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U.S. Securities and Exchange Commission
Washington, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarter ended March 31, 2003
[ ] TRANSITION REPORT UNDER 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 (I.R.S. Employer Identification No.)
of incorporation or organization)
322 East Main
Bismarck, North Dakota 58501
(Address of principal executive office)
(701) 250-3040
(Registrant's telephone number)
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes ___ No _X_
The number of shares of the registrant's outstanding common stock on May 2,
2003 was 2,703,295.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share and per share data)
March 31, December 31,
ASSETS 2003 2002
------------ ------------
CASH AND DUE FROM BANKS......................... $ 17,036 $ 16,978
INTEREST-BEARING DEPOSITS WITH BANKS............ 164 159
------------ ------------
Cash and cash equivalents.................. 17,200 17,137
INVESTMENT SECURITIES AVAILABLE FOR SALE........ 202,364 208,072
FEDERAL RESERVE BANK AND FEDERAL HOME
LOAN BANK STOCK............................... 7,071 7,071
LOANS AND LEASES, net........................... 329,461 335,794
ALLOWANCE FOR CREDIT LOSSES..................... (5,219) (5,006)
------------ ------------
Net loans and leases....................... 324,242 330,788
PREMISES AND EQUIPMENT, net..................... 15,314 11,100
INTEREST RECEIVABLE............................. 2,928 2,856
OTHER ASSETS.................................... 3,795 4,119
GOODWILL........................................ 12,210 12,210
OTHER INTANGIBLE ASSETS, net.................... 8,609 8,875
------------ ------------
$ 593,733 $ 602,228
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
DEPOSITS:
Noninterest-bearing........................ $ 37,477 $ 44,362
Interest-bearing -
Savings, interest checking
and money market..................... 190,072 187,531
Time deposits $100,000 and over........ 60,328 64,905
Other time deposits.................... 99,392 101,447
------------ ------------
Total deposits............................. 387,269 398,245
SHORT-TERM BORROWINGS........................... 20,339 28,120
FEDERAL HOME LOAN BANK ADVANCES................. 107,200 97,200
LONG-TERM BORROWINGS............................ 8,543 8,561
OTHER LIABILITIES............................... 9,925 10,053
------------ ------------
Total liabilities................. 533,276 542,179
GUARANTEED PREFERRED BENEFICIAL
INTERESTS IN COMPANY'S SUBORDINATED
DEBENTURES.................................... 22,117 22,326
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value -
2,000,000 shares authorized;
150 shares issued and outstanding........ -- --
Capital surplus - preferred stock.......... 1,500 1,500
Common stock, $.01 par value - 10,000,000
shares authorized; 2,702,029 and
2,700,929 shares issued and
outstanding (excluding 42,880 shares
held in treasury)...................... 27 27
Capital surplus - common stock............. 16,623 16,614
Retained earnings.......................... 18,382 17,395
Treasury stock (42,880 shares)............. (513) (513)
Accumulated other comprehensive income,
net of income taxes.................... 2,321 2,700
------------ ------------
Total stockholders' equity........ 38,340 37,723
------------ ------------
$ 593,733 $ 602,228
============ ============
See accompanying notes to consolidated
financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income
For the Three Months Ended March 31
(In thousands, except per share data)
2003 2002
------------ ------------
INTEREST INCOME:
Interest and fees on loans................... $ 5,184 $ 4,837
Interest and dividends on investments -
Taxable.................................... 1,867 2,458
Tax-exempt................................. 355 217
Dividends.................................. 62 55
Other........................................ -- 14
------------ ------------
Total interest income............. 7,468 7,581
------------ ------------
INTEREST EXPENSE:
Deposits..................................... 2,106 2,626
Short-term borrowings........................ 108 42
Federal Home Loan Bank advances.............. 1,276 1,441
Long-term borrowings......................... 99 2
------------ ------------
Total interest expense............ 3,589 4,111
------------ ------------
Net interest income............... 3,879 3,470
PROVISION FOR CREDIT LOSSES..................... 775 217
------------ ------------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES............................ 3,104 3,253
------------ ------------
NONINTEREST INCOME:
Insurance commissions........................ 4,062 467
Fees on loans................................ 461 504
Service charges.............................. 210 162
Trust and financial services................. 186 219
Net gain on sales of securities.............. 120 430
Brokerage income............................. 51 400
Rental income................................ 22 22
Other........................................ 107 141
------------ ------------
Total noninterest income.......... 5,219 2,345
------------ ------------
NONINTEREST EXPENSE:
Salaries and employee benefits............... 3,965 2,728
Occupancy.................................... 622 464
Interest on subordinated debentures.......... 437 457
Depreciation and amortization................ 348 300
Amortization of intangible assets............ 266 101
Professional services........................ 260 385
Office supplies, telephone and postage....... 254 246
Marketing and promotion...................... 119 135
FDIC and other assessments................... 51 54
Other........................................ 569 504
------------ ------------
Total noninterest expense......... 6,891 5,374
------------ ------------
Income from continuing operations before
income taxes.................................. 1,432 224
Income tax provision............................ 415 94
------------ ------------
Income from continuing operations............... 1,017 130
------------ ------------
See accompanying notes to consolidated
financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income, continued
For the Three Months Ended March 31
(In thousands, except per share data)
2003 2002
----------- ------------
Discontinued Operations:
Income from operations of discontinued
Fargo branch, net of income taxes.............. -- 60
----------- ------------
NET INCOME........................................ $ 1,017 $ 190
=========== ============
Dividends on preferred stock...................... $ 30 $ --
----------- ------------
Income available to common stockholders........... $ 987 $ 190
=========== ============
BASIC EARNINGS PER COMMON SHARE:
Income from continuing operations................. $ 0.37 $ 0.05
Income from discontinued Fargo branch,
net of income taxes............................. -- 0.03
----------- ------------
Basic earnings per common share................... $ 0.37 $ 0.08
=========== ============
DILUTED EARNINGS PER COMMON SHARE:
Income from continuing operations................. $ 0.36 $ 0.05
Income from discontinued Fargo branch,
net of income taxes............................. -- 0.03
----------- ------------
Diluted earnings per common share................. $ 0.36 $ 0.08
=========== ============
See accompanying notes to consolidated financial
statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
For the Three Months Ended March 31
(In thousands)
2003 2002
------------- -------------
NET INCOME.................................... $ 1,017 $ 190
OTHER COMPREHENSIVE LOSS -
Unrealized losses on investment
securities:
Unrealized holding losses
arising during the
period, net of income taxes............ (294) (240)
Less: reclassification adjustment
for gains included in net income,
net of income taxes.................... (85) (270)
------------- -------------
OTHER COMPREHENSIVE LOSS...................... (379) (510)
------------- -------------
COMPREHENSIVE INCOME (LOSS)................... $ 638 $ (320)
============= =============
See accompanying notes to consolidated
financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For the Three Months Ended March 31, 2003
(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,
2002.................... 150 $ -- $ 1,500 2,743,809 $ 27 $ 16,614 $ 17,395 $ (513) $ 2,700 $37,723
Net income.............. -- -- -- -- -- -- 1,017 -- -- 1,017
Other comprehensive
income -
Change in unrealized
holding gains on
securities available
for sale, net of
income taxes and
reclassification
adjustment............ -- -- -- -- -- -- -- -- (379) (379)
Preferred stock
dividends............. -- -- -- -- -- -- (30) -- -- (30)
Other .................. -- -- -- 1,100 -- 9 -- -- -- 9
------- ------- --------- --------- ------- -------- --------- -------- ------------- -------
BALANCE, March 31, 2003.. 150 $ -- $ 1,500 2,744,909 $ 27 $ 16,623 $ 18,382 $ (513) $ 2,321 $38,340
======= ======= ========= ========= ======= ======== ========= ======== ============= =======
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Three Months Ended March 31
(In thousands)
2003 2002
------------ ------------
OPERATING ACTIVITIES:
Net income........................................ $ 1,017 $ 190
Adjustments to reconcile net income to net cash
provided by (used in) operating activities -
Provision for credit losses................... 775 217
Depreciation and amortization................. 348 356
Amortization of intangible assets............. 266 101
Net premium amortization on investment
securities................................... 1,091 824
Proceeds from loans recovered................. 35 28
Write-down of other real estate owned
and repossessed assets....................... 4 --
Change in interest receivable and
other assets, net............................ 365 128
Gain on sale of bank premises and
equipment.................................... (5) --
Net realized gains on sales of
investment securities........................ (120) (430)
Deferred income taxes......................... 423 (84)
Change in dividend distribution payable....... (248) (241)
Change in other liabilities, net.............. (422) (1,246)
Originations of loans to be sold.............. (14,602) (17,526)
Proceeds from sale of loans................... 14,602 17,526
------------ ------------
Net cash provided by (used in)
operating activities....................... 3,529 (157)
------------ ------------
INVESTING ACTIVITIES:
Purchases of investment securities................ (13,158) (19,388)
Proceeds from sales of investment
securities....................................... 5,079 15,776
Proceeds from maturities of
investment securities............................ 12,208 17,718
Net decrease in loans............................. 5,736 3,338
Additions to premises and equipment............... (4,645) (1,623)
Proceeds from sale of premises and equipment...... 88 --
------------ ------------
Net cash provided by investing
activities................................ 5,308 15,821
------------ ------------
FINANCING ACTIVITIES:
Net decrease in demand, savings, interest
checking and money market accounts............... (4,344) (2,436)
Net decrease in time deposits..................... (6,632) (4,153)
Net increase (decrease) in short-term
borrowings....................................... (7,781) 3,184
Repayments of Federal Home Loan Bank advances..... (10,000) (20,000)
Proceeds from Federal Home Loan Bank advances..... 20,000 --
Repayments of long-term borrowings................ (18) (13)
Payment of preferred stock dividends.............. (30) --
Amortization of discount on subordinated
debentures....................................... 22 22
Other, net........................................ 9 3
------------ ------------
Net cash used in financing activities...... (8,774) (23,393)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS................................... 63 (7,729)
CASH AND CASH EQUIVALENTS, beginning
of period.......................................... 17,137 23,972
------------ ------------
CASH AND CASH EQUIVALENTS, end of period............. $ 17,200 $ 16,243
============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid..................................... $ 4,090 $ 4,342
============ ============
Income taxes paid................................. $ 68 $ 90
============ ============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 2003
NOTE 1 - BNCCORP, Inc.
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, Milne Scali & Company, BNC
Insurance, Inc. and BNC Asset Management, Inc., the "Bank"). BNCCORP, through
these wholly owned subsidiaries, which operate from 21 locations in Arizona,
Minnesota and North Dakota, provides a broad range of banking, insurance,
brokerage, trust and other financial services to small and mid-sized 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 consolidated financial statements included herein are for
BNCCORP, Inc. and its subsidiaries. All significant intercompany transactions
and balances have been eliminated in consolidation.
NOTE 2 - Basis of Presentation
The accompanying interim consolidated financial statements have been prepared by
the Company, without audit, in accordance with accounting principles generally
accepted in the United States for interim financial information and pursuant to
the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations, although the
Company believes that the disclosures made are adequate to make the information
presented not misleading.
The unaudited consolidated financial statements as of March 31, 2003 and for the
three-month periods ended March 31, 2003 and 2002 include, in the opinion of
management, all adjustments, consisting solely of normal recurring adjustments,
necessary for a fair presentation of the financial results for the respective
interim periods and are not necessarily indicative of results of operations to
be expected for the entire fiscal year ending December 31, 2003.
The accompanying interim consolidated financial statements have been prepared
under the presumption that users of the interim consolidated financial
information have either read or have access to the audited consolidated
financial statements for the year ended December 31, 2002. Accordingly, footnote
disclosures which would substantially duplicate the disclosures contained in the
December 31, 2002 audited consolidated financial statements have been omitted
from these interim consolidated financial statements. It is suggested that these
interim consolidated financial statements be read in conjunction with the
audited consolidated financial statements for the year ended December 31, 2002
and the notes thereto.
NOTE 3 - Reclassifications
Certain of the 2002 amounts have been reclassified to conform to the 2003
presentations. These reclassifications had no effect on net income or
stockholders' equity.
NOTE 4 - Earnings Per Share
The following table shows the amounts used in computing earnings per share
("EPS") and the effect on weighted average number of shares of potential
dilutive common stock issuances for the three-month periods ended March 31:
Net Per-Share
Income Shares Amount
------------ ------------- ------------
2003
Basic earnings per common share:
Income from continuing operations...... $1,017,000
Less: Preferred stock dividends........ 30,000
------------
Income from continuing operations
available to common stockholders...... $ 987,000 2,701,274 $ 0.37
============ ============
Effect of dilutive shares -
Options............................. 29,939
-------------
Diluted earnings per common share:
Income from continuing operations...... $1,017,000
Less: Preferred stock dividends........ 30,000
------------
Income from continuing operations
available to common stockholders...... $ 987,000 2,731,213 $ 0.36
============ ============
2002
Basic earnings per common share:
Income from continuing operations...... $ 130,000 2,399,170 $ 0.05
Income from discontinued Fargo
branch, net of income taxes........... 60,000 2,399,170 0.03
------------ ------------
Income available to common
stockholders.......................... $ 190,000 2,399,170 $ 0.08
============ ============
Effect of dilutive shares -
Options............................. 25,569
-------------
Diluted earnings per common share:
Income from continuing operations...... $ 130,000 2,424,739 $ 0.05
Income from discontinued Fargo
branch, net of income taxes........... 60,000 2,424,739 0.03
------------ ------------
Income available to common
stockholders.......................... $ 190,000 2,424,739 $ 0.08
============ ============
The following number of options, with exercise prices ranging from $8.20 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 BNCCORP's common stock for the period:
2003 2002
---------------- ---------------
Quarter ended March 31.......... 77,185 97,508
NOTE 5 - 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-sized 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 the
consolidated financial statements for the year ended December 31, 2002.
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.
The following tables present segment profit or loss, assets and a reconciliation
of segment information as of, and for the three months ended March 31 (in
thousands):
2003 2003
----------------------------------------------------- -------------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other(a) Totals Segments Other(a) Elimination Total
--------- --------- --------- ---------- -------- ---------- -------- ------------ ------------
Net interest
income................. $ 3,943 $ 22 $ -- $ (536) $ 3,429 $ 3,965 $ (536) $ 450 $ 3,879
Other revenue-
external customers..... 1,198 4,093 245 26 5,562 5,536 26 (343) 5,219
Other revenue-from
other segments......... 32 -- 12 155 199 44 155 (199) --
Depreciation and
amortization........... 390 216 3 5 614 609 5 -- 614
Equity in the net
income of investees.... 1,053 -- -- 1,461 2,514 1,053 1,461 (1,053) 1,461
Other significant
noncash items:
Provision for
credit losses........ 775 -- -- -- 775 775 -- -- 775
Segment profit (loss)
from continuing
operations............. 537 1,496 7 (608) 1,432 2,040 (608) -- 1,432
Income tax provision
(benefit).............. 153 429 (3) (164) 415 579 (164) -- 415
Segment profit (loss)... 384 1,067 10 (444) 1,017 1,461 (444) -- 1,017
Segment assets, from
continuing operations.. 593,097 27,782 1,327 67,837 690,043 622,206 67,837 (96,310) 593,733
Segment assets.......... 593,097 27,782 1,327 67,837 690,043 622,206 67,837 (96,310) 593,733
2002 2002
----------------------------------------------------- -------------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other(a) Totals Segments Other(a) Elimination Total
--------- --------- --------- ---------- -------- ---------- -------- ------------ -------------
Net interest income..... $ 3,440 $ 3 $ -- $ (445) $ 2,998 $ 3,443 $ (445) $ 471 $ 3,469
Other revenue-external
customers............... 1,498 489 618 50 2,655 2,605 50 (309) 2,346
Other revenue-from other
segments............... 27 -- 15 150 192 42 150 (192) --
Depreciation and
amortization........... 369 21 7 4 401 397 4 -- 401
Equity in the net income
(loss) of investees.... (104) -- -- 546 442 (104) 546 (442) --
Other significant
noncash items:
Provision for credit
losses............... 217 -- -- -- 217 217 -- -- 217
Segment profit (loss)
from continuing
operations............. 846 (17) (105) (500) 224 724 (500) -- 224
Income tax provision
(benefit).............. 288 (1) (48) (145) 94 239 (145) -- 94
Loss from discontinued
Fargo branch, net of
income taxes........... 60 -- -- -- 60 60 -- -- 60
Segment profit (loss)... 618 (16) (57) (355) 190 545 (355) -- 190
Segment assets, from
continuing operations.. 526,719 1,697 2,140 52,546 583,102 530,556 52,546 (55,287) 527,815
Segment assets.......... 558,763 1,697 2,140 52,546 615,146 562,600 52,546 (55,287) 559,859
- -------------
(a) The financial information in the "Other" column is for the bank holding
company.
NOTE 6 - Stock-Based Compensation
At March 31, 2003, the Company had two stock-based employee compensation plans.
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 three-month periods ended
March 31:
2003 2002
-------------- -------------
Net income, as reported.................... $ 1,017,000 $ 190,000
Add: total stock-based employee
compensation expense included
in reported net income, net
of related tax effects.................. 2,000 2,000
Deduct: total stock-based employee
compensation expense determined
under fair value method for all
awards, net of related tax effects...... (10,000) (10,000)
-------------- -------------
Pro forma net income....................... $ 1,009,000 $ 182,000
============== =============
Earnings per share:
Basic - as reported...................... $ 0.37 $ 0.08
Basic - pro forma........................ 0.35 0.07
Diluted - as reported.................... 0.36 0.08
Diluted - pro forma...................... 0.35 0.07
NOTE 7 - Goodwill and Other Intangible Assets
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 Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" ("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 had
$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. During the second quarter of
2002, the acquisition of Milne Scali & Company ("Milne Scali") resulted in
additional goodwill of approximately $11.8 million. The Company will complete
its annual goodwill impairment assessment during the second quarter of 2003.
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.
The Company reviews intangible assets annually for other-then-temporary
impairment, or whenever events or changes in circumstances indicate that their
carrying amounts may not be recoverable. If impairment is indicated through such
analysis, the asset is written down to the extent that the carrying value
exceeds its fair value.
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. Goodwill will be assessed for impairment
again during the second quarter of 2003.
The following table indicates that there were no changes in goodwill between
January 1, 2003 and March 31, 2003. Goodwill is presented by reporting segment
(amounts are in thousands):
Segment
-------------------------------------------------
Banking Insurance Other Total
----------- ----------- ---------- -----------
Balance, January 1, 2003...... $ 212 $ 11,821 $ 177 $ 12,210
Changes during the quarter.... -- -- -- --
----------- ----------- ---------- -----------
Balance, March 31, 2003....... $ 212 $ 11,821 $ 177 $ 12,210
=========== =========== ========== ===========
Intangible Assets. The gross carrying amount of intangible assets and the
associated accumulated amortization at March 31, 2003 is presented in the table
below (in thousands):
Gross
Carrying Accumulated Net Carrying
Amount Amortization Amount
----------- ------------ ------------
Intangible assets:
Core deposit intangibles....... $ 3,497 $ 2,672 $ 825
Insurance books of business
intangibles................... 8,018 638 7,380
Other.......................... 874 470 404
----------- ------------ ------------
Total.................... $ 12,389 $ 3,780 $ 8,609
=========== ============ ============
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 $266,000 and $101,000 for the
three-month periods ended March 31, 2003 and 2002, respectively.
The following table shows the estimated future amortization expense for
amortized intangible assets existing on the Company's books at March 31, 2003
(in thousands). Projections of amortization expense are based on existing asset
balances as of March 31, 2003. 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
------------- -------------- ---------- ----------
Nine months ended
December 31, 2003........ $ 262 $ 499 $ 36 $ 797
Year ended December 31,
2004.................... 350 665 48 1,063
2005.................... 233 665 48 946
2006.................... -- 665 -- 665
2007.................... -- 665 -- 665
2008.................... -- 665 -- 665
NOTE 8 - Related Party Transactions
During March 2003, the Company purchased the Milne Scali building at 1750 East
Glendale Avenue, Phoenix, Arizona. The Company purchased 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 was the appraised
amount of $3.9 million. The purchase was funded through cash generated from
operations. An independent party completed the appraisal.
NOTE 9 - Derivative Activities
During May and June 2001, the Company purchased 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 maturities and $20.0
million of 5.50 percent contracts having five-year maturities. The total amount
paid for the contracts was $1.2 million. The contracts are reflected in the
Company's consolidated balance sheet at their current combined fair value of
approximately $109,500. The contracts are not being accounted for as hedges
under Statement of Financial Accounting Standards No. 133, "Accounting for
Derivatives and Hedging Activities." 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 three months ended March 31, 2003 and 2002, the
impact of marking the contracts to market, reflected as additional interest
expense on Federal Home Loan Bank ("FHLB") advances, was a reduction to net
interest income of approximately $27,000 and $79,000, respectively.
NOTE 10 - Recently Adopted Accounting Standards
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. The Company adopted this standard on
January 1, 2003; however, adoption of this statement did not have a material
impact.
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.
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 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"). 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 Statement of Financial Accounting Standards No.
141, "Business Combinations" ("SFAS 141") and SFAS 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. 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. The Company has
adopted the disclosure requirements of Fin 45 and has applied the recognition
and measurement provisions for guarantees entered into or modified after
December 31, 2002. Between January 1, 2003 and March 31, 2003, the Company
entered into performance and financial standby letters of credit totaling $10.1
million. These guarantees have been recognized as liabilities on the Company's
balance sheet at their estimated combined fair value of approximately $68,000.
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 was permitted if statements for a
fiscal year ending prior to December 15, 2002 had 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 its December 31, 2002 consolidated financial statements and has
adopted the interim disclosure requirements of SFAS 148 for purposes of these
consolidated financial statements. Interim disclosures related to stock-based
compensation are presented in Note 6 to these consolidated financial statements.
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 has, and will continue to, adopt the
various provisions of 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.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Comparison of Financial Condition at March 31, 2003 and December 31, 2002
Assets. Our total assets decreased $8.5 million, from $602.2 million at December
31, 2002 to $593.7 million at March 31, 2003. The following table presents our
assets by category as of March 31, 2003 and December 31, 2002, as well as the
amount and percent of change between the two dates. Significant changes are
discussed in lettered explanations below the table (amounts are in thousands):
Change
March 31, December 31, ------------------------
Assets 2003 2002 $ %
- ----------------------------- ---------- ------------- ----------- ------------
Cash and due from
banks........................ $ 17,036 $ 16,978 $ 58 0.3%
Interest-bearing
deposits with banks.......... 164 159 5 3.1%
Investment securities
available for sale........... 202,364 208,072 (5,708) (2.7)% (a)
Federal Reserve Bank
and Federal Home Loan
Bank Stock................... 7,071 7,071 -- --
Loans and leases, net......... 324,242 330,788 (6,546) (2.0)% (b)
Premises and equipment, net... 15,314 11,100 4,214 38.0% (c)
Interest receivable........... 2,928 2,856 72 2.5%
Other assets.................. 3,795 4,119 (324) (7.9)%
Goodwill...................... 12,210 12,210 -- --
Other intangible assets, net.. 8,609 8,875 (266) (3.0)%
---------- ------------- ----------- ------------
Total assets......... $ 593,733 $ 602,228 $(8,495) (1.4)%
========== ============= =========== ============
- -------------------
(a) Investment securities available for sale decreased as part of our current
strategy of allowing maturing brokered and national market certificates of
deposit ("CDs") to run off without attempting to renew or replace them with
other such wholesale deposits. Cash flow from the investment portfolio
provides some of the liquidity to allow the CD run off.
(b) Loans typically increase at yearend as commercial customers draw down on
their lines of credit and then make payments on the lines during the first
quarter of the year. Total loans increased $38.0 million between March 31,
2002 and March 31, 2003. Commercial loan demand to date during 2003 has
decreased compared to such loan demand experienced for the same period in
2002. Due to current economic conditions, it is difficult to predict, with
any degree of certainty, loan growth in future periods.
(c) Premises and equipment increased due to our purchase of the Milne Scali
building in March 2003 for $3.9 million and the continued construction of a
facility in Scottsdale, Arizona.
Allowance for Credit Losses. The following table sets forth information
regarding changes in our allowance for credit losses for the three-month periods
ending March 31, 2003 and 2002 (amounts are in thousands):
Three Months
Ended March 31,
---------------------------------
2003 2002
--------------- ---------------
Balance, beginning of period....... $ 5,006 $ 4,325
Provision for credit losses........ 775 217
Loans charged off.................. (597) (84)
Loans recovered.................... 35 28
--------------- ---------------
Balance, end of period............. $ 5,219 $ 4,486
=============== ===============
Ending loan portfolio ............. $ 329,461 $ 291,492
=============== ===============
Allowance for credit losses as
a percentage of ending loan
portfolio......................... 1.58% 1.54%
As of March 31, 2003, our allowance for credit losses was 1.58 percent of total
loans as compared to 1.49 percent at December 31, 2002 and 1.54 percent at March
31, 2002. Net charge-offs as a percentage of average total loans for the
three-month periods ended March 31, 2003 and 2002 were as follows:
Three Months
Ended March 31,
-----------------------------
2003 2002
------------- -------------
Ratio of net charge-offs to
average total loans................. (0.17)% (0.02)%
Ratio of net charge-offs to
average total loans, annualized..... (0.69)% (0.08)%
Our provision for loan losses for the three-month period ended March 31, 2003
was $775,000 compared to $217,000 for the same period in 2002. This increase is
a direct response to the fact that a few large credits moved to the criticized
asset category during the quarter ended March 31, 2003.
Loans charged off during the first quarter of 2003 totaled $597,000,
representing a $513,000 increase over loans charged off during the first quarter
of 2002. The increase was primarily attributable to charge-offs related to two
commercial credits. The first is a contractor on which we charged off $400,000
of principal. We continue to pursue liquidation efforts on this credit. The
second charge-off totaled $182,000 of interest income, which was related to a
commercial real estate property. This credit is discussed further below in the
nonaccrual loans section under "Nonperforming Assets."
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 relied upon by management to ensure that changes in
estimated credit loss levels are reflected in our allowance for credit losses on
a timely basis. Management also considers 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 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.
Nonperforming Assets. The following table sets forth information concerning our
nonperforming assets as of the dates indicated (amounts are in thousands):
March 31, December 31,
2003 2002
------------ -------------
Nonperforming loans:
Loans 90 days or more delinquent
and still accruing interest............... $ 1,844 $ 5,081
Nonaccrual loans........................... 7,045 2,549
Restructured loans......................... -- --
------------ -------------
Total nonperforming loans..................... 8,889 7,630
Other real estate owned and repossessed
assets.................................... -- 8
------------ -------------
Total nonperforming assets.................... $ 8,889 $ 7,638
============ =============
Allowance for credit losses................... $ 5,219 $ 5,006
============ =============
Ratio of total nonperforming assets to
total assets ............................... 1.50% 1.27%
Ratio of total nonperforming loans to
total loans................................. 2.70% 2.27%
Ratio of allowance for credit losses to
total nonperforming loans................... 59% 66%
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 March 31, 2003 was a $1.8 million commercial real
estate loan on which we believe we are adequately collateralized.
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 $7.0 million in the nonaccrual category at March 31, 2003, $5.0 million
relates to one commercial real estate loan (which was included in the loans 90
days or more delinquent and still accruing interest category at December 31,
2002), $1.2 million relates to a second commercial credit relationship which
continues to be managed through liquidation of collateral which consists
primarily of commercial equipment and $528,000 relates to another commercial
relationship which is partially guaranteed by the Small Business Administration.
Regarding the $5.0 million credit, the Bank was scheduled to take title of the
property on April 24, 2003 and has voluntarily elected to postpone the
foreclosure until May 24, 2003.
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
March 31, 2003 or 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. We had no other real estate owned and repossessed assets at
March 31, 2003 and $8,000 at December 31, 2002.
Liabilities. Our total liabilities decreased $8.9 million, from $542.2 million
at December 31, 2002 to $533.3 million at March 31, 2003. The following table
presents our liabilities by category as of March 31, 2003 and December 31, 2002
as well as the amount and percent of change between the two dates. Significant
changes are discussed in lettered explanations below the table (amounts are in
thousands):
Change
------------------------
March 31, December 31,
Liabilities 2003 2002 $ %
- --------------------------- ---------- ------------ ----------- -----------
DEPOSITS:
Noninterest-bearing........ $ 37,477 $ 44,362 $ (6,885) (15.5)% (a)
Interest-bearing -
Savings, interest
checking and money
market.................. 190,072 187,531 2,541 1.4% (b)
Time deposits $100,000
and over................ 60,328 64,905 (4,577) (7.1)% (c)
Other time deposits...... 99,392 101,447 (2,055) (2.0)% (d)
Short-term borrowings...... 20,339 28,120 (7,781) (27.7)% (e)
Federal Home Loan Bank
advances.................. 107,200 97,200 10,000 10.3% (f)
Long-term borrowings....... 8,543 8,561 (18) (0.2)%
Other liabilities.......... 9,925 10,053 (128) (1.3)%
----------- ----------- -----------
Total liabilities...... $ 533,276 $ 542,179 $ (8,903) (1.6)%
=========== =========== ===========
- -------------------
(a) Our noninterest-bearing deposits typically increase at yearend as
commercial customers draw down on lines of credit and place funds in the
bank's noninterest-bearing deposit accounts. Noninterest-bearing deposits
can fluctuate widely on a day-to-day basis due to the number of commercial
customers we serve and the nature of their transaction account activity.
(b) The increase in savings, interest checking and money market accounts is due
to continued growth in the Company's Wealthbuilder product line, including
growth of these products in the Arizona and Minnesota markets.
(c) Time deposits $100,000 and over decreased primarily because brokered and
national market CDs decreased approximately $6.6 million between December
31, 2002 and March 31, 2003.
(d) Other time deposits declined primarily because a number of CDs, held by
credit unions and other financial institutions (with balances averaging
approximately $99,000), matured and the funds were not reinvested.
(e) Short-term borrowings decreased primarily because we had $15.0 million of
federal funds purchased outstanding at December 31, 2002 compared to only
$7.6 million at March 31, 2003.
(f) $10.0 million of FHLB advances held at December 31, 2002 matured in January
2003 and, at March 31, 2003, we had $20.0 million of short-term FHLB
advances. We use such short-term advances to manage liquidity similar to
how we use federal funds purchased on a day-to-day basis. The short-term
FHLB advances provide us with a slightly more cost-effective way of
managing our short-term liquidity needs since the FHLB gives a discount for
advances of $10.0 million or more.
Stockholders' Equity. Our stockholders' equity increased $617,000 between
December 31, 2002 and March 31, 2003. This increase was primarily attributable
to earnings of $1,017,000 offset by a $379,000 decrease in accumulated other
comprehensive income and $21,000 of other transactions such as payment of
preferred stock dividends, stock option exercises and vesting of restricted
stock.
Capital Adequacy and Expenditures. We actively monitor compliance with
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. The following table includes the risk-based
and leverage capital ratios of the Company and the Bank as of March 31, 2003:
Tier 1 Total Tier 1
Risk-Based Risk-Based Leverage
Ratio Ratio Ratio
------------- ------------ --------------
BNCCORP, consolidated..... 6.33% 9.83% 4.73%
BNC National Bank......... 9.76% 10.98% 7.29%
As of March 31, 2003, BNCCORP and the Bank exceeded capital adequacy
requirements and the Bank was considered "well-capitalized" under prompt
corrective action provisions.
During 2002, we 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. During March 2003, we purchased the Milne Scali building at
1750 East Glendale Avenue, Phoenix, Arizona for its appraised price of $3.9
million. The purchase was funded through cash generated from operations. See
Note 8 to the consolidated financial statements included under Item 1 for
further discussion of this transaction. There are no other major capital
expenditures anticipated during the remainder of 2003 as we expect current
facilities, along with the construction of the facility in Scottsdale, to be
sufficient for operating purposes.
Comparison of Operating Results for the Three Months
Ended March 31, 2003 and 2002
General. Record net income from continuing operations of $1.02 million, or $0.36
per diluted share, for the three-month period ended March 31, 2003 represented a
more than six-fold increase over net income from continuing operations of
$130,000, or $0.05 per share, reported for the same period in 2002. Net income
for the year-ago quarter also included income of $60,000, or $0.03 per share,
from the operations of our Fargo, North Dakota branch office, which was sold on
September 30, 2002, and subsequently reclassified as a discontinued operation.
The first quarter results for 2003 included a significant contribution from
insurance operations, primarily Milne Scali, a Phoenix, Arizona-based insurance
agency acquired in April 2002. The financial performance of the insurance
segment is generally strongest in the first quarter of the year due to
contingency payments received from insurance carriers.
Net interest income rose 11.8 percent, to $3.88 million for the first quarter of
2003, compared with $3.47 million for the same quarter one year earlier. Net
interest margin improved to 2.90 percent for the quarter ended March 31, 2003
compared with 2.80 percent for the same period one year earlier.
Noninterest income was $5.22 million for the 2003 first quarter, rising 122.6
percent from $2.35 million in the year-ago period. Noninterest income
represented 57.36 percent of gross revenues for the recent quarter, rising from
40.33 percent for the comparable period of 2002. The sharp improvement was
largely due to insurance commissions and contingency revenues produced by Milne
Scali, which was not part of our Company for the 2002 period.
Noninterest expense for the first quarter of 2003 was $6.89 million. This
represents a 28.2 percent increase from $5.37 million in the 2002 first quarter,
but a decrease of 4.8 percent sequentially from the $7.24 million recorded for
the fourth quarter of 2002. The year-over-year increase in noninterest expense
primarily reflected the addition of Milne Scali and our expanding Arizona
operations.
Our return on average common stockholders' equity, from continuing operations,
for the most recent quarter was 10.85 percent compared with 1.68 percent for the
same period one year earlier. Our return on average assets, from continuing
operations, for the most recent quarter was 0.69 percent compared with 0.10
percent for the same period one year earlier.
Net Interest Income. Net interest income for the three-month period ended March
31, 2003 increased approximately $409,000, or 11.8 percent, from approximately
$3.47 million to approximately $3.88 million. Net interest margin increased to
2.90 percent for the quarter ended March 31, 2003 from 2.80 percent for the same
period one year earlier. Net interest income and margin for the three-month
periods ended March 31, 2003 and 2002 were negatively impacted by derivative
contract-related transactions during the periods totaling approximately $27,000
and $79,000, respectively. Without these derivative transactions, net interest
income for the periods would have been approximately $3.91 and $3.55 million,
respectively, and net interest margin would have been 2.92 and 2.87 percent,
respectively.
The following table presents average balances, interest earned or paid,
associated yields on interest-earning assets and costs on interest-bearing
liabilities for the three-month periods ended March 31, 2003 and 2002, as well
as the changes between the periods presented. Significant factors contributing
to the increase in net interest income and net interest margin are discussed in
lettered notes below the table (amounts are in thousands):
Three Months Ended March 31,
---------------------------------------------------------------
2003* 2002* Change
------------------------------- ------------------------------ ---------------------------------
Interest Average Interest Average Interest Average
Average earned yield or Average earned yield or Average earned yield
balance or paid cost balance or paid cost balance or paid or cost
--------- --------- --------- --------- --------- -------- ---------- ---------- ---------
Interest-earning assets
Federal funds sold /
interest bearing due
from...................... $ 340 $ -- -- $ 1,822 $ 14 3.12% $ (1,482) $ (14) -3.12%
Investments................ 215,816 2,284 4.29% 210,247 2,730 5.27% 5,569 (446) -0.98%(a)
Loans...................... 331,007 5,184 6.35% 294,139 4,837 6.67% 36,868 347 -0.32%(b)
Allowance for
loan losses............. (4,939) -- (4,299) -- (640) --
--------- --------- --------- --------- ---------- ---------
Total interest-
earning assets......... $542,224 7,468 5.59% $501,909 7,581 6.13% $ 40,315 (113) -0.54%
========= --------- ========= --------- ========== ---------
Interest-bearing
liabilities
Interest checking &
money market accounts.... $184,847 596 1.31% $159,822 627 1.59% $ 25,025 (31) -0.28%(c)
Savings.................... 5,251 12 0.93% 4,113 9 0.89% 1,138 3 0.04%
Certificates of deposit
under $100,000........... 101,379 858 3.43% 103,539 1,094 4.29% (2,160) (236) -0.86%(d)
Certificates of deposit
$100,000 and over........ 63,099 640 4.11% 78,586 896 4.62% (15,487) (256) -0.51%(e)
--------- --------- --------- --------- ---------- ---------
Interest-bearing
deposits................. 354,576 2,106 2.41% 346,060 2,626 3.08% 8,516 (520) -0.67%
Short-term borrowings...... 19,568 108 2.24% 7,234 42 2.35% 12,334 66 -0.11%(f)
Federal Home Loan Bank
advances................. 103,923 1,276 4.98% 99,501 1,441 5.87% 4,422 (165) -0.89%(g)
Long-term borrowings....... 8,549 99 4.70% 5 2 -- 8,544 97 --(h)
--------- --------- --------- --------- ---------- ---------
Total borrowings.......... 132,040 1,483 4.55% 106,740 1,485 5.64% 25,300 (2) -1.09%
--------- --------- --------- --------- ---------- ---------
Total interest-
bearing liabilities...... $486,616 3,589 2.99% $452,800 4,111 3.68% $ 33,816 (522) -0.69%
========= --------- ========= --------- ==========
Net interest income/
spread.................. $ 3,879 2.60% $ 3,470 2.45% $ 409 0.15%
========= ========= =========
Net interest margin...... 2.90% 2.80% 0.10%
Notation:
Noninterest-bearing
deposits.................. $ 37,838 -- $ 28,773 -- $ 9,065 -- (i)
--------- --------- ---------
Total deposits........... $392,414 $ 2,106 2.18% $374,833 $ 2,626 2.84% $ 17,581 $ (520) -0.66%
========= ========= ========= ========= ========= =========
Taxable equivalents:
Total interest-
earning assets.......... $542,224 $ 7,651 5.72% $501,909 $ 8,199 6.63% $ 40,315 $ (548) -0.91%
Net interest income/
spread.................. -- $ 4,062 2.73% -- $ 4,088 2.95% -- $ (26) -0.22%
Net interest margin...... -- -- 3.04% -- -- 3.30% -- -- -0.26%
- ---------------------------------
* From continuing operations
(a) Investments - Average investments during the first quarter of 2003 exceeded
those for the same period in 2002 due to our portfolio and liquidzity
management strategies. Total investments at March 31, 2003 were $202.4
million compared with $197.6 million at March 31, 2002. The decreased yield
in the investment portfolio reflects the current rate environment caused by
additional Federal Reserve rate reductions during 2002.
(b) Loans - Average loans increased primarily as a result of loan growth in the
Arizona and Minnesota markets. The decreased yield reflects additional
Federal Reserve rate reductions during 2002.
(c) Interest checking and money market accounts - Increased average balances of
interest checking and money market accounts represents additional growth in
our floating-rate Wealthbuilder deposit products, particularly in the
Arizona and Minnesota markets. The decreased costs are reflective of the
lower rate environment in 2003 compared to the first quarter of 2002.
(d) Certificates of deposit under $100,000 - The decrease in average CDs under
$100,000 is primarily attributable to run off of some CDs during the first
quarter of 2003. The lower costs are representative of the lower interest
rate environment in 2003 compared to the first quarter of 2002.
(e) Certificates of deposit $100,000 and over - During the quarter ended March
31, 2003, average balances of brokered and national market CDs were $56.4
million as compared to $67.0 million for the same period one year earlier.
The reduced costs reflect the lower interest rate environment in 2003
compared to the first quarter of 2002.
(f) Short-term borrowings - Average short-term borrowings increased during the
three-month period ended March 31, 2003 compared to the same period in 2002
due to the use of customer repurchase agreements during late 2002 and early
2003.
(g) FHLB advances - The increased volume of FHLB advances resulted from the use
of short-term FHLB advances in early 2003 offset by the maturity of $10
million of long-term advances in January 2003. Short-term FHLB advances are
used to manage liquidity similar to how federal funds purchased are used on
a day-to-day basis. The short-term advances provide us with a slightly more
cost-effective way of managing short-term liquidity needs since the FHLB
gives a discount for advances of $10.0 million or more. At March 31, 2003,
$20.0 million of such advances were outstanding.
(h) Long-term borrowings - In conjunction with the acquisition of Milne Scali
in April 2002, we incurred $8.5 million of long-term debt.
(i) Noninterest-bearing deposits - Noninterest-bearing deposit balances have
increased largely due to commercial deposit growth in our Arizona and
Minnesota markets.
Provision for Credit Losses. The provision for credit losses was $775,000 for
the quarter ended March 31, 2003 as compared to $217,000 for the same period one
year earlier. See "Comparison of Financial Condition at March 31, 2003 and
December 31, 2002 - Allowance for Credit Losses."
Noninterest Income. The following table presents the major categories of our
noninterest income for the three-month periods ended March 31, 2003 and 2002 as
well as the amount and percent of change between the periods. Significant
changes are discussed in lettered explanations following the table (amounts are
in thousands):
For the Three Months Increase (Decrease)
Ended March 31, 2003 - 2002
--------------------- ----------------------
Noninterest Income 2003* 2002* $ %
--------- --------- --------- ----------
Insurance commissions......... $ 4,062 $ 467 $ 3,595 769.8% (a)
Fees on loans................. 461 504 (43) (8.5)%
Service charges............... 210 162 48 29.6%
Trust and financial
services.................... 186 219 (33) (15.1)%
Net gain on sales of
securities ................. 120 430 (310) (72.1)% (b)
Brokerage income.............. 51 400 (349) (87.3)% (c)
Rental income................. 22 22 -- --
Other......................... 107 141 (34) (24.1)%
--------- --------- ---------
Total noninterest income... $ 5,219 $ 2,345 $ 2,874 122.6%
========= ========= =========
-------------------------
*From continuing operations
(a) Insurance commissions increased due to the acquisition of Milne Scali in
April 2002. Additionally, most contingency fee income from insurance
companies is recorded during the first quarter of the year. Contingency fee
income recognized during the quarter ended March 31, 2003 was $817,000
compared to $2,000 for the same period in 2002. Although Milne Scali was
not part of the Company during the first quarter of 2002, contingency fee
income recognized by Milne Scali during the quarter ended March 31, 2002
was approximately $703,000.
(b) Gains and / or losses on the sale of investment securities vary from period
to period due to the volume and nature of the securities transactions
effected during the period.
(c) Brokerage revenue declined significantly due to the fact that we had
significantly fewer brokers during 2003 than in 2002 due to the closing of
the BNC Asset Management Inc. office in Fargo, North Dakota and fewer
brokers on staff in the Minnesota market during 2003.
Noninterest Expense. The following table presents the major categories of our
noninterest expense for the three-month periods ended March 31, 2003 and 2002 as
well as the amount and percent of change between the periods. Significant
changes are discussed in lettered explanations following the table (amounts are
in thousands):
For the Three Months Increase (Decrease)
Ended March 31 2003 - 2002
-------------------- -----------------------
Noninterest Expense 2003* 2002* $ %
-------- --------- ---------- -----------
Salaries and employee
benefits....................... $ 3,965 $ 2,728 $ 1,237 45.3% (a)
Occupancy....................... 622 464 158 34.1% (b)
Interest on subordinated
debentures..................... 437 457 (20) (4.4)%
Depreciation and
amortization................... 348 300 48 16.0%
Amortization of intangible
assets......................... 266 101 165 163.4% (c)
Professional services........... 260 385 (125) (32.5)% (d)
Office supplies, telephone
and postage.................... 254 246 8 3.3%
Marketing and promotion......... 119 135 (16) (11.9)%
FDIC and other assessments...... 51 54 (3) (5.6)%
Other........................... 569 504 65 12.9% (e)
-------- -------- ---------
Total noninterest expense.... $ 6,891 $ 5,374 $ 1,517 28.2%
======== ======== =========
Efficiency ratio ............... 75.74% 92.40% (16.7)%
======== ========
Adjusted efficiency ratio
excluding impact of
derivative contracts and
dividends paid on subordinated
debentures..................... 70.72% 83.41% (12.7)%
======== ========
Noninterest income as a percent
of gross revenues.............. 57.36% 40.33% 17.0%
======== ========
Total operating expenses as
a percent of average assets,
annualized..................... 4.69% 4.08% 0.6% (f)
======== ========
- ---------------
*From continuing operations.
(a) Salaries and employee benefits increased primarily due to the acquisition
of Milne Scali in April 2002. Average full time equivalent employees for
the quarter ended March 31, 2003 were 267 as compared to 211 for the same
period one year earlier.
(b) Occupancy expenses have increased due to expenses associated with the Milne
Scali acquisition and increased presence in the Arizona market.
(c) Amortization of intangible assets increased due to amortization of the
insurance books of business intangibles acquired in the Milne Scali
acquisition in April 2002.
(d) The decrease in professional services expenses is attributable to a
decrease in brokerage retainage and clearing fees and other consulting
fees.
(e) The increase in other noninterest expenses is due to increases in several
different items included in this category such as insurance expense, dues
and publications, education and development and other miscellaneous items.
(f) Total operating expenses as a percent of average assets have increased as
we have expanded our base of financial product and service offerings.
Income Tax Provision. Our provision for income taxes for the quarter ended March
31, 2003 increased $321,000 as compared to the same period in 2002 due to the
increase in pre-tax income. The estimated effective tax rates for the
three-month periods ended March 31, 2003 and 2002 were 29.0 and 42.0 percent,
respectively. The reduction in our effective tax rate is primarily attributable
to an increase in the amount of tax-exempt income in the 2003 period as compared
to the 2002 period.
Earnings per Common Share. See Note 4 to the interim consolidated financial
statements included under Item 1 for a summary of the EPS calculation for the
three-month periods ended March 31, 2003 and 2002.
Liquidity
Liquidity. 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 1 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 on terms ranging from overnight to 10 years and beyond. Advances from the
FHLB are generally collateralized by the Bank's mortgage loans and various
investment securities. We have also obtained funding through the issuance of
subordinated notes, subordinated debentures and long-term borrowings.
The following table sets forth, for the three months ended March 31, 2003 and
2002, a summary of our major sources and (uses) of funds. The summary
information is derived from the consolidated statements of cash flows included
under Item 1 (amounts are in thousands):
For the Three Months Ended
March 31,
--------------------------------
Major Sources and Uses of Funds 2003 2002
------------- -------------
Proceeds from FHLB advances............ $ 20,000 $ --
Proceeds from maturities
of investment securities.............. 12,208 17,718
Net decrease in loans.................. 5,736 3,338
Proceeds from sales of
investment securities................. 5,079 15,776
Purchases of investment
securities............................ (13,158) (19,388)
Net decrease in deposits............... (10,976) (6,589)
Repayments of FHLB advances............ (10,000) (20,000)
Net increase (decrease) in
short-term borrowings................. (7,781) 3,184
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 March 31, 2003, we had established three revolving lines of credit with
banks totaling $16.5 million of which $2.3 million had been advanced and $14.2
million remained available for advance. The lines, if drawn upon, mature daily
with interest rates that float at the federal funds rate. At March 31, 2003, we
also had the ability to draw additional FHLB advances of $41.4 million based
upon the mortgage loans and securities that were then pledged, subject to a
requirement to purchase additional FHLB stock.
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 nonperforming 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 March 31, 2003 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.
Forward-Looking Statements
Statements included in Item 2, "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 of 1933, as amended and Section 21E of the Securities Exchange
Act of 1934, 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.
Item 3. 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) Repricing risk - timing differences in the maturity/repricing
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.
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, collateralized mortgage obligation, 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 March 31,
2003 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 asset/liability committee ("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 March 31, 2003 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 March 31, 2003, 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 12-month horizon 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 three-year interest rate cap positions on three-month LIBOR
with a 4.50 percent strike and the $20.0 million cumulative notional original
five-year interest rate cap positions on three-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.
Net Interest Income Simulation
(amounts in thousands)
Movement in interest rates -100bp Unchanged +100bp +200bp +300bp +400bp
------ --------- ------ ------ ------ ------
Projected 12-month net interest income......... $ 14,925 $ 16,026 $17,239 $ 17,282 $ 17,649 $ 17,628
Dollar change from rates unchanged scenario.... $ (1,101) -- $ 1,213 $ 1,256 $ 1,623 $ 1,602
Percentage change from rates unchanged
scenario.................................... (6.87)% -- 7.57% 7.84% 10.13% 10.00%
Net benefit/(cost) of cumulative $40.0
million interest rate caps (1).............. $ (100) $ (70) $ (6) $ 99 $ 252 $ 474
Total net interest income impact with caps..... $ 14,825 $ 15,956 $17,233 $ 17,381 $ 17,901 $ 18,102
Dollar change from unchanged w/caps............ $ (1,131) -- $ 1,277 $ 1,425 $ 1,945 $ 2,146
Percentage change from unchanged w/caps........ (7.09)% -- 8.00% 8.93% 12.19% 13.45%
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
three-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
three-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.
Our rate sensitivity position over the projected 12-month horizon is asset
sensitive. This position 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 scenario.
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 12-month period. It is no less important,
however, to give attention to the absolute dollar level of projected net
interest income over the 12-month period. For example, even though in the -100bp
scenario, net interest income declines $1.1 million, or 7.09 percent, from the
unchanged scenario, the level of net interest income of $14.8 million is only
0.6 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 12-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.
Since there are limitations inherent in any methodology used to estimate the
exposure to changes in market interest rates, this analysis is 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, this analysis is based on our
assets and liabilities as of March 31, 2003 and does not contemplate any actions
we might undertake in response to changes in market interest rates.
Item 4. Controls and Procedures
Quarterly evaluation of the Company's Disclosure Controls and Internal Controls.
Within the 90 days prior to the date of this quarterly report on Form 10-Q, 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 Securities and Exchange
Commission ("SEC") require that in this section of the quarterly 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 quarterly 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 quarterly 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 Securities Exchange Act of 1934, such
as this quarterly 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 quarterly 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 is 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 quarterly 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.
Part II - Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 99.1 Certification Under Section 906 of the Sarbanes-Oxley Act of
2002
(b) Reports on Form 8-K
None.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BNCCORP, Inc.
Date: May 14, 2003 By /s/ Gregory K. Cleveland
---------------------------------------------
Gregory K. Cleveland
President and Chief Executive Officer
By /s/ Brenda L. Rebel
---------------------------------------------
Brenda L. Rebel
Treasurer and Chief Financial Officer
CERTIFICATIONS
I, Gregory K. Cleveland, President and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of BNCCORP, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly 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 quarterly
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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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
quarterly report whether or not 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: May 14, 2003 By /s/ Gregory K. Cleveland
-------------------------------------
Gregory K. Cleveland
President and Chief Executive Officer
I, Brenda L. Rebel, Treasurer and Chief fFinancial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of BNCCORP, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly 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 quarterly
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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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
quarterly report whether or not 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: May 14, 2003 By /s/ Brenda L. Rebel
-----------------------------------------------
Brenda L. Rebel
Treasurer and Chief Financial Officer