UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period ended June 30, 2003
Commission File Number: 001-13735
------------------------
MIDWEST BANC HOLDINGS, INC.
(Exact name of Registrant as specified in its charter.)
DELAWARE 36-3252484
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
501 W. NORTH AVE.
MELROSE PARK, ILLINOIS 60160
(Address of principal executive offices) (ZIP code)
- --------------------------------------------------------------------------------
(708) 865-1053
(Registrant's telephone number, including area code)
Indicate by checkmark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [ ] No [X]
Indicate by checkmark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
- --------------------------------------------------------------------------------
CLASS OUTSTANDING AT JULY 30, 2003
- --------------------------------------------------------------------------------
Common, par value $.01 17,799,968
- --------------------------------------------------------------------------------
MIDWEST BANC HOLDINGS, INC.
FORM 10-Q
TABLE OF CONTENTS
Page Number
-----------
PART I
Item 1. Financial Statements............................................. 1
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk....... 33
Item 4. Controls and Procedures.......................................... 34
PART II
Item 1. Legal Proceedings................................................ 36
Item 2. Changes in Securities and Use of Proceeds........................ 36
Item 3. Defaults Upon Senior Securities.................................. 36
Item 4. Submission of Matters to a Vote of Security Holders.............. 36
Item 5. Other Information................................................ 36
Item 6. Exhibits and Reports on Form 8-K................................. 36
Form 10-Q Signature Page................................................... 38
i
MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
2003 2002
---- ----
ASSETS
Cash and cash equivalents $ 84,161 $ 49,687
Securities available-for-sale 950,833 651,873
Securities held-to-maturity 85,996 118,620
Loans 1,078,278 1,136,704
Allowance for loan losses (12,044) (20,754)
------------ -----------
Net loans 1,066,234 1,115,950
Cash value of life insurance 24,438 20,634
Premises and equipment, net 27,771 18,999
Other real estate 1,723 533
Core deposit and other intangibles, net 3,358 244
Goodwill 6,212 4,360
Other assets 34,336 28,147
------------ -----------
Total assets $ 2,285,062 $ 2,009,047
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits
Non-interest-bearing $ 148,478 $ 134,858
Interest-bearing 1,432,177 1,255,790
------------ -----------
Total deposits 1,580,655 1,390,648
Federal funds purchased 3,800 20,825
Securities sold under agreements to repurchase 193,092 185,057
Advances from the Federal Home Loan Bank 258,594 219,500
Trust preferred securities 35,000 35,000
Note payable 7,500 2,000
Due to broker 18,038 20,582
Other liabilities 28,515 20,484
------------ -----------
Total liabilities 2,125,194 1,894,096
------------ -----------
STOCKHOLDERS' EQUITY
Preferred stock - -
Common stock 187 171
Surplus 64,078 29,366
Retained earnings 97,731 87,105
Accumulated other comprehensive income 6,133 7,145
Treasury stock, at cost (8,261) (8,836)
------------ -----------
Total stockholders' equity 159,868 114,951
------------ -----------
Total liabilities and stockholders' equity $ 2,285,062 $ 2,009,047
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
PAGE 1
MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED JUNE 30, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2003 2002
---- ----
INTEREST INCOME
Loans $ 17,784 $ 18,695
Securities
Taxable 8,979 9,561
Exempt from federal income taxes 795 605
Federal funds sold and other short-term investments 18 43
----------- -----------
Total interest income 27,576 28,904
INTEREST EXPENSE
Deposits 7,647 8,537
Federal funds purchased and securities sold
under agreements to repurchase 1,531 1,154
Advances from the Federal Home Loan Bank 2,875 3,290
Note payable 38 51
Trust preferred securities 658 374
----------- -----------
Total interest expense 12,749 13,406
----------- -----------
Net interest income 14,827 15,498
Provision for loan losses 755 815
----------- -----------
Net interest income after provision for loan losses 14,072 14,683
OTHER INCOME
Service charges on deposits 1,434 1,403
Net gains on securities transactions 2,701 757
Net trading account profits 130 3
Option income 2,019 122
Mortgage banking fees 377 89
Insurance and brokerage commissions 556 394
Trust income 169 147
Increase in cash surrender value of life insurance 234 234
Other income 319 174
----------- -----------
Total other income 7,939 3,323
OTHER EXPENSES
Salaries and employee benefits 5,999 5,243
Occupancy and equipment 1,465 1,229
Professional services 1,279 615
Other expenses 1,929 1,377
----------- -----------
Total other expenses 10,672 8,464
----------- -----------
Income before income taxes 11,339 9,542
Provision for income taxes 3,548 3,154
NET INCOME $ 7,791 $ 6,388
=========== ===========
Basic earnings per share $ 0.44 $ 0.40
=========== ===========
Diluted earnings per share $ 0.43 $ 0.39
=========== ===========
Cash dividend declared per common share $ 0.10 $ 0.10
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
PAGE 2
MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
THREE MONTHS ENDED JUNE 30, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2003 2002
---- ----
Net income $ 7,791 $ 6,388
Net increase (decrease) in fair value of
securities classified as available-for-sale,
net of income taxes and reclassification adjustments (1,436) 6,107
-------- -- -----
Comprehensive income $ 6,355 $ 12,495
======== ========
See accompanying notes to unaudited consolidated financial statements.
PAGE 3
MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2003 2002
---- ----
INTEREST INCOME
Loans $ 38,184 $ 36,540
Securities
Taxable 17,718 19,382
Exempt from federal income taxes 1,589 991
Federal funds sold and other short-term investments 67 73
----------- -----------
Total interest income 57,558 56,986
INTEREST EXPENSE
Deposits 15,672 17,113
Federal funds purchased and securities sold
under agreements to repurchase 2,992 2,097
Advances from the Federal Home Loan Bank 5,722 6,593
Note payable 74 104
Trust preferred securities 1,305 748
----------- -----------
Total interest expense 25,765 26,655
----------- -----------
Net interest income 31,793 30,331
Provision for loan losses 1,745 1,477
----------- -----------
Net interest income after provision for loan losses 30,048 28,854
OTHER INCOME
Service charges on deposits 2,901 2,709
Net gains on securities transactions 2,803 1,295
Net trading account profits 130 348
Option income 3,016 654
Mortgage banking fees 665 231
Insurance and brokerage commissions 1,014 540
Trust income 304 295
Increase in cash surrender value of life insurance 491 468
Other income 677 343
----------- -----------
Total other income 12,001 6,883
OTHER EXPENSES
Salaries and employee benefits 12,051 10,242
Occupancy expense and equipment 3,226 2,385
Professional services 2,467 1,276
Other expenses 3,711 2,759
----------- -----------
Total other expenses 21,455 16,662
----------- -----------
Income before income taxes 20,594 19,075
Provision for income taxes 6,409 6,374
----------- -----------
NET INCOME $ 14,185 $ 12,701
=========== ===========
Basic earnings per share $ 0.80 $ 0.79
=========== ===========
Diluted earnings per share $ 0.78 $ 0.77
=========== ===========
Cash dividends declared per common share $ 0.20 $ 0.20
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
PAGE 4
MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2003 2002
---- ----
Net income $ 14,185 $ 12,701
Net increase (decrease) in fair value of
securities classified as available-for-sale,
net of income taxes and reclassification adjustments (1,012) 4,922
-------- --------
Comprehensive income $ 13,173 $ 17,623
======== ========
See accompanying notes to unaudited consolidated financial statements.
PAGE 5
MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE DATA)
ACCUMULATED
OTHER TOTAL
COMPRE- STOCK-
COMMON RETAINED HENSIVE TREASURY HOLDERS'
STOCK SURPLUS EARNINGS INCOME (LOSS) STOCK EQUITY
----- ------- -------- ------------- ----- ------
Balance, January 1, 2002 $ 114 $ 29,587 $ 77,256 $ (1,057) $ (9,686) $ 96,214
Cash dividends declared ($0.20
per share) - - (3,227) - - (3,227)
Purchase of 15,000 shares of
treasury stock - - - - (204) (204)
Issuance of common stock
upon acquisition and exercise of
stock options, net of tax benefit - (78) - - 1,185 1,107
Comprehensive income
Net income - - 12,701 - - 12,701
Net increase in fair value of
securities classified as available-
for sale, net of income taxes and
reclassification adjustments - - - 4,922 - 4,922
---------
Total comprehensive income 17,623
--------- --------- --------- -------- -------- ---------
Balance, June 30, 2002 $ 114 $ 29,509 $ 86,730 $ 3,865 $ (8,705) $ 111,513
========= ========= ========= ======== ======== =========
Balance, January 1, 2003 $ 171 $ 29,366 $ 87,105 $ 7,145 $ (8,836) $ 114,951
Cash dividends declared ($0.20
per share) - - (3,559) - - (3,559)
Issuance of 1,599,088 shares of
common stock upon acquisition of
Big Foot Financial Corp. 16 30,448 - - - 30,464
Issuance of common stock
upon exercise of
stock options, net of tax benefit - 231 - - 575 806
Capital contribution from loan
payoff by related parties - 4,033 - - - 4,033
Comprehensive income
Net income - - 14,185 - - 14,185
Net decrease in fair value of
securities classified as available-
for-sale, net of income taxes and
reclassification adjustments - - - (1,012) - (1,012)
---------
Total comprehensive income 13,173
--------- --------- --------- -------- -------- ---------
Balance, June 30, 2003 $ 187 $ 64,078 $ 97,731 $ 6,133 $ (8,261) $ 159,868
========= ========= ========= ======== ======== =========
See accompanying notes to unaudited consolidated financial statements.
PAGE 6
MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2003 AND 2002
(IN THOUSANDS)
2003 2002
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 14,185 $ 12,701
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 1,191 1,136
Provision for loan losses 1,745 1,477
Amortization of other intangibles 247 -
Amortization of premiums and discounts on securities, net 5,556 1,695
Net gain on sales of securities (2,803) (1,295)
Net gain on sales of trading account securities (130) (348)
Federal Home Loan Bank stock dividend (647) (360)
Originations of real estate loans held for sale (54,583) (22,469)
Proceeds from sales real estate loans originated held for sale 54,397 25,135
Increase in cash surrender value of life insurance (491) (468)
Deferred income taxes (2,300) -
Loss (gain) on sale of other real estate - (9)
Change in other assets 283 (3,669)
Change in other liabilities 15,334 5,797
----------- -----------
Net cash from operating activities 31,984 19,323
CASH FLOWS FROM INVESTING ACTIVITIES
Sales and maturities of securities available-for-sale 301,521 187,945
Principal payments on securities 196,078 82,409
Purchase of securities available-for-sale (766,976) (249,764)
Purchase of securities held-to-maturity (4,437) -
Maturities of securities held-to-maturity 1,900 900
Net (increase) decrease in loans 67,066 (86,181)
Proceeds from sale of mortgage loans 142,546 -
Cash received (paid), net of cash and cash equivalents in acquisition
and stock issuance 17,783 (1,008)
Proceeds from sale of other real estate 1,517 118
Property and equipment expenditures, net (706) (671)
----------- -----------
Net cash from investing activities (43,708) (66,252)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 52,278 124,397
Borrowings 5,500 3,800
Repayment of borrowings - (8,500)
Dividends paid (3,396) (3,219)
Change in securities sold under agreements to repurchase
and federal funds purchased (8,990) (28,198)
Repurchase of common stock - 620
Proceeds from exercised stock options 806 -
----------- -----------
Net cash from financing activities 46,198 88,900
----------- -----------
Increase in cash and cash equivalents 34,474 41,970
Cash and cash equivalents at beginning of period 49,687 49,812
----------- -----------
Cash and cash equivalents at end of period $ 84,161 $ 91,782
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
PAGE 7
MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(CONTINUED)
2003 2002
---- ----
Supplemental disclosures
Cash paid during the year for
Interest $ 26,146 $ 25,595
Income Taxes 3,575 5,678
Amount due to broker for purchases of securities 18,038 -
Real estate acquired in settlement of loans 2,707 16
Supplemental schedule of noncash investing activities
Acquisitions
Noncash assets acquired:
Investment securities available for sale $ 17,065 $ -
Loans, net 157,477 -
Premises and equipment, net 9,257 139
Goodwill, net 1,852 761
Other intangibles, net 3,361 300
Other assets 5,930 -
---------- ---------
Total noncash assets acquired $ 194,942 $ 1,200
========== =========
Liabilities assumed:
Deposits 137,729 -
FHLB advances 36,727 -
Accrued expenses and other liabilities 8,188 -
---------- ---------
Total liabilities assumed 182,644 -
---------- ---------
Net noncash assets acquired $ 12,103 $ 1,200
========== =========
Cash and cash equivalents acquired $ 19,688 $ -
========== =========
See accompanying notes to unaudited consolidated financial statements.
PAGE 8
NOTE 1 - BASIS OF PRESENTATION
The consolidated financial information of Midwest Banc Holdings, Inc.
(the "Company") included herein is unaudited; however, such information reflects
all adjustments (consisting only of normal recurring adjustments) which are, in
the opinion of management, necessary for a fair presentation for the interim
periods. The financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X.
The annualized results of operations for the three months and six
months ended June 30, 2003 are not necessarily indicative of the results
expected for the full year ending December 31, 2003.
NOTE 2 - BUSINESS COMBINATION AND MERGER TERMINATION
On January 3, 2003, the Company acquired Big Foot Financial Corp.
("BFFC") through the issuance of approximately 1,599,088 shares at $18.81 per
share, cash paid of $1.4 million, and incurred acquisition costs of $557,000,
resulting in total consideration of $32.0 million. This purchase price generated
approximately $1.9 million in goodwill. BFFC and its subsidiary were merged into
Midwest Bank and Trust Company and are operated as branches. At closing the
Company transferred $3.4 million of securities categorized as held-to-maturity
to available-for-sale under permissible provisions of FASB Statement No. 115.
During the first quarter of 2003, the Company sold the mortgage loans and
mortgage servicing rights of $141.9 million of the acquired loans on a
non-recourse basis.
The business combination is accounted for under the purchase method of
accounting. Accordingly, the results of operations of the acquired company have
been included in the Company's results of operations since the date of
acquisition. Under this method of accounting, the purchase price is allocated to
the respective assets acquired and liabilities assumed based on their estimated
fair values. The excess of purchase price over the net assets acquired is
recorded as goodwill. The purchase price allocation has not been finalized.
The following is the unaudited proforma consolidated results of
operation of the Company for the three months and six months ended June 30, 2002
as though BFFC had been acquired as of January 1, 2002.
(In thousands, except per share data)
QTD YTD
--- ---
Net interest income $17,603 $34,416
Net income 6,682 13,384
Basic Earnings per share 0.38 0.76
Diluted Earnings per share 0.37 0.74
On November 1, 2002, the Company entered into an agreement with CoVest
Bancshares, Inc. ("CoVest") and its subsidiary, CoVest Bank N.A. which provided
for the acquisition of CoVest by the Company in a cash and stock merger
transaction. The Company announced on July 1, 2003 that the parties had mutually
agreed to terminate the merger agreement effective June 30, 2003 due to the
inability of the parties to agree upon the terms of an extension. Included in
other expenses are $425,000 of capitalized costs relating to the merger.
NOTE 3 - GOODWILL AND INTANGIBLES
On January 1, 2002, the Company implemented Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets. Under the
provisions of SFAS No. 142, goodwill is no
PAGE 9
longer subject to amortization over its estimated useful life, but instead is
subject to at least annual assessments for impairment by applying a fair-value
based test. SFAS No. 142 also requires that an acquired intangible asset be
separately recognized if the benefit of the intangible asset is obtained through
contractual or other legal rights, or if the asset can be sold, transferred,
licensed, rented or exchanged, regardless of the acquirer's intent to do so. The
Company determined that no transitional impairment loss was required at
January 1, 2002.
Intangible asset disclosures are as follows (in thousands):
JUNE 30, 2003 DECEMBER 31, 2002
----------------------------------- ------------------------------------
GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
----------------- ----------------- ----------------- -----------------
AMORTIZED INTANGIBLE ASSETS:
Core deposit and other intangibles $ 3,661 $ (303) $ 300 $ (56)
AGGREGATE INTANGIBLE AMORTIZATION EXPENSE:
For the three months ended June 30, 2003 $ 124
For the six months ended June 30, 2003 247
ESTIMATED INTANGIBLE AMORTIZATION EXPENSE:
For the year ending December 31, 2003 $ 495
For the year ending December 31, 2004 495
For the year ending December 31, 2005 495
For the year ending December 31, 2006 439
For the year ending December 31, 2007 420
The following tables present the changes in the carrying amount of goodwill and
other intangibles during the six months ended June 30, 2003 and the year ended
December 31, 2002 (in thousands):
JUNE 30, 2003
----------------------------------------
GOODWILL CORE DEPOSIT AND
OTHER INTANGIBLES
-------------------- -------------------
Balance at beginning of period $ 4,360 $ 244
Amortization expense - (247)
Goodwill and intangibles acquired 1,852 3,361
-------------------- -------------------
Balance at end of period $ 6,212 $ 3,358
=================== ==================
DECEMBER 31, 2002
-----------------------------------------
GOODWILL CORE DEPOSIT AND
OTHER INTANGIBLES
-------------------- --------------------
Balance at beginning of year $ 3,524 $ -
Amortization expense - (56)
Goodwill and intangibles acquired 836 300
-------------------- --------------------
Balance at end of year $ 4,360 $ 244
=================== ===================
NOTE 4 - EARNINGS PER SHARE
For purposes of per share calculations, the Company had 17,799,968 and
16,156,434 shares of common stock outstanding at June 30, 2003 and 2002,
respectively. Basic earnings per share for the three months and six months ended
June 30, 2003 and 2002 were computed by dividing net income by the
PAGE 10
weighted average number of shares outstanding. Diluted earnings per share for
the three and six months ended June 30, 2003 and 2002 were computed by dividing
net income by the weighted average number of shares outstanding, adjusted for
the dilutive effect of the stock options. Computations for basic and diluted
earnings per share are provided below.
IN THOUSANDS 2003 QTD 2002 QTD 2003 YTD 2002 YTD
------------ -------- -------- -------- --------
Basic
Net income $ 7,791 $ 6,388 $ 14,185 $ 12,701
=========== =========== =========== ===========
Weighted average common shares outstanding 17,798 16,127 17,763 16,102
=========== =========== =========== ===========
Basic earnings per common share $ 0.44 $ 0.40 $ 0.80 $ 0.79
=========== =========== =========== ===========
Diluted
Net income $ 7,791 $ 6,388 $ 14,185 $ 12,701
=========== =========== =========== ===========
Weighted average common shares outstanding 17,798 16,127 17,763 16,102
Diluted effect of stock options 414 472 406 392
----------- ----------- ----------- -----------
Dilutive average common shares 18,212 16,599 18,169 16,494
=========== =========== =========== ===========
Diluted earnings per common share $ 0.43 $ 0.39 $ 0.78 $ 0.77
=========== =========== =========== ===========
All outstanding options were included in the computation of diluted
earnings per share for the quarters and six months ended June 30, 2003 and 2002.
During the second quarter of 2003, 103,000 stock options were granted at an
exercise price of $18.34.
NOTE 5 - STOCK OPTIONS
During the first six months of 2003, 103,000 stock options were granted
at an exercise price of $18.34. In addition, during 2003, there were 60,513
options exercised. The total stock options outstanding were 1,137,782 at June
30, 2003 with exercise prices ranging between $5.42 and $18.34 and expiration
dates between 2006 and 2013.
NOTE 6 - ISSUANCE OF TRUST PREFERRED SECURITIES
In May 2000, the Company formed MBHI Capital Trust I (the "Trust"). The
Trust is a statutory business trust formed under the laws of the State of
Delaware and is wholly owned by the Company. In June 2000, the Trust issued 10%
preferred securities with an aggregate liquidation amount of $20.0 million ($25
per preferred security) to third-party investors in an underwritten public
offering. The Company also issued 10% junior subordinated debentures aggregating
$20.0 million to the Trust. The junior subordinated debentures are the sole
assets of the Trust. The junior subordinated debentures and the preferred
securities pay interest and dividends, respectively, on a quarterly basis. The
junior subordinated debentures will mature on June 7, 2030, at which time the
preferred securities must be redeemed. The junior subordinated debentures and
preferred securities can be redeemed contemporaneously, in whole or in part,
beginning June 7, 2005 at a redemption price of $25 per preferred security. The
Company has provided a full, irrevocable, and unconditional guarantee on a
subordinated basis of the obligations of the Trust under the preferred
securities in the event of the occurrence of an event of default, as defined in
such guarantee.
In October 2002, the Company formed MBHI Capital Trust II (the "Trust
II"), a statutory trust formed under the laws of the State of Delaware and a
wholly owned financing subsidiary of the Company. In October 2002, Trust II
issued $15.0 million in aggregate liquidation amount of trust preferred
securities in a private placement offering. Simultaneously with the issuance of
the trust preferred securities by Trust II, the Company issued an equivalent
amount of junior subordinated debentures to Trust II. The junior subordinated
debentures are the sole assets of Trust II. The junior subordinated debentures
and the trust preferred securities pay distributions and dividends,
respectively, on
PAGE 11
a quarterly basis, which are included in interest expense. The interest rate
payable on the debentures and the trust preferred securities resets quarterly,
and is equal to LIBOR plus 3.45% (4.74% at June 30, 2003), provided that this
rate cannot exceed 12.5% through the interest payment date in November 2007. The
junior subordinated debentures will mature on November 7, 2032, at which time
the preferred securities must be redeemed. The Company has provided a full,
irrevocable, and unconditional guarantee on a subordinated basis of the
obligations of Trust II under the preferred securities as set forth in such
guarantee agreement.
NOTE 7 - DERIVATIVE INSTRUMENTS
As of June 30, 2003, the Company has entered into various interest rate
swap transactions, which result in the Company converting $67.5 million of its
Federal Home Loan Bank Advance fixed rate debt to floating rate debt. The swap
transactions require payment of interest by the Company at a rate equal to the
three-month LIBOR plus a spread and, in turn, the Company receives a fixed rate.
Summary information about interest rate swaps at June 30 are as
follows:
2003 2002
---- ----
(Dollars in thousands)
Notional amounts $ 67,500 $ 20,000
Weighted average fixed rates received 5.91% 4.59%
Weighted average variable rates paid 3.68 2.04
Weighted average maturity 7.00 years 3.41 years
Fair value $ 2,807 $ 428
The Company has also bought and sold various put and call options with
terms less than or equal to 90 days on mortgage-backed securities. These are
stand-alone derivatives that are carried at their estimated fair value with the
corresponding gain or loss recorded in option income. The Company had no options
outstanding at June 30, 2003 and 2002.
In August 2002, the Company entered into a credit derivative
transaction with a notional amount of $20 million for a term of five years,
maturing August 30, 2007. The credit swap has a credit rating of Aa2/AA by
Moody's and Standard and Poors. In November 2002, the Company entered a credit
derivative transaction with a notional amount of $30 million for a term of five
years, maturing November 27, 2007. The second credit swap has a credit rating of
Aa1/AAA by Moody's and Standard and Poors. The notional amount, which is the
Company's maximum credit risk, represents the maximum accounting loss that could
be recognized at the reporting date if actual defaults exceeded certain
thresholds. These are stand-alone derivatives with changes in the market value
charged or credited to earnings on a quarterly basis. The Company receives fee
income quarterly (1.25% of the notional amount on an annual basis) to cover
potential credit losses in the event that actual defaults incurred by each
underlying instrument exceed certain thresholds. On each inception date, the
Company received 1% of the notional amount as payment for entering into each
contract. There has been no material change at June 30, 2003 in the fair value
of $500,000 since the Company entered into these credit derivatives. In both
transactions, the underlying asset-backed security is $1 billion and is
diversified amongst 100 companies.
NOTE 8 - STOCK COMPENSATION
Employee compensation expense under stock options is reported using the
intrinsic value method. No stock-based compensation cost is reflected in net
income, as all options granted had an exercise price equal to or greater than
the market price of the underlying common stock at date of grant. The following
table illustrates the effect on net income and earnings per share if expense was
measured using the fair
PAGE 12
value recognition provisions of FASB Statement No. 123, "Accounting for
Stock-Based Compensation" for three and six months ended June 30, 2003 and 2002.
IN THOUSANDS 2003 QTD 2002 QTD 2003 YTD 2002 YTD
-------- -------- -------- --------
Net income as reported $ 7,791 $ 6,388 $ 14,185 $ 12,701
Deduct: stock-based compensation expense
determined under fair value base method 75 80 149 161
--------- ---------- ---------- ----------
Pro forma net income $ 7,716 $ 6,308 $ 14,036 $ 12,541
========= ========== ========== ==========
BASIC EARNINGS PER SHARE AS REPORTED $ 0.44 $ 0.40 $ 0.80 $ 0.79
Pro forma basic earnings per share 0.43 0.39 0.79 0.78
DILUTED EARNINGS PER SHARE AS REPORTED $ 0.43 $ 0.39 $ 0.78 $ 0.77
Pro forma diluted earnings per share 0.42 0.38 0.77 0.76
NOTE 9 - OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK
The Company is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet financing needs of customers.
Since many commitments to extend credit expire without being used, the amounts
below do not necessarily represent future cash commitments. These financial
instruments include commitments to extend credit, standby letters of credit, and
unused lines of credit. Included in the commitments to extend credit are the
notional amounts of the credit derivative transactions discussed in Note 7.
These are summarized as follows:
(In thousands) June 30, December 31,
2003 2002
---- ----
Financial instruments whose contract amounts
represent credit risk
Unused lines of credit $ 293,899 $ 249,988
Commitments to extend credit 100,890 94,594
Letters of credit 20,226 20,329
At June 30, 2003 and December 31, 2002, commitments to extend credit
consisted of $7,847,000 and $18,933,000 of fixed rate loan commitments. These
commitments are due to expire within 30 to 90 days of issuance and have rates
ranging primarily from 3.50% to 7.50%. Substantially all of the unused lines of
credit are at adjustable rates of interest.
The Company also had Community Reinvestment Act ("CRA") investment
commitments outstanding of $3.5 million. These commitments include $1.5 million
and $1.0 million to be funded over seven and six years for investment in the
Chicago Equity Fund and $1.0 million to be funded over nine years for investment
in the Illinois Equity Fund.
The credit risk amounts represent the maximum accounting loss that
would be recognized at the reporting date if counterparties failed completely to
perform as contracted and any collateral or security proved to be of no value.
The Company has experienced little difficulty in accessing collateral when
necessary. The amounts of credit risk shown therefore greatly exceed expected
losses.
PAGE 13
NOTE 10 - RECENT ACCOUNTING PRONOUNCEMENTS
Guarantees: The Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others, an
interpretation of FASB Statement Nos. 5, 57 and 107 and Rescission of FASB
Interpretation No. 34. This interpretation elaborates on the disclosures to be
made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also 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 certain
guarantees. The initial recognition and measurement provisions of the
Interpretation are applicable on a prospective basis to guarantees issued or
modified after December 15, 2002. The adoption of the provisions of this
Interpretation did not have a material impact on the Company's consolidated
financial statements during the quarter ended June 30, 2003.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities". FIN 46 clarifies the application of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements" to certain variable
interest entities (VIEs) in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. The recognition and
measurement provisions of this Interpretation are effective for newly created
VIEs formed after January 31, 2003, and for existing VIEs on the first interim
or annual reporting period beginning after June 15, 2003. The Company has no
newly formed VIEs subject to the January 31, 2003 effective date. The Company
will adopt the provisions of FIN 46 for existing VIEs on July 1, 2003. The
Company is in the process of determining whether its pre-existing balance sheet
and off-balance sheet structures are subject to the provisions of FIN 46. At
this time the Company does not believe that adoption of FIN 46 will have a
material effect on the Company's financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities" to amend and clarify
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities." In addition, this Statement requires that contracts with comparable
characteristics be accounted for similarly. This Statement is effective for
contracts entered into or modified after June 30, 2003 (with certain exceptions)
and for hedging relationships designated after June 30, 2003. At this time, the
Company does not believe that adoption of SFAS No. 149 will have a material
effect on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity,"
which affects the accounting for certain freestanding financial instruments
depending on the type of financial instrument. The following types of
freestanding financial instruments are affected by SFAS No. 150: 1.) mandatorily
redeemable shares for which the issuer is obligated to purchase those shares;
2.) obligations to repurchase the issuer's equity shares; and 3.) certain
obligations to issue a variable number of shares. This Statement is effective
for affected financial instruments issued or modified after May 31, 2003. For
those issued prior to May 31, 2002, the Statement is required to be applied for
periods beginning after December 15, 2003. At this time, the Company does not
believe that adoption of SFAS No. 150 will have a material effect on the
Company's financial statements.
NOTE 11 - CAPITAL CONTRIBUTION AND REGULATORY MATTERS
As previously reported by the Company, on March 26, 2003, Midwest Bank
and Trust Company ("Bank") received proceeds from an entity indirectly owned by
certain directors and family members of directors of the Bank of approximately
$13.3 million in connection with the sale of previously classified loans, which
consisted of $12.5 million of the loan principal balance, $750,000 for the
letter of credit and
PAGE 14
$67,000 of accrued interest and late charges. As a result, the Bank recognized a
$4.0 million after-tax capital contribution as a result of the sale of these
loans to the related parties. As of December 31, 2002, $6.3 million of the $12.5
million outstanding principal amount of these loans was considered impaired.
During March 2003, the Board of Directors of the Bank considered and
approved a proposal for extension of credit to this entity, but
management of the Bank has indicated that no commitment to extend such credit
has been issued and that the Bank presently has no plans to extend such credit.
In an April 10, 2003 letter to the Company, the Federal Reserve Bank of Chicago
and the Illinois Office of Banks and Real Estate indicated that they would
require the Bank to reserve (which could be treated as an other expense for
financial reporting purposes) as of March 31, 2003, on a dollar for dollar basis
up to $8 million, if the Bank had issued a commitment to extend such loan or if
representations had been made to the bankruptcy court of the Bank's willingness
to provide credit to fund a plan of reorganization for the borrowers. The
Company is presently in discussions with the Federal Reserve and OBRE concerning
this matter. Since the Bank has not issued a commitment to extend such credit
and presently has no plans to do so, no reserve has been established by the Bank
relating to this matter.
On April 24, 2003, the Federal Reserve and the OBRE completed their
regularly scheduled examination of the Company's banking subsidiaries. The
examination included, among other items, a review of the Company's over-all risk
management, lending and credit review practices. Based upon preliminary
discussions with the regulators, the Company expects some form of informal or
formal regulatory action will be taken. The Company expected to receive the
written examination report during the second quarter; however the examination
report has not yet been received.
PAGE 15
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is intended as a review of
significant factors affecting the financial condition and results of
operations of the Company for the periods indicated. The discussion should
be read in conjunction with the unaudited Consolidated Financial Statements
and the Notes thereto presented herein. In addition to historical
information, the following Management's Discussion and Analysis of
Financial Condition and Results of Operations contains forward-looking
statements that involve risks and uncertainties. The Company's actual
results could differ significantly from those anticipated in these
forward-looking statements as a result of certain factors discussed in this
report.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. By their nature, changes in these
assumptions and estimates could significantly affect the Company's financial
position or results of operations. Actual results could differ from those
estimates. Discussed below are those critical accounting policies that are of
particular significance to the Company.
Allowance for Loan Losses: The allowance for loan losses is a valuation
allowance for probable incurred credit losses, increased by the provision for
loan losses and decreased by charge-offs less recoveries. Management estimates
the allowance balance required based on past loan loss experience, the nature
and volume of the portfolio, information about specific borrower situations and
estimated collateral values, economic conditions, and other factors. Allocations
of the allowance may be made for specific loans, but the entire allowance is
available for any loan that, in management's judgment, should be charged off.
Loan losses are charged against the allowance when management believes that the
uncollectibility of a loan balance is confirmed.
Fair Value of Financial Instruments: Fair values of financial
instruments are estimated using relevant market information and other
assumptions. Fair value estimates involve uncertainties and matters of
significant judgment regarding interest rates, credit risk, prepayments, and
other factors, especially in the absence of broad markets for particular items.
There is no ready market for a significant portion of the Company's financial
instruments. Accordingly, fair values are based on various factors relative to
expected loss experience, current economic conditions, risk characteristics, and
other factors. The assumptions and estimates used in the fair value
determination process are subjective in nature and involve uncertainties and
significant judgment and, therefore, fair values cannot be determined with
precision. Changes in assumptions or in market conditions could significantly
affect the estimates.
PAGE 16
RESULTS OF OPERATIONS - THREE MONTHS AND SIX MONTHS
ENDED JUNE 30, 2003 AND 2002
Consolidated net income for the second quarter of 2003 was $7.8 million
or $0.44 and $0.43 per basic and diluted share, respectively, a 22.0% or $1.4
million increase compared to $6.4 million or $0.40 and $0.39 per basic and
diluted share, respectively, for the second quarter of 2002. Diluted earnings
per share for the three months ended June 30, 2003 was 10.3% higher than for the
comparable period in 2002. Consolidated net income for the six months ended June
30, 2003 was $14.2 million or $0.80 and $0.78 per basic and diluted share,
respectively, an 11.7% or $1.5 million increase compared to $12.7 million or
$0.79 and $0.77 per basic and diluted share, respectively, for the similar
period in 2002. Diluted earnings per share for the six months ended June 30,
2003 was 1.3% higher than for the comparable period in 2002. The return on
average assets for the three months ended June 30, 2003 was 1.40% compared to
1.38% for the similar period in 2002. For the six months ended June 30, 2003,
the return on average assets was 1.29% compared to 1.39% for the similar period
in 2002. The return on average equity for the three months ended June 30, 2003
was 19.63% compared to 24.19% for the similar period in 2002. For the six months
ended June 30, 2003, the return on average equity was 18.71% compared to 24.86%
for the similar period in 2002.
Net interest income decreased 4.3% or $671,000 to $14.8 million in the
second quarter of 2003 compared to $15.5 million in the second quarter of 2002.
During the six months ended June 30, 2003, net interest income increased 4.8% or
$1.5 million to $31.8 million compared to $30.3 million for the comparable
period in 2002. Excluding gains on securities and trading account profits, other
income increased 99.3% to $5.1 million and other expenses increased 26.1% to
$10.7 million in the second quarter of 2003. Other income, excluding gains on
securities and trading account profits, increased 73.1% to $9.1 million for the
six months ended June 30, 2003 compared to the similar period in 2002. Other
expenses for the six months ended June 30, 2003 increased by $4.8 million or
28.8% compared to the similar period in 2002.
Net Interest Income
- -------------------
Net interest income is the difference between interest income and fees
on earning assets and interest expense on deposits and borrowings. Net interest
margin represents net interest income on a tax equivalent basis as a percentage
of average earning assets during the period. Net interest margin reflects the
spread between average yields earned on interest earning assets and the average
rates paid on interest bearing deposits and borrowings.
Net interest income was $14.8 million and $15.5 million during the
three months ended June 30, 2003 and 2002, respectively, a decrease of $671,000,
or 4.3%. During the six months ended June 30, 2003, net interest income
increased $1.5 million or 4.8% to $31.8 million compared to $30.3 million for
the similar period in 2002. The Company's net interest margin (tax equivalent
net interest income as a percentage of earning assets) was 3.03% for the three
months ended June 30, 2003 compared to 3.64% for the comparable period in 2002.
During the six months ended June 30, 2003, the net interest margin was 3.24%
compared to 3.61% for the similar period in 2002. Due to the low interest rate
environment, the Company experienced an increase in amortization expense
associated with its mortgage-backed securities it hold in its investment
securities portfolio. Amortization expense on the mortgage-backed securities was
$2.7 million and $5.0 million for the three and six months ended June 30, 2003,
respectively, compared to $775,000 and $1.7 million for the similar periods in
2002.
The average loan yield was 6.52% during the second quarter of 2003, a
decrease of 6.9% from 7.00% during the comparable period in 2002. For the six
months ended June 30, 2003, the average loan yield was 6.62%, a decrease of 5.4%
from 7.00% during the comparable period in 2002. Average loan balances increased
$27.1 million, or 2.5%, to $1.1 billion during the second quarter of 2003 from
$1.1
PAGE 17
billion during the similar period in 2002. During the first six months of
2003, average loan balances increased $110.3 million, or 10.5%, to $1.2 billion
from $1.1 billion during the similar period of 2002. The Company's net interest
income and net income is dependent in part on stable interest rates.
Yields on securities were 4.28% during the second quarter of 2003, a
decrease of 31.0% from 6.20% during the comparable period in 2002. During the
six months ended June 30, 2003, securities yields decreased 26.0% to 4.60% from
6.22% in the comparable period in 2002. The low rate environment stimulated an
increase in mortgage loan refinancing which has accelerated the prepayment
speeds of the Company's mortgage-backed securities and increased amortization
expense on these securities. Amortization expense increased $2.0 million and
$3.3 million for the three and six months ended June 30, 2003 compared to the
same periods in 2002. The Company has reallocated its securities holdings in
order to reduce the likelihood of an increase in future amortization expense by
investing a larger portion of the portfolio in lower-yielding U.S. Treasury and
government agency obligations.
Yields on earning assets decreased 18.6% to 5.44% during the second
quarter of 2003 compared to 6.68% for the second quarter of 2003. During the
first six months of 2003, yields on earning assets decreased to 5.70%, or 14.4%,
from 6.66% for the similar period in 2002. Average earning assets, however,
increased to $2.1 billion for both the three months and six months ended June
30, 2003 from $1.8 billion for both the three months and six months ended June
30, 2002. The decrease in yields on earning assets was offset by a decrease in
rates paid on deposits and borrowings. Average rates paid on deposits decreased
22.2% to 2.24% for the three months ended June 30, 2003 from 2.88% for the
comparable period in 2002. For the first six months of 2003, average rates paid
on deposits decreased 23.0% to 2.28% from 2.96% for the similar period of 2002.
Average rates paid on borrowings were 3.92% for the second quarter of 2003
compared to 4.44% for the second quarter of 2002. During the six months ended
June 30, 2003, average rates paid on borrowings were 3.92% compared to 4.34% for
the similar period in 2002. Average borrowings increased by $81.4 million and
$75.4 million for the three months and six months ended June 30, 2003 to $521.1
million and $514.6 million, respectively. FHLB advances increased as a result of
the $33.0 million acquired through BFFC. The Company has converted $67.5 million
of its FHLB advances from fixed rate debt to floating rate through interest rate
swap transactions in December 2002. These swap transactions resulted in a
$382,000 and $754,000 decrease in interest expense for the three and six months
ended June 30, 2003, respectively. Notes payable increased $5.5 million due in
part to the cash needed for the BFFC acquisition. The increase in borrowings was
also a result of the $15.0 million trust preferred securities offering in
October of 2002. Average Fed funds and repurchase agreements increased $51.4
million and $47.0 million for the three and six months ended June 30, 2003 to
$224.8 million and $218.9 million, respectively.
Going forward, it is expected that the net interest margin will begin
to stabilize and improve, although it is unlikely to increase back to the 2002
level during this year. Key factors for an improvement in the net interest
margin include an increase in loan volumes, slower prepayment speeds on
mortgage-backed securities, an interest rate swap completed early in the third
quarter related to high interest rate FHLB advances, and the impact of deposit
pricing strategies. Nevertheless, expected improvements in the net interest
margins assume no further cuts in interest rates by the Federal Reserve Board of
Governors this year.
PAGE 18
The quarter-to-date net interest margin calculation for June 30, 2003
and 2002 is shown below (interest income and average rate on non-taxable
securities and loans are reflected on a tax equivalent basis, assuming a 35%
federal tax rate for 2003 and 2002 and adjusted for the dividend received
deduction where applicable):
JUNE 30, 2003 JUNE 30, 2002
------------- -------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- ----
INTEREST-EARNING ASSETS
- -----------------------
Federal funds sold $ 6,257 $ 18 1.15% $ 9,434 $ 43 1.78%
Securities taxable 927,584 9,528 4.11 632,606 9,741 6.16
Securities tax-exempt (1) 72,767 1,222 6.72 55,033 929 6.76
Commercial loans (1) (3) 225,593 3,345 5.93 225,129 3,545 6.30
Commercial real estate loans (1) (3) (4) 699,522 11,614 6.64 677,665 12,159 7.18
Agriculture loans (1) (3) 55,790 916 6.57 51,386 879 6.84
Consumer real estate loans (1) (3) (4) 108,332 1,799 6.64 108,107 1,964 7.27
Consumer installment loans (1) (3) 13,190 261 7.92 13,072 254 7.77
----------- --------- ---- ----------- --------- ----
$ 2,109,035 $ 28,703 5.44% $ 1,772,432 $ 29,514 6.68%
=========== ========= ==== =========== ========= ====
INTEREST-BEARING LIABILITIES
- ----------------------------
Interest- bearing demand deposits $ 174,932 $ 527 1.21% $ 136,149 $ 523 1.54%
Money-market demand deposits
and savings deposits 328,843 1,022 1.24 258,588 1,100 1.70
Time deposits less than $100,000 716,990 5,110 2.85 583,889 5,299 3.63
Time deposits greater than $100,000 100,556 643 2.56 130,585 1,013 3.10
Public funds 55,161 345 2.50 70,757 602 3.40
Federal funds purchased
and repurchase agreements 224,830 1,531 2.72 173,393 1,154 2.66
FHLB advances 255,905 2,875 4.49 237,500 3,290 5.54
Notes payable and other borrowings 40,330 696 6.90 28,800 425 5.90
----------- --------- ---- ----------- --------- ----
$ 1,897,547 $ 12,749 2.68% $ 1,619,661 $ 13,406 3.32%
=========== ========= ==== =========== ========= ====
Net Interest Income (1) (5) $ 15,954 2.76% $ 16,108 3.36%
========= ==== ========= ====
Net Interest Margin (1) 3.03% 3.64%
==== ====
Net Interest Income (2) (5) $ 14,827 2.56% $ 15,498 3.20%
========= ==== ========= ====
Net Interest Margin (2) 2.81% 3.50%
==== ====
(1) Adjusted for 35% tax rate in 2003 and 2002 and adjusted for the
dividends-received deduction where applicable.
(2) Not adjusted for 35% tax rate in 2003 and 2002 or for the
dividends-received deduction.
(3) Nonaccrual loans are included in the average balance, however these loans
are not earning any interest.
(4) Loan fees are included in interest columns.
(5) The following table reconciles reported net interest income on a tax
equivalent basis for the periods presented:
2Q03 2Q02
Net interest income $14,827 $15,498
Tax equivalent adjustment to net interest income 1,127 610
------- --------
Net interest income, tax equivalent basis $15,954 $16,108
------- --------
The year-to-date net interest margin calculation for June 30, 2003 and
2002 is shown below (interest income and average rate on non-taxable securities
and loans are reflected on a tax equivalent basis, assuming a 35% federal tax
rate for 2003 and 2002 and adjusted for the dividend received deduction where
applicable):
JUNE 30, 2003 JUNE 30, 2002
------------- -------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- ----
INTEREST-EARNING ASSETS
- -----------------------
Federal funds sold $ 11,957 $ 67 1.12% $ 8,657 $ 73 1.66%
Securities taxable 848,427 18,694 4.41 645,726 19,944 6.18
Securities tax-exempt (1) 72,658 2,445 6.73 45,065 1,524 6.77
Commercial loans (1) (3) 230,256 6,951 6.04 225,720 7,094 6.29
Commercial real estate loans (1) (3) (4) 712,405 23,948 6.72 653,679 23,457 7.18
Agriculture loans (1) (3) 56,720 1,819 6.41 50,533 1,753 6.94
Consumer real estate loans (1) (3) (4) 148,827 5,194 6.98 108,472 3,907 7.20
PAGE 19
Consumer installment loans (1) (3) 13,486 540 8.01 12,979 541 8.34
----------- --------- ---- ----------- --------- ----
$ 2,094,736 $ 59,658 5.70% $ 1,750,831 $ 58,293 6.66%
=========== ========= ==== =========== ========= ====
INTEREST-BEARING LIABILITIES
- ----------------------------
Interest-bearing demand deposits $ 166,461 $ 1,008 1.21% $ 135,734 $ 1,039 1.53%
Money-market demand deposits
and savings deposits 323,278 2,025 1.25 259,855 2,196 1.69
Time deposits less than $100,000 699,714 10,255 2.93 556,216 10,453 3.76
Time deposits greater than $100,000 121,852 1,553 2.55 130,410 2,111 3.24
Public funds 64,392 831 2.58 75,401 1,314 3.49
Federal funds purchased
and repurchase agreements 218,858 2,992 2.73 171,906 2,097 2.44
FHLB advances 255,603 5,722 4.48 239,445 6,593 5.51
Notes payable and other borrowings 40,133 1,379 6.87 27,822 852 6.12
----------- --------- ---- ----------- --------- ----
$ 1,890,291 $ 25,765 2.72% $ 1,596,789 $ 26,655 3.34%
=========== ========= ==== =========== ========= ====
Net Interest Income (1) (5) $ 33,893 2.98% $ 31,638 3.32%
========= ==== ========= ====
Net Interest Margin (1) 3.24% 3.61%
==== ====
Net Interest Income (2) (5) $ 31,793 2.78% $ 30,331 3.16%
========= ==== ========= ====
Net Interest Margin (2) 3.04% 3.46%
==== ====
(1) Adjusted for 35% tax rate in 2003 and 2002 and adjusted for the
dividends-received deduction where applicable.
(2) Not adjusted for 35% tax rate in 2003 and 2002 or for the
dividends-received deduction.
(3) Nonaccrual loans are included in the average balance, however these loans
are not earning any interest.
(4) Loan fees are included in interest columns.
(5) The following table reconciles reported net interest income on a tax
equivalent basis for the periods presented:
2Q03 2Q02
Net interest income $31,793 $30,331
Tax equivalent adjustment to net interest income 2,100 1,307
------- --------
Net interest income, tax equivalent basis $33,893 $31,638
------- --------
Other Income
- ------------
Other income, excluding securities gains and trading account profits,
was $5.1 million for the three months ended June 30, 2003, an increase of $2.5
million, or 99.3% over the comparable period in 2002. For the six months ended
June 30, 2003, other income, excluding securities gains and trading account
profits, was $9.1 million, an increase of $3.8 million, or 73.1%, compared to
$5.2 million for the comparable period in 2002. The other income to average
assets ratio was 0.92% for the three months ended June 30, 2003 compared to
0.55% for the same period in 2002. For the six months ended June 30, 2003, the
other income to average assets ratio was 0.83% compared to 0.57% for the same
period in 2002. The increase in other income is due to increases in service
charges on deposits, option income, insurance and brokerage commissions, and
mortgage banking fees.
Service charges and fees increased 2.2%, or $31,000, to $1.4 million in
the second quarter of 2003 from $1.4 million in the second quarter of 2002.
Year-to-date, service charges and fees increased 7.1%, or $192,000, to $2.9
million in 2003 compared to $2.7 million for the comparable period in 2002. This
increase in service charges and fees, which include service charges on deposit
accounts, is mainly due to deposit growth. Management expects service charges
and fees to increase with future deposit growth.
Insurance and brokerage commissions increased $162,000 from $394,000 in
the second quarter of 2002 to $556,000 for the second quarter of 2003. For the
six months ended June 30, 2003, insurance and brokerage commissions increased
$474,000 to $1.0 million compared to $540,000 for the first six months of 2002.
This increase is due to the increased investment brokerage activities through
Midwest Financial and Investment Services, Inc., the Company's subsidiary, which
provides securities brokerage services to both bank and non-bank customers. The
Company anticipates that investment brokerage commissions will increase in the
future through this subsidiary.
PAGE 20
Mortgage banking fees increased $288,000 or 323.6% to $377,000 during
the second quarter of 2003 compared to $89,000 for the similar period in 2002.
Year-to-date, mortgage banking fees increased $434,000 or 187.9% to $665,000 in
2003 compared to $231,000 for the similar period in 2002. The Company places
most mortgages originated into the secondary market. The increase in mortgage
banking fees is attributed to the ongoing refinancing boom which may not
continue at current levels and may result in less fees in the future.
Trust income increased by 15.0% or $22,000 to $169,000 for the second
quarter of 2003 compared to $147,000 for the similar period in 2002. For the six
months ended June 30, 2003, trust income increased by $9,000 compared to the six
months ended June 30, 2002.
The Company manages its securities available-for-sale portfolio and
trading account portfolio on a total return basis. In this respect, management
regularly reviews the performance of its securities and sells specific
securities to provide opportunities to enhance net interest income and net
interest margin, and when possible it will recognize gains on the sale of
securities. The Company has a long history of managing its securities in this
manner. Trading account profits result from trading strategies that are utilized
to supplement narrowing bond yields during periods of interest rate volatility.
Net trading account profits were $130,000 and $3,000 during the second quarter
of 2003 and 2002, respectively. Year-to-date, net trading account profits were
$130,000 and $348,000 in 2003 and 2002, respectively. Sales of securities
available-for-sale resulted in net gains of $2.7 million in the second quarter
of 2003 compared to $757,000 for the comparable period in 2002. For the six
months ended June 30, 2003, gains on sales of securities available-for-sale were
$2.8 million compared to $1.3 million for the similar period in 2002. Securities
available-for-sale are held in a manner which allows for their sale in response
to changes in interest rates, liquidity needs, or significant prepayment risk.
The Company also looks for opportunities to enhance its revenues by purchasing
and/or selling securities held in the portfolio as deemed appropriate by
management.
Periodically, the Company has bought or sold various covered put and
call options, with terms less than or equal to 90 days, on mortgage-backed
securities as well as U.S. Treasury and government agency obligations. These
covered options have either expired or have been exercised, and the associated
income or expense has been recognized in the corresponding period. Option fee
income is a part of management's ongoing program to manage risk in the
securities portfolio and take advantage of favorable market conditions. Option
fee income increased $1.9 million to $2.0 million during the second quarter of
2003 compared to $122,000 in the second quarter of 2002. For the six months
ended June 30, 2003, option fee income increased $2.4 million to $3.0 million
compared to $654,000 in the similar period in 2002. The Company had no covered
put or call options outstanding at June 30, 2003. See Note 7 to the unaudited
consolidated financial statements.
Other Expenses
- --------------
Total other expenses increased 26.1%, or $2.2 million, to $10.7 million
during the second quarter of 2003 compared to $8.5 million for the comparable
period in 2002. For the six months ended June 30, 2003, total other expenses
increased 28.8%, or $4.8 million, to $21.5 million from $16.7 million in the
first six months of 2002. The other expenses to average assets ratio was 1.92%
for the three months ended June 30, 2003 compared to 1.82% for the same period
in 2002. For the six months ended June 30, 2003, the other expenses to average
assets ratio was 1.96% compared to 1.83% for the similar period in 2002. The net
overhead expenses to average assets ratio was 1.00% for the three months ended
June 30, 2003 compared to 1.27% for the same period in 2002. For the six months
ended June 30, 2003, the net overhead expenses to average assets ratio was 1.13%
compared to 1.25% for the similar period in 2002. The efficiency ratio was
49.86% for the three months ended June 30, 2003 compared to 44.84% for the same
period in 2002. The efficiency ratio was 49.15% for the six months ended June
30, 2003 compared to 44.74% for the similar period in 2002.
PAGE 21
Salary and benefit expenses increased 12.6% or $756,000 to $6.0 million
for the second quarter of 2003 compared to $5.2 million for the similar period
in 2002. For the six months ended June 30, 2003, salary and benefit expenses
increased $1.8 million or 17.7% to $12.1 million from $10.2 million for the
comparable period in 2002. The full-time equivalent number of employees was 433
as of June 30, 2003 compared to 383 as of June 30, 2002. Increased full-time
staff positions, including investment brokerage staff, employees added through
the acquisition of BFFC, and other new positions was the primary reason for the
increase in salaries and benefits. Enhanced benefit programs and increased
health insurance costs have also contributed in the increase in salaries and
employee benefits. Health insurance expense increased 15% for the 2003 plan
year.
Occupancy expenses increased $236,000 or 19.2% to $1.5 million during
the second quarter of 2003 compared to $1.2 million for the comparable period in
2002. For the six months ended June 30, 2003, occupancy expenses increased
$841,000 or 35.3% to $3.2 million from $2.4 million in the six months of 2002.
This increase reflects the addition of the three branches acquired as a result
of the BFFC acquisition.
Expenses, other than salary and employee benefits and occupancy,
increased $1.2 million or 61.0% to $3.2 million in the second quarter of 2003
compared to the similar period in 2002. Other expenses increased $2.1 million or
12.9% to $6.2 million for the six months ended June 30, 2003 from $4.0 million
for the comparable period in 2002. The increase in expenses was due primarily to
outsourcing arrangements, marketing expenses, and other loan related expenses.
Due to the acquisition of BFFC, the Company incurred nonrecurring
expenses of $126,000 in legal and data conversion fees, $348,000 due to the
disposal and purchase of equipment, and $30,000 in other operating expenses. Due
to the termination of the CoVest agreement, $425,000 in legal, consulting, and
data conversion fees were expensed. Specific collection expenses due to problem
loans reflected in the first six months of 2003 include $430,000, in
professional fees.
Income Taxes
- ------------
The Company recorded income tax expense of $3.5 million, or 31.3% of
income, and $3.2 million, or 33.1% of income, for the quarters ended June 30,
2003 and 2002, respectively. Year-to-date, the provision for income taxes
increased $35,000 or 0.5%. Income tax as a percent of income has decreased due
to the impact of a new regulation issued by the Illinois Department of Revenue
related to apportionment of business income of financial organizations as well
as the implementation of various other tax planning strategies.
FINANCIAL CONDITION
Loans
- -----
The following table sets forth the composition of the Company's loan
portfolio as of the indicated dates.
JUNE 30, 2003 DECEMBER 31, 2002
------------- -----------------
(IN THOUSANDS)
Loan Loan
Category Category
to Gross to Gross
Amount Loans Amount Loans
------ ----- ------ -----
Commercial $ 216,955 20.1% $ 229,764 20.2%
Commercial real estate 690,718 64.0 730,836 64.3
PAGE 22
Agricultural 56,286 5.2 57,426 5.1
Consumer real estate (1) 102,135 9.5 105,391 9.3
Consumer installment 13,160 1.2 14,573 1.3
----------- ----- ----------- -----
Total loans, gross 1,079,254 100.0 1,137,990 100.0
Unearned discount (976) (1,286)
----------- -----------
Total loans 1,078,278 1,136,704
Allowance for loan losses (12,044) (20,754)
----------- -----------
Net loans $ 1,066,234 $ 1,115,950
=========== ===========
Loans held for sale:
Consumer real estate $ 5,110 0.5% $ 4,924 0.4%
(1) Includes loans held for sale.
Total loans decreased $58.4 million or 5.1% to $1.1 billion as of June
30, 2003 from $1.1 billion as of December 31, 2002. Commercial loans decreased
$12.8 million or 5.6% to $217.0 million as of June 30, 2003 compared to $229.8
million as of December 31, 2002. Commercial real estate loans decreased 5.5% or
$40.1 million to $730.8 million as of June 30, 2003 from $690.1 million as of
December 31, 2002. Agricultural loans decreased 2.0% or $1.1 million to $56.3
million as of June 30, 2003 from $57.4 million as of December 31, 2002. Loan
demand was affected by current economic conditions, increased prepayments of
commercial and commercial real estate loans, and management's decision to
maintain fixed rate pricing disciplines to protect longer-term profitability.
Consumer real estate loans decreased $3.3 million or 3.1% to $102.1
million as of June 30, 2003 from $105.4 million as of December 31, 2002.
Consumer loans decreased $1.4 million or 9.7% to $13.2 million as of June 30,
2003 compared to $14.6 million as of December 31, 2002.
Most mortgage loans the Company originates are sold in the secondary
market. At any point in time, loans will be at various stages of the mortgage
banking process. Included as part of consumer real estate loans are loans held
for sale, which were $4.9 million as of December 31, 2002 and $5.1 million at
June 30, 2003. The carrying value of these loans approximated their market value
at that time.
Looking ahead, there is evidence that loan demand may be rebounding
based upon an increase in the internal loan pipeline and the growth of unused
customer commitments of the Company's banking subsidiaries.
Allowance for Loan Losses
- -------------------------
An allowance for loan losses has been established by management to
provide for those loans that may not be repaid in their entirety for a variety
of reasons. The allowance is maintained at a level considered by management to
be adequate to provide for probable incurred losses. The allowance is increased
by provisions charged to earnings and is reduced by chargeoffs, net of
recoveries. The provision for loan losses is based upon past loan loss
experience and management's evaluation of the loan portfolio under current
economic conditions. Loans are charged to the allowance for loan losses when,
and to the extent, they are deemed by management to be uncollectible. The
allowance for loan losses is composed of allocations for specific loans and a
historical portion for all other loans.
Following is a summary of changes in the allowance for loan losses for
the six months ended June 30:
PAGE 23
2003 2002
---- ----
(IN THOUSANDS)
Balance, January 1 $ 20,754 $ 10,135
Balance from acquisition 300 -
Adjustment for loan payoff by
related parties (1) (6,685) -
Provision charged to operations 1,745 1,477
Loans charged-off (4,177) (568)
Recoveries 107 166
---------- ----------
Balance, June 30 $ 12,044 $ 11,210
========== ==========
(1)Adjustment made following the March 26, 2003 receipt of $13.3
million of proceeds relating to the sale of certain loans, of which
$12.5 million was applied to outstanding principal, $750,000 to the
letter of credit, and $67,000 applied to interest income and late
charges. See Note 11.
The Company recognizes that credit losses in the loan portfolio will be
experienced and the risk of loss will vary with, among other things, general
economic conditions; the type of loan being made; the creditworthiness of the
borrower over the term of the loan and in the case of a collateralized loan, the
quality of the collateral for such loan. The allowance for loan losses
represents the Company's estimate of the allowance necessary to provide for
probable incurred losses in the portfolio. In making this determination, the
Company analyzes the ultimate collectibility of the loans in its portfolio by
incorporating feedback provided by internal loan staff, an independent loan
review function, and information provided by examinations performed by
regulatory agencies. The Company makes an ongoing evaluation as to the adequacy
of the allowance for loan losses.
On a quarterly basis, management of the Banks meets to review the
adequacy of the allowance for loan losses. Each bank loan officer grades these
individual credits, and the Company's independent loan review function validates
the officers' grades. In the event that loan review downgrades the loan, it is
included in the allowance analysis at the lower grade. The grading system is in
compliance with applicable regulatory classifications, and the allowance is
allocated to the loans based on the regulatory grading, except in instances
where there are known differences (e.g. collateral value is nominal).
The analysis of the allowance for loan losses is comprised of three
components: specific credit allocation; general portfolio allocation; and
subjectively determined allocation. The specific credit allocation includes a
detailed review of the credit in accordance with SFAS Nos. 114 and 118, and an
allocation is made based on this analysis. The general portfolio allocation
consists of an assigned reserve percentage based on the credit rating of the
loan and charge-off history. The subjective portion is determined based on loan
history and the Company's evaluation of various factors including economic and
industry outlooks. In addition, the subjective portion of the allowance is
influenced by current economic conditions and trends in the portfolio including
delinquencies and impairments, as well as changes in the composition of the
portfolio.
The allowance for loan losses is based on estimates, and ultimate
losses will vary from current estimates. These estimates are reviewed quarterly,
and as adjustments, either positive or negative, become necessary, a
corresponding increase or decrease is made in the provision for loan losses. The
methodology used to determine the adequacy of the allowance for possible loan
losses is consistent with prior periods.
The Company's provision for loan losses was $755,000 for the second
quarter of 2003 compared to $815,000 for the similar period in 2002. For the six
months ended June 30, 2003, the provision for losses was $1.7 million compared
to $1.5 million for the comparable period in 2002.
PAGE 24
The allowance for loan losses as a percentage of total loans was 1.12%
as of June 30, 2003 and 1.83% as of December 31, 2002. See Note 11.
Nonaccrual and Nonperforming Loans
- ----------------------------------
Nonaccrual loans decreased to $22.5 million as of June 30, 2003 from
$29.0 million as of December 31, 2002. On March 26, 2003, $12.5 million of
nonaccrual loans were sold. See Note 11.
Nonperforming loans include nonaccrual loans and accruing loans which
are 90 days or more delinquent. Typically, these loans have adequate collateral
protection or personal guaranties to provide a source of repayment to the Bank.
Nonperforming loans were $24.7 million as of June 30, 2003 compared to $31.5
million at December 31, 2002
The following table sets forth information on the Company's
nonperforming loans and other nonperforming assets as of the indicated dates.
JUNE 30, 2003 DECEMBER 31, 2002
------------- -----------------
(IN THOUSANDS)
Nonaccrual and impaired loans
not accruing $ 22,457 $ 29,035
Impaired and other loans 90 days
past due and accruing 2,209 2,514
----------- -----------
Total nonperforming loans 24,666 31,549
Other real estate 1,723 533
----------- -----------
Total nonperforming assets $ 26,389 $ 32,082
=========== ===========
Total nonperforming loans to
total loans 2.29% 2.78%
Total nonperforming assets to
total loans and other real estate 2.44 2.82
Total nonperforming assets to
total assets 1.16 1.60
Allowance to nonperforming loans 0.49x 0.66x
The Company utilizes an internal asset classification system as a means
of reporting problem and potential problem assets. At each scheduled bank Board
of Directors meeting, a watch list is presented, showing significant loan
relationships listed as Special Mention, Substandard, and Doubtful. An asset is
classified Substandard if it is inadequately protected by the current net worth
and paying capacity of the obligor or the collateral pledged, if any. Assets
classified as Doubtful have all the weaknesses inherent in those classified
Substandard with the added characteristic that the weaknesses present make
collection or liquidation in full, on the basis of currently existing facts,
conditions and values, highly questionable and improbable. Assets classified as
Loss are those considered uncollectible and viewed as non-bankable assets and
have been charged off. Assets that do not currently expose the Company to
sufficient risk to warrant classification in one of the aforementioned
categories, but possess weaknesses that may or may not be within the control of
the customer, are deemed to be Special Mention.
The Company's determination as to the classification of its assets and
the amount of its valuation allowances is subject to review by the Banks'
primary regulators in the course of its regulatory examinations, which can order
the establishment of additional general or specific loss allowances. There can
be no assurance that regulators, in reviewing the Company's loan portfolio, will
not request the Company to materially increase its allowance for loan losses.
Although management believes that
PAGE 25
adequate specific and general loan loss allowances have been established, actual
losses are dependent upon future events and, as such, further additions to the
level of specific and general loan loss allowances may become necessary.
The Company has four problem loans which total $19.2 million, or 77.7%
of total nonperforming loans at June 30, 2003. Specific reserves of $6.6 million
have been established for these loans. The remaining nonperforming loans are
individually less than $2.0 million. The first loan, a commercial loan, totals
$5.2 million and a specific reserve of $4.7 million has been established for it.
The second loan, is a townhouse development loan of $9.5 million of which the
borrower has ceased construction activities on the project and a construction
manager has been appointed. The Company will continue the development on an
interim basis as the property is marketed. The value of this property is based
on management's estimates. The Company is in process of obtaining an independent
valuation. A specific reserve of $929,000 has been established on this loan. The
third loan has a $1.0 million balance. This commercial credit was classified as
doubtful by bank regulators and has been reduced from $2.2 million since the
beginning of 2003. The Company expects the remaining balance to be fully
collected and recoveries of the previously charged-off portion of the loan are
anticipated. The fourth loan of $3.5 million is for the conversion and
rehabilitation of three mixed use buildings into condos and commercial units.
While this loan has not performed as originally expected, the Company has
adequate collateral coverage and no specific reserve has been established. The
Company feels that adequate specific reserves have been established for problems
loans, however, there is no guaranty that the reserves will be sufficient.
Potential problem loans are loans included on the watch list presented
to the Board of Directors that do not meet the definition of a nonperforming
loan, but where known information about possible credit problems of borrowers
causes management to have serious doubts as to the ability of such borrowers to
comply with present loan repayment terms. At June 30, 2003, special mention,
substandard, and doubtful classifications were $12.5 million, $36.1 million, and
$564,000, respectively, compared to $4.9 million, $8.0 million, and $355,000,
respectively, at December 31, 2002. Total classifications include those loans
that have been adversely classified by bank examiners and the Company's internal
loan review department. The Company's allowance for loan losses is considered by
management to be adequate at June 30, 2003.
Securities
- ----------
The Company manages its securities portfolio to provide a source of
both liquidity and earnings. Each Bank has its own asset/liability committee,
which develops current investment policies based upon its operating needs and
market circumstances. The investment policy of each Bank is reviewed by senior
financial management of the Company in terms of its objectives, investment
guidelines and consistency with overall Company performance and risk management
goals. Each Bank's investment policy is formally reviewed and approved annually
by its board of directors. The asset/liability committee of each Bank is
responsible for reporting and monitoring compliance with the investment policy.
Reports are provided to each Bank's board of directors and the Board of
Directors of the Company on a regular basis.
Historically, the Company has invested in mortgage-backed securities.
All fixed and adjustable rate mortgage pools contain a certain amount of risk
related to the uncertainty of prepayments of the underlying mortgages. Interest
rate changes have a direct impact upon prepayment rates. The Company uses
computer simulation models to test the average life, duration and yield
volatility of adjustable rate mortgage pools under various interest rate
assumptions to monitor volatility. Stress tests are performed quarterly.
Securities available-for-sale are carried at fair value, with related
unrealized net gains or losses, net of deferred income taxes, recorded as an
adjustment to equity capital. As of June 30, 2003, unrealized
PAGE 26
gains, net of taxes, on securities available-for-sale decreased $1.0 million
from $7.1 million at December 31, 2002 to $6.1 million. This change resulted in
a $1.0 million decrease in book equity.
Securities available-for-sale increased to $950.8 million as of June
30, 2003 from $651.9 million as of December 31, 2002. This increase is primarily
due to the reinvestment of the $141.9 million in proceeds from the sale of
mortgage loans acquired through the BFFC acquisition and to the reduced loan
volume. At December 31, 2002, the Company's holdings of mortgage-backed
securities accounted for 78.5% of total investments. Due to the low interest
rate environment, prepayment rates have increased and the Company has
experienced an increase in amortization expense associated with its
mortgage-backed securities. Amortization expense on the mortgage-backed
securities increased $1.9 million and $3.3 million for the quarter and six
months ended June 30, 2003 compared to the similar periods in 2002. The Company
has reallocated its securities holdings in order to mitigate the increase in
amortization expense. At June 30, 2003, mortgage-backed securities were 40.8% of
the portfolio. U.S. government agency mortgage-backed securities decreased 29.6%
or $146.7 million from $495.6 million as of December 31, 2002 to $348.8 million
as of June 30, 2003. U.S. Treasury and government agency obligations increased
$263.3 million to $287.1 million, representing 28.0% of the portfolio as of June
30, 2003 compared to $23.9 million as of December 31, 2002. Equity securities
increased $60.8 from $59.4 million at December 31, 2002 to $120.2 million as of
June 30, 2003. Equity securities at June 30, 2003 included capital securities of
United States agencies, bond-rated or credit equivalent community banks, and the
Federal Home Loan Bank and Federal Reserve Bank stock. Other bonds increased
$121.1 million to $128.3 million at June 30, 2003 compared to $7.1 million at
December 31, 2002. Other bonds include high grade corporate bonds primarily
issued by financial institutions. Obligations of state and political
subdivisions increased $1.8 million to $56.9 million at June 30, 2003 from $55.1
million at December 31, 2002.
Securities held-to-maturity decreased $32.6 million or 27.5% from
December 31, 2002 to June 30, 2003. Under permissible provisions of FASB
Statement No. 115, $3.4 million of mortgage-backed securities acquired through
the acquisition of BFFC were reclassified from held-to-maturity to
available-for-sale.
There were no trading account securities held at June 30, 2003 or
December 31, 2002. The Company holds trading account securities on a short-term
basis based on market and liquidity conditions.
Bank-Owned Life Insurance
- -------------------------
The Company's investment in Bank-Owned Life Insurance ("BOLI")
increased by $3.8 million; $3.3 million was acquired through the acquisition of
BFFC and the cash surrender value of the insurance increased $491,000 at June
30, 2003. The BOLI is intended to provide funding for future employee benefit
expense.
Deposits and Borrowed Funds
- ---------------------------
Total deposits of $1.6 billion as of June 30, 2003 represented an
increase of $190.0 million or 13.7% from $1.4 billion as of December 31, 2002.
Non-interest-bearing deposits were $148.5 million as of June 30, 2003,
approximately $13.6 million higher than the $134.9 million level as of December
31, 2002. Over the same period, interest-bearing deposits increased 14.0% or
$176.1 million. Certificates of deposit under $100,000 increased $123.9 million
from December 31, 2002 to June 30, 2003. Certificates of deposit over $100,000
and public funds decreased by $70.3 million from December 31, 2002 to June 30,
2003. The majority of the decrease was a result of brokered certificates of
deposit and public fund maturities. The Company's marketing efforts focused on
core and time deposit account growth in its retail markets, reducing the need
for public funds and brokered certificates of deposit.
PAGE 27
The Company acquired $73.4 million in core deposits and $64.6 million
in time deposits through the acquisition of BFFC. Deposits at these three
branches increased 18.8% to $163.9 million at June 30, 2003 compared to January
3, 2003, the acquisition date.
The Company's membership in the Federal Home Loan Bank System gives it
the ability to borrow funds from the Federal Home Loan Bank of Chicago for
short- or long-term purposes under a variety of programs. The loans are used to
fund growth and permit the Banks to extend term maturities, reduce funding costs
and manage interest rate risk exposures more effectively.
Federal Home Loan Bank advances were $255.8 million at June 30, 2003
and $219.5 million at December 31, 2002. FHLB advances increased as a result of
the $33.0 million acquired through BFFC. The Company has converted $67.5 million
of its FHLB advances from fixed rate debt to floating rate through interest rate
swap transactions in December 2002. These swap transactions resulted in a
$382,000 and $754,000 decrease in interest expense for the three and six months
ended June 30, 2003. The weighted average rate for Federal Home Loan Bank
advances was 4.80% during the six months ended June 30, 2003, with a range of
maturities between one and ten years.
Borrowed funds are listed below:
JUNE 30, DECEMBER 31,
2003 2002
---- ----
(IN THOUSANDS)
Federal Home Loan Bank (FHLB) advances
to bank subsidiaries $ 258,594 $ 219,500
Revolving line of credit 7,500 2,000
----------- -----------
Total notes payable $ 266,094 $ 221,500
=========== ===========
The Company has a credit agreement with a correspondent bank (the
"Credit Agreement"), which provides the Company with a revolving line of credit
with a maximum availability of $10.0 million and $25.0 million for June 30, 2003
and December 31, 2002, respectively. This revolving line of credit matures on
January 30, 2004.
Amounts outstanding under the Company's revolving line of credit
represent borrowings incurred to provide capital contributions to the Banks to
support their growth. The Company makes interest payments, at its option, at the
30-, 60-, 90-, or 180-day London Inter-Bank Offered Rate ("LIBOR") plus 120
basis points or the prime rate less 25 basis points. At July 30, 2003, the
Company had $7.5 million outstanding.
The revolving line of credit included the following covenants at June
30, 2003: (1) the banks must not have nonperforming assets in excess of 25% of
Tier 1 capital plus the loan loss allowance; (2) the Company and each subsidiary
bank must be considered well capitalized; (3) the Company must maintain
consolidated tangible net worth (as defined in the credit agreement) of not less
than $70 million; and (4) consolidated net income for the four previous quarters
combined must be at least $5.5 million. The Company was in compliance with these
covenants at June 30, 2003.
The Company also utilizes securities sold under repurchase agreements
as a source of funds. Most local municipalities and some other organizations
must have funds insured or collateralized pursuant to their own policies.
Repurchase agreements provide a source of funds and do not increase the
Company's reserve requirement. Although the balance of repurchase agreements is
subject to variation, particularly seasonal variation, the account relationships
represented by these balances are principally local and have been maintained for
relatively long periods of time. The Company had $193.1 million in
PAGE 28
securities sold under repurchase agreements at June 30, 2003 compared to $185.1
million at December 31, 2002. The Company had $3.8 million in federal funds
purchased at June 30, 2003 compared to $20.8 million at December 31, 2002.
The Company issued 10% junior subordinated debentures aggregating $20.0
million to MBHI Capital Trust I, a wholly-owned subsidiary of the Company. The
junior subordinated debentures pay interest on a quarterly basis and will mature
on June 7, 2030. The junior subordinated debentures can be redeemed in whole or
in part, beginning June 7, 2005.
MBHI Capital Trust II ("Trust II") issued $15.0 million in aggregate
liquidation amount of trust preferred securities in a private placement
offering. Simultaneously with the issuance of the trust preferred securities by
Trust II, the Company issued an equivalent amount of junior subordinated
debentures to Trust II. The junior subordinated debentures are the sole assets
of Trust II. The junior subordinated debentures and the trust preferred
securities pay distributions and dividends, respectively, on a quarterly basis,
which are included in interest expense. The interest rate payable on the
debentures and the trust preferred securities resets quarterly, and is equal to
LIBOR plus 3.45% (4.74% at June 30, 2003), provided that this rate cannot exceed
12.5% through the interest payment date in November 2007. The junior
subordinated debentures will mature on November 7, 2032, at which time the
preferred securities must be redeemed.
Capital Resources
- -----------------
Stockholders' equity increased $44.9 million or 39.1% to $159.9 million
at June 30, 2003 from $115.0 million at December 31, 2002. Total capital to
average risk based capital increased to 11.9% on June 30, 2003 from 11.7% on
December 31, 2002. During January 2003, the Company issued 1,599,088 shares of
common stock due to the acquisition of BFFC. The purchase price for that
acquisition totaled $30.4 million. On March 26, 2003, stockholders' equity
increased by $4.0 million due to the payoff of a loan by certain related parties
of the Company. See Note 11.
The Company and its two subsidiary banks are subject to regulatory
capital requirements administered by federal banking agencies. Capital adequacy
guidelines and prompt corrective action regulations involve quantitative
measures of assets, liabilities, and certain off-balance-sheet items calculated
under regulatory accounting practices. Capital amounts and classifications are
also subject to qualitative judgments by regulators about components, risk
weightings and other factors, and the regulators can lower classifications in
certain areas. Failure to meet various capital requirements can initiate
regulatory action that could have a direct material effect on the financial
statements.
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although these
terms are not used to represent overall financial condition. If adequately
capitalized, regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required.
The Company and each of the Banks were considered well capitalized as
of June 30, 2003 and December 31, 2002. Management is not aware of any
conditions or events since the most recent regulatory notification that would
change the Company's or the Banks' categories.
Capital levels and minimum required levels (dollars in thousands):
AS OF JUNE 30, 2003
----------------------------------------------------------------------------
MINIMUM REQUIRED
MINIMUM REQUIRED TO BE WELL
ACTUAL FOR CAPITAL ADEQUACY CAPITALIZED
------ -------------------- -----------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
(IN THOUSANDS)
Total capital to risk-weighted
assets
Company $ 190,477 11.7% $ 130,643 8.0% $ 163,303 10.0%
PAGE 29
Midwest Bank and
Trust Company 166,644 11.3 117,477 8.0 146,847 10.0
Midwest Bank of Western
Illinois 20,316 12.4 13,114 8.0 16,392 10.0
Tier I capital to risk-weighted
assets
Company 178,432 10.9 65,321 4.0 97,982 6.0
Midwest Bank and
Trust Company 155,633 10.6 58,739 4.0 88,108 6.0
Midwest Bank of Western
Illinois 19,282 11.8 6,557 4.0 9,835 6.0
Tier I capital to average assets
Company $ 178,432 8.0% $ 89,220 4.0% $ 111,525 5.0%
Midwest Bank and
Trust Company 155,633 8.1 77,112 4.0 96,390 5.0
Midwest Bank of Western
Illinois 19,282 6.7 11,556 4.0 14,446 5.0
PAGE 30
AS OF DECEMBER 31, 2002
----------------------------------------------------------------------------
MINIMUM REQUIRED
MINIMUM REQUIRED TO BE WELL
ACTUAL FOR CAPITAL ADEQUACY CAPITALIZED
------ -------------------- -----------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
(DOLLARS IN THOUSANDS)
Total capital to risk-weighted
assets
Company $ 154,740 11.7% $ 105,876 8.0% $ 132,345 10.0%
Midwest Bank and
Trust Company 129,364 11.1 93,568 8.0 116,960 10.0
Midwest Bank of Western
Illinois 19,615 13.2 11,871 8.0 14,838 10.0
Tier I capital to risk-weighted
assets
Company 138,197 10.4 52,938 4.0 79,407 6.0
Midwest Bank and
Trust Company 114,744 9.8 46,784 4.0 70,176 6.0
Midwest Bank of Western
Illinois 18,400 12.4 5,935 4.0 8,903 6.0
Tier I capital to average assets
Company 138,197 7.0 78,872 4.0 98,590 5.0
Midwest Bank and
Trust Company 114,744 6.8 67,472 4.0 84,341 5.0
Midwest Bank of Western
Illinois 18,400 6.7 10,984 4.0 13,730 5.0
Liquidity
- ---------
Liquidity measures the ability of the Company to meet maturing
obligations and its existing commitments, to withstand fluctuations in deposit
levels, to fund its operations and to provide for customers' credit needs. The
liquidity of the Company principally depends on cash flows from operating
activities, investment in and maturity of assets, changes in balances of
deposits and borrowings and its ability to borrow funds in the money or capital
markets.
Net cash inflows provided by operations were $32.0 million for the six
months ended June 30, 2003 compared to $19.3 million a year earlier. Net cash
outflows from investing activities were $43.7 million in the first six months of
2003 compared to a net cash outflow of $66.3 million a year earlier. Cash
inflows from financing activities for the six months ended June 30, 2003 were
$46.2 million compared to a net inflow of $88.9 million in 2002.
In the event of short-term liquidity needs, the Banks may purchase
federal funds from correspondent banks. In addition, the Company has established
repurchase agreements and brokered certificates of deposit arrangements with
various financial sources. The Company's membership in the Federal Home Loan
Bank System gives it the ability to borrow funds from the Federal Home Loan Bank
of Chicago for short- or long-term purposes under a variety of programs. The
Company also has a $10.0 million revolving line of credit of which $2.5 million
is available.
The Banks also have various funding arrangements with commercial and
investment banks providing up to $2.3 billion of available funding sources in
the form of Federal funds lines, repurchase agreements, and brokered certificate
of deposit programs. Unused capacity under these lines was $1.8 billion at June
30, 2003. The Banks maintain these funding arrangements to achieve favorable
costs of funds, manage interest rate risk, and enhance liquidity in the event of
deposit withdrawals.
Interest received net of interest paid was a principal source of
operating cash inflows for the three and six months ended June 30, 2003 and June
30, 2002, respectively. Management of investing and financing activities and
market conditions determine the level and the stability of net interest cash
flows.
PAGE 31
Management's policy is to mitigate the impact of changes in market interest
rates to the extent possible so that balance sheet growth is the principal
determinant of growth in net interest cash flows.
PAGE 32
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity Analysis
- ----------------------------------
The Company's overall interest rate sensitivity is demonstrated by net
interest income analysis. Net interest income analysis measures the change in
net interest income in the event of hypothetical changes in interest rates. This
analysis assesses the risk of change in net interest income in the event of
sudden and sustained 1.0% to 2.0% increases and 1.0% decrease in market interest
rates. The table below presents the Company's projected changes in net interest
income for the various rate shock levels at June 30, 2003. The base scenario is
a forecast of net interest income over the next twelve months based on a static
balance sheet as of June 30, 2003.
NET INTEREST INCOME
------------------------------------------------
AMOUNT $ CHANGE % CHANGE
------ -------- --------
(DOLLARS IN THOUSANDS)
+200 bp $ 64,927 $ (3,108) (4.57)%
+100 bp 66,367 (1,668) (2.45)
Base 68,035 - -
-100 bp 68,002 (32) 0.05
As shown above, at June 30, 2003, the effect of an immediate 100 basis
point decrease in interest rates would decrease the Company's net interest
income by 0.05% or $32,000. The effect of an immediate 200 basis point increase
in rates would decrease the Company's net interest income by 4.57% or $3.1
million.
The projected changes in the Company's net interest income for the
various rate shock levels at December 31, 2002 were as follows:
NET INTEREST INCOME
------------------------------------------------
AMOUNT $ CHANGE % CHANGE
------ -------- --------
(DOLLARS IN THOUSANDS)
+200 bp $ 64,348 $ (2,137) (3.21)%
+100 bp 64,487 (1,998) (3.01)
Base 66,485 - -
-100 bp 67,360 875 1.32
Computations of the prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit decay rates, and should not be relied upon
as indicative of actual results. Actual values may differ from those projections
set forth above should market conditions vary from assumptions used in preparing
the analyses. Further, the computations do not contemplate any actions the
Company may undertake in response to changes in interest rates.
PAGE 33
ITEM 4 - CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the Company's Chief
Executive Officer and Chief Financial Officer carried out an evaluation, with
the participation of other members of management as they deemed appropriate, of
the effectiveness of the design and operation of the Company's disclosure
controls and procedures as contemplated by Exchange Act Rule 13a-15. Based upon,
and as of the date of that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective, in all material respects, in timely alerting them to
material information relating to the Company (and its consolidated subsidiaries)
required to be included in the periodic reports the Company is required to file
and submit to the SEC under the Exchange Act. While management concluded that
its disclosure controls and procedures are adequate in all material respects for
SEC reporting purposes, the Company is currently reviewing its policies and
procedures regarding identification and classification of problem loans and its
asset quality review process in an effort to avoid subsequent changes to
previously reported financial results.
There have been no significant changes to the Company's internal
controls or in other factors that could significantly affect these controls
subsequent to the date that the internal controls were most recently evaluated
nor were there identified any significant deficiencies or material weaknesses
requiring corrective actions other than noted as follows. The Company's
management is addressing a reportable condition, i.e. one with significant
deficiencies in the design or operation of internal control, and other risk
management concerns that have been raised by the former external auditor and
bank regulators. The Company is currently reviewing its asset quality review
policies and procedures and may implement additional processes and controls to
strengthen its risk management. The Company's management, including the Chief
Executive Officer and the Chief Financial Officer, does not expect that its
disclosure controls or its internal controls will prevent all error and all
fraud. A control system, no matter how well conceived and operated, can provide
only reasonable assurance that the objectives of the control system are met.
Further, the design of a control system will take into account resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the Company have been detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, any system of controls can be circumvented by the individual acts
of some persons, by collusion of two or more people, or by management override
of the control. The design of any system of controls also is based in part upon
certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions; in addition, over time, controls may need to be
changed in order to address changes in conditions, or other factors in order to
remain effective. Because of the inherent limitations in a cost-effective
control system, misstatements due to error or fraud may occur and not be
detected. However, the Company's management believes its system of controls
provides reasonable assurances that the information required to be disclosed in
the Company's Exchange Act reports is recorded, processed, summarized and
reported within the time frames specified in the SEC's rules and forms.
PAGE 34
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995
This report contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. The Company intends such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995 and is including this statement for purposes of these safe harbor
provisions. Forward-looking statements, which are based on certain assumptions
and describe future plans, strategies and expectations of the Company, are
generally identifiable by use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project" or similar expressions. The Company's
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Factors which could have a material adverse effect on the
operations and future prospects of the Company and its subsidiaries, including
its ability to implement its growth strategies, include, but are not limited to,
changes in interest rates; general economic conditions; legislative or
regulatory changes; monetary and fiscal policies of the U.S. government,
including policies of the U.S. Treasury and the Federal Reserve Board; possible
administrative or enforcement action or similar direction of federal or state
banking regulators in connection with any material failure of any of the Banks
to comply with applicable banking laws, rules, and regulations; the quality or
composition of the loan or investment portfolios; the adequacy of the Company's
allowance for loan losses; demand for loan products; deposit flows; competition;
demand for financial services in the Company's market area; the Company's
ability to fully integrate the operations and branch offices acquired as a
result of the acquisition of Big Foot Financial Corp.; and changes in
accounting principles, policies and guidelines. These risks and uncertainties
should be considered in evaluating forward-looking statements and undue reliance
should not be placed on such statements.
PAGE 35
PART II
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company
or its subsidiaries are a party other than ordinary routine
litigation incidental to their respective businesses.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of stockholders of the Company was held on May 21,
2003. Three proposals were submitted to a vote of the stockholders as
described in the Company's proxy statement dated April 23, 2003. The
following is a brief description of the matters voted upon, as well
as the outcome of the vote:
1. To elect three members to serve on the Company's Board of
Directors for a term of three years: The nominees were Messrs.
Angelo DiPaolo, Joseph Rizza, and Leon Wolin.
To elect Angelo DiPaolo for a three year term:
Votes For: 14,771,739
Abstain: 397,699
To elect Joseph Rizza for a three year term:
Votes For: 14,440,799
Abstain: 728,639
To elect Leon Wolin for a three year term:
Votes For: 14,406,790
Abstain: 762,648
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are either filed as part of this report
or are incorporated herein by reference:
PAGE 36
3.1 Restated Certificate of Incorporation, as amended
(incorporated by reference to Registrant's Registration
Statement on Form S-1, Registration No. 333-42827).
3.2 Certificate of Amendment of Restated Certificate of
Incorporation (incorporated by reference to Registrant's Form
10-Q for the quarter ended June 30, 2002, File No. 001-13735).
3.3 Restated By-laws, as amended (incorporated by reference to
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998, File No. 0-29652).
3.4 Amendment of Restated By-laws (incorporated by reference to
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2000, File No. 0-29652).
4.1 Specimen Common Stock Certificate (incorporated by reference
to Registrant's Registration Statement on Form S-1,
Registration No. 333-042827).
4.2 Certain instruments defining the rights of the holders of
long-term debt of the Company and certain of its subsidiaries,
none of which authorize a total amount of indebtedness in
excess of 10% of the assets of the Company and its
subsidiaries on a consolidated basis, have not been filed as
Exhibits. The Company hereby agrees to furnish a copy of any
of these agreements to the SEC upon request.
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 from
the Company's Chief Executive Officer and Chief Financial
Officer.
(b) Reports on Form 8-K
Current Report on Form 8-K dated April 16, 2003, filed with
the SEC on April 17, 2003.
Current Report on Form 8-K/A dated April 29, 2003, filed with
the SEC on May 6, 2003.
Current Report on Form 8-K dated May 9, 2003, filed with the
SEC on May 12, 2003.
Current Report on Form 8-K dated May 14, 2003, filed with the
SEC on May 14, 2003.
Current Report on Form 8-K/A dated April 29, 2003, filed with
the SEC on May 19, 2003.
Current Report on Form 8-K dated May 16, 2003, filed with the
SEC on May 20, 2003.
Current Report on Form 8-K dated June 25, 2003, filed with the
SEC on June 27, 2003.
PAGE 37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: July 30, 2003
MIDWEST BANC HOLDINGS, INC.
(Registrant)
By: /s/ Brad A. Luecke
---------------------------
Brad A. Luecke,
President and
Chief Executive Officer
By: /s/ Daniel R. Kadolph
---------------------------
Daniel R. Kadolph,
Senior Vice President
and Chief Financial Officer
PAGE 38
EXHIBITS
3.1 Restated Certificate of Incorporation, as amended (incorporated by
reference to Registrant's Registration Statement on Form S-1,
Registration No. 333-42827).
3.2 Certificate of Amendment of Restated Certificate of Incorporation
(incorporated by reference to Registrant's Form 10-Q for the quarter
ended June 30, 2002, File No. 001-13735.
3.3 Restated By-laws, as amended (incorporated by reference to Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1998, File
No. 0-29652).
3.4 Amendment of Restated By-laws (incorporated by reference to
Registrant's Quarterly Report on Form 10-Q for the quarter ended June
30, 2000, File No. 0-29652).
4.1 Specimen Common Stock Certificate (incorporated by reference to
Registrant's Registration Statement on Form S-1, Registration No.
333-042827).
4.2 Certain instruments defining the rights of the holders of long-term
debt of the Company and certain of its subsidiaries, none of which
authorize a total amount of indebtedness in excess of 10% of the assets
of the Company and its subsidiaries on a consolidated basis, have not
been filed as Exhibits. The Company hereby agrees to furnish a copy of
any of these agreements to the SEC upon request.
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 from the Company's
Chief Executive Officer and Chief Financial Officer.