United States
Securities and Exchange Commission

Form 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

First Federal Capital Corp

Registrant’s telephone number, including area code: (608) 784-8000

Not applicable
(Former name, former address, and former fiscal year,
if changed since last report)

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 the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [X] No [   ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class: Common Stock—$.10 Par Value. Outstanding as of August 6, 2004: 22,543,511.

Form 10-Q Table of Contents

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Part I—Financial Information

Item 1—Financial Statements

Consolidated Statements of Financial Condition
June 30, 2004, and December 31, 2003

Refer to accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Operations
Three months ended June 30, 2004 and 2003

Refer to accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Operations
Six months ended June 30, 2004 and 2003

Refer to accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Stockholders’ Equity
Three months ended June 30, 2004 and 2003

Refer to accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Stockholders’ Equity
Six months ended June 30, 2004 and 2003

Refer to accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Cash Flows
Three months ended June 30, 2004 and 2003

Refer to accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Cash Flows
Six months ended June 30, 2004 and 2003

Refer to accompanying Notes to Consolidated Financial Statements.

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Notes to Consolidated Financial Statements

Note 1—Principles of Consolidation

     The consolidated financial statements include the accounts and balances of First Federal Capital Corp (the “Corporation”), First Federal Capital Bank (the “Bank”), and the Bank’s wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

Note 2—Basis of Presentation

     The accompanying interim consolidated financial statements are unaudited and do not include information or footnotes necessary for a complete presentation of financial condition, results of operations, or cash flows in accordance with generally accepted accounting principles (“GAAP”). However, in the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the consolidated financial statements have been included. Operating results for the three and six month periods ended June 30, 2004, may not necessarily be indicative of the results that may be expected for the entire year ending December 31, 2004.

     Certain 2003 balances have been reclassified to conform to the 2004 presentation.

Note 3—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 Corporation’s stock incentive plans. 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 three and six month periods ended June 30, 2004 and 2003, is as follows:

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Note 4—Contingencies

     The Corporation and its subsidiaries are engaged in various routine legal proceedings occurring in the ordinary course of business, which considered together are believed by management to be immaterial to the consolidated financial condition and operations of the Corporation.

     First Cap Holdings, Inc. (“FCHI”), a Nevada company and wholly-owned subsidiary of the Bank, has not been subject to taxation in Wisconsin since FCHI’s formation in 1993. 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”) has increased its examinations of banking entities in the state and is proposing that income of out-of-state investment subsidiaries (like FCHI) be allocated 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. The WDR is now taking the position that some or all investment subsidiary income is allocable to the parent banks and taxable in Wisconsin and has written to all affected Wisconsin banks, including the Bank, indicating a willingness to discuss settlements. While the WDR has indicated settlement terms would depend on individual situations, the WDR letter indicates that settlement payments would be less than the tax, interest, and penalties that would be sought based on an assessment and that some limited future use of investment subsidiaries may be permitted. The WDR letter further indicates that a number of banks have agreed to settlements. 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. While the WDR has indicated it may repudiate these rulings, the WDR exam has not yet resulted in an assessment against the Bank. The Bank will oppose an assessment, if any, and is not currently engaged in any settlement discussion with the WDR.

     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. Furthermore, if the WDR determines that the earnings of FCHI in open tax years prior to 2004 should have been subject to tax in Wisconsin, management estimates that the Bank may be subject to a tax obligation of up to $16.0 million, also 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 any assessment related to this issue

Note 5—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

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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.

     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.

     Segment Profit (Loss) Statements and Other Information The following table summarizes the profit (loss) and average assets of each of the Corporation’s reportable segments for the three and six month periods ended June 30, 2004 and 2003. 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, which consists principally of the net costs to operate the Corporation’s branch network, as previously described. The net cost to acquire and maintain deposit liabilities was 1.17% and 1.23% of average deposit liabilities outstanding during the three months ended June 30, 2004 and 2003, respectively. For the six month periods ended June 30, 2004 and 2003, the net cost to acquire and maintain deposit liabilities was 1.32% and 1.31%, respectively.

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Note 6—Stock-Based Compensation

     As permitted by GAAP, the Corporation has not adopted the “fair value method” of expense recognition for stock-based compensation awards. Rather, 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. The following table provides pro forma disclosure of the effects of the Corporation’s stock incentive plans using the fair value method.

     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.

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Note 7—Subsequent Event

     On April 27, 2004, the Corporation entered into a definitive agreement to be acquired by Associated Banc-Corp (“Associated”), headquartered in Green Bay, Wisconsin. The stock and cash transaction is valued at $613 million, including stock options, based on the closing Associated share price on April 27, 2004. According to the terms of the agreement, the Corporation will merge into Associated, with the Corporation’s shareholders exchanging each share of their common stock for 0.9525 shares of Associated’s common stock (adjusted to reflect a 3-for-2 stock split effected by Associated and paid to shareholders on May 12, 2004), an equivalent amount of cash, or a combination thereof. The agreement provides, however, that the aggregate consideration paid by Associated must be equal to ten percent (10%) cash and ninety percent (90%) stock. The transfer will be tax-free to the Corporation’s shareholders to the extent they receive Associated common stock.

     The acquisition has been approved by the boards of directors of each company and is expected to close during the fourth quarter of 2004, subject to shareholder approval, regulatory approvals, and various other conditions of closing.

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Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations

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. Furthermore, 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.

Application of Critical Accounting Policies

     Critical Judgments and Estimates For a summary of the Corporation’s significant accounting policies, refer to Note 1 of the Corporation’s Audited Consolidated Financial Statements included in Part II, Item 8, of its 2003 Form 10-K. 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 detailed discussion of the judgments and estimates relating to the initial recording of and ongoing accounting for mortgage servicing rights (“MSRs”), refer to the appropriate section in Note 1 of the Corporation’s Audited Consolidated Financial Statements, included in Part II, Item 8, of its 2003 Form 10-K. Additional discussion is also available in the 2003 Form 10-K “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 three and six month periods ended June 30, 2004 and 2003, 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 detailed 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 in Part II, Item 8, of its 2003 Form 10-K. Additional discussion is also available in the 2003 Form 10-K “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 three and six month periods ended June 30, 2004 and 2003, 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 six months ended June 30, 2004 and 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, three new accounting standards issued during the first six months of 2004, were significant to the financial services industry as a whole. These standards are itemized in the paragraphs that follow.

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          Staff Accounting Bulletin (“SAB”) 105, “Loan Commitments Accounted for as Derivative Instruments” (“SAB 105”) During the first quarter of 2004, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin 105, “Loan Commitments Accounted for as Derivative Instruments”. This SAB addresses the accounting for loan commitments entered into after March 31, 2004, and certain disclosure requirements relevant in the context of mortgage banking activities. The effects of SAB 105 are not expected to be material to the operations of the Corporation or its financial position.

          Emerging Issues Task Force (“EITF”) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. On March 31, 2004 the Financial Accounting Standards Board (“FASB”) ratified the consensus reached by the Emerging Issues Task Force (“EITF”) in EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“Issue 03-1”). Issue 03-1 provides guidance to determine when an investment is considered impaired, whether the impairment is other than temporary, and the measurement of an impaired loss. The guidance also includes accounting considerations subsequent to recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments.

          For debt securities that cannot be contractually prepaid or otherwise settled in a manner in which the investor would not recover substantially all of its cost, an impairment should be deemed other than temporary if (a) the investor does not have the ability and intent to hold an investment until a forecasted recovery of fair value up to the cost of the investment, which in certain cases may be until maturity, or (b) it is probable that the investor will be unable to collect all amounts due according to the contractual terms of the debt security. For equity securities (including cost method investments) and debt securities that can be contractually prepaid or otherwise settled in a manner in which the investor would not recover substantially all of its cost, an impairment should be deemed other than temporary unless (a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for a forecasted recovery of fair value up to the cost of the investment, and (b) evidence indicating the cost of the investment is recoverable within a reasonable period of time and outweighs evidence to the contrary.

          Although not presumptive, a pattern of selling investments prior to the forecasted recovery of fair value may call into question the investors intent. The guidance for evaluating whether an investment is other-than-temporarily impaired should be applied in other-than-temporary impairment evaluations made in reporting periods beginning after June 15, 2004. The disclosures are effective in annual financial statements for fiscal years ending after December 15, 2003, for investments accounted for under FASB Statements No. 115 and No. 124. The effects of Issue No. 03-1 are not expected to be material to the operations of the Corporation or its financial position.

          Financial Accounting Standards Board staff position (FSP) 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”. In May 2004, the FASB issued FSP 106-2 providing guidance on the accounting effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”). The Act, passed by Congress and signed into law on December 8, 2003, establishes a voluntary prescription drug benefit for eligible participants beginning January 1, 2006, at which time the U.S. Government will also begin to pay a special subsidy equal to 28% of a retiree’s covered prescription drug expenses between $250 and $5,000 (adjusted annually for changes in Medicare per capita prescription drug costs) to employers who sponsor equivalent plans. In accordance with FSP 106-2 which prescribes accounting for the Act and is effective for interim periods beginning after June 15, 2004, the Corporation has elected to defer including the effects of the Act in any measures of liabilities and expenses reflected in the Consolidated Financial Statements and accompanying notes. Clarifying regulations related to the interpretation or determination of actuarially equivalent plans are still pending. Therefore, any such effects included in the Corporations financial statements would be subject to change once final regulations have been issued. The Corporation does not expect that the Act will have a significant impact on postretirement liabilities and benefit costs.

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Other Matters

     On April 27, 2004, the Corporation entered into a definitive agreement to be acquired by Associated Banc-Corp (“Associated”), headquartered in Green Bay, Wisconsin. The stock and cash transaction is valued at $613 million, including stock options, based on the closing Associated share price on April 27, 2004. According to the terms of the agreement, the Corporation will merge into Associated, with the Corporation’s shareholders exchanging each share of their common stock for 0.9525 shares of Associated’s common stock (adjusted to reflect a 3-for-2 stock split effected by Associated and paid to shareholders on May 12, 2004), an equivalent amount of cash, or a combination thereof. The agreement provides, however, that the aggregate consideration paid by Associated must be equal to ten percent (10%) cash and ninety percent (90%) stock. The transfer will be tax-free to the Corporation’s shareholders to the extent they receive Associated common stock.

     The acquisition has been approved by the boards of directors of each company and is expected to close during the fourth quarter of 2004, subject to shareholder approval, regulatory approvals, and various other conditions of closing.

Results of Operations

     Quarter Overview The Corporation’s net income for the three months ended June 30, 2004, was $10.4 million or $0.46 per diluted share compared to $8.8 million or $0.44 in the same period last year. These amounts represented a return on average assets of 1.12% and 1.14%, respectively, and a return on average equity of 15.15% and 16.25%, respectively.

     The increase in net income from 2003 to 2004 was primarily attributable to a $9.6 million increase in net interest income and a $1.3 million increase in community banking revenue. These developments were offset partly by a $5.0 million increase in non-interest expense, a $2.2 million decrease in mortgage banking revenue, a $670,000 increase in provision for loan losses, and a $1.6 million increase in income tax expense.

     Six Month Overview The Corporation’s net income for the six months ended June 30, 2004, was $18.4 million or $0.81 per diluted share compared to $16.8 million or $0.84 in the same period last year. These amounts represented a return on average assets of 1.03% and 1.10%, respectively, and a return on average equity of 13.30% and 15.81%, respectively.

     The increase in net income from 2003 to 2004 was primarily attributable to a $19.1 million increase in net interest income and a $2.8 million increase in community banking revenue. These developments were offset in large part by an $11.1 million increase in non-interest expense, a $6.1 million decrease in mortgage banking revenue, a $1.9 million increase in provision for loan losses, and a $1.3 million increase in income tax expense.

     The following paragraphs discuss the aforementioned changes in more detail along with other changes in the components of net income during the three and six month periods ended June 30, 2004 and 2003 .

     Net Interest Income Net interest income increased by $9.6 million or nearly 52% and by $19.1 million or almost 52% during the three and six month periods ended June 30, 2004, as compared to the same periods in the previous year. The improvement was due in part to the fact that the Corporation’s average interest-earning assets increased by $565 million or 19.9% and by $466 million or 16.5%, respectively, between these periods. The principal source of this growth occurred in the Corporation’s commercial real estate loans, mortgage-related securities, commercial business loans, consumer loans, and single-family mortgage loans. This growth was largely funded by increases in money market deposit accounts and Federal Home Loan Bank (“FHLB”) term advances.

     Also contributing to the increase in net interest income in both the three and six months ended June 30, 2004, was a significant improvement in interest rate spread. The Corporation’s interest rate spread improved from 2.13% and 2.15% during the three and six month periods ended June 30, 2003, respectively, to 3.05% and 3.15% during the same periods in 2004, respectively. These improvements were caused primarily by the maturity of high-

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cost certificates of deposit during the last half of 2003, as well as the prepayment of high-cost FHLB advances late in the third quarter of 2003. These advances were replaced with lower-cost advances drawn to fund the purchase of CMOs during the first quarter of 2004. For additional discussion, refer to “Financial Condition—FHLB Advances”.

     Management expects market interest rates to trend higher during the remainder of 2004 as economic conditions improve but 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.

     The following tables set 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 during the three and six month periods ended June 30, 2004 and 2003.