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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
Commission file number...................................................0-18046
FIRST FEDERAL CAPITAL CORP
(Exact name of Registrant as specified in its charter)
WISCONSIN 39-1651288
(State or other jurisdiction of (IRS employer
incorporation or organization) identification no.)
605 STATE STREET
LA CROSSE, WISCONSIN 54601
(Address of principal executive office) (Zip code)
Registrant's telephone number, including area code: (608) 784-8000
Securities registered pursuant to Section 12(b) of the Act: NOT APPLICABLE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.10 PER SHARE
PREFERRED STOCK PURCHASE RIGHTS
(Title of Class)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period as the Registrant
has been subject to such requirements), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate value of the common stock of the Registrant that was held by
non-affiliates as of most recently completed second fiscal quarter (June 30,
2003), was approximately $337.0 million. This amount was based on the closing
price of $19.78 per share of the Registrant's common stock as of the same date.
Indicate by check mark if the Registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2). Yes [X] No [ ]
The number of shares of common stock of the Registrant outstanding as of March
3, 2004, was 22,393,714 (net of 11,552 shares held as treasury stock).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2004 Annual Meeting of Stockholders are
incorporated into Part III, Items 10 through 13 of this Form 10-K.
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FIRST FEDERAL CAPITAL CORP
FORM 10-K TABLE OF CONTENTS
Page
PART I
Item 1--Business.................................................................................... 2
Item 2--Properties.................................................................................. 14
Item 3--Legal Proceedings........................................................................... 14
Item 4--Submission of Matters to a Vote of Security Holders......................................... 14
PART II
Item 5--Market for Registrant's Common Equity and Related Stockholder Matters....................... 15
Item 6--Selected Financial Data..................................................................... 16
Item 7--Management's Discussion and Analysis of Financial Condition and Results of Operations....... 17
Item 7A--Quantitative and Qualitative Disclosures about Market Risk................................. 35
Item 8--Financial Statements and Supplementary Data................................................. 38
Item 9--Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........ 68
Item 9A--Controls and Procedures.................................................................... 68
PART III
Item 10--Directors and Executive Officers of the Registrant......................................... 69
Item 11--Executive Compensation..................................................................... 69
Item 12--Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters........................................................................ 69
Item 13--Certain Relationships and Related Transactions............................................. 69
PART IV
Item 14--Principal Accountant Fees and Services..................................................... 69
Item 15--Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................... 70
SIGNATURES.................................................................................................... 72
CERTIFICATION................................................................................................. 75
EXHIBITS...................................................................................................... 81
1
FORWARD-LOOKING STATEMENTS
This report includes certain forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. Such statements
include words and phrases such as "will likely result", "are expected to", "will
continue", "is anticipated", "is estimated", "is projected", "intends to", or
similar expressions. Forward-looking statements are based on management's
current expectations. Examples of factors which could cause future results to
differ from management's expectations include, but are not limited to, the
following: general economic and competitive conditions; legislative and
regulatory initiatives; monetary and fiscal policies of the federal government;
general market rates of interest; interest rates on competing investments;
interest rates on funding sources; consumer and business demand for deposit and
loan products and services; consumer and business demand for other financial
services; changes in accounting policies or guidelines; and changes in the
quality or composition of the Corporation's loan and investment portfolios.
Readers are cautioned that forward-looking statements are not guarantees of
future performance and that actual results may differ materially from
management's current expectations.
Management of the Corporation does not undertake and specifically
disclaims any obligation to update any forward-looking statements to reflect the
occurrence of anticipated or unanticipated events or circumstances after the
date of such statements.
PART I
ITEM 1--BUSINESS
FIRST FEDERAL CAPITAL CORP
This section of the report contains general information about First
Federal Capital Corp (the "Corporation"), its wholly-owned subsidiary First
Federal Capital Bank (the "Bank"), and the Bank's wholly-owned subsidiaries
(collectively "the reporting group"). Included in this section is information
regarding the reporting group's markets and business environments, significant
operating and accounting policies, practices, and procedures, as well as its
competitive and regulatory environments. Information regarding the reporting
group's current financial condition and results of operations is included in
Part II, Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations", Part II, Item 7A, "Quantitative and Qualitative
Disclosures about Market Risk", and Part II, Item 8, "Financial Statements and
Supplementary Data". This section should be read in conjunction with those
sections.
The Corporation's principal office is located at 605 State Street, La
Crosse, Wisconsin, 54601, and its telephone number is (608) 784-8000. The
Corporation's internet page is located at www.firstfed.com. The Corporation will
make available on its website free of charge its Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to
those Reports filed pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 as soon as reasonably practicable after they are filed with
the Securities and Exchange Commission. The Corporation has also made available
on its internet site the Code of Business Conduct and Ethics applicable to its
senior officers.
FIRST FEDERAL CAPITAL BANK
The Bank was founded in 1934 and is a federally-chartered,
federally-insured, savings bank headquartered in La Crosse, Wisconsin. Effective
March 1, 2003, the Bank changed its name from "First Federal Savings Bank La
Crosse-Madison" to "First Federal Capital Bank". Beginning on that date, the new
name appeared on all legal documents and official communications. Signs,
promotional messages, letterhead, and business cards did not change, but
continued to carry the "First Federal" name and logo. This change was made to
more appropriately reflect the Bank's expansion into new geographic markets in
recent years, as well as its expansion into business banking in 2001.
The Bank's primary business is community banking, which includes
attracting deposits from and making loans to the general public and private
businesses, as well as governmental and non-profit entities. In addition to
deposits, the Bank obtains funds through borrowings from the Federal Home Loan
Bank of Chicago ("FHLB"), as well as through other sources such as securities
sold under agreements to repurchase and purchases of federal funds. These
funding sources are principally used to originate loans, including single-family
residential loans, commercial real estate loans, business loans and lines of
credit, consumer loans, and education loans. The Bank also purchases and/or
participates in loans from third-party financial institutions and invests in
mortgage-backed and related securities. The Bank is also an active seller of
residential loans in the secondary market.
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The Bank's primary market areas for conducting its activities consist
of communities located in the southern two-thirds of Wisconsin, northern
Illinois, and south-eastern Minnesota. The Bank maintains 95 banking offices in
its market areas. Twenty of these offices are located in the Madison
metropolitan area, seven in the Eau Claire metropolitan area, six in the La
Crosse metropolitan area, four each in the Appleton and Wausau areas, three each
in the Beloit, Hudson, Oshkosh, and Green Bay areas, and two each in the cities
of Kenosha, Janesville, River Falls, and Neenah, Wisconsin. The Bank also
maintains one banking facility in fifteen other cities located throughout its
market area in Wisconsin. The Bank also has six offices in the Rockford,
Illinois, area and ten offices in Minnesota, including five in Rochester and one
in St. Paul. Finally, the Bank has three separate residential loan production
offices, two of which are located in Appleton and one in Eau Claire, Wisconsin.
The Bank is subject to regulation and examination by the Office of
Thrift Supervision ("OTS"), its chartering authority and primary regulator, and
by the Federal Deposit Insurance Corporation ("FDIC"), which administers the
Savings Association Insurance Fund ("SAIF"), which insures the Bank's deposits
to the maximum extent permitted by law.
The Bank's principal executive offices are located at 605 State Street,
La Crosse, Wisconsin, 54601, and its telephone number is (608) 784-8000. The
Bank's internet site is www.firstfed.com.
ORGANIZATIONAL STRUCTURE AND SEGMENT REPORTING
The principal components of the Corporation's organization consist of a
Retail Banking Division, which has primary responsibility for the sale and
delivery of all the Corporation's products and services to retail customers and
a Commercial Banking Division, which has primary responsibility for the sale and
delivery of products and services to business and commercial real estate
customers. The Corporation also has a Corporate Operations and Mortgage Banking
Division, which has primary responsibility for service and support of loan and
deposit products, data and technology management, property management, and the
origination and sale of single-family residential loans. Finally, the
Corporation has a Finance and Treasury Division, a Human Resources Division, and
a Marketing Department. Each division/department is led by an officer that
reports directly to the president of the Corporation.
The Corporation accounts for its operations along product lines. The
Corporation tracks profitability in six major areas: (i) residential lending,
(ii) commercial real estate lending, (iii) consumer lending, (iv) education
lending, (v) business banking, and (vi) investment and mortgage-related
securities. Residential lending is divided into two profit centers for segment
reporting purposes: (i) a mortgage banking profit center that is responsible for
loan origination, sales of loans in the secondary market, and servicing of
residential loans, and (ii) a residential loan portfolio that consists of loans
held by the Corporation for investment purposes (loans held for sale are
included in the mortgage banking profit center). This profit center also
includes mortgage-backed securities that are collateralized by loans that were
originated by the Corporation. Commercial real estate lending consists of the
Corporation's portfolio of multi-family and non-residential mortgage loans,
excluding loans assigned to the business banking profit center, as well as
functions related to the origination and servicing of such loans. Consumer
lending consists of the Corporation's second mortgage, automobile, and other
consumer installment loans, excluding loans assigned to the business banking
profit center, as well as functions related to the origination and servicing of
such loans. Education lending consists of the Corporation's portfolio of
education loans, as well as functions related to the origination and servicing
of such loans. Business banking consists of the Corporation's portfolio of
commercial business loans, including certain commercial real estate and consumer
loans assigned to the business banking profit center, as well as functions
related to the origination and servicing of such loans. Finally, the
Corporation's investment and mortgage-related securities portfolio is considered
a profit center for segment reporting purposes. As previously noted, however,
mortgage-backed securities collateralized by loans originated by the Corporation
are included in the residential loan profit center, rather than the investment
and mortgage-related securities portfolio.
The Corporation's extensive branch network, which delivers checking,
savings, certificates of deposit and other financial products and services to
customers, is considered a support department for segment reporting purposes.
For additional discussion regarding the Corporation's reportable
segments, refer to Note 14 of the Corporation's Audited Consolidated Financial
Statements, included herein under Part II, Item 8, "Financial Statements and
Supplementary Data", as well as Part II, Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations".
LENDING ACTIVITIES
GENERAL The principal categories of loans in the Corporation's
portfolio are conventional real estate loans secured by single-family
residences, commercial real estate loans secured by multi-family residential and
non-residential real estate,
3
consumer loans secured primarily by second mortgages on single-family residences
and automobiles, government-guaranteed education loans, and commercial loans to
businesses secured by varied collateral or consideration. As of December 31,
2003, approximately 76% of the Corporation's total assets consisted of loans
held for investment purposes.
RESIDENTIAL LENDING Single-family residential loans accounted for
approximately 30% of the Corporation's gross loans as of December 31, 2003.
Applications for single-family residential and construction loans are accepted
by commission-based employees of the Corporation at a number of locations (most
of which are located with deposit-taking offices) and by salaried employees at a
few other deposit-taking offices that are able to handle such applications.
In general, the Corporation retains in its portfolio only single-family
residential mortgage loans that provide for periodic adjustments of the interest
rate ("adjustable-rate mortgage loans"). These loans generally have terms of up
to 30 years and interest rates that adjust every one to two years in accordance
with an index based on the yield on certain U.S. government securities. A
portion of these loans may guarantee borrowers a fixed rate of interest for the
first three to five years of the loan's term. Furthermore, most of these loans
have annual interest rate change limits ranging from 1% to 2%, maximum lifetime
interest rates ranging from 11% to 13%, and minimum lifetime floor rates of
approximately 6% to 7%. It is the Corporation's practice from time-to-time to
discount the interest rate it charges on its adjustable-rate mortgage loans
during the first one to five years of the loan, which has the effect of reducing
a borrower's payment during such years. In addition, most of the Corporation's
owner-occupied adjustable-rate mortgage loan agreements permit borrowers to
convert their adjustable-rate loans to fixed-rate loans under certain
circumstances in exchange for a fee. Upon conversion, the Corporation generally
sells such loans in the secondary market.
Adjustable-rate mortgage loans decrease the Corporation's exposure to
risks associated with changes in interest rates, but involve other risks because
as interest rates increase, borrowers' monthly payments increase, thus
increasing the potential for default. This risk has not had any adverse effect
on the Corporation to date, although no assurances can be made with respect to
future periods.
The Corporation occasionally purchases adjustable-rate single-family
residential loans from third-party financial institutions. In general, such
loans are subject to the same underwriting standards as loans originated
directly by the Corporation. However, such loans are usually secured by
properties located outside of the Corporation's primary market areas. The seller
generally retains servicing of the loans. As of December 31, 2003, approximately
32% of the Corporation's single-family residential loan portfolio consisted of
purchased loans.
Although the Corporation generally retains only adjustable-rate
mortgage loans in its portfolio, it continues to originate and service
fixed-rate mortgage loans in order to provide a full range of products to its
customers. In general, such loans are originated only under terms, conditions,
and documentation standards that make such loans eligible for sale to the
Federal Home Loan Mortgage Corporation ("Freddie Mac"), the Federal National
Mortgage Association ("Fannie Mae"), the FHLB, and other institutional
investors. The Corporation generally sells these loans at the time they are
originated, but continues to service these loans for its customers. In addition,
the Corporation generally sells any adjustable-rate mortgage loans that convert
to fixed-rate loans in accordance with options granted to such borrowers in the
original loan documents, as previously described. Sales of mortgage loans
provide additional funds for lending and other business purposes.
Sales or securitizations of mortgage loans through Freddie Mac and
Fannie Mae have generally been under terms that do not provide for any recourse
against the Corporation by the investor. In the case of sales to the FHLB,
however, the Corporation retains the credit risk on the underlying loans in
exchange for a credit enhancement fee. Furthermore, the Corporation on occasion
has also retained the credit risk on certain securitizations of its own loans
into mortgage-backed securities through Freddie Mac or Fannie Mae.
The Corporation's general policy is to lend up to 80% of the
independently appraised value of the property securing a first mortgage loan
(referred to as the "loan-to-value ratio"). The Corporation will occasionally
lend in excess of an 80% loan-to-value ratio on a first mortgage loan, but will
generally require the borrower to obtain private mortgage insurance on the
portion of the loan that exceeds 80%. The Corporation receives commission
revenue from the independent insurance providers that sell such policies to the
Corporation's loan customers. Premium revenue on the sale of such policies is
also received through a wholly-owned, second-tier subsidiary of the Bank. This
revenue is received in exchange for the subsidiary's reinsurance of a portion of
the mortgage impairment risk. Refer to "Subsidiaries", below, for additional
discussion.
The Corporation also offers loan programs to qualifying borrowers with
good credit standing which will enable them to obtain a second mortgage loan
from the Corporation in conjunction with their first mortgage loan. Under these
4
programs, the combined principal balance of the loans will not exceed 100% of
the property's value and the Corporation will waive the requirement for private
mortgage insurance.
The Corporation also originates loans to individuals to construct
single-family residences. Such loans accounted for approximately 3% of the
Corporation's gross loans as of December 31, 2003. Construction loans may be
made without commitments to purchase the property being constructed and the
borrower may not have take-out commitments for permanent financing on hand at
the time of origination. Construction loans generally have a maturity of 6 to 12
months and a fixed rate of interest, with payments being made monthly on an
interest-only basis. Construction loans are otherwise underwritten and approved
in the same manner as other single-family residential loans. Construction loans,
however, are generally considered to involve a higher degree of risk than
conventional residential mortgage loans. This is because the risk of loss is
largely dependent on the accuracy of the initial estimate of the property's
value at completion of construction, the estimated cost of construction, and the
borrower's ability to advance additional construction funds, if necessary. This
risk has not had any adverse effect on the Corporation to date, although no
assurances can be made with respect to future periods.
In addition to servicing the loans in its own portfolio, the
Corporation continues to service most of the loans that it sells to third-party
investors (commonly referred to as "loans serviced for others"). Servicing
mortgage loans, whether for its own portfolio or for others, includes such
functions as collecting monthly principal and interest payments from borrowers,
maintaining escrow accounts for real estate taxes and insurance, and making such
payments on behalf of borrowers when they are due. When necessary, servicing of
mortgage loans also includes functions related to the collection of delinquent
principal and interest payments, loan foreclosure proceedings, and disposition
of foreclosed real estate. As of December 31, 2003, loans serviced for others
amounted to $3.3 billion.
When the Corporation services loans for others, it is compensated for
these services through the retention of a servicing fee from borrowers' monthly
payments. The Corporation pays the third-party investors an agreed-upon yield on
the loans, which is generally less than the interest agreed to be paid by the
borrowers. The difference, typically 25 basis points or more, is retained by the
Corporation and recognized as servicing fee income over the lives of the loans,
net of amortization of capitalized mortgage servicing rights. The Corporation
also receives fees and interest income from ancillary sources such as
delinquency charges and float on escrow and other funds. The Corporation also
purchases mortgage servicing rights from third parties for which it retains an
agreed-upon fee from borrowers' monthly payments, as previously described. The
Corporation performs substantially the same services for these loans as it does
on its own originations. As of December 31, 2003, approximately 2% of the
Corporation's servicing portfolio consisted of servicing purchased from third
parties.
Management believes that servicing mortgage loans for third parties
provides a natural hedge against other risks inherent in the Corporation's
mortgage banking operations. That is, fluctuations in volumes of mortgage loan
originations and resulting gains on sales of such loans caused by changes in
market interest rates will generally be offset in part by an opposite change in
loan servicing fee income. These fluctuations are usually the result of actual
loan prepayment activity that is different from that which was anticipated when
the related servicing rights were originally recorded. However, fluctuations in
the recorded value of mortgage servicing rights may also be caused by
mark-to-market adjustments required to be recognized under generally accepted
accounting principles ("GAAP"). That is, the value of servicing rights may
fluctuate because of changes in the future prepayment assumptions or discount
rates used to periodically value servicing rights. Although management believes
that most of the Corporation's loans that prepay are replaced by a new loan to
the same customer or even a different customer (thus preserving the future
servicing cash flow), GAAP requires mark-to-market losses resulting from a
change in future prepayment assumptions to be recorded in the period in which
the change occurs. However, the offsetting gain on the sale of the new loan, if
any, cannot be recorded under GAAP until the customer actually prepays the old
loan and the new loan is sold in the secondary market. Mortgage servicing rights
are particularly susceptible to unfavorable mark-to-market adjustments during
periods of declining interest rates during which prepayment activity typically
accelerates to levels above that which had been anticipated when the servicing
rights were originally recorded. For additional discussion, refer to Notes 1 and
4 of the Corporation's Audited Consolidated Financial Statements, included
herein under Part II, Item 8, "Financial Statements and Supplementary Data", as
well as Part II, Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations".
COMMERCIAL REAL ESTATE LENDING Multi-family residential loans and
non-residential real estate loans (together "commercial real estate loans")
accounted for approximately 28% of the Corporation's gross loans as of December
31, 2003. Applications for commercial real estate loans are accepted at the
Corporation's offices in La Crosse, Madison, Appleton, Milwaukee, and Wausau,
Wisconsin, and Rochester, St. Paul, and Wayzata, Minnesota. Underwriting and
approval of commercial real estate loans, originated by commissioned loan
officers located in such offices, is performed at the Corporation's main office
in La Crosse, as is the servicing of such loans on an on-going basis. Commercial
real estate
5
loans originated in conjunction with a business banking relationship are
underwritten and approved by authorized personnel in the local market where
business banking products and services are sold (currently La Crosse, Wausau,
Oshkosh, Rochester, and St. Paul). Such loans are subject to the general
policies and procedures outlined in "Commercial Business Lending", below. It is
the Corporation's general policy to restrict its commercial real estate lending
to loans secured by properties located within a 300-mile radius of La Crosse,
which includes all or a portion of the states of Wisconsin, Nebraska, Illinois,
Iowa, and Minnesota.
The Corporation's emphasis in commercial real estate lending is on
loans secured by collateral classified as Type A properties, which include
multi-family residential properties, retail shopping establishments, office
buildings, and multi-tenant industrial buildings. To a lesser extent, the
Corporation also makes loans secured by collateral classified as Type B
properties, examples of which include nursing homes, single-tenant industrial
buildings, hotels and motels, and churches. The Corporation's current policy is
to make only a limited amount of loans secured by collateral classified as Type
C properties, examples of which include restaurants, recreation facilities, and
other special purpose facilities.
Applications for commercial real estate loans are generally obtained
from existing borrowers, direct contacts by loan officers, and referrals. In
general, these loans have amortization periods ranging from 20 to 30 years,
mature in ten years or less, and have interest rates which are fixed for one to
five years--thereafter adjusting in accordance with a designated index that is
generally subject to a floor and a ceiling. Loan-to-value ratios on the
Corporation's commercial real estate loans may be as high as 80%. In addition,
as part of the criteria for underwriting commercial real estate loans, the
Corporation generally imposes on potential borrowers a "debt coverage ratio"
(the ratio of net cash from operations before payment of debt service to debt
service). This ratio varies depending on the nature of the collateral, but is
always greater than 115%. It is also the Corporation's general policy to obtain
personal guarantees on its commercial real estate loans and, when such
guarantees cannot be obtained, to impose more stringent loan-to-value ratios,
debt coverage ratios, and other underwriting requirements.
The Corporation occasionally purchases commercial real estate loans
from third-party financial institutions. In general, such loans are subject to
the same geographic restrictions and underwriting standards as loans originated
directly by the Corporation. The Corporation, however, does not generally
service such loans after their acquisition. As of December 31, 2003,
approximately 8% of the Corporation's commercial real estate portfolio consisted
of purchased loans.
From time-to-time the Corporation originates loans to construct
multi-family residential and non-residential real estate properties. Such loans
accounted for approximately 2% of the Corporation's gross loans as of December
31, 2003. Construction loans are generally considered to involve a higher degree
of risk than mortgage loans on completed properties. The Corporation's risk of
loss on a construction loan is dependent largely upon the accuracy of the
initial estimate of the property's value at completion of construction, the
estimated cost of construction, and the borrower's ability to advance additional
construction funds if such should become necessary.
Commercial real estate lending is generally considered to involve a
higher level of risk than single-family residential lending. This is due to the
concentration of principal in a limited number of loans and borrowers, the
effects of general economic conditions on real estate developers and managers
and on income producing properties, and the increased difficulty of evaluating
and monitoring these types of loans. Moreover, a construction loan can involve
additional risks because of the inherent difficulty in estimating both a
property's value at completion of the project and the estimated cost of the
project. In addition, loans secured by properties located outside of the
Corporation's immediate market area may involve a higher degree of risk. This is
because the Corporation may not be as familiar with market conditions and other
relevant factors as it would be in the case of loans secured by properties
located within its market areas. The Corporation does not have a material
concentration of commercial real estate loans outside of its immediate market
area.
The Corporation has attempted to minimize the foregoing risks by
adopting what management believes are conservative underwriting guidelines that
impose more stringent loan-to-value ratios, debt coverage ratios, and other
requirements on loans believed to have higher elements of risk. The Corporation
also requires independent appraisals on all loans, requires personal guarantees
where appropriate, limits the geographic area in which the Corporation will make
construction loans, and limits the types of loans in its portfolio, as
previously described.
CONSUMER LENDING The Corporation offers consumer loans in order to
provide a full range of financial services to its customers. Such loans
accounted for approximately 23% of the Corporation's gross loans as of December
31, 2003. Most of the Corporation's consumer loan portfolio consists of second
mortgage loans and home equity lines of credit, but also includes automobile
loans, recreational vehicle and mobile home loans, deposit account secured
loans, and unsecured lines of credit or signature loans. The Corporation
services all of its own consumer loans.
6
Applications for consumer loans are taken at most of the Corporation's
banking offices, through its internet banking channel, and over the phone at the
Corporation's headquarters in La Crosse. Applications for automobile loans are
also accepted through relationships established with a limited number of
qualifying automobile dealerships ("indirect automobile lending"). The majority
of consumer loans are underwritten, approved, and serviced on an on-going basis
at the Corporation's headquarters. In the case of indirect automobile lending,
such loans are underwritten and approved by the office that has established the
business banking relationship with the automobile dealership. As of December 31,
2003, indirect automobile lending was being conducted in Rochester and St. Paul,
Minnesota, and represented approximately 39% of the Corporation's automobile
loan portfolio.
Consumer loans generally have shorter terms and higher rates of
interest than conventional mortgage loans, but typically involve more credit
risk than such loans because of the nature of the collateral and, in some
instances, the absence of collateral. In general, consumer loans are more
dependent upon the borrower's continuing financial stability, are more likely to
be affected by adverse personal circumstances, and are often secured by rapidly
depreciating personal property such as automobiles. In addition, various laws,
including bankruptcy and insolvency laws, may limit the amount that may be
recovered from a borrower. However, such risks are mitigated to some extent in
the case of second mortgage loans and home-equity lines of credit. These types
of loans are secured by a second mortgage on the borrower's residence for which
the total principal balance outstanding (including the first mortgage) does not
generally exceed 100% of the property's value, although exceptions are sometimes
made for high net worth or other qualifying borrowers. Second mortgage loans are
generally fixed-rate and may have terms of up to ten years.
The Corporation believes that the higher yields earned on consumer
loans compensate for the increased risk associated with such loans and that
consumer loans are important to the Corporation's efforts to increase the
interest rate sensitivity and shorten the average maturity of its loan
portfolio. Furthermore, the Corporation's net charge-offs on consumer loans as a
percentage of gross loans have not been significant in recent years, despite the
risks inherent in consumer lending.
In conjunction with its consumer lending activities, the Corporation
offers customers credit life and disability insurance products underwritten and
administered by an independent insurance provider. The Corporation receives
commission revenue related to the sales of these products. In addition, a
wholly-owned subsidiary of the Bank receives premium revenue in exchange for the
portion of the insurance risk it has reinsured on these sales. Refer to
"Subsidiaries", below, for additional discussion.
EDUCATION LENDING The Corporation offers education loans through
programs sponsored by an agency of the federal government. As such, the agency
guarantees most of the principal and interest on such loans. A third-party
services the loans for the Corporation after they are originated. Education
loans generally carry variable rates of interest to the Corporation, subject to
a floor rate that is reset in July of each year. Education loans accounted for
approximately 8% of the Corporation's gross loans as of December 31, 2003.
COMMERCIAL BUSINESS LENDING As of December 31, 2003, commercial
business loans accounted for approximately 6% of the Corporation's gross loans.
These loans may take the form of lines of credit, single payment loans, or term
payment loans, and may be secured or unsecured depending on the creditworthiness
of the borrower. The Corporation operates under a commercial business lending
policy that establishes a number of tenets that guide management in making
commercial lending decisions. Among these tenets are the purpose of the loan,
the source of repayment, and an alternate source of repayment (generally in the
form of collateral or outside guarantee). Applications for commercial business
loans are accepted at the Corporation's offices in La Crosse, Wausau, and
Oskhosh, Wisconsin, as well as Rochester and St. Paul, Minnesota. Lending
relationships with total related borrowings of less than $1.0 million are
underwritten and approved by authorized personnel in these local markets.
Lending relationships between $1.0 million and $2.5 million are approved by an
intermediate commercial loan committee. Lending relationships between $2.5
million and $5.0 million are approved by the Corporation's senior loan
committee. Finally, lending relationships in excess of $5.0 million are approved
by the Corporation's board of directors. It is the Corporation's general policy
to restrict its commercial business lending to a market area defined as within a
150-mile radius of any office location where business banking products and
services are sold.
Commercial business loans are generally made for business expansion or
ongoing business needs. The purpose of commercial business loans can include the
purchase of equipment or the provision of operating capital for the financing of
accounts receivable and inventory. Commercial business loans are not generally
made for the purpose of acquiring real estate. Rather, such loans are typically
classified as "commercial real estate loans". However, real estate may
occasionally be accepted as incidental collateral on a loan made for another
business purpose. In general, such loans continue to be classified as
"commercial business loans".
7
Commercial business loans generally involve more credit risk because of
the nature of the collateral and, in some instances, the absence of collateral.
Credit risk is controlled and monitored through active asset quality management
and the use of lending standards, thorough review of potential borrowers, and
active asset quality administration. Active asset quality administration,
including early problem loan identification and timely resolution of problems,
further ensures appropriate management of credit risk and minimization of loan
losses.
The Corporation occasionally participates in commercial business loans
originated by third-party financial institutions. In general, such loans are
subject to the same geographic restrictions and underwriting standards as loans
originated by the Corporation. The Corporation, however, does not generally
service such loans. As of December 31, 2003, approximately 27% of the
Corporation's business loan portfolio consisted of loans originated by other
financial institutions.
The Corporation believes that the higher yields earned on commercial
business loans compensate for the increased risk associated with such loans and
that commercial business loans are important to the Corporation's efforts to
increase the interest rate sensitivity and shorten the average maturity of its
loan portfolio.
NON-PERFORMING AND OTHER CLASSIFIED ASSETS Loans are generally placed
on non-accrual status and considered "non-performing" when, in the judgment of
management, the probability of collection of principal or interest is deemed to
be insufficient to warrant further accrual of interest. When a loan is placed on
non-accrual and/or non-performing status, previously accrued but unpaid interest
is deducted from interest income. In general, the Corporation does not record
accrued interest on loans 90 or more days past due. Refer to Notes 1 and 3 of
the Corporation's Audited Consolidated Financial Statements, included herein
under Part II, Item 8, "Financial Statements and Supplementary Data".
When a loan is placed on non-accrual and/or non-performing status, the
Corporation generally institutes foreclosure or other collection proceedings.
Real estate property acquired by the Corporation as a result of foreclosure or
deed-in-lieu of foreclosure is classified as "real estate" and is considered
"non-performing" until it is sold. Other property acquired through adverse
judgment, such as automobiles and other depreciable assets, are generally
classified as an "other asset". The amount of foreclosed real estate and other
repossessed property has not been material to the Corporation in recent years.
Federal regulations require thrift institutions to classify their
assets on a regular basis. Accordingly, the Corporation has internal policies
and procedures in place to evaluate risk ratings on all loans. In addition, in
connection with examinations of thrift institutions, federal examiners have
authority to classify problem assets as "Substandard", "Doubtful", or "Loss". An
asset is classified as "Substandard" if it is determined to involve a distinct
possibility that the Corporation could sustain some loss if deficiencies
associated with the loan are not corrected. An asset is classified as "Doubtful"
if full collection is highly questionable or improbable. An asset is classified
as "Loss" if it is considered uncollectible, even if a partial recovery could be
expected in the future. If an asset or portion thereof is classified as "Loss",
the Corporation must either establish a specific allowance for the portion of
the asset classified as "Loss", or charge off such amount. Refer to Part II,
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations", for additional discussion.
ALLOWANCES FOR LOSSES ON LOANS AND REAL ESTATE The Corporation's policy
is to establish allowances for estimated losses on specific loans and real
estate when it determines that losses are probable and estimable. In addition,
the Corporation maintains a general loss allowance against its loan and real
estate portfolios that is based on its own loss experience, management's ongoing
assessment of current economic conditions, the credit risk inherent in the
portfolios, and the experience of the financial services industry. For
additional information, refer to Part II, Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and Notes 1 and 3 of
the Corporation's Audited Consolidated Financial Statements, included herein
under Part II, Item 8, "Financial Statements and Supplementary Data".
Management of the Corporation believes that the current allowances
established by the Corporation are adequate to cover probable and estimable
losses in the Corporation's loan and real estate portfolios. However, future
adjustments to these allowances may be necessary and the Corporation's results
of operations could be adversely affected if circumstances differ substantially
from the assumptions used by management in making its determinations in this
regard.
8
INVESTMENT AND MORTGAGE-RELATED SECURITIES
The Corporation periodically invests in collateralized mortgage
obligations ("CMOs") and MBSs (collectively "mortgage-backed and related
securities"). As of December 31, 2003, such investments accounted for
approximately 12% of the Corporation's total assets.
Management believes CMOs represent attractive investment alternatives
relative to other investment vehicles, due to the variety of maturity and
repayment options available through such investments and due to the limited
credit risk associated with such securities. CMOs purchased by the Corporation
represent a participation interest in a pool of single-family residential
mortgage loans and are generally rated triple-A by independent credit-rating
agencies. In addition, such investments are secured by credit enhancements
and/or subordinated tranches or are collateralized by U.S. government agency
MBSs. The Corporation generally invests only in sequential-pay, planned
amortization class ("PAC"), and targeted amortization class ("TAC") tranches
that, at the time of their purchase, are not considered to be high-risk
derivative securities, as defined in applicable regulations. The Corporation
does not invest in support-, companion-, or residual-type tranches. Furthermore,
the Corporation does not invest in interest-only, principal-only,
inverse-floating-rate CMO tranches, or similar complex securities.
The Corporation also invests in MBSs that are guaranteed by Freddie
Mac, Fannie Mae, or the Government National Mortgage Association ("Ginnie Mae").
In addition, the Corporation periodically securitizes or "swaps" mortgage loans
in its own portfolio into Freddie Mac or Fannie Mae MBSs and continues to hold
such securities. MBSs enhance the quality of the Corporation's assets by virtue
of the guarantees that back them, although the Corporation at times has
relinquished such guarantee on loans it has swapped into MBSs (for additional
discussion, refer to Note 2 of the Corporation's Audited Consolidated Financial
Statements, included herein under Part II, Item 8, "Financial Statements and
Supplementary Data"). In addition, MBSs are more liquid than individual mortgage
loans and receive treatment that is more favorable when used to collateralize
certain borrowings of the Corporation.
In addition to MBSs and CMOs, federally-chartered savings institutions
such as the Bank have authority to invest in various other types of investment
securities, including U.S. and state government obligations, securities of
various federal agencies, certificates of deposit issued by insured banks and
savings institutions, and federal funds. Subject to various restrictions,
federally-chartered savings institutions may also invest a portion of their
assets in commercial paper, corporate debt securities, and mutual funds whose
assets conform to the investments that a federally-chartered savings institution
is authorized to make directly. In general, investments in these types of
securities are limited to the four highest credit categories as established by
the major independent credit-rating agencies. Excluding U.S. government and
federal agency securities and mutual funds that invest exclusively in such
securities, the Corporation does not invest in individual securities that exceed
10% of its stockholder's equity. As of December 31, 2003, the Corporation held
no investment securities other than MBSs and CMOs described above.
The Corporation classifies its mortgage-backed and related securities
and its other investment securities as either available for sale or held for
investment. For additional discussion, refer to Note 1 of the Corporation's
Audited Consolidated Financial Statements, included herein under Part II, Item
8, "Financial Statements and Supplementary Data".
SOURCES OF FUNDS
DEPOSIT LIABILITIES The Corporation's current deposit products include
regular savings accounts, checking accounts, money market deposit accounts,
individual retirement accounts, and certificates of deposit ranging in terms
from three months to five years. Substantially all of the Corporation's deposits
are obtained from individuals and businesses located in Wisconsin, northern
Illinois, and south-eastern Minnesota. As of December 31, 2003, deposit
liabilities accounted for approximately 77% of the Corporation's total
liabilities and equity.
In addition to serving as the Corporation's primary source of funds,
deposit liabilities (especially checking accounts) are a substantial source of
non-interest income. This income is generally received in the form of overdraft
fees, periodic service charges, automated teller machine ("ATM") and debit card
fees, and other transaction charges. The Corporation's extensive branch network
also creates opportunities for sales of non-deposit products such as
tax-deferred annuities, mutual funds, and other investment products. In exchange
for these sales, the Corporation receives commission revenue from the
third-party providers of the financial products and/or services.
The principal methods used by the Corporation to attract deposit
accounts include offering a variety of products and services, competitive
interest rates, and convenient office locations and hours. Most of the
Corporation's free-standing banking offices have drive-up facilities and 49 of
the Corporation's banking facilities are located in supermarkets. The
9
Corporation also owns 137 ATM machines, most of which are located in the
Corporation's primary markets. Depositors may also obtain a debit card from the
Corporation, which allows them to purchase goods and services directly from
merchants. The same debit card also provides access to the ATM network.
From time-to-time, the Corporation has also used certificates of
deposit sold through third-party brokers ("brokered deposits") as an alternative
to borrowings from the FHLB. FDIC regulations govern the acceptance of brokered
deposits by insured depository institutions such as the Corporation. At December
31, 2003, the Corporation had $9.0 million in brokered deposits outstanding.
FEDERAL HOME LOAN BANK ADVANCES The Corporation obtains advances from
the FHLB secured by certain of its home mortgage loans and mortgage-related
securities, as well as stock in the FHLB, a minimum amount of which the
Corporation is required to own. Such advances may be made pursuant to several
different credit programs, each with its own interest rate and range of maturity
dates. As of December 31, 2003, FHLB advances accounted for approximately 11% of
the Corporation's total liabilities and equity.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE The Corporation
occasionally enters into sales of securities under agreements to repurchase
(commonly referred to as "reverse-repurchase agreements"). In form, these
transactions are an arrangement in which the sale of securities is accompanied
by a simultaneous agreement to repurchase the identical securities (or
substantially the same securities) at a future date. In substance, however,
these arrangements are borrowings secured by high-quality, highly-liquid
securities such as Fannie Mae or Freddie Mac MBSs. Accordingly, these
arrangements are accounted for as borrowings in the Corporation's financial
statements.
Securities sold under repurchase agreements are physically delivered to
the broker-dealers that arrange the transactions. The broker-dealers may sell,
loan, or otherwise dispose of such securities to other parties in the normal
course of their operations. The Corporation is exposed to risk in these types of
transactions in that changes in market prices, economic losses, or other factors
could prevent or delay the counter-parties in the transaction from returning the
securities at the maturity of the agreement. The Corporation limits its exposure
to such risk by utilizing standard industry agreements, limiting transactions to
large, reputable broker-dealers, limiting the amount that can be borrowed from
an individual broker-dealer, and limiting the duration of such agreements
(typically one to six months). There were no securities sold under agreements to
repurchase as of December 31, 2003.
FEDERAL FUNDS PURCHASED AND OTHER BORROWINGS The Corporation has lines
of credit with three financial institutions. These lines, which amount to $60.0
million in the aggregate, permit the overnight purchase of federal funds. The
Corporation also has a standard line of credit with one of these institutions in
the amount of $60.0 million. As of December 31, 2003, there was $65.6 million
outstanding under these lines of credit.
SUBSIDIARIES
The Bank has a number of subsidiaries that engage in certain activities
that management believes are more appropriately conducted by a subsidiary of the
Bank. Following is a brief description of each subsidiary.
FIRST CAP HOLDINGS, INC. The Bank formed a wholly-owned subsidiary in
the State of Nevada in 1993. The subsidiary, First Cap Holdings, Inc. ("FCHI"),
was formed to consolidate and improve the efficiency, management, safekeeping,
and operations of the Bank's investment securities portfolio and certain other
holdings. In addition, the formation of FCHI has resulted in a lower effective
income tax rate for the Bank because the State of Nevada does not currently
impose a corporate income tax. However, refer to "Taxation", below, for a
discussion relating to the taxability of FCHI's earnings in the State of
Wisconsin. In addition, refer to Note 11 of the Corporation's Audited
Consolidated Financial Statements, included herein under Part II, Item 8,
"Financial Statements and Supplementary Data". As of December 31, 2003, FCHI was
managing $387 million in investments and mortgage-related securities and $241
million in purchased single-family residential loans for the Bank. FCHI's net
income was $15.7 million, $21.7 million, and $26.4 million during the years
ended December 31, 2003, 2002, and 2001, respectively. The Bank's net investment
in FCHI as of December 31, 2003, was $633 million, which was eliminated in
consolidation in accordance with GAAP.
FIRST REINSURANCE, INC. The Bank formed a wholly-owned subsidiary in
the State of Arizona in 1998. The subsidiary, First Reinsurance, Inc. ("FRI"),
was formed to reinsure or "underwrite" credit life and disability insurance
policies sold to the Bank's consumer loan customers. FRI assumes the first level
of risk on these policies and a third-party insurer assumes the remaining risk.
The third-party insurer is also responsible for performing most of the
administrative functions of the subsidiary on a contract basis. FRI's net income
was $193,000, $153,000, and $227,000 during the years
10
ended December 31, 2003, 2002, and 2001, respectively. At December 31, 2003, the
Bank's net investment in FRI was $1.4 million, which was eliminated in
consolidation in accordance with GAAP.
FIRST ENTERPRISES, INC. The Bank's wholly-owned subsidiary, First
Enterprises, Inc. ("FEI"), was incorporated in 1971 in the State of Wisconsin.
During the period from the late-1970s to the mid-1980s, FEI was primarily
involved in the acquisition and development of hotels. Except for the
maintenance of its two remaining hotel investments, however, FEI is no longer
involved in these types of activities. The principal asset of FEI is its
investment in FF Mortgage Reinsurance, Inc. ("FFMR"), described in the next
paragraph. FEI had net income of $506,000, $350,000, and $113,000 during the
years ended December 31, 2003, 2002, and 2001, respectively. At December 31,
2003, the Bank's net investment in FEI was $1.6 million, which was eliminated in
consolidation in accordance with GAAP.
FF MORTGAGE REINSURANCE, INC. In December 2000, FEI formed FF Mortgage
Reinsurance, Inc. ("FFMR"), a Vermont corporation. FFMR was formed to reinsure
or "underwrite" a portion of the mortgage impairment insurance policies
purchased by the Bank's loan customers (refer to "Lending
Activities--Residential Lending"). FFMR assumes a second level of risk on these
policies, which is capped at a certain level. Third-party insurers assume the
first level of risk, as well as any risk above the capped amount. A third-party
management company is responsible for performing most of the administrative
functions of the subsidiary on a contract basis. FFMR had net income of
$479,000, $315,000, and $42,000 during the years ended December 31, 2003, 2002,
and 2001, respectively. FEI's net investment in FFMR as of December 31, 2003,
was $1.5 million, which was eliminated in consolidation in accordance with GAAP.
TURTLE CREEK CORPORATION The Bank acquired Turtle Creek Corporation
("Turtle Creek") in 1995 as a result of its acquisition of another financial
institution. Turtle Creek, a Wisconsin corporation, formerly held a limited
partnership interest in an apartment complex providing housing for
low-to-moderate income and elderly persons. Such investment was sold in the
fourth quarter of 2003. Turtle Creek had net income of $85,000 in 2003 and net
losses of $23,000, and $18,000 in 2002 and 2001, respectively. The Bank's net
investment in Turtle Creek as of December 31, 2003, was $151,000, which was
eliminated in consolidation in accordance with GAAP. The Corporation expects to
liquidate this subsidiary in 2004.
COMPETITION
The Corporation faces significant competition in attracting deposits
through its branch network. Its most direct competition has historically come
from commercial banks, credit unions, and other savings institutions located in
its market area. In addition, the Corporation faces significant competition from
mutual fund and insurance companies, as well as primary financial markets such
as the stock and bond markets. The Corporation competes for deposits principally
by offering customers a variety of deposit products, competitive prices,
convenient branch locations and operating hours, and other services. The
Corporation does not rely upon any individual group or entity for a material
portion of its deposits.
The Corporation's competition for loans comes principally from mortgage
banking companies, other savings institutions, commercial banks, finance and
insurance companies, and credit unions. The Corporation competes for loan
originations primarily through the interest rates and loan fees it charges, the
efficiency and quality of services it provides borrowers, the variety of its
products, and on referrals from real estate brokers, builders, and business
customers.
REGULATION AND SUPERVISION
References in this section to applicable laws and regulations are brief
summaries only. All such summaries are qualified in their entirety by the
applicable laws and regulations, which the reader is encouraged to consult to
fully understand their details and operation.
REGULATION OF THE CORPORATION The Corporation is a savings and loan
holding company within the meaning of Section 10 of the Home Owners' Loan Act
("HOLA"). As such, the Corporation is registered with and subject to OTS
examination and supervision as well as to certain OTS reporting requirements.
The Corporation is also required to file certain reports and otherwise comply
with the rules and regulations of the Securities and Exchange Commission
("SEC"). Furthermore, the Corporation is limited with respect to the
transactions it can execute with its affiliates (including the Bank), and its
ability to acquire control of another insured financial institution, as
specified more fully in the applicable regulations. There generally are no
restrictions as to activities of a unitary savings and loan holding company such
as the Corporation as long as its sole insured subsidiary, the Bank, continues
to meet certain regulatory requirements, which management believes it did as of
December 31, 2003.
REGULATION OF THE BANK The Bank, as a federally-chartered savings bank,
is subject to federal regulation and oversight by the OTS extending to all
aspects of its operations. The Bank also is subject to regulation and
examination by
11
the FDIC, which insures the deposits of the Bank to the maximum extent permitted
by law, and to certain requirements established by the Federal Reserve Board.
The laws and regulations governing the Bank generally have been promulgated to
protect depositors and not for the purpose of protecting stockholders of
financial institutions or their holding companies.
The investment and lending authority of a federally-chartered savings
bank is prescribed by federal laws and regulations. The Bank is also subject to
regulatory provisions affecting a wide variety of matters including, but not
limited to, branching, loans to one borrower, investment restrictions,
activities of subsidiaries, loans to "insiders," and transactions with
affiliates. Certain of the regulatory requirements applicable to the Bank are
described in more detail in the following paragraphs.
INSURANCE OF DEPOSITS The Bank's savings deposits are insured
by SAIF, which is administered by the FDIC, up to the maximum extent provided by
law, currently $100,000 for each depositor. The Bank is subject to a risk-based
insurance assessment system under which higher insurance assessment rates are
charged to those thrift institutions that are deemed to pose greater risk to the
deposit insurance fund. Under this system, insurance assessments range from 0%
of deposits for the healthiest financial institutions to 0.27% of deposits for
the weakest. This risk-based assessment schedule is identical to that for
institutions insured by the Bank Insurance Fund ("BIF"), which is also
administered by the FDIC. Under both funds, the insurance assessment paid by a
particular institution will depend on the "supervisory rating" it receives from
the FDIC ("A," "B," or "C") and on its regulatory capital level ("well
capitalized," "adequately capitalized," or "undercapitalized"). Based upon its
current supervisory rating and regulatory capital level, and assuming no change
in the Bank's risk classification or in overall premium assessment levels, the
Bank anticipates that its insurance assessment for 2004 will be zero, which is
the same as the Bank's 2003 rate.
CAPITAL STANDARDS The Bank is subject to minimum regulatory
capital requirements as specified by OTS regulations. As more fully described in
such regulations, the Bank is subject to a leverage limit of at least 3% of
total assets, a tangible capital limit of at least 1.5% of total assets and a
risk-based capital limit of at least 8% of risk-weighted assets. As of December
31, 2003, the Bank exceeded all minimum regulatory capital requirements as
specified by the OTS.
The Bank is also subject to minimum regulatory capital
requirements as specified by FDIC regulations. As more fully described in such
regulations, the Bank must meet the following capital standards to be classified
as "adequately capitalized" under FDIC guidelines: (1) Tier 1 capital in an
amount not less than 4% of adjusted total assets, (ii) Tier 1 capital in an
amount not less than 4% of risk-weighted assets, and (iii) total capital in an
amount not less than 8% of risk-weighted assets. As of December 31, 2003, the
Bank exceeded all minimum regulatory capital requirements as specified by the
FDIC. For additional discussion, refer to Note 12 of the Corporation's Audited
Consolidated Financial Statements, included herein under Part II, Item 8,
"Financial Statements and Supplementary Data."
CLASSIFICATION OF ASSETS As previously described, the Bank's
problem assets are subject to classification according to one of three
categories: "Substandard", "Doubtful" and "Loss". An institution is required to
develop its own program to classify its assets on a regular basis and to set
aside appropriate loss reserves on the basis of such classification. The Bank
believes that it is in compliance with the foregoing requirements.
QUALIFIED THRIFT LENDER TEST A savings association that does
not meet the Qualified Thrift Lender Test ("QTL Test"), as set forth in the HOLA
and OTS regulations, may lose access to FHLB advances and must either convert to
a bank charter or comply with certain restrictions on its operations. Under the
QTL Test, a savings association is required to maintain a certain percentage of
its assets in qualifying investments, as defined by regulations. In general,
qualifying investments consist of housing-related assets. At December 31, 2003,
the Bank's assets invested in qualifying investments exceeded the percentage
required to qualify the Bank under the QTL Test.
FEDERAL HOME LOAN BANK SYSTEM The Bank is a member of the FHLB
System, which consists of 12 regional FHLBs, subject to supervision and
regulation by the Federal Housing Finance Board. The FHLBs provide a central
credit facility primarily for member financial institutions. The Bank, as a
member of the FHLB of Chicago, is required to purchase and hold shares of
capital stock in the FHLB of Chicago. The requirement is equal to the greater of
1% of the Bank's aggregate unpaid residential mortgage loans, home purchase
contracts and similar obligations at the beginning of each year or 5% of its
outstanding advances from the FHLB of Chicago. At December 31, 2003, the Bank
had a $59.6 million investment in the stock of the FHLB and was in compliance
with this requirement.
The Bank's investment in FHLB stock, its single-family
mortgage loans, and certain other assets (consisting principally of CMOs and
MBSs) are used to secure advances from the FHLB of Chicago. The interest rates
charged on advances vary with the maturity of the advance and the FHLBs own cost
of funds.
12
FEDERAL RESERVE SYSTEM Regulation D, as promulgated by the
Federal Reserve Board, requires savings institutions to maintain
non-interest-earning reserves against certain transaction deposit accounts and
other liabilities. At December 31, 2003, the Bank's minimum required reserve
level was $53.3 million and it was in compliance with the regulation.
DIVIDEND RESTRICTIONS The payment of dividends by the Bank is
subject to various limitations set forth in federal regulations and as briefly
described in Note 12 of the Corporation's Audited Consolidated Financial
Statements, included herein under Part II, Item 8, "Financial Statements and
Supplementary Data." The Bank has not paid any dividends in violation of these
regulations.
COMMUNITY REINVESTMENT ACT Under the Community Reinvestment
Act of 1977, as amended (the "CRA"), and as implemented by OTS regulations, a
savings institution has a continuing and affirmative obligation, consistent with
its safe and sound operation, to help meet the credit needs of its entire
community, including low and moderate income neighborhoods. The CRA does not
establish specific lending requirements or programs for financial institutions
nor does it limit an institution's discretion to develop the types of products
and services that it believes are best suited to its particular community,
consistent with the CRA. The CRA requires the OTS, in connection with its
examination of a savings institution, to assess the institution's record of
meeting the credit needs of its community and to take such record into account
in its evaluation of certain applications by such institution. The CRA also
requires all institutions to make public disclosure of their CRA ratings. The
Bank's latest CRA rating, received in 2002, was "Outstanding".
TAXATION
FEDERAL TAXATION The Corporation is subject to those rules of federal
income taxation generally applicable to corporations under the Internal Revenue
Code of 1986, as amended (the "IRC"). The Corporation, the Bank, and the Bank's
wholly-owned subsidiaries (excluding FRI) file consolidated federal income tax
returns, which has the effect of eliminating or deferring the tax consequences
of intercompany distributions, including dividends, in the computation of
consolidated taxable income. The consolidated entity pays taxes at the federal
statutory rate of 35% of its taxable income, as defined in the IRC. Refer to
Notes 1 and 9 of the Corporation's Audited Consolidated Financial Statements,
included herein under Part II, Item, 8, "Financial Statements and Supplemental
Data," for additional discussion. As of December 31, 2003, the Corporation had
no material disputes outstanding with Internal Revenue Service.
STATE TAXATION The states of Wisconsin, Illinois, and Minnesota impose
a tax on their apportioned shares of the Corporation's taxable income at the
rate of 7.9%, 7.3%, and 9.8%, respectively (all state income taxes are
deductible on the Corporation's federal income tax return). These states'
definitions of taxable income are generally similar to the federal definition,
except that interest from state and municipal obligations is taxable, no
deduction is allowed for state income taxes (except for Illinois, which allows a
deduction for taxes paid to other states), and, in Wisconsin and Minnesota, net
operating losses may be carried forward but not back. Minnesota and Illinois
require the filing of combined state income tax returns, whereas Wisconsin
currently requires separate returns for each entity in the consolidated group.
FCHI is incorporated in the State of Nevada, which does not currently
impose a corporate income tax. Although the earnings of FCHI are not currently
subject to taxation in the State of Wisconsin, from time-to-time legislation is
proposed which, if adopted, would require combined income tax returns for
entities headquartered in the state and result in taxation of FCHI's earnings.
To date, none of these legislative proposals have been adopted. In addition, the
Wisconsin Department of Revenue ("WDR") recently increased its examinations of
banking entities in the state and is investigating whether to allocate income of
out-of-state investment subsidiaries like FCHI to their parent banks. Indeed, in
2003 the WDR began examinations of a number of financial institutions, including
the Bank, specifically aimed at their relationships with their investment
subsidiaries. Management believes the WDR may take the position that some or all
of the income of FCHI is allocable to the Bank and taxable in Wisconsin.
Management believes the Bank, as well as FCHI, have complied with the tax rules
relating to the income of out-of-state subsidiaries, and with the private
rulings the WDR issued to the Bank in 1993 and 1997 in connection with its
formation and operation of FCHI. The WDR has indicated that it may repudiate
these rulings and management is uncertain at this time whether the WDR exam will
result in an assessment. The Bank will oppose an assessment, if any.
If the WDR is successful in allocating FCHI's income to the Bank, or if
legislation referred to in the previous paragraph were to become law, such could
result in the earnings of FCHI being subject to taxation in the State of
Wisconsin. If the Corporation had been required to pay Wisconsin tax on FCHI's
income for the year ended December 31, 2003, the Corporation's income tax
expense would have been approximately $1.2 million higher than reported. This
would have reduced diluted and basic earnings per share by approximately $0.06
per share. Furthermore, if the WDR determines
13
that the earnings of FCHI in open tax years prior to 2003 should have been
subject to tax in Wisconsin, management estimates that the Bank may be subject
to a tax obligation of up to $14.5 million, net of federal and state tax
benefit. This amount includes an estimate for interest, but excludes any
penalties that may be assessed by the WDR, which could be as high as 25% of the
gross assessment. As previously mentioned, however, the Bank will oppose an
assessment related to this issue.
ITEM 2--PROPERTIES
As of December 31, 2003, the Corporation conducted its business from
its corporate offices in La Crosse, Wisconsin, 91 other banking facilities
located throughout Wisconsin, northern Illinois, and south-eastern Minnesota,
and three separate loan production offices, also located in Wisconsin. At such
date, the Corporation owned the building and/or land for 26 of its offices and
leased the building and/or the land for its remaining 69 properties, including
49 located in supermarkets. The Corporation also owns or leases certain other
properties to meet various business needs. For additional information, refer to
Note 5 of the Corporation's Audited Consolidated Financial Statements, included
herein under Part II, Item 8, "Financial Statements and Supplementary Data".
ITEM 3--LEGAL PROCEEDINGS
The information required herein is included in Note 11 of the
Corporation's Audited Consolidated Financial Statements, included herein under
Part II, Item 8, "Financial Statements and Supplementary Data".
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to security holders for vote during the
fourth quarter of 2003.
14
PART II
ITEM 5--MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASERS OF EQUITY SECURITIES
The Corporation's common stock is traded on the Nasdaq national market
under the symbol FTFC. As of February 18, 2004, the Corporation had 22,387,514
common shares outstanding (net of 15,352 shares of treasury stock), 1,420
stockholders of record, 3,330 estimated beneficial stockholders, and 4,750
estimated total stockholders.
Dividend and stock price information required by this item, as well as
information relating to the Corporation's stock repurchase plans, is included
under the following sections of this report:
(1) "Liquidity and Capital Resources", included herein under Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
(2) "Note 12--Stockholder's Equity", included herein under Item 8,
"Financial Statements and Supplementary Data--Audited Consolidated Financial
Statements".
(3) "Quarterly Financial Information", included herein under Item 8,
"Financial Statements and Supplementary Data--Supplementary Data".
On October 10, 2003, the Corporation completed its acquisition of
Liberty Bancshares, Inc. in St. Paul, Minnesota. The transaction was valued at
$79.6 million, of which 38% or $30.3 million was paid in cash and 62% or $49.3
million was paid in the form of 2,596,475 shares of common stock of the
Corporation. The Corporation issued the above shares of common stock based on
the exemption provided under Section 4(2) of the Securities Act of 1933, as
amended.
15
ITEM 6--SELECTED FINANCIAL DATA
The information in the following table contains selected consolidated
financial and other data. This information has been derived in part from the
Audited Consolidated Financial Statements included herein under Item 8,
"Financial Statements and Supplementary Data". Accordingly, the table should be
read in conjunction with such consolidated statements.
Dollars in thousands, except for per share amounts
SELECTED BALANCE SHEET DATA AS OF DECEMBER 31 2003 2002 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets $ 3,308,324 $ 3,025,624 $ 2,717,710 $ 2,352,726 $ 2,084,554
Investment securities available for sale, at fair value - - 35,462 817 873
Mortgage-backed and related securities:
Available for sale, at fair value 386,862 366,075 305,980 331,237 252,165
Held for investment, at cost 613 30,030 134,010 77,299 103,932
Loans held for investment, net 2,518,683 2,100,642 1,851,316 1,772,477 1,538,595
Allowance for loan losses 13,882 11,658 9,962 8,028 7,624
Mortgage servicing rights, net 36,341 30,171 29,909 23,280 21,728
Intangible assets 91,528 43,818 24,946 11,490 12,463
Deposit liabilities 2,552,837 2,355,148 2,029,254 1,699,252 1,471,259
FHLB advances and other borrowings 416,699 417,613 467,447 490,846 469,580
Stockholders' equity 276,589 205,452 192,398 146,549 127,275
===================================================================================================================================
SELECTED OPERATING DATA FOR YEAR ENDED DECEMBER 31 2003 2002 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
Interest income $ 147,918 $ 161,250 $ 171,533 $ 161,436 $ 130,071
Interest expense 66,125 79,726 108,330 101,896 75,953
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income 81,793 81,525 63,202 59,540 54,117
Provision for loan losses 1,456 3,468 1,763 1,009 387
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 80,337 78,057 61,438 58,531 53,730
- -----------------------------------------------------------------------------------------------------------------------------------
Gain (loss) from sale of investments and other assets - (166) 63 1,386 -
Other non-interest income 86,546 63,801 49,464 34,247 35,178
- -----------------------------------------------------------------------------------------------------------------------------------
Total non-interest income 86,546 63,635 49,527 35,633 35,178
Non-interest expense (1) 111,717 87,378 67,119 58,250 54,299
- -----------------------------------------------------------------------------------------------------------------------------------
Income before income tax expense 55,166 54,313 43,847 35,914 34,609
Income tax expense 20,439 19,398 15,398 12,770 12,167
- -----------------------------------------------------------------------------------------------------------------------------------
Net income $ 34,727 $ 34,916 $ 28,448 $ 23,144 $ 22,441
===================================================================================================================================
SELECTED OTHER DATA AT OR FOR THE YEAR ENDED DECEMBER 31 2003 2002 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
Return on average assets 1.11% 1.23% 1.14% 1.04% 1.19%
Return on average equity 15.03 17.56 17.19 17.01 17.63
Equity to assets at end of period 8.36 6.79 7.08 6.23 6.11
Tangible equity to tangible assets at end of period 5.75 5.42 6.22 5.77 5.54
Average interest rate spread 2.45 2.64 2.12 2.34 2.58
Average net interest margin 2.85 3.08 2.70 2.83 3.05
Ratio of allowance for loan losses to total loans held
for investment at end of period 0.55 0.55 0.54 0.45 0.50
Ratio of non-performing assets to total assets at end of
period 0.41 0.30 0.31 0.19 0.10
Ratio of non-interest income to total revenue (2) 51.41 43.84 43.93 37.44 39.40
Ratio of non-interest expense to average assets (3) 3.32 3.08 2.70 2.62 2.88
Efficiency ratio during period (4) 61.38 59.71 58.58 60.88 59.65
Earnings per share:
Diluted earnings per share $ 1.69 $ 1.73 $ 1.51 $ 1.25 $ 1.17
Basic earnings per share 1.71 1.76 1.52 1.26 1.21
Dividends paid per share 0.55 0.51 0.47 0.42 0.34
Stock price at end of period 22.56 19.31 15.70 14.50 14.63
Book value per share at end of period 12.35 10.43 9.52 7.99 6.92
Tangible book value per share at end of period 8.26 8.20 8.29 7.36 6.24
Banking facilities at end of period 95 89 78 72 64
Full-time equivalent employees at end of period 1,362 1,213 1,033 897 831
===================================================================================================================================
(1) Includes $7.4 million in FHLB prepayment penalty in 2003.
(2) Total revenue is defined as the sum of net interest income and non-interest
income.
(3) Excludes impact of FHLB prepayment penalty and gains (losses) on real estate
owned.
(4) Excludes amortization of intangible assets, impact of FHLB prepayment
penalty, and gains (losses) on sales of investment securities, if any.
16
ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion and analysis in this section should be read in
conjunction with Item 8, "Financial Statements and Supplementary Data", as well
as Item 7A, "Quantitative and Qualitative Disclosures about Market Risk", and
Part I, Item 1, "Business".
APPLICATION OF CRITICAL ACCOUNTING POLICIES
CRITICAL JUDGMENTS AND ESTIMATES The Corporation describes all of its
significant accounting policies in Note 1, of the Corporation's Audited
Consolidated Financial Statements, included herein under Item 8. Particular
attention should be paid to two accounting areas that, in management's judgment,
require significant judgments and/or estimates on the part of management because
of the inherent uncertainties surrounding these areas and/or the subjective
nature of the areas. These areas are itemized and referenced as follows.
MORTGAGE SERVICING RIGHTS For a discussion of the judgments
and estimates relating to the initial recording of and ongoing accounting for
mortgage servicing rights, refer to the appropriate section in Note 1 of the
Corporation's Audited Consolidated Financial Statements, included herein under
Item 8. Additional discussion is also available in the "Residential Lending"
section of Part I, Item 1, "Business--Lending Activities". Finally, information
on the impact mortgage servicing rights have had on the Corporation's financial
condition and results of operations for the years ending December 31, 2003,
2002, and 2001, can be found, below, in the sections entitled "Financial
Condition--Mortgage Servicing Rights" and "Results of Operations--Non-Interest
Income--Mortgage Banking Revenue".
ALLOWANCE FOR LOSSES ON LOANS AND REAL ESTATE For a discussion
of the judgments and estimates relating to allowances for losses on loans and
real estate, refer to the appropriate section in Note 1 of the Corporation's
Audited Consolidated Financial Statements, included herein under Item 8.
Additional discussion is also available in the "Non-Performing and Other
Classified Assets" section and the "Allowances for Losses on Loans and Real
Estate" section of Part I, Item 1, "Business--Lending Activities". Finally,
information on the impact loss allowances have had on the Corporation's
financial condition and results of operations for the years ending December 31,
2003, 2002, and 2001, can be found, below, in the sections entitled "Financial
Condition--Non-Performing Assets" and "Results of Operations--Provisions for
Loan Losses".
NEW ACCOUNTING STANDARDS AND POLICIES During the three-year period
ended December 31, 2003, the Corporation adopted no new accounting standards or
policies that, in management's judgment, had a material impact on its financial
condition or results of operations. However, two new accounting standards were
adopted during the period that were significant to the financial services
industry as a whole. These standards are itemized in the paragraphs that follow.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 141, "BUSINESS
COMBINATIONS" ("SFAS 141") This new standard requires the purchase method of
accounting for all mergers and acquisitions, except in very limited instances.
The Corporation adopted SFAS 141 in January 2002. This adoption did not have a
material impact on the Corporation because the acquisitions it completed in
2003, 2002, and 2001 would have been accounted for using the purchase method
regardless of SFAS 141. Refer to Note 15 of the Corporation's Audited
Consolidated Financial Statements, included herein under Item 8.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 142, "GOODWILL
AND OTHER INTANGIBLE ASSETS" ("SFAS 142") The Corporation adopted SFAS 142 in
January 2002. For further discussion, refer to "Goodwill and Intangible Assets"
in Note 1, as well as Note 6 of the Corporation's Audited Consolidated Financial
Statements, included herein under Item 8.
17
RESULTS OF OPERATIONS
OVERVIEW The Corporation's earnings for the years ended December 31,
2003, 2002, and 2001, were $34.7 million, $34.9 million, and $28.4 million,
respectively. These amounts represented returns on average assets of 1.11%,
1.23%, and 1.14%, respectively, and returns on average equity of 15.03%, 17.56%,
and 17.19%, respectively. Diluted earnings per share during these periods were
$1.69, $1.73, and $1.51, respectively.
The decrease in net income from 2002 to 2003 was principally due to
increases in non-interest expense (due primarily to compensation and employee
benefits and an FHLB prepayment penalty) and income tax expense (due in part to
a higher effective tax rate). These developments were partially offset by
increases in mortgage banking revenue, community banking revenue, and net
interest income, as well as a decline in provision for loan losses.
The increase in net income from 2001 to 2002 was principally due to
increases in net interest income, mortgage banking revenue, and community
banking revenue. These developments were partially offset by increases in
non-interest expense (particularly compensation and employee benefits),
provision for loan losses, and income tax expense (the latter due to higher
pre-tax earnings).
The following paragraphs discuss the aforementioned changes in greater
detail along with other changes in the components of net income during the years
ended December 31, 2003, 2002, and 2001.
NET INTEREST INCOME Net interest income increased by approximately
$268,000 or 0.3% and $18.3 million or almost 30% during the years ended December
31, 2003 and 2002, respectively. The improvement in both of these periods was
partly volume related as the Corporation's average interest-earning assets grew
by $226 million or 8.5% in 2003 and by $301 million or 12.8% in 2002. The
principal source of this growth occurred in the Corporation's mortgage-related
securities portfolio and in its consumer, commercial real estate, and commercial
business loan portfolios. Asset growth in both periods was principally funded by
an increase in deposit liabilities and, to a lesser degree, stockholders'
equity.
Also contributing to the increase in net interest income during 2003
and 2002 were significant increases in average non-interest-bearing deposit
liabilities, which was the principal reason the Corporation's ratio of average
interest-earning assets to average interest-bearing liabilities improved from
112% in 2001 to 115% in 2002 and to 117% in 2003. These improvements were due in
part to an increase in non-interest-bearing checking accounts. Also contributing
to the change, however, was an increased level of custodial deposit accounts.
The Corporation maintains borrowers' principal and interest payments in these
accounts on a temporary basis pending their remittance to the third-party owners
of the loans. Balances in these accounts increased significantly the past two
years because of increased loan prepayment activity, which was brought about by
a historically low interest rate environment.
The Corporation's interest rate spread declined from 2.64% in 2002 to
2.45% in 2003. This development almost entirely offset the aforementioned
increases in net interest income caused by growth in interest-earning assets and
non-interest-bearing liabilities. Market interest rates declined dramatically in
2002 and early 2003 and have remained at historically low levels since that
time. As a result, the Corporation experienced a larger decline in the yield on
its earning assets in 2003 than it did on its cost of funding sources, due
principally to high levels of refinance activity and the build-up of liquidity
on the Corporation's balance sheet. Unlike the most recent year, however, the
Corporation's interest rate spread increased from 2.12% in 2001 to 2.64% in
2002. This improvement was primarily the result of declines early in 2002 in the
Corporation's cost of deposits, which for that year exceeded the decline in
yield on the Corporation's earning assets.
Although the Corporation's interest rate spread declined for the entire
year 2003, the interest rate spread actually improved to 3.22% during the fourth
quarter of the year. This improvement was caused by the maturity of high-cost
certificates of deposit during the last half of the year, as well as the
prepayment of high-cost FHLB advances late in the third quarter. Also
contributing was an improved asset yield due to lower premium amortization on
purchased assets.
Management expects market interest rates to trend higher in 2004 as
economic conditions improve. However, management does not expect this movement
to be dramatic. As a result, management believes the Corporation will be able to
maintain its interest rate spread at or near the level experienced in the most
recent quarter. However, there can be no assurances.
During the first quarter of 2004 the Corporation expects to purchase up
to $300 million in short- to medium-term CMOs. Such purchases are expected to be
funded using term FHLB advances of six months to four years. Although there can
be no assurances, the pre-tax spread on these transactions is expected to be in
excess of 200 basis points. Because these
18
securities will be purchased by FCHI, the after-tax spread is expected to
approximate 150 basis points. Management believes this set of transactions alone
could add over $5.0 million to the Corporation's net interest income in 2004.
The following table sets forth information regarding the average
balances of the Corporation's assets, liabilities, and equity, as well as the
interest earned or paid and the average yield or cost of each. The information
is based on daily average balances for the years ended December 31, 2003, 2002,
and 2001.
Dollars in thousands
2003 2002 2001
-------------------------- --------------------------- ---------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
---------- -------- ------ ---------- ------- ------ ---------- ------- ------
Interest-earning assets:
Single-family mortgage loans $ 794,045 $ 40,970 5.16% $ 789,722 $49,673 6.29% $ 817,647 $58,799 7.19%
Commercial real estate loans 599,665 40,248 6.71 542,680 41,224 7.60 498,796 39,973 8.01
Consumer loans 528,416 34,951 6.61 439,491 33,476 7.62 355,504 30,530 8.59
Education loans 198,880 7,253 3.65 202,375 10,169 5.02 202,504 14,300 7.06
Commercial business loans 91,161 4,476 4.91 53,247 3,070 5.77 6,459 405 6.27
---------- -------- ------ ---------- ------- ------ ---------- ------- ------
Total loans 2,212,167 127,899 5.78 2,027,515 137,611 6.79 1,880,910 144,007 7.66
Mortgage-backed and
related securities 505,501 15,385 3.04 399,748 18,470 4.62 378,413 24,060 6.36
Investment securities - - - 2,865 92 3.14 6,482 209 3.15
Interest-bearing deposits
with banks 95,976 1,106 1.15 166,482 2,505 1.50 52,111 1,585 3.04
Other earning assets 57,082 3,529 6.18 48,455 2,571 5.31 26,281 1,672 6.36
---------- -------- ------ ---------- ------- ------ ---------- ------- ------
Total interest-earning assets 2,870,727 147,918 5.15 2,645,065 161,250 6.10 2,344,197 171,533 7.32
Non-interest-earning assets:
Office properties and equipment 40,046 33,560 28,652
Other assets 209,483 160,343 116,035
---------- -------- ------ ---------- ------- ------ ---------- ------- ------
Total assets $3,120,256 $2,838,968 $2,488,884
========== ======== ====== ========== ======= ====== ========== ======= ======
Interest-bearing liabilities:
Regular savings accounts $ 196,522 $ 492 0.25% $ 159,953 $ 1,151 0.72% $ 116,809 $ 1,529 1.31%
Checking accounts 147,899 595 0.40 118,122 475 0.41 80,221 573 0.71
Money market accounts 312,997 3,324 1.06 234,044 3,239 1.38 177,128 5,539 3.13
Certificates of deposit 1,378,053 44,997 3.27 1,346,628 52,218 3.89 1,257,943 75,944 6.04
---------- -------- ------ ---------- ------- ------ ---------- ------- ------
Total interest-bearing deposits 2,035,472 49,408 2.43 1,858,747 57,083 3.07 1,632,101 83,585 5.12
FHLB advances 374,722 16,135 4.31 432,325 22,393 5.18 401,954 22,061 5.49
Other borrowings 35,281 582 1.65 16,254 249 1.53 51,208 2,685 5.24
---------- -------- ------ ---------- ------- ------ ---------- ------- ------
Total interest-bearing liabilities 2,445,475 66,125 2.70 2,307,327 79,726 3.46 2,085,263 108,330 5.20
Non-interest-bearing liabilities:
Non-interest-bearing deposits 408,317 300,090 209,986
Other liabilities 35,419 32,680 28,098
---------- -------- ------ ---------- ------- ------ ---------- ------- ------
Total liabilities 2,889,210 2,640,097 2,323,347
Stockholders' equity 231,046 198,871 165,537
---------- -------- ------ ---------- ------- ------ ---------- ------- ------
Total liabilities and
stockholders' equity $3,120,256 $2,838,968 $2,488,884
========== ======== ====== ========== ======= ====== ========== ======= ======
Net interest income $ 81,793 $81,525 $63,202
========== ======== ====== ========== ======= ====== ========== ======= ======
Interest rate spread 2.45% 2.64% 2.12%
========== ======== ====== ========== ======= ====== ========== ======= ======
Net interest income as a percent
of average earning assets 2.85% 3.08% 2.70%
========== ======== ====== ========== ======= ====== ========== ======= ======
Average interest-earning assets
to average interest-bearing
liabilities 117.39% 114.64% 112.42%
========== ======== ====== ========== ======= ====== ========== ======= ======
Note: total interest-earning assets include non-accrual loans.
19
The following table sets forth the effects of changing rates and
volumes on net interest income of the Corporation for the periods indicated.
Information is provided with respect to (i) effects on net interest income
attributable to changes in volume (changes in volume multiplied by prior rate);
(ii) effects on net interest income attributable to changes in rate (changes in
rate multiplied by prior volume); (iii) changes attributable to combined effects
of rate and volume (changes in rate multiplied by changes in volume); and (iv)
the net change in interest income.
Dollars in thousands
2003 COMPARED TO 2002 2002 COMPARED TO 2001
INCREASE (DECREASE) INCREASE (DECREASE)
-------------------------------------- --------------------------------------
RATE/ RATE/
RATE VOLUME VOLUME NET RATE VOLUME VOLUME NET
-------- -------- -------- -------- -------- -------- -------- --------
Interest-earning assets:
Single-family mortgage loans ($ 8,929) $ 272 ($ 49) ($ 8,706) ($ 7,369) ($ 2,008) $ 251 ($ 9,126)
Commercial real estate loans (4,800) 4,335 (505) (970) (2,088) 3,523 (178) 1,251
Consumer loans (4,406) 6,773 (892) 1,475 (3,452) 7,213 (815) 2,946
Education loans (2,788) (176) 48 (2,916) (4,125) (9) 3 (4,131)
Commercial business loans (456) 2,186 (325) 1,405 (33) 2,934 (236) 2,665
-------- -------- -------- -------- -------- -------- -------- --------
Total loans (21,379) 13,390 (1,723) (9,713) (17,067) 11,653 (982) (6,396)
Mortgage-backed and related securities (6,304) 4,886 (1,668) (3,086) (6,576) 1,356 (370) (5,590)
Investment securities (92) (92) 92 (92) -- (116) (1) (117)
Interest-bearing deposits with banks (588) (1,061) 249 (1,400) (800) 3,478 (1,758) 920
Other earning assets 425 458 76 959 (279) 1,410 (232) 899
-------- -------- -------- -------- -------- -------- -------- --------
Total net change in income on
interest-earning assets (27,938) 17,581 (2,974) (13,332) (24,722) 17,781 (3,342) (10,283)
-------- -------- -------- -------- -------- -------- -------- --------
Interest-bearing liabilities:
Interest-bearing deposits (9,751) 2,658 (581) (7,675) (31,173) 7,969 (3,298) (26,502)
FHLB advances (3,778) (2,984) 503 (6,259) (1,241) 1,667 (94) 332
Other borrowings 19 292 22 333 (1,899) (1,833) 1,296 (2,436)
-------- -------- -------- -------- -------- -------- -------- --------
Total net change in expense on
interest-bearing liabilities (13,510) (34) (56) (13,600) (34,313) 7,803 (2,094) (28,604)
-------- -------- -------- -------- -------- -------- -------- --------
Net change in net interest income ($14,428) $ 17,615 ($ 2,918) $ 268 $ 9,591 $ 9,978 ($ 1,246) $ 18,323
======== ======== ======== ======== ======== ======== ======== ========
PROVISION FOR LOAN LOSSES Provision for loan losses was $1.5 million,
$3.5 million, and $1.8 million during the years ended December 31, 2003, 2002,
and 2001, respectively. During 2003, the Corporation did not record any loss
provisions over-and-above its actual charge-off activity due primarily to
diminished growth in its loans held for investment. Also affecting 2003
favorably was the recapture of $550,000 in specific loss allowances that were
established in the fourth quarter of 2002 on three business loan relationships
that subsequently paid off in 2003. During 2002 and 2001, the Corporation
recorded approximately $1.7 million and $672,000, respectively, in provision for
loan losses over-and-above its actual net charge-off activity. These additional
provisions were recorded to maintain the Corporation's allowance for loan losses
at a level deemed appropriate by management, and were considered proper in light
of significant growth in the Corporation's loans held for investment, an
increased mix of higher-risk consumer loans, commercial real estate loans, and
commercial business loans, and an increase in non-performing and classified
assets. Also impacting provision for loan losses in 2002 were the specific loss
allowances that had been established on the aforementioned business loan
relationships that paid off in 2003. In 2002, all or a portion of the loans in
these three relationships were past due and legal action had commenced to
collect that which was owed.
As of December 31, 2003, 2002, and 2001, the Corporation's allowance
for loan losses was $13.9 million, $11.7 million, and $10.0 million,
respectively, or 0.55%, 0.55%, and 0.54% of loans held for investment,
respectively. The allowance for loan losses was 145%, 217%, and 176% of
non-accrual loans as of the same dates, respectively. For additional discussion,
refer to "Financial Condition--Non-Performing Assets".
20
The following table summarizes the activity in the Corporation's
allowance for loan losses during each of years indicated. The allowance on loans
acquired in acquisition shown for 2003 and 2001 were from the acquisitions of
Liberty Bancshares, Inc. ("LBI") and American Community Bancshares, Inc.
("ACB"), respectively.
Dollars in thousands
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
Balance at beginning of period $ 11,658 $ 9,962 $ 8,028 $ 7,624 $ 7,624
Provision for losses 1,456 3,468 1,763 1,009 387
-------- -------- -------- -------- --------
Charge-offs:
Single-family mortgage loans 58 49 96 - -
Consumer loans 2,054 1,759 1,057 632 408
Education loans 45 31 36 33 26
Commercial business loans 49 6 - - -
-------- -------- -------- -------- --------
Total loans charged-off 2,206 1,845 1,189 665 434
Recoveries 101 73 98 60 47
-------- -------- -------- -------- --------
Charge-offs net of recoveries 2,105 1,772 1,091 605 387
Allowance on loans acquired in acquisition 2,874 - 1,262 - -
-------- -------- -------- -------- --------
Balance at end of period $ 13,882 $ 11,658 $ 9,962 $ 8,028 $ 7,624
======== ======== ======== ======== ========
Net charge-offs as a percentage of average loans outstanding 0.10% 0.09% 0.06% 0.04% 0.03%
======== ======== ======== ======== ========
Ratio of allowance to total loans held for investment at end of period 0.55% 0.55% 0.54% 0.45% 0.50%
======== ======== ======== ======== ========
Ratio of allowance to total non-accrual loans 145% 217% 176% 256% 724%
======== ======== ======== ======== ========
Note: there were no charge-offs of commercial real estate loans during the five
years ended December 31, 2003.
The following table shows the Corporation's total allowance for loan
losses and the allocation to the various loan categories as of December 31 for
each of the years indicated.
Dollars in thousands
2003 2002 2001 2000 1999
-------------- -------------- ------------- ------------- --------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
------- ---- ------- ---- ------ ---- ------ ----- ------ -----
Single-family mortgage loans $ 1,159 0.15% $ 1,159 0.16% $ 140 0.02% $ 149 0.02% $ 144 0.02%
Commercial real estate loans 6,314 0.89 5,669 1.12 7,665 1.50 7,257 1.65 7,088 2.00
Consumer loans 2,624 0.45 1,138 0.23 873 0.25 585 0.17 355 0.13
Commercial business loans 3,786 2.38 3,692 5.13 1,284 3.31 37 18.97 37 12.50
------- ---- ------- ---- ------ ---- ------ ----- ------ -----
Total allowance for loan losses $13,882 0.55% $11,658 0.55% $9,962 0.54% $8,028 0.45% $7,624 0.50%
======= ==== ======= ==== ====== ==== ====== ===== ====== =====
The amounts in the preceding table are expressed as a percentage of
gross loans outstanding for each loan category, excluding construction loans.
The total allowance is expressed as a percent of net loans held for investment.
There was no allowance for loan losses allocated to education loans as of
December 31 for any of the years presented.
Although management believes that the Corporation's present level of
allowance for loan losses is adequate, there can be no assurance that future
adjustments to the allowance will not be necessary, which could adversely affect
the Corporation's results of operations.
NON-INTEREST INCOME Non-interest income for the years ended December
31, 2003, 2002, and 2001, was $86.5 million, $63.6 million, and $49.5 million,
respectively. These amounts represented 51%, 44%, and 44% of the Corporation's
total revenue during such periods, respectively. The following paragraphs
discuss the principal components of non-interest income and the primary reasons
for their changes from 2002 to 2003 and 2001 to 2002.
COMMUNITY BANKING REVENUE Community banking revenue increased
by $6.1 million or 18.2% in 2003 and by $4.6 million or 15.8% in 2002. The
following table shows the Corporation's community banking revenue for the
twelve-month periods ended December 31.
Dollars in thousands
2003 2002 2001
------- ------- -------
Overdraft fees $20,036 $16,411 $14,132
ATM and debit card fees 10,932 9,837 7,916
Account service charges 2,548 2,205 1,863
Other fee income 1,696 1,464 1,299
------- ------- -------
Total deposit account revenue 35,212 29,917 25,210
------- ------- -------
Consumer loan insurance premiums and commissions 1,070 1,021 1,061
Other consumer loan fees 392 350 320
------- ------- -------
Total consumer loan revenue 1,462 1,371 1,381
------- ------- -------
Tax-deferred annuity commissions 1,562 1,501 2,116
Retail brokerage commissions 1,484 809 304
------- ------- -------
Total investment services revenue 3,046 2,310 2,420
------- ------- -------
Total community banking revenue $39,720 $33,598 $29,011
======= ======= =======
21
Deposit account revenue increased by $5.3 million or 17.7% in
2003 and by $4.7 million or 18.7% in 2002. This increase was due mostly to a
$3.6 million or 22.1% increase and a $2.3 million or 16.1% increase in overdraft
fees in 2003 and 2002, respectively. Also contributing to the increase in both
periods was a $1.1 million or 11.1% increase and a $1.9 million or nearly 25%
increase in fees from customers' use of debit cards and ATMs, respectively.
These increases were due in part to 12.5% and 12.1% growth in the number of
checking accounts serviced by the Corporation in 2003 and 2002, respectively.
Also contributing was an increase in per-item charges, as well as changes in
charging routines for certain services.
On August 1, 2003, interchange fees for issuers of debit cards
were reduced by MasterCard and Visa. This action arose out of the settlement of
a lawsuit by certain merchants against MasterCard and Visa. As a result of this
action, the Corporation believes its debit card income, a component of community
banking revenue, will decline by up to $500,000 per quarter based on historical
activity. Furthermore, during the first quarter of 2004, new interchange rates
are expected to go into effect. These rates will vary by merchant or merchant
category. Until these rates have been finalized, debit card issuers like the
Corporation will not be able to determine the impact such rate changes will have
on revenues from their debit card programs.
Consumer loan revenue increased by $91,000 or 6.6% in 2003 and
declined by $10,000 or less than 1% in 2002. The Corporation's principal sources
of consumer loan revenue consist of sales of credit life and disability
insurance policies to consumer loan customers. The increase in 2003 was
primarily the result of an increase in premium and commission revenue associated
with increased originations. While this trend also occurred during 2002, the
impact in that year was substantially offset by increased losses on insurance
claims. The Bank's wholly-owned reinsurance subsidiary, FRI, assumes the first
level of risk on these credit life and disability policies. Refer to Part I,
Item 1, "Business--Subsidiaries" for additional discussion.
Investment services revenue increased by $736,000 or nearly
32% in 2003 and declined by $110,000 or 4.5% in 2002. The Corporation's
principal sources of investment services revenue consist of commissions from
sales of tax-deferred annuities, mutual funds, and other debt and equity
securities. The increase during 2003 was due primarily to higher commissions
from sales of mutual funds and other equity investments caused in part by an
increase in the number of registered representatives in the Corporation's
offices. Also contributing was an improved equity market in 2003. The
combination of these events contributed to an increase in investor confidence
and their preference for these product offerings. The decline in 2002 was
primarily attributable to a response to general declines in market interest
rates that made tax-deferred annuities less attractive to the Corporation's
customers.
MORTGAGE BANKING REVENUE Mortgage banking revenue increased by
$16.6 million or over 60% in 2003 and by $9.2 million or 50% in 2002. The
following table shows the Corporation's mortgage banking revenue for the periods
ended December 31.
Dollars in thousands
2003 2002 2001
---------- ---------- ----------
Gross servicing fees $ 10,676 $ 9,532 $ 8,374
Mortgage servicing rights amortization (28,729) (25,274) (15,971)
Mortgage servicing rights valuation (loss) recovery 3,350 (750) 67
---------- ---------- ----------
Total loan servicing fees, net (14,703) (16,492) (7,530)
---------- ---------- ----------
Gain on sale of mortgage loans 56,989 42,208 24,373
Other mortgage-related income 1,758 1,758 1,421
---------- ---------- ----------
Total mortgage banking revenue $ 44,044 $ 27,474 $ 18,264
========== ========== ==========
Gross servicing fees increased by $1.1 million or 12.0% in
2003 and by $1.2 million or 13.8% in 2002. These increases were due primarily to
a $370 million or 13.2% and a $505 million or 22.0% growth in average loans
serviced for others in 2003 and 2002, respectively, compared to the year-ago
periods. The growth in both periods was caused by a significant increase in the
origination and sale of fixed-rate mortgage loans, as described in a later
paragraph. Also contributing were increased conversions by borrowers of
adjustable-rate mortgage loans into fixed-rate loans. Upon conversion, such
loans are generally sold in the secondary market and the Corporation retains the
servicing.
Amortization of mortgage servicing rights was $28.7 million,
$25.3 million, and $16.0 million in 2003, 2002, and 2001, respectively. With
market interest rates at historically low levels in 2003 and 2002, loan
prepayment activity increased dramatically as borrowers refinanced older,
higher-rate, residential mortgage loans, into lower-rate loans. As a result of
this activity, the Corporation recorded significant amortization of mortgage
servicing rights in 2003 and 2002.
Although there can be no assurances, management believes
interest rates will move higher in 2004. If this occurs, the Corporation will
most likely experience lower levels of amortization on its MSRs as a result of
reduced levels of loan prepayment activity. Such amortization, however, will
most likely be offset by lower levels of gains on sales
22
of mortgage loans, as described in a subsequent paragraph. As indicated in Note
4 of the Corporation's Audited Consolidated Financial Statements, included
herein under Item 8, amortization of MSRs varies considerably from period to
period. Readers wishing to forecast amortization for 2004 may want to use the
relationship between amortization and gross servicing fees in 2000 as a starting
point for their forecast. During that year, interest rates were generally higher
than they were in the preceding year, which is also management's expectations
for 2004, as previously noted. During 2000, amortization of MSRs was
approximately 48% of gross servicing fees.
During the twelve months ended December 31, 2003, the
Corporation recaptured $3.4 million in its valuation allowance for mortgage
servicing rights. This allowance had been established in previous periods as a
result of declining mortgage rates. The recapture was principally the result of
increases in mortgage rates during the last half of 2004, which lowered market
expectations for future prepayment activity. The balance in the valuation
allowance was zero at December 31, 2003 as a result of higher mortgage rates. It
should be noted, however, if market interest rates decline in the future the
Corporation may be exposed to unfavorable valuation adjustments against its
portfolio of MSRs--primarily because of probable increases in market
expectations for future prepayments.
At December 31, 2003 and 2002, loans serviced for others were
$3.3 billion and $3.0 billion, respectively. As of the same dates, mortgage
servicing rights were $36.3 million and $30.2 million, respectively. For
additional discussion, relating to mortgage servicing rights, refer to
"Financial Condition--Mortgage Servicing Rights", Part I, Item 1,
"Business--Lending Activities", and Notes 1 and 4 of the Corporation's Audited
Consolidated Financial Statements, included herein under Part II, Item 8,
"Financial Statements and Supplementary Data".
Gains on sales of mortgage loans for the years ended December
31, 2003, 2002, and 2001, were $57.0 million, $42.2 million, and $24.4 million,
respectively. The increase in 2003 and 2002 was primarily attributable to a $529
million or 28% and $467 million or 34% increase in the Corporation's mortgage
loan sales in such periods, respectively. These increases were due to a
historically low interest rate environment that resulted in increased
originations of fixed-rate mortgage loans, as well as increased conversions of
adjustable-rate loans into fixed-rate loans, both of which were generally sold
in the secondary market.
Also contributing to the increase in gains on sales of
mortgage loans in 2003 and 2002 was an increase in the average gain on
individual sales of such loans. In 2003, the average gain was 2.42% compared to
2.30% in 2002 and 1.76% in 2001. These increases were caused by a wider spread
between the mortgage rates charged to borrowers by the Corporation and the yield
demanded by investors in the secondary market. Contributing to a lesser degree
was improved management of the Corporation's mortgage loan pipeline.
Market interest rates have increased in recent months from
historically low levels. If this trend continues, management expects the
Corporation's gains on sales of mortgage loans to be substantially lower in 2004
than they were in 2003. The decline in gains, however, may be offset to some
degree by decreased amortization of MSRs, as more fully described in a previous
paragraph.
Other mortgage-related income was $1.8 million, $1.8 million,
and $1.4 million for the years ended December 31, 2003, 2002, and 2001,
respectively. The increase in 2002 was due in part to increases in fees from
customers' conversions of adjustable-rate mortgage loans into fixed-rate
mortgage loans due to the low interest rate environment, as previously
described. Also contributing were increases in fees received on loans originated
as agent for the Wisconsin State Veterans Administration and the Wisconsin
Housing and Economic Development Authority.
GAIN (LOSS) ON SALES OF INVESTMENTS AND OTHER ASSETS Gain
(loss) on sales of investments and other assets was zero, ($166,000), and
$63,000 for the years ended December 31, 2003, 2002, and 2001, respectively. The
loss in 2002 was due to the sale of $35.5 million in callable securities issued
by various agencies of the U.S. government. Despite the loss on the sale, the
holding period return on these securities was comparable to a money market
yield, which was the Corporation's minimum expectation when it purchased the
securities.
OTHER NON-INTEREST INCOME Other non-interest income increased
by $53,000 or 1.9% in 2003 and by $540,000 or 25% in 2002. The increase in 2003
was due primarily to a gain on the sale of a limited partnership interest in
Turtle Creek Corporation, one of the Bank's wholly-owned subsidiaries. As a
result of this sale, the Corporation expects to liquidate this subsidiary in
2004. The increase in 2002 was due in part to increases in the cash surrender
value of the Corporation's bank owned life insurance policies. Also contributing
to the increase in 2002 was the receipt of a special dividend related to the
Corporation's ownership in its primary ATM network provider.
23
NON-INTEREST EXPENSE Non-interest expense for the years ended December
31, 2003, 2002, and 2001, was $111.7 million, $87.4 million, and $67.1 million,
respectively. Excluding a $7.4 million FHLB prepayment penalty, non-interest
expense as a percent of average assets during these periods was 3.32%, 3.08%,
and 2.70%, respectively. The following paragraphs discuss the principal
components of non-interest expense and the primary reasons for their changes
from 2002 to 2003 and 2001 to 2002.
COMPENSATION AND EMPLOYEE BENEFITS Compensation and employee
benefits increased by $9.2 million or 17.4% in 2003 and $12.8 million or over
30% in 2002. In general, the increase in both periods was due to normal annual
merit increases, as well as growth in the number of banking facilities operated
by the Corporation and the resulting increase in the number of employees. Since
December 31, 2001, the Corporation has increased the number of its banking
facilities from 78 to 95. In October 2001, the Corporation obtained two
locations as a result of its acquisition of ACB in Wausau, Wisconsin, and in
April 2002 the Corporation completed the purchase of three banking locations
from another financial institution in Rochester, Minnesota. In September 2002,
the Corporation acquired four banking facilities in south-eastern Minnesota from
another financial institution. Finally, in October 2003, the Corporation
obtained one office as a result of its acquisition of LBI in St. Paul,
Minnesota. In addition, during this two-year period the Corporation opened ten
new banking offices and closed three offices. As of December 31, 2003, the
Corporation had 1,362 full-time equivalent employees. This compared to 1,213 and
1,033 as of December 31, 2002 and 2001, respectively.
Also contributing to the increase in compensation and employee
benefits in 2003 were increased salaries to employees hired over the past year
to support the implementation of the Corporation's business banking product
line, as well as higher commissions to mortgage loan originators, the latter
caused primarily by an increase in mortgage loan originations. During the first
quarter of 2003, the Corporation began offering business banking products in its
Oshkosh, Wisconsin, market. The Corporation intends to extend its business
banking product offerings into Appleton and Madison, Wisconsin markets during
the first half of 2004, and to additional markets in 2004, although there can be
no assurances. Compensation and employee benefits in both years was also
impacted by an increase in the cost of employee healthcare benefits. Such costs
rose by $669,000 or 18.6% in 2003 and by $547,000 or 18.0% in 2002.
OCCUPANCY AND EQUIPMENT Occupancy and equipment expense
increased by $2.6 million or 24.1% in 2003 and $2.0 million or 22.9% in 2002.
These increases were primarily attributable to growth in the number of banking
facilities operated by the Corporation, as well as increases in the number of
full-time equivalent employees and in the number of customers served by the
Corporation.
COMMUNICATIONS, POSTAGE, AND OFFICE SUPPLIES Communications,
postage, and office supplies expense increased by $730,000 or 11.4% in 2003 and
$1.2 million or 21.9% in 2002. These increases were also attributable to growth
in the number of banking facilities operated by the Corporation, as well as
increases in the number of full-time equivalent employees and in the number of
customers served by the Corporation.
ATM AND DEBIT CARD TRANSACTION COSTS ATM and debit card
transaction costs increased by $814,000 or 20.3% in 2003 and $763,000 or 23.5%
in 2002. The increase in both years was attributable to increased use by the
Corporation's customers of ATM and debit card networks, as well as an increase
in the number of ATMs operated by the Corporation. During 2003, the Corporation
increased to 137 the number of ATMs it owns and operates in its market areas, as
compared to 114 at the end of 2002.
ADVERTISING AND MARKETING Advertising and marketing costs
increased by $255,000 or 7.7% in 2003 and $710,000 or over 25% in 2002. These
increases correspond to general increases in prices for marketing-related
products and services, as well as increases in the number of communities and/or
market areas served by the Corporation.
AMORTIZATION OF INTANGIBLES Amortization of intangible assets,
which in 2003 and 2002 consisted primarily of deposit-based intangibles,
increased by $305,000 or approximately 44% in 2003 and decreased by $387,000 or
over 35% in 2002. The increase in 2003 was attributed to increased amortization
of the deposit-based intangibles recorded in connection with the Corporation's
acquisitions in the second and third quarters of 2002 and in the fourth quarter
of 2003. The decrease in 2002 was caused by the Corporation's adoption of SFAS
142 in January 2002 (for more information, refer to Note 6 of the Corporation's
Audited Consolidated Financial Statements, included herein under Part II, Item
8, "Financial Statements and Supplementary Data").
FHLB PREPAYMENT PENALTY During the third quarter of 2003 the
Bank prepaid $128 million in term advances from the FHLB and incurred a
prepayment penalty of $7.4 million. The advances had a remaining maturity of 1.3
years and a weighted average cost of 5.84%. They were replaced by overnight
borrowings from the FHLB at a
24
substantially lower rate. Management estimates that this action will increase
the Bank's net interest income by $5.9 million in 2004, assuming no change in
overnight borrowing rates.
OTHER NON-INTEREST EXPENSE Other non-interest expenses increased by
$3.0 million or more than 30% in 2003, and by $3.2 million or over 50% in 2002.
The increases in these periods were caused by a variety of factors, the most
significant of which was increased costs related to servicing of loans for
Fannie Mae and FHLB, which increased by $1.7 million or 75% in 2003 and by $1.2
million or over 115% in 2002. Under the terms of its servicing agreements with
these investors, the Corporation is required to forward a full month's interest
to the investors when certain loans are repaid, regardless of the actual date of
the loan payoff. A historically low interest rate environment and increased
prepayment activity in 2003 and 2002 resulted in higher prepayment and refinance
activity, which increased the amount of "loan pay-off interest" remitted to
Fannie Mae and FHLB. Also contributing to the increase in 2003 were losses on
the disposition of various residential properties. These developments were
partially offset by a decline in provision for customer losses and
merger-related expenditures. Also contributing to the increase in 2002 were
higher merger-related costs associated with the ACB and Rochester acquisitions,
and the establishment of a $416,000 loss allowance for items in the process of
collection from customers.
INCOME TAX EXPENSE Income tax expense for the years ended December 31,
2003, 2002, and 2001, was $20.4 million, $19.4 million, and $15.4 million,
respectively, or 37.0%, 35.7%, and 35.1% of pretax income, respectively. The
increase in the Corporation's effective income tax rate during 2003 and 2002 was
due to a higher mix of taxable earnings in the State of Wisconsin relative to
the State of Nevada, where the Corporation has established a wholly-owned
investment subsidiary and which has no corporate state income tax. Refer to Part
I, Item 1, "Business--Subsidiaries" and "Business--Taxation", for additional
discussion relating to the Corporation's tax situation.
SEGMENT INFORMATION The following paragraphs contain a discussion of
the financial performance of each of the Corporation's reportable segments
(hereafter referred to as "profit centers") for the years ended December 31,
2003, 2002, and 2001. This section of the report should be read in conjunction
with Note 14 of the Corporation's Audited Consolidated Financial Statements,
included herein under Part II, Item 8, "Financial Statements and Supplementary
Data".
The following table summarizes the after-tax profits (losses) of the
Corporation's profit centers during each of the years ended December 31, 2003,
2002, and 2001.
PROFIT (LOSS) BY PROFIT CENTER 2003 2002 2001
- ------------------------------ ------------ ------------ ------------
Mortgage banking $ 17,079,914 $ 11,679,493 $ 5,192,458
Residential loans 4,710,836 7,757,952 6,953,652
Commercial real estate lending 8,969,674 9,839,007 5,344,423
Consumer lending 6,229,968 6,362,992 4,039,371
Education lending 688,086 2,090,320 2,978,899
Business banking 528,643 - -
Investment and mortgage-related securities (175,662) 390,063 1,138,434
Other segments (489,770) (587,058) (145,142)
------------ ------------ ------------
Subtotal 37,541,689 37,532,766 25,502,095
Non-GAAP adjustments (2,815,145) (2,617,224) 2,946,129
------------ ------------ ------------
Net income $ 34,726,545 $ 34,915,542 $ 28,448,225
============ ============ ============
MORTGAGE BANKING Profits from the Corporation's mortgage
banking activities were $17.1 million in 2003 compared to $11.7 million in 2002
and $5.2 million in 2001. Loan origination volumes and loan servicing fees are
the principal drivers of performance in this profit center. The Corporation's
mortgage banking operation originated $2.7 billion, $2.2 billion, and $1.5
billion in single-family residential loans in the years ended December 31, 2003,
2002, and 2001, respectively. This improvement resulted in a similar increase in
the internal origination fees allocated to the mortgage banking profit center.
In 2003 and 2002, higher proportions of the Corporation's loan
originations were the result of increases in refinance activity. In such
environments, a substantial portion of the internal revenue allocated to the
mortgage banking profit center for loan originations is offset by an increase in
internal charges for lost servicing value. This methodology for measuring
results in the mortgage banking profit center recognizes that during periods of
high refinance activity the Corporation incurs significant costs related to the
preservation of existing mortgage customer relationships, rather than the
creation of new customer relationships. However, during 2003 and 2002, a
substantial improvement in the average gain on sale of mortgage loans offset
increases in internal charges for lost servicing value. The improvement in
average gain was principally the result of wider spreads in the secondary market
and, to a lesser degree, improved management of the mortgage loan pipeline.
25
RESIDENTIAL LOANS Profits from the Corporation's residential
loan portfolio decreased by $3.0 million, or 39.3% in 2003 compared to 2002.
Profits increased by $804,000 or 11.6% in 2002 compared to 2001. This profit
center is funded by a mix of deposit liabilities and wholesale borrowings. The
yield on the profit center's single family loans declined by 113 basis points
between 2003 and 2002. In contrast, the Corporation's average cost of
interest-bearing liabilities declined by only 76 basis points between the same
periods. A decline in average assets of $29.0 million or 3.4% also contributed
to the decrease in profits between 2003 and 2002. Also, net charge-offs assigned
to the profit center increased by $382,000 between the same periods.
In 2002, earnings for this profit center benefited from an 84
basis point increase in its interest rate spread. The improvement in this profit
center's earnings in 2002 compared to 2001 occurred despite a $107 million or
11.2% decline in the average assets assigned to the profit center.
COMMERCIAL REAL ESTATE LENDING Profits from commercial real
estate lending were $9.0 million, $9.8 million, and $5.3 million for the years
ended December 31, 2003, 2002, and 2001, respectively. The decrease in profits
in 2003 compared to 2002 was largely due to average assets decreasing by $28.7
million or 5.1% in 2003 compared to 2002. The interest rate spread for this
profit center also declined in 2003 compared to the previous year. This profit
center is primarily funded by deposit liabilities and, to a lesser extent, by
wholesale borrowings. The yield on commercial real estate loans declined by 89
basis points between 2003 and 2002. The Corporation's average cost of
interest-bearing liabilities declined by only 76 basis points between these same
periods.
The improvement in 2002 compared to 2001 was principally the
result of a significant increase in the profit center's interest rate spread
compared to the previous year. The Corporation's average cost of
interest-bearing liabilities declined by 174 basis points between 2002 and 2001.
The yield on commercial real estate loans, however, declined by only 41 basis
points between these years. Average assets increased by $41.0 million or 7.9% in
2002 compared to 2001.
CONSUMER LENDING Profits in the Corporation's consumer lending
profit center were $6.2 million, $6.4 million, and $4.0 million for the years
ended December 31, 2003, 2002, and 2001, respectively. The decrease in profits
in 2003 compared to 2002 was due to a decrease in interest rate spread. Similar
to commercial real estate loans, this profit center is principally funded by
deposit liabilities and, to a lesser extent, by wholesale borrowings. The yield
on consumer loans declined by 101 basis points between 2003 and 2002. The
Corporation's average cost of interest-bearing liabilities declined by only 76
basis points between these same periods. Average assets increased by $27.5
million or 6.0% in 2003 compared to 2002.
Profits increased in 2002 compared to 2001 largely due to an
increase in interest rate spread. The Corporation's average cost of
interest-bearing liabilities declined by 174 basis points between 2002 and 2001.
The yield on consumer loans, however, declined by only 97 basis points between
these same periods. A $86.2 million or 22.9% increase in the profit center's
average assets during 2002 also contributed to the increase in profits in 2002
compared to the previous year. The performance of this profit center was
adversely impacted by an increase in loan charge-off activity of $608,000 or 56%
in 2002 compared to the previous year.
EDUCATION LENDING Profits from education lending were
$688,000, $2.1 million, and $3.0 million for the years ending December 31, 2003,
2002, and 2001, respectively. These declines were due in part to decreases in
the profit center's interest rate spread during these years. Education loans
carry a floating rate of interest based on various three-month market indices.
During 2003 and 2002, the average yield on education loans declined more than
the average cost of the funding sources for the profit center, which consist
primarily of money market demand accounts. Average assets assigned to this
profit center were $209 million, $210 million, and $212 million for the years
ended December 31, 2003, 2002, and 2001, respectively.
INVESTMENT AND MORTGAGE-RELATED SECURITIES Profits (losses)
from the Corporation's investment securities portfolio were ($176,000),
$390,000, and $1.1 million for the year's ending December 31, 2003, 2002, and
2001, respectively. These declines were primarily due to a decrease in the
profit center's interest rate spread in 2003 and 2002 compared to 2001. These
declines are largely due to accelerated prepayments of higher yielding
securities. Due to the negative interest rate spread in this profit center in
2003, an increase of $87.3 million or 14.9% in average assets contributed to the
decline in profits in 2003 compared to 2002. The income tax benefit relative to
pretax income declined in 2003 compared to 2002 due to a decline in profits
generated by FCHI, the Bank's wholly-owned subsidiary in Nevada, relative to
total profits (losses) for the profit center. The performance of this profit
center in 2002 was adversely impacted by a $166,000 loss on the sale of certain
investment securities as described elsewhere in this report.
26
OTHER SEGMENTS This segment consists of the parent holding
company and certain of the Bank's wholly-owned subsidiaries. In addition, in
2002 and 2001 this profit center contains the preliminary results of the
Corporation's new line of business--business banking. The financial results of
this profit center were not reported separately in 2002 and 2001 due to
continuing efforts to develop the departmental allocations of costs and revenues
necessary to fairly present the operating results of this line of business.
NON-GAAP ADJUSTMENTS Non-GAAP adjustments were ($2.8) million,
($2.6) million, and $2.9 million for the years ended December 31, 2003, 2002,
and 2001, respectively. Non-GAAP adjustments decreased by $198,000 in 2003
compared to 2002 due to an increase in both FHLB prepayment penalties and
residential loan production, which increased the internally-generated
origination fees recorded in the mortgage banking profit center. This more than
offset an increase in charge-offs of internally-generated mortgage loan
servicing rights that continued because of further declines in interest rates.
Non-GAAP adjustments decreased by $5.6 million in 2002
compared to 2001 due in part to an increase in residential loan production as
noted previously. Also contributing to the decrease in non-GAAP adjustments was
the fact that the internal adjustment related to loan losses was larger than the
prior year.
NET COST TO ACQUIRE AND MAINTAIN DEPOSIT LIABILITIES In
addition to the after-tax performance of the aforementioned profit centers,
management of the Corporation closely monitors the net cost to acquire and
maintain deposit liabilities. The Corporation's profit centers are allocated a
share of the net cost to acquire and maintain deposit liabilities according to
their proportionate use of such deposits as a funding source. As such, changes
in the net cost to acquire and maintain deposit liabilities will impact most of
the Corporation's profit centers.
The net cost to acquire and maintain deposit liabilities was
1.36%, 1.33%, and 1.20% of average deposit liabilities outstanding during the
years ended December 31, 2003, 2002, and 2001 respectively. The increase in net
cost between these periods was the result of a larger increase in the
Corporation's net costs of operating its branch network than its average deposit
liabilities. As discussed elsewhere in this report, the Corporation has incurred
significant costs in recent years to expand its branch network, as well as its
product offerings.
FINANCIAL CONDITION
OVERVIEW The Corporation's total assets increased by $283 million or
9.3% during the twelve months ended December 31, 2003. This increase was due in
part to the acquisition of $451 million in assets of Liberty Bancshares, Inc.
("LBI") on October 10, 2003. For additional discussion, refer to Note 14 of the
Corporation's Audited Consolidated Financial Statements, included herein under
Part II, Item 8, "Financial Statements and Supplementary Data").
Excluding the effect of the LBI acquisition, total assets decreased by
approximately $168 million or 5.6% in 2003. This decrease was due primarily to
declines in overnight investments and loans held for sale, the proceeds from
which were redirected in part to mortgage-related securities and loans held for
investment, as well as a net reduction in deposit liabilities and FHLB advances.
INTEREST-BEARING DEPOSITS WITH BANKS Interest-bearing deposits with
banks, which consist of overnight investments at the FHLB and short-term money
market accounts, decreased by $173 million from $180 million at December 31,
2002, to $6.4 million at December 31, 2003. This decrease was the result of the
reinvestment of these balances into other interest-earning assets such as
mortgage-related securities and loans held for investment.
MORTGAGE-BACKED AND RELATED SECURITIES The Corporation's aggregate
investment in its mortgage-backed and related securities portfolios decreased by
$8.6 million or 2.2% during the twelve months ended December 31, 2003. During
this period, principal repayments in the portfolio offset the purchase of $476
million in short- and medium-term, fixed-rate collateralized mortgage
obligations ("CMOs"), as well as a $102 million floating-rate CMO. Principal
repayments on mortgage-related securities increased substantially during 2003 as
a result of a historically low interest rate environment that encouraged
borrowers to refinance higher-rate mortgage loans into lower-rate loans.
27
The following table sets forth the composition of the Corporation's
mortgage-backed and related securities portfolios as of December 31 for each of
the years indicated.
Dollars in thousands
2003 2002 2001
-------------------- -------------------- --------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
--------- --------- --------- --------- --------- ---------
Available for sale:
Collateralized mortgage obligations $ 362,605 $ 362,037 $ 321,054 $ 321,865 $ 221,777 $ 223,399
Mortgage-backed securities 23,474 24,825 41,441 44,210 81,011 82,581
--------- --------- --------- --------- --------- ---------
Total available for sale 386,079 386,862 362,495 366,075 302,789 305,980
--------- --------- --------- --------- --------- ---------
Held for investment:
Collateralized mortgage obligations - - 29,130 29,290 132,755 133,666
Mortgage-backed securities 613 610 900 902 1,255 1,272
--------- --------- --------- --------- --------- ---------
Total held for investment 613 610 30,030 30,192 134,010 134,937
--------- --------- --------- --------- --------- ---------
Total mortgage-backed and related securities $ 386,692 $ 387,473 $ 392,525 $ 396,267 $ 436,799 $ 440,917
========= ========= ========= ========= ========= =========
Weighted-average yield 3.92% 5.01% 6.06%
========= ========= ========= ========= ========= =========
During the first quarter of 2004 the Corporation expects to purchase up
to $300 million in short- to medium-term CMOs. Such purchases are expected to be
funded using term FHLB advances of six months to four years. Although there can
be no assurances, the pre-tax spread on these transactions is expected to be in
excess of 200 basis points. Because these securities will be purchased by FCHI,
the after-tax spread is expected to approximate 150 basis points.
The Corporation will continue to explore alternatives to maintain
growth in its interest-earning assets in the near term. These alternatives
include, but are not limited to, the purchase of additional CMOs, as well as
adjustable-rate residential mortgage loans from third-party financial
institutions. However, there are many considerations involved in such decisions
and there can be no assurances that the Corporation will elect to continue any
of these strategies to increase its interest-earning assets.
LOANS HELD FOR SALE The Corporation's loans held for sale declined by
$34.1 million or 68% during the year ended December 31, 2003. The following
table sets forth the activity in the Corporation's portfolio of loans held for
sale during each of the years indicated.
Dollars in thousands
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
Balance at beginning of period $ 50,237 $ 56,109 $ 22,974 $ 6,346 $ 72,002
Single-family mortgage loans originated for sale (1) 2,229,807 1,713,629 1,252,070 142,985 305,345
Loans transferred from held for investment (2) 93,970 119,631 165,583 23,743 21,283
Loans transferred to held for investment (3) - - - - (43,554)
Principal balance of loans sold (2,357,901) (1,839,132) (1,384,518) (150,100) (348,730)
------------ ------------ ------------ ------------ ------------
Balance at end of period $ 16,113 $ 50,237 $ 56,109 $ 22,974 $ 6,346
============ ============ ============ ============ ============
(1) Net of monthly principal payments received from borrowers during the period
held for sale.
(2) Consists of single-family adjustable-rate mortgage loans originated for
investment that converted to fixed-rate loans. The Corporation generally
sells such loans in the secondary market.
(3) Consists of fixed-rate mortgage loans transferred to loans held for
investment at the lower of cost or market to maintain growth in the
Corporation's earning assets.
LOANS HELD FOR INVESTMENT The Corporation's loans held for investment
increased by $131 million or 6.3% during the twelve months ended December 31,
2003 (excluding $287 million in loans acquired in the LBI acquisition in the
fourth quarter of 2003). Most of this increase was the result of the
Corporation's purchase of $186 million in single-family residential loans from
third-party financial institutions. During 2002 and continuing into 2003, the
interest rate environment had a significant impact on the ability of the
Corporation to maintain its internally-originated portfolio of loans held for
investment. This situation developed because low interest rates tend to increase
customer preference for fixed-rate mortgage loans, as opposed to adjustable-rate
loans. In addition, a low interest rate environment encourages borrowers to
refinance their existing adjustable-rate residential loans into fixed-rate loans
to "lock-in" a lower long-term rate. Given the Corporation's policy of selling
these types of loans in the secondary market, its internally-originated
portfolio of adjustable-rate residential loans declined in the most recent
period. Single-family residential loans purchased by the Corporation are
subjected to substantially the same underwriting process as the Corporation's
own loans. The servicing of these loans is retained by the sellers, for which
the Corporation pays a fee of approximately 38 basis points on the unpaid
principal balance. The loans are generally located throughout the U.S., with no
single state making up more than 30% to 40% of the overall principal. The loans
have adjustable-rates that reset annually at an average margin of approximately
275 basis points above the one-year U.S. Treasury bill. Most of the loans have
fixed interest rates for terms of five years before their first adjustment date.
FCHI, the Bank's wholly-owned investment subsidiary in Nevada, purchased the
loans.
28
The following table sets forth the composition of the Corporation's
portfolio of loans held for investment as of December 31 for each of the years
indicated.
Dollars in thousands
2003 2002 2001 2000 1999
---------------- ---------------- --------------- ---------------- ----------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
---------- --- ---------- --- ---------- --- ---------- --- ---------- ----
Real estate loans:
Single-family mortgage loans $ 759,490 30% $ 734,407 35% $ 669,867 36% $ 719,671 40% $ 652,883 42%
Non-residential real estate loans 426,644 17 250,224 12 257,043 14 203,842 11 168,453 11
Multi-family residential loans 284,991 11 254,294 12 252,312 14 236,003 13 186,591 12
Construction loans (1) 119,196 5 97,263 5 83,537 4 77,216 4 80,563 5
---------- --- ---------- --- ---------- --- ---------- --- ---------- ---
Total real estate loans 1,590,321 63 1,336,188 64 1,262,759 68 1,236,732 70 1,088,490 70
---------- --- ---------- --- ---------- --- ---------- --- ---------- ---
Consumer loans:
Second mortgage and home
equity loans 396,581 16 345,810 16 249,501 13 253,866 14 204,806 13
Automobile loans 146,677 6 126,455 6 75,009 4 64,841 4 46,956 3
Other consumer loans (2) 36,401 1 28,615 1 29,949 2 25,262 1 14,239 1
---------- --- ---------- --- ---------- --- ---------- --- ---------- ---
Total consumer loans 579,659 23 500,880 24 354,459 19 343,969 19 266,001 17
---------- --- ---------- --- ---------- --- ---------- --- ---------- ---
Education loans 195,052 8 194,597 9 201,183 11 197,579 11 190,170 12
Commercial business loans 158,761 6 71,904 3 38,736 2 195 - 296 -
---------- --- ---------- --- ---------- --- ---------- --- ---------- ---
Subtotal 2,523,793 100% 2,103,569 100% 1,857,137 100% 1,778,475 100% 1,544,958 100%
Unearned discounts, premiums, and
net deferred loan fees and costs 8,772 8,731 4,141 2,029 1,260
Allowance for loan losses (13,882) (11,658) (9,962) (8,028) (7,624)
---------- ---------- ---------- ---------- ----------
Total loans held for investment $2,518,683 $2,100,642 $1,851,316 $1,772,477 $1,538,595
========== ========== ========== ========== ==========
Weighted average contractual rate 5.67% 6.45% 7.36% 8.00% 7.58%
========== ========== ========== ========== ==========
(1) At December 31, 2003, construction loans consisted of $69.5 million in
single-family residences, $40.4 million in non-residential real estate, and
$9.3 million in multi-family residences.
(2) At December 31, 2003, other consumer loans included $18.3 million of
unsecured loans, $11.9 million of recreational and household good loans,
$4.6 million of deposit account-secured loans, and $1.6 million of mobile
home loans.
29
The following table sets forth the activity in the Corporation's
portfolio of loans held for investment during each of the years indicated.
Dollars in thousands
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
Balance at beginning of period $2,100,642 $1,851,316 $1,772,477 $1,538,595 $1,177,526
---------- ---------- ---------- ---------- ----------
Real estate loan originations:
Single-family mortgage loans (1) 460,489 411,368 270,071 354,734 293,227
Commercial real estate loans 221,663 110,328 112,715 120,459 112,180
Decrease (increase) in loans in process (2) (19,624) (16,304) 9,276 (13,546) (7,086)
---------- ---------- ---------- ---------- ----------
Total real estate loans originated 662,528 505,392 392,062 461,647 398,321
---------- ---------- ---------- ---------- ----------
Consumer loan originations:
Second mortgage and home equity loans 261,811 361,580 192,574 160,386 137,459
Automobile loans 87,479 87,770 56,081 52,967 39,635
Other consumer loans (3) 21,763 23,664 24,894 22,490 12,168
---------- ---------- ---------- ---------- ----------
Total consumer loans originated 371,053 473,014 273,549 235,843 189,262
---------- ---------- ---------- ---------- ----------
Education loan originations 59,142 43,929 33,705 33,859 29,521
Commercial business loan originations 58,731 33,803 2,278 - -
---------- ---------- ---------- ---------- ----------
Total loans originated for investment 1,151,454 1,056,138 701,595 731,350 617,103
---------- ---------- ---------- ---------- ----------
Loans purchased for investment:
Single-family residential loans 188,113 296,530 178,104 13,051 97,238
Commercial real estate loans 5,047 900 - 8,625 798
Commercial business loans 1,993 5,405 - - -
---------- ---------- ---------- ---------- ----------
Total loans purchased for investment 195,153 302,835 178,104 21,676 98,036
---------- ---------- ---------- ---------- ----------
Net loans acquired through merger (4) 286,714 115,457 114,287 - -
Loan principal repayments (1,109,569) (1,102,341) (742,074) (356,507) (371,999)
Loans transferred to held for sale portfolio (5) (93,970) (119,631) (165,583) (23,743) (21,283)
Education loans sold - - (1,334) (4,800) (2,165)
Loans swapped into mortgage-backed securities - - - (132,280) -
Loans transferred from held for sale portfolio (6) - - - - 43,554
Other changes in loans held for investment (7) (11,740) (3,131) (6,155) (1,813) (2,178)
---------- ---------- ---------- ---------- ----------
Balance at end of period $2,518,683 $2,100,642 $1,851,316 $1,772,477 $1,538,595
========== ========== ========== ========== ==========
(1) Excludes loans originated for sale and loans originated on an agency basis
for WHEDA and State VA. The latter amounted to $44.3 million, $34.0 million,
$22.6 million, $26.3 million, and $30.3 million in 2003, 2002, 2001, 2000,
and 1999, respectively.
(2) Consists of changes in loans in process on single-family, multi-family, and
non-residential real estate construction loans.
(3) Consists principally of loans secured by mobile homes, recreational and
household goods, and deposit accounts, as well as unsecured loans.
(4) In 2003, consists of $125.0 million in commercial real estate loans, $77.3
million in commercial business loans, $42.9 million in single-family
residential loans, and $41.5 million in consumer loans.
(5) In 2003, consists of single-family adjustable-rate mortgage loans that
converted to fixed-rate and were sold by the Corporation in the secondary
market.
(6) Consists of fixed-rate mortgage loans transferred from loans held for sale
at the lower of cost or market to maintain growth in earning assets.
(7) Consists principally of real estate foreclosures and changes in allowance
for loan losses, discounts, premiums, and deferred fees.
OFFICE PROPERTIES AND EQUIPMENT The Corporation's office properties and
equipment increased $17.4 million or nearly 50% during the twelve months ended
December 31, 2003. This increase was due principally to the LBI acquisition and
growth in the number of banking facilities operated by the Corporation.
MORTGAGE SERVICING RIGHTS The Corporation's mortgage servicing rights,
net of valuation allowances, were $36.3 million and $30.2 million as of December
31, 2003, and 2002, respectively. These amounts were 1.10% and 1.02% of the
principal serviced for others, which amounted to $3.3 billion and $3.0 billion
at December 31, 2003 and 2002, respectively. The valuation allowance for MSR
losses was zero at December 31, 2003, and $3.4 million at December 31, 2002.
INTANGIBLE ASSETS The Corporation's intangible assets increased by
$47.7 million or over 105% during the twelve months ended December 31, 2003.
This increase was the result of deposit-based intangibles and goodwill created
in the LBI acquisition. For additional discussion, refer to Note 6 and 15 of the
Corporation's Consolidated Financial Statements, included herein under Part II,
Item 8, "Financial Statements and Supplementary Data".
DEPOSIT LIABILITIES The Corporation's deposit liabilities decreased by
$209 million or 8.9% during the twelve months ended December 31, 2003 (excluding
$407 million assumed in the LBI acquisition). In March 2003, management lowered
rates on certificates of deposit and certain other deposit offerings in an
effort to improve the Corporation's interest rate spread. Although management
believes the Corporation's rates were still competitive, this decision resulted
in a net outflow of deposits as rate-sensitive customers sought higher rates at
competing financial institutions. Management does not expect to change this
pricing strategy in 2004, but believes that the most rate-sensitive customers
have left and that deposit growth should continue in 2004, although there can be
no assurances.
30
During 2003 the Corporation introduced a new money market product with
a guaranteed rate of 2% through the end of the year. Effective January 1, 2004,
these accounts were converted to a money market product with a minimum rate
indexed to money fund performance. The rate paid on these accounts at conversion
was 1.50%. Customer balances in money market accounts was $465 million and $241
million at December 31, 2003 and 2002, respectively.
The Corporation's deposit liabilities were also impacted by a $95.6
million or 69% decrease in custodial deposit accounts during the twelve months
ended December 31, 2003. The Corporation maintains borrowers' principal and
interest payments in such accounts on a temporary basis pending their remittance
to the third-party owners of the loans. Balances in these accounts declined at
December 31, 2003 due to significant declines in loan prepayment activity that
began late in the third quarter.
The following table sets forth the composition of the Corporation's
deposit liabilities as of December 31 for each of the years indicated.
Dollars in thousands
2003 2002 2001
---------------------- ---------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE AMOUNT RATE
---------- ----- ---------- ----- ---------- -----
Regular savings accounts $ 260,975 0.25% $ 163,844 0.25% $ 145,565 1.13%
Interest-bearing checking accounts 187,368 0.33 138,650 0.54 101,679 0.63
Non-interest bearing checking accounts 345,698 - 356,357 - 285,591 -
Money market accounts 464,780 1.37 241,114 0.90 214,604 1.80
Certificates of deposit 1,294,016 2.88 1,455,183 3.74 1,281,814 5.19
---------- ----- ---------- ----- ---------- -----
Total $2,552,837 1.76% $2,355,148 2.45% $2,029,254 3.58%
========== ===== ========== ===== ========== =====
At December 31, 2003, certificates of deposit in denominations of
$100,000 or more amounted to $191 million and mature as follows: $24.4 million
within three months, $18.9 million over three through six months, $48.8 million
over six through 12 months, $52.0 million over 12 through 24 months, and $46.4
million over 24 months. At December 31, 2003, certificates of deposits issued
through third-party broker-dealers amounted to $9.0 million, all of which was
scheduled to mature within six months.
FEDERAL FUNDS PURCHASED, SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
AND OTHER BORROWINGS The Corporation's federal funds purchased, securities sold
under agreement to repurchase, and other borrowings increased by $51.1 million
or over 300% in the aggregate during the twelve months ended December 31, 2003.
This increase was used to replace declines in deposit liabilities and the
prepayment of higher-costing FHLB advances, the latter described in a subsequent
paragraph.
FHLB ADVANCES The Corporation's FHLB advances and other borrowings
decreased by $27.5 million or 6.9% during the year ended December 31, 2003.
During the third quarter of 2003 the Bank prepaid $128 million in term advances
from the Federal Home Loan Bank of Chicago and incurred a prepayment penalty of
$7.4 million. The advances had a remaining maturity of 1.3 years and a weighted
average cost of 5.84%. They were replaced by overnight borrowings from the FHLB
at a substantially lower rate.
31
The following table presents certain information regarding the
Corporation's short-term borrowings (original maturity of less than one year) at
or for each of the years indicated.
Dollars in thousands
2003 2002 2001
-------- ------- --------
FHLB advances:
Average balance outstanding (1) $ 92,669 $ 2,885 $ 35,006
Maximum amount outstanding at any month-end during the period 350,600 12,500 112,080
Balance outstanding at end of period 270,575 - 12,500
Average interest rate during the period (2) 1.30% 2.61% 4.50%
Weighted-average interest rate at the end of period 1.27% - 2.61%
Federal funds purchased:
Average balance outstanding (1) $ 3,423 - $ 10,769
Maximum amount outstanding at any month-end during the period 24,500 - 20,000
Balance outstanding at end of period 24,500 - -
Average interest rate during the period (2) 1.23% - 5.15%
Weighted-average interest rate at the end of period 1.26% - -
Other borrowings:
Average balance outstanding (1) $ 20,099 $ 8,769 $54
Maximum amount outstanding at any month-end during the period 43,624 17,013 274
Balance outstanding at end of period 43,624 17,013 32
Average interest rate during the period (2) 2.30% 3.30% 8.83%
Weighted-average interest rate at the end of period 2.29% 2.46% 9.00%
Securities sold under agreements to repurchase:
Average balance outstanding (1) - - $ 36,923
Maximum amount outstanding at any month-end during the period - - 100,000
Balance outstanding at end of period - - -
Average interest rate during the period (2) - - 6.66%
Weighted-average interest rate at the end of period - - -
Total short-term borrowings:
Average balance outstanding (1) $116,191 $11,654 $ 82,752
Maximum amount outstanding at any month-end during the period 364,877 17,013 191,193
Balance outstanding at end of period 338,699 17,013 12,532
Average interest rate during the period (2) 1.47% 3.13% 5.55%
Weighted-average interest rate at the end of period 1.40% 2.46% 2.63%
======== ======= ========
(1) Calculated using month-end balances.
(2) Calculated using month-end average interest rates.
NON-PERFORMING ASSETS The Corporation's non-performing assets
(consisting of non-accrual loans, real estate acquired through foreclosure or
deed-in-lieu thereof, and real estate subject to redemption) amounted to $13.6
million or 0.41% of total assets at December 31, 2003, compared to $9.1 million
or 0.30% at December 31, 2002. The increase in non-performing assets in 2003 was
due primarily to the default of a $2.6 million loan participation on a hotel
property in the fourth quarter of 2003. The hotel is located in the Twin Cities
and has suffered from poor occupancy for an extended period of time, although it
is located in an attractive area. Although management believes it is possible
the Corporation may incur a loss on the future resolution of this problem loan,
such loss is not yet probable nor is it estimable at this time.
Also contributing to the increase in non-performing assets was an
increase in single-family mortgage and commercial business loans on non-accrual
status. These increases, along with a $337,000 increase in real estate subject
to redemption and real estate acquired through foreclosure, were principally
caused by a general deterioration in overall economic conditions in 2003.
32
The following table contains information regarding the Corporation's
non-performing assets as of December 31 for each of the years indicated.
Dollars in thousands
2003 2002 2001 2000 1999
------- ------ ------ ------ ------
Non-accrual loans:
Single-family mortgage loans $ 3,147 $2,307 $3,078 $2,065 $ 862
Commercial real estate loans 2,649 77 373 - -
Consumer loans 2,540 2,605 2,040 1,069 191
Commercial business loans 1,227 376 164 - -
------- ------ ------ ------ ------
Total non-accrual loans 9,563 5,365 5,655 3,134 1,053
Real estate owned and in judgment 4,068 3,731 2,847 1,222 1,091
------- ------ ------ ------ ------
Total non-performing assets $13,631 $9,096 $8,502 $4,356 $2,144
======= ====== ====== ====== ======
Ratio of non-accrual loans to loans held for investment 0.38% 0.26% 0.31% 0.18% 0.07%
======= ====== ====== ====== ======
Ratio of total non-performing assets to total assets 0.41% 0.30% 0.31% 0.19% 0.10%
======= ====== ====== ====== ======
Ratio of total allowance for loan and real estate losses
to total non-performing assets 103% 130% 120% 188% 365%
======= ====== ====== ====== ======
Note: there were no non-performing education loans as of December 31 for any of
the years presented.
In addition to non-performing assets, at December 31, 2003, management
was closely monitoring $22.6 million in assets, which it had classified as
doubtful or substandard. This compares to $22.6 million in such assets at
December 31, 2002. Although these loans were performing in accordance with their
terms, management of the Corporation deemed their classification prudent after
consideration of factors such as declines in the valuation of associated
collateral, reductions in occupancy rates, and deteriorating economic
conditions. Management is closely monitoring a $2.7 million loan secured by an
apartment complex located in Indiana. Although the borrower is performing in
accordance with the loan's original terms, the property has suffered from low
occupancy for an extended period of time. Although management believes it is
possible the Corporation may incur a loss on the future resolution of this
problem loan, such loss is not yet probable nor is it estimable at this time.
LIQUIDITY AND CAPITAL RESOURCES
The Corporation's primary sources of funds are deposits obtained
through its branch office network, borrowings from the FHLB and other sources,
amortization, maturity, and prepayment of outstanding loans and investments, and
sales of loans and other assets. During 2003, 2002, and 2001, the Corporation
used these sources of funds to fund loan commitments, purchase loans and
mortgage-related securities, and cover maturing liabilities and deposit
withdrawals. At December 31, 2003, the Corporation had $566 million in time
deposits, $321 million in FHLB advances, and $68.1 million in fed funds
purchased and other borrowings that were scheduled to mature within one year. In
addition, the Corporation had approved loan commitments and undisbursed
commitments on construction loans outstanding as of the same date. Management
believes that the Corporation has adequate resources to fund all of these
obligations or commitments, that all of these obligations or commitments will be
funded by the required date, and that the Corporation can adjust the rates it
offers on certificates of deposit and other customer deposits to retain such in
changing interest rate environments. Under FHLB lending and collateralization
guidelines, the Corporation had approximately $463 million in unused borrowing
capacity at the FHLB as of December 31, 2003. The Corporation also had $54.4
million in unused lines of credit with other financial institutions as of the
same date.
The Corporation's stockholders' equity ratio as of December 31, 2003,
was 8.36% of total assets. The Corporation's long-term objective is to maintain
its stockholders' equity ratio at approximately 7.0%, which is consistent with
the Corporations long-term objectives for return on equity of at least 15% per
year and return on assets of at least 1% per year. The Corporation's equity
ratio is above its target range as of December 31, 2003, primarily as a result
2.6 million in shares issued with the LBI acquisition. The Corporation expects
its equity ratio to return to its target range during the next 12 to 24 months,
although there can be no assurances. The Corporation's tangible stockholders'
equity ratio was 5.75% as of December 31, 2003.
The Bank is also required to maintain specified amounts of capital
pursuant to regulations promulgated by the OTS and the FDIC. The Bank's
objective is to maintain its regulatory capital in an amount sufficient to be
classified in the highest regulatory capital category (i.e., as a
"well-capitalized" institution). At December 31, 2003, the Bank's regulatory
capital exceeded all regulatory minimum requirements, as well as the amount
required to be classified as a "well-capitalized" institution. For additional
discussion, refer to Note 12 of the Corporation's Consolidated Financial
Statements, included herein under Part II, Item 8, "Financial Statements and
Supplementary Data".
The Corporation paid cash dividends of $11.2 million, $10.1 million,
and $8.9 million during the years ended December 31, 2003, 2002, and 2001,
respectively. These amounts equated to dividend payout ratios of 32.4%, 29.1%,
and
33
31.2% of the net income in such periods, respectively. It is the Corporation's
objective to maintain its dividend payout ratio in a range of 25% to 35% of net
income, which is consistent with the Corporation's long-term earnings and asset
growth rate objectives of 10% per year. However, the Corporation's dividend
policy and/or dividend payout ratio will be impacted by considerations such as
the level of stockholders' equity in relation to the Corporation's stated goal,
as previously described, regulatory capital requirements for the Bank, as
previously described, and certain dividend restrictions in effect for the Bank
(for additional discussion refer to Note 12 of the Corporation's Audited
Consolidated Financial Statements, included herein under Part II, Item 8,
"Financial Statements and Supplementary Data"). Furthermore, unanticipated or
non-recurring fluctuations in earnings may impact the Corporation's ability to
pay dividends and/or maintain a given dividend payout ratio.
On January 29, 2004, the Corporation's Board of Directors approved a
regular quarterly dividend of $0.14 per share payable on March 11, 2004, to
shareholders of record on February 19, 2004.
During 2003, the Corporation repurchased 26,198 shares under its 2000
stock repurchase plan (the "2000 Plan") at a cost of approximately $508,000. As
of December 31, 2003, 164,918 shares remain to be purchased under the 2000 plan.
In April 2002, the Corporation's Board of Directors adopted another stock
repurchase plan (the "2002 Plan") that authorizes the repurchase of up to
1,001,678 shares or approximately 5% of the Corporation's outstanding common
stock. In April 2003, the Corporation's Board of Directors extended the 2000 and
2002 Plans for another twelve months. Both the 2000 and 2002 Plans authorize the
Corporation to repurchase shares from time-to-time in open-market transactions
as, in the opinion of management, market conditions warrant. The repurchased
shares will be held as treasury stock and will be available for general
corporate purposes.
During 2003, the Corporation reissued 542,095 shares of common stock
out of its inventory of treasury stock with a cost basis of approximately $10.8
million (426,635 of these shares were issued in connection with the acquisition
of LBI). In general, these shares were otherwise issued upon the exercise of
stock options by, or the issuance of restricted stock to, employees and
directors of the Corporation.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
The Corporation has various financial obligations, including
contractual obligations and commitments that may require future cash payments.
OFF-BALANCE SHEET ARRANGEMENTS The Corporation has become a party to
financial instruments with off-balance sheet risk in the normal course of its
business in order to meet the financing needs of its customers and to reduce its
own exposure to fluctuations in interest rates. These financial instruments
include commitments to extend credit, standby letters of credit, lines of
credit, forward commitments to sell loans, and financial guarantees. For
additional discussion, refer to Notes 1 and 11 of the Corporation's Audited
Consolidated Financial Statements, included herein under Part II, Item 8,
"Financial Statements and Supplementary Data". These off-balance sheet
arrangements generally have a negligible impact on the Corporation's revenues,
expenses, and cash flows, until such time as they are converted to on-balance
sheet items. Furthermore, management is not aware of any event, demand,
commitment, trend, or uncertainty that will result in or is reasonably likely to
result in a material reduction in the availability of off-balance sheet
arrangements that provide material benefits to the Corporation.
CONTRACTUAL OBLIGATIONS The following table presents fixed and
determinable contractual obligations to third parties by payment date as of
December 31, 2003.
Dollars in thousands
MORE THAN MORE THAN
LESS THAN 1 YEAR TO 3 YEARS TO MORE THAN
1 YEAR 3 YEARS 5 YEARS 5 YEARS TOTAL
--------- --------- ---------- --------- --------
Long-term FHLB advances $50,000 $25,000 $27,500 - $102,500
Operating leases for facilities (1) 2,812 5,580 5,641 $22,659 36,692
Other long-term contractual obligations 265 242 - - 507
--------- --------- ---------- --------- --------
Total obligations $53,077 $30,822 $33,141 $22,659 $139,699
========= ========= ========== ========= ========
(1) Operating leases may include certain insurance and real estate tax
components.
The Corporation also has long-term obligations under its employee
benefit plans as described in its Audited Consolidated Financial Statements. For
additional discussion, refer to Note 10 of the Corporation's Audited
Consolidated Financial Statements, included herein under Part II, Item 8,
"Financial Statements and Supplementary Data".
The Corporation is party to numerous equipment maintenance and software
licensing arrangements that require periodic payments under the agreements.
Management of these arrangements is decentralized throughout the Corporation.
34
As such, management is unable to provide a five-year forecast of these amounts.
Equipment maintenance and software licensing expense under these arrangements
was $1.3 million, $1.3 million, and $935,000 during the years ended December 31,
2003, 2002, and 2001, respectively. These arrangements may or may not be
cancelable at the discretion of the Corporation, may or may not require the
payment of early-termination fees, and may or may not be long term in nature.
The Corporation and its subsidiaries are engaged in various other
routine purchase obligations in the ordinary course of business, which in the
aggregate are believed by management to be immaterial to the consolidated
financial condition of the Corporation.
ITEM 7A--QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Corporation manages the exposure of its operations to changes in
interest rates ("interest rate risk" or "market risk") by monitoring its ratios
of interest-earning assets to interest-bearing liabilities within one- and
three-year maturities and/or repricing dates (i.e., its one- and three-year
"gaps"). Management has sought to control the Corporation's one- and three-year
gaps, thereby limiting the affects of changes in interest rates on its future
earnings, by selling substantially all of its long-term, fixed-rate,
single-family mortgage loan production, investing in adjustable-rate
single-family mortgage loans, investing in consumer, education, and commercial
business loans, which generally have shorter terms to maturity and/or floating
rates of interest, and investing in commercial real estate loans, which also
tend to have shorter terms to maturity and/or floating rates of interest. The
Corporation also invests from time-to-time in adjustable-rate and short- and
medium-term fixed-rate CMOs and MBSs. As a result of this strategy, the
Corporation's exposure to interest rate risk is significantly impacted by its
funding of the aforementioned asset groups with deposit liabilities and FHLB
advances that tend to have average terms to maturity of less than one year or
carry floating rates of interest.
In general, it is management's long-term goal to maintain the
Corporation's one-year gap in a range of +/- 30% and its three-year gap in a
range of +/- 10%, although typically the Corporations' one- and three-year gaps
will be negative. Management believes this strategy takes advantage of the fact
that market yield curves tend to be upward sloping, which increases the spread
between the Corporation's earning assets and interest-bearing liabilities.
Furthermore, management of the Corporation does not believe that this strategy
exposes the Corporation to unacceptable levels of interest rate risk as
evidenced by the fact that the Corporation's three-year gap is generally
maintained in a narrow band around zero, which implies that the Corporation is
exposed to little interest rate risk over a three-year horizon. In addition, it
should be noted that for purposes of its gap analysis, the Corporation
classifies its interest-bearing checking, savings, and money market deposits in
the shortest category, due to their potential to reprice. However, it is the
Corporation's experience that these deposits do not reprice as quickly or to the
same extent as other financial instruments, especially in a rising rate
environment. In addition, the Corporation classifies certain FHLB advances that
are redeemable prior to maturity (at the option of the FHLB) according to their
redemption dates, which are earlier than their maturity dates.
35
The following table summarizes the Corporation's gap as of December 31,
2003.
Dollars in thousands
MORE THAN MORE THAN MORE THAN
6 MONTHS 6 MONTHS 1 YEAR TO 3 YEARS TO OVER
OR LESS TO 1 YEAR 3 YEARS 5 YEARS 5 YEARS TOTAL
---------- ---------- --------- ---------- -------- ----------
Interest-earning assets:
Mortgage loans:
Fixed $ 169,525 $ 88,335 $ 120,213 $ 48,039 $ 7,114 $ 433,226
Adjustable 267,874 222,128 427,953 247,373 2,159 1,167,487
Consumer and education loans 442,447 70,895 160,464 61,443 36,922 772,171
Commercial business loans 62,192 35,127 50,421 9,193 1,086 158,019
Mortgage-backed and related securities 63,490 57,456 201,606 59,488 2,402 384,442
Other earning assets 66,079 - - - - 66,079
----------- ----------- ---------- ---------- -------- ----------
Total $1,071,607 $ 473,941 $ 960,657 $ 425,536 $ 49,683 $2,981,424
=========== =========== ========== ========== ======== ==========
Interest-bearing liabilities:
Deposits liabilities:
Regular savings and checking accounts $ 443,824 - - - - $ 443,824
Money market deposit accounts 464,982 - - - - 464,982
Variable-rate IRA accounts 4,317 - - - - 4,317
Time deposits 244,218 $ 321,523 $ 597,224 $ 130,449 $ 602 1,294,016
FHLB advances and other borrowings 366,189 50,004 25,006 - - 441,199
----------- ----------- --------- ---------- -------- ----------
Total $1,523,530 $ 371,527 $ 622,230 $ 130,449 $ 602 $2,648,338
=========== =========== ========== ========== ======== ==========
Excess (deficiency) of earning assets
over interest-bearing liabilities ($ 451,923) $ 102,414 $ 338,427 $ 295,087 $ 49,081
=========== =========== ========== ========== ======== ==========
Cumulative excess (deficiency) of earning
assets over interest-bearing liabilities ($ 451,923) ($ 349,509) ($ 11,082) $ 284,005 $333,086
=========== =========== ========== ========== ======== ==========
Cumulative excess (deficiency) of earning
assets over interest-bearing liabilities as a
percent of total assets -13.66% -10.56% -0.33% 8.58% 10.07%
=========== =========== ========== ========== ======== ==========
Cumulative earning assets as a percentage of
interest-bearing liabilities 70.34% 81.56% 99.56% 110.73% 112.58%
=========== =========== ========== ========== ======== ==========
Note: If redeemable FHLB advances, interest-bearing checking, and regular
savings deposits were deemed to reprice after one year, the Corporation's
one-year funding gap would have been 3.68% as of December 31, 2003, which
compares to 8.93% and 5.79% as of December 31, 2002 and 2001, respectively.
The Corporation's one-year gap was - 10.56% at December 31, 2003,
compared to - 6.06% and - 11.63% at December 31, 2002 and 2001, respectively.
The Corporation's one-year negative gap widened in 2003 principally because of a
decline in overnight and short-term investments. Also contributing was an
extension in the weighted average lives of the Corporations CMOs in response to
higher interest rates late in 2003. Refer to "Financial Condition--Loans Held
for Investment" and "Financial Condition--Mortgage-Backed and Related
Securities" for additional discussion. The decline in the Corporation's negative
one-year gap in 2002 was primarily attributable to an increase in overnight and
short-term investments, a shortening of the weighted-average lives all of the
Corporation's mortgage-related assets due to declining interest rates.
Certain shortcomings are inherent in using gap to quantify exposure to
interest rate risk. For example, although certain assets and liabilities may
have similar maturities or repricings in the table, they may react differently
to actual changes in market interest rates. This is especially true for assets
such as mortgage loans that have embedded prepayment options and liabilities
that have early redemption features. Also, the interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. This is especially true in circumstances where management has a certain
amount of control over interest rates, as it does in the case of deposit
liabilities. Additionally, certain assets such as adjustable-rate mortgage loans
have features that restrict changes in interest rates on a short-term basis and
over the life of the asset. Furthermore, the proportion of adjustable-rate loans
in the Corporation's portfolio may change as interest rates change due to
changes in borrowers' preferences.
Although management believes that its asset/liability management
strategies reduce the potential effects of changes in interest rates on the
Corporation's operations, material and prolonged increases in interest rates may
adversely affect the Corporation's operations because the Corporation's
interest-bearing liabilities which mature or reprice within one year are greater
than the Corporation's interest-earning assets which mature or reprice within
the same period. Alternatively, material and prolonged decreases in interest
rates may benefit the Corporation's operations.
The Corporation does not use derivative financial instruments such as
futures, swaps, caps, floors, options, interest- or principal-only strips, or
similar financial instruments to manage its interest rate risk. However, the
Corporation does use forward sales of MBSs and other commitments of a similar
nature to manage exposure to market risk in its pipeline of single-family
residential loans intended for sale. This pipeline consists of mortgage loans
that are held for sale
36
as of the balance sheet date as well as commitments to originate mortgage loans
that are intended for sale, but are not closed as of the balance sheet date.
Loans held for sale are generally matched against forward sales that require
delivery within 30 to 60 days of the balance sheet date. The Corporation's
policy is to match substantially all of its pipeline with forward sales. These
forward sales generally require delivery within 30 to 60 days. Given these
policies, as well as the short-term nature of the Corporation's pipeline and its
related forward sales, management believes these financial instruments pose
little market risk to the Corporation.
The Corporation is required by the OTS to estimate the sensitivity of
its net portfolio value of equity ("NPV") to immediate and sustained changes in
interest rates and to measure such sensitivity on at least a quarterly basis.
NPV is defined as the estimated net present value of an institution's existing
assets, liabilities, and off-balance sheet instruments at a given level of
market interest rates. Computation of the estimated net present value of assets,
liabilities, and off-balance sheet instruments requires management to make
numerous assumptions with respect to such items. These assumptions include, but
are not limited to, appropriate discount rates, loan prepayment rates, deposit
decay rates, etc., for each interest rate scenario. In general, the Corporation
has used substantially the same assumptions for computing the net present value
of financial assets and liabilities in the base scenario as it uses in preparing
the fair value disclosures required under GAAP (refer to Notes 1 and 13 of the
Corporation's Audited Consolidated Financial Statements, included herein under
Part II, Item 8, "Financial Statements and Supplementary Data"). Computations of
net present values for other interest rate scenarios follow the same basic
approach except that discount rates, loan prepayment rates, and other
assumptions are adjusted accordingly. The net present values of non-financial
assets and liabilities are generally estimated to be equal to their carrying
values under all interest rate scenarios as permitted by OTS regulations. With
respect to off-balance sheet items, the Corporation generally relies on
estimates of value provided by the OTS. The same is true for certain other
assets such as deposit-based intangibles.
The following table summarizes as of December 31, 2003 and 2002, the
sensitivity of the Corporation's NPV to immediate and sustained changes in
interest rates, as shown (parallel shifts in the term structure of interest
rates are assumed as permitted by OTS regulations; dollars are presented in
millions).
Estimated NPV
-------------------
Change in Interest Rates 12/31/03 12/31/02
- ------------------------ -------- --------
200 basis point increase $ 312.3 $ 208.2
Base scenario 311.9 211.5
100 basis point decline 315.6 204.6
Certain shortcomings are inherent in using NPV to quantify exposure to
market risk. For example, actual and future values of assets, liabilities, and
off-balance sheet items will differ from those determined by the model for a
variety of reasons to include, but not limited to, differences in actual market
discount rates, differences in actual loan prepayment activity, and differences
in deposit customers' responses to changes in interest rates and the resulting
impact on the Corporation's offering rates. Furthermore, the analysis does not
contemplate future shifts in asset or liability mix or any actions management
may take in response to changes in interest rates. As a result of these
shortcomings, it is unlikely that actual or future values of the Corporation's
assets, liabilities, and off-balance sheet items are or will be equal to those
presented in the NPV analysis.
37
ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 2003 and 2002
2003 2002
-------------- --------------
ASSETS
Cash and due from banks $ 94,535,753 $ 84,482,722
Interest-bearing deposits with banks 6,444,374 179,755,367
Mortgage-backed and related securities:
Available for sale, at fair value 386,862,372 366,075,106
Held for investment, at cost (fair value of $610,294 and $30,192,176, respectively) 613,076 30,029,690
Loans held for sale 16,113,217 50,237,199
Loans held for investment, net of allowance of $13,882,350 and $11,658,086, respectively 2,518,683,388 2,100,641,557
Federal Home Loan Bank stock 59,634,800 55,634,400
Accrued interest receivable, net 15,802,753 17,522,581
Office properties and equipment 53,020,583 35,647,335
Mortgage servicing rights, net 36,340,856 30,171,341
Goodwill 78,168,866 38,546,439
Other intangible assets 13,358,976 5,271,947
Other assets 28,745,265 31,608,545
-------------- --------------
Total assets $3,308,324,280 $3,025,624,228
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposit liabilities $2,552,837,027 $2,355,148,292
Federal funds purchased 24,500,000 -
Federal Home Loan Bank advances 373,075,000 400,600,000
Other borrowings 43,624,308 17,012,682
Advance payments by borrowers for taxes and insurance 1,484,734 11,906,038
Accrued interest payable 2,234,905 3,119,227
Other liabilities 33,979,161 32,385,986
-------------- --------------
Total liabilities 3,031,735,135 2,820,172,225
-------------- --------------
Preferred stock, $0.10 par value (5,000,000 shares authorized, none outstanding) - -
Common stock, $0.10 par value (100,000,000 shares authorized, 22,394,773 and 20,215,933
shares issued, respectively) 2,239,477 2,021,593
Additional paid-in capital 87,323,995 46,577,431
Retained earnings 188,319,179 165,628,148
Treasury stock, at cost (0 and 511,497 shares, respectively) - (10,178,374)
Unearned restricted stock - (32,083)
Accumulated non-owner adjustments to equity, net (1,293,508) 1,435,289
-------------- --------------
Total stockholders' equity 276,589,144 205,452,003
-------------- --------------
Total liabilities and stockholders' equity $3,308,324,280 $3,025,624,228
============== ==============
Refer to accompanying Notes to Consolidated Financial Statements.
38
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2003, 2002, and 2001
2003 2002 2001
------------ ------------ ------------
Interest on loans $127,898,681 $137,611,379 $144,007,080
Interest on mortgage-backed and related securities 15,384,721 18,470,156 24,060,467
Interest and dividends on other investments 4,634,973 5,168,808 3,465,094
------------ ------------ ------------
Total interest income 147,918,375 161,250,343 171,532,641
------------ ------------ ------------
Interest on deposit liabilities 49,408,153 57,082,939 83,584,616
Interest on FHLB advances and other borrowings 16,717,204 22,642,672 24,745,757
------------ ------------ ------------
Total interest expense 66,125,357 79,725,611 108,330,373
------------ ------------ ------------
Net interest income 81,793,018 81,524,732 63,202,268
Provision for loan losses 1,455,835 3,468,063 1,763,391
------------ ------------ ------------
Net interest income after provision for loan losses 80,337,183 78,056,669 61,438,877
------------ ------------ ------------
Community banking revenue 39,720,029 33,598,092 29,010,521
Mortgage banking revenue 44,044,272 27,474,147 18,264,355
Gain (loss) on sale of investments and other assets - (166,264) 63,190
Other income 2,781,668 2,729,075 2,189,240
------------ ------------ ------------
Total non-interest income 86,545,969 63,635,051 49,527,306
------------ ------------ ------------
Compensation and employee benefits 62,199,472 52,985,416 40,152,644
Occupancy and equipment 13,305,277 10,717,300 8,721,140
Communications, postage, and office supplies 7,137,846 6,407,854 5,256,205
ATM and debit card transaction costs 4,818,698 4,005,468 3,241,996
Advertising and marketing 3,553,136 3,298,384 2,588,745
Amortization of intangibles 1,002,971 698,411 1,084,974
FHLB prepayment penalty 7,388,300 - -
Other expenses 12,311,532 9,265,480 6,073,769
------------ ------------ ------------
Total non-interest expense 111,717,231 87,378,312 67,119,473
------------ ------------ ------------
Income before income taxes 55,165,921 54,313,408 43,846,710
Income tax expense 20,439,376 19,397,866 15,398,485
------------ ------------ ------------
Net income $ 34,726,545 $ 34,915,542 $ 28,448,225
============ ============ ============
PER SHARE INFORMATION 2003 2002 2001
- -------------------------- ----- ----- -----
Diluted earnings per share $1.69 $1.73 $1.51
Basic earnings per share 1.71 1.76 1.52
Dividends paid per share 0.55 0.51 0.47
===== ===== =====
Refer to accompanying Notes to Audited Consolidated Financial Statements.
39
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2003, 2002, and 2001
COMMON
STOCK AND ACCUMULATED
ADDITIONAL UNEARNED NON-OWNER
PAID-IN RETAINED TREASURY RESTRICTED ADJUSTMENTS
CAPITAL EARNINGS STOCK STOCK TO EQUITY TOTAL
----------- ------------ ------------ ---------- ----------- ------------
Balance at December 31, 2000 $36,534,227 $122,921,606 ($15,127,142) ($142,083) $ 2,362,887 $146,549,495
Net income 28,448,225 28,448,225
Securities valuation adjustment,
net of income taxes of ($115,521) (214,539) (214,539)
Reclassification adjustment for
gain on securities included in
income, net of income taxes of ($4,619) (8,579) (8,579)
------------
Net income and non-owner
adjustments to equity 28,225,107
============
Common stock issued for
acquisition 12,085,017 16,518,776 28,603,793
Dividends paid (8,866,148) (8,866,148)
Exercise of stock options 8,684 (1,508,794) 1,821,742 321,632
Purchase of treasury stock (3,213,376) (3,213,376)
Amortization of restricted stock 722,200 55,000 777,200
----------- ------------ ------------ ---------- ------------ ------------
Balance at December 31, 2001 48,627,928 141,717,089 - (87,083) 2,139,769 192,397,703
Net income 34,915,542 34,915,542
Securities valuation adjustment,
net of income taxes of $42,698 79,296 79,296
Reclassification adjustment for
loss on securities included in
income, net of income taxes of $58,192 108,072 108,072
Additional minimum pension liability,
net of income taxes of ($594,566) (891,848) (891,848)
------------
Net income and non-owner
adjustments to equity 34,211,062
------------
Dividends paid (10,145,762) (10,145,762)
Exercise of stock options (28,904) (1,746,936) 3,591,732 1,815,892
Purchase of treasury stock (13,770,106) (13,770,106)
Amortization of restricted stock 888,214 55,000 943,214
----------- ------------ ------------ ---------- ------------ ------------
Balance at December 31, 2002 48,599,024 165,628,148 (10,178,374) (32,083) 1,435,289 205,452,003
Net income 34,726,545 34,726,545
Securities valuation adjustment,
net of income taxes of ($978,842) (1,817,850) (1,817,850)
Additional minimum pension liability,
net of income taxes of ($607,298) (910,947) (910,947)
------------
Net income and non-owner
adjustments to equity 31,997,748
------------
Common stock issued for
acquisition 40,824,948 8,463,937 49,288,885
Dividends paid (11,236,323) (11,236,323)
Exercise of stock options 118,000 (1,468,503) 2,291,336 940,833
Purchase of treasury stock (507,819) (507,819)
Amortization of restricted stock 839,232 32,083 871,315
Other activity 21,500 (169,920) (69,080) (217,500)
----------- ------------ ------------ ---------- ------------ ------------
Balance at December 31, 2003 $89,563,472 $188,319,179 - - ($ 1,293,508) $276,589,144
=========== ============ ============ ========== ============ ============
Refer to accompanying Notes to Audited Consolidated Financial Statements.
40
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2003, 2002, and 2001
2003 2002 2001
-------------- -------------- ---------------
Cash flows from operating activities:
Net income $ 34,726,545 $ 34,915,542 $ 28,448,225
Adjustments to reconcile net income to net cash provided (used) by
operations:
Provision for loan and real estate losses 1,897,668 3,415,158 1,807,782
Increase (decrease) in mortgage servicing rights valuation allowance (3,350,000) 750,000 (66,643)
Net loan costs deferred (4,474,060) (3,932,341) (2,740,892)
Amortization of mortgage servicing rights 28,728,884 25,273,796 15,970,764
Other amortization 14,026,798 6,887,848 2,891,259
Depreciation 4,076,566 3,319,594 2,586,951
Gains on sales of mortgage loans (56,989,114) (42,208,187) (24,372,880)
Loss (gain) on sales of investments and other assets - 166,264 (63,190)
Decrease in accrued interest receivable 3,599,538 1,901,575 1,610,828
Decrease in accrued interest payable (1,600,344) (1,465,034) (1,449,262)
Increase in current and deferred income taxes 2,709,917 1,473,902 3,990,480
Other accruals and prepaids, net (29,738) (4,666,092) (1,236,099)
-------------- -------------- ---------------
Net cash provided by operations before loan originations and sales 23,322,660 25,832,025 27,377,323
Loans originated for sale (2,229,806,539) (1,713,628,833) (1,252,070,158)
Sales of loans originated for sale or transferred from held for investment 2,386,958,243 1,858,340,739 1,390,901,215
-------------- -------------- ---------------
Net cash provided by operations 180,474,364 170,543,931 166,208,380
-------------- -------------- ---------------
Cash flows from investing activities:
Decrease (increase) in interest-bearing deposits with banks 173,337,538 (81,522,207) (75,614,559)
Purchases of investment securities available for sale - - (35,553,880)
Maturities of investment securities available for sale - - 100,000
Sales of investment securities available for sale 96,548,375 35,098,150 21,823,808
Purchases of mortgage-backed and related securities available for sale (578,202,342) (363,914,125) (167,327,646)
Principal repayments on mortgage-backed and related securities available
for sale 548,329,346 302,304,690 193,046,784
Sales of mortgage-backed and related securities available for sale - - 7,408,541
Purchases of mortgage-backed and related securities held for investment - - (100,780,023)
Principal repayments on mortgage-backed and related securities held for
investment 29,208,525 102,986,604 43,826,047
Loans originated for investment (1,151,453,870) (1,056,138,397) (701,594,833)
Loans purchased for investment (195,153,361) (302,834,697) (178,103,908)
Loan principal repayments 1,109,569,097 1,102,340,559 742,073,665
Purchases of Federal Home Loan Bank stock - (25,000,000) -
Additions to office properties and equipment (15,850,869) (7,524,801) (6,388,322)
Net cash acquired in acquisitions of other financial institutions 10,491,047 - 2,979,813
Purchase of net assets of other financial institutions - (7,914,840) -
Purchase of bank-owned life insurance - - (15,000,000)
Other, net 17,958,439 1,746,398 (10,144,757)
-------------- -------------- ---------------
Net cash used by investing activities 44,781,925 (300,372,666) (279,249,270)
-------------- -------------- ---------------
Cash flows from financing activities:
Increase (decrease) in deposit liabilities (204,509,646) 172,343,825 202,008,108
Purchased deposit liabilities - 25,290,037 -
Long-term advances from Federal Home Loan Bank - - 162,500,000
Repayment of long-term Federal Home Loan Bank advances (298,100,000) (54,315,000) (53,245,000)
Increase (decrease) in short-term Federal Home Loan Bank borrowings 270,575,000 (12,500,000) (23,045,000)
Decrease in securities sold under agreements to repurchase - - (100,000,000)
Increase (decrease) in federal funds purchased 24,500,000 - (20,000,000)
Increase (decrease) in other borrowings 26,361,626 16,980,371 (2,609,059)
Increase (decrease) in advance payments by borrowers for taxes and
insurance (10,434,690) 10,236,607 529,901
Purchase of treasury stock (507,819) (13,770,106) (3,213,376)
Dividends paid (11,236,323) (10,145,762) (8,866,148)
Other, net (11,851,406) 9,434,780 4,292,350
-------------- -------------- ---------------
Net cash provided (used) by financing activities (215,203,258) 143,554,752 158,351,776
-------------- -------------- ---------------
Net increase in cash and due from banks 10,053,031 13,726,017 45,310,886
Cash and due from banks at beginning of period 84,482,722 70,756,705 25,445,819
-------------- -------------- ---------------
Cash and due from banks at end of period $ 94,535,753 $ 84,482,722 $ 70,756,705
============== ============== ===============
Supplemental disclosures of cash flow information:
Interest and dividends received on loans and investments $ 151,517,914 $ 163,151,918 $ 173,143,469
Interest paid on deposits and borrowings 67,725,701 81,190,645 109,779,635
Income taxes paid 18,507,445 18,534,887 11,408,441
Income taxes refunded 1,769,576 616,089 1,454
Transfer of loans from held for investment to held for sale 93,970,482 119,630,789 165,583,373
Common stock issued in acquisition of other financial institutions 49,288,885 - 28,603,793
Net increase in assets from the acquisition of other financial
institutions, excluding cash and cash equivalents 38,797,838 - 25,623,980
============== ============== ===============
Refer to accompanying Notes to Audited Consolidated Financial Statements.
41
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS The Corporation provides a wide range of financial services to
individuals and businesses in Wisconsin, south-eastern Minnesota, and northern
Illinois through its wholly-owned subsidiary bank. The Corporation is subject to
competition from other financial institutions and markets. The Corporation, the
Bank, and the Bank's subsidiaries are also subject to the regulations of certain
governmental agencies and undergo periodic examinations by those regulatory
authorities.
BASIS OF FINANCIAL STATEMENT PRESENTATION The accounting and reporting
policies of the Corporation, the Bank, and the Bank's subsidiaries conform to
GAAP and to general practices within the financial services industry. In
preparing the financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the balance
sheet and revenues and expenses for the period. Actual results could differ from
those estimates.
PRINCIPLES OF CONSOLIDATION The consolidated financial statements
include the accounts and balances of the Corporation, the Bank, and the Bank's
wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
INVESTMENT SECURITIES, MORTGAGE-BACKED AND RELATED SECURITIES, AND
STOCK HELD FOR REGULATORY PURPOSES Investment securities and mortgage-backed and
related securities, are classified in one of two categories and accounted for as
follows: (1) securities that the Corporation has the positive intent and ability
to hold to maturity are classified as "held for investment" and reported at
amortized cost; (2) securities not classified as "held for investment" are
classified as "available for sale" and reported at fair value, with unrealized
gains and losses excluded from earnings and reported as non-owner adjustments to
equity, net of estimated income taxes. Management determines the appropriate
classification for its securities at the time of purchase. The specific
identification method is used to determine the cost of securities sold. The
Corporation does not maintain a trading account for investment securities or
mortgage-backed and related securities. Stock of the FHLB is primarily owned due
to regulatory requirements and is carried at cost.
INTEREST ON LOANS Interest income is accrued on loan balances
outstanding. Accrued interest on impaired loans is reversed when management
determines that the collection of interest or principal is considered unlikely.
In general, this occurs when a loan is 90 days past due. Interest income is
subsequently recognized only to the extent cash payments are received. Loans are
restored to accrual status when the obligation is brought current and the
ultimate collectibility of the total contractual principal and interest is no
longer in doubt.
DISCOUNTS, PREMIUMS, AND DEFERRED LOAN FEES AND COSTS Discounts and
premiums on loans are amortized over the life of the related loans using a
method that approximates the level-yield method. Loan origination fees and
certain direct loan origination costs are deferred and amortized over the life
of the related loans as an adjustment of yield. Such fees and costs are
amortized using a method that approximates the level-yield method.
LOANS HELD FOR SALE, DERIVATIVE INSTRUMENTS, AND HEDGING ACTIVITIES The
Corporation does not use derivative instruments such as futures, swaps, caps,
floors, options, interest- or principal-only strips, or similar financial
instruments to manage its operations. However, the Corporation does use forward
sales of MBSs and other commitments of a similar nature to manage exposure to
market risk in its "pipeline" of single-family residential loans intended for
sale. Forward sales are derivative instruments and are subject to the rules
established by Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities" ("SFAS 133"). In addition,
commitments to extend credit that relate to loans the Corporation intends to
sell ("interest rate commitments") are also considered to be derivative
instruments under SFAS 133 and Statement of Financial Accounting Standards No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" ("SFAS 149"). The Corporation's policy is to offset substantially
all of its exposure to market risk in its pipeline of loans intended for sale
against forward sales.
Single-family residential loans held for sale that are matched against
a forward sale are accounted for using the "fair value hedge method".
Accordingly, the loans and the forward sales are valued on a quarterly basis and
net unrealized gains or losses are recorded in the current period's earnings.
Loans held for sale that are not matched against forward sales are carried at
the lower of aggregate cost or market. Net unrealized losses on these loans, if
any, are recorded in the current period's earnings. In general, the Corporation
does not maintain a material amount of loans held for sale that are not matched
against forward sales.
42
Interest rate commitments on loans the Corporation intends to sell,
forward sales matched against such commitments, and forward sales that are not
matched against a loan or interest rate commitment are valued on a quarterly
basis. Net unrealized gains or losses associated with such derivative
instruments are recorded in the current period's earnings.
Net unrealized gains or losses associated with the Corporation's
pipeline are included in gain on sale of mortgage loans, which is a component of
mortgage banking revenue. Net unrealized gains and/or losses on the
Corporation's pipeline were not material during any of the periods presented in
the Corporation's Statements of Operations.
SECURITIZATIONS AND SALES OF MORTGAGE LOANS The Corporation sells
substantially all of the fixed-rate single-family mortgage loans it originates,
including adjustable-rate loans that convert to fixed-rate loans. These sales
are accomplished through cash sales to Freddie Mac, Fannie Mae, the FHLB, and
other third-party investors, as well as through securitizations with Freddie Mac
and Fannie Mae. In general, MBSs received from Freddie Mac or Fannie Mae in
exchange for fixed-rate mortgage loans are sold immediately in the securities
market. The gain or loss associated with sales of single-family mortgage loans
is recorded as a component of mortgage banking revenue.
Originations and sales of single-family mortgage loans will vary
significantly from period to period depending on customer preferences for
fixed-rate mortgage loans, customer refinance activity, and/or customer
conversions of adjustable-rate loans into fixed-rate loans. Accordingly, the
gain or loss associated with sales of single-family mortgage loans may vary
substantially from period to period. In general, however, fluctuations in gains
or losses on sales of single-family mortgage loans are offset to some degree by
opposite changes in the amortization of mortgage servicing rights, which is also
recorded as a component of mortgage banking revenue (refer to "Mortgage
Servicing Rights", below).
From time-to-time the Corporation also exchanges adjustable-rate
mortgage loans held for investment for Freddie Mac or Fannie Mae MBSs backed by
the same loans. The resulting MBSs are classified in the Corporation's Statement
of Financial Condition as "mortgage-backed and related securities available for
sale". The Corporation continues to service the loans underlying these
securities after they are exchanged.
Sales or securitizations of mortgage loans through Freddie Mac and
Fannie Mae are generally done under terms that do not provide for recourse to
the Corporation by the investor. However, in the case of sales to the FHLB, the
Corporation retains the credit risk on the underlying loans in exchange for a
credit enhancement fee. Furthermore, the Corporation sometimes retains an
exposure to credit risk on loans it securitizes into MBSs through Freddie Mac or
Fannie Mae. In these instances, the Corporation records a recourse liability to
provide for potential credit losses. Because the loans involved in these
transactions are similar to those in the Corporation's loans held for
investment, the review of the adequacy of the recourse liability is similar to
the review of the adequacy of the allowance for loan losses (refer to "Allowance
for Loan Losses", below).
MORTGAGE SERVICING RIGHTS The Corporation continues to service most
single-family mortgage loans it sells to third parties. Servicing mortgage loans
includes such functions as collecting monthly payments of principal and interest
from borrowers, passing such payments through to third-party investors,
maintaining escrow accounts for taxes and insurance, and making such payments
when they are due. When necessary, servicing mortgage loans also includes
functions related to the collection of delinquent principal and interest
payments, loan foreclosure proceedings, and disposition of foreclosed real
estate. The Corporation generally earns a servicing fee of 25 basis points or
more on the outstanding loan balance for performing these services as well as
fees and interest income from ancillary sources such as delinquency charges and
float. Servicing fee income is recorded as a component of mortgage banking
revenue, net of the amortization and charges described in the following
paragraphs.
The Corporation records originated mortgage servicing rights ("OMSR")
as a component of gain on sale of mortgage loans when the obligation to service
such loans has been retained by the Corporation. The initial value recorded for
OMSR is based on the relative values of the servicing rights and the underlying
loans without the servicing rights. This value approximates the present value of
the servicing fee adjusted for expected future costs to service the loans, as
well as income and fees expected to be received from ancillary sources, as
previously described. The carrying value of OMSR is amortized over the life of
and in proportion to net servicing fee income. Expected prepayments may vary
considerably from period to period. As a result, there may be considerable
variation in amortization of OMSRs from period to period depending on prepayment
expectations. In general, however, variations in the amortization of OMSRs will
offset to some degree opposite changes in gains or losses on sales of
single-family mortgage loans, as previously described (refer to "Securitizations
and Sales of Mortgage Loans", above).
43
From time-to-time the Corporation also purchases mortgage servicing
rights ("PMSR") from third-parties. Similar to originated servicing, the
Corporation generally earns a fee of 25 basis points or more for performing
duties similar to those described for its own originations. PMSR is recorded at
cost and is amortized in a manner similar to that described for OMSR. The
Corporation purchases or originates mortgage servicing rights on single-family
residential mortgage loans only.
The carrying value of OMSR and PMSR as recorded in the Corporation's
Consolidated Statements of Financial Condition (collectively "mortgage servicing
rights" or "MSRs") is subject to impairment because of changes in loan
prepayment expectations and in market discount rates used to value the future
cash flows associated with such assets. In valuing MSRs, the Corporation
stratifies the loans by investor and by the type of remittance program sponsored
by the investor, if applicable. If, based on a periodic evaluation, the
estimated fair value of the MSRs related to a particular stratum is determined
to be less than its carrying value, a valuation allowance is recorded against
such stratum and against the Corporation's loan servicing fee income, which is
included as a component of mortgage banking revenue. A valuation allowance is
not recorded if the estimated fair value of a stratum exceeds its carrying
value. Because of this treatment, the Corporation may be required to maintain a
valuation allowance against MSRs even though the estimated fair value of the
Corporation's total MSR portfolio exceeds its carrying value in total. In
addition, the Corporation may be required to maintain a valuation allowance even
though it is unlikely to actually incur an economic loss in future periods
because valuation allowances resulting from increases in prepayment expectations
are likely to be offset by additional OMSR gains in future periods. The
valuation allowance is calculated using the current outstanding principal
balance of the related loans, long-term prepayment assumptions as provided by
independent sources, a market-based discount rate, and other management
assumptions related to future costs to service the loans, as well as ancillary
sources of income.
ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is composed of
specific allowances for loans that are individually reviewed for impairment and
general valuation allowances for homogenous loans, which are evaluated on a
collective basis. The Corporation establishes specific valuation allowances on
loans it considers to be impaired and if loss is considered probable. A loan is
considered impaired when the carrying amount of the loan exceeds the present
value of the expected future cash flows, discounted at the loan's original
effective interest rate, or the fair value of the underlying collateral. A
specific valuation allowance is established for an amount equal to the
impairment. General valuation allowances are based on an evaluation of the
various risk components that are inherent in the credit portfolio. The risk
components that are evaluated include past loan loss experience; the level of
non-performing and classified assets; current economic conditions; volume,
growth, and composition of the loan portfolio; adverse situations that may
affect borrowers' ability to repay; the estimated value of any underlying
collateral; peer group comparisons; regulatory guidance; and other relevant
factors.
The allowance is increased by provisions charged to earnings and
reduced by charge-offs, net of recoveries. The Corporation's Board of Directors
reviews the adequacy of the allowance for loan losses on a quarterly basis. The
allowance reflects management's best estimate of the amount necessary to provide
for the impairment of loans. The allowance is based on a risk model developed
and implemented by management and approved by the Corporation's Board of
Directors.
REAL ESTATE Real estate acquired through foreclosure or deed in lieu of
foreclosure and real estate subject to redemption are recorded at the lower of
cost or estimated fair value, less estimated costs to sell. Costs relating to
the development and improvement of the property are capitalized. Income and
expenses incurred in connection with holding and operating the property are
included in the Corporation's Consolidated Statements of Operations.
OFFICE PROPERTIES AND EQUIPMENT Office properties and equipment are
recorded at cost less accumulated depreciation, which is provided over the
estimated useful lives (five to forty years) of the respective assets on a
straight-line basis. The cost of leasehold improvements is being amortized on
the straight-line basis over the lesser of the term of the respective lease or
the estimated economic life. When properties are retired or otherwise disposed
of, the related cost and accumulated depreciation are removed from the
respective accounts and the resulting gain or loss is recorded in income.
GOODWILL AND INTANGIBLE ASSETS From time-to-time the Corporation has
acquired all or a portion of the assets and liabilities of other financial
institutions and has paid or received amounts for such assets and liabilities
that are not equal to their identifiable fair value. Prior to 2002, a portion of
the resulting difference (deposit-based intangible) was amortized to earnings
over the estimated remaining lives of the deposit liabilities acquired in these
transactions. The remaining amount (goodwill) was amortized over 20 years. On
January 1, 2002, the Corporation adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under
SFAS 142, goodwill and intangible assets deemed to have indefinite lives are no
longer amortized but are subject to annual impairment tests in accordance with
the new statements. Other identifiable intangible assets continue to be
amortized over their useful lives, which include deposit-based intangibles.
44
In October 2002, the FASB issued Statement of Accounting Standards No.
147, "Acquisitions of Certain Financial Institutions" ("SFAS 147"). Although the
Corporation adopted this statement, such had no impact on its financial
condition or results of operations.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE The Corporation
occasionally enters into sales of securities under agreements to repurchase with
third-party broker-dealers (commonly referred to as "reverse-repurchase
agreements"). These arrangements are treated as a financing, and the obligations
to repurchase securities sold are reflected as a liability in the Corporation's
Consolidated Statements of Financial Condition. The securities underlying the
agreements remain in the asset accounts. There were no securities sold under
agreements to repurchase as of December 31, 2003, and December 31, 2002.
Securities sold under reverse repurchase agreements are physically
delivered to the broker-dealers that arranged the transactions. The
broker-dealers may have sold, loaned, or otherwise disposed of such securities
to other parties in the normal course of their operations. The Corporation is
exposed to risk in these types of transactions in that changes in market prices,
economic losses, or other factors could prevent or delay the counter-party in
the transaction from returning the securities at the maturity of the agreement.
The Corporation limits its exposure to such risk by utilizing standard industry
agreements, limiting counter-parties to large, reputable broker-dealers,
limiting the amount that can be borrowed from an individual counter-party, and
limiting the duration of such agreements (typically one to six months).
INCOME TAXES The Corporation, the Bank, and all but one of the Bank's
subsidiaries file a consolidated federal income tax return and separate or
combined state income tax returns, depending on the state. Income taxes are
accounted for using the "asset and liability" method. Under this method, a
deferred tax asset or liability is determined based on the enacted tax rates
that will be in effect when the differences between the financial statement
carrying amounts and tax bases of existing assets and liabilities are expected
to be reported in the Corporation's income tax returns. The effect on deferred
taxes of a change in tax rates is recognized in income in the period that
includes the enactment date of the change. A valuation allowance is provided for
any deferred tax asset for which it is more likely than not that the asset will
not be realized. Changes in valuation allowances are recorded as a component of
income.
PENSION COSTS AND OTHER POSTRETIREMENT BENEFITS The Corporation's net
periodic pension cost consists of the expected cost of benefits earned by
employees during the current period and an interest cost on the projected
benefit obligation, reduced by the earnings on assets held by the retirement
plan, and by amortization of any actuarial gains and losses over the estimated
future service period of existing plan participants. The projected unit credit
actuarial cost method is used to determine expected pension costs. The
Corporation's funding policy is to contribute amounts deductible for federal
income tax purposes.
The Corporation's cost of postretirement benefits, which consists of
medical reimbursements for retirees, is recognized during the years that the
employees render the necessary service, adjusted for interest costs on the
projected benefit obligation and for the amortization of a transitional
obligation over 20 years (beginning in 1993). The projected unit credit
actuarial cost method is used to determine expected postretirement benefit
costs. The Corporation's postretirement benefit plan is not currently funded.
FAIR VALUES OF FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET FINANCIAL
INSTRUMENTS The following methods and assumptions were used by the Corporation
in estimating the fair value of financial instruments disclosed elsewhere in
this report.
CASH AND DUE FROM BANKS AND INTEREST-BEARING DEPOSITS WITH
BANKS The face amounts presented in the Corporation's Consolidated Statements of
Financial Condition for cash and interest-bearing deposits approximates fair
value for such assets.
INVESTMENT SECURITIES AND MORTGAGE-BACKED AND RELATED
SECURITIES Fair values for this group of financial instruments are based on
average quoted market prices obtained from independent pricing sources. If
quoted market prices are not available, fair values are based on quoted market
prices of comparable instruments.
LOANS HELD FOR SALE OR FOR INVESTMENT The estimated fair
values of loans held for sale is based on what secondary markets are currently
offering for portfolios with similar characteristics. The estimated fair values
of loans held for investment is determined using discounted cash flow
techniques. Scheduled principal and interest payments are adjusted for estimated
future prepayments as provided by third-party market sources or as estimated by
management using historical prepayment experience. Discount rates used in the
fair value computations are generally based on interest rates
45
offered by the Corporation on similar loans as of the end of the period,
adjusted for management's estimate of differences in liquidity, credit risk,
remaining term to maturity, etc.
The estimated fair value of loans held for sale also includes
an adjustment for the estimated fair value of unfunded interest rate commitments
on loans the Corporation intends to sell, as well as forward commitments to sell
loans. The methods used to value these commitments are described under "Forward
Commitments to Sell Loans", below.
FEDERAL HOME LOAN BANK STOCK FHLB stock held in excess of
minimum requirements can be returned to the FHLB for face value. Accordingly,
the fair value of all FHLB stock is estimated to be equal to the face amount
presented in the Corporation's Consolidated Statements of Financial Condition.
ACCRUED INTEREST RECEIVABLE AND PAYABLE The fair value of
accrued interest is equal to the face amount presented in the Corporation's
Consolidated Statements of Financial Condition.
MORTGAGE SERVICING RIGHTS The fair value of MSRs is estimated
using a discounted cash flow calculation that applies discount rates considered
reasonable by management to a schedule of both contractual and estimated cash
flows. Such cash flows are adjusted for loan prepayment rates determined by
independent industry sources.
DEPOSIT LIABILITIES The fair values of demand deposit accounts
(i.e., interest-bearing and non-interest-bearing checking accounts and money
market and regular savings accounts) are equal to their face amount. The fair
value of fixed-rate time deposits is estimated using a discounted cash flow
calculation that applies interest rates offered by the Corporation as of the
measurement date to a schedule of aggregate contractual maturities of such
deposits as of the same dates.
FEDERAL HOME LOAN BANK ADVANCES The fair value of FHLB
advances is estimated using a discounted cash flow calculation that applies
interest rates quoted by the FHLB as of the measurement date to a schedule of
aggregate contractual maturities of such liabilities as of the same date. The
fair value of FHLB advances excludes the effect of any prepayment penalties that
may be incurred if the Corporation were to prepay any of its term advances.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE, FEDERAL FUNDS
PURCHASED, AND OTHER BORROWINGS These funding sources consist principally of
short-term or variable rate borrowings. As such, the Corporation has estimated
the fair value of these funding sources to approximate carrying value.
ADVANCE PAYMENTS BY BORROWERS FOR TAXES AND INSURANCE The fair
value of advance payments by borrowers for taxes and insurance is equal to the
face amount presented in the Corporation's Consolidated Statements of Financial
Condition.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS The Corporation has
become a party to financial instruments with off-balance sheet risk in the
normal course of its business in order to meet the financing needs of its
customers. These financial instruments include commitments to extend credit,
standby letters of credit, lines of credit, and financial guarantees.
Off-balance sheet financial instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amounts
recognized in the Statement of Financial Condition. In the event of
non-performance by the other party to a financial instrument, the Corporation's
exposure to credit loss is represented by the contractual amount of the
instrument. The Corporation uses the same credit policies in granting
commitments, letters and lines of credit, and financial guarantees as it does
for on-balance-sheet financial instruments.
The fair values of commitments to extend credit are determined
based on what secondary markets are currently offering for portfolios with
similar characteristics, similar to that which is used for loans held for sale,
as previously described.
Other than credit enhancements on loans sold to the FHLB, the
Corporation does not issue material amounts of financial guarantees or stand-by
letters of credit. Management believes that the Corporation's exposure to loss
on such instruments is insignificant, including its credit enhancements with the
FHLB. Accordingly, management believes the fair value of such financial
instruments approximates zero.
FORWARD COMMITMENTS TO SELL LOANS The fair values of forward
commitments to sell loans are based on average quoted market prices obtained
from independent pricing sources.
46
STOCK-BASED COMPENSATION The Corporation records expense relative to
stock-based compensation using the "intrinsic value method". Since the intrinsic
value of the Corporation's stock options is generally "zero" at the time of the
award, no expense is recorded. With respect to restricted stock awards, the
intrinsic value is generally equal to the fair value of the Corporation's common
stock on the date of the initial contingent award, adjusted retroactively for
any changes in the value of the stock between the initial award date and the
final measurement date. Such value is amortized as expense over the measurement
period of the award.
EARNINGS PER SHARE Basic and diluted earnings per share data are based
on the weighted-average number of common shares outstanding during each period.
Diluted earnings per share is further adjusted for potential common shares that
were dilutive and outstanding during the period. Potential common shares
generally consist of stock options outstanding under the incentive plans
described elsewhere in this report. The dilutive effect of potential common
shares is computed using the treasury stock method. All stock options are
assumed to be 100% vested for purposes of the earnings per share computations.
The computation of earnings per share for the years ended December 31, 2003,
2002, and 2001, is as follows:
2003 2002 2001
------------------------- ------------------------- -------------------------
DILUTED BASIC DILUTED BASIC DILUTED BASIC
----------- ----------- ----------- ----------- ----------- -----------
Net income $34,726,545 $34,726,545 $34,915,542 $34,915,542 $28,448,225 $28,448,225
=========== =========== =========== =========== =========== ===========
Average common shares issued, net
of actual treasury shares 20,352,640 20,352,640 19,892,179 19,892,179 18,682,407 18,682,407
Potential common shares issued under
stock options (treasury stock method) 245,035 - 271,658 - 188,582 -
----------- ----------- ----------- ----------- ----------- -----------
Average common shares and
potential common shares 20,597,675 20,352,640 20,163,837 19,892,179 18,870,989 18,682,407
=========== =========== =========== =========== =========== ===========
Earnings per share $ 1.69 $ 1.71 $ 1.73 $ 1.76 $ 1.51 $ 1.52
=========== =========== =========== =========== =========== ===========
CASH AND CASH EQUIVALENTS For purposes of the Corporation's
Consolidated Statements of Cash Flows, cash and cash equivalents consists solely
of cash on hand and non-interest-bearing deposits in banks ("cash and due from
banks"). The Corporation is required to maintain a certain amount of cash on
hand and non-interest-bearing account balances at the Federal Reserve Bank of
Minneapolis to meet specific reserve requirements. These requirements
approximated $53.3 million at December 31, 2003, and $49.6 million at December
31, 2002.
RECLASSIFICATION Certain 2002 and 2001 balances have been reclassified
to conform with the 2003 presentation.
NOTE 2--INVESTMENT SECURITIES AND MORTGAGE-BACKED AND RELATED SECURITIES
Mortgage-backed and related securities at December 31, 2003 and 2002,
are summarized as follows:
2003
------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------ ---------- ----------- ------------
Available for sale:
Collateralized mortgage obligations $362,605,326 $1,435,341 ($2,003,474) $362,037,193
Mortgage-backed securities 23,473,526 1,351,652 - 24,825,178
------------ ---------- ----------- ------------
Total available for sale 386,078,852 2,786,993 (2,003,474) 386,862,372
------------ ---------- ----------- ------------
Held for investment:
Mortgage-backed securities 613,076 5,557 (8,339) 610,294
------------ ---------- ----------- ------------
Total held for investment 613,076 5,557 (8,339) 610,294
------------ ---------- ----------- ------------
Total mortgage-related securities $386,691,928 $2,792,550 ($2,011,813) $387,472,666
============ ========== =========== ============
2003
------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------ ---------- ----------- ------------
Available for sale:
Collateralized mortgage obligations $321,054,160 $1,109,312 ($ 298,506) $321,864,966
Mortgage-backed securities 41,440,735 2,769,405 - 44,210,140
------------ ---------- ----------- ------------
Total available for sale 362,494,895 3,878,717 (298,506) 366,075,106
------------ ---------- ----------- ------------
Held for investment:
Collateralized mortgage obligations 29,129,314 188,596 (27,917) 29,289,994
Mortgage-backed securities 900,376 12,952 (11,146) 902,182
------------ ---------- ----------- ------------
Total held for investment 30,029,690 201,548 (39,063) 30,192,176
------------ ---------- ----------- ------------
Total mortgage-related securities $392,524,585 $4,080,265 ($ 337,569) $396,267,282
============ ========== =========== ============
47
Accrued interest receivable on mortgage-backed and related securities
was $1,524,381 and $2,085,348 at December 31, 2003 and 2002, respectively.
MBSs consist of Freddie Mac and Fannie Mae securities. As of December
31, 2003, the Corporation had retained the credit risk on $16.4 million in
Freddie Mac MBSs. CMOs consist of securities backed by the aforementioned
agency-backed securities or by whole-loans. As of December 31, 2003,
approximately 21% of the Corporation's CMO portfolio consisted of securities
backed by whole loans--all of which were rated triple-A or its equivalent by the
major credit-rating agencies. Approximately 31% of the Corporation's whole-loan
CMOs consisted of loans on properties located in the state of California. No
other geographical location had a material concentration. As of December 31,
2003, MBSs with a book value of $185,000 were pledged as collateral on a
treasury tax and loan deposit; CMOs with a book value of $97.4 million were
pledged to secure FHLB advances.
As of December 31, 2003 and 2002 there were no securities outstanding
other than MBSs and CMOs. There were no realized gains or losses on sales of
investment securities in 2003. Realized losses on sales of investment securities
were $166,264 in 2002. There were no realized gains or losses on sales of
mortgage-backed and related securities during 2003, 2002, and 2001.
NOTE 3--LOANS HELD FOR INVESTMENT
Loans held for investment at December 31 are summarized as follows:
2003 2002
-------------- --------------
First mortgage loans:
Single-family real estate $ 759,489,982 $ 734,407,400
Non-residential real estate 426,644,196 250,223,910
Multi-family real estate 284,991,259 254,294,478
Construction 119,195,922 97,263,177
Consumer loans:
Second mortgage and home equity 396,581,425 345,810,380
Automobile 146,676,852 126,454,963
Other consumer 36,400,783 28,613,347
Education loans 195,052,225 194,597,010
Commercial business loans 158,760,854 71,904,398
-------------- --------------
Subtotal 2,523,793,498 2,103,569,063
Unearned discount, premiums, and net deferred loan fees and costs 8,772,240 8,730,580
Allowance for loan losses (13,882,350) (11,658,086)
-------------- --------------
Total $2,518,683,388 $2,100,641,557
============== ==============
Accrued interest receivable on loans was $14,260,711 and $15,305,012 at
December 31, 2003 and 2002, respectively.
At December 31, 2003, substantially all of the Corporation's
single-family mortgage loans were pledged to secure FHLB advances.
At December 31, 2003 and 2002, loans on non-accrual status were $9.6
million and $5.4 million, respectively. The Corporation has no loans
contractually past due ninety or more days for which interest is being accrued.
With respect to single-family mortgage loans, it is the Corporation's
general policy to restrict lending to its primary market areas in Wisconsin,
Minnesota, and Illinois, as well as contiguous counties in Iowa, though from
time-to-time the Corporation will purchase single-family loans originated
outside of its primary market area. It is also the Corporation's general policy
to limit individual single-family mortgage loans to 80% of the appraised value
of the property securing the loan. The Corporation will occasionally lend more
than 80% of the appraised value of the property, but generally will require the
borrower to obtain private mortgage insurance on the portion of the loan amount
that exceeds 80% of the collateral. Single-family mortgage loans originated or
purchased outside of the Corporation's primary market area were $239 million and
$307 million at December 31, 2003 and 2002, respectively.
With respect to multi-family and non-residential real estate loans, it
is the Corporation's policy to restrict its lending area to loans secured by
property located within a 300-mile radius of La Crosse, to include all or a
portion of the states of Wisconsin, Nebraska, Illinois, Iowa, and Minnesota,
although in the past the Corporation originated multi-family and non-residential
real estate loans outside of this area. It is also the Corporation's general
policy to limit loans on multi-family residential complexes, retail shopping
centers, office buildings, and multi-tenant industrial buildings to 80% of the
48
appraised value of the property securing the loan. Loans on other types of
commercial properties, such as nursing homes, hotels/motels, churches, and
single-tenant industrial buildings are limited to 75% or less of the appraised
value of the property securing the loan. Multi-family and non-residential real
estate loans originated or purchased outside of the Corporation's market area
were $20.6 million and $19.9 million, at December 31, 2003 and 2002,
respectively.
With respect to consumer loans, it is the Corporation's policy that
such loans be supported primarily by the borrower's ability to repay the loan
and secondarily by the value of the collateral securing the loan, if any.
Furthermore, in the case of second mortgages and home equity loans, the
Corporation does not generally allow the sum of the first and second mortgage
amounts to exceed 100% of the appraised value of the property securing the loan.
Education loans are substantially guaranteed by an agency of the U.S.
government.
With respect to commercial business loans, it is the Corporation's
policy that such loans be supported primarily by the borrower's ability to repay
the loan and/or alternative sources of repayment (generally in the form of
collateral or outside guarantee), and secondarily by the value of the collateral
securing the loan, if any. Applications for commercial business loans are
accepted at the Corporation's offices in La Crosse, Wausau, and Oskhosh,
Wisconsin, as well as Rochester and St. Paul, Minnesota. It is the Corporation's
general policy to restrict its commercial business lending to a market area
defined as within a 150-mile radius of any office location where business
banking products and services are sold.
A summary of the activity in the allowance for loan losses is as
follows:
2003 2002 2001
----------- ----------- ----------
Balance at beginning of period $11,658,086 $ 9,961,577 $8,027,526
Provision charged to expense 1,455,835 3,468,063 1,763,391
----------- ----------- ----------
Loans charged-off (2,205,996) (1,844,943) (1,189,383)
Recoveries 100,537 73,389 98,026
----------- ----------- ----------
Charge-offs, net (2,105,459) (1,771,554) (1,091,357)
Allowance on loans acquired in acquisition 2,873,889 - 1,262,017
----------- ----------- ----------
Balance at end of period $13,882,350 $11,658,086 $9,961,577
=========== =========== ==========
NOTE 4--MORTGAGE SERVICING RIGHTS
A summary of the activity in mortgage servicing rights is as follows:
PURCHASED ORIGINATED VALUATION
MSR MSR ALLOWANCE TOTAL
----------- ------------ ----------- -----------
Balance at December 31, 2000 $ 3,656,097 $ 22,291,018 ($2,666,643) $23,280,472
Purchased servicing 1,100,197 1,100,197
Originated servicing 20,183,936 20,183,936
Originated servicing obtained through acquisition 1,248,285 1,248,285
Amortization charged to earnings (1,669,661) (14,301,103) (15,970,764)
Valuation adjustments charged to earnings 66,643 66,643
----------- ------------ ----------- -----------
Balance at December 31, 2001 3,086,633 29,422,136 (2,600,000) 29,908,769
Originated servicing 26,286,368 26,286,368
Amortization charged to earnings (1,754,025) (23,519,771) (25,273,796)
Valuation adjustments charged to earnings (750,000) (750,000)
----------- ------------ ----------- -----------
Balance at December 31, 2002 1,332,608 32,188,733 (3,350,000) 30,171,341
Originated servicing 31,548,399 31,548,399
Amortization charged to earnings (1,019,702) (27,709,182) (28,728,884)
Valuation adjustments charged to earnings 3,350,000 3,350,000
----------- ------------ ----------- -----------
Balance at December 31, 2003 $ 312,906 $ 36,027,950 - $36,340,856
=========== ============ =========== ===========
Loans serviced for investors were $3.3 billion, $3.0 billion, and $2.7
billion at December 31, 2003, 2002, and 2001, respectively. These loans are not
reflected in the Corporation's Consolidated Statements of Financial Condition.
At December 31, 2003, the Corporation had retained the credit risk related to
$2.4 billion in single-family residential loans sold to the FHLB in exchange for
a monthly credit enhancement fee.
As more fully described in Note 1, originated servicing is recorded as
a component of gain on sale of mortgage loans, which is included as a component
of mortgage banking revenue. In addition, amortization and valuation adjustments
charged to earnings are recorded as an offset to servicing fee income, which is
also recorded as a component of mortgage banking revenue.
49
As noted in the table, above, amortization of MSRs varies considerably
from period to period. The amortization of MSRs is significantly influenced by
the interest rate environment and the impact such has on borrower behavior and
the broader market's expectations for future loan prepayment activity. If the
interest rate environment at December 31, 2003, remains unchanged for the next
five years and/or the market's expectations for future loan prepayment activity
does not change over the same period, management estimates amortization of MSRs
will be $7.3 million, $6.2 million, $5.0 million, $3.9 million, and $3.1 million
during the years 2004 to 2008, respectively. Management cautions the reader that
the only thing known for certain with respect to this estimate is that it is a
virtual certainty that it will not transpire because it is a virtual certainty
that interest rates will fluctuate, borrower behavior will change, and market
expectations for future prepayments will vary, making any estimate of future
amortization subject to significant uncertainty in the near term. The reader is
also cautioned that the disclosure does not include an estimate of amortization
for MSRs originated or purchased after December 31, 2003. As a result of these
shortcomings, management cautions the reader that this disclosure may be of very
limited value.
NOTE 5--OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment at December 31 are summarized as
follows:
2003 2002
------------ -----------
Office buildings and improvements $ 27,714,291 $22,699,575
Furniture and equipment 29,972,259 26,338,144
Leasehold improvements 9,105,056 8,235,992
Land and improvements 7,027,059 4,616,028
Property acquired for expansion 7,728,871 712,330
Construction in progress 4,470,003 2,262,012
------------ -----------
Subtotal 86,017,539 64,864,081
Accumulated depreciation and amortization (32,996,956) (29,216,746)
------------ -----------
Total $ 53,020,583 $35,647,335
============ ===========
The Corporation rents office space and land under operating leases at
certain of its locations. These leases have terms expiring between 2004 and 2033
and provide for renewals subject to escalation clauses. Rental expense was
$3,210,117, $2,655,420, and $2,217,502 for the years ended December 31, 2003,
2002, and 2001, respectively. Management estimates lease payments will be
$2.8 million each year during the years 2004 to 2008.
NOTE 6--GOODWILL AND OTHER INTANGIBLE ASSETS
The Corporation adopted SFAS 142 on January 1, 2002. Under SFAS 142,
goodwill and intangible assets deemed to have indefinite lives are no longer
amortized but are subject to annual impairment tests. Other identifiable
intangible assets continue to be amortized over their useful lives, which
include deposit-based intangibles. If SFAS 142 had been in effect during the
twelve months ended December 31, 2001, the Corporation's net income in such
period would have been higher by approximately $662,000 or $0.03 per diluted
share.
The following table provides a summary of the Corporation's goodwill
and other intangible assets as of December 31:
2003 2002
----------- -----------
Goodwill:
Not deductible for tax purposes $55,229,555 $15,607,128
Deductible for tax purposes 22,939,311 22,939,311
----------- -----------
Total goodwill 78,168,866 38,546,439
Other intangible assets:
Deposit-based intangibles not deductible for tax purposes 10,076,213 1,465,617
Deposit-based intangibles deductible for tax purposes 2,442,771 2,876,753
Other intangibles, deductible for tax purposes 839,992 929,577
----------- -----------
Total other intangibles 13,358,976 5,271,947
----------- -----------
Total $91,527,842 $43,818,386
=========== ===========
As of December 31, 2003, the weighted-average remaining amortization
period for deposit-based intangibles deductible for tax purposes was
approximately 20 years. It was approximately 16 years for non-deductible
deposit-based intangibles. Amortization for all deposit-based intangibles is
expected to be $1.9 million in 2004, $1.7 million in 2005, $1.6 million in 2006,
$1.5 million in 2007, and $1.4 million in 2008. As of December 31, 2002, the
weighted-average
50
remaining amortization period for other intangibles was approximately 8 years.
Amortization for other intangibles is expected to be approximately $127,000 per
year in the years 2004 through 2006, $123,000 in 2007, and $85,000 in 2008.
As described in Note 14, the Corporation disregards the impact of
goodwill and other intangible assets in evaluating the performance of its
reportable segments. Consequently, no effort has been made to allocate such
assets to the Corporation's reportable segments. As described in Note 14, the
Corporation accounts for its operations along product lines. However, management
of the Corporation believes it is more appropriate in the banking industry for
goodwill and other intangible assets to continue to be associated with the
specific customer base or market from which such assets arose, as opposed to
particular product lines. Accordingly, the Corporation maintains its accounting
records for goodwill and other intangible assets by market, rather than by
product line. Management of the Corporation believes this approach to be
appropriate, because its annual impairment evaluation for goodwill and other
intangible assets begins with an analysis of its customer, loan, and deposit
bases in a particular market, as well as the wealth of public information that
is available in the banking industry on the value of such franchises. The
following table summarizes the Corporation's goodwill and other intangible
assets by market as of December 31:
2003 2002
------------------------------------ ------------------------------------
DEPOSIT-BASED DEPOSIT-BASED
MARKET GOODWILL INTANGIBLES OTHER GOODWILL INTANGIBLES OTHER
- ---------------------------- ----------- ----------- -------- ----------- ----------- --------
St. Paul, Minnesota $39,622,427 $8,841,013 - - - -
Rochester, Minnesota 16,662,680 2,292,153 - $16,662,680 $2,692,857 -
Wausau, Wisconsin 12,513,602 1,235,200 - 12,513,602 1,465,617 -
Rockford, Illinois 6,276,631 - - 6,276,631 - -
Beloit/Janesville, Wisconsin 3,093,526 10,151 - 3,093,526 20,327 -
All other markets - 140,466 839,992 - 163,569 929,577
----------- ----------- -------- ----------- ----------- --------
Total $78,168,866 $12,518,983 $839,992 $38,546,439 $4,342,370 $929,577
=========== =========== ======== =========== =========== ========
Management evaluated the Corporation's intangible assets as of June 30,
2003, in accordance with SFAS 142 and determined that such assets were not
impaired at that time. Management of the Corporation is not aware of any events
or circumstances that would change this assessment as of December 31, 2003.
NOTE 7--DEPOSIT LIABILITIES
Deposit liabilities at December 31 are summarized as follows:
2003 2002
-------------- --------------
Checking accounts:
Non-interest-bearing $ 345,698,378 $ 356,357,052
Interest-bearing 187,367,730 138,650,072
Money market accounts 464,779,883 241,113,975
Regular savings accounts 260,975,248 163,844,384
-------------- --------------
Total demand deposits 1,258,821,239 899,965,483
-------------- --------------
Time deposits maturing within
Three months 139,322,313 220,091,094
Four to six months 104,895,917 217,916,156
Seven to twelve months 321,522,681 653,508,965
Thirteen to twenty-four months 504,235,492 157,528,782
Twenty-five to thirty-six months 92,988,451 121,376,825
Thirty-seven to forty-eight months 90,854,429 14,508,390
Forty-nine to sixty months 40,196,503 70,252,597
-------------- --------------
Total time deposits 1,294,015,786 1,455,182,809
-------------- --------------
Total $2,552,837,027 $2,355,148,292
============== ==============
Accrued interest payable on deposit liabilities was $1,533,598 and
$1,295,729 at December 31, 2003 and 2002, respectively. Time deposits include
$191 million and $195 million of certificates in denominations of $100,000 or
more at December 31, 2003 and 2002, respectively. Time deposits also include
$9.0 million and $5.3 million in deposits obtained through third-party brokers
at December 31, 2003 and 2002, respectively.
Included in non-interest-bearing checking accounts at December 31, 2003
and 2002, were $43 million and $139 million, respectively, which represented
amounts held in custody for third-party investors in loans serviced by the
Corporation.
51
Interest expense on deposit liabilities for the year ended December 31
is summarized as follows:
2003 2002 2001
----------- ---------- -----------
Checking accounts $ 594,560 $ 475,103 $ 573,484
Money market savings accounts 3,324,235 3,239,148 5,538,599
Regular savings 492,047 1,150,568 1,528,534
Time deposits 44,997,311 52,218,120 75,943,999
----------- ---------- -----------
Total $49,408,153 $57,082,939 $83,584,616
=========== ========== ===========
NOTE 8--FEDERAL HOME LOAN BANK ADVANCES AND ALL OTHER BORROWINGS
FHLB advances and all other borrowings at December 31 are summarized as
follows:
2003 2002
--------------------------- ---------------------------
WEIGHTED WEIGHTED
BALANCE AVERAGE RATE BALANCE AVERAGE RATE
------------ ------------ ------------ ------------
Federal Home Loan Bank advances maturing in
2003 - - $170,600,000 5.32%
2004 $ 50,000,000 4.33% 125,000,000 5.09
2005 25,000,000 4.32 77,500,000 5.58
2008 27,500,000 4.96 27,500,000 4.96
Open line of credit 270,575,000 1.27 - -
------------ ------------ ------------ ------------
Total FHLB advances 373,075,000 2.16 400,600,000 5.27
Federal funds purchased 24,500,000 1.26 - -
Other borrowings 43,624,308 2.29 17,012,682 2.47
------------ ------------ ------------ ------------
Total $441,199,308 2.12% $417,612,682 5.16%
============ ============ ============ ============
Accrued interest payable on FHLB advances and all other borrowings was
$639,075 and $1,823,680 at December 31, 2003 and 2002, respectively.
The Corporation's borrowings at the FHLB are limited to the lesser of
35% of total assets or 60% of the book value of certain single-family
residential mortgage loans and 85% to 90% of the market value of certain
mortgage-related securities. As of December 31, 2003, substantially all of the
Corporation's single-family mortgage loans and $97.4 million in CMOs were
pledged to secure FHLB advances. As of that date, the Corporation was in an
"over-pledged" condition with the FHLB to facilitate possible future borrowings.
As of December 31, 2003, the Corporation had approximately $463 million of
unused borrowing capacity at the FHLB. Interest on the Corporation's open line
of credit with the FHLB is paid monthly at approximately 25 basis points above
the federal funds rate. There were no borrowings outstanding under this line of
credit at December 31, 2002. As of December 31, 2003, $27.5 million of the FHLB
advances maturing in 2008 consist of borrowings that are redeemable quarterly at
the option of the FHLB.
The Corporation has unsecured lines of credit with three financial
institutions. These lines, which amount to $60.0 million in the aggregate,
permit the overnight purchase of federal funds. As of December 31, 2003, there
was $24.5 million outstanding under these lines of credit. The Corporation also
has an additional unsecured line of credit with one of these institutions in the
amount of $60 million. As of December 31, 2003, there was $41.1 million
outstanding under this unsecured line of credit.
NOTE 9--INCOME TAXES
Federal and state income tax expense for the years ended December 31 is
summarized as follows:
2003 2002 2001
----------- ----------- -----------
Current:
Federal $13,772,660 $16,147,140 $12,819,735
State 356,780 197,726 128,750
----------- ----------- -----------
Total current 14,129,440 16,344,866 12,948,485
----------- ----------- -----------
Deferred:
Federal 4,080,000 1,901,000 2,427,000
State 2,229,936 1,152,000 23,000
----------- ----------- -----------
Total deferred 6,309,936 3,053,000 2,450,000
----------- ----------- -----------
Total $20,439,376 $19,397,866 $15,398,485
=========== =========== ===========
52
The income tax provision differs from the provision computed at the
federal statutory corporate tax rate for the years ended December 31 as follows:
2003 2002 2001
----------- ----------- -----------
Income taxes at federal statutory of 35% $19,308,072 $19,009,693 $15,346,348
State income tax net of federal income tax effect 1,674,738 877,322 98,637
Other (543,434) (489,149) (46,500)
----------- ----------- -----------
Income tax provision $20,439,376 $19,397,866 $15,398,485
=========== =========== ===========
The significant components of the Corporation's deferred tax assets and
liabilities as of December 31, are summarized as follows:
2003 2002
------------- ------------
Deferred tax assets:
Loan and real estate loss allowances $ 5,420,783 $ 4,623,320
Deferred compensation 3,610,743 3,362,802
State tax loss carryforwards, net 864,062 1,291,698
Additional minimum pension liability
Other 1,201,864 594,566
308,024 326,220
------------- ------------
Total deferred tax assets 11,405,476 10,198,606
Valuation allowance (347,494) (458,920)
------------- ------------
Adjusted deferred tax assets 11,057,982 9,739,686
Deferred tax liabilities:
Mortgage servicing rights 13,333,709 10,228,587
Securities valuation allowance 274,232 1,253,074
Office properties and equipment depreciation 1,111,661 627,397
Deferred loan fees 1,339,221 1,177,780
FHLB stock dividends 4,141,182 2,720,607
Purchase acquisition adjustments 4,314,259 1,218,408
Other 621,973 513,133
------------- ------------
Total deferred tax liabilities 25,136,237 17,738,986
------------- ------------
Net deferred tax liabilities ($ 14,078,255) ($ 7,999,300)
============= ============
The Bank qualifies under provisions of the IRC that prior to 1996
permitted it to deduct from taxable income an allowance for bad debts that
generally exceeded losses charged to income for financial reporting purposes.
Accordingly, no provision for income taxes has been made for $21.1 million of
retained income at December 31, 2003. If in the future the Bank no longer
qualifies as a bank for tax purposes, income taxes may be imposed at the
then-applicable rates. If income taxes had been provided, the tax liability
would have been approximately $8.5 million. At December 31, 2003, the
Corporation had $16.9 million in state net operating loss carryforwards for tax
purposes that expire between 2004 and 2018. The Corporation carries a valuation
allowance against certain state net operating loss carryforwards. As of December
31, 2003, management believes it is more likely than not that the benefit of
these loss carryforwards will not be realized.
NOTE 10--EMPLOYEE BENEFIT PLANS
PENSION PLAN The Corporation has established a pension plan for the
benefit of full-time employees that have at least one year of service and have
attained the age of 20. However, the Corporation implemented a plan change as of
December 31, 2003, which froze plan benefits for participants that did not meet
certain age and service requirements on January 1, 2003. New employees after
December 31, 2003, will not accrue any benefits under the pension plan. For
participants that met the age and service requirements, there was no change in
the pension plan. For participants whose benefits were not frozen, benefits
under the plan are based on the employee's years of service and compensation
during the years immediately preceding retirement.
53
The following table summarizes the components of pension benefit
obligation and plan assets, the funded status of the plan, the amount recognized
in the Corporation's consolidated financial statements, and the weighted-average
assumptions for the years ended December 31, 2003 and 2002.
2003 2002
----------- -----------
Reconciliation of benefit obligation:
Benefit obligation at beginning of year $ 15,306,228 $ 12,337,045
Service costs 1,359,608 852,988
Interest costs 1,246,652 910,252
Actuarial loss 4,421,890 1,587,379
Benefit payments (408,049) (344,131)
Plan amendment - (37,305)
Curtailments (1,834,375) -
Benefit obligation assumed in merger 3,174,399 -
------------ ------------
Benefit obligation at end of year $ 23,266,353 $ 15,306,228
============ ============
Reconciliation of fair value of plan assets:
Fair value of plan assets at beginning of year: $ 8,915,403 $ 10,038,249
Actual return on plan assets 2,243,140 (1,216,526)
Employer contributions 1,806,000 437,811
Benefit payments (408,049) (344,131)
Fair value of plan assets assumed in merger 2,507,438 -
------------ ------------
Fair value of plan assets at end of year $ 15,063,932 $ 8,915,403
============ ============
Funded status:
Funding shortfall at end of year $ 8,202,421 $ 6,390,825
Additional minimum pension liability 3,004,659 1,486,414
Unrecognized prior service cost (5,654) 7,475
Unrecognized net loss (6,635,696) (5,233,056)
------------ ------------
Accrued pension expense $ 4,565,730 $ 2,651,658
============ ============
Components of net periodic benefit cost:
Service costs $ 1,359,608 $ 852,988
Interest costs 1,246,652 910,252
Expected return on plan assets (1,117,018) (1,006,928)
Amortization of prior service costs (27,809) (22,174)
Recognized actuarial (gain) loss 296,739 -
Curtailment (gain) loss (223,306) -
------------ ------------
Net periodic benefit cost $ 1,534,866 $ 734,138
============ ============
Weighted-average assumptions:
Discount rate--benefit obligation 6.25% 6.75%
Discount rate--net periodic benefit cost 6.75% 7.25%
Expected return on plan assets 8.50% 9.00%
Rate of compensation increase 5.50% 5.50%
Measurement date 12/31/2003 12/31/2002
Census date 1/1/2003 1/1/2002
============ ============
The additional minimum pension liability of $3.0 million was recorded
through accumulated non-owner adjustments to equity, net of estimated income
taxes of $1.2 million. As of December 31, 2003 and 2002, the accumulated benefit
obligation was $16.7 million and $11.6 million, respectively.
The Corporation develops the expected return on plan assets using
capital asset modeling data provided by external consultants. The expected
return and risk components of the various asset classes in the portfolio are
reviewed and, based on the asset allocations, the Corporation then determines a
composite expected return assumption. The Corporation believes this assumption
is reasonable over a long-term period that is consistent with the estimated
duration of the plan's liabilities.
The Corporation's investment strategy with respect to the pension is to
invest in equity securities, fixed income securities, and other securities to
cover cash flow requirements of the plan and minimize long-term costs. The
Corporation periodically reviews the risk in various asset classes relative to
the liabilities to determine the appropriate asset allocations. As of December
31, 2003, 57.5% of the fair value of the pension's plan assets were invested in
equity securities, 24.5% in debt securities, and 18.0% in all other assets.
In 2004, the Corporation expects to make contributions of $1.9 million
to the pension plan. Due to the acquisition of LBI in the fourth quarter of
2003, the Corporation recorded a purchase accounting adjustment of $666,961 for
the immediate recognition of unrecognized amounts in the LBI pension plan.
POSTRETIREMENT EMPLOYEE BENEFITS The Corporation provides certain
health care benefits to retired employees. Substantially all of the employees of
the Corporation may become eligible for these benefits if they retire from the
54
Corporation after satisfying specified age and service criteria. The health care
coverage provided to these active employees will be available when they retire
after age 55 with at least 20 years of service or after age 60 with at least 10
years of service. The same coverage could continue until the employee and spouse
(if also covered) reach age 65 provided they pay the required premiums. The
retiree medical plan was changed for employees that did not meet certain age and
service requirements as of January 1, 2003. The Corporation will no longer
contribute toward the cost of this benefit for these employees. For employees
that did meet the age and service requirements on January 1, 2003, there was no
change in the retiree health care benefit.
The following table summarizes the components of postretirement benefit
obligation and funded status, as well as the amounts recognized in the
Corporation's consolidated financial statements for the years ended December 31,
2003 and 2002.
2003 2002
----------- -----------
Reconciliation of benefit obligation:
Benefit obligation at beginning of year $ 3,158,703 $ 3,013,756
Service costs 85,753 106,399
Interest costs 261,442 202,940
Actuarial (gain) loss 211,483 (83,163)
Benefit payments (131,584) (81,229)
----------- -----------
Benefit obligation at end of year $ 3,585,797 $ 3,158,703
=========== ===========
Funded status:
Funding shortfall at end of year $ 3,585,797 $ 3,158,703
Unrecognized transition asset (18,458) (342,299)
Unrecognized net loss (1,231,831) (820,449)
----------- -----------
Accrued post-retirement benefit expense $ 2,335,508 $ 1,995,955
=========== ===========
Components of net periodic benefit cost:
Service costs $ 85,753 $ 106,399
Interest costs 261,442 202,940
Amortization of transition obligation 2,051 34,230
Recognized actuarial loss 121,891 19,456
----------- -----------
Net periodic benefit cost $ 471,137 $ 363,025
=========== ===========
Weighted-average assumptions:
Discount rate--benefit obligation 6.25% 6.75%
Discount rate--net periodic benefit cost 6.75% 7.25%
Rate of compensation increase 5.00% 5.50%
Measurement date 12/31/2003 12/31/2002
Census date 1/1/2003 1/1/2002
=========== ===========
The assumed rate of increase in the per capita cost of covered benefits
was approximately 10% for 2003, declining to approximately 5% in 2008 and
thereafter. This assumption has a significant effect on the amounts reported in
the Corporation's consolidated financial statements. For example, a one
percentage point increase in the assumed trend rate would increase the
accumulated postretirement benefit obligation as of December 31, 2003, by
approximately $278,000 and the aggregate service and interest cost components of
postretirement benefit expense for 2003 by approximately $26,000. A one
percentage point decline would decrease these amounts by approximately $239,000,
and $23,000, respectively.
On December 8, 2003, Congress expanded Medicare to include, for the
first time, coverage for prescription drugs. The Corporation expects that this
legislation could eventually reduce the costs associated with the postretirement
benefits it provides to employees. At present, no analysis of the potential
reduction in the Corporation's costs or obligations has been performed. Because
of the various uncertainties around the legislation and accounting methodology,
the Corporation has elected to defer financial recognition of this legislation
until the Financial Accounting Standards Board issues final accounting guidance.
SAVINGS PLANS The Corporation maintains a 401(k) savings plan for the
benefit of substantially all of its employees. Employees may contribute up to a
certain percentage of their compensation to the plan and the Corporation will
match their contributions within certain limits. In addition, the employee may
also receive discretionary profit sharing contributions from the Corporation. On
January 1, 2003, the Corporation changed the savings plan for employees that met
certain age and service requirements on that date. The Corporation will provide
additional matching contributions up to specified limits for these participants.
During the years ended December 31, 2003, 2002, and 2001, the Corporation made
matching and discretionary contributions to the savings plan of approximately
$1.3 million, $968,000, and $790,000, respectively.
EMPLOYEE STOCK OWNERSHIP PLAN The Corporation makes annual
discretionary contributions to an Employee Stock Ownership Program ("ESOP") for
the benefit of substantially all of its employees. As of January 1, 2003, the
Corporation changed the ESOP for employees that met certain age and service
requirements as of that date. The
55
Corporation may provide additional contributions for these participants. All
contributions are recorded as compensation expense on the books of the
Corporation at the time they are made. The Corporation recorded approximately
$776,000, $657,000, and $482,000 in ESOP-related compensation expense during the
years ended December 31, 2003, 2002, and 2001, respectively.
SUPPLEMENTAL PENSION PLAN The Corporation makes annual contributions to
a supplemental pension plan for certain members of management. All contributions
are recorded as compensation expense on the books of the Corporation at the time
they are made. The Corporation recorded approximately $317,000, $347,000, and
$285,000 in such expense during the years ended December 31, 2003, 2002, and
2001, respectively.
STOCK INCENTIVE PLANS The Corporation has adopted a stock incentive
plan designed to attract and retain qualified personnel in key management
positions. The plan provides for the grant of stock options, restricted stock,
and stock appreciation rights. In general, stock options granted under the plan
are exercisable at a price equal to the fair value of the stock on the date of
the grant. Furthermore, the options are subject to three- to five-year graded
vesting requirements and a maximum exercise period of ten years. The plan
currently authorizes the issuance of approximately 1.5 million shares, of which
585,300 shares were unallocated as of December 31, 2003. Activity in these stock
incentive plans for each of the three years ended December 31, 2003, 2002, and
2001, is summarized as follows:
2003 2002 2001
------------------ ------------------ -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER PRICE NUMBER PRICE NUMBER PRICE
------- -------- ------- -------- ------- --------
Stock options outstanding at beginning of period 901,288 $ 13.84 996,802 $ 12.39 741,770 $ 10.24
Stock options granted 25,168 20.26 68,582 19.59 380,550 14.17
Stock options exercised (143,132) 13.68 (153,596) 6.89 (107,638) 3.61
Stock options forfeited (30,200) 13.55 (10,500) 15.36 (17,880) 13.80
------- -------- ------- -------- -------- --------
Stock options outstanding at end of period 753,124 $ 14.15 901,288 $ 13.84 996,802 $ 12.39
======= ======== ======= ======== ======== ========
Fully-vested options outstanding at end of period 578,119 $ 13.46 565,915 $ 13.18 498,420 $ 11.03
======= ======== ======= ======== ======== ========
The following table presents the stock options outstanding as of
December 31, 2003, by range of exercise prices:
WEIGHTED AVG WEIGHTED AVG
STOCK OPTIONS REMAINING EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING TERM PRICE
- ------------------------- ------------- ------------ ------------
$ 0.00 - $ 5.00 474 0.8 years $ 3.90
5.01 - 10.00 41,500 1.5 years 5.35
10.01 - 15.00 596,900 6.1 years 13.84
15.01 - 20.00 55,251 8.2 years 17.32
20.01 - 25.00 58,999 8.7 years 20.60
------------- ------------ ------------
Total Options Outstanding 753,124 6.2 years $ 14.15
============= ============ ============
During the years ended December 31, 2003, 2002, and 2001, 38,200,
46,000, and 68,000 shares of restricted stock were granted at weighted-average
fair values of $20.35, $18.88 and $14.50, respectively.
The Corporation has also adopted a stock incentive plan designed to
attract and retain qualified non-employee directors for the Corporation and its
subsidiaries. Under the plan each director receives options to purchase 8,800
shares upon election or re-election to the Board of Directors. In general, the
stock options are exercisable at a price at least equal to the fair value of the
stock on the date of grant and are fully-vested on the date of the grant. These
plans have authorized the issuance of 398,000 shares, of which 354,000 shares
were unallocated as of December 31, 2003. Activity in these stock incentive
plans for each of the three years ended December 31, 2003, 2002, and 2001, is
summarized as follows:
2003 2002 2001
------------------- ------------------- ------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER PRICE NUMBER PRICE NUMBER PRICE
-------- -------- -------- -------- ------- --------
Stock options outstanding at beginning of period 136,596 $ 12.17 156,396 $ 11.67 138,796 $ 10.42
Stock options granted 26,400 19.06 17,600 19.33 26,400 14.79
Stock options exercised (28,600) 9.15 (37,400) 13.46 (8,800) 1.36
-------- -------- -------- -------- ------- --------
Stock options outstanding at end of period 134,396 $ 14.16 136,596 $ 12.17 156,396 $ 11.67
======== ======== ======== ======== ======= ========
56
The following table presents the stock options outstanding as of
December 31, 2003, by range of exercise prices:
WEIGHTED AVG WEIGHTED AVG
STOCK OPTIONS REMAINING EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING TERM PRICE
- ------------------------- ------------- ------------- ------------
$ 0.00 - $ 5.00 8,796 0.3 years $ 4.70
5.01 - 10.00 20,000 2.9 years 8.17
10.01 - 15.00 52,800 6.6 years 13.27
15.01 - 20.00 52,800 8.1 years 18.91
------------- ------------- ------------
Total Options Outstanding 134,396 6.2 years $ 14.16
============= ============= ============
As described in Note 1, the Corporation has elected to provide pro
forma disclosure of the effects of its stock incentive plans. The following
table provides information on the Corporation's stock incentive plans had it
accounted for them using the fair value method:
Dollars in thousand, except per share data 2003 2002 2001
- ------------------------------------------ ------- ------- -------
Net income, as reported $34,727 $34,916 $28,448
Assumed compensation cost, net of tax (483) (846) (934)
------- ------- -------
Pro forma net income $34,244 $34,070 $27,514
======= ======= =======
Diluted earnings per share:
As reported $ 1.69 $ 1.73 $ 1.51
Pro forma $ 1.66 $ 1.69 $ 1.46
Basic earnings per share:
As reported $ 1.71 $ 1.76 $ 1.52
Pro forma $ 1.68 $ 1.71 $ 1.47
======= ======= =======
The weighted-average fair value of the options granted in 2003, 2002,
and 2001, were $4.72, $5.86, and $4.26, respectively. The fair values of these
options were estimated as of the dates they were granted using a Black-Scholes
option-pricing model. Weighted-average assumptions for 2003 were 3.5% risk-free
interest rate, 2.6% dividend yield, 24% volatility, and a seven-year expected
life. Weighted-average assumptions for 2002 were 3.4% risk-free interest rate,
2.7% dividend yield, 30% volatility, and a seven-year expected life.
Weighted-average assumptions for 2001 were 4.6% risk-free interest rate, 3.2%
dividend yield, 30% volatility, and a seven-year expected life.
NOTE 11--COMMITMENTS, CONTINGENCIES, AND GUARANTEES
INCOME TAXES FCHI is incorporated in the State of Nevada, which does
not currently impose a corporate income tax. Although the earnings of FCHI are
not currently subject to taxation in the State of Wisconsin, from time-to-time
legislation is proposed which, if adopted, would require combined income tax
returns for entities headquartered in the state and result in taxation of FCHI's
earnings. To date, none of these legislative proposals have been adopted. In
addition, the Wisconsin Department of Revenue ("WDR") recently increased its
examinations of banking entities in the state and is investigating whether to
allocate income of out-of-state investment subsidiaries like FCHI to their
parent banks. Indeed, in 2003 the WDR began examinations of a number of
financial institutions, including the Bank, specifically aimed at their
relationships with their investment subsidiaries. Management believes the WDR
may take the position that some or all of the income of FCHI is allocable to the
Bank and taxable in Wisconsin. Management believes the Bank, as well as FCHI,
have complied with the tax rules relating to the income of out-of-state
subsidiaries, and with the private rulings the WDR issued to the Bank in 1993
and 1997 in connection with its formation and operation of FCHI. The WDR has
indicated that it may repudiate these rulings and management is uncertain at
this time whether the WDR exam will result in an assessment. The Bank will
oppose an assessment, if any.
If the WDR is successful in allocating FCHI's income to the Bank, or if
legislation referred to in the previous paragraph were to become law, such could
result in the earnings of FCHI being subject to taxation in the State of
Wisconsin. If the Corporation had been required to pay Wisconsin tax on FCHI's
income for the year ended December 31, 2003, the Corporation's income tax
expense would have been approximately $1.2 million higher than reported. This
would have reduced diluted and basic earnings per share by approximately $0.06
per share. Furthermore, if the WDR determines that the earnings of FCHI in open
tax years prior to 2003 should have been subject to tax in Wisconsin, management
estimates that the Bank may be subject to a tax obligation of up to $14.5
million, net of federal and state tax benefit. This amount includes an estimate
for interest, but excludes any penalties that may be assessed by the WDR, which
could be as high as 25% of the gross assessment. As previously mentioned,
however, the Bank will oppose an assessment related to this issue.
57
LEGAL PROCEEDINGS The Corporation and its subsidiaries are engaged in
various routine legal proceedings occurring in the ordinary course of business,
which in the aggregate are believed by management to be immaterial to the
consolidated financial condition of the Corporation.
OTHER COMMITMENTS AND CONTINGENCIES At December 31, 2003, the
Corporation had commitments to originate single-family mortgage loans at market
terms aggregating approximately $28.8 million, which expire on various dates in
2004. At December 31, 2003, the Corporation also had commitments to fund $82.6
million in additional proceeds on construction loans. As of the same date the
Corporation had approximately $4.9 million in commitments outstanding under
standby letters of credit, $21.1 million in unused credit card lines, $107.0
million in commitments outstanding under unused home equity lines of credit, and
$95.4 million under commercial business lines of credit. Furthermore, the
Corporation had commitments to sell approximately $38.6 million in mortgage
loans to Freddie Mac, Fannie Mae, and the FHLB at various dates in 2004. Since
many of these commitments are expected to expire without being drawn upon the
total commitments do not necessarily represent future cash requirements.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates and may require payment of a fee. Since
many of these commitments are expected to expire without being drawn upon the
total commitments do not necessarily represent future cash requirements.
At December 31, 2003, the Corporation had retained the credit risk
related to $2.4 billion in single-family residential loans sold to the FHLB in
exchange for a monthly credit enhancement fee.
NOTE 12--STOCKHOLDERS' EQUITY
PREFERRED STOCK The Corporation is authorized to issue up to 5,000,000
shares of preferred stock, $.10 par value per share, although no such stock was
outstanding at December 31, 2003. The Board of Directors of the Corporation is
authorized to establish the voting powers, designations, preferences, or other
special rights of such shares and the qualifications, limitations, and
restrictions thereof. The preferred stock may be issued in distinctly designated
series, may be convertible to common stock, and may rank prior to the common
stock in dividend rights, liquidation preferences, or both.
SHAREHOLDERS' RIGHTS PLAN The Corporation's Board of Directors has
adopted a shareholders' rights plan (the "Rights Plan"). Under the terms of the
Rights Plan, the Board of Directors declared a dividend of one preferred share
purchase right on each outstanding share of common stock of the Corporation.
However, the rights can only be exercised if a person or group acquires 20% or
more of the common stock or announces a tender or exchange offer that would
result in a 20% or greater position in the stock. Initially, each right will
entitle shareholders to buy one one-hundredth share of the Corporation's
preferred stock at a price of $50.00, subject to adjustment. Under certain
circumstances, including the acquisition of beneficial ownership of 25% or more
of the Corporation's common stock, holders of the Corporation's common stock,
other than the acquirer, will be entitled to exercise the rights to purchase
common stock from the Corporation having a value equal to two times the exercise
price of the right. If the Corporation is acquired in a merger, share exchange,
or other business combination in which the Corporation is not the survivor,
after a person or group's acquisition of beneficial ownership of 20% or more of
the common stock, rights holders will be entitled to purchase the acquirer's
shares at a similar discount. Issuance of the rights has no dilutive effect,
will not affect reported earnings per share, is not taxable to the Corporation
or its shareholders, and will not change the way in which the Corporation's
shares are traded. The rights expire in 2005.
STOCK REPURCHASE PLANS AND TREASURY STOCK In 2002, 2000, and 1999 the
Corporation's Board of Directors authorized the repurchase of up to 1,001,678,
913,554, and 905,248 shares of the Corporation's outstanding common stock,
respectively. Under the plans, repurchases may be made from time-to-time in the
open market during the ensuing twelve months as, in the opinion of management,
market conditions warrant. Typically, all plans are extended each year for an
additional twelve months until such time as all shares have been issued under
the plans. Repurchased shares are held as treasury stock and are available for
general corporate purposes.
During 2003, 2002, and 2001, the Corporation repurchased 26,198,
713,144, and 228,800 shares under the 2002, 2000, and 1999 Plans at an average
cost of $19.38, $19.31, and $14.04 per share, respectively. As of December 31,
2003, no shares remained to be purchased under the 1999 Plan, and 1,001,678
shares and 164,918 shares remained under the 2002 and 2000 Plans, respectively.
During 2003, 2002, and 2001 the Corporation reissued 542,095, 201,647,
and 1,825,132 shares of common stock out of treasury stock, respectively. These
shares had an average cost basis of $19.84, $17.81, and $10.05 per share,
58
respectively. During 2003, 426,635 of these shares were issued in connection
with the acquisition of LBI. In addition, during 2001, 1,685,126 of these
shares, plus 250,178 previously unissued shares, were issued in connection with
the acquisition of ACB. In general, these shares were otherwise issued upon the
exercise of stock options by, or the issuance of restricted stock to, employees
and directors of the Corporation.
DIVIDEND RESTRICTIONS The ability of the Corporation to pay dividends
will depend primarily upon the receipt of dividends from the Bank. The Bank may
not declare or pay a cash dividend without regulatory approval if such dividend
would cause undercapitalization following the distribution or if the proposed
dividend exceeds the year-to-date net income of that year, combined with the net
income of the preceding two years, as reduced by any dividends paid during such
years.
REGULATORY CAPITAL REQUIREMENTS Financial institutions such as the Bank
are subject to minimum regulatory capital requirements as specified in federal
banking law and supporting regulations. Failure of a financial institution to
meet such requirements may subject the institution to certain mandatory--and
possibly discretionary--actions on the part of its regulators (referred to as
"prompt corrective actions"). Such actions, if undertaken, could severely
restrict the activities of the institution. During each of the years ended
December 31, 2003 and 2002, the Bank's regulatory capital was sufficient under
the prompt corrective action provisions of the federal banking law and
supporting regulations. Accordingly, the Bank is not subject to prompt
corrective actions by its regulators. In addition, the Corporation is not aware
of any events or circumstances that would subject it to prompt corrective by its
regulators.
The following table summarizes the Bank's current regulatory capital in
both percentage and dollar terms as of December 31, 2003 and 2002. It also
summarizes the minimum capital levels that must be maintained by the Bank for it
to be classified as "adequately capitalized" and "well capitalized" under the
prompt corrective action provisions of federal banking law and supporting
regulations. As indicated in the table, the Bank is "well capitalized" for
regulatory capital purposes.
DECEMBER 31, 2003
MINIMUM REQUIREMENTS
TO BE CLASSIFIED AS...
---------------------------
ADEQUATELY WELL
CAPITALIZED CAPITALIZED ACTUAL
------------ ------------ ------------
Tier 1 leverage ratio 4.0% 5.0% 6.80%
Tier 1 risk-based capital ratio 4.0% 6.0% 10.95%
Total risk-based capital ratio 8.0% 10.0% 11.64%
Tier 1 leverage ratio capital $129,282,000 $161,602,000 $219,706,000
Tier 1 risk-based capital 80,266,000 120,398,000 219,706,000
Total risk-based capital 160,531,000 200,664,000 233,498,000
============ ============ ============
DECEMBER 31, 2002
Tier 1 leverage ratio 4.0% 5.0% 5.63%
Tier 1 risk-based capital ratio 4.0% 6.0% 10.22%
Total risk-based capital ratio 8.0% 10.0% 10.88%
Tier 1 leverage ratio capital $119,667,000 $149,584,000 $168,476,000
Tier 1 risk-based capital 65,908,000 98,862,000 168,476,000
Total risk-based capital 131,816,000 164,770,000 179,254,000
============ ============ ============
59
NOTE 13--FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair values of financial instruments as of December 31 are as follows:
2003 2002
------------------------------- -------------------------------
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
-------------- -------------- -------------- --------------
Cash and due from banks $ 94,535,753 $ 94,535,753 $ 84,482,722 $ 84,482,722
Interest-bearing deposits with banks 6,444,374 6,444,374 179,755,367 179,755,367
Mortgage-backed and related securities:
Available for sale 386,862,372 386,862,372 366,075,106 366,075,106
Held for investment 613,076 610,294 30,029,690 30,192,176
Loans held for sale 16,113,217 16,200,000 50,237,199 50,300,000
Loans held for investment, gross 2,532,565,738 2,560,400,000 2,112,299,643 2,134,400,000
Federal Home Loan Bank stock 59,634,800 59,634,800 55,634,400 55,634,400
Accrued interest receivable 15,802,753 15,802,753 17,522,581 17,522,581
Mortgage servicing rights 36,340,856 40,570,000 30,171,341 31,500,000
Financial liabilities:
Deposit liabilities $2,552,837,027 $2,577,800,000 $2,355,148,292 $2,381,500,000
Federal Home Loan Bank advances and all other
borrowings 441,199,308 445,900,000 417,612,682 439,400,000
Advance payments by borrowers for taxes and insurance 1,484,734 1,484,734 11,906,038 11,906,038
Accrued interest payable 2,234,905 2,234,905 3,119,227 3,119,227
Refer to Note 1 for the methods and assumptions used by the Corporation
in estimating the fair value of financial instruments. The carrying value shown
for loans held for investment excludes the impact of the Corporation's allowance
for loan losses
NOTE 14--SEGMENT INFORMATION
REPORTABLE SEGMENTS The Corporation tracks profitability in six major
areas: (i) residential lending, (ii) commercial real estate lending, (iii)
consumer lending, (iv) education lending, (v) business banking, and (vi)
investment and mortgage-related securities. Residential lending is divided into
two profit centers for segment reporting purposes: (i) a mortgage banking profit
center that is responsible for loan origination, sales of loans in the secondary
market, and servicing of residential loans, and (ii) a residential loan
portfolio that consists of loans held by the Corporation for investment purposes
(loans held for sale are included in the mortgage banking profit center). This
profit center also includes mortgage-backed securities that are collateralized
by loans that were originated by the Corporation. Commercial real estate lending
consists of the Corporation's portfolio of multi-family and non-residential
mortgage loans, excluding loans assigned to the business banking profit center,
as well as functions related to the origination and servicing of such loans.
Consumer lending consists of the Corporation's second mortgage, automobile, and
other consumer installment loans, excluding loans assigned to the business
banking profit center, as well as functions related to the origination and
servicing of such loans. Education lending consists of the Corporation's
portfolio of education loans, as well as functions related to the origination
and servicing of such loans. Business banking consists of the Corporation's
portfolio of commercial business loans, including certain commercial real estate
and consumer loans assigned to the business banking profit center, as well as
functions related to the origination and servicing of such loans. Finally, the
Corporation's investment and mortgage-related securities portfolio is considered
a profit center for segment reporting purposes. As previously noted, however,
mortgage-backed securities collateralized by loans originated by the Corporation
are included in the residential loan profit center, rather than the investment
and mortgage-related securities portfolio.
The Corporation's extensive branch network, which delivers checking,
savings, certificates of deposit and other financial products and services to
customers, is considered a support department for segment reporting purposes, as
more fully described in a subsequent paragraph.
MEASUREMENT OF SEGMENT PROFIT (LOSS) Management evaluates the after-tax
performance of the Corporation's profit centers as if each center were a
separate entity--each with its own earning assets, actual and/or allocated
non-earning assets, and allocated funding resources. Each profit center has its
own interest income, non-interest income, and non-interest expense as captured
by the Corporation's accounting systems. Interest expense is allocated to each
profit center according to its use of the Corporation's funding sources, which
consist primarily of deposit liabilities, wholesale borrowings, and equity. In
general, all funding sources are allocated proportionately to each profit
center. However, in certain instances specific funding sources may be matched
against specific assets of profit centers. For example, deposits from business
customers are matched against the assets of the business banking profit center.
In addition, wholesale borrowings drawn to originate or purchase specific assets
are matched against the appropriate profit center.
60
The net cost of operating the Corporation's support departments is
allocated to the Corporation's profit centers and to the branch network using a
variety of methods deemed appropriate by management. In general, these net costs
are included in the non-interest expense of each profit center. In addition,
certain allocations of revenues and expenses are made between profit centers
when they perform services for each other. Such amounts, however, are not
generally material in nature.
The Corporation's branch network is considered a support department
center for segment reporting purposes. Community banking fees and revenues are
deducted from the non-interest expense of operating the network (to include an
allocation of net costs from the Corporation's other support departments) to
arrive at net costs for the branch network. This net cost is then allocated to
each profit center based on its use of deposit liabilities to fund its
operations. This amount is reported as "net cost to acquire and maintain deposit
liabilities" and is included as an adjustment to the net interest income of each
profit center.
NON-GAAP ADJUSTMENTS For segment reporting purposes, management makes
certain non-GAAP adjustments and reclassifications to the results of operations
and financial condition of the Corporation that, in management's judgment, more
fairly reflect the performance and/or financial condition of certain of the
Corporation's profit centers. Following is a description of the more significant
adjustments:
INTEREST INCOME AND EXPENSE Interest income is credited to the
mortgage banking profit center for implied earnings on non-interest-bearing
liabilities such as custodial and escrow accounts. The offsetting interest
expense is charged to each profit center according to their use of these funding
sources, as previously described. Fee income from customers that make their
monthly loan payments late ("late charges") is reclassified from interest income
to non-interest income in the mortgage banking profit center. Income from bank
owned life insurance is reclassified from non-interest income to interest income
in the investment and mortgage-related security profit center.
LOAN ORIGINATION FEES AND COSTS In accordance with GAAP,
origination fees earned on residential loans held for investment are deferred
and amortized over the expected life of the loans, as are the direct costs to
originate the loans. In general, these deferrals and their subsequent
amortization are disregarded for segment reporting purposes. As a result, the
mortgage banking profit center receives revenue for loans that it originates for
the portfolio of residential loans held for investment, as well as a full charge
for the costs to originate the loans. These fees and costs are in addition to
the fees it receives and the costs it incurs on loans originated for sale in the
secondary market, which are included in current earnings under GAAP.
MORTGAGE SERVICING RIGHTS In accordance with GAAP, mortgage
servicing rights are not recorded on residential loans held for investment.
However, for segment reporting purposes, the mortgage banking profit center
receives an income allocation for the origination of such loans, which
represents the estimated value of the mortgage servicing rights. This allocation
is in addition to the gain from mortgage servicing rights that is recorded on
loans sold in the secondary market, as permitted under GAAP. The amortization of
the mortgage servicing rights created by this allocation is charged-back to the
mortgage banking profit center over the estimated life of the loans.
LOAN SERVICING FEES In accordance with GAAP, loan servicing
fee income is not recorded on loans held for investment. However, for segment
reporting purposes, the mortgage banking profit center receives an income
allocation for the services it performs for the Corporation's residential,
commercial real estate, and consumer loan portfolios. This allocation is in
addition to the service fee income that the profit center receives on loans
serviced for third parties, as recorded in the Corporation's Consolidated
Statement of Operations. The aforementioned loan portfolios are charged with the
offsetting servicing cost.
PROVISION FOR LOAN AND REAL ESTATE LOSSES For segment
reporting purposes, the Corporation disregards provisions for loan and real
estate losses recorded under GAAP. Rather, actual charge-off (recovery) activity
is charged (credited) to each profit center in the period it occurs.
FHLB PREPAYMENT PENALTIES For segment reporting purposes, the
Corporation ignores FHLB prepayment penalties recorded under GAAP.
INTANGIBLE ASSETS The amortization of goodwill and other
intangible assets is disregarded for segment reporting purposes.
61
INCOME TAXES In general, a standard income tax rate of
approximately 40% is used for segment reporting purposes. However, the income
tax benefit associated with assets held in Nevada by FCHI, the Bank's
wholly-owned investment subsidiary, is allocated to the profit centers that own
such assets. This results in a lower effective income tax rate, or even a
negative rate, for such profit centers.
NON-GAAP ADJUSTMENTS TO FINANCIAL CONDITION Allowances for
losses on loans and real estate, intangible assets, purchase adjustments, and
security valuation allowances are added to and/or excluded from assets of the
profit centers. In addition, an estimated value for mortgage servicing rights
not recorded under GAAP is estimated and added to the assets of the mortgage
banking profit center. For each of these adjustments, a corresponding amount is
added to or excluded from equity prior to the proportionate allocation of equity
to the profit centers, as previously described. The amount added to or excluded
from equity is net of the estimated income tax effect.
SEGMENT PROFIT (LOSS) STATEMENTS AND OTHER INFORMATION The tables on
the following pages contain profit (loss) statements for each of the
Corporation's reportable segments for the years ended December 31, 2003, 2002,
and 2001, (2002 is presented on both pages to facilitate its comparison with
2003 and 2001). The financial results for the business banking profit center
have not been reported separately for 2002 and 2001 due to efforts in those
periods to design these products on the Corporation's systems as well as efforts
to develop departmental allocations of costs and revenues necessary to fairly
present the operating results of this line of business.
In addition to the after-tax performance of profit centers, management
of the Corporation closely monitors the net cost to acquire and maintain deposit
liabilities (as defined elsewhere in this footnote). The net cost to acquire and
maintain deposit liabilities was 1.36%, 1.33%, and 1.20% of average deposit
liabilities outstanding during the years ended December 31, 2003, 2002, and
2001, respectively.
62
COMMERCIAL
SEGMENT PROFIT (LOSS) STATEMENTS MORTGAGE RESIDENTIAL REAL ESTATE CONSUMER EDUCATION BUSINESS
YEAR ENDED DECEMBER 31, 2003 BANKING LOANS LENDING LENDING LENDING BANKING
- ---------------------------------- ------------- ------------- ------------- ------------- ------------ -------------
Interest income $ 2,817,182 $ 39,592,941 $ 34,765,237 $ 30,822,355 $ 7,253,464 $ 14,295,307
Interest expense 2,124,769 20,742,503 12,438,533 11,419,649 2,495,935 5,079,948
Net cost to acquire and maintain
deposit liabilities 787,254 7,392,745 5,599,386 5,154,316 2,200,093 2,890,798
------------- ------------- ------------- ------------- ------------ -------------
Net interest income (expense)
before charge-offs (94,841) 11,457,693 16,727,318 14,248,390 2,557,436 6,324,561
Net loan charge-offs (recoveries) - 401,250 - 1,839,883 45,134 261,025
------------- ------------- ------------- ------------- ------------ -------------
Net interest income (expense) (94,841) 11,056,443 16,727,318 12,408,507 2,512,302 6,063,536
Non-interest income 59,538,142 - 40,191 1,821,670 2,516 149,143
Non-interest expense 30,718,260 4,001,190 1,682,285 3,752,598 1,357,591 5,323,606
------------- ------------- ------------- ------------- ------------ -------------
Profit (loss) before taxes 28,725,041 7,055,253 15,085,224 10,477,579 1,157,227 889,073
Income tax expense (benefit) 11,645,127 2,344,417 6,115,550 4,247,611 469,141 360,430
------------- ------------- ------------- ------------- ------------ -------------
Segment profit (loss) $ 17,079,914 $ 4,710,836 $ 8,969,674 $ 6,229,968 $ 688,086 $ 528,643
============= ============= ============= ============= ============ =============
BALANCE SHEET INFORMATION
Dollars in thousands
------------- ------------- ------------- ------------- ------------ -------------
Average assets $ 97,405 $ 816,963 $ 533,961 $ 489,729 $ 209,201 $ 268,986
============= ============= ============= ============= ============ =============
Total assets at end of period $ 70,595 $ 901,241 $ 537,163 $ 520,134 $ 207,173 $ 539,936
============= ============= ============= ============= ============ =============
INVESTMENT SUPPORT
SEGMENT PROFIT (LOSS) STATEMENTS & MORTGAGE OTHER DEPARTMENT NON-GAAP
YEAR ENDED DECEMBER 31, 2003 SECURITIES SEGMENTS ADJUSTMENTS ALLOCATIONS CONSOLIDATED
- ---------------------------------- ------------- ------------ ----------- ----------------- --------------
Interest income $ 19,029,544 $ 2,616 - ($ 660,271) (1) $ 147,918,375
Interest expense 13,992,355 490,781 - (2,659,116) (1) 66,125,357
Net cost to acquire and maintain
deposit liabilities 6,966,709 15,333 (31,006,633) - -
------------- ------------ ----------- ----------------- --------------
Net interest income (expense)
before charge-offs (1,929,520) (503,498) 31,006,633 1,998,845 81,793,018
Net loan charge-offs (recoveries) - - - (1,091,457) (2) 1,455,835
------------- ------------ ----------- ----------------- --------------
Net interest income (expense) (1,929,520) (503,498) 31,006,633 3,090,302 80,337,183
Non-interest income - 472,854 37,419,497 (12,898,044) (3) 86,545,969
Non-interest expense 301,779 3,333,115 68,426,130 (7,179,323) (3) 111,717,231
------------- ------------ ----------- ----------------- --------------
Profit (loss) before taxes (2,231,299) (3,363,758) - (2,628,419) 55,165,921
Income tax expense (benefit) (2,055,637) (2,873,988) - 186,725 20,439,376
------------- ------------ ----------- ----------------- --------------
Segment profit (loss) ($ 175,662) ($ 489,770) - ($ 2,815,145) $ 34,726,545
============= ============ =========== ================= ==============
BALANCE SHEET INFORMATION
Dollars in thousands
------------- ------------ ----------- ----------------- --------------
Average assets $ 672,213 $ 1,454 - $ 30,346 (4) $ 3,120,256
============= ============ =========== ================= ==============
Total assets at end of period $ 499,402 $ 1,758 - $ 30,923 (4) $ 3,308,324
============= ============ =========== ================= ==============
COMMERCIAL
SEGMENT PROFIT (LOSS) STATEMENTS MORTGAGE RESIDENTIAL REAL ESTATE CONSUMER EDUCATION BUSINESS
YEAR ENDED DECEMBER 31, 2003 BANKING LOANS LENDING LENDING LENDING BANKING
- ---------------------------------- ------------- ------------- ------------- ------------- ------------ -------------
Interest income $ 2,368,108 $ 50,578,320 $ 40,980,844 $ 32,759,292 $ 10,168,607 -
Interest expense 2,374,432 27,039,946 17,000,886 13,860,620 3,320,310 -
Net cost to acquire and maintain
deposit liabilities 758,172 7,341,730 5,980,527 4,926,204 2,228,580 -
------------- ------------- ------------- ------------- ------------ -------------
Net interest income (expense)
before charge-offs (764,496) 16,196,644 17,999,431 13,972,468 4,619,718 -
Net loan charge-offs (recoveries) - 19,734 - 1,702,923 31,096 -
------------- ------------- ------------- ------------- ------------ -------------
Net interest income (expense) (764,496) 16,176,910 17,999,431 12,269,545 4,588,622 -
Non-interest income 45,648,631 - 28,464 1,746,340 1,892 -
Non-interest expense 25,241,523 4,619,974 1,480,542 3,314,528 1,074,992 -
------------- ------------- ------------- ------------- ------------ -------------
Profit (loss) before taxes 19,642,612 11,556,936 16,547,353 10,701,357 3,515,522 -
Income tax expense (benefit) 7,963,119 3,798,984 6,708,346 4,338,365 1,425,202 -
------------- ------------- ------------- ------------- ------------ -------------
Segment profit (loss) $ 11,679,493 $ 7,757,952 $ 9,839,007 $ 6,362,992 $ 2,090,320 -
============= ============= ============= ============= ============ =============
BALANCE SHEET INFORMATION
Dollars in thousands
------------- ------------- ------------- ------------- ------------ -------------
Average assets $ 80,216 $ 845,983 $ 562,691 $ 462,223 $ 210,234 -
============= ============= ============= ============= ============ =============
Total assets at end of period $ 95,703 $ 883,605 $ 529,820 $ 520,134 $ 204,623 -
============= ============= ============= ============= ============ =============
INVESTMENT SUPPORT
SEGMENT PROFIT (LOSS) STATEMENTS & MORTGAGE OTHER DEPARTMENT NON-GAAP
YEAR ENDED DECEMBER 31, 2003 SECURITIES SEGMENTS ADJUSTMENTS ALLOCATIONS CONSOLIDATED
- ---------------------------------- ------------- ------------ ----------- ----------------- --------------
Interest income $ 20,680,787 $ 3,757,135 - ($ 42,753) (1) $ 161,250,343
Interest expense 16,598,524 1,527,630 - (1,996,738) (1) 79,725,611
Net cost to acquire and maintain
deposit liabilities 5,240,318 773,478 (27,249,008) - -
------------- ------------ ----------- ----------------- --------------
Net interest income (expense)
before charge-offs (1,158,054) 1,456,028 27,249,008 1,953,985 81,524,732
Net loan charge-offs (recoveries) - 6,270 - 1,708,038 (2) 3,468,063
------------- ------------ ----------- ----------------- --------------
Net interest income (expense) (1,158,054) 1,449,758 27,249,008 245,947 78,056,669
Non-interest income (166,264) 536,506 31,631,274 (15,791,792) (3) 63,635,051
Non-interest expense 136,264 2,734,783 58,880,282 (10,104,575) (3) 87,378,312
------------- ------------ ----------- ----------------- --------------
Profit (loss) before taxes (1,460,583) (748,519) - (5,441,270) 54,313,408
Income tax expense (benefit) (1,850,645) (161,461) - (2,824,046) 19,397,866
------------- ------------ ----------- ----------------- --------------
Segment profit (loss) $ 390,063 ($ 587,058) - ($ 2,617,224) $ 34,915,542
============= ============ =========== ================= ==============
BALANCE SHEET INFORMATION
Dollars in thousands
------------- ------------ ----------- ----------------- --------------
Average assets $ 584,878 $ 62,977 - $ 29,766 (4) $ 2,838,968
============= ============ =========== ================= ==============
Total assets at end of period $ 627,487 $ 128,322 - $ 35,930 (4) $ 3,025,624
============= ============ =========== ================= ==============
(1) Consists principally of interest income and expense adjustments related
to late charges, implied earnings on custodial and escrow accounts, and
earnings on bank owned life insurance.
(2) In general, the Corporation records actual loan and real estate
charge-off (recovery) activity against each profit center for segment
reporting purposes.
(3) Consists principally of non-GAAP adjustments related to loan
origination fees and costs, mortgage servicing rights, loan servicing
fees, and FHLB prepayment penalties. The offsets for the adjustments
described in (1), above, are also included in non-interest income.
(4) Consists of allowances for loss on loans and real estate, intangible
assets, purchase adjustments, and security valuation allowances that
are disregarded for segment reporting purposes. Also includes mortgage
servicing rights that are not recorded under GAAP, but are recorded for
segment reporting purposes.
63
COMMERCIAL
SEGMENT PROFIT (LOSS) STATEMENTS MORTGAGE RESIDENTIAL REAL ESTATE CONSUMER EDUCATION BUSINESS
YEAR ENDED DECEMBER 31, 2003 BANKING LOANS LENDING LENDING LENDING BANKING
- ---------------------------------- ------------- ------------- ------------- ------------- ------------ -------------
Interest income $ 2,368,108 $ 50,578,320 $ 40,980,844 $ 32,759,292 $ 10,168,607 -
Interest expense 2,374,432 27,039,946 17,000,886 13,860,620 3,320,310 -
Net cost to acquire and maintain
deposit liabilities 758,172 7,341,730 5,980,527 4,926,204 2,228,580 -
------------- ------------- ------------- ------------- ------------ -------------
Net interest income (expense)
before charge-offs (764,496) 16,196,644 17,999,431 13,972,468 4,619,718 -
Net loan charge-offs (recoveries) - 19,734 - 1,702,923 31,096 -
------------- ------------- ------------- ------------- ------------ -------------
Net interest income (expense) (764,496) 16,176,910 17,999,431 12,269,545 4,588,622 -
Non-interest income 45,648,631 - 28,464 1,746,340 1,892 -
Non-interest expense 25,241,523 4,619,974 1,480,542 3,314,528 1,074,992 -
------------- ------------- ------------- ------------- ------------ -------------
Profit (loss) before taxes 19,642,612 11,556,936 16,547,353 10,701,357 3,515,522 -
Income tax expense (benefit) 7,963,119 3,798,984 6,708,346 4,338,365 1,425,202 -
------------- ------------- ------------- ------------- ------------ -------------
Segment profit (loss) $ 11,679,493 $ 7,757,952 $ 9,839,007 $ 6,362,992 $ 2,090,320 -
============= ============= ============= ============= ============ =============
BALANCE SHEET INFORMATION
Dollars in thousands
------------- ------------- ------------- ------------- ------------ -------------
Average assets $ 80,216 $ 845,983 $ 562,691 $ 462,223 $ 210,234 -
============= ============= ============= ============= ============ =============
Total assets at end of period $ 95,703 $ 883,605 $ 529,820 $ 520,134 $ 204,623 -
============= ============= ============= ============= ============ =============
INVESTMENT SUPPORT
SEGMENT PROFIT (LOSS) STATEMENTS & MORTGAGE OTHER DEPARTMENT NON-GAAP
YEAR ENDED DECEMBER 31, 2003 SECURITIES SEGMENTS ADJUSTMENTS ALLOCATIONS CONSOLIDATED
- ---------------------------------- ------------- ------------ ----------- ----------------- --------------
Interest income $ 20,680,787 $ 3,757,135 - ($ 42,753) (1) $ 161,250,343
Interest expense 16,598,524 1,527,630 - (1,996,738) (1) 79,725,611
Net cost to acquire and maintain
deposit liabilities 5,240,318 773,478 (27,249,008) - -
------------- ------------ ----------- ----------------- --------------
Net interest income (expense)
before charge-offs (1,158,054) 1,456,028 27,249,008 1,953,985 81,524,732
Net loan charge-offs (recoveries) - 6,270 - 1,708,038 (2) 3,468,063
------------- ------------ ----------- ----------------- --------------
Net interest income (expense) (1,158,054) 1,449,758 27,249,008 245,947 78,056,669
Non-interest income (166,264) 536,506 31,631,274 (15,791,792) (3) 63,635,051
Non-interest expense 136,264 2,734,783 58,880,282 (10,104,575) (3) 87,378,312
------------- ------------ ----------- ----------------- --------------
Profit (loss) before taxes (1,460,583) (748,519) - (5,441,270) 54,313,408
Income tax expense (benefit) (1,850,645) (161,461) - (2,824,046) 19,397,866
------------- ------------ ----------- ----------------- --------------
Segment profit (loss) $ 390,063 ($ 587,058) - ($ 2,617,224) $ 34,915,542
============= ============ =========== ================= ==============
BALANCE SHEET INFORMATION
Dollars in thousands
------------- ------------ ----------- ----------------- --------------
Average assets $ 584,878 $ 62,977 - $ 29,766 (4) $ 2,838,968
============= ============ =========== ================= ==============
Total assets at end of period $ 627,487 $ 128,322 - $ 35,930 (4) $ 3,025,624
============= ============ =========== ================= ==============
COMMERCIAL
SEGMENT PROFIT (LOSS) STATEMENTS MORTGAGE RESIDENTIAL REAL ESTATE CONSUMER EDUCATION BUSINESS
YEAR ENDED DECEMBER 31, 2003 BANKING LOANS LENDING LENDING LENDING BANKING
- ---------------------------------- ------------- ------------- ------------- ------------- ------------ -------------
Interest income $ 3,257,387 $ 65,810,100 $ 39,962,209 $ 30,359,780 $ 14,300,051 -
Interest expense 3,823,851 44,705,517 24,188,333 17,475,196 6,153,219 -
Net cost to acquire and maintain
deposit liabilities 503,629 6,336,321 5,495,949 3,981,966 2,241,482 -
------------- ------------- ------------- ------------- ------------ -------------
Net interest income (expense)
before charge-offs (1,070,093) 14,768,262 10,277,927 8,902,618 5,905,350 -
Net loan charge-offs (recoveries) - (7,563) - 1,094,829 36,463 -
------------- ------------- ------------- ------------- ------------ -------------
Net interest income (expense) (1,070,093) 14,775,825 10,277,927 7,807,789 5,868,887 -
Non-interest income 26,888,068 - 38,548 1,689,466 52,590 -
Non-interest expense 17,085,283 5,405,384 1,328,210 2,703,827 911,555 -
------------- ------------- ------------- ------------- ------------ -------------
Profit (loss) before taxes 8,732,692 9,370,441 8,988,265 6,793,428 5,009,922 -
Income tax expense (benefit) 3,540,234 2,416,789 3,643,842 2,754,056 2,031,023 -
------------- ------------- ------------- ------------- ------------ -------------
Segment profit (loss) $ 5,192,458 $ 6,953,652 $ 5,344,423 $ 4,039,371 $ 2,978,899 -
============= ============= ============= ============= ============ =============
BALANCE SHEET INFORMATION
Dollars in thousands
------------- ------------- ------------- ------------- ------------ -------------
Average assets $ 84,862 $ 953,105 $ 521,658 $ 376,020 $ 212,453 -
============= ============= ============= ============= ============ =============
Total assets at end of period $ 100,470 $ 848,751 $ 566,560 $ 379,174 $ 211,642 -
============= ============= ============= ============= ============ =============
INVESTMENT SUPPORT
SEGMENT PROFIT (LOSS) STATEMENTS & MORTGAGE OTHER DEPARTMENT NON-GAAP
YEAR ENDED DECEMBER 31, 2003 SECURITIES SEGMENTS ADJUSTMENTS ALLOCATIONS CONSOLIDATED
- ---------------------------------- ------------- ------------ ----------- ---------------- --------------
Interest income $ 17,106,976 $ 408,163 - $ 327,975 (1) $ 171,532,641
Interest expense 14,274,353 249,806 - (2,539,902) (1) 108,330,373
Net cost to acquire and maintain
deposit liabilities 2,450,646 81,359 (21,091,352) - -
------------- ------------ ----------- ---------------- --------------
Net interest income (expense)
before charge-offs 381,977 76,998 21,091,352 2,867,877 63,202,268
Net loan charge-offs (recoveries) - - - 639,662 (2) 1,763,391
------------- ------------ ----------- ---------------- --------------
Net interest income (expense) 381,977 76,998 21,091,352 2,228,215 61,438,877
Non-interest income - 285,599 26,748,850 (6,175,815) (3) 49,527,306
Non-interest expense 101,294 512,254 47,840,202 (8,768,536) (3) 67,119,473
------------- ------------ ----------- ---------------- --------------
Profit (loss) before taxes 280,683 (149,657) - 4,820,936 43,846,710
Income tax expense (benefit) (857,751) (4,515) - 1,874,807 15,398,485
------------- ------------ ----------- ---------------- --------------
Segment profit (loss) $ 1,138,434 ($ 145,142) - $ 2,946,129 $ 28,448,225
============= ============ =========== ================ ==============
BALANCE SHEET INFORMATION
Dollars in thousands
------------- ------------ ----------- ---------------- --------------
Average assets $ 325,934 $ 7,514 - $ 7,338 (4) $ 2,488,884
============= ============ =========== ================ ==============
Total assets at end of period $ 550,770 $ 42,379 - $ 17,964 (4) $ 2,717,710
============= ============ =========== ================ ==============
(1) Consists principally of interest income and expense adjustments related
to late charges, implied earnings on custodial and escrow accounts, and
earnings on bank owned life insurance.
(2) In general, the Corporation records actual loan and real estate
charge-off (recovery) activity against each profit center for segment
reporting purposes.
(3) Consists principally of non-GAAP adjustments related to loan
origination fees and costs, mortgage servicing rights and loan
servicing fees. The offsets for the adjustments described in (1) above,
are also included in non-interest income.
(4) Consists of allowances for loss on loans and real estate, intangible
assets, purchase adjustments, and security valuation allowances that
are disregarded for segment reporting purposes. Also includes mortgage
servicing rights that are not recorded under GAAP, but are recorded for
segment reporting purposes.
64
NOTE 15--ACQUISITION
On October 10, 2003, the Corporation completed the acquisition of
Liberty Bancshares, Inc., ("LBI") the parent company of Liberty State Bank,
headquartered in St. Paul, Minnesota. As of that date, LBI ceased to exist as a
separate entity and its results of operations were included in the Corporation's
consolidated results. This acquisition was made to expand the Corporation's
presence into a major metropolitan market and further the Corporation's
diversification strategy of acquiring successful commercial banks with
established business banking personnel and prospects. As a result of the
acquisition, LBI was merged into the Corporation, with LBI shareholders
receiving a combination of $30.3 million in cash and 2.6 million shares of the
Corporation's stock valued at $49.3 million. The amount of goodwill recorded in
connection with this transaction was $39.6 million, subject to final valuation.
In addition, the Corporation recorded a deposit-based intangible of $9.1 million
in connection with the transaction. LBI's consolidated net income during the
nine-month period ending September 30, 2003, was $3.6 million, and was $5.0
million and $4.0 million during the twelve-month periods ending December 31,
2002 and 2001, respectively.
Following is a summary of the assets acquired and liabilities assumed
in the acquisition. The table excludes cash and cash equivalents acquired of
$41.2 million.
ASSETS ACQUIRED AND LIABILITIES ASSUMED AMOUNT
- ----------------------------------------------------- ------------
Interest-bearing deposits with banks $ 26,545
Investment securities available for sale 96,548,375
Loans held for investment, net 286,713,925
Federal Home Loan Bank stock 474,500
Accrued interest receivable, net 1,879,710
Office properties and equipment 6,449,363
Goodwill 39,622,427
Other intangible assets 9,055,000
Other assets 10,564,726
------------
Total assets 451,334,571
------------
Deposit liabilities 407,034,985
Other borrowings 250,000
Advance payments by borrowers for taxes and insurance 13,386
Accrued interest payable 716,022
Other liabilities 4,522,340
------------
Total liabilities 412,536,733
------------
Net assets acquired and liabilities assumed $ 38,797,838
============
65
NOTE 16--PARENT COMPANY ONLY FINANCIAL INFORMATION
DECEMBER 31
---------------------------
CONDENSED STATEMENTS OF FINANCIAL CONDITION: 2003 2002
- ---------------------------------------------- ------------ ------------
Cash in bank $ 35,038 $ 27,870
Interest-bearing deposits with subsidiary bank 10,474,011 3,519,050
Investment in subsidiary 309,589,026 218,696,628
Other assets 171,338 197,768
------------ ------------
Total assets $320,269,413 $222,441,316
============ ============
Other borrowings $ 43,610,000 $ 16,989,313
Other liabilities 70,270 -
------------ ------------
Total liabilities 43,680,270 16,989,313
------------ ------------
Common stock 2,239,477 2,021,593
Additional paid-in capital 87,323,995 46,577,431
Retained earnings 188,319,179 165,628,148
Treasury stock, at cost - (10,178,374)
Unearned restricted stock - (32,083)
Non-owner adjustments to equity, net (1,293,508) 1,435,289
------------ ------------
Total stockholders' equity 276,589,144 205,452,003
------------ ------------
Total liabilities and stockholders' equity $320,269,413 $222,441,316
============ ============
YEAR ENDED DECEMBER 31
---------------------------------------
CONDENSED STATEMENTS OF OPERATIONS: 2003 2002 2001
- --------------------------------------------------------------- ----------- ----------- -----------
Other income $ 7,808 $ 5,738 $ 38,989
Other expense 889,097 623,876 379,623
Loss before income taxes and equity in earnings of subsidiary (881,289) (618,138) (340,634)
Income tax benefit 308,451 216,348 119,222
Loss before equity in earnings of subsidiary (572,838) (401,790) (221,412)
Equity in earnings of subsidiary 35,299,383 35,317,332 28,669,637
Net income $34,726,545 $34,915,542 $28,448,225
YEAR ENDED DECEMBER 31
------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS: 2003 2002 2001
- --------------------------------------------------------------------- ------------ ------------ ------------
Net income $ 34,726,545 $ 34,915,542 $ 28,448,225
Equity in earnings of subsidiary (35,299,383) (35,317,332) (28,669,637)
Change in income taxes and other accruals and prepaid (49,594) (115,892) 113,110
------------ ------------ ------------
Net cash used by operations (622,432) (517,682) (108,302)
------------ ------------ ------------
Decrease (increase) in interest-bearing deposits with subsidiary bank (6,954,961) (2,945,617) 3,782,086
Dividends received from subsidiary 22,000,000 15,750,000 9,900,000
Capital contributions to subsidiary (28,144,289) (7,500,000) (1,234,706)
Net cash acquired in acquisitions of other financial institutions 336,445 - 1,234,540
------------ ------------ ------------
Net cash (used) provided by investing activities (12,762,805) 5,304,383 13,681,920
------------ ------------ ------------
Increase (decrease) in other borrowings 23,870,687 16,989,313 (2,601,542)
Dividends paid to shareholders (11,236,323) (10,145,762) (8,866,148)
Purchases of treasury stock (507,819) (13,770,106) (3,213,376)
Other, net 1,265,860 2,150,599 1,071,630
------------ ------------ ------------
Net cash provided (used) by financing activities 13,392,405 (4,775,956) (13,609,436)
------------ ------------ ------------
Net increase (decrease) in cash in bank 7,168 10,745 (35,818)
Cash at beginning of period 27,870 17,125 52,943
------------ ------------ ------------
Cash in bank at end of period $ 35,038 $ 27,870 $ 17,125
============ ============ ============
66
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
First Federal Capital Corp:
We have audited the accompanying consolidated statement of financial condition
of First Federal Capital Corp and subsidiaries as of December 31, 2003, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit. The consolidated financial
statements of First Federal Capital Corp for the years ended December 31, 2002
and 2001 were audited by other auditors whose report dated January 23, 2003,
expressed an unqualified opinion on those statements.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the companies at December 31, 2003,
and the results of their operations and their cash flows for the year then ended
in conformity with accounting principles generally accepted in the United States
of America.
/s/ Deloitte & Touche LLP
February 23, 2004
Milwaukee, Wisconsin
67
SUPPLEMENTARY DATA
Quarterly Financial Information (Unaudited)
DEC. SEPT. JUNE MARCH DEC. SEPT. JUNE MARCH
Dollars in thousands, except for per share amounts 2003 2003 2003 2003 2002 2002 2002 2002
- ---------------------------------------------------- ------- ------- ------- ------- ------- ------- ------- -------
Interest on loans $34,447 $30,234 $30,792 $32,426 $35,252 $35,205 $34,098 $33,057
Interest on mortgage-backed and related securities 3,684 3,603 4,619 3,479 2,789 4,559 5,707 5,415
Interest and dividends on investments 1,068 1,111 1,202 1,253 1,681 1,319 1,208 961
------- ------- ------- ------- ------- ------- ------- -------
Total interest income 39,199 34,948 36,612 37,158 39,723 41,082 41,013 39,433
------- ------- ------- ------- ------- ------- ------- -------
Interest on deposits 11,044 11,730 12,977 13,657 14,090 14,191 13,789 15,014
Interest on FHLB advances and other borrowings 2,212 4,149 5,136 5,220 5,495 5,652 5,706 5,789
------- ------- ------- ------- ------- ------- ------- -------
Total interest expense 13,256 15,879 18,114 18,877 19,585 19,843 19,495 20,803
------- ------- ------- ------- ------- ------- ------- -------
Net interest income 25,943 19,070 18,499 18,281 20,138 21,240 21,518 18,630
Provision for loan losses 570 368 139 379 1,334 716 771 647
------- ------- ------- ------- ------- ------- ------- -------
Net interest income after provision for loan losses 25,373 18,702 18,360 17,902 18,804 20,524 20,747 17,982
------- ------- ------- ------- ------- ------- ------- -------
Gain (loss) on sale of investments and other assets - - - - - - - (166)
Other non-interest income 15,022 33,112 20,470 17,941 21,027 16,717 12,977 13,080
------- ------- ------- ------- ------- ------- ------- -------
Total non-interest income 15,022 33,112 20,470 17,941 21,027 16,717 12,977 12,913
Total non-interest expense 28,269 35,473 24,850 23,125 24,097 22,892 21,257 19,133
------- ------- ------- ------- ------- ------- ------- -------
Income before income taxes 12,126 16,341 13,980 12,718 15,734 14,349 12,467 11,763
Income tax expense 4,350 6,176 5,210 4,704 5,731 5,293 4,278 4,095
------- ------- ------- ------- ------- ------- ------- -------
Net Income $ 7,776 $10,166 $ 8,771 $ 8,014 $10,003 $ 9,056 $ 8,189 $ 7,667
======= ======= ======= ======= ======= ======= ======= =======
Diluted earnings per share $ 0.35 $ 0.51 $ 0.44 $ 0.40 $ 0.50 $ 0.45 $ 0.40 $ 0.38
======= ======= ======= ======= ======= ======= ======= =======
Dividends paid per share $ 0.14 $ 0.14 $ 0.14 $ 0.13 $ 0.13 $ 0.13 $ 0.13 $ 0.12
======= ======= ======= ======= ======= ======= ======= =======
Stock price at end of period $ 22.56 $ 20.55 $ 19.85 $ 20.41 $ 19.31 $ 19.43 $ 22.10 $ 18.85
======= ======= ======= ======= ======= ======= ======= =======
High stock price during period $ 24.00 $ 21.46 $ 20.57 $ 21.08 $ 19.50 $ 21.60 $ 22.47 $ 18.85
======= ======= ======= ======= ======= ======= ======= =======
Low stock price during period $ 20.55 $ 19.83 $ 18.50 $ 19.13 $ 16.88 $ 17.55 $ 18.50 $ 14.68
======= ======= ======= ======= ======= ======= ======= =======
Note: Quarterly earnings per share amounts may not equal annual earnings per
share amounts due to rounding.
ITEM 9--CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On July 7, 2003, the Corporation filed a Form 8-K that included a press
release announcing that the Corporation, on September 30, engaged Deloitte &
Touche LLP as its independent accountant, replacing Ernst & Young LLP. The
letter of concurrence was included by exhibit. No disagreements were cited.
ITEM 9A--CONTROLS AND PROCEDURES
An evaluation of the Corporation's disclosure controls and procedures
(as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act
of 1934 (the "Act") was carried out under the supervision and with the
participation of the Corporation's Chief Executive Officer, Chief Financial
Officer, Controller, and several other members of the Corporation's senior
management within the 90-day period preceding the filing date of this quarterly
report. The Corporation's Chief Executive Officer, Chief Financial Officer, and
Controller concluded that the Corporation's disclosure controls and procedures
as currently in effect are effective in ensuring that the information required
to be disclosed by the Corporation in the reports it files or submits under the
Act is (i) accumulated and communicated to the Corporation's management
(including the Chief Executive Officer, Chief Financial Officer, and Controller)
in a timely manner, and (ii) recorded, processed, summarized and reported within
the time periods specified in the SEC's rules and forms. In the quarter ended
December 31, 2003, the Corporation did not make any significant changes in, nor
take any corrective actions regarding, its internal controls or other factors
that could significantly affect these controls.
68
PART III
ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required herein is incorporated by reference from the
sections entitled "Matters to be Voted on at the Annual Meeting--Matter 1.
Election of Directors" and "Executive Officers Who Are Not Directors" in the
Proxy Statement of the Corporation dated March 15, 2004.
ITEM 11--EXECUTIVE COMPENSATION
The information required herein is incorporated by reference from the
section entitled "Compensation of Executive Officers and Directors" in the Proxy
Statement of the Corporation dated March 15, 2004.
ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required herein is incorporated by reference from the
section entitled "Beneficial Ownership of Common Stock by Certain Beneficial
Owners and Management" and in the section entitled "Compensation of Executive
Officers and Directors" in the Proxy Statement of the Corporation dated March
15, 2004.
ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required herein is incorporated by reference from the
section entitled "Indebtedness of Management and Certain Transactions" in the
Proxy Statement of the Corporation dated March 15, 2004.
ITEM 14--PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required herein is incorporated by reference from the
section entitled, "Indebtedness of Management and Certain Transactions" in the
Proxy Statement of the Corporation dated March 15, 2004.
69
PART IV
ITEM 15--EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
(1) The following financial statements are included herein under Part II, Item
8, "Financial Statements and Supplementary Data":
Consolidated Statements of Condition at December 31, 2003 and 2002
Consolidated Statements of Operations for each of the three years in the period
ended December 31, 2003
Consolidated Statements of Stockholders' Equity for each of the three years in
the period ended December 31, 2003
Consolidated Statements of Cash Flows for each of the three years in the period
ended December 31, 2003
Notes to Audited Consolidated Financial Statements
Report of Management
Report of Independent Auditors
(2) All financial statement schedules required under this item are omitted
because the required information is either not applicable or the required
information is included in the Audited Consolidated Financial Statements or in
the notes thereto.
EDGAR VERSION
(3) Exhibit Index.
No. Exhibit Description
3.1 Articles of Incorporation, as amended (7)
3.2 Bylaws, as amended (6)
4.1 Specimen stock certificate (1)
4.2 Rights Agreement, dated as of January 24, 1995 (5)
10.1 1989 Stock Incentive Plan (1)
10.2 1989 Directors' Stock Option Plan, as amended (2)
10.3 1992 Directors' Stock Option Plan, as amended (7)
10.4 1992 Stock Option and Incentive Plan (3)
10.5 Rock Financial Corp. 1992 Stock Option and Incentive Plan (4)
10.6 1997 Stock Option and Incentive Plan (6)
10.7 Employee Stock Ownership Plan (8)
10.8 Employment agreements, as amended, between the Corporation and the Bank
and the following executive officers:
a) Jack C. Rusch (8)
b) Thomas W. Schini (7)
c) Bradford R. Price (8)
d) Robert P. Abell (8)
e) Michael W. Dosland (8)
f) Milne J. Duncan (8)
10.9 First Federal of La Crosse Directors' Deferred Compensation Plan (1)
10.10 First Federal of La Crosse Annual Incentive Bonus Plan (1)
10.11 First Federal of La Crosse Incentive Bonus Plan for Group Life
Insurance (1)
10.12 First Federal of Madison Deferred Compensation Plan for Directors (1)
10.13 Resignation Agreement with Joseph M. Konradt (8)
70
11.1 Computation of Earnings Per Share--Reference is made to Note 1 of the
Corporation's Audited Consolidated Financial Statements, included
herein under Part II, Item 8, "Financial Statements and Supplementary
Data"
13.1 2004 President's Message (9)
21 Subsidiaries of the Registrant
23.1 Consent of Deloitte & Touche LLP (8)
32.2 Section 1350 Certification (8)
99.1 2004 Proxy Statement (8)
(1) Incorporated herein by reference to exhibits filed with the Corporation's
Form S-1 Registration Statement declared effective by the SEC on September
8, 1989 (Registration No. 33-98298-01).
(2) Incorporated herein by reference to exhibits filed with the Corporation's
Annual Report on Form 10-K for the year ended December 31, 1989.
(3) Incorporated herein by reference to the Corporation's Proxy Statement dated
March 11, 1992.
(4) Incorporated herein by reference to exhibits filed with the Corporation's
Post-Effective Amendment No. 1 on Form S-8 to Form S-4 Registration
Statement (Registration No. 33-98298-01).
(5) Incorporated herein by reference to the Corporation's Registration
Statement on Form 8-A.
(6) Incorporated herein by reference to the exhibits filed with the
Corporation's Annual Report on Form 10-K for the year ended December
31,1997.
(7) Incorporated herein by reference to exhibits filed with the Corporation's
Annual Report on Form 10-K for the year ended December 31, 2000.
(8) Filed herewith.
(9) Filed in paper format pursuant to Rule 101(b) of Regulation S-T.
(b) Reports on form 8-K filed with the SEC by the Corporation during the fourth
quarter of 2003.
Report filed October 23, 2003. The report included a press release
announcing earnings for First Federal Capital Corp for the three and
nine month periods ended September 30, 2003.
(c) Refer to item (a)(3) above for all exhibits filed herewith.
(d) Refer to items (a)(1) and (2) above for financial statements required under
this item.
71
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
FIRST FEDERAL CAPITAL CORP
February 24, 2004 By: /s/Jack C. Rusch
Jack C. Rusch
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Thomas W. Schini February 24 2004
Thomas W. Schini
Chairman of the Board
/s/ Jack C. Rusch February 24, 2004
Jack C. Rusch
President, Chief Executive Officer, and
Director (principal executive officer)
/s/ David W. Kruger February 24, 2004
David W. Kruger
Director
/s/ John F. Leinfelder February 24, 2004
John F. Leinfelder
Director
/s/ Richard T. Lommen February 24, 2004
Richard T. Lommen
Director
/s/ Patrick J. Luby February 24, 2004
Patrick J. Luby
Director
/s/ David C. Mebane February 24, 2004
David C. Mebane
Director
/s/ Phillip J. Quillin February 24, 2004
Phillip J. Quillin
Director
/s/ Edwin J. Zagzebski February 24, 2004
Edwin J. Zagzebski
Director
72
/s/ Michael W. Dosland February 24, 2004
Michael W. Dosland
Senior Vice President and
Chief Financial Officer
(principal financial officer)
/s/ Kenneth C. Osowski February 24, 2004
Kenneth C. Osowski
Vice President and Controller
(principal accounting officer)
73