UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

 

 

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 past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for past 90 days. Yes  ý  No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes  o  No  ý

 

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

 

 

 

SPECTRUM BANCORPORATION, INC.
INDEX TO FORM 10-Q FOR THE QUARTERLY
PERIOD ENDED MARCH 31, 2003

 

					PAGE
FORWARD-LOOKING STATEMENTS					3
PART I:			FINANCIAL INFORMATION
	ITEM 1:			FINANCIAL STATEMENTS
		Consolidated Balance Sheets at March 31, 2003(unaudited) and June 30, 2002			4
		Consolidated Statements of Income - Three months ended March 31, 2003 and March 31, 2002 (unaudited)			5
		Consolidated Statements of Income - Nine months ended March 31, 2003 and March 31, 2002 (unaudited)			6
		Consolidated Statements of Cash Flows - Nine months ended March 31, 2003 and March 31, 2002 (unaudited)			7
		Notes to Consolidated Financial Statements			8
	ITEM 2:			MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION	11
	ITEM 3:			QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	15
	ITEM 4:			CONTROLS AND PROCEDURES	15
PART II:			OTHER INFORMATION
	ITEM 1:			LEGAL PROCEEDINGS	16
	ITEM 2:			CHANGES IN SECURITIES AND USE OF PROCEEDS	16
	ITEM 3:			DEFAULTS UPON SENIOR SECURITIES	16
	ITEM 4:			SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	16
	ITEM 5:			OTHER INFORMATION	16
	ITEM 6:			EXHIBITS AND REPORTS ON FORM 8-K	16
				SIGNATURES	17
				CERTIFICATION BY CHIEF EXECUTIVE OFFICER	18
				CERTIFICATION BY CHIEF FINANCIAL OFFICER	19
				CERTIFICATION BY CHIEF EXECUTIVE OFFICER	20
				CERTIFICATION BY CHIEF FINANCIAL OFFICER	21

 

2

 

FORWARD-LOOKING STATEMENTS

 

This report includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements can include words such as “may”, “believe”, “will”, “anticipated”, “estimated”, “projected”, “could”, “should”, “plan” or similar expressions.  Forward-looking statements are based on management’s current expectations.  Factors that might cause future results to differ from management’s expectations include, but are not limited to: fluctuations in interest rates, inflation, the effect of regulatory or government legislative changes, expected cost savings and revenue growth not fully realized, the progress of strategic initiatives and whether realized within expected time frames, general economic conditions, adequacy of allowance for loan losses, costs or difficulties associated with restructuring initiatives, changes in accounting policies or guidelines, changes in the quality or composition of the Company’s loans and investment portfolios, technology changes and competitive pressures in the geographic and business areas where the Company conducts its operations.

 

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.  Additional information concerning the Company and its business, including other factors that could materially affect the Company’s financial results, is included in the Company’s filings with the Securities and Exchange Commission.

 

3

 

PART I
FINANCIAL INFORMATION

 

ITEM 1:

FINANCIAL STATEMENTS

 

SPECTRUM BANCORPORATION, INC.
Consolidated Balance Sheets
(In thousands, except share data)

 

		March 31, 2003			June 30, 2002
		(unaudited)
Assets
Cash and due from banks		$	61,642		$	52,927
Federal funds sold and other		44,865			16,351
Total cash and cash equivalents		106,507			69,278
Certificates of deposit		99			497
Securities available for sale		323,975			334,059
Securities held to maturity		110			0
Loans, net of allowance for loan losses of $21,581and $20,344		1,539,708			1,475,856
Premises and equipment, net		43,385			41,803
Accrued interest receivable		13,798			15,089
Core deposit intangible and other, net		3,851			5,294
Goodwill, net		45,930			43,913
Mortgage servicing rights, net		10,112			15,131
Other assets		13,116			11,237
		$	2,100,591		$	2,012,157
Liabilities and Stockholders’ Equity
Liabilities:
Deposits
Non interest bearing		$	253,417		$	194,792
Interest bearing		1,451,230			1,441,175
Total deposits		1,704,647			1,635,967
Federal funds purchased and securities sold under agreements to repurchase		57,944			70,544
FHLB advances and other borrowing		94,828			70,564
Notes payable		43,700			53,700
Company obligated mandatorily redeemable preferred securities of subsidiary trust holding solely subordinated debentures		58,000			48,000
Accrued interest and other liabilities		16,549			17,990
		1,975,668			1,896,765
Minority interest in subsidiaries		2,711			5,229
Stockholders’ equity:
Preferred stock, $100 par value; 500,000 shares authorized; issued and outstanding:  9,000 shares of 8% cumulative, nonvoting; 8,000 shares of 10% noncumulative, nonvoting; 100,000 shares of variable rate, noncumulative, nonvoting		11,700			11,700
Common stock, $1.00 par value, authorized 1,000,000 shares, issued and outstanding 124,952 and 125,132 shares, respectively		125			125
Additional paid-in capital		2,051			2,058
Retained earnings		103,433			92,285
Accumulated other comprehensive income, net		4,903			3,995
Total stockholders’ equity		122,212			110,163
		$	2,100,591		$	2,012,157

 

See Notes to Consolidated Financial Statements.

 

4

 

SPECTRUM BANCORPORATION, INC.
Consolidated Statements of Income
For The Three Months Ended
(In thousands, except share and per share data)
(unaudited)

 

		March 31, 2003			March 31, 2002
Interest income on:
Loans		$	26,617		$	26,678
Taxable securities		2,877			3,553
Nontaxable securities		475			325
Dividends on securities		60			64
Federal funds sold and other		169			280
		30,198			30,900
Interest expense on:
Deposits		8,269			10,396
Federal funds purchased and securities sold under agreements to repurchase		178			303
FHLB advances and other borrowing		1,007			1,076
Notes payable		557			661
Company obligated mandatorily redeemable preferred securities		1,310			1,183
		11,321			13,619
Net interest income		18,877			17,281
Provision for loan losses		857			1,505
Net interest income after provision for loan losses		18,020			15,776
Other income:
Service charges and other fees		3,214			2,542
Net gains from sale of loans		1,815			728
Loan servicing fees, net		804			780
Gain on securities, net		278			10
Trust department income		382			404
Net gains from sale of other real estate owned and other assets		1,240			23
Other		692			773
		8,425			5,260
Other expenses:
Salaries and employee benefits		8,880			7,453
Occupancy expenses, net		1,093			963
Data processing		994			760
Equipment expenses		715			604
Advertising		624			490
Professional fees		718			650
Communication expenses		505			485
Amortization of core deposit intangible and other		480			659
Amortization and valuation adjustments of mortgage servicing rights		2,579			10
Other operating expenses		1,733			1,335
		18,321			13,409
Income before income taxes and minority interest in net income of subsidiaries		8,124			7,627
Income taxes		2,989			2,561
Income before minority interest in net income of subsidiaries		5,135			5,066
Minority interest in net income of subsidiaries		93			116
Net income		$	5,042		$	4,950
Basic earnings per common share		$	37.74		$	35.83
Cash dividends per share declared on common stock		$	1.50		$	1.50
Weighted average shares outstanding		125,066			125,218

 

See Notes to Consolidated Financial Statements.

 

5

 

SPECTRUM BANCORPORATION, INC.
Consolidated Statements of Income
For The Nine Months Ended
(In thousands, except share and per share data)
(unaudited)

 

		March 31, 2003			March 31, 2002
Interest income on:
Loans		$	82,613		$	82,164
Taxable securities		9,711			10,898
Nontaxable securities		1,354			861
Dividends on securities		180			230
Federal funds sold and other		590			1,109
		94,448			95,262
Interest expense on:
Deposits		27,687			36,173
Federal funds purchased and securities sold under agreements to repurchase		650			1,346
FHLB advances and other borrowing		3,099			3,229
Notes payable		1,855			2,273
Company obligated mandatorily redeemable preferred securities		3,771			3,567
		37,062			46,588
Net interest income		57,386			48,674
Provision for loan losses		3,386			4,966
Net interest income after provision for loan losses		54,000			43,708
Other income:
Service charges and other fees		9,857			7,575
Net gains from sale of loans		4,861			2,440
Loan servicing fees, net		2,636			2,454
Gain on securities, net		368			186
Trust department income		1,271			1,236
Net gains from sale of other real estate owned and other assets		1,286			75
Other		2,223			2,267
		22,502			16,233
Other expenses:
Salaries and employee benefits		24,658			21,156
Occupancy expenses, net		3,178			2,767
Data processing		2,769			2,226
Equipment expenses		2,123			1,865
Advertising		2,702			1,627
Professional fees		2,320			1,983
Communication expenses		1,533			1,384
Amortization of core deposit intangible and other		1,420			1,948
Amortization and valuation adjustments of mortgage servicing rights		9,267			4,889
Other operating expenses		5,474			4,091
		55,444			43,936
Income before income taxes and minority interest in net income of subsidiaries		21,058			16,005
Income taxes		7,874			5,533
Income before minority interest in net income of subsidiaries		13,184			10,472
Minority interest in net income of subsidiaries		479			430
Net income		$	12,705		$	10,042
Basic earnings per common share		$	96.09		$	73.30
Cash dividends per share declared on common stock		$	4.50		$	4.50
Weighted average shares outstanding		125,110			125,251

 

See Notes to Consolidated Financial Statements.

 

6

 

SPECTRUM BANCORPORATION, INC.
Consolidated Statements of Cash Flows
For The Nine Months Ended
(In thousands)
(unaudited)

 

		March 31, 2003			March 31, 2002
Cash Flow from Operating Activities
Net cash provided by operating activities		$	9,226		$	27,678
Cash Flow from Investing Activities
Proceeds from maturities of certificates of deposit		398			5,235
Purchase of certificates of deposit		0			(4,199		)
Proceeds from sales and maturities of securities available for sale		147,624			99,423
Purchase of securities		(136,282		)	(116,864		)
Proceeds from sale of other real estate owned		3,383			358
Business acquisition (See below)		19,139			83
Net increase in loans		(49,138		)	(81,208		)
Proceeds from sale of premises and equipment		704			36
Purchase of premises and equipment		(4,962		)	(4,271		)
Purchase of mortgage servicing rights		(294		)	(4,843		)
Proceeds from sale of mortgage servicing rights		0			38
Net cash (used in) investing activities		(19,428		)	(106,212		)
Cash Flows from Financing Activities
Proceeds from issuance of preferred securities		10,000			0
Net increase in deposits		43,941			71,459
Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase		(12,985		)	6,843
Proceeds from notes payable		32,500			25,902
Payment of other liabilities		(3,760		)	(9,141		)
Principal payments on notes payable		(17,851		)	(18,082		)
Debt issuance cost incurred		(9		)	(38		)
Purchase of minority interest in subsidiaries		(2,876		)	0
Dividends paid, including ($161) and ($176) paid to minority interest, respectively		(1,408		)	(1,601		)
Retirement of common stock		(121		)	(79		)
Net cash provided by financing activities		47,431			75,263
Net increase (decrease) in cash and cash equivalents		37,229			(3,271		)
Cash and cash equivalents:
Beginning		69,278			106,436
Ending		$	106,507		$	103,165
Supplemental Disclosures of Cash Flow Information:
Cash payments for interest		$	39,169		$	49,920
Cash payments for income taxes		11,866			8,375
Supplemental Schedules of Noncash Investing and Financing Activities:
Net change in unrealized gain (loss) on securities available for sale		908			(1,372		)
Purchase of mortgage servicing rights for other liabilities		3,956			457
Loans transferred to other real estate owned and other assets		1,044			595
Deemed dividend to affiliate		(196		)	0
Business acquisitions, net of cash and cash equivalents acquired, allocated to:
Assets
Securities		$	390		$	27,289
Loans receivable		2,910			62,981
Other assets		22			2,392
Premises and equipment		65			3,285
Goodwill		2,017			4,182
Intangible assets		304			0
Liabilities assumed
Deposits		(24,739		)	(99,589		)
Other liabilities		(108		)	(623		)
Net cash and cash equivalents (received)		$	(19,139	)	$	(83	)

 

See Notes to Consolidated Financial Statements.

 

7

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.          Basis of presentation.

 

The consolidated financial statements include the accounts of the Company and its subsidiaries.  All material intercompany accounts and transactions with subsidiaries are eliminated in consolidation.

 

The consolidated subsidiaries are as follows: Great Western Bank (100.0% owned), which is chartered in Omaha, Nebraska; Great Western Bank, (95.8% owned), which is chartered in Watertown, South Dakota; Great Western Bank, (100.0% owned), which is chartered in Rapid City, South Dakota; Great Western Bank, (100.0% owned), which is chartered in Clive, Iowa; Great Western Service Corporation, (100.0% owned by bank subsidiaries, excluding Great Western Bank, Omaha), a data processing organization; Spectrum Capital Trust I (100.0% owned); Spectrum Capital Trust II (100.0% owned) and Spectrum Capital Trust III (100.0% owned). Great Western Bank, Omaha also owns 100.0% of GW Leasing, Inc., a leasing company.  See “Changes in Minority Interest and Business Acquisitions”.

 

The June 30, 2002 consolidated balance sheet has been derived from the Company’s audited balance sheet as of that date. The consolidated financial statements as of March 31, 2003 and for the three and nine months ended March 31, 2003 and 2002 are unaudited but include all adjustments (consisting only of normal recurring adjustments), which the Company considers necessary for a fair presentation of financial position and results of its operation and its cash flows for those periods. Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted.  These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K annual report for 2002 filed with the Securities and Exchange Commission.  Results for the three and nine months ended March 31, 2003 are not necessarily indicative of the results to be expected for future periods.

 

2.          Earnings per common share.

 

Earnings per share have been computed on the basis of weighted average number of common shares outstanding during each period presented. Dividends accumulated or declared on cumulative and noncumulative preferred stock, which totaled $322,000 and $464,000 in the three months ended March 31, 2003 and 2002 and totaled $683,000 and $861,000 for the nine months ended March 31, 2003 and 2002, reduced earnings available to common stockholders in the computation.

 

3.          Comprehensive Income.

 

Comprehensive income was $4,369,000 and $3,704,000 for the three months ended March 31, 2003 and 2002 and $13,613,000 and $8,670,000 for the nine months ended March 31, 2003 and 2002. The difference between comprehensive income and net income presented in the Consolidated Statements of Income is attributed solely to change in unrealized gains and losses on securities available for sale during the periods presented.

 

4.          Intangible Assets.

 

On October 1, 2002, the Company elected adoption of Statement of Financial Accounting Standards No. 147,  “Acquisitions of Certain Financial Institutions.”  This Statement addresses the financial accounting and reporting for the acquisition of all or part of a financial institution, except for a transaction between two or more mutual enterprises.  This Statement removes acquisitions of financial institutions, other than transactions between two or more mutual enterprises, from the scope of FASB Statement No. 72, “Accounting for Certain Acquisitions of Banking or Thrift Institutions”, and FASB Interpretation No. 9, “Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a Similar Institution Is Acquired in a Business Combination Accounted for by the Purchase Method.”  Transaction provisions for previously recognized unidentifiable intangible assets are effective on October 1, 2002, with earlier application permitted.  The carrying amount of an unidentifiable intangible asset shall continue to be amortized

 

8

 

as set forth in paragraph 5 of Statement 72 after October 1, 2002, unless the transaction in which the asset arose was a business combination.  If the transaction that gave rise to the unidentifiable intangible asset was a business combination, the carrying amount of the asset shall be reclassified to goodwill as of the later of the date of acquisition or the date Statement 142 was applied in its entirety.

 

The Company has identified those unidentifiable intangible assets that arose from a business combination.  In applying SFAS 147, the Company has reclassified the carrying amount of unidentifiable intangible assets of $4,598,000 to goodwill as of July 1, 2002.  As of June 30, 2002 total goodwill (including reclassified unidentifiable intangible assets of $4,598,000) was $43,913,000 and core deposit intangible and other, net was $5,294,000.  As of March 31, 2003, total goodwill (including reclassified unidentifiable intangible assets of $4,598,000) was $45,930,000 and core deposit intangible and other was $3,851,000.  If the goodwill reclassification of $4,598,000 were applied retroactively to July 1, 2001, net income for the three and nine month periods ended March 31, 2002 would be increased by approximately $60,000 and $180,000, respectively.

 

On July 1, 2001, the Company elected early adoption of Statement of Financial Accounting Standards No. 141, “Business Combinations,” and No. 142, “Goodwill and Other Intangible Assets” (SFAS 141 and 142).  SFAS 141 addresses financial accounting and reporting for business combinations and replaces APB Opinion No. 16, “Business Combinations” (APB 16).  SFAS 141 no longer allows the pooling of interests method of accounting for acquisitions, provides new recognition criteria for intangible assets and carries forward without reconsideration the guidance in APB 16 related to the application of the purchase method of accounting.  SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and replaces APB Opinion No. 17, “Intangible Assets.”  SFAS 142 addresses how intangible assets should be accounted for upon their acquisition and after they have been initially recognized in the financial statements.  The new standards provide specific guidance on measuring goodwill for impairment annually using a two-step process.  The first step identifies potential impairment and the second step measures the amount of goodwill impairment loss to be recognized.

 

The Company has identified those intangible assets that remain separable under the provisions of the new standard and those that are to be included in goodwill.  In applying SFAS 142, the Company has re-evaluated the useful lives of these separable intangible assets.  The weighted average life of the remaining amortizable intangible assets is 7 years.  In the year of adoption, SFAS 142 requires the first step of the goodwill impairment test to be completed within the first six months and the final step to be completed within twelve months of adoption.  The first step of the test was completed as of July 1, 2001 and no indications of goodwill impairment were found; therefore, step two of the goodwill impairment test was not applicable.  As of July 1, 2002 the fair value of each reporting unit was reviewed and it was determined that the fair values were equal to or greater than the fair values as of July 1, 2001; hence no indications of goodwill impairment were found.

 

5.          Legal Proceedings.

 

Spectrum and its subsidiary banks are from time to time parties to various legal actions arising in the normal course of business. Management believes there is no proceeding threatened or pending against Spectrum or its subsidiaries, which, if determined adversely, would have a material adverse effect on its financial condition or results of operation.

 

6.          Changes in Minority Interest and Business Acquisitions.

 

On December 13, 2002, Great Western Bank, Omaha acquired Peoples Bank, Overland Park, Kansas by cash merger.  At December 13, 2002, Peoples Bank had $24,847,000 in total assets, $2,910,000 in net loans and $24,739,000 in deposits.  Peoples Bank has one location, which at closing became a branch of Great Western Bank, Omaha. The results of operation of Peoples Bank after the date of acquisition are included in the consolidated financial statements.

 

A summary of the fair value of net assets acquired and net cash and cash equivalents received (in thousands) on the date of acquisition is as follows:

 

9

 

		Peoples Bank
Assets acquired:
Securities		$	390
Loans receivable		2,910
Other assets		22
Premises and equipment		65
Goodwill		2,017
Intangible assets		304
Liabilities assumed:
Deposits		(24,739		)
Other liabilities		(108		)
Net cash and cash equivalents (received)		$	(19,139	)

 

On September 30, 2002, the Company acquired 1,688 shares (4.8%) of the common stock of Great Western, Clive (formerly Citizens Bank, Clive, Iowa) for $673,288 in cash from a minority shareholder.  The transaction was accounted for as a purchase.

 

In October 2002, the Company purchased a total of 24 shares of common stock of Great Western, Watertown (formerly F & M Bank), from two minority shareholders for $90,765.  This transaction was accounted for as a purchase.

 

The Company issued 10,000 shares, $1,000 par value, of Company Capital Trust Pass-Through Securities (Preferred Securities) of Spectrum Capital Trust III on October 29, 2002 through a private placement.  The distribution rate is set quarterly at three month LIBOR plus 345 basis points, which was set on October 25, 2002 at 5.27%, with a maximum rate of 12.50% through November 7, 2007.  Distribution payment dates are February 7, May 7, August 7 and November 7 of each year, beginning February 7, 2003 and are payable in arrears.  The Company may, at one or more times, defer interest payments on the capital securities for up to 5 consecutive years following suspension of dividends on all other capital stock.  At the end of any deferral period, all accumulated and unpaid distributions will be paid. The capital securities will be redeemed thirty years from the issuance date; however, the Company has the option to accelerate the maturity date not earlier than five years from the issue date.  The redemption price is $1,000 per capital security plus any accrued and unpaid distributions to the date of redemption.  Holders of the Preferred Securities have no voting rights.  The Preferred Securities are unsecured and rank junior in priority of payment to all of the Company’s senior indebtedness and senior to the Company’s common and preferred stock.

 

The sole asset of the trust is junior subordinated deferrable interest debentures issued by the Company with interest and maturity provisions similar in term to the respective preferred securities.  The trust’s ability to pay amounts due on the Preferred Securities is solely dependent upon the Company making payment on the related junior subordinated debentures.  The Company’s obligation under the debentures and relevant trust agreement constitute a full, irrevocable and unconditional guarantee on a subordinated basis by it of the obligations of the trust under the Preferred Securities.

 

The Preferred Securities are classified as debt in the accompanying consolidated financial statements.  For regulatory purposes the Preferred Securities qualify as elements of capital.  Proceeds from the issue were used for general corporate purposes.

 

On January 24, 2003, the Company purchased from a minority shareholder 180 shares of common stock and 1,800 shares of preferred stock in Great Western Bank, Rapid City (formerly Rushmore Bank & Trust), subsidiary, for $2,111,492.  This transaction was accounted for as a purchase.  After January 24, 2003, the Company owns 100.0% of Great Western Bank, Rapid City.

 

On February 21, 2003, Citizens Bank, Mt Ayr, Iowa and Citizens Bank of Princeton, Princeton, Missouri merged with and into Citizens Bank, Clive, Iowa.  All three banks are 100.0% owned subsidiaries of the Company.  In addition, on March 29, 2003, the surviving bank was renamed Great Western Bank.  Management of Spectrum does not expect the merger to have a material effect on the business or earnings of Spectrum. The merger was accounted for at historical cost in a manner similar to a pooling-of-interests combination and, accordingly, the merger did not require any restatement of financial statements on a consolidated basis.  Regulatory approval had been obtained.

 

On March 3, 2003, Rushmore Bank and Trust, Rapid City, South Dakota and F & M Bank, Watertown, South Dakota were renamed Great Western Bank.

 

10

 

On March 17, 2003, Spectrum Banc Service Corporation was renamed Great Western Service Corporation.

 

7.          Subsequent Events-Merger.

 

Spectrum has obtained regulatory approval to merge Great Western Bank, Rapid City, South Dakota into Great Western Bank, Watertown, South Dakota. Management expects the merger to become effective May 30, 2003.  Management of Spectrum does not expect the merger to have a material effect on the business or earnings of Spectrum. The merger will be accounted for at historical cost in a manner similar to a pooling-of-interests combination and, accordingly, the merger will not require any restatement of financial statements on a consolidated basis.

 

ITEM 2:

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

 

GENERAL

 

The Company is a multi-bank holding company organized under the laws of Iowa whose primary business is providing trust, commercial, consumer, and mortgage banking services through its Nebraska, South Dakota and Iowa based subsidiary banks.  Substantially all of the Company’s income is generated from banking operations.

 

The Company’s fiscal year end is June 30.

 

CRITICAL ACCOUNTING POLICIES

 

Spectrum’s critical accounting policies involving the more significant judgments and assumptions used in the preparation of the consolidated financial statements as of March 31, 2003, have remained unchanged from June 30, 2002.  These policies involve the provision and allowance for loan losses, and valuation of mortgage servicing rights and intangibles.  Disclosure of these critical accounting policies is incorporated by reference under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation” in Spectrum’s Annual report on Form 10-K for Spectrum’s fiscal year ended June 30, 2002.

 

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

 

Average assets were $2,069,665,000 for the nine months ended March 31, 2003, compared to $1,822,709,000 for the nine months ended March 31, 2002, a 13.6% increase. Average interest-earning assets were $1,900,062,000 for the nine months ended March 31, 2003 and $1,667,816,000 for the nine months ended March 31, 2002, representing a 13.9% increase.  Average assets and average interest-earning assets increased due to internal growth and acquisitions.

 

Total assets were $2,100,591,000 at March 31, 2003, an increase of $88,434,000 or 4.4% from June 30, 2002. The increase in total assets is due to a $37,229,000 or 53.7%; increase in cash and cash equivalents and a $65,089,000 or 4.4% increase in loans, net unearned fees.

 

Loans, net unearned fees, grew $65,089,000 or 4.4% during the nine months ended March 31, 2003 due to internal growth.

 

Loans originated for resale were $275,251,000 for the nine months ended March 31, 2003; an increase of  $186,070,000 when compared to $89,181,000 for the nine months ended March 31, 2002. The increase in loans originated for resale is due to the low mortgage rates in the current period when compared to the same period one year ago.

 

Securities available for sale were $323,975,000 at March 31, 2003 compared to $334,059,000 at June 30, 2002, a decrease of $10,084,000 or 3.0%.  The decrease in securities is due to a large volume of called agency securities along with large pay downs in CMO and MBS securities due to a low interest rate environment.  Net proceeds of

 

11

 

$11,342,000 from securities during the current nine months period were used to finance loan growth and increase investment in federal funds sold.

 

Mortgage servicing rights, net, were $10,112,000 at March 31, 2003, a decrease of $5,019,000 or 33.2%, from June 30, 2002.  Mortgage servicing rights decreased due to $7,310,000 amortization expense, $1,959,000 valuation adjustment expense and increased due to purchases of $4,250,000.  See “Noninterest Expense”.

 

The allowance for loan losses increased to $21,581,000 at March 31, 2003 from $20,344,000 at June 30, 2002. The allowance represented 1.4% and 1.4% of loans, net unearned fees as of March 31, 2003 and June 30, 2002.  The increase in allowance for loan losses was due to a greater increase in loan loss provisions when compared to net charge-offs during the period.  See “Provision for Loan Losses”.

 

For the nine months ended March 31, 2003, the Company’s annualized return on average assets (“ROA”) was 0.8%, compared to 0.7% for the nine months ended March 31, 2002. Return on average stockholders’ equity (“ROE”) for the nine months ended March 31, 2003 and 2002 was 14.5% and 13.2%, respectively.  The increases in ROA and ROE are due to a 26.5% increase in net income for the nine months ending March 31, 2003 when compared to the same period a year ago.

 

Cash and cash equivalents, certificates of deposit, securities available for sale totaled $430,581,000 or 20.5% of total assets at March 31, 2003, compared to $403,834,000 or 20.1% of total assets, at June 30, 2002.  The increase occurred primarily because federal funds sold increased, $28,514,000, or 174.4%, due to additional funds from mortgage servicing loan payoffs.

 

Company obligated mandatorily redeemable preferred securities of subsidiary trust holding solely subordinated debentures increased to $58,000,000 at March 31, 2003 compared to $48,000,000 at June 30, 2002.  This increase is due to the Company issuing 10,000 shares, $1,000 par value, of Company Capital Trust Pass-Through Securities (Preferred Securities) of Spectrum Capital Trust III on October 29, 2002 through a private placement.  The distribution rate is set quarterly at three month LIBOR plus 345 basis points, which was set on October 25, 2002 at 5.27%, with a maximum rate of 12.50% through November 7, 2007.  Distribution payment dates are February 7, May 7, August 7 and November 7 of each year, beginning February 7, 2003 and are payable in arrears.  The Company may, at one or more times, defer interest payments on the capital securities for up to 5 consecutive years following suspension of dividends on all other capital stock.  At the end of any deferral period, all accumulated and unpaid distributions will be paid. The capital securities will be redeemed thirty years from the issuance date; however, the Company has the option to accelerate the maturity date not earlier than five years from the issue date.  The redemption price is $1,000 per capital security plus any accrued and unpaid distributions to the date of redemption.  Holders of the Preferred Securities have no voting rights.  The Preferred Securities are unsecured and rank junior in priority of payment to all of the Company’s senior indebtedness and senior to the Company’s common and preferred stock.

 

The sole asset of the trust is junior subordinated deferrable interest debentures issued by the Company with interest and maturity provisions similar in term to the respective Preferred Securities.  The trust’s ability to pay amounts due on the Preferred Securities is solely dependent upon the Company making payment on the related junior subordinated debentures.  The Company’s obligation under the debentures and relevant trust agreement constitute a full, irrevocable and unconditional guarantee on a subordinated basis by it of the obligations of the trust under the Preferred Securities.

 

The Preferred Securities are classified as debt in the accompanying consolidated financial statements.  For regulatory purposes the Preferred Securities qualify as elements of capital.  Proceeds from the issue were used for general corporate purposes.  As of March 31, 2003, $39,703,000 of Preferred Securities was eligible for treatment as Tier 1 Capital and $18,297,000 was eligible as Tier 2 Capital.

 

At March 31, 2003, the Company’s leverage ratio was 5.3%, Tier 1 risk-based capital ratio was 6.6%, and total risk-based capital ratio was 11.2%, compared to minimum required levels of 4% for leverage and Tier 1 risk-based capital ratios and 8% for total risk-based capital ratio, subject to change at the discretion of regulatory authorities to impose higher standards in individual cases. At March 31, 2003, the Company had net risk-weighted assets of $1,643,387,000.

 

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ACQUISITIONS

 

As of December 13, 2002, Great Western Bank, Omaha acquired Peoples Bank, Overland Park, Kansas by cash merger.  At December 13, 2002, Peoples Bank had $24,847,000 in total assets, $2,910,000 in net loans and $24,739,000 in deposits. Peoples Bank had one location at closing which became a branch of Great Western Bank, Omaha. The results of operation of Peoples Bank after the date of acquisition are included in the consolidated financial statements.

 

RESULTS OF OPERATION

 

Comparison of the Three Months Ended March 31, 2003 and March 31, 2002.

 

Net Interest Income

 

Total interest income for the three months ended March 31, 2003 was $30,198,000, a 2.3% decrease from $30,900,000 for the three months ended March 31, 2002. The slight decrease is the result of lower interest rates paid for interest bearing assets during the current period when compared to the same period March 31, 2002, despite an overall growth in average interest earning assets of 12.0%.

 

Average interest-earning assets were $1,914,281,000 for the three months ended March 31, 2003 and $1,709,450,000 for the three months ended March 31, 2002, representing a 12.0% increase.  This increase is primarily due to acquisitions and internal loan growth.

 

Total interest expense for the three months ended March 31, 2003 was $11,321,000, a 16.9% decrease from $13,619,000 for the three months ended March 31, 2002. The decrease was the result of lower interest rates paid for interest bearing deposits for the current period when compared to the same period a year ago.

 

Average interest-bearing liabilities were $1,703,220,000 and $1,559,368,000 for the three month periods ended March 31, 2003 and March 31, 2002.  Average interest-bearing liabilities increased between these periods $143,852,000 or 9.2%. This increase is primarily due to acquisitions and an increase in average interest-bearing deposits when compared to the same period for fiscal year 2002.

 

Net interest income was $18,877,000 for the three months ended March 31, 2003, compared to $17,281,000 for the same period in 2002, an increase of 9.2%. The Company’s net interest margin decreased to 3.9% for the three months ended March 31, 2003 from 4.0% for the three months ended March 31, 2002. The decrease in the net interest margin was caused by a $2,298,000 decrease in interest paid on interest bearing deposits and borrowings compared to a $702,000 decrease in interest earned on loans, securities and federal funds sold resulting in an $1,596,000 increase in net interest income.

 

Provision for Loan Losses

 

The provision for loan losses for the three months ended March 31, 2003, was $857,000, compared to $1,505,000 for the three months ended March 31, 2002.  The decrease was due to a decline in estimated loan losses.

 

Noninterest Income

 

Noninterest income for the three months ended March 31, 2003 was $8,425,000, an increase of $3,165,000, or 60.2%, over the same period last fiscal year. The increase resulted primarily from a $1,240,000 gain on sale of other real estate owned and other assets, a $1,087,000 increase in net gains from sale of loans and a $672,000 increase in service charges and other fees.

 

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Noninterest Expense

 

Noninterest expense for the three months ended March 31, 2003 was $18,321,000, an increase of $4,912,000, or 36.6% over the same period last fiscal year.  The increase resulted primarily from a $2,569,000 increase in amortization and valuation adjustment of mortgage servicing rights, a $1,427,000 increase in salaries and employee benefits and a $234,000 increase in data processing expenses.

 

Amortization and valuation adjustment of mortgage servicing rights increased $2,569,000 to $2,579,000 for the three months ended March 31, 2003 from $10,000 for the three months ended March 31, 2002. The increase is due to a $1,518,000 accelerated amortization and a $1,061,000 valuation adjustment resulting from the change in the current payoffs of mortgage servicing loans caused by a declining interest rate environment when compared to the three months ended March 31, 2002.

 

A decline in mortgage interest rates in future periods may result in further changes in prepayment rates and further acceleration in amortization expenses, the result of which will be estimated at the end of each quarter.

 

Income Taxes

 

Income taxes for the three months ended March 31, 2003 and March 31, 2002 were $2,989,000 and $2,561,000. The increase is due to a 6.5%, $497,000, increase in pretax income and an increase in the effective rate to 36.8% from 33.6% in the previous period.  These effective tax rates are impacted by items of income and expense that are not subject to federal or state taxation.

 

Comparison of the Nine Months Ended March 31, 2003 and March 31, 2002.

 

Net Interest Income

 

Total interest income for the nine months ended March 31, 2003 was $94,448,000, a 0.9% decrease from $95,262,000 for the nine months ended March 31, 2002. The slight decrease was due to a greater decrease in interest earned on federal funds sold and taxable securities offset by the increase in interest earned on loans for the current period when compared to the same period a year ago.

 

Average interest-earning assets were $1,900,062,000 for the nine months ended March 31, 2003 and $1,667,816,000 for the nine months ended March 31, 2002, representing a 13.9% increase.  This increase is primarily due to acquisitions and internal loan growth.

 

Total interest expense for the nine months ended March 31, 2003 was $37,062,000, a 20.5% decrease from $46,588,000 for the nine months ended March 31, 2002. The decrease was primarily the result of lower interest rates paid for interest bearing deposits during fiscal 2003 when compared to the same period a year ago.

 

Average interest-bearing liabilities were $1,669,241,000 and $1,519,131,000 for the nine months ended March 31, 2003 and March 31, 2002.

 

Average interest-bearing liabilities increased between these periods $150,110,000 or 9.9%. This increase is primarily due to acquisitions and an increase in average interest-bearing deposits when compared to the same period for fiscal year 2002.

 

Net interest income was $57,386,000 for the nine months ended March 31, 2003, compared to $48,674,000 for the same period in 2002, an increase of 17.9%. The Company’s net interest margin increased to 4.0% for the nine months ended March 31, 2003 from 3.9% for the nine months ended March 31, 2002. The increase in the net interest margin was caused by a $9,526,000 decrease in interest expense when compared to an $814,000 decrease in interest income over the same period one year ago.

 

Provision for Loan Losses

 

The provision for loan losses for the nine months ended March 31, 2003, was $3,386,000, compared to $4,966,000 for the nine months ended March 31, 2002.  The decrease was due to a decline in estimated loan losses for the current period.

 

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Noninterest Income

 

Noninterest income for the nine months ended March 31, 2003 was $22,502,000, an increase of $6,269,000, or 38.6%, over the same period last fiscal year. The increase resulted primarily from a $2,421,000 increase in net gains from sale of loans, a $2,282,000 increase in service charges and other fees and a $1,211,000 increase in net gains from sale of other real estate owned and other assets.

 

Noninterest Expense

 

Noninterest expense for the nine months ended March 31, 2003 was $55,444,000, an increase of $11,508,000, or 26.2%, over the same period last fiscal year.  The increase resulted primarily from a $4,378,000 increase in amortization and valuation adjustment of mortgage servicing rights, a $3,502,000 increase in salaries and employee benefits, and a $1,075,000 increase in advertising expenses.

 

Amortization and valuation adjustment of mortgage servicing rights increased $4,378,000 to $9,267,000 for the nine months ended March 31, 2003 from $4,889,000 for the nine months ended March 31, 2002.  The increase is due to accelerated amortization and valuation adjustments of mortgage servicing rights for the nine months ended March 31, 2003 when compared to the same period a year ago, attributable to the declining interest rate environment in the current period.

 

A decline in mortgage interest rates in future periods may result in further changes in prepayment rates and further acceleration in amortization expenses, the result of which will be estimated at the end of each quarter.

 

Income Taxes

 

Income taxes for the nine months ended March 31, 2003 and March 31, 2002 were $7,874,000 and $5,533,000. The increase is due to a 31.6%, $5,053,000, increase in pretax income. The effective tax rates for the periods were 37.4% and 34.6%.  These effective tax rates are impacted by items of income and expense that are not subject to federal or state taxation.

 

ITEM 3:

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Asset/liability management refers to management’s efforts to minimize fluctuations in net interest income caused by interest rate changes. This is accomplished by managing the repricing of interest rate sensitive interest-earning assets and interest-bearing liabilities. Controlling the maturity or repricing of an institution’s liabilities and assets in order to minimize interest rate risk is commonly referred to as gap management. Close matching of the repricing of assets and liabilities will normally result in little change in net interest income when interest rates change. A mismatched gap position will normally result in changes in net interest income as interest rates change.

 

Management regularly monitors the interest sensitivity position and considers this position in its decisions with regard to the Company’s interest rates and maturities for interest-earning assets acquired and interest-bearing liabilities accepted.

 

There has not been a material change in the interest rate sensitivity of the Company during the nine months ended March 31, 2003.

 

ITEM 4:

CONTROLS AND PROCEDURES

 

The Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures as defined in Exchange Act Rule 13a-14(c), based on their evaluation of such controls and procedures conducted within

 

15

 

90 days prior to the date hereof, are effective to ensure that information required to be disclosed by the Company in the reports it files under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referred to above.

 

PART II
OTHER INFORMATION

 

ITEM 1:	LEGAL PROCEEDINGS
		None
ITEM 2:	CHANGES IN SECURITIES AND USE OF PROCEEDS
		See Part 1, Item 2 “Financial Condition, Liquidity and Capital Resources” regarding the Company issuing 10,000 shares, $1,000 par value, of Company Capital Trust Pass-Through Securities of Spectrum Capital Trust III on October 29, 2002 through a private placement, and incorporated herein by reference.
ITEM 3:	DEFAULTS UPON SENIOR SECURITIES
		None
ITEM 4:	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
		None
ITEM 5:	OTHER INFORMATION
		None
ITEM 6:	EXHIBITS AND REPORTS ON FORM 8-K
	(a).	Exhibits:
	99.1 -	Chief Executive Officer’s Certificate Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (1)
	99.2 -	Chief Financial Officer’s Certificate Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (1)
	(b).	Reports on Form 8-K:
		The Company filed a current report on Form 8-K (Item 4) during the quarter ended March 31, 2003.  The Form 8-K was filed on March 3, 2003, and reported the Audit Committee of the Board of Directors of Spectrum Bancorporation, Inc., notified McGladrey & Pullen, LLP that they were dismissed as the Company’s independent auditor, effective February 27, 2003.  The report included a letter from McGladrey & Pullen, LLP regarding its concurrence with a Spectrum Bancorporation, Inc. statement regarding change of accountants.
		The Company filed a current report on Form 8-K (Item 4) subsequent to the quarter ended March 31, 2003.  The Form 8-K was filed on April 1, 2003, and reported the Audit Committee of the Board of Directors of Spectrum Bancorporation, Inc, engaged BKD, LLP, as its new auditor and BKD, LLP accepted such appointment.

 

16

 

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.

 

			SPECTRUM BANCORPORATION, INC.
Date:  May 9, 2003		By:	/s/ Deryl F. Hamann
			Deryl F. Hamann, Chairman and Chief Executive Officer (Duly Authorized Representative)

 

(Authorized officer and principal financial officer of the registrant)

 

Date:  May 9, 2003		By:	/s/ James R. Clark
			James R. Clark, CFO, Secretary and Treasurer

 

17

 

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

 

I, Deryl F. Hamann, certify that:

 

1.               I have reviewed this quarterly report on Form 10-Q of Spectrum Bancorporation, Inc.;

2.               Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.               Based on my knowledge, the financial statements and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.               The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

(a)          designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b)         evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

(c)          presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of this registrant’s board of directors (or persons performing the equivalent functions):

(a)          all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

(b)         any fraud, whether or not material, that involves management or other employees who have a significant role in registrant’s internal controls; and

 

6.               The registrant’s other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Date:	May 9, 2003		/s/ Deryl F. Hamann
				Deryl F. Hamann
				Chief Executive Officer

 

18

 

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

 

I, James R. Clark, certify that:

 

1.               I have reviewed this quarterly report on Form 10-Q of Spectrum Bancorporation, Inc.;

2.               Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.               Based on my knowledge, the financial statements and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.               The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a.               designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b.              evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c.               presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.               all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b.              any fraud, whether or not material, that involves management or other employees who have a significant role in registrant’s internal controls; and

 

6.               The registrant’s other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Date:	May 9, 2003	/s/ James R. Clarks
			James R. Clark
			Chief Financial Officer

 

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