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, 2004
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. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes ___ No _X_
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the Registrant, computed by reference to the price at which
the common equity was last sold, as of the last business day of the Registrant's
most recently completed second fiscal quarter was $31,867,968.00.
The number of shares of the Registrant's common stock outstanding on
March 15, 2005 was 2,885,976.
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 2005 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, 2004
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, Related Stockholder
Matters and Issuer Purchases of Equity Securities................. 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 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................... 114
Item 9A.Controls and Procedures........................................... 114
Item 9B.Other Information................................................. 115
PART III
Item 10.Directors and Executive Officers of the Registrant................ 116
Item 11.Executive Compensation............................................ 116
Item 12.Security Ownership of Certain Beneficial Owners and Management.... 116
Item 13.Certain Relationships and Related Transactions.................... 116
Item 14.Principal Accounting Fees and Services............................ 116
PART IV
Item 15.Exhibits, Financial Statement Schedules........................... 116
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, income and expenses of the
Company 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 26
locations in Arizona, Minnesota, North Dakota, Colorado and Utah 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 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.
We will continue to emphasize internally generated growth by focusing on
increasing our market share within the market areas we now serve. Acquisitions,
de novo branches and mergers have also played an important role in our strategy.
During the three years ended December 31, 2004, 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 may
seek additional growth opportunities through select acquisitions of financial
services companies that we believe complement our businesses.
At December 31, 2004, we had total assets of $673.7 million, total loans held
for sale of $60.2 million, total loans held for investment of $293.8 million and
total deposits of $455.3 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
serve as a one-stop financial services provider for our customers by 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 with strong loan policies and continuously
monitoring loans and the loan review process.
o Maintain centralized 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, North
Dakota, Colorado and Utah;
In this section of this annual report on Form 10-K, we detail these
distinguishing strengths, which we expect will help customers to reach their
financial goals, and allow us to establish 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 20 banking branch offices in
Arizona, Minnesota and North Dakota. 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 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. During 2004, the Bank initiated a mortgage loan financing program in which
the Bank purchases short-term participation interests in residential mortgage
loans originated by a mortgage company. Also during 2004, the Bank initiated a
student loan financing program in which the Bank purchases short-term interests
in student loans originated by a student loan origination company.
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, along with the mortgage and student loans described
above. 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 2004, we increased core
deposits $30.8 million, or 8.4 percent (noninterest-bearing deposits increased
$18.7 million, or 41.7 percent). Our Wealthbuilder family of interest checking
and money market deposit accounts continues to be popular. 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 offers customer repurchase agreements to acquire funds
from customers where the customers require or desire to have their funds
supported by collateral consisting of investment securities of the Bank.
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. 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 (up to $ 10.0
million) and the convenience of managing their certificates of deposit
investments through a single bank relationship. This service was made available
beginning in 2003 and we had $16.8 million of such deposits at December 31,
2004. 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. Our insurance segment has offices in the following major
cities: Phoenix, Tucson, Minneapolis, Bismarck, Salt Lake City and Englewood (a
suburb of Denver). Our insurance subsidiary, Milne Scali (which merged with BNC
Insurance during 2004) is an independent insurance agency 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. Several additional
insurance acquisitions were made during 2003 and 2004. These are all summarized
in Note 2 to the Consolidated Financial Statements included under Item 8 of Part
II. The acquisitions have helped to increase the scope of our insurance segment,
adding to insurance commission income volume, and opening new markets (such as
Colorado and Utah) to our insurance segment.
Milne Scali serves local, regional and national businesses. Its 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. The only industry in which Milne Scali has a concentration (defined
as 35% of commissions or more) is the construction industry in the Arizona
market. This customer base includes general contractors and commercial trade
contractors.
Acquisitions during 2003 and 2004 have broadened its geographical reach and
added a surety business based in Colorado. Milne Scali can provide a full range
of services from the self-insured multinational client to the local sole
proprietor. Milne Scali provides a wide array of products and services,
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.
The North Dakota/Minnesota division of Milne Scali (formerly BNC Insurance) also
provides a wide range of commercial and personal lines of insurance. The
division can look to Milne Scali's Phoenix division to assist in providing
expertise and insurance coverage and risk management products and services
beyond what was available to our 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 profit sharing payments from insurance carriers
are generally received during that quarter. The insurance segment continues to
be an important and significant part of our business.
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, operating out of 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.
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 primarily in three distinct markets: Arizona;
Minnesota; and North Dakota. While these areas have very different fundamentals,
each enjoys a solid economic base and what we believe are compelling long-term
growth dynamics.
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. During
2004, the Phoenix metropolitan area surged ahead of Atlanta as the country's top
new-home builder. The housing sector's strength is expected to continue due to
the Phoenix metropolitan area's large stretches of undeveloped land, new jobs
and resort climate. Low interest rates and affordable home prices have also
helped to make the Phoenix housing market more attractive. Tourism, retirement
and job creation in such industries as software and biotechnology are among the
additional 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, medical and healthcare, education and food
processing. Banking is the primary segment operating in the Twin Cities area
with some brokerage and insurance activities also conducted in the market.
Bismarck-Mandan (our largest market in North Dakota) 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. Several national retail
chains also are planning to open new locations in the Bismarck-Mandan area
during 2005 and 2006. The banking, insurance and brokerage/trust/financial
segments are all represented in the North Dakota market.
Our insurance segment also began operations in Englewood, Colorado and Salt Lake
City, Utah during 2004. These markets also exhibit growth characteristics and
good fundamentals.
Individually, each of our key 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, 2004, 33 percent of our loans were to borrowers located in
North Dakota, 30 percent to borrowers located in Arizona, 30 percent to
borrowers located in Minnesota, 4 percent to borrowers located in South Dakota
and the remainder to borrowers in various other states. Other than brokered
deposits 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, 2004 (in thousands):
Net Loans Held
Total for Investment
Location Deposits Outstanding 1
- ----------------------------- ---------- --------------
Bismarck, ND............. $ 130,823 $ 100,253
Crosby, ND............... 17,345 188
Ellendale, ND............ 10,173 484
Garrison, ND............. 15,664 467
Golden Valley, MN........ 12,954 4,779
Kenmare, ND.............. 10,428 189
Linton, ND............... 41,297 8,949
Minneapolis, MN.......... 43,144 83,602
Phoenix, AZ.............. 31,272 76,804
Scottsdale, AZ........... 41,512 17,312
Stanley, ND.............. 16,792 791
Tempe, AZ................ 13,614 785
Watford City, ND......... 11,536 84
Brokered deposits........ 55,010 --
National market deposits. 3,779 --
---------- ----------
Total ................ $ 455,343 $ 294,687
========== ==========
- ------------------
1 Before allowance for credit losses, unearned income and net unamortized
deferred fees and costs.
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 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 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 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. Every state has a Department of
Insurance that primarily acts as a consumer advocate. Milne Scali as a company
has an insurance resident license in Arizona, North Dakota and Minnesota and a
non-resident license in almost every other state. All insurance producers are
licensed by the state and most other Milne Scali employees also have insurance
licenses.
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's
Regulation W implements Sections 23A and 23B of the Act and codifies 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, 2004, 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, 2004 approximately $14.1
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
2004 at approximately $0.00360 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. The Bank Secrecy Act and its
implementing regulations are presently the subject of increased regulatory focus
and several financial institutions have been penalized due to deficiencies in
their Bank Secrecy Act programs.
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 (the "Financial Modernization
Act") expands the powers of banks and bank holding companies to sell any
financial product or service, closes the unitary thrift loophole, reforms the
Federal Home Loan Bank ("FHLB") System to increase community banks' access to
loan funding, protects banks from discriminatory state insurance regulation and
establishes a new framework for the regulation of bank and bank holding company
securities brokerage and underwriting activities. The Financial Modernization
Act also includes provisions in the privacy area, restricting the ability of
financial institutions to share nonpublic personal customer information with
third parties.
USA Patriot Act of 2001. The USA Patriot Act of 2001 (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.
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, 2004, we had 344 employees, including 336 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, 2004:
banking, 180; insurance, 153; and brokerage/trust/financial, 11.
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.
Loss of key employees may disrupt relationships with certain customers. Our
business is primarily relationship-driven in that many of our key employees have
extensive customer relationships. Loss of a key employee with such customer
relationships may lead to the loss of business if the customers were to follow
that employee to a competitor. While we believe our relationship with our key
producers is good, we cannot guarantee that all of our key personnel will remain
with our organization. Loss of such key personnel, should they enter into an
employment relationship with one of our competitors, could result in the loss of
some of our customers.
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.
Recent accounting changes may give rise to a future regulatory capital event
that would entitle the trusts created to facilitate our trust preferred
securities offerings to redeem the trust preferred securities which would result
in a reduction to our consolidated capital ratios. In accordance with the
provisions of Financial Accounting Standards Board Interpretation No. 46,
"Consolidation of Variable Interest Entities," we have deconsolidated the two
subsidiary trusts that have issued trust preferred securities for BNCCORP.
Accordingly, the trust preferred securities are now reported as a liability.
Under applicable regulatory guidelines, a portion of the trust preferred
securities qualifies as Tier 1 capital (to certain limits), and the remaining
portion qualifies as Tier 2 capital (to certain limits). On July 2, 2003, the
Federal Reserve issued Supervisory Letter (SR 03-13), which preserves the
historical capital treatment of trust preferred securities as capital despite
the deconsolidation of these securities. That Supervisory Letter remained in
effect at December 31, 2004, and we continue to include these securities in our
capital base. A final rule regarding trust preferred securities has just been
issued and is under review.
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 and 650
Douglas Drive, Golden Valley, Minnesota. It also owns its banking facilities in
Crosby, Ellendale, Kenmare, Linton, Stanley and Watford City, North Dakota. The
Bank has also purchased a property at 6515 East Grant in Tucson, Arizona. We
anticipate construction of a banking branch at this location sometime in the
future. The Bank has also purchased land at 4155 Dean Lakes Boulevard, Shakopee,
Minnesota where construction of a branch office is expected to commence during
2005.
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 Milne Scali
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 five locations in Arizona: 1750 East Glendale Avenue,
Phoenix; 660 South Mill Avenue, Tempe; 2400 East Highway 89A, Cottonwood; 6751
East Camino Principal, Tucson; and 8101 East Florentine Road, Prescott Valley.
Milne Scali also occupies locations at 8310 South Valley Highway, Englewood,
Colorado and 175 South Main, Salt Lake City, Utah. The Bank owns the properties
in Phoenix and Tucson and the remaining five 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
Terrence M. Scali v. BNCCORP, Inc., Milne Scali & Company, Inc., Gregory K.
Cleveland and Jacquelyn L. Cleveland, husband and wife, Tracy Scott and Myrt
Scott, husband and wife, and Richard W. Milne, Jr. and Robin Jayne Milne,
husband and wife, AAA No. 76 166 00014 05 JAFA (the "Arbitration"). The American
Arbitration Association is administering the Arbitration. Terrence M. Scali,
former executive vice president of BNCCORP, and former President and CEO of
Milne Scali, a subsidiary of the Bank, which is a subsidiary of BNCCORP, and a
former director of BNCCORP, has commenced an arbitration against BNCCORP, Milne
Scali, and three current executives and members of the Boards of Directors of
BNCCORP and Milne Scali. Mr. Scali alleges that his damages exceed $500,000 and
arise out of the termination of his employment with BNCCORP and Milne Scali in
July 2004. In his claims against BNCCORP and Milne Scali, Mr. Scali alleges
breach of contract, wrongful termination, and conversion. Mr. Scali has also
brought a claim for a declaration of his rights under an employment agreement,
seeking to have his noncompete, nonsolicitation, and nondisclosure agreements
nullified. For his claims against the executives, Mr. Scali alleges tortuous
interference with contract and defamation. Mr. Scali has also named the wives of
the three executives as respondents to the Arbitration in their capacity as
potential holders of community property interests with their husbands. BNCCORP,
Milne Scali and the executives deny any wrongdoing and will vigorously defend
against Mr. Scali's claims.
Terrence M. Scali v. Gregory K. Cleveland and Jane Doe Cleveland, husband and
wife, Tracy Scott and Jane Doe Scott, husband and wife, and Richard W. Milne,
Jr. and Robin Jayne Milne, husband and wife, State of Arizona Superior Court,
Maricopa County, Case No. CV2005-001741. Mr. Scali has commenced a parallel
action in Arizona Superior Court against BNCCORP and Milne Scali executives,
asserting the same claims in court that were asserted in the Arbitration. The
executives intend to vigorously defend against Mr. Scali's claims in the court
case, as they will do in the Arbitration.
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, 2004.
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities.
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.
2004 2003
----------------- ------------------
Period High Low High Low
------- ------- -------- -------
First Quarter...... $18.40 $15.16 $11.10 $ 7.00
Second Quarter..... 17.51 15.00 13.49 10.64
Third Quarter...... 18.10 13.62 15.25 12.23
Fourth Quarter..... 16.60 14.38 19.20 14.62
On January 28, 2005, there were 104 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 dated December 31, 2003, on
December 31, 2004, BNCCORP issued 15,692 shares of its Common Stock to IASW for
the second installment related to Milne Scali's acquisition of certain assets 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.
Pursuant to an asset purchase and sale agreement, on June 30, 2004, BNCCORP
issued 26,607 shares of its Common Stock to Finkbeiner Insurance, Inc. in
connection with Milne Scali's acquisition of certain assets and assumption of
certain liabilities of the insurance agency. The shares of Common Stock were
issued in reliance upon the exemption from registration provided by Section 4(2)
of the Securities Act.
Pursuant to an asset purchase and sale agreement, on March 31, 2004, BNCCORP
issued 22,470 shares of its Common Stock to The Richard Q. Perry Agency in
connection with Milne Scali's acquisition of certain assets and assumption of
certain liabilities of the insurance agency. The shares of Common Stock were
issued in reliance upon the exemption from registration provided by Section 4(2)
of the Securities Act.
Pursuant to an asset purchase and sale agreement, on January 5, 2004, BNCCORP
issued 2,888 shares of its Common Stock to Lynk Financial LLC ("Lynk") in
connection with the Bank's acquisition of certain assets of Lynk. The shares of
Common Stock were issued in reliance upon the exemption from registration
provided by Section 4(2) of the Securities Act.
BNCCORP did not purchase any of its Common Stock during 2004.
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, 2004, 2003, 2002, 2001 and 2000 are derived from the historical
audited consolidated financial statements of the Company. The Consolidated
Balance Sheets as of December 31, 2004, 2003, 2002, 2001 and 2000, and the
related Consolidated Statements of Income, Comprehensive Income, Stockholders'
Equity and Cash Flows for each of the five years in the period ended December
31, 2004 were audited by KPMG LLP, independent public accountants. 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
as such 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. The data presented in the table
below also includes the financial performance of our other acquisitions since
their respective acquisition dates. Additionally, the financial performance of
the Bank's Fargo, North Dakota branch (which was sold on September 30, 2003) 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,
----------------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- ---------- --------- ---------
(dollars in thousands, except share and
per share data)
Income Statement Data:
Total interest income............. $ 30,141 $ 28,646 $ 31,818 $ 37,586 $ 40,658
Total interest expense............ 14,100 15,268 18,736 24,033 27,679
--------- --------- ---------- --------- ---------
Net interest income............... 16,041 13,378 13,082 13,553 12,979
Provision for credit losses....... 175 1,475 1,202 1,699 1,202
Noninterest income................ 23,450 20,812 16,296 8,714 7,683
Noninterest expense............... 34,768 27,290 25,329 18,182 15,821
Income tax provision.............. 1,144 1,581 822 691 1,183
--------- --------- ---------- --------- ---------
Income from continuing operations. $ 3,404 $ 3,844 $ 2,025 $ 1,695 $ 2,456
========= ========= ========== ========= =========
Balance Sheet Data: (at end of
period)
Total assets...................... $ 673,710 $ 621,477 $ 602,228 $ 555,967 $ 547,447
Investments....................... 235,916 262,568 208,072 211,801 253,566
Federal Reserve Bank and Federal
Home Loan Bank stock........... 7,541 7,596 7,071 7,380 9,619
Loans held for sale............... 60,197 -- -- -- --
Loans held for investment, net of
unearned income................ 293,814 283,555 335,794 297,924 252,753
Allowance for credit losses....... (3,335) (4,763) (5,006) (4,325) (3,588)
Total deposits.................... 455,343 395,942 398,245 375,277 330,894
Short-term borrowings............. 33,697 31,833 28,120 760 33,228
Federal Home Loan Bank advances... 97,200 112,200 97,200 117,200 117,200
Long-term borrowings.............. 10,079 8,640 8,561 13 12,642
Guaranteed preferred beneficial
interests in Company's
subordinated debentures........ 22,509 22,397 22,326 22,244 7,606
Common stockholders' equity....... 42,596 38,686 36,223 30,679 29,457
Book value per common share
outstanding.................... $ 14.77 $ 14.07 $ 13.41 $ 12.79 $ 12.30
Earnings Performance /
Share Data (1):
Return on average total assets.... 0.54% 0.64% 0.36% 0.31% 0.47%
Return on average common
stockholders' equity........... 8.01% 9.92% 5.77% 5.51% 10.02%
Net interest margin............... 2.86% 2.47% 2.51% 2.63% 2.65%
Net interest spread............... 2.72% 2.29% 2.29% 2.25% 2.35%
Basic earnings per
common share (1)............... $ 1.18 $ 1.38 $ 0.74 $ 0.71 $ 1.02
Diluted earnings per common
share (1)...................... $ 1.14 $ 1.35 $ 0.74 $ 0.70 $ 1.02
Cash dividends per common share... -- -- -- -- --
Cash dividends per preferred
share.......................... $ 700.00 $ 800.00 $ 526.67 -- --
Total cash dividends - preferred
stock.......................... $ 93 $ 120 $ 79 -- --
Average common shares
outstanding.................... 2,813,531 2,705,602 2,611,629 2,395,353 2,397,356
Average common and common
equivalent shares.............. 2,896,241 2,764,816 2,628,798 2,421,113 2,398,553
Shares outstanding at yearend..... 2,884,876 2,749,196 2,700,929 2,399,170 2,395,030
Balance Sheet and Other Key
Ratios (1):
Nonperforming assets to total
assets......................... 0.08% 1.28% 1.27% 0.80% 0.12%
Nonperforming loans to
total loans.................... 0.19% 2.80% 2.27% 1.47% 0.23%
Net loan charge-offs to average
loans.......................... (0.58)% (0.56)% (0.17)% (0.33)% (0.20)%
Allowance for credit losses to
total loans.................... 1.14% 1.68% 1.49% 1.45% 1.42%
Allowance for credit losses
to nonperforming loans......... 607% 60% 66% 99% 619%
Average common stockholders'
equity to average
total assets................... 6.50% 6.25% 5.93% 5.64% 4.71%
- -------------------------
(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):
2004 2003 2002
------------ ----------- ------------
Income from continuing operations.... $ 3,404 $ 3,844 $ 2,025
Net income........................... 3,404 3,844 2,039
Basic earnings per common share...... 1.18 1.38 0.75
Diluted earnings per common share.... 1.14 1.35 0.75
Executive Summary - 2004 vs. 2003. The following information highlights key
developments during 2004:
o 2004 net income was $3.40 million ($1.14 per share on a diluted basis)
compared with $3.84 million ($1.35 per share) for 2003.
o Our insurance segment again provided a significant contribution to 2004
profitability.
o Net interest income for 2004 rose $2.66 million to $16.04 million compared
with $13.38 million in 2003 primarily due to an increase in interest
income, a decrease in interest expense and a decrease in the cost of
interest-bearing liabilities.
o Noninterest income for 2004 rose $2.64 million to $23.45 million compared
with $20.81 million in 2003.
o Noninterest income represented 59.4 percent of gross revenues in 2004
compared with 60.9 percent in 2003.
o Insurance commission income accounted for $17.49 million, or 74.6 percent
of noninterest income, compared with $14.57 million, or 70.0 percent in
2003.
o Net interest margin widened to 2.86 percent in 2004 compared with 2.47
percent in 2003.
o Noninterest expense rose 27.4 percent to $34.77 million for 2004 compared
with $27.29 million for 2003. The increase primarily reflected costs
associated with expanded banking operations in Arizona and Minnesota along
with expanded insurance operations in Arizona, Colorado and Utah. $688,000
of the increase related to the termination of employment of a former
officer of Milne Scali. The payment represented the acceleration of the
remaining salary due under his multi-year employment contract.
o Total assets reached $673.71 million at December 31, 2004 compared with
$621.48 million one year earlier.
o Total loans held for sale were $60.20 million at December 31, 2004, a
result of the inception of mortgage loan and student loan financing
programs during 2004.
o Total loans held for investment increased $10.26 million in 2004, to
$293.81 million.
o The provision for credit losses was $175,000 in 2004 compared to $1.48
million in 2003, the reduction reflecting a significant reduction in
nonperforming loans during 2004.
o Nonperforming loans declined to $549,000 at December 31, 2004 from $7.95
million at December 31, 2003 primarily reflecting the full pay-off of a
$4.5 million loan and the resolution of a $2.2 million loan that resulted
in a charge-off of $1.2 million (of which $975,000 was reserved for at
December 31, 2003).
o Loan charge-offs were $1.88 million in 2004 compared with $1.82 million in
2003 with $1.2 million of the charge-offs related to the $2.2 million loan
referred to above.
o The ratio of the allowance for credit losses to total nonperforming loans
was 607 percent at December 31, 2004 compared with 60 percent at December
31, 2003.
o Investment securities available for sale declined $26.65 million to $235.92
million at December 31, 2004 compared with $262.57 million one year
earlier.
o Core deposits increased $30.8 million, or 8.4 percent over the 12-month
period ended December 31, 2004. The growth was primarily attributable to
our Arizona market and our new branch office in Golden Valley, Minnesota.
o Noninterest-bearing deposits increased $18.7 million, or 41.7 percent over
the 12-month period ended December 31, 2004.
o Total deposits increased $59.40 million to $455.34 million at December 31,
2004 compared with $395.94 million at December 31, 2004.
o Total common stockholders' equity was approximately $42.60 million at
December 31, 2004, equivalent to book value per common share of $14.77
(tangible book value per common share of $4.42).
During 2004, we continued to take actions which we believe will strengthen the
performance of our core businesses.
In banking, we opened our Golden Valley, Minnesota branch office and completed
our acquisition of a mortgage banking operation.
In insurance, we increased the volume of insurance commission income and made
acquisitions in several different market areas.
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.
Looking forward to 2005, 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.
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,
---------------------------------------------------------------------------------------------------
2004 2003 2002
------------------------------ ------------------------------- ----------------------------------
Interest Average Interest Average Interest Average
Average earned yield Average earned Yield Average earned yield
balance or paid or cost balance or paid or cost balance or paid or cost
--------- -------- -------- --------- -------- --------- --------- ---------- ----------
(dollars in thousands)
Assets
Federal funds
sold/interest-bearing due
from...................... $ 495 $ 8 1.62% $ 1,447 $ 11 0.76% $ 3,795 $ 66 1.74%
Taxable investments......... 236,854 9,664 4.08% 203,051 7,803 3.84% 193,972 9,997 5.15%
Tax-exempt investments...... 34,538 1,604 4.64% 32,982 1,535 4.65% 19,979 977 4.89%
Loans held for sale......... 15,818 718 4.54% -- -- -- --
Loans and leases held for
investment (2)............ 276,653 18,147 6.56% 308,115 19,297 6.26% 307,227 20,778 6.76%
Allowance for credit losses. (3,757) -- (4,909) -- (4,579) --
--------- -------- --------- -------- --------- ----------
Total interest-earning
assets (3)............... 560,601 30,141 5.38% 540,686 28,646 5.30% 520,394 31,818 6.11%
Noninterest-earning assets:
Cash and due from banks.. 11,938 11,733 13,706
Other.................... 63,600 48,249 34,946
--------- --------- ---------
Total assets from
continuing operations.... 636,139 600,668 569,046
Assets from discontinued
Fargo branch............. -- -- 22,258
--------- --------- ---------
Total assets......... $636,139 $600,668 $591,304
========= ========= =========
Liabilities and Stockholders'
Equity
Deposits:
Interest checking and
money market accounts... $198,992 2,130 1.07% $186,796 2,189 1.17% $174,108 2,849 1.64%
Savings................... 6,695 47 0.70% 6,052 51 0.84% 4,511 39 0.86%
Certificates of deposit:
Under $100,000............ 95,509 2,439 2.55% 94,820 3,012 3.18% 104,964 4,068 3.88%
$100,000 and over......... 58,625 1,916 3.27% 55,928 2,186 3.91% 73,639 3,286 4.46%
--------- -------- --------- -------- --------- ----------
Total interest-bearing
deposits.................. 359,821 6,532 1.82% 343,596 7,438 2.16% 357,222 10,242 2.87%
Borrowings:
Short-term borrowings..... 29,663 519 1.75% 21,942 382 1.74% 7,799 141 1.81%
FHLB advances............. 109,195 4,898 4.49% 111,777 5,333 4.77% 97,711 6,214 6.36%
Long-term borrowings...... 9,371 393 4.19% 8,623 387 4.49% 6,063 310 5.11%
Subordinated debentures... 22,239 1,758 7.91% 22,141 1,728 7.80% 22,056 1,829 8.29%
--------- -------- --------- -------- --------- ----------
Total interest-bearing
liabilities............... 530,289 14,100 2.66% 508,079 15,268 3.01% 490,851 18,736 3.82%
Noninterest-bearing
demand accounts.......... 52,822 40,022 33,951
--------- -------- ---------
Total deposits and
interest-bearing
liabilities............ 583,111 548,101 524,802
Other noninterest-bearing
liabilities................. 10,551 13,542 11,336
Liabilities from discontinued
Fargo branch................ -- -- 20,476
--------- -------- ---------
Total liabilities.... 593,662 561,643 556,614
Stockholders' equity.......... 42,477 39,025 34,690
--------- -------- ---------
Total liabilities
and stockholders'
equity............. $636,139 $600,668 $591,304
========= ======== =========
Net interest income........... $16,041 $13,378 $ 13,082
======== ======== =========
Net interest spread........... 2.72% 2.29% 2.29%
======== ======== ======
Net interest margin (4)....... 2.86% 2.47% 2.51%
======== ======== ======
Ratio of average
interest-earning
assets to average
interest-bearing
liabilities............... 105.72% 106.42% 106.02%
========= ======== =========
--------------------
(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 $2.0, $1.5 and $1.3 million is included in loan interest
income for the 12-month periods ended December 31, 2004, 2003 and 2002,
respectively.
(3) Tax-exempt income has not been presented on a taxable equivalent basis.
Tax-exempt income of $1.6 and $1.5 million and $982,000 was recognized
during the years ended December 31, 2004, 2003 and 2002, 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,
----------------------------------------------------------
2004 Compared to 2003 2003 Compared to 2002
--------------------------- ----------------------------
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.......................... $ 4 $ (7) $ (3) $ (30) $ (25) $ (55)
Taxable investments................. 1,358 503 1,861 493 (2,687) (2,194)
Tax-exempt investments.............. 72 (3) 69 603 (45) 558
Loans held for sale................. 665 1 666 -- -- --
Loans held for investment........... (2,065) 967 (1,098) 60 (1,541) (1,481)
--------- -------- ------- --------- --------- --------
Total increase (decrease) in
interest income................. 34 1,461 1,495 1,126 (4,298) (3,172)
--------- -------- ------- --------- --------- --------
Interest Expense on Interest-Bearing
Liabilities
Interest checking and money market
accounts.......................... 181 (240) (59) 228 ( 888) (660)
Savings............................ 7 (11) (4) 13 (1) 12
Certificates of Deposit:
Under $100,000.................... 22 (595) (573) (368) (688) (1,056)
$100,000 and over................. 112 (382) (270) (726) (374) (1,100)
Short-term borrowings............... 135 1 136 246 (5) 241
FHLB advances....................... (121) (314) (435) 1,198 (2,079) (881)
Long-term borrowings................ 25 (19) 6 108 (31) 77
Subordinated debentures............. 8 23 31 7 (108) (101)
--------- -------- ------- --------- --------- --------
Total increase (decrease) in
interest expense.................. 369 (1,537) (1,168) 706 (4,174) (3,468)
--------- -------- ------- --------- --------- --------
Increase (decrease) in net interest
income............................ $ (335) $2,998 $2,663 $ 420 $ (124) $ 296
========= ======== ======= ========= ========= ========
(1) From continuing operations for all periods presented.
Year ended December 31, 2004 compared to year ended December 31, 2003. Net
interest income increased $2.7 million, or 19.9 percent, and totaled $16.0
million for 2004. Net interest spread and net interest margin adjusted to 2.72
and 2.86 percent, respectively, for the 12-month period ended December 31, 2004
from 2.29 and 2.47, respectively, for the 12-month period ended December 31,
2003.
Net interest income and margin for the 12-month period ended December 31, 2004
were favorably impacted by the recovery of cash basis interest income of
approximately $408,000 on a $4.5 million loan that had been classified as
nonaccrual at December 31, 2003 and was paid in full during the first quarter of
2004. Net interest income and margin for the 12-month period ended December 31,
2003 were negatively impacted by the charge-off of interest income of
approximately $287,000 on the same loan, Additionally, net interest income and
margin for the 12-month periods ended December 31, 2004 and 2003 were slightly
impacted by derivative contract-related transactions during the periods which
decreased net interest income by $55,000 and $80,000, respectively. Without
these interest income variances and derivative transactions, net interest margin
for the 2004 and 2003 periods would have been 2.80 percent and 2.54 percent,
respectively.
The remaining fair value of our interest rate cap contracts on December 31, 2004
was $1,000. 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 2004 as
compared to 2003. Lettered explanations following the summary describe causes of
the changes in these major factors.
Net Interest Income Analysis - 2004 vs. 2003 (1)
For the Years
Ended December 31, Change
--------------------- ------------------
2004 2003
--------- ----------
(amounts in millions)
Total interest income increased................. $ 30.1 $ 28.6 $ 1.5 5.2%
Due to:
Increase in average earning assets.......... $ 560.6 $ 540.7 $ 19.9 3.7%
Driven by:
Increase in average loans held
for sale (a).............................. $ 15.8 -- $ 15.8 --
Increase in average investments (b)......... $ 271.4 $ 236.0 $ 35.4 15.0%
Offset by:
Decrease in average loans held for
investment (c)............................ $ 276.7 $ 308.1 $(31.4) (10.2)%
The overall increase in average earning
assets was coupled with:
Increase in yield on interest-earnings
assets.................................. 5.38% 5.30% 0.08% 1.5%
Driven by:
Increase in yield on loans held for
investment (d)............................ 6.56% 6.26% 0.30% 4.8%
Increase in yield on investments (e)........ 4.15% 3.96% 0.19% 4.8%
Total interest expense decreased................ $ 14.1 $ 15.3 $ (1.2) (7.8)%
Due to:
Decrease in cost of interest-bearing
liabilities............................... 2.66% 3.01% (0.35)% (11.6)%
Driven by:
Decrease in cost of interest-bearing
deposits (f).............................. 1.82% 2.16% (0.34)% (15.7)%
Decrease in cost of borrowings (g).......... 4.44% 4.76% (0.32)% (6.7)%
These decreases were offset by:
Increase in average interest-bearing
liabilities............................... $ 530.2 $ 508.1 $ 22.2 4.4%
Driven by:
Increase in average borrowings (h).......... $ 170.5 $ 164.5 $ 6.0 3.6%
Increase in average interest-bearing
deposits (i).............................. $ 359.8 $ 343.6 $ 16.2 4.7%
- ---------------
(1) From continuing operations for all periods presented.
(a) Average loans held for sale increased due to mortgage loan and student loan
financing programs initiated during 2004.
(b) Although period end investments available for sale decreased $26.7 million
between December 31, 2003 and December 31, 2004, average investments for
the 12-month period ended December 31, 2004 increased $35.4 million. Total
investments at December 31, 2003 were $262.6 million. Outstanding
investments were increased to $288.4 million at March 31, 2004 to replace a
reduction in loans held for investment that occurred due to general planned
loan payoffs of approximately $15.0 million, general pay downs on revolving
lines of credit of approximately $8.4 million and the payoff of a $4.5
million loan that was on nonaccrual status at December 31, 2003.
Investments available for sale ended June 30, 2004 at $263.4 million and
September 30, 2004 at $236.3 million. Over $30.0 million of investments
available for sale were sold during September 2004 and the proceeds were
used to fund other earning assets, particularly mortgage loans and student
loans held for sale.
(c) Average loans held for investment during 2004 declined despite an increase
in period end loans between December 31, 2003 and December 31, 2004. Loans
held for investment declined in early 2004 to a low of $254.0 million at
March 31, 2004 but finished out the year with increases ending at $294.7
million at December 31, 2004. Average loans held for investment were as low
as $261.2 million in April 2004 compared with $303.6 million in December
31, 2004.
(d) Our increased loan yield reflects the Federal Reserve interest rate
increases during 2004. The daily average prime rate in 2004 was 4.35
percent as compared to 4.12 percent for 2003. The higher prime rate caused
floating rate loans to reprice at higher rates and new loans, which, as
discussed above, came on primarily in the second half of 2004, to be
originated at higher interest rate levels.
(e) The increased yield on investments reflects the higher interest rate
environment during 2004 combined with the lower levels of prepayments on
mortgage-backed securities and collateralized mortgage obligations relative
to 2003. During 2004, lower premium amortization ($2.9 million versus $4.1
million in 2003) helped generate higher yields in the investment portfolio.
(f) The decrease in cost of interest-bearing deposits reflects our efforts to
contain deposit costs during a rising rate environment in 2004. The
decrease also reflects a full year of benefit of rate decreases at the end
of 2003. Additionally, during 2003, new certificates of deposit and
repricing certificates of deposit priced at lower rates that then reduced
the cost of deposits going forward into 2004.
(g) The decrease in cost of borrowings was primarily a result of a decrease in
the average cost of FHLB borrowings. $15 million of FHLB advances priced at
a weighted average rate of 4.77 matured during 2004.
(h) The increase in average borrowings is primarily attributable to higher use
of Federal funds purchased and the $1.5 million increase in our long-term
borrowings that occurred during 2004.
(i) The increase in average interest-bearing deposits is primarily attributable
to the increase in average interest checking and money market accounts due
to growth in our Wealthbuilder family of deposit products. The growth was
generated primarily in the Arizona market with some growth attributable to
our new Golden Valley, Minnesota branch office.
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 and margin for the 12-month period ended December 31, 2003
were impacted by the charge-off of interest income of approximately $287,000 on
the loan discussed earlier. Net interest income for the 12-month periods ended
December 31, 2003 and 2002 also reflected mark-to-market losses on the value of
derivative contracts, which decreased net interest income by $80,000 and
$779,000, respectively. Without the interest income charged off and the
mark-to-market adjustments on these derivative contracts for the two periods,
net interest margin would have been 2.54 percent for the 12 months ended
December 31, 2003 and 2.66 percent for the 12 months ended December 31, 2002.
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.
Net interest income and margin in future periods may be impacted by several
factors. Changes in net interest income are dependent upon the volume and mix of
interest-earning assets and interest-bearing liabilities, the movement of
interest rates and the level of nonperforming assets. Achieving net interest
margin growth is dependent on our ability to generate higher-yielding assets and
lower cost funding sources such as deposits and borrowings. If variable index
rates, such as the prime rate, were to decline, we could experience compression
of our net interest margin depending upon the timing and amount of any
reductions, as it is possible that interest rates paid on some deposits and
borrowings may not decline as quickly, or to the same extent, as the decline in
the yield on interest-rate-sensitive assets such as commercial and other loans.
Competition for checking, savings and money market deposits, important sources
of lower cost funds for us, is intense. We could also experience net interest
margin compression if rates paid on deposits and borrowings increase, or as a
result of new pricing strategies and lower rates offered on loan products in
response to competitive pressures, rates on interest-bearing liabilities
increase faster, or to a greater extent, than the increase in the yield on
interest-rate-sensitive assets. The level and nature of the impact cannot be
precisely ascertained. Federal Reserve actions in response to economic
developments can vary causing prime and other rates to adjust and, in some
cases, immediately impact our interest-earning assets and interest-bearing
liabilities.
These factors, including the competitive environment in the markets in which we
operate, the multitude of financial and investment products available to the
public and the monetary policies of the Federal Reserve, can materially impact
our operating results. Therefore, we cannot predict, with any degree of
certainty, prospects for net interest income and net interest margin in future
periods. See Item 7A, "Quantitative and Qualitative Disclosures About Market
Risk," for information relating to the impact of fluctuating interest rates on
our future net interest income prospects.
Provision for Credit Losses. We determine a provision for credit losses which we
consider sufficient to maintain our allowance for credit losses at a level
considered adequate to provide for an estimate of probable losses related to
specifically identified loans as well as probable losses in the remaining loan
and lease portfolio that have been incurred as of each balance sheet date. The
provision for credit losses for the year ended December 31, 2004 was $175,000 as
compared to $1.5 million in 2003 and $1.2 million in 2002. Net loan and lease
charge-offs were $1.9 million, or 0.58 percent of average loans and leases in
2004 compared with $1.8 million, or 0.56 percent in 2003 and $521,000, or 0.17
percent in 2002. The decrease in the provision for credit losses in 2004
reflected the resolution of a significant amount of nonperforming loans that
were reserved for at December 31, 2003 and were reduced to $549,000 at December
31, 2004 from $8.0 million at December 31, 2003. Of the $1.9 million of
charge-offs in 2004, $1.2 million related to one commercial loan. $975,000 had
been reserved for on that loan at December 31, 2003.
The provision for credit losses is calculated as part of the determination of
the allowance for credit losses and the related provision for credit losses is a
critical accounting policy which involves consideration of a number of factors
such as loan growth, net charge-offs, changes in the composition of the loan
portfolio, delinquencies in the loan and lease portfolio, the value of
underlying collateral on problem loans, general economic conditions and our
assessment of credit risk in the current loan and lease portfolio. Periodic
fluctuations in the provision for credit losses result from our assessment of
the adequacy of the allowance for credit losses; however, actual loan losses may
vary from current estimates.
The allowance for loan losses totaled $3.3 million at December 31, 2004 compared
with $4.8 and $5.0 million at December 31, 2003 and 2002, respectively. See Note
1 to the Consolidated Financial Statements included under Item 8, "-Financial
Condition-Loan Portfolio-Allowance for Credit Losses" and "-Critical Accounting
Policies" for further discussion of the components of the allowance for credit
losses, our systematic methodology for determining the adequacy of the allowance
and additional data pertaining to charge-offs, recoveries and other related
information.
Noninterest Income. Noninterest income, primarily driven by insurance
commissions, is becoming a more significant source of revenues for us as we
continue to emphasize our goal of focusing on local relationship banking and
providing a broad range of financial products and services that will meet the
needs of our customers, both commercial and consumer. Our noninterest income
increased approximately $2.6 million, or 12.7 percent, in 2004