarily indicative of the results to be expected
for the entire year.
Note D: Earnings Per Share Calculations
Basic and diluted earnings per common share have been computed using 12,000,000
common shares outstanding for all periods. The Company does not have any
dilutive securities.
Note E: Securities
Investment securities classified as held-to-maturity are valued at amortized
historical cost. Investment securities and mortgage-backed securities classified
as available-for-sale are valued at fair value. Unrealized holding gains and
losses are excluded from earnings and reported, net of tax, as a separate
component of shareholders' equity until realized, except for the portion
allocated to redeemable class A stock. Gains or losses on these securities are
computed based on the amortized cost of the specific securities when sold.
7
Note F: Redeemable Class A Common Stock
At June 30, 2003, 960,000 shares of redeemable class A stock were issued and
outstanding. At June 30, 2003, these shares were subject to redemption at a
price of $37.71 per share, which approximated book value. These shares are owned
by employees and directors of the Company and its subsidiaries and the employee
benefit plans of the Company. These holders of class A common stock have the
right to require the Company to purchase their shares under certain
circumstances. It is the Company's intent that these 960,000 shares will
continue to be held by employees, directors, and employee benefit plans of the
Company and its subsidiaries and not be directly purchased by the Company or the
Otto Bremer Foundation. During the period from January 1, 2003 through June 30,
2003, we did not directly purchase any shares of class A common stock but
assigned to various parties our options that arose during that period to
purchase a total of 41,536.0806 shares. These options were assigned to the
Bremer Financial Corporation Employee Stock Ownership Plan ("ESOP") (2,965.3036
shares), the Bremer Banks Profit Sharing Plus Plan (12,271.777 shares), and
executives and directors under the Executive Stock Purchase Plan (26,299.0000
shares). To the best of our knowledge, shares purchased by these parties upon
exercise of these assigned options were the only transfers of shares of class A
common stock effected during the period from January 1, 2003 through June 30,
2003.
Note G: Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of income and expenses during the reported period. Actual
results may differ from those estimates.
Note H: Comprehensive Income
The Company reported comprehensive income for the first six months of 2003 of
$29.2 million, compared to the $36.6 million reported for the same period in
2002. Comprehensive income is defined as the change in equity of a business
enterprise during a period resulting from transactions and other events and
circumstances from nonowner sources. It includes all changes in equity during a
period except those resulting from investments by owners and distributions to
owners. For the Company, comprehensive income consists of net income, as
reported in the financial statements, and other comprehensive income, which
consists of the change in unrealized gains and losses on available-for-sale
securities and the change in the minimum pension liability.
Note I: Goodwill and Intangible Assets
Intangible assets consist of goodwill, core deposit intangibles, and other
intangibles. The remaining unamortized balances at June 30, 2003 and 2002 were
$103.7 million and $107.4 million. The core deposit and other intangibles have
remaining amortization lives of 5 to 10 years. Goodwill is not amortized but is
tested regularly for impairment. On January 1, 2002, the
8
Company adopted Statements of Financial Accounting Standards ("SFAS")
No. 142, "Goodwill and Other Intangible Assets," which addresses the accounting
and reporting for acquired goodwill and other intangible assets. Under the
provisions of SFAS No. 142, intangible assets acquired in a business
combination, which do not possess finite useful lives, will no longer be
amortized into net income over an estimated useful life. However, these
intangible assets will be tested for impairment at least annually based on
specific guidance provided in the new standard. Management performed its annual
impairment assessment on its goodwill assets, and no impairment loss was
recorded as a result of this test.
In October 2002, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 147, "Acquisitions of Certain Financial Institutions." This Statement
removes acquisitions of financial institutions from the scope of both SFAS 72,
"Accounting for Certain Acquisitions of Banking or Thrift Institutions," and
FASB Interpretation No. 9, "Applying Accounting Principles Board Opinion ("APB")
Opinions No. 16 and 17 When a Savings and Loan Association or a Similar
Institution Is Acquired in a Business Combination Accounted for by the Purchase
Method." SFAS No. 72 included a requirement to recognize and subsequently
amortize any excess of the fair value of the liabilities assumed in certain
acquisitions over the fair value of tangible and identifiable intangible assets
acquired as an unidentifiable intangible asset. Under the requirements of SFAS
No. 147, for a transaction that is a business combination, the unidentifiable
intangible asset that is required to be recognized under SFAS No. 72 represents
goodwill that should be accounted for under SFAS No. 142. The financial
statements for the three and six month periods ended June 30, 2002 have been
restated to reflect the adoption of SFAS No. 147.
9
The following table presents relevant information about the Company's amortized
and unamortized intangible assets:
As of June 30, 2003
-------------------
Gross Carrying Accumulated
Amount Amortization
------ ------------
Amortized intangible assets
Core deposit premium $ 21,313 $ 5,985
Other 8,364 4,236
----- -----
Total $ 29,677 $ 10,221
======== ========
Unamortized intangible assets
Goodwill $ 84,226
--------
Total $ 84,226
========
As of June 30, 2002
-------------------
Gross Carrying Accumulated
Amount Amortization
------ ------------
Amortized intangible assets
Core deposit premium $ 21,313 $ 3,447
Other 6,582 2,184
----- -----
Total $ 27,895 $ 5,631
======== =======
Unamortized intangible assets
Goodwill $ 85,148
--------
Total $ 85,148
========
The Company recorded aggregate intangible amortization expense of $1.4 million
for the six months ended June 30, 2003 and $1.5 million for the six months ended
June 30, 2002. The Company sold two branches that were part of its Marshall,
Minnesota bank subsidiary in June 2003. The sale reduced goodwill by
approximately $922 thousand, which was the amount of unamortized goodwill
assigned to these two branches which were originally acquired by the Company in
1999. The estimated amortization expense for each of the next five years is
approximately $2.6 million.
Note J: Accounting for Asset Retirement Obligations
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which is required to be adopted for fiscal years beginning after
June 15, 2002. SFAS No. 143 establishes accounting and reporting standards for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. It requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of the fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. The
10
Company adopted SFAS No. 143 on January 1, 2003, and the adoption did not
have a material impact on its financial position or results of operations.
Note K: Recent Accounting Pronouncements
In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN No. 45 clarifies the
requirements for a guarantor's accounting for and disclosure of certain
guarantees issued and outstanding. The initial recognition and initial
measurement provisions of FIN No. 45 are applicable to guarantees issued or
modified after December 31, 2002. The disclosure requirements of FIN No. 45 are
effective for financial statements of interim or annual periods after December
15, 2002. The adoption of FIN No. 45 did not have a significant impact on the
Company's financial statement disclosures, consolidated balance sheet, or
results of operations.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities, an interpretation of Account Research Bulletin No. 51, Consolidated
Financial Statements." FIN No. 46 explains how to identify variable interest
entities and how an enterprise assesses its interests in a variable interest
entity to decide whether to consolidate that entity. This Interpretation
requires existing unconsolidated variable interest entities to be consolidated
by their primary beneficiaries if the entities do not effectively disperse risks
among parties involved. FIN No. 46 is effective immediately for variable
interest entities created after January 31, 2003, and to variable interest
entities in which an enterprise obtains an interest after that date. The
Interpretation applies in the first fiscal quarter beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The adoption of FIN No. 46
did not have a material effect on the Company's financial position or results of
operations.
Note L: Commitments and Contingencies
The Company utilizes various off-balance sheet instruments to satisfy the
financing needs of customers. These instruments represent contractual
obligations of the Company to provide funding, within a specified time period,
to a customer. The following table represents the outstanding obligations:
June 30 December 31
2003 2002
---- ----
(in thousands)
Standby letters of credit $ 51,943 $ 37,245
Loan commitments 1,071,228 1,040,027
Standby letters of credit represent a conditional commitment to satisfy an
obligation to a third party, generally to support public and private borrowing
arrangements, on behalf of the customer. Loan commitments represent contractual
agreements to provide funding to customers over a specified time period as long
as there is no violation of any condition of the contract. These loans generally
will take the form of operating lines.
11
The Company's potential exposure to credit loss in the event of nonperformance
by the other party is represented by the contractual amount of those
instruments. The credit risk associated with letters of credit and loan
commitments is substantially the same as extending credit in the form of a loan;
therefore, the same credit policies apply in evaluating potential letters of
credit or loan commitments. The amount of collateral obtained, if deemed
necessary upon the extension of credit, is based on management's credit
evaluation. The type of collateral held varies, but includes accounts
receivable, inventory, and productive assets.
Under substantially noncancelable contracts, the Company is obligated to pay
approximately $4.8 million in annual data processing and item processing fees to
a third party provider through May 2008. The costs under the item processing
contract are calculated in accordance with a volume-based fee schedule, which is
subject to change annually.
The Company is routinely involved in legal actions which are incidental to the
business of the Company. Although it is difficult to predict the ultimate
outcome of these cases, management believes, based on discussions with counsel,
that any ultimate liability will not materially affect the Company's
consolidated financial position or operations.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Critical Accounting Policies
In preparing the financial statements, we follow accounting principles generally
accepted in the United States of America, which in many cases require us to make
assumptions, estimates and judgments that affect the amounts reported. A summary
of our significant accounting policies can be found in the footnotes to the
consolidated financial statements, and many of these policies are relatively
straightforward. However, management has identified the accounting policies
described below as those that, due to the judgments, estimates and assumptions
inherent in these policies, are critical to an understanding of our consolidated
financial statements and management's discussion and analysis.
The difficulty in applying these policies arises from the assumptions, estimates
and judgments that have to be made currently about matters that are inherently
uncertain, such as future economic conditions, operating results and valuations
as well as management intentions. As the difficulty increases, the level of
precision decreases, meaning that actual results can and probably will be
different from those currently estimated. We base our assumptions, estimates and
judgments on a combination of historical experiences and other reasonable
factors.
Reserves for Credit Losses. In general, determining the amount of the reserve
for credit losses requires significant judgment and the use of estimates by
management. We maintain an allowance for credit losses to absorb probable losses
in the loan and lease portfolio based on a quarterly analysis of the portfolio
and expected future losses. Reserves for credit losses include charges to reduce
the recorded balances of loans receivable and real estate to their estimated net
realizable value or fair value, as applicable.
Investment Securities. Purchased investment securities are recorded at cost,
which includes premiums and discounts if purchased at other than par or face
value. We amortize premiums and discounts as an adjustment to interest income
using the effective interest method over the estimated life of the security. The
cost of investment securities sold, and any resulting gain or loss, is based on
the specific identification method.
Investments in marketable equity and debt securities are classified into three
categories - held to maturity, available for sale, or trading - pursuant to
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." As of June 30, 2003, no
investments were classified as trading securities. Held-to-maturity securities
represent investments for which we have the ability and intent to hold to
maturity and may be sold only under very limited circumstances. We currently
classify our investments in certain municipal bond obligations and certain U.S.
government agency obligations as held-to-maturity securities. Available-for-sale
securities consist of debt and equity securities that will be held for
indefinite periods of time, including securities that may be sold in response to
changes in market interest or prepayment rates, needs for liquidity, or changes
in the availability or yield of alternative investments. These securities are
valued at fair value with the resulting unrealized holding gains and losses
excluded from earnings and reported, net of tax and
13
amounts allocable to redeemable class A common stock, as a separate
component of shareholders' equity until realized. Gains or losses on these
securities are computed based on the amortized cost of the specific securities
when sold.
Management periodically evaluates investment securities for other than temporary
declines in fair value. Declines in fair value of individual investment
securities below their amortized cost that are deemed to be other than temporary
will be written down to current fair value and included in earnings as realized
losses. There were no investment securities which management identified to be
other-than-temporarily impaired for the period ended June 30, 2003. If the
financial markets experience deterioration and investments decline in fair
value, charges to income could occur in future periods.
Interest Income Recognition. We recognize interest income by methods that
conform to general accounting practices within the banking industry. Interest
income is accrued on loan and lease balances based on the principal amount
outstanding. Loans and leases are reviewed regularly by management and placed on
nonaccrual status when the collection of interest or principal is unlikely. The
accrual of interest on loans and leases is suspended when the credit becomes 90
days or more past due, unless the loan or lease is fully secured and in the
process of collection. Thereafter, no interest is recognized as income unless
received in cash or until such time the borrower demonstrates the ability to pay
interest and principal.
Goodwill and Other Intangible Assets. SFAS No. 142, "Accounting for Goodwill and
Other Intangible Assets," establishes standards for the amortization of acquired
intangible assets and the non-amortization and impairment assessment of
goodwill. In addition, SFAS No. 147, "Acquisitions of Certain Financial
Institutions," establishes standards for unidentifiable intangible assets
acquired specifically in branch purchases that qualify as business combinations.
At June 30, 2003, we had $84.2 million of goodwill, which is not subject to
periodic amortization, and $19.5 million in other intangible assets, which is
subject to periodic amortization. We sold two branches of our Marshall,
Minnesota bank subsidiary in June 2003. The sale reduced goodwill by
approximately $922,000, which was the amount of unamortized goodwill assigned to
these two branches which were originally acquired by the Company in 1999.
Goodwill arising from business combinations represents the value attributable to
unidentifiable intangible elements in the business acquired. Our recorded
goodwill relates to value inherent in the banking business, and the value is
dependent upon our ability to provide quality, cost effective services in a
competitive market place. As such, goodwill value is supported ultimately by
revenue that is driven by the volume of business transacted. A decline in
revenue as a result of a lack of growth or the inability to deliver cost
effective services over sustained periods can lead to impairment of goodwill
that could adversely impact earnings in future periods.
Under accounting principles generally accepted in the United States of America
in effect through December 31, 2001, we amortized goodwill on a straight-line
basis over periods ranging from 15 to 25 years. Effective January 1, 2002, we no
longer were required to amortize previously recorded goodwill as a result of
adopting SFAS No. 142 and SFAS No. 147.
14
We performed the annual impairment test on our goodwill assets and have
concluded that the recorded value of goodwill was not impaired as of June 30,
2003. There are many assumptions and estimates underlying the determination of
impairment. Another estimate using different, but still reasonable, assumptions
could produce a significantly different result. Additionally, future events
could cause management to conclude impairment indicators exist and our goodwill
is impaired, which would result in us recording an impairment loss. Any
resulting impairment loss could have a material adverse impact on our financial
condition and results of operations.
Overview
Earnings. We reported net income of $15.4 million or $1.28 basic and diluted
earnings per share for the second quarter of 2003. This compares to $16.2
million or $1.35 basic and diluted earnings per share in the second quarter of
2002. On a year-to-date basis through June 30, 2003 net income was $31.6
million, a 3.4% decrease from the $32.7 million earned in the first six months
of 2002. Return on average equity was 13.83% for the second quarter of 2003
compared to 15.91% for the same quarter of 2002. On a year-to-date basis, we
reported a return on average equity of 14.36%, compared to 16.34% in the first
six months of 2002. Return on average assets decreased to 1.16% in the second
quarter of 2003 from 1.32% in the second quarter of 2002. On a year-to-date
basis, we reported a return on average assets of 1.22%, compared to 1.34% in the
first six months of 2002.
Results of Operations
Net Interest Income. Net interest income for the second quarter of 2003 was
$46.4 million, a decrease of 4.9% from the $48.8 million reported for the same
period a year ago, as our net interest margin decreased to 3.93% in the second
quarter of 2003 from 4.45% in the second quarter of 2002. On a year-to-date
basis, net interest income decreased $4.1 million, or 4.2% from the first six
months of 2002, as our net interest margin decreased to 4.02% from 4.43%.
Offsetting some of the decline in net interest margin when comparing the two
six-month periods was an increase in our average loans and leases of $254
million, or 7.3%. The decline in net interest margin, which was primarily due to
the effects of historically low interest rates, is expected to continue during
the remainder of 2003. The average yield on our earning assets declined by 90
basis points when comparing the first six months of 2003 with the first six
months of 2002. Largely as a result of competitive pressure in deposit markets
and already historically low deposit rates, we were able to reduce the average
cost of our interest bearing liabilities by only 52 basis points when comparing
the same two periods.
15
The following tables set forth, for the periods indicated, information regarding
average balances of assets and liabilities and the total dollar amounts of
interest income from interest bearing assets and interest expense on interest
bearing liabilities. In addition, the tables show resultant yields or costs,
net interest income, net interest spread, and net interest margin:
For the Three Months Ended June 30
----------------------------------
(unaudited)
2003 2002
Average Average
Average Rate/ Average Rate/
Balance Interest (1) Yield Balance Interest (1) Yield
------- ------------ ----- ------- ------------ -----
(dollars in thousands)
Assets
Loans and Leases (2)
Commercial and other $ 916,816 $ 12,902 5.64 % $ 879,483 $ 13,884 6.33 %
Commercial real estate 1,191,978 19,213 6.47 1,046,464 19,040 7.30
Agricultural 439,708 6,531 5.96 406,981 6,879 6.78
Residential real estate 773,391 11,916 6.18 727,798 13,036 7.18
Consumer 332,246 5,897 7.12 334,490 6,729 8.07
Tax-exempt 120,871 2,442 8.10 110,827 2,317 8.39
------- ----- ------- -----
Total Loans and Leases 3,775,010 58,901 6.26 3,506,043 61,885 7.08
Reserve for Credit Losses (61,856) (56,381)
------- -------
Net Loans and Leases 3,713,154 3,449,662
Securities (3)
Mortgage-backed 767,848 7,292 3.81 765,418 10,379 5.44
Other taxable 204,366 1,387 2.72 89,119 818 3.68
Tax-exempt 180,081 3,402 7.58 195,583 3,723 7.64
------- ----- ------- -----
Total Securities 1,152,295 12,081 4.21 1,050,120 14,920 5.70
Federal funds sold 7,586 22 1.16 20,014 85 1.70
Other earning assets 4,238 53 5.02 4,201 37 3.53
----- -- ----- --
Total Earning Assets (4) $4,939,129 $ 71,057 5.77 % $4,580,378 $ 76,927 6.74 %
Cash and due from banks 147,350 131,205
Other non interest earning assets 276,474 254,264
------- -------
Total Assets $5,301,097 $4,909,466
========== ==========
Liabilities and Shareholders' Equity
Noninterest bearing deposits $ 641,834 $ 554,166
Interest bearing deposits
Savings and NOW accounts 456,817 $ 374 0.33 % 417,843 $ 528 0.51 %
Money market checking 249,673 100 0.16 239,413 152 0.25
Money market savings 1,135,665 3,865 1.37 945,281 2,529 1.07
Savings certificates 1,006,429 7,274 2.90 1,200,216 11,843 3.96
Certificates over $100,000 220,640 1,510 2.75 275,116 2,692 3.92
------- ----- ------- -----
Total Interest Bearing Deposits 3,069,224 13,123 1.71 3,077,869 17,744 2.31
--------- ------ --------- ------
Total Deposits 3,711,058 3,632,035
Short-term borrowings 590,301 1,922 1.31 396,676 1,560 1.58
Long-term debt 415,508 5,803 5.60 337,356 4,983 5.92
Company obligated mandatorily redeemable
preferred securities 76,500 1,794 9.40 76,500 1,794 9.40
------ ----- ------ -----
Total Interest Bearing Liabilities $4,151,533 $ 22,642 2.19 % $3,888,401 $ 26,081 2.69 %
Other noninterest bearing liabilities 61,227 59,029
------ ------
Total Liabilities 4,854,594 4,501,596
Minority Interest 150 150
Redeemable Class A Common Stock 35,708 32,618
Shareholders' equity 410,645 375,102
------- -------
Total Liabilities and Equity $5,301,097 $4,909,466
========== ==========
Net interest income $ 48,415 $ 50,846
======== ========
Net interest spread 3.58 % 4.05 %
Net interest margin 3.93 % 4.45 %
- ---------------------------------------
(1) Interest income includes $2,049 and $2,047 in 2003 and 2002 to adjust to a fully taxable basis using the federal statutory
rate of 35%.
(2) Net of unearned discount and includes nonaccrual loans and leases.
(3) Excluding net unrealized gain (loss) on available-for-sale securities.
(4) Before deducting the reserve for credit losses.
16
For the Six Months Ended June 30,
---------------------------------
(unaudited)
2003 2002
---- ----
Average Average
Average Rate/ Average Rate/
Balance Interest (1) Yield Balance Interest (1) Yield
------- ------------ ----- ------- ------------ -----
(dollars in thousands)
Assets
Loans and Leases (2)
Commercial and other $ 893,257 $ 25,260 5.70 % $ 862,820 $ 27,574 6.44 %
Commercial real estate 1,169,486 38,015 6.56 1,040,679 38,031 7.37
Agricultural 425,793 12,843 6.08 398,560 13,767 6.97
Residential real estate 773,453 23,893 6.23 721,120 26,013 7.27
Consumer 333,689 11,989 7.25 334,741 13,546 8.16
Tax-exempt 119,856 4,859 8.18 103,892 4,442 8.62
------- ----- ------- -----
Total Loans and Leases 3,715,534 116,859 6.34 3,461,812 123,373 7.19
Reserve for Credit Losses (60,964) (55,670)
------- -------
Net Loans and Leases 3,654,570 3,406,142
Securities (3)
Mortgage-backed 743,607 15,460 4.19 765,450 20,958 5.52
Other taxable 191,688 2,631 2.77 127,920 2,107 3.32
Tax-exempt 180,922 6,818 7.60 204,541 7,739 7.63
------- ----- ------- -----
Total Securities 1,116,217 24,909 4.50 1,097,911 30,804 5.66
Federal funds sold 10,041 58 1.16 17,144 142 1.67
Other earning assets 4,216 70 3.35 4,219 70 3.35
----- -- ----- --
Total Earning Assets (4) $4,846,008 $141,896 5.90 % $4,581,086 $154,389 6.80 %
Cash and due from banks 147,948 134,714
Other non interest earning assets 278,852 254,567
------- -------
Total Assets $5,211,844 $4,914,697
========== ==========
Liabilities and Shareholders' Equity
Noninterest bearing deposits $ 631,626 $ 549,336
Interest bearing deposits
Savings and NOW accounts 461,446 $ 785 0.34 % 414,299 $ 1,053 0.51 %
Money market checking 249,319 196 0.16 237,482 301 0.26
Money market savings 1,083,041 7,129 1.33 965,851 5,198 1.09
Savings certificates 1,036,551 15,436 3.00 1,210,747 24,948 4.16
Certificates over $100,000 231,100 3,314 2.89 272,026 5,528 4.10
-------- ------- ----- ------- -----
Total Interest Bearing Deposits 3,061,457 26,860 1.77 3,100,405 37,028 2.41
--------- ------ --------- ------
Total Deposits 3,693,083 3,649,741
Short-term borrowings 520,480 3,371 1.31 387,121 3,071 1.60
Long-term debt 416,340 11,592 5.61 338,653 9,968 5.94
Company obligated mandatorily redeemable
preferred securities 76,500 3,587 9.45 76,500 3,587 9.45
------ ----- ------ -----
Total Interest Bearing Liabilities $4,074,777 $ 45,410 2.25 % $3,902,679 $ 53,654 2.77 %
Other noninterest bearing liabilities 61,985 59,123
------ ------
Total Liabilities 4,768,388 4,511,138
Minority Interest 150 150
Redeemable Class A Common Stock 35,465 32,273
Shareholders' equity 407,841 371,136
------- -------
Total Liabilities and Equity $5,211,844 $4,914,697
========== ==========
Net interest income $ 96,486 $100,735
======== ========
Net interest spread 3.66 % 4.02 %
Net interest margin 4.02 % 4.43 %
- -------------------------------------
(1) Interest income includes $3,992 and $4,146 in 2003 and 2002 to adjust to a fully taxable basis using the federal statutory
rate of 35%.
(2) Net of unearned discount and includes nonaccrual loans and leases.
(3) Excluding net unrealized gain (loss) on available-for-sale securities.
(4) Before deducting the reserve for credit losses.
17
The following table illustrates, on a tax-equivalent basis, for the periods
indicated, the changes in our net interest income due to changes in volume and
changes in interest rates. Changes in net interest income other than those due
to volume have been included in changes due to rate:
Six Months Ended June 30,
-------------------------
2003 vs. 2002
-------------
Increase (Decrease)
Due to Change in
----------------
Volume Rate Total
------ ---- -----
(in thousands)
Interest earning assets:
Loans and leases (1) $ 9,043 $(15,557) $ (6,514)
Taxable securities 1,083 (6,057) (4,974)
Tax-exempt securities (1) (894) (27) (921)
Federal funds sold (59) (25) (84)
--- --- ---
Total interest earning assets $ 9,173 $(21,666) $(12,493)
======= ======== ========
Interest bearing liabilities:
Savings and NOW accounts $ 115 $ (383) $ (268)
Money market accounts 599 1,227 1,826
Savings certificates (4,421) (7,305) (11,726)
Short-term borrowings 1,058 (758) 300
Long-term debt 2,287 (663) 1,624
----- ---- -----
Total interest bearing liabilities (362) (7,882) (8,244)
---- ------ ------
Change in net interest income $ 9,535 $(13,784) $ (4,249)
======= ======== ========
- -----------------------------
(1) Interest income includes $3,992 in 2003 and $4,146 in 2002 to adjust to a fully
taxable basis using the federal statutory rate of 35%.
Provision for Credit Losses. The provision for credit losses is charged against
earnings to cover both current period net charge-offs and to maintain the
allowance for credit losses at an acceptable level to cover losses inherent in
the portfolio as of the reporting date. The provision for credit losses
decreased to $2.7 million for the second quarter of 2003 from $2.9 million for
the same quarter in 2002. On a year-to-date basis, the provision for credit
losses decreased to $6.2 million in 2003 from $6.9 million for the first six
months of 2002. Net charge-offs were $1.6 million during the second quarter of
2003 compared to $923 thousand for the same period in 2002 and $2.6 million
during the first six months of 2003 compared to $3.2 million for the same period
in 2002. Our ratio of reserve to total loans and leases increased slightly to
1.62% at June 30, 2003 from 1.59% at June 30, 2002. Our reserve coverage on
nonperforming loans and leases was 204% at June 30, 2003 and at June 30, 2002.
For further discussion related to the
18
allowance for credit losses, see the later section entitled "- Financial
Condition - Reserve for Credit Losses."
Noninterest Income. Noninterest income reflected a $5.7 million, or 34.2%,
increase to $22.5 million for the second quarter of 2003 from the $16.7 million
recorded in the second quarter of 2002. On a year-to-date basis, noninterest
income was $45.3 million, a $9.2 million, or 25.6%, increase over the $36.0
million recorded in the first six months of 2002. The major contributors to the
significant increases in noninterest income were gains on sale of loans and
securities. Gains on sale of loans increased by $6.2 million to $10.5 million in
the first six months of 2003, an increase of 145% from the $4.3 million recorded
in the first six months of 2002, as residential mortgage loan activity remained
strong due largely to the refinancing of mortgages. The pipeline of new
residential mortgage loans in process remains strong, and a high level of loan
sales activity is expected to continue during the third quarter of 2003.
In order to better balance our interest rate risk position, we sold shorter
duration mortgage backed securities with high prepayment rates and reinvested
the proceeds in longer duration securities that better matched the duration of
our liabilities. These securities sales, which took place during March and April
2003, resulted in securities gains of $5.8 million in the first six months of
2003, compared to securities gains of $1.9 million in the first six months of
2002. Other noninterest income declined to $2.8 million for the first six months
of 2003 from $3.9 million recorded in the first six months of 2002, as the first
six months of 2002 included more than $1.0 million in gains on sale of other
assets.
The following table summarizes the components of noninterest income:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
(in thousands)
Service charges $ 7,634 $ 7,117 $ 14,732 $ 13,758
Insurance 1,786 2,262 4,024 4,670
Trust 2,444 2,404 4,784 4,801
Brokerage 1,345 1,332 2,582 2,718
Gain on sale of loans 6,208 1,938 10,520 4,301
Other recurring noninterest income 1,341 1,329 2,660 2,814
----- ----- ----- -----
Recurring noninterest income 20,758 16,382 39,302 33,062
Gain on sale of other assets 65 30 124 1,059
Gain on sale of securities 1,637 326 5,839 1,926
----- --- ----- -----
Total noninterest income $ 22,460 $ 16,738 $ 45,265 $ 36,047
======== ======== ======== ========
Noninterest Expense. Noninterest expense increased $4.1 million, or 10.6%, to
$42.3 million in the second quarter of 2003 from $38.2 million in the second
quarter of 2002. On a year-to-date basis, total noninterest expense increased
$6.7 million, or 8.8%, to $83.2 million in 2003 from $76.4 million in 2002.
Personnel costs, primarily in the form of higher pension expense and
19
health care premiums, contributed most significantly to the increase in
noninterest expenses when comparing the first six months of 2003 to the first
six months of 2002. All other noninterest expenses, exclusive of personnel
costs, increased a total of $1.4 million, or 4.6%, when comparing those same
six-month periods.
The following table summarizes the components of noninterest expense:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
(in thousands)
Salaries and wages $ 19,599 $ 17,941 $ 37,887 $ 35,435
Employee benefits 6,100 4,559 12,271 9,422
Occupancy 2,801 2,573 5,590 5,146
Furniture and equipment 2,570 2,341 5,072 4,747
Printing, postage and telephone 1,639 1,582 3,419 3,151
Marketing 1,199 1,357 3,119 3,123
Data processing fees 2,498 2,341 4,983 4,520
Professional fees 829 1,056 1,450 2,087
Other real estate owned 140 25 160 37
FDIC premiums and examination fees 439 438 876 886
Amortization of intangibles 716 745 1,433 1,493
Other noninterest expense 3,763 3,277 6,919 6,392
----- ----- ----- -----
Total noninterest expense $ 42,293 $ 38,235 $ 83,179 $ 76,439
======== ======== ======== ========
A common industry statistic used to measure the productivity of banking
organizations is the operating efficiency ratio. The operating efficiency ratio
measures the cost required to generate each dollar of revenue and is calculated
by dividing recurring noninterest expense by tax-equivalent net interest income
and recurring noninterest income. Gain on sale of securities and gains on sales
of other assets are not components of recurring noninterest income and are not
included in the calculation. Recurring noninterest expense does not include
amortization of intangibles, certain losses, and other expenses that are not
part of normal operations. Our operating efficiency ratio was 59.6% for the
second quarter of 2003 compared to 55.6% for the second quarter of 2002. On a
year-to-date basis, the ratio was 59.9% for the six months ending June 30, 2003
compared to 55.9% for the same period in 2002.
Income Taxes. The provision for income taxes was $8.5 million for the quarter
ended June 30, 2003 compared to $8.2 million for the same period in 2002. On a
year-to-date basis, the provision for income taxes increased to $16.8 million in
2003 from $16.6 million in 2002. Comparing the second quarter of 2003 to the
same period in 2002, our effective tax rate increased to 35.6% from 33.6%. Our
effective tax rate increased to 34.8% for the first six months of 2003 from
33.7% for the same period in 2002. Our effective tax rate increased primarily as
a result of the branch sale that occurred during the second quarter of 2003.
20
Financial Condition
Loan and Lease Portfolio. The following table presents the components of our
gross loans and lease portfolio:
At June 30, 2003 At December 31, 2002
---------------- --------------------
Percent of Percent of
Amount Total Loans Amount Total Loans
------ ----------- ------ -----------
(in thousands)
Commercial and other $ 953,259 24.8 % $ 872,597 23.7 %
Commercial real estate 1,133,577 29.4 1,052,194 28.6
- Construction 73,604 1.9 76,460 2.1
Agricultural 457,556 11.9 436,364 11.9
Residential real estate 753,078 19.6 768,068 20.9
- Construction 19,369 0.5 23,546 0.6
Consumer 335,351 8.7 332,428 9.0
Tax-exempt 122,401 3.2 118,465 3.2
------- --- ------- ---
Total $3,848,195 100.0 % $3,680,122 100.0 %
========== ===== ========== =====
Our total loan and lease portfolio increased to $3.8 billion at June 30, 2003
from $3.7 billion at December 31, 2002. Commercial loans increased by $80.7
million, or 9.2%, during the first six months of 2003. Commercial real estate
loans increased by $78.5 million, or 7.0%, during the first six months of 2003,
with almost two-thirds of the increase taking place in the Twin Cities market.
Agricultural loans increased by $21.2 million, or 4.9%, during the first six
months of 2003, with the increase being primarily seasonal in nature.
Residential real estate loans decreased by $19.2 million, or 2.4%, as most of
our new first mortgages are being sold in the secondary market. These sales
resulted in gains on sale of loans of $10.5 million in the first six months of
2003 as residential mortgage loan activity remained strong due largely to the
refinancing of mortgages. Consumer loans increased $2.9 million, or just less
than 1.0%, and tax-exempt loans increased by $3.9 million, or 3.3%, during the
first six months of 2003.
Nonperforming Assets. Nonperforming assets include nonaccrual loans,
restructured loans and other real estate owned. Nonperforming assets were $33.8
million at June 30, 2003, an increase of $1.9 million, or 6.0%, from the $31.9
million level at December 31, 2002. Nonperforming assets as a percentage of
total loans, leases and OREO increased slightly to .88% as of June 30, 2003 from
..87% as of December 31, 2002. Approximately $13.5 million, or 40.0% of our
nonperforming assets, are commercial and commercial real estate credits
originated in our finance company subsidiary. This finance company subsidiary,
which had a total loan and lease portfolio of $39.3 million at June 30, 2003
compared to $45.9 million at December 31, 2002, is in the process of winding
down operations and is no longer accepting new loan applications. Accruing loans
and leases 90 days or more past due totaled $4.6 million at June 30, 2003,
compared to $3.4 million at December 31, 2002.
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Our nonperforming assets are summarized in the following table:
June 30 December 31
2003 2002
---- ----
(dollars in thousands)
Nonaccrual loans and leases $30,256 $28,782
Restructured loans and leases 303 323
--- ---
Total nonperforming loans and leases 30,559 29,105
Other real estate owned (OREO) 3,275 2,805
----- -----
Total nonperforming assets $33,834 $31,910
======= =======
Accruing loans and leases 90 days or more past due $ 4,557 $ 3,407
======= =======
Nonperforming loans and leases to total loans and leases 0.79 % 0.79 %
Nonperforming assets to total loans, leases and OREO 0.88 0.87
Nonperforming assets and accruing loans and leases 90
days or more past due to total loans, leases and OREO 1.00 0.96
Reserve for Credit Losses. At June 30, 2003, the reserve for credit losses was
$62.3 million, an increase of $3.5 million or 6.0% from the balance of $58.8
million at December 31, 2002. At June 30, 2003, the reserve for credit losses as
a percentage of total loans and leases was 1.62%, compared to 1.60% at December
31, 2002.
22
Activity in the reserve for credit losses for the following periods is shown
in the following table:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
Balance at beginning of period $ 61,270 $ 55,381 $ 58,799 $ 53,716
Charge-offs:
Commercial and other 871 572 1,465 2,919
Commercial real estate 144 35 178 42
Agricultural 102 76 103 104
Residential real estate 31 28 148 63
Consumer 707 593 1,183 1,186
--- --- ----- -----
Total charge-offs 1,854 1,304 3,077 4,314
Recoveries:
Commercial and other 63 96 97 584
Commercial real estate 10 41 16 87
Construction - 4 - 4
Agricultural 9 45 15 67
Residential real estate 2 9 15 30
Consumer 124 186 294 347
--- --- --- ---
Total recoveries 221 381 437 1,119
--- --- --- -----
Net charge-offs 1,633 923 2,640 3,195
Provision for credit losses 2,678 2,927 6,156 6,864
----- ----- ----- -----
Balance at end of period $ 62,315 $ 57,385 $ 62,315 $ 57,385
======== ======== ======== ========
Average loans and leases $3,775,010 $3,506,043 $3,715,534 $3,461,812
Annualized net charge-offs to average loans and leases 0.17 % 0.11 % 0.14 % 0.19 %
------------------------------
Reserve as a percentage of:
Period-end loans and leases 1.62 % 1.59 %
Nonperforming loans and leases 203.91 204.05
Nonperforming assets 184.18 190.89
23
Securities. Our investment portfolio, including available-for-sale securities
and held-to-maturity securities, increased by $67.3 million to $1.2 billion at
June 30, 2003 from $1.1 billion at December 31, 2002. We increased the size of
the investment portfolio during the second quarter of 2003, with the majority of
the increase due to purchases of hybrid adjustable rate mortgage-backed
securities that have a fixed coupon for three years and a variable coupon that
resets annually thereafter. We also sold shorter duration mortgage backed
securities with high prepayment rates and reinvested the proceeds in longer
duration securities that better matched the duration of our liabilities in the
first six months of 2003. These actions reduced the level of asset sensitivity
in our balance sheet and provided us with a more balanced interest rate risk
position. These securities sales resulted in securities gains of $5.8 million in
the first six months of 2003, compared to securities gains of $1.9 million in
the first six months of 2002.
Deposits. Total deposits were $3.8 billion at June 30, 2003 and at December 31,
2002. Noninterest bearing deposits decreased $14.3 million, or 2.0%, to $709.8
million at June 30, 2003 from $724.1 million at December 31, 2002. Interest
bearing deposits increased $24.2 million, or .8%, to $3.1 billion at June 30,
2003, compared to $3.0 billion at December 31, 2002.
Borrowings. Short-term borrowings, which include federal funds purchased,
securities sold under agreements to repurchase, treasury tax and loan notes, and
Federal Home Loan Bank ("FHLB") advances, increased $165.9 million or 32.4% to
$677.4 million at June 30, 2003 from $511.5 million at December 31, 2002. The
increased use of short-term borrowings as a funding source was the result of our
loan growth outpacing our deposit growth in the first six months of 2003 and
the use of short-term borrowings to fund growth in the investment portfolio
during this same period.
Long-term debt. Long-term debt consists primarily of FHLB advances and $65.0
million of privately-placed senior debt. FHLB advances decreased $2.0 million to
$348.7 million at June 30, 2003 from $350.8 million at December 31, 2002.
Company Obligated Mandatorily Redeemable Preferred Securities. The $76.5 million
in outstanding Company Obligated Mandatorily Redeemable Preferred Securities at
June 30, 2003 qualifies as Tier I capital under guidelines of the Federal
Reserve.
Capital Management. The Federal Deposit Insurance Corporation Improvement Act
("FDICIA") required the establishment of a capital-based supervisory system of
prompt corrective action for all depository institutions. The Federal Reserve
Board's implementation of FDICIA defines "well-capitalized" institutions as
those whose Tier I capital ratio equals or exceeds 6%, total risk-based capital
ratio equals or exceeds 10%, and leverage ratio equals or exceeds 5%. We have
maintained our capital at the "well-capitalized" level in each of these
categories in the past and expect to do so in the future. The capital ratios of
the Subsidiary Banks in each of these categories met or exceeded the
"well-capitalized" ratios as of June 30, 2003.
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The following table compares our consolidated capital ratios with the minimum
requirements for well-capitalized and adequately capitalized banks as of June
30, 2003:
Minimum Requirements
--------------------
June 30 December 31 Well Adequately
2003 2002 Capitalized Capitalized
---- ---- ----------- -----------
Tier I capital to risk-weighted assets 10.25 % 10.44 % 6.00 % 4.00 %
Total capital to risk-weighted assets 11.51 11.70 10.00 8.00
Tier I capital to average tangible assets 8.03 7.86 5.00 4.00
Payment of dividends to us by the subsidiary banks is subject to various
limitations by bank regulators, which includes maintenance of certain minimum
capital ratios.
Liquidity Management. The objective of liquidity management is to ensure the
continuous availability of funds to meet our financial commitments. We use an
asset liability management committee ("ALCO") as part of our risk management
process. ALCO is responsible for managing balance sheet and off-balance sheet
commitments to meet the needs of customers while achieving our financial
objectives. ALCO meets regularly to review funding capacity, current and
forecasted loan demand, investment opportunities, and liquidity positions as
outlined in our asset liability policy. With this information, ALCO guides
changes in the balance sheet structure to provide for adequate ongoing
liquidity.
Several factors provide for a favorable liquidity position. The first is the
ability to acquire and retain funds in the local markets we serve. This
in-market funding provides an historically stable source of funding and
represented approximately 84% of total liabilities at June 30, 2003. Our
available-for-sale securities portfolio is a secondary source of liquidity
because of its readily marketable nature and predictable stream of maturities.
While we prefer to fund the balance sheet with in-market funding sources,
another source of liquidity is our ready access to regional and national
wholesale funding markets, including federal funds purchased, Federal Home Loan
Bank advances, and brokered deposits. As of June 30, 2003, we also had available
$30.0 million of borrowing capacity under an unsecured credit facility. As of
June 30, 2003, there were no advances outstanding under this facility. This
credit facility is used primarily for contingency purposes.
Commitments and Contingencies. There have been no material changes in our
outstanding commitments and contingencies since those reported at December 31,
2002 in the Form 10-K for 2002.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
There have been no material changes in market risk exposures that affect the
quantitative and qualitative disclosures presented as of December 31, 2002 in
the 2002 Form 10-K.
25
Item 4. Controls and Procedures
Our management, including the Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the design and operation of our
disclosure controls and procedures at the end of the period covered by this
quarterly report. Based on their evaluation, the Chief Executive Officer and
Chief Financial Officer have concluded that these disclosure controls and
procedures were effective as of June 30, 2003. There were no changes in our
internal controls over financial reporting that occurred during the most recent
fiscal quarter that have materially affected, or are reasonably likely to
affect, the Company's internal controls over financial reporting.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
12.1 Statement Regarding Computation of Ratio of Earnings to Fixed
Charges.
31.1 Certification of Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) A Current Report on Form 8-K dated July 22, 2003, which disclosed the
issuance of a press release under Item 9 in satisfaction of Item 12,
was filed by the Company with the Securities and Exchange Commission
July 22, 2003. The press release described the Company's financial
results for the quarter ended June 30, 2003.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: August 12 , 2003 BREMER FINANCIAL CORPORATION
By: /s/ Stan K. Dardis
--------------------------
Stan K. Dardis
President and
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Stuart F. Bradt
--------------------------
Stuart F. Bradt
Controller
(Chief Accounting Officer)
27