-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NnGe7zeomimviWjzwbbPNygUZnrnHuUKk59fu8xNlI9UvXLJNSlWov0+MVWyTgLN Z3IUqLA+4qWyHQrFhxHhpw== 0000912057-97-011154.txt : 19970401 0000912057-97-011154.hdr.sgml : 19970401 ACCESSION NUMBER: 0000912057-97-011154 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: NORTHERN STATES FINANCIAL CORP /DE/ CENTRAL INDEX KEY: 0000744485 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 363449727 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-19300 FILM NUMBER: 97569194 BUSINESS ADDRESS: STREET 1: 1601 N LEWIS AVE CITY: WAUKEGAN STATE: IL ZIP: 60085 BUSINESS PHONE: 7082446000 MAIL ADDRESS: STREET 1: 1601 NORTH LEWIS AVENUE CITY: WAUKEGAN STATE: IL ZIP: 60085 10-K 1 10-K - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------------------- FORM 10-K [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______ to ______ --------------------------------- COMMISSION FILE NUMBER 0 - 19300 NORTHERN STATES FINANCIAL CORPORATION (Exact name of Registrant as specified in its charter) Delaware 36-3449727 (State of incorporation) (I.R.S. Employer Identification No.) 1601 North Lewis Avenue Waukegan, Illinois 60085 (847) 244-6000 (Address, including zip code, and telephone number, including area code, of principal executive office) ------------------------------- Securities registered pursuant to Section 12(g) of the Act: Name of each exchange on Title of each class which registered ---------------------------- ------------------------ Common Stock $2.00 par value NASDAQ Small-Cap Market Cover Page 1 of 2 Page 1 of 88 Pages Exhibit Index Appears on Page 29 1 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. [ X ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting shares held by nonaffiliates of the Registrant is $57,513,897, as of March 18, 1997. Solely for the purpose of this computation, it has been assumed that executive officers and directors of the Registrant are "affiliates" and that the last price known to management was a sale on March 18, 1997, of $93.00 per share. 889,273 shares of common stock were outstanding as of March 18, 1997. DOCUMENTS INCORPORATED BY REFERENCE Portions of Parts II and IV are incorporated by reference from the Registrant's 1996 Annual Report to Stockholders; and a portion of Part III is incorporated by reference from the Registrant's Proxy Statement dated March 21, 1997, for the Annual Meeting of Stockholders to be held April 24, 1997. Except for those portions of the 1996 Annual Report incorporated by reference, the Annual Report is not deemed filed as part of this Report. Cover Page 2 of 2 INDEX 2 PART I PAGE NO. - ----------------------------------------------------------------- Item 1 Business 4 Item 2 Properties 14 Item 3 Legal Proceedings 14 Item 4 Submission of Matters to a Vote of Security Holders 14 PART II - ------- Item 5 Market for the Registrant's Common Stock and Related Stockholder Matters 15 Item 6 Selected Financial Data 15 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 8 Financial Statements and Supplementary Data 16 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 16 PART III - -------- Item 10 Directors and Executive Officers of the Registrant 17 Item 11 Executive Compensation 17 Item 12 Security Ownership of Certain Beneficial Owners and Management 17 Item 13 Certain Relationships and Related Transactions 17 PART IV - ------- Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 18 Signatures 19 3 PART I Item 1. BUSINESS THE COMPANY OVERVIEW Northern States Financial Corporation (the "Registrant" or the "Company") is a bank holding company organized in 1984 under the laws of Delaware, for the purpose of becoming the parent bank holding company of the Bank of Waukegan (the "Bank"). In 1984, the Company acquired Northern States Trust Company (the "Trust Company"). On January 1, 1992, the Trust Company's accounts and operations were assumed by the Bank. By combining the operations of the Trust Company and the Bank's Trust Department, the Company provides more efficient and effective service to its trust customers. During 1994, the Trust Company charter was surrendered and the Trust Company was liquidated. In 1991, the Registrant acquired First Federal Bank, fsb ("First Federal" or the "Thrift"). The Registrant is registered under the Bank Holding Company Act of 1956, as amended, and owns all the outstanding stock of the Bank and First Federal. At December 31, 1996, the Company had approximately 452 registered shareholders of record, 889,273 shares of Common Stock outstanding, and total consolidated assets of approximately $427 million. Aside from the stock of the Bank, First Federal and cash, the Registrant has no other substantial assets. As a large, community-oriented, independent banking organization in the Waukegan-Gurnee area in the State of Illinois, the Company is well positioned to take advantage of the growth in Waukegan-Gurnee and its surrounding communities. The Company has continuously served the community since 1919 when First Federal was chartered; complemented by the Bank when it was chartered in 1962. The Company's local management, coupled with its long record of service, has allowed it to compete successfully in the banking market. The Company operates traditional community and savings banks with conveniently located facilities and a professional staff. The Registrant, Bank and First Federal have no material patents, trademarks, licenses or franchises except the corporate franchises which permit them to engage in banking and trust practices pursuant to law. The following table shows loans and deposits of the Bank and First Federal as of December 31, 1996 (in thousands of dollars): LOANS DEPOSITS ----------------------- Bank of Waukegan $164,794 $237,589 First Federal Bank, fsb 66,966 92,013 4 The principal business of the Registrant, operating through the Bank and First Federal, consists of attracting deposits and securities sold under repurchase agreements from the general public, making commercial loans, loans secured by residential and commercial real estate and consumer loans, and operating a trust business. SUBSIDIARY OPERATIONS THE BANK OF WAUKEGAN The Bank of Waukegan was chartered as a state bank in 1962 and is located in Waukegan, Illinois. Waukegan is located approximately 37 miles north of Chicago, Illinois and has a population of approximately 70,000. At December 31, 1996 the Bank of Waukegan had total assets of approximately $318.8 million, deposits of approximately $237.6 million and stockholder's equity of approximately $40.6 million. The Bank has two banking offices located in Waukegan and one office located in Antioch, Illinois. The Bank provides services to individuals, businesses and local governmental units in northeastern Illinois and southeastern Wisconsin. The Bank's full service banking business includes the customary consumer and commercial products and services which banks provide, including the following: demand, savings, time, securities sold under repurchase agreements, individual retirement accounts; commercial, consumer and real estate lending, including installment loans, student loans, lines of credit and overdraft checking; safe deposit operations; trust services; and a variety of additional services tailored to the needs of individual customers, such as the acquisition of U.S. Treasury notes and bonds, the sale of traveler's checks, money orders, cashier's checks and foreign currency, direct deposit, and other special services. Commercial and consumer loans are made to corporations, partnerships and individuals, primarily on a secured basis. Commercial lending focuses on business, capital, construction, inventory and real estate. The installment loan department of the Bank makes direct and indirect loans to consumers and commercial customers. The mortgage division originates and services commercial and residential mortgages. The Bank's trust department acts as executor, administrator, trustee, conservator, guardian, custodian and agent. At December 31, 1996, the Trust Department had assets under management or custodial arrangements of approximately $176 million. Its office is located in Waukegan, Illinois. 5 FIRST FEDERAL BANK First Federal, headquartered in Waukegan, Illinois was incorporated in Illinois in 1919 as Waukegan Building and Loan Association, a state chartered mutual savings and loan association. It converted to a federally chartered mutual savings and loan association in 1934 and changed its name to First Federal Savings & Loan Association of Waukegan. In 1990, First Federal converted to a federal mutual savings bank and changed its name to First Federal Bank, fsb. First Federal is a member of the Federal Home Loan Bank System and its deposit accounts are insured by the Federal Deposit Insurance Corporation ("FDIC"). First Federal had total assets of approximately $107.5 million, deposits of approximately $92.0 million, and stockholder's equity of approximately $13.4 million at December 31, 1996. First Federal's market area is comprised of sections of northeastern Illinois, including Waukegan and Gurnee, and is situated in the center of the Chicago-Milwaukee corridor. First Federal operates as a traditional savings institution. Its business consists primarily of acquiring retail savings and checking deposits, originating residential and nonresidential real estate mortgage loans for both its portfolio and sale into the secondary market, and investing in government and other debt securities. First Federal has two offices located in Waukegan, Illinois and one office located in Gurnee, Illinois. COMPANY OPERATING STRATEGY Corporate policy, strategy and goals are established by the Board of Directors of the Company. Pursuant to the Company's philosophy, operational and administrative policies for the Bank and Thrift are also established by the Company. Within this framework, both subsidiaries focus on providing personalized services and quality products to customers to meet the needs of the communities in which they operate. As part of its community banking approach, the Company encourages the officers of both institutions to actively participate in community organizations. In addition, within credit and rate of return parameters, the Company attempts to ensure that each institution meets the credit needs of the community. In addition, the Bank (and the Thrift to a lesser extent) invests in local municipal securities. 6 LENDING ACTIVITIES GENERAL - Both banks provide a range of commercial and retail lending services to corporations, partnerships and individuals, including, but not limited to, commercial business loans, commercial and residential real estate construction and mortgage loans, consumer loans, revolving lines of credit and letters of credit. The installment loan departments of each bank makes direct and indirect loans to consumers and commercial customers. The mortgage departments originate and service commercial and residential mortgages. The majority of commercial mortgages are originated by the Bank, while the Thrift originates most of the residential mortgages. Each bank aggressively markets its services to qualified lending customers in both the commercial and consumer sectors. The Bank's commercial lending officers actively solicit the business of new companies entering the surrounding market as well as longstanding members of the business community. Through personalized professional service and competitive pricing, the Bank has been successful in attracting new commercial lending customers. At the same time, the Bank actively advertises its consumer loan products and continually attempts to make its lending officers more accessible. COMMERCIAL LOANS - The Bank seeks new commercial loans in its market area and much of the increase in these loans in recent years can be attributed to the successful solicitation of new business. The Bank's areas of emphasis include, but are not limited to, loans to manufacturers, building contractors, developers, business services companies and retailers. The Bank provides a wide range of commercial business loans, including lines of credit for working capital purposes and term loans for the acquisition of equipment and other purposes. Collateral for these loans generally includes accounts receivable, inventory, equipment and real estate. Loans may be made on an unsecured basis where warranted by the overall financial condition of the borrower. Terms of commercial business loans generally range from one to five years. The majority of the Bank's commercial business loans have floating interest rates or reprice within one year. The primary repayment risk for commercial loans is the failure of the business due to economic or financial factors. In most cases, the Bank has collateralized these loans and/or taken personal guarantees to help assure repayment. Both the Bank and the Thrift regularly provide financing to developers who have demonstrated a favorable record of performance for the construction of homes. Sales of these homes have remained very strong in Lake County due to the growth in population. MORTGAGE BANKING - The Thrift conducts a mortgage origination operation through its mortgage division. Since 1991, the Thrift began funding all long- term residential mortgage loans and selling them in the secondary market with servicing retained. The Bank will also originate residential mortgages. As a result of such actions, the Thrift has built its mortgage servicing portfolio to approximately $64.9 million at December 31, 1996. Management believes that the retention of mortgage servicing provides First Federal with a relatively steady source of fee income as compared to fees generated solely from mortgage origination operations, while maintaining the customer relationship. 7 CONSUMER LENDING - The Company's consumer lending departments provide all types of consumer loans including motor vehicle, home improvement, home equity, student loans, unsecured loans and small personal credit lines. TRUST DEPARTMENT - The Bank's trust department has been providing trust services to the community for over 10 years. Currently, the Bank has over $176 million of trust assets and provides a full complement of trust services for individuals and corporations including land trust services. To build on the trust department's mainstay of personal trust administration, the trust department's focus is in two major areas: (i) investment management for individuals and (ii) administration and investment services for employee benefit plans. COMPETITION The Registrant and its subsidiaries encounter significant competition in all of their activities. The Chicago metropolitan area and suburban Lake County have a high density of financial institutions, many of which are significantly larger and have substantially greater financial resources than the Company and its subsidiaries, and all of which are competitors of the Company and its subsidiaries to varying degrees. The Registrant and its subsidiaries are subject to competition from various financial institutions, including state and national banks, state and federal savings associations, credit unions, certain non-banking consumer lenders, and other companies or firms, including brokerage houses and mortgage brokers, that provide similar services in northeastern Illinois. In total, there are 22 financial institutions located in the Waukegan- Gurnee area, including the Company's two subsidiaries. These financial institutions consist of 9 banks, 6 savings associations and 7 credit unions. The Company also competes with money funds and with insurance companies with respect to its individual retirement accounts. Competition may increase as a result of the continuing reduction in the effective restrictions on the interstate operations of financial institutions. The Registrant and its subsidiaries face additional competition for deposits from short-term money market mutual funds and other corporate and government securities funds. Since the elimination of federal interest rate controls on deposits, the competition from other financial institutions for deposits has increased. The primary factors influencing competition for deposits are interest rates, service, and convenience of office locations. The Company competes for loans principally through the range and quality of the services it provides, interest rate and loan fee terms. The Company believes that its long-standing presence in the community and personal service philosophy enhances its ability to compete favorably in attracting and retaining individual and business customers. The Company actively solicits deposit-related clients and competes for deposits by offering customers personal attention, professional service and competitive interest rates. 8 EMPLOYEES The Registrant and its subsidiaries employed 119 full-time and 26 part-time employees as of December 31, 1996. None of the Registrant's employees is represented by any collective bargaining group. The Company offers a variety of employee benefits and management considers its employee relations to be good. GOVERNMENTAL MONETARY POLICY AND ECONOMIC CONDITIONS The earnings and growth of the Company are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government and its agencies. In particular, the Federal Reserve Board regulates monetary and credit conditions and interest rates in order to influence general economic conditions, primarily through open-market operations in U.S. Government securities, varying the discount rate on bank borrowings, and setting reserve requirements against bank deposits. These policies have a significant influence on overall growth and distribution of the Company's loans, investments and deposits, and affect interest rates charged on loans and earned on investments or paid for deposits. The monetary policies of the Federal Reserve Board are expected to continue their substantial influence on the operating results of banks. The general effect, if any, of such policies upon the future business and earnings of the Company and its subsidiaries cannot accurately be predicted. SUPERVISION AND REGULATION Financial institutions and their holding companies are extensively regulate under federal and state laws. As a result, the business, financial condition and prospects of the Company, the Bank and First Federal can be materially affected not only by management decisions and general economic conditions, but also by applicable statutes and regulations and other regulatory pronouncements and policies promulgated by regulatory agencies with jurisdiction over the Comapany, the Bank and First Federal, such as the Board of Governors of the Federal Reserve System ("FRB"), the Office of Thrift Supervsion (the "OTS"), the Federal Deposit Insurance Corporation ("FDIC") and the Office of the Illinois Commissioner of Banks and Real Estate (the "Commissioner"). The effect of such statutes, regulations and other pronouncements and policies are intended to protect depositors and the FDIC's deposit insurance funds, not to protect stockholders. 9 The Company and its subidiarires are "affiliates" within the meaning of the Federal Reserve Act so that the Bank and First Federal are subject to certain restrictions with respect to loans to the Company and certain other transactions with the Company or involving it securities. The Company is a bank holding company subject to the Bank Holding Company Act of 1956, as amended (the "Act"), and to regulation by the FRB. The Act limits the activities which may be engaged in by bank holding companies and their nonbank subsidiaries, with certain exceptions, to those so closely related to banking or managing or controlling banks as to be a proper incident thereto. Also, under the Act and the FRB's regulations, a bank holding company, as well as certain of its subsidiaries, are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or provision of any property or services. The Act also prohibits bank holding companies from acquiring substantially all the assets of or owning more than 5% of the voting shares of any bank or nonbanking company, which is not already majority owned, without the prior approval of the FRB. Beginning September 29, 1995 the Reigle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act") permits an adequately capitalized and adequately managed bank holding company to acquire, with FRB approval, a bank located in a state other than the bank holding company's home state, without regard to whether the transaction is permitted under any state law, except that a host state may establish by statute the minimum age of its banks (up to a maximum of 5 years) subject to acquisition by out-of-state bank holding companies. The FRB may not approve the acquisition if the applicant bank holding company, upon consumation, would control more that 10% of total U.S. insured depository institution deposits or more than 30% of the host state's total insured depository institution deposits. Effective as of September 29, 1994, the Interstate Act permits a bank, with the approval of the appropriate Federal bank regulatory agency, to establish a de novo branch in a state, other than the bank's home state, in which the bank does not presently maintain a branch if the host state has enacted a law that applies equally to all banks and expressly permits all out-of-state banks to branch de novo into the host state. Commencing June 1, 1997, banks having different home states may, with approval of the appropriate Federal bank regulatory agency, merge accross state lines, unless the home state of a participating bank has opted- out. The Interstate Act permits, as of September 29, 1995, any bank subsidiary of a bank holding company to receive deposits, renew time deposits, close loans, service loans and receive payments on loans and other obligations as agent for a bank or thrift affiliate, whether such affiliate is located in a different state or in the same state. Illinois law allows the Bank to establish branches anywhere in the state. The Illinois Bank Holding Company Act (the "IBHCA") permits Illinois bank holding companies to acquire control of banks in any state that permits bank holding companies whose principal place of business is in another state to acquire control of Illinois banks or bank holding companies upon satisfactory application to the Commissioner. In reviewing any such application, the Commissioner will review, amoung other things, compliance by the applicant banks with the requirements of the Community Reinvestment Act (the "CRA") and other information designed to determine such banks' abilities to meet community credit needs. 10 The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") amended the Act to authorize the FRB to allow bank holding companies to acquire any savings association (whether healthy, failed or failing) and removed "tandem operations" restrictions, which previously prohibited savings associations from being operated in tandem with a bank holding company's other subsidiaries. As a result, bank holding companies now have expanded opportunities to acquire savings associations. Under FIRREA, and insured depository institution which is commonly controlled with another insured depository institution shall generally be liable for any loss incurred, or reasonably anticipated to be incurred, by the FDIC in connection with the default of such commonly controlled institution, or for any assistance provided by the FDIC to such commonly controlled institution, which is in danger of default. The term "default" is defined to mean the appointment of a conservator or receiver for such institution. Such liability is subordinated in right of payment to deposit liabilities, secured obligations, any other general or senior liability and any obligation subordinated to depositors and or other general creditors, other than obligations owed to any affiliate of the depository institution (with certain exceptions) and any obligations to stockholders in such capacity. The Company, as part of its acquisition of First Federal, became a savings and loan holding company within the meaning of the Home Owners' Loan Act of 1933, as amended (the "HOLA"). As such, the Company was required to register with the OTS and is subject to OTS regulations, examinations, supervsion and reporting requirements. In addition, the OTS has enforcement authority over the Company in significant aspects of its business. Among other things, this authority permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution. The HOLA prohibits a savings and loan company, directly or indirectly, or through one or more subsidiaries, or through one or more transactions, from (i) acquiring control of, or acquiring by merger or purchase of assets, another savings institution or holding company therof, withour prior written OTS approval; (ii) acquiring or retaining, with certain exceptions, more than 5% of the voting shares of a nonsubsidiary savings institution or holding company thereof; or (iii) acquiring or retaining control of a financial institution not federally insured. The Bank is a member of the Federal Reserve System, its deposits are insured by the FDIC and it is subject to regulation by both these entities, as well as by the Commissioner. First Federal is primarily regulated by the OTS. Under the Illinois Banking Act (the "IBA"), the Bank is permitted to declare and pay dividends in amounts up to the amount of its accumulated net profits provided that it shall retain in its surplus at least one-tenth of its net profits since the date of the declaration of its most recent previous dividend until such additions to surplus, in the aggregate, equal at least the paid-in capital of the Bank. In no event may the Bank, while it continues its banking business, pay dividends in excess of its net profits then on hand (after deductions for losses and bad debts). 11 Under the FDIC's risk-based insurance assessment system, each insured depository institution is placed in one of nine risk categories based on its level of capital and other relevant information. Each insured depository institution's insurance assessment rate is then determined by the risk category in which it has been classified by the FDIC. At December 31, 1996 the Bank exceeded applicable minimum capital requirements. During 1996, the Thrift was assessed at the rate of .23%, the lowest factor, of deposits under the assessment system. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FIDICIA") substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made revisions to several other federal banking statutes. In general, FDICIA subjects depository institutions to significantly increased regulation and supervision. Among other things, FDICIA requires federal bank regulatory authorities to take "prompt corrective action" with respect to depository institutions that do not meet minimum capital requirements, and imposes certain restrictions upon depository institutions which meet minimum capital requirements but are not "well capitalized" for purposes of FDICIA. FDICIA and the regulations adopted under it establish five capital categories as follows, with the category for any institution determined by the lowest of any of these ratios: TIER 1 TOTAL LEVERAGE RATIO RISKED-BASED RATIO RISKED-BASED RATIO Well Capitalized 5% or above 6% or above 10% or above Adequately Capitalized 4% or above* 4% of above 8% or above Undercapitalized Less than 4% Less than 4% Less than 8% Significantly Capitalized Less than 3% Less than 3% Less than 6% RATIO OF TANGIBLE EQUITY TO TOTAL ASSETS Critically Undercapitalized 2% or below *3% for banks with the highest CAMEL (supervisory) rating. An insured depository institution may be deemed to be in a capital category that is lower than is indicated by its capital ratios if it receives an unsatisfactory rating by its examiners with respect to its assets, management, earnings or liquidity. 12 Under FIDCIA, a bank that is not well capitalized is generally prohibited from accepting or renewing brokered deposits and offering interest rates on deposits significantly higher than the prevailing rate in its normal market area or nationally (depending upon where the deposits are solicited); in addition, "pass through" insurance coverage may not be available for certain employee benefit accounts. FIDICIA generally prohibits a depository institution from mking any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to limitations on growth and are required to submit a capital restoration plan, which must be gauranteed by the institution's parent company. Institutions that fail to submit an acceptable plan, or that are significantly undercapitalized, are subject to a host of more drastic regulatory restrictions and measures. The Bank and First Federal are considered "well capitalized" according to FDICIA guidelines. FIDICIA directs that each federal banking agency prescribe standards for depository institutions or depository institutions' holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses and other standards as they deem appropriate. Many regulations implementing these directives have been adopted by the agencies BUSINESS-STATISTICAL DISCLOSURE The information set forth under the caption "Management's Discussion and Analysis of Financial Condition and the Results of Operations" on Pages 11 through 27 of the 1996 Annual Report to Stockholders (filed as Exhibit 13, pages 23 through 39 of this report) is incorporated herein by reference. 13 ITEM 2. PROPERTIES The Bank conducts its operations through its main office and two branches. The Company's office is located in the main office of the Bank. All of such offices are owned by the Bank and are located in Lake County, Illinois. The Bank believes that its current facilities are adequate for the conduct of its business. First Federal conducts its business through its main office and two branch offices. All offices are located in Lake County and have drive-up facilities. With the addition of its newest branch office in Gurnee, which opened in December 1990, First Federal believes that its facilities are adequate to meet its present and immediately foreseeable needs. The following table sets forth information relating to each of such offices: Bank of Waukegan: Main Office: Trust Department: 1601 North Lewis Avenue 1601 North Lewis Avenue Waukegan, Illinois 60085 Waukegan, Illinois 60085 Branches: 3233 Grand Avenue 40220 N. Route 59 Waukegan, Illinois 60085 Antioch, Illinois 60002 First Federal Bank, fsb: Main Office: 216 Madison Street Waukegan, Illinois 60085 Branches: 1428 N. Lewis Avenue 5384 Grand Avenue Waukegan, Illinois 60085 Gurnee, Illinois 60031 ITEM 3. LEGAL PROCEEDINGS Due to the nature of their business, the Registrant and its subsidiaries are often subject to various legal actions. These legal actions, whether pending or threatened, arise through the normal course of business and are not considered unusual or material. Currently, no material legal procedures are pending which involve the Registrant, the Bank, or First Federal. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not Applicable 14 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTER The information set forth under the captions "Stock Market Information"; "Price Summary"; and "Cash Dividends" on Page 46 of the 1996 Annual Report to Stockholders (filed as Exhibit 13, page 58 of this report) is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL AND OTHER DATA The information set forth under the caption "Selected Consolidated Financial Data" on Page 10 of the 1996 Annual Report to Stockholders (filed as Exhibit 13, page 22 of this report) is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information set forth under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" on Pages 11 through 27 of the 1996 Annual Report to Stockholders (filed as Exhibit 13, pages 23 through 39 of this report) is incorporated herein by reference. 15 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements of the Registrant and the Independent Auditors' Report as set forth on the following pages of the 1996 Annual Report to Stockholders (filed as Exhibit 13, to this report) are incorporated herein by reference: Annual Report to Stockholders Page --------------- Independent Auditors' Report 28 Consolidated Balance Sheets as of December 31, 1996 and 1995 29 Consolidated Statements of Income for the Years ended December 31, 1996, 1995 and 1994 30 Consolidated Statements of Cash Flows for the Years ended December 31, 1996, 1995 and 1994 31 Consolidated Statements of Stockholders' Equity for the Years ended December 31, 1996, 1995 and 1994 32 Notes to the Consolidated Financial Statements 33 Parent Company only financial statements 45 The portions of the 1996 Annual Report to Stockholders which are not specifically incorporated by reference as a part of this Form 10-K are not deemed to be a part of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 16 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS - The information with respect to Directors of the Registrant set forth under the caption "Directors and Executive Management" on pages 2 of the Registrant's Proxy Statement, dated March 21, 1997, relating to the April 24, 1997 Annual Meeting of Stockholders is incorporated herein by reference. EXECUTIVE OFFICERS - The Company's only executive officers are Mr. Fred Abdula, the President of the Company, and Mr. Kenneth W. Balza, the Vice President and Treasurer of the Company. The information with respect to Mr. Abdula and Mr. Balza is set forth under the caption "Directors and Executive Management" on page 2 of the Registrant's Proxy Statement, dated March 21, 1997, relating to the April 24, 1997 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION. The information set forth under the caption "Executive Compensation" and "Summary Compensation Table" on page 5 of the Registrant's Proxy Statement, dated March 21, 1997, relating to the April 24, 1997 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information set forth under the caption "Security Ownership of Certain Beneficial Owners and Management" on page 4 through 5 of the Registrant's Proxy Statement, dated March 21, 1997, relating to the April 24, 1997 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information set forth under the caption "Compensation Committee Interlocks and Insider Participation" on page 9 of the Registrant's Proxy Statement, dated March 21, 1997, relating to the April 24, 1997 Annual Meeting of Stockholders is incorporated herein by reference. 17 PART IV. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. FINANCIAL STATEMENTS All financial statements of the Registrant are incorporated herein by reference as set forth under Item 8, Part II of this report on Form 10-K. 2. FINANCIAL STATEMENT SCHEDULES Not applicable 3. EXHIBITS (Numbered in accordance with Item 601 of Regulation S-K) The following exhibits are filed as part of this report: 3-A Articles of Incorporation of the Company, as amended to date. (Filed with Registrant's annual report on Form 10-K for the year ended December 31, 1994 Commission File 0-19300 and incorporated here by reference.) 3-B Bylaws of the Company, as amended to date. (Filed with Registrant's annual report on Form 10-K for the year ended December 31, 1994 Commission File 0-19300 and incorporated here by reference.) 10 1992 Northern States Omnibus Incentive Plan. (Filed with Registrant's annual report on Form 10-K for the year ended December 31, 1994 Commission File 0-19300 and incorporated here by reference.) 11 Statement of Computation of per share earnings. Contained in Note 1 to the consolidated financial statements, page 34, 1996 Annual Report to Stockholders (filed as Exhibit 13 to this report) is incorporated by reference. 13 Copy of the Company's Annual Report to Stockholders for the year ended December 31, 1996. This exhibit, except for portions thereof that have been specifically incorporated by reference into this report, is furnished for the information of the Commission and shall not be deemed "filed" as part hereof. 21 List of Subsidiaries. (b) REPORTS ON FORM 8-K No reports on Form 8-K were filed during the fourth quarter of the year ended December 31, 1996. (c) Exhibit List and Index 18 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized, on this 18th day of March 1997. NORTHERN STATES FINANCIAL CORPORATION (Registrant) Fred Abdula, Chairman of the Board and President /S/ FRED ABDULA (Principal Executive Officer) - ---------------------------- Thomas M. Nemeth, Assistant Vice President (Principal Financial Officer and /S/ THOMAS M. NEMETH Principal Accounting Officer) - ---------------------------- 19 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. Each director of the Registrant, whose signature appears below, hereby appoints Fred Abdula and Thomas M. Nemeth and each of them severally, as his attorney-in-fact, to sign in his name and on his behalf, as a director of the Registrant, and to file with the Commission any and all Amendments to this Report on Form 10-K, on this 18th day of March 1997. Fred Abdula, Director /s/ Fred Abdula ------------------------------- Kenneth W. Balza, Director /s/ Kenneth W. Balza ------------------------------- Jack H. Blumberg, Director /s/ Jack H. Blumberg ------------------------------- Frank Furlan, Director /s/ Frank Furlan ------------------------------- Harry S. Gaples, Director /s/ Harry S. Gaples ------------------------------- Laurance A. Guthrie, Director /s/ Laurance A. Guthrie ------------------------------- James A. Hollensteiner, Director /s/ James A. Hollensteiner ------------------------------- Raymond M. Mota, Director /s/ Raymond M. Mota ------------------------------- Helen Rumsa, Director /s/ Helen Rumsa ------------------------------- Frank Ryskiewicz, Director /s/ Frank Ryskiewicz ------------------------------- Henry G. Tewes, Director /s/ Henry G. Tewes ------------------------------- Arthur J. Wagner, Director /s/ Arthur J. Wagner ------------------------------- 20 NORTHERN STATES FINANCIAL CORPORATION AND SUBSIDIARIES FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996 EXHIBIT INDEX Exhibits Page(s) - -------- ------- 3-A Articles of Incorporation of the Company, as amended to date. (Filed with Registrant's annual report on Form 10-K for the year ended December 31, 1994 Commission File 0-19300 and incorporated here by reference.) 3-B Bylaws of the Company, as amended to date. (Filed with Registrant's annual report on Form 10-K for the year ended December 31, 1994 Commission File 0-19300 and incorporated here by reference.) 10 1992 Northern States Omnibus Incentive Plan. (Filed with Registrant's annual report on Form 10-K for the year ended December 31, 1994 Commission File 0-19300 and incorporated here by reference.) 11 Statement of Computation of per share earnings. Contained in Note 1 to the consolidated financial statements, Page 34, 1996 Annual Report to Stockholders (filed as Exhibit 13 to this report) is incorporated by reference. 46 13 Copy of the Company's Annual Report to Stockholders for the year ended December 31, 1996. This exhibit, except for portions thereof that have been specifically incorporated by reference into this Report, is furnished for the information of the Commission and shall not be deemed "filed" as part hereof. 22 21 List of Subsidiaries. 59 27 Financial Data Schedule 21 EX-13 2 EXHIBIT 13 SELECTED CONSOLIDATED FINANCIAL DATA ($000'S, EXCEPT PER SHARE DATA)
AT OR FOR THE YEAR ENDED DECEMBER 31, 1996 1995 1994 1993 1992 - ------------------------------------- ---- ---- ---- ---- ---- INCOME STATEMENT DATA: Interest income $ 31,671 $ 30,893 $ 27,375 $ 26,836 $ 29,598 Interest expense 14,808 14,705 11,429 11,708 14,583 -------- -------- -------- -------- -------- Net interest income 16,863 16,188 15,946 15,128 15,015 Provision for loan losses 1,190 1,480 1,440 1,481 1,474 -------- -------- -------- -------- -------- Net interest income after provision for loan losses 15,673 14,708 14,506 13,647 13,541 Noninterest income 3,239 2,702 2,764 3,540 3,431 Noninterest expenses 10,372 10,433 11,010 11,387 11,169 -------- -------- -------- -------- -------- Income before income taxes 8,540 6,977 6,260 5,800 5,803 Provision for income taxes 2,529 2,040 1,785 1,366 1,633 -------- -------- -------- -------- -------- NET INCOME $ 6,011 $ 4,937 $ 4,475 $ 4,434 $ 4,170 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- BALANCE SHEET DATA: Cash and due from banks $ 15,247 $ 18,119 $ 16,539 $ 19,133 $ 15,717 Investments (2) 166,585 171,125 164,254 164,542 150,233 Loans, net 227,814 220,865 212,823 216,163 229,807 Direct lease financing 999 622 373 993 1,281 All other assets 15,919 17,160 17,646 15,298 15,440 -------- -------- -------- -------- -------- TOTAL ASSETS $426,564 $427,891 $411,635 $416,129 $412,478 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Deposits $328,795 $327,555 $329,363 $349,360 $352,623 Other borrowings 36,758 43,278 30,654 18,113 15,080 All other liabilities 6,176 6,053 5,918 4,858 4,491 Stockholders' equity 54,835 51,005 45,700 43,798 40,284 -------- -------- -------- -------- -------- Total liabilities and stockholders' equity $426,564 $427,891 $411,635 $416,129 $412,478 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- PER SHARE DATA: Net income $ 6.76 $ 5.57 $ 5.05 $ 5.01 $ 4.71 Cash dividends declared 2.00 1.65 1.45 1.30 1.15 Book value (at end of year) 61.66 57.47 51.57 49.43 45.47 SELECTED FINANCIAL AND OTHER RATIOS: Return on average assets (1) 1.43% 1.21% 1.08% 1.09% 1.03% Return on average equity (1) 11.47 10.15 9.89 10.35 10.68 Average stockholders' equity to average assets (1) 12.47 11.93 10.96 10.53 9.63 Tax equivalent interest rate spread 3.64 3.62 3.78 3.73 3.62 Tax equivalent net interest income to average earning assets (1) 4.50 4.46 4.34 4.23 4.20 Non-performing loans and other real estate owned to total assets 0.94 2.25 2.39 2.72 1.72 Dividend payout ratio (3) 29.60 29.63 28.72 25.98 24.44
(1) Does not reflect impact of securities available-for-sale fair values on average balances. (2) Includes interest-bearing deposits in other financial institutions, federal funds sold, securities available-for-sale and securities held-to-maturity. (3) Total cash dividends divided by net income. Page 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of Northern States Financial Corporation's (Company) financial position and results of operations. It should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. The Company has two wholly-owned subsidiaries (the Subsidiaries): The Bank of Waukegan (Bank), a commercial banking company providing traditional banking services, including trust services, to corporate, retail and civic entities in the market; and First Federal Bank, fsb, (Thrift), a savings institution providing traditional thrift services primarily to individuals and small businesses in the local market area. The Company and its subsidiaries are subject to regulation by numerous agencies including the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Illinois Office of Banks and Real Estate and the Office of Thrift Supervision. Among other things, these agencies limit the activities in which the Company and its Subsidiaries may engage, the investments and loans which the Bank and/or Thrift funds, and the reserves against deposits which the Bank and Thrift must maintain. The reader should recognize that the financial results vary significantly between a commercial bank and a traditional savings and loan entity. A savings and loan institution normally has a higher percentage of fixed rate loans to total earning assets, a much lower volume of noninterest bearing transaction accounts, and a relatively low allowance for loan losses to total loans. Approximately 25% of the Company's assets are invested in the Thrift. The statements contained in this management's discussion and analysis that are not historical facts are forward-looking statements subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. The Company cautions readers of this Annual Report that a number of important factors could cause the Company's actual results in 1997 and beyond to differ materially from those expressed in any such forward-looking statements. TABLE 1 ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES ($000's)
1996 1995 1994 --------------------------- --------------------------- --------------------------- AVERAGE AVERAGE AVERAGE FOR THE YEARS ENDED DECEMBER 31, BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE - -------------------------------- ------- -------- ---- ------- -------- ---- ------- -------- ---- ASSETS Loans (1) (2) (3) $233,167 $ 22,296 9.56% $223,806 $ 21,788 9.74% $214,922 $ 19,006 8.84% Taxable securities (5) 124,271 7,663 6.12 122,401 7,313 5.95 127,328 6,428 5.02 Securities exempt from federal income taxes (2) (5) 22,058 1,799 8.36 20,838 1,751 8.43 21,769 1,893 8.70 Interest-bearing deposits in financial institutions 504 28 5.56 1,572 117 7.44 9,520 381 4.00 Bankers' acceptances 0 0 0.00 0 0 0.00 564 21 3.72 Federal funds sold 13,844 742 5.36 12,541 740 5.90 9,590 383 3.99 -------- -------- ----- -------- ------- ----- -------- -------- ----- Interest-earning assets 393,844 32,528 8.25 381,158 31,709 8.31 383,693 28,112 7.31 Noninterest earning assets 25,818 26,018 28,469 -------- -------- ----- -------- ------- ----- -------- -------- ----- Average assets (4) $419,662 $407,176 $412,162 -------- -------- -------- -------- -------- -------- LIABILITIES AND STOCKHOLDERS' EQUITY NOW deposits $ 39,474 1,177 2.98 $ 39,361 1,149 2.92 $ 36,911 982 2.66 Money market deposits 44,272 1,792 4.05 39,980 1,866 4.67 52,029 1,442 2.77 Savings deposits 46,828 1,395 2.98 48,796 1,436 2.94 55,585 1,573 2.83 Time deposits 155,378 8,720 5.61 150,994 8,381 5.55 152,933 6,349 4.15 Other borrowings 35,006 1,724 4.92 34,633 1,873 5.41 26,086 1,083 4.15 -------- -------- ----- -------- ------- ----- -------- -------- ----- Interest-bearing liabilities 320,958 14,808 4.61 313,764 14,705 4.69 323,544 11,429 3.53 -------- -------- ----- -------- ------- ----- -------- -------- ----- Demand deposits and other noninterest bear- ing liabilities 46,580 45,125 43,797 Stockholders' equity 52,124 48,287 44,821 -------- -------- ----- -------- ------- ----- -------- -------- ----- Average liabilities and stockholders' equity $419,662 $407,176 $412,162 -------- -------- -------- -------- -------- -------- Net interest income $17,720 $17,004 $16,683 ------- ------- ------- ------- ------- ------- Net yield on interest earning assets 4.50% 4.46% 4.34% ------ ------ ------ ------ ------ ------ Interest-bearing liabilities to earning assets ratio 81.40% 82.22% 84.19% ------ ------ ------ ------ ------ ------
(1) - Interest income on loans includes loan origination and other fees of $443 for 1996, $540 for 1995 and $706 for 1994. Average loans include direct lease financing. (2) - Tax exempt income is reflected on a fully tax equivalent basis utilizing a 34% rate for all years presented. (3) - Nonaccrual loans are included in average loans. (4) - Average balances are derived from the average daily balances. (5) - Rate information was calculated based on the average amortized cost for securities. The 1996, 1995 and 1994 average balance information includes an average valuation allowance for taxable securities of $(985), $(521) and $(623). The 1996 and 1995 average balance information includes an average valuation allowance of $540 and $58 for tax-exempt securities. Page 23 NET INTEREST INCOME Table 1 shows a comparison of net interest income and average volumes, together with effective yields earned and rates paid on such funds. The results shown reflect the excess of interest earned on assets over the interest paid for funds. Interest income is the primary source of revenue for the Company. It comprised 90.7% of the Company's total revenues in 1996, 92.0% in 1995 and 90.8% in 1994. Net interest income is the difference between interest income earned on average interest-earning assets, such as loans and securities, and interest expense on average interest-bearing liabilities, such as deposits and other borrowings. In table 1, interest income on non-taxable securities and loans has been adjusted to be fully taxable equivalent so as to be comparable with rates earned and paid elsewhere. In addition, rates earned on securities are calculated based upon the average amortized cost of the related securities. Several factors affect net interest income of which one factor is changes in interest rates which are usually indicated by the changes in the prime lending rate. The prime rate decreased and stabilized in 1996, peaked in 1995, and significantly increased in 1994. The weighted average prime lending rate in 1996 was 8.27%, a decrease of 56 basis points from 8.83% in 1995, and was 7.15% in 1994. During 1996 the prime lending rate began the year at 8.50% and dropped to 8.25% on February 1, 1996 where it remained for the balance of the year. The decline in the prime lending rate in 1996 caused corresponding decreases in rates earned on variable rate loans that were tied to the prime rate and on fixed rate loans as they were renewed or new fixed rate loans were made. Table 1 shows that rates earned on average loans in 1996 decreased to 9.56% in 1996 from 9.74% in 1995 after increasing in 1995 from 8.84% in 1994. The general decline in rates in 1996 is evidenced by the decline in yields on total average interest-earning assets which declined 6 basis points in 1996 while rates on average interest-bearing liabilities dropped 8 basis points in 1996 after increasing 116 basis points in 1995. Another important factor affecting net interest income is the average earning asset ratio, which is the percentage of average assets that earn interest income to total average assets. For the Company this ratio exceeded 93% for all periods shown in table 1. As indicated in table 1, the Company's net interest income rose in 1996, with a higher growth rate than experienced in 1995 compared to 1994. Net interest income increased $716,000 in 1996 or 4.21% as compared to 1995 net interest income which had increased $321,000 or 1.92% over 1994. A significant reason for the 1996 increase was that average interest-earning assets increased $12.7 million in 1996 while average interest-bearing liabilities only increased $7.2 million. This is further evidenced in Table 2 which shows that the 1996 increase in net interest income is primarily attributable to changes due to volume. Another factor that influenced net interest income in 1996 was a slight increase in the interest rate spread. The interest rate spread is the difference between the yield earned on assets less the rates paid on liabilities. The interest rate spread was 3.64% in 1996 as compared to 3.62% in 1995 and 3.78% in 1994. The Company's average deposit and other borrowing rates were 4.61% in 1996, a slight drop from 4.69% in 1995 which had increased from 3.53% in 1994. The rates earned on average earning assets during 1996 decreased slightly to 8.25% from 8.31% in 1995 which had risen from 7.31% in 1994. In 1996 the Company had more interest-bearing liabilities repricing than assets. On a forward looking basis, the Company is "liability sensitive" out to at least one year. This means that in a decreasing rate environment, interest-bearing deposits and other liabilities will reprice downward faster than our interest-earning assets. This is evidenced in 1996 that as rates declined and stabilized, yields on interest-earning assets declined only 6 basis points while the rates on interest-bearing liabilities declined 8 basis points. Another factor influencing net interest income is the "interest-bearing liabilities to earning assets ratio" as shown in table 1 which indicates how many cents of each dollar of earning assets are funded by an interest-bearing liability. As table 1 indicates, this relationship has declined to less than 82% in 1996 from 84% in 1994. The decline in this ratio has a positive impact on interest income. The mix of assets and liabilities also affects net interest income. Average assets increased by 3.1% in 1996, as compared with a decrease of 1.2% in 1995. Local economic conditions continued to improve in 1996 as evidenced by the increase in average loans. Average loan volume increased 4.2% in 1996 after an increase of 4.1% in 1995. Average total securities increased 2.2% in 1996 after declining 3.9% in 1995. In 1996, total average interest-bearing deposits increased $6.8 million from 1995 levels while average other borrowings, which consists primarily of repurchase agreement products, increased only $373,000 from 1995. The increase in average interest-bearing deposits occurred at the Bank where average interest-bearing deposits increased $8.2 million. At the Thrift average interest-bearing deposits declined $1.4 million in 1996 while the decline in 1995 was $7.8 million. Thrifts traditionally have paid slightly higher rates on deposits. In 1995, the Company adjusted the Thrift's deposit rate structure to be in line with the Bank's and as a consequence some deposits left the Thrift. In 1996, customers at both institutions continued to increase their deposits in money market accounts which had higher yields compared to savings deposits, which balances decreased. Interest rates paid on deposits and charged for loans dur- Page 24 NET INTEREST INCOME (CONTINUED) ing 1996 remained comparable with other local financial institutions during the year. In spite of the many non-bank investment products available to our customers today, as well as from other financial institutions, the Company is pleased in its ability to maintain the level of interest-bearing liabilities. As table 1 indicates, the average balances of other borrowings increased only slightly in 1996 after increasing $8.5 million in 1995. Most of the other borrowings are in the form of securities sold under repurchase agreements (repurchase agreements) which the Company continues to offer as an alternative to certificates of deposit. A repurchase agreement is not subject to FDIC insurance and to reserve requirements, and therefore is less costly to the Company. The repurchase agreement also gives the customer added security for the borrowing in the form of a security pledged by the Company. Management expects to continue to offer repurchase agreements as an alternative to certificates of deposit in the future. Many other factors beyond Management's control can have a significant impact on changes in net interest income from one period to another. Examples of such factors are: (1) credit demands by customers; (2) fiscal and debt management policy of federal and state governments; (3) monetary policy of the Federal Reserve Board; and (4) changes in regulations. The components of the changes in net interest income are shown in table 2. Table 2 allocates changes in net interest income between amounts attributable to changes in rate and changes in volume for the various categories of interest-earning assets and interest-bearing liabilities. TABLE 2 ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE ($ 000'S)
1996 COMPARED TO 1995 1995 COMPARED TO 1994 -------------------------- -------------------------- INCREASE (DECREASE) INCREASE (DECREASE) -------------------------- -------------------------- CHANGE CHANGE CHANGE CHANGE TOTAL DUE TO DUE TO TOTAL DUE TO DUE TO FOR THE YEAR ENDED DECEMBER 31 CHANGE VOLUME RATE CHANGE VOLUME RATE - ------------------------------ ------ ------ ------ ------ ------ ------ INTEREST INCOME Loans $ 508 $ 902 $(394) $2,782 $ 809 $1,973 Taxable securities 350 140 210 885 (261) 1,146 Securities exempt from federal income taxes 48 62 (14) (142) (84) (58) Interest-bearing deposits in financial institutions (89) (65) (24) (264) (453) 189 Bankers' acceptances 0 0 0 (21) (21) 0 Federal funds sold 2 73 (71) 357 140 217 ------ ----- ----- ------ ----- ------ Total interest income 819 1,112 (293) 3,597 130 3,467 ------ ----- ----- ------ ----- ------ INTEREST EXPENSE NOW deposits 28 3 25 167 68 99 Money market deposits (74) 188 (262) 424 (392) 816 Savings deposits (41) (58) 17 (137) (198) 61 Time deposits 339 245 94 2,032 (81) 2,113 Other borrowings (149) 20 (169) 790 411 379 ------ ----- ----- ------ ----- ------ Total interest expense 103 398 (295) 3,276 (192) 3,468 ------ ----- ----- ------ ----- ------ NET INTEREST INCOME $ 716 $ 714 $ 2 $ 321 $ 322 $ (1) ------ ----- ----- ------ ----- ------ ------ ----- ----- ------ ----- ------
Rate/volume variances are allocated to the rate variance and the volume variance on an absolute basis. Tax-exempt income is reflected on a fully tax equivalent basis utilizing a 34% rate. Page 25 TABLE 3 SECURITIES ($ 000'S)
DECEMBER 31, 1996 1995 1994 - ----------- ------------------- ------------------- ------------------- % OF TOTAL % OF TOTAL % OF TOTAL SECURITIES AVAILABLE-FOR-SALE AMOUNT PORTFOLIO AMOUNT PORTFOLIO AMOUNT PORTFOLIO - ----------------------------- ------ ---------- ------ ---------- ------ ---------- U.S. Treasury $ 16,114 10.76% $ 37,248 24.01% $40,448 56.06% U.S. Government agencies and corporations 89,604 59.84 71,581 46.13 17,233 23.88 States and political subdivisions 25,482 17.02 22,065 14.22 0 0.00 Mortgage-backed securities 16,430 10.97 20,472 13.19 10,979 15.22 Equity securities and mutual fund investment in debt securities 2,120 1.41 3,804 2.45 3,493 4.84 -------- ------- -------- ------- ------- ------- Total $149,750 100.00% $155,170 100.00% $72,153 100.00% -------- ------- -------- ------- ------- ------- -------- ------- -------- ------- ------- -------
($ 000'S) DECEMBER 31, 1994 - ------------ ------------------- % OF TOTAL SECURITIES HELD-TO-MATURITY AMOUNT PORTFOLIO - --------------------------- ------ ---------- U.S. Treasury $19,224 24.50% U.S. Government agencies and corporations 23,352 29.75 States and political subdivisions 23,838 30.37 Mortgage-backed securities 12,074 15.38 ------- ------- Total $78,488 100.00% ------- ------- ------- ------- As of December 31, 1996, the Company held no securities of any single issuer, other than the U.S. Treasury and U.S. Government agencies and corporations, including the Federal Home Loan Mortgage Corporation (FHLMC), the Federal Home Loan Bank (FHLB), the Federal National Mortgage Association (FNMA), and the Government National Mortgage Association (GNMA), that exceeded 10% of consolidated stockholders' equity. Virtually all of the Company's securities at December 31, 1996 are considered investment grade. Although the Company holds securities issued by municipalities within the state of Illinois which in the aggregate exceed 10% of consolidated stockholders' equity, none of the holdings from individual municipal issuers exceed this threshold. The Company also holds local municipal bonds which, although not rated, are considered low risk investments. The carrying value of interest-bearing balances with banks and federal funds sold consisted of the following at December 31, 1996: First USA Bank, Dallas $ 8,000 LaSalle National Bank, Chicago 7,500 Federal Home Loan Bank, Chicago 1,200 Bank of America, Illinois 100 Harris Bank, Chicago 35 ------- Total carrying value $16,835 ------- ------- Page 26 SECURITIES All securities of the Company at December 31, 1996 are classified as available-for-sale. The Company classifies its securities as available-for-sale to provide flexibility in the event that it may be necessary to sell securities to raise cash for liquidity purposes, to adjust the portfolio for interest rate risk purposes or to adjust for income tax purposes. In previous years, until late in 1995, securities that were subject to repricing or had an original maturity of two years or less were classified as available-for-sale while all other securities were classified as held-to-maturity. Late in 1995, the Company, as permitted by the Statement of Financial Accounting Standards ("SFAS") No. 115 implementation guide released in 1995, exercised a one time opportunity to reassess the appropriateness of the classification of all securities held. Based on this review, the Company reclassified securities, having an amortized cost of $96,547,000 and a net unrealized gain of $772,000 during 1995, from held-to-maturity to available-for-sale. This reclassification transferred all held-to-maturity securities to the available-for-sale classification and provided the Company with an improved ability to manage its securities portfolio. The securities portfolio decreased $5.4 million at year end 1996 from 1995, after an increase of $4.5 million at year-end 1995 from 1994. However, average securities, as shown in table 1, increased in 1996 from 1995 by $3.1 million. The increase was the result of increased average interest-bearing liabilities, of which the excess, after being used to increase our loans, was invested in securities. Holdings of U.S. Treasury securities declined $21.1 million at December 31, 1996 compared to December 31, 1995. As U.S. Treasury securities matured they were reinvested into U.S. Government agency issues which increased by $18.0 million to $89.6 million at December 31, 1996, from $71.6 million at December 31, 1995. The increase in U.S. Government agency issues is the result of the Company investing in higher yielding agency issues that have call provisions in order to maximize yields on the Company's securities portfolio while helping to minimize state income taxes. The Company attempts to keep at least half its portfolio in U.S. Treasury and U.S. Government agency issues, which was the case for all periods reported in table 3. This allows the Company to better manage its exposure to changing interest rates, while minimizing credit risk within the portfolio. U.S. Treasury and U.S. Government agency issues comprised over 70% of the total portfolio at December 31, 1996. Holdings of tax-exempt securities had an increase of $3.4 million to $25.5 million at December 31, 1996. Reflecting the change applicable to commercial banks in the federal tax law, a bank is not allowed an interest deduction for the cost of deposits or borrowings used to fund most tax-exempt issues acquired after August 7, 1986. However, the Company was able to purchase "bank qualified" tax-exempt issues from local taxing bodies. The Company will continue to buy securities issued by local tax-exempt entities, in an effort to support the local community, consistent with the investment standards contained in the investment policy. During 1996 a loan that was made to a local taxing body was converted by the Bank into a "bank qualified" tax-exempt security in the amount of $4.7 million. In as much as the Thrift is required, by regulation, to have 65% of its assets invested in mortgage related product, the Thrift invests in pools of collateralized mortgage obligations and other mortgage-backed securities as an alternative to keeping mortgage loans originated at long-term fixed-rates in their portfolio. As a result, mortgage-backed securities balances at December 31, 1996 were $16.4 million, a decrease of $4.0 million from the previous year. The majority of the mortgage-backed securities portfolio is at the Thrift and the decrease is consistent with the Thrift's decrease in total assets during 1996. First Federal sold its investment in a mutual fund during 1996 with proceeds of $2,675,000 and a gain of $5,000. The Company's equity securities at December 31, 1996 consist of Student Loan Marketing Association (SLMA) and Federal Home Loan Bank (FHLB) stock. Efforts by the Company to maintain appropriate liquidity includes periodic adjustments to the securities portfolio as management considers necessary, typically accomplished through the maturity schedule of securities purchased. The maturity distribution and average yields, on a fully tax equivalent basis, of the securities portfolio at December 31, 1996 is shown in table 4. Page 27 TABLE 4 SECURITIES MATURITY SCHEDULE & YIELDS
GREATER THAN 1 YR. GREATER THAN 5 YRS. SECURITIES AVAILABLE-FOR-SALE LESS THAN OR AND LESS THAN OR AND LESS THAN OR GREATER ($ 000'S) EQUAL TO 1 YR. EQUAL TO 5 YRS. EQUAL TO 10 YRS. THAN 10 YRS. TOTALS - ----------------------------- --------------- ----------------- ------------------- -------------- --------------- AS OF DECEMBER 31, 1996 BALANCE YIELD BALANCE YIELD BALANCE YIELD BALANCE YIELD BALANCE YIELD - ----------------------------- ------- ----- ------- ----- ------- ----- ------- ----- ------- ---- U.S. Treasury $11,033 5.62% $ 5,081 5.69% $ 0 0.00% $ 0 0.00% $ 16,114 5.64% U.S. Government agencies and corporations 6,490 5.00 78,095 6.38 5,019 7.09 0 0.00 89,604 6.32 States and political subdivisions (1) 2,285 7.95 14,730 8.02 8,467 8.74 0 0.00 25,482 8.25 Mortgage-backed securities (2) 8,463 6.22 5,031 7.05 859 6.36 2,077 7.12 16,430 6.60 Equity and other securities 2,120 6.49 0 0.00 0 0.00 0 0.00 2,120 6.49 ------- ----- -------- ----- -------- ---- ------ ----- -------- ----- Total $30,391 5.89% $102,937 6.61% $14,345 8.02% $2,077 7.12% $149,750 6.61% ------- ----- -------- ----- -------- ---- ------ ----- -------- ----- ------- ----- -------- ----- -------- ---- ------ ----- -------- -----
(1) - The yield is reflected on a fully tax equivalent basis utilizing a 34% tax rate. (2) - Mortgage-backed securities reflect the contractual maturity of the related instrument. TABLE 5 LOAN PORTFOLIO $000'S)
DECEMBER 31, 1996 1995 1994 1993 1992 - ------------ ---- ---- ---- ---- ---- Commercial $ 50,762 $ 53,886 $ 50,495 $ 54,902 $ 56,393 Real estate-construction 26,905 23,720 21,815 19,719 18,369 Real estate-mortgage 146,552 137,941 132,830 135,224 144,408 Installment 9,203 10,903 13,069 11,761 15,793 -------- -------- -------- -------- -------- Total loans 233,422 226,450 218,209 221,606 234,963 Unearned income (240) (370) (592) (755) (1,261) Deferred loan fees (529) (701) (829) (924) (1,086) -------- -------- -------- -------- -------- Loans, net of unearned income and deferred loan fees 232,653 225,379 216,788 219,927 232,616 Allowance for loan losses (4,839) (4,514) (3,965) (3,764) (2,809) -------- -------- -------- -------- -------- Loans, net $227,814 $220,865 $212,823 $216,163 $229,807 -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
The Company had one foreign loan outstanding in the amount of $188 at December 31, 1996. Page 28 LOAN PORTFOLIO Loans for the Company continued to grow in 1996 due to lower loan interest rates and a strong local economy. As shown in table 5, gross loans increased $6,972,000 or 3.1% at year end 1996, following an increase of $8,241,000 or 3.8% in 1995. Table 1 shows that average loans in 1996 were $233,167,000 an increase of $9,361,000 over the average loans in 1995. The Company's commercial loans at year end declined $3.1 million after growing $3.4 million in 1995. During 1996 one commercial loan to a local taxing body was converted by the Bank into a "bank qualified" tax-exempt security in the amount of $4.7 million which contributed to the decrease in commercial loans. As projects funded by short-term commercial loans during 1996 were completed, the loans were transferred to the longer term mortgage loan portfolio. Increases in the Company's real estate construction lending portfolio reflected the strong local economy in 1996. Construction lending at year end 1996 increased by 13.4% to $26,905,000. The Company has developed an expertise in construction lending and has developed a portfolio of construction and construction-related loans. This portfolio has averaged approximately $22 million over the last five years. The construction portfolio consists of loans to residential builders, housing developers, and for commercial building projects. The Bank recognizes that successful construction lending is dependent upon the successful completion of construction contracts and good management of the construction company. Construction loans are generally made on properties which have been sold on contract. Loans are secured by first lien positions on the real estate and have loan to value ratios between 50% - 80% of appraised value. These loans are usually processed through a title company construction escrow. Terms generally range from six months to three years. The Bank attempts to minimize the risk of construction lending by granting credit to established customers and restricting these loans to our market area. The Company increased its mortgage loan portfolio in 1996 as shown in table 5 by $8,611,000. A large percentage of the mortgages booked were commercial related mortgages that had initially been short-term commercial loans or construction loans in which the related projects were completed and transferred to mortgage loans. These commercial mortgages were primarily made at fixed rates with call features after five years. The home equity loan program, classified as real estate-mortgage in table 5, is a product that allows consumers to use the equity in their homes to finance purchases and to receive an interest deduction on their tax return. This product is new since the 1986 Reform Act phased out interest deductions on consumer loans. The interest deduction has made this product an attractive alternative to traditional consumer financing and is a product that the Company expects to grow in the future. The home equity portfolio continued to grow during 1996 with balances of approximately $13.0 million at December 31, 1996, an increase of 11.3% over last year. At First Federal, mortgage loans originated for sale increased to $9.2 million in 1996 from $8.3 million in 1995. First Federal's loans originated for sale are normally sold through the Federal Home Loan Mortgage Corporation (FHLMC) gold or Federal National Mortgage Association (FNMA) live pricing programs. Mortgage loans originated and held for sale in the secondary market are carried at the lower of cost, net of loan fees collected, or estimated market value in the aggregate. These loans are Company financed mortgage loans awaiting sale to FHLMC or FNMA. The sale generally occurs approximately three days after funding. Loans held for sale on December 31, 1996 and 1995 were $893,000 and $3,641,000, and are classified as real estate mortgage loans. The Company services the mortgages sold on the secondary market, which generates additional fee income. The unpaid principal balances of these loans at December 31, 1996 and 1995 were $65.3 million and $64.5 million. Installment lending decreased by $1.7 million during 1996, a decline of 15.6%, as consumers were provided with lower cost loan incentives to purchase consumer goods. Prior to 1995, half of the consumer loan portfolio was made up of indirect automobile paper. At December 31, 1996 this percentage had decreased to less than 15%. There are three primary factors for the decline in indirect paper that have negatively impacted consumer loan volume. Dealer incentives have driven the interest rate spread lower, the customer has lost the interest deduction for taxes, and other institutions have securitized these portfolios for sale in the bond market, thereby making loan rates unattractive. It is expected that the consumer loan portfolio will decline in 1997, but at a smaller rate. The Company has a small direct lease financing portfolio, which increased in 1996 to $999,000. While the Company does not presently solicit leasing business, the Company does occasional make leases to provide customers with financial alternatives. _______________________________________________________________________________ MATURITY OF LOANS Table 6 highlights the maturity distribution of the Company's loan portfolio, excluding mortgage and installment loans. The short-term sensitivity of the portfolio to interest rate changes is reflected in the fact that approximately 53.1% of the loans are scheduled to mature or are subject to rate change within one year. Of the remaining loans maturing beyond one year, 73.2% of that total are loans subject to immediate repricing. Page 29 TABLE 6 LOAN MATURITY SCHEDULE
MATURING AFTER ($ 000'S) LESS THAN OR 1 YR.AND LESS THAN MATURING AS OF DECEMBER 31, 1996 EQUAL TO 1 YR. OR EQUAL TO 5 YRS. AFTER 5 YRS. TOTAL - ----------------------- -------------- ------------------- ------------ ----- Commercial $22,083 $23,710 $4,969 $50,762 Real estate-construction 19,180 5,140 2,585 26,905 ------- ------- ------ ------- Total $41,263 $28,850 $7,554 $77,667 ------- ------- ------ ------- ------- ------- ------ ------- Percent of total 53.13% 37.15% 9.72% 100.00% ------- ------- ------ ------- ------- ------- ------ -------
Commercial and construction loans maturing after one year: Fixed rate $ 9,746 Variable rate 26,658 ------- Total $36,404 ------- ------- Real estate-construction loans reflect the contractual maturity of the related note. Due to anticipated rollovers of real estate-construction notes, management estimates that the loans will actually mature between one and five years based upon the related types of construction. Loans that mature within one year are considered to be variable rate loans as they can be repriced upon maturity. _______________________________________________________________________________ NON-PERFORMING ASSETS Non-performing assets consist of non-performing loans and other real estate owned. Non-performing loans, which include impaired loans, are: (1) loans accounted for on a non-interest accrual basis; (2) accruing loans contractually past due ninety days or more as to interest or principal payment; and (3) loans with terms that have been renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the financial condition of the borrower. Total non-performing loans at December 31, 1996 were $1,166,000. Impaired loans, as defined by Statement of Financial Accounting Standards (SFAS) No. 114 and No. 118, are included in non-performing loans and totaled $828,000 and $5,161,000 at December 31, 1996 and December 31, 1995. SFAS No. 114 and No. 118 became effective January 1, 1995 and consider a loan to be impaired if full principal or interest payments are not anticipated. Impaired loans are carried at the present value of expected cash flows discounted at the loan's effective interest rate or at the fair value of the collateral, if the loan is collateral dependent. At December 31, 1996 approximately 3.0% of the allowance for loan losses is specifically allocated for impaired loans as compared to 21.6% at December 31, 1995. Other real estate owned includes assets acquired through loan foreclosure and repossession. The carrying value of other real estate owned is reviewed by management at least quarterly to assure the reasonableness of its carrying value, which is lower of cost (fair value at date of foreclosure) or fair value less estimated selling costs. Loans are placed in nonaccrual status when they are 90 days past due, unless they are fully secured and in the process of collection. As illustrated in table 7, non-performing assets decreased significantly by $5,644,000 or 58.5% in 1996. This reduction follows a slight decrease of $163,000, or 1.7% in 1995. The loans on nonaccrual status decreased to $1,108,000 in 1996 from $5,692,000 in 1995. Loans 90 days or more past due still accruing were reduced to $58,000 in 1996 as compared to $1,653,000 in 1995. These reductions can be primarily attributed to the Company charging off $1,141,000 in loans and the foreclosure and transfer of $2,432,000 in loans to other real estate owned during 1996. Collection efforts resulted in additional payoffs or the bringing of payments up to date on nonaccrual loans or 90 days or more past due still accruing loans, which further reduced the non-performing loans at December 31, 1996. During 1996, the Company resumed accruing interest on a loan that was classified as nonaccrual as of December 31, 1995. This loan was delinquent in prior years, which prompted classification as nonaccrual. However, all payments were brought current and the loan was being paid in accordance with the loan agreement during 1996. Therefore, the loan was returned to accrual status in the third quarter of 1996 and the Company recorded $494,000 of previously unrecognized interest income. Despite the foreclosure and transfer of $2.4 million of loans to other real estate owned during 1996, other real estate owned increased only $535,000 at December 31, 1996. The Company was able to liquidate a major portion of its other real estate, realizing sale proceeds of $2.2 million with gains of $305,000 on the sale of other real estate owned in 1996. Management continues to be conservative in placing loans on nonaccrual status. This conservative approach eliminates any unearned interest income which would inflate the Company's earnings. Management will continue its emphasis on the collection of all non-performing loans, including the collection of unpaid interest. On December 31, 1996, one piece of property accounted for approximately 62.6% of the total of other real estate owned. The property was acquired by the Bank through the receipt of a deed in lieu of foreclosure in 1987. The parcel consists of approximately 525,000 square feet of land situated on Lake Michigan in Waukegan. During 1994, a purchase agreement for the property, along with some neighboring parcels, was negotiated for an amount that satisfies the current carrying value. The agreement provides for the sale of the property and provides for a fee to be paid to the Bank for the agreement and any 6 month extensions of the agreement. During 1996 all option and extension fees have been received by the Bank at the appropriate time and the agreement remains in force. Conditions necessary to finalize the purchase include approvals from the City of Waukegan and favorable legislative action by the State of Illinois Senate and House of Representatives. It is still uncertain as to when the state legislature will consider approval of the required legislation. Management continues to emphasize the early identification of loan related problems. Management is not currently aware of any other significant loan, group of loans, or segment of the loan portfolio not included in the discussion above as to which there are serious doubts as to the ability of the borrower(s) to comply with the present loan payment terms. There were no other interest-bearing assets at December 31, 1996 that would be required to be disclosed as non-performing if such assets were loans. Page 30 TABLE 7 NON-PERFORMING ASSETS $000'S)
DECEMBER 31, 1996 1995 1994 1993 1992 - ------------ ---- ---- ---- ---- ---- LOANS Nonaccrual status $1,108 $5,692 $4,912 $ 7,873 $2,962 90 days or more past due, still accruing 58 1,653 2,179 557 519 ------ ------ ------ ------- ------ Total non-performing loans 1,166 7,345 7,091 8,430 3,481 Other real estate owned 2,846 2,311 2,728 2,891 3,607 ------ ------ ------ ------- ------ Total non-performing assets $4,012 $9,656 $9,819 $11,321 $7,088 ------ ------ ------ ------- ------ ------ ------ ------ ------- ------ Non-performing loans as a percentage of total loans, net of unearned income and deferred loan fees .50% 3.24% 3.27% 3.83% 1.50% Non-performing assets as a percentage of total assets .94 2.25 2.39 2.72 1.72 Non-performing loans as a percentage of the allowance for loan losses 24.10 161.74 178.84 223.96 123.92
Loans are placed in nonaccrual status when they are 90 days past due, unless they are fully secured and in the process of collection. Impaired Loans - At December 31, 1996 and 1995 impaired loans totaled $828 and $5,161 and are included in nonaccrual loans. Potential Problem Loans - At December 31, 1996 there were no other loans classified as problem loans that are not included above. Other Problem Assets - At December 31, 1996, there were no other classified assets, including direct lease financing, other than the loans and other real estate owned shown above. _______________________________________________________________________________ PROVISION FOR LOAN LOSSES A provision is credited to an allowance for loan losses, which is maintained at a level considered by management to be adequate to absorb future loan losses. The adequacy of the loan loss allowance is analyzed at least quarterly. Factors considered in assessing the adequacy of the allowance include: changes in the type and volume of the loan portfolio; review of the larger credits within each subsidiary; historical loss experience; current economic trends and conditions; review of the present value of expected cash flows and fair value of collateral on impaired loans; loan growth; and other factors management deems appropriate. As mentioned previously, SFAS No. 114 and SFAS No. 118 were adopted in January, 1995. The standards require management to discount impaired loans based on expected cash flows or collateral values. A portion of the allowance for loan losses is then allocated to each impaired loan. Throughout the year, management determines the level of provision necessary to maintain an adequate allowance based upon current conditions and outstanding loan volumes. The level of non-performing loans at December 31, 1996 was significantly lower than the Company's historical average between 1995 and 1992. Therefore, management during 1996 lowered the loan loss provision to $1,190,000 from $1,480,000 in 1995 which was increased from $1,440,000 in 1994. If the level of non-performing assets remains low in 1997 it is expected that there will be further reductions to the loan loss provision. In 1996, the loan loss provision of $1,190,000 exceeded actual net charged-off loans by $325,000. As a result, the allowance for loan losses increased to 2.08% of total loans outstanding at December 31, 1996 from 2.00% of total loans outstanding at December 31, 1995. First Federal has experienced few loan losses in its history; therefore, like most savings institutions, it had little or no loan loss allowance prior to 1990. Management recognizes the importance of having a general allowance for loan losses at the Thrift and has built its allowance to $1,138,000 or 1.7% of total loans compared to 1.4% of total loans last year. The Bank's allowance as a percentage of loans on December 31, 1996 was 2.2% of total loans outstanding, compared to 2.3% on December 31, 1995. Table 8 indicates the types of loans charged-off and recovered for the five years ending in 1996 as well as each year's provision. Because management is not certain as to the full collectibility of the non-performing loans, potential loss exposure has been provided in the Company's allocation of the allowance for loan losses. As illustrated in table 9, the unallocated portion of the allowance, the portion of the allowance that is not specifically reserved for any particular problem credit, was 59.0% of the total allowance at December 31, 1996 as compared to an average of 36.9% over the previous four years. The December 31, 1996 increase in the level of unallocated allowance was a result of management's assessment of non-performing loans which required a lesser percentage of the allowance to be allocated to those credits identified as impaired per SFAS No. 114 and No. 118. The allocation of the allowance for installment loans continued to decline from the previous years' levels due to the continued decline in the installment portfolio. The allocation for real estate-construction loans declined significantly by $543,000 due to the reduction in non-performing real estate-construction loans during 1996 due to collection efforts which included foreclosure and transferring of loans to other real estate owned. The allocation for commercial loans for similar reasons was reduced in 1996. The allocation of the allowance for mortgage loans increased during 1996 by $165,000 as a result of the increases made in the mortgage loan portfolio. Based upon management's analysis, the allowance for loan losses at December 31, 1996, is adequate to cover future possible loan losses. Page 31 TABLE 8 ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES ($000'S)
YEARS ENDED DECEMBER 31, 1996 1995 1994 1993 1992 - ------------------------ ---- ---- ---- ---- ---- Balance at the beginning of year $4,514 $3,965 $3,764 $2,809 $2,296 ------ ------ ------ ------ ------ Charge-offs: Commercial 288 145 687 488 946 Real estate-construction 523 334 22 8 0 Real estate-mortgage 145 473 496 0 13 Installment 185 57 110 147 245 ------ ------ ------ ------ ------ Total charge-offs 1,141 1,009 1,315 643 1,204 ------ ------ ------ ------ ------ Recoveries: Commercial 183 18 9 14 125 Real estate-construction 50 0 0 0 0 Real estate-mortgage 0 0 0 0 0 Installment 43 60 67 103 118 ------ ------ ------ ------ ------ Total recoveries 276 78 76 117 243 ------ ------ ------ ------ ------ Net charge-offs 865 931 1,239 526 961 ------ ------ ------ ------ ------ Additions charged to operations 1,190 1,480 1,440 1,481 1,474 ------ ------ ------ ------ ------ Balance at end of year $4,839 $4,514 $3,965 $3,764 $2,809 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Allowance as a % of total loans, net of unearned income and deferred loan fees 2.08% 2.00% 1.83% 1.71% 1.21% ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Net charge-offs during the year to average loans outstanding during the year .37% 0.42% 0.58% 0.23% 0.40% ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
In addition to management's assessment, loans are examined periodically by federal and state banking authorities. TABLE 9 ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES ($000'S)
DECEMBER 31, 1996 1995 1994 - ----------- --------------------- --------------------- ----------------------- PERCENT OF PERCENT OF PERCENT OF LOANS IN EACH LOANS IN EACH LOANS IN EACH CATEGORY TO CATEGORY TO CATEGORY TO AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS ------ ------------- ------ ------------- ------ ------------- Commercial $ 947 21.75% $1,741 23.80% $1,468 23.14% Real estate-construction 184 11.53 727 10.47 168 10.00 Real estate-mortgage 809 62.78 644 60.92 813 60.87 Installment 45 3.94 87 4.81 116 5.99 Unallocated 2,854 NA 1,315 NA 1,400 NA ------ ------- ------ ------- ------ ------- Total $4,839 100.00% $4,514 100.00% $3,965 100.00% ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ -------
DECEMBER 31, 1993 1992 - ----------- --------------------- --------------------- PERCENT OF PERCENT OF LOANS IN EACH LOANS IN EACH CATEGORY TO CATEGORY TO AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS ------ ------------- ------ ------------- Commercial $1,553 24.77% $ 865 24.00% Real estate-construction 95 8.90 50 7.82 Real estate-mortgage 609 61.02 224 61.46 Installment 138 5.31 206 6.72 Unallocated 1,369 NA 1,464 NA ------ ------- ------ ------- Total $3,764 100.00% $2,809 100.00% ------ ------- ------ ------- ------ ------- ------ -------
Page 32 NONINTEREST INCOME Noninterest income increased by $537,000 or 19.9% during 1996 following a decrease of $62,000 or 2.2% during 1995. Service fees on deposits declined by $76,000 in 1996. The major portion of this decline occurred at the Bank where overdraft fee income fell $66,000 from 1995 as average customer demand deposit balances increased in 1996 from 1995. Trust income increased $62,000 or 13.4% from the same period in 1995 due to increased fees and additional trust business. During 1996 a sale of equity securities classified as available-for-sale took place at the Thrift for liquidity purposes which realized proceeds of $2,675,000 and a resulting gain of $5,000. Effective January 1, 1996 the Company adopted SFAS No. 122, "Accounting for Mortgage Servicing Rights." For mortgage sales during 1996 a cost basis or value was added to the servicing rights which resulted in additional net gains on the sale of loans of approximately $96,000. Total net gains on sales of loans were $210,000 for 1996 an increase of $85,000 over 1995 which had declined $194,000 from 1994. Other operating income rose $461,000 or 67.5% in 1996. The majority of this increase is attributable to the Company booking, during 1996, gains on sales of other real estate owned totaling $305,000. Other income also increased $131,000 due to the one-time collection of back interest and fees on a loan in excess of the amount charged off by the Bank. Comparing 1995 to 1994, noninterest income declined slightly by $62,000 or 2.2%. Much of the decrease is attributable to declines in gains on loans sold which decreased $194,000 in 1995 from 1994. This is the result of higher loan interest rates in 1995 which created lower levels of home mortgage refinancing. Loans originated for sale at First Federal decreased in 1995 to $8.2 million from $15.4 million in 1994. Service fees on deposits remained stable in 1995 increasing only $8,000 from 1994. Trust fees declined due to decreased fiduciary activity levels in 1995 as compared to 1994. The decrease amounted to $91,000 or 16.5%. Other operating income rose $147,000 in 1995 from 1994. Much of this increase was attributable to gains on sales of other real estate owned totaling $93,000. _______________________________________________________________________________ NONINTEREST EXPENSES In 1996, total noninterest expenses remained stable and declined slightly by $61,000 to $10,372,000. Over the last three years total other expenses averaged $10,605,000 as the Company emphasized its desire to control operating expenses. As a percent of average assets, noninterest expense was 2.5% in 1996 compared to 2.6% in 1995 and 2.7% in 1994. Compared to its bank holding company peers, the Company's ability to control overhead expenses is one of its operating strengths. Salaries and other employee expenses decreased $222,000 or 3.9% in 1996. This decrease is primarily related to First Federal, which continued to experience staff reductions during 1996 due to increased efficiencies. No layoffs of staff occurred, but as employees left or retired their responsibilities were closely examined by management and delegated to others if possible. Benefit costs were approximately the same in 1996 as 1995 and 1994. Management will continue to monitor this expense closely in 1997 and seek out ways to increase efficiencies. Management expects that the decline in salaries and other employee expenses will not continue to the extent that it has in 1996 and 1995 and expects an approximate increase of 4.0% during 1997 in this area. Occupancy expenses declined slightly by $32,000 or 2.4% during 1996 as compared to the same period in 1995. This is the result of a reduction of depreciation expense of $41,000 which occurred at the Thrift as building and equipment became fully depreciated. Data processing expense increased $15,000 or 2.8% during 1996 as compared to the same period in 1995. This is due to a small increase in our data processing service bureau charges. It is expected that data processing expenses will increase 4.5% in 1997 due to contractual yearly data processing service bureau price increases and data processing disaster plan implementation. FDIC deposit insurance expense increased significantly in 1996 by $334,000 or 69.2% as compared to 1995. This increase is a result of First Federal booking a $603,000 one-time FDIC expense due to legislation requiring recapitalization of the FDIC Savings Association Insurance Fund (SAIF) during 1996. The Bank had only nominal FDIC insurance premiums during 1996 as the Bank Insurance Fund (BIF) was fully funded. With both FDIC SAIF and BIF being funded it is expected that FDIC expense in 1997 will decline significantly. Other real estate owned expenses increased $51,000 or 29.7% during 1996 compared to last year due to the increase in transfers of loans to other real estate owned which occurred in 1996. During 1996, loans totaling $2,432,000 were transferred to other real estate owned compared to $981,000 during 1995. Balances held in other real estate owned increased $535,000 at December 31, 1996 as compared to December 31, 1995. Other operating expenses for 1996 declined by $207,000 or 9.3% as compared to last year. Much of this decrease is attributable to one-time expenses during the early Page 33 NONINTEREST EXPENSES (CONTINUED) part of 1995 related to the conversion to a new data processing service bureau and the installation of new data processing equipment that went along with the conversion. Printing and supplies declined $31,000 as last year new forms had to be ordered for the new data processing system. Professional fees declined $110,000 as consultants were used during the conversion to assist and train Company personnel on the new system and equipment. Other expenses related to the employment of new employees decreased $21,000 in 1996 and other expenses pertaining to goodwill decreased $24,000 as goodwill associated with the purchase of a branch office were fully amortized in 1995. Comparing 1995 to 1994, total noninterest expenses declined $577,000 or 5.2% to $10,433,000. Salaries and other employee expenses decreased $233,000 or 3.9% in 1995. This decrease from 1994 resulted from staff reductions at First Federal due to increased efficiencies. No layoffs of staff occurred, but management closely scrutinized job responsibilities as employees left or retired and whenever possible the job tasks were delegated to others. Occupancy expenses increased $116,000 during 1995 as compared to 1994. This is the result of new equipment purchases made during the fourth quarter of 1994 in which a full years depreciation was taken in 1995 and increased maintenance costs which were incurred in 1995 as the warranty period ended. Data processing expense declined $181,000 or 25.6% during 1995 compared to the same period in 1994 due to lower data processing service bureau charges brought about by utilizing a new data processing service bureau and by putting all Subsidiaries on the same data processing system. The data processing conversion took place in the fourth quarter in 1994 at both the Bank and the Thrift. FDIC deposit insurance expense declined significantly in 1995 by $301,000 or 38.4% as compared to 1994. This decrease is a result of the FDIC deposit Bank Insurance Fund (BIF) becoming fully funded during 1995 with the FDIC issuing banks a one time refund of which the Bank received a refund of $137,000. As a result of the funding of the BIF the 1995 Bank FDIC insurance premiums were also significantly reduced. Other real estate owned expenses decreased $36,000 or 17.31% during 1995 compared to 1994. This is the result of lower balances held in other real estate owned which declined $417,000 at December 31, 1995 as compared to December 31, 1994, a decrease of 15.3%. Other operating expenses for 1995 increased slightly by $58,000 or 2.7% as compared to the previous year. The Company experienced increases to professional and consulting fees of $114,000 during 1995 related to the changes to our operations during 1995 as a result of the data processing conversion which occurred during the fourth quarter of 1994. Business development expenses decreased $35,000 during 1995 as the Bank and Thrift were able in certain situations experience economies of scale through combined advertising. _______________________________________________________________________________ FEDERAL AND STATE INCOME TAXES For the years ended December 31, 1996 and 1995, the Company's provision for federal and state taxes as a percentage of pretax earnings were 29.6% and 29.2%. The actual tax rates differ from the statutory rates because the pretax earnings include significant amounts of interest on United States Government securities, which are nontaxable for state income tax purposes, qualified interest on loans to local political subdivisions, which are nontaxable for federal income tax purposes, and interest on qualified state and local political subdivision securities, which are nontaxable for federal income tax purposes. Page 34 TABLE 10 MATURITY OR REPRICING OF ASSETS AND LIABILITIES
SUBJECT TO REPRICING WITHIN ----------------------------------------------------------------------------- ($000)s IMMEDIATE 91 DAYS 181 DAYS 1 - 3 3 - 5 5 - 10 DECEMBER 31, 1996 BALANCES TO 90 DAYS TO 180 DAYS TO 365 DAYS YEARS YEARS YEARS - ----------------- -------- ---------- ----------- ----------- ----- ----- ----- Assets: Interest-bearing deposits in financial institutions $ 1,335 $ 1,235 $ 0 $ 0 $ 0 $ 0 $ 100 Federal funds sold 15,500 15,500 0 0 0 0 0 Securities: U.S. Treasury 16,114 4,009 3,020 4,004 5,081 0 0 U.S. Government agencies and corporations 89,604 9,073 0 0 18,628 56,884 5,019 States & political subdivisions 25,482 185 284 1,816 5,676 9,054 8,467 Equity securities 2,120 1,622 498 0 0 0 0 Mortgage-backed securities (1) 16,430 5,519 78 3,012 6,185 1,636 0 Loans: Commercial 50,762 39,009 274 1,098 2,988 6,804 589 Real estate - construction 26,905 25,479 1,054 122 0 0 250 Real estate - mortgage 146,552 57,559 6,580 5,155 27,480 29,957 19,821 Installment, net of unearned income 8,963 3,608 736 1,094 2,208 1,220 97 Direct lease financing 999 325 30 120 290 234 0 -------- -------- ------- ------- ------- --------- ------- TOTAL INTEREST-EARNING ASSETS $400,766 $163,123 $12,554 $16,421 $68,536 $105,789 $34,343 -------- -------- ------- ------- ------- --------- ------- -------- -------- ------- ------- ------- --------- ------- Liabilities: Now accounts $ 38,159 $ 38,159 $ 0 $ 0 $ 0 $ 0 $ 0 Money market accounts 44,426 44,426 0 0 0 0 0 Savings 44,843 44,843 0 0 0 0 0 Time deposits, $100,000 and over 69,052 31,814 22,348 11,105 3,785 0 0 Time deposits, under $100,000 89,092 34,392 18,973 19,517 16,015 184 11 Other interest-bearing liabilities 36,758 25,918 4,515 3,225 3,100 0 0 -------- -------- ------- ------- ------- --------- ------- TOTAL INTEREST-BEARING LIABILITIES $322,330 $219,552 $ 45,836 $ 33,847 $22,900 $ 184 $ 11 -------- -------- ------- ------- ------- --------- ------- -------- -------- ------- ------- ------- --------- ------- EXCESS INTEREST-EARNING ASSETS (LIABILITIES) $(56,429) $ (33,282) $(17,426) $45,636 $105,605 $34,332 CUMULATIVE EXCESS INTEREST-EARNING ASSETS (LIABILITIES) (56,429) (89,711) (107,137) (61,501) 44,104 78,436 CUMULATIVE INTEREST RATE SENSITIVITY RATIO (2) 0.74 0.66 0.64 0.81 1.14 1.24
(1) Mortgage-backed securities reflect the time horizon when these financial instruments are subject to rate change or repricing. (2) Interest-earning assets divided by interest-bearing liabilities. This table does not necessarily indicate the impact of general interest rate movements on the Company's net interest income because the repricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures. As a result, assets and liabilities indicated as repricing within the same period may in fact reprice at different times and at different rate levels. Page 35 NORTHERN STATES FINANCIAL CORPORATION - -------------------------------------------------------------------------------- LIQUIDITY AND INTEREST RATE SENSITIVITY ANALYSIS The primary functions of asset/liability management are to assure adequate liquidity and maintain an appropriate balance between interest sensitive earning assets and interest-bearing liabilities. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income. The Company's gap position is illustrated in table 10. Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers knowing that sufficient funds will be available to meet their credit needs. In addition to federal funds sold and interest-bearing deposits in banks, marketable securities, particularly those of shorter maturities, are a principal source of asset liquidity. The Company classifies all of its securities as available-for-sale which increases the Company's flexibility in that the Company can sell any of its unpledged securities to meet liquidity requirements. Securities available-for-sale amounted to $149,750,000 at December 31, 1996, representing 100% of the securities portfolio. Securities at December 31, 1996 in the amount of $97,052,000 were pledged to secure public deposits and repurchase agreements. Rate sensitivity varies with different types of interest-earning assets and interest-bearing liabilities. Federal funds sold on which the rate varies daily and loans tied to the prime rate differ considerably from long-term securities and fixed rate loans. Time deposits over $100,000 are more rate sensitive than savings accounts. Management has portrayed savings accounts as immediately repriceable, because of management's ability to change the savings interest rate. Table 11 illustrates the maturity schedule as of December 31, 1996 of the time deposits $100,000 and over portfolio. As shown, 5.5% of the time deposits $100,000 and over mature after a year. At December 31, 1995, 16.5% of time deposits matured after a year showing a shift by large time deposit customers to shorter term certificates of deposit. This shortening of maturity lengths on time deposits of $100,000 and over has increased the Company's negative gap position in 1996. The Company historically has a high level of time deposits and other borrowings over $100,000. As of December 31, 1996, time deposits and other borrowings over $100,000 were 28.9% of total deposits and other borrowings, a slight increase from the 28.5% total in 1995. This level of deposits and borrowings is stable and has not fluctuated significantly year-to-year. Being located in the county seat, the Company accepts time deposits over $100,000 from various government agencies. With 53.8% of the Company's loan portfolio floating with the prime rate or repriceable within 90 days, the effect on interest income when rates rise or fall is felt quickly while expense changes more slowly as certificates of deposit mature. As the gap table shows, the Company is liability sensitive through the three year time horizon by $61.5 million. This is a change from last year, where the Company was liability sensitive through the three year time horizon by $40.5 million. Although management has attempted during the past year to reduce its liability sensitive gap position, its efforts continue to be restricted by competitive pressures in the area of commercial and commercial real estate loans which have increased the level of fixed rate loans with intermediate term balloon maturities at the Bank. The Bank has increased the maturity time horizon on its securities by purchasing intermediate term U.S. Government agency securities that have call provisions in order to maximize yields on its securities portfolio. Management has continued its efforts to reduced its liability sensitive position at First Federal by continuing to sell a majority of fixed rate loans originated there. First Federal continues to maintain fixed rate business and nonconforming owner-occupied residential real estate and ARM loans in its portfolio. It is management's desire to reduce the liability gap position during the upcoming year. - -------------------------------------------------------------------------------- TABLE 11 TIME DEPOSITS, $100,000 AND OVER MATURITY SCHEDULE
GREATER THAN GREATER THAN ($ 000's) LESS THAN OR 3 MOS. & LESS THAN 6 MOS. & LESS THAN GREATER THAN AS OF DECEMBER 31, 1996 EQUAL TO 3 MOS. OR EQUAL TO 6 MOS. OR EQUAL TO 12 MOS. 12 MOS. TOTAL - ---------------------------------------------------------------------------------------------------------------------------------- Time deposits, $100,000 and over: Retail deposits $ 11,039 $ 6,212 $ 6,837 $ 2,518 $ 26,606 Corporate deposits 5,618 8,298 550 950 15,416 Public fund deposits 15,157 7,838 3,718 317 27,030 ------------------------------------------------------------------------------------------ Total time deposits, $100,000 and over $ 31,814 $ 22,348 $ 11,105 $ 3,785 $ 69,052 ------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------
The Company has no foreign banking offices or deposits. Page 36 - -------------------------------------------------------------------------------- SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER SHORT-TERM BORROWINGS Securities sold under repurchase agreements (repurchase agreements) and other short-term borrowings during 1996 have continued to be an alternative to certificates of deposit as a source of funds. At December 31, 1996 the Company had other borrowings balances of $36,758,000 which were entirely made up of repurchase agreements. Most municipalities, other public entities and some other organizations, require that their funds are insured or collateralized as a matter of their policies. Commercial depositors also find the collateralization of repurchase agreements attractive as an alternative to certificates of deposits. Repurchase agreements provide a source of funds and do not increase the Company's reserve requirements with the Federal Reserve Bank or create an expense relating to FDIC insurance. Repurchase agreements consequently are less costly to the Company. Management expects to continue to offer repurchase agreements as an alternative to certificates of deposit in the future. Table 12 shows that the average balances of repurchase agreements increased $373,000 in 1996 after an increase of $8.5 million in 1995. Growth slowed in repurchase agreements at the Bank. This decline in growth is because as the Bank's FDIC insurance rate declined the rate differential between repurchase agreements and certificates of deposit narrowed making repurchase agreements less attractive in 1996 than in previous years. Table 12 provides information as to balances and interest rates pertaining to securities sold under repurchase agreements and other short-term borrowings. - -------------------------------------------------------------------------------- TABLE 12 SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER SHORT-TERM BORROWINGS
($ 000's) AT OR FOR THE YEAR ENDED DECEMBER 31, 1996 1995 1994 - --------------------------------------------------------------------------------------------------------- Balance at end of year $ 36,758 $ 43,278 $ 30,654 Weighted average interest rate at end of year 4.93% 5.28% 4.62% Maximum amount outstanding $ 44,135 $ 78,116 $ 37,891 Average amount outstanding 35,006 34,633 26,086 Weighted average interest rate 4.92% 5.41% 4.15%
- -------------------------------------------------------------------------------- CAPITAL RESOURCES Capital provides the foundation for future growth. Regulatory agencies have developed minimum guidelines by which the adequacy of a financial institution's capital may be evaluated. Northern States' capital ratios exceed these minimum guidelines, both in terms of Tier I capital (stockholders' equity of the Company less intangible assets), and in terms of Tier II capital (Tier I capital plus qualifying long-term debt and the allowance for loan losses). The portion of the allowance for loan losses qualifying as Tier II capital is limited to 1.25% of risk weighted assets. The effect of the unrealized gains (losses) on securities available-for-sale is excluded from the capital ratio calculations. The Company has never had any long-term debt outstanding. Regulatory capital guidelines require that the amount of capital increase with the amount of risk inherent in a company's balance sheet and off-balance sheet exposure. Capital requirements in order for the Company to be considered well capitalized are that Tier I capital to average assets must be 5.00% and Tier I capital to risk weighted assets must be 6.00%. The requirements are that Tier II capital must be 10.00% of risk adjusted assets in order for the Company to be considered well capitalized. All of the Company's capital ratios exceed the level required under regulatory guidelines as shown in table 13. Page 37 - -------------------------------------------------------------------------------- TABLE 13 CAPITAL STANDARDS ($ 000'S) AS OF DECEMBER 31, 1996 TIER I CAPITAL: - --------------- Common stock $ 1,779 Surplus 11,216 Retained earnings 41,849 Less - Intangible assets (140) --------- TOTAL QUALIFYING TIER I CAPITAL 54,704 QUALIFYING FOR TIER II CAPITAL: - ------------------------------- Allowance for loan losses 3,432 --------- TOTAL QUALIFYING TIER II CAPITAL $ 58,136 --------- --------- TOTAL ASSETS $ 426,597 --------- --------- RISK-BASED ASSETS TOTAL RISK-BASED - --------------------------------------------------------------------------- Zero percent risk $ 21,304 $ 0 ------------------------ Twenty percent risk 158,339 31,668 Fifty percent risk 106,618 53,309 One hundred percent risk (1) 189,565 189,565 ------------------------ TOTAL RISK-WEIGHTED ASSETS $ 475,826 $ 274,542 ------------------------ ------------------------ (1) Includes off-balance-sheet items CAPITAL REQUIREMENTS $ % - --------------------------------------------------------------------------- (Tier I Capital to Average Assets) REQUIRED $ 21,005 5.00% ACTUAL 54,704 13.02 RISK-BASED CAPITAL: Tier I: REQUIRED $ 16,473 6.00% ACTUAL 54,704 19.93 Tier II: REQUIRED $ 27,454 10.00% ------------------------ ACTUAL 58,136 21.18 ------------------------ ------------------------ Page 38 - -------------------------------------------------------------------------------- CASH FLOWS Cash flows from operating activities were greater than accrual basis net income by $6.2 million in 1996. In 1995, cash flows from operating income were below net income by $.2 million. In 1994, cash flows from operating income exceeded net income by $2.1 million. Cash flows from the change in loans held for sale significantly increased by $2.8 million in 1996. Management expects ongoing operating activities to continue to be a primary source of cash flow for the Company. Deposits increased $1.2 million or .38% in 1996. The Company has experienced a stable deposit level over the past several years, which has helped maintain an adequate level of cash for the Company's activities. While competition for deposits is expected to remain keen and future deposit growth cannot be predicted with any certainty, the Company plans to continue to actively seek profitable new deposit business. The increase in loans during 1996 provided greater interest income revenues for the Company. These increases to loans were funded through cash flows from operating activities, proceeds of maturities and sales of securities available-for-sale, and increases to deposits. To insure the ability to meet its funding needs, including any unexpected strain on liquidity, the Company has $20 million in federal funds lines of credit from two independent banks. In addition, the Company, through its Subsidiaries, also has the ability to borrow funds, if necessary, directly from the Federal Reserve Bank and the Federal Home Loan Bank. The Company has no notes payable or similar debt on its balance sheet. The lack of a debt service requirement allows the Company to use its funds for other operating purposes. Equity capital is in excess of regulatory requirements, as determined on both risk-based and leverage ratio criteria. Cash dividends have been a relatively modest percentage of net income for the past three years, ranging from 29.6% in 1996 to 28.7% in 1994. During 1996 the Bank made a $61,000 outlay for an updated new telephone system and $49,000 to replace 2 ATMs that were over 10 years old. During 1994, $700,000 was expended on new data processing equipment necessary as part of the Company's conversion to a new data processing service bureau. There are no planned significant capital outlays in 1997 which would be a significant burden on the Company's cash flows. - -------------------------------------------------------------------------------- RECENT ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities", was issued by the Financial Accounting Standards Board in 1996. It revises the accounting for transfers of financial assets, such as loans and securities, and for distinguishing between sales and secured borrowings. It is effective for some transactions in 1997 and others in 1998. The effect of on the financial statements has not yet been determined. Page 39 - -------------------------------------------------------------------------------- STATEMENT OF MANAGEMENT RESPONSIBILITY Northern States Financial Corporation's management is responsible for the accompanying consolidated financial statements which have been prepared in conformity with generally accepted accounting principles. They are based on our best estimates and judgments. Financial information elsewhere in this annual report is consistent with the data presented in these statements. We acknowledge the integrity and objectivity of published financial data. To this end, we maintain an accounting system and related internal controls which we believe sufficient in all material respects to provide reasonable assurance that financial records are reliable for preparing financial statements and that assets are safeguarded from loss or unauthorized use. Our independent auditing firm, Crowe, Chizek and Company LLP, provides an objective review as to management's discharge of its responsibilities insofar as they relate to the fairness of reported operating results and the financial condition of the Company. This firm obtains and maintains an understanding of our accounting and financial controls and employs such testing and verification procedures as it deems necessary to arrive at an opinion on the fairness of the consolidated financial statements. The Board of Directors pursues its responsibilities for the accompanying consolidated financial statements through its Audit Committee. The Committee meets periodically with Northern States Financial Corporation's internal auditor and/or independent auditors to review and approve the scope and timing of the internal and external audits and the findings therefrom. The Committee recommends to the Board of Directors the engagement of the independent auditors and the auditors have direct access to the Audit Committee. /s/ Fred Abdula /s/ Thomas M. Nemeth FRED ABDULA THOMAS M. NEMETH CHAIRMAN OF THE BOARD & CHIEF ASSISTANT VICE PRESIDENT EXECUTIVE OFFICER - -------------------------------------------------------------------------------- INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders Northern States Financial Corporation Waukegan, Illinois We have audited the accompanying consolidated balance sheets of NORTHERN STATES FINANCIAL CORPORATION as of December 31, 1996 and 1995 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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 NORTHERN STATES FINANCIAL CORPORATION as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. /s/ Crowe, Chizek and Company LLP CROWE, CHIZEK AND COMPANY LLP OAK BROOK, ILLINOIS FEBRUARY 13, 1997 Page 40 - -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS
($ 000's, EXCEPT PER SHARE DATA) DECEMBER 31, 1996 1995 - ------------------------------------------------------------------------------------------------------------------------ ASSETS Cash and due from banks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 15,247 $ 18,119 Interest-bearing deposits in financial institutions - maturities less than 90 days . . . . 1,235 355 Federal funds sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,500 15,500 ------------------------- Total cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31,982 33,974 Interest-bearing deposits in financial institutions - maturities over 90 days. . . . . . . 100 100 Securities available-for-sale. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149,750 155,170 Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232,653 225,379 Less: Allowance for loan losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,839) (4,514) ------------------------- Loans, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227,814 220,865 Direct lease financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 999 622 Office buildings and equipment, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,250 6,587 Other real estate owned, net of allowance for losses of $532 and $510. . . . . . . . . . . 2,846 2,311 Accrued interest receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,955 4,366 Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,868 3,896 ------------------------- Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 426,564 $ 427,891 ------------------------- ------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits Demand - noninterest-bearing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 43,223 $ 43,774 NOW accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,159 39,818 Money market accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,426 43,639 Savings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,843 47,259 Time, $100,000 and over. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69,052 62,309 Time, under $100,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89,092 90,756 ------------------------- Total deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 328,795 327,555 Securities sold under repurchase agreements and other short-term borrowings. . . . . . . . 36,758 43,278 Advances from borrowers for taxes and insurance. . . . . . . . . . . . . . . . . . . . . . 1,021 1,281 Accrued interest payable and other liabilities . . . . . . . . . . . . . . . . . . . . . . 5,155 4,772 ------------------------- Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 371,729 376,886 ------------------------- STOCKHOLDERS' EQUITY Common stock - $2 par value: 1,750,000 shares authorized; 889,273 and 887,431 shares issued and outstanding at December 31, 1996 and 1995. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,779 1,775 Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,216 11,123 Retained earnings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41,849 37,617 Unrealized gain (loss) on securities available-for-sale, net . . . . . . . . . . . . . . (9) 490 ------------------------- Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54,835 51,005 ------------------------- Total liabilities and stockholders' equity . . . . . . . . . . . . . . . . . . . . . . $ 426,564 $ 427,891 ------------------------- -------------------------
The accompanying notes are an integral part of these consolidated financial statements. Page 41 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF INCOME
($ 000's, EXCEPT PER SHARE DATA) YEARS ENDED DECEMBER 31, 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Loans (including fee income) . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 22,050 $ 21,567 $ 18,913 Securities Taxable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,663 7,313 6,428 Exempt from federal income tax . . . . . . . . . . . . . . . . . . . . . . . . . 1,188 1,156 1,249 Interest-bearing deposits in financial institutions. . . . . . . . . . . . . . . . 28 117 381 Bankers' acceptances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 21 Federal funds sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 742 740 383 ---------------------------------------- Total interest income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31,671 30,893 27,375 ---------------------------------------- INTEREST EXPENSE Time deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,720 8,381 6,349 Other deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,364 4,451 3,997 Other borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,724 1,873 1,083 ---------------------------------------- Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,808 14,705 11,429 ---------------------------------------- NET INTEREST INCOME. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,863 16,188 15,946 Provision for loan losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,190 1,480 1,440 ---------------------------------------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES. . . . . . . . . . . . . . . . . 15,673 14,708 14,506 ---------------------------------------- NONINTEREST INCOME Service fees on deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,357 1,433 1,425 Trust income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 523 461 552 Net security gains (losses). . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 0 (68) Net gains on sales of loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . 210 125 319 Other operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,144 683 536 ---------------------------------------- Total noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,239 2,702 2,764 ---------------------------------------- NONINTEREST EXPENSES Salaries and employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . . 5,477 5,699 5,932 Occupancy and equipment expenses, net. . . . . . . . . . . . . . . . . . . . . . . 1,301 1,333 1,217 Data processing expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 542 527 708 FDIC deposit insurance expense . . . . . . . . . . . . . . . . . . . . . . . . . . 817 483 784 Other real estate owned expenses . . . . . . . . . . . . . . . . . . . . . . . . . 223 172 208 Other operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,012 2,219 2,161 ---------------------------------------- Total noninterest expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,372 10,433 11,010 ---------------------------------------- INCOME BEFORE INCOME TAXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,540 6,977 6,260 Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,529 2,040 1,785 ---------------------------------------- NET INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,011 $ 4,937 $ 4,475 ---------------------------------------- ---------------------------------------- Earnings per common share. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6.76 $ 5.57 $ 5.05 Weighted average common shares outstanding . . . . . . . . . . . . . . . . . . . . . 888,913 887,081 886,131
The accompanying notes are an integral part of these consolidated financial statements. Page 42 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS
($ 000's) YEARS ENDED DECEMBER 31, 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,011 $ 4,937 $ 4,475 Adjustments to reconcile net income to cash from operating activities: Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 546 621 557 Provision for loan losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,190 1,480 1,440 Provision for losses on other real estate owned. . . . . . . . . . . . . . . . . 22 23 25 Amortization of unearned portion of restricted stock awards. . . . . . . . . . . 0 0 14 Deferred loan fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (172) (128) (95) Net (gain) loss on sales of securities . . . . . . . . . . . . . . . . . . . . . (5) 0 68 Net change in loans held for sale. . . . . . . . . . . . . . . . . . . . . . . . 2,863 (1,029) 851 Net gains on sales of loans. . . . . . . . . . . . . . . . . . . . . . . . . . . (115) (125) (319) Net gains on sales of other real estate owned. . . . . . . . . . . . . . . . . . (305) 0 0 Net change in interest receivable. . . . . . . . . . . . . . . . . . . . . . . . 411 (579) (756) Net change in interest payable . . . . . . . . . . . . . . . . . . . . . . . . . 342 428 373 Net change in other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,138 (656) (582) Net change in other liabilities. . . . . . . . . . . . . . . . . . . . . . . . . 290 (269) 565 ---------------------------------------- Net cash from operating activities . . . . . . . . . . . . . . . . . . . . . . 12,216 4,703 6,616 ---------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Net change in interest-bearing deposits in financial institutions - maturities over 90 days. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 4,100 13,895 Proceeds from sales of securities available-for-sale . . . . . . . . . . . . . . . 2,675 0 4,501 Proceeds from maturities of securities available-for-sale. . . . . . . . . . . . . 90,571 66,116 36,777 Proceeds from maturities of securities held-to-maturity. . . . . . . . . . . . . . 0 27,584 29,054 Purchases of securities available-for-sale . . . . . . . . . . . . . . . . . . . . (83,959) (49,799) (67,741) Purchases of securities held-to-maturity . . . . . . . . . . . . . . . . . . . . . 0 (45,642) (27,177) Change in loans made to customers. . . . . . . . . . . . . . . . . . . . . . . . . (17,847) (9,221) 537 Property and equipment expenditures. . . . . . . . . . . . . . . . . . . . . . . . (209) (97) (993) Net change in direct lease financing . . . . . . . . . . . . . . . . . . . . . . . (377) (249) 620 Proceeds from sales of other real estate owned . . . . . . . . . . . . . . . . . . 2,180 1,375 1,064 ---------------------------------------- Net cash from investing activities . . . . . . . . . . . . . . . . . . . . . . (6,966) (5,833) (9,463) ---------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Net change in: Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,240 (1,808) (19,997) Securities sold under repurchase agreements and other short-term borrowings. . . (6,520) 12,624 12,541 Advances from borrowers for taxes and insurance. . . . . . . . . . . . . . . . . (260) (255) 126 Net proceeds from exercise of stock options. . . . . . . . . . . . . . . . . . . . 77 54 0 Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,779) (1,463) (1,285) ---------------------------------------- Net cash from financing activities . . . . . . . . . . . . . . . . . . . . . . (7,242) 9,152 (8,615) ---------------------------------------- Net change in cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . (1,992) 8,022 (11,462) Cash and cash equivalents at beginning of year . . . . . . . . . . . . . . . . . . . 33,974 25,952 37,414 ---------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR . . . . . . . . . . . . . . . . . . . . . . $ 31,982 $ 33,974 $ 25,952 ---------------------------------------- ---------------------------------------- Supplemental disclosures Cash paid during the year for Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 14,466 $ 14,277 $ 11,056 Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,335 1,833 2,159 Noncash investing activities Transfers from loans to other real estate owned. . . . . . . . . . . . . . . . . 2,432 981 926 Transfers made from securities held-to-maturity to securities available-for-sale, at fair value. . . . . . . . . . . . . . . . . . . . . . . 0 97,319 0 Transfers made from tax-exempt loans to securities available-for-sale, at fair value. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,700 0 0
The accompanying notes are an integral part of these consolidated financial statements. Page 43 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
UNREALIZED GAIN (LOSS) ON ADDITIONAL SECURITIES UNEARNED TOTAL ($ 000's, EXCEPT PER SHARE DATA) COMMON PAID-IN RETAINED AVAILABLE, RESTRICTED STOCKHOLDERS' YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 STOCK CAPITAL EARNINGS FOR-SALE, NET STOCK AWARDS EQUITY - ------------------------------------------------------------------------------------------------------------------------------------ Balance, January 1, 1994 . . . . . . . . . . . $ 1,772 $ 11,050 $ 30,953 $ 37 $ (14) $ 43,798 Net income . . . . . . . . . . . . . . . . . . 4,475 4,475 Cash dividends ($1.45 per share) . . . . . . . (1,285) (1,285) Tax benefit from the increase in the fair value of restricted stock issued . . . . . . 4 4 Amortization of unearned portion of restricted stock awards . . . . . . . . . . . . . . . . 14 14 Unrealized net loss on securities available-for-sale . . . . . . . . . . . . . (1,306) (1,306) ------------------------------------------------------------------------------- Balance, December 31, 1994 . . . . . . . . . . 1,772 11,054 34,143 (1,269) 0 45,700 Net income . . . . . . . . . . . . . . . . . . 4,937 4,937 Cash dividends ($1.65 per share) . . . . . . . (1,463) (1,463) Exercise of stock options on 1,300 shares of common stock. . . . . . . . . . . . . . . 3 51 54 Tax benefit from the increase in the fair value of restricted stock issued . . . . . . 7 7 Tax benefit from the exercise of stock options 11 11 Transfer of securities from held-to-maturity to available-for-sale. . . . . . . . . . . . 473 473 Unrealized net gain on securities available-for-sale . . . . . . . . . . . . . 1,286 1,286 ------------------------------------------------------------------------------- Balance, December 31, 1995 . . . . . . . . . . 1,775 11,123 37,617 490 0 51,005 Net income . . . . . . . . . . . . . . . . . . 6,011 6,011 Cash dividends ($2.00 per share) . . . . . . . (1,779) (1,779) Exercise of stock options on 1,842 shares of common stock. . . . . . . . . . . . . . . 4 73 77 Tax benefit from the exercise of stock options 20 20 Unrealized net loss on securities available-for-sale . . . . . . . . . . . . . (499) (499) ------------------------------------------------------------------------------- Balance, December 31, 1996 . . . . . . . . . . $ 1,779 $ 11,216 $ 41,849 $ (9) $ 0 $ 54,835 ------------------------------------------------------------------------------- -------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. Page 44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995 & 1994 - -------------------------------------------------------------------------------- NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of Northern States Financial Corporation (Company) and its wholly owned subsidiaries, Bank of Waukegan (Bank) and First Federal Bank, fsb (Thrift). The Bank and the Thrift are referred to collectively as "the Subsidiaries". All significant intercompany transactions and balances have been eliminated in consolidation. NATURE OF OPERATIONS: The Company's and the Subsidiaries' revenues and assets are primarily from the banking industry. Loan customers are mainly located in Lake County, Illinois, and surrounding areas, and include a wide range of individuals, businesses, and other organizations. A major portion of loans are secured by various forms of collateral including real estate, business assets, consumer property, and other items. The Thrift also engages in mortgage banking operations. USE OF ESTIMATES: To prepare financial statements in conformity with generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The collectibility of loans, fair values of financial instruments, and status of contingencies are particularly subject to change. CASH FLOW REPORTING: Cash and cash equivalents are defined as cash and due from banks, federal funds sold, and interest-bearing deposits in financial institutions with original maturities under 90 days. Net cash flows are reported for customer loan and deposit transactions, securities sold under agreements to repurchase and other short-term borrowings, and interest bearing deposits in financial institutions with maturities over 90 days. SECURITIES: Securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities are classified as available-for-sale when they might be sold before maturity. Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported separately in shareholders' equity, net of tax. Securities are written down to fair value by charges to income when a decline in fair value is not temporary. Gains and losses on sales are determined using the amortized cost of the specific security sold. Interest income includes amortization of purchase premiums and discounts. As permitted by the Statement of Financial Accounting Standards (SFAS) No. 115 implementation guide released in 1995, the Company exercised a one time opportunity to reassess the appropriateness of the classifications of all securities held. Based on this review, the Company reclassified securities having an amortized cost of $96,547,000 and a net unrealized gain of $772,000 during 1995 from held-to-maturity to available-for-sale. LOANS HELD FOR SALE: Loans held for sale are reported at the lower of cost or market value in the aggregate. LOANS. Loans are reported at the principal balance outstanding, net of deferred loan fees and costs and the allowance for loan losses. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Interest income is not reported when full loan repayment is in doubt, typically when payments are past due over 90 days. Payments received on such loans are reported as principal reductions. ALLOWANCE FOR LOAN LOSSES. Because some loans may not be repaid in full, an allowance for loan losses is recorded. Increases to the allowance are recorded by a provision for loan losses charged to expense. Estimating the risk of loss and the amount of loss on any loan is necessarily subjective. Accordingly, the allowance is maintained by management at a level considered adequate to cover possible losses that are currently anticipated based on past loss experience, general economic conditions, information about specific borrower situations including their financial position and collateral values, and other factors and estimates which are subject to change over time. While management may periodically allocate portions of the allowance for specific problem loan situations, the whole allowance is available for any loan charge-offs that occur. A loan is charged-off by management as a loss when deemed uncollectible, although collection efforts continue and future recoveries may occur. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's and the Thrift's allowances for loan losses. Such agencies may require the Bank and the Thrift to provide additions to the allowance based on their judgements at the time of their examinations. SFAS No. 114 and No. 118 became effective January 1, 1995 regarding loan impairment. Loans are considered impaired if full principal or interest payments are not anticipated. Impaired loans are carried at the present value of expected cash flows discounted at the loan's effective interest rate or at fair value of the collateral if the loan is collateral dependent. Page 45 - -------------------------------------------------------------------------------- NOTE 1 (CONTINUED) A portion of the allowance for loan losses is allocated to impaired loans. The effect of adopting these new accounting standards was not material to the financial statements. Smaller-balance homogeneous loans are evaluated for impairment in total. Such loans include residential first mortgage loans secured by one-to-four family residences, residential construction loans, and automobile, home equity and second mortgage loans. Commercial loans and mortgage loans secured by other properties are evaluated individually for impairment. All loans in nonaccrual status and other selected watch list loans are considered impaired. Impaired loans or portions thereof are charged off when deemed uncollectible. The nature of disclosures for impaired loans is considered generally comparable to prior nonaccrual, renegotiated, non-performing and past-due loan disclosures. Increases or decreases in the valuation allowance for an impaired loan are reported as reductions or increases to the provision of loan losses. OFFICE BUILDINGS AND EQUIPMENT. Asset cost is reported net of accumulated depreciation. Depreciation expense is calculated on the straight-line method over asset useful lives. OTHER REAL ESTATE: Real estate acquired in settlement of loans is initially reported at estimated fair value at acquisition. After acquisition, a valuation allowance reduces the reported amount to the lower of the initial amount or fair value less costs to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other real estate owned expenses. SERVICING RIGHTS: The Company has not purchased rights to service loans for others. Subsequent to adopting Financial Accounting Standard No. 122 at the start of 1996, servicing rights represent the allocated value of servicing rights retained on loans sold. Servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights, using groupings of the underlying loans as to interest rates. Any impairment of a grouping is reported as a valuation allowance. The effect of adopting SFAS No. 122 was not material to the Company's consolidated net income. GOODWILL AND IDENTIFIED INTANGIBLES: Goodwill is the excess of purchase price over the fair value of net assets in business acquisitions. Goodwill is expensed on the straight-line method over 25 years. Identified intangibles represent the value of depositor relationships purchased and was expensed over 7 years ending in 1995, with expense of $24,000 and $29,000 in 1995 and 1994. Goodwill and identified intangibles are assessed for impairment based on estimated undiscounted cash flows, and written down if necessary. EMPLOYEE BENEFITS: A profit sharing plan covers substantially all employees. Contributions are expensed annually and are made at the discretion of the Board of Directors. Contributions totaled $255,000, $224,000 and $251,000 in 1996, 1995 and 1994. The plan allows employees to make voluntary contributions, although such contributions are not matched by the Company. STOCK COMPENSATION. Expense for employee compensation under stock option plans is based on Accounting Principles Board Opinion 25, with expense reported only if options are granted below market price at grant date. Pro forma disclosures of net income and earnings per share are provided as if the fair value method of SFAS No. 123 are used for any stock-based compensation awarded after January 1, 1995. INCOME TAXES: Income tax expense is the sum of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. FAIR VALUES OF FINANCIAL INSTRUMENTS: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed separately. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. The fair value estimates of existing on and off-balance sheet financial instruments do not include the value of anticipated future business or the values of assets and liabilities not considered financial instruments. EARNINGS PER SHARE: Earnings per share are based on weighted-average outstanding shares during the year. The effect of stock options was not material to earnings per share for any years presented. Page 46 (TABLE AMOUNTS IN THOUSANDS OF DOLLARS) - -------------------------------------------------------------------------------- NOTE 2 SECURITIES Year-end securities were as follows:
AMORTIZED GROSS UNREALIZED DECEMBER 31, 1996 COST GAINS LOSSES FAIR VALUE - --------------------------------------------------------------------------------------------------------- SECURITIES AVAILABLE-FOR-SALE U.S. Treasury $ 16,098 $ 25 $ (9) $ 16,114 U.S. Government agencies and corporations 90,359 32 (787) 89,604 States and political subdivisions 24,827 699 (44) 25,482 Mortgage-backed securities 16,408 131 (109) 16,430 Equity securities and mutual fund investment in debt securities 2,091 128 (99) 2,120 ------------------------------------------------------- Total $ 149,783 $ 1,015 $ (1,048) $ 149,750 ------------------------------------------------------- -------------------------------------------------------
AMORTIZED GROSS UNREALIZED DECEMBER 31, 1996 COST GAINS LOSSES FAIR VALUE - --------------------------------------------------------------------------------------------------------- SECURITIES AVAILABLE-FOR-SALE U.S. Treasury $ 37,176 $ 93 $ (21) $ 37,248 U.S. Government agencies and corporations 71,718 162 (299) 71,581 States and political subdivisions 21,337 763 (35) 22,065 Mortgage-backed securities 20,320 211 (59) 20,472 Equity securities and mutual fund investment in debt securities 3,814 89 (99) 3,804 ------------------------------------------------------- Total $ 154,365 $ 1,318 $ (513) $ 155,170 ------------------------------------------------------- -------------------------------------------------------
Page 47 - -------------------------------------------------------------------------------- NOTE 2 (CONTINUED) Contractual maturities of debt securities at year end 1996 were as follows. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. AMORTIZED COST FAIR VALUE - -------------------------------------------------------------------------------- Due in one year or less $ 19,793 $ 19,808 Due after one year through five years 98,296 97,906 Due after five years through ten years 13,195 13,486 ------------------------- 131,284 131,200 Mortgage-backed securities 16,408 16,430 Equity securities and mutual fund investment in debt securities 2,091 2,120 ------------------------- Total $ 149,783 $ 149,750 ------------------------- ------------------------- Mortgage-backed securities are comprised of investments in pools of residential mortgages. The mortgage pools are issued and guaranteed by the Federal Home Loan Mortgage Corporation (FHLMC), the Federal National Mortgage Association (FNMA), and the Government National Mortgage Association (GNMA). As of December 31, 1996, the Company held structured notes with an amortized cost of $3,101,000 and a fair value of $3,082,000. These securities were issued by the Federal Home Loan Bank (FHLB). The structured notes are comprised primarily of securities which have coupon interest rates which "step up" periodically during the term to maturity. There were no sales of debt securities during the years ended December 31, 1996, 1995, and 1994. Proceeds from sales of equity securities in 1996 and 1994 totaled $2,675,000 and $4,501,000 with a resulting gain of $5,000 in 1996 and a loss of $68,000 in 1994. During 1996 and 1994, the Federal Home Loan Bank of Chicago redeemed 250 and 2,201 shares of its stock held by the Thrift, with proceeds of $25,000 and $220,100 and with no resulting gain or loss. Securities carried at $97,052,000 and 97,970,000 at year-end 1996 and 1995 were pledged to secure public deposits, repurchase agreements and for other purposes as required or permitted by law. As of December 31, 1996, the Company had no securities of a single issuer, other than U.S. Treasury and U.S. Government agencies and corporations including FHLB, FHLMC, FNMA, and GNMA, that exceeded 10% of stockholders' equity. Although the Company holds securities issued by municipalities within the state of Illinois which in the aggregate exceed 10% of stockholders' equity, none of the holdings from individual municipal issuers exceeded this threshold. Interest-bearing balances with other financial institutions and federal funds sold consisted of the following at December 31, 1996: First USA Bank, Dallas $ 8,000 LaSalle National Bank, Chicago 7,500 Federal Home Loan Bank, Chicago 1,200 Bank of America, Illinois 100 Harris Bank, Chicago 35 ---------- Total $ 16,835 ---------- ---------- Page 48 (TABLE AMOUNTS IN THOUSANDS OF DOLLARS) - -------------------------------------------------------------------------------- NOTE 3 LOANS Year end loans were as follows: 1996 1995 - ------------------------------------------------------------------------------- Commercial $ 50,762 $ 53,886 Real estate - construction 26,905 23,720 Real estate - mortgage 146,552 137,941 Installment 9,203 10,903 ------------------------- Total loans 233,422 226,450 Less: Unearned income (240) (370) Deferred loan fees (529) (701) ------------------------- Loans, net of unearned income and deferred loan fees 232,653 225,379 Allowance for loan losses (4,839) (4,514) ------------------------- Total loans, net $ 227,814 $ 220,865 ------------------------- ------------------------- Impaired loans were as follows: 1996 1995 - ------------------------------------------------------------------------------- Year-end loans with no allowance for losses allocated $ 0 $ 0 Year-end loans with allowance for losses allocated 828 5,161 Amount of the allowance allocated 146 975 Average of impaired loans during the year 2,620 5,111 Interest income recognized during impairment 587 113 Cash-basis interest income recognized 218 111 Loans on nonaccrual status amounted to $4,912,000 at December 31, 1994. Interest income which would have been recognized had these loans been on an accrual basis throughout the year approximated $545,000 in 1994. Interest recognized on nonaccrual loans in 1994 amounted to $108,000. Related party loans were as follows for 1996: Total loans at beginning of year $ 413 New loans 925 Repayments (354) Other Changes 7 ---------- Total loans at end of year $ 991 ---------- ---------- Real estate loans with a carrying value of $15,454,000 and $14,624,000 were pledged to secure public deposits at December 31, 1996 and 1995. Loans held for sale at year-end 1996 and 1995 were approximately $893,000 and $3,641,000 and are classified as real estate mortgage loans. Page 49 - -------------------------------------------------------------------------------- NOTE 4 ALLOWANCES FOR LOAN AND OTHER REAL ESTATE OWNED LOSSES Activity in the allowance for loan losses for the year ended December 31, follows:
1996 1995 1994 - ----------------------------------------------------------------------------------------------- Balance at beginning of year $ 4,514 $ 3,965 $ 3,764 Provision charged to operating expense 1,190 1,480 1,440 Loans charged off (1,141) (1,009) (1,315) Recoveries on loans previously charged-off 276 78 76 ---------------------------------------- Balance at end of year $ 4,839 $ 4,514 $ 3,965 ---------------------------------------- ----------------------------------------
Activity in the allowance for other real estate owned losses for the year ended December 31, follows:
1996 1995 1994 - ----------------------------------------------------------------------------------------------- Balance at beginning of year $ 510 $ 526 $ 679 Provision charged to operating expense 22 23 25 Losses on other real estate owned 0 (39) (178) ---------------------------------------- Balance at end of year $ 532 $ 510 $ 526 ---------------------------------------- ----------------------------------------
- -------------------------------------------------------------------------------- NOTE 5 OFFICE BUILDINGS AND EQUIPMENT Office buildings and equipment consisted of the following at December 31, 1996 and 1995: 1996 1995 - ----------------------------------------------------------------- Land $ 1,489 $ 1,489 Office buildings and improvements 7,203 7,248 Furniture and equipment 3,802 3,824 ------------------------- Total cost 12,494 12,561 Accumulated depreciation (6,244) (5,974) ------------------------- Net book value $ 6,250 $ 6,587 ------------------------- ------------------------- Depreciation expense amounted to $546,000 in 1996, $621,000 in 1995 and $557,000 in 1994. - -------------------------------------------------------------------------------- NOTE 6 LOAN SERVICING Mortgage loans serviced for others are not reported as assets. These loans totalled $65,321,000 and $64,519,000 at year-end 1996 and 1995. Related escrow deposit balances were $612,000 and $594,000 at year-end 1996 and 1995. Activity for capitalized mortgage servicing rights was as follows for 1996: Beginning of year $ 0 Additions 95 Amortized to expense (15) ---------- End of year $ 80 ---------- ---------- Page 50 (TABLE AMOUNTS IN THOUSANDS OF DOLLARS) - -------------------------------------------------------------------------------- NOTE 7 DEPOSITS At year-end 1996, stated maturities of time deposits were: 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 138,149 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,693 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,107 2000 and thereafter. . . . . . . . . . . . . . . . . . . . . . . . . 195 ---------- $ 158,144 ---------- ---------- Related party deposits at year-end 1996 totalled $10,953,000. - -------------------------------------------------------------------------------- NOTE 8 SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER SHORT-TERM BORROWINGS Securities sold under repurchase agreements and other short-term borrowings are financing arrangements. Physical control is maintained for all securities sold under repurchase agreements. Information concerning securities sold under repurchase agreements is summarized as follows: 1996 1995 - ------------------------------------------------------------------------------- Average daily balance during the year $ 35,006 $ 34,633 Average interest rate during the year 4.92% 5.41% Maximum month end balance during the year $ 37,804 $ 43,278 Securities sold under repurchase agreements with directors of the Company and related interests totaled $18,757,000 at December 31, 1996 and have a weighted maturity of 3 months. Page 51 - -------------------------------------------------------------------------------- NOTE 9 INCOME TAXES A summary of federal and state income taxes on operations follows: 1996 1995 1994 - ------------------------------------------------------------------------------- Current payable Federal $ 2,184 $ 1,877 $ 1,652 State 151 316 116 Deferred income tax benefit 194 (153) 17 ---------------------------------------- Provision for income taxes $ 2,529 $ 2,040 $ 1,785 ---------------------------------------- ---------------------------------------- The components of the deferred tax assets and liabilities at December 31, 1996 and 1995 follow: 1996 1995 - ------------------------------------------------------------------------------- Deferred tax assets: Allowances for loan and other real estate losses $ 1,791 $ 1,660 Deferred loan fees 134 215 Deferred compensation and directors' fees 148 150 Unrealized net loss on securities available-for-sale 25 0 Taxable income on non-performing loans not recorded for book purposes 7 192 ------------------------- Gross deferred tax assets 2,105 2,217 Deferred tax liabilities: Depreciation (575) (538) Federal Home Loan Bank stock dividend (37) (37) Unrealized net gain on securities available-for-sale 0 (315) Other items (61) (41) ------------------------- Gross deferred tax liabilities (673) (931) ------------------------- Net deferred tax asset $ 1,432 $ 1,286 ------------------------- ------------------------- The Thrift has qualified under provisions of the Internal Revenue Code which permit it to deduct from taxable income a provision for bad debts which differs from the provision charged to income in the financial statements. Tax legislation passed in 1996 now requires all thrift institutions to deduct a provision for bad debts for tax purposes based on actual loss experience and recapture of the excess bad debt reserve accumulated in tax years after 1987. The related amount of deferred tax liability which must be recaptured is $1,400 and is payable over a six-year period beginning no later than 1998. Retained earnings at December 31, 1996 includes approximately $3,269,000 for which no pro vision for federal income taxes has been made. If, in the future, this portion of retained earnings is used for any purpose other than to absorb bad debt losses, federal income taxes would be imposed at the then prevailing rates, resulting in approximately $1,266,000 of deferred tax liability. 52 - -------------------------------------------------------------------------------- NOTE 9 INCOME TAXES CONTINUED No valuation allowance is required for deferred tax assets. The provision for income taxes differs from that computed at the statutory federal corporate tax rate as follows: 1996 1995 1994 - ------------------------------------------------------------------------------- Income tax calculated at statutory rate (34%) $ 2,904 $ 2,372 $ 2,128 Add (subtract) tax effect of: Tax-exempt income, net of disallowed interest expense (503) (483) (436) State income tax, net of federal tax benefit 120 186 61 Other items, net 8 (35) 32 ---------------------------------------- Provision for income taxes $ 2,529 $ 2,040 $ 1,785 ---------------------------------------- ---------------------------------------- - -------------------------------------------------------------------------------- NOTE 10 OMNIBUS INCENTIVE PLAN INSTRUMENTS The 1992 Omnibus Incentive Plan (the "Plan") authorizes the issuance of up to 75,000 shares of the Company's common stock, including the granting of non-qualified stock options, restricted stock and stock appreciation rights. Financial Accounting Standard No. 123, which became effective for 1996, requires pro forma disclosures for companies that do not adopt its fair value accounting method for stock-based employee compensation. The Company did not grant any stock options during 1996 or 1995. Stock options are used to reward directors and employees and provide them with an additional equity interest. Options are issued for 10 year periods and are fully vested when granted. Information about option grants follow: NUMBER OF WEIGHTED-AVG. OPTIONS EXERCISE PRICE --------- -------------- Outstanding, beginning of 1994 8,320 $41.64 Exercised 1994 0 0 --------- Outstanding, end of 1994 8,320 41.64 Exercised 1995 (1,300) 41.69 --------- Outstanding, end of 1995 7,020 41.63 Exercised 1996 (1,842) 41.64 --------- Outstanding, end of 1996 5,178 41.62 --------- --------- At year-end 1996, options outstanding ranged in exercise price from $41.60 to $42.00 and had a weighted average remaining option life of 5.1 years. On May 1, 1992, 2,950 restricted stock shares were awarded without payment to the Company. Recipients have all of the rights of stockholders, except that the shares cannot be disposed of until the restrictions have lapsed. On the date of grant, the estimated market price of the shares was added to common stock and capital surplus and an equal amount was deducted from stockholders' equity (unearned portion of restricted stock awards). The unearned portion was amortized to expense over the three-year vesting period on the straight-line method and was completely amortized at December 31, 1994. Amortization of the restricted stock awards was approximately $14,000 for the year ended December 31, 1994. The Committee at its discretion may grant stock appreciation rights under the Plan. A stock appreciation right entitles the holder to receive from the Company an amount equal to the excess, if any, of the aggregate fair market value of the Company's common stock which is the subject of such grant over the grant price. As of December 31, 1996 and 1995, 3,904 and 6,812 stock appreciation rights were awarded at $41.60. The Company's expense was $70,000, $21,000 and $117,000 for the years ended December 31, 1996, 1995 and 1994. The stock appreciation rights will expire on April 30, 2002. 53 - -------------------------------------------------------------------------------- NOTE 11 COMMITMENTS, OFF BALANCE SHEET RISK, AND CONTINGENCIES There are various contingent liabilities that are not reflected in the financial statements, including claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material effect on financial condition or results of operations. At year-end 1996 and 1995 reserves of $2,756,000 and $2,757,000 were required as deposits with the Federal Reserve or as cash on hand. These reserves do not earn interest. Some financial instruments are used in the normal course of business to meet the financing needs of customers and to reduce exposure to interest rate changes. These financial instruments include commitments to extend credit, standby letters of credit, and financial guarantees. These involve to varying degrees, credit and interest-rate risk in excess of the amount reported in the financial statements. Exposure to credit loss if the other party does not perform is represented by the contractual amount for commitments to extend credit, standby letters of credit, and financial guarantees written. The same credit policies are used for commitments and conditional obligations as are used for loans. Collateral or other security is normally not required to support financial instruments with credit risk. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being used, the commitments do not necessarily represent future cash requirements. Standby letters of credit and financial guarantees written are conditional commitments to guarantee a customer's performance to a third party. A summary of the notional or contractual amounts of financial instruments with off balance sheet risk at year-end follows: 1996 1995 ---------------------------------------------------------------------- Unused lines of credit and commitments to make loans: Fixed rate $ 17,696 $ 12,995 Variable rate 57,979 49,984 ------------------------- Total $ 75,675 $ 62,979 ------------------------- ------------------------- Standby letters of credit $ 6,250 $ 5,579 Commitments to make loans at a fixed rate have interest rates ranging primarily from 6.00% to 9.00%. - -------------------------------------------------------------------------------- NOTE 12 FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate fair values for financial instruments. The carrying amount is considered to estimate fair value for cash and cash equivalents, interest-bearing deposits in financial institutions, demand deposits, advances from borrowers for taxes and insurance, and accrued interest. Securities' fair values are based on quoted market prices or, if no quotes are available, on the rate and term of the security and/or information about the issuer. For fixed rate loans or deposits and securities sold under repurchase agreements, the fair value is estimated by discounted cash flow analysis using current market rates for the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values where applicable. Fair value of loans held for sale is based on market estimates. The fair value of off balance sheet items is based on the fees or cost that would currently be charged to enter or terminate such arrangements. The estimated year-end fair values of financial instruments were:
ESTIMATED 1996 CARRYING VALUE FAIR VALUE - -------------------------------------------------------------------------------------------------------------- Financial assets: Cash and cash equivalents $ 31,982 $ 31,982 Interest-bearing deposits in financial institutions - maturities over 90 days 100 100 Securities available-for-sale 149,750 149,750 Loans 232,653 233,017 Allowance for loan losses (4,839) (4,839) Direct lease financing 999 999 Accrued interest receivable 3,955 3,955 Financial liabilities: Deposits $ (328,795) $ (328,909) Securities sold under repurchase agreements and other short-term borrowings (36,758) (36,770) Advances from borrowers for taxes and insurance (1,021) (1,021) Accrued interest payable (2,498) (2,498)
Page 54 - -------------------------------------------------------------------------------- NOTE 12 (CONTINUED)
ESTIMATED 1995 CARRYING VALUE FAIR VALUE - -------------------------------------------------------------------------------------------------------------- Financial assets: Cash and cash equivalents $ 33,974 $ 33,974 Interest-bearing deposits in financial institutions -maturities over 90 days 100 100 Securities available-for-sale 155,170 155,170 Loans 225,379 226,415 Allowance for loan losses (4,514) (4,514) Direct lease financing 622 622 Accrued interest receivable 4,366 4,366 Financial liabilities: Deposits $ (327,555) $ (328,109) Securities sold under repurchase agreements and other short-term borrowings (43,278) (43,310) Advances from borrowers for taxes and insurance (1,281) (1,281) Accrued interest payable (1,741) (1,741)
- -------------------------------------------------------------------------------- NOTE 13 REGULATORY MATTERS The Company and Subsidiaries are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgements by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required. The minimum requirements are: TIER 1 CAPITAL TO RISK-WEIGHTED ASSETS CAPITAL TO TOTAL TIER I AVERAGE ASSETS - ------------------------------------------------------------------------------- Well capitalized 10.00% 6.00% 5.00% Adequately capitalized 8.00% 4.00% 4.00% Undercapitalized 6.00% 3.00% 3.00% Page 55 - -------------------------------------------------------------------------------- NOTE 13 (CONTINUED) At year end, actual capital levels and minimum required levels were:
MINIMUM REQUIRED TO BE MINIMUM REQUIRED WELL CAPITALIZED FOR CAPITAL UNDER PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION REGULATIONS - -------------------------------------------------------------------------------------------------------------------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO - -------------------------------------------------------------------------------------------------------------------------- 1996 Total Capital (to risk weighted assets) Consolidated $ 58,136 21.18% $ 21,963 8.00% $ 27,454 10.00% Bank 43,335 20.18 17,182 8.00 21,478 10.00 Tier I Capital (to risk weighted assets) Consolidated 54,704 19.93 10,982 4.00 16,473 6.00 Bank 40,650 18.93 8,591 4.00 12,887 6.00 Tier I Capital (to average assets) Consolidated 54,704 13.02 16,804 4.00 21,005 5.00 Bank 40,650 12.98 12,523 4.00 15,654 5.00 1995 Total Capital (to risk weighted assets) Consolidated $ 53,674 20.22% $ 21,228 8.00% $ 26,536 10.00% Bank 39,272 19.29 16,289 8.00 20,361 10.00 Tier I Capital (to risk weighted assets) Consolidated 50,365 19.98 10,614 4.00 15,921 6.00 Bank 36,727 18.04 8,144 4.00 12,217 6.00 Tier I Capital (to average assets) Consolidated 50,365 11.79 16,305 4.00 20,381 5.00 Bank 36,727 12.32 11,929 4.00 14,911 5.00
The Company and the Subsidiaries at year end 1996 were categorized as well capitalized. Management knows of no circumstances or events which would change these categorizations. The Company's primary source of funds to pay dividends to shareholders is the dividends it receives from the Subsidiaries. The Subsidiaries are subject to certain restrictions on the amount of dividends that they may declare without prior regulatory approval. At December 31, 1996, $24,900,000 of the Subsidiaries' retained earnings were available for dividend declaration without prior regulatory approval. Page 56 - -------------------------------------------------------------------------------- NOTE 14 PARENT COMPANY CONDENSED FINANCIAL STATEMENTS Following are condensed parent company financial statements: CONDENSED BALANCE SHEETS DECEMBER 31, 1996 1995 - -------------------------------------------------------------------------------- Assets Cash on deposit at subsidiary bank - noninterest-bearing $ 807 $ 831 Interest-bearing deposits in unaffiliated bank 35 34 ------------------------- Total cash and cash equivalents 842 865 Investment in wholly-owned subsidiaries Equity in underlying book value: Bank of Waukegan 40,645 37,109 First Federal Bank, fsb 13,445 13,079 Goodwill, net 140 150 ------------------------- Total investment in subsidiaries 54,230 50,338 Other assets 419 270 ------------------------- Total assets $ 55,491 $ 51,473 ------------------------- ------------------------- Liabilities and Stockholders' Equity Accounts payable and other liabilities $ 656 $ 468 Stockholders' equity 54,835 51,005 ------------------------- Total liabilities and stockholders' equity $ 55,491 $ 51,473 ------------------------- ------------------------- CONDENSED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1996 1995 1994 - ------------------------------------------------------------------------------- Operating Income Dividends from subsidiaries $ 1,745 $ 758 $ 1,261 Interest income 1 1 0 ------------------------------ Total operating income 1,746 759 1,261 Operating expenses 214 293 257 ------------------------------ Income before income taxes and equity in undistributed earnings of subsidiaries 1,532 466 1,004 Income tax benefit 78 130 55 ------------------------------ Income before equity in undistributed earnings of subsidiaries 1,610 596 1,059 Equity in undistributed earnings of subsidiaries 4,401 4,341 3,416 ------------------------------ Net income $ 6,011 $ 4,937 $ 4,475 ------------------------------ ------------------------------ CONDENSED STATEMENT OF CASH FLOWS YEARS ENDED DECEMBER 31, 1996 1995 1994 - ------------------------------------------------------------------------------- Cash flows from operating activities Net income $ 6,011 $ 4,937 $ 4,475 Adjustments to reconcile net income to net cash from operating activities Equity in undistributed earnings of subsidiaries (4,401) (4,341) (3,416) Amortization of unearned portion of restricted stock award 0 0 14 Goodwill amortization 10 11 11 (Increase) decrease in other assets (149) 321 226 Increase in other liabilities 208 110 125 ------------------------------ Net cash provided by operating activities 1,679 1,038 1,435 ------------------------------ Cash flows provided by investing activities Capital distribution from Northern States Trust Company 0 0 1 ------------------------------ Cash flows from financing activities Exercise of stock options 77 54 0 Dividends paid (1,779) (1,463) (1,285) ------------------------------ Net cash used in financing activities (1,702) (1,409) (1,285) ------------------------------ Increase (decrease) in cash and cash equivalents (23) (371) 151 Cash and cash equivalents at beginning of year 865 1,236 1,085 ------------------------------ Cash and cash equivalents at end of year $ 842 $ 865 $ 1,236 ------------------------------ ------------------------------ Page 57 STOCKHOLDER INFORMATION ANNUAL MEETING: All stockholders are invited to attend our annual meeting, which will be held at 4:30 P.M., on Thursday, April 24, 1997 in the lobby of the Bank of Waukegan, 1601 N. Lewis Avenue, Waukegan, Illinois 60085. We look forward to meeting all stockholders and welcome your questions at the annual meeting. Any shareholder unable to attend this year's meeting is invited to send questions and comments in writing to Fred Abdula, Chairman of the Board and Chief Executive Officer, at Northern States Financial Corporation. FORM 10-K: Stockholders who wish to obtain a copy at no charge of Northern States Financial Corporation's Form 10-K for the fiscal year ended December 31, 1996, as filed with the Securities and Exchange Commission, may do so by writing Thomas M. Nemeth, Assistant Vice President, at Northern States Financial Corporation. FOR FURTHER INFORMATION: Stockholders and prospective investors are welcome to call or write Northern States Financial Corporation with questions or requests for additional information. Please direct inquiries to: Thomas M. Nemeth Assistant Vice President Northern States Financial Corporation 1601 N. Lewis Avenue Waukegan, Illinois 60085 (847) 244-6000 ext. 269 TRANSFER AGENT, REGISTRAR & DIVIDEND DISBURSEMENTS: Stockholders with a change of address or related inquiries should contact: Investors Services Unit Firstar Trust Company 615 E. Michigan Street, 4th Floor Milwaukee, Wisconsin 53202 (800) 637-7549 QUARTERLY CALENDAR: The Company operates on a fiscal year ending December 31. Quarterly results are announced within 45 days after the end of each quarter, and audited results are announced within 90 days after year end. SEMI-ANNUAL DIVIDEND DATES: Dividends are expected to be announced and paid on the following schedule during 1997: HALF RECORD DATE PAYMENT DATE - -------------------------------------------------------------------------------- First May 16 June 1 Second November 15 December 1 STOCK MARKET INFORMATION: The common stock of Northern States Financial Corporation is traded on the National Association of Securities Dealers Automated Quotation System (NASDAQ Small-Cap Market) under the ticker symbol NSFC. Stock price quotations are published daily in the Chicago Tribune and Chicago Sun-Times newspapers and, when traded, in The Wall Street Journal. The stock is commonly listed as NthStat. As of December 31, 1996, there were 1,750,000 common shares authorized; 889,273 common shares were outstanding, held by approximately 452 registered stockholders. As of December 31, 1996, the following securities firms indicated they were maintaining an inventory of Northern States Financial Corporation common stock and acting as market makers: ABN AMRO Chicago Corp. Howe Barnes & Johnson, Inc. Chicago, Illinois Chicago, Illinois (800) 621-0686 ext. 6195 (800) 800-4693 (312) 855-6195 (312) 655-2954 PRICE SUMMARY: The following schedule details our stock's quarter ending bid and ask price. 1996 1995 - ------------------------------------------------------------ BID ASK BID ASK --- --- --- --- Quarter Ended: March 31 $69 $74 $63 $68 June 30 71 76 63 68 September 30 74 79 64 69 December 31 83 87 66 71 CASH DIVIDENDS: Northern States Financial Corporation pays semi-annual cash dividends in June and December. Uninterrupted cash dividends have been paid since the Company's formation in 1984 and have been increased each year since then. The table below shows semi-annual cash dividends per share for the past seven years. Dividends have been restated to reflect the five-for-one stock split which occurred in June of 1991. JUNE 1 DECEMBER 1 TOTAL - ------------------------------------------------------------ 1990 $ .46 $ .46 $ .92 1991 .47 .53 1.00 1992 .55 .60 1.15 1993 .63 .67 1.30 1994 .70 .75 1.45 1995 .80 .85 1.65 1996 .95 1.05 2.00 INDEPENDENT AUDITORS Crowe, Chizek and Company LLP Oak Brook, Illinois Page 58 EX-21 3 EXHIBIT 21 EXHIBIT 21. SUBSIDIARIES OF NORTHERN STATES FINANCIAL CORPORATION Bank of Waukegan 1601 N. Lewis Avenue Waukegan, Illinois 60085 State of Incorporation - Illinois A Wholly-Owned Subsidiary of Northern States Financial Corporation First Federal Bank, fsb 216 Madison Street Waukegan, Illinois 60085 State of Incorporation - Illinois A Wholly-Owned Subsidiary of Northern States Financial Corporation 59 EX-27 4 EXHIBIT 27
9 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 15,247 1,325 15,500 0 149,759 0 0 232,653 4,839 426,564 328,795 36,758 6,176 0 0 0 1,779 53,056 426,564 22,050 8,851 770 31,671 13,084 14,808 16,863 1,190 5 10,372 8,540 6,011 0 0 6,011 6.76 6.76 4.50 1,108 58 0 0 4,514 1,141 276 4,839 1,985 0 2,854
-----END PRIVACY-ENHANCED MESSAGE-----