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 March 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to __________
_________________________________________________________
NORTHERN STATES FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 0-19300 36-3449727
(State of Incorporation) (Commission (I.R.S. Employer
File Number) Identification No.)
1601 North Lewis Avenue
Waukegan, Illinois 60085
(847) 244-6000
(Address, including zip code, and telephone number, including
area code, of principal executive office)
_________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, (or for 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: XXX NO: ____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). YES: XXX NO: ____
4,305,105 shares of common stock were outstanding
as of April 30, 2004
NORTHERN STATES FINANCIAL CORPORATION AND SUBSIDIARY
----------------------------------------------------
FORM 10-Q
---------
FOR THE QUARTER ENDED MARCH 31, 2004
------------------------------------
INDEX
-----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page Number
Report of Independent Accountants.................................2
Condensed Consolidated Financial Statements and Notes,............ 3
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................9
Item 3. Quantitative and Qualitative Disclosures
About Market Risk................................................ 19
Item 4. Controls and Procedures.......................................... 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................ 22
Item 2. Changes in Securities, Use of Proceeds
and Issuer Purchases of Equity Securities.........................22
Item 3. Defaults upon Senior Securities...................................22
Item 4. Submission of Matters to a Vote of Security Holders...............22
Item 5. Other Information.................................................22
Item 6. Exhibits and Reports on Form 8-K..................................23
Signatures....................................................................24
EXHIBIT INDEX.................................................................25
1
PART 1. FINANCIAL INFORMATION
- -----------------------------
ITEM 1. FINANCIAL STATEMENTS
- ----------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Stockholders
Northern States Financial Corporation
Waukegan, Illinois
We have reviewed the condensed consolidated balance sheet of NORTHERN
STATES FINANCIAL CORPORATION as of March 31, 2004 and the condensed consolidated
statements of income and cash flows for the three month periods ended March 31,
2004 and 2003. These financial statements are the responsibility of the
Company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures and
making inquiries of persons responsible for financial and accounting matters. It
is substantially less in scope than an audit conducted in accordance with
generally accepted auditing standards, the objective of which is the expression
of an opinion regarding the financial statements taken as a whole. Accordingly,
we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications
that should be made to the condensed financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States of America.
We have previously audited, in accordance with auditing standards
generally accepted in the United States of America, the consolidated balance
sheet of Northern States Financial Corporation as of December 31, 2003, and the
related consolidated statements of income, stockholders' equity and cash flows
for the year then ended (not presented herein); and in our report dated March
18, 2004, we expressed an unqualified opinion on those financial statements. In
our opinion, the information set forth in the accompanying condensed
consolidated balance sheet as of December 31, 2003, is fairly stated, in all
material respects, in relation to the consolidated balance sheet from which it
has been derived.
/s/ Crowe Chizek and Company LLC
- -------------------------------------
Oak Brook, Illinois
May 6, 2004
2
NORTHERN STATES FINANCIAL CORPORATION
- -------------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
- -------------------------------------
March 31, 2004 and December 31, 2003
(In thousands of dollars) (Unaudited)
March 31, December 31,
2004 2003
--------- ------------
Assets
Cash and due from banks................................................................. $ 18,466 $ 18,403
Interest bearing deposits in financial institutions -
maturities less than 90 days......................................................... 117 181
Federal funds sold....................................................................... 52,994 20,000
-------- --------
Total cash and cash equivalents....................................................... 71,577 38,584
Securities available for sale............................................................ 262,452 280,445
Loans and leases......................................................................... 430,180 358,226
Less: Allowance for loan and lease losses................................................ (3,934) (4,383)
-------- --------
Loans and leases, net................................................................. 426,246 353,843
Federal Home Loan Bank and Federal Reserve Bank stock.................................... 2,051 1,871
Office buildings and equipment, net...................................................... 9,249 5,370
Other real estate owned.................................................................. 3,766 3,766
Goodwill................................................................................. 9,717 85
Other intangible assets.................................................................. 3,130 0
Accrued interest receivable and other assets............................................. 4,560 5,655
-------- --------
Total assets.......................................................................... $792,748 $689,619
======== ========
Liabilities and Stockholders' Equity
Liabilities
Deposits
Demand - noninterest bearing.......................................................... $ 57,169 $ 52,398
Interest bearing...................................................................... 576,158 440,734
-------- --------
Total deposits..................................................................... 633,327 493,132
Securities sold under repurchase agreements.............................................. 65,721 83,367
Federal funds purchased.................................................................. 0 26,500
Federal Home Loan Bank advances.......................................................... 6,500 6,500
Advances from borrowers for taxes and insurance.......................................... 1,259 535
Accrued interest payable and other liabilities........................................... 7,553 4,256
-------- --------
Total liabilities.................................................................. 714,360 614,290
Stockholders' Equity
Common stock............................................................................. 1,789 1,789
Additional paid-in capital............................................................... 11,584 11,584
Retained earnings........................................................................ 68,494 66,833
Accumulated other comprehensive income (loss), net....................................... 909 (489)
Treasury stock, at cost.................................................................. (4,388) (4,388)
-------- --------
Total stockholders' equity............................................................ 78,388 75,329
-------- --------
Total liabilities and stockholders' equity......................................... $792,748 $689,619
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
NORTHERN STATES FINANCIAL CORPORATION
- -------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
- -------------------------------------------
Three months ended March 31, 2004 and 2003
(In thousands of dollars, except per share data) (Unaudited)
Three months ended
March 31, March 31,
2004 2003
--------- ---------
Interest income
Loans (including fee income)............................................................ $5,651 $5,232
Securities
Taxable............................................................................... 1,918 1,702
Exempt from federal income tax........................................................ 97 82
Federal funds sold and other............................................................ 95 19
------ ------
Total interest income............................................................... 7,761 7,035
------ ------
Interest expense
Time deposits........................................................................... 1,631 1,783
Other deposits.......................................................................... 377 376
Repurchase agreements, federal funds purchased and Federal Home Loan Bank advances...... 305 546
------ ------
Total interest expense.............................................................. 2,313 2,705
------ ------
Net interest income........................................................................ 5,448 4,330
Provision for loan and lease losses........................................................ 250 130
------ ------
Net interest income after provision for loan and lease losses.............................. 5,198 4,200
------ ------
Noninterest income
Service fees on deposits................................................................ 619 514
Trust income............................................................................ 215 157
Mortgage banking income................................................................. 18 120
Other operating income.................................................................. 214 135
------ ------
Total noninterest income............................................................ 1,066 926
------ ------
Noninterest expense
Salaries and employee benefits.......................................................... 2,116 1,700
Occupancy and equipment, net............................................................ 465 370
Data processing......................................................................... 317 133
Legal................................................................................... 168 383
Amortization of intangibles............................................................. 116 0
Other operating expenses................................................................ 595 366
------ ------
Total noninterest expense........................................................... 3,777 2,952
------ ------
Income before income taxes................................................................. 2,487 2,174
Provision for income taxes................................................................. 826 792
------ ------
Net income................................................................................. $1,661 $1,382
====== ======
Basic and diluted earnings per share....................................................... $0.39 $0.32
Comprehensive income....................................................................... $3,059 $1,119
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
NORTHERN STATES FINANCIAL CORPORATION
- -------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
- -----------------------------------------------
Three months ended March 31, 2004 and 2003
(In thousands of dollars) (Unaudited)
Three months ended
March 31, March 31,
2004 2003
--------- ---------
Cash flows from operating activities
Net income.......................................................................... $ 1,661 $ 1,382
Adjustments to reconcile net income to net cash from
operating activities:
Depreciation..................................................................... 136 93
Federal Home Loan Bank stock dividends........................................... (30) (48)
Provision for loan and lease losses.............................................. 250 130
Proceeds from sale of loans...................................................... 530 0
Loans originated for sale........................................................ (203) 0
Amortization of other intangible assets.......................................... 116 0
Net change in accrued interest receivable and other assets....................... 1,939 98
Net change in accrued interest payable and other liabilities..................... 641 99
-------- --------
Net cash from operating activities............................................ 5,040 1,754
-------- --------
Cash flows from investing activities
Acquisition of subsidiary, net of cash equivalents received...................... (366) 0
Proceeds from maturities and calls of securities available for sale.............. 200,882 312,154
Purchases of securities available for sale....................................... (166,806) (341,045)
Change in loans made to customers................................................ (2,379) (9,918)
Property and equipment expenditures.............................................. (105) (151)
-------- --------
Net cash from investing activities............................................ 31,226 (38,960)
-------- --------
Cash flows from financing activities
Net increase (decrease) in:
Deposits....................................................................... 40,389 (1,318)
Securities sold under repurchase agreements and federal funds purchased........ (44,146) 15,090
Advances from borrowers for taxes and insurance................................ 484 441
Purchases of treasury stock...................................................... 0 (285)
-------- --------
Net cash from financing activities............................................ (3,273) 13,928
-------- --------
Net change in cash and cash equivalents.................................................... 32,993 (23,278)
Cash and cash equivalents at beginning of period........................................... 38,584 37,578
-------- --------
Cash and cash equivalents at end of period................................................. $ 71,577 $ 14,300
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
March 31, 2004
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
Note 1 - Basis of Presentation
- ------------------------------
The accompanying interim condensed consolidated financial statements
are prepared without audit and reflect all adjustments which are of a normal and
recurring nature and, in the opinion of management, are necessary to present
interim financial statements of Northern States Financial Corporation (the
"Company") in accordance with accounting principles generally accepted in the
United States of America. The interim financial statements do not purport to
contain all the necessary financial disclosures covered by accounting principles
generally accepted in the United States of America that might otherwise be
necessary for complete financial statements.
To prepare financial statements in conformity with accounting
principles generally accepted in the United States of America, management makes
estimates and assumptions based on available information. These estimates and
assumptions affect the amounts reported in the financial statements and the
disclosures provided, and future results could differ. The allowance for loan
and lease losses and status of contingencies are particularly subject to change.
The interim condensed financial statements should be read in
conjunction with the audited financial statements and accompanying notes (or
"notes thereto") of the Company for the years ended December 31, 2003, 2002 and
2001. The results of operations for the three month period ended March 31, 2004,
are not necessarily indicative of the results to be expected for the full year.
Net income was utilized to calculate both basic and diluted earnings
per share for all periods presented. Information regarding weighted average
shares utilized in computing basic and diluted earnings per share follows. It
should be noted that all stock options were exercised in early 2002 and there
have since been none outstanding.
Three months ended
March 31, March 31,
2004 2003
--------- ---------
Average outstanding common shares......... 4,305,105 4,308,216
Effect of stock options................... 0 0
--------- ---------
Average outstanding shares for
diluted earnings per share................ 4,305,105 4,308,216
========= =========
On April 17, 2002, the Company announced that its Board of Directors
had approved a stock repurchase program that allows the Company to purchase up
to 200,000 shares of Northern States Financial Corporation stock either in open
market or private transactions. On February 19, 2003, the Company announced that
its Board of Directors had approved an additional repurchase program to purchase
an additional 200,000 shares of its stock. At March 31, 2004, the Company had a
total of 167,150 shares of treasury stock that it purchased under these
programs. Treasury stock is carried at cost.
6
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
March 31, 2004
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
Information related to stockholders' equity was as follows:
March 31, December 31,
2004 2003
--------- ------------
Par value per share............... $ 0.40 $ 0.40
Authorized shares................. 6,500,000 6,500,000
Issued shares..................... 4,472,255 4,472,255
Treasury shares................... 167,150 167,150
Outstanding shares................ 4,305,105 4,305,105
Note 2 - Commitments, Off-Balance Sheet Risk and Contingencies
- --------------------------------------------------------------
At March 31, 2004 and December 31, 2003, the contract amount of the
Company's off-balance sheet commitments were as follows:
March 31, December 31,
2004 2003
--------- -----------
Unused lines of credit and commitments to make loans:
Fixed rate.................................... $11,733 $14,101
Variable rate................................. 93,377 72,809
-------- -------
Total..................................... $105,110 $86,910
======== =======
Standby letters of credit........................... $4,914 $5,605
Since many commitments to make loans expire without being used, the
amounts above do not necessarily represent future cash commitments. Collateral
obtained upon exercise of the commitments is determined using management's
credit evaluation of the borrower, and may include commercial and residential
real estate and other business and consumer assets.
Commitments to make loans to related parties totaled $638 and $642 at
March 31, 2004 and December 31, 2003. These commitments were made at the same
terms and conditions available to nonrelated parties.
The Company also has Community Reinvestment Act (CRA) investment
commitments outstanding of $774 as of March 31, 2004. The commitments are to be
funded over the next five years.
7
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
March 31, 2004
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
Note 3 - Acquisition
- --------------------
On January 5, 2004, the Company acquired the outstanding stock of Round
Lake Bankcorp, Inc. the holding Company for First State Bank of Round Lake
("First State Bank") for cash in the amount of $21,408 including transaction
costs. Round Lake Bankcorp, Inc. was dissolved through the transaction with the
First State Bank remaining as a separate subsidiary of the Company. The results
of First State Bank have been included in the consolidated financial statements
since that date. As a result of the acquisition, the Company has expanded into
the Round Lake area of Lake County, Illinois. The Company expects to merge the
First State Bank into its Bank of Waukegan subsidiary at some point in the
future.
The following table summarizes estimated fair values of the assets
acquired and liabilities assumed at January 5, 2004. The allocation of the
purchase price is subject to refinement.
January 5, 2004
---------------
Cash and cash equivalents $ 21,042
Securities available for sale 13,960
Loans 70,589
Office buildings and equipment 3,910
Other assets 1,165
Intangible assets 3,246
Goodwill 9,632
--------
Total assets acquired 123,544
Deposits 99,806
Other liabilities 2,330
--------
Total liabilities acquired 102,136
--------
Net assets acquired $ 21,408
========
The acquired intangible asset was assigned to core deposits that
management estimates will be amortized over 10 years, which may change upon
receipt of the independent valuation of this asset.
Unaudited proforma, consolidated results of operation for the quarter
ended March 31, 2003 as though First State Bank had been acquired as of
January 1, 2003 are presented below.
Net interest income $5,523
Net income 1,724
Basic and diluted earnings per share 0.40
8
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
- -------------------------------------------------------------------
AND RESULTS OF OPERATIONS
- -------------------------
The following discussion focuses on the consolidated financial
condition of the Northern States Financial Corporation (the "Company") at March
31, 2004 and the consolidated results of operations for the three-month period
ended March 31, 2004, compared with the same period of 2003. The purpose of this
discussion is to provide a better understanding of the condensed consolidated
financial statements of Northern States Financial Corporation and the operations
of its wholly owned subsidiaries, Bank of Waukegan (the "Bank") and First State
Bank of Round Lake ("First State Bank") and the Bank's wholly owned subsidiary,
Northern States Community Development Corporation ("NSCDC"). This discussion
should be read in conjunction with the interim condensed consolidated unaudited
financial statements and notes thereto included herein.
Statements contained in this management's discussion and analysis that
are not historical facts may constitute forward-looking statements (within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended),
which involve significant risks and uncertainties. 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 invoking 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 the use of the words "believe," "expect,"
"intend," "anticipate," "estimate," "project," "plan," or similar expressions.
The Company's ability to predict results or the actual effect of future plans or
strategies is inherently uncertain and actual results may differ from those
predicted. The Company undertakes no obligation to update these forward-looking
statements in the future. The Company cautions readers of this report that a
number of important factors could cause the Company's actual results subsequent
to March 31, 2004 to differ materially from those expressed in forward-looking
statements. Factors that could cause actual results to differ from those
predicted and could affect the future prospects of the Company and its
subsidiaries include, but are not limited to, difficulties in integrating the
acquired operations of First State Bank, changes from the estimated purchase
accounting adjustments relating to the acquisition of Round Lake Bankcorp, Inc.,
difficulties in achieving anticipated cost savings related to the operation of
the acquired banking offices or higher than expected costs related to the
transaction, the potential for further deterioration in the credit quality of
the Company's loan and lease portfolio, uncertainty regarding the Company's
ability to ultimately recover on the surety bonds relating to the equipment
lease pools currently on nonaccrual status, unanticipated changes in interest
rates, general economic conditions, legislative/regulatory changes, monetary and
fiscal policies of the U.S. Government, including policies of the U.S. Treasury
and the Federal Reserve Board, the quality or composition of the Company's loan
or securities portfolios, deposit flows, competition, demand for loan products
and financial services in the Company's market area, and changes in accounting
principles, policies and guidelines. These risks and uncertainties should be
considered in evaluating forward-looking statements.
9
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
-----------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
OVERVIEW
- --------
Records were set at March 31, 2004 for assets, loans and leases and
deposits. Assets reached $792.7 million at March 31, 2004 compared with $689.6
million at December 31, 2003. Loans and leases totaled $430.2 million at March
31, 2004. Deposits, at March 31, 2004, totaled a record $633.3 million. The
growth is attributable to the acquisition of First State Bank that added $126
million in assets, $70 million in loans and $102 million in deposits to the
Company at March 31, 2004. Book value rose to $18.21 per share from $17.50 per
share at December 31, 2003. The Company recorded $12.9 million of goodwill and
other intangible assets resulting from the acquisition of First State Bank in
the first quarter of 2004.
Earnings also improved during the first quarter of 2004 and were $.39
per share (diluted), or $1,661,000 as compared with $.32 per share (diluted), or
$1,382,000 for the first quarter of 2003, an increase of 22 percent in earnings
per share. Much of the increase in earnings is attributable to improved net
interest income that increased $1,118,000 to $5,448,000 during the quarter
compared with $4,330,000 the same period last year. The acquisition of First
State Bank by the Company on January 5, 2004, helped increase net interest
income due to First State Bank's lower-cost core deposits. First State Bank
contributed $.03 to earnings per share during the quarter.
At March 31, 2004, nonperforming loans and leases totaled $21,761,000
as compared to $19,650,000 at December 31, 2003. Increases to nonperforming
loans at March 31, 2004 were mainly secured by real estate. During the quarter,
the Company charged off $1.5 million of commercial loans that were classified as
nonperforming at December 31, 2003. As a result of the chargeoffs and the higher
level of nonperforming loans and leases, the Company made an increased provision
for loan and lease losses of $250,000 occurred during the quarter compared with
$130,000 for the same quarter of 2003. It is expected that the provision for
loan and leases losses will continue to be greater in 2004 if levels of
nonperforming loans and leases remain at the current levels or increase.
The Company showed increases of $140,000 to noninterest income during
the first quarter of 2004 as compared with the same quarter of 2003. These
increases were in part from the acquisition of First State Bank and occurred
despite declines in mortgage banking income. Mortgage banking income decreased
$102,000 during the three months ended March 31, 2004 as compared with the same
time period last year as home mortgage rates increases in 2004 caused the volume
of mortgage refinancing to slow.
Noninterest expense also increased $825,000 during the three months
ended March 31, 2004 as compared to the same quarter of 2003, mostly
attributable to the acquisition of First State Bank. The acquisition added 38
additional employees and two branch offices that increased salary and occupancy
and equipment expenses compared to the same quarter last year. Data processing
expense also increased during the quarter as First State Bank uses a separate
data processing service bureau from the Bank.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
Certain critical accounting policies involve estimates and assumptions
by management. To prepare financial statements in conformity with accounting
principles generally accepted in the United States of America, management makes
estimates and assumptions based on available information. These estimates and
assumptions affect the amounts reported in the financial statements and the
disclosures provided, and future results could differ. The allowance for loan
and lease losses is a critical accounting policy for the Company because
management must make estimates of losses and these estimates are subject to
change.
10
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
-----------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
The allowance for loan and lease losses is a valuation allowance for
probable incurred credit losses, increased by the provision for loan and lease
losses and decreased by charge-offs less recoveries. Management estimates the
allowance balance required using past loan and lease loss experience, the nature
and volume of the portfolio, information about specific borrower situations,
estimated collateral values, economic conditions and other factors. Allocations
of the allowance may be made for specific loans and leases, but the entire
allowance is available for any loan or lease that, in the management's
judgement, should be charged-off.
One of the components of the allowance for loan losses is historical
loss experience. Different loan classifications within the portfolio have
different loss experience ratios. For example, loans secured by real estate
generally have a better loss experience than loans secured by other assets.
Changes in the classification between periods can impact the allocation for
historical losses. Although loans increased due to the acquisition of First
State Bank during the first quarter of 2004, there was no significant change in
the composition of the loan portfolio.
Management specifically analyzes its non-performing loans for probable
losses. The change in the volume of non-performing loans may significantly
impact the amount specifically reserved on these loans depending on the adequacy
of the loan collateral and the borrowers' ability to repay the loan. As specific
allocations are done on a loan-by-loan basis, the amount of the specific
allocation is more likely subject to fluctuation than an allocation based on
historical loss trends. As the volume of non-performing loans grew during the
first quarter of 2004, more loans were subject to specific allocation analysis;
however the amount of the allocations on non-performing loans may fluctuate in
future periods due to changes in conditions of underlying collateral and changes
in the borrowers' ability to repay.
A loan or lease is impaired when full payment under the loan or lease
terms is not expected. Impairment is evaluated on an aggregate basis for
smaller-balance loans of similar nature such as residential mortgage, consumer
and credit card loans, and on an individual loan or lease basis for other loans
and leases. If a specific loan or lease is determined to be impaired, a portion
of the allowance is allocated so that the loan or lease, net of the allocated
estimated loss, is carried at the present value of estimated cash flows using
the loan's or lease's existing rate or at the fair value of collateral if
repayment is expected solely from the collateral. Loan and lease losses are
charged against the allowance when management believes the uncollectibility of a
loan or lease balance is confirmed.
FINANCIAL CONDITION
- -------------------
The Company's consolidated total assets were $792.7 million at March
31, 2004, increasing $103.1 million from $689.6 million at December 31, 2003.
Loans and leases, at March 31, 2004, increased $72.0 million and totaled $430.2
million as compared with $358.2 million at December 31, 2003. Deposits also
increased $140.2 million to $633.3 million at March 31, 2004 as compared to
$493.1 million at December 31, 2003. These increases were primarily the result
of First State Bank that was acquired on January 5, 2004. First State Bank added
$126.1 million in assets, $70.0 million in loans and $102.1 million in deposits
at March 31, 2004. The Company recorded $12.9 million of goodwill and other
intangible assets as a result of the acquisition.
The Company's federal funds sold at March 31, 2004 increased $33.0
million to $53.0 million from $20.0 million at December 31, 2003. The Company's
federal funds sold position increased as deposits increased during the quarter.
The fair value of securities at March 31, 2004 was $262.5 million, of which
11
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
-----------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
$236.7 million were pledged to secure repurchase agreements and public deposits.
During the first three months of 2004, $200.9 million in securities were called
or matured while $166.8 million in securities were purchased. As bond interest
rates fell, the issuers of securities had incentive to call the securities. The
Company is attempting to replace the securities as they are called but the
purchases may take weeks to settle. At March 31, 2004, the Company has $146.8
million in U.S. Government agency securities with call options and another $62.0
million that mature within 90 days.
Loans and leases increased to $430.2 million at March 31, 2004 from
$358.2 million at December 31, 2003 with the growth primarily due to the
acquisition of First State Bank. The cash flow statement shows that the net cash
outflows for loans and leases made to customers came to only $2.4 million during
the first quarter of 2004 compared with $9.9 million for the first quarter of
2003. Loan commitments have increased $18.2 million to $105.1 million at March
31, 2004 compared with $86.9 million at December 31, 2003, with only $7.8
million of the increase attributable to the First State Bank acquisition.
Borrowers have not been drawing on their credit lines due to uncertainties as to
future interest rates and fuel prices. At March 31, 2004, loans to related
parties totaled $5.5 million increasing $865,000 from December 31, 2003.
During the first three months of 2004, deposits increased by $140.2
million to $633.3 million at March 31, 2004 from $493.1 million at December 31,
2003. A majority of the growth in deposits during the quarter is attributable to
the acquired First State Bank that had $102.1 million in deposits at March 31,
2004 of which $64.3 million were in core deposits consisting of checking, NOW,
money market and savings accounts. Additional growth in deposits came from
brokered time deposits that increased $37.0 million to $85.9 million at March
31, 2004 compared with $48.9 million at December 31, 2003. Brokered time
deposits of $25.3 million at March 31, 2004 have maturities of greater than one
year. Brokered time deposits in denominations of $100,000 or more totaled $59.1
million at March 31, 2004. At March 31, 2004, deposits to related parties
totaled $13.6 million.
Securities sold under repurchase agreements decreased by $17.6 million
to $65.7 million at March 31, 2004 from $83.3 million at December 31, 2003.
Securities sold under repurchase agreements are offered through either an
overnight repurchase agreement product or a term product with maturities from 7
days to one year. The decrease in repurchase agreements was mainly from term
product maturities as purchasers of the term product retained their funds for
other business purposes. At March 31, 2004, securities sold under repurchase
agreements to related parties totaled $25.3 million. Borrowings from the Federal
Home Loan Bank through term advances remained at $6.5 million at March 31, 2004.
Included in other liabilities at March 31, 2004 is $400,000 related to
estimated environmental clean-up expenses, an obligation that was assumed by the
Company in the First State Bank acquisition. If the actual expenses are
greater than $400,000, there may be an adjustment to goodwill. The Company
intends to seek reimbursement of these expenses from the State of Illinois that
has a fund for this type of cleanup. However, there can be no assurance that the
Company will be successful in obtaining any such reimbursement.
CAPITAL
- -------
Total stockholders' equity increased $3.1 million to $78.4 million
during the three months ended March 31, 2004. The increase is the result of net
income of $1.7 million, plus the adjustment to the market value of securities
available for sale, net of deferred tax, of $1.4 million. Book value per share
was $18.21 at March 31, 2004 as compared to $17.50 at December 31, 2003.
12
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
-----------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
The Company's tier 1 capital to average asset ratio at March 31, 2004
was 8.34% and the total tier 2 capital to asset ratio, on a risk adjusted basis,
amounted to 12.77%. These ratios exceed the minimum required to be considered
"well capitalized" under bank regulatory prompt corrective action regulations,
which minimums are 5.00% and 10.00%, respectively. The impact of $12.9 million
in goodwill and other intangible assets associated with the First State Bank
transaction caused the tier 1 capital to average assets and total tier 2
capital to asset ratios to decline from December 31, 2003, when they had been
11.92% and 17.67%, respectively. Goodwill and other intangible assets must be
deducted from capital when assessing capital for regulatory purposes.
LIQUIDITY
- ---------
Liquidity management involves the ability to meet the cash flow
requirements of customers. The Company needs to have proper cash flow to meet
the requirements of depositors wanting to withdraw funds. Federal funds sold,
interest bearing deposits in banks and marketable securities, particularly those
of shorter maturities, are principal sources of asset liquidity. Federal funds
sold at March 31, 2004 were $53.0 million. The Company sells excess funds
overnight to money center banks and these funds provide the Company with
liquidity to fund loans or meet depositor requirements. The Company classifies
all of its securities as available for sale, which increases the Company's
flexibility in that the Company can sell any of its unpledged securities to meet
liquidity requirements. Securities available for sale had a carrying value of
$262.5 million at March 31, 2004, of which $236.7 million were pledged to secure
public deposits and repurchase agreements.
Other sources of liquidity available to the Company for funds are
deposits and borrowings. The Company has used brokered deposits for liquidity
and at March 31, 2004 had $85.9 million in brokered time deposits. To help
ensure the ability to meet its funding needs, including any unexpected strain on
liquidity, the Company has $35.0 million in federal funds lines of credit from
two independent banks.
RESULTS OF OPERATIONS
- ---------------------
NET INCOME
Consolidated net income for the quarter ended March 31, 2004 was
$1,661,000 increasing $279,000 or 20.19% compared with net income of $1,382,000
for the same period the previous year. The annualized return on average assets
is .85% for the quarter, a decrease from a return on average assets for the same
quarter the previous year of .88%. Much of the increase in earnings is
attributable to improved net interest income that increased $1,118,000 during
the quarter compared with the same period last year. The acquisition of First
State Bank by the Company on January 5, 2004, helped increase net interest
income due in part to First State Bank's lower-cost core deposits.
NET INTEREST INCOME
Net interest income, the difference between interest income earned on
average interest earning assets and interest expense on average interest bearing
liabilities, increased $1,118,000 or 25.82% to $5,448,000 during the three
months ended March 31, 2004, compared with $4,330,000 for the same three months
in 2003.
13
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
-----------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
TABLE 1
NORTHERN STATES FINANCIAL CORPORATION
ANALYSIS OF AVERAGE BALANCE AND TAX EQUIVALENT
RATES For the Three Months Ended March 31, 2004 and 2003 - Rates are Annualized
($ 000s)
2004 2003
------------------------------------ -------------------------------------
Average Average
Balance Interest Rate Balance Interest Rate
------------------------------------ -------------------------------------
Assets
Loans (1)(2)(3) $428,041 $5,675 5.30% $358,148 $5,243 5.86%
Taxable securities (4) 256,390 1,918 2.99% 234,359 1,702 2.93%
Tax-advantaged securities (2) (4) 11,001 147 5.48% 7,958 125 6.51%
Federal funds sold and other 39,685 95 .96% 6,568 19 1.16%
------------------------------------ -------------------------------------
Interest earning assets (4) 735,117 7,835 4.26% 607,033 7,089 4.69%
Noninterest earning assets 44,796 21,131
------------ -------------
Average assets $779,913 $628,164
============ =============
Liabilities and stockholders' equity
NOW deposits $61,159 $82 .54% $49,491 $82 .66%
Money market deposits 68,415 145 .85% 48,718 174 1.43%
Savings deposits 81,783 150 .73% 48,910 120 .98%
Time deposits 344,121 1,631 1.90% 252,747 1,783 2.82%
Other borrowings 78,470 305 1.55% 100,203 546 2.18%
------------------------------------ -------------------------------------
Total interest bearing
liabilities 633,948 2,313 1.46% 500,069 2,705 2.16%
---------- ------- --------- ------
Demand deposits 62,503 45,636
Other noninterest earning
liabilities 6,167 5,404
Stockholders' equity 77,295 77,055
------------ -------------
Average liabilities and
Stockholders' equity $779,913 $628,164
============ =============
Net interest income $5,522 $4,384
============= =============
Net yield on interest earning
assets (4) 3.01% 2.90%
=========== ===========
Interest bearing liabilities
to earning assets ratio 86.26% 82.67%
=========== ===========
(1) - Interest income on loans includes loan origination and other fees of
$106 and $86 for the three months ended March 31, 2004 and 2003.
(2) - Tax-exempt income is reflected on a fully tax equivalent basis
utilizing a 34% rate.
(3) - Non-accrual loans are included in average loans.
(4) - Rate information was calculated on the average amortized cost for
securities. The three months ended March 31, 2004 and 2003 average
balance information includes an average unrealized gain (loss) for
taxable securities of ($69) and $1,877 and for tax-advantaged
securities of $262 and $275.
14
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
-----------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
A positive factor that helped to increase net interest income for the
three months ended March 31, 2004 was that rates paid on deposits and borrowings
declined to a greater extent than the yields earned on interest earning assets.
Interest rates during the three months ended March 31, 2004 were lower as
compared with interest rates during the same period in 2003. The Company's prime
lending rate for the first quarter of 2004 was 4.00% compared with 4.25% during
the first quarter of 2003. Table 1, "Analysis of Average Balance and Tax
Equivalent Rates for the Three Months ended March 31, 2004 and 2003", shows that
the average yields on interest earning assets decreased 43 basis points to 4.26%
during the first quarter of 2004 from 4.69% during the same period last year.
Average rates on interest bearing liabilities decreased to a greater extent and
were 70 basis points lower during the first quarter of 2004 at 1.46% as compared
with yields of 2.16% during the first quarter of 2003. The decline in average
rates paid on interest bearing liabilities during the first quarter of 2004 was
aided by the influx of lower cost core deposits acquired with First State Bank.
These core deposits of First State Bank averaged $63.8 million during the
quarter.
Another factor that increased net interest income during the first
quarter of 2004 was the growth in interest earning assets resulting from the
acquisition of First State Bank. Average interest earning assets increased
$128.1 million during the first quarter of 2004 as compared with the same
quarter last year with most of the increase attributable to the acquisition.
ASSET QUALITY AND THE PROVISION FOR LOAN AND LEASE LOSSES
Management, with the concurrence of the Board of Directors, after
carefully reviewing the adequacy of the allowance for loan and lease losses and
the levels of nonperforming and impaired loans and leases, found that a $250,000
provision for loan and lease losses was necessary for the three months ended
March 31, 2004 compared to $130,000 for the same period of 2003. The increased
provision for loan and lease losses resulted from the charge off of loans during
the quarter and the growth in nonperforming loans experienced by the Company.
At March 31, 2004, the allowance for loan and lease losses was
$3,934,000 or .92% of loans and leases as compared with $4,383,000 or 1.23% of
total loans and leases at December 31, 2003. The acquisition of First State Bank
on January 5, 2004 included an allowance for loan and lease losses of $805,000.
During the first quarter of 2004, $1,508,000 in loans were charged off through
the allowance compared with $269,000 during the same period last year. Of the
$1,508,000 charged off during the first quarter of 2004, the Company had
specific reserves allocated of $1,417,000 at December 31, 2003. There were
$4,000 in recoveries of loans previously charged off during the first quarter of
2004 compared with no recoveries during the same period in 2003.
Nonperforming loans and leases, which includes loans and leases on
nonaccrual status in addition to loans and leases 90 days or more past due and
in the process of collection, were $21.8 million at March 31, 2004 or 4.73% of
total loans and leases. Nonperforming loan and lease totals increased $2.1
million from December 31, 2003 when nonperforming loan levels were $19.7 million
or 5.49% of loans and leases. The largest items classified as nonperforming
loans and leases are lease pools totaling $11.3 million placed on nonaccrual
status at June 30, 2002. These lease pools were purchased in late 2000 and 2001
and are secured by equipment and carry surety bonds that were designed to insure
performance. The Company is in the process of seeking to collect on these leases
from the sureties through litigation.
15
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
-----------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
The Company also is carrying a $4.3 million loan on nonaccrual status
that is for a 90-unit condominium construction project. This loan was classified
as a nonaccrual loan at December 31, 2003. The Company has participated on this
construction project with other financial institutions and only has a portion of
the total loan. The construction project has experienced substantial cost
overruns and the principal borrowers have declared bankruptcy. The financial
institutions as a group have begun foreclosure procedures to help remedy the
situation.
The Company also has a nonperforming loan totaling $1.5 million that is
secured by a motel. This loan has been classified as a nonaccrual loan since
June 30, 2003. The lodging industry has been especially hurt by the aftermath of
9/11 due to the decline in travel. At March 31, 2004, the Company had loans for
motels totaling $38.3 million in its loan portfolio that, other than the $1.5
million discussed above, are performing in accordance with their terms.
During the quarter ended March 31, 2004, $2.8 million in loans were
added to the Company's total nonaccrual loans. The acquisition of First State
Bank included $1.2 million in nonaccrual loans while the Bank placed $1.6
million in loans on nonaccrual status during the quarter. Of the $2.8 million in
loans put on nonaccrual status, $2.5 million are secured by real estate.
Impaired loans and leases at March 31, 2004 were $20.4 million
increasing from $18.2 million at December 31, 2003. The Company considers a loan
or lease impaired if it is carried as a nonaccrual loan or lease and it is
expected that full principal and interest will not be collected under the
contractual terms of the note. Impaired loans and leases are carried at the
present value of expected cash flows discounted at the loan's effective interest
rate or at the fair value of the collateral, if the loan or lease is collateral
dependent. Through allocation of specific reserves in the allowance for loan
and lease losses, the amount of the allowance allocated for impaired loans and
leases, including $11.3 million of impaired equipment lease pools, was
$1,706,000 at March 31, 2004, increasing from $1,193,000 at December 31, 2003.
Management analyzes the adequacy of the allowance for loan and lease
losses at least quarterly. Loans and leases judged to be impaired, with probable
incurred loss exposure, that are no longer accruing interest, and historical net
loss percentages are reviewed in the analysis of the allowance for loan and
lease losses. Factors considered in assessing the adequacy of the allowance
include: changes in the type and volume of the loan and lease portfolio; review
of the larger credits within the subsidiary banks; historical loss experience;
current economic trends and conditions; review of the present value of expected
cash flows or fair value of collateral on impaired loans and leases; growth; and
other factors management deems appropriate. Based on management's analysis, the
allowance for loan and lease losses at March 31, 2004 is adequate to cover
probable incurred credit losses.
Another component of non-performing assets is other real estate owned,
consisting of assets acquired through loan foreclosure and repossession. The
fair value of other real estate owned is reviewed by management at least
quarterly to help ensure the reasonableness of its carrying value, which is
lower of cost or the fair value less estimated selling costs. At March 31, 2004,
other real estate owned was $3.8 million and remained unchanged from December
31, 2003. One major piece of property reported as other real estate owned is
carried at the amount of $1,783,000 and was acquired by the Bank of Waukegan
through the receipt of a deed in lieu of foreclosure in 1987. The parcel
consists of approximately 525,000 square feet of land situated on Lake Michigan
in Waukegan, Illinois. During the fourth quarter of 2002, the Bank formed
Northern States Community Development Corporation ("NSCDC"), as a subsidiary of
the Bank. NSCDC assets consist of cash and this parcel of other real estate
owned. This subsidiary was formed for
16
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
-----------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
the purpose of developing and selling this parcel as part of the City of
Waukegan's lakefront development plans. Proposals under discussion for use of
this property include the building of a minor league baseball park and
condominiums.
NONINTEREST INCOME
Noninterest income for the three months ended March 31, 2004 was
$1,066,000 as compared to $926,000 for the three months ended March 31, 2003, an
increase of $140,000. Service fees on deposits increased $105,000 during the
first quarter of 2004 as a result of a higher number of accounts resulting from
the acquisition of First State Bank. Trust income increased $58,000 during the
first quarter of 2004 compared to the same quarter last year as the trust area
has brought in new customers. The improvement in equity markets also had a
positive impact on trust fee income. Mortgage banking income declined in the
first quarter of 2004 by $102,000 compared to the same quarter last year as the
level of mortgage banking activity slowed due to an increase in mortgage rates
during the quarter. Other operating income increased during the quarter by
$79,000 with much of the increase resulting from First State Bank acquisition.
NONINTEREST EXPENSE
Noninterest expense for the quarter ended March 31, 2004 was
$3,777,000, increasing $825,000 from the same quarter last year. The Company's
efficiency ratio, noninterest expense divided by the sum of net interest income
and noninterest income, was 57.98% for the first quarter of 2004 as compared
with 56.16% for the same quarter of 2003. Increases to noninterest expense
brought about by the First State Bank acquisition primarily impacted noninterest
expense and this ratio. The Company expects that its efficiency ratio will
continue to be impacted until the two bank subsidiaries are merged at some point
in the future.
Salary and employee benefit expenses were $416,000 greater during the
first quarter of 2004 compared to the same period last year. The acquisition of
First State Bank added 38 employees to the staff of the Company adding to salary
expense. In January 2004, yearly merit increases occurred, also increasing
salary expense.
Occupancy and equipment expense for the first quarter of 2004 were
$95,000 greater than the same quarter of 2003. Two offices were added to the
Company from the First State Bank acquisition and the depreciation and utility
expenses of these branches account for this increase.
Data processing expense increased $184,000 during the three months
ended March 31, 2004 to $317,000 compared to $133,000 last year. First State
Bank uses a separate data processing service bureau than the one used by the
Bank of Waukegan. The Company plans to convert First State Bank to the same data
processing service bureau during the fourth quarter of 2004. This conversion
should reduce some data processing expenses after the conversion takes place. In
April 2004, the Bank of Waukegan outsourced its item processing function to
accommodate new check clearing technologies that will be required later in 2004
due to new regulations. It is estimated that data processing expenses will
increase $72,000 per quarter as a result of the implementation of the new item
processing technology.
17
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
-----------------------------------------------------------
AND RESULTS OF OPERATION
------------------------
Legal expenses decreased $215,000 during the first quarter of 2004
compared to the same time period last year. Most of the legal fees pertain to
litigation involving the nonperforming lease pools. Legal fees during the first
quarter 2003 were greater than this year as there were higher initial legal fees
at that time related to this litigation. It is expected that litigation against
the insurance companies that issued the surety bonds on the lease pools will
continue. The Company expects to continue to incur legal expenses in connection
with this litigation.
Purchase accounting for financial institutions requires that an
intangible asset be made for the acquisition of lower-cost core deposits such as
checking, savings and money market accounts. The core deposit valuation for the
acquisition of First State Bank was $3.2 million and will be amortized over an
estimated life of approximately ten years. During the first quarter of 2004, the
related amortization of intangibles expense was $116,000.
The Company's other operating expenses during the three months ended
March 31, 2004 were $229,000 greater than during the same period of 2003. The
Company's other operating expenses during the first three months of 2003 were
lower due to the one-time reversal of a $183,000 charitable contribution made at
the end of 2002. The Company received information late in the first quarter of
2003 that disallowed the charitable contribution and the Company consequently
reversed the contribution expense in the first quarter of 2003.
FEDERAL AND STATE INCOME TAXES
For the three months ended March 31, 2004 and 2003, the Company's
provision for federal and state income taxes was $826,000 and $792,000, which as
a percentage of pretax earnings was 33.2% and 36.4%. The 2003 tax rate was
inflated as a percentage of pretax earnings as the result of the reversal of a
tax benefit taken late in 2002 in the amount of $72,000 based on a $183,000
charitable contribution made in 2002. Income taxes as a percentage of pretax
earnings would have been 32.6% if the tax benefit reversal had not taken place.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
- ---------------------------------------------------------
The Company has contractual obligations that may not appear on the
balance sheet. The largest of these obligations is commitments to make loans or
extend credit through stand-by letters of credit. Many of the commitments expire
without being used. The following Table 2 presents the Company's significant
fixed and determinable contractual obligations as of March 31, 2004, by payment
date. The payment amount represents those amounts contractually due to the
recipient and do not include any unamortized premiums or discounts or similar
carrying amount adjustments. The Company does not have any material off-balance
sheet arrangements that have, or are reasonably likely to have, a current or
future effect on its financial condition.
18
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
-----------------------------------------------------------
AND RESULTS OF OPERATION
------------------------
TABLE 2
NORTHERN STATES FINANCIAL CORPORATION
CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT
LIABILITIES AND OFF-BALANCE SHEET ARRANGEMENTS
As of March 31, 2004
($000s)
Greater than
1 year and
less than or
One year equal to 3 Greater than
or less years 3 years Total
-------- ------------- ------------- -----
Long-term debt
Federal Home Loan Bank advance................... $ 0 $ 0 $ 6,500 $ 6,500
Other contractual obligations
Unused commitments to make loans................. 40,910 37,923 26,277 105,110
Standby letters of credit........................ 4,914 0 0 4,914
Community Reinvestment Act
Investment commitment......................... 0 0 774 774
Data processing contracts........................ 1,040 576 648 2,264
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------------------------------------------------------------------
The Company's primary market risk exposure is interest rate risk and,
to a lesser extent, liquidity risk. Interest-rate risk ("IRR") is the exposure
of a banking organization's financial condition to adverse movements in interest
rates. Accepting this risk can be an important source of profitability and
stockholder value, however excessive levels of IRR can pose a significant threat
to the Company's earnings and capital base.
Evaluating a financial institution's exposure to changes in interest
rates includes assessing both the adequacy of the management process used to
control IRR and the organization's quantitative level of exposure. When
assessing the IRR management process, the Company seeks to ensure that
appropriate policies, procedures, management information systems and internal
controls are in place to maintain IRR at prudent levels with consistency and
continuity. Evaluating the quantitative level of IRR exposure requires the
Company to assess the existing and potential future effects of changes in
interest rates on its consolidated financial condition, including capital
adequacy, earnings, liquidity, and, where appropriate, asset quality.
One approach used by management to analyze IRR is to periodically
evaluate the "shock" to the balance sheet of an assumed instantaneous decrease
and increase in rates of 2% using computer simulation to show the effect of rate
changes on the fair value of the Company's financial instruments. This approach
falls under the broad definition of asset/liability management. The Company's
primary asset/liability management technique is the interest rate shock. The
most recent shock analysis currently available to the Company is as of
December 31, 2003.
19
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
TABLE 3
NORTHERN STATES FINANCIAL CORPORATION
EFFECT OF INTEREST RATE SHOCKS ON FINANCIAL INSTRUMENTS
as of December 31, 2003 and December 31, 2002
($000s)
Fair Value at December 31, 2003
------------------------------------------
Down 2% Current Up 2%
------------------------------------------
Assets
Cash and cash equivalents $38,586 $38,584 $38,582
Securities available for sale 284,264 280,445 267,427
Loans and leases 370,694 355,769 342,007
Federal Home Loan Bank stock 1,871 1,871 1,871
Accrued interest receivable 3,429 3,429 3,429
Financial liabilities:
Deposits $497,245 $493,555 $490,134
Securities sold under repurchase
agreements and other short-term
borrowings 83,573 83,352 83,132
Federal funds purchased 26,500 26,500 26,500
Federal Home Loan Bank term advances 7,001 6,542 6,115
Advances from borrowers for taxes and
insurance 535 535 535
Accrued interest payable 2,180 2,180 2,180
Fair Value at December 31, 2002
------------------------------------------
Down 2% Current Up 2%
------------------------------------------
Assets
Cash and cash equivalents $37,580 $37,578 $37,576
Securities available for sale 238,968 236,898 230,683
Loans and leases 379,290 361,709 345,796
Federal Home Loan Bank stock 1,734 1,734 1,734
Accrued interest receivable 2,951 2,951 2,951
Financial liabilities:
Deposits $454,566 $451,460 $448,508
Securities sold under repurchase
agreements and other short-term
borrowings 97,437 97,192 96,948
Federal Home Loan Bank term advances 7,102 6,523 5,995
Advances from borrowers for taxes and
insurance 466 466 466
Accrued interest payable 3,407 3,407 3,407
20
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
Several ways the Company can manage IRR include: selling existing
assets or repaying certain liabilities and matching repricing periods for new
assets and liabilities, for example, by shortening terms of new loans or
securities. Financial institutions are also subject to prepayment risk in
falling rate environments. For example, a debtor may prepay financial assets so
that the debtor may refinance obligations at new, lower rates. Prepayments of
assets carrying higher rates reduce the Company's interest income and overall
asset yields. A large portion of the Bank's institution's liabilities may be
short term or due on demand, while most of its assets may be invested in
longer-term loans or securities. Accordingly, the Company seeks to have in place
sources of cash to meet short-term demands. Increasing deposits, borrowing, or
selling assets can obtain these funds.
Table 3, "Effect of Interest Shocks on Financial Instruments as of
December 31, 2003 and December 31, 2002", shows how interest rate shocks of
decreasing rates 2% and increasing rates 2% effect the fair value of the
Company's financial instruments. The data shown in Table 3 is as of December 31,
2003, as the March 31, 2004 data is not yet available from the computer
simulation model. First State Bank's financial data is not included in Table 3
as First State Bank was not acquired until after December 31, 2003. Management
believes that market risk has not materially changed at March 31, 2004 from the
risk exposure at December 31, 2003. The computer simulation model used to do the
interest rate shocks and calculate the effect on the fair value of the Company's
financial instruments takes into consideration maturity and repricing schedules
of the various assets and liabilities. At December 31, 2003 the fair value of
securities available for sale increases $3.8 million when rates are shocked
downward 2% while the fair value decreases $13.0 million for a 2% upwards rate
shock. The change in fair value of securities is smaller when rates are shocked
down because there were call provisions on $188.5 million of the U.S. Government
agency securities at December 31, 2003. At December 31, 2003 the fair value of
the Company's financial asset instruments was $680.1 million compared to the
fair value on the Company's financial asset instruments at December 31, 2002 of
$640.9 million.
ITEM 4. CONTROLS AND PROCEDURES
- -------------------------------
As of the end the period covered by this report, an evaluation was
carried out under the supervision and with the participation of Northern States
Financial Corporation's management, including our Chairman of the Board and
President and Vice President and Treasurer, of the effectiveness of our
disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934). Based on and as of the date of their
evaluation, our Chairman of the Board and President and Vice President and
Treasurer have concluded that the Company's disclosure controls and procedures
are, to the best of their knowledge, effective in all material respects, to
ensure that information required to be disclosed by Northern States Financial
Corporation in reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms.
21
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
PART II. OTHER INFORMATION
- --------------------------
ITEM 1. LEGAL PROCEEDINGS
- --------------------------
No change during the quarter ended March 31, 2004.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND
- -----------------------------------------------------
ISSUER PURCHASES OF EQUITY SECURITIES
-------------------------------------
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
22
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ------- --------------------------------
(a) Exhibits.
Exhibit 3.1 Articles of Incorporation of the Company, as amended to
date. (Filed with Company's annual report on Form 10-K for the year
ended December 31, 1994 Commission File 0-19300 and incorporated here
by reference.)
Exhibit 3.2 By-Laws of the Company, as amended and restated to date.
Exhibit 31.1 Section 302 Certification of Chairman of the Board and
President.
Exhibit 31.2 Section 302 Certification of Vice President and Treasurer.
Exhibit 32.1 Section 906 Certification.
(b) The following current reports on Form 8-K were filed by the Company
with the Securities and Exchange Commission during the first quarter of
2004:
(1) Form 8-K (Item 2) filed with the SEC on March 22, 2004.
23
NORTHERN STATES FINANCIAL CORPORATION
-------------------------------------
FORM 10-Q
---------
March 31, 2004
--------------
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report on Form 10-Q to be signed on its behalf
by the undersigned hereunto duly authorized, on this 7th day of May 2004.
NORTHERN STATES FINANCIAL CORPORATION
(Registrant)
Date: May 7, 2004 By: /s/ Fred Abdula
------------------------------------- -------------------------------
Fred Abdula
Chairman of the Board of
Directors and President
Date: May 7, 2004 By: /s/ Thomas M. Nemeth
------------------------------------- -------------------------------
Thomas M. Nemeth
Vice President and Treasurer
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NORTHERN STATES FINANCIAL CORPORATION
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FORM 10-Q
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March 31, 2004
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EXHIBIT INDEX
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Exhibits
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Exhibit 3.1 Articles of Incorporation of the Company, as amended to
date. (Filed with Company's annual report on Form 10-K for the year
ended December 31, 1994 Commission File 0-19300 and incorporated here
by reference.)
Exhibit 3.2 By-Laws of the Company, as amended and restated to date.
Exhibit 31.1 Section 302 Certification of Chairman of the Board and
President.
Exhibit 31.2 Section 302 Certification of Vice President and Treasurer.
Exhibit 32.1 Section 906 Certification.
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