SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the fiscal year ended December 31, 2002
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 0-018166
STATE FINANCIAL SERVICES CORPORATION
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(Exact name of registrant as specified in its charter)
WISCONSIN 39-1489983
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
10708 WEST JANESVILLE ROAD, HALES CORNERS, WISCONSIN 53130
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(Address and zip code of principal executive offices)
(414) 425-1600
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(Registrant's telephone number, including area code)
Securities registered pursuant
to Section 12(b) of the Act: None
Securities registered pursuant Common Stock, $0.10 par value.
to Section 12(g) of the Act: Preferred Share Purchase Rights.
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 and Exchange Act of 1934
during the preceding 12 months (or for shorter periods 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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
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The aggregate market value of the voting and non-voting common equity held by
nonaffiliates of the registrant as of June 28, 2002 was approximately
$88,294,144.
As of March 11, 2003, there were 6,947,931 shares of Common Stock issued and
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for 2003 Annual Meeting (to be filed with the
Commission under Regulation 14A within 120 days after the registrant's fiscal
year end, and upon such filing, to be incorporated by reference into Part III.)
INDEX
Page
PART I ----
ITEM 1. BUSINESS 1
ITEM 2. PROPERTIES 7
ITEM 3. LEGAL PROCEEDINGS 7
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 8
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND 8
RELATED STOCKHOLDER MATTERS
ITEM 6. SELECTED FINANCIAL DATA 10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF 11
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES 29
ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 31
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS 54
ON ACCOUNTING AND FINANCIAL DISCLOSURE
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 54
ITEM 11. EXECUTIVE COMPENSATION 55
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS 55
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 56
ITEM 14. CONTROLS AND PROCEDURES 56
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND 56
REPORTS ON FORM 8-K
SIGNATURES 57
EXHIBITS FILED AS PART OF FORM 10-K Exhibit Index
PART I
ITEM 1. BUSINESS
General
State Financial Services Corporation, together with its consolidated
subsidiaries is hereinafter referred to as the "Company," "SFSC," or
"Registrant." SFSC is a Wisconsin corporation organized in 1984 as a bank
holding company headquartered in Hales Corners, Wisconsin. The Company owns
State Financial Bank, National Association (the "Bank"), which operates through
twenty-six locations in southeastern Wisconsin and northeastern Illinois.
Through its banking network, the Company provides commercial and retail banking
products, long-term fixed-rate secondary market mortgage origination and
brokerage activities.
In the fourth quarter, 2000, the Company consolidated its five bank and
thrift charters into one nationally chartered bank. Prior to the consolidation,
SFSC owned and operated State Financial Bank (Wisconsin), State Financial
Bank-Waterford, State Financial Bank (Illinois), Bank of Northern Illinois, N.A.
and Home Federal Savings and Loan Association of Elgin.
Forward Looking Statements
Certain matters discussed in this Annual Report are "forward-looking
statements" that are intended to qualify for the safe harbor from liability
established by the Private Securities Litigation Reform Act of 1995. These
forward-looking statements can be identified as such because the statements
generally will include words such as "believes," "anticipates," "expects," or
words of similar meaning. Similarly, statements that describe future plans,
objectives, outlooks, targets or goals are also forward-looking statements. Such
forward-looking statements are subject to certain risks and uncertainties that
could cause actual results to differ materially from those anticipated as of the
date of this Annual Report. Factors that could cause such a variance include,
but are not limited to, changes in interest rates, local market competition,
customer loan and deposit preferences, governmental regulations, and other
general economic conditions. Shareholders, potential investors, and other
readers are urged to consider these factors in evaluating the forward-looking
statements and cautioned not to place undue reliance on such forward-looking
statements. The forward-looking statements included in this Annual Report are
only made as of the date of this Annual Report, and the Company undertakes no
obligation to publicly update such forward-looking statements to reflect
subsequent events or circumstances.
Business Strategy
SFSC is committed to community banking and places a high degree of emphasis
on developing full service banking and financial services relationships with its
business and retail customers. To capitalize on management's knowledge of its
immediate market, SFSC operates each of its offices with substantial
independence, supported by centralized administrative and operational functions
to promote efficiency, permitting the management responsible for each office the
flexibility to concentrate on customer service and business development in its
market area. To be an effective community bank, SFSC believes the
decision-making process must rest primarily in the offices with respect to their
credit decisions and customer service. SFSC believes the empowerment of the
day-to-day decision making to the individual office locations remains critical
to its success as an effective community banking organization.
The Bank seeks to develop and enhance full-service banking relationships
through a systematic calling program directed at both existing customers and
referral sources from its customer base, attorneys, accountants, and business
people. The officers and employees of the Bank are actively involved in a
variety of civic, charitable, and community organizations both as an additional
referral source and as a service to their respective communities.
Products and Services
Through the Bank, SFSC provides a broad range of services to individual and
commercial customers. These services include accepting demand, savings, and time
deposits, including regular checking accounts, NOW accounts, money market
accounts, certificates of deposit, individual retirement accounts, and club
accounts. SFSC also offers a variety of brokerage and annuity products through
the Bank's in-house securities representatives. The Bank's lending products
include secured and unsecured commercial, commercial real estate, mortgage,
construction, and consumer term loans on both a fixed and variable rate basis.
Historically, the terms on these loans range from one month to five years and
are retained in the Bank's portfolio. The Bank provides lines of credit to
commercial accounts and to individuals through home equity products. SFSC also
originates residential real estate loans in the form of adjustable and long-term
fixed-rate first mortgages, selling these originations in the secondary mortgage
market with servicing released.
The Company's acquisition efforts have focused on expanding its community
banking network and directly providing complementary financial services such as
securities brokerage to its banking customers. The Company has entered into
strategic partnerships to provide ancillary financial product offerings such as
insurance and asset management as part of its strategic objective to capitalize
on these growing segments of the financial services industry. The Company
believes this strategy is essential if it is to continue to compete effectively
in the era of financial deregulation. The Company's goal is to build a large
share of this business which is currently being provided to its banking
customers by unaffiliated providers and to attract new customer relationships by
providing a comprehensive source of financial services delivered in the
community banking tradition of attention to personalized service and individual
attention.
Competition and Market Environment
Each of the Bank's offices experiences substantial competition from other
financial institutions, including other banks, savings banks, credit unions,
mortgage banking companies, consumer finance companies, mutual funds, and other
financial service providers located in their respective and surrounding
communities. The Bank competes for deposits principally by offering depositors a
variety of deposit programs, convenient office locations and banking hours,
24-hour account access through telephone and internet delivery systems, and
other services. The Bank competes for loan originations primarily through the
interest rates and loan fees it charges, the efficiency and quality of services
it provides borrowers, and the variety of its products. Factors affecting
competition include the general and local economic conditions and current
interest rate levels. Management believes that continued changes in the local
banking industry, including mergers and consolidations involving both commercial
and thrift institutions, have resulted in a reduction in the level of service
provided to both retail and commercial customers. The Company and the Bank also
compete for customers by emphasizing the personalized service and individualized
attention each provides to both retail and commercial customers. The Company
markets itself as a full-service provider of financial products and services, as
well as offering, through strategic partners, related financial products such as
retail and commercial property and casualty insurance, asset management and
financial planning, as well as directly offering brokerage activities.
Management considers its reputation for customer service as its major
competitive advantage in attracting and retaining customers in its market areas.
The Company also believes that it benefits from its community orientation, as
well as its established deposit base and level of core deposits.
Employees
At December 31, 2002, the Company employed 310 full-time and 110 part-time
employees. The Company considers its relationships with its employees to be
good.
The Bank and Its Consolidated Subsidiaries
At or for the year ended December 31, 2002, the Bank (consolidated with its
subsidiaries) had total assets of $1.3 billion, net loans of $735.7 million,
total deposits of $940.9 million, stockholders' equity of $104.9 million and net
income of $11.2 million. The Bank is engaged in the general commercial and
consumer banking business and provides full-service banking to individuals and
businesses, including the acceptance of deposits to demand, time, and savings
accounts and the servicing of such accounts; commercial, consumer, and mortgage
lending; and such other banking
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services as are usual and customary for commercial banks. The Bank also sells
annuities and other investments through in-house representatives.
The Bank has three wholly-owned subsidiaries that are consolidated into its
operations. Hales Corners Investment Corporation is a subsidiary created to
manage the majority of the Bank's investment portfolio with the objective of
enhancing the overall return on the Bank's investment securities.
Hales Corners Development Corporation ("HCDC") is a subsidiary that owns
the real estate related to the Hales Corners and Muskego offices. In February
1999, HCDC accepted an Offer to Purchase eight rental properties adjacent to the
Hales Corners location from a local developer. The property was sold in October
2002. The Company believes that the developer's intention is to level the
existing properties and construct several retail outlets anchored by a newly
constructed major food store.
State Financial Funding Corporation ("SFFC") was formed to manage certain
real estate loans held by its wholly-owned subsidiary, State Financial Real
Estate Investment Corporation ("SFREIC").
Supervision and Regulation
Bank holding companies and financial institutions are highly regulated at
both the federal and state level. Numerous statutes and regulations affect the
businesses of SFSC and the Bank. To the extent that the information below is a
summary of statutory provisions or regulations, such information is qualified in
its entirety by reference to the statutory provisions or regulations described.
There are additional laws and regulations having a direct or indirect effect on
the business of SFSC or the Bank.
As a bank holding company, business activities of SFSC are regulated by the
Federal Reserve Board ("FRB") under the Bank Holding Company Act of 1956 as
amended (the "Act"), which imposes various requirements and restrictions on the
operations of SFSC. As part of this supervision, SFSC files periodic reports
with and is subject to periodic examination by the FRB. The Act requires the
FRB's prior approval before SFSC may acquire direct or indirect ownership or
control of more than five percent of the voting shares of any bank or bank
holding company. The FRB can order bank holding companies and their subsidiaries
to cease and desist from any actions which in the opinion of the FRB constitute
serious risk to the financial safety, soundness or stability of a subsidiary
bank and are inconsistent with sound banking principles or in violation of law.
The FRB has adopted regulations that deal with the measure of capitalization for
bank holding companies. Such regulations are essentially the same as those
adopted by the OCC, described below. The FRB has also issued a policy statement
on the payment of cash dividends by bank holding companies, wherein the FRB has
stated that a bank holding company experiencing earnings weaknesses should not
pay cash dividends exceeding its net income or which could only be funded in
ways that weaken the bank holding company's financial health, such as by
borrowing. Under FRB policy, a bank holding company is expected to act as a
source of financial strength to its banking subsidiaries and to commit resources
to their support. The Act limits the activities of SFSC and its banking and
non-banking subsidiaries to the business of banking and activities closely
related or incidental to banking.
The Gramm-Leach-Bliley Act or Financial Services Modernization Act of 1999
(the "GLB Act") significantly changed financial services regulation by expanding
permissible non-banking activities of bank holding companies and removing
barriers to affiliations among banks, insurance companies, securities firms and
other financial services entities. These activities can be conducted through a
holding company structure or, subject to certain limitations, through a
financial subsidiary of a bank. The GLB Act also establishes a system of federal
and state regulation based on functional regulation, meaning the primary
regulatory oversight for a particular activity will generally reside with the
federal or state regulator designated as having the principal responsibility for
that activity. Banking is to be supervised by banking regulators, insurance by
state insurance regulators and securities activities by the federal and state
securities regulators. The GLB Act also establishes a minimum federal standard
of financial privacy by, among other provisions, requiring banks to adopt and
disclose privacy policies with respect to customer information and prohibiting
the disclosure of certain types of customer information to third parties not
affiliated with the bank unless the customer has been given an opportunity to
block that type of disclosure. The GLB Act also requires the disclosure of
agreements reached with community groups that relate to the Community
Reinvestment Act, and contains various other provisions designed to
3
improve the delivery of financial services to consumers while maintaining an
appropriate level of safety in the financial services industry.
The GLB Act repeals the anti-affiliation provision of the Glass-Steagall
Act and revises the Act to permit qualifying holding companies, called
"financial holding companies," to engage in, or to affiliate with companies
engaged in a full range of financial activities including banking, insurance
activities (including insurance underwriting and portfolio investing),
securities activities, merchant banking, and additional activities that are
"financial in nature," incidental to financial activities or in certain
circumstances, complementary to financial activities. A bank holding company's
subsidiary banks must be "well-capitalized" and "well-managed" and have at least
a "satisfactory" Community Reinvestment Act rating for the bank holding company
to elect status as a financial holding company. SFSC has not elected to become a
financial holding company.
SFSC expects that the new affiliations and activities permitted financial
services organizations may over time change the nature of its competition. At
present, however, it is not possible to predict the full nature and effect of
the changes that may occur.
The Bank is a nationally chartered bank regulated by the Office of the
Comptroller of the Currency ("OCC") and subject to periodic examination by the
OCC. Additionally, the Bank's deposits are insured by the FDIC and are subject
to the provisions of the Federal Deposit Insurance Act.
Subsidiary banks of a bank holding company are subject to certain
restrictions imposed by the Federal Reserve Act on any extensions of credit to
the bank holding company or any of its subsidiaries, on investments in stock or
other securities of the bank holding company and on the taking of such stock or
securities as collateral for loans to any borrower. Under the Federal Reserve
Act and regulations of the FRB, a bank holding company and its subsidiaries are
prohibited from engaging in certain tie-in arrangements in connection with any
extension of credit or of any property or service.
The activities and operations of banks are subject to a number of
additional detailed, complex and sometimes overlapping federal and state laws
and regulations. These include state usury and consumer credit laws, state laws
relating to fiduciaries, the Federal Truth-in-Lending Act and Regulation Z, the
Federal Equal Credit Opportunity act and Regulation B, the Fair Credit Reporting
act, the Financial Institutions Reform, Recovery and Enforcement Act of 1989,
the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"),
the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, the
Community Reinvestment Act, the USA Patriot Act, anti-redlining legislation and
the antitrust laws. The Community Reinvestment Act includes provisions under
which the federal bank regulatory agencies must consider, in connection with
applications for certain required approvals, including applications to acquire
control of a bank or holding company or to establish a branch, the records of
regulated financial institutions in satisfying their continuing and affirmative
obligations to help meet the credit needs of their local communities, including
those of low and moderate-income borrowers.
FDICIA, among other things, establishes five tiers of capital requirements:
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized. The OCC has adopted
regulations which define the relevant capital measures for the five capital
categories. An institution is deemed to be "well capitalized" if it has a total
risk-based capital ratio (total capital to risk-weighted assets) of 10% or
greater, a Tier I risk-based capital ratio (Tier I Capital to risk-weighted
assets) of 6% or greater, and a Tier I leverage capital ratio (Tier I Capital to
total assets) of 5% or greater, and is not subject to a regulatory order,
agreement, or directive to meet and maintain a specific capital level for any
capital measure. The other categories are identified by descending levels of
capitalization. A depository institution's failure to maintain a capital level
within the top two categories will result in specific actions from the federal
regulatory agencies. These actions could include the inability to pay dividends,
restriction of new business activity, prohibiting bank acquisitions, asset
growth limitations and other restrictions on a case by case basis. Additionally,
FDICIA implemented a risk related assessment system for FDIC insurance premiums
based, among other things, on the depository institution's capital adequacy and
risk classification. At December 31, 2002, SFSC and the Bank each met the
"well-capitalized" definition of capital adequacy.
4
In recent years, the banking and financial industry has been the subject of
numerous legislative acts and proposals, administrative rules and regulations at
both federal and state regulatory levels. As a result of many of such regulatory
changes, the nature of the banking industry in general has changed dramatically
as increasing competition and a trend toward deregulation have caused the
traditional distinctions among different types of financial institutions to be
obscured.
The performance and earnings of the Bank, like other commercial banks, are
affected not only by general economic conditions but also by the policies of
various governmental regulatory authorities. In particular, the Federal Reserve
System regulates money and credit conditions and interest rates in order to
influence general economic conditions primarily through open-market operations
in U.S. Government securities, varying the discount rate on bank borrowings, and
setting reserve requirements against bank deposits. The policies of the Federal
Reserve have a significant influence on overall growth and distribution of bank
loans, investments and deposits, and affect interest rates earned on loans and
investments. The general effect, if any, of such policies upon the future
business and earnings of the Bank cannot accurately be predicted.
Internet Access
The Company's Internet address is http://www.statefinancialbank.com. The
Company makes available free of charge (other than an investor's own Internet
access charges) through its Internet website the Company's Annual Report on Form
10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and
amendments to those reports, as soon as reasonably practicable after it
electronically files such material with, or furnishes such material to, the
Securities and Exchange Commission. The Company is not including the information
contained on or available through its website as a part of, or incorporating
such information by reference into, this Annual Report on Form 10-K.
Directors
Information is provided below with respect to the directors of SFSC.
Name Age Positions Held with the Company
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Jerome J. Holz 75 Chairman of the Board of SFSC and Chairman
of the Board of SFBNA
Michael J. Falbo 53 President, Chief Executive Officer, and
Director of SFSC; Vice Chairman, Chief
Executive Officer and Director of SFBNA
Robert J. Cera 41 Executive Vice President and Director of
SFSC; President, Chief Operating
Officer and Director of SFBNA
Richard A. Horn 78 Director of SFSC and SFBNA
Ulice Payne, Jr. 47 Director of SFSC
Thomas S. Rakow 60 Director of SFSC and SFBNA
David M. Stamm 54 Director of SFSC and SFBNA
Barbara E. Weis 47 Director of SFSC and SFBNA
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Executive Officers
Information is provided below with respect to the executive officers of
SFSC who are not directors. Each executive officer is elected annually by the
Board of Directors and serves for one year or until his/her successor is
appointed.
Name Age Positions Held
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John B. Beckwith 49 Senior Vice President of SFSC
President, State Financial Bank, N.A.
Metro Milwaukee Market
Donna M. Bembenek 41 Senior Vice President, Sales and
Marketing of SFSC
Thomas M. Lilly 43 Senior Vice President of SFSC
President, State Financial Bank, N.A.
Stateline Market
Michael A. Reindl 43 Senior Vice President and Treasurer of SFSC
Secretary of SFSC
Secretary of State Financial Bank, N.A.
Daniel L. Westrope 53 Senior Vice President and Chief Financial
Officer of SFSC
John B. Beckwith has served as Senior Vice President of SFSC since 1997.
Mr. Beckwith also is President of State Financial Bank, N.A.'s Metro Milwaukee
Market, which includes thirteen full service branch locations in Wisconsin. From
1994 to October 2000, Mr. Beckwith was the president of the former State
Financial Bank (Wisconsin). Mr. Beckwith has served as a Director of State
Financial Bank, N.A., or a predecessor thereof, since 1991. Mr. Beckwith joined
the Company in 1990.
Donna M. Bembenek has served as Senior Vice President, Sales and Marketing
of SFSC since December, 2000. From 1995 to 2000, Ms. Bembenek served as Vice
President of Marketing. Ms. Bembenek joined the Company in 1993 with nine years
of sales, marketing and sales management experience.
Thomas M. Lilly was elected Senior Vice President of SFSC in January 2002.
Mr. Lilly also is President of State Financial Bank, N.A.'s Stateline Market,
which includes four full service branch locations (three in Wisconsin and one in
Illinois). From 1998 to October 2000, Mr. Lilly was the President of the former
State Financial Bank-Waterford. Mr. Lilly joined the Company in 1985.
Michael A. Reindl has served as Senior Vice President and Treasurer of SFSC
since August 2000. From 1993 to 2000, Mr. Reindl was Chief Financial Officer and
Controller of SFSC and prior thereto, held various financial positions with
SFSC. Mr. Reindl is also the Secretary of SFSC and the Secretary of State
Financial Bank, N.A. Mr. Reindl joined the Company in 1984.
Daniel L. Westrope was elected Chief Financial Officer of SFSC in January
2003. Mr. Westrope has served as Senior Vice President of SFSC since joining the
Company in 1998. From October 2000 to December 2002 Mr. Westrope served as
President of State Financial Bank, N.A.'s Suburban Market, which includes eleven
full service branch locations in Illinois. From December 1998 to October 2000,
Mr. Westrope was the president of the former Home Federal Savings and Loan
Association of Elgin. Prior to joining the Company, Mr. Westrope was employed by
First Union Securities (1995 to 1998) and prior thereto by the Federal Reserve
Bank of Chicago. Mr. Westrope served as a Director of State Financial Bank, N.A.
from October 2000 to December 2002.
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ITEM 2. PROPERTIES
The following table sets forth the owned/leased locations of the Company's
banking offices.
Year
Year Acquired Square Leased
Office Address County Originated by SFSC Feet Owned
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Hales Corners, WI 10708 W. Janesville Rd. Milwaukee 1910 (7) 37,000 Owned
Muskego, WI S76 W17655 Janesville Rd. Waukesha 1968 (7) 2,680 Owned
Milwaukee, WI 2650 N. Downer Ave. Milwaukee 1971 1985 3,000 Leased
Milwaukee, WI 815 N. Water St. Milwaukee 1989 1989 11,793 Leased
Milwaukee, WI 4623 W. Lisbon Ave. Milwaukee 1986 2001 2,000 Owned
Whitefish Bay, WI 312 E. Silver Spring Dr. Milwaukee 1995 2001 1,300 Leased
Fox Point, WI 8607 N. Port Washington Rd. Milwaukee 1996 2001 1,000 Owned
Greenfield, WI (1) 4811 S. 76th St. Milwaukee 1978 1987 9,000 Leased
Glendale, WI (2) 7020 N. Port Washington Rd. Milwaukee 1990 (7) 7,500 Leased
Brookfield, WI 12600 W. North Ave. Waukesha 1990 1992 4,800 Owned
Waukesha, WI (5) 1700 Coral Ave. Waukesha 2000 (7) 8,836 Owned
New Berlin, WI 15505 W. National Ave. Waukesha 1998 2001 3,124 Owned
Waterford, WI 217 N. Milwaukee St. Racine 1906 1995 10,100 Owned
Burlington, WI 1050 Milwaukee Ave. Racine 1997 (7) 6,300 Leased
Elkhorn, WI (4) 850 N. Wisconsin St. Walworth 1999 (7) 9,200 Owned
Richmond, IL (3) 10910 Main St. McHenry 1920 1997 16,030 Owned
Elgin, IL 16 N. Spring St. Kane 1883 1998 34,169 Owned
South Elgin, IL 300 N. McLean Blvd. Kane 1996 1998 5,200 Owned
West Elgin, IL (6) 2001 Larkin Ave. Kane 2001 (7) 29,380 Owned
Bartlett, IL 200 Bartlett Ave. Cook 1979 1998 5,418 Owned
Crystal Lake, IL 180 Virginia St. McHenry 1974 1998 8,268 Owned
Roselle, IL 56 E. Irving Park Rd. Du Page 1975 1998 3,800 Owned
Waukegan, IL 1 S. Genessee Lake 1852 1999 21,000 Owned
Gurnee, IL 1313 N. Delany Lake 1987 1999 15,000 Owned
Glenview, IL 1301 Waukegan Rd. Cook 1960 1999 7,500 Owned
Libertyville, IL 929 N. Milwaukee Ave. Lake 1993 1999 4,200 Owned
- -------------------------------------------------------------------------------------------------
(1) The Bank leases this property from Edgewood Plaza Joint Venture. See "Certain Transactions
and Other Relationships with Management and Principal Shareholders" in the Company's Proxy
Statement for further information.
(2) The Bank leases approximately 1,200 square feet to a third party.
(3) The Bank leases approximately 2,960 square feet to third parties.
(4) The Bank leases approximately 5,400 square feet to third parties.
(5) The Bank leases approximately 4,800 square feet to third parties.
(6) The Bank leases approximately 3,000 square feet to third parties.
(7) Organized by the Bank or a predecessor thereof.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company and the Bank are party to legal proceedings
arising out of their general lending activities and other operations. In
February 2002, an action was filed against SFSC in the Circuit Court in Rock
County, Wisconsin. The plaintiffs in the litigation allege that in April 2001 an
employee of SFSC wrongfully issued and then SFSC refused to honor cashier's
checks issued on behalf of a customer of SFSC. The allegations arise out of an
apparent scheme perpetrated by a mutual customer of one of the plaintiffs, a
credit union, and SFSC. The plaintiffs seek recovery of $1.5 million plus fees
and expenses. The Company has established a reserve to cover anticipated costs
to cover the
7
pending litigation, but believes the action is without merit and intends to
defend its position vigorously in the litigation. The resolution of this matter
is not expected to have a material adverse effect on the Company's financial
condition or result of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our shareholders during the quarter
ended December 31, 2002.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Market Price and Dividends for Common Stock
At March 17, 2003, there were approximately 1,177 shareholders of record
and 2,529 estimated additional beneficial shareholders for an approximate total
of 3,706 shareholders of the Company's Common Stock.
Holders of Common Stock are entitled to receive dividends as may be
declared by the Company's Board of Directors and paid from time to time out of
funds legally available therefore. The Company's ability to pay dividends
depends upon its subsidiary Bank's ability to pay dividends, which is regulated
by banking statutes. The declaration of dividends by the Company is
discretionary and will depend on operating results, financial condition,
regulatory limitations, tax considerations, and other factors. See Notes to the
Consolidated Financial Statements for information concerning restrictions on the
payment of dividends. Although the Company has regularly paid dividends since
its inception in 1984, there can be no assurance that such dividends will be
paid in the future.
The following table sets forth the historical market price of and dividends
declared with respect to the Common Stock since January 1, 2001:
Quarter Ended High Low Dividend
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March 31, 2001 $11.76 $8.10 $0.12
June 30, 2001 12.48 10.91 0.12
September 30, 2001 13.34 10.55 0.12
December 31, 2001 12.12 11.04 0.12
March 31, 2002 $13.67 $10.58 $0.12
June 30, 2002 15.33 12.98 0.12
September 30, 2002 15.50 12.94 0.12
December 31, 2002 16.86 13.68 0.12
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Recent Sale of Unregistered Securities
On October 29, 2002, the Company sold through a wholly owned statutory
business trust (the "Trust") floating rate trust preferred securities (the
"Preferred Securities") in an aggregate liquidation amount of $15,000,000 in a
private placement. The Preferred Securities have a variable dividend adjusted
quarterly based on the London Interbank Offered Rate (LIBOR) plus 3.45%. The
Company has guaranteed the Preferred Securities with respect to distributions
and payments upon liquidation, redemption and otherwise to the extent provided
in a Guarantee Agreement between the Company, as guarantor, and Wilmington Trust
Company, as guarantee trustee. The Trust invested the proceeds from the sale of
the Preferred Securities in an equivalent amount of floating rate junior
subordinated debt securities due 2032 (the "Subordinated Debt Securities") of
the Company bearing an interest rate equal to the dividend rate on the Preferred
Securities. The terms of the Subordinated Debt Securities are set forth in an
Indenture between the Company and Wilmington Trust Company, as trustee. The
Subordinated Debt Securities, which are the sole assets of the Trust, are
subordinate and junior in right of payment to the Company's present and future
senior debt (as defined in the Indenture) and certain other financial
obligations of the Company.
8
After the payment of placement fees, the Company received approximately
$14,500,000 in net proceeds from these transactions. The Company used the net
proceeds for general corporate purposes and to fund the costs and expenses of
repurchasing 715,695 shares of its common stock pursuant to a Dutch Auction
tender offer that expired on December 6, 2002. The Company and the Trust issued
these securities without registration under the Securities Act of 1933, as
amended (the "Securities Act"), in reliance upon the exemption from registration
thereunder available under Section 4(2) of the Securities Act.
Stock Listing
State Financial Services Corporation's Common Stock is traded on the Nasdaq
National Market tier of the Nasdaq Stock Market ("Nasdaq") under the symbol
"SFSW." Nasdaq is a highly-regulated electronic securities market comprised of
competing market makers whose trading is supported by a communications network
linking them to quotation dissemination, trade reporting, and order execution
systems. This market also provides specialized automation services for
screen-based negotiations of transactions, on-line comparison of transactions,
and a range of informational services tailored to the needs of the securities
industry, investors, and issuers. Nasdaq is operated by The Nasdaq Stock Market,
Inc., a wholly-owned subsidiary of the National Association of Securities
Dealers, Inc.
The Company's stock quotation appears in the Wall Street Journal, the
Milwaukee Journal/Sentinel, and other publications usually as "State Financial."
Dividend Reinvestment Plan
The Company has a Dividend Reinvestment Plan (the "DRP") for the benefit of
all shareholders. The DRP is administered by American Stock Transfer & Trust
Company. Under the DRP, registered shareholders of the Company can elect to have
their dividends reinvested to purchase additional shares of the Company's Common
Stock. Registered shareholders of the Company receive an Enrollment Form for the
DRP with each dividend check. For further information on the DRP, please contact
Michael A. Reindl, Senior Vice President and Treasurer, State Financial Services
Corporation, 10708 West Janesville Road, Hales Corners, Wisconsin 53130, or call
(414) 425-1600.
Form 10-K
The Company's annual report on Form 10-K for the year ended December 31,
2002 as filed with the Securities and Exchange Commission is available upon
request without charge to shareholders of record. Please contact Daniel L.
Westrope, Senior Vice President and Chief Financial Officer, State Financial
Services Corporation, 10708 West Janesville Road, Hales Corners, Wisconsin
53130, or call (414) 425-1600.
Annual Meeting
The annual meeting of shareholders of State Financial Services Corporation
will be held at 4:00 P.M. (CDT) on Wednesday, May 7, 2003 at The Milwaukee
Brewers Baseball Club, Miller Park, One Brewers Way, Milwaukee, WI 53214.
Financial Information Transfer Agent
- --------------------------------------------------------------------------------
Daniel L. Westrope American Stock Transfer &
Senior Vice President and Chief Financial Officer Trust Company
State Financial Services Corporation 59 Maiden Lane
10708 West Janesville Road Plaza Level
Hales Corners, Wisconsin 53130 New York, New York 10038
(414) 425-1600 Toll free (800) 937-5449
Direct (718) 921-8124
Facsimile (718) 236-2641
Internet www.amstock.com
Equity Compensation Plan Information
Certain information about the Company's equity compensation plan is
contained in Part III, Item 12 of this Annual Report on Form 10-K.
9
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data of State Financial
Services Corporation (hereinafter referred to as the "Company") and its
subsidiaries on a consolidated basis for the last five years (dollars in
thousands, except per share data):
As of or for the years ended December 31,
- -------------------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------
Condensed Income Statement:
Total interest income (taxable equivalent)(1) $69,659 $75,499 $79,039 $66,610 $58,397
Total interest expense 23,400 35,619 41,693 30,132 25,923
- -------------------------------------------------------------------------------------------------------------------
Net interest income 46,259 39,880 37,346 36,478 32,474
Provision for loan losses 2,400 3,855 810 750 690
Other income 12,358 12,303 5,806 7,993 6,965
Other expense 38,799 39,173 36,297 30,963 34,801
- -------------------------------------------------------------------------------------------------------------------
Income before income tax 17,418 9,155 6,045 12,758 3,948
Income tax 4,794 3,724 1,925 4,333 1,981
Less taxable equivalent adjustment 1,471 1,297 1,122 993 810
- -------------------------------------------------------------------------------------------------------------------
Net income $11,153 $4,134 $2,998 $7,432 $1,157
- -------------------------------------------------------------------------------------------------------------------
Per common share data:
Basic earnings per share $1.52 $0.55 $0.38 $0.80 $0.12
Diluted earnings per share 1.51 0.55 0.38 0.80 0.12
Dividends declared 0.48 0.48 0.48 0.48 0.48
Book Value 15.10 13.66 13.33 12.79 13.36
Balance sheet totals:
Total assets $1,316,824 $1,171,053 $1,080,786 $1,090,024 $828,369
Loans, net of allowance 735,719 745,786 660,909 742,196 607,949
Allowance for loan losses 8,805 7,900 7,149 6,905 4,485
Deposits 940,874 954,459 859,356 847,051 652,905
Borrowed funds 229,037 86,287 99,120 89,634 29,117
Notes payable 30,700 15,653 7,309 39,959 6,750
Shareholders' equity 104,933 106,360 106,499 109,668 134,637
Financial Ratios:
Return on average assets 0.91% 0.36% 0.27% 0.78% 0.15%
Return on average equity 9.96 3.79 2.73 6.00 0.86
Dividend payout ratio 30.95 86.90 125.58 58.77 457.38
Allowance for loan losses to total loans 1.18 1.05 1.07 0.92 0.73
Non-performing assets to total assets 0.99 0.89 0.84 0.50 0.47
Net charge-offs to average loans 0.22 0.55 0.08 0.08 0.10
- -------------------------------------------------------------------------------------------------------------------
1. Taxable-equivalent adjustments to interest income involve the conversion of tax-exempt sources of interest
income to the equivalent amounts of interest income that would be necessary to derive the same net return if
the investments had been subject to income taxes. A 35% incremental income tax rate in 2002, and 34% in prior
years is used in the conversion of tax-exempt interest income to a taxable-equivalent basis.
2. All dividends represent the amount per share declared by the Company for each period presented.
10
Selected Quarterly Financial Data
The following table sets forth certain unaudited income and expense data on
a quarterly basis for the periods indicated (dollars in thousands, except per
share data).
2002 2001
- --------------------------------------------------------------------------------------------------------------
12/31 9/30 6/30 3/31 12/31 9/30 6/30 3/31
- --------------------------------------------------------------------------------------------------------------
Interest income $16,786 $17,234 $17,144 $17,024 $18,097 $18,950 $18,162 $18,993
Interest expense 5,944 5,927 5,563 5,966 7,440 9,169 9,125 9,885
- --------------------------------------------------------------------------------------------------------------
Net interest income 10,842 11,307 11,581 11,058 10,657 9,781 9,037 9,108
Provision for loan losses 450 1,050 450 450 3,045 270 270 270
Other income 3,563 3,373 2,696 2,726 3,248 2,937 3,517 2,601
Other expense 10,001 9,487 9,744 9,567 11,896 9,459 9,135 8,683
- --------------------------------------------------------------------------------------------------------------
Income (loss) before
income tax 3,954 4,143 4,083 3,767 (1,036) 2,989 3,149 2,756
Income tax 1,094 1,267 1,279 1,154 291 1,074 1,335 1,024
- --------------------------------------------------------------------------------------------------------------
Net income (loss) $2,860 $2,876 $2,804 $2,613 ($1,327) $1,915 $1,814 $1,732
- --------------------------------------------------------------------------------------------------------------
Net income (loss) per
share:
Basic $0.40 $0.39 $0.38 $0.35 $(0.18) $0.26 $0.24 $0.23
Diluted 0.39 0.39 0.37 0.35 (0.18) 0.26 0.24 0.23
Dividends per share 0.12 0.12 0.12 0.12 0.12 0.12 0.12 0.12
- --------------------------------------------------------------------------------------------------------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The following discussion is intended as a review of the significant factors
affecting the Company's financial condition and results of operations as of and
for the year ended December 31, 2002, as well as providing comparisons with
previous years. This discussion should be read in conjunction with the
consolidated financial statements and accompanying notes and the selected
financial data presented elsewhere in this annual report.
Application of Critical Accounting Policies
The Company's consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United States and follow
general practices within the banking industry. Application of these principles
requires management to make estimates, assumptions, and judgments that affect
the amounts reported in the financial statements and accompanying notes. These
estimates, assumptions, and judgments are based on information available as of
the date of the financial statements. Future changes in information may affect
these estimates, assumptions, and judgments, which, in turn, may affect amounts
reported in the consolidated financial statements.
All significant accounting policies are presented in Note 1 to the
consolidated financial statements. These policies, along with the disclosures
presented in the other financial statement notes and in this discussion, provide
information on how significant assets and liabilities are valued in the
consolidated financial statements and how those values are determined.
11
Management has determined that its accounting policies with respect to the
allowance for loan losses is the accounting area requiring subjective or complex
judgments that is most important to the Company's financial position and results
of operations, and therefore, is its only critical accounting policy. The
allowance for loan losses represents management's estimate of probable credit
losses inherent in the loan portfolio. Determining the amount of the allowance
for loan losses is considered a critical accounting estimate because it requires
significant judgment and the use of estimates related to the amount and timing
of expected future cash flows on impaired loans, estimated losses on pools of
homogeneous loans based on historical loss experience, and consideration of
current economic trends and conditions, all of which may be susceptible to
significant change. The loan portfolio also represents the largest asset type on
the consolidated statement of condition. Note 1 to the consolidated financial
statements describes the methodology used to determine the allowance for loan
losses. In addition, a discussion of the factors driving changes in the amount
of the allowance for loan losses is included in the Provision for Loan Losses
section of Management's discussion.
NET INCOME AND DIVIDENDS
For the years ended December 31, 2002, 2001, and 2000, the Company reported
net income of $11.2 million, $4.1 million, and $3.0 million, respectively. For
comparative purposes net income, adjusted to exclude the effects of adopting
SFAS 142, for the years ended December 31, 2002, 2001, and 2000 was $11.2
million, $8.2 million, and $5.0 million, respectively. An additional $2.0
million provision for loan losses and approximately $2.0 million loss to
liquidate its asset management subsidiary impacted earnings in 2001. Expenses in
2000 of approximately $4.7 million related to the Company's consolidation of its
five bank and thrift charters into one nationally chartered bank impacted
earnings for that year. The Company's reported return on average assets for the
years ended December 31, 2002, 2001, and 2000 was 0.91%, 0.36%, and 0.27%,
respectively. Reported return on average equity for the same periods was 9.96%,
3.79%, and 2.73%. On a per share basis, basic earnings were $1.52 for 2002,
$0.55 for 2001, and $0.38 for 2000. The Company declared per share dividends of
$0.48 for each year ended December 31, 2002, 2001, and 2000.
Income Statement Analysis
Net Interest Income
Net interest income equals the difference between interest earned on assets
and the interest paid on liabilities and is a measurement of the Company's
effectiveness in managing its interest rate sensitivity. For the year ended
December 31, 2002, taxable-equivalent net interest income improved $6.4 million
to $46.3 million. Changes in the volume of outstanding interest-earning assets
and interest-bearing liabilities accounted for an increase of $0.9 million while
changes in interest rates accounted for an increase of $5.5 million in
taxable-equivalent net interest income.
Rate changes most fundamentally impacted the components of the Company's
consolidated taxable-equivalent net interest income in 2002. Taxable-equivalent
total interest income decreased $5.9 million in 2002 mainly due to the
significant declining rate environment, offset by the increase in the volume of
average total outstanding interest-earning assets resulting from the inclusion
of the Liberty acquisition and changes in the composition of the Company's
interest earning assets. As a result of the volume increase, interest income
improved $3.3 million for the year ended December 31, 2002. Interest income
decreased by $9.2 million due to the declining interest rate environment.
Taxable-equivalent total interest income decreased $3.5 million in 2001
mainly due to the significant declining rate environment, offset by the increase
in the volume of average total outstanding interest-earning assets resulting
from the inclusion of the Liberty acquisition. As a result of the volume
increase, interest income improved $1.8 million for the year ended December 31,
2001. Interest income decreased by $5.3 million due to the declining interest
rate environment. The combined impact of these changes resulted in a decrease in
the Company's taxable-equivalent yield on interest-earning assets to 7.26% in
2001 from 7.84% in 2000.
The Company experienced a decrease in the interest rate on its funding
costs in 2002 to 2.45% from 4.00% for the year ended December 31, 2001. The
decreased funding cost was mainly due to the significant declining rate
environment. The Company uses wholesale funding sources, such as the Federal
Home Loan Bank, to balance the timing differences between its various business
funding sources and to support loan origination. In 2002, notes payable, Federal
12
Home Loan Bank borrowings, federal funds purchased, and securities sold under
agreements to repurchase increased to 17.1% of the Company's average
interest-bearing liabilities from 13.5% in 2001. For the year ended December 31,
2002, average money market accounts comprised 23.1% of the Company's average
interest-bearing liabilities compared to 24.5% for 2001. Time deposits comprised
36.4% of the Company's average interest-bearing liabilities in 2002 compared to
38.2% in 2001.
The Company's net yield on interest-earning assets (net interest margin)
increased to 4.15% for the year ended December 31, 2002 from 3.84% for the year
ended December 31, 2001 as a result of the aforementioned factors. For the year
ended December 31, 2002, average loans comprised 61% and average investments
comprised 39% of the Company's interest-earning assets compared to 70% for
average loans and 30% for average investments for the year ended December 31,
2001. The 2002 decrease in average loans outstanding and increase in average
investments outstanding was primarily due to the Company's securitization of
mortgage loans and retention of the underlying securities created therefrom to
enhance balance sheet liquidity. The combined impact of these changes resulted
in a decrease in the Company's taxable-equivalent yield on interest-earning
assets to 6.25% in 2002 from 7.26% in 2001.
The Company's 2001 cost of funds decreased to 4.00% from 4.77% for the year
ended December 31, 2000, due primarily to a lower interest rate environment, a
decreased percentage of interest-bearing liabilities in wholesale borrowings and
decreased debt incurred to fund the Company's stock repurchase activities.
Short-term borrowings decreased in 2001 to 13.5% of the Company's average
interest-bearing liabilities compared to 16.9% in 2000. For the year ended
December 31, 2001, average money market accounts comprised 24.5% of the
Company's average interest-bearing liabilities compared to 21.5% for 2000. Time
deposits comprised 38.2% of the Company's average interest-bearing liabilities
in 2001 compared to 34.2% in 2000.
13
The following table sets forth average balances, related interest income and expense, and effective interest yields and
rates for the years ended December 31, 2002, 2001, and 2000 (dollars in thousands):
2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
- ----------------------------------------------------------------------------------------------------------------------------
ASSETS
Interest-earning assets:
Loans (1,2,3) $683,069 $47,196 6.91% $724,543 $56,569 7.81% $726,027 $60,018 8.24%
Taxable investment
securities 334,460 17,795 5.32 229,884 14,437 6.28 221,313 15,141 6.82
Tax-exempt investment
securities(3) 65,124 4,103 6.30 51,873 3,476 6.70 41,710 2,921 6.98
Other short-term
investments 490 10 2.04 788 31 3.91 591 39 6.66
Interest-earning deposits 1,505 82 5.45 8,740 310 3.56 7,697 383 4.95
Federal funds sold 29,725 473 1.59 23,937 676 2.82 7,833 537 6.84
- ----------------------------------------------------------------------------------------------------------------------------
Total interest-earning
assets 1,114,373 69,659 6.25 1,039,765 75,499 7.26 1,005,171 79,039 7.84
- ----------------------------------------------------------------------------------------------------------------------------
Non-interest-earning
assets:
Cash and due from banks 44,486 39,576 35,730
Premises and equipment,
net 28,273 27,452 24,519
Other assets 47,009 38,933 40,971
Less allowance for loan
losses (8,504) (7,651) (7,121)
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL $1,225,637 $1,138,075 $1,099,270
- ----------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing
liabilities:
NOW accounts $99,007 $492 0.50% $89,546 $1,066 1.19% $102,487 $1,714 1.67%
Money market accounts 220,235 3,139 1.43 220,998 7,213 3.26 187,436 9,274 4.93
Savings deposits 124,604 1,147 0.92 120,275 2,295 1.91 136,672 3,634 2.65
Time deposits 348,074 12,899 3.71 340,441 18,835 5.53 298,187 17,084 5.71
Notes payable 18,844 683 3.62 15,999 913 5.71 33,758 2,781 8.22
FHLB borrowings 55,332 2,705 4.89 83,714 4,303 5.14 89,062 5,600 6.27
Federal funds purchased 2,021 38 1.88 2,338 144 6.16 11,525 829 7.17
Securities sold under
agreement to repurchase 87,152 2,297 2.64 17,936 849 4.73 12,440 777 6.23
- ----------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 955,269 23,400 2.45 891,247 35,618 4.00 871,567 41,693 4.77
- ----------------------------------------------------------------------------------------------------------------------------
Non-interest-bearing
liabilities:
Demand deposits 149,640 130,259 113,305
Other 8,733 7,417 4,723
- ----------------------------------------------------------------------------------------------------------------------------
Total liabilities 1,113,642 1,028,923 989,595
- ----------------------------------------------------------------------------------------------------------------------------
Shareholders' equity 111,995 109,152 109,675
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL $1,225,637 $1,138,075 $1,099,270
- ----------------------------------------------------------------------------------------------------------------------------
Net interest earning and
Interest rate spread $46,259 3.80% $39,881 3.26% $37,346 3.07%
- ----------------------------------------------------------------------------------------------------------------------------
Net yield on interest-
earning assets 4.15% 3.84% 3.71%
- ----------------------------------------------------------------------------------------------------------------------------
1. For the purpose of these computations, nonaccrual loans are included in the daily average loan amounts outstanding.
2. Interest earned on loans includes loan fees, which are not material in amount.
3. Taxable-equivalent adjustments are made in calculating interest income and yields using a 35% tax rate for 2002, and 34%
for all prior years presented.
14
The following table presents the amount of changes in interest income and
interest expense for major components of interest-earning assets and
interest-bearing liabilities (dollars in thousands). The table distinguishes
between the changes related to average outstanding balances (changes in volume
holding the initial rate constant) and the changes related to average interest
rates (changes in average rate holding the initial balance constant). Change
attributable to the combined impact of volume and rate has been allocated
proportionately to change due to volume and change due to rate.
2002 Compared to 2001 2001 Compared to 2000
----------------------------- ----------------------------
Increase/(Decrease) Due to Increase/(Decrease) Due to
- -----------------------------------------------------------------------------------------------------------
Volume Rate Net Volume Rate Net
- -----------------------------------------------------------------------------------------------------------
Interest earned on:
Loans(1,2) $ (3,110) $(6,263) $(9,373) $(123) $(3,326) $(3,449)
Taxable investment securities 5,819 (2,461) 3,358 569 (1,274) (705)
Tax-exempt investment securities(2) 844 (217) 627 685 (130) 555
Other short-term investments (9) (12) (21) 11 (19) (8)
Interest-earning deposits (340) 112 (228) 47 (118) (71)
Federal funds sold 136 (339) (203) 599 (461) 138
- -----------------------------------------------------------------------------------------------------------
Total interest-earning assets 3,340 (9,180) (5,840) 1,788 (5,328) (3,540)
Interest paid on:
NOW accounts 102 (676) (574) (198) (450) (648)
Money market accounts (25) (4,049) (4,074) 1,463 (3,524) (2,061)
Savings deposits 80 (1,228) (1,148) (400) (939) (1,339)
Time deposits 414 (6,350) (5,936) 2,362 (611) 1,751
Notes payable, FHLB borrowings, federal
funds purchased, and securities sold
under agreement to repurchase 1,861 (2,347) (486) (1,634) (2,144) (3,778)
- -----------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 2,432 (14,650) (12,218) 1,593 (7,668) (6,075)
- -----------------------------------------------------------------------------------------------------------
Net interest income $908 $5,470 $6,378 $195 $2,340 $2,535
- -----------------------------------------------------------------------------------------------------------
1. Interest earned on loans includes loan fees, which are not material in amount.
2. Taxable-equivalent adjustments are made in calculating interest income and yields using a 35% tax rate
for 2002, and 34% for all prior years presented.
Provision for Loan Losses
The provisions for loan losses were $2.4 million, $3.9 million, and $810.0
thousand for the years ended December 31, 2002, 2001, and 2000, respectively.
The decrease of $1.5 million in 2002 compared to 2001 is due to a $2.0 million
additional provision in 2001 offset by management's decision to increase the
Allowance in 2002. The increase in 2001 compared to 2000 is due to an additional
$2.0 million provision related to credit impairment on one specific loan and the
Liberty acquisition. The increases in annual provision reflect the change in the
total loan portfolio with increases in commercial and commercial real estate
loans and decreases in real estate mortgages.
Other Income
Other income in 2002 increased $55.0 thousand from 2001 due to increases in
service charges on deposit accounts, gains on mortgage origination sales, and
other income offset by decreases in automated teller machine ("ATM") and
merchant services, security commissions and management fees, and investment
security gains. Other income in 2001 increased $6.5 million from 2000 mainly due
to a loss in 2000 of $2.5 million from the sale of approximately $90.0 million
in fixed-rate mortgage loans and losses on the sale of investment securities
that had yields below market interest rates. Exclusive of the losses, total
other income increased $4.0 million mainly due to increases in ATM and merchant
services, investment securities gains, gains on mortgage origination sales, and
other income offset by decreases in service charges on deposit accounts and
security commissions and management fees. The composition of other income is
shown in the following table (dollars in thousands).
15
Years ended December 31,
- ------------------------------------------------------------------------------
2002 2001 2000
- ------------------------------------------------------------------------------
Service charges on deposit accounts $2,626 $2,089 $2,134
ATM and Merchant services 3,057 3,122 2,654
Security commissions and management fees 468 738 1,149
Investment securities gains, net 509 1,925 39
Gain (loss) on sale of loans 3,151 2,315 (1,549)
Other 2,547 2,114 1,379
- ------------------------------------------------------------------------------
Total other income $12,358 $12,303 $5,806
- ------------------------------------------------------------------------------
For the year ended December 31, 2002 service charges on deposit accounts
increased $537.0 thousand compared to 2001 due to a full year inclusion of
Liberty's results compared to a half a year in 2001 and increased fees on
business accounts. Service Charges decreased $45.0 thousand for the year ended
December 31, 2001 compared to the year ended December 31, 2000.
ATM service charges are the terminal usage fees charged to non-customers
and the fees received from other institutions resulting from their customers'
usage of the Company's automated teller machines. Merchant services are the fees
the Company charges businesses for processing credit card payments. Income in
this category decreased $65.0 thousand in 2002 compared to 2001 due to decreased
volume from the ATM machines offset by increased volume from merchant services.
The reduced volume from the ATM machines is due to the removal of several
machines. ATM and merchant services increased $468.0 thousand in 2001 compared
to 2000 due to ATM service charges from the acquired Liberty machines and a full
year of the added merchant services in the Illinois area.
Security commissions and management fees are the fees received from the
Company's investment and asset management services and brokerage activities. For
the year ended December 31, 2002 security commissions and management fees
decreased $270.0 thousand compared to 2001. For the year ended December 31, 2001
security commissions and management fees decreased $411.0 thousand compared to
2000. The decreases in both years were mainly due to the economic environment, a
decline in investment related activities, and the sale of the Company's asset
management subsidiary during 2001.
The Company realized $509.0 thousand in net investment security gains for
the year ended December 31, 2002 due to the sale of marketable equity
securities, which resulted in a net gain of $286.0 thousand. The remaining net
gain of $223.0 thousand was due to the sale of investment securities as part of
restructuring the investment portfolio. For the year ended December 31, 2001,
the Company realized $1.9 million in net investment security gains due to the
sale of approximately $96.7 million of investment securities. For the year ended
December 31, 2000, the Company realized $39.0 thousand in investment security
gains.
The gain of $3.2 million on sale of loans for the year ended December 31,
2002 and the gain of $2.3 million for the year ended December 31, 2001 were both
due to increased refinancing activity on residential mortgages. The loss on sale
of loans of $1.5 million for the year ended December 31, 2000 was mainly due to
a $2.3 million loss from balance sheet restructuring offset by $751.0 thousand
in gains on mortgage origination sales.
Other income increased $433.0 thousand in 2002 and $735.0 thousand in 2001.
The increase in 2002 was mainly due to a gain of approximately $668.0 thousand
from the sale of rental property that was adjacent to the Hales Corners office
and approximately $258.0 thousand of income related to bank owned life
insurance. The increases in 2002 were offset by reduced rent income from the
sale of the rental properties and also by the distribution received in 2001 on
the exchange of an ATM service provider's common stock. The increase in 2001 was
mainly due to a distribution received on exchange of common stock resulting from
the merger of an ATM service provider. In addition to this distribution there
were increases in retail sales commissions, insurance commission, mortgage
origination fees, and building rent.
16
Other Expense
Other expense decreased $374.0 million for the year ended December 31,
2002. Other expense increased $2.9 million for the year ended December 31, 2001,
which included a $2.0 million loss from the liquidation of the asset management
subsidiary. The composition of other expense is shown in the following table
(dollars in thousands).
Years ended December 31,
- ----------------------------------------------------------------------------
2002 2001 2000
- ----------------------------------------------------------------------------
Salaries and employee benefits $18,564 $16,700 $14,671
Occupancy and equipment 6,529 6,237 6,008
Data processing 2,170 2,047 1,918
Legal and professional 1,901 1,883 1,682
ATM and Merchant services 2,140 2,207 1,847
Consolidation and merger-related charges 0 0 2,230
Advertising 1,131 1,015 1,223
Goodwill amortization 0 4,063 2,053
Other 6,364 5,021 4,665
- ----------------------------------------------------------------------------
Total other expense $38,799 $39,173 $36,297
- ----------------------------------------------------------------------------
Salaries and employee benefits increased $1.9 million in 2002 due to a full
year inclusion of the Liberty acquisition and increased sales commissions from
the increased volume of sales of mortgage loans into the secondary mortgage
market. In 2001 salaries and employee benefits increased $2.0 million mainly due
to increased sales commissions from the increased volume of sales of mortgage
loans into the secondary mortgage market, the Liberty acquisition, and
additional staff associated with opening a new office.
Occupancy and equipment expense increased $292.0 thousand in 2002 due to a
full year inclusion of the additional six locations from the Liberty
acquisition. Occupancy and equipment expense increased $229.0 thousand in 2001
due to the Liberty acquisition and a newly constructed office in West Elgin
offset by decreases in repair and maintenance and service contracts.
During 2002, data processing expense increased $123.0 thousand due to a
full year inclusion of the Liberty acquisition. Data processing expense
increased $129.0 thousand in 2001 compared to 2000 due to the additional expense
related to the Liberty acquisition.
Legal and professional fees increased $18.0 thousand in 2002 and $201.0 in
2001, due to certain legal matters, acquisitions and increased audit costs
resulting from the Company's growth over the preceding two years.
ATM expense is the fees charged by the Company's service provider for the
Company's customer use of automated teller machines that are not owned by the
Company. Merchant service expense results from providing the Company's business
customers the ability to accept credit cards in payment for goods and services.
For the year ended December 31, 2002, ATM and merchant services decreased $67.0
thousand due to decreased volume from the ATM machines offset by increased
volume from merchant services. The reduced volume from the ATM machines is due
to the removal of several machines. For the year ended December 31, 2001, ATM
and merchant services increased $360.0 thousand due to increased customer volume
for merchant services.
In the third quarter, 2000, the Company recorded a non-recurring
consolidation charge of approximately $2.2 million related to the charter
consolidation of the Company's five banks. The charge included expense for
employee severance, branch closure, and data processing conversion
Advertising expense increased $116.0 thousand in 2002, as the Company
executed a local branding initiative, and decreased $208 thousand in 2001.
17
Goodwill amortization decreased $4.1 million in 2002 as a result of the
implementation of SFAS No. 142, "Goodwill and Other Intangible Assets" under
which goodwill is no longer amortized but is instead tested annually for
impairment. Goodwill of $2.0 million was deemed impaired and written off in 2001
due to the liquidation of the asset management subsidiary.
Other expense increased $1.3 million in 2002 mainly due to a larger number
of branches resulting from the Liberty acquisition, increases in delivery and
postage, insurance expense, and corresponding bank service charges. Other
expense increased $356.0 thousand in 2001 mainly due to increased delivery and
postage, office supplies, ORE expense, and charity and donations, offset by
decreases in correspondent bank service charges and core deposit intangible.
Income Tax
The Company's consolidated income tax rate varies from statutory rates
principally due to nondeductible goodwill, tax-exempt interest income on
investment securities, loans, and nondeductible merger related expenses. The
effective tax rate for 2002 was 30.1% compared to 47.4% in 2001 and 39.1% in
2000. The effective tax rate for 2002 was affected by the adoption of SFAS No.
142. The effective tax rate for 2001 was affected by the write-off of goodwill
related to the liquidation of the asset management subsidiary. Provisions for
income tax were $4.8 million, $3.7 million, and $1.9 million for the years 2002,
2001, and 2000, respectively. Income tax expense increased $1.1 million in 2002
and $1.8 million in 2001 due to increased taxable income in both years.
Balance Sheet Analysis
The composition of assets and liabilities are generally the result of
management decisions influenced by market forces. The Company reported total
assets at December 31, 2002 of $1.3 billion and $1.2 billion at December 31,
2001.
Lending Activities
The Company's largest asset category continues to be loans. The Company's
gross loans, as a percentage of total deposits, were 79.1% at December 31, 2002
compared to 79.0% at December 31, 2001. The following table shows the Company's
loan portfolio composition on the dates indicated (dollars in thousands).
At December 31,
- ---------------------------------------------------------------------------------------------------------------------
% of % of % of % of % of
2002 total 2001 total 2000 total 1999 total 1998 total
- ---------------------------------------------------------------------------------------------------------------------
Commercial $156,816 21.1% $151,125 20.1% $139,865 20.9% $129,470 17.3% $56,675 9.3%
Commercial Real Estate 330,151 44.3 179,587 23.8 115,427 17.3 100,914 13.5 67,958 11.1
Real Estate Mortgage 194,225 26.1 343,108 45.5 329,658 49.3 445,624 59.5 438,886 71.7
Installment 55,323 7.4 71,797 9.5 70,668 10.6 62,180 8.3 37,519 6.1
Other 8,009 1.1 8,069 1.1 12,440 1.9 10,913 1.5 11,395 1.9
- ---------------------------------------------------------------------------------------------------------------------
Total Loans $744,524 $753,686 $668,058 $749,101 $612,433
- ---------------------------------------------------------------------------------------------------------------------
Total loans outstanding decreased $9.2 million in 2002, due to the
conversion of approximately $100.0 million of long-term fixed-rate mortgages
into a mortgage-backed security during the first quarter of 2002. The decrease
from the conversion was substantially offset by increased loan growth, mainly in
the commercial real estate category. Total loans outstanding increased $85.6
million in 2001 mainly due to the acquisition of Liberty Bank.
The Company continues to emphasize commercial and commercial real estate
lending. Commercial loans increased $5.7 million in 2002. Commercial loans
increased $11.3 million in 2001 due to the Liberty acquisition and internal loan
growth. Commercial loans are underwritten according to the Company's loan
policy, which sets forth the amount of credit which can be extended based upon
the borrower's cash flow, debt service capacity, leverage and discounted
collateral value. Commercial loans are typically made on the basis of the
borrower's ability to make repayment from the cash flow of the business. In
recognition of specific borrower risk, as well as inherent risk due to the
general economic environment, the Company emphasizes capacity to repay the loan,
adequacy of the borrower's
18
capital, an evaluation of the industry conditions affecting the borrower, and
current credit file documentation. The Company's commercial loans are typically
secured by the borrower's business assets such as, inventory, accounts
receivable, fixtures, and equipment. Generally, commercial loans carry the
personal guarantees of the principals.
Commercial real estate mortgages represent the Company's largest loan
category, comprising 44.3% of the loan portfolio at December 31, 2002 and 23.8%
at December 31, 2001. Commercial real estate activity increased $150.6 million
in 2002 compared to 2001 primarily due to strong local conditions. Commercial
real estate activity increased $64.2 million in 2001 compared to 2000 mainly due
to the Liberty acquisition and internal loan growth. The Company's commercial
real estate loans continue to be primarily focused on owner occupied, improved
property such as office buildings, warehouses, small manufacturing operations,
and retail facilities located in the Company's primary market areas subject to a
maximum 75% loan to value ratio pursuant to its loan policy. Loans for
construction and land development are generally secured by the property under
construction or development up to a maximum loan to value of 75% of estimated
cost or appraisal value of the completed project, whichever is less. The Company
further monitors construction and land development credits by disbursing draws
under the credit commitment upon satisfactory title company inspections of
construction progress and evidence of proper lien waivers. The borrower's
creditworthiness and the economic feasibility and cash flow abilities of the
project are fundamental concerns in the Company's commercial real estate and
construction/land development lending. Loans secured by commercial property,
whether existing or under construction, and land development are generally
larger in size and involve greater risks than residential mortgage loans because
payments on loans secured by commercial property are dependent upon the
successful operation and management of these properties, businesses, or
developments. As a result, the value of properties securing such loans are
likely to be subject to the local real estate market and general economic
conditions, including movements in interest rates. The Company generally writes
commercial real estate loans for maturities up to five years although the total
amortization period may be as long as twenty-five years, amortized monthly. The
Company generally writes construction and land development loans on terms up to
a maximum of 24 months and requires the borrower to make defined principal
reductions at stated intervals during that term. The Company additionally
attempts to have construction credits further supported by end mortgage
commitments, wherever possible. The Company will generally make credit
extensions for land development projects to experienced, strong borrowers with
adequate outside liquidity to support the project in the event the actual
project performance is slower than projection.
The Company's real estate loans, like all of the Company's loans, are
underwritten according to its written loan policy. The loan policy sets forth
the term, debt service capacity, credit extension, and loan to value guidelines,
which the Company considers acceptable to recognize the level of risk associated
with each specific loan category. The following table sets forth the percentage
composition of the real estate loan portfolio as of December 31, 2002.
- -----------------------------------------------------------------------------
Commercial real estate 57.36%
1-4 family first liens on residential real estate 19.19
Multifamily residential 5.76
1-4 family junior liens on residential real estate
(including home equity lines of credit) 9.54
Construction, land development, and farmland 8.15
- -----------------------------------------------------------------------------
Installment loans decreased $16.5 million during 2002 due to strong
refinance activity in a low rate environment, primarily into real estate
mortgages. Competition from the captive auto manufacturers finance affiliates
has also been strong. Installment loans increased $1.1 million during 2001 due
to the Liberty acquisition. The Company cultivates installment loans primarily
through the purchase of loan contracts from its network of auto dealers
developed over the years. The Company continues to pursue additional auto dealer
contacts to build this network of loan referrals. The Company's indirect auto
loan underwriting emphasizes the purchase of the highest quality loan contracts
to minimize risk of loss in this lending activity.
Other loans decreased $60.0 thousand in 2002. Other loans decreased $4.4
million in 2001 due to decreases in municipal loans and overdrafts.
19
The following table shows the maturity of loans (excluding residential
mortgages on one-to-four-family residences, and installment loans) outstanding
as of December 31, 2002 (dollars in thousands) and the amounts due after one
year classified according to the sensitivity to changes in interest rates:
After One
Within But Within After
One Year Five Years Five Years Total
- -------------------------------------------------------------------------------
Commercial $69,158 $65,652 $1,997 $136,807
Real Estate Mortgage 57,911 333,195 19,121 410,227
- -------------------------------------------------------------------------------
$127,069 $398,847 $21,118 $547,034
- -------------------------------------------------------------------------------
Loans Maturing after one year with:
Fixed Interest Rates $364,440 $26,661
Variable Interest Rates 16,011 0
- -------------------------------------------------------------------------------
Total $380,451 $26,661
- -------------------------------------------------------------------------------
Risk Elements in the Loan Portfolio
Certain risks are inherent in the lending function including a borrower's
subsequent inability to pay, insufficient collateral coverage, and changes in
interest rates. The Company attempts to reduce these risks by adherence to a
written set of loan policies and procedures. Included in these policies and
procedures are underwriting practices covering debt-service coverage,
loan-to-value ratios, and loan term. Evidence of a specific repayment source is
required on each credit extension, with documentation of the borrower's
repayment capacity. Generally, this repayment source is the borrower's cash
flow, which must demonstrate the ability to service the debt based upon
historical results and projections of future performance.
Management maintains the Allowance for Loan and Lease Losses (the
"Allowance") at a level considered adequate to provide for estimable and
probable loan losses. The Allowance is increased by provisions charged to
earnings, and is reduced by charge-offs, net of recoveries. At December 31,
2002, the Allowance was $8.8 million and $7.9 million at December 31, 2001.
The determination of Allowance adequacy is based upon on-going evaluations
of the Company's loan portfolio conducted by the Internal Loan Review function
of the Bank and reviewed by management. These evaluations consider a variety of
factors, including, but not limited to, general economic conditions, loan
portfolio size and composition, previous loss experience, the borrowers'
financial condition, collateral adequacy, and the level of non-performing loans.
As a percentage of total loans outstanding, the Allowance increased to
1.18% at the end of 2002 compared to 1.05% at the end of 2001. Because of the
downturn in the national economy and the change in the composition of the
Company's loan portfolio, management made the decision to increase the
Allowance. Based on its analyses, management considers the Allowance adequate to
recognize the risk inherent in the consolidated loan portfolio at December 31,
2002.
20
The balance of the Allowance and actual loan loss experience for the last
five years is summarized in the following table (dollars in thousands):
Years ended December 31,
- ---------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------
Balance at beginning of period $7,900 $7,149 $6,905 $4,485 $4,370
Charge-offs:
Commercial 1,425 3,558 464 776 146
Real Estate Mortgage 35 77 74 57 39
Installment 523 560 255 283 465
Other 15 51 40 48 149
- ---------------------------------------------------------------------------------------------------
Total charge-offs 1,998 4,246 833 1,164 799
- ---------------------------------------------------------------------------------------------------
Recoveries:
Commercial 390 17 96 445 79
Real Estate Mortgage 0 14 4 14 59
Installment 107 211 160 121 60
Other 6 11 7 25 26
- ---------------------------------------------------------------------------------------------------
Total recoveries 503 253 267 605 224
- ---------------------------------------------------------------------------------------------------
Net charge-offs 1,495 3,993 566 559 575
Balance of acquired allowances at date of acquisitions 0 889 0 2,229 0
Additions charged to operations 2,400 3,855 810 750 690
- ---------------------------------------------------------------------------------------------------
Balance at end of period $8,805 $7,900 $7,149 $6,905 $4,485
===================================================================================================
Ratios:
Net charge-offs to average loans outstanding 0.22% 0.55% 0.08% 0.08% 0.10%
Net charge-offs to total allowance 16.98 50.54 7.92 8.10 12.82
Allowance to year end loans outstanding 1.18 1.05 1.07 0.92 0.73
===================================================================================================
When, in the opinion of management, serious doubt exists as to the
collectibility of a loan, the loan is placed on nonaccrual status. At the time a
loan is classified as nonaccrual, interest credited to income in the current
year is reversed and interest income accrued in the prior year is charged to the
Allowance. The Company generally does not recognize income on loans past due 90
days or more. The following table summarizes non-performing assets on the dates
indicated (dollars in thousands).
At or for the years ended December 31,
- ---------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------
Nonaccrual loans $12,558 $9,800 $8,729 $4,737 $3,245
Accruing loans past due 90 days or more 0 0 106 14 106
Restructured loans 0 0 0 0 0
- ---------------------------------------------------------------------------------------------------
Total non-performing and restructured loans 12,558 9,800 8,835 4,751 3,351
Other real estate owned 452 671 267 740 572
- ---------------------------------------------------------------------------------------------------
Total non-performing assets $13,010 $10,471 $9,102 $5,491 $3,923
===================================================================================================
Ratios:
Non-performing loans to total loans 1.69% 1.30% 1.32% 0.64% 0.55%
Allowance to non-performing loans 70.11 80.61 80.92 145.34 133.84
Non-performing assets to total assets 0.99 0.89 0.84 0.50 0.47
Interest income that would have been recorded on
nonaccrual loans under original terms $774 $679 $781 $425 $286
Interest income recorded during the period on
nonaccrual loans 20 39 151 71 158
===================================================================================================
21
The percentage of non-performing loans to total loans was 1.69% at December
31, 2002 compared to 1.30% at December 31, 2001.
Financial Accounting Standards Board Statement No. 114 ("FASB 114") defines
a loan as impaired if, based on current information or events, it is probable
that a creditor will not be able to collect all amounts (both contractual
principal and interest) due in accordance with the terms of the original loan
agreement. At December 31, 2002, the Company identified approximately $1.2
million in loans considered impaired pursuant to this definition. These loans
are included as part of the nonaccrual loans set forth in the table above. Based
upon the analyses of the underlying collateral value of these loans and the low
percentage of these loans in relation to the gross loan portfolio, management
believes the allowance is adequate to provide for the inherent risk associated
with these loans.
At December 31, 2002, there were no additional loans to borrowers where
available information would indicate that such loans were likely to later be
included as nonaccrual, impaired (as defined in FASB Statement No. 114), past
due, or restructured.
Investment Activities
Investment securities that the Company has both the positive intent and
ability to hold-to-maturity are carried at amortized cost. Investment securities
that the Company does not have either the positive intent and/or the ability to
hold to maturity and all marketable equity securities are classified as
available-for-sale and carried at their respective fair market values.
Unrealized holding gains and losses on securities classified as
available-for-sale, net of related tax effects, are carried as a component of
shareholders' equity. The company has no assets classified as trading. See Note
3 to the Consolidated Financial Statements for additional information.
Total investment securities outstanding at December 31, 2002 increased
$161.8 million mainly due to the Company leveraging its capital position by
entering into approximately $143.8 million in leverage transactions.
Additionally, the Company securitized approximately $100.0 million of fixed-rate
mortgage loans and retained the resulting investments created from the
securitization. Offsetting the aforementioned increases were approximately $88.3
million in prepayments from mortgage-related securities resulting from the
accelerated mortgage refinancing activity and bullet maturities that were not
reinvested during 2002. The following table presents the combined carrying
values of the Company's held-to-maturity and available-for-sale investment
securities on the dates indicated (dollars in thousands).
At December 31,
- -------------------------------------------------------------------------------------------------
% of % of %of
2002 total 2001 total 2000 total
- -------------------------------------------------------------------------------------------------
U.S. Treasury securities and obligations
of U.S. government agencies $67,784 16.0% $19,947 7.6% $19,582 6.4%
Obligations of states and
political subdivisions 64,991 15.3 62,781 24.0 42,529 14.0
Mortgage-related securities 200,228 47.3 151,203 57.8 224,224 73.9
Other securities 90,584 21.4 27,815 10.6 17,306 5.7
- -------------------------------------------------------------------------------------------------
TOTAL $423,587 $261,746 $303,641
=================================================================================================
During 2002, the Company strategically decided to leverage its balance
sheet to take advantage of its strong capital position to enhance net interest
income. All leverage transactions were structured to match fund the investment
purchase with a borrowing (either repurchase agreements or FHLB borrowings) of
comparable maturity, duration, or term to interest repricing. The resulting
spread from each transaction (the difference between the acquired asset and the
related funding vehicle) was targeted to provide 150 basis points at a minimum.
The investments purchased were a combination of $31.9 million of
mortgage-related securities, $50.0 million of U.S. Government Agencies, $19.4
million of investment grade corporate notes, and $42.5 million of investment
grade floating-rate trust preferred securities. Funding consisted of $117.3
million of repurchase agreements, $24.9 million of FHLB borrowings, and $1.6
million from other sources. In the aggregate, the Company's spread on leverage
transactions entered into during 2002 was 214 basis points at December 31, 2002.
22
Balances in mortgage-related securities increased $49.0 million in 2002 due
to the conversion of approximately $100.0 million in fixed-rate mortgage loans
in March 2002 and retaining the assets in the form of the resulting investment
securities. The Company entered into this transaction to enhance the liquidity
of the underlying mortgages to fund future loan portfolio growth. In addition,
the Company acquired approximately $30 million in mortgage-related securities in
a leverage transaction match-funded with repurchase agreements of comparable
duration at a 162 basis point spread. Offsetting these increases were
approximately $84.2 million in accelerated prepayments, impacted by the
continued exceptionally high level of mortgage refinancing that occurred as a
result of continued declines in long-term interest rates during the year. The
Company's mortgage-related securities primarily represent balances outstanding
on fixed and adjustable rate collateralized-mortgage obligations (CMO's) and
mortgage-backed securities (MBS's) supported by one-to-four family residential
mortgage securities issued by the Federal National Mortgage Association (FNMA)
or the Federal Home Loan Mortgage Corporation (FHLMC) and private label issuers
rated AAA or better by Moody's or Standard and Poor's. At December 31, 2002,
mortgage-related securities accounted for 47.3% of the Company's investment
portfolio compared to 57.8% at December 31, 2001.
Obligations of states and political subdivisions increased $2.2 million at
December 31, 2002 compared to December 31, 2001 as the Company primarily
reinvested maturities. With growth in other investment portfolio categories,
obligations of states and political subdivisions declined to 15.3% of the
Company's investment portfolio at December 31, 2002 from 24.1% at December 31,
2001.
U.S. Treasury securities and obligations of U.S. government agencies
(Treasuries/Agencies) increased $47.8 million in 2002 due to a leverage
transaction match-funded with a repurchase agreement of comparable maturity,
yielding a 165 basis point spread. At December 31, 2002, Treasuries/Agencies
comprised 16.0% of the Company's investment portfolio compared to 7.6% at
December 31, 2001.
Other securities increased $62.8 million in 2002, mainly due to leverage
transactions, as previously discussed. At December 31, 2002, other securities
comprised 21.4% of the Company's investment portfolio compared to 10.6% at
December 31, 2001.
The maturities and weighted-average yield of the Company's investment
securities at December 31, 2002 are presented in the following table (dollars in
thousands). Taxable-equivalent adjustments (using a 34% tax rate) have been made
in calculating the yields on obligations of states and political subdivisions.
After One After Five
Within But Within But Within After
One Year Five Years Ten Years Ten Years
- -----------------------------------------------------------------------------------------------------------
Amount Yield Amount Yield Amount Yield Amount Yield
- -----------------------------------------------------------------------------------------------------------
U.S. Treasury securities and
obligations of U.S. government
agencies $52,270 4.06% $15,514 3.51% $0 0.00% $0 0.00%
Obligations of states and
political subdivisions 16,335 4.73 22,027 5.96 22,910 6.84 3,719 6.93
Mortgage-related securities 20,264 5.24 164,976 5.95 8,279 4.64 6,709 6.57
Other securities 30,928 2.40 21,122 7.90 299 5.86 38,235 3.36
- -----------------------------------------------------------------------------------------------------------
TOTAL $119,797 3.92% $223,639 5.96% $31,488 6.23% $48,663 4.05%
===========================================================================================================
At December 31, 2002, the Company had approximately $46.0 thousand in net
unrealized gains on its held-to-maturity securities and approximately $9.9
million in net unrealized gains on its available-for-sale securities. Unrealized
gains and losses resulting from marketable equity securities are impacted by the
current market price quoted for the underlying security in relation to the price
at which the security was acquired by the Company. Unrealized gains and losses
on investment securities are the result of changes in market interest rates and
the relationship of the Company's investments to those rates for comparable
maturities. Unrealized gains generally result from the interest rates on the
Company's portfolio of investment securities exceeding market rates for
comparable maturities. Conversely, unrealized losses generally result from the
interest rates on the Company's portfolio of investment securities falling below
market
23
rates for comparable maturities. If material, unrealized losses could negatively
impact the Company's future performance as earnings from these investments would
be less than alternative investments currently available and may not provide as
wide a spread between earnings and funding costs.
Deposits
Deposits are the Company's principal funding source. Deposit inflows and
outflows are significantly influenced by general interest rates, money market
conditions, market competition, and the overall condition of the economy. For
the year ended December 31, 2002, total average deposits increased $40.0 million
mainly due to internal growth. For the year ended December 31, 2001, total
average deposits increased $63.4 million mainly due to the Liberty acquisition.
Exclusive of Liberty total deposits increased approximately $22.0 million due to
customer deposit growth.
The following table sets forth the average amount and the average rate paid
by the Company by deposit category (dollars in thousands):
Years ended December 31,
- ---------------------------------------------------------------------------------------------------------------
2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------
Average Average % of Average Average % of Average Average % of
Amount Rate Total Amount Rate Total Amount Rate Total
- ---------------------------------------------------------------------------------------------------------------
Non-interest-bearing
demand deposits $149,640 15.9% $130,259 14.5% $113,305 13.5%
NOW accounts 99,007 0.50% 10.5 89,546 1.19% 9.9 102,487 1.67% 12.2
Money market deposits 220,235 1.43 23.4 220,998 3.26 24.5 187,436 4.93 22.4
Savings 124,604 0.92 13.2 120,275 1.91 13.3 136,672 2.65 16.3
Time deposits 348,074 3.71 37.0 340,441 5.53 37.8 298,187 5.71 35.6
- ---------------------------------------------------------------------------------------------------------------
TOTAL $941,560 1.88% $901,519 3.26% $838,087 3.77%
===============================================================================================================
For the year ended December 31, 2002, average non-interest bearing demand
deposits increased $19.4 million mainly due to internal growth. For the year
ended December 31, 2001, average non-interest bearing demand deposits increased
$17.0 million mainly due to the Liberty acquisition. Non-interest bearing demand
deposits represent 15.9% of the Company's average deposit portfolio at December
31, 2002 compared to 14.5% at December 31, 2001.
Average NOW accounts increased $9.5 million for the year ended December 31,
2002 over 2001. Average NOW accounts decreased $12.9 million for the year ended
December 31, 2001 over 2000 mainly due to customers transferring their deposits
into money market and time deposit accounts because of the higher rate offered
on those products. At December 31, 2002, NOW accounts represent 10.5% of the
Company's average total deposits compared to 9.9% at December 31, 2001.
Average money market deposits decreased $763 thousand for the year ended
December 31, 2002. At December 31, 2002, average money market balances of the
Company represent 23.4% of average total deposits compared to 24.5% at December
31, 2001 and 22.4% at December 31, 2000. Average savings balances increased $4.3
million for the year ended December 31, 2002 over 2001. Average savings balances
represent 13.2% of average total deposits at December 31, 2002 compared to 13.3%
at December 31, 2001 and 16.3% at December 31, 2000.
Average time deposit balances increased $7.6 million for the year ended
December 31, 2002 compared to the year ended December 31, 2001. At December 31,
2002, average time deposits represent 37.0% of average total deposits compared
to 37.8% at December 31, 2001 and 35.6% at December 31, 2000.
24
Maturities of time certificates of deposit and other time deposits of
$100,000 or more outstanding at December 31, 2002 are summarized as follows
(dollars in thousands).
----------------------------------------------------------------
3 month or less $24,328
Over 3 through 6 months 16,662
Over 6 through 12 months 28,279
Over 12 months 18,732
----------------------------------------------------------------
TOTAL $88,001
================================================================
Approximately 6.3% of the Company's total assets at December 31, 2002 were
supported by time deposits with balances in excess of $100.0 thousand as
compared to 7.3% at December 31, 2001. The Company's reliance in large balance
time deposits to fund its asset base has been significantly less than the large
liability funding dependence exhibited by its peers, per the Uniform Bank
Performance Report, which defines the Company's peers as all insured commercial
banks in the United States having assets between $1 billion and $3 billion.
Liquidity
The primary functions of asset/liability management are to assure adequate
liquidity and to maintain an appropriate balance between interest-earning assets
and interest-bearing liabilities. Liquidity management involves the ability to
meet the cash flow requirements of depositors and borrowers.
The Company's primary funding sources are deposits, loan principal and
interest payments, and maturities of loans and investment securities.
Contractual maturities and amortization of loans and investments are predictable
funding sources, whereas deposit flows and loan prepayments are impacted by
market interest rates, economic conditions, and competition. The Company uses
wholesale funding sources, such as the Federal Home Loan Bank, to balance the
timing differences between its various business funding sources and to support
loan origination.
The Company's primary funds utilization is loan originations. During 2002,
loans decreased $7.7 million, net of approximately $100.0 million in long-term
fixed-rate mortgage loans securitized during the year. Exclusive of the
securitization, loans increased $92.3 million. The assets from the
securitization were retained in the form of investment securities, which
increased $157.2 million. Other uses of funds were to purchase $20.0 million in
bank owned life insurance, fund a $13.6 million decrease in deposits, repurchase
and retire $11.8 million (715,695 shares) of common stock in the Dutch Auction
tender offer, pay dividends of $3.5 million, purchase $1.9 million of premises
and equipment, and repurchase $1.9 million (136,300 shares) of treasury stock
prior to completion of the Dutch Auction tender offer. Sources of funds came
from a $17.0 million increase in cash provided by operating activities, $15.0
million in notes payable, $108.0 million in repurchase agreements, $24.7 million
in FHLB advances, and $10.0 million in Federal Funds purchased.
During 2001, loans increased $13.2 million, net of approximately $50.0
million in fixed-rate mortgage loan refinancings during the year. Exclusive of
the refinancing activity, loans increased $63.2 million or 9.5% during 2001. A
$14.8 million increase in cash provided by operating activities provided
sufficient funding for the $13.2 million increase in loans outstanding. Net
contraction in investment securities totaling $50.6 million combined with $12.7
million in deposit growth and $6.7 million in net notes payable proceeds were
used to fund the $44.5 million increase in cash and cash equivalents, reduce net
wholesale funding (Federal Home Loan Bank advances, repurchase agreements, and
federal funds purchased) by $12.8 million, purchase $4.4 million in net fixed
assets, pay cash dividends of $3.6 million, and purchase 207,500 shares of the
Company's common stock totaling $2.5 million under its stock repurchase program
and fund the Liberty acquisition.
Cash and cash equivalents are generally the Company's most liquid assets.
The Company's level of operating, financing, and investing activities during a
given period impact the resultant level of cash and cash equivalents reported.
The Company had liquid assets of $67.5 million and $94.5 million at December 31,
2002 and 2001, respectively. Liquid assets in excess of necessary cash reserves
are generally invested in short-term investments such as federal funds sold,
commercial paper, and interest-earning deposits.
25
Interest Rate Sensitivity
Interest rate risk is an inherent part of the banking business as financial
institutions gather deposits and borrow funds to finance interest-earning
assets. Interest rate risk results when repricing of rates paid on deposits and
other borrowing does not coincide with the repricing of interest-earning assets.
Interest rate sensitivity management seeks to avoid fluctuating net interest
margins and to enhance consistent growth of net interest income through periods
of changing interest rates. The following table shows the estimated maturity and
repricing structure of the Company's interest-earning assets and
interest-bearing liabilities for three different independent and cumulative time
intervals as of December 31, 2002 (dollars in millions). For purposes of
presentation in the following table, the Company used the national deposit decay
rate assumptions published by the Office of the Comptroller of the Currency as
of December 31, 2002, which, for NOW accounts, money market accounts, and
savings deposits in the one year or less category were 0%, 50%, and 50%,
respectively. The table does not necessarily indicate the impact general
interest rate movements may have on the Company's net interest income as the
actual repricing experience of certain assets and liabilities, such as loan
prepayments and deposit withdrawals, is beyond the Company's control. As a
result, certain assets and liabilities may reprice at intervals different from
the maturities assumed in the following table given the general movement in
interest rates. Also, the interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
interest rates on other types may lag behind changes in market rates.
0-30 31-90 91-365 Total
days days days 0-365 days
- --------------------------------------------------------------------------------
ASSETS
Loans
Fixed $45.4 $20.6 $60.1 $126.1
Variable 256.0 0.0 0.0 256.0
Investments 80.8 14.2 63.6 158.6
Federal Funds 8.7 0.0 0.0 8.7
- --------------------------------------------------------------------------------
Total $390.9 $34.8 $123.7 $549.4
================================================================================
LIABILITIES
Savings and NOW deposits $5.2 $10.3 $46.4 $61.9
Time deposits 48.3 39.8 132.00 220.1
Money market deposits 9.2 18.4 83.0 110.6
Other interest-bearing liabilities 102.4 40.9 12.0 155.3
- --------------------------------------------------------------------------------
Total $165.1 $109.4 $273.4 $547.9
================================================================================
Interest sensitivity gap $225.8 $(74.6) $(149.7) $1.5
Cumulative interest sensitivity gap 225.8 151.2 1.5 1.5
Cumulative interest sensitivity gap as a
percentage of total earning assets 19.3% 12.9% 0.1% 0.1%
Cumulative total interest-earning
assets as a percentage of cumulative
interest-bearing liabilities 226.8% 155.0% 100.3% 100.3%
- --------------------------------------------------------------------------------
At December 31, 2002, interest-sensitive assets and interest-sensitive
liabilities subject to repricing within one year, as a percentage of total
assets, were 41.7% and 41.6%, respectively. Variable rate and maturing fixed
rate loans are the primary interest-sensitive assets repricing within one year.
Time deposits are the most significant liabilities subject to repricing within
one year on the funding side of the balance sheet.
At December 31, 2002, the Company reported a positive cumulative one-year
gap of 0.1% compared to a negative cumulative one-year gap of (7.3)% at December
31, 2001. The Company's transition to a positive cumulative one-year gap at
December 31, 2002 was mainly due to an increase in the amount of variable rate
loans outstanding and a reduction in time deposits with a maturity of one year
or less. The Company's asset-sensitivity at December 31, 2002 would normally
indicate that the Company's net interest margin would improve if rates increased
and deteriorate if interest rates decreased.
26
Capital Resources
Total shareholders' equity was $104.9 million, $106.4 million, and $106.5
million at December 31, 2002, 2001, and 2000, respectively. During 2002, the
Company repurchased 136 thousand shares of its common stock in the open market
at an average price of $14.28 in open market purchases. Additionally, in
December 2002, the Company completed its Dutch Auction tender offer, purchasing
and retiring 716 thousand shares at $16.50 per share. As a result of stock
repurchase activity, total shareholders' equity decreased $13.8 million in 2002.
Offsetting this decline in 2002 were net retained earnings and tax-effected
unrealized gains in the Company's investment portfolio. The equity decreases in
2001 and 2000 were primarily due to the Company's stock repurchase program under
which the Company repurchased approximately 200 thousand shares of common stock
at a average price of $12.16 per share in 2001; and 600 thousand shares at a
average price of $10.17 per share in 2000.
Total dividends declared were $3.5 million in 2002, $3.6 million in 2001,
and $3.8 million in 2000. The Company maintained a cash dividend declared amount
of $.48 per share in each of these years. The total dollar decreases in each
year are the direct result of the stock repurchase program.
Total assets increased 12.4% in 2002 in comparison to 2001 primarily due to
the Company leveraging its balance sheet. Total assets increased 8.4% in 2001 in
comparison to 2000 primarily due to the acquisition of LB Bancorp, Inc.
Acquisitions and asset growth, coupled with the Company's stock repurchase
program and Dutch Auction tender offer, impacted the average equity to asset
ratios of 9.14%, 9.59%, and 9.98% in the years 2002, 2001, and 2000,
respectively.
There are certain regulatory constraints which affect the Company's capital
levels. At December 31, 2002, the Company's actual regulatory amounts and ratios
exceeded those necessary to be defined as "well capitalized" under regulatory
framework. See Note 13 and Note 18 to the Consolidated Financial Statements for
additional explanation of these regulatory constraints.
Impact of Inflation and Changing Prices
The Company's Consolidated Financial Statements have been prepared in
conformity with generally accepted accounting principles which require the
measurement of financial position and operating results in terms of historical
dollars without consideration of changes in the relative purchasing power of
money over time impacted by inflation. The impact of inflation is reflected in
the Company's other expenses which tend to rise during periods of general
inflation. The majority of the Company's assets and liabilities are monetary in
nature and therefore differ greatly from most commercial and industrial
companies that have significant investments in fixed assets or inventories.
Consequently, interest rates have a greater impact on the Company's performance
than do the general levels of inflation. Management believes the most
significant impact on the Company's financial results is its ability to react to
interest rate changes and endeavors to maintain an essentially balanced position
between interest sensitive assets and liabilities in order to protect against
wide fluctuations in the Company's net interest margin.
27
Report of Management
The management of State Financial Services Corporation is responsible for
the preparation and integrity of the Consolidated Financial Statements and other
financial information included in this Annual Report. The financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States and include amounts that are based upon informed judgements
and estimates by management. The other financial information in this Annual
Report is consistent with the financial statements.
The Company maintains a system of controls and management believes that the
internal accounting controls provide reasonable assurance that transactions are
executed and recorded in accordance with Company policies and procedures and
that the accounting records may be relied on as a basis for preparation of the
financial statements and other financial information.
The Company's independent auditors were engaged to perform an audit of the
Consolidated Financial Statements, and the auditor's report expresses their
opinion as to the fair presentation of the consolidated financial statements in
conformity with accounting principles generally accepted in the United States.
The Audit Committee of the Board of Directors, comprised of directors who
are not employees of the Company, meets with management and the independent
auditors to discuss the adequacy of the internal accounting controls. The
independent auditors have full and free access to the Audit Committee.
/s/ Michael J. Falbo
Michael J. Falbo
President and Chief Executive Officer
/s/ Daniel L. Westrope
Daniel L. Westrope
Senior Vice President and Chief Financial Officer
28
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and Qualitative Disclosures about Market Risk
The Company's primary market risk exposure is interest rate risk and, to a
lesser extent, liquidity risk. All of the Company's transactions are denominated
in U.S. currency with no specific foreign exchange exposure. The Company has a
limited number of agricultural loans and accordingly has no significant exposure
to changes in commodity prices. Any impact that changes in foreign exchange
rates and commodity prices would have on interest rates are assumed to be
insignificant.
Interest rate risk ("IRR") is the exposure of a banking organization's
financial condition to adverse movements in interest rates. Accepting this risk
can be an important source of profitability and shareholder value, however
excessive levels of IRR can significantly impact the Company's earnings and
capital base. Accordingly, effective risk management that maintains IRR at
prudent levels is essential to the Company's safety and soundness.
Evaluating a financial institution's exposure to interest rate changes
includes assessing both the adequacy of the management process used to monitor
and control IRR and the organization's quantitative exposure level. When
assessing the IRR management process, the Company seeks to ensure that
appropriate policies, procedures, management information systems, and internal
controls are in place to maintain IRR at prudent levels with consistency and
continuity. Evaluating the quantitative level of IRR exposure requires the
Company to assess the existing and potential future effects of changes in
interest rates on its consolidated financial condition, including capital
adequacy, earnings, liquidity, and where appropriate, asset quality.
The Federal Reserve Board, together with the Office of the Comptroller of
the Currency and the FDIC, adopted a Joint Agency Policy Statement on IRR. The
policy statement provides guidance to examiners and bankers on sound practices
for managing IRR, which forms the basis for an ongoing evaluation of the
adequacy of IRR management at institutions under their respective supervision.
The policy statement also outlines fundamental elements of sound management that
have been identified in prior Federal Reserve guidance and discusses the
importance of these elements in the context of managing IRR. Specifically, the
guidance emphasizes the need for active board of director and senior management
oversight and a comprehensive risk management process which effectively
identifies, measures, and controls IRR.
Financial institutions derive their income primarily from the excess of
interest collected over interest paid. The rates of interest an institution
earns on its assets and owes on its liabilities generally are established
contractually for a period of time. Since market interest rates change over
time, an institution is exposed to lower profit margins (or losses) if it cannot
adapt to interest rate changes. For example, assume that an institution's assets
carry intermediate or long-term fixed rates and that those assets are funded
with short-term liabilities. If market interest rates rise by the time the
short-term liabilities must be refinanced, the increase in the institution's
interest expense on its liabilities may not be sufficiently offset if assets
continue to earn at the contractual long-term fixed rates. Accordingly, an
institution's profits could decrease on existing assets because the institution
will either have lower net interest income or, possibly, higher net interest
expense. Similar risks exist when assets are subject to contractual interest
rate ceilings, or rate sensitive assets are funded by longer-term fixed-rate
liabilities in a decreasing rate environment.
An institution might use various techniques to minimize IRR. One approach
used by the Company is to analyze its assets and liabilities and make future
financing and investment decisions based on payment streams, interest rates,
contractual maturities, and estimate sensitivity to actual or potential market
interest rate changes. Such activities fall under the broad definition of
asset/liability management. The Company's primary asset/liability management
technique is the measurement of its asset/liability gap which is defined as the
difference between the cash flow amounts of interest-sensitive assets and
liabilities that will be refinanced or repriced over a given time period. For
example, if the asset amount to be repriced exceeds the corresponding liability
amount subject to repricing for a given day, month, year, or longer period, the
institution is in an asset-sensitive gap position. In this situation, net
interest income would increase if market interest rates rose and conversely
decrease if market interest rates fell. Alternatively, if more liabilities than
assets will reprice, the institution is in a liability-sensitive position.
Accordingly, net interest income would decline when rates rose and improve when
rates fell. Also, these examples assume that interest rate changes for assets
and liabilities are of the same magnitude, whereas actual interest rate changes
generally differ in magnitude for assets and liabilities.
29
Several ways an institution can manage IRR include selling existing assets
or repaying certain liabilities; matching repricing periods for new assets and
liabilities for example by, shortening terms of new loans or investments; and
hedging existing assets, liabilities, or anticipated transactions. An
institution might also invest in more complex financial instruments intended to
hedge or otherwise change IRR. Interest rate swaps, futures contracts, options
on futures, and other such derivative financial instruments are often used for
this purpose. Because these instruments are sensitive to interest rate changes,
they require management expertise to be effective. SFSC has not purchased
derivative financial instruments in the past.
Financial institutions are also subject to prepayment risk in falling
interest rate environments. For example, mortgage loans and other financial
assets may be prepaid by a debtor so that the debtor may refinance its
obligations at new, lower interest rates. Prepayments of assets carrying higher
rates reduce the Company's interest income and overall asset yields. Certain
portions of an institution's liabilities may be short-term or due on demand,
while most of its assets may be invested in long-term loans or investments.
Accordingly, the Company seeks to have in place sources of cash to meet
short-term demands. These funds can be obtained by increasing deposits,
borrowing, or selling assets. Federal Home Loan Bank advances and short-term
borrowings provide additional sources of liquidity for the Company. SFSC also
has a $40.0 million line of credit available through a third party financial
institution.
The following table sets forth information about the Company's financial
instruments that are sensitive to changes in interest rates as of December 31,
2002. The Company had no derivative financial instruments, or trading portfolio,
as of that date. The expected maturity date values for loans, mortgage backed
securities, and investment securities were calculated adjusting the underlying
instrument's contractual maturity date for prepayment expectations. Expected
maturity date values for interest-bearing deposits were not based upon estimates
of the period over which the deposits would be outstanding, but rather the
opportunity for repricing. Similarly, with respect to its variable rate
instruments, the Company believes that repricing dates, as opposed to maturity
dates are more relevant in analyzing the value of such instruments and are
reported as such in the following table. Company borrowings are also reported
based on conversion or repricing dates.
Quantitative Disclosures of Market Risk
- --------------------------------------------------------------------------------------------------------------------
Fair Value
Maturity Date 2003 2004 2005 2006 2007 Thereafter Total 12/31/02
- --------------------------------------------------------------------------------------------------------------------
Rate sensitive assets:
Fixed rate loans $93,713 $124,977 $118,957 $47,537 $47,423 $17,967 $450,574 $459,146
Average interest rate 7.81% 7.24% 7.14% 7.26% 6.43% 6.58% 7.22%
Variable rate loans $143,713 $34,140 $41,606 $11,949 $41,138 $21,404 $293,950 $293,950
Average interest rate 5.32% 4.53% 4.26% 4.62% 4.48% 7.04% 5.06%
Investment securities $69,644 $111,933 $47,038 $6,218 $65,979 $112,899 $413,711 $423,633
Average interest rate 3.76% 5.70% 6.04% 4.71% 5.80% 4.54% 5.10%
- --------------------------------------------------------------------------------------------------------------------
Rate sensitive liabilities:
Savings & interest-
bearing Checking $449,455 --- --- --- --- --- $449,455 $449,455
Average interest rate 1.08% --- --- --- --- --- 1.08%
Time deposits $229,162 $56,920 $24,023 $6,927 $10,797 553 $328,382 $334,084
Average interest rate 2.81% 3.80% 4.95% 4.99% 4.07% 6.91% 3.23%
Variable rate borrowings $259,737 --- --- --- --- --- $259,737 $259,737
Average interest rate 2.84% --- --- --- --- --- 2.84%
- --------------------------------------------------------------------------------------------------------------------
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Ernst & Young LLP, Independent Auditors
Board of Directors and Shareholders
State Financial Services Corporation
We have audited the accompanying consolidated statements of financial
condition of State Financial Services Corporation and subsidiaries (the Company)
as of December 31, 2002 and 2001, and the related consolidated statements of
income, shareholder's equity and cash flows for each of the three years in the
period ended December 31, 2002. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company at December 31, 2002 and 2001, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States.
As discussed in Note 1, in 2002 the Company changed its method of
accounting for goodwill.
/s/ Ernst & Young LLP
Chicago, Illinois
January 17, 2003
31
State Financial Services Corporation and Subsidiaries
Consolidated Statements of Financial Condition
December 31
2002 2001
----------------------------------
Assets
Cash and due from banks $56,767,916 $54,541,162
Interest-bearing bank balances 2,040,592 1,402,789
Federal funds sold 8,708,297 38,605,567
----------------------------------
Cash and cash equivalents 67,516,805 94,549,518
Investment securities:
Available-for-sale (at fair value) 422,081,645 259,841,523
Held-to-maturity (fair value of
$1,551,666--2002 and $1,953,066--2001) 1,505,269 1,904,547
Loans (net of allowance for loan losses of
$8,805,000--2002 and $7,899,922--2001) 703,968,455 722,593,419
Loans held for sale 31,750,135 23,192,133
Premises and equipment 27,789,893 28,694,648
Accrued interest receivable 7,789,746 5,599,880
Goodwill 27,465,062 27,465,062
Bank owned life insurance 20,258,388 -
Other assets 6,698,985 7,212,410
----------------------------------
Total Assets $1,316,824,383 $1,171,053,140
==================================
Liabilities and Shareholders' Equity
Deposits:
Demand $163,036,430 $147,992,336
Savings 228,312,579 213,328,297
Money market 221,142,347 243,324,258
Time deposits in excess of $100,000 88,001,266 85,574,897
Other time deposits 240,381,060 264,238,960
----------------------------------
Total deposits 940,873,682 954,458,748
Federal Home Loan Bank advances 92,400,000 67,700,000
Note payable 15,700,000 15,652,776
Trust preferred securities 15,000,000 -
Securities sold under agreement to repurchase 126,636,913 18,586,952
Federal funds purchased 10,000,000 -
Accrued expenses and other liabilities 9,089,417 5,845,082
Accrued interest payable 2,191,711 2,449,482
----------------------------------
Total Liabilities 1,211,891,723 1,064,693,040
Shareholders' Equity:
Preferred stock, $1 par value; authorized--
100,000 shares; issued and outstanding--none - -
Common stock, $.10 par value; authorized
25,000,000 shares; issued and outstanding
9,406,321 shares in 2002 and 10,108,769 in 2001 940,632 1,010,877
Additional paid-in capital 83,157,808 94,797,858
Retained earnings 54,288,325 46,587,268
Accumulated other comprehensive income 6,518,045 2,302,673
Unearned shares held by ESOP (4,160,060) (4,473,357)
Treasury stock (2,459,340 shares in 2002 and
2,323,040 shares in 2001) (35,812,090) (33,865,219)
----------------------------------
Total Shareholders' Equity 104,932,660 106,360,100
----------------------------------
Total Liabilities and Shareholders' Equity $1,316,824,383 $1,171,053,140
==================================
32
State Financial Services Corporation and Subsidiaries
Consolidated Statements of Income
Year ended December 31
2002 2001 2000
-------------------------------------------
Interest income:
Loans $47,119,572 $56,453,228 $59,891,105
Investment securities:
Taxable 17,887,812 14,778,546 15,563,104
Tax-exempt 2,707,780 2,293,839 1,927,597
Federal funds sold and other
short-term investments 472,867 676,029 536,995
-------------------------------------------
Total interest income 68,188,031 74,201,642 77,918,801
Interest expense:
Deposits 17,676,849 29,409,899 31,705,889
Note payable and other borrowings 5,722,589 6,208,370 9,988,048
-------------------------------------------
Total interest expense 23,399,438 35,618,269 41,693,937
-------------------------------------------
Net interest income 44,788,593 38,583,373 36,224,864
Provision for loan losses 2,400,000 3,855,130 810,000
-------------------------------------------
Net interest income after provision
for loan losses 42,388,593 34,728,243 35,414,864
Other income:
Service charges on deposit accounts 2,625,713 2,089,093 2,133,802
ATM and merchant services 3,056,944 3,122,031 2,653,995
Security commissions and management fees 468,254 737,791 1,148,425
Investment securities gains, net 509,180 1,925,380 39,172
Gain (loss) on sale of loans 3,151,300 2,314,563 (1,549,206)
Other 2,546,304 2,114,445 1,379,372
-------------------------------------------
12,357,695 12,303,303 5,805,560
Other expenses:
Salaries and employee benefits 18,563,570 16,699,900 14,670,735
Net occupancy expense 2,702,797 2,433,629 2,047,317
Equipment rentals, depreciation
and maintenance 3,826,646 3,803,061 3,961,304
Data processing 2,170,150 2,047,047 1,918,119
Legal and professional 1,901,249 1,882,828 1,682,563
ATM and merchant services 2,140,395 2,206,614 1,846,716
Consolidation and merger-related charges -- -- 2,230,000
Advertising 1,130,759 1,015,257 1,222,654
Goodwill amortization -- 4,063,373 2,053,155
Other 6,364,006 5,021,180 4,664,740
-------------------------------------------
38,799,572 39,172,889 36,297,303
-------------------------------------------
Income before income taxes 15,946,716 7,858,657 4,923,121
Income taxes 4,793,893 3,724,415 1,925,283
-------------------------------------------
Net income $11,152,823 $4,134,242 $2,997,838
===========================================
Basic earnings per share $1.52 $.55 $.38
Diluted earnings per share 1.51 .55 .38
===========================================
33
State Financial Services Corporation and Subsidiaries
Consolidated Statements of Shareholders' Equity
Accumulated
Additional Other
Common Paid-In Retained Comprehensive Unearned Treasury
Stock Capital Earnings Income ESOP Stock Total
Shares
-------------------------------------------------------------------------------------------------
Balance at January 1, 2000 $1,009,269 $94,923,187 $46,812,497 $(2,709,310) $(5,131,608) $(25,236,482) $109,667,553
Comprehensive income:
Net income - - 2,997,838 - - - 2,997,838
Change in net unrealized
gain on securities
available-for-sale, net of
income taxes of $919,181 - - - 3,597,704 - - 3,597,704
-------------------------------------------------------------------------------------------------
Total comprehensive income - - 2,997,838 3,597,704 - - 6,595,542
Cash dividends declared - $0.48
per share - - (3,764,802) - - - (3,764,802)
Issuance of 15,040 shares under
stock plans 1,504 104,404 - - - - 105,908
Purchase of 600,400 shares of
treasury stock - - - - - (6,104,944) (6,104,944)
-------------------------------------------------------------------------------------------------
Balances at December 31, 2000 $1,010,773 $95,027,591 $46,045,533 $888,394 $(5,131,608) $(31,341,426) $106,499,257
=================================================================================================
Comprehensive income:
Net income - - 4,134,242 - - - 4,134,242
Change in net unrealized
gain on securities
available-for-sale, net of
income taxes of $2,619,770 - - - 1,414,279 - - 1,414,279
-------------------------------------------------------------------------------------------------
Total comprehensive income - - 4,134,242 1,414,279 - - 5,548,521
Cash dividends declared -$0.48
per share - - (3,592,507) - - - (3,592,507)
Issuance of 1,041 shares under
stock plans 104 10,072 - - - - 10,176
Purchase of 207,500 shares of
treasury stock - - - - - (2,523,793) (2,523,793)
ESOP shares earned - (239,805) - - 658,251 - 418,446
-------------------------------------------------------------------------------------------------
Balance at December 31, 2001 $1,010,877 $94,797,858 $46,587,268 $2,302,673 $(4,473,357) $(33,865,219) $106,360,100
=================================================================================================
Comprehensive income:
Net income - - 11,152,823 - - - 11,152,823
Change in net unrealized
gain on securities
available-for-sale, net of
income taxes of $2,171,554 - - - 4,215,372 - - 4,215,372
-------------------------------------------------------------------------------------------------
Total comprehensive income - - 11,152,823 4,215,372 - - 15,368,195
Cash dividends declared -$0.48
per share - - (3,451,766) - - - (3,451,766)
Issuance of 13,247 shares under
stock plans 1,325 106,286 - - - - 107,611
Repurchase of 715,695 shares (71,570) (11,737,398) - - - - (11,808,968)
Purchase of 136,300 shares of
treasury stock - - - - - (1,946,871) (1,946,871)
ESOP shares earned - (8,938) - - 313,297 - 304,359
-------------------------------------------------------------------------------------------------
Balance at December 31, 2002 $940,632 $83,157,808 $54,288,325 $6,518,045 $(4,160,060) $(35,812,090) $104,932,660
=================================================================================================
34
State Financial Services Corporation and Subsidiaries
Consolidated Statements of Cash Flows
Year ended December 31
2002 2001 2000
---------------------------------------------
Operating activities:
Net income $11,152,823 $4,134,242 $2,997,838
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 2,400,000 3,855,130 810,000
Depreciation 2,793,799 2,743,818 2,636,047
Amortization of premiums and accretion
of discounts on investment securities 2,295,880 576,376 (34,291)
Amortization of goodwill - 4,063,373 2,053,155
Deferred income tax provision (508,000) 1,013,721 572,000
Market adjustment for committed ESOP shares (8,938) (239,805) -
Income from bank owned life insurance (258,388) - -
Decrease (increase) in accrued interest receivable (2,189,866) 1,825,645 (1,168,206)
Increase (decrease) in accrued interest payable (257,771) (799,756) 717,094
Realized investment securities gains (509,180) (1,925,380) (39,172)
Other 2,094,206 (483,106) 3,691,383
---------------------------------------------
Net cash provided by operating activities 17,004,565 14,764,258 12,235,848
Investing activities:
Proceeds from maturities or principal payments
of investment securities held-to-maturity 400,499 997,523 345,063
Purchases of securities available-for-sale (395,815,592) (160,228,303) (159,358,500)
Proceeds from maturities and sales of investment
securities available-for-sale 238,174,475 209,612,811 81,898,298
Net decrease (increase) in loans 7,666,962 (13,198,067) 80,476,890
Net purchases of premises and equipment (1,889,044) (4,362,792) (4,702,332)
Business acquisitions, net of cash and cash
equivalents acquired of $6,952,438 - (4,183,444) -
Purchase of bank owned life insurance (20,000,000) - -
---------------------------------------------
Net cash provided by (used in) investing activities (171,462,700) 28,637,728 (1,340,581)
Financing activities:
Net increase (decrease) in deposits (13,585,066) 12,693,409 12,305,224
Repayment of notes payable (1,700,000) (13,769,224) (42,500,000)
Proceeds of notes payable 1,747,224 20,446,750 9,850,641
Proceeds from trust preferred securities 15,000,000 - -
Net decrease in guaranteed ESOP obligation 313,297 658,251 -
Increase (decrease) in securities sold under
agreements to repurchase 108,049,961 7,167,442 (4,314,299)
Increase (decrease) in Federal Home Loan Bank advances 24,700,000 (10,000,000) 16,200,000
Cash dividends (3,451,766) (3,592,507) (3,764,803)
Proceeds (repayments) of federal funds purchased 10,000,000 (10,000,000) (2,400,000)
Purchase of treasury stock (1,946,871) (2,523,793) (6,104,944)
Repurchase of Common Stock (11,808,968) - -
Proceeds from exercise of stock options and
restricted stock awards 107,611 10,176 105,909
---------------------------------------------
Net cash provided by (used in) financing activities 127,425,422 1,090,504 (20,622,272)
---------------------------------------------
Increase (decrease) in cash and cash equivalents (27,032,713) 44,492,490 (9,727,005)
Cash and cash equivalents at beginning of year 94,549,518 50,057,028 59,784,033
---------------------------------------------
Cash and cash equivalents at end of year $67,516,805 $94,549,518 $50,057,028
=============================================
Supplementary information:
Interest paid $23,657,209 $36,079,436 $40,976,843
Income taxes paid 5,606,836 2,486,022 1,528,301
Conversion of mortgage loans into fixed
rate securities 101,567,223 0 109,839,222
35
1. Accounting Policies
The accounting policies followed by State Financial Services Corporation
(the Company) and the methods of applying those principles which materially
affect the determination of its financial position, cash flows or results of
operations are summarized below.
Organization
The Company is a financial services company operating through twenty-six
locations in southeastern Wisconsin and northeastern Illinois. Through its
banking network, the Company provides commercial and retail banking products,
long-term fixed-rate secondary market mortgage origination and brokerage
activities.
The Company and its subsidiaries are subject to competition from other
financial institutions and financial service providers, and are subject to
certain federal and state regulations and undergo periodic examinations by
regulatory agencies.
Basis of Presentation
The consolidated statements include the accounts of the Company and its
subsidiaries. All significant intercompany transactions have been eliminated.
The financial statements are prepared in accordance with accounting
principles generally accepted in the United States and include amounts based on
management's prudent judgments and estimates. Actual results may differ from
these estimates.
Cash and Cash Equivalents
Cash and cash equivalents include cash and due from banks, interest-bearing
bank balances and federal funds sold, all with an original maturity of three
months or less.
Investment Securities
Securities classified as available-for-sale are reported at fair value,
with unrealized gains and losses, net of tax, excluded from earnings and
reported as other comprehensive income.
Securities classified as held-to-maturity are reported at amortized cost if
management has the intent and ability to hold the securities to maturity.
The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity, or in the case of mortgage
related securities, over the estimated life of the security. Such amortization
is calculated using the level-yield method, adjusted for prepayments and is
included in interest income from investments. Realized gains and losses, and
declines in value judged to be other than temporary are included in net
investment securities gains and losses. The cost of securities is based on the
specific identification method.
Bank Owned Life Insurance
The Company purchased bank owned life insurance on the lives of certain
employees. The Company is the beneficiary of the insurance policies. Increases
in the cash value of the policies, as well as insurance proceeds received, are
recorded in non-interest income, and are not subject to income taxes.
36
Interest on Loans
Interest income on loans is accrued and credited to operations based on the
principal amount outstanding. The accrual of interest income is generally
discontinued when a loan becomes 90 days past due as to principal or interest
and/or when, in the opinion of management, full collection is questionable. When
interest accruals are discontinued, unpaid interest credited to income in the
current year is reversed and unpaid interest accrued in the prior year is
charged to the allowance for loan losses. Management may elect to continue the
accrual of interest when the loan is in the process of collection and the fair
value of collateral is sufficient to cover the principal balance and accrued
interest. Interest received on nonaccrual loans is either applied against
principal or reported as interest income according to management's judgment
regarding the collectibility of principal. Generally, loans are restored to
accrual status when the obligation is brought current, has performed in
accordance with the contractual terms for a reasonable period of time and the
ultimate collectibility of the total contractual principal and interest is no
longer in doubt.
Loan Fees and Related Costs
Loan origination and commitment fees and certain direct loan origination
costs are deferred and the net amounts are amortized as an adjustment of the
related loan yield. The Company generally amortizes these amounts using the
level-yield method over the contractual life of the related loans. Fees related
to standby letters of credit are recognized over the commitment period.
Loans Held for Sale
Loans held for sale consist of residential mortgages and are carried at the
lower of cost or aggregate market value. Net unrealized losses are recognized
through a valuation allowance and are charged to income.
Mortgage Servicing Rights
The Company has originated and sold mortgage loans with servicing rights
retained. The rights to service these loans are capitalized at the time of sale.
The capitalized cost of loan servicing rights is amortized in proportion to, and
over the period of, estimated net future servicing revenue. Mortgage servicing
rights are periodically evaluated for impairment. For purposes of measuring
impairment, the servicing rights are stratified into pools based on one or more
predominant risk characteristics of the underlying loans including loan type,
interest rate, term and geographic location, if applicable. Impairment
represents the excess of the remaining capitalized cost of a stratified pool
over its fair value and is recorded through a valuation allowance. The fair
value of each servicing rights pool is evaluated based on the present value of
estimated future cash flows using a discount rate commensurate with the risk
associated with that pool, given current market conditions. Estimates of fair
value include assumptions about prepayment speeds, interest rates and other
factors which are subject to change over time. Changes in these underlying
assumptions could cause the fair value of mortgage servicing rights, and the
related valuation allowance, if any, to change significantly in the future.
Allowance for Loan Losses
The allowance for loan losses is composed of specific and general valuation
allowances. The Company establishes specific valuation allowances on loans
considered impaired equal to the amount of the impairment. A loan is considered
impaired when the carrying amount of the loan exceeds the present value of the
expected future cash flows, discounted at the loan's original effective interest
rate or the fair value of the underlying collateral.
General valuation allowances are based on an evaluation of the various risk
components that are inherent in the loan portfolio. The risk components that are
evaluated include past loan loss experience; the level of nonperforming and
classified loans; current economic conditions; volume, growth and composition of
the loan portfolio; adverse situations that may affect the borrower's ability to
repay; the estimated value of any underlying collateral; peer group comparisons;
regulatory guidance; and other relevant factors. The allowance is increased by
provisions charged to earnings and reduced by charge-offs, net of recoveries.
Management may transfer reserves between specific and general valuation
allowances as considered necessary.
37
The allowance for loan losses reflects management's best estimate of the
reserves needed to provide for the impairment of income-producing loans and is
based on a risk model developed and implemented by management. Actual results
could differ from estimates and future additions to the allowance may be
necessary based on unforeseen changes in economic conditions. In addition,
federal regulators annually review the loan portfolio and the allowance for loan
losses. Such regulators have the authority to require the Company to recognize
additions to the allowance at the time of their examination.
Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation.
The provision for depreciation is computed using both accelerated and
straight-line methods over the estimated useful lives of the respective assets.
Leasehold improvements are amortized using both accelerated and straight-line
methods over the shorter of the useful life of the leasehold asset or lease
term. Land is carried at cost.
Goodwill
The excess of the purchase price over the fair value of net assets of
companies acquired is recorded as goodwill. Effective January 1, 2002, goodwill
is no longer amortized and is subject to annual impairment testing and between
annual tests if facts and circumstances suggest that it may be impaired. If this
review indicates that there is impairment the carrying amount of goodwill is
reduced by the difference between the implied fair value and the carrying value
of goodwill. The amount of impairment is recorded to operating expense. See
"Accounting Changes" for a detailed discussion of the impact of this new
accounting standard.
Treasury Stock
Common stock purchased for treasury is recorded at cost. At the date of
subsequent reissueance, the treasury stock account is reduced by the cost of
such stock on a first-in, first-out basis.
Employee Stock Ownership Plan (ESOP)
Compensation expense under the ESOP is equal to the fair value of common
shares released or committed to be released to participants in the ESOP in each
respective period. Common stock purchased by the ESOP and not committed to be
released to participants is included in the consolidated statements of financial
condition at cost as a reduction of shareholders' equity.
Earnings Per Share
Basic earnings per share is computed by dividing net income by the
weighted-average common shares outstanding less unearned ESOP shares. Diluted
earnings per share are computed by dividing net income by the weighted-average
common shares outstanding less unallocated ESOP shares plus the assumed
conversion of all potentially dilutive securities using the treasury stock
method.
The denominators for the earnings per share amounts are as follows:
2002 2001 2000
------------------------------------
Basic:
Weighted-average number of
shares outstanding 7,685,460 7,844,094 8,288,947
Less: weighted-average number
of unearned ESOP shares (346,781) (362,883) (379,468)
------------------------------------
Denominator for basic earnings
per share 7,338,679 7,481,211 7,909,479
====================================
Fully diluted:
Denominator for basic earnings
per share 7,338,679 7,481,211 7,909,479
Add: assumed conversion of stock
options using the treasury
stock method 64,882 31,905 3,559
------------------------------------
Denominator for fully diluted
earnings per share 7,403,561 7,513,116 7,913,038
====================================
38
At December 31, 2002, 288,561 stock options with a weighted-average
exercise price of $16.21 were excluded from the calculation of fully diluted
earnings per share as their impact was anti-dilutive.
Stock-Based Compensation
The Company follows Accounting Principles Board Opinion No. 25 under which
no compensation expense is recorded when the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of grant. The Company's pro forma information regarding net income and net
income per share has been determined as if these options had been accounted for
since January 1, 1995, in accordance with the fair value method of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation".
The Black-Scholes option valuation model is commonly used in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Since the
Company's employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimates, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
In determining compensation expense in accordance with SFAS No. 123, the
fair value for these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions for 2002 and 2001. No options were granted in 2000.
Year ended December 31,
---------------------------
2002 2001
- -----------------------------------------------------------------------------
Expected life of options 6.75 years 6.75 years
Risk-free interest rate 1.6% 3.33%
Expected dividend yield 3.0% 3.0%
Expected volatility factor 15.77% 15.77%
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period, which is
generally six months. The Company's pro forma information is as follows:
Year ended December 31,
---------------------------
(Thousands, except per share data) 2002 2001 2000
- --------------------------------------------------------------------------------
Net income, as reported $11,153 $4,134 $2,998
Pro forma compensation expense in
accordance with SFAS No. 123, net of tax (241) (178) --
- --------------------------------------------------------------------------------
Pro forma net income (loss) $10,912 $3,956 $2.998
================================================================================
Net income (loss) per common share, as reported:
Basic $1.52 $0.55 $0.38
Diluted $1.51 $0.55 $0.38
Pro forma net income (loss) per common share:
Basic $1.49 $0.53 $0.38
Diluted $1.47 $0.53 $0.38
The pro forma disclosures only include the effect of options granted
subsequent to January 1, 1995. Accordingly, the effects of applying the SFAS No.
123 pro forma disclosures to future periods may not be indicative of future
effects.
39
Income Taxes
The Company accounts for income taxes using the liability method. Deferred
income tax assets and liabilities are adjusted regularly to amounts estimated to
be receivable or payable based on current tax law and the Company's tax status.
Valuation allowances are established for deferred tax assets for amounts for
which it is more likely than not that they will be realized.
Accounting Changes
On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets," (SFAS 142), which requires that goodwill no longer be
amortized, but instead tested for impairment at least annually in accordance
with the provisions of the Statement.
The Company has performed the required impairment tests of goodwill as of
January 1, 2002 and again as of October 31, 2002. As a result of these tests,
the Company has determined there is no impairment to its goodwill. The Company
will perform the required impairment tests of goodwill annually to determine
what the effect of these tests will be, if any, on the earnings and financial
position of the Company.
For comparative purposes, the following table illustrates net income and
net income per share for the years ended December 31, 2002, 2001, and 2000
adjusted to exclude the effects of amortizing goodwill (dollars in thousands
except per share data):
Year ended December 31,
------------------------------
2002 2001 2000
------------------------------
Reported net income $11,153 $4,134 $2,998
Add back: Goodwill amortization - 4,063 2,053
------------------------------
Adjusted net income $11,153 $8,197 $5,051
==============================
Basic earnings per common share:
Reported net income $1.52 $.55 $.38
Goodwill amortization 0 .54 .26
------------------------------
Adjusted net income $1.52 $1.09 $.64
==============================
Diluted earnings per common share:
Reported net income $1.51 $.55 $.38
Goodwill amortization 0 .54 .26
------------------------------
Adjusted net income $1.51 $1.09 $.64
==============================
Guarantees
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." This interpretation expands the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees and requires the guarantor to recognize a
liability for the fair value of an obligation assumed under a guarantee. FIN 45
clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The disclosure requirements of FIN 45 are effective for
the Company as of December 31, 2002, and require disclosure of the nature of the
guarantee, the maximum potential amount of future payments that the guarantor
could be required to make under the guarantee, and the current amount of the
liability, if any, for the guarantor's obligations under the guarantee. The
recognition requirements of FIN 45 are to be applied prospectively to guarantees
issued or modified after December 31, 2002. Significant guarantees that have
been entered into by the Company are disclosed in Note 15 to the consolidated
financial statements. The Company does not expect the requirements of FIN 45 to
have a material impact on results of operations, financial position, or
liquidity.
40
2. Restrictions on Cash and Due From Bank Accounts
State Financial Bank, N.A. (Bank) is required to maintain reserve balances
with the Federal Reserve Bank. The average amount of reserve balances for the
years ended December 31, 2002 and 2001, was approximately $15.3 million and
$14.4 million, respectively.
3. Investment Securities
The amortized cost and estimated fair values of investment securities
follow:
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------------------------------------------------
Held-to-Maturity
December 31, 2002:
Obligations of state and political subdivisions $1,105,269 $46,407 $0 $1,151,676
Other securities 400,000 0 (10) 399,990
------------------------------------------------------
$1,505,269 $46,407 $(10) $1,551,666
======================================================
December 31, 2001:
Obligations of state and political subdivisions $1,404,547 $48,509 $0 $1,453,056
Other securities 500,000 120 (110) 500,010
------------------------------------------------------
$1,904,547 $48,629 $(110) $1,953,066
======================================================
Available-for-Sale
December 31, 2002:
U.S. Treasury securities and obligations of U.S.
government agencies $67,165,645 $619,791 $(1,636) $67,783,800
Obligations of state and political subdivisions 61,543,876 2,346,674 (5,098) 63,885,452
Mortgage-related securities 194,097,108 6,137,599 (6,711) 200,227,996
Other securities 89,399,191 1,072,146 (286,940) 90,184,397
------------------------------------------------------
$412,205,820 $10,176,210 $(300,385) $422,081,645
======================================================
December 31, 2001:
U.S. Treasury securities and obligations of U.S.
government agencies $19,659,243 $313,609 $(25,969) $19,946,883
Obligations of state and political subdivisions 60,795,837 852,700 (272,409) 61,376,128
Mortgage-related securities 148,316,045 2,997,555 (110,813) 151,202,787
Other securities 27,581,499 184,372 (450,146) 27,315,725
------------------------------------------------------
$256,352,624 $4,348,236 $(859,337) $259,841,523
======================================================
The amortized cost and estimated fair value of investment securities at
December 31, 2002, by contractual maturity, are as follows:
Held-to-Maturity Available-for-Sale
----------------------- ---------------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
------------------------------------------------------
Due in one year or less $300,818 $304,523 $119,426,124 $119,495,912
Due after one year through five years 915,080 954,303 214,561,221 222,723,615
Due after five years through ten years 139,856 141,598 30,121,955 31,347,845
Due after ten years 149,515 151,242 48,096,520 48,514,273
------------------------------------------------------
$1,505,269 $1,551,666 $412,205,820 $422,081,645
======================================================
Expected maturities may differ from contractual maturities because
borrowers or issuers may have the right to call or prepay obligations with or
without call or prepayment penalties. The Company's investments in
mortgage-related securities have been allocated to the various maturity
categories based on expected maturities using current prepayment estimates.
41
Proceeds from sales of investments in available-for-sale securities were
approximately $84.2 million, $94.7 million, and $51.0 million during 2002, 2001,
and 2000 respectively. Gross gains of approximately $1.2 million, $1.9 million,
and $178 thousand were realized on the 2002, 2001, and 2000 sales, respectively.
Losses of $685 thousand were recognized on investment security sales in 2002 and
no losses recognized on investment security sales in 2001. Gross losses of
approximately $139 thousand were recognized in 2000.
A schedule of the unrealized gains (losses) on available-for-sale
securities is as follows:
2002
------------------------------------------
Before Tax (Benefit) Net-of-
Tax Amount Expense Tax Amount
------------------------------------------
Unrealized gains on available-
for-sale securities $6,896,106 $2,371,203 $4,524,903
Less: reclassification adjustment
for gains realized in net income (509,180) (199,649) (309,531)
------------------------------------------
Changes in unrealized gains $6,386,926 $2,171,554 $4,215,372
==========================================
2001
------------------------------------------
Before Tax (Benefit) Net-of-
Tax Amount Expense Tax Amount
------------------------------------------
Unrealized gains on available-
for-sale securities $5,959,429 $3,374,711 $2,584,718
Less: reclassification adjustment
for gains realized in net income (1,925,380) (754,941) (1,170,439)
------------------------------------------
Changes in unrealized gains $4,034,049 $2,619,770 $1,414,279
==========================================
2000
------------------------------------------
Before Tax (Benefit) Net-of-
Tax Amount Expense Tax Amount
------------------------------------------
Unrealized gains on available-
for-sale securities $4,556,057 $934,540 $3,621,517
Less: reclassification adjustment
for gains realized in net income (39,172) (15,359) (23,813)
------------------------------------------
Changes in unrealized gains $4,516,885 $919,181 $3,597,704
==========================================
At December 31, 2002, 2001, and 2000 investment securities with a carrying
value of approximately $165.2 million, $50.0 million, and $54.7 million
respectively, were pledged as collateral to secure repurchase agreements, public
deposits and for other purposes.
4. Loans
A summary of loans outstanding at December 31, 2002 and 2001 is as follows:
2002 2001
------------------------------------
Commercial $156,815,883 $151,124,639
Commercial real estate 330,150,613 179,587,403
Real estate mortgage 162,474,578 319,915,569
Consumer 55,323,676 71,796,544
Other 8,008,705 8,069,186
------------------------------------
$712,773,455 $730,493,341
====================================
42
5. Allowance for Loan Losses
Changes in the allowance for loan losses for each of the three years in the
period ended December 31, 2002 are as follows:
2002 2001 2000
----------------------------------------
Balance at beginning of year $7,899,922 $7,149,147 $6,904,980
Allowance from acquired bank - 889,330 -
Provision for loan losses 2,400,000 3,855,130 810,000
Charge-offs (1,997,625) (4,246,294) (832,710)
Recoveries 502,703 252,609 266,877
----------------------------------------
Net charge-offs (1,494,922) (3,993,685) (565,833)
----------------------------------------
Balance at end of year $8,805,000 $7,899,922 $7,149,147
========================================
Total nonaccrual loans were $12.6 million and $9.8 million at December 31,
2002 and 2001, respectively.
6. Loans to Related Parties and Related Party Agreements
Loans to Related Parties
In the ordinary course of business the Bank extends credit to directors,
principal shareholders and executive officers of the Bank, the Company and its
subsidiaries, and to the related interests of the aforementioned persons.
"Related interest," means a company, or political or campaign committee, that is
directly or indirectly controlled by a director, principal shareholder or
executive officer. All of these individuals and related interests, collectively,
are called insiders.
Credit extended to insiders must be on substantially the same terms,
including interest rate, collateral and repayment, as those prevailing for
comparable transactions with unrelated persons. Insider credit may not involve
more than the normal risk associated with lending money.
The Bank may extend aggregated credit to any one insider up to the Bank's
legal lending limit. The Bank may not extend credit to an insider unless that
credit, when aggregated with extensions of credit to all Bank insiders, does not
exceed the Bank's unimpaired capital and unimpaired surplus.
The combined balance of loans outstanding and commitments to lend to
insiders as of December 31, 2002 and 2001 was $21.5 million and $23.0 million,
respectively. The decrease of $1.5 million for December 31, 2002 compared to
December 31, 2001 was due to combined new advances of $5.2 million and combined
pay-downs of $6.7 million.
Executive Employment and Consulting Agreement
The Company has an Executive Employment and Consulting Agreement with
Jerome J. Holz, Chairman of the Board of the Company, pursuant to which the
Company will pay Mr. Holz annual compensation of $100,000 per year for each year
(or portion thereof) that Mr. Holz serves as Chairman of the Board of the
Company; provided that Mr. Holz shall not continue to serve as Chairman of the
Board after December 31, 2004. Under the agreement, Mr. Holz will serve as a
consultant to the Company for life beginning January 1, 2001, and the Company
will pay Mr. Holz an annual consulting payment of $225,000 (subject to downward
adjustment) and provide supplemental Medicare insurance coverage and
prescription medication coverage for each year during such consulting period.
The agreement also provides that in the event of a change in control of the
Company, Mr. Holz shall receive one lump sum payment equal to the then present
value of the remaining consulting compensation for the remainder of Mr. Holz's
then actuarial life expectancy. The agreement uses the same definition of a
"change of control" as the transition agreements described under "Compensation
of Executive Officers - Agreements with Named Executive Officers." In 1980, the
Company also granted Mr. Holz a Deferred Compensation Agreement pursuant to
which the Company was obligated to pay Mr. Holz $1,000 per month for 120 months
following termination of his employment. The Company's obligations under this
agreement were insured. In December 2001,the Company and Mr. Holz mutually
agreed to terminate this Deferred
43
Compensation Agreement and the Company paid Mr. Holz $120,000 from the proceeds
received from the termination of the life insurance policy related to this
agreement. The Company has no further obligations under the Deferred
Compensation Agreement."
7. Premises and Equipment
A summary of premises and equipment at December 31, 2002 and 2001, is as
follows:
2002 2001
---------------------------------
Buildings $25,142,830 $25,227,644
Furniture and equipment 22,892,333 21,449,098
Leasehold improvements 3,081,437 3,166,831
---------------------------------
51,116,600 49,843,573
Less accumulated depreciation (28,642,955) (26,801,517)
Land 5,316,248 5,652,592
---------------------------------
$27,789,893 $28,694,648
=================================
8. Federal Home Loan Bank and Other Borrowings
Federal Home Loan Bank (FHLB) advances and other borrowings at December 31,
2002 and 2001 are summarized as follows:
2002 2001
--------------------------------------------------
Weighted Weighted
Average Average
Maturity Balance Rate Balance Rate
--------------------------------------------------
2002 $ - $30,200,000 4.26%
2003 30,400,000 1.66 - -
2004 12,300,000 4.31 7,500,000 5.63
2005 24,900,000 4.97 10,000,000 6.18
2007 4,800,000 3.47 - -
2011 20,000,000 4.55 20,000,000 4.55
--------------------------------------------------
Total FHLB advances 92,400,000 3.44 67,700,000 4.78
Note payable 15,700,000 2.78 15,652,776 3.38
Trust preferred securities 15,000,000 5.27 - -
Securities sold under
agreement to repurchase 126,636,913 2.46 18,586,953 2.01
Federal funds purchased 10,000,000 1.75 - -
--------------------------------------------------
Total $259,736,913 2.96% $101,939,729 4.06%
==================================================
The Company has a collateral pledge agreement whereby it agrees to keep on
hand, free of all other pledges, loans and encumbrances, performing loans with
unpaid principal balances aggregating no less than 167% of the outstanding FHLB
advances. All stock in the Federal Home Loan Bank of Chicago is also pledged as
additional collateral for advances.
The Company has a $40 million line of credit available through May 31,
2003, at 90-day LIBOR plus 1.35%. Outstanding advances under this line were
approximately $15.7 million at December 31, 2002 and 2001, respectively.
The Company issued $15 million of Trust Preferred Securities in October
2002. See Note 9 for further details.
The Company also has securities sold under repurchase agreements.
Securities sold under agreements to repurchase are entered into with customers
and nationally recognized securities dealers. Securities sold under agreements
to repurchase can have varying maturities. In exchange for the loan, the Company
pledges designated collateral, which consists generally of investment
securities, to the customer or securities dealer.
44
9. Long-term Debt - Trust Preferred Securities
In the fourth quarter of 2002 the Company formed SFSC Capital Trust I
("SFSCCT"), a wholly-owned subsidiary, which issued and sold $15 million of
Trust Preferred Securities. The securities are reported on the consolidated
statement of financial condition as trust preferred debt and qualify as tier 1
capital under Federal Reserve Board guidelines. Interest expense on the Trust
Preferred Securities is also deductible for income tax purposes.
The securities accrue and pay distributions semi-annually at a variable
dividend rate adjusted quarterly based on the 90-day LIBOR plus 3.45%, which was
5.27% at December 31, 2002. The Trust Preferred Securities have a stated final
maturity of November 7, 2032 and are redeemable at the Company's option, at par,
on November 7, 2007 and quarterly thereafter.
10. Deposits
Remaining contractual maturities of time deposits for the years 2003
through 2007 and thereafter are $229.2 million, $56.9 million, $24.0 million,
$6.9 million, and $11.4 million, respectively.
11. Employee Benefit Plans
The Company has a noncontributory money purchase defined contribution
pension plan covering substantially all employees who meet certain minimum age
and service requirements. Annual contributions are fixed based on compensation
of participants. The Company's funding policy is to contribute annually the
maximum amount that can be deducted for federal income tax purposes. Company
contributions are made annually at the discretion of the board of directors and
amounted to $464,000 in 2002, $420,000 in 2001, and $365,000 in 2000. Plan
assets are invested in a diversified portfolio of high-quality debt and equity
investments.
The Company sponsors a 401(k) savings plan which covers all full-time
employees who have completed certain minimum age and service requirements.
Company contributions are discretionary. The Company has not made any
contributions for 2002, 2001, or 2000.
The Company has an Employee Stock Ownership Plan (ESOP) for the benefit of
employees meeting certain minimum age and service requirements. Company
contributions to the ESOP trust, which was established to fund the plan, are
made on a discretionary basis and are expensed to operations in the year
committed. The number of shares released to participants is determined based on
the annual contribution amount plus any dividends paid on unearned shares
divided by the market price of the stock at the contribution date.
The aggregate activity in the number of unearned ESOP shares follows:
2002 2001 2000
---------------------------------
Balance at beginning of year 349,187 375,501 375,501
Shares committed to be released 26,585 26,314 --
---------------------------------
Balance at end of year 322,602 349,187 375,501
=================================
At December 31, 2002, the fair value of unearned ESOP shares was $5.4
million. Total ESOP expense recognized for the years ended December 31, 2002,
2001, and 2000, was $425,000, $315,000, and $230,000, respectively.
The Company purchased bank owned life insurance on the lives of certain
employees. The Company is the beneficiary of the insurance policies. Increases
in the cash value of the policies, as well as insurance proceeds received, are
recorded in non-interest income, and are not subject to income taxes.
45
12. Income Taxes
The Company and its subsidiaries file a consolidated federal income tax
return. The subsidiaries provide for income taxes on a separate-return basis and
remit to the Company amounts determined to be currently payable or realize the
benefit they would be entitled to on such a basis. The Company and subsidiaries
file separate state income tax returns for Wisconsin and a combined state return
for Illinois.
Significant components of the provision for income taxes are as follows:
2002 2001 2000
----------------------------------------
Current Federal expense $4,663,893 $3,131,415 $1,078,388
Current State expense 638,000 826,000 275,000
----------------------------------------
5,301,893 3,957,415 1,353,388
Deferred Federal expense (benefit) (425,000) (147,000) 469,000
Deferred State expense (benefit) (83,000) (86,000) 103,000
----------------------------------------
(508,000) (233,000) 572,000
----------------------------------------
$4,793,893 $3,724,415 $1,925,388
========================================
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities as of December 31, 2002 and
2001 are as follows:
2002 2001
-------------------------
Deferred tax assets:
Federal net operating loss carryforwards $143,000 $244,000
State net operating loss carryforwards 883,000 805,000
Allowance for loan loss 3,122,000 2,211,000
Accumulated depreciation 55,000 218,000
Unearned income 9,000 35,000
Deferred loan fees 101,000 68,000
Other 4,000 139,000
-------------------------
4,317,000 3,720,000
Valuation allowance for deferred tax assets (910,000) (842,000)
-------------------------
Net deferred tax assets 3,407,000 2,878,000
Deferred tax liabilities:
Unrealized gain on available-for-sale securities 3,358,000 1,186,000
FHLB dividends 728,000 521,000
Purchase accounting 829,000 1,015,000
-------------------------
Total deferred tax liabilities 4,915,000 2,722,000
-------------------------
Net deferred tax asset (liability) $(1,508,000) $156,000
=========================
46
Income tax expense differs from that computed at the federal statutory
corporate tax rate as follows:
2002 2001 2000
--------------------------------------
Income before income taxes $15,946,716 $7,858,657 $4,923,121
======================================
Income tax expense at the federal
statutory rate $5,421,883 $2,671,943 $1,673,861
Increase (decrease) resulting from:
Tax-exempt interest income (916,000) (832,000) (679,000)
State income taxes, net of federal
income tax benefit 366,000 488,000 267,000
Nondeductible merger-related expenses - 32,000 -
Goodwill amortization - 1,382,000 698,000
Bank owned life insurance (102,000) - -
Increase (decrease) in valuation
allowance for deferred tax assets (33,000) 62,000 33,000
Other 57,010 (79,528) (67,578)
--------------------------------------
Income taxes $4,793,893 $3,724,415 $1,925,283
======================================
At December 31, 2002, the Company had federal net operating loss
carryforwards of approximately $365 thousand and state net operating loss
carryforwards of approximately $17.3 million. The federal net operating loss
carryforwards and $694 thousand of state net operating loss carryforwards are
subject to an annual limitation of approximately $230 thousand and are available
to reduce future tax expense through the year ending December 31, 2009. The
remaining state net operating loss carryforwards expire in years 2003 through
2017.
Retained earnings at December 31, 2002 and 2001 include $4.8 million for
which no provision for federal income tax has been made. A prior subsidiary
acquisition qualified under provisions of the Internal Revenue Code that
permitted it to deduct from taxable income an allowance for bad debts that
differed from the provision for losses charged to income for financial reporting
purposes. If income taxes had been provided, the deferred tax liability would
have been approximately $1.8 million.
13. Restrictions on Subsidiary Dividends, Loans or Advances
Dividends paid by the Company are derived, mainly, from dividends provided
by the Bank. Certain restrictions exist limiting the ability of the Bank to
transfer funds to the Company in the form of cash dividends, loans or advances.
The Bank's primary regulator must approve the payment of dividends in excess of
certain levels of the Bank's retained earnings. As of December 31, 2002, the
Bank had net retained earnings of approximately $7.6 million, available for
distribution to the Company without prior regulatory approval.
Federal Reserve Bank regulations place limits on loans to affiliates,
including the Company, unless such loans are collateralized by specific
obligations. The aggregate limit for any one affiliate is 10% of the Bank's
capital stock and surplus. In the case of all affiliates, the aggregate amount
to all affiliates may not exceed 20% of the capital stock and surplus of the
Bank.
14. Shareholders' Equity - Preferred Share Purchase Rights
On July 27, 1999, the Board of Directors of the Company declared a dividend
of one preferred share purchase right (a Right) for each outstanding share of
common stock, $.10 par value, of the Company. Each Right entitles the registered
holder to purchase from the Company one one-thousandth of a share of Class A
Preferred Stock, $1.00 par value (the Preferred Shares), of the Company at a
price of $70 per one one-thousandth of a Preferred Share, subject to adjustment.
The Rights are not exercisable until the earlier to occur of (i) a public
announcement that a person or group of affiliated or associated persons has
acquired beneficial ownership of 15% or more of the outstanding Common Shares or
(ii) ten business days following the commencement of, or announcement of an
intention to make, a tender offer or exchange offer the consummation of which
would result in the beneficial ownership by a person or group of 15% or more of
such outstanding Common Shares. The Rights will expire on July 27, 2009.
47
Each Preferred Share will be entitled to a minimum preferential quarterly
dividend payment of $10.00 per share but will be entitled to an aggregate
dividend of 1,000 times the dividend declared per Common Share. In the event of
liquidation, the holders of the Preferred Shares will be entitled to a minimum
preferential liquidation payment of $1,000 per share but will be entitled to an
aggregate payment of 1,000 times the payment made per Common Share. Each
Preferred Share will have 1,000 votes, voting together with the Common Shares.
Finally, in the event of any merger, consolidation or other transaction in which
Common Shares are exchanged, each Preferred Share will be entitled to receive
1,000 times the amount received per Common Share. These rights are protected by
customary antidilution provisions. Because of the nature of the Preferred
Shares' dividend, voting and liquidation rights, the value of the one
one-thousandth interest in a Preferred Share purchasable upon exercise of each
Right should approximate the value of one Common Share.
15. Financial Instruments With Off-Balance-Sheet Risk
Loan commitments and standby letters of credit are credit facilities the
Bank offers to its customers. These facilities commit the Bank to lend money to,
or make payments on behalf of its customers if certain specified events occur at
a future date. Both facilities are subject to credit risk. Management recognizes
this risk and requires that all requests be underwritten following the Bank's
standard credit underwriting guidelines.
As of December 31, 2002, the Bank had outstanding loan commitments and
letters of credit of $160.3 million and $4.0 million, respectively. Loan
commitments and standby letters of credit were $127.4 million and $4.6 million,
respectively, at December 31, 2001.
16. Leases
The Company rents space for some of its banking facilities under operating
leases. Certain leases include renewal options and provide for the payment of
building operating expenses and additional rentals based on adjustments due to
inflation. Rent expense under operating leases totaled approximately $815,000,
$637,000, and $552,000 in 2002, 2001, and 2000, respectively.
Future minimum payments for the years indicated under noncancellable
operating leases with initial terms of one year or more consisted of the
following at December 31, 2001:
2003 $606,000
2004 579,000
2005 565,000
2006 515,000
2007 449,000
Thereafter 1,716,000
-----------
$4,430,000
===========
Minimum rentals for 2003 include $110 thousand for space used by the
Company, which is leased from a partnership, two partners of which are also
directors of the Company.
17. Commitments and Contingent Liabilities
The Company is involved in various legal actions arising in the normal
course of business. Management, after taking into consideration legal counsel's
evaluation of such actions, is of the opinion that the outcome of these matters
will not have a material adverse effect on the financial position or operations
of the Company.
18. Regulatory Capital
National banks and bank holding companies are subject to various capital
guidelines as set forth by regulation. Under the capital adequacy guidelines and
the regulatory framework for prompt corrective action, banks and holding
48
companies must meet specific standards that involve quantitative measures of the
bank's assets, liabilities and certain off-balance sheet items as calculated
under accepted accounting practices. These assets and liabilities of the Company
and Bank are also subject to qualitative assessment by regulators.
Minimum capital standards are established by regulation, however, the
Office of the Comptroller of the Currency (OCC) is authorized to establish
minimum capital requirements for a bank, at its discretion, that it deems
appropriate in light of the particular circumstances for a given bank. In either
case, the OCC will implement mandatory corrective action if capital ratios fall
below the minimum standards.
Quantitative measures require the Bank and Company to maintain minimum
amounts and ratios of total and Tier I capital to risk-weighted assets, and Tier
I capital to average assets (as defined in the regulations and set forth in the
table below). Management believes that, as of December 31, 2002, the Bank and
the Company met or exceeded all regulatory capital adequacy requirements.
In 2002 the Bank's regulators provided a notification that categorized the
Bank and Company as "well capitalized" under the regulatory framework. The
categories are set forth in the following table. There have been no changes in
the financial condition of the Bank or Company, since receiving the notification
that would cause a change in the category of either entity.
The Bank's and Company's "minimum," "well capitalized" and actual capital
amounts and ratios are presented in the table (dollars in thousands):
Minimum Well Capitalized
For Capital For Capital
Adequacy Purposes Adequacy Purposes Actual
-------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
-------------------------------------------------------
As of December 31, 2002:
Total Capital (to Risk Weighted Assets):
Consolidated $71,818 8% $89,773 10% $94,517 10.5%
Bank 71,241 8 89,051 10 103,055 11.6
Tier I Capital (to Risk Weighted Assets):
Consolidated 35,909 4 53,864 6 85,712 9.5
Bank 35,621 4 53,431 6 94,250 10.6
Tier I Capital (to Average Assets):
Consolidated 50,566 4 63,208 5 85,712 6.8
Bank 50,070 4 62,588 5 94,250 7.5
As of December 31, 2001:
Total Capital (to Risk Weighted Assets):
Consolidated $59,754 8% $74,692 10% $83,919 11.2%
Bank 59,263 8 74,078 10 94,204 12.7
Tier I Capital (to Risk Weighted Assets):
Consolidated 29,877 4 44,815 6 76,019 10.2
Bank 29,631 4 44,447 6 86,304 11.7
Tier I Capital (to Average Assets):
Consolidated 46,065 4 57,582 5 76,019 6.6
Bank 45,697 4 57,121 5 86,304 7.6
49
19. Stock Plans and Options
The Company's Stock Incentive Plan allows for grants of restricted stock,
incentive stock options and nonqualified options to officers, directors, and key
consultants of the Company. Options are exercisable at a price equal to the fair
market value of the shares at the time of the grant. Options must be exercised
within ten years after grant.
A summary of all restricted stock and stock option transactions follows:
Number of
Shares of Number Total
Restricted of Stock Number
Stock Price Options Price of Shares
-----------------------------------------------------------------
Balance at January 1, 2000 3,153 $7.67-$21.88 687,370 $3.86-$21.88 690,523
Vested restricted stock 943 7.67-21.88 - - 943
Exercised - - 15,334 3.86-8.10 15,334
Canceled 290 8.10 358,858 9.26-21.88 359,148
-----------------------------------------------------------------
Balance at December 31, 2000 1,920 $15.69-$21.88 313,178 $6.63-$21.88 315,098
Granted - - 134,410 10.13 134,410
Acquired - - 23,027 5.28-6.55 23,027
Exercised - - 1,041 8.11-10.13 1,041
Canceled - - 12,234 9.26-15.69 12,234
-----------------------------------------------------------------
Balance at December 31, 2001 1,920 $15.69-$21.88 457,340 $5.28-$21.88 459,260
Granted - - 170,430 13.00 170,430
Vested restricted stock 630 15.69-21.88 - - 630
Exercised - - 13,247 5.63-10.13 13,247
Canceled - - 7,876 6.88-21.88 7,876
-----------------------------------------------------------------
Balance at December 31, 2002 1,290 $15.69-$21.88 606,647 $5.28-$21.88 607,937
=================================================================
At December 31, 2002, the weighted-average remaining contractual life of
outstanding options was 6.57 years at a weighted-average exercisable price of
$13.71 per share compared to seven years and a price of $13.78 per share at
December 31, 2001.
20. Fair Values of Financial Instruments
Fair value information about financial instruments, whether or not
recognized in the statement of condition, for which it is practicable to
estimate that value follows. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows.
In that regard, the derived fair value estimates cannot be substantiated by
comparison to independent markets and, in many cases, could not be realized in
immediate settlement of the instrument. Certain financial instruments and all
nonfinancial instruments are excluded from the following disclosures.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company.
The Company does not routinely measure the market value of financial
instruments, because such measurements represent point-in-time estimates of
value. It is not the intent of the Company to liquidate and therefore realize
the difference between market value and carrying value and, even if it were,
there is no assurance that the estimated market values could be realized. Thus,
the information presented is not particularly relevant to predicting the
Company's future earnings or cash flows.
50
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and Cash Equivalents. The carrying amounts reported in the
consolidated statements of financial condition for cash and cash equivalents
approximate those assets fair values.
Investment Securities. Fair values for investment securities are based on
quoted market prices, where available.
Loans. For variable-rate mortgage loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying values. The
fair values for commercial, commercial real estate and fixed-rate mortgage,
consumer and other loans are estimated using discounted cash flow analyses,
using interest rates currently being offered for loans with similar terms to
borrowers of similar credit quality.
Deposits. The fair values disclosed for interest and noninterest checking
accounts, savings accounts, and money market accounts are, by definition, equal
to the amount payable on demand at the reporting date (i.e., their carrying
amounts). The fair values for fixed-rate certificates of deposit are estimated
using a discounted cash flow calculation that applies interest rates currently
being offered on certificates to a schedule of aggregated expected monthly
maturities of the outstanding certificates of deposit.
Securities Sold Under Agreement to Repurchase and Federal Funds Purchased.
The carrying amounts of securities sold under agreement to repurchase and
federal funds purchased approximate their fair value.
Accrued Interest Receivable and Payable. The carrying amounts reported in
the consolidated statements of financial condition for accrued interest
receivable and payable approximate their fair values.
Note Payable. The carrying values of the Company's note payable approximate
fair value.
Off-Balance-Sheet Instruments. Commitments to extend credit are agreements
to lend to a customer as long as there is no violation of any condition
established in the contract. Commitments generally have fixed expiration dates
or other termination clauses and generally require payment of a fee. As a
consequence, the estimated fair value of the commitments is approximately equal
to the related fee received, which is nominal.
The carrying amounts and fair values of the Company's financial instruments
consist of the following at December 31, 2002 and 2001:
2002 2001
--------------------------------------------------------------
Carrying Amount Fair Value Carrying Amount Fair Value
--------------------------------------------------------------
Cash and due from banks $56,767,916 $56,767,916 $54,541,162 $54,541,162
Interest-bearing bank balances 2,040,592 2,040,592 1,402,789 1,402,789
Federal funds sold 8,708,297 8,708,297 38,605,567 38,605,567
Investment securities 423,586,914 423,633,311 261,746,070 261,794,589
Loans held for sale 31,750,135 31,750,135 23,192,133 23,192,133
Loans 703,968,455 721,345,223 722,593,419 732,303,259
Accrued interest receivable 8,048,134 8,048,134 5,599,880 5,599,880
Deposits 940,873,682 946,503,862 954,458,748 961,070,083
Notes payable 15,700,000 15,700,000 15,652,776 15,652,776
Trust preferred securities 15,000,000 15,000,000 - -
Securities sold under agreement to repurchase 126,636,913 126,636,913 18,586,952 18,586,952
Federal funds purchased 10,000,000 10,000,000 - -
Federal Home Loan Bank advances 92,400,000 92,400,000 67,700,000 67,700,000
Accrued interest payable 2,191,711 2,191,711 2,449,482 2,449,482
51
21. State Financial Services Corporation (Parent Company Only) Financial
Information
Financial statements of the Parent Company Only at December 31, 2002 and
2001, and for the three years ended December 31, 2002, follow:
STATEMENTS OF CONDITION
December 31
2002 2001
------------------------------
Assets
Cash and cash equivalents $755,394 $753,995
Investments:
Available-for-sale 4,711,717 3,528,758
Held-to-maturity 100,000 100,000
Investment in Subsidiaries 128,402,059 116,614,125
Recoverable income taxes 2,109,817 1,098,628
Fixed assets 138,460 185,023
Other assets 1,774,885 1,316,900
------------------------------
Total assets $137,992,332 $123,597,429
==============================
Liabilities
Accrued expenses and other liabilities $2,359,672 $1,584,553
Notes payable 15,700,000 15,652,776
Trust preferred securities 15,000,000 -
------------------------------
Total liabilities 33,059,672 17,237,329
Shareholders' equity
Common stock 940,632 1,010,877
Additional paid-in capital 83,157,808 94,797,858
Retained earnings 54,288,325 46,587,268
Accumulated other comprehensive income 6,518,045 2,302,673
Unearned shares held by ESOP (4,160,060) (4,473,357)
Treasury stock (35,812,090) (33,865,219)
------------------------------
Total shareholders' equity 104,932,660 106,360,100
------------------------------
Total liabilities and shareholders' equity $137,992,332 $123,597,429
==============================
52
21. State Financial Services Corporation (Parent Company Only) Financial
Information (continued)
STATEMENTS OF INCOME
Year ended December 31
2002 2001 2000
-------------------------------------------
Income:
Dividends $5,000,000 $8,800,000 $42,800,000
Interest 424,292 561,421 689,551
Management fees 2,266,294 1,592,244 1,596,031
Other 335,555 936,861 207,483
-------------------------------------------
8,026,141 11,890,526 45,293,065
Expenses:
Interest 907,105 1,275,554 3,145,229
Other 4,250,770 3,402,920 2,316,311
-------------------------------------------
5,157,875 4,678,474 5,461,540
-------------------------------------------
Income before income tax credit
and equity in undistributed
net income of subsidiaries 2,868,266 7,212,052 39,831,525
Income tax credit 684,846 521,880 1,003,289
-------------------------------------------
3,553,112 7,733,932 40,834,814
-------------------------------------------
Equity in undistributed net
income of subsidiaries 7,599,711 (3,599,690) (37,836,976)
-------------------------------------------
Net income $11,152,823 $4,134,242 $2,997,838
===========================================
53
21. State Financial Services Corporation (Parent Company Only) Financial
Information (continued)
STATEMENTS OF CASH FLOWS
Year ended December 31
2002 2001 2000
------------------------------------------------
Operating activities:
Net income $11,152,823 $4,134,242 $2,997,838
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed income (7,599,711) 3,599,690 37,836,976
Depreciation 81,862 105,347 107,774
Decrease (increase) in recoverable income (1,011,189) 1,531,646 542,657
Realized investment securities gains, net (286,178) (879,148) (167,561)
Other 303,145 (266,274) 777,089
------------------------------------------------
Net cash provided by operating activities 2,640,752 8,225,503 42,094,773
Investing activities:
Purchases of securities available-for-sale (3,400,150) (2,488,148) (1,376,608)
Maturities of securities available-for-sale - - 22,674
Sales of securities available for sale 2,544,509 5,077,456 769,564
Decrease (increase) in loans receivable from
subsidiaries - 288,840 (46,854)
Purchases of premises and equipment (35,299) (35,095) (173,206)
Acquisition of subsidiaries - (11,230,387) -
Additional investment in subsidiaries - (433,465) -
------------------------------------------------
Net cash used by investing activities (890,940) (8,820,799) (804,430)
Financing activities:
Proceeds (repayment) of note payable 47,224 6,677,526 (32,649,359)
Proceeds of trust preferred securities 15,000,000 - -
Decrease in guaranteed ESOP obligation 304,359 658,251 -
Cash dividends (3,451,768) (3,592,508) (3,764,804)
Purchase of treasury stock (1,946,871) (2,523,793) (6,104,944)
Repurchase of common stock (11,808,968) - -
Proceeds from exercise of stock options 107,611 10,176 105,908
------------------------------------------------
Net cash provided (used) by financing activities (1,748,413) 1,229,652 (42,413,199)
------------------------------------------------
Increase (decrease) in cash and cash equivalents 1,399 634,356 (1,122,856)
Cash and cash equivalents at beginning of year 753,995 119,639 1,242,495
------------------------------------------------
Cash and cash equivalents at end of year $755,394 $753,995 $119,639
================================================
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors. The information required by this item with respect to directors
and Section 16 compliance is contained under the captions "Proposal No.1.
Election of Directors--Directors" and "Miscellaneous Section 16(a)
54
Beneficial Ownership Reporting Compliance," respectively, in the Proxy Statement
and is hereby incorporated by reference.
Executive Officers. The information required by this item with respect to
executive officers appears in Part I of this Annual Report.
ITEM 11. EXECUTIVE COMPENSATION
The information contained under the captions "Proposal No.1. Election of
Directors--Compensation of Directors" and "Compensation of Executive Officers"
in the Proxy Statement is incorporated herein by reference; provided, however,
that the information under the subheading "Board of Directors Report on
Executive Compensation" shall not be deemed to be incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF DIRECTORS, EXECUTIVE OFFICERS, AND BENEFICIAL
OWNERS
Equity Compensation Plan Information
The following table provides information about the Company's equity
compensation plans (including individual compensation arrangements) as of
December 31, 2002.
Number of Number of securities
securities to remaining available for
be issued upon Weighted-average future issuance under
the exercise exercise price equity compensation
of outstanding of outstanding plans (excluding
options, warrants options, warrants securities reflected
Plan category and rights(1) and rights in the first column)(2)
- --------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders 589,377 $13.95 453,605
Equity compensation plans not
approved by security
holders(3) 17,270 $5.49 --
- --------------------------------------------------------------------------------------------------
Total 606,647 $13.71 453,605
==================================================================================================
(1) Represents options to purchase the Company's Common Stock granted under the Company's 1990
Stock Option/Stock Appreciation Rights and Restricted Stock Plan for Key Officers and
Employees, 1990 Director Stock Option Plan and 1998 Stock Incentive Plan, the Home Bancorp of
Elgin, Inc. 1997 Stock Option Plan (4) and the Liberty Bank 1994 Stock Option Plan.
(2) Includes -0- shares of the Company's Common Stock available for issuance under the Company's
1990 Stock Option/Stock Appreciation Rights and Restricted Stock Plan for Key Officers and
Employees, and 1990 Director Stock Options Plan, 453,605 shares of the Company's Common Stock
available for issuance under the Company's 1998 Stock Incentive Plan, -0- shares of the
Company's Common Stock available for issuance under the Home Bancorp of Elgin, Inc. 1997
Stock Option Plan, and -0- shares of the Company's Common Stock available for issuance under
the Liberty Bank 1994 Stock Option Plan.
(3) In connection with the June 2001 acquisition of Liberty Bank, the Company adopted the Liberty
Bank 1994 Stock Option Plan and assumed certain options granted thereunder to three employees
of Liberty Bank, which options were converted into options to purchase shares of the
Company's Common Stock at a conversion ratio based on the consideration paid in connection
with the acquisition. Shareholder approval was not required for the adoption of the Liberty
Bank 1994 Stock Option Plan or assumption of the options granted thereunder. Other than
shares subject to the options assumed by the Company under the Liberty Bank 1994 Stock Option
Plan, no other shares of the Company's Common Stock are available for grant thereunder. Each
of the assumed options were issued by Liberty Bank as incentive stock options under the
requirements Section 422 of the Internal Revenue Code with an exercise price equal to 100% of
fair market value of shares of Liberty Bank common stock on the date of grant. All of the
assumed options are fully vested and exercisable. A copy of the Liberty Bank 1994 Stock
Option Plan is included as an exhibit to this Annual Report on Form 10-K.
(4) The Home Bancorp of Elgin, Inc. 1997 Stock Option Plan was assumed by the Company as part of
the Merger Agreement between the Company and Home Bancorp of Elgin, Inc. approved by the
Company's shareholders on November 5, 1998.
The information contained under the caption "Proposal 1. Election of
Directors--Security Ownership of Management and Certain Beneficial Owners" in
the Proxy Statement is incorporated herein by reference.
55
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained under the caption "Proposal 1. Election of
Directors--Certain Transactions and Other Relationships with Management and
Principal Shareholders" in the Proxy Statement is incorporated herein by
reference.
ITEM 14. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. Our Chief Executive
Officer and our Chief Financial Officer, based on their evaluation of the
effectiveness of our disclosure controls and procedures as of a date within 90
days of the filing of this Annual Report on Form 10-K, have concluded that our
disclosure controls and procedures were adequate and effective to ensure that
material information relating to the company and its consolidated subsidiaries
would be made known to them by others within those entities.
Changes in internal controls. There were no significant changes in our
internal controls or in other factors that could significantly affect our
disclosure controls and procedures subsequent to the date of their evaluation,
nor were there any significant deficiencies or material weaknesses in our
internal controls. As a result, no corrective actions were required or
undertaken.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed:
1. Financial Statements. The Consolidated Financial Statements of
the Company and subsidiaries, for the year ended December 31,
2002, are set forth in Item 8.
2. Financial Statement Schedules. Schedules to the Consolidated
Financial Statements required by Article 9 of Regulation S-X are
not required under the related instructions or are inapplicable,
and therefore have been omitted.
3. Exhibits. See Exhibit Index, which is filed with this Form 10-K
following the signature page and is incorporated herein by
reference.
(b) Reports on Form 8-K:
On November 19, 2002, State Financial Services Corporation (the
"Company") filed a Current Report on Form 8-K, including a press
release announcing that Timothy L. King, the Company's Senior Vice
President and Chief Financial Officer, died of natural causes on
November 18, 2002 at age 57.
(c) Exhibits:
See Exhibit Index, which is filed with this Form 10-K following the
signature page and is incorporated herein by reference.
(d) Financial Statement Schedules:
None.
56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
STATE FINANCIAL SERVICES CORPORATION
By: /s/ Michael J. Falbo
-------------------------------------
Michael J. Falbo,
President and Chief Executive Officer
Date: March 14, 2003
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Principal Executive and Financial Officers
/s/ Michael J. Falbo President and Chief March 14, 2003
- --------------------------- Executive Officer
Michael J. Falbo
/s/ Daniel L. Westrope Senior Vice President March 14, 2003
- --------------------------- and Chief Financial Officer
/s/ Michael A. Reindl Senior Vice President March 14, 2003
- --------------------------- and Treasurer
Michael A. Reindl
Directors
/s/ Jerome J. Holz Director March 14, 2003
- ---------------------------
Jerome J. Holz
/s/ Michael J. Falbo Director March 14, 2003
- ---------------------------
Michael J. Falbo
/s/ Robert J. Cera Director March 14, 2003
- ---------------------------
Robert J. Cera
/s/ Richard A. Horn Director March 14, 2003
- ---------------------------
Richard A. Horn
/s/ Ulice Payne, Jr. Director March 14, 2003
- ---------------------------
Ulice Payne, Jr.
/s/ Thomas S. Rakow Director March 14, 2003
- ---------------------------
Thomas S. Rakow
/s/ David M. Stamm Director March 14, 2003
- ---------------------------
David M. Stamm
/s/ Barbara E. Weis Director March 14, 2003
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Barbara E. Weis
57
CERTIFICATION
I, Michael J. Falbo, certify that:
1. I have reviewed this annual report on Form 10-K of State Financial Services
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 14, 2003 /s/ Michael J. Falbo
Michael J. Falbo
President and Chief Executive Officer
58
CERTIFICATION
I, Daniel L. Westrope, certify that:
1. I have reviewed this annual report on Form 10-K of State Financial Services
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 14, 2003 /s/ Daniel L. Westrope
Daniel L. Westrope
Senior Vice President and Chief Financial Officer
59
STATE FINANCIAL SERVICES CORPORATION
EXHIBIT INDEX
TO
ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED December 31, 2002
NOTE: To maintain a set of exhibit reference numbers consistent with
Registrant's prior filings under the Securities Act of 1933 and the
Securities Act of 1934, Registrant has intentionally omitted exhibit
reference numbers which pertain to exhibits which are not applicable or
in effect. Except as specifically noted below, all of the exhibits
identified are filed herewith.
Exhibit
Number Description
2.1 Agreement and Plan of Merger, dated as of June 1, 1998, by and between
Registrant and Home Bancorp of Elgin, Inc. (11)
2.2 Agreement and Plan of Reorganization between Registrant and Eastbrook
State Bank, dated January 22, 1992, as amended and restated. (5)
2.3 Branch Purchase and Assumption Agreement between Eastbrook State Bank
and North Shore Bank, FSB, dated December 29, 1992. (1)
2.4 Agreement and Plan of Merger By and Among Registrant, WBAC, Inc., and
Waterford Bancshares, Inc. dated April 12, 1995. (6)
2.5 Agreement and Plan of Merger By and Among Registrant, RBI, Inc. and
Richmond Bancorp, Inc. (8)
2.6 Agreement and Plan of Merger By and Among Registrant, FWC Acquisition
Corp., and First Waukegan Corporation dated March 12, 1999. (12)
2.7 Agreement to Merge between State Financial Bank (Wisconsin), State
Financial Bank - Waterford (Wisconsin), State Financial Bank
(Illinois), Home Federal Savings and Loan Association of Elgin and
Bank of Northern Illinois, National Association under the charter of
Bank of Northern Illinois, National Association under the title of
State Financial Bank, National Association. (17)
2.8 Agreement and Plan of Merger, dated as of March 7, 2001, by and among
State Financial Services Corporation, State Financial Bank, National
Association, LB Bancorp, Inc. and Liberty Bank. (16)
3.1 Articles of Incorporation of the Registrant as Amended and Restated.
(14)
3.2 Bylaws of Registrant, as amended and restated effective January 27,
1998. (10)
4.1 Rights Agreement between State Financial Services Corporation and
Firstar Bank, N.A. dated July 27, 1999. (13)
4.2 Amended and Restated Certificate of Trust, dated October 29, 2002,
among Registrant, as Sponsor, Wilmington Trust Company, as Delaware
Trustee and Institutional Trustee, the administrators named therein
and the holders, from time to time, of undivided beneficial interests
in the assets of SFSC Capital Trust I. (18)
4.3 Indenture, dated October 29, 2002, between Registrant and Wilmington
Trust Company, as Trustee. (18)
4.4 Guarantee, dated October 29, 2002, between Registrant, as Guarantor,
and Wilmington Trust Company, as Guarantee Trustee. (18)
60
10.1 Lease between SFB (formerly State Bank, Hales Corners) and Hales
Corners Development Corporation (10708 West Janesville Road, Hales
Corners, Wisconsin). (2)
10.2 Lease between SFB (formerly State Bank, Hales Corners) and Hales
Corners Development Corporation (S76 W17655 Janesville Road, Muskego,
Wisconsin). (3)
10.3 Lease between SFB (formerly Edgewood Bank) and Edgewood Plaza Joint
Venture (4811 South 76th Street, Greenfield, Wisconsin). (3)
10.4 Lease between SFB (formerly University National Bank) and Northeast
Corporate Center (7020 North Port Washington Road, Milwaukee,
Wisconsin). (3)
10.5 Lease between SFB (formerly University National Bank) and Downer
Investments (2650 North Downer Avenue, Milwaukee, Wisconsin) (4)
10.6 Lease between SFB-Waterford and Mangold Investments, LLP (1050 North
Milwaukee Avenue, Burlington, Wisconsin). (9)
10.7 State Financial Services Corporation 1990 Stock Option/Stock
Appreciation Rights and Restricted Stock Plan for Key Officers and
Employees, as amended on March 10, 1993. (1)
10.8 State Financial Services Corporation 1990 Director Stock Option Plan,
as amended March 10, 1993. (1)
10.9 State Financial Services Corporation Supplemental Executive Retirement
Plan for Michael J. Falbo effective November 22, 1994. (7)
10.10 State Financial Services Corporation 1998 Stock Incentive Plan, as
amended. (14)
10.11 Liberty Bank 1994 Stock Option Plan (15)
10.12 Executive Employment and Consulting Agreement between State Financial
Services Corporation and Jerome J. Holz. (14)
10.13 Form of Key Executive Employment and Severance Agreement between State
Financial Services Corporation and each of Michael J. Falbo, Robert J.
Cera, Timothy L. King, Michael A. Reindl and Daniel L. Westrope. (14)
10.14 Form of Key Executive Employment and Severance Agreement between State
Financial Services Corporation and each of John B. Beckwith, Jeryl M
Sturino, Donna M. Bembenek, Thomas A. Lilly, and David G. Towe. (14)
21 Subsidiaries of Registrant.
23.1 Consent of Ernst & Young LLP.
99.1 Written Statement of the Chief Executive Officer pursuant to 18
U.S.C. ss. 1350.
99.2 Written Statement of the Chief Financial Officer pursuant to 18
U.S.C. ss. 1350.
99.3 Proxy Statement for the 2003 Annual Meeting of Shareholders [The Proxy
Statement for the 2003 Annual Meeting of Shareholders will be filed
with the Securities and Exchange Commission under Regulation 14A
within 120 days after the end of the Company's fiscal year. Except to
the extent specifically incorporated by reference, the Proxy Statement
for the 2003 Annual Meeting of Shareholders shall not be deemed to be
filed with the Securities and Exchange Commission as part of this
Annual Report on Form 10-K.]
61
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(1) Incorporated by reference from Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1992.
(2) Incorporated by reference from Registrant's registration statement on
Form S-1, Registration Number 33-31517, dated October 11, 1989.
(3) Incorporated by reference from Amendment No. 1 to the Registrant's
registration statement on Form S-1, dated December 6, 1989.
(4) Incorporated by reference from Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1991.
(5) Incorporated by reference from Exhibit 2.1 to Amendment No. 3 to
Registrant's registration statement on Form S-4, Registration Number
33-46280, dated May 3, 1992.
(6) Incorporated by reference from Amendment No. 2 to the Registrant's
registration statement on Form S-4, Registration Number 33-59665,
dated July 18, 1995.
(7) Incorporated by reference from Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1994.
(8) Incorporated by reference from Registrant's Current Report on Form
8-K, dated January 14, 1998.
(9) Incorporated by reference from Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1996.
(10) Incorporated by reference from Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1997.
(11) Incorporated by reference from Registrant's registration statement on
Form S-4, Registration Number 33-64375, dated September 25, 1998.
(12) Incorporated by reference from Registrant's Current Report on Form
8-K, dated March 12, 1999.
(13) Incorporated by reference from Registrant's Current Report on Form
8-K, dated July 27, 1999.
(14) Incorporated by reference from Registrant's Annual Report on Form 10-K
for the year ended December 31, 1999.
(15) Incorporated by reference from Registrant's registration statement on
Form S-8, Registration Number 333-67486, dated September 14, 2001.
(16) Incorporated by reference from Exhibit 2.1 of Registrant's Current
Report on Form 8-K, dated March 7, 2001.
(17) Incorporated by reference from Exhibit 2.7 to Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 2000.
(18) Incorporated by reference from Registrant's Tender Offer Statement on
Schedule TO, Dated November 1, 2002.
62
The issuer, State Financial Services Corporation, will furnish a copy of
any exhibit described above upon request and upon reimbursement to the issuer of
its reasonable expenses of furnishing such exhibit, which shall be limited to a
photocopying charge of $0.25 per page and, if mailed to the requesting party,
the cost of first-class postage.
63