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 September 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
incorporation or organization) Number)
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 NOVEMBER 12, 2003
- ------------------------------------ ---------------------------------------
Common, par value $.01 17,840,562
- ------------------------------------ ---------------------------------------
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...... 32
Item 4. Controls and Procedures......................................... 33
PART II
Item 1. Legal Proceedings............................................... 35
Item 2. Changes in Securities and Use of Proceeds....................... 35
Item 3. Defaults Upon Senior Securities................................. 35
Item 4. Submission of Matters to a Vote of Security Holders............. 35
Item 5. Other Information............................................... 35
Item 6. Exhibits and Reports on Form 8-K................................ 35
Form 10-Q Signature Page.................................................. 37
MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
2003 2002
---- ----
ASSETS
Cash and cash equivalents $ 88,432 $ 49,687
Securities available-for-sale 893,310 651,873
Securities held-to-maturity 68,302 118,620
Loans 1,060,448 1,136,704
Allowance for loan losses (14,452) (20,754)
-------------- --------------
Net loans 1,045,996 1,115,950
Cash value of life insurance 24,672 20,634
Premises and equipment, net 27,512 18,999
Other real estate 7,782 533
Core deposit and other intangibles, net 3,234 244
Goodwill 5,581 4,360
Due from broker 40,810 -
Other assets 48,223 28,147
-------------- --------------
Total assets $ 2,253,854 $ 2,009,047
=============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits
Non-interest-bearing $ 154,637 $ 134,858
Interest-bearing 1,421,370 1,255,790
-------------- --------------
Total deposits 1,576,007 1,390,648
Federal funds purchased 325 20,825
Securities sold under agreements to repurchase 205,180 185,057
Advances from the Federal Home Loan Bank 256,751 219,500
Trust preferred securities 35,000 35,000
Note payable 7,500 2,000
Due to broker - 20,582
Other liabilities 29,357 20,484
-------------- --------------
Total liabilities 2,110,120 1,894,096
-------------- --------------
STOCKHOLDERS' EQUITY
Preferred stock - -
Common stock 187 171
Surplus 64,234 29,366
Retained earnings 97,873 87,105
Accumulated other comprehensive income (loss) (10,705) 7,145
Treasury stock, at cost (7,855) (8,836)
-------------- --------------
Total stockholders' equity 143,734 114,951
-------------- --------------
Total liabilities and stockholders' equity $ 2,253,854 $ 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 SEPTEMBER 30, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2003 2002
---- ----
INTEREST INCOME
Loans $ 17,023 $ 19,114
Securities
Taxable 9,303 8,383
Exempt from federal income taxes 793 817
Trading account securities - -
Federal funds sold and other short-term investments 18 39
----------- -----------
Total interest income 27,137 28,353
INTEREST EXPENSE
Deposits 7,324 8,617
Federal funds purchased 62 72
Securities sold under agreements to repurchase 1,559 1,047
Advances from the Federal Home Loan Bank 2,606 3,328
Trust preferred securities 657 210
Note payable 49 63
----------- -----------
Total interest expense 12,257 13,337
----------- -----------
Net interest income 14,880 15,016
Provision for loan losses 7,743 10,915
----------- -----------
Net interest income after provision for loan losses 7,137 4,101
OTHER INCOME
Service charges on deposits 1,481 1,489
Net gains on securities transactions 917 97
Net trading account profits (losses) (144) -
Option income 1,952 335
Mortgage banking fees 295 208
Insurance and brokerage commissions 582 385
Trust income 147 134
Increase in cash surrender value of life insurance 234 234
Other income 326 165
----------- -----------
Total other income 5,790 3,047
OTHER EXPENSES
Salaries and employee benefits 6,119 5,227
Occupancy and equipment 1,648 1,136
Professional services 900 708
Other expenses 1,998 1,234
----------- -----------
Total other expenses 10,665 8,305
----------- -----------
Income (loss) before income taxes 2,262 (1,157)
Provision for income taxes (21) (1,487)
----------- -----------
NET INCOME $ 2,283 $ 330
=========== ===========
Basic earnings per share $ 0.13 $ 0.02
=========== ===========
Diluted earnings per share $ 0.12 $ 0.02
=========== ===========
Cash dividends declared per common share $ 0.12 $ 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 SEPTEMBER 30, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2003 2002
---- ----
Net income $ 2,283 $ 330
Net increase (decrease) in fair value of securities
classified as available-for-sale, net of income
taxes and reclassification adjustments (16,838) 3,687
----------- -----------
Comprehensive income (loss) $ (14,555) $ 4,017
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
Page 3
MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2003 2002
---- ----
INTEREST INCOME
Loans $ 55,207 $ 55,654
Securities
Taxable 27,002 27,765
Exempt from federal income taxes 2,382 1,808
Trading account securities 19 -
Federal funds sold and other short-term investments 85 112
----------- -----------
Total interest income 84,695 85,339
INTEREST EXPENSE
Deposits 22,996 25,730
Federal funds purchased 163 264
Securities sold under agreements to repurchase 4,450 2,951
Advances from the Federal Home Loan Bank 8,328 9,921
Trust preferred securities 1,962 958
Note payable 123 168
----------- -----------
Total interest expense 38,022 39,992
----------- -----------
Net interest income 46,673 45,347
Provision for loan losses 9,488 12,392
----------- -----------
Net interest income after provision for loan losses 37,185 32,955
OTHER INCOME
Service charges on deposits 4,382 4,198
Net gains on securities transactions 3,721 1,392
Net trading account profits (losses) (14) 348
Option income 4,968 989
Mortgage banking fees 960 440
Insurance and brokerage commissions 1,596 988
Trust income 451 430
Increase in cash surrender value of life insurance 725 702
Other income 1,003 503
----------- -----------
Total other income 17,792 9,990
OTHER EXPENSES
Salaries and employee benefits 18,170 15,470
Occupancy and equipment 4,874 3,584
Professional services 3,367 1,982
Other expenses 5,710 3,991
----------- -----------
Total other expenses 32,121 25,027
----------- -----------
Income before income taxes 22,856 17,918
Provision for income taxes 6,388 4,887
----------- -----------
NET INCOME $ 16,468 $ 13,031
=========== ===========
Basic earnings per share $ 0.93 $ 0.81
=========== ===========
Diluted earnings per share $ 0.91 $ 0.79
=========== ===========
Cash dividends declared per common share $ 0.32 $ 0.30
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
Page 4
MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2003 2002
---- ----
Net income $ 16,468 $ 13,031
Net increase (decrease) in fair value of securities classified as
available-for-sale, net of income taxes and
reclassification adjustments (17,850) 8,609
----------- -----------
Comprehensive income (loss) $ (1,382) $ 21,640
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
Page 5
MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 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 ($0.30
per share) - - (4,843) - - (4,843)
Purchase of 25,000 shares of
treasury stock - - - - (390) (390)
Issuance of common stock
upon acquisition and exercise of
stock options, net of tax benefit - (195) - - 1,426 1,231
Comprehensive income
Net income - - 13,031 - - 13,031
Net increase in fair value of
securities classified as available-
for-sale, net of income taxes and
reclassification adjustments - - - 8,609 - 8,609
---------
Total comprehensive income 21,640
--------- --------- --------- -------- -------- ---------
Balance, September 30, 2002 $ 114 $ 29,392 $ 85,444 $ 7,552 $ (8,650) $ 113,852
========= ========= ========= ======== ======== =========
Balance, January 1, 2003 $ 171 $ 29,366 $ 87,105 $ 7,145 $ (8,836) $ 114,951
Cash dividends declared ($0.32
per share) - - (5,700) - - (5,700)
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 - 387 - - 981 1,368
Capital contribution from loan
payoff by related parties - 4,033 - - - 4,033
Comprehensive income
Net income - - 16,468 - - 16,468
Net decrease in fair value of
securities classified as available-
for-sale, net of income taxes and
reclassification adjustments - - - (17,850) - (17,850)
---------
Total comprehensive (loss) (1,382)
--------- --------- --------- -------- -------- ---------
Balance, September 30, 2003 $ 187 $ 64,234 $ 97,873 $(10,705) $ (7,855) $ 143,734
========= ========= ========= ======== ======== =========
See accompanying notes to unaudited consolidated financial statements.
Page 6
MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(IN THOUSANDS)
2003 2002
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 16,468 $ 13,031
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 1,799 1,688
Provision for loan losses 9,488 12,392
Amortization of other intangibles 371 37
Amortization of premiums and discounts on securities, net 8,706 2,883
Net gain on sale of securities (3,721) (1,392)
Net (gain) loss on sales of trading account securities 14 (348)
Federal Home Loan Bank stock dividend (970) (517)
Originations of real estate loans held for sale (78,104) (46,237)
Proceeds from real estate loans originated held for sale 82,152 46,006
Increase in cash surrender value of life insurance (725) (702)
Deferred income taxes (11,521) 5,106
(Gain) loss on sale of other real estate 300 (9)
Change in other assets 296 (7,409)
Change in other liabilities 3,996 (1,458)
----------- -----------
Net cash from operating activities 28,549 23,071
CASH FLOWS FROM INVESTING ACTIVITIES
Sales and maturities of securities available-for-sale 380,525 299,308
Principal payments on securities 292,338 137,315
Purchase of securities available-for-sale (937,054) (408,381)
Maturities of securities held-to-maturity 1,900 900
Sale of derivatives or futures contracts (6,217) -
Net (increase) decrease in loans 68,910 (131,243)
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 1,575 261
Property and equipment expenditures, net (1,055) (830)
----------- -----------
Net cash from investing activities (38,749) (103,678)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 47,630 142,476
Borrowings 5,500 6,300
Repayment of borrowings - (8,500)
Dividends paid (5,176) (4,834)
Change in securities sold under agreements to
repurchase and federal funds purchased (377) (32,923)
Repurchase of common stock - (390)
Proceeds from exercised stock options 1,368 814
----------- -----------
Net cash from financing activities 48,945 102,943
----------- -----------
Increase in cash and cash equivalents 38,745 22,336
Cash and cash equivalents at beginning of period 49,687 49,812
----------- -----------
Cash and cash equivalents at end of period $ 88,432 $ 72,148
=========== ===========
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 $ 38,130 $ 39,801
Income Taxes 5,665 8,757
Amount due to broker for purchases of securities - 10,715
Amount due from broker for purchases of securities 40,810 -
Transfer from available-for-sale securities to held-to-maturity - 99,841
Real estate acquired in settlement of loans 9,124 142
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 1,221 761
Other intangibles, net 3,361 300
Other assets 5,930 -
----------- -----------
Total noncash assets acquired $ 194,311 $ 1,200
=========== ===========
Liabilities assumed:
Deposits 137,729 -
FHLB advances 36,727 -
Accrued expenses and other liabilities 7,557 -
----------- -----------
Total liabilities assumed 182,013 -
----------- -----------
Net noncash assets acquired $ 12,298 $ 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 nine
months ended September 30, 2003 are not necessarily indicative of the results
expected for the full year ending December 31, 2003.
NOTE 2 - BUSINESS COMBINATION
On January 3, 2003, the Company acquired Big Foot Financial Corp.
("BFFC") through the issuance of approximately 1,599,088 shares of common stock
at $18.81 per share and 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 $1.2 million in goodwill. BFFC was merged
into the Company, and its banking subsidiary was merged into and became branches
of Midwest Bank and Trust Company. 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 BFFC been included in the
Company's results of operations since January 3, 2003, 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 nine months ended September
30, 2002 as though BFFC had been acquired as of January 1, 2002.
(In thousands, except per share data)
Three months ended Nine months ended
September 30, 2002 September 30, 2002
------------------ ------------------
Net interest income $17,075 $51,491
Net income 725 14,108
Basic Earnings per share 0.04 0.80
Diluted Earnings per share 0.04 0.78
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 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,
Page 9
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):
SEPTEMBER 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 $ (427) $ 300 $ (56)
AGGREGATE INTANGIBLE AMORTIZATION EXPENSE:
For the three months ended September 30, 2003 $ 124
For the nine months ended September 30, 2003 371
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 nine months ended September 30, 2003 and the year
ended December 31, 2002 (in thousands):
SEPTEMBER 30, 2003
----------------------------------------
GOODWILL CORE DEPOSIT AND
OTHER INTANGIBLES
-------------------- -------------------
Balance at beginning of period $ 4,360 $ 244
Amortization expense - (371)
Goodwill and intangibles acquired 1,221 3,361
------------------- ------------------
Balance at end of period $ 5,581 $ 3,234
=================== ==================
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 17,841,000 and
16,164,000 shares of common stock outstanding at September 30, 2003 and 2002,
respectively. Basic earnings per share for the three months and nine months
ended September 30, 2003 and 2002 were computed by dividing net income by the
weighted average number of shares outstanding. Diluted earnings per share for
the three and nine months ended September 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 outstanding stock options. Computations
for basic and diluted earnings per share as of these dates are provided below.
Page 10
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2003 2002 2003 2002
---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Basic
Net income $ 2,283 $ 330 $ 16,468 $ 13,031
=========== =========== =========== ===========
Weighted average common shares outstanding 17,816 16,160 17,781 16,122
=========== =========== =========== ===========
Basic earnings per common share $ 0.13 $ 0.02 $ 0.93 $ 0.81
=========== =========== =========== ===========
Diluted
Net income $ 2,283 $ 330 $ 16,468 $ 13,031
=========== =========== =========== ===========
Weighted average common shares outstanding 17,816 16,160 17,781 16,121
Diluted effect of stock options 458 476 411 398
----------- ----------- ----------- -----------
Dilutive average common shares 18,274 16,636 18,192 16,519
=========== =========== =========== ===========
Diluted earnings per common share $ 0.12 $ 0.02 $ 0.91 $ 0.79
=========== =========== =========== ===========
All outstanding options were included in the computation of diluted
earnings per share for the three months and nine months ended September 30, 2003
and 2002.
NOTE 5 - STOCK OPTIONS
During the first nine months of 2003, 103,000 stock options were
granted at an exercise price of $18.34 per share. In addition, during the first
nine months of 2003, there were 87,444 outstanding options exercised. Total
stock options outstanding were 1,097,188 at September 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. The Company then 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 distributions and
dividends, respectively, on a quarterly basis, which are included in interest
expense. 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 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% (4.58% at September 30,
Page 11
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 September 30, 2003, the Company has entered into various interest
rate swap transactions, which result in the Company converting $137.5 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 September 30 are as
follows:
2003 2002
---- ----
(Dollars in thousands)
Notional amounts $ 137,500 $ -
Weighted average fixed rates received 5.46%
Weighted average variable rates paid 3.28
Weighted average maturity 6.86 years
Fair value $ 1,183 $ -
From time to time the Company has also bought and sold various put and
call options with terms less than or equal to 90 days on the mortgage-backed
securities and U.S. Treasury and government agency obligations held in its
investment securities portfolio. 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 put or call options outstanding at
September 30, 2003 and 2002.
In August 2002, the Company entered into a credit derivative
transaction with a notional amount of $20.0 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 $30.0 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 September 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 $1.0 billion and is
diversified amongst 100 companies.
In September 2003, the Company entered into 2,000 U.S. Treasury 10-year
note futures contracts with a notional value of $200.0 million and a delivery
date of December 2003. The Company sold these contracts in order to hedge
certain U.S. Agency notes held in its available-for-sale portfolio. The
Company's objective was to preserve the market value of these U.S. Agency notes.
These futures contracts are fair value hedges with the changes in market value
of the futures contracts as well as the changes in the market value of the
hedged items charged or credited to earnings on a quarterly basis. For
Page 12
the period ending September 30, 2003, the hedge ineffectiveness included in the
net gains on securities transactions was a net loss of $194,000.
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 value recognition provisions of FASB Statement No. 123,
"Accounting for Stock-Based Compensation" for three and nine months ended
September 30, 2003 and 2002.
IN THOUSANDS 2003 QTD 2002 QTD 2003 YTD 2002 YTD
-------- -------- -------- --------
Net income as reported $ 2,283 $ 330 $ 16,468 $ 13,031
Deduct: stock-based compensation expense
determined under fair value base method 113 80 338 241
--------- ---------- ---------- ----------
Pro forma net income $ 2,170 $ 250 $ 16,130 $ 12,790
========= ========== ========== ==========
BASIC EARNINGS PER SHARE AS REPORTED $ 0.13 $ 0.02 $ 0.93 $ 0.81
Pro forma basic earnings per share 0.12 0.02 0.91 0.79
DILUTED EARNINGS PER SHARE AS REPORTED $ 0.12 $ 0.02 $ 0.91 $ 0.79
Pro forma diluted earnings per share 0.12 0.02 0.89 0.77
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) September 30, December 31,
2003 2002
---- ----
Financial instruments whose contract amounts
represent credit risk
Unused lines of credit $ 286,933 $ 249,988
Commitments to extend credit 84,433 94,594
Letters of credit 25,254 20,329
At September 30, 2003 and December 31, 2002, commitments to extend
credit consisted of $4,305,000 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 4.50% to 7.50%. Substantially all of the unused
lines of credit are at adjustable rates of interest.
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- 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 $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.
On April 24, 2003, the Federal Reserve and the OBRE completed the
on-site portion of 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. The
Company received the examination report during the third quarter of 2003 and,
based upon discussions with the regulators, the Company expects some form of
informal or formal regulatory action will be taken. As of this date, however,
the Company has not received written notice of any such regulatory action.
In its examination, the Federal Reserve noted deficiencies in the
Company's risk management, credit administration, operational risk and internal
controls, as well as certain residual issues involving market risk management
remaining from its last examination. Management believes the Company has already
addressed many of the issues raised in the regulatory examination, and new
processes have been implemented to enhance overall risk-management and lending
and credit review practices. The Company has entered into two consulting
engagements with a leading financial services consulting firm to review its
initiatives and recommend additional best practices appropriate and consistent
for the organization.
NOTE 11 - 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.
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 December 15, 2003. The Company has no
newly formed VIEs subject to the January 31, 2003 effective date. At this time,
the Company does not believe that adoption of FIN 46 will have a material effect
on the Company's financial statements.
Page 14
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. The adoption of
SFAS No. 149 did not 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, and is
otherwise effective at the beginning of the first interim period beginning after
June 15, 2003. The adoption of SFAS No. 150 on July 1, 2003 did not have a
material effect on the Company's financial statements.
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. Also, see "Note 10 - Capital Contribution and Regulatory Matters"
to our unaudited consolidated financial statements and "Item 4 - Controls
and Procedures" for a discussion of certain regulatory matters.
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 NINE MONTHS ENDED
SEPTEMBER 30, 2003 AND 2002
Consolidated net income for the third quarter of 2003 was $2.3 million,
or $0.13 per basic share and $0.12 per diluted share, a 591.8% increase compared
to $330,000, or $ 0.02 per basic and diluted share for the third quarter of
2002. Basic and diluted earnings per share for the three months ended September
30, 2003 were 550.0% and 500.0%, respectively, higher than for the comparable
period in 2002. The net income for the three months ended September 30, 2002
reflected a provision of $10.9 million taken as the result of the
reclassification of certain loans during the quarter as a result of the
regulatory examination. Consolidated net income for the nine months ended
September 30, 2003 was $16.5 million, or $0.93 and $0.91 per basic and diluted
share, respectively, a 26.4% increase compared to $13.0 million or $0.81 and
$0.79 per basic and diluted share, respectively, for the similar period in 2002.
Basic and diluted earnings per share for the nine months ended September 30,
2003 were 14.8% and 15.2%, respectively, higher than for the comparable period
in 2002. The return on average assets for the three months ended September 30,
2003 was 0.40% compared to 0.07% for the similar period in 2002. For the nine
months ended September 30, 2003, the return on average assets was 0.99% compared
to 0.94% for the similar period in 2002. The return on average equity for the
three months ended September 30, 2003 was 6.33% compared to 1.14% for the
similar period in 2002. For the nine months ended September 30, 2003, the return
on average equity was 14.72% compared to 16.30% for the similar period in 2002.
Net interest income decreased $136,000, or 0.9%, to $14.9 million in
the third quarter of 2003 compared to $15.0 million in the third quarter of
2002. During the nine months ended September 30, 2003, net interest income
increased $1.3 million, or 2.9%, to $46.7 million compared to $45.3 million for
the comparable period in 2002. Excluding gains on securities and trading account
profits, other income increased 70.1% to $5.0 million and other expenses
increased 28.4% to $10.7 million in the third quarter of 2003. Other income,
excluding gains on securities and trading account profits, increased 70.7% to
$14.1 million for the nine months ended September 30, 2003 compared to the
similar period in 2002. Other expenses for the nine months ended September 30,
2003 increased by $7.1 million or 28.3% 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 $14.9 million during the quarter ended
September 30, 2003 compared to $15.0 million during the three months ended
September 30, 2002, a decrease of $136,000 or 0.9%. During the nine months ended
September 30, 2003, net interest income increased $1.3 million, or 2.9%, to
$46.7 million compared to $45.3 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 3.00% for the three months ended September 30,
2003 compared to 3.50% for the comparable period in 2002. During the nine months
ended September 30, 2003, the net interest margin was 3.16% compared to 3.58%
for the similar period in 2002. Due to the continued low interest rate
environment during the third quarter of 2003, the Company experienced additional
net interest margin compression due in part to the recognition of premium
amortization expense associated with its mortgage-backed securities it holds in
its investment securities portfolio. Amortization expense on the mortgage-backed
securities was $2.8 million and $7.8 million for the three and nine months ended
September 30, 2003, respectively, compared to $1.3 million
Page 17
and $3.0 million for the similar periods in 2002. The Company reduced its
portion of the investment portfolio invested in mortgage-backed securities in an
attempt to decrease the earnings volatility related to accelerated premium
amortization due to the mortgage refinancing. Accordingly, as of September 30,
2003, mortgage-backed securities comprised 32.7% of the portfolio compared to
78.5% at December 31, 2002.
The average loan yield was 6.40% during the third quarter of 2003, a
decrease of 7.0% from 6.88% during the comparable period in 2002. For the nine
months ended September 30, 2003, the average loan yield was 6.55%, a decrease of
5.9% from 6.96% during the comparable period in 2002. Average loan balances
decreased $43.8 million, or 3.9%, to $1.1 billion during the third quarter of
2003 from the similar period in 2002. During the first nine months of 2003,
average loan balances increased $58.3 million, or 5.4%, to $1.1 billion compared
to the similar period of 2002.
Yields on securities during the third quarter of 2003 were 4.20%, a
decrease of 27.6% from 5.80% during the comparable period in 2002. During the
nine months ended September 30, 2003, security yields decreased 26.8% to 4.45%
from 6.08% 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 $1.5 million and
$4.8 million for the three and nine months ended September 30, 2003,
respectively, compared to the same periods in 2002. The Company has reallocated
its investment securities portfolio in order to reduce the likelihood of an
increase in future amortization.
Yields on earning assets decreased 17.4% to 5.32% during the third
quarter of 2003 compared to 6.44% for the third quarter of 2002. During the
first nine months of 2003, yields on earning assets decreased to 5.56%, or
15.6%, from 6.59% for the similar period in 2002. Average earning assets,
however, increased $322.0 million to $2.1 billion for the three months September
30, 2003 and increased $336.5 million to $2.1 billion for the nine months ended
September 30, 2003 from $1.8 billion for the three months and nine months ended
September 30, 2002.
The decrease in yields on earning assets was partially offset by a
decrease in rates paid on deposits and borrowings. Average rates paid on
deposits decreased 26.8% to 2.08% for the three months ended September 30, 2003
from 2.84% for the comparable period in 2002. For the first nine months of 2003,
average rates paid on deposits decreased 24.3% to 2.21% from 2.92% for the
similar period of 2002. Average rates paid on borrowings were 3.56% for the
third quarter of 2003 compared to 4.44% for the third quarter of 2002. During
the nine months ended September 30, 2003, average rates paid on borrowings were
3.80% compared to 4.38% for the similar period in 2002. Average borrowings
increased by $129.5 million and $93.7 million for the three months and nine
months ended September 30, 2003 to $553.8 million and $527.8 million,
respectively. FHLB advances increased as a result of the $33.0 million of
advances acquired as a result of the acquisition of BFFC. The Company converted
$67.5 million of its FHLB advances from fixed rate debt to floating rate through
interest rate swap transactions in December 2002, and another $70.0 million in
July 2003. These swap transactions resulted in a $688,000 and $1.4 million
decrease in interest expense for the three and nine months ended September 30,
2003, respectively. 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 $96.7 million and $63.7 million for
the three and nine months ended September 30, 2003 to $252.8 million and $230.3
million, respectively.
Going forward, it is expected that the net interest margin will
stabilize and improve, although it is unlikely to increase back to the 2002
level during the next quarter. Key factors for an expected improvement in the
net interest margin include an increase in loan volumes, slower prepayments on
the remaining mortgage-backed securities the Company holds in its portfolio,
continued benefit of interest
Page 18
rate swaps related to high interest rate FHLB advances, and the impact of
deposit pricing strategies. The expected improvements in the net interest margin
also assume no further cuts in interest rates by the Federal Open Market
Committee in the near future.
The net interest margin calculation for the three months ended
September 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 income tax rate for 2003 and 2002 and adjusted for the
dividend received deduction where applicable):
2003 2002
---- ----
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- ----
INTEREST-EARNING ASSETS
Federal funds sold $ 7,007 $ 18 1.03% $ 10,500 $ 39 1.49%
Securities taxable 974,901 9,828 4.03 604,115 8,603 5.70
Securities tax-exempt (1) 72,713 1,220 6.71 74,149 1,257 6.78
Commercial loans (1) (3) 213,959 2,941 5.50 232,726 3,385 5.82
Commercial real estate loans (1) (3) (4) 691,193 11,476 6.64 702,720 12,604 7.17
Agriculture loans (1) (3) 57,274 904 6.31 55,859 958 6.86
Consumer real estate loans (1) (3) (4) 96,775 1,572 6.50 109,125 1,965 7.20
Consumer installment loans (1) (3) 12,882 257 7.98 15,502 322 8.31
----------- --------- ----------- ---------
$ 2,126,704 $ 28,216 5.32% $ 1,804,696 $ 29,133 6.44%
=========== ========= =========== =========
2003 2002
---- ----
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- ----
INTEREST-BEARING LIABILITIES
Interest-bearing demand deposits $ 186,501 $ 539 1.16% $ 135,942 $ 517 1.52%
Money-market demand deposits
and savings deposits 324,580 888 1.09 257,096 1,081 1.68
Time deposits less than $100,000 743,331 5,092 2.74 620,261 5,508 3.55
Time deposits greater than $100,000 102,406 575 2.25 136,847 1,044 3.05
Public funds 42,069 230 2.19 62,093 467 3.01
Federal funds purchased
and repurchase agreements 252,846 1,621 2.56 156,107 1,119 2.86
FHLB advances 258,464 2,606 4.03 237,500 3,328 5.61
Notes and other debentures 42,500 706 6.64 30,659 273 3.56
----------- --------- ----------- ---------
$ 1,952,697 $ 12,257 2.52% $ 1,636,505 $ 13,337 3.24%
=========== ========= =========== =========
Net Interest Income (1) (5) $ 15,959 2.80% $ 15,796 3.20%
========= =========
Net Interest Margin (1) 3.00% 3.50%
Net Interest Income (2) (5) $ 14,880 2.58% $ 15,016 3.04%
========= =========
Net Interest Margin (2) 2.80% 3.33%
(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:
3Q03 3Q02
---- ----
Net interest income $ 14,880 $ 15,016
Tax equivalent adjustment to net interest income 1,079 780
--------------------------
Net interest income, tax equivalent basis $ 15,959 $ 15,796
--------------------------
Page 19
The net interest margin calculation for the nine months ended September
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):
2003 2002
---- ----
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- ----
INTEREST-EARNING ASSETS
Federal funds sold $ 10,289 $ 85 1.10% $ 9,278 $ 112 1.61%
Securities taxable 891,048 28,522 4.27 631,703 28,546 6.03
Securities tax-exempt (1) 72,677 3,665 6.72 54,866 2,782 6.76
Commercial loans (1) (3) 224,753 9,892 5.87 228,081 10,479 6.13
Commercial real estate loans (1) (3) (4) 705,257 35,424 6.70 670,206 36,060 7.17
Agriculture loans (1) (3) 56,907 2,724 6.38 52,328 2,711 6.91
Consumer real estate loans (1) (3) (4) 131,286 6,766 6.87 108,692 5,872 7.20
Consumer installment loans (1) (3) 13,282 796 7.99 13,830 864 8.33
----------- --------- ----------- ---------
$ 2,105,499 $ 87,874 5.56% $ 1,768,984 $ 87,426 6.59%
=========== ========= =========== =========
INTEREST-BEARING LIABILITIES
Interest-bearing demand deposits $ 173,214 $ 1,547 1.19% $ 135,804 $ 1,556 1.53%
Money-market demand deposits
and savings deposits 323,717 2,912 1.20 258,925 3,277 1.69
Time deposits less than $100,000 714,413 15,347 2.86 577,799 15,962 3.68
Time deposits greater than $100,000 115,299 2,128 2.46 132,580 3,155 3.17
Public funds 56,869 1,061 2.49 70,916 1,780 3.35
Federal funds purchased
and repurchase agreements 230,312 4,614 2.67 166,582 3,215 2.57
FHLB advances 256,577 8,328 4.33 238,789 9,921 5.54
Notes and other debentures 40,930 2,085 6.79 28,778 1,126 5.22
----------- --------- ----------- ---------
$ 1,911,331 $ 38,022 2.65% $ 1,610,173 $ 39,992 3.31%
=========== ========= =========== =========
Net Interest Income (1) (5) $ 49,852 2.91% $ 47,434 3.28%
========= =========
Net Interest Margin (1) 3.16% 3.58%
Net Interest Income (2) (5) $ 46,673 2.71% $ 45,347 3.13%
========= =========
Net Interest Margin (2) 2.96% 3.42%
(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:
YTD YTD
3Q03 3Q02
---- ----
Net interest income $ 46,673 $ 45,347
Tax equivalent adjustment to net interest income 3,179 2,087
---------------------
Net interest income, tax equivalent basis $ 49,852 $ 47,434
---------------------
Other Income
- ------------
Other income, excluding securities gains and trading account profits,
was $5.0 million for the three months ended September 30, 2003, an increase of
$2.1 million, or 70.1%, over the comparable period in 2002. For the nine months
ended September 30, 2003, other income, excluding securities gains and trading
account profits, was $14.1 million, an increase of $5.8 million, or 70.7%,
compared to $8.3 million for the comparable period in 2002. The other income to
average assets ratio was 0.88% for the three months ended September 30, 2003
compared to 0.62% for the same period in 2002. For the nine months ended
September 30, 2003, the other income to average assets ratio was 0.84% compared
to
Page 20
0.59% for the same period in 2002. The increase in other income for the three
and nine month periods is mainly due to increases in service charges on
deposits, option income, and insurance and brokerage commissions.
Service charges on deposits slightly decreased 0.5%, or $8,000, to $1.5
million in the third quarter of 2003 from $1.5 million in the third quarter of
2002. For the nine months ended September 30, 2003, service charges on deposits
increased 4.4%, or $184,000, to $4.4 million compared to $4.2 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 continue to increase with future
deposit growth.
Insurance and brokerage commissions increased $197,000 to $582,000 for
the third quarter of 2003 from $385,000 in the third quarter of 2002. For the
nine months ended September 30, 2003, insurance and brokerage commissions
increased $608,000 to $1.6 million compared to $988,000 for the first nine
months of 2002. This increase is due to the increased investment brokerage
activities conducted 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 continue to increase in the future through this subsidiary.
Mortgage banking fees increased 41.8% to $295,000 during the third
quarter of 2003 compared to $208,000 for the similar period in 2002. For the
nine months ended September 30, 2003, mortgage banking fees increased $520,000
to $960,000 from $440,000 in the comparable 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 9.7% or $13,000 to $147,000 for the third
quarter of 2003 compared to $134,000 for the similar period in 2002. For the
nine months ended September 30, 2003, trust income increased by $21,000 to
$451,000 compared to $430,000 in the nine months ended September 30, 2002.
Trading account profits result from trading strategies that are
utilized to supplement narrowing bond yields during periods of interest rate
volatility. There were no trading account profits during the three months ended
September 30, 2002 compared to a loss of $144,000 during the three months ended
September 30, 2003. Year-to-date net trading account losses were $14,000 in 2003
and net trading account profits were $348,000 in 2002. Included in the
quarter-to-date and year-to-date trading account losses is a loss of $288,000
for a futures trading position. Sales of securities available-for-sale resulted
in net gains of $917,000 in the third quarter of 2003 compared to $97,000 for
the comparable period in 2002. For the nine months ended September 30, 2003,
gains on sales of securities available-for-sale were $3.7 million compared to
$1.4 million for the similar period in 2002. Included in the net gains on
available-for-sale securities transactions was a net loss of $194,000 as a
result of the hedge ineffectiveness on derivative instruments. See Note 7.
Periodically, the Company has bought or sold various covered put and
call options, with terms less than 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 increased
$1.6 million to $2.0 million during the third quarter of 2003 compared to
$335,000 in the third quarter of 2002. For the nine months ended September 30,
2003, option fee income increased $4.0 million to $5.0 million compared to
$989,000 in the similar period in 2002. Option fees are part of management's
ongoing strategy to manage risk in the securities portfolio and take advantage
of favorable market conditions. Management has effectively used the proceeds
from selling covered call and put options to offset net interest margin
compression and has administered such sales in a coordinated process with the
Page 21
Company's overall asset/liability management. Management is poised to adjust its
option strategy when interest rates increase or decrease. There is no assurance
that the option fee income realized through September 30, 2003 is sustainable in
future periods. The Company had no covered put or call options outstanding at
September 30, 2003. See Note 7.
Other Expenses
- --------------
Total other expenses increased 28.4%, or $2.4 million, to $10.7 million
during the third quarter of 2003 compared to $8.3 million for the comparable
period in 2002. For the nine months ended September 30, 2003, total other
expenses increased 28.4%, or $7.1 million, to $32.1 million from $25.0 million
in the first nine months of 2002. The other expenses to average assets ratio was
1.86% for the three months ended September 30, 2003 compared to 1.74% for the
same period in 2002. For the nine months ended September 30, 2003, the other
expense to average assets ratio was 1.93% compared to 1.80% for the similar
period in 2002.
Net overhead expense is total other expenses less total other income
excluding securities gains and trading account profits. The net overhead
expenses to average assets ratio was 0.99% for the three months ended September
30, 2003 compared to 1.12% for the same period in 2002. For the nine months
ended September 30, 2003, the net overhead expenses to average assets ratio was
1.08% compared to 1.21% for the similar period in 2002. The efficiency ratio is
total other expenses less the amortization of intangibles expenses as a
percentage of the sum of net interest income on a fully taxable equivalent basis
and total other income. The efficiency ratio was 50.03% for the three months
ended September 30, 2003 compared to 44.61% for the same period in 2002. For the
nine months ended September 30, 2003 the efficiency ratio was 49.44% compared to
44.75% for the same period in 2002. The increase in the efficiency ratio was
primarily due to the increase in other expenses during the quarter.
Salary and benefit expenses increased 17.1% or $892,000 to $6.1 million
for the third quarter of 2003 compared to $5.2 million for the similar period in
2002. For the nine months ended September 30, 2003, salary and benefit expenses
increased $2.7 million or 17.5% to $18.2 million from $15.5 million for the
comparable period in 2002. The number of full-time equivalent employees was 431
as of September 30, 2003 compared to 388 as of September 30, 2002. An increase
in full-time staff positions, including investment brokerage staff, employees
added through the acquisition of BFFC, and other new positions were 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
2003-2004 plan year.
Occupancy expenses increased $512,000 or 45.1% to $1.6 million during
the third quarter of 2003 compared to $1.1 million for the similar period in
2002. For the nine months ended September 30, 2003, occupancy expenses increased
$1.3 million or 36.0% to $4.9 million from $3.6 million in the nine 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 $956,000 or 49.2% to $2.9 million in the third quarter of 2003
compared to the similar period in 2002. Other expenses increased $3.1 million or
52.0% to $9.1 million for the nine months ended September 30, 2003 compared to
$6.0 million for the similar period in 2002. During the third quarter of 2003,
$291,000 was expensed to write down a portion of other real estate owned to its
net realizable value. The increase in expenses was due primarily to outsourcing
arrangements, other loan related expenses, and general operating costs.
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
during the first nine months of 2003. Due to the termination of the CoVest
Page 22
agreement, $425,000 in legal, consulting, and data conversion fees were
expensed. Specific collection expenses due to problem loans reflected in the
first nine months of 2003 include $430,000 in professional fees.
Income Taxes
- ------------
The Company recorded an income tax benefit of $21,000 for the quarter
ended September 30, 2003. For the nine months ended September 30, 2003, the
provision for income taxes increased 30.7% to $6.4 million, or 27.9% of net
income compared to $4.9 million or 27.3% of net income for the similar period in
2002.
FINANCIAL CONDITION
Loans
- -----
The following table sets forth the composition of the Company's loan
portfolio as of the indicated dates.
SEPTEMBER 30, 2003 DECEMBER 31, 2002
------------------ -----------------
(IN THOUSANDS)
Loan Loan
Category Category
to Gross to Gross
Amount Loans Amount Loans
------ ----- ------ -----
Commercial $ 200,072 18.8% $ 229,764 20.2%
Commercial real estate 695,064 65.5 730,836 64.2
Agricultural 58,416 5.5 57,426 5.0
Consumer real estate (1) 95,057 9.0 105,391 9.3
Consumer installment 12,744 1.2 14,573 1.3
----------- ----- ----------- -----
Total loans, gross 1,061,353 100.0 1,137,990 100.0
Unearned discount (905) (1,286)
---------- -----------
Total loans 1,060,448 1,136,704
Allowance for loan losses (14,452) (20,754)
---------- -----------
Net loans $1,045,996 $ 1,115,950
========== ===========
Loans held for sale:
Consumer real estate $ 876 0.1% $ 4,924 0.4%
(1) Includes loans held for sale.
Total loans decreased $76.3 million, or 6.7%, to $1.1 billion as of
September 30, 2003 from $1.1 billion as of December 31, 2002. Overall loan
demand has been down as a result of current economic conditions and other
competitive factors. In addition, the decrease in loans was due to a corporate
commitment to tighter credit standards and pricing disciplines applied to
commercial and commercial real estate loans to protect the Company's long-term
profitability.
Commercial loans decreased $29.7 million, or 12.9%, to $200.1 million
as of September 30, 2003 compared to $229.8 million at December 31, 2002.
Commercial real estate loans decreased 4.9%, or $35.8 million, to $695.1 million
as of September 30, 2003 from $730.8 million as of December 31, 2002.
Agricultural loans increased 1.7%, or $990,000, to $58.4 million as of September
30, 2003 from $57.4 million as of December 31, 2002.
Page 23
Consumer real estate loans decreased $10.3 million, or 9.8%, to $95.1
million as of September 30, 2003 from $105.4 million as of December 31, 2002.
Consumer loans decreased 12.6% to $12.7 million as of September 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 $876,000 at
September 30, 2003. The carrying value of these loans approximated their market
value at that time.
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 nine months ended September 30:
2003 2002
---- ----
(IN THOUSANDS)
Balance, January 1 $ 20,754 $ 10,135
Balance from acquisition 300 -
Adjustment for loan sale to related parties (1) (6,685) -
Provision charged to operations 9,488 12,392
Loans charged-off (9,548) (1,770)
Recoveries 143 193
---------- -----------
Balance, September 30 $ 14,452 $ 20,950
========== ===========
(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 10.
The Company recognizes that credit losses 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
ongoing evaluations 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
Page 24
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 loan losses is
consistent with prior periods.
The Company's provision for loan losses was $7.7 million for the third
quarter of 2003 compared to $10.9 million for the similar period in 2002. For
the nine months ended September 30, 2003, the provision for losses was $9.5
million compared to $12.4 million for the comparable period in 2002.
The allowance for loan losses was $14.5 million, or 1.36% of total
loans, as of September 30, 2003 and $20.8 million, or 1.83% of total loans, at
December 31, 2002. See Note 10.
Nonaccrual and Nonperforming Loans
- ----------------------------------
Nonaccrual loans decreased 41.3% or $12.0 million to $17.0 million as
of September 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 10.
Nonperforming loans include nonaccrual loans and accruing loans which
are 90 days or more delinquent. Typically, these loans have adequate collateral
protection and/or personal guaranties to provide a source of repayment to the
Bank. Nonperforming loans were $17.1 million as of September 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.
SEPTEMBER 30, 2003 DECEMBER 31, 2002
------------------ -----------------
(IN THOUSANDS)
Nonaccrual and impaired loans
not accruing $ 17,039 $ 29,035
Impaired and other loans 90 days
past due and accruing 69 2,514
----------- -----------
Total nonperforming loans 17,108 31,549
Other real estate 7,782 533
----------- -----------
Total nonperforming assets $ 24,890 $ 32,082
=========== ===========
Page 25
Total nonperforming loans to
total loans 1.61% 2.78%
Total nonperforming assets to
total loans and other real estate 2.33 2.82
Total nonperforming assets to
total assets 1.10 1.60
Allowance to nonperforming loans 0.84x 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 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.
Five loans totaling $9.4 million represented 55.0% of the total
nonperforming loans at September 30, 2003. Specific reserves of $2.3 million
have been established for these loans. Approximately $500,000 of total
nonperforming loans were paid off during October 2003, and another $1.6 million
were current as of October 31, 2003. Management expects additional collections
on its nonperforming loans during the fourth quarter of 2003. The remaining
nonperforming loans are secured by collateral, including personal guaranties,
and are in varying stages of workout at this time. Management expects the
allowance coverage of nonperforming loans to improve and move closer to peer
group levels in the future. This improvement should be achieved through normal
provisions for loan losses, anticipated partial recoveries of previously
charged-off loans, and the satisfactory resolution of current workout efforts
with specific borrowers.
Other real estate owned was $7.8 million at September 30, 2003, an
increase of $7.2 million compared to $533,000 at December 31, 2002. Included in
other real estate owned are two properties that total $7.2 million of the $7.8
million other real estate owned. One property is a townhouse development on
which the borrower ceased construction and a construction manager has been
appointed. The Company will continue the development on an interim basis as the
property is marketed for sale. The Company has signed a letter of intent to sell
this property at $7.5 million; however, there can be no guarantee that the
property will be sold at this price, or at all. The other property is a
single-family residence at its net realizable value based on the appraised value
of the property. The Company has obtained a sales contract on the single-family
residence and expects to close the sale in December 2003.
Page 26
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 September 30, 2003, special
mention, substandard, and doubtful classifications were $12.3 million, $38.5
million, and $1.2 million, 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 September 30, 2003.
Securities
- ----------
The Company manages, via a centralized portfolio management department,
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 duration and yield volatility of its
investments in mortgage-backed securities under various interest rate
assumptions. 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 September 30, 2003, net unrealized losses on
securities available-for-sale was $10.7 million compared to an unrealized gain
of $7.1 million at December 31, 2002. This change resulted in a $17.9 million
decrease in book equity. For the three months ended September 30, 2003, the
decrease in fair value of securities available-for-sale net of income tax was
$16.8 million. The Company has entered into futures contracts as a means to
reduce market risk and partially offset further declines in book equity
attributable to increases in interest rates. In September 2003, the Company
entered into 2,000 U.S. Treasury 10 year note futures contracts with a notional
value of $200.0 million and a delivery date of December 2003. The Company sold
these contracts in order to hedge a group of U.S. Agency notes held in its
available-for-sale portfolio. The Company's objective was to preserve the market
value of these U.S. Agency notes. See Note 7.
Securities available-for-sale increased to $893.3 million as of
September 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 $1.5 million and $4.8 million for the quarter and nine
months ended September 30, 2003, respectively, compared to the similar periods
in 2002. The Company has reallocated its securities holdings in order to
mitigate the increase in amortization expense. At September 30, 2003,
mortgage-backed securities were 32.7% of the portfolio. U.S. government agency
mortgage-backed securities decreased 46.0% or $228.2 million from $495.6 million
as of December 31, 2002 to $267.4 million as of September 30, 2003. U.S.
Treasury and government agency obligations increased $339.4 million to $363.3
million, representing 37.1% of the
Page 27
portfolio as of September 30, 2003 compared to $23.9 million as of December 31,
2002. Equity securities increased $60.7 from $59.4 million at December 31, 2002
to $120.0 million as of September 30, 2003. Equity securities at September 30,
2003 included capital securities of United States agencies, investment grade or
credit equivalent community banks, and the Federal Home Loan Bank and Federal
Reserve Bank stock. Other bonds increased $96.7 million to $103.9 million at
September 30, 2003 compared to $7.2 million at December 31, 2002. Other bonds
include high grade corporate bonds primarily issued by financial institutions.
Obligations of state and political subdivisions increased $1.9 million to $57.0
million at September 30, 2003 from $55.1 million at December 31, 2002.
Securities held-to-maturity decreased $50.3 million to $68.3 million as
of September 30, 2003 from $118.6 million as of December 31, 2002. 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 September 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 $4.0 million; $3.3 million was acquired as a result of the
acquisition of BFFC; in addition, the cash surrender value of the insurance
increased $725,000 from December 31, 2002 to September 30, 2003. The BOLI is
intended to provide funding for future employee benefit expense.
Other Assets
- ------------
Other assets increased $20.1 million to $48.2 million at September 30,
2003 compared to $28.1 million at December 31, 2002. This increase is primarily
due to the increase in deferred tax assets attributed to unrealized losses on
securities available-for-sale.
Deposits and Borrowed Funds
- ---------------------------
Total deposits of $1.6 billion as of September 30, 2003 represented an
increase of $185.4 million or 13.3% from $1.4 billion as of December 31, 2002.
Non-interest-bearing deposits were $154.6 million at September 30, 2003, $19.8
million higher than the $134.9 million level as of December 31, 2002. Over the
same period, interest-bearing deposits increased 13.2% or $165.6 million.
Certificates of deposit under $100,000 increased $122.9 million from December
31, 2002 to September 30, 2003. Certificates of deposit over $100,000 and public
funds decreased $66.0 million from December 31, 2002 to September 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 to rely on
public funds and brokered certificates of deposit.
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 25.8% to $173.5 million at September 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. Standard and Poors and
Moody's rated the Federal Home Loan Bank of Chicago as a AAA rated financial
institution. 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.
Page 28
Federal Home Loan Bank advances were $256.8 million at September 30,
2003 and $219.5 million at December 31, 2002. FHLB advances increased as a
result of the $33.0 million acquired as a result of the acquisition of 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, and an
additional $70.0 million in July 2003. These swap transactions resulted in a
$688,000 and $1.4 million decrease in interest expense for the three and nine
months ended September 30, 2003. The weighted average rate for Federal Home Loan
Bank advances was 5.45% during the nine months ended September 30, 2003 with a
range of maturities between one and ten years.
Borrowed funds at September 30, 2003 and December 31, 2002 are listed
below:
2003 2002
---- ----
(IN THOUSANDS)
Federal funds purchased $ 325 $ 20,825
Securities sold under agreements to
repurchase 205,180 185,057
Federal Home Loan Bank (FHLB) advances
to bank subsidiaries 256,751 219,500
Trust preferred securities 35,000 35,000
Revolving line of credit 7,500 2,000
------------ ------------
Total notes payable $ 504,756 $ 462,382
============ ============
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 at September 30, 2003 and $25.0
million at December 31, 2002. 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 September 30, 2003, the
Company had $7.5 million outstanding under the revolving line of credit.
The revolving line of credit included the following covenants at
September 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 September 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 $205.2 million in securities
sold under repurchase agreements at September 30, 2003 compared to $185.1
million at December 31, 2002. The Company had $325,000 in federal funds
purchased at September 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.
Page 29
The Company issued variable rate junior subordinated debentures
aggregating $15.0 million to MBHI Capital Trust II, a wholly-owned subsidiary of
the Company. The interest rate resets quarterly, and is equal to LIBOR plus
3.45% (4.58% at September 30, 2003), provided that this rate cannot exceed 12.5%
through the interest payment date in November 2007. The junior subordinated
debentures pay interest on a quarterly basis and will mature on November 7,
2032.
Capital Resources
- -----------------
Stockholders' equity increased $28.8 million, or 25.0%, to $143.7
million at September 30, 2003 from $115.0 million at December 31, 2002. Total
capital to risk-weighted assets increased to 13.1% on September 30, 2003 from
11.7% on December 31, 2002. During January 2003, the Company issued 1,599,088
shares of common stock as partial payment of the purchase price of BFFC,
representing an increase of $30.4 million in equity. Stockholders' equity also
increased by $1.4 million due to the exercise of outstanding employee stock
options. 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 10.
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 categorized as well capitalized
as of September 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 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 $ 192,103 13.1% $ 117,177 8.0% $ 146,471 10.0%
Midwest Bank and Trust Company 167,321 12.9 103,616 8.0 129,520 10.0
Midwest Bank of Western Illinois 19,978 11.8 13,501 8.0 16,876 10.0
Tier I capital to risk-weighted assets
Company 177,651 12.1 58,588 4.0 87,883 6.0
Midwest Bank and Trust Company 154,031 11.9 51,808 4.0 77,712 6.0
Midwest Bank of Western Illinois 18,816 11.1 6,751 4.0 10,126 6.0
Tier I capital to average assets
Company 177,651 7.8 90,860 4.0 113,575 5.0
Midwest Bank and Trust Company 154,031 7.8 78,505 4.0 98,131 5.0
Midwest Bank of Western Illinois 18,816 6.4 11,726 4.0 14,657 5.0
Page 30
AS OF SEPTEMBER 30, 2003
------------------------------------------------------------------------
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 $28.5 million for the nine
months ended September 30, 2003 compared to $23.1 million a year earlier. Net
cash outflows from investing activities were $38.7 million in the first nine
months of 2003 compared to net cash outflows of $103.7 million a year earlier.
Cash inflows from financing activities for the nine months ended September 30,
2003 were $48.9 million compared to net cash inflows of $102.9 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
was available at September 30, 2003.
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 $1.9 billion at
September 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 nine months ended September 30, 2003
and September 30, 2002, respectively. Management of investing and financing
activities and market conditions determine the level and the stability of net
interest cash flows. 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 31
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 September 30, 2003.
NET INTEREST INCOME
----------------------------------------------------
AMOUNT $ CHANGE % CHANGE
------ -------- --------
(DOLLARS IN THOUSANDS)
+200 bp $ 60,632 $ (1,991) (3.18)%
+100 bp 61,206 (1,418) (2.26)
Base 62,623 - -
-100 bp 62,726 103 0.16
As shown above, at September 30, 2003, the effect of an immediate 100
basis point decrease in interest rates would increase the Company's net interest
income by 0.16% or $103,000. The effect of an immediate 200 basis point increase
in rates would decrease the Company's net interest income by 3.18% or $2.0
million.
The projected changes in the Company's net interest income for the
various rate shock levels at December 31, 2002 were the following:
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 bps 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 32
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 and has made certain
enhancements to its policies and procedures regarding identification and
classification of problem loans and its asset quality review process.
There have been no significant changes to the Company's internal
controls over financial reporting or in other factors that could significantly
affect these controls subsequent to the date that the internal controls over
financial reporting 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 Company's 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.
In addition, the Company's management is addressing credit administration,
operational risk and internal controls, and market risk deficiencies that have
been identified in its most recent regulatory examination.
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 33
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 34
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
None
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:
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
Page 35
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 July 1, 2003, filed with the SEC on
July 1, 2003.
Current Report on Form 8-K dated July 29, 2003, filed with the SEC on
July 30, 2003.
Page 36
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: November 12, 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 37
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.