U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 for the fiscal year ended December 31, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 0-26290
BNCCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 45-0402816
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
322 East Main Avenue 58501
Bismarck, North Dakota (Zip Code)
(Address of principal executive office)
Registrant's telephone number, including area code: (701) 250-3040
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
Common Stock, $.01 par value
Preferred Stock Purchase Rights
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes ___ No X
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the Registrant, computed by reference to the price at which
the common equity was last sold, as of the last business day of the Registrant's
most recently completed second fiscal quarter was $14,943,000.
The number of shares of the Registrant's common stock outstanding on March
15, 2003 was 2,701,829.
Documents incorporated by reference. Portions of the Registrant's proxy
statement to be filed with the Securities and Exchange Commission in connection
with the Registrant's 2003 annual meeting of stockholders are incorporated by
reference into Part III hereof.
BNCCORP, INC.
ANNUAL REPORT ON FORM 10-K
FOR FISCAL YEAR ENDED DECEMBER 31, 2002
TABLE OF CONTENTS
Page
PART I
Item 1. Business................................................. 3
Item 2. Properties............................................... 15
Item 3. Legal Proceedings........................................ 15
Item 4. Submission of Matters to a Vote of Security Holders...... 15
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters............................. 16
Item 6. Selected Financial Data.................................. 17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 19
Item 7A. Quantitative and Qualitative Disclosures
about Market Risk....................................... 54
Item 8. Financial Statements and Supplementary Data.............. 58
Item 9. Changes In and Disagreements With Accountants
on Accounting and Financial Disclosure.................. 108
PART III
Item 10. Directors and Executive Officers of the Registrant....... 108
Item 11. Executive Compensation................................... 108
Item 12. Security Ownership of Certain Beneficial
Owners and Management................................... 108
Item 13. Certain Relationships and Related Transactions........... 108
Item 14. Controls and Procedures.................................. 109
PART IV
Item 15. Exhibits, Financial Statement Schedules and
Reports on Form 8-K..................................... 110
PART I
The discussions contained in this Annual Report on Form 10-K which are not
historical in nature may constitute forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act") and, as such, may involve risks and uncertainties.
We caution readers that these forward-looking statements, including without
limitation, those relating to future business prospects, revenues, working
capital, liquidity, capital needs, interest costs and income of BNCCORP, Inc., a
Delaware corporation, are subject to certain risks and uncertainties that could
cause actual results to differ materially from those indicated in the
forward-looking statements due to several important factors. These factors
include, but are not limited to: risks of loans and investments, including
dependence on local and regional economic conditions; competition for our
customers from other providers of financial services; possible adverse effects
of changes in interest rates including the effects of such changes on derivative
contracts and associated accounting consequences; risks associated with our
acquisition and growth strategies; and other risks which are difficult to
predict and many of which are beyond our control. For a discussion of some of
the additional factors that might cause such differences, see Item 1. Business
"-Factors That May Affect Future Results of Operations."
We refer to "we," "our," "BNC" or the "Company" when such reference includes
BNCCORP, Inc. and its consolidated subsidiaries, collectively; "BNCCORP" when
referring only to BNCCORP, Inc.; "the Bank" when referring only to BNC National
Bank; "Milne Scali" when referring only to Milne Scali & Company, Inc.; "BNC
Insurance" when referring only to BNC Insurance, Inc.; and "BNC AMI" when
referring only to BNC Asset Management, Inc.
Item 1. Business
General / Growth Strategy
BNCCORP is a bank holding company registered under the Bank Holding Company Act
of 1956 (the "BHCA") headquartered in Bismarck, North Dakota. We are dedicated
to providing a broad range of financial products and superior customer service
to businesses and consumers within the communities we serve. BNCCORP operates 21
locations in Arizona, Minnesota and North Dakota through its subsidiary, BNC
National Bank. The Company also provides a wide array of insurance, brokerage
and trust and financial services through BNC National Bank's subsidiaries, Milne
Scali, BNC Insurance and BNC AMI, and the Bank's trust and financial services
division. The Company offers a wide variety of traditional and nontraditional
financial products and services in order to meet the financial needs of its
current customer base, establish new relationships in the markets it serves and
expand its business opportunities.
Expansion, mergers and divestitures have played an important role in our
strategy. During the three years ended December 31, 2002, we completed the
following transactions: established a bank subsidiary in Arizona, merged all of
our banking subsidiaries under one national bank charter, acquired Milne Scali
in April 2002 and sold the Fargo, North Dakota branch of the Bank in September
2002. See Note 2 to the Consolidated Financial Statements included under Item 8
of Part II for further information related to these transactions. We will
continue to emphasize internally generated growth by focusing on increasing our
market share within the communities we serve. We may also seek growth
opportunities through select acquisitions of financial services companies that
we believe complement our businesses. We may also generate growth through de
novo branching in markets such as Arizona, Minnesota, North Dakota and,
possibly, other states.
At December 31, 2002, we had total assets of $602.2 million, total loans of
$335.8 million and total deposits of $398.2 million.
Mission Statement
Our mission is to provide tailor-made financial solutions for our customers that
will assist them in achieving their goals, while enhancing shareholder value.
Goal
Our primary goal continues to be the creation of a well-capitalized financial
services organization focused on local relationship banking and providing a
broad range of financial products and services that will meet the needs of our
customers, both commercial and consumer.
Operating Strategy
We provide relationship-based banking and financial services to small to
mid-sized businesses, business owners, professionals and consumers in our
primary market areas of Arizona, Minnesota and North Dakota. Our goal is to
become a one-stop financial services provider offering traditional bank products
and services, insurance, brokerage, asset management, trust, tax planning and
preparation, employee benefit plan design and administration and other
financial-related services. The other key elements of our operating strategy
are:
o Emphasize individualized, high-level customer service.
o Encourage an entrepreneurial attitude among the employees who provide
products and services.
o Maintain high asset quality by implementing strong loan policies and
continuously monitoring loans and the loan review process.
o Centralize administrative and support functions.
History / Strategic Vision
Since our formation more than 15 years ago, we have diligently pursued a sharply
focused strategic vision: to provide a broad range of financial products and
superior service to a well-defined customer base, primarily consisting of small
to mid-sized businesses, business owners, professionals and consumers. We
believe that our entrepreneurial approach to banking and the introduction of new
products and services will continue to attract small and mid-sized businesses,
their owners and employee base. Small businesses frequently have difficulty
finding banking services that meet their specific needs and have sought banking
institutions that are more relationship-oriented. By remaining committed to this
strategic vision, we have built a company that is distinguished by its:
o Diversified business base of banking, insurance and brokerage / trust
/ financial services;
o Presence in multiple attractive markets: Arizona, Minnesota and North
Dakota;
o Strengthening financial performance, as investments in new businesses
and markets drive earnings growth; and
o Determined management team, with a decided focus on delivering
results.
In this section of this annual report on Form 10-K, we detail these
distinguishing strengths, which have not only helped customers to reach their
financial goals, but also have established a solid foundation upon which to
build shareholder value.
Diversified Business Base. BNCCORP today consists of three core businesses:
banking, insurance and brokerage/trust/financial services. This structure allows
us to offer a wide range of services that is responsive to the financial needs
of our customers, while also diversifying and balancing our sources of revenue.
Banking segment. BNC National Bank operates 15 banking branch offices in three
states. Known for its business banking services such as business financing and
commercial mortgages, corporate cash management and merchant programs, our
banking division also offers a full range of consumer lending and deposit
options. The Bank is differentiated by its service culture of "high personal
touch," supported by effective technology. Among the innovative services offered
are online, bill pay and telephone banking operations, and products such as the
"Sweep/Repo" account, the "Wealthbuilder" family of variable-rate interest
checking and money market deposit products and the BNC cash back debit card.
The banking segment's loans primarily consist of commercial and industrial
loans, real estate mortgage and construction loans, agricultural loans, consumer
loans and lease financing. In allocating our assets among loans, investments and
other earning assets, we attempt to maximize return while managing risk at
acceptable levels. Our primary lending focus is on commercial loans and
owner-occupied real estate loans to small and mid-sized businesses and
professionals. We offer a broad range of commercial and consumer lending
services, including commercial revolving lines of credit, residential and
commercial real estate mortgage and construction loans, consumer loans and
equipment financing. Interest rates charged on loans may be fixed or variable
and vary with the degree of risk, size and maturity of the loans, underwriting
and servicing costs, the extent of other banking relationships maintained with
customers and the Bank's cost of funds. Rates are further subject to competitive
pressures, the current interest rate environment, availability of funds and
government regulations. For more information on our lending activities, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Loan Portfolio" included under Item 7 of Part
II.
Each of our bank branches offers the usual and customary range of depository
products provided by commercial banks, including checking, savings and money
market deposits and certificates of deposit. During 2002, we continued to
increase core deposits largely through the continuing success of our
Wealthbuilder interest checking and money market deposit accounts introduced
during 1999. These are competitively priced floating rate accounts with rates
variable at our discretion. The Bank's deposits are not received from a single
depositor or group of affiliated depositors, the loss of any one of which would
have a material adverse effect on our business. Rates paid on deposits vary
among the categories of deposits due to different terms, the size of the
individual deposit, the nature of other banking relationships with the
depositor, the current interest rate environment and rates paid by competitors
on similar deposits. The Bank also accepts brokered deposits and obtains direct
non-brokered certificates of deposit through national deposit networks when
management believes such transactions are beneficial to the Bank. For more
information on our deposit activities, see "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Financial Condition -
Deposits" included under Item 7 of Part II.
Our banking segment also offers services such as money orders, travelers'
checks, MasterCard and Visa merchant deposit services and, in some markets, safe
deposit, lockbox and messenger services.
Insurance segment. Milne Scali and BNC Insurance are independent insurance
agencies representing many of the nation's leading insurance carriers. Our
insurance operations were greatly expanded in 2002 through the acquisition of
Milne Scali, one of the largest independent insurance agencies in the Arizona
market. Today, we offer a full array of insurance brokerage services with a
strong concentration in business insurance, risk management and employee
benefit-related insurance. We also offer home, personal life, health,
disability, automobile and other vehicle insurance, universal and mortgage life
insurance, workers' compensation, excess liability coverage, farm and crop
insurance and commercial trucking coverage. The insurance segment will generally
have its strongest performance in the first quarter of each fiscal year as
contingency payments from insurance carriers are generally paid during the first
quarter.
Brokerage/trust/financial services segment. BNC AMI and the Bank's trust and
financial services divisions provide customers with an extensive complement of
financial services options. The trust and financial services divisions,
presently operating primarily out of Bismarck, provide trust, financial,
business, estate and tax planning, estate administration, agency accounts,
payroll services, accounting services, employee benefit plan design and
administration, individual retirement accounts ("IRAs"), individual custodial
self-directed IRAs, asset management, tax preparation and the BNC Global
Balanced Collective Investment Fund, a proprietary investment vehicle for
qualified retirement plans. BNC AMI, with offices in Bismarck and Minneapolis,
in affiliation with Raymond James Financial Services, Inc. offers financial
services alternatives such as securities trading, investment management of
institutional and individual accounts, mutual funds and annuities.
With this "palette" of financial resources, a customer can turn to us to obtain
business financing or a home mortgage; access the cash management, insurance,
accounting and tax preparation services needed to run a successful business;
create a 401(k) program for employees; or establish a trust to manage personal
assets - to cite just a few examples. We employ a "relationship pricing matrix"
that gives customers even more reason to take maximum advantage of our diverse
services.
Revenues from external customers, measures of profit and/or loss and total
assets for each of the segments listed above are presented in Note 16 to the
Consolidated Financial Statements included under Item 8 of Part II.
Attractive Markets. We operate in three distinct markets:
Tempe-Phoenix-Scottsdale, Arizona; Minneapolis-St. Paul, Minnesota; and
Bismarck-Mandan, North Dakota and surrounding communities (Crosby, Ellendale,
Garrison, Kenmare, Linton, Stanley and Watford City). While these areas have
very different fundamentals, each enjoys a solid economic base and what we
believe are compelling long-term growth dynamics. To ensure that we maintain a
sharp focus on each market area, Chairman Tracy Scott has responsibility for
managing operations in North Dakota, with President and Chief Executive Officer
Greg Cleveland directly in charge of the Arizona and Minneapolis market areas.
Our Arizona market has been one of the fastest growing areas of the country in
population and personal income for the past several years. The population is
expected to continue increasing at a rate of more than 100,000 per year.
Tourism, retirement and job creation in such industries as software and
biotechnology are among the drivers of the economy, according to studies by the
University of Arizona. Segments with significant operations in the Arizona
market include banking and insurance.
The Twin Cities area is home to a large and growing population, with a tight
labor market and robust construction. The U.S. census estimates that the area's
population will rise by more than 900,000 by 2030, driving business formation
and residential construction over the long term. Key growth industries currently
include electronics manufacturing, healthcare, education and food processing.
Banking is the primary segment operating in the Minneapolis-St. Paul area with
some brokerage activities also conducted in the market.
Bismarck-Mandan is characterized by low unemployment and generally favorable
economic conditions. Bismarck is not only the state capital, but also the trade
and transportation hub for South Central North Dakota. The area is experiencing
strong residential and commercial growth, and its diverse economic base includes
energy, health care, agriculture and an expanding data processing/customer
service component. The banking, insurance and brokerage/trust/financial segments
are all represented in the North Dakota market.
Individually, each of our markets presents strong potential demand for our range
of financial services offerings. Together, we believe they provide attractive
business opportunities and balance our exposure to regional economic cycles.
As of December 31, 2002, 32 percent of our loans were to borrowers located in
North Dakota, 30 percent to borrowers located in Minnesota, 26 percent to
borrowers located in Arizona, 7 percent to borrowers located in South Dakota and
the remainder to borrowers in various other states. Other than brokered
certificates of deposit and direct non-brokered certificates of deposit obtained
through national deposit networks, each banking branch draws most of its
deposits from its general market area.
The following table presents total deposits and net loans outstanding at each of
our locations as of December 31, 2002 (in thousands):
Total Net Loans
Location Deposits Outstanding 1
----------------------------- ----------- -------------
Bismarck, ND............. $119,021 $124,885
Crosby, ND............... 17,263 258
Ellendale, ND............ 11,117 521
Garrison, ND............. 15,363 465
Kenmare, ND.............. 11,830 222
Linton, ND............... 42,698 9,847
Minneapolis, MN.......... 48,650 105,436
Phoenix, AZ.............. 13,186 75,529
Stanley, ND.............. 16,306 958
Tempe, AZ................ 33,148 18,431
Watford City, ND......... 10,973 108
Brokered deposits........ 31,386 --
National market deposits. 27,304 --
---------- ----------
Total ................ $398,245 $336,660
========== ==========
- ------------------
1 Before allowance for credit losses, unearned income and net unamortized
deferred fees and costs.
Strengthening Financial Performance. In 2002, we demonstrated the value of our
financial management strategies. Efforts to diversify our sources of revenue,
and in particular the decision to expand our insurance business through the
Milne Scali acquisition, drove a 64 percent year-over-year increase in earnings.
Our management of our investment portfolio generated unrealized gains of nearly
$4.4 million. We believe that our continued attention to asset quality should
help guard the loan portfolio against future economic shocks.
While we are justifiably proud of these strong results, we believe our full
earnings potential should be even more evident in the coming year due to several
factors. First, our financial performance in 2003 will reflect a full year
contribution from Milne Scali, which was part of the Company for only two full
quarters of 2002. Second, we should benefit from our efforts to improve both the
cost structure and productivity of BNC AMI.
Determined Management Team. Our financial and operational accomplishments during
2002 are, in large measure, a reflection of our determination to enhance
shareholder value. The determination to invest in the future led to a thriving
and highly profitable insurance agency business and the creation of a growing
presence in the Arizona market. A determination to make tough decisions, such as
divesting the Fargo branch of the Bank and maintaining a tight grasp on
operating costs, should lead to greater efficiency and profitability. And, a
determined focus on achieving excellence in business - through superior service,
a consistent vision and prudent financial management - should continue to yield
positive results in the years to come.
Regional Community Banking Philosophy
In order to meet the demands of the increasingly competitive banking and
financial services industries, we employ a regional community banking
philosophy. This philosophy is based on our belief that banking and financial
services clients value doing business with locally managed institutions that can
provide a full service commercial banking relationship through an understanding
of the clients' financial needs and the flexibility to deliver customized
solutions through our menu of products and services. With this philosophy we are
better able to build successful and broadly based client relationships. The
primary focus for our relationship managers is to cultivate and nurture their
client relationships. Relationship managers are assigned to each borrowing
client to provide continuity in the relationship. This emphasis on personalized
relationships requires that all of the relationship managers maintain close ties
to the communities in which they serve so that they are able to capitalize on
their efforts through expanded business opportunities. While client service
decisions and day-to-day operations are maintained at each location, our broad
base of financial services offers the advantage of affiliation with service
providers who can provide extended products and services to our clients.
Additionally, BNCCORP and the Bank provide centralized administrative functions,
including credit and other policy development and review, internal audit and
compliance services, investment management, data processing, accounting, loan
servicing and other specialized support functions.
Distribution methods
We offer our banking and financial products and services through our network of
offices and other traditional industry distribution methods. Additionally, we
offer 24-hour telephone banking services through BNC Bankline. We also provide
Internet banking and bill-pay services through our Internet banking site at
www.bncbank.com. This system allows customers to process account transactions,
transfer funds, initiate wire transfers, automated clearing house transactions
and stop payments and obtain account history and other information. Messenger
services in select markets are also of great convenience to our customers.
Risk Management
The uncertainty of whether unforeseen events will have an adverse impact on our
capital or earnings is an inevitable component of the business of banking. To
address the risks inherent in our business we identify, measure, control and
monitor them. Our management team is responsible for determining our desired
risk profile, allocating resources to the lines of business, approving major
investment programs that are consistent with strategic priorities and risk
appetite and making capital management decisions. We address each of the major
risk categories identified by the banking regulators, if applicable, as well as
any additional identified risks inherent in our business. Such risks include,
but are not limited to, credit, liquidity, interest rate, transaction,
compliance, strategic and reputation risk. In each identified risk area, we
measure the level of risk to the Company based on the business we conduct and
develop plans to bring risks within acceptable tolerances. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Financial Condition-Loan Portfolio and-Liquidity, Market and Credit
Risk" included under Item 7 of Part II and "Quantitative and Qualitative
Disclosures About Market Risk" included under Item 7A of Part II for further
discussion of credit, liquidity and interest rate risk.
Competition
The deregulation of the banking industry and the availability of nationwide
interstate banking have increased the level of competition in our already
intensely competitive market areas. The increasingly competitive environment is
a result of changes in regulation, changes in technology and product delivery
systems and the pace of consolidation among financial services providers. The
Bank and its subsidiaries compete for deposits, loans, insurance and brokerage,
trust and financial services as well as customers with numerous providers of
similar products and services. Principal competitors include multi-regional
financial institutions as well as large and small thrifts, independent banks,
credit unions, many national and regional brokerage companies, mortgage
companies, insurance companies, finance companies, money market funds and other
non-bank financial service providers. Some of these competitors are much larger
in total assets and capitalizations, including the availability of larger legal
lending limits, have greater access to capital markets and offer a broader range
of financial services than BNC. In addition, some of the non-bank financial
institutions that compete with us are not subject to the extensive federal
regulations that govern our operations.
In order to compete with other financial services providers, the Bank and its
subsidiaries principally rely on local promotional activities, personal
relationships established by officers, directors and employees with their
customers, specialized services tailored to meet the needs of the communities
served and cross-selling efforts among the various segments within our
organization. We believe that many of our competitors have emphasized retail
banking and financial services for large companies, leaving the small and
mid-sized business market underserved. This has allowed us to compete
effectively by emphasizing customer service, establishing long-term customer
relationships and providing services meeting the needs of such businesses and
the individuals associated with them. The banking and financial services
industries are highly competitive, and our future profitability will depend on
our ability to continue to compete successfully in our market areas.
Supervision and Regulation, Economic Conditions and Monetary Policy
General. BNCCORP and the Bank are extensively regulated under federal and state
laws and regulations. These laws and regulations are primarily intended to
protect depositors and the federal deposit insurance funds, not investors in the
securities of BNCCORP. From time to time, legislation, as well as regulations,
is enacted that has the effect of increasing the cost of doing business,
limiting or expanding permissible activities, or affecting the competitive
balance between banks and other financial services providers. Proposals to
change laws and regulations governing the operations and taxation of banks, bank
holding companies and other financial institutions and financial services
providers are frequently made in the U.S. Congress, in the state legislatures
and by various regulatory agencies.
The following information briefly summarizes certain material laws and
regulations affecting BNCCORP and the Bank and is qualified in its entirety by
reference to the particular statutory and regulatory provisions. Any change in
applicable laws, regulations or regulatory policies may have a material effect
on our business, operations and future prospects. We are unable to predict the
nature or extent of the effects that new or revised federal or state legislation
may have on our business and earnings in the future.
Primary Regulators. BNCCORP is a bank holding company registered under the BHCA,
and is subject to regulation, supervision and examination by the Board of
Governors of the Federal Reserve System ("Federal Reserve"). BNCCORP is required
to file periodic reports with the Federal Reserve and such other reports as the
Federal Reserve may require pursuant to the BHCA. The Bank is a national banking
association and is subject to supervision, regulation and examination by the
Office of the Comptroller of the Currency ("OCC"). Since the Federal Deposit
Insurance Corporation ("FDIC") insures the deposits of the Bank, the Bank is
also subject to regulation and supervision by the FDIC. Additionally, the Bank
is a member of the Federal Reserve System.
If, as a result of an examination by federal regulatory agencies, an agency
should determine that the financial condition, capital resources, asset quality,
earnings prospects, management, liquidity or other aspects of a bank or bank
holding company's operations are unsatisfactory or that the bank or bank holding
company or its management is violating or has violated any law or regulation,
various remedies are available to these regulatory agencies. Such remedies
include the power to enjoin "unsafe or unsound" practices, to require
affirmative action to correct any conditions resulting from any violation or
practice, to issue an administrative order that can be judicially enforced, to
direct an increase in capital, to restrict the growth of the bank, to assess
civil monetary penalties, to remove officers and directors and ultimately to
terminate the bank's deposit insurance and/or revoke the bank's charter or the
bank holding company's registration.
Acquisitions and Permissible Activities. As a registered bank holding company,
BNCCORP is restricted in its acquisitions, certain of which are subject to
approval by the Federal Reserve. A bank holding company may not acquire, or may
be required to give certain notice regarding acquisitions of, companies
considered to engage in activities other than those determined by the Federal
Reserve to be closely related to banking or managing banks.
Transactions with Affiliates. Under Section 23A of the Federal Reserve Act (the
"Act"), certain restrictions are placed on loans and other extensions of credit
by the Bank to BNCCORP which is defined as an "affiliate" of the Bank under the
Act. Section 23B of the Act places standards of fairness and reasonableness on
other of the Bank's transactions with its affiliates. The Federal Reserve
recently issued Regulation W to implement Sections 23A and 23B of the Act and
codify many previously issued Federal Reserve interpretations of those sections.
Anti-Tying Restrictions. Bank holding companies and their affiliates are
prohibited from tying the provision of certain services, such as extensions of
credit, to other services offered by a holding company or its affiliates.
Restrictions on Loans to One Borrower. Under federal law, permissible loans to
one borrower by banks are generally limited to 15 percent of the bank's
unimpaired capital, surplus, undivided profits and credit loss reserves. The
Bank seeks participations to accommodate borrowers whose financing needs exceed
its lending limits or internally established credit concentration limits.
Loans to Executive Officers, Directors and Principal Stockholders. Certain
limitations and reporting requirements are also placed on extensions of credit
by the Bank to principal stockholders of BNCCORP and to directors and certain
executive officers of the Bank (and BNCCORP and its nonbank subsidiaries
provided certain criteria are met) and to "related interests" of such principal
stockholders, directors and officers. In addition, any director or officer of
BNCCORP or the Bank or principal stockholder of BNCCORP may be limited in his or
her ability to obtain credit from financial institutions with which the Bank
maintains correspondent relationships.
Interstate Banking and Branching. The BHCA permits bank holding companies from
any state to acquire banks and bank holding companies located in any other
state, subject to certain conditions, including certain nation-wide and
state-imposed concentration limits. The Bank has the ability, subject to certain
restrictions, to acquire by acquisition or merger branches outside its home
state. The establishment of new interstate branches is also possible in those
states with laws that expressly permit it. Interstate branches are subject to
certain laws of the states in which they are located. Competition may increase
further as banks branch across state lines and enter new markets.
Capital Adequacy. The capital adequacy of BNCCORP and the Bank is monitored by
the federal regulatory agencies using a combination of risk-based and leverage
ratios. Failure to meet the applicable capital guidelines could subject BNCCORP
or the Bank to supervisory or enforcement actions. In addition, BNCCORP could be
required to guarantee a capital restoration plan of the Bank, should the Bank
become "undercapitalized" under capital guidelines. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Financial
Condition-Capital Resources and Expenditures" included under Item 7 of Part II
and Note 18 to the Consolidated Financial Statements included under Item 8 of
Part II for further discussion regarding the capital status of BNCCORP and the
Bank.
Prompt Corrective Action and Other Enforcement Mechanisms. Federal banking
agencies possess broad powers to take corrective and other supervisory action to
resolve the problems of insured depository institutions, including but not
limited to those institutions that fall below one or more prescribed minimum
capital ratios. Each federal banking agency has promulgated regulations defining
the following five categories in which an insured depository institution will be
placed, based on its capital ratios: well capitalized; adequately capitalized;
undercapitalized; significantly undercapitalized; and critically
undercapitalized. At December 31, 2002, the Bank exceeded the required ratios
for classification as well capitalized.
An institution that, based upon its capital levels, is classified as well
capitalized, adequately capitalized or undercapitalized may be treated as though
it were in the next lower capital category if the appropriate federal banking
agency, after notice and opportunity for hearing, determines that an unsafe or
unsound condition or practice warrants such treatment. At each successive lower
capital category, an insured depository institution is subject to more
restrictions. The federal banking agencies, however, may not treat a
significantly undercapitalized institution as critically undercapitalized unless
its capital ratios actually warrant such treatment.
In addition to measures taken under the prompt corrective action provisions,
commercial banking organizations may be subject to potential enforcement actions
by federal regulators for unsafe or unsound practices in conducting their
business or for violations of any law, rule, regulation or any condition imposed
in writing by the agency or any written agreement with the agency.
Safety and Soundness Standards. The Federal banking agencies have adopted
guidelines designed to assist the agencies in identifying and addressing
potential safety and soundness concerns before capital becomes impaired. The
guidelines set forth operational and managerial standards relating to: internal
controls, information systems and internal audit systems; loan documentation;
credit underwriting; asset growth; earnings; and compensation, fees and
benefits. Additionally, the federal banking agencies have also adopted safety
and soundness guidelines with respect to asset quality and earnings standards.
These guidelines provide six standards for establishing and maintaining a system
to identify problem assets and prevent those assets from deteriorating. Under
these standards, an insured depository institution should: conduct periodic
asset quality reviews to identify problem assets; estimate the inherent losses
in problem assets and establish reserves that are sufficient to absorb estimated
losses; compare problem asset totals to capital; take appropriate corrective
action to resolve problem assets; consider the size and potential risks of
material asset concentrations; and provide periodic asset quality reports with
adequate information for management and the board of directors to assess the
level of asset risk. These guidelines also set forth standards for evaluating
and monitoring earnings and for ensuring that earnings are sufficient for the
maintenance of adequate capital and reserves.
Dividend Restrictions. Dividends from bank subsidiaries often constitute a
principal source of income to a bank holding company. Federal rules limit a
bank's ability to pay dividends to its parent bank holding company in excess of
amounts generally equal to the bank's net profits from the current year plus
retained net profits for the preceding two years or if the payment would result
in the bank being considered "undercapitalized" under regulatory capital
guidelines. Bank regulatory agencies also have authority to prohibit a bank from
engaging in activities that, in the opinion of the applicable bank regulatory
authority, constitute unsafe or unsound practices in conducting its business. It
is possible, depending upon the financial condition of the bank in question and
other factors, that the applicable bank regulatory authority could assert that
the payment of dividends or other payments might, under some circumstances, be
such an unsafe or unsound practice. At December 31, 2002 approximately $9.4
million of retained earnings were available for Bank dividend declaration
without prior regulatory approval.
Community Reinvestment Act and Fair Lending Developments. The Bank is subject to
certain fair lending requirements and reporting obligations involving home
mortgage lending operations and Community Reinvestment Act ("CRA") activities.
The CRA generally requires the Federal banking agencies to evaluate the record
of a financial institution in meeting the credit needs of its local communities,
including low- and moderate-income areas. A bank may be subject to substantial
penalties and corrective measures for a violation of certain fair lending laws.
The Federal banking agencies may take compliance with such laws and CRA
obligations into account when regulating and supervising other activities of the
Bank. A Bank's compliance with its CRA obligations is based on a
performance-based evaluation system that bases CRA ratings on its lending
service and investment performance. When a bank holding company applies for
approval to acquire a bank or other bank holding company, the Federal Reserve
will review the assessment of each subsidiary bank of the applicant bank holding
company, and such records may be the basis for denying the application. In
connection with its assessment of CRA performance, the appropriate bank
regulatory agency assigns a rating of "outstanding," "satisfactory," "needs to
improve," or "substantial noncompliance." As a result of its most recent CRA
assessment, the Bank was rated satisfactory under this rating system.
Deposit Insurance. Through the Bank Insurance Fund (the "BIF") and the Savings
Association Insurance Fund (the "SAIF"), the FDIC insures the deposits of the
Bank up to prescribed limits for each depositor. FDIC-insured depository
institutions that are members of the BIF and SAIF pay insurance premiums at
rates based on their assessment risk classification, which is determined in part
based on the institution's capital ratios and in part on factors that the FDIC
deems relevant to determine the risk of loss to the insurance funds. Assessment
rates currently range from zero to 27 cents per $100 of deposits. The FDIC may
increase or decrease the assessment rate schedule on a semi-annual basis. An
increase in the assessment rate could have a material adverse effect on our
earnings, depending on the amount of the increase. The FDIC may terminate a
depository institution's deposit insurance upon a finding by the FDIC that the
institution's financial condition is unsafe or unsound or that the institution
has engaged in unsafe or unsound practices or has violated any applicable rule,
regulation, order or condition enacted or imposed by the institution's
regulatory agency. The termination of deposit insurance for the Bank could have
a material adverse effect on our earnings.
All FDIC-insured depository institutions must pay an annual assessment to
provide funds for the payment of interest on bonds issued by the Financing
Corporation, a Federal corporation chartered under the authority of the Federal
Housing Finance Board. The bonds, commonly referred to as FICO bonds, were
issued to capitalize the Federal Savings and Loan Insurance Corporation. The
FDIC established the FICO assessment rates effective for the fourth quarter of
2002 at approximately $.0084 per $100 annually for assessable deposits. The FICO
assessments are adjusted quarterly to reflect changes in the assessment bases of
the FDIC's insurance funds and do not vary depending on a depository
institution's capitalization or supervisory evaluations.
Cross-Guarantee. The Financial Institutions, Reform, Recovery and Enforcement
Act of 1989 provides for cross-guarantees of the liabilities of insured
depository institutions pursuant to which any bank subsidiary of a bank holding
company may be required to reimburse the FDIC for any loss or anticipated loss
to the FDIC that arises from a default of any of such holding company's other
subsidiary banks or assistance provided to such an institution in danger of
default.
Support of Banks. Bank holding companies are also subject to the "source of
strength doctrine" which requires such holding companies to serve as a source of
"financial and managerial" strength for their subsidiary banks and to conduct
its operations in a safe and sound manner. Additionally, it is the Federal
Reserve's policy that in serving as a source of strength to its subsidiary
banks, a bank holding company should stand ready to use available resources to
provide adequate capital funds to its subsidiary banks during periods of
financial stress or adversity and should maintain the financial flexibility and
capital-raising capacity to obtain additional resources for assisting its
subsidiary banks. A bank holding company's failure to meet its obligations to
serve as a source of strength to its subsidiary banks will generally be
considered by the Federal Reserve to be an unsafe and unsound banking practice
or a violation of the Federal Reserve's regulations or both.
Registration with the Securities and Exchange Commission. BNCCORP's securities
are registered with the Securities and Exchange Commission ("SEC") under the
Exchange Act. As such, BNCCORP is subject to the information, proxy
solicitation, insider trading and other requirements and restrictions of the
Exchange Act.
Conservator and Receivership Powers. Federal banking regulators have broad
authority to place depository institutions into conservatorship or receivership
to include, among other things, appointment of the FDIC as conservator or
receiver of an undercapitalized institution under certain circumstances. If the
Bank were placed into conservatorship or receivership, because of the
cross-guarantee provisions of the Federal Deposit Insurance Act, as amended,
BNCCORP, as the sole stockholder of the Bank, would likely lose its investment
in the Bank.
Bank Secrecy Act. The Bank Secrecy Act requires financial institutions to keep
records and file reports that are determined to have a high degree of usefulness
in criminal, tax and regulatory matters, and to implement counter-money
laundering programs and compliance procedures.
Consumer Laws and Regulations. In addition to the laws and regulations discussed
herein, the Bank is also subject to certain consumer laws and regulations that
are designed to protect customers in transactions with banks. These include, but
are not limited to, the Truth in Lending Act, the Truth in Savings Act, the
Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal
Credit Opportunity Act, the Home Mortgage Disclosure Act, the Real Estate
Settlement Procedures Act, the Fair Credit Reporting Act, the Flood Disaster
Protection Act, the Fair Housing Act and the Right to Financial Privacy Act.
These laws mandate certain disclosure requirements and regulate the manner in
which financial institutions must deal with customers when taking deposits or
making loans to such customers.
Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act signed into law on November
12, 1999 (the "Financial Modernization Act") has expanded the powers of banks
and bank holding companies to sell any financial product or service, closed the
unitary thrift loophole, reformed the Federal Home Loan Bank ("FHLB") System to
increase community banks' access to loan funding, protected banks from
discriminatory state insurance regulation and established a new framework for
the regulation of bank and bank holding company securities brokerage and
underwriting activities. The Financial Modernization Act also included new
provisions in the privacy area, restricting the ability of financial
institutions to share nonpublic personal customer information with third
parties. We have been reviewing implementing regulations and other guidance
issued by bank regulatory agencies in response to the Financial Modernization
Act and establishing policies, procedures and programs required or recommended
by such regulations and guidelines.
USA Patriot Act of 2001. Enacted in response to the terrorist attacks in New
York, Pennsylvania and Washington, D.C. on September 11, 2001, the USA Patriot
Act of 2001 (the "Patriot Act") is intended to strengthen U.S. law enforcement's
and the intelligence communities' ability to work cohesively to combat terrorism
on a variety of fronts. The potential impact of the Patriot Act on financial
institutions of all kinds is significant and wide ranging. The Patriot Act
contains sweeping anti-money laundering and financial transparency laws and
requires various regulations including: due diligence requirements for financial
institutions that administer, maintain or manage private bank accounts or
correspondent accounts for non-U.S. persons; standards for verifying customer
identification at the time of account opening; rules to promote cooperation
among financial institutions, regulators, and law enforcement entities in
identifying parties that may be involved in terrorism or money laundering;
reports by nonfinancial trades and business filed with the Treasury Department's
Financial Crimes Enforcement Network for transactions exceeding $10,000 and;
filing of suspicious activity reports by brokers and dealers if they believe a
customer may be violating U.S. laws and regulations. The impact on bank
operations from the Patriot Act will ultimately depend on the types of customers
served by the bank and the form that issued and pending regulations ultimately
take.
Changing Regulatory Structure. The Federal Reserve, OCC and FDIC have extensive
authority to police unsafe or unsound practices and violations of applicable
laws and regulations by depository institutions and their holding companies. The
agencies' authority has been expanded by federal legislation in recent years. In
addition, state banking authorities possess significant authority to address
violations of their state's banking laws by banks operating in their respective
states by enforcement and other supervisory actions.
As indicated above, the laws and regulations affecting banks and bank holding
companies are numerous and have changed significantly in recent years. There is
reason to expect that changes will continue in the future, although it is
difficult to predict the outcome of these changes or the impact such changes
will have on us.
Economic Conditions and Monetary Policy. Profitability in our banking segment,
like most financial institutions, is primarily dependent on interest rate
differentials. In general, the difference between the interest rates paid by the
Bank on interest-bearing liabilities, such as deposits and borrowings, and the
interest rates received by the Bank on its interest-earning assets, such as
loans extended to clients and securities held in the investment portfolio,
comprise the major portion of the banking segment's earnings. These rates are
highly sensitive to many factors that are beyond our control, such as inflation,
recession and unemployment, and the impact which other changes in economic
conditions might have on us cannot be predicted.
The monetary and fiscal policies of the Federal government and the policies of
the regulatory agencies, particularly the Federal Reserve, influence our
business. The Federal Reserve implements national monetary policies with
objectives such as curbing inflation and combating recession through its
open-market operations in the U.S. government securities by adjusting the
required level of reserves for depository institutions subject to its reserve
requirements, and by varying the target federal funds and discount rates
applicable to borrowings by depository institutions. The actions of the Federal
Reserve in these areas influence the growth of bank loans, investments and
deposits and also affect interest rates earned on interest-earning assets and
paid on interest-bearing liabilities. We cannot fully predict the nature and
impact on BNC of any future changes in monetary and fiscal policies.
Employees
At December 31, 2002, we had 285 employees, including 270 full-time equivalent
employees. None of our employees is covered by a collective bargaining
agreement. We consider our relationships with our employees to be satisfactory.
Approximate employees by segment were as follows as of December 31, 2002:
banking, 161; insurance, 110; and brokerage/trust/financial, 14.
Factors That May Affect Future Results of Operations
In addition to the other information contained in this report, the following
risks may affect us. If any of these risks occur, our business, financial
condition or operating results could be adversely affected.
Failure to Successfully Execute our Growth, Operating and Cross-Selling
Strategies. Our financial performance and profitability depends on our ability
to execute our corporate growth, operating and cross-selling strategies. Future
acquisitions and continued growth can present operating and other issues that
could have an adverse effect on our business, financial condition and results of
operations. Our financial performance will also depend on our ability to
maintain profitable operations through implementation of our banking and
financial services philosophies, including our efforts to cross-sell our various
products and services, which were described earlier. Therefore, there can be no
assurance that we will be able to execute our growth and operating strategies or
maintain any particular level of profitability.
Regional Presences, Related Economic Conditions and Credit Concentrations.
Although our operations are presently somewhat geographically disbursed, our
focus in the Arizona, Minnesota and North Dakota regions could adversely affect
our results of operations if economic and business conditions in any of these
regions were to exhibit weaknesses. A prolonged decline in economic or business
conditions in our market areas, in particular in those industries in which we
have credit concentrations, could have a material impact on the quality of our
loan portfolio or the demand for our other products and services, which in turn
may have a material adverse effect on our results of operations. A continued
weakening in the national economy might further exacerbate local or regional
economic conditions. The extent of the future impact of these events on economic
and business conditions cannot be predicted.
Changes in Market Interest Rates. Changing interest rates impact our earnings.
Changes in interest rates impact the demand for new loans, the credit profile of
existing loans, the rates received on loans and investment securities, rates
paid on deposits and borrowings and the value of our derivative contracts and
their associated impact on earnings. The relationship between the rates received
on loans and investment securities and the rates paid on deposits and borrowings
is known as interest rate spread. Given our current volume and mix of
interest-earning assets, interest-bearing liabilities and derivative contracts,
our interest rate spread could be expected to increase during periods of rising
interest rates and to decline during periods of falling interest rates. Although
we believe our current level of interest rate sensitivity is reasonable and
effectively managed, significant fluctuations in interest rates may have an
adverse effect on our business, financial condition and results of operations.
Government Regulation. The financial services industry is extensively regulated.
Federal and state regulation is designed primarily to protect the deposit
insurance funds and consumers, and not to benefit our shareholders. Such
regulations can at times impose significant limitations on our operations.
Additionally, these regulations are constantly evolving and may change
significantly over time. Significant new laws, such as those issued in recent
years, or changes in or repeal of existing laws may cause our results to differ
materially. Further, Federal monetary policy, particularly as implemented
through the Federal Reserve System, significantly affects interest rate and
credit conditions, which are material considerations for us.
Competition. The banking and financial services business is highly competitive.
We face competition in making loans, attracting deposits and providing
insurance, brokerage, trust and other financial services. Increased competition
in the banking and financial services businesses may reduce our market share,
impair our growth or cause the prices we charge for our services to decline. Our
results of operations may differ in future periods depending upon the level and
nature of competition we encounter in our various market areas.
Failure to Perform on Behalf of Borrowers, Guarantors and Related Parties. We
encounter significant sources of risk from the possibility that losses will be
sustained if a significant number of our borrowers, guarantors and related
parties fail to perform in accordance with the terms of their loans, commitments
or letters of credit. We have adopted underwriting and credit monitoring
procedures and credit policies, including the establishment and methodological
review and analysis of the allowance for credit losses. We believe these
processes and procedures are appropriate to minimize this risk by assessing the
likelihood of nonperformance, tracking loan performance and diversifying our
credit portfolio. These policies and procedures, however, may not prevent
unexpected losses that could materially adversely affect our results of
operations. Additionally, as noted earlier, the performance of borrowers,
guarantors and related parties can be negatively impacted by prevailing economic
conditions over which we have no control. Such negative impacts on these parties
could also materially adversely affect our results of operations.
Item 2. Properties
The principal offices of BNCCORP are located at 322 East Main Avenue, Bismarck,
North Dakota. The Bank owns the building. The principal office of the Bank is
located at 660 South Mill Avenue, Tempe, Arizona. The Bank also owns branch
offices at 219 South 3rd Street and 807 East Century Avenue and an additional
office building at 116 North 4th Street in Bismarck. It also owns its banking
facilities in Crosby, Ellendale, Kenmare, Linton and Stanley, North Dakota. The
Bank is presently constructing an office building at 17045 North Scottsdale
Road, Scottsdale, Arizona.
The Bank's facilities at 502 West Main Street (Mandan), Garrison and Watford
City, North Dakota are leased. The facilities occupied by the Bank and BNC AMI
at 333 South Seventh Street, Minneapolis, Minnesota, and the Bank's facilities
at 640 and 660 South Mill Avenue, Tempe, Arizona, along with 2725 East Camelback
Road, Phoenix, Arizona are also leased.
Milne Scali occupies three locations in Arizona: 1750 East Glendale Avenue,
Phoenix, 4515 S. McClintock, Tempe, and 2400 East Highway 89A, Cottonwood. All
of these facilities are presently leased. See Notes 22 and 27 to the
Consolidated Financial Statements included under Item 8 of Part II for
information related to the pending purchase of the building at 1750 East
Glendale Avenue in Phoenix, a related party transaction.
We believe that all owned and leased properties are well maintained and
considered in good operating condition. They, along with the property being
constructed in Scottsdale, are believed adequate for the Company's present and
foreseeable future operations; however, future expansion could result in the
leasing or construction of additional properties. We do not anticipate any
difficulty in renewing our leases or leasing additional suitable space upon
expiration of present lease terms. See Note 27 to the Consolidated Financial
Statements included under Item 8 of Part II for additional information
concerning our present lease commitments.
Item 3. Legal Proceedings
From time to time, we may be a party to legal proceedings arising out of our
lending, deposit operations or other activities. We engage in foreclosure
proceedings and other collection actions as part of our loan collection
activities. From time to time, borrowers may also bring actions against us, in
some cases claiming damages. Some financial services companies have been
subjected to significant exposure in connection with litigation, including class
action litigation and punitive damage claims. While we are not aware of any
actions or allegations that should reasonably give rise to any material adverse
effect, it is possible that we could be subjected to such a claim in an amount
that could be material. Based upon a review with our legal counsel, we believe
that the ultimate disposition of pending litigation will not have a material
effect on our financial condition, results of operations or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter ended
December 31, 2002.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
BNCCORP's common stock, $.01 par value ("Common Stock"), is traded on the Nasdaq
Stock Market under the symbol "BNCC."
The following table lists the high and low sales prices of our Common Stock for
the periods indicated as reported by the Nasdaq Stock Market. The quotes reflect
the high and low closing sales prices for our Common Stock as reported by
Nasdaq.
2002 2001
----------------- ------------------
Period High Low High Low
------- ------- -------- -------
First Quarter...... $8.90 $7.28 $8.56 $5.94
Second Quarter..... 8.60 7.47 9.50 7.00
Third Quarter...... 7.75 5.49 9.41 7.51
Fourth Quarter..... 8.03 5.25 8.45 7.28
On March 14, 2003, there were 117 record holders of the Company's Common Stock.
BNCCORP's policy is to retain its earnings to support the growth of its
business. Our board of directors has never declared cash dividends on our Common
Stock and does not plan to do so in the foreseeable future. In making the
determination to pay dividends, we will consider all relevant factors including,
among other things, our capital position and current tax law as it relates to
the treatment of dividends. The ability of BNCCORP to pay cash dividends largely
depends on the amount of cash dividends paid to it by the Bank. Capital
distributions, including dividends, by the Bank are subject to federal
regulatory restrictions tied to the bank's earnings and capital. Approval of the
OCC, the Bank's principal regulator, would be required for the Bank to pay
dividends in excess of the Bank's net profits from the current year plus
retained net profits for the preceding two years. See "Supervision and
Regulation-Dividend Restrictions" included under Item 1 of Part I.
Equity-Based Compensation Plans. The following table summarizes information
relative to our equity-based compensation plans as of December 31, 2002:
(a) (b) (c)
------------------ ----------------- -----------------------
Number of securities Number of securities
to be issued upon Weighted-average remaining available
exercise of exercise price for future issuance
outstanding of outstanding under equity
options, options, compensation plans
warrants and warrants and (excluding securities
Plan Category rights rights reflected in column (a))
- ---------------------- ------------------ ----------------- -----------------------
Equity compensation
plans approved by
security holders 173,935 $10.48 169,717 (1)
- ---------------------- ------------------ ----------------- -----------------------
Equity compensation
plans not approved
by security holders N/A N/A N/A
- ----------------------
(1) Shares may be issued under our 1995 and 2002 stock incentive plans as
restricted stock or stock based awards (which awards are based in whole or in
part on the value of our common stock).
Item 6. Selected Financial Data
The selected consolidated financial data presented below under the captions
"Income Statement Data" and "Balance Sheet Data" as of and for the years ended
December 31, 2002, 2001, 2000, 1999 and 1998 are derived from the historical
audited consolidated financial statements of the Company. The Consolidated
Balance Sheets as of December 31, 2002, 2001 and 2000, and the related
Consolidated Statements of Income, Comprehensive Income, Stockholders' Equity
and Cash Flows for each of the three years in the period ended December 31, 2002
were audited by KPMG LLP, independent public accountants. The Consolidated
Balance Sheets as of December 31, 1999 and 1998 and the related Consolidated
Statements of Income, Comprehensive Income, Stockholders' Equity and Cash Flows
for each of the two years in the period ended December 31, 1999 were audited by
Arthur Andersen LLP, independent public accountants who have ceased operations.
The financial data below should be read in conjunction with and are qualified by
the Consolidated Financial Statements and the notes thereto included under Item
8.
Selected Financial Data (1)
For the Years Ended December 31,
---------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- -----------
(dollars in thousands, except share and per share data)
Income Statement Data:
Total interest income.......................... $ 31,818 $ 37,586 $ 40,658 $ 28,535 $ 27,801
Total interest expense......................... 16,907 22,656 27,280 16,438 15,152
---------- ---------- ---------- ---------- ----------
Net interest income............................ 14,911 14,930 13,378 12,097 12,649
Provision for credit losses.................... 1,202 1,699 1,202 1,138 1,201
Noninterest income............................. 16,296 8,714 7,683 6,028 4,843
Noninterest expense............................ 27,158 19,559 16,220 17,435 13,342
Income tax provision (benefit)................. 822 691 1,183 (193) 1,017
---------- ---------- ---------- ---------- ----------
Income (loss) from continuing operations....... $ 2,025 $ 1,695 $ 2,456 $ (255) $ 1,932
========== ========== ========== ========== ==========
Balance Sheet Data: (at end of period)
Total assets................................... $ 602,228 $ 555,967 $ 547,447 $ 445,232 $ 372,227
Federal Reserve Bank and Federal
Home Loan Bank stock.......................... 7,071 7,380 9,619 5,643 3,512
Loans, net of unearned income.................. 335,794 297,924 252,753 254,009 247,181
Allowance for credit losses.................... (5,006) (4,325) (3,588) (2,872) (2,854)
Total deposits................................. 398,245 375,277 330,894 316,772 284,499
Short-term borrowings.......................... 28,120 760 33,228 2,200 7,790
Federal Home Loan Bank advances................ 97,200 117,200 117,200 86,500 41,500
Long-term borrowings........................... 8,561 13 12,642 14,470 9,195
Guaranteed preferred beneficial interests
in Company's subordinated debentures.......... 22,326 22,244 7,606 -- --
Common stockholders' equity.................... 36,223 30,679 29,457 23,149 25,255
Book value per common share outstanding........ $ 13.41 $ 12.79 $ 12.30 $ 9.65 $ 10.57
Earnings Performance/Share Data(1):
Return on average total assets................. 0.36% 0.31% 0.47% (0.07)% 0.55%
Return on average common stockholders' equity.. 5.77% 5.51% 10.02% (1.22)% 8.71%
Net interest margin............................ 2.87% 2.90% 2.73% 3.38% 3.88%
Net interest spread............................ 2.50% 2.40% 2.40% 3.07% 3.43%
Basic earnings (loss) per common share (1)..... $ 0.74 $ 0.71 $ 1.02 $ (0.11) $ 0.81
Diluted earnings (loss) per common share (1)... $ 0.74 $ 0.70 $ 1.02 $ (0.11) $ 0.77
Cash dividends per common share................ -- -- -- -- --
Cash dividends per preferred share............. $ 526.67 -- -- -- --
Total cash dividends - preferred stock......... $ 79 -- -- -- --
Average common shares outstanding.............. 2,611,629 2,395,353 2,397,356 2,406,618 2,397,340
Average common and common equivalent shares.... 2,628,798 2,421,113 2,398,553 2,407,018 2,503,535
Shares outstanding at yearend.................. 2,700,929 2,399,170 2,395,030 2,399,980 2,390,184
Balance Sheet and Other Key Ratios (1):
Nonperforming assets to total assets........... 1.27% 0.80% 0.12% 0.64% 1.21%
Nonperforming loans to total loans............. 2.27% 1.47% 0.23% 0.65% 0.97%
Net loan charge-offs to average loans.......... (0.17)% (0.33)% (0.20)% (0.46)% (0.54)%
Allowance for credit losses to total loans..... 1.49% 1.45% 1.42% 1.13% 1.15%
Allowance for credit losses to nonperforming
loans......................................... 66% 99% 619% 173% 119%
Average common stockholders' equity to average
total assets.................................. 5.93% 5.64% 4.71% 5.48% 6.33%
- -------------------------
(1) From continuing operations for all periods presented.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The following table summarizes income from continuing operations, net income and
basic and diluted earnings per share for the twelve months ended December 31
(amounts in thousands):
2002 2001 2000
------------ ----------- ------------
Income from continuing operations... $ 2,025 $ 1,695 $ 2,456
Net income.......................... 2,039 1,245 2,297
Basic earnings per common share..... 0.75 0.52 0.96
Diluted earnings per common share... 0.75 0.51 0.96
2002 vs. 2001. Strategic initiatives we pursued in recent years, including
diversifying our sources of business, focusing on what we believe are attractive
and growing core markets and managing for long-term shareholder value generated
favorable results in 2002, particularly in the third and fourth quarters.
Net income for 2002 rose 64 percent, to $2.04 million, or $0.75 per common share
on a diluted basis, compared with $1.25 million, or $0.51 per share for 2001.
Our growth in earnings was primarily due to net income from insurance operations
of $1.03 million, reflecting the acquisition of Milne Scali in April 2002. The
results included income from discontinued operations of our former Fargo, N.D.
branch office of $0.01 per share in 2002, and a loss of $0.08 per share from
such operations in 2001. The 2001 results also included extraordinary charges of
$0.06 per share on early extinguishment of debt and $0.05 for cumulative effect
of a change in accounting principle.
Net interest income remained relatively constant, at $14.9 million in both 2002
and 2001. Net interest income included mark-to-market losses on the value of
derivative contracts totaling ($779,000) in 2002 and ($184,000) in 2001. These
losses are subject to fluctuations based on changes in interest rates and the
associated value of the derivative contracts. Excluding the impact of the
mark-to-market losses, net interest income would have increased 3.8 percent
year-over-year.
Demonstrating the benefits of our diverse business base, noninterest income was
up 87 percent year-over-year, to $16.3 million for 2002. Noninterest income
represented 52.2 percent of gross revenues this year, increasing substantially
from 36.9 percent in 2001, and exceeding our internal target of 50 percent.
Insurance commissions, largely produced by Milne Scali, were the largest
component of noninterest income in 2002. Loan fees, gains on sales of securities
and service charges also increased compared to 2001, while brokerage and
trust/financial services income declined.
Noninterest expense was $27.2 million, an increase of nearly 39 percent versus
2001. This primarily reflected our expanded banking and insurance operations in
Arizona and the winding down of the Fargo office of our BNC AMI subsidiary -
actions that are expected to enhance profitability in the future. In any event,
the rate of growth in both net income and noninterest income exceeded the rise
in noninterest expense.
Total assets reached $602.2 million at December 31, 2002, up 8.3 percent from a
year ago. Total loans increased by 12.7 percent, to $335.8 million at the end of
2002, while total deposits rose 6.1 percent to $398.2 million. All stated
amounts reflect continuing operations. Reflecting the success of our expansion
into new markets, the Arizona operations of the Bank accounted for approximately
28 percent of total loans and 12 percent of total deposits at the end of 2002.
Maintaining sound asset quality continued to be a focus for us. The provision
for credit losses was $1.2 million for 2002 versus $1.7 million for the prior
year. Loan charge-offs in 2002 were $657,000, or about one-half the level of
2001. The allowance for credit losses as a percentage of total loans at the end
of 2002 was 1.49 percent, nearly even with 1.45 percent one year ago. The ratio
of nonperforming assets to total assets was 1.27 percent at December 31, 2002,
compared with the year-end 2001 level of 0.80 percent. The ratio of the
allowance for credit losses to total nonperforming loans was 66 percent and 99
percent at December 31, 2002 and 2001, respectively.
Total common stockholders' equity was approximately $36.2 million at December
31, 2002, equivalent to book value per common share of $13.41 (tangible book
value per common share of $5.60). Net unrealized gains in our investment
portfolio as of December 31, 2002 were nearly $4.4 million, or approximately
$1.62 per share, on a pretax basis.
During 2002, we undertook a series of actions to sharpen the focus and
strengthen the performance of each of our three core businesses: banking,
insurance and brokerage/trust/financial services.
In banking, we sold our Fargo, N.D. branch allowing us to redeploy our resources
in markets we believe present greater potential for profitability.
In insurance, the acquisition of Milne Scali in the second quarter of 2002
significantly increased the scale of our insurance business and that business
has already begun to generate encouraging earnings.
In brokerage/trust/financial services, in order to enhance the financial options
available to our customers, we formed a relationship with Raymond James
Financial Services, Inc. We also reorganized the management and office network
of BNC AMI to improve the productivity of this aspect of our business.
We believe that we have achieved our goal of building a diversified business
base, which has long been a cornerstone of our strategy. We believe each of our
core businesses is now well defined and well positioned to serve the needs of
our customers, while contributing to our long-term corporate financial
performance and share value creation.
We believe that our record financial performance in the third and fourth
quarters of 2002 provides a meaningful indication of our earnings potential. Of
the $2.04 million in net income we recorded for the year, most was generated
during the second half of the year. Looking ahead to 2003, we expect to derive a
full year of benefit from our investments in expanding our insurance operations,
implementing programs to encourage cross-selling across all of our business
lines and controlling overhead.
2001 vs. 2000. We reported income from continuing operations of $1.7 million for
2001, or $0.70 per share on a diluted basis. This compares with income from
continuing operations for 2000 of $2.5 million, or $1.02 per share. The results
for 2001 reflected double-digit growth in both net interest income and
noninterest income, but also higher noninterest expense due to the establishment
of our Tempe, Arizona operations and the issuance of trust preferred securities.
Net income for 2001 was $1.2 million, or $0.51 per share on a diluted basis,
after a loss on operations of our discontinued Fargo, N.D. branch of $0.08, an
extraordinary loss on early extinguishment of debt of $0.06 per share and a
charge for the cumulative effect of a change in accounting principle of $0.05
per share. For 2000, net income was nearly $2.3 million, or $0.96 per share,
although this reflected a gain on disposal of our asset-based lending subsidiary
of $0.07 per share, a loss of $0.24 per share from operations of the
discontinued Fargo, N.D branch and a gain on early extinguishment of debt of
$0.11 per share.
Our results for 2001 reflected our strategic diversification of revenue sources
and active asset-liability management. Net interest income increased 12 percent
to $14.9 million, as we continued to shift our earning asset mix from investment
securities to loans while growing the deposit base. Gains generated through
management of the investment portfolio were reflected in noninterest income,
which rose 13 percent to $8.7 million. Other noninterest income items, including
loan fees, insurance commissions and income from brokerage, trust and financial
services, held relatively stable or declined slightly.
Noninterest expense was $19.6 million for 2001, a 21 percent increase from the
previous year, again reflecting our Arizona initiative and expenses related to
trust preferred securities. In particular, we view the cost of operations such
as our Arizona operations as an important investment in growth. Unlike many
companies, we have typically expanded by establishing wholly new operations
rather than making acquisitions. In these particular cases, we record the
investment needed to operate in new markets as an expense, whereas companies
that depend on acquisition for growth are able to recognize much of their "entry
cost" as goodwill.
The benefits of our investment in building new markets were evident in our
strong loan and deposit growth during 2001. Total loans rose 18 percent during
the twelve months ended December 31, 2001, reaching $297.9 million. Total
deposits increased 13 percent over the 2000 level, to $375.3 million at December
31, 2001. Significantly, some 90 percent of the new loan volume and 19 percent
of the deposit increase were generated by our new Arizona operations. Total
assets increased $15.0 million to $585.1 million at December 31, 2001.
Responding to the weaknesses felt by many sectors of the nation's economy, we
continued to focus on maintaining credit quality. The provision for credit
losses was increased to $1.7 million in 2001, from $1.2 million for the prior
year. The allowance for credit losses as a percentage of total loans was 1.45
percent at December 31, 2001, increasing slightly from 1.42 percent one year
earlier. The ratio of nonperforming assets to total assets was 0.80 percent at
December 31, 2001, compared with 0.12 percent at year-end 2000. The ratio of
allowance for credit losses to total nonperforming loans was 99 percent at
December 31, 2001, compared with 619 percent one year earlier.
Total common stockholders' equity was approximately $30.7 million at December
31, 2001, equivalent to book value per common share of $12.79 (tangible book
value per common share of $11.88). Net unrealized gains in our investment
portfolio as of December 31, 2001 were nearly $2.7 million, or approximately
$1.11 per share, on a pretax basis.
Results of Operations
Net Interest Income. Net interest income, the difference between total interest
income earned on interest-earning assets and total interest expense paid on
interest-bearing liabilities, is the banking segment's primary source of
earnings. The amount of net interest income is affected by changes in the volume
and mix of earning assets, the level of rates earned on those assets, the volume
and mix of interest-bearing liabilities and the level of rates paid on those
liabilities.
The following table sets forth, for the periods indicated, certain information
relating to our average balance sheet and reflects the yield on average assets
and cost of average liabilities. Such yields and costs are derived by dividing
income and expense by the average balance of assets and liabilities. All average
balances have been derived from monthly averages, which are indicative of daily
averages.
Analysis of Average Balances, Interest and Yields/Rates (1)
For the Years ended December 31,
----------------------------------------------------------------------------------
2002 2001 2000
--------------------------- -------------------------- --------------------------
Interest Average Interest Average Interest Average
earned yield earned Yield earned yield
Average or or Average or or Average or or
balance paid cost balance paid cost balance paid cost
------- -------- -------- -------- -------- ------- ------- ------- -------
(dollars in thousands)
Assets
Federal funds sold/interest-
bearing due from........... $ 3,795 $ 66 1.74% $ 1,830 $ 50 2.73% $ 5,660 $ 242 4.28%
Taxable investments......... 193,972 9,997 5.15% 206,572 12,716 6.16% 225,559 16,054 7.12%
Tax-exempt investments...... 19,979 977 4.89% 16,452 829 5.04% 17,624 940 5.33%
Loans and leases (2)........ 307,227 20,778 6.76% 293,716 23,991 8.17% 244,526 23,422 9.58%
Allowance for credit losses. (4,579) -- (4,153) -- (3,405) --
-------- ------- -------- ------- -------- -------
Total interest-earning
assets (3)............... 520,394 31,818 6.11% 514,417 37,586 7.31% 489,964 40,658 8.30%
Noninterest-earning assets:
Cash and due from banks.. 13,706 11,997 8,939
Other.................... 34,946 19,388 21,848
-------- -------- --------
Total assets from
continuing operations... 569,046 545,802 520,751
Assets from discontinued
Fargo branch............ 22,258 22,270 17,003
-------- -------- --------
Total assets......... $591,304 $568,072 $537,754
======== ======== ========
Liabilities and Stockholders'
Equity
Deposits:
Interest checking and
money market accounts... $174,108 2,849 1.64% $147,775 4,669 3.16% $130,007 6,913 5.32%
Savings................... 4,511 39 0.86% 3,758 56 1.49% 4,042 84 2.08%
Certificates of deposit:
Under $100,000............ 104,964 4,068 3.88% 98,639 5,280 5.35% 101,624 5,768 5.68%
$100,000 and over......... 73,639 3,286 4.46% 73,806 4,248 5.76% 54,592 3,263 5.98%
-------- ------- -------- ------- -------- -------
Total interest-bearing
deposits.................. 357,222 10,242 2.87% 323,978 14,253 4.40% 290,265 16,028 5.52%
Borrowings:
Short-term borrowings..... 7,799 141 1.81% 10,206 441 4.32% 3,459 234 6.76%
FHLB advances............. 97,711 6,214 6.36% 118,705 7,185 6.05% 154,784 9,766 6.31%
Long-term borrowings...... 6,063 310 5.11% 8,378 777 9.27% 13,497 1,252 9.28%
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities............... 468,795 16,907 3.61% 461,267 22,656 4.91% 462,005 27,280 5.90%
Noninterest-bearing
demand accounts........ 33,951 28,474 26,953
-------- -------- --------
Total deposits and
interest-bearing
liabilities........... 502,746 489,741 488,958
Other noninterest-bearing
liabilities................. 11,336 8,765 5,666
Liabilities from discontinued
Fargo branch................ 20,476 24,654 15,516
-------- -------- --------
Total liabilities.... 534,558 523,160 510,140
Subordinated debentures....... 22,056 13,542 3,108
Stockholders' equity.......... 34,690 31,370 24,506
-------- -------- --------
Total liabilities
and stockholders'
equity.............. $591,304 $568,072 $537,754
======== ======== ========
Net interest income........... $14,911 $14,930 $13,378
======= ======= =======
Net interest spread........... 2.50% 2.40% 2.40%
====== ====== ======
Net interest margin (4)....... 2.87% 2.90% 2.73%
====== ====== ======
Ratio of average
interest-earning
assets to average
interest-bearing
liabilities............... 111.01% 111.52% 106.35%
======== ======== ========
--------------------
(1) From continuing operations for all periods presented.
(2) Average balances of loans and leases include nonaccrual loans and leases,
and are presented net of unearned income. Loan fee amortization totaling
approximately $1.3 million, $812,000 and $388,000 is included in loan
interest income for the twelve month periods ended December 31, 2002, 2001
and 2000, respectively.
(3) Tax-exempt income was not significant and thus has not been presented on a
taxable equivalent basis. Tax-exempt income of $982,000, $840,000 and
$951,000 was recognized during the years ended December 31, 2002, 2001 and
2000, respectively.
(4) Net interest margin equals net interest income divided by average
interest-earning assets for the period.
The following table illustrates, for the periods indicated, the dollar amount of
changes in our interest income and interest expense for the major components of
interest-earning assets and interest-bearing liabilities and distinguishes
between the increase related to higher outstanding balances and the volatility
of interest rates. Changes attributable to the combined impact of volume and
rate have been allocated proportionately to the change due to volume and the
change due to rate:
Analysis of Changes in Net Interest Income (1)
For the Years Ended December 31,
-----------------------------------------------------
2002 Compared to 2001 2001 Compared to 2000
---------------------- ------------------------
Change Due to Change Due to
----------------- ---------------
Volume Rate Total Volume Rate Total
------- --------- -------- -------- -------- --------
(in thousands)
Interest Earned on Interest-Earning
Assets
Federal funds sold/interest-bearing
due from............................ $ 24 $ (8) $ 16 $ (126) $ (66) $ (192)
Investments.......................... (533) (2,038) (2,571) (1,337) (2,112) (3,449)
Loans................................ 1,172 (4,385) (3,213) 2,121 (1,552) 569
-------- -------- -------- -------- -------- --------
Total increase (decrease) in
interest income................... 663 (6,431) (5,768) 658 (3,730) (3,072)
-------- -------- -------- -------- -------- --------
Interest Expense on Interest-Bearing
Liabilities
Interest checking and money market
accounts............................ 1,067 (2,887) (1,820) 1,139 (3,383) (2,244)
Savings.............................. 16 (33) (17) (6) (22) (28)
Certificates of Deposit:
Under $100,000..................... 367 (1,579) (1,212) (166) (322) (488)
$100,000 and over.................. (10) (952) (962) 1,101 (116) 985
Short-term borrowings................ (87) (213) (300) 254 (47) 207
FHLB advances........................ (1,361) 390 (971) (2,198) (383) (2,581)
Long-term borrowings................. (178) (289) (467) (475) -- (475)
-------- -------- -------- -------- -------- --------
Total increase (decrease) in
interest expense.................... (186) (5,563) (5,749) (351) (4,273) (4,624)
-------- -------- -------- -------- -------- --------
Increase (decrease) in net interest
income.............................. $ 849 $ (868) $ (19) $ 1,009 $ 543 $ 1,552
======== ======== ======== ======== ======== ========
- ---------------------
(1) From continuing operations for all periods presented.
Year ended December 31, 2002 compared to year ended December 31, 2001. Net
interest income decreased $19,000, or 0.1 percent, remaining relatively level at
$14.9 million. Net interest spread and net interest margin adjusted to 2.50 and
2.87 percent, respectively, for the twelve-month period ended December 31, 2002
from 2.40 and 2.90, respectively, for the twelve-month period ended December 31,
2001.
Net interest income for the twelve-month periods ended December 31, 2002 and
2001 reflected mark-to-market losses on the value of derivative contracts
totaling ($779,000) and ($184,000), respectively. Without the mark-to-market
adjustments on these derivative contracts for the two periods, net interest
margin would have been 3.01 percent for the twelve months ended December 31,
2002 and 2.94 percent for the twelve months ended December 31, 2001.
The remaining fair value of our interest rate cap contracts on December 31, 2002
was $136,000. Therefore, net interest income in future periods can only be
negatively affected to that amount if the fair value of the contracts were to be
required to be written to $0. If the fair value of the derivative contracts were
to be increased in future periods due to increases in 3-month LIBOR (the rate
upon which our current cap contracts are based), this would have a favorable
effect on net interest income in those future periods as favorable adjustments
to the fair value of the contracts would be reflected as reduced interest
expense.
The following condensed information summarizes the major factors combining to
create the changes to net interest income, spread and margin. Lettered
explanations following the summary describe causes of the changes in these major
factors.
Net Interest Income Analysis - 2002 vs. 2001 (1)
For the Years
Ended December 31, Change
-------------------- ----------------
2002 2001
--------- ---------
(amounts in millions)
Total interest income decreased............. $ 31.8 $ 37.6 $ (5.8) (15)%
Due to:
Decrease in yield on earnings assets.... 6.11% 7.31% (1.20)% (16)%
Driven by:
Decreased yield on loans (a)............ 6.76% 8.17% (1.41)% (17)%
Decreased yield on investments (b)...... 5.13% 6.07% (0.94)% (15)%
The decreased yields were offset by:
Increased average earning assets ....... $ 520.4 $ 514.4 $ 6.0 1%
Driven by:
Increase in average loans (c)........... $ 307.2 $ 293.7 $ 13.5 5%
Offset by:
Decrease in average investments (d)..... $ 214.0 $ 223.0 $ (9.0) (4)%
Total interest expense decreased............ $ 16.9 $ 22.7 $ (5.8) (26)%
Due to:
Decrease in cost of interest-bearing
liabilities............................ 3.61% 4.91% (1.30)% (26)%
Driven by:
Decrease in cost of interest-bearing
deposits (e)........................... 2.87% 4.40% (1.53)% (35)%
Decrease in cost of borrowings (f)...... 5.97% 6.12% (0.15)% (2)%
These decreases in cost of interest-
bearing liabilities were offset by:
Increase in average interest-bearing
liabilities............................ $ 468.8 $ 461.3 $ 7.5 2%
Driven by:
Increase in average interest-bearing
deposits (g)........................... $ 357.2 $ 324.0 $ 33.2 10%
Offset by:
Decrease in average borrowings (h)...... $ 111.6 $ 137.3 $ (25.7) (19)%
- --------------------
(1) From continuing operations for all periods presented.
(a) Our decreased loan yield is reflective of the significantly lower interest
rate environment during 2002. The lower rate environment was caused by
several Federal Reserve reductions in the Federal funds target rate causing
prime rate to decrease significantly during 2001 and continuing into 2002.
The daily average prime rate in 2002 was 4.68 percent as compared to 6.91
percent for 2001. The lower prime rate caused floating rate loans to
reprice at lower levels and new loans to be originated at levels lower than
those originated in the prior period.
(b) The decreased yield on investments was also reflective of the lower
interest rate environment during 2002.
(c) The increase in average loans was driven primarily by loan growth in the
Arizona and Minnesota markets.
(d) Average investments declined as the portfolio was restructured to better
manage our capital, shift our earning asset mix from investments to loans
and to establish the proper forward-looking risk/reward profile for the
investment portfolio.
(e) The decrease in cost of interest-bearing deposits was reflective of the
lower interest rate environment during 2002. Floating rate deposit accounts
repriced at lower levels and certificates of deposit renewed or were
originated at lower levels than those in the prior period.
(f) Borrowing costs decreased due to the lower rate environment during 2002,
the payoff of our 8 5/8 percent subordinated notes during 2001 and the
adjustment of the $15.0 million floating rate subordinated debentures in
response to the lower rates in 2002. Borrowing costs in 2002 would have
decreased to 5.28 percent (versus 5.97 percent) without factoring in the
$779,000 impact of marking our interest rate cap contracts to fair value.
The fair value adjustments to the interest rate cap contracts were
reflected as increases in borrowing costs.
(g) Average interest-bearing deposits increased largely due to further
increases in volume of our Wealthbuilder interest checking and money market
accounts originating primarily in our Arizona and Minnesota markets.
(h) Average borrowings decreased due to lower averages of short-term
borrowings, the pay down of $20 million of FHLB advances in early 2002, a
continued shift in our funding base from borrowings to core deposits and
the retirement of our subordinated notes, which were outstanding through
August 31, 2001.
Net interest income and margin in future periods may be impacted by several
factors. Changes in net interest income are dependent upon the volume and mix of
interest-earning assets and interest-bearing liabilities, the movement of
interest rates and the level of non-performing assets. Achieving net interest
margin growth is dependent on our ability to generate higher-yielding assets and
lower cost funding sources such as deposits and borrowings. If variable index
rates, such as the prime rate, were to decline, we could experience compression
of our net interest margin depending upon the timing and amount of any
reductions, as it is possible that interest rates paid on some deposits and
borrowings may not decline as quickly, or to the same extent, as the decline in
the yield on interest-rate-sensitive assets such as commercial and other loans.
Competition for checking, savings and money market deposits, important sources
of lower cost funds for us, is intense. We could also experience net interest
margin compression if rates paid on deposits and borrowings increase, or as a
result of new pricing strategies and lower rates offered on loan products in
response to competitive pressures, rates on interest-bearing liabilities
increase faster, or to a greater extent, than the increase in the yield on
interest-rate-sensitive assets. The level and nature of the impact cannot be
precisely ascertained. Federal Reserve actions in response to economic
developments can vary causing prime and other rates to adjust and, in some
cases, immediately impact our interest-earning assets and interest-bearing
liabilities.
These factors, including the competitive environment in the markets in which we
operate, the multitude of financial and investment products available to the
public and the monetary policies of the Federal Reserve, can materially impact
our operating results. Therefore, we cannot predict, with any degree of
certainty, prospects for net interest income and net interest margin in future
periods. See "Supervision and Regulation, Economic Conditions and Monetary
Policy-Economic Conditions and Monetary Policy" included under Item 1 of Part I.
See also Item 7A, "Quantitative and Qualitative Disclosures About Market Risk,"
for information relating to the impact of fluctuating interest rates on our
future net interest income prospects.
Year ended December 31, 2001 compared to year ended December 31, 2000. Net
interest income increased $1.6 million, or 11.6 percent, to $14.9 million as
compared to $13.4 million. Net interest spread and net interest margin were 2.40
and 2.90 percent, respectively as compared to 2.40 and 2.73 percent for the
prior period.
Net interest income for the twelve-month period ended December 31, 2001
reflected mark-to-market losses on the value of derivative contracts totaling
($184,000). Without the mark-to-market adjustments on these derivative contracts
net interest margin for the period would have been 2.94 percent. Net interest
income for the twelve-month period ended December 31, 2000 reflected
amortization of an interest rate floor contract totaling ($224,000). Without
this amortization expense net interest margin for the period would have been
2.78 percent. The cost of the interest rate floor contract was being amortized
during 2000 because Statement of Financial Accounting Standards No. 133,
"Accounting for Derivatives and Hedging Activities" ("SFAS 133"), as amended
relating to the accounting for derivatives, was not yet effective.
The following condensed information summarizes the major factors combining to
create the changes to net interest income, spread and margin. Lettered
explanations following the summary describe causes of the changes in these major
factors:
Net Interest Income Analysis - 2001 vs. 2000 (1)
For the Years
Ended December 31, Change
-------------------- ----------------
2001 2000
--------- ---------
(amounts in millions)
Total interest income decreased............. $ 37.6 $ 40.7 $ (3.1) (8)%
Due to:
Decrease in yield on interest-
earnings assets........................ 7.31% 8.30% (.99)% (12)%
Driven by:
Decrease in yield on loans (a).......... 8.17% 9.58% (1.41)% (15)%
Decrease in yield on investments (b).... 6.07% 6.99% (0.92)% (13)%
The decreases in yield on
interest-earning assets were
Offset by:
Increase in average earning assets....... $ 514.4 $ 490.0 $ 24.4 5%
Driven by:
Increase in average loans (c)........... $ 293.7 $ 244.5 $ 49.2 20%
Offset by:
Decrease in average investments (d)..... $ 223.0 $ 243.2 $ (20.2) (8)%
Total interest expense decreased............ $ 22.7 $ 27.3 $ (4.6) (17)%
Due to:
Decrease in cost of
interest-bearing liabilities........... 4.91% 5.90% (0.99)% (17)%
Driven by:
Decrease in cost of
interest-bearing deposits (e).......... 4.40% 5.52% (1.12)% (20)%
Decrease in cost of borrowings (f)...... 6.12% 6.55% (0.43)% (7)%
These decreases were coupled with:
Decrease in average
interest-bearing liabilities........... $ 461.3 $ 462.0 $ (0.7) --
Driven by:
Decrease in average borrowings (g)...... $ 137.3 $ 171.7 $ (34.4) (20)%
Offset by:
Increase in average interest-bearing
deposits (h)........................... $ 324.0 $ 290.3 $ 33.7 12%
- --------------------
(1) From continuing operations for all periods presented.
(a) The decreased loan yield is reflective of a 475 basis point decrease in the
prime rate over the course of 2001 as monetary policy eased in response to
weakening national economic conditions. Floating rate loans tied to prime
repriced lower and new loans originated during 2001 came on at lower rates
than those originated during 2000.
(b) The decreased investment yield reflects the lower rate environment in 2001
as well as the reduction in the size of the investment portfolio in order
to shift the earning asset mix toward loans.
(c) Loan growth was attributable to increases in loans originated in our
Arizona, Minnesota and North Dakota markets.
(d) Average investments decreased due to the strategic shift in earning asset
mix from investment securities to loans as lending opportunities arose in
the Arizona, Minnesota and North Dakota markets.
(e) Decreased cost of interest-bearing deposits is reflective of the rise in
volume of Wealthbuilder interest checking and money market accounts and the
associated decreases in cost as interest rates declined during 2001. The
Wealthbuilder accounts carry rates that are variable at management's
discretion. Management lowered the rates paid on these deposits in response
to the monetary easing that took place during 2001 while maintaining the
competitive nature of the Wealthbuilder products in the Company's various
markets. Additionally, in a lower rate environment, the cost of
certificates of deposit also decreases with renewals and new accounts.
(f) Rates are reflective of the overall decreased rate environment in 2001 as
compared to 2000.
(g) We decreased our volume of FHLB advances due to greater use of national
market certificates of deposit as a wholesale funding source in order to
maintain borrowing capacity at the FHLB, support the earning asset base and
take advantage of favorable costs of national market certificates of
deposit relative to FHLB advances. In addition, on August 31, 2001 we
redeemed $12.6 million of our 8 5/8 percent subordinated notes due May 31,
2004 through the exercise of our call option.
(h) Deposit growth was primarily attributable to the continued success of the
Wealthbuilder family of interest checking and money market accounts in
addition to increased use of direct non-brokered national market
certificates of deposit obtained via posting rates on national networks.
National market certificates of deposit were $34.0 million as of December
31, 2001 compared to $9.0 on December 31, 2000.
Provision for Credit Losses. We determine a provision for credit losses which we
consider sufficient to maintain our allowance for credit losses at a level
considered adequate to provide for an estimate of probable losses related to
specifically identified loans as well as probable losses in the remaining loan
and lease portfolio that have been incurred as of each balance sheet date. The
provision for credit losses for the year ended December 31, 2002 was $1.2
million as compared to $1.7 million in 2001 and $1.2 million in 2000. Net loan
and lease charge-offs were $521,000, or 0.17 percent of average loans and leases
in 2002 compared with $962,000, or 0.33 percent in 2001 and $486,000, or 0.20
percent in 2000. The increase in provision and net-charge-offs in 2001 primarily
reflected the impact of developments in our truck leasing portfolio and
deterioration in performance of a number of our contracting customers.
The provision for credit losses is calculated as part of the determination of
the allowance for credit losses and the related provision for credit losses is a
critical accounting policy which involves consideration of a number of factors
such as loan growth, net charge-offs, changes in the composition of the loan
portfolio, delinquencies in the loan and lease portfolio, the value of
underlying collateral on problem loans, general economic conditions and our
assessment of credit risk in the current loan and lease portfolio. Periodic
fluctuations in the provision for credit losses result from our assessment of
the adequacy of the allowance for credit losses; however, actual loan losses may
vary from current estimates.
The allowance for loan losses totaled $5.0 million at December 31, 2002 compared
with $4.3 and $3.6 million at December 31, 2001 and 2000, respectively. See Note
1 to the Consolidated Financial Statements included under Item 8, "-Financial
Condition-Loan Portfolio-Allowance for Credit Losses" and "-Critical Accounting
Policies" for further discussion of the components of the allowance for credit
losses, our systematic methodology for determining the adequacy of the allowance
and additional data pertaining to charge-offs, recoveries and other related
information.
Noninterest Income. Noninterest income is becoming a more significant source of
revenues for us as we continue to emphasize our goal of focusing on local
relationship banking and providing a broad range of financial products and
services that will meet the needs of our customers, both commercial and
consumer. Our noninterest income increased approximately $7.6 million, or 87
percent, in 2002 largely due to insurance commission income generated by Milne
Scali, which we acquired in April 2002. Fees on loans, net gain on sales of
securities and service charges also increased in 2002. Noninterest income
increased approximately $1.0 million, or 13 percent, in 2001 primarily as a
result of increases in net gains on sales of securities.
The following table presents, for the periods indicated, the major categories of
our noninterest income as well as the amount and percent of change between each
of the periods presented. Related information and significant changes are
discussed in lettered explanations following the table:
Noninterest Income (1)
Increase (Decrease)
--------------------------------------
For the Years Ended
December 31, 2002 - 2001 2001 - 2000
---------------------------- ----------------- ------------------
2002 2001 2000 $ % $ %
-------- -------- -------- -------- ------- -------- --------
(in thousands)
Insurance commissions... $ 8,981 $ 1,891 $ 2,003 $ 7,090 375% $ (112) (6)% (a)
Fees on loans........... 2,169 1,936 1,848 233 12% 88 5% (b)
Net gain on sales of
securities ........... 1,870 1,396 276 474 34% 1,120 406% (c)
Brokerage income........ 1,094 1,407 1,466 (313) (22)% (59) (4)% (d)
Service charges......... 755 636 581 119 19% 55 9% (e)
Trust and financial
services............... 751 899 1,064 (148) (16)% (165) (16)% (f)
Rental income........... 89 54 27 35 65% 27 100%
Other................... 587 495 418 92 19% 77 18%
-------- -------- -------- -------- --------
Total noninterest
income................. $16,296 $ 8,714 $ 7,683 $ 7,582 87% $ 1,031 13%
======== ======== ======== ======== ========
- --------------------
(1) From continuing operations for all periods presented.
(a) Insurance commissions. In 2002, insurance commissions increased
dramatically due to the April 16, 2002 acquisition of Milne Scali. In 2001,
insurance commissions declined in the face of a challenging economic
environment and catastrophic weather-related events in the North Dakota
market during 2000 that reduced and/or eliminated contingency fees paid by
insurance companies in 2001. We expect insurance commission income to
increase during 2003 due to a full year of production by Milne Scali along
with contingency fees generally received by Milne Scali in the first
quarter of each year.
(b) Fees on loans. The increase in loan fees for 2002 is largely attributable
to loans originated and sold on the secondary market. Loan volume
generation and the related loan fees associated with such loans can be
subject to significant fluctuations making it difficult to anticipate the
amount of loans that will be originated or placed and related loan fees
that will be recognized in future periods.
(c) Net gain on sales of securities. Net gain on sales of securities in 2002
was primarily a result of repositioning the investment portfolio's
forward-looking risk/reward profile. Net gain on sales of securities in
2001 was a function of selling investment securities in the process of
shifting the earning asset mix from investment securities to loan
opportunities available in new and existing markets. In addition, given the
significant decline in interest rates during 2001, sales of investment
securities were necessary in order to adjust the forward-looking
risk/reward profile of the investment portfolio. We cannot guarantee our
ability to generate realized gains in the future such as those recognized
during the most recent two years given the current absolute low level of
interest rates. In the future, the investment portfolio risk/reward
management process may require us to recognize net realized losses in order
to optimize the forward-looking profile of the portfolio.
(d) Brokerage income. In 2002 brokerage income declined as a result of market
conditions and a decrease in the number of brokers at BNC AMI, including
the closing of BNC AMI's Fargo office in September. In 2001, brokerage
income was relatively stable in the face of a challenging economic
environment and a prolonged period of soft conditions in equity markets.
(e) Service charges. Service charges increased in 2002 and 2001 as the Company
continued to increase its Wealthbuilder interest checking and money market
account volume along with an increase in non-interest bearing deposits
which are primarily business deposit relationships that tend to utilize a
greater level of fee-based deposit services.
(f) Trust and financial services. The 2002 and 2001 decreases in trust and
financial services revenue are attributable to reduced fees from the BNC
U.S. Opportunities Fund LLC as such fees are primarily a function of the
asset size of the fund and the fund has decreased over the two periods. The
fund's size has been negatively impacted by the overall decline in equity
markets in both years.
Noninterest Expense. Noninterest expense increased approximately $7.6 million,
or 39 percent, in 2002 primarily as a result of the Milne Scali acquisition and
our expanding presence in the Arizona market. Noninterest expense increased
approximately $3.3 million, or 21 percent, in 2001 due to several factors
including our entry into the Arizona market.
The following table presents, for the periods indicated, the major categories of
our noninterest expense as well as the amount and percent of change between each
of the periods presented. Related information and significant changes are
discussed in lettered explanations below the table:
Noninterest Expense (1)
Increase (Decrease)
--------------------------------------
For the Years Ended
December 31, 2002 - 2001 2001 - 2000
---------------------------- ------------------- -----------------
2002 2001 2000 $ % $ %
-------- ------- -------- --------- -------- -------- -------
(in thousands)
Salaries and employee
benefits.................. $14,723 $ 9,911 $ 8,266 $ 4,812 49% $ 1,645 20% (a)
Occupancy.................. 2,235 1,661 1,187 574 35% 474 40% (b)
Interest on subordinated
debentures................ 1,829 1,377 399 452 33% 978 245% (c)
Professional services...... 1,495 1,326 1,278 169 13% 48 4% (d)
Depreciation and
amortization.............. 1,320 1,123 993 197 18% 130 13% (e)
Office supplies,
telephone and postage..... 1,106 940 863 166 18% 77 9% (f)
Amortization of
intangible assets......... 881 482 527 399 83% (45) (9)% (g)
Marketing and promotion.... 749 709 488 40 6% 221 45% (h)
FDIC and other assessments. 214 193 200 21 11% (7) (4)%
Repossessed and impaired
asset expenses /
write-offs................ 142 40 470 102 255% (430) (91)% (i)
Other...................... 2,464 1,797 1,549 667 37% 248 16% (j)
-------- -------- -------- --------- --------
Total noninterest expense.. $27,158 $19,559 $16,220 $ 7,599 39% $ 3,339 21%
======== ======== ======== ========= ========
Efficiency ratio........... 87.03% 82.72% 77.01% 4.31% 5.71% (k)
Adjusted efficiency ratio
excluding impact of
derivative contracts and
dividends paid on
subordinated debentures... 79.19% 76.34% 76.20% 2.85% 0.14%
Total operating expenses
as a percent of average
assets.................... 4.77% 3.58% 3.11% 1.19% 0.47% (l)
- --------------------
(1) From continuing operations for all periods presented.
(a) Salaries and employee benefits. The 2002 increase represents the addition
of approximately 85 Milne Scali employees effective April 16, 2002 as well
as additional employees added in the Arizona market. The 2001 increase
reflects additions to personnel associated with our establishment of a
banking subsidiary in Arizona along with additional personnel in the
Minneapolis market. Average full time equivalents for each year in the
three-year period ended December 31, 2002 were 253, 189 and 163,
respectively.
(b) Occupancy. The 2002 increase reflects the addition of Milne Scali in April
2002. The increase in 2001 was primarily associated with newly occupied
facilities due to the establishment of a banking subsidiary in Arizona.
(c) Interest on subordinated debentures. This is the interest expense
associated with our fixed rate subordinated debentures (commonly referred
to as trust preferred securities) issued in July 2000 and the additional
interest expense from our floating rate subordinated debentures issued in
July 2001. The 2002 increase is primarily attributable to the $15.0 million
of subordinated debentures issued in July 2001 being outstanding for a full
year during 2002. The increase in 2001 reflects a the full year expense of
the July 2000 issuance along with five months of expense related to the
July 2001 issuance. See Note 14 to the Consolidated Financial Statements
included under Item 8 for further information related to our subordinated
debentures.
(d) Professional services. The 2002 increase in professional services
represents increases in legal fees (including those incurred by Milne
Scali), software support fees and other consulting and investment banking
fees.
(e) Depreciation and amortization. Depreciation and amortization expenses
increased in 2002 due to the Milne Scali acquisition along with costs
associated with additional expansion in the Arizona market. Depreciation
and amortization in 2001 increased over 2000 due primarily to the
initiation of activities in the Arizona market.
(f) Office supplies, telephone and postage. Increases in this line item in 2002
are associated with the Milne Scali acquisition and additional expenses
associated with expansion in the Arizona market.
(g) Amortization of intangible assets. The increase in 2002 primarily
represents the amortization of the insurance books of business intangibles
acquired in the Milne Scali acquisition in April 2002.
(h) Marketing and promotion. Increased marketing costs in 2001 resulted from
promotions in various markets including those associated with development
of our Arizona market.
(i) Repossessed and impaired asset expenses/write-offs. These expenses
represent write-downs to estimated net realizable value of other real
estate owned and repossessed assets and related collection expenses. We had
no other real estate owned at December 31, 2002 and repossessed assets were
valued at $8,000.
(j) Other. The 2002 increase represents increases in several miscellaneous line
items included in this category (some of which are associated with the
acquisition of Milne Scali in April 2002) and include increases in
insurance premiums, OCC assessments, travel expenses, dues and
publications, data processing fees and expenses associated with winding
down the BNC AMI operations in Fargo. The 2001 increase represents a number
of increases in various expense categories including travel expenses, meals
and entertainment, correspondent bank charges and expenses associated with
the resignation of two brokers in BNC AMI's Minneapolis office.
(k) Noninterest expense divided by an amount equal to net interest income plus
noninterest income.
(l) Total operating expenses as a percent of average assets have increased as
our profile has changed from that of a traditional banking organization to
an organization with a broader base of financial product and service
offerings the revenues and expenses of which are generally not asset-based.
Income taxes. We recorded income tax expense of $822,000, $691,000 and $1.2
million for the years ended December 31, 2002, 2001 and 2000, respectively. Our
effective tax rates were 28.87, 28.96 and 32.51 percent for the twelve-month
periods ended December 31, 2002, 2001 and 2000, respectively. The effective tax
rates were lower than the statutory rates principally due to tax-exempt income
on municipal securities.
The determination of current and deferred income taxes is a critical accounting
policy which is based on complex analyses of many factors including
interpretations of Federal and state income tax laws, the differences between
tax and financial reporting basis of assets and liabilities (temporary
differences), estimates of amounts due or owed such as the timing of reversal of
temporary differences and current financial accounting standards. Actual results
could differ significantly from the estimates and interpretations used in
determining the current and deferred income tax liabilities. Additional detail
on income taxes is provided in Note 24 to the Consolidated Financial Statements
included under Item 8.
Financial Condition
Overview. Although subsequent sections of this discussion and analysis of
financial condition address certain aspects of our major assets and liabilities
in significant detail, the following two tables are presented as a general
overview of the financial condition of the Company.
Total assets increased approximately $17.2 million, or 3 percent, between
December 31, 2001 and December 31, 2002 and approximately $15.0 million, or 3
percent, between December 31, 2000 and December 31, 2001. Our total assets at
December 31, 2002 were $602.2 million.
The following table presents our assets by category as of December 31, 2002,
2001 and 2000, as well as the amount and percent of change between the dates.
Significant changes are discussed in lettered notes following the table (amounts
are in thousands):
Assets
Increase (Decrease)
---------------------------------------
As of December 31, 2002 - 2001 2001 - 2000
------------------------------- ------------------ ------------------
2002 2001 2000 $ % $ %
--------- --------- --------- -------- -------- --------- -------
Cash and due from
banks...............$ 16,978 $ 16,346 $ 14,988 $ 632 4% $ 1,358 9%
Interest-bearing
deposits with banks. 159 126 595 33 26% (469) (79)%
Federal funds sold... -- 7,500 -- (7,500) (100)% 7,500 100% (a)
Investment securities
available for sale.. 208,072 211,801 253,566 (3,729) (2)% (41,765) (16)% (b)
Federal Reserve
Bank and Federal
Home Loan Bank
stock............... 7,071 7,380 9,619 (309) (4)% (2,239) (23)%
Loans and leases,
net................. 330,788 293,599 249,165 37,189 13% 44,434 18% (c)
Premises and
equipment, net...... 11,100 9,180 8,477 1,920 21% 703 8%
Interest receivable.. 2,856 3,008 3,854 (152) (5)% (846) (22)%
Other assets......... 4,119 4,856 4,465 (737) (15)% 391 9%
Goodwill............. 12,210 437 561 11,773 2,694% (124) (22)% (d)
Other intangible
assets, net......... 8,875 1,734 2,158 7,141 412% (424) (20)% (e)
Assets of
discontinued Fargo
operations.......... -- 29,090 22,568 (29,090) (100)% 6,522 29% (f)
--------- --------- --------- --------- ---------
Total assets.... $ 602,228 $ 585,057 $ 570,016 $ 17,171 3% $ 15,041 3%
========= ========= ========= ========= =========
(a) Federal funds sold. Federal funds sold can fluctuate on a daily basis
depending upon our liquidity management activities.
(b) Investment securities available for sale. We implemented a balance sheet
leveraging strategy beginning late in 1999 whereby the earning asset
portfolio was increased through the purchase of additional investment
securities funded primarily by borrowings from the FHLB. In 2001, we began
to strategically shift the larger earning asset base to loans from
investment securities.
(c) Loans and leases. In 2001, we increased our net loans and leases by
strategically shifting our earning asset mix toward loans from investment
securities. The increase in net loans and leases reflected commercial real
estate and real estate construction loans arising from opportunities in the
Arizona, Minnesota and North Dakota markets. The 2002 increase in loans
represented loan growth primarily in the Arizona and Minnesota markets.
(d) Goodwill. Goodwill increased significantly in 2002 due to the acquisition
of Milne Scali in April 2002.
(e) Other intangible assets. The 2002 increase in other intangible assets
represents insurance books of business intangibles acquired in the Milne
Scali acquisition of April 2002.
(f) Assets of discontinued Fargo operations. The Fargo branch of the Bank was
sold on September 30, 2002. The assets indicated for December 31, 2001 and
2000 represent the assets attributable to that branch as of those dates.
Our total liabilities increased approximately $10.0 million, or 2 percent,
between December 31, 2001 and December 31, 2002 and decreased $819,000 between
December 31, 2000 and December 31, 2001. Total liabilities at December 31, 2002
were approximately $542.2 million. Stockholders' equity was approximately $37.7,
$30.7 and $29.5 million at December 31, 2002, 2001 and 2000, respectively.
The following table presents our liabilities, guaranteed preferred beneficial
interests in subordinated debentures and stockholders' equity by category as of
December 31, 2002, 2001 and 2000, as well as the amount and percent of change
between the dates. Significant changes are discussed in lettered notes following
the table (amounts are in thousands):
Liabilities, Subordinated Debentures and Stockholders' Equity
Increase (Decrease)
--------------------------------------
As of December 31, 2002 - 2001 2001 - 2000
----------------------------- ------------------ ------------------
2002 2001 2000 $ % $ %
-------- --------- -------- -------- -------- --------- --------
Deposits:
Noninterest-bearing..... $ 44,362 $ 30,521 $ 26,931 $13,841 45% $ 3,590 13% (a)
Interest-bearing -
Savings, interest
checking and
money market......... 187,531 160,721 150,584 26,810 17% 10,137 7% (b)
Time deposits
$100,000 and over.... 64,905 78,969 59,086 (14,064) (18)% 19,883 34% (c)
Other time deposits.... 101,447 105,066 94,293 (3,619) 3% 10,773 11% (d)
Short-term borrowings.. 28,120 760 33,228 27,360 3,600% (32,468) (98)% (e)
FHLB advances........... 97,200 117,200 117,200 (20,000) (17)% 0 0% (f)
Long-term borrowings.... 8,561 13 12,642 8,548 65,754% (12,629) (100)% (g)
Other liabilities....... 10,053 6,192 7,419 3,861 62% (1,227) (17)%
Liabilities of
discontinued Fargo
operations............. -- 32,692 31,570 (32,692) (100)% 1,122 4% (h)
-------- --------- -------- -------- ---------
Total liabilities.... 542,179 532,134 532,953 10,045 2% (819) --
Guaranteed preferred
beneficial interests in
Company's subordinated
debentures............. 22,326 22,244 7,606 82 0% 14,638 192% (i)
Stockholders' equity.... 37,723 30,679 29,457 7,044 23% 1,222 4% (j)
-------- --------- -------- -------- ---------
Total.............. $602,228 $585,057 $570,016 $ 17,171 3% $ 15,041 3%
======== ========= ======== ======== =========
- ------------------------
(a) Noninterest-bearing deposits. Noninterest-bearing deposits can fluctuate
significantly on a daily basis due to transactions associated primarily
with commercial customers. The increase in 2002 also reflects new
commercial and retail customer activity in the Arizona and Minnesota
markets.
(b) Savings, interest checking and money market. Increases in this category are
attributable to the continued popularity of the Company's Wealthbuilder
deposit products and reflect deposit growth primarily in the Arizona and
Minnesota markets.
(c) Time deposits $100,000 and over. Brokered deposits totaled $31.4 million at
December 31, 2002 compared to $34.4 and $30.7 million at December 31, 2001
and 2000, respectively. National certificates of deposit acquired through
national networks totaled $27.1 million at December 31, 2002 compared to
$34.0 million at December 31, 2001 and $9.0 million at December 31, 2000.
In 2002, we allowed national market certificates of deposit to run off and
be replaced by growth in the Wealthbuilder interest checking and money
market account categories. The increase in 2001 was due to greater use of
national certificates of deposit as a wholesale funding source in order to
maintain borrowing capacity at the FHLB and take advantage of favorable
costs of national certificates of deposits relative to FHLB advances.
(d) Other time deposits. During 2001, this category increased due to certain
special promotions in select markets.
(e) Short-term borrowings. The increase in short term borrowings in 2002
reflects $15.0 million of Federal funds purchased at December 31, 2002
coupled with $13.1 million of repurchase agreements with customers. These
repurchase agreements are renewable daily. The decrease in short-term
borrowings between December 31, 2000 and 2001 was a result of a decrease in
Federal funds purchased at December 31, 2001. Federal funds purchased can
fluctuate daily based on the funds management activities of the Bank.
(f) FHLB advances. $20 million of FHLB advances matured in early 2002 and were
not replaced due to the availability of other funding sources.
(g) Long-term borrowings. The 2002 increase reflects the $8.5 million long-term
note originated at the time of the Milne Scali acquisition in April 2002.
The 2001 decrease represents the fact that, on August 31, 2001, the Company
retired its remaining 8 5/8 percent subordinated notes due May 31, 2004
through the exercise of its call option by using a portion of the proceeds
from the issuance of floating rate trust preferred securities in July 2001.
(h) Liabilities of discontinued Fargo operations. The Fargo branch of the Bank
was sold on September 30, 2002. The liabilities indicated for December 31,
2001 and 2000 represent the liabilities attributable to that branch as of
those dates.
(i) Guaranteed preferred beneficial interests in Company's subordinated
debentures. We issued $15.0 million of floating rate trust preferred
securities in July 2001. See Note 14 to the consolidated financial
statements included under Item 8 for further information related to our
trust preferred securities.
(j) Stockholders' equity. The increase in 2002 reflects $1.5 million of
preferred stock issued in 2002, $2.5 million of common stock issued in
conjunction with the Milne Scali acquisition in April 2002, $2.0 million of
earnings recorded in 2002 and $1.1 million in after-tax unrealized holding
gains on securities available for sale arising during the period.
Investment Securities Available for Sale. Our investment policy is designed to
enhance net income and return on equity through prudent management of risk,
ensure liquidity for cash-flow requirements, help manage interest rate risk,
ensure collateral is available for public deposits, advances and repurchase
agreements and manage asset diversification. In managing the portfolio, we seek
a balance between current income (yield) and future market value volatility,
while simultaneously managing credit and liquidity risks. The goal of this
process is to maximize our longer-term profitability as well as the economic
performance of the portfolio over the long-term.
Investments are centrally managed in order to maximize compliance (Federal laws
and regulations place certain restrictions on the amounts and types of
investments we may hold) and effectiveness of overall investing activities. The
primary goal of our investment policy is to contribute to our overall
profitability. The objective is to purchase and own securities and combinations
of securities with good risk/reward characteristics. "Good" risk/reward
securities are those identified through thorough analysis of the cash flows and
potential cash flows as well as market value and potential future market value
of the security in question given various interest rate scenarios. Investment
strategies are developed in light of a constant view of our overall
asset/liability position. As it relates to investment strategies, the focus of
our Asset/Liability management committee ("ALCO") is to determine the impact of
interest-rate changes on both future income and market value of securities in
the portfolio. See Item 7A, "Quantitative and Qualitative Disclosures about
Market Risk," for additional information relating to the impact of fluctuating
interest rates on our net interest income, including income generated by our
investment securities portfolio.
The following table presents the composition of the available-for-sale
investment portfolio by major category as of the dates indicated:
Investment Portfolio Composition (1)
December 31,
--------------------------------------------------------------------
2002 2001 2000
--------------------- --------------------- --------------------
Estimated Estimated Estimated
fair fair fair
Amortized market Amortized market Amortized market
cost value cost value Cost value
--------- --------- --------- --------- --------- ---------
(in thousands)
U.S. government agency
mortgage-backed
securities......... $ 47,072 $ 47,576 $ 42,027 $ 41,946 $ 44,272 $ 44,468
U.S. government
agency securities.. 4,608 5,203 4,396 4,495 4,880 4,890
Collateralized
mortgage
obligations........ 122,795 124,480 135,423 137,268 164,221 165,404
State and municipal
bonds.............. 27,276 28,815 16,952 17,481 20,782 20,905
Corporate bonds...... 1,938 1,998 10,329 10,611 16,968 17,899
--------- --------- --------- --------- --------- ---------
Total investments.... $ 203,689 $ 208,072 $ 209,127 $ 211,801 $ 251,123 $ 253,566
========= ========= ========= ========= ========= =========
- ----------------------
(1) From continuing operations for all periods presented.
The following table presents maturities for all securities available for sale
(other than equity securities) and yields for all securities in our investment
portfolio at December 31, 2002:
Investment Portfolio - Maturity and Yields
Maturing
----------------------------------------------------------------------------
After 1 but After 5 but
Within 1 year within 5 years within 10 years After 10 years Total
----------------- ----------------- ----------------- ------------------ ------------------
Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1)
------- -------- ------- -------- -------- -------- -------- --------- -------- ---------
U.S. government
agency
mortgage-backed
securities (2)(3).... $ -- -- $ -- -- $ 972 5.97% $ 46,100 5.70% $ 47,072 5.70%
U.S. government
agency
securities (2)....... -- -- 944 11.07% -- -- 3,664 6.03% 4,608 7.06%
Collateralized
mortgage
obligations (2)(3)... -- -- 1,864 7.36% 2,892 5.98% 118,039 4.94% 122,795 5.00%
State and municipal
bonds (2)............ 5 13.49% -- -- 501 6.91% 26,770 7.22% 27,276 7.22%
Corporate bonds (2)... -- -- -- -- -- -- 1,938 3.61% 1,938 3.61%
------- ------- ------- -------- --------
Total book value
of investment
securities........... $ 5 13.49% $ 2,808 8.61% $ 4,365 6.09% $196,511 5.44% 203,689 5.49%
======= ======= ======== ======== --------
Unrealized holding
gain on securities
available for sale.. 4,383
--------
Total investment in
securities available
for sale (4)........ $208,072 5.38%
========
- --------------------
(1) Yields include adjustments for tax-exempt income; yields do not reflect
changes in fair value that are reflected as a separate component of
stockholders' equity (except as noted in (4) below).
(2) Based on amortized cost/book value.
(3) Maturities of mortgage-backed securities and collateralized mortgage
obligations ("CMOs") are based on contractual maturities. Actual maturities
may vary because obligors may have the right to call or prepay obligations
with or without call or prepayment penalties.
(4) Yield reflects changes in fair value that are reflected as a separate
component of stockholders' equity.
As of December 31, 2002, we had $208.1 million of available-for-sale securities
in the investment portfolio as compared to $211.8 and $253.6 million at December
31, 2001 and 2000, respectively, based on fair value of the securities on those
dates. In the process of carrying out the portfolio management process objective
to purchase securities and combinations of securities with good economic
risk/reward characteristics, we increased U.S. government agency mortgage-backed
securities, U.S. government agency securities and state and municipal bonds by
$5.6 million, $708,000 and $11.3 million, respectively and decreased CMOs and
corporate debt securities by $12.8 and $8.6 million, respectively. The $8.6
million reduction in corporate debt securities during 2002 allowed us to better
manage our risk-based capital ratios as such securities are risk-weighted at 100
percent for risk-based capital purposes. Given our earnings in the 2002 third
and fourth quarters, and the forecasted level of future earnings, we increased
our holdings of state and municipal bonds by $11.3 million in order to increase
our level of tax-exempt income in the future. In addition to the role state and
municipal bonds play in managing our tax position, state and municipal bonds
offer an attractive risk/reward profile particularly when considered in
combination with other securities in the portfolio.
In addition, during 2002, mortgage rates declined to their lowest levels in
decades. This decrease in mortgage rates increased the level of mortgage
refinancing and prepayments for U.S. government agency mortgage-backed
securities and CMOs. The ongoing portfolio management process and individual
security risk/reward analysis described above led to the sale of individual
securities whose forward-looking risk/reward profiles given the lower interest
rate and increased prepayment environment were inferior to other securities
available for purchase. This analysis and ongoing management of the portfolio's
forward looking risk/reward profile resulted in transactions that generated net
realized securities gains of $1.9 million during 2002. We cannot guarantee our
ability to generate realized gains in the future such as those recognized during
the most recent year given the current absolute low level of interest rates. In
the future, the risk/reward management process may require us to recognize net
realized losses in order to optimize the forward-looking profile of the
portfolio.
As part of the strategic shift in the earning asset mix from investment
securities to loans in 2001, we decreased our holdings in CMOs, corporate bonds
and state and municipal bonds by $28.1, $7.3 and $3.4 million, respectively.
In addition, as a result of 475 basis points of monetary easing over the course
of 2001, the yield curve experienced a significant downward shift and increase
in slope relative to 2000. The ongoing portfolio management process and
individual security risk/reward analysis described above led to the sale of
individual securities whose forward-looking risk/reward profile given various
interest rate scenarios was inferior to other securities available for purchase.
The need to optimize the risk/reward profile of the portfolio as a whole in
addition to the reduction in the portfolio size as more earning assets were
shifted to loans resulted in transactions that generated net realized securities
gains of $1.4 million. We cannot guarantee our ability to generate realized
gains in the future such as those recognized during the most recent two years
given the current absolute low level of interest rates. In the future, the
risk/reward management process may require us to recognize net realized losses
in order to optimize the forward-looking profile of the portfolio.
During 2000, we had increased our holdings in CMOs, U.S. government agency
mortgage-backed securities and corporate bonds by $70.4, $18.2 and $17.9
million, respectively as part of our strategy to increase our earning asset
portfolio by purchasing investment securities primarily funded through FHLB
borrowings. The portfolio management process, investment objectives, and
risk/reward analysis described above led the increase in the investment
portfolio to be over-weighted toward CMOs due to their risk/reward
characteristics. In addition, over the course of 2000, principal cash flows were
primarily reinvested in CMOs because they offered a better risk/reward profile
(due to the structure of the CMO cash flows) relative to mortgage-backed
securities.
At December 31, 2002, we held no securities of any single issuer, other than
U.S. government agency securities and agency mortgage-backed securities and
CMOs, that exceeded ten percent of stockholders' equity. A significant portion
of our investment securities portfolio (approximately 85 percent at December 31,
2002) was pledged as collateral for public deposits and borrowings, including
borrowings with the FHLB.
Federal Reserve Bank and Federal Home Loan Bank Stock. Our equity securities
consisted of $1.2 million, $849,000 and $759,000 of Federal Reserve Bank ("FRB")
stock at December 31, 2002, 2001 and 2000, respectively and $5.8, $6.5 and $8.9
million of FHLB stock at December 31, 2002, 2001 and 2000, respectively. Our
holdings in FRB stock have increased due to the amount of capital stock issued
by the Bank. Our holdings in FHLB stock fluctuate due to the level of FHLB
advances outstanding. From 2000 to 2002, our investment in FHLB stock has
decreased as we reduced our usage of FHLB advances.
Loan Portfolio. The banking segment's primary source of income is interest
earned on loans. Net loans increased $37.2 million, or 13 percent, to $330.8
million at December 31, 2002 as compared to $293.6 million at December 31, 2001.
In 2001, net loans increased $44.4 million, or 18 percent, as compared to
December 31, 2000. The following table presents the composition of our loan
portfolio as of the dates indicated:
Loan Portfolio Composition (1)
December 31,
-------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
---------------- ---------------- ----------------- ---------------- ----------------
Amount % Amount % Amount % Amount % Amount %
-------- ------- -------- ------- -------- -------- -------- ------- -------- -------
(dollars in thousands)
Commercial and
industrial ........... $ 94,075 28.4 $103,883 35.4 $109,335 43.9 $108,593 43.2 $107,886 44.2
Real estate mortgage... 147,825 44.7 123,727 42.1 85,082 34.1 88,251 35.1 76,692 31.4
Real estate
construction.......... 62,926 19.0 34,225 11.7 21,879 8.8 15,684 6.3 20,831 8.5
Agricultural........... 18,023 5.5 19,069 6.5 15,016 6.0 15,906 6.3 19,777 8.1
Consumer/other......... 8,227 2.5 9,953 3.4 11,552 4.6 14,559 5.8 14,761 6.1
Lease financing........ 5,584 1.7 7,578 2.6 10,154 4.1 11,214 4.5 7,422 3.0
-------- ------- -------- ------- -------- -------- -------- ------- -------- -------
Total principal
amount of loans....... 336,660 101.8 298,435 101.7 253,018 101.5 254,207 101.2 247,369 101.3
Unearned income and
net unamortized
deferred fees and
costs................. (866) (0.3) (511) (0.2) (265) (0.1) (198) (0.1) (188) (0.1)
-------- ------- -------- ------- -------- -------- -------- ------- -------- -------
Loans, net of
unearned income
and unamortized
fees and costs......... 335,794 101.5 297,924 101.5 252,753 101.4 254,009 101.1 247,181 101.2
Less allowance for
credit losses......... (5,006) (1.5) (4,325) (1.5) (3,588) (1.4) (2,872) (1.1) (2,854) (1.2)
-------- ------- -------- ------- -------- -------- -------- ------- -------- -------
Net loans........... $330,788 100.00 $293,599 100.00 $249,165 100.00 $251,137 100.0 $244,327 100.0
======== ======= ======== ======= ======== ======== ======== ======= ======== =======
- ---------------------
(1) From continuing operations for all periods presented.
The following table presents, for the periods indicated, the amount and percent
of change in each category of loans in our loan portfolio. Significant changes
are discussed in lettered explanations below the table:
Change in Loan Portfolio Composition (1)
Increase (Decrease)
-----------------------------------------------
2002 - 2001 2001 - 2000
---------------------- ---------------------
$ % $ %
----------- --------- ---------- ---------
(dollars in thousands)
Commercial and industrial..... $ (9,808) (9)% $ (5,452) (5)% (a)
Real estate mortgage.......... 24,098 19% 38,645 45% (b)
Real estate construction...... 28,701 84% 12,346 56% (c)
Agricultural.................. (1,046) (5)% 4,053 27%
Consumer/other................ (1,726) (17)% (1,599) (14)%
Lease financing............... (1,994) (26)% (2,576) (25)%
----------- ----------
Total principal amount of
loans....................... 38,225 13% 45,417 18%
Unearned income/unamortized
fees and costs.............. (355) (69)% (246) (93)%
----------- ----------
Loans, net of unearned
income/unamortized fees
and costs................ 37,870 13% 45,171 18%
Allowance for credit losses (681) (16)% (737) (21)%
----------- ----------
Net Loans.................. $ 37,189 13% $ 44,434 18% (d)
=========== ==========
- --------------------
(1) From continuing operations for all periods presented.
(a) Commercial and industrial loans. In addition to general pay-down of loans
in the ordinary course of business, the decreases in 2002 and 2001 are
attributable to a number of commercial loan pay-offs in the portfolio of a
former loan officer operating in the Minneapolis market.
(b) Real estate mortgage loans. The increase in 2002 is attributable to
continued commercial real estate loan growth primarily in the Arizona and
Minnesota markets. The increase in 2001 is attributable to commercial real
estate loan volume generated out of the Arizona, Minnesota and North Dakota
markets.
(c) Real estate construction loans. The increase in 2002 is attributable to
continued commercial real estate construction loan growth primarily in the
Arizona and Minnesota markets. The increase in 2001 is also attributable to
real estate construction loans generated primarily in the Arizona and
Minnesota markets.
(d) Net loans. During 2002, we increased net loans $37.2 million or 13 percent.
We were able to fund these loans primarily due to deposit growth
originating from the Arizona and Minnesota markets. During 2001, we
increased our net loans $44.4 million or 18 percent as part of a strategic
shift in the earning asset mix from investment securities to loans,
primarily commercial real estate and construction loans.
While prospects for continued loan growth appear favorable in some of our
markets, future loan growth potential is subject to volatility. Our loan
portfolio is concentrated in commercial, industrial and real estate loans and we
have credit concentrations in certain industries (see "-Concentrations of
Credit") and certain geographical concentrations that relate to our primary
market areas. A downturn in certain sectors of the economy could adversely
impact our borrowers. This could, in turn, reduce the demand for loans and
impact the borrowers' abilities to repay their loans, while also decreasing our
net interest margin. Taking a conservative posture relative to credit
underwriting, we believe, is a prudent course of action, especially during
slowing economic times. We believe it is in our best interest and in the
interest of our shareholders to focus attention on our quality customer
relationships and to avoid growth in other than high-quality credit during these
uncertain times. We cannot predict with any degree of certainty the full impact
of current or future economic conditions on our ability to generate loan volume
or the ultimate impact of economic conditions on our currently existing
portfolio of loans. See "Factors That May Affect Future Results of Operations"
included under Item 1 of Part I.
Credit Policy, Underwriting, Approval and Review Procedures. We follow a uniform
credit policy that sets forth underwriting and loan administration criteria. The
Board of Directors (the "Board") establishes our loan policy, including lending
guidelines for the various types of credit we offer based upon the
recommendations of senior lending management. Credit committees may be
established at either the Bank or corporate level. Our loan policy is reviewed
and reaffirmed by the Board at least annually.
We delegate lending decision authority among various lending officers and the
credit committees based on the size of the customer's credit relationship with
BNC. All loans and commitments approved in excess of $300,000 are presented to
the Board on a quarterly basis for summary review. Any exceptions to loan
policies and guidelines, to the extent the credit relationship amount exceeds
individual loan officer lending authorities, are subject to special approval by
the Bank's Chief Credit Officer or the appropriate credit committee.
Underwriting criteria are based upon the risks associated with each type of
credit offered, the related borrowers and types of collateral. In underwriting
commercial loans, we emphasize the borrower's earnings history, capitalization
and secondary sources of repayment. In most instances, we require third party
guarantees or highly liquid collateral.
Our credit administration function includes an internal loan review department
that reviews established levels of our loan portfolio on a continuous basis.
Loan review personnel are not involved in any way in the credit underwriting or
approval process. Additionally, our lenders, loan review staff, Chief Credit
Officer, loan committees and various management team members review
credit-related information monthly. Such information includes, but may not be
limited to, delinquencies, classified and nonperforming assets, and other
information, in order to evaluate credit risk within our credit portfolio and to
review and establish the adequacy of the allowance for credit losses.
Loan Participations. Pursuant to our lending policy, loans may not exceed 85
percent of the Bank's legal lending limit (except to the extent collateralized
by U.S. Treasury securities or Bank deposits and, accordingly, excluded from the
Bank's legal lending limit). To accommodate customers whose financing needs
exceed lending limits and internal loan restrictions relating primarily to
industry concentration, the Bank sells loan participations to outside
participants without recourse. Loan participations sold on a nonrecourse basis
to outside financial institutions were as follows as of the dates indicated:
Loan Participations Sold (1)
December 31,
-----------------------------------
(in thousands)
2002........... 173,895
2001........... 208,975
2000........... 187,773
1999........... 118,463
1998........... 56,700
- ----------------------
(1) From continuing operations for all periods presented.
The Bank generally retains the right to service the loans as well as the right
to receive a portion of the interest income on the loans. Many of the loans sold
by the Bank are commercial lines of credit for which balances and related
payment streams cannot be reasonably estimated in order to determine the fair
value of the servicing rights and/or future interest income retained by the
Bank. We cannot reliably predict our ability to continue to generate or sell
loan participations in future periods or the terms of any such sales.
Concentrations of Credit. Our credit policies emphasize diversification of risk
among industries, geographic areas and borrowers. For purposes of the analysis
of concentrations of credit as of December 31, 2002 the total outstanding loans
as well as all outstanding loan commitments were included. As of December 31,
2002, we identified three concentrations of loans exceeding ten percent of total
loans and loan commitments outstanding. These concentrations were in real
estate, construction and lodging places, which represented 26.7, 15.8 and 11.7
percent, respectively, of total loans and loan commitments outstanding.
The real estate loans and commitments were extended to 138 customers who are
diversified across our market areas and who can be generally categorized as
indicated below:
Percent of total
outstanding
Number of loans and loan
customers commitments
------------- --------------
Non-residential and apartment
building operators,
developers and lessors of
real property.................... 75 17.8%
Real estate holding companies...... 63 8.9%
------------- --------------
Total......................... 138 26.7%
============= ==============
Loans and commitments in the construction category were extended to 58 customers
who are located primarily in Minnesota, Iowa, North Dakota and South Dakota and
who can be generally categorized as indicated below:
Percent of total
outstanding
Number of loans and loan
customers commitments
-------------- --------------
General building contractors....... 30 13.6%
Heavy construction, excluding
building......................... 10 .8%
Special trade contractors.......... 18 1.4%
------------- --------------
Total......................... 58 15.8%
============= ==============
The contractors are involved in various aspects of the construction industry,
including highway and street construction, water/sewer drilling, plumbing,
heating and air conditioning, commercial painting, electrical, concrete and
excavating and foundation contractors. Loans in this category are secured, in
many cases, by construction equipment.
The lodging loans and commitments were extended to 18 customers whose properties
are located throughout the United States. Loans in this category are made
primarily to borrowers that have seasoned hotel portfolios and that are well
diversified by location, property type and chain.
We continually monitor industry and other credit concentrations as part of our
credit risk management strategies. In cases where significant concentrations
exist without sufficient diversification and other mitigating factors, we
generally sell loans without recourse to outside financial institutions (see
"-Loan Participations").
Agricultural Loans. Our agricultural loan portfolio totals approximately $18.0
million, or 5.5 percent of total loans. Within the portfolio, loans are
diversified by type and include loans to grain and/or livestock producers,
agricultural real estate loans, machinery and equipment and other types of
loans. The majority of our agricultural loans are extended to borrowers located
in North Dakota, and are diversified over several counties. As of December 31,
2002, there were no agricultural loans classified as nonperforming.
Loan Maturities. The following table sets forth the remaining maturities of
loans in each major category of our portfolio as of December 31, 2002. Actual
maturities may differ from the contractual maturities shown below as a result of
renewals and prepayments. Loan renewals are evaluated in the same manner as new
credit applications:
Maturities of Loans (1)
Over 1 year
through 5 years Over 5 years
------------------- ------------------
One
year Fixed Floating Fixed Floating
or less rate rate rate rate Total
--------- -------- --------- --------- -------- ---------
(in thousands)
Commercial and
industrial.............. $ 65,493 $ 11,248 $ 14,388 $ 2,158 $ 788 $ 94,075
Real estate mortgage...... 40,402 16,947 51,331 19,701 19,444 147,825
Real estate construction.. 48,557 1,895 12,474 -- -- 62,926
Agricultural.............. 10,159 2,981 2,298 418 2,167 18,023
Consumer/other............ 4,412 2,942 625 248 -- 8,227
Lease financing........... 646 4,938 -- -- -- 5,584
--------- -------- --------- --------- -------- ---------
Total principal amount of
loans................... $ 169,669 $ 40,951 $ 81,116 $ 22,525 $ 22,399 $ 336,660
========= ======== ========= ========= ======== =========
- --------------------
(1) Maturities are based upon contractual maturities. Floating rate loans
include loans that would reprice prior to maturity if base rates change.
See Item 7A, "Quantitative and Qualitative Disclosures about Market Risk,"
for further discussion regarding repricing of loans and other assets.
Interest Rate Caps and Floors. From time to time we may use off-balance-sheet
instruments, principally interest rate caps and floors, to adjust the interest
rate sensitivity of on-balance-sheet items, including loans. At January 1, 2001,
we had an interest rate floor contract that qualified as a cash flow hedge of
interest rate risk associated with floating rate commercial loans under SFAS
133. The floor contract was sold during 2001. See -"Liquidity, Market and Credit
Risk," Item 7A, "Quantitative and Qualitative Disclosures about Market Risk,"
and Notes 1 and 17 to the Consolidated Financial Statements included under Item
8 for further discussion about accounting policies applicable to derivative
financial instruments and currently outstanding instruments.
Nonperforming Loans and Assets. Nonperforming loans consists of loans 90 days or
more delinquent and still accruing interest, nonaccrual and restructured loans.
Other nonperforming assets includes other real estate owned and repossessed
assets. Our lending personnel are responsible for continuous monitoring of the
quality of the loan portfolio. Officers are expected to maintain loan quality
and deal with credit issues in a timely and proactive manner. Loan officers are
responsible for regular reviews of past due loans in their respective
portfolios. The loan portfolio is also monitored regularly and examined by our
loan review personnel. Loans demonstrating weaknesses are downgraded in a timely
fashion and the Board receives a listing of all such loans on a quarterly basis.
The following table sets forth, as of the dates indicated, the amounts of
nonperforming loans and other assets, the allowance for credit losses and
certain related ratios:
Nonperforming Assets (1)
December 31,
------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
(dollars in thousands)
Nonperforming loans:
Loans 90 days or more delinquent
and still accruing interest.... $ 5,081 $ 983 $ 221 $ 22 $ 307
Nonaccrual loans (2) (3)......... 2,549 3,391 343 1,620 2,042
Restructured loans (2) (3)....... -- 5 16 16 44
-------- -------- -------- -------- --------
Total nonperforming loans..... 7,630 4,379 580 1,658 2,393
Other real estate owned and
repossessed assets............. 8 70 84 1,207 2,112
-------- -------- -------- -------- --------
Total nonperforming assets.... $ 7,638 $ 4,449 $ 664 $ 2,865 $ 4,505
======== ======== ======== ======== ========
Allowance for credit losses......... $ 5,006 $ 4,325 $ 3,588 $ 2,872 $ 2,854
======== ======== ======== ======== ========
Ratio of total nonperforming loans
to total loans...................... 2.27% 1.47% .23% .65% .97%
Ratio of total nonperforming assets
to total assets..................... 1.27% .80% .12% .64% 1.21%
Ratio of allowance to nonperforming
loans............................... 66% 99% 619% 173% 119%
- --------------------
(1) From continuing operations for all periods presented.
(2) If the Company's nonaccrual and restructured loans had been current in
accordance with their original terms, we would have recognized additional
interest income of $236,000, $84,000, $29,000, $112,000 and $49,000 for the
years ended December 31, 2002, 2001, 2000, 1999 and 1998, respectively.
(3) The interest income on nonaccrual and restructured loans actually included
in our net income was $1,000, $3,000, $6,000, $29,000 and $175,000 for the
years ended December 31, 2002, 2001, 2000, 1999 and 1998, respectively.
Loans 90 days or more delinquent and still accruing interest include loans over
90 days past due which we believe, based on our specific analysis of the loans,
do not present doubt about the collection of interest and principal in
accordance with the loan contract. Loans in this category must be well secured
and in the process of collection. Our lending and management personnel monitor
these loans closely. Included in this category at December 31, 2002 was a $5.0
million loan which was past due 91 days and still accruing interest. See further
discussion of this credit below.
Nonaccrual loans include loans on which the accrual of interest has been
discontinued. Accrual of interest is discontinued when we believe, after
considering economic and business conditions and collection efforts, that the
borrower's financial condition is such that the collection of interest is
doubtful. A delinquent loan is generally placed on nonaccrual status when it
becomes 90 days or more past due unless the loan is well-secured and in the
process of collection. When a loan is placed on nonaccrual status, accrued but
uncollected interest income applicable to the current reporting period is
reversed against interest income of the current period. Accrued but uncollected
interest income applicable to previous reporting periods is charged against the
allowance for credit losses. No additional interest is accrued on the loan
balance until the collection of both principal and interest becomes reasonably
certain. When a problem loan is finally resolved, there may ultimately be an
actual write down or charge-off of the principal balance of the loan which may
necessitate additional charges to earnings. Of the $2.5 million of loans
included in the nonaccrual loan category at December 31, 2002, $2.3 million
relates to two commercial customers. One of these relationships, with total
outstanding loans of $528,000, is partially guaranteed by the Small Business
Administration.
Restructured loans are those for which concessions, including a reduction of the
interest rate or the deferral of interest or principal, have been granted due to
the borrower's weakened financial condition. Interest on restructured loans is
accrued at the restructured rates when it is anticipated that no loss of
original principal will occur. We had no restructured loans in our portfolio at
December 31, 2002.
Other real estate owned and repossessed assets represents properties and other
assets acquired through, or in lieu of, loan foreclosure. Such properties and
assets are included in other assets in the consolidated balance sheets. They are
initially recorded at fair value at the date of acquisition establishing a new
cost basis. Write-downs to fair value at the time of acquisition are charged to
the allowance for credit losses. After foreclosure, we perform valuations
periodically and the real estate or assets are carried at the lower of carrying
amount or fair value less cost to sell. Write-downs, revenues and expenses
incurred subsequent to foreclosure are charged to operations as
recognized/incurred.
Our ratios of total nonperforming loans to total loans and total nonperforming
assets to total assets increased between December 31, 2001 and December 31,
2002. The ratio of the allowance for credit losses to nonperforming loans
decreased between December 31, 2001 and December 31, 2002. This ratio at
December 31, 2002 was 66 percent as compared to 99 percent at December 31, 2001.
This decrease (and the increase in the other asset quality ratios mentioned
above) is primarily attributable to the $5.0 million commercial credit in the
category loans past due 90 days and still accruing interest at December 31,
2002. Subsequent to December 31, 2002, this loan was placed on nonaccrual;
however, at December 31, 2002, and currently, based on the most current
appraisal of the property, the loan appears to be sufficiently collateralized.
Based on appraised value combined with additional guarantor support, we expect
to collect the full principal balance outstanding. On April 24, 2003, the
Company expects to take title of the property and will thereafter begin the
process of selling the property. Allowing for timing required for full
resolution of the credit, we feel that the amount of the allowance for credit
losses allocated to this loan is sufficient given the facts and circumstances
surrounding the status of the credit both at December 31, 2002 and at present.
Without this credit in the nonperforming category, the ratio of the allowance
for credit losses to nonperforming loans at December 31, 2002 would have been
190 percent.
Potential Problem Loans. In accordance with accounting standards, we identify
loans considered impaired and the valuation allowance attributable to these
loans. Impaired loans generally include loans on which we believe, based on
current information and events, it is probable that we will not be able to
collect all amounts due in accordance with the terms of the loan agreement and
which are analyzed for a specific reserve allowance. We generally consider all
loans risk-graded substandard and doubtful as well as nonaccrual and
restructured loans as impaired. Impaired loans at December 31, 2002, not
including the past due, nonaccrual and restructured loans reported above,
totaled $5.8 million. A significant portion of these loans are not in default
but may have characteristics such as recent adverse operating cash flows or
general risk characteristics that the loan officer feels might jeopardize the
future timely collection of principal and interest payments. The ultimate
resolution of these credits is subject to changes in economic conditions and
other factors. These loans are closely monitored to ensure that our position as
creditor is protected to the fullest extent possible.
Allowance for Credit Losses. Credit risk is the risk of loss from a customer
default. We have in place a process to identify and manage our credit risk. The
process includes initial credit review and approval, periodic monitoring to
measure compliance with credit agreements and internal credit policies, internal
credit review, monitoring changes in the risk ratings of loans and leases,
identification of problem loans and leases and special procedures for collection
of problem loans and leases. The risk of loss is difficult to quantify and is
subject to fluctuations in values and general economic conditions and other
factors. As discussed previously, the determination of the allowance for credit
losses is a critical accounting policy, which involves estimates and our
judgment on a number of factors such as net charge-offs, delinquencies in the
loan and lease portfolio and general and economic conditions. We consider the
allowance for credit losses of $5.0 million adequate to cover losses inherent in
the loan and lease portfolio as of December 31, 2002. However, no assurance can
be given that we will not, in any particular period, sustain loan and lease
losses that are sizable in relation to the amount reserved, or that subsequent
evaluations of the loan and lease portfolio, in light of factors then
prevailing, including economic conditions and our ongoing credit review process,
will not require significant increases in the allowance for credit losses. A
protracted economic slowdown and/or a decline in commercial, industrial or real
estate segments may have an adverse impact on the adequacy of the allowance for
credit losses by increasing credit risk and the risk of potential loss. See
Notes 1 and 7 to the Consolidated Financial Statements included under Item 8 and
"-Critical Accounting Policies" for further information concerning accounting
policies associated with the allowance for credit losses.
We maintain our allowance for credit losses at a level considered adequate to
provide for an estimate of probable losses related to specifically identified
loans as well as probable losses in the remaining loan and lease portfolio that
have been incurred as of each balance sheet date. The loan and lease portfolio
and other credit exposures are reviewed regularly to evaluate the adequacy of
the allowance for credit losses. In determining the level of the allowance, we
evaluate the allowance necessary for specific nonperforming loans and also
estimate losses in other credit exposures. The resultant three allowance
components are specific reserves, reserves for homogeneous loan pools and a
qualitative reserve. These components are fully described under "Critical
Accounting Policies."
Continuous credit monitoring processes and the analysis of loss components is
the principal method we rely upon to ensure that changes in estimated credit
loss levels are reflected in our allowance for credit losses on a timely basis.
We also consider experience of peer institutions and regulatory guidance in
addition to our own experience.
Loans, leases and other extensions of credit deemed uncollectible are charged to
the allowance. Subsequent recoveries, if any, are credited to the allowance. The
amount of the allowance for credit losses is highly dependent upon our estimates
of variables affecting valuation, appraisals of collateral, evaluations of
performance and status, and the amounts and timing of future cash flows expected
to be received on impaired loans. Such estimates, appraisals, evaluations and
cash flows may be subject to frequent adjustments due to changing economic
prospects of borrowers, lessees or properties. These estimates are reviewed
periodically. Actual losses may vary from current estimates and the amount of
the provision may be either greater than or less than actual net charge-offs.
The related provision for credit losses, which is charged to income, is the
amount necessary to adjust the allowance to the level determined appropriate
through the application of the above processes and those discussed below in the
"Critical Accounting Policies" section.
At year end 2002, our total allowance was $5.0 million which equates to
approximately 5.6 and 4.6 times the average charge-offs for the last three and
five years, respectively, and 7.6 and 5.7 times the average net charge-offs for
the same three-and five-year periods, respectively. Because historical
charge-offs are not necessarily indicative of future charge-off levels, we also
give consideration to other risk indicators when determining the appropriate
allowance level. Those risk factors have been summarized above. Our charge-off
policy is generally consistent with regulatory standards.
Our Chief Credit Officer and Vice President-Internal Audit/Credit Review have
the primary responsibility of affirming our systematic allowance methodology,
performing credit loss migration analyses and assessing the allowance components
in relation to estimated and actual charge-off trends. This analysis is
presented to members of management who are responsible for assessing and
reporting on the appropriateness of the allowance for credit losses as well as
recommending revisions to our methodology for determining the adequacy of the
allowance as they become necessary.
Concentrations of credit risk are discussed under "-Concentrations of Credit."
Concentrations exist in real estate, construction and lodging places loans and
commitments. Additionally, a geographic concentration of credit risk also arises
because we have historically operated primarily in the upper Midwest with 69
percent of loans outstanding as of December 31, 2002 having been extended to
customers in Minnesota, North Dakota and South Dakota. As of December 31, 2002,
26 percent of our loans had been extended to customers in Arizona. Other groups
of credit risk may not constitute a significant concentration, but are analyzed
based on other evident risk factors for the purpose of determining an adequate
allowance level.
Nonperforming and potential problem loans are defined and discussed under
"-Nonperforming Loans and Assets" and "-Potential Problem Loans." Many of these
loans are specifically analyzed for purposes of determining the adequacy of the
allowance for credit losses.
Estimating the risk and amount of loss on any loan is subjective and ultimate
losses may vary from current estimates. Although we believe that the allowance
for credit losses is adequate to cover probable losses in the loan and lease
portfolio, there can be no assurance that the allowance will prove sufficient to
cover actual credit losses in the future. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the adequacy of our allowance for credit losses. Such agencies may require us to
make additional provisions to the allowance based upon their judgments about
information available to them at the time of their examination.
The following table summarizes, for the periods indicated, activity in the
allowance for credit losses, including amounts of loans charged-off, amounts of
recoveries, additions to the allowance charged to operating expense, the ratio
of net charge-offs to average total loans, the ratio of the allowance to total
loans at the end of each period and the ratio of the allowance to nonperforming
loans:
Analysis of Allowance for Credit Losses (1)
For the Years ended December 31,
---------------------------- -------- --------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
(dollars in thousands)
Balance of allowance for credit
losses, beginning of period.......... $ 4,325 $ 3,588 $ 2,872 $ 2,854 $ 2,919
-------- -------- -------- -------- --------
Charge-offs:
Commercial and industrial.......... 408 542 574 1,090 1,316
Real estate mortgage............... 9 99 58 10 66
Agricultural....................... -- -- 16 35 --
Consumer/other..................... 75 213 39 137 73
Lease financing.................... 165 411 68 18 --
-------- -------- -------- -------- --------
Total charge-offs............... 657 1,265 755 1,290 1,455
-------- -------- -------- -------- --------
Recoveries:
Commercial and industrial.......... 86 140 100 86 151
Real estate mortgage............... 8 30 96 1 26
Agricultural....................... 4 1 33 -- --
Consumer/other..................... 11 132 25 71 12
Lease financing.................... 27 -- 15 12 --
-------- -------- -------- -------- --------
Total recoveries................ 136 303 269 170 189
-------- -------- -------- -------- --------
Net charge-offs....................... (521) (962) (486) (1,120) (1,266)
Provision for credit losses charged
to operations........................ 1,202 1,699 1,202 1,138 1,201
-------- -------- -------- -------- --------
Balance of allowance for credit
losses, end of period................ $ 5,006 $ 4,325 $ 3,588 $ 2,872 $ 2,854
======== ======== ======== ======== ========
Ratio of net charge-offs to average
loans............................... (.17%) (.33%) (.20%) (.46%) (.54%)
======== ======== ======== ======== ========
Average gross loans outstanding
during the period.................... $307,227 $293,716 $244,526 $246,148 $234,342
======== ======== ======== ======== ========
Ratio of allowance for credit losses
to total loans....................... 1.49% 1.45% 1.42% 1.13% 1.15%
======== ======== ======== ======== ========
Ratio of allowance for credit losses
to nonperforming loans............... 66% 99% 619% 173% 119%
======== ======== ======== ======== ========
- --------------------------
(1) From continuing operations for all periods presented.
Our ratio of allowance for credit losses to nonperforming loans decreased from
99 percent at December 31, 2001 to 66 percent at December 31, 2002. See
"-Nonperforming Loans and Assets" for a discussion of the specific loan
responsible for this decrease and the facts and circumstances surrounding the
status of the loan.
The table below presents, for the periods indicated, an allocation of the
allowance for credit losses among the various loan categories and sets forth the
percentage of loans in each category to gross loans. The allocation of the
allowance for credit losses as shown in the table should neither be interpreted
as an indication of future charge-offs, nor as an indication that charge-offs in
future periods will necessarily occur in these amounts or in the indicated
proportions.
Allocation of the Allowance for Loan Losses (1)
December 31,
-------------------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------------------- ---------------------- ---------------------- ---------------------- ----------------------
Loans in Loans in Loans in Loans in Loans in
category as a category as a category as a category as a category as a
Amount percentage Amount percentage Amount percentage Amount percentage Amount percentage
of of total of of total of of total of of total of of total
Allowance gross loans Allowance gross loans Allowance gross loans Allowance gross loans Allowance gross loans
--------- ------------- --------- ------------ --------- ------------ --------- ----------- --------- -------------
(dollars in thousands)
Commercial
and
industrial....$ 2,344 28% $ 2,586 34% $ 2,066 42% $ 1,356 43% $ 1,155 44%
Real estate
mortgage...... 1,836 44% 1,038 42% 702 34% 712 35% 667 31%
Real estate
construction... 398 19% 137 11% 112 10% 151 6% 129 8%
Agricultural... 231 5% 267 6% 342 6% 220 6% 252 8%
Consumer/other. 85 2% 118 5% 128 5% 138 6% 217 6%
Lease
financing..... 112 2% 179 2% 145 3% 88 4% 133 3%
Unallocated.... -- 0% -- 0% 93 0% 207 0% 301 0%
--------- ------------- --------- ------------ --------- ------------ --------- ----------- --------- -----------
Total..........$ 5,006 100% $ 4,325 100% $ 3,588 100% $ 2,872 100% $ 2,854 100%
========= ============= ========= ============ ========= ============ ========= =========== ========= ===========
- -----------------------
(1) From continuing operations for all periods presented.
Deposits. Our core deposits consist of noninterest- and interest-bearing demand
deposits, savings deposits, money market deposit accounts, certificates of
deposit under $100,000, certain certificates of deposit of $100,000 and over and
public funds. Total deposits were $398.2 million at December 31, 2002 compared
with $375.3 and $330.9 million at December 31, 2001 and 2000, respectively. We
use these deposits, along with other borrowed funds, to support our asset base.
The following table sets forth, for the periods indicated, the distribution of
our average deposit account balances and average cost of funds rates on each
category of deposits. See "Results of Operations-Net Interest Income" for an
explanation of changes in deposit volume and costs during the periods presented:
Average Deposits and Deposit Costs (1)
For the Years Ended December 31,
-------------------------------------------------------------------------------
2002 2001 2000
------------------------ ------------------------- --------------------------
Percent Wgtd. Percent Wgtd. Percent Wgtd.
Average of avg. Average of avg. Average of avg.
balance deposits rate balance deposits rate balance deposits rate
-------- -------- ----- -------- -------- ----- -------- -------- ------
(dollars in thousands)
Interest checking and
MMDAs................ $174,108 44.51% 1.64% $147,775 41.92% 3.16% $130,007 40.98% 5.37%
Savings deposits...... 4,511 1.15% 0.86% 3,758 1.07% 1.49% 4,042 1.27% 2.08%
Time deposits (CDs):
CDs under $100,000.... 104,964 26.83% 3.88% 98,639 27.99% 5.35% 101,624 32.04% 5.68%
CDs $100,000 and over. 73,639 18.83% 4.46% 73,806 20.94% 5.76% 54,592 17.21% 5.98%
-------- -------- -------- -------- -------- --------
Total time deposits... 178,603 45.66% 4.12% 172,445 48.93% 5.52% 156,216 49.25% 5.78%
-------- -------- -------- -------- -------- --------
Total interest-bearing
deposits.............. 357,222 91.32% 2.87% 323,978 91.92% 4.40% 290,265 91.50% 5.52%
Noninterest-bearing
demand deposits..... 33,951 8.68% -- 28,474 8.08% -- 26,953 8.50% --
-------- -------- -------- -------- -------- --------
Total deposits........ $391,173 100.00% 2.62% $352,452 100.00% 4.04% $317,218 100.0% 5.07%
======== ======== ======== ======== ======== ========
- --------------------
(1) From continuing operations for all periods presented.
At times earning asset growth can outpace core deposit growth resulting in the
use of brokered and out of market certificates of deposit and other borrowed
funds. See "-Borrowed Funds." This trend has been common in the banking industry
because of the proliferation of non-bank competitors and the multitude of
financial and investment products available to customers as well as the need to
utilize such funds in the process of our overall balance sheet management. At
times, access to brokered and out of market deposits is available at maturities
and rates more favorable than those available in our local markets. As of
December 31, 2002, we held a total of $27.3 million of national market
certificates of deposit and $31.4 million of certificates of deposit acquired
through brokers. Under current FDIC regulations, only "well capitalized"
financial institutions may fund themselves with brokered deposits without prior
approval of regulators. Our Bank was well capitalized at December 31, 2002. See
"Capital Resources and Expenditures" and Note 18 to the Consolidated Financial
Statements included under Item 8 for a summary of the capital status of the
Bank.
Time deposits in denominations of $100,000 and more totaled $64.9 million at
December 31, 2002 as compared to $79.0 and $59.1 million at December 31, 2001
and 2000, respectively. The following table sets forth the amount and maturities
of time deposits of $100,000 or more as of December 31, 2002:
Time Deposits of $100,000 and Over
(in thousands)
Maturing in:
3 months or less.................... $ 9,655
Over 3 months through 6 months...... 11,725
Over 6 months through 12 months..... 15,797
Over 12 months...................... 27,728
----------
Total............................ $ 64,905
==========
Borrowed Funds. We use short-term borrowings, FHLB advances and long-term
borrowings to support our asset base. Short-term borrowings include Federal
funds purchased and U.S. Treasury tax and loan note option accounts and
securities sold under agreements to repurchase. At December 31, 2002, short-term
borrowings were $28.1 million compared to $760,000 at December 31, 2001 and
$33.2 million at December 31, 2000.
The following table provides a summary of our short-term borrowings and related
cost information as of, or for the periods ended, December 31:
Short-Term Borrowings (1)
2002 2001 2000
-------- -------- --------
(dollars in thousands)
Short-term borrowings outstanding
at period end.................................... $28,120 $ 760 $33,228
Weighted average interest rate at period end....... 1.48% 2.53% 6.45%
Maximum month-end balance during the period........ $28,120 $39,924 $37,324
Average borrowings outstanding for the period...... $ 7,799 $10,206 $ 3,459
Weighted average interest rate for the period...... 1.81% 4.32% 6.76%
- ---------------------
(1) From continuing operations for all periods presented.
Note 11 to the Consolidated Financial Statements included under Item 8
summarizes the general terms of our short-term borrowings outstanding at
December 31, 2002 and 2001, including interest rates, maturity dates, weighted
average yields and other applicable terms.
FHLB advances totaled $97.2, $117.2 and $117.2 million at December 31, 2002,
2001 and 2000, respectively while long-term borrowings totaled $8.6 million,
$13,000 and $12.6 million, respectively, for the same periods.
Notes 12 and 13 to the Consolidated Financial Statements included under Item 8
summarize the general terms of our FHLB advances and long-term borrowings at
December 31, 2002 and 2001, including interest rates, maturity dates, weighted
average yields and other applicable terms.
During 2002, $20.0 million of our FHLB advances matured and were not replaced
due to the availability of other funding sources. Also during 2002, we incurred
$8.5 million of long-term debt in conjunction with the acquisition of Milne
Scali.
During 2001, we purchased and retired $82,000 of our 8 5/8 percent subordinated
notes due May 31, 2004 ("the Notes") at a discount using cash generated from the
sale of our asset-based lending subsidiary, BNC Financial Corporation, Inc.
which was sold on December 31, 1999. On August 31, 2001, we redeemed the
remaining $12.6 million of the Notes at par through exercise of our call option
on the Notes. The remaining $12.6 million of the Notes were redeemed using a
portion of the cash generated from the issuance of subordinated debentures
through the establishment of BNC Statutory Trust II (see "Guaranteed Preferred
Beneficial Interests in Company's Subordinated Debentures" and Note 14 to the
Consolidated Financial Statements included under Item 8 for further discussion
of our subordinated debenture issuances). The transactions and redemption of the
Notes during 2001 resulted in an extraordinary loss of $134,000 ($0.06 per
diluted share) net of income taxes of ($70,000).
Interest Rate Caps and Floors. From time to time we may use off-balance-sheet
instruments, principally interest rate caps and floors, to adjust the interest
rate sensitivity of on-balance-sheet items, including borrowings. During May and
June 2001, we purchased, for $1.2 million, interest rate cap contracts with
notional amounts totaling $40.0 million to mitigate interest rate risk in
rising-rate scenarios. The referenced interest rate is three-month LIBOR with
$20.0 million of 4.50 percent contracts having three-year original maturities
and $20.0 million of 5.50 percent contracts having five-year original
maturities. The contracts, classified as other assets, are reflected in our
December 31, 2002 consolidated balance sheet at their then combined fair value
of $136,000. The contracts are not being accounted for as hedges under SFAS 133.
As a result, the impact of marking the contracts to fair value has been, and
will continue to be, included in net interest income. During the years ended
December 31, 2002 and 2001, the impact of marking the contracts to market
(reflected in the consolidated income statements as an increase in interest
expense on borrowings) was $779,000 and $331,000, respectively. The fair value
of $136,000 as of December 31, 2002 reflects the full extent of the potential
loss on the contracts should further write downs to fair value be required. See
- -"Liquidity, Market and Credit Risk," Item 7A, "Quantitative and Qualitative
Disclosures about Market Risk," and Notes 1 and 17 to the Consolidated Financial
Statements included under Item 8 for further discussion about accounting
policies applicable to derivative financial instruments.
Guaranteed Preferred Beneficial Interests in Company's Subordinated Debentures.
In July 2000, we established a special purpose trust for the purpose of issuing
$7.5 million of fixed rate subordinated debentures. The subordinated debentures
qualify as Tier 1 capital up to certain limits with the balance qualifying as
Tier 2 capital up to certain limits. See Note 14 to the Consolidated Financial
Statements included under Item 8 for a complete description of the fixed rate
subordinated debentures.
In July 2001, we established an additional special purpose trust for the purpose
of issuing $15.0 million of floating rate subordinated debentures. The
subordinated debentures qualify as Tier 1 capital up to certain limits with the
balance qualifying as Tier 2 capital up to certain limits. We used $12.6 million
of the proceeds from the subordinated debentures issued in 2001 to retire the
remaining $12.6 million of our 8 5/8 percent subordinated notes due May 31, 2004
through the exercise of the call option on the notes. See Note 14 to the
Consolidated Financial Statements included under Item 8 for a complete
description of the floating rate subordinated debentures.
Capital Resources and Expenditures. We actively monitor compliance with bank
regulatory capital requirements, including risk-based and leverage capital
measures. Under the risk-based capital method of capital measurement, the ratio
computed is dependent on the amount and composition of assets recorded on the
balance sheet, and the amount and composition of off-balance sheet items, in
addition to the level of capital. Note 18 to the Consolidated Financial
Statements included under Item 8 includes a summary of the risk-based and
leverage capital ratios of BNCCORP and its subsidiary banks as of December 31,
2002 and 2001, including the capital ratios and capital amounts necessary to be
considered "well capitalized" under prompt corrective action regulatory
provisions and adequately capitalized for capital adequacy purposes. As of each
of those dates, BNCCORP and the Bank(s) exceeded capital adequacy requirements
and the Bank(s) were considered "well capitalized" under prompt corrective
action provisions.
The capital ratios of the Company and the Bank(s) were as follows as of those
dates:
Tier 1 Total
Risk- Risk- Tier 1
Based Based Leverage
As of December 31, 2002 Ratio Ratio Ratio
----------- ----------- -----------
BNCCORP, consolidated......... 5.92% 9.53% 4.46%
BNC National Bank............. 9.29% 10.45% 7.00%
As of December 31, 2001
BNCCORP, consolidated......... 8.87% 12.96% 6.33%
BNC National Bank............. 9.96% 11.01% 6.96%
BNC National Bank of Arizona.. 21.70% 22.93% 20.10%
Our consolidated capital ratios declined from December 31, 2001 to December 31,
2002 largely due to the intangible assets acquired in the Milne Scali
acquisition. Intangible assets are direct deductions from Tier 1 capital. Our
equity capital increased from $29.0 million at December 31, 2001 to $35.0
million at December 31, 2002. This increase was attributable to the issuance of
$2.5 million of common stock in the Milne Scali acquisition, the issuance of
$1.5 million of noncumulative perpetual preferred stock and earnings of $2.0
million. Additionally, as Tier 1 capital increases, a larger proportion of our
subordinated debentures qualify for Tier 1 capital ($9.7 million at December 31,
2001 and $11.7 million at December 31, 2002). The remaining subordinated
debentures qualify as Tier 2 capital. The increase in equity capital and the
resultant increase in Tier 1 capital was more than offset by the increase in
intangible assets of $18.9 million between December 31, 2001 and December 31,
2002. In spite of this increase in intangible assets, our consolidated and bank
capital ratios at December 31, 2002 met all regulatory requirements.
During 2002, the Company initiated construction of an office building at 17045
North Scottsdale Road, Scottsdale, Arizona. Total cost for the building,
including furniture and equipment is estimated at $1.8 million. We expect
construction to be completed during 2003 and the project is being funded through
cash generated from operations. The Company also plans to purchase the Milne
Scali building at 1750 East Glendale Avenue, Phoenix, Arizona for its appraised
price of $3.9 million during the first quarter of 2003. The purchase will be
funded through cash generated from operations. There are no other major capital
expenditures anticipated during the remainder of 2003 as we expect our current
facilities, along with the construction of the facility in Scottsdale, to be
sufficient for operating purposes.
Off-Balance Sheet Arrangements. In the normal course of business, we are a party
to various financial instruments with off-balance sheet risk, primarily to meet
the needs of our customers as well as to manage our interest rate risk. These
instruments, which we issue for purposes other than trading, carry varying
degrees of credit, interest rate or liquidity risk in excess of the amount
reflected in the consolidated balance sheets. We also have entered into certain
guarantee arrangements that are also not reflected in the consolidated balance
sheets. Notes 20 and 21 to the Consolidated Financial Statements included under
Item 8 of Part II include a summary of our off-balance sheet arrangements and
guarantees.
Contractual Obligations, Contingent Liabilities and Commitments. As disclosed in
the Notes to the Consolidated Financial Statements included under Item 8, we
have certain obligations and commitments to make future payments under
contracts. At December 31, 2002, the aggregate contractual obligations
(excluding bank deposits) and commercial commitments were as follows (in
thousands):
Payments due by period
---------------------------------------------------
Less
Contractual Obligations: than 1 1 to 3 4 to 5 After 5
year years years years Total
-------- --------- -------- --------- ---------
Total borrowings.................. $43,127 $ 28,554 $ -- $ 62,200 $133,881
Annual rental commitments
under non-cancelable
operating leases................. 1,421 2,428 1,874 2,025 7,748 (a)
-------- --------- -------- --------- ---------
Total............................. $44,548 $ 30,982 $ 1,874 $ 64,225 $141,629
======== ========= ======== ========= =========
Amount of Commitment - Expiration by Period
---------------------------------------------------
Less
Other Commercial Commitments: than 1 1 to 3 4 to 5 After 5
year years years years Total
-------- --------- -------- --------- ---------
Commitments to lend............... $72,405 $ 25,861 $ 4,097 $ 653 $ 103,016
Standby and commercial letters of
credit......................... 1,109 143 7,666 -- 8,918
-------- --------- -------- --------- ---------
Total............................. $73,514 $ 26,004 $ 11,763 $ 653 $ 111,934
======== ========= ======== ========= =========
(a) If the Milne Scali building is purchased during the first quarter of 2003 as
anticipated, the amounts presented in this line item would be reduced by
$295,000 for the less than 1 year column, $786,000 for the 1 to 3 year column,
$786,000 for the 4 to 5 year column and $1.7 million for the after 5 year
column.
Liquidity, Market and Credit Risk
Our business activities generate, in addition to other risks, significant
liquidity, market and credit risks. Liquidity risk is the possibility of being
unable to meet all present and future financial obligations in a timely manner.
Market risk arises from changes in interest rates, exchange rates, commodity
prices and equity prices and represents the possibility that changes in future
market rates or prices will have a negative impact on our earnings or value. Our
principal market risk is interest rate risk. See Item 7A, "Quantitative and
Qualitative Disclosures about Market Risk" for further discussion about interest
rate risk and its impact on net interest income. Credit risk is the possibility
of loss from the failure of a customer to perform according to the terms of a
contract. We are a party to transactions involving financial instruments that
create risks that may or may not be reflected on a traditional balance sheet.
These financial instruments can be subdivided into three categories:
Cash financial instruments, generally characterized as on-balance-sheet
items, include investments, loans, mortgage-backed securities, deposits and
debt obligations.
Credit-related financial instruments, generally characterized as
off-balance-sheet items, include such instruments as commitments to extend
credit, commercial letters of credit and performance and financial standby
letters of credit.
Derivative financial instruments, on-balance-sheet items as of January 1,
2001, include such instruments as interest rate, foreign exchange,
commodity price and equity price contracts, including forwards, swaps and
options.
Our risk management policies are intended to monitor and limit exposure to
liquidity, market and credit risks that arise from each of these financial
instruments. See "-Loan Portfolio" for a discussion of our credit risk
management strategies.
Liquidity Risk Management. Liquidity risk management encompasses our ability to
meet all present and future financial obligations in a timely manner. The
objectives of liquidity management policies are to maintain adequate liquid
assets, liability diversification among instruments, maturities and customers
and a presence in both the wholesale purchased funds market and the retail
deposit market.
The Consolidated Statements of Cash Flows in the Consolidated Financial
Statements included under Item 8 of Part II present data on cash and cash
equivalents provided by and used in operating, investing and financing
activities. In addition to liquidity from core deposit growth, together with
repayments and maturities of loans and investments, we utilize brokered
deposits, sell securities under agreements to repurchase and borrow overnight
federal funds. The Bank is a member of the FHLB, which affords it the
opportunity to borrow funds in terms ranging from overnight to ten years and
beyond. Borrowings from the FHLB are generally collateralized by the Bank's
mortgage loans and various investment securities. See "-Investment Securities"
and Note 12 to the Consolidated Financial Statements included under Item 8 of
Part II. We have also obtained funding through the issuance of Subordinated
Notes, subordinated debentures and long-term borrowings. See "-Borrowed Funds,"
"Guaranteed Preferred Beneficial Interests in Company's Subordinated Debentures"
and Notes 13 and 14 to the Consolidated Financial Statements included under Item
8 of Part II for further information on these instruments.
The following table sets forth, for the periods indicated, a summary of our
major sources and (uses) of funds. This summary information is derived from the
Consolidated Statements of Cash Flows included under Item 8 of Part II:
Major Sources and Uses of Funds
For the Years Ended December 31,
-----------------------------------
2002 2001 2000
---------- ---------- -----------
(in thousands)
Proceeds from sales of investment securities...... $ 100,651 $ 119,394 $ 23,789
Proceeds from maturities of investment
securities....................................... 50,984 86,414 48,345
Net increase (decrease) in short-term borrowings.. 27,360 (32,467) 31,028
Net increase in deposits.......................... 21,293 45,505 37,753
Net increase (decrease) in long-term borrowings... 8,548 (13,000) (1,921)
Proceeds from issuance of preferred stock......... 1,500 -- --
Proceeds from issuance of subordinated
debentures....................................... -- 14,429 7,220
Proceeds from FHLB advances....................... -- -- 1,159,700
Purchases of investment securities................ (146,985) (162,321) (178,827)
Net increase in loans............................. (35,144) (53,132) (7,630)
Repayments of FHLB advances....................... (20,000) -- (1,129,000)
Cash paid for acquisition of insurance
subsidiary....................................... (13,964) -- --
Disposition of discontinued Fargo branch.......... (4,365) -- --
Our liquidity is measured by our ability to raise cash when we need it at a
reasonable cost and with a minimum of loss. Given the uncertain nature of our
customers' demands as well as our desire to take advantage of earnings
enhancement opportunities, we must have adequate sources of on- and off-balance
sheet funds that can be acquired in time of need. Accordingly, in addition to
the liquidity provided by balance sheet cash flows, liquidity is supplemented
with additional sources such as credit lines with the FHLB, credit lines with
correspondent banks for federal funds, wholesale and retail repurchase
agreements, brokered certificates of deposit and direct non-brokered national
certificates of deposit through national deposit networks.
We measure our liquidity position on a monthly basis. Key factors that determine
our liquidity are the reliability or stability of our deposit base, the
pledged/non-pledged status of our investments and potential loan demand. Our
liquidity management system divides the balance sheet into liquid assets, and
short-term liabilities that are assumed to be vulnerable to non-replacement
under abnormally stringent conditions. The excess of liquid assets over
short-term liabilities is measured over a 30-day planning horizon. Assumptions
for short-term liabilities vulnerable to non-replacement under abnormally
stringent conditions are based on a historical analysis of the month-to-month
percentage changes in deposits. The excess of liquid assets over short-term
liabilities and other key factors such as expected loan demand as well as access
to other sources of liquidity such as lines with the FHLB, federal funds and
those other supplemental sources listed above are tied together to provide a
measure of our liquidity. We have a targeted range and manage our operations
such that these targets can be achieved. We believe that our prudent management
policies and guidelines will ensure adequate levels of liquidity to fund
anticipated needs of on- and off-balance-sheet items. In addition, a contingency
funding policy statement identifies actions to be taken in response to an
adverse liquidity event.
As of December 31, 2002, we had established two revolving lines of credit with
banks totaling $5.5 million that were not drawn on. The lines, if drawn upon,
mature daily with interest rates that float at the Federal funds rate. At
December 31, 2002, we also had the ability to draw additional FHLB advances of
$61.2 million based upon the mortgage loans and securities that were then
pledged, subject to a requirement to purchase additional FHLB stock.
Forward-Looking Statements
Statements included in Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" which are not historical in
nature are intended to be, and are hereby identified as "forward-looking
statements" for purposes of the safe harbor provided by Section 27A of the
Securities Act, as amended and Section 21E of the Exchange Act, as amended. We
caution readers that these forward-looking statements, including without
limitation, those relating to our future business prospects, revenues, working
capital, liquidity, capital needs, interest costs and income, are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those indicated in the forward-looking statements due to several
important factors. These factors include, but are not limited to: risks of loans
and investments, including dependence on local and regional economic conditions;
competition for our customers from other providers of financial services;
possible adverse effects of changes in interest rates including the effects of
such changes on derivative contracts and associated accounting consequences;
risks associated with our acquisition and growth strategies; and other risks
which are difficult to predict and many of which are beyond our control. For a
discussion of some of the additional factors that might cause such differences,
see Item 1 of Part I, "-Factors That May Affect Future Results of Operations."
Effects of Inflation
Unlike most industrial companies, the assets and liabilities of financial
institutions are primarily monetary in nature. Therefore, banking organizations
do not necessarily gain or lose due to the effects of inflation. Changes in
interest rates, which are a major determinant of a financial service
organization's profitability, do not necessarily correspond to changes in the
prices of goods and services; however, interest rates may change in response to
changes in expectations of future inflation. An analysis of a banking
organization's asset and liability structure provides the best indication of how
the organization is positioned to respond to changing interest rates and
maintain profitability.
The financial statements and supplementary financial data have been prepared,
primarily, on a historical basis, which is mandated by accounting principles
generally accepted in the United States. Fluctuations in the relative value of
money due to inflation or recession are generally not considered.
Recently Issued and Adopted Accounting Pronouncements
Note 1 to the Consolidated Financial Statements included under Item 8 includes a
summary of recently issued and adopted accounting pronouncements and their
related or anticipated impact on the Company.
Critical Accounting Policies
Critical accounting policies are dependent on estimates that are particularly
susceptible to significant change and include the determination of the allowance
for credit losses and income taxes. The following have been identified as
"critical accounting policies."
Allowance for Credit Losses. We maintain our allowance for credit losses at a
level considered adequate to provide for an estimate of probable losses related
to specifically identified loans as well as probable losses in the remaining
loan and lease portfolio that have been incurred as of each balance sheet date.
The loan and lease portfolio and other credit exposures are reviewed regularly
to evaluate the adequacy of the allowance for credit losses. In determining the
level of the allowance, we evaluate the allowance necessary for specific
nonperforming loans and also estimate losses in other credit exposures. The
resultant three allowance components are as follows:
Specific Reserves. The amount of specific reserves is determined through a
loan-by-loan analysis of problem loans over a minimum size that considers
expected future cash flows, the value of collateral and other factors that
may impact the borrower's ability to make payments when due. Included in
this group are those nonaccrual or renegotiated loans that meet the
criteria as being "impaired" under the definition in Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a
Loan," ("SFAS 114"). A loan is impaired when, based on current information
and events, it is probable that a creditor will be unable to collect all
amounts due according to the contractual terms of the loan agreement.
Problem loans also include those credits that have been internally
classified as credits requiring management's attention due to underlying
problems in the borrower's business or collateral concerns. Under SFAS 114,
any allowance on impaired loans is generally based on one of three methods.
It requires that impaired loans be measured at either the present value of
expected cash flows at the loan's effective interest rate, the loan's
observable market price or the fair value of the collateral of the loan.
Reserves for Homogeneous Loan Pools. We make a significant number of loans
and leases that, due to their underlying similar characteristics, are
assessed for loss as "homogeneous" pools. Included in the homogeneous pools
are consumer loans and commercial loans under a certain size, which have
been excluded from the specific reserve allocation previously discussed. We
segment the pools by type of loan or lease and using historical loss
information estimate a loss reserve for each pool.
Qualitative Reserve. Our senior lending management also allocates reserves
for special situations, which are unique to the measurement period. These
include, among other things, prevailing and anticipated economic trends,
such as economic conditions in certain geographical or industry segments of
the portfolio and economic trends in the retail lending sector,
management's assessment of credit risk inherent in the loan portfolio,
delinquency trends, historical loss experience, peer-group loss history and
other factors.
Continuous credit monitoring processes and the analysis of loss components is
the principal method we rely upon to ensure that changes in estimated credit
loss levels are reflected in our allowance for credit losses on a timely basis.
We also consider experience of peer institutions and regulatory guidance in
addition to our own experience. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the allowance
for credit losses. Such agencies may require additions to the allowance based on
their judgment about information available to them at the time of their
examination.
Loans, leases and other extensions of credit deemed uncollectible are charged to
the allowance. Subsequent recoveries, if any, are credited to the allowance. The
amount of the allowance for credit losses is highly dependent upon our estimates
of variables affecting valuation, appraisals of collateral, evaluations of
performance and status, and the amounts and timing of future cash flows expected
to be received on impaired loans. Such estimates, appraisals, evaluations and
cash flows may be subject to frequent adjustments due to changing economic
prospects of borrowers, lessees or properties. These estimates are reviewed
periodically. Actual losses may vary from current estimates and the amount of
the provision may be either greater than or less than actual net charge-offs.
The related provision for credit losses, which is charged to income, is the
amount necessary to adjust the allowance to the level determined appropriate
through application of the above processes.
As indicated above, we employ a systematic methodology for determining our
allowance for credit losses that includes an ongoing review process and
quarterly adjustment of the allowance. Our process includes periodic
loan-by-loan review for loans that are individually evaluated for impairment as
well as detailed reviews of other loans (either individually or in pools). This
includes an assessment of known problem loans, potential problem loans and other
loans that exhibit indicators of deterioration.
Our methodology incorporates a variety of risk considerations, both quantitative
and qualitative, in establishing an allowance for credit losses that we believe
is appropriate at each reporting date. Quantitative factors include our
historical loss experience, delinquency and charge-off trends, collateral
values, changes in non-performing loans and other factors. Quantitative factors
also incorporate known information about individual loans, including borrowers'
sensitivity to interest rate movements and borrowers' sensitivity to
quantifiable external factors including commodity and finished goods prices as
well as acts of nature (violent weather, fires, etc.) that occur in a particular
period.
Qualitative factors include the general economic environment in our markets and,
in particular, the state of certain industries in our market areas. Size and
complexity of individual credits in relation to lending officers' background and
experience levels, loan structure, extent and nature of waivers of existing loan
policies and pace of portfolio growth are other qualitative factors that are
considered in our methodology.
Our methodology is, and has been, consistently applied. However, as we add new
products, increase in complexity and expand our geographical coverage, we will
enhance our methodology to keep pace with the size and complexity of the loan
and lease portfolio. In this regard, we may, if deemed appropriate, engage
outside firms to independently assess our methodology. On an ongoing basis we
perform independent credit reviews of our loan portfolio. We believe that our
systematic methodology continues to be appropriate given our size and level of
complexity.
While our methodology utilizes historical and other objective information, the
establishment of the allowance for credit losses and the classification of loans
is, to some extent, based on our judgment and experience. We believe that the
allowance for credit losses is adequate as of December 31, 2002 to cover known
and inherent risks in the loan and lease portfolio. However, future changes in
circumstances, economic conditions or other factors could cause us to increase
or decrease the allowance for credit losses as necessary.
Income Taxes. We file consolidated federal and state income tax returns.
Income taxes are accounted for using the asset and liability method. Under this
method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Such differences can relate to differences in accounting for credit
losses, depreciation timing differences, unrealized gains and losses on
investment securities, deferred compensation and leases, which are treated as
operating leases for tax purposes and loans for financial statement purposes.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
The determination of current and deferred income taxes is based on complex
analyses of many factors including interpretation of federal and state income
tax laws, the difference between tax and financial reporting basis of assets and
liabilities (temporary differences), estimates of amounts due or owed such as
the timing of reversals of temporary differences and current financial
accounting standards. Actual results could differ significantly from the
estimates and interpretations used in determining the current and deferred
income tax liabilities.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk arises from changes in interest rates, exchange rates, and commodity
prices and equity prices and represents the possibility that changes in future
market rates or prices will have a negative impact on our earnings or value. Our
principal market risk is interest rate risk.
Interest rate risk arises from changes in interest rates. Interest rate risk can
result from: (1) Re-pricing risk - timing differences in the maturity/re-pricing
of assets, liabilities, and off-balance sheet contracts; (2) Options risk - the
effect of embedded options, such as loan prepayments, interest rate caps/floors,
and deposit withdrawals; (3) Basis risk - risk resulting from unexpected changes
in the spread between two or more different rates of similar maturity, and the
resulting impact on the behavior of lending and funding rates; and (4) Yield
curve risk - risk resulting from unexpected changes in the spread between two or
more rates of different maturities from the same type of instrument. We have
risk management policies to monitor and limit exposure to interest rate risk. To
date we have not conducted trading activities as a means of managing interest
rate risk. Our asset/liability management process is utilized to manage our
interest rate risk. The measurement of interest rate risk associated with
financial instruments is meaningful only when all related and offsetting on-and
off-balance-sheet transactions are aggregated, and the resulting net positions
are identified. Our interest rate risk exposure is actively managed with the
objective of managing the level and potential volatility of net interest income
in addition to the long-term growth of equity, bearing in mind that we will
always be in the business of taking on rate risk and that rate risk immunization
is not entirely possible. Also, it is recognized that as exposure to interest
rate risk is reduced, so too may the overall level of net interest income and
equity. In general, the assets and liabilities generated through ordinary
business activities do not naturally create offsetting positions with respect to
repricing or maturity characteristics. Access to the derivatives market can be
an important element in maintaining our interest rate risk position within
policy guidelines. Using derivative instruments, principally interest rate
floors and caps, the interest rate sensitivity of specific transactions, as well
as pools of assets or liabilities, is adjusted to maintain the desired interest
rate risk profile. See "-Loan Portfolio-Interest Rate Caps and Floors"
"-Borrowings-Interest Rate Caps and Floors" and Notes 1 and 17 to the
Consolidated Financial Statements included under Item 8 for a summary of our
accounting policies pertaining to such instruments.
Our primary tool in measuring and managing interest rate risk is net interest
income simulation. This exercise includes our assumptions regarding the level of
interest rate or balance changes on indeterminate maturity deposit products
(savings, interest checking, money market and demand deposits) for a given level
of market rate changes. These assumptions have been developed through a
combination of historical analysis and future expected pricing behavior.
Interest rate caps and floors are included to the extent that they are exercised
in the 12-month simulation period. Additionally, changes in prepayment behavior
of the residential mortgage, CMOs, and mortgage-backed securities portfolios in
each rate environment are captured using industry estimates of prepayment speeds
for various coupon segments of the portfolio. For purposes of this simulation,
projected month-end balances of the various balance sheet planning accounts are
held constant at their December 31, 2002 levels. Cash flows from a given
planning account are reinvested back into the same planning account so as to
keep the month-end balance constant. The static balance sheet assumption is made
so as to project the interest rate risk to net interest income embedded in the
existing balance sheet. With knowledge of the balance sheet's existing net
interest income profile, more informed strategies and tactics may be developed
as it relates to the structure/mix of growth.
We monitor the results of net interest income simulation on a quarterly basis at
regularly scheduled ALCO meetings. Each quarter net interest income is generally
simulated for the upcoming 12-month horizon in seven interest scenarios. The
scenarios generally modeled are parallel interest ramps of +/- 100bp, 200bp, and
300bp along with a rates unchanged scenario. The parallel movement of interest
rates means all projected market interest rates move up or down by the same
amount. A ramp in interest rates means that the projected change in market
interest rates occurs over the 12-month horizon projected. For example, in the
- -100bp scenario, the projected prime rate will decrease from its starting point
at December 31, 2002 of 4.25 percent to 3.25 percent 12 months later. The prime
rate in this example will decrease 1/12th of the overall decrease of 100 basis
points each month. Given the historically low absolute level of market interest
rates as of December 31, 2002, the declining rate scenario analysis was limited
to -100bp for the summary table presented below and a +400bp scenario was added.
The net interest income simulation result for the twelve-month horizon that
covers the calendar year of 2003 is shown below. The impact of each interest
rate scenario on projected net interest income is displayed before and after the
impact of the $20.0 million cumulative notional original 3-year interest rate
cap positions on 3-month LIBOR with a 4.50 percent strike and the $20.0 million
cumulative notional original 5-year interest rate cap positions on 3-month LIBOR
with a 5.50 percent strike. The impact of the cap positions is calculated by
determining the fair value of the contracts at the end of the 12-month horizon
using an interest rate option valuation model. The change in fair value plus any
expected cash flow in the various rate scenarios is summed to determine the
total net benefit/(cost) of the portfolio of interest rate cap contracts. See
Notes 1 and 17 to the Consolidated Financial Statements included under Item 8 of
Part II for further discussion related to our interest rate caps and accounting
policies related to these derivative instruments.
Net Interest Income Simulation
(amounts in thousands)
Movement in interest rates -100bp Unchanged +100bp +200bp +300bp +400bp
------ --------- -------- -------- -------- --------
Projected 12-month net
interest income.............. $ 14,740 $ 16,820 $ 17,255 $ 17,640 $ 18,016 $ 18,133
Dollar change from rates
unchanged scenario........... $(2,080) -- $ 435 $ 820 $ 1,196 $ 1,313
Percentage change from rates
unchanged scenario........... (12.37)% -- 2.59% 4.88% 7.11% 7.81%
Net benefit/(cost) of
cumulative $40.0 million
interest rate caps (1)...... $ (108) $ (51) $ 48 $ 196 $ 404 $ 706
Total net interest income
impact with caps............. $ 14,632 $ 16,769 $17,303 $ 17,836 $ 18,421 $ 18,839
Dollar change from unchanged
w/caps....................... $(2,137) -- $ 534 $ 1,067 $ 1,652 $ 2,070
Percentage change from
unchanged w/caps............. (12.74)% -- 3.18% 6.36% 9.85% 12.34%
Policy guidelines (decline
limited to).................. 5.00% -- 5.00% 10.00% 15.00% 20.00%
(1) In May and June 2001, we purchased four interest rate cap contracts on
3-month LIBOR with strikes at 4.50 percent each in the amount of $5.0 million
notional with original terms of three years for total notional of $20.0 million.
We also purchased four interest rate cap contracts on 3-month LIBOR with strikes
at 5.50 percent each in the amount of $5.0 million notional with original terms
of five years for total notional of $20.0 million. See Notes 1 and 17 to the
Consolidated Financial Statements included under Item 8 for further information
on accounting policies related to derivative financial investments.
Our rate sensitivity position over the projected twelve-month horizon is asset
sensitive. This is evidenced by the projected increase in net interest income in
the rising interest rate scenarios, and the decrease in net interest income in
falling rate scenarios.
Because one of the objectives of asset/liability management is to manage net
interest income over a one-year planning horizon, policy guidelines are stated
in terms of maximum potential reduction in net interest income resulting from
changes in interest rates over the twelve-month period. It is no less important,
however, to give attention to the absolute dollar level of projected net
interest income over the twelve-month period. For example, even though in the
- -100bp scenario, net interest income declines $2.1 million, or 12.74 percent,
from the unchanged scenario, the level of net interest income of $14.6 million
is only 1.9 percent below the $14.9 million of net interest income recorded for
the year ended December 31, 2002.
Our general policy is to limit the percentage decrease in projected net interest
income to 5, 10, 15 and 20 percent from the rates unchanged scenario for the +/-
100bp, 200bp, 300bp and 400bp interest rate ramp scenarios, respectively. If the
projected dollars of net interest income over the next twelve-month period are
in excess of the Board and ALCO established targets, then the above percentages
decline do not apply. However, if the projected percentage declines are within
the above guidelines but the projected dollars of net interest income are less
than the Board and ALCO established targets, then the ALCO will consider tactics
to increase the projected level of dollars of net interest income. A targeted
level of net interest income is established and approved by the Board and ALCO.
This target is reevaluated and reset at each quarterly ALCO meeting.
The methodology used in the above net interest income simulation has changed
from that we used in 2001. For the simulation presented at December 31, 2001,
the projected net interest income in the various interest rate scenarios
included planned growth assumptions applied to the various balance sheet
planning accounts. The above simulation does not include planned growth
assumptions but, rather, assumes a static balance sheet so as to project the
interest rate risk to net interest income embedded in the balance sheet existing
at December 31, 2002.
Net interest income under the various interest rate scenarios, if presented with
planned growth assumptions for 2003 applied to the various balance sheet
planning accounts (the methodology presented at December 31, 2001), would result
in the following:
Net Interest Income Simulation
(amounts in thousands)
Movement in interest rates -100bp Unchanged +100bp +200bp +300bp +400bp
-------- --------- -------- -------- -------- --------
Projected 12-month net
interest income.............. $ 14,771 $ 17,104 $ 17,460 $ 17,813 $ 18,137 $ 18,168
Dollar change from rates
unchanged scenario........... $(2,333) -- $ 356 $ 709 $ 1,033 $ 1,064
Percentage change from rates
unchanged scenario........... (13.64)% -- 2.08% 4.15% 6.04% 6.22%
Net benefit/(cost) of
cumulative $40.0 million
interest rate caps (1)....... $ (108) $ (51) $ 48 $ 196 $ 404 $ 706
Total net interest income
impact with caps............. $ 14,663 $ 17,053 $ 17,508 $ 18,009 $ 18,541 $ 18,874
Dollar change from unchanged
w/caps....................... $(2,390) -- $ 455 $ 956 $ 1,488 $ 1,821
Percentage change from
unchanged w/caps............. (14.02)% -- 2.67% 5.61% 8.73% 10.68%
Policy guidelines (decline
limited to).................. 5.00% -- 5.00% 10.00% 15.00% 20.00%
(1) In May and June 2001, we purchased four interest rate cap contracts on
3-month LIBOR with strikes at 4.50 percent each in the amount of $5.0 million
notional with original terms of three years for total notional of $20.0 million.
We also purchased four interest rate cap contracts on 3-month LIBOR with strikes
at 5.50 percent each in the amount of $5.0 million notional with original terms
of five years for total notional of $20.0 million. See Notes 1 and 17 to the
Consolidated Financial Statements included under Item 8 for further information
on accounting policies related to derivative financial investments.
Static gap analysis is another tool that may be used for interest rate risk
measurement. The net differences between the amount of assets, liabilities,
equity and off-balance-sheet instruments repricing within a cumulative calendar
period is typically referred to as the "rate sensitivity position" or "gap
position." The following table sets forth our rate sensitivity position as of
December 31, 2002. Assets and liabilities are classified by the earliest
possible repricing date or maturity, whichever occurs first:
Interest Sensitivity Gap Analysis
Estimated maturity or repricing at December 31, 2002
----------------------------------------------------
0-3 4-12 1-5 Over
months months years 5 Years Total
--------- --------- -------- --------- ---------
(dollars in thousands)
Interest-earning assets:
Interest-bearing deposits with
banks............................ $ 159 $ -- $ -- $ -- 159
Investment securities (1)......... 12,952 30,903 89,877 74,340 208,072
FRB and FHLB Stock................ 7,071 -- -- -- 7,071
Fixed rate loans (2).............. 20,389 30,375 34,489 15,774 101,027
Floating rate loans (2)........... 229,586 624 5,423 -- 235,633
--------- --------- --------- --------- ---------
Total interest-earning assets... $ 270,157 $ 61,902 $ 129,789 $ 90,114 $ 551,962
========= ========= ========= ========= =========
Interest-bearing liabilities:
Interest checking and money
market accounts.................. $ 182,490 $ -- $ -- $ -- $ 182,490
Savings........................... 5,041 -- -- -- 5,041
Time deposits under $100,000...... 15,777 44,528 40,540 602 101,447
Time deposits $100,000 and over... 9,655 27,522 27,728 -- 64,905
Borrowings........................ 38,124 5,003 28,554 62,200 133,881
--------- --------- --------- --------- ---------
Total interest-bearing
liabilities.................... $ 251,087 $ 77,053 $ 96,822 $ 62,802 $ 487,764
========= ========= ========= ========= =========
Interest rate gap...................
$ 19,070 $(15,151) $ 32,967 $ 27,312 $ 64,198
========= ========= ========= ========= =========
Cumulative interest rate gap at
December 31, 2002.................. $ 19,070 $ 3,919 $ 36,886 $ 64,198
========= ========= ========= =========
Cumulative interest rate gap to
total assets........................ 3.17% 0.65% 6.12% 10.66%
- --------------------
(1) Investment securities are generally reported in the timeframe representing
the earliest of repricing date, call date (for callable securities),
estimated life or maturity date. Estimated lives of mortgage-backed
securities and CMOs are based on published industry prepayment estimates
for securities with comparable weighted average interest rates and
contractual maturities.
(2) Loans are stated gross of the allowance for credit losses and are placed in
the earliest timeframe in which maturity or repricing may occur.
The table assumes that all savings and interest-bearing demand deposits reprice
in the earliest period presented, however, we believe a significant portion of
these accounts constitute a core component and are generally not rate sensitive.
Our position is supported by the fact that aggressive reductions in interest
rates paid on these deposits historically have not caused notable reductions in
balances.
The table does not necessarily indicate the future impact of general interest
rate movements on our net interest income because the repricing of certain
assets and liabilities is discretionary and is subject to competitive and other
pressures. As a result, assets and liabilities indicated as repricing within the
same period may in fact reprice at different times and at different rate levels.
Static gap analysis does not fully capture the impact of embedded options,
lagged interest rate changes, administered interest rate products, or certain
off-balance-sheet sensitivities to interest rate movements. Therefore, this tool
generally cannot be used in isolation to determine the level of interest rate
risk exposure in banking institutions.
Since there are limitations inherent in any methodology used to estimate the
exposure to changes in market interest rates, these analyses are not intended to
be a forecast of the actual effect of changes in market interest rates such as
those indicated above on the Company. Further, these analyses are based on our
assets and liabilities as of December 31, 2002 (without forward adjustments for
planned growth and anticipated business activities) and do not contemplate any
actions we might undertake in response to changes in market interest rates.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Financial Statements: Page
Independent Auditors' Report.................................. 59
Consolidated Balance Sheets as of
December 31, 2002 and 2001.................................. 60
Consolidated Statements of Income for the years
ended December 31, 2002, 2001 and 2000...................... 61
Consolidated Statements of Comprehensive Income
for the years ended December 31, 2002, 2001, and 2000........ 63
Consolidated Statements of Stockholders' Equity for
the years ended December 31, 2002, 2001, and 2000............ 64
Consolidated Statements of Cash Flows for the
years ended December 31, 2002, 2001, and 2000................ 65
Notes to Consolidated Financial Statements.................... 66
Independent Auditors' Report
The Board of Directors and Stockholders
BNCCORP, Inc.:
We have audited the accompanying consolidated balance sheets of BNCCORP, Inc.
and subsidiaries as of December 31, 2002 and 2001, and the related consolidated
statements of income, comprehensive income, stockholders' equity, and cash flows
for each of the years in the three-year period ended December 31, 2002. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of BNCCORP, Inc. and
subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America.
As discussed in note 1 to the consolidated financial statements, the Company
adopted the provisions of the Financial Accounting Standards Board's (FASB)
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets, and FASB Statement No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, as of January 1, 2002.
KPMG LLP
Minneapolis, Minnesota
January 29, 2003
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
As of December 31
(In thousands, except share and per share data)
ASSETS
2002 2001
-------------- ------------
CASH AND DUE FROM BANKS.......................... $ 16,978 $ 16,346
INTEREST-BEARING DEPOSITS WITH BANKS............. 159 126
FEDERAL FUNDS SOLD............................... -- 7,500
-------------- ------------
Cash and cash equivalents................... 17,137 23,972
INVESTMENT SECURITIES AVAILABLE FOR SALE......... 208,072 211,801
FEDERAL RESERVE BANK AND FEDERAL HOME
LOAN BANK STOCK................................ 7,071 7,380
LOANS AND LEASES, net............................ 335,794 297,924
ALLOWANCE FOR CREDIT LOSSES...................... (5,006) (4,325)
-------------- ------------
Net loans and leases........................ 330,788 293,599
PREMISES AND EQUIPMENT, net...................... 11,100 9,180
INTEREST RECEIVABLE.............................. 2,856 3,008
OTHER ASSETS..................................... 4,119 4,856
GOODWILL......................................... 12,210 437
OTHER INTANGIBLE ASSETS, net..................... 8,875 1,734
ASSETS OF DISCONTINUED FARGO OPERATIONS.......... -- 29,090
-------------- ------------
$ 602,228 $ 585,057
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
DEPOSITS:
Noninterest-bearing........................... $ 44,362 $ 30,521
Interest-bearing -
Savings, interest checking and
money market............................ 187,531 160,721
Time deposits $100,000 and over........... 64,905 78,969
Other time deposits....................... 101,447 105,066
-------------- ------------
Total deposits................................ 398,245 375,277
SHORT-TERM BORROWINGS............................ 28,120 760
FEDERAL HOME LOAN BANK ADVANCES.................. 97,200 117,200
LONG-TERM BORROWINGS............................. 8,561 13
OTHER LIABILITIES................................ 10,053 6,192
LIABILITIES OF DISCONTINUED FARGO OPERATIONS..... -- 32,692
-------------- ------------
Total liabilities.................. 542,179 532,134
COMMITMENTS AND CONTINGENCIES
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN
COMPANY'S SUBORDINATED DEBENTURES........ 22,326 22,244
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value - 2,000,000
shares authorized; 150 shares issued and
outstanding as of December 31, 2002........ -- --
Capital surplus - preferred stock............. 1,500 --
Common stock, $.01 par value - 10,000,000
shares authorized; 2,700,929 and 2,399,170
shares issued and outstanding (excluding
42,880 shares held in treasury)........... 27 24
Capital surplus - common stock................ 16,614 14,084
Retained earnings............................. 17,395 15,435
Treasury stock (42,880 shares)................ (513) (513)
Accumulated other comprehensive income, net
of income taxes........................... 2,700 1,649
-------------- ------------
Total stockholders' equity......... 37,723 30,679
-------------- ------------
$ 602,228 $ 585,057
============== =============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income
For the Years Ended December 31
(In thousands, except per share data)
2002 2001 2000
------------ ------------ ------------
INTEREST INCOME:
Interest and fees on loans................ $ 20,778 $ 23,991 $ 23,422
Interest and dividends on investments -
Taxable................................. 9,774 12,354 15,420
Tax-exempt.............................. 977 829 940
Dividends............................... 223 362 634
Other..................................... 66 50 242
------------ ------------- ------------
Total interest income.......... 31,818 37,586 40,658
------------ ------------- ------------
INTEREST EXPENSE:
Deposits.................................. 10,242 14,253 16,028
Short-term borrowings..................... 141 441 234
Federal Home Loan Bank advances........... 6,214 7,185 9,766
Long-term borrowings...................... 310 777 1,252
------------ ------------- ------------
Total interest expense......... 16,907 22,656 27,280
------------ ------------- ------------
Net interest income............ 14,911 14,930 13,378
PROVISION FOR CREDIT LOSSES.................. 1,202 1,699 1,202
------------ ------------- ------------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES.................. 13,709 13,231 12,176
------------ ------------- ------------
NONINTEREST INCOME:
Insurance commissions..................... 8,981 1,891 2,003
Fees on loans............................. 2,169 1,936 1,848
Net gain on sales of securities........... 1,870 1,396 276
Brokerage income.......................... 1,094 1,407 1,466
Service charges........................... 755 636 581
Trust and financial services.............. 751 899 1,064
Rental income............................. 89 54 27
Other..................................... 587 495 418
------------ ------------- ------------
Total noninterest income....... 16,296 8,714 7,683
------------ ------------- ------------
NONINTEREST EXPENSE:
Salaries and employee benefits............ 14,723 9,911 8,266
Occupancy................................. 2,235 1,661 1,187
Interest on subordinated debentures....... 1,829 1,377 399
Professional services..................... 1,495 1,326 1,278
Depreciation and amortization............. 1,320 1,123 993
Office supplies, telephone and postage.... 1,106 940 863
Amortization of intangible assets......... 881 482 527
Marketing and promotion................... 749 709 488
FDIC and other assessments................ 214 193 200
Repossessed and impaired asset
expenses/write-offs.................. 142 40 470
Other..................................... 2,464 1,797 1,549
------------ ------------- ------------
Total noninterest expense...... 27,158 19,559 16,220
------------ ------------- ------------
Income from continuing operations before
income taxes......................... 2,847 2,386 3,639
Income tax provision......................... 822 691 1,183
------------ ------------- ------------
Income from continuing operations............ 2,025 1,695 2,456
------------ ------------- ------------
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income, continued
For the Years Ended December 31
(In thousands, except per share data)
2002 2001 2000
------------ ----------- ------------
Discontinued Operations:
Gain on disposal of asset-based lending
subsidiary, net of income taxes
of $82................................... -- -- 159
Gain (loss) from operations of
discontinued Fargo branch (including
net loss on sale of $49 for 2002),
net of income taxes of $6, $(83) and
$(277)................................... 14 (203) (575)
------------ ----------- ------------
Income before extraordinary item and
cumulative effect of change in
accounting principle..................... 2,039 1,492 2,040
Extraordinary item - gain (loss) on early
extinguishment of debt, net of
income taxes of $(70) and $132.......... -- (134) 257
Cumulative effect of change in accounting
principle, net of income taxes
of $(66) ................................ -- (113) --
------------ ----------- ------------
NET INCOME................................... $ 2,039 $ 1,245 $ 2,297
============ =========== ============
Dividends on preferred stock................. $ (79) $ -- $ --
------------ ----------- ------------
Income available to common stockholders...... $ 1,960 $ 1,245 $ 2,297
============ =========== ============
BASIC EARNINGS PER COMMON SHARE:
Income from continuing operations............ $ 0.74 $ 0.71 $ 1.02
Gain on disposal of asset-based
lending subsidiary, net of income taxes.... -- -- 0.07
Gain (loss) from discontinued Fargo branch,
net of income taxes........................ 0.01 (0.08) (0.24)
Extraordinary item - gain (loss) on early
extinguishment of debt, net of
income taxes............................... -- (0.06) 0.11
Cumulative effect of change in accounting
principle, net of income taxes........... -- (0.05) --
------------ ----------- ------------
Basic earnings per common share.............. $ 0.75 $ 0.52 $ 0.96
============ =========== ============
DILUTED EARNINGS PER COMMON SHARE:
Income from continuing operations............ $ 0.74 $ 0.70 $ 1.02
Gain on disposal of asset-based lending
subsidiary, net of income taxes.......... -- -- 0.07
Gain (loss) from discontinued Fargo
branch, net of income taxes.............. 0.01 (0.08) (0.24)
Extraordinary item - gain (loss) on
early extinguishment of debt, net of
income taxes............................. -- (0.06) 0.11
Cumulative effect of change in
accounting principle, net of
income taxes.............................
-- (0.05) --
------------ ----------- ------------
Diluted earnings per common share............ $ 0.75 $ 0.51 $ 0.96
============ =========== ============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
For the Years Ended December 31
(In thousands)
2002 2001 2000
----------- ----------- -----------
NET INCOME.............................. $ 2,039 $ 1,245 $ 2,297
OTHER COMPREHENSIVE INCOME (LOSS) -
Unrealized gains on securities:
Unrealized holding gains
arising during the period,
net of income taxes of $1,197,
$283, and $2,022................... 2,381 885 4,123
Less: reclassification adjustment
for gains included in net income,
net of income taxes................ (1,330) (942) (186)
----------- ----------- -----------
OTHER COMPREHENSIVE INCOME (LOSS)....... 1,051 (57) 3,937
----------- ----------- -----------
COMPREHENSIVE INCOME.................... $ 3,090 $ 1,188 $ 6,234
=========== =========== ===========
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
(In thousands, except share data)
Capital Capital Accumulated
Preferred Stock Surplus Common Stock Surplus Other
--------------- Preferred ------------------ Common Retained Treasury Comprehensive
Shares Amount Stock Shares Amount Stock Earnings Stock Income Total
------- ------- --------- --------- ------- --------- --------- --------- ------------ ---------
BALANCE, December 31, 1999.. -- $ -- $ -- 2,442,860 $ 24 $ 13,976 $ 11,893 $ (513) $ (2,231) $ 23,149
Net income................ -- -- -- -- -- -- 2,297 -- -- 2,297
Other comprehensive
income -
Change in unrealized
holding losses on
securities available
for sale, net of
income taxes and
reclassification
adjustment............. -- -- -- -- -- -- -- -- 3,937 3,937
Other.................... -- -- -- (4,950) -- 74 -- -- -- 74
------- ------- --------- --------- ------- --------- --------- --------- ------------ ---------
BALANCE, December 31, 2000.. -- -- -- 2,437,910 24 14,050 14,190 (513) 1,706 29,457
Net income................ -- -- -- -- -- -- 1,245 -- -- 1,245
Other comprehensive loss -
Change in unrealized
holding gains on
securities available
for sale, net of
income taxes and
reclassification
adjustment.............. -- -- -- -- -- -- -- -- (57) (57)
Other.................... -- -- -- 4,140 -- 34 -- -- -- 34
------- ------- --------- --------- ------- --------- --------- --------- ------------ ---------
BALANCE, December 31, 2001.. -- -- -- 2,442,050 24 14,084 15,435 (513) 1,649 30,679
Net income............... -- -- -- -- -- -- 2,039 -- -- 2,039
Other comprehensive
income -
Change in unrealized
holding gains on
securities available
for sale, net of
income taxes and
reclassification
adjustment............. -- -- -- -- -- -- -- -- 1,051 1,051
Issuance of preferred
stock................... 150 -- 1,500 -- -- -- -- -- -- 1,500
Preferred stock dividends. -- -- -- -- -- -- (79) -- -- (79)
Issuance of common stock.. -- -- -- 297,759 3 2,497 -- -- -- 2,500
Other .................... -- -- -- 4,000 -- 33 -- -- -- 33
------- ------- --------- --------- ------- --------- --------- --------- ------------ ---------
December 31, 2002....... 150 $ -- $ 1,500 2,743,809 $ 27 $ 16,614 $ 17,395 $ (513) $ 2,700 $ 37,723
======= ======= ========= ========= ======= ========= ========= ========= ============ =========
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31
(In thousands)
2002 2001 2000
---------- ---------- -----------
OPERATING ACTIVITIES:
Net income....................................... $ 2,039 $ 1,245 $ 2,297
Adjustments to reconcile net income to net
cash provided by operating activities -
Provision for credit losses................... 1,202 1,699 1,202
Depreciation and amortization................. 1,489 1,364 1,131
Amortization of intangible assets............. 881 482 508
Net premium amortization on
investment securities........................ 2,966 2,144 737
Proceeds from loans recovered................. 136 303 269
Write down of other real estate
owned and repossessed assets................. 142 40 470
Change in interest receivable
and other assets, net........................ 2,308 541 (1,843)
Gain on disposal of asset-based
lending subsidiary........................... -- -- (159)
Loss on sale of bank premises and equipment... 5 5 57
Net realized gains on sales of
investment securities........................ (1,870) (1,396) (276)
Deferred income taxes......................... (269) (342) 603
Change in dividend distribution payable....... (4) 413 398
Change in other liabilities, net.............. (2,965) (1,233) 1,572
Originations of loans to be sold.............. (92,004) (122,180) (130,563)
Proceeds from sale of loans................... 92,004 122,180 130,563
---------- ----------- ----------
Net cash provided by operating activities... 6,060 5,265 6,966
---------- ----------- ----------
INVESTING ACTIVITIES:
Purchases of investment securities............... (146,985) (162,321) (178,827)
Proceeds from sales of investment securities..... 100,651 119,394 23,789
Proceeds from maturities of
investment securities........................... 50,984 86,414 48,345
Net increase in loans............................ (35,144) (53,132) (7,630)
Additions to premises and equipment.............. (2,974) (1,965) (4,296)
Proceeds from sale of premises and equipment..... 161 66 241
Cash paid for acquisition of
insurance subsidiary............................ (13,964) -- --
Disposition of discontinued
asset-based lending subsidiary.................. -- -- 159
Disposition of discontinued Fargo branch......... (4,365) -- --
---------- ----------- -----------
Net cash used in investing activities....... (51,636) (11,544) (118,219)
---------- ----------- -----------
FINANCING ACTIVITIES:
Net increase in demand, savings, interest
checking and money market accounts.............. 36,723 12,824 43,632
Net increase (decrease) in time deposits......... (15,430) 32,681 (5,879)
Net increase (decrease) in
short-term borrowings........................... 27,360 (32,467) 31,028
Repayments of FHLB advances...................... (20,000) -- (1,129,000)
Proceeds from FHLB advances...................... -- -- 1,159,700
Repayments of long-term borrowings............... (62) (13,000) (2,009)
Proceeds from long-term borrowings............... 8,610 -- 88
Amortization of discount on subordinated notes... -- 371 93
Amortization of deferred charges................. -- -- 20
Proceeds from issuance of
subordinated debentures......................... -- 14,429 7,220
Proceeds from issuance of preferred stock........ 1,500 -- --
Payment of preferred stock dividends............. (79) -- --
Amortization of discount on
subordinated debentures......................... 86 (50) (12)
Other, net....................................... 33 (120) 74
---------- ----------- ------------
Net cash provided by financing activities... 38,741 14,668 104,955
---------- ----------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS..................................... (6,835) 8,389 (6,298)
CASH AND CASH EQUIVALENTS, beginning of year...... 23,972 15,583 21,881
---------- ----------- ------------
CASH AND CASH EQUIVALENTS, end of year............ $ 17,137 $ 23,972 $ 15,583
========== =========== ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid.................................. $ 19,481 $ 24,601 $ 27,431
========== =========== ============
Income taxes paid.............................. $ 912 $ 920 $ 541
========== =========== ============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
1. Description of Business and Summary of Significant Accounting Policies
Description of Business. BNCCORP, Inc. ("BNCCORP") is a registered bank holding
company incorporated under the laws of Delaware. It is the parent company of BNC
National Bank (together with its wholly-owned subsidiaries, BNC Insurance, Inc.,
Milne Scali & Company, Inc. and BNC Asset Management, Inc., the "Bank").
BNCCORP, through these wholly owned subsidiaries, which operate from twenty-one
locations in Arizona, Minnesota and North Dakota, provides a broad range of
banking, insurance, brokerage, trust and other financial services to small and
mid-size businesses and individuals.
The accounting and reporting policies of BNCCORP and its subsidiaries
(collectively, the "Company") conform to accounting principles generally
accepted in the United States and general practices within the financial
services industry. The more significant accounting policies are summarized
below.
Principles of Consolidation. The accompanying consolidated financial statements
include the accounts of BNCCORP and its wholly owned subsidiaries. All
significant intercompany transactions and balances have been eliminated in
consolidation.
Use of Estimates. The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United States
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. Ultimate results could differ
from those estimates.
Critical Accounting Policies
Critical accounting policies are dependent on estimates that are particularly
susceptible to significant change and include the determination of the allowance
for credit losses and income taxes. The following have been identified as
"critical accounting policies."
Allowance for Credit Losses. The Company maintains its allowance for credit
losses at a level considered adequate to provide for an estimate of probable
losses related to specifically identified loans as well as probable losses in
the remaining loan and lease portfolio that have been incurred as of each
balance sheet date. The loan and lease portfolio and other credit exposures are
reviewed regularly to evaluate the adequacy of the allowance for credit losses.
In determining the level of the allowance, the Company evaluates the allowance
necessary for specific nonperforming loans and also estimates losses in other
credit exposures. The resultant three allowance components are as follows:
Specific Reserves. The amount of specific reserves is determined through a
loan-by-loan analysis of problem loans over a minimum size that considers
expected future cash flows, the value of collateral and other factors that
may impact the borrower's ability to make payments when due. Included in
this group are those nonaccrual or renegotiated loans that meet the
criteria as being "impaired" under the definition in Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a
Loan" ("SFAS 114"). A loan is impaired when, based on current information
and events, it is probable that a creditor will be unable to collect all
amounts due according to the contractual terms of the loan agreement.
Problem loans also include those credits that have been internally
classified as credits requiring management's attention due to underlying
problems in the borrower's business or collateral concerns. Under SFAS 114,
any allowance on impaired loans is generally based on one of three methods.
It requires that impaired loans be measured at either the present value of
expected cash flows at the loan's effective interest rate, the loan's
observable market price or the fair value of the collateral of the loan.
Reserves for Homogeneous Loan Pools. The Company makes a significant number
of loans and leases that, due to their underlying similar characteristics,
are assessed for loss as "homogeneous" pools. Included in the homogeneous
pools are consumer loans and commercial loans under a certain size, which
have been excluded from the specific reserve allocation previously
discussed. The Company segments the pools by type of loan or lease and
using historical loss information estimates a loss reserve for each pool.
Qualitative Reserve. The Company's senior lending management also allocates
reserves for special situations, which are unique to the measurement
period. These include, among other things, prevailing and anticipated
economic trends, such as economic conditions in certain geographical or
industry segments of the portfolio and economic trends in the retail
lending sector, management's assessment of credit risk inherent in the loan
portfolio, delinquency trends, historical loss experience, peer-group loss
history and other factors.
Continuous credit monitoring processes and the analysis of loss components is
the principal method relied upon by management to ensure that changes in
estimated credit loss levels are reflected in the Company's allowance for credit
losses on a timely basis. Management also considers experience of peer
institutions and regulatory guidance in addition to the Company's own
experience. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the allowance for credit losses.
Such agencies may require additions to the allowance based on their judgment
about information available to them at the time of their examination.
Loans, leases and other extensions of credit deemed uncollectible are charged to
the allowance. Subsequent recoveries, if any, are credited to the allowance. The
amount of the allowance for credit losses is highly dependent upon management's
estimates of variables affecting valuation, appraisals of collateral,
evaluations of performance and status, and the amounts and timing of future cash
flows expected to be received on impaired loans. Such estimates, appraisals,
evaluations and cash flows may be subject to frequent adjustments due to
changing economic prospects of borrowers, lessees or properties. These estimates
are reviewed periodically. Actual losses may vary from current estimates and the
amount of the provision may be either greater than or less than actual net
charge-offs. The related provision for credit losses, which is charged to
income, is the amount necessary to adjust the allowance to the level determined
appropriate through application of the above processes.
Income Taxes. The Company files consolidated federal and state income tax
returns.
Income taxes are accounted for using the asset and liability method. Under this
method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Such differences can relate to differences in accounting for credit
losses, depreciation timing differences, unrealized gains and losses on
investment securities, deferred compensation and leases, which are treated as
operating leases for tax purposes and loans for financial statement purposes.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
The determination of current and deferred income taxes is based on complex
analyses of many factors including interpretation of federal and state income
tax laws, the difference between tax and financial reporting basis of assets and
liabilities (temporary differences), estimates of amounts due or owed such as
the timing of reversals of temporary differences and current financial
accounting standards. Actual results could differ significantly from the
estimates and interpretations used in determining the current and deferred
income tax liabilities.
Other Significant Accounting Policies
Business Combinations. Business combinations that have been accounted for under
the purchase method of accounting include the results of operations of the
acquired businesses from the date of acquisition. Net assets of the companies
acquired were recorded at their estimated fair value as of the date of
acquisition. Effective with the issuance of Statement of Financial Accounting
Standards No. 141, "Business Combinations" ("SFAS 141"), all business
combinations are required to be accounted for by the purchase method. Note 2 to
these consolidated financial statements includes a summary of all business
combinations completed during the three-year period ended December 31, 2002.
Discontinued Operations. The results of the discontinued operations and any gain
or loss on disposal are reported separately from continuing operations. Prior
period financial statements have been restated to give effect to the
discontinued operations accounted for under this method.
Cash and Cash Equivalents. For purposes of presentation in the consolidated
statements of cash flows, the Company considers amounts included in the
consolidated balance sheet captions "cash and due from banks," "interest-bearing
deposits with banks" and "federal funds sold" (summarized in the consolidated
balance sheet as "cash and cash equivalents") to be cash equivalents.
Investment Securities. Investment and mortgage-backed securities which the
Company intends to hold for indefinite periods of time as part of its
asset/liability strategy, or that may be sold in response to changes in interest
rates, changes in prepayment risk, the need to increase regulatory capital or
similar factors are classified as available for sale. Available-for-sale
securities are carried at market value. Net unrealized gains and losses, net of
deferred income taxes, on investments and mortgage-backed securities available
for sale are reported as a separate component of stockholders' equity until
realized (see "Comprehensive Income"). All securities, other than the securities
of the Federal Reserve Bank ("FRB") and the Federal Home Loan Bank ("FHLB"),
were classified as available for sale as of December 31, 2002 and 2001.
Investment and mortgage-backed securities that the Company intends to hold until
maturity are carried at cost, adjusted for amortization of premiums and
accretion of discounts using a method that approximates level yield over the
period to maturity. The Company did not have any securities classified as held
to maturity as of December 31, 2002 or 2001.
Premiums and discounts are amortized or accreted over the life of the related
security as an adjustment to yield using the effective interest method. Dividend
and interest income is recognized when earned. Realized gains and losses on the
sale of investment securities are determined using the specific-identification
method and recognized in noninterest income on the trade date.
Declines in the fair value of individual available-for-sale or held-to-maturity
securities below their cost, which are deemed other than temporary, could result
in a charge to earnings and the corresponding establishment of a new cost basis
for the security. Such write-downs, should they occur, would be included in
noninterest income as realized losses. There were no such write-downs during
2002, 2001 or 2000.
Federal Reserve Bank and Federal Home Loan Bank Stock. Investments in FRB and
FHLB stock are carried at cost, which approximates fair value.
Loans and Leases. Loans and leases held for investment are stated at their
outstanding principal amount net of unearned income, net unamortized deferred
fees and costs and an allowance for credit losses. Interest income is recognized
on an accrual basis using the interest method prescribed in the loan agreement
except when collectibility is in doubt.
Loans and leases, including loans that are considered to be impaired, are
reviewed regularly by management and are placed on nonaccrual status when the
collection of interest or principal is 90 days or more past due, unless the loan
or lease is adequately secured and in the process of collection. Past due status
is based on payments as they relate to contractual terms. When a loan or lease
is placed on nonaccrual status, unless collection of all principal and interest
is considered to be assured, uncollected interest accrued in prior years is
charged off against the allowance for credit losses. Interest accrued in the
current year is reversed against interest income of the current period. Interest
payments received on nonaccrual loans and leases are generally applied to
principal unless the remaining principal balance has been determined to be fully
collectible. Accrual of interest is resumed when it can be determined that all
amounts due under the contract are expected to be collected and the loan has
exhibited a sustained level of performance, generally at least six months.
All impaired loans, including all loans that are restructured in a troubled debt
restructuring involving a modification of terms, are measured at the present
value of expected future cash flows discounted at the loan's initial effective
interest rate. The fair value of collateral of an impaired collateral-dependent
loan or an observable market price, if one is available, may be used as an
alternative to discounting. If the measure of the impaired loan is less than the
recorded investment in the loan, impairment will be recognized as a charge off
through the allowance for credit losses. A loan is considered impaired when,
based on current information and events, it is probable that a creditor will be
unable to collect all amounts due according to the contractual terms of the loan
agreement. All loans are reviewed for impairment on an individual basis.
Loan Origination Fees and Costs. Loan origination fees and costs incurred to
extend credit are deferred and amortized over the term of the loan as a yield
adjustment. Loan fees representing adjustments of yield are generally deferred
and amortized into interest income over the term of the loan using the interest
method or a method that approximates a level yield over the estimated remaining
lives of the loans. Loan commitment fees are generally deferred and amortized
into noninterest income on a straight-line basis over the commitment period.
Loan fees not representing adjustments of yield are also included in noninterest
income.
Mortgage Servicing and Transfers of Financial Assets. The Bank regularly sells
loans to others on a non-recourse basis. Sold loans are not included in the
accompanying consolidated balance sheets. The Bank generally retains the right
to service the loans as well as the right to receive a portion of the interest
income on the loans. At December 31, 2002 and 2001, the Bank was servicing loans
for the benefit of others with aggregate unpaid principal balances of $194.7 and
$235.8 million, respectively. Many of the loans sold by the Bank are commercial
lines of credit for which balances and related payment streams cannot be
reasonably estimated in order to determine the fair value of the servicing
assets or liabilities and/or future interest income retained by the Bank. Upon
sale, any unearned net loan fees or costs are recognized in noninterest income.
Gains on sales of loans were $0, $22,000 and $71,000 for 2002, 2001 and 2000,
respectively, and are included in noninterest income as fees on loans in the
consolidated statements of income.
Premises and Equipment. Land is carried at cost. Premises and equipment are
reported at cost less accumulated depreciation and amortization. Depreciation
and amortization for financial reporting purposes is charged to operating
expense using the straight-line method over the estimated useful lives of the
assets. Estimated useful lives are up to 40 years for buildings and three to ten
years for furniture and equipment. Leasehold improvements are amortized over the
shorter of the lease term or the estimated useful life of the improvement. The
costs of improvements are capitalized. Maintenance and repairs, as well as gains
and losses on dispositions of premises and equipment, are included in
noninterest income or expense as incurred.
Other Real Estate Owned and Repossessed Property. Real estate properties and
other assets acquired through, or in lieu of, loan foreclosure are included in
other assets in the balance sheet and are stated at the lower of carrying amount
or fair value less estimated costs to sell at the date of transfer to other real
estate owned or repossessed property. When an asset is acquired, the excess of
the recorded investment in the asset over fair value less estimated costs to
sell, if any, is charged to the allowance for credit losses. Management performs
valuations periodically. Fair value is generally determined based upon
appraisals of the assets involved. Subsequent declines in the estimated fair
value, net operating results and gains and losses on disposition of the asset
are included in other noninterest expense. The Company's investment in such
assets at December 31, 2002 and 2001 was $8,000 and $70,000, respectively.
Goodwill. Goodwill represents the aggregate excess of the cost of businesses
acquired over the fair value of their net assets at dates of acquisition. Prior
to the adoption of Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142") on January 1, 2002, goodwill
was amortized over its estimated useful life of 15 to 25 years using the
straight-line method. The Company reviewed goodwill for impairment periodically
or whenever changes in circumstances indicated that the carrying amount of the
goodwill may not have been recoverable. With the adoption of SFAS 142, goodwill
is no longer amortized, but instead is tested for impairment annually or when
impairment indicators are present. Note 9 to these consolidated financial
statements includes transition disclosures related to the adoption of SFAS 142.
Other Intangible Assets. Other intangible assets include premiums paid for
deposits assumed, insurance books of business intangibles and other
miscellaneous intangibles. Deposit premiums are being amortized over their
estimated lives of ten years using the straight-line method. Such accounting
treatment is consistent with the recently issued Statement of Financial
Accounting Standards No. 147, "Acquisition of Certain Financial Institutions, an
Amendment to FASB Statements No. 72 ("SFAS 72") and 144 and FASB Interpretation
No. 9 ("FIN 9")" ("SFAS 147"), which became effective on October 1, 2002.
Insurance books of business intangibles are being amortized over their estimated
lives of 12.5 years for commercial lines and 9.8 years for personal lines. Under
SFAS 142, the Company's other intangible assets with identifiable lives are
amortized over those lives and are monitored to assess recoverability and
determine whether events and circumstances require adjustment to the recorded
amounts or amortization periods. Intangible assets with indefinite lives are no
longer amortized but are tested for impairment annually or when impairment
indicators are present. Prior to the adoption of SFAS 142, other intangible
assets were amortized over their expected lives using either the straight-line
or effective interest method (for debt-related costs) as deemed appropriate for
such assets. Note 9 to these consolidated financial statements includes
additional information related to the Company's other intangible assets.
Impairment of Long-Lived Assets. The Company reviews long-lived assets,
including property and equipment, certain identifiable intangibles and goodwill
for impairment periodically or whenever events or changes in circumstances
indicate that the carrying amount of any such asset may not be recoverable. If
impairment is identified, the assets are written down to their fair value
through a charge to noninterest expense. No such impairment losses were recorded
during 2002, 2001 or 2000.
Securities Sold Under Agreements to Repurchase. From time to time, the Company
enters into sales of securities under agreements to repurchase, generally for
periods of less than 90 days. Fixed coupon agreements are treated as financings,
and the obligations to repurchase securities sold are reflected as a liability
in the consolidated balance sheets. The costs of securities underlying the
agreements remain in the asset accounts.
Fair Values of Financial Instruments. The Company is required to disclose the
estimated fair value of financial instruments for which it is practicable to
estimate fair value. Fair value estimates are made at a specific point in time,
based on relevant market information and information about the financial
instruments. Fair value estimates are subjective in nature, involving
uncertainties and matters of significant judgment, and therefore cannot be
determined with precision. Changes in assumptions could significantly affect the
estimates. Non-financial instruments are excluded from fair value of financial
instrument disclosure requirements. The following methods and assumptions are
used by the Company in estimating fair value disclosures for its financial
instruments, all of which are issued or held for purposes other than trading
(see Note 19 to these consolidated financial statements):
Cash and Cash Equivalents, Noninterest-Bearing Deposits and Demand
Deposits. The carrying amounts approximate fair value due to the short
maturity of the instruments. The fair value of deposits with no stated
maturity, such as interest checking, savings and money market accounts, is
equal to the amount payable on demand at the reporting date.
Investment Securities Available for Sale. The fair value of the Company's
securities equals the quoted market price.
Federal Reserve Bank and Federal Home Loan Bank Stock. The carrying amount
of FRB and FHLB stock approximates their fair values.
Loans and Leases. Fair values for loans and leases are estimated by
discounting future cash flow payment streams using rates at which current
loans to borrowers with similar credit ratings and similar loan maturities
are being made.
Accrued Interest Receivable. The fair value of accrued interest receivable
equals the amount receivable due to the current nature of the amounts
receivable.
Derivative Financial Instruments. The fair value of the Company's
derivatives equals the quoted market price.
Interest-Bearing Deposits. Fair values of interest-bearing deposit
liabilities are estimated by discounting future cash flow payment streams
using rates at which comparable current deposits with comparable maturities
are being issued. The intangible value of long-term customer relationships
with depositors is not taken into account in the fair values disclosed.
Borrowings and Advances. The carrying amount of short-term borrowings
approximates fair value due to the short maturity and, if applicable, the
instruments' floating interest rates, which are tied to market conditions.
The fair values of long-term borrowings, for which the maturity extends
beyond one year, are estimated by discounting future cash flow payment
streams using rates at which comparable borrowings are currently being
offered.
Accrued Interest Payable. The fair value of accrued interest payable equals
the amount payable due to the current nature of the amounts payable.
Guaranteed Preferred Beneficial Interests in Company's Subordinated
Debentures. The fair values of the Company's subordinated debentures are
estimated by discounting future cash flow payment streams using discount
rates estimated to reflect those at which comparable instruments could
currently be offered.
Financial Instruments with Off-Balance-Sheet Risk. The fair values of the
Company's commitments to extend credit and commercial and standby letters
of credit are estimated using fees currently charged to enter into similar
agreements.
Derivative Financial Instruments. Effective January 1, 2001, the Company adopted
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), as amended. SFAS 133 requires
that all derivative instruments, as defined, including certain derivative
instruments embedded in other financial instruments or contracts, be recognized
in the consolidated balance sheet as either assets or liabilities measured at
fair value. The fair value of the Company's derivative financial instruments is
determined based on quoted market prices for comparable instruments, if
available, or a valuation model that calculates the present value of expected
future cash flows. Subsequent changes in a derivative's fair value are
recognized currently in earnings unless specific hedge accounting criteria are
met.
The Company may enter into derivative financial instruments such as interest
rate swaps, caps and floors as part of managing its interest rate risk. Interest
rate swaps are used to exchange fixed and floating rate interest payment
obligations and caps and floors are used to protect the Company's balance sheet
from unfavorable movements in interest rates while allowing benefit from
favorable movements.
All derivative instruments that qualify for specific hedge accounting are
recorded at fair value and classified either as a hedge of the fair value of a
recognized asset or liability ("fair value" hedge) or as a hedge of the
variability of cash flows to be received or paid related to a recognized asset
or liability or a forecasted transaction ("cash flow" hedge). All relationships
between hedging instruments and hedged items are formally documented, including
the risk management objective and strategy for undertaking various hedge
transactions. This process includes linking all derivatives that are designated
as hedges to specific assets or liabilities on the balance sheet.
Changes in the fair value of a derivative that is highly effective and
designated as a fair value hedge and the offsetting changes in the fair value of
the hedged item are recorded in income. Changes in the fair value of a
derivative that is highly effective and designated as a cash flow hedge are
recognized in other comprehensive income until income from the cash flows of the
hedged item are recognized. The Company performs an assessment, both at the
inception of the hedge and on a quarterly basis thereafter, to determine whether
these derivatives are highly effective in offsetting changes in the value of the
hedged items. Any change in fair value resulting from hedge ineffectiveness is
immediately recorded in income.
Revenue Recognition. The Company recognizes revenue on an accrual basis for
interest and dividend income on loans, investment securities, federal funds sold
and interest bearing due from accounts. Noninterest income is recognized when it
has been realized or is realizable and has been earned. In accordance with
existing accounting and industry standards, as well as guidance issued by the
Securities and Exchange Commission, the Company considers revenue to be realized
or realizable and earned when the following criteria have been met: persuasive
evidence of an arrangement exists (generally, there is contractual
documentation); delivery has occurred or services have been rendered; the
seller's price to the buyer is fixed or determinable; and collectibility is
reasonably assured. Additionally, there can be no outstanding contingencies that
could ultimately cause the revenue to be passed back to the payor. In the
isolated instances where these criteria have not been met, receipts are
generally placed in escrow until such time as they can be recognized as revenue.
Trust Fees. Trust fees are recorded on the accrual basis of accounting.
Earnings Per Common Share. Basic earnings per share ("EPS") excludes dilution
and is computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding during the applicable
period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity. Such potential dilutive instruments include stock
options and warrants. Note 25 to these consolidated financial statements
includes disclosure of the Company's EPS calculations.
Comprehensive Income. Comprehensive income is defined as the change in equity
during a period from transactions and other events from non-owner sources.
Comprehensive income is the total of net income and other comprehensive income,
which for the Company, is generally comprised of unrealized gains and losses on
securities available for sale and, if applicable, unrealized gains on hedging
instruments qualifying for cash flow hedge accounting treatment pursuant to SFAS
133, as amended. The Company presents consolidated statements of comprehensive
income.
Segment Disclosures. BNCCORP segments its operations into separate business
activities, based on the nature of the products and services for each segment:
banking operations, insurance operations and brokerage, trust and financial
services operations. The amount of each segment item reported is the measure
reported to the chief operating decision maker for purposes of making decisions
about allocating resources to the segment and assessing its performance.
Adjustments and eliminations made in preparing an enterprise's general purpose
financial statements and allocation of revenues, expenses and gains or losses
are included in determining reported segment profit or loss if they are included
in the measure of the segment's profit or loss that is used by the chief
operating decision maker. Similarly, only those assets that are included in the
measure of the segment's assets that is used by the chief operating decision
maker is reported for that segment. Segment disclosures are provided in Note 16
to these consolidated financial statements.
Stock-Based Compensation. At December 31, 2002, the Company had two stock-based
employee compensation plans, which are described more fully in Note 28 to these
consolidated financial statements. The Company applies the recognition and
measurement principles of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," ("APB 25") and related
interpretations in accounting for those plans. No stock-based employee
compensation expense is reflected in net income for stock options granted under
the plans as all options granted under those plans had an exercise price equal
to the market value of the underlying common stock on the date of grant.
Compensation expense is reflected in net income for the periods presented below
for restricted stock issued under the stock plans and its net effect on net
income is reflected in the table below.
The following table illustrates the effect on net income and EPS if the Company
had applied the fair value recognition provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123") to stock-based employee compensation for the years ended December 31:
2002 2001 2000
----------- ----------- -----------
Net income, as reported................ $ 2,039,000 $ 1,245,000 $ 2,297,000
Add: total stock-based employee
compensation expense
included in reported net income,
net of related tax effects.......... 6,000 6,000 50,000
Deduct: total stock-based employee
compensation expense determined
under fair value method for all
awards, net of related tax effects... (40,000) (106,000) (110,000)
----------- ----------- -----------
Pro forma net income................... $ 2,005,000 $ 1,145,000 $ 2,237,000
=========== =========== ===========
Earnings per share:
Basic - as reported.................. $ 0.75 $ 0.52 $ 0.96
Basic - pro forma.................... 0.72 0.45 0.89
Diluted - as reported................ 0.75 0.51 0.96
Diluted - pro forma.................. 0.72 0.44 0.89
Recently Issued and Adopted Accounting Pronouncements.
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 143, "Accounting for Asset Retirement
Obligations" ("SFAS 143"). SFAS 143 amends FASB Statement No. 19, "Financial
Accounting and Reporting by Oil and Gas Producing Companies," and applies to all
entities. The statement addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. It applies to legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development and / or the normal operation of a long-lived asset,
except for certain obligations of lessees. BNCCORP adopted this standard on
January 1, 2003; however, adoption of this statement did not have a material
impact.
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
144"). SFAS 144 supersedes FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of,"
and the accounting and reporting provisions of APB Opinion No. 30, "Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of a segment of a business (as previously
defined in that opinion). SFAS 144 requires that one accounting model be used
for long-lived assets to be disposed of by sale, whether previously held and
used or newly acquired, and broadens the presentation of discontinued operations
to include more disposal transactions than were included under the previous
standards. BNCCORP adopted SFAS 144 on January 1, 2002. Under SFAS 144, the sale
of the Fargo branch of the Bank on September 30, 2002 has been presented as a
discontinued operation for financial reporting purposes.
In April 2002, the FASB issued Statement of Financial Accounting Standards No.
145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" ("SFAS 145"). SFAS 145 rescinds
FASB Statement No. 4, "Reporting Gains and Losses from Extinguishment of Debt,"
and an amendment of that Statement, FASB Statement No. 64, "Extinguishments of
Debt Made to Satisfy Sinking-Fund Requirements." SFAS 145 also rescinds FASB
Statement No. 44, "Accounting for Intangible Assets of Motor Carriers." Finally,
SFAS 145 amends FASB Statement No. 13, "Accounting for Leases," to eliminate
inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions and amends other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions. The
provisions of SFAS 145 related to the rescission of FASB Statement No. 4 are to
be applied in fiscal years beginning after May 15, 2002 (January 1, 2003 for the
Company) with any gain or loss on extinguishment of debt that was classified as
an extraordinary item in prior periods presented that does not meet the criteria
in APB Opinion 30 for classification as an extraordinary item being
reclassified. The provisions of SFAS 145 related to FASB Statement No. 13 that
relate to modifications of a capital lease that make it an operating lease
became effective for transactions occurring after May 15, 2002. Management is
still assessing the impact of adoption of this pronouncement.
In June 2002, the FASB issued Statement of Financial Accounting Standards No.
146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS
146"). SFAS 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)" ("EITF Issue 94-3"). One of the principal differences
between SFAS 146 and EITF Issue 94-3 pertains to the criteria for recognizing a
liability for exit or disposal costs. Under EITF Issue 94-3, a liability for
such costs was recognized as of the date of an entity's commitment to an exit
plan. Pursuant to SFAS 146, a liability is recorded as of the date an obligation
is incurred. SFAS 146 requires that an exit or disposal liability be initially
measured at fair value. Provisions of SFAS 146 are effective for exit or
disposal activities that are initiated after December 31, 2002. The Company
adopted SFAS 146 on January 1, 2003 with no material impact.
In October 2002, the FASB issued SFAS 147. SFAS 147 removes acquisitions of
financial institutions from the scope of both SFAS 72 and FIN 9 and requires
that those transactions be accounted for in accordance with SFAS 141 and 142.
Thus, the requirement to recognize (and subsequently amortize) any excess of the
fair value of liabilities assumed over the fair value of tangible and
identifiable intangible assets acquired as an unidentifiable intangible asset no
longer applies to acquisitions within the scope of SFAS 147. Entities with
previously recognized unidentifiable intangible assets that are still amortizing
them in accordance with SFAS 72 must, effective the latter of the date of the
acquisition or the full adoption of SFAS 142, reclassify those intangible assets
to goodwill and terminate amortization on them. The Company adopted SFAS 147 on
October 1, 2002 and the adoption resulted in no reclassification or revisions to
prior period financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees Including Indirect Guarantees of
Indebtedness of Others" ("Fin 45"), which addresses the disclosures to be made
by a guarantor in its interim and annual financial statements about its
obligations under guarantees. These disclosure requirements are included in Note
21 to these consolidated financial statements. Fin 45 also requires the
recognition of a liability by a guarantor at the inception of certain
guarantees. Fin 45 requires the guarantor to recognize a liability for the
non-contingent component of the guarantee, which is the obligation to stand
ready to perform in the event that specified triggering events or conditions
occur. The initial measurement of this liability is the fair value of the
guarantee at inception. The recognition of the liability is required even if it
is not probable that payments will be required under the guarantee or if the
guarantee was issued with a premium payment or as part of a transaction with
multiple elements. As noted above, the Company has adopted the disclosure
requirements of Fin 45 (see Note 21) and will apply the recognition and
measurement provisions for all guarantees entered into or modified after
December 31, 2002. The adoption is not expected to have a material impact.
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation; Transition and Disclosure"
("SFAS 148"). SFAS 148 amends SFAS 123 to provide new guidance concerning
transition when an entity changes from the intrinsic value method to the fair
value method of accounting for employee stock-based compensation cost. As
amended by SFAS 148, SFAS 123 now also requires additional information to be
disclosed regarding such cost in annual financial statements and in condensed
interim statements of public companies. In general, the new transition
requirements are effective for financial statements for fiscal years ending
after December 15, 2002. Earlier application is permitted if statements for a
fiscal year ending prior to December 15, 2002 have not yet been issued as of
December 2002. Interim disclosures are required for reports containing condensed
financial statements for periods beginning after December 15, 2002. The Company
accounts for stock-based compensation using the intrinsic method under ABP 25
and plans to continue to do so while providing the disclosures provided for in
SFAS 123. The Company adopted the annual disclosure requirements for SFAS 148
for purposes of these consolidated financial statements and will adopt the
interim disclosure requirements of SFAS 148 beginning with its interim financial
statements for the period ended March 31, 2003.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 addresses consolidation by
business enterprises of variable interest entities which have certain
characteristics by requiring that if a business enterprise has a controlling
interest in a variable interest entity (as defined by FIN 46), the assets,
liabilities and results of activities of the variable interest entity be
included in the consolidated financial statements with those of the business
enterprise. FIN 46 applies immediately to variable interest entities created
after January 31, 2003 and to variable interest entities in which an enterprise
obtains an interest after that date. For variable interests acquired before
February 1, 2003, FIN 46 applies in the first fiscal year or interim period
beginning after June 15, 2003. The Company will adopt FIN 46 as indicated above
but presently does not have any variable interest entities that would be
required to be included in its consolidated financial statements.
Regulatory Environment. BNCCORP and its subsidiaries are subject to regulations
of certain state and federal agencies, including periodic examinations by those
regulatory agencies. BNCCORP and the Bank are also subject to minimum regulatory
capital requirements. At December 31, 2002, capital levels exceeded minimum
capital requirements (see Note 18 to these consolidated financial statements).
Reclassifications. Certain amounts in the financial statements for prior years
have been reclassified to conform to the current year's presentation.
2. Acquisitions, Mergers and Divestitures:
The following acquisitions, mergers and divestitures, or transactions associated
with them, transpired during the three-year period ended December 31, 2002:
On September 30, 2002, the Company sold its Fargo, North Dakota branch largely
due to the fact that the branch did not achieve critical mass for the Company in
the Fargo marketplace and the sale allowed the Company to redirect assets to
markets where they can be more productively and profitably employed. Pursuant to
a definitive branch purchase and assumption agreement dated July 26, 2002, the
Company sold the assets of the Fargo branch, including the bank building,
furniture, fixtures and equipment totaling $6.0 million and $19.5 million of
loans. The Company also sold $31.0 million in deposits. Prior to the application
of the Company's direct costs incurred in the sale of the branch ($56,000), the
transaction resulted in a net gain on sale of $7,000. These amounts are included
in the line item "Gain (loss) from operations of discontinued Fargo branch
(including net loss on sale of $49,000 for 2002), net of income taxes" in the
consolidated statements of income. The Fargo branch's profit or loss, for the
periods presented, is also reflected in this line item. Additionally, included
in this line item are the following amounts of net interest income for the Fargo
branch for the twelve months ended December 31, 2002, 2001 and 2000,
respectively: $973,000, $726,000 and $267,000. The Fargo branch had previously
been reported in the banking operations segment of the Company's segment
disclosures.
On April 16, 2002, in order to further grow its insurance segment, the Company
acquired 100 percent of the voting equity interests of Milne Scali & Company,
Inc. and its related companies ("Milne Scali"), a Phoenix, Arizona-based
insurance agency, for 297,759 shares of newly issued common stock (valued at
$2.5 million) and $15.5 million in cash. Acquisitions of such agencies generally
result in the recognition of goodwill due to the service nature of the business,
the lack of tangible assets acquired and the profitability of the acquired
agency. To effect the transaction, the Company incurred $8.5 million in
long-term debt. Of the total $18.0 million purchase price, $7.2 million was
allocated to the net assets acquired (including intangible assets) and the
excess purchase price of approximately $10.8 million over the fair value of net
assets was recorded as goodwill. As part of the transaction, deferred tax
liabilities of $2.3 million were initially recorded, which also increased
goodwill by the same amount. Subsequent to the acquisition, the Company and
Milne Scali have made an Internal Revenue Code Section 338(h)(10) election to
step up the basis in the acquired assets. Upon the election, goodwill was
reduced by $1.8 million, deferred taxes were reduced by $2.3 million and a
liability for the resulting income taxes in the amount of $590,000 was recorded.
Under the Section 338(h)(10) election, all of the goodwill related to the
acquisition will be deductible for tax purposes. Additional consideration of up
to $8.5 million is payable to the former shareholders of Milne Scali, subject to
Milne Scali achieving certain financial performance targets. In accordance with
purchase method accounting requirements, such payments would increase the cost
of the transaction in future periods and are not reflected as liabilities in the
Company's current consolidated balance sheet.
Prospectively, the goodwill, all of which is attributable to the Company's
insurance segment, will be evaluated for possible impairment under the
provisions of SFAS 142. Other acquired intangible assets related to personal and
commercial insurance lines books of business and totaling approximately $8.0
million will be amortized using a method that approximates the anticipated
useful life of the associated customer lists, which will cover a period of 9.8
to 12.5 years.
Milne Scali's results of operations have been included in the Company's
consolidated financial statements since the acquisition date of April 16, 2002.
The following is a condensed balance sheet indicating the amount assigned to
each major asset and liability caption of Milne Scali as of the acquisition date
(amounts are in thousands):
Assets -
Cash.......................................... $ 1,536
Accounts receivable........................... 1,305
Fixed assets.................................. 412
Intangible assets, books of business.......... 8,018
Goodwill...................................... 13,096
Other......................................... 104
-------------
Total assets.................................... $ 24,471
=============
Liabilities -
Notes payable................................. $ 1,421
Insurance company payables.................... 1,486
Deferred tax liabilities...................... 2,346
Other......................................... 1,218
-------------
Total liabilities............................... 6,471
Stockholders' equity.......................... 18,000
-------------
Total liabilities and stockholders' equity...... $ 24,471
=============
The following pro forma information has been prepared assuming that the
acquisition of Milne Scali had been consummated at the beginning of the
respective periods. The pro forma financial information is not necessarily
indicative of the results of operations as they would have been had the
transaction been consummated on the assumed dates (amounts are in thousands):
Twelve Months Ended December 31,
-------------------------------------------
2002 2001 2000
------------- ------------ ------------
Net interest income................. $ 14,761 $ 14,251 $ 11,494
Noninterest income.................. 19,553 18,131 16,086
Noninterest expense................. 28,032 26,215 23,202
Income from continuing operations... 2,313 2,196 2,686
Income (loss) from discontinued
operations....................... 14 (203) (416)
Income before extraordinary item
and cumulative effect of
change in accounting principle... 2,327 1,993 2,270
Net income.......................... 2,327 1,746 2,527
Basic earnings per common share..... $ 0.79 $ 0.65 $ 0.94
Diluted earnings per common share... $ 0.79 $ 0.64 $ 0.94
On April 8, 2002, the Company merged BNC National Bank, its Minnesota chartered
bank, with and into BNC National Bank of Arizona and the name of the combined
bank was changed to BNC National Bank. The transaction was accounted for as a
pooling of interests.
On July 9, 2001, the Company established a new banking subsidiary, BNC National
Bank of Arizona headquartered in Tempe, Arizona.
On November 20, 2000, the Company merged BNC National Bank, its North Dakota
chartered bank, with and into BNC National Bank of Minnesota and the name of the
combined bank was changed to BNC National Bank. The transaction was accounted
for as a pooling of interests.
On December 31, 1999, the Company sold its asset-based lending subsidiary, BNC
Financial Corporation ("BNC Financial"), to Associated Banc-Corp of Green Bay,
Wisconsin. The Company received $5.3 million in cash for all of the issued and
outstanding common stock of BNC Financial. The 2000 gain on disposal of $159,000
(pretax gain of $241,000, net of income tax effects of $82,000) resulted from
recoveries on a credit charged off in 1999 at the time of the sale of BNC
Financial.
3. Restrictions on Cash and Due From Banks:
The Bank is required to maintain reserve balances in cash on hand or with the
FRB under the Federal Reserve Act and Federal Reserve Board's Regulation D.
Required reserve balances were $3.6 and $4.2 million as of December 31, 2002 and
2001, respectively.
4. Investment Securities Available For Sale:
Investment securities have been classified in the consolidated balance sheets
according to management's intent. The Company had no securities designated as
trading or held-to-maturity in its portfolio at December 31, 2002 or 2001. The
carrying amount of available-for-sale securities and their approximate fair
values were as follows as of December 31 (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------- --------------- --------------- ---------------
2002
U.S. government agency mortgage-
backed securities.................. $ 47,072 $ 547 $ (43) $ 47,576
U.S. government agency securities.... 4,608 595 -- 5,203
Collateralized mortgage obligations.. 122,795 2,527 (842) 124,480
State and municipal bonds............ 27,276 1,589 (50) 28,815
Corporate debt securities............ 1,938 60 -- 1,998
---------------- --------------- --------------- ---------------
$ 203,689 $ 5,318 $ (935) $ 208,072
================ =============== =============== ===============
2001 Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------- ---------------- --------------- ----------------
U.S. government agency mortgage-
backed securities.................. $ 42,027 $ 243 $ (324) $ 41,946
U.S. government agency securities.... 4,396 99 -- 4,495
Collateralized mortgage obligations.. 135,423 2,236 (391) 137,268
State and municipal bonds............ 16,952 649 (120) 17,481
Corporate debt securities............ 10,329 376 (94) 10,611
--------------- ---------------- --------------- ----------------
$ 209,127 $ 3,603 $ (929) $ 211,801
=============== ================ =============== ================
The amortized cost and estimated fair market value of available-for-sale
securities classified according to their contractual maturities at December 31,
2002, were as follows (in thousands):
Estimated
Amortized Fair
Cost Value
----------- ----------
Due in one year or less................. $ 5 $ 5
Due after one year through five years... 2,808 3,023
Due after five years through ten years.. 4,365 4,515
Due after ten years..................... 196,511 200,529
----------- -----------
Total.............................. $ 203,689 $ 208,072
=========== ===========
Securities carried at approximately $177.8 and $186.0 million at December 31,
2002 and 2001, respectively, were pledged as collateral for public and trust
deposits and borrowings, including borrowings with the FHLB.
Sales proceeds and gross realized gains and losses on available-for-sale
securities were as follows for the years ended December 31 (in thousands):
2002 2001 2000
----------- ------------- -----------
Sales proceeds........... $ 100,651 $ 119,394 $ 23,789
Gross realized gains..... 2,003 1,530 324
Gross realized losses.... 133 134 48
5. Federal Reserve Bank and Federal Home Loan Bank Stock:
The carrying amounts of FRB and FHLB stock, which approximate their fair values,
consisted of the following as of December 31 (in thousands):
2002 2001
----------- -----------
Federal Reserve Bank Stock, at cost......... $ 1,236 $ 849
Federal Home Loan Bank Stock, at cost....... 5,835 6,531
----------- -----------
Total..................................... $ 7,071 $ 7,380
=========== ===========
There is no contractual maturity on these investments; they represent required
regulatory investments.
6. Loans and Leases:
Composition of Loan and Lease Portfolio. The composition of the loan and lease
portfolio was as follows as of December 31 (in thousands):
2002 2001
---------- ----------
Commercial and industrial................... $ 94,075 $ 103,883
Real estate:
Mortgage................................. 147,825 123,727
Construction............................. 62,926 34,225
Agricultural................................ 18,023 19,069
Consumer.................................... 7,948 8,404
Lease financing............................. 5,554 7,578
Other....................................... 309 1,549
---------- ----------
Total.................................. 336,660 298,435
Less:
Allowance for credit losses.............. (5,006) (4,325)
Unearned income and net unamortized
deferred fees and costs................ (866) (511)
---------- ----------
Net loans and leases............... $ 330,788 $ 293,599
========== ==========
Geographic Location and Types of Loans. Loans were to borrowers located in the
following market areas as of December 31:
2002 2001
------ ------
North Dakota....................... 32% 37%
Minnesota.......................... 30 35
Arizona............................ 26 17
South Dakota....................... 7 9
Other.............................. 5 2
------ ------
Totals.................... 100% 100%
====== ======
Commercial loan borrowers are generally small- and mid-sized corporations,
partnerships and sole proprietors in a wide variety of businesses. Loans to
consumers are both secured and unsecured. Real estate loans are fixed or
variable rate and include both amortizing and revolving line-of-credit loans.
Real estate mortgage loans include various types of loans for which the Company
holds real property as collateral. Of the $147.8 and $123.7 million of real
estate mortgages as of December 31, 2002 and 2001, respectively, many of the
loans are loans made to commercial customers where the collateral for the loan
is, among other things, the real estate occupied by the business of the
customer. Accordingly, certain loans categorized as real estate mortgage loans
can be characterized as commercial loans that are secured by real estate.
Single- and multi-family residential mortgage loans totaling $10.1 and $6.6
million at December 31, 2002 and 2001, respectively, were pledged as collateral
for FHLB borrowings. Commercial loans totaling $38.5 and $35.6 million at
December 31, 2002 and 2001, respectively, were pledged as collateral for
borrowings, including FHLB borrowings.
Concentrations of Credit. The Company's credit policies emphasize
diversification of risk among industries, geographic areas and borrowers. The
only concentrations of loans exceeding 10 percent of total loans at December 31,
2002 are real estate loans, such as loans to non-residential and apartment
building operators and lessors of real property ($94.2 million), loans related
to hotels and other lodging places ($46.9 million) and construction loans ($48.5
million). Loans within these categories are diversified across different types
of borrowers, geographically dispersed, and secured by many different types of
real estate and other collateral.
Impaired Loans. As of December 31, the Company's recorded investment in impaired
loans and the related valuation allowance was as follows (in thousands):
2002 2001
------------------------- -------------------------
Recorded Valuation Recorded Valuation
Investment Allowance Investment Allowance
------------ ----------- ------------ -----------
Impaired loans -
Valuation allowance
required.............. $ 13,412 $ 2,210 $ 11,571 $ 769
No valuation
allowance required.... 10 -- 17 --
------------ ----------- ------------ -----------
Total impaired
loans............... $ 13,422 $ 2,210 $ 11,588 $ 769
============ =========== ============ ===========
Impaired loans generally include loans on which management believes, based on
current information and events, it is probable that the Company will not be able
to collect all amounts (i.e., contractual principal and interest) due in
accordance with the terms of the loan agreement and which are analyzed for a
specific reserve allowance. The Company generally considers all loans
risk-graded substandard and doubtful as well as nonaccrual and restructured
loans as impaired loans.
The valuation allowance on impaired loans is included in the Company's allowance
for credit losses.
Interest payments received on impaired loans are recorded as interest income
unless collection of the remaining recorded investment is doubtful at which time
payments received are recorded as reductions of principal. The average recorded
investment in impaired loans and approximate interest income recognized for such
loans were as follows for the years ended December 31 (in thousands):
2002 2001 2000
----------- ----------- -----------
Average recorded investment
in impaired loans............... $ 13,135 $ 9,101 $ 7,393
=========== =========== ===========
Interest income recognized
on impaired loans............... $ 658 $ 761 $ 791
=========== =========== ===========
Average recorded investment in
impaired loans as a percentage
of average total loans.......... 4.0% 2.9% 2.9%
=========== =========== ===========
Past Due, Nonaccrual and Restructured Loans. As of December 31, 2002 and 2001,
the Company had $5.1 million and $983,000, respectively, of loans past due 90
days or more and still accruing interest. As of December 31, 2002 and 2001, the
Company had $2.5 and $3.4 million, respectively, of nonaccrual loans and $0 and
$5,000, respectively, of restructured loans (included as impaired loans above).
The following table indicates the effect on income if interest on such loans
outstanding at year-end had been recognized at original contractual rates during
the year ended December 31 (in thousands):
2002 2001 2000
-------- -------- --------
Interest income that would
have been recorded............... $ 237 $ 87 $ 35
Interest income recorded........... 1 3 6
-------- --------- --------
Effect on interest income.......... $ 236 $ 84 $ 29
======== ========= ========
As of December 31, 2002, the Company had no commitments to lend additional funds
to borrowers with loans whose terms had been modified in troubled debt
restructurings.
Loans to Related Parties. Note 22 to these consolidated financial statements
includes information relating to loans to executive officers, directors,
principal shareholders and associates of such persons.
Leases. The Company extends credit to borrowers under direct finance lease
obligations. The direct finance lease obligations are stated at their
outstanding principal amount net of unearned income and net unamortized deferred
fees and costs. At December 31, 2002, the total minimum annual lease payments
for direct finance lease obligations with remaining terms of greater than one
year were as follows (in thousands):
2003................................ $ 1,133
2004................................ 890
2005................................ 466
2006................................ 354
2007................................ 158
Thereafter.......................... --
--------
Total future minimum lease payments.. 3,001
Unguaranteed residual values......... 873
--------
Total all payments................... 3,874
Unearned income...................... (485)
--------
Net outstanding principal amount..... $ 3,389
========
The Company also extends financing to lease companies, securing the loan with an
assignment of lease payments and a security filing against the underlying asset
of the lease. These loans are classified above as lease financing but are not
direct finance lease obligations.
7. Allowance for Credit Losses:
Transactions in the allowance for credit losses were as follows for the years
ended December 31 (in thousands):
2002 2001 2000
---------- ---------- ----------
Balance, beginning of year......... $ 4,325 $ 3,588 $ 2,872
Provision for credit losses... 1,202 1,699 1,202
Loans charged off............. (657) (1,265) (755)
Loans recovered............... 136 303 269
---------- ---------- ----------
Balance, end of year............... $ 5,006 $ 4,325 $ 3,588
========== ========== ==========
8. Premises and Equipment
Premises and equipment consisted of the following at December 31 (in thousands):
2002 2001
----------- -----------
Land and improvements............................. $ 1,857 $ 569
Buildings and improvements........................ 6,002 5,655
Leasehold improvements............................ 1,418 1,035
Furniture, fixtures and equipment................. 8,873 8,123
----------- -----------
Total cost................................... 18,150 15,382
Less accumulated depreciation and amortization.... (7,050) (6,202)
----------- -----------
Net premises, leasehold improvements
and equipment.............................. $ 11,100 $ 9,180
=========== ===========
Depreciation and amortization expense on premises and equipment charged to
continuing operations totaled approximately $1.3 million, $1.1 million and
$993,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
9. Goodwill and Other Intangible Assets - Adoption of SFAS 142
Goodwill, representing the excess of the purchase price over the fair value of
net assets acquired, results from purchase acquisitions made by the Company. On
January 1, 2002, the Company adopted SFAS 142. Under SFAS 142, goodwill
associated with business combinations completed after June 30, 2001 is not
required to be amortized. During the transition period from July 1, 2001 through
December 31, 2001, all of the Company's goodwill associated with business
combinations completed prior to July 1, 2001 was amortized over 15 to 25 year
periods. Effective January 1, 2002, the Company discontinued all goodwill
amortization.
Since January 1, 2002, goodwill has been assessed for impairment at the
reporting unit and qualifying subsidiary levels by applying a fair-value-based
test at least annually or if impairment indicators are present. The Company has
$437,000 of unamortized goodwill related to five separate transactions completed
prior to July 1, 2001. Pursuant to SFAS 142, the Company completed its initial
goodwill impairment assessment during the second quarter of 2002 and concluded
that goodwill was not impaired as of January 1, 2002. No subsequent events have
occurred that would change the conclusion reached.
Core deposit intangibles are amortized based on a useful life of 10 years.
Insurance books of business intangibles are being amortized over their estimated
lives of 12.5 years for commercial lines and 9.8 years for personal lines.
Certain identifiable intangible assets that are also included in the caption
"other intangible assets" in the consolidated balance sheets are generally
amortized over a useful life of 10 to 15 years.
Adjusted Earnings - SFAS 142 Transitional Disclosure. Effective January 1, 2002,
the Company discontinued all goodwill amortization. The following tables
reconcile income from continuing operations, income before extraordinary items
and cumulative effect of change in accounting principle, net income and EPS,
adjusted to exclude amortization expense recognized in those periods related to
goodwill for the years ended December 31 (amounts are in thousands):
2002 2001 2000
---------- ---------- ---------
Reported income from continuing
operations.............................. $ 2,025 $ 1,695 $ 2,456
Add back: goodwill amortization, net
of income taxes......................... -- 51 57
---------- ---------- ---------
Adjusted income from continuing
operations.............................. $ 2,025 $ 1,746 $ 2,513
========== ========== =========
Reported income before extraordinary item
and cumulative effect of change in
accounting principle.................... $ 2,039 $ 1,492 $ 2,040
Add back: goodwill amortization, net of
income taxes............................ -- 51 57
Adjusted income before extraordinary item
and cumulative effect of change in
accounting principle.................... $ 2,039 $ 1,543 $ 2,097
========== ========== =========
Reported net income ...................... $ 1,960 $ 1,245 $ 2,297
Add back: goodwill amortization, net of
income taxes........................... -- 51 57
---------- ---------- ---------
Adjusted net income ...................... $ 1,960 $ 1,296 $ 2,354
========== ========== =========
Basic earnings per common share:
Reported net income ................... $ 0.75 $ 0.52 $ 0.96
Goodwill amortization, net of
income taxes........................ -- 0.02 0.02
---------- ---------- ---------
Adjusted net income ...................... $ 0.75 $ 0.54 $ 0.98
========== ========== =========
Diluted earnings per common share:
Reported net income ................... $ 0.75 $ 0.51 $ 0.96
Goodwill amortization, net
of income taxes..................... -- 0.02 0.02
---------- ---------- ---------
Adjusted net income ...................... $ 0.75 $ 0.53 $ 0.98
========== ========== =========
Intangible Assets. The gross carrying amount of intangible assets and the
associated accumulated amortization at December 31, 2002 is presented in the
table below (in thousands):
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
------------ ------------- ---------------
Intangible assets:
Core deposit intangibles.......... $ 3,497 $ 2,584 $ 913
Insurance books of business
intangibles..................... 8,018 471 7,547
Other............................. 874 459 415
------------ ------------- ---------------
Total....................... $ 12,389 $ 3,514 $ 8,875
============ ============= ===============
One intangible asset included in the "other" category above has a net carrying
value of $271,000 but is not being amortized because it has an indefinite life.
Amortization expense for intangible assets was $881,000, $482,000 and $528,000
for the years ended December 31, 2002, 2001 and 2000, respectively.
The following table shows the estimated future amortization expense for
amortized intangible assets existing on the Company's books at December 31, 2002
(in thousands). Projections of amortization expense are based on existing asset
balances as of December 31, 2002. Actual amortization expense may differ
significantly depending upon changes in market conditions:
Insurance
Commercial and
Core Personal Books
Deposit of Business
Intangibles Intangibles Other Total
------------- -------------- ------------ -----------
Year ended December 31,
2003................ 350 665 48 1,063
2004................ 350 665 48 1,063
2005................ 233 665 48 946
2006................ -- 665 -- 665
2007................ -- 665 -- 665
Goodwill. At January 1, 2002, the Company had a total of $437,000 of unamortized
goodwill relating to five separate purchase transactions completed prior to July
1, 2001. As indicated above, pursuant to SFAS 142, the goodwill was assessed for
impairment during the second quarter of 2002. Management concluded that goodwill
was not impaired as of January 1, 2002. No subsequent events have occurred that
would change the conclusion reached.
The following table shows the change in goodwill, by reporting segment, between
January 1, 2002 and December 31, 2002 (amounts are in thousands):
Segment
-----------------------------------------------
Banking Insurance Other Total
--------- --------- --------- ---------
Balance, January 1, 2002....... $ 212 $ 45 $ 177 $ 434
Goodwill attributable to
purchase acquisition......... -- 11,776 -- 11,776
--------- --------- --------- ---------
Balance, December 31, 2002..... $ 212 $11,821 $ 177 $12,210
========= ========= ========= =========
10. Deposits:
The scheduled maturities of time deposits as of December 31, 2002 are as follows
(in thousands):
2003.................. $ 97,482
2004.................. 47,401
2005.................. 13,579
2006.................. 4,872
2007.................. 2,416
Thereafter............ 602
----------------
$ 166,352
================
At December 31, 2002 and 2001, the Bank had $27.3 and $34.0 million,
respectively, of time deposits that had been acquired in the national market and
$31.4 and $34.4 million, respectively, of time deposits that had been acquired
through a broker.
At December 31, 2002 mortgage-backed and related securities with an amortized
cost of approximately $15.1 million were pledged as collateral for certain
deposits and $14.5 million of bank depository guaranty bonds from a bankers
surety company were pledged as additional collateral on Bank deposits.
Deposits Received from Related Parties. Note 22 to these consolidated financial
statements includes information relating to deposits received from executive
officers, directors, principal shareholders and associates of such persons.
11. Short-Term Borrowings:
The following table sets forth selected information for short-term borrowings
(borrowings with an original maturity of less than one year) as of December 31
(in thousands):
2002 2001
------------ ------------
Federal funds purchased
and U. S. Treasury tax
and loan note option accounts (1)..... $ 15,000 $ 447
Repurchase agreements with customers,
renewable daily, interest payable
monthly, rates at 1.50%, secured by
government agency collateralized
mortgage obligations (1).............. 13,120 313
------------ ------------
$ 28,120 $ 760
============ ============
(1) The weighted average interest rate on short-term borrowings outstanding as
of December 31, 2002 and 2001 was 1.48% and 2.53%, respectively.
Customer repurchase agreements are used by the Bank to acquire funds from
customers where the customer is required or desires to have their funds
supported by collateral consisting of government, government agency or other
types of securities. The repurchase agreement is a promise to sell these
securities to a customer at a certain price and repurchase them at a future date
at that same price plus interest accrued at an agreed upon rate. The Bank uses
customer repurchase agreements in its liquidity plan as well as an accommodation
to customers. At December 31, 2002, $13.1 million of securities sold under
repurchase agreements with an interest rate of 1.50% maturing in 2003 were
collateralized by government agency collateralized mortgage obligations having a
carrying value of $15.7 million, a market value of $15.7 million, and
unamortized principal balances of $15.1 million.
The Company had established two additional revolving lines of credit with banks,
totaling $5.5 million, which were not drawn on at December 31, 2002. The lines,
if drawn upon, mature daily with interest rates that float at the federal funds
rate.
12. Federal Home Loan Bank Advances:
FHLB advances consisted of the following at December 31 (in thousands):
2002 2001
--------------------------- ---------------------------
Weighted Weighted
Year of Maturity Amount Average Rate Amount Average Rate
----------- -------------- ----------- --------------
2002............. -- -- $ 20,000 5.33%
2003............. $ 15,000 4.56% 15,000 4.56
2004............. 15,000 4.77 15,000 4.77
2005............. 5,000 3.84 5,000 3.84
2009............. 10,000 5.64 10,000 5.64
2010............. 52,200 6.09 52,200 6.09
------------ -------------- ------------ --------------
$ 97,200 5.49% $ 117,200 5.46%
============ ============== ============ ==============
Some of the advances listed above have call provisions that allow the FHLB to
request that the advance be paid back or refinanced at the rates then being
offered by the FHLB. As of December 31, 2002, the Company had $62.2 million of
callable FHLB advances all callable quarterly during the first quarter of 2003.
At December 31, 2002, the advances from the FHLB were collateralized by the
Bank's mortgage loans with unamortized principal balances of approximately $42.9
million resulting in a FHLB collateral equivalent of $26.4 million. In addition,
the advances from the FHLB were collateralized by securities with unamortized
principal balances of approximately $134.9 million. The Bank has the ability to
draw additional advances of $61.2 million based upon the mortgage loans and
securities that are currently pledged, subject to a requirement to purchase
additional FHLB stock.
13. Long Term Borrowings:
The following table sets forth selected information for long-term borrowings
(borrowings with an original maturity of greater than one year) as of December
31 (in thousands):
2002 2001
------------ ------------
Note payable to the Bank of North Dakota,
principal due April 1, 2004,
interest payable quarterly at 30 day
LIBOR plus 3.20%, secured by the stock
of BNC National Bank ......................... $ 8,500 $ --
Other .......................................... 61 13
------------ ------------
$ 8,561 $ 13
============ ============
The $8.5 million loan from the Bank of North Dakota includes various covenants
that are primarily operational rather than financial in nature. As of December
31, 2002, the Company was in compliance with these covenants.
At December 31, 2000, BNCCORP had outstanding $12.6 million of subordinated
notes. The 8 5/8 percent Subordinated Notes (the "Notes"), which qualified as
Tier 2 capital up to a certain limit under the Federal Reserve Board's
risk-based capital guidelines (60 percent at December 31, 2000), were considered
unsecured general obligations of BNCCORP. They were redeemable, at the option of
BNCCORP, at par plus accrued interest to the date of redemption. Payment of
principal of the Notes could be accelerated only in the case of certain events
relating to bankruptcy, insolvency or reorganization of BNCCORP. An initial
discount of $750,000 was being amortized to interest expense over the term of
the Notes using the effective interest rate method.
During 2001, BNCCORP purchased and retired $82,000 of the Notes at a discount
using cash generated from the sale of BNC Financial. On August 31, 2001, the
Company redeemed the remaining $12.6 million of the Notes at par through
exercise of the option of BNCCORP discussed above. The remaining $12.6 million
of the Notes were redeemed using a portion of the cash generated from issuing
trust preferred securities through the establishment of BNC Statutory Trust II
(see Note 14 to these consolidated financial statements). The transactions and
redemption of the Notes resulted in an extraordinary loss of $134,000 ($0.06 per
diluted share), net of income taxes of ($70,000).
During 2000, BNCCORP retired $2.0 million of the Notes. BNCCORP purchased the
Notes at a discount, and the transactions resulted in extraordinary gains of
$257,000 ($.11 per diluted share), net of income taxes of $132,000. The Notes
were retired using cash generated from the sale of BNC Financial.
14. Guaranteed Preferred Beneficial Interests in Company's Subordinated
Debentures:
In July 2001, BNCCORP established a special purpose trust, BNC Statutory Trust
II, for the purpose of issuing $15.0 million of floating rate trust preferred
securities. The floating rate trust preferred securities were issued at an
initial rate of 7.29 percent and adjust quarterly to a rate equal to 3-month
LIBOR plus 3.58 percent. The interest rate at December 31, 2002 was 5.34
percent. Prior to July 31, 2011, the rate shall not exceed 12.5 percent. The
proceeds from the issuance, together with the proceeds of the related issuance
of $464,000 of common securities of the trust, were invested in $15.5 million of
junior subordinated deferrable interest debentures of BNCCORP. The floating rate
junior subordinated deferrable interest debentures were issued at an initial
rate of 7.29 percent and adjust quarterly to a rate equal to 3-month LIBOR plus
3.58 percent. The interest rate at December 31, 2002 was 5.34 percent. Prior to
July 31, 2011, the rate shall not exceed 12.5 percent. Concurrent with the
issuance of the preferred securities by the trust, BNCCORP fully and
unconditionally guaranteed all obligations of the special purpose trust related
to the trust preferred securities. The trust preferred securities provide
BNCCORP with a more cost-effective means of obtaining Tier 1 capital for
regulatory purposes than if BNCCORP itself were to issue preferred stock because
BNCCORP is allowed to deduct, for income tax purposes, amounts paid in respect
of the debentures and ultimately distributed to the holders of the trust
preferred securities. The sole assets of the special purpose trust are the
debentures. BNCCORP owns all of the common securities of the trust. The common
securities and debentures, along with the related income effects, are eliminated
within the consolidated financial statements. The preferred securities issued by
the trust rank senior to the common securities. For presentation in the
consolidated balance sheet, the securities are shown net of discount and direct
issuance costs.
The trust preferred securities are subject to mandatory redemption on July 31,
2031, the stated maturity date of the debentures, or upon repayment of the
debentures, or earlier, pursuant to the terms of the trust agreement. On or
after July 31, 2006, the trust preferred securities may be redeemed and the
corresponding debentures may be prepaid at the option of BNCCORP, subject to
Federal Reserve Board approval, at declining redemption prices. Prior to July
31, 2006, the securities may be redeemed at the option of BNCCORP on the
occurrence of certain events that result in a negative tax impact, negative
regulatory impact on the trust preferred securities or negative legal or
regulatory impact on the special purpose trust which would cause it to be deemed
to be an "investment company" for regulatory purposes. In addition, BNCCORP has
the right to defer payment of interest on the debentures and, therefore,
distributions on the trust preferred securities for up to five years.
In July 2000, BNCCORP established a special purpose trust, BNC Capital Trust I,
for the purpose of issuing $7.5 million of 12.045 percent trust preferred
securities. The proceeds from the issuance, together with the proceeds of the
related issuance of $232,000 of 12.045 percent common securities of the trust,
were invested in $7.7 million of 12.045 percent junior subordinated deferrable
interest debentures of BNCCORP. Concurrent with the issuance of the preferred
securities by the trust, BNCCORP fully and unconditionally guaranteed all
obligations of the special purpose trust related to the trust preferred
securities. The trust preferred securities provide BNCCORP with a more
cost-effective means of obtaining Tier 1 capital for regulatory purposes than if
BNCCORP itself were to issue preferred stock because BNCCORP is allowed to
deduct, for income tax purposes, amounts paid in respect of the debentures and
ultimately distributed to the holders of the trust preferred securities. The
sole assets of the special purpose trust are the debentures. BNCCORP owns all of
the common securities of the trust. The common securities and debentures, along
with the related income effects, are eliminated within the consolidated
financial statements. The preferred securities issued by the trust rank senior
to the common securities. For presentation in the consolidated balance sheet,
the securities are shown net of discount and direct issuance costs. The trust
preferred securities are subject to mandatory redemption on July 19, 2030, the
stated maturity date of the debentures, or upon repayment of the debentures, or
earlier, pursuant to the terms of the trust agreement. On or after July 19,
2010, the trust preferred securities may be redeemed and the corresponding
debentures may be prepaid at the option of BNCCORP, subject to Federal Reserve
Board approval, at declining redemption prices. Prior to July 19, 2010, the
securities may be redeemed at the option of BNCCORP on the occurrence of certain
events that result in a negative tax impact, negative regulatory impact on the
trust preferred securities or negative legal or regulatory impact on the special
purpose trust which would cause it to be deemed to be an "investment company"
for regulatory purposes. In addition, BNCCORP has the right to defer payment of
interest on the debentures and, therefore, distributions on the trust preferred
securities for up to five years.
15. Stockholders' Equity:
BNCCORP and the Bank are subject to certain minimum capital requirements (see
Note 18 to these consolidated financial statements). BNCCORP is also subject to
certain restrictions on the amount of dividends it may declare without prior
regulatory approval in accordance with the Federal Reserve Act. In addition,
certain regulatory restrictions exist regarding the ability of the Bank to
transfer funds to BNCCORP in the form of cash dividends. Approval of the Office
of the Comptroller of the Currency ("OCC"), the Bank's principal regulator, is
required for the Bank to pay dividends to BNCCORP in excess of the Bank's net
profits from the current year plus retained net profits for the preceding two
years. At December 31, 2002 approximately $9.4 million of retained earnings were
available for bank dividend declaration without prior regulatory approval.
Pursuant to a Stock Purchase Agreement (the "Agreement"), in April 2002, BNCCORP
issued 297,759 shares of its common stock to Richard W. Milne, Jr., Terrence M.
Scali, and the other sellers named in the Agreement in connection with the
Company's acquisition of Milne Scali. Note 2 to these consolidated financial
statements includes additional information related to the acquisition of Milne
Scali.
On May 3, 2002, BNCCORP issued 150 shares of its noncumulative preferred stock
to Richard W. Milne, Jr. and Terrence M. Scali for cash. Each share has a
preferential noncumulative dividend at an annual rate of 8.00 percent and a
preferred liquidation value of $10,000 per share. The noncumulative preferred
stock is not redeemable by BNCCORP and carries no conversion rights. The
proceeds of the issuance were used for general corporate purposes.
On May 30, 2001, BNCCORP's Board of Directors adopted a rights plan intended to
protect stockholder interests in the event BNCCORP becomes the subject of a
takeover initiative that BNCCORP's Board of Directors believes could deny
BNCCORP's stockholders the full value of their investment. This plan does not
prohibit the Board from considering any offer that it deems advantageous to its
stockholders. BNCCORP has no knowledge that anyone is considering a takeover.
The rights were issued to each common stockholder of record on May 30, 2001, and
they will be exercisable only if a person acquires, or announces a tender offer
that would result in ownership of, 15 percent or more of BNCCORP's outstanding
common stock. The rights will expire on May 30, 2011, unless redeemed or
exchanged at an earlier date.
Each right entitles the registered holder to purchase from BNCCORP one
one-hundredth of a share of Series A Participating Cumulative Preferred Stock,
$.01 par value (the "Preferred Stock"), of BNCCORP at a price of $100 per one
one-hundredth of a share, subject to adjustment. Each share of Preferred Stock
will be entitled to a minimum preferential quarterly dividend payment of $1.00
but will be entitled to an aggregate dividend of 100 times the dividend declared
per share of common stock. In the event of liquidation, the holders of the
Preferred Stock will be entitled to a minimum preferential liquidation payment
of $0.01 per share but will be entitled to an aggregate payment of 100 times the
payment made per share of common stock. Each share of Preferred Stock will have
100 votes, voting together with the common stock. Finally, in the event of any
merger, consolidation or other transaction in which common stock is exchanged,
each share of Preferred Stock will be entitled to receive 100 times the amount
received per share of common stock. Because of the nature of the Preferred
Stock's dividend, liquidation and voting rights, the value of the one
one-hundredth of a share of Preferred Stock purchasable upon exercise of each
right should approximate the value of one share of common stock.
16. Segment Disclosures:
The Company segments its operations into three separate business activities,
based on the nature of the products and services for each segment: banking
operations, insurance operations and brokerage, trust and financial services
operations.
Banking operations provide traditional banking services to individuals and small
and mid-size businesses, such as accepting deposits, consumer and mortgage
banking activities and making commercial loans. The mortgage and commercial
banking activities include the origination and purchase of loans as well as the
sale to and servicing of commercial loans for other institutions.
Insurance operations broker a full range of insurance products and services
including commercial insurance, surety bonds, employee benefits-related
insurance, personal insurance and claims management.
Brokerage, trust and financial services operations provide securities brokerage,
trust and other financial services to individuals and businesses. Brokerage
investment options include individual equities, fixed income investments and
mutual funds. Trust and financial services operations provide a wide array of
trust and other financial services including employee benefit and personal trust
administration services, financial, tax, business and estate planning, estate
administration, agency accounts, employee benefit plan design and
administration, individual retirement accounts ("IRAs"), including custodial
self-directed IRAs, asset management, tax preparation, accounting and payroll
services.
The accounting policies of the three segments are the same as those described in
the summary of significant accounting policies included in Note 1 to these
consolidated financial statements.
The Company's financial information for each segment is derived from the
internal profitability reporting system used by management to monitor and manage
the financial performance of the Company. The operating segments have been
determined by how executive management has organized the Company's business for
making operating decisions and assessing performance.
During 2002, the Company presented the following segments: banking operations,
insurance operations and brokerage operations with brokerage operations not
meeting the thresholds for separate presentation in the interim financial
statement segment disclosures. Due to the changing nature of the brokerage
operations segment and its closer alignment with the trust and financial
services operations of the Company, the Company has elected to redefine its
reporting segments as noted above. Because segment disclosures were not
presented in the 2001 and 2000 audited consolidated financial statements, only
one set of segment disclosures is included in these consolidated financial
statements.
The following tables present segment profit or loss, assets and a reconciliation
of segment information as of, and for the years ended December 31 (in
thousands):
2002 2002
--------------------------------------------------- ----------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other (a) Totals Segments Other(a) Elimination Total
--------- --------- ---------- ---------- -------- ---------- --------- ----------- ------------
Net interest income.......... $ 15,089 $ 41 $ - $ (2,102) $ 13,028 $15,130 $(2,102) $ 1,883 $ 14,911
Other revenue-external
customers................... 6,272 9,191 1,934 115 17,512 17,397 115 (1,216) 16,296
Other revenue-from other
segments................... 99 -- 55 648 802 154 648 (802) --
Depreciation and
amortization............... 1,518 633 33 17 2,201 2,184 17 -- 2,201
Equity in the net income
of investees............... 639 -- -- 3,620 4,259 639 3,620 (4,259) --
Other significant noncash
items:
Provision for credit
losses.................... 1,202 -- -- -- 1,202 1,202 -- -- 1,202
Segment profit (loss) from
continuing operations..... 4,502 1,461 (677) (2,439) 2,847 5,286 (2,439) -- 2,847
Income tax provision
(benefit).................. 1,505 430 (255) (858) 822 1,680 (858) -- 822
Income from discontinued
Fargo branch, net of
income taxes............... 49 -- -- -- 49 49 -- -- 49
Loss on sale of
discontinued Fargo branch,
net of income taxes........ (35) -- -- -- (35) (35) -- -- (35)
Segment profit (loss)........ 3,011 1,031 (422) (1,581) 2,039 3,620 (1,581) -- 2,039
Segment assets, from
continuing operations...... 599,415 26,364 1,307 66,931 694,017 627,086 66,931 (91,789) 602,228
Segment assets............... 599,415 26,364 1,307 66,931 694,017 627,086 66,931 (91,789) 602,228
2001 2001
--------------------------------------------------- ----------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other (a) Totals Segments Other(a) Elimination Total
--------- --------- ---------- ---------- -------- ---------- --------- ----------- ------------
Net interest income......... $ 15,380 $ 18 $ - $ (1,885) $ 13,513 $ 15,398 $ (1,885) $ 1,417 $ 14,930
Other revenue-external
customers.................. 5,204 1,952 2,176 70 9,402 9,332 70 (688) 8,714
Other revenue-from other
segments................... 62 -- 69 703 834 131 703 (834) --
Depreciation and
amortization............... 1,368 96 84 57 1,605 1,548 57 -- 1,605
Equity in the net income
(loss)of investees......... (384) -- -- 2,820 2,436 (384) 2,820 (2,436) --
Other significant noncash
items:
Provision for credit
losses................... 1,699 -- -- -- 1,699 1,699 -- -- 1,699
Segment profit (loss) from
continuing operations.... 5,032 140 (655) (2,131) 2,386 4,517 (2,131) -- 2,386
Income tax provision
(benefit).................. 1,757 (9) (367) (690) 691 1,381 (690) -- 691
Loss from discontinued
Fargo branch, net of
income taxes............... (203) -- -- -- (203) (203) -- -- (203)
Extraordinary item - loss
on early extinguishment
of debt, net of income
taxes...................... -- -- -- (134) (134) -- (134) -- (134)
Cumulative effect of
change in accounting
principle, net of income
taxes...................... (113) -- -- -- (113) (113) -- -- (113)
Segment profit (loss)....... 2,959 149 (288) (1,575) 1,245 2,820 (1,575) -- 1,245
Segment assets, from
continuing operations...... 558,175 2,026 1,976 52,475 614,652 562,177 52,475 (58,685) 555,967
Segment assets.............. 587,265 2,026 1,976 52,475 643,742 591,267 52,475 (58,685) 585,057
2000 2000
--------------------------------------------------- ----------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other (a) Totals Segments Other(a) Elimination Total
--------- --------- ---------- ---------- -------- ---------- --------- ----------- ------------
Net interest income....... $ 14,306 $ 18 $ (1) $ (1,355) $ 12,968 $14,323 $ (1,355) $ 410 $ 13,378
Other revenue-external
customers................ 2,925 2,012 2,998 53 7,988 7,935 53 (305) 7,683
Other revenue-from
other segments........... 2 -- 59 1,426 1,487 61 1,426 (1,487) --
Depreciation and
amortization............. 1,270 95 87 68 1,520 1,452 68 -- 1,520
Equity in the net
income of investees...... 85 -- -- 2,954 3,039 85 2,954 (3,039) --
Other significant
noncash items:
Provision for credit
losses................. 1,202 -- -- -- 1,202 1,202 -- -- 1,202
Segment profit (loss)
from continuing
operations............... 4,728 216 287 (1,592) 3,639 5,231 (1,592) -- 3,639
Income tax provision
(benefit)................ 1,580 20 101 (518) 1,183 1,701 (518) -- 1,183
Loss from discontinued
Fargo branch, net of
income taxes............. (575) -- -- -- (575) (575) -- -- (575)
Gain on disposal of
asset-based lending
subsidiary, net of
income taxes............. -- -- -- 159 159 -- 159 -- 159
Extraordinary item -
gain on early
extinguishment of debt,
net of income taxes...... -- -- -- 257 257 -- 257 -- 257
Segment profit (loss)..... 2,573 196 186 (658) 2,297 2,955 (658) -- 2,297
Segment assets, from
continuing operations.... 545,748 1,794 2,814 48,906 599,262 550,356 48,906 (51,814) 547,448
Segment assets............ 568,316 1,794 2,814 48,906 621,830 572,924 48,906 (51,814) 570,016
- ---------------------------------
(a) The financial information in the "Other" column is for the bank holding
company.
17. Derivatives:
On January 1, 2001, the Company had an interest rate floor contract that
qualified as a cash flow hedge of interest rate risk associated with floating
rate commercial loans. As a result of the adoption of SFAS 133, the Company
recognized this derivative instrument at its fair value and recorded a charge to
earnings of $113,000, net of taxes, for the derivative instrument's loss
excluded from the assessment of hedge effectiveness. This amount is presented as
the cumulative effect of a change in accounting principle for the year ended
December 31, 2001. During 2001, the Company recognized in interest income
$256,000 for the derivative instrument's gain and a loss of $(109,000) was
reclassified into interest income as a result of the discontinuance of its cash
flow hedge.
During May and June 2001, the Company purchased, for $1.2 million, interest rate
cap contracts with notional amounts totaling $40 million to mitigate interest
rate risk in rising-rate scenarios. The referenced interest rate is three-month
LIBOR with $20 million of 4.50 percent contracts having three-year original
maturities and $20 million of 5.50 percent contracts having five-year original
maturities. The contracts, classified as other assets, are reflected in the
Company's December 31, 2002 consolidated balance sheet at their then combined
fair value of $136,000. The contracts are not being accounted for as hedges
under SFAS 133. As a result, the impact of marking the contracts to fair value
has been, and will continue to be, included in net interest income. During the
years ended December 2002 and 2001, the impact of marking the contracts to
market (reflected as an increase in interest expense) was $779,000 and $331,000,
respectively.
18. Regulatory Capital:
BNCCORP and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial results. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, BNCCORP
and the Bank must meet specific capital guidelines that involve quantitative
measures of their assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. Capital amounts and
classifications of BNCCORP and the Bank are also subject to qualitative
judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by the regulations to ensure capital adequacy
require BNCCORP and the Bank to maintain minimum amounts and ratios (set forth
in the tables that follow) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes that, as of
December 31, 2002, BNCCORP and the Bank met all capital adequacy requirements to
which they are subject.
As of December 31, 2002, the most recent notifications from the OCC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must maintain
minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set
forth in the table that follows. There are no conditions or events since that
notification that management believes have changed the institution's category.
Actual capital amounts and ratios of BNCCORP and its subsidiary bank(s) as of
December 31 are also presented in the tables (dollar amounts in thousands):
To be Well Capitalized Under
For Capital Adequacy Prompt Corrective Action
Actual Purposes Provisions
------------------------ ------------------------- ------------------------------
Amount Ratio Amount Ratio Amount Ratio
------------- --------- ------------ ---------- ------------ ---------------
As of December 31, 2002
Total Capital (to risk-weighted assets):
Consolidated............................ $ 41,270 9.53 % $ 34,641 8.0 % N/A N/A
BNC National Bank....................... 45,142 10.45 34,562 8.0 $ 43,202 10.0 %
Tier I Capital (to risk-weighted assets):
Consolidated............................ 25,613 5.92 17,321 4.0 N/A N/A
BNC National Bank....................... 40,137 9.29 17,281 4.0 25,921 6.0
Tier I Capital (to average assets):
Consolidated............................ 25,613 4.46 22,948 4.0 N/A N/A
BNC National Bank....................... 40,137 7.00 22,923 4.0 28,654 5.0
As of December 31, 2001
Total Capital (to risk-weighted assets):
Consolidated............................ $ 53,428 12.96 % $ 32,969 8.0 % N/A N/A
BNC National Bank....................... 44,098 11.01 32,053 8.0 $ 40,067 10.0 %
BNC National Bank of Arizona............ 2,657 22.93 927 8.0 1,159 10.0
Tier I Capital (to risk-weighted assets):
Consolidated............................ 36,536 8.87 16,485 4.0 N/A N/A
BNC National Bank....................... 39,916 9.96 16,027 4.0 24,040 6.0
BNC National Bank of Arizona............ 2,514 21.70 464 4.0 695 6.0
Tier I Capital (to average assets):
Consolidated............................ 36,536 6.33 23,074 4.0 N/A N/A
BNC National Bank....................... 39,916 6.96 22,940 4.0 28,675 5.0
BNC National Bank of Arizona............ 2,514 20.10 500 4.0 625 5.0
19. Fair Value of Financial Instruments:
The estimated fair values of the Company's financial instruments are as follows
as of December 31 (in thousands):
2002 2001
--------------------------------- --------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------------- --------------- ---------------- ---------------
Assets:
Cash, due from banks and federal
funds sold............................ $ 17,137 $ 17,137 $ 23,972 $ 23,972
Investment securities available
for sale.............................. 208,072 208,072 211,801 211,801
Federal Reserve Bank and Federal Home
Loan Bank Stock....................... 7,071 7,071 7,380 7,380
Loans and leases, net................... 330,788 331,034 293,599 296,416
Accrued interest receivable............. 2,856 2,856 3,008 3,008
Derivative financial instruments........ 136 136 915 915
---------------- --------------- ---------------- ---------------
566,060 $ 566,306 540,675 $ 543,492
=============== ===============
Other assets........................... 36,168 44,382
---------------- ----------------
$ 602,228 $ 585,057
================ ================
Liabilities:
Deposits, noninterest-bearing........... $ 44,377 $ 44,377 $ 30,521 $ 30,521
Deposits, interest-bearing.............. 353,868 356,736 344,756 346,765
Borrowings and advances................. 133,881 142,393 117,973 118,846
Accrued interest payable................ 1,608 1,608 2,428 2,428
Guaranteed preferred beneficial
interests in Company's
subordinated debentures............... 22,326 23,926 22,244 22,915
---------------- --------------- ---------------- ---------------
556,060 $ 569,040 517,922 $ 521,475
=============== ===============
Other liabilities....................... 8,445 36,456
Stockholders' equity.................... 37,723 30,679
---------------- ----------------
$ 602,228 $ 585,057
================ ================
Financial instruments with
off-balance-sheet risk:
Commitments to extend credit............ $ 351 $ 323
Standby and commercial
letters of credit..................... 89 7
---------------- ---------------
$ 440 $ 330
================ ===============
20. Financial Instruments With Off-Balance-Sheet Risk:
In the normal course of business, the Company is a party to various financial
instruments with off-balance-sheet risk, primarily to meet the needs of its
customers as well as to manage its interest rate risk. These instruments, which
are issued by the Company for purposes other than trading, carry varying degrees
of credit, interest rate or liquidity risk in excess of the amount reflected in
the consolidated balance sheets.
Commitments to Extend Credit. Commitments to extend credit are agreements to
lend to a customer provided there is no violation of any condition in the
contract. Commitments to extend credit are legally binding and generally have
fixed expiration dates or other termination clauses and may require payment of a
fee. The contractual amount represents the Company's exposure to credit loss in
the event of default by the borrower; however, at December 31, 2002 no losses
were anticipated as a result of these commitments, based on current information.
The Company manages this credit risk by using the same credit policies it
applies to loans. Collateral is obtained to secure commitments based on
management's credit assessment of the borrower. The collateral may include
marketable securities, receivables, inventory, equipment and real estate. Since
the Company expects many of the commitments to expire without being drawn, total
commitment amounts do not necessarily represent the Company's future liquidity
requirements related to such commitments.
Standby and Commercial Letters of Credit. Standby letters of credit are
conditional commitments issued by the Company to guarantee the performance of a
customer to a third party. Commercial letters of credit are issued on behalf of
customers to ensure payment or collection in connection with trade transactions.
In the event of a customer's nonperformance, the Company's credit loss exposure
is the same as in any extension of credit, up to the letter's contractual
amount; however, at December 31, 2002 no losses were anticipated as a result of
these commitments, based on current information. Management assesses the
borrower's credit to determine the necessary collateral, which may include
marketable securities, real estate, accounts receivable and inventory. Since the
conditions requiring the Company to fund letters of credit may not occur, the
Company expects its liquidity requirements related to such letters of credit to
be less than the total outstanding commitments.
The contractual amounts of these financial instruments were as follows as of
December 31, (in thousands):
2002 2001
---------------------- -------------------------
Variable Variable
Fixed Rate Rate Fixed Rate Rate
---------- --------- ---------- ------------
Commitments to
extend credit............. $ 11,322 $ 91,694 $ 18,425 $ 92,543
Standby and commercial
letters of credit......... 188 8,730 355 1,834
Interest Rate Swaps, Caps and Floors. Interest rate swaps are contracts to
exchange fixed and floating rate interest payment obligations based on a
notional principal amount. The Company enters into swaps to hedge its balance
sheet against fluctuations in interest rates. Interest rate caps and floors are
used to protect the Company's balance sheet from unfavorable movements in
interest rates while allowing benefit from favorable movements. The credit risk
related to interest rate contracts is that counterparties may be unable to meet
the contractual terms of the agreements. This risk is estimated by calculating
the present value of the cost to replace outstanding contracts in a gain
position at current market rates, reported on a net basis by counterparties. The
Company manages the credit risk of its interest rate contracts through bilateral
collateral agreements, credit approvals, limits and monitoring procedures.
Additionally, the Company reduces the assumed counterparty credit risk through
master netting agreements that permit the Company to settle interest rate
contracts with the same counterparty on a net basis.
The notional amounts of these financial instruments were as follows as of
December 31 (in thousands):
2002 2001
-------------- --------------
Interest rate caps........... $ 40,000 $ 40,000
21. Guarantees
As of December 31, 2002, the Company had entered into the following guarantee
arrangements:
Contingent Consideration in Business Combination. Pursuant to the terms of the
agreement related to the acquisition of Milne Scali in April 2002, additional
consideration of up to $8.5 million may be payable to the former shareholders of
Milne Scali, subject to Milne Scali achieving certain financial performance
targets. In accordance with SFAS 141, there is no current carrying amount
associated with this guarantee. Additionally, there are no recourse provisions
associated with this guarantee that would enable the Company to recover from
third parties any of the amounts paid under the guarantee and there are no
assets held either as collateral or by third parties that, upon the occurrence
of any triggering event or condition under the guarantee that the Company could
obtain and liquidate to recover all or a portion of the amounts paid under the
guarantee.
Guaranteed Preferred Beneficial Interests in Company's Subordinated Debentures.
BNCCORP, concurrent with the issuance of preferred securities in July 2000 by
BNC Capital Trust I and in July 2001 by BNC Statutory Trust II, fully and
unconditionally guaranteed all obligations of the special purpose trusts related
to the trust preferred securities (See Note 14 for a full description of the
nature of the established trusts and the securities issued by the trusts). There
are no recourse provisions associated with these guarantees that would enable
BNCCORP to recover from third parties any of the amounts paid under the
guarantees and there are no assets held either as collateral or by third parties
that, upon the occurrence of any triggering event or condition under the
guarantees that BNCCORP could obtain and liquidate to recover all or a portion
of the amounts paid under the guarantees.
Performance Standby Letters of Credit. As of December 31, 2002, the Bank had
issued $642,000 of performance standby letters of credit. Performance standby
letters of credit are irrevocable obligations to the beneficiary on the part of
the Bank to make payment on account of any default by the account party in the
performance of a nonfinancial or commercial obligation. Under these
arrangements, the Bank could, in the event of the account party's
nonperformance, be required to pay a maximum of the amount of issued letters of
credit. Under the agreements, the Bank has recourse against the account party up
to and including the amount of the performance standby letter of credit. The
Bank evaluates each account party's creditworthiness on a case-by-case basis and
the amount of collateral obtained varies and is based on management's credit
evaluation of the account party. As of December 31, 2002, under accounting
standards then effective, there was no current carrying amount associated with
these guarantees. Effective January 1, 2003, such guarantees will be recognized
as liabilities at their fair values as they are modified or entered into, in
accordance with FIN 45.
Financial Standby Letters of Credit. As of December 31, 2002, the Bank had
issued $7.9 million of financial standby letters of credit. Financial standby
letters of credit are irrevocable obligations to the beneficiary on the part of
the Bank to repay money borrowed by or advanced to or for the account of the
account party or to make payment on account of any indebtedness undertaken by
the account party, in the event that the account party fails to fulfill its
obligation to the beneficiary. Under these arrangements, the Bank could, in the
event of the account party's nonperformance, be required to pay a maximum of the
amount of issued letters of credit. Under the agreements, the Bank has recourse
against the account party up to and including the amount of the financial
standby letter of credit. The Bank evaluates each account party's
creditworthiness on a case-by-case basis and the amount of collateral obtained
varies and is based on management's credit evaluation of the account party. As
of December 31, 2002, under accounting standards then effective, there was no
current carrying amount associated with these guarantees. Effective January 1,
2003, such guarantees will be recognized as liabilities at their fair values as
they are modified or entered into, in accordance with FIN 45.
22. Related-Party/Affiliate Transactions:
The Bank has entered into transactions with related parties such as opening
deposit accounts for and extending credit to employees of the Company. In the
opinion of management, such transactions have been fair and reasonable to the
Bank and have been entered into under terms and conditions substantially the
same as those offered by the Bank to unrelated parties.
In the normal course of business, loans are granted to, and deposits are
received from, executive officers, directors, principal stockholders and
associates of such persons. The aggregate dollar amount of these loans,
exclusive of loans to any such persons which in the aggregate did not exceed
$60,000, were $1.0 and $1.8 million at December 31, 2002 and 2001, respectively.
During 2002, $264,000 of new loans were made and repayments totaled $1.2
million. The total amount of deposits received from these parties was $3.1 and
$1.8 million at December 31, 2002 and 2001, respectively. Loans to, and deposits
received from, these parties were made on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with unrelated persons and do not involve more than the
normal risk of collection.
On May 3, 2002, BNCCORP issued 150 shares of its noncumulative preferred stock
to Richard W. Milne, Jr. and Terrence M. Scali, executive officers of the
Company, for cash. Each share has a preferential noncumulative dividend at an
annual rate of 8.0 percent and a preferred liquidation value of $10,000 per
share. The noncumulative preferred stock is not redeemable by BNCCORP and
carries no conversion rights.
During the first quarter of 2003, the Company expects to purchase the Milne
Scali building at 1750 East Glendale Avenue, Phoenix, Arizona. The Company will
purchase the building from Milne Scali Properties, LLC. Milne Scali Properties,
LLC is a limited liability company whose members are Richard W. Milne, Jr. and
Terrence M. Scali, executive officers of the Company. The purchase price for the
building will be the appraised amount of $3.9 million, which will be funded
through cash generated from operations. An independent party completed the
appraisal. See Note 27, "Commitments and Contingencies - Leases" for further
discussion of the option to purchase the building.
The Federal Reserve Act limits amounts of, and requires collateral on,
extensions of credit by the Bank to BNCCORP, and with certain exceptions, its
non-bank affiliates. There are also restrictions on the amounts of investment by
the Bank in stocks and other subsidiaries of BNCCORP and such affiliates and
restrictions on the acceptance of their securities as collateral for loans by
the Bank. As of December 31, 2002, BNCCORP and its affiliates were in compliance
with these requirements.
23. Repossessed and Impaired Asset Expenses/Write-Offs:
The Company recorded write downs to estimated net realizable value of other real
estate owned and repossessed assets, and related collection and other expenses,
of $142,000, $40,000, and $470,000 for the years ended December 31, 2002, 2001
and 2000, respectively. The Company's investment in repossessed assets of $8,000
as of December 31, 2002 represents management's current estimate of net
realizable value based upon current valuation of the assets.
24. Income Taxes:
The provision (benefit) for income taxes consists of the following for the years
ended December 31 (in thousands):
2002 2001 2000
----------- ------------ -----------
Continuing Operations -
Current:
Federal..................... $ 800 $ 657 $ 380
State....................... 218 376 200
Deferred:
Federal..................... (250) (218) 385
State....................... 54 (124) 218
----------- ------------ -----------
$ 822 $ 691 $ 1,183
=========== ============ ===========
2002 2001 2000
----------- ------------- -----------
Discontinued Operations -
Current:
Federal..................... $ 5 $ (77) $ (181)
State....................... 1 (6) (96)
----------- ------------- -----------
$ 6 $ (83) $ (277)
=========== ============= ===========
The provision (benefit) for federal income taxes expected at the statutory rate
differs from the actual provision as follows for the years ended December 31 (in
thousands):
2002 2001 2000
----------- ----------- ----------
Tax at 34% statutory rate.......... $ 967 $ 811 $ 1,237
State taxes (net of federal
benefit)......................... 108 85 253
Tax-exempt interest............... (289) (250) (321)
Other, net........................ 36 45 14
----------- ----------- ----------
$ 822 $ 691 $ 1,183
=========== =========== ==========
Temporary differences between the financial statement carrying amounts and tax
bases of assets and liabilities that result in significant portions of the
Company's deferred tax assets and liabilities are as follows as of December 31
(in thousands):
2002 2001
----------- -----------
Deferred tax asset:
Loans, primarily due to
differences in accounting
for credit losses.......................... $ 1,809 $ 1,490
Difference between book and
tax amortization of branch
premium acquisition costs.................. 312 276
Other........................................ 731 392
----------- -----------
Deferred tax asset............... 2,852 2,158
----------- -----------
Deferred tax liability:
Unrealized gain on securities
available for sale......................... 1,666 1,016
Leases, primarily due to differences
in accounting for leases................... 594 420
Premises and equipment, primarily due
to differences in original cost
basis and depreciation................... 902 578
----------- -----------
Deferred tax liability.............. 3,162 2,014
----------- -----------
Net deferred tax asset (liability).. $ (310) $ 144
=========== ===========
The Company has, in its judgment, made certain reasonable assumptions relating
to the realization of deferred tax assets. Based upon these assumptions, the
Company has determined that no valuation allowance is required with respect to
the deferred tax assets.
25. Earnings Per Share:
The following table shows the amounts used in computing EPS and the effect on
weighted average number of shares of potential dilutive common stock issuances:
Net
Income
(Loss) Shares Per-Share
(Numerator) (Denominator) Amount
------------ ------------- -----------
2002
Basic earnings per common share:
Income from continuing operations...... $ 2,025,000
Less: Preferred stock dividends........ (79,000)
------------
Income from continuing operations
available to common stockholders..... 1,946,000 2,611,629 $ 0.74
Income from discontinued Fargo
branch, net of income taxes.......... 14,000 2,611,629 0.01
------------ -----------
Income attributable to common
stockholders......................... $ 1,960,000 2,611,629 $ 0.75
============ ===========
Effect of dilutive shares -
Options............................ 17,169
--------------
Diluted earnings per common share:
Income from continuing operations...... $ 2,025,000
Less: Preferred stock dividends........ (79,000)
------------
Income from continuing operations
available to common stockholders..... 1,946,000 2,628,798 $ 0.74
Income from discontinued Fargo
branch, net of income taxes.......... 14,000 2,628,798 0.01
------------ -----------
Income attributable to common
stockholders......................... $ 1,960,000 2,628,798 $ 0.75
============ ===========
2001
Basic earnings per common share:
Income from continuing operations...... $ 1,695,000 2,395,353 $ 0.71
Loss from discontinued Fargo branch,
net of income taxes.................. (203,000) 2,395,353 (0.08)
Extraordinary item - loss on early
extinguishment of debt, net of
income taxes......................... (134,000) 2,395,353 (0.06)
Cumulative effect of change in
accounting principle, net
of income taxes...................... (113,000) 2,395,353 (0.05)
------------ -----------
Income available to common
stockholders......................... $ 1,245,000 $ 0.52
============ ===========
Effect of dilutive shares -
Options............................ 25,760
------------
Diluted earnings per common share:
Income from continuing operations...... $ 1,695,000 2,421,113 $ 0.70
Loss from discontinued Fargo branch,
net of income taxes.................. (203,000) 2,421,113 (0.08)
Extraordinary item - loss on early
extinguishment of debt,
net of income taxes.................. (134,000) 2,421,113 (0.06)
Cumulative effect of change in
accounting principle, net
of income taxes.................... (113,000) 2,421,113 (0.05)
------------- -----------
Income available to common
stockholders......................... $ 1,245,000 $ 0.51
============= ===========
Net
Income
(Loss) Shares Per-Share
(Numerator) (Denominator) Amount
------------ ------------- ----------
2000
Basic earnings per common share:
Income from continuing operations...... $ 2,456,000 2,397,356 $ 1.02
Gain on disposal of asset-based
lending subsidiary, net of
income taxes......................... 159,000 2,397,356 0.07
Loss from discontinued Fargo branch,
net of income taxes.................. (575,000) 2,397,356 (0.24)
Extraordinary item - gain on early
extinguishment of debt, net of
income taxes......................... 257,000 2,397,356 0.11
------------- ----------
Income available to common
stockholders......................... $ 2,297,000 2,397,356 $ 0.96
============= ==========
Effect of dilutive shares -
Options............................. 1,197
-------------
Diluted earnings per common share:
Income from continuing operations...... $ 2,456,000 2,398,553 $ 1.02
Gain on disposal of asset-based
lending subsidiary, net of
income taxes......................... 159,000 2,398,553 0.07
Loss from discontinued Fargo branch,
net of income taxes.................. (575,000) 2,398,553 (0.24)
Extraordinary item - gain on early
extinguishment of debt, net of
income taxes......................... 257,000 2,398,553 0.11
-------------- ----------
Income available to common
stockholders......................... $ 2,297,000 2,398,553 $ 0.96
============== ==========
The following options and warrants, with exercise prices ranging from $5.88 to
$17.75, were outstanding during the periods indicated but were not included in
the computation of diluted EPS because their exercise prices were higher than
the average price of the Company's common stock for the period:
2002 2001 2000
------------ ------------ -----------
Quarter ended March 31............. 97,508 101,570 159,934
Quarter ended June 30.............. 96,145 97,177 152,548
Quarter ended September 30......... 103,498 95,508 154,348
Quarter ended December 31.......... 91,989 101,649 120,512
26. Benefit Plans:
BNCCORP has a qualified, tax-exempt 401(k) savings plan covering all employees
of BNCCORP and its subsidiaries who meet specified age and service requirements.
The BNCCORP 401(k) savings plan will be merged with the plan of Milne Scali on
April 1, 2003. Under the BNCCORP plan, eligible employees may elect to defer up
to 50 percent of compensation each year not to exceed the dollar limit set by
law. At their discretion, BNCCORP and its subsidiaries provide matching
contributions of up to 50 percent of employee deferrals up to a maximum employer
contribution of 5 percent of employee compensation. Generally, all participant
contributions and earnings are fully and immediately vested. The Company makes
its matching contribution during the first calendar quarter following the last
day of each calendar year and an employee must be employed by the Company on the
last calendar day of the year in order to receive the current year's employer
match. The anticipated matching contribution is expensed monthly over the course
of the calendar year based on employee contributions made throughout the year.
The Company made matching contributions of $261,000, $207,000 and $188,000 for
2002, 2001 and 2000, respectively. Under the investment options available under
the 401(k) savings plan, employees may elect to invest their salary deferrals in
BNCCORP common stock. At December 31, 2002, the assets in the plan totaled $5.5
million and included $1.4 million (200,211 shares) invested in BNCCORP common
stock.
27. Commitments and Contingencies:
Employment Agreements and Noncompete Convenants. The Company has entered into
three-year employment agreements with its chairman of the board and president
and chief executive officer (the "Executives"). The Executives will be paid
minimum annual salaries throughout the terms of the agreements and annual
incentive bonuses as may, from time to time, be fixed by the board of directors.
The Executives will also be provided with benefits under any employee benefit
plan maintained by BNCCORP for its employees generally, or for its senior
executive officers in particular, on the same terms as are applicable to other
senior executives of BNCCORP. Under the agreements, if status as employees with
BNCCORP is terminated for any reason other than death, disability, cause, as
defined in the agreements, or if they terminate their employment for good
reason, as defined in the agreements, or following a change in control of the
Company, as defined in the agreements, then the Executives will be paid a
lump-sum amount equal to three times their current annual compensation.
In conjunction with the April 2002 business combination with Milne Scali, the
Company has entered into five-year employment agreements with the chairman and
president of Milne Scali (the "Insurance Executives"). The Insurance Executives
will be paid minimum annual salaries throughout the terms of the agreements and
annual incentive bonuses as may, from time to time, be fixed by the board of
directors. The Insurance Executives will also be provided with benefits under
any employment benefit plan maintained by BNCCORP for its employees generally,
or for its senior executive officers in particular, on the same terms as are
applicable to other senior executives of BNCCORP.
In conjunction with its 1998 business combination with Lips & Lahr, Inc., ("Lips
& Lahr") the Company assumed five-year employment agreements with two officers
of Lips & Lahr (the "Officers"). The agreements, which originally provided for
salaries based upon a percentage of all net annual commissions received by Lips
& Lahr on business written by the Officers, were amended to provide for minimum
annual salaries through the remainder of the contract term, which ran through
December 31, 2000. Additionally, the agreements provide for the payment of
deferred compensation for a term of ten years commencing on February 1, 2001 and
continuing monthly until paid in full. Finally, as separate consideration for
the release of all present and future claims to the Officers' books of business
at the end of the term of the employment contract and for other terms of the
contract involving confidentiality, nonpiracy and a restrictive covenant
covering a period of five years after the term of the agreement, the agreements
provide for 120 monthly payments also commencing on February 1, 2001. The
deferred compensation payments have been accrued for as of December 31, 2002.
Both of the Officers resigned and the Company remains obligated under the
deferred compensation and non-compete provisions of the original employment
agreements.
In the business combination with Lips & Lahr, BNC Insurance assumed two
additional non-compete agreements with former officers of Lips & Lahr. Monthly
payments under these agreements, which commenced in 1996, are scheduled to
continue into 2006.
Legal Proceedings. From time to time, the Company may be a party to legal
proceedings arising out of its lending, deposit operations or other activities.
The Company engages in foreclosure proceedings and other collection actions as
part of its loan collection activities. From time to time, borrowers may also
bring actions against the Company, in some cases claiming damages. Some
financial services companies have been subjected to significant exposure in
connection with litigation, including class action litigation and punitive
damage claims. While the Company is not aware of any actions or allegations that
should reasonably give rise to any material adverse effect, it is possible that
the Company could be subjected to such a claim in an amount that could be
material. Based upon a review with its legal counsel, management believes that
the ultimate disposition of pending litigation will not have a material effect
on the Company's financial condition, results of operations or cash flows.
Leases. The Company has entered into operating lease agreements for certain
facilities and equipment used in its operations. Rent expense for the years
ended December 31, 2002, 2001 and 2000, was $1.2 million, $675,000 and $422,000,
respectively, for facilities, and $94,000, $94,000 and $43,000, respectively,
for equipment and other items. At December 31, 2002, the total minimum annual
base lease payments for operating leases were as follows:
2003...................... $ 1,421
2004...................... 1,309
2005...................... 1,119
2006...................... 956
2007...................... 918
Thereafter................ 2,025
The Company has the option to purchase the Milne Scali building at 1750 East
Glendale Avenue, Phoenix, Arizona if such option is exercised before the
fifteenth day of April, 2004 or a date which is fifteen days of receipt of
written notice from the lessor that the lessor has received a bona fide third
party purchase offer, whichever is sooner. Under the lease agreement, the
purchase price, payable in cash, shall be the greater of $4.1 million, the price
set forth in a purchase offer, if any, or the fair market value of the building
as of the date the purchase notice is delivered to the lessor. The Company and
the lessor have agreed that the option to purchase the building will be
exercised during the first quarter of 2003. The purchase price will be $3.9
million, the appraised value of the building, and will be funded through cash
generated from operations. If the purchase of the building is completed as
planned, the annual base lease payments for operating leases stated above will
be reduced by $295,000 for 2003, $393,000 for each of the years 2004 through
2007 and $1.7 million for the period thereafter. See Note 22,
"Related-Party/Affiliate Transactions" for further information related to this
transaction.
The Company is subleasing a building in Bismarck. The sublease runs for a term
of 24 months, terminating on May 30, 2003, renewable for 5 additional two-year
terms. Future minimum rentals to be received under the sublease are $84,300 per
annum, paid annually in advance by each June 1.
28. Stock-Based Compensation:
BNCCORP's 1995 Stock Incentive Plan (the "1995 Stock Plan") and its 2002 Stock
Incentive Plan (the "2002 Stock Plan," together, the "Stock Plans") are intended
to provide long-term incentives to its key employees, including officers and
directors who are employees of the Company. The 1995 Stock Plan, which is
administered by the compensation committee of the board of directors (the
"Committee"), provides for an authorization of 250,000 shares of common stock
for issuance thereunder. The 2002 Stock Plan, which is also administered by the
Committee, provides for an authorization of 125,000 shares of common stock for
issuance thereunder. Under the Stock Plans, the Company may grant employees
incentive stock options, nonqualified stock options, restricted stock, stock
awards or any combination thereof. The Committee establishes the exercise price
of any stock options granted under the Stock Plans provided that the exercise
price may not be less than the fair market value of a share of common stock on
the date of grant. The Committee determines vesting requirements, which may
vary, and the maximum term of options granted is generally ten years.
As of December 31, 2002, 24,473 restricted shares issued under the 1995 Stock
Plan were outstanding. 22,473 of the shares were fully vested. 2,000 shares vest
50 percent in each of 2003 and 2004. The Company records the compensation
expense related to restricted stock on a straight-line basis over the applicable
service period. Compensation cost charged to operations was $9,000, $9,000 and
$74,000 in 2002, 2001 and 2000, respectively. The Company did not issue any
restricted stock during 2002, 2001 or 2000.
The Company's Nonemployee Director Stock Option Plan (the "Directors' Plan") was
adopted during 1998, administered by the Committee and terminated during 1999.
The Company applies APB 25 and related interpretations in accounting for both
the Stock Plans and the Directors' Plan. Accordingly, no compensation cost has
been recognized for the options issued under the plans in 2002, 2001 or 2000. As
of December 31, 2002, 180,810 options had been awarded under the 1995 Stock
Plan. 10,775 of them had been exercised and 170,035 remained outstanding. 3,900
options awarded under the Directors' Plan remained outstanding. No awards had
been made under the 2002 Stock Plan. Had compensation cost been determined on
the basis of fair value pursuant to SFAS 123, net income and EPS would have been
reduced as follows for the years ended December 31:
2002 2001 2000
------------- -------------- --------------
Net Income:
As Reported....... $ 2,039,000 $1,245,000 $2,297,000
Pro Forma......... 2,005,000 1,145,000 2,237,000
Basic EPS:
As Reported....... 0.75 0.52 0.96
Pro Forma......... 0.72 0.45 0.89
Diluted EPS:
As Reported....... 0.75 0.51 0.96
Pro Forma......... 0.72 0.44 0.89
Following is a summary of stock option transactions for the years ended December
31:
2002 2001 2000
-------------------------- ---------------------------- -----------------------------
Options Weighted Options Weighted Options Weighted
To Average to Average to Average
Purchase Exercise Purchase Exercise Purchase Exercise
Shares Price Shares Price Shares Price
----------- ----------- ------------ ------------- ----------- -------------
Outstanding, beginning of year.... 208,408 $10.37 118,148 $ 13.84 122,434 $ 14.82
Granted........................... 2,500 7.51 109,840 6.16 18,500 6.03
Exercised......................... (4,000) 6.03 (4,840) 5.94 -- --
Forfeited......................... (32,973) 10.12 (14,740) 8.21 (22,786) 12.80
----------- ------------ -----------
Outstanding, end of year.......... 173,935 10.48 208,408 10.37 118,148 13.84
=========== ============ ===========
Exercisable, end of year.......... 92,248 12.87 106,948 12.88 62,688 13.11
=========== ============ ===========
Weighted average fair value
of options:
Granted....................... $ 3.35 $ 2.91 $ 3.05
=========== ============ ===========
Exercised..................... $ 2.91 $ 2.83 $ --
=========== ============ ===========
Forfeited..................... $ 4.61 $ 3.88 $ 5.84
=========== ============ ===========
The fair value of each option granted is estimated on the grant date using the
Black-Scholes option pricing model. The following assumptions were made in
estimating fair value of options granted for the years ended December 31:
Weighted average - 2002 2001 2000
---------- ----------- ----------
Dividend yield................... 0.00% 0.00% 0.00%
Risk-free interest rate -
7 year treasury yield........... 3.35% 5.00% 6.30%
Volatility....................... 36.73% 35.36% 36.08%
Expected life.................... 7.0 years 7.0 years 7.0 years
Following is a summary of the status of options outstanding at December 31,
2002:
Outstanding Options Exercisable Options
-------------------------------------------- ------------------------------
Weighted Average Weighted Weighted
Remaining Average Average
Contractual Exercise Exercise
Number Life Price Number Price
---------- ---------------- ------------ ----------- ------------
Options with exercise prices
ranging from:
$17.00 to $17.75 63,500 6.0 years $ 17.05 51,580 $ 17.06
$5.88 to $10.00 110,435 8.2 years $ 6.70 40,668 $ 7.56
---------- -----------
173,935 92,248
========== ===========
29. Condensed Financial Information-Parent Company Only:
Condensed financial information of BNCCORP on a parent company only basis is as
follows:
Parent Company Only
Condensed Balance Sheets
As of December 31
(In thousands, except share data)
2002 2001
------------ -------------
Assets:
Cash and cash equivalents................... $ 3,871 $ 6,250
Investment in subsidiaries.................. 64,518 46,847
Loans....................................... -- 5
Receivable from subsidiaries................ 95 86
Deferred charges and intangible
assets, net................................ 154 154
Other....................................... 993 782
------------ -------------
$ 69,631 $ 54,124
============ =============
Liabilities and stockholders' equity:
Subordinated debentures..................... $ 22,484 $ 22,398
Long term note.............................. 8,500 --
Accrued expenses and other liabilities...... 924 1,047
------------ -------------
31,908 23,445
------------ -------------
Preferred stock, $.01 par value -
2,000,000 shares authorized; 150 shares
issued and outstanding as of
December 31, 2002...................... -- --
Capital surplus - preferred stock........... 1,500 --
Common stock, $.01 par value -
10,000,000 shares authorized;
2,700,929 and 2,399,170 shares
issued and outstanding (excluding
42,880 shares held in treasury)........ 27 24
Capital surplus - common stock.............. 16,614 14,084
Retained earnings........................... 17,395 15,435
Treasury stock (42,880 shares).............. (513) (513)
Accumulated other comprehensive income,
net of income taxes..................... 2,700 1,649
------------ -------------
Total stockholders' equity.................. 37,723 30,679
------------ -------------
$ 69,631 $ 54,124
============== =============
Parent Company Only
Condensed Statements of Income
For the Years Ended December 31
(In thousands)
2002 2001 2000
----------- ----------- ---------
Income:
Management fee income.................. $ 649 $ 703 $ 1,426
Interest............................... 83 322 322
Other.................................. 114 70 53
----------- ----------- ---------
Total income....................... 846 1,095 1,801
----------- ----------- ---------
Expenses:
Interest............................... 2,185 2,207 1,677
Personnel expense...................... 521 512 1,162
Legal and other professional........... 210 144 124
Depreciation and amortization.......... 17 57 68
Other.................................. 352 307 361
----------- ----------- ---------
Total expenses..................... 3,285 3,227 3,392
----------- ----------- ---------
Loss before income tax benefit and
equity in undistributed income of
subsidiaries........................... (2,439) (2,132) (1,591)
Income tax benefit.......................... 858 691 518
----------- ----------- ---------
Loss before equity in undistributed
income of subsidiaries................. (1,581) (1,441) (1,073)
Equity in undistributed income of
subsidiaries........................... 3,606 3,023 3,529
----------- ----------- ---------
Income from continuing operations........... 2,025 1,582 2,456
Equity in undistributed income (loss) from
operations of discontinued branch...... 14 (203) (575)
----------- ----------- ---------
Income before gain on disposal of
asset-based lending subsidiary......... 2,039 1,379 1,881
Gain on disposal of asset-based lending
subsidiary............................. -- -- 159
----------- ----------- ---------
Income before extraordinary item............ 2,039 1,379 2,040
Extraordinary item-gain (loss) on early
extinguishment of debt, net of
income taxes........................... -- (134) 257
----------- ----------- ---------
Net income......................... $ 2,039 $ 1,245 $ 2,297
=========== =========== =========
Parent Company Only
Condensed Statements of Cash Flows
For the Years Ended December 31
(In thousands)
2002 2001 2000
--------- --------- ---------
Operating activities:
Net income.................................... $ 2,039 $ 1,245 $ 2,297
Adjustments to reconcile net income to net
cash used in operating activities -
Gain on sale of discontinued operation...... -- -- (159)
Depreciation and amortization............... 18 43 48
Equity in undistributed income of
subsidiaries.............................. (3,620) (2,820) (2,954)
Change in prepaid expenses and other
receivables............................... 265 (111) 20
Change in accrued expenses and other
liabilities............................... (123) 332 98
Other....................................... (482) 386 14
--------- --------- ---------
Net cash used in operating activities.. (1,903) (925) (636)
--------- --------- ---------
Investing activities:
Net decrease in loans........................ 5 11 --
Increase in investment in subsidiaries ...... (13,000) (3,464) (232)
Additions to premises and equipment, net..... (21) 12 (59)
--------- --------- ---------
Net cash used in investing activities.... (13,016) (3,441) (291)
--------- --------- ---------
Financing activities:
Repayments of long-term borrowings........... -- (13,172) (2,001)
Proceeds from long-term borrowings........... 8,500 -- --
Amortization of discount on
subordinated notes......................... -- 371 93
Amortization of deferred charges............. -- 14 20
Proceeds from issuance of subordinated
debentures................................. -- 14,893 7,440
Proceeds from issuance of preferred stock.... 1,500 -- --
Proceeds from issuance of common stock....... 2,524 -- --
Amortization of discount on subordinated
debentures................................. 86 53 12
Payment of preferred stock dividends......... (79) -- --
Other, net................................... 9 (86) 74
--------- --------- ---------
Net cash provided by financing
activities.............................. 12,540 2,073 5,638
--------- --------- ---------
Net increase (decrease) in cash and cash
equivalents.................................. (2,379) (2,293) 4,711
Cash and cash equivalents, beginning of year.... 6,250 8,543 3,832
--------- --------- ---------
Cash and cash equivalents, end of year.......... $ 3,871 $ 6,250 $ 8,543
========= ========= =========
Supplemental cash flow information:
Interest paid................................ $ 2,050 $ 2,143 $ 1,293
========= ========= =========
Income tax payments received from
subsidiary bank(s), net of
income taxes paid......................... $ 1,563 $ 652 $ 69
========= ========= =========
30. Quarterly Financial Data (unaudited, in thousands, except shares and EPS):
2002
-------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------
Interest income............... $ 7,581 $ 7,825 $ 8,431 $ 7,981
Interest expense.............. 4,111 4,538 4,347 3,911
----------- ----------- ----------- ----------
Net interest income........... 3,470 3,287 4,084 4,070
Provision for credit
losses...................... 217 185 400 400
----------- ----------- ----------- ----------
Net interest income
after provision
for credit losses........... 3,253 3,102 3,684 3,670
Noninterest income............ 2,345 4,119 5,123 4,709
Noninterest expense........... 5,374 7,187 7,355 7,242
----------- ----------- ----------- ----------
Income before income
taxes....................... 224 34 1,452 1,137
Income tax provision
(benefit)................... 94 (30) 430 328
----------- ----------- ----------- ----------
Income from continuing
operations.................. 130 64 1,022 809
Gain (loss) from
discontinued Fargo
branch, net of
income taxes................ 60 38 (69) (15)
----------- ----------- ----------- ----------
Net income.................... $ 190 $ 102 $ 953 $ 794
=========== =========== =========== ==========
Dividends on preferred
stock....................... $ -- $ (19) $ (30) $ (30)
----------- ----------- ----------- ----------
Net income attributable
to common stockholders...... $ 190 $ 83 $ 923 $ 764
=========== =========== =========== ==========
Basic earnings per common
share:
Income from continuing
operations (less
preferred stock
dividends).................. $ 0.05 $ 0.02 $ 0.37 $ 0.29
Gain (loss) from
discontinued Fargo
branch, net of
income taxes................ 0.03 0.01 (0.03) (0.01)
----------- ----------- ----------- ----------
Basic earnings per common
share....................... $ 0.08 $ 0.03 $ 0.34 $ 0.28
=========== =========== =========== ==========
Diluted earnings per common
share:
Income from continuing
operations (less preferred
stock dividends)............ $ 0.05 $ 0.02 $ 0.37 $ 0.29
Gain (loss) from discontinued
Fargo branch, net of income
taxes....................... 0.03 0.01 (0.03) (0.01)
----------- ----------- ----------- ----------
Diluted earnings per common
share....................... $ 0.08 $ 0.03 $ 0.34 $ 0.28
=========== =========== =========== ==========
Average common shares:
Basic......................... 2,399,170 2,645,213 2,697,929 2,699,951
Diluted....................... 2,424,739 2,670,195 2,702,709 2,710,311
Unaudited - see accompanying accountant's report.
2001
-------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------- ----------- ----------- ----------
Interest income........................$ 10,155 $ 9,844 $ 8,887 $ 8,700
Interest expense....................... 6,469 5,836 6,027 4,324
----------- ----------- ----------- -----------
Net interest income.................... 3,686 4,008 2,860 4,376
Provision for credit losses............ 350 600 500 249
----------- ----------- ----------- -----------
Net interest income after
provision for credit losses.......... 3,336 3,408 2,360 4,127
Noninterest income..................... 2,187 2,478 1,827 2,222
Noninterest expense.................... 4,305 4,701 5,084 5,469
----------- ----------- ----------- -----------
Income (loss) before income taxes...... 1,218 1,185 (897) 880
Income tax provision (benefit)......... 371 354 (378) 344
----------- ----------- ----------- -----------
Income (loss) from continuing
operations........................... 847 831 (519) 536
Income (loss) from discontinued
Fargo branch, net of income taxes.... (58) (144) (57) 56
----------- ----------- ----------- -----------
Income (loss) before extraordinary
item and cumulative effect of change
in accounting principle.............. 789 687 (576) 592
Extraordinary item - gain (loss) on
early extinguishment of debt, net
of income taxes...................... 4 4 (142) --
Cumulative effect of change in
accounting principle, net of income
taxes................................ (113) -- -- --
----------- ----------- ----------- -----------
Net income (loss)......................$ 680 $ 691 $ (718) $ 592
=========== =========== =========== ===========
Basic earnings per common share:
Income (loss) from continuing
operations...........................$ 0.35 $ 0.35 $ (0.22) $ 0.23
Income (loss) from discontinued
Fargo branch, net of income taxes.... (0.02) (0.06) (0.02) 0.02
Extraordinary item - loss on early
extinguishment of debt, net of
income taxes......................... -- -- (0.06) --
Cumulative effect of change in
accounting principle, net of
income taxes......................... (0.05) -- -- --
----------- ----------- ----------- -----------
Basic earnings (loss) per
common share.........................$ 0.28 $ 0.29 $ (0.30) $ 0.25
=========== =========== =========== ===========
Diluted earnings per common share:
Income (loss) from continuing
operations...........................$ 0.35 $ 0.34 $ (0.22) $ 0.22
Income (loss) from discontinued
Fargo branch, net of income taxes.... (0.02) (0.06) (0.02) 0.02
Extraordinary item - loss on early
extinguishment of debt, net of
income taxes......................... -- -- (0.06) --
Cumulative effect of change in
accounting principle, net of
income taxes......................... (0.05) -- -- --
----------- ----------- ----------- -----------
Diluted earnings (loss) per
common share.........................$ 0.28 $ 0.28 $ (0.30) $ 0.24
=========== =========== =========== ===========
Average common shares:
Basic.................................. 2,394,610 2,394,330 2,398,118 2,399,170
Diluted................................ 2,411,482 2,426,269 2,398,118 2,421,819
Unaudited - see accompanying accountant's report.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
On April 5, 2002, Arthur Andersen LLP ("Arthur Andersen") resigned as our
independent auditors. We filed a Form 8-K on April 5, 2002 reporting Arthur
Andersen's resignation. On May 28, 2002, we appointed KPMG LLP ("KPMG") as our
independent auditors to replace Arthur Andersen. The decision to appoint KPMG
was approved by our Board of Directors, subject to approval of the terms of
KPMG's engagement by the Audit Committee of our Board of Directors. We filed a
Form 8-K on May 28, 2002 reporting the appointment of KPMG.
During its tenure as our independent public accountants, Arthur Andersen's
reports on our consolidated financial statements at and for the years ended
December 31, 2001 and 2000 did not contain an adverse opinion or disclaimer of
opinion and were not qualified or modified as to uncertainty, audit scope or
accounting principles. During the period covered by our consolidated financial
statements at and for the years ended December 31, 2001 and 2000 through the
date of Arthur Andersen's resignation, there were no disagreements on any matter
of accounting principles or practices, financial statement disclosure or
auditing scope or procedure which, if not resolved to Arthur Andersen's
satisfaction, would have caused it to make reference to the subject matter in
conjunction with its report on our consolidated financial statements for such
years; and there were no reportable events as defined in Item 304(a)(1)(v) of
Regulation S-K.
Arthur Andersen was provided with the disclosure set forth above and provided us
with a letter to the effect that it did not disagree with the above statements
as far as they relate to Arthur Andersen.
During the period covered by our consolidated financial statements at and for
the years ended December 31, 2001 and 2000 through the date of appointment of
KPMG, we did not consult KPMG with respect to the application of accounting
principles to a specified transaction, either completed or proposed, or the type
of audit opinion that might be rendered on our financial statements, or any
other matters or reportable events described in Item 304(a)(2) of Regulation
S-K.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information concerning our directors and officers called for by this item will
be included in our definitive Proxy Statement prepared in connection with the
2003 Annual Meeting of Stockholders and is incorporated herein by reference.
Item 11. Executive Compensation
Information concerning the compensation of our executives called for by this
item will be included in our definitive Proxy Statement prepared in connection
with the 2003 Annual Meeting of Stockholders and is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information concerning security ownership of certain beneficial owners and
management called for by this item will be included in our definitive Proxy
Statement prepared in connection with the 2003 Annual Meeting of Stockholders
and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions called for
by this item will be included in our definitive Proxy Statement prepared in
connection with the 2003 Annual Meeting of Stockholders and is incorporated
herein by reference.
Item 14. Controls and Procedures
Quarterly evaluation of the Company's Disclosure Controls and Internal Controls.
Within the 90 days prior to the date of this annual report on Form 10-K, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures ("Disclosure Controls"), and our internal controls and
procedures for financial reporting ("Internal Controls"). This evaluation (the
"Controls Evaluation") was done under the supervision and with the participation
of management, including our President and Chief Executive Officer ("CEO") and
Chief Financial Officer ("CFO"). Rules adopted by the SEC require that in this
section of the annual report we present the conclusions of the CEO and the CFO
about the effectiveness of our Disclosure Controls and Internal Controls based
on and as of the date of the Controls Evaluation.
CEO and CFO Certifications. Appearing immediately following the Signatures
section of this annual report there are "Certifications" of the CEO and the CFO.
The Certifications are required in accordance with Section 302 of the
Sarbanes-Oxley Act of 2002 (the "Section 302 Certifications"). This section of
the annual report is the information concerning the Controls Evaluation referred
to in the Section 302 Certifications and this information should be read in
conjunction with the Section 302 Certifications for a more complete
understanding of the topics presented.
Disclosure Controls and Internal Controls. Disclosure controls are procedures
that are designed with the objective of ensuring that information required to be
disclosed in our reports filed under the Exchange Act, such as this annual
report, is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms. Disclosure Controls are also designed
with the objective of ensuring that such information is accumulated and
communicated to our management, including the CEO and CFO, as appropriate to
allow timely decisions regarding required disclosure. Internal Controls are
procedures which are designed with the objective of providing reasonable
assurance that (1) our transactions are properly authorized; (2) our assets are
safeguarded against unauthorized or improper use; and (3) our transactions are
properly recorded and reported, all to permit the preparation of our financial
statements in conformity with accounting principles generally accepted in the
United States.
Limitations on the Effectiveness of Controls. Our management, including the CEO
and CFO, does not expect that our Disclosure Controls or our Internal Controls
will prevent all error and all fraud. A control system, no matter how well
developed and operated, can provide only reasonable, but not absolute, assurance
that the objectives of the control system are met. Further, the design of a
control system must reflect the fact that there are 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, 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.
Over time, control may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.
Scope of the Controls Evaluation. The CEO/CFO evaluation of our Disclosure
Controls and our Internal Controls included a review of the controls' objectives
and design, our controls' implementation and the effect of the controls on the
information generated for use in this annual report. In the course of the
Controls Evaluation, we sought to identify data errors, controls problems or
acts of fraud and to confirm that appropriate corrective action, including
process improvements, were being undertaken. This type of evaluation will be
done on a quarterly basis so that the conclusions concerning controls
effectiveness can be reported in our quarterly reports on Form 10-Q and annual
report on Form 10-K. Our Internal Controls are also evaluated on an ongoing
basis by our internal audit and credit review departments in connection with
their audit and review activities. The overall goals of these various evaluation
activities are to monitor our Disclosure Controls and our Internal Controls and
to make modifications as necessary. Our external auditors also review Internal
Controls in connection with their audit and review activities. Our intent in
this regard is that the Disclosure Controls and Internal Controls will be
maintained as dynamic systems that change (including with improvements and
corrections) as conditions warrant.
Among other matters, we sought in our evaluation to determine whether there were
any "significant deficiencies" or "material weaknesses" in our Internal
Controls, or whether we had identified any acts of fraud involving personnel who
have a significant role in our Internal Controls. This information was important
both for the Controls Evaluation generally and because items 5 and 6 in the
Section 302 Certifications of the CEO and CFO require that the CEO and CFO
disclose that information to our board's audit committee and to our independent
auditors and to report on related matters in this section of the annual report.
In the professional auditing literature, "significant deficiencies" are referred
to as "reportable conditions." These are control issues that could have a
significant adverse effect on the ability to record, process, summarize and
report financial data in the financial statements. A "material weakness" is
defined in the auditing literature as a particularly serious reportable
condition where the internal control does not reduce to a relatively low level
the risk that misstatements caused by error or fraud may occur in amounts that
would be material in relation to the financial statements and not be detected
within a timely period by employees in the normal course of performing their
assigned functions. We also sought to deal with other controls matters in the
Controls Evaluation, and in each case if a problem was identified, we considered
what revision, improvement and/or correction to make in accordance with our
ongoing procedures.
In accordance with SEC requirements, the CEO and CFO note that, since the date
of the Controls Evaluation to the date of this annual report, there have been no
significant changes in Internal Controls or in other factors that could
significantly affect Internal Controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Conclusions. Based upon the Controls Evaluation, our CEO and CFO have concluded
that, subject to the limitations noted above, our Disclosure Controls are
effective to ensure that material information relating to BNCCORP and its
consolidated subsidiaries is made known to management, including the CEO and
CFO, particularly during the period when our periodic reports are being
prepared, and that our Internal Controls are effective to provide reasonable
assurance that our financial statements are fairly presented in conformity with
accounting principles generally accepted in the United States.
Information concerning certain controls and procedures called for by this item
will be included in our definitive Proxy Statement prepared in connection with
the 2003 Annual Meeting of Stockholders and is incorporated herein by reference.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits.
Reference is made to the Exhibit Index beginning on page E-1 hereby. We
will furnish to any eligible stockholder, upon written request of such
stockholder, a copy of any exhibit listed upon the payment of a reasonable
fee equal to our expenses in furnishing such exhibit.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended December 31,
2002.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant caused this report to be signed on its behalf by the
undersigned; thereunto duly authorized, on March 18, 2003.
BNCCORP, Inc.
By: /s/ Tracy Scott
--------------------------------
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated, on March 18, 2003.
/s/ Tracy Scott Chairman of the Board and Director
- ------------------------------------
Tracy Scott
/s/ Gregory K. Cleveland President, Chief Executive Officer and
- ------------------------------------ Director
Gregory K. Cleveland (Principal Executive Officer)
(Principal Financial Officer)
/s/ Brenda L. Rebel Chief Financial Officer and Director
- ------------------------------------ (Principal Accounting Officer)
Brenda L. Rebel Director
/s/ Denise Forte-Pathroff, M.D.
- ------------------------------------ Director
Denise Forte-Pathroff, M.D.
/s/ John A. Hipp, M.D.
- ------------------------------------ Director
John A. Hipp, M.D.
/s/ Richard M. Johnsen, Jr.
- ------------------------------------ Director
Richard M. Johnsen, Jr.
/s/ David A. Erickson
- ------------------------------------ Director
David A. Erickson
/s/ Jerry R. Woodcox
- ------------------------------------ Director
Jerry R. Woodcox
/s/ Terrence M. Scali
- ------------------------------------ Director
Terrence M. Scali
CERTIFICATIONS
I, Gregory K. Cleveland, President and Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of BNCCORP, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 18, 2003 By /s/ Gregory K. Cleveland
-------------------------------------
Gregory K. Cleveland
President and Chief Executive Officer
I, Brenda L. Rebel, Treasurer and Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-K of BNCCORP, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 18, 2003 By /s/ Brenda L. Rebel
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Brenda L. Rebel
Treasurer and Chief Financial Officer
EXHIBIT INDEX
Exhibit
No. Exhibit Description
2.1 Stock Purchase Agreement dated as of December 6, 1999, by and between
BNCCORP, Inc. and Associated Banc-Corp, incorporated by reference to
Exhibit 2.1 to the Registrant's Form 8-K dated as of January 14, 2000.
3.1 Certificate of Incorporation of the Company, incorporated by reference
to Exhibit 3.1 to the Registrant's Registration Statement on Form SB-2
(Registration No. 33-92369).
3.2 Bylaws of the Company, incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form SB-2 (Registration No.
33-92369).
4.1 Specimen of Common Stock Certificate, incorporated by reference to
Exhibit 4 to Amendment No. 1 to the Registrant's Registration
Statement on Form SB-2 (Registration No. 33-92369).
4.2 Form of Indenture by and between BNCCORP, Inc. and Firstar Trust
Company, as Trustee, incorporated by reference to Exhibit 4.1 to the
Registrant's Registration Statement on Form SB-2 (Registration No.
333-26703).
4.3 Rights Agreement, dated as of May 30, 2001, between BNCCORP, Inc. and
American Stock Transfer and Trust Company, as Rights Agent,
incorporated by reference to Exhibit 1 to the Registrant's Form 8-A
dated June 5, 2001.
10.1 Form of Indemnity Agreement by and between the Company and each of the
Company's Directors, incorporated by reference to Exhibit 10.1 to the
Registrant's Registration Statement on Form SB-2 (Registration No.
33-92369).
10.2 Form of Employment Agreement between the Company and each of Tracy J.
Scott and Gregory K. Cleveland, incorporated by reference to Exhibit
10.2 to the Registrant's Registration Statement on Form SB-2
(Registration No. 33-92369).
10.3 Form of BNCCORP, Inc. 1995 Stock Incentive Plan, incorporated by
reference to Exhibit 10.3 to the Registrant's Registration Statement
on Form SB-2 (Registration No. 33-92369).
10.4 Form of Stock Option Agreement for the Grant of Non-Qualified Stock
Options Under the BNCCORP, Inc. 1995 Stock Incentive Plan dated as of
June 7, 1995, incorporated by reference to Exhibit 10.5 to the
Registrant's Form 10-KSB dated as of March 29, 1996.
10.5 Junior Subordinated Indenture between BNCCORP, Inc. and First Union
National Bank as Trustee dated as of July 12, 2000, incorporated by
reference to Exhibit 10.1 to the Registrant's Form 10-Q dated as of
August 2, 2000.
10.6 Guarantee Agreement between BNCCORP, Inc. as Guarantor and First Union
National Bank as Guarantee Trustee dated as of July 12, 2000 - BNC
Capital Trust I, incorporated by reference to Exhibit 10.2 to the
Registrant's Form 10-Q dated as of August 2, 2000.
10.7 Amended and Restated Trust Agreement among BNCCORP, Inc. as Depositor,
First Union National Bank as Property Trustee, First Union Trust
Company, National Association as Delaware Trustee and the
Administrative Trustees dated as of July 12, 2000 - BNC Capital Trust
I, incorporated by reference to the Registrant's Form 10-Q dated as of
August 2, 2000.
10.8 Indenture between BNCCORP, Inc., as issuer, and State Street Bank and
Trust Company of Connecticut, National Association, as Trustee,
Floating Rate Junior Subordinated Deferrable Interest Debentures Due
2031, dated July 31, 2001, incorporated by reference to Exhibit 10.1
to the Registrant's Form 10-Q dated as of August 13, 2001.
10.9 Guarantee Agreement by and between BNCCORP, Inc. and State Street Bank
and Trust Company of Connecticut, National Association, dated July 31,
2001, incorporated by reference to Exhibit 10.2 to the Registrant's
Form 10-Q dated as of August 13, 2001.
10.10 Amended and Restated Declaration of Trust by and among State Street
Bank and Trust Company of Connecticut, National Association, as
Institutional Trustee, BNCCORP, Inc., as Sponsor, and Gregory K.
Cleveland, Tracy Scott and Brenda L. Rebel, as Administrators, dated
July 31, 2001, incorporated by reference to Exhibit 10.3 to the
Registrant's Form 10-Q dated as of August 13, 2001.
10.11 Form of BNCCORP, Inc. 2002 Stock Incentive Plan, incorporated by
reference to Appendix A to the Company's Definitive Proxy Statement
dates May 17, 2002.
10.12 Stock Purchase Agreement, dated March 22, 2002, by and among BNCCORP,
Inc., BNC Insurance, Inc. and the Sellers named therein, incorporated
by reference to the registrant's Form 8-K filed on May 1, 2002.
10.13 Employment and Non-competition Agreement, dated April 15, 2002, by and
between BNC Insurance, Inc., Milne & Company Insurance, Inc. and
Richard W. Milne, Jr., incorporated by reference to the registrant's
Form 8-K filed on May 1, 2002.
10.14 Employment and Non-competition Agreement, dated April 15, 2002, by and
between BNC Insurance, Inc., Milne & Company Insurance, Inc. and
Terrence M. Scali, incorporated by reference to the registrant's Form
8-K filed on May 1, 2002.
10.15 Branch Purchase and Assumption Agreement by and among Alerus Financial,
National Association, BNC National Bank and its parent, BNCCORP, Inc.,
dated as of July 26, 2002, incorporated by reference to the
registrant's Form 10-Q filed on November 12, 2002.
21.1 Subsidiaries of Company.
23.1 Consent of Independent Certified Public Accountants
99.1 Certifications of Chief Executive Officer and Chief Financial Officer