U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 for the fiscal year ended December 31, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 0-26290
BNCCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 45-0402816
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
322 East Main Avenue 58501
Bismarck, North Dakota (Zip Code)
(Address of principal executive office)
Registrant's telephone number, including area code: (701) 250-3040
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
Common Stock, $.01 par value
Preferred Stock Purchase Rights
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes ___ No _X_
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the Registrant, computed by reference to the price at which
the common equity was last sold, as of the last business day of the Registrant's
most recently completed second fiscal quarter was $31,867,968.00.
The number of shares of the Registrant's common stock outstanding on
March 15, 2005 was 2,885,976.
Documents incorporated by reference. Portions of the Registrant's proxy
statement to be filed with the Securities and Exchange Commission in
connection with the Registrant's 2005 annual meeting of stockholders
are incorporated by reference into Part III hereof.
BNCCORP, INC.
ANNUAL REPORT ON FORM 10-K
FOR FISCAL YEAR ENDED DECEMBER 31, 2004
TABLE OF CONTENTS
Page
PART I
Item 1. Business ......................................................... 3
Item 2. Properties........................................................ 16
Item 3. Legal Proceedings................................................. 16
Item 4. Submission of Matters to a Vote of Security Holders............... 17
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities................. 17
Item 6. Selected Financial Data .......................................... 18
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................... 20
Item 7A.Quantitative and Qualitative Disclosures about Market Risk........ 57
Item 8. Financial Statements and Supplementary Data....................... 61
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................... 114
Item 9A.Controls and Procedures........................................... 114
Item 9B.Other Information................................................. 115
PART III
Item 10.Directors and Executive Officers of the Registrant................ 116
Item 11.Executive Compensation............................................ 116
Item 12.Security Ownership of Certain Beneficial Owners and Management.... 116
Item 13.Certain Relationships and Related Transactions.................... 116
Item 14.Principal Accounting Fees and Services............................ 116
PART IV
Item 15.Exhibits, Financial Statement Schedules........................... 116
PART I
The discussions contained in this Annual Report on Form 10-K which are not
historical in nature may constitute forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), and, as such, may involve risks and uncertainties.
We caution readers that these forward-looking statements, including without
limitation, those relating to future business prospects, revenues, working
capital, liquidity, capital needs, interest costs, income and expenses of the
Company are subject to certain risks and uncertainties that could cause actual
results to differ materially from those indicated in the forward-looking
statements due to several important factors. These factors include, but are not
limited to: risks of loans and investments, including dependence on local and
regional economic conditions; competition for our customers from other providers
of financial services; possible adverse effects of changes in interest rates
including the effects of such changes on derivative contracts and associated
accounting consequences; risks associated with our acquisition and growth
strategies; and other risks which are difficult to predict and many of which are
beyond our control. For a discussion of some of the additional factors that
might cause such differences, see Item 1. Business "-Factors That May Affect
Future Results of Operations."
We refer to "we," "our," "BNC" or the "Company" when such reference includes
BNCCORP, Inc. and its consolidated subsidiaries, collectively; "BNCCORP" when
referring only to BNCCORP, Inc.; "the Bank" when referring only to BNC National
Bank; "Milne Scali" when referring only to Milne Scali & Company, Inc.; "BNC
Insurance" when referring only to BNC Insurance, Inc.; and "BNC AMI" when
referring only to BNC Asset Management, Inc.
Item 1. Business
General
BNCCORP is a bank holding company registered under the Bank Holding Company Act
of 1956 (the "BHCA") headquartered in Bismarck, North Dakota. We are dedicated
to providing a broad range of financial products and superior customer service
to businesses and consumers within the communities we serve. BNCCORP operates 26
locations in Arizona, Minnesota, North Dakota, Colorado and Utah through its
subsidiary, BNC National Bank. The Company also provides a wide array of
insurance, brokerage and trust and financial services through BNC National
Bank's subsidiaries, Milne Scali and BNC AMI, and the Bank's trust and financial
services division. The Company offers a wide variety of traditional and
nontraditional financial products and services in order to meet the financial
needs of its current customer base, establish new relationships in the markets
it serves and expand its business opportunities.
We will continue to emphasize internally generated growth by focusing on
increasing our market share within the market areas we now serve. Acquisitions,
de novo branches and mergers have also played an important role in our strategy.
During the three years ended December 31, 2004, we completed several such
transactions. See Note 2 to the Consolidated Financial Statements included under
Item 8 of Part II for further information related to these transactions. We may
seek additional growth opportunities through select acquisitions of financial
services companies that we believe complement our businesses.
At December 31, 2004, we had total assets of $673.7 million, total loans held
for sale of $60.2 million, total loans held for investment of $293.8 million and
total deposits of $455.3 million.
Mission Statement
Our mission is to provide tailor-made financial solutions for our customers that
will assist them in achieving their goals, while enhancing shareholder value.
Operating Strategy
We provide relationship-based banking and financial services to small- to
mid-sized businesses, business owners, professionals and consumers in our
primary market areas of Arizona, Minnesota and North Dakota. Our goal is to
serve as a one-stop financial services provider for our customers by offering
traditional bank products and services, insurance, brokerage, asset management,
trust, tax planning and preparation, employee benefit plan design and
administration and other financial-related services. The other key elements of
our operating strategy are:
o Emphasize individualized, high-level customer service.
o Encourage an entrepreneurial attitude among the employees who provide
products and services.
o Maintain high asset quality with strong loan policies and continuously
monitoring loans and the loan review process.
o Maintain centralized administrative and support functions.
Strategic Vision
Since our formation more than 15 years ago, we have diligently pursued a sharply
focused strategic vision: to provide a broad range of financial products and
superior service to a well-defined customer base, primarily consisting of small-
to mid-sized businesses, business owners, professionals and consumers. We
believe that our entrepreneurial approach to banking and the introduction of new
products and services will continue to attract small- and mid-sized businesses,
their owners and employee base. Small businesses frequently have difficulty
finding banking services that meet their specific needs and have sought banking
institutions that are more relationship-oriented. By remaining committed to this
strategic vision, we have built a company that is distinguished by its:
o Diversified business base of banking, insurance and
brokerage/trust/financial services;
o Presence in multiple attractive markets: Arizona, Minnesota, North
Dakota, Colorado and Utah;
In this section of this annual report on Form 10-K, we detail these
distinguishing strengths, which we expect will help customers to reach their
financial goals, and allow us to establish a solid foundation upon which to
build shareholder value.
Diversified Business Base. BNCCORP today consists of three core businesses:
banking, insurance and brokerage/trust/financial services. This structure allows
us to offer a wide range of services that is responsive to the financial needs
of our customers, while also diversifying and balancing our sources of revenue.
Banking segment. BNC National Bank operates 20 banking branch offices in
Arizona, Minnesota and North Dakota. Known for its business banking services
such as business financing and commercial mortgages, corporate cash management
and merchant programs, our banking division also offers a full range of consumer
lending and deposit options. The Bank is differentiated by its service culture
of "high personal touch," supported by effective technology. Among the services
offered are online, bill pay and telephone banking operations, and products such
as the "Sweep/Repo" account, the "Wealthbuilder" family of variable-rate
interest checking and money market deposit products and the BNC cash back debit
card. During 2004, the Bank initiated a mortgage loan financing program in which
the Bank purchases short-term participation interests in residential mortgage
loans originated by a mortgage company. Also during 2004, the Bank initiated a
student loan financing program in which the Bank purchases short-term interests
in student loans originated by a student loan origination company.
The banking segment's loans primarily consist of commercial and industrial
loans, real estate mortgage and construction loans, agricultural loans, consumer
loans and lease financing, along with the mortgage and student loans described
above. In allocating our assets among loans, investments and other earning
assets, we attempt to maximize return while managing risk at acceptable levels.
Our primary lending focus is on commercial loans and owner-occupied real estate
loans to small- and mid-sized businesses and professionals. We offer a broad
range of commercial and consumer lending services, including commercial
revolving lines of credit, residential and commercial real estate mortgage and
construction loans, consumer loans and equipment financing. Interest rates
charged on loans may be fixed or variable and vary with the degree of risk, size
and maturity of the loans, underwriting and servicing costs, the extent of other
banking relationships maintained with customers and the Bank's cost of funds.
Rates are further subject to competitive pressures, the current interest rate
environment, availability of funds and government regulations. For more
information on our lending activities, see "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Financial Condition - Loan
Portfolio" included under Item 7 of Part II.
Each of our bank branches offers the usual and customary range of depository
products provided by commercial banks, including checking, savings and money
market deposits and certificates of deposit. During 2004, we increased core
deposits $30.8 million, or 8.4 percent (noninterest-bearing deposits increased
$18.7 million, or 41.7 percent). Our Wealthbuilder family of interest checking
and money market deposit accounts continues to be popular. These are
competitively priced floating rate accounts with rates variable at our
discretion. The Bank's deposits are not received from a single depositor or
group of affiliated depositors, the loss of any one of which would have a
material adverse effect on our business. Rates paid on deposits vary among the
categories of deposits due to different terms, the size of the individual
deposit, the nature of other banking relationships with the depositor, the
current interest rate environment and rates paid by competitors on similar
deposits. The Bank also offers customer repurchase agreements to acquire funds
from customers where the customers require or desire to have their funds
supported by collateral consisting of investment securities of the Bank.
The Bank also accepts brokered deposits and obtains direct non-brokered
certificates of deposit through national deposit networks when management
believes such transactions are beneficial to the Bank. Additionally, through the
Certificate of Deposit Account Registry ServiceSM (CDARSSM), the Bank can now
place large customer deposits into smaller denomination (fully FDIC-insured)
certificates of deposit at multiple institutions. This provides the Bank's large
deposit customers with FDIC insurance on their entire balances (up to $ 10.0
million) and the convenience of managing their certificates of deposit
investments through a single bank relationship. This service was made available
beginning in 2003 and we had $16.8 million of such deposits at December 31,
2004. For more information on our deposit activities, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Financial Condition - Deposits" included under Item 7 of Part II.
Our banking segment also offers services such as travelers' checks, MasterCard
and Visa merchant deposit services and, in some markets, safe deposit, lockbox
and messenger services.
Insurance segment. Our insurance segment has offices in the following major
cities: Phoenix, Tucson, Minneapolis, Bismarck, Salt Lake City and Englewood (a
suburb of Denver). Our insurance subsidiary, Milne Scali (which merged with BNC
Insurance during 2004) is an independent insurance agency representing many of
the nation's leading insurance carriers. Our insurance operations were greatly
expanded in 2002 through the acquisition of Milne Scali, one of the largest
independent insurance agencies in the Arizona market. Several additional
insurance acquisitions were made during 2003 and 2004. These are all summarized
in Note 2 to the Consolidated Financial Statements included under Item 8 of Part
II. The acquisitions have helped to increase the scope of our insurance segment,
adding to insurance commission income volume, and opening new markets (such as
Colorado and Utah) to our insurance segment.
Milne Scali serves local, regional and national businesses. Its clients range
from large, established companies with hundreds of millions in sales to emerging
businesses with growing needs. It serves clients in nearly every industry,
including construction, real estate development, manufacturing, distribution and
wholesale, professionals, government, financial institutions, retail and service
industries. The only industry in which Milne Scali has a concentration (defined
as 35% of commissions or more) is the construction industry in the Arizona
market. This customer base includes general contractors and commercial trade
contractors.
Acquisitions during 2003 and 2004 have broadened its geographical reach and
added a surety business based in Colorado. Milne Scali can provide a full range
of services from the self-insured multinational client to the local sole
proprietor. Milne Scali provides a wide array of products and services,
including but not limited to:
Business insurance such as property, liability, fleet auto, workers'
compensation, errors and omissions, directors and officers, employment
practices, crime and employee dishonesty, umbrella and excess, boiler and
machinery, surety and bonds, flood and earthquake.
Risk management such as risk and loss control services, risk transfer analysis,
risk consulting, risk management program design and implementation.
Group benefits insurance such as health, life, dental, disability, 401(k)s and
SEPs, prepaid legal, key man protection, buy/sell protection, estate and
business continuation.
Association and affinity group insurance programs such as group auto and
homeowners, benefit plans, product liability programs, workers' compensation
groups, self-insured pools, risk retention groups, captive and rent-a-captive
operations.
Personal lines such as homeowners and renters, personal articles floater,
automobile, watercraft, aircraft, flood and earthquake, umbrella and life.
The North Dakota/Minnesota division of Milne Scali (formerly BNC Insurance) also
provides a wide range of commercial and personal lines of insurance. The
division can look to Milne Scali's Phoenix division to assist in providing
expertise and insurance coverage and risk management products and services
beyond what was available to our customers prior to our acquisition of Milne
Scali.
The insurance segment will typically have its strongest performance in the first
quarter of each fiscal year as profit sharing payments from insurance carriers
are generally received during that quarter. The insurance segment continues to
be an important and significant part of our business.
Brokerage/trust/financial services segment. BNC AMI and the Bank's trust and
financial services divisions provide customers with an extensive complement of
financial services options. The trust and financial services divisions,
presently operating primarily out of Bismarck, provide trust, financial,
business, estate and tax planning, estate administration, agency accounts,
payroll services, accounting services, employee benefit plan design and
administration, individual retirement accounts ("IRAs"), individual custodial
self-directed IRAs, asset management, tax preparation and the BNC Global
Balanced Collective Investment Fund, a proprietary investment vehicle for
qualified retirement plans. BNC AMI, operating out of Bismarck and Minneapolis,
in affiliation with Raymond James Financial Services, Inc. offers financial
services alternatives such as securities trading, investment management of
institutional and individual accounts, mutual funds and annuities.
Revenues from external customers, measures of profit and/or loss and total
assets for each of the segments listed above are presented in Note 16 to the
Consolidated Financial Statements included under Item 8 of Part II.
Attractive Markets. We operate primarily in three distinct markets: Arizona;
Minnesota; and North Dakota. While these areas have very different fundamentals,
each enjoys a solid economic base and what we believe are compelling long-term
growth dynamics.
Our Arizona market has been one of the fastest growing areas of the country in
population and personal income for the past several years. The population is
expected to continue increasing at a rate of more than 100,000 per year. During
2004, the Phoenix metropolitan area surged ahead of Atlanta as the country's top
new-home builder. The housing sector's strength is expected to continue due to
the Phoenix metropolitan area's large stretches of undeveloped land, new jobs
and resort climate. Low interest rates and affordable home prices have also
helped to make the Phoenix housing market more attractive. Tourism, retirement
and job creation in such industries as software and biotechnology are among the
additional drivers of the economy, according to studies by the University of
Arizona. Segments with significant operations in the Arizona market include
banking and insurance.
The Twin Cities area is home to a large and growing population, with a tight
labor market and robust construction. The U.S. census estimates that the area's
population will rise by more than 900,000 by 2030, driving business formation
and residential construction over the long term. Key growth industries currently
include electronics manufacturing, medical and healthcare, education and food
processing. Banking is the primary segment operating in the Twin Cities area
with some brokerage and insurance activities also conducted in the market.
Bismarck-Mandan (our largest market in North Dakota) is characterized by low
unemployment and generally favorable economic conditions. Bismarck is not only
the state capital, but also the trade and transportation hub for South Central
North Dakota. The area is experiencing strong residential and commercial growth,
and its diverse economic base includes energy, health care, agriculture and an
expanding data processing/customer service component. Several national retail
chains also are planning to open new locations in the Bismarck-Mandan area
during 2005 and 2006. The banking, insurance and brokerage/trust/financial
segments are all represented in the North Dakota market.
Our insurance segment also began operations in Englewood, Colorado and Salt Lake
City, Utah during 2004. These markets also exhibit growth characteristics and
good fundamentals.
Individually, each of our key markets presents strong potential demand for our
range of financial services offerings. Together, we believe they provide
attractive business opportunities and balance our exposure to regional economic
cycles.
As of December 31, 2004, 33 percent of our loans were to borrowers located in
North Dakota, 30 percent to borrowers located in Arizona, 30 percent to
borrowers located in Minnesota, 4 percent to borrowers located in South Dakota
and the remainder to borrowers in various other states. Other than brokered
deposits and direct non-brokered certificates of deposit obtained through
national deposit networks, each banking branch draws most of its deposits from
its general market area.
The following table presents total deposits and net loans outstanding at each of
our locations as of December 31, 2004 (in thousands):
Net Loans Held
Total for Investment
Location Deposits Outstanding 1
- ----------------------------- ---------- --------------
Bismarck, ND............. $ 130,823 $ 100,253
Crosby, ND............... 17,345 188
Ellendale, ND............ 10,173 484
Garrison, ND............. 15,664 467
Golden Valley, MN........ 12,954 4,779
Kenmare, ND.............. 10,428 189
Linton, ND............... 41,297 8,949
Minneapolis, MN.......... 43,144 83,602
Phoenix, AZ.............. 31,272 76,804
Scottsdale, AZ........... 41,512 17,312
Stanley, ND.............. 16,792 791
Tempe, AZ................ 13,614 785
Watford City, ND......... 11,536 84
Brokered deposits........ 55,010 --
National market deposits. 3,779 --
---------- ----------
Total ................ $ 455,343 $ 294,687
========== ==========
- ------------------
1 Before allowance for credit losses, unearned income and net unamortized
deferred fees and costs.
Regional Community Banking Philosophy
In order to meet the demands of the increasingly competitive banking and
financial services industries, we employ a regional community banking
philosophy. This philosophy is based on our belief that banking and financial
services clients value doing business with locally managed institutions that can
provide a full service commercial banking relationship through an understanding
of the clients' financial needs and the flexibility to deliver customized
solutions through our menu of products and services. With this philosophy we are
better able to build successful and broadly based client relationships. The
primary focus for our relationship managers is to cultivate and nurture their
client relationships. Relationship managers are assigned to each borrowing
client to provide continuity in the relationship. This emphasis on personalized
relationships requires that all of the relationship managers maintain close ties
to the communities in which they serve so that they are able to capitalize on
their efforts through expanded business opportunities. While client service
decisions and day-to-day operations are maintained at each location, our broad
base of financial services offers the advantage of affiliation with service
providers who can provide extended products and services to our clients.
Additionally, BNCCORP and the Bank provide centralized administrative functions,
including credit and other policy development and review, internal audit and
compliance services, investment management, data processing, accounting, loan
servicing and other specialized support functions.
Distribution methods
We offer our banking and financial products and services through our network of
offices and other traditional industry distribution methods. Additionally, we
offer 24-hour telephone banking services through BNC Bankline. We also provide
Internet banking and bill-pay services through our Internet banking site at
www.bncbank.com. This system allows customers to process account transactions,
transfer funds, initiate wire transfers, automated clearing house transactions
and stop payments and obtain account history and other information. Messenger
services in select markets are also of great convenience to our customers.
Risk Management
The uncertainty of whether unforeseen events will have an adverse impact on our
capital or earnings is an inevitable component of the business of banking. To
address the risks inherent in our business we identify, measure and monitor
them. Our management team is responsible for determining our desired risk
profile, allocating resources to the lines of business, approving major
investment programs that are consistent with strategic priorities and making
capital management decisions. We address each of the major risk categories
identified by the banking regulators, if applicable, as well as any additional
identified risks inherent in our business. Such risks include, but are not
limited to, credit, liquidity, interest rate, transaction, compliance, strategic
and reputation risk. In each identified risk area, we measure the level of risk
to the Company based on the business we conduct and develop plans to bring risks
within acceptable tolerances. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Financial Condition-Loan Portfolio
and-Liquidity, Market and Credit Risk" included under Item 7 of Part II and
"Quantitative and Qualitative Disclosures About Market Risk" included under Item
7A of Part II for further discussion of credit, liquidity and interest rate
risk.
Competition
The deregulation of the banking industry and the availability of nationwide
interstate banking have increased the level of competition in our already
intensely competitive market areas. The increasingly competitive environment is
a result of changes in regulation, technology and product delivery systems and
the pace of consolidation among financial services providers. The Bank and its
subsidiaries compete for deposits, loans, insurance and brokerage, trust and
financial services as well as customers with numerous providers of similar
products and services. Principal competitors include multi-regional financial
institutions as well as large and small thrifts, independent banks, credit
unions, many national and regional brokerage companies, mortgage companies,
insurance companies, finance companies, money market funds and other non-bank
financial service providers. Some of these competitors are much larger in total
assets and capitalizations, including the availability of larger legal lending
limits, have greater access to capital markets and offer a broader range of
financial services than BNC. In addition, some of the nonbank financial
institutions that compete with us are not subject to the extensive Federal
regulations that govern our operations.
In order to compete with other financial services providers, the Bank and its
subsidiaries principally rely on personal relationships established by officers,
directors and employees with their customers, specialized services tailored to
meet the needs of the communities served and cross-selling efforts among the
various segments within our organization. We believe that many of our
competitors have emphasized retail banking and financial services for large
companies, leaving the small- and mid-sized business market underserved. This
has allowed us to compete effectively by emphasizing customer service,
establishing long-term customer relationships and providing services meeting the
needs of such businesses and the individuals associated with them. The banking
and financial services industries are highly competitive, and our future
profitability will depend on our ability to continue to compete successfully in
our market areas.
Supervision and Regulation
General. BNCCORP and the Bank are extensively regulated under Federal and state
laws and regulations. These laws and regulations are primarily intended to
protect depositors and the Federal deposit insurance funds, not investors in the
securities of BNCCORP. From time to time, legislation, as well as regulation, is
enacted that has the effect of increasing the cost of doing business, limiting
or expanding permissible activities, or affecting the competitive balance
between banks and other financial services providers. Proposals to change laws
and regulations governing the operations and taxation of banks, bank holding
companies and other financial institutions and financial services providers are
frequently made in the U.S. Congress, in the state legislatures and by various
regulatory agencies.
The following information briefly summarizes certain material laws and
regulations affecting BNCCORP and the Bank and is qualified in its entirety by
reference to the particular statutory and regulatory provisions. Any change in
applicable laws, regulations or regulatory policies may have a material effect
on our business, operations and future prospects. We are unable to predict the
nature or extent of the effects that new or revised Federal or state legislation
may have on our business and earnings in the future.
Primary Regulators. BNCCORP is a bank holding company registered under the BHCA,
and is subject to regulation, supervision and examination by the Board of
Governors of the Federal Reserve System ("Federal Reserve"). BNCCORP is required
to file periodic reports with the Federal Reserve and such other reports as the
Federal Reserve may require pursuant to the BHCA. The Bank is a national banking
association and is subject to supervision, regulation and examination by the
Office of the Comptroller of the Currency ("OCC"). Since the Federal Deposit
Insurance Corporation ("FDIC") insures the deposits of the Bank, the Bank is
also subject to regulation and supervision by the FDIC. Additionally, the Bank
is a member of the Federal Reserve System. Every state has a Department of
Insurance that primarily acts as a consumer advocate. Milne Scali as a company
has an insurance resident license in Arizona, North Dakota and Minnesota and a
non-resident license in almost every other state. All insurance producers are
licensed by the state and most other Milne Scali employees also have insurance
licenses.
If, as a result of an examination by Federal regulatory agencies, an agency
should determine that the financial condition, capital resources, asset quality,
earnings prospects, management, liquidity or other aspects of a bank or bank
holding company's operations are unsatisfactory or that the bank or bank holding
company or its management is violating or has violated any law or regulation,
various remedies are available to these regulatory agencies. Such remedies
include the power to enjoin "unsafe or unsound" practices, to require
affirmative action to correct any conditions resulting from any violation or
practice, to issue an administrative order that can be judicially enforced, to
direct an increase in capital, to restrict the growth of the bank, to assess
civil monetary penalties, to remove officers and directors and ultimately to
terminate the bank's deposit insurance and/or revoke the bank's charter or the
bank holding company's registration.
Acquisitions and Permissible Activities. As a registered bank holding company,
BNCCORP is restricted in its acquisitions, certain of which are subject to
approval by the Federal Reserve. A bank holding company may not acquire, or may
be required to give certain notice regarding acquisitions of, companies
considered to engage in activities other than those determined by the Federal
Reserve to be closely related to banking or managing banks.
Transactions with Affiliates. Under Section 23A of the Federal Reserve Act (the
"Act"), certain restrictions are placed on loans and other extensions of credit
by the Bank to BNCCORP which is defined as an "affiliate" of the Bank under the
Act. Section 23B of the Act places standards of fairness and reasonableness on
other of the Bank's transactions with its affiliates. The Federal Reserve's
Regulation W implements Sections 23A and 23B of the Act and codifies many
previously issued Federal Reserve interpretations of those sections.
Anti-Tying Restrictions. Bank holding companies and their affiliates are
prohibited from tying the provision of certain services, such as extensions of
credit, to other services offered by a holding company or its affiliates.
Restrictions on Loans to One Borrower. Under Federal law, permissible loans to
one borrower by banks are generally limited to 15 percent of the bank's
unimpaired capital, surplus, undivided profits and credit loss reserves. The
Bank seeks participations to accommodate borrowers whose financing needs exceed
its lending limits or internally established credit concentration limits.
Loans to Executive Officers, Directors and Principal Stockholders. Certain
limitations and reporting requirements are also placed on extensions of credit
by the Bank to principal stockholders of BNCCORP and to directors and certain
executive officers of the Bank (and BNCCORP and its nonbank subsidiaries
provided certain criteria are met) and to "related interests" of such principal
stockholders, directors and officers. In addition, any director or officer of
BNCCORP or the Bank or principal stockholder of BNCCORP may be limited in his or
her ability to obtain credit from financial institutions with which the Bank
maintains correspondent relationships.
Interstate Banking and Branching. The BHCA permits bank holding companies from
any state to acquire banks and bank holding companies located in any other
state, subject to certain conditions, including certain nation-wide and
state-imposed concentration limits. The Bank has the ability, subject to certain
restrictions, to acquire by acquisition or merger branches outside its home
state. The establishment of new interstate branches is also possible in those
states with laws that expressly permit it. Interstate branches are subject to
certain laws of the states in which they are located. Competition may increase
further as banks branch across state lines and enter new markets.
Capital Adequacy. The capital adequacy of BNCCORP and the Bank is monitored by
the Federal regulatory agencies using a combination of risk-based and leverage
ratios. Failure to meet the applicable capital guidelines could subject BNCCORP
or the Bank to supervisory or enforcement actions. In addition, BNCCORP could be
required to guarantee a capital restoration plan of the Bank, should the Bank
become "undercapitalized" under capital guidelines. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Financial
Condition-Capital Resources and Expenditures" included under Item 7 of Part II
and Note 18 to the Consolidated Financial Statements included under Item 8 of
Part II for further discussion regarding the capital status of BNCCORP and the
Bank.
Prompt Corrective Action and Other Enforcement Mechanisms. Federal banking
agencies possess broad powers to take corrective and other supervisory action to
resolve the problems of insured depository institutions, including but not
limited to those institutions that fall below one or more prescribed minimum
capital ratios. Each Federal banking agency has promulgated regulations defining
the following five categories in which an insured depository institution will be
placed, based on its capital ratios: well capitalized; adequately capitalized;
undercapitalized; significantly undercapitalized; and critically
undercapitalized. At December 31, 2004, the Bank exceeded the required ratios
for classification as well capitalized.
An institution that, based upon its capital levels, is classified as well
capitalized, adequately capitalized or undercapitalized may be treated as though
it were in the next lower capital category if the appropriate Federal banking
agency, after notice and opportunity for hearing, determines that an unsafe or
unsound condition or practice warrants such treatment. At each successive lower
capital category, an insured depository institution is subject to more
restrictions. The Federal banking agencies, however, may not treat a
significantly undercapitalized institution as critically undercapitalized unless
its capital ratios actually warrant such treatment.
In addition to measures taken under the prompt corrective action provisions,
commercial banking organizations may be subject to potential enforcement actions
by Federal regulators for unsafe or unsound practices in conducting their
business or for violations of any law, rule, regulation or any condition imposed
in writing by the agency or any written agreement with the agency.
Safety and Soundness Standards. The Federal banking agencies have adopted
guidelines designed to assist the agencies in identifying and addressing
potential safety and soundness concerns before capital becomes impaired. The
guidelines set forth operational and managerial standards relating to: internal
controls, information systems and internal audit systems; loan documentation;
credit underwriting; asset growth; earnings; and compensation, fees and
benefits. Additionally, the Federal banking agencies have also adopted safety
and soundness guidelines with respect to asset quality and earnings standards.
These guidelines provide six standards for establishing and maintaining a system
to identify problem assets and prevent those assets from deteriorating. Under
these standards, an insured depository institution should: conduct periodic
asset quality reviews to identify problem assets; estimate the inherent losses
in problem assets and establish reserves that are sufficient to absorb estimated
losses; compare problem asset totals to capital; take appropriate corrective
action to resolve problem assets; consider the size and potential risks of
material asset concentrations; and provide periodic asset quality reports with
adequate information for management and the board of directors to assess the
level of asset risk. These guidelines also set forth standards for evaluating
and monitoring earnings and for ensuring that earnings are sufficient for the
maintenance of adequate capital and reserves.
Dividend Restrictions. Dividends from bank subsidiaries often constitute a
principal source of income to a bank holding company. Federal rules limit a
bank's ability to pay dividends to its parent bank holding company in excess of
amounts generally equal to the bank's net profits from the current year plus
retained net profits for the preceding two years or if the payment would result
in the bank being considered "undercapitalized" under regulatory capital
guidelines. Bank regulatory agencies also have authority to prohibit a bank from
engaging in activities that, in the opinion of the applicable bank regulatory
authority, constitute unsafe or unsound practices in conducting its business. It
is possible, depending upon the financial condition of the bank in question and
other factors, that the applicable bank regulatory authority could assert that
the payment of dividends or other payments might, under some circumstances, be
such an unsafe or unsound practice. At December 31, 2004 approximately $14.1
million of retained earnings were available for Bank dividend declaration
without prior regulatory approval.
Community Reinvestment Act and Fair Lending Developments. The Bank is subject to
certain fair lending requirements and reporting obligations involving home
mortgage lending operations and Community Reinvestment Act ("CRA") activities.
The CRA generally requires the Federal banking agencies to evaluate the record
of a financial institution in meeting the credit needs of its local communities,
including low- and moderate-income areas. A bank may be subject to substantial
penalties and corrective measures for a violation of certain fair lending laws.
The Federal banking agencies may take compliance with such laws and CRA
obligations into account when regulating and supervising other activities of the
Bank. A Bank's compliance with its CRA obligations is based on a
performance-based evaluation system that bases CRA ratings on its lending
service and investment performance. When a bank holding company applies for
approval to acquire a bank or other bank holding company, the Federal Reserve
will review the assessment of each subsidiary bank of the applicant bank holding
company, and such records may be the basis for denying the application. In
connection with its assessment of CRA performance, the appropriate bank
regulatory agency assigns a rating of "outstanding," "satisfactory," "needs to
improve" or "substantial noncompliance." As a result of its most recent CRA
assessment, the Bank was rated satisfactory under this rating system.
Deposit Insurance. Through the Bank Insurance Fund (the "BIF") and the Savings
Association Insurance Fund (the "SAIF"), the FDIC insures the deposits of the
Bank up to prescribed limits for each depositor. FDIC-insured depository
institutions that are members of the BIF and SAIF pay insurance premiums at
rates based on their assessment risk classification, which is determined in part
based on the institution's capital ratios and in part on factors that the FDIC
deems relevant to determine the risk of loss to the insurance funds. Assessment
rates currently range from zero to 27 cents per $100 of deposits. The FDIC may
increase or decrease the assessment rate schedule on a semi-annual basis. An
increase in the assessment rate could have a material adverse effect on our
earnings, depending on the amount of the increase. The FDIC may terminate a
depository institution's deposit insurance upon a finding by the FDIC that the
institution's financial condition is unsafe or unsound or that the institution
has engaged in unsafe or unsound practices or has violated any applicable rule,
regulation, order or condition enacted or imposed by the institution's
regulatory agency. The termination of deposit insurance for the Bank could have
a material adverse effect on our earnings.
All FDIC-insured depository institutions must pay an annual assessment to
provide funds for the payment of interest on bonds issued by the Financing
Corporation, a Federal corporation chartered under the authority of the Federal
Housing Finance Board. The bonds, commonly referred to as FICO bonds, were
issued to capitalize the Federal Savings and Loan Insurance Corporation. The
FDIC established the FICO assessment rates effective for the fourth quarter of
2004 at approximately $0.00360 per $100 of assessable deposits. The FICO
assessments are adjusted quarterly to reflect changes in the assessment bases of
the FDIC's insurance funds and do not vary depending on a depository
institution's capitalization or supervisory evaluations.
Cross-Guarantee. The Financial Institutions, Reform, Recovery and Enforcement
Act of 1989 provides for cross-guarantees of the liabilities of insured
depository institutions pursuant to which any bank subsidiary of a bank holding
company may be required to reimburse the FDIC for any loss or anticipated loss
to the FDIC that arises from a default of any of such holding company's other
subsidiary banks or assistance provided to such an institution in danger of
default.
Support of Banks. Bank holding companies are also subject to the "source of
strength doctrine" which requires such holding companies to serve as a source of
"financial and managerial" strength for their subsidiary banks and to conduct
its operations in a safe and sound manner. Additionally, it is the Federal
Reserve's policy that in serving as a source of strength to its subsidiary
banks, a bank holding company should stand ready to use available resources to
provide adequate capital funds to its subsidiary banks during periods of
financial stress or adversity and should maintain the financial flexibility and
capital-raising capacity to obtain additional resources for assisting its
subsidiary banks. A bank holding company's failure to meet its obligations to
serve as a source of strength to its subsidiary banks will generally be
considered by the Federal Reserve to be an unsafe and unsound banking practice
or a violation of the Federal Reserve's regulations or both.
Registration with the Securities and Exchange Commission. BNCCORP's securities
are registered with the Securities and Exchange Commission ("SEC") under the
Exchange Act. As such, BNCCORP is subject to the information, proxy
solicitation, insider trading and other requirements and restrictions of the
Exchange Act.
Conservator and Receivership Powers. Federal banking regulators have broad
authority to place depository institutions into conservatorship or receivership
to include, among other things, appointment of the FDIC as conservator or
receiver of an undercapitalized institution under certain circumstances. If the
Bank were placed into conservatorship or receivership, because of the
cross-guarantee provisions of the Federal Deposit Insurance Act, as amended,
BNCCORP, as the sole stockholder of the Bank, would likely lose its investment
in the Bank.
Bank Secrecy Act. The Bank Secrecy Act requires financial institutions to keep
records and file reports that are determined to have a high degree of usefulness
in criminal, tax and regulatory matters, and to implement counter-money
laundering programs and compliance procedures. The Bank Secrecy Act and its
implementing regulations are presently the subject of increased regulatory focus
and several financial institutions have been penalized due to deficiencies in
their Bank Secrecy Act programs.
Consumer Laws and Regulations. In addition to the laws and regulations discussed
herein, the Bank is also subject to certain consumer laws and regulations that
are designed to protect customers in transactions with banks. These include, but
are not limited to, the Truth in Lending Act, the Truth in Savings Act, the
Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal
Credit Opportunity Act, the Home Mortgage Disclosure Act, the Real Estate
Settlement Procedures Act, the Fair Credit Reporting Act, the Flood Disaster
Protection Act, the Fair Housing Act and the Right to Financial Privacy Act.
These laws mandate certain disclosure requirements and regulate the manner in
which financial institutions must deal with customers when taking deposits or
making loans to such customers.
Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act (the "Financial Modernization
Act") expands the powers of banks and bank holding companies to sell any
financial product or service, closes the unitary thrift loophole, reforms the
Federal Home Loan Bank ("FHLB") System to increase community banks' access to
loan funding, protects banks from discriminatory state insurance regulation and
establishes a new framework for the regulation of bank and bank holding company
securities brokerage and underwriting activities. The Financial Modernization
Act also includes provisions in the privacy area, restricting the ability of
financial institutions to share nonpublic personal customer information with
third parties.
USA Patriot Act of 2001. The USA Patriot Act of 2001 (the "Patriot Act")
contains sweeping anti-money laundering and financial transparency laws and
requires various regulations including: due diligence requirements for financial
institutions that administer, maintain or manage private bank accounts or
correspondent accounts for non-U.S. persons; standards for verifying customer
identification at the time of account opening; rules to promote cooperation
among financial institutions, regulators, and law enforcement entities in
identifying parties that may be involved in terrorism or money laundering;
reports by nonfinancial trades and business filed with the Treasury Department's
Financial Crimes Enforcement Network for transactions exceeding $10,000 and;
filing of suspicious activity reports by brokers and dealers if they believe a
customer may be violating U.S. laws and regulations.
Changing Regulatory Structure. The Federal Reserve, OCC and FDIC have extensive
authority to police unsafe or unsound practices and violations of applicable
laws and regulations by depository institutions and their holding companies. The
agencies' authority has been expanded by Federal legislation in recent years. In
addition, state banking authorities possess significant authority to address
violations of their state's banking laws by banks operating in their respective
states by enforcement and other supervisory actions.
As indicated above, the laws and regulations affecting banks and bank holding
companies are numerous and have changed significantly in recent years. There is
reason to expect that changes will continue in the future, although it is
difficult to predict the outcome of these changes or the impact such changes
will have on us.
Employees
At December 31, 2004, we had 344 employees, including 336 full-time equivalent
employees. None of our employees is covered by a collective bargaining
agreement. We consider our relationships with our employees to be satisfactory.
Approximate employees by segment were as follows as of December 31, 2004:
banking, 180; insurance, 153; and brokerage/trust/financial, 11.
Factors That May Affect Future Results of Operations
In addition to the other information contained in this report, the following
risks may affect us. If any of these risks occur, our business, financial
condition or operating results could be adversely affected.
Failure to successfully execute our growth, operating and cross-selling
strategies can negatively impact our profitability. Our financial performance
and profitability depends on our ability to execute our corporate growth,
operating and cross-selling strategies. Future acquisitions and continued growth
can present operating and other issues that could have an adverse effect on our
business, financial condition and results of operations. Our financial
performance will also depend on our ability to maintain profitable operations
through implementation of our banking and financial services philosophies,
including our efforts to cross-sell our various products and services, which
were described earlier. Therefore, there can be no assurance that we will be
able to execute our growth and operating strategies or maintain any particular
level of profitability.
Regional presences, related economic conditions and credit concentrations could
adversely affect our operating results. Although our operations are presently
somewhat geographically dispersed, our focus in the Arizona, Minnesota and North
Dakota regions could adversely affect our results of operations if economic and
business conditions in any of these regions were to exhibit weaknesses. A
prolonged decline in economic or business conditions in our market areas, in
particular in those industries in which we have credit concentrations, could
have a material impact on the quality of our loan portfolio or the demand for
our other products and services, which in turn may have a material adverse
effect on our results of operations. Weakening in the national economy might
further exacerbate local or regional economic conditions. The extent of the
future impact of these events on economic and business conditions cannot be
predicted.
Changes in market interest rates can significantly impact our earnings. Changes
in interest rates impact the demand for new loans, the credit profile of
existing loans, the rates received on loans and investment securities, rates
paid on deposits and borrowings and the value of our derivative contracts and
their associated impact on earnings. The relationship between the interest
income received on loans and investment securities and interest expense paid on
deposits and borrowings is known as net interest income. The level of net
interest income can fluctuate given changes in market interest rates. We measure
interest rate risk under various rate scenarios and using specific criteria and
assumptions. A summary of this process, along with the results of our net
interest income simulations is presented at "Quantitative and Qualitative
Disclosures About Market Risk" included under Item 7A of Part II. Although we
believe our current level of interest rate sensitivity is reasonable and
effectively managed, significant fluctuations in interest rates may have an
adverse effect on our business, financial condition and results of operations.
Changes in market interest rates can directly influence the performance of our
insurance segment. Interest rate movements directly affect insurance company
investment in bonds and, as a result, the rates they subsequently charge for
insurance policies. A rising interest rate environment increases investment
returns for insurers and generally allows those insurers to compete more
aggressively with lower insurance rates. During the past three years, interest
rates have been low and insurance rates were up. Over the next several years,
interest rates could move up and lower insurance rates would be expected, which
in turn would create lower premiums and commissions. We cannot predict, with any
degree of certainty, interest rate developments, and the resulting impact on
insurance premiums and commissions, in future periods.
Government regulation can result in limitations on our operations. The financial
services industry is extensively regulated. Federal and state regulation is
designed primarily to protect the deposit insurance funds and consumers, and not
to benefit our stockholders. Such regulations can at times impose significant
limitations on our operations. Additionally, these regulations are constantly
evolving and may change significantly over time. Significant new laws, such as
those issued in recent years, or changes in or repeal of existing laws may cause
our results to differ materially. Further, Federal monetary policy, particularly
as implemented through the Federal Reserve System, significantly affects
interest rate and credit conditions, which are material considerations for us.
Competition from other financial services providers could adversely impact our
results of operations. The banking and financial services business is highly
competitive. We face competition in making loans, attracting deposits and
providing insurance, brokerage, trust and other financial services. Increased
competition in the banking and financial services businesses may reduce our
market share, impair our growth or cause the prices we charge for our services
to decline. Our results of operations may differ in future periods depending
upon the level and nature of competition we encounter in our various market
areas.
Failure to perform on behalf of borrowers, guarantors and related parties
exposes us to risk of loss that can materially adversely affect our results of
operations. We encounter significant sources of risk from the possibility that
losses will be sustained if a significant number of our borrowers, guarantors
and related parties fail to perform in accordance with the terms of their loans,
commitments or letters of credit. We have adopted underwriting and credit
monitoring procedures and credit policies, including the establishment and
methodological review and analysis of the allowance for credit losses. We
believe these processes and procedures are appropriate to minimize this risk by
assessing the likelihood of nonperformance, tracking loan performance and
diversifying our credit portfolio. These policies and procedures, however, may
not prevent unexpected losses that could materially adversely affect our results
of operations. Additionally, as noted earlier, the performance of borrowers,
guarantors and related parties can be negatively impacted by prevailing economic
conditions over which we have no control. Such negative impacts on these parties
could also materially adversely affect our results of operations.
Loss of key employees may disrupt relationships with certain customers. Our
business is primarily relationship-driven in that many of our key employees have
extensive customer relationships. Loss of a key employee with such customer
relationships may lead to the loss of business if the customers were to follow
that employee to a competitor. While we believe our relationship with our key
producers is good, we cannot guarantee that all of our key personnel will remain
with our organization. Loss of such key personnel, should they enter into an
employment relationship with one of our competitors, could result in the loss of
some of our customers.
Impairment of goodwill or other intangible assets could require charges to
earnings, which could result in a negative impact on our results of operations.
Under current accounting standards, goodwill and certain other intangible assets
with indeterminate lives are no longer amortized but, instead, are assessed for
impairment periodically or when impairment indicators are present. Assessment of
goodwill and such other intangible assets could result in circumstances where
the applicable intangible asset is deemed to be impaired for accounting
purposes. Under such circumstances, the intangible asset's impairment would be
reflected as a charge to earnings in the period during which such impairment is
identified. Further information regarding intangible assets is presented in Note
9 to the Consolidated Financial Statements included under Item 8 of Part II.
Recent accounting changes may give rise to a future regulatory capital event
that would entitle the trusts created to facilitate our trust preferred
securities offerings to redeem the trust preferred securities which would result
in a reduction to our consolidated capital ratios. In accordance with the
provisions of Financial Accounting Standards Board Interpretation No. 46,
"Consolidation of Variable Interest Entities," we have deconsolidated the two
subsidiary trusts that have issued trust preferred securities for BNCCORP.
Accordingly, the trust preferred securities are now reported as a liability.
Under applicable regulatory guidelines, a portion of the trust preferred
securities qualifies as Tier 1 capital (to certain limits), and the remaining
portion qualifies as Tier 2 capital (to certain limits). On July 2, 2003, the
Federal Reserve issued Supervisory Letter (SR 03-13), which preserves the
historical capital treatment of trust preferred securities as capital despite
the deconsolidation of these securities. That Supervisory Letter remained in
effect at December 31, 2004, and we continue to include these securities in our
capital base. A final rule regarding trust preferred securities has just been
issued and is under review.
Item 2. Properties
The principal offices of BNCCORP are located at 322 East Main Avenue, Bismarck,
North Dakota. The Bank owns the building. The principal office of the Bank is
located at 2425 East Camelback Road, Phoenix, Arizona, which it is leasing. The
Bank owns branch offices at 219 South 3rd Street and 801 East Century Avenue and
an additional office building at 116 North 4th Street in Bismarck. The Bank also
owns a branch office at 17045 North Scottsdale Road, Scottsdale, Arizona and 650
Douglas Drive, Golden Valley, Minnesota. It also owns its banking facilities in
Crosby, Ellendale, Kenmare, Linton, Stanley and Watford City, North Dakota. The
Bank has also purchased a property at 6515 East Grant in Tucson, Arizona. We
anticipate construction of a banking branch at this location sometime in the
future. The Bank has also purchased land at 4155 Dean Lakes Boulevard, Shakopee,
Minnesota where construction of a branch office is expected to commence during
2005.
The Bank's facilities at 502 West Main Street (Mandan) and Garrison, North
Dakota are leased. The facilities occupied by the Bank, BNC AMI and Milne Scali
at 333 South Seventh Street, Minneapolis, Minnesota, and the Bank's facilities
at 640 and 660 South Mill Avenue, Tempe, Arizona, along with 2425 East Camelback
Road, Phoenix, Arizona are also leased.
Milne Scali occupies five locations in Arizona: 1750 East Glendale Avenue,
Phoenix; 660 South Mill Avenue, Tempe; 2400 East Highway 89A, Cottonwood; 6751
East Camino Principal, Tucson; and 8101 East Florentine Road, Prescott Valley.
Milne Scali also occupies locations at 8310 South Valley Highway, Englewood,
Colorado and 175 South Main, Salt Lake City, Utah. The Bank owns the properties
in Phoenix and Tucson and the remaining five facilities are presently leased.
We believe that all owned and leased properties are well maintained and
considered in good operating condition. They are believed adequate for the
Company's present operations; however, future expansion could result in the
leasing or construction of additional facilities. We do not anticipate any
difficulty in renewing our leases or leasing additional suitable space upon
expiration of present lease terms. See Note 27 to the Consolidated Financial
Statements included under Item 8 of Part II for additional information
concerning our present lease commitments.
Item 3. Legal Proceedings
Terrence M. Scali v. BNCCORP, Inc., Milne Scali & Company, Inc., Gregory K.
Cleveland and Jacquelyn L. Cleveland, husband and wife, Tracy Scott and Myrt
Scott, husband and wife, and Richard W. Milne, Jr. and Robin Jayne Milne,
husband and wife, AAA No. 76 166 00014 05 JAFA (the "Arbitration"). The American
Arbitration Association is administering the Arbitration. Terrence M. Scali,
former executive vice president of BNCCORP, and former President and CEO of
Milne Scali, a subsidiary of the Bank, which is a subsidiary of BNCCORP, and a
former director of BNCCORP, has commenced an arbitration against BNCCORP, Milne
Scali, and three current executives and members of the Boards of Directors of
BNCCORP and Milne Scali. Mr. Scali alleges that his damages exceed $500,000 and
arise out of the termination of his employment with BNCCORP and Milne Scali in
July 2004. In his claims against BNCCORP and Milne Scali, Mr. Scali alleges
breach of contract, wrongful termination, and conversion. Mr. Scali has also
brought a claim for a declaration of his rights under an employment agreement,
seeking to have his noncompete, nonsolicitation, and nondisclosure agreements
nullified. For his claims against the executives, Mr. Scali alleges tortuous
interference with contract and defamation. Mr. Scali has also named the wives of
the three executives as respondents to the Arbitration in their capacity as
potential holders of community property interests with their husbands. BNCCORP,
Milne Scali and the executives deny any wrongdoing and will vigorously defend
against Mr. Scali's claims.
Terrence M. Scali v. Gregory K. Cleveland and Jane Doe Cleveland, husband and
wife, Tracy Scott and Jane Doe Scott, husband and wife, and Richard W. Milne,
Jr. and Robin Jayne Milne, husband and wife, State of Arizona Superior Court,
Maricopa County, Case No. CV2005-001741. Mr. Scali has commenced a parallel
action in Arizona Superior Court against BNCCORP and Milne Scali executives,
asserting the same claims in court that were asserted in the Arbitration. The
executives intend to vigorously defend against Mr. Scali's claims in the court
case, as they will do in the Arbitration.
From time to time, we may be a party to legal proceedings arising out of our
lending, deposit operations or other activities. We engage in foreclosure
proceedings and other collection actions as part of our loan collection
activities. From time to time, borrowers may also bring actions against us, in
some cases claiming damages. Some financial services companies have been
subjected to significant exposure in connection with litigation, including class
action litigation and punitive damage claims. While we are not aware of any such
actions or allegations that should reasonably give rise to any material adverse
effect, it is possible that we could be subjected to such a claim in an amount
that could be material. Based upon a review with our legal counsel, we believe
that the ultimate disposition of such pending litigation will not have a
material effect on our financial condition, results of operations or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter ended
December 31, 2004.
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities.
BNCCORP's common stock, $.01 par value ("Common Stock"), is traded on the Nasdaq
Stock Market under the symbol "BNCC."
The following table lists the high and low sales prices of our Common Stock for
the periods indicated as reported by the Nasdaq Stock Market. The quotes reflect
the high and low closing sales prices for our Common Stock as reported by
Nasdaq.
2004 2003
----------------- ------------------
Period High Low High Low
------- ------- -------- -------
First Quarter...... $18.40 $15.16 $11.10 $ 7.00
Second Quarter..... 17.51 15.00 13.49 10.64
Third Quarter...... 18.10 13.62 15.25 12.23
Fourth Quarter..... 16.60 14.38 19.20 14.62
On January 28, 2005, there were 104 record holders of the Company's Common Stock
as reported by the Company's stock transfer agent and registrar, American Stock
Transfer & Trust Company.
BNCCORP's policy is to retain its earnings to support the growth of its
business. Our board of directors has never declared cash dividends on our Common
Stock and does not plan to do so in the foreseeable future. In making the
determination to pay dividends, we will consider all relevant factors including,
among other things, our capital position and current tax law as it relates to
the treatment of dividends. "Supervision and Regulation - Dividend Restrictions"
included under Item 1 of Part I discusses regulatory restrictions on dividends
payable by the Bank to BNCCORP.
Pursuant to an asset purchase and sale agreement dated December 31, 2003, on
December 31, 2004, BNCCORP issued 15,692 shares of its Common Stock to IASW for
the second installment related to Milne Scali's acquisition of certain assets of
IASW. The shares of Common Stock were issued in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act.
Pursuant to an asset purchase and sale agreement, on June 30, 2004, BNCCORP
issued 26,607 shares of its Common Stock to Finkbeiner Insurance, Inc. in
connection with Milne Scali's acquisition of certain assets and assumption of
certain liabilities of the insurance agency. The shares of Common Stock were
issued in reliance upon the exemption from registration provided by Section 4(2)
of the Securities Act.
Pursuant to an asset purchase and sale agreement, on March 31, 2004, BNCCORP
issued 22,470 shares of its Common Stock to The Richard Q. Perry Agency in
connection with Milne Scali's acquisition of certain assets and assumption of
certain liabilities of the insurance agency. The shares of Common Stock were
issued in reliance upon the exemption from registration provided by Section 4(2)
of the Securities Act.
Pursuant to an asset purchase and sale agreement, on January 5, 2004, BNCCORP
issued 2,888 shares of its Common Stock to Lynk Financial LLC ("Lynk") in
connection with the Bank's acquisition of certain assets of Lynk. The shares of
Common Stock were issued in reliance upon the exemption from registration
provided by Section 4(2) of the Securities Act.
BNCCORP did not purchase any of its Common Stock during 2004.
Item 6. Selected Financial Data
The selected consolidated financial data presented below under the captions
"Income Statement Data" and "Balance Sheet Data" as of and for the years ended
December 31, 2004, 2003, 2002, 2001 and 2000 are derived from the historical
audited consolidated financial statements of the Company. The Consolidated
Balance Sheets as of December 31, 2004, 2003, 2002, 2001 and 2000, and the
related Consolidated Statements of Income, Comprehensive Income, Stockholders'
Equity and Cash Flows for each of the five years in the period ended December
31, 2004 were audited by KPMG LLP, independent public accountants. The financial
data below should be read in conjunction with and is qualified by the
Consolidated Financial Statements and the notes thereto included under Item 8.
The adoption of Statement of Financial Accounting Standards No. 150, "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity" ("SFAS 150") in 2003, which requires that the expense associated with
BNCCORP's subordinated debentures be included in interest expense, is reflected
as such in all applicable periods in the table below.
The data presented in the table below includes the financial performance of
Milne Scali since its acquisition in April 2002. The data presented in the table
below also includes the financial performance of our other acquisitions since
their respective acquisition dates. Additionally, the financial performance of
the Bank's Fargo, North Dakota branch (which was sold on September 30, 2003) is
not reflected in the data below. All data presented is from continuing
operations as of and for all periods presented.
Selected Financial Data (1)
For the Years Ended December 31,
----------------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- ---------- --------- ---------
(dollars in thousands, except share and
per share data)
Income Statement Data:
Total interest income............. $ 30,141 $ 28,646 $ 31,818 $ 37,586 $ 40,658
Total interest expense............ 14,100 15,268 18,736 24,033 27,679
--------- --------- ---------- --------- ---------
Net interest income............... 16,041 13,378 13,082 13,553 12,979
Provision for credit losses....... 175 1,475 1,202 1,699 1,202
Noninterest income................ 23,450 20,812 16,296 8,714 7,683
Noninterest expense............... 34,768 27,290 25,329 18,182 15,821
Income tax provision.............. 1,144 1,581 822 691 1,183
--------- --------- ---------- --------- ---------
Income from continuing operations. $ 3,404 $ 3,844 $ 2,025 $ 1,695 $ 2,456
========= ========= ========== ========= =========
Balance Sheet Data: (at end of
period)
Total assets...................... $ 673,710 $ 621,477 $ 602,228 $ 555,967 $ 547,447
Investments....................... 235,916 262,568 208,072 211,801 253,566
Federal Reserve Bank and Federal
Home Loan Bank stock........... 7,541 7,596 7,071 7,380 9,619
Loans held for sale............... 60,197 -- -- -- --
Loans held for investment, net of
unearned income................ 293,814 283,555 335,794 297,924 252,753
Allowance for credit losses....... (3,335) (4,763) (5,006) (4,325) (3,588)
Total deposits.................... 455,343 395,942 398,245 375,277 330,894
Short-term borrowings............. 33,697 31,833 28,120 760 33,228
Federal Home Loan Bank advances... 97,200 112,200 97,200 117,200 117,200
Long-term borrowings.............. 10,079 8,640 8,561 13 12,642
Guaranteed preferred beneficial
interests in Company's
subordinated debentures........ 22,509 22,397 22,326 22,244 7,606
Common stockholders' equity....... 42,596 38,686 36,223 30,679 29,457
Book value per common share
outstanding.................... $ 14.77 $ 14.07 $ 13.41 $ 12.79 $ 12.30
Earnings Performance /
Share Data (1):
Return on average total assets.... 0.54% 0.64% 0.36% 0.31% 0.47%
Return on average common
stockholders' equity........... 8.01% 9.92% 5.77% 5.51% 10.02%
Net interest margin............... 2.86% 2.47% 2.51% 2.63% 2.65%
Net interest spread............... 2.72% 2.29% 2.29% 2.25% 2.35%
Basic earnings per
common share (1)............... $ 1.18 $ 1.38 $ 0.74 $ 0.71 $ 1.02
Diluted earnings per common
share (1)...................... $ 1.14 $ 1.35 $ 0.74 $ 0.70 $ 1.02
Cash dividends per common share... -- -- -- -- --
Cash dividends per preferred
share.......................... $ 700.00 $ 800.00 $ 526.67 -- --
Total cash dividends - preferred
stock.......................... $ 93 $ 120 $ 79 -- --
Average common shares
outstanding.................... 2,813,531 2,705,602 2,611,629 2,395,353 2,397,356
Average common and common
equivalent shares.............. 2,896,241 2,764,816 2,628,798 2,421,113 2,398,553
Shares outstanding at yearend..... 2,884,876 2,749,196 2,700,929 2,399,170 2,395,030
Balance Sheet and Other Key
Ratios (1):
Nonperforming assets to total
assets......................... 0.08% 1.28% 1.27% 0.80% 0.12%
Nonperforming loans to
total loans.................... 0.19% 2.80% 2.27% 1.47% 0.23%
Net loan charge-offs to average
loans.......................... (0.58)% (0.56)% (0.17)% (0.33)% (0.20)%
Allowance for credit losses to
total loans.................... 1.14% 1.68% 1.49% 1.45% 1.42%
Allowance for credit losses
to nonperforming loans......... 607% 60% 66% 99% 619%
Average common stockholders'
equity to average
total assets................... 6.50% 6.25% 5.93% 5.64% 4.71%
- -------------------------
(1) From continuing operations for all periods presented.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The following table summarizes income from continuing operations, net income and
basic and diluted earnings per share for the 12 months ended December 31
(amounts in thousands):
2004 2003 2002
------------ ----------- ------------
Income from continuing operations.... $ 3,404 $ 3,844 $ 2,025
Net income........................... 3,404 3,844 2,039
Basic earnings per common share...... 1.18 1.38 0.75
Diluted earnings per common share.... 1.14 1.35 0.75
Executive Summary - 2004 vs. 2003. The following information highlights key
developments during 2004:
o 2004 net income was $3.40 million ($1.14 per share on a diluted basis)
compared with $3.84 million ($1.35 per share) for 2003.
o Our insurance segment again provided a significant contribution to 2004
profitability.
o Net interest income for 2004 rose $2.66 million to $16.04 million compared
with $13.38 million in 2003 primarily due to an increase in interest
income, a decrease in interest expense and a decrease in the cost of
interest-bearing liabilities.
o Noninterest income for 2004 rose $2.64 million to $23.45 million compared
with $20.81 million in 2003.
o Noninterest income represented 59.4 percent of gross revenues in 2004
compared with 60.9 percent in 2003.
o Insurance commission income accounted for $17.49 million, or 74.6 percent
of noninterest income, compared with $14.57 million, or 70.0 percent in
2003.
o Net interest margin widened to 2.86 percent in 2004 compared with 2.47
percent in 2003.
o Noninterest expense rose 27.4 percent to $34.77 million for 2004 compared
with $27.29 million for 2003. The increase primarily reflected costs
associated with expanded banking operations in Arizona and Minnesota along
with expanded insurance operations in Arizona, Colorado and Utah. $688,000
of the increase related to the termination of employment of a former
officer of Milne Scali. The payment represented the acceleration of the
remaining salary due under his multi-year employment contract.
o Total assets reached $673.71 million at December 31, 2004 compared with
$621.48 million one year earlier.
o Total loans held for sale were $60.20 million at December 31, 2004, a
result of the inception of mortgage loan and student loan financing
programs during 2004.
o Total loans held for investment increased $10.26 million in 2004, to
$293.81 million.
o The provision for credit losses was $175,000 in 2004 compared to $1.48
million in 2003, the reduction reflecting a significant reduction in
nonperforming loans during 2004.
o Nonperforming loans declined to $549,000 at December 31, 2004 from $7.95
million at December 31, 2003 primarily reflecting the full pay-off of a
$4.5 million loan and the resolution of a $2.2 million loan that resulted
in a charge-off of $1.2 million (of which $975,000 was reserved for at
December 31, 2003).
o Loan charge-offs were $1.88 million in 2004 compared with $1.82 million in
2003 with $1.2 million of the charge-offs related to the $2.2 million loan
referred to above.
o The ratio of the allowance for credit losses to total nonperforming loans
was 607 percent at December 31, 2004 compared with 60 percent at December
31, 2003.
o Investment securities available for sale declined $26.65 million to $235.92
million at December 31, 2004 compared with $262.57 million one year
earlier.
o Core deposits increased $30.8 million, or 8.4 percent over the 12-month
period ended December 31, 2004. The growth was primarily attributable to
our Arizona market and our new branch office in Golden Valley, Minnesota.
o Noninterest-bearing deposits increased $18.7 million, or 41.7 percent over
the 12-month period ended December 31, 2004.
o Total deposits increased $59.40 million to $455.34 million at December 31,
2004 compared with $395.94 million at December 31, 2004.
o Total common stockholders' equity was approximately $42.60 million at
December 31, 2004, equivalent to book value per common share of $14.77
(tangible book value per common share of $4.42).
During 2004, we continued to take actions which we believe will strengthen the
performance of our core businesses.
In banking, we opened our Golden Valley, Minnesota branch office and completed
our acquisition of a mortgage banking operation.
In insurance, we increased the volume of insurance commission income and made
acquisitions in several different market areas.
We believe that we have achieved our goal of building a diversified business
base, which has long been a cornerstone of our strategy. We believe each of our
core businesses is well defined and well positioned to serve the needs of our
customers, while contributing to our long-term corporate financial performance
and share value creation.
Looking forward to 2005, we hope to continue to derive benefits from our
investments in expanding our banking and insurance operations, and implementing
programs to encourage cross-selling across all of our business lines.
Results of Operations
Net Interest Income. Net interest income, the difference between total interest
income earned on interest-earning assets and total interest expense paid on
interest-bearing liabilities, is the banking segment's primary source of
earnings. The amount of net interest income is affected by changes in the volume
and mix of earning assets, the level of rates earned on those assets, the volume
and mix of interest-bearing liabilities and the level of rates paid on those
liabilities.
The following table sets forth, for the periods indicated, certain information
relating to our average balance sheet and reflects the yield on average assets
and cost of average liabilities. Such yields and costs are derived by dividing
income and expense by the average balance of assets and liabilities. All average
balances have been derived from monthly averages, which are indicative of daily
averages.
Analysis of Average Balances, Interest and Yields/Rates (1)
For the Years ended December 31,
---------------------------------------------------------------------------------------------------
2004 2003 2002
------------------------------ ------------------------------- ----------------------------------
Interest Average Interest Average Interest Average
Average earned yield Average earned Yield Average earned yield
balance or paid or cost balance or paid or cost balance or paid or cost
--------- -------- -------- --------- -------- --------- --------- ---------- ----------
(dollars in thousands)
Assets
Federal funds
sold/interest-bearing due
from...................... $ 495 $ 8 1.62% $ 1,447 $ 11 0.76% $ 3,795 $ 66 1.74%
Taxable investments......... 236,854 9,664 4.08% 203,051 7,803 3.84% 193,972 9,997 5.15%
Tax-exempt investments...... 34,538 1,604 4.64% 32,982 1,535 4.65% 19,979 977 4.89%
Loans held for sale......... 15,818 718 4.54% -- -- -- --
Loans and leases held for
investment (2)............ 276,653 18,147 6.56% 308,115 19,297 6.26% 307,227 20,778 6.76%
Allowance for credit losses. (3,757) -- (4,909) -- (4,579) --
--------- -------- --------- -------- --------- ----------
Total interest-earning
assets (3)............... 560,601 30,141 5.38% 540,686 28,646 5.30% 520,394 31,818 6.11%
Noninterest-earning assets:
Cash and due from banks.. 11,938 11,733 13,706
Other.................... 63,600 48,249 34,946
--------- --------- ---------
Total assets from
continuing operations.... 636,139 600,668 569,046
Assets from discontinued
Fargo branch............. -- -- 22,258
--------- --------- ---------
Total assets......... $636,139 $600,668 $591,304
========= ========= =========
Liabilities and Stockholders'
Equity
Deposits:
Interest checking and
money market accounts... $198,992 2,130 1.07% $186,796 2,189 1.17% $174,108 2,849 1.64%
Savings................... 6,695 47 0.70% 6,052 51 0.84% 4,511 39 0.86%
Certificates of deposit:
Under $100,000............ 95,509 2,439 2.55% 94,820 3,012 3.18% 104,964 4,068 3.88%
$100,000 and over......... 58,625 1,916 3.27% 55,928 2,186 3.91% 73,639 3,286 4.46%
--------- -------- --------- -------- --------- ----------
Total interest-bearing
deposits.................. 359,821 6,532 1.82% 343,596 7,438 2.16% 357,222 10,242 2.87%
Borrowings:
Short-term borrowings..... 29,663 519 1.75% 21,942 382 1.74% 7,799 141 1.81%
FHLB advances............. 109,195 4,898 4.49% 111,777 5,333 4.77% 97,711 6,214 6.36%
Long-term borrowings...... 9,371 393 4.19% 8,623 387 4.49% 6,063 310 5.11%
Subordinated debentures... 22,239 1,758 7.91% 22,141 1,728 7.80% 22,056 1,829 8.29%
--------- -------- --------- -------- --------- ----------
Total interest-bearing
liabilities............... 530,289 14,100 2.66% 508,079 15,268 3.01% 490,851 18,736 3.82%
Noninterest-bearing
demand accounts.......... 52,822 40,022 33,951
--------- -------- ---------
Total deposits and
interest-bearing
liabilities............ 583,111 548,101 524,802
Other noninterest-bearing
liabilities................. 10,551 13,542 11,336
Liabilities from discontinued
Fargo branch................ -- -- 20,476
--------- -------- ---------
Total liabilities.... 593,662 561,643 556,614
Stockholders' equity.......... 42,477 39,025 34,690
--------- -------- ---------
Total liabilities
and stockholders'
equity............. $636,139 $600,668 $591,304
========= ======== =========
Net interest income........... $16,041 $13,378 $ 13,082
======== ======== =========
Net interest spread........... 2.72% 2.29% 2.29%
======== ======== ======
Net interest margin (4)....... 2.86% 2.47% 2.51%
======== ======== ======
Ratio of average
interest-earning
assets to average
interest-bearing
liabilities............... 105.72% 106.42% 106.02%
========= ======== =========
--------------------
(1) From continuing operations for all periods presented.
(2) Average balances of loans and leases include nonaccrual loans and leases,
and are presented net of unearned income. Loan fee amortization totaling
approximately $2.0, $1.5 and $1.3 million is included in loan interest
income for the 12-month periods ended December 31, 2004, 2003 and 2002,
respectively.
(3) Tax-exempt income has not been presented on a taxable equivalent basis.
Tax-exempt income of $1.6 and $1.5 million and $982,000 was recognized
during the years ended December 31, 2004, 2003 and 2002, respectively.
(4) Net interest margin equals net interest income divided by average
interest-earning assets for the period.
The following table illustrates, for the periods indicated, the dollar amount of
changes in our interest income and interest expense for the major components of
interest-earning assets and interest-bearing liabilities and distinguishes
between the increase related to higher outstanding balances and the volatility
of interest rates. Changes attributable to the combined impact of volume and
rate have been allocated proportionately to the change due to volume and the
change due to rate:
Analysis of Changes in Net Interest Income (1)
For the Years Ended December 31,
----------------------------------------------------------
2004 Compared to 2003 2003 Compared to 2002
--------------------------- ----------------------------
Change Due to Change Due to
------------------- --------------------
Volume Rate Total Volume Rate Total
--------- -------- ------- --------- --------- --------
(in thousands)
Interest Earned on Interest-Earning
Assets
Federal funds sold/interest-bearing
due from.......................... $ 4 $ (7) $ (3) $ (30) $ (25) $ (55)
Taxable investments................. 1,358 503 1,861 493 (2,687) (2,194)
Tax-exempt investments.............. 72 (3) 69 603 (45) 558
Loans held for sale................. 665 1 666 -- -- --
Loans held for investment........... (2,065) 967 (1,098) 60 (1,541) (1,481)
--------- -------- ------- --------- --------- --------
Total increase (decrease) in
interest income................. 34 1,461 1,495 1,126 (4,298) (3,172)
--------- -------- ------- --------- --------- --------
Interest Expense on Interest-Bearing
Liabilities
Interest checking and money market
accounts.......................... 181 (240) (59) 228 ( 888) (660)
Savings............................ 7 (11) (4) 13 (1) 12
Certificates of Deposit:
Under $100,000.................... 22 (595) (573) (368) (688) (1,056)
$100,000 and over................. 112 (382) (270) (726) (374) (1,100)
Short-term borrowings............... 135 1 136 246 (5) 241
FHLB advances....................... (121) (314) (435) 1,198 (2,079) (881)
Long-term borrowings................ 25 (19) 6 108 (31) 77
Subordinated debentures............. 8 23 31 7 (108) (101)
--------- -------- ------- --------- --------- --------
Total increase (decrease) in
interest expense.................. 369 (1,537) (1,168) 706 (4,174) (3,468)
--------- -------- ------- --------- --------- --------
Increase (decrease) in net interest
income............................ $ (335) $2,998 $2,663 $ 420 $ (124) $ 296
========= ======== ======= ========= ========= ========
(1) From continuing operations for all periods presented.
Year ended December 31, 2004 compared to year ended December 31, 2003. Net
interest income increased $2.7 million, or 19.9 percent, and totaled $16.0
million for 2004. Net interest spread and net interest margin adjusted to 2.72
and 2.86 percent, respectively, for the 12-month period ended December 31, 2004
from 2.29 and 2.47, respectively, for the 12-month period ended December 31,
2003.
Net interest income and margin for the 12-month period ended December 31, 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 and was paid in full during the first quarter of
2004. Net interest income and margin for the 12-month period ended December 31,
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 12-month periods ended December 31, 2004 and 2003 were slightly
impacted by derivative contract-related transactions during the periods which
decreased net interest income by $55,000 and $80,000, respectively. Without
these interest income variances and derivative transactions, net interest margin
for the 2004 and 2003 periods would have been 2.80 percent and 2.54 percent,
respectively.
The remaining fair value of our interest rate cap contracts on December 31, 2004
was $1,000. Therefore, net interest income in future periods can only be
negatively affected to that amount if the fair value of the contracts were
required to be written to $0. If the fair value of the derivative contracts were
to be increased in future periods due to increases in three-month LIBOR (the
rate upon which our current cap contracts are based), this would have a
favorable effect on net interest income in those future periods as favorable
adjustments to the fair value of the contracts would be reflected as reduced
interest expense.
The following condensed information summarizes the major factors combining to
create the changes to net interest income, spread and margin during 2004 as
compared to 2003. Lettered explanations following the summary describe causes of
the changes in these major factors.
Net Interest Income Analysis - 2004 vs. 2003 (1)
For the Years
Ended December 31, Change
--------------------- ------------------
2004 2003
--------- ----------
(amounts in millions)
Total interest income increased................. $ 30.1 $ 28.6 $ 1.5 5.2%
Due to:
Increase in average earning assets.......... $ 560.6 $ 540.7 $ 19.9 3.7%
Driven by:
Increase in average loans held
for sale (a).............................. $ 15.8 -- $ 15.8 --
Increase in average investments (b)......... $ 271.4 $ 236.0 $ 35.4 15.0%
Offset by:
Decrease in average loans held for
investment (c)............................ $ 276.7 $ 308.1 $(31.4) (10.2)%
The overall increase in average earning
assets was coupled with:
Increase in yield on interest-earnings
assets.................................. 5.38% 5.30% 0.08% 1.5%
Driven by:
Increase in yield on loans held for
investment (d)............................ 6.56% 6.26% 0.30% 4.8%
Increase in yield on investments (e)........ 4.15% 3.96% 0.19% 4.8%
Total interest expense decreased................ $ 14.1 $ 15.3 $ (1.2) (7.8)%
Due to:
Decrease in cost of interest-bearing
liabilities............................... 2.66% 3.01% (0.35)% (11.6)%
Driven by:
Decrease in cost of interest-bearing
deposits (f).............................. 1.82% 2.16% (0.34)% (15.7)%
Decrease in cost of borrowings (g).......... 4.44% 4.76% (0.32)% (6.7)%
These decreases were offset by:
Increase in average interest-bearing
liabilities............................... $ 530.2 $ 508.1 $ 22.2 4.4%
Driven by:
Increase in average borrowings (h).......... $ 170.5 $ 164.5 $ 6.0 3.6%
Increase in average interest-bearing
deposits (i).............................. $ 359.8 $ 343.6 $ 16.2 4.7%
- ---------------
(1) From continuing operations for all periods presented.
(a) Average loans held for sale increased due to mortgage loan and student loan
financing programs initiated during 2004.
(b) Although period end investments available for sale decreased $26.7 million
between December 31, 2003 and December 31, 2004, average investments for
the 12-month period ended December 31, 2004 increased $35.4 million. Total
investments at December 31, 2003 were $262.6 million. Outstanding
investments were increased to $288.4 million at March 31, 2004 to replace a
reduction in loans held for investment that occurred due to general planned
loan payoffs of approximately $15.0 million, general pay downs on revolving
lines of credit of approximately $8.4 million and the payoff of a $4.5
million loan that was on nonaccrual status at December 31, 2003.
Investments available for sale ended June 30, 2004 at $263.4 million and
September 30, 2004 at $236.3 million. Over $30.0 million of investments
available for sale were sold during September 2004 and the proceeds were
used to fund other earning assets, particularly mortgage loans and student
loans held for sale.
(c) Average loans held for investment during 2004 declined despite an increase
in period end loans between December 31, 2003 and December 31, 2004. Loans
held for investment declined in early 2004 to a low of $254.0 million at
March 31, 2004 but finished out the year with increases ending at $294.7
million at December 31, 2004. Average loans held for investment were as low
as $261.2 million in April 2004 compared with $303.6 million in December
31, 2004.
(d) Our increased loan yield reflects the Federal Reserve interest rate
increases during 2004. The daily average prime rate in 2004 was 4.35
percent as compared to 4.12 percent for 2003. The higher prime rate caused
floating rate loans to reprice at higher rates and new loans, which, as
discussed above, came on primarily in the second half of 2004, to be
originated at higher interest rate levels.
(e) The increased yield on investments reflects the higher interest rate
environment during 2004 combined with the lower levels of prepayments on
mortgage-backed securities and collateralized mortgage obligations relative
to 2003. During 2004, lower premium amortization ($2.9 million versus $4.1
million in 2003) helped generate higher yields in the investment portfolio.
(f) The decrease in cost of interest-bearing deposits reflects our efforts to
contain deposit costs during a rising rate environment in 2004. The
decrease also reflects a full year of benefit of rate decreases at the end
of 2003. Additionally, during 2003, new certificates of deposit and
repricing certificates of deposit priced at lower rates that then reduced
the cost of deposits going forward into 2004.
(g) The decrease in cost of borrowings was primarily a result of a decrease in
the average cost of FHLB borrowings. $15 million of FHLB advances priced at
a weighted average rate of 4.77 matured during 2004.
(h) The increase in average borrowings is primarily attributable to higher use
of Federal funds purchased and the $1.5 million increase in our long-term
borrowings that occurred during 2004.
(i) The increase in average interest-bearing deposits is primarily attributable
to the increase in average interest checking and money market accounts due
to growth in our Wealthbuilder family of deposit products. The growth was
generated primarily in the Arizona market with some growth attributable to
our new Golden Valley, Minnesota branch office.
Year ended December 31, 2003 compared to year ended December 31, 2002. Net
interest income increased $296,000, or 2.3 percent, and totaled $13.4 million
for 2003. Net interest spread and net interest margin adjusted to 2.29 and 2.47
percent, respectively, for the 12-month period ended December 31, 2003 from 2.29
and 2.51, respectively, for the 12-month period ended December 31, 2002.
Net interest income and margin for the 12-month period ended December 31, 2003
were impacted by the charge-off of interest income of approximately $287,000 on
the loan discussed earlier. Net interest income for the 12-month periods ended
December 31, 2003 and 2002 also reflected mark-to-market losses on the value of
derivative contracts, which decreased net interest income by $80,000 and
$779,000, respectively. Without the interest income charged off and the
mark-to-market adjustments on these derivative contracts for the two periods,
net interest margin would have been 2.54 percent for the 12 months ended
December 31, 2003 and 2.66 percent for the 12 months ended December 31, 2002.
The following condensed information summarizes the major factors combining to
create the changes to net interest income, spread and margin during 2003 as
compared to 2002. Lettered explanations following the summary describe causes of
the changes in these major factors.
Net Interest Income Analysis - 2003 vs. 2002 (1)
For the Years
Ended December 31, Change
-------------------- ----------------
2003 2002
--------- ---------
(amounts in millions)
Total interest income decreased................. $ 28.7 $ 31.8 $ (3.1) (10)%
Due to:
Decrease in yield on interest-earnings
assets.................................... 5.30% 6.11% (0.81)% (13)%
Driven by:
Decrease in yield on loans (a).............. 6.26% 6.76% (0.50)% (7)%
Decrease in yield on investments (b)........ 3.96% 5.13% (1.17)% (23)%
The decreases in yield on interest-earning
assets were
Offset by:
Increase in average earning assets.......... $ 540.7 $ 520.4 $ 20.3 4%
Driven by:
Increase in average loans (c)............... $ 308.1 $ 307.2 $ 0.9 0%
Increase in average investments (d)......... $ 236.0 $ 214.0 $ 22.0 10%
Total interest expense decreased................ $ 15.3 $ 18.7 $ (3.4) (18)%
Due to:
Decrease in cost of interest-bearing
liabilities............................... 3.01% 3.82% (0.81)% (21)%
Driven by:
Decrease in cost of interest-bearing
deposits (e).............................. 2.16% 2.87% (0.71)% (25)%
Decrease in cost of borrowings (f).......... 4.76% 6.36% (1.60)% (25)%
These decreases were coupled with:
Increase in average interest-bearing
liabilities............................... $ 508.1 $ 490.9 $ 17.2 4%
Driven by:
Increase in average borrowings (g).......... $ 164.5 $ 133.6 $ 30.9 23%
Offset by:
Decrease in average interest-bearing
deposits (h).............................. $ 343.6 $ 357.2 $(13.6) (4)%
- ---------------
(1) From continuing operations for all periods presented.
(a) Our decreased loan yield is reflective of the lower interest rate
environment during 2003. The lower rate environment was caused by several
Federal Reserve reductions in the Federal funds target rate causing prime
rate to decrease significantly during 2001 and continuing into 2002 and
2003. The daily average prime rate in 2003 was 4.12 percent as compared to
4.68 percent for 2002. The lower prime rate caused floating rate loans to
reprice at lower levels and new loans to be originated at interest rate
levels lower than those originated in the prior period.
(b) The decreased yield on investments was also reflective of the lower
interest rate environment during 2003.
(c) Average loans remained relatively stable during 2003 in spite of a
significant decline in period end loans at December 31, 2003 versus
December 31, 2002.
(d) Average investments increased in 2003 to maintain an acceptable average
earning asset portfolio and related interest income. The increase in
average investments in 2003 caused the mix in the earning asset portfolio
to change resulting in downward pressure on net interest margin.
(e) The decrease in cost of interest-bearing deposits was reflective of the
lower interest rate environment during 2003. Floating rate deposit accounts
repriced at lower interest rate levels and certificates of deposit renewed
or were originated at lower interest rate levels than those in the prior
period.
(f) 2003 borrowing costs decreased due to the lower interest rate environment.
The lower interest rates were reflected in decreased cost on our $15.0
million floating rate subordinated debentures, our $8.5 million floating
rate loan, floating rate Federal funds purchased and repurchase agreements
with customers.
(g) Average borrowings increased in 2003 due to higher average balances of
Federal funds purchased, customer repurchase agreements and FHLB advances.
(h) Average deposits in 2003 decreased largely due to a $27.2 million reduction
in brokered and national market certificates of deposit during the 12
months ended December 31, 2003.
Net interest income and margin in future periods may be impacted by several
factors. Changes in net interest income are dependent upon the volume and mix of
interest-earning assets and interest-bearing liabilities, the movement of
interest rates and the level of nonperforming assets. Achieving net interest
margin growth is dependent on our ability to generate higher-yielding assets and
lower cost funding sources such as deposits and borrowings. If variable index
rates, such as the prime rate, were to decline, we could experience compression
of our net interest margin depending upon the timing and amount of any
reductions, as it is possible that interest rates paid on some deposits and
borrowings may not decline as quickly, or to the same extent, as the decline in
the yield on interest-rate-sensitive assets such as commercial and other loans.
Competition for checking, savings and money market deposits, important sources
of lower cost funds for us, is intense. We could also experience net interest
margin compression if rates paid on deposits and borrowings increase, or as a
result of new pricing strategies and lower rates offered on loan products in
response to competitive pressures, rates on interest-bearing liabilities
increase faster, or to a greater extent, than the increase in the yield on
interest-rate-sensitive assets. The level and nature of the impact cannot be
precisely ascertained. Federal Reserve actions in response to economic
developments can vary causing prime and other rates to adjust and, in some
cases, immediately impact our interest-earning assets and interest-bearing
liabilities.
These factors, including the competitive environment in the markets in which we
operate, the multitude of financial and investment products available to the
public and the monetary policies of the Federal Reserve, can materially impact
our operating results. Therefore, we cannot predict, with any degree of
certainty, prospects for net interest income and net interest margin in future
periods. See Item 7A, "Quantitative and Qualitative Disclosures About Market
Risk," for information relating to the impact of fluctuating interest rates on
our future net interest income prospects.
Provision for Credit Losses. We determine a provision for credit losses which we
consider sufficient to maintain our allowance for credit losses at a level
considered adequate to provide for an estimate of probable losses related to
specifically identified loans as well as probable losses in the remaining loan
and lease portfolio that have been incurred as of each balance sheet date. The
provision for credit losses for the year ended December 31, 2004 was $175,000 as
compared to $1.5 million in 2003 and $1.2 million in 2002. Net loan and lease
charge-offs were $1.9 million, or 0.58 percent of average loans and leases in
2004 compared with $1.8 million, or 0.56 percent in 2003 and $521,000, or 0.17
percent in 2002. The decrease in the provision for credit losses in 2004
reflected the resolution of a significant amount of nonperforming loans that
were reserved for at December 31, 2003 and were reduced to $549,000 at December
31, 2004 from $8.0 million at December 31, 2003. Of the $1.9 million of
charge-offs in 2004, $1.2 million related to one commercial loan. $975,000 had
been reserved for on that loan at December 31, 2003.
The provision for credit losses is calculated as part of the determination of
the allowance for credit losses and the related provision for credit losses is a
critical accounting policy which involves consideration of a number of factors
such as loan growth, net charge-offs, changes in the composition of the loan
portfolio, delinquencies in the loan and lease portfolio, the value of
underlying collateral on problem loans, general economic conditions and our
assessment of credit risk in the current loan and lease portfolio. Periodic
fluctuations in the provision for credit losses result from our assessment of
the adequacy of the allowance for credit losses; however, actual loan losses may
vary from current estimates.
The allowance for loan losses totaled $3.3 million at December 31, 2004 compared
with $4.8 and $5.0 million at December 31, 2003 and 2002, respectively. See Note
1 to the Consolidated Financial Statements included under Item 8, "-Financial
Condition-Loan Portfolio-Allowance for Credit Losses" and "-Critical Accounting
Policies" for further discussion of the components of the allowance for credit
losses, our systematic methodology for determining the adequacy of the allowance
and additional data pertaining to charge-offs, recoveries and other related
information.
Noninterest Income. Noninterest income, primarily driven by insurance
commissions, is becoming a more significant source of revenues for us as we
continue to emphasize our goal of focusing on local relationship banking and
providing a broad range of financial products and services that will meet the
needs of our customers, both commercial and consumer. Our noninterest income
increased approximately $2.6 million, or 12.7 percent, in 2004 largely due to
increased insurance commissions, including commissions related to acquisitions
made during 2003 and 2004. Fees on loans and brokerage income increased in 2004
while service charges, trust and financial services income, net gain on sales of
securities and rental income declined. Noninterest income increased
approximately $4.5 million, or 27.7 percent, in 2003 largely due to a full year
of insurance commission income generated by Milne Scali. Service charges, trust
and financial services income and rental income also increased, while fees on
loans, brokerage income and net gain on sale of securities declined.
The following table presents, for the periods indicated, the major categories of
our noninterest income as well as the amount and percent of change between each
of the periods presented. Related information and significant changes are
discussed in lettered explanations following the table:
Noninterest Income (1)
Increase (Decrease)
------------------------------------
For the Years Ended
December 31, 2004 - 2003 2003 - 2002
---------------------------- ----------------- ----------------
2004 2003 2002 $ % $ %
-------- -------- -------- -------- ------- -------- ------
(in thousands)
Insurance commissions.....$ 17,490 $ 14,568 $ 8,981 $ 2,922 20% $5,587 62% (a)
Fees on loans............. 2,175 2,022 2,169 153 8% (147) (7)% (b)
Service charges........... 827 909 755 (82) (9)% 154 20% (c)
Brokerage income.......... 538 420 1,094 118 28% (674) (62)% (d)
Trust and financial
services................ 486 1,009 751 (523) (52)% 258 34% (e)
Net gain on sales of
securities ............. 269 968 1,870 (699) (72)% (902) (48)% (f)
Rental income............. 109 212 89 (103) (49)% 123 138%
Other..................... 1,556 704 587 852 121% 117 20% (g)
-------- -------- -------- -------- --------
Total noninterest income..$ 23,450 $20,812 $ 16,296 $ 2,638 13% $4,516 28%
======== ======== ======== ======== ========
- --------------------
(1) From continuing operations for all periods presented.
(a) In 2004, insurance commissions increased due to increased commission
and profit sharing income at Milne Scali in Phoenix. The increase also
reflected production from recent acquisitions. In 2003, insurance
commissions increased due to a full year of production of Milne Scali,
acquired in April 2002. Profit Sharing income (received primarily
during the first quarter of each year) included in the amounts above
totaled approximately $1.4 million, $990,000 and $124,000 for the
years ended December 31, 2004, 2003 and 2002, respectively.
(b) The 2004 increase in fees on loans reflects fees associated with loans
originated and sold, fees associated with the mortgage loan and
student loan financing programs and some fees associated with
commercial credit line availability. The decrease in noninterest
income loan fees in 2003 primarily reflects a decline in loan
generation due to reduced loan demand, which was reflective of the
economic environment during 2003. Loan volume generation and the
related loan fees associated with such loans can be subject to
significant fluctuations making it difficult to anticipate the amount
of loans that will be originated or placed and related loan fees that
will be recognized in future periods.
(c) Service charges increased in 2003 as the Bank continued to increase
its Wealthbuilder interest checking and money market account volume
along with an increase in non-interest bearing deposits which are
primarily business deposit relationships that tend to utilize a
greater level of fee-based deposit services.
(d) In 2004, brokerage income increased primarily due to increased
production in the Minnesota market. In 2003, brokerage income declined
largely due to the Bank having fewer brokers on staff in Minnesota.
(e) The 2004 decrease in trust and financial services income is
attributable to a $488,000 fee recognized in 2003 by the Bank's
financial services division for management of the sale of two
companies on behalf of a customer. The 2003 increase reflects the
$488,000 fee. This 2003 fee income was offset by decreases in other
fee income in the trust and financial services division including the
loss of fee income associated with the BNC U.S. Opportunities Fund
LLC, which was terminated during 2003.
(f) Net gain on sales of securities varies depending on the nature of
investment securities sales transacted during the respective periods.
We cannot guarantee our ability to generate realized gains in the
future given the level of interest rates. In the future, the
investment portfolio risk/reward management process may require us to
recognize net realized losses in order to optimize the forward-looking
profile of the portfolio.
(g) Other income. The 2004 increase is primarily attributable 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. Additionally, BOLI (bank-owned life insurance) income was
approximately $464,000 during 2004 compared with approximately
$183,000 during 2003. The increase in other income in 2003 as compared
to 2002 is also attributable to BOLI income as the BOLI program was
initiated during the second half of 2003.
Noninterest Expense. Noninterest expense increased approximately $7.5 million,
or 27.4 percent, in 2004 primarily as a result of our expanding presence in the
Arizona and Minnesota markets. Noninterest expense increased approximately $2.0
million, or 7.7 percent, in 2003 primarily as a result of the April 2002 Milne
Scali acquisition and our expanding presence in the Arizona market.
The following table presents, for the periods indicated, the major categories of
our noninterest expense as well as the amount and percent of change between each
of the periods presented. Related information and significant changes are
discussed in lettered explanations below the table:
Noninterest Expense (1)
Increase (Decrease)
--------------------------------------
For the Years Ended
December 31, 2004 - 2003 2003 - 2002
---------------------------- ------------------- -----------------
2004 2003 2002 $ % $ %
-------- -------- -------- --------- -------- -------- -------
(in thousands)
Salaries and employee
benefits................$ 21,662 $ 16,478 $14,723 $ 5,184 31% $ 1,755 12% (a)
Occupancy................. 2,700 2,306 2,235 394 17% 71 3% (b)
Depreciation and
amortization............ 1,640 1,458 1,320 182 12% 138 10% (c)
Professional services..... 1,471 1,146 1,495 325 28% (349) (23)% (d)
Office supplies,
telephone and postage... 1,414 1,214 1,106 200 16% 108 10% (e)
Amortization of
intangible assets....... 1,274 1,063 881 211 20% 182 21% (f)
Marketing and promotion... 1,098 803 749 295 37% 54 7% (g)
FDIC and other
assessments............. 205 201 214 4 2% (13) (6)%
Other..................... 3,304 2,621 2,606 683 26% 15 1% (h)
-------- -------- ------- --------- --------
Total noninterest
expense.................$ 34,768 $ 27,290 $ 25,329 $ 7,478 27% $ 1,961 8%
======== ======== ======= ========= ========
Efficiency ratio.......... 88.04% 79.82% 86.22% 8.22% (6.40)% (i)
Total operating expenses
as a percent of average
assets.................. 5.47% 4.54% 4.45% 0.93% 0.09% (j)
- --------------------
(1) From continuing operations for all periods presented.
(a) Salaries and employee benefits expenses increased in 2004 due to
growth and expansion in our banking and insurance segments,
particularly in our Minnesota and Arizona markets. 2004 also reflected
a full year of expense associated with management talent added in late
2003 and new management team members added during 2004. 2004 also
included a $688,000 payment related to the termination of 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. The 2003 increase is largely
attributable to the addition of banking personnel, particularly in the
Arizona market. Average full time equivalents for each year in the
three-year period ended December 31, 2004 were 318, 276 and 253,
respectively.
(b) Occupancy expenses increased in 2004 due to the addition of the
Esplanade location in Phoenix, the Golden Valley location in
Minnesota, and the Tucson, Salt Lake City, Prescott Valley and Denver
insurance locations.
(c) Depreciation and amortization expenses related to fixed assets
increased in 2004 due to the expansion discussed in (b) above,
primarily in our Arizona and Minnesota markets. Depreciation and
amortization expenses increased in 2003 due to the Milne Scali
acquisition along with costs associated with additional expansion in
the Arizona market.
(d) 2004 professional services expenses increased due to an increase in
brokerage retainage and clearing fees (resulting from the increase in
brokerage production) as well as increases in legal, software support,
appraisal and recording and other consulting fees. The 2003 decrease
is attributable to decreased expenses in a number of areas including
brokerage clearing and retainage expense (resulting from the decrease
in associated brokerage revenue), appraisal and recording fees, audit
fees, other consulting fees, legal and collection fees and software
support fees.
(e) 2004 office supplies, telephone and postage expenses increased due to
the expansion described in (b) above, primarily in our Arizona and
Minnesota markets. Increases in this line item in 2003 are associated
with the Milne Scali acquisition and additional expenses associated
with expansion in the Arizona market.
(f) 2004 amortization of intangible assets expenses increased primarily
due to amortization of the insurance customer list intangibles added
when we acquired certain assets and assumed certain liabilities of
several small insurance agencies. 2003 reflects a full year of
amortization of the Milne Scali customer list intangibles.
(g) Marketing and promotion expenses increased in 2004 primarily due to
market expansion and the associated advertising and marketing.
(h) The 2004 increase in other noninterest expense is due to increases in
several different items included in this category such as travel,
other employee benefits, insurance, business meals and entertainment,
dues and publications and correspondent bank charges.
(i) Noninterest expense divided by an amount equal to net interest income
plus noninterest income.
(j) Total operating expenses as a percent of average assets have increased
as our profile has changed from that of a traditional banking
organization to an organization with a broader base of financial
product and service offerings the revenues and expenses of which are
generally not asset-based.
Income taxes. We recorded income tax expense of $1.1 and $1.6 million and
$822,000 for the years ended December 31, 2004, 2003 and 2002, respectively. Our
effective tax rates were 25.15, 29.14 and 28.87 percent for the 12-month periods
ended December 31, 2004, 2003 and 2002, respectively. The effective tax rates
were lower than the statutory rates principally due to tax-exempt income on
municipal securities and, for part of 2003 and all of 2004, tax-exempt income
associated with $10.0 million of bank-owned life insurance.
The determination of current and deferred income taxes is a critical accounting
policy which is based on complex analyses of many factors including
interpretations of Federal and state income tax laws, the differences between
tax and financial reporting bases of assets and liabilities (temporary
differences), estimates of amounts due or owed, the timing of reversal of
temporary differences and current financial accounting standards. Actual results
could differ significantly from the estimates and interpretations used in
determining the current and deferred income tax liabilities. Additional detail
on income taxes is provided in Note 24 to the Consolidated Financial Statements
included under Item 8 and "-Critical Accounting Policies."
Financial Condition
Overview. Although subsequent sections of this discussion and analysis of
financial condition address certain aspects of our major assets and liabilities
in significant detail, the following two tables are presented as a general
overview of the financial condition of the Company.
Total assets increased approximately $52.2 million, or 8.4 percent, between
December 31, 2003 and December 31, 2004 and approximately $19.2 million, or 3.2
percent, between December 31, 2002 and December 31, 2003. Our total assets at
December 31, 2004 were approximately $673.7 million.
The following table presents our assets by category as of December 31, 2004,
2003 and 2002, as well as the amount and percent of change between the dates.
Significant changes are discussed in lettered notes following the table (amounts
are in thousands):
Assets
Increase (Decrease)
----------------------------------------
As of December 31, 2004 - 2003 2003 - 2002
------------------------------ ------------------- ------------------
2004 2003 2002 $ % $ %
--------- --------- -------- --------- -------- --------- -------
Cash and due from
banks...............$ 11,867 $ 12,520 $ 16,978 $ (653) (5)% $ (4,458) (26)% (a)
Interest-bearing
deposits with banks 14 -- 159 14 -- (159) (100)%
Investment
securities
available for sale.. 235,916 262,568 208,072 (26,652) (10)% 54,496 26% (b)
Federal Reserve
Bank and Federal
Home Loan Bank
stock............... 7,541 7,596 7,071 (55) (1)% 525 7%
Loans held for sale.. 60,197 -- -- 60,197 -- -- -- (c)
Loans and leases
held for
investment, net..... 290,479 278,792 330,788 11,687 4% (51,996) (16)% (d)
Premises and
equipment, net...... 21,799 18,570 11,100 3,229 17% 7,470 67% (e)
Interest receivable.. 2,686 2,462 2,856 224 9% (394) (14)%
Other assets......... 13,357 15,507 4,119 (2,150) (14)% 11,388 276% (f)
Goodwill............. 21,779 15,089 12,210 6,690 44% 2,879 24% (g)
Other intangible
assets, net......... 8,075 8,373 8,875 (298) (4)% (502) (6)%
--------- --------- -------- -------- ---------
Total assets.....$ 673,710 $ 621,477 $602,228 $ 52,233 8% $ 19,249 3%
========= ========= ======== ======== =========
- -----------------
(a) The 2003 decrease in cash and due from banks is primarily attributable to
an account reclassification program that was implemented during 2003 and
results in the Bank holding less cash at the Federal Reserve.
(b) During 2004, we purchased $89.9 million of investment securities while we
sold $74.4 million and there were $38.0 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 (c) below as well as real estate construction and commercial
and industrial loans discussed in (d) below. During 2003, investment
securities available for sale increased as loan volume decreased (see (d)
below) and we maintained a somewhat static earning asset portfolio.
(c) Loans held for sale at December 31, 2004 represent loans originated under
mortgage loan and student loan financing programs initiated during 2004.
(d) Loans held for investment increased during the second half of 2004 due to
increases in real estate construction and commercial and industrial loans.
Loan volume in 2003 was negatively impacted by planned loan reductions and
the completion of some financed commercial real estate projects. The loan
reductions were not offset by loan growth due to a lack of loan demand
driven by economic conditions during the year. It is difficult to predict,
with any degree of certainty, loan volume in future periods.
(e) The 2004 increase in premises and equipment is primarily attributable to
our renovation of a banking facility in Golden Valley, Minnesota, some
additional upgrading of our location at 322 East Main Avenue in Bismarck,
the purchase of land and a building in Tucson and the purchase of land for
a future bank site in Shakopee, Minnesota. The 2003 increase is
attributable to the purchase of the Milne Scali building in Phoenix,
Arizona in March 2003 for its appraised value of $3.9 million, the
construction of a facility in Scottsdale, Arizona, leasehold improvements
related to the relocation of our office at 2725 East Camelback Road,
Phoenix to 2425 East Camelback Road, the purchase of property in Golden
Valley, Minnesota and some improvements to our office building at 322 East
Main Avenue, Bismarck, North Dakota.
(f) The 2003 increase in other assets is primarily attributable to the purchase
of $10.0 million of bank-owned life insurance during the third quarter of
2003.
(g) Goodwill increased during 2004 due to the payment of the remaining earnout
payments related to the Milne Scali acquisition and goodwill generated by
three insurance agency acquisitions and a mortgage company acquisition.
Goodwill increased in 2003 due to a $2.3 million earnout payment related to
the purchase of Milne Scali and the purchase of IASW in December 2003.
Our total liabilities increased approximately $48.6 million, or 8.4 percent,
between December 31, 2003 and December 31, 2004 and increased $16.8 million, or
3.0 percent, between December 31, 2002 and December 31, 2003. Total liabilities
at December 31, 2004 were approximately $629.9 million. Stockholders' equity was
approximately $43.8, $40.2 and $37.7 million at December 31, 2004, 2003 and
2002, respectively.
The following table presents our liabilities and stockholders' equity by
category as of December 31, 2004, 2003 and 2002, as well as the amount and
percent of change between the dates. Significant changes are discussed in
lettered notes following the table (amounts are in thousands):
Liabilities, Subordinated Debentures and Stockholders' Equity
Increase (Decrease)
--------------------------------------
As of December 31, 2004 - 2003 2003 - 2002
----------------------------- ------------------ ------------------
2004 2003 2002 $ % $ %
-------- --------- -------- -------- -------- --------- --------
Deposits:
Noninterest-bearing.....$ 63,386 $ 44,725 $ 44,362 $ 18,661 42% $ 363 1% (a)
Interest-bearing -
Savings, interest
checking and
money market......... 210,887 215,525 187,531 (4,638) (2)% 27,994 15% (b)
Time deposits
$100,000 and over.... 83,952 46,569 64,905 37,383 80% (18,336) (28)% (c)
Other time deposits.... 97,118 89,123 101,447 7,995 9% (12,324) (12)% (d)
Short-term borrowings... 33,697 31,383 28,120 2,314 7% 3,263 12% (e)
FHLB advances........... 97,200 112,200 97,200 (15,000) (13)% 15,000 15% (f)
Long-term borrowings.... 10,079 8,640 8,561 1,439 17% 79 1% (g)
Guaranteed preferred
beneficial interests
in Company's
subordinated
debentures............. 22,509 22,397 22,326 112 1% 71 0%
Other liabilities....... 11,036 10,729 10,053 307 3% 676 7%
-------- --------- -------- -------- ---------
Total liabilities... 629,864 581,291 564,505 48,573 8% 16,786 3%
Stockholders' equity.... 43,846 40,186 37,723 3,660 9% 2,463 7% (h)
-------- --------- -------- -------- ---------
Total...............$673,710 $ 621,477 $602,228 $ 52,233 8% $ 19,249 3%
======== ========= ======== ======== =========
- ----------------
(a) Noninterest-bearing deposits increased in 2004 primarily due to growth in
our Arizona and Minnesota markets. Noninterest-bearing deposits can also
fluctuate significantly on a daily basis due to transactions associated
primarily with commercial customers.
(b) The 2003 increase in savings, interest checking and money market deposits
was attributable to the popularity of our Wealthbuilder deposit products
and reflects deposit growth primarily in the Arizona market.
(c) Brokered and national market certificates of deposit were $55.6 million at
December 31, 2004 compared with $30.2 million at December 31, 2003.
Additionally, deposits in the CDARSsm deposit program totaled $16.8 million
at December 31, 2004 compared with $1.4 million at December 31, 2003. At
December 31, 2002, brokered and national market certificates of deposit
totaled $58.7 million.
(d) The 2004 increase in other time deposits represents core deposit growth,
primarily in our Arizona and Minnesota markets. The 2003 decline is
partially attributable to the $27.2 million decrease in brokered and
national market certificates of deposit. Additionally, time deposits
declined partly because a number of certificates of deposit, held by credit
unions and other financial institutions (with balances averaging $99,000)
matured and the funds were not reinvested.
(e) The increase in short-term borrowings in both 2004 and 2003 is primarily
due to increased Federal funds purchased at December 31, 2004 and 2003.
(f) $15.0 million of FHLB advances matured during 2004 and were replaced with
other funding sources. $10.0 million of FHLB advances held at December 31,
2002 matured in January 2003 and, during the third quarter of 2003, we
converted $20.0 million of short-term FHLB advances to $30.0 million of
longer term FHLB advances maturing in 2005 and 2006.
(g) The 2004 increase in long-term borrowings represents an increase in the
term loan at BNCCORP from $8.5 million at December 31, 2003 to $10.0
million at December 31, 2004.
(h) The 2004 increase in stockholders' equity reflects $3.4 million of earnings
and $1.5 million of stock issued in acquisitions, as restricted stock and
in stock option exercises offset by a $912,000 decrease in unrealized
holding gains on securities available for sale, net of income taxes and
reclassification adjustment and $93,000 of preferred stock dividends paid
during 2004. The increase in 2003 primarily reflects $3.8 million of
earnings offset by a $1.7 million decrease in unrealized holding gains on
securities available for sale, net of income taxes and reclassification
adjustment.
Investment Securities Available for Sale. Our investment policy is designed to
enhance net income and return on equity through prudent management of risk,
ensure liquidity for cash-flow requirements, help manage interest rate risk,
ensure collateral is available for public deposits, advances and repurchase
agreements and manage asset diversification. In managing the portfolio, we seek
a balance between current income (yield) and future market value volatility,
while simultaneously managing credit and liquidity risks. The goal of this
process is to maximize our longer term profitability as well as the economic
performance of the portfolio over the long-term.
Investments are centrally managed in order to maximize compliance (Federal laws
and regulations place certain restrictions on the amounts and types of
investments we may hold) and effectiveness of overall investing activities. The
primary goal of our investment policy is to contribute to our overall
profitability. The objective is to purchase and own securities and combinations
of securities with good risk/reward characteristics. "Good" risk/reward
securities are those identified through thorough analysis of the cash flows and
potential cash flows as well as market value and potential future market value
of the security in question given various interest rate scenarios. Investment
strategies are developed in light of a constant view of our overall
asset/liability position. As it relates to investment strategies, the focus of
our Asset/Liability management committee ("ALCO") is to determine the impact of
interest rate changes on both future income and market value of securities in
the portfolio. See Item 7A, "Quantitative and Qualitative Disclosures about
Market Risk," for additional information relating to the impact of fluctuating
interest rates on our net interest income, including income generated by our
investment securities portfolio.
The following table presents the composition of the available-for-sale
investment portfolio by major category as of the dates indicated:
Investment Portfolio Composition (1)
December 31,
-------------------------------------------------------------------------------
2004 2003 2002
------------------------ -------------------------- ------------------------
Estimated Estimated Estimated
Amortized fair market Amortized fair market Amortized fair market
cost value cost value Cost value
----------- ----------- ----------- ------------ ----------- -----------
(in thousands)
U.S. government agency
mortgage-backed
securities......... $ 9,715 $ 9,877 $ 14,374 $ 14,755 $ 47,072 $ 47,576
U.S. government
agency securities.. 981 1,036 961 1,083 4,608 5,203
Collateralized
mortgage
obligations........ 189,783 187,704 210,760 209,676 122,795 124,480
State and municipal
bonds.............. 33,390 35,301 32,909 35,056 27,276 28,815
Corporate bonds...... 1,941 1,998 1,939 1,998 1,938 1,998
----------- ----------- --------- ------------ ----------- -----------
Total investments.... $ 235,810 $ 235,916 $ 260,943 $ 262,568 $ 203,689 $ 208,072
=========== =========== ========= ============ =========== ===========
- ------------------
(1) From continuing operations for all periods presented.
The following table presents maturities for all securities available for sale
(other than equity securities) and yields for all securities in our investment
portfolio at December 31, 2004:
Investment Portfolio - Maturity and Yields
Maturing
---------------------------------------------------------------------------------------------------
After 1 but After 5 but
Within 1 year within 5 years within 10 years After 10 years Total
------------------ ------------------ ------------------ ------------------- ------------------
Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield (1) Amount Yield(1)
-------- -------- -------- -------- -------- -------- -------- --------- -------- --------
U.S. government
agency
mortgage-backed
securities (2)(3)...$ -- -- $ -- -- $ 393 5.54% $ 9,322 5.87% 9,715 5.86%
U.S. government
agency
securities (2)...... 981 9.71% -- -- -- -- -- -- 981 9.71%
Collateralized
mortgage
obligations (2)(3).. -- -- -- -- 41,322 3.66% 148,461 3.99% 189,783 3.92%
State and municipal
bonds (2)........... -- -- 1,048 8.03% 1,983 6.98% 30,359 7.04% 33,390 7.07%
Corporate bonds (2)... -- -- -- -- -- -- 1,941 4.65% 1,941 4.65%
-------- -------- -------- -------- --------
Total book value
of investment
securities..........$ 981 9.71% $ 1,048 8.03% $ 43,698 3.82% $190,082 4.57% 235,810 4.47%
======== ======== ======== ========
Unrealized holding
gain on securities
available for sale.. 106
--------
Total investment
in securities
available for $235,916 4.47%
sale (4)............ ========
- --------------------
(1) Yields include adjustments for tax-exempt income; yields do not reflect
changes in fair value that are reflected as a separate component of
stockholders' equity (except as noted in (4) below).
(2) Based on amortized cost/book value.
(3) Maturities of mortgage-backed securities and collateralized mortgage
obligations ("CMOs") are based on contractual maturities. Actual maturities
may vary because obligors may have the right to call or prepay obligations
with or without call or prepayment penalties.
(4) Yield reflects changes in fair value that are reflected as a separate
component of stockholders' equity.
As of December 31, 2004, we had $235.9 million of available-for-sale securities
in the investment portfolio as compared to $262.6 and $208.1 million at December
31, 2003 and 2002, respectively, based on fair value of the securities on those
dates. During 2004, the amount of available-for-sale securities decreased $26.7
million in order to provide liquidity to fund earning asset growth in the form
of loans, and, in particular, loans held for sale. In light of our overall
asset/liability position, much of the decrease in available-for-sale securities
was in the U.S. government agency mortgage-backed securities (down $4.9 million)
and CMOs (down $22.0 million) because of their forward looking economic
risk/reward profiles relative to other types of securities within the portfolio
and that of other earning asset opportunities. The volume in state and municipal
bonds, U.S. government agency securities and corporate bonds was relatively
unchanged for the year.
During the first quarter of 2004, the available-for-sale portfolio increased
$25.8 million from $262.6 million as of December 31, 2003 to $288.4 million in
order to maintain the level of earning assets while planned loan reductions and
the completion of some financed commercial real estate projects reduced the loan
portfolio by $29.6 million during the same period. Over the remaining three
quarters of 2004, the available-for-sale portfolio decreased by $52.5 million to
end the year at $235.9 million as proceeds from sales and maturities, net of new
purchases were directed toward an increase in loan volume for the latter three
quarters of 2004. Finally, the overall level of market interest rates increased
during 2004 and the yield curve experienced a flattening relative to the end of
2003. In carrying out the ongoing portfolio management objective to purchase and
own securities and combinations of securities with good risk/reward
characteristics, and in constant light of managing the available-for-sale
portfolio's risk/reward profile in the context of our overall balance sheet, we
engaged in securities transactions that generated net realized securities gains
of $269,000 during 2004. We cannot guarantee our ability to generate realized
gains in the future such as those recognized during recent years given the
current level of interest rates. In the future, the risk-reward management
process may require us to recognize net realized losses in order to optimize the
forward-looking economic profile of the portfolio and balance sheet.
During 2003, the amount of available-for-sale securities increased $54.5 million
in order to maintain earning asset portfolio levels while planned loan
reductions and the completion of some financed commercial real estate projects
reduced the loan portfolio by $52.2 million. Much of the increase in
available-for-sale securities was directed toward CMOs because of their economic
risk/reward profiles (due to the structure of the CMO cash flows) relative to
mortgage-backed or other types of securities and the ability to pledge such
securities as collateral for borrowings at the FHLB. In the process of carrying
out the portfolio management objective to purchase securities and combinations
of securities with good economic risk/reward characteristics, we decreased U.S.
government agency mortgage-backed securities and U.S. government agency
securities by $32.8 and $4.1 million, respectively, and increased CMOs and state
and municipal bonds by $85.2 and $6.2 million, respectively. Given our
forecasted level of future earnings, we increased our holdings of state and
municipal bonds by $6.2 million in order to increase our level of tax-exempt
income.
The first half of 2003 saw the level of interest rates, including interest rates
for mortgages, decline to record or near record lows. The pace of mortgage
refinancing reached record levels in the second quarter of 2003. During the
third quarter of 2003, interest rates rose from the record lows of the first
half of the year. This decreased mortgage prepayments from their earlier levels.
This made 2003 a volatile year for interest rates and mortgage prepayments. The
ongoing portfolio management process described above and individual security
risk/reward analysis led to the sale of individual securities whose
forward-looking risk/reward profiles given the changed interest rate and
prepayment environments were inferior to other securities available for
purchase. This analysis and ongoing management of the portfolio's forward
looking risk/reward profile resulted in transactions that generated net realized
securities gains of $968,000 during 2003.
During 2002, we increased U.S. government agency mortgage-backed securities,
U.S. government agency securities, and state and municipal bonds by $5.6
million, 708,000 and $11.3 million, respectively and decreased CMOs and
corporate debt securities by $12.8 and $8.6 million, respectively. The $8.6
million reduction in corporate debt securities during 2002 allowed us to manage
our risk-based capital position as such securities are risk-weighted at 100
percent for risk-based capital purposes. Given our earnings in the third and
fourth quarters of 2002 and our then forecasted level of future earnings, we
increased our holdings of state and municipal bonds by $11.3 million in order to
increase our level of future tax-exempt income. In addition to the role state
and municipal bonds play in managing our tax position, state and municipal bonds
offer an attractive risk/reward profile when considered in combination with
other securities in the portfolio (CMOs and mortgage-backed securities) and our
overall balance sheet position.
In addition, during 2002, mortgage rates declined to their lowest levels in
decades. This decrease in mortgage rates increased the level of mortgage
refinancing and prepayments for U.S. government agency mortgage-backed
securities and CMOs. The ongoing portfolio management process and individual
security risk/reward analysis described above led to the sale of individual
securities whose forward-looking risk/reward profiles given the lower interest
rate and increased prepayment environment were inferior to other securities
available for purchase. This analysis and ongoing management of the portfolio's
forward looking risk/reward profile resulted in transactions that generated net
realized securities gains of $1.9 million during 2002.
At December 31, 2004, we held no securities of any single issuer, other than
U.S. government agency securities and agency mortgage-backed securities and
CMOs, that exceeded 10 percent of stockholders' equity. A significant portion of
our investment securities portfolio (approximately 87.6 percent at December 31,
2004) was pledged as collateral for public deposits and borrowings, including
borrowings with the FHLB.
Federal Reserve Bank and Federal Home Loan Bank Stock. Our equity securities
consisted of $1.3, $1.2 and $1.2 million of Federal Reserve Bank ("FRB") stock
at December 31, 2004, 2003 and 2002, respectively, and $6.3, $6.4 and $5.8
million of FHLB stock at December 31, 2004, 2003 and 2002, respectively. Our
holdings in FRB stock increased due to the amount of capital stock issued by the
Bank. From 2002 to 2004, our investment in FHLB stock fluctuated with our usage
of FHLB advances.
Loan Portfolio. The banking segment's primary source of income is interest
earned on loans held for investment. Total loans held for investment, net of
unearned income and unamortized fees and costs, increased $10.3 million, or 3.6
percent, to $293.8 million at December 31, 2004 as compared to $283.6 million at
December 31, 2003. In 2003, net loans decreased $52.2 million, or 15.6 percent,
as compared to December 31, 2002.
The following table presents the composition of our loan portfolio as of the
dates indicated:
Loan Portfolio Composition (1)
December 31,
-------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------------- ------------------ ------------------ ------------------ ------------------
Amount % Amount % Amount % Amount % Amount %
--------- ------ --------- ------- --------- ------- --------- ------- --------- -------
(dollars in thousands)
Commercial and
industrial ........$ 75,460 26.0 $ 73,001 26.2 $ 94,075 28.4 $103,883 35.4 $109,335 43.9
Real estate
mortgage........... 129,321 44.5 129,443 46.4 147,825 44.7 123,727 42.1 85,082 34.1
Real estate
construction....... 68,967 23.7 60,056 21.5 62,926 19.0 34,225 11.7 21,879 8.8
Agricultural......... 13,919 4.8 12,529 4.5 18,023 5.5 19,069 6.5 15,016 6.0
Consumer/other....... 5,480 1.9 6,277 2.3 8,227 2.5 9,953 3.4 11,552 4.6
Lease financing...... 1,540 0.5 2,757 1.0 5,584 1.7 7,578 2.6 10,154 4.1
--------- ------ --------- ------- --------- ------- --------- ------- --------- -------
Total principal
amount of loans.... 294,687 101.4 284,063 101.9 336,660 101.8 298,435 101.7 253,018 101.5
Unearned income
and net
unamortized
deferred fees
and costs.......... (873) (0.3) (508) (0.2) (866) (0.3) (511) (0.2) (265) (0.1)
-------- ------ --------- ------- --------- ------- --------- ------- --------- -------
Loans, net of
unearned income
and unamortized
fees and costs..... 293,814 101.1 283,555 101.7 335,794 101.5 297,924 101.5 252,753 101.4
Less allowance for
credit losses..... (3,335) (1.1) (4,763) (1.7) (5,006) (1.5) (4,325) (1.5) (3,588) (1.4)
--------- ------ --------- ------- --------- ------- --------- ------- --------- -------
Net loans............$290,479 100.00 $278,792 100.00 $330,788 100.00 $293,599 100.00 $249,165 100.00
========= ====== ========= ======= ========= ======= ========= ======= ========= =======
(1) From continuing operations for all periods presented.
The following table presents, for the periods indicated, the amount and percent
of change in each category of loans in our loan portfolio. Significant changes
are discussed in lettered explanations below the table:
Change in Loan Portfolio Composition (1)
Increase (Decrease)
----------------------------------------------
2004 - 2003 2003 - 2002
---------------------- ---------------------
$ % $ %
----------- --------- ---------- ---------
(dollars in thousands)
Commercial and industrial..... $ 2,459 3% $ (21,074) (22)% (a)
Real estate mortgage.......... (122) 0% (18,382) (12)% (b)
Real estate construction...... 8,911 15% (2,870) (5)% (c)
Agricultural.................. 1,390 11% (5,494) (30)% (d)
Consumer/other................ (797) (13)% (1,950) (24)%
Lease financing............... (1,217) (44)% (2,827) (51)%
----------- ----------
Total principal amount of
loans....................... 10,624 4% (52,597) (16)%
Unearned income/unamortized
fees and costs.............. (365) (72)% 358 41%
----------- ----------
Loans, net of unearned
income/unamortized fees
and costs................... 10,259 4% (52,239) (16)%
Allowance for credit losses... 1,428 30% 243 5%
----------- ----------
Net Loans..................... $ 11,687 4% $ (51,996) (16)%
=========== ==========
(1) From continuing operations for all periods presented.
(a) Commercial and industrial loans decreased in 2003 due to planned loan
pay-downs, loan pay- offs and the lack of loan demand due to economic
conditions.
(b) The decrease in real estate mortgage loans during 2003 reflects the
completion of some financed commercial real estate projects.
(c) The increase in 2004 is primarily attributable to commercial real
estate construction loan growth in our Arizona and Minnesota markets.
(d) The 2003 decrease in agricultural loans is primarily due to loan
pay-offs in the North Dakota market.
While prospects for loan growth appear to be favorable in some of our markets,
future loan growth potential is subject to volatility. Our loan portfolio is
concentrated in commercial, industrial and real estate loans and we have credit
concentrations in certain industries (see "-Concentrations of Credit") and
certain geographic concentrations that relate to our primary market areas. A
downturn in certain sectors of the economy could adversely impact our borrowers.
This could, in turn, reduce the demand for loans and impact the borrowers'
ability to repay their loans, while also decreasing our net interest margin.
Taking a conservative posture relative to credit underwriting, we believe, is a
prudent course of action. We believe it is in our best interest and in the
interest of our stockholders to focus attention on our quality customer
relationships and to avoid growth in other than high-quality credit. We cannot
predict with any degree of certainty the full impact of current or future
economic conditions on our ability to generate loan volume or the ultimate
impact of economic conditions on our currently existing portfolio of loans. See
"Factors That May Affect Future Results of Operations" included under Item 1 of
Part I.
Credit Policy, Underwriting, Approval and Review Procedures. We follow a uniform
credit policy that sets forth underwriting and loan administration criteria. The
Board of Directors (the "Board") establishes our loan policy, including lending
guidelines for the various types of credit we offer based upon the
recommendations of senior lending management. We have an Executive Credit
Committee that approves loans over a certain size. Our loan policy is reviewed
and reaffirmed by the Board at least annually.
We delegate lending decision authority among various lending officers and the
Executive Credit Committee based on the size of the customer's credit
relationship with BNC. All loans and commitments approved in excess of $300,000
are presented to the Board on a quarterly basis for summary review. Any
exceptions to loan policies and guidelines, to the extent the credit
relationship amount exceeds individual loan officer lending authorities, are
subject to special approval by the Bank's Chief Credit Officer or the
appropriate credit committee.
Underwriting criteria are based upon the risks associated with each type of
credit offered, the related borrowers and types of collateral. In underwriting
commercial loans, we emphasize the borrower's earnings history, capitalization
and secondary sources of repayment. In most instances, we require third party
guarantees or highly liquid collateral.
Our credit administration function includes an internal loan review department
that reviews established levels of our loan portfolio on a continuous basis.
Loan review personnel are not involved in any way in the credit underwriting or
approval process. Additionally, our lenders, loan review staff, Chief Credit
Officer, Executive Credit Committee and various management team members review
credit-related information monthly. Such information includes, but may not be
limited to, delinquencies, classified and nonperforming assets, and other
information. Such reviews are conducted in order to evaluate credit risk within
our credit portfolio and to review and establish the adequacy of the allowance
for credit losses.
Loan Participations. Pursuant to our lending policy, loans may not exceed 85
percent of the Bank's legal lending limit (except to the extent collateralized
by U.S. Treasury securities or Bank deposits and, accordingly, excluded from the
Bank's legal lending limit) unless the Chief Credit Officer and the Executive
Credit Committee grant prior approval. To accommodate customers whose financing
needs exceed lending limits and internal loan restrictions relating primarily to
industry concentration, the Bank sells loan participations to outside
participants without recourse. Loan participations sold on a nonrecourse basis
to outside financial institutions were as follows as of the dates indicated:
Loan Participations Sold (1)
December 31,
- -----------------------------------
(in thousands)
2004........... $ 131,317
2003........... 146,988
2002........... 173,895
2001........... 208,975
2000........... 187,773
- -----------
(1) From continuing operations for all periods presented.
The Bank generally retains the right to service the loans as well as the right
to receive a portion of the interest income on the loans. Many of the loans sold
by the Bank are commercial lines of credit for which balances and related
payment streams cannot be reasonably estimated in order to determine the fair
value of the servicing rights and/or future interest income retained by the
Bank. We cannot reliably predict our ability to continue to generate or sell
loan participations in future periods or the terms of any such sales.
Concentrations of Credit. Our credit policies emphasize diversification of risk
among industries, geographic areas and borrowers. For purposes of the analysis
of concentrations of credit as of December 31, 2004 the total outstanding loans
as well as all outstanding loan commitments were included. As of December 31,
2004, we identified two concentrations of loans exceeding 10 percent of total
loans and loan commitments outstanding. These concentrations were in real estate
and construction, which represented 23.4 and 14.5 percent, respectively, of
total loans and loan commitments outstanding.
The real estate loans and commitments were extended to 121 customers who are
diversified across our market areas and who can generally be categorized as
indicated below:
Percent of
total
outstanding
Number of loans and
customers loan commitments
------------- ----------------
Non-residential and apartment
building operators,
developers and lessors of
real property................ 86 20.7%
Real estate holding companies.. 35 2.7%
------------- ----------------
Total..................... 121 23.4%
============= ================
Loans and commitments in the construction category were extended to 60 customers
who are located primarily in Minnesota, Iowa, North Dakota and South Dakota and
who can generally be categorized as indicated below:
Percent of
total
outstanding
Number of loans and
customers loan commitments
------------- ----------------
General building contractors....... 36 13.4%
Special trade contractors.......... 17 0.4%
Heavy construction, excluding
building......................... 7 0.7%
------------- ---------------
Total......................... 60 14.5%
============= ===============
The contractors are involved in various aspects of the construction industry,
including highway and street construction, water/sewer drilling, plumbing,
heating and air conditioning, commercial painting, electrical, concrete and
excavating and foundation contractors. Loans in this category are secured, in
many cases, by construction equipment.
We continually monitor industry and other credit concentrations as part of our
credit risk management strategies. In cases where significant concentrations
exist without sufficient diversification and other mitigating factors, we
generally sell loans without recourse to outside financial institutions (see
"-Loan Participations").
Loan Maturities. The following table sets forth the remaining maturities of
loans in each major category of our portfolio as of December 31, 2004. Actual
maturities may differ from the contractual maturities shown below as a result of
renewals and prepayments. Loan renewals are evaluated in the same manner as new
credit applications:
Maturities of Loans (1)
Over 1 year
through 5 years Over 5 years
------------------- ------------------
One year Fixed Floating Fixed Floating
or less rate rate rate rate Total
-------- -------- --------- --------- -------- ---------
(in thousands)
Commercial and
industrial............ $51,038 $ 8,534 $ 12,729 $ 660 $ 2,499 $ 75,460
Real estate mortgage.... 34,678 16,142 47,589 15,127 15,785 129,321
Real estate
construction.......... 35,292 1,259 26,481 3,759 2,176 68,967
Agricultural............ 6,487 1,902 2,807 415 2,308 13,919
Consumer/other.......... 2,202 2,610 467 201 -- 5,480
Lease financing......... 418 1,122 -- -- -- 1,540
-------- -------- --------- --------- -------- ---------
Total principal amount
of loans................ $130,115 $ 31,569 $ 90,073 $ 20,162 $ 22,768 $ 294,687
======== ======== ========= ========= ======== =========
- --------------------------
(1) Maturities are based upon contractual maturities. Floating rate loans
include loans that would reprice prior to maturity if base rates change.
See Item 7A, "Quantitative and Qualitative Disclosures about Market Risk,"
for further discussion regarding repricing of loans and other assets.
Interest Rate Caps and Floors. From time to time we may use off-balance-sheet
instruments, principally interest rate caps and floors, to adjust the interest
rate sensitivity of on-balance-sheet items, including loans. See -"Liquidity,
Market and Credit Risk," Item 7A, "Quantitative and Qualitative Disclosures
about Market Risk," and Notes 1 and 17 to the Consolidated Financial Statements
included under Item 8 for further discussion about accounting policies
applicable to derivative financial instruments and currently outstanding
instruments.
Nonperforming Loans and Assets. Nonperforming loans consist of loans 90 days or
more delinquent and still accruing interest, nonaccrual and restructured loans.
Other nonperforming assets includes other real estate owned and repossessed
assets. Our lending personnel are responsible for continuous monitoring of the
quality of the loan portfolio. Officers are expected to maintain loan quality
and deal with credit issues in a timely and proactive manner. Loan officers are
responsible for regular reviews of past due loans in their respective
portfolios. The loan portfolio is also monitored regularly and examined by our
loan review personnel. Loans demonstrating weaknesses are downgraded in a timely
fashion and the Board receives a listing of all such loans on a quarterly basis.
The following table sets forth, as of the dates indicated, the amounts of
nonperforming loans and other assets, the allowance for credit losses and
certain related ratios:
Nonperforming Assets (1)
December 31,
-------------------------------------------
2004 2003 2002 2001 2000
------- ------- ------- ------- -------
(dollars in thousands)
Nonperforming loans:
Loans 90 days or more delinquent
and still accruing interest.... $ 25 $ 38 $ 5,081 $ 983 $ 221
Nonaccrual loans (2) (3)......... 524 7,913 2,549 3,391 343
Restructured loans (2) (3)....... -- -- -- 5 16
------- ------- ------- ------- -------
Total nonperforming loans..... 549 7,951 7,630 4,379 580
Other real estate owned and
repossessed assets............. -- -- 8 70 84
------- ------- ------- ------- -------
Total nonperforming assets.... $ 549 $ 7,951 $ 7,638 $ 4,449 $ 664
======= ======= ======= ======= =======
Allowance for credit losses......... $ 3,335 $ 4,763 $ 5,006 $ 4,325 $ 3,588
======= ======= ======= ======= =======
Ratio of total nonperforming loans
to total loans.................... 0.19% 2.80% 2.27% 1.47% .23%
Ratio of total nonperforming assets
to total assets................... 0.08% 1.28% 1.27% .80% .12%
Ratio of allowance for credit
losses to nonperforming loans..... 607% 60% 66% 99% 619%
- --------------------
(1) From continuing operations for all periods presented.
(2) If the Company's nonaccrual and restructured loans had been current in
accordance with their original terms, we would have recognized additional
interest income of $29,000, $65,000, $236,000, $84,000 and $29,000 for the
years ended December 31, 2004, 2003, 2002, 2001 and 2000, respectively.
(3) The interest income on nonaccrual and restructured loans actually included
in our net income was $43,000, $56,000, $1,000, $3,000 and $6,000 for the
years ended December 31, 2004, 2003, 2002, 2001 and 2000 respectively.
Loans 90 days or more delinquent and still accruing interest include loans over
90 days past due which we believe, based on our specific analysis of the loans,
do not present doubt about the collection of interest and principal in
accordance with the loan contract. Loans in this category must be well secured
and in the process of collection. Our lending and management personnel monitor
these loans closely.
Nonaccrual loans include loans on which the accrual of interest has been
discontinued. Accrual of interest is discontinued when we believe, after
considering economic and business conditions and collection efforts, that the
borrower's financial condition is such that the collection of interest is
doubtful. A delinquent loan is generally placed on nonaccrual status when it
becomes 90 days or more past due unless the loan is well secured and in the
process of collection. When a loan is placed on nonaccrual status, accrued but
uncollected interest income applicable to the current reporting period is
reversed against interest income of the current period. Accrued but uncollected
interest income applicable to previous reporting periods is charged against the
allowance for credit losses. No additional interest is accrued on the loan
balance until the collection of both principal and interest becomes reasonably
certain. When a problem loan is finally resolved, there may ultimately be an
actual write down or charge-off of the principal balance of the loan which may
necessitate additional charges to earnings.
Restructured loans are those for which concessions, including a reduction of the
interest rate or the deferral of interest or principal, have been granted due to
the borrower's weakened financial condition. Interest on restructured loans is
accrued at the restructured rates when it is anticipated that no loss of
original principal will occur. We had no restructured loans in our portfolio at
December 31, 2004.
Other real estate owned and repossessed assets represents properties and other
assets acquired through, or in lieu of, loan foreclosure. Such properties and
assets are included in other assets in the consolidated balance sheets. They are
initially recorded at fair value at the date of acquisition establishing a new
cost basis. Write-downs to fair value at the time of acquisition are charged to
the allowance for credit losses. After foreclosure, we perform valuations
periodically and the real estate or assets are carried at the lower of carrying
amount or fair value less cost to sell. Write-downs, revenues and expenses
incurred subsequent to foreclosure are charged to operations as
recognized/incurred. We had no outstanding other real estate owned or
repossessed assets at December 31, 2004.
Our ratios of total nonperforming loans to total loans, and total nonperforming
assets to total assets, decreased between December 31, 2003 and December 31,
2004. The ratio of the allowance for credit losses to nonperforming loans
increased between December 31, 2003 and December 31, 2004. This ratio at
December 31, 2004 was 607 percent as compared to 60 percent at December 31,
2003. These improvements in nonperforming loan/asset ratios is primarily the
result of a sharp decrease in nonperforming loans, which declined to $549,000 at
December 31, 2004, from $7.95 million at December 31, 2003. This decrease is due
primarily to the full payment of a $4.5 million loan and the resolution of a
$2.2 million loan that resulted in a charge-off of $1.2 million (of which
$975,000 was reserved for at December 31, 2003).
Potential Problem Loans. In accordance with accounting standards, we identify
loans considered impaired and the valuation allowance attributable to these
loans. Impaired loans generally include loans on which we believe, based on
current information and events, it is probable that we will not be able to
collect all amounts due in accordance with the terms of the loan agreement and
which are analyzed for a specific reserve allowance. We generally consider all
loans risk-graded substandard and doubtful as well as nonaccrual and
restructured loans as impaired. Potential problem loans at December 31, 2004,
not including the past due, nonaccrual and restructured loans reported above,
totaled $3.0 million as compared to $3.1 million at December 31, 2003. A
significant portion of these potential problem loans are not in default but may
have characteristics such as recent adverse operating cash flows or general risk
characteristics that the loan officer feels might jeopardize the future timely
collection of principal and interest payments. The ultimate resolution of these
credits is subject to changes in economic conditions and other factors. These
loans are closely monitored to ensure that our position as creditor is protected
to the fullest extent possible.
Allowance for Credit Losses. Credit risk is the risk of loss from a customer
default. We have in place a process to identify and manage our credit risk. The
process includes initial credit review and approval, periodic monitoring to
measure compliance with credit agreements and internal credit policies, internal
credit review, monitoring changes in the risk ratings of loans and leases,
identification of problem loans and leases and special procedures for collection
of problem loans and leases. The risk of loss is difficult to quantify and is
subject to fluctuations in values and general economic conditions and other
factors. As discussed previously, the determination of the allowance for credit
losses is a critical accounting policy, which involves estimates and our
judgment on a number of factors such as net charge-offs, delinquencies in the
loan and lease portfolio and general and economic conditions. We consider the
allowance for credit losses of $3.3 million adequate to cover losses inherent in
the loan and lease portfolio as of December 31, 2004. However, no assurance can
be given that we will not, in any particular period, sustain loan and lease
losses that are sizable in relation to the amount reserved, or that subsequent
evaluations of the loan and lease portfolio, in light of factors then
prevailing, including economic conditions and our ongoing credit review process,
will not require significant increases in the allowance for credit losses. A
protracted economic slowdown and/or a decline in commercial, industrial or real
estate segments may have an adverse impact on the adequacy of the allowance for
credit losses by increasing credit risk and the risk of potential loss. See
Notes 1 and 7 to the Consolidated Financial Statements included under Item 8 and
"-Critical Accounting Policies" for further information concerning accounting
policies associated with the allowance for credit losses.
We maintain our allowance for credit losses at a level considered adequate to
provide for an estimate of probable losses related to specifically identified
loans as well as probable losses in the remaining loan and lease portfolio that
have been incurred as of each balance sheet date. The loan and lease portfolio
and other credit exposures are reviewed regularly to evaluate the adequacy of
the allowance for credit losses. In determining the level of the allowance, we
evaluate the allowance necessary for specific nonperforming loans and also
estimate losses in other credit exposures. The resultant three allowance
components are specific reserves, reserves for homogeneous loan pools and a
qualitative reserve. These components are fully described under "Critical
Accounting Policies."
Continuous credit monitoring processes and the analysis of loss components is
the principal method we rely upon to ensure that changes in estimated credit
loss levels are reflected in our allowance for credit losses on a timely basis.
We also consider experience of peer institutions and regulatory guidance in
addition to our own experience.
Loans, leases and other extensions of credit deemed uncollectible are charged to
the allowance. Subsequent recoveries, if any, are credited to the allowance. The
amount of the allowance for credit losses is highly dependent upon our estimates
of variables affecting valuation, appraisals of collateral, evaluations of
performance and status, and the amounts and timing of future cash flows expected
to be received on impaired loans. Such estimates, appraisals, evaluations and
cash flows may be subject to frequent adjustments due to changing economic
prospects of borrowers, lessees or properties. These estimates are reviewed
periodically. Actual losses may vary from current estimates and the amount of
the provision may be either greater than or less than actual net charge-offs.
The related provision for credit losses, which is charged to income, is the
amount necessary to adjust the allowance to the level determined appropriate
through the application of the above processes and those discussed below in the
"Critical Accounting Policies" section.
At yearend 2004, our total allowance was $3.3 million which equates to
approximately 2.3 and 2.6 times the average gross charge-offs for the last three
and five years, respectively, and 2.6 and 3.2 times the average net charge-offs
for the same three-and five-year periods, respectively. Because historical
charge-offs are not necessarily indicative of future charge-off levels, we also
give consideration to other risk indicators when determining the appropriate
allowance level. Those risk factors have been summarized above. Our charge-off
policy is generally consistent with regulatory standards.
Our Chief Credit Officer and Loan Review Manager have the primary responsibility
of affirming our systematic allowance methodology, performing credit loss
migration analyses and assessing the allowance components in relation to
estimated and actual charge-off trends. This analysis is presented to members of
management who are responsible for assessing and reporting on the
appropriateness of the allowance for credit losses as well as recommending
revisions to our methodology for determining the adequacy of the allowance as
they become necessary.
Concentrations of credit risk are discussed under "-Concentrations of Credit."
Concentrations exist in real estate and construction loans and commitments.
Additionally, a geographic concentration of credit risk also arises because we
have historically operated primarily in the upper Midwest with 67 percent of
loans outstanding as of December 31, 2004 having been extended to customers in
Minnesota, North Dakota and South Dakota. As of December 31, 2004, 30 percent of
our loans had been extended to customers in Arizona. Other groups of credit risk
may not constitute a significant concentration, but are analyzed based on other
evident risk factors for the purpose of determining an adequate allowance level.
Nonperforming and potential problem loans are defined and discussed under
"-Nonperforming Loans and Assets" and "-Potential Problem Loans." Many of these
loans are specifically analyzed for purposes of determining the adequacy of the
allowance for credit losses.
Estimating the risk and amount of loss on any loan is subjective and ultimate
losses may vary from current estimates. Although we believe that the allowance
for credit losses is adequate to cover probable losses in the loan and lease
portfolio, there can be no assurance that the allowance will prove sufficient to
cover actual credit losses in the future. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the adequacy of our allowance for credit losses. Such agencies may require us to
make additional provisions to the allowance based upon their judgments about
information available to them at the time of their examination.
The following table summarizes, for the periods indicated, activity in the
allowance for credit losses, including amounts of loans charged-off, amounts of
recoveries, additions to the allowance charged to operating expense, the ratio
of net charge-offs to average total loans, the ratio of the allowance to total
loans at the end of each period and the ratio of the allowance to nonperforming
loans:
Analysis of Allowance for Credit Losses (1)
For the Years ended December 31,
------------------------------------------------
2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
(dollars in thousands)
Balance of allowance for
credit losses,
beginning of period...........$ 4,763 $ 5,006 $ 4,325 $ 3,588 $ 2,872
-------- -------- -------- -------- --------
Charge-offs:
Commercial and industrial.... 1,578 1,508 408 542 574
Real estate mortgage......... -- 189 9 99 58
Agricultural................. 97 10 -- -- 16
Consumer/other............... 208 23 75 213 39
Lease financing.............. -- 90 165 411 68
-------- -------- -------- -------- --------
Total charge-offs......... 1,883 1,820 657 1,265 755
-------- -------- -------- -------- --------
Recoveries:
Commercial and industrial.... 141 73 86 140 100
Real estate mortgage......... 33 7 8 30 96
Agricultural................. -- -- 4 1 33
Consumer/other............... 97 11 11 132 25
Lease financing.............. 9 11 27 -- 15
-------- -------- -------- -------- --------
Total recoveries.......... 280 102 136 303 269
-------- -------- -------- -------- --------
Net charge-offs................. (1,603) (1,718) (521) (962) (486)
Provision for credit losses
charged to operations......... 175 1,475 1,202 1,699 1,202
-------- -------- -------- -------- --------
Balance of allowance for
credit losses, end of
period........................$ 3,335 $ 4,763 $ 5,006 $ 4,325 $ 3,588
======== ======== ======== ======== ========
Ratio of net charge-offs
to average loans.............. (0.58)% (0.56)% (0.17)% (0.33)% (0.20)%
======== ======== ======== ======== ========
Average gross loans
outstanding during
the period....................$276,652 $308,115 $307,227 $293,716 $244,526
======== ======== ======== ======== ========
Ratio of allowance for
credit losses to
total loans................... 1.14% 1.68% 1.49% 1.45% 1.42%
======== ======== ======== ======== ========
Ratio of allowance for
credit losses to
nonperforming loans........... 607% 60% 66% 99% 619%
======== ======== ======== ======== ========
(1) From continuing operations for all periods presented.
Of the $1.9 million of charge-offs for the year ended December 31, 2004,
approximately $1.2 million relates to one commercial contractor. A $975,000
reserve was established for this credit at December 31, 2003.
Our ratio of allowance for credit losses to total loans was 1.14 percent at
December 31, 2004 compared with 1.68 percent one year earlier. The ratio at
December 31, 2004 reflects $1.9 million of charge-offs over the course of the
12-month period ended December 31, 2004, as well as the reduced reserve
requirement related to the sharp decrease in nonperforming loans during the same
period.
The table below presents, for the periods indicated, an allocation of the
allowance for credit losses among the various loan categories and sets forth the
percentage of loans in each category to gross loans. The allocation of the
allowance for credit losses as shown in the table should neither be interpreted
as an indication of future charge-offs, nor as an indication that charge-offs in
future periods will necessarily occur in these amounts or in the indicated
proportions.
Allocation of the Allowance for Loan Losses (1)
December 31,
-------------------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
---------------------- --------------------- --------------------- --------------------- ----------------------
Loans in Loans in Loans in Loans in Loans in
category category category category category
as a as a as a as a as a
Amount percentage Amount percentage Amount percentage Amount percentage Amount percentage
of of total of of total of of total of of total of of total
allowance gross loans allowance gross loans allowance gross loans allowance gross loans allowance gross loans
--------- ------------ --------- ----------- --------- ----------- --------- ----------- --------- -----------
(dollars in thousands)
Commercial and
industrial......$ 1,583 25% $ 2,093 26% $ 2,344 28% $ 2,586 34% $ 2,066 42%
Real estate
mortgage........ 1,116 44% 1,976 46% 1,836 44% 1,038 42% 702 34%
Real estate
construction.... 379 23% 395 21% 398 19% 137 11% 112 10%
Agricultural..... 186 5% 211 4% 231 5% 267 6% 342 6%
Consumer/other... 62 2% 68 2% 85 2% 118 5% 128 5%
Lease
financing....... 9 1% 20 1% 112 2% 179 2% 145 3%
Unallocated...... -- 0% -- 0% -- 0% -- 0% 93 0%
--------- ------------ --------- ----------- --------- ----------- --------- ----------- --------- -----------
Total............$ 3,335 100% $4,763 100% $ 5,006 100% $ 4,325 100% $ 3,588 100%
========= ============ ========= =========== ========= =========== ========= =========== ========= ===========
- ---------------
(1) From continuing operations for all periods presented.
Deposits. Our core deposits consist of noninterest- and interest-bearing demand
deposits, savings deposits, money market deposit accounts, certificates of
deposit under $100,000, certain certificates of deposit of $100,000 and over,
public funds and certificates of deposit in the CDARSsm program. Total deposits
were $455.3 million at December 31, 2004 compared with $395.9 and $398.2 million
at December 31, 2003 and 2002, respectively. We use these deposits, along with
other borrowed funds, to support our asset base.
The following table sets forth, for the periods indicated, the distribution of
our average deposit account balances and average cost of funds rates on each
category of deposits. See "Results of Operations-Net Interest Income" for an
explanation of changes in deposit volume and costs during the periods presented:
Average Deposits and Deposit Costs (1)
For the Years Ended December 31,
---------------------------------------------------------------------------------------
2004 2003 2002
--------------------------- --------------------------- ---------------------------
Percent Wgtd. Percent Wgtd. Percent Wgtd.
Average of avg. Average of avg. Average of avg.
balance deposits rate balance deposits rate balance deposits rate
--------- -------- ------ --------- -------- ------ --------- -------- ------
(dollars in thousands)
Interest checking and
MMDAs.................$ 198,992 48.22% 1.07% $ 186,796 48.69% 1.17% $ 174,108 44.51% 1.64%
Savings deposits........ 6,695 1.62% 0.70% 6,052 1.58% 0.84% 4,511 1.15% 0.86%
Time deposits (CDs):
CDs under $100,000...... 95,509 23.15% 2.55% 94,820 24.72% 3.18% 104,964 26.83% 3.88%
CDs $100,000 and over... 58,625 14.21% 3.27% 55,928 14.58% 3.91% 73,639 18.83% 4.46%
--------- -------- --------- -------- --------- --------
Total time deposits..... 154,134 37.36% 2.83% 150,748 39.30% 3.45% 178,603 45.66% 4.12%
--------- -------- --------- -------- --------- --------
Total interest-bearing
deposits.............. 359,821 87.20% 1.82% 343,596 89.57% 2.16% 357,222 91.32% 2.87%
Noninterest-bearing
demand deposits....... 52,822 12.80% -- 40,022 10.43% -- 33,951 8.68% --
--------- -------- --------- -------- --------- --------
Total deposits........ $412,643 100.00% 1.58% $383,618 100.00% 1.94% $ 391,173 100.00% 2.62%
========= ======== ========= ======== ========= ========
(1) From continuing operations for all periods presented.
At times earning asset growth can outpace core deposit growth resulting in the
use of brokered deposits and out of market certificates of deposit and other
borrowed funds. See "-Borrowed Funds." This trend has been common in the banking
industry because of the proliferation of nonbank competitors and the multitude
of financial and investment products available to customers as well as the need
to utilize such funds in the process of our overall balance sheet management. At
times, access to brokered and out of market deposits is available at maturities
and rates more favorable than those available in our local markets. As of
December 31, 2004, we held a total of $3.8 million of national market
certificates of deposit and $55.0 million of deposits acquired through brokers.
Under current FDIC regulations, only "well capitalized" financial institutions
may fund themselves with brokered deposits without prior regulatory approval.
Our Bank was considered "well capitalized" at December 31, 2004. See "Capital
Resources and Expenditures" and Note 18 to the Consolidated Financial Statements
included under Item 8 for a summary of the capital status of the Bank.
Time deposits in denominations of $100,000 and more totaled $83.9 million at
December 31, 2004 as compared to $46.6 and $64.9 million at December 31, 2003
and 2002, respectively. The following table sets forth the amount and maturities
of time deposits of $100,000 or more as of December 31, 2004:
Time Deposits of $100,000 and Over
(in thousands)
Maturing in:
3 months or less.................... $ 18,817
Over 3 months through 6 months...... 28,523
Over 6 months through 12 months..... 10,493
Over 12 months...................... 26,119
----------
Total............................ $ 83,952
==========
Borrowed Funds. We use short-term borrowings, FHLB advances and long-term
borrowings to support our asset base. Short-term borrowings include Federal
funds purchased and U.S. Treasury tax and loan note option accounts and
securities sold under agreements to repurchase. At December 31, 2004, short-term
borrowings were $33.7 million compared to $31.4 million at December 31, 2003 and
$28.1 million at December 31, 2002.
The following table provides a summary of our short-term borrowings and related
cost information as of, or for the periods ended, December 31:
Short-Term Borrowings (1)
2004 2003 2002
------- -------- --------
(dollars in thousands)
Short-term borrowings outstanding at period end.... $33,697 $31,383 $28,120
Weighted average interest rate at period end....... 2.40% 1.41% 1.48%
Maximum month-end balance during the period........ $50,566 $37,670 $28,120
Average borrowings outstanding for the period...... $29,663 $21,942 $ 7,799
Weighted average interest rate for the period...... 1.75% 1.74% 1.81%
(1) From continuing operations for all periods presented.
Note 11 to the Consolidated Financial Statements included under Item 8
summarizes the general terms of our short-term borrowings outstanding at
December 31, 2004 and 2003, including interest rates, maturity dates, weighted
average yields and other applicable terms.
FHLB advances totaled $97.2, $112.2, and $97.2 million at December 31, 2004,
2003 and 2002, respectively while long-term borrowings totaled $10.1, $8.6 and
$8.6 million, respectively, for the same periods.
During 2004, $15.0 million of our FHLB advances matured and were replaced with
other funding sources. During 2003, $15.0 million of our FHLB advances matured
and we originated $30.0 million of new FHLB advances primarily for the purpose
of funding the purchase of CMOs. During 2002, $20.0 million of our FHLB advances
matured and were not replaced due to the availability of other funding sources.
Also during 2002, we incurred $8.5 million of long-term debt in conjunction with
the acquisition of Milne Scali. An additional $1.5 million of long-term debt was
added in 2004.
Notes 12 and 13 to the Consolidated Financial Statements included under Item 8
summarize the general terms of our FHLB advances and long-term borrowings at
December 31, 2004 and 2003, including interest rates, maturity dates, weighted
average yields and other applicable terms.
Interest Rate Caps and Floors. From time to time we may use off-balance-sheet
instruments, principally interest rate caps and floors, to adjust the interest
rate sensitivity of on-balance-sheet items, including borrowings. During May and
June 2001, we purchased, for $1.2 million, interest rate cap contracts with
notional amounts totaling $40.0 million to mitigate interest rate risk in
rising-rate scenarios. The referenced interest rate is three-month LIBOR with
$20.0 million of 4.50 percent contracts having three-year original maturities
and $20.0 million of 5.50 percent contracts having five-year original
maturities. The $20.0 million of 4.50 percent contracts having three-year
original maturities matured during the second quarter of 2004. The remaining
contracts will mature during the second quarter of 2006. The contracts,
classified as other assets, are reflected in our December 31, 2004 consolidated
balance sheet at their combined fair value of $1,000. The contracts are not
being accounted for as hedges under SFAS 133. As a result, the impact of marking
the contracts to fair value has been, and will continue to be, included in net
interest income. During the years ended December 31, 2004 and 2003, the impact
of marking the contracts to market (reflected in the consolidated income
statements as an increase in interest expense on borrowings) was $55,000 and
$80,000, respectively. The fair value of $1,000 as of December 31, 2004 reflects
the full extent of the potential loss on the contracts should further write
downs to fair value be required. See -"Liquidity, Market and Credit Risk," Item
7A, "Quantitative and Qualitative Disclosures about Market Risk," and Notes 1
and 17 to the Consolidated Financial Statements included under Item 8 for
further discussion about accounting policies applicable to derivative financial
instruments.
Guaranteed Preferred Beneficial Interests in Company's Subordinated Debentures.
In July 2000, we established a special purpose trust for the purpose of issuing
$7.5 million of fixed rate subordinated debentures. The subordinated debentures
qualify as Tier 1 capital up to certain limits with the balance qualifying as
Tier 2 capital up to certain limits. See Note 14 to the Consolidated Financial
Statements included under Item 8 for a complete description of the fixed rate
subordinated debentures.
In July 2001, we established an additional special purpose trust for the purpose
of issuing $15.0 million of floating rate subordinated debentures. The
subordinated debentures qualify as Tier 1 capital up to certain limits with the
balance qualifying as Tier 2 capital up to certain limits. See Note 14 to the
Consolidated Financial Statements included under Item 8 for a complete
description of the floating rate subordinated debentures.
Capital Resources and Expenditures. We actively monitor compliance with
regulatory capital requirements, including risk-based and leverage capital
measures. Under the risk-based capital method of capital measurement, the ratio
computed is dependent on the amount and composition of assets recorded on the
balance sheet, and the amount and composition of off-balance-sheet items, in
addition to the level of capital. Note 18 to the Consolidated Financial
Statements included under Item 8 includes a summary of the risk-based and
leverage capital ratios of BNCCORP and the Bank as of December 31, 2004 and
2003, including the capital ratios and capital amounts necessary to be
considered "well capitalized" under prompt corrective action regulatory
provisions and adequately capitalized for capital adequacy purposes. As of each
of those dates, BNCCORP and the Bank exceeded capital adequacy requirements and
the Bank was considered "well capitalized" under prompt corrective action
provisions.
The capital ratios of the Company and the Bank were as follows as of those
dates:
Tier 1 Total
Risk- Risk- Tier 1
As of December 31, 2004 Based Based Leverage
Ratio Ratio Ratio
----------- ----------- -----------
BNCCORP, consolidated......... 6.35% 8.85% 4.51%
BNC National Bank............. 9.61% 10.36% 6.83%
As of December 31, 2003
BNCCORP, consolidated......... 7.14% 10.63% 4.90%
BNC National Bank............. 10.74% 11.92% 7.37%
The changes in capital ratios between December 31, 2003 and December 31, 2004
are primarily due to an increase in total risk-weighted assets from $403.7
million at December 31, 2003 to $449.2 million at December 31, 2004 for the
consolidated ratios and, for the bank ratios, an increase in total risk-weighted
assets from $403.3 million at December 31, 2003 to $448.6 million at December
31, 2004. The capital ratios were also impacted by the payment of the remaining
earnout amounts related to the Milne Scali acquisition (which increased goodwill
by $6.0 million) and the acquisition of three insurance agencies and a mortgage
company (which increased goodwill and other intangible assets by approximately
$1.6 million).
During 2004, we completed the renovation of the property in Golden Valley,
Minnesota (purchased in 2003). We also purchased property in Tucson, Arizona for
use by insurance personnel. We also made some improvements to our office
building at 322 East Main Avenue, Bismarck, North Dakota and purchased property
in Shakopee, Minnesota for a future bank site, which is expected to open in
2006. Finally, we installed a videoconference system that ties together certain
locations. Capital expenditures for 2005 will include the construction of the
Shakopee facility, some remodeling of the exterior of our building at 322 East
Main Avenue in Bismarck, the interior of the Milne Scali building in Phoenix,
and could include the purchase or lease of additional facilities in our various
market areas should such facilities or properties be deemed to add additional
franchise value.
Off-Balance-Sheet Arrangements. In the normal course of business, we are a party
to various financial instruments with off-balance-sheet risk. Such instruments
help us to meet the needs of our customers, manage our interest rate risk and
effectuate business combination transactions. These instruments and commitments,
which we enter into for purposes other than trading, carry varying degrees of
credit, interest rate or liquidity risk in excess of the amount reflected in the
consolidated balance sheets. We have also entered into certain guarantee
arrangements that are not reflected in the consolidated balance sheets. Each of
these instruments is discussed in the following sections.
Commitments to Extend Credit. Commitments to extend credit are agreements to
lend to a customer provided there is no violation of any condition in the
contract. Commitments to extend credit are legally binding and generally have
fixed expiration dates or other termination clauses and may require payment of a
fee. The contractual amount represents our exposure to credit loss in the event
of default by the borrower; however, at December 31, 2004, based on current
information, no losses were anticipated as a result of these commitments. We
manage this credit risk by using the same credit policies we apply to loans.
Collateral is generally required to secure the loans covered by the commitments
based on management's credit assessment of the borrower. The collateral may
include marketable securities, real estate and other types of business assets of
the borrower such as accounts receivable, inventory, equipment, deposit accounts
and general intangibles. Since we expect some of the commitments to expire
without being drawn, total commitment amounts do not necessarily represent our
future liquidity requirements related to such commitments.
Commitments to extend credit are important to us in that they provide sources of
liquidity to our customers. Our liquidity is impacted to the extent that the
customer draws upon the commitments. Our revenues are impacted to the extent
advances of funds are made and interest is earned on such advances of funds or
we charge a fee for extending or maintaining the commitment. Such commitments
don't typically result in material expenses for us, but rather, result in normal
operating expenses involved with processing, approval and other activities
associated with the extension and administration of such credit facilities. Our
cash flow is impacted to the extent the commitments are drawn upon by our
customers. There are no retained interests, securities issued or other
indebtedness incurred by us in connection with these commitments to extend
credit, and, other than the obligation to honor the commitment if drawn by the
customer, there are no other obligations or liabilities, including contingent
obligations or liabilities, arising from such commitments. At the present time,
other than the passage of time or the nonperformance of customers under these
commitments, there is no known event, demand, commitment, trend or uncertainty
that will result in or is reasonably likely to result in termination of such
commitments to a material extent. The contractual amount of our commitments to
extend credit totaled $152.2 million at December 31, 2004.
Commercial Letters of Credit. Commercial letters of credit are issued on behalf
of customers to ensure payment or collection in connection with trade
transactions. In the event of a customer's nonperformance, our credit loss
exposure is the same as in any extension of credit, up to the letter's
contractual amount; however, at December 31, 2004, based on current information,
no losses were anticipated as a result of these commitments. We assess the
borrower's credit to determine the necessary collateral, which may include
marketable securities, real estate and other types of business assets of the
borrower such as accounts receivable, inventory, equipment, deposit accounts and
general intangibles. Since the conditions requiring us to fund letters of credit
may not occur, our liquidity requirements related to such letters of credit will
likely be less than the total outstanding commitments.
Commercial letters of credit are an important service provided by us to our
commercial customers. Our liquidity is impacted only to the extent we must honor
a commercial letter of credit due to nonperformance of the commercial customer.
Our revenues are impacted to the extent we are required to perform under the
letter of credit and earn interest income on the advanced funds or we charge a
fee for issuing or maintaining the letter of credit. Such letters of credit
typically don't result in material expenses for us, but rather, result in normal
operating expenses involved with processing, approval and other activities
associated with the extension and administration of such letters of credit. Our
cash flow is impacted to the extent the nonperformance of the customer requires
us to advance under the letter of credit. There are no retained interests,
securities issued or other indebtedness incurred by us in connection with these
letters of credit, and, other than the obligation to honor the letter of credit,
there are no other obligations or liabilities, including contingent obligations
or liabilities, arising from such letters of credit. At the present time, other
than the passage of time or nonperformance of customers under their letters of
credit, there is no known event, demand, commitment, trend or uncertainty that
will result or is reasonably likely to result in termination of such letters of
credit to a material extent. The contractual amount of our commercial letters of
credit totaled $249,000 at December 31, 2004.
Performance and Financial Standby Letters of Credit. Performance standby letters
of credit are irrevocable obligations to the beneficiary on our part to make
payment on account of any default by the account party in the performance of a
nonfinancial or commercial obligation. Under these arrangements, we could, in
the event of the account party's nonperformance, be required to pay a maximum of
the amount of issued letters of credit. Under the agreements, we have recourse
against the account party up to and including the amount of the performance
standby letter of credit. We evaluate each account party's creditworthiness on a
case-by-case basis and the amount of collateral obtained varies and is based on
our credit evaluation of the account party. As of December 31, 2004, we had
outstanding $6.8 million of performance standby letters of credit.
Financial standby letters of credit are irrevocable obligations to the
beneficiary on our part to repay money borrowed by or advanced to or for the
account of the account party or to make payment on account of any indebtedness
undertaken by the account party, in the event that the account party fails to
fulfill its obligation to the beneficiary. Under these arrangements, we could,
in the event of the account party's nonperformance, be required to pay a maximum
of the amount of issued letters of credit. Under the agreements, we have
recourse against the account party up to and including the amount of the
financial standby letter of credit. We evaluate each account party's
creditworthiness on a case-by-case basis and the amount of collateral obtained
varies and is based on our credit evaluation of the account party. As of
December 31, 2004, we had outstanding $44.5 million of financial standby letters
of credit. $34.0 million of these letters of credit were participated to other
financial institutions.
Performance and financial standby letters of credit are also an important
service we provide to our commercial customers. Our liquidity is impacted only
to the extent we must honor such a letter of credit due to nonperformance of the
customer. Our revenues are impacted to the extent we are required to perform
under the letter of credit and interest is earned on outstanding advances or if
we charge a fee for issuing or administering the letter of credit. Such letters
of credit typically don't result in material expenses for us, but rather, normal
operating expenses involved with processing, approval and other activities
associated with the extension and administration of such letters of credit. Our
cash flow is impacted to the extent the nonperformance of the customer requires
us to advance under the letter of credit. There are no retained interests,
securities issued or other indebtedness incurred by us in connection with these
letters of credit and, other than the obligation to honor the letter of credit,
there are no other obligations or liabilities, including contingent obligations
or liabilities, arising from such letters of credit. At the present time, other
than the passage of time or nonperformance of customers under their letters of
credit, there is no known event, demand, commitment, trend or uncertainty that
will result in or is reasonably likely to result in terminations of such letters
of credit to a material extent.
Interest Rate Swaps, Caps and Floors. Interest rate swaps are contracts to
exchange fixed and floating rate interest payment obligations based on a
notional principal amount. From time to time we may enter into swaps to hedge
our balance sheet against fluctuations in interest rates. Interest rate caps and
floors are used to protect our balance sheet from unfavorable movements in
interest rates while allowing benefit from favorable movements. The credit risk
related to interest rate contracts is that counterparties may be unable to meet
the contractual terms of the agreements. This risk is estimated by calculating
the present value of the cost to replace outstanding contracts in a gain
position at current market rates, reported on a net basis by counterparties. We
manage the credit risk of our interest rate contracts through bilateral
collateral agreements, credit approvals, limits and monitoring procedures.
Additionally, we reduce the assumed counterparty credit risk through master
netting agreements that permit us to settle interest rate contracts with the
same counterparty on a net basis. At December 31, 2004, we held $20.0 million of
interest rate caps. These caps are reflected in the December 31, 2004 balance
sheet at their combined fair value of $1,000.
Interest rate swaps, caps and floors can be an effective way to hedge interest
rate risk. Due to the fact that they are purchased at fair value, which is
generally significantly less than the notional amount of the instrument, our
liquidity is not generally materially affected by the origination of such
instruments. The amount of revenues or expenses associated with such instruments
is dependent upon the accounting methodology selected for the instruments (i.e.,
whether such instruments are officially designated as hedges under applicable
accounting standards). Our current interest rate caps are not accounted for as
hedges. Therefore, increases in their fair value are presented as a reduction to
interest expense while decreases in their fair value are presented as an
increase in interest expense. Cash flow is not affected under these instruments
other than at the time of purchase and, during their life, if interest rates
move in such a fashion that payments under the interest rate caps are received.
There are no retained interests, securities issued or other indebtedness
incurred by us in connection with these interest rate caps, and, there are no
other obligations or liabilities, including contingent obligations or
liabilities, arising from such interest rate caps. The interest rate caps will
terminate upon their scheduled maturity dates, which are in May and June 2006.
Until such time as those contracts mature, there are no known events, demands,
commitments, trends or uncertainties that will result in or is reasonably likely
to result in termination of the contracts. We do have the option to sell the
contracts at their fair value at any time.
Contingent Consideration in Business Combinations. Pursuant to the terms of the
agreement related to the IASW asset acquisition in December 2003, additional
consideration of up to $320,000 may be payable to IASW, subject to the operation
of the acquired assets achieving certain financial performance targets. In
accordance with current accounting standards, there is no current carrying
amount associated with this contractual obligation. Additionally, there are no
recourse provisions associated with this guarantee that would enable us to
recover from third parties any of the amounts paid under the guarantee and there
are no assets held either as collateral or by third parties that, upon the
occurrence of any triggering event or condition under the guarantee, we could
obtain and liquidate to recover all or a portion of the amounts paid under the
guarantee.
Contingent consideration in business combinations, under current accounting
standards and provided certain criteria are met, is not required to be recorded
at the time of the transaction. Such contingent consideration, which may be
based on the financial performance of the acquired entity or other factors, can
be an effective tool in maintaining or encouraging certain levels of performance
by the acquired entity. Such consideration may be critical to accomplishing the
business combination. Our cash flow and liquidity are impacted to the extent the
contractual financial performance is attained and we are, therefore, required to
make the contingency payments. There are no known events, demands, commitments,
trends or uncertainties, other than the passage of time and the financial
performance of the acquiree, that will result in or is reasonably likely to
result in termination of the contingent consideration agreement.
Guaranteed Preferred Beneficial Interests in Company's Subordinated Debentures.
BNCCORP, concurrent with the issuance of preferred securities in July 2000 by
BNC Capital Trust I and in July 2001 by BNC Statutory Trust II, fully and
unconditionally guaranteed all obligations of the special purpose trusts related
to the trust preferred securities. Note 14 to the Consolidated Financial
Statements included under item 8 includes a full description of the nature of
the established trusts and the securities issued by the trusts. There are no
recourse provisions associated with these guarantees that would enable BNCCORP
to recover from third parties any of the amounts paid under the guarantees and
there are no assets held either as collateral or by third parties that, upon the
occurrence of any triggering event or condition under the guarantees, BNCCORP
could obtain and liquidate to recover all or a portion of the amounts paid under
the guarantees.
The trust preferred securities are important to us in that they provide for a
cost-effective means of obtaining Tier 1 capital for regulatory purposes.
Additionally, BNCCORP is allowed to deduct, for income tax purposes, amounts
paid in respect of the securities and ultimately distributed to the holders of
the preferred securities. Our consolidated interest expense reflects interest
paid on the preferred securities and cash flows are impacted accordingly. There
are no retained interests (other than the common stock of the trusts held by
BNCCORP), securities issued (other than as described above) or additional
indebtedness incurred by us in connection with these securities, and, there are
no other obligations or liabilities, including contingent obligations and
liabilities, arising from the securities. Due to recently issued accounting
standards, the Federal Reserve is presently considering the regulatory capital
status of such instruments. A change in the regulatory capital status of these
existing instruments could materially impact us in that our consolidated capital
ratios would decline if the securities could not be treated as Tier 1 capital
(to certain limits) or Tier 2 capital (to certain limits). Should such a change
in regulatory capital status be required to be implemented, BNCCORP likely would
need to immediately explore opportunities for issuing other instruments that
qualify as regulatory capital. It is difficult to predict, with any degree of
certainty, the Federal Reserve's final decision as it pertains to the capital
treatment of such instruments.
Indemnifications. In conjunction with various business combinations, we have
entered into certain indemnifications with the contracting parties. Such
indemnifications, although considered guarantees under current accounting
standards, are not deemed to be material to our financial condition or results
of operations.
Contractual Obligations, Contingent Liabilities and Commitments.
As disclosed in the Notes to the Consolidated Financial Statements included
under Item 8, we have certain contractual obligations, contingent liabilities
and commitments. Certain of these commitments have been discussed in the
sections above. At December 31, 2004, the aggregate contractual obligations
(excluding bank deposits), contingent liabilities and commitments were as
follows (in thousands):
Payments due by period
---------------------------------------------------
Less
Contractual Obligations: than 1 1 to 3 3 to 5 After 5
year years years years Total
-------- --------- -------- --------- ---------
Total borrowings........... $ 49,364 $ 21,412 $ 11,333 $ 81,376 $ 163,485
Annual rental commitments
under non-cancelable
operating leases.......... 1,057 1,635 705 276 3,673
-------- --------- -------- --------- ---------
Total...................... $ 50,421 $ 23,047 $ 12,038 $ 81,652 $ 167,158
======== ========= ======== ========= =========
Amount of Commitment - Expiration by Period
---------------------------------------------------
Less
than 1 1 to 3 3 to 5 After 5
Other Commitments: year years years years Total
-------- --------- -------- --------- ---------
Commitments to lend........ $117,333 $ 28,235 $ 6,524 $ 87 $ 152,179
Standby and commercial
letters of credit......... 6,101 11,434 -- -- 17,535
-------- --------- -------- --------- ---------
Total...................... $123,434 $ 39,669 $ 6,524 $ 87 $ 169,714
======== ========= ======== ========= =========
Liquidity, Market and Credit Risk
Our business activities generate, in addition to other risks, significant
liquidity, market and credit risks. Liquidity risk is the possibility of being
unable to meet all present and future financial obligations in a timely manner.
Market risk arises from changes in interest rates, exchange rates, commodity
prices and equity prices and represents the possibility that changes in future
market rates or prices will have a negative impact on our earnings or value. Our
principal market risk is interest rate risk. See Item 7A, "Quantitative and
Qualitative Disclosures about Market Risk" for further discussion about interest
rate risk and its impact on net interest income. Credit risk is the possibility
of loss from the failure of a customer to perform according to the terms of a
contract. We are a party to transactions involving financial instruments that
create risks that may or may not be reflected on a traditional balance sheet.
These financial instruments can be subdivided into three categories:
Cash financial instruments, generally characterized as on-balance-sheet
items, include investments, loans, mortgage-backed securities, deposits and
debt obligations.
Credit-related financial instruments, generally characterized as
off-balance-sheet items, include such instruments as commitments to extend
credit, commercial letters of credit and performance and financial standby
letters of credit.
Derivative financial instruments, on-balance-sheet items as of January 1,
2001, include such instruments as interest rate, foreign exchange,
commodity price and equity price contracts, including forwards, swaps and
options.
Our risk management policies are intended to monitor and limit exposure to
liquidity, market and credit risks that arise from each of these financial
instruments. See "-Loan Portfolio" for a discussion of our credit risk
management strategies.
Liquidity Risk Management. Liquidity risk management encompasses our ability to
meet all present and future financial obligations in a timely manner. The
objectives of liquidity management policies are to maintain adequate liquid
assets, liability diversification among instruments, maturities and customers
and a presence in both the wholesale purchased funds market and the retail
deposit market.
The Consolidated Statements of Cash Flows in the Consolidated Financial
Statements included under Item 8 of Part II present data on cash and cash
equivalents provided by and used in operating, investing and financing
activities. In addition to liquidity from core deposit growth, together with
repayments and maturities of loans and investments, we utilize brokered
deposits, sell securities under agreements to repurchase and borrow overnight
Federal funds. The Bank is a member of the FHLB, which affords it the
opportunity to borrow funds in terms ranging from overnight to 10 years and
beyond. Advances from the FHLB are generally collateralized by the Bank's
mortgage loans and various investment securities. See "-Investment Securities"
and Note 12 to the Consolidated Financial Statements included under Item 8 of
Part II. We have also obtained funding through the issuance of Subordinated
Notes, subordinated debentures and long-term borrowings. See "-Borrowed Funds,"
"Guaranteed Preferred Beneficial Interests in Company's Subordinated Debentures"
and Notes 13 and 14 to the Consolidated Financial Statements included under Item
8 of Part II for further information on these instruments.
The following table sets forth, for the periods indicated, a summary of our
major sources and (uses) of funds. This summary information is derived from the
Consolidated Statements of Cash Flows included under Item 8 of Part II:
Major Sources and Uses of Funds
For the Years Ended December 31,
-----------------------------------
2004 2003 2002
---------- ---------- -----------
(in thousands)
Proceeds from FHLB advances..................$ 382,000 $ 175,300 $ --
Proceeds from sales of investment
securities................................. 74,363 76,652 100,651
Net increase (decrease) in deposits.......... 59,401 (2,303) 21,293
Proceeds from maturities of investment
securities................................. 38,049 56,598 50,984
Net increase in short-term borrowings........ 2,314 3,263 27,360
Proceeds from issuance of preferred stock.... 1,500 -- 1,500
Net increase in long-term borrowings......... 1,439 279 8,548
Repayments of FHLB advances.................. (397,000) (160,300) (20,000)
Purchases of investment securities........... (89,904) (193,653) (146,985)
Net (increase) decrease in loans............. (10,670) 50,419 (35,144)
Cash paid for Milne Scali earnouts........... (6,012) (2,315) --
Additions to premises and equipment.......... (5,035) (9,012) (2,974)
Repurchase of preferred stock................ (1,750) -- --
Cash paid for acquisition of
insurance agencies......................... (462) (260) (13,964)
Disposition of discontinued
Fargo branch............................... -- -- (4,365)
Our liquidity is measured by our ability to raise cash when we need it at a
reasonable cost and with a minimum of loss. Given the uncertain nature of our
customers' demands as well as our desire to take advantage of earnings
enhancement opportunities, we must have adequate sources of on- and
off-balance-sheet funds that can be acquired in time of need. Accordingly, in
addition to the liquidity provided by balance sheet cash flows, liquidity is
supplemented with additional sources such as credit lines with the FHLB, credit
lines with correspondent banks for Federal funds, wholesale and retail
repurchase agreements, brokered deposits and direct non-brokered national
certificates of deposit acquired through national deposit networks.
We measure our liquidity position on a monthly basis. Key factors that determine
our liquidity are the reliability or stability of our deposit base, the
pledged/non-pledged status of our investments and potential loan demand. Our
liquidity management system divides the balance sheet into liquid assets, and
short-term liabilities that are assumed to be vulnerable to non-replacement
under abnormally stringent conditions. The excess of liquid assets over
short-term liabilities is measured over a 30-day planning horizon. Assumptions
for short-term liabilities vulnerable to non-replacement under abnormally
stringent conditions are based on a historical analysis of the month-to-month
percentage changes in deposits. The excess of liquid assets over short-term
liabilities and other key factors such as expected loan demand as well as access
to other sources of liquidity such as lines with the FHLB, Federal funds and
those other supplemental sources listed above are tied together to provide a
measure of our liquidity. We have a targeted range and manage our operations
such that these targets can be achieved. We believe that our prudent management
policies and guidelines will ensure adequate levels of liquidity to fund
anticipated needs of on- and off-balance-sheet items. In addition, a contingency
funding policy statement identifies actions to be taken in response to an
adverse liquidity event. During 2004, our management team conducted an on-site
funding crisis simulation designed to model several days of a funding crisis.
As of December 31, 2004, we had established three revolving lines of credit with
banks, totaling $17.5 million. At December 31, 2004, the Bank had not drawn on
these lines leaving $17.5 million available under these revolving lines of
credit. The lines, if drawn upon, mature daily with interest rates that float at
the Federal funds rate. 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. At December 31,
2004, we also had the ability to draw additional FHLB advances of $54.6 million
based upon the mortgage loans and securities that were then pledged, subject to
a requirement to purchase additional FHLB stock.
Forward-Looking Statements
Statements included in Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" which are not historical in
nature are intended to be, and are hereby identified as "forward-looking
statements" for purposes of the safe harbor provided by Section 27A of the
Securities Act and Section 21E of the Exchange Act. We caution readers that
these forward-looking statements, including without limitation, those relating
to our future business prospects, revenues, working capital, liquidity, capital
needs, interest costs, income and expenses, are subject to certain risks and
uncertainties that could cause actual results to differ materially from those
indicated in the forward-looking statements due to several important factors.
These factors include, but are not limited to: risks of loans and investments,
including dependence on local and regional economic conditions; competition for
our customers from other providers of financial services; possible adverse
effects of changes in interest rates including the effects of such changes on
derivative contracts and associated accounting consequences; risks associated
with our acquisition and growth strategies; and other risks which are difficult
to predict and many of which are beyond our control. For a discussion of some of
the additional risk factors that might cause such differences, see Item 1 of
Part I, "-Factors That May Affect Future Results of Operations."
Effects of Inflation
Unlike most industrial companies, the assets and liabilities of financial
institutions are primarily monetary in nature. Therefore, banking organizations
do not necessarily gain or lose due to the effects of inflation. Changes in
interest rates, which are a major determinant of a financial service
organization's profitability, do not necessarily correspond to changes in the
prices of goods and services; however, interest rates may change in response to
changes in expectations of future inflation. An analysis of a banking
organization's asset and liability structure provides the best indication of how
the organization is positioned to respond to changing interest rates and
maintain profitability.
The financial statements and supplementary financial data have been prepared,
primarily, on a historical basis, which is mandated by accounting principles
generally accepted in the United States. Fluctuations in the relative value of
money due to inflation or recession are generally not considered.
Recently Issued and Adopted Accounting Pronouncements
Note 1 to the Consolidated Financial Statements included under Item 8 includes a
summary of recently issued and adopted accounting pronouncements and their
related or anticipated impact on the Company.
Critical Accounting Policies
Critical accounting policies are dependent on estimates that are particularly
susceptible to significant change and include the determination of the allowance
for credit losses, income taxes and impairment testing related to goodwill and
other intangible assets. The following have been identified as "critical
accounting policies."
Allowance for Credit Losses. We maintain our allowance for credit losses at a
level considered adequate to provide for an estimate of probable losses related
to specifically identified loans as well as probable losses in the remaining
loan and lease portfolio that have been incurred as of each balance sheet date.
The loan and lease portfolio and other credit exposures are reviewed regularly
to evaluate the adequacy of the allowance for credit losses. In determining the
level of the allowance, we evaluate the allowance necessary for specific
nonperforming loans and also estimate losses in other credit exposures. The
resultant three allowance components are as follows:
Specific Reserves. The amount of specific reserves is determined through a
loan-by-loan analysis of problem loans over a minimum size that considers
expected future cash flows, the value of collateral and other factors that
may impact the borrower's ability to make payments when due. Included in
this group are those nonaccrual or renegotiated loans that meet the
criteria as being "impaired" under the definition in Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a
Loan," ("SFAS 114"). A loan is impaired when, based on current information
and events, it is probable that a creditor will be unable to collect all
amounts due according to the contractual terms of the loan agreement.
Problem loans also include those credits that have been internally
classified as credits requiring management's attention due to underlying
problems in the borrower's business or collateral concerns. Under SFAS 114,
any allowance on impaired loans is generally based on one of three methods.
The accounting standard requires that impaired loans be measured at either
the present value of expected cash flows at the loan's effective interest
rate, the loan's observable market price or the fair value of the
collateral of the loan. Specific reserves totaled $904,000 at December 31,
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 that have been
excluded from the specific reserve allocation previously discussed. We
segment the pools by type of loan or lease and, using historical loss
information, estimate a loss reserve for each pool. Reserves for
homogeneous loan pools totaled $2.313 million at December 31, 2004.
Qualitative Reserve. Our senior lending management also allocates reserves
for special situations that are unique to the measurement period. These
include, among other things, prevailing and anticipated economic trends,
such as economic conditions in certain geographic or industry segments of
the portfolio and economic trends in the retail-lending sector,
management's assessment of credit risk inherent in the loan portfolio,
delinquency trends, historical loss experience and peer-group loss history.
Our qualitative reserve totaled $118,000 at December 31, 2004.
Continuous credit monitoring processes and the analysis of loss components is
the principal method we rely upon to ensure that changes in estimated credit
loss levels are reflected in our allowance for credit losses on a timely basis.
We also consider experience of peer institutions and regulatory guidance in
addition to our own experience. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the allowance
for credit losses. Such agencies may require additions to the allowance based on
their judgment about information available to them at the time of their
examination.
Loans, leases and other extensions of credit deemed uncollectible are charged to
the allowance. Subsequent recoveries, if any, are credited to the allowance. The
amount of the allowance for credit losses is highly dependent upon our estimates
of variables affecting valuation, appraisals of collateral, evaluations of
performance and status, and the amounts and timing of future cash flows expected
to be received on impaired loans. Such estimates, appraisals, evaluations and
cash flows may be subject to frequent adjustments due to changing economic
prospects of borrowers, lessees or properties. These estimates are reviewed
periodically. Actual losses may vary from current estimates and the amount of
the provision may be either greater than or less than actual net charge-offs.
The related provision for credit losses, which is charged to income, is the
amount necessary to adjust the allowance to the level determined appropriate
through application of the above processes.
As indicated above, we employ a systematic methodology for determining our
allowance for credit losses that includes an ongoing review process and
quarterly adjustment of the allowance. Our process includes periodic
loan-by-loan review for loans that are individually evaluated for impairment as
well as detailed reviews of other loans (either individually or in pools). This
includes an assessment of known problem loans, potential problem loans and other
loans that exhibit indicators of deterioration.
Our methodology incorporates a variety of risk considerations, both quantitative
and qualitative, in establishing an allowance for credit losses that we believe
is appropriate at each reporting date. Quantitative factors include our
historical loss experience, delinquency and charge-off trends, collateral
values, changes in nonperforming loans and other factors. Quantitative factors
also incorporate known information about individual loans, including borrowers'
sensitivity to interest rate movements and borrowers' sensitivity to
quantifiable external factors including commodity and finished goods prices as
well as acts of nature (violent weather, fires, etc.) that occur in a particular
period.
Qualitative factors include the general economic environment in our markets and,
in particular, the state of certain industries in our market areas. Size and
complexity of individual credits in relation to lending officers' background and
experience levels, loan structure, extent and nature of waivers of existing loan
policies and pace of portfolio growth are other qualitative factors that are
considered in our methodology.
Our methodology is, and has been, consistently applied. However, as we add new
products, increase in complexity and expand our geographic coverage, we will
enhance our methodology to keep pace with the size and complexity of the loan
and lease portfolio. In this regard, we may, if deemed appropriate, engage
outside firms to independently assess our methodology. On an ongoing basis we
perform independent credit reviews of our loan portfolio. We believe that our
systematic methodology continues to be appropriate given our size and level of
complexity.
While our methodology utilizes historical and other objective information, the
establishment of the allowance for credit losses and the classification of loans
is, to some extent, based on our judgment and experience. We believe that the
allowance for credit losses is adequate, as of December 31, 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 December 31, 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 $3.3 million necessitated that
a provision for credit losses of $175,000 be charged to operations for the year
ended December 31, 2004. Should our analysis have resulted in the need for a
higher or lower allowance for credit losses, an additional or reduced amount
would have been charged to operations during the period. For example, should our
analysis have indicated the need for an allowance for credit losses of $3.5
million, an additional $200,000 would have been charged to the provision for
loan losses resulting in net income of approximately $3.3 million as compared to
the $3.4 million recorded for the year ended December 31, 2004. Had our analysis
indicated the need for an allowance for credit losses of $3.1 million, the
provision for credit losses would have been reduced by the full $175,000, plus
an additional $25,000 would have been reversed out of the reserve, resulting in
net income of approximately $3.6 million as compared to the $3.4 million
recorded for the period.
In the past three years there have been changes in the qualitative and
quantitative factors noted above. From period to period, economic situations
change, credits may deteriorate or improve and the other factors we consider in
arriving at our estimates may change. However, our basic methodology for
determining an appropriate allowance for credit losses has remained relatively
stable. This methodology has resulted in allowance levels of $3.3, $4.8 and $5.0
million at each of December 31, 2004, 2003 and 2002, 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. Income taxes are accounted for using the asset and liability
method according to SFAS 109. Under this method, deferred tax assets and
liabilities and the amounts of tax currently payable or refundable are
recognized.
Deferred tax assets and liabilities are recognized for the estimated 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, amortization timing differences of
intangible assets 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. We subscribe to several tax reporting
services to allow us to constantly monitor federal and state legislation,
regulation and judicial activity to keep abreast of any changes which may affect
these assets or liabilities.
The realization of these deferred tax assets and liabilities could differ
significantly from the amounts recorded. Our analysis includes consideration of
many factors including our continued growth and expansion into new lines of
business and taxing jurisdictions such that the Company could be subject to
different taxing methodologies. The amount of the assets or liabilities realized
is dependent on the tax rates in effect in the taxing jurisdictions we are
subject to at the time the temporary differences are recovered. The tax rates
vary from state to state and we continue to achieve nexus in new states which
may have higher or lower rates in effect.
We have considered the need for a valuation allowance and have determined the
Company has a deferred tax asset resulting from certain state tax net operating
loss carry-forwards which it believes will not be realized. These losses were
incurred in years a unitary return was not filed and the Company does not
believe it will have sufficient apportioned income to this state to receive a
benefit from them before they expire. In all other respects, the Company
believes there is credible evidence to expect sufficient taxable income to
absorb future deductible temporary differences. As part of this assessment, we
have considered the timing of the expected recoveries of the temporary
differences.
Current tax liabilities or amounts refundable are recognized based on currently
enacted tax legislation, federal and state regulations, rulings and procedures,
applicable federal and state judicial rulings and our interpretation thereof.
The Company files its federal tax return on a consolidated basis and has taken
the position it is a unitary business and files all state returns as such.
We employ a systematic methodology of determining our tax related balances that
includes an ongoing review process and quarterly adjustments. Our process
includes comparison and reconciliation of recorded amounts to those reported to
the taxing authorities.
Impairment Testing Related to Goodwill and Other Intangible Assets. In
accordance with SFAS No. 142, the Company tests goodwill and other intangible
assets for impairment annually or when impairment indicators are present. These
tests are required to be conducted at the reporting unit level. Goodwill and
other intangible assets are impaired when the carrying amount of the reporting
unit exceeds the implied fair value of the reporting unit.
The North Dakota banking group was used as the reporting unit for goodwill and
other intangible assets related to the acquisition of various branches and
deposits in North Dakota. The mortgage branch was used as the reporting unit for
the goodwill related to the acquisition of the mortgage consulting and brokerage
firm. The trust and professional services departments were used as the reporting
unit for the intangible assets related to acquisition of customer lists and a
management contract. Milne Scali was used as the reporting unit for goodwill and
other intangible assets related to all insurance acquisitions.
The Company uses current, comparable transactions to estimate the fair value of
the respective reporting units when available. The Company calculates an
estimated fair value based on multiples of revenues, earnings, and book value of
the comparable transactions. However, when such comparable transactions are not
available or may have become outdated, the Company uses other methods to
estimate the fair value of the reporting units. These other methods may include
the discounted cash flow approach, the same methodology used to establish the
initial purchase price or the average of several methods.
Assessing impairment of the Company's goodwill and other intangible assets is an
inexact science and can be approached using a variety of methods. Specific
factors and rates used to assess value are based on management's best estimates
of variables affecting the valuation analyses. The estimates are assessed
periodically and any identified impairment would result in a change to earnings.
Such charges could materially affect the Company's results of operations due to
the significant amount of goodwill and other intangible assets that must be
assessed periodically or when impairment indicators are present.
The effect of any impairment is recorded in earnings in the period it is
determined.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk arises from changes in interest rates, exchange rates, and commodity
prices and equity prices and represents the possibility that changes in future
market rates or prices will have a negative impact on our earnings or value. Our
principal market risk is interest rate risk.
Interest rate risk arises from changes in interest rates. Interest rate risk can
result from: (1) Repricing risk - timing differences in the maturity/repricing
of assets, liabilities, and off-balance-sheet contracts; (2) Options risk - the
effect of embedded options, such as loan prepayments, interest rate caps/floors,
and deposit withdrawals; (3) Basis risk - risk resulting from unexpected changes
in the spread between two or more different rates of similar maturity, and the
resulting impact on the behavior of lending and funding rates; and (4) Yield
curve risk - risk resulting from unexpected changes in the spread between two or
more rates of different maturities from the same type of instrument. We have
risk management policies to monitor and limit exposure to interest rate risk. To
date we have not conducted trading activities as a means of managing interest
rate risk. Our asset/liability management process is utilized to manage our
interest rate risk. The measurement of interest rate risk associated with
financial instruments is meaningful only when all related and offsetting on-and
off-balance-sheet transactions are aggregated, and the resulting net positions
are identified.
Our interest rate risk exposure is actively managed with the objective of
managing the level and potential volatility of net interest income in addition
to the long-term growth of equity, bearing in mind that we will always be in the
business of taking on rate risk and that rate risk immunization is not entirely
possible. Also, it is recognized that as exposure to interest rate risk is
reduced, so too may the overall level of net interest income and equity. In
general, the assets and liabilities generated through ordinary business
activities do not naturally create offsetting positions with respect to
repricing or maturity characteristics. Access to the derivatives market can be
an important element in maintaining our interest rate risk position within
policy guidelines. Using derivative instruments, principally interest rate
floors and caps, the interest rate sensitivity of specific transactions, as well
as pools of assets or liabilities, is adjusted to maintain the desired interest
rate risk profile. See "-Loan Portfolio-Interest Rate Caps and Floors"
"-Borrowings-Interest Rate Caps and Floors" and Notes 1 and 17 to the
Consolidated Financial Statements included under Item 8 for a summary of our
accounting policies pertaining to such instruments.
Our primary tool for measuring and managing interest rate risk is net interest
income simulation. This exercise includes our assumptions regarding the level of
interest rates and their impact on our current balance sheet. Interest rate caps
and floors are included to the extent that they are exercised in the 12-month
simulation period. Additionally, changes in prepayment behavior of the
residential mortgage, CMOs, and mortgage-backed securities portfolios in each
rate environment are captured using industry estimates of prepayment speeds for
various coupon segments of the portfolio. For purposes of this simulation,
projected month-end balances of the various balance sheet accounts are held
constant at their December 31, 2004 levels. Cash flows from a given account are
reinvested back into the same account so as to keep the month-end balance
constant at its December 31, 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 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 on a pro-rata basis. For
example, in the +100bp scenario, the projected prime rate will increase from its
starting point at December 31, 2004 of 5.25 percent to 6.25 percent 12 months
later. The prime rate in this example will increase 1/12th of the overall
increase of 100 basis points each month. Given the historically low absolute
level of market interest rates as of December 31, 2004, the declining rate
scenario analysis was limited to -100bp and -200bp for the summary table
presented below and a +400bp scenario was added. As the yield curve flattened
over the course of 2004 with short-term rates increasing more than long-term
rates, the parallel movement of interest rates takes the level of the 10-year
U.S. Treasury note yield in the -200bp scenario to 2.26 percent. This is nearly
100bp below the June 13, 2003 low for the 10-year U.S. Treasury note yield of
3.11 percent. Therefore, the level of mortgage prepayment activity built into
the model is significantly greater than the record levels experienced during the
2003 lows in mortgage rates.
The net interest income simulation result for the 12-month horizon that covers
the calendar year of 2005 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. These interest
rate caps had a remaining maturity of approximately 18 months as of December 31,
2004. The impact of the cap positions is calculated by determining the fair
value of the contracts at the end of the 12-month horizon using an interest rate
option valuation model. The change in fair value plus any expected cash flow in
the various rate scenarios is summed to determine the total net benefit/(cost)
of the portfolio of interest rate cap contracts. See Notes 1 and 17 to the
Consolidated Financial Statements included under Item 8 of Part II for further
discussion related to our interest rate caps and accounting policies related to
these derivative instruments.
Net Interest Income Simulation
(amounts in thousands)
Movement in interest rates -200bp -100bp Unchanged +100bp +200bp +300bp +400bp
-------- -------- --------- -------- -------- -------- --------
Projected 12-month net
interest income........... $ 14,087 $ 15,122 $ 16,825 $ 17,340 $ 17,847 $ 18,076 $ 18,228
Dollar change from rates
unchanged scenario.........$(2,738) $(1,703) -- $ 515 $ 1,022 $ 1,251 $ 1,403
Percentage change from rates
unchanged scenario.........(16.27)% (10.12)% -- 3.06% 6.07% 7.44% 8.34%
Net benefit/(cost) of
cumulative $40.0 million
interest rate caps (1).....$ (1) $ (1) $ (1) $ (1) -- $ 25 $ 109
Total net interest income
impact with caps...........$ 14,086 $ 15,121 $ 16,824 $ 17,339 $ 17,847 $ 18,101 $ 18,337
Dollar change from unchanged
w/caps.....................$(2,738) $(1,703) -- $ 515 $ 1,022 $ 1,277 $ 1,513
Percentage change from
unchanged w/caps...........(16.27)% (10.12)% -- 3.06% 6.07% 7.59% 8.99%
Policy guidelines (decline
limited to).................. 10.00% 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 of 2006. See
Notes 1 and 17 to the Consolidated Financial Statements included under Item
8 for further information on accounting policies related to derivative
financial investments.
Our rate sensitivity position over the projected 12-month horizon is asset
sensitive. This is evidenced by the projected increase in net interest income in
the rising interest rate scenarios.
Because one of the objectives of asset/liability management is to manage net
interest income over a one-year planning horizon, policy guidelines are stated
in terms of maximum potential reduction in net interest income resulting from
changes in interest rates over the 12-month period. It is no less important,
however, to give attention to the absolute dollar level of projected net
interest income over the 12-month period.
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 and -200bp scenarios above, the ALCO reviews the circumstances
surrounding the exception and, considering the level of net interest income
generated in the scenario and other related factors, may approve the exception
to the general policy or recommend actions aimed at bringing the respective
scenario within the general limits noted above. A targeted level of net interest
income is established and approved by the Board and ALCO. This target is
reevaluated and reset as appropriate at each quarterly ALCO meeting.
Static gap analysis is another tool that may be used for interest rate risk
measurement. The net differences between the amount of assets, liabilities,
equity and off-balance-sheet instruments repricing within a cumulative calendar
period is typically referred to as the "rate sensitivity position" or "gap
position." The following table sets forth our rate sensitivity position as of
December 31, 2004. Assets and liabilities are classified by the earliest
possible repricing date or maturity, whichever occurs first:
Interest Sensitivity Gap Analysis
Estimated maturity or repricing
at December 31, 2004
-------------------------------------------------
0-3 4-12 1-5 Over
months months years 5 years Total
--------- --------- -------- --------- --------
(dollars in thousands)
Interest-earning assets:
Interest-bearing deposits with
banks..........................$ 14 $ -- $ -- $ -- $ 14
Investment securities (1)........ 8,349 18,175 118,119 91,273 235,916
FRB and FHLB stock............... 7,541 -- -- -- 7,541
Loans held for sale, fixed rate.. 512 -- -- -- 512
Loans held for sale, floating
rate........................... 32,454 27,231 -- -- 59,685
Loans held for investment,
fixed rate (2)................. 10,576 15,117 29,987 11,080 66,760
Loans held for investment,
floating rate (2).............. 223,124 564 4,239 -- 227,927
--------- --------- -------- --------- --------
Total interest-earning assets..$282,570 $ 61,087 $152,345 $102,353 $598,355
========= ========= ======== ========= ========
Interest-bearing liabilities:
Interest checking and money
market accounts................$210,887 $ -- $ -- $ -- $210,887
Savings.......................... 7,248 -- -- -- 7,248
Time deposits under $100,000..... 21,873 49,200 25,307 738 97,118
Time deposits $100,000 and over.. 18,817 39,016 6,329 19,790 83,952
Short-term borrowings............ 33,697 -- -- -- 33,697
FHLB advances.................... -- 15,000 30,000 52,200 97,200
Long-term borrowings............. 667 -- 2,745 6,667 10,079
Subordinated debentures.......... -- -- -- 22,509 22,509
--------- --------- -------- --------- --------
Total interest-bearing
liabilities..................$293,189 $103,216 $ 64,381 $101,904 $562,690
========= ========= ======== ========= ========
Interest rate gap....................$(10,619) $(42,129) $ 87,964 $ 449 $ 35,665
========= ========= ======== ========= ========
Cumulative interest rate gap at
December 31, 2004..................$(10,619) $(52,748) $ 35,216 $ 35,665
========= ========= ======== =========
Cumulative interest rate gap to
total assets....................... (1.58)% (7.83)% 5.23% 5.29%
- --------------------
(1) Investment securities are generally reported in the timeframe representing
the earliest of repricing date, call date (for callable securities),
estimated life or maturity date. Estimated lives of mortgage-backed
securities and CMOs are based on published industry prepayment estimates
for securities with comparable weighted average interest rates and
contractual maturities.
(2) Loans are stated gross of the allowance for credit losses and are placed in
the earliest timeframe in which maturity or repricing may occur.
The table assumes that all savings and interest-bearing demand deposits reprice
in the earliest period presented, however, we believe a significant portion of
these accounts constitute a core component and are generally not rate sensitive.
Our position is supported by the fact that aggressive reductions in interest
rates paid on these deposits historically have not caused notable reductions in
balances. For example, while the Federal funds target rate increased 125 basis
points during the second half of 2004, the rates paid on these deposits were
only increased slightly, without any noticeable reductions in balances.
The table does not necessarily indicate the future impact of general interest
rate movements on our net interest income because the repricing of certain
assets and liabilities is discretionary and is subject to competitive and other
pressures. As a result, assets and liabilities indicated as repricing within the
same period may in fact reprice at different times and at different rate levels.
Static gap analysis does not fully capture the impact of embedded options,
lagged interest rate changes, administered interest rate products, or certain
off-balance-sheet sensitivities to interest rate movements. Therefore, this tool
generally cannot be used in isolation to determine the level of interest rate
risk exposure in banking institutions.
Since there are limitations inherent in any methodology used to estimate the
exposure to changes in market interest rates, these analyses are not intended to
be a forecast of the actual effect of changes in market interest rates such as
those indicated above on the Company. Further, these analyses are based on our
assets and liabilities as of December 31, 2004 (without forward adjustments for
planned growth and anticipated business activities) and do not contemplate any
actions we might undertake in response to changes in market interest rates.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Financial Statements: Page
Independent Auditors' Report................................................. 62
Consolidated Balance Sheets as of December 31, 2004 and 2003................. 63
Consolidated Statements of Income for the years ended December 31, 2004,
2003 and 2002................................................................ 64
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2004, 2003, and 2002............................................ 66
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2004, 2003, and 2002............................................ 67
Consolidated Statements of Cash Flows for the years ended December 31,
2004, 2003, and 2002......................................................... 68
Notes to Consolidated Financial Statements................................... 69
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
BNCCORP, Inc.:
We have audited the accompanying consolidated balance sheets of BNCCORP, Inc.
and subsidiaries as of December 31, 2004 and 2003, and the related consolidated
statements of income, comprehensive income, stockholders' equity, and cash flows
for each of the years in the three-year period ended December 31, 2004. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of BNCCORP, Inc. and
subsidiaries as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2004, in conformity with accounting principles generally
accepted in the United States of America.
[signed] KPMG LLP
Minneapolis, Minnesota
February 14, 2005
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
As of December 31
(In thousands, except share and per share data)
ASSETS
2004 2003
----------------- ---------------
CASH AND DUE FROM BANKS............................................................. $ 11,867 $ 12,520
INTEREST-BEARING DEPOSITS WITH BANKS................................................. 14 --
----------------- ---------------
Cash and cash equivalents....................................................... 11,881 12,520
INVESTMENT SECURITIES AVAILABLE FOR SALE............................................. 235,916 262,568
FEDERAL RESERVE BANK AND FEDERAL HOME LOAN BANK STOCK................................ 7,541 7,596
LOANS HELD FOR SALE.................................................................. 60,197 --
LOANS AND LEASES, net................................................................ 293,814 283,555
ALLOWANCE FOR CREDIT LOSSES.......................................................... (3,335) (4,763)
----------------- ---------------
Net loans and leases............................................................ 290,479 278,792
PREMISES AND EQUIPMENT, net.......................................................... 21,799 18,570
INTEREST RECEIVABLE.................................................................. 2,686 2,462
OTHER ASSETS......................................................................... 13,357 15,507
GOODWILL............................................................................. 21,779 15,089
OTHER INTANGIBLE ASSETS, net......................................................... 8,075 8,373
----------------- ---------------
$ 673,710 $ 621,477
================= ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
DEPOSITS:
Noninterest-bearing............................................................. $ 63,386 $ 44,725
Interest-bearing -
Savings, interest checking and money market................................. 210,887 215,525
Time deposits $100,000 and over............................................. 83,952 46,569
Other time deposits......................................................... 97,118 89,123
----------------- ---------------
Total deposits.................................................................. 455,343 395,942
SHORT-TERM BORROWINGS................................................................ 33,697 31,383
FEDERAL HOME LOAN BANK ADVANCES...................................................... 97,200 112,200
LONG-TERM BORROWINGS................................................................. 10,079 8,640
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY'S
SUBORDINATED DEBENTURES............................................................ 22,509 22,397
OTHER LIABILITIES.................................................................... 11,036 10,729
----------------- ---------------
Total liabilities...................................................... 629,864 581,291
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value - 2,000,000 shares authorized;
125 and 150 shares issued and outstanding................................ -- --
Capital surplus - preferred stock............................................... 1,250 1,500
Common stock, $.01 par value - 10,000,000 shares authorized; 2,884,876 and
2,749,196 shares issued and outstanding (excluding 43,901 and
42,880 shares held in treasury)............................................. 29 28
Capital surplus - common stock.................................................. 18,601 17,074
Retained earnings............................................................... 24,430 21,119
Treasury stock (43,901 and 42,880 shares)....................................... (530) (513)
Accumulated other comprehensive income, net of income taxes................... 66 978
----------------- ---------------
Total stockholders' equity............................................. 43,846 40,186
----------------- ---------------
$ 673,710 $ 621,477
================= ===============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income
For the Years Ended December 31
(In thousands, except per share data)
2004 2003 2002
------------ ------------ ------------
INTEREST INCOME:
Interest and fees on loans............................................. $ 18,865 $ 19,297 $ 20,778
Interest and dividends on investments -
Taxable.............................................................. 9,455 7,545 9,774
Tax-exempt........................................................... 1,604 1,535 977
Dividends............................................................ 209 259 223
Other.................................................................. 8 10 66
------------ ------------- ------------
Total interest income....................................... 30,141 28,646 31,818
------------ ------------- ------------
INTEREST EXPENSE:
Deposits............................................................... 6,532 7,438 10,242
Short-term borrowings.................................................. 519 382 141
Federal Home Loan Bank advances........................................ 4,898 5,333 6,214
Long-term borrowings................................................... 393 387 310
Subordinated debentures................................................ 1,758 1,728 1,829
------------ ------------- ------------
Total interest expense...................................... 14,100 15,268 18,736
------------ ------------- ------------
Net interest income......................................... 16,041 13,378 13,082
PROVISION FOR CREDIT LOSSES............................................... 175 1,475 1,202
------------ ------------- ------------
NET INTEREST INCOME AFTER PROVISION FOR
CREDIT LOSSES........................................................... 15,866 11,903 11,880
------------ ------------- ------------
NONINTEREST INCOME:
Insurance commissions.................................................. 17,490 14,568 8,981
Fees on loans.......................................................... 2,175 2,022 2,169
Service charges........................................................ 827 909 755
Brokerage income....................................................... 538 420 1,094
Trust and financial services........................................... 486 1,009 751
Net gain on sales of securities........................................ 269 968 1,870
Rental income.......................................................... 109 212 89
Other.................................................................. 1,556 704 587
------------ ------------- ------------
Total noninterest income.................................... 23,450 20,812 16,296
------------ ------------- ------------
NONINTEREST EXPENSE:
Salaries and employee benefits......................................... 21,662 16,478 14,723
Occupancy.............................................................. 2,700 2,306 2,235
Depreciation and amortization.......................................... 1,640 1,458 1,320
Professional services.................................................. 1,471 1,146 1,495
Office supplies, telephone and postage................................. 1,414 1,214 1,106
Amortization of intangible assets...................................... 1,274 1,063 881
Marketing and promotion................................................ 1,098 803 749
FDIC and other assessments............................................. 205 201 214
Other.................................................................. 3,304 2,621 2,606
------------ ------------- ------------
Total noninterest expense................................... 34,768 27,290 25,329
------------ ------------- ------------
Income from continuing operations before income taxes..................... 4,548 5,425 2,847
Income tax provision...................................................... 1,144 1,581 822
------------ ------------- ------------
Income from continuing operations......................................... 3,404 3,844 2,025
------------ ------------- ------------
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income, continued
For the Years Ended December 31
(In thousands, except per share data)
2004 2003 2002
------------ ----------- ------------
Discontinued Operations:
Gain from operations of discontinued Fargo branch (including net loss on
sale of $49 for 2002), net of income taxes of $6...................... -- -- 14
------------ ----------- ------------
NET INCOME................................................................ $ 3,404 $ 3,844 $ 2,039
============ =========== ============
Dividends on preferred stock.............................................. $ (93) $ (120) $ (79)
------------ ----------- ------------
Income available to common stockholders................................... $ 3,311 $ 3,724 $ 1,960
============ =========== ============
BASIC EARNINGS PER COMMON SHARE:
Income from continuing operations........................................ $ 1.18 $ 1.38 $ 0.74
Gain from discontinued Fargo branch, net of income taxes.................. -- -- 0.01
------------ ----------- ------------
Basic earnings per common share........................................... $ 1.18 $ 1.38 $ 0.75
============ =========== ============
DILUTED EARNINGS PER COMMON SHARE:
Income from continuing operations......................................... $ 1.14 $ 1.35 $ 0.74
Gain from discontinued Fargo branch, net of income taxes.................. -- -- 0.01
------------ ----------- ------------
Diluted earnings per common share......................................... $ 1.14 $ 1.35 $ 0.75
============ =========== ============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
For the Years Ended December 31
(In thousands)
2004 2003 2002
-------------- ------------- -------------
NET INCOME.................................................. $ 3,404 $ 3,844 $ 2,039
OTHER COMPREHENSIVE INCOME (LOSS) -
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during
the period, net of income taxes of $(539), $(668),
and $1,197.......................................... (711) (1,122) 2,381
Reclassification adjustment for gains included in
net income, net of income taxes..................... (201) (600) (1,330)
-------------- ------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS)........................... (912) (1,722) 1,051
-------------- ------------- -------------
COMPREHENSIVE INCOME........................................ $ 2,492 $ 2,122 $ 3,090
============== ============= =============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For the Periods Indicated
(In thousands, except share data)
Capital Capital Accumulated
Preferred Stock Surplus Common Stock Surplus Other
------------------ Preferred ------------------- Common Retained Treasury Comprehensive
Shares Amount Stock Shares Amount Stock Earnings Stock Income Total
-------- --------- ---------- ---------- -------- --------- --------- -------- ------------- ----------
BALANCE, December 31, 2001... -- $ -- $ -- 2,442,050 $ 24 $ 14,084 $ 15,435 $ (513) $ 1,649 $ 30,679
Net income................ -- -- -- -- -- -- 2,039 -- -- 2,039
Other comprehensive
income -
Change in unrealized
holding gains on
securities available
for sale, net of income
taxes and
reclassification
adjustment.............. -- -- -- -- -- -- -- -- 1,051 1,051
Issuance of preferred stock 150 -- 1,500 -- -- -- -- -- -- 1,500
Preferred stock dividends.. -- -- -- -- -- -- (79) -- -- (79)
Issuance of common stock... -- -- -- 297,759 3 2,497 -- -- -- 2,500
Other ..................... -- -- -- 4,000 -- 33 -- -- -- 33
-------- --------- ---------- ---------- -------- --------- --------- -------- ------------- ----------
BALANCE, December 31, 2002... 150 -- 1,500 2,743,809 27 16,614 17,395 (513) 2,700 37,723
Net income................. -- -- -- -- -- -- 3,844 -- -- 3,844
Other comprehensive loss -
Change in unrealized
holding gains on
securities available
for sale, net of income
taxes and
reclassification
adjustment............... -- -- -- -- -- -- -- -- (1,722) (1,722)
Preferred stock dividends... -- -- -- -- -- -- (120) -- -- (120)
Issuance of common stock.... -- -- -- 12,701 -- 227 -- -- -- 227
Other ...................... -- -- -- 35,566 1 233 -- -- -- 234
-------- --------- ---------- ---------- -------- --------- --------- -------- ------------- ----------
BALANCE, December 31, 2003... 150 -- 1,500 2,792,076 28 17,074 21,119 (513) 978 40,186
Net income................. 3,404 3,404
Other comprehensive loss -
Change in unrealized
holding gains on
securities available
for sale, net of income
taxes and
reclassification
adjustment............... (912) (912)
Repurchase of preferred
stock..................... (150) -- (1,500) (1,500)
Issuance of preferred stock. 150 -- 1,500 1,500
Repurchase of preferred
stock..................... (25) -- (250) (250)
Preferred stock dividends... (93) (93)
Issuance of common stock.... 67,657 1 1,089 1,090
Other ...................... 69,044 -- 438 (17) 421
-------- --------- ---------- ---------- -------- --------- --------- -------- ------------- ----------
BALANCE, December 31, 2004... 125 $ -- $ 1,250 2,928,777 $ 29 $18,601 $ 24,430 $ (530) $ 66 $ 43,846
======== ========= ========== ========== ======== ========= ========= ======== ============= ==========
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31
(In thousands)
2004 2003 2002
------------ ------------- --------------
OPERATING ACTIVITIES:
Net income....................................................... $ 3,404 $ 3,844 $ 2,039
Adjustments to reconcile net income to net cash provided by (used
in) operating activities -
Provision for credit losses.................................. 175 1,475 1,202
Depreciation and amortization................................ 1,640 1,458 1,489
Amortization of intangible assets............................ 1,274 1,063 881
Net premium amortization on investment securities............ 2,894 4,116 2,966
Proceeds from loans recovered................................ 280 102 136
Write down of other real estate owned and repossessed assets. 44 40 142
Change in interest receivable and other assets, net.......... 2,148 (10,946) 2,308
Loss on sale of bank premises and equipment.................. 25 17 5
Net realized gains on sales of investment securities......... (269) (968) (1,870)
Deferred income taxes........................................ 537 874 (269)
Change in dividend distribution payable...................... 26 (15) (4)
Change in other liabilities, net............................. 147 71 (2,965)
Originations of loans held for sale.......................... (210,070) -- --
Proceeds from sale of loans held for sale.................... 148,400 -- --
Originations of loans to be sold............................. (65,194) (81,706) (92,004)
Proceeds from sale of loans.................................. 65,194 81,706 92,004
------------ ------------- --------------
Net cash provided by (used in) operating activities.... (49,345) 1,131 6,060
------------ ------------- --------------
INVESTING ACTIVITIES:
Purchases of investment securities............................... (89,904) (193,653) (146,985)
Proceeds from sales of investment securities..................... 74,363 76,652 100,651
Proceeds from maturities of investment securities................ 38,049 56,598 50,984
Purchases of Federal Reserve and Federal Home Loan Bank stock.... (7,862) (3,007) --
Proceeds from sales of Federal Reserve and Federal Home Loan Bank
stock........................................................ 7,917 2,482 --
Net (increase) decrease in loans................................. (10,670) 50,419 (35,144)
Additions to premises and equipment.............................. (5,035) (9,012) (2,974)
Proceeds from sale of premises and equipment..................... 149 108 161
Cash paid for Milne Scali earnouts............................... (6,012) (2,315) --
Cash paid for acquisition of insurance agencies.................. (462) (260) (13,964)
Cash paid for acquisition of mortgage company.................... (150) -- --
Disposition of discontinued Fargo branch......................... -- -- (4,365)
Other............................................................ 4 -- --
------------ ------------- --------------
Net cash provided by (used in) investing activities.... 387 (21,988) (51,636)
------------ ------------- --------------
FINANCING ACTIVITIES:
Net increase in demand, savings, interest checking and money
market accounts.............................................. 10,803 28,357 36,723
Net increase (decrease) in time deposits......................... 48,598 (30,660) (15,430)
Net increase (decrease) in short-term borrowings................. 2,314 3,263 27,360
Repayments of Federal Home Loan Bank advances.................... (397,000) (160,300) (20,000)
Proceeds from Federal Home Loan Bank advances.................... 382,000 175,300 --
Repayments of long-term borrowings............................... (61) (62) (62)
Proceeds from long-term borrowings............................... 1,500 141 8,610
Proceeds from issuance of preferred stock........................ 1,500 -- 1,500
Repurchase of preferred stock.................................... (1,750) -- --
Payment of preferred stock dividends............................. (93) (120) (79)
Amortization of discount on subordinated debentures.............. 86 86 86
Other, net....................................................... 422 235 33
------------ ------------- --------------
Net cash provided by financing activities.............. 48,319 16,240 38,741
------------ ------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............... (639) (4,617) (6,835)
CASH AND CASH EQUIVALENTS, beginning of year........................ 12,520 17,137 23,972
------------ ------------- --------------
CASH AND CASH EQUIVALENTS, end of year.............................. $ 11,881 $ 12,520 $ 17,137
============ ============= ==============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid.................................................... $ 13,699 $ 15,693 $ 19,481
============ ============= ==============
Income taxes paid................................................ $ 594 $ 817 $ 912
============ ============= ==============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
1. Description of Business and Summary of Significant Accounting Policies
Description of Business. BNCCORP, Inc. ("BNCCORP") is a registered bank holding
company incorporated under the laws of Delaware. It is the parent company of BNC
National Bank (together with its wholly-owned subsidiaries, Milne Scali &
Company, Inc. ("Milne Scali") and BNC Asset Management, Inc., the "Bank").
BNCCORP, through these wholly owned subsidiaries, which operate from 26
locations in Arizona, Minnesota, North Dakota, Colorado and Utah, 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 more significant accounting policies are
summarized below.
Principles of Consolidation. The accompanying consolidated financial statements
include the accounts of BNCCORP and its wholly-owned subsidiaries. All
significant intercompany transactions and balances have been eliminated in
consolidation.
Use of Estimates. The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Ultimate results could
differ from those estimates.
Critical Accounting Policies
Critical accounting policies are dependent on estimates that are particularly
susceptible to significant change and include the determination of the allowance
for credit losses, income taxes and impairment testing related to goodwill and
other intangible assets. The following have been identified as "critical
accounting policies."
Allowance for Credit Losses. The Bank maintains its allowance for credit losses
at a level considered adequate to provide for an estimate of probable losses
related to specifically identified loans as well as probable losses in the
remaining loan and lease portfolio that have been incurred as of each balance
sheet date. The loan and lease portfolio and other credit exposures are reviewed
regularly to evaluate the adequacy of the allowance for credit losses. In
determining the level of the allowance, the Bank evaluates the allowance
necessary for specific nonperforming loans and also estimates losses in other
credit exposures. The resultant three allowance components are as follows:
Specific Reserves. The amount of specific reserves is determined through a
loan-by-loan analysis of problem loans over a minimum size that considers
expected future cash flows, the value of collateral and other factors that
may impact the borrower's ability to make payments when due. Included in
this group are those nonaccrual or renegotiated loans that meet the
criteria as being "impaired" under the definition in Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a
Loan" ("SFAS 114"). A loan is impaired when, based on current information
and events, it is probable that a creditor will be unable to collect all
amounts due according to the contractual terms of the loan agreement.
Problem loans also include those credits that have been internally
classified as credits requiring management's attention due to underlying
problems in the borrower's business or collateral concerns. Under SFAS 114,
any allowance on impaired loans is generally based on one of three methods.
The accounting standard requires that impaired loans be measured at either
the present value of expected cash flows at the loan's effective interest
rate, the loan's observable market price or the fair value of the
collateral of the loan.
Reserves for Homogeneous Loan Pools. The Bank makes a significant number of
loans and leases that, due to their underlying similar characteristics, are
assessed for loss as "homogeneous" pools. Included in the homogeneous pools
are consumer loans and commercial loans under a certain size, which have
been excluded from the specific reserve allocation previously discussed.
The Bank segments the pools by type of loan or lease and, using historical
loss information, estimates a loss reserve for each pool.
Qualitative Reserve. The Bank's senior lending management also allocates
reserves for special situations which are unique to the measurement period.
These include, among other things, prevailing and anticipated economic
trends, such as economic conditions in certain geographic or industry
segments of the portfolio and economic trends in the retail lending sector,
management's assessment of credit risk inherent in the loan portfolio,
delinquency trends, historical loss experience and peer-group loss history.
Continuous credit monitoring processes and the analysis of loss components is
the principal method relied upon by management to ensure that changes in
estimated credit loss levels are reflected in the Bank's allowance for credit
losses on a timely basis. Management also considers experience of peer
institutions and regulatory guidance in addition to the Bank's own experience.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the allowance for credit losses. Such
agencies may require additions to the allowance based on their judgment about
information available to them at the time of their examination.
Loans, leases and other extensions of credit deemed uncollectible are charged to
the allowance. Subsequent recoveries, if any, are credited to the allowance. The
amount of the allowance for credit losses is highly dependent upon management's
estimates of variables affecting valuation, appraisals of collateral,
evaluations of performance and status, and the amounts and timing of future cash
flows expected to be received on impaired loans. Such estimates, appraisals,
evaluations and cash flows may be subject to frequent adjustments due to
changing economic prospects of borrowers, lessees or properties. These estimates
are reviewed periodically. Actual losses may vary from current estimates and the
amount of the provision may be either greater than or less than actual net
charge-offs. The related provision for credit losses, which is charged to
income, is the amount necessary to adjust the allowance to the level determined
appropriate through application of the above processes.
Income Taxes. The Company files consolidated Federal and unitary state income
tax returns.
Income taxes are accounted for using the asset and liability method. Under this
method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Such differences can relate to differences in accounting for credit
losses, depreciation timing differences, unrealized gains and losses on
investment securities, deferred compensation and leases, which are treated as
operating leases for tax purposes and loans for financial statement purposes.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
The determination of current and deferred income taxes is based on complex
analyses of many factors including interpretation of Federal and state income
tax laws, the difference between tax and financial reporting basis of assets and
liabilities (temporary differences), estimates of amounts due or owed 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.
Impairment Testing Related to Goodwill and Other Intangible Assets. In
accordance with SFAS No. 142, the Company tests goodwill and other intangible
assets for impairment annually or when impairment indicators are present. These
tests are required to be conducted at the reporting unit level. Goodwill and
other intangible assets are impaired when the carrying amount of the reporting
unit exceeds the implied fair value of the reporting unit.
The North Dakota banking group was used as the reporting unit for goodwill and
other intangible assets related to the acquisition of various branches and
deposits in North Dakota. The mortgage branch was used as the reporting unit for
the goodwill related to the acquisition of the mortgage consulting and brokerage
firm. The Financial Services Group was used as the reporting unit for the
intangible assets related to acquisition of customer lists and a management
contract. Milne Scali & Company was used as the reporting unit for goodwill and
other intangible assets related to all insurance acquisitions.
The Company uses current, comparable transactions to estimate the fair value of
the respective reporting units when available. The company calculates an
estimated fair value based on multiples of revenues, earnings, and book value of
the comparable transactions. However, when such comparable transactions are not
available or may have become outdated, the Company uses other methods to
estimate the fair value of the reporting units. These other methods may include
the discounted cash flow approach, the same methodology used to establish the
initial purchase price or the average of several methods.
Assessing impairment of the Company's goodwill and other intangible assets is an
inexact science and can be approached using a variety of methods. Specific
factors and rates used to assess value are based on management's best estimates
of variables affecting the valuation analyses. The estimates are assessed
periodically and any identified impairment would result in a change to earnings.
Such charges could materially affect the Company's results of operations due to
the significant amount of goodwill and other intangible assets that must be
assessed periodically or when impairment indicators are present.
The effect of any impairment is recorded in earnings in the period it is
determined. There was no goodwill impairment recorded during the reporting
periods included in these consolidated financial statements.
Other Significant Accounting Policies
Business Combinations. Business combinations that have been accounted for under
the purchase method of accounting include the results of operations of the
acquired businesses from the date of acquisition. Net assets of the companies
acquired were recorded at their estimated fair value as of the date of
acquisition. Effective with the issuance of Statement of Financial Accounting
Standards No. 141, "Business Combinations" ("SFAS 141"), all business
combinations are required to be accounted for by the purchase method. Note 2 to
these consolidated financial statements includes a summary of all business
combinations completed during the three-year period ended December 31, 2004.
Discontinued Operations. The results of the discontinued operations and any gain
or loss on disposal are reported separately from continuing operations. Prior
period financial statements have been restated to give effect to the
discontinued operations accounted for under this method.
Cash and Cash Equivalents. For purposes of presentation in the consolidated
statements of cash flows, the Company considers amounts included in the
consolidated balance sheet captions "cash and due from banks" and
"interest-bearing deposits with banks" (summarized in the consolidated balance
sheet as "cash and cash equivalents") to be cash equivalents.
Investment Securities. Investment and mortgage-backed securities that the Bank
intends to hold for indefinite periods of time as part of its asset/liability
strategy, or that may be sold in response to changes in interest rates, changes
in prepayment risk, the need to increase regulatory capital or similar factors
are classified as available for sale. Available-for-sale securities are carried
at market value. Net unrealized gains and losses, net of deferred income taxes,
on investments and mortgage-backed securities available for sale are reported as
a separate component of stockholders' equity until realized (see "Comprehensive
Income"). All securities, other than the securities of the Federal Reserve Bank
("FRB") and the Federal Home Loan Bank ("FHLB"), were classified as available
for sale as of December 31, 2004 and 2003. Investment and mortgage-backed
securities that the Bank intends to hold until maturity are carried at cost,
adjusted for amortization of premiums and accretion of discounts using a level
yield methd over the period to maturity. The Bank did not have any securities
classified as held to maturity as of December 31, 2004 or 2003.
Premiums and discounts are amortized or accreted over the life of the related
security as an adjustment to yield using the effective interest method. Dividend
and interest income is recognized when earned. Realized gains and losses on the
sale of investment securities are determined using the specific-identification
method and recognized in noninterest income on the trade date.
Declines in the fair value of individual available-for-sale or held-to-maturity
securities below their cost, which are deemed other than temporary, could result
in a charge to earnings and the corresponding establishment of a new cost basis
for the security. Such write-downs, should they occur, would be included in
noninterest income as realized losses. There were no such write-downs during
2004, 2003 or 2002. Note 4 to these consolidated financial statements includes a
summary of investment securities in a loss position at December 31, 2004 along
with the length of time that individual securities have been in a continuous
unrealized loss position and a discussion concerning such securities.
Federal Reserve Bank and Federal Home Loan Bank Stock. Investments in FRB and
FHLB stock are carried at cost, which approximates fair value.
Loans Held for Sale. Loans held for sale are recorded at the lower of cost or
market value. The Bank has initiated a financing program in which it purchases
short-term participation interests in residential mortgage loans originated by a
mortgage company. Residential mortgage loans held for sale at December 31, 2004
totaled $35.0 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 it
purchases interests in student loans originated by a student loan origination
company. Student loans held for sale at December 31, 2004 totaled $25.2 million.
The student loans will be held until the end of the first quarter or the
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.
Loans and Leases. Loans and leases held for investment are stated at their
outstanding principal amount net of unearned income, net unamortized deferred
fees and costs and an allowance for credit losses. Interest income is recognized
on an accrual basis using the interest method prescribed in the loan agreement
except when collectibility is in doubt.
Loans and leases, including loans that are considered to be impaired, are
reviewed regularly by management and are placed on nonaccrual status when the
collection of interest or principal is 90 days or more past due, unless the loan
or lease is adequately secured and in the process of collection. Past due status
is based on payments as they relate to contractual terms. When a loan or lease
is placed on nonaccrual status, unless collection of all principal and interest
is considered to be assured, uncollected interest accrued in prior years is
charged off against the allowance for credit losses. Interest accrued in the
current year is reversed against interest income of the current period. Interest
payments received on nonaccrual loans and leases are generally applied to
principal unless the remaining principal balance has been determined to be fully
collectible. Accrual of interest is resumed when it can be determined that all
amounts due under the contract are expected to be collected and the loan has
exhibited a sustained level of performance, generally at least six months.
All impaired loans, including all loans that are restructured in a troubled debt
restructuring involving a modification of terms, are measured at the present
value of expected future cash flows discounted at the loan's initial effective
interest rate. The fair value of collateral of an impaired collateral-dependent
loan or an observable market price, if one is available, may be used as an
alternative to discounting. If the measure of the impaired loan is less than the
recorded investment in the loan, impairment will be recognized as a charge-off
through the allowance for credit losses. A loan is considered impaired when,
based on current information and events, it is probable that a creditor will be
unable to collect all amounts due according to the contractual terms of the loan
agreement. All loans are reviewed for impairment on an individual basis.
Loan Origination Fees and Costs. Loan origination fees and costs incurred to
extend credit are deferred and amortized over the term of the loan as a yield
adjustment. Loan fees representing adjustments of yield are generally deferred
and amortized into interest income over the term of the loan using the interest
method. Loan commitment fees are generally deferred and amortized into
noninterest income on a straight-line basis over the commitment period. Loan
fees not representing adjustments of yield are also included in noninterest
income.
Mortgage Servicing and Transfers of Financial Assets. The Bank regularly sells
loans to others on a non-recourse basis. Sold loans are not included in the
accompanying consolidated balance sheets. The Bank generally retains the right
to service the loans as well as the right to receive a portion of the interest
income on the loans. At December 31, 2004 and 2003, the Bank was servicing loans
for the benefit of others with aggregate unpaid principal balances of $131.3 and
$147.0 million, respectively. Many of the loans sold by the Bank are commercial
lines of credit for which balances and related payment streams cannot be
reasonably estimated in order to determine the fair value of the servicing
assets or liabilities and/or future interest income retained by the Bank. Upon
sale, any unearned net loan fees or costs are recognized in noninterest income.
Premises and Equipment. Land is carried at cost. Premises and equipment are
reported at cost less accumulated depreciation and amortization. Depreciation
and amortization for financial reporting purposes is charged to operating
expense using the straight-line method over the estimated useful lives of the
assets. Estimated useful lives are up to 40 years for buildings and three to 10
years for furniture and equipment. Leasehold improvements are amortized over the
shorter of the lease term or the estimated useful life of the improvement. The
costs of improvements are capitalized. Maintenance and repairs, as well as gains
and losses on dispositions of premises and equipment, are included in
noninterest income or expense as incurred.
Other Real Estate Owned and Repossessed Property. Real estate properties and
other assets acquired through, or in lieu of, loan foreclosure are included in
other assets in the balance sheets, and are stated at the lower of carrying
amount or fair value less estimated costs to sell, at the date of transfer to
other real estate owned or repossessed property. When an asset is acquired, the
excess of the recorded investment in the asset over fair value less estimated
costs to sell, if any, is charged to the allowance for credit losses. Management
performs valuations periodically. Fair value is generally determined based upon
appraisals of the assets involved. Subsequent declines in the estimated fair
value, net operating results and gains and losses on disposition of the asset
are included in other noninterest expense. The Bank had no outstanding other
real estate owned or repossessed property at either December 31, 2004 or
December 31, 2003.
Goodwill. Goodwill represents the aggregate excess of the cost of businesses
acquired over the fair value of their net assets at dates of acquisition.
Goodwill is not amortized, but instead is tested for impairment annually or when
impairment indicators are present. Note 9 to these consolidated financial
statements includes other disclosures related to goodwill.
Other Intangible Assets. Other intangible assets include premiums paid for
deposits assumed, insurance books of business and other miscellaneous
intangibles. Deposit premiums are being amortized over their estimated lives of
10 years using the straight-line method. Such accounting treatment is consistent
with Statement of Financial Accounting Standards No. 147, "Acquisition of
Certain Financial Institutions, an Amendment to FASB Statements No. 72 ("SFAS
72") and 144 and FASB Interpretation No. 9 ("FIN 9")" ("SFAS 147"), which became
effective on October 1, 2003. Insurance books of business intangibles are being
amortized over their estimated lives of 12.5 or 10 years for commercial lines
and 9.8 or 10 years for personal lines. Under Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), the
Company's other intangible assets with identifiable lives are amortized over
those lives and are monitored to assess recoverability and determine whether
events and circumstances require adjustment to the recorded amounts or
amortization periods. Intangible assets with indefinite lives are no longer
amortized but are tested for impairment annually or when impairment indicators
are present. Note 9 to these consolidated financial statements includes
additional information related to the Company's other intangible assets.
Impairment of Long-Lived Assets. The Company reviews long-lived assets,
including property and equipment, certain identifiable intangibles and goodwill
for impairment periodically or whenever events or changes in circumstances
indicate that the carrying amount of any such asset may not be recoverable. If
impairment is identified, the assets are written down to their fair value
through a charge to noninterest expense. No such impairment losses were recorded
during 2004, 2003 or 2002.
Securities Sold Under Agreements to Repurchase. From time to time, the Bank
enters into sales of securities under agreements to repurchase, generally for
periods of less than 90 days. Fixed coupon agreements are treated as financings,
and the obligations to repurchase securities sold are reflected as a liability
in the consolidated balance sheets. The costs of securities underlying the
agreements remain in the asset accounts.
Fair Values of Financial Instruments. The Company is required to disclose the
estimated fair value of financial instruments for which it is practicable to
estimate fair value. Fair value estimates are made at a specific point in time,
based on relevant market information and information about the financial
instruments. Fair value estimates are subjective in nature, involving
uncertainties and matters of significant judgment, and therefore cannot be
determined with precision. Changes in assumptions could significantly affect the
estimates. Non-financial instruments are excluded from fair value of financial
instrument disclosure requirements. The following methods and assumptions are
used by the Company in estimating fair value disclosures for its financial
instruments, all of which are issued or held for purposes other than trading
(see Note 19 to these consolidated financial statements):
Cash and Cash Equivalents, Noninterest-Bearing Deposits and Demand
Deposits. The carrying amounts approximate fair value due to the short
maturity of the instruments. The fair value of deposits with no stated
maturity, such as interest checking, savings and money market accounts, is
equal to the amount payable on demand at the reporting date.
Investment Securities Available for Sale. The fair value of the Company's
securities equals the quoted market price.
Federal Reserve Bank and Federal Home Loan Bank Stock. The carrying amount
of FRB and FHLB stock is their cost, which approximates fair value.
Loans held for sale. The fair value of the Company's loans held for sale is
stated as the lower of cost or market value of the loans.
Loans and Leases. Fair values for loans and leases are estimated by
discounting future cash flow payment streams using rates at which current
loans to borrowers with similar credit ratings and similar loan maturities
are being made.
Accrued Interest Receivable. The fair value of accrued interest receivable
equals the amount receivable due to the current nature of the amounts
receivable.
Derivative Financial Instruments. The fair value of the Company's
derivatives equals the quoted market price.
Interest-Bearing Deposits. Fair values of interest-bearing deposit
liabilities are estimated by discounting future cash flow payment streams
using rates at which comparable current deposits with comparable maturities
are being issued. The intangible value of long-term customer relationships
with depositors is not taken into account in the fair values disclosed.
Borrowings and Advances. The carrying amount of short-term borrowings
approximates fair value due to the short maturity and, if applicable, the
instruments' floating interest rates, which are tied to market conditions.
The fair values of long-term borrowings, for which the maturity extends
beyond one year, are estimated by discounting future cash flow payment
streams using rates at which comparable borrowings are currently being
offered.
Accrued Interest Payable. The fair value of accrued interest payable equals
the amount payable due to the current nature of the amounts payable.
Guaranteed Preferred Beneficial Interests in Company's Subordinated
Debentures. The fair values of the Company's subordinated debentures are
estimated by discounting future cash flow payment streams using discount
rates estimated to reflect those at which comparable instruments could
currently be offered.
Financial Instruments with Off-Balance-Sheet Risk. The fair values of the
Company's commitments to extend credit and commercial and standby letters
of credit are estimated using fees currently charged to enter into similar
agreements.
Derivative Financial Instruments. Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"), as amended, requires that all derivative instruments, as defined,
including certain derivative instruments embedded in other financial instruments
or contracts, be recognized in the consolidated balance sheets as either assets
or liabilities measured at fair value. The fair value of the Company's
derivative financial instruments is determined based on quoted market prices for
comparable instruments, if available, or a valuation model that calculates the
present value of expected future cash flows. Subsequent changes in a
derivative's fair value are recognized currently in earnings unless specific
hedge accounting criteria are met.
The Company may enter into derivative financial instruments such as interest
rate swaps, caps and floors as part of managing its interest rate risk. Interest
rate swaps are used to exchange fixed and floating rate interest payment
obligations and caps and floors are used to protect the Company's balance sheet
from unfavorable movements in interest rates while allowing benefit from
favorable movements.
All derivative instruments that qualify for specific hedge accounting are
recorded at fair value and classified either as a hedge of the fair value of a
recognized asset or liability ("fair value" hedge) or as a hedge of the
variability of cash flows to be received or paid related to a recognized asset
or liability or a forecasted transaction ("cash flow" hedge). All relationships
between hedging instruments and hedged items are formally documented, including
the risk management objective and strategy for undertaking various hedge
transactions. This process includes linking all derivatives that are designated
as hedges to specific assets or liabilities on the balance sheet.
Changes in the fair value of a derivative that is highly effective and
designated as a fair value hedge and the offsetting changes in the fair value of
the hedged item are recorded in income. Changes in the fair value of a
derivative that is highly effective and designated as a cash flow hedge are
recognized in other comprehensive income until income from the cash flows of the
hedged item are recognized. The Company performs an assessment, both at the
inception of the hedge and on a quarterly basis thereafter, to determine whether
these derivatives are highly effective in offsetting changes in the value of the
hedged items. Any change in fair value resulting from hedge ineffectiveness is
immediately recorded in income.
Revenue Recognition. The Company recognizes revenue on an accrual basis for
interest and dividend income on loans, investment securities, Federal funds sold
and interest bearing due from accounts. Noninterest income is recognized when it
has been realized or is realizable and has been earned. In accordance with
existing accounting and industry standards, as well as guidance issued by the
Securities and Exchange Commission, the Company considers revenue to be realized
or realizable and earned when the following criteria have been met: persuasive
evidence of an arrangement exists (generally, there is contractual
documentation); delivery has occurred or services have been rendered; the
seller's price to the buyer is fixed or determinable; and collectibility is
reasonably assured. Additionally, there can be no outstanding contingencies that
could ultimately cause the revenue to be passed back to the payor. In the
isolated instances where these criteria have not been met, receipts are
generally placed in escrow until such time as they can be recognized as revenue.
Trust Fees. Trust fees are recorded on the accrual basis of accounting.
Earnings Per Common Share. Basic earnings per share ("EPS") excludes dilution
and is computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding during the applicable
period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity. Such potential dilutive instruments include stock
options and contingently issuable stock. Note 25 to these consolidated financial
statements includes disclosure of the Company's EPS calculations.
Comprehensive Income. Comprehensive income is defined as the change in equity
during a period from transactions and other events from non-owner sources.
Comprehensive income is the total of net income and other comprehensive income,
which for the Company, is generally comprised of unrealized gains and losses on
securities available for sale and, if applicable, unrealized gains on hedging
instruments qualifying for cash flow hedge accounting treatment pursuant to SFAS
133, as amended. The Company presents consolidated statements of comprehensive
income.
Segment Disclosures. BNCCORP segments its operations into separate business
activities, based on the nature of the products and services for each segment:
banking operations, insurance operations and brokerage, trust and financial
services operations. The amount of each segment item reported is the measure
reported to the chief operating decision maker for purposes of making decisions
about allocating resources to the segment and assessing its performance.
Adjustments and eliminations made in preparing an enterprise's general purpose
financial statements and allocation of revenues, expenses and gains or losses
are included in determining reported segment profit or loss if they are included
in the measure of the segment's profit or loss that is used by the chief
operating decision maker. Similarly, only those assets that are included in the
measure of the segment's assets that is used by the chief operating decision
maker is reported for that segment. Segment disclosures are provided in Note 16
to these consolidated financial statements.
Stock-Based Compensation. At December 31, 2004, the Company had two stock-based
employee compensation plans, which are described more fully in Note 28 to these
consolidated financial statements. The Company applies the recognition and
measurement principles of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for those plans. No stock-based employee
compensation expense is reflected in net income for stock options granted under
the plans as all options granted under those plans had an exercise price equal
to the market value of the underlying common stock on the date of grant.
Compensation expense is reflected in net income for the periods presented below
for restricted stock issued under the stock plans and its net effect on net
income is reflected in the table below.
The following table illustrates the effect on net income and EPS if the Company
had applied the fair value recognition provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123") to stock-based employee compensation for the years ended December 31
(amounts in thousands):
2004 2003 2002
--------------- --------------- ----------------
Net income, as reported............................... $ 3,404 $ 3,844 $ 2,039
Add: total stock-based employee compensation expense
included in reported net income, net of related tax
effects............................................ 114 96 6
Deduct: total stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects......................... (154) (147) (40)
--------------- --------------- ----------------
Pro forma net income.................................. $ 3,364 $ 3,793 $ 2,005
=============== =============== ================
Earnings per share:
Basic - as reported................................. $ 1.18 $ 1.38 $ 0.75
Basic - pro forma................................... 1.13 1.30 0.72
Diluted - as reported............................... 1.14 1.35 0.75
Diluted - pro forma................................. 1.10 1.27 0.72
Recently Issued or Adopted Accounting Pronouncements
The following represent accounting pronouncements issued and/or adopted during
the three-year period ended December 31, 2004:
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 143, "Accounting for Asset Retirement
Obligations" ("SFAS 143"). SFAS 143 amended FASB Statement No. 19, "Financial
Accounting and Reporting by Oil and Gas Producing Companies," and applies to all
entities. The statement addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. It applies to legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development and/or the normal operation of a long-lived asset,
except for certain obligations of lessees. The Company adopted this standard on
January 1, 2003; however, adoption of this statement did not have a material
impact.
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
144"). SFAS 144 superseded FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,"
and the accounting and reporting provisions of APB Opinion No. 30, "Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of a segment of a business (as previously
defined in that opinion). SFAS 144 requires that one accounting model be used
for long-lived assets to be disposed of by sale, whether previously held and
used or newly acquired, and broadens the presentation of discontinued operations
to include more disposal transactions than were included under the previous
standards. The Company adopted SFAS 144 on January 1, 2002. Under SFAS 144, the
sale of the Fargo branch of the Bank on September 30, 2002 has been presented as
a discontinued operation for financial reporting purposes.
In April 2002, the FASB issued Statement of Financial Accounting Standards No.
145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" ("SFAS 145"). SFAS 145 rescinded
FASB Statement No. 4, "Reporting Gains and Losses from Extinguishment of Debt,"
and an amendment of that Statement, FASB Statement No. 64, "Extinguishments of
Debt Made to Satisfy Sinking-Fund Requirements." SFAS 145 also rescinded FASB
Statement No. 44, "Accounting for Intangible Assets of Motor Carriers." Finally,
SFAS 145 amended FASB Statement No. 13, "Accounting for Leases," to eliminate
inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions and amended other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions. The
provisions of SFAS 145 related to the rescission of FASB Statement No. 4 were to
be applied in fiscal years beginning after May 15, 2002 (January 1, 2003 for the
Company) with any gain or loss on extinguishment of debt that was classified as
an extraordinary item in prior periods presented that did not meet the criteria
in APB Opinion 30 for classification as an extraordinary item being
reclassified. The provisions of SFAS 145 related to FASB Statement No. 13 that
relate to modifications of a capital lease that make it an operating lease
became effective for transactions occurring after May 15, 2002. The Company
adopted this standard on January 1, 2003.
In June 2002, the FASB issued Statement of Financial Accounting Standards No.
146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS
146"). SFAS 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)" ("EITF Issue 94-3"). One of the principal differences
between SFAS 146 and EITF Issue 94-3 pertains to the criteria for recognizing a
liability for exit or disposal costs. Under EITF Issue 94-3, a liability for
such costs was recognized as of the date of an entity's commitment to an exit
plan. Pursuant to SFAS 146, a liability is recorded as of the date an obligation
is incurred. SFAS 146 requires that an exit or disposal liability be initially
measured at fair value. Provisions of SFAS 146 are effective for exit or
disposal activities that are initiated after December 31, 2002. The Company
adopted SFAS 146 on January 1, 2003 with no material impact.
In October 2002, the FASB issued SFAS 147. SFAS 147 removes acquisitions of
financial institutions from the scope of both SFAS 72 and FIN 9 and requires
that those transactions be accounted for in accordance with SFAS 141 and 142.
Thus, the requirement to recognize (and subsequently amortize) any excess of the
fair value of liabilities assumed over the fair value of tangible and
identifiable intangible assets acquired as an unidentifiable intangible asset no
longer applies to acquisitions within the scope of SFAS 147. Entities with
previously recognized unidentifiable intangible assets that were still
amortizing them in accordance with SFAS 72 were required to, effective the
latter of the date of the acquisition or the full adoption of SFAS 142,
reclassify those intangible assets to goodwill and terminate amortization on
them. The Company adopted SFAS 147 on October 1, 2002 and the adoption resulted
in no reclassification or revisions to prior period financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"), which addresses the disclosures to be made
by a guarantor in its interim and annual financial statements about its
obligations under guarantees. These disclosure requirements are included in Note
21 to these consolidated financial statements. FIN 45 also requires the
recognition of a liability by a guarantor at the inception of certain
guarantees. FIN 45 requires the guarantor to recognize a liability for the
non-contingent component of the guarantee, which is the obligation to stand
ready to perform in the event that specified triggering events or conditions
occur. The initial measurement of this liability is the fair value of the
guarantee at inception. The recognition of the liability is required even if it
is not probable that payments will be required under the guarantee or if the
guarantee was issued with a premium payment or as part of a transaction with
multiple elements. The Company adopted the disclosure requirements of FIN 45 on
December 31, 2002 (see Note 21) and has applied the recognition and measurement
provisions for all guarantees entered into or modified since December 31, 2002.
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation; Transition and Disclosure"
("SFAS 148"). SFAS 148 amended SFAS 123 to provide guidance concerning
transition when an entity changes from the intrinsic value method to the fair
value method of accounting for employee stock-based compensation cost. As
amended by SFAS 148, SFAS 123 now also requires additional information to be
disclosed regarding such cost in annual financial statements and in condensed
interim statements of public companies. In general, the new transition
requirements became effective for financial statements for fiscal years ending
after December 15, 2002. Earlier application was permitted if statements for a
fiscal year ending prior to December 15, 2002 had not yet been issued as of
December 2002. Interim disclosures were required for reports containing
condensed financial statements for periods beginning after December 15, 2002.
The Company accounts for stock-based compensation using the intrinsic method
under ABP 25 and plans to continue to do so while providing the disclosures
provided for in SFAS 123. The Company adopted the annual disclosure requirements
for SFAS 148 for purposes of its December 31, 2002 consolidated financial
statements and adopted the interim disclosure requirements of SFAS 148 beginning
with its interim financial statements for the period ended March 31, 2003.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 addresses consolidation by
business enterprises of variable interest entities which have certain
characteristics by requiring that if a business enterprise has a controlling
interest in a variable interest entity (as defined by FIN 46), the assets,
liabilities and results of activities of the variable interest entity be
included in the consolidated financial statements with those of the business
enterprise. FIN 46 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. During 2003, the FASB delayed the implementation
date for these provisions until the fourth quarter of 2003. Accordingly, the
Company adopted FIN 46 during the fourth quarter of 2003. The adoption resulted
in the deconsolidation of two BNCCORP trusts that have issued subordinated
debentures (commonly referred to as "trust preferred securities") (see Note 14).
Prior periods have been reclassified to reflect the adoption of FIN 46.
In April 2003, the FASB issued Statement of Financial Accounting Standards No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" ("SFAS 149"). SFAS 149 amended Statement 133 for decisions made (1)
as part of the Derivatives Implementation Group process that effectively
required amendments to Statement 133, (2) in connection with other FASB projects
dealing with financial instruments, and (3) in connection with the
implementation issues raised in relation to the application of the definition of
a derivative, in particular, the meaning of "an initial net investment that is
smaller than would be required for other types of contracts that would be
expected to have a similar response to changes in market factors," the meaning
of "underlying," and the characteristics of a derivative that contains financing
components. SFAS 149 is generally effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships designated after June
30, 2003. The Company adopted SFAS 149 on July 1, 2003 and such adoption did not
have a material effect on its financial position or results of operations.
In May 2003, the FASB issued Statement of Financial Accounting Standards No.
150, "Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity" ("SFAS 150"). SFAS 150 establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. The statement requires that an
issuer classify a financial instrument that is within its scope as a liability
(or asset in some circumstances). Many of those instruments were previously
classified as equity. SFAS 150 became effective for financial instruments
entered into or modified after May 31, 2003, and otherwise at the beginning of
the first interim period beginning after June 15, 2003, except for mandatorily
redeemable financial instruments for nonpublic companies. The Company adopted
SFAS 150 on July 1, 2003. Adoption of the standard required classification of
BNCCORP's subordinated debentures as liabilities as compared to the previous
classification between the liability and equity section of the balance sheets.
Additionally, the standard requires that the interest expense associated with
the subordinated debentures be included in interest expense and, hence, included
in the computation of net interest income and net interest margin. Prior periods
have been reclassified to reflect the adoption of SFAS 150.
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 replaced 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 were 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 ended after December 31, 2003. Public
companies that are not small business issuers were required to adopt the
accounting requirements of FIN 46R by the end of the first reporting period that
ended after March 15, 2004. The Company has adopted the various provisions of
FIN 46R as indicated above but presently does not have any additional 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 will 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 acts 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 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 would have
to use more detailed criteria to evaluate whether to record a loss and would
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 a material 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.
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 153, "Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29
("SFAS 153"). SFAS 153 addresses the measurement of exchanges of nonmonetary
assets. It eliminates the exception from fair value measurement for nonmonetary
exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29,
"Accounting for Nonmonetary Transactions," and replaces it with an exception for
exchanges that do not have commercial substance. SFAS 153 specifies that a
nonmonetary exchange has commercial substance if the future cash flows of the
entity are expected to change significantly as a result of the exchange. The
provisions of SFAS 153 become effective for nonmonetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. Earlier application
is permitted for nonmonetary asset exchanges occurring in fiscal periods
beginning after December 2004. The provisions of SFAS 153 are to be applied
prospectively. The Company expects to adopt SFAS 153 on January 1, 2006;
however, adoption of the standard is not expected to have a material effect on
the Company's financial position or results of operations.
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"). SFAS 123R requires
that the cost resulting from all share-based payment transactions be recognized
in the financial statements. SFAS 123R establishes fair value as the measurement
objective in accounting for share-based payment arrangements and requires all
entities to apply a fair-value-based measurement method in accounting for
share-based payment transactions with employees except for equity instruments
held by employee share ownership plans. However, SFAS 123R provides certain
exceptions to the measurement method if it is not possible to reasonably
estimate the fair value of an award at the grant date. A nonpublic entity also
may choose to measure its liabilities under share-based payment arrangements at
intrinsic value. SFAS 123R also establishes fair value as the measurement
objective for transactions in which an entity requires goods or services from
nonemployees in share-based payment transactions. SFAS 123R amends Statement of
Financial Accounting Standards No. 95, "Statement of Cash Flows" to require that
excess tax benefits be reported as a financing cash inflow rather than as a
reduction of taxes paid. SFAS 123R replaces SFAS 123 and supersedes APB 25.
Additional other pronouncements are also superseded or amended by SFAS 123R.
SFAS 123R becomes effective for public entities that do not file as small
business issuers as of the beginning of the first interim or annual reporting
period that begins after June 15, 2005. Therefore, the Company will adopt the
provisions of SFAS 123R on or before July 1, 2005. Adoption of the standard will
affect results of operations to the extent that expenses associated with stock
options are required to be recognized in the financial statements under the fair
value accounting method. The disclosures included under Note 1 ("Stock-Based
Compensation"), as well as those presented in Note 28 to these consolidated
financial statements, provide an estimation of the impact on the Company's
results of operations under the revised accounting standard.
Regulatory Environment. BNCCORP and its subsidiaries are subject to regulations
of certain state and Federal agencies, including periodic examinations by those
regulatory agencies. BNCCORP and the Bank are also subject to minimum regulatory
capital requirements. At December 31, 2004, capital levels exceeded minimum
capital requirements (see Note 18 to these consolidated financial statements).
Reclassifications. Certain amounts in the financial statements for prior years
have been reclassified to conform to the current year's presentation.
2. Acquisitions and Divestitures:
The following acquisitions and divestitures transpired during the three-year
period ended December 31, 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 the 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.
On July 31, 2004, in order to increase the scope of the Company's insurance
segment 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 SFAS142. The results
of operations of the acquired assets are included in the Company's consolidated
financial statements effective August 1, 2004.
On June 30, 2004, in order to further grow the Company's insurance segment,
Milne Scali acquired certain assets and assumed certain liabilities of
Finkbeiner Insurance, Inc., a Prescott Valley, Arizona-based insurance agency,
for 26,607 shares of newly issued BNCCORP common stock (valued at $ 466,000) and
$545,000 of cash. Of the total $1.0 million purchase price, $487,000 was
allocated to the net assets acquired (including intangible assets) and the
excess of the purchase price of approximately $523,000 over the fair value of
the net assets was recorded as goodwill. Additional consideration of up to
$180,000 is payable to Finkbeiner Insurance, Inc. subject to the insurance
operation achieving certain performance targets. In accordance with purchase
method accounting requirements, such payments would increase the cost of the
transaction in future periods and are not reflected as liabilities in the
Company's current consolidated balance sheet. The goodwill, all of which is
attributable to the Company's insurance segment, will be evaluated for possible
impairment under the provisions of SFAS 142. Other acquired intangible assets
related to personal and commercial insurance lines books of business and
totaling approximately $459,300, will be amortized using a method that
approximates the anticipated useful life of the associated customer lists, which
will cover a period of 10 years. The results of operations of the acquired
assets are included in the Company's consolidated financial statements effective
July 1, 2004.
On March 31, 2004, in order to further grow the Company's insurance segment,
Milne Scali acquired certain assets and assumed certain liabilities of The
Richard Q. Perry Agency, a Salt Lake City, Utah-based insurance agency, for
22,470 shares of newly issued BNCCORP common stock (valued at $341,000). Of the
total $341,000 purchase price, $166,000 was allocated to the net assets acquired
(all intangible assets) and the excess of the purchase price of approximately
$175,000 over the fair value of the net assets was recorded as goodwill. The
goodwill, all of which is attributable to the Company's insurance segment, will
be evaluated for possible impairment under the provisions of SFAS 142. Other
acquired intangible assets related to personal and commercial insurance lines
books of business and totaling approximately $166,000 will be amortized using a
method that approximates the anticipated useful life of the associated customer
lists, which will cover a period of 10 years. The results of operations of the
acquired assets are included in the Company's consolidated financial statements
effective April 1, 2004.
On March 31, 2004, BNC Insurance, Inc., a subsidiary of the Bank, was merged
with and into Milne & Company Insurance, Inc. and the name of Milne & Company
Insurance, Inc. was changed to Milne Scali & Company, Inc.
On December 31, 2003, in order to further grow the Company's insurance segment,
Milne Scali acquired the assets and assumed certain liabilities of The Insurance
Alliance of the Southwest ("IASW"), a Tucson, Arizona-based insurance agency,
for 12,701 shares of newly issued BNCCORP common stock (valued at $227,000) and
$256,000 in cash. A subsequent payment of $156,000 in cash and 15,692 shares of
newly issued BNCCORP common stock (valued at $233,000) was made on December 31,
2004 and a similar payment is due on December 31, 2005. Of the total $1.3
million purchase price, $601,000 was allocated to the net assets acquired
(including intangible assets) and the excess purchase price of approximately
$659,000 over the fair value of the net assets was recorded as goodwill.
Additional consideration of up to $320,000 is payable to IASW, subject to the
insurance operation achieving certain performance targets. In accordance with
purchase method accounting requirements, such payments would increase the cost
of the transaction in future periods and are not reflected as liabilities in the
Company's current consolidated balance sheet. The goodwill, all of which is
attributable to the Company's insurance segment, is evaluated for possible
impairment under the provisions of SFAS 142. Other acquired intangible assets
related to personal and commercial insurance lines books of business and
totaling approximately $562,000 are amortized using a method that approximates
the anticipated useful life of the associated customer lists, which will cover a
period of 10 years. The results of operations of the acquired assets are
included in the Company's consolidated financial statements effective January 1,
2004.
On December 1, 2003, in order to further grow its mortgage banking operations,
the Bank executed an Asset Purchase and Sale Agreement (the "Purchase
Agreement") with Lynk Financial LLC of Arizona ("Lynk") and its principal owner.
Under the Purchase Agreement, the Bank, on January 5, 2004, acquired certain
assets of Lynk for 2,888 shares of newly issued BNCCORP common stock (valued at
$50,000) and $150,000 in cash. Acquisition of the mortgage operation resulted in
the recognition of goodwill due to the service nature of the business, the lack
of tangible assets acquired and the profitability of the acquired assets. Of the
total $200,000 purchase price, $5,000 was allocated to the net assets acquired
and the excess purchase price of $195,000 over the fair value of the net assets
was recorded as goodwill. The goodwill, all of which is attributable to the
Company's banking segment, is evaluated for possible impairment under the
provisions of SFAS 142. The results of operation of the mortgage banking
operation are included in the Company's consolidated financial statements
effective January 5, 2004.
On September 30, 2002, the Bank sold its Fargo, North Dakota branch largely due
to the fact that the branch did not achieve critical mass for the Bank in the
Fargo marketplace and the sale allowed the Bank to redirect assets to markets
where they can be more productively and profitably employed. Pursuant to a
definitive branch purchase and assumption agreement dated July 26, 2002, the
Bank sold the assets of the Fargo branch, including the bank building,
furniture, fixtures and equipment totaling $6.0 million and $19.5 million of
loans. The Bank also sold $31.0 million in deposits. Prior to the application of
the Bank's direct costs incurred in the sale of the branch ($56,000), the
transaction resulted in a net gain on sale of $7,000. These amounts are included
in the line item "Gain from operations of discontinued Fargo branch (including
net loss on sale of $49,000 for 2002), net of income taxes" in the consolidated
statements of income. The Fargo branch's profit or loss, for the periods
presented, is also reflected in this line item. Additionally, included in this
line item is $973,000 of net interest income for the Fargo branch for the 12
months ended December 31, 2002. The Fargo branch had previously been reported in
the banking operations segment of the Company's segment disclosures.
On April 16, 2002, in order to further grow its insurance segment, the Company
acquired 100 percent of the voting equity interests of Milne Scali, a Phoenix,
Arizona-based insurance agency, for 297,759 shares of newly issued common stock
(valued at $2.5 million) and $15.5 million in cash. To effect the transaction,
BNCCORP incurred $8.5 million in long-term debt. Of the total $18.0 million
purchase price, $7.2 million was allocated to the net assets acquired (including
intangible assets) and the excess purchase price of approximately $10.8 million
over the fair value of net assets was recorded as goodwill. As part of the
transaction, deferred tax liabilities of $2.3 million were initially recorded,
which also increased goodwill by the same amount. Subsequent to the acquisition,
the Company and Milne Scali made an Internal Revenue Code Section 338(h)(10)
election to step up the basis in the acquired assets. Upon the election,
goodwill was reduced by $1.8 million, deferred taxes were reduced by $2.3
million and a liability for the resulting income taxes in the amount of $590,000
was recorded. Subsequent to the acquisition it was determined that $155,000 of
the $590,000 of accrued income taxes would not be due. Goodwill and the
liability for income taxes were reduced by this amount. Under the Section
338(h)(10) election, all of the goodwill related to the acquisition will be
deductible for tax purposes.
Earnout payments of $2.3 and $2.6 million were made during 2003 and 2004,
respectively. During 2004, an accelerated earnout payment of $3.4 million was
also made. The payment of the accelerated earnout is the final 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. The earnout payments increased the goodwill associated
with the acquisition. The goodwill, all of which is attributable to the
Company's insurance segment, is evaluated for possible impairment under the
provisions of SFAS 142. Other acquired intangible assets related to personal and
commercial insurance lines books of business and totaling approximately $8.0
million are being amortized using a method that approximates the anticipated
useful life of the associated customer lists, which cover a period of 9.8 to
12.5 years. Milne Scali's results of operations have been included in the
Company's consolidated financial statements since the acquisition date of April
16, 2002.
The following is a condensed balance sheet indicating the amount assigned to
each major asset and liability caption of Milne Scali as of the acquisition date
(in thousands):
Assets -
Cash......................................... $ 1,536
Accounts receivable.......................... 1,305
Fixed assets................................. 412
Intangible assets, books of business......... 8,018
Goodwill..................................... 13,096
Other........................................ 104
-------------
Total assets................................... $ 24,471
=============
Liabilities -
Notes payable................................ $ 1,421
Insurance company payables................... 1,486
Deferred tax liabilities..................... 2,346
Other........................................ 1,218
-------------
Total liabilities.............................. 6,471
Stockholders' equity......................... 18,000
-------------
Total liabilities and stockholders' equity..... $ 24,471
=============
The following pro forma information has been prepared assuming that the
acquisition of Milne Scali had been consummated at the beginning of the
respective period. The pro forma financial information is not necessarily
indicative of the results of operations as they would have been had the
transaction been consummated on the assumed dates (amounts are in thousands):
12 Months Ended
December 31, 2002
------------------------
Net interest income.................... $ 14,761
Noninterest income..................... 19,553
Noninterest expense.................... 28,032
Income from continuing operations...... 2,313
Income from discontinued operations.... 14
Net income............................. 2,327
Basic earnings per common share........ $ 0.79
Diluted earnings per common share...... $ 0.79
3. Restrictions on Cash and Due From Banks:
The Bank is required to maintain reserve balances in cash on hand or with the
FRB under the Federal Reserve Act and Federal Reserve Board's Regulation D.
Required reserve balances were $25,000 and $25,000 as of December 31, 2004 and
2003, respectively.
4. Investment Securities Available For Sale:
Investment securities have been classified in the consolidated balance sheets
according to management's intent. The Company had no securities designated as
trading or held-to-maturity in its portfolio at December 31, 2004 or 2003. The
carrying amount of available-for-sale securities and their approximate fair
values were as follows as of December 31 (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------- --------------- --------------- ---------------
2004
U.S. government agency mortgage-
backed securities.................... $ 9,715 $ 167 $ (5) $ 9,877
U.S. government agency securities...... 981 55 -- 1,036
Collateralized mortgage obligations.... 189,783 190 (2,269) 187,704
State and municipal bonds.............. 33,390 2,028 (117) 35,301
Corporate debt securities.............. 1,941 57 -- 1,998
---------------- --------------- --------------- ---------------
$ 235,810 $ 2,497 $ (2,391) $ 235,916
================ =============== =============== ===============
2003
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------- ---------------- --------------- ----------------
U.S. government agency mortgage-
backed securities.................... $ 14,374 $ 389 $ (8) $ 14,755
U.S. government agency securities...... 961 122 -- 1,083
Collateralized mortgage obligations.... 210,760 1,451 (2,535) 209,676
State and municipal bonds.............. 32,909 2,264 (117) 35,056
Corporate debt securities.............. 1,939 59 -- 1,998
--------------- ---------------- --------------- ----------------
$ 260,943 $ 4,285 $ (2,660) $ 262,568
=============== ================ =============== ================
The amortized cost and estimated fair market value of available-for-sale
securities classified according to their contractual maturities at December 31,
2004, were as follows (in thousands):
Estimated
Amortized Fair
Cost Value
--------------- ---------------
Due in one year or less................... $ 981 $ 1,036
Due after one year through five years..... 1,048 1,166
Due after five years through ten years.... 43,699 43,324
Due after ten years....................... 190,082 190,390
--------------- ---------------
Total................................ $ 235,810 $ 235,916
=============== ===============
Securities carried at approximately $206.6 and $234.0 million at December 31,
2004 and 2003, respectively, were pledged as collateral for public and trust
deposits and borrowings, including borrowings with the FHLB and repurchase
agreements with customers.
Sales proceeds and gross realized gains and losses on available-for-sale
securities were as follows for the years ended December 31 (in thousands):
2004 2003 2002
---------------- ---------------- ----------------
Sales proceeds.............. $ 74,363 $ 76,652 $ 100,651
Gross realized gains........ 886 1,573 2,003
Gross realized losses....... 617 605 133
The following table shows the Company's investments' gross unrealized losses and
fair value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position at December 31,
2004 (amounts are in thousands):
Less than 12 months 12 months or more Total
------------------------ ---------------------------- ----------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Securities Value Loss Value Loss # Value Loss
----------- ------------ --------------- ------------ ------- ------------ -------------
U.S. government agency
mortgage-backed
securities................$ -- $ -- $ 805 $ (5) 3 $ 805 $ (5)
Collateralized mortgage
obligations............... 147,715 (1,489) 27,550 (780) 25 175,265 (2,269)
State and municipal bonds.. 969 (30) 1,862 (87) 7 2,831 (117)
----------- ------------ --------------- ------------ ------- ------------ -------------
Total temporarily
impaired securities.......$ 148,684 $ (1,519) $ 30,217 $ (872) 35 $ 178,901 $ (2,391)
=========== ============ =============== ============ ======= ============ =============
In reaching the conclusion that the impairments disclosed in the table above are
temporary and not other-than-temporary in nature, the Company considered the
nature of the securities, the associated guarantees and collateralization, the
securities ratings and the level of impairment of the securities. There were
three U.S. government agency mortgage-backed securities, all issued and
guaranteed by GNMA. There were 25 collateralized mortgage obligations, 24 of
which are issued and guaranteed by FNMA and FHLMC and one that is issued and
guaranteed by GNMA. The sum of the fair value of the six collateralized mortgage
obligation positions that have been in a continuous unrealized loss position for
12 months or more as of December 31, 2004 was only 2.75 percent below the sum of
their amortized cost. There were seven state and municipal bonds, all of which
are insured, AAA rated general obligation bonds. None of the impairments was due
to deterioration in credit quality that might result in the non-collection of
contractual principal and interest. The cause of the impairments is, in general,
attributable to changes in interest rates.
5. Federal Reserve Bank and Federal Home Loan Bank Stock:
The carrying amounts of FRB and FHLB stock, which approximate their fair values,
consisted of the following as of December 31 (in thousands):
2004 2003
---------------- ----------------
Federal Reserve Bank Stock, at cost..... $ 1,268 $ 1,236
Federal Home Loan Bank Stock, at cost... 6,273 6,360
---------------- ----------------
Total................................. $ 7,541 $ 7,596
================ ================
There is no contractual maturity on these investments; they represent required
regulatory investments.
6. Loans and Leases:
Composition of Loan and Lease Portfolio. The composition of the loan and lease
portfolio was as follows as of December 31 (in thousands):
2004 2003
--------------- --------------
Commercial and industrial................... $ 75,460 $ 73,001
Real estate:
Mortgage................................. 129,321 129,443
Construction............................. 68,967 60,056
Agricultural................................ 13,919 12,529
Consumer.................................... 5,091 6,188
Lease financing............................. 1,540 2,757
Other....................................... 389 89
--------------- --------------
Total.................................. 294,687 284,063
Less:
Unearned income and net unamortized
deferred fees and costs................ (873) (508)
--------------- --------------
Loans and leases, net.................... 293,814 283,555
Allowance for credit losses.............. (3,335) (4,763)
--------------- --------------
Net loans and leases............... $ 290,479 $ 278,792
=============== ==============
Geographic Location and Types of Loans. Loans were to borrowers located in the
following market areas as of December 31:
2004 2003
---------- ----------
North Dakota....................... 33% 31%
Arizona............................ 30 29
Minnesota.......................... 30 28
South Dakota....................... 4 8
Other.............................. 3 4
---------- ----------
Totals.................... 100% 100%
========== ==========
Commercial loan borrowers are generally small- and mid-sized corporations,
partnerships and sole proprietors in a wide variety of businesses. Real estate
loans are fixed or variable rate and include both amortizing and revolving
line-of-credit loans. Real estate mortgage loans include various types of loans
for which the Bank holds real property as collateral. Of the $129.3 and $129.4
million of real estate mortgages as of December 31, 2004 and 2003, respectively,
many are loans made to commercial customers where the collateral for the loan
is, among other things, the real estate occupied by the business of the
customer. Accordingly, certain loans categorized as real estate mortgage loans
could be characterized as commercial loans that are secured by real estate.
Agricultural loans include loans to grain and/or livestock producers,
agricultural real estate loans, machinery and equipment and other types of
loans. Loans to consumers are both secured and unsecured. Lease financing
represents credit to borrowers under direct finance lease obligations. The Bank
also extends financing to lease companies, securing the loan with an assignment
of lease payments and a security filing against the underlying asset of the
lease. These loans are classified as lease financing but are not direct finance
lease obligations. Single- and multi-family residential mortgage loans totaling
$11.9 and $8.3 million at December 31, 2004 and 2003, respectively, were pledged
as collateral for FHLB borrowings. Commercial loans totaling $39.3 and $43.4
million at December 31, 2004 and 2003, respectively, were pledged as collateral
for borrowings, including FHLB borrowings.
Concentrations of Credit. The Bank's credit policies emphasize diversification
of risk among industries, geographic areas and borrowers. The only
concentrations of loans exceeding 10 percent of total loans at December 31, 2004
were real estate loans, such as loans to non-residential and apartment building
operators and lessors of real property ($72.1 million) and construction loans
($37.2 million). Loans within these categories are diversified across different
types of borrowers, geographically dispersed, and secured by many different
types of real estate and other collateral.
Impaired Loans. As of December 31, the Bank's recorded investment in impaired
loans and the related valuation allowance was as follows (in thousands):
2004 2003
--------------------------------- ---------------------------------
Recorded Valuation Recorded Valuation
Investment Allowance Investment Allowance
--------------- -------------- -------------- ---------------
Impaired loans -
Valuation allowance required......... $ 3,508 $ 1,043 $ 10,996 $ 2,245
No valuation allowance required...... 39 -- -- --
--------------- -------------- -------------- ---------------
Total impaired loans............. $ 3,547 $ 1,043 $ 10,996 $ 2,245
=============== ============== ============== ===============
Impaired loans generally include loans on which management believes, based on
current information and events, it is probable that the Bank will not be able to
collect all amounts (i.e., contractual principal and interest) due in accordance
with the terms of the loan agreement and which are analyzed for a specific
reserve allowance. The Bank generally considers all loans risk-graded
substandard and doubtful, as well as nonaccrual and restructured loans, as
impaired loans.
The valuation allowance on impaired loans is included in the Bank's allowance
for credit losses.
Interest payments received on impaired loans are recorded as interest income
unless collection of the remaining recorded investment is doubtful, at which
time payments received are recorded as reductions of principal. The average
recorded investment in impaired loans, and approximate interest income
recognized for such loans, were as follows for the years ended December 31
(amounts in thousands):
2004 2003 2002
------------ ------------ ------------
Average recorded investment in impaired loans...... $ 4,991 $ 13,415 $ 13,135
============ ============ ============
Interest income recognized on impaired loans....... $ 273 $ 758 $ 658
============ ============ ============
Average recorded investment in impaired loans
as a percentage of average total loans........ 1.8% 4.4% 4.0%
============ ============ ============
Past Due, Nonaccrual and Restructured Loans. As of December 31, 2004 and 2003,
the Bank had $25,000 and $38,000, respectively, of loans past due 90 days or
more and still accruing interest. As of December 31, 2004 and 2003, the Bank had
$524,000 and $7.9 million, respectively, of nonaccrual loans and no restructured
loans (included as impaired loans above). The following table indicates the
effect on income if interest on such loans outstanding at yearend had been
recognized at original contractual rates during the year ended December 31 (in
thousands):
2004 2003 2002
------------ ----------- -------------
Interest income that would have been recorded....... $ 72 $ 121 $ 237
Interest income recorded............................ 43 56 1
------------ ----------- -------------
Effect on interest income........................... $ 29 $ 65 $ 236
============ =========== =============
As of December 31, 2004 the Bank had no commitments to lend additional funds to
borrowers with loans whose terms had been modified in troubled debt
restructurings.
Loans to Related Parties. Note 22 to these consolidated financial statements
includes information relating to loans to executive officers, directors,
principal shareholders and associates of such persons.
Leases. The Bank extends credit to borrowers under direct finance lease
obligations. The direct finance lease obligations are stated at their
outstanding principal amount net of unearned income and net unamortized deferred
fees and costs. At December 31, 2004 the total minimum annual lease payments for
direct finance lease obligations with remaining terms of greater than one year
were as follows (in thousands):
2005..................................... $ 383
2006..................................... 354
2007..................................... 166
2008..................................... --
2009..................................... --
Thereafter............................... --
----------------
Total future minimum lease payments...... 903
Unguaranteed residual values............. 340
----------------
Total all payments....................... 1,243
Unearned income.......................... (121)
----------------
Net outstanding principal amount......... $ 1,122
================
The Bank also extends financing to lease companies, securing the loan with an
assignment of lease payments and a security filing against the underlying asset
of the lease. These loans are classified above as lease financing but are not
direct finance lease obligations.
7. Allowance for Credit Losses:
Transactions in the allowance for credit losses were as follows for the years
ended December 31 (in thousands):
2004 2003 2002
------------- -------------- -------------
Balance, beginning of year......... $ 4,763 $ 5,006 $ 4,325
Provision for credit losses... 175 1,475 1,202
Loans charged off............. (1,883) (1,820) (657)
Loans recovered............... 280 102 136
------------- -------------- -------------
Balance, end of year............... $ 3,335 $ 4,763 $ 5,006
============= ============== =============
8. Premises and Equipment
Premises and equipment consisted of the following at December 31 (in thousands):
2004 2003
------------- -------------
Land and improvements............................. $ 4,913 $ 3,142
Buildings and improvements........................ 13,269 11,873
Leasehold improvements............................ 1,755 1,796
Furniture, fixtures and equipment................. 10,692 9,638
------------- -------------
Total cost....................................... 30,629 26,449
Less accumulated depreciation and amortization.... (8,830) (7,879)
------------- -------------
Net premises, leasehold improvements and
equipment....................................... $ 21,799 $ 18,570
============= =============
Depreciation and amortization expense on premises and equipment charged to
continuing operations totaled approximately $1.6, $1.5 and $1.3 million for the
years ended December 31, 2004, 2003 and 2002, respectively.
9. Goodwill and Other Intangible Assets
Goodwill, representing the excess of the purchase price over the fair value of
net assets acquired, results from purchase acquisitions made by the Company. On
January 1, 2002, the Company adopted SFAS 142. Under SFAS 142, goodwill
associated with business combinations completed after June 30, 2001 is not
required to be amortized. Effective January 1, 2002, the Company discontinued
all goodwill amortization.
Since January 1, 2002, goodwill has been assessed for impairment at the
reporting unit and qualifying subsidiary levels by applying a fair-value-based
test at least annually or if impairment indicators are present. The Company has
$257,000 of unamortized goodwill related to four separate transactions completed
prior to July 1, 2001 and $21.5 million of goodwill related to transactions
completed during 2002, 2003 and 2004. Pursuant to SFAS 142, the Company
completed its annual goodwill impairment assessment during the second quarter of
2004 and concluded that goodwill was not impaired as of June 30, 2004. No
subsequent events have occurred that would change the conclusion reached.
Core deposit intangibles are amortized based on a useful life of 10 years.
Insurance books of business intangibles are being amortized over their estimated
lives of 12.5 years for commercial lines and 9.8 years for personal lines for
the books of business acquired in the Milne Scali acquisition and 10 years for
the books of business acquired in the IASW, the Salt Lake City agency, the
Prescott Valley agency and the Denver surety business acquisitions. Certain
identifiable intangible assets that are also included in the caption "other
intangible assets" in the consolidated balance sheets are generally amortized
over a useful life of 10 years.
The gross carrying amount of intangible assets and the associated accumulated
amortization at December 31, 2004 is presented in the table below (in
thousands):
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
------------- -------------- -------------
Intangible assets:
Core deposit intangibles......... $ 3,497 $ 3,283 $ 214
Insurance books of business
intangibles..................... 9,379 1,901 7,478
Other............................ 1,138 755 383
----------- -------------- -------------
Total...................... $ 14,014 $ 5,939 $ 8,075
=========== ============== =============
Amortization expense for intangible assets was $1.3, $1.1 million and $881,000
for the years ended December 31, 2004, 2003 and 2002, respectively.
The following table shows the estimated amortization expense, for the next five
years, for amortized intangible assets existing on the Company's books at
December 31, 2004 (in thousands). Projections of amortization expense are based
on existing asset balances as of December 31, 2004. Actual amortization expense
may differ significantly depending upon changes in market conditions:
Insurance
Commercial and
Core Personal Books
Deposit of Business
Intangibles Intangibles Other Total
------------ --------------- ----------- ------------
Year ended December 31,
2005.................. $ 213 $ 801 $ 160 $ 1,174
2006.................. -- 801 112 913
2007.................. -- 801 112 913
2008.................. -- 801 -- 801
2009.................. -- 801 -- 801
The following table shows the change in goodwill, by reporting segment, between
January 1, 2004 and December 31, 2004 (in thousands):
Segment
-----------------------------------------------------------------
Banking Insurance Other Total
------------- -------------- ------------- -------------
Balance, January 1, 2004.............................. $ 212 $ 14,700 $ 177 $ 15,089
Goodwill attributable to purchase acquisitions........ 198 712 -- 910
Goodwill attributable to earnout payments............. -- 6,012 -- 6,012
Other................................................. -- (55) (177) (232)
------------- -------------- ------------- -------------
Balance, December 31, 2004............................ $ 410 $ 21,369 $ -- $ 21,779
============= ============== ============= =============
10. Deposits:
The scheduled maturities of time deposits as of December 31, 2004 are as follows
(in thousands):
2005........................ $ 128,906
2006........................ 24,690
2007........................ 4,120
2008........................ 1,378
2009........................ 1,448
Thereafter.................. 20,528
----------------
$ 181,070
================
At December 31, 2004 and 2003, the Bank had $3.8 and $12.9 million,
respectively, of time deposits that had been acquired in the national market and
$51.8 and $18.6 million, respectively, of time deposits that had been acquired
through a broker.
At December 31, 2004 collateralized mortgage obligations and state and municipal
bonds with an amortized cost of approximately $21.2 million were pledged as
collateral for certain deposits and $4.8 million of bank depository guaranty
bonds from a bankers surety company were pledged as additional collateral on
Bank deposits.
Deposits Received from Related Parties. Note 22 to these consolidated financial
statements includes information relating to deposits received from executive
officers, directors, principal shareholders and associates of such persons.
11. Short-Term Borrowings:
The following table sets forth selected information for short-term borrowings
(borrowings with an original maturity of less than one year) as of December 31
(in thousands):
2004 2003
------------- -------------
Federal funds purchased and
U. S. Treasury tax and loan
note option accounts (1)................... $ 21,314 $17,114
Repurchase agreements with customers,
renewable daily, interest payable
monthly, rates ranging from 2.00%
to 3.19%, and 1.50%, respectively,
secured by government agency
collateralized mortgage obligations (1).... 12,383 14,269
------------- -------------
$ 33,697 $31,383
============= =============
(1) The weighted average interest rate on short-term borrowings outstanding as
of December 31, 2004 and 2003 was 2.40% and 1.41%, respectively.
Customer repurchase agreements are used by the Bank to acquire funds from
customers where the customers are required or desire to have their funds
supported by collateral consisting of government, government agency or other
types of securities. The repurchase agreement is a promise to sell these
securities to a customer at a certain price and repurchase them at a future date
at that same price plus interest accrued at an agreed upon rate. The Bank uses
customer repurchase agreements in its liquidity plan as well as an accommodation
to customers. At December 31, 2004, $12.4 million of securities sold under
repurchase agreements, with a weighted average interest rate of 2.37%, maturing
in 2005, were collateralized by government agency collateralized mortgage
obligations having a carrying value of $25.3 million, a market value of $25.3
million and unamortized principal balances of $25.4 million.
As of December 31, 2004, the Bank had established three additional revolving
lines of credit with banks, totaling $17.5 million. At December 31, 2004, the
Bank had not drawn on these lines leaving $17.5 million available under these
revolving lines of credit. The lines, if drawn upon, mature daily with interest
rates that float at the Federal funds rate. 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.
12. Federal Home Loan Bank Advances:
FHLB advances consisted of the following at December 31 (amounts are in
thousands):
2004 2003
--------------------------------- ---------------------------------
Weighted Weighted
Average Average
Year of Maturity Amount Rate Amount Rate
--------------- -------------- -------------- ---------------
2004............ $ -- -- $ 15,000 4.77%
2005............ 15,000 2.30% 15,000 2.30
2006............ 20,000 2.06 20,000 2.06
2009............ 10,000 5.64 10,000 5.64
2010............ 52,200 6.09 52,200 6.09
--------------- -------------- -------------- ---------------
$ 97,200 4.63% $ 112,200 4.65%
=============== ============== ============== ===============
Some of the advances listed above have call provisions that allow the FHLB to
request that the advance be paid back or refinanced at the rates then being
offered by the FHLB. As of December 31, 2004, the Bank had $62.2 million of
callable FHLB advances all callable quarterly during the first quarter of 2005.
At December 31, 2004, the advances from the FHLB were collateralized by the
Bank's mortgage loans with unamortized principal balances of approximately $51.2
million resulting in a FHLB collateral equivalent of $31.9 million. In addition,
the advances from the FHLB were collateralized by securities with unamortized
principal balances of approximately $148.1 million. The Bank has the ability to
draw additional advances of $54.6 million based upon the mortgage loans and
securities that are currently pledged, subject to a requirement to purchase
additional FHLB stock.
13. Long-Term Borrowings:
The following table sets forth selected information for long-term borrowings
(borrowings with an original maturity of greater than one year) as of December
31 (in thousands):
2004 2003
------------ ------------
Note payable to the Bank of North Dakota,
principal and interest due each March 31,
beginning on March 31, 2005 and ending
March 31, 2019, interest payable at
30-day LIBOR plus 2.45%, secured by
the stock of BNC National Bank ............... $ 10,000 $ 8,500
Other .......................................... 79 140
------------ ------------
$ 10,079 $ 8,640
============ ============
The $10.0 million loan from the Bank of North Dakota includes various covenants
that are primarily operational rather than financial in nature. As of December
31, 2004, the Company was in compliance with these covenants.
14. Guaranteed Preferred Beneficial Interests in Company's Subordinated
Debentures:
In July 2001, BNCCORP established a special purpose trust, BNC Statutory Trust
II, for the purpose of issuing $15.0 million of floating rate trust preferred
securities. The floating rate trust preferred securities were issued at an
initial rate of 7.29 percent and adjust quarterly to a rate equal to three-month
LIBOR plus 3.58 percent. The interest rate at December 31, 2004 was 5.74
percent. Prior to July 31, 2011, the rate shall not exceed 12.5 percent. The
proceeds from the issuance, together with the proceeds of the related issuance
of $464,000 of common securities of the trust, were invested in $15.5 million of
junior subordinated deferrable interest debentures of BNCCORP. The floating rate
junior subordinated deferrable interest debentures were issued at an initial
rate of 7.29 percent and adjust quarterly to a rate equal to three-month LIBOR
plus 3.58 percent. The interest rate at December 31, 2004 was 5.74 percent.
Prior to July 31, 2011, the rate shall not exceed 12.5 percent. Concurrent with
the issuance of the preferred securities by the trust, BNCCORP fully and
unconditionally guaranteed all obligations of the special purpose trust related
to the trust preferred securities. The trust preferred securities provide
BNCCORP with a more cost-effective means of obtaining Tier 1 capital for
regulatory purposes than if BNCCORP itself were to issue preferred stock because
BNCCORP is allowed to deduct, for income tax purposes, amounts paid in respect
of the debentures and ultimately distributed to the holders of the trust
preferred securities. The sole assets of the special purpose trust are the
debentures. BNCCORP owns all of the common securities of the trust. The common
securities and debentures, along with the related income effects, are eliminated
within the consolidated financial statements. The preferred securities issued by
the trust rank senior to the common securities. For presentation in the
consolidated balance sheet, the securities are shown net of discount and direct
issuance costs.
The trust preferred securities are subject to mandatory redemption on July 31,
2031, the stated maturity date of the debentures, or upon repayment of the
debentures, or earlier, pursuant to the terms of the trust agreement. On or
after July 31, 2006, the trust preferred securities may be redeemed and the
corresponding debentures may be prepaid at the option of BNCCORP, subject to
Federal Reserve Board approval, at declining redemption prices. Prior to July
31, 2006, the securities may be redeemed at the option of BNCCORP on the
occurrence of certain events that result in a negative tax impact, negative
regulatory impact on the trust preferred securities or negative legal or
regulatory impact on the special purpose trust which would cause it to be deemed
to be an "investment company" for regulatory purposes. In addition, BNCCORP has
the right to defer payment of interest on the debentures and, therefore,
distributions on the trust preferred securities for up to five years.
In July 2000, BNCCORP established a special purpose trust, BNC Capital Trust I,
for the purpose of issuing $7.5 million of 12.045 percent trust preferred
securities. The proceeds from the issuance, together with the proceeds of the
related issuance of $232,000 of 12.045 percent common securities of the trust,
were invested in $7.7 million of 12.045 percent junior subordinated deferrable
interest debentures of BNCCORP. Concurrent with the issuance of the preferred
securities by the trust, BNCCORP fully and unconditionally guaranteed all
obligations of the special purpose trust related to the trust preferred
securities. The trust preferred securities provide BNCCORP with a more
cost-effective means of obtaining Tier 1 capital for regulatory purposes than if
BNCCORP itself were to issue preferred stock because BNCCORP is allowed to
deduct, for income tax purposes, amounts paid in respect of the debentures and
ultimately distributed to the holders of the trust preferred securities. The
sole assets of the special purpose trust are the debentures. BNCCORP owns all of
the common securities of the trust. The common securities and debentures, along
with the related income effects, are eliminated within the consolidated
financial statements. The preferred securities issued by the trust rank senior
to the common securities. For presentation in the consolidated balance sheet,
the securities are shown net of discount and direct issuance costs.
The trust preferred securities are subject to mandatory redemption on July 19,
2030, the stated maturity date of the debentures, or upon repayment of the
debentures, or earlier, pursuant to the terms of the trust agreement. On or
after July 19, 2010, the trust preferred securities may be redeemed and the
corresponding debentures may be prepaid at the option of BNCCORP, subject to
Federal Reserve Board approval, at declining redemption prices. Prior to July
19, 2010, the securities may be redeemed at the option of BNCCORP on the
occurrence of certain events that result in a negative tax impact, negative
regulatory impact on the trust preferred securities or negative legal or
regulatory impact on the special purpose trust which would cause it to be deemed
to be an "investment company" for regulatory purposes. In addition, BNCCORP has
the right to defer payment of interest on the debentures and, therefore,
distributions on the trust preferred securities for up to five years.
Pursuant to SFAS 150 and FIN 46, the subordinated debentures are presented as
debt in the consolidated financial statements. Previously they were presented
between the liabilities and equity sections of the balance sheets. Prior periods
have been reclassified to reflect the adoption of these accounting
pronouncements. The subordinated debentures qualify as Tier 1 capital for
regulatory capital purposes, up to a certain allowed amount. Any excess over the
amount allowed in Tier 1 capital can be included in Tier 2 capital, up to
certain allowed amounts. (See Note 18 for further discussion of the impact of
the subordinated debentures on the Company's consolidated regulatory capital
calculations).
15. Stockholders' Equity:
BNCCORP and the Bank are subject to certain minimum capital requirements (see
Note 18 to these consolidated financial statements). BNCCORP is also subject to
certain restrictions on the amount of dividends it may declare without prior
regulatory approval in accordance with the Federal Reserve Act. In addition,
certain regulatory restrictions exist regarding the ability of the Bank to
transfer funds to BNCCORP in the form of cash dividends. Approval of the Office
of the Comptroller of the Currency ("OCC"), the Bank's principal regulator, is
required for the Bank to pay dividends to BNCCORP in excess of the Bank's net
profits from the current year plus retained net profits for the preceding two
years. At December 31, 2004 approximately $14.1 million of retained earnings
were available for Bank dividend declaration without prior regulatory approval.
Pursuant to an asset purchase and sale agreement, on December 31, 2004, BNCCORP
issued 15,692 shares of its common stock to IASW for the second installment
related to Milne Scali's acquisition of certain assets of IASW. Note 2 to these
consolidated financial statements includes information related to the
acquisition of the assets.
On October 29, 2004, BNCCORP repurchased 25 shares of its noncumulative
preferred stock from a trust controlled by Richard W. Milne, Jr. for cash. The
repurchased shares had a preferential noncumulative dividend at an annual rate
of 8.00 percent and a preferred liquidation value of $10,000 per share.
On September 14, 2004, BNCCORP issued 150 shares of its noncumulative preferred
stock to a trust controlled by Richard W. Milne, Jr. for cash. Each share has a
preferential noncumulative dividend at an annual rate of 8.00 percent and a
preferred liquidation value of $10,000 per share. The noncumulative preferred
stock is not redeemable by BNCCORP and carries no conversion rights. The
proceeds of the issuance were used for general corporate purposes.
On June 30, 2004, BNCCORP repurchased the then-outstanding 150 shares of its
noncumulative preferred stock from trusts controlled by Richard W. Milne, Jr.
and Terrence M. Scali for cash. The repurchased shares had a preferential
noncumulative dividend at an annual rate of 8.00 percent and a preferred
liquidation value of $10,000 per share.
Pursuant to an asset purchase and sale agreement, on June 30, 2004, BNCCORP
issued 26,607 shares of its common stock to the owners of Finkbeiner Insurance,
Inc. in connection with Milne Scali's acquisition of certain assets and
assumption of certain liabilities of the insurance agency. Note 2 to these
consolidated financial statements includes additional information related to the
acquisition of the assets and the assumption of the liabilities.
Pursuant to an asset purchase and sale agreement, on March 31, 2004, BNCCORP
issued 22,470 shares of its common stock to owners of The Richard Q. Perry
Agency in connection with Milne Scali's acquisition of certain assets and
assumption of certain liabilities of the insurance agency. Note 2 to these
consolidated financial statements includes additional information related to the
acquisition of the assets and the assumption of the liabilities.
Pursuant to an asset purchase and sale agreement executed on December 1, 2003,
on January 5, 2004, BNCCORP issued 2,888 shares of its common stock to Lynk in
connection with the Bank's acquisition of certain assets of Lynk. Note 2 to
these consolidated financial statements includes additional information related
to the acquisition of the assets.
Pursuant to an asset purchase and sale agreement, on December 31, 2003, BNCCORP
issued 12,701 shares of its common stock to IASW in connection with Milne
Scali's acquisition of certain assets of IASW. Note 2 to these consolidated
financial statements includes additional information related to the acquisition
of the assets.
On May 3, 2002, BNCCORP issued 150 shares of its noncumulative preferred stock
to trusts controlled by Richard W. Milne, Jr. and Terrence M. Scali for cash.
Each share had a preferential noncumulative dividend at an annual rate of 8.00
percent and a preferred liquidation value of $10,000 per share. The
noncumulative preferred stock was not redeemable by BNCCORP and carried no
conversion rights. The proceeds of the issuance were used for general corporate
purposes.
Pursuant to a Stock Purchase Agreement (the "Agreement"), in April 2002, BNCCORP
issued 297,759 shares of its common stock to Richard W. Milne, Jr., Terrence M.
Scali, and the other sellers named in the Agreement in connection with the
Company's acquisition of Milne Scali. Note 2 to these consolidated financial
statements includes additional information related to the acquisition of Milne
Scali.
On May 30, 2001, BNCCORP's Board of Directors (the "Board") adopted a rights
plan intended to protect stockholder interests in the event BNCCORP becomes the
subject of a takeover initiative that BNCCORP's Board believes could deny
BNCCORP's stockholders the full value of their investment. This plan does not
prohibit the Board from considering any offer that it deems advantageous to its
stockholders. BNCCORP has no knowledge that anyone is considering a takeover.
The rights were issued to each common stockholder of record on May 30, 2001, and
they will be exercisable only if a person acquires, or announces a tender offer
that would result in ownership of, 15 percent or more of BNCCORP's outstanding
common stock. The rights will expire on May 30, 2011, unless redeemed or
exchanged at an earlier date.
Each right entitles the registered holder to purchase from BNCCORP one
one-hundredth of a share of Series A Participating Cumulative Preferred Stock,
$.01 par value (the "Preferred Stock"), of BNCCORP at a price of $100 per one
one-hundredth of a share, subject to adjustment. Each share of Preferred Stock
will be entitled to a minimum preferential quarterly dividend payment of $1.00
but will be entitled to an aggregate dividend of 100 times the dividend declared
per share of common stock. In the event of liquidation, the holders of the
Preferred Stock will be entitled to a minimum preferential liquidation payment
of $0.01 per share but will be entitled to an aggregate payment of 100 times the
payment made per share of common stock. Each share of Preferred Stock will have
100 votes, voting together with the common stock. Finally, in the event of any
merger, consolidation or other transaction in which common stock is exchanged,
each share of Preferred Stock will be entitled to receive 100 times the amount
received per share of common stock. Because of the nature of the Preferred
Stock's dividend, liquidation and voting rights, the value of the one
one-hundredth of a share of Preferred Stock purchasable upon exercise of each
right should approximate the value of one share of common stock.
16. Segment Disclosures:
The Company segments its operations into three separate business activities,
based on the nature of the products and services for each segment: banking
operations, insurance operations and brokerage, trust and financial services
operations.
Banking operations provide traditional banking services to individuals and
small- and mid-sized businesses, such as accepting deposits, consumer and
mortgage banking activities and making commercial loans. The mortgage and
commercial banking activities include the origination and purchase of loans as
well as the sale to and servicing of commercial loans for other institutions.
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 these
consolidated financial statements.
The Company's financial information for each segment is derived from the
internal profitability reporting system used by management to monitor and manage
the financial performance of the Company. The operating segments have been
determined by how executive management has organized the Company's business for
making operating decisions and assessing performance.
The following tables present segment profit or loss, assets and a reconciliation
of segment information as of, and for the years ended December 31 (in
thousands):
2004 2004
-----------------------------------------------------------------------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other(a) Totals Segments Other(a) Elimination Total
----------- ---------- ---------- --------- -------- ---------- -------- ------------ ------------
Net interest income..... $ 17,890 $ 46 $ 223 $ (2,169) $ 15,990 $ 18,159 $(2,169) $ 51 $ 16,041
Other revenue-external
customers.............. 8,387 18,298 1,017 88 27,790 27,702 88 (4,340) 23,450
Other revenue-from
other segments......... 697 -- 96 918 1,711 793 918 (1,711) --
Depreciation and
amortization........... 1,661 1,112 131 10 2,914 2,904 10 -- 2,914
Equity in the net
income of investees.... 1,242 -- -- 5,107 6,349 1,242 5,107 (6,349) --
Other significant
noncash items:
Provision for
credit losses........ 175 -- -- -- 175 175 -- -- 175
Segment pre-tax
profit (loss)from
continuing operations.. 4,922 2,407 (190) (2,591) 4,548 7,139 (2,591) -- 4,548
Income tax provision
(benefit).............. 1,167 940 (75) (888) 1,144 2,032 (888) -- 1,144
Segment profit (loss)... 3,755 1,467 (115) (1,703) 3,404 5,107 (1,703) -- 3,404
Segment assets.......... 653,484 33,438 16,747 77,714 781,383 703,669 77,714 (107,673) 673,710
---------------------------------
(a) The financial information in the "other" column is for the bank holding
company.
2003 2003
-----------------------------------------------------------------------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other(a) Totals Segments Other(a) Elimination Total
----------- ---------- ---------- --------- -------- ---------- -------- ------------ ------------
Net interest income..... $ 15,378 $ 69 $ - $ (2,121) $ 13,326 $ 15,447 $(2,121) $ 52 $ 13,378
Other revenue-external
customers.............. 6,189 14,712 1,457 118 22,476 22,358 118 (1,664) 20,812
Other revenue-from
other segments......... 124 -- 64 651 839 188 651 (839) --
Depreciation and
amortization........... 1,629 865 12 15 2,521 2,506 15 -- 2,521
Equity in the net
income of investees.... 2,208 -- -- 5,325 7,533 2,208 5,325 (7,533) --
Other significant
noncash items:
Provision for credit
losses............... 1,475 -- -- -- 1,475 1,475 -- -- 1,475
Segment pre-tax profit
(loss)from continuing
operations............. 3,787 3,709 372 (2,443) 5,425 7,868 (2,443) -- 5,425
Income tax provision
(benefit).............. 960 1,438 144 (961) 1,581 2,542 (961) -- 1,581
Segment profit (loss)... 2,827 2,271 228 (1,482) 3,844 5,326 (1,482) -- 3,844
Segment assets.......... 616,998 30,063 1,180 71,225 719,466 648,241 71,225 (97,989) 621,477
- ----------------------------------
(a) The financial information in the "other" column is for the bank holding
company.
2002 2002
-----------------------------------------------------------------------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other(a) Totals Segments Other(a) Elimination Total
----------- ---------- ---------- --------- -------- ---------- -------- ------------ ------------
Net interest income..... $ 15,089 $ 41 $ -- $ (3,931) $ 11,199 $ 15,130 $(3,931) $ 1,883 $ 13,082
Other revenue-external
customers............. 6,272 9,191 1,934 115 17,512 17,397 115 (1,216) 16,296
Other revenue-from
other segments......... 99 -- 55 648 802 154 648 (802) --
Depreciation and
amortization........... 1,518 633 33 17 2,201 2,184 17 -- 2,201
Equity in the net
income of investees.... 639 -- -- 3,620 4,259 639 3,620 (4,259) --
Other significant
noncash items:
Provision for
credit losses........ 1,202 -- -- -- 1,202 1,202 -- -- 1,202
Segment pre-tax
profit (loss)from
continuing operations.. 4,502 1,461 (677) (2,439) 2,847 5,286 (2,439) -- 2,847
Income tax provision
(benefit).............. 1,505 430 (255) (858) 822 1,680 (858) -- 822
Income from
discontinued Fargo
branch, net of
income taxes.......... 49 -- -- -- 49 49 -- -- 49
Loss on sale of
discontinued Fargo
branch, net of income
taxes................ (35) -- -- -- (35) (35) -- -- (35)
Segment profit (loss)... 3,011 1,031 (422) (1,581) 2,039 3,620 (1,581) -- 2,039
Segment assets.......... 599,415 26,364 1,307 66,931 694,017 627,086 66,931 (91,789) 602,228
(a) The financial information in the "other" column is for the bank holding
company.
17. Derivatives:
During May and June 2001, the Bank purchased, for $1.2 million, interest rate
cap contracts with notional amounts totaling $40.0 million to mitigate interest
rate risk in rising-rate scenarios. The referenced interest rate is three-month
LIBOR with $20.0 million of 4.50 percent contracts having three-year original
maturities (matured during May and June of 2004) and $20.0 million of 5.50
percent contracts having five-year original maturities (maturing during May and
June of 2006). The remaining $20.0 million of contracts, classified as other
assets, are reflected in the Company's December 31, 2004 consolidated balance
sheet at their then combined fair value of $1,000. The contracts are not being
accounted for as hedges under SFAS 133. As a result, the impact of marking the
contracts to fair value has been, and will continue to be, included in net
interest income. During the years ended December 31, 2004, 2003 and 2002, the
impact of marking the contracts to market (reflected as an increase in interest
expense) was $55,000, $80,000 and $779,000, respectively.
18. Regulatory Capital:
BNCCORP and the Bank are subject to various regulatory capital requirements
administered by the Federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial results. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, BNCCORP
and the Bank must meet specific capital guidelines that involve quantitative
measures of their assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. Capital amounts and
classifications of BNCCORP and the Bank are also subject to qualitative
judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by the regulations to ensure capital adequacy
require BNCCORP and the Bank to maintain minimum amounts and ratios (set forth
in the tables that follow) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as
defined) to average assets (as defined). Management believes that, as of
December 31, 2004, BNCCORP and the Bank met all capital adequacy requirements to
which they are subject.
Under current regulatory capital regulations, BNCCORP's subordinated debentures
qualify as Tier 1 capital for purposes of the consolidated capital calculations
up to 25 percent of Tier 1 capital prior to the deduction of intangible assets.
The remainder of the subordinated debentures qualify as Tier 2 capital provided
that the total of Tier 2 capital does not exceed Tier 1 capital. As of December
31, 2004, $14.6 million of the subordinated debentures qualified as Tier 1
capital with the remaining $7.9 million qualifying as Tier 2 capital. As of
December 31, 2003, $13.1 million of the subordinated debentures qualified as
Tier 1 capital with the remaining $9.3 million qualifying as Tier 2 capital.
These amounts are reflected in the consolidated capital amounts presented in the
table below.
As of December 31, 2004, the most recent notifications from the OCC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must maintain
minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set
forth in the table that follows. There are no conditions or events since that
notification that management believes have changed the institution's category.
Actual capital amounts and ratios of BNCCORP and the Bank as of December 31 are
also presented in the tables (amounts are in thousands):
To be Well Capitalized Under
For Capital Adequacy Prompt Corrective Action
Actual Purposes Provisions
------------------------ ------------------------- ------------------------------
Amount Ratio Amount Ratio Amount Ratio
------------- --------- ------------ ---------- ------------ ---------------
2004
Total Capital (to risk-weighted assets):
Consolidated......................... $ 39,770 8.85 % $ 35,940 8.0 % N/A N/A
BNC National Bank.................... 46,451 10.36 35,885 8.0 $44,856 10.0 %
Tier 1 Capital (to risk-weighted assets):
Consolidated......................... 28,520 6.35 17,970 4.0 N/A N/A
BNC National Bank.................... 43,116 9.61 17,942 4.0 26,914 6.0
Tier 1 Capital (to average assets):
Consolidated......................... 28,520 4.51 25,268 4.0 N/A N/A
BNC National Bank.................... 43,116 6.83 25,237 4.0 31,457 5.0
2003
Total Capital (to risk-weighted assets):
Consolidated......................... $ 42,905 10.63 % $ 32,296 8.0 % N/A N/A
BNC National Bank.................... 48,074 11.92 32,260 8.0 $ 40,325 10.0 %
Tier 1 Capital (to risk-weighted assets):
Consolidated......................... 28,815 7.14 16,148 4.0 N/A N/A
BNC National Bank.................... 43,311 10.74 16,130 4.0 24,195 6.0
Tier 1 Capital (to average assets):
Consolidated......................... 28,815 4.90 23,545 4.0 N/A N/A
BNC National Bank.................... 43,311 7.37 23,522 4.0 29,403 5.0
The change in capital ratios over the 12-month period ended December 31, 2004
reflected an increase in total risk-weighted assets, for the consolidated group,
from $403.7 million at December 31, 2003 to $449.2 million at December 31, 2004
and, for the bank, from $403.3 million at December 31, 2003 to $448.6 million at
December 31, 2004. The capital ratios were also impacted by 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 acquisition 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 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.
19. Fair Value of Financial Instruments:
The estimated fair values of the Company's financial instruments are as follows
as of December 31 (in thousands):
2004 2003
--------------------------------- --------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------------- --------------- ---------------- ---------------
Assets:
Cash and cash equivalents....................... $ 11,881 $ 11,881 $ 12,520 $ 12,520
Investment securities available
for sale.................................... 235,916 235,916 262,568 262,568
Federal Reserve Bank and Federal Home
Loan Bank stock............................. 7,541 7,541 7,596 7,596
Loans held for sale............................. 60,197 60,197 -- --
Loans and leases, net........................... 290,479 289,351 278,792 277,548
Accrued interest receivable..................... 2,686 2,686 2,462 2,462
Derivative financial instruments................ 1 1 56 56
---------------- --------------- ---------------- ---------------
608,701 $ 607,573 563,994 $ 562,750
=============== ===============
Other assets.................................... 65,009 57,483
---------------- ----------------
$ 673,710 $ 621,477
================ ================
Liabilities and Stockholders' Equity:
Deposits, noninterest-bearing................... $ 63,386 $ 63,386 $ 44,725 $ 44,725
Deposits, interest-bearing...................... 391,957 392,538 351,217 352,771
Borrowings and advances......................... 140,976 145,835 152,223 158,439
Accrued interest payable........................ 1,584 1,584 1,183 1,183
Guaranteed preferred beneficial interests in
Company's subordinated debentures........... 22,509 23,867 22,397 23,795
---------------- ---------------- --------------- ---------------
620,412 $ 627,210 571,745 $ 580,913
=============== ===============
Other liabilities............................... 9,452 9,546
Stockholders' equity............................ 43,846 40,186
---------------- ----------------
$ 673,710 $ 621,477
================ ================
Financial instruments with off-balance-sheet risk:
Commitments to extend credit.................. $ 442 $ 155
Standby and commercial letters of credit ..... 175 106
--------------- ---------------
$ 617 $ 261
=============== ===============
20. Financial Instruments With Off-Balance-Sheet Risk:
In the normal course of business, the Company is a party to various financial
instruments with off-balance-sheet risk, primarily to meet the needs of its
customers as well as to manage its interest rate risk. These instruments, which
are issued by the Company for purposes other than trading, carry varying degrees
of credit, interest rate or liquidity risk in excess of the amount reflected in
the consolidated balance sheets.
Commitments to Extend Credit. Commitments to extend credit are agreements to
lend to a customer provided there is no violation of any condition in the
contract. Commitments to extend credit are legally binding and generally have
fixed expiration dates or other termination clauses and may require payment of a
fee. The contractual amount represents the Bank's exposure to credit loss in the
event of default by the borrower; however, at December 31, 2004, based on
current information, no losses were anticipated as a result of these
commitments. The Bank manages this credit risk by using the same credit policies
it applies to loans. Collateral is obtained to secure commitments based on
management's credit assessment of the borrower. The collateral may include
marketable securities, receivables, inventory, equipment and real estate. Since
the Bank expects many of the commitments to expire without being drawn, total
commitment amounts do not necessarily represent the Bank's future liquidity
requirements related to such commitments.
Standby and Commercial Letters of Credit. Standby letters of credit are
conditional commitments issued by the Bank to guarantee the performance of a
customer to a third party. Commercial letters of credit are issued on behalf of
customers to ensure payment or collection in connection with trade transactions.
In the event of a customer's nonperformance, the Bank's credit loss exposure is
the same as in any extension of credit, up to the letter's contractual amount;
however, at December 31, 2004, based on current information, no losses were
anticipated as a result of these commitments. Management assesses the borrower's
credit to determine the necessary collateral, which may include marketable
securities, real estate, accounts receivable and inventory. Since the conditions
requiring the Bank to fund letters of credit may not occur, the Bank expects its
liquidity requirements related to such letters of credit to be less than the
total outstanding commitments.
The contractual amounts of these financial instruments were as follows as of
December 31 (in thousands):
2004 2003
--------------------------------- ---------------------------------
Fixed Variable Fixed Variable
Rate Rate Rate Rate
--------------- -------------- -------------- ---------------
Commitments to extend credit............... $ 9,002 $ 143,177 $ 6,547 $ 87,590
Standby and commercial letters of credit... 872 16,663 833 9,726
Interest Rate Swaps, Caps and Floors. Interest rate swaps are contracts to
exchange fixed and floating rate interest payment obligations based on a
notional principal amount. The Company enters into swaps to hedge its balance
sheet against fluctuations in interest rates. Interest rate caps and floors are
used to protect the Company's balance sheet from unfavorable movements in
interest rates while allowing benefit from favorable movements. The credit risk
related to interest rate contracts is that counterparties may be unable to meet
the contractual terms of the agreements. This risk is estimated by calculating
the present value of the cost to replace outstanding contracts in a gain
position at current market rates, reported on a net basis by counterparties. The
Company manages the credit risk of its interest rate contracts through bilateral
collateral agreements, credit approvals, limits and monitoring procedures.
Additionally, the Company reduces the assumed counterparty credit risk through
master netting agreements that permit the Company to settle interest rate
contracts with the same counterparty on a net basis.
The notional amounts of these financial instruments were as follows as of
December 31 (in thousands):
2004 2003
-------------- --------------
Interest rate caps...................... $ 20,000 $ 40,000
21. Guarantees and Contingent Consideration
As of December 31, 2004, the Company had entered into the following guarantee
arrangements:
Contingent Consideration in a Purchase Acquisition. Pursuant to the terms of the
agreement related to the IASW asset acquisition in December 2003, additional
consideration of up to $320,000 may be payable to IASW, subject to the operation
of the acquired assets achieving certain financial performance targets. In
accordance with SFAS 141, there is no current carrying amount associated with
this guarantee. Additionally, there are no recourse provisions associated with
this guarantee that would enable Milne Scali to recover from third parties any
of the amounts paid under the guarantee and there are no assets held either as
collateral or by third parties that, upon the occurrence of any triggering event
or condition under the guarantee, Milne Scali could obtain and liquidate to
recover all of a portion of the amounts paid under the guarantee.
Guaranteed Preferred Beneficial Interests in Company's Subordinated Debentures.
BNCCORP, concurrent with the issuance of preferred securities in July 2000 by
BNC Capital Trust I and in July 2001 by BNC Statutory Trust II, fully and
unconditionally guaranteed all obligations of the special purpose trusts related
to the trust preferred securities (See Note 14 for a full description of the
nature of the established trusts and the securities issued by the trusts). There
are no recourse provisions associated with these guarantees that would enable
BNCCORP to recover from third parties any of the amounts paid under the
guarantees and there are no assets held either as collateral or by third parties
that, upon the occurrence of any triggering event or condition under the
guarantees, BNCCORP could obtain and liquidate to recover all or a portion of
the amounts paid under the guarantees.
Performance Standby Letters of Credit. As of December 31, 2004 and 2003, the
Bank had outstanding $6.8 million and $641,000, respectively of performance
standby letters of credit. Performance standby letters of credit are irrevocable
obligations to the beneficiary on the part of the Bank to make payment on
account of any default by the account party in the performance of a nonfinancial
or commercial obligation. Under these arrangements, the Bank could, in the event
of the account party's nonperformance, be required to pay a maximum of the
amount of issued letters of credit. Under the agreements, the Bank has recourse
against the account party up to and including the amount of the performance
standby letter of credit. The Bank evaluates each account party's
creditworthiness on a case-by-case basis and the amount of collateral obtained
varies and is based on management's credit evaluation of the account party.
Effective January 1, 2003, such guarantees are required to be recognized as
liabilities at their fair values as they are modified or entered into, in
accordance with FIN 45.
Financial Standby Letters of Credit. As of December 31, 2004 and 2003, the Bank
had outstanding $44.5 and $43.8 million of financial standby letters of credit.
Of the $44.5 million of financial standby letters of credit outstanding at
December 31, 2004, $34.0 million was participated to other financial
institutions. Financial standby letters of credit are irrevocable obligations to
the beneficiary on the part of the Bank to repay money borrowed by or advanced
to or for the account of the account party or to make payment on account of any
indebtedness undertaken by the account party, in the event that the account
party fails to fulfill its obligation to the beneficiary. Under these
arrangements, the Bank could, in the event of the account party's
nonperformance, be required to pay a maximum of the amount of issued letters of
credit. Under the agreements, the Bank has recourse against the account party up
to and including the amount of the financial standby letter of credit. The Bank
evaluates each account party's creditworthiness on a case-by-case basis and the
amount of collateral obtained varies and is based on management's credit
evaluation of the account party. Effective January 1, 2003, such guarantees are
required to be recognized as liabilities at their fair values as they are
modified or entered into, in accordance with FIN 45.
Between January 1, 2004 and December 31, 2004, the Bank originated performance
and financial standby letters of credit totaling $200.0 million. Of that amount,
$135.7 million was participated to other financial institutions. The balance of
performance and financial standby letters of credit outstanding on the Bank's
books as of December 31, 2004 was $17.3 million. These outstanding guarantees
were recognized as liabilities on the Bank's balance sheet at their current
estimated combined fair value of approximately $84,000.
22. Related-Party/Affiliate Transactions:
The Bank has entered into transactions with related parties, such as opening
deposit accounts for and extending credit to, employees of the Company. In the
opinion of management, such transactions have been fair and reasonable to the
Bank and have been entered into under terms and conditions substantially the
same as those offered by the Bank to unrelated parties.
In the normal course of business, loans are granted to, and deposits are
received from, executive officers, directors, principal stockholders and
associates of such persons. The aggregate dollar amount of these loans,
exclusive of loans to any such persons which in the aggregate did not exceed
$60,000, were $1.3 and $1.1 million at December 31, 2004 and 2003, respectively.
During 2004, $436,000 of new loans were made and repayments totaled $246,000.
The total amount of deposits received from these parties was $3.5 and $6.5
million at December 31, 2004 and 2003, respectively. Loans to, and deposits
received from, these parties were made on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with unrelated persons and do not involve more than the
normal risk of collection.
The following additional related party transactions occurred during the
three-year period ended December 31, 2004:
On October 29, 2004, BNCCORP repurchased 25 shares of its noncumulative
preferred stock from a trust controlled by Richard W. Milne, Jr., Chairman and
President of Milne Scali. The repurchased shares had a preferential
noncumulative dividend at an annual rate of 8.00 percent and a preferred
liquidation value of $10,000 per share.
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 Milne Scali.
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 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 June 30, 2004, BNCCORP repurchased the then-outstanding 150 shares of its
noncumulative preferred stock from trusts controlled by Richard W. Milne, Jr.
and Terrence M. Scali, at the time both executive officers of the Company. The
repurchased shares had a preferential noncumulative dividend at an annual rate
of 8.00 percent and a preferred liquidation value of $10,000 per share.
On May 28, 2004, Milne Scali paid to the former stockholders of Milne Scali the
earnout then due under the earnout provisions of the Milne Scali purchase
agreement. The earnout payment of $2.6 million included payments to trusts
controlled by Richard W. Milne, Jr. and Terrence M. Scali, at the time both
executive officers of the Company.
In October 2003, BNC Insurance, Inc. ("BNC Insurance") purchased from Milne
Scali Properties LLC, an Arizona limited liability company, one share of the
class A voting redeemable common shares, $2,000 par value per share, of Mountain
View Indemnity, Ltd., a Bermuda limited liability company ("MVI"), and one share
of the non-voting redeemable preference shares, $1.00 par value per share, of
MVI for $65,000 in cash. Milne Scali Properties LLC is owned by Richard W.
Milne, Jr. and Terrence M. Scali, at the time both executive officers of the
Company. Under the by-laws of MVI, share value is established using stockholders
equity plus retained earnings divided by the number of stockholders. This
methodology was used for purposes of valuing the shares purchased by BNC
Insurance.
On May 19, 2003, Milne Scali paid to the former stockholders of Milne Scali the
earnout then due under the earnout provisions of the Milne Scali purchase
agreement. The earnout payment of $2.3 million included payments to trusts
controlled by Richard W. Milne, Jr. and Terrence M. Scali, at the time both
executive officers of the Company.
During the first quarter of 2003, the Bank purchased the Milne Scali building at
1750 East Glendale Avenue, Phoenix, Arizona. The Bank purchased the building
from Milne Scali Properties LLC. Milne Scali Properties LLC is a limited
liability company whose members are Richard W. Milne, Jr. and Terrence M. Scali,
at the time both executive officers of the Company. The purchase price for the
building was the appraised amount of $3.9 million, which was funded through cash
generated from operations. An independent party completed the appraisal.
On May 3, 2002, BNCCORP issued 150 shares of its noncumulative preferred stock
to trusts controlled by Richard W. Milne, Jr. and Terrence M. Scali, at the time
both executive officers of the Company, for cash. Each share had a preferential
noncumulative dividend at an annual rate of 8.00 percent and a preferred
liquidation value of $10,000 per share. The noncumulative preferred stock was
not redeemable by BNCCORP and carried no conversion rights.
The Federal Reserve Act limits amounts of, and requires collateral on,
extensions of credit by the Bank to BNCCORP, and with certain exceptions, its
non-bank affiliates. There are also restrictions on the amounts of investment by
the Bank in stocks and other subsidiaries of BNCCORP and such affiliates and
restrictions on the acceptance of their securities as collateral for loans by
the Bank. As of December 31, 2004, BNCCORP and its affiliates were in compliance
with these requirements.
23. Repossessed and Impaired Asset Expenses/Write-Offs:
The Bank recorded write downs to estimated net realizable value of other real
estate owned and repossessed assets, and related collection and other expenses,
of $44,000, $40,000 and $142,000 for the years ended December 31, 2004, 2003 and
2002, respectively. There were no repossessed assets recorded as of December 31,
2004.
24. Income Taxes:
The provision (benefit) for income taxes consists of the following for the years
ended December 31 (in thousands):
2004 2003 2002
----------- ------------ -----------
Continuing Operations -
Current:
Federal........................... $ 105 $ 805 $ 800
State............................. 166 241 218
Prior year state refunds
from change in filing position... -- (339) --
----------- ------------ -----------
271 707 1,018
----------- ------------ -----------
Deferred:
Federal........................... 725 726 (250)
State............................. 148 148 54
----------- ------------ -----------
873 874 (196)
----------- ------------ -----------
Total from continuing operations.. $1,144 $1,581 $ 822
=========== ============ ===========
Discontinued Operations -
Current:
Federal........................... $ -- $ -- $ 5
State............................. -- -- 1
----------- ------------ -----------
Total from discontinued
operations....................... $ -- $ -- $ 6
=========== ============ ===========
The provision for Federal income taxes expected at the statutory rate differs
from the actual provision as follows for the years ended December 31 (in
thousands):
2004 2003 2002
----------- ----------- ----------
Tax at 34% statutory rate.......... $ 1,547 $ 1,845 $ 967
Prior year state refunds
(net of Federal benefit)..... -- (229) --
State taxes (net of
Federal benefit)............. 191 266 108
Tax-exempt interest........... (501) (473) (289)
Increase in cash surrender
value of bank-owned life
insurance.................. (158) (62) --
Other, net.................... 65 234 36
----------- ----------- ----------
$ 1,144 $ 1,581 $ 822
=========== =========== ==========
Temporary differences between the financial statement carrying amounts and tax
bases of assets and liabilities that result in significant portions of the
Company's deferred tax assets and liabilities are as follows as of December 31
(in thousands):
2004 2003
----------- -----------
Deferred tax asset:
Loans, primarily due to
differences in accounting
for credit losses....................... $ 1,197 $ 1,737
Difference between book and
tax amortization of branch
premium acquisition
costs................................... 392 373
Other..................................... 678 564
----------- -----------
Deferred tax asset............... 2,267 2,674
----------- -----------
Deferred tax liability:
Unrealized gain on securities
available for sale....................... 40 605
Leases, primarily due to
differences in accounting for leases..... 439 706
Difference between book and tax
amortization of acquired intangibles.....
912 490
Premises and equipment, primarily
due to differences in original cost
basis and depreciation................ 997 677
----------- -----------
Deferred tax liability........... 2,388 2,478
----------- -----------
Valuation allowance.............. (310) (319)
----------- -----------
Net deferred tax liability....... $ (431) $ (123)
=========== ===========
The valuation allowance primarily represents the tax benefits of a certain state
net operating loss carryforward which may expire without being utilized. During
2004, the valuation allowance decreased $9,000. This decrease primarily relates
to a state net operating loss carryforward for which the Company does not
anticipate receiving a benefit in future periods.
25. Earnings Per Share:
The following table shows the amounts used in computing EPS and the effect on
weighted average number of shares of potential dilutive common stock issuances:
Net
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------- ------------- -------------
2004
Basic earnings per common share:
Income from continuing operations............. $ 3,404,000
Less: Preferred stock dividends............... (93,000)
-------------
Income attributable to common stockholders.... $ 3,311,000 2,813,531 $ 1.18
============= ============
Effect of dilutive shares -
Options and contingent stock.............. 82,710
------------
Diluted earnings per common share:
Income from continuing operations............. $ 3,404,000
Less: Preferred stock dividends............... (93,000)
-------------
Income attributable to common stockholders.... $ 3,311,000 2,896,241 $ 1.14
============= ============
Net
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------- ------------- -------------
2003
Basic earnings per common share:
Income from continuing operations............. $ 3,844,000
Less: Preferred stock dividends............... (120,000)
-------------
Income attributable to common stockholders.... $ 3,724,000 2,705,602 $ 1.38
============= =============
Effect of dilutive shares -
Options and contingent stock.............. 59,214
-------------
Diluted earnings per common share:
Income from continuing operations............. $ 3,844,000
Less: Preferred stock dividends............... (120,000)
-------------
Income attributable to common stockholders.... $ 3,724,000 2,764,816 $ 1.35
============= =============
2002
Basic earnings per common share:
Income from continuing operations............. $ 2,025,000
Less: Preferred stock dividends............... (79,000)
-------------
Income from continuing operations available
to common stockholders....................... 1,946,000 2,611,629 $ 0.74
Income from discontinued Fargo branch,
net of income taxes.......................... 14,000 2,611,629 0.01
------------- -------------
Income attributable to common stockholders.... $ 1,960,000 2,611,629 $ 0.75
============= =============
Effect of dilutive shares -
Options................................... 17,169
-------------
Diluted earnings per common share:
Income from continuing operations............. $ 2,025,000
Less: Preferred stock dividends............... (79,000)
-------------
Income from continuing operations
available to common stockholders............. 1,946,000 2,628,798 $ 0.74
Income from discontinued Fargo
branch, net of income taxes.................. 14,000 2,628,798 0.01
------------- -------------
Income attributable to common stockholders.... $ 1,960,000 2,628,798 $ 0.75
============= =============
The following options, with exercise prices ranging from $7.25 to $17.75, were
outstanding during the periods indicated but were not included in the
computation of diluted EPS because their exercise prices were higher than the
average price of the Company's common stock for the period:
2004 2003 2002
------------- -------------- --------------
Quarter ended March 31......... 3,250 77,185 97,508
Quarter ended June 30.......... 61,850 63,500 96,145
Quarter ended September 30..... 61,850 62,027 103,498
Quarter ended December 31...... 60,550 3,250 91,989
26. Benefit Plans:
BNCCORP has a qualified, tax-exempt 401(k) savings plan covering all employees
of BNCCORP and its subsidiaries who meet specified age and service requirements.
Under the BNCCORP plan, eligible employees may elect to defer up to 50 percent
of compensation each year not to exceed the dollar limit set by law. At their
discretion, BNCCORP and its subsidiaries provide matching contributions of up to
50 percent of employee deferrals up to a maximum employer contribution of five
percent of employee compensation. Generally, all participant contributions and
earnings are fully and immediately vested. The Company makes its matching
contribution during the first calendar quarter following the last day of each
calendar year and an employee must be employed by the Company on the last day of
the calendar year in order to receive the current year's employer match. The
anticipated matching contribution is expensed monthly over the course of the
calendar year based on employee contributions made throughout the year. The
Company made matching contributions of $368,000, $341,000 and $261,000 for 2004,
2003 and 2002, respectively. Under the investment options available under the
401(k) savings plan, employees may elect to invest their salary deferrals in
BNCCORP common stock. At December 31, 2004, the assets in the plan totaled $11.9
million and included $2.8 million (171,277 shares) invested in BNCCORP common
stock.
27. Commitments and Contingencies:
Employment Agreements and Noncompete Covenants. The Company has entered into
three-year employment agreements with its chairman of the board and president
and chief executive officer (the "Executives"). The Executives will be paid
minimum annual salaries throughout the terms of the agreements and annual
incentive bonuses as may, from time to time, be fixed by the Board. The
Executives will also be provided with benefits under any employee benefit plan
maintained by BNCCORP for its employees generally, or for its senior executive
officers in particular, on the same terms as are applicable to other senior
executives of BNCCORP. Under the agreements, if their status as employees with
the Company is terminated for any reason other than death, disability, cause, as
defined in the agreements, or if they terminate their employment for good
reason, as defined in the agreements, or following a change in control of
BNCCORP, as defined in the agreements, then the Executives will be paid a
lump-sum amount equal to three times their current annual compensation.
In conjunction with the April 2002 business combination with Milne Scali, the
Company has entered into a five-year employment agreement with the chairman and
president of Milne Scali (the "Insurance Executive"). The Insurance Executive
will be paid a minimum annual salary throughout the term of the agreement and
annual incentive bonuses as may, from time to time, be fixed by the Board. The
Insurance Executive will also be provided with benefits under any employment
benefit plan maintained by BNCCORP for its employees generally, or for its
senior executive officers in particular, on the same terms as are applicable to
other senior executives of BNCCORP.
In conjunction with its 1998 business combination with Lips & Lahr, Inc., ("Lips
& Lahr") BNC Insurance assumed five-year employment agreements with two officers
of Lips & Lahr (the "Officers"). The agreements, which originally provided for
salaries based upon a percentage of all net annual commissions received by Lips
& Lahr on business written by the Officers, were amended to provide for minimum
annual salaries through the remainder of the contract term, which ran through
December 31, 2000. Additionally, the agreements provide for the payment of
deferred compensation for a term of 10 years commencing on February 1, 2001 and
continuing monthly until paid in full. Finally, as separate consideration for
the release of all present and future claims to the Officers' books of business
at the end of the term of the employment contract and for other terms of the
contract involving confidentiality, nonpiracy and a restrictive covenant
covering a period of five years after the term of the agreement, the agreements
provide for 120 monthly payments also commencing on February 1, 2001. The
deferred compensation payments have been accrued for as of December 31, 2004.
Both of the Officers resigned and Milne Scali remains obligated under the
deferred compensation and non-compete provisions of the original employment
agreements.
In the business combination with Lips & Lahr, BNC Insurance assumed two
additional non-compete agreements with former officers of Lips & Lahr. Monthly
payments under these agreements, which commenced in 1996, are scheduled to
continue into 2006.
Legal Proceedings. From time to time, the Company may be a party to legal
proceedings arising out of its lending, deposit operations or other activities.
The Bank engages in foreclosure proceedings and other collection actions as part
of its loan collection activities. From time to time, borrowers may also bring
actions against the Bank, in some cases claiming damages. Some financial
services companies have been subjected to significant exposure in connection
with litigation, including class action litigation and punitive damage claims.
While the Company is not aware of any actions or allegations that should
reasonably give rise to any material adverse effect, it is possible that the
Company could be subjected to such a claim in an amount that could be material.
Based upon a review with its legal counsel, management believes that the
ultimate disposition of pending litigation will not have a material effect on
the Company's financial condition, results of operations or cash flows.
Leases. The Bank has entered into operating lease agreements for certain
facilities and equipment used in its operations. Rent expense for the years
ended December 31, 2004, 2003 and 2002, was $993,000, $1.0 and $1.2 million,
respectively, for facilities, and $157,000, $107,000 and $94,000, respectively,
for equipment and other items. At December 31, 2004, the total minimum annual
base lease payments for operating leases were as follows (amounts are in
thousands):
2005........................ $ 1,057
2006........................ 835
2007........................ 800
2008........................ 462
2009........................ 243
Thereafter.................. 276
Milne Scali is subleasing a building in Bismarck. The sublease runs for a term
of 18 months, with initial termination on December 31, 2004, renewable for five
additional two-year terms. Future minimum rentals to be received under the
sublease are $84,300 per annum, paid annually in advance by each June 1. The
Bank is also subleasing a portion of its office space in Minneapolis. The
sublease runs for a term of 12 months, with initial termination on June 30,
2004, at which time it reverted to a month-to-month lease. Rent received under
the sublease is $3,000 per month.
28. Stock-Based Compensation:
BNCCORP's 1995 Stock Incentive Plan (the "1995 Stock Plan") and its 2002 Stock
Incentive Plan (the "2002 Stock Plan," together, the "Stock Plans") are intended
to provide long-term incentives to its key employees, including officers and
directors who are employees of the Company. The 1995 Stock Plan, which is
administered by the compensation committee of the Board (the "Committee"),
provides for an authorization of 250,000 shares of common stock for issuance
thereunder. The 2002 Stock Plan, which is also administered by the Committee,
provides for an authorization of 125,000 shares of common stock for issuance
thereunder. Under the Stock Plans, the Company may grant employees incentive
stock options, nonqualified stock options, restricted stock, stock awards or any
combination thereof. The Committee establishes the exercise price of any stock
options granted under the Stock Plans provided that the exercise price may not
be less than the fair market value of a share of common stock on the date of
grant. The Committee determines vesting requirements, which may vary, and the
maximum term of options granted is generally 10 years.
As of December 31, 2004, 58,973 restricted shares issued under the 1995 Stock
Plan were outstanding. 38,723 of the shares were fully vested. The balance of
the shares vest incrementally between now and December 31, 2010. As of December
31, 2004, 33,000 restricted shares issued under the 2002 Stock Plan were
outstanding. None of the shares were vested. The shares vest incrementally
between December 31, 2005 and July 31, 2010. The Company records the
compensation expense related to restricted stock on a straight-line basis over
the applicable service period. Compensation cost charged to operations was
$153,000, $136,000 and $9,000 in 2004, 2003 and 2002, respectively. The Company
issued 43,000, 24,500 and 0 shares of restricted stock during 2004, 2003 and
2002, respectively.
The Company's Nonemployee Director Stock Option Plan (the "Directors' Plan") was
adopted during 1998, administered by the Committee and terminated during 1999.
The Company applies APB 25 and related interpretations in accounting for both
the Stock Plans and the Directors' Plan. Accordingly, no compensation cost has
been recognized for the options issued under the plans in 2004, 2003 or 2002. As
of December 31, 2004, 186,476 options had been awarded under the 1995 Stock
Plan. 47,885 of them had been exercised and 138,591 remained outstanding. As of
December 31, 2004, 35,000 options had been awarded under the 2002 Stock Plan.
All of these remained outstanding. 3,250 options awarded under the Directors'
Plan remained outstanding. Had compensation cost been determined on the basis of
fair value pursuant to SFAS 123, net income and EPS would have been reduced as
follows for the years ended December 31 (amounts in thousands):
2004 2003 2002
---------------- ----------------- ----------------
Net Income:
As Reported........ $ 3,404 $ 3,844 $ 2,039
Pro Forma.......... 3,364 3,793 2,005
Basic EPS:
As Reported........ 1.18 1.38 0.75
Pro Forma.......... 1.13 1.30 0.72
Diluted EPS:
As Reported........ 1.14 1.35 0.75
Pro Forma.......... 1.10 1.27 0.72
Following is a summary of stock option transactions for the years ended December
31:
2004 2003 2002
-------------------------- ---------------------------- ----------------------------
Options Weighted Options Weighted Options Weighted
To Average to Average to Average
Purchase Exercise Purchase Exercise Purchase Exercise
Shares Price Shares Price Shares Price
----------- ----------- ------------ ------------- ----------- -------------
Outstanding, beginning of year.... 173,285 $ 10.41 173,935 $ 10.48 208,408 $ 10.37
Granted........................... 2,000 14.00 17,500 7.00 2,500 7.51
Exercised......................... (26,044) 6.48 (11,066) 6.79 (4,000) 6.03
Forfeited......................... (5,400) 9.05 (7,084) 9.31 (32,973) 10.12
----------- ------------ -----------
Outstanding, end of year.......... 143,841 11.22 173,285 10.41 173,935 10.48
=========== ============ ===========
Exercisable, end of year.......... 105,341 12.90 110,702 12.71 92,248 12.87
=========== ============ ===========
Weighted average fair value
of options:
Granted....................... $ 7.53 $ 3.76 $ 3.35
=========== ============ ===========
Exercised..................... $ 3.13 $ 3.14 $ 2.91
=========== ============ ===========
Forfeited..................... $ 4.45 $ 4.23 $ 4.61
=========== ============ ===========
The fair value of each option granted is estimated on the grant date using the
Black-Scholes option pricing model. The following assumptions were made in
estimating fair value of options granted for the years ended December 31:
Weighted average - 2004 2003 2002
------------- -------------- -------------
Dividend yield............... 0.00% 0.00% 0.00%
Risk-free interest rate -
seven-year treasury
yield....................... 3.75% 3.66% 3.35%
Volatility................... 36.24% 36.39% 36.73%
Expected life................ 7.0 years 7.0 years 7.0 years
Following is a summary of the status of options outstanding at December 31,
2004:
Outstanding Options Exercisable Options
----------------------------------------------------------- -------------------------------
Weighted Weighted
Weighted Average Average Average
Remaining Exercise Exercise
Number Contractual Life Price Number Price
-------------- ------------------------ ------------ --------------- ------------
Options with exercise prices
ranging from:
$14.00 to $17.75 62,650 3.2 years $ 16.94 60,650 $ 17.04
$5.88 to $10.00 81,191 5.5 years 6.81 44,691 7.27
-------------- ---------------
143,841 105,341
============== ===============
29. Condensed Financial Information-Parent Company Only:
Condensed financial information of BNCCORP on a parent company only basis is as
follows:
Parent Company Only
Condensed Balance Sheets
As of December 31
(In thousands, except share data)
2004 2003
-------------- --------------
Assets:
Cash and cash equivalents.......................................... $ 2,867 $ 2,977
Investment in subsidiaries......................................... 73,579 68,300
Receivable from subsidiaries....................................... 415 259
Deferred charges and intangible assets, net........................ 154 154
Other.............................................................. 765 513
-------------- --------------
$ 77,780 $ 72,203
============== ==============
Liabilities and stockholders' equity:
Subordinated debentures............................................ $ 22,656 $ 22,570
Long term note..................................................... 10,000 8,500
Accrued expenses and other liabilities............................. 1,278 947
-------------- --------------
33,934 32,017
-------------- --------------
Preferred stock, $.01 par value - 2,000,000 shares -- --
authorized; 125 and 150 shares issued and outstanding..........
Capital surplus - preferred stock.................................. 1,250 1,500
Common stock, $.01 par value - 10,000,000 shares authorized;
2,884,876 and 2,749,196 shares issued and outstanding (excluding
43,901 and 42,880 shares held in treasury)..................... 29 28
Capital surplus - common stock..................................... 18,601 17,074
Retained earnings.................................................. 24,430 21,119
Treasury stock (43,901 and 42,880 shares).......................... (530) (513)
Accumulated other comprehensive income, net of income taxes........ 66 978
-------------- --------------
Total stockholders' equity......................................... 43,846 40,186
-------------- --------------
$ 77,780 $ 72,203
============== ==============
Parent Company Only
Condensed Statements of Income
For the Years Ended December 31
(In thousands)
2004 2003 2002
-------------- -------------- -------------
Income:
Management fee income........................................... $ 918 $ 650 $ 649
Interest........................................................ 28 36 83
Other........................................................... 88 120 114
-------------- -------------- -------------
Total income................................................ 1,034 806 846
-------------- -------------- -------------
Expenses:
Interest........................................................ 2,197 2,156 2,185
Personnel expense............................................... 626 530 521
Legal and other professional.................................... 376 216 210
Depreciation and amortization................................... 10 14 17
Other........................................................... 416 332 352
-------------- -------------- -------------
Total expenses.............................................. 3,625 3,248 3,285
-------------- -------------- -------------
Loss before income tax benefit and equity in undistributed income of (2,591) (2,442) (2,439)
subsidiaries....................................................
Income tax benefit................................................... 888 961 858
-------------- -------------- -------------
Loss before equity in undistributed income of subsidiaries........... (1,703) (1,481) (1,581)
Equity in undistributed income of subsidiaries....................... 5,107 5,325 3,606
-------------- -------------- -------------
Income from continuing operations.................................... 3,404 3,844 2,025
Equity in undistributed income from operations of discontinued branch -- -- 14
-------------- -------------- -------------
Net income.................................................. $ 3,404 $ 3,844 $ 2,039
============== ============== =============
Parent Company Only
Condensed Statements of Cash Flows
For the Years Ended December 31
(In thousands)
2004 2003 2002
-------------- -------------- --------------
Operating activities:
Net income............................................................. $ 3,404 $ 3,844 $ 2,039
Adjustments to reconcile net income to net cash used in operating
activities -
Depreciation and amortization...................................... 10 14 18
Equity in undistributed income of subsidiaries..................... (5,107) (5,325) (3,620)
Change in prepaid expenses and other receivables................... (410) 300 265
Change in accrued expenses and other liabilities................... 331 23 (123)
Other.............................................................. 1 (2) (482)
-------------- -------------- --------------
Net cash used in operating activities......................... (1,771) (1,146) (1,903)
-------------- -------------- --------------
Investing activities:
Net decrease in loans.................................................. -- -- 5
Increase in investment in subsidiaries ................................ (1,085) (181) (13,000)
Additions to premises and equipment, net............................... (8) 5 (21)
-------------- -------------- --------------
Net cash used in investing activities......................... (1,093) (176) (13,016)
-------------- -------------- --------------
Financing activities:
Proceeds from long-term borrowings..................................... 1,500 -- 8,500
Proceeds from issuance of preferred stock.............................. 1,500 -- 1,500
Repurchase of preferred stock.......................................... (1,750) -- --
Proceeds from issuance of common stock................................. 1,511 462 2,524
Amortization of discount on subordinated debentures.................... 86 86 86
Payment of preferred stock dividends................................... (93) (120) (79)
Other, net............................................................. -- -- 9
-------------- -------------- --------------
Net cash provided by financing activities..................... 2,754 428 12,540
-------------- -------------- --------------
Net decrease in cash and cash equivalents................................... (110) (894) (2,379)
Cash and cash equivalents, beginning of year................................ 2,977 3,871 6,250
-------------- -------------- --------------
Cash and cash equivalents, end of year...................................... $ 2,867 $ 2,977 $ 3,871
============== ============== ==============
Supplemental cash flow information:
Interest paid.......................................................... $ 1,871 $ 2,172 $ 2,050
============== ============== ==============
Income tax payments received from subsidiary bank(s), net of income
taxes paid......................................................... $ 512 $ 903 $ 1,563
============== ============== ==============
30. Quarterly Financial Data (unaudited, in thousands, except shares and EPS):
2004
-----------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------- -------------- ------------- -------------
Interest income........................................ $ 7,859 $ 6,954 $ 7,376 $ 7,952
Interest expense....................................... 3,489 3,379 3,518 3,714
------------- -------------- ------------- -------------
Net interest income.................................... 4,370 3,575 3,858 4,238
Provision for credit losses............................ -- -- -- 175
------------- -------------- ------------- -------------
Net interest income after provision for credit losses.. 4,370 3,575 3,858 4,063
Noninterest income..................................... 6,007 6,055 5,598 5,790
Noninterest expense.................................... 7,887 8,663 9,367 8,851
------------- -------------- ------------- -------------
Income before income taxes............................. 2,490 967 89 1,002
Income tax provision (benefit)......................... 677 261 (34) 240
------------- -------------- ------------- -------------
Net income............................................. $ 1,813 $ 706 $ 123 $ 762
============= ============== ============= =============
Dividends on preferred stock........................... $ 30 $ 30 $ 5 $ 28
------------- -------------- ------------- -------------
Net income attributable to common stockholders......... $ 1,783 $ 676 $ 118 $ 734
============= ============== ============= =============
Basic earnings per common share:
------------- -------------- ------------- -------------
Basic earnings per common share........................ $ 0.65 $ 0.24 $ 0.04 $ 0.26
============= ============== ============= =============
Diluted earnings per common share:
------------- -------------- ------------- -------------
Diluted earnings per common share...................... $ 0.63 $ 0.23 $ 0.04 $ 0.25
============= ============== ============= =============
Average common shares:
Basic.................................................. 2,757,882 2,793,045 2,839,309 2,863,065
Diluted................................................ 2,852,315 2,882,567 2,927,476 2,921,794
Unaudited - see accompanying accountant's report.
2003
-----------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------- -------------- ------------- -------------
Interest income........................................ $ 7,468 $ 7,265 $ 6,734 $ 7,179
Interest expense....................................... 4,026 3,897 3,697 3,648
------------- -------------- ------------- -------------
Net interest income.................................... 3,442 3,368 3,037 3,531
Provision for credit losses............................ 775 400 300 --
------------- -------------- ------------- -------------
Net interest income after provision for credit losses.. 2,667 2,968 2,737 3,531
Noninterest income..................................... 5,219 5,411 5,402 4,780
Noninterest expense.................................... 6,454 6,701 6,834 7,301
------------- -------------- ------------- -------------
Income before income taxes............................. 1,432 1,678 1,305 1,010
Income tax provision (benefit)......................... 415 504 389 273
------------- -------------- ------------- -------------
Net income............................................. $ 1,017 $ 1,174 $ 916 $ 737
============= ============== ============= =============
Dividends on preferred stock........................... $ 30 $ 30 $ 30 $ 30
------------- -------------- ------------- -------------
Net income attributable to common stockholders......... $ 987 $ 1,144 $ 886 $ 707
============= ============== ============= =============
Basic earnings per common share:
------------- -------------- ------------- -------------
Basic earnings per common share........................ $ 0.37 $ 0.42 $ 0.33 $ 0.26
============= ============== ============= =============
Diluted earnings per common share:
------------- -------------- ------------- -------------
Diluted earnings per common share...................... $ 0.36 $ 0.41 $ 0.32 $ 0.25
============= ============== ============= =============
Average common shares:
Basic.................................................. 2,701,274 2,703,071 2,706,323 2,711,620
Diluted................................................ 2,731,213 2,758,171 2,766,118 2,803,674
Unaudited - see accompanying accountant's report.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 9A. Controls and Procedures
Quarterly evaluation of the Company's Disclosure Controls and Internal Controls.
As of the end of the period covered by this annual report on Form 10-K, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures ("Disclosure Controls"), and our internal control over
financial reporting ("Internal Controls"). This evaluation (the "Controls
Evaluation") was done under the supervision and with the participation of
management, including our President and Chief Executive Officer ("CEO") and
Chief Financial Officer ("CFO"). Rules adopted by the SEC require that in this
section of the annual report we present the conclusions of the CEO and the CFO
about the effectiveness of our Disclosure Controls and any change in our
Internal Controls that occurred during our most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect, our Internal
Controls based on and as of the date of the Controls Evaluation.
CEO and CFO Certifications. Appearing, as Exhibits 31.1 and 31.2 to this annual
report, there are "Certifications" of the CEO and the CFO. The Certifications
are required in accordance with the Exchange Act and the SEC's implementing Rule
13a-14 (the "Rule 13a-14 Certifications"). This section of the annual report is
the information concerning the Controls Evaluation referred to in the Rule
13a-14 Certifications and this information should be read in conjunction with
the Rule 13a-14 Certifications for a more complete understanding of the topics
presented.
Disclosure Controls and Internal Controls. Disclosure controls are procedures
that are designed with the objective of ensuring that information required to be
disclosed in our reports filed under the Exchange Act, such as this annual
report, is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms. Disclosure Controls are also designed
with the objective of ensuring that material information relating to BNCCORP,
including its consolidated subsidiaries, is made known to the CEO and CFO by
others within those entities, particularly during the period in which the
applicable report is being prepared. Internal Controls are procedures which are
designed with the objective of providing reasonable assurance that (1) our
transactions are properly authorized; (2) our assets are safeguarded against
unauthorized or improper use; and (3) our transactions are properly recorded and
reported, all to permit the preparation of our financial statements in
conformity with accounting principles generally accepted in the United States.
Limitations on the Effectiveness of Controls. Our management, including the CEO
and CFO, does not expect that our Disclosure Controls or our Internal Controls
will prevent all error and all fraud. A control system, no matter how well
developed and operated, can provide only reasonable, but not absolute, assurance
that the objectives of the control system are met. Further, the design of a
control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their costs. Because of
the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions.
Over time, control may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.
Scope of the Controls Evaluation. The CEO/CFO evaluation of our Disclosure
Controls and our Internal Controls included a review of the controls' objectives
and design, our controls' implementation and the effect of the controls on the
information generated for use in this annual report. In the course of the
Controls Evaluation, we sought to identify data errors, controls problems or
acts of fraud and to confirm that appropriate corrective action, including
process improvements, were being undertaken. This type of evaluation is done on
a quarterly basis so that the conclusions concerning controls effectiveness can
be reported in our quarterly reports on Form 10-Q and annual report on Form
10-K. Our Internal Controls are also evaluated on an ongoing basis by our
internal audit and credit review departments in connection with their audit and
review activities. The overall goals of these various evaluation activities are
to monitor our Disclosure Controls and our Internal Controls and to make
modifications as necessary. Our external auditors also review Internal Controls
in connection with their audit and review activities. Our intent in this regard
is that the Disclosure Controls and Internal Controls will be maintained as
dynamic systems that change (including with improvements and corrections) as
conditions warrant.
Among other matters, we sought in our evaluation to determine whether there were
any "significant deficiencies" or "material weaknesses" in our Internal Controls
which are reasonably likely to adversely affect our ability to record, process,
summarize and report financial information, or whether we had identified any
acts of fraud, whether or not material, involving management or other employees
who have a significant role in our Internal Controls. This information was
important both for the Controls Evaluation generally and because item 5 in the
Rule 13a-14 Certifications of the CEO and CFO require that the CEO and CFO
disclose that information to our Board's audit committee and to our independent
auditors and to report on related matters in this section of the annual report.
In the professional auditing literature, "significant deficiencies" are referred
to as "reportable conditions." These are control issues that could have a
significant adverse effect on the ability to record, process, summarize and
report financial data in the financial statements. A "material weakness" is
defined in the auditing literature as a particularly serious reportable
condition where the internal control does not reduce to a relatively low level
the risk that misstatements caused by error or fraud may occur in amounts that
would be material in relation to the financial statements and not be detected
within a timely period by employees in the normal course of performing their
assigned functions. We also sought to deal with other controls matters in the
Controls Evaluation, and in each case if a problem was identified, we considered
what revision, improvement and/or correction to make in accordance with our
ongoing procedures.
Conclusions. Based upon the Controls Evaluation, our CEO and CFO have concluded
that, subject to the limitations noted above, our Disclosure Controls are
effective to ensure that material information relating to BNCCORP and its
consolidated subsidiaries is made known to management, including the CEO and
CFO, particularly during the period when our periodic reports are being
prepared, and that our Internal Controls are effective to provide reasonable
assurance that our financial statements are fairly presented in conformity with
accounting principles generally accepted in the United States. Additionally,
there has been no change in our Internal Controls that occurred during our most
recent fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our Internal Controls.
Item 9B. Other Information
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information concerning our directors and executive officers called for by this
item will be included in our definitive Proxy Statement prepared in connection
with the 2005 Annual Meeting of Stockholders and is incorporated herein by
reference.
Item 11. Executive Compensation
Information concerning the compensation of our executives called for by this
item will be included in our definitive Proxy Statement prepared in connection
with the 2005 Annual Meeting of Stockholders and is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information concerning security ownership of certain beneficial owners and
management called for by this item will be included in our definitive Proxy
Statement prepared in connection with the 2005 Annual Meeting of Stockholders
and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions called for
by this item will be included in our definitive Proxy Statement prepared in
connection with the 2005 Annual Meeting of Stockholders and is incorporated
herein by reference.
Item 14. Principal Accounting Fees and Services
Information concerning fees to, and services provided by, our independent
auditor called for by this item will be included in our definitive Proxy
Statement prepared in connection with the 2005 Annual Meeting of Stockholders
and is incorporated herein by reference.
PART IV
Item 16. Exhibits, Financial Statement Schedules
(a) Exhibits.
Reference is made to the Exhibit Index beginning on page E-1 hereby.
We will furnish to any eligible stockholder, upon written request of
such stockholder, a copy of any exhibit listed upon the payment of a
reasonable fee equal to our expenses in furnishing such exhibit.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on March 29, 2005.
BNCCORP, Inc.
By: /s/ Gregory K. Cleveland
----------------------------------------
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated.
/s/ Tracy Scott 3-15-05
- ------------------------------- ------------------
Tracy Scott Chairman of the Board and Date
Director
/s/ Gregory K. Cleveland 3-28-05
- ------------------------------- ------------------
Gregory K. Cleveland President, Chief Executive Date
Officer and Director
(Principal Executive Officer)
/s/ Brenda L. Rebel 3-29-05
- ------------------------------- ------------------
Brenda L. Rebel Chief Financial Officer Date
and Director
(Principal Financial Officer)
(Principal Accounting Officer)
/s/ Denise Forte-Pathroff, M.D. 3-16-05
- ------------------------------- ------------------
Denise Forte-Pathroff, M.D. Director Date
/s/ Gaylen Ghylin 3-22-05
- ------------------------------- ------------------
Gaylen Ghylin Director Date
/s/ John A. Hipp, M.D. 3-18-05
- ------------------------------- ------------------
John A. Hipp, M.D. Director Date
/s/ Richard M. Johnsen, Jr. 3-16-05
- ------------------------------- ------------------
Richard M. Johnsen, Jr. Director Date
/s/ Mark W. Sheffert 3-18-05
- ------------------------------- ------------------
Mark W. Sheffert Director Date
/s/ Jerry R. Woodcox 3-17-05
- ------------------------------- ------------------
Jerry R. Woodcox Director Date
EXHIBIT INDEX
Exhibit
No. Exhibit Description
- --------------------------------------------------------------------------------
3.1 Certificate of Incorporation of the Company, incorporated by
reference to Exhibit 3.1 to the Registrant's Registration Statement
on Form SB-2 (Registration No. 33-92369).
3.2 Bylaws of the Company, incorporated by reference to Exhibit 3.2 to
the Registrant's Registration Statement on Form SB-2 (Registration
No. 33-92369).
4.1 Specimen of Common Stock Certificate, incorporated by reference to
Exhibit 4 to Amendment No. 1 to the Registrant's Registration
Statement on Form SB-2 (Registration No. 33-92369).
4.2 Rights Agreement, dated as of May 30, 2001, between BNCCORP, Inc. and
American Stock Transfer and Trust Company, as Rights Agent,
incorporated by reference to Exhibit 1 to the Registrant's Form 8-A
dated June 5, 2001.
10.1 Form of Indemnity Agreement by and between the Company and each of the
Company's Directors, incorporated by reference to Exhibit 10.1 to the
Registrant's Registration Statement on Form SB-2 (Registration No.
33-92369).
10.2 Form of Employment Agreement between the Company and each of Tracy J.
Scott and Gregory K. Cleveland, incorporated by reference to Exhibit
10.2 to the Registrant's Registration Statement on Form SB-2
(Registration No. 33-92369).
10.3 Form of BNCCORP, Inc. 1995 Stock Incentive Plan, incorporated by
reference to Exhibit 10.3 to the Registrant's Registration Statement
on Form SB-2 (Registration No. 33-92369).
10.4 Form of Stock Option Agreement for the Grant of Non-Qualified Stock
Options Under the BNCCORP, Inc. 1995 Stock Incentive Plan dated as of
June 7, 1995, incorporated by reference to Exhibit 10.5 to the
Registrant's Form 10-KSB dated as of March 29, 1996.
10.5 Junior Subordinated Indenture between BNCCORP, Inc. and First Union
National Bank as Trustee dated as of July 12, 2000, incorporated by
reference to Exhibit 10.1 to the Registrant's Form 10-Q dated as of
August 2, 2000.
10.6 Guarantee Agreement between BNCCORP, Inc. as Guarantor and First Union
National Bank as Guarantee Trustee dated as of July 12, 2000 - BNC
Capital Trust I, incorporated by reference to Exhibit 10.2 to the
Registrant's Form 10-Q dated as of August 2, 2000.
10.7 Amended and Restated Trust Agreement among BNCCORP, Inc. as Depositor,
First Union National Bank as Property Trustee, First Union Trust
Company, National Association as Delaware Trustee and the
Administrative Trustees dated as of July 12, 2000 - BNC Capital Trust
I, incorporated by reference to the Registrant's Form 10-Q dated as of
August 2, 2000.
10.8 Indenture between BNCCORP, Inc., as issuer, and State Street Bank and
Trust Company of Connecticut, National Association, as Trustee,
Floating Rate Junior Subordinated Deferrable Interest Debentures Due
2031, dated July 31, 2001, incorporated by reference to Exhibit 10.1 to
the Registrant's Form 10-Q dated as of August 13, 2001.
10.9 Guarantee Agreement by and between BNCCORP, Inc. and State Street Bank
and Trust Company of Connecticut, National Association, dated July 31,
2001, incorporated by reference to Exhibit 10.2 to the Registrant's
Form 10-Q dated as of August 13, 2001.
10.10 Amended and Restated Declaration of Trust by and among State Street
Bank and Trust Company of Connecticut, National Association, as
Institutional Trustee, BNCCORP, Inc., as Sponsor, and Gregory K.
Cleveland, Tracy Scott and Brenda L. Rebel, as Administrators, dated
July 31, 2001, incorporated by reference to Exhibit 10.3 to the
Registrant's Form 10-Q dated as of August 13, 2001.
10.11 Form of BNCCORP, Inc. 2002 Stock Incentive Plan, incorporated by
reference to Appendix A to the Company's Definitive Proxy Statement
dated as of May 17, 2002.
10.12 Stock Purchase Agreement, dated March 22, 2002, by and among BNCCORP,
Inc., BNC Insurance, Inc. and the Sellers named therein, incorporated
by reference to the registrant's Form 8-K filed on May 1, 2002.
10.13 Employment and Non-competition Agreement, dated April 15, 2002, by
and between BNC Insurance, Inc., Milne & Company Insurance, Inc. and
Richard W. Milne, Jr., incorporated by reference to the registrant's
Form 8-K filed on May 1, 2002.
10.14 Branch Purchase and Assumption Agreement by and among Alerus Financial,
National Association, BNC National Bank and its parent, BNCCORP, Inc.,
dated as of July 26, 2002, incorporated by reference to the
registrant's Form 10-Q filed on November 12, 2002.
14.1 Code of Ethics and Business Conduct.
21.1 Subsidiaries of Company.
23.1 Consent of Independent Auditors.
31.1 Chief Executive Officer's Certification Under Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer's Certification Under Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification Under Section 906 of the Sarbanes-Oxley Act of 2002.