U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 for the fiscal year ended December 31, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 0-26290
BNCCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 45-0402816
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
322 East Main Avenue 58501
Bismarck, North Dakota (Zip Code)
(Address of principal executive office)
Registrant's telephone number, including area code: (701) 250-3040
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
Common Stock, $.01 par value
Preferred Stock Purchase Rights
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes ___ No X
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the Registrant, computed by reference to the price at which
the common equity was last sold, as of the last business day of the Registrant's
most recently completed second fiscal quarter was $14,943,000.
The number of shares of the Registrant's common stock outstanding on March
15, 2003 was 2,701,829.
Documents incorporated by reference. Portions of the Registrant's proxy
statement to be filed with the Securities and Exchange Commission in connection
with the Registrant's 2003 annual meeting of stockholders are incorporated by
reference into Part III hereof.
BNCCORP, INC.
ANNUAL REPORT ON FORM 10-K
FOR FISCAL YEAR ENDED DECEMBER 31, 2002
TABLE OF CONTENTS
Page
PART I
Item 1. Business................................................. 3
Item 2. Properties............................................... 15
Item 3. Legal Proceedings........................................ 15
Item 4. Submission of Matters to a Vote of Security Holders...... 15
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters............................. 16
Item 6. Selected Financial Data.................................. 17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 19
Item 7A. Quantitative and Qualitative Disclosures
about Market Risk....................................... 54
Item 8. Financial Statements and Supplementary Data.............. 58
Item 9. Changes In and Disagreements With Accountants
on Accounting and Financial Disclosure.................. 108
PART III
Item 10. Directors and Executive Officers of the Registrant....... 108
Item 11. Executive Compensation................................... 108
Item 12. Security Ownership of Certain Beneficial
Owners and Management................................... 108
Item 13. Certain Relationships and Related Transactions........... 108
Item 14. Controls and Procedures.................................. 109
PART IV
Item 15. Exhibits, Financial Statement Schedules and
Reports on Form 8-K..................................... 110
PART I
The discussions contained in this Annual Report on Form 10-K which are not
historical in nature may constitute forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act") and, as such, may involve risks and uncertainties.
We caution readers that these forward-looking statements, including without
limitation, those relating to future business prospects, revenues, working
capital, liquidity, capital needs, interest costs and income of BNCCORP, Inc., a
Delaware corporation, are subject to certain risks and uncertainties that could
cause actual results to differ materially from those indicated in the
forward-looking statements due to several important factors. These factors
include, but are not limited to: risks of loans and investments, including
dependence on local and regional economic conditions; competition for our
customers from other providers of financial services; possible adverse effects
of changes in interest rates including the effects of such changes on derivative
contracts and associated accounting consequences; risks associated with our
acquisition and growth strategies; and other risks which are difficult to
predict and many of which are beyond our control. For a discussion of some of
the additional factors that might cause such differences, see Item 1. Business
"-Factors That May Affect Future Results of Operations."
We refer to "we," "our," "BNC" or the "Company" when such reference includes
BNCCORP, Inc. and its consolidated subsidiaries, collectively; "BNCCORP" when
referring only to BNCCORP, Inc.; "the Bank" when referring only to BNC National
Bank; "Milne Scali" when referring only to Milne Scali & Company, Inc.; "BNC
Insurance" when referring only to BNC Insurance, Inc.; and "BNC AMI" when
referring only to BNC Asset Management, Inc.
Item 1. Business
General / Growth Strategy
BNCCORP is a bank holding company registered under the Bank Holding Company Act
of 1956 (the "BHCA") headquartered in Bismarck, North Dakota. We are dedicated
to providing a broad range of financial products and superior customer service
to businesses and consumers within the communities we serve. BNCCORP operates 21
locations in Arizona, Minnesota and North Dakota through its subsidiary, BNC
National Bank. The Company also provides a wide array of insurance, brokerage
and trust and financial services through BNC National Bank's subsidiaries, Milne
Scali, BNC Insurance and BNC AMI, and the Bank's trust and financial services
division. The Company offers a wide variety of traditional and nontraditional
financial products and services in order to meet the financial needs of its
current customer base, establish new relationships in the markets it serves and
expand its business opportunities.
Expansion, mergers and divestitures have played an important role in our
strategy. During the three years ended December 31, 2002, we completed the
following transactions: established a bank subsidiary in Arizona, merged all of
our banking subsidiaries under one national bank charter, acquired Milne Scali
in April 2002 and sold the Fargo, North Dakota branch of the Bank in September
2002. See Note 2 to the Consolidated Financial Statements included under Item 8
of Part II for further information related to these transactions. We will
continue to emphasize internally generated growth by focusing on increasing our
market share within the communities we serve. We may also seek growth
opportunities through select acquisitions of financial services companies that
we believe complement our businesses. We may also generate growth through de
novo branching in markets such as Arizona, Minnesota, North Dakota and,
possibly, other states.
At December 31, 2002, we had total assets of $602.2 million, total loans of
$335.8 million and total deposits of $398.2 million.
Mission Statement
Our mission is to provide tailor-made financial solutions for our customers that
will assist them in achieving their goals, while enhancing shareholder value.
Goal
Our primary goal continues to be the creation of a well-capitalized financial
services organization focused on local relationship banking and providing a
broad range of financial products and services that will meet the needs of our
customers, both commercial and consumer.
Operating Strategy
We provide relationship-based banking and financial services to small to
mid-sized businesses, business owners, professionals and consumers in our
primary market areas of Arizona, Minnesota and North Dakota. Our goal is to
become a one-stop financial services provider offering traditional bank products
and services, insurance, brokerage, asset management, trust, tax planning and
preparation, employee benefit plan design and administration and other
financial-related services. The other key elements of our operating strategy
are:
o Emphasize individualized, high-level customer service.
o Encourage an entrepreneurial attitude among the employees who provide
products and services.
o Maintain high asset quality by implementing strong loan policies and
continuously monitoring loans and the loan review process.
o Centralize administrative and support functions.
History / Strategic Vision
Since our formation more than 15 years ago, we have diligently pursued a sharply
focused strategic vision: to provide a broad range of financial products and
superior service to a well-defined customer base, primarily consisting of small
to mid-sized businesses, business owners, professionals and consumers. We
believe that our entrepreneurial approach to banking and the introduction of new
products and services will continue to attract small and mid-sized businesses,
their owners and employee base. Small businesses frequently have difficulty
finding banking services that meet their specific needs and have sought banking
institutions that are more relationship-oriented. By remaining committed to this
strategic vision, we have built a company that is distinguished by its:
o Diversified business base of banking, insurance and brokerage / trust
/ financial services;
o Presence in multiple attractive markets: Arizona, Minnesota and North
Dakota;
o Strengthening financial performance, as investments in new businesses
and markets drive earnings growth; and
o Determined management team, with a decided focus on delivering
results.
In this section of this annual report on Form 10-K, we detail these
distinguishing strengths, which have not only helped customers to reach their
financial goals, but also have established a solid foundation upon which to
build shareholder value.
Diversified Business Base. BNCCORP today consists of three core businesses:
banking, insurance and brokerage/trust/financial services. This structure allows
us to offer a wide range of services that is responsive to the financial needs
of our customers, while also diversifying and balancing our sources of revenue.
Banking segment. BNC National Bank operates 15 banking branch offices in three
states. Known for its business banking services such as business financing and
commercial mortgages, corporate cash management and merchant programs, our
banking division also offers a full range of consumer lending and deposit
options. The Bank is differentiated by its service culture of "high personal
touch," supported by effective technology. Among the innovative services offered
are online, bill pay and telephone banking operations, and products such as the
"Sweep/Repo" account, the "Wealthbuilder" family of variable-rate interest
checking and money market deposit products and the BNC cash back debit card.
The banking segment's loans primarily consist of commercial and industrial
loans, real estate mortgage and construction loans, agricultural loans, consumer
loans and lease financing. In allocating our assets among loans, investments and
other earning assets, we attempt to maximize return while managing risk at
acceptable levels. Our primary lending focus is on commercial loans and
owner-occupied real estate loans to small and mid-sized businesses and
professionals. We offer a broad range of commercial and consumer lending
services, including commercial revolving lines of credit, residential and
commercial real estate mortgage and construction loans, consumer loans and
equipment financing. Interest rates charged on loans may be fixed or variable
and vary with the degree of risk, size and maturity of the loans, underwriting
and servicing costs, the extent of other banking relationships maintained with
customers and the Bank's cost of funds. Rates are further subject to competitive
pressures, the current interest rate environment, availability of funds and
government regulations. For more information on our lending activities, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Loan Portfolio" included under Item 7 of Part
II.
Each of our bank branches offers the usual and customary range of depository
products provided by commercial banks, including checking, savings and money
market deposits and certificates of deposit. During 2002, we continued to
increase core deposits largely through the continuing success of our
Wealthbuilder interest checking and money market deposit accounts introduced
during 1999. These are competitively priced floating rate accounts with rates
variable at our discretion. The Bank's deposits are not received from a single
depositor or group of affiliated depositors, the loss of any one of which would
have a material adverse effect on our business. Rates paid on deposits vary
among the categories of deposits due to different terms, the size of the
individual deposit, the nature of other banking relationships with the
depositor, the current interest rate environment and rates paid by competitors
on similar deposits. The Bank also accepts brokered deposits and obtains direct
non-brokered certificates of deposit through national deposit networks when
management believes such transactions are beneficial to the Bank. For more
information on our deposit activities, see "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Financial Condition -
Deposits" included under Item 7 of Part II.
Our banking segment also offers services such as money orders, travelers'
checks, MasterCard and Visa merchant deposit services and, in some markets, safe
deposit, lockbox and messenger services.
Insurance segment. Milne Scali and BNC Insurance are independent insurance
agencies representing many of the nation's leading insurance carriers. Our
insurance operations were greatly expanded in 2002 through the acquisition of
Milne Scali, one of the largest independent insurance agencies in the Arizona
market. Today, we offer a full array of insurance brokerage services with a
strong concentration in business insurance, risk management and employee
benefit-related insurance. We also offer home, personal life, health,
disability, automobile and other vehicle insurance, universal and mortgage life
insurance, workers' compensation, excess liability coverage, farm and crop
insurance and commercial trucking coverage. The insurance segment will generally
have its strongest performance in the first quarter of each fiscal year as
contingency payments from insurance carriers are generally paid during the first
quarter.
Brokerage/trust/financial services segment. BNC AMI and the Bank's trust and
financial services divisions provide customers with an extensive complement of
financial services options. The trust and financial services divisions,
presently operating primarily out of Bismarck, provide trust, financial,
business, estate and tax planning, estate administration, agency accounts,
payroll services, accounting services, employee benefit plan design and
administration, individual retirement accounts ("IRAs"), individual custodial
self-directed IRAs, asset management, tax preparation and the BNC Global
Balanced Collective Investment Fund, a proprietary investment vehicle for
qualified retirement plans. BNC AMI, with offices in Bismarck and Minneapolis,
in affiliation with Raymond James Financial Services, Inc. offers financial
services alternatives such as securities trading, investment management of
institutional and individual accounts, mutual funds and annuities.
With this "palette" of financial resources, a customer can turn to us to obtain
business financing or a home mortgage; access the cash management, insurance,
accounting and tax preparation services needed to run a successful business;
create a 401(k) program for employees; or establish a trust to manage personal
assets - to cite just a few examples. We employ a "relationship pricing matrix"
that gives customers even more reason to take maximum advantage of our diverse
services.
Revenues from external customers, measures of profit and/or loss and total
assets for each of the segments listed above are presented in Note 16 to the
Consolidated Financial Statements included under Item 8 of Part II.
Attractive Markets. We operate in three distinct markets:
Tempe-Phoenix-Scottsdale, Arizona; Minneapolis-St. Paul, Minnesota; and
Bismarck-Mandan, North Dakota and surrounding communities (Crosby, Ellendale,
Garrison, Kenmare, Linton, Stanley and Watford City). While these areas have
very different fundamentals, each enjoys a solid economic base and what we
believe are compelling long-term growth dynamics. To ensure that we maintain a
sharp focus on each market area, Chairman Tracy Scott has responsibility for
managing operations in North Dakota, with President and Chief Executive Officer
Greg Cleveland directly in charge of the Arizona and Minneapolis market areas.
Our Arizona market has been one of the fastest growing areas of the country in
population and personal income for the past several years. The population is
expected to continue increasing at a rate of more than 100,000 per year.
Tourism, retirement and job creation in such industries as software and
biotechnology are among the drivers of the economy, according to studies by the
University of Arizona. Segments with significant operations in the Arizona
market include banking and insurance.
The Twin Cities area is home to a large and growing population, with a tight
labor market and robust construction. The U.S. census estimates that the area's
population will rise by more than 900,000 by 2030, driving business formation
and residential construction over the long term. Key growth industries currently
include electronics manufacturing, healthcare, education and food processing.
Banking is the primary segment operating in the Minneapolis-St. Paul area with
some brokerage activities also conducted in the market.
Bismarck-Mandan is characterized by low unemployment and generally favorable
economic conditions. Bismarck is not only the state capital, but also the trade
and transportation hub for South Central North Dakota. The area is experiencing
strong residential and commercial growth, and its diverse economic base includes
energy, health care, agriculture and an expanding data processing/customer
service component. The banking, insurance and brokerage/trust/financial segments
are all represented in the North Dakota market.
Individually, each of our markets presents strong potential demand for our range
of financial services offerings. Together, we believe they provide attractive
business opportunities and balance our exposure to regional economic cycles.
As of December 31, 2002, 32 percent of our loans were to borrowers located in
North Dakota, 30 percent to borrowers located in Minnesota, 26 percent to
borrowers located in Arizona, 7 percent to borrowers located in South Dakota and
the remainder to borrowers in various other states. Other than brokered
certificates of deposit and direct non-brokered certificates of deposit obtained
through national deposit networks, each banking branch draws most of its
deposits from its general market area.
The following table presents total deposits and net loans outstanding at each of
our locations as of December 31, 2002 (in thousands):
Total Net Loans
Location Deposits Outstanding 1
----------------------------- ----------- -------------
Bismarck, ND............. $119,021 $124,885
Crosby, ND............... 17,263 258
Ellendale, ND............ 11,117 521
Garrison, ND............. 15,363 465
Kenmare, ND.............. 11,830 222
Linton, ND............... 42,698 9,847
Minneapolis, MN.......... 48,650 105,436
Phoenix, AZ.............. 13,186 75,529
Stanley, ND.............. 16,306 958
Tempe, AZ................ 33,148 18,431
Watford City, ND......... 10,973 108
Brokered deposits........ 31,386 --
National market deposits. 27,304 --
---------- ----------
Total ................ $398,245 $336,660
========== ==========
- ------------------
1 Before allowance for credit losses, unearned income and net unamortized
deferred fees and costs.
Strengthening Financial Performance. In 2002, we demonstrated the value of our
financial management strategies. Efforts to diversify our sources of revenue,
and in particular the decision to expand our insurance business through the
Milne Scali acquisition, drove a 64 percent year-over-year increase in earnings.
Our management of our investment portfolio generated unrealized gains of nearly
$4.4 million. We believe that our continued attention to asset quality should
help guard the loan portfolio against future economic shocks.
While we are justifiably proud of these strong results, we believe our full
earnings potential should be even more evident in the coming year due to several
factors. First, our financial performance in 2003 will reflect a full year
contribution from Milne Scali, which was part of the Company for only two full
quarters of 2002. Second, we should benefit from our efforts to improve both the
cost structure and productivity of BNC AMI.
Determined Management Team. Our financial and operational accomplishments during
2002 are, in large measure, a reflection of our determination to enhance
shareholder value. The determination to invest in the future led to a thriving
and highly profitable insurance agency business and the creation of a growing
presence in the Arizona market. A determination to make tough decisions, such as
divesting the Fargo branch of the Bank and maintaining a tight grasp on
operating costs, should lead to greater efficiency and profitability. And, a
determined focus on achieving excellence in business - through superior service,
a consistent vision and prudent financial management - should continue to yield
positive results in the years to come.
Regional Community Banking Philosophy
In order to meet the demands of the increasingly competitive banking and
financial services industries, we employ a regional community banking
philosophy. This philosophy is based on our belief that banking and financial
services clients value doing business with locally managed institutions that can
provide a full service commercial banking relationship through an understanding
of the clients' financial needs and the flexibility to deliver customized
solutions through our menu of products and services. With this philosophy we are
better able to build successful and broadly based client relationships. The
primary focus for our relationship managers is to cultivate and nurture their
client relationships. Relationship managers are assigned to each borrowing
client to provide continuity in the relationship. This emphasis on personalized
relationships requires that all of the relationship managers maintain close ties
to the communities in which they serve so that they are able to capitalize on
their efforts through expanded business opportunities. While client service
decisions and day-to-day operations are maintained at each location, our broad
base of financial services offers the advantage of affiliation with service
providers who can provide extended products and services to our clients.
Additionally, BNCCORP and the Bank provide centralized administrative functions,
including credit and other policy development and review, internal audit and
compliance services, investment management, data processing, accounting, loan
servicing and other specialized support functions.
Distribution methods
We offer our banking and financial products and services through our network of
offices and other traditional industry distribution methods. Additionally, we
offer 24-hour telephone banking services through BNC Bankline. We also provide
Internet banking and bill-pay services through our Internet banking site at
www.bncbank.com. This system allows customers to process account transactions,
transfer funds, initiate wire transfers, automated clearing house transactions
and stop payments and obtain account history and other information. Messenger
services in select markets are also of great convenience to our customers.
Risk Management
The uncertainty of whether unforeseen events will have an adverse impact on our
capital or earnings is an inevitable component of the business of banking. To
address the risks inherent in our business we identify, measure, control and
monitor them. Our management team is responsible for determining our desired
risk profile, allocating resources to the lines of business, approving major
investment programs that are consistent with strategic priorities and risk
appetite and making capital management decisions. We address each of the major
risk categories identified by the banking regulators, if applicable, as well as
any additional identified risks inherent in our business. Such risks include,
but are not limited to, credit, liquidity, interest rate, transaction,
compliance, strategic and reputation risk. In each identified risk area, we
measure the level of risk to the Company based on the business we conduct and
develop plans to bring risks within acceptable tolerances. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Financial Condition-Loan Portfolio and-Liquidity, Market and Credit
Risk" included under Item 7 of Part II and "Quantitative and Qualitative
Disclosures About Market Risk" included under Item 7A of Part II for further
discussion of credit, liquidity and interest rate risk.
Competition
The deregulation of the banking industry and the availability of nationwide
interstate banking have increased the level of competition in our already
intensely competitive market areas. The increasingly competitive environment is
a result of changes in regulation, changes in technology and product delivery
systems and the pace of consolidation among financial services providers. The
Bank and its subsidiaries compete for deposits, loans, insurance and brokerage,
trust and financial services as well as customers with numerous providers of
similar products and services. Principal competitors include multi-regional
financial institutions as well as large and small thrifts, independent banks,
credit unions, many national and regional brokerage companies, mortgage
companies, insurance companies, finance companies, money market funds and other
non-bank financial service providers. Some of these competitors are much larger
in total assets and capitalizations, including the availability of larger legal
lending limits, have greater access to capital markets and offer a broader range
of financial services than BNC. In addition, some of the non-bank financial
institutions that compete with us are not subject to the extensive federal
regulations that govern our operations.
In order to compete with other financial services providers, the Bank and its
subsidiaries principally rely on local promotional activities, personal
relationships established by officers, directors and employees with their
customers, specialized services tailored to meet the needs of the communities
served and cross-selling efforts among the various segments within our
organization. We believe that many of our competitors have emphasized retail
banking and financial services for large companies, leaving the small and
mid-sized business market underserved. This has allowed us to compete
effectively by emphasizing customer service, establishing long-term customer
relationships and providing services meeting the needs of such businesses and
the individuals associated with them. The banking and financial services
industries are highly competitive, and our future profitability will depend on
our ability to continue to compete successfully in our market areas.
Supervision and Regulation, Economic Conditions and Monetary Policy
General. BNCCORP and the Bank are extensively regulated under federal and state
laws and regulations. These laws and regulations are primarily intended to
protect depositors and the federal deposit insurance funds, not investors in the
securities of BNCCORP. From time to time, legislation, as well as regulations,
is enacted that has the effect of increasing the cost of doing business,
limiting or expanding permissible activities, or affecting the competitive
balance between banks and other financial services providers. Proposals to
change laws and regulations governing the operations and taxation of banks, bank
holding companies and other financial institutions and financial services
providers are frequently made in the U.S. Congress, in the state legislatures
and by various regulatory agencies.
The following information briefly summarizes certain material laws and
regulations affecting BNCCORP and the Bank and is qualified in its entirety by
reference to the particular statutory and regulatory provisions. Any change in
applicable laws, regulations or regulatory policies may have a material effect
on our business, operations and future prospects. We are unable to predict the
nature or extent of the effects that new or revised federal or state legislation
may have on our business and earnings in the future.
Primary Regulators. BNCCORP is a bank holding company registered under the BHCA,
and is subject to regulation, supervision and examination by the Board of
Governors of the Federal Reserve System ("Federal Reserve"). BNCCORP is required
to file periodic reports with the Federal Reserve and such other reports as the
Federal Reserve may require pursuant to the BHCA. The Bank is a national banking
association and is subject to supervision, regulation and examination by the
Office of the Comptroller of the Currency ("OCC"). Since the Federal Deposit
Insurance Corporation ("FDIC") insures the deposits of the Bank, the Bank is
also subject to regulation and supervision by the FDIC. Additionally, the Bank
is a member of the Federal Reserve System.
If, as a result of an examination by federal regulatory agencies, an agency
should determine that the financial condition, capital resources, asset quality,
earnings prospects, management, liquidity or other aspects of a bank or bank
holding company's operations are unsatisfactory or that the bank or bank holding
company or its management is violating or has violated any law or regulation,
various remedies are available to these regulatory agencies. Such remedies
include the power to enjoin "unsafe or unsound" practices, to require
affirmative action to correct any conditions resulting from any violation or
practice, to issue an administrative order that can be judicially enforced, to
direct an increase in capital, to restrict the growth of the bank, to assess
civil monetary penalties, to remove officers and directors and ultimately to
terminate the bank's deposit insurance and/or revoke the bank's charter or the
bank holding company's registration.
Acquisitions and Permissible Activities. As a registered bank holding company,
BNCCORP is restricted in its acquisitions, certain of which are subject to
approval by the Federal Reserve. A bank holding company may not acquire, or may
be required to give certain notice regarding acquisitions of, companies
considered to engage in activities other than those determined by the Federal
Reserve to be closely related to banking or managing banks.
Transactions with Affiliates. Under Section 23A of the Federal Reserve Act (the
"Act"), certain restrictions are placed on loans and other extensions of credit
by the Bank to BNCCORP which is defined as an "affiliate" of the Bank under the
Act. Section 23B of the Act places standards of fairness and reasonableness on
other of the Bank's transactions with its affiliates. The Federal Reserve
recently issued Regulation W to implement Sections 23A and 23B of the Act and
codify many previously issued Federal Reserve interpretations of those sections.
Anti-Tying Restrictions. Bank holding companies and their affiliates are
prohibited from tying the provision of certain services, such as extensions of
credit, to other services offered by a holding company or its affiliates.
Restrictions on Loans to One Borrower. Under federal law, permissible loans to
one borrower by banks are generally limited to 15 percent of the bank's
unimpaired capital, surplus, undivided profits and credit loss reserves. The
Bank seeks participations to accommodate borrowers whose financing needs exceed
its lending limits or internally established credit concentration limits.
Loans to Executive Officers, Directors and Principal Stockholders. Certain
limitations and reporting requirements are also placed on extensions of credit
by the Bank to principal stockholders of BNCCORP and to directors and certain
executive officers of the Bank (and BNCCORP and its nonbank subsidiaries
provided certain criteria are met) and to "related interests" of such principal
stockholders, directors and officers. In addition, any director or officer of
BNCCORP or the Bank or principal stockholder of BNCCORP may be limited in his or
her ability to obtain credit from financial institutions with which the Bank
maintains correspondent relationships.
Interstate Banking and Branching. The BHCA permits bank holding companies from
any state to acquire banks and bank holding companies located in any other
state, subject to certain conditions, including certain nation-wide and
state-imposed concentration limits. The Bank has the ability, subject to certain
restrictions, to acquire by acquisition or merger branches outside its home
state. The establishment of new interstate branches is also possible in those
states with laws that expressly permit it. Interstate branches are subject to
certain laws of the states in which they are located. Competition may increase
further as banks branch across state lines and enter new markets.
Capital Adequacy. The capital adequacy of BNCCORP and the Bank is monitored by
the federal regulatory agencies using a combination of risk-based and leverage
ratios. Failure to meet the applicable capital guidelines could subject BNCCORP
or the Bank to supervisory or enforcement actions. In addition, BNCCORP could be
required to guarantee a capital restoration plan of the Bank, should the Bank
become "undercapitalized" under capital guidelines. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Financial
Condition-Capital Resources and Expenditures" included under Item 7 of Part II
and Note 18 to the Consolidated Financial Statements included under Item 8 of
Part II for further discussion regarding the capital status of BNCCORP and the
Bank.
Prompt Corrective Action and Other Enforcement Mechanisms. Federal banking
agencies possess broad powers to take corrective and other supervisory action to
resolve the problems of insured depository institutions, including but not
limited to those institutions that fall below one or more prescribed minimum
capital ratios. Each federal banking agency has promulgated regulations defining
the following five categories in which an insured depository institution will be
placed, based on its capital ratios: well capitalized; adequately capitalized;
undercapitalized; significantly undercapitalized; and critically
undercapitalized. At December 31, 2002, the Bank exceeded the required ratios
for classification as well capitalized.
An institution that, based upon its capital levels, is classified as well
capitalized, adequately capitalized or undercapitalized may be treated as though
it were in the next lower capital category if the appropriate federal banking
agency, after notice and opportunity for hearing, determines that an unsafe or
unsound condition or practice warrants such treatment. At each successive lower
capital category, an insured depository institution is subject to more
restrictions. The federal banking agencies, however, may not treat a
significantly undercapitalized institution as critically undercapitalized unless
its capital ratios actually warrant such treatment.
In addition to measures taken under the prompt corrective action provisions,
commercial banking organizations may be subject to potential enforcement actions
by federal regulators for unsafe or unsound practices in conducting their
business or for violations of any law, rule, regulation or any condition imposed
in writing by the agency or any written agreement with the agency.
Safety and Soundness Standards. The Federal banking agencies have adopted
guidelines designed to assist the agencies in identifying and addressing
potential safety and soundness concerns before capital becomes impaired. The
guidelines set forth operational and managerial standards relating to: internal
controls, information systems and internal audit systems; loan documentation;
credit underwriting; asset growth; earnings; and compensation, fees and
benefits. Additionally, the federal banking agencies have also adopted safety
and soundness guidelines with respect to asset quality and earnings standards.
These guidelines provide six standards for establishing and maintaining a system
to identify problem assets and prevent those assets from deteriorating. Under
these standards, an insured depository institution should: conduct periodic
asset quality reviews to identify problem assets; estimate the inherent losses
in problem assets and establish reserves that are sufficient to absorb estimated
losses; compare problem asset totals to capital; take appropriate corrective
action to resolve problem assets; consider the size and potential risks of
material asset concentrations; and provide periodic asset quality reports with
adequate information for management and the board of directors to assess the
level of asset risk. These guidelines also set forth standards for evaluating
and monitoring earnings and for ensuring that earnings are sufficient for the
maintenance of adequate capital and reserves.
Dividend Restrictions. Dividends from bank subsidiaries often constitute a
principal source of income to a bank holding company. Federal rules limit a
bank's ability to pay dividends to its parent bank holding company in excess of
amounts generally equal to the bank's net profits from the current year plus
retained net profits for the preceding two years or if the payment would result
in the bank being considered "undercapitalized" under regulatory capital
guidelines. Bank regulatory agencies also have authority to prohibit a bank from
engaging in activities that, in the opinion of the applicable bank regulatory
authority, constitute unsafe or unsound practices in conducting its business. It
is possible, depending upon the financial condition of the bank in question and
other factors, that the applicable bank regulatory authority could assert that
the payment of dividends or other payments might, under some circumstances, be
such an unsafe or unsound practice. At December 31, 2002 approximately $9.4
million of retained earnings were available for Bank dividend declaration
without prior regulatory approval.
Community Reinvestment Act and Fair Lending Developments. The Bank is subject to
certain fair lending requirements and reporting obligations involving home
mortgage lending operations and Community Reinvestment Act ("CRA") activities.
The CRA generally requires the Federal banking agencies to evaluate the record
of a financial institution in meeting the credit needs of its local communities,
including low- and moderate-income areas. A bank may be subject to substantial
penalties and corrective measures for a violation of certain fair lending laws.
The Federal banking agencies may take compliance with such laws and CRA
obligations into account when regulating and supervising other activities of the
Bank. A Bank's compliance with its CRA obligations is based on a
performance-based evaluation system that bases CRA ratings on its lending
service and investment performance. When a bank holding company applies for
approval to acquire a bank or other bank holding company, the Federal Reserve
will review the assessment of each subsidiary bank of the applicant bank holding
company, and such records may be the basis for denying the application. In
connection with its assessment of CRA performance, the appropriate bank
regulatory agency assigns a rating of "outstanding," "satisfactory," "needs to
improve," or "substantial noncompliance." As a result of its most recent CRA
assessment, the Bank was rated satisfactory under this rating system.
Deposit Insurance. Through the Bank Insurance Fund (the "BIF") and the Savings
Association Insurance Fund (the "SAIF"), the FDIC insures the deposits of the
Bank up to prescribed limits for each depositor. FDIC-insured depository
institutions that are members of the BIF and SAIF pay insurance premiums at
rates based on their assessment risk classification, which is determined in part
based on the institution's capital ratios and in part on factors that the FDIC
deems relevant to determine the risk of loss to the insurance funds. Assessment
rates currently range from zero to 27 cents per $100 of deposits. The FDIC may
increase or decrease the assessment rate schedule on a semi-annual basis. An
increase in the assessment rate could have a material adverse effect on our
earnings, depending on the amount of the increase. The FDIC may terminate a
depository institution's deposit insurance upon a finding by the FDIC that the
institution's financial condition is unsafe or unsound or that the institution
has engaged in unsafe or unsound practices or has violated any applicable rule,
regulation, order or condition enacted or imposed by the institution's
regulatory agency. The termination of deposit insurance for the Bank could have
a material adverse effect on our earnings.
All FDIC-insured depository institutions must pay an annual assessment to
provide funds for the payment of interest on bonds issued by the Financing
Corporation, a Federal corporation chartered under the authority of the Federal
Housing Finance Board. The bonds, commonly referred to as FICO bonds, were
issued to capitalize the Federal Savings and Loan Insurance Corporation. The
FDIC established the FICO assessment rates effective for the fourth quarter of
2002 at approximately $.0084 per $100 annually for assessable deposits. The FICO
assessments are adjusted quarterly to reflect changes in the assessment bases of
the FDIC's insurance funds and do not vary depending on a depository
institution's capitalization or supervisory evaluations.
Cross-Guarantee. The Financial Institutions, Reform, Recovery and Enforcement
Act of 1989 provides for cross-guarantees of the liabilities of insured
depository institutions pursuant to which any bank subsidiary of a bank holding
company may be required to reimburse the FDIC for any loss or anticipated loss
to the FDIC that arises from a default of any of such holding company's other
subsidiary banks or assistance provided to such an institution in danger of
default.
Support of Banks. Bank holding companies are also subject to the "source of
strength doctrine" which requires such holding companies to serve as a source of
"financial and managerial" strength for their subsidiary banks and to conduct
its operations in a safe and sound manner. Additionally, it is the Federal
Reserve's policy that in serving as a source of strength to its subsidiary
banks, a bank holding company should stand ready to use available resources to
provide adequate capital funds to its subsidiary banks during periods of
financial stress or adversity and should maintain the financial flexibility and
capital-raising capacity to obtain additional resources for assisting its
subsidiary banks. A bank holding company's failure to meet its obligations to
serve as a source of strength to its subsidiary banks will generally be
considered by the Federal Reserve to be an unsafe and unsound banking practice
or a violation of the Federal Reserve's regulations or both.
Registration with the Securities and Exchange Commission. BNCCORP's securities
are registered with the Securities and Exchange Commission ("SEC") under the
Exchange Act. As such, BNCCORP is subject to the information, proxy
solicitation, insider trading and other requirements and restrictions of the
Exchange Act.
Conservator and Receivership Powers. Federal banking regulators have broad
authority to place depository institutions into conservatorship or receivership
to include, among other things, appointment of the FDIC as conservator or
receiver of an undercapitalized institution under certain circumstances. If the
Bank were placed into conservatorship or receivership, because of the
cross-guarantee provisions of the Federal Deposit Insurance Act, as amended,
BNCCORP, as the sole stockholder of the Bank, would likely lose its investment
in the Bank.
Bank Secrecy Act. The Bank Secrecy Act requires financial institutions to keep
records and file reports that are determined to have a high degree of usefulness
in criminal, tax and regulatory matters, and to implement counter-money
laundering programs and compliance procedures.
Consumer Laws and Regulations. In addition to the laws and regulations discussed
herein, the Bank is also subject to certain consumer laws and regulations that
are designed to protect customers in transactions with banks. These include, but
are not limited to, the Truth in Lending Act, the Truth in Savings Act, the
Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal
Credit Opportunity Act, the Home Mortgage Disclosure Act, the Real Estate
Settlement Procedures Act, the Fair Credit Reporting Act, the Flood Disaster
Protection Act, the Fair Housing Act and the Right to Financial Privacy Act.
These laws mandate certain disclosure requirements and regulate the manner in
which financial institutions must deal with customers when taking deposits or
making loans to such customers.
Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act signed into law on November
12, 1999 (the "Financial Modernization Act") has expanded the powers of banks
and bank holding companies to sell any financial product or service, closed the
unitary thrift loophole, reformed the Federal Home Loan Bank ("FHLB") System to
increase community banks' access to loan funding, protected banks from
discriminatory state insurance regulation and established a new framework for
the regulation of bank and bank holding company securities brokerage and
underwriting activities. The Financial Modernization Act also included new
provisions in the privacy area, restricting the ability of financial
institutions to share nonpublic personal customer information with third
parties. We have been reviewing implementing regulations and other guidance
issued by bank regulatory agencies in response to the Financial Modernization
Act and establishing policies, procedures and programs required or recommended
by such regulations and guidelines.
USA Patriot Act of 2001. Enacted in response to the terrorist attacks in New
York, Pennsylvania and Washington, D.C. on September 11, 2001, the USA Patriot
Act of 2001 (the "Patriot Act") is intended to strengthen U.S. law enforcement's
and the intelligence communities' ability to work cohesively to combat terrorism
on a variety of fronts. The potential impact of the Patriot Act on financial
institutions of all kinds is significant and wide ranging. The Patriot Act
contains sweeping anti-money laundering and financial transparency laws and
requires various regulations including: due diligence requirements for financial
institutions that administer, maintain or manage private bank accounts or
correspondent accounts for non-U.S. persons; standards for verifying customer
identification at the time of account opening; rules to promote cooperation
among financial institutions, regulators, and law enforcement entities in
identifying parties that may be involved in terrorism or money laundering;
reports by nonfinancial trades and business filed with the Treasury Department's
Financial Crimes Enforcement Network for transactions exceeding $10,000 and;
filing of suspicious activity reports by brokers and dealers if they believe a
customer may be violating U.S. laws and regulations. The impact on bank
operations from the Patriot Act will ultimately depend on the types of customers
served by the bank and the form that issued and pending regulations ultimately
take.
Changing Regulatory Structure. The Federal Reserve, OCC and FDIC have extensive
authority to police unsafe or unsound practices and violations of applicable
laws and regulations by depository institutions and their holding companies. The
agencies' authority has been expanded by federal legislation in recent years. In
addition, state banking authorities possess significant authority to address
violations of their state's banking laws by banks operating in their respective
states by enforcement and other supervisory actions.
As indicated above, the laws and regulations affecting banks and bank holding
companies are numerous and have changed significantly in recent years. There is
reason to expect that changes will continue in the future, although it is
difficult to predict the outcome of these changes or the impact such changes
will have on us.
Economic Conditions and Monetary Policy. Profitability in our banking segment,
like most financial institutions, is primarily dependent on interest rate
differentials. In general, the difference between the interest rates paid by the
Bank on interest-bearing liabilities, such as deposits and borrowings, and the
interest rates received by the Bank on its interest-earning assets, such as
loans extended to clients and securities held in the investment portfolio,
comprise the major portion of the banking segment's earnings. These rates are
highly sensitive to many factors that are beyond our control, such as inflation,
recession and unemployment, and the impact which other changes in economic
conditions might have on us cannot be predicted.
The monetary and fiscal policies of the Federal government and the policies of
the regulatory agencies, particularly the Federal Reserve, influence our
business. The Federal Reserve implements national monetary policies with
objectives such as curbing inflation and combating recession through its
open-market operations in the U.S. government securities by adjusting the
required level of reserves for depository institutions subject to its reserve
requirements, and by varying the target federal funds and discount rates
applicable to borrowings by depository institutions. The actions of the Federal
Reserve in these areas influence the growth of bank loans, investments and
deposits and also affect interest rates earned on interest-earning assets and
paid on interest-bearing liabilities. We cannot fully predict the nature and
impact on BNC of any future changes in monetary and fiscal policies.
Employees
At December 31, 2002, we had 285 employees, including 270 full-time equivalent
employees. None of our employees is covered by a collective bargaining
agreement. We consider our relationships with our employees to be satisfactory.
Approximate employees by segment were as follows as of December 31, 2002:
banking, 161; insurance, 110; and brokerage/trust/financial, 14.
Factors That May Affect Future Results of Operations
In addition to the other information contained in this report, the following
risks may affect us. If any of these risks occur, our business, financial
condition or operating results could be adversely affected.
Failure to Successfully Execute our Growth, Operating and Cross-Selling
Strategies. Our financial performance and profitability depends on our ability
to execute our corporate growth, operating and cross-selling strategies. Future
acquisitions and continued growth can present operating and other issues that
could have an adverse effect on our business, financial condition and results of
operations. Our financial performance will also depend on our ability to
maintain profitable operations through implementation of our banking and
financial services philosophies, including our efforts to cross-sell our various
products and services, which were described earlier. Therefore, there can be no
assurance that we will be able to execute our growth and operating strategies or
maintain any particular level of profitability.
Regional Presences, Related Economic Conditions and Credit Concentrations.
Although our operations are presently somewhat geographically disbursed, our
focus in the Arizona, Minnesota and North Dakota regions could adversely affect
our results of operations if economic and business conditions in any of these
regions were to exhibit weaknesses. A prolonged decline in economic or business
conditions in our market areas, in particular in those industries in which we
have credit concentrations, could have a material impact on the quality of our
loan portfolio or the demand for our other products and services, which in turn
may have a material adverse effect on our results of operations. A continued
weakening in the national economy might further exacerbate local or regional
economic conditions. The extent of the future impact of these events on economic
and business conditions cannot be predicted.
Changes in Market Interest Rates. Changing interest rates impact our earnings.
Changes in interest rates impact the demand for new loans, the credit profile of
existing loans, the rates received on loans and investment securities, rates
paid on deposits and borrowings and the value of our derivative contracts and
their associated impact on earnings. The relationship between the rates received
on loans and investment securities and the rates paid on deposits and borrowings
is known as interest rate spread. Given our current volume and mix of
interest-earning assets, interest-bearing liabilities and derivative contracts,
our interest rate spread could be expected to increase during periods of rising
interest rates and to decline during periods of falling interest rates. Although
we believe our current level of interest rate sensitivity is reasonable and
effectively managed, significant fluctuations in interest rates may have an
adverse effect on our business, financial condition and results of operations.
Government Regulation. The financial services industry is extensively regulated.
Federal and state regulation is designed primarily to protect the deposit
insurance funds and consumers, and not to benefit our shareholders. Such
regulations can at times impose significant limitations on our operations.
Additionally, these regulations are constantly evolving and may change
significantly over time. Significant new laws, such as those issued in recent
years, or changes in or repeal of existing laws may cause our results to differ
materially. Further, Federal monetary policy, particularly as implemented
through the Federal Reserve System, significantly affects interest rate and
credit conditions, which are material considerations for us.
Competition. The banking and financial services business is highly competitive.
We face competition in making loans, attracting deposits and providing
insurance, brokerage, trust and other financial services. Increased competition
in the banking and financial services businesses may reduce our market share,
impair our growth or cause the prices we charge for our services to decline. Our
results of operations may differ in future periods depending upon the level and
nature of competition we encounter in our various market areas.
Failure to Perform on Behalf of Borrowers, Guarantors and Related Parties. We
encounter significant sources of risk from the possibility that losses will be
sustained if a significant number of our borrowers, guarantors and related
parties fail to perform in accordance with the terms of their loans, commitments
or letters of credit. We have adopted underwriting and credit monitoring
procedures and credit policies, including the establishment and methodological
review and analysis of the allowance for credit losses. We believe these
processes and procedures are appropriate to minimize this risk by assessing the
likelihood of nonperformance, tracking loan performance and diversifying our
credit portfolio. These policies and procedures, however, may not prevent
unexpected losses that could materially adversely affect our results of
operations. Additionally, as noted earlier, the performance of borrowers,
guarantors and related parties can be negatively impacted by prevailing economic
conditions over which we have no control. Such negative impacts on these parties
could also materially adversely affect our results of operations.
Item 2. Properties
The principal offices of BNCCORP are located at 322 East Main Avenue, Bismarck,
North Dakota. The Bank owns the building. The principal office of the Bank is
located at 660 South Mill Avenue, Tempe, Arizona. The Bank also owns branch
offices at 219 South 3rd Street and 807 East Century Avenue and an additional
office building at 116 North 4th Street in Bismarck. It also owns its banking
facilities in Crosby, Ellendale, Kenmare, Linton and Stanley, North Dakota. The
Bank is presently constructing an office building at 17045 North Scottsdale
Road, Scottsdale, Arizona.
The Bank's facilities at 502 West Main Street (Mandan), Garrison and Watford
City, North Dakota are leased. The facilities occupied by the Bank and BNC AMI
at 333 South Seventh Street, Minneapolis, Minnesota, and the Bank's facilities
at 640 and 660 South Mill Avenue, Tempe, Arizona, along with 2725 East Camelback
Road, Phoenix, Arizona are also leased.
Milne Scali occupies three locations in Arizona: 1750 East Glendale Avenue,
Phoenix, 4515 S. McClintock, Tempe, and 2400 East Highway 89A, Cottonwood. All
of these facilities are presently leased. See Notes 22 and 27 to the
Consolidated Financial Statements included under Item 8 of Part II for
information related to the pending purchase of the building at 1750 East
Glendale Avenue in Phoenix, a related party transaction.
We believe that all owned and leased properties are well maintained and
considered in good operating condition. They, along with the property being
constructed in Scottsdale, are believed adequate for the Company's present and
foreseeable future operations; however, future expansion could result in the
leasing or construction of additional properties. We do not anticipate any
difficulty in renewing our leases or leasing additional suitable space upon
expiration of present lease terms. See Note 27 to the Consolidated Financial
Statements included under Item 8 of Part II for additional information
concerning our present lease commitments.
Item 3. Legal Proceedings
From time to time, we may be a party to legal proceedings arising out of our
lending, deposit operations or other activities. We engage in foreclosure
proceedings and other collection actions as part of our loan collection
activities. From time to time, borrowers may also bring actions against us, in
some cases claiming damages. Some financial services companies have been
subjected to significant exposure in connection with litigation, including class
action litigation and punitive damage claims. While we are not aware of any
actions or allegations that should reasonably give rise to any material adverse
effect, it is possible that we could be subjected to such a claim in an amount
that could be material. Based upon a review with our legal counsel, we believe
that the ultimate disposition of pending litigation will not have a material
effect on our financial condition, results of operations or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter ended
December 31, 2002.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
BNCCORP's common stock, $.01 par value ("Common Stock"), is traded on the Nasdaq
Stock Market under the symbol "BNCC."
The following table lists the high and low sales prices of our Common Stock for
the periods indicated as reported by the Nasdaq Stock Market. The quotes reflect
the high and low closing sales prices for our Common Stock as reported by
Nasdaq.
2002 2001
----------------- ------------------
Period High Low High Low
------- ------- -------- -------
First Quarter...... $8.90 $7.28 $8.56 $5.94
Second Quarter..... 8.60 7.47 9.50 7.00
Third Quarter...... 7.75 5.49 9.41 7.51
Fourth Quarter..... 8.03 5.25 8.45 7.28
On March 14, 2003, there were 117 record holders of the Company's Common Stock.
BNCCORP's policy is to retain its earnings to support the growth of its
business. Our board of directors has never declared cash dividends on our Common
Stock and does not plan to do so in the foreseeable future. In making the
determination to pay dividends, we will consider all relevant factors including,
among other things, our capital position and current tax law as it relates to
the treatment of dividends. The ability of BNCCORP to pay cash dividends largely
depends on the amount of cash dividends paid to it by the Bank. Capital
distributions, including dividends, by the Bank are subject to federal
regulatory restrictions tied to the bank's earnings and capital. Approval of the
OCC, the Bank's principal regulator, would be required for the Bank to pay
dividends in excess of the Bank's net profits from the current year plus
retained net profits for the preceding two years. See "Supervision and
Regulation-Dividend Restrictions" included under Item 1 of Part I.
Equity-Based Compensation Plans. The following table summarizes information
relative to our equity-based compensation plans as of December 31, 2002:
(a) (b) (c)
------------------ ----------------- -----------------------
Number of securities Number of securities
to be issued upon Weighted-average remaining available
exercise of exercise price for future issuance
outstanding of outstanding under equity
options, options, compensation plans
warrants and warrants and (excluding securities
Plan Category rights rights reflected in column (a))
- ---------------------- ------------------ ----------------- -----------------------
Equity compensation
plans approved by
security holders 173,935 $10.48 169,717 (1)
- ---------------------- ------------------ ----------------- -----------------------
Equity compensation
plans not approved
by security holders N/A N/A N/A
- ----------------------
(1) Shares may be issued under our 1995 and 2002 stock incentive plans as
restricted stock or stock based awards (which awards are based in whole or in
part on the value of our common stock).
Item 6. Selected Financial Data
The selected consolidated financial data presented below under the captions
"Income Statement Data" and "Balance Sheet Data" as of and for the years ended
December 31, 2002, 2001, 2000, 1999 and 1998 are derived from the historical
audited consolidated financial statements of the Company. The Consolidated
Balance Sheets as of December 31, 2002, 2001 and 2000, and the related
Consolidated Statements of Income, Comprehensive Income, Stockholders' Equity
and Cash Flows for each of the three years in the period ended December 31, 2002
were audited by KPMG LLP, independent public accountants. The Consolidated
Balance Sheets as of December 31, 1999 and 1998 and the related Consolidated
Statements of Income, Comprehensive Income, Stockholders' Equity and Cash Flows
for each of the two years in the period ended December 31, 1999 were audited by
Arthur Andersen LLP, independent public accountants who have ceased operations.
The financial data below should be read in conjunction with and are qualified by
the Consolidated Financial Statements and the notes thereto included under Item
8.
Selected Financial Data (1)
For the Years Ended December 31,
---------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- -----------
(dollars in thousands, except share and per share data)
Income Statement Data:
Total interest income.......................... $ 31,818 $ 37,586 $ 40,658 $ 28,535 $ 27,801
Total interest expense......................... 16,907 22,656 27,280 16,438 15,152
---------- ---------- ---------- ---------- ----------
Net interest income............................ 14,911 14,930 13,378 12,097 12,649
Provision for credit losses.................... 1,202 1,699 1,202 1,138 1,201
Noninterest income............................. 16,296 8,714 7,683 6,028 4,843
Noninterest expense............................ 27,158 19,559 16,220 17,435 13,342
Income tax provision (benefit)................. 822 691 1,183 (193) 1,017
---------- ---------- ---------- ---------- ----------
Income (loss) from continuing operations....... $ 2,025 $ 1,695 $ 2,456 $ (255) $ 1,932
========== ========== ========== ========== ==========
Balance Sheet Data: (at end of period)
Total assets................................... $ 602,228 $ 555,967 $ 547,447 $ 445,232 $ 372,227
Federal Reserve Bank and Federal
Home Loan Bank stock.......................... 7,071 7,380 9,619 5,643 3,512
Loans, net of unearned income.................. 335,794 297,924 252,753 254,009 247,181
Allowance for credit losses.................... (5,006) (4,325) (3,588) (2,872) (2,854)
Total deposits................................. 398,245 375,277 330,894 316,772 284,499
Short-term borrowings.......................... 28,120 760 33,228 2,200 7,790
Federal Home Loan Bank advances................ 97,200 117,200 117,200 86,500 41,500
Long-term borrowings........................... 8,561 13 12,642 14,470 9,195
Guaranteed preferred beneficial interests
in Company's subordinated debentures.......... 22,326 22,244 7,606 -- --
Common stockholders' equity.................... 36,223 30,679 29,457 23,149 25,255
Book value per common share outstanding........ $ 13.41 $ 12.79 $ 12.30 $ 9.65 $ 10.57
Earnings Performance/Share Data(1):
Return on average total assets................. 0.36% 0.31% 0.47% (0.07)% 0.55%
Return on average common stockholders' equity.. 5.77% 5.51% 10.02% (1.22)% 8.71%
Net interest margin............................ 2.87% 2.90% 2.73% 3.38% 3.88%
Net interest spread............................ 2.50% 2.40% 2.40% 3.07% 3.43%
Basic earnings (loss) per common share (1)..... $ 0.74 $ 0.71 $ 1.02 $ (0.11) $ 0.81
Diluted earnings (loss) per common share (1)... $ 0.74 $ 0.70 $ 1.02 $ (0.11) $ 0.77
Cash dividends per common share................ -- -- -- -- --
Cash dividends per preferred share............. $ 526.67 -- -- -- --
Total cash dividends - preferred stock......... $ 79 -- -- -- --
Average common shares outstanding.............. 2,611,629 2,395,353 2,397,356 2,406,618 2,397,340
Average common and common equivalent shares.... 2,628,798 2,421,113 2,398,553 2,407,018 2,503,535
Shares outstanding at yearend.................. 2,700,929 2,399,170 2,395,030 2,399,980 2,390,184
Balance Sheet and Other Key Ratios (1):
Nonperforming assets to total assets........... 1.27% 0.80% 0.12% 0.64% 1.21%
Nonperforming loans to total loans............. 2.27% 1.47% 0.23% 0.65% 0.97%
Net loan charge-offs to average loans.......... (0.17)% (0.33)% (0.20)% (0.46)% (0.54)%
Allowance for credit losses to total loans..... 1.49% 1.45% 1.42% 1.13% 1.15%
Allowance for credit losses to nonperforming
loans......................................... 66% 99% 619% 173% 119%
Average common stockholders' equity to average
total assets.................................. 5.93% 5.64% 4.71% 5.48% 6.33%
- -------------------------
(1) From continuing operations for all periods presented.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The following table summarizes income from continuing operations, net income and
basic and diluted earnings per share for the twelve months ended December 31
(amounts in thousands):
2002 2001 2000
------------ ----------- ------------
Income from continuing operations... $ 2,025 $ 1,695 $ 2,456
Net income.......................... 2,039 1,245 2,297
Basic earnings per common share..... 0.75 0.52 0.96
Diluted earnings per common share... 0.75 0.51 0.96
2002 vs. 2001. Strategic initiatives we pursued in recent years, including
diversifying our sources of business, focusing on what we believe are attractive
and growing core markets and managing for long-term shareholder value generated
favorable results in 2002, particularly in the third and fourth quarters.
Net income for 2002 rose 64 percent, to $2.04 million, or $0.75 per common share
on a diluted basis, compared with $1.25 million, or $0.51 per share for 2001.
Our growth in earnings was primarily due to net income from insurance operations
of $1.03 million, reflecting the acquisition of Milne Scali in April 2002. The
results included income from discontinued operations of our former Fargo, N.D.
branch office of $0.01 per share in 2002, and a loss of $0.08 per share from
such operations in 2001. The 2001 results also included extraordinary charges of
$0.06 per share on early extinguishment of debt and $0.05 for cumulative effect
of a change in accounting principle.
Net interest income remained relatively constant, at $14.9 million in both 2002
and 2001. Net interest income included mark-to-market losses on the value of
derivative contracts totaling ($779,000) in 2002 and ($184,000) in 2001. These
losses are subject to fluctuations based on changes in interest rates and the
associated value of the derivative contracts. Excluding the impact of the
mark-to-market losses, net interest income would have increased 3.8 percent
year-over-year.
Demonstrating the benefits of our diverse business base, noninterest income was
up 87 percent year-over-year, to $16.3 million for 2002. Noninterest income
represented 52.2 percent of gross revenues this year, increasing substantially
from 36.9 percent in 2001, and exceeding our internal target of 50 percent.
Insurance commissions, largely produced by Milne Scali, were the largest
component of noninterest income in 2002. Loan fees, gains on sales of securities
and service charges also increased compared to 2001, while brokerage and
trust/financial services income declined.
Noninterest expense was $27.2 million, an increase of nearly 39 percent versus
2001. This primarily reflected our expanded banking and insurance operations in
Arizona and the winding down of the Fargo office of our BNC AMI subsidiary -
actions that are expected to enhance profitability in the future. In any event,
the rate of growth in both net income and noninterest income exceeded the rise
in noninterest expense.
Total assets reached $602.2 million at December 31, 2002, up 8.3 percent from a
year ago. Total loans increased by 12.7 percent, to $335.8 million at the end of
2002, while total deposits rose 6.1 percent to $398.2 million. All stated
amounts reflect continuing operations. Reflecting the success of our expansion
into new markets, the Arizona operations of the Bank accounted for approximately
28 percent of total loans and 12 percent of total deposits at the end of 2002.
Maintaining sound asset quality continued to be a focus for us. The provision
for credit losses was $1.2 million for 2002 versus $1.7 million for the prior
year. Loan charge-offs in 2002 were $657,000, or about one-half the level of
2001. The allowance for credit losses as a percentage of total loans at the end
of 2002 was 1.49 percent, nearly even with 1.45 percent one year ago. The ratio
of nonperforming assets to total assets was 1.27 percent at December 31, 2002,
compared with the year-end 2001 level of 0.80 percent. The ratio of the
allowance for credit losses to total nonperforming loans was 66 percent and 99
percent at December 31, 2002 and 2001, respectively.
Total common stockholders' equity was approximately $36.2 million at December
31, 2002, equivalent to book value per common share of $13.41 (tangible book
value per common share of $5.60). Net unrealized gains in our investment
portfolio as of December 31, 2002 were nearly $4.4 million, or approximately
$1.62 per share, on a pretax basis.
During 2002, we undertook a series of actions to sharpen the focus and
strengthen the performance of each of our three core businesses: banking,
insurance and brokerage/trust/financial services.
In banking, we sold our Fargo, N.D. branch allowing us to redeploy our resources
in markets we believe present greater potential for profitability.
In insurance, the acquisition of Milne Scali in the second quarter of 2002
significantly increased the scale of our insurance business and that business
has already begun to generate encouraging earnings.
In brokerage/trust/financial services, in order to enhance the financial options
available to our customers, we formed a relationship with Raymond James
Financial Services, Inc. We also reorganized the management and office network
of BNC AMI to improve the productivity of this aspect of our business.
We believe that we have achieved our goal of building a diversified business
base, which has long been a cornerstone of our strategy. We believe each of our
core businesses is now well defined and well positioned to serve the needs of
our customers, while contributing to our long-term corporate financial
performance and share value creation.
We believe that our record financial performance in the third and fourth
quarters of 2002 provides a meaningful indication of our earnings potential. Of
the $2.04 million in net income we recorded for the year, most was generated
during the second half of the year. Looking ahead to 2003, we expect to derive a
full year of benefit from our investments in expanding our insurance operations,
implementing programs to encourage cross-selling across all of our business
lines and controlling overhead.
2001 vs. 2000. We reported income from continuing operations of $1.7 million for
2001, or $0.70 per share on a diluted basis. This compares with income from
continuing operations for 2000 of $2.5 million, or $1.02 per share. The results
for 2001 reflected double-digit growth in both net interest income and
noninterest income, but also higher noninterest expense due to the establishment
of our Tempe, Arizona operations and the issuance of trust preferred securities.
Net income for 2001 was $1.2 million, or $0.51 per share on a diluted basis,
after a loss on operations of our discontinued Fargo, N.D. branch of $0.08, an
extraordinary loss on early extinguishment of debt of $0.06 per share and a
charge for the cumulative effect of a change in accounting principle of $0.05
per share. For 2000, net income was nearly $2.3 million, or $0.96 per share,
although this reflected a gain on disposal of our asset-based lending subsidiary
of $0.07 per share, a loss of $0.24 per share from operations of the
discontinued Fargo, N.D branch and a gain on early extinguishment of debt of
$0.11 per share.
Our results for 2001 reflected our strategic diversification of revenue sources
and active asset-liability management. Net interest income increased 12 percent
to $14.9 million, as we continued to shift our earning asset mix from investment
securities to loans while growing the deposit base. Gains generated through
management of the investment portfolio were reflected in noninterest income,
which rose 13 percent to $8.7 million. Other noninterest income items, including
loan fees, insurance commissions and income from brokerage, trust and financial
services, held relatively stable or declined slightly.
Noninterest expense was $19.6 million for 2001, a 21 percent increase from the
previous year, again reflecting our Arizona initiative and expenses related to
trust preferred securities. In particular, we view the cost of operations such
as our Arizona operations as an important investment in growth. Unlike many
companies, we have typically expanded by establishing wholly new operations
rather than making acquisitions. In these particular cases, we record the
investment needed to operate in new markets as an expense, whereas companies
that depend on acquisition for growth are able to recognize much of their "entry
cost" as goodwill.
The benefits of our investment in building new markets were evident in our
strong loan and deposit growth during 2001. Total loans rose 18 percent during
the twelve months ended December 31, 2001, reaching $297.9 million. Total
deposits increased 13 percent over the 2000 level, to $375.3 million at December
31, 2001. Significantly, some 90 percent of the new loan volume and 19 percent
of the deposit increase were generated by our new Arizona operations. Total
assets increased $15.0 million to $585.1 million at December 31, 2001.
Responding to the weaknesses felt by many sectors of the nation's economy, we
continued to focus on maintaining credit quality. The provision for credit
losses was increased to $1.7 million in 2001, from $1.2 million for the prior
year. The allowance for credit losses as a percentage of total loans was 1.45
percent at December 31, 2001, increasing slightly from 1.42 percent one year
earlier. The ratio of nonperforming assets to total assets was 0.80 percent at
December 31, 2001, compared with 0.12 percent at year-end 2000. The ratio of
allowance for credit losses to total nonperforming loans was 99 percent at
December 31, 2001, compared with 619 percent one year earlier.
Total common stockholders' equity was approximately $30.7 million at December
31, 2001, equivalent to book value per common share of $12.79 (tangible book
value per common share of $11.88). Net unrealized gains in our investment
portfolio as of December 31, 2001 were nearly $2.7 million, or approximately
$1.11 per share, on a pretax basis.
Results of Operations
Net Interest Income. Net interest income, the difference between total interest
income earned on interest-earning assets and total interest expense paid on
interest-bearing liabilities, is the banking segment's primary source of
earnings. The amount of net interest income is affected by changes in the volume
and mix of earning assets, the level of rates earned on those assets, the volume
and mix of interest-bearing liabilities and the level of rates paid on those
liabilities.
The following table sets forth, for the periods indicated, certain information
relating to our average balance sheet and reflects the yield on average assets
and cost of average liabilities. Such yields and costs are derived by dividing
income and expense by the average balance of assets and liabilities. All average
balances have been derived from monthly averages, which are indicative of daily
averages.
Analysis of Average Balances, Interest and Yields/Rates (1)
For the Years ended December 31,
----------------------------------------------------------------------------------
2002 2001 2000
--------------------------- -------------------------- --------------------------
Interest Average Interest Average Interest Average
earned yield earned Yield earned yield
Average or or Average or or Average or or
balance paid cost balance paid cost balance paid cost
------- -------- -------- -------- -------- ------- ------- ------- -------
(dollars in thousands)
Assets
Federal funds sold/interest-
bearing due from........... $ 3,795 $ 66 1.74% $ 1,830 $ 50 2.73% $ 5,660 $ 242 4.28%
Taxable investments......... 193,972 9,997 5.15% 206,572 12,716 6.16% 225,559 16,054 7.12%
Tax-exempt investments...... 19,979 977 4.89% 16,452 829 5.04% 17,624 940 5.33%
Loans and leases (2)........ 307,227 20,778 6.76% 293,716 23,991 8.17% 244,526 23,422 9.58%
Allowance for credit losses. (4,579) -- (4,153) -- (3,405) --
-------- ------- -------- ------- -------- -------
Total interest-earning
assets (3)............... 520,394 31,818 6.11% 514,417 37,586 7.31% 489,964 40,658 8.30%
Noninterest-earning assets:
Cash and due from banks.. 13,706 11,997 8,939
Other.................... 34,946 19,388 21,848
-------- -------- --------
Total assets from
continuing operations... 569,046 545,802 520,751
Assets from discontinued
Fargo branch............ 22,258 22,270 17,003
-------- -------- --------
Total assets......... $591,304 $568,072 $537,754
======== ======== ========
Liabilities and Stockholders'
Equity
Deposits:
Interest checking and
money market accounts... $174,108 2,849 1.64% $147,775 4,669 3.16% $130,007 6,913 5.32%
Savings................... 4,511 39 0.86% 3,758 56 1.49% 4,042 84 2.08%
Certificates of deposit:
Under $100,000............ 104,964 4,068 3.88% 98,639 5,280 5.35% 101,624 5,768 5.68%
$100,000 and over......... 73,639 3,286 4.46% 73,806 4,248 5.76% 54,592 3,263 5.98%
-------- ------- -------- ------- -------- -------
Total interest-bearing
deposits.................. 357,222 10,242 2.87% 323,978 14,253 4.40% 290,265 16,028 5.52%
Borrowings:
Short-term borrowings..... 7,799 141 1.81% 10,206 441 4.32% 3,459 234 6.76%
FHLB advances............. 97,711 6,214 6.36% 118,705 7,185 6.05% 154,784 9,766 6.31%
Long-term borrowings...... 6,063 310 5.11% 8,378 777 9.27% 13,497 1,252 9.28%
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities............... 468,795 16,907 3.61% 461,267 22,656 4.91% 462,005 27,280 5.90%
Noninterest-bearing
demand accounts........ 33,951 28,474 26,953
-------- -------- --------
Total deposits and
interest-bearing
liabilities........... 502,746 489,741 488,958
Other noninterest-bearing
liabilities................. 11,336 8,765 5,666
Liabilities from discontinued
Fargo branch................ 20,476 24,654 15,516
-------- -------- --------
Total liabilities.... 534,558 523,160 510,140
Subordinated debentures....... 22,056 13,542 3,108
Stockholders' equity.......... 34,690 31,370 24,506
-------- -------- --------
Total liabilities
and stockholders'
equity.............. $591,304 $568,072 $537,754
======== ======== ========
Net interest income........... $14,911 $14,930 $13,378
======= ======= =======
Net interest spread........... 2.50% 2.40% 2.40%
====== ====== ======
Net interest margin (4)....... 2.87% 2.90% 2.73%
====== ====== ======
Ratio of average
interest-earning
assets to average
interest-bearing
liabilities............... 111.01% 111.52% 106.35%
======== ======== ========
--------------------
(1) From continuing operations for all periods presented.
(2) Average balances of loans and leases include nonaccrual loans and leases,
and are presented net of unearned income. Loan fee amortization totaling
approximately $1.3 million, $812,000 and $388,000 is included in loan
interest income for the twelve month periods ended December 31, 2002, 2001
and 2000, respectively.
(3) Tax-exempt income was not significant and thus has not been presented on a
taxable equivalent basis. Tax-exempt income of $982,000, $840,000 and
$951,000 was recognized during the years ended December 31, 2002, 2001 and
2000, respectively.
(4) Net interest margin equals net interest income divided by average
interest-earning assets for the period.
The following table illustrates, for the periods indicated, the dollar amount of
changes in our interest income and interest expense for the major components of
interest-earning assets and interest-bearing liabilities and distinguishes
between the increase related to higher outstanding balances and the volatility
of interest rates. Changes attributable to the combined impact of volume and
rate have been allocated proportionately to the change due to volume and the
change due to rate:
Analysis of Changes in Net Interest Income (1)
For the Years Ended December 31,
-----------------------------------------------------
2002 Compared to 2001 2001 Compared to 2000
---------------------- ------------------------
Change Due to Change Due to
----------------- ---------------
Volume Rate Total Volume Rate Total
------- --------- -------- -------- -------- --------
(in thousands)
Interest Earned on Interest-Earning
Assets
Federal funds sold/interest-bearing
due from............................ $ 24 $ (8) $ 16 $ (126) $ (66) $ (192)
Investments.......................... (533) (2,038) (2,571) (1,337) (2,112) (3,449)
Loans................................ 1,172 (4,385) (3,213) 2,121 (1,552) 569
-------- -------- -------- -------- -------- --------
Total increase (decrease) in
interest income................... 663 (6,431) (5,768) 658 (3,730) (3,072)
-------- -------- -------- -------- -------- --------
Interest Expense on Interest-Bearing
Liabilities
Interest checking and money market
accounts............................ 1,067 (2,887) (1,820) 1,139 (3,383) (2,244)
Savings.............................. 16 (33) (17) (6) (22) (28)
Certificates of Deposit:
Under $100,000..................... 367 (1,579) (1,212) (166) (322) (488)
$100,000 and over.................. (10) (952) (962) 1,101 (116) 985
Short-term borrowings................ (87) (213) (300) 254 (47) 207
FHLB advances........................ (1,361) 390 (971) (2,198) (383) (2,581)
Long-term borrowings................. (178) (289) (467) (475) -- (475)
-------- -------- -------- -------- -------- --------
Total increase (decrease) in
interest expense.................... (186) (5,563) (5,749) (351) (4,273) (4,624)
-------- -------- -------- -------- -------- --------
Increase (decrease) in net interest
income.............................. $ 849 $ (868) $ (19) $ 1,009 $ 543 $ 1,552
======== ======== ======== ======== ======== ========
- ---------------------
(1) From continuing operations for all periods presented.
Year ended December 31, 2002 compared to year ended December 31, 2001. Net
interest income decreased $19,000, or 0.1 percent, remaining relatively level at
$14.9 million. Net interest spread and net interest margin adjusted to 2.50 and
2.87 percent, respectively, for the twelve-month period ended December 31, 2002
from 2.40 and 2.90, respectively, for the twelve-month period ended December 31,
2001.
Net interest income for the twelve-month periods ended December 31, 2002 and
2001 reflected mark-to-market losses on the value of derivative contracts
totaling ($779,000) and ($184,000), respectively. Without the mark-to-market
adjustments on these derivative contracts for the two periods, net interest
margin would have been 3.01 percent for the twelve months ended December 31,
2002 and 2.94 percent for the twelve months ended December 31, 2001.
The remaining fair value of our interest rate cap contracts on December 31, 2002
was $136,000. Therefore, net interest income in future periods can only be
negatively affected to that amount if the fair value of the contracts were to be
required to be written to $0. If the fair value of the derivative contracts were
to be increased in future periods due to increases in 3-month LIBOR (the rate
upon which our current cap contracts are based), this would have a favorable
effect on net interest income in those future periods as favorable adjustments
to the fair value of the contracts would be reflected as reduced interest
expense.
The following condensed information summarizes the major factors combining to
create the changes to net interest income, spread and margin. Lettered
explanations following the summary describe causes of the changes in these major
factors.
Net Interest Income Analysis - 2002 vs. 2001 (1)
For the Years
Ended December 31, Change
-------------------- ----------------
2002 2001
--------- ---------
(amounts in millions)
Total interest income decreased............. $ 31.8 $ 37.6 $ (5.8) (15)%
Due to:
Decrease in yield on earnings assets.... 6.11% 7.31% (1.20)% (16)%
Driven by:
Decreased yield on loans (a)............ 6.76% 8.17% (1.41)% (17)%
Decreased yield on investments (b)...... 5.13% 6.07% (0.94)% (15)%
The decreased yields were offset by:
Increased average earning assets ....... $ 520.4 $ 514.4 $ 6.0 1%
Driven by:
Increase in average loans (c)........... $ 307.2 $ 293.7 $ 13.5 5%
Offset by:
Decrease in average investments (d)..... $ 214.0 $ 223.0 $ (9.0) (4)%
Total interest expense decreased............ $ 16.9 $ 22.7 $ (5.8) (26)%
Due to:
Decrease in cost of interest-bearing
liabilities............................ 3.61% 4.91% (1.30)% (26)%
Driven by:
Decrease in cost of interest-bearing
deposits (e)........................... 2.87% 4.40% (1.53)% (35)%
Decrease in cost of borrowings (f)...... 5.97% 6.12% (0.15)% (2)%
These decreases in cost of interest-
bearing liabilities were offset by:
Increase in average interest-bearing
liabilities............................ $ 468.8 $ 461.3 $ 7.5 2%
Driven by:
Increase in average interest-bearing
deposits (g)........................... $ 357.2 $ 324.0 $ 33.2 10%
Offset by:
Decrease in average borrowings (h)...... $ 111.6 $ 137.3 $ (25.7) (19)%
- --------------------
(1) From continuing operations for all periods presented.
(a) Our decreased loan yield is reflective of the significantly lower interest
rate environment during 2002. The lower rate environment was caused by
several Federal Reserve reductions in the Federal funds target rate causing
prime rate to decrease significantly during 2001 and continuing into 2002.
The daily average prime rate in 2002 was 4.68 percent as compared to 6.91
percent for 2001. The lower prime rate caused floating rate loans to
reprice at lower levels and new loans to be originated at levels lower than
those originated in the prior period.
(b) The decreased yield on investments was also reflective of the lower
interest rate environment during 2002.
(c) The increase in average loans was driven primarily by loan growth in the
Arizona and Minnesota markets.
(d) Average investments declined as the portfolio was restructured to better
manage our capital, shift our earning asset mix from investments to loans
and to establish the proper forward-looking risk/reward profile for the
investment portfolio.
(e) The decrease in cost of interest-bearing deposits was reflective of the
lower interest rate environment during 2002. Floating rate deposit accounts
repriced at lower levels and certificates of deposit renewed or were
originated at lower levels than those in the prior period.
(f) Borrowing costs decreased due to the lower rate environment during 2002,
the payoff of our 8 5/8 percent subordinated notes during 2001 and the
adjustment of the $15.0 million floating rate subordinated debentures in
response to the lower rates in 2002. Borrowing costs in 2002 would have
decreased to 5.28 percent (versus 5.97 percent) without factoring in the
$779,000 impact of marking our interest rate cap contracts to fair value.
The fair value adjustments to the interest rate cap contracts were
reflected as increases in borrowing costs.
(g) Average interest-bearing deposits increased largely due to further
increases in volume of our Wealthbuilder interest checking and money market
accounts originating primarily in our Arizona and Minnesota markets.
(h) Average borrowings decreased due to lower averages of short-term
borrowings, the pay down of $20 million of FHLB advances in early 2002, a
continued shift in our funding base from borrowings to core deposits and
the retirement of our subordinated notes, which were outstanding through
August 31, 2001.
Net interest income and margin in future periods may be impacted by several
factors. Changes in net interest income are dependent upon the volume and mix of
interest-earning assets and interest-bearing liabilities, the movement of
interest rates and the level of non-performing assets. Achieving net interest
margin growth is dependent on our ability to generate higher-yielding assets and
lower cost funding sources such as deposits and borrowings. If variable index
rates, such as the prime rate, were to decline, we could experience compression
of our net interest margin depending upon the timing and amount of any
reductions, as it is possible that interest rates paid on some deposits and
borrowings may not decline as quickly, or to the same extent, as the decline in
the yield on interest-rate-sensitive assets such as commercial and other loans.
Competition for checking, savings and money market deposits, important sources
of lower cost funds for us, is intense. We could also experience net interest
margin compression if rates paid on deposits and borrowings increase, or as a
result of new pricing strategies and lower rates offered on loan products in
response to competitive pressures, rates on interest-bearing liabilities
increase faster, or to a greater extent, than the increase in the yield on
interest-rate-sensitive assets. The level and nature of the impact cannot be
precisely ascertained. Federal Reserve actions in response to economic
developments can vary causing prime and other rates to adjust and, in some
cases, immediately impact our interest-earning assets and interest-bearing
liabilities.
These factors, including the competitive environment in the markets in which we
operate, the multitude of financial and investment products available to the
public and the monetary policies of the Federal Reserve, can materially impact
our operating results. Therefore, we cannot predict, with any degree of
certainty, prospects for net interest income and net interest margin in future
periods. See "Supervision and Regulation, Economic Conditions and Monetary
Policy-Economic Conditions and Monetary Policy" included under Item 1 of Part I.
See also Item 7A, "Quantitative and Qualitative Disclosures About Market Risk,"
for information relating to the impact of fluctuating interest rates on our
future net interest income prospects.
Year ended December 31, 2001 compared to year ended December 31, 2000. Net
interest income increased $1.6 million, or 11.6 percent, to $14.9 million as
compared to $13.4 million. Net interest spread and net interest margin were 2.40
and 2.90 percent, respectively as compared to 2.40 and 2.73 percent for the
prior period.
Net interest income for the twelve-month period ended December 31, 2001
reflected mark-to-market losses on the value of derivative contracts totaling
($184,000). Without the mark-to-market adjustments on these derivative contracts
net interest margin for the period would have been 2.94 percent. Net interest
income for the twelve-month period ended December 31, 2000 reflected
amortization of an interest rate floor contract totaling ($224,000). Without
this amortization expense net interest margin for the period would have been
2.78 percent. The cost of the interest rate floor contract was being amortized
during 2000 because Statement of Financial Accounting Standards No. 133,
"Accounting for Derivatives and Hedging Activities" ("SFAS 133"), as amended
relating to the accounting for derivatives, was not yet effective.
The following condensed information summarizes the major factors combining to
create the changes to net interest income, spread and margin. Lettered
explanations following the summary describe causes of the changes in these major
factors:
Net Interest Income Analysis - 2001 vs. 2000 (1)
For the Years
Ended December 31, Change
-------------------- ----------------
2001 2000
--------- ---------
(amounts in millions)
Total interest income decreased............. $ 37.6 $ 40.7 $ (3.1) (8)%
Due to:
Decrease in yield on interest-
earnings assets........................ 7.31% 8.30% (.99)% (12)%
Driven by:
Decrease in yield on loans (a).......... 8.17% 9.58% (1.41)% (15)%
Decrease in yield on investments (b).... 6.07% 6.99% (0.92)% (13)%
The decreases in yield on
interest-earning assets were
Offset by:
Increase in average earning assets....... $ 514.4 $ 490.0 $ 24.4 5%
Driven by:
Increase in average loans (c)........... $ 293.7 $ 244.5 $ 49.2 20%
Offset by:
Decrease in average investments (d)..... $ 223.0 $ 243.2 $ (20.2) (8)%
Total interest expense decreased............ $ 22.7 $ 27.3 $ (4.6) (17)%
Due to:
Decrease in cost of
interest-bearing liabilities........... 4.91% 5.90% (0.99)% (17)%
Driven by:
Decrease in cost of
interest-bearing deposits (e).......... 4.40% 5.52% (1.12)% (20)%
Decrease in cost of borrowings (f)...... 6.12% 6.55% (0.43)% (7)%
These decreases were coupled with:
Decrease in average
interest-bearing liabilities........... $ 461.3 $ 462.0 $ (0.7) --
Driven by:
Decrease in average borrowings (g)...... $ 137.3 $ 171.7 $ (34.4) (20)%
Offset by:
Increase in average interest-bearing
deposits (h)........................... $ 324.0 $ 290.3 $ 33.7 12%
- --------------------
(1) From continuing operations for all periods presented.
(a) The decreased loan yield is reflective of a 475 basis point decrease in the
prime rate over the course of 2001 as monetary policy eased in response to
weakening national economic conditions. Floating rate loans tied to prime
repriced lower and new loans originated during 2001 came on at lower rates
than those originated during 2000.
(b) The decreased investment yield reflects the lower rate environment in 2001
as well as the reduction in the size of the investment portfolio in order
to shift the earning asset mix toward loans.
(c) Loan growth was attributable to increases in loans originated in our
Arizona, Minnesota and North Dakota markets.
(d) Average investments decreased due to the strategic shift in earning asset
mix from investment securities to loans as lending opportunities arose in
the Arizona, Minnesota and North Dakota markets.
(e) Decreased cost of interest-bearing deposits is reflective of the rise in
volume of Wealthbuilder interest checking and money market accounts and the
associated decreases in cost as interest rates declined during 2001. The
Wealthbuilder accounts carry rates that are variable at management's
discretion. Management lowered the rates paid on these deposits in response
to the monetary easing that took place during 2001 while maintaining the
competitive nature of the Wealthbuilder products in the Company's various
markets. Additionally, in a lower rate environment, the cost of
certificates of deposit also decreases with renewals and new accounts.
(f) Rates are reflective of the overall decreased rate environment in 2001 as
compared to 2000.
(g) We decreased our volume of FHLB advances due to greater use of national
market certificates of deposit as a wholesale funding source in order to
maintain borrowing capacity at the FHLB, support the earning asset base and
take advantage of favorable costs of national market certificates of
deposit relative to FHLB advances. In addition, on August 31, 2001 we
redeemed $12.6 million of our 8 5/8 percent subordinated notes due May 31,
2004 through the exercise of our call option.
(h) Deposit growth was primarily attributable to the continued success of the
Wealthbuilder family of interest checking and money market accounts in
addition to increased use of direct non-brokered national market
certificates of deposit obtained via posting rates on national networks.
National market certificates of deposit were $34.0 million as of December
31, 2001 compared to $9.0 on December 31, 2000.
Provision for Credit Losses. We determine a provision for credit losses which we
consider sufficient to maintain our allowance for credit losses at a level
considered adequate to provide for an estimate of probable losses related to
specifically identified loans as well as probable losses in the remaining loan
and lease portfolio that have been incurred as of each balance sheet date. The
provision for credit losses for the year ended December 31, 2002 was $1.2
million as compared to $1.7 million in 2001 and $1.2 million in 2000. Net loan
and lease charge-offs were $521,000, or 0.17 percent of average loans and leases
in 2002 compared with $962,000, or 0.33 percent in 2001 and $486,000, or 0.20
percent in 2000. The increase in provision and net-charge-offs in 2001 primarily
reflected the impact of developments in our truck leasing portfolio and
deterioration in performance of a number of our contracting customers.
The provision for credit losses is calculated as part of the determination of
the allowance for credit losses and the related provision for credit losses is a
critical accounting policy which involves consideration of a number of factors
such as loan growth, net charge-offs, changes in the composition of the loan
portfolio, delinquencies in the loan and lease portfolio, the value of
underlying collateral on problem loans, general economic conditions and our
assessment of credit risk in the current loan and lease portfolio. Periodic
fluctuations in the provision for credit losses result from our assessment of
the adequacy of the allowance for credit losses; however, actual loan losses may
vary from current estimates.
The allowance for loan losses totaled $5.0 million at December 31, 2002 compared
with $4.3 and $3.6 million at December 31, 2001 and 2000, respectively. See Note
1 to the Consolidated Financial Statements included under Item 8, "-Financial
Condition-Loan Portfolio-Allowance for Credit Losses" and "-Critical Accounting
Policies" for further discussion of the components of the allowance for credit
losses, our systematic methodology for determining the adequacy of the allowance
and additional data pertaining to charge-offs, recoveries and other related
information.
Noninterest Income. Noninterest income is becoming a more significant source of
revenues for us as we continue to emphasize our goal of focusing on local
relationship banking and providing a broad range of financial products and
services that will meet the needs of our customers, both commercial and
consumer. Our noninterest income increased approximately $7.6 million, or 87
percent, in 2002 largely due to insurance commission income generated by Milne
Scali, which we acquired in April 2002. Fees on loans, net gain on sales of
securities and service charges also increased in 2002. Noninterest income
increased approximately $1.0 million, or 13 percent, in 2001 primarily as a
result of increases in net gains on sales of securities.
The following table presents, for the periods indicated, the major categories of
our noninterest income as well as the amount and percent of change between each
of the periods presented. Related information and significant changes are
discussed in lettered explanations following the table:
Noninterest Income (1)
Increase (Decrease)
--------------------------------------
For the Years Ended
December 31, 2002 - 2001 2001 - 2000
---------------------------- ----------------- ------------------
2002 2001 2000 $ % $ %
-------- -------- -------- -------- ------- -------- --------
(in thousands)
Insurance commissions... $ 8,981 $ 1,891 $ 2,003 $ 7,090 375% $ (112) (6)% (a)
Fees on loans........... 2,169 1,936 1,848 233 12% 88 5% (b)
Net gain on sales of
securities ........... 1,870 1,396 276 474 34% 1,120 406% (c)
Brokerage income........ 1,094 1,407 1,466 (313) (22)% (59) (4)% (d)
Service charges......... 755 636 581 119 19% 55 9% (e)
Trust and financial
services............... 751 899 1,064 (148) (16)% (165) (16)% (f)
Rental income........... 89 54 27 35 65% 27 100%
Other................... 587 495 418 92 19% 77 18%
-------- -------- -------- -------- --------
Total noninterest
income................. $16,296 $ 8,714 $ 7,683 $ 7,582 87% $ 1,031 13%
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(1) From continuing operations for all periods presented.
(a) Insurance commissions. In 2002, insurance commissions increased
dramatically due to the April 16, 2002 acquisition of Milne Scali. In 2001,
insurance commissions declined in the face of a challenging economic
environment and catastrophic weather-related events in the North Dakota
market during 2000 that reduced and/or eliminated contingency fees paid by
insurance companies in 2001. We expect insurance commission income to
increase during 2003 due to a full year of production by Milne Scali along
with contingency fees generally received by Milne Scali in the first
quarter of each year.
(b) Fees on loans. The increase in loan fees for 2002 is largely attributable
to loans originated and sold on the secondary market. Loan volume
generation and the related loan fees associated with such loans can be
subject to significant fluctuations making it difficult to anticipate the
amount of loans that will be originated or placed and related loan fees
that will be recognized in future periods.
(c) Net gain on sales of securities. Net gain on sales of securities in 2002
was primarily a result of repositioning the investment portfolio's
forward-looking risk/rewa