U.S. Securities and Exchange Commission
Washington, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarter ended March 31, 2005
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission File No. 0-26290
BNCCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 45-0402816
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
322 East Main
Bismarck, North Dakota 58501
(Address of principal executive office)
(701) 250-3040
(Registrant's telephone number)
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes X No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes ___ No _X_
The number of shares of the registrant's outstanding common stock on May 2,
2005 was 2,885,781.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share and per share data)
March 31, December 31,
ASSETS 2005 2004
---------------- ----------------
(unaudited)
CASH AND CASH EQUIVALENTS............................................................ $ 15,724 $ 11,881
INVESTMENT SECURITIES AVAILABLE FOR SALE............................................. 232,314 235,916
FEDERAL RESERVE BANK AND FEDERAL HOME LOAN BANK STOCK................................ 7,971 7,541
LOANS HELD FOR SALE.................................................................. 64,997 60,197
LOANS AND LEASES, net................................................................ 292,898 293,814
ALLOWANCE FOR CREDIT LOSSES.......................................................... (3,590) (3,335)
---------------- ----------------
Net loans and leases............................................................ 289,308 290,479
PREMISES AND EQUIPMENT, net.......................................................... 21,871 21,799
INTEREST RECEIVABLE.................................................................. 2,997 2,686
OTHER ASSETS......................................................................... 14,376 13,357
GOODWILL............................................................................. 21,779 21,779
OTHER INTANGIBLE ASSETS, net......................................................... 7,747 8,075
---------------- ----------------
$ 679,084 $ 673,710
================= ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
DEPOSITS:
Noninterest-bearing............................................................. $ 70,066 $ 63,386
Interest-bearing -
Savings, interest checking and money market................................. 219,783 210,887
Time deposits $100,000 and over............................................. 75,917 83,952
Other time deposits......................................................... 101,838 97,118
---------------- ----------------
Total deposits.................................................................. 467,604 455,343
SHORT-TERM BORROWINGS................................................................ 26,899 33,697
FEDERAL HOME LOAN BANK ADVANCES...................................................... 97,200 97,200
LONG-TERM BORROWINGS................................................................. 9,397 10,079
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY'S
SUBORDINATED DEBENTURES.......................................................... 22,314 22,509
OTHER LIABILITIES.................................................................... 12,149 11,036
---------------- ----------------
Total liabilities...................................................... 635,563 629,864
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value - 2,000,000 shares authorized;
100 and 125 shares issued and outstanding................................ -- --
Capital surplus - preferred stock............................................... 1,000 1,250
Common stock, $.01 par value - 10,000,000 shares authorized; 2,885,781 and
2,787,304 shares issued and outstanding (excluding
44,096 and 42,880 shares held in treasury).................................. 29 29
Capital surplus - common stock.................................................. 18,664 18,601
Retained earnings............................................................... 26,196 24,430
Treasury stock (44,096 and 42,880 shares)....................................... (533) (530)
Accumulated other comprehensive income, net of income taxes................... (1,835) 66
---------------- ----------------
Total stockholders' equity............................................. 43,521 43,846
---------------- ----------------
$ 679,084 $ 673,710
================= ===============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income
For the Three Months Ended March 31
(In thousands, except per share data)
2005 2004
------------ ------------
INTEREST INCOME: (unaudited) (unaudited)
Interest and fees on loans............................... $ 5,797 $ 4,724
Interest and dividends on investments -
Taxable................................................ 2,052 2,691
Tax-exempt............................................. 435 401
Dividends.............................................. 73 43
------------ ------------
Total interest income......................... 8,357 7,859
------------ ------------
INTEREST EXPENSE:
Deposits................................................. 2,245 1,618
Short-term borrowings.................................... 170 99
Federal Home Loan Bank advances.......................... 1,185 1,253
Long-term borrowings..................................... 123 93
Subordinated debentures.................................. 477 426
------------ ------------
Total interest expense........................ 4,200 3,489
------------ ------------
Net interest income........................... 4,157 4,370
PROVISION FOR CREDIT LOSSES................................. 250 --
------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES....... 3,907 4,370
------------ ------------
NONINTEREST INCOME:
Insurance income......................................... 5,768 4,562
Fees on loans............................................ 1,295 576
Service charges.......................................... 184 211
Trust and financial services............................. 159 124
Brokerage income......................................... 84 179
Rental income............................................ 7 35
Net gain (loss) on sales of securities................... (66) --
Other.................................................... 282 320
------------ ------------
Total noninterest income...................... 7,713 6,007
------------ ------------
NONINTEREST EXPENSE:
Salaries and employee benefits........................... 5,619 4,914
Occupancy................................................ 755 585
Professional services.................................... 446 319
Depreciation and amortization............................ 408 398
Office supplies, telephone and postage................... 361 311
Amortization of intangible assets........................ 328 308
Marketing and promotion.................................. 281 271
FDIC and other assessments............................... 55 51
Other.................................................... 958 730
------------ ------------
Total noninterest expense..................... 9,211 7,887
------------ ------------
Income before income taxes.................................. 2,409 2,490
Income tax provision........................................ 620 677
------------ ------------
Net income.................................................. 1,789 1,813
============ ============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income, continued
For the Three Months Ended March 31
(In thousands, except per share data)
2005 2004
------------ -------------
(unaudited) (unaudited)
Dividends on preferred stock.............................................. $ 23 $ 30
------------ -------------
Income available to common stockholders................................... $ 1,766 $ 1,783
============ =============
BASIC EARNINGS PER COMMON SHARE:
Basic earnings per common share........................................... $ 0.61 $ 0.65
============ =============
DILUTED EARNINGS PER COMMON SHARE:
Diluted earnings per common share......................................... $ 0.60 $ 0.63
============ =============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
For the Three Months Ended March 31
(In thousands)
2005 2004
------------- -------------
(unaudited) (unaudited)
NET INCOME.............................................. $ 1,789 $ 1,813
OTHER COMPREHENSIVE INCOME (LOSS) -
Unrealized gains (losses) on investment securities:
Unrealized holding gains (losses) arising during
the period, net of income taxes................. (1,950) 1,944
Less: reclassification adjustment for
gains/(losses) included in net income, net of
income taxes.................................... 49 --
------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS)....................... (1,901) 1,944
------------- -------------
COMPREHENSIVE INCOME (LOSS) ............................ $ (112) $ 3,757
============= =============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For the Three Months Ended March 31
(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, 2003. 150 $ -- $ 1,500 2,792,076 $ 28 $ 17,074 $ 21,119 $ (513) $ 978 $ 40,186
Net income (unaudited)... -- -- -- -- -- -- 1,813 -- -- 1,813
Other comprehensive
income -
Change in unrealized
holding gains on
securities
available for sale,
net of income taxes
and reclassification
adjustment(unaudited).. -- -- -- -- -- -- -- -- 1,944 1,944
Preferred stock
dividends (unaudited).. -- -- -- -- -- -- (30) -- -- (30)
Other (unaudited) ....... -- -- -- 38,108 -- 492 -- -- -- 492
------ ------ --------- --------- ------ -------- --------- -------- ------------- --------
BALANCE, March 31, 2004
(unaudited)............. 150 $ -- $ 1,500 2,830,184 $ 28 $ 17,566 $ 22,902 $ (513) $ 2,922 $ 44,405
====== ====== ========= ========= ====== ======== ========= ======== ============= ========
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, 2004. 125 $ -- $ 1,250 2,928,777 $ 29 $ 18,601 $ 24,430 $ (530) $ 66 $ 43,846
Net income (unaudited).... -- -- -- -- -- -- 1,789 -- -- 1,789
Other comprehensive
income -
Change in unrealized
holding gains on
securities
available for sale,
net of income taxes
and reclassification
adjustment (unaudited).. -- -- -- -- -- -- -- -- (1,901) (1,901)
Preferred stock
dividends (unaudited)... -- -- -- -- -- -- (23) -- -- (23)
Other (unaudited)......... (25) -- (250) 1,100 -- 63 -- (3) -- (190)
------ ------ --------- --------- ------ -------- --------- -------- ------------- --------
BALANCE, March 31, 2005
(unaudited)............. 100 $ -- $ 1,000 2,929,877 $ 29 $ 18,664 $ 26,196 $ (533) $ (1,835) $ 43,521
====== ====== ========= ========= ====== ======== ========= ======== ============= ========
See accompanying notes to consolidated financialstatements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Three Months Ended March 31
(In thousands)
2005 2004
-------------- --------------
OPERATING ACTIVITIES: (unaudited) (unaudited)
Net income....................................................... $ 1,789 $ 1,813
Adjustments to reconcile net income to net cash provided by (used
in) operating activities -
Provision for credit losses.................................. 250 --
Depreciation and amortization................................ 408 398
Amortization of intangible assets............................ 328 308
Net premium amortization on investment securities............ 589 587
Proceeds from loans recovered................................ 118 55
Write-down of other real estate owned and repossessed assets. 6 1
Change in interest receivable and other assets, net.......... (216) (4,466)
(Gain) loss on sale of bank premises and equipment........... 1 2
Net realized loss on sales of investment securities.......... 66 --
Deferred income taxes........................................ 63 522
Change in dividend distribution payable...................... (217) (229)
Change in other liabilities, net............................. 1,091 (305)
Originations of loans held for sale.......................... (115,535) --
Proceeds received from sale of loans held for sale........... 110,451 --
Originations paid of loans to be sold........................ (57,551) (23,080)
Proceeds received from sale of loans......................... 57,551 23,080
-------------- --------------
Net cash used in operating activities.................. (808) (1,314)
-------------- --------------
INVESTING ACTIVITIES:
Purchases of investment securities............................... (8,195) (32,269)
Proceeds from sales of investment securities..................... 1,631 --
Proceeds from maturities of investment securities................ 6,445 9,040
Purchases of Federal Reserve and Federal Home Loan Bank stock ... (1,844) (1,905)
Redemptions of Federal Reserve and Federal Home Loan Bank stock.. 1,414 1,684
Net decrease in loans............................................ 1,089 28,290
Additions to premises and equipment.............................. (481) (1,633)
Proceeds from sale of premises and equipment..................... 1 10
Stock issued for acquisition of insurance subsidiary............. -- 340
Stock issued for acquisition of mortgage company................. -- 50
-------------- --------------
Net cash provided by investing activities.............. 60 3,607
-------------- --------------
FINANCING ACTIVITIES:
Net increase (decrease) in demand, savings, interest checking and
money market accounts........................................... 2,052 (7,250)
Net increase (decrease) in time deposits......................... 10,211 13,625
Net increase (decrease) in short-term borrowings................. (6,798) 2,432
Repayments of Federal Home Loan Bank advances.................... (120,000) (85,000)
Proceeds from Federal Home Loan Bank advances.................... 120,000 85,000
Repayments of long-term borrowings............................... (682) (15)
Redemption of preferred stock.................................... (250) --
Payment of preferred stock dividends............................. (22) (30)
Amortization of discount on subordinated debentures.............. 21 21
Other, net....................................................... 59 101
-------------- --------------
Net cash provided by financing activities.............. 4,591 8,884
-------------- --------------
NET INCREASE IN CASH AND CASH EQUIVALENTS........................... 3,843 11,177
CASH AND CASH EQUIVALENTS, beginning of period...................... 11,881 12,520
-------------- --------------
CASH AND CASH EQUIVALENTS, end of period............................ $ 15,724 $ 23,697
============== ==============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid.................................................... $ 4,253 $ 3,367
============== ==============
Income taxes paid................................................ $ 61 $ 57
============== ==============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 2005
NOTE 1 - BNCCORP, Inc.
BNCCORP, Inc. ("BNCCORP") is a registered bank holding company incorporated
under the laws of Delaware. It is the parent company of BNC National Bank
(together with its wholly owned subsidiaries, Milne Scali & Company, Inc. and
BNC Asset Management, Inc., collectively the "Bank"). BNCCORP, through these
wholly owned subsidiaries, which operate from 28 locations in Arizona, Colorado,
Minnesota, North Dakota and Utah, provides a broad range of banking, insurance,
brokerage, trust and other financial services to individuals and small and
mid-sized businesses.
The accounting and reporting policies of BNCCORP and its subsidiaries
(collectively, the "Company") conform to accounting principles generally
accepted in the United States of America and general practices within the
financial services industry. The consolidated financial statements included
herein are for BNCCORP and its subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
NOTE 2 - Basis of Presentation
The accompanying interim consolidated financial statements have been prepared by
the Company, without audit, in accordance with accounting principles generally
accepted in the United States of America for interim financial information and
pursuant to the rules and regulations of the Securities and Exchange Commission
("SEC"). Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures made are
adequate to make the information presented not misleading.
The unaudited consolidated financial statements as of March 31, 2005 and for the
three-month periods ended March 31, 2005 and 2004 include, in the opinion of
management, all adjustments, consisting solely of normal recurring adjustments,
necessary for a fair presentation of the financial results for the respective
interim periods and are not necessarily indicative of results of operations to
be expected for the entire fiscal year ending December 31, 2005.
The accompanying interim consolidated financial statements have been prepared
under the presumption that users of the interim consolidated financial
information have either read or have access to the audited consolidated
financial statements for the year ended December 31, 2004. Accordingly, footnote
disclosures which would substantially duplicate the disclosures contained in the
December 31, 2004 audited consolidated financial statements have been omitted
from these interim consolidated financial statements. It is suggested that these
interim consolidated financial statements be read in conjunction with the
audited consolidated financial statements for the year ended December 31, 2004
and the notes thereto.
NOTE 3 - Reclassifications
Certain of the 2004 amounts have been reclassified to conform to the 2005
presentations. These reclassifications had no effect on net income or
stockholders' equity.
NOTE 4 - Earnings Per Share
The following table shows the amounts used in computing earnings per share
("EPS") and the effect on weighted average number of shares of potential
dilutive common stock issuances for the three-month periods ended March 31:
Net Per-Share
Income Shares Amount
---------------- ---------------- ---------------
2005
Basic earnings per common share:
Net income.................................................. $1,789,000
Less: Preferred stock dividends............................. 23,000
----------------
Income available to common stockholders..................... $1,766,000 2,885,414 $ 0.61
================ ===============
Effect of dilutive shares -
Options and contingent stock............................. 63,771
----------------
Diluted earnings per common share:
Net income.................................................. $1,789,000
Less: Preferred stock dividends............................. 23,000
----------------
Income available to common stockholders..................... $1,766,000 2,949,185 $ 0.60
================ ===============
2004
Basic earnings per common share:
Net income.................................................. $1,813,000
Less: Preferred stock dividends............................. 30,000
----------------
Income available to common stockholders..................... $1,783,000 2,757,882 $ 0.65
================ ===============
Effect of dilutive shares -
Options.................................................. 94,433
----------------
Diluted earnings per common share:
Net income.................................................. $1,813,000
Less: Preferred stock dividends............................. 30,000
----------------
Income available to common stockholders..................... $1,783,000 2,852,315 $ 0.63
================ ===============
The following number of options, with exercise prices ranging from $17.00 to
$17.75, were outstanding during the periods indicated but were not included in
the computation of diluted EPS because their exercise prices were higher than
the average price of BNCCORP's common stock for the period:
2005 2004
---------------- ---------------
Quarter ended March 31........ 60,550 3,250
NOTE 5 - Segment Disclosures
The Company segments its operations into three separate business activities,
based on the nature of the products and services for each segment: banking
operations, insurance operations and brokerage, trust and financial services
operations.
Banking operations provide traditional banking services to individuals and small
and mid-sized businesses, such as accepting deposits, consumer and mortgage
banking activities and making commercial loans. The mortgage and commercial
banking activities include the origination and purchase of loans as well as the
sale to and servicing of commercial loans for other institutions.
Insurance operations provide a full range of insurance brokerage services,
including commercial insurance, surety bonds, employee benefits-related
insurance, personal insurance and claims management to individuals and small and
mid-sized businesses.
Brokerage, trust and financial services operations provide securities brokerage,
trust and other financial services to individuals and small and mid-sized
businesses. Brokerage investment options include individual equities, fixed
income investments and mutual funds. Trust and financial services operations
provide a wide array of trust and other financial services, including personal
trust administration services, financial, tax, business and estate planning,
estate administration, agency accounts, employee benefit plan design and
administration, individual retirement accounts ("IRAs"), including custodial
self-directed IRAs, asset management, tax preparation, accounting and payroll
services.
The accounting policies of the three segments are the same as those described in
the summary of significant accounting policies included in Note 1 to the
consolidated financial statements for the year ended December 31, 2004.
The Company's financial information for each segment is derived from the
internal profitability reporting system used by management to monitor and manage
the financial performance of the Company. The operating segments have been
determined by how executive management has organized the Company's business for
making operating decisions and assessing performance.
The following tables present segment profit or loss, assets and a reconciliation
of segment information as of, and for the three months ended March 31 (in
thousands):
2005 2005
------------------------------------------------ ----------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other (a) Totals Segments Other(a) Elimination Total
------- --------- --------- --------- ------ ---------- --------- ------------ ------------
Net interest income................$ 4,639 $ 8 $ 101 $ (605) $ 4,143 $ 4,748 $ (605) $ 14 $ 4,157
Other revenue-external customers... 2,728 5,841 268 23 8,860 8,837 23 (1,177) 7,683
Other revenue-from other segments.. 220 -- 24 243 487 244 243 (487) --
Depreciation and amortization...... 416 285 32 3 736 733 3 -- 736
Equity in the net income of
investees....................... 1,056 -- -- 2,058 3,114 1,056 2,058 (3,114) --
Other significant noncash items:
Provision for credit losses...... 250 -- -- -- 250 250 -- -- 250
Segment profit (loss) from
continuing operations........... 1,311 1,776 (10) (668) 2,409 3,077 (668) -- 2,409
Income tax provision (benefit)..... 332 690 (4) (398) 620 1,018 (398) -- 620
Segment profit (loss).............. 979 1,086 (6) (270) 1,789 2,059 (270) -- 1,789
Segment assets..................... 661,344 36,068 16,267 78,491 792,170 713,679 78,491 (113,086) 679,084
2004 2004
------------------------------------------------ ----------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other (a) Totals Segments Other(a) Elimination Total
------- --------- --------- --------- ------ ---------- --------- ------------ ------------
Net interest income................$ 4,867 $ 13 $ -- $ (523) $ 4,357 $ 4,880 $ (523) $ 13 $ 4,370
Other revenue-external customers... 2,114 4,630 304 23 7,071 7,048 23 (1,064) 6,007
Other revenue-from other segments.. 150 -- 21 186 357 171 186 (357) --
Depreciation and amortization...... 403 268 32 3 706 703 3 -- 706
Equity in the net income (loss)
of investees.................... 734 -- -- 2,115 2,849 734 2,115 (2,849) --
Other significant noncash items:
Provision for credit losses...... -- -- -- -- -- -- -- -- --
Segment profit (loss) from
continuing operations........... 1,968 1,227 (87) (618) 2,490 3,108 (618) -- 2,490
Income tax provision (benefit)..... 553 475 (35) (316) 677 993 (316) -- 677
Segment profit (loss).............. 1,415 752 (52) (302) 1,813 2,115 (302) -- 1,813
Segment assets..................... 632,989 31,700 1,153 73,434 739,276 665,842 73,434 (103,583) 635,693
(a) The financial information in the "Other" column is for the bank holding
company.
NOTE 6 - Stock-Based Compensation
At March 31, 2005, the Company had two stock-based employee compensation plans.
The Company applies the recognition and measurement principles of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and
related interpretations in accounting for those plans. No stock-based employee
compensation expense is reflected in net income for stock options granted under
the plans as all options granted under those plans had an exercise price equal
to the market value of the underlying common stock on the date of grant.
Compensation expense is reflected in net income for the periods presented below
for restricted stock issued under the stock plans and its net effect on net
income is reflected in the table below.
The following table illustrates the effect on net income and EPS if the Company
had applied the fair value recognition provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" to
stock-based employee compensation for the three-month periods ended March 31:
2005 2004
---------------- ---------------
Net income, as reported................................. $ 1,789,000 $ 1,813,000
Add: total stock-based employee compensation expense
included in reported net income, net of related tax
effects.............................................. 41,000 22,000
Deduct: total stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects........................... (51,000) (32,000)
---------------- ---------------
Pro forma net income.................................... $ 1,779,000 $ 1,803,000
================ ===============
Earnings per share:
Basic - as reported................................... $ 0.61 $ 0.65
Basic - pro forma..................................... 0.59 0.61
Diluted - as reported................................. 0.60 0.63
Diluted - pro forma................................... 0.58 0.59
NOTE 7 - Derivative Activities
The Company has interest rate cap contracts with notional amounts that totaled
$20 million at March 31, 2005 and $40 million at March 31, 2004. These contracts
were purchased 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 maturities
(maturing during May and June of 2006). The total amount paid for the original
contracts was $1.2 million. The contracts are reflected in the Company's
consolidated balance sheet at their current fair value of approximately $1,000
at March 31, 2005 and $19,000 at March 31, 2004. The contracts are not being
accounted for as hedges under Statement of Financial Accounting Standards No.
133, "Accounting for Derivatives and Hedging Activities." As a result, the
impact of marking the contracts to fair value has been, and will continue to be,
included in net interest income. During the three months ended March 31, 2005
and 2004, the impact of marking the contracts to market, reflected as additional
interest expense on Federal Home Loan Bank ("FHLB") advances, was a reduction to
net interest income of $0 and approximately $37,000, respectively.
NOTE 8 - Subsequent Event
On April 27, 2005, the Company repurchased the then-outstanding 100 shares of
its noncumulative preferred stock, $0.01 par value per share, from a trust
controlled by Richard W. Milne, Jr. for cash consideration of $1,006,000.00. Mr.
Milne is Chairman, President and CEO of the Companies indirect subsidiary, Milne
Scali & Company, Inc. and a director of the Companies subsidiary, BNC National
Bank. 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 and were issued on September 14, 2004.
NOTE 9 - Recently Issued or Adopted Accounting Standards
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 adopted SOP
03-3 on January 1, 2005. The Adoption of SOP 03-3 did not have a material impact
on the Company's financial position or results of operations.
In December 2004, the financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123R ("SFAS 123R") (revised December 2004),
Share-based Payment, which established standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. This statement does not change the accounting guidance for share-based
payment transactions with parties other than employees provided in SFAS 123,
however non-employee directors are scoped into SFAS 123R. This statement
requires a public entity to measure the cost of employee services received in
exchange for an award of equity instruments based on the grant-date fair value
of the award. SFAS 123R allows the use of valuation models other than the
Black-Scholes model prescribed in SFAS 123, specifically the Binominal Lattice
method. Therefore, the pro forma costs of stock option expense estimated in Note
1 using the Black-Scholes method may not be representative of the costs
recognized by the Company upon adoption of SFAS 123R. The Company is still in
the process of analyzing the cost of stock options under SFAS 123R. On April 14,
2005, the Securities and Exchange Commission delayed the effective date for SFAS
123R, which allows companies to implement the statement at the beginning of
their first fiscal year beginning after June 15, 2005, which would be January 1,
2006 for the Company.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
For purposes of Items 2, 3 and 4 of Part I of this Form 10-Q, we refer to "we,"
"our" or the "Company" when such reference includes BNCCORP, Inc. and its
consolidated subsidiaries, collectively; "BNCCORP" when referring only to
BNCCORP, Inc.; the "Bank" when referring only to BNC National Bank; "Milne
Scali" when referring only to Milne Scali & Company, Inc.; and "BNC AMI" when
referring only to BNC Asset Management, Inc.
Comparison of Financial Condition at March 31, 2005 and December 31, 2004
Assets. Our total assets increased $5.4 million, from $673.7 million at December
31, 2004 to $679.1 million at March 31, 2005. The following table presents our
assets by category as of March 31, 2005 and December 31, 2004, as well as the
amount and percent of change between the two dates. Significant changes are
discussed in lettered explanations below the table (amounts are in thousands):
Change
----------------------------
March 31, December 31,
Assets 2005 2004 $ %
- -------------------------------------------- ---------------- ------------------ ------------ ------------
Cash and due from banks.................... $ 15,724 $ 11,867 $ 3,857 32.5% (a)
Interest-bearing deposits with banks....... -- 14 (14) (100.0)%
Investment securities available
for sale............................... 232,314 235,916 (3,602) (1.5)%
Federal Reserve Bank and Federal Home Loan
Bank Stock............................. 7,971 7,541 430 5.7%
Loans held for sale........................ 64,997 60,197 4,800 8.0%
Loans and leases, net...................... 289,308 290,479 (1,171) (0.4)%
Premises and equipment, net................ 21,871 21,799 72 0.3%
Interest receivable........................ 2,997 2,686 311 11.6%
Other assets............................... 14,376 13,357 1,019 7.6%
Goodwill................................... 21,779 21,779 -- --
Other intangible assets, net............... 7,747 8,075 (328) (4.1)%
---------------- ------------------ ------------
Total assets...................... $ 679,084 $ 673,710 $ 5,374 0.8%
================ ================== ============
(a) The increase is attributable to $5.0m of cashletter credits that were
processed on March 31, 2005
Allowance for Credit Losses. The following table sets forth information
regarding changes in our allowance for credit losses for the three-month periods
ending March 31, 2005 and 2004 (amounts are in thousands):
Three Months
Ended March 31,
------------------------------------------
2005 2004
--------------------- --------------------
Balance, beginning of period.................................... $ 3,335 $ 4,763
Provision for credit losses..................................... 250 --
Loans charged off............................................... (113) (1,273)
Loans recovered................................................. 118 55
--------------------- --------------------
Balance, end of period.......................................... $ 3,590 $ 3,545
===================== ====================
Ending loan portfolio .......................................... $ 292,898 $ 253,992
===================== ====================
Allowance for credit losses as a percentage of ending loan
portfolio....................................................... 1.23% 1.40%
As of March 31, 2005, our allowance for credit losses was 1.23 percent of total
loans as compared to 1.14 percent at December 31, 2004 and 1.40 percent at March
31, 2004.
There was a $250,000 provision for loan losses for the three-month period ended
March 31, 2005 based upon the increase of total loans as well as an increase in
criticized loans during the quarter. There was no provision for loan losses for
the same period in 2004 based on the decrease in total and non-performing loans
during that quarter.
Loans charged off during the first quarter of 2005 totaled $113,000,
representing a $1.16 million decrease over loans charged off during the first
quarter of 2004. The decrease was primarily attributable to charge-offs related
to one commercial loan in 2004.
Net charge-offs as a percentage of average total loans for the three-month
periods ended March 31, 2005 and 2004 were as follows:
Three Months
Ended March 31,
------------------------------------------
2005 2004
--------------------- --------------------
Ratio of net charge-offs to average total loans................. 0.00% (0.45)%
Ratio of net charge-offs to average total loans, annualized..... 0.00% (1.82)%
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.
Reserves for Homogeneous Loan Pools. We make a significant number of loans
and leases that, due to their underlying similar characteristics, are
assessed for loss as "homogeneous" pools. Included in the homogeneous pools
are consumer loans and commercial loans under a certain size, which have
been excluded from the specific reserve allocation, previously discussed.
We segment the pools by type of loan or lease and, using historical loss
information, estimate a loss reserve for each pool.
Qualitative Reserve. Our senior lending management also allocates reserves
for special situations, which are unique to the measurement period. These
include, among other things, prevailing and anticipated economic trends,
such as economic conditions in certain 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 our allowance for credit losses on
a timely basis. Management also considers experience of peer institutions and
regulatory guidance in addition to our own experience. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the allowance for credit losses. Such agencies may require
additions to the allowance based on their judgment about information available
to them at the time of their examination.
Loans, leases and other extensions of credit deemed uncollectible are charged to
the allowance. Subsequent recoveries, if any, are credited to the allowance. The
amount of the allowance for credit losses is highly dependent upon management's
estimates of variables affecting valuation, appraisals of collateral,
evaluations of performance and status, and the amounts and timing of future cash
flows expected to be received on impaired loans. Such estimates, appraisals,
evaluations and cash flows may be subject to frequent adjustments due to
changing economic prospects of borrowers, lessees or properties. These estimates
are reviewed periodically. Actual losses may vary from current estimates and the
amount of the provision may be either greater than or less than actual net
charge-offs. The related provision for credit losses, which is charged to
income, is the amount necessary to adjust the allowance to the level determined
appropriate through application of the above processes. Further information on
the allowance for credit losses is included under "-Critical Accounting
Policies."
Nonperforming Assets. The following table sets forth information concerning our
nonperforming assets as of the dates indicated (amounts are in thousands):
March 31, December 31,
2005 2004
------------ ------------
Nonperforming loans:
Loans 90 days or more delinquent and still
accruing interest................................ $ 20 $ 25
Nonaccrual loans.................................... 71 524
Restructured loans.................................. -- --
------------ ------------
Total nonperforming loans.............................. 91 549
Other real estate owned and repossessed assets...... -- --
------------ ------------
Total nonperforming assets............................. $ 91 $ 549
============ ============
Allowance for credit losses............................ $ 3,590 $ 3,335
============ ============
Ratio of total nonperforming assets to total assets ... 0.01% 0.08%
Ratio of total nonperforming loans to total loans...... 0.03% 0.19%
Ratio of allowance for credit losses to total
nonperforming loans................................. 3,945% 607%
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
March 31, 2005 or December 31, 2004.
Other real estate owned and repossessed assets represent properties and other
assets acquired through, or in lieu of, loan foreclosure. Such properties and
assets are included in other assets in the consolidated balance sheets. They are
initially recorded at fair value at the date of acquisition establishing a new
cost basis. Write-downs to fair value at the time of acquisition are charged to
the allowance for credit losses. After foreclosure, we perform valuations
periodically and the real estate or assets are carried at the lower of carrying
amount or fair value less cost to sell. Write-downs, revenues and expenses
incurred subsequent to foreclosure are charged to operations as
recognized/incurred. We had no other real estate owned and repossessed assets at
March 31, 2005 or December 31, 2004.
Liabilities. Our total liabilities increased $5.7 million, from $629.9 million
at December 31, 2004 to $635.6 million at March 31, 2005. The following table
presents our liabilities by category as of March 31, 2005 and December 31, 2004
as well as the amount and percent of change between the two dates. Significant
changes are discussed in lettered explanations below the table (amounts are in
thousands):
Change
-------------------------------
March 31, December 31,
Liabilities 2005 2004 $ %
- ---------------------------------------- ------------------ ------------------ -------------- ------------
DEPOSITS:
Noninterest-bearing.................... $ 70,066 $ 63,386 $ 6,680 10.5% (a)
Interest-bearing -
Savings, interest checking and money
market............................ 219,783 210,887 8,896 4.2%
Time deposits $100,000 and over...... 75,917 83,952 (8,035) (9.6)%
Other time deposits.................. 101,838 97,118 4,720 4.9%
Short-term borrowings.................. 26,899 33,697 (6,798) (20.2)% (b)
Federal Home Loan Bank advances........ 97,200 97,200 -- --
Long-term borrowings................... 9,397 10,079 (682) (6.8)%
Guaranteed preferred beneficial
interests in company's subordinated
debentures........................... 22,314 22,509 (195) (0.9)%
Other liabilities...................... 12,149 11,036 1,113 10.1%
------------------ ------------------ --------------
Total liabilities............. $ 635,563 $ 629,864 $ 5,699 0.9%
================== ================== ==============
(a) These accounts generally fluctuate daily due to the cash management
activities of our commercial customers. Additionally some customers draw
down on their lines of credit at year end and place the funds in their
transaction accounts and, during the first quarter of each year, make
payments on the lines of credit from these same transactions accounts. This
can cause seasonal fluctuations
(b) This was a planned decrease in short-term borrowings as a result of an
increase in deposits.
Stockholders' Equity. Our stockholders' equity decreased $325,000 between
December 31, 2004 and March 31, 2005. The decrease was the result of the
unrealized losses on investment securities in accumulated other comprehensive
income and payment of a preferred stock dividend being greater than the net
income for the period. Also, on February 15, 2005, the Company repurchased 25
shares of its noncumulative preferred stock from a trust controlled by Mr.
Milne, an executive officer, for cash consideration of $252,556. All of 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.
Capital Adequacy and Expenditures. We actively monitor compliance with
regulatory capital requirements, including risk-based and leverage capital
measures. Under the risk-based capital method of capital measurement, the ratio
computed is dependent upon the amount and composition of assets recorded on the
balance sheet, the amount and composition of off-balance-sheet items, in
addition to the level of capital. The following table includes the risk-based
and leverage capital ratios of the Company and the Bank as of March 31, 2005:
Tier 1 Total
Risk- Risk- Tier 1
Based Based Leverage
Ratio Ratio Ratio
--------------- ---------------- --------------
BNCCORP, consolidated...... 7.12% 9.60% 4.71%
BNC National Bank.......... 10.48% 11.31% 6.93%
As of March 31, 2005, BNCCORP and the Bank exceeded capital adequacy
requirements and the Bank was considered "well-capitalized" under prompt
corrective action provisions.
Capital expenditures expected in 2005 total $3.2 million and consists of
building a new banking branch in Shakopee, MN, computer software and hardware
throughout the Company, remodeling several of North Dakota branch offices,
remodeling the Phoenix office of Milne Scali and could include purchase or
leasing of additional facilities in our various market areas should facilities
or properties be deemed to add additional franchise value. Additionally,
potential acquisitions could increase capital expenditures as such transactions
are consummated.
Comparison of Operating Results for the Three Months Ended March 31, 2005 and
2004
General. Net income of $1.79 million, or $0.60 per share on a diluted basis, was
reported for the quarter ended March 31, 2005. These 2005 first quarter earnings
nearly equaled the record net income of $1.81 million, or $0.63 per diluted
share reported for the same period of 2004.
The recent quarter benefited from an increase in insurance income as well as
loan fees generated by a significant commercial real estate transaction
originated by the Minneapolis office and mortgage banking. These increases
offset the slight decrease in net interest income and higher noninterest
expenses related to our investments in staff and facilities to support the
growth of our insurance and banking businesses.
The financial performance of our insurance segment is typically strongest in the
first quarter due to profit sharing payments received from insurance carriers.
Insurance revenues were $5.77 million for the quarter ended March 31, 2005
compared with $4.56 million for the same period one year earlier, an increase of
26.4 percent. Profit sharing payments totaled $1.46 million for the quarter
ended March 31, 2005 compared to $1.04 million for the quarter ended March 31,
2004.
Net interest income was $4.16 million for the first quarter of 2005, compared
with $4.37 million for the first quarter of 2004. Net interest income for the
quarter ended March 31, 2004 was 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 but was subsequently paid in
full. Without this recovery, net interest income for the quarter ended March 31,
2004 would have been approximately $3.96 million resulting in a net interest
margin of 2.92 percent compared to the net interest margin of 2.78 percent for
the quarter ended March 31, 2005.
Noninterest income was $7.71 million for the 2005 first quarter, an increase of
28.4 percent from $6.01 million in the year-ago period. As noted earlier, higher
insurance income was a key factor in this increase. The insurance income
increase was generated by the Company's insurance agency subsidiary, Milne Scali
& Company, and resulted from growth from existing offices as well as the new
offices opened in 2004. Loan fees also rose, due primarily by a significant
commercial real estate transaction originated by the Minneapolis office as well
as increased mortgage banking fees. Noninterest income represented 64.98 percent
of gross revenues for the recent quarter, compared with 57.89 percent for the
comparable period of 2004. Without the inclusion of the cash basis interest
income recovery of $408,000, noninterest income for the first quarter of 2004
represented 60.26 percent of revenues.
Noninterest expense for the first quarter of 2005 was $9.21 million, an increase
of 16.8 percent from $7.89 million a year ago, due to staffing and other
increases to support growth from new banking branch offices in Arizona and
Minnesota and new insurance offices in Arizona, Colorado and Utah. Increased
professional services expense and increased other noninterest expenses were
attributable to expenses paid and accrued in conjunction with a suit filed by
Terrence M. Scali. See Item 5, Legal Proceedings.
Total assets rose to $679.1 million at March 31, 2005 versus $673.7 million at
December 31, 2004. Total loans held for investment at the end of the 2005 first
quarter were $292.9 million compared with $293.8 million at December 31, 2004.
Total loans held for sale were $65.0 million at March 31, 2005 compared with
$60.2 million at December 31, 2004, reflecting an increase in our student loan
financing program implemented during 2004. Investment securities available for
sale were $232.3 million at March 31, 2005 compared with $235.9 million at
December 31, 2004. Total deposits at March 31, 2005 were $467.6 million, up from
$455.3 million at December 31, 2004. Total common stockholders' equity for
BNCCORP was $42.5 million at March 31, 2005, equivalent to book value per common
share of $14.73 (tangible book value per common share of $4.50). Net unrealized
losses in the investment portfolio as of that date were $2.96 million, or a
decrease of approximately $0.64 per share, net of tax.
Charge-offs for the quarter ended March 31, 2005 were $113,000 compared with
$1.3 million for the same period one year earlier. $1.2 million of the
charge-offs in the first quarter of 2004 related to the final resolution of one
commercial loan. The ratio of allowance for credit losses to total nonperforming
loans increased to 3,945 percent at March 31, 2005, compared with 607 percent at
December 31, 2004. The allowance for credit losses as a percentage of total
loans at March 31, 2005 was 1.23 percent, compared with 1.14 percent a year ago.
Total nonperforming loans decreased to $91,000 at March 31, 2005, compared to
$549,000 at December 31, 2004. The ratio of nonperforming assets to total assets
decreased to 0.01 percent at March 31, 2005 from 0.08 percent at December 31,
2004. The provision for credit losses was $250,000 for the period ended March
31, 2005 and $0 for the same period in 2004.
Net Interest Income. Net interest income for the first quarter of 2005 was $4.16
million, a decrease of 4.9 percent, from the $4.37 million reported for the
first quarter of 2004. The decrease reflected a reduction in the net interest
margin to 2.78 percent for the quarter ended March 31, 2005, from 3.22 percent
for the same period in 2004. Net interest income and margin for the three-month
period ending March 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. Without this recovery, net
interest income for the quarter ended March 31, 2004 would have been
approximately $3.96 million resulting in a net interest margin of 2.92 percent.
The following table presents average balances; interest earned or paid
associated yields on interest-earning assets and costs on interest-bearing
liabilities for the three-month periods ended March 31, 2005 and 2004, as well
as the changes between the periods presented. Significant factors contributing
to the decrease in net interest income and net interest margin are discussed in
lettered notes below the table (amounts are in thousands):
Three Months Ended March 31,
-------------------------------------------------------------------
2005 2004 Change
--------------------------------- -------------------------------- ------------------------------
Interest Average Interest Average Interest Average
Average earned yield or Average earned yield or Average earned yield
Balance or paid cost balance or paid cost balance or paid or cost
---------- ---------- --------- --------- --------- --------- -------- -------- ----------
Interest-earning assets
Federal funds sold/interest
bearing due from...........$ 240 $ -- -- $ 480 $ -- -- $ (240) $ -- --
Investments................... 243,487 2,560 4.26% 281,463 3,135 4.48% (37,976) (575) -0.22%(a)
Loans held for sale........... 71,232 821 4.67% 301 4 5.34% 70,931 817 -0.67%(b)
Loans and leases held for
investment................. 294,110 4,976 6.86% 269,127 4,720 7.05% 24,983 256 -0.19%(b)
Allowance for loan losses.. (3,335) -- (4,751) -- 1,416 --
---------- ---------- --------- --------- -------- --------
Total interest-earning
assets.....................$ 605,734 8,357 5.60% $546,620 7,859 5.78% $ 59,114 498 -0.18%
========== ========== ========= ========= ======== ========
Interest-bearing liabilities
Interest checking & money
market accounts............$ 212,620 804 1.53% $208,478 539 1.04% $ 4,142 265 0.49%(c)
Savings....................... 7,353 15 0.83% 6,566 12 0.74% 787 3 0.09%
Certificates of deposit under
$100,000................... 100,046 678 2.75% 93,699 635 2.73% 6,347 43 0.02%
Certificates of deposit
$100,000 and over.......... 83,504 748 3.63% 47,110 432 3.69% 36,394 316 -0.06%(d)
---------- ---------- --------- --------- -------- --------
Interest-bearing deposits.. 403,523 2,245 2.26% 355,853 1,618 1.83% 47,670 627 0.43%
Short-term borrowings......... 26,342 170 2.62% 26,394 99 1.51% (52) 71 1.11%(e)
Federal Home Loan Bank
advances................... 106,526 1,185 4.51% 109,458 1,253 4.60% (2,932) (68) -0.09%
Long-term borrowings.......... 10,062 123 4.96% 8,631 93 4.33% 1,431 30 0.63%(f)
Subordinated debentures....... 22,239 477 8.70% 22,137 426 7.74% 102 51 0.96%(g)
---------- ---------- --------- --------- -------- --------
Total borrowings........... 165,169 1,955 4.80% 166,620 1,871 4.52% (1,451) 84 0.28%
---------- ---------- --------- --------- -------- --------
Total interest-bearing
liabilities...............$ 568,692 4,200 3.00% $522,473 3,489 2.69% $ 46,219 711 0.31%
========== ---------- ========= --------- ======== --------
Net interest income/spread. $ 4,157 2.60% $ 4,370 3.09% $(213) -0.49%
========== ========= ========
Net interest margin........ 2.78% 3.22% -0.44%(h)
Notation:
Noninterest-bearing deposits..$ 62,403 -- $ 41,850 -- $ 20,553 --
---------- --------- --------
Total deposits............$ 465,926 $ 2,245 1.95% $397,703 $ 1,618 1.64% $ 68,223 $ 627 0.31%
========== ========== ========= ========= ========= ========
Taxable equivalents:
Total interest-earning
assets....................$ 605,734 $ 8,581 5.75% $546,620 $ 8,066 5.93% $ 59,114 $ 515 -0.18%
Net interest income/spread. -- $ 4,381 2.75% -- $ 4,577 3.24% -- $(196) -0.49%
Net interest margin........ -- -- 2.93% -- -- 3.37% -- -- -0.44%
(a) Average investments during the first quarter of 2005 were less than the
same period in 2004. Investment volume decreased during 2004 in order to
fund part of the increase in loans outstanding, particularly loans held for
sale. Investments available for sale at March 31, 2005 were $232.3 million
compared with $288.4 million at March 31, 2004.
(b) Actual balances of loans held for sale totaled $65 million and $0 as of
March 31, 2005 and March 31, 2004, respectively, reflecting increased
amounts of residential mortgage and student loan financing programs. Actual
balances of loans held for investment at March 31, 2005 and March 31, 2004
were $292.9 and $254.0 million, respectively. Loan yield for the quarter
ended March 31, 2004 was favorably impacted by the recovery of $408,000 of
cash basis interest income on a $4.5 million loan that was classified as
nonaccrual at December 31, 2003 and was subsequently paid in full during
the first quarter of 2004. Without this recovery, interest income on loans
for the first quarter of 2004 would have been approximately $4.3 million
and the yield on loans would have been 6.44 percent, compared to 6.86
percent for the first quarter of 2005. The increase is due to the higher
short-term interest rate environment in the first quarter of 2005 relative
to the first quarter of 2004.
(c) Average balances of interest checking and money market accounts increased
slightly. The increased costs of interest checking and money market
accounts reflect the higher short-term interest rate environment in the
first quarter of 2005 versus the first quarter of 2004.
(d) During the quarter ended March 31, 2005, average balances of brokered and
national market CDs were $54.9 million as compared to $36.6 million for the
same period one year earlier, as brokered deposits were increased in order
to provide funding for the increase in loans outstanding, particularly
loans held for sale.
(e) Average short-term borrowings were relatively unchanged for the three-month
period ended March 31, 2005 compared to the same period in 2004. The
increased cost of short-term borrowings reflects the higher short-term
interest rate environment in the first quarter of 2005 versus the first
quarter of 2004.
(f) The increase in the average balance of long-term borrowing reflects a $1.5
million increase in the level of the Company's long-term borrowing during
2004. The increased cost of long-term borrowings reflects the higher
short-term interest rate environment in the first quarter 2005 versus the
first quarter of 2004 as the interest rate of the company's long-term
borrowings is indexed to one-month LIBOR.
(g) The increased cost of subordinated debentures reflects the higher
short-term interest rate environment in the first quarter of 2005 relative
to the first quarter of 2004 as the interest rate on $15 million of the
Company's subordinated debentures is indexed to three-month LIBOR
(h) In the first quarter of 2004 net interest margin was favorably impacted by
the previously mentioned recovery of cash basis interest income of
$408,000. Without this recovery, net interest margin would have been 2.92
percent for the quarter ended March 31, 2004. .
Provision for Credit Losses. The provision for credit losses was $250,000 for
the quarter ended March 31, 2005 based upon the increase of total loans as well
as an increase in criticized loans during the quarter. There was no provision
for loan losses for the same period in 2004 based on the decrease in total and
non-performing loans during that quarter. See "Comparison of Financial Condition
at March 31, 2005 and December 31, 2004 - Allowance for Credit Losses."
Noninterest Income. The following table presents the major categories of our
noninterest income for the three-month periods ended March 31, 2005 and 2004 as
well as the amount and percent of change between the periods. Significant
changes are discussed in lettered explanations following the table (amounts are
in thousands):
For the Three Months Ended Increase (Decrease)
March 31, 2005 - 2004
---------------------------- ----------- ---------------
Noninterest Income 2005 2004 $ %
------------- ------------ ----------- ---------------
Insurance commissions................. $ 5,768 $ 4,562 $ 1,206 26.4% (a)
Fees on loans......................... 1,295 576 719 124.8% (b)
Service charges....................... 184 211 (27) (12.8)%
Trust and financial services.......... 159 124 35 28.2% (c)
Brokerage income...................... 84 179 (95) (53.1)% (d)
Rental income......................... 7 35 (28) (80.0)%
Net loss on sales of securities ...... (66) -- (66) (100.0)% (e)
Other................................. 282 320 (38) (11.9)%
Total noninterest income........... $ 7,713 $ 6,007 $ 1,706 28.4%
============= ============ ============
Noninterest income as a percent of
gross revenues.................... 64.98% 57.89% 7.1%
Noninterest income as a percent of
gross revenues adjusted for cash
basis interest income recovered.... 64.98% 60.26%
(a) Insurance revenue increased due to an increase in profit sharing income
received from insurance companies as well as growth in the insurance
segment. Most profit sharing income from insurance companies is recorded
during the first quarter of the year. Profit sharing income recognized
during the quarter ended March 31, 2005 was $1.46 million compared to $1.04
million for the same period in 2004.
(b) Loan fees included in noninterest income increased primarily due to a
commercial real estate transaction originated by the Minneapolis office and
mortgage banking fees. Loans sold in the first quarter of 2005 totaled
$57.6 million compared to $23.1 million in the same period of 2004.
(c) Trust and financial services income increased due to increased trust assets
under management.
(d) Brokerage revenue decreased primarily due to lower production in the
Minneapolis market relative to that of the first quarter of 2004.
(e) Gains and/or losses on the sale of investment securities vary from period
to period due to the volume and nature of the securities transactions
affected during the period. Sales of investment securities during the
quarter ended March 31, 2005 resulted in a net realized loss of $66,000.
There were no sales of investment securities in the first quarter of 2004.
Noninterest Expense. The following table presents the major categories of our
noninterest expense for the three-month periods ended March 31, 2005 and 2004 as
well as the amount and percent of change between the periods. Significant
changes are discussed in lettered explanations following the table (amounts are
in thousands):
For the Three Months Increase (Decrease)
Ended March 31 2005 - 2004
--------------------------- ---------------------------
Noninterest Expense 2005 2004 $ %
----------- ----------- ----------- ------------
Salaries and employee benefits............... $ 5,619 $ 4,914 $ 705 14.3% (a)
Occupancy.................................... 755 585 170 29.1% (b)
Professional services........................ 446 319 127 39.8% (c)
Depreciation and amortization................ 408 398 10 2.5%
Office supplies, telephone and postage....... 361 311 50 16.1% (d)
Amortization of intangible assets............ 328 308 20 6.5% (e)
Marketing and promotion...................... 281 271 10 3.7%
FDIC and other assessments................... 55 51 4 7.8%
Other........................................ 958 730 228 31.2% (f)
----------- ----------- -----------
Total noninterest expense................. $ 9,211 $ 7,887 $ 1,324 16.8%
=========== =========== ===========
Efficiency ratio ............................ 77.60% 76.00% 1.6%
=========== ===========
Total operating expenses as a percent of
average assets, annualized................ 5.44% 5.13% 0.3%
=========== ===========
- ---------------
(a) Salaries and employee benefits expenses increased primarily due to new
banking branch offices in Arizona and Minnesota and new insurance offices
in Arizona, Colorado and Utah as well as increased incentive compensation
related to the previously mentioned commercial real estate loan fees from
the Minneapolis market. Average full time equivalent employees for the
quarter ended March 31, 2005 were 320 as compared to 301 for the same
period one year earlier.
(b) Occupancy expense increased due to new banking branch offices in Arizona
and Minnesota and new insurance offices in Arizona, Colorado and Utah.
(c) The increase in professional services expense is primarily attributable to
legal fees in conjunction with a suit filed by Terrence M Scali. See Item
5, Legal Proceedings.
(d) The increase in office supplies, telephone and postage expense is primarily
attributable to expansion, including the expenses associated with an
increase in the number of locations and personnel.
(e) Amortization of intangible assets increased primarily due to amortization
of the insurance books of business intangibles acquired from several
insurance agency asset acquisitions in 2004.
(f) The increase in other noninterest expense is primarily attributable to a
potential settlement relating to the legal proceeding.
Income Tax Provision. Our provision for income taxes for the quarter ended March
31, 2005 decreased $57,000 as compared to the same period in 2004. The estimated
effective tax rates for the three-month periods ended March 31, 2005 and 2004
were 25.8 and 27.2 percent, respectively. The reduction in our effective tax
rate is primarily attributable to an increase in the amount of tax-exempt income
in the 2005 period as compared to the 2004 period.
Earnings per Common Share. See Note 4 to the interim consolidated financial
statements included under Item 1 for a summary of the EPS calculation for the
three-month periods ended March 31, 2005 and 2004.
Liquidity
Liquidity. Liquidity risk management encompasses our ability to meet all present
and future financial obligations in a timely manner. The objectives of liquidity
management policies are to maintain adequate liquid assets, liability
diversification among instruments, maturities and customers and a presence in
both the wholesale purchased funds market and the retail deposit market.
The consolidated statements of cash flows in the consolidated financial
statements included under Item 1 present data on cash and cash equivalents
provided by and used in operating, investing and financing activities. In
addition to liquidity from core deposit growth, together with repayments and
maturities of loans and investments, we utilize brokered deposits, sell
securities under agreements to repurchase and borrow overnight Federal funds.
The Bank is a member of the FHLB, which affords it the opportunity to borrow
funds on terms ranging from overnight to 10 years and beyond. Advances from the
FHLB are collateralized by the Bank's mortgage loans and various investment
securities. We have also obtained funding through the issuance of subordinated
notes, subordinated debentures and long-term borrowings.
The following table sets forth, for the three months ended March 31, 2005 and
2004, a summary of our major sources and (uses) of funds. The summary
information is derived from the consolidated statements of cash flows included
under Item 1 (amounts are in thousands):
For the Three Months
Ended March 31,
--------------------
Major Sources and (Uses) of Funds 2005 2004
--------- --------
Proceeds from FHLB advances...........................$ 120,000 $ 85,000
Net increase (decrease) in deposits................... 12,263 6,375
Proceeds from maturities of investment securities..... 6,445 9,040
Proceeds from sales of investment securities.......... 1,631 --
Net decrease in loans................................. 1,089 28,290
Repayments of FHLB advances........................... (120,000) (85,000)
Purchases of investment securities.................... (8,195) (32,269)
Net increase (decrease) in short-term borrowings...... (6,798) 2,432
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.
As of March 31, 2005, we had established three revolving lines of credit with
banks totaling $17.5 million all of which remained available for advance. The
lines, if drawn upon, mature daily with interest rates that float at the Federal
funds rate. At March 31, 2005, we also had the ability to draw additional FHLB
advances of $64.3 million based upon the mortgage loans and securities that were
then pledged, subject to a requirement to purchase additional FHLB stock.
Application of Critical Accounting Policies
The Company's significant accounting policies are described in Note 1 to the
consolidated financial statements included in the Company's Form 10-K for the
year-ended December 31, 2004. The Company considers the following accounting
policies and related estimates to be the most critical in their potential effect
on its financial position or results of operations:
Allowance for Loan Losses. The allowance for loan losses is established through
a charge against current earnings to the provision for loan losses. The
allowance for loan losses is based on management's estimate of the amount
required to reflect the probable inherent losses in the loan portfolio, based on
circumstances and conditions known at each reporting date in accordance with
Generally Accepted Accounting Principles ("GAAP"). There are three components of
the allowance for loan losses: 1) specific reserves for loans considered to be
impaired or for other loans for which management considers a specific reserve to
be necessary; 2) allocated reserves based upon management's formula-based
process for assessing the adequacy of the allowance for loan losses; and 3) a
non-specific environmentally-driven allowance considered necessary by management
based on its assessment of other qualitative factors. The allowance for loan
losses is a significant estimate and is regularly reviewed by the Company for
adequacy using a consistent, systematic methodology which assesses such factors
as changes in the mix and volume of the loan portfolio; trends in portfolio
credit quality, including delinquency and charge-off rates; and current economic
conditions that may affect a borrower's ability to repay. Adverse changes in
management's assessment of these factors could lead to additional provisions for
loan losses. The Company's methodology with respect to the assessment of the
adequacy of the allowance for loan losses is more fully discussed in its Form
10-K for the period ended December 31, 2004.
Goodwill Impairment. The Company adopted Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangibles, effective January 1, 2002.
The statement addresses the method of identifying and measuring goodwill and
other intangible assets acquired in a business combination, eliminates further
amortization of goodwill, and require periodic impairment evaluations of
goodwill. Impairment evaluations are required to be performed annually and may
be required more frequently if certain conditions indicating potential
impairment exist. In the event that the Company were to determine that its
goodwill were impaired, the recognition of an impairment charge could have an
adverse impact on its results of operations in the period that the impairment
occurred or on its financial position.
Interest Income Recognition . Interest on loans is included in income as earned
based upon interest rates applied to unpaid principal. Interest is not accrued
on loans 90 days or more past due unless they are adequately secured and in the
process of collection or on other loans when management believes collection is
doubtful. All loans considered impaired are nonaccruing. Interest on nonaccruing
loans is recognized as payments are received when the ultimate collectibility of
interest is no longer considered doubtful. When a loan is placed on nonaccrual
status, all interest previously accrued is reversed against current-period
interest income; therefore an increase in loans on nonaccrual status could have
an adverse impact on interest income recognized in future periods.
Income Taxes. The Company estimates income tax expense in each of the
jurisdictions in which it operates for each period for which a statement of
operations is presented. This involves estimating the Company's actual current
tax exposure as well as assessing temporary differences resulting from differing
treatment of items, such as timing of the deduction of expenses, for tax and
accounting purposes. These differences result in deferred tax assets and
liabilities, which are included in the Company's consolidated balance sheets.
The Company must also assess the likelihood that any deferred tax assets will be
recovered from future taxable income and to the extent that recovery is not
likely, a valuation allowance must be established. Significant management
judgment is required in determining income tax expense, and deferred tax assets
and liabilities. As of March 31, 2005, there was a valuation allowance set aside
against the deferred tax asset.
Forward-Looking Statements
Statements included in Item 2, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" which are not historical in
nature are intended to be, and are hereby identified as "forward-looking
statements" for purposes of the safe harbor provided by Section 27A of the
Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). We caution
readers that these forward-looking statements, including without limitation,
those relating to our future business prospects, revenues, working capital,
liquidity, capital needs, interest costs and income, are subject to certain
risks and uncertainties that could cause actual results to differ materially
from those indicated in the forward-looking statements due to several important
factors. These factors include, but are not limited to: risks of loans and
investments, including dependence on local and regional economic conditions;
competition for our customers from other providers of financial services;
possible adverse effects of changes in interest rates including the effects of
such changes on derivative contracts and associated accounting consequences;
risks associated with our acquisition and growth strategies; and other risks
which are difficult to predict and many of which are beyond our control.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk arises from changes in interest rates, exchange rates, and commodity
prices and equity prices and represents the possibility that changes in future
market rates or prices will have a negative impact on our earnings or value. Our
principal market risk is interest rate risk.
Interest rate risk arises from changes in interest rates. Interest rate risk can
result from: (1) Repricing risk - timing differences in the maturity/repricing
of assets, liabilities, and off-balance sheet contracts; (2) Options risk - the
effect of embedded options, such as loan prepayments, interest rate caps/floors,
and deposit withdrawals; (3) Basis risk - risk resulting from unexpected changes
in the spread between two or more different rates of similar maturity, and the
resulting impact on the behavior of lending and funding rates; and (4) Yield
curve risk - risk resulting from unexpected changes in the spread between two or
more rates of different maturities from the same type of instrument. We have
risk management policies to monitor and limit exposure to interest rate risk. To
date we have not conducted trading activities as a means of managing interest
rate risk. Our asset/liability management process is utilized to manage our
interest rate risk. The measurement of interest rate risk associated with
financial instruments is meaningful only when all related and offsetting on-and
off-balance sheet transactions are aggregated, and the resulting net positions
are identified.
Our interest rate risk exposure is actively managed with the objective of
managing the level and potential volatility of net interest income in addition
to the long-term growth of equity, bearing in mind that we will always be in the
business of taking on rate risk and that rate risk immunization is not entirely
possible. Also, it is recognized that as exposure to interest rate risk is
reduced, so too may the overall level of net interest income and equity. In
general, the assets and liabilities generated through ordinary business
activities do not naturally create offsetting positions with respect to
repricing or maturity characteristics. Access to the derivatives market can be
an important element in maintaining our interest rate risk position within
policy guidelines. Using derivative instruments, principally interest rate
floors and caps, the interest rate sensitivity of specific transactions, as well
as pools of assets or liabilities, is adjusted to maintain the desired interest
rate risk profile.
Our primary tool 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, collateralized mortgage obligation, and mortgage-backed
securities portfolios in each rate environment are captured using industry
estimates of prepayment speeds for various coupon segments of the portfolio. For
purposes of this simulation, projected month-end balances of the various balance
sheet accounts are held constant at their March 31, 2005 levels. Cash flows from
a given planning account are reinvested back into the same planning account so
as to keep the month-end balance constant at its March 31, 2005 level. The
static balance sheet assumption is made so as to project the interest rate risk
to net interest income embedded in the existing balance sheet. With knowledge of
the balance sheet's existing net interest income profile, more informed
strategies and tactics may be developed as it relates to the structure/mix of
growth.
We monitor the results of net interest income simulation on a quarterly basis at
regularly scheduled asset/liability committee ("ALCO") meetings. Each quarter
net interest income is generally simulated for the upcoming 12-month horizon in
seven interest scenarios. The scenarios generally modeled are parallel interest
ramps of +/- 100bp, 200bp, and 300bp along with a rates unchanged scenario. The
parallel movement of interest rates means all projected market interest rates
move up or down by the same amount. A ramp in interest rates means that the
projected change in market interest rates occurs over the 12-month horizon
projected. For example, in the -100bp scenario, the projected prime rate will
decrease from its starting point at March 31, 2005 of 5.75 percent to 4.75
percent 12 months later. The prime rate in this example will decrease 1/12th of
the overall decrease of 100 basis points each month. Given the historically low
absolute level of market interest rates as of March 31, 2005, the declining rate
scenario analysis were limited to -100bp and -200bp for the summary table
presented below and a +400bp scenario was added.
The net interest income simulation result for the 12-month horizon is shown
below. The impact of each interest rate scenario on projected net interest
income is displayed before and after the impact of the 20.0 million cumulative
notional original five-year interest rate cap positions on three-month LIBOR
with a 5.50 percent strike. The impact of the cap positions is calculated by
determining the fair value of the contracts at the end of the 12-month horizon
using an interest rate option valuation model. The change in fair value plus any
expected cash flow in the various rate scenarios is summed to determine the
total net benefit/(cost) of the portfolio of interest rate cap contracts.
Net Interest Income Simulation
(amounts are in thousands)
Movement in interest rates -200bp -100bp Unchanged +100bp +200bp +300bp +400bp
------ ------ --------- ------ ------ ------ ------
Projected 12-month net
interest income........... $ 15,853 $ 16,119 $ 17,071 $ 17,428 $ 17,684 $ 17,828 $17,898
Dollar change from rates
unchanged scenario........ $ (1,218) $ (952) -- $ 357 $ 613 $ 757 $ 827
Percentage change from rates
unchanged scenario........ (7.13)% (5.58)% -- 2.09% 3.59% 4.43% 4.84%
Net benefit/(cost) of
cumulative $20.0 million
interest rate caps (1).... $ (1) $ (1) $ (1) $ (1) $ (1) $ (1) $ 31
Total net interest income
impact with caps.......... $ 15,852 $ 16,118 $ 17,070 $ 17,427 $ 17,683 $ 17,827 $17,929
Dollar change from unchanged
w/caps.................... $ (1,218) $ (952) -- $ 357 $ 613 $ 757 $ 859
Percentage change from
unchanged w/caps.......... (7.14)% (5.58)% -- 2.09% 3.59% 4.43% 5.03%
Policy guidelines (decline
limited to)............... 10.00% 5.00% -- 5.00% 10.00% 15.00% 20.00%
(1) We have four interest rate cap contracts on three-month LIBOR with strikes
at 5.5 percent each in the amount of $5 million notional with original
terms of five years for total notional of $20 million. These contracts will
expire in May and June 2006.
Because one of the objectives of asset/liability management is to manage net
interest income over a one-year planning horizon, policy guidelines are stated
in terms of maximum potential percentage reduction in net interest income
resulting from changes in interest rates over the 12-month period. It is no less
important, however, to give attention to the absolute dollar level of projected
net interest income over the 12-month period. For example, even though in the
- -100bp scenario, net interest income declines $952,000, or 5.58 percent, from
the unchanged scenario, the level of net interest income of $16.1 million is
still greater than the $16 million of net interest income recorded for the year
ended December 31, 2004.
Our general policy is to limit the percentage decrease in projected net interest
income to 5, 10, 15 and 20 percent from the rates unchanged scenario for the +/-
100bp, 200bp, 300bp and 400bp interest rate ramp scenarios, respectively. When a
given scenario falls outside of these limits, such as is the case with the -
100bp scenario above, the ALCO reviews the circumstances surrounding the
exception and, considering the level of net interest income generated in the
scenario and other related factors, may approve the exception to the general
policy or recommend actions aimed at bringing the respective scenario within the
general limits noted above. A targeted level of net interest income is
established and approved by the Board of Directors and ALCO. This target is
reevaluated and reset at each quarterly ALCO meeting.
Since there are limitations inherent in any methodology used to estimate the
exposure to changes in market interest rates, 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 March 31, 2005 (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 4. Controls and Procedures
Quarterly evaluation of the Company's Disclosure Controls and Internal Controls.
As of the end of the period covered by this quarterly report on Form 10-Q, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures ("Disclosure Controls"), and our internal control over
financial reporting ("Internal Controls"). This evaluation (the "Controls
Evaluation") was done under the supervision and with the participation of
management, including our President and Chief Executive Officer ("CEO") and
Chief Financial Officer ("CFO"). Rules adopted by the SEC require that in this
section of the quarterly report we present the conclusions of the CEO and the
CFO about the effectiveness of our Disclosure Controls and any change in our
Internal Controls that occurred during our most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect our Internal
Controls based on and as of the date of the Controls Evaluation.
CEO and CFO Certifications. Appearing, as Exhibits 31.1 and 31.2 to this
quarterly report, there are "Certifications" of the CEO and the CFO. The
Certifications are required in accordance with the Exchange Act and the SEC's
implementing Rule 13a-14 (the "Rule 13a-14 Certifications"). This section of the
quarterly report is the information concerning the Controls Evaluation referred
to in the Rule 13a-14 Certifications and this information should be read in
conjunction with the Rule 13a-14 Certifications for a more complete
understanding of the topics presented.
Disclosure Controls and Internal Controls. Disclosure controls are procedures
that are designed with the objective of ensuring that information required to be
disclosed in our reports filed under the Exchange Act, such as this quarterly
report, is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms. Disclosure Controls are also designed
with the objective of ensuring that material information relating to BNCCORP,
including its consolidated subsidiaries is made known to the CEO and CFO by
others within those entities, particularly during the period in which the
applicable report is being prepared. Internal Controls are procedures which are
designed with the objective of providing reasonable assurance that (1) our
transactions are properly authorized; (2) our assets are safeguarded against
unauthorized or improper use; and (3) our transactions are properly recorded and
reported, all to permit the preparation of our financial statements in
conformity with accounting principles generally accepted in the United States of
America.
Limitations on the Effectiveness of Controls. Our management, including the CEO
and CFO, does not expect that our Disclosure Controls or our Internal Controls
will prevent all error and all fraud. A control system, no matter how well
developed and operated, can provide only reasonable, but not absolute, assurance
that the objectives of the control system are met. Further, the design of a
control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their costs. Because of
the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions.
Over time, control may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.
Scope of the Controls Evaluation. The CEO/CFO evaluation of our Disclosure
Controls and our Internal Controls included a review of the controls' objectives
and design, our controls' implementation and the effect of the controls on the
information generated for use in this quarterly report. In the course of the
Controls Evaluation, we sought to identify data errors, controls problems or
acts of fraud and to confirm that appropriate corrective action, including
process improvements, were being undertaken. This type of evaluation is done on
a quarterly basis so that the conclusions concerning controls effectiveness can
be reported in our quarterly reports on Form 10-Q and annual report on Form
10-K. Our Internal Controls are also evaluated on an ongoing basis by our
internal audit and credit review departments in connection with their audit and
review activities. The overall goal of these various evaluation activities is to
monitor our Disclosure Controls and our Internal Controls and to make
modifications as necessary. Our external auditors also review Internal Controls
in connection with their audit and review activities. Our intent in this regard
is that the Disclosure Controls and Internal Controls will be maintained as
dynamic systems that change (including with improvements and corrections) as
conditions warrant.
Among other matters, we sought in our evaluation to determine whether there were
any "significant deficiencies" or "material weaknesses" in our Internal Controls
which are reasonably likely to adversely affect our ability to record, process,
summarize and report financial information, or whether we had identified any
acts of fraud, whether or not material, involving management or other employees
who have a significant role in our Internal Controls. This information was
important both for the Controls Evaluation generally and because item 5 in the
Rule 13a-14 Certifications of the CEO and CFO require that the CEO and CFO
disclose that information to our board's audit committee and to our independent
auditors and to report on related matters in this section of the quarterly
report. In the professional auditing literature, "significant deficiencies" are
referred to as "reportable conditions." These are control issues that could have
a significant adverse effect on the ability to record, process, summarize and
report financial data in the financial statements. A "material weakness" is
defined in the auditing literature as a particularly serious reportable
condition where the internal control does not reduce to a relatively low level
the risk that misstatements caused by error or fraud may occur in amounts that
would be material in relation to the financial statements and not be detected
within a timely period by employees in the normal course of performing their
assigned functions. We also sought to deal with other controls matters in the
Controls Evaluation, and in each case if a problem was identified, we considered
what revision, improvement and/or correction to make in accordance with our
ongoing procedures.
Conclusions. Based upon the Controls Evaluation, our CEO and CFO have concluded
that, subject to the limitations noted above, our Disclosure Controls are
effective to ensure that material information relating to BNCCORP and its
consolidated subsidiaries is made known to management, including the CEO and
CFO, particularly during the period when our periodic reports are being
prepared, and that our Internal Controls are effective to provide reasonable
assurance that our financial statements are fairly presented in conformity with
accounting principles generally accepted in the United States of America.
Additionally, there has been no change in our Internal Controls that occurred
during our most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our Internal Controls.
Item 5. 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 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.
Part II - Other Information
Item 2 Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
Pursuant to stock options issued on January 5, 2001, BNCCORP issued 300 shares
of its common stock on February 4, 2005 and 800 shares of its common stock on
February 5, 2005.
Item 6. Exhibits
(a) Exhibit 31.1 Chief Executive Officer's Certification Under Rule
13a-14(a) of the Exchange Act
Exhibit 31.2 Chief Financial Officer's Certification Under Rule
13a-14(a) of the Exchange Act
Exhibit 32.1 Chief Executive Officer and Chief Financial Officer
Certifications Under Rule 13a-14(b) of the Exchange Act
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BNCCORP, Inc.
Date: May 13, 2005 By /s/ Gregory K. Cleveland
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Gregory K. Cleveland
President and Chief Executive Officer
By /s/ Neil M. Brozen
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Neil M. Brozen
Chief Financial Officer