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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission file Number 0-21292
MERCHANTS AND MANUFACTURERS BANCORPORATION, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Wisconsin 39-1413328
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(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
19105 West Capitol Drive, Suite 200
Brookfield, Wisconsin 53045
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(Address of principal executive office)
(262) 790-2120
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Registrant's telephone number, including area code:
Indicate by check mark whether the Registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days.
Yes [X] No [ ].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2)
Yes [X] No [ ].
As of May 1, 2004, 3,335,915 shares of Common Stock were outstanding.
MERCHANTS AND MANUFACTURERS BANCORPORATION, INC.
FORM 10-Q
INDEX
PAGE NUMBER
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Consolidated Statements of Financial Condition as of March 31,
2004, December 31, 2003
and March 31, 2003 3
Unaudited Consolidated Statements of Income for the Three Months ended
March 31, 2004 and 2003 4
Unaudited Consolidated Statements of Cash Flows for the Three Months ended
March 31, 2004 and 2003 5
Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 11
Item 3. Quantitative and Qualitative Disclosure About Market Risk 23
Item 4. Controls and Procedures 24
PART II. OTHER INFORMATION
Items 1-6 25
Signatures 26
2
PART I. FINANCIAL INFORMATION
MERCHANTS AND MANUFACTURERS BANCORPORATION, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
MARCH 31, DECEMBER 31, MARCH 31,
2004 2003 2003
----------- ------------ -----------
(Amounts In Thousands, Except
Share and Per Share Amounts)
ASSETS
Cash and due from banks $ 24,774 $ 29,376 $ 26,272
Interest bearing deposits in banks 4,956 2,647 8,593
Federal funds sold 5,456 15,632 17,676
----------- ----------- -----------
Cash and cash equivalents 35,186 47,655 52,541
Available-for-sale securities 158,476 156,597 129,924
Loans, less allowance for loan losses of $9,412 at
March 31, 2004, $9,136 at December 31, 2003
and $7,939 at March 31, 2003 871,881 847,938 685,681
Accrued interest receivable 4,784 4,421 4,513
FHLB stock 16,519 16,245 14,900
Premises and equipment 21,536 20,591 14,896
Goodwill and intangible assets 30,107 30,502 9,592
Other assets 22,088 21,658 14,831
----------- ----------- -----------
TOTAL ASSETS $ 1,160,577 $ 1,145,607 $ 926,878
=========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Non-interest bearing $ 110,955 $ 109,755 $ 99,725
Interest bearing 807,081 802,193 634,455
----------- ----------- -----------
Total deposits 918,036 911,948 734,180
Short-term borrowings 29,097 34,007 34,329
Long-term borrowings 84,309 72,346 68,537
Subordinated debentures 36,084 36,084 10,310
Accrued interest payable 1,522 1,417 1,368
Other liabilities 9,669 9,831 8,080
----------- ----------- -----------
TOTAL LIABILITIES 1,078,717 1,065,633 856,804
Stockholders' equity
Preferred stock, $1.00 par value; 250,000 shares authorized,
shares issued and shares outstanding - none -- -- --
Common stock $1.00 par value; 6,000,000 shares authorized;
Shares issued: 3,436,036, at March 31, 2004 and December 31,
2003, 2,977,231 at March 31, 2003; shares outstanding:
3,335,356 at March 31, 2004, 3,326,089 at December 31, 2003
and 2,875,495 at March 31, 2003 3,436 3,436 2,977
Additional paid-in capital 43,622 43,691 26,302
Retained earnings 35,814 35,007 42,939
Accumulated other comprehensive income 1,555 663 738
Treasury stock, at cost (100,680 shares at March 31, 2004,
109,947 shares at December 31, 2003 and 101,736 shares
at March 31, 2003) (2,567) (2,823) (2,882)
----------- ----------- -----------
TOTAL STOCKHOLDERS' EQUITY 81,860 79,974 70,074
----------- ----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,160,577 $ 1,145,607 $ 926,878
=========== =========== ===========
See Notes to Unaudited Consolidated Financial Statements.
3
MERCHANTS AND MANUFACTURERS BANCORPORATION, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, MARCH 31,
2004 2003
------- -------
(In Thousands, Except Per Share Amounts)
Interest income:
Interest and fees on loans $12,819 $10,998
Interest and dividends on securities:
Taxable 468 589
Tax-exempt 381 353
Interest on mortgage-backed securities 646 670
Interest on interest bearing deposits in banks and federal funds sold 54 88
------- -------
TOTAL INTEREST INCOME 14,368 12,698
Interest expense:
Interest on deposits 3,100 3,071
Interest on short-term borrowings 151 148
Interest on long-term borrowings 734 656
Interest on Company Obligated Manadatorily Redeemable
Preferred Securities 557 119
------- -------
TOTAL INTEREST EXPENSE 4,542 3,994
NET INTEREST INCOME 9,826 8,704
Provision for loan losses 450 302
------- -------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 9,376 8,402
Noninterest income:
Service charges on deposit accounts 725 572
Service charges on loans 427 559
Securities gains, net 177 73
Gain on sale of loans, net 144 413
Other 1,222 605
------- -------
TOTAL NONINTEREST INCOME: 2,695 2,222
Noninterest expenses:
Salaries and employee benefits 5,860 4,265
Premises and equipment 1,476 1,218
Data processing fees 361 310
Marketing and business development 334 358
Federal deposit insurance premiums 41 33
Other 2,010 1,415
------- -------
TOTAL NONINTEREST EXPENSES: 10,082 7,599
INCOME BEFORE INCOME TAXES 1,989 3,025
Income taxes 582 1,029
------- -------
NET INCOME $ 1,407 $ 1,996
======= =======
Basic earnings per share $ 0.42 $ 0.63
======= =======
Diluted earnings per share $ 0.42 $ 0.63
======= =======
Dividends per share $ 0.18 $ 0.17
======= =======
See Notes to Unaudited Consolidated Financial Statements.
4
MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31,
2003 2003
-------- --------
(In Thousands)
Cash Flows From Operating Activities
Net income $ 1,407 $ 1,996
Adjustments to reconcile net income to cash
provided by operating activities:
Provision for loan losses 450 302
Depreciation 454 396
Amortization and accretion of premiums and discounts, net 429 145
Security gains, net (177) (73)
Gain on sale of loans, net (144) (413)
Decrease in accrued interest receivable (363) (394)
Increase (decrease) in accrued interest payable 105 (35)
Other 188 108
-------- --------
Net cash provided by operations before loan originations and sales 2,349 2,032
Loans originated for sale (11,865) (40,334)
Proceeds from sales of loans 11,066 38,939
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,550 637
Cash Flows From Investing Activities
Purchase of available-for-sale securities (35,529) (16,931)
Proceeds from sales of available-for-sale securities 7,253 4,357
Proceeds from redemptions and maturities of available-for-sale securities 26,926 12,329
Net increase in loans (23,723) (26,400)
(Purchase) sale of premises and equipment (1,399) 120
Redemption (purchase) of Federal Home Loan Bank stock (274) 35
-------- --------
NET CASH USED IN INVESTING ACTIVITIES (26,746) (26,490)
Cash Flows From Financing Activities
Net increase in deposits 6,087 4,724
Net increase (decrease) in short-term borrowings (4,947) 16,241
Dividends paid (600) (546)
Proceeds from long-term borrowings 23,500 11,000
Repayment of long-term borrowings (11,500) (14,785)
Purchase of treasury stock 0 0
Proceeds from sale of treasury stock 187 5
-------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES 12,727 16,639
DECREASE IN CASH AND CASH EQUIVALENTS (12,469) (9,214)
Cash and cash equivalents at beginning of period 47,655 61,755
-------- --------
Cash and cash equivalents at end of period $ 35,186 $ 52,541
======== ========
Supplemental Cash Flow Information and Noncash Transactions:
Interest paid $ 4,437 $ 4,029
Income taxes paid 164 89
Loans transferred to other real estate owned 273 --
Supplemental Schedules of Noncash Investing Activities,
change in accumulated other comprehensive income, unrealized
gains (losses) on available-for-sale securities, net $ 892 ($ 710)
See Notes to Unaudited Consolidated Financial Statements.
5
MERCHANTS AND MANUFACTURERS BANCORPORATION, INC.
Notes to Unaudited Consolidated Financial Statements
March 31, 2004
NOTE A -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include the
accounts of Merchants and Manufacturers Bancorporation, Inc. and its wholly
owned subsidiaries: Lincoln State Bank, Franklin State Bank, Grafton State Bank,
Community Bank Financial, Reedsburg Bank, Fortress Bank of Westby, Fortress Bank
of Cresco, Fortress Bank, N.A. (collectively, the Banks), Merchants Merger
Corp., CBG Financial Services, Inc., Merchants New Merger Corp., CBG Mortgage,
Inc. and Lincoln Neighborhood Redevelopment Corporation. Lincoln State Bank also
includes the accounts of its wholly owned subsidiary, M&M Lincoln Investment
Corporation. Grafton State Bank also includes the accounts of its wholly owned
subsidiary, GSB Investments, Inc. and Community Bank Financial also includes the
accounts of its wholly owned subsidiary, CBOC Investments, Inc. The Reedsburg
Bank also includes the accounts of its wholly owned subsidiary, Reedsburg
Investments, Inc. Fortress Bank of Westby also includes the accounts of its
wholly owned subsidiaries, Westby Investment Company, Inc. and Fortress Mortgage
Services Company. CBG Financial Services also includes the accounts of its
wholly owned subsidiaries Link Community Financial Services and Keith C. Winters
& Associates (KCW). All significant intercompany balances and transactions have
been eliminated.
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three-month period ended March 31, 2004
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2004. For further information, refer to the consolidated
financial statements and footnotes thereto included in our Form 10-K for the
year ended December 31, 2003.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions which affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of date of
the financial statements, as well as the reported amounts of income and expenses
during the reported periods. Actual results could differ from those estimates.
6
NOTE B -- EARNINGS PER SHARE
Presented below are the calculations for basic and diluted earnings per share:
Three Months Ended
March 31,
2004 2003
-------------------------------------
(In Thousands, except per share data)
Basic
Net income $1,407 $1,996
Weighted average shares outstanding 3,331 3,163
Basic earnings per share $ 0.42 $ 0.63
====== ======
Diluted:
(In Thousands, except per share data)
Net income $1,407 $1,996
Weighted average shares outstanding 3,331 3,163
Effect of dilutive stock options outstanding 37 8
------ ------
Diluted weighted average shares outstanding 3,368 3,171
Diluted earnings per share $ 0.42 $ 0.63
====== ======
NOTE C -- COMPREHENSIVE INCOME
The following table presents our comprehensive income.
Three Months Ended
March 31,
2004 2003
------- -------
(In Thousands)
Net income $ 1,407 $ 1,996
Other comprehensive income
Change in unrealized securities gains (losses) 1,244 (1,162)
Reclassification adjustment for gains included
in net income 144 73
Income tax effect (496) 379
------- -------
Total comprehensive income $ 2,299 $ 1,286
======= =======
7
NOTE D -- LOANS RECEIVABLE
During the first quarter of 2004, the Corporation performed an evaluation of the
purpose and collateral of each loan. This evaluation resulted in a reallocation
of loan dollars between primarily commercial real estate and commercial loans.
The following table shows the composition of our loan portfolio on the dates
indicated. (dollars in thousands):
March 31, December 31, March 31,
2004 2003 2003
--------- ------------ ---------
First Mortgage:
Conventional single-family residential $116,382 $113,479 $100,934
Commercial and multifamily residential 382,072 283,433 192,913
Construction 52,062 47,894 42,696
Farmland 45,863 43,676 23,082
-------- -------- --------
596,379 488,482 359,625
-------- -------- --------
Commercial business loans 215,390 294,645 272,139
Consumer and installment loans 49,158 51,886 45,294
Home equity loans 15,538 14,664 12,106
Other 4,828 7,397 4,456
-------- -------- --------
284,914 368,592 333,995
-------- -------- --------
Total loans 881,293 857,074 693,620
Less allowance for loan losses 9,412 9,136 7,939
-------- -------- --------
Loans, net $871,881 $847,938 $685,681
======== ======== ========
NOTE E - STOCK-BASED COMPENSATION PLAN
At March 31, 2004 we had a stock-based key officer and employee compensation
plan. We account for this plan under the recognitions and measurement principles
of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. No stock-based employee compensation cost is reflected in
income, as all options granted under this plan had an exercise price equal to
the market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income and earnings per share if
we had applied the fair value recognition provisions of the Financial Accounting
Standards Board (FASB) Statement No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation.
Three Months Ended
March 31,
2004 2003
---------- ----------
(Amounts In Thousands,
Except Per Share Data)
Net income, as reported $ 1,407 $ 1,996
Deduct total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects 334 0
---------- ----------
PRO FORMA NET INCOME $ 1,073 $ 1,996
========== ==========
Earnings per share:
Basic:
As reported $ 0.42 $ 0.63
Pro forma $ 0.34 $ 0.63
Diluted:
As reported $ 0.42 $ 0.63
Pro forma $ 0.33 $ 0.63
8
In determining compensation cost using the fair value method prescribed in
Statement No. 123, the value of each grant is estimated at the grant date with
the following weighted-average assumptions used for grants at March 31, 2004:
dividend yield of 1.60%; expected price volatility of 19.74%; blended risk-free
interest rates of 3.76%; and expected life of 10 years.
NOTE F - RECENT ACQUISITION
On November 1, 2003, we acquired Reedsburg Bancorporation. ("Reedsburg") and its
wholly-owned subsidiary, the Reedsburg Bank. The purchase price for Reedsburg
was $36.0 million including $17.8 million in cash, $12.8 million in promissory
notes and 146,800 shares of common stock valued at $5.4 million based on the
average price over the contractual pricing period. At the date of the
acquisition Reedsburg had assets of $141.8 million, loans of $97.2 million and
deposits of $120.6 million. The year-to-year comparisons are impacted by our
completion of the acquisition of Reedsburg. The acquisition was accounted for
using the purchase method of accounting, and accordingly, the assets and
liabilities of Reedsburg were recorded at their respective fair values on
November 1, 2003 and account balances acquired are included in our financial
results.
NOTE G - PENDING ACQUISITION
On April 24, 2003, we announced the signing of a Definitive Agreement to acquire
Random Lake Bancorp Limited ("Random Lake"). Random Lake serves as a one-bank
holding company for Wisconsin State Bank. As of March 31, 2004, Random Lake has
total assets of $93.5 million with four locations in Wisconsin. The proposed
acquisition is subject to a number of closing conditions and there can be no
assurance that the proposed acquisition will be completed or, if completed, that
the terms of the proposed acquisition will be as presently contemplated.
NOTE H - RECENT ACCOUNTING PRONOUNCEMENTS
FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation of
Accounting Research Bulletin No. 51 (Revised December 2003): FIN 46 establishes
accounting guidance for consolidation of variable interest entities (VIE) that
function to support the activities of the primary beneficiary. The primary
beneficiary of a VIE entity is the entity that absorbs a majority of the VIE's
expected losses, receives a majority of the VIE's expected residual returns, or
both, as a result of ownership, controlling interest, contractual relationship
or other business relationship with a VIE. Prior to the implementation of FIN
46, VIE's were generally consolidated by an enterprise when the enterprise had a
controlling financial interest through ownership of a majority of voting
interest in the entity. The provisions of FIN 46 were effective immediately for
all arrangements entered into after January 31, 2003. However, subsequent
revisions to the interpretation deferred the implementation date of FIN 46 until
the first period ending after March 15, 2004.
The Corporation adopted FIN 46, as revised, in connection with its consolidated
financial statements for the quarter ended March 31, 2004. The Corporation has
previously formed four statutory trusts (the "Trusts") to issue an aggregate of
$35,000,000 of trust preferred securities. The implementation of FIN 46 required
the Corporation to de-consolidate its investment in the Trusts because the
Corporation is not the primary beneficiary. There was no impact on stockholders'
equity or net income upon adoption of the standard.
9
The trust preferred securities issued by the Trusts are currently included in
the Tier 1 capital of the Corporation for regulatory capital purposes. However,
because the financial statements of the Trusts will no longer be included in the
Corporation's consolidated financial statements, the Federal Reserve Board may
in the future disallow inclusion of the trust preferred securities in Tier 1
capital for regulatory capital purposes. In July 2003, the Federal Reserve Board
issued a supervisory letter instructing bank holding companies to continue to
include the trust preferred securities in their Tier 1 capital for regulatory
capital purposes until notice is given to the contrary. The Federal Reserve
Board intends to review the regulatory implications of the change in accounting
treatment of subsidiary trusts that issue trust preferred securities and, if
necessary or warranted, provide further appropriate guidance. There can be no
assurance that the Federal Reserve Board will continue to permit institutions to
include trust preferred securities in Tier I capital for regulatory capital
purposes.
The Accounting Standards Executive Committee has issued Statement of Position
(SOP) 03-3 "Accounting for Certain Loans or Debt Securities Acquired in a
Transfer". This Statement applies to all loans acquired in a transfer, including
those acquired in the acquisition of a bank or a branch, and provides that such
loans be accounted for at fair value with no allowance for loan losses, or other
valuation allowance, permitted at the time of acquisition. The difference
between cash flows expected at the acquisition date and the investment in the
loan should be recognized as interest income over the life of the loan. If
contractually required payments for principal and interest are less than
expected cash flows, this amount should not be recognized as a yield adjustment,
a loss accrual, or a valuation allowance. For the Corporation this Statement is
effective for calendar year 2005, and early adoption, although permitted, is not
planned. No significant impact is expected on the consolidated financial
statements at the time of adoption.
NOTE I - COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business, the Corporation is involved in various legal
proceedings. In the opinion of management, any liability resulting from such
proceedings would not have a material adverse effect on the consolidated
financial statements.
The Corporation is party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit, financial
guarantees, and standby letters of credit. They involve, to varying degrees,
elements of credit risk in excess of amounts recognized on the consolidated
balance sheets.
The Corporation's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments. The Corporation uses the same credit policies in making
commitments and issuing letters of credit as they do for on-balance-sheet
instruments.
10
Off-balance-sheet financial instruments whose contracts represented credit
and/or interest rate risk at March 31, 2004, December 31, 2003 and March 31,
2003, are as follows:
March 31, December 31, March 31,
2004 2003 2003
-------- -------- --------
(Amounts In Thousand)
Commitments to originate mortgage loans $ 37,069 $ 29,248 $ 32,983
Unused lines of credit:
Commercial business 105,198 108,163 75,400
Home equity 14,561 13,957 11,426
Credit cards 16,417 17,146 11,142
Standby letters of credit 10,799 10,275 10,825
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 or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. Standby letters of credit are conditional
commitments issued by the Bank to guarantee the performance of a customer to a
third party. Those guarantees are primarily issued to support public and private
borrowing arrangements and, generally, have terms of one year or less. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. The Bank holds
collateral, which may include accounts receivable, inventory, property,
equipment, and income-producing properties, supporting those commitments if
deemed necessary. In the event the customer does not perform in accordance with
the terms of the agreement with the third party, the Bank would be required to
fund the commitment. The maximum potential amount of future payments the Bank
could be required to make is represented by the contractual amount shown in the
summary above. If the commitment is funded the Bank would be entitled to seek
recovery from the customer. Credit card commitments are unsecured. At March 31,
2004 no amounts have been recorded as liabilities for the Bank's potential
obligations under these guarantees.
Except for the above-noted commitments to originate loans in the normal course
of business, the Corporation and the Banks have not undertaken the use of
off-balance-sheet derivative financial instruments for any purpose.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
The Corporation had net income of $1.4 million, or $0.42 per diluted share, for
the three months ended March 31, 2004 compared to $2.0 million, or $0.63 per
diluted share, for the three months ended March 31, 2003, representing a 29.5%
decrease in net income and a 33.3% decrease in diluted earnings per share. The
decrease in net income for the current quarter compared to the prior year is
attributed to lower net interest margins and a decrease in non-interest income
primarily from reduced income from the Corporation's mortgage banking operation.
11
The year-to-year comparisons are impacted by the Corporation's completion of the
Reedsburg acquisition on November 1, 2003. The acquisition was accounted for
using the purchase method of accounting, and accordingly, the assets and
liabilities of Reedsburg were recorded at their respective fair values on
November 1, 2003. The Corporation acquired approximately $141.8 million in
assets, $97.2 million in loans, $120.6 million in deposits and recognized
goodwill and intangible assets of approximately $19.1 million related to the
transaction. The year-to-year comparisons are also impacted by the Corporation's
May 1, 2003 acquisitions of Keith C. Winters & Associates, LTD. ("KCW"), a tax
preparation and tax consulting firm with offices located in Franklin, Brookfield
and Milwaukee, Wisconsin, and Integrated Financial Services ("IFS"), an
insurance agency. The KCW and IFS acquisitions were accounted for using the
purchase method of accounting.
2004 is going to be a year of transition for the Corporation. Through a
company-wide project called "Vision Unlimited", the Corporation is in the
process of standardizing policies and procedures across the organization and
centralizing many operational functions. In addition, the Corporation is
converting all of the Banks to a single data processing platform. The
Corporation expects these changes will allow it to better manage risk, operate
more efficiently and serve customers better. Each of the Banks will continue to
keep its name, charter, board of directors and management teams but will
transition its human resources from the Bank's operational activities to
customer related activities. Bank employees will have the tools and resources
they need to effectively focus on customer service, customer retention and
customer prospecting. While the Corporation expects these changes to enhance
shareholder value in the long run, a transition of this magnitude will involve
short-term costs which the Corporation expects will range between $850,000 and
$1.0 million before tax in 2004.
The Corporation is also facing two other significant challenges in 2004. Like
all public companies, the Corporation is working towards compliance with the
Sarbanes-Oxley Act of 2002. While the Corporation is utilizing an outside third
party at a significant cost, compliance with Sarbanes-Oxley is largely being
accomplished internally through the Vision Unlimited project. The Corporation
expects its Sarbanes-Oxley compliance costs will range from $300,000 to $400,000
in 2004. In addition, like hundreds of other Wisconsin banking organizations,
the Corporation is in discussion with the Wisconsin Department of Revenue
("WDR") regarding the tax treatment of its Nevada investment subsidiaries.
Nevada does not have an income tax and historically the earnings of these Nevada
investment subsidiaries have not been subject to taxation in Wisconsin. The
Corporation believes that it has complied with private letter rulings the WDR
previously issued in connection with the formation and operation of its Nevada
investment subsidiaries. However, the effect and intent of these rulings is in
question and the WDR may take the position that some or all of the income of the
Corporation's Nevada investment subsidiaries is allocable to their Wisconsin
corporate parents and taxable in Wisconsin. The WDR may also take the position
that such a reallocation should apply to prior open tax years. The result of
these discussions with the WDR could materially increase the Corporation's
future income tax expense and could also result in a significant current year
tax charge.
Financial Condition
TOTAL ASSETS
Total assets increased $15.0 million, or 1.3% to $1.2 billion at March 31, 2004
compared to $1.1 billion at December 31, 2003. The growth in loans caused the
majority of the increase.
12
INVESTMENT SECURITIES
Available-for-sale investment securities increased $2.0 million, or 1.2%, from
$156.6 million at December 31, 2003, to $158.5 million at March 31, 2004. The
purchases of investment securities offset the sales, redemptions and maturities
of securities during the period.
LOANS RECEIVABLE
Loans receivable, net of allowance for loan losses increased $23.9 million from
$847.9 million at December 31, 2003 compared to $871.9 million at March 31,
2004. The growth in loans can be attributed to the growth in commercial business
and commercial real estate loans that were partially offset by the decrease in
consumer and installment loans. Currently, loans receivable consists mainly of
commercial loans secured by business assets, real estate and guarantees as well
as mortgages secured by residential properties located in our primary market
areas. At March 31, 2004 we designated $1.2 million of loans as held for sale.
TOTAL DEPOSITS AND BORROWINGS
Total deposits increased $6.1 million, or 0.7%, from $911.9 million on December
31, 2003 to $918.0 million on March 31, 2004. The increase in deposits can be
attributed to the growth in retail money market accounts and commercial checking
accounts currently offered by our subsidiary banks. Short-term borrowings
decreased by $4.9 million, or 14.4% from $34.0 million on December 31, 2003 to
$29.1 million on March 31, 2004. Short-term borrowings consist of federal funds
borrowed from correspondent banks and repurchase agreements. Long-term debt
increased by $12.0 million, or 16.5%, from $72.3 million on December 31, 2003 to
$84.3 million on March 31, 2004. Long-term debt consists of Federal Home Loan
Bank advances and acquisition notes associated with the Reedsburg transaction.
Subordinated Debentures totaled $36.1 million at March 31, 2004, unchanged from
December 31, 2003. We had obligations represented by subordinated debentures at
March 31, 2004 totaling $35.0 million with our wholly-owned trusts that were
created for the purpose of issuing trust preferred securities. The subordinated
debentures were the sole assets of the trusts at March 31, 2004. In accordance
with FIN 46, as of March 31, 2004 we began deconsolidating the wholly-owned
trusts that issued the trust preferred securities. As a result, these securities
no longer are consolidated on our balance sheet. Instead, the subordinated
debentures held by the trusts are disclosed on the balance sheet as other debt.
CAPITAL RESOURCES
Stockholders' equity at March 31, 2004 was $81.9 million compared to $80.0
million at December 31, 2003, an increase of $1.9 million. The change in
stockholders' equity consists of net income of $1.4 million, an $892,000 net
increase in accumulated other comprehensive income, $256,000 decrease in
treasury stock less payments of dividends to shareholders of $600,000. We and
our banks continue to exceed our regulatory capital requirements.
Under the Federal Reserve Board's risk-based guidelines, capital is measured
against our subsidiary banks' risk-weighted assets. Our tier 1 capital (common
stockholders' equity less goodwill) to risk-weighted assets was 8.2% at March
31, 2004, above the 4.0% minimum required. Total capital to risk-adjusted
assets was 10.1%; also above the 8.0% minimum requirement. The leverage ratio
was at 6.9% compared to the 4.0% minimum requirement. According to FDIC capital
guidelines, our subsidiary banks are considered to be "well capitalized" as
well.
13
NONPERFORMING ASSETS AND ALLOWANCE FOR LOSSES
Generally a loan is classified as nonaccrual and the accrual of interest on such
loan is discontinued when the contractual payment of principal or interest has
become 90 days past due or management has serious doubts about further
collectibility of principal or interest. Generally, loans are restored to
accrual status when the obligation is brought current, has performed in
accordance with the contractual terms for a reasonable period of time and the
ultimate collectibility of the total contractual principal and interest is no
longer in doubt.
Nonperforming assets are summarized, for the dates indicated, as follows
(dollars in thousands):
March 31, December 31, March 31,
2004 2003 2003
------- ------ -------
Non-accrual loans:
Conventional single-family residential $ 700 $ 456 $ 497
Commercial and multifamily residential 2,218 2,344 1,515
Commercial business loans 669 1,484 1,661
Consumer and installment loans 842 998 774
------- ------- -------
Total non-accrual loans 4,429 5,282 4,447
Other real estate owned 2,130 1,945 1,911
------- ------- -------
Total nonperforming assets $ 6,559 $ 7,227 $ 6,358
======= ======= =======
RATIOS:
Non-accrual loans to total loans 0.50% 0.62% 0.64%
Nonperforming assets to total assets 0.57 0.63 0.69
Loan loss allowance to non-accrual loans 212.51 172.96 178.52
Loan loss allowance to total loans 1.07 1.07 1.14
Nonperforming assets decreased by $668,000 from $7.2 million at December 31,
2003 to $6.6 million at March 31, 2004, a decrease of 9.2%. Payments received on
past due loans lead to the decline. We believe that any losses on current
non-accrual loans balances will be negligible, due to the collateral position in
each situation. However, additional charge offs may occur upon sale of the other
real estate.
The following table presents changes in the allowance for loan losses (dollars
in thousands):
Three Months Ended
March 31, 2004 March 31, 2003
-------------- --------------
Balance at beginning of period $9,135 $7,663
Provision for loan losses 450 302
Charge-offs:
Commercial and multifamily residential 95 28
Commercial business loans 88 7
Consumer and installment loans 79 25
------ ------
Total charge-offs 262 60
------ ------
Recoveries:
Commercial and multifamily residential 2 0
Commercial business loans 38 15
Consumer and installment loans 49 19
------ ------
Total recoveries 89 34
------ ------
Net charge-offs 173 27
------ ------
Balance at March 31, $9,412 $7,939
====== ======
14
We believe the allowance for loan losses accounting policy is critical to the
portrayal and understanding of our financial condition and results of
operations. As such, selection and application of this "critical accounting
policy" involves judgments, estimates, and uncertainties that are susceptible to
change. In the event that different assumptions or conditions were to prevail,
and depending upon the severity of such changes, the possibility of materially
different financial condition or results of operations is a reasonable
likelihood.
We maintain our allowance for loan losses at a level that management believes
will be adequate to absorb probable losses on existing loans based on an
evaluation of the collectibility of loans and prior loss experience. We also use
a risk rating system to evaluate the adequacy of the allowance for loan losses.
With this system, each loan is risk rated between one and seven by the
originating loan officer or loan committee, with one being the best case and
seven being a loss or the worst case. Loan loss reserve factors are multiplied
against the balances in each risk-rating category to determine an appropriate
level for the allowance for loan losses. Loans with risk ratings between four
and six are monitored much closer by the officers. Control of our loan quality
is continually monitored by management and is reviewed by the Board of Directors
and our credit quality committee on a quarterly basis. We consistently apply our
methodology for determining the adequacy of the allowance for loan losses, but
may make adjustments to its methodologies and assumptions based on historical
information related to charge-offs and management's evaluation of the current
loan portfolio.
The allowance for loan losses is based on estimates, and ultimate losses will
vary from current estimates. These estimates are reviewed quarterly, and as
adjustments, either positive or negative, become necessary, a corresponding
increase or decrease is made in the provision for loan losses. The methodology
used to determine the adequacy of the allowance for loan losses for the first
quarter 2004 is consistent with prior periods.
POTENTIAL PROBLEM LOANS
We utilize an internal asset classification system as a means of reporting
problem and potential problem assets. At least quarterly, a watch list is
presented to each subsidiary bank's Board of Directors (except one, which is
presented upon request of the Board of Directors) showing all loans listed as
"Management Attention (or equivalent designation at the various subsidiary
banks)", "Substandard", "Doubtful", and "Loss." An asset is classified
Substandard if it is inadequately protected by the current net worth and paying
capacity of the obligor or of the collateral pledged, if any. Substandard assets
include those characterized by the distinct possibility that we will sustain
some loss if the deficiencies are not corrected. Assets classified as Doubtful
have all the weaknesses inherent in those classified Substandard with the added
characteristic that the weaknesses present make collection or liquidation in
full, on the basis of currently existing facts, conditions and values, highly
questionable and improbable. Assets classified as Loss are those considered
uncollectible and viewed as non-bankable assets, worthy of charge-off. Assets
that do not currently expose us to sufficient risk to warrant classification in
one of the aforementioned categories, but possess weaknesses that may or may not
be within the control of the customer are deemed to be Management Attention (or
equivalent designation at the various subsidiary banks). As of March 31, 2004
the loans classified as Substandard, Doubtful, or Management Attention, totaled
$54.3 million compared to $51.7 million as of December 31, 2003, and increase of
$2.6 million or 5.0%.
15
Our determination as to the classification of our assets and the amount of our
valuation allowances is subject to review by the Banks' primary regulators,
which can order the establishment of additional general or specific loss
allowances. The FDIC, in conjunction with the other federal banking agencies,
has adopted an interagency policy statement on the allowance for loan losses.
The policy statement provides guidance for financial institutions on both the
responsibilities of management for the assessment and establishment of adequate
allowances and guidance for banking agency examiners to use in determining the
adequacy of general valuation guidelines. Generally, the policy statement
recommends that (i) institutions have effective systems and controls to
identify, monitor and address asset quality problems; (ii) management has
analyzed all significant factors that affect the collectibility of the portfolio
in a reasonable manner; and (iii) management has established acceptable
allowance evaluation processes that meet the objectives set forth in the policy
statement. We have established an adequate allowance for probable loan losses.
We analyze the process regularly, with modifications made if needed, and report
those results four times per year to each subsidiary bank's Board of Directors
(except one, which is presented upon request of the Board of Directors).
However, there can be no assurance that regulators, in reviewing our loan
portfolio, will not request us to materially increase our allowance for loan
losses at the time. Although management believes that adequate specific and
general loan loss allowances have been established, actual losses are dependent
upon future events and, as such, further additions to the level of specific and
general loan loss allowances may become necessary.
COMPARISON OF THREE MONTHS ENDED MARCH 31, 2004 AND 2003
NET INTEREST INCOME
Net interest income equals the difference between interest earned on assets and
the interest paid on liabilities and is a measure of how effectively management
has balanced and allocated our interest rate sensitive assets and liabilities as
well being the most significant component of earnings. Net interest income on a
fully taxable-equivalent basis for the three months ended March 31, 2004 was
$10.0 million, an increase of 12.7% from the $8.9 million reported for the same
period in 2003. The increase is due partly from revenue resulting from the
acquisition of Reedsburg as well as the increase in loan and investment volume
made possible by an increase in deposits. Our net interest margin on a fully
taxable-equivalent basis was 3.84% and 4.29% for the first quarters of 2004 and
2003, respectively. The continued low interest rate environment, the incremental
effect of the acquisitions as well as the increased amortization of purchase
accounting premiums associated with our acquisitions resulted in lower margins.
The reduction in market interest rates and increased premium amortization during
the quarter caused the average rate on a fully taxable-equivalent basis earned
on interest earning assets to decrease from 6.21% for the three months ended
March 31, 2003 to 5.58% for the three month period ended March 31, 2004.
16
The following table presents, for the periods indicated, the total dollar amount
of interest income from average interest earning assets and the resultant
yields, as well as the interest expense on average interest bearing liabilities,
and the resultant costs, expressed both in dollars and rates (dollars in
thousands):
AVERAGE BALANCES, INTEREST RATES AND YIELDS
FOR THE THREE MONTHS ENDED MARCH 31,
---------------------------------------------------------------------------------
2004 2003
-------------------------------------- -------------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- ---------- ------- ---------- ---------- -------
ASSETS
Loans, net (1)(2) $ 860,888 $ 12,770 5.97% $ 668,667 $ 10,949 6.64%
Loans exempt from federal income taxes (3) 3,951 74 7.53% 3,617 74 8.30%
Taxable investment securities (4) 46,250 468 4.07% 37,636 589 6.35%
Mortgage-related securities (4) 79,965 646 3.25% 73,494 670 3.70%
Investment securities exempt from federal
income taxes (3)(4) 43,907 577 5.29% 34,043 535 6.37%
Other securities 17,172 54 1.26% 25,619 88 1.39%
---------- ---------- ---------- ----------
Interest earning assets 1,052,133 14,589 5.58% 843,086 12,905 6.21%
---------- ----------
Non interest earning assets 92,455 58,947
---------- ----------
Average assets $1,144,588 $ 902,033
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
NOW deposits $ 85,639 105 0.49% $ 57,818 107 0.75%
Money market deposits 262,717 731 1.12% 200,733 819 1.65%
Savings deposits 115,954 235 0.82% 84,599 143 0.69%
Time deposits 333,274 2,029 2.45% 286,096 2,002 2.84%
Short-term borrowings 36,890 151 1.65% 27,273 148 2.20%
Long-term borrowings 78,233 734 3.77% 70,219 656 3.79%
Subordinated debentures 35,000 557 6.40% 10,000 119 4.83%
---------- ---------- ---------- ----------
Interest bearing liabilities 947,707 4,542 1.93% 736,738 3,994 2.20%
---------- ---------- ---------- ----------
Demand deposits and other non interest
bearing liabilities 115,795 95,864
Stockholders' equity 81,086 69,431
---------- ----------
Average liabilities and stockholders'
equity $1,144,588 $ 902,033
========== ==========
Net interest spread (5) $ 10,047 3.65% $ 8,911 4.01%
Net interest earning assets $ 104,426 $ 106,348
Net interest margin on a fully tax 3.84% 4.29%
equivalent basis (6)
Net interest margin (6) 3.76% 4.19%
Ratio of average interest-earning assets
to average interest-bearing 1.11 1.14
liabilities
- -------------------------
(1) For the purpose of these computations, nonaccrual loans are included in
the daily average loan amounts outstanding.
(2) Interest earned on loans includes loan fees (which are not material in
amount) and interest income which has been received from borrowers whose
loans were removed from nonaccrual status during the period indicated.
(3) Taxable-equivalent adjustments were made using a 34% corporate tax rate
for all years presented in calculating interest income and yields.
(4) Average balances of securities available-for-sale are based on amortized
cost.
(5) Interest rate spread represents the difference between the average yield
on interest earning assets and the average cost of interest bearing
liabilities and is represented on a fully tax equivalent basis.
(6) Net interest margin represents net interest income as a percentage of
average interest earning assets.
17
The following table sets forth the effects of changing interest rates and
volumes of interest earning assets and interest bearing liabilities on our net
interest income. Information is provided with respect to (i) effect 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) and (iii) net change. The net
change attributable to the combined impact of volume and rate has been allocated
proportionately to the change due to volume and the change due to rate. (dollars
in thousands):
VOLUME, RATE AND MIX ANALYSIS OF NET INTEREST INCOME
THREE MONTHS ENDED MARCH 31, 2004
COMPARED TO MARCH 31, 2003
-----------------------------------
CHANGE CHANGE
DUE TO DUE TO TOTAL
VOLUME RATE CHANGE
------- ------- -------
Interest-Earning Assets:
Loans, net (1) $ 3,300 $(1,479) $ 1,821
Loans exempt from federal income
taxes (2) 14 (14) --
Taxable investment securities 15 (136) (121)
Mortgage-related securities 54 (78) (24)
Investment securities exempt from
federal income taxes (2) 188 (146) 42
Other securities (29) (5) (34)
------- ------- -------
Total interest-earning assets $ 3,542 $(1,858) $ 1,684
======= ======= =======
Interest-Bearing Liabilities:
NOW deposits $ 94 ($ 96) ($ 2)
Money market deposits 1,825 (1,913) (88)
Savings deposits 58 34 92
Time deposits 476 (449) 27
Short-term borrowings 83 (80) 3
Long-term borrowings 76 2 78
Subordinated debentures 312 126 438
------- ------- -------
Total interest-bearing $ 2,924 $(2,376) $ 548
======= ======= =======
liabilities $ 1,136
=======
- ------------------------
(1) Interest earned on loans includes loan fees (which are not material in
amount) and interest income which has been received from borrowers whose
loans were removed from nonaccrual during the period indicated.
(2) Taxable-equivalent adjustments were made using a 34% corporate tax rate
for all years presented in calculating interest income and yields.
PROVISION FOR LOAN LOSSES
For the three months ended March 31, 2004, the provision for loan losses was
$450,000 compared to $302,000 for the same period in 2003 due to the growth in
the overall loan portfolio especially in higher risk categories of commercial
and commercial real estate loans and management's assessment of general economic
conditions. Net loan charge-offs for the three-month period ending March 31,
2004 were $173,000 compared to $27,000 for the three-month period ending March
31, 2003. We use a risk-based assessment of our loan portfolio to determine the
level of the loan loss allowance. This procedure is based on internal reviews
intended to determine the adequacy of the loan loss allowance in view of
presently known factors. However, changes in economic conditions in the future
financial conditions of borrowers cannot be predicted and may result in
increased future provisions to the loan loss allowance.
18
NON-INTEREST INCOME
Non-interest income for the three months ended March 31, 2004 was $2.7 million
compared to $2.2 million for the three months ended March 31, 2003, an increase
of $473,000 or 21.3%. The increase was due to the inclusion of Reedsburg's
results, increased service charges collected on deposit accounts and gains on
the sales of investment securities. Additionally, non-interest income increased
during the first quarter of 2004 compared to 2003 from growth in tax, brokerage
and insurance commissions due to growth in sales and the acquisitions of KCW and
IFS that occurred in the second quarter of 2003. The composition of non-interest
income is shown in the following table (dollars in thousands).
For the Three Months Ended March 31,
2004 2003
------ ------
Service charges on deposit accounts $ 725 $ 572
Service charges on loans 427 559
Securities gains, net 177 73
Gain on sale of loans, net 144 413
Net gain on sale of premises 0 6
Other 1,222 599
------ ------
Total non-interest income $2,695 $2,222
====== ======
Service charges on deposit accounts for the three months ended March 31, 2004
was $725,000 compared to $572,000 for the three months ended March 31, 2003, an
increase of $153,000, or 26.7%. The increase in 2004 is the result of growth in
deposit accounts, both internal and through acquisition and fee structure
modifications company wide.
Service charges on loans for the three months ended March 31, 2004 was $427,000
compared to $559,000 for the three months ended March 31, 2003, a decrease of
$132,000, or 23.6%. The decrease is due directly to the reduction in mortgage
and commercial loans refinanced in 2004 when compared to 2003.
We recorded a net gain of $177,000 on the sale of $7.3 million of securities in
the first quarter of 2004 compared to a gain of $73,000 on the sale of $4.4
million of securities during the same period in 2003. The proceeds from the sale
of the investments were used to fund loan demand or reduce debt.
Gains on the sale of loans were $144,000 for the three months ended March 31,
2004 compared to $413,000 for the three months ended March 31, 2003. All-time
low market interest rates led to higher secondary market sales volume of 15 and
30 year residential mortgage loans in the first quarter of 2003 compared to
2004.
Other income for the three-month period ending March 31, 2004 included
commissions on tax, investment and insurance products generated from the
acquisitions of IFS in April 2003 and KCW in May 2003.
19
NON-INTEREST EXPENSE
Non-interest expense for the three months ended March 31, 2004 was $10.1 million
compared to $7.6 million for the three months ended March 31, 2003, an increase
of $2.5 million, or 32.7%. The increase in non-interest expense is due in part
to expenses related to the inclusion of the Reedsburg Bank's non-interest
expenses in our 2004 first quarter operating results. Additionally, non-interest
expense increased during the first quarter of 2004 compared to 2003 from
expenses associated with the activities of KCW and IFS. The major components of
non-interest expense are shown in the following table (dollars in thousands).
For the Three Months Ended March 31,
2004 2003
------- ------
Salaries and employee benefits $ 5,860 $4,265
Premises and equipment 1,476 1,218
Data processing fees 361 310
Marketing and business development 334 358
Federal deposit insurance premiums 41 33
Other 2,010 1,415
------- ------
Total noninterest expense $10,082 $7,599
======= ======
Salaries and employee benefits for the three months ended March 31, 2004 was
$5.9 million compared to $4.3 million for the three months ended March 31, 2003,
an increase of $1.6 million, or 37.4%. The increase was primarily due to
acquisitions. Also impacting salaries and employee benefits in the 2004 first
quarter were additional staff hires particularly in the business development and
acquisition support staff areas, higher benefit costs, changes in personnel and
normal pay raises.
Premises and equipment expense for the three months ended March 31, 2004 was
$1.5 million compared to $1.2 million for the three months ended March 31, 2003,
an increase of $258,000, or 21.2%. Higher utility costs, building lease
payments, depreciation, maintenance of our facilities and acquisitions
contributed to the increase.
Data processing fees for the three months ended March 31, 2004 was $361,000
compared to $310,000 for the three months ended March 31, 2003, an increase of
$51,000, or 16.5%. The increase was due to the increased reliance on outside
consultants for information technology issues as well as equipment and software
upgrades.
Other expenses for the three months ended March 31, 2004 was $2.0 million
compared to $1.4 million for the three months ended March 31, 2003, an increase
of $595,000, or 42.0%. The increase in first quarter of 2004 other expenses are
the result of training our employees sales techniques, maintaining our internet
banking program, consulting fees and legal fees. Additionally, the increase in
other expense is due in part to expenses related to the inclusion of the
Reedsburg Bank's other expenses in our 2004 first quarter operating results as
well as expenses associated with the activities of KCW and IFS.
INCOME TAXES
Income taxes for the three-month period ended March 31, 2004 was $582,000
compared to $1.0 million for the three months ended March 31, 2003, a decrease
of $447,000, or 43.4%. The effective tax rate for the three months ended March
31, 2004 was 29.2% compared to 34.0% for the same period in 2003. The reduced
tax rate is due to the decrease in fully taxed income at CBG Mortgage and the
inclusion of Reedsburg's operation in our 2004 results.
20
NET INCOME
On an after tax basis, for the three month period ended March 31, 2004, we
reported net income of $1.4 million or $0.42 per diluted share, compared to $2.0
million or $0.63 for the same period in 2003.
LIQUIDITY
Our cash flows are composed of three classifications: cash flows from operating
activities, cash flows from investing activities, and cash flows from financing
activities. Net cash provided by operating activities was $1.6 million and
$637,000 for the three months ended March 31, 2004 and 2003, respectively, a
increase of $913,000. Net cash used in investing activities increased by
$256,000, to $26.7 million used in for the three months ended March 31, 2004
from $26.5 million used in the same period in 2003. Net cash provided by
financing activities was $12.7 million for the three months ended March 31, 2004
compared to $16.6 million provided by financing activities during the
three-month period in 2003. The $3.9 million decrease in net cash provided by
financing activities was primarily due to a $4.9 million decrease in short-term
borrowings compared to a $16.2 million increase in 2003.
The Company expects to have available cash to meet its liquidity needs.
Liquidity management is monitored by the Asset/Liability committee, which takes
into account the marketability of assets, the sources and stability of funding
and the level of unfunded commitments. In the event that additional short-term
liquidity is needed, the Banks have established relationships with our
correspondent banks to provide short-term borrowings in the form of federal
funds purchased. While there are no firm lending commitments in place, we
believe that the Banks could borrow $96.2 million for a short time from these
banks on a collective basis. The Banks are members of the Federal Home Loan Bank
(FHLB) and each has the ability to borrow from the FHLB. As a contingency plan
for significant funding needs, the Asset/Liability Management committee may also
consider the sale of investment securities, selling securities under agreement
to repurchase or the temporary curtailment of lending activities.
21
ASSET/LIABILITY MANAGEMENT
Financial institutions are subject to interest rate risk to the extent their
interest-bearing liabilities (primarily deposits) mature or reprice at different
times and on a different basis than their interest-earning assets (consisting
primarily of loans and securities). Interest rate sensitivity management seeks
to match maturities on assets and liabilities and avoid fluctuating net interest
margins while enhancing net interest income during periods of changing interest
rates. The difference between the amount of interest-earning assets maturing or
repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within the same time period is referred to as
an interest rate gap. A gap is considered positive when the amount of interest
rate sensitive assets exceeds the amount of interest rate sensitive liabilities.
A gap is considered negative when the amount of interest rate sensitive
liabilities exceeds the amount of interest rate sensitive assets. During periods
of falling interest rates, a negative gap tends to positively affect net
interest income while a positive gap tends to result in a decrease in net
interest income. During a period of rising interest rates, a positive gap tends
to result in an increase in net interest income while a negative gap tends to
adversely affect net interest income.
The following table shows the interest rate sensitivity gap for four different
time intervals as of March 31, 2004. Certain assumptions regarding prepayment
and withdrawal rates made are based upon the Corporation's historical experience
and management believes such assumptions are reasonable.
AMOUNTS MATURING OR REPRICING AS OF MARCH 31, 2004
WITHIN SIX TO TWELVE ONE TO FIVE OVER
SIX MONTHS MONTHS YEARS FIVE YEARS TOTAL
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Fixed-rate mortgage loans $ 51,767 $ 90,310 $ 278,934 $ 16,437 $ 437,448
Adjustable-rate mortgage loans 130,996 16,875 11,044 16 158,931
---------- ---------- ---------- ----------- ----------
Total mortgage loans 182,763 107,185 289,978 16,453 596,379
Commercial business loans 114,821 31,055 66,029 3,485 215,390
Consumer and other loans 18,167 4,955 25,710 1,533 50,365
Home equity loans 15,345 73 21 99 15,538
Tax-exempt loans 181 384 1,157 1,899 3,621
Mortgage-related securities 12,399 24,360 41,541 9,127 87,427
Fixed rate investment securities and other 7,929 4,315 19,523 39,286 71,053
Variable rate investment securities and
other 28,757 0 25 0 28,782
---------- ---------- ---------- ----------- ----------
Total interest-earning assets $ 380,362 $ 172,327 $ 443,984 $ 71,882 $1,068,555
========== ========== ========== =========== ==========
Interest-bearing liabilities:
Deposits
Time deposits $ 138,459 $ 109,416 $ 81,556 $ 5,390 $ 334,821
NOW accounts 5,185 5,185 51,845 24,195 86,410
Savings accounts 7,365 8,458 73,649 34,370 123,842
Money market accounts 31,069 14,741 147,408 68,790 262,008
Short-term borrowings 29,097 0 0 0 29,097
Long-term borrowings 10,606 13,214 55,838 4,651 84,309
Subordinated debentures 18,042 0 0 18,042 36,084
---------- ---------- ---------- ----------- ----------
Total interest-bearing liabilities $ 239,823 $ 151,014 $ 410,296 $ 155,438 $ 956,571
========== ========== ========== =========== ==========
Interest-earning assets less
interest-bearing liabilities $ 140,539 $ 21,313 $ 33,688 ($ 83,556) $ 111,984
========== ========== ========== =========== ==========
Cumulative interest rate sensitivity gap $ 140,539 $ 161,852 $ 195,540 $ 111,984
========== ========== ========== ===========
Cumulative interest rate sensitivity gap as
a percentage of total assets 12.11% 13.95% 16.85% 9.65%
========== ========== ========== ===========
22
At March 31, 2004, the Corporation's cumulative interest-rate sensitive gap as a
percentage of total assets was a positive 12.11% for six months and a positive
13.95% for one-year maturities. Therefore, we are positively gapped at one year
and may benefit from rising interest rates.
Certain shortcomings are inherent in the method of analysis presented in the
above schedule. For example, although certain assets and liabilities may have
similar maturities or periods of repricing, they may react in different degrees
to changes in market interest rates. 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. Additionally, certain assets, such as adjustable rate mortgage loans,
have features that restrict changes in interest rates, on a short-term basis
over the life of the asset. Further, in the event of a change in interest rates,
prepayment and early withdrawal levels would likely deviate significantly from
those assumed in calculating the schedule.
FORWARD-LOOKING STATEMENTS
When used in this Quarterly Report on Form 10-Q and in other filings with the
Securities and Exchange Commission, in press releases or other public
shareholder communications, or in oral statements made with the approval of an
authorized executive officer, the words or phrases "believe," "will likely
result," "are expected to," "will continue," "is anticipated," "estimate,"
"project," "plans," or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. You are cautioned not to place undue reliance on
any forward-looking statements, which speak only as of the date made. These
statements may relate to our future financial performance, strategic plans or
objectives, revenues or earnings projections, or other financial items. By their
nature, these statements are subject to numerous uncertainties that could cause
actual results to differ materially from those anticipated in the statements.
Important factors that could cause actual results to differ materially from the
results anticipated or projected include, but are not limited to, the following:
(1) the credit risks of lending activities, including changes in the level and
direction of loan delinquencies and write-offs; (2) changes in management's
estimate of the adequacy of the allowance for loan losses; (3) competitive
pressures among depository institutions; (4) interest rate movements and their
impact on customer behavior and our net interest margin; (5) the impact of
repricing and competitors' pricing initiatives on loan and deposit products; (6)
our ability to adapt successfully to technological changes to meet customers'
needs and developments in the market place; (7) our ability to access
cost-effective funding; (8) changes in financial markets and general economic
conditions; (9) new legislation or regulatory changes; (10) changes in
accounting principles, policies or guidelines; (11) the result of the
Corporation's discussions with WDR; (12) the acquisition of Random Lake Bancorp
Limited is subject to a number of conditions, and no assurance can be given that
the acquisition will be completed or, if completed, that the terms of the
acquisition will be as presently contemplated; and (13) expected cost savings
and synergies from our recently completed acquisition of Reedsburg
Bancorporation, Inc., might not be realized within the expected time frame.
We do not undertake any obligation to update any forward-looking statement to
reflect circumstances or events that occur after the date on which the
forward-looking statement is made.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Corporation has not experienced any material changes to its market risk
position since December 31, 2003, from that disclosed in the Corporation's 2003
Form 10-K Annual Report.
23
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the Corporation's Chairman
of the Board and Principal Executive Officer and the Corporation's Chief
Financial Officer carried out an evaluation, with the participation of other
members of management as they deemed appropriate, of the effectiveness of the
design and operation of the Corporation's disclosure controls and procedures as
contemplated by Exchange Act Rule 13a-15. Based upon, and as of the date of that
evaluation, the Chairman of the Board and Principal Executive Officer and the
Chief Financial Officer concluded that the Corporation's disclosure controls and
procedures are effective, in all material respects, in timely alerting them to
material information relating to the Corporation (and its consolidated
subsidiaries) required to be included in the periodic reports the Corporation is
required to file and submit to the SEC under the Exchange Act. It should be
noted that in designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, and management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible controls and
procedures. The Corporation has designed its disclosure controls and procedures
to reach a level of reasonable assurance of achieving the desired control
objectives and, based on the evaluation described above, the Corporation's
Chairman of the Board and Principal Executive Officer and the Corporation's
Chief Financial Officer concluded that the Corporation's disclosure controls and
procedures were effective at reaching that level of reasonable assurance.
There was no change in the Corporation's internal control over financial
reporting during the Corporation's most recently completed fiscal quarter that
has materially affected, or is reasonably likely to materially affect, the
Corporation's internal control over financial reporting.
24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
As of March 31, 2004 there were no material pending legal proceedings,
other than ordinary routine litigation incidental to the business of
the Corporation, to which the Corporation or any of its subsidiaries
was a party or to which any of their property was subject.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities - NONE
Item 3. Defaults upon Senior Securities - NONE
Item 4. Submission of Matters to Vote of Security Holders - NONE
Item 5. Other Information - NONE
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - The following exhibits are filed as part of this report:
EXHIBIT 10.1 Employment Agreement, dated as of January 1,
2004, between the Corporation and Donald L. Rowland.
EXHIBIT 31.1 Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 by the Principal
Executive Officer
EXHIBIT 31.2 Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 by the Chief Financial
Officer
EXHIBIT 32.1* Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 by the Principal
Executive Officer
EXHIBIT 32.2* Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 by the Chief Financial
Officer
- ------------------------
* These certifications are not "filed" for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended, or incorporated by reference into
any filing under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended.
Reports on Form 8-K:
(b) NONE
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MERCHANTS AND MANUFACTURERS
BANCORPORATION, INC.
----------------------------
(Registrant)
Date May 10, 2004 /s/ Michael J. Murry
---------------------------------------
Michael J. Murry
Chairman of the Board of Directors
and Principal Executive Officer
Date May 10, 2004 /s/ James C. Mroczkowski
---------------------------------------
James C. Mroczkowski
Executive Vice President & Chief
Financial Officer
Principal Financial Officer
26
10-Q EXHIBIT LIST
EXHIBIT NO. DESCRIPTION
EXHIBIT 10.1 Employment Agreement, dated as of January 1, 2004, between
the Corporation and Donald L. Rowland.
EXHIBIT 31.1 Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 by the Principal Executive
Officer
EXHIBIT 31.2 Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 by the Chief Financial Officer
EXHIBIT 32.1* Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 by the Principal Executive
Officer
EXHIBIT 32.2* Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 by the Chief Financial Officer
- ------------------------
* These certifications are not "filed" for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended, or incorporated by reference into
any filing under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended.