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EX-21 - EX-21 - NORTHERN STATES FINANCIAL CORP /DE/ | c57103exv21.htm |
EX-14 - EX-14 - NORTHERN STATES FINANCIAL CORP /DE/ | c57103exv14.htm |
EX-32 - EX-32 - NORTHERN STATES FINANCIAL CORP /DE/ | c57103exv32.htm |
EX-99.1 - EX-99.1 - NORTHERN STATES FINANCIAL CORP /DE/ | c57103exv99w1.htm |
EX-99.2 - EX-99.2 - NORTHERN STATES FINANCIAL CORP /DE/ | c57103exv99w2.htm |
EX-31.2 - EX-31.2 - NORTHERN STATES FINANCIAL CORP /DE/ | c57103exv31w2.htm |
EX-31.1 - EX-31.1 - NORTHERN STATES FINANCIAL CORP /DE/ | c57103exv31w1.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2009
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 000 19300
NORTHERN STATES FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware (State of incorporation) |
36-3449727 (I.R.S. Employer Identification No.) |
1601 North Lewis Avenue
Waukegan, Illinois 60085
(847) 244-6000
Waukegan, Illinois 60085
(847) 244-6000
(Address, including zip code, and telephone number, including area code, of principal executive office)
Securities registered pursuant to Section 12(b) of the Act
Securities registered pursuant to Section 12(b) of the Act
Common Stock $.40 par value | The NASDAQ Stock Market (NASDAQ Capital Market) |
|
(Title of each class) | (Name of each exchange on which registered) |
Indicate by check if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Exchange Act.
YES o NO þ
YES o NO þ
Indicate by check if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Securities Exchange Act.
YES o NO þ
YES o NO þ
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 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
þ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a small reporting company. See the definitions of accelerated filer,
large accelerated filer and small reporting company in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer o | Accelerated filer o | Nonaccelerated filer o | Smaller reporting company þ | |||
(Do not check if a smaller reporting company) |
Indicate by check whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
YES o NO þ
The aggregate market value of the voting and non-voting common equity held by nonaffiliates of
the Registrant is $13,922,685, as of June 30, 2009, based on the last sale price of the
Registrants common stock on June 30, 2009 of $5.33 per share. Solely for the purpose of this
computation, it has been assumed that executive officers and directors of the Registrant are
affiliates.
As of March 13, 2010, 4,072,255 shares of the Registrants common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
A portion of Part III is incorporated by reference from the Registrants Proxy Statement for
its 2010 Annual Meeting of Stockholders to be held on May 20, 2010.
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Table of Contents
PART I
Item 1. Business.
Cautionary Note About Forward-Looking Statements. Statements contained in this report that are
not historical facts may constitute forward-looking statements (within the meaning of Section 21E
of the Securities Exchange Act of 1934, as amended), which involve significant risks and
uncertainties. Northern States Financial Corporation (the Company) cautions readers of this
report that a number of important factors could cause the Companys actual results subsequent to
December 31, 2009 to differ materially from those expressed in forward-looking statements contained
in this report. The Company intends such forward-looking statements to be covered by the safe
harbor provisions for forward-looking statements contained in the Private Securities Litigation
Reform Act of 1995, and is including this statement for purposes of invoking these safe harbor
provisions. Forward-looking statements, which are based on certain assumptions and describe future
plans, strategies and expectations of the Company, are generally identifiable by the use of the
words believe, expect, intend, anticipate, estimate, project, plan, or similar
expressions. The Companys ability to predict results or the actual effect of future plans or
strategies is inherently uncertain and actual results may differ from those predicted. The Company
undertakes no obligation to update these forward-looking statements in the future unless required
to do so under the federal securities laws. Factors that could cause actual results to differ from
those predicted and could affect the future prospects of the Company and its subsidiaries include,
but are not limited to, the potential for further deterioration in the credit quality of the
Companys loan and lease portfolios, uncertainty regarding the Companys ability to ultimately
recover on loans pools currently on nonaccrual status, the Banks ability to comply with the
provisions of any regulatory enforcement actions including the existing Memorandum of Understanding
and the anticipated Consent Order, deterioration of securities investments causing them to be other
than temporarily impaired, unanticipated changes in interest rates, general economic conditions,
legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including
policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the
Companys investment portfolios, demand for loan products, deposit flows, competition, demand for
financial services in the Companys market area, and changes in accounting principles, policies and
guidelines. These risks and uncertainties should be considered in evaluating any forward-looking
statements.
THE COMPANY
Overview
The Company is a bank holding company organized in 1984 under the laws of the state of
Delaware, for the purpose of becoming the parent bank holding company of the Bank of Waukegan. In
1991, the Company acquired First Federal Bank, fsb (First Federal or the Thrift). In 1998 the
Thrift was merged with and into the Bank of Waukegan. On January 5, 2004, Northern States Financial
Corporation acquired First State Bank of Round Lake (First State Bank). On November 10, 2005
First State Bank was merged with and into the Bank of Waukegan and the name of the merged entity
was changed to NorStates Bank (the Bank). During 2008, the Company formed subsidiary
NorProperties, Inc. for the purpose of managing and disposing of the Companys nonperforming
assets.
The Company is registered under the Bank Holding Company Act of 1956, as amended, and owns all
the outstanding stock of the Bank. At December 31, 2009, the Company had 310 registered
stockholders of record, 4,072,255 shares of common stock outstanding, and total consolidated assets
of approximately $622 million. Aside from the stock of the Bank, stock of NorProperties, Inc. and
cash, the Company has no other substantial assets.
As a community-oriented, independent banking organization in Lake County in the State of
Illinois, the Company believes it is well positioned to take advantage of the growth in the
communities in Lake County, Illinois and the surrounding counties. The Company (or its
predecessors) has continuously served the community since 1919 when First Federal was
chartered. The Companys local management, coupled with its long record of service, has
allowed it to compete successfully in the banking market. The Bank operates as a traditional
community-oriented bank with conveniently located branches and a professional staff.
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Neither the Company nor the Bank has material patents, licenses or franchises except the
Banks charter, which permits it to engage in banking and offer trust services pursuant to
applicable law.
The principal business of the Company, operating through the Bank, consists of traditional
retail and commercial banking activities, including attracting deposits and securities sold under
repurchase agreements from the general public, making commercial loans, loans secured by
residential and commercial real estate and consumer loans, and operating mortgage banking and trust
businesses.
The Companys annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and all amendments to those reports are currently made available free of charge via the
Companys internet website (www.nsfc.net) as soon as practicable after such material is
electronically filed with, or furnished to, the Securities and Exchange Commission (the
Commission).
Subsidiary Operations
NorStates Bank was chartered as a state bank in 1962 and is located in Waukegan, Illinois.
Waukegan is located approximately 37 miles north of Chicago, Illinois and has a population of
approximately 90,000. At December 31, 2009, NorStates Bank had total assets of $622 million, loans
and leases of $431 million, deposits of $517 million and stockholders equity of $50 million. The
Bank has three branch offices located in Waukegan, one office located in Antioch, Illinois, one
office located in Gurnee, Illinois, one office located in Winthrop Harbor, Illinois, one office in
Round Lake Beach, Illinois and one office in Round Lake, Illinois.
The Bank provides traditional community banking services to individuals, businesses and local
governmental units in northeastern Illinois and southeastern Wisconsin.
The Banks full service banking business includes the customary consumer and commercial
products and services which banks provide, including the following: demand, savings, and time
deposits, securities sold under repurchase agreements and individual retirement accounts;
commercial, consumer and real estate lending, including installment loans, home equity loans, lines
of credit and overdraft checking; safe deposit operations; trust services; and a variety of
additional services tailored to the needs of individual customers, such as the sale of travelers
checks, money orders, cashiers checks and foreign currency, direct deposit, and other special
services.
Commercial and consumer loans are made to corporations, partnerships and individuals,
primarily on a secured basis. Commercial lending focuses on business, capital, construction,
inventory and real estate. The Bank also makes direct and indirect loans to consumers and
commercial customers. The Bank also originates and services commercial and residential mortgages.
The Banks trust department acts as executor, administrator, trustee, conservator, guardian,
custodian and agent. At December 31, 2009, the trust department had assets under management or
custodial arrangements of approximately $161 million. Its office is located at the Banks branch
office at 3233 Grand Avenue, Waukegan, Illinois.
During 2002 the Bank formed Northern States Community Development Corporation (NSCDC), a
wholly-owned subsidiary of the Bank. NSCDCs assets consist of cash and of other real estate owned.
This subsidiary was formed for the purpose of developing and selling a parcel of other real estate
owned as part of the City of Waukegans lakefront development plans. At December 31, 2009, assets
of NSCDC totaled $2.2 million, which includes cash of $49,000 and the property valued at
$2,081,000, and were consolidated into the NorStates Banks financial statements.
During 2008, the Company formed NorProperties, Inc. (NorProp), a wholly-owned subsidiary of
the Company. This subsidiary was formed for the purpose of managing and disposing of nonperforming
assets of the Company. At December 31, 2009, assets of NorProp
totaled $26,000, which consisted of cash. These assets were consolidated into the Companys
financial statements.
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During 2009, the Bank formed XPC LLC, a wholly-owned subsidiary of the Bank. This subsidiary
was formed for the purpose of making collections on a charged off loan relationship. At December
31, 2009, XPC LLC had no assets.
COMPANY OPERATING STRATEGY
Corporate policy, strategy and goals are established by the Board of Directors of the Company.
Pursuant to the Companys philosophy and applicable law and regulation, the Company also
establishes operational and administrative policies for the Bank. Within this framework, the Bank
focuses on providing personalized services and quality products to customers to meet the needs of
the communities in which it operates.
As part of its community banking approach, the Company encourages the officers of the Bank to
actively participate in community organizations. In addition, within credit and rate of return
parameters, the Company attempts to ensure that the Bank meets the credit needs of the community.
In addition, the Bank invests in local municipal securities.
Lending Activities
General The Bank provides a wide range of commercial and retail lending services to
corporations, partnerships and individuals, including, but not limited to, commercial business
loans, commercial and residential real estate construction and mortgage loans, consumer loans,
revolving lines of credit and letters of credit. The installment loan department makes direct and
indirect loans to consumers and commercial customers. The mortgage department originates and
services commercial and residential mortgages. The Banks mortgage banking operation originates
mortgage loans on behalf of other financial institutions that fund and own the loans.
The Bank aggressively markets its services to qualified borrowers in both the commercial and
consumer sectors. The Banks commercial lending officers actively solicit the business of new
companies entering the surrounding market as well as long-standing members of the business
community. Through personalized, professional service and competitive pricing, the Bank has been
successful in attracting new commercial lending customers. At the same time, the Bank actively
advertises its consumer loan products and continually attempts to make its lending officers more
accessible.
Commercial Loans The Bank seeks new commercial loans in its market area. The Bank has also
purchased commercial loans or portions of commercial loans from other financial institutions and
investment banking firms. The Banks lending areas of emphasis include, but are not limited to,
loans to manufacturers, building contractors, developers, hotels, business services companies and
retailers. The Bank provides a wide range of commercial business loans, including lines of credit
for working capital purposes and term loans for the acquisition of equipment and other purposes.
Collateral for these loans generally includes accounts receivable, inventory, equipment and real
estate. Loans may be made on an unsecured basis where warranted by the overall financial condition
of the borrower. Terms of commercial business loans generally range from one to five years. The
majority of the Banks commercial business loans have floating interest rates or reprice within one
year. The primary repayment risk for commercial loans is the failure of the business due to
economic or financial factors. In most cases, the Bank collateralizes these loans and/or takes
personal guarantees to help assure repayment.
Mortgage Banking From 1991 until 1998, the Bank funded conforming long-term residential
mortgage loans and sold them in the secondary market with servicing retained. Since 1998, the
Banks mortgage banking operation originates mortgage loans for a fee on behalf of other financial
institutions that fund and own the loans. The Bank does not retain servicing on these originated
mortgage loans. The Bank had a portfolio of serviced mortgages of approximately $1.5 million at
December 31, 2009.
Consumer Lending The Banks consumer lending department provides all types of
consumer loans including motor vehicle, home improvement, home equity, unsecured loans and small
personal credit lines.
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Trust Activities
The Banks trust and investment services department has been providing trust services to the
community for over 20 years. As of December 31, 2009, the Bank had approximately $161 million of
trust assets under management and provides a full complement of trust services for individuals and
corporations, including land trust services.
To build on the trust departments mainstay of personal trust administration, the trust
departments focus is in two major areas: (i) investment management for individuals and (ii)
administration and investment services for employee benefit plans.
COMPETITION
The Company and the Bank encounter significant competition in all of their activities. The
Chicago metropolitan area and suburban Lake County have a high density of financial institutions,
many of which are significantly larger and have substantially greater financial resources than the
Company and its subsidiaries, and all of which are competitors of the Company and its subsidiaries
to varying degrees. In Lake County, Illinois there are 44 commercial banks and savings
institutions. The Company and the Bank are subject to intense competition from various financial
institutions, including state and national banks, state and federal savings associations, credit
unions, certain non-banking consumer lenders, and other companies or firms, including brokerage
firms and mortgage brokers that provide similar services in northeastern Illinois. The Bank also
competes with Internet-based financial institutions, money market funds and with insurance
companies with respect to its individual retirement accounts.
Continuing reduction in the effective restrictions on the interstate operations of financial
institutions has increased competition. The Company and the Bank face additional competition for
deposits from short-term money market mutual funds and other corporate and government securities
funds.
The primary factors influencing competition for deposits are interest rates, service, and
convenience of office locations. The Company competes for loans principally through the range and
quality of the services it provides, interest rate and loan fee terms. The Company believes that
its long-standing presence in the community and personal service philosophy enhances its ability to
compete favorably in attracting and retaining individual and business customers. The Company
actively solicits deposit-related clients and competes for deposits by offering customers personal
attention, professional service and competitive interest rates.
EMPLOYEES
The Company and its subsidiaries employed 137 full-time equivalent employees as of December
31, 2009. None of the Companys employees is represented by any collective bargaining group. The
Company offers a variety of employee benefits and management considers its employee relations to be
good.
GOVERNMENTAL MONETARY POLICY AND ECONOMIC CONDITIONS
The earnings and growth of the Company are affected not only by general economic conditions,
but also by the fiscal and monetary policies of the federal government and its agencies. In
particular, the Federal Reserve Board regulates monetary and credit conditions and interest rates
in order to influence general economic conditions, primarily through open-market operations in U.S.
Government securities, varying the discount rate on bank borrowings, and setting reserve
requirements against bank deposits.
These policies have a significant influence on overall growth and distribution of the
Companys loans, investments and deposits, and affect interest rates charged on loans and earned on
investments or paid for deposits. The monetary policies of the Federal Reserve Board are expected
to continue their substantial influence on the operating results of Bank. The general effect, if
any, of such policies upon the future business and earnings of the Company and its subsidiary
cannot accurately be predicted.
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SUPERVISION AND REGULATION
Financial institutions and their holding companies are extensively regulated under federal and
state laws. As a result, the business, financial condition and prospects of the Company and the
Bank can be materially affected not only by management decisions and general economic conditions,
but also by applicable statutes and regulations and other regulatory pronouncements and policies
promulgated by regulatory agencies with jurisdiction over the Company and the Bank, such as the
Federal Reserve Board, the Federal Deposit Insurance Corporation (FDIC) and the Illinois
Department of Financial and Professional Regulation (IDFPR). Such statutes, regulations and other
pronouncements and policies are intended to protect depositors and the FDICs Deposit Insurance
Fund (DIF), rather than stockholders of banks and bank holding companies.
This description is not intended to be a complete explanation of such statutes and regulations
and their effect on the Company and the Bank and is qualified in its entirety by reference to the
actual statutes and regulations. These statutes and regulations may change in the future, and we
cannot predict what effect these changes, if made, will have on our operations.
The Company is a bank holding company under the Bank Holding Company Act of 1956, as amended
(the Act), and subject to supervision and regulation by the Federal Reserve Board. The Bank is an
Illinois state-chartered bank subject to supervision and regulation by the IDFPR and the FDIC.
Under the Act and the Federal Reserve Boards regulations, a bank holding company, as well as
certain of its subsidiaries, is prohibited from engaging in certain tie-in arrangements in
connection with an extension of credit, lease or sale of property, furnishings or services.
Accordingly, a bank holding company may not condition a customers purchase of one service on the
purchase of another of the holding companys services, except with respect to traditional banking
products. The Act also requires prior Federal Reserve Board approval for, among other things, a
bank holding companys acquisition of direct or indirect control of more than 5% of the voting
shares or substantially all of the assets of any bank or for a merger or consolidation of a bank
holding company with another bank holding company.
With limited exceptions, the Act prohibits a bank holding company from acquiring direct or
indirect ownership or control of voting shares of any company that is not a bank or bank holding
company and from engaging directly or indirectly in any activity other than banking or managing or
controlling banks or performing services for its authorized subsidiaries. A bank holding company
may, however, engage in or acquire an interest in a company that engages in activities that the
Federal Reserve Board has determined, by regulation or order, to be so closely related to banking
or managing or controlling banks as to be a proper incident thereto, such as owning and operating a
savings association, performing functions or activities that may be performed by a trust company,
owning a mortgage company, or acting as an investment or financial advisor. The Federal Reserve
Board, as a matter of policy, may require a bank holding company to be well capitalized at the time
of filing an acquisition application and upon consummation of a proposed acquisition.
The GrammLeach-Bliley Act (the GLB Act) permits qualifying holding companies, called
financial holding companies, to engage in, or to affiliate with companies engaged in, a full
range of financial activities including banking, certain insurance activities (including insurance
underwriting and portfolio investing), securities activities and merchant banking activities. A
bank holding companys subsidiary banks must be well capitalized and well managed and have at
least a satisfactory Community Reinvestment Act (the CRA) rating for the bank holding company
to elect, and maintain, status as a financial holding company.
Under the Illinois Banking Act (the IBA), any acquisition of our stock that results in a
change in control may require the prior approval of the IDFPR. Under the Change in Bank Control
Act, a person may be required to obtain the prior regulatory approval of the Federal Reserve Board
before acquiring the power to directly or indirectly control the management,
operations or policies of the Company or before acquiring control of 10% or more of any class
of our outstanding voting stock.
The Reigle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the Interstate Act)
permits a bank holding company that is adequately capitalized and managed to acquire, with certain
limitations and approval, a bank located in a state other than the bank holding companys home
state. The Interstate Act also permits
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a bank, with the approval of the appropriate Federal and state bank regulatory agencies, to
establish a de novo branch in a state, other than the banks home state, in which the bank does not
presently maintain a branch if the host state has enacted a law that applies equally to all banks
and expressly permits all out-of-state banks to branch de novo into the host state. Banks having
different home states may, under certain circumstances, with approval of the appropriate Federal
and state bank regulatory agencies, merge across state lines.
The Illinois Bank Holding Company Act permits Illinois bank holding companies to acquire
control of banks in any state and permits bank holding companies whose principal place of business
is in another state to acquire control of Illinois banks or bank holding companies, upon
satisfactory application to the IDFPR. In reviewing any such application, the IDFPR will review,
among other things, compliance by the applicant with the requirements of the CRA and other
information designed to determine such banks abilities to meet community credit needs.
It is the policy of the Federal Reserve Board that the Company is expected to act as a source
of financial and managerial strength to the Bank and to commit resources to support the Bank. The
Federal Reserve Board takes the position that in implementing this policy, it may require the
Company to provide such support when the Company otherwise would not consider itself able to do so.
Federal and state statutes place certain restrictions and limitations on transactions between
banks and their affiliates, which include holding companies. Among other provisions, these laws
place restrictions upon:
| extensions of credit by a bank to its affiliates; | ||
| the purchase by a bank of assets from its affiliates; | ||
| the issuance of guarantees, acceptances or letters of credit by a bank on behalf of its affiliates; and | ||
| investments by a bank in stock or other securities issued by affiliates or acceptance thereof as collateral for an extension of credit to its affiliates. |
Under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), an
insured depository institution which is commonly controlled with another insured depository
institution shall generally be liable for any loss incurred, or reasonably anticipated to be
incurred, by the FDIC in connection with the default of such commonly controlled institution, or
for any assistance provided by the FDIC to such commonly controlled institution, which is in danger
of default. The term default is defined to mean the appointment of a conservator or receiver for
such institution. The FDIC maintains discretion to issue a notice of assessment to the liable
institution for the estimated amount of the loss incurred or reasonably anticipated to be incurred
by the FDIC.
Federal Reserve Board policy provides that, as a general matter, a bank holding company should
eliminate, defer, or severely limit the payment of dividends if (i) the bank holding companys net
income over the prior four quarters is not sufficient to fully fund the dividends; (ii) the bank
holding companys prospective rate of earnings retention is not consistent with the bank holding
companys capital needs and overall current and prospective financial condition; and (iii) the bank
holding company will not meet, or is in danger of not meeting, its minimum regulatory capital
adequacy ratios. The Federal Reserve Board may find that the bank holding company is operating in
an unsafe and unsound manner if the bank holding company does not comply with the Federal Reserve
Boards dividend policy and may use its enforcement powers to limit or prohibit the payment of
dividends by bank holding companies.
Delaware law also places certain limitations on the ability of the Company to pay dividends.
For example, if the capital of the holding company has been diminished to an amount less than the
aggregate amount of capital represented by the issued and outstanding stock, a dividend shall not
be paid until the deficiency in capital is repaired.
The Company in the past has paid semi-annual cash dividends in June and December to its common
stockholders. Following a review of the Company by the Federal Reserve Bank of Chicago (Federal
Reserve Bank),
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the Board of Directors of the Company adopted a Board Resolution dated November 17, 2009 (the
Board Resolution) whereby the Company agreed to obtain the written approval of the Federal
Reserve Bank prior to: (1) paying dividends to its common or preferred stockholders; (2) increasing
holding company debt or subordinated debentures issued in conjunction with trust preferred
securities obligations; and (3) paying interest on its existing subordinated debentures.
In response, in November 2009, the Company notified the U.S. Treasury Department (Treasury)
of its intent to suspend its dividend payments on its Fixed Rate Cumulative Perpetual Preferred
Stock, Series A (Series A Preferred Stock). The suspension of the dividend payments is
permissible under the terms of the Troubled Asset Relief Program (TARP) Capital Purchase Program
(CPP), but the dividend is a cumulative dividend and failure to pay dividends for six dividend
periods would trigger board of director appointment rights for the holder of the Series A Preferred
Stock. While dividends are being deferred on the preferred stock issued under the TARP Capital
Purchase Program, the Company may not pay dividends on its common stock. Also, per the Board
Resolution, in November 2009, the Company notified the trustee that holds the Companys junior
subordinated debentures relating to its trust preferred securities that the Company would be
deferring its regularly scheduled quarterly interest payments. The Company has the right to defer
the payment of interest on the junior subordinated debentures at any time, for a period not to
exceed 20 consecutive quarters. During the deferral period, the Company may not pay any dividends
on its common or preferred stock. Accordingly, the Company may not now pay dividends on its common
stock for the foreseeable future.
In addition, pursuant to the terms of the existing Memorandum of Understanding (MOU) and the
anticipated terms of the Consent Order discussed below, the Bank cannot pay dividends to the
Company without the written approval of the FDIC and the IDFPR. The Bank serves as the sole source
of dividends paid by the Company.
Pursuant to the IBA, the Bank is permitted to declare and pay dividends in amounts that the
board of directors deems expedient, provided that dividends are only paid out of the Banks net
profits then on hand (after deductions for losses and bad debts).
As an FDIC-insured institution, the Bank is required to pay deposit insurance premiums based
on the risk it poses to the DIF. The FDIC has authority to raise or lower assessment rates on
insured deposits in order to achieve statutorily required reserve ratios in the insurance fund and
to impose special additional assessments. To determine an institutions assessment rate, the FDIC
places each insured depository institution in one of four risk categories using a two-step process
based on capital and supervisory information. Each depository institution is assigned to one of
three capital groups: well capitalized, adequately capitalized or undercapitalized. Each
institution is then assigned one of three supervisory ratings: A (institutions with few minor
weaknesses), B (institutions which demonstrate weaknesses which, if not corrected, could result
in significant deterioration of the institution and increased risk of loss to DIF) and C
(institutions that pose a substantial probability of loss to DIF unless effective corrective action
is taken). Banks classified as strongest by the FDIC are subject to the lowest insurance assessment
rate; banks classified as weakest by the FDIC are subject to the highest insurance assessment rate.
In addition to its insurance assessment, each insured financial institution is subject to quarterly
debt service assessments (FICO assessments) in connection with bonds issued by a government
corporation that financed the federal savings and loan bailout of the 1980s. For the third quarter
of 2009, the DIF assessment rate for the Bank was 21.60 cents per $100 in assessable deposits and
the FICO assessment rate for the Bank was 1.06 cents per $100 in assessable deposits. In order to
strengthen the cash position of the DIF, the FDIC required insured institutions to prepay deposit
insurance assessments for three years. Accordingly, on December 30, 2009, the Bank prepaid its
estimated deposit insurance premiums for the years 2010, 2011 and 2012. The prepaid amounts may be
adjusted based on applicable assessment rates at the time of the actual assessment. The Bank will
continue to pay FICO assessments quarterly. Due to the anticipated
Consent Order, the Bank anticipates being required to pay additional FDIC premium amounts
during at least 2010 in addition to the amount that was already prepaid for 2010.
Pursuant to the Emergency Economic Stabilization Act (described more fully below), the maximum
deposit insurance on individual accounts was increased from $100,000 to $250,000 per depositor
through December 31, 2013. In addition, the Bank is also participating in the FDICs Transaction
Account Guarantee Program
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(described more fully below), which guarantees the entire balances of non-interest bearing
transaction accounts and NOW accounts with interest rates of 0.50% or less through June 30, 2010.
Deposit insurance may be terminated by the FDIC upon a finding that an institution has engaged in
unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has
violated any applicable law, regulation, rule, order or condition imposed by the FDIC. Such
terminations can only occur, if contested, following judicial review through the federal courts.
The Company does not know of any practice, condition or violation that might lead to termination of
deposit insurance for the Bank.
The respective federal bank regulators have adopted risk-based capital guidelines for banks
and bank holding companies. Under FDIC regulations, a bank is adequately capitalized if its minimum
ratio of qualifying total capital to risk-weighted assets, including certain off-balance sheet
items (the Total Risk-Based Capital Ratio), is 8%, and the minimum ratio of that portion of total
capital that is composed of items such as common stock, related additional paid-in capital,
retained earnings, certain types of perpetual preferred stock and certain minority interests, less
certain intangibles and other assets, including goodwill (Tier 1 Capital), to risk-weighted
assets (the Tier 1 Risk-Based Capital Ratio) is 4%. Tier 1 Capital must comprise at least 50% of
the total capital base of a bank. The balance of total capital may consist of items such as other
preferred stock, certain other instruments, and limited amounts of subordinated debt and the
institutions loan and lease loss allowance. The minimum ratio of Tier 1 Capital to total assets
(the Leverage Ratio) for banks is 4%. As of December 31, 2009, the Bank had a Total Risk-Based
Capital Ratio of 12.33%, a Tier 1 Risk-Based Capital Ratio of 11.05% and a Leverage Ratio of 8.05%.
Under Federal Reserve Bank capital guidelines, bank holding companies are required to maintain
a minimum Total Risk-Based Capital Ratio of 8%, of which at least 4% must be in the form of Tier 1
Capital. The minimum Leverage Ratio is 3% for strong bank holding companies (those rated a
composite 1 under the Federal Reserve Banks rating system) and 4% for all other bank holding
companies. The Federal Reserve Bank guidelines provide that banking organizations experiencing
internal growth or completing acquisitions will be expected to maintain strong capital positions
substantially above the minimum supervisory levels. As of December 31, 2009, the Company had a
Total Risk-Based Capital Ratio of 12.45%, a Tier 1 Risk-Based Ratio of 11.17% and a Leverage Ratio
of 8.10%.
Following a joint examination of the Bank by the FDIC and the IDFPR, the Board of Directors of
the Bank approved and executed on September 21, 2009, a Memorandum of Understanding (MOU)
concerning the Banks commitment to enhance certain areas of the Banks operation as identified
during the regulators examination of the Bank.
The MOU provides an understanding among the FDIC, IDFPR and the Bank, that the Bank will,
among other things, adopt written plans to: (i) formulate and implement a profit plan and budget,
including goals and strategies for improving earnings; (ii) create a written plan to monitor,
improve and lessen risks from the Banks substandard assets; (iii) implement steps to correct loan
administration weaknesses; and (iv) maintain the Banks Leverage Ratio at a level at or exceeding
8% while the MOU is in effect. As noted above, the Banks Leverage Ratio was 8.05% as of December
31, 2009. Pursuant to the MOU, the Bank will submit quarterly progress reports to the FDIC and the
IDFPR with respect to the matters outlined in the MOU.
During the fourth quarter of 2009, the FDIC and the IDFPR conducted a risk management review
of the Bank. As a result of that review, during the first quarter of 2010, the FDIC and the IDFPR
advised management of their decision to propose that the Bank be required to enter into a joint
Consent Order, whereby the Bank would agree, among other things, to: (1) maintain a Leverage Ratio
of at least 8% and a Total Risk-Based Capital Ratio of at least 12%, (2) prohibit the extension of
additional credit to any existing borrower with an outstanding classified loan or a loan that has
been previously charged-off, (3) adopt written action plans to reduce the Banks level of
classified assets and delinquent loans and to reduce concentrations of credit identified by
the examiners, and (4) adopt a profit plan, a capital contingency plan and a liquidity plan. A
final Consent Order has not yet been negotiated. Management is committed to resolving the issues
addressed in both the MOU and the Consent Order as promptly as possible, and has already taken
numerous steps to address these matters. The Bank expects to report to the FDIC and the IDFPR
quarterly regarding its progress in complying with the provisions to be included in the
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Consent Order. Should the Bank enter into the Consent Order, and because the Consent Order
establishes specific capital amounts to be maintained by the Bank, the Bank will not be considered
better than adequately capitalized for capital adequacy purposes, even if the Bank exceeds the
levels of capital set forth in the Consent Order. Currently, the Bank does exceed the capital
levels being proposed by the FDIC and the IDFPR in the proposed Consent Order.
Definitive plans are being developed to conduct a formal assessment of Banks management. The
Bank continues to dedicate significant resources to effectively identify, monitor, and manage
problem assets and reduce real estate loan concentrations. In view of these matters, the Banks
ability to improve its financial condition is dependent upon the success of managements plans to
address concerns raised by the bank regulators regarding profitability and asset quality.
Management believes they are taking appropriate steps aimed at returning the Bank to profitability
and improving asset quality. Managements success will ultimately be determined by the
implementation of its plans, as well as factors beyond its control, such as the economy and the
real estate market.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) requires federal
bank regulatory authorities to take prompt corrective action with respect to depository
institutions that do not meet minimum capital requirements. FDICIA generally prohibits a depository
institution from making any capital distribution (including payment of a dividend) if the
depository institution would thereafter be undercapitalized. Undercapitalized depository
institutions may be subject to a variety of actions including limitations on growth and investment
activities, and are required to submit a capital restoration plan, which must be guaranteed by the
institutions parent company. Institutions that fail to submit an acceptable plan, or significantly
undercapitalized institutions, may be subject to a host of more severe regulatory restrictions and
measures.
The capital-based prompt corrective action provisions of FDICIA and their implementing
regulations apply to FDIC-insured depository institutions. However, federal banking agencies have
indicated that, in regulating bank holding companies, the agencies may take appropriate action at
the holding company level based on their assessment of the effectiveness of supervisory actions
imposed on subsidiary insured depository institutions pursuant to the prompt corrective action
provisions of FDICIA.
Federal and state statutes and regulations provide financial institution regulatory agencies
with great flexibility to undertake enforcement action against an institution that fails to comply
with regulatory requirements, violates certain laws or regulations or for various other reasons.
Possible enforcement actions include the imposition of a capital plan and capital directive, civil
money penalties, cease-and-desist orders, conservator ship, receivership or deposit insurance
termination.
The Federal Deposit Insurance Act (FDIA), as amended by FDICIA and the Interstate Act
require the FDIC, together with the other federal bank regulatory agencies, to prescribe standards
of safety and soundness, by regulations or guidelines, relating generally to operations and
management, asset growth, asset quality, earnings, stock valuation, and compensation. The FDIC and
the other federal bank regulatory agencies have adopted a set of guidelines prescribing safety and
soundness standards pursuant to FDIA, as amended. The guidelines establish general standards
relating to internal controls and information systems, internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. The
guidelines require, among other things, appropriate systems and practices to identify and manage
the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation
as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are
unreasonable or disproportionate to the services performed by an executive officer, employee,
director or principal shareholder. In addition, the FDIC has adopted regulations that authorize,
but do not require, the FDIC to order an institution that has been given notice by the FDIC that it
is not satisfying any of such safety and soundness standards
to submit a compliance plan. If, after being so notified, an institution fails to submit an
acceptable compliance plan or fails in any material respect to implement an accepted compliance
plan, the FDIC must issue an order directing action to correct the deficiency and may issue an
order directing other actions of the types to which an undercapitalized association is subject
under the prompt corrective action provisions of FDICIA. If an institution fails to comply with
such an order, the FDIC may seek to enforce such order in judicial proceedings and to impose civil
money penalties. The FDIC and the other federal bank regulatory agencies also have adopted
guidelines for asset quality and earnings standards.
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As an insured depository institution, the Bank is subject to Federal Reserve Board regulations
requiring depository institutions to maintain reserves against a specified percentage of
transaction accounts (primarily NOW and regular checking accounts). Reserves are maintained in the
form of vault cash or deposits with the Federal Reserve Bank. The first $10.7 million of
transaction accounts (subject to adjustments by the Federal Reserve Bank) are exempted from the
reserve requirements. The Federal Reserve Board regulations generally require 3% reserves on the
next $44.5 million of transaction accounts. For transaction accounts totaling over $55.2 million,
Federal Reserve Board regulations require reserves of $1,335,000 plus 10% of the amount more than
$55.2 million. The Bank is in compliance with the foregoing requirements.
Under the Bank Secrecy Act (BSA), a financial institution is required to have systems in
place to detect certain transactions, based on the size and nature of the transaction. Financial
institutions are generally required to report cash transactions involving more than $10,000 to the
United States Treasury. In addition, financial institutions are required to file suspicious
activity reports for transactions that involve more than $5,000 and which the financial institution
knows, suspects or has reason to suspect involves illegal funds, is designed to evade the
requirements of the BSA or has no lawful purpose.
The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and
Obstruct Terrorism Act of 2001 (the PATRIOT Act), which amended the BSA, contains anti-money
laundering and financial transparency laws, as well as enhanced information collection tools and
enforcement mechanisms for the U.S. government. The PATRIOT Act provisions include the following:
standards for verifying customer identity when opening accounts; rules to promote cooperation among
financial institutions, regulators and law enforcement; and due diligence requirements for
financial institutions that administer, maintain or manage certain bank accounts. The Bank is
subject to BSA and PATRIOT Act requirements.
Under the CRA, a financial institution has a continuing and affirmative obligation, consistent
with the safe and sound operation of such institution, to serve the convenience and needs of its
entire community, including low and moderate income neighborhoods. The CRA does not establish
specific lending requirements or programs for financial institutions nor does it limit an
institutions discretion to develop the types of products and services that it believes are best
suited to its particular community. The CRA requires each federal banking agency, in connection
with its examination of a financial institution, to assess and assign one of four ratings to the
institutions record of meeting the credit needs of its community and to take such record into
account in its evaluation of certain applications by the institution, including applications for
charters, branches and other deposit facilities, relocations, mergers, consolidations and
acquisitions of assets or assumptions of liabilities. The CRA also requires that all institutions
make public disclosure of their CRA ratings. The Bank received a satisfactory rating on its most
recent CRA examination in May 2007.
In addition to the above, the Bank is subject to many state and Federal statutes and
regulations that are designed to protect consumers, including the Truth in Lending Act, the Truth
in Savings Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement
Procedures Act and the Home Mortgage Disclosure Act.
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2008 Emergency Economic Stabilization Act
On October 3, 2008, the U.S. Congress enacted the Emergency Economic Stabilization Act
(EESA). EESA authorized the Secretary of the U.S. Department of the Treasury to purchase up to
$700 billion in troubled assets from qualifying institutions pursuant to the Troubled Asset Relief
Program (TARP). On October 14, 2008, the U.S. Department of the Treasury (Treasury), pursuant
to its authority under EESA, announced the Capital Purchase Program (CPP). Pursuant to the CPP,
qualifying public financial institutions were permitted to issue senior preferred stock to the
Treasury in an amount not less than 1% of the institutions risk-weighted assets and not more than
3% of the institutions risk-weighted assets or $25 billion, whichever was less. Preferred stock
issued pursuant to the CPP qualifies as Tier 1 capital. Preferred stock issuers under the CPP pay a
5% dividend per annum until the fifth year of the investment and 9% per annum thereafter. In
addition to the senior preferred stock, participating public financial institutions must issue a
warrant to Treasury for the purchase of common stock in an amount equal to 15% of the preferred
stock investment. Treasury will not exercise any voting rights with respect to the common shares
acquired through the exercise of the warrant. Financial institutions participating in the CPP must
also agree and comply with certain restrictions, including restrictions on dividends, stock
redemptions and repurchases, and executive compensation, as discussed below. Finally, Treasury may
unilaterally amend any provision of the CPP to comply with changes in applicable federal statutes.
Pursuant to the terms of the CPP, as modified by the American Recovery and Reinvestment Act of
2009 (ARRA), a financial institution may redeem the senior preferred stock prior if the
institution receives approval from its primary federal regulator and the institution gives the
preferred stock holders proper notice.
Prior to the third anniversary of the investment or the date on which the Treasurys senior
preferred stock investment has been fully redeemed or transferred, the financial institution may
not increase common dividends without Treasurys consent. In addition, the financial institution
may not pay dividends on common stock unless the financial institution has paid dividends on the
preferred stock. If the financial institution does not pay dividends on the senior preferred stock
for six dividend periods, the Treasury will have the right to elect two individuals to the
institutions board of directors.
Prior to the third anniversary of the investment or the date on which the Treasurys senior
preferred stock investment has been fully redeemed or transferred, the financial institution may
not repurchase other equity securities or trust preferred securities without Treasurys consent,
except repurchases in the ordinary course related to employee benefit plans in a manner consistent
with past practice, certain market-making and related transactions by a broker-dealer subsidiary of
the financial institution, certain custodian or trustee transactions for another beneficial owner,
or certain agreements pre-dating CPP participation.
Financial institutions participating in the CPP must modify certain senior executive
compensation agreements consistent with EESA, which generally prohibits incentive compensation
agreements that encourage senior executive officers to take unnecessary and excessive risks. In
addition, incentive compensation paid to senior executive officers must be recovered if such
payments are subsequently determined to be based upon materially inaccurate financial results.
Participating institutions are prohibited from making golden parachute payments to senior executive
officers and are required to limit the federal tax deduction for compensation paid to senior
executive officers to $500,000. For this purpose, senior executive officer means an individual
who is one of the top five highly paid executives whose compensation is required to be disclosed
pursuant to the Exchange Act. As discussed below, these executive compensation restrictions were
further expanded by ARRA.
On February 20, 2009, the Company closed the transaction with Treasury in order to participate
in the CPP. The Company issued Series A Preferred Stock to Treasury equal to $17,211,000 and a
warrant to purchase 584,084 shares of common stock at an exercise price of
$4.42 per share. Pursuant to its participation in the CPP, the Company is subject to the
provisions therein.
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American Recovery and Reinvestment Tax Act of 2009
On February 17, 2009, the ARRA was signed into law. Included among the many provisions in the
ARRA are restrictions affecting financial institutions that participate in TARP, which are set
forth in the form of amendments to the EESA. These amendments provide that during the period in
which any obligation under the TARP remains outstanding (other than obligations relating to
outstanding warrants), TARP recipients are subject to appropriate standards for executive
compensation and corporate governance which were set forth in an interim final rule regarding TARP
standards for Compensation and Corporate Governance, issued by Treasury and effective on June 15,
2009 (Interim Final Rule). Among the executive compensation and corporate governance provisions
included in ARRA and the Interim Final Rule are the following:
| an incentive compensation clawback provision to cover senior executive officers (defined in this instance and below to mean the named executive officers for whom compensation disclosure is provided in the companys proxy statement) and the next 20 most highly compensated employees; | ||
| a prohibition on certain golden parachute payments to cover any payment related to a departure for any reason (with limited exceptions) made to any senior executive officer (as defined above) and the next five most highly compensated employees; | ||
| a limitation on incentive compensation paid or accrued to the most highly compensated employee of the financial institution, subject to limited exceptions for pre-existing arrangements set forth in written employment contracts executed on or prior to February 11, 2009, and certain awards of restricted stock which may not exceed one-third of the individuals annual compensation, are subject to a two year holding period and cannot be transferred until Treasurys preferred stock is redeemed in full; | ||
| a requirement that the Companys chief executive officer and chief financial officer provide in annual securities filings, a written certification of compliance with the executive compensation and corporate governance provisions of the Interim Final Rule; | ||
| an obligation for the compensation committee of the board of directors to evaluate with the companys chief risk officer certain compensation plans to ensure that such plans do not encourage unnecessary or excessive risks or the manipulation of reported earnings; | ||
| a requirement that companies adopt a company-wide policy regarding excessive or luxury expenditures; | ||
| a requirement that companies permit a separate, non-binding shareholder vote to approve the compensation of executives; and | ||
| a provision that allows Treasury to review compensation paid prior to enactment of ARRA to senior executive officers and the next 20 most highly-compensated employees to determine whether any payments were inconsistent with the executive compensation restrictions of the EESA, as amended, TARP or otherwise contrary to the public interest. |
As outlined above, companies that have issued preferred stock to Treasury under TARP are now
permitted to redeem such investments at any time, subject to consultation with banking regulators.
Upon such redemption, the warrants issued to Treasury are to be immediately liquidated.
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FDIC Temporary Liquidity Guarantee Program
In October 2008, the FDIC announced the Temporary Liquidity Guarantee Program (TLGP) to
strengthen confidence and encourage liquidity in the banking system. The program is comprised of
two voluntary components: the Transaction Account Guarantee Program (TAGP) and the Debt Guarantee
Program (DGP).
Pursuant to the TAGP, the FDIC will fully insure, without limit, qualifying transaction
accounts held at qualifying depository institutions through June 30, 2010 (extended from December
31, 2009 provided the institution did not previously opt out of the TAGP). Qualifying transaction
accounts include non-interest-bearing transaction accounts, Interest on Lawyers Trust Accounts
(IOLTAs) and NOW accounts with interest rates less than 0.5 percent. The FDIC assessed a fee equal
to 10 basis points on transaction account deposit balances in excess of the $250,000 insured limit.
During the six-month extension period in 2010, the fee assessment increased to 15 basis points, 20
basis points or 25 basis points, based on an institutions risk category.
Pursuant to the DGP, eligible entities were permitted to issue FDIC-guaranteed senior
unsecured debt up to 125 percent of the entitys senior unsecured debt outstanding as of September
30, 2008. The Company did not issue any guaranteed debt under the DGP.
Item 1A. Risk Factors.
Our business, financial condition and results of operations are subject to various risks,
including those discussed below, which may affect the value of our common stock. Set forth below
are certain risk factors which we believe to be relevant to an understanding of our business. This
list should not be considered a comprehensive list of all potential risks and uncertainties. You
should also refer to the other information included or incorporated by reference in this Form 10-K,
including our consolidated financial statements and related notes for the year ended December 31,
2009.
Significant risk factors include:
Credit Risk The U.S. economy has been in a prolonged recession over the previous two years,
and the local economy in our market remains stressed and volatile. This market turmoil has
decreased both our borrowers ability to repay their loans and the value of collateral, such as
real estate, which secures many of our loans. As a result, the Companys levels of nonperforming
assets substantially increased during 2008 and 2009. If these economic conditions persist, our loan
customers may not be able to repay their loans according to their terms and the collateral may be
insufficient to repay the loan. Management makes quarterly provisions to the allowance for loan and
lease losses after taking into account specifically impaired loans, historical loss ratios and
general economic conditions, among other factors. To the extent the ability of our borrowers to
repay their loans worsens, or general economic conditions continue to deteriorate, we may need to
continue to substantially increase our allowance, which would have an adverse affect on our results
of operations and financial condition. See Managements Discussion and Analysis of Financial
Condition and Results of Operations for discussion of our allowance for loan and lease losses.
Economic Risk Sustained weakness in the real estate market, reduced business activity, high
unemployment, instability in the financial markets, less available credit and lack of confidence in
the financial sector, among other factors, have adversely affected the Company and the financial
services industry in general over the last two years. A sustained period of high unemployment or
further deterioration in national or local business or economic conditions could result in, among
other things, a further deterioration in credit quality or reduced demand for credit with a
resultant negative effect on the Companys loan portfolio and allowance for loan and lease losses.
Economic factors may also continue to cause increased delinquencies and loan charge-offs, which
will negatively affect our results of operations and financial condition.
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Real Estate Market Risk The commercial and residential real estate markets continue to
experience extraordinary challenges following the downturn in the last three years. A significant
amount of the Companys loans are secured by real estate, which has declined in value. Economic
factors have and may continue to cause deterioration to the value of real estate the Company uses
to secure its loans. The resultant effect of the continued weakness of the economy and the
deterioration of our real estate portfolio could result in additional increases in the provision
for loan and lease losses, higher delinquencies and additional charge-offs in future periods that
may materially affect the Companys financial condition and results of operations.
Capital Resources and Liquidity Risk Liquidity is a measure of whether our cash flows and
liquid assets are sufficient to satisfy current and future financial obligations, such as demand
for loans, deposit withdrawals and operating costs. Our liquidity position is affected by a number
of factors, including the amount of cash and other liquid assets on hand, payment of interest and
dividends on debt and equity instruments that we have issued, capital we inject into the Bank and
dividends received from the Bank. Continued weakness or worsening of the economy, real estate
markets or unemployment levels may deplete our liquid assets. If our liquidity becomes limited, it
may have a material adverse effect on our results of operations and financial condition.
Furthermore, as a banking institution, we are subject to regulations that require us to
maintain certain capital ratios, such as the ratio of our Tier 1 capital to our risk-based assets.
If our regulatory capital ratios decline, as a result of decreases in the value of our loan
portfolio or otherwise, we will be required to improve such ratios by either raising additional
capital or by disposing of assets. If we choose to dispose of assets, we cannot be certain that we
will be able to do so at prices that we believe to be appropriate, and our future operating results
could be negatively affected. If we choose to raise additional capital, we may accomplish this by
selling additional shares of common stock, or securities convertible into or exchangeable for
common stock, which could significantly dilute the ownership percentage of holders of our common
stock and cause the market price of our common stock to decline. Additionally, events or
circumstances in the capital markets generally may increase our capital costs and impair our
ability to raise capital at any given time.
If finalized, the pending Consent Order will cause the Bank to be considered adequately
capitalized because it establishes a ratio of capital that the Bank is to maintain. As an
adequately capitalized institution, the Bank may not accept brokered deposits without prior
approval of the FDIC. As of year end, the Bank had $94.9 million in brokered deposits. The Bank
believes it will be able to find alternative funding sources for these brokered deposits. The Bank
believes it will be able to find alternative funding sources for these brokered deposits as they
come due, and does not anticipate seeking FDIC approval to receive brokered deposits. However, the
other depositors, including some local government entities, may not maintain their deposits at the
Bank if the Bank is no longer well capitalized
Concentration Risk In the Companys loan portfolio
there is a concentration of loans to the hotel industry and an overall concentration of loans
secured by real estate. The recent general downturn in hotel occupancy rates has impacted and will
continue to negatively impact borrowers ability to repay and consequently affect the Companys
earnings and its allowance for loan and lease losses.
The Company also has a concentration of loans that have payment schedules where only interest
is collected until the loan matures. If the value of the collateral securing these loans should
decrease, the Banks loan to collateral value will decrease to a greater extent than loans that
have payment schedules requiring principal reductions.
Regulatory Risk We are subject to extensive supervision, regulation and examination. This
regulatory structure gives the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies to address not only compliance with
applicable laws and regulations (including laws and regulations governing consumer credit, and
anti-money laundering and anti-terrorism laws), but also capital adequacy, asset quality and risk,
management ability and performance, earnings, liquidity, and various other factors. As part of this
regulatory structure, we are subject to policies and other guidance developed by the regulatory
agencies with respect to capital levels, the timing and amount of dividend payments, the
classification of assets and the establishment of adequate loan loss reserves for regulatory
purposes.
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Under this structure the regulatory agencies have broad discretion to impose restrictions and
limitations on our operations if they determine, among other things, that our operations are unsafe
or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and
regulations or with the supervisory policies of these agencies. This supervisory framework could
materially impact the conduct, growth and profitability of our operations. Any failure on our part
to comply with current laws, regulations, other regulatory requirements or safe and sound banking
practices or concerns about our financial condition, or any related regulatory sanctions or adverse
actions against us, could increase our costs or restrict our ability to operate our business and
result in damage to our reputation.
The Companys ongoing participation in the Treasurys TARP CPP creates additional regulatory
oversight and compliance. The TARP regulations place limitations on compensation for executive
officers and on dividend payments. These regulations may affect the ability of the Company to
recruit and keep management. The regulations pertaining to TARP could affect the Companys ability
to operate in a competitive environment. See Supervision and Regulation.
Personnel Risk Our success depends upon the continued service of our senior management team,
their relationships with our customers and our ability to attract and retain qualified financial
services personnel. Loss of key personnel could negatively impact our results of operations and
financial condition through loss of their customer relationships and the potential difficulty
promptly replacing officers in this competitive environment.
Interest Rate Risk Our earnings and profitability depend significantly on our net interest
income, which is the difference between the interest earned on loans and investments and the
interest paid on deposits and borrowings. Since interest rates can fluctuate in response to general
economic conditions and the policies of various governmental and regulatory agencies, including the
Federal Reserve Bank, our asset-liability management strategy may not be able to prevent changes in
interest rates from having a material adverse effect on our results of operations and financial
condition.
Industry Risk We operate in a rapidly changing and intensely competitive market, with
numerous competitors including other banks and insurance companies, securities dealers, trust and
investment companies and mortgage bankers. Our profitability depends upon our continued success in
competing in the Chicago market.
Operational Risk We are subject to operations risks, including, but not limited to, an
interruption or breach in security of information systems, customer or employee fraud and
catastrophic failures. While we maintain a system of internal controls and insurance coverage where
applicable, an event may occur that has an adverse affect on our results of operations and
financial condition.
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Item 1B. | Unresolved Staff Comments. |
Not Applicable.
Item 2. | Properties. |
The Bank conducts its operations through its main office and seven branches. The Companys
office is located in the main office of the Bank. All of such offices are owned by the Bank and are
located in Lake County, Illinois. The Company believes that its current facilities are adequate for
the conduct of its business.
The following table sets forth information relating to each of the Banks offices:
Main Office: | Trust Department: | |||||||
1601 North Lewis Avenue Waukegan, Illinois 60085 |
3233 Grand Avenue Waukegan, Illinois 60085 |
|||||||
Branches: | ||||||||
3233 Grand Avenue Waukegan, Illinois 60085 |
40220 N. Route 59 Antioch, Illinois 60002 |
|||||||
216 Madison Street Waukegan, Illinois 60085 |
700 N. Sheridan Road Winthrop Harbor, Illinois 60096 |
|||||||
5384 Grand Avenue Gurnee, Illinois 60031 |
1777 N. Cedar Lake Road Round Lake Beach, Illinois 60073 |
|||||||
301 Goodnow Boulevard Round Lake, Illinois 60073 |
Item 3. | Legal Proceedings. |
Due to the nature of their business, the Company and its subsidiaries are often subject to
various legal actions. These legal actions, whether pending or threatened, arise through the normal
course of business and are not considered by management to be unusual or material. Management
believes that any liabilities arising from these actions or proceedings would not have a material
adverse effect on the Companys business, consolidated results of operations, financial condition
or cash flow.
Item 4. | (Removed and Reserved). |
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PART II
Item 5. | Market for the Companys Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. |
Stockholder Information
The Companys common stock is traded on the NASDAQ Capital Market under the ticker symbol
NSFC. As of March 2, 2010, there were 6,500,000 common shares authorized; 4,472,255 common shares
issued and 4,072,255 outstanding; held by approximately 302 registered stockholders.
Stock Price Summary
The following schedule details the quarterly high and low bid price of the Companys common
stock on the NASDAQ Capital Market for the periods presented:
2009 | 2008 | |||||||||||||||
HIGH | LOW | HIGH | LOW | |||||||||||||
QUARTER ENDED: |
||||||||||||||||
March 31 |
$ | 7.92 | $ | 1.75 | $ | 22.30 | $ | 18.60 | ||||||||
June 30 |
7.00 | 2.20 | 19.98 | 17.50 | ||||||||||||
September 30 |
5.61 | 3.25 | 17.51 | 7.19 | ||||||||||||
December 31 |
4.37 | 2.25 | 9.31 | 3.75 |
Cash Dividends
The Company has historically paid semi-annual dividends in June and December. However,
dividends are declared at the discretion of the Board of Directors, subject to applicable legal and
regulatory restrictions, and there is no guarantee that the Company will pay dividends in the
future. On October 21, 2008, the Board of Directors of the Company determined that there would be
no cash dividend on December 1, 2008 due to the reduced earnings of the Company in 2008, and the
Company did not pay dividends on its common stock in 2009.
In February 2009, the Company sold $17.2 million of preferred stock to the Treasury pursuant
to the terms of the TARP CPP. As long as any TARP Series A Preferred Stock issued under the CPP
remains outstanding, the terms of the CPP prohibit the Company from increasing semi-annual
dividends on its common stock above $0.40 per share without the Treasurys consent.
In its press release on November 10, 2009 announcing its financial results for the third
quarter 2009, the Company also announced that it has notified the Treasury of its intent to suspend
the payment of its regular quarterly cash dividends on its TARP Series A Preferred Stock. Under the
terms of the TARP Series A Preferred Stock, the Company is required to pay on a quarterly basis a
dividend rate of 5% per year for the first five years, after which the dividend rate automatically
increases to 9% per year. Dividend payments may be suspended, but the dividend is a cumulative
dividend and failure to pay dividends for six dividend periods would trigger board appointment
rights for the holder of the TARP Series A Preferred Stock. No dividends may be paid on the
Companys common stock until all accrued and unpaid dividends on the preferred stock issued to the
Treasury are paid.
17
Table of Contents
In addition, in November 2009 the Company announced that it had notified the trustee that
holds the Companys junior subordinated debentures relating to its outstanding trust preferred
securities that the Company will defer its regularly scheduled quarterly interest payments on the
junior subordinated debentures. Under the terms of the debentures, the Company is permitted to
defer the payment of interest on the junior subordinated debentures at any time, for up to 20
consecutive quarters, without default. Due to the deferral, the trust will likewise suspend the
declaration and payment of dividends on the trust preferred securities. During the deferral period,
the Company may not pay any dividends on its common or preferred stock.
Following a review of the Company by the Federal Reserve Bank, the Board of Directors of the
Company adopted a Board Resolution dated November 17, 2009 concerning the Companys conservation of
financial resources.
The Board Resolution provides an understanding among the Federal Reserve and the Company, that
the Companys Board of Directors will obtain written approval from the Federal Reserve prior to:
(1) paying dividends to common or preferred stockholders; (2) increasing holding company debt or
subordinated debentures issued in conjunction with trust preferred securities obligations; and (3)
paying interest on its existing subordinated debentures.
During the first quarter of 2010, FDIC and the IDFPR advised management that they would
request that the Bank enter into a Consent Order, as further described above under Supervision and
Regulation. Proposal requirements of the Consent Order include restrictions on the payment of
dividends from the Bank to the Company without regulatory approval.
The table below shows the semi-annual cash dividends per share paid on the Companys common
stock over the past two years:
JUNE 1 | DECEMBER 1 | TOTAL | ||||||||||
2008 |
$ | .40 | $ | .00 | $ | .40 | ||||||
2009 |
.00 | .00 | .00 |
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Item 6. | Selected Financial Data. |
SELECTED CONSOLIDATED FINANCIAL DATA
($ 000s, except per share data)
($ 000s, except per share data)
As of or for the Year Ended December 31, | 2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||||||
INCOME STATEMENT DATA: |
||||||||||||||||||||
Interest income |
$ | 29,338 | $ | 34,874 | $ | 38,421 | $ | 36,633 | $ | 35,056 | ||||||||||
Interest expense |
10,187 | 13,795 | 20,060 | 20,695 | 15,372 | |||||||||||||||
Net interest income |
19,151 | 21,079 | 18,361 | 15,938 | 19,684 | |||||||||||||||
Provision for loan and lease losses |
22,778 | 13,663 | 81 | 0 | 3,428 | |||||||||||||||
Net interest income (loss) after
provision for loan and lease losses |
(3,627 | ) | 7,416 | 18,280 | 15,938 | 16,256 | ||||||||||||||
Noninterest income |
3,784 | (6,045 | ) | 5,038 | 5,346 | 4,370 | ||||||||||||||
Noninterest expenses |
30,153 | 16,929 | 16,830 | 17,303 | 18,008 | |||||||||||||||
Income (Loss) before income taxes |
(29,996 | ) | (15,558 | ) | 6,488 | 3,981 | 2,618 | |||||||||||||
Provision (benefits) for income taxes |
5,562 | (6,285 | ) | 2,100 | 889 | 531 | ||||||||||||||
Net (Loss) Income |
$ | (35,558 | ) | $ | (9,273 | ) | $ | 4,388 | $ | 3,092 | $ | 2,087 | ||||||||
BALANCE SHEET DATA: |
||||||||||||||||||||
Cash, non-interest bearing |
$ | 10,646 | $ | 14,108 | $ | 14,273 | $ | 19,023 | $ | 23,586 | ||||||||||
Investments (1) |
158,770 | 112,711 | 164,083 | 291,464 | 273,235 | |||||||||||||||
Loans and leases, net |
413,259 | 470,410 | 431,128 | 366,553 | 389,884 | |||||||||||||||
All other assets |
39,615 | 43,490 | 28,672 | 32,969 | 35,823 | |||||||||||||||
Total Assets |
$ | 622,290 | $ | 640,719 | $ | 638,156 | $ | 710,009 | $ | 722,528 | ||||||||||
Deposits |
$ | 517,236 | $ | 500,821 | $ | 480,959 | $ | 522,596 | $ | 554,449 | ||||||||||
Securities sold under repurchase
agreements and other borrowings (2) |
49,364 | 42,574 | 66,797 | 86,775 | 73,093 | |||||||||||||||
Federal Home Loan Bank advances |
0 | 20,000 | 0 | 11,500 | 6,500 | |||||||||||||||
Subordinated debentures |
10,000 | 10,000 | 10,000 | 10,000 | 10,000 | |||||||||||||||
All other liabilities |
5,389 | 5,710 | 6,946 | 7,675 | 7,734 | |||||||||||||||
Stockholders equity |
40,301 | 61,614 | 73,454 | 71,463 | 70,752 | |||||||||||||||
Total Liabilities and
Stockholders Equity |
$ | 622,290 | $ | 640,719 | $ | 638,156 | $ | 710,009 | $ | 722,528 | ||||||||||
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2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||||||||
PER SHARE DATA: |
||||||||||||||||||||
Basic and diluted earnings per share |
$ | (8.94 | ) | $ | (2.26 | ) | $ | 1.05 | $ | 0.72 | $ | 0.49 | ||||||||
Cash dividends declared |
0.00 | 0.40 | 0.72 | 0.65 | 0.62 | |||||||||||||||
Book value (at end of year) |
5.67 | 15.13 | 17.58 | 16.88 | 16.47 | |||||||||||||||
SELECTED FINANCIAL AND OTHER RATIOS: |
||||||||||||||||||||
Return on average assets |
-5.55 | % | -1.43 | % | 0.66 | % | 0.44 | % | 0.28 | % | ||||||||||
Return on average equity |
-53.49 | -13.09 | 6.06 | 4.36 | 2.90 | |||||||||||||||
Average stockholderss equity
to average assets |
10.39 | 10.90 | 10.83 | 10.03 | 9.62 | |||||||||||||||
Tax equivalent interest spread |
2.92 | 3.06 | 2.38 | 1.89 | 2.49 | |||||||||||||||
Tax equivalent net interest income
to average earning assets |
3.22 | 3.49 | 2.96 | 2.41 | 2.83 | |||||||||||||||
Nonperforming assets to total assets |
9.77 | 7.44 | 2.33 | 1.57 | 3.65 | |||||||||||||||
Dividend payout ratio (3) |
0.00 | -17.56 | 68.55 | 89.59 | 127.60 |
(1) | Includes interest bearing deposits in other financial institutions, federal funds sold, securities available for sale and Federal Home Loan Bank and Federal Reserve Bank stock. | |
(2) | Securities sold under repurchase agreements and federal funds purchased. | |
(3) | Total cash dividends divided by net income. |
20
Table of Contents
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations.
The following is a discussion and analysis of Northern States Financial Corporations (the
Company) financial position and results of operations and should be read in conjunction with the
consolidated financial statements and notes thereto appearing elsewhere in this report.
OVERVIEW
The continued downturn in the economy during 2009 negatively impacted the Company and almost
all financial institutions. The unemployment rate increased into double digits while real estate
values continued to fall. The Companys levels of nonperforming assets continued to increase
significantly during 2009 for the second straight year while real estate used as collateral for its
loans declined in value. The Companys nonperforming assets increased $13.2 million during 2009
while the Company had net charge offs of $15.2 million of nonperforming loans and recognized
provisions for loan losses of $22.8 million as compared to $13.7 million in 2008. The deteriorating
economy also caused the Company to recognize net impairment losses of $3.1 million on its
securities portfolio.
Other factors affecting the Companys 2009 performance were the write-down of goodwill,
increased FDIC insurance expense and the establishment of a deferred tax asset valuation allowance.
In 2009, the Company took a one-time noncash write-off of $9.5 million of its goodwill. Due to the
economic strains on the financial services industry, the Companys FDIC insurance expense for 2009
increased to $1.4 million as
compared with $222,000 for 2008. Per accounting rules, during 2009, the Company was required
to create a deferred tax asset valuation allowance of $13.7 million that increased 2009 income tax
expense by that amount based on uncertainties as to the likelihood of the Company realizing the
related tax benefits. The Company also experienced net losses of $1.4 million on sales of other
real estate owned during 2009.
The effect of these developments in 2009 was that the Company experienced a net loss of $35.6
million, or $8.94 loss per share, as compared to net loss of $9.3 million, or $2.26 loss per share,
in 2008.
During 2009, the Company had gains on sales of its securities of $3.9 million as the Company
managed its capital position. Salaries and employee benefits expense were reduced $343,000, or 4.2
percent, in 2009 as staff levels were carefully managed and no bonuses were paid.
The Companys asset levels decreased during 2009 due to the Companys repositioning of its
balance sheet. Assets at year-end 2009 were $622.3 million, decreasing $18.4 million from year-end
2008. Loans and leases decreased $49.5 million during 2009 as nonperforming loans were charged off
and $18.3 million in loans were transferred into other real estate owned as properties securing the
loans were foreclosed on. Investments in securities increased $30.2 million as the Company sought
to increase its earning asset yields while maintaining liquidity.
The Companys investments in overnight federal funds increased $13.3 million at year-end 2009
as compared with year-end 2008 as the Company managed its liquidity. The Company maintained its
liquidity levels due in part from the receipt of $17.2 million in proceeds from the issuance of
TARP Series A Preferred Stock under the Treasurys TARP CPP on February 20, 2009. These funds
assisted in maintaining the Companys capital adequacy levels.
The Companys deposits increased $16.4 million during 2009 while borrowings declined $13.2
million. The increase in deposits came from growth in core NOW accounts of $22.5 million while
brokered deposits declined $4.3 million.
Noninterest income increased in 2009 by $9.8 million compared with 2008 primarily due to
reduced net impairment losses to securities in 2009 that were only $3.1 million as compared with
$10.5 million in 2008. Noninterest income also increased from the sale of investment securities
that netted a gain of $3.9 million in 2009.
21
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The Company had increased noninterest expenses of $13.2 million in 2009 despite continued
steps to contain costs during 2009. The increase came primarily from the noncash $9.5 million
write-down of goodwill in 2009. Certain noninterest expenses also increased as a result of the
increased levels of nonperforming assets. During 2009, legal expenses increased $815,000 compared
with 2008 due to expenses incurred in pursuing foreclosures and the collection efforts involving
the Companys nonperforming assets. During 2009, the Company recognized $1.7 million in write-downs
to its other real estate owned as the market values of these properties declined. Finally, FDIC
insurance premiums increased $1.2 million in 2009 as nonperforming asset issues affected the
nations financial institutions.
CRITICAL ACCOUNTING POLICIES
Certain critical accounting policies involve estimates and assumptions by management. To
prepare financial statements in conformity with accounting principles generally accepted in the
United States of America, management makes estimates and assumptions based on available
information. These estimates and assumptions affect the amounts reported in the financial
statements and the disclosures provided; future results could differ. The allowance for loan and
lease losses is a critical accounting policy for the Company because management must make estimates
of losses and these estimates are subject to change. Estimates are also used to determine the fair
value of financial assets including the disclosures as to the carrying value of securities.
The allowance for loan and lease losses is a valuation allowance for probable incurred credit
losses, that is increased by the provision for loan and lease losses and decreased by charge-offs
less recoveries. Management estimates the balance for the allowance based on information about
specific borrower situations, estimated collateral values and the borrowers ability to repay the
loan. Management also reviews past loan and lease loss experience, the nature and volume of the
portfolio, economic conditions and other factors. Allocations of the allowance may be made for
specific loans and leases, but the entire allowance is available for any loan or lease that, in
managements judgement, should be charged-off. Loan and lease losses are charged against the
allowance when management believes the uncollectibility of a loan or lease balance is confirmed.
A loan or lease is impaired when full payment under the loan or lease terms is not expected
within the contractual terms of the loan. Impairment is evaluated on an aggregate basis for
smaller-balance loans of similar nature such as residential mortgage and consumer loans, and on an
individual loan or lease basis for other loans and leases. If a specific loan or lease is
determined to be impaired, a portion of the allowance may be specifically allocated to that loan or
lease. The specific allocation is calculated at the present value of estimated cash flows using the
existing rate of the loan or lease or the fair value of collateral if repayment is expected solely
from the collateral.
Goodwill results from business acquisitions and represents the excess of the purchase price
over the fair value of acquired tangible assets and liabilities and identifiable intangible assets.
Goodwill is assessed at least annually for impairment and any such impairment will be recognized in
the period identified. During 2009, goodwill was analyzed and was found to be impaired in its
entirety and was written off in the amount of $9.5 million.
The core deposit intangible asset arose from the acquisition of First State Bank of Round Lake
in January 2004. The core deposit intangible asset was initially measured at fair value and is
being amortized over its estimated useful life. This intangible asset is also assessed at least
annually for impairment. At year-end 2010, the core deposit intangible will be fully amortized.
The assessment of tax assets and liabilities involves the use of estimates, assumptions,
interpretations and judgment concerning certain accounting pronouncements and federal and state tax
codes. There can be no assurance that future events, such as court decisions or positions of
federal and state taxing authorities, will not differ from managements current assessment, the
impact of which could be significant to the consolidated results of operations and reported
earnings. For financial reporting purposes, a valuation allowance has been recognized at
22
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December 31, 2009, to offset deferred tax assets related to federal and state tax
carryforwards. The Company believes that tax assets and liabilities are properly recorded in the
consolidated financial statements. However, there is no guarantee that the tax benefits associated
with the remaining tax assets will be fully realized. The Company has concluded that it is more
likely than not that the tax benefits associated with the remaining deferred tax assets will be
realized. See Note 1, Summary of Significant Accounting Policies, and Note 11, Income Taxes, of
the notes to the consolidated financial statements and the section entitled Federal and State
Income Taxes.
Table 1 Analysis of Average Balances, Tax Equivalent Yields and Rates
($ 000s)
For the Years Ended December 31, | 2009 | 2008 | 2007 | |||||||||||||||||||||||||||||||||
Average | Average | Average | ||||||||||||||||||||||||||||||||||
Balance | Interest | Rate | Balance | Interest | Rate | Balance | Interest | Rate | ||||||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||||||||||
Loans and leases (1) (2) (3) |
$ | 467,370 | $ | 24,498 | 5.24 | % | $ | 471,483 | $ | 27,908 | 5.92 | % | $ | 389,670 | $ | 27,867 | 7.15 | % | ||||||||||||||||||
Taxable securities (5) |
96,094 | 4,541 | 4.80 | 120,466 | 6,490 | 5.36 | 213,874 | 9,509 | 4.43 | |||||||||||||||||||||||||||
Securities exempt from
federal income taxes (2) (5) |
8,778 | 541 | 6.19 | 11,046 | 685 | 6.15 | 8,336 | 472 | 5.66 | |||||||||||||||||||||||||||
Federal funds sold and other
interest earning assets |
32,252 | 31 | 0.10 | 9,434 | 112 | 1.19 | 15,150 | 812 | 5.36 | |||||||||||||||||||||||||||
Interest earning assets (5) |
604,494 | 29,611 | 4.91 | 612,429 | 35,195 | 5.74 | 627,030 | 38,660 | 6.16 | |||||||||||||||||||||||||||
Noninterest earning assets |
35,620 | 38,021 | 41,556 | |||||||||||||||||||||||||||||||||
Average assets (4) (5) |
$ | 640,114 | $ | 650,450 | $ | 668,586 | ||||||||||||||||||||||||||||||
Liabilities and stockholders equity |
||||||||||||||||||||||||||||||||||||
NOW deposits |
$ | 50,344 | 273 | 0.54 | $ | 44,813 | 151 | 0.34 | $ | 47,433 | 357 | 0.75 | ||||||||||||||||||||||||
Money market deposits |
62,970 | 902 | 1.43 | 66,409 | 1,216 | 1.83 | 75,684 | 2,757 | 3.64 | |||||||||||||||||||||||||||
Savings deposits |
61,483 | 173 | 0.28 | 61,863 | 320 | 0.52 | 65,323 | 493 | 0.75 | |||||||||||||||||||||||||||
Time deposits |
274,396 | 7,739 | 2.82 | 258,727 | 10,081 | 3.90 | 251,589 | 12,112 | 4.81 | |||||||||||||||||||||||||||
Other borrowings |
62,467 | 1,100 | 1.76 | 83,100 | 2,027 | 2.44 | 90,452 | 4,341 | 4.80 | |||||||||||||||||||||||||||
Interest bearing liabilities |
511,660 | 10,187 | 1.99 | 514,912 | 13,795 | 2.68 | 530,481 | 20,060 | 3.78 | |||||||||||||||||||||||||||
Demand deposits |
56,389 | 57,386 | 57,775 | |||||||||||||||||||||||||||||||||
Other noninterest
bearing liabilities |
5,586 | 7,290 | 7,953 | |||||||||||||||||||||||||||||||||
Stockholders equity |
66,479 | 70,862 | 72,377 | |||||||||||||||||||||||||||||||||
Average liabilities and
stockholders equity |
$ | 640,114 | $ | 650,450 | $ | 668,586 | ||||||||||||||||||||||||||||||
Net interest income |
$ | 19,424 | $ | 21,400 | $ | 18,600 | ||||||||||||||||||||||||||||||
Net interest spread |
2.92 | % | 3.06 | % | 2.38 | % | ||||||||||||||||||||||||||||||
Net yield on interest
earning assets (5) |
3.22 | % | 3.49 | % | 2.96 | % | ||||||||||||||||||||||||||||||
Interest-bearing liabilities
to earning assets ratio |
84.64 | % | 84.08 | % | 84.60 | % | ||||||||||||||||||||||||||||||
(1) - | Interest income on loans includes loan origination and other fees of $119,000 for 2009, $210,000 for 2008 and $398,000 for 2007. | |
(2) - | Interest income is adjusted by the tax equivalent adjustment amount utilizing a 34% rate on federally tax-exempt municipal loans and securities. The tax equivalent adjustment reflected in the above table for municipal loans is approximately $89,000, $88,000 and $78,000 for the years ended 2009, 2008 and 2007, respectively. The tax equivalent adjustment reflected in the above table for municipal securities is approximately $184,000, $233,000 and $161,000 for the years ended 2009, 2008 and 2007, respectively. | |
(3) - | Nonaccrual loans are included in average loans. | |
(4) - | Average balances are derived from the average daily balances. | |
(5) - | Rate information was calculated based on the average amortized cost for securities. The 2009, 2008 and 2007 average balance information includes an average unrealized gain (loss) for taxable securities of $1,525,000, ($694,000) and ($965,000), respectively. The 2009, 2008 and 2007 average balance information includes an average unrealized gain (loss) of $45,000, ($92,000) and ($6,000), respectively for tax-exempt securities. Average taxable securities includes Federal Home Loan Bank stock. |
23
Table of Contents
RESULTS OF OPERATIONS YEARS-ENDED DECEMBER 31, 2009 COMPARED WITH DECEMBER 31, 2008 AND
DECEMBER 31, 2008 COMPARED WITH DECEMBER 31, 2007
DECEMBER 31, 2008 COMPARED WITH DECEMBER 31, 2007
NET INTEREST INCOME
Net interest income is the Companys largest source of income and is defined as the difference
between interest income earned on average interest earning assets, such as loans and securities,
and interest expense on average interest bearing liabilities, such as deposits and other
borrowings. Major factors affecting net interest income are the general level of interest rates,
changes to interest rates and the amount and composition of interest earning assets and interest
bearing liabilities.
Table 1, Analysis of Average Balances, Tax Equivalent Yields and Rates, shows a comparison
of net interest income, on a fully tax equivalent basis, and average volumes, together with
effective yields earned on such assets and rates paid on such funds. The results shown reflect the
excess of interest earned on assets over the cost of funds.
The Companys net interest income for 2009, on a fully tax equivalent basis, was $19.4
million, decreasing $2.0 million from $21.4 million in 2008 after increasing $2.8 million from
2007. The net interest spread in 2009 was 2.92%, decreasing 14 basis points from 2008 after
increasing 68 basis points from 2007. During 2009, the yields on earning assets declined 83 basis
points from 2008 while rates paid on interest bearing liabilities decreased 69 basis points.
The major factor causing net interest income on a tax equivalent basis to decrease in 2009 was
the increase to nonperforming loans. Average impaired loans in 2009, which are primarily loans on
nonaccrual status, totaled $49.1 million, increasing $31.7 million from $17.4 million for 2008.
During 2009, as loans were placed on nonaccrual status, the Company reversed $500,000 of interest
income that had previously been recognized, further reducing net interest income.
Interest income earned on loans on a fully tax equivalent basis totaled $24.5 million in 2009,
a decrease of $3.4 million as compared with $27.9 million in 2008 after increasing only $41,000
from 2007. General interest rates were at low levels in 2009 as government policy maintained low
short-term rates in an effort to foster growth during the economic downturn. During 2009 the prime
lending rate remained at 3.25% for the entire year as compared with 2008 when the prime lending
rate began the year at 7.25%, declining through several rate reductions to 3.25% at year-end 2008.
Due in part to the lower prime rate in 2009 as compared with 2008 and the increases to
nonperforming loans in 2009, the Companys loan yield declined to 5.24% as compared with 5.92% in
2008 and 7.15% in 2007. Table 2 attributes $3.2 million of the reduced loan income for 2009 to the
lower loan rates.
Lower average loan balances in 2009, also contributed to the decline of interest income
generated by loans. Average loans for 2009 were $467.4 million as compared with $471.5 million, a
decrease of $4.1 million. Table 2 attributes $241,000 of the reduced loan income for 2009 to the
lower volume of loan balances in 2009.
Table 1 shows that the Companys taxable securities averaged
$96.1 million in 2009 and decreased $24.4 million from $120.5 million in 2008 after decreasing
$93.4 million from 2007. As the Company realigned its balance sheet in 2009, it reduced its average
taxable securities. Taxable securities purchased to replace matured or sold taxable
securities had lower rates due to the generally lower rates in 2009. Taxable securities earned
average yields of 4.80% in 2009, decreasing from average yields of 5.36% in 2008 as compared with
yields of 4.43% in 2007. As $74.3 million of the Companys taxable securities were sold at a gain
of $3.9 million during 2009, securities purchased to replace the sold securities have lower
effective yields and, as a result, it is expected that the average yields on the taxable securities
for 2010 will be lower than the average yields earned in 2009.
24
Table of Contents
Average levels of tax-exempt securities in 2009, as shown in Table 1, totaled $8.8 million, a
decrease of $2.2 million from 2008 levels after increasing $2.7 million from 2007. Yields on
tax-exempt securities for 2009 remained stable as compared with 2008 with yields at 6.19% for 2009
and 6.15% for 2008. Although the average tax equivalent yields on the qualified bonds issued by
state and political subdivisions were greater than those earned on loans during 2009, the term to
maturity of these investments is greater than that on loans. The Company must carefully consider
the effect of possible changes to future interest rates when deciding the proper levels of tax
exempt securities to carry in its securities portfolio. With reduced earnings, the Company must
also consider the realizable tax benefits from the tax-exempt securities.
To manage its liquidity, the Company increased its federal funds sold and other interest
earning assets. Federal funds sold are overnight investments that the Company places (sells) to
money center banks. Average balances for federal funds sold for 2009 were $32.3 million, increasing
$22.9 million from 2008 after decreasing $5.7 million from 2007. Rates earned on federal funds sold
for 2009 were .10% as compared with 1.19% for 2008, a decrease of 109 basis points. The change to
the Companys earning asset mix reflecting an increase in lower yielding federal funds sold had a
negative impact on the total yield earned on interest earning assets, during 2009.
As interest rates remained at low levels during 2009, the Company carefully reviewed the rates
paid on its deposits and other borrowings, such as repurchase agreements, and was able to reduce
its cost of funds. Average rates paid on the Companys money market accounts, savings and time
deposits during 2009 declined 40, 24 and 108 basis points, respectively, from 2008 continuing a
trend as rates on these deposit products had also declined in 2008 compared with 2007. Average
rates paid on NOW deposits increased during 2009 by 20 basis points from 2008 after declining 41
basis points from 2007. The 2009 NOW account rates increased as the Company introduced its High
Yield Checking product, a core NOW account deposit that paid a premium rate on the customers
first $25,000 account balance if certain requirements were met. Through the marketing of this
product the Company was able to increase its average NOW account deposits by $5.5 million in 2009
from 2008 after declining $2.6 million from 2007.
Average rates paid on the Companys borrowings in 2009 also declined from 2008 by 68 basis
points after decreasing 236 basis points from 2007. The levels of the Companys average borrowings
decreased $20.6 million during 2009 from 2008 continuing a trend as borrowings declined $7.4
million during 2008 from 2007.
Many other factors beyond managements control have a significant impact on changes in net
interest income from one period to another. Examples of such factors are: (1) credit demands by
customers; (2) fiscal and debt management policy of federal and state governments; (3) monetary
policy of the Federal Reserve Board; and (4) changes in regulations.
25
Table of Contents
Table 2 Analysis of Changes in Interest Income and Expense
($ 000s)
For the Year Ended December 31, | 2009 Compared to 2008 | 2008 Compared to 2007 | ||||||||||||||||||||||
Increase (Decrease) | Increase (Decrease) | |||||||||||||||||||||||
Change | Change | Change | Change | |||||||||||||||||||||
Total | Due To | Due To | Total | Due To | Due To | |||||||||||||||||||
Change | Volume | Rate | Change | Volume | Rate | |||||||||||||||||||
Interest Income |
||||||||||||||||||||||||
Loans |
$ | (3,410 | ) | $ | (241 | ) | $ | (3,169 | ) | $ | 41 | $ | 5,297 | $ | (5,256 | ) | ||||||||
Taxable securities |
(1,949 | ) | (1,324 | ) | (625 | ) | (3,019 | ) | (4,734 | ) | 1,715 | |||||||||||||
Securities exempt from federal income taxes |
(144 | ) | (149 | ) | 5 | 213 | 169 | 44 | ||||||||||||||||
Federal funds sold and other |
(81 | ) | 90 | (171 | ) | (700 | ) | (229 | ) | (471 | ) | |||||||||||||
Total interest income |
(5,584 | ) | (1,624 | ) | (3,960 | ) | (3,465 | ) | 503 | (3,968 | ) | |||||||||||||
Interest Expense |
||||||||||||||||||||||||
NOW deposits |
122 | 21 | 101 | (206 | ) | (19 | ) | (187 | ) | |||||||||||||||
Money market deposits |
(314 | ) | (60 | ) | (254 | ) | (1,541 | ) | (305 | ) | (1,236 | ) | ||||||||||||
Savings deposits |
(147 | ) | (2 | ) | (145 | ) | (173 | ) | (25 | ) | (148 | ) | ||||||||||||
Time deposits |
(2,342 | ) | 580 | (2,922 | ) | (2,031 | ) | 335 | (2,366 | ) | ||||||||||||||
Other borrowings |
(927 | ) | (437 | ) | (490 | ) | (2,314 | ) | (328 | ) | (1,986 | ) | ||||||||||||
Total interest expense |
(3,608 | ) | 102 | (3,710 | ) | (6,265 | ) | (342 | ) | (5,923 | ) | |||||||||||||
Net Interest Income |
$ | (1,976 | ) | $ | (1,726 | ) | $ | (250 | ) | $ | 2,800 | $ | 845 | $ | 1,955 | |||||||||
Notes: | ||
Rate/volume variances are allocated to the rate variance and the volume variance on an absolute basis. |
Interest income is adjusted by the tax equivalent amount utilizing a 34% rate on federally
tax-exempt municipal loans and securities. The tax equivalent adjustment reflected in the above
table for municipal loans is approximately $89,000, $88,000 and $78,000 for the years ended 2009,
2008 and 2007, respectively. The tax equivalent adjustment reflected in the above table for
municipal securities is approximately $184,000, $233,000 and $161,000 for the years ended 2009,
2008 and 2007, respectively.
Table 3 Securities Available For Sale
($ 000s)
December 31, | 2009 | 2008 | 2007 | |||||||||||||||||||||
% of | % of | % of | ||||||||||||||||||||||
Total | Total | Total | ||||||||||||||||||||||
Amount | Portfolio | Amount | Portfolio | Amount | Portfolio | |||||||||||||||||||
U.S. Treasury |
$ | 1,006 | 0.75 | % | $ | 1,024 | 0.99 | % | $ | 1,005 | 0.66 | % | ||||||||||||
U.S. government-sponsored entities |
0 | 0.00 | 1,038 | 1.01 | 58,459 | 38.14 | ||||||||||||||||||
States and political subdivisions |
9,641 | 7.23 | 11,987 | 11.62 | 13,984 | 9.12 | ||||||||||||||||||
Mortgage backed securities |
118,729 | 88.99 | 83,055 | 80.48 | 66,393 | 43.31 | ||||||||||||||||||
Other bonds |
37 | 0.03 | 2,265 | 2.19 | 9,808 | 6.40 | ||||||||||||||||||
Equity securities |
4,008 | 3.00 | 3,825 | 3.71 | 3,628 | 2.37 | ||||||||||||||||||
Total securities available-for-sale |
$ | 133,421 | 100.00 | % | $ | 103,194 | 100.00 | % | $ | 153,277 | 100.00 | % | ||||||||||||
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SECURITIES
The Company maintains a securities portfolio to generate earnings, provide liquidity, assist
in the management of the Companys tax position, assist in capital management, aid in the Companys
asset/liability management and accommodate pledging collateral requirements. The Companys policy
is that no undue risks be taken with the securities portfolio and that the safety of the securities
is the primary and utmost concern of Company management.
All securities of the Company at December 31, 2009 were classified as available for sale. The
carrying values of the securities reflect the fair or market value of the securities. The Company
classifies its securities as available for sale to provide flexibility in the event that it may be
necessary to sell securities to raise cash for liquidity purposes, adjust its capital position,
alter its interest rate risk profile or make changes for income tax purposes.
The carrying value of the securities portfolio increased $30.2 million to $133.4 million at
year-end 2009 as compared with $103.2 million at year-end 2008 after declining $50.1 million from
year-end 2007. In 2009, the Company used the cash flows generated from the payments and maturities
of loans and from increased deposit volume to increase its securities portfolio.
The Company changed its mix of securities slightly in 2009 and continued to emulate the mix of
securities of the top performing 25% of its peer group. Table 3 shows the Companys various types
of investments and the percentage of each type to the total portfolio for the past three year-ends.
The Companys investment in mortgage-backed securities continued to grow in 2009, increasing $35.7
million to $118.7 million at year-end 2009 and making up almost 89% of the portfolio as compared
with 80% at December 31, 2008.
The Company increased its mortgage-backed securities during 2009 as the yield on this type of
security is generally higher than yields on U.S. Treasury notes and on issues of U.S.
government-sponsored entity securities. The mortgage-backed securities are generally low risk as
they are either guaranteed by the U.S government or by U.S. government-sponsored entities.
Another factor in the Companys decision to purchase mortgage-backed securities is the
expected payment streams from the mortgages underlying this type of security. Although Table 4
shows that the contractual maturities of the mortgage-backed securities were almost all greater
than 10 years, the expected average life of these securities at year-end 2009 was between 3 to 5
years. The mortgages underlying these securities are expected to be paid-down much earlier than
their contractual maturities due to regular payments, sales of the homes securing the loans and
refinancing. At year-end 2009, interest rates were at historic lows and, if interest rates should
increase, the Company may reinvest payments received on these securities to purchase higher
yielding securities.
During 2009, the Company used its securities portfolio for capital management as it received
proceeds of $74.3 million from the sale of a large portion of its mortgage-backed securities and
recognized gains of $3.9 million. The gain increased the Companys capital by increasing retained
earnings. The Companys regulatory capital position was also augmented due to the sale of
mortgage-backed securities that had a
higher risk weighting for regulatory capital purposes than the different types of
mortgage-backed securities that were later purchased. The effect was that the Companys asset risk
rating decreased, further strengthening the Companys regulatory risk weighted capital ratios.
The Companys yields earned on its securities declined during 2009. At year-end 2009, the
average yield of the securities portfolio decreased to 3.57% as compared with 5.87% at year-end
2008. This occurred as interest rates generally were at historic low levels during 2009 and
securities purchased during 2009 were at the lower market interest rates.
During 2008, the Company had recognized other than temporary impairment losses of $8.5 million
on its Collateralized Debt Obligations (CDOs) that the Company classified as other bonds. This
2008 loss was due to defaults and deferral of payments by the financial institutions and insurance
companies that issued the debt
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underlying the securities. During 2008, the Company recognized $2.0 million of other than temporary
impair-men losses on its equity investments in Federal National Mortgage Association and Federal
Home Loan Mortgage Corporation preferred stock. At April 1, 2009, the Company changed its
accounting treatment to comply with new accounting guidance. The effect of this change was that
$1.6 million of 2008s other than temporary impairment loss was determined to be a noncredit
related loss. This amount of $1.6 million less the tax effect, or $1.0 million, was credited back
to retained earnings. During 2009, the Company recognized other than temporary impairment losses of
$3.8 million on these CDOs as the credit quality of the entities issuing the debt underlying the
CDOs continued to decline.
The Company pledges securities to secure public deposits, repurchase agreements and for other
purposes as required or permitted by law. At December 31, 2009, the Company had $94.2 million of
its securities pledged, or 70.6% of its total securities portfolio, as compared with $72.0 million,
or 70.0%, at year-end 2008.
Holdings of securities issued by states and political subdivisions, of
which over 86% are tax-exempt, decreased $2.4 million to $9.6 million at year-end 2009 from $12.0
million at year-end 2008. According to federal tax law, a bank is not allowed an interest deduction
for the cost of deposits or borrowings used to fund most tax-exempt issues acquired after August 7,
1986. As the Company lacked taxable income during 2009, the Company was unable to take full
advantage of the interest deductions provided by tax-exempt securities issued by states and
political subdivisions. Due to the decrease in taxable income, the Company chose to let its
investment in these types of securities decrease during 2009 as these securities matured or were
called.
Efforts by the Company to maintain appropriate liquidity include periodic adjustments to the
securities portfolio, as management considers necessary, typically accomplished through the
maturity schedule of investments purchased. The maturity distribution and average yields, on a
fully tax equivalent basis, of the securities portfolio at December 31, 2009 is shown in Table 4,
Securities Maturity Schedule & Yields.
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Table 4 Securities Maturity Schedule & Yields
( $ 000s)
Greater than | Greater than | |||||||||||||||||||||||||||||||||||||||
1 yr. and less | 5 yrs. and less | |||||||||||||||||||||||||||||||||||||||
Less than or | than or equal | than or equal | Greater than | |||||||||||||||||||||||||||||||||||||
Securities available for sale | equal to 1 yr. | to 5 yrs. | to 10 yrs. | 10 yrs. | Totals | |||||||||||||||||||||||||||||||||||
As of December 31, 2009 | Balance | Yield | Balance | Yield | Balance | Yield | Balance | Yield | Balance | Yield | ||||||||||||||||||||||||||||||
U.S. Treasury |
$ | 1,006 | 2.36 | % | $ | 0 | 0.00 | % | $ | 0 | 0.00 | % | $ | 0 | 0.00 | % | $ | 1,006 | 2.36 | % | ||||||||||||||||||||
States and political subdivisions (1) |
3,173 | 5.30 | 792 | 5.61 | 1,886 | 6.08 | 3,790 | 6.30 | 9,641 | 5.87 | ||||||||||||||||||||||||||||||
Mortgage-backed securities (2) |
0 | 0.00 | 0 | 0.00 | 44 | 8.00 | 118,685 | 3.40 | 118,729 | 3.40 | ||||||||||||||||||||||||||||||
Other bonds |
0 | 0.00 | 0 | 0.00 | 0 | 0.00 | 37 | 0.00 | 37 | 0.00 | ||||||||||||||||||||||||||||||
Equity securities |
4,008 | 3.25 | 0 | 0.00 | 0 | 0.00 | 0 | 0.00 | 4,008 | 3.25 | ||||||||||||||||||||||||||||||
Total |
$ | 8,187 | 3.94 | % | $ | 792 | 5.61 | % | $ | 1,930 | 6.12 | % | $ | 122,512 | 3.49 | % | $ | 133,421 | 3.57 | % | ||||||||||||||||||||
(1) - | The yield is reflected on a fully tax equivalent basis utilizing a 34% tax rate. | |
(2) - | Mortgage-backed securities reflect the contractual maturity of the related instrument. |
Table 5 Loan and Lease Portfolio
($ 000s)
($ 000s)
As of December 31, | 2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||||||
Commercial |
$ | 31,685 | $ | 54,529 | $ | 55,763 | $ | 47,400 | $ | 58,802 | ||||||||||
Real estate-construction |
39,006 | 57,707 | 51,024 | 46,806 | 42,567 | |||||||||||||||
Real estate-mortgage 1-4 family |
43,803 | 47,289 | 52,541 | 36,352 | 38,145 | |||||||||||||||
Real estate-mortgage 5+ family |
54,986 | 55,302 | 53,159 | 38,735 | 29,426 | |||||||||||||||
Real estate-mortgage commercial |
232,634 | 234,765 | 190,916 | 169,064 | 185,219 | |||||||||||||||
Home equity |
26,501 | 26,826 | 24,604 | 25,936 | 31,226 | |||||||||||||||
Leases |
955 | 2,352 | 4,723 | 5,502 | 10,585 | |||||||||||||||
Installment |
2,236 | 2,745 | 3,435 | 4,309 | 5,136 | |||||||||||||||
Total loans and leases |
431,806 | 481,515 | 436,165 | 374,104 | 401,106 | |||||||||||||||
Deferred loan fees |
(520 | ) | (703 | ) | (431 | ) | (389 | ) | (604 | ) | ||||||||||
Loans and leases, net of unearned
income and deferred loan fees |
431,286 | 480,812 | 435,734 | 373,715 | 400,502 | |||||||||||||||
Allowance for loan and lease losses |
(18,027 | ) | (10,402 | ) | (4,606 | ) | (7,162 | ) | (10,618 | ) | ||||||||||
Loans and leases, net |
$ | 413,259 | $ | 470,410 | $ | 431,128 | $ | 366,553 | $ | 389,884 | ||||||||||
Note: | ||
The Company had no foreign loans outstanding at December 31, 2009. |
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LOAN AND LEASE PORTFOLIO
The Companys loan and lease portfolio is the largest interest earning asset of the Company.
In 2009, the Companys loans and leases provided $24.4 million of interest income, 83.2% of the
interest income generated by the Company. In 2008, interest on loans and leases accounted for 79.8%
of interest income.
For purposes of this discussion, when loans are mentioned it should be taken to include leases
unless specified otherwise. As shown in Table 5, Loan and Lease Portfolio, loans and leases, net
of unearned income and deferred loan fees at December 31, 2009 totaled $431.3 million, decreasing
$49.5 million from year-end 2008. At December 31, 2008, loans totaled $480.8 million and increased
$45.1 million from December 31, 2007. The Companys lending activities relate mainly to loans to
small and mid-sized businesses in the Lake County, Illinois area and adjoining areas in the
surrounding counties in northeastern Illinois and southeastern Wisconsin.
The downturn in the economy during 2009, which had begun in 2008, affected the Companys
lending in that there was lower general demand as commercial borrowers cut back on expansion plans
and sought to limit their expenses. Uncertainties, such as falling values of real estate used for
collateral, have also caused our lenders to have stricter lending underwriting. These factors
contributed to the decreases in the Companys loans by $49.5 million. Also causing reductions to
the Companys loans were net loan charge offs of $15.2 million of nonper-forming loans during 2009
and the transfer of $18.3 million in loans into other real estate owned as properties securing
nonperforming loans were foreclosed on.
The Company attempts to secure commercial purpose loans with real estate whenever possible. At
December 31, 2009, over 92% of the Companys loans are secured by real estate. Real
estate-mortgage commercial loans are loans secured by properties that are primarily nonresidential
properties and include office buildings, stores, restaurants, warehouses and other commercial
purpose properties. Real estate-mortgage commercial loans decreased $2.1 million to $232.6 million
at year-end 2009 compared with $234.7 million at year-end 2008 after increasing $43.8 million as
compared with year-end 2007. The Company has had growth in its real-estate mortgage commercial
loans to the hotel industry by $6.8 million in 2009, with hotel industry loans totaling $72.0
million at year-end 2009 as compared with $65.2 million at year-end 2008.
During 2009, real estate-construction loans decreased $18.7 million to $39.0 million at
year-end 2009 as compared with $57.7 million at year-end 2008. This decline in real-estate
construction loans was attributable to construction projects that were completed and were either
paid off or transferred to the completed type of mortgage on the Companys books. Another factor
decreasing real-estate construction loans was property securing the construction loan was acquired
through foreclosure and reclassified as other real estate owned which totaled $1.8 million in 2009.
The Companys loans secured by 1 4 family homes declined in 2009 by $3.5 million after
decreasing $5.3 million in 2008 from 2007. The majority of real estate mortgage 1 4 family loans
are for commercial purposes where residences are used to secure these loans. These loans decreased
as borrowers were concerned about the economy. It should be noted that the Company never
participated in making subprime mortgages on 1 4 family homes and does not carry subprime loans
in its loan portfolio.
At December 31, 2009, the Company had loans secured by residential units of 5 or more families
that totaled $54.9 million. The size of this portfolio has remained stable during 2009, decreasing
only $316,000 from year-end 2008.
The Companys retail lending of home equity and installment loans declined by $834,000 in 2009
compared with 2008 after increasing $1.5 million from 2007. The home equity product decreased
$325,000 to $26.5 million at year-end 2009. The Companys home equity product is a revolving line
of credit with a variable interest rate tied to the prime lending rate. Installment loans declined
$509,000 during 2009.
The Company had reductions of $22.8 million to its commercial loans that were not secured by
real estate, which totaled $31.7 million at year-end 2009 as compared with $54.5 million at
year-end 2008. These loans were partially reduced by charge offs of $8.5 million of this type of
loan in 2009. The balance of the decrease to
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commercial loan balances resulted from payments received from customers and from borrowers
collateralizing these loans with real estate with the loan balance being transferred to the various
mortgage loan categories.
The lower general loan demand and stricter underwriting during 2009 not only resulted in the
decreased loan balances but also in decreased unfunded loan commitments and letters of credit at
year-end 2009. The Companys loan commitments totaled $58.7 million at December 31, 2009, declining
$24.7 million from $83.4 million at December 31, 2008. Standby letters of credit issued by the
Company also decreased to $6.5 million at year-end 2009, declining $1.3 million from $7.8 million
at year-end 2008.
At December 31, 2009, the Company had loans totaling $492,000 to related parties. Related
parties are officers of the Company or its subsidiaries with titles of Vice President or above and
Directors of the Company and the Bank and their related interests. Commitments for loans to related
parties at year-end 2009 totaled $1.9 million. Loans and commitments are made to related parties at
the same terms and conditions that are available to the public.
Table 5 shows the year end balance of loans outstanding by loan purpose for each of the last
five years.
MATURITY OF LOANS
Table 6, Loan Maturity Schedule, highlights the maturity distribution of the Companys
commercial and real estate-construction loan portfolio at year-end 2009.
Table 6 shows $33.0 million in commercial and construction loans maturing in greater than one
year which includes $9.3 million of nonaccrual construction loans. Other than the nonperforming
construction loans, these loans maturing in greater than one year are for commercial building
projects and the construction phase of the projects are expected to be completed in less than two
years. At that time, the loans will be reclassified as real estate-mortgage loans.
The short-term rate sensitivity of the commercial and real estate-construction loan portfolio
to interest rate changes is reflected in the fact that approximately 53.4% of these loans are
scheduled to mature within one year.
Table 6 Loan Maturity Schedule
($ 000s)
Greater Than | ||||||||||||||||
1 yr. and less | ||||||||||||||||
Less than or | than or equal | Greater than | ||||||||||||||
As of December 31, 2009 | equal to 1 yr. | to 5 yrs. | 5 yrs. | Totals | ||||||||||||
Commercial |
$ | 19,533 | $ | 8,427 | $ | 3,725 | $ | 31,685 | ||||||||
Real estate-construction |
18,186 | 20,820 | 0 | 39,006 | ||||||||||||
Total |
$ | 37,719 | $ | 29,247 | $ | 3,725 | $ | 70,691 | ||||||||
Percent of total |
53.36 | % | 41.37 | % | 5.27 | % | 100.00 | % | ||||||||
Commercial and construction loans maturing after one year:
Fixed Rate: |
$ | 32,488 | ||
Variable Rate: |
484 | |||
Total |
$ | 32,972 | ||
Notes: | ||
Real estate-construction loans reflect the contractual maturity of the related note. Due to anticipated roll-overs of real estate-construction notes, management estimates that the loans will actually mature between one and five years based upon the related types of construction. Loans that mature within one year are considered to be variable rate loans as they can be repriced upon maturity. |
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NONPERFORMING ASSETS
Nonperforming assets consist of nonperforming loans and leases and other real estate owned.
For purposes of this discussion, when loans are mentioned it should be taken to include leases
unless specified otherwise. As shown in Table 7, nonperforming assets at year-end 2009 were $60.8
million, increasing $13.2 million from year-end 2008. During 2008, nonperforming assets increased
by $32.8 million to $47.6 million compared with levels of $14.8 million at December 31, 2007.
Nonperforming loans are: (1) loans accounted for on a nonaccrual basis; and (2) accruing loans
in the process of collection that are contractually past due 90 days or more as to interest or
principal payment. Total nonperforming loans at December 31, 2009 were $41.6 million, increasing
$4.5 million as compared with $37.1 million at December 31, 2008 after increasing $25.1 million
from $12.0 million at December 31, 2007. Nonperforming loans increased in 2009 primarily as the
result of continued deteriorating economic conditions and falling real estate values, continuing a
trend that began in 2007. Commercial property vacancies became more pronounced in 2009 as business
activities slowed due to the recession, which negatively affected borrowers cash flows needed to
make loan payments.
At December 31, 2009, the Companys nonaccrual loans, loans where interest is no longer earned
and where payments received are applied to the principal balance, totaled $41.6 million. All but
$375,000 of these loans were secured by real estate. The Company had $9.3 million of real
estate-construction loans on nonaccrual status at December 31, 2009. Nonaccrual loans secured by
family residences totaled $16.4 million at year-end 2009 consisting of $2.4 million of mortgages on
1-4 family residences, $11.6 million of mortgages on 5 or more family residences and $2.4 million
of home equity loans. Loans secured by commercial properties on nonaccrual status at year-end 2009
totaled $15.6 million.
At December 31, 2009, the Companys largest nonaccrual loan relationship totaled $11.6 million
in loans to a borrower secured by 5 or more family residential properties. This loan relationship
was originally placed on nonaccrual status in 2008. The borrower continues to experience cash flow
difficulties due to one propertys major tenants being severely delinquent. At year-end 2009, the
Company has $730,000 of its allowance for loan and lease losses allocated to this loan
relationship. The Company, during 2009, entered into a foreclosure complaint and the court
appointed a receiver to collect rents on the Companys behalf. During 2009, the borrower entered
into bankruptcy which delayed the Companys collection and foreclosure efforts. Once the bankruptcy
issues have been resolved, the Company will continue with the foreclosure.
A loan relationship secured by a hotel totaling $9.3 million was placed on nonaccrual status
during 2009 due to the borrowers inadequate cash flows to make the loan payments. The borrower has
hired new management in an attempt to increase cash flows and is actively attempting to sell the
property. The Company has allocated $3.2 million of its allowance for loan and lease losses at
year-end 2009 to this loan relationship.
Loans totaling $3.5 million were placed on nonaccrual
status during 2009 as the borrower overextended himself and experienced cash flow problems. The
borrowers loans consist of a $250,000 real estate construction loan, a $2.3 million home equity
loan and a $970,000 commercial real estate loan. The Company is presently working with the borrower
as the borrower attempts to increase his cash flow. At year-end 2009, the Company has $1.2 million of its allowance for loan and lease losses allocated to
this loan relationship.
A construction project totaling $3.3 million for upscale condominiums was placed on nonaccrual
status during 2009 due to lack of sales. The borrower has committed to the completion and sale of 4
condo units in 2010 and may have to reduce the sales price to do so. The Company has allocated
$622,000 of its allowance for loan and lease losses at year-end 2009 to this construction loan.
A real estate construction loan of $2.5 million for the development of lots for residential
homes was placed on nonaccrual status during 2009 due to lack of sales. In 2009, the borrower
provided additional real estate collateral for security for the loan and the Company entered into a
forbearance agreement with the borrower. At year-end 2009, the forbearance expired and the Company
expects to institute foreclosure proceedings. The Company determined that at year-end 2009, that
the values of the properties securing the loan were sufficient that no allocation of the allowance
for loan losses was necessary.
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The Company had purchased a portion of a construction loan during 2007 for the building of 890
condominium units in Orlando, Florida. This project totaled $140 million of which the Companys
portion was $2.5 million. The units to be constructed had originally been presold to foreign
nationals who have been unable to get end financing to buy the units upon completion as they are
not U.S. citizens. As a result the project has stalled and the Company put the $2.5 million on
nonaccrual status during 2009. The Company has allocated $1.5 million of its allowance for loan and
lease losses at year-end 2009 to this construction loan.
A loan relationship of $10.4 million was placed on nonaccrual status during 2009 as loan
payments were not received amid allegations of fraud. Later in 2009, the Company charged off $8.7
million of this relationship leaving $1.7 million of nonaccrual loans at year-end 2009. The
remaining $1.7 million is secured by a commercial building in Chicago and equipment. The Company is
in the process of foreclosing on this property. At year-end 2009, the Company has allocated $1.2
million of its allowance for loan and lease losses to this loan relationship.
During 2009, loans totaling $1.2 million were placed on nonaccrual status as the borrower
experienced cash flow difficulties. The loan relationship is secured primarily by a commercial
building and additional vacant land. The borrower is attempting to sell the properties in order to
satisfy the debt. The Company has allocated $161,000 of its allowance for loan and lease losses at
year-end 2009 to this loan relationship.
A loan for $1.1 million secured by a commercial building in Waukegan was placed on nonaccrual
status during 2009 as the borrower was unable to rent or sell the property that was originally
designed to be a restaurant. The Company had entered into a forbearance agreement with the borrower
which expired at year-end 2009. The Company expects to foreclose on this property during 2010. At
year-end 2009, the Company has allocated $107,000 of its allowance for loan and lease losses to
this loan relationship.
Various other loans to several borrowers that total approximately $5.0 million were on
nonaccrual status at year-end 2009. Among these loans were real estate construction loans totaling
$97,000, loans secured by 14 family residences totaling $2.4 million, commercial real estate loans
totaling $2.3 million, home equity loans totaling $128,000 and commercial and installment loans
totaling $70,000. At year-end 2009, the Company has $780,000 of its allowance for loan and lease
losses allocated to these loans which are in various stages of collection.
Table 7 shows that at December 31, 2009, the Company had $30,000 in nonperforming loans that
were 90 days past due and still accruing interest as compared with $442,000 at year-end 2008. These
loans, at year-end 2009 and 2008, were fully secured and in the process of collection.
Impaired loans at December 31, 2009 totaled $56.3 million as compared with $43.8 million at
year-end 2008 and $10.7 million at year-end 2007. The Company considers a loan impaired if it is
probable that full principal and interest will not be collected within the contractual terms of the
note. Impaired loans and leases are carried at the present value of expected cash flows discounted
at the loans effective interest rate or at the fair value of the collateral, if the loan is
collateral dependent. Nonaccrual loans are included as impaired. At-year end 2009, the Company had
a total of $14.7
million of impaired loans that were still on an accrual basis of which $5.7 million were real
estate-construction loans, $1.0 million were real estate 1-4 family mortgage loans and $8.0 million
were real estate commercial mortgage loans. It is probable that all payments on the $14.7 million
of impaired loans still on accrual basis will not be received in accordance with the contractual
agreements.
Another component of nonperforming assets is other real estate owned, consisting of assets
acquired through loan foreclosure and repossession. At December 31, 2009, other real estate owned
totaled $19.2 million as compared with$10.6 million at December 31, 2008 and $2.9 million at
December 31, 2007. The fair value of other real estate owned is reviewed by management at least
quarterly to help ensure the reasonableness of its carrying value, which is the lower of the cost
or the fair value less estimated selling costs.
The Companys total other real estate owned increased $8.6 million to $19.2 million at
year-end 2009 as $18.3 million in loans were transferred from loans into other real estate owned
during 2009 as the Company received title to the properties securing the nonperforming loans. Also
increasing the carrying value of other real estate owned were $243,000 of improvements which in
some cases were needed to complete construction
33
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projects. Other real estate was reduced $8.2 million during 2009 as properties were sold for net
proceeds of $6.8 million with losses of $1.4 million recognized on the sales. Write-downs to other
real estate of $1.7 million were also recognized during 2009 due to decreases in real estate
values.
At year-end 2009, the Companys other real estate owned consisted of $3.8 million of
construction and development properties, $1.7 million of 1-4 family residential properties and
$13.7 million of commercial real estate properties. The Company is actively seeking to sell these
properties.
On December 31, 2009, the Company has one piece of property carried at $2.1 million as other
real estate owned that was acquired by the Bank through the receipt of a deed in lieu of
foreclosure in 1987. The parcel consists of approximately 525,000 square feet of land overlooking
Lake Michigan in Waukegan, Illinois. During 2002 the Bank formed Northern States Community
Development Corporation (NSCDC), a subsidiary of the Bank. NSCDC assets consist of cash and this
parcel of other real estate owned. This subsidiary was formed for the purpose of developing and
selling this parcel as part of the City of Waukegans lakefront development plans.
This property is a former commercial/industrial site and environmental remediation costs may
be incurred in disposing of this property. During the fourth quarter of 2009, the Company had an
independent environmental consultant update its opinion as to estimated environmental remediation
costs with this property. This updated report estimated that there were remaining costs of $104,000
to achieve acceptable levels of contaminants for commercial/industrial or restricted residential
land use and to prevent migration of contaminants to adjoining off-site properties and Lake
Michigan. No determination has yet been made as to the ultimate end use of the property, which
would need to be approved by the City of Waukegan as part of its Lakefront Downtown Master Plan.
The appraised value of the property supports the Banks carrying value plus the estimated remaining
remediation costs and as such, at this time no liability has been recorded for these estimated
environmental remediation costs.
Management continues to emphasize the early identification of loan related problems.
Management is not currently aware of any other significant loan, group of loans, or segment of the
loan portfolio not included in the discussion above as to which there are serious doubts as to the
ability of the borrower(s) to comply with the present loan payment terms.
There were no other interest earning assets at December 31, 2009 that are required to be
disclosed as nonperforming.
34
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Table 7 Nonperforming Assets
($ 000s)
($ 000s)
December 31, | 2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||||||
Loans and leases: |
||||||||||||||||||||
Nonaccrual status |
$ | 41,589 | $ | 36,624 | $ | 10,752 | $ | 8,064 | $ | 21,554 | ||||||||||
90 days or more past due, still accruing |
30 | 442 | 1,230 | 118 | 358 | |||||||||||||||
Total nonperforming loans and leases |
41,619 | 37,066 | 11,982 | 8,182 | 21,912 | |||||||||||||||
Other real estate owned |
19,198 | 10,575 | 2,857 | 2,983 | 4,431 | |||||||||||||||
Total nonperforming assets |
$ | 60,817 | $ | 47,641 | $ | 14,839 | $ | 11,165 | $ | 26,343 | ||||||||||
Nonperforming loans and leases as a
percentage of total loans and leases,
net of unearned income and deferred
loan fees |
9.65 | % | 7.71 | % | 2.75 | % | 2.19 | % | 5.47 | % | ||||||||||
Nonperforming assets as a
percentage of total assets |
9.77 | 7.44 | 2.33 | 1.57 | 3.65 | |||||||||||||||
Nonperforming loans and leases
as a percentage of the allowance
for loan and lease losses |
230.87 | 356.34 | 260.14 | 114.24 | 206.37 |
Notes: |
Loans and leases are placed in nonaccrual status when they are 90 days past due, unless they
are fully secured and in the process of collection.
Impaired Loans At December 31, 2009, 2008, 2007, 2006 and 2005 impaired loans totaled
$56,254,000, $43,756,000, $10,742,000, $9,500,000 and $32,054,000, respectively, and included
nonaccrual loans.
At December 31, 2009 impaired loans included $14,665,000 of accruing loans that it is probable
that all payments will not be received in accordance with the contractual agreements. At December
31, 2006, and 2005 impaired loans included $1,477,000 and $10,533,000, respectively, of
restructured loans.
At December 31, 2009 there were $481,000 in restructured loans that were not considered impaired. |
35
Table of Contents
PROVISION AND ALLOWANCE FOR LOAN AND LEASE LOSSES
During 2009, the Company had provision for loan and lease losses of $22.8 million, an increase of
$9.1 million from $13.7 million during 2008 which increased $13.6 million from 2007. The provision
for 2009 increased significantly due to the increases to nonperforming loans and decreases in the
real estate values of the properties securing the loans. The provision was based on the following
allocation methodology.
A provision is credited to an allowance for loan and lease losses, which is maintained at a level
considered by management to be adequate to absorb loan losses. For purposes of this discussion,
when loans are mentioned it should be taken to include leases unless specified otherwise. The
adequacy of the loan and lease loss allowance is analyzed at least quarterly. Factors considered in
assessing the adequacy of the allowance include: changes in the type and volume of the loan
portfolio; review of the larger credits; historical loss experience; current economic trends and
conditions; review of the present value of expected cash flows and fair value of collateral on
impaired loans; loan growth; and other factors management deems appropriate.
The methodology used by the Company to allocate the allowance begins by internally rating the risk
of loss on the loans. Poorly rated loans that are impaired, past due or have known factors making
future payments uncertain are individually reviewed. An allocation is made for each
individual loan based on the present value of expected cash flows discounted at the loans
effective interest rate or on the fair value of the collateral, if the loan is collateral
dependent. In cases where the present value of expected cash flows or the fair value of the
collateral is greater than the loan balance, a specific allocation is not required.
Those loans rated satisfactory have an allocation made to the allowance using a percentage based on
the 2009s losses on loans of a similar type. This differs from a 3-year average of losses on loans
of a similar type used in 2008 and a 5-year average used in years previous 2008, as the 2009 losses
recognized were significantly higher and 2009s losses were considered to be more indicative of
current operating conditions than the either the 3-year or 5-year average. Allocations to the
allowance may be adjusted based on an analysis of economic conditions or trends. In the Companys
market area, one of the major industries and employers is the pharmaceutical industry as evidenced
by Abbott Laboratories and Baxter Healthcare. If, in the future, there would be major problems in
the pharmaceutical industry, this could possibly impact the loan portfolio and could require
additional allocations of the allowance.
As shown in Table 8, Analysis of the Allowance for Loan and Lease Losses, during 2009 there were
net charge-offs of $15.2 million compared with $7.9 million in 2008 and $2.6 million in 2007. The
net charge-offs for 2009 increased significantly as there was a charge-off totaling $8.7 million of
one loan relationship consisting of a $7.9 of unsecured commercial loans and $829,000 of leases
amid allegations of fraud. There were $4.1 million of charge-offs during 2009 for a loan
relationship consisting primarily of commercial real estate loans as the properties securing the
loans were transferred to other real estate owned at their fair value.
Table 8 also indicates the types of loans charged-off and recovered for the five years from 2005
through 2009 as well as each years provision. The table shows that the largest loan charge-offs
during those years were in 2009.
The Companys allocation of the allowance for loan losses is illustrated in Table 9, Allocation of
the Allowance for Loan and Lease Losses. Table 9 shows the amount of $12.1 million allocated to
real estate-commercial loans of which $4.8 million was specifically allocated to impaired real
estate-commercial loans. Table 9 also shows $2.6 million allocated to real estate construction
loans, as $15.0 million or over 38% of the Companys total real estate construction loans were
considered to be impaired at December 31, 2009. The amount allocated to home equity loans at
year-end 2009 was $1.2 million, increasing from $367,000 at year-end 2008, and were specifically
allocated to impaired home equity loans that totaled $2.4 million at year-end 2009. The allocation
for commercial loans at year-end 2009 totaled $516,000 as compared with $2.4 million at year-end
2008. This amount decreased as the amounts of impaired commercial loans requiring specific
allocations dropped to $98,000 at year-end 2009.
36
Table of Contents
It should be noted that negative changes to the collateral value or events that may disrupt the
borrowers expected cash flows might require an increase to the allowance. Larger allocations to
the allowance for loan and lease losses might be required for those loans affected.
Based upon its analysis, management believes that the allowance for loan and lease losses at
December 31, 2009 is adequate to cover probable incurred loan losses.
Table 8 Analysis of the Allowance for Loan and Lease Losses
($ 000s)
($ 000s)
Years ended December 31, | 2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||||||
Balance at beginning of year |
$ | 10,402 | $ | 4,606 | $ | 7,162 | $ | 10,618 | $ | 7,812 | ||||||||||
Additions due to acquisition |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
Charge-offs: |
||||||||||||||||||||
Commercial |
(8,487 | ) | (2,788 | ) | (265 | ) | (2,145 | ) | (132 | ) | ||||||||||
Real estate-construction |
(465 | ) | (1,682 | ) | (10 | ) | (0 | ) | (54 | ) | ||||||||||
Real estate-mortgage 1-4 family |
(546 | ) | (2,045 | ) | (0 | ) | (0 | ) | (112 | ) | ||||||||||
Real estate-mortgage 5+ family |
(6 | ) | (0 | ) | (0 | ) | (0 | ) | (0 | ) | ||||||||||
Real estate-mortgage commercial |
(5,278 | ) | (0 | ) | (349 | ) | (1,391 | ) | (487 | ) | ||||||||||
Home equity |
(500 | ) | (1,540 | ) | (0 | ) | (0 | ) | (0 | ) | ||||||||||
Leases |
(829 | ) | (0 | ) | (2,000 | ) | (0 | ) | (0 | ) | ||||||||||
Installment |
(23 | ) | (65 | ) | (69 | ) | (31 | ) | (39 | ) | ||||||||||
Total charge-offs |
(16,134 | ) | (8,120 | ) | (2,693 | ) | (3,567 | ) | (824 | ) | ||||||||||
Recoveries: |
||||||||||||||||||||
Commercial |
28 | 216 | 7 | 75 | 199 | |||||||||||||||
Real estate-construction |
942 | 0 | 0 | 0 | 0 | |||||||||||||||
Real estate-mortgage 1-4 family |
4 | 33 | 0 | 30 | 0 | |||||||||||||||
Real estate-mortgage 5+ family |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
Real estate-mortgage commercial |
0 | 0 | 34 | 0 | 0 | |||||||||||||||
Home equity |
0 | 2 | 0 | 0 | 0 | |||||||||||||||
Leases |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
Installment |
7 | 2 | 15 | 6 | 3 | |||||||||||||||
Total recoveries |
981 | 253 | 56 | 111 | 202 | |||||||||||||||
Net charge-offs |
(15,153 | ) | (7,867 | ) | (2,637 | ) | (3,456 | ) | (622 | ) | ||||||||||
Additions charged to operations |
22,778 | 13,663 | 81 | 0 | 3,428 | |||||||||||||||
Balance at end of year |
$ | 18,027 | $ | 10,402 | $ | 4,606 | $ | 7,162 | $ | 10,618 | ||||||||||
Allowance as a % of total loans
and leases net of unearned
income and deferred loan fees |
4.18 | % | 2.16 | % | 1.06 | % | 1.92 | % | 2.65 | % | ||||||||||
Net charge-offs during
during the year to average loans
and leases outstanding
during the year |
3.24 | % | 1.67 | % | 0.68 | % | 0.89 | % | 0.15 | % |
37
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Table 9 Allocation of the Allowance for Loan and Lease Losses
($ 000s)
($ 000s)
December 31, | 2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||||||||||||||||||||||||||
Percent | Percent | Percent | Percent | Percent | ||||||||||||||||||||||||||||||||||||
of loans | of loans | of loans | of loans | of loans | ||||||||||||||||||||||||||||||||||||
in each | in each | in each | in each | in each | ||||||||||||||||||||||||||||||||||||
category | category | category | category | category | ||||||||||||||||||||||||||||||||||||
to total | to total | to total | to total | to total | ||||||||||||||||||||||||||||||||||||
Amount | loans | Amount | loans | Amount | loans | Amount | loans | Amount | loans | |||||||||||||||||||||||||||||||
Commercial |
$ | 516 | 7.34 | % | $ | 2,390 | 11.32 | % | $ | 1,314 | 12.78 | % | $ | 2,481 | 12.67 | % | $ | 3,911 | 14.66 | % | ||||||||||||||||||||
Real estate-construction |
2,591 | 9.03 | 1,178 | 11.98 | 325 | 11.70 | 214 | 12.51 | 293 | 10.61 | ||||||||||||||||||||||||||||||
Real estate-mortgage 1-4 family |
725 | 10.14 | 1,382 | 9.82 | 347 | 12.05 | 276 | 9.72 | 114 | 9.51 | ||||||||||||||||||||||||||||||
Real estate-mortgage +5 family |
799 | 12.74 | 817 | 11.49 | 322 | 12.19 | 171 | 10.35 | 50 | 7.34 | ||||||||||||||||||||||||||||||
Real estate-mortgage commercial |
12,138 | 53.87 | 4,198 | 48.76 | 2,047 | 43.77 | 1,787 | 45.20 | 3,723 | 46.18 | ||||||||||||||||||||||||||||||
Home equity |
1,241 | 6.14 | 367 | 5.57 | 148 | 5.64 | 117 | 6.93 | 45 | 7.78 | ||||||||||||||||||||||||||||||
Leases |
0 | 0.22 | 9 | 0.49 | 43 | 1.08 | 2,043 | 1.47 | 2,409 | 2.64 | ||||||||||||||||||||||||||||||
Installment |
17 | 0.52 | 61 | 0.57 | 60 | 0.79 | 73 | 1.15 | 73 | 1.28 | ||||||||||||||||||||||||||||||
Total |
$ | 18,027 | 100.00 | % | $ | 10,402 | 100.00 | % | $ | 4,606 | 100.00 | % | $ | 7,162 | 100.00 | % | $ | 10,618 | 100.00 | % | ||||||||||||||||||||
38
Table of Contents
NONINTEREST INCOME
Noninterest income totaled $3,784,000 in 2009, increasing $9,829,000 compared with a negative
$6,045,000 of noninterest income in 2008. The Company generates noninterest income from service
charges and from trust operations. It also recognizes as noninterest income gains or losses from
sales of securities and other real estate owned and net other than temporary impairment losses on
securities. Other operating income consists of miscellaneous fees from loans, mortgage banking
activities, deposit box rental and ATM and debit card transactions.
Noninterest income increased in 2009, primarily as net other than temporary impairment losses on
securities decreased during 2009. These losses were $3.1 million during 2009 compared with $10.5
million during 2008, increasing 2009s noninterest income by $7.4 million. The net other than
temporary impairment losses during 2009 and $8.5 million of 2008s losses came from issues
involving CDOs that the Company classifies as other bonds. The losses on the CDOs were due to
defaults and deferral of payments and the declining financial condition of the financial
institutions and insurance companies that issued the debt underlying the securities. During 2009,
the Company did not recognize any net other than temporary impairment losses on its equity
investments of Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage
Corporation (FHLMC) preferred stock, on which the Company had incurred impairment losses of $2.0
million in 2008.
Another factor increasing 2009s noninterest income compared with 2008 was the gain on the sale of
securities of $3.9 million in 2009 compared to a gain of only $40,000 in 2008. In 2009, the Company
sold a large portion of its mortgage backed securities, received proceeds of $74.3 million and
recognized a gain from the sale of $3.9 million. The Company sold the securities for capital
management purposes as the gain provided increased capital and the different types of
mortgage-backed securities later purchased had lower asset risk weightings for regulatory capital
purposes than the mortgage-backed securities sold.
Other operating income increased by $118,000 during 2009 from 2008. The increase to other income
was attributable to the growth of debit card fee income of $111,000 to $560,000 in 2009 as compared
with $449,000 for 2008. The popularity of the Banks high yield NOW account product, introduced in
2009, contributed to the increased debit card fee income as this account product requires customers
to complete ten signature-based debit card transactions each month.
Offsetting these increases to noninterest income were losses on the sale of other real estate owned
of $1.4 million during 2009 as compared with no gains or losses during 2008. During 2009, the
Company sold a luxury home that had been valued at $5.9 million for $4.2 million, recognizing a
$1.7 million loss on the sale. The Companys loss on the sale was due to declining values of luxury
homes, large inventory, the limited number of buyers for such homes and the high costs for holding
the property, such as real estate taxes and maintenance.
Service fees on deposits also declined $176,000 to $2.4 million for 2009 as compared with $2.6
million in 2008. Overdraft fee income declined $70,000 in 2009 as compared with 2008. Retail
account service charges declined in 2009 by $67,000 as the Company lowered service charges to be
competitive with other financial institutions.
Noninterest income for 2008 as compared with 2007 showed a decrease of $11.0 million to a negative
$6.0 million for 2008 as compared with $5.0 million for 2007. The decrease came from the 2008
recognition of other than temporary impairment losses on the Companys securities of $10.5 million
of which $8.5 million was for the CDOs and $2.0 million was for the FNMA and FHLMC preferred stock.
There was no other than temporary impairment losses in 2007.
39
Table of Contents
NONINTEREST EXPENSES
In 2009, total noninterest expenses were $30.2 million, increasing by $13.2 million from 2008 or
78.1%. As a percent of average assets, noninterest expenses were 4.71% in 2009, 2.60% in 2008 and
2.52% in 2007.
The efficiency ratio, noninterest expenses divided by the sum of net interest income and
noninterest income, is frequently used as an indicator of how well a financial institution manages
its noninterest expenses. A ratio of less than 50.0 percent is often used as a benchmark for
financial institutions in considering whether noninterest expenses are well-managed. The Companys
efficiency ratio was 131.5% in 2009 compared with 112.6% in 2008 and 71.9% in 2007.
The increases to noninterest expenses in 2009 and the impact of these expenses on the efficiency
ratio were mainly the result of the $9.5 million write-down of the Companys goodwill and the $1.7
million write-down to other real estate owned. Other major factors having an impact were increases
in FDIC insurance expense, which was $1.2 million greater in 2009 than in 2008, and to legal
expenses, which increased $815,000 in 2009 over 2008.
During 2009, the Company conducted its annual goodwill impairment review in light of decreases in
the Companys stock price and decreases in net income. The Company engaged a specialist to assist
with the goodwill impairment review. Both a market based approach and an income approach were used
to evaluate the Companys fair value of equity as a major part of the analysis. The review showed
that the goodwill was impaired in its entirety and the existing goodwill of $9.5 was written off,
eliminating the goodwill from the Companys balance sheet. The write-down of goodwill was a
one-time accounting, nontax deductible, noncash transaction with no affect on regulatory capital or
liquidity. The goodwill had been booked by the Company primarily as the result of its 2004
acquisition of First State Bank of Round Lake.
Write-downs to other real estate owned of $1.7 million were also recognized during 2009 as compared
with write-downs of only $44,000 during 2008. The write-downs were necessary due to decreases in
the values of the other real estate owned as real estate prices of these properties in particular,
and properties in general, fell during 2009. Other real estate owned consists of real estate
properties acquired through loan foreclosure and repossession. The fair value of other real estate
owned is reviewed by management at least quarterly to help ensure the reasonableness of its
carrying value, which is lower of cost or the fair value less estimated selling costs.
The economic recession has caused a severe strain to the FDIC insurance fund. In order to
recapitalize the FDIC insurance fund, the FDIC increased insurance premiums payable by all
financial institutions and levied a special assessment during 2009. The Companys FDIC premiums
totaled $1.4 million during 2009 as compared with only $222,000 during 2008. Due to the anticipated
Consent Order, the Bank anticipates being required to pay additional FDIC premium amounts during at
least 2010 in addition to the amount that was already prepaid for 2010.
During 2009 legal expenses were $1.3 million, increasing $815,000 from 2008. Much of the increase
to legal expenses was related to attention to asset quality issues.
Other operating expenses also increased $699,000 or 35.9% in 2009 as compared with 2008. The
Companys other real estate owned expense, a component of other operating expenses, increased in
2009 by $647,000 over 2008 as other real estate owned increased $8.6 million. While properties are
carried as other real estate owned, the Company must maintain and insure the properties as well as
pay the real estate taxes.
During 2009, the Company reduced its salaries and employee benefits expense by $343,000 or 4.24%,
primarily as a result of the reduction in the number of full-time equivalent employees to 137 at
year-end 2009 as compared to 145 at year-end 2008. Staffing levels and job functions were carefully
analyzed in determining the reductions. During 2009 and 2008, the Company paid no bonuses nor made
any profit sharing contributions. The Company expects salaries expense to decline by 10% in 2010 as
executive compensation for 2010 was reduced.
40
Table of Contents
The Companys audit and other professional expense for 2009 was $883,000, declining $380,000 from
2008, primarily as a result of reduced audit expenses due to the smaller size and scope of the
Companys business.
Comparing 2008 with 2007, noninterest expenses remained static, only increasing $99,000 in 2008 as
compared with 2007. The Company had increases to occupancy, data processing, audit and other
professional and FDIC expenses during 2008 compared with 2007. Occupancy expenses increased
$124,000 due to maintenance expense increases in 2008 as remodeling was completed. Data processing
expense grew $141,000 as ATM and service bureau fees increased during 2008. Audit and professional
fees were $118,000 greater in 2008 as the Company engaged a consultant for investment strategy
assistance. During 2008, FDIC insurance increased $161,000 as the Companys credits with the FDIC
became depleted. Partially offsetting these expense increases during 2008 as compared with 2007
were decreases to salary and employee benefits. The Company was able to reduce salary and employee
benefits by $518,000 in 2008 due to reductions in staff and nonpayment of bonuses and profit
sharing.
FEDERAL AND STATE INCOME TAXES
The Company recognized income tax expense of $5.6 million for 2009 despite having an operating loss
before income taxes of $30.0 million. Per accounting rules, during 2009, the Company was required
to create a deferred tax asset valuation allowance of $13.7 million based on uncertainties as to
the Company realizing certain deferred tax benefits based on projections of three years of
earnings. The creation of the deferred tax asset valuation allowance increased 2009 income tax
expense by $13.7 million and was a noncash event.
For 2008, the Company had a tax benefit of $6.3 million due to a net operating loss before taxes of
$15.6 million. For 2007, the Company had net income prior to taxes of $6.5 million, and the
provision for income taxes as a percentage of pretax earnings was 32.4%.
During 2009, the Company had pretax earnings of interest on U.S. Treasury and U.S.
government-sponsored entity securities totaling $72,000, which were nontaxable for state income tax
purposes as compared with $1.3 million in 2008 and $7.2 million in 2007. The Company has
significantly reduced its portfolio of U.S. government-sponsored entity securities and as a
consequence, interest earned from this source declined in 2009. This has been done as the Company
has had net operating losses for state tax purposes that resulted in state tax credits. It is
expected that the Companys nontaxable income for state tax purposes will continue to be at low
levels in future years which will assist the Company in future years in generating state taxable
income. It is expected that future state taxable income will offset the state tax net operating
loss carry forward prior to 2017 when the state tax credits begin to expire.
Qualified interest on loans to local political subdivisions and on qualified state and local
political subdivision securities are nontaxable for federal income tax purposes. Interest earned on
local political subdivision securities that were nontaxable for federal income tax purposes was
$368,000 in 2009, $452,000 in 2008 and $311,000 in 2007. The Company has in the past purchased
qualified state and political subdivision securities from local governmental units in order to
assist its local communities as well as for tax planning purposes. As the Company lacked taxable
income during 2009, the Company was unable to take full advantage of the interest deductions
provided by tax-exempt securities issued by states and political subdivisions. Due to the decrease
in taxable income, the Company lowered its balances of these types of securities during 2009 and it
is expected that nontaxable income for federal income tax purposes from these securities will
further decline in 2010.
41
Table of Contents
Table 10 Maturity or Repricing of Assets and Liabilities
($ 000s)
($ 000s)
Subject to Repricing Within | ||||||||||||||||||||||||||||
Immediate | 90 Days | 180 Days | ||||||||||||||||||||||||||
to | to | to | 1 - 3 | 3 - 5 | 5 Years | |||||||||||||||||||||||
December 31, 2009 | Balances | 90 Days | 180 Days | 365 Days | Years | Years | or Greater | |||||||||||||||||||||
Assets: |
||||||||||||||||||||||||||||
Interest bearing deposits
in financial institutions |
$ | 2,760 | $ | 2,760 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||||||
Federal funds sold |
20,788 | 20,788 | 0 | 0 | 0 | 0 | 0 | |||||||||||||||||||||
Securities: |
||||||||||||||||||||||||||||
U.S. Treasury |
1,006 | 0 | 1,006 | 0 | 0 | 0 | 0 | |||||||||||||||||||||
State & political subdivisions |
9,641 | 957 | 1,108 | 1,108 | 522 | 270 | 5,676 | |||||||||||||||||||||
Mortgage-backed securities (1) |
118,729 | 0 | 0 | 0 | 0 | 0 | 118,729 | |||||||||||||||||||||
Other bonds (2) |
37 | 0 | 0 | 0 | 0 | 0 | 37 | |||||||||||||||||||||
Equity securities (3) |
5,809 | 5,809 | 0 | 0 | 0 | 0 | 0 | |||||||||||||||||||||
Loans and leases: |
||||||||||||||||||||||||||||
Commercial |
31,685 | 13,214 | 2,268 | 4,535 | 3,991 | 4,531 | 3,146 | |||||||||||||||||||||
Real estate construction |
39,006 | 18,049 | 46 | 91 | 12,288 | 8,532 | 0 | |||||||||||||||||||||
Real estate mortgage 1-4 family |
43,803 | 9,791 | 2,072 | 4,145 | 12,008 | 12,438 | 3,349 | |||||||||||||||||||||
Real estate mortgage 5+ family |
54,986 | 10,271 | 2,138 | 4,277 | 14,889 | 16,501 | 6,910 | |||||||||||||||||||||
Real estate mortgage commercial |
232,634 | 34,200 | 3,851 | 7,703 | 76,064 | 88,361 | 22,455 | |||||||||||||||||||||
Home equity |
26,501 | 14,721 | 0 | 0 | 11,005 | 775 | 0 | |||||||||||||||||||||
Leases |
955 | 535 | 0 | 0 | 306 | 114 | 0 | |||||||||||||||||||||
Installment |
2,236 | 201 | 85 | 170 | 1,034 | 726 | 20 | |||||||||||||||||||||
Total Interest Earning Assets |
$ | 590,576 | $ | 131,296 | $ | 12,574 | $ | 22,029 | $ | 132,107 | $ | 132,248 | $ | 160,322 | ||||||||||||||
Liabilities: |
||||||||||||||||||||||||||||
NOW accounts |
$ | 65,302 | $ | 65,302 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||||||
Money market accounts |
60,398 | 60,398 | 0 | 0 | 0 | 0 | 0 | |||||||||||||||||||||
Savings |
61,049 | 61,049 | 0 | 0 | 0 | 0 | 0 | |||||||||||||||||||||
Time deposits, $100,000 and over |
85,253 | 28,098 | 19,893 | 32,071 | 5,191 | 0 | 0 | |||||||||||||||||||||
Time deposits, under $100,000 |
92,286 | 36,486 | 18,565 | 23,214 | 14,021 | 0 | 0 | |||||||||||||||||||||
Time deposits, brokered |
94,947 | 34,030 | 32,247 | 7,226 | 21,444 | 0 | 0 | |||||||||||||||||||||
Securities sold under repurchase
agreements |
49,364 | 40,866 | 1,060 | 7,438 | 0 | 0 | 0 | |||||||||||||||||||||
Subordinated debentures |
10,000 | 5,000 | 0 | 5,000 | 0 | 0 | 0 | |||||||||||||||||||||
Total Interest Bearing Liabilities |
$ | 518,599 | $ | 331,229 | $ | 71,765 | $ | 74,949 | $ | 40,656 | $ | 0 | $ | 0 | ||||||||||||||
Excess Interest Earning Assets (Liabilities) |
$ | (199,933 | ) | $ | (59,191 | ) | $ | (52,920 | ) | $ | 91,451 | $ | 132,248 | $ | 160,322 | |||||||||||||
Cumulative Excess Interest Earning
Assets (Liabilities) |
(199,933 | ) | (259,124 | ) | (312,044 | ) | (220,593 | ) | (88,345 | ) | 71,977 | |||||||||||||||||
Cumulative Interest Rate Sensitivity Ratio (4) |
0.40 | 0.36 | 0.35 | 0.57 | 0.83 | 1.14 |
1) | Mortgage-backed securities reflect the time horizon when these financial instruments are subject to rate change or maturity. | |
2) | Other bonds reflect the time horizon when these financial instruments are subject to rate change or maturity. | |
3) | Equity securites includes Federal Home Loan Bank (FHLB) stock. | |
4) | Cumulative interest-earning assets divided by cumulative interest bearing liabilities. |
This table does not necessarily indicate the impact of general interest rate movements on the Companys net interest income because the repricing of certain
assets and liabilities is discretionary and is subject to competition and other pressures. As a result, assets and liabilities indicating or repricing within the same
period may in fact reprice at different times and different rate levels.
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Table 11 Time Deposits, $100,000 and Over Maturity Schedule
($ 000s)
($ 000s)
Greater than | Greater than | |||||||||||||||||||
3 mos. and less | 6 mos. and less | |||||||||||||||||||
Less than or | than or equal | than or equal | Greater than | |||||||||||||||||
As of December 31, 2009 | equal to 3 mos. | to 6 mos. | to 12 mos. | to 12 mos. | Total | |||||||||||||||
Time deposits, $100,000 and over: |
||||||||||||||||||||
Retail deposits |
$ | 17,918 | $ | 6,798 | $ | 14,448 | $ | 4,675 | $ | 43,839 | ||||||||||
Corporate deposits |
2,915 | 4,033 | 4,128 | 516 | 11,592 | |||||||||||||||
Public fund deposits |
7,265 | 9,062 | 13,495 | 0 | 29,822 | |||||||||||||||
Total time deposits,
$100,000 and over |
$ | 28,098 | $ | 19,893 | $ | 32,071 | $ | 5,191 | $ | 85,253 | ||||||||||
Note: | ||
The Company has no foreign banking offices or deposits. |
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CASH FLOWS AND LIQUIDITY
The statement of cash flows shows the Companys sources and uses of cash. The three major
activities of the Company that create cash flows are operating, investing and financing.
Cash flows from operating activities come primarily from net income, which is adjusted to a
cash basis. Net cash from operating activities in 2009 was $4.7 million, above accrual basis net
loss by $40.3 million. This was primarily due to provisions for loan and lease losses of $22.8
million, the write-down of goodwill of $9.5 million, and net impairment losses on securities of
$3.1 million. Net cash from operating activities in 2008 were above accrual basis net loss by $16.7
million due the provision for loan losses of $13.7 million and impairment losses on securities of
$10.5 million that were partially offset by deferred tax benefits of $6.6 million. In 2007, net
cash flows from operating activities were above net income by $2.5 million due to decreases to
interest receivable of $1.2 million and to other assets of $1.1 million.
Major cash flows from investing activities are derived from securities available for sale,
loans, other real estate owned and property and equipment transactions. There were net cash
outflows of $12.3 million for investing activities during 2009 as the Company increased its
securities portfolio. There was outgoing cash of $142.1 million for the purchase of securities
during 2009. This outflow of cash was partially offset by incoming cash flows from maturities and
sales of securities of $107.5 million, decreases to loans from maturities and payment of loans of
$16.2 million and proceeds from the sale of other real estate owned of $6.8 million.
During 2008, net outflows of cash from investing activities were $21.1 million as loans were
funded for $60.7 million and securities totaling $67.4 million were purchased. These outflows were
partially offset by maturities and sales of securities that created incoming cash flows of $108.9
million.
During 2007, the Company had net inflows from investing activities of $63.8 million as the
Company reduced its securities portfolio during 2007.
Primary financing activities of the Company that create cash flows are in the areas of
deposits, repurchase agreements, borrowings, payment of dividends, purchase of treasury stock and
selling stock. During 2009 the Company had net incoming cash flows from financing activities of
$19.9 million. In February 2009, the Company issued Series A Preferred Stock as it participated in
the Treasurys TARP CPP and received $17.2 in proceeds. The Company also had incoming cash flows
during 2009 from increases to deposits of $16.4 million and from increases to repurchase agreements
of $6.8 million. Partially offsetting the 2009 incoming cash flows were cash outflows of $20.0
million for net repayments of its Federal Home Loan Bank advances.
The Company had net incoming cash flows from financing activities during 2008 of $11.9 million
as the Company had net increases in Federal Home Loan Bank advances of $20.0 million and increases
to deposits of $19.9 million. These cash inflows were partially offset by cash outflows of $24.2
million as securities sold under repurchase agreements declined during 2008.
Total cash outflows in 2007 for financing activities were $77.1 million as the Company
restructured its balance sheet. As part of the restructuring the Company lowered its levels of
deposit and repurchase agreements and other short-term borrowings. Outgoing cash of $41.6 million
was used to lower deposits and $20.0 million was used to reduce repurchase agreements. Net
repayments of Federal Home Loan Bank advances also caused an $11.5 million outflow of cash in 2007.
The timing of these cash flows does not always match and the Company must use liquidity
management to provide funds to fill the gaps in these timing differences. Liquidity management at
the Bank involves the ability to meet the daily cash flow requirements of depositors wanting to
withdraw funds and borrowers needs for credit.
The Companys liquidity is measured by the ability to raise funds through deposits, borrowed
funds, capital or cash flow from the repayment or maturities of loans and securities available for
sale and net profits. Liquidity is primarily managed through the growth of deposits and by liquid
assets such as cash and due from banks less any reserve requirements, securities available for sale
less any pledged securities and federal funds sold. Asset and liability management is the process
of managing the balance sheet to achieve a mix of earning assets and
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liabilities. This is done in such a way that achieves an interest rate risk profile acceptable to
management and assists in achieving a desired level of profitability. An important part of the
overall asset and liability management process is providing adequate liquidity.
Liquid assets at the Bank were $64.4 million at December 31, 2009 as compared with $46.8
million at December 31, 2008. Liquid assets consist of cash and due from banks, federal funds sold,
interest bearing deposits in financial institutions with maturities less than 90 days and unpledged
securities available for sale less reserve requirements. Management reviews the liquidity ratio of
the Bank at least weekly. The liquidity ratio is the net liquid assets divided by net deposits and
short-term liabilities. At December 31, 2009, this ratio at the Bank was 13.6%, within managements
internal policy guidelines.
The Company primarily uses federal funds sold, interest bearing deposits in banks and
securities available for sale, particularly those of shorter maturities, as principal sources of
liquidity. Federal funds sold at December 31, 2009 were $20.8 million as compared with $7.5 million
at December 31, 2008. The Company classifies all of its securities as available for sale, which
increases the Companys flexibility in that the Company can use its unpledged securities to meet
liquidity requirements by increasing its repurchase agreement balances or by selling the unpledged
securities. At year-end 2009, the Company had securities available for sale carried at $133.4
million of which $94.2 million was pledged to secure public deposits and repurchase agreements.
Securities available for sale totaled $103.2 million at year-end 2008 of which $72.0 million was
pledged.
Liquidity is also made available from scheduled maturities of securities. At December 31,
2009, the Company has $8.2 million of securities that either mature in 2010 or were equity
securities that could be sold to provide liquidity. Additional liquidity is made available from
payment received on the Companys investments in mortgage-backed securities from which the Company
estimates payments of $30.0 million during 2010 from borrower payments and payoffs on the mortgages
underlying the securities.
Other sources of liquidity available to the Company are deposits and borrowings. Wholesale
brokered deposits, a component of total brokered deposits, are a possible source of liquidity for
the Company. Brokered deposits are time deposits placed by a broker from depositors outside of the
Companys market area. The Company normally offers time deposit rates for wholesale brokered time
deposits that are 10 to 15 basis points greater than rates offered to local depositors. Brokered
deposits totaled $94.9 million, or 18.4% of total deposits at year-end 2009, as compared with $99.2
million, or 19.8% of total deposits at year-end 2008.
Another short-term source of funds to the Company consists of securities sold under repurchase
agreements that amounted to $49.4 million and $42.6 million at December 31, 2009 and 2008. At
December 31, 2009, all repurchase agreements mature or reprice within one year. Securities sold
under repurchase agreements are offered through either an overnight repurchase agreement product or
a term product with maturities from 7 days to one year.
To help ensure the ability to meet its funding needs, including any unexpected strain on
liquidity, at December 31, 2009, the Company had $30.0 million available through arrangements that
allow the Company to purchase federal funds from three independent banks. In addition, the Company
has the ability to make short-term borrowings at the Federal Reserve Banks discount window up to
$16.1 million. The Company has pledged $26.1 million of its commercial loans for this line of
credit.
Another source of liquidity is that, at December 31, 2009, the Company had the ability to
borrow $18.1 million at the Federal Home Loan Bank of Chicago. The Company had $35.0 million of
loans consisting of 1-4 family and 5 or more family real estate mortgages pledged for this line of
credit at December 31, 2009.
Subsequent to year-end the Banks primary regulators, the Federal Deposit Insurance
Corporation (the FDIC) and the Illinois Department of Financial and Professional Regulation (the
IDFPR) have advised management to expect to receive a Consent Order based on their latest risk
management visitation. If finalized, the pending Consent Order will cause the Bank to be considered
adequately capitalized because it establishes a ratio of capital that the Bank is to maintain. As
an adequately capitalized institution, the Bank may not accept brokered deposits without the prior
approval of the FDIC. As of year end, the Bank had $94.9 million in brokered
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deposits. The Bank believes it will be able to find alternative funding sources for these brokered
deposits as they come due, and does not anticipate seeking FDIC approval to receive brokered
deposits. However, other depositors, including some local government entities, may not maintain
their deposits at the Bank if the Bank is no longer well capitalized.
The Bank is developing a liquidity plan to deal with possible decreases to deposits. Included
in this plan would be the possibility of selling unpledged investment securities. As part of this
plan, expected liquidity from principal reductions of loan balances would be considered. This plan
would also consider the lines of credit totaling $30.0 million from three independent banks as well
as the $16.1 million available from the Federal Home Loan Bank of Chicago.
DEPOSITS
The Bank as a commercial banking company provides traditional deposit banking services to
retail, corporate and public entities. These include demand deposit checking accounts, NOW, money
market, savings and time deposit accounts. The deposit function solidifies the Banks identity to
the communities it serves and provides the foundation for future growth.
On October 3, 2008, President George W. Bush signed the Emergency Economic Stabilization Act
of 2008, which temporarily raised the basic limit on federal deposit insurance coverage from
$100,000 to $250,000 per depositor. Legislation provides that the basic FDIC insurance coverage
will return to $100,000 on December 31, 2013. The Bank also has participated in the FDICs
Transaction Account Guarantee Program which guarantees the entire balances of non-interest bearing
transaction accounts and NOW accounts with interest rates of 0.50% or less. The Transaction Account
Guarantee Program will expire on June 30, 2010.
At year-end 2009, the Banks deposits totaled $517.2 million, an increase of $16.4 million or
3.3% from year-end 2008 deposit totals of $500.8 million. The increase in deposits was from growth
from NOW accounts that increased $22.5 million at year-end 2009 as compared with year-end 2008.
Retail deposits totaled $308.0 million at December 31, 2009 compared with $306.7 million at
year-end 2008 increasing $1.3 million in 2009. Retail deposits as a percentage of total deposits
were approximately 60% at year-end 2009 as compared with 61% at year-end 2008 and 67% at year-end
2007.
Much of the Banks loan portfolio is to commercial customers and the Bank seeks to provide
these commercial loan customers with deposit products. Commercial deposits totaled $56.3 million at
December 31, 2009, decreasing $6.3 million from year-end 2008. The decrease is attributable to
commercial depositors needing funds for business purposes due to the weakened economy. Commercial
deposits as a percentage of total deposits were approximately 11% at year-end 2009 as compared with
13% at year-end 2008.
The Banks main office and two of its branches are located in the local county seat and the
Bank has traditionally had deposit relationships with local public entities. Public deposits have
increased $26.0 million to $56.8 million at year-end 2009 as compared with $30.8 million at
year-end 2008 after decreasing $15.5 million from $46.3 million at year-end 2007. Public deposit
balances often fluctuate based on the municipalities liquidity needs as well as interest rate paid.
The Bank must often pledge securities for its public entity deposits. The growth to public deposits
caused the Banks pledged securities to increase to $94.2 million at year-end 2009 as compared with
$72.0 million at year-end 2008.
During 2009, the Bank, to reduce interest expense, continued to price its time, savings and
money market deposit product rates at the midpoint of the market. This strategy was successful as
illustrated in Table 1, which shows time deposit rates in 2009 averaged 2.82%, decreasing 108 basis
points from 3.90% in 2008 after decreasing 91 basis points from 2007. The Companys total cost for
interest bearing liabilities averaged 1.99%, decreasing 69 basis points from 2.68% in 2008 after
decreasing 110 basis points from 2007.
The Company lowered its brokered time deposits by $4.3 million to $94.9 million, or $18.4% of
total deposits, at year-end 2009 from $99.2 million, or 19.8% of total deposits, at year-end 2008.
The Company has
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two types of time deposits classified as brokered time deposits; wholesale brokered time deposits
and CDARS time deposits. Wholesale brokered time deposits are time deposits placed by a broker from
depositors outside of the Companys market area. In order to decrease its cost of funds during
2009, the Companys strategy during 2009 was to decrease its dependence on wholesale brokered time
deposits. The Company wholesale brokered time deposits totaled $47.6 million at year-end 2009, a
reduction of $42.0 million from $89.6 million at year-end 2008.
If finalized, the pending Consent Order will cause the Bank to be considered adequately
capitalized because it establishes a ratio of capital that the Bank is to maintain. As an
adequately capitalized institution, the Bank may not accept brokered deposits without the prior
approval of the FDIC. As of year end, the Bank had $94.9 million in brokered deposits. The Bank
believes it will be able to find alternative funding sources for these brokered deposits as they
come due, and does not anticipate seeking FDIC approval to receive brokered deposits.
CDARS time deposits, classified as brokered time deposits, are Bank customer time deposits of
$250,000 or greater that allows the depositor to increase their FDIC insurance coverage over the
FDIC limits. The Bank trades portions of the customers time deposits with other independent
financial institutions across the country to accomplish this. The effect is that it allows large
time deposit customers to have their entire time deposits to be fully FDIC insured. At year-end
2009, the Company had $47.3 million of CDARS brokered time deposits, an increase of $37.7 million
from $9.6 million at year-end 2008.
Core deposits are those retail and commercial demand, NOW, money market and savings accounts
that have generally lower interest costs and are considered more stable. Total core deposits at
year-end 2009 totaled $216.9 million, increasing $9.8 million or 4.73% from $207.1 million at
year-end 2008.
Most of the 2009 core deposit growth came from the introduction of the Banks High Yield NOW
account product. During 2009, the Bank paid a rate of interest of 4.50% on the first $25,000 of a
customers High Yield NOW account. In order to qualify for the account the customer must have
had, on a monthly basis, at least 10 point of sale signature based transactions, an ACH credit or
debit and electronic statement delivery. As a result of the success of this product, retail NOW
accounts increased $13.0 million in 2009 to $48.6 million at December 31, 2009 as compared with
$35.6 million at December 31, 2008. In January 2010, the rate of interest for the High Yield NOW
account was reduced to 3.50% on the first $25,000 in this account.
Core retail demand deposits also showed growth during 2009. Retail demand deposits increased
$3.3 million to $26.4 million at year-end 2009 as compared with $23.1 million at year-end 2008. A
positive trend has been growth in the number of retail demand accounts that totaled 6,403 at
December 31, 2009, increasing 440 accounts from 5,963 at December 31, 2008, after increasing 547
accounts from 5,416 accounts at December 31, 2007.
Besides the new High Yield checking account product, the Bank expects other efforts to
assist in achieving its goal of increasing core deposits. Increased marketing and employee
incentives will be part of these efforts. The Bank believes that its network of 8 branches, 7 ATMs,
internet banking, debit cards and telephone banking will assist with attracting core deposits. The
Banks participation in the Directo a Mexico program, a joint initiative with the U.S. Federal
Reserve Banks and Banco de Mexico, allows Bank customers to send money to Mexico conveniently,
safely and at a much lower cost. By
better servicing the local Hispanic community, the Bank believes it will increase core
deposits from this market.
The Company had related party deposits totaling $10.2 million at December 31, 2009. The
deposits from related parties were issued at the same terms and conditions that were offered to
other customers.
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SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
AND OTHER SHORT-TERM BORROWINGS
AND OTHER SHORT-TERM BORROWINGS
Securities sold under repurchase agreements (repurchase agreements) and other short-term
borrowings during 2009 have continued to be an alternative to time deposits as a source of funds.
The Company offers repurchase agreements with a term product and an overnight product in which
customers may invest their excess funds. At December 31, 2009, the Company had balances of $49.4
million made up of repurchase agreements of securities where the securities had a carrying value of
$55.2 million.
Most municipalities, other public entities and some other organizations require that
their funds are insured or collateralized. Commercial depositors also find the collateralization of
repurchase agreements attractive as an alternative to time deposits. Repurchase agreements provide
a source of funds and do not increase the Companys reserve requirements with the Federal Reserve
Bank or create an expense relating to FDIC insurance. Management expects to continue to offer
repurchase agreements as an alternative to deposits in the future.
The Company experienced a $6.8 million increase to its repurchase agreements at year-end 2009
compared with year-end 2008 after a $24.2 million decrease at year-end 2008 as compared with
year-end 2007. At year-end 2009, the Company had repurchase agreements issued to one customer
totaling $9.7 million in term repurchase agreement products with a weighted average remaining
maturity of 229 days. Another customer, who was a related party, had $8.5 million in the overnight
repurchase agreement product. Total repurchase agreements issued to related parties of the Company
were $13.0 million at December 31, 2009. The repurchase agreements to related parties were issued
at the same terms and conditions that were offered to other customers.
At year-end 2009, the Company was able to borrow up to $30.0 million in combined federal funds
purchased for liquidity purposes from three money center banks with which the Bank has
correspondent relationships. The Company also has the ability to borrow at the Federal Reserve
discount window in the amount of $16.1 million. The Companys borrowings in federal funds purchased
were negligible in 2009 while averaging $4.4 million in 2008 and $1.2 million in 2007.
During 2009, the Company repaid its borrowings from the Federal Home Loan Bank of Chicago
having no borrowings from the Federal Home Loan Bank at year-end 2009 compared with Federal Home
Loan Bank term advances of $20.0 million at year-end 2008. At year-end 2009, the Company had
availability of $18.1 million of borrowings from the Federal Home Loan Bank. Subsequent to year-end
2009, the Company borrowed $14.0 million in Federal Home Loan Bank advances with $4.1 million
remaining as available to be drawn on. The Companys Federal Home Loan Bank term advance borrowings
averaged $10.9 million in 2009, $19.9 million in 2008 and $4.8 million in 2007.
Table 12 Securties Sold Under Repurchase Agreements
($ 000s)
($ 000s)
At or for the Year Ended December 31, | 2009 | 2008 | 2007 | |||||||||
Average daily balance outstanding during the year |
$ | 41,532 | $ | 48,724 | $ | 74,393 | ||||||
Weighted average interest rate during the year |
1.43 | % | 2.03 | % | 4.56 | % | ||||||
Maximum amount outstanding |
$ | 49,364 | $ | 74,767 | $ | 81,112 | ||||||
Balance at end of year |
49,364 | 42,574 | 66,797 | |||||||||
Weighted average interest rate at end of year |
0.71 | % | 1.71 | % | 3.45 | % |
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Table 13 Capital Standards
($ 000s)
($ 000s)
As of December 31, 2009 | ||||
Qualifying for Tier I Capital: | ||||
Common stock |
$ | 1,789 | ||
Preferred stock |
16,641 | |||
Warrants |
681 | |||
Additional paid-in capital |
11,584 | |||
Retained earnings |
20,632 | |||
Treasury stock, at cost |
(9,280 | ) | ||
Net unrealized loss on equity
securities available for sale |
(9 | ) | ||
Trust preferred securities |
10,000 | |||
Less Disallowed deferred tax assets |
0 | |||
Less Intangible assets |
(462 | ) | ||
Total Qualifying for Tier I Capital |
$ | 51,576 | ||
Qualifying for Tier II Capital: | ||||
Total Qualifying Tier I Capital |
$ | 51,576 | ||
Allowance for loan losses qualifying portion |
5,925 | |||
Total Qualifying for Tier II Capital |
$ | 57,501 | ||
Total Average Net Fourth Quarter Assets |
$ | 636,415 | ||
Risk-based Assets | Total | Risk-based | ||||||
Zero percent risk weighting |
$ | 125,426 | $ | 0 | ||||
Twenty percent risk weighting |
41,942 | 8,389 | ||||||
Fifty percent risk weighting |
42,212 | 21,106 | ||||||
One hundred percent risk weighting (1) |
432,418 | 432,418 | ||||||
Total Risk-weighted Assets |
$ | 641,998 | $ | 461,913 | ||||
(1) Includes off-balance sheet items |
Minimum Capital Requirements | $ | % | ||||||
Tier I Capital to Net Average Fourth Quarter Assets |
||||||||
Required |
$ | 25,457 | 4.00 | % | ||||
Actual |
51,576 | 8.10 | ||||||
Capital to Risk-based Assets: |
||||||||
Tier I: |
||||||||
Required |
$ | 18,477 | 4.00 | % | ||||
Actual |
51,576 | 11.17 | ||||||
Tier II: |
||||||||
Required |
$ | 36,954 | 8.00 | % | ||||
Actual |
57,501 | 12.45 |
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CAPITAL RESOURCES & REGULATORY MATTERS
Capital is important to the Company as it provides a basis for future growth and it provides a
base to absorb any financial setbacks that might be encountered.
During January 2009, the Companys stockholders approved an amendment to the Certificate of
Incorporation allowing the Company to issue preferred stock in conjunction with the Companys
application in late 2008 with the Treasury to participate in the TARP CPP. During January 2009, the
Company received approval from the Treasury for the TARP funds in the amount of $17.2 million and
these funds were received by the Company in February 2009. These funds provided additional
liquidity to the Company and were considered components of Tier I capital. Under the terms of the
TARP CPP the Company issued 17,211 shares of Series A Preferred Stock to the Treasury having a
dividend of 5.0% on the $17.2 million. In addition, the Company also issued warrants to purchase
584,084 shares of the Companys Common Stock at a price of $4.42 per share.
Regulatory agencies have developed minimum guidelines by which the adequacy of a financial institutions capital may be
evaluated. At December 31, 2009, the Companys capital ratios exceed statutory regulatory minimum
guidelines in all respects.
Regulatory statutory capital guidelines require that the amount of capital increase with the
amount of risk inherent in a companys balance sheet and off-balance sheet exposures. Minimum
statutory capital requirements for Tier I capital to average assets and Tier I capital to risk
weighted assets are that they must both be above 4.00%. As shown in Table 13, at December 31, 2009,
the Companys Tier I capital to average assets was at 8.10% and Tier I capital to risk weighted
assets was at 11.17%, both more than twice the minimum amount of statutory capital necessary. The
minimum statutory requirement for Tier II capital to risk based assets is 8.00%, while the
Companys capital for this ratio was 12.45% or more than 1.5 times the statutory amount necessary.
Following a joint examination of the Bank by the FDIC and the IDFPR, the Board of Directors of
the Bank approved and signed on September 21, 2009, a MOU concerning the Banks commitment to
enhance certain areas of the Banks operation as identified during the regulators examination of
the Bank.
The MOU provides an understanding among the FDIC, IDFPR and the Bank, that the Bank will,
among other things adopt written plans to: (i) formulate and implement a profit plan and budget,
including goals and strategies fro improving earnings; (ii) create a written plan to monitor,
improve and lessen risks from the Banks substandard assets; (iii) implement steps to correct loan
administration weaknesses; and (iv) maintain the Banks Leverage Ratio at a level at or exceeding
8% while the MOU is in effect. As noted above, the Banks Leverage Ratio was 8.05% as of December
31, 2009.
Following a review of the Company by the Federal Reserve Bank of Chicago (Federal Reserve),
the Board of Directors of the Company adopted a Board Resolution dated November 17, 2009 whereby
the Company agreed to obtain written approval from the Federal Reserve prior to: (1) paying
dividends to common or preferred stockholders (2) increasing holding company level debt or
subordinated debentures issued in conjunction with trust preferred securities obligations and (3)
paying interest on its existing subordinated debentures.
In response, in November 2009, the Company notified the U.S. Treasury Department of its intent to suspend its dividend payments on its Fixed
Rate Cumulative Perpetual Preferred Stock, Series A. The suspension of the dividend payments is
permissible under the terms of the TARP Capital Purchase Program, but the dividend is a cumulative
dividend and failure to pay dividends for six dividend periods would trigger board of director
appointment rights for the holder of the Series A Preferred Stock. While dividends are being
deferred on the preferred stock issued under the TARP Capital Purchase Program, the Company may not
pay dividends on its common stock. Also, per the Board Resolution, in November 2009, the Company
notified the trustee that holds the Companys junior subordinated debentures relating to its trust
preferred securities that the Company would be deferring its regularly scheduled quarterly interest
payments. The Company has the right to defer the payment of interest on the junior subordinated
debentures at any time, for a period not to exceed 20 consecutive quarters. During the deferral
period, the Company may not pay any dividends on its common or preferred stock. Accordingly, the
Company may not now pay dividends on its common stock and does not contemplate the ability to pay
dividends on its common stock for the foreseeable future.
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During the fourth quarter of 2009, the FDIC and the IDFPR conducted a risk management review
of the Bank. As a result of that review, during the first quarter of 2010, the FDIC and the IDFPR
advised management of their decision to propose that the Bank be required to enter into a joint
Consent Order, whereby the Bank would agree, among other things, to: (1) maintain a Leverage Ratio
of at least 8% and a Total Risk-Based Capital Ratio of at least 12%, (2) prohibit the extension of
additional credit to any existing borrower with an outstanding classifies loan or a loan that has
been previously charged-off, (3) adopt written action plans to reduce the Banks level of
classified assets and delinquent loans and to reduce concentrations of credit identified by the
examiners, and (4) adopt a profit plan, a capital contingency plan and liquidity plan. A final Consent
Order has not yet been negotiated. Management is committed to resolving the issues addressed in
both the MOU and the Consent Order as promptly as possible, and has already taken numerous steps to
address these matters. The Bank expects to report to the FDIC and the IDFPR quarterly regarding its
progress in complying with the provisions to be included in the Consent Order. Should the Bank
enter into the Consent Order, and because the Consent Order establishes specific capital amounts to
be maintained by the Bank, the Bank will not be considered better than adequately capitalized for
capital adequacy purposes, even if the Bank exceeds the levels of capital set forth in the Consent
Order. Currently, the Bank does exceed the capital levels being proposed by the FDIC and the IDFPR
in the proposed Consent Order.
The Company believes that its capital is adequate for the foreseeable future. The Company is
developing a capital contingency plan in the event that the Company should need additional capital.
This plan will consider such strategies as the possible selling of the Companys securities, sale
lease-back arrangements of the Companys building and land, as well as access to capital markets.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The Company has contractual obligations that may not appear on the balance sheet. The largest
of these off balance sheet obligations is commitments to make loans or extend credit through
standby letters of credit. At year-end 2009 the Company had commitments to make loans of $58.7
million as compared with $83.4 million at year-end 2008 and $136.7 million at year-end 2007.
Letters of credit totaled $6.5 million at December 31, 2009 as compared with $7.8 million at
December 31, 2008 and $10.7 million at December 31, 2007. Many of these commitments expire without
being used. Table 14 presents the Companys significant fixed and determinable contractual
obligations by payment date. The payment amounts in Table 14 represent those amounts contractually
due to the recipient and do not include any unamortized premiums or discounts or similar carrying
amount adjustments.
Table 14 Contractual Obligations, Commitments, Contingent Liabilities and Off-Balance Sheet Arrangements
($ 000s)
($ 000s)
Greater than | Greater than | |||||||||||||||||||
one year and | three years and | |||||||||||||||||||
One year | less than or equal | less than or | Greater than | |||||||||||||||||
As of December 31, 2009 | or less | to three years | equal to five years | five years | Total | |||||||||||||||
Long-term debt |
||||||||||||||||||||
Subordinated debentures |
$ | 0 | $ | 0 | $ | 0 | $ | 10,000 | $ | 10,000 | ||||||||||
Time deposits |
231,830 | 40,656 | 0 | 0 | 272,486 | |||||||||||||||
Other contractual obligations |
||||||||||||||||||||
Standby letters of credit |
6,535 | 0 | 0 | 0 | 6,535 |
51
Table of Contents
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Companys primary market risk exposure is interest rate risk and, to a lesser extent,
liquidity risk. Interest rate risk is the exposure of a banking organizations financial condition
to adverse movements in interest rates. The Company seeks to achieve consistent growth in net
interest income and net income while managing volatility that arises from shifts in interest rates.
The Companys Asset and Liability Management Committee (ALCO) oversees interest rate risk
programs instituted by management and measurements of interest rate risk to determine whether they
are within authorized limits set by the Companys Board of Directors.
Evaluating a financial institutions exposure to changes in interest rates includes assessing
both the adequacy of the management process used to control interest rate risk and the
organizations quantitative level of exposure. When assessing the interest rate risk management
process, the Company seeks to ensure that appropriate policies, procedures, management information
systems and internal controls are in place to maintain interest rate risk at prudent levels with
consistency and continuity. Evaluating the quantitative level of interest rate risk exposure
requires the Company to assess the existing and potential future effects of changes in interest
rates on its consolidated financial condition, including capital adequacy, earnings, liquidity,
and, where appropriate, asset quality.
Proper interest rate risk evaluation must include active board of director and senior
management oversight and a comprehensive risk-management process that effectively identifies,
measures, and controls interest rate risk. Several techniques might be used by an institution to
minimize interest rate risk. Such activities fall under the broad definition of asset/liability
management.
One approach used by the Company is to periodically analyze the matching of assets and
liabilities by examining the extent to which such assets and liabilities are interest rate
sensitive and by monitoring an institutions interest rate sensitivity gap.
An asset or liability is said to be interest rate sensitive within a specific time period if
it will mature or reprice within that time period. The interest rate sensitivity gap is defined as
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
that same time period. 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 in a given time frame. During a period of rising interest rates, a negative gap would
tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest
income. The Companys gap position is illustrated in Table 10, Maturity or Repricing of Assets and Liabilities.
Rate sensitivity varies with different types of interest earning assets and interest bearing
liabilities. Rate sensitivity on loans tied to the prime rate differs considerably from long-term
investment securities and fixed rate loans. Time deposits are usually more rate sensitive than
savings accounts. Management has portrayed savings accounts and NOW accounts as immediately
repricable in Table 10, because of managements ability to change the savings and NOW account
interest rate. As interest rates change, however, market conditions may allow rates on savings
accounts and NOW accounts to remain stable or may change to a lesser extent than rates on other
types of deposits. It is highly unlikely that rates would further decline on savings accounts.
Average rates paid in 2009 on savings were 0.28%, already extremely low.
Table 14 shows that $40.7 million in time deposits mature after one year at December 31, 2009
that account for 14.9% of the Companys total time deposits. This compares with December 31, 2008
when 20.6% of time deposits matured after one year and shows a shift in customer preference to
shorter time deposit maturities.
At December 31, 2009, Table 10 shows that approximately 23% of the Companys loan portfolio
floats with the prime rate or is repricable within 90 days, unchanged from December 31, 2008. At
December 31, 2009, $85.9 million of variable rate loans have reached their floors and are reflected
as fixed rate loans in Table 10. For
52
Table of Contents
example, a variable rate loan tied to the prime rate that is due in a lump sum after one year and has reached its
floor would appear to reprice in Table 10 within the one to three year time frame. If the prime rate would increase
above the loans floor, this loan would reprice immediately, while if the prime rate would decrease, this loan
would not reprice until its maturity.
Securities that mature or reprice within 90 days amount to $6.8 million at year-end 2009
according to Table 10 as compared with $7.0 million at year-end 2008 and $26.9 million at year-end
2007. It should be noted that in Table 10, the repricing of these securities is based on the
maturity date of the investments. Mortgage-backed securities are shown in Table 10 based on their
maturity date or when the security is subject to rate change if the security is rate adjustable.
Table 10 does not reflect the monthly principal reductions that the Company receives on the
mortgage-backed securities from payments and payoffs of the mortgages that underlie the securities.
Table 10 does not consider the call options that may be on the securities.
Table 10, shows that at December 31, 2009, the Company has cumulative excess interest earning
liabilities of $312 million within the one-year time frame. At year-end 2008, the Company had
cumulative excess interest earning liabilities of $267 million within the one-year time frame. This
shows a significant shift as the negative gap increased in 2009 as the Company has lengthened the
repricing time frames of its interest earning assets.
Another approach used by management to analyze interest rate risk is to periodically evaluate
or shock the Companys base 12-month projected net interest income by assuming an instantaneous
decrease and increase in rates of 1% and 2% using computer simulation. Table 15 shows this analysis
at December 31, 2009 and December 31, 2008. The computer simulation model used to do the interest
rate shocks and calculate the effect on projected net interest income takes into consideration
maturity and repricing schedules of the various assets and liabilities as well as call provisions
on the Companys securities. Current policy set by the Board of Directors limits exposure to net
interest income from interest rate shocks of plus or minus 2% to plus or minus 1% of the base
projected 12 month net interest income.
At December 31, 2009, the forecasted 2010 net interest income decreases $59,000 when rates are
shocked upwards 2% while net interest income decreases $427,000 for a 2% downwards rate shock.
These changes to net interest income are within internal policy parameters.
Ways the Company can manage interest rate risk include: selling existing assets or repaying
certain liabilities and matching repricing periods for new assets and liabilities, for example, by
shortening terms of new loans or securities. Financial institutions are also subject to prepayment
risk in a falling rate environment. For example, a debtor may prepay financial assets so that the
debtor may refinance obligations at new, lower rates. The Company attempts to mitigate this by
having prepayment penalties on fixed rate loans. With downward rates, the Company seeks to mitigate
the effect on net interest income from variable rate loans by placing floors whenever possible on
variable rate loans as to how low the rate on the loan may go. Prepayments of assets carrying higher
rates reduce the Companys interest income and overall asset yields.
53
Table of Contents
Table 15 Effect of Interest Shocks on Net Interest Income
($ 000s)
($ 000s)
Down 2% | Down 1% | Up 1% | Up 2% | |||||||||||||
December 31, 2009 |
||||||||||||||||
Dollar change from base |
$ | (427 | ) | $ | 17 | $ | (2 | ) | $ | (59 | ) | |||||
Percent change from base |
-2.35 | % | -0.09 | % | -0.01 | % | -0.33 | % | ||||||||
December 31, 2008 |
||||||||||||||||
Dollar change from base |
$ | (656 | ) | $ | (325 | ) | $ | (88 | ) | $ | (250 | ) | ||||
Percent change from base |
-3.82 | % | -1.89 | % | -0.51 | % | -1.45 | % |
54
Table of Contents
Item 8. Financial Statements and Supplementary Data.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Northern States Financial Corporation and Subsidiaries
We have audited the accompanying consolidated balance sheets of Northern States Financial
Corporation and subsidiaries as of December 31, 2009 and 2008, and the related consolidated
statements of operations, stockholders equity, cash flows and comprehensive operations for each of
the three years in the period ended December 31, 2009. These financial statements are the
responsibility of the Corporations management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Northern States Financial Corporation and
subsidiaries at December 31, 2009 and 2008, and the consolidated results of its operations and its
cash flows for each of the three years in the period ended December 31, 2009, in conformity with
U.S. generally accepted accounting principles.
As discussed in Note 21 in the consolidated financial statements, subsequent to year end the Banks
primary regulators, the Federal Deposit Insurance Corporation (the FDIC) and the Illinois
Department of Financial and Professional Regulation (the IDFPR) noted their concerns based on a
risk management visitation to the Bank which showed declines in asset quality. The Bank anticipates
a formal agreement in the form of a Consent Order. Managements future plans in response to these
conditions are described in Note 22.
/s/ Plante & Moran, PLLC | ||||
Chicago, Illinois | ||||
March 12, 2010 |
55
Table of Contents
NORTHERN STATES FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
($ 000s)
December 31, | 2009 | 2008 | ||||||
Assets |
||||||||
Cash and due from banks |
$ | 10,646 | $ | 14,108 | ||||
Interest bearing deposits in financial institutions -
maturities less than 90 days |
2,760 | 242 | ||||||
Federal funds sold |
20,788 | 7,518 | ||||||
Total cash and cash equivalents |
34,194 | 21,868 | ||||||
Securities available for sale |
133,421 | 103,194 | ||||||
Loans and leases |
431,286 | 480,812 | ||||||
Less: Allowance for loan and lease losses |
(18,027 | ) | (10,402 | ) | ||||
Loans and leases, net |
413,259 | 470,410 | ||||||
Federal Home Loan Bank stock |
1,801 | 1,757 | ||||||
Office buildings and equipment, net |
9,719 | 9,916 | ||||||
Other real estate owned |
19,198 | 10,575 | ||||||
Accrued interest receivable |
2,203 | 2,334 | ||||||
Goodwill |
0 | 9,522 | ||||||
Core deposit intangible assets |
462 | 926 | ||||||
Other assets |
8,033 | 10,217 | ||||||
Total assets |
$ | 622,290 | $ | 640,719 | ||||
Liabilities and Stockholders Equity |
||||||||
Liabilities |
||||||||
Deposits |
||||||||
Demand noninterest bearing |
$ | 58,001 | $ | 57,313 | ||||
NOW accounts |
65,302 | 42,783 | ||||||
Money market accounts |
60,398 | 62,200 | ||||||
Savings |
61,049 | 59,819 | ||||||
Time, $100,000 and over |
85,253 | 77,550 | ||||||
Time, under $100,000 |
92,286 | 101,959 | ||||||
Time, brokered |
94,947 | 99,197 | ||||||
Total deposits |
517,236 | 500,821 | ||||||
Securities sold under repurchase agreements |
49,364 | 42,574 | ||||||
Federal Home Loan Bank advance |
0 | 20,000 | ||||||
Subordinated debentures |
10,000 | 10,000 | ||||||
Advances from borrowers for taxes and insurance |
898 | 1,011 | ||||||
Accrued interest payable and other liabilities |
4,491 | 4,699 | ||||||
Total liabilities |
581,989 | 579,105 | ||||||
Stockholders Equity |
||||||||
Common stock (Par value $0.40 per share, authorized 6,500,000
shares, issued 4,472,255 shares and outstanding 4,072,255 shares
at December 31, 2009 and 2008) |
1,789 | 1,789 | ||||||
Preferred stock (Par value $0.40 per share, authorized 1,000,000
shares, issued and outstanding 17,211 shares with liquidation
amounts of $1,000.00 per share at December
31, 2009) |
16,641 | 0 | ||||||
Warrants (584,084 issued and outstanding at December 31, 2009) |
681 | 0 | ||||||
Additional paid-in capital |
11,584 | 11,584 | ||||||
Retained earnings |
20,632 | 56,082 | ||||||
Treasury stock, at cost (400,000 common shares at
December 31, 2009 and 2008) |
(9,280 | ) | (9,280 | ) | ||||
Accumulated other comprehensive (loss) income |
(1,746 | ) | 1,439 | |||||
Total stockholders equity |
40,301 | 61,614 | ||||||
Total liabilities and stockholders equity |
$ | 622,290 | $ | 640,719 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
56
Table of Contents
NORTHERN STATES FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
($ 000s, except per share data)
($ 000s, except per share data)
Years ended December 31, | 2009 | 2008 | 2007 | |||||||||
Interest income |
||||||||||||
Loans (including fee income) |
$ | 24,409 | $ | 27,820 | $ | 27,789 | ||||||
Securities |
||||||||||||
Taxable |
4,541 | 6,490 | 9,509 | |||||||||
Exempt from federal income tax |
357 | 452 | 311 | |||||||||
Federal funds sold and other |
31 | 112 | 812 | |||||||||
Total interest income |
29,338 | 34,874 | 38,421 | |||||||||
Interest expense |
||||||||||||
Time deposits |
7,739 | 10,081 | 12,112 | |||||||||
Other deposits |
1,348 | 1,687 | 3,607 | |||||||||
Repurchase agreements and federal funds purchased |
593 | 1,110 | 3,456 | |||||||||
Federal Home Loan Bank advances |
52 | 347 | 205 | |||||||||
Subordinated debentures |
455 | 570 | 680 | |||||||||
Total interest expense |
10,187 | 13,795 | 20,060 | |||||||||
Net interest income |
19,151 | 21,079 | 18,361 | |||||||||
Provision for loan and lease losses |
22,778 | 13,663 | 81 | |||||||||
Net interest income after provision for
loan and lease losses |
(3,627 | ) | 7,416 | 18,280 | ||||||||
Noninterest income |
||||||||||||
Service fees on deposits |
2,395 | 2,571 | 2,847 | |||||||||
Trust income |
760 | 798 | 794 | |||||||||
Gain (loss) on sales of other real estate owned |
(1,432 | ) | 0 | (8 | ) | |||||||
Gain on sale of securities |
3,908 | 40 | 0 | |||||||||
Other than temporary impairment of securities |
(3,794 | ) | (10,541 | ) | 0 | |||||||
Noncredit portion of other than temporary
impairment on securities |
742 | 0 | 0 | |||||||||
Other operating income |
1,205 | 1,087 | 1,405 | |||||||||
Total noninterest income |
3,784 | (6,045 | ) | 5,038 | ||||||||
Noninterest expense |
||||||||||||
Salaries and employee benefits |
7,739 | 8,082 | 8,600 | |||||||||
Occupancy and equipment, net |
2,330 | 2,433 | 2,309 | |||||||||
Data processing |
1,847 | 1,705 | 1,564 | |||||||||
Legal |
1,278 | 463 | 439 | |||||||||
FDIC insurance |
1,376 | 222 | 61 | |||||||||
Audit and professional |
883 | 1,263 | 1,145 | |||||||||
Amortization of intangible assets |
464 | 464 | 464 | |||||||||
Printing and supplies |
346 | 306 | 403 | |||||||||
Write-down of goodwill |
9,522 | 0 | 0 | |||||||||
Write-down of other real estate owned |
1,722 | 44 | 0 | |||||||||
Other operating expenses |
2,646 | 1,947 | 1,845 | |||||||||
Total noninterest expense |
30,153 | 16,929 | 16,830 | |||||||||
Income (loss) before income taxes |
(29,996 | ) | (15,558 | ) | 6,488 | |||||||
Provision for income taxes |
5,562 | (6,285 | ) | 2,100 | ||||||||
Net (loss) income |
$ | (35,558 | ) | $ | (9,273 | ) | $ | 4,388 | ||||
Contractual dividends to preferred stockholders |
743 | 0 | 0 | |||||||||
Accretion of discount on preferred stock |
111 | 0 | 0 | |||||||||
Net (loss) income available to common stockholders |
$ | (36,412 | ) | $ | (9,273 | ) | $ | 4,388 | ||||
Basic earnings (loss) per share |
$ | (8.94 | ) | $ | (2.26 | ) | $ | 1.05 | ||||
Diluted earnings (loss) per share |
$ | (8.94 | ) | $ | (2.26 | ) | $ | 1.05 |
The accompanying notes are an integral part of these consolidated financial statements.
57
Table of Contents
NORTHERN STATES FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
($ 000s)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
($ 000s)
Years ended December 31, | 2009 | 2008 | 2007 | |||||||||
Net (loss) income |
$ | (35,558 | ) | $ | (9,273 | ) | $ | 4,388 | ||||
Other comprehensive income: |
||||||||||||
Unrealized gains on securities
available for sale, net of tax |
(2,223 | ) | 1,139 | 1,852 | ||||||||
Comprehensive (loss) income |
$ | (37,781 | ) | $ | (8,134 | ) | $ | 6,240 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
58
Table of Contents
NORTHERN STATES FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
($ 000s, except per share data)
Accumulated | ||||||||||||||||||||||||||||||||
Additional | Other | Total | ||||||||||||||||||||||||||||||
Common | Preferred | Paid-In | Retained | Treasury | Comprehensive | Stockholders | ||||||||||||||||||||||||||
Years ended December 31, 2009, 2008 and 2007 | Stock | Stock | Warrants | Capital | Earnings | Stock, at Cost | Income (Loss), Net | Equity | ||||||||||||||||||||||||
Balance, December 31, 2006 |
$ | 1,789 | $ | | $ | | $ | 11,584 | $ | 65,603 | $ | (5,961 | ) | $ | (1,552 | ) | $ | 71,463 | ||||||||||||||
Net income |
4,388 | 4,388 | ||||||||||||||||||||||||||||||
Purchase of 55,000 shares of common
stock
as treasury stock |
(1,241 | ) | (1,241 | ) | ||||||||||||||||||||||||||||
Cash dividends ($ .72 per share) |
(3,008 | ) | (3,008 | ) | ||||||||||||||||||||||||||||
Unrealized net gain on securitie
available for sale |
1,852 | 1,852 | ||||||||||||||||||||||||||||||
Balance, December 31, 2007 |
1,789 | | | 11,584 | 66,983 | (7,202 | ) | 300 | 73,454 | |||||||||||||||||||||||
Net loss |
(9,273 | ) | (9,273 | ) | ||||||||||||||||||||||||||||
Purchase of 105,850 shares of common
stock
as treasury stock |
(2,078 | ) | (2,078 | ) | ||||||||||||||||||||||||||||
Cash dividends ($ .40 per share) |
(1,628 | ) | (1,628 | ) | ||||||||||||||||||||||||||||
Unrealized net gain on securities
available for sale |
1,139 | 1,139 | ||||||||||||||||||||||||||||||
Balance, December 31, 2008 |
1,789 | | | 11,584 | 56,082 | (9,280 | ) | 1,439 | 61,614 | |||||||||||||||||||||||
Net loss |
(1,457 | ) | (1,457 | ) | ||||||||||||||||||||||||||||
Issuance of preferred stock and warrants |
16,530 | 681 | 17,211 | |||||||||||||||||||||||||||||
Accrued dividend on preferred stock |
(98 | ) | (98 | ) | ||||||||||||||||||||||||||||
Accretion of preferred stock discount
issued |
20 | (20 | ) | | ||||||||||||||||||||||||||||
Unrealized net loss on securities
available for sale |
(735 | ) | (735 | ) | ||||||||||||||||||||||||||||
Balance, March 31, 2009 |
1,789 | 16,550 | 681 | 11,584 | 54,507 | (9,280 | ) | 704 | 76,535 | |||||||||||||||||||||||
Adjustment for change in accounting
from adoption of new accounting
pronouncement (see Note 1) |
962 | (962 | ) | | ||||||||||||||||||||||||||||
Balance, April 1, 2009 |
1,789 | 16,550 | 681 | 11,584 | 55,469 | (9,280 | ) | (258 | ) | 76,535 | ||||||||||||||||||||||
Net loss |
(34,101 | ) | (34,101 | ) | ||||||||||||||||||||||||||||
Accrued dividend on preferred stock |
(645 | ) | (645 | ) | ||||||||||||||||||||||||||||
Accretion of preferred stock discount issued |
91 | (91 | ) | | ||||||||||||||||||||||||||||
Unrealized net loss on securities
available for sale |
(1,488 | ) | (1,488 | ) | ||||||||||||||||||||||||||||
Balance, December 31, 2009 |
$ | 1,789 | $ | 16,641 | $ | 681 | $ | 11,584 | $ | 20,632 | $ | (9,280 | ) | $ | (1,746 | ) | $ | 40,301 | ||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
59
Table of Contents
NORTHERN STATES FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($ 000s)
($ 000s)
Years ended December 31, | 2009 | 2008 | 2007 | |||||||||
Cash flows from operating activities |
||||||||||||
Net income (loss) |
$ | (35,558 | ) | $ | (9,273 | ) | $ | 4,388 | ||||
Adjustments to reconcile net income to net cash from
operating activities: |
||||||||||||
Depreciation |
632 | 544 | 573 | |||||||||
Net gain on sales of securities |
(3,908 | ) | (40 | ) | 0 | |||||||
Net impairment loss on securities |
3,052 | 10,541 | 0 | |||||||||
Provision for loan and lease losses |
22,778 | 13,663 | 81 | |||||||||
Write-down of other real estate owned |
1,722 | 44 | 0 | |||||||||
Deferred loan fees |
(183 | ) | 272 | 42 | ||||||||
Deferred tax expense (benefit) |
(5,944 | ) | (6,561 | ) | 68 | |||||||
Change in deferred tax asset valuation allowance |
13,680 | 0 | 0 | |||||||||
Net losses on sale of other real estate owned |
1,432 | 0 | 8 | |||||||||
Write-down of goodwill |
9,522 | 0 | 0 | |||||||||
Amortization of intangible assets |
464 | 464 | 464 | |||||||||
Net change in interest receivable |
131 | 750 | 1,151 | |||||||||
Net change in other assets |
(2,549 | ) | (1,784 | ) | 1,120 | |||||||
Net change in interest payable and other liabilities |
(533 | ) | (1,181 | ) | (1,001 | ) | ||||||
Net cash provided from operating activities |
4,738 | 7,439 | 6,894 | |||||||||
Cash flows from investing activities |
||||||||||||
Proceeds from maturities, calls and principal repayments
of securities available for sale |
33,248 | 100,626 | 247,289 | |||||||||
Proceeds from sales of securities available for sale |
74,283 | 8,240 | 0 | |||||||||
Purchases of securities available for sale |
(142,128 | ) | (67,396 | ) | (118,485 | ) | ||||||
Purchases of Federal Home Loan Bank Stock |
(44 | ) | (312 | ) | 0 | |||||||
Change in loans made to customers |
16,239 | (60,698 | ) | (64,699 | ) | |||||||
Property and equipment expenditures |
(435 | ) | (1,262 | ) | (377 | ) | ||||||
Improvements to other real estate owned |
(243 | ) | (281 | ) | 0 | |||||||
Proceeds from sale of other real estate owned |
6,783 | 0 | 118 | |||||||||
Net cash provided (used) from investing activities |
(12,297 | ) | (21,083 | ) | 63,846 | |||||||
Cash flows from financing activities |
||||||||||||
Net increase (decrease) in: |
||||||||||||
Deposits |
16,415 | 19,862 | (41,637 | ) | ||||||||
Securities sold under repurchase agreements
and other short-term borrowings |
6,790 | (24,223 | ) | (19,978 | ) | |||||||
Advances from borrowers for taxes and insurance |
(113 | ) | (55 | ) | 272 | |||||||
Proceeds from Federal Home Loan Bank advances |
10,000 | 70,000 | 10,000 | |||||||||
Repayment of Federal Home Loan Bank advances |
(30,000 | ) | (50,000 | ) | (21,500 | ) | ||||||
Net proceeds from issuance of preferred stock |
17,211 | 0 | 0 | |||||||||
Purchases of treasury stock |
0 | (2,078 | ) | (1,241 | ) | |||||||
Dividends paid on preferred stock |
(418 | ) | 0 | 0 | ||||||||
Dividends paid on common stock |
0 | (1,628 | ) | (3,008 | ) | |||||||
Net cash provided (used) in financing activities |
19,885 | 11,878 | (77,092 | ) | ||||||||
Net change in cash and cash equivalents |
12,326 | (1,766 | ) | (6,352 | ) | |||||||
Cash and cash equivalents at beginning of year |
21,868 | 23,634 | 29,986 | |||||||||
Cash and cash equivalents at end of year |
$ | 34,194 | $ | 21,868 | $ | 23,634 | ||||||
Supplemental disclosures |
||||||||||||
Cash paid during the year for |
||||||||||||
Interest |
$ | 10,745 | $ | 15,071 | $ | 20,604 | ||||||
Income taxes |
0 | 2,130 | 1,475 | |||||||||
Noncash investing activities |
||||||||||||
Transfers made from loans to other real estate owned |
18,317 | 7,481 | 0 |
The accompanying notes are an integral part of these consolidated financial statements.
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Northern States Financial Corporation
Notes to the Consolidated Financial Statements
Note 1 Summary of Significant Accounting Policies
Principles of Consolidation: The consolidated financial statements include the accounts of Northern
States Financial Corporation (Company), its wholly owned subsidiaries, NorStates Bank (Bank)
and NorProper-ties, Inc. (NorProp) and NorStates Banks wholly-owned subsidiaries, Northern
States Community Development Corporation (NSCDC), XPC LLC and Waukegan Hotels, LLC (WHLLC).
NorProp was formed during the fourth quarter of 2008 to purchase nonperforming assets of the Bank
which NorProp manages and disposes. NSCDC was formed in 2002 and the Bank contributed a parcel of
the other real estate owned and cash to this entity. XPC LLC was formed during 2009 to make
collections on a charged off relationship. WHLLC was formed in 2006 to operate two motels that the
Bank had acquired through foreclosure. The Bank contributed the two motels and cash to WHLLC. WHLLC
was dissolved during the second quarter of 2007 as the motels were sold in the fourth quarter of
2006 and all operations were completed during the first quarter of 2007. Significant inter-company
transactions and balances are eliminated in consolidation.
Nature of Operations: The Companys and the Banks revenues, operating income and assets are
primarily from the banking industry. Loan customers are mainly located in Lake County, Illinois and
surrounding areas of northeastern Illinois and southeastern Wisconsin and include a wide range of
individuals, businesses and other organizations. A major portion of loans are secured by various
forms of collateral, including real estate, business assets, consumer property and other items.
Use of Estimates: To prepare financial statements in conformity with accounting principles
generally accepted in the United States of America, management makes estimates and assumptions
based on available information. These estimates and assumptions affect the amounts reported in the
financial statements and the disclosure provided, and future results could differ. The allowance
for loan and lease losses, fair value of other real estate owned, fair value of financial
instruments, deferred tax asset valuation allowance, value of goodwill, valuation of securities and
status of contingencies are particularly subject to change.
Cash Flow Reporting: Cash and cash equivalents are defined as cash and due from banks, federal
funds sold and interest bearing deposits in financial institutions maturing in less than ninety
days. Net cash flows are reported for customer loan and deposit transactions, securities sold under
repurchase agreements and other short-term borrowings.
Securities: Securities are classified as available for sale when they might be sold before
maturity. Securities available for sale are carried at fair value, with unrealized holding gains
and losses reported separately as other comprehensive income, net of tax.
Gains and losses on sales are determined using the amortized cost of the specific security
sold. Interest income includes amortization of premiums and accretion of discounts. Securities are
written down for expected credit losses when a decline in fair value is determined as not being
temporary.
Declines in fair value of securities below their cost that are other than temporary are
reflected as realized losses. In estimating other than temporary impairment losses, management
considers: (1) the length of time and extent that fair value has been less than cost, (2) the
financial condition and near term prospects of the issuer, (3) the discount value of cash flows,
and (4) the Companys ability and intent to hold the security for a period sufficient to allow for
any anticipated recovery in fair value.
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Federal Home Loan Bank Stock: The Company as a member of the Federal Home Loan Bank of Chicago
(FHLB) is required to maintain an investment in the capital stock of the FHLB. There is no ready
market for the stock and it does not have any quoted market value. The stock is redeemable at par
by the FHLB and is, carried at cost and periodically evaluated for impairment. The Company records
dividends in income on the dividend declaration date. In October 2007, the FHLB entered into a
consensual cease and desist order with its regulator, the Federal Housing Finance Board (Finance
Board), which prohibits capital stock repurchases and redemptions without approval of the Finance
Board, and requires certain capital ratios. FHLB does not expect the order to impact any products
or services offered to its members and the FHLB is not paying dividends until certain capital
ratios are met.
At acquisition, the Company carries FHLB stock at cost. The FHLB stock is periodically
assessed to determine impairment and any such impairment will be recognized in the period
identified. During 2009, the Company assessed its FHLB stock for impairment. This assessment
reviewed the financial condition and credit rating of the FHLB. This assessment also considered the
imputed value of the services available to the Company from the FHLB as the result of the Companys
ownership of FHLB stock. At year-end 2009, it was concluded that the Companys investment in FHLB
was not impaired.
Loans and Leases: Loans and leases are reported at the principal balance outstanding, net of
deferred loans fees and costs and the allowance for loan and lease losses.
Interest income is reported on the accrual method and includes amortization of deferred loan
fees over the loan term. Interest income on mortgage and commercial loans is discontinued at the
time the loan is 90 days delinquent unless the credit is well secured and in process of collection.
Consumer loans are typically charged-off when they become later than 180 days past due. In all
cases, loans are placed on nonaccrual or charged-off if collection of principal or interest is
considered doubtful.
Interest received on nonaccrual loans is accounted for on the cash-basis or cost-recovery
method, until qualifying for return to actual accrual. Loans are returned to accrual status when
all the principal and interest amounts contractually due are brought current and future payments
are reasonably assured.
Allowance for Loan and Lease Losses: The allowance for loan and lease losses is a valuation
allowance for probable incurred credit losses, increased by the provision for loan and lease losses
and decreased by charge-offs net of recoveries. Management estimated the allowance balance required
using past loan and lease loss experience, the nature and volume of the portfolio, information
about specific borrower situations, estimated collateral values, economic conditions and other
factors. Allocations of the allowance may be made for specific loans and leases, but the entire
allowance is available for any loan or lease that, in the managements judgement, should be
charged-off. Loan and lease losses are charged against the allowance when management believes the
uncollectibility of a loan or lease balance is confirmed.
A loan or lease is impaired when full payment under the loan or lease terms is not expected.
Impairment is evaluated in total for smaller-balance loans of similar nature such as residential
mortgage, consumer and credit card loans, and on an individual loan or lease basis for other loans
and leases. If a loan or lease is impaired, a portion for the allowance is allocated so that the
loan or lease is reported, net, at the present value of estimated cash flows using the loans or
leases existing rate or at the fair value of collateral if repayment is expected solely from the
collateral.
Office Building and Equipment: Land is carried at cost. Building and related components are
depreciated using the straight-line method with useful lives ranging from 7 to 40 years. Furniture,
fixtures and equipment are depreciated using the straight-line method with useful lives ranging
from 3 to 10 years.
Other Real Estate Owned: Real estate acquired in settlement of loans is initially reported at the
lesser amount of the principal balance of the loan transferred or the estimated fair value at
acquisition less estimated costs to sell. After acquisition, the carrying value of the real estate
is reduced if the estimated fair value less estimated costs to sell declines below the carrying
value of the property. Other real estate is periodically assessed to determine impairment and any
such impairment will be recognized in the period identified.
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Goodwill and Other Intangible Assets: Goodwill results from prior business acquisitions and
represents the excess of the purchase price over the fair value of acquired tangible assets and
liabilities and identifiable intangible assets. During 2009, goodwill was assessed and determined
to be impaired and a write-down was done for the entire amount of goodwill.
The core deposit intangible arising from the First State Bank of Round Lake acquisition was
measured at fair value and is being amortized on the straight-line method over seven years.
Long-lived Assets: These assets are reviewed for impairment when events indicate their carrying
amount may not be recoverable from future discounted cash flows. If impaired, the assets are
recorded at discounted amounts.
Repurchase Agreements: Substantially all repurchase agreement
liabilities represent amounts advanced by various customers. Securities are pledged to cover these
liabilities, which are not covered by federal deposit insurance.
Employee Benefits: A profit sharing plan covers substantially all employees. Contributions are
expensed annually and are made at the discretion of the Board of Directors. No contribution was
made in 2009 and 2008. Contributions totaled $216,000 in 2007. The plan allows employees to make
voluntary contributions, although such contributions are not matched by the Company.
Income Taxes: Income tax expense is the sum of the current year income tax due or refundable and
the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the
expected future tax consequences of temporary differences between the carrying amounts and tax
basis of assets and liabilities computed using enacted tax rates. A valuation allowance, if needed,
reduces deferred tax assets to the amount expected to be realized. During 2009, a deferred tax
asset valuation reserve was created in the amount of $13,680,000.
Fair Value of Financial Instruments: Fair values of financial instruments are estimated using
relevant market information and other assumptions, as more fully disclosed separately. Fair value
estimates involve uncertainties and matters of significant judgement regarding interest rates,
credit risk, prepayments and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or in market conditions could significantly affect the
estimates. The fair value estimates of on- and off-balance sheet financial instruments does not
include the value of anticipated future business or the values of assets and liabilities not
considered financial instruments.
Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet
credit instruments, such as commitments to make loans and commercial letters of credit, issued to
meet customer financing needs. The face amount for these items represents the exposure to loss,
before considering customer collateral or ability to repay. Such financial instruments are recorded
when they are funded.
Earnings per Share: Basic earnings per share is based on weighted average common shares
outstanding. Diluted earnings per share further assumes issue of any dilutive potential common
shares.
Comprehensive Income: Comprehensive income consists of results of operations and other
comprehensive income. Other comprehensive income includes unrealized gains and losses on securities
available for sale, net of deferred tax, which are also recognized as separate components of
equity.
Reclassification: Some items in the prior year financial statements were reclassified to conform to
current presentation.
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Adopted Recently Issued Accounting Pronouncements:
Other Than Temporary Impairment On April 9, 2009 the Financial Accounting Standards Board
released new accounting guidance on the recognition and presentation of other than temporary
impairment, amending the prior guidance for investment securities available for sale and held to
maturity. The objective of the new other than temporary impairment guidance was to make the prior
guidance more operational and to improve the presentation and disclosure of other than temporary
impairment on debt and equity securities in the financial statements.
Prior to the new guidance, if other than temporary impairment was determined to exist, the
Company recognized an other than temporary impairment charge into earnings in an amount equal to
the entire difference between the securitys amortized cost basis and its fair value as of the
balance sheet date. Under the new guidance, if other than temporary has been incurred, and it is
more likely that the Company will not sell the security before the recovering of its amortized cost
basis, then the other than temporary impairment was to be separated into (a) the amount
representing the credit loss and (b) the amount related to all other factors.
During 2008, the Company had recognized other than temporary impairment losses on its
consolidated statements of operations of $10,541,000 on its debt securities consisting of
Collateralized Debt Obligations (CDOs) where there was no available market for these CDOs. The
Company changed its accounting treatment to comply with the new guidance effective April 1, 2009
and determined that $1,572,000 of the 2008 other than temporary impairment loss was the result of
noncredit related loss. As such the Company on April 1, 2009 added back the noncredit related loss
less the tax effect, or $962,000, to retained earnings.
Estimating Fair Value On April 9, 2009,
the FASB released new accounting guidance for determining fair value when the volume and level of
activity for the asset or liability has significantly decreased and for identifying transactions
that are not orderly. This guidance emphasizes that despite significant decreases in volume and
level of activity and regardless of the valuation technique used for the asset or liability, the
fair value measurement remains the same. Fair value is the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation
or distressed sale) between market participants at the measurement date under current market
conditions.
This accounting guidance was adopted effective April 1, 2009. The guidance had no effect on
the Companys financial statements at the time of adoption.
Disclosures about Fair Value - On April 9, 2009, the FASB released new guidance which amended
disclosures about fair values of financial instruments to require entities to disclose, among other
things, the methods and significant assumptions used to estimate the fair value of financial
instruments in both interim and annual financial statements. The new disclosure guidance was
adopted effective April 1, 2009.
Subsequent Events On May 28, 2009, the FASB released new guidance pertaining to subsequent
events. The new guidance defines subsequent events as events or transactions that occur after the
balance sheet date but before the financial statements are issued or filed with the SEC.
One type of subsequent event consists of events or transactions that provide additional
evidence about conditions that existed at the date of the balance sheet, including the estimates
inherent in the process of preparing the financial statements. The Company is required to recognize
the effects of these subsequent events in our financial statements as of the balance sheet date;
for example, subsequent events affecting the realization of assets such as investment securities
may need to be recognized.
Another type of subsequent event consists of events that provide evidence about conditions
that did not exist at the date of the balance sheet but arose after that date (non-recognized
subsequent events). The Company may be required to disclose the effects of these subsequent events
in our SEC filing; for example a significant commitment entered into after the balance sheet date.
The Company adopted this new guidance effective December 31, 2009.
Accounting Standards Codification On July 1, 2009, the FASB issued new accounting guidance
pertaining to the accounting standards Codification and the hierarchy of Generally Accepted
Accounting Principles (GAAP). Effective July 1, 2009, the Codification became the single source
of authoritative nongovernmental U.S. GAAP.
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All existing accounting standard documents are superseded. All other accounting literature not
included in the Codification will be considered non-authoritative. All guidance contained in the
Codification carries an equal level of authority. Any effects of applying the provisions of
Codification should be accounted for as a change in accounting principle or correction of an error,
as applicable. The Companys adoption of the Codification did not have a significant effect on the
Companys financial statements.
Amendment to Existing Fair Value Measurement In August 2009, the FASB issued an amendment to
existing fair value measurement guidance with respect to measuring liabilities. The guidance
indicates that the preferred fair value measurement methodology is in the following order:
Level 1 A quoted price of an identical liability should be used when available. If unavailable, then a
quoted price of the identical liability when traded as asset should be used provided that no
adjustments need to be made to the quoted price.
Level 2 A quoted price for similar liabilities or similar liabilities when traded as assets
should be used.
Level 2 or Level 3 Another valuation technique that is consistent with fair value
measurements principles should be used, such as the income approach, present value measurement or a
market approach. The fair value determined under these valuation techniques should reflect the
price that would be paid to transfer a liability in an orderly transaction between market
participants at the measurement date.
The amendment clarifies that when estimating the fair value of a liability, a reporting entity
is not required to include a separate input or adjustment to other inputs relating to the existence
of a restriction that prevents the transfer of the liability.
The amendment is effective for the reporting period beginning October 1, 2009. The amendment
did not have an effect on the Companys financial statements at the time of adoption.
Recently Issued Accounting Pronouncements Not Yet Adopted:
Transfers of Financial Assets On June 12, 2009, the FASB issued new accounting guidance on the
accounting for transfers of financial assets. The new guidance eliminates the scope exception for
qualifying special purpose entities, thereby requiring a determination as to whether consolidation
of such entities is appropriate under consolidation accounting guidance.
The new guidance also clarifies that the transferor must consider all arrangements or
agreements made contemporaneously with, or in contemplation of, the transfer of financial assets,
even if they were not entered into at a the time of transfer when determining whether or not the
transferor has surrendered control over the transferred financial assets.
This new guidance is applicable only to transfers of financial assets occurring on or after
January 1, 2010. The Company is still assessing the potential effect of the new guidance on the
financial statements or operating activities of the Company.
Variable Interest Entities On June 12, 2009, the FASB issued new accounting guidance pertaining
to consolidating variable interest entities. The new guidance amends existing consolidation
accounting principles to require an analysis to determine whether the enterprises variable
interest or interests give it a controlling interest in a variable interest entity.
This analysis identifies the primary beneficiary of a variable interest entity as the
enterprise that has the power to direct the activities of a variable interest entity that most
significantly impacts the entitys activities. The analysis also identifies any obligations to
absorb losses of the entity that could potentially be significant to the variable interest entity
of the right to receive benefits from the entity that could potentially be significant to the
variable interest entity.
This new guidance is applicable is effective after January 1, 2010 and earlier application is
prohibited. The Company is still assessing the potential effect of the new guidance on the
financial statements or operating activities of the Company.
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Note 2 Securities
(Table amounts in $ 000s)
(Table amounts in $ 000s)
Year-end securities available for sale were as follows:
Fair | Gross Unrealized | |||||||||||
December 31, 2009 | Value | Gains | Losses | |||||||||
U.S. Treasury |
$ | 1,006 | $ | 7 | $ | 0 | ||||||
States and political subdivisions |
9,641 | 193 | (27 | ) | ||||||||
Mortgage-backed securities |
118,729 | 207 | (2,477 | ) | ||||||||
Other bonds |
37 | 0 | (742 | ) | ||||||||
Equity securities |
4,008 | 0 | (9 | ) | ||||||||
Total |
$ | 133,421 | $ | 407 | $ | (3,255 | ) | |||||
Fair | Gross Unrealized | |||||||||||
December 31, 2008 | Value | Gains | Losses | |||||||||
U.S. Treasury |
$ | 1,024 | $ | 27 | $ | 0 | ||||||
U.S. government-sponsored entities |
1,038 | 38 | 0 | |||||||||
States and political subdivisions |
11,987 | 83 | (211 | ) | ||||||||
Mortgage-backed securities |
83,055 | 2,484 | (2 | ) | ||||||||
Other bonds |
2,265 | 0 | 0 | |||||||||
Equity securities |
3,825 | 0 | (41 | ) | ||||||||
Total |
$ | 103,194 | $ | 2,632 | $ | (254 | ) | |||||
Sales of securities available for sale were as follows:
2009 | 2008 | 2007 | ||||||||||
Proceeds |
$ | 74,283 | $ | 8,240 | $ | 0 | ||||||
Gross gains |
3,908 | 40 | 0 | |||||||||
Gross losses |
0 | 0 | 0 |
Contractual maturities of debt securities available for sale at year-end 2009 were as
follows. Securities not due at a single maturity date, primarily mortgage-backed
securities, are shown separately.
Fair | ||||
Value | ||||
Due in one year or less |
$ | 4,179 | ||
Due after one year through five years |
792 | |||
Due after five years through ten years |
1,886 | |||
Due after ten years |
3,827 | |||
10,684 | ||||
Mortgage-backed securities |
118,729 | |||
Equity securities |
4,008 | |||
Total |
$ | 133,421 | ||
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Note 2 Securities (Continued)
(Table amounts in $ 000s)
(Table amounts in $ 000s)
Securities carried at $94,156,000 and $72,023,000 at year-end 2009 and 2008, were pledged to
secure public deposits, repurchase agreements and for other purposes as required or permitted by
law.
The Company holds securities issued by municipalities within various states with no states
aggregate total exceeding 10% of consolidated stockholders equity.
Securities with unrealized losses at year-end 2009 and 2008 aggregated by investment category
and length of time that individual securities have been in continuous unrealized loss position are
as follows:
Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
December 31, 2009 | Value | Losses | Value | Losses | Value | Losses | ||||||||||||||||||
States and political subdivisions |
$ | 616 | $ | (7 | ) | $ | 771 | $ | (20 | ) | $ | 1,387 | $ | (27 | ) | |||||||||
Mortgage-backed securities |
100,181 | (2,477 | ) | 0 | 0 | 100,181 | (2,477 | ) | ||||||||||||||||
Other bonds |
0 | 0 | 37 | (742 | ) | 37 | (742 | ) | ||||||||||||||||
Equity securities |
3,965 | (9 | ) | 0 | 0 | 3,965 | (9 | ) | ||||||||||||||||
Total temporarily impaired |
$ | 104,762 | $ | (2,493 | ) | $ | 808 | $ | (762 | ) | $ | 105,570 | $ | (3,255 | ) | |||||||||
On December 31, 2009, the Company had 20 individual securities in an unrealized loss position.
Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
December 31, 2008 | Value | Losses | Value | Losses | Value | Losses | ||||||||||||||||||
States and political subdivisions |
$ | 5,601 | $ | (211 | ) | $ | 0 | $ | 0 | $ | 5,601 | $ | (211 | ) | ||||||||||
Mortgage-backed securities |
157 | (2 | ) | 0 | 0 | 157 | (2 | ) | ||||||||||||||||
Equity securities |
3,782 | (41 | ) | 0 | 0 | 3,782 | (41 | ) | ||||||||||||||||
Total temporarily impaired |
$ | 9,540 | $ | (254 | ) | $ | 0 | $ | 0 | $ | 9,540 | $ | (254 | ) | ||||||||||
On December 31, 2008, the Company had 20 individual securities in an unrealized loss position.
Management has the intent and ability to hold these securities for the foreseeable future and
the decline in fair value is largely due to increases in market interest rates subsequent to the
purchase of the securities. The fair value is expected to recover as the securities approach their
maturity date.
During 2009 and 2008, the Company recognized net other than temporary impairment losses of
$3,052,000 and $8,529,000, respectively, on Collateral Debt Obligation securities (CDOs)
classified as other bonds. The impairment losses on the CDOs were due to defaults and deferral of
payments by the financial institutions and insurance companies that issued the debt underlying the
securities.
The Companys investment in CDOs at year-end 2009 consisted of three securities; PreTSL XXII,
PreTSL XXIV and PreTSL XXVII. The Companys CDOs consist of various tranches of each security with
tranches having various risk factors and repayment schedules with an A tranche having the least
risk and D and Income Notes having the highest risk. For PreTSL XXII, the Companys tranche
level is Mezzanine Class C-2 and at year-end 2009, approximately 24.5% of the issuers of the debt
underlying PreTSL XXII were in default or deferring payments on their debt. For PreTSL XXIV, the
Companys tranche level is Mezzanine Class D and at year-end 2009, approximately 29.4% of the
issuers of the debt underlying PreTSL XXIV were in default or deferring payments on their debt. For
PreTSL XXVII, the Companys tranche level is Mezzanine Class C-1 and at year-end 2009,
approximately 21.2% of the issuers of the debt underlying PreTSL XXVII were in default or deferring
payments on their debt.
At April 1, 2009, the Company changed its accounting treatment to comply with the new
accounting guidance. It was determined that $1,572,000 of net other than temporary loss taken
during 2008 was the result of noncredit related loss and as such was added back to retained
earnings less the tax effect.
The Company purchased preferred stock, during 2008, issued by the Federal National Mortgage
Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC). During 2008, the Company
incurred other than temporary impairment losses of $2,012,000 as these preferred stocks became
impaired when these entities were placed in receivership with the U.S. Treasury. At that time, the
U.S. Treasury suspended dividend payments and began to restructure these entities. There have been
no further impairment losses on the FNMA and FHLMC preferred stocks during 2009. At December 31,
2009 and 2008, the Companys carrying value of the FNMA and FHLMC preferred stocks was $43,000.
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Note 3 Loans
(Table amounts in $ 000s)
(Table amounts in $ 000s)
Year-end loans were as follows:
2009 | 2008 | |||||||
Commercial |
$ | 31,685 | $ | 54,529 | ||||
Real estate construction |
39,006 | 57,707 | ||||||
Real estate mortgage 1-4 family |
43,803 | 47,289 | ||||||
Real estate mortgage 5+ family |
54,986 | 55,302 | ||||||
Real estate mortgage commercial |
232,634 | 234,765 | ||||||
Home equity |
26,501 | 26,826 | ||||||
Leases |
955 | 2,352 | ||||||
Installment |
2,236 | 2,745 | ||||||
Total loans |
431,806 | 481,515 | ||||||
Less: |
||||||||
Deferred loan fees |
(520 | ) | (703 | ) | ||||
Loans, net of unearned income and deferred loan fees |
431,286 | 480,812 | ||||||
Allowance for loan and lease losses |
(18,027 | ) | (10,402 | ) | ||||
Loans, net |
$ | 413,259 | $ | 470,410 | ||||
Impaired loans were as follows:
2009 | 2008 | 2007 | ||||||||||
Year-end impaired loans and leases with no allowance for loan and lease losses allocated |
$ | 20,755 | $ | 18,036 | $ | 8,825 | ||||||
Year-end impaired loans and leases with allowance for loan and lease losses allocated |
35,499 | 25,720 | 1,917 | |||||||||
Total impaired loans and leases impaired
at year-end |
$ | 56,254 | $ | 43,756 | $ | 10,742 | ||||||
Amount of the allowance allocated to
impaired loans and leases |
$ | 10,052 | $ | 2,898 | $ | 510 | ||||||
Average of impaired loans and leases during
the year |
49,061 | 17,425 | 7,311 | |||||||||
Interest income recognized on impaired loans and
leases during impairment |
98 | 101 | 71 | |||||||||
Non-performing loans and leases were as follows: |
2009 | 2008 | 2007 | ||||||||||
Nonaccrual loans and leases |
$ | 41,589 | $ | 36,624 | $ | 10,752 | ||||||
Loans and leases past due over 90 days and still accruing interest |
30 | 442 | 1,230 | |||||||||
Total nonperforming loans |
$ | 41,619 | $ | 37,066 | $ | 11,982 | ||||||
Related party loans were as follows:
2009 | ||||
Total loans at beginning of year |
$ | 978 | ||
New loans |
45 | |||
Repayments |
(531 | ) | ||
Other changes |
0 | |||
Total loans at end of year |
$ | 492 | ||
The Company had pledged loans to the Federal Home Loan Bank of Chicago of
$35,038,000 and to the Federal Reserve Bank of Chicago of $26,139,000 at December 31,
2009.
Real estate-mortgage commercial loans with a carrying value of $71,971,000 and
$65,168,000 were made to borrowers in the hotel industry at December 31, 2009 and 2008.
At December 31, 2009, there were approximately $121,716,000 of loans that had payment
schedules where only interest is collected until the loans mature. Of these loans,
$26,501,000 consist of home equity loans.
There were no loans held for sale at year-end 2009 and 2008.
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Note 4 Allowance for Loan and Lease Losses
(Table amounts in $ 000s)
(Table amounts in $ 000s)
Activity in the allowance for loan and lease losses for the years ended December 31, 2009, 2008
and 2007 follows:
2009 | 2008 | 2007 | ||||||||||
Balance at beginning of year |
$ | 10,402 | $ | 4,606 | $ | 7,162 | ||||||
Provision charged to operating expense |
22,778 | 13,663 | 81 | |||||||||
Loans charged off |
(16,134 | ) | (8,120 | ) | (2,693 | ) | ||||||
Recoveries on loans previously charged off |
981 | 253 | 56 | |||||||||
Balance at end of year |
$ | 18,027 | $ | 10,402 | $ | 4,606 | ||||||
Note 5 Office Buildings and Equipment
(Table amounts in $ 000s)
(Table amounts in $ 000s)
Office and equipment consisted of the following at December 31, 2009 and 2008:
2009 | 2008 | |||||||
Land |
$ | 2,895 | $ | 2,895 | ||||
Office buildings and improvement |
12,880 | 12,800 | ||||||
Furniture and equipment |
4,798 | 4,481 | ||||||
Total cost |
20,573 | 20,176 | ||||||
Accumulated depreciation |
(10,854 | ) | (10,260 | ) | ||||
Net book value |
$ | 9,719 | $ | 9,916 | ||||
Depreciation expense amounted to approximately $632,000 in 2009, $544,000 in 2008, and
$573,000 in 2007.
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Note 6 Other Real Estate Owned
(Table amounts in $000s)
(Table amounts in $000s)
The Company carries as other real estate owned properties acquired through loan foreclosure
and repossession. Year-end other real estate owned consisted of the following properties:
2009 | 2008 | |||||||
Real estate construction and land development |
$ | 3,765 | $ | 1,991 | ||||
Real estate 1-4 family |
1,680 | 6,104 | ||||||
Real estate commercial |
13,753 | 2,480 | ||||||
Total other real estate owned |
$ | 19,198 | $ | 10,575 | ||||
Activity to other real estate owned for the years ended December 31, 2009, 2008, and 2007 follows.
2009 | 2008 | 2007 | ||||||||||
Balance at beginning of year |
$ | 10,575 | $ | 2,857 | $ | 2,983 | ||||||
Additions |
18,317 | 7,481 | 0 | |||||||||
Improvements |
243 | 281 | 0 | |||||||||
Sales proceeds |
(6,783 | ) | 0 | (118 | ) | |||||||
Gains (losses) on sales |
(1,432 | ) | 0 | (8 | ) | |||||||
Write-downs |
(1,722 | ) | (44 | ) | 0 | |||||||
Balance at end of year |
$ | 19,198 | $ | 10,575 | $ | 2,857 | ||||||
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Table of Contents
Note 7 Goodwill and Core Deposit Intangible Assets
(Table amounts in $ 000s)
(Table amounts in $ 000s)
The change in goodwill during the year is as follows:
2009 | 2008 | 2007 | ||||||||||
Balance at beginning of year |
$ | 9,522 | $ | 9,522 | $ | 9,522 | ||||||
Write-down of goodwill |
(9,522 | ) | 0 | 0 | ||||||||
Balance at end of year |
$ | 0 | $ | 9,522 | $ | 9,522 | ||||||
During 2009, the Company conducted its annual review of its goodwill for impairment in light
of decreases to the Companys stock price. The Companys results of operations due to increased
nonperforming assets and increased provisions to the allowance for loan losses was a factor in the
Companys reviewing of its goodwill. Another factor leading up to the goodwill impairment review
was the general decline in the valuation of financial institutions.
To determine whether the Companys goodwill was impaired, the Company determined the fair
value of the Companys equity. To assist the Company with this determination during 2009, the
Company engaged a specialist. The Company used both a market based approach and an income approach
to evaluate the fair value of the Companys equity. The market approach reviewed sales of
comparable financial institutions while the income approach estimated the present value of expected
future earnings to determine the fair value of the Companys equity.
The analysis determined that the Companys goodwill was impaired in its entirety and as such
the Company recognized a $9,522,000 write-down to its goodwill during 2009.
The core deposit intangible asset arising from the First State Bank of Round Lake acquisition
on January 5, 2004 was recorded at $3,246,000. Amortization expense was $464,000 in 2009, 2008 and
2007. The core deposit intangible is being amortized on the straight-line method over seven years
with one year remaining as of December 31, 2009.
Acquired intangible assets were as follows as of year end:
2009 | 2008 | |||||||||||||||||||||||
Gross | Net | Gross | Net | |||||||||||||||||||||
Carrying | Accumulated | Carrying | Carrying | Accumulated | Carrying | |||||||||||||||||||
Amount | Amortization | Amount | Amount | Amortization | Amount | |||||||||||||||||||
Core deposit intangible |
$ | 3,246 | $ | 2,784 | $ | 462 | $ | 3,246 | $ | 2,320 | $ | 926 | ||||||||||||
Amortization for 2010 is expected to be $462,000.
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Table of Contents
Note 8 Deposits
(Table amounts in $ 000s)
(Table amounts in $ 000s)
At year-end 2009, stated maturities of time deposits were:
2010 |
$ | 231,830 | ||
2011 |
36,481 | |||
2012 |
4,175 | |||
$ | 272,486 |
Related party deposits at year-end 2009 and 2008 totaled $10,178,000 and $11,727,000,
respectively. Brokered deposits at year-end 2009 and 2008 totaled $94,947,000 and $99,197,000,
respectively.
Included in brokered deposits were CDARS time deposits. CDARS time deposits are Bank customer
time deposits of $250,000 or greater that allows the depositor to increase their FDIC insurance
coverage over the FDIC limits. The Bank trades portions of the customers time deposits with other
independent financial institutions across the county to accomplish this. The effect is that it
allows large time deposit customers to have their entire time deposits fully FDIC insured. At
year-end 2009 and 2008, the Company had $47,336,000 and $9,552,000, respectively, of CDARS time
deposits.
Note 9 Borrowings
(Table amounts in $ 000s)
(Table amounts in $ 000s)
Securities sold under agreements to repurchase totaled $49,364,000 and $42,574,000 at year-end
2009 and 2008, respectively. These repurchase agreements were secured by U.S. government-sponsored
entity or mortgaged-backed securities with a carrying amount of $55,221,000 and $43,720,000 at
December 31, 2009 and 2008, respectively.
Securities sold under agreements to repurchase are financing arrangements that mature within
one year. At maturity, the securities underlying the concerning securities sold under agreements to
repurchase and federal funds purchased is summarized agreements are returned to the Company.
Information as follows:
2009 | 2008 | |||||||
Average daily balance during the year |
$ | 41,532 | $ | 48,724 | ||||
Average interest rate during the year |
1.43 | % | 2.03 | % | ||||
Maximum month end balance during the year |
$ | 49,364 | $ | 74,767 | ||||
Weighted average interest rate at year-end |
0.71 | % | 1.71 | % |
Related party securities sold under repurchase agreements at year-end 2009 and 2008 totaled
$12,955,000 and $4,836,000.
At year-end 2009, there were three customer relationships in which the customer had securities
sold under repurchase agreements that totaled in excess of 10% of the consolidated stockholders
equity. One relationship totaled $9,720,000 and had a weighted average maturity of 229 days.
Another relationship totaled $8,489,000 and had a weighted average maturity of one day in an
overnight product. The third relationship totaled $7,579,000 and had a weighted average maturity of
one day in an overnight product.
The Company had no advances from the Federal Home Loan Bank at December 31, 2009. The Company
had $20,000,000 in advances from the Federal Home Loan Bank at December 31, 2008.
The Banks maintains a collateral pledge agreement with the FHLB covering secured advances
whereby the Bank agrees to retain first mortgage loans with an unpaid principal balances
aggregating no less than 167% of the outstanding secured advance from the FHLB.
Federal funds purchased is a short-term borrowing from a money center bank or from the Federal
Reserve Bank discount window. At December 31, 2009 and December 31, 2008 there were no federal
funds purchased.
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Note 10 Subordinated Debentures
On September 15, 2005, the Company issued $10 million of trust preferred securities through
Northern States Statutory Trust I, an unconsolidated wholly-owned grantor trustee. The Company
issued $10 million of subordinated debentures to Northern States Statutory Trust I, which in turn
issued $10 million of trust preferred securities. The subordinated debentures mature in September
2035 and at December 31, 2009 bear interest at a rate of 4.120%. At December 31, 2008, the
subordinated debenture carried a rate of 4.991%. From December 2005 until September 15, 2010, the
subordinated debentures bear interest at a rate equal to the sum of the product of 50% times the
3-month London Interbank Offered Rate (LIBOR) plus 1.80%, plus the product of 50% times 6.186%,
and thereafter at a rate equal to the 3-month LIBOR plus 1.80%. The 3-month LIBOR rate used at
December 31, 2009 and 2008 was 0.254% and 1.996%, respectively. For the years ended December 31,
2009, 2008 and 2007, interest expense on the subordinated debentures was $455,000, $570,000 and
$680,000, respectively.
The Company has guaranteed the payment of distributions and payments upon liquidation or
redemption of the trust preferred securities, in each case to the extent of funds held by the
Trust. The Company and the Trust believe that, taken together, the obligations of the Company under
the guarantee, the subordinated debentures, and other related agreements provide, in the aggregate,
a full, irrevocable and unconditional guarantee, on a subordinated basis, of all of the obligations
of the Trust under the trust preferred securities. Subject to certain limitations, the Company has
the right to defer the payment of interest on the junior subordinated debentures at any time, or
from time to time, for a period not to exceed 20 consecutive quarters. In November 2009, the
Company notified the trustee that holds the Companys junior subordinated debentures relating to
its outstanding trust preferred securities that the Company would be deferring its regularly
scheduled quarterly interest payments. At December 15, 2009, the Company deferred payment of
$108,000 for its quarterly interest payment on the subordinated debentures. During the deferral
period, the Company may not pay any dividends on its common or preferred stock. The trust preferred
securities are subject to mandatory redemption, in whole or in part, upon repayment of the
subordinated debentures at maturity or their earlier redemption. The subordinated debentures are
callable at par beginning at September 15, 2010 and earlier at the discretion of the Company if
certain conditions are met, and, in any event, only after the Company has obtained Federal Reserve
approval, if then required under applicable guidelines or regulations. Subject to certain
exceptions, the Company may not, without the consent of the Treasury, engage in repurchases of the
Companys common stock or trust preferred securities for three years or, if earlier, the date on
which all shares of Series A Preferred Stock issued to the Treasury have been redeemed or
transferred by the Treasury.
Regulations allow bank holding companies and banks to include subordinated debentures, subject
to some limitations, as a component of capital for the purpose of meeting certain regulatory
requirements.
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Table of Contents
Note 11 Income Taxes
(Table amounts in $ 000s)
A summary of federal and state income taxes on operations follow:
2009 | 2008 | 2007 | ||||||||||
Current payable tax: |
||||||||||||
Federal |
$ | (2,174 | ) | $ | 276 | $ | 2,032 | |||||
State |
0 | 0 | 0 | |||||||||
Change in valuation allowance |
13,680 | 0 | 0 | |||||||||
Deferred tax (benefit) |
(5,944 | ) | (6,561 | ) | 68 | |||||||
Provision for income taxes |
$ | 5,562 | $ | (6,285 | ) | $ | 2,100 | |||||
The components of deferred tax assets and liabilities at December 31, 2009 and 2008 follow:
2009 | 2008 | |||||||
Deferred tax assets: |
||||||||
Allowance for loan and lease losses |
$ | 6,998 | $ | 4,636 | ||||
Deferred compensation and directors fees |
94 | 91 | ||||||
Net operating loss carry forward for state income tax purposes |
856 | 405 | ||||||
Net operating loss carry forward for federal income tax purposes |
1,275 | 186 | ||||||
Alternative minimum tax credit carry forward |
380 | 0 | ||||||
Low income housing limited partnership credit carry forward |
322 | 80 | ||||||
Impairment on securities available for sale |
4,666 | 4,092 | ||||||
Unrealized loss on securities available for sale |
1,102 | 0 | ||||||
Other items |
921 | 178 | ||||||
Gross deferred tax assets |
16,614 | 9,668 | ||||||
Deferred tax liabilities: |
||||||||
Depreciation |
(836 | ) | (813 | ) | ||||
Federal Home Loan Bank stock dividends |
(195 | ) | (195 | ) | ||||
Deferred loan fees |
(267 | ) | (146 | ) | ||||
Basis difference in acquired assets |
(514 | ) | (684 | ) | ||||
Unrealized gain on securities available for sale |
0 | (939 | ) | |||||
Other items |
(20 | ) | (94 | ) | ||||
Gross deferred tax liabilities |
(1,832 | ) | (2,871 | ) | ||||
Valuation allowance |
(13,680 | ) | 0 | |||||
Net deferred tax asset |
$ | 1,102 | $ | 6,797 | ||||
The remaining net deferred tax asset of the Company at year-end 2009 of $1,102,000 consisted
primarily of the tax effect of the net gross unrealized losses of the Companys securities. There
was no deferred tax asset valuation allowance against these deferred taxes as the market values of
the securities change. Subsequent to year-end, at February 28, 2010, the Company had a deferred tax
liability as the Company had net gross unrealized gains on its securities.
In 2009, the Company had an accumulated net operating loss for state income tax purposes of
approximately $17,757,000, which will be carried forward to reduce future taxable income. The net
operating loss carried forward will begin to expire in 2017 if it is not utilized.
In 2009, the Company had an accumulated net operating loss for federal income tax purposes of
approximately $3,750,000, which will be carried forward to reduce future taxable income. The credit
will expire in 2029 if it is not utilized.
In 2009, the Company had a low income housing investments tax credit carry forward of $322,000
for federal income tax purposes. This credit will expire in 2026 if it is not utilized.
In 2009, the Company had an alternative minimum tax credit carry forward of $380,000 for
federal income tax purposes. There is no statutory expiration date for the alternative minimum tax
credits.
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Table of Contents
Note 11 Income Taxes (continued)
(Table amounts in $ 000s)
The provision for income taxes differs from that computed at the statutory federal
corporate rates as follows:
2009 | 2008 | 2007 | ||||||||||
Income tax calculated at statutory rate (34%) |
$ | (10,199 | ) | $ | (5,290 | ) | $ | 2,206 | ||||
Add (subtract) tax effect of |
||||||||||||
Tax-exempt income, net of disallowed
interest expense |
(171 | ) | (218 | ) | (135 | ) | ||||||
State income tax, net of federal tax benefit |
(143 | ) | (810 | ) | (27 | ) | ||||||
Tax credits from low income housing
investments |
(80 | ) | (80 | ) | (81 | ) | ||||||
Goodwill impairment |
3,696 | 0 | 0 | |||||||||
Change in valuation allowance |
13,680 | 0 | 0 | |||||||||
Other items, net |
(1,221 | ) | 113 | 137 | ||||||||
Provision for income taxes |
$ | 5,562 | $ | (6,285 | ) | $ | 2,100 | |||||
During 2009, the Company recognized a $9,522,000 write-down of goodwill. The Company was
unable to tax effect the goodwill write-down as the goodwill primarily was derived from the
acquisition of another financial institution through the purchase of the financial institutions
stock.
Prior to being merged with the Bank, the former subsidiary, First Federal Bank, fsb (the
Thrift) qualified under provisions of the Internal Revenue Code which permitted it to deduct from
taxable income a provision for bad debts which differed from the provision charged to income in the
financial statements. Tax legislation passed in 1996 requires all thrift institutions to deduct a
provision for bad debts for tax purposes based on actual loss experience. Retained earnings at
December 31, 2009, includes approximately $3,269,000 for which no provision for federal income
taxes has been made. If, in the future, this portion of retained earnings is used for any purpose
other than to absorb bad debt losses, federal income taxes would be imposed at the then prevailing
rates, resulting in approximately $1,269,000 of deferred tax liability.
At year-end 2009, management reviewed whether it had any material contingent liabilities
associated with uncertain tax positions and determined that it had none.
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Table of Contents
Note 12 Preferred Stock
On February 20, 2009, pursuant to the Treasurys TARP CPP, the Company issued to the Treasury,
in exchange for total proceeds of $17,211,000, (i) 17,211 shares of the Companys Fixed Rate
Cumulative Perpetual Preferred Stock, Series A (the Series A Preferred Stock), par value $.40 per
share and a liquidation amount per share equal to $1,000 per share, and (ii) a ten-year warrant
(the Warrant) to purchase up to 584,084 shares of the Companys common stock, at an exercise
price of $4.42 per share. The $17,211,000 of proceeds were allocated to the Series A Preferred
Stock and the Warrant based on the relative fair value of the instruments. The fair value of the
Series A Preferred Stock was estimated using an approximate 12% discount rate and a five-year
expected life. A fair value of $681,000 was estimated for the warrants using a Black-Sholes
valuation. The assumptions used in Black-Sholes valuation were as follows: $4.42 strike price based
on the contract, approximately 53% for the calculated volatility, 3.1% for the weighted average
dividends, five years for the expected term and 2% for the risk free rate.
The difference between the initial carrying value of $16,530,000 that was allocated to the
Series A Preferred Stock and its redemption value of $17,211,000 will be charged to retained
earnings (with a corresponding increase to the carrying value of the Series A Preferred Stock) over
the first five years as an adjustment to the dividend yield using the effective yield method. The
Series A Preferred Stock is generally non-voting and qualifies as Tier 1 capital.
In the event of a liquidation or dissolution of the Company, the Series A Preferred Stock then
outstanding takes precedence over the Companys common stock for the payment of dividends and
distribution of assets.
Dividends are payable quarterly on the Series A Preferred Stock at an annual dividend rate of
5% per year for the first five years, and 9% per year thereafter. The effective yield of the Series
A Preferred Stock approximates 5.94%. In November 2009, the Company notified the Treasury of its
intent to suspend its dividend payments on its Series A Preferred Stock. At November 15, 2009, the
Company suspended its dividend payment to the Treasury of $215,000. The suspension of dividend
payments is permissible under the terms of the TARP CPP, but the dividend is a cumulative dividend
and failure to pay dividends for six dividend periods would trigger board of director appointment
rights for the holder of the Series A Preferred Stock.
For as long as any shares of Series A Preferred Stock are outstanding, no dividends may be
declared or paid on the Companys common stock unless all accrued and unpaid dividends for all past
dividend periods on the Series A Preferred Stock are fully paid. Pursuant to the Capital Purchase
Program, the Treasury Departments consent is required for any increase in dividends on the
Companys common stock from the amount of $0.40 per share, the last semi-annual stock dividend
declared by the Company prior to October 14, 2008, unless the Series A Preferred Stock is redeemed
in whole or the Treasury Department has transferred all of the Series A Preferred Stock it owns to
third parties.
The Company may not repurchase any of its common stock of the Company without the prior
consent of the Treasury for as long as the shares of Series A Preferred Stock are outstanding to
the Treasury or the Treasury transfers all of the Series A Preferred Stock it owns to third
parties.
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Table of Contents
Note 13 Regulatory Matters
(Table amounts in $ 000s)
The Company and its subsidiary, NorStates Bank, are subject to regulatory capital requirements
administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action
regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet
items calculated under regulatory accounting practices. Capital amounts and classifications are
also subject to qualitative judgments by regulators about components, risk weighting, and other
factors, and the regulators can lower classifications in certain cases. Failure to meet various
capital requirements can initiate regulatory action that could have a direct material effect on the
financial statements.
The prompt corrective action regulations provide five statutory classifications, including
well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and
critically undercapitalized, although these terms are not used to represent overall financial
condition. If adequately capitalized, regulatory approval is required for the Bank to accept
brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required.
Actual capital levels and minimum statutory required levels were as follows at December 31, 2009 and 2008: |
Minimum Required to be | ||||||||||||||||||||||||
Minimum Required | Well Capitalized | |||||||||||||||||||||||
For Capital | Under Prompt Corrective | |||||||||||||||||||||||
Actual | Adequacy Purposes | Action Regulations | ||||||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
2009 | ||||||||||||||||||||||||
Tier I Capital (to average assets) |
||||||||||||||||||||||||
Consolidated |
$ | 51,576 | 8.10 | % | $ | 25,457 | 4.00 | % | N/A | |||||||||||||||
NorStates Bank |
51,045 | 8.05 | 25,355 | 4.00 | 31,694 | 5.00 | ||||||||||||||||||
Tier I Capital (to risk weighted assets) |
||||||||||||||||||||||||
Consolidated |
51,576 | 11.17 | 18,476 | 4.00 | N/A | |||||||||||||||||||
NorStates Bank |
51,045 | 11.05 | 18,477 | 4.00 | 27,716 | 6.00 | ||||||||||||||||||
Total Capital (to risk weighted assets) |
||||||||||||||||||||||||
Consolidated |
57,501 | 12.45 | 36,952 | 8.00 | N/A | |||||||||||||||||||
NorStates Bank |
56,970 | 12.33 | 36,954 | 8.00 | 46,193 | 10.00 | ||||||||||||||||||
2008 |
||||||||||||||||||||||||
Tier I Capital (to average assets) |
||||||||||||||||||||||||
Consolidated |
$ | 59,686 | 9.04 | % | $ | 26,407 | 4.00 | % | N/A | |||||||||||||||
NorStates Bank |
50,593 | 7.70 | 26,297 | 4.00 | 32,872 | 5.00 | ||||||||||||||||||
Tier I Capital (to risk weighted assets) |
||||||||||||||||||||||||
Consolidated |
59,686 | 10.50 | 22,744 | 4.00 | N/A | |||||||||||||||||||
NorStates Bank |
50,583 | 9.19 | 22,013 | 4.00 | 33,020 | 6.00 | ||||||||||||||||||
Total Capital (to risk weighted assets) |
||||||||||||||||||||||||
Consolidated |
66,834 | 11.75 | 45,488 | 8.00 | N/A | |||||||||||||||||||
NorStates Bank |
57,516 | 10.50 | 44,027 | 8.00 | 55,034 | 10.00 |
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Table of Contents
Following a joint examination of NorStates Bank (Bank) by the Federal Deposit Insurance
Corporation (FDIC) and the Illinois Department of Financial and Professional Regulation
(IDFPR), the Board of Directors of the Bank approved and signed on September 21, 2009, a
memorandum of understanding (MOU) concerning the Banks commitment to enhance certain areas of
the Banks operation as identified during the regulators examination of the Bank.
The MOU provides an understanding among the FDIC, IDFPR and the Bank, that the Bank will,
among other things adopt written plans to: (i) formulate and implement a profit plan and budget,
including goals and strategies fro improving earnings; (ii) create a written plan to monitor,
improve and lessen risks from the Banks substandard assets; (iii) implement steps to correct loan
administration weaknesses; and (iv) maintain the Banks Leverage Ratio at a level at or exceeding
8% while the MOU is in effect. As noted above, the Banks Leverage Ratio was 8.05% as of December
31, 2009. Pursuant to the MOU, the Bank will submit quarterly progress reports to the FDIC and the
IDFPR with respect to the matters outlined in the MOU. Management is committed to resolving the
issues addressed in the MOU as promptly as possible, and has already taken numerous steps to
address these matters prior to executing the MOU.
Following a review of the Company by the Federal Reserve Bank of Chicago (Federal Reserve),
the Board of Directors of the Company adopted a Board Resolution dated November 17, 2009 whereby
the Company agreed to obtain written approval from the Federal Reserve prior to: (1) paying
dividends to common or preferred stockholders (2) increasing holding company level debt or
subordinated debentures issued in conjunction with trust preferred securities obligations (3)
paying interest on subordinated debentures.
In response, in November 2009, the Company notified the U.S. Treasury Department of its intent
to suspend its dividend payments on its Fixed Rate Cumulative Perpetual Preferred Stock, Series A.
The suspension of the dividend payments is permissible under the terms of the TARP Capital Purchase
Program, but the dividend is a cumulative dividend and failure to pay dividends for six dividend
periods would trigger board of director appointment rights for the holder of the Series A Preferred
Stock. While dividends are being deferred on the preferred stock issued under the TARP Capital
Purchase Program, the Company may not pay dividends on its common stock. Also, per the Board
Resolution, in November 2009, the Company notified the trustee that holds the Companys junior
subordinated debentures relating to its trust preferred securities that the Company would be
deferring its regularly scheduled quarterly interest payments. The Company has the right to defer
the payment of interest on the junior subordinated debentures at any time, for a period not to
exceed 20 consecutive quarters. During the deferral period, the Company may not pay any dividends
on its common or preferred stock. Accordingly, the Company may not now pay dividends on its common
stock and does not contemplate the ability to pay dividends on its common stock for the foreseeable
future.
For subsequent events affecting regulatory matters, see Note 21 and Note 22. |
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Table of Contents
Note 14 Commitments, Off-Balance Sheet Risk, and Contingencies
(Table amounts in $ 000s)
There are various contingent liabilities that are not reflected in the financial statements,
including claims and legal actions arising in the ordinary course of business. In the opinion of
management, after consultation with legal counsel, the ultimate disposition of these matters is not
expected to have a material effect on financial condition or results of operations.
At year-end 2009 and 2008, reserves of $9,108,000 and $6,262,000 were required as deposits
with the Federal Reserve or as cash on hand. At year-end 2009, the Company earns interest on its
deposits at the Federal Reserve at a rate of 0.25%.
Cash and cash equivalents at December 31, 2009 and 2008 included $17,956,000 and $14,352,000
at the Companys main correspondent bank, Bank of America, Chicago IL.
Some financial instruments are used in the normal course of business to meet the financing
needs of customers and to reduce exposure to interest rate changes. These financial instruments
include commitments to extend credit, standby letters of credit, and financial guarantees. These
involve, to varying degrees, credit and interest-rate risk in excess of the amount reported in the
financial statements.
The same credit policies are used for commitments and conditional obligations as are used for
loans. Collateral or other security is normally not required to support financial instruments with
credit risk.
Commitments to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the commitment. 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 used, the commitment does not necessarily
represent future cash requirements. Standby letters of credit and financial guarantees written are
conditional commitments to guarantee a customers performance to a third party.
A summary of the notional or contractual amounts of financial instruments with
off-balance-sheet risk at year-end follows:
2009 | 2008 | |||||||
Unused lines of credit and commitments to make loans: | ||||||||
Fixed rate |
$ | 8,496 | $ | 12,583 | ||||
Variable rate |
50,241 | 70,825 | ||||||
Total |
$ | 58,737 | $ | 83,408 | ||||
Standby letters of credit |
$ | 6,535 | $ | 7,800 |
Commitments to make loans at a fixed rate have interest rates ranging primarily from 6.00% to 7.50% at December 31, 2009. |
Commitments to make loans to related parties totaled $1,887,000 and $1,885,000 at December 31, 2009 and 2008. |
Other real estate includes a property acquired in 1987 through the receipt of a deed in lieu
of foreclosure. This property is a former commercial/industrial site located overlooking Lake
Michigan in Waukegan, Illinois, with a carrying value of $2,081,000 at December 31, 2009. During
the fourth quarter of 2009, the Company had an independent environmental consultant update its
opinion as to the estimated environmental remediation costs that may be incurred in disposing
of this property. This updated report estimated that there were costs remaining of approximately
$104,000 to achieve acceptable levels of contaminants for commercial/industrial or restricted
residential land use and to prevent migration of contaminants to adjoining off-site properties and
Lake Michigan. The Company has made environmental improvements to the property of $90,000 and
$281,000 during 2009 and 2008, respectively. No determination has yet been made as to the ultimate
use of the property, which must be approved by the City of Waukegan as part of its Lakefront
Downtown Master Plan. The appraised value of the property supports the Companys carrying value
plus the estimated remaining remediation costs. At this time no liability has been recorded for the
remaining estimated environmental remediation costs.
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Table of Contents
Note 15 Earnings Per Share and Capital Matters
(Table amounts in $ 000s, except per share data)
Information related to common stockholders equity at December 31, 2009 and 2008 was as follows:
2009 | 2008 | |||||||
Par value per share |
$ | 0.40 | $ | 0.40 | ||||
Authorized shares |
6,500,000 | 6,500,000 | ||||||
Issued shares |
4,472,255 | 4,472,255 | ||||||
Outstanding shares |
4,072,255 | 4,072,255 | ||||||
Treasury shares |
400,000 | 400,000 |
Net (loss) income was utilized to calculate earnings (loss) per share for all years presented.
During 2009, the Company had preferred stock and common stock equivalents from warrants related to
funds received from the U.S. Department of the Treasury (the Treasury Department) through its
Capital Purchase Program. However, common stock equivalents from warrants during 2009 were
antidilutive and, therefore, not considered in computing diluted earnings per share. The Company
had no common stock equivalents during 2008 and 2007.
Net (loss) income available to common stockholders was utilized to calculate both basic and
diluted earnings per share for all years presented. Information regarding weighted average shares
utilized in computing basic and diluted earnings per share is as follows:
2009 | 2008 | 2007 | ||||||||||
Basic earnings per share: |
||||||||||||
Net (loss) income |
$ | (35,558 | ) | $ | (9,273 | ) | $ | 4,388 | ||||
Dividends to preferred stockholders |
743 | 0 | 0 | |||||||||
Accretion of discount on preferred stock |
111 | 0 | 0 | |||||||||
Net (loss) income available to common stockholders |
$ | (36,412 | ) | $ | (9,273 | ) | $ | 4,388 | ||||
Weighted average common shares outstanding |
4,072,255 | 4,102,276 | 4,189,256 | |||||||||
Basic earnings per share |
$ | (8.94 | ) | $ | (2.26 | ) | $ | 1.05 | ||||
Diluted earnings per share: |
||||||||||||
Net (loss) income |
$ | (35,558 | ) | $ | (9,273 | ) | $ | 4,388 | ||||
Dividends to preferred stockholders |
743 | 0 | 0 | |||||||||
Accretion of discount on preferred stock |
111 | 0 | 0 | |||||||||
Net (loss) income available to common stockholders |
$ | (36,412 | ) | $ | (9,273 | ) | $ | 4,388 | ||||
Weighted average common shares outstanding |
4,072,255 | 4,102,276 | 4,189,256 | |||||||||
Add: Dilutive effect of common stock equivilents |
0 | 0 | 0 | |||||||||
Weighted average common and dilutive common shares outstanding |
4,072,255 | 4,102,276 | 4,189,256 | |||||||||
Diluted earnings per share |
$ | (8.94 | ) | $ | (2.26 | ) | $ | 1.05 | ||||
80
Table of Contents
Note 16 Other Comprehensive (Loss) Income
(Table amounts in $ 000s)
Other comprehensive (loss) income components and related taxes were as follows: |
Years ended December 31, | 2009 | 2008 | 2007 | |||||||||
Changes in unrealized holding gains
on securities available for sale |
$ | (4,370 | ) | $ | (8,613 | ) | $ | 3,024 | ||||
Reclassification adjustments
for gains recognized in income |
(3,908 | ) | (40 | ) | 0 | |||||||
Impairment losses recognized in income |
3,052 | 10,541 | 0 | |||||||||
Net unrealized (losses) gains |
(5,226 | ) | 1,888 | 3,024 | ||||||||
Adjustment for change in accounting
from adoption
of new accounting
pronouncement (see Note 1) |
1,572 | 0 | 0 | |||||||||
Tax effect |
1,431 | (749 | ) | (1,172 | ) | |||||||
Other comprehensive (loss) income |
$ | (2,223 | ) | $ | 1,139 | $ | 1,852 | |||||
81
Table of Contents
Note 17 Fair Value Measurement
(Table amounts in $ 000s)
Below shows information about the Companys securities that were measured at fair value on a
recurring basis at year-end 2009, and the valuation techniques used by the Company on a recurring
basis at year-end 2009 and 2008, and the valuation techniques used by the Company to determine fair
values.
In general, fair values determined by Level 1 inputs use a quoted price in active markets for
identical securities that the Company had the ability to access.
Fair values determined by Level 2 inputs use other inputs that are observable, either directly
or indirectly. These Level 2 inputs include quoted prices for similar securities in active markets,
and other input such as interest rates and yield curves that are observable at commonly quoted
intervals.
Level 3 inputs are unobservable inputs, including inputs that are available in situations
where there is little, if any, market activity for the related securities.
In instances where inputs used to measure fair value fall into different levels in the above
fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest
input that is significant to the valuation. The Companys assessment of the significance of
particular inputs to these fair value measurements requires judgment and considers factors specific
to each security.
On an annual basis, the Company validates the measurement of the fair values of its securities
to an independent securities valuation firm. This independent securities valuation firm determines
the fair values of the securities portfolio that is then compared to the fair value using the
methods outlined. When this validation was last done on September 30, 2009, the difference between
the fair value reported and the fair value determined by the independent securities valuation firm
was considered immaterial.
Fair Value Measurements at Reporting Date Using | ||||||||||||||||
Quoted Prices | ||||||||||||||||
in Active | Significant | |||||||||||||||
Markets for | Other | Significant | ||||||||||||||
Identical | Observable | Unobservable | ||||||||||||||
Assets | Inputs | Inputs | ||||||||||||||
Securities Available for Sale | Total | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
At December 31, 2009 |
$ | 133,421 | $ | 1,006 | $ | 132,378 | $ | 37 | ||||||||
At December 31, 2008 |
$ | 103,194 | $ | 1,024 | $ | 99,905 | $ | 2,265 | ||||||||
The Companys change in Level 3 measured at fair value on a recurring basis were as follows:
Securities | ||||
Available | ||||
for Sale | ||||
Balance at December 31, 2007 |
$ | 0 | ||
Total realized losses included in income |
(8,529 | ) | ||
Total unrealized gains (losses) included in other comprehensive income |
0 | |||
Net transfers into Level 3 |
10,794 | |||
Balance at December 31, 2008 |
2,265 | |||
Total realized losses included in income |
(3,052 | ) | ||
Total unrealized gains (losses) included in other comprehensive income |
830 | |||
Net principal reductions |
(6 | ) | ||
Net transfers into Level 3 |
0 | |||
Balance at December 31, 2009 |
$ | 37 | ||
82
Table of Contents
Note 17 Fair Value Measurement (continued)
(Table amounts in $ 000s)
The Company used accounting guidelines to determine other than temporary impairment losses on
its Collateralized Debt Obligations (CDOs) as the fair values of these securities were not
readily determinable by the market. The impairment losses on the CDOs were due to defaults and
deferral of payments by the financial institutions and insurance companies that issued the debt
underlying the securities. The Company used cash flow analyses on its CDOs to determine other than
temporary impairment losses of $3,052,000 on these CDOs during 2009. The cash flow analyses used at
December 31, 2009 assumed that 5.00 percent of the debt that underlies the CDOs will default during
2010, and annually thereafter, there will be defaults of 1.25 percent and recoveries of .15 percent
lagging two years after the defaults. The Company believes that these estimates are supportable
based on its analyses of actual defaults and deferrals and of the actual financial condition of the
debtors underlying the CDOs. At year-end 2009 and 2008, the Companys carrying value of the CDOs
was $37,000 an $2,265,000, respectively.
The Company also has assets that under certain conditions are subject to measurement at fair
value on a nonrecurring basis. These assets are held to maturity loans or other real estate owned
that are considered impaired per accounting principles. The Company has estimated the fair value of
these impaired assets using Level 3 inputs, specifically discounted cash flow projections or fair
value of collateral.
Fair Value Measurements at Reporting Date Using | ||||||||||||||||
Quoted Prices | ||||||||||||||||
in Active | Significant | |||||||||||||||
Markets for | Other | Significant | ||||||||||||||
Identical | Observable | Unobservable | ||||||||||||||
Assets | Inputs | Inputs | ||||||||||||||
Impaired Loans | Total | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
At December 31, 2009
|
$ | 25,447 | $ | 0 | $ | 0 | $ | 25,447 | ||||||||
At December 31, 2008
|
$ | 22,822 | $ | 0 | $ | 0 | $ | 22,822 | ||||||||
During 2009 and 2008, the Company recorded adjustments to certain collateral dependent loans
that were measured for impairment in accordance with accounting guidelines. Such amounts are
generally based on the estimated underlying collateral values less estimated costs to sell that
support the loans. In cases where the carrying value of the loans exceed the estimated fair value
of the collateral less estimated costs, an impairment loss was recognized.
Fair Value Measurements at Reporting Date Using | ||||||||||||||||
Quoted Prices | ||||||||||||||||
in Active | Significant | |||||||||||||||
Markets for | Other | Significant | ||||||||||||||
Identical | Observable | Unobservable | ||||||||||||||
Assets | Inputs | Inputs | ||||||||||||||
Impaired Other Real Estate Owned | Total | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
At December 31, 2009 |
$ | 13,185 | $ | 0 | $ | 0 | $ | 13,185 | ||||||||
At December 31, 2008 |
$ | 982 | $ | 0 | $ | 0 | $ | 982 | ||||||||
During 2009 and 2008, the Company recorded adjustments to certain properties carried as other
real estate owned that were measured for impairment in accordance with accounting guidelines. Such
amounts are generally based on the estimated underlying fair values of the properties less
estimated costs to sell. In cases where the carrying value of the properties exceed the estimated
fair value of the property less estimated costs, an impairment loss was recognized.
83
Table of Contents
Note 18 Fair Values of Financial Instruments
(Table amounts in $ 000s)
The following methods and assumptions were used to estimate fair values for financial
instruments. Securities fair values are based on quoted market prices or, if no quotes are
available, on the rate and term of the security and or information about the issuer. For loans,
leases, deposits, securities sold under repurchase agreements and fixed rate FHLB advances, the
fair value is estimated by discounted cash flow analysis using market rates for the estimated life
and credit risk. Fair values for impaired loans are estimated using discounted cash flow analyses
or underlying collateral values, where applicable. Then fair value of off-balance sheet items is
based on the fees or cost that would currently be charged to enter or terminate such arrangements,
and the fair value is not material.
The estimated year end fair values of financial instruments were: |
Carrying | Estimated | |||||||
2009 | Value | Fair Value | ||||||
Financial assets: |
||||||||
Cash and cash equivalents |
$ | 34,194 | $ | 34,194 | ||||
Securities available for sale |
133,421 | 133,421 | ||||||
Loans and leases, net |
413,259 | 418,085 | ||||||
Federal Home Loan Bank stock |
1,801 | 1,801 | ||||||
Accrued interest receivable |
2,203 | 2,203 | ||||||
Financial liabilities: |
||||||||
Deposits |
$ | (517,236 | ) | $ | (519,606 | ) | ||
Securities sold under repurchase agreements |
(49,364 | ) | (49,244 | ) | ||||
Subordinated debentures |
(10,000 | ) | (6,728 | ) | ||||
Advances from borrowers for taxes and insurance |
(898 | ) | (898 | ) | ||||
Accrued interest payable |
(1,773 | ) | (1,773 | ) |
Carrying | Estimated | |||||||
2008 | Value | Fair Value | ||||||
Financial assets: |
||||||||
Cash and cash equivalents |
$ | 21,868 | $ | 21,868 | ||||
Securities available for sale |
103,194 | 103,194 | ||||||
Loans and leases, net |
470,410 | 485,206 | ||||||
Federal Home Loan Bank stock |
1,757 | 1,757 | ||||||
Accrued interest receivable |
2,334 | 2,334 | ||||||
Financial liabilities: |
||||||||
Deposits |
$ | (500,821 | ) | $ | (505,905 | ) | ||
Securities sold under repurchase agreements |
(42,574 | ) | (42,541 | ) | ||||
Federal Home Loan Bank advances |
(20,000 | ) | (20,004 | ) | ||||
Subordinated debentures |
(10,000 | ) | (10,151 | ) | ||||
Advances from borrowers for taxes and insurance |
(1,011 | ) | (1,011 | ) | ||||
Accrued interest payable |
(2,331 | ) | (2,331 | ) |
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Table of Contents
Note 19 Parent Company Condensed Financial Statements
(Table amounts in $ 000s)
Following are condensed parent company financial statements:
Condensed Balance Sheets
December 31, | 2009 | 2008 | ||||||
Assets |
||||||||
Cash on deposit at subsidiary bank noninterest bearing |
$ | 1,024 | $ | 1,604 | ||||
Interest-bearing deposits in unaffiliated bank |
0 | 0 | ||||||
Total cash and cash equivalents |
1,024 | 1,604 | ||||||
Investment in wholly-owned subsidiary bank |
49,769 | 62,436 | ||||||
Investment in wholly-owned subsidiary company |
26 | 7,239 | ||||||
Other assets |
3 | 458 | ||||||
Total assets |
$ | 50,822 | $ | 71,737 | ||||
Liabilities and Stockholders Equity |
||||||||
Accounts payable and other liabilities |
$ | 521 | $ | 123 | ||||
Subordinated debentures |
10,000 | 10,000 | ||||||
Total liabilities |
10,521 | 10,123 | ||||||
Stockholders equity |
40,301 | 61,614 | ||||||
Total liabilities and stockholders equity |
$ | 50,822 | $ | 71,737 | ||||
Condensed Statements of Operations
Years ended December 31, | 2009 | 2008 | 2007 | |||||||||
Operating income |
||||||||||||
Dividends from NorStates Bank |
$ | 0 | $ | 9,951 | $ | 2,936 | ||||||
Dividends from NorProperties, Inc |
5,473 | 0 | 0 | |||||||||
Interest income |
0 | 0 | 2 | |||||||||
Total operating income |
5,473 | 9,951 | 2,938 | |||||||||
Operating expenses |
||||||||||||
Interest expense |
455 | 570 | 680 | |||||||||
Other operating expenses |
417 | 264 | 264 | |||||||||
Total operating expenses |
872 | 834 | 944 | |||||||||
Income before income taxes and equity in undistributed
(overdistributed) earnings of wholly-owned subsidiaries |
4,601 | 9,117 | 1,994 | |||||||||
Income tax benefit (expense) |
(52 | ) | 323 | 365 | ||||||||
Income before equity in undistributed (overdistributed)
earnings of wholly owned subsidiaries |
4,549 | 9,440 | 2,359 | |||||||||
Equity in undistributed (overdistributed) earnings of NorStates Bank |
(32,894 | ) | (17,652 | ) | 2,029 | |||||||
Equity in undistributed (overdistributed) earnings of NorProperties, Inc |
(7,213 | ) | (1,061 | ) | 0 | |||||||
Net (loss) income |
$ | (35,558 | ) | $ | (9,273 | ) | $ | 4,388 | ||||
85
Table of Contents
Note 19 Parent Company Condensed Financial Statements (continued)
(Table amounts in $ 000s)
Condensed Statements of Cash Flows
Years ended December 31, | 2009 | 2008 | 2007 | |||||||||
Cash flows from operating activities |
||||||||||||
Net (loss) income |
$ | (35,558 | ) | $ | (9,273 | ) | $ | 4,388 | ||||
Adjustments to reconcile net income to
to net cash from operating activities |
||||||||||||
Equity in (undistributed) overdistributed
earnings of NorStates Bank |
32,894 | 17,652 | (2,029 | ) | ||||||||
Equity in (undistributed) overdistributed
earnings of NorProperties, Inc |
7,213 | 1,061 | 0 | |||||||||
Write-down of goodwill |
85 | 0 | 0 | |||||||||
(Increase) decrease in other assets |
45 | 88 | 86 | |||||||||
Increase (decrease) in other liabilities |
398 | (13 | ) | 16 | ||||||||
Net cash provided from operating activities |
5,077 | 9,515 | 2,461 | |||||||||
Cash flows from investing activities |
||||||||||||
Investment in NorStates Bank |
(22,450 | ) | 0 | 0 | ||||||||
Investment in NorProperties Inc |
0 | (8,300 | ) | 0 | ||||||||
Net cash used from investing activities |
(22,450 | ) | (8,300 | ) | 0 | |||||||
Cash flows from financing activities |
||||||||||||
Purchases of treasury stock |
0 | (2,078 | ) | (1,241 | ) | |||||||
Net proceeds from the issuance of preferred stock |
17,211 | 0 | 0 | |||||||||
Dividends paid on preferred stock |
(418 | ) | 0 | 0 | ||||||||
Dividends paid on common stock |
0 | (1,628 | ) | (3,008 | ) | |||||||
Net cash provided (used) from financing activities |
16,793 | (3,706 | ) | (4,249 | ) | |||||||
Decrease in cash and cash equivalents |
(580 | ) | (2,491 | ) | (1,788 | ) | ||||||
Cash and cash equivalents at beginning of year |
1,604 | 4,095 | 5,883 | |||||||||
Cash and cash equivalents at end of year |
$ | 1,024 | $ | 1,604 | $ | 4,095 | ||||||
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Note 20 Quarterly Financial Data (Unaudited)
(Table amounts in $000s, except per share data)
Interest | Net Interest | Net (Loss) | Earnings per Share | |||||||||||||
2009 | Income | Income | Income | Basic and Diluted (1) | ||||||||||||
First quarter (2) |
$ | 7,789 | $ | 4,793 | $ | (1,457 | ) | $ | (0.39 | ) | ||||||
Second quarter (3) |
7,213 | 4,566 | (11,831 | ) | (2.97 | ) | ||||||||||
Third quarter (4) |
7,375 | 4,963 | (17,742 | ) | (4.42 | ) | ||||||||||
Fourth quarter (5) |
6,961 | 4,829 | (4,528 | ) | (1.17 | ) | ||||||||||
$ | 29,338 | $ | 19,151 | $ | (35,558 | ) | $ | (8.94 | ) |
Interest | Net Interest | Net (Loss) | Earnings per Share | |||||||||||||
2008 | Income | Income | Income | Basic and Diluted (1) | ||||||||||||
First quarter |
$ | 9,319 | $ | 5,383 | $ | 1,201 | $ | 0.29 | ||||||||
Second quarter (6) |
8,881 | 5,556 | (150 | ) | (0.04 | ) | ||||||||||
Third quarter (7) |
8,960 | 5,748 | (2,781 | ) | (0.68 | ) | ||||||||||
Fourth quarter (8) |
7,714 | 4,392 | (7,543 | ) | (1.85 | ) | ||||||||||
$ | 34,874 | $ | 21,079 | $ | (9,273 | ) | $ | (2.26 | ) |
(1) | Earnings per share for the quarters and fiscal year have been calculated separately. Accordingly, quarterly amounts may not add to the annual amounts because of rounding, and differences to average shares outstanding quarter to quarter. | |
(2) | During the first quarter 2009, there was a provision for loan and lease losses of $1.7 million as nonperforming loans increased $2.4 million from year-end 2008 and real estate values on properties used as collateral for the nonperforming loans declined. The Company also recognized a loss on the sale of other real estate owned of $1.7 million. | |
(3) | During the second quarter 2009, the Company recognized a $9.5 million one-time write-down of goodwill due to the economy negatively affecting bank stock prices and the Companys earnings. The provision for loan and lease losses was $3.7 million as nonperforming loans increased $10.6 million during the quarter. Impairment write-downs of $628,000 to collateralized debt obligations in the Companys securities portfolio were also recognized. | |
(4) | During the third quarter 2009, the Company had a provision for loan and lease losses of $12.8 million of which $8.3 million was specifically allocated to a $10.3 million loan relationship that had allegations of possible fraud. The Company recognized $9.2 million of increased income tax expense as accounting rules required the creation of a deferred tax asset valuation allowance. The Company took $2.4 million of additional impairment write-downs to its collateralized debt obligations in the Companys securities portfolio. | |
(5) | During the fourth quarter 2009, the Company had gains from the sale of investment securities of $3.9 million. The provision for loan and lease losses was $4.6 million as real estate values on properties used as collateral for the nonperforming loans declined The Company recognized $4.5 million of increased income tax expense as accounting rules required an adjustment to the deferred tax asset valuation allowance. Declining real estate values also caused the Company to recognize a write-down to its other real estate owned of $1.7 million. | |
(6) | During the second quarter 2008, there was a provision for loan and lease losses of $2.7 million due to the growth in nonperforming loans by $7.6 million from year-end 2007. | |
(7) | During the third quarter 2008, there was a provision for loan and lease losses of $5.1 million due to the growth in nonperforming loans by $8.2 million during the quarter. In addition, the Company recognized impairment losses on its securities of $2.3 million mainly relating to impairment to its investment in Federal National Mortgage Association and Federal Home Loan Mortgage Corporation preferred stocks. | |
(8) | During the fourth quarter 2008, the Company recognized impairment losses of $8.4 million on its other bond securities consisting of collateralized debt obligation securities. In addition, there was a provision for loan and lease losses of $5.5 million due to the growth in nonperforming loans by $9.2 million during the quarter. Approximately $1.1 million in loan interest income was also reversed out of interest income as nonperforming loans were placed on nonaccrual status. |
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Note 21 Subsequent Events
During the fourth quarter of 2009, the FDIC and the IDFPR conducted a risk management review
of the Bank. As a result of that review, during the first quarter of 2010, the FDIC and the IDFPR
advised management of their decision to propose that the Bank be required to enter into a joint
Consent Order, whereby the Bank would agree, among other things, to: (1) maintain a Leverage Ratio
of at least 8% and a Total Risk-Based Capital Ratio of at least 12%, (2) prohibit the extension of
additional credit to any existing borrower with an outstanding classified loan or a loan that has
been previously charged-off, (3) adopt written action plans to reduce the Banks level of
classified assets and delinquent loans and to reduce concentrations of credit identified by the
examiners, and (4) adopt a profit plan, a capital contingency plan and a liquidity plan. A final
Consent Order has not yet been negotiated. The Bank expects to report to the FDIC and the IDFPR
quarterly regarding its progress in complying with the provisions to be included in the Consent
Order. Should the Bank enter into the Consent Order, and because the Consent Order establishes
specific capital amounts to be maintained by the Bank, the Bank will not be considered better than
adequately capitalized for capital adequacy purposes, even if the Bank exceeds the levels of
capital set forth in the Consent Order. Currently, the Bank does exceed the capital levels being
proposed by the FDIC and the IDFPR in the proposed Consent Order.
Note 22 Management Plans
For the year ended December 31, 2009, the Company had a net loss of approximately $35,558,000.
As of December 31, 2009, the Banks total risk-based capital ratio was above well capitalized
while core Tier 1 ratios are still above well capitalized. In addition, the Bank experienced
significant decline in asset quality related to loans and investments largely due to downturns in
the national and regional real estate market, but also because of other general economic
conditions. The financial impact of the aforementioned events has resulted in notification by the
Banks Federal and State regulators subsequent to year-end that they intend to issued a formal
Consent Order based on the FDIC risk management review conducted prior to year-end as described in
Note 21.
Definitive plans are being developed to conduct a formal assessment of Banks management. The
Bank continues to dedicate significant resources to effectively identify, monitor, and manage
problem assets and reduce real estate loan concentrations. The Company does not intend to replace
its expected reductions in real estate concentrations due to liquidity and capital considerations.
Dividends have already been restricted and the Company has suspended its dividend payments on its
Series A Preferred Stock issued to the Treasury Department as is permissible under the terms of the
TARP Capital Purchase Program.
In view of these matters, the Banks ability to improve its financial condition is dependent
upon the success of managements plans to address concerns regarding profitability and asset
quality. The Banks management believes they have taken appropriate steps aimed at returning the
Bank to profitability and improving asset quality. Managements success will ultimately be
determined by its implementation of its plans, as well as factors beyond its control, such as the
economy and the real estate market.
88
Table of Contents
Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. |
None.
Item 9A(T). | Controls and Procedures. |
Disclosure Control and Procedures
The Company maintains disclosure and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (the Exchange Act)) that are designed to
ensure that information required to be disclosed in the Companys Exchange Act reports it furnishes
to or files with the Commission is recorded, processed, summarized and reported within the time
periods specified in the Commissions rules and forms, and that such information is accumulated and
communicated to the Companys management, including its President and Chief Executive Officer and
Vice President and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure.
As of the end of the period covered by this report, the Companys management carried out an
evaluation, under the supervision and with the participation of the President and Chief Executive
Officer and Vice President and Chief Financial Officer, of the effectiveness of the design and
operation of the Companys disclosure controls and procedures. Based upon, and as of the date of
that evaluation, the President and Chief Executive Officer and Vice President and Chief Financial
Officer concluded that the Companys disclosure controls and procedures were effective, in all
material respects, to ensure that information required to be disclosed by the Company in reports
that it files under the Exchange Act is recorded, processed, summarized and reported within the
time periods specified in Commission rules and forms.
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Table of Contents
Report of Management on Internal Control over Financial Reporting
The management of Northern States Financial Corporation (the Company) is responsible for
establishing and maintaining adequate internal control over financial reporting. The Companys
internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of the financial statements
for external purposes in accordance with accounting principles generally accepted in the United
States of America. The Companys internal control over financial reporting includes those policies
and procedures that (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with accounting principles generally accepted in the United
States of America, and that receipts and expenditures of the Company are being made only in
accordance with authorizations of management and directors of the Company; and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the Companys assets that could have a material effect on the financial statements.
Management has assessed the effectiveness of the Companys internal control over financial
reporting as of December 31, 2009, based on the framework set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based
on that assessment, management concluded that, as of December 31, 2009, the Companys internal
control over financial reporting was effective based on the criteria established in Internal
Control-Integrated Framework.
/s/ Scott Yelvington
|
/s/ Brett Houston | |
Scott Yelvington
|
Brett Houston | |
President & Chief Executive Officer
|
Vice President & Chief Financial Officer |
This annual report does not included an attestation report of the Companys registered public
accounting firm regarding internal control over financial reporting. Managements report was not
subject to attestation by the Companys registered public accounting firm pursuant to temporary
rules of the Commission that permit the Company to provide only managements report in the annual
report.
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Table of Contents
Changes in Internal Control over Financial Reporting
There were no changes in the Companys internal control over financial reporting during the
three months ended December 31, 2009 that have materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting.
Item 9B. | Other Information. |
None.
PART III
Item 10. | Directors, Executive Officers, and Corporate Governance. |
Directors
The information required by this item with respect to Directors of the Company is set forth
under the caption Directors and Executive Officers in the Companys definitive proxy statement,
relating to its 2010 Annual Meeting of Stockholders (the Proxy Statement), to be filed within 120
days of December 31, 2009 and is incorporated herein by reference as if set forth in full herein as
permitted by the General Instruction G(3) to Form 10-K.
Executive Officers
The Companys executive officers are Scott Yelvington, President and Chief Executive Officer
of the Company, Brett Houston, Vice President and Chief Financial Officer of the Company, Kerry
Biegay, Vice President and Secretary of the Company, Thomas M. Nemeth, Vice President and Treasurer
of the Company, and Shelly Christian, Executive Vice President and Chief Lending Officer of the
Bank. The information called for by this item with respect to executive officers is set forth under
the caption Directors and Executive Officers in the Companys Proxy Statement and is incorporated
herein by reference.
The information set forth under Section 16(a) Beneficial Ownership Reporting Compliance in
the Companys Proxy Statement is incorporated herein by reference.
Information regarding the Companys Nominating and Corporate Governance Committee of its Board
of Directors and the procedures by which stockholders may recommend nominees to the Companys Board
of Directors, and information regarding the Companys Audit Committee of its Board of Directors and
its audit committee financial expert, is included in the Companys Proxy Statement under the
headings Corporate Governance Board Committees Director Nomination Process, Corporate
Governance Board Committees Stockholder Recommendations, Corporate Governance Board
Committees Nominating and Corporate Governance Committee, and Corporate Governance Board
Committees Audit Committee and is incorporated herein by reference.
The Company has adopted a code of ethics as required by the NASDAQ listing standards and the
rules of the SEC. This code applies to the directors and officers of the
Company and its subsidiaries. A copy of the code of ethics is filed as an exhibit to this
report as Exhibit 14. The Company will file on Form 8-K any amendments to, or waivers from, the
code of ethics applicable to any of its directors or executive officers.
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Item 11. | Executive Compensation. |
The information called for by this item is set forth under the captions Compensation
Discussion and Analysis, Summary Executive Officer Compensation, Director Compensation,
Directors Compensation for 2009, Compensation and Employee Benefits Committee Report, and
Summary Compensation Table in the Companys Proxy Statement and is incorporated herein by
reference.
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. |
The information set forth under the caption Security Ownership of Certain Beneficial Owners
and Management in the Companys Proxy Statement is incorporated herein by reference.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information, as of December 31, 2009, relating to our equity
compensation plan pursuant to which equity awards are authorized for issuance.
Equity Compensation Plan Information | ||||||||||||
Number of securities | ||||||||||||
Weighted-average | remaining available for | |||||||||||
Number of securities to | exercise price of | future issuance under | ||||||||||
be issued upon exercise | outstanding options, | equity compensation plans | ||||||||||
of outstanding options, | warrants, and | (excluding securities | ||||||||||
warrants, and rights | rights | reflected in column (a)) | ||||||||||
Equity Compensation Plan Category | (a) | (b) | (c) | |||||||||
Approved by securities holders(1) |
0 | $ | 0 | 400,000 | ||||||||
Not approved by security holders |
0 | 0 | | |||||||||
Total |
0 | $ | 0 | 400,000 | ||||||||
(1) | Includes all shares authorized for issuance under the Companys 2009 Restricted Stock Plan. |
Item 13. | Certain Relationships and Related Transactions, and Director Independence. |
The information called for by this item is set forth under the captions Certain Relationships
and Related Transactions, Directors and Executive Officers and Corporate Governance Board
Committees in the Companys Proxy Statement and is incorporated herein by reference.
Item 14. | Principal Accounting Fees and Services. |
The information called for by this item is set forth under the caption Ratification of the
Selection of Independent Auditors in the Companys Proxy Statement and is incorporated herein by
reference.
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PART IV
Item 15.
|
Exhibits, Financial Statement Schedules. | |
(a).1
|
Financial Statements |
All financial statements of the Company are incorporated herein by reference as set forth under Item 9, Part II of this report on Form 10-K. | ||
2. | Financial Statement Schedules Not applicable | |
3. | Exhibits (numbered in accordance with Item 601 of Regulation S-K) | |
The following exhibits are filed as part of this report: | ||
3.1 | Certificate of Incorporation of the Company, as amended (incorporated herein by reference to the Companys Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 000-19300)). | |
3.2 | Certificate of Amendment of the Certificate of Incorporation of the Company, as amended, dated April 27, 1998 (incorporated herein by reference to the Companys Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 000-19300) filed on March 25, 2009). | |
3.3 | Certificate of Amendment of the Certificate of Incorporation of the Company, as amended, dated January 20, 2009 (incorporated herein by reference to the Companys Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 000-19300) filed on March 25, 2009). | |
3.4 | Certificate of Designations of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, dated February 18, 2009 (incorporated herein by reference to Exhibit 3.1 to the Companys Current Report on Form 8-K (File No. 000-19300) filed on February 20, 2009). | |
3.5 | Amended and Restated By-laws of the Company dated April 20, 2004 (incorporated herein by reference to Exhibit 3.2 to the Companys Quarterly Report on Form 10-Q (File No. 000-19300) filed on May 10, 2004). | |
4.1 | Form of Certificate of the Preferred Stock (incorporated herein by reference to Exhibit 4.1 to the Companys Current Report on Form 8-K (File No. 000-19300) filed on February 20, 2009). | |
4.2 | Warrant to purchase shares of Common Stock (incorporated herein by reference to Exhibit 4.2 to the Companys Current Report on Form 8-K (File No. 000-19300) filed on February 20, 2009). | |
10.1 | Letter Agreement including the Securities Purchase Agreement Standard Terms attached thereto, dated February 20, 2009, between the Company and the U.S. Department of the Treasury, with respect to the issuance and sale of Preferred Stock and the Warrant (incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K (File No. 000-19300) filed on February 20, 2009). | |
10.2 | Side Letter with the U.S. Department of the Treasury, dated February 20, 2009, relating to the Letter Agreement and Securities Purchase Agreement (incorporated herein by reference to Exhibit 10.2 to the Companys Current Report on Form 8-K (File No. 000-19300) filed on February 20, 2009). | |
10.3 | Form of Senior Executive Officer Letter Agreement and Waiver executed by each of the following executive officers of the Company as required pursuant to the Securities Purchase Agreement dated February 20, 2009 entered into between the Company and the U.S. Department of the Treasury: Fred Abdula, Kerry Biegay, Shelly Christian, Brett Houston, Thomas Nemeth and Scott Yelvington (incorporated herein by reference to the Companys Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 000-19300) filed on March 25, 2009).* | |
10.4 | Employment Agreement by and between NorStates Bank and Scott Yelvington dated September 16, 2008 (incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K (File No. 000-19300) filed on September 17, 2008).* |
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10.5 | Northern States Financial Corporation 2009 Restricted Stock Plan (incorporated herein by reference to Appendix A to the Proxy Statement for Northern States Financial Corporations 2009 Annual Meeting of Stockholders (File No. 000-19300) filed on April 23, 2009).* | |
11.1 | Statement of Computation of Per Share Earnings. Contained in Notes 1 and 15 to the consolidated financial statements. | |
14 | Code of Ethics. | |
21 | List of Subsidiaries. | |
24 | Power of Attorney (set forth on signature page). | |
31.1 | Section 302 Certification of President and Chief Executive Officer. | |
31.2 | Section 302 Certification of Vice President and Chief Financial Officer. | |
32 | Section 906 Certification. | |
99.1 | Certification of Chief Executive Officer pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009. | |
99.2 | Certification of Chief Financial Officer pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009. |
* | Exhibits 10.3 through10.5 are management contracts or compensatory plans or arrangements. |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized, on this 26th day of March 2010.
NORTHERN STATES FINANCIAL CORPORATION
(Registrant)
Scott Yelvington, | ||
President and Chief Executive Officer | ||
/s/ Scott Yelvington
|
(Principal Executive Officer) | |
Brett Houston, | ||
Vice President and Chief Financial Officer | ||
/s/ Brett Houston
|
(Principal Financial Officer and Principal Accounting Officer) |
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POWER OF ATTORNEY
Each director of the Registrant, whose signature appears below, hereby appoints Scott
Yelvington and Brett Houston and each of them severally, as his attorney-in-fact, to sign in his
name and on his behalf, as a director of the Registrant, and to file with the Commission any and
all Amendments to this Report on Form 10-K, on this 16th day of March 2010.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the capacities and on this
16th day of March 2010.
Fred Abdula, Director
|
/s/ Fred Abdula | |
Kenneth W. Balza, Director
|
/s/ Kenneth W. Balza | |
Theodore A. Bertrand, Director
|
/s/ Theodore A. Bertrand | |
Jack H. Blumberg, Director
|
/s/ Jack H. Blumberg | |
Frank J. Furlan, Director
|
/s/ Frank J. Furlan | |
James A. Hollensteiner, Director
|
/s/ James A. Hollensteiner | |
Allan J. Jacobs, Director
|
/s/ Allan J. Jacobs | |
Raymond M. Mota, Director
|
/s/ Raymond M. Mota | |
Scott Yelvington, Director
|
/s/ Scott Yelvington | |
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EXHIBIT INDEX
Exhibits
3.1 | Certificate of Incorporation of the Company, as amended (incorporated herein by reference to the Companys Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 000-19300)). | |
3.2 | Certificate of Amendment of the Certificate of Incorporation of the Company, as amended, dated April 27, 1998 (incorporated herein by reference to the Companys Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 000-19300) filed on March 25, 2009). | |
3.3 | Certificate of Amendment of the Certificate of Incorporation of the Company, as amended, dated January 20, 2009 (incorporated herein by reference to the Companys Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 000-19300) filed on March 25, 2009). | |
3.4 | Certificate of Designations of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, dated February 18, 2009 (incorporated herein by reference to Exhibit 3.1 to the Companys Current Report on Form 8-K (File No. 000-19300) filed on February 20, 2009). | |
3.5 | Amended and Restated By-laws of the Company dated April 20, 2004 (incorporated herein by reference to Exhibit 3.2 to the Companys Quarterly Report on Form 10-Q (File No. 000-19300) filed on May 10, 2004). | |
4.1 | Form of Certificate of the Preferred Stock (incorporated herein by reference to Exhibit 4.1 to the Companys Current Report on Form 8-K (File No. 000-19300) filed on February 20, 2009). | |
4.2 | Warrant to purchase shares of Common Stock (incorporated herein by reference to Exhibit 4.2 to the Companys Current Report on Form 8-K (File No. 000-19300) filed on February 20, 2009). | |
10.1 | Letter Agreement including the Securities Purchase Agreement Standard Terms attached thereto, dated February 20, 2009, between the Company and the U.S. Department of the Treasury, with respect to the issuance and sale of Preferred Stock and the Warrant (incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K (File No. 000-19300) filed on February 20, 2009). | |
10.2 | Side Letter with the U.S. Department of the Treasury, dated February 20, 2009, relating to the Letter Agreement and Securities Purchase Agreement (incorporated herein by reference to Exhibit 10.2 to the Companys Current Report on Form 8-K (File No. 000-19300) filed on February 20, 2009). | |
10.3 | Form of Senior Executive Officer Letter Agreement and Waiver executed by each of the following executive officers of the Company as required pursuant to the Securities Purchase Agreement dated February 20, 2009 entered into between the Company and the U.S. Department of the Treasury: Fred Abdula, Kerry Biegay, Shelly Christian, Brett Houston, Thomas Nemeth and Scott Yelvington (incorporated herein by reference to the Companys Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 000-19300) filed on March 25, 2009).* | |
10.4 | Employment Agreement by and between NorStates Bank and Scott Yelvington dated September 16, 2008 (incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K (File No. 000-19300) filed on September 17, 2008).* | |
10.5 | Northern States Financial Corporation 2009 Restricted Stock Plan (incorporated herein by reference to Appendix A to the Proxy Statement for Northern States Financial Corporations 2009 Annual Meeting of Stockholders (File No. 000-19300) filed on April 23, 2009).* | |
11.1 | Statement of Computation of Per Share Earnings. Contained in Notes 1 and 15 to the consolidated financial statements. | |
14 | Code of Ethics. |
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21 | List of Subsidiaries. | |
24 | Power of Attorney (set forth on signature page). | |
31.1 | Section 302 Certification of President and Chief Executive Officer. | |
31.2 | Section 302 Certification of Vice President and Chief Financial Officer. | |
32 | Section 906 Certification. | |
99.1 | Certification of Chief Executive Officer pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009. | |
99.2 | Certification of Chief Financial Officer pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009. |
* | Exhibits 10.3 through10.5 are management contracts or compensatory plans or arrangements. |
98