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, 2003
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 No.)
incorporation or organization)
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. [ ]
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 $21,069,000.
The number of shares of the Registrant's common stock outstanding on
March 16, 2004 was 2,764,684.
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 2004 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, 2003
TABLE OF CONTENTS
Page
PART I
Item 1. Business....................................................... 3
Item 2. Properties..................................................... 16
Item 3. Legal Proceedings.............................................. 16
Item 4. Submission of Matters to a
Vote of Security Holders.................................. 17
PART II
Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters............................ 17
Item 6. Selected Financial Data......................................... 18
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations.............. 20
Item 7A. Quantitative and Qualitative Disclosures about
Market Risk................................................ 57
Item 8. Financial Statements and Supplementary Data..................... 61
Item 9A. Controls and Procedures......................................... 112
PART III
Item 10. Directors and Executive Officers of the Registrant.............. 113
Item 11. Executive Compensation.......................................... 114
Item 12. Security Ownership of Certain Beneficial Owners
and Management............................................. 114
Item 13. Certain Relationships and Related Transactions.................. 114
Item 14. Principal Accounting Fees and Services.......................... 114
PART IV
Item 16. Exhibits, Financial Statement Schedules and
Reports on Form 8-K........................................ 114
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
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.
Acquisitions, de novo branches and mergers have played an important role in our
strategy. During the three years ended December 31, 2003, we completed several
such transactions. 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, 2003, we had total assets of $621.5 million, total loans of
$283.6 million and total deposits of $395.9 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.
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.
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 16 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 2003, 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. Our core deposit growth
during 2003 allowed us to reduce brokered and national market certificates of
deposit by $27.2 million during the year ended December 31, 2003. Additionally,
through the Certificate of Deposit Account Registry ServiceSM (CDARSSM), the
Bank can now place large customer deposits into smaller denomination (fully
FDIC-insured) certificates of deposit at multiple institutions. This provides
the Bank's large deposit customers with FDIC insurance on their entire balances
and the convenience of managing their certificates of deposit investments
through a single bank relationship. This service was made available beginning in
2003. 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 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. On December 31, 2003, we also acquired certain assets and assumed
certain liabilities of The Insurance Alliance of the Southwest ("IASW"), a
Tucson-based insurance agency. The acquisition included the staff and owners of
IASW. The insurance segment has become an important and significant part of our
business.
Milne Scali began as an independently owned and operated commercial insurance
brokerage serving the needs of local, regional and national businesses.
Combining the talents of experienced insurance professionals, Milne Scali
provides solutions for every business insurance need. Its agents and customer
service representatives have more than 1,000 years of insurance knowledge
amongst them - experience that Milne Scali feels benefits its customers on a
daily basis. Many of Milne Scali's representatives began their careers at large,
national brokerage firms and insurance companies such as Fireman's Fund
Insurance Co., C.T. Bowring (Brokers, Lloyd's of London), Wausau Insurance,
Aetna Insurance Co., Arkwright Mutual, Alexander & Alexander, Travelers
Insurance Company, Marsh USA Risk & Insurance Services, Inc. and The Willis
Group. From these backgrounds, Milne Scali's representatives have developed
skills that serve its clients well. At the same time, Milne Scali has added the
extra benefits of an entrepreneurial business dedicated to providing the best
solution at the best possible price.
Milne Scali's clients range from large, established companies with hundreds of
millions in sales to emerging businesses with growing needs. It serves clients
in nearly every industry including construction, real estate development,
manufacturing, distribution and wholesale, professionals, government, financial
institutions, retail and service industries. Milne Scali's ability to serve each
client is enhanced by its ability to draw upon the varied needs arising from its
diverse client base. One contact can handle all customer insurance needs -
business and personal. Milne Scali's agents and customer service representatives
make it their job to be familiar with its customers' business and their
families, always looking for better ways to serve the customers' diverse needs.
Milne Scali was founded primarily to specialize in commercial insurance. The
intent was to be different in two very specific practices from its major
competitors. First, its employee culture and environment is structured to foster
creativity and entrepreneurial work ethics enabling associates to create
opportunities for themselves and thereby grow with Milne Scali. Second, the
negotiating character of Milne Scali's brokers and agents is structured to
foster threefold relationships to benefit its clients. Those relationships are
built with (1) the client (and its personnel), (2) the insurance companies (and
their personnel), and (3) the Milne Scali staff. All three relationships are
focused on protecting the clients' assets and thereby designed to help Milne
Scali grow.
From inception, Milne Scali's intent was to be different in its client
relationship focus. As entrepreneurs, Milne Scali takes an active partnering
role with its clients. Much like its clients, Milne Scali manages its company
while at the same time working with its client needs. The dual role of partner
and broker allows Milne Scali to better understand the internal working
operations of its clients and businesses. It is Milne Scali's pledge to find the
best possible coverage for customer needs, no matter how difficult the
challenge.
Since inception, Milne Scali's creativity and entrepreneurial spirit have
produced dramatic results as it rapidly became the second largest privately
owned Phoenix-based insurance broker. Milne Scali can provide the full range of
services from the self-insured multinational client to the local sole
proprietor. Milne Scali provides an extremely wide array of products and
expertise, including but not limited to:
Business insurance such as property, liability, fleet auto, workers'
compensation, errors and omissions, directors and officers, employment
practices, crime and employee dishonesty, umbrella and excess, boiler and
machinery, surety and bonds, flood and earthquake.
Risk management such as risk and loss control services, risk transfer analysis,
risk consulting, risk management program design and implementation.
Group benefits insurance such as health, life, dental, disability, 401(k)s and
SEPs, prepaid legal, key man protection, buy/sell protection, estate and
business continuation.
Association and affinity group insurance programs such as group auto and
homeowners, benefit plans, product liability programs, workers' compensation
groups, self-insured pools, risk retention groups, captive and rent-a-captive
operations.
Personal lines such as homeowners and renters, personal articles floater,
automobile, watercraft, aircraft, flood and earthquake, umbrella and life.
Milne Scali starts by examining customer current programs and policies -
analyzing the classifications, the coverage and the price. Its years of
experience and knowledge of the insurance industry and of its competitors helps
Milne Scali to identify and solve problems customers may have never known
existed - until it was too late. Milne Scali's objective is to reduce customer
cost of risk. Its clients think of Milne Scali as problem solvers, not problem
finders. Every one of Milne Scali's professionals is committed to making
customer lives easier rather than complicating it with endless forms. Milne
Scali is committed to enhancing customer progress by producing bonds and proof
of coverage when customers need them. It prides itself on delivering the fastest
response in the industry to customer insurance needs without sacrificing quality
or value. Above all, the difference Milne Scali offers is the
relationship-driven service that always puts customer needs first. Milne Scali
knows that care and attention bring its clients back year after year. Care and
attention, along with problem solving, is the Milne Scali difference.
BNC Insurance also has a long history of providing insurance brokerage services
as the genesis of the company had its roots back in the late 1800's. What is now
BNC Insurance is the culmination of multiple insurance agency beginnings; some
of them with what are today some of the largest financial institutions in the
country. BNC Insurance also provides a wide range of commercial and personal
lines of insurance and can look to Milne Scali to assist in providing expertise
and insurance coverage and risk management products and services beyond what was
available to customers prior to our acquisition of Milne Scali.
The insurance segment will typically have its strongest performance in the first
quarter of each fiscal year as contingency payments from insurance carriers are
generally received during that quarter. Our insurance segment has offices in the
following major cities: Phoenix, Tucson, Minneapolis and Bismarck. The
Minneapolis office was opened during 2003 and the Tucson office (IASW) was
acquired on December 31, 2003.
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 and Tucson, 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, we recently added a market president
in each of our major markets: Arizona, Minnesota and North Dakota.
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 and insurance 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, 2003, 31 percent of our loans were to borrowers located in
North Dakota, 29 percent to borrowers located in Arizona, 28 percent to
borrowers located in Minnesota, 8 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, 2003 (in thousands):
Total Net Loans
Location Deposits Outstanding(1)
- ------------------------------------------ -------------- ---------------
Bismarck, ND.......................... $122,669 $103,004
Crosby, ND............................ 16,604 250
Ellendale, ND......................... 10,437 450
Garrison, ND.......................... 15,185 506
Kenmare, ND........................... 10,981 133
Linton, ND............................ 42,794 8,958
Minneapolis, MN....................... 39,955 81,090
Phoenix, AZ........................... 15,582 65,659
Scottsdale, AZ........................ 39,716 11,734
Stanley, ND........................... 16,943 819
Tempe, AZ............................. 23,396 11,376
Watford City, ND...................... 10,196 84
Brokered deposits..................... 18,579 --
National market deposits.............. 12,905 --
-------------- ---------------
Total ............................. $395,942 $284,063
============== ===============
- ------------------
(1) Before allowance for credit losses, unearned income and net unamortized
deferred fees and costs.
Strengthening Financial Performance. In 2003, we demonstrated the value of our
financial management strategies. The results of our efforts to diversify our
sources of revenue, and in particular the decision to expand our insurance
business through the Milne Scali acquisition, drove an 88.5 percent
year-over-year increase in earnings.
Determined Management Team. We believe our financial and operational
accomplishments during 2003 are, in large measure, a reflection of our
determination to enhance shareholder value. The determination to invest in the
future continued to contribute to a highly profitable insurance agency business
and the creation of a growing presence in the Arizona and Minnesota markets. We
believe 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, 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 nonbank 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
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 regulation, 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, 2003, 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, 2003 approximately $12.3
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
2003 at approximately $0.00385 per $100 of 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") 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 reviewed implementing regulations and other guidance issued by
bank regulatory agencies in response to the Financial Modernization Act and have
established 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 form those 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.
Employees
At December 31, 2003, we had 302 employees, including 291 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, 2003:
banking, 163; insurance, 129; and brokerage/trust/financial, 10.
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 can negatively impact our profitability. 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 could
adversely affect our operating results. Although our operations are presently
somewhat geographically dispersed, 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. 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 can significantly 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 interest
income received on loans and investment securities and interest expense paid on
deposits and borrowings is known as net interest income. The level of net
interest income can fluctuate given changes in market interest rates. We measure
interest rate risk under various rate scenarios and using specific criteria and
assumptions. A summary of this process, along with the results of our net
interest income simulations is presented at "Quantitative and Qualitative
Disclosures About Market Risk" included under Item 7A of Part II. 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.
Changes in market interest rates can directly influence the performance of our
insurance segment. Interest rate movements directly affect insurance company
investment in bonds and, as a result, the rates they subsequently charge for
insurance policies. A rising interest rate environment increases investment
returns for insurers and generally allows those insurers to compete more
aggressively with lower insurance rates. During the past three years, interest
rates have been low and insurance rates were up. Over the next several years,
interest rates could move up and lower insurance rates would be expected, which
in turn would create lower premiums and commissions. We cannot predict, with any
degree of certainty, interest rate developments, and the resulting impact on
insurance premiums and commissions, in future periods.
Government regulation can result in limitations on our operations. 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 stockholders. 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 from other financial services providers could adversely impact our
results of operations. 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
exposes us to risk of loss that can materially adversely affect our results of
operations. 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.
Impairment of goodwill or other intangible assets could require charges to
earnings, which could result in a negative impact on our results of operations.
Under current accounting standards, goodwill and certain other intangible assets
with indeterminate lives are no longer amortized but, instead, are assessed for
impairment periodically or when impairment indicators are present. Assessment of
goodwill and such other intangible assets could result in circumstances where
the applicable intangible asset is deemed to be impaired for accounting
purposes. Under such circumstances, the intangible asset's impairment would be
reflected as a charge to earnings in the period during which such impairment is
identified. Further information regarding intangible assets is presented in Note
9 to the Consolidated Financial Statements included under Item 8 of Part II.
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 2425 East Camelback Road, Phoenix, Arizona, which it is leasing. The
Bank owns branch offices at 219 South 3rd Street and 801 East Century Avenue and
an additional office building at 116 North 4th Street in Bismarck. The Bank also
owns a branch office at 17045 North Scottsdale Road, Scottsdale, Arizona. It
also owns its banking facilities in Crosby, Ellendale, Kenmare, Linton, Stanley
and Watford City, North Dakota. During 2003, the Bank purchased a facility in
Golden Valley, Minnesota. The facility will be an additional branch office of
the Bank and is expected to commence operations during 2004. In February 2004,
the Bank also purchased properties at 6501 East Grant and 6515 East Grant in
Tucson, Arizona. We anticipate construction of a banking branch at 6515 East
Grant to commence during late 2004 or early 2005 and the 6501 East Grant
property is expected to be occupied by insurance personnel, primarily personnel
from IASW.
The Bank's facilities at 502 West Main Street (Mandan) and Garrison, North
Dakota are leased. The facilities occupied by the Bank, BNC AMI and BNC
Insurance at 333 South Seventh Street, Minneapolis, Minnesota, and the Bank's
facilities at 640 and 660 South Mill Avenue, Tempe, Arizona, along with 2425
East Camelback Road, Phoenix, Arizona are also leased.
Milne Scali occupies four locations in Arizona: 1750 East Glendale Avenue,
Phoenix, 660 South Mill Avenue, Tempe, 2400 East Highway 89A, Cottonwood and
6751 East Camino Principal, Tucson. The Bank owns the property in Phoenix and
the remaining three facilities are presently leased.
We believe that all owned and leased properties are well maintained and
considered in good operating condition. They are believed adequate for the
Company's present operations; however, future expansion could result in the
leasing or construction of additional facilities. 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
BNCCORP, Inc. v. Kenneth Hilton Johnson, No. 309299 on the Docket of the United
States District Court for the Northern District of Illinois, Eastern Division.
In December 2003, we filed suit against Kenneth Hilton Johnson under Section
16(b) of the Exchange Act, as amended. Mr. Johnson is the beneficial owner of
more than 10 percent of our common stock. We seek to recover at least $98,179.45
plus interest in profits made by Mr. Johnson in connection with profitable
purchase and sales transactions of our common stock within the same six- month
period. As of March 9, 2004, Mr. Johnson had not filed an answer to the lawsuit.
On December 31, 2003, Mr. Johnson's attorney tendered a check to us in an
apparent attempt to settle the suit. We have requested, as a condition of
dismissal, an affidavit from Mr. Johnson or his broker(s) stating that the Form
4's filed as exhibits to our complaint reflect all of Mr. Johnson's trades in
our common stock during the period covered by the complaint and that the amount
tendered to us reflects the sum of all of the shortswing profits that Mr.
Johnson owes to the Company under Section 16(b), as of the date of any dismissal
of the lawsuit. As of March 9, 2004, we had not received the requested
affidavit. If we actually receive this affidavit, we will consider accepting the
amount tendered in settlement and dismissal of the lawsuit. Otherwise, we will
recover the full amount due to us by Mr. Johnson under Section 16(b).
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 such
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 such 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, 2003.
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.
2003 2002
------------------------- ---------------------------
Period High Low High Low
----------- ----------- ------------ -----------
First Quarter...... $11.10 $7.00 $8.90 $7.28
Second Quarter..... 13.49 10.64 8.60 7.47
Third Quarter...... 15.25 12.23 7.75 5.49
Fourth Quarter..... 19.20 14.62 8.03 5.25
On March 5, 2004, there were 102 record holders of the Company's Common Stock as
reported by the Company's stock transfer agent and registrar, American Stock
Transfer & Trust Company.
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. "Supervision and Regulation - Dividend Restrictions"
included under Item 1 of Part I discusses regulatory restrictions on dividends
payable by the Bank to BNCCORP.
Pursuant to an Asset Purchase and Sale Agreement, on December 31, 2003, BNCCORP
issued 12,701 shares of its Common Stock to IASW in connection with Milne
Scali's acquisition of certain assets and assumption of certain liabilities of
IASW. The shares of Common Stock were issued in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act.
Equity-Based Compensation Plans. The following table summarizes information
relative to our equity-based compensation plans as of December 31, 2003:
(a) (b) (c)
-------------------------- ---------------------- ----------------------------------
Number of securities remaining
Number of securities to Weighted-average available for future issuance
be issued upon exercise exercise price of under equity compensation plans
of outstanding options, outstanding options, (excluding securities reflected
Plan Category warrants and rights warrants and rights in column (a))
- ------------------------------- -------------------------- ---------------------- ----------------------------------
Equity compensation plans
approved by security holders 173,285 $10.41 134,151
- ------------------------------- -------------------------- ---------------------- ----------------------------------
Equity compensation plans not
approved by security holders N/A N/A N/A
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, 2003, 2002, 2001, 2000 and 1999 are derived from the historical
audited consolidated financial statements of the Company. The Consolidated
Balance Sheets as of December 31, 2003, 2002 and 2001, and the related
Consolidated Statements of Income, Comprehensive Income, Stockholders' Equity
and Cash Flows for each of the four years in the period ended December 31, 2003
were audited by KPMG LLP, independent public accountants. The Consolidated
Balance Sheet as of December 31, 1999 and the related Consolidated Statements of
Income, Comprehensive Income, Stockholders' Equity and Cash Flows for the one
year 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 is qualified by the Consolidated
Financial Statements and the notes thereto included under Item 8.
The adoption of Statement of Financial Accounting Standards No. 150, "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity" ("SFAS 150") in 2003, which requires that the expense associated with
BNCCORP's subordinated debentures be included in interest expense, is reflected
in all applicable periods in the table below. The data presented in the table
below includes the financial performance of Milne Scali since its acquisition in
April 2002. Additionally, the financial performance of the Bank's Fargo, North
Dakota branch (which was sold on September 30, 2003) and BNC Financial
Corporation, Inc. (which was sold on December 31, 1999) is not reflected in the
data below. All data presented is from continuing operations as of and for all
periods presented.
Selected Financial Data (1)
For the Years Ended December 31,
--------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ------------ ------------ ------------- -------------
(dollars in thousands, except share and per share data)
Income Statement Data:
Total interest income............................. $ 28,646 $ 31,818 $ 37,586 $ 40,658 $ 28,535
Total interest expense............................ 15,268 18,736 24,033 27,679 16,438
----------- ------------ ------------ ------------- -------------
Net interest income............................... 13,378 13,082 13,553 12,979 12,097
Provision for credit losses....................... 1,475 1,202 1,699 1,202 1,138
Noninterest income................................ 20,812 16,296 8,714 7,683 6,028
Noninterest expense............................... 27,290 25,329 18,182 15,821 17,435
Income tax provision (benefit).................... 1,581 822 691 1,183 (193)
----------- ------------ ------------ ------------- -------------
Income (loss) from continuing operations.......... $ 3,844 $ 2,025 $ 1,695 $ 2,456 $ (255)
=========== ============ ============ ============= =============
Balance Sheet Data: (at end of period)
Total assets...................................... $ 621,477 $ 602,228 $ 555,967 $ 547,447 $ 445,232
Investments....................................... 262,568 208,072 211,801 253,566 145,349
Federal Reserve Bank and Federal Home Loan Bank
stock........................................ 7,596 7,071 7,380 9,619 5,643
Loans, net of unearned income..................... 283,555 335,794 297,924 252,753 254,009
Allowance for credit losses....................... (4,763) (5,006) (4,325) (3,588) (2,872)
Total deposits.................................... 395,942 398,245 375,277 330,894 316,772
Short-term borrowings............................. 31,833 28,120 760 33,228 2,200
Federal Home Loan Bank advances................... 112,200 97,200 117,200 117,200 86,500
Long-term borrowings.............................. 8,640 8,561 13 12,642 14,470
Guaranteed preferred beneficial interests in
Company's subordinated debentures............ 22,397 22,326 22,244 7,606 --
Common stockholders' equity....................... 38,686 36,223 30,679 29,457 23,149
Book value per common share outstanding........... $ 14.07 $ 13.41 $ 12.79 $ 12.30 $ 9.65
Earnings Performance / Share Data (1):
Return on average total assets.................... 0.64% 0.36% 0.31% 0.47% (0.07)%
Return on average common stockholders' equity..... 9.92% 5.77% 5.51% 10.02% (1.22)%
Net interest margin............................... 2.47% 2.51% 2.63% 2.65% 3.38%
Net interest spread............................... 2.29% 2.29% 2.25% 2.35% 3.07%
Basic earnings (loss) per common share (1)........ $ 1.38 $ 0.74 $ 0.71 $ 1.02 $ (0.11)
Diluted earnings (loss) per common share (1)...... $ 1.35 $ 0.74 $ 0.70 $ 1.02 $ (0.11)
Cash dividends per common share................... -- -- -- -- --
Cash dividends per preferred share................ $ 800.00 $ 526.67 -- -- --
Total cash dividends - preferred stock............ $ 120 $ 79 -- -- --
Average common shares outstanding................. 2,705,602 2,611,629 2,395,353 2,397,356 2,406,618
Average common and common equivalent shares....... 2,764,816 2,628,798 2,421,113 2,398,553 2,407,018
Shares outstanding at yearend..................... 2,749,196 2,700,929 2,399,170 2,395,030 2,399,980
Balance Sheet and Other Key Ratios (1):
Nonperforming assets to total assets.............. 1.28% 1.27% 0.80% 0.12% 0.64%
Nonperforming loans to total loans................ 2.80% 2.27% 1.47% 0.23% 0.65%
Net loan charge-offs to average loans............. (0.56)% (0.17)% (0.33)% (0.20)% (0.46)%
Allowance for credit losses to total loans........ 1.68% 1.49% 1.45% 1.42% 1.13%
Allowance for credit losses to
nonperforming loans........................... 60% 66% 99% 619% 173%
Average common stockholders' equity to average
total assets.................................. 6.25% 5.93% 5.64% 4.71% 5.48%
- -------------------------
(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 12 months ended December 31
(amounts in thousands):
2003 2002 2001
------------- ------------- ------------
Income from continuing operations..... $ 3,844 $ 2,025 $ 1,695
Net income............................ 3,844 2,039 1,245
Basic earnings per common share....... 1.38 0.75 0.52
Diluted earnings per common share..... 1.35 0.75 0.51
Executive Summary - 2003 vs. 2002. 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
stockholder value generated favorable results in 2003. The following information
highlights key developments during 2003.
o 2003 net income rose 88.5 percent, to $3.84 million ($1.35 per share on a
diluted basis) compared with $2.04 million ($0.75 per share) for 2002.
o Our insurance segment provided a significant contribution to 2003
profitability.
o Noninterest income rose to 60.9 percent of gross revenues in 2003 compared
with 55.5 percent in 2002.
o Noninterest income increased 27.7 percent in 2003 to $20.81 million
compared with $16.30 million in 2002.
o Insurance commission income accounted for $14.57 million, or 70.0 percent
of noninterest income, compared with $8.98 million, or 55.1 percent, in
2002 with 2003 representing a full year of contribution from Milne Scali,
acquired in April 2002.
o Our trust and financial services division recorded a $488,000 fee for
coordinating the sale of two companies.
o Net interest income in 2003 remained relatively flat at $13.38 million
compared with $13.08 million in 2002. Included in net interest income were
mark-to-market losses on the value of derivative contracts totaling
($80,000) in 2003 and ($779,000) in 2002.
o Net interest margin narrowed to 2.47 percent in 2003 compared with 2.51
percent in 2002. Adoption of SFAS 150 required interest associated with
BNCCORP's subordinated debentures to be reflected as interest expense. All
prior periods have been reclassified to reflect this change.
o Noninterest expense rose 7.7 percent to $27.29 million for 2003 compared
with $24.33 million for 2002. The increase primarily reflected costs
associated with expanded banking and insurance operations in Arizona,
actions expected to support increased operating levels in 2004.
o Total assets reached $621.45 million at December 31, 2003 compared with
$602.23 million one year earlier.
o Total loans decreased 15.6 percent in 2003, to $283.56 million. Loan volume
was impacted by planned loan reductions, completion of some financed
commercial real estate projects and slower loan demand that was reflective
of economic conditions.
o The provision for credit losses in 2003 was $1.48 million compared with
$1.20 million in 2002.
o Loan charge-offs were $1.82 million in 2003 compared with $657,000 in 2002.
$1.3 million of the 2003 charge-offs related to one commercial contractor.
o The allowance for credit losses as a percentage of total loans at December
31, 2003 was 1.68 percent compared with 1.45 percent one year earlier. The
ratio of the allowance for credit losses to total nonperforming loans was
60 percent at December 31, 2003 compared with 66 percent one year earlier.
o We had $7.95 million of nonperforming loans at December 31, 2003 compared
with $7.63 million one year earlier. During January 2004, a $4.5 million
loan (reflected as a nonperforming loan at December 31, 2003) was paid in
full, including accrued interest. A $2.2 million nonperforming loan is
expected to be resolved during the second quarter of 2004. These
developments should result in much-improved asset quality moving forward
into 2004.
o Investment securities available for sale increased 26.2 percent in 2003, to
$262.57 million as investments were increased to maintain an acceptable
earning asset portfolio despite the reduction in loan volume.
o Core deposits increased $24.89 million or 7.3 percent during 2003. The
growth was primarily attributable to our Arizona market as we continued to
see demand for our Wealthbuilder family of deposit products.
o Brokered and national market certificates of deposit decreased $27.21
million during 2003.
o Reflecting continued success of our expansion into new markets, the Arizona
operations of the Bank accounted for approximately 31.2 percent of total
loans and 19.9 percent of total deposits at December 31, 2003.
o Total common stockholders' equity was approximately $38.69 million at
December 31, 2003, equivalent to book value per common share of $14.07
(tangible book value per common share of $5.54).
During 2003, we continued to take actions which we believe will strengthen the
performance of our core businesses.
In banking, we opened our Scottsdale branch office, relocated our East Camelback
office in Phoenix to a more prominent and visible location, acquired property
for a branch office in Golden Valley, Minnesota and acquired a mortgage banking
operation.
In insurance, the acquisition of IASW in December 2003 will help to increase the
volume of our insurance 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 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 2003 provides a meaningful
indication of our earnings potential. Looking ahead to 2004, we hope to continue
to derive benefits from our investments in expanding our banking and insurance
operations, and implementing programs to encourage cross-selling across all of
our business lines.
Executive Summary - 2002 vs. 2001. The following information highlights key
developments during 2002.
o Net income rose 63.8 percent, to $2.04 million ($0.75 per common share on a
diluted basis) compared with $1.25 million ($0.51 per share) in 2001.
o Our insurance segment made a strong contribution to 2002 profitability with
the acquisition of Milne Scali in April 2002.
o Noninterest income rose to 55.5 percent of gross revenues in 2002 compared
with 39.1 percent in 2001.
o Noninterest income increased 87.0 percent in 2002, to $16.30 million
compared with $8.71 million in 2001.
o Insurance commission income accounted for $8.98 million, or 55.1 percent,
of noninterest income, compared with $1.89 million, or 21.7 percent, in
2001.
o Net interest income in 2002 remained relatively flat at $13.08 million
compared with $13.55 million in 2001. Included in net interest income were
mark-to-market losses on the value of derivative contracts totaling
($779,000) in 2002 and ($184,000) in 2001.
o Net interest margin narrowed to 2.51 percent in 2002 compared with 2.63
percent in 2001.
o Noninterest expense rose 39.3 percent, to $25.33 million, for 2002 compared
with $18.18 million for 2001. The 2002 increase primarily reflected our
expanded banking and insurance operations in Arizona, including the
acquisition of Milne Scali in April, 2002, and the winding down of the
Fargo office of BNC AMI.
o Total assets were $602.23 million at December 31, 2002 compared with
$585.06 million one year earlier.
o Total loans increased $37.87 million, or 12.7 percent, to $335.79 million
at the end of 2002.
o The provision for credit losses in 2002 was $1.20 million compared with
$1.70 million in 2001.
o Loan charge-offs were $657,000 in 2002 compared with $1.27 million in 2001.
o The allowance for credit losses as a percentage of total loans at December
31, 2002 was 1.49 percent compared with 1.45 percent one year earlier. The
ratio of the allowance for credit losses to total nonperforming loans was
66 percent at December 31, 2002 compared with 99 percent one year earlier.
o We had $7.63 million of nonperforming loans at December 31, 2002 compared
with $4.38 million one year earlier.
o Total deposits rose 6.1 percent to $398.25 million at December 31, 2002
compared with $375.28 million one year earlier.
o Total common stockholders' equity was approximately $36.22 million at
December 31, 2002, equivalent to book value per common share of $13.41
(tangible book value per common share of $5.60).
o Net unrealized gains in our investment portfolio at December 31, 2002 were
nearly $4.4 million.
During 2002, we also 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, North Dakota 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.
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.
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,
-----------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------- ------------------------------- ------------------------------
Interest Average Interest Average Interest Average
Average earned yield or Average earned Yield Average earned yield
balance or paid cost balance or paid or cost balance or paid or cost
---------- --------- --------- ---------- --------- --------- ---------- -------- --------
(dollars in thousands)
Assets
Federal funds sold/interest
-bearing due from............. $ 1,447 $ 11 0.76% $ 3,795 $ 66 1.74% $ 1,830 $ 50 2.73%
Taxable investments............ 203,051 7,803 3.84% 193,972 9,997 5.15% 206,572 12,716 6.16%
Tax-exempt investments......... 32,982 1,535 4.65% 19,979 977 4.89% 16,452 829 5.04%
Loans and leases (2)........... 308,115 19,297 6.26% 307,227 20,778 6.76% 293,716 23,991 8.17%
Allowance for credit losses.... (4,909) -- (4,579) -- (4,153) --
---------- --------- ---------- --------- ---------- --------
Total interest-earning
assets (3).................. 540,686 28,646 5.30% 520,394 31,818 6.11% 514,417 37,586 7.31%
Noninterest-earning assets:
Cash and due from banks.... 11,733 13,706 11,997
Other...................... 48,249 34,946 19,388
---------- ---------- ----------
Total assets from continuing
operations.................... 600,668 569,046 545,802
Assets from discontinued
Fargo branch.................. -- 22,258 22,270
---------- ---------- ----------
Total assets......... $600,668 $591,304 $568,072
========== ========== ==========
Liabilities and Stockholders'
Equity
Deposits:
Interest checking and
money market accounts....... $186,796 2,189 1.17% $174,108 2,849 1.64% $147,775 4,669 3.16%
Savings..................... 6,052 51 0.84% 4,511 39 0.86% 3,758 56 1.49%
Certificates of deposit:
Under $100,000............... 94,820 3,012 3.18% 104,964 4,068 3.88% 98,639 5,280 5.35%
$100,000 and over............ 55,928 2,186 3.91% 73,639 3,286 4.46% 73,806 4,248 5.76%
---------- --------- ---------- --------- ---------- --------
Total interest-bearing
deposits...................... 343,596 7,438 2.16% 357,222 10,242 2.87% 323,978 14,253 4.40%
Borrowings:
Short-term borrowings....... 21,942 382 1.74% 7,799 141 1.81% 10,206 441 4.32%
FHLB advances............... 111,777 5,333 4.77% 97,711 6,214 6.36% 118,705 7,185 6.05%
Long-term borrowings......... 8,623 387 4.49% 6,063 310 5.11% 8,378 777 9.27%
Subordinated debentures...... 22,141 1,728 7.80% 22,056 1,829 8.29% 13,542 1,377 10.17%
---------- --------- ---------- --------- ---------- --------
Total interest-bearing
liabilities.................. 508,079 15,268 3.01% 490,851 18,736 3.82% 474,809 24,033 5.06%
Noninterest-bearing
demand accounts............ 40,022 33,951 28,474
---------- ---------- ----------
Total deposits and
interest-bearing
liabilities............. 548,101 524,802 503,283
Other noninterest-bearing
liabilities................... 13,542 11,336 8,765
Liabilities from discontinued
Fargo branch.................. -- 20,476 24,654
---------- ---------- ----------
Total liabilities..... 561,643 556,614 536,702
Stockholders' equity............ 39,025 34,690 31,370
---------- ---------- ----------
Total liabilities and
stockholders' equity.... $600,668 $591,304 $568,072
========== ========== ==========
Net interest income............. $ 13,378 $13,082 $13,553
========= ========= ========
Net interest spread............. 2.29% 2.29% 2.25%
========= ========= ========
Net interest margin (4)......... 2.47% 2.51% 2.63%
========= ========= ========
Ratio of average
interest-earning assets
to average interest-bearing
liabilities................. 106.42% 106.02% 108.34%
========== ========== ==========
- --------------------
(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 $1.5 million, $1.3 million and $812,000 is included in loan
interest income for the 12-month periods ended December 31, 2003, 2002 and
2001, respectively.
(3) Tax-exempt income has not been presented on a taxable equivalent basis.
Tax-exempt income of $1.5 million, $982,000 and $840,000 was recognized
during the years ended December 31, 2003, 2002 and 2001, 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,
-------------------------------------------------------------------------
2003 Compared to 2002 2002 Compared to 2001
------------------------------------ -----------------------------------
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........ $ (30) $ (26) $ (56) $ 24 $ (8) $ 16
Investments......................................... 1,347 (2,982) (1,635) (533) (2,038) (2,571)
Loans............................................... 60 (1,541) (1,481) 1,172 (4,385) (3,213)
------------ ------------ -------- ----------- -------- ------------
Total increase (decrease) in interest income..... 1,377 (4,549) (3,172) 663 (6,431) (5,768)
------------ ------------ -------- ----------- -------- ------------
Interest Expense on Interest-Bearing Liabilities
Interest checking and money market accounts......... 228 (888) (660) 1,067 (2,887) (1,820)
Savings............................................. 13 (1) 12 16 (33) (17)
Certificates of Deposit:
Under $100,000................................... (368) (688) (1,056) 367 (1,579) (1,212)
$100,000 and over................................ (726) (374) (1,100) (10) (952) (962)
Short-term borrowings............................... 246 (5) 241 (87) (213) (300)
FHLB advances..................................... 1,198 (2,079) (881) (1,361) 390 (971)
Long-term borrowings................................ 108 (31) 77 (178) (289) (467)
Subordinated debentures............................. 7 (108) (101) 639 (187) 452
------------ ------------ -------- ----------- -------- ------------
Total increase (decrease) in interest expense....... 706 (4,174) (3,468) 453 (5,750) (5,297)
------------ ------------ -------- ----------- -------- ------------
Increase (decrease) in net interest income.......... $ 671 $ (375) $ 296 $ 210 $ (681) $ (471)
============ ============ ======== =========== ======== ============
(1) From continuing operations for all periods presented.
Year ended December 31, 2003 compared to year ended December 31, 2002. Net
interest income increased $296,000, or 2.3 percent, and totaled $13.4 million
for 2003. Net interest spread and net interest margin adjusted to 2.29 and 2.47
percent, respectively, for the 12-month period ended December 31, 2003 from 2.29
and 2.51, respectively, for the 12-month period ended December 31, 2002.
Net interest income for the 12-month periods ended December 31, 2003 and 2002
reflected mark-to-market losses on the value of derivative contracts totaling
($80,000) and ($779,000), respectively. Without the mark-to-market adjustments
on these derivative contracts for the two periods, net interest margin would
have been 2.49 percent for the 12 months ended December 31, 2003 and 2.66
percent for the 12 months ended December 31, 2002.
The remaining fair value of our interest rate cap contracts on December 31, 2003
was $56,000. Therefore, net interest income in future periods can only be
negatively affected to that amount if the fair value of the contracts were
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 three-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 during 2003 as
compared to 2002. Lettered explanations following the summary describe causes of
the changes in these major factors.
Net Interest Income Analysis - 2003 vs. 2002 (1)
For the Years Ended
December 31, Change
------------------------- -----------------------
2003 2002
---------- -----------
(amounts in millions)
Total interest income decreased................................ $ 28.7 $ 31.8 $ ( 3.1) (10)%
Due to:
Decrease in yield on interest-earnings assets............ 5.30% 6.11% (0.81)% (13)%
Driven by:
Decrease in yield on loans (a)........................... 6.26% 6.76% (0.50)% (7)%
Decrease in yield on investments (b)..................... 3.96% 5.13% (1.17)% (23)%
The decreases in yield on interest-earning assets
were Offset by:
Increase in average earning assets....................... $ 540.7 $ 520.4 $ 20.3 4%
Driven by:
Increase in average loans (c)............................ $ 308.1 $ 307.2 $ 0.9 0%
Increase in average investments (d)...................... $ 236.0 $ 214.0 $ 22.0 10%
Total interest expense decreased............................... $ 15.3 $ 18.7 $ (3.4) (18)%
Due to:
Decrease in cost of interest-bearing liabilities......... 3.01% 3.82% (0.81)% (21)%
Driven by:
Decrease in cost of interest-bearing deposits (e)........ 2.16% 2.87% (0.71)% (25)%
Decrease in cost of borrowings (f)....................... 4.76% 6.36% (1.60)% (25)%
These decreases were coupled with:
Increase in average interest-bearing liabilities......... $ 508.1 $ 490.9 $ 17.2 4%
Driven by:
Increase in average borrowings (g)....................... $ 164.5 $ 133.6 $ 30.9 23%
Offset by:
Decrease in average interest-bearing deposits (h)........ $ 343.6 $ 357.2 $ (13.6) (4)%
- ---------------
(1) From continuing operations for all periods presented.
(a) Our decreased loan yield is reflective of the lower interest rate
environment during 2003. 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 and
2003. The daily average prime rate in 2003 was 4.12 percent as compared to
4.68 percent for 2002. The lower prime rate caused floating rate loans to
reprice at lower levels and new loans to be originated at interest rate
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 2003.
(c) Average loans remained relatively stable during 2003 in spite of a
significant decline in period end loans at December 31, 2003 versus
December 31, 2002.
(d) Average investments increased in 2003 to maintain an acceptable average
earning asset portfolio and related interest income. The increase in
average investments in 2003 caused the mix in the earning asset portfolio
to change resulting in downward pressure on net interest margin.
(e) The decrease in cost of interest-bearing deposits was reflective of the
lower interest rate environment during 2003. Floating rate deposit accounts
repriced at lower interest rate levels and certificates of deposit renewed
or were originated at lower interest rate levels than those in the prior
period.
(f) 2003 borrowing costs decreased due to the lower interest rate environment.
The lower interest rates were reflected in decreased cost on our $15.0
million floating rate subordinated debentures, our $8.5 million floating
rate loan, floating rate Federal funds purchased and repurchase agreements
with customers.
(g) Average borrowings increased in 2003 due to higher average balances of
Federal funds purchased, customer repurchase agreements and FHLB advances.
(h) Average deposits in 2003 decreased largely due to a $27.2 million reduction
in brokered and national market certificates of deposit during the 12
months ended December 31, 2003.
Year ended December 31, 2002 compared to year ended December 31, 2001. Net
interest income decreased $471,000, or 3.5 percent, to $13.1 million. Net
interest spread and net interest margin adjusted to 2.29 and 2.51 percent,
respectively, for the 12-month period ended December 31, 2002 from 2.25 and
2.63, respectively, for the 12-month period ended December 31, 2001.
Net interest income for the 12-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 2.66 percent for the 12 months ended December 31, 2002 and 2.67
percent for the 12 months ended December 31, 2001.
The following condensed information summarizes the major factors combining to
create the changes to net interest income, spread and margin during 2002 as
compared to 2001. 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............................. $ 18.7 $ 24.0 $ (5.3) (22)%
Due to:
Decrease in cost of interest-bearing liabilities....... 3.82% 5.06% (1.24)% (25)%
Driven by:
Decrease in cost of interest-bearing deposits (e)...... 2.87% 4.40% (1.53)% (35)%
Decrease in cost of borrowings (f)..................... 6.36% 6.48% (0.12)% (2)%
These decreases in cost of interest-bearing liabilities
were offset by:
Increase in average interest-bearing liabilities....... $ 490.9 $ 474.8 $ 16.1 3%
Driven by:
Increase in average interest-bearing deposits (g)...... $ 357.2 $ 324.0 $ 33.2 10%
Offset by:
Decrease in average borrowings (h)..................... $ 133.6 $ 150.8 $ (17.2) (11)%
- --------------------
(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