U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 for the fiscal year ended December 31, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 0-26290
BNCCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 45-0402816
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
322 East Main Avenue 58501
Bismarck, North Dakota (Zip Code)
(Address of principal executive office)
Registrant's telephone number, including area code: (701) 250-3040
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
Common Stock, $.01 par value
Preferred Stock Purchase Rights
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes ___ No _X_
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the Registrant, computed by reference to the price at which
the common equity was last sold, as of the last business day of the Registrant's
most recently completed second fiscal quarter was $21,069,000.
The number of shares of the Registrant's common stock outstanding on
March 16, 2004 was 2,764,684.
Documents incorporated by reference. Portions of the Registrant's proxy
statement to be filed with the Securities and Exchange Commission in connection
with the Registrant's 2004 annual meeting of stockholders are incorporated by
reference into Part III hereof.
BNCCORP, INC.
ANNUAL REPORT ON FORM 10-K
FOR FISCAL YEAR ENDED DECEMBER 31, 2003
TABLE OF CONTENTS
Page
PART I
Item 1. Business....................................................... 3
Item 2. Properties..................................................... 16
Item 3. Legal Proceedings.............................................. 16
Item 4. Submission of Matters to a
Vote of Security Holders.................................. 17
PART II
Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters............................ 17
Item 6. Selected Financial Data......................................... 18
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations.............. 20
Item 7A. Quantitative and Qualitative Disclosures about
Market Risk................................................ 57
Item 8. Financial Statements and Supplementary Data..................... 61
Item 9A. Controls and Procedures......................................... 112
PART III
Item 10. Directors and Executive Officers of the Registrant.............. 113
Item 11. Executive Compensation.......................................... 114
Item 12. Security Ownership of Certain Beneficial Owners
and Management............................................. 114
Item 13. Certain Relationships and Related Transactions.................. 114
Item 14. Principal Accounting Fees and Services.......................... 114
PART IV
Item 16. Exhibits, Financial Statement Schedules and
Reports on Form 8-K........................................ 114
PART I
The discussions contained in this Annual Report on Form 10-K which are not
historical in nature may constitute forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act") and, as such, may involve risks and uncertainties.
We caution readers that these forward-looking statements, including without
limitation, those relating to future business prospects, revenues, working
capital, liquidity, capital needs, interest costs and income of BNCCORP, Inc., a
Delaware corporation, are subject to certain risks and uncertainties that could
cause actual results to differ materially from those indicated in the
forward-looking statements due to several important factors. These factors
include, but are not limited to: risks of loans and investments, including
dependence on local and regional economic conditions; competition for our
customers from other providers of financial services; possible adverse effects
of changes in interest rates including the effects of such changes on derivative
contracts and associated accounting consequences; risks associated with our
acquisition and growth strategies; and other risks which are difficult to
predict and many of which are beyond our control. For a discussion of some of
the additional factors that might cause such differences, see Item 1. Business
"-Factors That May Affect Future Results of Operations."
We refer to "we," "our," "BNC" or the "Company" when such reference includes
BNCCORP, Inc. and its consolidated subsidiaries, collectively; "BNCCORP" when
referring only to BNCCORP, Inc.; "the Bank" when referring only to BNC National
Bank; "Milne Scali" when referring only to Milne Scali & Company, Inc.; "BNC
Insurance" when referring only to BNC Insurance, Inc.; and "BNC AMI" when
referring only to BNC Asset Management, Inc.
Item 1. Business
General
BNCCORP is a bank holding company registered under the Bank Holding Company Act
of 1956 (the "BHCA") headquartered in Bismarck, North Dakota. We are dedicated
to providing a broad range of financial products and superior customer service
to businesses and consumers within the communities we serve. BNCCORP operates 21
locations in Arizona, Minnesota and North Dakota through its subsidiary, BNC
National Bank. The Company also provides a wide array of insurance, brokerage
and trust and financial services through BNC National Bank's subsidiaries, Milne
Scali, BNC Insurance and BNC AMI, and the Bank's trust and financial services
division. The Company offers a wide variety of traditional and nontraditional
financial products and services in order to meet the financial needs of its
current customer base, establish new relationships in the markets it serves and
expand its business opportunities.
Acquisitions, de novo branches and mergers have played an important role in our
strategy. During the three years ended December 31, 2003, we completed several
such transactions. See Note 2 to the Consolidated Financial Statements included
under Item 8 of Part II for further information related to these transactions.
We will continue to emphasize internally generated growth by focusing on
increasing our market share within the communities we serve. We may also seek
growth opportunities through select acquisitions of financial services companies
that we believe complement our businesses. We may also generate growth through
de novo branching in markets such as Arizona, Minnesota, North Dakota and,
possibly, other states.
At December 31, 2003, we had total assets of $621.5 million, total loans of
$283.6 million and total deposits of $395.9 million.
Mission Statement
Our mission is to provide tailor-made financial solutions for our customers that
will assist them in achieving their goals, while enhancing shareholder value.
Operating Strategy
We provide relationship-based banking and financial services to small- to
mid-sized businesses, business owners, professionals and consumers in our
primary market areas of Arizona, Minnesota and North Dakota. Our goal is to
become a one-stop financial services provider offering traditional bank products
and services, insurance, brokerage, asset management, trust, tax planning and
preparation, employee benefit plan design and administration and other
financial-related services. The other key elements of our operating strategy
are:
o Emphasize individualized, high-level customer service.
o Encourage an entrepreneurial attitude among the employees who provide
products and services.
o Maintain high asset quality by implementing strong loan policies and
continuously monitoring loans and the loan review process.
o Centralize administrative and support functions.
Strategic Vision
Since our formation more than 15 years ago, we have diligently pursued a sharply
focused strategic vision: to provide a broad range of financial products and
superior service to a well-defined customer base, primarily consisting of small-
to mid-sized businesses, business owners, professionals and consumers. We
believe that our entrepreneurial approach to banking and the introduction of new
products and services will continue to attract small- and mid-sized businesses,
their owners and employee base. Small businesses frequently have difficulty
finding banking services that meet their specific needs and have sought banking
institutions that are more relationship-oriented. By remaining committed to this
strategic vision, we have built a company that is distinguished by its:
o Diversified business base of banking, insurance and
brokerage/trust/financial services;
o Presence in multiple attractive markets: Arizona, Minnesota and North
Dakota;
o Strengthening financial performance, as investments in new businesses and
markets drive earnings growth; and
o Determined management team, with a decided focus on delivering results.
In this section of this annual report on Form 10-K, we detail these
distinguishing strengths, which have not only helped customers to reach their
financial goals, but also have established a solid foundation upon which to
build shareholder value.
Diversified Business Base. BNCCORP today consists of three core businesses:
banking, insurance and brokerage/trust/financial services. This structure allows
us to offer a wide range of services that is responsive to the financial needs
of our customers, while also diversifying and balancing our sources of revenue.
Banking segment. BNC National Bank operates 16 banking branch offices in three
states. Known for its business banking services such as business financing and
commercial mortgages, corporate cash management and merchant programs, our
banking division also offers a full range of consumer lending and deposit
options. The Bank is differentiated by its service culture of "high personal
touch," supported by effective technology. Among the innovative services offered
are online, bill pay and telephone banking operations, and products such as the
"Sweep/Repo" account, the "Wealthbuilder" family of variable-rate interest
checking and money market deposit products and the BNC cash back debit card.
The banking segment's loans primarily consist of commercial and industrial
loans, real estate mortgage and construction loans, agricultural loans, consumer
loans and lease financing. In allocating our assets among loans, investments and
other earning assets, we attempt to maximize return while managing risk at
acceptable levels. Our primary lending focus is on commercial loans and
owner-occupied real estate loans to small- and mid-sized businesses and
professionals. We offer a broad range of commercial and consumer lending
services, including commercial revolving lines of credit, residential and
commercial real estate mortgage and construction loans, consumer loans and
equipment financing. Interest rates charged on loans may be fixed or variable
and vary with the degree of risk, size and maturity of the loans, underwriting
and servicing costs, the extent of other banking relationships maintained with
customers and the Bank's cost of funds. Rates are further subject to competitive
pressures, the current interest rate environment, availability of funds and
government regulations. For more information on our lending activities, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Loan Portfolio" included under Item 7 of Part
II.
Each of our bank branches offers the usual and customary range of depository
products provided by commercial banks, including checking, savings and money
market deposits and certificates of deposit. During 2003, we continued to
increase core deposits largely through the continuing success of our
Wealthbuilder interest checking and money market deposit accounts introduced
during 1999. These are competitively priced floating rate accounts with rates
variable at our discretion. The Bank's deposits are not received from a single
depositor or group of affiliated depositors, the loss of any one of which would
have a material adverse effect on our business. Rates paid on deposits vary
among the categories of deposits due to different terms, the size of the
individual deposit, the nature of other banking relationships with the
depositor, the current interest rate environment and rates paid by competitors
on similar deposits.
The Bank also accepts brokered deposits and obtains direct non-brokered
certificates of deposit through national deposit networks when management
believes such transactions are beneficial to the Bank. Our core deposit growth
during 2003 allowed us to reduce brokered and national market certificates of
deposit by $27.2 million during the year ended December 31, 2003. Additionally,
through the Certificate of Deposit Account Registry ServiceSM (CDARSSM), the
Bank can now place large customer deposits into smaller denomination (fully
FDIC-insured) certificates of deposit at multiple institutions. This provides
the Bank's large deposit customers with FDIC insurance on their entire balances
and the convenience of managing their certificates of deposit investments
through a single bank relationship. This service was made available beginning in
2003. For more information on our deposit activities, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Financial Condition - Deposits" included under Item 7 of Part II.
Our banking segment also offers services such as travelers' checks, MasterCard
and Visa merchant deposit services and, in some markets, safe deposit, lockbox
and messenger services.
Insurance segment. Milne Scali and BNC Insurance are independent insurance
agencies representing many of the nation's leading insurance carriers. Our
insurance operations were greatly expanded in 2002 through the acquisition of
Milne Scali, one of the largest independent insurance agencies in the Arizona
market. On December 31, 2003, we also acquired certain assets and assumed
certain liabilities of The Insurance Alliance of the Southwest ("IASW"), a
Tucson-based insurance agency. The acquisition included the staff and owners of
IASW. The insurance segment has become an important and significant part of our
business.
Milne Scali began as an independently owned and operated commercial insurance
brokerage serving the needs of local, regional and national businesses.
Combining the talents of experienced insurance professionals, Milne Scali
provides solutions for every business insurance need. Its agents and customer
service representatives have more than 1,000 years of insurance knowledge
amongst them - experience that Milne Scali feels benefits its customers on a
daily basis. Many of Milne Scali's representatives began their careers at large,
national brokerage firms and insurance companies such as Fireman's Fund
Insurance Co., C.T. Bowring (Brokers, Lloyd's of London), Wausau Insurance,
Aetna Insurance Co., Arkwright Mutual, Alexander & Alexander, Travelers
Insurance Company, Marsh USA Risk & Insurance Services, Inc. and The Willis
Group. From these backgrounds, Milne Scali's representatives have developed
skills that serve its clients well. At the same time, Milne Scali has added the
extra benefits of an entrepreneurial business dedicated to providing the best
solution at the best possible price.
Milne Scali's clients range from large, established companies with hundreds of
millions in sales to emerging businesses with growing needs. It serves clients
in nearly every industry including construction, real estate development,
manufacturing, distribution and wholesale, professionals, government, financial
institutions, retail and service industries. Milne Scali's ability to serve each
client is enhanced by its ability to draw upon the varied needs arising from its
diverse client base. One contact can handle all customer insurance needs -
business and personal. Milne Scali's agents and customer service representatives
make it their job to be familiar with its customers' business and their
families, always looking for better ways to serve the customers' diverse needs.
Milne Scali was founded primarily to specialize in commercial insurance. The
intent was to be different in two very specific practices from its major
competitors. First, its employee culture and environment is structured to foster
creativity and entrepreneurial work ethics enabling associates to create
opportunities for themselves and thereby grow with Milne Scali. Second, the
negotiating character of Milne Scali's brokers and agents is structured to
foster threefold relationships to benefit its clients. Those relationships are
built with (1) the client (and its personnel), (2) the insurance companies (and
their personnel), and (3) the Milne Scali staff. All three relationships are
focused on protecting the clients' assets and thereby designed to help Milne
Scali grow.
From inception, Milne Scali's intent was to be different in its client
relationship focus. As entrepreneurs, Milne Scali takes an active partnering
role with its clients. Much like its clients, Milne Scali manages its company
while at the same time working with its client needs. The dual role of partner
and broker allows Milne Scali to better understand the internal working
operations of its clients and businesses. It is Milne Scali's pledge to find the
best possible coverage for customer needs, no matter how difficult the
challenge.
Since inception, Milne Scali's creativity and entrepreneurial spirit have
produced dramatic results as it rapidly became the second largest privately
owned Phoenix-based insurance broker. Milne Scali can provide the full range of
services from the self-insured multinational client to the local sole
proprietor. Milne Scali provides an extremely wide array of products and
expertise, including but not limited to:
Business insurance such as property, liability, fleet auto, workers'
compensation, errors and omissions, directors and officers, employment
practices, crime and employee dishonesty, umbrella and excess, boiler and
machinery, surety and bonds, flood and earthquake.
Risk management such as risk and loss control services, risk transfer analysis,
risk consulting, risk management program design and implementation.
Group benefits insurance such as health, life, dental, disability, 401(k)s and
SEPs, prepaid legal, key man protection, buy/sell protection, estate and
business continuation.
Association and affinity group insurance programs such as group auto and
homeowners, benefit plans, product liability programs, workers' compensation
groups, self-insured pools, risk retention groups, captive and rent-a-captive
operations.
Personal lines such as homeowners and renters, personal articles floater,
automobile, watercraft, aircraft, flood and earthquake, umbrella and life.
Milne Scali starts by examining customer current programs and policies -
analyzing the classifications, the coverage and the price. Its years of
experience and knowledge of the insurance industry and of its competitors helps
Milne Scali to identify and solve problems customers may have never known
existed - until it was too late. Milne Scali's objective is to reduce customer
cost of risk. Its clients think of Milne Scali as problem solvers, not problem
finders. Every one of Milne Scali's professionals is committed to making
customer lives easier rather than complicating it with endless forms. Milne
Scali is committed to enhancing customer progress by producing bonds and proof
of coverage when customers need them. It prides itself on delivering the fastest
response in the industry to customer insurance needs without sacrificing quality
or value. Above all, the difference Milne Scali offers is the
relationship-driven service that always puts customer needs first. Milne Scali
knows that care and attention bring its clients back year after year. Care and
attention, along with problem solving, is the Milne Scali difference.
BNC Insurance also has a long history of providing insurance brokerage services
as the genesis of the company had its roots back in the late 1800's. What is now
BNC Insurance is the culmination of multiple insurance agency beginnings; some
of them with what are today some of the largest financial institutions in the
country. BNC Insurance also provides a wide range of commercial and personal
lines of insurance and can look to Milne Scali to assist in providing expertise
and insurance coverage and risk management products and services beyond what was
available to customers prior to our acquisition of Milne Scali.
The insurance segment will typically have its strongest performance in the first
quarter of each fiscal year as contingency payments from insurance carriers are
generally received during that quarter. Our insurance segment has offices in the
following major cities: Phoenix, Tucson, Minneapolis and Bismarck. The
Minneapolis office was opened during 2003 and the Tucson office (IASW) was
acquired on December 31, 2003.
Brokerage/trust/financial services segment. BNC AMI and the Bank's trust and
financial services divisions provide customers with an extensive complement of
financial services options. The trust and financial services divisions,
presently operating primarily out of Bismarck, provide trust, financial,
business, estate and tax planning, estate administration, agency accounts,
payroll services, accounting services, employee benefit plan design and
administration, individual retirement accounts ("IRAs"), individual custodial
self-directed IRAs, asset management, tax preparation and the BNC Global
Balanced Collective Investment Fund, a proprietary investment vehicle for
qualified retirement plans. BNC AMI, with offices in Bismarck and Minneapolis,
in affiliation with Raymond James Financial Services, Inc. offers financial
services alternatives such as securities trading, investment management of
institutional and individual accounts, mutual funds and annuities.
With this "palette" of financial resources, a customer can turn to us to obtain
business financing or a home mortgage; access the cash management, insurance,
accounting and tax preparation services needed to run a successful business;
create a 401(k) program for employees; or establish a trust to manage personal
assets - to cite just a few examples. We employ a "relationship pricing matrix"
that gives customers even more reason to take maximum advantage of our diverse
services.
Revenues from external customers, measures of profit and/or loss and total
assets for each of the segments listed above are presented in Note 16 to the
Consolidated Financial Statements included under Item 8 of Part II.
Attractive Markets. We operate in three distinct markets:
Tempe-Phoenix-Scottsdale and Tucson, Arizona; Minneapolis-St. Paul, Minnesota;
and Bismarck-Mandan, North Dakota and surrounding communities (Crosby,
Ellendale, Garrison, Kenmare, Linton, Stanley and Watford City). While these
areas have very different fundamentals, each enjoys a solid economic base and
what we believe are compelling long-term growth dynamics. To ensure that we
maintain a sharp focus on each market area, we recently added a market president
in each of our major markets: Arizona, Minnesota and North Dakota.
Our Arizona market has been one of the fastest growing areas of the country in
population and personal income for the past several years. The population is
expected to continue increasing at a rate of more than 100,000 per year.
Tourism, retirement and job creation in such industries as software and
biotechnology are among the drivers of the economy, according to studies by the
University of Arizona. Segments with significant operations in the Arizona
market include banking and insurance.
The Twin Cities area is home to a large and growing population, with a tight
labor market and robust construction. The U.S. census estimates that the area's
population will rise by more than 900,000 by 2030, driving business formation
and residential construction over the long term. Key growth industries currently
include electronics manufacturing, healthcare, education and food processing.
Banking is the primary segment operating in the Minneapolis-St. Paul area with
some brokerage and insurance activities also conducted in the market.
Bismarck-Mandan is characterized by low unemployment and generally favorable
economic conditions. Bismarck is not only the state capital, but also the trade
and transportation hub for South Central North Dakota. The area is experiencing
strong residential and commercial growth, and its diverse economic base includes
energy, health care, agriculture and an expanding data processing/customer
service component. The banking, insurance and brokerage/trust/financial segments
are all represented in the North Dakota market.
Individually, each of our markets presents strong potential demand for our range
of financial services offerings. Together, we believe they provide attractive
business opportunities and balance our exposure to regional economic cycles.
As of December 31, 2003, 31 percent of our loans were to borrowers located in
North Dakota, 29 percent to borrowers located in Arizona, 28 percent to
borrowers located in Minnesota, 8 percent to borrowers located in South Dakota
and the remainder to borrowers in various other states. Other than brokered
certificates of deposit and direct non-brokered certificates of deposit obtained
through national deposit networks, each banking branch draws most of its
deposits from its general market area.
The following table presents total deposits and net loans outstanding at each of
our locations as of December 31, 2003 (in thousands):
Total Net Loans
Location Deposits Outstanding(1)
- ------------------------------------------ -------------- ---------------
Bismarck, ND.......................... $122,669 $103,004
Crosby, ND............................ 16,604 250
Ellendale, ND......................... 10,437 450
Garrison, ND.......................... 15,185 506
Kenmare, ND........................... 10,981 133
Linton, ND............................ 42,794 8,958
Minneapolis, MN....................... 39,955 81,090
Phoenix, AZ........................... 15,582 65,659
Scottsdale, AZ........................ 39,716 11,734
Stanley, ND........................... 16,943 819
Tempe, AZ............................. 23,396 11,376
Watford City, ND...................... 10,196 84
Brokered deposits..................... 18,579 --
National market deposits.............. 12,905 --
-------------- ---------------
Total ............................. $395,942 $284,063
============== ===============
- ------------------
(1) Before allowance for credit losses, unearned income and net unamortized
deferred fees and costs.
Strengthening Financial Performance. In 2003, we demonstrated the value of our
financial management strategies. The results of our efforts to diversify our
sources of revenue, and in particular the decision to expand our insurance
business through the Milne Scali acquisition, drove an 88.5 percent
year-over-year increase in earnings.
Determined Management Team. We believe our financial and operational
accomplishments during 2003 are, in large measure, a reflection of our
determination to enhance shareholder value. The determination to invest in the
future continued to contribute to a highly profitable insurance agency business
and the creation of a growing presence in the Arizona and Minnesota markets. We
believe a determined focus on achieving excellence in business - through
superior service, a consistent vision and prudent financial management - should
continue to yield positive results in the years to come.
Regional Community Banking Philosophy
In order to meet the demands of the increasingly competitive banking and
financial services industries, we employ a regional community banking
philosophy. This philosophy is based on our belief that banking and financial
services clients value doing business with locally managed institutions that can
provide a full service commercial banking relationship through an understanding
of the clients' financial needs and the flexibility to deliver customized
solutions through our menu of products and services. With this philosophy we are
better able to build successful and broadly based client relationships. The
primary focus for our relationship managers is to cultivate and nurture their
client relationships. Relationship managers are assigned to each borrowing
client to provide continuity in the relationship. This emphasis on personalized
relationships requires that all of the relationship managers maintain close ties
to the communities in which they serve so that they are able to capitalize on
their efforts through expanded business opportunities. While client service
decisions and day-to-day operations are maintained at each location, our broad
base of financial services offers the advantage of affiliation with service
providers who can provide extended products and services to our clients.
Additionally, BNCCORP and the Bank provide centralized administrative functions,
including credit and other policy development and review, internal audit and
compliance services, investment management, data processing, accounting, loan
servicing and other specialized support functions.
Distribution methods
We offer our banking and financial products and services through our network of
offices and other traditional industry distribution methods. Additionally, we
offer 24-hour telephone banking services through BNC Bankline. We also provide
Internet banking and bill-pay services through our Internet banking site at
www.bncbank.com. This system allows customers to process account transactions,
transfer funds, initiate wire transfers, automated clearing house transactions
and stop payments and obtain account history and other information. Messenger
services in select markets are also of great convenience to our customers.
Risk Management
The uncertainty of whether unforeseen events will have an adverse impact on our
capital or earnings is an inevitable component of the business of banking. To
address the risks inherent in our business we identify, measure, control and
monitor them. Our management team is responsible for determining our desired
risk profile, allocating resources to the lines of business, approving major
investment programs that are consistent with strategic priorities and risk
appetite and making capital management decisions. We address each of the major
risk categories identified by the banking regulators, if applicable, as well as
any additional identified risks inherent in our business. Such risks include,
but are not limited to, credit, liquidity, interest rate, transaction,
compliance, strategic and reputation risk. In each identified risk area, we
measure the level of risk to the Company based on the business we conduct and
develop plans to bring risks within acceptable tolerances. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Financial Condition-Loan Portfolio and-Liquidity, Market and Credit
Risk" included under Item 7 of Part II and "Quantitative and Qualitative
Disclosures About Market Risk" included under Item 7A of Part II for further
discussion of credit, liquidity and interest rate risk.
Competition
The deregulation of the banking industry and the availability of nationwide
interstate banking have increased the level of competition in our already
intensely competitive market areas. The increasingly competitive environment is
a result of changes in regulation, technology and product delivery systems and
the pace of consolidation among financial services providers. The Bank and its
subsidiaries compete for deposits, loans, insurance and brokerage, trust and
financial services as well as customers with numerous providers of similar
products and services. Principal competitors include multi-regional financial
institutions as well as large and small thrifts, independent banks, credit
unions, many national and regional brokerage companies, mortgage companies,
insurance companies, finance companies, money market funds and other non-bank
financial service providers. Some of these competitors are much larger in total
assets and capitalizations, including the availability of larger legal lending
limits, have greater access to capital markets and offer a broader range of
financial services than BNC. In addition, some of the nonbank financial
institutions that compete with us are not subject to the extensive Federal
regulations that govern our operations.
In order to compete with other financial services providers, the Bank and its
subsidiaries principally rely on local promotional activities, personal
relationships established by officers, directors and employees with their
customers, specialized services tailored to meet the needs of the communities
served and cross-selling efforts among the various segments within our
organization. We believe that many of our competitors have emphasized retail
banking and financial services for large companies, leaving the small- and
mid-sized business market underserved. This has allowed us to compete
effectively by emphasizing customer service, establishing long-term customer
relationships and providing services meeting the needs of such businesses and
the individuals associated with them. The banking and financial services
industries are highly competitive, and our future profitability will depend on
our ability to continue to compete successfully in our market areas.
Supervision and Regulation
General. BNCCORP and the Bank are extensively regulated under Federal and state
laws and regulations. These laws and regulations are primarily intended to
protect depositors and the Federal deposit insurance funds, not investors in the
securities of BNCCORP. From time to time, legislation, as well as regulation, is
enacted that has the effect of increasing the cost of doing business, limiting
or expanding permissible activities, or affecting the competitive balance
between banks and other financial services providers. Proposals to change laws
and regulations governing the operations and taxation of banks, bank holding
companies and other financial institutions and financial services providers are
frequently made in the U.S. Congress, in the state legislatures and by various
regulatory agencies.
The following information briefly summarizes certain material laws and
regulations affecting BNCCORP and the Bank and is qualified in its entirety by
reference to the particular statutory and regulatory provisions. Any change in
applicable laws, regulations or regulatory policies may have a material effect
on our business, operations and future prospects. We are unable to predict the
nature or extent of the effects that new or revised Federal or state legislation
may have on our business and earnings in the future.
Primary Regulators. BNCCORP is a bank holding company registered under the BHCA,
and is subject to regulation, supervision and examination by the Board of
Governors of the Federal Reserve System ("Federal Reserve"). BNCCORP is required
to file periodic reports with the Federal Reserve and such other reports as the
Federal Reserve may require pursuant to the BHCA. The Bank is a national banking
association and is subject to supervision, regulation and examination by the
Office of the Comptroller of the Currency ("OCC"). Since the Federal Deposit
Insurance Corporation ("FDIC") insures the deposits of the Bank, the Bank is
also subject to regulation and supervision by the FDIC. Additionally, the Bank
is a member of the Federal Reserve System.
If, as a result of an examination by Federal regulatory agencies, an agency
should determine that the financial condition, capital resources, asset quality,
earnings prospects, management, liquidity or other aspects of a bank or bank
holding company's operations are unsatisfactory or that the bank or bank holding
company or its management is violating or has violated any law or regulation,
various remedies are available to these regulatory agencies. Such remedies
include the power to enjoin "unsafe or unsound" practices, to require
affirmative action to correct any conditions resulting from any violation or
practice, to issue an administrative order that can be judicially enforced, to
direct an increase in capital, to restrict the growth of the bank, to assess
civil monetary penalties, to remove officers and directors and ultimately to
terminate the bank's deposit insurance and/or revoke the bank's charter or the
bank holding company's registration.
Acquisitions and Permissible Activities. As a registered bank holding company,
BNCCORP is restricted in its acquisitions, certain of which are subject to
approval by the Federal Reserve. A bank holding company may not acquire, or may
be required to give certain notice regarding acquisitions of, companies
considered to engage in activities other than those determined by the Federal
Reserve to be closely related to banking or managing banks.
Transactions with Affiliates. Under Section 23A of the Federal Reserve Act (the
"Act"), certain restrictions are placed on loans and other extensions of credit
by the Bank to BNCCORP which is defined as an "affiliate" of the Bank under the
Act. Section 23B of the Act places standards of fairness and reasonableness on
other of the Bank's transactions with its affiliates. The Federal Reserve
recently issued Regulation W to implement Sections 23A and 23B of the Act and
codify many previously issued Federal Reserve interpretations of those sections.
Anti-Tying Restrictions. Bank holding companies and their affiliates are
prohibited from tying the provision of certain services, such as extensions of
credit, to other services offered by a holding company or its affiliates.
Restrictions on Loans to One Borrower. Under Federal law, permissible loans to
one borrower by banks are generally limited to 15 percent of the bank's
unimpaired capital, surplus, undivided profits and credit loss reserves. The
Bank seeks participations to accommodate borrowers whose financing needs exceed
its lending limits or internally established credit concentration limits.
Loans to Executive Officers, Directors and Principal Stockholders. Certain
limitations and reporting requirements are also placed on extensions of credit
by the Bank to principal stockholders of BNCCORP and to directors and certain
executive officers of the Bank (and BNCCORP and its nonbank subsidiaries
provided certain criteria are met) and to "related interests" of such principal
stockholders, directors and officers. In addition, any director or officer of
BNCCORP or the Bank or principal stockholder of BNCCORP may be limited in his or
her ability to obtain credit from financial institutions with which the Bank
maintains correspondent relationships.
Interstate Banking and Branching. The BHCA permits bank holding companies from
any state to acquire banks and bank holding companies located in any other
state, subject to certain conditions, including certain nation-wide and
state-imposed concentration limits. The Bank has the ability, subject to certain
restrictions, to acquire by acquisition or merger branches outside its home
state. The establishment of new interstate branches is also possible in those
states with laws that expressly permit it. Interstate branches are subject to
certain laws of the states in which they are located. Competition may increase
further as banks branch across state lines and enter new markets.
Capital Adequacy. The capital adequacy of BNCCORP and the Bank is monitored by
the Federal regulatory agencies using a combination of risk-based and leverage
ratios. Failure to meet the applicable capital guidelines could subject BNCCORP
or the Bank to supervisory or enforcement actions. In addition, BNCCORP could be
required to guarantee a capital restoration plan of the Bank, should the Bank
become "undercapitalized" under capital guidelines. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Financial
Condition-Capital Resources and Expenditures" included under Item 7 of Part II
and Note 18 to the Consolidated Financial Statements included under Item 8 of
Part II for further discussion regarding the capital status of BNCCORP and the
Bank.
Prompt Corrective Action and Other Enforcement Mechanisms. Federal banking
agencies possess broad powers to take corrective and other supervisory action to
resolve the problems of insured depository institutions, including but not
limited to those institutions that fall below one or more prescribed minimum
capital ratios. Each Federal banking agency has promulgated regulations defining
the following five categories in which an insured depository institution will be
placed, based on its capital ratios: well capitalized; adequately capitalized;
undercapitalized; significantly undercapitalized; and critically
undercapitalized. At December 31, 2003, the Bank exceeded the required ratios
for classification as well capitalized.
An institution that, based upon its capital levels, is classified as well
capitalized, adequately capitalized or undercapitalized may be treated as though
it were in the next lower capital category if the appropriate Federal banking
agency, after notice and opportunity for hearing, determines that an unsafe or
unsound condition or practice warrants such treatment. At each successive lower
capital category, an insured depository institution is subject to more
restrictions. The Federal banking agencies, however, may not treat a
significantly undercapitalized institution as critically undercapitalized unless
its capital ratios actually warrant such treatment.
In addition to measures taken under the prompt corrective action provisions,
commercial banking organizations may be subject to potential enforcement actions
by Federal regulators for unsafe or unsound practices in conducting their
business or for violations of any law, rule, regulation or any condition imposed
in writing by the agency or any written agreement with the agency.
Safety and Soundness Standards. The Federal banking agencies have adopted
guidelines designed to assist the agencies in identifying and addressing
potential safety and soundness concerns before capital becomes impaired. The
guidelines set forth operational and managerial standards relating to: internal
controls, information systems and internal audit systems; loan documentation;
credit underwriting; asset growth; earnings; and compensation, fees and
benefits. Additionally, the Federal banking agencies have also adopted safety
and soundness guidelines with respect to asset quality and earnings standards.
These guidelines provide six standards for establishing and maintaining a system
to identify problem assets and prevent those assets from deteriorating. Under
these standards, an insured depository institution should: conduct periodic
asset quality reviews to identify problem assets; estimate the inherent losses
in problem assets and establish reserves that are sufficient to absorb estimated
losses; compare problem asset totals to capital; take appropriate corrective
action to resolve problem assets; consider the size and potential risks of
material asset concentrations; and provide periodic asset quality reports with
adequate information for management and the board of directors to assess the
level of asset risk. These guidelines also set forth standards for evaluating
and monitoring earnings and for ensuring that earnings are sufficient for the
maintenance of adequate capital and reserves.
Dividend Restrictions. Dividends from bank subsidiaries often constitute a
principal source of income to a bank holding company. Federal rules limit a
bank's ability to pay dividends to its parent bank holding company in excess of
amounts generally equal to the bank's net profits from the current year plus
retained net profits for the preceding two years or if the payment would result
in the bank being considered "undercapitalized" under regulatory capital
guidelines. Bank regulatory agencies also have authority to prohibit a bank from
engaging in activities that, in the opinion of the applicable bank regulatory
authority, constitute unsafe or unsound practices in conducting its business. It
is possible, depending upon the financial condition of the bank in question and
other factors, that the applicable bank regulatory authority could assert that
the payment of dividends or other payments might, under some circumstances, be
such an unsafe or unsound practice. At December 31, 2003 approximately $12.3
million of retained earnings were available for Bank dividend declaration
without prior regulatory approval.
Community Reinvestment Act and Fair Lending Developments. The Bank is subject to
certain fair lending requirements and reporting obligations involving home
mortgage lending operations and Community Reinvestment Act ("CRA") activities.
The CRA generally requires the Federal banking agencies to evaluate the record
of a financial institution in meeting the credit needs of its local communities,
including low- and moderate-income areas. A bank may be subject to substantial
penalties and corrective measures for a violation of certain fair lending laws.
The Federal banking agencies may take compliance with such laws and CRA
obligations into account when regulating and supervising other activities of the
Bank. A Bank's compliance with its CRA obligations is based on a
performance-based evaluation system that bases CRA ratings on its lending
service and investment performance. When a bank holding company applies for
approval to acquire a bank or other bank holding company, the Federal Reserve
will review the assessment of each subsidiary bank of the applicant bank holding
company, and such records may be the basis for denying the application. In
connection with its assessment of CRA performance, the appropriate bank
regulatory agency assigns a rating of "outstanding," "satisfactory," "needs to
improve" or "substantial noncompliance." As a result of its most recent CRA
assessment, the Bank was rated satisfactory under this rating system.
Deposit Insurance. Through the Bank Insurance Fund (the "BIF") and the Savings
Association Insurance Fund (the "SAIF"), the FDIC insures the deposits of the
Bank up to prescribed limits for each depositor. FDIC-insured depository
institutions that are members of the BIF and SAIF pay insurance premiums at
rates based on their assessment risk classification, which is determined in part
based on the institution's capital ratios and in part on factors that the FDIC
deems relevant to determine the risk of loss to the insurance funds. Assessment
rates currently range from zero to 27 cents per $100 of deposits. The FDIC may
increase or decrease the assessment rate schedule on a semi-annual basis. An
increase in the assessment rate could have a material adverse effect on our
earnings, depending on the amount of the increase. The FDIC may terminate a
depository institution's deposit insurance upon a finding by the FDIC that the
institution's financial condition is unsafe or unsound or that the institution
has engaged in unsafe or unsound practices or has violated any applicable rule,
regulation, order or condition enacted or imposed by the institution's
regulatory agency. The termination of deposit insurance for the Bank could have
a material adverse effect on our earnings.
All FDIC-insured depository institutions must pay an annual assessment to
provide funds for the payment of interest on bonds issued by the Financing
Corporation, a Federal corporation chartered under the authority of the Federal
Housing Finance Board. The bonds, commonly referred to as FICO bonds, were
issued to capitalize the Federal Savings and Loan Insurance Corporation. The
FDIC established the FICO assessment rates effective for the fourth quarter of
2003 at approximately $0.00385 per $100 of assessable deposits. The FICO
assessments are adjusted quarterly to reflect changes in the assessment bases of
the FDIC's insurance funds and do not vary depending on a depository
institution's capitalization or supervisory evaluations.
Cross-Guarantee. The Financial Institutions, Reform, Recovery and Enforcement
Act of 1989 provides for cross-guarantees of the liabilities of insured
depository institutions pursuant to which any bank subsidiary of a bank holding
company may be required to reimburse the FDIC for any loss or anticipated loss
to the FDIC that arises from a default of any of such holding company's other
subsidiary banks or assistance provided to such an institution in danger of
default.
Support of Banks. Bank holding companies are also subject to the "source of
strength doctrine" which requires such holding companies to serve as a source of
"financial and managerial" strength for their subsidiary banks and to conduct
its operations in a safe and sound manner. Additionally, it is the Federal
Reserve's policy that in serving as a source of strength to its subsidiary
banks, a bank holding company should stand ready to use available resources to
provide adequate capital funds to its subsidiary banks during periods of
financial stress or adversity and should maintain the financial flexibility and
capital-raising capacity to obtain additional resources for assisting its
subsidiary banks. A bank holding company's failure to meet its obligations to
serve as a source of strength to its subsidiary banks will generally be
considered by the Federal Reserve to be an unsafe and unsound banking practice
or a violation of the Federal Reserve's regulations or both.
Registration with the Securities and Exchange Commission. BNCCORP's securities
are registered with the Securities and Exchange Commission ("SEC") under the
Exchange Act. As such, BNCCORP is subject to the information, proxy
solicitation, insider trading and other requirements and restrictions of the
Exchange Act.
Conservator and Receivership Powers. Federal banking regulators have broad
authority to place depository institutions into conservatorship or receivership
to include, among other things, appointment of the FDIC as conservator or
receiver of an undercapitalized institution under certain circumstances. If the
Bank were placed into conservatorship or receivership, because of the
cross-guarantee provisions of the Federal Deposit Insurance Act, as amended,
BNCCORP, as the sole stockholder of the Bank, would likely lose its investment
in the Bank.
Bank Secrecy Act. The Bank Secrecy Act requires financial institutions to keep
records and file reports that are determined to have a high degree of usefulness
in criminal, tax and regulatory matters, and to implement counter-money
laundering programs and compliance procedures.
Consumer Laws and Regulations. In addition to the laws and regulations discussed
herein, the Bank is also subject to certain consumer laws and regulations that
are designed to protect customers in transactions with banks. These include, but
are not limited to, the Truth in Lending Act, the Truth in Savings Act, the
Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal
Credit Opportunity Act, the Home Mortgage Disclosure Act, the Real Estate
Settlement Procedures Act, the Fair Credit Reporting Act, the Flood Disaster
Protection Act, the Fair Housing Act and the Right to Financial Privacy Act.
These laws mandate certain disclosure requirements and regulate the manner in
which financial institutions must deal with customers when taking deposits or
making loans to such customers.
Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act signed into law on November
12, 1999 (the "Financial Modernization Act") expanded the powers of banks and
bank holding companies to sell any financial product or service, closed the
unitary thrift loophole, reformed the Federal Home Loan Bank ("FHLB") System to
increase community banks' access to loan funding, protected banks from
discriminatory state insurance regulation and established a new framework for
the regulation of bank and bank holding company securities brokerage and
underwriting activities. The Financial Modernization Act also included new
provisions in the privacy area, restricting the ability of financial
institutions to share nonpublic personal customer information with third
parties. We have reviewed implementing regulations and other guidance issued by
bank regulatory agencies in response to the Financial Modernization Act and have
established policies, procedures and programs required or recommended by such
regulations and guidelines.
USA Patriot Act of 2001. Enacted in response to the terrorist attacks in New
York, Pennsylvania and Washington, D.C. on September 11, 2001, the USA Patriot
Act of 2001 (the "Patriot Act") is intended to strengthen U.S. law enforcement's
and the intelligence communities' ability to work cohesively to combat terrorism
on a variety of fronts. The potential impact of the Patriot Act on financial
institutions of all kinds is significant and wide ranging. The Patriot Act
contains sweeping anti-money laundering and financial transparency laws and
requires various regulations including: due diligence requirements for financial
institutions that administer, maintain or manage private bank accounts or
correspondent accounts for non-U.S. persons; standards for verifying customer
identification at the time of account opening; rules to promote cooperation
among financial institutions, regulators, and law enforcement entities in
identifying parties that may be involved in terrorism or money laundering;
reports by nonfinancial trades and business filed with the Treasury Department's
Financial Crimes Enforcement Network for transactions exceeding $10,000 and;
filing of suspicious activity reports by brokers and dealers if they believe a
customer may be violating U.S. laws and regulations. The impact on bank
operations from the Patriot Act will ultimately depend on the form those issued
and pending regulations ultimately take.
Changing Regulatory Structure. The Federal Reserve, OCC and FDIC have extensive
authority to police unsafe or unsound practices and violations of applicable
laws and regulations by depository institutions and their holding companies. The
agencies' authority has been expanded by Federal legislation in recent years. In
addition, state banking authorities possess significant authority to address
violations of their state's banking laws by banks operating in their respective
states by enforcement and other supervisory actions.
As indicated above, the laws and regulations affecting banks and bank holding
companies are numerous and have changed significantly in recent years. There is
reason to expect that changes will continue in the future, although it is
difficult to predict the outcome of these changes or the impact such changes
will have on us.
Employees
At December 31, 2003, we had 302 employees, including 291 full-time equivalent
employees. None of our employees is covered by a collective bargaining
agreement. We consider our relationships with our employees to be satisfactory.
Approximate employees by segment were as follows as of December 31, 2003:
banking, 163; insurance, 129; and brokerage/trust/financial, 10.
Factors That May Affect Future Results of Operations
In addition to the other information contained in this report, the following
risks may affect us. If any of these risks occur, our business, financial
condition or operating results could be adversely affected.
Failure to successfully execute our growth, operating and cross-selling
strategies can negatively impact our profitability. Our financial performance
and profitability depends on our ability to execute our corporate growth,
operating and cross-selling strategies. Future acquisitions and continued growth
can present operating and other issues that could have an adverse effect on our
business, financial condition and results of operations. Our financial
performance will also depend on our ability to maintain profitable operations
through implementation of our banking and financial services philosophies,
including our efforts to cross-sell our various products and services, which
were described earlier. Therefore, there can be no assurance that we will be
able to execute our growth and operating strategies or maintain any particular
level of profitability.
Regional presences, related economic conditions and credit concentrations could
adversely affect our operating results. Although our operations are presently
somewhat geographically dispersed, our focus in the Arizona, Minnesota and North
Dakota regions could adversely affect our results of operations if economic and
business conditions in any of these regions were to exhibit weaknesses. A
prolonged decline in economic or business conditions in our market areas, in
particular in those industries in which we have credit concentrations, could
have a material impact on the quality of our loan portfolio or the demand for
our other products and services, which in turn may have a material adverse
effect on our results of operations. Weakening in the national economy might
further exacerbate local or regional economic conditions. The extent of the
future impact of these events on economic and business conditions cannot be
predicted.
Changes in market interest rates can significantly impact our earnings. Changes
in interest rates impact the demand for new loans, the credit profile of
existing loans, the rates received on loans and investment securities, rates
paid on deposits and borrowings and the value of our derivative contracts and
their associated impact on earnings. The relationship between the interest
income received on loans and investment securities and interest expense paid on
deposits and borrowings is known as net interest income. The level of net
interest income can fluctuate given changes in market interest rates. We measure
interest rate risk under various rate scenarios and using specific criteria and
assumptions. A summary of this process, along with the results of our net
interest income simulations is presented at "Quantitative and Qualitative
Disclosures About Market Risk" included under Item 7A of Part II. Although we
believe our current level of interest rate sensitivity is reasonable and
effectively managed, significant fluctuations in interest rates may have an
adverse effect on our business, financial condition and results of operations.
Changes in market interest rates can directly influence the performance of our
insurance segment. Interest rate movements directly affect insurance company
investment in bonds and, as a result, the rates they subsequently charge for
insurance policies. A rising interest rate environment increases investment
returns for insurers and generally allows those insurers to compete more
aggressively with lower insurance rates. During the past three years, interest
rates have been low and insurance rates were up. Over the next several years,
interest rates could move up and lower insurance rates would be expected, which
in turn would create lower premiums and commissions. We cannot predict, with any
degree of certainty, interest rate developments, and the resulting impact on
insurance premiums and commissions, in future periods.
Government regulation can result in limitations on our operations. The financial
services industry is extensively regulated. Federal and state regulation is
designed primarily to protect the deposit insurance funds and consumers, and not
to benefit our stockholders. Such regulations can at times impose significant
limitations on our operations. Additionally, these regulations are constantly
evolving and may change significantly over time. Significant new laws, such as
those issued in recent years, or changes in or repeal of existing laws may cause
our results to differ materially. Further, Federal monetary policy, particularly
as implemented through the Federal Reserve System, significantly affects
interest rate and credit conditions, which are material considerations for us.
Competition from other financial services providers could adversely impact our
results of operations. The banking and financial services business is highly
competitive. We face competition in making loans, attracting deposits and
providing insurance, brokerage, trust and other financial services. Increased
competition in the banking and financial services businesses may reduce our
market share, impair our growth or cause the prices we charge for our services
to decline. Our results of operations may differ in future periods depending
upon the level and nature of competition we encounter in our various market
areas.
Failure to perform on behalf of borrowers, guarantors and related parties
exposes us to risk of loss that can materially adversely affect our results of
operations. We encounter significant sources of risk from the possibility that
losses will be sustained if a significant number of our borrowers, guarantors
and related parties fail to perform in accordance with the terms of their loans,
commitments or letters of credit. We have adopted underwriting and credit
monitoring procedures and credit policies, including the establishment and
methodological review and analysis of the allowance for credit losses. We
believe these processes and procedures are appropriate to minimize this risk by
assessing the likelihood of nonperformance, tracking loan performance and
diversifying our credit portfolio. These policies and procedures, however, may
not prevent unexpected losses that could materially adversely affect our results
of operations. Additionally, as noted earlier, the performance of borrowers,
guarantors and related parties can be negatively impacted by prevailing economic
conditions over which we have no control. Such negative impacts on these parties
could also materially adversely affect our results of operations.
Impairment of goodwill or other intangible assets could require charges to
earnings, which could result in a negative impact on our results of operations.
Under current accounting standards, goodwill and certain other intangible assets
with indeterminate lives are no longer amortized but, instead, are assessed for
impairment periodically or when impairment indicators are present. Assessment of
goodwill and such other intangible assets could result in circumstances where
the applicable intangible asset is deemed to be impaired for accounting
purposes. Under such circumstances, the intangible asset's impairment would be
reflected as a charge to earnings in the period during which such impairment is
identified. Further information regarding intangible assets is presented in Note
9 to the Consolidated Financial Statements included under Item 8 of Part II.
Item 2. Properties
The principal offices of BNCCORP are located at 322 East Main Avenue, Bismarck,
North Dakota. The Bank owns the building. The principal office of the Bank is
located at 2425 East Camelback Road, Phoenix, Arizona, which it is leasing. The
Bank owns branch offices at 219 South 3rd Street and 801 East Century Avenue and
an additional office building at 116 North 4th Street in Bismarck. The Bank also
owns a branch office at 17045 North Scottsdale Road, Scottsdale, Arizona. It
also owns its banking facilities in Crosby, Ellendale, Kenmare, Linton, Stanley
and Watford City, North Dakota. During 2003, the Bank purchased a facility in
Golden Valley, Minnesota. The facility will be an additional branch office of
the Bank and is expected to commence operations during 2004. In February 2004,
the Bank also purchased properties at 6501 East Grant and 6515 East Grant in
Tucson, Arizona. We anticipate construction of a banking branch at 6515 East
Grant to commence during late 2004 or early 2005 and the 6501 East Grant
property is expected to be occupied by insurance personnel, primarily personnel
from IASW.
The Bank's facilities at 502 West Main Street (Mandan) and Garrison, North
Dakota are leased. The facilities occupied by the Bank, BNC AMI and BNC
Insurance at 333 South Seventh Street, Minneapolis, Minnesota, and the Bank's
facilities at 640 and 660 South Mill Avenue, Tempe, Arizona, along with 2425
East Camelback Road, Phoenix, Arizona are also leased.
Milne Scali occupies four locations in Arizona: 1750 East Glendale Avenue,
Phoenix, 660 South Mill Avenue, Tempe, 2400 East Highway 89A, Cottonwood and
6751 East Camino Principal, Tucson. The Bank owns the property in Phoenix and
the remaining three facilities are presently leased.
We believe that all owned and leased properties are well maintained and
considered in good operating condition. They are believed adequate for the
Company's present operations; however, future expansion could result in the
leasing or construction of additional facilities. We do not anticipate any
difficulty in renewing our leases or leasing additional suitable space upon
expiration of present lease terms. See Note 27 to the Consolidated Financial
Statements included under Item 8 of Part II for additional information
concerning our present lease commitments.
Item 3. Legal Proceedings
BNCCORP, Inc. v. Kenneth Hilton Johnson, No. 309299 on the Docket of the United
States District Court for the Northern District of Illinois, Eastern Division.
In December 2003, we filed suit against Kenneth Hilton Johnson under Section
16(b) of the Exchange Act, as amended. Mr. Johnson is the beneficial owner of
more than 10 percent of our common stock. We seek to recover at least $98,179.45
plus interest in profits made by Mr. Johnson in connection with profitable
purchase and sales transactions of our common stock within the same six- month
period. As of March 9, 2004, Mr. Johnson had not filed an answer to the lawsuit.
On December 31, 2003, Mr. Johnson's attorney tendered a check to us in an
apparent attempt to settle the suit. We have requested, as a condition of
dismissal, an affidavit from Mr. Johnson or his broker(s) stating that the Form
4's filed as exhibits to our complaint reflect all of Mr. Johnson's trades in
our common stock during the period covered by the complaint and that the amount
tendered to us reflects the sum of all of the shortswing profits that Mr.
Johnson owes to the Company under Section 16(b), as of the date of any dismissal
of the lawsuit. As of March 9, 2004, we had not received the requested
affidavit. If we actually receive this affidavit, we will consider accepting the
amount tendered in settlement and dismissal of the lawsuit. Otherwise, we will
recover the full amount due to us by Mr. Johnson under Section 16(b).
From time to time, we may be a party to legal proceedings arising out of our
lending, deposit operations or other activities. We engage in foreclosure
proceedings and other collection actions as part of our loan collection
activities. From time to time, borrowers may also bring actions against us, in
some cases claiming damages. Some financial services companies have been
subjected to significant exposure in connection with litigation, including class
action litigation and punitive damage claims. While we are not aware of any such
actions or allegations that should reasonably give rise to any material adverse
effect, it is possible that we could be subjected to such a claim in an amount
that could be material. Based upon a review with our legal counsel, we believe
that the ultimate disposition of such pending litigation will not have a
material effect on our financial condition, results of operations or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter ended
December 31, 2003.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
BNCCORP's common stock, $.01 par value ("Common Stock"), is traded on the Nasdaq
Stock Market under the symbol "BNCC."
The following table lists the high and low sales prices of our Common Stock for
the periods indicated as reported by the Nasdaq Stock Market. The quotes reflect
the high and low closing sales prices for our Common Stock as reported by
Nasdaq.
2003 2002
------------------------- ---------------------------
Period High Low High Low
----------- ----------- ------------ -----------
First Quarter...... $11.10 $7.00 $8.90 $7.28
Second Quarter..... 13.49 10.64 8.60 7.47
Third Quarter...... 15.25 12.23 7.75 5.49
Fourth Quarter..... 19.20 14.62 8.03 5.25
On March 5, 2004, there were 102 record holders of the Company's Common Stock as
reported by the Company's stock transfer agent and registrar, American Stock
Transfer & Trust Company.
BNCCORP's policy is to retain its earnings to support the growth of its
business. Our board of directors has never declared cash dividends on our Common
Stock and does not plan to do so in the foreseeable future. In making the
determination to pay dividends, we will consider all relevant factors including,
among other things, our capital position and current tax law as it relates to
the treatment of dividends. "Supervision and Regulation - Dividend Restrictions"
included under Item 1 of Part I discusses regulatory restrictions on dividends
payable by the Bank to BNCCORP.
Pursuant to an Asset Purchase and Sale Agreement, on December 31, 2003, BNCCORP
issued 12,701 shares of its Common Stock to IASW in connection with Milne
Scali's acquisition of certain assets and assumption of certain liabilities of
IASW. The shares of Common Stock were issued in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act.
Equity-Based Compensation Plans. The following table summarizes information
relative to our equity-based compensation plans as of December 31, 2003:
(a) (b) (c)
-------------------------- ---------------------- ----------------------------------
Number of securities remaining
Number of securities to Weighted-average available for future issuance
be issued upon exercise exercise price of under equity compensation plans
of outstanding options, outstanding options, (excluding securities reflected
Plan Category warrants and rights warrants and rights in column (a))
- ------------------------------- -------------------------- ---------------------- ----------------------------------
Equity compensation plans
approved by security holders 173,285 $10.41 134,151
- ------------------------------- -------------------------- ---------------------- ----------------------------------
Equity compensation plans not
approved by security holders N/A N/A N/A
Item 6. Selected Financial Data
The selected consolidated financial data presented below under the captions
"Income Statement Data" and "Balance Sheet Data" as of and for the years ended
December 31, 2003, 2002, 2001, 2000 and 1999 are derived from the historical
audited consolidated financial statements of the Company. The Consolidated
Balance Sheets as of December 31, 2003, 2002 and 2001, and the related
Consolidated Statements of Income, Comprehensive Income, Stockholders' Equity
and Cash Flows for each of the four years in the period ended December 31, 2003
were audited by KPMG LLP, independent public accountants. The Consolidated
Balance Sheet as of December 31, 1999 and the related Consolidated Statements of
Income, Comprehensive Income, Stockholders' Equity and Cash Flows for the one
year period ended December 31, 1999 were audited by Arthur Andersen LLP,
independent public accountants who have ceased operations. The financial data
below should be read in conjunction with and is qualified by the Consolidated
Financial Statements and the notes thereto included under Item 8.
The adoption of Statement of Financial Accounting Standards No. 150, "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity" ("SFAS 150") in 2003, which requires that the expense associated with
BNCCORP's subordinated debentures be included in interest expense, is reflected
in all applicable periods in the table below. The data presented in the table
below includes the financial performance of Milne Scali since its acquisition in
April 2002. Additionally, the financial performance of the Bank's Fargo, North
Dakota branch (which was sold on September 30, 2003) and BNC Financial
Corporation, Inc. (which was sold on December 31, 1999) is not reflected in the
data below. All data presented is from continuing operations as of and for all
periods presented.
Selected Financial Data (1)
For the Years Ended December 31,
--------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ------------ ------------ ------------- -------------
(dollars in thousands, except share and per share data)
Income Statement Data:
Total interest income............................. $ 28,646 $ 31,818 $ 37,586 $ 40,658 $ 28,535
Total interest expense............................ 15,268 18,736 24,033 27,679 16,438
----------- ------------ ------------ ------------- -------------
Net interest income............................... 13,378 13,082 13,553 12,979 12,097
Provision for credit losses....................... 1,475 1,202 1,699 1,202 1,138
Noninterest income................................ 20,812 16,296 8,714 7,683 6,028
Noninterest expense............................... 27,290 25,329 18,182 15,821 17,435
Income tax provision (benefit).................... 1,581 822 691 1,183 (193)
----------- ------------ ------------ ------------- -------------
Income (loss) from continuing operations.......... $ 3,844 $ 2,025 $ 1,695 $ 2,456 $ (255)
=========== ============ ============ ============= =============
Balance Sheet Data: (at end of period)
Total assets...................................... $ 621,477 $ 602,228 $ 555,967 $ 547,447 $ 445,232
Investments....................................... 262,568 208,072 211,801 253,566 145,349
Federal Reserve Bank and Federal Home Loan Bank
stock........................................ 7,596 7,071 7,380 9,619 5,643
Loans, net of unearned income..................... 283,555 335,794 297,924 252,753 254,009
Allowance for credit losses....................... (4,763) (5,006) (4,325) (3,588) (2,872)
Total deposits.................................... 395,942 398,245 375,277 330,894 316,772
Short-term borrowings............................. 31,833 28,120 760 33,228 2,200
Federal Home Loan Bank advances................... 112,200 97,200 117,200 117,200 86,500
Long-term borrowings.............................. 8,640 8,561 13 12,642 14,470
Guaranteed preferred beneficial interests in
Company's subordinated debentures............ 22,397 22,326 22,244 7,606 --
Common stockholders' equity....................... 38,686 36,223 30,679 29,457 23,149
Book value per common share outstanding........... $ 14.07 $ 13.41 $ 12.79 $ 12.30 $ 9.65
Earnings Performance / Share Data (1):
Return on average total assets.................... 0.64% 0.36% 0.31% 0.47% (0.07)%
Return on average common stockholders' equity..... 9.92% 5.77% 5.51% 10.02% (1.22)%
Net interest margin............................... 2.47% 2.51% 2.63% 2.65% 3.38%
Net interest spread............................... 2.29% 2.29% 2.25% 2.35% 3.07%
Basic earnings (loss) per common share (1)........ $ 1.38 $ 0.74 $ 0.71 $ 1.02 $ (0.11)
Diluted earnings (loss) per common share (1)...... $ 1.35 $ 0.74 $ 0.70 $ 1.02 $ (0.11)
Cash dividends per common share................... -- -- -- -- --
Cash dividends per preferred share................ $ 800.00 $ 526.67 -- -- --
Total cash dividends - preferred stock............ $ 120 $ 79 -- -- --
Average common shares outstanding................. 2,705,602 2,611,629 2,395,353 2,397,356 2,406,618
Average common and common equivalent shares....... 2,764,816 2,628,798 2,421,113 2,398,553 2,407,018
Shares outstanding at yearend..................... 2,749,196 2,700,929 2,399,170 2,395,030 2,399,980
Balance Sheet and Other Key Ratios (1):
Nonperforming assets to total assets.............. 1.28% 1.27% 0.80% 0.12% 0.64%
Nonperforming loans to total loans................ 2.80% 2.27% 1.47% 0.23% 0.65%
Net loan charge-offs to average loans............. (0.56)% (0.17)% (0.33)% (0.20)% (0.46)%
Allowance for credit losses to total loans........ 1.68% 1.49% 1.45% 1.42% 1.13%
Allowance for credit losses to
nonperforming loans........................... 60% 66% 99% 619% 173%
Average common stockholders' equity to average
total assets.................................. 6.25% 5.93% 5.64% 4.71% 5.48%
- -------------------------
(1) From continuing operations for all periods presented.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The following table summarizes income from continuing operations, net income and
basic and diluted earnings per share for the 12 months ended December 31
(amounts in thousands):
2003 2002 2001
------------- ------------- ------------
Income from continuing operations..... $ 3,844 $ 2,025 $ 1,695
Net income............................ 3,844 2,039 1,245
Basic earnings per common share....... 1.38 0.75 0.52
Diluted earnings per common share..... 1.35 0.75 0.51
Executive Summary - 2003 vs. 2002. Strategic initiatives we pursued in recent
years, including diversifying our sources of business, focusing on what we
believe are attractive and growing core markets and managing for long-term
stockholder value generated favorable results in 2003. The following information
highlights key developments during 2003.
o 2003 net income rose 88.5 percent, to $3.84 million ($1.35 per share on a
diluted basis) compared with $2.04 million ($0.75 per share) for 2002.
o Our insurance segment provided a significant contribution to 2003
profitability.
o Noninterest income rose to 60.9 percent of gross revenues in 2003 compared
with 55.5 percent in 2002.
o Noninterest income increased 27.7 percent in 2003 to $20.81 million
compared with $16.30 million in 2002.
o Insurance commission income accounted for $14.57 million, or 70.0 percent
of noninterest income, compared with $8.98 million, or 55.1 percent, in
2002 with 2003 representing a full year of contribution from Milne Scali,
acquired in April 2002.
o Our trust and financial services division recorded a $488,000 fee for
coordinating the sale of two companies.
o Net interest income in 2003 remained relatively flat at $13.38 million
compared with $13.08 million in 2002. Included in net interest income were
mark-to-market losses on the value of derivative contracts totaling
($80,000) in 2003 and ($779,000) in 2002.
o Net interest margin narrowed to 2.47 percent in 2003 compared with 2.51
percent in 2002. Adoption of SFAS 150 required interest associated with
BNCCORP's subordinated debentures to be reflected as interest expense. All
prior periods have been reclassified to reflect this change.
o Noninterest expense rose 7.7 percent to $27.29 million for 2003 compared
with $24.33 million for 2002. The increase primarily reflected costs
associated with expanded banking and insurance operations in Arizona,
actions expected to support increased operating levels in 2004.
o Total assets reached $621.45 million at December 31, 2003 compared with
$602.23 million one year earlier.
o Total loans decreased 15.6 percent in 2003, to $283.56 million. Loan volume
was impacted by planned loan reductions, completion of some financed
commercial real estate projects and slower loan demand that was reflective
of economic conditions.
o The provision for credit losses in 2003 was $1.48 million compared with
$1.20 million in 2002.
o Loan charge-offs were $1.82 million in 2003 compared with $657,000 in 2002.
$1.3 million of the 2003 charge-offs related to one commercial contractor.
o The allowance for credit losses as a percentage of total loans at December
31, 2003 was 1.68 percent compared with 1.45 percent one year earlier. The
ratio of the allowance for credit losses to total nonperforming loans was
60 percent at December 31, 2003 compared with 66 percent one year earlier.
o We had $7.95 million of nonperforming loans at December 31, 2003 compared
with $7.63 million one year earlier. During January 2004, a $4.5 million
loan (reflected as a nonperforming loan at December 31, 2003) was paid in
full, including accrued interest. A $2.2 million nonperforming loan is
expected to be resolved during the second quarter of 2004. These
developments should result in much-improved asset quality moving forward
into 2004.
o Investment securities available for sale increased 26.2 percent in 2003, to
$262.57 million as investments were increased to maintain an acceptable
earning asset portfolio despite the reduction in loan volume.
o Core deposits increased $24.89 million or 7.3 percent during 2003. The
growth was primarily attributable to our Arizona market as we continued to
see demand for our Wealthbuilder family of deposit products.
o Brokered and national market certificates of deposit decreased $27.21
million during 2003.
o Reflecting continued success of our expansion into new markets, the Arizona
operations of the Bank accounted for approximately 31.2 percent of total
loans and 19.9 percent of total deposits at December 31, 2003.
o Total common stockholders' equity was approximately $38.69 million at
December 31, 2003, equivalent to book value per common share of $14.07
(tangible book value per common share of $5.54).
During 2003, we continued to take actions which we believe will strengthen the
performance of our core businesses.
In banking, we opened our Scottsdale branch office, relocated our East Camelback
office in Phoenix to a more prominent and visible location, acquired property
for a branch office in Golden Valley, Minnesota and acquired a mortgage banking
operation.
In insurance, the acquisition of IASW in December 2003 will help to increase the
volume of our insurance business.
We believe that we have achieved our goal of building a diversified business
base, which has long been a cornerstone of our strategy. We believe each of our
core businesses is well defined and well positioned to serve the needs of our
customers, while contributing to our long-term corporate financial performance
and share value creation.
We believe that our record financial performance in 2003 provides a meaningful
indication of our earnings potential. Looking ahead to 2004, we hope to continue
to derive benefits from our investments in expanding our banking and insurance
operations, and implementing programs to encourage cross-selling across all of
our business lines.
Executive Summary - 2002 vs. 2001. The following information highlights key
developments during 2002.
o Net income rose 63.8 percent, to $2.04 million ($0.75 per common share on a
diluted basis) compared with $1.25 million ($0.51 per share) in 2001.
o Our insurance segment made a strong contribution to 2002 profitability with
the acquisition of Milne Scali in April 2002.
o Noninterest income rose to 55.5 percent of gross revenues in 2002 compared
with 39.1 percent in 2001.
o Noninterest income increased 87.0 percent in 2002, to $16.30 million
compared with $8.71 million in 2001.
o Insurance commission income accounted for $8.98 million, or 55.1 percent,
of noninterest income, compared with $1.89 million, or 21.7 percent, in
2001.
o Net interest income in 2002 remained relatively flat at $13.08 million
compared with $13.55 million in 2001. Included in net interest income were
mark-to-market losses on the value of derivative contracts totaling
($779,000) in 2002 and ($184,000) in 2001.
o Net interest margin narrowed to 2.51 percent in 2002 compared with 2.63
percent in 2001.
o Noninterest expense rose 39.3 percent, to $25.33 million, for 2002 compared
with $18.18 million for 2001. The 2002 increase primarily reflected our
expanded banking and insurance operations in Arizona, including the
acquisition of Milne Scali in April, 2002, and the winding down of the
Fargo office of BNC AMI.
o Total assets were $602.23 million at December 31, 2002 compared with
$585.06 million one year earlier.
o Total loans increased $37.87 million, or 12.7 percent, to $335.79 million
at the end of 2002.
o The provision for credit losses in 2002 was $1.20 million compared with
$1.70 million in 2001.
o Loan charge-offs were $657,000 in 2002 compared with $1.27 million in 2001.
o The allowance for credit losses as a percentage of total loans at December
31, 2002 was 1.49 percent compared with 1.45 percent one year earlier. The
ratio of the allowance for credit losses to total nonperforming loans was
66 percent at December 31, 2002 compared with 99 percent one year earlier.
o We had $7.63 million of nonperforming loans at December 31, 2002 compared
with $4.38 million one year earlier.
o Total deposits rose 6.1 percent to $398.25 million at December 31, 2002
compared with $375.28 million one year earlier.
o Total common stockholders' equity was approximately $36.22 million at
December 31, 2002, equivalent to book value per common share of $13.41
(tangible book value per common share of $5.60).
o Net unrealized gains in our investment portfolio at December 31, 2002 were
nearly $4.4 million.
During 2002, we also undertook a series of actions to sharpen the focus and
strengthen the performance of each of our three core businesses: banking,
insurance and brokerage/trust/financial services.
In banking, we sold our Fargo, North Dakota branch allowing us to redeploy our
resources in markets we believe present greater potential for profitability.
In insurance, the acquisition of Milne Scali in the second quarter of 2002
significantly increased the scale of our insurance business.
In brokerage/trust/financial services, in order to enhance the financial options
available to our customers, we formed a relationship with Raymond James
Financial Services, Inc. We also reorganized the management and office network
of BNC AMI to improve the productivity of this aspect of our business.
Results of Operations
Net Interest Income. Net interest income, the difference between total interest
income earned on interest-earning assets and total interest expense paid on
interest-bearing liabilities, is the banking segment's primary source of
earnings. The amount of net interest income is affected by changes in the volume
and mix of earning assets, the level of rates earned on those assets, the volume
and mix of interest-bearing liabilities and the level of rates paid on those
liabilities.
The following table sets forth, for the periods indicated, certain information
relating to our average balance sheet and reflects the yield on average assets
and cost of average liabilities. Such yields and costs are derived by dividing
income and expense by the average balance of assets and liabilities. All average
balances have been derived from monthly averages, which are indicative of daily
averages.
Analysis of Average Balances, Interest and Yields/Rates (1)
For the Years ended December 31,
-----------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------- ------------------------------- ------------------------------
Interest Average Interest Average Interest Average
Average earned yield or Average earned Yield Average earned yield
balance or paid cost balance or paid or cost balance or paid or cost
---------- --------- --------- ---------- --------- --------- ---------- -------- --------
(dollars in thousands)
Assets
Federal funds sold/interest
-bearing due from............. $ 1,447 $ 11 0.76% $ 3,795 $ 66 1.74% $ 1,830 $ 50 2.73%
Taxable investments............ 203,051 7,803 3.84% 193,972 9,997 5.15% 206,572 12,716 6.16%
Tax-exempt investments......... 32,982 1,535 4.65% 19,979 977 4.89% 16,452 829 5.04%
Loans and leases (2)........... 308,115 19,297 6.26% 307,227 20,778 6.76% 293,716 23,991 8.17%
Allowance for credit losses.... (4,909) -- (4,579) -- (4,153) --
---------- --------- ---------- --------- ---------- --------
Total interest-earning
assets (3).................. 540,686 28,646 5.30% 520,394 31,818 6.11% 514,417 37,586 7.31%
Noninterest-earning assets:
Cash and due from banks.... 11,733 13,706 11,997
Other...................... 48,249 34,946 19,388
---------- ---------- ----------
Total assets from continuing
operations.................... 600,668 569,046 545,802
Assets from discontinued
Fargo branch.................. -- 22,258 22,270
---------- ---------- ----------
Total assets......... $600,668 $591,304 $568,072
========== ========== ==========
Liabilities and Stockholders'
Equity
Deposits:
Interest checking and
money market accounts....... $186,796 2,189 1.17% $174,108 2,849 1.64% $147,775 4,669 3.16%
Savings..................... 6,052 51 0.84% 4,511 39 0.86% 3,758 56 1.49%
Certificates of deposit:
Under $100,000............... 94,820 3,012 3.18% 104,964 4,068 3.88% 98,639 5,280 5.35%
$100,000 and over............ 55,928 2,186 3.91% 73,639 3,286 4.46% 73,806 4,248 5.76%
---------- --------- ---------- --------- ---------- --------
Total interest-bearing
deposits...................... 343,596 7,438 2.16% 357,222 10,242 2.87% 323,978 14,253 4.40%
Borrowings:
Short-term borrowings....... 21,942 382 1.74% 7,799 141 1.81% 10,206 441 4.32%
FHLB advances............... 111,777 5,333 4.77% 97,711 6,214 6.36% 118,705 7,185 6.05%
Long-term borrowings......... 8,623 387 4.49% 6,063 310 5.11% 8,378 777 9.27%
Subordinated debentures...... 22,141 1,728 7.80% 22,056 1,829 8.29% 13,542 1,377 10.17%
---------- --------- ---------- --------- ---------- --------
Total interest-bearing
liabilities.................. 508,079 15,268 3.01% 490,851 18,736 3.82% 474,809 24,033 5.06%
Noninterest-bearing
demand accounts............ 40,022 33,951 28,474
---------- ---------- ----------
Total deposits and
interest-bearing
liabilities............. 548,101 524,802 503,283
Other noninterest-bearing
liabilities................... 13,542 11,336 8,765
Liabilities from discontinued
Fargo branch.................. -- 20,476 24,654
---------- ---------- ----------
Total liabilities..... 561,643 556,614 536,702
Stockholders' equity............ 39,025 34,690 31,370
---------- ---------- ----------
Total liabilities and
stockholders' equity.... $600,668 $591,304 $568,072
========== ========== ==========
Net interest income............. $ 13,378 $13,082 $13,553
========= ========= ========
Net interest spread............. 2.29% 2.29% 2.25%
========= ========= ========
Net interest margin (4)......... 2.47% 2.51% 2.63%
========= ========= ========
Ratio of average
interest-earning assets
to average interest-bearing
liabilities................. 106.42% 106.02% 108.34%
========== ========== ==========
- --------------------
(1) From continuing operations for all periods presented.
(2) Average balances of loans and leases include nonaccrual loans and leases,
and are presented net of unearned income. Loan fee amortization totaling
approximately $1.5 million, $1.3 million and $812,000 is included in loan
interest income for the 12-month periods ended December 31, 2003, 2002 and
2001, respectively.
(3) Tax-exempt income has not been presented on a taxable equivalent basis.
Tax-exempt income of $1.5 million, $982,000 and $840,000 was recognized
during the years ended December 31, 2003, 2002 and 2001, respectively.
(4) Net interest margin equals net interest income divided by average
interest-earning assets for the period.
The following table illustrates, for the periods indicated, the dollar amount of
changes in our interest income and interest expense for the major components of
interest-earning assets and interest-bearing liabilities and distinguishes
between the increase related to higher outstanding balances and the volatility
of interest rates. Changes attributable to the combined impact of volume and
rate have been allocated proportionately to the change due to volume and the
change due to rate:
Analysis of Changes in Net Interest Income (1)
For the Years Ended December 31,
-------------------------------------------------------------------------
2003 Compared to 2002 2002 Compared to 2001
------------------------------------ -----------------------------------
Change Due to Change Due to
-------------------------- ---------------------
Volume Rate Total Volume Rate Total
------------ ------------ -------- ----------- -------- ------------
(in thousands)
Interest Earned on Interest-Earning Assets
Federal funds sold/interest-bearing due from........ $ (30) $ (26) $ (56) $ 24 $ (8) $ 16
Investments......................................... 1,347 (2,982) (1,635) (533) (2,038) (2,571)
Loans............................................... 60 (1,541) (1,481) 1,172 (4,385) (3,213)
------------ ------------ -------- ----------- -------- ------------
Total increase (decrease) in interest income..... 1,377 (4,549) (3,172) 663 (6,431) (5,768)
------------ ------------ -------- ----------- -------- ------------
Interest Expense on Interest-Bearing Liabilities
Interest checking and money market accounts......... 228 (888) (660) 1,067 (2,887) (1,820)
Savings............................................. 13 (1) 12 16 (33) (17)
Certificates of Deposit:
Under $100,000................................... (368) (688) (1,056) 367 (1,579) (1,212)
$100,000 and over................................ (726) (374) (1,100) (10) (952) (962)
Short-term borrowings............................... 246 (5) 241 (87) (213) (300)
FHLB advances..................................... 1,198 (2,079) (881) (1,361) 390 (971)
Long-term borrowings................................ 108 (31) 77 (178) (289) (467)
Subordinated debentures............................. 7 (108) (101) 639 (187) 452
------------ ------------ -------- ----------- -------- ------------
Total increase (decrease) in interest expense....... 706 (4,174) (3,468) 453 (5,750) (5,297)
------------ ------------ -------- ----------- -------- ------------
Increase (decrease) in net interest income.......... $ 671 $ (375) $ 296 $ 210 $ (681) $ (471)
============ ============ ======== =========== ======== ============
(1) From continuing operations for all periods presented.
Year ended December 31, 2003 compared to year ended December 31, 2002. Net
interest income increased $296,000, or 2.3 percent, and totaled $13.4 million
for 2003. Net interest spread and net interest margin adjusted to 2.29 and 2.47
percent, respectively, for the 12-month period ended December 31, 2003 from 2.29
and 2.51, respectively, for the 12-month period ended December 31, 2002.
Net interest income for the 12-month periods ended December 31, 2003 and 2002
reflected mark-to-market losses on the value of derivative contracts totaling
($80,000) and ($779,000), respectively. Without the mark-to-market adjustments
on these derivative contracts for the two periods, net interest margin would
have been 2.49 percent for the 12 months ended December 31, 2003 and 2.66
percent for the 12 months ended December 31, 2002.
The remaining fair value of our interest rate cap contracts on December 31, 2003
was $56,000. Therefore, net interest income in future periods can only be
negatively affected to that amount if the fair value of the contracts were
required to be written to $0. If the fair value of the derivative contracts were
to be increased in future periods due to increases in three-month LIBOR (the
rate upon which our current cap contracts are based), this would have a
favorable effect on net interest income in those future periods as favorable
adjustments to the fair value of the contracts would be reflected as reduced
interest expense.
The following condensed information summarizes the major factors combining to
create the changes to net interest income, spread and margin during 2003 as
compared to 2002. Lettered explanations following the summary describe causes of
the changes in these major factors.
Net Interest Income Analysis - 2003 vs. 2002 (1)
For the Years Ended
December 31, Change
------------------------- -----------------------
2003 2002
---------- -----------
(amounts in millions)
Total interest income decreased................................ $ 28.7 $ 31.8 $ ( 3.1) (10)%
Due to:
Decrease in yield on interest-earnings assets............ 5.30% 6.11% (0.81)% (13)%
Driven by:
Decrease in yield on loans (a)........................... 6.26% 6.76% (0.50)% (7)%
Decrease in yield on investments (b)..................... 3.96% 5.13% (1.17)% (23)%
The decreases in yield on interest-earning assets
were Offset by:
Increase in average earning assets....................... $ 540.7 $ 520.4 $ 20.3 4%
Driven by:
Increase in average loans (c)............................ $ 308.1 $ 307.2 $ 0.9 0%
Increase in average investments (d)...................... $ 236.0 $ 214.0 $ 22.0 10%
Total interest expense decreased............................... $ 15.3 $ 18.7 $ (3.4) (18)%
Due to:
Decrease in cost of interest-bearing liabilities......... 3.01% 3.82% (0.81)% (21)%
Driven by:
Decrease in cost of interest-bearing deposits (e)........ 2.16% 2.87% (0.71)% (25)%
Decrease in cost of borrowings (f)....................... 4.76% 6.36% (1.60)% (25)%
These decreases were coupled with:
Increase in average interest-bearing liabilities......... $ 508.1 $ 490.9 $ 17.2 4%
Driven by:
Increase in average borrowings (g)....................... $ 164.5 $ 133.6 $ 30.9 23%
Offset by:
Decrease in average interest-bearing deposits (h)........ $ 343.6 $ 357.2 $ (13.6) (4)%
- ---------------
(1) From continuing operations for all periods presented.
(a) Our decreased loan yield is reflective of the lower interest rate
environment during 2003. The lower rate environment was caused by several
Federal Reserve reductions in the Federal funds target rate causing prime
rate to decrease significantly during 2001 and continuing into 2002 and
2003. The daily average prime rate in 2003 was 4.12 percent as compared to
4.68 percent for 2002. The lower prime rate caused floating rate loans to
reprice at lower levels and new loans to be originated at interest rate
levels lower than those originated in the prior period.
(b) The decreased yield on investments was also reflective of the lower
interest rate environment during 2003.
(c) Average loans remained relatively stable during 2003 in spite of a
significant decline in period end loans at December 31, 2003 versus
December 31, 2002.
(d) Average investments increased in 2003 to maintain an acceptable average
earning asset portfolio and related interest income. The increase in
average investments in 2003 caused the mix in the earning asset portfolio
to change resulting in downward pressure on net interest margin.
(e) The decrease in cost of interest-bearing deposits was reflective of the
lower interest rate environment during 2003. Floating rate deposit accounts
repriced at lower interest rate levels and certificates of deposit renewed
or were originated at lower interest rate levels than those in the prior
period.
(f) 2003 borrowing costs decreased due to the lower interest rate environment.
The lower interest rates were reflected in decreased cost on our $15.0
million floating rate subordinated debentures, our $8.5 million floating
rate loan, floating rate Federal funds purchased and repurchase agreements
with customers.
(g) Average borrowings increased in 2003 due to higher average balances of
Federal funds purchased, customer repurchase agreements and FHLB advances.
(h) Average deposits in 2003 decreased largely due to a $27.2 million reduction
in brokered and national market certificates of deposit during the 12
months ended December 31, 2003.
Year ended December 31, 2002 compared to year ended December 31, 2001. Net
interest income decreased $471,000, or 3.5 percent, to $13.1 million. Net
interest spread and net interest margin adjusted to 2.29 and 2.51 percent,
respectively, for the 12-month period ended December 31, 2002 from 2.25 and
2.63, respectively, for the 12-month period ended December 31, 2001.
Net interest income for the 12-month periods ended December 31, 2002 and 2001
reflected mark-to-market losses on the value of derivative contracts totaling
($779,000) and ($184,000), respectively. Without the mark-to-market adjustments
on these derivative contracts for the two periods, net interest margin would
have been 2.66 percent for the 12 months ended December 31, 2002 and 2.67
percent for the 12 months ended December 31, 2001.
The following condensed information summarizes the major factors combining to
create the changes to net interest income, spread and margin during 2002 as
compared to 2001. Lettered explanations following the summary describe causes of
the changes in these major factors.
Net Interest Income Analysis - 2002 vs. 2001 (1)
For the Years Ended
December 31, Change
------------------------- -----------------------
2002 2001
---------- -----------
(amounts in millions)
Total interest income decreased.............................. $ 31.8 $ 37.6 $ (5.8) (15)%
Due to:
Decrease in yield on earnings assets................... 6.11% 7.31% (1.20)% (16)%
Driven by:
Decreased yield on loans (a)........................... 6.76% 8.17% (1.41)% (17)%
Decreased yield on investments (b)..................... 5.13% 6.07% (0.94)% (15)%
The decreased yields were offset by:
Increased average earning assets ...................... $ 520.4 $ 514.4 $ 6.0 1%
Driven by:
Increase in average loans (c).......................... $ 307.2 $ 293.7 $ 13.5 5%
Offset by:
Decrease in average investments (d).................... $ 214.0 $ 223.0 $ (9.0) (4)%
Total interest expense decreased............................. $ 18.7 $ 24.0 $ (5.3) (22)%
Due to:
Decrease in cost of interest-bearing liabilities....... 3.82% 5.06% (1.24)% (25)%
Driven by:
Decrease in cost of interest-bearing deposits (e)...... 2.87% 4.40% (1.53)% (35)%
Decrease in cost of borrowings (f)..................... 6.36% 6.48% (0.12)% (2)%
These decreases in cost of interest-bearing liabilities
were offset by:
Increase in average interest-bearing liabilities....... $ 490.9 $ 474.8 $ 16.1 3%
Driven by:
Increase in average interest-bearing deposits (g)...... $ 357.2 $ 324.0 $ 33.2 10%
Offset by:
Decrease in average borrowings (h)..................... $ 133.6 $ 150.8 $ (17.2) (11)%
- --------------------
(1) From continuing operations for all periods presented.
(a) Our decreased loan yield is reflective of the significantly lower interest
rate environment during 2002. The lower rate environment was caused by
several Federal Reserve reductions in the Federal funds target rate causing
prime rate to decrease significantly during 2001 and continuing into 2002.
The daily average prime rate in 2002 was 4.68 percent as compared to 6.91
percent in 2001. The lower prime rate caused floating rate loans to reprice
at lower levels and new loans to be originated at interest rate levels
lower than those originated in the prior period.
(b) The decreased yield on investments was also reflective of the lower
interest rate environment during 2002.
(c) The increase in average loans was driven primarily by loan growth in the
Arizona and Minnesota markets.
(d) Average investments declined in 2002 as the portfolio was restructured to
better manage our capital, shift our earning asset mix from investments to
loans and establish the proper forward-looking risk/reward profile for the
investment portfolio.
(e) The decrease in cost of interest-bearing deposits was reflective of the
lower interest rate environment during 2002. Floating rate deposit accounts
repriced at lower levels and certificates of deposit renewed or were
originated at lower interest rate levels than those in the prior period.
(f) Borrowing costs decreased due to the lower rate environment during 2002,
the payoff of our 8 5/8 percent subordinated notes during 2001 and the
adjustment of the $15.0 million floating rate subordinated debentures in
response to the lower rates in 2002.
(g) Average interest-bearing deposits increased largely due to increases in the
volume of our Wealthbuilder interest checking and money market accounts
originating primarily in our Arizona and Minnesota markets.
(h) Average borrowings decreased due to lower averages of short-term
borrowings, the pay down of $20.0 million of FHLB advances in early 2002, a
continued shift in our funding base from borrowings to core deposits and
the retirement of our subordinated notes, which were outstanding through
August 31, 2001.
Net interest income and margin in future periods may be impacted by several
factors. Changes in net interest income are dependent upon the volume and mix of
interest-earning assets and interest-bearing liabilities, the movement of
interest rates and the level of nonperforming assets. Achieving net interest
margin growth is dependent on our ability to generate higher-yielding assets and
lower cost funding sources such as deposits and borrowings. If variable index
rates, such as the prime rate, were to decline, we could experience compression
of our net interest margin depending upon the timing and amount of any
reductions, as it is possible that interest rates paid on some deposits and
borrowings may not decline as quickly, or to the same extent, as the decline in
the yield on interest-rate-sensitive assets such as commercial and other loans.
Competition for checking, savings and money market deposits, important sources
of lower cost funds for us, is intense. We could also experience net interest
margin compression if rates paid on deposits and borrowings increase, or as a
result of new pricing strategies and lower rates offered on loan products in
response to competitive pressures, rates on interest-bearing liabilities
increase faster, or to a greater extent, than the increase in the yield on
interest-rate-sensitive assets. The level and nature of the impact cannot be
precisely ascertained. Federal Reserve actions in response to economic
developments can vary causing prime and other rates to adjust and, in some
cases, immediately impact our interest-earning assets and interest-bearing
liabilities.
These factors, including the competitive environment in the markets in which we
operate, the multitude of financial and investment products available to the
public and the monetary policies of the Federal Reserve, can materially impact
our operating results. Therefore, we cannot predict, with any degree of
certainty, prospects for net interest income and net interest margin in future
periods. See Item 7A, "Quantitative and Qualitative Disclosures About Market
Risk," for information relating to the impact of fluctuating interest rates on
our future net interest income prospects.
Provision for Credit Losses. We determine a provision for credit losses which we
consider sufficient to maintain our allowance for credit losses at a level
considered adequate to provide for an estimate of probable losses related to
specifically identified loans as well as probable losses in the remaining loan
and lease portfolio that have been incurred as of each balance sheet date. The
provision for credit losses for the year ended December 31, 2003 was $1.5
million as compared to $1.2 million in 2002 and $1.7 million in 2001. Net loan
and lease charge-offs were $1.7 million, or 0.56 percent of average loans and
leases in 2003 compared with $521,000, or 0.17 percent in 2002 and $962,000, or
0.33 percent in 2001. The increase in the provision for credit losses and net
charge-offs in 2003 reflected the inclusion of certain commercial credits in the
nonperforming loans category and subsequent charge-off of some commercial loans.
The provision for credit losses is calculated as part of the determination of
the allowance for credit losses and the related provision for credit losses is a
critical accounting policy which involves consideration of a number of factors
such as loan growth, net charge-offs, changes in the composition of the loan
portfolio, delinquencies in the loan and lease portfolio, the value of
underlying collateral on problem loans, general economic conditions and our
assessment of credit risk in the current loan and lease portfolio. Periodic
fluctuations in the provision for credit losses result from our assessment of
the adequacy of the allowance for credit losses; however, actual loan losses may
vary from current estimates.
The allowance for loan losses totaled $4.8 million at December 31, 2003 compared
with $5.0 and $4.3 million at December 31, 2002 and 2001, respectively. See Note
1 to the Consolidated Financial Statements included under Item 8, "-Financial
Condition-Loan Portfolio-Allowance for Credit Losses" and "-Critical Accounting
Policies" for further discussion of the components of the allowance for credit
losses, our systematic methodology for determining the adequacy of the allowance
and additional data pertaining to charge-offs, recoveries and other related
information.
Noninterest Income. Noninterest income, primarily driven by insurance
commissions, is becoming a more significant source of revenues for us as we
continue to emphasize our goal of focusing on local relationship banking and
providing a broad range of financial products and services that will meet the
needs of our customers, both commercial and consumer. Our noninterest income
increased approximately $4.5 million, or 27.7 percent, in 2003 largely due to a
full year of insurance commission income generated by Milne Scali, which we
acquired in April 2002. Service charges, trust and financial services income and
rental income also increased in 2003 while fees on loans, net gain on sales of
securities and brokerage income declined. Noninterest income increased
approximately $7.6 million, or 87.0 percent, in 2002 largely due to insurance
commission income generated by Milne Scali. Fees on loans, net gain on sale of
securities and service charges also increased, while brokerage income and trust
and financial services income declined.
The following table presents, for the periods indicated, the major categories of
our noninterest income as well as the amount and percent of change between each
of the periods presented. Related information and significant changes are
discussed in lettered explanations following the table:
Noninterest Income (1)
Increase (Decrease)
----------------------------------------------------
For the Years Ended December 31, 2003 - 2002 2002 - 2001
---------------------------------------- ------------------------- ----------------------
2003 2002 2001 $ % $ %
----------- --------- ---------- ---------- ---------- ---------- --------
(in thousands)
Insurance commissions..... $ 14,568 $ 8,981 $ 1,891 $ 5,587 62% $ 7,090 375% (a)
Fees on loans............. 2,022 2,169 1,936 (147) (7)% 233 12% (b)
Trust and financial
services............... 1,009 751 899 258 34% (148) (16)% (c)
Net gain on sales of
securities ............ 968 1,870 1,396 (902) (48)% 474 34% (d)
Service charges........... 909 755 636 154 20% 119 19% (e)
Brokerage income.......... 420 1,094 1,407 (674) (62)% (313) (22)% (f)
Rental income............. 212 89 54 123 138% 35 65% (g)
Other..................... 704 587 495 117 20% 92 19%
----------- --------- ---------- ---------- ----------
Total noninterest income.. $ 20,812 $16,296 $ 8,714 $ 4,516 28% $ 7,582 87%
=========== ========= ========== ========== ==========
- --------------------
(1) From continuing operations for all periods presented.
(a) Insurance commissions. In 2003, insurance commissions increased due to
a full year of production of Milne Scali, acquired in April 2002.
Insurance commissions in 2002 increased dramatically also due to the
acquisition of Milne Scali. Contingency fees (received primarily
during the first quarter of each year) included in the amounts above
totaled approximately $990,000, $124,000 and $27,000 for the years
ended December 31, 2003, 2002 and 2001, respectively.
(b) Fees on loans. The decrease in noninterest income loan fees in 2003
primarily reflects a decline in loan generation due to reduced loan
demand which was reflective of the economic environment during 2003.
The increase in loan fees for 2002 is largely attributable to loans
originated and sold on the secondary market. Loan volume generation
and the related loan fees associated with such loans can be subject to
significant fluctuations making it difficult to anticipate the amount
of loans that will be originated or placed and related loan fees that
will be recognized in future periods.
(c) Trust and financial services. The 2003 increase reflects a $488,000
fee recognized by the Bank's financial services division for
management of the sale of two companies on behalf of a customer. This
fee was offset by decreases in other fee income in the trust and
financial services division including the loss of fee income
associated with the BNC U.S. Opportunities Fund LLC, which was
terminated during 2003. The 2002 decrease in trust and financial
services revenue is attributable to reduced fees from the BNC U.S.
Opportunities Fund LLC as such fees were primarily a function of the
asset size of the fund and the fund decreased during 2002. The fund's
size was also negatively impacted by the overall decline in equity
markets in 2002.
(d) Net gain on sales of securities. Net gain on sales of securities
varies depending on the nature of investment securities sales
transacted during the respective periods. The net gain on sales of
securities in 2002 was primarily a result of repositioning the
investment portfolio's forward-looking risk/reward profile. We cannot
guarantee our ability to generate realized gains in the future such as
those recognized during the most recent three years given the current
absolute low level of interest rates. In the future, the investment
portfolio risk/reward management process may require us to recognize
net realized losses in order to optimize the forward-looking profile
of the portfolio.
(e) Service charges. Service charges increased in 2003 and 2002 as the
Bank continued to increase its Wealthbuilder interest checking and
money market account volume along with an increase in non-interest
bearing deposits which are primarily business deposit relationships
that tend to utilize a greater level of fee-based deposit services.
(f) Brokerage income. In 2003, brokerage income declined largely due to
the Bank having fewer brokers on staff in Minnesota. In 2002,
brokerage income declined as a result of market conditions and a
decrease in the number of brokers at BNC AMI, including the closing of
BNC AMI's Fargo office in September.
(g) Rental income. The increase in rental income in 2003 is attributable
to the rental of space associated with some of the Company's new
facilities.
Noninterest Expense. Noninterest expense increased approximately $2.0 million,
or 7.7 percent, in 2003 primarily as a result of the April 2002 Milne Scali
acquisition and our expanding presence in the Arizona market. Noninterest
expense increased approximately $7.1 million, or 39.3 percent, in 2002 also due
to the April 2002 acquisition of Milne Scali and our expanded presence in the
Arizona market.
The following table presents, for the periods indicated, the major categories of
our noninterest expense as well as the amount and percent of change between each
of the periods presented. Related information and significant changes are
discussed in lettered explanations below the table:
Noninterest Expense (1)
Increase (Decrease)
--------------------------------------------
For the Years Ended December 31, 2003 - 2002 2002 - 2001
---------------------------------- ---------------------- --------------------
2003 2002 2001 $ % $ %
---------- ---------- ---------- ----------- --------- --------- ---------
(in thousands)
Salaries and employee benefits..... $ 16,478 $ 14,723 $ 9,911 $ 1,755 12% $ 4,812 49% (a)
Occupancy.......................... 2,306 2,235 1,661 71 3% 574 35% (b)
Depreciation and amortization...... 1,458 1,320 1,123 138 10% 197 18% (c)
Office supplies, telephone and
postage.......................... 1,214 1,106 940 108 10% 166 18% (d)
Professional services.............. 1,146 1,495 1,326 (349) (23)% 169 13% (e)
Amortization of intangible assets.. 1,063 881 482 182 21% 399 83% (f)
Marketing and promotion............ 803 749 709 54 7% 40 6%
FDIC and other assessments......... 201 214 193 (13) (6)% 21 11%
Repossessed and impaired asset
expenses/write-offs.............. 40 142 40 (102) (72)% 102 255%
Other.............................. 2,581 2,464 1,797 117 5% 667 37% (g)
---------- ---------- ---------- ----------- ----------
Total noninterest expense.......... $ 27,290 $ 25,329 $ 18,182 $ 1,961 8% $ 7,147 39%
========== ========== ========== =========== ==========
Efficiency ratio................... 79.82% 86.22% 81.65% (6.40)% 4.57% (h)
Total operating expenses as a
percent of average assets......... 4.54% 4.45% 3.33% 0.09% 1.12% (i)
- --------------------
(1) From continuing operations for all periods presented.
(a) Salaries and employee benefits. The 2003 increase is largely
attributable to the addition of banking personnel, particularly in the
Arizona market. The 2002 increase represents the addition of
approximately 85 Milne Scali employees effective April 16, 2002 as
well as additional employees added in the Arizona market. Average full
time equivalents for each year in the three-year period ended December
31, 2003 were 276, 253 and 189, respectively.
(b) Occupancy. Occupancy expenses remained relatively stable in 2003 as
the restructuring of some of the Company's facilities leases offset
expansion in the Arizona market. The 2002 increase reflects increased
activity in the Arizona market and the addition of Milne Scali in
April 2002.
(c) Depreciation and amortization. Depreciation and amortization expenses
increased in 2003 and 2002 due to the Milne Scali acquisition along
with costs associated with additional expansion in the Arizona market.
(d) Office supplies, telephone and postage. Increases in this line item in
2003 and 2002 are associated with the Milne Scali acquisition and
additional expenses associated with expansion in the Arizona market.
(e) Professional services. The 2003 decrease is attributable to decreased
expenses in a number of areas including brokerage clearing and
retainage expense (resulting from the decrease in associated brokerage
revenue), appraisal and recording fees, audit fees, other consulting
fees, legal and collection fees and software support fees. The 2002
increase in professional services represents increases in legal fees
(including those incurred by Milne Scali), software support fees and
other consulting and investment banking fees.
(f) Amortization of intangible assets. 2003 reflects a full year of
amortization of the Milne Scali books of business intangibles. The
increase in 2002 primarily represents the amortization of the
insurance books of business intangibles booked in the Milne Scali
acquisition in April 2002.
(g) Other. The 2002 increase represents increases in several miscellaneous
line items included in this category (some of which are associated
with the acquisition of Milne Scali in April 2002) and include
increases in insurance premiums, OCC assessments, travel expenses,
dues and publications, data processing fees and expenses associated
with winding down the BNC AMI operations in Fargo.
(h) Noninterest expense divided by an amount equal to net interest income
plus noninterest income.
(i) Total operating expenses as a percent of average assets have increased
as our profile has changed from that of a traditional banking
organization to an organization with a broader base of financial
product and service offerings the revenues and expenses of which are
generally not asset-based.
Income taxes. We recorded income tax expense of $1.6 million, $822,000 and
$691,000 for the years ended December 31, 2003, 2002 and 2001, respectively. Our
effective tax rates were 29.14, 28.87 and 28.96 percent for the 12-month periods
ended December 31, 2003, 2002 and 2001, respectively. The effective tax rates
were lower than the statutory rates principally due to tax-exempt income on
municipal securities.
The determination of current and deferred income taxes is a critical accounting
policy which is based on complex analyses of many factors including
interpretations of Federal and state income tax laws, the differences between
tax and financial reporting basis of assets and liabilities (temporary
differences), estimates of amounts due or owed, the timing of reversal of
temporary differences and current financial accounting standards. Actual results
could differ significantly from the estimates and interpretations used in
determining the current and deferred income tax liabilities. Additional detail
on income taxes is provided in Note 24 to the Consolidated Financial Statements
included under Item 8.
Financial Condition
Overview. Although subsequent sections of this discussion and analysis of
financial condition address certain aspects of our major assets and liabilities
in significant detail, the following two tables are presented as a general
overview of the financial condition of the Company.
Total assets increased approximately $19.2 million, or 3.2 percent, between
December 31, 2002 and December 31, 2003 and approximately $17.2 million, or 2.9
percent, between December 31, 2001 and December 31, 2002. Our total assets at
December 31, 2003 were approximately $621.5 million.
The following table presents our assets by category as of December 31, 2003,
2002 and 2001, as well as the amount and percent of change between the dates.
Significant changes are discussed in lettered notes following the table (amounts
are in thousands):
Assets
Increase (Decrease)
----------------------------------------------------
As of December 31, 2003 - 2002 2002 - 2001
---------------------------------- ------------------------- ------------------------
2003 2002 2001 $ % $ %
---------- ---------- ---------- ----------- ---------- ----------- ----------
Cash and due from
banks....................... $ 12,520 $ 16,978 $ 16,346 $ (4,458) (26)% $ 632 4% (a)
Interest-bearing deposits
with banks.................. -- 159 126 (159) (100)% 33 26%
Federal funds sold........... -- -- 7,500 -- -- (7,500) (100)% (b)
Investment securities
available for sale.......... 262,568 208,072 211,801 54,496 26% (3,729) (2)% (c)
Federal Reserve Bank and
Federal Home Loan Bank
stock....................... 7,596 7,071 7,380 525 7% (309) (4)%
Loans and leases, net........ 278,792 330,788 293,599 (51,996) (16)% 37,189 13% (d)
Premises and equipment, net.. 18,570 11,100 9,180 7,470 67% 1,920 21% (e)
Interest receivable.......... 2,462 2,856 3,008 (394) (14)% (152) (5)%
Other assets................. 15,507 4,119 4,856 11,388 276% (737) (15)% (f)
Goodwill..................... 15,089 12,210 437 2,879 24% 11,773 2,694% (g)
Other intangible assets, net. 8,373 8,875 1,734 (502) (6)% 7,141 412% (h)
Assets of discontinued
Fargo operations............ -- -- 29,090 -- -- (29,090) (100)% (i)
---------- ---------- ---------- ----------- -----------
Total assets........... $621,477 $602,228 $585,057 $ 19,249 3% $17,171 3%
========== ========== ========== =========== ===========
(a) Cash and due from banks. The 2003 decrease in cash and due from banks is
primarily attributable to an account reclassification program that was
implemented during 2003 and results in the Bank holding less cash at the
Federal Reserve.
(b) Federal funds sold. Federal funds sold can fluctuate on a daily basis
depending upon our liquidity management activities. There were no Federal
funds sold outstanding at December 31, 2002 or 2003.
(c) Investment securities available for sale. During 2003, investment
securities available for sale increased as loan volume decreased (see (d)
below) and we maintained a somewhat static earning asset portfolio.
(d) Loans and leases. Loan volume in 2003 was negatively impacted by planned
loan reductions and the completion of some financed commercial real estate
projects. The loan reductions were not offset by loan growth due to a lack
of loan demand driven by economic conditions during the year. The 2002
increase in loans represented loan growth primarily in the Arizona and
Minnesota markets. Due to current economic and other conditions, it is
difficult to predict, with any degree of certainty, loan volume in future
periods.
(e) Premises and equipment, net. The 2003 increase is attributable to the
purchase of the Milne Scali building in Phoenix, Arizona in March 2003 for
its appraised value of $3.9 million, the construction of a facility in
Scottsdale, Arizona, leasehold improvements related to the relocation of
our office at 2725 East Camelback Road, Phoenix to 2425 East Camelback
Road, the purchase of property in Golden Valley, Minnesota and some
improvements to our office building at 322 East Main Avenue, Bismarck,
North Dakota.
(f) Other assets. The 2003 increase in other assets is primarily attributable
to the purchase of $10.0 million of bank-owned life insurance during the
third quarter of 2003.
(g) Goodwill. Goodwill increased in 2003 due to a $2.3 million earnout payment
related to the purchase of Milne Scali and the purchase of IASW in December
2003. Goodwill increased significantly in 2002 due to the acquisition of
Milne Scali in April 2002.
(h) Other intangible assets. The 2002 increase in other intangible assets
represents insurance books of business intangibles acquired in the Milne
Scali acquisition of April 2002.
(i) Assets of discontinued Fargo operations. The Fargo branch of the Bank was
sold on September 30, 2002. The assets indicated for December 31, 2001
represent the assets attributable to that branch as of that date.
Our total liabilities increased approximately $16.8 million, or 3.0 percent,
between December 31, 2002 and December 31, 2003 and increased $10.1 million, or
1.8 percent, between December 31, 2001 and December 31, 2002. Total liabilities
at December 31, 2003 were approximately $581.3 million. Stockholders' equity was
approximately $40.2, $37.7 and $30.7 million at December 31, 2003, 2002 and
2001, respectively.
The following table presents our liabilities and stockholders' equity by
category as of December 31, 2003, 2002 and 2001, as well as the amount and
percent of change between the dates. Significant changes are discussed in
lettered notes following the table (amounts are in thousands):
Liabilities, Subordinated Debentures and Stockholders' Equity
Increase (Decrease)
--------------------------------------------------
As of December 31, 2003 - 2002 2002 - 2001
-------------------------------------- ----------------------- ------------------------
2003 2002 2001 $ % $ %
------------ ----------- ----------- ----------- ---------- ----------- -----------
Deposits:
Noninterest-bearing.......... $ 44,725 $ 44,362 $ 30,521 $ 363 1% $ 13,841 45% (a)
Interest-bearing -
Savings, interest checking
and money market......... 215,525 187,531 160,721 27,994 15% 26,810 17% (b)
Time deposits $100,000 and
over..................... 46,569 64,905 78,969 (18,336) (28)% (14,064) (18)% (c)
Other time deposits........ 89,123 101,447 105,066 (12,324) (12)% (3,619) (3)% (d)
Short-term borrowings........ 31,383 28,120 760 3,263 12% 27,360 3,600% (e)
FHLB advances................ 112,200 97,200 117,200 15,000 15% (20,000) (17)% (f)
Long-term borrowings......... 8,640 8,561 13 79 1% 8,548 65,754% (g)
Guaranteed preferred
beneficial interests in
Company's subordinated
debentures.................. 22,397 22,326 22,244 71 0% 82 0%
Other liabilities............ 10,729 10,053 6,192 676 7% 3,861 62%
Liabilities of discontinued
Fargo operations............ -- -- 32,692 -- -- (32,692) (100)% (h)
------------ ----------- ----------- ----------- -----------
Total liabilities...... 581,291 564,505 554,378 16,786 3% 10,127 2%
Stockholders' equity......... 40,186 37,723 30,679 2,463 7% 7,044 23% (i)
------------ ----------- ----------- ----------- -----------
Total.................. $ 621,477 $602,228 $585,057 $ 19,249 3% $ 17,171 3%
============ =========== =========== =========== ===========
- -----------------------------
(a) Noninterest-bearing deposits. Noninterest-bearing deposits can fluctuate
significantly on a daily basis due to transactions associated primarily
with commercial customers. The increase in 2002 also reflects new
commercial and retail customer activity in the Arizona and Minnesota
markets.
(b) Savings, interest checking and money market. Increases in this category are
attributable to the continued popularity of our Wealthbuilder deposit
products and reflect deposit growth primarily in the Arizona market for
2003 and in the Arizona and Minnesota markets in 2002.
(c) Time deposits $100,000 and over. Time deposits $100,000 and over declined
in 2003 and 2002 primarily because of a decrease in brokered and national
market certificates of deposit during the two periods. Brokered deposits
totaled $18.6 million at December 31, 2003 compared to $31.4 and $34.4
million at December 31, 2002 and 2001, respectively. National certificates
of deposit acquired through national networks totaled $12.9 million at
December 31, 2003 compared to $27.3 million at December 31, 2002 and $34.0
million at December 31, 2001. In 2003 we allowed brokered and national
market certificates of deposit to run off and be replaced by growth in the
Wealthbuilder interest checking and money market account categories. In
2002, we allowed national market certificates of deposit to run off and be
replaced by growth in the Wealthbuilder interest checking and money market
account categories.
(d) Other time deposits. The 2003 decline is partially attributable to the
$27.2 million decrease in brokered and national market certificates of
deposit. Additionally, time deposits declined partly because a number of
certificates of deposit, held by credit unions and other financial
institutions (with balances averaging $99,000) matured and the funds were
not reinvested.
(e) Short-term borrowings. The increase in short-term borrowings in 2002
reflects $15.0 million of Federal funds purchased at December 31, 2002
coupled with $13.1 million of repurchase agreements with customers. These
repurchase agreements are renewable daily.
(f) FHLB advances. $10.0 million of FHLB advances held at December 31, 2002
matured in January 2003 and, during the third quarter of 2003, we converted
$20.0 million of short-term FHLB advances to $30.0 million of longer term
FHLB advances maturing in 2005 and 2006. Additionally, $20.0 million of
FHLB advances matured in early 2002 and were not replaced due to the
availability of other funding sources.
(g) Long-term borrowings. The 2002 increase reflects the $8.5 million long-term
note originated at the time of the Milne Scali acquisition in April 2002.
(h) Liabilities of discontinued Fargo operations. The Fargo branch of the Bank
was sold on September 30, 2002. The liabilities indicated for December 31,
2001 represent the liabilities attributable to that branch as of that date.
(i) Stockholders' equity. The increase in 2003 primarily reflects $3.8 million
of earnings offset by a $1.7 million decrease in unrealized holding gains
on securities available for sale, net of income taxes and reclassification
adjustment. The increase in 2002 reflects $1.5 million of preferred stock
issued in 2002, $2.5 million of common stock issued in conjunction with the
Milne Scali acquisition in April 2002, $2.0 million of earnings recorded in
2002 and $1.1 million in after-tax unrealized holding gains on securities
available for sale arising during the period.
Investment Securities Available for Sale. Our investment policy is designed to
enhance net income and return on equity through prudent management of risk,
ensure liquidity for cash-flow requirements, help manage interest rate risk,
ensure collateral is available for public deposits, advances and repurchase
agreements and manage asset diversification. In managing the portfolio, we seek
a balance between current income (yield) and future market value volatility,
while simultaneously managing credit and liquidity risks. The goal of this
process is to maximize our longer term profitability as well as the economic
performance of the portfolio over the long-term.
Investments are centrally managed in order to maximize compliance (Federal laws
and regulations place certain restrictions on the amounts and types of
investments we may hold) and effectiveness of overall investing activities. The
primary goal of our investment policy is to contribute to our overall
profitability. The objective is to purchase and own securities and combinations
of securities with good risk/reward characteristics. "Good" risk/reward
securities are those identified through thorough analysis of the cash flows and
potential cash flows as well as market value and potential future market value
of the security in question given various interest rate scenarios. Investment
strategies are developed in light of a constant view of our overall
asset/liability position. As it relates to investment strategies, the focus of
our Asset/Liability management committee ("ALCO") is to determine the impact of
interest rate changes on both future income and market value of securities in
the portfolio. See Item 7A, "Quantitative and Qualitative Disclosures about
Market Risk," for additional information relating to the impact of fluctuating
interest rates on our net interest income, including income generated by our
investment securities portfolio.
The following table presents the composition of the available-for-sale
investment portfolio by major category as of the dates indicated:
Investment Portfolio Composition (1)
December 31,
---------------------------------------------------------------------------------
2003 2002 2001
-------------------------- --------------------------- --------------------------
Estimated Estimated Estimated
Amortized fair market Amortized fair market Amortized fair market
cost value cost value Cost value
------------ ------------- ------------- ------------- ------------ -------------
(in thousands)
U.S. government agency
mortgage-backed securities... $ 14,374 $ 14,755 $ 47,072 $ 47,576 $ 42,027 $ 41,946
U.S. government agency
securities................... 961 1,083 4,608 5,203 4,396 4,495
Collateralized mortgage
obligations.................. 210,760 209,676 122,795 124,480 135,423 137,268
State and municipal bonds...... 32,909 35,056 27,276 28,815 16,952 17,481
Corporate bonds................ 1,939 1,998 1,938 1,998 10,329 10,611
------------ ------------- ------------- ------------- ------------ -------------
Total investments.............. $ 260,943 $ 262,568 $ 203,689 $ 208,072 $ 209,127 $ 211,801
============ ============= ============= ============= ============ =============
(1) From continuing operations for all periods presented.
The following table presents maturities for all securities available for sale
(other than equity securities) and yields for all securities in our investment
portfolio at December 31, 2003:
Investment Portfolio - Maturity and Yields
Maturing
--------------------------------------------------------------------------
After 1 but After 5 but
Within 1 year within 5 years within 10 years After 10 years Total
---------------- ----------------- ----------------- ------------------ --------------------
Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1)
-------- -------- -------- -------- -------- -------- --------- -------- ---------- --------
U.S. government agency
mortgage-backed
securities (2) (3)........ $ -- -- $ -- -- $ 5,417 4.34% $ 8,957 -- $ 14,374 4.89%
U.S. government agency
securities (2)............ -- -- 961 10.18% -- -- -- -- 961 10.18%
Collateralized mortgage
obligations (2) (3)....... -- -- 1,631 6.90% 16,074 3.74% 193,055 4.03% 210,760 4.03%
State and municipal
bonds (2).................. -- -- -- -- 2,145 7.09% 30,764 7.06% 32,909 7.06%
Corporate bonds (2)......... -- -- -- -- -- -- 1,939 3.36% 1,939 3.36%
-------- -------- -------- --------- ----------
Total book value of
investment securities.... $ -- -- $ 2,592 8.12% $23,636 4.18% $234,715 4.46% 260,943 4.47%
======== ======== ======== =========
Unrealized holding gain on
securities available for
sale...................... 1,625
----------
Total investment in
securities available for
sale (4).................. $262,568 4.45%
==========
- --------------------
(1) Yields include adjustments for tax-exempt income; yields do not reflect
changes in fair value that are reflected as a separate component of
stockholders' equity (except as noted in (4) below).
(2) Based on amortized cost/book value.
(3) Maturities of mortgage-backed securities and collateralized mortgage
obligations ("CMOs") are based on contractual maturities. Actual maturities
may vary because obligors may have the right to call or prepay obligations
with or without call or prepayment penalties.
(4) Yield reflects changes in fair value that are reflected as a separate
component of stockholders' equity.
As of December 31, 2003, we had $262.6 million of available-for-sale securities
in the investment portfolio as compared to $208.1 and $211.8 million at December
31, 2002 and 2001, respectively, based on fair value of the securities on those
dates. During 2003, the amount of available-for-sale securities increased $54.5
million in order to maintain earning asset portfolio levels while planned loan
reductions and the completion of some financed commercial real estate projects
reduced the loan portfolio by $52.2 million. Much of the increase in
available-for-sale securities was directed toward CMOs because of their economic
risk/reward profiles (due to the structure of the CMO cash flows) relative to
mortgage-backed or other types of securities and the ability to pledge such
securities as collateral for borrowings at the FHLB. In the process of carrying
out the portfolio management objective to purchase securities and combinations
of securities with good economic risk/reward characteristics, we decreased U.S.
government agency mortgage-backed securities and U.S. government agency
securities by $32.8 and $4.1 million, respectively, and increased CMOs and state
and municipal bonds by $85.2 and $6.2 million, respectively. Given our earnings
during 2003 and the forecasted level of future earnings, we increased our
holdings of state and municipal bonds by $6.2 million in order to increase our
level of tax-exempt income.
The first half of 2003 saw the level of interest rates, including interest rates
for mortgages, decline to record or near record lows. The pace of mortgage
refinancing reached record levels in the second quarter of 2003. During the
third quarter of 2003, interest rates rose from the record lows of the first
half of the year. This decreased mortgage prepayments from their earlier levels.
This made 2003 a volatile year for interest rates and mortgage prepayments. The
ongoing portfolio management process described above and individual security
risk/reward analysis led to the sale of individual securities whose
forward-looking risk/reward profiles given the changed interest rate and
prepayment environments were inferior to other securities available for
purchase. This analysis and ongoing management of the portfolio's forward
looking risk/reward profile resulted in transactions that generated net realized
securities gains of $968,000 during 2003. We cannot guarantee our ability to
generate realized gains in the future such as those recognized during the most
recent year given the current absolute low level of interest rates. In the
future, the risk/reward management process may require us to recognize net
realized losses in order to optimize the forward-looking economic profile of the
portfolio.
During 2002, we increased U.S. government agency mortgage-backed securities,
U.S. government agency securities, and state and municipal bonds by $5.6
million, $708,000 and $11.3 million, respectively and decreased CMOs and
corporate debt securities by $12.8 and $8.6 million, respectively. The $8.6
million reduction in corporate debt securities during 2002 allowed us to manage
our risk-based capital position as such securities are risk-weighted at 100
percent for risk-based capital purposes. Given our earnings in the third and
fourth quarters of 2002 and our then forecasted level of future earnings, we
increased our holdings of state and municipal bonds by $11.3 million in order to
increase our level of future tax-exempt income. In addition to the role state
and municipal bonds play in managing our tax position, state and municipal bonds
offer an attractive risk/reward profile when considered in combination with
other securities in the portfolio (CMOs and mortgage-backed securities) and our
overall balance sheet position.
In addition, during 2002, mortgage rates declined to their lowest levels in
decades. This decrease in mortgage rates increased the level of mortgage
refinancing and prepayments for U.S. government agency mortgage-backed
securities and CMOs. The ongoing portfolio management process and individual
security risk/reward analysis described above led to the sale of individual
securities whose forward-looking risk/reward profiles given the lower interest
rate and increased prepayment environment were inferior to other securities
available for purchase. This analysis and ongoing management of the portfolio's
forward looking risk/reward profile resulted in transactions that generated net
realized securities gains of $1.9 million during 2002.
In 2001, as a result of 475 basis points of monetary easing over the course of
the year, the yield curve experienced a significant downward shift and increase
in slope relative to 2000. The ongoing portfolio management process and
individual security risk/reward analysis described above led to the sale of
individual securities whose forward-looking risk/reward profile given various
interest rate scenarios was inferior to other securities available for purchase.
The need to optimize the risk/reward profile of the portfolio as a whole in
addition to the reduction in the portfolio size as more earning assets were
shifted to loans resulted in transactions that generated net realized securities
gains of $1.4 million.
At December 31, 2003, we held no securities of any single issuer, other than
U.S. government agency securities and agency mortgage-backed securities and
CMOs, that exceeded 10 percent of stockholders' equity. A significant portion of
our investment securities portfolio (approximately 89 percent at December 31,
2003) was pledged as collateral for public deposits and borrowings, including
borrowings with the FHLB.
Federal Reserve Bank and Federal Home Loan Bank Stock. Our equity securities
consisted of $1.2 million, $1.2 million and $849,000 of Federal Reserve Bank
("FRB") stock at December 31, 2003, 2002 and 2001, respectively, and $6.4, $5.8
and $6.5 million of FHLB stock at December 31, 2003, 2002 and 2001,
respectively. Our holdings in FRB stock increased due to the amount of capital
stock issued by the Bank. Our holdings in FHLB stock fluctuate due to the level
of FHLB advances outstanding. From 2001 to 2003, our investment in FHLB stock
fluctuated with our usage of FHLB advances.
Loan Portfolio. The banking segment's primary source of income is interest
earned on loans. Total loans, net of unearned income and unamortized fees and
costs, decreased $52.2 million, or 15.6 percent, to $283.6 million at December
31, 2003 as compared to $335.8 million at December 31, 2002. In 2002, net loans
increased $37.9 million, or 12.7 percent, as compared to December 31, 2001. The
following table presents the composition of our loan portfolio as of the dates
indicated:
Loan Portfolio Composition (1)
December 31,
---------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------- ------------------ ------------------ ------------------- -----------------
Amount % Amount % Amount % Amount % Amount %
---------- -------- --------- -------- ---------- ------- --------- --------- --------- -------
(dollars in thousands)
Commercial and industrial . $ 73,001 26.2 $ 94,075 28.4 $ 103,883 35.4 $109,335 43.9 $108,593 43.2
Real estate mortgage....... 129,443 46.4 147,825 44.7 123,727 42.1 85,082 34.1 88,251 35.1
Real estate construction... 60,056 21.5 62,926 19.0 34,225 11.7 21,879 8.8 15,684 6.3
Agricultural............... 12,529 4.5 18,023 5.5 19,069 6.5 15,016 6.0 15,906 6.3
Consumer/other............. 6,277 2.3 8,227 2.5 9,953 3.4 11,552 4.6 14,559 5.8
Lease financing............ 2,757 1.0 5,584 1.7 7,578 2.6 10,154 4.1 11,214 4.5
---------- -------- --------- -------- ---------- ------- --------- --------- --------- -------
Total principal amount of
loans.................... 284,063 101.9 336,660 101.8 298,435 101.7 253,018 101.5 254,207 101.2
Unearned income and net
unamortized deferred
fees and costs........... (508) (0.2) (866) (0.3) (511) (0.2) (265) (0.1) (198) (0.1)
---------- -------- --------- -------- ---------- ------ --------- --------- --------- -------
Loans, net of unearned
income and unamortized
fees and costs........... 283,555 101.7 335,794 101.5 297,924 101.5 252,753 101.4 254,009 101.1
Less allowance for credit
losses................... (4,763) (1.7) (5,006) (1.5) (4,325) (1.5) (3,588) (1.4) (2,872) (1.1)
---------- -------- --------- -------- ---------- ------- --------- --------- --------- -------
Net loans.................. $278,792 100.00 $330,788 100.00 $ 293,599 100.00 $249,165 100.00 $251,137 100.00
========== ======== ========= ======== ========== ======= ========= ========= ========= =======
(1) From continuing operations for all periods presented.
The following table presents, for the periods indicated, the amount and percent
of change in each category of loans in our loan portfolio. Significant changes
are discussed in lettered explanations below the table:
Change in Loan Portfolio Composition (1)
Increase (Decrease)
---------------------------------------------------
2003 - 2002 2002 - 2001
------------------------- ------------------------
$ % $ %
------------ ----------- ------------ ----------
(dollars in thousands)
Commercial and industrial..............$ (21,074) (22)% $ (9,808) (9)% (a)
Real estate mortgage................... (18,382) (12)% 24,098 19% (b)
Real estate construction............... (2,870) (5)% 28,701 84% (c)
Agricultural........................... (5,494) (30)% (1,046) (5)% (d)
Consumer/other......................... (1,950) (24)% (1,726) (17)%
Lease financing........................ (2,827) (51)% (1,994) (26)%
------------ ------------
Total principal amount of loans........ (52,597) (16)% 38,225 13%
Unearned income/unamortized fees
and costs............................ 358 41% (355) (69)%
------------ ------------
Loans, net of unearned
income/unamortized fees and costs... (52,239) (16)% 37,870 13%
Allowance for credit losses............ 243 5% (681) (16)%
------------ ------------
Net Loans..............................$ (51,996) (16)% $ 37,189 13%
============ ============
(1) From continuing operations for all periods presented.
(a) Commercial and industrial loans. Commercial and industrial loans
decreased in 2003 due to planned loan pay-downs, loan pay- offs and
the lack of loan demand due to economic conditions. The decrease in
2002 reflects general pay-down of loans in the ordinary course of
business.
(b) Real estate mortgage loans. The decrease in real estate mortgage loans
during 2003 reflects the completion of some financed commercial real
estate projects. The increase in 2002 is attributable to commercial
real estate loan growth primarily in the Arizona and Minnesota
markets.
(c) Real estate construction loans. The increase in 2002 is attributable
to commercial real estate construction loan growth primarily in the
Arizona and Minnesota markets.
(d) Agricultural loans. The 2003 decrease is primarily due to loan
pay-offs in the North Dakota market.
While prospects for loan growth appear to be developing in some of our markets,
future loan growth potential is subject to volatility. Our loan portfolio is
concentrated in commercial, industrial and real estate loans and we have credit
concentrations in certain industries (see "-Concentrations of Credit") and
certain geographic concentrations that relate to our primary market areas. A
downturn in certain sectors of the economy could adversely impact our borrowers.
This could, in turn, reduce the demand for loans and impact the borrowers'
ability to repay their loans, while also decreasing our net interest margin.
Taking a conservative posture relative to credit underwriting, we believe, is a
prudent course of action, especially during weaker economic times. We believe it
is in our best interest and in the interest of our stockholders to focus
attention on our quality customer relationships and to avoid growth in other
than high-quality credit during uncertain times. We cannot predict with any
degree of certainty the full impact of current or future economic conditions on
our ability to generate loan volume or the ultimate impact of economic
conditions on our currently existing portfolio of loans. See "Factors That May
Affect Future Results of Operations" included under Item 1 of Part I.
Credit Policy, Underwriting, Approval and Review Procedures. We follow a uniform
credit policy that sets forth underwriting and loan administration criteria. The
Board of Directors (the "Board") establishes our loan policy, including lending
guidelines for the various types of credit we offer based upon the
recommendations of senior lending management. Credit committees may be
established at either the Bank or corporate level. Our loan policy is reviewed
and reaffirmed by the Board at least annually.
We delegate lending decision authority among various lending officers and the
credit committees based on the size of the customer's credit relationship with
BNC. All loans and commitments approved in excess of $300,000 are presented to
the Board on a quarterly basis for summary review. Any exceptions to loan
policies and guidelines, to the extent the credit relationship amount exceeds
individual loan officer lending authorities, are subject to special approval by
the Bank's Chief Credit Officer or the appropriate credit committee.
Underwriting criteria are based upon the risks associated with each type of
credit offered, the related borrowers and types of collateral. In underwriting
commercial loans, we emphasize the borrower's earnings history, capitalization
and secondary sources of repayment. In most instances, we require third party
guarantees or highly liquid collateral.
Our credit administration function includes an internal loan review department
that reviews established levels of our loan portfolio on a continuous basis.
Loan review personnel are not involved in any way in the credit underwriting or
approval process. Additionally, our lenders, loan review staff, Chief Credit
Officer, loan committees and various management team members review
credit-related information monthly. Such information includes, but may not be
limited to, delinquencies, classified and nonperforming assets, and other
information. Such reviews are conducted in order to evaluate credit risk within
our credit portfolio and to review and establish the adequacy of the allowance
for credit losses.
Loan Participations. Pursuant to our lending policy, loans may not exceed 85
percent of the Bank's legal lending limit (except to the extent collateralized
by U.S. Treasury securities or Bank deposits and, accordingly, excluded from the
Bank's legal lending limit). To accommodate customers whose financing needs
exceed lending limits and internal loan restrictions relating primarily to
industry concentration, the Bank sells loan participations to outside
participants without recourse. Loan participations sold on a nonrecourse basis
to outside financial institutions were as follows as of the dates indicated:
Loan Participations Sold (1)
December 31,
- ---------------------------------------------------
(in thousands)
2003................... $ 146,988
2002................... 173,895
2001................... 208,975
2000................... 187,773
1999................... 118,463
(1) From continuing operations for all periods presented.
The Bank generally retains the right to service the loans as well as the right
to receive a portion of the interest income on the loans. Many of the loans sold
by the Bank are commercial lines of credit for which balances and related
payment streams cannot be reasonably estimated in order to determine the fair
value of the servicing rights and/or future interest income retained by the
Bank. We cannot reliably predict our ability to continue to generate or sell
loan participations in future periods or the terms of any such sales.
Concentrations of Credit. Our credit policies emphasize diversification of risk
among industries, geographic areas and borrowers. For purposes of the analysis
of concentrations of credit as of December 31, 2003 the total outstanding loans
as well as all outstanding loan commitments were included. As of December 31,
2003, we identified three concentrations of loans exceeding 10 percent of total
loans and loan commitments outstanding. These concentrations were in real
estate, construction and lodging places, which represented 18.9, 12.4 and 11.7
percent, respectively, of total loans and loan commitments outstanding.
The real estate loans and commitments were extended to 105 customers who are
diversified across our market areas and who can generally be categorized as
indicated below:
Percent of total
outstanding loans
Number of and loan
customers commitments
----------------- --------------------
Non-residential and apartment
building operators, developers
and lessors of real property....... 61 13.1%
Real estate holding companies....... 44 5.8%
----------------- --------------------
Total......................... 105 18.9%
================= ====================
Loans and commitments in the construction category were extended to 47 customers
who are located primarily in Minnesota, Iowa, North Dakota and South Dakota and
who can generally be categorized as indicated below:
Percent of total
outstanding
Number of loans and loan
customers commitments
------------------ -----------------
General building contractors.............. 21 10.8%
Special trade contractors................. 18 1.0%
Heavy construction, excluding building.... 8 .6%
------------------ -----------------
Total................................ 47 12.4%
================== =================
The contractors are involved in various aspects of the construction industry,
including highway and street construction, water/sewer drilling, plumbing,
heating and air conditioning, commercial painting, electrical, concrete and
excavating and foundation contractors. Loans in this category are secured, in
many cases, by construction equipment.
The lodging loans and commitments were extended to 15 customers whose properties
are located throughout the United States. Loans in this category are made
primarily to borrowers that have seasoned hotel portfolios and that are well
diversified by location, property type and chain.
We continually monitor industry and other credit concentrations as part of our
credit risk management strategies. In cases where significant concentrations
exist without sufficient diversification and other mitigating factors, we
generally sell loans without recourse to outside financial institutions (see
"-Loan Participations").
Agricultural Loans. Our agricultural loan portfolio totals approximately $12.5
million, or 4.4 percent of total loans. Within the portfolio, loans are
diversified by type and include loans to grain and/or livestock producers,
agricultural real estate loans, machinery and equipment and other types of
loans. The majority of our agricultural loans are extended to borrowers located
in North Dakota, and are diversified over several counties. As of December 31,
2003, there were no agricultural loans classified as nonperforming.
Loan Maturities. The following table sets forth the remaining maturities of
loans in each major category of our portfolio as of December 31, 2003. Actual
maturities may differ from the contractual maturities shown below as a result of
renewals and prepayments. Loan renewals are evaluated in the same manner as new
credit applications:
Maturities of Loans (1)
Over 1 year
through 5 years Over 5 years
----------------------------- -------------------------
One year Fixed Floating Fixed Floating
or less rate rate rate rate Total
------------ ------------ ------------- ------------ ----------- -------------
(in thousands)
Commercial and industrial.......... $ 46,209 $ 10,984 $ 13,208 $ 1,686 $ 914 $ 73,001
Real estate mortgage............... 32,117 21,584 39,216 18,296 18,230 129,443
Real estate construction........... 45,547 434 13,395 576 104 60,056
Agricultural....................... 5,792 2,318 1,384 1,209 1,826 12,529
Consumer/other..................... 3,318 2,656 183 120 -- 6,277
Lease financing.................... 768 1,989 -- -- -- 2,757
------------ ------------ ------------- ------------ ----------- -------------
Total principal amount of loans.... $ 133,751 $ 39,965 $ 67,386 $ 21,887 $ 21,074 $ 284,063
============ ============ ============= ============ =========== =============
- --------------------------
(1) Maturities are based upon contractual maturities. Floating rate loans
include loans that would reprice prior to maturity if base rates change. See
Item 7A, "Quantitative and Qualitative Disclosures about Market Risk," for
further discussion regarding repricing of loans and other assets.
Interest Rate Caps and Floors. From time to time we may use off-balance-sheet
instruments, principally interest rate caps and floors, to adjust the interest
rate sensitivity of on-balance-sheet items, including loans. At January 1, 2001,
we had an interest rate floor contract that qualified as a cash flow hedge of
interest rate risk associated with floating rate commercial loans under
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). The floor contract was sold
during 2001. See -"Liquidity, Market and Credit Risk," Item 7A, "Quantitative
and Qualitative Disclosures about Market Risk," and Notes 1 and 17 to the
Consolidated Financial Statements included under Item 8 for further discussion
about accounting policies applicable to derivative financial instruments and
currently outstanding instruments.
Nonperforming Loans and Assets. Nonperforming loans consist of loans 90 days or
more delinquent and still accruing interest, nonaccrual and restructured loans.
Other nonperforming assets includes other real estate owned and repossessed
assets. Our lending personnel are responsible for continuous monitoring of the
quality of the loan portfolio. Officers are expected to maintain loan quality
and deal with credit issues in a timely and proactive manner. Loan officers are
responsible for regular reviews of past due loans in their respective
portfolios. The loan portfolio is also monitored regularly and examined by our
loan review personnel. Loans demonstrating weaknesses are downgraded in a timely
fashion and the Board receives a listing of all such loans on a quarterly basis.
The following table sets forth, as of the dates indicated, the amounts of
nonperforming loans and other assets, the allowance for credit losses and
certain related ratios:
Nonperforming Assets (1)
December 31,
--------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ----------- ------------ ----------- -----------
(dollars in thousands)
Nonperforming loans:
Loans 90 days or more delinquent and still
accruing interest............................. $ 38 $ 5,081 $ 983 $ 221 $ 22
Nonaccrual loans (2) (3)........................ 7,913 2,549 3,391 343 1,620
Restructured loans (2) (3)...................... -- -- 5 16 16
----------- ----------- ------------ ----------- -----------
Total nonperforming loans................... 7,951 7,630 4,379 580 1,658
Other real estate owned and repossessed assets.. -- 8 70 84 1,207
----------- ----------- ------------ ----------- -----------
Total nonperforming assets.................. $ 7,951 $ 7,638 $ 4,449 $ 664 $ 2,865
=========== =========== ============ =========== ===========
Allowance for credit losses.......................... $ 4,763 $ 5,006 $ 4,325 $ 3,588 $ 2,872
=========== =========== ============ =========== ===========
Ratio of total nonperforming loans to total loans.... 2.80% 2.27% 1.47% .23% .65%
Ratio of total nonperforming assets to total assets.. 1.28% 1.27% .80% .12% .64%
Ratio of allowance for credit losses to
nonperforming loans.................................. 60% 66% 99% 619% 173%
- --------------------
(1) From continuing operations for all periods presented.
(2) If the Company's nonaccrual and restructured loans had been current in
accordance with their original terms, we would have recognized additional
interest income of $65,000, $236,000, $84,000, $29,000 and $112,000 for the
years ended December 31, 2003, 2002, 2001, 2000 and 1999, respectively.
(3) The interest income on nonaccrual and restructured loans actually included
in our net income was $56,000, $1,000, $3,000, $6,000 and $29,000 for the
years ended December 31, 2003, 2002, 2001, 2000 and 1999 respectively.
Loans 90 days or more delinquent and still accruing interest include loans over
90 days past due which we believe, based on our specific analysis of the loans,
do not present doubt about the collection of interest and principal in
accordance with the loan contract. Loans in this category must be well secured
and in the process of collection. Our lending and management personnel monitor
these loans closely.
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 $7.9 million of loans
included in the nonaccrual loan category at December 31, 2003, $6.7 million
relates to two commercial customers. One of the loans, with a principal balance
of $4.5 million at December 31, 2003, was paid in full, including accrued
interest, during January 2004. The second loan for $2.2 million is a commercial
loan on which a liquidation settlement agreement has been executed. We believe
the agreement will result in resolution of this problem credit during the second
quarter of 2004. A charge-off of approximately $900,000 is expected as this loan
is brought to full resolution and that amount had been fully reserved at
December 31, 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
December 31, 2003.
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 outstanding other real estate owned or
repossessed assets at December 31, 2003.
Our ratios of total nonperforming loans to total loans, and total nonperforming
assets to total assets, increased between December 31, 2002 and December 31,
2003. The ratio of the allowance for credit losses to nonperforming loans
decreased between December 31, 2002 and December 31, 2003. This ratio at
December 31, 2003 was 60 percent as compared to 66 percent at December 31, 2002.
This decrease (and the increase in the other asset quality ratios mentioned
above) is primarily attributable to the previously mentioned commercial loan
that was paid in full during January 2004. Without this sizable credit, the
above-mentioned ratios would be significantly positively impacted. Additionally,
the pending resolution of the $2.2 million commercial credit also mentioned
above should positively impact our asset quality ratios.
Potential Problem Loans. In accordance with accounting standards, we identify
loans considered impaired and the valuation allowance attributable to these
loans. Impaired loans generally include loans on which we believe, based on
current information and events, it is probable that we will not be able to
collect all amounts due in accordance with the terms of the loan agreement and
which are analyzed for a specific reserve allowance. We generally consider all
loans risk-graded substandard and doubtful as well as nonaccrual and
restructured loans as impaired. Potential problem loans at December 31, 2003,
not including the past due, nonaccrual and restructured loans reported above,
totaled $3.1 million as compared to $5.8 million at December 31, 2002. A
significant portion of these potential problem loans are not in default but may
have characteristics such as recent adverse operating cash flows or general risk
characteristics that the loan officer feels might jeopardize the future timely
collection of principal and interest payments. The ultimate resolution of these
credits is subject to changes in economic conditions and other factors. These
loans are closely monitored to ensure that our position as creditor is protected
to the fullest extent possible.
Allowance for Credit Losses. Credit risk is the risk of loss from a customer
default. We have in place a process to identify and manage our credit risk. The
process includes initial credit review and approval, periodic monitoring to
measure compliance with credit agreements and internal credit policies, internal
credit review, monitoring changes in the risk ratings of loans and leases,
identification of problem loans and leases and special procedures for collection
of problem loans and leases. The risk of loss is difficult to quantify and is
subject to fluctuations in values and general economic conditions and other
factors. As discussed previously, the determination of the allowance for credit
losses is a critical accounting policy, which involves estimates and our
judgment on a number of factors such as net charge-offs, delinquencies in the
loan and lease portfolio and general and economic conditions. We consider the
allowance for credit losses of $4.8 million adequate to cover losses inherent in
the loan and lease portfolio as of December 31, 2003. However, no assurance can
be given that we will not, in any particular period, sustain loan and lease
losses that are sizable in relation to the amount reserved, or that subsequent
evaluations of the loan and lease portfolio, in light of factors then
prevailing, including economic conditions and our ongoing credit review process,
will not require significant increases in the allowance for credit losses. A
protracted economic slowdown and/or a decline in commercial, industrial or real
estate segments may have an adverse impact on the adequacy of the allowance for
credit losses by increasing credit risk and the risk of potential loss. See
Notes 1 and 7 to the Consolidated Financial Statements included under Item 8 and
"-Critical Accounting Policies" for further information concerning accounting
policies associated with the allowance for credit losses.
We maintain our allowance for credit losses at a level considered adequate to
provide for an estimate of probable losses related to specifically identified
loans as well as probable losses in the remaining loan and lease portfolio that
have been incurred as of each balance sheet date. The loan and lease portfolio
and other credit exposures are reviewed regularly to evaluate the adequacy of
the allowance for credit losses. In determining the level of the allowance, we
evaluate the allowance necessary for specific nonperforming loans and also
estimate losses in other credit exposures. The resultant three allowance
components are specific reserves, reserves for homogeneous loan pools and a
qualitative reserve. These components are fully described under "Critical
Accounting Policies."
Continuous credit monitoring processes and the analysis of loss components is
the principal method we rely upon to ensure that changes in estimated credit
loss levels are reflected in our allowance for credit losses on a timely basis.
We also consider experience of peer institutions and regulatory guidance in
addition to our own experience.
Loans, leases and other extensions of credit deemed uncollectible are charged to
the allowance. Subsequent recoveries, if any, are credited to the allowance. The
amount of the allowance for credit losses is highly dependent upon our estimates
of variables affecting valuation, appraisals of collateral, evaluations of
performance and status, and the amounts and timing of future cash flows expected
to be received on impaired loans. Such estimates, appraisals, evaluations and
cash flows may be subject to frequent adjustments due to changing economic
prospects of borrowers, lessees or properties. These estimates are reviewed
periodically. Actual losses may vary from current estimates and the amount of
the provision may be either greater than or less than actual net charge-offs.
The related provision for credit losses, which is charged to income, is the
amount necessary to adjust the allowance to the level determined appropriate
through the application of the above processes and those discussed below in the
"Critical Accounting Policies" section.
At yearend 2003, our total allowance was $4.8 million which equates to
approximately 3.8 and 4.1 times the average charge-offs for the last three and
five years, respectively, and 4.5 and 5.0 times the average net charge-offs for
the same three-and five-year periods, respectively. Because historical
charge-offs are not necessarily indicative of future charge-off levels, we also
give consideration to other risk indicators when determining the appropriate
allowance level. Those risk factors have been summarized above. Our charge-off
policy is generally consistent with regulatory standards.
Our Chief Credit Officer and Vice President-Internal Audit/Credit Review have
the primary responsibility of affirming our systematic allowance methodology,
performing credit loss migration analyses and assessing the allowance components
in relation to estimated and actual charge-off trends. This analysis is
presented to members of management who are responsible for assessing and
reporting on the appropriateness of the allowance for credit losses as well as
recommending revisions to our methodology for determining the adequacy of the
allowance as they become necessary.
Concentrations of credit risk are discussed under "-Concentrations of Credit."
Concentrations exist in real estate, construction and lodging places loans and
commitments. Additionally, a geographic concentration of credit risk also arises
because we have historically operated primarily in the upper Midwest with 67
percent of loans outstanding as of December 31, 2003 having been extended to
customers in Minnesota, North Dakota and South Dakota. As of December 31, 2003,
29 percent of our loans had been extended to customers in Arizona. Other groups
of credit risk may not constitute a significant concentration, but are analyzed
based on other evident risk factors for the purpose of determining an adequate
allowance level.
Nonperforming and potential problem loans are defined and discussed under
"-Nonperforming Loans and Assets" and "-Potential Problem Loans." Many of these
loans are specifically analyzed for purposes of determining the adequacy of the
allowance for credit losses.
Estimating the risk and amount of loss on any loan is subjective and ultimate
losses may vary from current estimates. Although we believe that the allowance
for credit losses is adequate to cover probable losses in the loan and lease
portfolio, there can be no assurance that the allowance will prove sufficient to
cover actual credit losses in the future. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the adequacy of our allowance for credit losses. Such agencies may require us to
make additional provisions to the allowance based upon their judgments about
information available to them at the time of their examination.
The following table summarizes, for the periods indicated, activity in the
allowance for credit losses, including amounts of loans charged-off, amounts of
recoveries, additions to the allowance charged to operating expense, the ratio
of net charge-offs to average total loans, the ratio of the allowance to total
loans at the end of each period and the ratio of the allowance to nonperforming
loans:
Analysis of Allowance for Credit Losses (1)
For the Years ended December 31,
--------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ------------ ------------ ----------- -----------
(dollars in thousands)
Balance of allowance for credit losses,
beginning of period.................................. $ 5,006 $ 4,325 $ 3,588 $ 2,872 $ 2,854
----------- ------------ ------------ ----------- -----------
Charge-offs:
Commercial and industrial......................... 1,508 408 542 574 1,090
Real estate mortgage.............................. 189 9 99 58 10
Agricultural...................................... 10 -- -- 16 35
Consumer/other.................................... 23 75 213 39 137
Lease financing................................... 90 165 411 68 18
----------- ------------ ------------ ----------- -----------
Total charge-offs.............................. 1,820 657 1,265 755 1,290
----------- ------------ ------------ ----------- -----------
Recoveries:
Commercial and industrial......................... 73 86 140 100 86
Real estate mortgage.............................. 7 8 30 96 1
Agricultural...................................... -- 4 1 33 --
Consumer/other.................................... 11 11 132 25 71
Lease financing................................... 11 27 -- 15 12
----------- ------------ ------------ ----------- -----------
Total recoveries............................... 102 136 303 269 170
----------- ------------ ------------ ----------- -----------
Net charge-offs........................................ (1,718) (521) (962) (486) (1,120)
Provision for credit losses charged to operations...... 1,475 1,202 1,699 1,202 1,138
----------- ------------ ------------ ----------- -----------
Balance of allowance for credit losses, end of period.. $ 4,763 $ 5,006 $ 4,325 $ 3,588 $ 2,872
=========== ============ ============ =========== ===========
Ratio of net charge-offs to average loans.............. (0.56)% (0.17)% (0.33)% (0.20)% (0.46)%
=========== ============ ============ =========== ===========
Average gross loans outstanding during the period...... $308,115 $307,227 $293,716 $244,526 $246,148
=========== ============ ============ =========== ===========
Ratio of allowance for credit losses to total loans.... 1.68% 1.49% 1.45% 1.42% 1.13%
=========== ============ ============ =========== ===========
Ratio of allowance for credit losses to
nonperforming loans.................................... 60% 66% 99% 619% 173%
=========== ============ ============ =========== ===========
(1) From continuing operations for all periods presented.
Of the $1.8 million of charge-offs for the year ended December 31, 2003,
approximately $1.3 million relates to one commercial contractor. The Bank is
continuing the liquidation process with this credit, which has been fully
charged-off. Due to further liquidation efforts, the Bank may recover some of
the previously charged-off amounts.
Our ratio of allowance for credit losses to nonperforming loans decreased from
66 percent at December 31, 2002 to 60 percent at December 31, 2003. See
"-Nonperforming Loans and Assets" for a discussion of the specific loans
responsible for this decrease and the facts and circumstances surrounding the
status of the loans.
The table below presents, for the periods indicated, an allocation of the
allowance for credit losses among the various loan categories and sets forth the
percentage of loans in each category to gross loans. The allocation of the
allowance for credit losses as shown in the table should neither be interpreted
as an indication of future charge-offs, nor as an indication that charge-offs in
future periods will necessarily occur in these amounts or in the indicated
proportions.
Allocation of the Allowance for Loan Losses (1)
December 31,
---------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
--------------------- ---------------------- --------------------- ---------------------- ---------------------
Loans in Loans in Loans in Loans in Loans in
category category category category category
as a as a as a as a as a
Amount percentage Amount percentage Amount percentage Amount percentage Amount percentage
of of total of of total of of total of of total of of total
allowance gross loans allowance gross loans allowance gross loans allowance gross loans allowance gross loans
--------- ----------- --------- ------------ --------- ----------- ---------- ----------- --------- -----------
(dollars in thousands)
Commercial and
industrial..... $ 2,093 26% $ 2,344 28% $ 2,586 34% $ 2,066 42% $1,356 43%
Real estate
mortgage....... 1,976 46% 1,836 44% 1,038 42% 702 34% 712 35%
Real estate
construction... 395 21% 398 19% 137 11% 112 10% 151 6%
Agricultural..... 211 4% 231 5% 267 6% 342 6% 220 6%
Consumer/other... 68 2% 85 2% 118 5% 128 5% 138 6%
Lease financing.. 20 1% 112 2% 179 2% 145 3% 88 4%
Unallocated...... -- 0% -- 0% -- 0% 93 0% 207 0%
--------- ----------- --------- ------------ --------- ----------- ---------- ----------- --------- -----------
Total............ $ 4,763 100% $ 5,006 100% $ 4,325 100% $ 3,588 100% $2,872 100%
========= =========== ========= ============ ========= =========== ========== =========== ========= ===========
(1) From continuing operations for all periods presented.
Deposits. Our core deposits consist of noninterest- and interest-bearing demand
deposits, savings deposits, money market deposit accounts, certificates of
deposit under $100,000, certain certificates of deposit of $100,000 and over and
public funds. Total deposits were $395.9 million at December 31, 2003 compared
with $398.2 and $375.3 million at December 31, 2002 and 2001, respectively. We
use these deposits, along with other borrowed funds, to support our asset base.
The following table sets forth, for the periods indicated, the distribution of
our average deposit account balances and average cost of funds rates on each
category of deposits. See "Results of Operations-Net Interest Income" for an
explanation of changes in deposit volume and costs during the periods presented:
Average Deposits and Deposit Costs (1)
For the Years Ended December 31,
--------------------------------------------------------------------------------------------------------
2003 2002 2001
-------------------------------- --------------------------------- -----------------------------------
Percent Wgtd. Percent Wgtd. Percent Wgtd.
Average of avg. Average of avg. Average of avg.
balance deposits rate balance deposits rate balance deposits rate
---------- ----------- ------- ----------- ---------- -------- ----------- --------- ----------
(dollars in thousands)
Interest checking
and MMDAs................ $186,796 48.69% 1.17% $ 174,108 44.51% 1.64% $ 147,775 41.92% 3.16%
Savings deposits.......... 6,052 1.58% 0.84% 4,511 1.15% 0.86% 3,758 1.07% 1.49%
Time deposits (CDs):
CDs under $100,000........ 94,820 24.72% 3.18% 104,964 26.83% 3.88% 98,639 27.99% 5.35%
CDs $100,000 and over..... 55,928 14.58% 3.91% 73,639 18.83% 4.46% 73,806 20.94% 5.76%
---------- ----------- ----------- ---------- ----------- ---------
Total time deposits....... 150,748 39.30% 3.45% 178,603 45.66% 4.12% 172,445 48.93% 5.52%
---------- ----------- ----------- ---------- ----------- ---------
Total interest-bearing
deposits................. 343,596 89.57% 2.16% 357,222 91.32% 2.87% 323,978 91.92% 4.40%
Noninterest-bearing
demand deposits.......... 40,022 10.43% -- 33,951 8.68% -- 28,474 8.08% --
---------- ----------- ----------- ---------- ----------- ---------
Total deposits............ $383,618 100.00% 1.94% $ 391,173 100.00% 2.62% $ 352,452 100.00% 4.04%
========== =========== =========== ========== =========== =========
(1) From continuing operations for all periods presented.
At times earning asset growth can outpace core deposit growth resulting in the
use of brokered and out of market certificates of deposit and other borrowed
funds. See "-Borrowed Funds." This trend has been common in the banking industry
because of the proliferation of nonbank competitors and the multitude of
financial and investment products available to customers as well as the need to
utilize such funds in the process of our overall balance sheet management. At
times, access to brokered and out of market deposits is available at maturities
and rates more favorable than those available in our local markets. As of
December 31, 2003, we held a total of $12.9 million of national market
certificates of deposit and $18.6 million of certificates of deposit acquired
through brokers. Under current FDIC regulations, only "well capitalized"
financial institutions may fund themselves with brokered deposits without prior
approval of regulators. Our Bank was well capitalized at December 31, 2003. See
"Capital Resources and Expenditures" and Note 18 to the Consolidated Financial
Statements included under Item 8 for a summary of the capital status of the
Bank.
Time deposits in denominations of $100,000 and more totaled $46.6 million at
December 31, 2003 as compared to $64.9 and $79.0 million at December 31, 2002
and 2001, respectively. The following table sets forth the amount and maturities
of time deposits of $100,000 or more as of December 31, 2003:
Time Deposits of $100,000 and Over
(in thousands)
Maturing in:
3 months or less....................... $ 10,109
Over 3 months through 6 months......... 16,231
Over 6 months through 12 months........ 11,742
Over 12 months......................... 8,487
--------------
Total................................. $ 46,569
==============
Borrowed Funds. We use short-term borrowings, FHLB advances and long-term
borrowings to support our asset base. Short-term borrowings include Federal
funds purchased and U.S. Treasury tax and loan note option accounts and
securities sold under agreements to repurchase. At December 31, 2003, short-term
borrowings were $31.4 million compared to $28.1 million at December 31, 2002 and
$760,000 at December 31, 2001.
The following table provides a summary of our short-term borrowings and related
cost information as of, or for the periods ended, December 31:
Short-Term Borrowings (1)
2003 2002 2001
----------- ------------ ------------
(dollars in thousands)
Short-term borrowings outstanding
at period end....................... $31,383 $28,120 $ 760
Weighted average interest rate
at period end....................... 1.41% 1.48% 2.53%
Maximum month-end balance
during the period................... $37,670 $28,120 $39,924
Average borrowings outstanding
for the period...................... $21,942 $ 7,799 $10,206
Weighted average interest rate
for the period...................... 1.74% 1.81% 4.32%
(1) From continuing operations for all periods presented.
Note 11 to the Consolidated Financial Statements included under Item 8
summarizes the general terms of our short-term borrowings outstanding at
December 31, 2003 and 2002, including interest rates, maturity dates, weighted
average yields and other applicable terms.
FHLB advances totaled $112.2, $97.2, and $117.2 million at December 31, 2003,
2002 and 2001, respectively while long-term borrowings totaled $8.6 million,
$8.6 million and $13,000, respectively, for the same periods.
Notes 12 and 13 to the Consolidated Financial Statements included under Item 8
summarize the general terms of our FHLB advances and long-term borrowings at
December 31, 2003 and 2002, including interest rates, maturity dates, weighted
average yields and other applicable terms.
During 2003, $15.0 million of our FHLB advances matured and we originated $30.0
million of new FHLB advances primarily for the purpose of funding the purchase
of CMOs.
During 2002, $20.0 million of our FHLB advances matured and were not replaced
due to the availability of other funding sources. Also during 2002, we incurred
$8.5 million of long-term debt in conjunction with the acquisition of Milne
Scali.
During 2001, we purchased and retired $82,000 of our 8 5/8 percent subordinated
notes due May 31, 2004 ("the Notes") at a discount using cash generated from the
sale of our asset-based lending subsidiary, BNC Financial Corporation, Inc.
which was sold on December 31, 1999. On August 31, 2001, we redeemed the
remaining $12.6 million of the Notes at par through exercise of our call option
on the Notes. The remaining $12.6 million of the Notes were redeemed using a
portion of the cash generated from the issuance of subordinated debentures
through the establishment of BNC Statutory Trust II (see "Guaranteed Preferred
Beneficial Interests in Company's Subordinated Debentures" and Note 14 to the
Consolidated Financial Statements included under Item 8 for further discussion
of our subordinated debenture issuances). The transactions and redemption of the
Notes during 2001 resulted in an extraordinary loss of $134,000 ($0.06 per
diluted share) net of income taxes of ($70,000).
Interest Rate Caps and Floors. From time to time we may use off-balance-sheet
instruments, principally interest rate caps and floors, to adjust the interest
rate sensitivity of on-balance-sheet items, including borrowings. During May and
June 2001, we purchased, for $1.2 million, interest rate cap contracts with
notional amounts totaling $40.0 million to mitigate interest rate risk in
rising-rate scenarios. The referenced interest rate is three-month LIBOR with
$20.0 million of 4.50 percent contracts having three-year original maturities
and $20.0 million of 5.50 percent contracts having five-year original
maturities. The $20.0 million of 4.50 percent contracts having three-year
original maturities will mature in the second quarter of 2004. The contracts,
classified as other assets, are reflected in our December 31, 2003 consolidated
balance sheet at their combined fair value of $56,000. The contracts are not
being accounted for as hedges under SFAS 133. As a result, the impact of marking
the contracts to fair value has been, and will continue to be, included in net
interest income. During the years ended December 31, 2003 and 2002, the impact
of marking the contracts to market (reflected in the consolidated income
statements as an increase in interest expense on borrowings) was $80,000 and
$779,000, respectively. The fair value of $56,000 as of December 31, 2003
reflects the full extent of the potential loss on the contracts should further
write downs to fair value be required. See -"Liquidity, Market and Credit Risk,"
Item 7A, "Quantitative and Qualitative Disclosures about Market Risk," and Notes
1 and 17 to the Consolidated Financial Statements included under Item 8 for
further discussion about accounting policies applicable to derivative financial
instruments.
Guaranteed Preferred Beneficial Interests in Company's Subordinated Debentures.
In July 2000, we established a special purpose trust for the purpose of issuing
$7.5 million of fixed rate subordinated debentures. The subordinated debentures
qualify as Tier 1 capital up to certain limits with the balance qualifying as
Tier 2 capital up to certain limits. See Note 14 to the Consolidated Financial
Statements included under Item 8 for a complete description of the fixed rate
subordinated debentures.
In July 2001, we established an additional special purpose trust for the purpose
of issuing $15.0 million of floating rate subordinated debentures. The
subordinated debentures qualify as Tier 1 capital up to certain limits with the
balance qualifying as Tier 2 capital up to certain limits. We used $12.6 million
of the proceeds from the subordinated debentures issued in 2001 to retire the
remaining $12.6 million of our 8 5/8 percent subordinated notes due May 31, 2004
through the exercise of the call option on the Notes. See Note 14 to the
Consolidated Financial Statements included under Item 8 for a complete
description of the floating rate subordinated debentures.
Capital Resources and Expenditures. We actively monitor compliance with
regulatory capital requirements, including risk-based and leverage capital
measures. Under the risk-based capital method of capital measurement, the ratio
computed is dependent on the amount and composition of assets recorded on the
balance sheet, and the amount and composition of off-balance-sheet items, in
addition to the level of capital. Note 18 to the Consolidated Financial
Statements included under Item 8 includes a summary of the risk-based and
leverage capital ratios of BNCCORP and the Bank as of December 31, 2003 and
2002, including the capital ratios and capital amounts necessary to be
considered "well capitalized" under prompt corrective action regulatory
provisions and adequately capitalized for capital adequacy purposes. As of each
of those dates, BNCCORP and the Bank exceeded capital adequacy requirements and
the Bank was considered "well capitalized" under prompt corrective action
provisions.
The capital ratios of the Company and the Bank were as follows as of those
dates:
Tier 1 Total
Risk- Risk- Tier 1
As of December 31, 2003 Based Based Leverage
Ratio Ratio Ratio
------------- ------------ -----------
BNCCORP, consolidated................... 7.14% 10.63% 4.90%
BNC National Bank....................... 10.74% 11.92% 7.37%
As of December 31, 2002
BNCCORP, consolidated................... 5.92% 9.53% 4.46%
BNC National Bank....................... 9.29% 10.45% 7.00%
Our consolidated risk-based capital ratios improved between December 31, 2002
and December 31, 2003. The improvements were attributable to increases in Tier 1
capital and total capital combined with a decrease in total risk-weighted
assets. Total Tier 1 capital increased from $25.6 million at December 31, 2002
to $28.8 million at December 31, 2003. An increase in total equity capital was
primarily attributable to earnings recognized during 2003. Additionally, because
of the increase in total equity capital, $1.4 million more of our subordinated
debentures qualified as Tier 1 capital at December 31, 2003 than at December 31,
2002. These capital increases were partially offset by an increase in intangible
assets (a direct deduction from equity capital) of $2.4 million in 2003. Total
risk-weighted assets declined from $433.0 million at December 31, 2002 to $403.7
million at December 31, 2003. The decrease in total risk-weighted assets was
attributable to several factors, but most importantly, our decrease in loan
volume. Our consolidated leverage ratio also improved between December 31, 2002
and December 31, 2003 due to the increase in Tier 1 capital offset by an
increase in quarterly average assets (less intangible assets) between the two
dates, from $573.7 million at December 31, 2002 to $588.6 million at December
31, 2003.
During 2003, we completed construction of our office building at 17045 North
Scottsdale Road, Scottsdale, Arizona. We also purchased the Milne Scali building
at 1750 East Glendale Avenue, Phoenix, Arizona, relocated our 2725 East
Camelback Road office to 2425 East Camelback Road, Phoenix and made some
improvements to our office building at 322 East Main Avenue, Bismarck, North
Dakota. Additionally during 2003, we purchased a property in Golden Valley,
Minnesota. This facility is presently undergoing renovation and is expected to
open during 2004. In early 2004, we purchased property in Tucson, Arizona for
future use by IASW personnel along with adjacent land for a future bank site.
Capital expenditures expected in 2004 include the completion of renovation of
the Golden Valley facility and could include purchase or leasing of additional
facilities in our various market areas should such facilities or properties be
deemed to add additional franchise value.
Off-Balance-Sheet Arrangements. In the normal course of business, we are a party
to various financial instruments with off-balance-sheet risk. Such instruments
help us to meet the needs of our customers, manage our interest rate risk and
effectuate business combination transactions. These instruments and commitments,
which we enter into for purposes other than trading, carry varying degrees of
credit, interest rate or liquidity risk in excess of the amount reflected in the
consolidated balance sheets. We have also entered into certain guarantee
arrangements that are not reflected in the consolidated balance sheets. Each of
these instruments is discussed in the following sections.
Commitments to Extend Credit. Commitments to extend credit are agreements to
lend to a customer provided there is no violation of any condition in the
contract. Commitments to extend credit are legally binding and generally have
fixed expiration dates or other termination clauses and may require payment of a
fee. The contractual amount represents our exposure to credit loss in the event
of default by the borrower; however, at December 31, 2003, based on current
information, no losses were anticipated as a result of these commitments. We
manage this credit risk by using the same credit policies we apply to loans.
Collateral is generally required to secure the loans covered by the commitments
based on management's credit assessment of the borrower. The collateral may
include marketable securities, real estate and other types of business assets of
the borrower such as accounts receivable, inventory, equipment, deposit accounts
and general intangibles. Since we expect some of the commitments to expire
without being drawn, total commitment amounts do not necessarily represent our
future liquidity requirements related to such commitments.
Commitments to extend credit are important to us in that they provide sources of
liquidity to our customers. Our liquidity is impacted to the extent that the
customer draws upon the commitments. Our revenues are impacted to the extent
advances of funds are made and interest is earned on such advances of funds or
we charge a fee for extending or maintaining the commitment. Such commitments
don't typically result in material expenses for us, but rather, result in normal
operating expenses involved with processing, approval and other activities
associated with the extension and administration of such credit facilities. Our
cash flow is impacted to the extent the commitments are drawn upon by our
customers. There are no retained interests, securities issued or other
indebtedness incurred by us in connection with these commitments to extend
credit, and, other than the obligation to honor the commitment if drawn by the
customer, there are no other obligations or liabilities, including contingent
obligations or liabilities, arising from such commitments. At the present time,
other than the passage of time or the nonperformance of customers under these
commitments, there is no known event, demand, commitment, trend or uncertainty
that will result in or is reasonably likely to result in termination of such
commitments to a material extent. The contractual amount of our commitments to
extend credit totaled $94.1 million at December 31, 2003.
Commercial Letters of Credit. Commercial letters of credit are issued on behalf
of customers to ensure payment or collection in connection with trade
transactions. In the event of a customer's nonperformance, our credit loss
exposure is the same as in any extension of credit, up to the letter's
contractual amount; however, at December 31, 2003, based on current information,
no losses were anticipated as a result of these commitments. We assess the
borrower's credit to determine the necessary collateral, which may include
marketable securities, real estate and other types of business assets of the
borrower such as accounts receivable, inventory, equipment, deposit accounts and
general intangibles. Since the conditions requiring us to fund letters of credit
may not occur, our liquidity requirements related to such letters of credit will
likely be less than the total outstanding commitments.
Commercial letters of credit are an important service provided by us to our
commercial customers. Our liquidity is impacted only to the extent we must honor
a commercial letter of credit due to nonperformance of the commercial customer.
Our revenues are impacted to the extent we are required to perform under the
letter of credit and earn interest income on the advanced funds or we charge a
fee for issuing or maintaining the letter of credit. Such letters of credit
typically don't result in material expenses for us, but rather, result in normal
operating expenses involved with processing, approval and other activities
associated with the extension and administration of such letters of credit. Our
cash flow is impacted to the extent the nonperformance of the customer requires
us to advance under the letter of credit. There are no retained interests,
securities issued or other indebtedness incurred by us in connection with these
letters of credit, and, other than the obligation to honor the letter of credit,
there are no other obligations or liabilities, including contingent obligations
or liabilities, arising from such letters of credit. At the present time, other
than the passage of time or nonperformance of customers under their letters of
credit, there is no known event, demand, commitment, trend or uncertainty that
will result or is reasonably likely to result in termination of such letters of
credit to a material extent. The contractual amount of our commercial letters of
credit totaled $10.6 million at December 31, 2003.
Performance and Financial Standby Letters of Credit. Performance standby letters
of credit are irrevocable obligations to the beneficiary on our part to make
payment on account of any default by the account party in the performance of a
nonfinancial or commercial obligation. Under these arrangements, we could, in
the event of the account party's nonperformance, be required to pay a maximum of
the amount of issued letters of credit. Under the agreements, we have recourse
against the account party up to and including the amount of the performance
standby letter of credit. We evaluate each account party's creditworthiness on a
case-by-case basis and the amount of collateral obtained varies and is based on
our credit evaluation of the account party. As of December 31, 2003, we had
outstanding $641,000 of performance standby letters of credit.
Financial standby letters of credit are irrevocable obligations to the
beneficiary on our part to repay money borrowed by or advanced to or for the
account of the account party or to make payment on account of any indebtedness
undertaken by the account party, in the event that the account party fails to
fulfill its obligation to the beneficiary. Under these arrangements, we could,
in the event of the account party's nonperformance, be required to pay a maximum
of the amount of issued letters of credit. Under the agreements, we have
recourse against the account party up to and including the amount of the
financial standby letter of credit. We evaluate each account party's
creditworthiness on a case-by-case basis and the amount of collateral obtained
varies and is based on our credit evaluation of the account party. As of
December 31, 2003, we had outstanding $43.8 million of financial standby letters
of credit. $34.1 million of these letters of credit were participated to other
financial institutions.
Performance and financial standby letters of credit are also an important
service we provide to our commercial customers. Our liquidity is impacted only
to the extent we must honor such a letter of credit due to nonperformance of the
customer. Our revenues are impacted to the extent we are required to perform
under the letter of credit and interest is earned on outstanding advances or if
we charge a fee for issuing or administering the letter of credit. Such letters
of credit typically don't result in material expenses for us, but rather, normal
operating expenses involved with processing, approval and other activities
associated with the extension and administration of such letters of credit. Our
cash flow is impacted to the extent the nonperformance of the customer requires
us to advance under the letter of credit. There are no retained interests,
securities issued or other indebtedness incurred by us in connection with these
letters of credit and, other than the obligation to honor the letter of credit,
there are no other obligations or liabilities, including contingent obligations
or liabilities, arising from such letters of credit. At the present time, other
than the passage of time or nonperformance of customers under their letters of
credit, there is no known event, demand, commitment, trend or uncertainty that
will result in or is reasonably likely to result in terminations of such letters
of credit to a material extent.
Interest Rate Swaps, Caps and Floors. Interest rate swaps are contracts to
exchange fixed and floating rate interest payment obligations based on a
notional principal amount. From time to time we may enter into swaps to hedge
our balance sheet against fluctuations in interest rates. Interest rate caps and
floors are used to protect our balance sheet from unfavorable movements in
interest rates while allowing benefit from favorable movements. The credit risk
related to interest rate contracts is that counterparties may be unable to meet
the contractual terms of the agreements. This risk is estimated by calculating
the present value of the cost to replace outstanding contracts in a gain
position at current market rates, reported on a net basis by counterparties. We
manage the credit risk of our interest rate contracts through bilateral
collateral agreements, credit approvals, limits and monitoring procedures.
Additionally, we reduce the assumed counterparty credit risk through master
netting agreements that permit us to settle interest rate contracts with the
same counterparty on a net basis. At December 31, 2003, we held $40.0 million of
interest rate caps. These caps are reflected in the December 31, 2003 balance
sheet at their combined fair value of $56,000.
Interest rate swaps, caps and floors can be an effective way to hedge interest
rate risk. Due to the fact that they are purchased at fair value, which is
generally significantly less than the notional amount of the instrument, our
liquidity is not generally materially affected by the origination of such
instruments. The amount of revenues or expenses associated with such instruments
is dependent upon the accounting methodology selected for the instruments (i.e.,
whether such instruments are officially designated as hedges under applicable
accounting standards). Our current interest rate caps are not accounted for as
hedges. Therefore, increases in their fair value are presented as a reduction to
interest expense while decreases in their fair value are presented as an
increase in interest expense. Cash flow is not affected under these instruments
other than at the time of purchase and, during their life, if interest rates
move in such a fashion that payments under the interest rate caps are received.
There are no retained interests, securities issued or other indebtedness
incurred by us in connection with these interest rate caps, and, there are no
other obligations or liabilities, including contingent obligations or
liabilities, arising from such interest rate caps. The interest rate caps will
terminate upon their maturity dates ($20.0 million in May and June 2004 and the
remaining $20.0 million in May and June 2006). Until such time as those
contracts mature, there are no known events, demands, commitments, trends or
uncertainties that will result in or is reasonably likely to result in
termination of the contracts. We do have the option to sell the contracts at
their fair value at any time.
Contingent Consideration in Business Combinations. Pursuant to the terms of the
agreement related to the acquisition of Milne Scali in April 2002, additional
consideration of up to $6.2 million may be payable to the former shareholders of
Milne Scali, subject to Milne Scali achieving certain financial performance
targets. In accordance with current accounting standards, there is no current
carrying amount associated with this contractual obligation. Additionally, there
are no recourse provisions associated with this contractual obligation that
would enable us to recover from third parties any of the amounts paid under the
contractual obligation and there are no assets held either as collateral or by
third parties that, upon the occurrence of any triggering event or condition
under the contractual obligation, we could obtain to liquidate to recover all or
a portion of the amounts paid under the guarantee.
Pursuant to the terms of the agreement related to the IASW asset acquisition in
December 2003, additional consideration of up to $480,000 may be payable to
IASW, subject to the operation of the acquired assets achieving certain
financial performance targets. In accordance with current accounting standards,
there is no current carrying amount associated with this contractual obligation.
Additionally, there are no recourse provisions associated with this guarantee
that would enable us to recover from third parties any of the amounts paid under
the guarantee and there are no assets held either as collateral or by third
parties that, upon the occurrence of any triggering event or condition under the
guarantee, we could obtain and liquidate to recover all or a portion of the
amounts paid under the guarantee.
Contingent consideration in business combinations, under current accounting
standards and provided certain criteria are met, is not required to be recorded
at the time of the transaction. Such contingent consideration, which may be
based on the financial performance of the acquired entity or other factors, can
be an effective tool in maintaining or encouraging certain levels of performance
by the acquired entity. Such consideration may be critical to accomplishing the
business combination. Our cash flow and liquidity are impacted to the extent the
contractual financial performance is attained and we are, therefore, required to
make the contingency payments. There are no known events, demands, commitments,
trends or uncertainties, other than the passage of time and the financial
performance of the respective acquiree, that will result in or is reasonably
likely to result in termination of the contingent consideration agreements.
Guaranteed Preferred Beneficial Interests in Company's Subordinated Debentures.
BNCCORP, concurrent with the issuance of preferred securities in July 2000 by
BNC Capital Trust I and in July 2001 by BNC Statutory Trust II, fully and
unconditionally guaranteed all obligations of the special purpose trusts related
to the trust preferred securities. Note 14 to the Consolidated Financial
Statements included under item 8 includes a full description of the nature of
the established trusts and the securities issued by the trusts. There are no
recourse provisions associated with these guarantees that would enable BNCCORP
to recover from third parties any of the amounts paid under the guarantees and
there are no assets held either as collateral or by third parties that, upon the
occurrence of any triggering event or condition under the guarantees, BNCCORP
could obtain and liquidate to recover all or a portion of the amounts paid under
the guarantees.
The trust preferred securities are important to us in that they provide for a
cost-effective means of obtaining Tier 1 capital for regulatory purposes.
Additionally, BNCCORP is allowed to deduct, for income tax purposes, amounts
paid in respect of the securities and ultimately distributed to the holders of
the preferred securities. Our consolidated interest expense reflects interest
paid on the preferred securities and cash flows are impacted accordingly. There
are no retained interests (other than the common stock of the trusts held by
BNCCORP), securities issued (other than as described above) or additional
indebtedness incurred by us in connection with these securities, and, there are
no other obligations or liabilities, including contingent obligations and
liabilities, arising from the securities. Due to recently issued accounting
standards, the Federal Reserve is presently considering the regulatory capital
status of such instruments. A change in the regulatory capital status of these
existing instruments could materially impact us in that our consolidated capital
ratios would decline if the securities could not be treated as Tier 1 capital
(to certain limits) or Tier 2 capital (to certain limits). Should such a change
in regulatory capital status be required to be implemented, BNCCORP likely would
need to immediately explore opportunities for issuing other instruments that
qualify as regulatory capital. It is difficult to predict, with any degree of
certainty, the Federal Reserve's final decision as it pertains to the capital
treatment of such instruments.
Indemnifications. In conjunction with various business combinations, we have
entered into certain indemnifications with the contracting parties. Such
indemnifications, although considered guarantees under current accounting
standards, are not deemed to be material to our financial condition or results
of operations.
Contractual Obligations, Contingent Liabilities and Commitments.
As disclosed in the Notes to the Consolidated Financial Statements included
under Item 8, we have certain contractual obligations, contingent liabilities
and commitments. Certain of these commitments have been discussed in the
sections above. At December 31, 2003, the aggregate contractual obligations
(excluding bank deposits), contingent liabilities and commitments were as
follows (in thousands):
Payments due by period
--------------------------------------------------------------------------
Less than 1 to 3 3 to 5 After 5
1 year years years years Total
Contractual Obligations: ----------- ------------ ------------ ------------- -------------
Total borrowings............ $ 54,883 $ 35,140 $ -- $ 84,597 $ 174,620
Annual rental commitments
under non-cancelable
operating leases........... 1,113 1,641 1,133 435 4,322
----------- ------------ ------------ ------------- -------------
Total....................... $ 55,996 $ 36,781 $ 1,133 $ 85,032 $ 178,942
=========== ============ ============ ============= =============
Amount of Commitment - Expiration by Period
--------------------------------------------------------------------------
Less than 1 to 3 3 to 5 After 5 Total
Other Commitments: 1 year years years years
----------- ------------ ------------ ------------- -------------
Commitments to lend......... $ 79,319 $ 11,121 $ 3,320 $ 377 $ 94,137
Standby and commercial
letters of credit.......... 1,138 9,421 -- -- 10,559
----------- ------------ ------------ ------------- -------------
Total....................... $ 80,457 $ 20,542 $ 3,320 $ 377 $ 104,696
=========== ============ ============ ============= =============
Liquidity, Market and Credit Risk
Our business activities generate, in addition to other risks, significant
liquidity, market and credit risks. Liquidity risk is the possibility of being
unable to meet all present and future financial obligations in a timely manner.
Market risk arises from changes in interest rates, exchange rates, commodity
prices and equity prices and represents the possibility that changes in future
market rates or prices will have a negative impact on our earnings or value. Our
principal market risk is interest rate risk. See Item 7A, "Quantitative and
Qualitative Disclosures about Market Risk" for further discussion about interest
rate risk and its impact on net interest income. Credit risk is the possibility
of loss from the failure of a customer to perform according to the terms of a
contract. We are a party to transactions involving financial instruments that
create risks that may or may not be reflected on a traditional balance sheet.
These financial instruments can be subdivided into three categories:
Cash financial instruments, generally characterized as on-balance-sheet
items, include investments, loans, mortgage-backed securities, deposits and
debt obligations.
Credit-related financial instruments, generally characterized as
off-balance-sheet items, include such instruments as commitments to extend
credit, commercial letters of credit and performance and financial standby
letters of credit.
Derivative financial instruments, on-balance-sheet items as of January 1,
2001, include such instruments as interest rate, foreign exchange,
commodity price and equity price contracts, including forwards, swaps and
options.
Our risk management policies are intended to monitor and limit exposure to
liquidity, market and credit risks that arise from each of these financial
instruments. See "-Loan Portfolio" for a discussion of our credit risk
management strategies.
Liquidity Risk Management. Liquidity risk management encompasses our ability to
meet all present and future financial obligations in a timely manner. The
objectives of liquidity management policies are to maintain adequate liquid
assets, liability diversification among instruments, maturities and customers
and a presence in both the wholesale purchased funds market and the retail
deposit market.
The Consolidated Statements of Cash Flows in the Consolidated Financial
Statements included under Item 8 of Part II present data on cash and cash
equivalents provided by and used in operating, investing and financing
activities. In addition to liquidity from core deposit growth, together with
repayments and maturities of loans and investments, we utilize brokered
deposits, sell securities under agreements to repurchase and borrow overnight
Federal funds. The Bank is a member of the FHLB, which affords it the
opportunity to borrow funds in terms ranging from overnight to 10 years and
beyond. Borrowings from the FHLB are generally collateralized by the Bank's
mortgage loans and various investment securities. See "-Investment Securities"
and Note 12 to the Consolidated Financial Statements included under Item 8 of
Part II. We have also obtained funding through the issuance of Subordinated
Notes, subordinated debentures and long-term borrowings. See "-Borrowed Funds,"
"Guaranteed Preferred Beneficial Interests in Company's Subordinated Debentures"
and Notes 13 and 14 to the Consolidated Financial Statements included under Item
8 of Part II for further information on these instruments.
The following table sets forth, for the periods indicated, a summary of our
major sources and (uses) of funds. This summary information is derived from the
Consolidated Statements of Cash Flows included under Item 8 of Part II:
Major Sources and Uses of Funds
For the Years Ended December 31,
--------------------------------------------------
2003 2002 2001
------------- -------------- ---------------
(in thousands)
Proceeds from FHLB advances.......................... $175,300 $ -- $ --
Proceeds from sales of investment securities......... 76,652 100,651 119,394
Proceeds from maturities of investment securities.... 56,598 50,984 86,414
Net (increase) decrease in loans..................... 50,419 (35,144) (53,132)
Net increase (decrease) in short-term borrowings..... 3,263 27,360 (32,467)
Net increase (decrease) in long-term borrowings...... 279 8,548 (13,000)
Net increase (decrease) in deposits.................. (2,303) 21,293 45,505
Purchases of investment securities................... (193,653) (146,985) (162,321)
Repayments of FHLB advances.......................... (160,300) (20,000) --
Additions to premises and equipment.................. (9,012) (2,974) (1,965)
Cash paid for acquisition of insurance subsidiary.... (260) (13,964) --
Proceeds from issuance of preferred stock............ -- 1,500 --
Proceeds from issuance of subordinated debentures.... -- -- 14,429
Disposition of discontinued Fargo branch............. -- (4,365) --
Our liquidity is measured by our ability to raise cash when we need it at a
reasonable cost and with a minimum of loss. Given the uncertain nature of our
customers' demands as well as our desire to take advantage of earnings
enhancement opportunities, we must have adequate sources of on- and
off-balance-sheet funds that can be acquired in time of need. Accordingly, in
addition to the liquidity provided by balance sheet cash flows, liquidity is
supplemented with additional sources such as credit lines with the FHLB, credit
lines with correspondent banks for Federal funds, wholesale and retail
repurchase agreements, brokered certificates of deposit and direct non-brokered
national certificates of deposit acquired through national deposit networks.
We measure our liquidity position on a monthly basis. Key factors that determine
our liquidity are the reliability or stability of our deposit base, the
pledged/non-pledged status of our investments and potential loan demand. Our
liquidity management system divides the balance sheet into liquid assets, and
short-term liabilities that are assumed to be vulnerable to non-replacement
under abnormally stringent conditions. The excess of liquid assets over
short-term liabilities is measured over a 30-day planning horizon. Assumptions
for short-term liabilities vulnerable to non-replacement under abnormally
stringent conditions are based on a historical analysis of the month-to-month
percentage changes in deposits. The excess of liquid assets over short-term
liabilities and other key factors such as expected loan demand as well as access
to other sources of liquidity such as lines with the FHLB, Federal funds and
those other supplemental sources listed above are tied together to provide a
measure of our liquidity. We have a targeted range and manage our operations
such that these targets can be achieved. We believe that our prudent management
policies and guidelines will ensure adequate levels of liquidity to fund
anticipated needs of on- and off-balance-sheet items. In addition, a contingency
funding policy statement identifies actions to be taken in response to an
adverse liquidity event.
As of December 31, 2003, we had established three additional revolving lines of
credit with banks, totaling $16.5 million. At December 31, 2003, we had drawn
$2.5 million on one of those lines leaving $14.0 million available under these
revolving lines of credit. The lines, if drawn upon, mature daily with interest
rates that float at the Federal funds rate. At December 31, 2003, we also had
the ability to draw additional FHLB advances of $83.1 million based upon the
mortgage loans and securities that were then pledged, subject to a requirement
to purchase additional FHLB stock.
Forward-Looking Statements
Statements included in Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" which are not historical in
nature are intended to be, and are hereby identified as "forward-looking
statements" for purposes of the safe harbor provided by Section 27A of the
Securities Act and Section 21E of the Exchange Act. We caution readers that
these forward-looking statements, including without limitation, those relating
to our future business prospects, revenues, working capital, liquidity, capital
needs, interest costs and income, are subject to certain risks and uncertainties
that could cause actual results to differ materially from those indicated in the
forward-looking statements due to several important factors. These factors
include, but are not limited to: risks of loans and investments, including
dependence on local and regional economic conditions; competition for our
customers from other providers of financial services; possible adverse effects
of changes in interest rates including the effects of such changes on derivative
contracts and associated accounting consequences; risks associated with our
acquisition and growth strategies; and other risks which are difficult to
predict and many of which are beyond our control. For a discussion of some of
the additional factors that might cause such differences, see Item 1 of Part I,
"-Factors That May Affect Future Results of Operations."
Effects of Inflation
Unlike most industrial companies, the assets and liabilities of financial
institutions are primarily monetary in nature. Therefore, banking organizations
do not necessarily gain or lose due to the effects of inflation. Changes in
interest rates, which are a major determinant of a financial service
organization's profitability, do not necessarily correspond to changes in the
prices of goods and services; however, interest rates may change in response to
changes in expectations of future inflation. An analysis of a banking
organization's asset and liability structure provides the best indication of how
the organization is positioned to respond to changing interest rates and
maintain profitability.
The financial statements and supplementary financial data have been prepared,
primarily, on a historical basis, which is mandated by accounting principles
generally accepted in the United States. Fluctuations in the relative value of
money due to inflation or recession are generally not considered.
Recently Issued and Adopted Accounting Pronouncements
Note 1 to the Consolidated Financial Statements included under Item 8 includes a
summary of recently issued and adopted accounting pronouncements and their
related or anticipated impact on the Company.
Critical Accounting Policies
Critical accounting policies are dependent on estimates that are particularly
susceptible to significant change and include the determination of the allowance
for credit losses and income taxes. The following have been identified as
"critical accounting policies."
Allowance for Credit Losses. We maintain our allowance for credit losses at a
level considered adequate to provide for an estimate of probable losses related
to specifically identified loans as well as probable losses in the remaining
loan and lease portfolio that have been incurred as of each balance sheet date.
The loan and lease portfolio and other credit exposures are reviewed regularly
to evaluate the adequacy of the allowance for credit losses. In determining the
level of the allowance, we evaluate the allowance necessary for specific
nonperforming loans and also estimate losses in other credit exposures. The
resultant three allowance components are as follows:
Specific Reserves. The amount of specific reserves is determined through a
loan-by-loan analysis of problem loans over a minimum size that considers
expected future cash flows, the value of collateral and other factors that
may impact the borrower's ability to make payments when due. Included in
this group are those nonaccrual or renegotiated loans that meet the
criteria as being "impaired" under the definition in Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a
Loan," ("SFAS 114"). A loan is impaired when, based on current information
and events, it is probable that a creditor will be unable to collect all
amounts due according to the contractual terms of the loan agreement.
Problem loans also include those credits that have been internally
classified as credits requiring management's attention due to underlying
problems in the borrower's business or collateral concerns. Under SFAS 114,
any allowance on impaired loans is generally based on one of three methods.
The accounting standard 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. Specific reserves totaled $2.0 million at December
31, 2003.
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 that 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. Reserves for homogeneous
loan pools totaled $2.6 million at December 31, 2003.
Qualitative Reserve. Our senior lending management also allocates reserves
for special situations that are unique to the measurement period. These
include, among other things, prevailing and anticipated economic trends,
such as economic conditions in certain geographic 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 and peer-group loss history.
Our qualitative reserve totaled $185,000 at December 31, 2003.
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 geographic coverage, we will
enhance our methodology to keep pace with the size and complexity of the loan
and lease portfolio. In this regard, we may, if deemed appropriate, engage
outside firms to independently assess our methodology. On an ongoing basis we
perform independent credit reviews of our loan portfolio. We believe that our
systematic methodology continues to be appropriate given our size and level of
complexity.
While our methodology utilizes historical and other objective information, the
establishment of the allowance for credit losses and the classification of loans
is, to some extent, based on our judgment and experience. We believe that the
allowance for credit losses is adequate, as of December 31, 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.
Allowance for Credit Losses - Impact on Earnings. As indicated above, the
determined level of the allowance for credit losses involves assumptions
underlying our estimates that reflect highly uncertain matters in the current
period. Additionally, a different estimate that could have been used in the
current period could have had a material impact on reported financial condition
or results of operations. We are not aware, at this time, of known trends,
commitments, events or other uncertainties reasonably likely to occur that would
materially affect our methodology or the assumptions used, although changes in
the qualitative and quantitative factors noted above could occur at any time and
such changes could be of a material nature. We have used our assumptions to
arrive at the level of the allowance for credit losses that we consider 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 December 31, 2003. The qualitative and quantitative
factors noted above can reasonably be expected to impact the estimates applied
and cause such estimates to change from period to period.
Our allowance for credit losses of approximately $4.8 million necessitated that
a provision for credit losses of approximately $1.5 million be charged to
operations for the year ended December 31, 2003. Should our analysis have
resulted in the need for a higher or lower allowance for credit losses, an
additional or reduced amount would have been charged to operations during the
period. For example, should our analysis have indicated the need for an
allowance for credit losses of $5.3 million, an additional $500,000 would have
been charged to the provision for loan losses resulting in net income of
approximately $3.5 million as compared to the $3.8 million recorded for the year
ended December 31, 2003. Had our analysis indicated the need for an allowance
for credit losses of $4.3 million, the provision for credit losses would have
been reduced by $500,000 resulting in net income of approximately $4.2 million
as compared to the $3.8 million recorded for the period.
In the past three years there have been changes in the qualitative and
quantitative factors noted above. From period to period, economic situations
change, credits may deteriorate or improve and the other factors we consider in
arriving at our estimates may change. However, our basic methodology for
determining an appropriate allowance for credit losses has remained relatively
stable. This methodology has resulted in allowance levels of $4.8, $5.0 and $4.3
million at each of December 31, 2003, 2002 and 2001, respectively. As noted
above, the amount of the provision for credit losses charged to operations is
directly related to our estimates of the appropriate level of the allowance for
credit losses. Charge-offs and recoveries during the applicable periods also
impact the level of the allowance for credit losses resulting in a provision for
credit losses that could be higher or lower in order to bring the allowance for
credit losses in line with our estimates.
Income Taxes. We file consolidated Federal and unitary 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, the
timing of reversals of temporary differences and current financial accounting
standards. Actual results could differ significantly from the estimates and
interpretations used in determining the current and deferred income tax
liabilities.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk arises from changes in interest rates, exchange rates, and commodity
prices and equity prices and represents the possibility that changes in future
market rates or prices will have a negative impact on our earnings or value. Our
principal market risk is interest rate risk.
Interest rate risk arises from changes in interest rates. Interest rate risk can
result from: (1) 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. See "-Loan Portfolio-Interest Rate Caps and Floors"
"-Borrowings-Interest Rate Caps and Floors" and Notes 1 and 17 to the
Consolidated Financial Statements included under Item 8 for a summary of our
accounting policies pertaining to such instruments.
Our primary tool for measuring and managing interest rate risk is net interest
income simulation. This exercise includes our assumptions regarding the level of
interest rates and their impact on our current balance sheet. Interest rate caps
and floors are included to the extent that they are exercised in the 12-month
simulation period. Additionally, changes in prepayment behavior of the
residential mortgage, CMOs, and mortgage-backed securities portfolios in each
rate environment are captured using industry estimates of prepayment speeds for
various coupon segments of the portfolio. For purposes of this simulation,
projected month-end balances of the various balance sheet accounts are held
constant at their December 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 at its December 31, 2003 level. The static balance
sheet assumption is made so as to project the interest rate risk to net interest
income embedded in the existing balance sheet. With knowledge of the balance
sheet's existing net interest income profile, more informed strategies and
tactics may be developed as it relates to the structure/mix of growth.
We monitor the results of net interest income simulation on a quarterly basis at
regularly scheduled ALCO meetings. Each quarter net interest income is generally
simulated for the upcoming 12-month horizon in seven interest scenarios. The
scenarios generally modeled are parallel interest ramps of +/- 100bp, 200bp, and
300bp along with a rates unchanged scenario. The parallel movement of interest
rates means all projected market interest rates move up or down by the same
amount. A ramp in interest rates means that the projected change in market
interest rates occurs over the 12-month horizon projected. For example, in the
- -100bp scenario, the projected prime rate will decrease from its starting point
at December 31, 2003 of 4.00 percent to 3.00 percent 12 months later. The prime
rate in this example will decrease 1/12th of the overall decrease of 100 basis
points each month. Given the historically low absolute level of market interest
rates as of December 31, 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 that covers
the calendar year of 2004 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. See Notes 1 and 17 to the Consolidated Financial Statements included
under Item 8 of Part II for further discussion related to our interest rate caps
and accounting policies related to these derivative instruments.
Net Interest Income Simulation
(amounts in thousands)
Movement in interest rates -100bp Unchanged +100bp +200bp +300bp +400bp
--------- --------- --------- --------- --------- ---------
Projected 12-month net interest income......... $13,561 $14,513 $14,536 $ 14,324 $ 13,933 $ 13,425
Dollar change from rates unchanged scenario.... $ (952) -- $ 23 $ (189) $ (580) $(1,088)
Percentage change from rates unchanged
scenario.................................... (6.56)% -- 0.16% (1.30)% (4.00)% (7.50)%
Net benefit/(cost) of cumulative $40.0
million interest rate caps (1).............. $ (56) $ (50) $ (28) $ 18 $ 98 $ 217
Total net interest income impact with caps..... $13,505 $14,463 $14,508 $ 14,342 $ 14,031 $ 13,642
Dollar change from unchanged w/caps............ $ (958) -- $ 45 $ (121) $ (432) $ (821)
Percentage change from unchanged w/caps........ (6.62)% -- 0.31% (0.84)% (2.99)% (5.68)%
Policy guidelines (decline limited to)......... 5.00% -- 5.00% 10.00% 15.00% 20.00%
(1) In May and June 2001, we purchased four interest rate cap contracts on
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. These contracts will expire in May and June 2004. 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. These contracts will expire in May
and June of 2006. See Notes 1 and 17 to the Consolidated Financial Statements
included under Item 8 for further information on accounting policies related to
derivative financial investments.
Our rate sensitivity position over the projected 12-month horizon is fairly
stable to slightly liability sensitive. This is evidenced by the projected
decrease in net interest income in most of the rising interest rate scenarios.
Because one of the objectives of asset/liability management is to manage net
interest income over a one-year planning horizon, policy guidelines are stated
in terms of maximum potential reduction in net interest income resulting from
changes in interest rates over the 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 $958,000, or 6.62 percent, from the
unchanged scenario, the level of net interest income of $13.5 million is only
0.95 percent above the $13.4 million recorded for the year ended December 31,
2003.
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. When a
given scenario falls outside of these limits, such as is the case with the
- -100bp scenario above, the ALCO reviews the circumstances surrounding the
exception and, considering the level of net interest income generated in the
scenario and other related factors, may approve the exception to the general
policy or recommend actions aimed at bringing the respective scenario within the
general limits noted above. 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.
Static gap analysis is another tool that may be used for interest rate risk
measurement. The net differences between the amount of assets, liabilities,
equity and off-balance-sheet instruments repricing within a cumulative calendar
period is typically referred to as the "rate sensitivity position" or "gap
position." The following table sets forth our rate sensitivity position as of
December 31, 2003. Assets and liabilities are classified by the earliest
possible repricing date or maturity, whichever occurs first:
Interest Sensitivity Gap Analysis
Estimated maturity or repricing at December 31, 2003
-------------------------------------------------------------------------
0-3 4-12 1-5 Over
months months years 5 years Total
------------- ------------- ------------ ------------ ------------
(dollars in thousands)
Interest-earning assets:
Interest-bearing deposits with banks........... $ -- $ -- $ -- $ -- $ --
Investment securities (1)...................... 10,597 25,265 91,415 135,291 262,568
FRB and FHLB Stock............................. 7,596 -- -- -- 7,596
Fixed rate loans (2)........................... 7,805 17,738 34,851 14,081 74,475
Floating rate loans (2)........................ 205,875 324 3,389 -- 209,588
------------- ------------- ------------ ------------ ------------
Total interest-earning assets............... $ 231,873 $ 43,327 $ 129,655 $ 149,372 $ 554,227
============= ============= ============ ============ ============
Interest-bearing liabilities:
Interest checking and money market accounts.... $ 208,914 $ -- $ -- $ -- $ 208,914
Savings........................................ 6,611 -- -- -- 6,611
Time deposits under $100,000................... 16,171 47,314 25,012 626 89,123
Time deposits $100,000 and over................ 10,108 27,974 8,487 -- 46,569
Borrowings..................................... 41,383 13,500 35,140 84,597 174,620
------------- ------------- ------------ ------------ ------------
Total interest-bearing liabilities.......... $ 283,187 $ 88,788 $ 68,639 $ 85,223 $ 525,837
============= ============= ============ ============ ============
Interest rate gap................................... $ (51,314) $ (45,461) $ 61,016 $ 64,149 $ 28,390
============= ============= ============ ============ ============
Cumulative interest rate gap at December 31, 2003... $ (51,314) $ (96,775) $ (35,759) $ 28,390
============= ============= ============ ============
Cumulative interest rate gap to total assets........ (8.26)% (15.57)% (5.75)% 4.57%
- --------------------
(1) Investment securities are generally reported in the timeframe representing
the earliest of repricing date, call date (for callable securities),
estimated life or maturity date. Estimated lives of mortgage-backed
securities and CMOs are based on published industry prepayment estimates
for securities with comparable weighted average interest rates and
contractual maturities.
(2) Loans are stated gross of the allowance for credit losses and are placed in
the earliest timeframe in which maturity or repricing may occur.
The table assumes that all savings and interest-bearing demand deposits reprice
in the earliest period presented, however, we believe a significant portion of
these accounts constitute a core component and are generally not rate sensitive.
Our position is supported by the fact that aggressive reductions in interest
rates paid on these deposits historically have not caused notable reductions in
balances.
The table does not necessarily indicate the future impact of general interest
rate movements on our net interest income because the repricing of certain
assets and liabilities is discretionary and is subject to competitive and other
pressures. As a result, assets and liabilities indicated as repricing within the
same period may in fact reprice at different times and at different rate levels.
Static gap analysis does not fully capture the impact of embedded options,
lagged interest rate changes, administered interest rate products, or certain
off-balance-sheet sensitivities to interest rate movements. Therefore, this tool
generally cannot be used in isolation to determine the level of interest rate
risk exposure in banking institutions.
Since there are limitations inherent in any methodology used to estimate the
exposure to changes in market interest rates, these analyses are not intended to
be a forecast of the actual effect of changes in market interest rates such as
those indicated above on the Company. Further, these analyses are based on our
assets and liabilities as of December 31, 2003 (without forward adjustments for
planned growth and anticipated business activities) and do not contemplate any
actions we might undertake in response to changes in market interest rates.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Financial Statements: Page
Independent Auditors' Report.................................... 62
Consolidated Balance Sheets as of
December 31, 2003 and 2002.................................... 63
Consolidated Statements of Income for the
years ended December 31, 2003, 2002 and 2001.................. 64
Consolidated Statements of Comprehensive Income
for the years ended December 31, 2003, 2002, and 2001......... 66
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 2003, 2002, and 2001................. 67
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002, and 2001............................. 68
Notes to Consolidated Financial Statements...................... 69
Independent Auditors' Report
The Board of Directors and Stockholders
BNCCORP, Inc.:
We have audited the accompanying consolidated balance sheets of BNCCORP, Inc.
and subsidiaries as of December 31, 2003 and 2002, and the related consolidated
statements of income, comprehensive income, stockholders' equity, and cash flows
for each of the years in the three-year period ended December 31, 2003. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of BNCCORP, Inc. and
subsidiaries as of December 31 2003 and 2002, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America.
KPMG LLP
Minneapolis, Minnesota
January 29, 2004
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
As of December 31
(In thousands, except share and per share data)
ASSETS 2003 2002
------------ ------------
CASH AND DUE FROM BANKS............................. $ 12,520 $ 16,978
INTEREST-BEARING DEPOSITS WITH BANKS................ -- 159
------------ ------------
Cash and cash equivalents...................... 12,520 17,137
INVESTMENT SECURITIES AVAILABLE FOR SALE............ 262,568 208,072
FEDERAL RESERVE BANK AND FEDERAL HOME LOAN
BANK STOCK....................................... 7,596 7,071
LOANS AND LEASES, net............................... 283,555 335,794
ALLOWANCE FOR CREDIT LOSSES......................... (4,763) (5,006)
------------ ------------
Net loans and leases........................... 278,792 330,788
PREMISES AND EQUIPMENT, net......................... 18,570 11,100
INTEREST RECEIVABLE................................. 2,462 2,856
OTHER ASSETS........................................ 15,507 4,119
GOODWILL............................................ 15,089 12,210
OTHER INTANGIBLE ASSETS, net........................ 8,373 8,875
------------ ------------
$ 621,477 $ 602,228
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
DEPOSITS:
Noninterest-bearing............................ $ 44,725 $ 44,362
Interest-bearing -
Savings, interest checking and
money market............................. 215,525 187,531
Time deposits $100,000 and over............ 46,569 64,905
Other time deposits........................ 89,123 101,447
------------ ------------
Total deposits................................. 395,942 398,245
SHORT-TERM BORROWINGS............................... 31,383 28,120
FEDERAL HOME LOAN BANK ADVANCES..................... 112,200 97,200
LONG-TERM BORROWINGS................................ 8,640 8,561
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN
COMPANY'S SUBORDINATED DEBENTURES................. 22,397 22,326
OTHER LIABILITIES................................... 10,729 10,053
------------ ------------
Total liabilities..................... 581,291 564,505
COMMITMENTS AND CONTINGENCIES
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; 2,749,196 and
2,700,929 shares issued and outstanding
(excluding 42,880 shares held in
treasury).................................. 28 27
Capital surplus - common stock................. 17,074 16,614
Retained earnings.............................. 21,119 17,395
Treasury stock (42,880 shares)................. (513) (513)
Accumulated other comprehensive income,
net of income taxes........................ 978 2,700
------------ ------------
Total stockholders' equity............ 40,186 37,723
------------ ------------
$ 621,477 $ 602,228
============ ============
See accompanying notes to consolidated
financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income
For the Years Ended December 31
(In thousands, except per share data)
2003 2002 2001
------------ ------------ ------------
INTEREST INCOME:
Interest and fees on loans..................... $ 19,297 $ 20,778 $ 23,991
Interest and dividends on investments -
Taxable...................................... 7,545 9,774 12,354
Tax-exempt................................... 1,535 977 829
Dividends.................................... 259 223 362
Other.......................................... 10 66 50
------------ ------------ ------------
Total interest income............... 28,646 31,818 37,586
------------ ------------ ------------
INTEREST EXPENSE:
Deposits....................................... 7,438 10,242 14,253
Short-term borrowings.......................... 382 141 441
Federal Home Loan Bank advances................ 5,333 6,214 7,185
Long-term borrowings........................... 387 310 777
Subordinated debentures........................ 1,728 1,829 1,377
------------ ------------ ------------
Total interest expense.............. 15,268 18,736 24,033
------------ ------------ ------------
Net interest income................. 13,378 13,082 13,553
PROVISION FOR CREDIT LOSSES....................... 1,475 1,202 1,699
------------ ------------ ------------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES............................... 11,903 11,880 11,854
------------ ------------ ------------
NONINTEREST INCOME:
Insurance commissions.......................... 14,568 8,981 1,891
Fees on loans.................................. 2,022 2,169 1,936
Trust and financial services................... 1,009 751 899
Net gain on sales of securities................ 968 1,870 1,396
Service charges................................ 909 755 636
Brokerage income............................... 420 1,094 1,407
Rental income.................................. 212 89 54
Other.......................................... 704 587 495
------------ ------------ ------------
Total noninterest income............ 20,812 16,296 8,714
------------ ------------ ------------
NONINTEREST EXPENSE:
Salaries and employee benefits................. 16,478 14,723 9,911
Occupancy...................................... 2,306 2,235 1,661
Depreciation and amortization.................. 1,458 1,320 1,123
Office supplies, telephone and postage......... 1,214 1,106 940
Professional services.......................... 1,146 1,495 1,326
Amortization of intangible assets.............. 1,063 881 482
Marketing and promotion........................ 803 749 709
FDIC and other assessments..................... 201 214 193
Repossessed and impaired asset
expenses/write-offs.......................... 40 142 40
Other.......................................... 2,581 2,464 1,797
------------ ------------ ------------
Total noninterest expense........... 27,290 25,329 18,182
------------ ------------ ------------
Income from continuing operations
before income taxes............................ 5,425 2,847 2,386
Income tax provision.............................. 1,581 822 691
------------ ------------ ------------
Income from continuing operations................. 3,844 2,025 1,695
------------ ------------ ------------
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income, continued
For the Years Ended December 31
(In thousands, except per share data)
2003 2002 2001
------------ ------------ ------------
Discontinued Operations:
Gain (loss) from operations of
discontinued Fargo branch
(including net loss on sale
of $49 for 2002), net of income
taxes of $6 and $(83)............................ -- 14 (203)
------------ ----------- ------------
Income before nonoperating item
and cumulative effect of
change in accounting principle.................. 3,844 2,039 1,492
Nonoperating item - loss on early
extinguishment of debt, net
of income taxes of $(70)....................... -- -- (134)
Cumulative effect of change in
accounting principle, net
of income taxes of $(66) ....................... -- -- (113)
------------ ----------- ------------
NET INCOME.......................................... $ 3,844 $ 2,039 $ 1,245
============ =========== ============
Dividends on preferred stock........................ $ (120) $ (79) $ --
------------ ----------- ------------
Income available to common stockholders............. $ 3,724 $ 1,960 $ 1,245
============ =========== ============
BASIC EARNINGS PER COMMON SHARE:
Income from continuing operations................... $ 1.38 $ 0.74 $ 0.71
Gain (loss) from discontinued Fargo
branch, net of income taxes..................... -- 0.01 (0.08)
Nonoperating item - loss on early
extinguishment of debt, net
of income taxes................................. -- -- (0.06)
Cumulative effect of change in
accounting principle, net of income taxes....... -- -- (0.05)
------------ ----------- ------------
Basic earnings per common share..................... $ 1.38 $ 0.75 $ 0.52
============ =========== ============
DILUTED EARNINGS PER COMMON SHARE:
Income from continuing operations................... $ 1.35 $ 0.74 $ 0.70
Gain (loss) from discontinued Fargo branch,
net of income taxes............................ -- 0.01 (0.08)
Nonoperating item - loss on early extinguishment
of debt, net of income taxes................... -- -- (0.06)
Cumulative effect of change in accounting
principle, net of income taxes................. -- -- (0.05)
------------ ----------- ------------
Diluted earnings per common share................... $ 1.35 $ 0.75 $ 0.51
============ =========== ============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
For the Years Ended December 31
(In thousands)
2003 2002 2001
------------ ----------- ------------
NET INCOME........................................ $ 3,844 $ 2,039 $ 1,245
OTHER COMPREHENSIVE INCOME (LOSS) -
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)
arising during the period, net of
income taxes of $(668), $1,197, and $283...... (1,122) 2,381 885
Less: reclassification adjustment for gains
included in net income, net of income taxes... (600) (1,330) (942)
------------ ----------- ------------
OTHER COMPREHENSIVE INCOME (LOSS)................. (1,722) 1,051 (57)
------------ ----------- ------------
COMPREHENSIVE INCOME.............................. $ 2,122 $ 3,090 $ 1,188
============ =========== ============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
(In thousands, except share data)
Capital Capital Accumulated
Preferred Stock Surplus Common Stock Surplus Other
------------------ Preferred ------------------- Common Retained Treasury Comprehensive
Shares Amount Stock Shares Amount Stock Earnings Stock Income Total
-------- --------- ----------- --------- --------- --------- -------- --------- ------------- ---------
BALANCE,
December 31, 2000...... -- $ -- $ -- 2,437,910 $ 24 $ 14,050 $ 14,190 $ (513) $ 1,706 $ 29,457
Net income............ -- -- -- -- -- -- 1,245 -- -- 1,245
Other comprehensive
loss -
Change in
unrealized
holding gains
on securities
available for
sale, net of
income taxes and
reclassification
adjustment......... -- -- -- -- -- -- -- -- (57) (57)
Other................ -- -- -- 4,140 -- 34 -- -- -- 34
-------- --------- ----------- --------- --------- --------- -------- --------- ------------- ---------
BALANCE,
December 31, 2001...... -- -- -- 2,442,050 24 14,084 15,435 (513) 1,649 30,679
Net income............ -- -- -- -- -- -- 2,039 -- -- 2,039
Other comprehensive
income -
Change in
unrealized
holding gains
on securities
available for
sale, net of
income taxes and
reclassification
adjustment......... -- -- -- -- -- -- -- -- 1,051 1,051
Issuance of
preferred stock...... 150 -- 1,500 -- -- -- -- -- -- 1,500
Preferred stock
dividends............ -- -- -- -- -- -- (79) -- -- (79)
Issuance of common
stock................ -- -- -- 297,759 3 2,497 -- -- -- 2,500
Other ................ -- -- -- 4,000 -- 33 -- -- -- 33
-------- --------- ----------- --------- --------- --------- -------- --------- ------------- ---------
BALANCE,
December 31, 2002...... 150 -- 1,500 2,743,809 27 16,614 17,395 (513) 2,700 37,723
Net income........... -- -- -- -- -- -- 3,844 -- -- 3,844
Other comprehensive
loss -
Change in
unrealized
holding gains
on securities
available for
sale, net of
income taxes and
reclassification
adjustment......... -- -- -- -- -- -- -- -- (1,722) (1,722)
Preferred stock
dividends............ -- -- -- -- -- -- (120) -- -- (120)
Issuance of common
stock................ -- -- -- 12,701 -- 227 -- -- -- 227
Other ................ -- -- -- 35,566 1 233 -- -- -- 234
-------- --------- ----------- --------- --------- --------- -------- --------- ------------- ---------
BALANCE,
December 31, 2003...... 150 $ -- $ 1,500 2,792,076 $ 28 $ 17,074 $ 21,119 $ (513) $ 978 $ 40,186
======== ========= =========== ========= ========= ========= ======== ========= ============= =========
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31
(In thousands)
2003 2002 2001
------------ ------------ ------------
OPERATING ACTIVITIES:
Net income............................................................. $ 3,844 $ 2,039 $ 1,245
Adjustments to reconcile net income to net cash provided by (used
in) operating activities -
Provision for credit losses........................................ 1,475 1,202 1,699
Depreciation and amortization...................................... 1,458 1,489 1,364
Amortization of intangible assets.................................. 1,063 881 482
Net premium amortization on investment securities.................. 4,116 2,966 2,144
Proceeds from loans recovered...................................... 102 136 303
Write down of other real estate owned and repossessed assets....... 40 142 40
Change in interest receivable and other assets, net................ (13,261) 2,308 541
Loss on sale of bank premises and equipment........................ 17 5 5
Net realized gains on sales of investment securities............... (968) (1,870) (1,396)
Deferred income taxes.............................................. 874 (269) (342)
Change in dividend distribution payable............................ (15) (4) 413
Change in other liabilities, net................................... 71 (2,965) (1,233)
Originations of loans to be sold................................... (81,706) (92,004) (122,180)
Proceeds from sale of loans........................................ 81,706 92,004 122,180
------------ ------------ ------------
Net cash provided by (used in) operating activities.......... (1,184) 6,060 5,265
------------ ------------ ------------
INVESTING ACTIVITIES:
Purchases of investment securities..................................... (193,653) (146,985) (162,321)
Proceeds from sales of investment securities........................... 76,652 100,651 119,394
Proceeds from maturities of investment securities...................... 56,598 50,984 86,414
Purchases of FRB and FHLB stock........................................ (3,007) -- --
Proceeds from sales of FRB and FHLB stock.............................. 2,482 -- --
Net (increase) decrease in loans....................................... 50,419 (35,144) (53,132)
Additions to premises and equipment.................................... (9,012) (2,974) (1,965)
Proceeds from sale of premises and equipment........................... 108 161 66
Cash paid for acquisition of insurance subsidiary...................... (260) (13,964) --
Disposition of discontinued Fargo branch............................... -- (4,365) --
------------ ------------ ------------
Net cash used in investing activities........................ (19,673) (51,636) (11,544)
------------ ------------ ------------
FINANCING ACTIVITIES:
Net increase in demand, savings, interest checking and money
market accounts.................................................... 28,357 36,723 12,824
Net increase (decrease) in time deposits............................... (30,660) (15,430) 32,681
Net increase (decrease) in short-term borrowings....................... 3,263 27,360 (32,467)
Repayments of FHLB advances............................................ (160,300) (20,000) --
Proceeds from FHLB advances............................................ 175,300 -- --
Repayments of long-term borrowings..................................... (62) (62) (13,000)
Proceeds from long-term borrowings..................................... 141 8,610 --
Amortization of discount on subordinated notes......................... -- -- 371
Proceeds from issuance of subordinated debentures...................... -- -- 14,429
Proceeds from issuance of preferred stock.............................. -- 1,500 --
Payment of preferred stock dividends................................... (120) (79) --
Amortization of discount on subordinated debentures.................... 86 86 (50)
Other, net............................................................. 235 33 (120)
------------ ------------- ------------
Net cash provided by financing activities.................... 16,240 38,741 14,668
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS..................... (4,617) (6,835) 8,389
CASH AND CASH EQUIVALENTS, beginning of year.............................. 17,137 23,972 15,583
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, end of year.................................... $ 12,520 $ 17,137 $ 23,972
------------ ------------ ------------
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid.......................................................... $ 15,693 $ 19,481 $ 24,601
------------ ------------ ------------
Income taxes paid...................................................... $ 817 $ 912 $ 920
============ ============ ============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
1. Description of Business and Summary of Significant Accounting Policies
Description of Business. BNCCORP, Inc. ("BNCCORP") is a registered bank holding
company incorporated under the laws of Delaware. It is the parent company of BNC
National Bank (together with its wholly-owned subsidiaries, BNC Insurance, Inc.,
Milne Scali & Company, Inc. ("Milne Scali") and BNC Asset Management, Inc., the
"Bank"). BNCCORP, through these wholly owned subsidiaries, which operate from 22
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.
On July 9, 2001, the Company established a new banking subsidiary, BNC National
Bank of Arizona headquartered in Tempe, Arizona.
On April 8, 2002, the Company merged BNC National Bank, its Minnesota chartered
bank, with and into BNC National Bank of Arizona and the name of the combined
bank was changed to BNC National Bank. The transaction was accounted for as a
pooling of interests.
The accounting and reporting policies of BNCCORP and its subsidiaries
(collectively, the "Company") conform to accounting principles generally
accepted in the United States and general practices within the financial
services industry. The more significant accounting policies are summarized
below.
Principles of Consolidation. The accompanying consolidated financial statements
include the accounts of BNCCORP and its wholly owned subsidiaries. All
significant intercompany transactions and balances have been eliminated in
consolidation.
Use of Estimates. The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Ultimate results could differ
from those estimates.
Critical Accounting Policies
Critical accounting policies are dependent on estimates that are particularly
susceptible to significant change and include the determination of the allowance
for credit losses and income taxes. The following have been identified as
"critical accounting policies."
Allowance for Credit Losses. The Company maintains its allowance for credit
losses at a level considered adequate to provide for an estimate of probable
losses related to specifically identified loans as well as probable losses in
the remaining loan and lease portfolio that have been incurred as of each
balance sheet date. The loan and lease portfolio and other credit exposures are
reviewed regularly to evaluate the adequacy of the allowance for credit losses.
In determining the level of the allowance, the Company evaluates the allowance
necessary for specific nonperforming loans and also estimates losses in other
credit exposures. The resultant three allowance components are as follows:
Specific Reserves. The amount of specific reserves is determined through a
loan-by-loan analysis of problem loans over a minimum size that considers
expected future cash flows, the value of collateral and other factors that
may impact the borrower's ability to make payments when due. Included in
this group are those nonaccrual or renegotiated loans that meet the
criteria as being "impaired" under the definition in Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a
Loan" ("SFAS 114"). A loan is impaired when, based on current information
and events, it is probable that a creditor will be unable to collect all
amounts due according to the contractual terms of the loan agreement.
Problem loans also include those credits that have been internally
classified as credits requiring management's attention due to underlying
problems in the borrower's business or collateral concerns. Under SFAS 114,
any allowance on impaired loans is generally based on one of three methods.
The accounting standard requires that impaired loans be measured at either
the present value of expected cash flows at the loan's effective interest
rate, the loan's observable market price or the fair value of the
collateral of the loan.
Reserves for Homogeneous Loan Pools. The Company makes a significant number
of loans and leases that, due to their underlying similar characteristics,
are assessed for loss as "homogeneous" pools. Included in the homogeneous
pools are consumer loans and commercial loans under a certain size, which
have been excluded from the specific reserve allocation previously
discussed. The Company segments the pools by type of loan or lease and,
using historical loss information, estimates a loss reserve for each pool.
Qualitative Reserve. The Company's senior lending management also allocates
reserves for special situations which are unique to the measurement period.
These include, among other things, prevailing and anticipated economic
trends, such as economic conditions in certain geographic 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 and peer-group loss history.
Continuous credit monitoring processes and the analysis of loss components is
the principal method relied upon by management to ensure that changes in
estimated credit loss levels are reflected in the Company's allowance for credit
losses on a timely basis. Management also considers experience of peer
institutions and regulatory guidance in addition to the Company's own
experience. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the allowance for credit losses.
Such agencies may require additions to the allowance based on their judgment
about information available to them at the time of their examination.
Loans, leases and other extensions of credit deemed uncollectible are charged to
the allowance. Subsequent recoveries, if any, are credited to the allowance. The
amount of the allowance for credit losses is highly dependent upon management's
estimates of variables affecting valuation, appraisals of collateral,
evaluations of performance and status, and the amounts and timing of future cash
flows expected to be received on impaired loans. Such estimates, appraisals,
evaluations and cash flows may be subject to frequent adjustments due to
changing economic prospects of borrowers, lessees or properties. These estimates
are reviewed periodically. Actual losses may vary from current estimates and the
amount of the provision may be either greater than or less than actual net
charge-offs. The related provision for credit losses, which is charged to
income, is the amount necessary to adjust the allowance to the level determined
appropriate through application of the above processes.
Income Taxes. The Company files consolidated Federal and unitary 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, the
timing of reversals of temporary differences and current financial accounting
standards. Actual results could differ significantly from the estimates and
interpretations used in determining the current and deferred income tax
liabilities.
Other Significant Accounting Policies
Business Combinations. Business combinations that have been accounted for under
the purchase method of accounting include the results of operations of the
acquired businesses from the date of acquisition. Net assets of the companies
acquired were recorded at their estimated fair value as of the date of
acquisition. Effective with the issuance of Statement of Financial Accounting
Standards No. 141, "Business Combinations" ("SFAS 141"), all business
combinations are required to be accounted for by the purchase method. Note 2 to
these consolidated financial statements includes a summary of all business
combinations completed during the three-year period ended December 31, 2003.
Discontinued Operations. The results of the discontinued operations and any gain
or loss on disposal are reported separately from continuing operations. Prior
period financial statements have been restated to give effect to the
discontinued operations accounted for under this method.
Cash and Cash Equivalents. For purposes of presentation in the consolidated
statements of cash flows, the Company considers amounts included in the
consolidated balance sheet captions "cash and due from banks" and
"interest-bearing deposits with banks" (summarized in the consolidated balance
sheet as "cash and cash equivalents") to be cash equivalents.
Investment Securities. Investment and mortgage-backed securities that the
Company intends to hold for indefinite periods of time as part of its
asset/liability strategy, or that may be sold in response to changes in interest
rates, changes in prepayment risk, the need to increase regulatory capital or
similar factors are classified as available for sale. Available-for-sale
securities are carried at market value. Net unrealized gains and losses, net of
deferred income taxes, on investments and mortgage-backed securities available
for sale are reported as a separate component of stockholders' equity until
realized (see "Comprehensive Income"). All securities, other than the securities
of the Federal Reserve Bank ("FRB") and the Federal Home Loan Bank ("FHLB"),
were classified as available for sale as of December 31, 2003 and 2002.
Investment and mortgage-backed securities that the Company intends to hold until
maturity are carried at cost, adjusted for amortization of premiums and
accretion of discounts using a method that approximates level yield over the
period to maturity. The Company did not have any securities classified as held
to maturity as of December 31, 2003 or 2002.
Premiums and discounts are amortized or accreted over the life of the related
security as an adjustment to yield using the effective interest method. Dividend
and interest income is recognized when earned. Realized gains and losses on the
sale of investment securities are determined using the specific-identification
method and recognized in noninterest income on the trade date.
Declines in the fair value of individual available-for-sale or held-to-maturity
securities below their cost, which are deemed other than temporary, could result
in a charge to earnings and the corresponding establishment of a new cost basis
for the security. Such write-downs, should they occur, would be included in
noninterest income as realized losses. There were no such write-downs during
2003, 2002 or 2001. Note 4 to these consolidated financial statements includes a
summary of investment securities in a loss position at December 31, 2003 along
with the length of time that individual securities have been in a continuous
unrealized loss position and a discussion concerning such securities.
Federal Reserve Bank and Federal Home Loan Bank Stock. Investments in FRB and
FHLB stock are carried at cost, which approximates fair value.
Loans and Leases. Loans and leases held for investment are stated at their
outstanding principal amount net of unearned income, net unamortized deferred
fees and costs and an allowance for credit losses. Interest income is recognized
on an accrual basis using the interest method prescribed in the loan agreement
except when collectibility is in doubt.
Loans and leases, including loans that are considered to be impaired, are
reviewed regularly by management and are placed on nonaccrual status when the
collection of interest or principal is 90 days or more past due, unless the loan
or lease is adequately secured and in the process of collection. Past due status
is based on payments as they relate to contractual terms. When a loan or lease
is placed on nonaccrual status, unless collection of all principal and interest
is considered to be assured, uncollected interest accrued in prior years is
charged off against the allowance for credit losses. Interest accrued in the
current year is reversed against interest income of the current period. Interest
payments received on nonaccrual loans and leases are generally applied to
principal unless the remaining principal balance has been determined to be fully
collectible. Accrual of interest is resumed when it can be determined that all
amounts due under the contract are expected to be collected and the loan has
exhibited a sustained level of performance, generally at least six months.
All impaired loans, including all loans that are restructured in a troubled debt
restructuring involving a modification of terms, are measured at the present
value of expected future cash flows discounted at the loan's initial effective
interest rate. The fair value of collateral of an impaired collateral-dependent
loan or an observable market price, if one is available, may be used as an
alternative to discounting. If the measure of the impaired loan is less than the
recorded investment in the loan, impairment will be recognized as a charge-off
through the allowance for credit losses. A loan is considered impaired when,
based on current information and events, it is probable that a creditor will be
unable to collect all amounts due according to the contractual terms of the loan
agreement. All loans are reviewed for impairment on an individual basis.
Loan Origination Fees and Costs. Loan origination fees and costs incurred to
extend credit are deferred and amortized over the term of the loan as a yield
adjustment. Loan fees representing adjustments of yield are generally deferred
and amortized into interest income over the term of the loan using the interest
method or a method that approximates a level yield over the estimated remaining
lives of the loans. Loan commitment fees are generally deferred and amortized
into noninterest income on a straight-line basis over the commitment period.
Loan fees not representing adjustments of yield are also included in noninterest
income.
Mortgage Servicing and Transfers of Financial Assets. The Bank regularly sells
loans to others on a non-recourse basis. Sold loans are not included in the
accompanying consolidated balance sheets. The Bank generally retains the right
to service the loans as well as the right to receive a portion of the interest
income on the loans. At December 31, 2003 and 2002, the Bank was servicing loans
for the benefit of others with aggregate unpaid principal balances of $147.0 and
$194.7 million, respectively. Many of the loans sold by the Bank are commercial
lines of credit for which balances and related payment streams cannot be
reasonably estimated in order to determine the fair value of the servicing
assets or liabilities and/or future interest income retained by the Bank. Upon
sale, any unearned net loan fees or costs are recognized in noninterest income.
Gains on sales of loans were $9,000, $0 and $22,000 for 2003, 2002 and 2001,
respectively, and are included in noninterest income as fees on loans in the
consolidated statements of income.
Premises and Equipment. Land is carried at cost. Premises and equipment are
reported at cost less accumulated depreciation and amortization. Depreciation
and amortization for financial reporting purposes is charged to operating
expense using the straight-line method over the estimated useful lives of the
assets. Estimated useful lives are up to 40 years for buildings and three to 10
years for furniture and equipment. Leasehold improvements are amortized over the
shorter of the lease term or the estimated useful life of the improvement. The
costs of improvements are capitalized. Maintenance and repairs, as well as gains
and losses on dispositions of premises and equipment, are included in
noninterest income or expense as incurred.
Other Real Estate Owned and Repossessed Property. Real estate properties and
other assets acquired through, or in lieu of, loan foreclosure are included in
other assets in the balance sheets, and are stated at the lower of carrying
amount or fair value less estimated costs to sell, at the date of transfer to
other real estate owned or repossessed property. When an asset is acquired, the
excess of the recorded investment in the asset over fair value less estimated
costs to sell, if any, is charged to the allowance for credit losses. Management
performs valuations periodically. Fair value is generally determined based upon
appraisals of the assets involved. Subsequent declines in the estimated fair
value, net operating results and gains and losses on disposition of the asset
are included in other noninterest expense. The Company's investment in such
assets at December 31, 2003 and 2002 was $0 and $8,000, respectively.
Goodwill. Goodwill represents the aggregate excess of the cost of businesses
acquired over the fair value of their net assets at dates of acquisition. Prior
to the adoption of Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142") on January 1, 2002, goodwill
was amortized over its estimated useful life of 15 to 25 years using the
straight-line method. The Company reviewed goodwill for impairment periodically
or whenever changes in circumstances indicated that the carrying amount of the
goodwill may not have been recoverable. With the adoption of SFAS 142, goodwill
is no longer amortized, but instead is tested for impairment annually or when
impairment indicators are present. Note 9 to these consolidated financial
statements includes transition and other disclosures related to goodwill.
Other Intangible Assets. Other intangible assets include premiums paid for
deposits assumed, insurance books of business and other miscellaneous
intangibles. Deposit premiums are being amortized over their estimated lives of
10 years using the straight-line method. Such accounting treatment is consistent
with the recently issued Statement of Financial Accounting Standards No. 147,
"Acquisition of Certain Financial Institutions, an Amendment to FASB Statements
No. 72 ("SFAS 72") and 144 and FASB Interpretation No. 9 ("FIN 9")" ("SFAS
147"), which became effective on October 1, 2003. Insurance books of business
intangibles are being amortized over their estimated lives of 12.5 or 10 years
for commercial lines and 9.8 or 10 years for personal lines. Under SFAS 142, the
Company's other intangible assets with identifiable lives are amortized over
those lives and are monitored to assess recoverability and determine whether
events and circumstances require adjustment to the recorded amounts or
amortization periods. Intangible assets with indefinite lives are no longer
amortized but are tested for impairment annually or when impairment indicators
are present. Prior to the adoption of SFAS 142, other intangible assets were
amortized over their expected lives using either the straight-line or effective
interest method as deemed appropriate for such assets. Note 9 to these
consolidated financial statements includes additional information related to the
Company's other intangible assets.
Impairment of Long-Lived Assets. The Company reviews long-lived assets,
including property and equipment, certain identifiable intangibles and goodwill
for impairment periodically or whenever events or changes in circumstances
indicate that the carrying amount of any such asset may not be recoverable. If
impairment is identified, the assets are written down to their fair value
through a charge to noninterest expense. No such impairment losses were recorded
during 2003, 2002 or 2001.
Securities Sold Under Agreements to Repurchase. From time to time, the Company
enters into sales of securities under agreements to repurchase, generally for
periods of less than 90 days. Fixed coupon agreements are treated as financings,
and the obligations to repurchase securities sold are reflected as a liability
in the consolidated balance sheets. The costs of securities underlying the
agreements remain in the asset accounts.
Fair Values of Financial Instruments. The Company is required to disclose the
estimated fair value of financial instruments for which it is practicable to
estimate fair value. Fair value estimates are made at a specific point in time,
based on relevant market information and information about the financial
instruments. Fair value estimates are subjective in nature, involving
uncertainties and matters of significant judgment, and therefore cannot be
determined with precision. Changes in assumptions could significantly affect the
estimates. Non-financial instruments are excluded from fair value of financial
instrument disclosure requirements. The following methods and assumptions are
used by the Company in estimating fair value disclosures for its financial
instruments, all of which are issued or held for purposes other than trading
(see Note 19 to these consolidated financial statements):
Cash and Cash Equivalents, Noninterest-Bearing Deposits and Demand
Deposits. The carrying amounts approximate fair value due to the short
maturity of the instruments. The fair value of deposits with no stated
maturity, such as interest checking, savings and money market accounts, is
equal to the amount payable on demand at the reporting date.
Investment Securities Available for Sale. The fair value of the Company's
securities equals the quoted market price.
Federal Reserve Bank and Federal Home Loan Bank Stock. The carrying amount
of FRB and FHLB stock approximates their fair values.
Loans and Leases. Fair values for loans and leases are estimated by
discounting future cash flow payment streams using rates at which current
loans to borrowers with similar credit ratings and similar loan maturities
are being made.
Accrued Interest Receivable. The fair value of accrued interest receivable
equals the amount receivable due to the current nature of the amounts
receivable.
Derivative Financial Instruments. The fair value of the Company's
derivatives equals the quoted market price.
Interest-Bearing Deposits. Fair values of interest-bearing deposit
liabilities are estimated by discounting future cash flow payment streams
using rates at which comparable current deposits with comparable maturities
are being issued. The intangible value of long-term customer relationships
with depositors is not taken into account in the fair values disclosed.
Borrowings and Advances. The carrying amount of short-term borrowings
approximates fair value due to the short maturity and, if applicable, the
instruments' floating interest rates, which are tied to market conditions.
The fair values of long-term borrowings, for which the maturity extends
beyond one year, are estimated by discounting future cash flow payment
streams using rates at which comparable borrowings are currently being
offered.
Accrued Interest Payable. The fair value of accrued interest payable equals
the amount payable due to the current nature of the amounts payable.
Guaranteed Preferred Beneficial Interests in Company's Subordinated
Debentures. The fair values of the Company's subordinated debentures are
estimated by discounting future cash flow payment streams using discount
rates estimated to reflect those at which comparable instruments could
currently be offered.
Financial Instruments with Off-Balance-Sheet Risk. The fair values of the
Company's commitments to extend credit and commercial and standby letters
of credit are estimated using fees currently charged to enter into similar
agreements.
Derivative Financial Instruments. Effective January 1, 2001, the Company adopted
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), as amended. SFAS 133 requires
that all derivative instruments, as defined, including certain derivative
instruments embedded in other financial instruments or contracts, be recognized
in the consolidated balance sheets as either assets or liabilities measured at
fair value. The fair value of the Company's derivative financial instruments is
determined based on quoted market prices for comparable instruments, if
available, or a valuation model that calculates the present value of expected
future cash flows. Subsequent changes in a derivative's fair value are
recognized currently in earnings unless specific hedge accounting criteria are
met.
The Company may enter into derivative financial instruments such as interest
rate swaps, caps and floors as part of managing its interest rate risk. Interest
rate swaps are used to exchange fixed and floating rate interest payment
obligations and caps and floors are used to protect the Company's balance sheet
from unfavorable movements in interest rates while allowing benefit from
favorable movements.
All derivative instruments that qualify for specific hedge accounting are
recorded at fair value and classified either as a hedge of the fair value of a
recognized asset or liability ("fair value" hedge) or as a hedge of the
variability of cash flows to be received or paid related to a recognized asset
or liability or a forecasted transaction ("cash flow" hedge). All relationships
between hedging instruments and hedged items are formally documented, including
the risk management objective and strategy for undertaking various hedge
transactions. This process includes linking all derivatives that are designated
as hedges to specific assets or liabilities on the balance sheet.
Changes in the fair value of a derivative that is highly effective and
designated as a fair value hedge and the offsetting changes in the fair value of
the hedged item are recorded in income. Changes in the fair value of a
derivative that is highly effective and designated as a cash flow hedge are
recognized in other comprehensive income until income from the cash flows of the
hedged item are recognized. The Company performs an assessment, both at the
inception of the hedge and on a quarterly basis thereafter, to determine whether
these derivatives are highly effective in offsetting changes in the value of the
hedged items. Any change in fair value resulting from hedge ineffectiveness is
immediately recorded in income.
Revenue Recognition. The Company recognizes revenue on an accrual basis for
interest and dividend income on loans, investment securities, Federal funds sold
and interest bearing due from accounts. Noninterest income is recognized when it
has been realized or is realizable and has been earned. In accordance with
existing accounting and industry standards, as well as guidance issued by the
Securities and Exchange Commission, the Company considers revenue to be realized
or realizable and earned when the following criteria have been met: persuasive
evidence of an arrangement exists (generally, there is contractual
documentation); delivery has occurred or services have been rendered; the
seller's price to the buyer is fixed or determinable; and collectibility is
reasonably assured. Additionally, there can be no outstanding contingencies that
could ultimately cause the revenue to be passed back to the payor. In the
isolated instances where these criteria have not been met, receipts are
generally placed in escrow until such time as they can be recognized as revenue.
Trust Fees. Trust fees are recorded on the accrual basis of accounting.
Earnings Per Common Share. Basic earnings per share ("EPS") excludes dilution
and is computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding during the applicable
period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity. Such potential dilutive instruments include stock
options and contingently issuable stock. Note 25 to these consolidated financial
statements includes disclosure of the Company's EPS calculations.
Comprehensive Income. Comprehensive income is defined as the change in equity
during a period from transactions and other events from non-owner sources.
Comprehensive income is the total of net income and other comprehensive income,
which for the Company, is generally comprised of unrealized gains and losses on
securities available for sale and, if applicable, unrealized gains on hedging
instruments qualifying for cash flow hedge accounting treatment pursuant to SFAS
133, as amended. The Company presents consolidated statements of comprehensive
income.
Segment Disclosures. BNCCORP segments its operations into separate business
activities, based on the nature of the products and services for each segment:
banking operations, insurance operations and brokerage, trust and financial
services operations. The amount of each segment item reported is the measure
reported to the chief operating decision maker for purposes of making decisions
about allocating resources to the segment and assessing its performance.
Adjustments and eliminations made in preparing an enterprise's general purpose
financial statements and allocation of revenues, expenses and gains or losses
are included in determining reported segment profit or loss if they are included
in the measure of the segment's profit or loss that is used by the chief
operating decision maker. Similarly, only those assets that are included in the
measure of the segment's assets that is used by the chief operating decision
maker is reported for that segment. Segment disclosures are provided in Note 16
to these consolidated financial statements.
Stock-Based Compensation. At December 31, 2003, the Company had two stock-based
employee compensation plans, which are described more fully in Note 28 to these
consolidated financial statements. The Company applies the recognition and
measurement principles of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for those plans. No stock-based employee
compensation expense is reflected in net income for stock options granted under
the plans as all options granted under those plans had an exercise price equal
to the market value of the underlying common stock on the date of grant.
Compensation expense is reflected in net income for the periods presented below
for restricted stock issued under the stock plans and its net effect on net
income is reflected in the table below.
The following table illustrates the effect on net income and EPS if the Company
had applied the fair value recognition provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123") to stock-based employee compensation for the years ended December 31:
2003 2002 2001
--------------- --------------- ----------------
Net income, as reported............................... $ 3,844,000 $ 2,039,000 $ 1,245,000
Add: total stock-based employee compensation expense
included in reported net income, net of related tax
effects............................................ 96,000 6,000 6,000
Deduct: total stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects......................... (147,000) (40,000) (106,000)
--------------- --------------- ----------------
Pro forma net income.................................. $ 3,793,000 $ 2,005,000 $ 1,145,000
=============== =============== ================
Earnings per share:
Basic - as reported................................. $ 1.38 $ 0.75 $ 0.52
Basic - pro forma................................... 1.30 0.72 0.45
Diluted - as reported............................... 1.35 0.75 0.51
Diluted - pro forma................................. 1.27 0.72 0.44
Recently Issued and Adopted Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 143, "Accounting for Asset Retirement
Obligations" ("SFAS 143"). SFAS 143 amends FASB Statement No. 19, "Financial
Accounting and Reporting by Oil and Gas Producing Companies," and applies to all
entities. The statement addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. It applies to legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development and/or the normal operation of a long-lived asset,
except for certain obligations of lessees. BNCCORP adopted this standard on
January 1, 2003; however, adoption of this statement did not have a material
impact.
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
144"). SFAS 144 supersedes FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of,"
and the accounting and reporting provisions of APB Opinion No. 30, "Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of a segment of a business (as previously
defined in that opinion). SFAS 144 requires that one accounting model be used
for long-lived assets to be disposed of by sale, whether previously held and
used or newly acquired, and broadens the presentation of discontinued operations
to include more disposal transactions than were included under the previous
standards. BNCCORP adopted SFAS 144 on January 1, 2002. Under SFAS 144, the sale
of the Fargo branch of the Bank on September 30, 2002 has been presented as a
discontinued operation for financial reporting purposes.
In April 2002, the FASB issued Statement of Financial Accounting Standards No.
145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" ("SFAS 145"). SFAS 145 rescinds
FASB Statement No. 4, "Reporting Gains and Losses from Extinguishment of Debt,"
and an amendment of that Statement, FASB Statement No. 64, "Extinguishments of
Debt Made to Satisfy Sinking-Fund Requirements." SFAS 145 also rescinds FASB
Statement No. 44, "Accounting for Intangible Assets of Motor Carriers." Finally,
SFAS 145 amends FASB Statement No. 13, "Accounting for Leases," to eliminate
inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions and amends other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions. The
provisions of SFAS 145 related to the rescission of FASB Statement No. 4 are to
be applied in fiscal years beginning after May 15, 2002 (January 1, 2003 for the
Company) with any gain or loss on extinguishment of debt that was classified as
an extraordinary item in prior periods presented that does not meet the criteria
in APB Opinion 30 for classification as an extraordinary item being
reclassified. The provisions of SFAS 145 related to FASB Statement No. 13 that
relate to modifications of a capital lease that make it an operating lease
became effective for transactions occurring after May 15, 2002. The Company
adopted this standard on January 1, 2003. A loss on early extinguishment of debt
incurred during 2001, previously classified as an extraordinary item, has now
been reclassified as a nonoperating item in these consolidated financial
statements.
In June 2002, the FASB issued Statement of Financial Accounting Standards No.
146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS
146"). SFAS 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)" ("EITF Issue 94-3"). One of the principal differences
between SFAS 146 and EITF Issue 94-3 pertains to the criteria for recognizing a
liability for exit or disposal costs. Under EITF Issue 94-3, a liability for
such costs was recognized as of the date of an entity's commitment to an exit
plan. Pursuant to SFAS 146, a liability is recorded as of the date an obligation
is incurred. SFAS 146 requires that an exit or disposal liability be initially
measured at fair value. Provisions of SFAS 146 are effective for exit or
disposal activities that are initiated after December 31, 2002. The Company
adopted SFAS 146 on January 1, 2003 with no material impact.
In October 2002, the FASB issued SFAS 147. SFAS 147 removes acquisitions of
financial institutions from the scope of both SFAS 72 and FIN 9 and requires
that those transactions be accounted for in accordance with SFAS 141 and 142.
Thus, the requirement to recognize (and subsequently amortize) any excess of the
fair value of liabilities assumed over the fair value of tangible and
identifiable intangible assets acquired as an unidentifiable intangible asset no
longer applies to acquisitions within the scope of SFAS 147. Entities with
previously recognized unidentifiable intangible assets that are still amortizing
them in accordance with SFAS 72 must, effective the latter of the date of the
acquisition or the full adoption of SFAS 142, reclassify those intangible assets
to goodwill and terminate amortization on them. The Company adopted SFAS 147 on
October 1, 2002 and the adoption resulted in no reclassification or revisions to
prior period financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"), which addresses the disclosures to be made
by a guarantor in its interim and annual financial statements about its
obligations under guarantees. These disclosure requirements are included in Note
21 to these consolidated financial statements. FIN 45 also requires the
recognition of a liability by a guarantor at the inception of certain
guarantees. FIN 45 requires the guarantor to recognize a liability for the
non-contingent component of the guarantee, which is the obligation to stand
ready to perform in the event that specified triggering events or conditions
occur. The initial measurement of this liability is the fair value of the
guarantee at inception. The recognition of the liability is required even if it
is not probable that payments will be required under the guarantee or if the
guarantee was issued with a premium payment or as part of a transaction with
multiple elements. The Company adopted the disclosure requirements of FIN 45 at
December 31, 2002 (see Note 21) and has applied the recognition and measurement
provisions for all guarantees entered into or modified since December 31, 2002.
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation; Transition and Disclosure"
("SFAS 148"). SFAS 148 amends SFAS 123 to provide new guidance concerning
transition when an entity changes from the intrinsic value method to the fair
value method of accounting for employee stock-based compensation cost. As
amended by SFAS 148, SFAS 123 now also requires additional information to be
disclosed regarding such cost in annual financial statements and in condensed
interim statements of public companies. In general, the new transition
requirements are effective for financial statements for fiscal years ending
after December 15, 2002. Earlier application is permitted if statements for a
fiscal year ending prior to December 15, 2002 have not yet been issued as of
December 2002. Interim disclosures are required for reports containing condensed
financial statements for periods beginning after December 15, 2002. The Company
accounts for stock-based compensation using the intrinsic method under ABP 25
and plans to continue to do so while providing the disclosures provided for in
SFAS 123. The Company adopted the annual disclosure requirements for SFAS 148
for purposes of its December 31, 2002 consolidated financial statements and
adopted the interim disclosure requirements of SFAS 148 beginning with its
interim financial statements for the period ended March 31, 2003.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 addresses consolidation by
business enterprises of variable interest entities which have certain
characteristics by requiring that if a business enterprise has a controlling
interest in a variable interest entity (as defined by FIN 46), the assets,
liabilities and results of activities of the variable interest entity be
included in the consolidated financial statements with those of the business
enterprise. FIN 46 applies immediately to variable interest entities created
after January 31, 2003 and to variable interest entities in which an enterprise
obtains an interest after that date. For variable interests acquired before
February 1, 2003, FIN 46 applies in the first fiscal year or interim period
beginning after June 15, 2003. During 2003, the FASB delayed the implementation
date for these provisions until the fourth quarter of 2003. Accordingly, the
Company adopted FIN 46 during the fourth quarter of 2003. The adoption resulted
in the deconsolidation of two BNCCORP trusts that have issued subordinated
debentures (commonly referred to as "trust preferred securities") (see Note 14).
Prior periods have been reclassified to reflect the adoption of FIN 46.
In April 2003, the FASB issued Statement of Financial Accounting Standards No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" ("SFAS 149"). SFAS 149 amends Statement 133 for decisions made (1)
as part of the Derivatives Implementation Group process that effectively
required amendments to Statement 133, (2) in connection with other FASB projects
dealing with financial instruments, and (3) in connection with the
implementation issues raised in relation to the application of the definition of
a derivative, in particular, the meaning of "an initial net investment that is
smaller than would be required for other types of contracts that would be
expected to have a similar response to changes in market factors," the meaning
of "underlying," and the characteristics of a derivative that contains financing
components. SFAS 149 is generally effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships designated after June
30, 2003. The Company adopted SFAS 149 on July 1, 2003 and such adoption did not
have a material effect on its financial position or results of operations.
In May 2003, the FASB issued Statement of Financial Accounting Standards No.
150, "Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity" ("SFAS 150"). SFAS 150 establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. The statement requires that an
issuer classify a financial instrument that is within its scope as a liability
(or asset in some circumstances). Many of those instruments were previously
classified as equity. SFAS 150 became effective for financial instruments
entered into or modified after May 31, 2003, and otherwise at the beginning of
the first interim period beginning after June 15, 2003, except for mandatorily
redeemable financial instruments for nonpublic companies. The Company adopted
SFAS 150 on July 1, 2003. Adoption of the standard required classification of
BNCCORP's subordinated debentures as liabilities as compared to the previous
classification between the liability and equity section of the balance sheets.
Additionally, the standard requires that the interest expense associated with
the subordinated debentures be included in interest expense and, hence, included
in the computation of net interest income and net interest margin. Prior periods
have been reclassified to reflect the adoption of SFAS 150.
Regulatory Environment. BNCCORP and its subsidiaries are subject to regulations
of certain state and Federal agencies, including periodic examinations by those
regulatory agencies. BNCCORP and the Bank are also subject to minimum regulatory
capital requirements. At December 31, 2003, capital levels exceeded minimum
capital requirements (see Note 18 to these consolidated financial statements).
Reclassifications. Certain amounts in the financial statements for prior years
have been reclassified to conform to the current year's presentation.
2. Acquisitions and Divestitures:
The following acquisitions and divestitures transpired during the three-year
period ended December 31, 2003:
On December 31, 2003, in order to further grow its insurance segment, Milne
Scali acquired the assets and assumed certain liabilities of The Insurance
Alliance of the Southwest ("IASW"), a Tucson, Arizona-based insurance agency,
for 12,701 shares of newly issued BNCCORP common stock (valued at $227,000) and
$256,000 in cash. Subsequent payments of $156,000 in cash and BNCCORP common
stock valued at $233,000 will be made on each of the first and second annual
anniversaries of the transaction. Acquisition of insurance agencies generally
result in the recognition of goodwill due to the service nature of the business,
the lack of tangible assets acquired and the profitability of the acquired
agency. Of the total $1.3 million purchase price, $601,000 was allocated to the
net assets acquired (including intangible assets) and the excess purchase price
of approximately $659,000 over the fair value of the net assets was recorded as
goodwill. Additional consideration of up to $480,000 is payable to IASW, subject
to the insurance operation achieving certain performance targets. In accordance
with purchase method accounting requirements, such payments would increase the
cost of the transaction in future periods and are not reflected as liabilities
in the Company's current consolidated balance sheet. The goodwill, all of which
is attributable to the Company's insurance segment, will be evaluated for
possible impairment under the provisions of SFAS 142. Other acquired intangible
assets related to personal and commercial insurance lines books of business and
totaling approximately $562,000 will be amortized using a method that
approximates the anticipated useful life of the associated customer lists, which
will cover a period of 10 years. The results of operations of the acquired
assets are being included in the Company's consolidated financial statements
effective January 1, 2004.
On December 1, 2003, in order to further grow its mortgage banking operations,
the Bank executed an Asset Purchase and Sale Agreement (the "Purchase
Agreement") with Lynk Financial LLC of Arizona ("Lynk") and its principal owner.
Under the Purchase Agreement, the Bank would, on January 5, 2004, acquire
certain assets of Lynk for newly issued common stock of BNCCORP with a fair
value of $50,000 and $150,000 in cash. The transaction closed as scheduled on
January 5, 2004 with BNCCORP issuing 2,888 shares of its common stock.
Acquisition of the mortgage operation resulted in the recognition of goodwill
due to the service nature of the business, the lack of tangible assets acquired
and the profitability of the acquired assets. Of the total $200,000 purchase
price, $5,000 was allocated to the net assets acquired and the excess purchase
price of $195,000 over the fair value of the net assets was recorded as
goodwill. The goodwill, all of which is attributable to the Company's banking
segment, will be evaluated for possible impairment under the provisions of SFAS
142. The results of operation of the mortgage banking operation are being
included in the Company's consolidated financial statements effective January 5,
2004.
On September 30, 2002, the Company sold its Fargo, North Dakota branch largely
due to the fact that the branch did not achieve critical mass for the Company in
the Fargo marketplace and the sale allowed the Company to redirect assets to
markets where they can be more productively and profitably employed. Pursuant to
a definitive branch purchase and assumption agreement dated July 26, 2002, the
Company sold the assets of the Fargo branch, including the bank building,
furniture, fixtures and equipment totaling $6.0 million and $19.5 million of
loans. The Company also sold $31.0 million in deposits. Prior to the application
of the Company's direct costs incurred in the sale of the branch ($56,000), the
transaction resulted in a net gain on sale of $7,000. These amounts are included
in the line item "Gain (loss) from operations of discontinued Fargo branch
(including net loss on sale of $49,000 for 2002), net of income taxes" in the
consolidated statements of income. The Fargo branch's profit or loss, for the
periods presented, is also reflected in this line item. Additionally, included
in this line item are the following amounts of net interest income for the Fargo
branch for the 12 months ended December 31, 2002 and 2001, respectively:
$973,000 and $726,000. The Fargo branch had previously been reported in the
banking operations segment of the Company's segment disclosures.
On April 16, 2002, in order to further grow its insurance segment, the Company
acquired 100 percent of the voting equity interests of Milne Scali, a Phoenix,
Arizona-based insurance agency, for 297,759 shares of newly issued common stock
(valued at $2.5 million) and $15.5 million in cash. Acquisitions of such
agencies generally result in the recognition of goodwill due to the service
nature of the business, the lack of tangible assets acquired and the
profitability of the acquired agency. To effect the transaction, the Company
incurred $8.5 million in long-term debt. Of the total $18.0 million purchase
price, $7.2 million was allocated to the net assets acquired (including
intangible assets) and the excess purchase price of approximately $10.8 million
over the fair value of net assets was recorded as goodwill. As part of the
transaction, deferred tax liabilities of $2.3 million were initially recorded,
which also increased goodwill by the same amount. Subsequent to the acquisition,
the Company and Milne Scali made an Internal Revenue Code Section 338(h)(10)
election to step up the basis in the acquired assets. Upon the election,
goodwill was reduced by $1.8 million, deferred taxes were reduced by $2.3
million and a liability for the resulting income taxes in the amount of $590,000
was recorded. Under the Section 338(h)(10) election, all of the goodwill related
to the acquisition will be deductible for tax purposes. An earnout payment of
$2.3 million was made during 2003 (see Note 21). This payment increased the
goodwill associated with the acquisition. Additional consideration of up to $6.2
million is payable to the former shareholders of Milne Scali, subject to Milne
Scali achieving certain financial performance targets. In accordance with
purchase method accounting requirements, such payments would increase the cost
of the transaction in future periods and are not reflected as liabilities in the
Company's current consolidated balance sheet. The goodwill, all of which is
attributable to the Company's insurance segment, is evaluated for possible
impairment under the provisions of SFAS 142. Other acquired intangible assets
related to personal and commercial insurance lines books of business and
totaling approximately $8.0 million are being amortized using a method that
approximates the anticipated useful life of the associated customer lists, which
cover a period of 9.8 to 12.5 years. Milne Scali's results of operations have
been included in the Company's consolidated financial statements since the
acquisition date of April 16, 2002.
The following is a condensed balance sheet indicating the amount assigned to
each major asset and liability caption of Milne Scali as of the acquisition date
(in thousands):
Assets -
Cash...................................... $ 1,536
Accounts receivable....................... 1,305
Fixed assets.............................. 412
Intangible assets, books of business...... 8,018
Goodwill.................................. 13,096
Other..................................... 104
-------------
Total assets................................ $ 24,471
=============
Liabilities -
Notes payable............................. $ 1,421
Insurance company payables................ 1,486
Deferred tax liabilities.................. 2,346
Other..................................... 1,218
-------------
Total liabilities........................... 6,471
Stockholders' equity...................... 18,000
-------------
Total liabilities and stockholders' equity.. $ 24,471
=============
The following pro forma information has been prepared assuming that the
acquisition of Milne Scali had been consummated at the beginning of the
respective periods. The pro forma financial information is not necessarily
indicative of the results of operations as they would have been had the
transaction been consummated on the assumed dates (amounts are in thousands):
12 Months Ended December 31
---------------------------------------
2002 2001
------------------ ------------------
Net interest income................. $ 14,761 $ 14,251
Noninterest income.................. 19,553 18,131
Noninterest expense................. 28,032 26,215
Income from continuing operations... 2,313 2,196
Income (loss) from discontinued
operations..................... 14 (203)
Income before nonoperating item
and cumulative effect of
change in accounting principle. 2,327 1,993
Net income.......................... 2,327 1,746
Basic earnings per common share..... $ 0.79 $ 0.65
Diluted earnings per common share... $ 0.79 $ 0.64
3. Restrictions on Cash and Due From Banks:
The Bank is required to maintain reserve balances in cash on hand or with the
FRB under the Federal Reserve Act and Federal Reserve Board's Regulation D.
Required reserve balances were $25,000 and $3.6 million as of December 31, 2003
and 2002, respectively. The Bank's required reserve balance declined during 2003
due to the implementation of an account reclassification program.
4. Investment Securities Available For Sale:
Investment securities have been classified in the consolidated balance sheets
according to management's intent. The Company had no securities designated as
trading or held-to-maturity in its portfolio at December 31, 2003 or 2002. The
carrying amount of available-for-sale securities and their approximate fair
values were as follows as of December 31 (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------- --------------- --------------- ---------------
2003
U.S. government agency mortgage-
backed securities....................... $ 14,374 $ 389 $ (8) $ 14,755
U.S. government agency securities............ 961 122 -- 1,083
Collateralized mortgage obligations.......... 210,760 1,451 (2,535) 209,676
State and municipal bonds.................... 32,909 2,264 (117) 35,056
Corporate debt securities.................... 1,939 59 -- 1,998
---------------- --------------- --------------- ---------------
$ 260,943 $ 4,285 $ (2,660) $ 262,568
================ =============== =============== ===============
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
2002 Cost Gains Losses Value
---------------- ---------------- --------------- ----------------
U.S. government agency mortgage-
backed securities....................... $ 47,072 $ 547 $ (43) $ 47,576
U.S. government agency securities............ 4,608 595 -- 5,203
Collateralized mortgage obligations.......... 122,795 2,527 (842) 124,480
State and municipal bonds.................... 27,276 1,589 (50) 28,815
Corporate debt securities.................... 1,938 60 -- 1,998
---------------- ---------------- --------------- ----------------
$ 203,689 $ 5,318 $ (935) $ 208,072
================ ================ =============== ================
The amortized cost and estimated fair market value of available-for-sale
securities classified according to their contractual maturities at December 31,
2003, were as follows (in thousands):
Estimated
Amortized Fair
Cost Value
--------------- ---------------
Due in one year or less....................... $ -- $ --
Due after one year through five years......... 2,592 2,742
Due after five years through ten years........ 23,636 23,932
Due after ten years........................... 234,715 235,894
--------------- ---------------
Total.................................... $ 260,943 $ 262,568
=============== ===============
Securities carried at approximately $234.0 and $177.8 million at December 31,
2003 and 2002, respectively, were pledged as collateral for public and trust
deposits and borrowings, including borrowings with the FHLB and repurchase
agreements with customers.
Sales proceeds and gross realized gains and losses on available-for-sale
securities were as follows for the years ended December 31 (in thousands):
2003 2002 2001
-------------- -------------- --------------
Sales proceeds................ $ 76,652 $ 100,651 $ 119,394
Gross realized gains.......... 1,573 2,003 1,530
Gross realized losses......... 605 133 134
The following table shows the Company's investments' gross unrealized losses and
fair value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position at December 31,
2003 (amounts are in thousands):
Less than 12 months 12 months or more Total
---------------------------------- ------------------------------- ------------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Securities # Value Loss % # Value Loss % # Value Loss %
---- ---------- ------------ ----- ---- -------- ---------- ----- ---- ----------- ------------ ------
U.S. government agency
mortgage-backed
securities............... 1 $ 661 $ (3) .5 2 $ 354 $ (5) 1.4 3 $ 1,015 $ (8) .8
Collateralized mortgage
obligations.............. 19 116,673 (2,176) 1.9 3 10,942 (359) 3.3 22 127,615 (2,535) 2.0
State and municipal bonds 7 3,043 (117) 3.8 -- -- -- -- 7 3,043 (117) 3.8
---- ---------- ----------- ----- ---- -------- ---------- ----- ---- ----------- ------------ ------
Total temporarily
impaired securities...... 27 $120,377 $(2,297) 1.9 5 $11,296 $ (364) 3.2 32 $ 131,673 $ (2,660) 2.0
==== ========== =========== ===== ==== ======== ========== ===== ==== =========== ============ ======
The Company considered the following information in reaching the conclusion that
the impairments disclosed in the table above are temporary and not
other-than-temporary impairments. The nature of the investments with gross
unrealized losses as of December 31, 2003 was as follows: U.S. government agency
mortgage-backed securities (3 positions issued and guaranteed by GNMA);
collateralized mortgage obligations (19 positions issued and guaranteed by FNMA
or FHLMC and 3 non-agency collateralized mortgage obligations each carrying two
AAA ratings from a combination of Fitch, Moody's or S & P) - the duration of the
3 collateralized mortgage obligation positions that have been in a continuous
unrealized loss position for 12 months or more as of December 31, 2003 was only
15 months; and state and municipal bonds (7 insured, AAA rated, general
obligation bonds). Therefore, none of the impairments in the above table were
due to a deterioration in the credit quality of any of the issues that might
result in the noncollection of contractual principal and interest. The cause of
the impairments is due to changes in interest rates.
5. Federal Reserve Bank and Federal Home Loan Bank Stock:
The carrying amounts of FRB and FHLB stock, which approximate their fair values,
consisted of the following as of December 31 (in thousands):
2003 2002
---------------- ----------------
Federal Reserve Bank Stock, at cost...... $ 1,236 $ 1,236
Federal Home Loan Bank Stock, at cost.... 6,360 5,835
---------------- ----------------
Total.................................. $ 7,596 $ 7,071
================ ================
There is no contractual maturity on these investments; they represent required
regulatory investments.
6. Loans and Leases:
Composition of Loan and Lease Portfolio. The composition of the loan and lease
portfolio was as follows as of December 31 (in thousands):
2003 2002
--------------- --------------
Commercial and industrial..................... $ 73,001 $ 94,075
Real estate:
Mortgage................................... 129,443 147,825
Construction............................... 60,056 62,926
Agricultural.................................. 12,529 18,023
Consumer...................................... 6,188 7,948
Lease financing............................... 2,757 5,554
Other......................................... 89 309
--------------- --------------
Total.................................... 284,063 336,660
Less:
Unearned income and net unamortized
deferred fees and costs.................. (508) (866)
--------------- --------------
Loans and leases, net...................... 283,555 335,794
Allowance for credit losses................ (4,763) (5,006)
--------------- --------------
Net loans and leases................. $ 278,792 $ 330,788
=============== ==============
Geographic Location and Types of Loans. Loans were to borrowers located in the
following market areas as of December 31:
2003 2002
---------- ----------
North Dakota....................... 31% 32%
Arizona............................ 29 26
Minnesota.......................... 28 30
South Dakota....................... 8 7
Other.............................. 4 5
---------- ----------
Totals.................... 100% 100%
========== ==========
Commercial loan borrowers are generally small- and mid-sized corporations,
partnerships and sole proprietors in a wide variety of businesses. Loans to
consumers are both secured and unsecured. Real estate loans are fixed or
variable rate and include both amortizing and revolving line-of-credit loans.
Real estate mortgage loans include various types of loans for which the Company
holds real property as collateral. Of the $129.4 and $147.8 million of real
estate mortgages as of December 31, 2003 and 2002, respectively, many are loans
made to commercial customers where the collateral for the loan is, among other
things, the real estate occupied by the business of the customer. Accordingly,
certain loans categorized as real estate mortgage loans could be characterized
as commercial loans that are secured by real estate. Single- and multi-family
residential mortgage loans totaling $8.3 and $10.1 million at December 31, 2003
and 2002, respectively, were pledged as collateral for FHLB borrowings.
Commercial loans totaling $43.4 and $38.5 million at December 31, 2003 and 2002,
respectively, were pledged as collateral for borrowings, including FHLB
borrowings.
Concentrations of Credit. The Company's credit policies emphasize
diversification of risk among industries, geographic areas and borrowers. The
only concentrations of loans exceeding 10 percent of total loans at December 31,
2003 were real estate loans, such as loans to non-residential and apartment
building operators and lessors of real property ($62.7 million), loans related
to hotels and other lodging places ($42.2 million) and construction loans ($34.9
million). Loans within these categories are diversified across different types
of borrowers, geographically dispersed, and secured by many different types of
real estate and other collateral.
Impaired Loans. As of December 31, the Company's recorded investment in impaired
loans and the related valuation allowance was as follows (in thousands):
2003 2002
--------------------------------- ---------------------------------
Recorded Valuation Recorded Valuation
Investment Allowance Investment Allowance
--------------- -------------- -------------- ---------------
Impaired loans -
Valuation allowance required......... $ 10,996 $ 2,245 $ 13,412 $ 2,210
No valuation allowance required...... -- -- 10 --
--------------- -------------- -------------- ---------------
Total impaired loans............. $ 10,996 $ 2,245 $ 13,422 $ 2,210
=============== ============== ============== ===============
Impaired loans generally include loans on which management believes, based on
current information and events, it is probable that the Company will not be able
to collect all amounts (i.e., contractual principal and interest) due in
accordance with the terms of the loan agreement and which are analyzed for a
specific reserve allowance. The Company generally considers all loans
risk-graded substandard and doubtful, as well as nonaccrual and restructured
loans, as impaired loans.
The valuation allowance on impaired loans is included in the Company's allowance
for credit losses.
Interest payments received on impaired loans are recorded as interest income
unless collection of the remaining recorded investment is doubtful, at which
time payments received are recorded as reductions of principal. The average
recorded investment in impaired loans, and approximate interest income
recognized for such loans, were as follows for the years ended December 31
(amounts in thousands):
2003 2002 2001
------------ ------------ ------------
Average recorded investment
in impaired loans.................... $ 13,415 $ 13,135 $ 9,101
============ ============ ============
Interest income recognized
on impaired loans.................... $ 758 $ 658 $ 761
============ ============ ============
Average recorded investment
in impaired loans as a
percentage of average total loans.... 4.4% 4.0% 2.9%
============ ============ ============
Past Due, Nonaccrual and Restructured Loans. As of December 31, 2003 and 2002,
the Company had $38,000 and $5.1 million, respectively, of loans past due 90
days or more and still accruing interest. As of December 31, 2003 and 2002, the
Company had $7.9 and $2.5 million, respectively, of nonaccrual loans and no
restructured loans (included as impaired loans above). The following table
indicates the effect on income if interest on such loans outstanding at yearend
had been recognized at original contractual rates during the year ended December
31 (in thousands):
2003 2002 2001
------------ ----------- -------------
Interest income that would
have been recorded............... $ 121 $ 237 $ 87
Interest income recorded.......... 56 1 3
------------ ----------- -------------
Effect on interest income......... $ 65 $ 236 $ 84
============ =========== =============
As of December 31, 2003 the Company had no commitments to lend additional funds
to borrowers with loans whose terms had been modified in troubled debt
restructurings.
Loans to Related Parties. Note 22 to these consolidated financial statements
includes information relating to loans to executive officers, directors,
principal shareholders and associates of such persons.
Leases. The Company extends credit to borrowers under direct finance lease
obligations. The direct finance lease obligations are stated at their
outstanding principal amount net of unearned income and net unamortized deferred
fees and costs. At December 31, 2003 the total minimum annual lease payments for
direct finance lease obligations with remaining terms of greater than one year
were as follows (in thousands):
2004................................... $ 608
2005................................... 478
2006................................... 354
2007................................... 166
2008................................... --
Thereafter............................. --
----------------
Total future minimum lease payments.... 1,606
Unguaranteed residual values........... 525
----------------
Total all payments..................... 2,131
Unearned income........................ (248)
----------------
Net outstanding principal amount....... $ 1,883
================
The Company also extends financing to lease companies, securing the loan with an
assignment of lease payments and a security filing against the underlying asset
of the lease. These loans are classified above as lease financing but are not
direct finance lease obligations.
7. Allowance for Credit Losses:
Transactions in the allowance for credit losses were as follows for the years
ended December 31 (in thousands):
2003 2002 2001
------------- -------------- -------------
Balance, beginning of year...... $ 5,006 $ 4,325 $ 3,588
Provision for credit losses.. 1,475 1,202 1,699
Loans charged off............ (1,820) (657) (1,265)
Loans recovered.............. 102 136 303
------------- -------------- -------------
Balance, end of year........... $ 4,763 $ 5,006 $ 4,325
============= ============== =============
8. Premises and Equipment
Premises and equipment consisted of the following at December 31 (in thousands):
2003 2002
------------- -------------
Land and improvements............................ $ 3,142 $ 1,857
Buildings and improvements....................... 11,873 6,002
Leasehold improvements........................... 1,796 1,418
Furniture, fixtures and equipment................ 9,638 8,873
------------- -------------
Total cost.................................. 26,449 18,150
Less accumulated depreciation and
amortization.................................... (7,879) (7,050)
------------- -------------
Net premises, leasehold improvements
and equipment.............................. $ 18,570 $ 11,100
============= =============
Depreciation and amortization expense on premises and equipment charged to
continuing operations totaled approximately $1.5, $1.3 and $1.1 million for the
years ended December 31, 2003, 2002 and 2001, respectively.
9. Goodwill and Other Intangible Assets - Adoption of SFAS 142
Goodwill, representing the excess of the purchase price over the fair value of
net assets acquired, results from purchase acquisitions made by the Company. On
January 1, 2002, the Company adopted SFAS 142. Under SFAS 142, goodwill
associated with business combinations completed after June 30, 2001 is not
required to be amortized. During the transition period from July 1, 2001 through
December 31, 2001, all of the Company's goodwill associated with business
combinations completed prior to July 1, 2001 was amortized over 15 to 25 year
periods. Effective January 1, 2002, the Company discontinued all goodwill
amortization.
Since January 1, 2002, goodwill has been assessed for impairment at the
reporting unit and qualifying subsidiary levels by applying a fair-value-based
test at least annually or if impairment indicators are present. The Company has
$437,000 of unamortized goodwill related to five separate transactions completed
prior to July 1, 2001 and $14.7 million of goodwill related to transactions
completed during 2002 and 2003. Pursuant to SFAS 142, the Company completed its
annual goodwill impairment assessment during the second quarter of 2003 and
concluded that goodwill was not impaired as of June 30, 2003. No subsequent
events have occurred that would change the conclusion reached.
Core deposit intangibles are amortized based on a useful life of 10 years.
Insurance books of business intangibles are being amortized over their estimated
lives of 12.5 years for commercial lines and 9.8 years for personal lines for
the books of business acquired in the Milne Scali acquisition and 10 years for
the books of business acquired in the IASW acquisition. 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 years.
Adjusted Earnings - SFAS 142 Transitional Disclosure. Effective January 1, 2002,
the Company discontinued all goodwill amortization. The following tables
reconcile income from continuing operations, income before nonoperating item and
cumulative effect of change in accounting principle, net income and EPS,
adjusted to exclude amortization expense recognized in those periods related to
goodwill for the years ended December 31 (amounts are in thousands):
2003 2002 2001
-------------- ------------ -------------
Reported income from continuing operations..................... $ 3,844 $ 2,025 $ 1,695
Add back: goodwill amortization, net of income taxes........... -- -- 51
-------------- ------------ -------------
Adjusted income from continuing operations..................... $ 3,844 $ 2,025 $ 1,746
============== ============ =============
Reported income before nonoperating item and cumulative
effect of change in accounting principle................... $ 3,844 $ 2,039 $ 1,492
Add back: goodwill amortization, net of income taxes........... -- -- 51
-------------- ------------ -------------
Adjusted income before nonoperating item and cumulative
effect of change in accounting principle................... $ 3,844 $ 2,039 $ 1,543
============== ============ =============
Reported net income ........................................... $ 3,844 $ 2,039 $ 1,245
Add back: goodwill amortization, net of income taxes........... -- -- 51
-------------- ------------ -------------
Adjusted net income ........................................... $ 3,844 $ 2,039 $ 1,296
============== ============ =============
Basic earnings per common share:
Reported net income ........................................ $ 1.38 $ 0.75 $ 0.52
Goodwill amortization, net of income taxes................ -- -- 0.02
-------------- ------------ -------------
Adjusted net income ........................................... $ 1.38 $ 0.75 $ 0.54
============== ============ =============
Diluted earnings per common share:
Reported net income ........................................ $ 1.35 $ 0.75 $ 0.51
Goodwill amortization, net of income taxes................ -- -- 0.02
-------------- ------------ -------------
Adjusted net income ........................................... $ 1.35 $ 0.75 $ 0.53
============== ============ =============
Intangible Assets. The gross carrying amount of intangible assets and the
associated accumulated amortization at December 31, 2003 is presented in the
table below (in thousands):
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
------------ ------------ -------------
Intangible assets:
Core deposit intangibles........... $ 3,497 $ 2,934 $ 563
Insurance books of business
intangibles...................... 8,579 1,137 7,442
Other.............................. 874 506 368
------------ ------------ -------------
Total........................ $ 12,950 $ 4,577 $ 8,373
============ ============ =============
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 $1.1 million, $881,000 and
$482,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
The following table shows the estimated amortization expense, for the next five
years, for amortized intangible assets existing on the Company's books at
December 31, 2003 (in thousands). Projections of amortization expense are based
on existing asset balances as of December 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
--------------- ---------------- ------------ -------------
Year ended
December 31,
2004........... 350 722 48 1,120
2005........... 213 722 48 983
2006........... -- 722 -- 722
2007........... -- 722 -- 722
2008........... -- 722 -- 722
Goodwill. The following table shows the change in goodwill, by reporting
segment, between January 1, 2003 and December 31, 2003 (in thousands):
Segment
-----------------------------------------------------------------
Banking Insurance Other Total
------------- -------------- ------------- -------------
Balance, January 1, 2003.............................. $ 212 $ 11,821 $ 177 $ 12,210
Goodwill attributable to purchase acquisition......... -- 663 -- 663
Goodwill attributable to earnout payment.............. -- 2,315 -- 2,315
Other................................................. -- (99) -- (99)
------------- -------------- ------------- -------------
Balance, December 31, 2003............................ $ 212 $ 14,700 $ 177 $ 15,089
============= ============== ============= =============
10. Deposits:
The scheduled maturities of time deposits as of December 31, 2003 are as follows
(in thousands):
2004........................... $ 101,567
2005........................... 23,553
2006........................... 6,007
2007........................... 2,739
2008........................... 1,200
Thereafter..................... 626
----------------
$ 135,692
================
At December 31, 2003 and 2002, the Bank had $12.9 and $27.3 million,
respectively, of time deposits that had been acquired in the national market and
$18.6 and $31.4 million, respectively, of time deposits that had been acquired
through a broker.
At December 31, 2003 collateralized mortgage obligations and state and municipal
bonds with an amortized cost of approximately $18.8 million were pledged as
collateral for certain deposits and $7.9 million of bank depository guaranty
bonds from a bankers surety company were pledged as additional collateral on
Bank deposits.
Deposits Received from Related Parties. Note 22 to these consolidated financial
statements includes information relating to deposits received from executive
officers, directors, principal shareholders and associates of such persons.
11. Short-Term Borrowings:
The following table sets forth selected information for short-term borrowings
(borrowings with an original maturity of less than one year) as of December 31
(in thousands):
2003 2002
------------- -------------
Federal funds purchased and
U. S. Treasury tax and loan
note option accounts (1).................. $ 17,114 $ 15,000
Repurchase agreements with customers,
renewable daily, interest payable
monthly, rates at 1.50%, secured
by government agency collateralized
mortgage obligations (1).................. 14,269 13,120
------------- -------------
$ 31,383 $ 28,120
============= =============
(1) The weighted average interest rate on short-term borrowings outstanding as
of December 31, 2003 and 2002 was 1.41% and 1.48%, respectively.
Customer repurchase agreements are used by the Bank to acquire funds from
customers where the customers are required or desire to have their funds
supported by collateral consisting of government, government agency or other
types of securities. The repurchase agreement is a promise to sell these
securities to a customer at a certain price and repurchase them at a future date
at that same price plus interest accrued at an agreed upon rate. The Bank uses
customer repurchase agreements in its liquidity plan as well as an accommodation
to customers. At December 31, 2003, $14.3 million of securities sold under
repurchase agreements, with a weighted average interest rate of 1.75%, maturing
in 2004, were collateralized by government agency collateralized mortgage
obligations having a carrying value of $25.4 million, a market value of $25.4
million and unamortized principal balances of $25.4 million.
The Company had established two additional revolving lines of credit with banks,
totaling $16.5 million. At December 31, 2003, the Company had drawn $2.5 million
on one of these lines leaving $14.0 million available under these revolving
lines of credit. The lines, if drawn upon, mature daily with interest rates that
float at the Federal funds rate.
12. Federal Home Loan Bank Advances:
FHLB advances consisted of the following at December 31 (amounts are in
thousands):
2003 2002
---------------------------- ------------------------------
Weighted Weighted
Year of Maturity Amount Average Rate Amount Average Rate
------------- -------------- -------------- --------------
2003.......... $ -- -- $ 15,000 4.56%
2004.......... 15,000 4.77% 15,000 4.77
2005.......... 15,000 2.30 5,000 3.84
2006.......... 20,000 2.06 -- --
2009.......... 10,000 5.64 10,000 5.64
2010.......... 52,200 6.09 52,200 6.09
------------- -------------- -------------- --------------
$ 112,200 4.65% $ 97,200 5.49%
============= ============== ============== ==============
Some of the advances listed above have call provisions that allow the FHLB to
request that the advance be paid back or refinanced at the rates then being
offered by the FHLB. As of December 31, 2003, the Company had $62.2 million of
callable FHLB advances all callable quarterly during the first quarter of 2004.
At December 31, 2003, the advances from the FHLB were collateralized by the
Bank's mortgage loans with unamortized principal balances of approximately $53.9
million resulting in a FHLB collateral equivalent of $32.9 million. In addition,
the advances from the FHLB were collateralized by securities with unamortized
principal balances of approximately $176.7 million. The Bank has the ability to
draw additional advances of $83.1 million based upon the mortgage loans and
securities that are currently pledged, subject to a requirement to purchase
additional FHLB stock.
13. Long Term Borrowings:
The following table sets forth selected information for long-term borrowings
(borrowings with an original maturity of greater than one year) as of December
31 (in thousands):
2003 2002
------------ ------------
Note payable to the Bank of North Dakota,
principal due April 1, 2004, interest
payable quarterly at 30-day LIBOR plus
3.20%, secured by the stock of
BNC National Bank ......................... $ 8,500 $ 8,500
Other ....................................... 140 61
------------ ------------
$ 8,640 $ 8,561
============ ============
The $8.5 million loan from the Bank of North Dakota includes various covenants
that are primarily operational rather than financial in nature. As of December
31, 2003, the Company was in compliance with these covenants.
At December 31, 2000, BNCCORP had outstanding $12.6 million of subordinated
notes. The 8 5/8 percent Subordinated Notes (the "Notes"), which qualified as
Tier 2 capital up to a certain limit under the Federal Reserve Board's
risk-based capital guidelines (60 percent at December 31, 2000), were considered
unsecured general obligations of BNCCORP. They were redeemable, at the option of
BNCCORP, at par plus accrued interest to the date of redemption. Payment of
principal of the Notes could be accelerated only in the case of certain events
relating to bankruptcy, insolvency or reorganization of BNCCORP. An initial
discount of $750,000 was being amortized to interest expense over the term of
the Notes using the effective interest rate method.
During 2001, BNCCORP purchased and retired $82,000 of the Notes at a discount
using cash generated from the sale of its asset-based lending subsidiary, BNC
Financial Corporation, Inc. On August 31, 2001, the Company redeemed the
remaining $12.6 million of the Notes at par through exercise of the option of
BNCCORP discussed above. The remaining $12.6 million of the Notes were redeemed
using a portion of the cash generated from issuing subordinated debentures
through the establishment of BNC Statutory Trust II (see Note 14 to these
consolidated financial statements). The transactions and redemption of the Notes
resulted in a nonoperating loss of $134,000 ($0.06 per diluted share), net of
income taxes of ($70,000).
14. Guaranteed Preferred Beneficial Interests in Company's Subordinated
Debentures:
In July 2001, BNCCORP established a special purpose trust, BNC Statutory Trust
II, for the purpose of issuing $15.0 million of floating rate trust preferred
securities. The floating rate trust preferred securities were issued at an
initial rate of 7.29 percent and adjust quarterly to a rate equal to three-month
LIBOR plus 3.58 percent. The interest rate at December 31, 2003 was 4.74
percent. Prior to July 31, 2011, the rate shall not exceed 12.5 percent. The
proceeds from the issuance, together with the proceeds of the related issuance
of $464,000 of common securities of the trust, were invested in $15.5 million of
junior subordinated deferrable interest debentures of BNCCORP. The floating rate
junior subordinated deferrable interest debentures were issued at an initial
rate of 7.29 percent and adjust quarterly to a rate equal to three-month LIBOR
plus 3.58 percent. The interest rate at December 31, 2003 was 4.74 percent.
Prior to July 31, 2011, the rate shall not exceed 12.5 percent. Concurrent with
the issuance of the preferred securities by the trust, BNCCORP fully and
unconditionally guaranteed all obligations of the special purpose trust related
to the trust preferred securities. The trust preferred securities provide
BNCCORP with a more cost-effective means of obtaining Tier 1 capital for
regulatory purposes than if BNCCORP itself were to issue preferred stock because
BNCCORP is allowed to deduct, for income tax purposes, amounts paid in respect
of the debentures and ultimately distributed to the holders of the trust
preferred securities. The sole assets of the special purpose trust are the
debentures. BNCCORP owns all of the common securities of the trust. The common
securities and debentures, along with the related income effects, are eliminated
within the consolidated financial statements. The preferred securities issued by
the trust rank senior to the common securities. For presentation in the
consolidated balance sheet, the securities are shown net of discount and direct
issuance costs.
The trust preferred securities are subject to mandatory redemption on July 31,
2031, the stated maturity date of the debentures, or upon repayment of the
debentures, or earlier, pursuant to the terms of the trust agreement. On or
after July 31, 2006, the trust preferred securities may be redeemed and the
corresponding debentures may be prepaid at the option of BNCCORP, subject to
Federal Reserve Board approval, at declining redemption prices. Prior to July
31, 2006, the securities may be redeemed at the option of BNCCORP on the
occurrence of certain events that result in a negative tax impact, negative
regulatory impact on the trust preferred securities or negative legal or
regulatory impact on the special purpose trust which would cause it to be deemed
to be an "investment company" for regulatory purposes. In addition, BNCCORP has
the right to defer payment of interest on the debentures and, therefore,
distributions on the trust preferred securities for up to five years.
In July 2000, BNCCORP established a special purpose trust, BNC Capital Trust I,
for the purpose of issuing $7.5 million of 12.045 percent trust preferred
securities. The proceeds from the issuance, together with the proceeds of the
related issuance of $232,000 of 12.045 percent common securities of the trust,
were invested in $7.7 million of 12.045 percent junior subordinated deferrable
interest debentures of BNCCORP. Concurrent with the issuance of the preferred
securities by the trust, BNCCORP fully and unconditionally guaranteed all
obligations of the special purpose trust related to the trust preferred
securities. The trust preferred securities provide BNCCORP with a more
cost-effective means of obtaining Tier 1 capital for regulatory purposes than if
BNCCORP itself were to issue preferred stock because BNCCORP is allowed to
deduct, for income tax purposes, amounts paid in respect of the debentures and
ultimately distributed to the holders of the trust preferred securities. The
sole assets of the special purpose trust are the debentures. BNCCORP owns all of
the common securities of the trust. The common securities and debentures, along
with the related income effects, are eliminated within the consolidated
financial statements. The preferred securities issued by the trust rank senior
to the common securities. For presentation in the consolidated balance sheet,
the securities are shown net of discount and direct issuance costs.
The trust preferred securities are subject to mandatory redemption on July 19,
2030, the stated maturity date of the debentures, or upon repayment of the
debentures, or earlier, pursuant to the terms of the trust agreement. On or
after July 19, 2010, the trust preferred securities may be redeemed and the
corresponding debentures may be prepaid at the option of BNCCORP, subject to
Federal Reserve Board approval, at declining redemption prices. Prior to July
19, 2010, the securities may be redeemed at the option of BNCCORP on the
occurrence of certain events that result in a negative tax impact, negative
regulatory impact on the trust preferred securities or negative legal or
regulatory impact on the special purpose trust which would cause it to be deemed
to be an "investment company" for regulatory purposes. In addition, BNCCORP has
the right to defer payment of interest on the debentures and, therefore,
distributions on the trust preferred securities for up to five years.
Pursuant to SFAS 150 and FIN 46, the subordinated debentures are now presented
as debt in the consolidated financial statements. Previously they were presented
between the liabilities and equity sections of the balance sheets. Prior periods
have been reclassified to reflect the adoption of these accounting
pronouncements. The subordinated debentures qualify as Tier 1 capital for
regulatory capital purposes, up to a certain allowed amount. Any excess over the
amount allowed in Tier 1 capital can be included in Tier 2 capital, up to
certain allowed amounts. (See Note 18 for further discussion of the impact of
the subordinated debentures on the Company's consolidated regulatory capital
calculations).
15. Stockholders' Equity:
BNCCORP and the Bank are subject to certain minimum capital requirements (see
Note 18 to these consolidated financial statements). BNCCORP is also subject to
certain restrictions on the amount of dividends it may declare without prior
regulatory approval in accordance with the Federal Reserve Act. In addition,
certain regulatory restrictions exist regarding the ability of the Bank to
transfer funds to BNCCORP in the form of cash dividends. Approval of the Office
of the Comptroller of the Currency ("OCC"), the Bank's principal regulator, is
required for the Bank to pay dividends to BNCCORP in excess of the Bank's net
profits from the current year plus retained net profits for the preceding two
years. At December 31, 2003 approximately $12.3 million of retained earnings
were available for bank dividend declaration without prior regulatory approval.
Pursuant to an Asset Purchase and Sale Agreement executed on December 1, 2003,
on January 5, 2004, BNCCORP issued 2,888 shares of its common stock to Lynk in
connection with the Bank's acquisition of certain assets of Lynk. Note 2 to
these consolidated financial statements includes additional information related
to the acquisition of the assets.
Pursuant to an Asset Purchase and Sale Agreement, on December 31, 2003, BNCCORP
issued 12,701 shares of its common stock to IASW in connection with Milne
Scali's acquisition of certain assets of IASW. Note 2 to these consolidated
financial statements includes additional information related to the acquisition
of the assets.
Pursuant to a Stock Purchase Agreement (the "Agreement"), in April 2002, BNCCORP
issued 297,759 shares of its common stock to Richard W. Milne, Jr., Terrence M.
Scali, and the other sellers named in the Agreement in connection with the
Company's acquisition of Milne Scali. Note 2 to these consolidated financial
statements includes additional information related to the acquisition of Milne
Scali.
On May 3, 2002, BNCCORP issued 150 shares of its noncumulative preferred stock
to Richard W. Milne, Jr. and Terrence M. Scali for cash. Each share has a
preferential noncumulative dividend at an annual rate of 8.00 percent and a
preferred liquidation value of $10,000 per share. The noncumulative preferred
stock is not redeemable by BNCCORP and carries no conversion rights. The
proceeds of the issuance were used for general corporate purposes.
On May 30, 2001, BNCCORP's Board of Directors (the "Board") adopted a rights
plan intended to protect stockholder interests in the event BNCCORP becomes the
subject of a takeover initiative that BNCCORP's Board believes could deny
BNCCORP's stockholders the full value of their investment. This plan does not
prohibit the Board from considering any offer that it deems advantageous to its
stockholders. BNCCORP has no knowledge that anyone is considering a takeover.
The rights were issued to each common stockholder of record on May 30, 2001, and
they will be exercisable only if a person acquires, or announces a tender offer
that would result in ownership of, 15 percent or more of BNCCORP's outstanding
common stock. The rights will expire on May 30, 2011, unless redeemed or
exchanged at an earlier date.
Each right entitles the registered holder to purchase from BNCCORP one
one-hundredth of a share of Series A Participating Cumulative Preferred Stock,
$.01 par value (the "Preferred Stock"), of BNCCORP at a price of $100 per one
one-hundredth of a share, subject to adjustment. Each share of Preferred Stock
will be entitled to a minimum preferential quarterly dividend payment of $1.00
but will be entitled to an aggregate dividend of 100 times the dividend declared
per share of common stock. In the event of liquidation, the holders of the
Preferred Stock will be entitled to a minimum preferential liquidation payment
of $0.01 per share but will be entitled to an aggregate payment of 100 times the
payment made per share of common stock. Each share of Preferred Stock will have
100 votes, voting together with the common stock. Finally, in the event of any
merger, consolidation or other transaction in which common stock is exchanged,
each share of Preferred Stock will be entitled to receive 100 times the amount
received per share of common stock. Because of the nature of the Preferred
Stock's dividend, liquidation and voting rights, the value of the one
one-hundredth of a share of Preferred Stock purchasable upon exercise of each
right should approximate the value of one share of common stock.
16. Segment Disclosures:
The Company segments its operations into three separate business activities,
based on the nature of the products and services for each segment: banking
operations, insurance operations and brokerage, trust and financial services
operations.
Banking operations provide traditional banking services to individuals and
small- and mid-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 provide a full range of insurance brokerage services
including commercial insurance, surety bonds, employee benefits-related
insurance, personal insurance and claims management.
Brokerage, trust and financial services operations provide securities brokerage,
trust and other financial services to individuals and businesses. Brokerage
investment options include individual equities, fixed income investments and
mutual funds. Trust and financial services operations provide a wide array of
trust and other financial services including employee benefit and personal trust
administration services, financial, tax, business and estate planning, estate
administration, agency accounts, employee benefit plan design and
administration, individual retirement accounts ("IRAs"), including custodial
self-directed IRAs, asset management, tax preparation, accounting and payroll
services.
The accounting policies of the three segments are the same as those described in
the summary of significant accounting policies included in Note 1 to these
consolidated financial statements.
The Company's financial information for each segment is derived from the
internal profitability reporting system used by management to monitor and manage
the financial performance of the Company. The operating segments have been
determined by how executive management has organized the Company's business for
making operating decisions and assessing performance.
The following tables present segment profit or loss, assets and a reconciliation
of segment information as of, and for the years ended December 31 (in
thousands):
2003 2003
-------------------------------------------------------- --------------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other (a) Totals Segments Other (a) Elimination Total
---------- ---------- ---------- --------- -------- ---------- --------- ------------- ------------
Net interest income.....$ 15,378 $ 69 $ -- $ (2,121) $ 13,326 $ 15,447 $ (2,121) $ 52 $ 13,378
Other revenue-external
customers.............. 6,189 14,712 1,457 118 22,476 22,358 118 (1,664) 20,812
Other revenue-from
other segments......... 124 -- 64 651 839 188 651 (839) --
Depreciation and
amortization........... 1,629 865 12 15 2,521 2,506 15 -- 2,521
Equity in the net
income of investees.... 2,208 -- -- 5,325 7,533 2,208 5,325 (7,533) --
Other significant
noncash items:
Provision for
credit losses........ 1,475 -- -- -- 1,475 1,475 -- -- 1,475
Segment profit (loss)
from continuing
operations............ 3,787 3,709 372 (2,443) 5,425 7,868 (2,443) -- 5,425
Income tax provision
(benefit)............. 960 1,438 144 (961) 1,581 2,542 (961) -- 1,581
Segment profit (loss)... 2,827 2,271 228 (1,482) 3,844 5,326 (1,482) -- 3,844
Segment assets.......... 616,998 30,063 1,180 71,225 719,466 648,241 71,225 (97,989) 621,477
- ---------------------------------
(a) The financial information in the "other" column is for the bank holding
company.
2002 2002
-------------------------------------------------------- --------------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other (a) Totals Segments Other (a) Elimination Total
---------- ---------- ---------- --------- --------- ---------- --------- ------------- ------------
Net interest income......$ 15,089 $ 41 $ -- $ (3,931) $ 11,199 $ 15,130 $ (3,931) $ 1,883 $ 13,082
Other revenue-external
customers.............. 6,272 9,191 1,934 115 17,512 17,397 115 (1,216) 16,296
Other revenue-from other
segments............... 99 -- 55 648 802 154 648 (802) --
Depreciation and
amortization........... 1,518 633 33 17 2,201 2,184 17 -- 2,201
Equity in the net
income of investees.... 639 -- -- 3,620 4,259 639 3,620 (4,259) --
Other significant
noncash items:
Provision for credit
losses................. 1,202 -- -- -- 1,202 1,202 -- -- 1,202
Segment profit (loss)
from continuing
operations............. 4,502 1,461 (677) (2,439) 2,847 5,286 (2,439) -- 2,847
Income tax provision
(benefit).............. 1,505 430 (255) (858) 822 1,680 (858) -- 822
Income from discontinued
Fargo branch, net of
income taxes........... 49 -- -- -- 49 49 -- -- 49
Loss on sale of
discontinued Fargo
branch, net of income
taxes.................. (35) -- -- -- (35) (35) -- -- (35)
Segment profit (loss).... 3,011 1,031 (422) (1,581) 2,039 3,620 (1,581) -- 2,039
Segment assets........... 599,415 26,364 1,307 66,931 694,017 627,086 66,931 (91,789) 602,228
- --------------------------
(a) The financial information in the "other" column is for the bank holding
company.
2001 2001
-------------------------------------------------------- --------------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other (a) Totals Segments Other (a) Elimination Total
---------- ---------- ---------- --------- -------- ---------- --------- ------------- ------------
Net interest income......$ 15,380 $ 18 $ -- $ (3,262) $ 12,136 $ 15,398 $ (3,262) $ 1,417 $ 13,533
Other revenue-external
customers............... 5,204 1,952 2,176 70 9,402 9,332 70 (688) 8,714
Other revenue-from
other segments.......... 62 -- 69 703 834 131 703 (834) --
Depreciation and
amortization............ 1,368 96 84 57 1,605 1,548 57 -- 1,605
Equity in the net
income (loss)
of investees............ (384) -- -- 2,820 2,436 (384) 2,820 (2,436) --
Other significant
noncash items:
Provision for
credit losses......... 1,699 -- -- -- 1,699 1,699 -- -- 1,699
Segment profit (loss)
from continuing
operations............. 5,032 140 (655) (2,131) 2,386 4,517 (2,131) -- 2,386
Income tax provision
(benefit).............. 1,757 (9) (367) (690) 691 1,381 (690) -- 691
Loss from discontinued
Fargo branch, net
of income taxes........ (203) -- -- -- (203) (203) -- -- (203)
Nonoperating item -
loss on early
extinguishment of
debt, net of income
taxes.................. -- -- -- (134) (134) -- (134) -- (134)
Cumulative effect of
change in accounting
principle, net of
income taxes.......... (113) -- -- -- (113) (113) -- -- (113)
Segment profit (loss).... 2,959 149 (288) (1,575) 1,245 2,820 (1,575) -- 1,245
Segment assets, from
continuing operations.. 558,175 2,026 1,976 52,475 614,652 562,177 52,475 (58,685) 555,967
Segment assets........... 587,265 2,026 1,976 52,475 643,742 591,267 52,475 (58,685) 585,057
- ----------------------------------
(a) The financial information in the "Other" column is for the bank holding
company.
17. Derivatives:
On January 1, 2001, the Company had an interest rate floor contract that
qualified as a cash flow hedge of interest rate risk associated with floating
rate commercial loans. As a result of the adoption of SFAS 133, the Company
recognized this derivative instrument at its fair value and recorded a charge to
earnings of $113,000, net of taxes, for the derivative instrument's loss
excluded from the assessment of hedge effectiveness. This amount is presented as
the cumulative effect of a change in accounting principle for the year ended
December 31, 2001. During 2001, the Company recognized in interest income
$256,000 for the derivative instrument's gain and a loss of $(109,000) was
reclassified into interest income as a result of the discontinuance of its cash
flow hedge.
During May and June 2001, the Company purchased, for $1.2 million, interest rate
cap contracts with notional amounts totaling $40.0 million to mitigate interest
rate risk in rising-rate scenarios. The referenced interest rate is three-month
LIBOR with $20.0 million of 4.50 percent contracts having three-year original
maturities and $20.0 million of 5.50 percent contracts having five-year original
maturities. The contracts, classified as other assets, are reflected in the
Company's December 31, 2003 consolidated balance sheet at their then combined
fair value of $56,000. The contracts are not being accounted for as hedges under
SFAS 133. As a result, the impact of marking the contracts to fair value has
been, and will continue to be, included in net interest income. During the years
ended December 31, 2003, 2002 and 2001, the impact of marking the contracts to
market (reflected as an increase in interest expense) was $80,000, $779,000 and
$331,000, respectively.
18. Regulatory Capital:
BNCCORP and the Bank are subject to various regulatory capital requirements
administered by the Federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial results. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, BNCCORP
and the Bank must meet specific capital guidelines that involve quantitative
measures of their assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. Capital amounts and
classifications of BNCCORP and the Bank are also subject to qualitative
judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by the regulations to ensure capital adequacy
require BNCCORP and the Bank to maintain minimum amounts and ratios (set forth
in the tables that follow) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as
defined) to average assets (as defined). Management believes that, as of
December 31, 2003, BNCCORP and the Bank met all capital adequacy requirements to
which they are subject.
Under current regulatory capital regulations, BNCCORP's subordinated debentures
qualify as Tier 1 capital for purposes of the consolidated capital calculations
up to 25 percent of Tier 1 capital prior to the deduction of intangible assets.
The remainder of the subordinated debentures qualify as Tier 2 capital provided
that the total of Tier 2 capital does not exceed Tier 1 capital. As of December
31, 2003, $13.1 million of the subordinated debentures qualified as Tier 1
capital with the remaining $9.3 million qualifying as Tier 2 capital. As of
December 31, 2002, $11.7 million of the subordinated debentures qualified as
Tier 1 capital with the remaining $10.6 million qualifying as Tier 2 capital.
These amounts are reflected in the consolidated capital amounts presented in the
table below.
As of December 31, 2003, the most recent notifications from the OCC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must maintain
minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set
forth in the table that follows. There are no conditions or events since that
notification that management believes have changed the institution's category.
Actual capital amounts and ratios of BNCCORP and the Bank as of December 31 are
also presented in the tables (amounts are in thousands):
To be Well Capitalized Under
For Capital Adequacy Prompt Corrective Action
Actual Purposes Provisions
------------------------ ------------------------- ------------------------------
Amount Ratio Amount Ratio Amount Ratio
------------- --------- ------------ ---------- ------------ ---------------
2003
Total Capital (to risk-weighted assets):
Consolidated......................... $ 42,905 10.63 % $ 32,296 8.0 % N/A N/A
BNC National Bank.................... 48,074 11.92 32,260 8.0 $ 40,325 10.0 %
Tier 1 Capital (to risk-weighted assets):
Consolidated......................... 28,815 7.14 16,148 4.0 N/A N/A
BNC National Bank.................... 43,311 10.74 16,130 4.0 24,195 6.0
Tier 1 Capital (to average assets):
Consolidated......................... 28,815 4.90 23,545 4.0 N/A N/A
BNC National Bank.................... 43,311 7.37 23,522 4.0 29,403 5.0
2002
Total Capital (to risk-weighted assets):
Consolidated......................... $ 41,270 9.53 % $ 34,641 8.0 % N/A N/A
BNC National Bank.................... 45,142 10.45 34,562 8.0 $ 43,202 10.0 %
Tier 1 Capital (to risk-weighted assets):
Consolidated......................... 25,613 5.92 17,321 4.0 N/A N/A
BNC National Bank.................... 40,137 9.29 17,281 4.0 25,921 6.0
Tier 1 Capital (to average assets):
Consolidated......................... 25,613 4.46 22,948 4.0 N/A N/A
BNC National Bank.................... 40,137 7.00 22,923 4.0 28,654 5.0
19. Fair Value of Financial Instruments:
The estimated fair values of the Company's financial instruments are as follows
as of December 31 (in thousands):
2003 2002
--------------------------------- --------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------------- --------------- ---------------- ---------------
Assets:
Cash and due from banks......................... $ 12,520 $ 12,520 $ 17,137 $ 17,137
Investment securities available
for sale..................................... 262,568 262,568 208,072 208,072
Federal Reserve Bank and Federal Home
Loan Bank stock.............................. 7,596 7,596 7,071 7,071
Loans and leases, net........................... 278,792 277,548 330,788 331,034
Accrued interest receivable..................... 2,462 2,462 2,856 2,856
Derivative financial instruments................ 56 56 136 136
---------------- --------------- --------------- ----------------
563,994 $ 562,750 566,060 $ 566,306
=============== ===============
Other assets.................................... 57,483 36,168
---------------- ----------------
$ 621,477 $ 602,228
================ ================
Liabilities and Stockholders' Equity:
Deposits, noninterest-bearing................... $ 44,725 $ 44,725 $ 44,362 $ 44,362
Deposits, interest-bearing...................... 351,217 352,771 353,883 356,736
Borrowings and advances......................... 152,223 158,439 133,881 142,393
Accrued interest payable........................ 1,183 1,183 1,608 1,608
Guaranteed preferred beneficial interests in
Company's subordinated debentures........... 22,397 23,795 22,326 23,926
---------------- --------------- ---------------- ---------------
571,745 $ 580,913 556,060 $ 569,025
=============== ===============
Other liabilities............................... 9,546 8,445
Stockholders' equity............................ 40,186 37,723
---------------- ----------------
$ 621,477 $ 602,228
================ ================
Financial instruments with off-balance-sheet risk:
Commitments to extend credit.................. $ 155 $ 351
Standby and commercial letters of credit ..... 106 89
--------------- ---------------
$ 261 $ 440
=============== ===============
20. Financial Instruments With Off-Balance-Sheet Risk:
In the normal course of business, the Company is a party to various financial
instruments with off-balance-sheet risk, primarily to meet the needs of its
customers as well as to manage its interest rate risk. These instruments, which
are issued by the Company for purposes other than trading, carry varying degrees
of credit, interest rate or liquidity risk in excess of the amount reflected in
the consolidated balance sheets.
Commitments to Extend Credit. Commitments to extend credit are agreements to
lend to a customer provided there is no violation of any condition in the
contract. Commitments to extend credit are legally binding and generally have
fixed expiration dates or other termination clauses and may require payment of a
fee. The contractual amount represents the Company's exposure to credit loss in
the event of default by the borrower; however, at December 31, 2003, based on
current information, no losses were anticipated as a result of these
commitments. The Company manages this credit risk by using the same credit
policies it applies to loans. Collateral is obtained to secure commitments based
on management's credit assessment of the borrower. The collateral may include
marketable securities, receivables, inventory, equipment and real estate. Since
the Company expects many of the commitments to expire without being drawn, total
commitment amounts do not necessarily represent the Company's future liquidity
requirements related to such commitments.
Standby and Commercial Letters of Credit. Standby letters of credit are
conditional commitments issued by the Company to guarantee the performance of a
customer to a third party. Commercial letters of credit are issued on behalf of
customers to ensure payment or collection in connection with trade transactions.
In the event of a customer's nonperformance, the Company's credit loss exposure
is the same as in any extension of credit, up to the letter's contractual
amount; however, at December 31, 2003, based on current information, no losses
were anticipated as a result of these commitments. Management assesses the
borrower's credit to determine the necessary collateral, which may include
marketable securities, real estate, accounts receivable and inventory. Since the
conditions requiring the Company to fund letters of credit may not occur, the
Company expects its liquidity requirements related to such letters of credit to
be less than the total outstanding commitments.
The contractual amounts of these financial instruments were as follows as of
December 31 (in thousands):
2003 2002
--------------------------------- ---------------------------------
Fixed Rate Variable Rate Fixed Rate Variable Rate
--------------- -------------- -------------- ---------------
Commitments to extend credit............. $ 6,547 $ 87,590 $ 11,322 $ 91,694
Standby and commercial letters of credit. 833 9,726 188 8,730
Interest Rate Swaps, Caps and Floors. Interest rate swaps are contracts to
exchange fixed and floating rate interest payment obligations based on a
notional principal amount. The Company enters into swaps to hedge its balance
sheet against fluctuations in interest rates. Interest rate caps and floors are
used to protect the Company's balance sheet from unfavorable movements in
interest rates while allowing benefit from favorable movements. The credit risk
related to interest rate contracts is that counterparties may be unable to meet
the contractual terms of the agreements. This risk is estimated by calculating
the present value of the cost to replace outstanding contracts in a gain
position at current market rates, reported on a net basis by counterparties. The
Company manages the credit risk of its interest rate contracts through bilateral
collateral agreements, credit approvals, limits and monitoring procedures.
Additionally, the Company reduces the assumed counterparty credit risk through
master netting agreements that permit the Company to settle interest rate
contracts with the same counterparty on a net basis.
The notional amounts of these financial instruments were as follows as of
December 31 (in thousands):
2003 2002
-------------- --------------
Interest rate caps............. $ 40,000 $ 40,000
21. Guarantees
As of December 31, 2003, the Company had entered into the following guarantee
arrangements:
Contingent Consideration in Business Combination. Pursuant to the terms of the
agreement related to the acquisition of Milne Scali in April 2002, additional
consideration of up to $6.2 million may be payable to the former shareholders of
Milne Scali, subject to Milne Scali achieving certain financial performance
targets. In accordance with SFAS 141, there is no current carrying amount
associated with this guarantee. Additionally, there are no recourse provisions
associated with this guarantee that would enable the Company to recover from
third parties any of the amounts paid under the guarantee and there are no
assets held either as collateral or by third parties that, upon the occurrence
of any triggering event or condition under the guarantee, the Company could
obtain and liquidate to recover all or a portion of the amounts paid under the
guarantee.
Contingent Consideration in a Purchase Acquisition. Pursuant to the terms of the
agreement related to the IASW asset acquisition in December 2003, additional
consideration of up to $480,000 may be payable to IASW, subject to the operation
of the acquired assets achieving certain financial performance targets. In
accordance with SFAS 141, there is no current carrying amount associated with
this guarantee. Additionally, there are no recourse provisions associated with
this guarantee that would enable the Company to recover from third parties any
of the amounts paid under the guarantee and there are no assets held either as
collateral or by third parties that, upon the occurrence of any triggering event
or condition under the guarantee, the Company could obtain and liquidate to
recover all of a portion of the amounts paid under the guarantee.
Guaranteed Preferred Beneficial Interests in Company's Subordinated Debentures.
BNCCORP, concurrent with the issuance of preferred securities in July 2000 by
BNC Capital Trust I and in July 2001 by BNC Statutory Trust II, fully and
unconditionally guaranteed all obligations of the special purpose trusts related
to the trust preferred securities (See Note 14 for a full description of the
nature of the established trusts and the securities issued by the trusts). There
are no recourse provisions associated with these guarantees that would enable
BNCCORP to recover from third parties any of the amounts paid under the
guarantees and there are no assets held either as collateral or by third parties
that, upon the occurrence of any triggering event or condition under the
guarantees, BNCCORP could obtain and liquidate to recover all or a portion of
the amounts paid under the guarantees.
Performance Standby Letters of Credit. As of December 31, 2003 and 2002, the
Bank had outstanding $641,000 and $642,000, respectively of performance standby
letters of credit. Performance standby letters of credit are irrevocable
obligations to the beneficiary on the part of the Bank to make payment on
account of any default by the account party in the performance of a nonfinancial
or commercial obligation. Under these arrangements, the Bank could, in the event
of the account party's nonperformance, be required to pay a maximum of the
amount of issued letters of credit. Under the agreements, the Bank has recourse
against the account party up to and including the amount of the performance
standby letter of credit. The Bank evaluates each account party's
creditworthiness on a case-by-case basis and the amount of collateral obtained
varies and is based on management's credit evaluation of the account party. As
of December 31, 2002, under accounting standards then effective, there was no
carrying amount associated with these guarantees. Effective January 1, 2003,
such guarantees are required to be recognized as liabilities at their fair
values as they are modified or entered into, in accordance with FIN 45.
Financial Standby Letters of Credit. As of December 31, 2003 and 2002, the Bank
had outstanding $43.8 and $7.9 million of financial standby letters of credit.
Of the $43.8 million of financial standby letters of credit outstanding at
December 31, 2003, $34.1 million was participated to other financial
institutions. Financial standby letters of credit are irrevocable obligations to
the beneficiary on the part of the Bank to repay money borrowed by or advanced
to or for the account of the account party or to make payment on account of any
indebtedness undertaken by the account party, in the event that the account
party fails to fulfill its obligation to the beneficiary. Under these
arrangements, the Bank could, in the event of the account party's
nonperformance, be required to pay a maximum of the amount of issued letters of
credit. Under the agreements, the Bank has recourse against the account party up
to and including the amount of the financial standby letter of credit. The Bank
evaluates each account party's creditworthiness on a case-by-case basis and the
amount of collateral obtained varies and is based on management's credit
evaluation of the account party. As of December 31, 2002, under accounting
standards then effective, there was no carrying amount associated with these
guarantees. Effective January 1, 2003, such guarantees are required to be
recognized as liabilities at their fair values as they are modified or entered
into, in accordance with FIN 45.
Between January 1, 2003 and December 31, 2003, the Bank originated performance
and financial standby letters of credit totaling $146.9 million. Of that amount,
$107.5 million was participated to other financial institutions. The balance of
performance and financial standby letters of credit outstanding on the Bank's
books as of December 31, 2003 was $10.3 million. These outstanding guarantees
were recognized as liabilities on the Bank's balance sheet at their current
estimated combined fair value of approximately $99,000.
22. Related-Party/Affiliate Transactions:
The Bank has entered into transactions with related parties, such as opening
deposit accounts for and extending credit to, employees of the Company. In the
opinion of management, such transactions have been fair and reasonable to the
Bank and have been entered into under terms and conditions substantially the
same as those offered by the Bank to unrelated parties.
In the normal course of business, loans are granted to, and deposits are
received from, executive officers, directors, principal stockholders and
associates of such persons. The aggregate dollar amount of these loans,
exclusive of loans to any such persons which in the aggregate did not exceed
$60,000, were $1.1 and $1.0 million at December 31, 2003 and 2002, respectively.
During 2003, $620,000 of new loans were made and repayments totaled $434,000.
The total amount of deposits received from these parties was $6.5 and $3.1
million at December 31, 2003 and 2002, respectively. Loans to, and deposits
received from, these parties were made on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with unrelated persons and do not involve more than the
normal risk of collection.
On May 3, 2002, BNCCORP issued 150 shares of its noncumulative preferred stock
to Richard W. Milne, Jr. and Terrence M. Scali, executive officers of the
Company, for cash. Each share has a preferential noncumulative dividend at an
annual rate of 8.00 percent and a preferred liquidation value of $10,000 per
share. The noncumulative preferred stock is not redeemable by BNCCORP and
carries no conversion rights.
During the first quarter of 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, which was funded through cash
generated from operations. An independent party completed the appraisal.
In October 2003, BNC Insurance, Inc. ("BNC Insurance") purchased from Milne
Scali Properties LLC, an Arizona limited liability company, one share of the
class A voting redeemable common shares, $2,000 par value per share, of Mountain
View Indemnity, Ltd., a Bermuda limited liability company ("MVI"), and one share
of the non-voting redeemable preference shares, $1.00 par value per share, of
MVI for $65,000 in cash. Milne Scali Properties LLC is owned by Richard W.
Milne, Jr. and Terrence M. Scali, executive officers of the Company. Under the
by-laws of MVI, share value is established using stockholders equity plus
retained earnings divided by the number of stockholders. This methodology was
used for purposes of valuing the shares purchased by BNC Insurance.
The Federal Reserve Act limits amounts of, and requires collateral on,
extensions of credit by the Bank to BNCCORP, and with certain exceptions, its
non-bank affiliates. There are also restrictions on the amounts of investment by
the Bank in stocks and other subsidiaries of BNCCORP and such affiliates and
restrictions on the acceptance of their securities as collateral for loans by
the Bank. As of December 31, 2003, BNCCORP and its affiliates were in compliance
with these requirements.
23. Repossessed and Impaired Asset Expenses/Write-Offs:
The Company recorded write downs to estimated net realizable value of other real
estate owned and repossessed assets, and related collection and other expenses,
of $40,000, $142,000 and $40,000 for the years ended December 31, 2003, 2002 and
2001, respectively. There were no repossessed assets recorded as of December 31,
2003.
24. Income Taxes:
The provision (benefit) for income taxes consists of the following for the years
ended December 31 (in thousands):
2003 2002 2001
----------- ----------- -----------
Continuing Operations -
Current:
Federal............................... $ 805 $ 800 $ 657
State................................. 241 218 376
Prior year state refunds
from change in filing position...... (339) -- --
----------- ----------- -----------
707 1,018 1,033
----------- ----------- -----------
Deferred:
Federal............................... 726 (250) (218)
State................................. 148 54 (124)
----------- ----------- -----------
874 (196) (342)
----------- ----------- -----------
Total from continuing operations...... $ 1,581 $ 822 $ 691
=========== =========== ===========
Discontinued Operations -
Current:
Federal................................ $ -- $ 5 $ (77)
State.................................. -- 1 (6)
----------- ----------- -----------
Total from discontinued
operations............................. $ -- $ 6 $ (83)
=========== =========== ===========
The provision for Federal income taxes expected at the statutory rate differs
from the actual provision as follows for the years ended December 31 (in
thousands):
2003 2002 2001
----------- ----------- -----------
Tax at 34% statutory rate................. $ 1,845 $ 967 $ 811
Prior year state refunds
(net of Federal benefit)............... (229) -- --
State taxes (net of Federal benefit).... 266 108 85
Tax-exempt interest..................... (473) (289) (250)
Other, net.............................. 172 36 45
----------- ----------- -----------
$ 1,581 $ 822 $ 691
=========== =========== ===========
Temporary differences between the financial statement carrying amounts and tax
bases of assets and liabilities that result in significant portions of the
Company's deferred tax assets and liabilities are as follows as of December 31
(in thousands):
2003 2002
----------- -----------
Deferred tax asset:
Loans, primarily due to
differences in accounting
for credit losses....................... $ 1,737 $ 1,809
Difference between book and
tax amortization of branch
premium acquisition costs............... 373 312
Other................................. 245 902
----------- -----------
Deferred tax asset........... 2,355 3,023
----------- -----------
Deferred tax liability:
Unrealized gain on securities
available for sale...................... 605 1,666
Leases, primarily due to
differences in accounting
for leases.............................. 706 594
Difference between book and
tax amortization of acquired
intangibles............................. 490 171
Premises and equipment,
primarily due to differences
in original cost basis and
depreciation............................ 677 902
----------- -----------
Deferred tax liability.................. 2,478 3,333
----------- -----------
Net deferred tax liability.............. $ (123) $ (310)
=========== ===========
The Company has, in its judgment, made certain reasonable assumptions relating
to the realization of deferred tax assets. Based upon these assumptions, the
Company has determined that no valuation allowance is required with respect to
the deferred tax assets.
25. Earnings Per Share:
The following table shows the amounts used in computing EPS and the effect on
weighted average number of shares of potential dilutive common stock issuances:
Net
Income (Loss) Shares Per-Share
(Numerator) (Denominator) Amount
--------------- ------------------- ----------------
2003
Basic earnings per common share:
Income from continuing operations................ $ 3,844,000
Less: Preferred stock dividends.................. (120,000)
---------------
Income attributable to common stockholders....... $ 3,724,000 2,705,602 $ 1.38
=============== ================
Effect of dilutive shares -
Options and contingent stock................. 59,214
-------------------
Diluted earnings per common share:
Income from continuing operations................ $ 3,844,000
Less: Preferred stock dividends.................. (120,000)
---------------
Income attributable to common stockholders....... $ 3,724,000 2,764,816 $ 1.35
=============== ================
2002
Basic earnings per common share:
Income from continuing operations................ $ 2,025,000
Less: Preferred stock dividends.................. (79,000)
---------------
Income from continuing operations
available to common stockholders............... 1,946,000 2,611,629 $ 0.74
Income from discontinued Fargo branch,
net of income taxes............................ 14,000 2,611,629 0.01
--------------- ----------------
Income attributable to common stockholders....... $ 1,960,000 2,611,629 $ 0.75
=============== ================
Effect of dilutive shares -
Options...................................... 17,169
-------------------
Diluted earnings per common share:
Income from continuing operations................ $ 2,025,000
Less: Preferred stock dividends.................. (79,000)
---------------
Income from continuing operations available
to common stockholders........................ 1,946,000 2,628,798 $ 0.74
Income from discontinued Fargo branch, net
of income taxes............................... 14,000 2,628,798 0.01
--------------- ----------------
Income attributable to common stockholders....... $ 1,960,000 2,628,798 $ 0.75
=============== ================
2001
Basic earnings per common share:
Income from continuing operations................ $ 1,695,000 2,395,353 $ 0.71
Loss from discontinued Fargo branch, net
of income taxes................................. (203,000) 2,395,353 (0.08)
Nonoperating item - loss on early
extinguishment of debt, net of income taxes..... (134,000) 2,395,353 (0.06)
Cumulative effect of change in accounting
principle, net of income taxes.................. (113,000) 2,395,353 (0.05)
--------------- ----------------
Income available to common stockholders.......... $ 1,245,000 $ 0.52
=============== ================
Effect of dilutive shares -
Options...................................... 25,760
-------------------
Diluted earnings per common share:
Income from continuing operations................ $ 1,695,000 2,421,113 $ 0.70
Loss from discontinued Fargo branch,
net of income taxes............................ (203,000) 2,421,113 (0.08)
Nonoperating item - loss on early
extinguishment of debt, net of income taxes.... (134,000) 2,421,113 (0.06)
Cumulative effect of change in accounting
principle, net of income taxes................. (113,000) 2,421,113 (0.05)
--------------- ----------------
Income available to common stockholders.......... $ 1,245,000 $ 0.51
=============== ================
The following options, with exercise prices ranging from $7.25 to $17.75, were
outstanding during the periods indicated but were not included in the
computation of diluted EPS because their exercise prices were higher than the
average price of the Company's common stock for the period:
2003 2002 2001
------------ ------------ ------------
Quarter ended March 31........... 77,185 97,508 101,570
Quarter ended June 30............ 63,500 96,145 97,177
Quarter ended September 30....... 62,027 103,498 95,508
Quarter ended December 31........ 3,250 91,989 101,649
26. Benefit Plans:
BNCCORP has a qualified, tax-exempt 401(k) savings plan covering all employees
of BNCCORP and its subsidiaries who meet specified age and service requirements.
The BNCCORP 401(k) savings plan was merged with the plan of Milne Scali on April
1, 2003. Under the BNCCORP plan, eligible employees may elect to defer up to 50
percent of compensation each year not to exceed the dollar limit set by law. At
their discretion, BNCCORP and its subsidiaries provide matching contributions of
up to 50 percent of employee deferrals up to a maximum employer contribution of
five percent of employee compensation. Generally, all participant contributions
and earnings are fully and immediately vested. The Company makes its matching
contribution during the first calendar quarter following the last day of each
calendar year and an employee must be employed by the Company on the last day of
the calendar year in order to receive the current year's employer match. The
anticipated matching contribution is expensed monthly over the course of the
calendar year based on employee contributions made throughout the year. The
Company made matching contributions of $341,000, $261,000 and $207,000 for 2003,
2002 and 2001, respectively. Under the investment options available under the
401(k) savings plan, employees may elect to invest their salary deferrals in
BNCCORP common stock. At December 31, 2003, the assets in the plan totaled $10.6
million and included $3.3 million (183,034 shares) invested in BNCCORP common
stock.
27. Commitments and Contingencies:
Employment Agreements and Noncompete Convenants. The Company has entered into
three-year employment agreements with its chairman of the board and president
and chief executive officer (the "Executives"). The Executives will be paid
minimum annual salaries throughout the terms of the agreements and annual
incentive bonuses as may, from time to time, be fixed by the Board. The
Executives will also be provided with benefits under any employee benefit plan
maintained by BNCCORP for its employees generally, or for its senior executive
officers in particular, on the same terms as are applicable to other senior
executives of BNCCORP. Under the agreements, if their status as employees with
BNCCORP is terminated for any reason other than death, disability, cause, as
defined in the agreements, or if they terminate their employment for good
reason, as defined in the agreements, or following a change in control of the
Company, as defined in the agreements, then the Executives will be paid a
lump-sum amount equal to three times their current annual compensation.
In conjunction with the April 2002 business combination with Milne Scali, the
Company has entered into five-year employment agreements with the chairman and
president of Milne Scali (the "Insurance Executives"). The Insurance Executives
will be paid minimum annual salaries throughout the terms of the agreements and
annual incentive bonuses as may, from time to time, be fixed by the Board. The
Insurance Executives will also be provided with benefits under any employment
benefit plan maintained by BNCCORP for its employees generally, or for its
senior executive officers in particular, on the same terms as are applicable to
other senior executives of BNCCORP.
In conjunction with its 1998 business combination with Lips & Lahr, Inc., ("Lips
& Lahr") the Company assumed five-year employment agreements with two officers
of Lips & Lahr (the "Officers"). The agreements, which originally provided for
salaries based upon a percentage of all net annual commissions received by Lips
& Lahr on business written by the Officers, were amended to provide for minimum
annual salaries through the remainder of the contract term, which ran through
December 31, 2000. Additionally, the agreements provide for the payment of
deferred compensation for a term of 10 years commencing on February 1, 2001 and
continuing monthly until paid in full. Finally, as separate consideration for
the release of all present and future claims to the Officers' books of business
at the end of the term of the employment contract and for other terms of the
contract involving confidentiality, nonpiracy and a restrictive covenant
covering a period of five years after the term of the agreement, the agreements
provide for 120 monthly payments also commencing on February 1, 2001. The
deferred compensation payments have been accrued for as of December 31, 2003.
Both of the Officers resigned and the Company remains obligated under the
deferred compensation and non-compete provisions of the original employment
agreements.
In the business combination with Lips & Lahr, BNC Insurance assumed two
additional non-compete agreements with former officers of Lips & Lahr. Monthly
payments under these agreements, which commenced in 1996, are scheduled to
continue into 2006.
Legal Proceedings. From time to time, the Company may be a party to legal
proceedings arising out of its lending, deposit operations or other activities.
The Company engages in foreclosure proceedings and other collection actions as
part of its loan collection activities. From time to time, borrowers may also
bring actions against the Company, in some cases claiming damages. Some
financial services companies have been subjected to significant exposure in
connection with litigation, including class action litigation and punitive
damage claims. While the Company is not aware of any actions or allegations that
should reasonably give rise to any material adverse effect, it is possible that
the Company could be subjected to such a claim in an amount that could be
material. Based upon a review with its legal counsel, management believes that
the ultimate disposition of pending litigation will not have a material effect
on the Company's financial condition, results of operations or cash flows.
Leases. The Company has entered into operating lease agreements for certain
facilities and equipment used in its operations. Rent expense for the years
ended December 31, 2003, 2002 and 2001, was $1.0 million, $1.2 million and
$675,000, respectively, for facilities, and $107,000, $94,000 and $94,000,
respectively, for equipment and other items. At December 31, 2003, the total
minimum annual base lease payments for operating leases were as follows (amounts
are in thousands):
2004........................ $ 1,113
2005........................ 889
2006........................ 752
2007........................ 715
2008........................ 418
Thereafter.................. 435
The Company is subleasing a building in Bismarck. The sublease runs for a term
of 18 months, terminating on December 31, 2004, renewable for five additional
two-year terms. Future minimum rentals to be received under the sublease are
$84,300 per annum, paid annually in advance by each June 1. The Company is also
subleasing a portion of its office space in Minneapolis. The sublease runs for a
term of 12 months, terminating on June 30, 2004, at which time it will revert to
a month-to-month lease. Rent received under the sublease is $3,000 per month.
28. Stock-Based Compensation:
BNCCORP's 1995 Stock Incentive Plan (the "1995 Stock Plan") and its 2002 Stock
Incentive Plan (the "2002 Stock Plan," together, the "Stock Plans") are intended
to provide long-term incentives to its key employees, including officers and
directors who are employees of the Company. The 1995 Stock Plan, which is
administered by the compensation committee of the Board (the "Committee"),
provides for an authorization of 250,000 shares of common stock for issuance
thereunder. The 2002 Stock Plan, which is also administered by the Committee,
provides for an authorization of 125,000 shares of common stock for issuance
thereunder. Under the Stock Plans, the Company may grant employees incentive
stock options, nonqualified stock options, restricted stock, stock awards or any
combination thereof. The Committee establishes the exercise price of any stock
options granted under the Stock Plans provided that the exercise price may not
be less than the fair market value of a share of common stock on the date of
grant. The Committee determines vesting requirements, which may vary, and the
maximum term of options granted is generally 10 years.
As of December 31, 2003, 48,973 restricted shares issued under the 1995 Stock
Plan were outstanding. 30,973 of the shares were fully vested. The balance of
the shares vest incrementally between now and December 31, 2006. The Company
records the compensation expense related to restricted stock on a straight-line
basis over the applicable service period. Compensation cost charged to
operations was $136,000, $9,000 and $9,000 in 2003, 2002 and 2001, respectively.
The Company issued 24,500 shares of restricted stock during 2003 and no shares
of restricted stock during 2002 and 2001.
The Company's Nonemployee Director Stock Option Plan (the "Directors' Plan") was
adopted during 1998, administered by the Committee and terminated during 1999.
The Company applies APB 25 and related interpretations in accounting for both
the Stock Plans and the Directors' Plan. Accordingly, no compensation cost has
been recognized for the options issued under the plans in 2003, 2002 or 2001. As
of December 31, 2003, 191,876 options had been awarded under the 1995 Stock
Plan. 21,841 of them had been exercised and 170,035 remained outstanding. 3,250
options awarded under the Directors' Plan remained outstanding. No awards had
been made under the 2002 Stock Plan. Had compensation cost been determined on
the basis of fair value pursuant to SFAS 123, net income and EPS would have been
reduced as follows for the years ended December 31:
2003 2002 2001
------------- ------------- -------------
Net Income:
As Reported......... $ 3,844,000 $ 2,039,000 $1,245,000
Pro Forma........... 3,793,000 2,005,000 1,145,000
Basic EPS:
As Reported......... 1.38 0.75 0.52
Pro Forma........... 1.30 0.72 0.45
Diluted EPS:
As Reported......... 1.35 0.75 0.51
Pro Forma........... 1.27 0.72 0.44
Following is a summary of stock option transactions for the years ended December
31:
2003 2002 2001
-------------------------- -------------------------- --------------------------
Options Weighted Options Weighted Options Weighted
To Average to Average to Average
Purchase Exercise Purchase Exercise Purchase Exercise
Shares Price Shares Price Shares Price
----------- ----------- ----------- ----------- ----------- -----------
Outstanding, beginning of year.... 173,935 $ 10.48 208,408 $10.37 118,148 $ 13.84
Granted........................... 17,500 7.00 2,500 7.51 109,840 6.16
Exercised......................... (11,066) 6.79 (4,000) 6.03 (4,840) 5.94
Forfeited......................... (7,084) 9.31 (32,973) 10.12 (14,740) 8.21
----------- ------------ -----------
Outstanding, end of year.......... 173,285 10.41 173,935 10.48 208,408 10.37
=========== ============ ===========
Exercisable, end of year.......... 110,702 12.71 92,248 12.87 106,948 12.88
=========== ============ ===========
Weighted average fair value
of options:
Granted....................... $ 3.76 $ 3.35 $ 2.91
=========== ============ ===========
Exercised..................... $ 3.14 $ 2.91 $ 2.83
=========== ============ ===========
Forfeited..................... $ 4.23 $ 4.61 $ 3.88
=========== ============ ===========
The fair value of each option granted is estimated on the grant date using the
Black-Scholes option pricing model. The following assumptions were made in
estimating fair value of options granted for the years ended December 31:
2003 2002 2001
------------- -------------- -------------
Weighted average -
Dividend yield............. 0.00% 0.00% 0.00%
Risk-free interest
rate - seven-year
treasury yield............ 3.66% 3.35% 5.00%
Volatility................. 36.39% 36.73% 35.36%
Expected life.............. 7.0 years 7.0 years 7.0 years
Following is a summary of the status of options outstanding at December 31,
2003:
Outstanding Options Exercisable Options
----------------------------------------------------------- -------------------------------
Weighted Weighted
Weighted Average Average Average
Remaining Contractual Exercise Exercise
Number Life Price Number Price
-------------- ------------------------ ------------ --------------- ------------
Options with exercise prices
ranging from:
$17.00 to $17.75 61,850 4.0 years $ 17.04 61,850 $ 17.04
$5.88 to $10.00 111,435 6.6 years 6.73 48,852 7.22
-------------- ---------------
173,285 110,702
============== ===============
29. Condensed Financial Information-Parent Company Only:
Condensed financial information of BNCCORP on a parent company only basis is as
follows:
Parent Company Only
Condensed Balance Sheets
As of December 31
(In thousands, except share data)
2003 2002
-------------- --------------
Assets:
Cash and cash equivalents.......................................... $ 2,977 $ 3,871
Investment in subsidiaries......................................... 68,300 64,518
Receivable from subsidiaries....................................... 259 95
Deferred charges and intangible assets, net........................ 154 154
Other.............................................................. 513 993
-------------- --------------
$ 72,203 $ 69,631
============== ==============
Liabilities and stockholders' equity:
Subordinated debentures............................................ $ 22,570 $ 22,484
Long term note..................................................... 8,500 8,500
Accrued expenses and other liabilities............................. 947 924
-------------- --------------
32,017 31,908
-------------- --------------
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;
2,749,196 and 2,700,929 shares issued and outstanding
(excluding 42,880 shares held in treasury)..................... 28 27
Capital surplus - common stock..................................... 17,074 16,614
Retained earnings.................................................. 21,119 17,395
Treasury stock (42,880 shares)..................................... (513) (513)
Accumulated other comprehensive income, net of income taxes........ 978 2,700
-------------- --------------
Total stockholders' equity......................................... 40,186 37,723
-------------- --------------
$ 72,203 $ 69,631
============== ==============
Parent Company Only
Condensed Statements of Income
For the Years Ended December 31
(In thousands)
2003 2002 2001
-------------- -------------- -------------
Income:
Management fee income........................... $ 650 $ 649 $ 703
Interest........................................ 36 83 322
Other........................................... 120 114 70
-------------- -------------- -------------
Total income................................ 806 846 1,095
-------------- -------------- -------------
Expenses:
Interest........................................ 2,156 2,185 2,207
Personnel expense............................... 530 521 512
Legal and other professional.................... 216 210 144
Depreciation and amortization................... 14 17 57
Other........................................... 332 352 307
-------------- -------------- -------------
Total expenses.............................. 3,248 3,285 3,227
-------------- -------------- -------------
Loss before income tax benefit and equity in
undistributed income of subsidiaries............... (2,442) (2,439) (2,132)
Income tax benefit................................... 961 858 691
-------------- -------------- -------------
Loss before equity in undistributed income of
subsidiaries....................................... (1,481) (1,581) (1,441)
Equity in undistributed income of subsidiaries....... 5,325 3,606 3,023
-------------- -------------- -------------
Income from continuing operations.................... 3,844 2,025 1,582
Equity in undistributed income (loss) from
operations of discontinued branch.................. -- 14 (203)
-------------- -------------- -------------
Income before nonoperating item...................... 3,844 2,039 1,379
Nonoperating item - loss on early extinguishment
of debt, net of income taxes....................... -- -- (134)
-------------- -------------- -------------
Net income.................................. $ 3,844 $ 2,039 $ 1,245
============== ============== =============
Parent Company Only
Condensed Statements of Cash Flows
For the Years Ended December 31
(In thousands)
2003 2002 2001
-------------- -------------- --------------
Operating activities:
Net income.................................................... $ 3,844 $ 2,039 $ 1,245
Adjustments to reconcile net income to net cash
used in operating activities -
Depreciation and amortization............................. 14 18 43
Equity in undistributed income of subsidiaries............ (5,325) (3,620) (2,820)
Change in prepaid expenses and other receivables.......... 300 265 (111)
Change in accrued expenses and other liabilities.......... 23 (123) 332
Other..................................................... (2) (482) 386
-------------- -------------- --------------
Net cash used in operating activities................ (1,146) (1,903) (925)
-------------- -------------- --------------
Investing activities:
Net decrease in loans......................................... -- 5 11
Increase in investment in subsidiaries ....................... (181) (13,000) (3,464)
Additions to premises and equipment, net...................... 5 (21) 12
-------------- -------------- --------------
Net cash used in investing activities................ (176) (13,016) (3,441)
-------------- -------------- --------------
Financing activities:
Repayments of long-term borrowings............................ -- -- (13,172)
Proceeds from long-term borrowings............................ -- 8,500 --
Amortization of discount on subordinated notes................ -- -- 371
Amortization of deferred charges.............................. -- -- 14
Proceeds from issuance of subordinated debentures............. -- -- 14,893
Proceeds from issuance of preferred stock..................... -- 1,500 --
Proceeds from issuance of common stock........................ 462 2,524 --
Amortization of discount on subordinated debentures........... 86 86 53
Payment of preferred stock dividends.......................... (120) (79) --
Other, net.................................................... -- 9 (86)
-------------- -------------- --------------
Net cash provided by financing activities............ 428 12,540 2,073
-------------- -------------- --------------
Net decrease in cash and cash equivalents.......................... (894) (2,379) (2,293)
Cash and cash equivalents, beginning of year....................... 3,871 6,250 8,543
-------------- -------------- --------------
Cash and cash equivalents, end of year............................. $ 2,977 $ 3,871 $ 6,250
============== ============== ==============
Supplemental cash flow information:
Interest paid................................................. $ 2,172 $ 2,050 $ 2,143
============== ============== ==============
Income tax payments received from subsidiary
bank(s), net of income taxes paid.......................... $ 903 $ 1,563 $ 652
============== ============== ==============
30. Quarterly Financial Data (unaudited, in thousands, except shares and EPS):
2003
-----------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------- -------------- ------------- -------------
Interest income............................ $ 7,468 $ 7,265 $ 6,734 $ 7,179
Interest expense........................... 4,026 3,897 3,697 3,648
------------- -------------- ------------- -------------
Net interest income........................ 3,442 3,368 3,037 3,531
Provision for credit losses................ 775 400 300 --
------------- -------------- ------------- -------------
Net interest income after provision
for credit losses........................ 2,667 2,968 2,737 3,531
Noninterest income......................... 5,219 5,411 5,402 4,780
Noninterest expense........................ 6,454 6,701 6,834 7,301
------------- -------------- ------------- -------------
Income before income taxes................. 1,432 1,678 1,305 1,010
Income tax provision....................... 415 504 389 273
------------- -------------- ------------- -------------
Net income................................. $ 1,017 $ 1,174 $ 916 $ 737
============= ============== ============= =============
Dividends on preferred stock............... $ 30 $ 30 $ 30 $ 30
------------- -------------- ------------- -------------
Net income attributable to
common stockholders...................... $ 987 $ 1,144 $ 886 $ 707
============= ============== ============= =============
Basic earnings per common share:
------------- -------------- ------------- -------------
Basic earnings per common share............ $ 0.37 $ 0.42 $ 0.33 $ 0.26
============= ============== ============= =============
Diluted earnings per common share:
------------- -------------- ------------- -------------
Diluted earnings per common share.......... $ 0.36 $ 0.41 $ 0.32 $ 0.25
============= ============== ============= =============
Average common shares:
Basic...................................... 2,701,274 2,703,071 2,706,323 2,711,620
Diluted.................................... 2,731,213 2,758,171 2,766,118 2,803,674
2002
-----------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------- -------------- ------------- -------------
Interest income............................. $ 7,581 $ 7,825 $ 8,431 $ 7,981
Interest expense............................ 4,568 4,993 4,811 4,364
------------- -------------- ------------- -------------
Net interest income......................... 3,013 2,832 3,620 3,617
Provision for credit losses................. 217 185 400 400
------------- -------------- ------------- -------------
Net interest income after provision
for credit losses.......................... 2,796 2,647 3,220 3,217
Noninterest income.......................... 2,345 4,119 5,123 4,709
Noninterest expense......................... 4,917 6,732 6,891 6,789
------------- -------------- ------------- -------------
Income before income taxes.................. 224 34 1,452 1,137
Income tax provision (benefit).............. 94 (30) 430 328
------------- -------------- ------------- -------------
Income from continuing operations........... 130 64 1,022 809
Gain (loss) from discontinued Fargo
branch, net of income taxes................ 60 38 (69) (15)
------------- -------------- ------------- -------------
Net income.................................. $ 190 $ 102 $ 953 $ 794
============= ============== ============= =============
Dividends on preferred stock................ $ -- $ (19) $ (30) $ (30)
------------- -------------- ------------- -------------
Net income attributable to common
stockholders.............................. $ 190 $ 83 $ 923 $ 764
============= ============== ============= =============
Basic earnings per common share:
Income from continuing operations (less
preferred stock dividends)................ $ 0.05 $ 0.02 $ 0.37 $ 0.29
Gain (loss) from discontinued Fargo
branch, net of income taxes............... 0.03 0.01 (0.03) (0.01)
------------- -------------- ------------- -------------
Basic earnings per common share............. $ 0.08 $ 0.03 $ 0.34 $ 0.28
============= ============== ============= =============
Diluted earnings per common share:
Income from continuing operations (less
preferred stock dividends)................ $ 0.05 $ 0.02 $ 0.37 $ 0.29
Gain (loss) from discontinued Fargo
branch, net of income taxes............... 0.03 0.01 (0.03) (0.01)
------------- -------------- ------------- -------------
Diluted earnings per common share........... $ 0.08 $ 0.03 $ 0.34 $ 0.28
============= ============== ============= =============
Average common shares:
Basic....................................... 2,399,170 2,645,213 2,697,929 2,699,951
Diluted..................................... 2,424,739 2,670,195 2,702,709 2,710,311
Unaudited - see accompanying accountant's report.
Item 9A. Controls and Procedures
Quarterly evaluation of the Company's Disclosure Controls and Internal Controls.
As of the end of the period covered by this annual report on Form 10-K, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures ("Disclosure Controls"), and our internal control over
financial reporting ("Internal Controls"). This evaluation (the "Controls
Evaluation") was done under the supervision and with the participation of
management, including our President and Chief Executive Officer ("CEO") and
Chief Financial Officer ("CFO"). Rules adopted by the SEC require that in this
section of the annual report we present the conclusions of the CEO and the CFO
about the effectiveness of our Disclosure Controls and any change in our
Internal Controls that occurred during our most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect, our Internal
Controls based on and as of the date of the Controls Evaluation.
CEO and CFO Certifications. Appearing, as Exhibits 31.1 and 31.2 to this annual
report, there are "Certifications" of the CEO and the CFO. The Certifications
are required in accordance with the Exchange Act and the SEC's implementing Rule
13a-14 (the "Rule 13a-14 Certifications"). This section of the annual report is
the information concerning the Controls Evaluation referred to in the Rule
13a-14 Certifications and this information should be read in conjunction with
the Rule 13a-14 Certifications for a more complete understanding of the topics
presented.
Disclosure Controls and Internal Controls. Disclosure controls are procedures
that are designed with the objective of ensuring that information required to be
disclosed in our reports filed under the Exchange Act, such as this annual
report, is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms. Disclosure Controls are also designed
with the objective of ensuring that material information relating to BNCCORP,
including its consolidated subsidiaries, is made known to the CEO and CFO by
others within those entities, particularly during the period in which the
applicable report is being prepared. Internal Controls are procedures which are
designed with the objective of providing reasonable assurance that (1) our
transactions are properly authorized; (2) our assets are safeguarded against
unauthorized or improper use; and (3) our transactions are properly recorded and
reported, all to permit the preparation of our financial statements in
conformity with accounting principles generally accepted in the United States.
Limitations on the Effectiveness of Controls. Our management, including the CEO
and CFO, does not expect that our Disclosure Controls or our Internal Controls
will prevent all error and all fraud. A control system, no matter how well
developed and operated, can provide only reasonable, but not absolute, assurance
that the objectives of the control system are met. Further, the design of a
control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their costs. Because of
the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions.
Over time, control may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.
Scope of the Controls Evaluation. The CEO/CFO evaluation of our Disclosure
Controls and our Internal Controls included a review of the controls' objectives
and design, our controls' implementation and the effect of the controls on the
information generated for use in this annual report. In the course of the
Controls Evaluation, we sought to identify data errors, controls problems or
acts of fraud and to confirm that appropriate corrective action, including
process improvements, were being undertaken. This type of evaluation 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
which are reasonably likely to adversely affect our ability to record, process,
summarize and report financial information, or whether we had identified any
acts of fraud, whether or not material, involving management or other employees
who have a significant role in our Internal Controls. This information was
important both for the Controls Evaluation generally and because item 5 in the
Rule 13a-14 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.
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. Additionally,
there has been no change in our Internal Controls that occurred during our most
recent fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our Internal Controls.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information concerning our directors and officers called for by this item will
be included in our definitive Proxy Statement prepared in connection with the
2004 Annual Meeting of Stockholders and is incorporated herein by reference.
Item 11. Executive Compensation
Information concerning the compensation of our executives called for by this
item will be included in our definitive Proxy Statement prepared in connection
with the 2004 Annual Meeting of Stockholders and is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information concerning security ownership of certain beneficial owners and
management called for by this item will be included in our definitive Proxy
Statement prepared in connection with the 2004 Annual Meeting of Stockholders
and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions called for
by this item will be included in our definitive Proxy Statement prepared in
connection with the 2004 Annual Meeting of Stockholders and is incorporated
herein by reference.
Item 14. Principal Accounting Fees and Services
Information concerning fees to, and services provided by, our independent
auditor called for by this item will be included in our definitive Proxy
Statement prepared in connection with the 2004 Annual Meeting of Stockholders
and is incorporated herein by reference.
PART IV
Item 16. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits.
Reference is made to the Exhibit Index beginning on page E-1 hereby.
We will furnish to any eligible stockholder, upon written request of
such stockholder, a copy of any exhibit listed upon the payment of a
reasonable fee equal to our expenses in furnishing such exhibit.
(b) Reports on Form 8-K.
On October 17, 2003, we filed a Form 8-K, furnishing under Item 7, our
earnings press release for the quarter ended September 30, 2003.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant caused this report to be signed on its behalf by the
undersigned; thereunto duly authorized, on March 19, 2004.
BNCCORP, Inc.
By: /s/ Gregory K. Cleveland
-----------------------------------------------
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated, on March 19, 2004.
/s/ Tracy Scott
- ---------------------------------
Tracy Scott Chairman of the Board and Director
/s/ Gregory K. Cleveland
- ---------------------------------
Gregory K. Cleveland President, Chief Executive Officer and Director
(Principal Executive Officer)
/s/ Brenda L. Rebel
- ---------------------------------
Brenda L. Rebel Chief Financial Officer and Director
(Principal Financial Officer)
(Principal Accounting Officer)
/s/ Denise Forte-Pathroff, M.D.
- ---------------------------------
Denise Forte-Pathroff, M.D. Director
/s/ John A. Hipp, M.D.
- ---------------------------------
John A. Hipp, M.D. Director
/s/ Richard M. Johnsen, Jr.
- ---------------------------------
Richard M. Johnsen, Jr. Director
/s/ Gaylen Ghylin
- ---------------------------------
Gaylen Ghylin Director
/s/ Jerry R. Woodcox
- ---------------------------------
Jerry R. Woodcox Director
/s/ Terrence M. Scali
- ----------------------------------
Terrence M. Scali Director
EXHIBIT INDEX
Exhibit
No. Exhibit Description
- ------------- ------------------------------------------------------------------
3.1 Certificate of Incorporation of the Company, incorporated by
reference to Exhibit 3.1 to the Registrant's Registration
Statement on Form SB-2 (Registration No. 33-92369).
3.2 Bylaws of the Company, incorporated by reference to Exhibit 3.2
to the Registrant's Registration Statement on Form SB-2
(Registration No. 33-92369).
4.1 Specimen of Common Stock Certificate, incorporated by reference
to Exhibit 4 to Amendment No. 1 to the Registrant's Registration
Statement on Form SB-2 (Registration No. 33-92369).
4.2 Rights Agreement, dated as of May 30, 2001, between BNCCORP, Inc.
and American Stock Transfer and Trust Company, as Rights Agent,
incorporated by reference to Exhibit 1 to the Registrant's Form
8-A dated June 5, 2001.
10.1 Form of Indemnity Agreement by and between the Company and each
of the Company's Directors, incorporated by reference to Exhibit
10.1 to the Registrant's Registration Statement on Form SB-2
(Registration No. 33-92369).
10.2 Form of Employment Agreement between the Company and each of
Tracy J. Scott and Gregory K. Cleveland, incorporated by
reference to Exhibit 10.2 to the Registrant's Registration
Statement on Form SB-2 (Registration No. 33-92369).
10.3 Form of BNCCORP, Inc. 1995 Stock Incentive Plan, incorporated by
reference to Exhibit 10.3 to the Registrant's Registration
Statement on Form SB-2 (Registration No. 33-92369).
10.4 Form of Stock Option Agreement for the Grant of Non-Qualified
Stock Options Under the BNCCORP, Inc. 1995 Stock Incentive Plan
dated as of June 7, 1995, incorporated by reference to Exhibit
10.5 to the Registrant's Form 10-KSB dated as of March 29, 1996.
10.5 Junior Subordinated Indenture between BNCCORP, Inc. and First
Union National Bank as Trustee dated as of July 12, 2000,
incorporated by reference to Exhibit 10.1 to the Registrant's
Form 10-Q dated as of August 2, 2000.
10.6 Guarantee Agreement between BNCCORP, Inc. as Guarantor and First
Union National Bank as Guarantee Trustee dated as of July 12,
2000 - BNC Capital Trust I, incorporated by reference to Exhibit
10.2 to the Registrant's Form 10-Q dated as of August 2, 2000.
10.7 Amended and Restated Trust Agreement among BNCCORP, Inc. as
Depositor, First Union National Bank as Property Trustee, First
Union Trust Company, National Association as Delaware Trustee and
the Administrative Trustees dated as of July 12, 2000 - BNC
Capital Trust I, incorporated by reference to the Registrant's
Form 10-Q dated as of August 2, 2000.
10.8 Indenture between BNCCORP, Inc., as issuer, and State Street Bank
and Trust Company of Connecticut, National Association, as
Trustee, Floating Rate Junior Subordinated Deferrable Interest
Debentures Due 2031, dated July 31, 2001, incorporated by
reference to Exhibit 10.1 to the Registrant's Form 10-Q dated as
of August 13, 2001.
10.9 Guarantee Agreement by and between BNCCORP, Inc. and State Street
Bank and Trust Company of Connecticut, National Association,
dated July 31, 2001, incorporated by reference to Exhibit 10.2 to
the Registrant's Form 10-Q dated as of August 13, 2001.
10.10 Amended and Restated Declaration of Trust by and among State
Street Bank and Trust Company of Connecticut, National
Association, as Institutional Trustee, BNCCORP, Inc., as Sponsor,
and Gregory K. Cleveland, Tracy Scott and Brenda L. Rebel, as
Administrators, dated July 31, 2001, incorporated by reference to
Exhibit 10.3 to the Registrant's Form 10-Q dated as of August 13,
2001.
10.11 Form of BNCCORP, Inc. 2002 Stock Incentive Plan, incorporated by
reference to Appendix A to the Company's Definitive Proxy
Statement dated as of May 17, 2002.
10.12 Stock Purchase Agreement, dated March 22, 2002, by and among
BNCCORP, Inc., BNC Insurance, Inc. and the Sellers named therein,
incorporated by reference to the registrant's Form 8-K filed on
May 1, 2002.
10.13 Employment and Non-competition Agreement, dated April 15, 2002,
by and between BNC Insurance, Inc., Milne & Company Insurance,
Inc. and Richard W. Milne, Jr., incorporated by reference to the
registrant's Form 8-K filed on May 1, 2002.
10.14 Employment and Non-competition Agreement, dated April 15, 2002,
by and between BNC Insurance, Inc., Milne & Company Insurance,
Inc. and Terrence M. Scali, incorporated by reference to the
registrant's Form 8-K filed on May 1, 2002.
10.15 Branch Purchase and Assumption Agreement by and among Alerus
Financial, National Association, BNC National Bank and its
parent, BNCCORP, Inc., dated as of July 26, 2002, incorporated by
reference to the registrant's Form 10-Q filed on November 12,
2002.
21.1 Subsidiaries of Company.
23.1 Consent of Independent Auditors.
31.1 Chief Executive Officer's Certification Under Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer's Certification Under Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification Under Section 906 of the Sarbanes-Oxley Act of
2002.