U.S. Securities and Exchange Commission
Washington, D.C. 20549
--------
FORM 10-Q
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[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarter ended September 30, 2004
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission File No. 0-26290
BNCCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 45-0402816
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
322 East Main
Bismarck, North Dakota 58501
(Address of principal executive office)
(701) 250-3040
(Registrant's telephone number)
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes X No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes ___ No X
The number of shares of the registrant's outstanding common stock on
November 5, 2004 was 2,849,605.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share and per share data)
September 30, December 31,
ASSETS 2004 2003
------------- -------------
(unaudited)
CASH AND DUE FROM BANKS........................... $ 13,209 $ 12,520
------------- -------------
Cash and cash equivalents.................... 13,209 12,520
INVESTMENT SECURITIES AVAILABLE FOR SALE.......... 236,318 262,568
FEDERAL RESERVE BANK AND FEDERAL HOME
LOAN BANK STOCK................................. 7,782 7,596
LOANS HELD FOR SALE............................... 39,520 --
LOANS AND LEASES, net............................. 283,554 283,555
ALLOWANCE FOR CREDIT LOSSES....................... (3,424) (4,763)
------------- -------------
Net loans and leases......................... 319,650 278,792
PREMISES AND EQUIPMENT, net....................... 21,001 18,570
INTEREST RECEIVABLE............................... 2,550 2,462
OTHER ASSETS...................................... 14,240 15,507
GOODWILL.......................................... 21,834 15,089
OTHER INTANGIBLE ASSETS, net...................... 8,403 8,373
------------- -------------
$ 644,987 $ 621,477
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
DEPOSITS:
Noninterest-bearing.......................... $ 61,164 $ 44,725
Interest-bearing -
Savings, interest checking and
money market........................... 204,586 215,525
Time deposits $100,000 and over.......... 64,526 46,569
Other time deposits...................... 96,158 89,123
------------- -------------
Total deposits............................... 426,434 395,942
SHORT-TERM BORROWINGS............................. 29,869 31,383
FEDERAL HOME LOAN BANK ADVANCES................... 102,200 112,200
LONG-TERM BORROWINGS.............................. 10,095 8,640
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN
COMPANY'S SUBORDINATED DEBENTURES............... 22,249 22,397
OTHER LIABILITIES................................. 10,401 10,729
------------- -------------
Total liabilities................... 601,248 581,291
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value -
2,000,000 shares authorized;
150 shares issued and
outstanding on September 30, 2004
and December 31, 2003, respectively....... -- --
Capital surplus - preferred stock............ 1,500 1,500
Common stock, $.01 par value - 10,000,000
shares authorized; 2,849,605 and
2,749,196 shares issued and outstanding
(excluding 42,880 shares held in treasury)
on September 30, 2004 and
December 31, 2003, respectively........... 29 28
Capital surplus - common stock............... 18,281 17,074
Retained earnings............................ 23,696 21,119
Treasury stock (42,880 shares)............... (513) (513)
Accumulated other comprehensive income,
net of income taxes....................... 746 978
------------- -------------
Total stockholders' equity.......... 43,739 40,186
------------- -------------
$ 644,987 $ 621,477
============= =============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(In thousands, except per share data)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
----------------------------- ----------------------------
2004 2003 2004 2003
------------- ------------- ------------ -------------
INTEREST INCOME: (unaudited) (unaudited)
Interest and fees on loans................. $ 4,593 $ 4,536 $ 13,456 $ 14,958
Interest and dividends on investments -
Taxable................................. 2,321 1,723 7,379 5,174
Tax-exempt.............................. 403 400 1,206 1,135
Dividends............................... 56 66 145 190
Other...................................... 3 9 3 10
------------- ------------- ------------ -------------
Total interest income.......... 7,376 6,734 22,189 21,467
------------- ------------- ------------ -------------
INTEREST EXPENSE:
Deposits................................... 1,590 1,741 4,746 5,770
Short-term borrowings...................... 140 84 357 305
Federal Home Loan Bank advances............ 1,246 1,345 3,707 3,953
Long-term borrowings....................... 99 97 280 292
Subordinated debentures.................... 443 430 1,296 1,300
------------- ------------- ------------ -------------
Total interest expense......... 3,518 3,697 10,386 11,620
------------- ------------- ------------ -------------
Net interest income............ 3,858 3,037 11,803 9,847
PROVISION FOR CREDIT LOSSES.................. -- 300 -- 1,475
------------- ------------- ------------ -------------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES.......................... 3,858 2,737 11,803 8,372
------------- ------------- ------------ -------------
NONINTEREST INCOME:
Insurance commissions...................... 4,312 3,498 13,296 10,983
Fees on loans.............................. 455 698 1,370 1,641
Service charges............................ 214 239 635 667
Trust and financial services............... 120 95 378 912
Net gain on sales of securities............ 116 448 167 869
Brokerage income........................... 95 141 448 291
Rental income.............................. 25 68 86 145
Other...................................... 261 215 1,280 524
------------- ------------- ------------ -------------
Total noninterest income....... 5,598 5,402 17,660 16,032
------------- ------------- ------------ -------------
NONINTEREST EXPENSE:
Salaries and employee benefits............. 6,021 4,113 16,194 12,075
Occupancy.................................. 718 564 1,973 1,750
Professional services...................... 417 288 1,151 857
Depreciation and amortization.............. 416 369 1,226 1,085
Office supplies, telephone and postage..... 381 284 1,052 893
Amortization of intangible assets.......... 326 265 946 797
Marketing and promotion.................... 244 227 783 522
FDIC and other assessments................. 51 50 153 152
Other...................................... 793 674 2,439 1,858
------------- ------------- ------------ -------------
Total noninterest expense...... 9,367 6,834 25,917 19,989
------------- ------------- ------------ -------------
Income before income taxes................... 89 1,305 3,546 4,415
Income tax provision (benefit)............... (34) 389 904 1,308
------------- ------------- ------------ -------------
Net income................................... $ 123 $ 916 $ 2,642 $ 3,107
============= ============= ============ =============
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income, continued
(In thousands, except per share data)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
---------------------------- -----------------------------
2004 2003 2004 2003
------------ ------------ ------------- -------------
(unaudited) (unaudited)
Dividends on preferred stock............. $ 5 $ 30 $ 65 $ 90
------------ ------------ ------------- -------------
Income available to common stockholders.. $ 118 $ 886 $ 2,577 $ 3,017
============ ============ ============= =============
BASIC EARNINGS PER COMMON SHARE:
Basic earnings per common share.......... $ 0.04 $ 0.33 $ 0.92 $ 1.12
============ ============ ============= =============
DILUTED EARNINGS PER COMMON SHARE:
Diluted earnings per common share........ $ 0.04 $ 0.32 $ 0.89 $ 1.10
============ ============ ============= =============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(In thousands)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------------------ ------------------------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
(unaudited) (unaudited)
NET INCOME............................................ $ 123 $ 916 $ 2,642 $ 3,107
OTHER COMPREHENSIVE INCOME (LOSS) -
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising
during the period, net of income taxes....... 1,924 (727) (128) (563)
Less: reclassification adjustment for
securities gains included in net income, net
of income taxes.............................. (72) (278) (104) (539)
------------- ------------- ------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS)..................... 1,852 (1,005) (232) (1,102)
------------- ------------- ------------- -------------
COMPREHENSIVE INCOME (LOSS)........................... $ 1,975 $ (89) $ 2,410 $ 2,005
============= ============= ============= =============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(In thousands, except share data)
For the Nine Months Ended September 30, 2004
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,
2003...................... 150 $ -- $ 1,500 2,792,076 $ 28 $ 17,074 $ 21,119 $ (513) $ 978 $40,186
Net income (unaudited).... -- -- -- -- -- -- 2,642 -- -- 2,642
Other comprehensive
income -
Change in unrealized
holding gains on
securities
available for
sale, net of
income taxes and
reclassification
adjustment
(unaudited)........... -- -- -- -- -- -- -- -- (232) (232)
Preferred stock
dividends
(unaudited)............. -- -- -- -- -- -- (65) -- -- (65)
Repurchase of
preferred stock
(unaudited)............. (150) -- (1,500) -- -- -- -- -- -- (1,500)
Issuance of preferred
stock (unaudited)....... 150 -- 1,500 -- -- -- -- -- -- 1,500
Other (unaudited) ......... -- -- -- 100,409 1 1,207 -- -- -- 1,208
------- ------- --------- --------- -------- -------- -------- -------- ------------- --------
Balance, September 30,
2004 (unaudited).......... 150 $ -- $ 1,500 2,892,485 $ 29 $ 18,281 $ 23,696 $ (513) $ 746 $43,739
======= ======= ========= ========= ======== ======== ======== ======== ============= ========
For the Nine Months Ended September 30, 2003
Capital Capital Accumulated
Preferred Stock Surplus Common Stock Surplus Other
--------------- Preferred ------------------- Common Retained Treasury Comprehensive
Shares Amount Stock Shares Amount Stock Earnings Stock Income Total
------- ------- --------- --------- -------- -------- -------- -------- ------------- --------
Balance, December 31, 2002... 150 $ -- $ 1,500 2,743,809 $ 27 $ 16,614 $ 17,395 $ (513) $ 2,700 $37,723
Net income (unaudited).... -- -- -- -- -- -- 3,107 -- -- 3,107
Other comprehensive
income -
Change in unrealized
holding gains on
securities
available for
sale, net of
income taxes and
reclassification
adjustment
(unaudited)........... -- -- -- -- -- -- -- -- (1,102) (1,102)
Preferred stock
dividends
(unaudited)............. -- -- -- -- -- -- (90) -- -- (90)
Other (unaudited) ......... -- -- -- 9,066 1 70 -- -- -- 71
------- ------- --------- --------- -------- -------- -------- -------- ------------- --------
Balance, September 30,
2003 (unaudited).......... 150 $ -- $ 1,500 2,752,875 $ 28 $ 16,684 $ 20,412 $ (513) $ 1,598 $ 39,709
======= ======= ========= ========= ======== ======== ======== ======== ============= ========
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Nine Months Ended September 30
(In thousands)
2004 2003
-------------- --------------
OPERATING ACTIVITIES: (unaudited) (unaudited)
Net income....................................................... $ 2,642 $ 3,107
Adjustments to reconcile net income to net cash provided by (used
in) operating activities -
Provision for credit losses.................................. -- 1,475
Depreciation and amortization................................ 1,226 1,085
Amortization of intangible assets............................ 946 797
Net premium amortization on investment securities............ 2,293 3,372
Proceeds from loans recovered................................ 257 71
Write down of other real estate owned and repossessed assets. 33 5
Change in interest receivable and other assets, net.......... 1,097 (9,081)
(Gain) loss on sale of bank premises and equipment........... 14 (1)
Net realized gains on sales of investment securities......... (167) (869)
Deferred income taxes........................................ 817 533
Change in dividend distribution payable...................... (212) (243)
Change in other liabilities, net............................. (1,021) (480)
Originations of loans to be sold............................. (42,128) (63,122)
Proceeds from sale of loans.................................. 42,128 63,122
-------------- --------------
Net cash provided by (used in) operating activities.... 7,925 (229)
-------------- --------------
INVESTING ACTIVITIES:
Purchases of investment securities............................... (58,723) (158,271)
Proceeds from sales of investment securities..................... 51,498 71,542
Proceeds from maturities of investment securities................ 31,024 43,802
Purchases of Federal Reserve and Federal Home Loan Bank Stock.... (5,438) --
Sales of Federal Reserve and Federal Home Loan Bank Stock........ 5,252 --
Net (increase) decrease in loans................................. (41,115) 54,677
Additions to premises and equipment.............................. (3,778) (5,977)
Proceeds from sale of premises and equipment..................... 115 107
Cash paid for Milne Scali earnouts............................... (6,012) (2,315)
Cash paid for acquisition of insurance agencies.................. (695) --
Cash paid for acquisition of mortgage company.................... (150) --
-------------- --------------
Net cash provided by (used in) investing activities.... (28,022) 3,565
-------------- --------------
FINANCING ACTIVITIES:
Net increase in demand, savings, interest checking and money
market accounts.............................................. 5,500 996
Net increase (decrease) in time deposits......................... 24,992 (22,816)
Net decrease in short-term borrowings............................ (1,514) (6,172)
Repayments of Federal Home Loan Bank advances.................... (342,000) (117,300)
Proceeds from Federal Home Loan Bank advances.................... 332,000 137,300
Repayments of long-term borrowings............................... (45) (47)
Proceeds from long-term borrowings............................... 1,500 141
Issuance of preferred stock...................................... 1,500 --
Payment of preferred stock dividends............................. (65) (90)
Repurchase of preferred stock.................................... (1,500) --
Amortization of discount on subordinated debentures.............. 64 65
Other, net....................................................... 354 72
-------------- --------------
Net cash provided by (used in) financing activities.... 20,786 (7,851)
-------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................ 689 (4,515)
CASH AND CASH EQUIVALENTS, beginning of period...................... 12,520 17,137
-------------- --------------
CASH AND CASH EQUIVALENTS, end of period............................ $ 13,209 $ 12,622
============== ==============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid.................................................... $ 13,446 $ 12,442
============== ==============
Income taxes paid................................................ $ 586 $ 814
============== ==============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 2004
NOTE 1 - BNCCORP, Inc.
BNCCORP, Inc. ("BNCCORP") is a registered bank holding company incorporated
under the laws of Delaware. It is the parent company of BNC National Bank
(together with its wholly owned subsidiaries, Milne Scali & Company, Inc. and
BNC Asset Management, Inc., the "Bank"). BNCCORP, through these wholly owned
subsidiaries, which operate from 26 locations in Arizona, Minnesota, North
Dakota, Utah and Colorado, provides a broad range of banking, insurance,
brokerage, trust and other financial services to small- and mid-sized businesses
and individuals.
The accounting and reporting policies of BNCCORP and its subsidiaries
(collectively, the "Company") conform to accounting principles generally
accepted in the United States of America and general practices within the
financial services industry. The consolidated financial statements included
herein are for BNCCORP and its subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
NOTE 2 - Basis of Presentation
The accompanying interim consolidated financial statements have been prepared by
the Company, without audit, in accordance with accounting principles generally
accepted in the United States of America for interim financial information and
pursuant to the rules and regulations of the Securities and Exchange Commission
("SEC"). Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures made are
adequate to make the information presented not misleading.
The unaudited consolidated financial statements as of September 30, 2004 and for
the three-month and nine-month periods ended September 30, 2004 and 2003
include, in the opinion of management, all adjustments, consisting solely of
normal recurring adjustments, necessary for a fair presentation of the financial
results for the respective interim periods and are not necessarily indicative of
results of operations to be expected for the entire fiscal year ending December
31, 2004.
The accompanying interim consolidated financial statements have been prepared
under the presumption that users of the interim consolidated financial
information have either read or have access to the audited consolidated
financial statements for the year ended December 31, 2003. Accordingly, footnote
disclosures which would substantially duplicate the disclosures contained in the
December 31, 2003 audited consolidated financial statements have been omitted
from these interim consolidated financial statements. It is suggested that these
interim consolidated financial statements be read in conjunction with the
audited consolidated financial statements for the year ended December 31, 2003
and the notes thereto.
NOTE 3 - Reclassifications
Certain of the 2003 amounts may have been reclassified to conform to the 2004
presentations. These reclassifications had no effect on net income or
stockholders' equity.
NOTE 4 - Earnings Per Share
The following table shows the amounts used in computing earnings per share
("EPS") and the effect on weighted average number of shares of potential
dilutive common stock issuances for the three-month periods ended September 30:
Net Per-Share
Income Shares Amount
------------ ----------- ------------
2004
Basic earnings per common share:
Net income................................ $ 123,000
Less: Preferred stock dividends........... (5,000)
------------
Income available to common stockholders... $ 118,000 2,839,309 $ 0.04
============ ============
Effect of dilutive shares -
Options and contingent stock........... 88,167
-----------
Diluted earnings per common share:
Net income................................ $ 123,000
Less: Preferred stock dividends........... (5,000)
------------
Income available to common stockholders... $ 118,000 2,927,476 $ 0.04
============ ============
2003
Basic earnings per common share:
Net income................................ $ 916,000
Less: Preferred stock dividends........... (30,000)
------------
Income available to common stockholders... $ 886,000 2,706,323 $ 0.33
============ ============
Effect of dilutive shares -
Options................................ 59,795
-----------
Diluted earnings per common share:
Net income................................ $ 916,000
Less: Preferred stock dividends........... (30,000)
------------
Income available to common stockholders... $ 886,000 2,766,118 $ 0.32
============ ============
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
for the nine-month periods ended September 30:
Net Per-Share
Income Shares Amount
------------ ---------- ------------
2004
Basic earnings per common share:
Net income................................ $ 2,642,000
Less: Preferred stock dividends........... (65,000)
------------
Income available to common stockholders... $ 2,577,000 2,796,901 $ 0.92
============ ============
Effect of dilutive shares -
Options and contingent stock........... 90,706
----------
Diluted earnings per common share:
Net income................................ $ 2,642,000
Less: Preferred stock dividends........... (65,000)
------------
Income available to common stockholders... $ 2,577,000 2,887,607 $ 0.89
============ ============
2003
Basic earnings per common share:
Net income................................ $ 3,107,000
Less: Preferred stock dividends........... (90,000)
------------
Net income available to common
stockholders............................ $ 3,017,000 2,703,577 $ 1.12
============ ============
Effect of dilutive shares -
Options................................ 48,272
----------
Diluted earnings per common share:
Net income................................ $ 3,107,000
Less: Preferred stock dividends........... (90,000)
------------
Net income available to common
stockholders............................ $ 3,017,000 2,751,849 $ 1.10
============ ============
The following number of options, with exercise prices ranging from $10.00 to
$17.75, were outstanding during the periods indicated but were not included in
the computation of diluted EPS because their exercise prices were higher than
the average price of BNCCORP's common stock for the period:
2004 2003
---------------- ---------------
Quarter ended March 31........... 3,250 77,185
Quarter ended June 30............ 61,850 63,500
Quarter ended September 30....... 61,850 62,027
NOTE 5 - Segment Disclosures
The Company segments its operations into three separate business activities,
based on the nature of the products and services for each segment: banking
operations, insurance operations and brokerage, trust and financial services
operations.
Banking operations provide traditional banking services to individuals and
small- and mid-sized businesses, such as accepting deposits, consumer and
mortgage banking activities and making commercial loans. The mortgage and
commercial banking activities include the origination and purchase of loans as
well as the sale to and servicing of commercial loans for other institutions.
Banking operations also engages in financing programs related to residential
mortgage loans and student loans.
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 personal trust administration
services, financial, tax, business and estate planning, estate administration,
agency accounts, employee benefit plan design and administration, individual
retirement accounts ("IRAs"), including custodial self-directed IRAs, asset
management, tax preparation, accounting and payroll services.
The accounting policies of the three segments are the same as those described in
the summary of significant accounting policies included in Note 1 to the
consolidated financial statements for the year ended December 31, 2003.
The Company's financial information for each segment is derived from the
internal profitability reporting system used by management to monitor and manage
the financial performance of the Company. The operating segments have been
determined by how executive management has organized the Company's business for
making operating decisions and assessing performance.
The following tables present segment profit or loss, assets and a reconciliation
of segment information as of, and for the three months ended September 30 (in
thousands):
2004 2004
-------------------------------------------------- -----------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other (a) Totals Segments Other (a) Elimination Total
--------- --------- ---------- --------- --------- ---------- ---------- ------------ ------------
Net interest income...............$ 4,283 $ 10 $ 101 $ (548) $ 3,846 $ 4,394 $ (548) $ 12 $ 3,858
Other revenue-external customers.. 2,023 4,369 211 21 6,624 6,602 21 (1,025) 5,598
Other revenue-from other segments. 179 -- 34 273 486 213 273 (486) --
Depreciation and amortization..... 424 282 34 2 742 740 2 -- 742
Equity in the net income of
investees...................... (243) -- -- 614 371 (243) 614 (371) --
Other significant noncash items:
Provision for credit losses..... -- -- -- -- -- -- -- -- --
Segment pre-tax profit (loss)..... 1,070 (338) (14) (629) 89 718 (629) -- 89
Income tax provision (benefit).... 238 (128) (5) (138) (33) 104 (138) -- (34)
Segment profit (loss)............. 832 (210) (9) (491) 122 614 (491) -- 123
Segment assets.................... 623,457 34,168 16,754 76,675 751,054 674,379 76,675 (106,067) 644,987
2003 2003
-------------------------------------------------- -----------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other (a) Totals Segments Other (a) Elimination Total
--------- --------- ---------- --------- --------- ---------- ---------- ------------ ------------
Net interest income...............$ 3,539 $ 13 $ -- $ (528) $ 3,024 $ 3,552 $ (528) $ 13 $ 3,037
Other revenue-external customers.. 2,047 3,532 236 21 5,836 5,815 21 (434) 5,402
Other revenue-from other segments. 32 -- 27 174 233 59 174 (233) --
Depreciation and amortization..... 413 215 3 3 634 631 3 -- 634
Equity in the net income of
investees...................... 332 -- -- 1,226 1,558 332 1,226 (1,558) --
Other significant noncash items:
Provision for credit losses..... 300 -- -- -- 300 300 -- -- 300
Segment pre-tax profit (loss)..... 1,218 732 (37) (608) 1,305 1,913 (608) -- 1,305
Income tax provision (benefit).... 334 387 (34) (298) 389 687 (298) -- 389
Segment profit (loss)............. 884 345 (3) (310) 916 1,226 (310) -- 916
Segment assets.................... 593,784 28,373 1,265 70,006 693,428 623,442 70,006 (97,901) 595,527
- -------------
(a) The financial information in the "Other" column is for the bank holding
company.
The following tables present segment profit or loss, assets and a reconciliation
of segment information as of, and for the nine months ended September 30 (in
thousands):
2004 2004
-------------------------------------------------- -----------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other (a) Totals Segments Other (a) Elimination Total
--------- --------- ---------- --------- --------- ---------- ---------- ------------ ------------
Net interest income...............$ 13,191 $ 41 $ 124 $(1,591) $ 11,765 $ 13,356 $ (1,591) $ 38 $ 11,803
Other revenue-external customers.. 5,984 13,990 821 65 20,860 20,794 65 (3,199) 17,660
Other revenue-from other segments. 494 -- 75 689 1,258 569 689 (1,258) --
Depreciation and amortization..... 1,244 821 99 8 2,172 2,164 8 -- 2,172
Equity in the net income of
investees...................... 1,242 -- -- 3,908 5,150 1,242 3,908 (5,150) --
Other significant noncash items:
Provision for credit losses..... -- -- -- -- -- -- -- -- --
Segment pre-tax profit (loss)..... 3,471 2,150 (152) (1,923) 3,546 5,469 (1,923) -- 3,546
Income tax provision (benefit).... 783 839 (60) (657) 905 1,561 (657) -- 904
Segment profit (loss)............. 2,688 1,311 (92) (1,266) 2,641 3,908 (1,266) -- 2,642
Segment assets.................... 625,711 31,914 16,754 76,675 751,054 674,379 76,675 (106,067) 644,987
2003 2003
-------------------------------------------------- -----------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other (a) Totals Segments Other (a) Elimination Total
--------- --------- ---------- --------- --------- ---------- ---------- ------------ ------------
Net interest income...............$ 11,346 $ 57 $ -- $(1,595) $ 9,808 $ 11,403 $ (1,595) $ 39 $ 9,847
Other revenue-external customers.. 4,844 11,086 1,213 101 17,244 17,143 101 (1,212) 16,032
Other revenue-from other segments. 99 -- 49 493 641 148 493 (641) --
Depreciation and amortization..... 1,216 645 9 12 1,882 1,870 12 -- 1,882
Equity in the net income of
investees...................... 1,807 -- -- 4,188 5,995 1,807 4,188 (5,995) --
Other significant noncash items:
Provision for credit losses..... 1,475 -- -- -- 1,475 1,475 -- -- 1,475
Segment pre-tax profit (loss)..... 2,761 3,031 436 (1,813) 4,415 6,228 (1,813) -- 4,415
Income tax provision (benefit).... 754 1,177 109 (732) 1,308 2,040 (732) -- 1,308
Segment profit (loss)............. 2,007 1,854 327 (1,081) 3,107 4,188 (1,081) -- 3,107
Segment assets.................... 593,784 28,373 1,265 70,006 693,428 623,422 70,006 (97,901) 595,527
- -------------
(a) The financial information in the "Other" column is for the bank holding
company.
NOTE 6 - Stock-Based Compensation
At September 30, 2004, the Company had two stock-based employee compensation
plans. The Company applies the recognition and measurement principles of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" 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" to
stock-based employee compensation (dollars in thousands):
For the three months ended For the nine months ended
September 30, September 30,
-------------------------------- -----------------------------
2004 2003 2004 2003
---------------- ------------ -------------- -----------
Net income, as reported................................. $ 123 $ 916 $ 2,642 $ 3,107
Add: total stock-based employee compensation expense
included in reported net income, net of related
tax effects........................................ 30 2 76 5
Deduct: total stock-based employee compensation
expense determined under fair value method for
all awards, net of related tax effects............. (40) (22) (106) (46)
---------------- ------------ -------------- -----------
Pro forma net income.................................... $ 113 $ 896 $ 2,612 $ 3,066
================ ============ ============== ===========
Earnings per share:
Basic - as reported................................ $ 0.04 $ 0.33 $ 0.92 $ 1.12
Basic - pro forma.................................. $ 0.04 $ 0.30 $ 0.88 $ 1.04
Diluted - as reported.............................. $ 0.04 $ 0.32 $ 0.89 $ 1.10
Diluted - pro forma................................ $ 0.04 $ 0.30 $ 0.85 $ 1.02
NOTE 7 - Derivative Activities
The Company has interest rate cap contracts with notional amounts totaling $20.0
million that were purchased to mitigate interest rate risk in rising-rate
scenarios. The referenced interest rate is three-month LIBOR with the 5.50
percent contracts having five-year original maturities (maturing during May and
June of 2006). An additional $20.0 million of 4.50 percent contracts having
three-year original maturities expired during May and June of 2004. The total
amount paid for the contracts was $1.2 million. The remaining contracts are
reflected in the Company's consolidated balance sheet at their current combined
fair value of approximately $3,000. The contracts are not being accounted for as
hedges under Statement of Financial Accounting Standards No. 133, "Accounting
for Derivatives and Hedging Activities." As a result, the impact of marking the
contracts to fair value has been, and will continue to be, included in net
interest income. During the three months ended September 30, 2004 and 2003, the
impact of marking the contracts to market, reflected as additional (or reduced)
interest expense on Federal Home Loan Bank ("FHLB") advances, was an increase
(reduction) to net interest income of approximately ($26,000) and $20,000,
respectively. During the nine months ended September 30, 2004 and 2003, the
impact of marking the contracts to market was a reduction to net interest income
of approximately ($53,000) and ($76,000), respectively.
NOTE 8 - Change in Goodwill
During the third quarter of 2004, the Company accelerated the payment of the
earnout amount due as a result of the acquisition of Milne Scali & Company
("Milne Scali") in April 2002. The earnout payment was approximately $3.4
million and increased goodwill by that amount. No further amounts are payable as
additional consideration under the Milne Scali acquisition contract. The earnout
payment was accelerated as a result of the termination of a former officer of
Milne Scali. See also Note 11 - Related Party Transactions.
NOTE 9 - Acquisitions
On July 31, 2004, in order to increase the scope of its insurance segment's
operations, Milne Scali acquired the assets of a Denver, Colorado-based surety
producer, for $150,000 of cash. Acquisitions of insurance agencies generally
result in the recognition of intangible assets due to the service nature of the
business, the lack of tangible assets acquired and the profitability of the
acquired agency. The entire purchase price of $150,000 was allocated to an
intangible asset (customer lists), which the surety producer had recently
purchased from his former employer. The intangible asset 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 intangible asset, all
of which is attributable to the Company's insurance segment, will be evaluated
for possible impairment under the provisions of Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets." The
results of operations of the acquired assets are being included in the Company's
consolidated financial statements effective August 1, 2004.
Milne Scali entered into an option agreement with an insurance agency and an
insurance producer on August 17, 2004 (the "Option Agreement"), in order to
further increase the scope of its insurance segment's operations in Utah. The
Option Agreement gives Milne Scali an irrevocable right to purchase all of the
assets of the insurance agency at any time until January 31, 2006. The insurance
producer, the sole shareholder of the insurance agency, also entered into an
employment and non-competition agreement with Milne Scali on August 17, 2004.
The primary term of his employment will be through January 31, 2006. Milne Scali
will make monthly payments of approximately $3,000 in partial consideration for
the grant of the option. These payments will be made to the former owners of the
insurance agency for debt totaling $397,000, which the insurance producer
incurred when he acquired the agency in August of 2001. Milne Scali has not
assumed these obligations and the payments will end if the insurance producer's
employment is terminated or if Milne Scali exercises the option. The option
price is the assumption of the remaining debt obligations. The principal balance
of the debt when Milne Scali entered into the Option Agreement was approximately
$288,000 and the balance will be approximately $268,000 in January of 2006 prior
to the expiration of the Option Agreement.
NOTE 10 - Loans Held for Sale
The Bank has initiated a financing program in which the Bank purchases
short-term participation interests in residential mortgage loans originated by a
mortgage company. Residential mortgage loans held for sale at September 30, 2004
totaled $24.7 million. The majority of the residential mortgage loans will be
paid in full within 60 days. The maximum term for these loans is 120 days. It is
anticipated that additional residential mortgage loans will be purchased under
the program. The Bank has also initiated a financing program in which the Bank
purchases interests in student loans originated by a student loan origination
company. Student loans held for sale at September 30, 2004 totaled $14.8
million. The student loans will be held until the end of the first quarter or
beginning of the second quarter of 2005 at which time they will be paid in full
by proceeds received from the sale of these loans on the secondary market. It is
anticipated that additional student loans will be purchased under the program.
NOTE 11 - Related Party Transactions
On July 23, 2004, Milne Scali paid to a former executive officer, Terrence M.
Scali, $688,000 representing the remaining salary due under his multi-year
employment contract. Mr. Scali is a director of BNCCORP.
On September 14, 2004, Milne Scali paid to the former stockholders of Milne
Scali the remaining amount due under the earnout provisions of the Milne Scali
purchase agreement. The accelerated earnout payment of $3.4 million included
payments to trusts controlled by Richard W. Milne, Jr. and Terrence M. Scali.
Richard W. Milne, Jr. is Chairman and President of Milne Scali and Terrence M.
Scali is a director of BNCCORP. No further amounts are payable as additional
consideration under the Milne Scali purchase agreement.
On September 14, 2004, BNCCORP issued 150 shares of its noncumulative preferred
stock, $0.01 par value per share, to a trust controlled by Richard W. Milne, Jr.
for aggregate cash consideration of $1.5 million. The noncumulative preferred
stock has a preferred noncumulative dividend payable at an annual rate of 8.00
percent and a preferred liquidation value of $10,000 per share. Richard W.
Milne, Jr. is Chairman and President of the Bank's subsidiary Milne Scali.
NOTE 12 - Recently Issued or Adopted Accounting Standards
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46").
FIN 46 addressed 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 applied 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 applied in the first fiscal year or
interim period beginning after June 15, 2003. The Company has adopted the
various provisions of FIN 46 as indicated above but presently does not have any
variable interest entities that would be required to be included in its
consolidated financial statements.
On December 24, 2003, the FASB issued Interpretation No. 46 (revised December
2003), "Consolidation of Variable Interest Entities" ("FIN 46R") which addresses
how a business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FIN 46. FIN 46R indicates that
when voting interests are not effective in identifying whether an entity is
controlled by another party, the economic risks and rewards inherent in the
entity's assets and liabilities and the way in which the various parties that
have involvement with the entity share in those economic risks and rewards
should be used to determine whether the entity should be consolidated. An
enterprise that is involved with another entity generally must assess whether
that involvement requires consolidation under FIN 46R. That involvement may
arise in a variety of ways, such as (a) lending to the entity, (b) investing in
equity (voting or nonvoting) of the entity, (c) issuing guarantees related to
the assets or liabilities of the entity, or both, (d) retaining a beneficial
interest in (or providing financial support for) assets transferred or sold to
the entity, (e) managing the assets of the entity, (f) leasing assets to or from
the entity and (g) entering into a derivative contract with the entity. The
objective of FIN 46R is to provide consolidation guidance for situations in
which voting equity interests do not adequately reflect the controlling
interests in an entity. Public entities are required to apply FIN 46 or FIN 46R
to all entities that are considered special purpose entities in practice and
under the FASB literature that was applied before the issuance of FIN 46 by the
end of the first reporting period that ends after December 31, 2003. Public
companies that are not small business issuers are required to adopt the
accounting requirements of FIN 46R by the end of the first reporting period that
ends after March 15, 2004. The Company has adopted the various provisions of FIN
46R as indicated above but presently does not have any variable interest
entities that would be required to be included in its consolidated financial
statements.
On December 12, 2003, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer"
("SOP 03-3"). SOP 03-3 addresses accounting for differences between contractual
cash flows and cash flows expected to be collected from an investor's initial
investment in loans or debt securities ("loans") acquired in a transfer if those
differences are attributable, at least in part, to credit quality. It includes
such loans acquired in purchase business combinations and applies to all
nongovernmental entities. SOP 03-3 does not apply to loans originated by the
entity. SOP 03-3 limits the yield that may be accreted ("accretable yield") to
the excess of the investor's estimate of undiscounted expected principal,
interest and other cash flows (cash flows expected at acquisition to be
collected) over the investor's initial investment in the loan. SOP 03-3 requires
that the excess of contractual cash flows over cash flows expected to be
collected ("nonaccretable difference") not be recognized as an adjustment of
yield, loss accrual or valuation allowance. SOP 03-3 prohibits investors from
displaying accretable yield and nonaccretable difference in the balance sheet.
Subsequent increases in cash flows expected to be collected generally should be
recognized prospectively through adjustment of the loan's yield over its
remaining life. Decreases in cash flows expected to be collected should be
recognized as impairment. SOP 03-3 prohibits "carrying over" or creation of
valuation allowances in the initial accounting of all loans acquired in a
transfer that are within the scope of SOP 03-3. This prohibition of the
valuation allowance carryover applies to the purchase of an individual loan, a
pool of loans, a group of loans and loans acquired in a purchase business
combination. SOP 03-3 is effective for loans acquired in fiscal years beginning
after December 15, 2004. Early adoption is encouraged. The Company expects to
adopt SOP 03-3 on January 1, 2005. At this time, adoption of SOP 03-3 is not
expected to have a material impact on the Company's financial position or
results of operations.
On March 9, 2004, the SEC issued Staff Accounting Bulletin No. 105, "Application
of Accounting Principles to Loan Commitments" ("SAB 105"). SAB 105 summarizes
the views of the SEC staff regarding the application of generally accepted
accounting principles to loan commitments accounted for as derivative
instruments. SAB 105 will act to significantly limit opportunities to recognize
an asset related to a commitment to originate a mortgage loan that will be held
for sale prior to funding the loan. SAB 105 pertains to recognizing and
disclosing the loan commitments and is effective for commitments to originate
mortgage loans to be held for sale that are entered into after March 31, 2004.
The Company adopted the provisions of SAB 105 beginning April 1, 2004. Adoption
of SAB 105 did not have a material impact on the Company's financial position or
results of operations.
At its March 2004 meeting, the Emerging Issues Task Force ("EITF") revisited
EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments" ("EITF No. 03-1"). Effective with reporting
periods beginning after June 15, 2004, companies carrying certain types of debt
and equity securities at amounts higher than the securities' fair values will
have to use more detailed criteria to evaluate whether to record a loss and will
have to disclose additional information about unrealized losses. The Company has
reviewed the revised EITF No. 03-1 and had planned to implement these additional
procedures effective with the quarter beginning on July 1, 2004, however the
FASB has since issued a statement of financial position deferring the effective
date of the revised EITF No. 03-1 until further implementation issues may be
resolved. Adoption of the new issuance could have an impact on the Company's
financial position and results of operations but the extent of any impact will
vary due to the fact that the model, as issued, calls for many judgments and
additional evidence gathering as such evidence exists at each securities
valuation date.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
For purposes of Items 2, 3 and 4 of Part I of this Form 10-Q, we refer to "we,"
"our" 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.; and "BNC AMI" when
referring only to BNC Asset Management, Inc.
Comparison of Financial Condition at September 30, 2004 and December 31, 2003
Assets. Our total assets increased $23.5 million, from $621.5 million at
December 31, 2003 to $645.0 million at September 30, 2004. The following table
presents our assets by category as of September 30, 2004 and December 31, 2003,
as well as the amount and percent of change between the two dates. Significant
changes are discussed in lettered explanations below the table (amounts are in
thousands):
Change
----------------------------
Assets September 30, December 31,
2004 2003 $ %
----------------- ------------------ ------------- -----------
Cash and due from banks.................... $ 13,209 $ 12,520 $ 689 5.5%
Investment securities available
for sale............................... 236,318 262,568 (26,250) (10.0)% (a)
Federal Reserve Bank and Federal
Home Loan Bank Stock................... 7,782 7,596 186 2.4%
Loans held for sale........................ 39,520 -- 39,520 -- (b)
Loans and leases, net...................... 280,130 278,792 1,338 0.5%
Premises and equipment, net................ 21,001 18,570 2,431 13.1% (c)
Interest receivable........................ 2,550 2,462 88 3.6%
Other assets............................... 14,240 15,507 (1,267) (8.2)%
Goodwill................................... 21,834 15,089 6,745 44.7% (d)
Other intangible assets, net............... 8,403 8,373 30 0.4%
----------------- ------------------ ------------- -----------
Total assets...................... $ 644,987 $ 621,477 $23,510 3.8%
================= ================== ============= ===========
- -------------------
(a) During the nine-month period ended September 30, 2004, we purchased $58.7
million of investment securities while we sold $51.5 million and there were
$31.0 million of investment securities that matured and were paid off. We
used the proceeds from the investment security sales and maturities to fund
some of the loans held for sale discussed in note (b) below.
(b) The Bank has initiated a financing program in which the Bank purchases
short-term participation interests in residential mortgage loans originated
by a mortgage company. Residential mortgage loans held for sale at
September 30, 2004 totaled $24.7 million. The majority of the residential
mortgage loans will be paid in full within 60 days. The maximum term for
these loans is 120 days. It is anticipated that additional residential
mortgage loans will be purchased under the program. The Bank has also
initiated a financing program in which the Bank purchases interests in
student loans originated by a student loan origination company. Student
loans held for sale at September 30, 2004 totaled $14.8 million. The
student loans will be held until the end of the first quarter or beginning
of the second quarter of 2005 at which time they will be paid in full by
proceeds received from the sale of these loans on the secondary market. It
is anticipated that additional student loans will be purchased under the
program.
(c) The increase in premises and equipment is primarily attributable to our
renovation of a banking facility in Golden Valley, Minnesota along with
some upgrading of our location at 322 East Main Avenue in Bismarck.
(d) Goodwill increased due to the 2004 earnout payment related to the
acquisition of Milne Scali ($2.6 million) as well as the goodwill generated
by three insurance agency acquisitions ($1.4 million) and a mortgage
company acquisition ($225,000) between December 31, 2003 and September 30,
2004. Additionally, during the third quarter of 2004, we paid the
accelerated earnout related to the Milne Scali acquisition ($3.4 million).
The accelerated earnout payment is the final payment due under the Milne
Scali acquisition agreement.
Allowance for Credit Losses. The following table sets forth information
regarding changes in our allowance for credit losses for the three- and
six-month periods ended September 30, 2004 and 2003 (amounts are in thousands):
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------------------- -----------------------------------
2004 2003 2004 2003
-------------------- ---------------- ----------------- -----------------
Balance, beginning of period............... $ 3,443 $ 4,953 $ 4,763 $ 5,006
Provision for credit losses................ -- 300 -- 1,475
Loans charged off.......................... (23) (438) (1,596) (1,725)
Loans recovered............................ 4 12 257 71
-------------------- ---------------- ----------------- -----------------
Balance, end of period..................... $ 3,424 $ 4,827 $ 3,424 $ 4,827
==================== ================ ================= =================
Ending loan portfolio ..................... $ 323,074 $ 279,391
==================== ================
Allowance for credit losses as
a percentage of ending loan portfolio.... 1.06% 1.73%
As of September 30, 2004, our allowance for credit losses was 1.06 percent of
total loans as compared to 1.73 percent at September 30, 2003. The decrease is
reflective of approximately $1.6 million of charge-offs and the reduced reserve
requirement related to a significant decline in nonperforming loans between
December 31, 2003 and September 30, 2004. Nonperforming loans declined from
approximately $8.0 million to $864,000 over the nine-month period ended
September 30, 2004.
There was no provision for loan losses for the three- or nine-month periods
ended September 30, 2004 compared to $300,000 and $1.5 million, respectively,
for the three- and nine-month periods ended September 30, 2003. This decrease is
a direct response to a significant reduction in nonperforming loans between
December 31, 2003 and September 30, 2004. See "-Nonperforming Assets" below.
Loans charged off during the first three quarters of 2004 totaled $1.6 million,
representing a $129,000 decrease from loans charged off during the same period
of 2003. The charge-offs for 2004 were primarily attributable to charge-offs of
approximately $1.2 million related to one commercial loan in the first quarter
of 2004. $975,000 of the $1.2 million was reserved for as of December 31, 2003
and $162,000 related to this loan was collected in June 2004. During the second
quarter of 2004, we also charged off $264,000 related to a business loan. A
settlement agreement was subsequently entered into with respect to this loan and
monthly payments have resumed. The payments will be credited to the allowance
for credit losses as received.
Net charge-offs as a percentage of average total loans for the three- and
nine-month periods ended September 30, 2004 and 2003 were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2004 2003 2004 2003
---------- ---------- ---------- -----------
Ratio of net charge-offs to
average total loans............. (0.01)% (0.15)% (0.48)% (0.52)%
Ratio of net charge-offs to
average total loans,
annualized...................... (0.03)% (0.58)% (0.64)% (0.70)%
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 approximately $956,000 at
September 30, 2004.
Reserves for Homogeneous Loan Pools. We make a significant number of loans
and leases that, due to their underlying similar characteristics, are
assessed for loss as "homogeneous" pools. Included in the homogeneous pools
are consumer loans and commercial loans under a certain size, which have
been excluded from the specific reserve allocation previously discussed. We
segment the pools by type of loan or lease and, using historical loss
information, estimate a loss reserve for each pool. Reserves for
homogeneous loan pools totaled approximately $2.4 million at September 30,
2004.
Qualitative Reserve. Our senior lending management also allocates reserves
for special situations, which are unique to the measurement period. These
include, among other things, prevailing and anticipated economic trends,
such as economic conditions in certain 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 approximately $76,000 at September 30,
2004.
Continuous credit monitoring processes and the analysis of loss components is
the principal method relied upon by management to ensure that changes in
estimated credit loss levels are reflected in our allowance for credit losses on
a timely basis. Management also considers experience of peer institutions and
regulatory guidance in addition to our own experience. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the allowance for credit losses. Such agencies may require
additions to the allowance based on their judgment about information available
to them at the time of their examination.
Loans, leases and other extensions of credit deemed uncollectible are charged to
the allowance. Subsequent recoveries, if any, are credited to the allowance. The
amount of the allowance for credit losses is highly dependent upon management's
estimates of variables affecting valuation, appraisals of collateral,
evaluations of performance and status, and the amounts and timing of future cash
flows expected to be received on impaired loans. Such estimates, appraisals,
evaluations and cash flows may be subject to frequent adjustments due to
changing economic prospects of borrowers, lessees or properties. These estimates
are reviewed periodically. Actual losses may vary from current estimates and the
amount of the provision may be either greater than or less than actual net
charge-offs. The related provision for credit losses, which is charged to
income, is the amount necessary to adjust the allowance to the level determined
appropriate through application of the above processes. Further information on
the allowance for credit losses is included under "-Critical Accounting
Policies."
Nonperforming Assets. The following table sets forth information concerning our
nonperforming assets as of the dates indicated (amounts are in thousands):
September 30, December 31,
2004 2003
---------------- -----------------
Nonperforming loans:
Loans 90 days or more delinquent
and still accruing interest............. $ 27 $ 38
Nonaccrual loans......................... 837 7,913
Restructured loans....................... -- --
---------------- -----------------
Total nonperforming loans................... 864 7,951
Other real estate owned and
repossessed assets...................... -- --
---------------- -----------------
Total nonperforming assets.................. $ 864 $ 7,951
================ =================
Allowance for credit losses................. $ 3,424 $ 4,763
================ =================
Ratio of total nonperforming assets
to total assets ........................... 0.13% 1.28%
Ratio of total nonperforming loans
to total loans............................. 0.27% 2.80%
Ratio of allowance for credit losses
to total nonperforming loans............... 396% 60%
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.
During the quarter ended March 31, 2004, two loans totaling approximately $6.7
million and reflected as nonaccrual loans at December 31, 2003 were resolved.
The first was a $4.5 million loan secured by commercial real estate on which we
received full payoff, including collection of cash basis interest income of
approximately $408,000. The second loan of approximately $2.2 million was
resolved resulting in a charge-off of approximately $1.2 million. $975,000 of
the $1.2 million was reserved for at December 31, 2003. $162,000 related to this
loan was collected in June 2004.
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
September 30, 2004 or 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 other real estate owned and repossessed assets at
September 30, 2004 or at December 31, 2003.
Liabilities. Our total liabilities increased approximately $19.9 million, from
$581.3 million at December 31, 2003 to $601.2 million at September 30, 2004. The
following table presents our liabilities by category as of September 30, 2004
and December 31, 2003 as well as the amount and percent of change between the
two dates. Significant changes are discussed in lettered explanations below the
table (amounts are in thousands):
Change
-------------------------------
Liabilities September 30, December 31,
2004 2003 $ %
------------------- ------------------ --------------- ------------
DEPOSITS:
Noninterest-bearing.................... $ 61,164 $ 44,725 $ 16,439 36.8% (a)
Interest-bearing -
Savings, interest checking and money
market............................ 204,586 215,525 (10,939) (5.1)% (b)
Time deposits $100,000 and over...... 64,526 46,569 17,957 38.6% (c)
Other time deposits.................. 96,158 89,123 7,035 7.9% (c)
Short-term borrowings.................. 29,869 31,383 (1,514) (4.8)%
Federal Home Loan Bank advances........ 102,200 112,200 (10,000) (8.9)% (d)
Long-term borrowings................... 10,095 8,640 1,455 16.8% (e)
Guaranteed preferred beneficial
interests in company's subordinated
debentures........................... 22,249 22,397 (148) (0.7)%
Other liabilities...................... 10,401 10,729 (328) (3.1)%
------------------- ------------------ ---------------
Total liabilities............. $ 601,248 $ 581,291 $ 19,957 3.4%
=================== ================== ===============
- -------------------
(a) Noninterest-bearing deposits increased due to deposit growth generated
primarily by our recently opened Scottsdale and Phoenix (Arizona) and
Golden Valley (Minnesota) branches. Such deposits can also fluctuate on a
day-to-day basis due to the number of commercial customers we serve and the
nature of their transaction account activity.
(b) The decrease in savings, interest checking and money market deposits is
largely attributable to the fact that, at December 31, 2003, several
customers had funds in our Wealthbuilder deposit accounts awaiting
placement into the CDARSsm certificates of deposit program. These balances
were transferred during 2004. Decreases in this category can also be
attributable to the fact that, at year-end, commercial customers often draw
down on their lines of credit and place the money in their deposit
accounts. Subsequently, during the following year, the deposits are used to
pay down the lines of credit. These reductions in balances in this category
were offset by growth in the Wealthbuilder family of deposit products,
particularly in the Arizona and Minnesota markets.
(c) Certificates of deposit increased due to a $14.7 million increase in
brokered deposits and a $13.8 million increase in deposits made under the
CDARSsm program, including some of the deposits noted in (b) above. The
CDARSsm program was implemented during the second half of 2003. These
increases were offset by a $7.5 million decrease in national market
certificates of deposit as these deposits matured and were replaced with
other funding sources.
(d) $10.0 million of FHLB advances held at December 31, 2003 matured in January
2004.
(e) The increase in long-term borrowings is attributable to a $1.5 million
advance made in June 2004 for the purpose of repurchasing our outstanding
shares of noncumulative preferred stock for $1.5 million.
Stockholders' Equity. Our stockholders' equity increased approximately $3.6
million between December 31, 2003 and September 30, 2004. This increase was
attributable to earnings of approximately $2.6 million coupled with
approximately $1.2 million of other transactions such as stock option exercises,
vesting of restricted stock and stock issued in acquisitions. These increases
were offset by a $232,000 decrease in accumulated other comprehensive income and
the payment of $65,000 of preferred stock dividends. Our outstanding shares of
noncumulative preferred stock was repurchased for $ 1.5 million (its liquidation
preference) during the second quarter of 2004 and then reissued for $1.5 million
during the third quarter of 2004.
Capital Adequacy and Expenditures. We actively monitor compliance with
regulatory capital requirements, including risk-based and leverage capital
measures. Under the risk-based capital method of capital measurement, the ratio
computed is dependent on the amount and composition of assets recorded on the
balance sheet, and the amount and composition of off-balance-sheet items, in
addition to the level of capital. The following table includes the risk-based
and leverage capital ratios of the Company and the Bank as of September 30,
2004:
Tier 1 Total
Risk- Risk- Tier 1
Based Based Leverage
Ratio Ratio Ratio
--------------- ---------------- --------------
BNCCORP, consolidated...... 6.33% 8.98% 4.43%
BNC National Bank.......... 9.67% 10.47% 6.77%
As of September 30, 2004, the Company and the Bank exceeded capital adequacy
requirements and the Bank was considered "well capitalized" under prompt
corrective action provisions.
At September 30, 2004, our consolidated tier 1 leverage ratio was 4.43 percent
compared with 4.90 percent at December 31, 2003. Our consolidated tier 1
risk-based capital ratio was 6.33 percent at September 30, 2004 versus 7.14
percent at December 31, 2003. Our consolidated total risk-based capital ratio
was 8.98 percent at September 30, 2004 versus 10.63 percent at December 31,
2003. The change in capital ratios during the nine-month period primarily
reflected the payment of the 2004 earnout related to the Milne Scali acquisition
(which increased goodwill by $2.6 million), the payment of the accelerated
earnout related to the Milne Scali acquisition (which increased goodwill by $3.4
million) and the acquisitions of three insurance agencies and a mortgage company
(which increased goodwill and other intangible assets by approximately $1.6
million). The payment of the accelerated earnout is the final earnout payment
due under the Milne Scali acquisition agreement and was precipitated by the
termination of an executive officer of Milne Scali. The accelerated earnout
payment represented payments that would have been made during 2005 and 2006
under the Milne Scali acquisition agreement.
Capital expenditures expected during the remainder of 2004 could consist of the
purchase or leasing of additional facilities in our various market areas should
such facilities or properties be deemed to add additional franchise value. Such
capital expenditures will be paid through cash generated from operations.
Additionally, potential acquisitions could increase capital expenditures as such
transactions are consummated. Such capital expenditures would likely be paid
through cash generated from operations or the issuance of BNCCORP common stock.
Comparison of Operating Results for the Three and Nine Months
Ended September 30, 2004 and 2003
General. We reported net income of $123,000, or $0.04 per share on a diluted
basis, for the third quarter ended September 30, 2004. For the same quarter of
2003, we reported net income of $916,000, or $0.32 per diluted share.
Results for the 2004 third quarter included the expense of $688,000 related to
the previously announced termination of the employment of a former officer of
our insurance subsidiary. The payment represented the acceleration of the
remaining salary due under his multi-year employment contract originally
scheduled to expire in April 2007. The recent quarter's results also reflect our
continued investments in branch locations, business operations and management
personnel that we believe will generate profitable growth and enhance the value
of the Company in the long term. While these growth initiatives have not yet
translated into higher earnings, we are already beginning to see some results,
especially in terms of deposit growth, loan growth, including our mortgage loan
financing business, and rising insurance commission volume.
Growth initiatives during 2003 and 2004 included new branch offices in Phoenix
and Scottsdale, Arizona, and Golden Valley, Minnesota. Additionally, we expanded
our insurance segment through asset acquisitions in Salt Lake City, Utah; Tucson
and Prescott Valley, Arizona; and Denver, Colorado. We also acquired a mortgage
banking operation based in Tempe, Arizona.
Looking forward to the fourth quarter of 2004, we believe we can produce a
healthy improvement in earnings as compared with this year's third quarter which
was impacted in particular by the employment contract termination payment
mentioned earlier. We are pleased with the $51.5 million, or 15.3 percent,
growth in core deposits over the twelve-month period ended September 30, 2004
and the positive trends emerging in yield on earning assets and the cost of
interest-bearing liabilities (discussed in the sections that follow). Over the
twelve-month period ended September 30, 2004, noninterest-bearing deposits
increased $20.1 million, or 49.1 percent, while core certificates of deposit
grew $18.7 million over the same period. A significant portion of this deposit
growth has come from the new branch offices discussed above.
Net interest income for the third quarter of 2004 was $3.86 million, up 27.0
percent from $3.04 million in the same period of 2003. This increase reflected a
widening of the net interest margin to 2.72 percent for the quarter ended
September 30, 2004, from 2.21 percent for the same period in 2003.
Noninterest income was $5.60 million for the 2004 third quarter, an increase of
3.6 percent from $5.40 million for the year-ago period. Commissions generated by
our insurance agency subsidiary, Milne Scali, were the largest contributor to
noninterest income ($4.31 million) rising 23.3 percent from the year-ago
quarter, primarily due to acquisitions. Trust and financial services income rose
slightly compared with the same quarter of 2003, while loan fees, service
charges, brokerage income and net gain on the sale of securities decreased.
Noninterest income represented 59.20 percent of gross revenues for the recent
quarter, down from 64.01 percent a year ago.
Noninterest expense for the third quarter of 2004 was $9.37 million, compared
with $6.83 million in the same quarter of 2003. The increase primarily reflected
higher employee and occupancy expenses due to the expansion of our branch
offices and insurance agency operations as well as the employment contract
termination expense noted earlier. Further discussion of our performance in the
third quarter of 2004 versus that of the third quarter of 2003 is presented in
the sections that follow.
For the first nine months of 2004, we reported net income of $2.64 million, or
$0.89 per diluted share, compared with net income of $3.11 million, or $1.10 per
diluted share, in the same period of 2003.
Net interest income was $11.80 million for the first nine months of 2004, rising
19.9 percent from $9.85 million in the year-ago period. The net interest margin
widened to 2.85 percent for the first nine months of 2004, from 2.44 percent for
the same period in 2003. Some nonrecurring items impacted net interest income
and margin for the nine months ended September 30, 2004 and 2003 and those are
discussed in the section that follows.
Noninterest income rose to $17.66 million for the first nine months of 2004, a
10.2 percent increase from $16.03 million in the same period of 2003. The
increase largely reflected a higher volume of insurance commissions. Trust and
financial services income decreased from the year-ago period, which included a
$488,000 transaction fee generated by the Bank's financial services division.
Noninterest income represented 59.94 percent of gross revenues for the recent
period, compared with 61.95 percent for the same 2003 period. Additionally, a
nonrecurring gain of $527,000 from the final resolution of a reinsurance program
previously associated with Milne Scali, was reflected in other income during the
recent nine-month period.
Noninterest expense for the first nine months of 2004 was $25.92 million, an
increase of 29.7 percent compared with $19.99 million in the year-ago period,
largely due to the employment contract termination expense and investments in
staffing and locations, as noted previously. Further discussion of our
performance in the first nine months of 2004 versus the same period in 2003 is
presented in the sections that follow.
Net Interest Income. Net interest income for the three-month period ended
September 30, 2004 increased approximately $821,000, or 27.0 percent, from
approximately $3.04 million to approximately $3.86 million. Net interest margin
increased to 2.72 percent for the quarter ended September 30, 2004 from 2.21
percent for the same period one year earlier. The 51 basis point improvement in
net interest margin reflected an increase in average earning asset volume
coupled with a 29 basis point increase in yield on earning assets. Importantly,
average interest-bearing deposit volume increased $27.33 million and was coupled
with a 31 basis point reduction in the cost of those deposits. The cost of total
interest-bearing liabilities was reduced by 29 basis points in the 2004 versus
2003 third quarter.
Net interest income for the nine-month period ended September 30, 2004 increased
approximately $1.96 million, or 19.9 percent, from approximately $9.85 million
to approximately $11.80 million. Net interest margin increased to 2.85 percent
for the nine months ended September 30, 2004 from 2.44 percent for the same
period one year earlier. Net interest income and margin for the nine-month
period ended September 30, 2004 were favorably impacted by the recovery of cash
basis interest income of approximately $408,000 on a $4.5 million loan that had
been classified as nonaccrual at December 31, 2003. Net interest income and
margin for the nine-month period ended September 30, 2003 were negatively
impacted by the charge-off of interest income of approximately $287,000 on the
same loan. Additionally, net interest income and margin for the nine-month
periods ended September 30, 2004 and 2003 were negatively impacted by derivative
contract-related transactions during the periods totaling approximately
($53,000) and ($76,000), respectively. Without these interest income variances
and derivative transactions, net interest income for the periods would have been
approximately $11.45 and $10.21 million, respectively, and net interest margin
would have been 2.76 and 2.53 percent, respectively.
A significant contribution to the improvement in net interest margin for the
nine-month period ended September 30, 2004 was a 45 basis point reduction in the
cost of interest-bearing liabilities caused by a 46 basis point reduction in the
cost of interest-bearing deposits coupled with a 50 basis point reduction in the
cost of borrowings. Our active management of deposit costs during the latter
part of 2003 and the early part of 2004 along with a change in the mix of the
average interest-bearing deposit portfolio (a reduction in certificates of
deposit and an increase in interest checking and money market deposits) helped
to create this reduction in the cost of interest-bearing liabilities.
The following tables present average balances, interest earned or paid,
associated yields on interest-earning assets and costs on interest-bearing
liabilities for the three- and nine-month periods ended September 30, 2004 and
2003, as well as the changes between the periods presented. Significant factors
contributing to the increase in net interest income and net interest margin are
discussed in lettered notes below the tables (amounts are in thousands):
Three Months Ended September 30,
------------------------------------------------------------------
2004 2003 Change
-------------------------------- -------------------------------- --------------------------------
Interest Average Interest Average Interest Average
Average earned yield or Average earned yield or Average earned yield
balance or paid cost balance or paid cost balance or paid or cost
---------- ---------- ---------- ---------- ---------- ---------- ---------- --------- ---------
Interest-earning assets
Federal funds sold/interest
bearing due from............ $ 781 $ 3 1.53% $ 4,223 $ 9 0.85% $ (3,442) $ (6) 0.68%
Investments................... 269,529 2,780 4.10% 251,496 2,189 3.45% 18,033 591 0.65%(a)
Loans......................... 297,466 4,593 6.14% 293,619 4,536 6.13% 3,847 57 0.01%(b)
Allowance for loan losses... (3,436) -- (4,776) -- 1,340 --
---------- ---------- ---------- ---------- ---------- ---------
Total interest-earning
assets..................... $ 564,340 7,376 5.20% $ 544,562 6,734 4.91% $ 19,778 642 0.29%
========== ---------- ========== ---------- ========== ---------
Interest-bearing liabilities
Interest checking & money
market accounts............. $ 194,267 511 1.05% $ 182,015 500 1.09% $ 12,252 11 -0.04%(c)
Savings....................... 6,563 11 0.67% 6,285 13 0.82% 278 (2) -0.15%
Certificates of deposit
under $100,000.............. 96,749 597 2.45% 92,057 711 3.06% 4,692 (114) -0.61%
Certificates of deposit
$100,000 and over........... 64,485 471 2.91% 54,373 517 3.77% 10,112 (46) -0.86%(d)
---------- ---------- ---------- ---------- ---------- ---------
Interest-bearing deposits... 362,064 1,590 1.75% 334,730 1,741 2.06% 27,334 (151) -0.31%
Short-term borrowings......... 30,920 140 1.80% 21,935 84 1.52% 8,985 56 0.28%(e)
Federal Home Loan Bank
advances.................... 109,063 1,246 4.54% 116,985 1,345 4.56% (7,922) (99) -0.02%(f)
Long-term borrowings.......... 10,100 99 3.90% 8,662 97 4.44% 1,438 2 -0.54%
Subordinated debentures....... 22,180 443 7.95% 22,094 430 7.72% 86 13 0.23%
---------- ---------- ---------- ---------- ---------- ---------
Total borrowings............ 172,263 1,928 4.45% 169,676 1,956 4.57% 2,587 (28) -0.12%
---------- ---------- ---------- ---------- ---------- ---------
Total interest-bearing
liabilities............... $ 534,327 3,518 2.62% $ 504,406 3,697 2.91% $ 29,921 (179) -0.29%
========== ---------- ========== ==========
Net interest income/spread.. $ 3,858 2.58% $3,037 2.00% $ 821 0.58%
========== ========== =========
Net interest margin......... 2.72% 2.21% 0.51%(g)
Notation:
Noninterest-bearing deposits.. $ 55,908 -- $ 40,934 -- $ 14,974 --
---------- ----------- ----------
Total deposits.............. $ 417,972 $ 1,590 1.51% $ 375,664 $1,741 1.84% $ 42,308 $ (151) -0.33%
========== ========== ========== ========== ========== =========
Taxable equivalents:
Total interest-earning
assets.................... $ 564,340 $ 7,413 5.23% $ 544,562 $6,964 5.09% $ 19,778 $ 449 0.14%
Net interest income/spread.. -- $ 3,895 2.61% -- $3,267 2.18% -- $ 628 0.43%
Net interest margin......... -- -- 2.75% -- -- 2.39% -- -- 0.36%
- ------------------------------
Nine Months Ended September 30,
-------------------------------------------------------------------
2004 2003 Change
-------------------------------- --------------------------------- --------------------------------
Interest Average Interest Average Interest Average
Average earned yield or Average earned yield or Average earned yield
balance or paid cost balance or paid cost balance or paid or cost
---------- ---------- ---------- ---------- ----------- ---------- ----------- --------- ---------
Interest-earning assets
Federal funds sold/interest
bearing due from........... $ 375 $ 3 1.07% $ 1,663 $ 10 0.80% $ (1,288) $ (7) 0.27%
Investments................... 279,568 8,730 4.17% 225,897 6,499 3.85% 53,671 2,231 0.32%(a)
Loans......................... 277,854 13,456 6.47% 317,188 14,958 6.31% (39,334) (1,502) 0.16%(b)
Allowance for loan losses... (3,919) -- (4,948) -- 1,029 --
---------- ---------- ---------- ----------- ----------- ---------
Total interest-earning
assets..................... $ 553,878 22,189 5.35% $539,800 21,467 5.32% $ 14,078 722 0.03%
========== ---------- ========== ----------- =========== ---------
Interest-bearing liabilities
Interest checking & money
market accounts............. $ 197,051 1,521 1.03% $182,236 1,659 1.22% $ 14,815 (138) -0.19%(c)
Savings....................... 6,624 34 0.69% 5,878 39 0.89% 746 (5) -0.20%
Certificates of deposit
under $100,000.............. 95,571 1,837 2.57% 96,607 2,347 3.25% (1,036) (510) -0.68%
Certificates of deposit
$100,000 and over........... 54,783 1,354 3.30% 58,207 1,725 3.96% (3,424) (371) -0.66%(d)
---------- ---------- ---------- ----------- ----------- ---------
Interest-bearing deposits... 354,029 4,746 1.79% 342,928 5,770 2.25% 11,101 (1,024) -0.46%
Short-term borrowings......... 30,094 357 1.58% 22,492 305 1.81% 7,602 52 -0.23%(e)
Federal Home Loan Bank
advances.................... 111,254 3,707 4.45% 107,710 3,953 4.91% 3,544 (246) -0.46%(f)
Long-term borrowings.......... 9,132 280 4.10% 8,615 292 4.53% 517 (12) -0.43%
Subordinated debentures....... 22,203 1,296 7.80% 22,105 1,300 7.86% 98 (4) -0.06%
---------- ---------- ---------- -----------
Total borrowings............ 172,683 5,640 4.36% 160,922 5,850 4.86% 11,761 (210) -0.50%
---------- ---------- ---------- ----------- ----------- ---------
Total interest-bearing
liabilities............... $ 526,712 10,386 2.63% $503,850 11,620 3.08% $ 22,862 (1,234) -0.45%
========== ---------- ========== ===========
Net interest income/spread.. $11,803 2.72% $ 9,847 2.24% $ 1,956 0.48%
========== =========== =========
Net interest margin......... 2.85% 2.44% 0.41%(g)
Notation:
Noninterest-bearing deposits.. $ 48,607 -- $ 39,210 -- $ 9,397 --
---------- ---------- -----------
Total deposits.............. $ 402,636 $ 4,746 1.57% $382,138 $ 5,770 2.02% $ 20,498 $(1,024) -0.45%
========== ========== ========== =========== =========== =========
Taxable equivalents:
Total interest-earning
assets.................... $ 553,878 $22,811 5.50% $539,800 $22,053 5.46% $ 14,078 $ 758 0.04%
Net interest income/spread.. -- $12,425 2.87% -- $10,433 2.38% -- $ 1,992 0.49%
Net interest margin......... -- -- 3.00% -- -- 2.58% -- -- 0.42%
- ---------------------------------
(a) Average investments during the three- and nine-month periods ended
September 30, 2004 exceeded those for the same periods in 2003 due to our
portfolio and liquidity management strategies, including the purchase of
investment securities to offset a decrease in the earning asset portfolio
that resulted from a net decrease in loan volume. While total investments
at September 30, 2004 were $236.3 million compared with $246.3 million at
September 30, 2003, (due to securities sales and maturities during the
nine-month period ended September 30, 2004), the average balances for the
two 2004 periods reflected above exceeded those for the 2003 periods. The
yield variance in the three-month period was primarily attributable to
events during 2003 when increased premium amortization on mortgage-backed
securities and collateralized mortgage obligations and increased
prepayments in the third quarter of 2003 resulted from the record-low
mortgage rates in the second quarter of 2003.
(b) Average loans in the nine-month comparison above decreased primarily as a
result of general planned loan payoffs and paydowns of commercial revolving
lines of credit. Actual loan balances at September 30, 2004 and September
30, 2003 were $323.1 and $279.4 million, respectively. The September 30,
2004 loan volume was impacted by $24.7 million of residential mortgage
loans and $14.8 million of student loans held for sale as of that date
under the recently established loan programs described in Note 10 to the
financial statements included under Item I. Loan yield for the nine-month
period ended September 30, 2004 was favorably impacted by the recovery of
$408,000 of cash basis interest income on a $4.5 million loan that was
classified as nonaccrual at December 31, 2003 and was paid in full during
the first quarter of 2004. Without this recovery, interest income on loans
for the nine-month period ended September 30, 2004 would have been
approximately $13.0 million and the yield on loans would have been 6.27
percent. Loan yield for the nine-month period ended September 30, 2003 was
negatively impacted by the charge-off of $287,000 of interest income on the
same loan. Without this charge-off, interest income on loans for the
nine-month period ended September 30, 2003 would have been approximately
$15.2 million and the yield on loans would have been 6.43 percent.
(c) Increased average balances of interest checking and money market accounts
represents additional growth in our floating-rate Wealthbuilder deposit
products. These transaction accounts can fluctuate significantly based on
the cash management activities of our commercial customers. This is
evidenced by the fact that, as indicated earlier, the period-end balance in
these accounts at September 30, 2004 is down from the period-end balance at
December 31, 2003. Commercial customers often draw down on their lines of
credit at year-end and place these funds in interest checking and money
market accounts. After year-end, customers pay down on their lines of
credit using these funds. While this can negatively impact the period end
numbers in the subsequent year, averages for the presented periods were
actually up in 2004 versus the same periods in 2003. Yields in this deposit
category declined in 2004 for the three- and nine-month comparisons due to
our active management of deposit costs in late 2003 and early 2004.
(d) For the three months ended September 30, 2004, average balances in
brokered, national market and CDARSsm certificates of deposit totaled
$32.0, $6.3 and $15.7 million, respectively. Average balances in brokered
and national market and CDARSsm certificates of deposit totaled $22.3 and
$17.3 million and $32,000, respectively, for the three months ended
September 30, 2003. For the nine months ended September 30, 2004, average
balances of brokered, national market and CDARSsm certificates of deposit
were $23.6, $8.8 and $12.3 million, respectively. For the same period
during 2003, average balances of brokered, national market and CDARSsm
certificates of deposit totaled $25.6 and $21.6 million and $11,000,
respectively. The reduced cost of these certificates of deposit reflects
the maturity of higher rate certificates of deposit and renewal or
origination of new certificates of deposit at lower current rates.
(e) Average short-term borrowings increased during the three- and nine-month
periods ended September 30, 2004 over the same periods in 2003 due to an
increase in average Federal funds purchased. For the three-month periods
ended September 30, 2004 and 2003, average Federal funds purchased were
$15.5 and $5.0 million, respectively. For the nine-month periods ended
September 30, 2004 and 2003, average Federal funds purchased were $14.1 and
$6.8 million, respectively. Reduced costs of short-term borrowings for the
nine-month period ended September 30, 2004 reflect the overall interest
rate environment in 2004 versus 2003. Increased costs of short-term
borrowings for the three-month period ended September 30, 2004 reflect
recent increases in the Federal funds rate by the Federal Reserve.
(f) The increase in volume of FHLB advances for the nine-month period ended
September 30, 2004 resulted from the use of additional short-term FHLB
advances in early 2004. Short-term FHLB advances are used to manage
liquidity similar to how Federal funds purchased are used on a day-to-day
basis. The short-term advances provide us with a slightly more
cost-effective way of managing short-term liquidity needs since the FHLB
gives a discount for advances of $10.0 million or more. The lower costs of
FHLB advances reflect the overall lower rate structure in 2004 versus 2003.
For the three-month period ended September 30, 2004, average FHLB advances
declined as compared to the same period in 2003 due to the increase in
other funding sources. The yield in 2004 compared with 2003 is beginning to
reflect Federal Reserve rate increases during 2004.
(g) Net interest margin for the nine months ended September 30, 2004 was
favorably impacted by the previously mentioned recovery of cash basis
interest income of $408,000 during the quarter ended March 31, 2004.
Without this recovery, and without the impact of derivative contract
adjustments, net interest margin would have been 2.76 percent for the nine
months ended September 30, 2004. Additionally, net interest margin for the
nine months ended September 30, 2003 was negatively impacted by the
charge-off of interest income on the same loan of $287,000 during the
quarter ended March 31, 2003. Without this charge-off and without the
impact of derivative contract adjustments, net interest margin would have
been 2.53 percent for the nine months ended September 30, 2003.
Provision for Credit Losses. There was no provision for credit losses for the
three- or nine-month periods ended September 30, 2004 as compared to $300,000
and $1.5 million, respectively, for the three- and nine-month periods ended
September 30, 2003. No provisions for credit losses have been necessary during
2004 largely due to the significant decline in nonperforming assets between
December 31, 2003 and September 30, 2004. See "Comparison of Financial Condition
at September 30, 2004 and December 31, 2003 - Allowance for Credit Losses."
Noninterest Income. The following table presents the major categories of our
noninterest income for the three- and nine-month periods ended September 30,
2004 and 2003 as well as the amount and percent of change between the periods.
Significant changes are discussed in lettered explanations following the table
(amounts are in thousands):
Noninterest Income Three Months Ended Nine Months Ended
September 30, Change September 30, Change
------------------------ --------------------- -------------------------- ---------------------
2004 2003 $ % 2004 2003 $ %
---------- ------------ ---------- ---------- ----------- ------------- ---------- ----------
Insurance commissions........... $ 4,312 $ 3,498 $ 814 23.3% $13,296 $ 10,983 $2,313 21.1% (a)
Fees on loans................... 455 698 (243) (34.8)% 1,370 1,641 (271) (16.5)% (b)
Service charges................. 214 239 (25) (10.5)% 635 667 (32) (4.8)%
Trust and financial services.... 120 95 25 26.3% 378 912 (534) (58.6)% (c)
Net gain on sales of securities. 116 448 (332) (74.1)% 167 869 (702) (80.8)% (d)
Brokerage income................ 95 141 (46) (32.6)% 448 291 157 54.0% (e)
Rental income................... 25 68 (43) (63.2)% 86 145 (59) (40.7)%
Other........................... 261 215 46 21.4% 1,280 524 756 144.3% (f)
---------- ------------ ---------- ----------- ------------- ----------
Total noninterest income........ $ 5,598 $ 5,402 $ 196 3.6% $17,660 $ 16,032 $1,628 10.2%
========== ============ ========== =========== ============= ==========
Noninterest income as a
percent of gross revenues...... 59.2% 64.0% (4.8)% 59.9% 61.9% (2.0)%
========== ============ =========== =============
- -----------------
(a) Insurance commissions increased due to growth in the insurance segment,
including production from the Tucson location acquired on December 31,
2003, the Salt Lake City location acquired on March 31, 2004, the Prescott
Valley location acquired on June 30, 2004 and the Denver location acquired
on July 31, 2004. Additionally, there was an increase in contingency fee
income received from insurance companies. Contingency fee income recognized
during the nine months ended September 30, 2004 was $1.34 million compared
to $945,000 for the same period in 2003.
(b) Loan fees included in noninterest income decreased during the three- and
nine-month periods ended September 30, 2004 due to the amount and nature of
loan transactions completed during the periods as compared to the same
periods in 2003. During the nine-month period ended September 30, 2004 we
originated and sold $42.1 million of loans compared with $63.1 million
during the same period in 2003.
(c) Trust and financial services revenues have decreased in 2004 primarily due
to a $488,000 fee received (during the second quarter of 2003) by the
Bank's financial services division for the management of the sale of two
companies on behalf of a customer.
(d) Gains and/or losses on the sale of investment securities vary from period
to period due to the volume and nature of the securities transactions
affected during the period. Investment securities sales for the nine-month
period ended September 30, 2004 totaled $51.5 million while sales for the
nine-month period ended September 30, 2003 totaled $71.5 million.
(e) Brokerage revenue has increased on a year to date basis primarily due to
increased production in the Minnesota market.
(f) Other noninterest income increased during the nine-month period ended
September 30, 2004 primarily due to the receipt of $527,000 by Milne Scali.
The payment related to the final resolution of a reinsurance program
previously associated with Milne Scali.
Noninterest Expense. The following table presents the major categories of our
noninterest expense for the three- and nine-month periods ended September 30,
2004 and 2003 as well as the amount and percent of change between the periods.
Significant changes are discussed in lettered explanations following the table
(amounts are in thousands):
Three Months Ended Nine Months Ended Change
Noninterest Expense September 30, Change September 30,
------------------------ ---------------------- ----------------------- -----------------------
2004 2003 $ % 2004 2003 $ %
---------- --------- -------- ---------- ---------- ---------- ---------- ----------
Salaries and employee
benefits.................. $ 6,021 $ 4,113 $ 1,908 46.4% $16,194 $ 12,075 $ 4,119 34.1% (a)
Occupancy................... 718 564 154 27.3% 1,973 1,750 223 12.7% (b)
Professional services....... 417 288 129 44.8% 1,151 857 294 34.3% (c)
Depreciation and
amortization.............. 416 369 47 12.7% 1,226 1,085 141 13.0% (d)
Office supplies, telephone
and postage............... 381 284 97 34.2% 1,052 893 159 17.8% (e)
Amortization of intangible
assets.................... 326 265 61 23.0% 946 797 149 18.7% (f)
Marketing and promotion..... 244 227 17 7.5% 783 522 261 50.0% (g)
FDIC and other assessments.. 51 50 1 2.0% 153 152 1 0.7%
Other....................... 793 674 119 17.7% 2,439 1,858 581 31.3% (h)
---------- -------- -------- ---------- ----------- ----------
Total noninterest expense.. $ 9,367 $ 6,834 $ 2,533 37.1% $25,917 $ 19,989 $ 5,928 29.7%
========== ======== ======== ========== =========== ==========
Efficiency ratio........... 99.1% 81.0% 18.1% 88.0% 77.2% 10.8%
========== ======== ========== ===========
Total operating expenses
as a percent of average
assets, annualized........ 5.8% 4.5% 1.3% 5.5% 4.5% 1.0%
========== ======== ========== ===========
(a) Salaries and employee benefits expenses increased in the three- and
nine-month periods ended September 30, 2004 due to growth and expansion of
our banking and insurance segments, particularly in our Minnesota and
Arizona markets. Average full time equivalent employees for the three- and
nine-month periods ended September 30, 2004 were 329 and 315, respectively,
compared to 281 and 274, respectively, for the same periods in 2003.
(b) Occupancy expenses have increased due to the addition of the Esplanade
location in Phoenix, the Golden Valley location in Minnesota, the Tucson
insurance agency on December 31, 2003, the Salt Lake City agency on March
31, 2004, the Prescott Valley agency on June 30, 2004 and the Denver
insurance location on July 31, 2004.
(c) The increase in professional services expenses is attributable to an
increase in year to date brokerage retainage and clearing fees (resulting
from the increase in year to date brokerage production), as well as
increases in legal, appraisal and recording and other consulting fees.
(d) Depreciation and amortization expenses related to fixed assets have
increased due to the expansion described in note (b) above, primarily in
our Arizona and Minnesota markets.
(e) Office supplies, telephone and postage expenses have increased due to the
expansion described in note (b) above, primarily in our Arizona and
Minnesota markets.
(f) Amortization of intangible assets increased primarily due to amortization
of the insurance books of business intangibles acquired in the insurance
agency acquisitions of December 31, 2003, March 31, 2004 and June 30, 2004
and the acquisition of the Denver insurance book of business on July 31,
2004.
(g) Marketing and promotion expenses increased primarily due to market
expansion and the associated advertising and marketing.
(h) The increase in other noninterest expense is due to increases in several
different items included in this category such as travel expenses, other
employee benefits expenses, insurance expenses, business meals and
entertainment expenses, dues and publications expenses and correspondent
bank charges.
Income Tax Provision. For the quarter ended September 30, 2004, we recorded a
tax benefit of $34,000. This tax benefit resulted from the reduction in
projected before-tax income for 2004 which, due to the projected level of
tax-exempt income to overall income, reduced our projected effective tax rate
for 2004 to 25.5 percent compared with the previously projected 27 percent.
Our provision for income taxes for the nine months ended September 30, 2004
decreased $404,000 as compared to the same period in 2003 due to the decrease in
pre-tax income.
Earnings per Common Share. See Note 4 to the interim consolidated financial
statements included under Item 1 for a summary of the EPS calculations for the
three- and nine-month periods ended September 30, 2004 and 2003.
Liquidity
Liquidity. Liquidity risk management encompasses our ability to meet all present
and future financial obligations in a timely manner. The objectives of liquidity
management policies are to maintain adequate liquid assets, liability
diversification among instruments, maturities and customers and a presence in
both the wholesale purchased funds market and the retail deposit market.
The consolidated statements of cash flows in the consolidated financial
statements included under Item 1 present data on cash and cash equivalents
provided by and used in operating, investing and financing activities. In
addition to liquidity from core deposit growth, together with repayments and
maturities of loans and investments, we utilize brokered deposits, sell
securities under agreements to repurchase and borrow overnight Federal funds.
The Bank is a member of the FHLB, which affords it the opportunity to borrow
funds on terms ranging from overnight to 10 years and beyond. Advances from the
FHLB are generally collateralized by the Bank's mortgage loans and various
investment securities. We have also obtained funding through the issuance of
subordinated notes, subordinated debentures and long-term borrowings.
The following table sets forth, for the nine months ended September 30, 2004 and
2003, a summary of our major sources and (uses) of funds. The summary
information is derived from the consolidated statements of cash flows included
under Item 1 (amounts are in thousands):
For the Nine Months
Ended September 30,
------------------------
Major Sources and (Uses) of Funds 2004 2003
----------- -----------
Proceeds from FHLB advances.......................... $ 332,000 $ 137,300
Proceeds from sales of investment securities......... 51,498 71,542
Proceeds from maturities of investment securities.... 31,024 43,802
Net increase (decrease) in deposits.................. 30,492 (21,820)
Proceeds from long-term borrowings................... 1,500 141
Issuance of preferred stock.......................... 1,500 --
Repayments of FHLB advances.......................... (342,000) (117,300)
Purchases of investment securities................... (58,723) (158,271)
Net (increase) decrease in loans..................... (41,115) 54,677
Cash paid for Milne Scali earnouts................... (6,012) (2,315)
Additions to premises and equipment.................. (3,778) (5,977)
Net decrease in short-term borrowings................ (1,514) (6,172)
Repurchase of preferred stock........................ (1,500) --
Our liquidity is measured by our ability to raise cash when we need it at a
reasonable cost and with a minimum of loss. Given the uncertain nature of our
customers' demands as well as our desire to take advantage of earnings
enhancement opportunities, we must have adequate sources of on- and
off-balance-sheet funds that can be acquired in time of need. Accordingly, in
addition to the liquidity provided by balance sheet cash flows, liquidity is
supplemented with additional sources such as credit lines with the FHLB, credit
lines with correspondent banks for Federal funds, wholesale and retail
repurchase agreements, brokered certificates of deposit and direct non-brokered
national certificates of deposit through national deposit networks.
We measure our liquidity position on a monthly basis. Key factors that determine
our liquidity are the reliability or stability of our deposit base, the
pledged/non-pledged status of our investments and potential loan demand. Our
liquidity management system divides the balance sheet into liquid assets, and
short-term liabilities that are assumed to be vulnerable to non-replacement
under abnormally stringent conditions. The excess of liquid assets over
short-term liabilities is measured over a 30-day planning horizon. Assumptions
for short-term liabilities vulnerable to non-replacement under abnormally
stringent conditions are based on a historical analysis of the month-to-month
percentage changes in deposits. The excess of liquid assets over short-term
liabilities and other key factors such as expected loan demand as well as access
to other sources of liquidity such as lines with the FHLB, Federal funds and
those other supplemental sources listed above are tied together to provide a
measure of our liquidity. We have a targeted range and manage our operations
such that these targets can be achieved. We believe that our prudent management
policies and guidelines will ensure adequate levels of liquidity to fund
anticipated needs of on- and off-balance sheet items. In addition, a contingency
funding policy statement identifies actions to be taken in response to an
adverse liquidity event.
As of September 30, 2004, we had established three revolving lines of credit
with banks totaling $17.5 million of which none had been advanced. The lines, if
drawn upon, mature daily with interest rates that float at the Federal funds
rate. At September 30, 2004, we also had the ability to draw additional FHLB
advances of $64.3 million based upon the mortgage loans and securities that were
then pledged, subject to a requirement to purchase additional FHLB stock. The
Bank has also been approved for repurchase agreement lines of up to $100.0
million with a major financial institution. The lines, if utilized, would be
collateralized by investment securities.
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. Our accounting policy for determining the allowance
for credit losses is set forth under "Comparison of Financial Condition at
September 30, 2004 and December 31, 2003 - Allowance for Credit Losses." As
indicated in that policy statement, we employ a systematic methodology for
determining our allowance for credit losses that includes an ongoing review
process and quarterly adjustment of the allowance. Our process includes periodic
loan-by-loan review for loans that are individually evaluated for impairment as
well as detailed reviews of other loans (either individually or in pools). This
includes an assessment of known problem loans, potential problem loans and other
loans that exhibit indicators of deterioration.
Our methodology incorporates a variety of risk considerations, both quantitative
and qualitative, in establishing an allowance for credit losses that we believe
is appropriate at each reporting date. Quantitative factors include our
historical loss experience, delinquency and charge-off trends, collateral
values, changes in non-performing loans and other factors. Quantitative factors
also incorporate known information about individual loans, including borrowers'
sensitivity to interest rate movements and borrowers' sensitivity to
quantifiable external factors including commodity and finished goods prices as
well as acts of nature (violent weather, fires, etc.) that occur in a particular
period.
Qualitative factors include the general economic environment in our markets and,
in particular, the state of certain industries in our market areas. Size and
complexity of individual credits in relation to lending officers' background and
experience levels, loan structure, extent and nature of waivers of existing loan
policies and pace of portfolio growth are other qualitative factors that are
considered in our methodology.
Our methodology is, and has been, consistently applied. However, as we add new
products, increase in complexity and expand our 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 September 30, 2004 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 September 30, 2004. 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 $3.4 million did not
necessitate that a provision for credit losses be made for the three- and
nine-month periods ended September 30, 2004. Should our analysis have resulted
in the need for a higher or lower allowance for loan losses, a provision for
loan losses would have been charged to earnings or, in the case of the need for
a lower allowance for credit losses, a reversal of some of the allowance would
have been credited to earnings. For example, should our analysis have indicated
the need for an allowance for credit losses of $3.6 million, an additional
$200,000 would have been charged to the provision for loan losses resulting in a
net loss of approximately ($25,000) as compared to the $123,000 of net income
recorded for the quarter ended September 30, 2004. Had our analysis indicated
the need for an allowance for credit losses of $3.2 million, $200,000 of the
allowance would have been reversed and credited to earnings resulting in net
income of approximately $272,000 as compared to the $123,000 recorded for the
period.
In recent periods 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 for credit losses levels of $3.4 and $4.8
million at September 30, 2004 and December 31, 2003, 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 such as
the timing of reversals of temporary differences and current financial
accounting standards. Actual results could differ significantly from the
estimates and interpretations used in determining the current and deferred
income tax liabilities.
Forward-Looking Statements
Statements included in Item 2, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" which are not historical in
nature are intended to be, and are hereby identified as "forward-looking
statements" for purposes of the safe harbor provided by Section 27A of the
Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the
Securities Exchange Act of 1934, as amended (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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk arises from changes in interest rates, exchange rates, and commodity
prices and equity prices and represents the possibility that changes in future
market rates or prices will have a negative impact on our earnings or value. Our
principal market risk is interest rate risk.
Interest rate risk arises from changes in interest rates. Interest rate risk can
result from: (1) Repricing risk - timing differences in the maturity/repricing
of assets, liabilities, and off-balance-sheet contracts; (2) Options risk - the
effect of embedded options, such as loan prepayments, interest rate caps/floors,
and deposit withdrawals; (3) Basis risk - risk resulting from unexpected changes
in the spread between two or more different rates of similar maturity, and the
resulting impact on the behavior of lending and funding rates; and (4) Yield
curve risk - risk resulting from unexpected changes in the spread between two or
more rates of different maturities from the same type of instrument. We have
risk management policies to monitor and limit exposure to interest rate risk. To
date we have not conducted trading activities as a means of managing interest
rate risk. Our asset/liability management process is utilized to manage our
interest rate risk. The measurement of interest rate risk associated with
financial instruments is meaningful only when all related and offsetting on-and
off-balance-sheet transactions are aggregated, and the resulting net positions
are identified.
Our interest rate risk exposure is actively managed with the objective of
managing the level and potential volatility of net interest income in addition
to the long-term growth of equity, bearing in mind that we will always be in the
business of taking on rate risk and that rate risk immunization is not entirely
possible. Also, it is recognized that as exposure to interest rate risk is
reduced, so too may the overall level of net interest income and equity. In
general, the assets and liabilities generated through ordinary business
activities do not naturally create offsetting positions with respect to
repricing or maturity characteristics. Access to the derivatives market can be
an important element in maintaining our interest rate risk position within
policy guidelines. Using derivative instruments, principally interest rate
floors and caps, the interest rate sensitivity of specific transactions, as well
as pools of assets or liabilities, is adjusted to maintain the desired interest
rate risk profile.
Our primary tool in measuring and managing interest rate risk is net interest
income simulation. This exercise includes our assumptions regarding the level of
interest 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, collateralized mortgage obligation, and mortgage-backed
securities portfolios in each rate environment are captured using industry
estimates of prepayment speeds for various coupon segments of the portfolio. For
purposes of this simulation, projected month-end balances of the various balance
sheet planning accounts are held constant at their September 30, 2004 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 September
30, 2004 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 asset/liability committee ("ALCO") meetings. Each quarter
net interest income is generally simulated for the upcoming 12-month horizon in
seven interest scenarios. The scenarios generally modeled are parallel interest
ramps of +/- 100bp, 200bp, and 300bp along with a rates unchanged scenario. The
parallel movement of interest rates means all projected market interest rates
move up or down by the same amount. A ramp in interest rates means that the
projected change in market interest rates occurs over the 12-month horizon
projected. For example, in the -100bp scenario, the projected prime rate will
decrease from its starting point at September 30, 2004 of 4.50 percent to 3.50
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 September 30, 2004, the declining
rate scenario analysis was limited to -100bp for the summary table presented
below and a +400bp scenario was added.
The net interest income simulation result for the 12-month horizon is shown
below. The impact of each interest rate scenario on projected net interest
income is displayed before and after the impact of the $20.0 million cumulative
notional original five-year interest rate cap positions on three-month LIBOR
with a 5.50 percent strike. The impact of the cap positions is calculated by
determining the fair value of the contracts at the end of the 12-month horizon
using an interest rate option valuation model. The change in fair value plus any
expected cash flow in the various rate scenarios is summed to determine the
total net benefit/(cost) of the portfolio of interest rate cap contracts.
Net Interest Income Simulation
(amounts in thousands)
Movement in interest rates -100bp Unchanged +100bp +200bp +300bp +400bp
-------- --------- -------- -------- -------- --------
Projected 12-month net interest income........ $ 13,761 $ 15,763 $ 16,469 $ 16,684 $ 16,834 $ 16,816
Dollar change from rates unchanged scenario... $ (2,002) -- $ 706 $ 921 $ 1,071 $ 1,053
Percentage change from rates unchanged
scenario................................... (12.70)% -- 4.48% 5.84% 6.79% 6.68%
Net benefit/(cost) of cumulative $20.0
million interest rate caps (1)............. $ (3) $ (3) (2) $ 3 $ 31 $ 106
Total net interest income impact with caps.... $ 13,758 $ 15,760 $ 16,467 $ 16,687 $ 16,865 $ 16,922
Dollar change from unchanged w/caps........... $ (2,002) -- $ 707 $ 927 $ 1,105 $ 1,162
Percentage change from unchanged w/caps....... (12.70)% -- 4.49% 5.88% 7.01% 7.37%
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 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 2006.
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.
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 of Directors and ALCO. This target is
reevaluated and reset at each quarterly ALCO meeting.
Since there are limitations inherent in any methodology used to estimate the
exposure to changes in market interest rates, this analysis is not intended to
be a forecast of the actual effect of changes in market interest rates such as
those indicated above on the Company. Further, this analysis is based on our
assets and liabilities as of September 30, 2004 and does not contemplate any
actions we might undertake in response to changes in market interest rates.
Item 4. Controls and Procedures
Quarterly evaluation of the Company's Disclosure Controls and Internal Controls.
As of the end of the period covered by this quarterly report on Form 10-Q, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures ("Disclosure Controls"), and our internal 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 quarterly 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
quarterly 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
quarterly 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 quarterly
report, is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms. Disclosure Controls are also designed
with the objective of ensuring that 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 of
America.
Limitations on the Effectiveness of Controls. Our management, including the CEO
and CFO, does not expect that our Disclosure Controls or our Internal Controls
will prevent all error and all fraud. A control system, no matter how well
developed and operated, can provide only reasonable, but not absolute, assurance
that the objectives of the control system are met. Further, the design of a
control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their costs. Because of
the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions.
Over time, control may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.
Scope of the Controls Evaluation. The CEO/CFO evaluation of our Disclosure
Controls and our Internal Controls included a review of the controls' objectives
and design, our controls' implementation and the effect of the controls on the
information generated for use in this quarterly report. In the course of the
Controls Evaluation, we sought to identify data errors, controls problems or
acts of fraud and to confirm that appropriate corrective action, including
process improvements, were being undertaken. This type of evaluation is done on
a quarterly basis so that the conclusions concerning controls effectiveness can
be reported in our quarterly reports on Form 10-Q and annual report on Form
10-K. Our Internal Controls are also evaluated on an ongoing basis by our
internal audit and credit review departments in connection with their audit and
review activities. The overall goal of these various evaluation activities is 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 quarterly
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 of America.
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 II - Other Information
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
On September 14, 2004, BNCCORP issued 150 shares of its noncumulative preferred
stock, $0.01 par value per share, to a trust controlled by Richard W. Milne, Jr.
for aggregate consideration of $1.5 million. The noncumulative preferred stock
has a preferred noncumulative dividend payable at an annual rate of 8.00 percent
and a preferred liquidation value of $10,000 per share. Richard W. Milne, Jr. is
Chairman and President of the Bank's subsidiary Milne Scali. The shares of
preferred stock were issued in reliance on the exemption provided by Section
4(2) of the Securities Act, as amended.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 31.1 Chief Executive Officer's Certification Under Rule 13a-14(a)
of the Exchange Act
Exhibit 31.2 Chief Financial Officer's Certification Under Rule 13a-14(a)
of the Exchange Act
Exhibit 32.1 Chief Executive Officer and Chief Financial Officer
Certifications Under Rule 13a-14(b) of the Exchange Act
(b) Reports on Form 8-K
On July 29, 2004, we filed a Form 8-K, furnishing, under Item 7, our
earnings press release for the quarter ended June 30, 2004.
On August 31, 2004, we filed a Form 8-K reporting under Items 5.02 and 7.01
the election of a new member to our board.
On September 15, 2004, we filed a Form 8-K reporting under Item 3.02 the
issuance of preferred stock.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BNCCORP, Inc.
Date: November 5, 2004 By /s/ Gregory K. Cleveland
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Gregory K. Cleveland
President and Chief Executive Officer
By /s/ Brenda L. Rebel
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Brenda L. Rebel
Treasurer and Chief Financial Officer