10-K 1 c91180e10vk.txt ANNUAL REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2004 Commission file number 0-25983 FIRST MANITOWOC BANCORP, INC. (Exact Name of Registrant as Specified in Its Charter) Wisconsin 39-1435359 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 402 North Eighth Street Manitowoc, Wisconsin 54221-0010 (Address of principal executive offices) (Zip Code) (920) 684-6611 (Registrant's telephone number, including area code) SECURITIES REGISTERED UNDER SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED UNDER SECTION 12(g) OF THE ACT: Common Stock, Par Value $1.00 (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 amendments to this Form 10-K. [ x ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [x] No [ ] The aggregate market value of registrant's common stock, par value $1.00 per share, held by non-affiliates (excludes a total of 1,461,000 shares reported as beneficially owned by directors and executive officers or held in the registrant's profit sharing 401(k) plan; does not constitute an admission as to affiliate status), as of June 30, 2004, was approximately $84,882,154 As of February 28, 2005, 6,937,268 shares of registrant's common stock, par value $1.00 per share were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of First Manitowoc Bancorp, Inc.'s Definitive Proxy Statement for the 2005 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K. 2004 FORM 10-K TABLE OF CONTENTS
DESCRIPTION PAGE NO. ----------- -------- PART I ITEM 1. BUSINESS 1 ITEM 2. PROPERTIES 13 ITEM 3. LEGAL PROCEEDINGS 13 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 13 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS 14 ITEM 6. SELECTED FINANCIAL DATA 16 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 18 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 33 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 36 ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 67 ITEM 9A. CONTROLS AND PROCEDURES 67 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 67 ITEM 11. EXECUTIVE COMPENSATION 67 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDERS MATTERS 67 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 68 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 68 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 68 SIGNATURES
PART I FORWARD-LOOKING STATEMENTS Statements made in this Report on Form 10-K and in documents that are incorporated by reference which are not purely historical are forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, including any statements regarding descriptions of management's plans, objectives, or goals for future operations, products or services, and forecasts of its revenues, earnings, or other measures of performance. Forward-looking statements are based on current management expectations and, by their nature, are subject to risks and uncertainties. These statements may be identified by the use of words such as believe, expect, anticipate, plan, estimate, should, will, intend, or similar expressions. Shareholders should note that many factors, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference, could affect the future financial results of First Manitowoc Bancorp, Inc. (the "Corporation") and could cause those results to differ materially from those expressed in forward-looking statements contained or incorporated by reference in this document. These factors, many of which are beyond the Corporation's control, include, but are not limited to: - General economic conditions, either nationally or the state in which the Corporation does business; - Legislation or regulatory changes which adversely affect the businesses in which the Corporation is engaged; - Changes in the interest rate environment which increase or decrease interest rate margins; - Changes in securities markets with respect to the market value of financial assets and the level of volatility in certain markets such as foreign exchange; - Significant increases in competition in the banking and financial services industry resulting from industry consolidation, regulatory changes and other factors, as well as actions taken by particular competitors; - Changes in consumer spending, borrowing and savings habits; - Technological changes; - Acquisitions and unanticipated occurrences which delay or reduce the expected benefits of acquisitions; - The Corporation's ability to increase market share and control expenses; - The effect of compliance with legislation or regulatory changes; - The effect of changes in accounting policies and practices; - The costs and effects of unanticipated litigation and of unexpected or adverse outcomes in such litigation; and - The factors discussed in Item 1 in this report and in the Management's Discussion and Analysis in Item 7, as well as those discussed elsewhere in this report and the documents incorporated herein by reference. All forward-looking statements contained in this report are based upon information presently available and the Corporation assumes no obligation to update any forward-looking statements. ITEM 1. BUSINESS GENERAL First Manitowoc Bancorp, Inc. is a Wisconsin corporation and registered bank holding company. The Corporation engages in its business through its sole subsidiary, First National Bank in Manitowoc (the "Bank"), a national banking association. The Bank has a wholly owned investment subsidiary, FNBM Investment Corp. and a wholly-owned insurance subsidiary, Insurance Center of Manitowoc, Inc. ("ICM"). Insurance Center of Manitowoc, Inc. also operates an office known as Gary Vincent and Associates in Green Bay, Wisconsin. Effective January 26, 2005, ICM's board of directors approved a name change to "The Vincent Group, Inc." The Insurance Center is an independent agency offering commercial, personal, life and health insurance. The Corporation acquired the Bank through the merger of the Bank into an interim national banking association formed as a Corporation subsidiary for the purpose of the merger, pursuant to a Plan of Reorganization and Agreement to Merge (the "Plan") proposed by Bank management and approved by the Bank's shareholders in 1982. Pursuant to the Plan, each outstanding share of Bank common stock was exchanged for three shares of the Corporation's common stock. The Bank's charter was not affected by the merger. Currently, the Corporation has outstanding 6,937,268 shares of common stock, par value $1.00 per share ("Shares"). Shares were held by 665 holders of record on February 28, 2005. As of December 31, 2004, the Corporation had assets of approximately $622.2 million, net loans of approximately $382.7 million, and deposits of $445.8 million. For additional financial information, see the Consolidated Financial Statements and Notes beginning at Item 8 of this Form 10-K. The Corporation's and the Bank's main office is located at 402 North Eighth Street, Manitowoc, Wisconsin. The Bank has thirteen full service branch offices located in Francis Creek, St. Nazianz, Two Rivers, Mishicot, Manitowoc, Kiel, Newton, New Holstein, Plymouth, Bellevue, and Ashwaubenon, Wisconsin. The Corporation's home page on the Internet is www.bankfirstnational.com. The Corporation's web site content is for information purposes only, and it should not be relied upon for investment purposes, nor is it incorporated by reference into this Form 10-K. Throughout this Form 10-K information from parts of other documents filed with the Securities and Exchange Commission ("SEC") is incorporated by reference. The SEC allows us to disclose important information by referring to it in this manner, and you should review this information. We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy statement for our annual shareholders' meeting, as well as any amendments to those reports filed pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, available free of charge through our web site as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our SEC reports can be accessed through the "Investor Relations, SEC web site" link of our web site. The SEC also maintains a web site at www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants. STATEMENT ON CORPORATE GOVERNANCE We have reviewed the provisions of the Sarbanes-Oxley Act of 2002 and the SEC rules regarding corporate governance policies and processes and are in compliance with the rules and listing standards. We have adopted a Code of Business Conduct and Ethics which is applicable to all of our directors, officers and employees. You can access our Nominating Committee Charter, Audit Committee Charter and Code of Business Conduct and Ethics on our Website at http://www.bankfirstnational.com or by writing to us at 402 North Eighth Street, Manitowoc, Wisconsin 54221 Attention: Rachel Wiegert, Secretary. BUSINESS STRATEGY The Bank's strategy is to provide high quality financial products and services to individuals, businesses, and governmental entities. The Bank employs a well-trained, qualified staff and maximizes automation to provide fast, efficient, convenient delivery of its products and services. BANKING PRODUCTS AND SERVICES The Bank has been doing business in Wisconsin since 1894 and is engaged in both the commercial and consumer banking business. The Bank provides a wide range of personal banking services designed to meet the needs of local consumers. As a convenience to its customers, the Bank offers Saturday banking hours; drive-thru teller windows; "Telebanc," a telephone banking service; and 24-hour automated teller machines. Additionally, the Bank offers an Internet web site, which includes on-line banking, bill payment, e-mail statements, account transfers, check ordering, and check copies among other services. Services provided include checking accounts, savings and time accounts, and safe deposit boxes. The Bank makes loans in the following categories: Commercial and Agricultural loans, Commercial Real Estate, Residential Real Estate, and Consumer and Other loans. COMMERCIAL AND AGRICULTURAL BUSINESS LENDING As of December 31, 2004, commercial and agricultural business loans accounted for approximately 30.05% of the Bank's gross loans. These loans may take the form of lines of credit, single payment loans, or term payment loans, and may be secured or unsecured depending on the creditworthiness of the borrower. The Bank operates under a commercial business lending policy that establishes guidelines for management in making commercial lending decisions. Among these guidelines are the purpose of the loan, the source of repayment, and an alternate source of repayment (generally in the form of collateral or guarantee). Applications for commercial and agricultural business loans are accepted at the Bank's main and branch offices. It is the Bank's general policy to restrict its commercial and agricultural business lending to a market area defined as within a 100-mile radius of any office location where business banking products and services are sold. Commercial and agricultural business loans are generally made for business expansion or ongoing business needs. The purpose of commercial and agricultural business loans can include the purchase of equipment or the provision of operating capital for the financing of accounts receivable and inventory. Commercial business loans are not generally made for the purpose of acquiring real estate, although real estate may occasionally be accepted as incidental collateral on a loan made for another business purpose. Agricultural business loans, however, may include loans for farmland, including a farm residence and other improvements. Credit risk is controlled and monitored through active asset quality management and the use of lending standards, thorough review of potential borrowers, and active asset quality administration. Active asset quality administration, including early problem loan identification and timely resolution of problems, further ensures appropriate management of credit risk and minimization of loan losses. The Bank occasionally participates in commercial business loans originated by third-party financial institutions. The Corporation, however, does not generally service such loans. The Bank believes that the higher yields earned on commercial business loans compensate for the increased risk associated with such loans and that commercial business loans are important to the Bank's efforts to increase the interest rate sensitivity and shorten the average maturity of its loan portfolio. COMMERCIAL REAL ESTATE LENDING Non-residential real estate loans accounted for approximately 28.71% of the Bank's gross loans as of December 31, 2004. Such loans are subject to the general policies and procedures outlined in "Commercial Business Lending", below. It is the Bank's general policy to restrict its commercial real estate lending to loans secured by properties located within a 100-mile radius of Manitowoc. There are no policy restrictions on the amount of loan funds secured by types of property or collateral. Applications for commercial real estate loans are generally obtained from existing borrowers, direct contacts by loan officers, and referrals. In general, these loans have amortization periods ranging from 10 to 25 years, mature in five years or less, and have interest rates which are fixed or variable. Loan-to-value ratios on the Bank's commercial real estate loans follow OCC requirements. It is also the Bank's general policy to obtain personal guarantees on its commercial real estate loans and, when such guarantees cannot be obtained, to impose more stringent loan-to-value ratios, debt coverage ratios, and other underwriting requirements. From time-to-time the Bank originates loans to construct multi-family residential and non-residential real estate properties. Construction loans are generally considered to involve a higher degree of risk than mortgage loans on completed properties. The Bank's risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction, the reputation of the contractor, the estimated cost of construction, and the borrower's ability to advance additional construction funds if such should become necessary. Commercial real estate lending is generally considered to involve a higher level of risk than single-family residential lending. This is due to the concentration of principal in a limited number of loans and borrowers, and the effects of general economic conditions on real estate developers and managers and on income producing properties. In addition, loans secured by properties located outside of the Corporation's immediate market area may involve a higher degree of risk. This is because the Bank may not be as familiar with market conditions and other relevant factors as it would be in the case of loans secured by properties located within its market areas. The Bank does not have a material concentration of commercial real estate loans outside of its immediate market area. RESIDENTIAL REAL ESTATE LENDING Single-family residential loans accounted for approximately 36.12% of the Bank's gross loans as of December 31, 2004. Applications for single-family residential loans are accepted by qualified lenders at all offices except the Plymouth West office and the Expo Drive office. The Bank makes predominantly fixed-rate loans for terms ranging from ten to thirty years, but does also make loans that provide for periodic adjustments of the interest rate ("adjustable rate loans"). In general, the Bank looks to sell to the secondary market but will do an in house loan on occasion. Although the Corporation generally does not retain residential loans in its portfolio, it continues to originate and service residential loans in order to provide a full range of products to its customers. In general, such loans are originated only under terms, conditions, and documentation standards that make such loans eligible for sale to the Federal National Mortgage Association ("Fannie Mae" or "FNMA"). Sales or securitizations of mortgage loans through Fannie Mae have generally been under terms that do not provide for any recourse against the Bank by the investor. The Bank generally sells these loans at the time they are originated, but continues to service these loans for its customers. Sales of mortgage loans provide additional funds for lending and other business purposes. The Bank's general policy is to lend up to 80% of the independently appraised value of the property (referred to as the "loan-to-value ratio"). The Bank will occasionally lend in excess of an 80% loan-to-value ratio on a first mortgage loan, but will generally require the borrower to obtain private mortgage insurance on the portion of the loan that exceeds 80%. The Bank also originates loans to individuals to construct single-family residences. The borrower must have take-out commitments for permanent financing on hand at the time of origination. Construction loans generally have a maturity of 6 to 12 months and a fixed rate of interest, with payments being made monthly on an interest-only basis. Construction loans are otherwise underwritten and approved in the same manner as other single-family residential loans. Construction loans, however, are generally considered to involve a higher degree of risk than conventional residential mortgage loans. This is because the risk of loss is largely dependent on the accuracy of the initial estimate of the property's value at completion of construction, the reputation of the contractor, the estimated cost of construction, and the borrower's ability to advance additional construction funds, if necessary. This risk has not had any adverse effect on the Bank to date, although no assurances can be made with respect to future periods. The Bank continues to service most of the loans that it sells to third-party investors (commonly referred to as "loans serviced for others"). Servicing mortgage loans, whether for its own portfolio or for others, includes such functions as collecting monthly principal and interest payments from borrowers, maintaining escrow accounts for real estate taxes and insurance, and making such payments on behalf of borrowers when they are due. When necessary, servicing of mortgage loans also includes functions related to the collection of delinquent principal and interest payments, loan foreclosure proceedings, and disposition of foreclosed real estate. As of December 31, 2004, loans serviced for others were $181.3 million. The amount of capitalized mortgage servicing rights as of December 31, 2004 was $1.8 million. When the Bank services loans for others, it is compensated for these services through the retention of a servicing fee from borrowers' monthly payments. The Bank pays the third-party investors an agreed-upon yield on the loans, which is generally less than the interest agreed to be paid by the borrowers. The difference is retained by the Bank and recognized as servicing fee income over the lives of the loans, net of amortization of capitalized mortgage servicing rights. The Bank also receives fees and interest income from ancillary sources such as delinquency charges and float on escrow and other funds. Management believes that servicing mortgage loans for third parties provides a natural hedge against other risks inherent in the Bank's mortgage banking operations. That is, fluctuations in volumes of mortgage loan originations and resulting gains on sales of such loans caused by changes in market interest rates will generally be offset in part by an opposite change in loan servicing fee income. These fluctuations are usually the result of actual loan prepayment activity that is different from that which was anticipated when the related servicing rights were originally recorded. However, fluctuations in the value of mortgage servicing rights may also be caused by lower of cost or market adjustments under generally accepted accounting principles ("GAAP"). That is, the value of servicing rights may fluctuate because of changes in the future prepayment assumptions or discount rates used to periodically value servicing rights. Although management believes that most of the Bank's loans that prepay are replaced by a new loan to the same customer or even a different customer (thus preserving the future servicing cash flow), GAAP requires mark-to-market gains or losses resulting from a change in future prepayment assumptions to be recorded in the period in which the change occurs. However, the offsetting gain on the sale of the new loan, if any, cannot be recorded under GAAP until the customer actually prepays the old loan and the new loan is sold in the secondary market. Mortgage servicing rights are particularly susceptible to unfavorable mark-to-market adjustments during periods of declining interest rates during which prepayment activity typically accelerates to levels above that which had been anticipated when the servicing rights were originally recorded. During periods of rising rates, mark-to-market adjustments tend to result in gains to the value of servicing rights as the assumption is adjusted to reflect a deceleration in payments. CONSUMER AND OTHER LENDING The Bank offers consumer and other loans in order to provide a full range of financial services to its customers. Such loans accounted for approximately 5.12% of the Corporation's gross loans as of December 31, 2004. Most of the Bank's consumer loan portfolio consists of second mortgage loans and home equity lines of credit, but also includes automobile loans, recreational vehicle and mobile home loans, deposit account secured loans, and unsecured lines of credit or signature loans. The Bank services all of its own consumer loans. Applications for consumer loans are taken at all of the Bank's offices except the Expo Drive office. Applications for automobile loans are also accepted through relationships established with a limited number of qualifying automobile dealerships ("indirect automobile lending"). The majority of consumer loans are underwritten, approved, and serviced on an on-going basis by loan officers. Consumer loans generally have shorter terms and higher rates of interest than conventional mortgage loans, but typically involve more credit risk than such loans because of the nature of the collateral and, in some instances, the absence of collateral. In general, consumer loans are more dependent upon the borrower's continuing financial stability, are more likely to be affected by adverse personal circumstances, and are often secured by rapidly depreciating personal property such as automobiles. In addition, various laws, including bankruptcy and insolvency laws, may limit the amount that may be recovered from a borrower. However, such risks are mitigated to some extent in the case of second mortgage loans and home-equity lines of credit. These types of loans are secured in part or in full by a second mortgage on the borrower's residence. The Bank believes that the higher yields earned on consumer loans compensate for the increased risk associated with such loans and that consumer loans are important to the Bank's efforts to increase the interest rate sensitivity and shorten the average maturity of its loan portfolio. Furthermore, the Bank's net charge-offs on consumer loans as a percentage of gross loans have not been significant in recent years, despite the risks inherent in consumer lending. In conjunction with its consumer lending activities, the Corporation offers customers credit life and disability insurance products. The Bank and its loan officers receive commission revenue related to the sales of these products. In addition, a wholly-owned subsidiary of the Bank receives premium revenue in exchange for the portion of the insurance risk it has reinsured on these sales. Refer to "Subsidiaries", below, for additional discussion. The Bank offers a full range of trust services that include trust under agreement, testamentary trust, guardianships and conservatorships, probate estates, estate planning, and financial planning. The Bank employs a licensed investment representative who provides a variety of investment and insurance products through arrangements with other service providers. These products include mutual funds, stocks, bonds, annuities, and life insurance products. Insurance products, including commercial, personal, life, and health insurance, are offered through Insurance Center of Manitowoc, Inc. Effective January 26, 2005, Insurance Center's board of directors approved a name change to "The Vincent Group, Inc." To attract new business and retain existing customers, the Bank relies on local marketing promotions, personal contact by its officers, staff and directors, referrals by current customers, extended banking hours, personalized service, and contact with on-line customers via the Bank's website or e-mail statements. NON-PERFORMING AND OTHER CLASSIFIED ASSETS Loans are generally placed on non-accrual status and considered "non-performing" when, in the judgment of management, the probability of collection of principal or interest is deemed to be insufficient to warrant further accrual of interest. When a loan is placed on non-accrual and/or non-performing status, previously accrued but unpaid interest is deducted from interest income. In general, the Bank does not record accrued interest on loans 90 or more days past due. For additional information, refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Notes 1 and 3 of the Corporation's Audited Consolidated Financial Statements, included herein under Part II, Item 8, "Financial Statements and Supplementary Data". When a loan is placed on non-accrual and/or non-performing status, the Bank generally institutes foreclosure or other collection proceedings. Real estate acquired by the Bank as a result of foreclosure or deed-in-lieu of foreclosure is classified as "other real estate" and is considered "non-performing" until sold. Other property acquired through adverse judgment, such as automobiles and other depreciable assets, are generally classified as "other personal property". The Bank has internal policies and procedures in place to evaluate risk ratings on all loans. In addition, in connection with examinations of banks, federal examiners have authority to classify problem assets as "Substandard", "Doubtful", or "Loss". An asset is classified as "Substandard" if it is determined to involve a distinct possibility that the Bank could sustain some loss if deficiencies associated with the loan are not corrected. An asset is classified as "Doubtful" if full collection is highly questionable or improbable. An asset is classified as "Loss" if it is considered uncollectible, even if a partial recovery could be expected in the future. If an asset or portion thereof is classified as "Loss", the Bank must either establish a specific allowance for the portion of the asset classified as "Loss", or charge off such amount. Refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for additional discussion. ALLOWANCES FOR LOSSES ON LOANS AND REAL ESTATE The Bank's policy is to establish allowances for estimated losses on specific loans and real estate when it determines that losses are probable and estimable. In addition, the Corporation maintains a general loss allowance against its loan and real estate portfolios that is based on its own loss experience, management's ongoing assessment of current economic conditions, the credit risk inherent in the portfolios, and the experience of the financial services industry. For additional information, refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Notes 1 and 3 of the Corporation's Audited Consolidated Financial Statements, included herein under Part II, Item 8, "Financial Statements and Supplementary Data". Management of the Bank believes that the current allowances established by the Bank are adequate to cover probable and estimable losses in the Bank's loan and real estate portfolios. However, future adjustments to these allowances may be necessary and the Bank's results of operations could be adversely affected if circumstances differ substantially from the assumptions used by management in making its determinations in this regard. SOURCES OF FUNDS DEPOSIT LIABILITIES The Bank's current deposit products include regular savings accounts, checking accounts, money market deposit accounts, individual retirement accounts, and certificates of deposit ranging in terms from three months to five years. As of December 31, 2004, deposit liabilities accounted for approximately 71.6% of the Corporation's total liabilities and equity. In addition to serving as the Bank's primary source of funds, deposit liabilities (especially checking accounts) are a substantial source of non-interest income. This income is generally received in the form of overdraft fees, periodic service charges, automated teller machine ("ATM") and debit card fees, and other transaction charges. The Bank's extensive branch network also creates opportunities for sales of non-deposit products such as tax-deferred annuities, mutual funds, and other investment products. In exchange for these sales, the Bank receives commission revenue from the third-party providers of the financial products and/or services. The principal methods used by the Bank to attract deposit accounts include offering a variety of products and services, competitive interest rates, and convenient office locations and hours. All of the Bank's offices have drive-up facilities and the Bank owns twelve ATM machines, all of which are located in the Bank's primary markets. Depositors may also obtain a debit card from the Bank, which allows them to purchase goods and services directly from merchants. The same debit card also provides access to the ATM network. FEDERAL HOME LOAN BANK ADVANCES The Bank obtains advances from the FHLB secured by certain of its home mortgage loans and mortgage-related securities, as well as stock in the FHLB, a minimum amount of which the Bank is required to own. Such advances may be made pursuant to several different credit programs, each with its own interest rate and range of maturity dates. As of December 31, 2004, FHLB advances accounted for approximately 6.4% of the Bank's total liabilities and equity. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE The Bank regularly enters into sales of securities under agreements to repurchase. In form, these transactions are an arrangement in which the sale of securities is accompanied by a simultaneous agreement to repurchase the identical securities (or substantially the same securities) at a future date. In substance, however, these arrangements are borrowings secured by high-quality, highly-liquid securities such as Fannie Mae or Freddie Mac Mortgage Backed Securities. Accordingly, these arrangements are accounted for as borrowings in the Bank's financial statements. FEDERAL FUNDS PURCHASED AND OTHER BORROWINGS The Corporation has lines of credit with three financial institutions. These lines, which amount to $25 million in the aggregate, permit the overnight purchase of federal funds. As of December 31, 2004, there were no outstanding borrowings against these lines of credit. BANK SUBSIDIARY CORPORATIONS FNBM Investment Corporation. FNBM Investment Corporation ("FNBM") was incorporated in the State of Nevada in December 1993. FNBM is located in Las Vegas, Nevada. The Bank owns 100% of the outstanding common stock of FNBM. FNBM was formed to consolidate and improve the efficiency, management, safekeeping, and operations of the Bank's investment securities portfolio and certain other holdings. Insurance Center of Manitowoc, Inc. Insurance Center of Manitowoc, Inc. ("ICM") was incorporated in the State of Wisconsin in 1932. Bank acquired 100% of the outstanding common stock of the ICM in January 2001. ICM has an office in Manitowoc, Wisconsin that operates under the trade name Insurance Center of Manitowoc, Inc. and an office in Green Bay, Wisconsin that operates under the trade name Gary Vincent & Associates, Inc. ICM is a regional independent agency offering commercial, personal, life, and health insurance. ICM provides various bank-related insurance coverages for the Bank including Directors & Officers Liability, Trust, and Blanket Bond. In April of 2004, Professional Insurance Advantage, Incorporated joined Gary Vincent & Associates. This Green Bay agency consisting of three employees offers group and individual life, health, dental, vision, disability, long-term care, 401(k) retirement plans, and investment services in addition to property and casualty insurance. Effective January 26, 2005, ICM's board of directors approved a name change to The Vincent Group, Inc. United Financial Services, Inc. United Financial Services, Inc. ("UFS") was incorporated in the State of Wisconsin in September 1991. UFS is located in Grafton, Wisconsin. The Bank owns 49.8% of the outstanding common stock of UFS. The subsidiary, UFS, was formed to provide data processing services to the banking industry. UFS provides data processing services to owner banks Baylake Bank and the Bank in addition to 52 other banks located in Wisconsin. The Bank's investment in UFS is accounted for under the equity method. SEASONALITY The management of the Bank does not believe that the deposits or business of the Bank in general are seasonal in nature. The deposits may, however, vary with local and national economic conditions but not enough to have a material effect on planning and policy making. FOREIGN OPERATIONS The Bank does not engage in operations in foreign countries. EMPLOYEES As of February 28, 2005, the Corporation employed 233 individuals, 76 of whom worked part-time. COMPETITION The Bank offers many personalized services and attracts customers by being responsive and sensitive to the needs of the community. The Bank relies on goodwill and referrals from satisfied customers as well as traditional media advertising to attract new customers. To enhance a positive image in the community, the Bank supports and participates in many local events, such as the Manitowoc County Fair, Manitowoc County Airport Day, First National Bank Maritime Bay Bike Classic, Two Rivers Ethnic Festival, and French Creek Days. Employees, officers, and directors represent the Bank on many boards and local civic and charitable organizations. The primary factors in competing for deposits are interest rates, personalized services, the quality and range of financial services, convenience of office locations and office hours. Competition for deposits comes primarily from other commercial banks, savings associations, credit unions, money market funds and other investment alternatives. The primary factors in competing for loans are interest rates, loan origination fees, the quality and range of lending services and personalized services. Competition for loans comes primarily from other commercial banks, savings associations, mortgage banking firms, credit unions and other financial intermediaries. Competition in the Bank's market area is expected to continue for the foreseeable future. SUPERVISION AND REGULATION General. The Corporation and the Bank are extensively regulated under federal and state law. Generally, these laws and regulations are intended to protect depositors, not shareholders. The following is a summary description of certain provisions of certain laws which affect the regulation of bank holding companies and banks. The discussion is qualified in its entirety by reference to applicable laws and regulation. Changes in such laws and regulations may have a material effect on the business and prospects of the Corporation and the Bank. Federal Bank Holding Company Regulation and Structure. The Corporation is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "Act"). As such, it is subject to regulation, supervision, and examination by the Federal Reserve Board ("FRB"). The Corporation is required to file annual and quarterly reports with the FRB and to provide the FRB with such additional information as the FRB may require. The FRB may conduct examinations of the Corporation and its subsidiaries. With certain limited exceptions, the Corporation is required to obtain prior approval from the FRB before acquiring direct or indirect ownership or control of more than 5% of any voting securities or substantially all of the assets of a bank or bank holding company, or before merging or consolidating with another bank holding company. Additionally, with certain exceptions, any person proposing to acquire control through direct or indirect ownership of 25% or more of any voting securities of the Corporation is required to give 60 days' written notice of the acquisition to the FRB, which may prohibit the transaction, and to publish notice to the public. Generally, a bank holding company may not engage in any activities other than banking, managing or controlling its bank and other authorized subsidiaries, and providing services to these subsidiaries. With prior approval of the FRB, the Corporation may acquire more than 5% of the assets or outstanding shares of a company engaging in non-bank activities determined by the FRB to be closely related to the business of banking or of managing or controlling banks. The FRB provides expedited procedures for expansion into approved categories of non-bank activities. Subsidiary banks of a bank holding company are subject to certain quantitative and qualitative restrictions on extensions of credit to the bank holding company or its subsidiaries, on investments in their securities and on the use of their securities as collateral for loans to any borrower. These regulations and restrictions may limit the Corporation's ability to obtain funds from the Bank for its cash needs, including funds for the payment of dividends, interest and operating expenses. Further, subject to certain exceptions, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. For example, the Bank may not generally require a customer to obtain other services from itself or the Corporation, and may not require that a customer promise not to obtain other services from a competitor as a condition to an extension of credit to the customer. Under FRB policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to make capital injections into a troubled subsidiary bank, and the FRB may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. A required capital injection may be called for when the holding company does not have the resources to provide it. Federal Bank Regulation. The Corporation's banking subsidiary is a federally-chartered national bank regulated by the Office of Comptroller of Currency ("OCC"). The OCC may prohibit the institutions over which it has supervisory authority from engaging in activities or investments that the agency believes constitutes unsafe or unsound banking practices. Federal banking regulators have extensive enforcement authority over the institutions they regulate to prohibit or correct activities which violate law, regulation or a regulatory agreement or which are deemed to constitute unsafe or unsound practices. Enforcement actions may include the appointment of a conservator or receiver, the issuance of a cease and desist order, the termination of deposit insurance, the imposition of civil money penalties on the institution, its directors, officers, employees and institution-affiliated parties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the removal of or restrictions on directors, officers, employees and institution-affiliated parties, and the enforcement of any such mechanisms through restraining orders or other court actions. The Bank is subject to certain restrictions on extensions of credit to executive officers, directors, principal shareholders or any related interest of such persons which generally require that such credit extensions be made on substantially the same terms as are available to third persons dealing with the Bank and not involve more than the normal risk of repayment. Other laws tie the maximum amount which may be loaned to any one customer and its related interests to capital levels. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), each federal banking agency is required to prescribe, by regulation, non-capital safety and soundness standards for institutions under its authority. The federal banking agencies, including the OCC, have adopted standards covering internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. An institution which fails to meet those standards may be required by the agency to develop a plan acceptable to the agency, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. The Corporation, on behalf of the Bank, believes that it meets substantially all standards which have been adopted. FDICIA also imposed new capital standards on insured depository institutions. Before establishing new branch offices, the Bank must meet certain minimum capital stock and surplus requirements and the Bank must obtain OCC approval. Deposit Insurance. As a FDIC member institution, the Bank's deposits are insured to a maximum of $100,000 per depositor through the Bank Insurance Fund ("BIF"), administered by the FDIC. The Bank pays a quarterly deposit insurance premium assessment to the FDIC. The insurance premium assessment is based upon the FDIC's risk-based assessment system by which institutions are assigned to one of three categories based on their capitalization and one of three subcategories based on examination ratings and other supervisory information. An institution's assessment rate depends on the "supervisory rating" it receives from the FDIC ("A," "B," or "C") and on their regulatory capital level ("well capitalized," "adequately capitalized," or "undercapitalized"). Assessment rates for insured institutions are determined semiannually by the FDIC and currently range from zero basis points for the healthiest institutions to 27 basis points for the riskiest. The FDIC has authority to increase insurance assessments and is required under federal law to establish assessment rates that will maintain the insurance fund's ratio of reserves to insured deposits at $1.25 per $100. The Bank was classified as "well capitalized" at December 31, 2004. Capital Requirements. The federal banking regulators have adopted certain risk-based capital guidelines to assist in the assessment of the capital adequacy of a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans. A banking organization's risk-based capital ratios are obtained by dividing its qualifying capital by its total risk- adjusted assets. The regulators measure risk-adjusted assets, which include off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. "Tier 1," or core capital, includes common equity, less goodwill and other intangibles, subject to certain exceptions. "Tier 2," or supplementary capital, includes the allowance for loan and lease losses, subject to certain limitations. Banks and bank holding companies subject to the risk-based capital guidelines are required to maintain a ratio of Tier 1 capital to risk-weighted assets of at least 4.0% and a ratio of total capital to risk-weighted assets of at least 8.0%. The appropriate regulatory authority may set higher capital requirements when particular circumstances warrant. In addition to risk-based capital, banks and bank holding companies are required to maintain a minimum amount of Tier 1 capital to total average assets, referred to as the leverage capital ratio, of at least 4.0%. Federal banking agencies include in their evaluations of a bank's capital adequacy, an assessment of the Bank's interest rate risk ("IRR") exposure. The standards for measuring the adequacy and effectiveness of a banking organization's interest rate risk management includes a measurement of board of director and senior management oversight, and a determination of whether a banking organization's procedures for comprehensive risk management are appropriate to the circumstances of the specific banking organization. The Bank has internal IRR models that are used to measure and monitor IRR. Failure to meet applicable capital guidelines could subject a banking organization to a variety of enforcement actions, including limitations on its ability to pay dividends, the issuance by the applicable regulatory authority of a capital directive to increase capital and, in the case of depository institutions, the termination of deposit insurance by the FDIC. In addition, future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Bank to grow and could restrict the amount of profits, if any, available for the payment of dividends to the Corporation. Monetary Policy. The earnings of a bank holding company are affected by the policies of regulatory authorities, including the FRB, in connection with the FRB's regulation of the money supply. Various methods employed by the FRB are open market operations in United States Government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These methods are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may also affect interest rates charged on loans or paid on deposits. Because of ongoing change in the national economy and in the money markets, as well as the effect of monetary and fiscal policies of the Federal Reserve System and Federal government, prediction cannot be made as to future changes in interest rates, loan demand, deposit levels or the effect on the earnings of the Corporation. Federal Taxation. The Corporation is subject to those rules of federal income taxation generally applicable to corporations under the Internal Revenue Code of 1986, as amended (the "IRC"). The Corporation, the Bank, and the Bank's wholly-owned subsidiaries file a consolidated federal income tax return. This has the effect of eliminating or deferring the tax consequences of intercompany distributions, including dividends, in the computation of consolidated taxable income. The consolidated entity pays taxes at the federal statutory rate of 34% of its taxable income, as defined in the IRC. State Taxation. The State of Wisconsin imposes a tax on the Corporation's taxable income at the rate of 7.9%. State income taxes are deductible on the Corporation's federal income tax return. Wisconsin's definition of taxable income is generally similar to the federal definition, except that interest from state and municipal obligations is taxable. In Wisconsin, net operating losses may be carried forward but not back. FNBM is incorporated in the State of Nevada, which does not currently impose a corporate income tax. Although the earnings of FNBM are not currently subject to taxation in the State of Wisconsin, from time-to-time legislation is proposed which, if adopted, would require consolidated income tax returns for entities headquartered in the state and result in taxation of FNBM's earnings. To date, none of these legislative proposals have been adopted. In addition, from time-to-time the Wisconsin Department of Revenue ("WDR") attempts to impose income tax on out-of-state investment subsidiaries like FNBM. Indeed, in 2003 the WDR began examinations of a number of financial institutions, including the Bank, specifically aimed at their relationships with their investment subsidiaries. Management believes the WDR will take the position that the income of FNBM is taxable in Wisconsin, and a number of other Wisconsin financial institutions have entered into settlements with the WDR related to taxation of the income of their Nevada subsidiaries. Management believes the Bank, as well as FNBM, have complied with the tax rules relating to the income of out-of-state subsidiaries. The WDR has indicated that it may repudiate these rulings and management believes it is more likely than not that the WDR exam will result in an assessment. The Bank and FNBM have held productive discussions with the WDR and while no final agreement has been reached, believe there is a strong likelihood of settlement. If no settlement is reached, the Bank will probably oppose an assessment, if any. Anti-Terrorism Act. On October 6, 2002, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (the "Patriot Act") was signed into law. While not primarily banking legislation, the Patriot Act contained provisions requiring financial institutions to adopt a variety of policies aimed at preventing money-laundering. The OCC is the primary regulator for purposes of insuring compliance by the Bank with Patriot Act requirements and certain of those requirements will not become effective until adoption of implementing regulations by the OCC. Management of the Bank does not believe that compliance with the Patriot Act and its implementing regulations has a significant impact on the Bank's business. ITEM 2. PROPERTIES The Corporation owns real property at two branch locations at: 1509 Washington Street, Two Rivers, Wisconsin 54241 ("Two Rivers Branch Office"); and 2915 Custer Street, Manitowoc, Wisconsin 54220 ("Custer Street Branch Office"). The Bank owns real property at the location of its main office at 402 North Eighth Street, Manitowoc, Wisconsin 54220; and at nine of its branch locations at: 106 South Packer Drive, Francis Creek, Wisconsin 54214 ("Francis Creek Branch Office"); 109 South Fourth Avenue, St. Nazianz, Wisconsin 54232 ("St. Nazianz Branch Office"); 110 Baugniet Street, Mishicot, Wisconsin 54228 ("Mishicot Branch Office"); 108 Fremont Street, Kiel, Wisconsin 53042 ("Kiel Branch Office"); 5724 CTH U, Newton, Wisconsin 53063 ("Newton Branch Office"); 2210 Calumet Drive, New Holstein, Wisconsin 53061 ("New Holstein Branch Office"); 2323 Eastern Avenue, Plymouth, Wisconsin 53073 ("Plymouth East Branch Office"); 300 East Mill Street, Plymouth, Wisconsin 53073 ("Plymouth West Branch Office"); and 2747 Manitowoc Road, Green Bay, Wisconsin 54311 ("Bellevue Branch Office"). The Bank leases real property at two branch locations: 2865 South Ridge Road, Green Bay, Wisconsin, 54304 ("Ashwaubenon Branch Office"). 4712 Expo Drive, Manitowoc, Wisconsin, 54220 ("Expo Branch Office"). Insurance Center of Manitowoc, Inc. owns real property located at: 4712 Expo Drive, Manitowoc, Wisconsin 54220 ("Insurance Center of Manitowoc, Inc. Office"). Insurance Center of Manitowoc, Inc. leases real property at: 425 South Adams Street, Green Bay, Wisconsin, 54301 ("Gary G. Vincent & Associates, Inc. Office"). There are no encumbrances on any of these properties. ITEM 3. LEGAL PROCEEDINGS The Corporation is involved in various legal actions arising in the normal course of its business. While the ultimate outcome of these various legal proceedings cannot be predicted with certainty, it is the opinion of management and through consultation with legal counsel that the resolution of these legal actions will not have a material effect on the Corporation's consolidated financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to security holders for a vote during the fourth quarter of 2004. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES MARKET INFORMATION There is no established public trading market for the Corporation's common stock ("Shares"). Accordingly, there is no comprehensive record of trades or the prices of any such trades. The following tables reflect stock prices for Shares to the extent such information is made known and available to management of the Corporation, and the dividends declared with respect thereto during the preceding two years.
2004 ------------------------------------------------------------------------- 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter High Low High Low High Low High Low ------- ------- ------- ------- ------- ------- ------- ------- $ 15.50 $ 14.05 $ 16.25 $ 14.90 $ 16.00 $ 15.00 $ 16.00 $ 15.10
2003 ------------------------------------------------------------------------- 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter High Low High Low High Low High Low ------- ------- ------- ------- ------- ------- ------- ------- $ 14.50 $ 14.50 $ 15.75 $ 14.50 $ 15.50 $ 14.50 $ 16.00 $ 14.00
CASH DIVIDENDS
2004 -------------------------------------------------------------- 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Total ----------- ----------- ----------- ----------- ------- $ 0.055 $ 0.055 $ 0.055 $ 0.065 $ 0.230
2003 -------------------------------------------------------------- 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Total ----------- ----------- ----------- ----------- ------- $ 0.050 $ 0.050 $ 0.050 $ 0.060 $ 0.210
HOLDERS As of February 28, 2005, there were approximately 665 holders of record of the Corporation's Shares. ISSUER PURCHASES OF EQUITY SECURITIES None DIVIDENDS The Corporation declared and paid cash dividends totaling $0.230 per share or $1.6 million during fiscal 2004, and $0.210 per share or $1.5 million during fiscal 2003. The Corporation currently expects that comparable cash dividends will continue in the future. Dividends may be paid to the holders of the Corporation's shares, when, as, and if declared by the Corporation's Board of Directors, subject to the restrictions imposed by Wisconsin law. The only statutory limitation applicable to the Corporation is that dividends may not be paid if the Corporation is insolvent or if the dividend would cause the Corporation to become insolvent. There are no contractual restrictions that currently limit the Corporation's ability to pay dividends or that the Corporation reasonably believes are likely to limit materially the future payment of dividends on the Corporation's shares. Currently, its only source of income is from the dividends paid by the Bank to the Corporation. Therefore, the dividend restrictions applicable to national banks will impact the Corporation's ability to pay dividends. Under the National Bank Act, dividends may be paid only out of retained earnings as defined in the statute. The approval of the OCC is required if the dividends for any year exceed the net profits, as defined, for that year plus the retained net profits for the preceding two years. In addition, unless a national bank's capital surplus equals or exceeds the stated capital for its common stock, no dividends may be declared unless the bank makes transfers from retained earnings to capital surplus. ITEM 6. SELECTED FINANCIAL DATA The following selected financial data should be read in conjunction with the Corporation's Consolidated Financial Statements and the related notes and with the Corporation's Management's Discussion and Analysis of Financial Condition and Results of Operations, provided elsewhere herein. In thousands, except per share amounts.
FOR THE YEAR ENDED DECEMBER 31, 2004 2003 2002 2001 2000 ---------- ---------- ---------- ---------- ---------- Interest income $ 28,042 $ 27,189 $ 30,811 $ 35,421 $ 34,979 Interest expense 8,796 9,683 11,978 17,982 18,995 Net interest income 19,246 17,506 18,833 17,439 15,984 Provision for loan losses 450 1,250 1,950 3,000 1,065 Net interest income after provision for loan losses 18,796 16,256 16,883 14,439 14,919 Other income 6,494 7,887 6,585 5,344 2,711 Other expense 14,982 14,433 14,542 13,455 11,428 Net income 7,902 7,629 7,089 5,405 5,301 Per Share Data:* Net income - basic and diluted $ 1.140 $ 1.100 $ 1.020 $ 0.780 $ 0.760 Cash dividends declared 0.230 0.210 0.183 0.150 0.140 Book value 9.500 8.680 7.820 6.700 5.980 Weighted average shares outstanding 6,937,268 6,937,268 6,937,268 6,937,268 6,937,268
AT YEAR ENDED DECEMBER 31, 2004 2003 2002 2001 2000 ---------- ---------- ---------- ---------- ---------- Total assets $ 622,175 $ 581,953 $ 565,810 $ 527,304 $ 495,410 Loans 386,515 371,125 344,103 327,440 326,571 Allowance for loan losses 3,824 3,999 3,384 2,737 3,824 Investment securities 156,669 138,275 135,747 126,754 114,375 Deposits 445,786 428,284 416,099 394,092 394,601 Repurchase Agreements 61,620 55,359 50,884 33,108 29,952 Borrowed funds 42,280 31,910 38,138 47,179 23,000 Shareholders' equity 65,873 60,223 54,284 46,489 41,461 AVERAGE BALANCES Assets $ 598,770 $ 564,735 $ 534,622 $ 505,518 $ 472,285 Deposits 431,459 415,926 387,953 384,856 373,035 Shareholders' equity 62,969 57,189 50,750 44,763 37,455 FINANCIAL RATIOS Return on average assets 1.32% 1.35% 1.33% 1.07% 1.12% Return on average equity 12.55% 13.34% 13.97% 12.07% 14.15% Average equity to average assets 10.52% 10.13% 9.49% 8.85% 7.93% Dividend payout ratio 20.18% 19.09% 17.86% 19.26% 18.32%
* Per share data for 2000 through 2002 is restated to reflect the two-for-one stock splits effective June 30, 2000 and October 18, 2002. SUMMARY QUARTERLY FINANCIAL INFORMATION In thousands, except per share amounts
Three Months Ended, 2004 March 31 June 30 September 30 December 31 ---- -------- ------- ------------ ----------- Selected Operations Data: Interest income $ 6,656 $ 6,747 $ 7,251 $ 7,388 Interest expense 2,092 2,100 2,244 2,360 -------- ------- ------------ ----------- Net interest income 4,564 4,647 5,007 5,028 Provision for loan losses 100 100 150 100 Other income 2,053 1,261 1,705 1,475 Other expenses 3,729 3,535 3,768 3,950 -------- ------- ------------ ----------- Income before income taxes 2,788 2,273 2,794 2,453 Provision for income taxes 641 450 769 546 -------- ------- ------------ ----------- Net income $ 2,147 $ 1,823 $ 2,025 $ 1,907 Per Share Data: Net income (Basic and Diluted) $ 0.31 $ 0.26 $ 0.29 $ 0.28
Three Months Ended, March 31 June 30 September 30 December 31 -------- ------- ------------ ----------- 2003 ---- Selected Operations Data: Interest income $ 7,135 $ 6,791 $ 6,591 $ 6,672 Interest expense 2,667 2,533 2,294 2,189 -------- ------- ------------ ----------- Net interest income 4,468 4,258 4,297 4,483 Provision for loan losses 200 450 300 300 Other income 1,886 2,093 2,342 1,566 Other expenses 3,692 3,419 3,703 3,619 -------- ------- ------------ ----------- Income before income taxes 2,462 2,482 2,636 2,130 Provision for income taxes 561 532 595 393 -------- ------- ------------ ----------- Net income $ 1,901 $ 1,950 $ 2,041 $ 1,737 Per Share Data: Net income (Basic and Diluted) $ 0.27 $ 0.28 $ 0.29 $ 0.26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The discussion and analysis in this section should be read in conjunction with Item 8, Financial Statements and Supplemental Data as well as with the selected financial data found elsewhere in this report. Critical Accounting Policies In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Estimates that are particularly susceptible to significant change include the determination of the allowance for loan losses and mortgage servicing rights valuation. The consolidated financial statements of the Corporation are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industries in which it operates. This preparation requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Management believes the following policies are both important to the portrayal of the Corporation's financial condition and results and require subjective or complex judgments and, therefore, management considers the following to be critical accounting policies. Allowance for Loan Losses. Management's evaluation process used to determine the adequacy of the allowance for loan losses is subject to the use of estimates, assumptions, and judgments including management's ongoing review and grading of the loan portfolio, consideration of past loan loss experience, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect probable credit losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly. As an integral part of their examination process, various regulatory agencies also review the allowance for loan losses. Such agencies may require that certain loan balances be charged off when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. The Corporation believes the allowance for loan losses is adequate and properly recorded in the financial statements. See section "Allowance for Loan Losses." Mortgage Servicing Rights Valuation. The fair value of the Corporation's mortgage servicing rights asset is important to the presentation of the consolidated financial statements in that mortgage servicing rights are subject to a fair value-based impairment standard. Mortgage servicing rights do not trade in an active open market with readily observable prices. As such, like other participants in the mortgage banking business, the Corporation relies on an internal estimated cash flow model to establish the fair value of its mortgage servicing rights. While the Corporation believes that the values produced by its internal model are indicative of the fair value of its mortgage servicing rights portfolio, these values can change significantly depending upon the then current interest rate environment, estimated prepayment speeds of the underlying mortgages serviced, and other economic conditions. The proceeds that might be received should the Corporation actually consider a sale of the mortgage servicing rights portfolio could differ from the amounts reported at any point in time. The Corporation believes the mortgage servicing rights asset is properly recorded in the financial statements. For additional information concerning critical accounting policies, see Notes to Consolidated Financial Statements, "Note 1, Summary of Significant Accounting Policies". Results of Operations INCOME STATEMENT The Corporation recorded net income of $7.9 million for the year ended December 31, 2004, an increase of 3.9% over the $7.6 million earned in 2003. These amounts represented returns on average assets of 1.32% for 2004 and 1.35% for 2003. Returns on average equity were 12.55% for 2004 and 13.34% for 2003. Earnings per share in 2004 (basic and diluted) were $1.14, an increase of 3.6% over 2003 earnings per share of $1.10. Interest income increased $0.8 million, from $27.2 million in 2003 to $28.0 million in 2004. Interest expense decreased from $9.7 million in 2003 to $8.8 million in 2004. Interest rates were relatively stable and historically low during 2003 and the first half of 2004. As a result, net interest income increased $1.7 million in 2004. There were five interest rate increases of 25 basis points each during the second half of 2004. Interest rates on deposits increased at a slower rate than those on securities which contributed to the increase in the net interest margin. Other income decreased $1.4 million in 2004, from $7.9 million in 2003 to $6.5 million in 2004. Notably lower revenue from significantly lower refinancing activity occurred throughout the industry. As a result, service charges, loan servicing income and gain on sales of mortgage loans sold to the secondary market, accounted for the major decreases in other income. Increases occurred in Insurance Center commissions and other miscellaneous income, a result of increased volume and contingency commission income. Other expense increased $0.6 million from $14.4 million in 2003 to $15.0 million in 2004. Increases in employee compensation and outside service fees (Sarbanes-Oxley internal control documentation requirements) were mainly responsible for the difference. BALANCE SHEET Total assets at December 31, 2004 increased $40.2 million from $582.0 million in 2003 to $622.2 million in 2004. Loans were $386.5 million at December 31, 2004, an increase of $15.4 million or 4.1% over December 31, 2003. Significant increases in loans were as follows: Commercial loans increased $5.2 million and residential real estate loans increased $10.4 million. The allowance for loan losses decreased to $3.8 million at December 31, 2004 from $4.0 million at December 31, 2003. The ratio of allowance for loan losses to total loans was 0.99% for 2004 and 1.08% for 2003. Non-performing loans were $3.1 million, representing 0.79% of total loans at year end 2004, compared to $3.3 million or 0.88% of total loans last year. The decrease in non-performing loans came primarily from the commercial loan sector of the Bank's loan portfolio. Deposits increased $17.5 million, from $428.3 million at December 31, 2003 to $445.8 million at December 31, 2004. The bank continues to experience strong competition from other commercial banks, credit unions, the stock market, and mutual funds. There are no predetermined divisions in the asset/liability policy for the mix of deposits. Repurchase agreements increased $6.2 million or 11.3% over 2003 due to increased deposits by municipalities at year end as a result of tax collections. Borrowed funds increased $10.4 million to $42.3 million at December 31, 2004 from $31.9 million at December 31, 2003. Results of Operations Overview for fiscal years 2004, 2003 and 2002 The Corporation reported $7.9 million in net income for 2004 or $1.14 per share compared to 2003 net income of $7.6 million or $1.10 per share, and $7.1 million or $1.02 per share for 2002. Earnings for the year represent a record level of performance for the Corporation, exceeding the previous record of $7.6 million achieved in 2003. The improvement was primarily attributed to net interest income. Return on average assets was 1.32%, 1.35% and 1.33% in 2004, 2003 and 2002, respectively. Return on average equity was 12.55% for 2004, 13.34% for 2003, and 13.97% for 2002. Net Interest Income, Interest Rate Spread, and Net Interest Margin Management and the Board of Directors of the Bank monitor interest rates on a regular basis to assess the Bank's competitive position and to maintain a reasonable and profitable interest rate spread. The Bank also considers the maturity distribution of loans, investments, and deposits and its effect on net interest income as interest rates rise and fall over time. Tables 1 and 2 do not include financial data for the Corporation as they include only Bank financial information. In Table 1, nonaccrual loans have been included in the average balances, loan fees are included in interest income and the yield on tax exempt loans and securities is computed on a tax-equivalent basis using a tax rate of 34%. Table 1 provides average balances of earning assets and interest-bearing liabilities, the associated interest income and expense and the corresponding interest rates earned and paid. Net interest income, interest rate spread and net interest margin on a tax-equivalent basis are shown for the three years ended December 31, 2004, 2003, and 2002, respectively. Net interest income is the principal source of earnings for a banking company. It represents the differences between interest and fees earned on the loan and investment portfolios and interest-bearing deposits offset by the interest paid on deposits and borrowings. The amount of net interest income is affected by changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities. Interest rates fell during 2003 and 2002, but improved slightly during 2004. Net interest income (on a tax equivalent basis) for 2004 increased by $2.8 million or 14.8% compared to the year ended December 31, 2003, while 2003 net interest income decreased by $1.3 million or 6.2% from the previous year ended December 31, 2002. (See Tables 1 and 2) Interest rate spread and net interest margin are utilized to measure and explain changes in net interest income. Interest rate spread is the difference between the average yield on interest earning assets and the average rate paid on interest bearing liabilities. Interest rate spread for the years ended December 31, 2004, 2003, and 2002 was 3.62%, 3.28%, and 3.68%, respectively. Net interest margin is calculated as tax equivalent net interest income divided by average earning assets and represents the Bank's net yield on its earning assets. The net interest margin exceeds the interest rate spread because non-interest bearing sources of funds, primarily demand deposits and shareholder's equity, also support earning assets. For 2004, the net interest margin was 3.96% compared to 3.66% in 2003. The net interest margin for 2002 was 4.12%. These changes are the result of repricing and volume changes as previously discussed and illustrated in Table 2 "Rate and Volume Variance Analysis Based on Average Balances." As shown in the rate/volume analysis in Table 2, changes in the rates in 2004 resulted in a $1.2 million increase in taxable equivalent net interest income. Increases in volume and changes in the mix of both earning assets and interest-bearing liabilities added $1.6 million for a combined increase of $2.8 million in taxable equivalent net interest income. Rate changes on interest-bearing liabilities lowered interest expense by $1.4 million, while rate changes on earning assets decreased interest income by $0.2 million. For 2004, the cost of interest-bearing liabilities decreased 30 basis points to 1.93% aided by the low interest rate environment. Decreases occurred in the CD and IRA deposit category (a decline of 46 basis points), repurchase agreements (a decline of 34 basis points) and borrowings (a decline of 114 basis points). The yield on earning assets increased 3 basis points to 5.54% for 2004. The average loan yield was 5.90%. The lower rate environment for new originations, competitive pricing pressure and refinancing contributed to the downward trend in loan yields. The yield on investment securities, however, was up 27 basis points to 5.14%. From a volume perspective, earning assets contributed $2.1 million to taxable equivalent net interest income while interest-bearing liabilities cost $0.5 million, netting a $1.6 million increase to taxable equivalent net interest income. Average earning assets were $554.7 million in 2004, an increase of $31.8 million from 2003. Loans increased $25.0 million or 7.1% over 2003. Securities increased $18.1 million or 12.8% over 2003. Average interest-bearing liabilities were $456.7 million in 2004, an increase of $22.2 million from 2003. Certificates of deposit and IRA deposits along with repurchase agreements and borrowings accounted for a $16.6 million increase on average over 2003. Table 1 displays the average balances and average rates paid on all major deposit classifications for 2004, 2003, and 2002. AVERAGE BALANCES, YIELD AND RATES (In thousands) TABLE 1
For the year ended For the year ended For the year ended December 31, 2004 December 31, 2003 December 31, 2002 ----------------------------- --------------------------- -------------------------- Interest Average Interest Average Interest Average Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate Balance Expense Rate --------- -------- ------- -------- -------- ------- -------- -------- ------- ASSETS: Interest earning assets: Federal funds sold $ 16,511 $ 221 1.34% $ 27,751 $ 304 1.10% $ 20,749 $ 336 1.62% Investment securities: US Treasury securities and obligations of US government agencies $ 72,968 $ 2,377 3.26% $ 60,339 $ 1,478 2.45% $ 65,727 $ 2,973 4.52% Tax exempt obligations of States and political subdivisions $ 76,406 $ 5,104 6.68% $ 70,474 $ 4,780 6.78% $ 64,163 $ 4,587 7.15% All other investment securities $ 10,530 $ 734 6.97% $ 11,003 $ 645 5.86% $ 8,525 $ 623 7.31% --------- -------- -------- -------- -------- -------- Total investment securities $ 159,904 $ 8,215 5.14% $141,816 $ 6,903 4.87% $138,415 $ 8,183 5.91% Loans net of unearned income: Commercial loans $ 129,139 $ 7,832 6.06% $ 96,233 $ 7,087 7.36% $ 98,948 $ 7,713 7.80% Mortgage loans $ 228,693 $ 12,438 5.44% $234,759 $ 12,260 5.22% $213,685 $ 13,670 6.40% Installment loans $ 15,663 $ 1,257 8.03% $ 16,343 $ 1,463 8.95% $ 17,273 $ 1,692 9.80% Other loans $ 4,834 $ 794 16.43% $ 5,977 $ 798 13.35% $ 5,752 $ 772 13.42% --------- -------- -------- -------- -------- -------- Total loans $ 378,329 $ 22,321 5.90% $353,312 $ 21,608 6.12% $335,658 $ 23,847 7.10% TOTAL INTEREST EARNING ASSETS $ 554,744 $ 30,757 5.54% $522,879 $ 28,815 5.51% $494,822 $ 32,366 6.54% Cash and due from banks $ 13,379 $ 12,904 $ 12,668 Other assets $ 34,549 $ 32,706 $ 28,918 Allowance for loan and lease losses $ (3,902) $ (3,754) $ (2,851) --------- -------- -------- TOTAL ASSETS $ 598,770 $564,735 $533,557 ========= ======== ======== LIABILITIES: Interest bearing liabilities: Savings deposits $ 46,984 $ 106 0.23% $ 43,935 $ 76 0.17% $ 42,325 $ 131 0.31% Market Plus accounts $ 69,710 $ 634 0.91% $ 68,345 $ 553 0.81% $ 63,295 $ 803 1.27% Super NOW accounts $ 30,654 $ 255 0.83% $ 30,084 $ 276 0.92% $ 25,565 $ 329 1.29% Money market deposit accounts $ 18,186 $ 185 1.02% $ 17,535 $ 152 0.87% $ 18,606 $ 237 1.27% Certificates of deposit and IRA deposits $ 193,802 $ 5,253 2.71% $189,826 $ 6,019 3.17% $179,883 $ 7,385 4.11% Repurchase agreements $ 56,101 $ 1,202 2.14% $ 50,359 $ 1,250 2.48% $ 47,057 $ 1,310 2.78% Federal funds purchased $ 10 $ - 0.00% $ - $ - 0.00% $ 6 $ 0 2.35% Borrowings $ 41,279 $ 1,161 2.81% $ 34,370 $ 1,357 3.95% $ 42,170 $ 1,783 4.23% --------- -------- -------- -------- -------- -------- TOTAL INTEREST BEARING LIABILITIES $ 456,726 $ 8,796 1.93% $434,454 $ 9,683 2.23% $418,907 $ 11,978 2.86% Demand Deposits $ 72,123 $ 66,201 $ 58,279 Other Liabilities $ 6,952 $ 6,891 $ 6,663 --------- -------- -------- Total Liabilities $ 535,801 $507,546 $483,849 Shareholders' Equity $ 62,969 $ 57,189 $ 49,708 --------- -------- -------- TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $ 598,770 $564,735 $533,557 ========= ======== ======== Recap: Interest Income $ 30,757 5.54% $ 28,815 5.51% $ 32,366 6.54% Interest Expense $ 8,796 1.93% $ 9,683 2.23% $ 11,978 2.86% -------- -------- -------- Net Interest Income/Spread $ 21,961 3.62% $ 19,132 3.28% $ 20,388 3.68% Contribution of Non-Interest-bearing Funds 0.34% 0.38% 0.44% Net Interest Margin 3.96% 3.66% 4.12% Ratio of Average Interest Earning Assets to Average Interest-Bearing Liabilities 121.46% 120.35% 118.12%
Net interest margin is calculated as tax equivalent net interest income divided by average earning assets and represents the Bank's net yield on its earning assets. The tax equivalent adjustment was calculated using the statutory federal income tax rate of 34%. The following table sets forth the effects of changing rates and volumes on net interest income of the Corporation for the periods indicated. Information is provided with respect to (1) effects on net interest income attributable to changes in volume (changes in volume multiplied by prior rate); (2) effects on net interest income attributable to changes in rate (changes in rate multiplied by prior volume); and (3) the net change in interest income. The apportionment of changes resulting from the combined effect of both volume and rate was based on the separately determined volume and rate changes. Table 2 RATE AND VOLUME VARIANCE ANALYSIS BASED ON AVERAGE BALANCES (In thousands)
2004 COMPARED TO 2003 2003 COMPARED TO 2002 --------------------- --------------------- INCREASE(DECREASE) IN NET INTEREST INCOME INCREASE(DECREASE) IN NET INTEREST INCOME NET DUE TO DUE TO NET DUE TO DUE TO CHANGE RATE VOLUME CHANGE RATE VOLUME --------- --------- --------- ---------- --------- -------- Interest earning assets Federal funds sold $ (83) $ 58 $ (141) $ (32) $ (127) $ 95 Investment securities: US Treasury securities and obligations of US government agencies $ 899 $ 550 $ 349 $ (1,495) $ (1,268) $ (227) Tax exempt obligations of States and political subdivisions $ 324 $ (73) $ 397 $ 193 $ (243) $ 436 All other investment securities $ 89 $ 118 $ (29) $ 22 $ (138) $ 160 --------- --------- --------- ---------- --------- -------- Total investment securities $ 1,312 $ 595 $ 717 $ (1,280) $ (1,649) $ 369 Loans net of unearned income: Commercial loans $ 745 $ (1,396) $ 2,141 $ (626) $ (418) $ (208) Mortgage loans $ 178 $ 500 $ (322) $ (1,410) $ (2,672) $ 1,262 Installment loans $ (206) $ (147) $ (59) $ (229) $ (141) $ (88) Other loans $ (4) $ 165 $ (169) $ 26 $ (4) $ 30 --------- --------- --------- ---------- --------- -------- Total loans $ 713 $ (879) $ 1,592 $ (2,239) $ (3,235) $ 996 TOTAL INTEREST EARNING ASSETS $ 1,942 $ (226) $ 2,168 $ (3,551) $ (5,011) $ 1,460 Interest bearing liabilities: Savings deposits $ 30 $ 24 $ 6 $ (55) $ (60) $ 5 Market Plus accounts $ 81 $ 70 $ 11 $ (250) $ (310) $ 60 Super NOW accounts $ (21) $ (26) $ 5 $ (53) $ (105) $ 52 Money market deposit accounts $ 33 $ 27 $ 6 $ (85) $ (72) $ (13) Certificates of deposit and IRA deposits $ (766) $ (890) $ 124 $ (1,366) $ (1,756) $ 390 Repurchase agreements $ (48) $ (182) $ 134 $ (60) $ (148) $ 88 Federal funds purchased $ - $ - $ - $ (0) $ (0) $ (0) Borrowings $ (196) $ (437) $ 241 $ (426) $ (112) $ (314) --------- --------- --------- ---------- --------- -------- TOTAL INTEREST BEARING LIABILITIES $ (887) $ (1,413) $ 526 $ (2,295) $ (2,563) $ 268 Net Change in Net Interest Income $ 2,829 $ 1,187 $ 1,642 $ (1,256) $ (2,448) $ 1,192
Provision and Allowance for Loan Losses For the year ended December 31, 2004, the Bank recorded net charge-offs of $625,000 compared to net charge- offs of $635,000 in 2003 and $1,303,000 in 2002. Internal loan review, in particular, works toward identifying problem credits and achieving timely recognition of potential and actual losses within the loan portfolio. Gross charge-offs amounted to $795,000 in 2004, $749,000 in 2003, and $1,578,000 in 2002, the majority of which were commercial loans. Loans charged off are subject to ongoing review and effort is made to maximize recovery of principal, interest and related expenses. Recoveries were $170,000 in 2004, $114,000 in 2003, and $275,000 in 2002. The methodology used in determining the allowance for loan losses is based on guidelines provided by the Financial Accounting Standards Board. The allowance for loan losses is maintained at a level believed adequate by management to absorb estimated loan losses. There are several factors that are included in the analysis of the adequacy of the allowance for loan losses. Management considers loan volume trends, levels and trends in delinquencies and nonaccruals, current problem credits, national and local economic trends and conditions, concentrations of credit by industry, current and historical levels of charge-offs, the experience and ability of the lending staff, and other miscellaneous factors. The factor of loan volume trends is based on actual lending activity. This factor is for estimated losses that are believed to be inherently part of the loan portfolio but that have not yet been identified as specific problem credits. The current problem credits factor includes the exposure believed to exist for specifically identified problem loans determined on a loan-by-loan basis. Specific problem loans are subject to classification according to one of two categories: "Substandard" or "Doubtful". An institution is required to develop its own program to classify its assets on a regular basis and to set aside appropriate loss reserves on the basis of such classification. The allocation of the allowance among the various loan categories is based on the average proportion within those categories using a three year historical loss percentage. The unallocated portion of the allowance consists of the other factors included in the analysis because those factors cannot be tied to specific loans or loan categories. The allocation of the allowance for loan losses is shown in the following table. Table 3 ALLOCATION OF ALLOWANCE FOR LOAN LOSSES (IN THOUSANDS) DECEMBER 31
% Of % Of % Of % Of % Of Loans In Loans In Loans In Loans In Loans In Category Category Category Category Category To Total To Total To Total To Total To Total 2004 Loans 2003 Loans 2002 Loans 2001 Loans 2000 Loans ------ -------- ------ -------- ------ -------- ------ -------- ------- -------- Specific Problem Loans $1,610 $2,262 $1,974 $ 843 $ 625 Loan Type Allocation: Commercial & Agricultural 698 30.1% 950 29.4% 1,006 29.5% 1,476 26.4% 2,688 29.1% Commercial Real Estate 112 28.7% 87 30.0% 31 30.2% 103 26.0% 436 23.4% Residential Real Estate 110 36.1% 53 34.8% 13 36.7% 19 40.1% 25 40.3% Consumer 182 5.1% 221 5.8% 77 3.6% 12 7.5% 36 7.2% ------ ------ ------ ------ ------- Non-Specific Problem Loans 1,102 1,311 1,127 1,610 3,185 Unallocated 1,112 426 283 284 14 ------ ------ ------ ------ ------- Total $3,824 $3,999 $3,384 $2,737 $ 3,824 ====== ====== ====== ====== =======
Local economic concerns continue to affect the bank's customers. These concerns are reflected in the allocation of allowance for loan losses. An increase in local unemployment rates since December 31, 2002 was taken into consideration when determining the increase in the unallocated portion of the allowance. The unallocated allowance for loan losses is based on historical charge-off rates for various loan categories and is applied to loans outstanding at the end of the quarter. The allocation and total for the allowance for loan losses is not to be interpreted as a single year's exposure for loss nor the loss for any specified time period. Table 4 ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES (IN THOUSANDS) FOR THE YEARS ENDED DECEMBER 31,
2004 2003 2002 2001 2000 ------- ------- -------- --------- ------- Balance at beginning of period $ 3,999 $ 3,384 $ 2,737 $ 3,824 $ 3,700 Charge-offs: Commercial Real Estate $ 39 $ 97 $ 0 $ 0 $ 83 Residential Real Estate 112 179 272 22 2 Commercial & Agricultural 468 240 1,095 3,872 668 Consumer 176 233 211 240 243 ------- ------- -------- --------- ------- $ 795 $ 749 $1,578 $4,134 $ 996 ======= ======= ======== ========= ======= Recoveries: Commercial Real Estate $ 3 $ 29 $ 8 $ 0 $ 9 Residential Real Estate 23 1 17 2 2 Commercial & Agricultural 111 26 211 21 27 Consumer 33 58 39 24 17 ------- ------- -------- --------- ------- $ 170 $ 114 $ 275 $ 47 $ 55 ======= ======= ======== ========= ======= Net charge-offs 625 635 1,303 4,087 941 Provision for loan losses 450 1,250 1,950 3,000 1,065 ------- ------- -------- --------- ------- Balance at end of period $ 3,824 $3,999 $ 3,384 $ 2,737 $ 3,824 ======= ======= ======== ========= ======= Ratio of net charge-offs during period to average loans outstanding during period 0.17% 0.18% 0.39% 1.23% 0.30% Ratio of allowance for loan losses to total loans 0.99% 1.08% 0.98% 0.84% 1.17%
The allowance for loan losses of $3,824,000 as of December 31, 2004 amounted to 0.99% of the outstanding loan portfolio. As of December 31, 2003, the $3,999,000 allowance for loan losses was 1.08% of gross loans and the allowance for loan losses of $3,384,000 as of December 31, 2002 represented 0.98% of gross loans. Net charge-offs for the year ended December 31, 2004 were greater than the provision for loan losses for 2004. This accounts for the decrease in the allowance for loan losses from $3,999,000 at December 31, 2003 to $3,824,000 at December 31, 2004. Analysis by internal loan review supports the adequacy of the allowance. Management has determined that the allowance for loan losses is adequate to absorb probable loan losses as of December 31, 2004. See Note 3 in the Consolidated Financial Statements. Other Income Other income decreased $1.4 million, or 17.7%, from 2003 to 2004. Reduced FNMA financing in 2004 resulted in dramatic decreases in the gain on sales of mortgage loans to the secondary market and the corresponding servicing income. The dollar volume decreased from $132.7 million to $49.7 million. The real estate premiums and discounts on FNMA loans sold in the secondary market decreased by $1.6 million during 2004 from $1.8 million in 2003 to $0.2 million in 2004. The Insurance Center experienced growth in volume during 2004, contributing to increased commission income. Other miscellaneous income increased as a result of contingency commission income for lower than expected insurance claims. Other income increased $1.3 million, or 19.8%, from 2002 to 2003. The increased volume of mortgage loans and refinancings processed and sold to the FNMA secondary market led to increased gains on loans sold and servicing fees associated with them. Other Expense Other expense increased by $0.6 million, or 4.2%, from 2003 to 2004. Increases in employee compensation and Sarbanes-Oxley fees were partially offset by cost savings in the operating expenses, specifically telephone and printing costs. Other expense decreased by $109,000, or 0.8%, from 2002 to 2003. Income Taxes The effective tax rates for the Corporation were 23.34%, 21.40%, and 20.58%, for 2004, 2003, and 2002, respectively. The increase in the effective tax rate for 2004 is a result of higher Wisconsin state taxes paid in 2004. See Note 12 in the Consolidated Financial Statements and Item 1, "State Taxation" for additional information. Securities Securities available for sale are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions as part of the asset/liability management strategy. Securities available for sale are carried at fair value, with unrealized holding gains and losses, net of the related tax effect, reported as a separate component of accumulated other comprehensive income. Securities held to maturity are those that management has both the positive intent and ability to hold to maturity, and are reported at amortized cost. The Bank does not own trading or held to maturity securities. Total securities were $156.7 million, $138.3 million, and $135.7 million as of December 31, 2004, 2003, and 2002, respectively. The higher level of investments in securities resulted primarily from the increase in available funds derived from increases in deposits, securities sold under repurchase agreements, and borrowings. The Bank manages its investment portfolios within policies that seek to achieve desired levels of liquidity, manage interest rate sensitivity risk, meet earnings objectives, and provide required collateral support for deposit activities. The Bank had no concentrations of securities from any single issues that exceeded 10% of shareholders' equity. Table 5 exhibits the distribution, by type, of the investment portfolio as of December 31, for the years indicated. Table 5 SECURITIES AVAILABLE FOR SALE (IN THOUSANDS)
December 31, 2004 December 31, 2003 December 31, 2002 ----------------- ----------------- ----------------- U.S. Treasury securities and obligations of U.S. $ 2,974 $ 13,663 $ 16,427 Government corporations and agencies Obligations of states and political subdivisions 80,160 70,357 50,915 Mortgage-backed securities 70,232 49,924 62,784 Corporate Notes 100 100 999 ----------------- ----------------- ----------------- TOTAL AMORTIZED COST $ 153,466 $ 134,044 $ 131,125 ================= ================= ================= TOTAL FAIR VALUE $ 156,669 $ 138,275 $ 135,747 ================= ================= =================
The following table presents the maturity by type of the investment portfolio for the year ended December 31, 2004. Table 6 INVESTMENT PORTFOLIO ANALYSIS DECEMBER 31, 2004 (IN THOUSANDS)
Mortgage-Backed U.S. Govt Agencies Municipals Securities Corporate Notes -------------------------------------------------------------------------------------------------------------------------------- Avg Avg Avg Avg Description & Book TE Book TE Book TE Book TE Total Total Term Value Yield Value Yield Value Yield Value Yield Amortized Cost Fair Value -------------------------------------------------------------------------------------------------------------------------------- 0-12 months $ - $ - $ 3,165 7.48% $ 10,742 3.39% $ - - $ 13,907 $ 13,924 1-5 Years - - 17,435 6.80% 59,490 3.83% - - 76,925 77,306 5-10 Years 1,939 2.49% 38,893 6.89% - - 100 7.30% 40,932 42,894 Over 10 Years 1,035 3.03% 20,667 6.61% - - - - 21,702 22,545 ------- ----- -------- ----- -------- ----- ----- ----- -------------- ---------- Total $ 2,974 2.68% $ 80,160 6.82% $ 70,232 3.76% $ 100 7.30% $ 153,466 $ 156,669 ======= ===== ======== ===== ======== ===== ===== ===== ============== ==========
Loan Portfolio The Bank is actively engaged in originating loans to customers in Manitowoc, Calumet, Sheboygan and Brown counties. The Bank has policies and procedures designed to mitigate credit risk and to maintain the quality of the loan portfolio. These policies include underwriting standards for new credits as well as the continuous monitoring and reporting of asset quality and the adequacy of the allowance for loan losses. These polices, coupled with continuous training efforts, have provided effective checks and balances for the risk associated with the lending process. Lending authority is based on the level of risk, size of the loan and the experience of the lending officer. Bank underwriting procedures are based on a process which evaluates the management, repayment ability, collateral support, credit history, and overall financial strength of prospective and current customers from a relationship oriented perspective. Residential mortgage loans are predominantly underwritten to general FNMA guidelines. The Bank extends the following types of credit: commercial loans, agricultural loans, real estate loans and consumer loans. Commercial loans are often secured with first liens on accounts receivable, inventory and/or equipment. Commercial loans generally have loan to value ratios of 80% or less. Agricultural loans are collateralized with first liens on crops, farm products, farm personal property and/or real estate. Agricultural loans generally have loan to value ratios of 70% or less, except for agricultural real estate loans which have loan to value ratios of 80% or less. Real estate loans include commercial real estate loans and residential real estate loans. Real estate loans are collateralized with first mortgages. Commercial real estate loans generally have loan to value ratios of 80% or less while residential real estate loans have loan to value ratios of 90% or less. Consumer loans include loans to individuals for personal, family or household purposes. Consumer loans may be secured with first lien positions or be unsecured depending upon the credit quality. The Bank will make subordinate loans in any category if the borrower's financial position justifies it. The Bank is not involved in credit risk insurance. Bank management assesses the loan portfolio mix at least annually as part of its planning and budget process. While there are no predetermined fixed targets for various loan types established in the loan policy, general guidelines are established annually for new loan activity based on loan portfolio mix and credit needs in the Bank's main markets. The risks associated with the Bank's loan categories are as follows: Commercial and Agricultural. Credit risk is considered moderate. Past due loans are below industry averages. The portfolio is fairly diversified with no significant concentrations within one industry. Agricultural loans represent approximately 1.10% of total loans. Real Estate. Credit risk is considered low, with delinquency ratios and non-performing loans at low levels. Consumer. Credit risk is considered moderate, with delinquency ratios and non-performing loans at low levels. Unallocated. (Table 3) The risk associated with the unallocated allowance for loan losses is based on historical charge-off rates for various loan categories and is applied to loans outstanding at the end of each quarter. No loan customer exceeds the legal lending limit among the loan categories. The Bank's legal and internal lending limit as of December 31, 2004 was $8.6 million. Extensions of credit used predominantly for business or agricultural purposes are classified as commercial and agricultural loans. Commercial loans include lines of credit for seasonal requirements of businesses, short-term loans payable within 12 months for one time specific purposes and term loans with maturities greater than 12 months for capital assets and fixed assets which are amortized and repaid from cash flow. Agricultural loans include short-term farm operating loans, intermediate-term farm personal property loans and long-term agricultural real estate loans. Agricultural real estate loans generally are written for one to two year terms with amortizations exceeding five years. Commercial term loans for capital assets and fixed assets and commercial real estate loans that have maturities of more than five years are generally arranged through government assisted financing programs such as SBA. The increase in commercial loans and commercial real estate loans resulted mainly from the general credit needs within the Bank's primary markets. The Bank also made it a priority to sell residential mortgage loans to the FNMA secondary market. Table 7 "Summary of Loan Portfolio" presents the composition of the Bank's loan portfolio by significant concentration. Table 7 SUMMARY OF LOAN PORTFOLIO (IN THOUSANDS) LOANS OUTSTANDING AS OF DECEMBER 31,
2004 2003 2002 2001 2000 -------------------- -------------------- -------------------- -------------------- -------------------- Percent of Percent of Percent of Percent of Percent of Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans -------- ----------- -------- ----------- -------- ----------- -------- ----------- -------- ----------- Commercial and Agricultural $116,145 30.05% $110,884 29.36% $101,531 29.51% $ 86,565 26.44% $ 94,886 29.06% Commercial Real Estate 110,972 28.71% 109,469 30.02% 104,042 30.24% 85,036 25.97% 76,478 23.42% Residential Real Estate 139,612 36.12% 129,212 34.82% 126,122 36.65% 131,362 40.12% 131,592 40.29% Consumer 16,980 4.39% 18,301 4.93% 9,470 2.75% 23,213 7.08% 22,270 6.82% Other 2,806 0.73% 3,259 0.87% 2,938 0.85% 1,264 0.39% 1,345 0.41% -------- ------ -------- ------ -------- ----- -------- ------ -------- ------- Total $386,515 100.00% $371,125 100.00% $344,103 100.0% $327,440 100.00% $326,571 100.00% ======== ====== ======== ====== ======== ===== ======== ====== ======== ======
Table 8 MATURITIES OF LOAN PORTFOLIO DECEMBER 31, 2004 (IN THOUSANDS)
Commercial Commercial Residential Maturing & Agricultural Real Estate Real Estate Consumer Other Total -------- -------------- ----------- ----------- -------- -------- -------- 0-12 months $ 95,139 $ 84,341 $ 88,005 $ 4,911 $ 1,919 $274,315 1-5 years 19,101 22,879 48,514 11,942 847 103,283 Over 5 years 1,905 3,752 3,093 127 40 8,917 -------- -------- -------- -------- -------- -------- Total $116,145 $110,972 $139,612 $ 16,980 $ 2,806 $386,515 ======== ======== ======== ======== ======== ========
Maturing Fixed Rate Adjustable Rate Total -------- ---------- --------------- -------- 0-12 months $110,010 $164,305 $274,315 1-5 years 101,422 1,861 103,283 Over 5 years 8,917 0 8,917 -------- -------- -------- Total $220,349 $166,166 $386,515 -------- ======== ========
The Bank's policy is to make the majority of its loan commitments in the market area it serves. This tends to reduce risk because management is familiar with the credit histories of loan applicants and has an in-depth knowledge of the risk to which a given credit is subject. The Bank had no foreign loans in its portfolio as of December 31, 2004. It is the policy of the Bank to place a loan on nonaccrual status whenever there is substantial doubt about the ability of a borrower to pay principal or interest on any outstanding credit. Management considers such factors as payment history, the nature and value of collateral securing the loan and the overall economic situation of the borrower when making a nonaccrual decision. Nonaccrual loans are closely monitored by management. A nonaccrual loan is restored to current status when the prospects of future contractual payments are no longer in doubt. Nonaccrual loans at December 31, 2004 and 2003 were $2.6 million and $3.3 million, respectively. The fluctuation in the level of nonaccrual loans over the past five years is attributed mainly to isolated credit deterioration in a few larger account relationships. These included consumer loans, commercial loans, agricultural loans and residential real estate loans. However, no trend in economic, industrial, geographical or other factors could be identified to account for the fluctuations in the level of nonaccrual loans. Accruing loans 90 days or more past due include loans that are both well secured and in the process of collection. Table 9 RISK ELEMENTS OF LOAN PORTFOLIO (IN THOUSANDS) DECEMBER 31,
2004 2003 2002 2001 2000 ------ ------ ------ ------ ------ Nonaccrual loans $2,603 $3,272 $1,801 $2,312 $1,765 Accruing loans past due 90 days or more 452 6 2 529 419 ------ ------ ------ ------ ------ Total nonperforming loans $3,055 $3,278 $1,803 $2,841 $2,184 Nonperforming loans as a percent of loans 0.79% 0.88% 0.52% 0.87% 0.67% Ratio of the allowance for loan losses to nonperforming loans 125% 122% 187% 96% 175%
Total nonperforming loans at December 31, 2004 were $3.1 million, a decrease of $0.2 million from $3.3 million at December 31, 2003. Management maintains a listing of potential problem loans. The decision of management to place loans in this category does not necessarily indicate that the Bank expects losses to occur, but that management recognizes that a higher degree of risk is associated with these performing loans. The loans that have been reported as potential problem loans are not concentrated in a particular industry, but rather cover a diverse range of businesses. Management does not presently expect significant losses from credits in the potential problem loan category. Deposits The following table represents maturities of time deposits in denominations of $100,000 or more for the years ended December 31, 2004 and 2003. Table 10 MATURITY OF TIME DEPOSITS $100,000 OR MORE (IN THOUSANDS) FOR THE YEARS ENDED DECEMBER 31,
2004 2003 ------- ------- 3 months or less $ 9,352 $10,033 3 - 6 months 11,628 11,558 6 - 12 months 15,407 15,644 Over 12 months 15,421 11,297 ------- ------- TOTAL $51,808 $48,532 ======= =======
Borrowings FHLB advances increased from $30.0 million at December 31, 2003 to $40.0 million at December 31, 2004, an increase of $10.0 million or 33.0%. FHLB advances are subject to a prepayment penalty if they are repaid prior to maturity. FHLB advances are callable either six months or one year after origination and quarterly thereafter. Promissory notes to former shareholders of the Insurance Center at 9% maturing July 1, 2008 totaled $280,000 at December 31, 2004. Contractual Obligations The following table represents the maturities of Long-Term Obligations and Operating Lease Obligations as of December 31, 2004. PAYMENTS DUE BY PERIOD AS OF 12/31/2004
Less than 1-3 3-5 More than Total 1 year years years 5 years Long-Term Debt Obligations FHLB Borrowings $ 40,000 $ 25,000 $ - $ - $ 15,000 Other Obligations $ 2,280 $ 2,000 $ - $ 280 $ - --------- --------- --------- --------- --------- Total Long-Term Obligations $ 42,280 $ 27,000 $ - $ 280 $ 15,000 Operating Lease Obligations Branch office lease $ 231 $ - $ 231 $ - $ - --------- --------- --------- --------- --------- Total Operating Lease Obligations $ 231 $ - $ 231 $ - $ - --------- --------- --------- --------- --------- Total Contractual Obligations $ 42,511 $ 27,000 $ 231 $ 280 $ 15,000 ========= ========= ========= ========= =========
Other Obligations include primarily Treasury Tax and Loan borrowings. Off-Balance Sheet Arrangements The Corporation has become a party to financial instruments with off-balance sheet risk in the normal course of its business in order to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. Off-balance sheet financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the Statement of Financial Condition. In the event of non-performance by the other party to a financial instrument, the Corporation's exposure to credit loss is represented by the contractual amount of the instrument. The Corporation uses the same credit policies in granting commitments and letters of credit as it does for on-balance sheet financial instruments. See Note 17 of the consolidated financial statements for specifics on the Corporation's off-balance sheet arrangements. Liquidity Management Liquidity management describes the ability of the Bank to access funding sources at a minimum cost to meet fluctuating deposit, withdrawal, and loan demand needs and to fund current and planned expenditures. The Bank maintains its asset liquidity position internally through short-term investments, the maturity distribution of the investment portfolio, loan repayments and income from interest earning assets. A substantial portion of the investment portfolio contains readily marketable securities that could be converted to cash immediately. Refer to Note 2 in the Consolidated Financial Statements for a table showing the maturity distribution of the Bank's securities portfolio and the related estimated fair value. On the liability side of the balance sheet, liquidity is affected by the timing of maturing liabilities and the ability to generate new deposits or borrowings as needed. Other sources are available through borrowings from the Federal Reserve Bank, the Federal Home Loan Bank and from lines of credit approved at correspondent banks. Management knows of no trend or event that will have a material impact on the Bank's ability to maintain liquidity at satisfactory levels. Capital Resources and Adequacy Total shareholders' equity increased $5.7 million or 9.5% in 2004 to $65.9 million at the end of the year from $60.2 million at December 31, 2003. Net income of $7.9 million less other comprehensive loss of $0.6 million and $1.6 million in dividends paid contributed to this increase. One measure of capital adequacy is the leverage ratio which is calculated by dividing average total assets for the most recent quarter into Tier 1 capital. The regulatory minimum for this ratio is 4.0%. The Bank's leverage ratio for the years ended December 31, 2004, 2003, and 2002 was 8.9%, 8.4%, and 7.5%, respectively. The Corporation's leverage ratio for the years ended December 31, 2004, 2003 and 2002 was 8.9%, 8.6% and 7.7%, respectively. Banks and bank holding companies are also required to maintain a ratio of Tier 1 capital to risk-weighted assets of at least 4.0%. The Bank's Tier 1 capital (to risk-weighted assets) ratio for the years ended December 31, 2004, 2003, and 2002 was 12.8%, 12.0%, and 11.1% respectively. The Corporation's Tier 1 capital (to risk-weighted assets) ratio for the years ended December 31, 2004, 2003 and 2002 was 12.8%, 12.3% and 11.4%, respectively. Another measure of capital adequacy is the risk-based capital ratio or the ratio of total capital to risk-adjusted assets. Total capital is composed of both core capital (Tier 1) and supplemental capital (Tier 2) including adjustments for off balance sheet items such as letters of credit and taking into account the different degrees of risk among various assets. Regulators require a minimum total risk-based capital ratio of 8.0%. The Bank's ratio at December 31, 2004, and for each of the two preceding years was 13.7%, 13.1%, and 12.0%, respectively. The Corporation's total capital ratio (to risk-weighted assets) was 13.7%, 13.3% and 12.3% for the years ended December 31, 2004, 2003 and 2002, respectively. According to FDIC capital guidelines, the Bank is considered to be "well capitalized" as of December 31, 2004. Management knows of no other trend or event which will have a material impact on capital. Please also refer to Note 14 in the Consolidated Financial Statements for additional discussion of regulatory matters. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Corporation's primary exposure to market risk relates to changes in interest rates, exchange rates, commodity prices, and other relevant market rate or price risk through our banking operations. The Bank monitors interest rate factors on a monthly basis to assess interest rate risk of the portfolio of assets and liabilities. Maturity terms of assets are matched to the maturity terms of liabilities to the extent possible. The maturity structure of the municipal securities, however, is long term to optimize tax advantages and yield returns within an acceptable level of market risk. In addition, based on prior experience, the average life of the mortgage backed securities has been shorter than the scheduled maturities. There are no interest rate caps or floors on variable rate instruments that could affect the cash flows on those instruments. Variable rate loans, investments and deposits reprice immediately because they are related to changes in the prime rate of interest. Fixed rate commercial loans reprice at least annually. Fixed rate real estate loans are scheduled for 1 to 2 year terms with balloon payments. Loans do not have prepayment penalty clauses. The following table also assumes all loans and deposits will be renewed under the same terms. Interest rates on those renewals are based on anticipated rates at the date of renewal. There is a 20% prepayment assumption for the entire loan portfolio based on historical trends. Interest Rate Risk In order to measure earnings sensitivity to changing rates, the Corporation uses three different measurement tools: static gap analysis, simulation of earnings, and economic value of equity. The static gap analysis starts with contractual repricing information for assets, liabilities, and off-balance sheet instruments. These items are then combined with repricing estimations for administered rate (interest-bearing demand deposits, savings, and money market accounts) and non-rate related products (demand deposit accounts, other assets, and other liabilities) to create a baseline repricing balance sheet. In addition to the contractual information, residential mortgage whole loan products and mortgage-backed securities are adjusted based on industry estimates of prepayment speeds that capture the expected prepayment of principal above the contractual amount based on how far away the contractual coupon is from market coupon rates. The following table represents the Corporation's consolidated static gap position as of December 31, 2003. Table 11: Interest Rate Sensitivity Analysis
December 31, 2004 ------------------------------------------------ Interest Rate Sensitivity Period 0-12 1-5 Over 5 Months Years Years Total -------- --------- ------- -------- Interest Earnings Assets: Investment securities, at fair value 13,924 77,306 65,439 156,669 Loans 274,315 103,283 8,917 386,515 Other earning assets 20,901 - - 20,901 -------- --------- ------- -------- Total Earning Assets 309,140 180,589 74,356 564,085 ======== ========= ======= ======== Interest Bearing Liabilities: Deposits(Interest and Non-Interest Bearing)* 162,544 282,974 268 445,786 Other borrowings 27,000 280 15,000 42,280 Securities sold under repurchase agreements 61,620 - - 61,620 -------- --------- ------- -------- Total Interest Bearing Liabilities 251,164 283,254 15,268 549,686 ======== ========= ======= ======== Interest Sensitivity Gap 57,976 (102,665) 59,088 14,399 Cumulative Interest Sensitivity Gap 57,976 (44,689) 14,399 12 month cumulative gap as a percentage of earning assets at December 31, 2004 18.75% ========
*Based on historical evidence 90% of non-interest bearing deposits have a 1-5 year life while 10% have a 0-12 month life. (1) The interest rate sensitivity assumptions for demand deposits, savings accounts, money market accounts, and interest-bearing demand deposit accounts are based on current and historical experiences regarding portfolio retention and interest rate repricing behavior. Based on these experiences, a portion of these balances are considered to be long-term and fairly stable and are therefore included in the "1 - 5 year" category. The static gap analysis in Table 11 provides a representation of the Corporation's earnings sensitivity to changes in interest rates. It is a static indicator that does not reflect various repricing characteristics and may not necessarily indicate the sensitivity of net interest income in a changing interest rate environment. At the end of 2004, the Corporation's assets were repricing faster than liabilities. In the 1 - 5 year category, liabilities are repricing faster than assets. The Corporation cannot predict interest rates with certainty. Rates will change based on market conditions. However, the Corporation believes there is a higher likelihood that rates will increase rather than decrease so the Corporation prefers to be more asset sensitive than liability sensitive. In the event rates would decrease, the Corporation could reduce its income expense by raising liabilities at a slower pace. Interest rate risk of embedded positions (including prepayment and early withdrawal options, lagged interest rate changes, administered interest rate products, and cap and floor options within products) require a more dynamic measuring tool to capture earnings risk. Earnings simulation and economic value of equity are used to more completely assess interest rate risk. Along with the static gap analysis, determining the sensitivity of short-term future earnings to a hypothetical plus or minus 100, 200, and 300 basis point parallel rate shock can be accomplished through the use of simulation modeling. In addition to the assumptions used to create the static gap, simulation of earnings includes the modeling of the balance sheet as an ongoing entity. Future business assumptions involving administered rate products, prepayments for future rate-sensitive balances, and the reinvestment of maturing assets and liabilities are included. These items are then modeled to project net interest income based on a hypothetical change in interest rates. The resulting net interest income for the next 12-month period is compared to the net interest income amount calculated using the flat rates. This difference represents the Corporation's earnings sensitivity to a plus or minus 100 basis point parallel rate shock. The resulting simulations for December 31, 2004, projected that net interest income would decrease by approximately 0.2% of budgeted net interest income if rates rose by a 100 basis point shock, and projected that the net interest income would decrease by approximately 2.5% if rates fell by a 100 basis point shock. Economic value of equity is another tool used to measure the impact of interest rates on the present value of assets, liabilities and off-balance sheet financial instruments. This measurement is a longer-term analysis of interest rate risk as it evaluates every cash flow produced by the current balance sheet. The projected changes for earnings simulation and economic value of equity for 2004 were within the Corporation's interest rate risk policy. The results of the 2004 modeling mirrored the other interest rate risk tests discussed above, as the Corporation maintained a relatively neutral position at December 31, 2004. These results are based solely on immediate and sustained parallel changes in market rates and do not reflect the earnings sensitivity that may arise from other factors. These factors may include changes in the shape of the yield curve, the change in spread between key market rates, or accounting recognition of the impairment of certain intangibles. The above results are also considered to be conservative estimates due to the fact that no management actions to mitigate potential income variances are included within the simulation process. This action could include, but would not be limited to, delaying an increase in deposit rates, extending liabilities, changing the pricing characteristics of loans, or changing the growth rate of certain assets and liabilities. Item 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA [WIPFLI LLP LOGO] Report of Independent Registered Public Accounting Firm Board of Directors and Stockholders First Manitowoc Bancorp, Inc. Manitowoc, Wisconsin We have audited the accompanying consolidated balance sheets of First Manitowoc Bancorp, Inc. and Subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2004. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Manitowoc Bancorp, Inc. and Subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of First Manitowoc Bancorp, Inc. and Subsidiaries' internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated January 21, 2005, expressed an unqualified opinion on management's assessment of internal control over financial reporting and an unqualified opinion on the effectiveness of internal control over financial reporting. /s/ Wipfli LLP Wipfli LLP January 21, 2005 Green Bay, Wisconsin [WIPFLI LLP LOGO] Report of Independent Registered Public Accounting Firm Board of Directors and Stockholders First Manitowoc Bancorp, Inc. Manitowoc, Wisconsin We have audited management's assessment, included in the accompanying Report of Management, that First Manitowoc Bancorp, Inc. and Subsidiaries maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management has informed us that the scope of its assessment includes financial reporting presented in conformity with both generally accepted accounting principles and Federal Financial Institutions Examination Council Instructions for Consolidated Reports of Condition and Income (call report instructions). First Manitowoc Bancorp, Inc. and Subsidiaries' management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Corporation's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that First Manitowoc Bancorp, Inc. and Subsidiaries maintained effective internal control over financial reporting presented in conformity with generally accepted accounting principles and call report instructions as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, First Manitowoc Bancorp, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of First Manitowoc Bancorp, Inc. and Subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated January 21, 2005, expressed an unqualified opinion. /s/ Wipfli LLP Wipfli LLP January 21, 2005 Green Bay, Wisconsin FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Consolidated Balance Sheets
December 31 ----------------------- 2004 2003 --------- --------- (In Thousands) Assets Cash and due from banks $ 13,179 $ 16,355 Interest-bearing deposits 5,345 7,979 Federal funds sold 21,349 11,433 --------- --------- Cash and cash equivalents 39,873 35,767 Securities available for sale, at fair value 156,669 138,275 Other investments (at cost) 5,340 5,052 Loans, net 382,691 367,126 Premises and equipment, net 8,778 8,608 Goodwill 8,973 8,968 Intangible assets 1,936 2,117 Cash surrender value of life insurance 11,673 11,244 Other assets 6,242 4,796 --------- --------- TOTAL ASSETS $ 622,175 $ 581,953 ========= ========= Liabilities and Stockholders' Equity Deposits $ 445,786 $ 428,284 Securities sold under repurchase agreements 61,620 55,359 Borrowed funds 42,280 31,910 Other liabilities 6,616 6,177 --------- --------- Total liabilities 556,302 521,730 --------- --------- Stockholders' equity: Common stock - $1 par value: Authorized - 10,000,000 shares Issued - 7,583,628 shares 7,584 7,584 Retained earnings 56,866 50,560 Accumulated other comprehensive income 2,123 2,779 Treasury stock, at cost - 646,360 shares in 2004 and 2003 (700) (700) --------- --------- Total stockholders' equity 65,873 60,223 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 622,175 $ 581,953 ========= =========
See accompanying notes to consolidated financial statements. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Income
Years Ended December 31 ----------------------- 2004 2003 2002 ------- ------- ------- (In Thousands, Except per Share Amounts) Interest income: Loans, including fees $21,760 $21,608 $23,847 Federal funds sold 221 304 336 Securities: Taxable 2,704 2,123 3,596 Tax-exempt 3,357 3,154 3,032 ------- ------- ------- Total interest income 28,042 27,189 30,811 ------- ------- ------- Interest expense: Deposits 6,431 7,076 8,885 Securities sold under repurchase agreements 1,202 1,250 1,310 Borrowed funds 1,163 1,357 1,783 ------- ------- ------- Total interest expense 8,796 9,683 11,978 ------- ------- ------- Net interest income 19,246 17,506 18,833 Provision for loan losses 450 1,250 1,950 ------- ------- ------- Net interest income after provision for loan losses 18,796 16,256 16,883 ------- ------- ------- Other income: Trust service fees 568 533 548 Service charges 1,494 1,819 1,564 Insurance Center commissions 2,175 1,781 1,772 Loan servicing income 489 784 839 Income on equity investment 402 369 378 Gain on sales of mortgage loans 232 1,851 868 Gain on sales of securities 43 - - Other 1,091 750 616 ------- ------- ------- Total other income 6,494 7,887 6,585 ------- ------- ------- Other expenses: Salaries, commissions, and employee benefits 8,956 8,478 8,242 Occupancy 1,659 1,752 1,932 Data processing 1,091 1,059 1,176 Postage, stationery, and supplies 491 589 508 Advertising 314 355 425 Outside service fees 815 478 497 Loss on sales of other real estate 58 - - Amortization of intangibles 224 274 303 Other 1,374 1,448 1,459 ------- ------- ------- Total other expenses 14,982 14,433 14,542 ------- ------- ------- Income before provision for income taxes 10,308 9,710 8,926 Provision for income taxes 2,406 2,081 1,837 ------- ------- ------- Net income $ 7,902 $ 7,629 $ 7,089 ======= ======= ======= Earnings per share - Basic and diluted $ 1.14 $ 1.10 $ 1.02 ======= ======= =======
See accompanying notes to consolidated financial statements. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity
Years Ended December 31, 2004, 2003, and 2002 --------------------------------------------------- Accumulated Other Common Retained Comprehensive Treasury Stock Earnings Income Stock Total ------- -------- ------------- -------- ------- (In Thousands) Balance, January 1, 2002 $ 7,584 $ 38,563 $1,042 ($ 700) $46,489 Comprehensive income: Net income 7,089 7,089 Other comprehensive income 1,971 1,971 ------- Total comprehensive income 9,060 Cash dividends ($0.18 per share) (1,265) (1,265) -------- ------- Balance, December 31, 2002 7,584 44,387 3,013 (700) 54,284 Comprehensive income: Net income 7,629 7,629 Other comprehensive loss (234) (234) ------- Total comprehensive income 7,395 Cash dividends ($0.21 per share) (1,456) (1,456) -------- ------- Balance, December 31, 2003 7,584 50,560 2,779 (700) 60,223 Comprehensive income: Net income 7,902 7,902 Other comprehensive loss (656) (656) ------- Total comprehensive income 7,246 Cash dividends ($0.23 per share) (1,596) (1,596) ------- -------- ------ ------ ------- Balance, December 31, 2004 $ 7,584 $ 56,866 $2,123 ($ 700) $65,873 ======= ======== ====== ====== =======
See accompanying notes to consolidated financial statements. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows
Years Ended December 31 ------------------------------------ 2004 2003 2002 -------- --------- --------- (In Thousands) Cash flows from operating activities: Net income $ 7,902 $ 7,629 $ 7,089 -------- --------- --------- Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 450 1,250 1,950 Depreciation and amortization of premises and equipment 723 736 946 Amortization of intangibles 224 274 303 Net amortization of securities 802 1,017 421 Stock dividends on FHLB stock (288) (194) (122) Proceeds from sales of mortgage loans 49,519 135,251 115,951 Originations of mortgage loans held for sale (49,287) (133,400) (114,872) Gain on sales of mortgage loans (232) (1,851) (868) Gain on sale of fixed assets - (1) (2) Realized gain on sale of securities available for sale (43) - - Undistributed income of joint venture (402) (369) (378) Net earnings on life insurance (429) (434) (259) (Increase) decrease in other assets (1,386) 305 1,217 Increase (decrease) in other liabilities 439 (228) (31) -------- --------- --------- Total adjustments 90 2,356 4,256 -------- --------- --------- Net cash provided by operating activities 7,992 9,985 11,345 -------- --------- --------- Cash flows from investing activities: Activity in securities available for sale: Sales 24,334 - - Maturities, prepayments, and calls 45,051 61,169 32,417 Purchases (89,566) (65,105) (39,012) Purchase of other investments - (2,000) (103) Net increase in loans (15,264) (27,657) (17,765) Acquisition of insurance agency (85) - - Purchases of premises and equipment (893) (701) (305) Proceeds from sale of assets - 11 139 Purchase of life insurance - (5,000) - -------- --------- --------- Net cash used in investing activities (36,423) (39,283) (24,629) -------- --------- ---------
FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (Continued)
Years Ended December 31 ---------------------------------- 2004 2003 2002 -------- -------- -------- (In Thousands) Cash flows from financing activities: Net increase in deposits $ 17,502 $ 12,185 $ 22,007 Net increase in securities sold under repurchase agreements 6,261 4,475 17,776 Proceeds from advances of borrowed funds 27,000 - 21,747 Repayment of borrowed funds (16,630) (6,228) (30,788) Dividends paid (1,596) (1,456) (1,265) -------- -------- -------- Net cash provided by financing activities 32,537 8,976 29,477 -------- -------- -------- Net increase (decrease) in cash and cash equivalents 4,106 (20,322) 16,193 Cash and cash equivalents at beginning 35,767 56,089 39,896 -------- -------- -------- Cash and cash equivalents at end $ 39,873 $ 35,767 $ 56,089 ======== ======== ======== Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 8,701 $ 10,165 $ 11,321 Income taxes 2,191 1,799 1,634 Supplemental schedule of noncash activities: Loans transferred to foreclosed properties $ 751 $ - $ - Investments reclassified as loans - - 201
See accompanying notes to consolidated financial statements. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 1 Summary of Significant Accounting Policies The accounting and reporting policies of First Manitowoc Bancorp, Inc. and Subsidiaries (the "Corporation") conform to generally accepted accounting principles and general practices within the financial institution industry. Significant accounting and reporting policies are summarized below. Principles of Consolidation - The accompanying consolidated financial statements include the accounts of First Manitowoc Bancorp, Inc., its wholly owned subsidiary, First National Bank in Manitowoc (the "Bank"), and the Bank's wholly owned subsidiaries, FNBM Investment Corp. and Insurance Center of Manitowoc, Inc. (the "Insurance Center"). All significant intercompany balances and transactions have been eliminated. Investment in United Financial Services, Inc., the Bank's 49.8% owned subsidiary, is accounted for on the equity method. Business - The Corporation provides a full range of financial services to individual and corporate customers in Northeastern Wisconsin through the Bank. The Corporation is subject to competition from other traditional and nontraditional financial institutions and is also subject to the regulations of certain federal agencies and undergoes periodic examinations by those regulatory authorities. Use of Estimates in Preparation of Financial Statements - The preparation of the accompanying consolidated financial statements of the Corporation in conformity with generally accepted accounting principles requires management to make estimates and assumptions that directly affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates. Cash and Cash Equivalents - For purposes of reporting cash flows, cash and cash equivalents include cash on hand, due from banks, interest-bearing deposits, and federal funds sold. Generally, federal funds are purchased and sold for one-day periods. The Bank is required to maintain non-interest-bearing deposits on hand or with the Federal Reserve Bank. At December 31, 2004, those required reserves of $1,929,000 were satisfied by currency and coin holdings. In the normal course of business, the Corporation maintains cash and due from bank balances with correspondent banks. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $100,000. Total uninsured balances at December 31, 2004, were approximately $9,807,000. Investment Securities - The Corporation's securities are classified and accounted for as securities available for sale. Available-for-sale securities are stated at fair value with the unrealized gains and losses, net of tax, reported as accumulated other comprehensive income (loss) within stockholders' equity until realized. Interest and dividends are included in interest income from securities as earned. Premiums are recognized in interest income using the interest method over the period to the call date. Discounts are recognized in interest income using the interest method over the period to maturity. Realized gains and losses and declines in value judged to be other than temporary are included in net gains and losses from sales of investment and mortgage-related securities. Declines in fair value of securities that are deemed to be other than temporary, if applicable, are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers the length of time and the extent to which fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The cost of securities sold is based on the specific-identification method. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 1 Summary of Significant Accounting Policies (Continued) Fair values of many securities are estimates based on financial methods or prices paid for similar securities. It is possible interest rates could change considerably resulting in a material change in the estimated fair value. Other Investments - Other investments are carried at cost and consist of Federal Home Loan Bank stock, Federal Reserve stock, Bankers Bancorporation stock, and preferred stock in a community development project. Other investments are evaluated for impairment on an annual basis. Loans Held for Sale - Loans held for sale consist of the current origination of certain fixed-rate mortgage loans which are recorded at the lower of aggregate cost or fair value. A gain or loss is recognized at the time of the sale reflecting the present value of the difference between the contractual interest rate of the loans sold and the yield to the investor, adjusted for the initial value of mortgage servicing rights. Loans and Related Interest Income - Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff generally are reported at their outstanding unpaid principal balances adjusted for charge-offs and the allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding and is recognized in the period earned. Loan-origination fees are credited to income when received and the related loan-origination costs are expensed as incurred. Capitalization of the fees net of the related costs would not have a material effect on the consolidated financial statements. Interest on loans is accrued and credited to income as earned. Accrual of interest is generally discontinued either when reasonable doubt exists as to the full, timely collection of interest or principal or generally when a loan becomes contractually past due by 90 days or more with respect to interest or principal. At that time, any accrued but uncollected interest is reversed and additional income is recorded only to the extent that payments are received and the collection of principal is reasonably assured. Loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectibility of the total contractual principal and interest is reasonably assured. Allowance for Loan Losses - The allowance for loan losses is provided for based on past experience and prevailing market conditions. Management's evaluation of loss considers various factors including, but not limited to, general economic conditions, loan portfolio composition, and prior loss experience. This evaluation is inherently subjective since it requires material estimates that may be susceptible to significant change. Loans are charged against the allowance for loan losses when management believes the collectibility of the principal is unlikely. In addition, various regulatory agencies periodically review the allowance for loan losses. These agencies may require additions to the allowance for loan losses based on their judgments of collectibility. The Corporation considers loans secured by one- to four-unit residential properties and all consumer loans to be large groups of smaller-balance homogenous loans. These loans are collectively evaluated in the analysis of the adequacy of the allowance for loan losses. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 1 Summary of Significant Accounting Policies (Continued) The Corporation's commercial portfolio is subject to a loan-by-loan analysis of the adequacy of the allowance for loan losses and impairment. These loans are considered impaired when, based on current information, it is probable the Corporation will not collect all amounts due in accordance with the contractual terms of the loan agreement. The value of impaired loans is based on discounted cash flows of expected future payments using the loan's internal effective interest rate or the fair value of the collateral if the loan is collateral dependent. Interest income on impaired loans is recorded when cash is received and only if principal is considered to be fully collectible. In management's judgment, the allowance for loan losses is adequate to cover probable losses relating to specifically identified loans, as well as probable losses inherent in the balance of the loan portfolio. Mortgage Servicing Rights - The Corporation recognizes mortgage servicing rights on loans that are originated and subsequently sold or securitized and servicing is retained. A portion of the cost of the loans is allocated to the servicing rights based on the relative fair values of the loans and the servicing rights. The Corporation amortizes these mortgage servicing rights over the period of estimated net servicing revenue. Impairment of mortgage servicing rights is assessed based on the fair value of those rights. Fair values are estimated using discounted cash flows based on a current market interest rate. Premises and Equipment - Premises and equipment are stated at cost. Maintenance and repair costs are charged to expense as incurred. Gains or losses on disposition of premises and equipment are reflected in income. Depreciation is computed on the straight-line method and is based on the estimated useful lives of the assets. Foreclosed Properties - Foreclosed properties acquired by the Corporation through foreclosure or deed in lieu of foreclosure on loans for which the borrowers have defaulted as to the payment of principal and interest are initially recorded at the lower of the fair value of the asset, less the estimated costs to sell the asset, or the carrying value of the related loan balance. Costs relating to the development and improvement of the property are capitalized. Income and expenses incurred in connection with holding and operating the property are charged to expense. Valuations are periodically performed by management and third parties and a charge to expense is taken for the excess of the carrying value of a property over its fair value less costs to sell. Intangible Assets and Goodwill - Intangible assets consist of the value of core deposits purchased as part of the bank acquisitions, servicing assets, and trade name and customer base intangibles acquired in the acquisition of the Insurance Center. Intangible assets are stated at cost less accumulated amortization and are amortized over a period of one to ten years. Intangible assets that have finite useful lives are amortized using a straight-line method over their useful lives, and are tested at least annually for impairment. Intangible assets are considered impaired if the fair value of the intangible asset is lower than cost. The Corporation reviews intangible assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Adjustments are recorded if it is determined that the fair value of the intangible asset has decreased in comparison to the carrying amount. Goodwill is tested for impairment on an annual basis. The Corporation tested goodwill for impairment during the fourth quarter and determined that there was no impairment during 2004, 2003, and 2002. No amortization or impairment expense was recognized in 2004, 2003, or 2002. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 1 Summary of Significant Accounting Policies (Continued) Income Taxes - The Corporation files one consolidated federal income tax return. Federal income tax expense (credit) is allocated to each subsidiary based on an intercompany tax sharing agreement. The subsidiaries file separate state tax returns as applicable. Deferred income taxes have been provided under the liability method. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the current enacted tax rates which will be in effect when these differences are expected to reverse. Deferred tax expense (benefit) is the result of changes in the deferred tax asset and liability. Off-Balance-Sheet Financial Instruments - In the ordinary course of business, the Corporation has entered into off-balance-sheet financial instruments consisting of commitments to extend credit, commitments under commercial letters of credit, and standby letters of credit. Such financial instruments are recorded in the consolidated financial statements when they become payable. Rate Lock Commitments - The Corporation enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. Accordingly, such commitments, along with any related fees received from potential borrowers, are recorded at fair value as derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans. Fair value is based on fees currently charged to enter into similar agreements, and for fixed-rate commitments also considers the difference between current levels of interest rates and the committed rates. The notional amount of rate lock commitments at December 31, 2004, was $2,243,000. The fair value of these derivatives was immaterial to the financial statements. Advertising Costs - Advertising costs are expensed as incurred. Comprehensive Income - Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale, net of tax, which are recognized as a separate component of equity, accumulated other comprehensive income (loss). Per Share Computations - All per share financial information and equity accounts have been adjusted to reflect the 2-for-1 stock split declared in October 2002. Weighted average shares outstanding were 6,937,268 for the years ended December 31, 2004, 2003, and 2002. Reclassifications - Certain reclassifications have been made to the 2003 and 2002 consolidated financial statements to conform to the 2004 classifications. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 2 Securities Available for Sale The amortized cost and estimated fair value of securities available for sale are as follows:
Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Fair Value --------- ---------- ---------- ---------- (In Thousands) December 31, 2004 U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 2,974 $ - ($ 38) $ 2,936 Obligations of states and political subdivisions 80,160 3,695 (52) 83,803 Mortgage-backed securities 70,232 107 (510) 69,829 Corporate notes 100 1 - 101 -------- ---------- ---------- ---------- Total $153,466 $ 3,803 ($ 600) $ 156,669 ======== ========== ========== ========== December 31, 2003 U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 13,663 $ 14 ($ 84) $ 13,593 Obligations of states and political subdivisions 70,357 4,423 (37) 74,743 Mortgage-backed securities 49,924 233 (321) 49,836 Corporate notes 100 3 - 103 -------- ---------- ---------- ---------- Total $134,044 $ 4,673 ($ 442) $ 138,275 ======== ========== ========== ==========
FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 2 Securities Available for Sale (Continued) The amortized cost and estimated fair value of securities at December 31, 2004, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized Estimated Cost Fair Value --------- ---------- (In Thousands) Due in one year or less $ 3,165 $ 3,210 Due after one year through five years 17,435 18,190 Due after five years through ten years 40,932 42,894 Due after ten years 21,702 22,546 -------- --------- 83,234 86,840 Mortgage-backed securities 70,232 69,829 -------- --------- Total $153,466 $ 156,669 ======== =========
The following is a summary of the proceeds from sales of securities available for sale, as well as gross gains and losses from the years ended December 31:
Years Ended December 31 ----------------------- 2004 2003 2002 ------- ---- ----- (In Thousands) Proceeds from sales, maturities, and calls of securities $24,334 $ - $ - Gross gains on sales 94 - - Gross losses on sales 51 - -
The estimated fair value of investment securities available for sale pledged to secure public deposits, securities sold under repurchase agreements, FHLB advances, and for other purposes required by law were $82,427,000 and $70,825,000 as of December 31, 2004 and 2003, respectively. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 2 Securities Available for Sale (Continued) The following table shows the securities' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31:
Less Than 12 months 12 Months or More Total ---------------------- ----------------- ---------------------- Description Fair Unrealized Fair Unrealized Fair Unrealized of Securities Value Losses Value Losses Value Losses ---------------------------- -------- ---------- ----- ---------- -------- ---------- (In Thousands) 2004 U.S. Treasury securities and direct obligations of U.S. government agencies $ 2,936 $ 38 $ - $ - $ 2,936 $ 38 Obligations of states and political subdivisions 6,661 52 - - 6,661 52 Mortgage-backed securities 46,524 510 - - 46,524 510 -------- -------- ---- ------- -------- -------- Total temporarily impaired securities $ 56,121 $ 600 $ - $ - $ 56,121 $ 600 ======== ======== ==== ======= ======== ======== 2003 U.S. Treasury securities and direct obligations of U.S. government agencies $ 10,119 $ 84 $ - $ - $ 10,119 $ 84 Obligations of states and political subdivisions 3,796 37 - - 3,796 37 Mortgage-backed securities 25,395 321 - - 25,395 321 -------- -------- ---- ------- -------- -------- Total temporarily impaired securities $ 39,310 $ 442 $ - $ - $ 39,310 $ 442 ======== ======== ==== ======= ======== ========
At December 31, 2004, 75 debt securities have unrealized losses with aggregate depreciation of 1.0% from the Corporation's amortized cost basis. These unrealized losses related principally to the increase in interest rates and are not due to changes in the financial condition of the issuer. In analyzing an issuer's financial condition, management considers whether the securities are issued by a government body or agency, whether a rating agency has downgraded the securities, and industry analysts' reports. Since management has the ability to hold debt securities until maturity (or the foreseeable future for securities available for sale), no declines are deemed to be other than temporary. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 3 Loans The composition of loans at December 31 follows:
2004 2003 ----------- ----------- (In Thousands) Commercial and agricultural $ 116,145 $ 110,884 Commercial real estate 110,972 109,469 Residential real estate 139,612 129,212 Consumer 16,980 18,301 Other 2,806 3,259 ----------- ----------- Subtotals 386,515 371,125 Allowance for loan losses (3,824) (3,999) ----------- ----------- Loans, net $ 382,691 $ 367,126 =========== ===========
An analysis of the allowance for loan losses for the years ended December 31 follows:
2004 2003 2002 --------- --------- --------- (In Thousands) Balance at beginning $ 3,999 $ 3,384 $ 2,737 Provision for loan losses 450 1,250 1,950 Loans charged off (795) (749) (1,578) Recoveries on loans 170 114 275 --------- --------- --------- Balance at end $ 3,824 $ 3,999 $ 3,384 ========= ========= =========
Information regarding impaired and nonperforming loans as of December 31 follows:
2004 2003 -------- -------- (In Thousands) As of December 31: Impaired loans for which an allowance has been provided $ 1,275 $ 2,398 Impaired loans for which no allowance has been provided 573 169 -------- -------- Total impaired loans $ 1,848 $ 2,567 ======== ======== Impairment reserve (included in allowance for loan losses) $ 542 $ 673 Total nonaccrual loans 2,603 3,272 Total loans past due 90 days or more and still accruing 452 6 For the years ended December 31: Average investment in impaired loans $ 2,039 $ 2,725 Interest income that would have been recognized on an accrual basis 287 419 Cash-basis interest income recognized 51 197
FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 3 Loans (Continued) The Bank, in the ordinary course of banking business, grants loans to the Corporation's executive officers and directors, including their immediate families and affiliated companies in which they are principal owners. Substantially all loans to officers, directors, and stockholders owning 5% or more of the Corporation were made on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others and did not involve more than the normal risk of collectibility or present other unfavorable features. Activity in such loans during 2004 is summarized below (in thousands): Loans outstanding, December 31, 2003 $ 12,640 New loans 37,997 Repayments (32,067) ---------- Loans outstanding, December 31, 2004 $ 18,570 ==========
Note 4 Loan Servicing Mortgage loans of $181,318,000 and $178,722,000 as of December 31, 2004 and 2003, respectively, were serviced for others. These loans are not included in the accompanying consolidated balance sheets. Mortgage servicing rights are capitalized when the serviced loans are sold. This asset is amortized over the estimated period that servicing income is recognized. The following is an analysis of changes in mortgage servicing rights:
2004 2003 2002 --------- --------- --------- (In Thousands) Balance, January 1 $ 1,789 $ 1,520 $ 1,094 Capitalized amounts 467 1,334 1,144 Amortization (500) (1,065) (718) --------- --------- --------- Balance, December 31 $ 1,756 $ 1,789 $ 1,520 ========= ========= =========
The carrying value of the mortgage servicing rights is included with intangible assets and approximates fair market value at December 31, 2004 and 2003. The fair value of mortgage servicing rights was determined using the present value of future cash flows method. No impairment of mortgage servicing rights existed at December 31, 2004 or 2003; therefore, no valuation allowance was recorded. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 5 Premises and Equipment Premises and equipment at December 31 consist of the following:
2004 2003 --------- --------- (In Thousands) Land $ 1,413 $ 1,413 Buildings and improvements 8,354 7,903 Furniture and equipment 5,548 5,106 --------- --------- Totals 15,315 14,422 Less - Accumulated depreciation and amortization 6,537 5,814 --------- --------- Net depreciated value $ 8,778 $ 8,608 ========= =========
Depreciation and amortization expense was $723,000, $736,000, and $946,000 for the years ended December 31, 2004, 2003, and 2002, respectively. Note 6 Investment in United Financial Services, Inc. The Bank owns 49.8% of United Financial Services, Inc. ("venture") whose business is developing and providing data processing services to the Bank and other financial institutions. The venture has total assets of $5,482,000 and liabilities of $426,000. The Bank's investment in the venture was $2,491,000 and $2,088,000 at December 31, 2004 and 2003, respectively. The investment is accounted for on the equity method and included in other assets. The Bank's earnings from its investment in the venture were approximately $402,000, $369,000, and $378,000 for the years ended December 31, 2004, 2003, and 2002, respectively. Data processing service fees paid by the Bank to the venture were approximately $781,000, $787,000, and $843,000 for the years ended December 31, 2004, 2003, and 2002, respectively. The Bank has a contract with the venture that extends through December 2005. At that time, the contract is automatically renewed for a period of one year. The Bank has the option to terminate the contract at any time, but would have incurred a termination penalty of approximately $469,000 at December 31, 2004. The termination penalty is calculated using the greater of 50% of the total estimated remaining unpaid monthly processing fees or six times the average monthly fee over the prior three months. A termination penalty is not incurred if the Bank provides 180 days' notice and continues processing up to the end of that period. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 7 Intangible Assets Intangible assets consist of the following at December 31:
Range of Lives (Years) 2004 2003 -------- -------- -------- (In Thousands) Core deposit premium 10.0 $ 1,509 $ 1,509 Trade name 5.0 377 376 Customer base 15.0 214 135 Servicing asset 7.0 68 72 -------- -------- -------- Subtotals 2,168 2,092 Less - Accumulated amortization 1,988 1,764 -------- -------- -------- Subtotals 180 328 Mortgage servicing rights - Net 5.0 1,756 1,789 -------- -------- -------- Totals $ 1,936 $ 2,117 ======== ========
Amortization expense for intangible assets, excluding servicing rights, was $224,000 in 2004, $274,000 in 2003, and $303,000 in 2002. The following table shows the estimated future amortization expense for amortizing intangible assets. The projections of amortization expense are based on existing asset balances as of December 31, 2004.
Trade Customer Servicing Name Base Asset ----- -------- --------- (In Thousands) 2005 $ 89 $ 5 $ 5 2006 1 5 3 2007 - 5 1 2008 - 5 2 2009 - 5 - Thereafter - 54 - ----- ----- ----- Total $ 90 $ 79 $ 11 ===== ===== =====
FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 8 Goodwill Changes in goodwill for the years ended December 31, 2004 and 2003, were as follows:
2004 2003 -------- -------- (In Thousands) Balance at beginning $ 8,968 $ 8,968 Goodwill acquired during the year 5 - -------- -------- Totals $ 8,973 $ 8,968 ======== ========
During 2004, the Corporation acquired the customer base of an insurance agency in Green Bay, Wisconsin. The purchase price included goodwill amounting to $5,000, a noncompete agreement amounting to $1,000, and an amount related to customer-based assets of $79,000. Additional contingent payments may be made to the seller, who was retained as an agent, based upon the retention of the customer base over a five-year period. The Corporation tested for impairment and determined that there was no impairment of goodwill during 2004. No amortization or impairment expense was recognized during 2004 or 2003. Note 9 Deposits The distribution of deposits at December 31 is as follows:
2004 2003 ---------- ---------- (In Thousands) Non-interest-bearing demand deposits $ 76,336 $ 71,195 Interest-bearing demand deposits 59,389 53,411 Savings deposits 116,765 116,786 Time deposits 193,296 186,892 ---------- ---------- Total deposits $ 445,786 $ 428,284 ========== ==========
Time deposits of $100,000 or more were approximately $51,808,000 and $48,532,000 at December 31, 2004 and 2003, respectively. Interest expense on time deposits of $100,000 or more was approximately $1,340,000, $1,505,000, and $1,978,000 for the years ended December 31, 2004, 2003, and 2002, respectively. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 9 Deposits (Continued) At December 31, 2004, the scheduled maturities of time deposits are as follows (in thousands): 2005 $ 137,295 2006 30,738 2007 14,320 2008 6,331 2009 4,344 Thereafter 268 ---------- Total $ 193,296 ==========
Deposit balances with the Corporation's executive officers, directors, and affiliated companies in which they are principal owners were $1,077,000 and $1,120,000 at December 31, 2004 and 2003, respectively. Note 10 Securities Sold Under Repurchase Agreements Securities sold under repurchase agreements have contractual maturities up to one year from the transaction date with variable and fixed-rate terms. The agreements to repurchase securities require that the Corporation (seller) repurchase identical securities as those that are sold. The securities underlying the agreements were under the Corporation's control. Information concerning securities sold under repurchase agreements consists of the following:
2004 2003 2002 --------- --------- --------- (Dollars in Thousands) Outstanding balance at the end of the year $ 61,620 $ 55,359 $ 50,884 Weighted average interest rate at the end of the year 2.52% 2.00% 2.58% Average balance during the year $ 55,992 $ 50,212 $ 46,895 Average interest rate during the year 2.15% 2.49% 2.79% Maximum month-end balance during the year $ 61,620 $ 55,359 $ 53,143
Securities sold under repurchase agreements with the Corporation's executive officers, directors, and affiliated companies in which they are principal owners were $3,715,000 and $3,493,000 at December 31, 2004 and 2003, respectively. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 11 Borrowed Funds Borrowed funds are summarized as follows at December 31:
2004 2003 -------- -------- (In Thousands) FHLB advance, 1.46%, due March 2005 $ 5,000 $ - FHLB advance, 1.24%, due March 2005 5,000 10,000 FHLB advance, 1.65%, due July 2005 15,000 5,000 FHLB advance, 4.55%, due January 2011 5,000 5,000 FHLB advance, 4.33%, due November 2011 10,000 10,000 Promissory notes to former stockholders of the Insurance Center, at 9%, maturing July 1, 2008 280 345 -------- -------- Subtotals 40,280 30,345 Treasury, tax, and loan account 2,000 1,565 -------- -------- Total borrowed funds $ 42,280 $ 31,910 ======== ========
The Corporation is a treasury, tax & loan (TT&L) depository for the Federal Reserve Bank and, as such, it accepts TT&L deposits. The Corporation is allowed to borrow these funds until they are called. The average rate paid on the TT&L account was 1.12% in 2004, 1.08% in 2003, and 1.46% in 2002. U.S. Agency Securities with a face value greater than or equal to the amount borrowed are pledged as a condition of borrowing TT&L deposits. FHLB advances are subject to a prepayment penalty if they are repaid prior to maturity. The FHLB advances are callable either six months or one year after origination and quarterly thereafter. The Corporation is required to maintain as collateral unencumbered first mortgage loans in its portfolio aggregating at least 167% of the amount of outstanding advances from the FHLB. Total loans pledged as collateral were approximately $104,776,000 and $105,892,000 at December 31, 2004 and 2003, respectively. The FHLB advances are also collateralized by $4,920,100 and $4,631,700 of FHLB stock owned by the Corporation and included in other investments at December 31, 2004 and 2003, respectively. This stock is recorded at cost, which approximates fair value. Transfer of the stock is substantially restricted. Scheduled maturities of borrowed funds outstanding other than TT&L at December 31, 2004, are as follows (in thousands): 2005 $ 25,070 2006 76 2007 84 2008 50 2009 - Thereafter 15,000 -------- Total $ 40,280 ========
FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 12 Income Taxes The provision for income taxes consists of the following for the years ended December 31:
2004 2003 2002 -------- -------- -------- (In Thousands) Current tax expense: Federal $ 1,900 $ 2,054 $ 1,671 State 284 16 19 -------- -------- -------- Total current 2,184 2,070 1,690 -------- -------- -------- Deferred tax expense (credit): Federal 80 (85) 107 State 142 96 40 -------- -------- -------- Total deferred 222 11 147 -------- -------- -------- Total provision for income taxes $ 2,406 $ 2,081 $ 1,837 ======== ======== ========
A summary of the source of differences between income taxes at the federal statutory rate and the provision for income taxes for the years ended December 31 follows:
2004 2003 2002 -------- -------- -------- (In Thousands) Tax expense at federal statutory rate $ 3,504 $ 3,301 $ 3,035 Increase (decrease) in taxes resulting from: Tax-exempt interest (1,179) (1,110) (1,071) State income taxes - Net of federal tax benefit 281 74 39 Cash surrender value of life insurance (146) (151) (88) Income of joint venture (137) (125) (128) Nondeductible intangible amortization 42 42 42 Other 41 50 8 -------- -------- -------- Total provision for income taxes $ 2,406 $ 2,081 $ 1,837 ======== ======== ========
FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 12 Income Taxes (Continued) Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Corporation's assets and liabilities. The major components of the net deferred tax liability at December 31 are as follows:
2004 2003 -------- -------- (In Thousands) Deferred tax assets: Deferred compensation $ 981 $ 896 Allowance for loan losses 1,499 1,476 Intangibles 85 120 Accrued vacation 140 133 State net operating loss carryforward - 136 Other 4 28 -------- -------- Total deferred tax assets 2,709 2,789 -------- -------- Deferred tax liabilities: Investment acquisition and discount accretion (90) (86) Mortgage servicing rights (689) (701) Depreciation (549) (514) Unrealized gain on securities available for sale (1,080) (1,452) FHLB stock dividends (365) (250) -------- -------- Total deferred tax liabilities (2,773) (3,003) -------- -------- Net deferred tax liability ($ 64) ($ 214) ======== ========
Note 13 Benefit Plans Effective January 1, 2002, the Corporation merged its defined contribution money purchase plan into its defined contribution profit sharing 401(k) plan, and effective January 1, 2003, the plan was amended to include provisions for an employee stock ownership plan (ESOP). All participants of the 401(k) plan are eligible for the ESOP. Shares are purchased on the open market as they become available. As of December 31, 2004, the plan held 637,927 shares. These shares are included in the calculation of the Corporation's earnings per share. The plan is available to all employees over 18 years of age after completion of six months of service. Employees participating in the plan may elect to defer a minimum of 2% of compensation up to the limits specified by law. The Corporation may make discretionary contributions up to the limits established by IRS regulations. The discretionary match was 35% of participant tax deferred contributions up to 10% in 2004, 2003, and 2002. The Corporation made additional discretionary contributions to the plan of $341,000, $333,000, and $323,000 in 2004, 2003, and 2002, respectively. All discretionary contributions are at the direction of the Board of Directors. Total expense associated with the plans was approximately $533,000, $508,000, and $487,000 in 2004, 2003, and 2002, respectively. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 13 Benefit Plans (Continued) The Corporation has a deferred compensation agreement with one of its officers. Under the terms of the agreement, benefits to be received in the future continue to vest each year until the officer reaches retirement age. The benefits are generally payable beginning with the date of termination of employment with the Corporation. The agreement initially required an annual payment of $80,600 over 15 years. The annual payment increases 5% for each year the officer remains employed with the Corporation from 2004 through 2008. Related expense for this agreement was approximately $32,000, $107,000, and $107,000 for the years ended December 31, 2004, 2003, and 2002, respectively. Included in other liabilities is the vested present value of future payments of approximately $675,000 and $643,000 at December 31, 2004 and 2003, respectively. The Corporation has a nonqualified deferred directors' fee plan which permits directors to defer a portion of their compensation. The benefits are generally payable beginning with the earlier of attaining age 70 or resignation from the Board of the Corporation. Included in other liabilities is the estimated present value of future payments of approximately $1,826,000 and $1,641,000 at December 31, 2004 and 2003, respectively. Expense associated with this plan was approximately $197,000, $210,000, and $200,000 in 2004, 2003, and 2002, respectively. Note 14 Stockholders' Equity The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Corporation's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Corporation's and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets and of Tier I capital to average assets. Management believes, as of December 31, 2004, that the Corporation and the Bank meet all capital adequacy requirements to which they are subject. As of December 31, 2004, the most recent notification from the regulatory agencies categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 14 Stockholders' Equity (Continued) The Corporation's and the Bank's actual and regulatory capital amounts and ratios are as follows:
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ---------------- ------------------------------ ------------------------------ Amount Ratio Amount Ratio Amount Ratio -------- ----- -------------- ---------- -------------- ----------- (Dollars in Thousands) December 31, 2004: Total capital (to risk-weighted assets): Consolidated $ 58,335 13.9% > or = $33,540 > or = 8.0% N/A First National Bank in Manitowoc $ 57,092 13.7% > or = $33,460 > or = 8.0% > or = $41,825 > or = 10.0% Tier I capital (to risk-weighted assets): Consolidated $ 54,511 13.0% > or = $16,770 > or = 4.0% N/A First National Bank in Manitowoc $ 53,268 12.8% > or = $16,730 > or = 4.0% > or = $25,095 > or = 6.0% Tier I capital (to average assets): Consolidated $ 54,511 9.1% > or = $24,050 > or = 4.0% N/A First National Bank in Manitowoc $ 53,268 8.9% > or = $24,009 > or = 4.0% > or = $30,012 > or = 5.0% December 31, 2003: Total capital (to risk-weighted assets): Consolidated $ 51,982 13.3% > or = $31,224 > or = 8.0% N/A First National Bank in Manitowoc $ 50,886 13.1% > or = $31,140 > or = 8.0% > or = $38,924 > or = 10.0% Tier I capital (to risk-weighted assets): Consolidated $ 47,983 12.3% > or = $15,610 > or = 4.0% N/A First National Bank in Manitowoc $ 46,887 12.0% > or = $15,570 > or = 4.0% > or = $23,355 > or = 6.0% Tier I capital (to average assets): Consolidated $ 47,983 8.6% > or = $22,357 > or = 4.0% N/A First National Bank in Manitowoc $ 46,887 8.4% > or = $22,314 > or = 4.0% > or = $27,893 > or = 5.0%
The Bank, as a national bank, is subject to the dividend restrictions set forth by the Office of the Comptroller of the Currency. Under such restrictions, the Bank may not, without the prior approval of the Office of the Comptroller of the Currency, declare dividends in excess of the sum of the current year's earnings (as defined) plus the retained earnings (as defined) from the prior two years. The dividends the Bank could declare without the prior approval of the Office of the Comptroller of the Currency as of December 31, 2004, totaled approximately $19,909,000. The payment of dividends may be further limited by the need for the Corporation and the Bank to maintain capital ratios satisfactory to applicable regulatory agencies. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 15 Accumulated Other Comprehensive Income Comprehensive income is shown in the consolidated statements of stockholders' equity. The Corporation's accumulated other comprehensive income is comprised of the unrealized gain or loss on securities available for sale. The following shows the activity in accumulated other comprehensive income:
2004 2003 2002 -------- -------- -------- (In Thousands) Accumulated other comprehensive income at beginning $ 2,779 $ 3,013 $ 1,042 -------- -------- -------- Activity: Unrealized gain (loss) on securities available for sale (1,071) (391) 3,020 Reclassification adjustments for gains realized in income 43 - - -------- -------- -------- Subtotals (1,028) (391) 3,020 Tax impact 372 157 (1,049) -------- -------- -------- Other comprehensive income (loss) (656) (234) 1,971 -------- -------- -------- Accumulated other comprehensive income at end $ 2,123 $ 2,779 $ 3,013 ======== ======== ========
Note 16 Segment Information First Manitowoc Bancorp, Inc., through a branch network of its subsidiary, First National Bank in Manitowoc, provides a full range of consumer and commercial financial institution services to individuals and businesses in Northeastern Wisconsin. These services include credit cards; secured and unsecured consumer, commercial, and real estate loans; demand, time, and savings deposits; ATM processing; insurance services; and trust services. The Corporation also offers a full line of insurance services through the Insurance Center. While the Corporation's chief decision makers monitor the revenue streams of various Corporation products and services, operations are managed and financial performance is evaluated on a Corporation-wide basis. Accordingly, all of the Corporation's financial institution operations are considered by management to be aggregated in one reportable operating segment. Note 17 Commitments and Contingencies The Corporation is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist of commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts reflect the extent of involvement the Corporation has in the particular class of financial instrument. The Corporation's maximum exposure to credit loss for commitments to extend credit is represented by the contract amount of those instruments. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 17 Commitments and Contingencies (Continued) Off-balance-sheet financial instruments whose contract amounts represent credit and/or interest rate risk at December 31 are as follows:
Notional Amount ------------------- 2004 2003 -------- -------- (In Thousands) Commitments to extend credit: Fixed $ 68,322 $ 75,134 Variable 11,460 - Credit card arrangements 6,295 2,510 Standby letters of credit 6,653 5,826
Commitments to extend credit and credit card arrangements are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. A portion of the commitments are expected to be drawn upon, thus representing future cash requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable; inventory; property, plant, and equipment; real estate; and stocks and bonds. Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation holds collateral supporting those commitments for which collateral is deemed necessary. Because these instruments have fixed maturity dates and because many of them expire without being drawn upon, they do not generally present any significant liquidity risk to the Corporation. The Corporation has no investments in nor is a party to transactions involving derivative instruments, except mortgage-related securities which represent minimal risk to the Corporation. The Bank has a non-Wisconsin subsidiary that holds and manages investment assets which have not been subject to Wisconsin tax. Over the past year, the Wisconsin Department of Revenue (WDOR) has conducted an audit of the subsidiary. Subsequent to the balance sheet date, the Corporation has reached a tentative settlement with the WDOR. The terms of the settlement are confidential. The amount was appropriately reserved for as of the balance sheet date. Legal Contingencies - Various legal claims arise from time to time in the normal course of business. In the opinion of management, any liability resulting from such proceedings would not have a material impact on the consolidated financial statements. Concentrations of Credit Risk - The majority of the Corporation's loans, commitments, and standby letters of credit have been granted to customers in the Corporation's market area. The concentrations of credit by type are set forth in Note 3. Standby letters of credit were granted primarily to commercial borrowers. Management believes the diversity of the local economy will prevent significant losses in the event of an economic downturn. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 18 Fair Value of Financial Instruments Fair value estimates, methods, and assumptions for the Corporation's financial instruments are summarized below. Cash and Cash Equivalents - The carrying values approximate the fair values for these assets. Securities Available for Sale - Fair values are based on quoted market prices where available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Other Investments - The carrying amount reported in the consolidated balance sheets for other investments approximates the fair value of these assets. Loans and Loans Held for Sale - For certain homogeneous categories of loans, such as fixed-rate residential mortgages, fair value is estimated using the quoted market prices for similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. Impaired loans and other nonperforming loans are measured at the estimated fair value of the expected future cash flows at the loan's effective interest rate or the fair value of the collateral for loans which are collateral dependent. Therefore, the carrying values of impaired loans approximate the estimated fair values for these assets. Mortgage Servicing Rights - Fair values were determined using the present value of future cash flows method. Carrying value approximates fair value. Cash Surrender Value of Life Insurance - The carrying amount approximates its fair value. Deposits - The fair value of deposits with no stated maturity, such as passbooks, negotiable order of withdrawal accounts, and variable rate insured money market accounts, is the amount payable on demand on the reporting date. The fair value of fixed-rate, fixed-maturity certificate accounts is estimated using discounted cash flows with discount rates at interest rates currently offered for deposits of similar remaining maturities. Securities Sold Under Repurchase Agreements - The fair value of securities sold under repurchase agreements with variable rates or due on demand is the amount payable at the reporting date. The fair value of securities sold under repurchase agreements with fixed terms is estimated using discounted cash flows with discount rates at interest rates currently offered for securities sold under repurchase agreements of similar remaining maturities. Borrowed Funds - Rates currently available to the Corporation for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. The fair value of borrowed funds due on demand is the amount payable at the reporting date. The fair value of borrowed funds with fixed terms is estimated using discounted cash flows with discount rates at interest rates currently offered by lenders for similar remaining maturities. Accrued Interest - The carrying amount of accrued interest approximates its fair value. Off-Balance-Sheet Instruments - The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the current interest rates, and the present creditworthiness of the counterparties. Since this amount is immaterial, no amounts for fair value are presented. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 18 Fair Value of Financial Instruments (Continued) The carrying amount and estimated fair value of financial instruments at December 31 were as follows:
2004 2003 -------------------------- -------------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ---------- ------------- ---------- ------------- (In Thousands) Financial assets: Cash and cash equivalents $ 39,873 $ 39,873 $ 35,767 $ 35,767 Securities available for sale 156,669 156,669 138,275 138,275 Other investments 5,340 5,340 5,052 5,052 Loans - Net 382,691 382,156 367,126 371,167 Mortgage servicing rights 1,756 1,756 1,789 1,789 Cash surrender value of life insurance 11,673 11,673 11,244 11,244 Accrued interest receivable 2,642 2,642 2,375 2,375 ---------- ------------- ---------- ------------- Total financial assets $ 600,644 $ 600,109 $ 561,628 $ 565,669 ========== ============= ========== ============= Financial liabilities: Deposits $ 445,786 $ 446,858 $ 428,284 $ 431,625 Securities sold under repurchase agreements 61,620 61,831 55,359 55,554 Borrowed funds 42,280 42,324 31,910 33,994 Accrued interest payable 1,311 1,311 1,305 1,305 ---------- ------------- ---------- ------------- Total financial liabilities $ 550,997 $ 552,324 $ 516,858 $ 522,478 ========== ============= ========== =============
Limitations - Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation's entire holdings of a particular instrument. Because no market exists for a significant portion of the Corporation's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters that could affect the estimates. Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Deposits with no stated maturities are defined as having a fair value equivalent to the amount payable on demand. This prohibits adjusting fair value derived from retaining those deposits for an expected future period of time. This component, commonly referred to as a deposit base intangible, is neither considered in the above amounts nor is it recorded as an intangible asset on the consolidated balance sheets. Significant assets and liabilities that are not considered financial assets and liabilities include premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates. FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 19 Condensed Parent Company Only Financial Statements Balance Sheets
December 31 -------------------- 2004 2003 -------- -------- (In Thousands) Assets Cash $ 4 $ 9 Repurchase agreements with Bank 238 47 Investment in Bank 64,630 59,127 Premises and equipment 1,008 1,053 -------- -------- TOTAL ASSETS $ 65,880 $ 60,236 ======== ======== Liabilities and Stockholders' Equity Liabilities: Other liabilities $ 7 $ 13 -------- -------- Total liabilities 7 13 -------- -------- Stockholders' equity: Common stock 7,584 7,584 Retained earnings 56,866 50,560 Accumulated other comprehensive income 2,123 2,779 Treasury stock, at cost (700) (700) -------- -------- Total stockholders' equity 65,873 60,223 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 65,880 $ 60,236 ======== ========
FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 19 Condensed Parent Company Only Financial Statements (Continued) Statements of Income
Years Ended December 31 ------------------------------- 2004 2003 2002 -------- -------- -------- (In Thousands) Dividends received from Bank $ 1,755 $ 1,350 $ 1,350 Rental income received from Bank 157 157 151 Interest and other income 1 2 2 Equity in earnings of subsidiaries 6,159 6,265 5,729 -------- -------- -------- Total income 8,072 7,774 7,232 -------- -------- -------- Other operating expenses 179 135 136 -------- -------- -------- Income before provision (credit) for income taxes 7,893 7,639 7,096 Provision (credit) for income taxes (9) 10 7 -------- -------- -------- Net income $ 7,902 $ 7,629 $ 7,089 ======== ======== ========
FIRST MANITOWOC BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Note 19 Condensed Parent Company Only Financial Statements (Continued) Statements of Cash Flows
Years Ended December 31 -------------------------------- 2004 2003 2002 -------- -------- -------- (In Thousands) Cash flows from operating activities: Net income $ 7,902 $ 7,629 $ 7,089 -------- -------- -------- Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 45 43 41 Equity in earnings of subsidiary (6,159) (6,265) (5,729) Change in other operating liabilities (6) 3 4 -------- -------- -------- Total adjustments (6,120) (6,219) (5,684) -------- -------- -------- Net cash provided by operating activities 1,782 1,410 1,405 -------- -------- -------- Cash flows from investing activities: Purchases of premises and equipment - (48) - (Increase) decrease in repurchase agreements (191) 99 (141) -------- -------- -------- Net cash provided by (used in) investing activities (191) 51 (141) -------- -------- -------- Net cash used in financing activities - Cash dividends paid (1,596) (1,456) (1,265) -------- -------- -------- Net increase (decrease) in cash (5) 5 (1) Cash at beginning 9 4 5 -------- -------- -------- Cash at end $ 4 $ 9 $ 4 ======== ======== ========
Note 20 Subsequent Event On February 25, 2005, the Corporation announced that it would be engaging in a "going private" transaction (the "Transaction") to eliminate annual expenses in connection with compliance with the Sarbanes-Oxley Act of 2002 and the reporting requirements of the Securities Exchange Act of 1934. The Transaction is designed to reduce the number of the Corporation's stockholders to permit the Corporation to terminate its registration with the United States Securities and Exchange Commission. ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures. We have established disclosure controls and procedures to ensure that material information relating to the Corporation, including its consolidated subsidiaries, is made known to the officers who certify the Corporation's financial reports and to other members of senior management and the Board of Directors. Based on their evaluation as of December 31, 2004, the principal executive officer and principal financial officer of the Corporation have concluded that the Corporation's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are effective to ensure that the information required to be disclosed by the Corporation in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Management's Report on Internal Control Over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control - Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2004. Our management's assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004 has been audited by Wipfli LLP, an independent registered public accounting firm, as stated in their report which is included herein. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 401 of Regulation S-K is included in the Corporation's definitive Proxy Statement, prepared for the 2005 Annual Meeting of Shareholders, under the caption "Election of Directors," and the information concerning executive officers of the registrant, under the caption "Executive Officers Who Are Not Directors," which is incorporated herein by reference. The information required by Item 405 of Regulation S-K concerning compliance with Section 16(a) of the Exchange Act is included in the Corporation's definitive Proxy Statement, prepared for the 2005 Annual Meeting of Shareholders, under the caption "Section 16(a) Beneficial Ownership Reporting Compliance," which is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is included under the heading "Compensation of Executive Officers and Directors" in the Corporation's definitive Proxy Statement, prepared for the 2005 Annual Meeting of Shareholders, which is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDERS MATTERS The information required by this item is included under the heading "Security Ownership of Certain Beneficial Owners and Management" in the Corporation's definitive Proxy Statement, prepared for the 2005 Annual Meeting of Shareholders, which is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is included under the heading "Indebtedness of Management and Certain Transactions" in the Corporation's definitive Proxy Statement, prepared for the 2005 Annual Meeting of Shareholders, which is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this item is included under the heading "Principal Accountant Fees and Services" in the Corporation's definitive Proxy Statement, prepared for the 2005 Annual Meeting of Shareholders, which is incorporated herein by reference. PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a)(1) Financial Statements The following financial statements and financial statement schedules are included under a separate caption "Financial Statements and Supplementary Data" in Part II, Item 8 hereof and are incorporated herein by reference: Reports of Independent Registered Public Accounting Firm Consolidated Balance Sheets---December 31, 2004 and 2003 Consolidated Statements of Income---For the Years Ended December 31, 2004, 2003, and 2002 Consolidated Statements of Shareholders' Equity---For the Years Ended December 31, 2004, 2003, and 2002 Consolidated Statements of Cash Flows---For the Years Ended December 31, 2004, 2003, and 2002 Notes to Consolidated Financial Statements (a)(2) Financial Statement Schedules All financial statement schedules have been omitted because they are not applicable, not required, or the information has been otherwise supplied in the Consolidated Financial Statements or notes to the Consolidated Financial Statements. (a)(3) Exhibits
EXHIBIT NUMBER DESCRIPTION OF DOCUMENTS 3.1 Articles of Incorporation (incorporated by reference to Exhibit (3)(1) to the Corporation's Report on Form 10 filed May 5, 1999). 3.2 Bylaws of First Manitowoc Bancorp, Inc. as amended on February 11, 2003 (incorporated by reference to Exhibit (3)(2) to the Corporation's Report on Form 10-K filed March 14, 2003). 10.1 First Manitowoc Bancorp, Inc. 401(k) Profit Sharing Plan (incorporated by reference to Exhibit (10)(1) to the Corporation's Report on Form 10-Q filed May 15, 2003). 10.2 Executive Employee Salary Continuation Plan for Thomas J. Bare, dated March 19, 1998, between First National Bank in Manitowoc and Thomas J. Bare (incorporated by reference to Exhibit (10)(2) to the Corporation's Report on Form 10-K filed March 14, 2003). 10.3 First National Bank in Manitowoc Voluntary Deferred Compensation Plan (incorporated by reference to Exhibit (10)(3) to the Corporation's Report on Form 10-K filed March 14, 2003). 11 Statement Re Computation of Per Share Earnings. See Note 1 in Part II Item 8. 12 Annual Report of First Manitowoc Bancorp, Inc. to Shareholders for the period ended December 31, 2004. 21 Subsidiaries of the Corporation. 23 Consent of Independent Registered Public Accounting Firm 31.1 Certification of Thomas J. Bare pursuant to Rule 13a-14(a) or 15(d)-14(a) 31.2 Certification of Paul H. Wojta pursuant to Rule 13a-14(a) or 15(d)-14(a) 32.1 Section 1350 Certification of Thomas J. Bare and Paul H. Wojta 99.1 Proxy Statement of First Manitowoc Bancorp, Inc. for 2005 Annual Meeting of Shareholders.
A copy of one or more of the exhibits listed herein can be obtained by writing Paul H. Wojta, Chief Financial Officer, First Manitowoc Bancorp, 402 North Eighth Street, Manitowoc, Manitowoc County, Wisconsin. (b) Reports on Form 8-K During the fourth quarter of 2004, the Corporation did not file any current reports on Form 8-K. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST MANITOWOC BANCORP, INC. Date: March 15, 2005 /s/ Thomas J. Bare ------------------ Thomas J. Bare Chief Executive Officer /s/ Paul H. Wojta ----------------- Paul H. Wojta Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/ Thomas J. Bare /s/ Robert S. Weinert ------------------ --------------------- Thomas J. Bare, President and Chief Robert S. Weinert, Chairman Executive Officer Date: March 15, 2005 Date: March 15, 2005 /s/ John J. Zimmer /s/ John M. Jagemann ------------------ -------------------- John J. Zimmer, Vice President John M. Jagemann, Director Date: March 15, 2005 Date: March 15, 2005 /s/ John C. Miller /s/ John E. Nordstrom ------------------ --------------------- John C. Miller, Director John E. Nordstrom, Director Date: March 15, 2005 Date: March 15, 2005 /s/ Craig A. Pauly /s/ Katherine M. Reynolds ------------------ ------------------------- Craig A. Pauly, Director Katherine M. Reynolds, Director Date: March 15, 2005 Date: March 15, 2005 /s/ John M. Webster ------------------- John M. Webster, Director Date: March 15, 2005