-----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, BCy7iflB0giglttXIPULu7ppspDxTTdRnwNbhEfgP5zpLacCSNz8A/gyGj1GlKgm LXdTKft6I3vbl2YCstmMeA== 0001047469-98-010997.txt : 19980324 0001047469-98-010997.hdr.sgml : 19980324 ACCESSION NUMBER: 0001047469-98-010997 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980323 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: SEC FILE NUMBER: 000-19300 FILM NUMBER: 98571179 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 FORM 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, 1997 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. [X] The aggregate market value of the voting shares held by nonaffiliates of the Registrant is $98,967,520, as of March 20, 1998. 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 17, 1998, of $160.00 per share. 889,373 shares of common stock were outstanding as of March 20, 1998. DOCUMENTS INCORPORATED BY REFERENCE Portions of Parts II and IV are incorporated by reference from the Registrant's 1997 Annual Report to Stockholders; and a portion of Part III is incorporated by reference from the Registrant's Proxy Statement dated March 23, 1998, for the Annual Meeting of Stockholders to be held April 23, 1998. Except for those portions of the 1997 Annual Report incorporated by reference, the Annual Report is not deemed filed as part of this Report. Cover Page 2 of 2 2 INDEX
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 7A Quantitative and Qualitative Disclosures about Market Risk 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, 1997, the Company had 438 registered stockholders of record, 889,373 shares of Common Stock outstanding, and total consolidated assets of approximately $459 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, 1997 (in thousands of dollars):
Loans Deposits -------- --------- Bank of Waukegan $177,537 $260,429 First Federal Bank, fsb 63,349 88,395
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, 1997 the Bank of Waukegan had total assets of approximately $349.1 million, deposits of approximately $260.4 million and stockholder's equity of approximately $45.5 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, 1997, the Trust Department had assets under management or custodial arrangements of approximately $197 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 $109.7 million, deposits of approximately $88.4 million, and stockholder's equity of approximately $14.1 million at December 31, 1997. 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. On December 16, 1997 the Company's Board of Directors announced that it had approved the merger of its two wholly owned subsidiaries, Bank of Waukegan and First Federal Bank, fsb. The Bank of Waukegan will be the surviving entity in the merger. The proposed merger is subject to the receipt of various bank regulatory approvals. Subject to regulatory approval, the merger will become effective during the second quarter of 1998. 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 make 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 long-standing 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 to fund conforming 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, 1997. 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 $197 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 111 full-time and 30 part-time employees as of December 31, 1997. 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 regulated 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 Company, the Bank and First Federal, such as the Board of Governors of the Federal Reserve System ("FRB"), the Office of Thrift Supervision (the "OTS"), the Federal Deposit Insurance Corporation ("FDIC") and the Illinois Office of Banks and Real Estate (the "Office"). 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 subsidiaries 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 its 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 consummation, 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 across 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 permits Illinois bank holding companies to acquire control of banks in any state and 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 Office. In reviewing any such application, the Office will review, among other things, compliance by the applicant 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, an 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 Bank is subject to regulation the FDIC, as well as by the Office. 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). 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. Under the assessment schedule applicable for the second semi-annual assessment period of 1997 to BIF-insured institutions (such as the Bank) and to SAIF-insured institutions (such as First Federal), assessment rates ranged from 0% to 0.27% of deposits. In addition, the Bank and First Federal are subject to "FICO assessments" to repay obligations issued by a federally chartered corporation to provide financing for resolving the thrift crises of the 1980s. The FICO assessment rate applicable to BIF-assessable deposits is limited by law to 20% of the rate applicable to SAIF-assessable deposits. Currently, the FICO assessment rate applicable to BIF-assessable deposits is 1.26 basis points, and the rate applicable to SAIF-assessable deposits is 6.30 basis points. 11 The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") 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 Undercapitalized 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 FDICIA, 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. FDICIA generally prohibits a depository institution from making 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 guaranteed 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. FDICIA 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 26 of the 1997 Annual Report to Stockholders (filed as Exhibit 13, pages 23 through 38 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. 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 MATTERS The information set forth under the captions "Stock Market Information"; "Price Summary"; and "Cash Dividends" on Page 46 of the 1997 Annual Report to Stockholders (filed as Exhibit 13, page 58 of this report) is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA The information set forth under the caption "Selected Consolidated Financial Data" on Page 10 of the 1997 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 26 of the 1997 Annual Report to Stockholders (filed as Exhibit 13, pages 23 through 38 of this report) is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information set forth under the caption "Qunatitative and Qualitative Disclosures about Market Risk" on Pages 26 and 27 of the 1997 Annual Report to Stockholders (filed as Exhibit 13, pages 38 and 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 1997 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, 1997 and 1996 29 Consolidated Statements of Income for the Years ended December 31, 1997, 1996 and 1995 30 Consolidated Statements of Cash Flows for the Years ended December 31, 1997, 1996 and 1995 31 Consolidated Statements of Stockholders' Equity for the Years ended December 31, 1997, 1996 and 1995 32 Notes to the Consolidated Financial Statements 33 Parent Company only financial statements 45
The portions of the 1997 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 page 2 of the Registrant's Proxy Statement, dated March 23, 1998, relating to the April 23, 1998 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 23, 1998, relating to the April 23, 1998 Annual Meeting of Stockholders and 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 23, 1998, relating to the April 23, 1998 Annual Meeting of Stock holders 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 of the Registrant's Proxy Statement, dated March 23, 1998, relating to the April 23, 1998 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 pages 8 and 9 of the Registrant's Proxy Statement, dated March 23, 1998, relating to the April 23, 1998 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 Notes 1 and 14 to the consolidated financial statements, pages 34 and 44, 1997 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, 1997. 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. 27 Financial Data Schedule. (b) REPORTS ON FORM 8-K No reports on Form 8-K were filed during the fourth quarter of the year ended December 31, 1997. (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 20th day of March 1998. 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 20th day of March 1998. 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, 1997 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 Notes 1 and 14 to the consolidated financial statements, pages 34 and 44, 1997 Annual Report to Stockholders (filed as Exhibit 13 to this report) is incorporated by reference. 46 and 56 13 Copy of the Company's Annual Report to Stockholders for the year ended December 31, 1997. 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 NORTHERN STATES FINANCIAL CORPORATION SELECTED CONSOLIDATED FINANCIAL DATA
($ 000's, except per share data) - --------------------------------------------------------------------------------------------------------------------------------- At or for the Year Ended December 31, 1997 1996 1995 1994 1993 - --------------------------------------------------------------------------------------------------------------------------------- INCOME STATEMENT DATA: Interest income $ 32,759 $ 31,671 $ 30,893 $ 27,375 $ 26,836 Interest expense 15,615 14,808 14,705 11,429 11,708 ------------------------------------------------------------------------- Net interest income 17,144 16,863 16,188 15,946 15,128 Provision for loan losses 480 1,190 1,480 1,440 1,481 ------------------------------------------------------------------------- Net interest income after provision for loan losses 16,664 15,673 14,708 14,506 13,647 Noninterest income 2,687 3,239 2,702 2,764 3,540 Noninterest expenses 9,132 10,372 10,433 11,010 11,387 ------------------------------------------------------------------------- Income before income taxes 10,219 8,540 6,977 6,260 5,800 Provision for income taxes 3,209 2,529 2,040 1,785 1,366 ------------------------------------------------------------------------- NET INCOME $ 7,010 $ 6,011 $ 4,937 $ 4,475 $ 4,434 ------------------------------------------------------------------------- ------------------------------------------------------------------------- BALANCE SHEET DATA: Cash, non-interest bearing $ 14,200 $ 15,247 $ 18,119 $ 16,539 $ 19,133 Investments (2) 192,078 166,585 171,125 164,254 164,542 Loans, net 236,794 227,814 220,865 212,823 216,163 Direct lease financing 1,274 999 622 373 993 All other assets 14,640 15,919 17,160 17,646 15,298 ------------------------------------------------------------------------- TOTAL ASSETS $458,986 $426,564 $427,891 $411,635 $416,129 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Deposits $347,950 $328,795 $327,555 $329,363 $349,360 Other borrowings 43,504 36,758 43,278 30,654 18,113 All other liabilities 7,337 6,176 6,053 5,918 4,858 Stockholders' equity 60,195 54,835 51,005 45,700 43,798 ------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $458,986 $426,564 $427,891 $411,635 $416,129 ------------------------------------------------------------------------- ------------------------------------------------------------------------- PER SHARE DATA: Basic earnings per share $ 7.88 $ 6.76 $ 5.57 $ 5.05 $ 5.01 Diluted earnings per share 7.87 6.75 5.56 5.04 5.00 Cash dividends declared 2.40 2.00 1.65 1.45 1.30 Book value (at end of year) 67.68 61.66 57.47 51.57 49.43 SELECTED FINANCIAL AND OTHER RATIOS: Return on average assets (1) 1.61% 1.43% 1.21% 1.08% 1.09% Return on average equity (1) 12.28 11.47 10.15 9.89 10.35 Average stockholders' equity to average assets (1) 13.13 12.47 11.93 10.96 10.53 Tax equivalent interest rate spread 3.39 3.64 3.62 3.78 3.73 Tax equivalent net interest income to average earning assets (1) 4.33 4.50 4.46 4.34 4.23 Non-performing loans and other real estate owned to total assets 0.78 0.94 2.25 2.39 2.72 Dividend payout ratio (3) 30.44 29.60 29.63 28.72 25.98
(1) Does not reflect impact of securities available for sale 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. 10 NSFC ANNUAL REPORT 1997 22 NORTHERN STATES FINANCIAL CORPORATION 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 and 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 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, limit the investments and loans which the Bank and/or Thrift funds, and determine 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 non-interest bearing transaction accounts, and a relatively low allowance for loan losses to total loans. Approximately 24% 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. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are identifiable by the use of the words "believe", "expect", "intend", "estimate" or similar expressions. The Company cautions readers of this Annual Report that a number of important factors such as changes in interest rates, general economic conditions, regulatory policies, loan demand, and competition could cause the Company's actual results in 1998 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) - ------------------------------------------------------------------------------------------------------------------------ For the Years Ended December 31, 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------ Average Average Average Balance Interest Rate Balance Interest Rate Balance Interest Rate --------------------------------------------------------------------------------------- ASSETS Loans (1) (2) (3) $241,019 $22,343 9.27% $233,167 $22,296 9.56% $223,806 $21,788 9.74% Taxable securities (5) 132,128 8,411 6.34 124,271 7,663 6.12 122,401 7,313 5.95 Securities exempt from federal income taxes (2) (5) 21,301 1,741 8.38 22,058 1,799 8.36 20,838 1,751 8.43 Interest bearing deposits in financial institutions 617 35 5.67 504 28 5.56 1,572 117 7.44 Federal funds sold 17,437 965 5.53 13,844 742 5.36 12,541 740 5.90 --------------------------------------------------------------------------------------- Interest earning assets 412,502 33,495 8.12 393,844 32,528 8.25 381,158 31,709 8.31 Noninterest earning assets 22,344 25,818 26,018 --------------------------------------------------------------------------------------- Average assets (4) $434,846 $419,662 $407,176 -------- -------- -------- -------- -------- -------- LIABILITIES AND STOCKHOLDERS' EQUITY NOW deposits $ 37,672 1,120 2.97 $ 39,474 1,177 2.98 $ 39,361 1,149 2.92 Money market deposits 41,945 1,672 3.99 44,272 1,792 4.05 39,980 1,866 4.67 Savings deposits 44,458 1,322 2.97 46,828 1,395 2.98 48,796 1,436 2.94 Time deposits 171,149 9,714 5.68 155,378 8,720 5.61 150,994 8,381 5.55 Other borrowings 35,082 1,787 5.09 35,006 1,724 4.92 34,633 1,873 5.41 --------------------------------------------------------------------------------------- Interest bearing liabilities 330,306 15,615 4.73 320,958 14,808 4.61 313,764 14,705 4.69 Demand deposits and other noninterest bearing liabilities 47,453 46,580 45,125 Stockholders' equity 57,087 52,124 48,287 --------------------------------------------------------------------------------------- Average liabilities and stockholders' equity $434,846 $419,662 $407,176 -------- -------- -------- -------- -------- -------- Net interest income (2) $17,880 $17,720 $17,004 ------- ------- ------- ------- ------- ------- Net yield on interest earning assets 4.33% 4.50% 4.46% ----- ----- ----- ----- ----- ----- Interest-bearing liabilities to earning assets ratio 80.07% 81.40% 82.22% ------ ------ ------ ------ ------ ------
(1) - Interest income on loans includes loan origination and other fees of $492 for 1997, $443 for 1996 and $540 for 1995. Average loans include direct lease financing. (2) - Tax-exempt income is reflected on a fully tax equivalent basis utilizing a 34% rate. (3) - Non-accrual 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 1997, 1996 and 1995 average balance information includes an average valuation allowance for taxable securities of $(526), $(985) and $(521). The 1997, 1996 and 1995 average balance information includes an average valuation allowance of $530, $540 and $58 for tax-exempt securities. NSFC ANNUAL REPORT 1997 11 23 NORTHERN STATES FINANCIAL CORPORATION 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 92.4% of the Company's total revenues in 1997, 90.7% in 1996 and 92.0% in 1995. 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 weighted average prime lending rate in 1997 was 8.44%, an increase of 17 basis points from 8.27% in 1996, and was 8.83% in 1995. During 1997 the prime lending rate began the year at 8.25% and increased to 8.50% on March 26, 1997, where it remained for the balance of the year. The rises in rates in 1997 caused corresponding increases in rates earned on taxable securities. Average rates earned on taxable securities increased to 6.34%, up 22 basis points from 1996 levels, after increasing only 17 basis points in 1996 from 1995 levels. Rates on federal funds sold increased 17 basis points in 1997 after declining 54 basis points in 1996. Another major factor affecting the net interest margin is rates earned on loans. Table 1 shows that rates earned on average loans in 1997 decreased to 9.27% in 1997 from 9.56% in 1996 after declining in 1996 from 9.74% in 1995. The yields on loans decreased 29 basis points from 1996 even though the weighted average prime lending rate in 1997 increased 17 basis points from 1996. Competitive pressures have caused our loan rates to decline and increased the Company's portfolio of fixed rate loans. It is expected that competitive pressures will continue to affect loan pricing in 1998. Loan rates in 1996 declined 18 basis points from 1995 which resulted from the general decrease in loan rates during 1996 as evidenced by the reduction in the prime rate during 1996. The average earning asset ratio is another important factor affecting net interest income. The average earning asset ratio is the percentage of average assets that earn interest income to total average assets. This ratio has increased for the Company during 1997 to 94.86% compared to 93.85% in 1996 and 93.61% in 1995. As indicated in Table 1, the Company's net interest income rose in 1997 to $17,880,000. Net interest income increased $160,000 in 1997 from 1996. During 1996 net interest income increased $716,000 from 1995. A significant reason for the 1997 increase was that interest earning assets increased $18.7 million in 1996 while interest bearing liabilities only increased by $9.3 million. This is further evidenced in Table 2 which shows that the 1997 increase in net interest income is attributable to changes due to volume, which was partially offset by a decrease in the net interest spread. The interest rate spread is the difference between the yield earned on assets less the rates paid on liabilities. The interest rate spread decreased to 3.39% in 1997 as compared to 3.64% in 1996 and 3.62% in 1995. The Company's average deposit and other borrowing rates were 4.73% in 1997, an increase from 4.61% in 1996, which had declined slightly from 4.69% in 1995. The rates earned on average earning assets during 1997 decreased slightly to 8.12% from 8.25% in 1996, which had declined from 8.31% in 1995. The rates on average earning assets decreased due to competitive pressures on loan rates during 1997. In 1997 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 an increasing rate environment as experienced in 1997, interest bearing deposits and other liabilities will reprice upward faster than our interest earning assets. This is evidenced in 1997 when rates increased and stabilized which caused yields on interest bearing liabilities to increase by 12 basis points. Another factor influencing net interest income is the "interest bearing liabilities to earning assets ratio", as shown in Table 1. This ratio 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 80.07% in 1997 from 81.40% in 1996, which was lower than 1995's ratio of 82.22%. 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 3.62% in 1997, as compared with an increase of 3.07% in 1996. Local economic conditions continued to improve in 1997 as evidenced by the increase in average loans. Average loan volume increased 3.37% in 1997 after an increase of 4.18% in 1996. Average total securities increased 4.85% in 1997 after increasing 2.16% in 1996. In 1997, total average interest bearing deposits increased $9.3 million from 1996 levels while average other borrowings, which consists primarily of repurchase agreement products and a term advance from the Federal Home Loan Bank, increased only $76 thousand from 1996. The 1997 increase in average interest bearing deposits was in time deposits which increased $15.8 million while lower cost savings and NOW deposits declined $4.2 million and money market deposits declined $2.3 million. Interest rates paid on deposits and charged for loans during 1997 remained comparable with other local financial institutions during the year. In spite of the many non-bank investment products available to our customers today, as well as from other financial institutions, the Company is pleased with its ability to maintain the level of interest bearing liabilities. As Table 1 indicates, the average balances of other borrowings increased only slightly in 1997 and 1996. Most of the other borrowings are in the form of securities sold under repurchase agreements (repurchase agreements) which the Company continues to offer as an alternative to certificates of deposit. A repurchase agreement is not subject to FDIC insurance and is not subject to reserve requirements, and therefore is less costly to the Company. The repurchase agreement also gives the customer added security for the borrowing in the form of a security pledged by the Company. Management expects to continue to offer repurchase agreements as an alternative to certificates of deposit in the future. Many other factors beyond Management's control can have a 12 NSFC ANNUAL REPORT 1997 24 NORTHERN STATES FINANCIAL CORPORATION NET INTEREST INCOME CONTINUED significant impact on changes in net interest income from one period to another. Examples of such factors are: (1) credit demands by customers; (2) fiscal and debt management policy of federal and state governments; (3) monetary policy of the Federal Reserve Board; and (4) changes in regulations. The components of the changes in net interest income are shown in Table 2. This table allocates changes in net interest income between amounts attributable to changes in volume and changes in rate for the various categories of interest earning assets and interest bearing liabilities. TABLE 2 ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE
($ 000's) - --------------------------------------------------------------------------------------------------------------------------------- For the Year Ended December 31 1997 Compared to 1996 1996 Compared to 1995 - --------------------------------------------------------------------------------------------------------------------------------- Increase (Decrease) Increase (Decrease) Change Change Change Change Total Due To Due To Total Due To Due To Change Volume Rate Change Volume Rate ------------------------------------------------------------------------------------- INTEREST INCOME Loans $ 47 $ 737 $(690) $ 508 $ 902 $(394) Taxable securities 748 463 285 350 140 210 Securities exempt from federal income taxes (58) (63) 5 48 62 (14) Interest-bearing deposits in financial institutions 7 6 1 (89) (65) (24) Federal funds sold 223 198 25 2 73 (71) ------------------------------------------------------------------------------------- Total interest income 967 1,341 (374) 819 1,112 (293) ------------------------------------------------------------------------------------- INTEREST EXPENSE NOW deposits (57) (54) (3) 28 3 25 Money market deposits (120) (93) (27) (74) 188 (262) Savings deposits (73) (70) (3) (41) (58) 17 Time deposits 994 894 100 339 245 94 Other borrowings 63 4 59 (149) 20 (169) ------------------------------------------------------------------------------------- Total interest expense 807 681 126 103 398 (295) ------------------------------------------------------------------------------------- NET INTEREST INCOME $ 160 $ 660 $(500) $ 716 $ 714 $ 2 ------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------
Volume/rate variances are allocated to the volume variance and the rate variance on an absolute basis. Tax-exempt income is reflected on a fully tax equivalent basis utilizing a 34% rate. NSFC ANNUAL REPORT 1997 13 25 NORTHERN STATES FINANCIAL CORPORATION TABLE 3 SECURITIES
($ 000's) - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------------ % of Total % of Total % of Total Securities available for sale Amount Portfolio Amount Portfolio Amount Portfolio ----------------------------------------------------------------------------------- U.S. Treasury $ 14,031 7.77% $ 16,114 10.76% $ 37,248 24.01% U.S. Government agencies and corporations 128,872 71.33 89,604 59.84 71,581 46.13 States and political subdivisions 22,408 12.40 25,482 17.02 22,065 14.22 Mortgage-backed securities 13,123 7.26 16,430 10.97 20,472 13.19 Equity securities 2,238 1.24 2,120 1.41 3,804 2.45 ----------------------------------------------------------------------------------- Total securities available for sale $180,672 100.00% $149,750 100.00% $155,170 100.00% ----------------------------------------------------------------------------------- -----------------------------------------------------------------------------------
As of December 31, 1997, the Company held no securities of a single issuer, other than the U.S. Treasury and U.S. Government agencies and corporations, including the Federal Home Loan Bank (FHLB), the Federal Home Loan Mortgage Corporation (FHLMC), the Government National Mortgage Association (GNMA), the Federal National Mortgage Association (FNMA), the Federal Farm Credit Bank (FFCB), and the Student Loan Marketing Association (SLMA), 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 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, 1997: First USA Bank, Dallas $ 5,500 LaSalle National Bank, Chicago 4,000 Harris Bank, Chicago 1,736 Bank of America, Illinois 100 Federal Home Loan Bank, Chicago 70 ------- Total carrying value $11,406 ------- -------
14 NSFC ANNUAL REPORT 1997 26 NORTHERN STATES FINANCIAL CORPORATION SECURITIES All securities of the Company at December 31, 1997 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 increased $30.9 million at year end 1997 from 1996, after a decline of $5.4 million at year end 1996 from 1995. However, average securities as shown in Table 1, increased in 1997 from 1996 by $7.1 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 $2.1 million at December 31, 1997 compared to December 31, 1996. U.S. Government agency issues increased by $39.3 million to $128.9 million at December 31, 1997, from $89.6 million at December 31, 1996. 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 79% of the total portfolio at December 31, 1997. Holdings of securities issued by states and public subdivisions, of which 90% are tax-exempt, declined by $3.1 million to $22.4 million at December 31, 1997. 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 has been able to purchase "bank qualified" tax-exempt issues from local taxing bodies to offset some of the runoff in this portfolio. The Company will continue to buy bonds of local tax-exempt entities, in an effort to support the local community, consistent with the investment standards contained in the investment policy. In as much as the Thrift is required, by regulation, to have 65% of its assets invested in mortgage related products, the Thrift invests in pools of 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, 1997 were $13.1 million, a decrease of $3.3 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 1997. The Company's equity securities consist of Student Loan Marketing Association (SLMA) and Federal Home Loan Bank (FHLB) stock which totaled $2.2 million at December 31, 1997. Efforts by the Company to maintain appropriate liquidity includes periodic adjustments to the securities portfolio as management considers necessary, typically accomplished through the maturity schedule of investments purchased. The maturity distribution and average yields, on a fully tax equivalent basis, of the securities portfolio at December 31, 1997 is shown in Table 4. TABLE 4 SECURITIES MATURITY SCHEDULE & YIELDS
Greater than 1 yr. Greater than 5 yrs. Securities available for sale Less than or and less than or and less than or Greater ($ 000's) equal to 1 yr. equal to 5 yrs. equal to 10 yrs. than 10 yrs. Totals - ----------------------------------------------------------------------------------------------------------------------------------- As of December 31, 1997 Balance Yield Balance Yield Balance Yield Balance Yield Balance Yield - ----------------------------------------------------------------------------------------------------------------------------------- U.S. Treasury $10,022 5.75% $ 4,009 5.76% $ 0 0.00% $ 0 0.00% $ 14,031 5.75% U.S. Government agencies and corporations 9,723 5.51 110,574 6.31 8,575 6.87 0 0.00 128,872 6.29 States and political subdivisions (1) 3,140 7.90 13,737 8.09 5,531 8.53 0 0.00 22,408 8.17 Mortgage-backed securities (2) 0 0.00 573 6.53 3,211 6.53 9,339 6.89 13,123 6.79 Equity securities 1,561 7.00 677 4.91 0 0.00 0 0.00 2,238 6.37 --------------------------------------------------------------------------------------------------- Total $24,446 6.01% $129,570 6.48% $17,317 7.34% $9,339 6.89% $180,672 6.52% --------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------
(1) - The yield is reflected on a fully tax equivalent basis utilizing a 34% tax rate. (2) - Mortgage-backed securities reflect the contractual maturity of the related instrument. NSFC ANNUAL REPORT 1997 15 27 NORTHERN STATES FINANCIAL CORPORATION TABLE 5 LOAN PORTFOLIO
($ 000's) - -------------------------------------------------------------------------------------------------- December 31, 1997 1996 1995 1994 1993 - -------------------------------------------------------------------------------------------------- Commercial $ 54,701 $ 50,762 $ 53,886 $ 50,495 $ 54,902 Real estate-construction 26,768 26,905 23,720 21,815 19,719 Real estate-mortgage 152,856 146,552 137,941 132,830 135,224 Installment 8,544 9,203 10,903 13,069 11,761 -------------------------------------------------------------- Total loans 242,869 233,422 226,450 218,209 221,606 Unearned income (154) (240) (370) (592) (755) Deferred loan fees (491) (529) (701) (829) (924) -------------------------------------------------------------- Loans, net of unearned income and deferred loan fees 242,224 232,653 225,379 216,788 219,927 Allowance for loan losses (5,430) (4,839) (4,514) (3,965) (3,764) -------------------------------------------------------------- Loans, net $236,794 $227,814 $220,865 $212,823 $216,163 -------------------------------------------------------------- --------------------------------------------------------------
The Company has one foreign loan outstanding in the amount of $188 at December 31, 1997. LOAN PORTFOLIO Loans for the Company continued to grow in 1997 due to a strong local economy. As shown in Table 5, gross loans increased $9,447,000 or 4.0% at year end 1997, following an increase of $6,972,000 or 3.1% in 1996. Table 1 shows that average loans in 1997 were $241,019,000, an increase of $7,852,000 over the average loans in 1996. The Company's commercial loans at year end increased $3.9 million to $54.7 million as of December 31, 1997 after declining $3.1 million in 1996. The growth in commercial loans reflects the strong local economy in 1997. The Company's real estate construction lending portfolio stabilized during 1997 with balances at December 31, 1997 of $26.8 million, a slight decrease from 1996 year end balances of $26.9 million. 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 $23 million over the last five years. The construction portfolio consists of loans to residential builders, housing developers, and for commercial building projects. The Company recognizes that successful construction lending is dependent upon the successful completion of construction contracts and efficient management of the construction company. Construction loans are generally made on properties which are under sold contracts. Loans are secured by first lien positions on the real estate and have loan to value ratios between 50% - 75% of appraised value. These loans are usually processed through a title company construction escrow. Terms generally range from six months to five years. The Company attempts to minimize the risk of construction lending by granting credit to established customers and restricting these loans to our market area. The mortgage loan portfolio of the Company increased by $6,304,000 at December 31, 1997 as compared to December 31, 1996 as shown in Table 5. 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 get 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 1997 with balances of approximately $14.7 million at December 31, 1997, an increase of 13.1% over last year. At First Federal, mortgage loans originated for sale increased to $11.2 million in 1997 from $9.2 million in 1996. 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, 1997 and 1996 were approximately $1,338,000 and $893,000 and are classified as real estate mortgage loans. 16 NSFC ANNUAL REPORT 1997 28 NORTHERN STATES FINANCIAL CORPORATION LOAN PORTFOLIO CONTINUED 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, 1997 and 1996 were $64.9 million and $65.3 million. Installment lending decreased by $.7 million during 1997, a decline of 7.2%, 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, 1997 this percentage had decreased to less than 10%. There are three primary factors for the decline in indirect paper that has 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 1998, but at a smaller rate. The Company has a small direct lease financing portfolio, which increased in 1997 to $1,274,000. While the Company does not presently solicit leasing business, the Company does occasionally make leases to provide customers with financial alternatives. Table 5 shows the year end balance of loans outstanding by loan purpose for each of the last five years. MATURITY OF LOANS Table 6 highlights the maturity distribution of the Company's loan portfolio, excluding mortgage and installment loans. The short-term sensitivity of the portfolio to interest rate changes is reflected in the fact that approximately 49.2% of the loans are scheduled to mature within one year. Of the remaining loans maturing beyond one year, 69.9% of that total are loans subject to immediate repricing. TABLE 6 LOAN MATURITY SCHEDULE
Greater than ($ 000's) Less than or 1 yr. and less than Greater than - ---------------------------------------------------------------------------------------------------------- As of December 31, 1997 equal to 1 yr. or equal to 5 yrs. 5 yrs. Total - ---------------------------------------------------------------------------------------------------------- Commercial $22,424 $25,579 $6,698 $54,701 Real estate-construction 17,685 7,963 1,120 26,768 --------------------------------------------------------------------------- Total $40,109 $33,542 $7,818 $81,469 --------------------------------------------------------------------------- --------------------------------------------------------------------------- Percent of total 49.23% 41.17% 9.60% 100.00% --------------------------------------------------------------------------- --------------------------------------------------------------------------- Commercial and construction loans maturing after one year: Fixed rate $12,436 Variable rate 28,924 ------------- Total $41,360 ------------- -------------
Real estate-construction loans reflect the contractual maturity of the related note. Due to anticipated roll-overs 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. NSFC ANNUAL REPORT 1997 17 29 NORTHERN STATES FINANCIAL CORPORATION 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, of which there were none for any year in Table 7. Total non-performing loans at December 31, 1997, were $1,006,000. Impaired loans, as defined by Statement of Financial Accounting Standards (SFAS) No. 114 and No. 118, are included in non-performing loans and totaled $754,000 and $828,000 at December 31, 1997 and 1996. SFAS No. 114 and No. 118 consider a loan 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, 1997, approximately 2.3% of the allowance for loan losses is specifically allocated for impaired loans. Interest income recognized on impaired loans in 1997 was $36,000 which was all cash basis income, down from $587,000 and $113,000 of income recognized on impaired loans in 1996 and 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. Other real estate owned declined slightly to $2,555,000 at December 31, 1997 from $2,846,000 at December 31, 1996. Loans are placed in nonaccrual status when they are 90 days past due, unless they are fully secured and in the process of collection. At December 31, 1997 the Company had $3,000 in loans that were 90 days past due, still accruing interest. As illustrated in Table 7, total non-performing assets during 1997 decreased slightly from the 1996 levels in the amount of $451,000. The loans on nonaccrual status decreased by $105,000 in 1997 from $1,108,000 in 1996. Loans 90 days or more past due, still accruing, were reduced by $55,000 in 1997. Loans in the amount of $174,000 were foreclosed upon and transferred to other real estate owned during 1997. In addition, other real estate owned decreased $291,000 during 1997. The Company was able to liquidate a portion of its other real estate, realizing sales proceeds of $586,000 with gains of $142,000. Management continues to be conservative by quickly placing loans on nonaccrual status. This approach is used to eliminate any unearned interest income which would inflate the Company's earnings. Management will continue its emphasis on the collection of all non-performing loans, including the collection of unpaid interest. On December 31, 1997, one piece of property accounted for approximately 69.8% of the total of other real estate owned. The property was acquired by the Bank through the receipt of a deed in lieu of foreclosure in 1987. The parcel consists of approximately 525,000 square feet of land situated on Lake Michigan in Waukegan. During 1994, a purchase agreement for the property, along with some neighboring parcels, was negotiated for an amount that satisfies the current carrying value. The agreement provides for the sale of the property and provides for a fee to be paid to the Bank for the agreement and any 6 month extensions of the agreement. During 1997 all option and extension fees have been received by the Bank at the appropriate time and the agreement remains in force. Conditions necessary to finalize the purchase include approvals from the City of Waukegan and favorable legislative action by the State of Illinois Senate and House of Representatives. It is still uncertain as to when the state legislature will consider such approval of the required legislation. Management continues to emphasize the early identification of loan related problems. Management is not currently aware of any other significant loan, group of loans, or segment of the loan portfolio not included in the discussion above as to which there are serious doubts as to the ability of the borrower(s) to comply with the present loan payment terms. There were no other interest-bearing assets at December 31, 1997, that would be required to be disclosed as non-performing if such assets were loans. TABLE 7 NON-PERFORMING ASSETS
($ 000's) - -------------------------------------------------------------------------------------------------------- December 31, 1997 1996 1995 1994 1993 - -------------------------------------------------------------------------------------------------------- Loans Non-accrual status $1,003 $1,108 $5,692 $4,912 $ 7,873 90 days or more past due, still accruing 3 58 1,653 2,179 557 ---------------------------------------------------------- Total non-performing loans 1,006 1,166 7,345 7,091 8,430 Other real estate owned 2,555 2,846 2,311 2,728 2,891 ---------------------------------------------------------- Total non-performing assets $3,561 $4,012 $9,656 $9,819 $11,321 ---------------------------------------------------------- ---------------------------------------------------------- Non-performing loans as a percentage of total loans, net of unearned income and deferred loan fees 0.42% 0.50% 3.24% 3.27% 3.83% Non-performing assets as a percentage of total assets 0.78 0.94 2.25 2.39 2.72 Non-performing loans as a percentage of the allowance for loan losses 18.53 24.10 161.74 178.84 223.96
Loans are placed in non-accrual status when they are 90 days past due, unless they are fully secured and in the process of collection. Impaired Loans - At December 31, 1997, 1996 and 1995 impaired loans totaled $754, $828 and $5,161 and are included in non-accrual loans. Potential Problem Loans - At December 31, 1997 there were no other loans classified as problem loans that are not included above. Other Problem Assets - At December 31, 1997, there were no other classified assets, including direct lease financing, other than the loans and other real estate owned shown above. 18 NSFC ANNUAL REPORT 1997 30 NORTHERN STATES FINANCIAL CORPORATION 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 require that management 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, 1997, was lower than the Company's historical average between 1993 and 1995. Therefore, management during 1997 lowered the loan loss provision to $480,000 from $1,190,000 in 1996 which was decreased from $1,480,000 in 1995. If the level of non-performing assets remains low in 1998 it is expected that there will be further reductions to the loan loss provision. As shown in Table 8, during 1997 the loan loss provision of $480,000 plus net recoveries of $111,000 increased the allowance for loan losses to $5,430,000. As a result, the allowance for loan losses increased to 2.2% of total loans outstanding at December 31, 1997. Table 8 also indicates the types of loans charged-off and recovered for the five years from 1993 through 1997 as well as each year's provision. Because management is not certain as to the full collectibility of the non-performing loans, potential loss exposure has been provided in the Company's allocation of the allowance for loan losses. As illustrated in Table 9, the unallocated portion of the allowance, the portion of the allowance that is not specifically reserved for any particular problem credit, was 49.76% of the total allowance at December 31, 1997, which is a decrease from 58.98% of the total allowance at December 31, 1996. Based upon management's analysis, the allowance for loan losses at December 31, 1997, is adequate to cover future possible loan losses. TABLE 8 ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
($ 000's) - ------------------------------------------------------------------------------------------------------------ Years Ended December 31, 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------------ Balance at the beginning of year $4,839 $4,514 $3,965 $3,764 $2,809 ------------------------------------------------------- Charge-offs: Commercial 86 288 145 687 488 Real estate-construction 0 523 334 22 8 Real estate-mortgage 38 145 473 496 0 Installment 85 185 57 110 147 ------------------------------------------------------- Total charge-offs 209 1,141 1,009 1,315 643 ------------------------------------------------------- Recoveries: Commercial 33 183 18 9 14 Real estate-construction 0 50 0 0 0 Real estate-mortgage 206 0 0 0 0 Installment 81 43 60 67 103 ------------------------------------------------------- Total recoveries 320 276 78 76 117 ------------------------------------------------------- Net charge-offs (recoveries) (111) 865 931 1,239 526 ------------------------------------------------------- Additions charged to operations 480 1,190 1,480 1,440 1,481 ------------------------------------------------------- Balance at end of year $5,430 $4,839 $4,514 $3,965 $3,764 ------------------------------------------------------- ------------------------------------------------------- Allowance as a % of total loans, net of unearned income and deferred loan fees 2.24% 2.08% 2.00% 1.83% 1.71% ------------------------------------------------------- ------------------------------------------------------- Net charge-offs (recoveries) during the year to average loans outstanding during the year -0.05% 0.37% 0.42% 0.58% 0.23% ------------------------------------------------------- -------------------------------------------------------
In addition to management's assessment, loans are examined periodically by federal and state banking authorities. NSFC ANNUAL REPORT 1997 19 31 NORTHERN STATES FINANCIAL CORPORATION TABLE 9 ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
($ 000's) - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------------------------------------ Percent of Percent of Percent of Percent of Percent of loans in each loans in each loans in each loans in each loans in each category to category to category to category to category to Amount total loans Amount total loans Amount total loans Amount total loans Amount total loans -------------------------------------------------------------------------------------------------------- Commercial $1,335 22.52% $ 947 21.75% $1,741 23.80% $1,468 23.14% $1,553 24.77% Real estate-construction 389 11.02 184 11.53 727 10.47 168 10.00 95 8.90 Real estate-mortgage 946 62.94 809 62.78 644 60.92 813 60.87 609 61.02 Installment 58 3.52 45 3.94 87 4.81 116 5.99 138 5.31 Unallocated 2,702 NA 2,854 NA 1,315 NA 1,400 NA 1,369 NA -------------------------------------------------------------------------------------------------------- Total $5,430 100.00% $4,839 100.00% $4,514 100.00% $3,965 100.00% $3,764 100.00% -------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------
NONINTEREST INCOME Noninterest income declined by $552,000 or 17.0% during 1997 following an increase of $537,000 or 19.9% during 1996. Service fees on deposits declined by $93,000 in 1997. The major portion of this decline was the result of decreased overdraft fee income which fell $31,000 from 1996 as average customer demand deposit balances increased in 1997. Service charges on retail deposits declined $21,000 in 1997 as average account balances increased from 1996. Service charge income from automated teller machines (ATMs) decreased $37,000 due to a change in the accounting treatment for credits received when noncustomers use our ATMs. These credits in 1997 were applied against data processing expense relating to ATM transactions. Trust income increased $102,000 or 19.5% from the same period in 1996 due to increased fees and additional trust business. There were no security sales during 1997 and there were no corresponding security gains. During 1996 there was a sale of equity securities classified as available for sale for liquidity purposes which realized proceeds of $2,675,000 and a resulting gain of $5,000. Gains on sales of loans declined $38,000 during 1997 as compared to 1996. Volume of loan sales during 1997 remained stable with $10.7 million in loans sold in 1997 as compared to $10.8 million sold in 1996. The decline in gains was the result of competitive pressures which caused the Company to narrow its profit margin on sales of loans in order to maintain sales volume. Other operating income declined $518,000 or 45.3% in 1997. The decrease is attributable to the Company booking $163,000 more in gains from the sale of other real estate owned during 1996 than in 1997. Other operating income also declined during 1997 due to the one-time collection during 1996 of back interest and fees on a loan in excess of the amount charged off of $131,000. Competitive pressures for the origination of loans for sale on the secondary market reduced other loan fee income by $37,000 during 1997. Comparing 1996 to 1995, noninterest income increased by $537,000 or 19.9%. The majority of this increase is attributable to increases in other operating income which rose $461,000 or 67.5% during 1996. The Company booked gains from the sale of other real estate owned of $305,000 during 1996. Other income also increased during 1996 due to the one-time collection of back interest and fees on a loan in excess of the amount charged off of $131,000. Service fees on deposits declined $76,000 in 1996 as compared to 1995 as average customer demand deposit balances increased. Income from trust activities increased $62,000 during 1996 as fiduciary activities rose in 1996 as compared to 1995. Gains on sales of loans rose $85,000 in 1996 from 1995 as a result of adopting SFAS 122, "Accounting for Mortgage Servicing Rights" during 1996 which allowed additional gains pertaining to servicing rights to be booked. NONINTEREST EXPENSES In 1997, total noninterest expenses declined by $1,240,000 to $9,132,000, a decrease of 11.96%. Over the last three years total noninterest expenses averaged $9,979,000 as the Company emphasized its ability to control operating expenses. As a percent of average assets, noninterest expense was 2.1% in 1997 compared to 2.5% in 1996 and 2.6% in 1995. The efficiency ratio, noninterest expenses divided by the sum of net interest income and noninterest income, is frequently used as an indicator as to how well a financial institution manages its noninterest expenses. A decreasing ratio is an indication of improving performance. The Company's efficiency ratio was 46.1% in 1997, 51.6% in 1996 and 55.2% in 1995. 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 $70,000 in 1997 which was a smaller decrease than in 1996. The Company continued to experience staff reductions during 1997 due to increased efficiencies. The Company hired one senior lender during the third quarter of 1997 because of increases to the loan portfolio. Occupancy expenses declined $117,000 or 9% during 1997 as compared to the same period in 1996. A majority of this reduction is a result of decreases in the accrual for property taxes which declined $81,000 during 1997. Management was able to successfully protest and significantly decrease the assessed valuation of the Company's real property. 20 NSFC ANNUAL REPORT 1997 32 NORTHERN STATES FINANCIAL CORPORATION NONINTEREST EXPENSES CONTINUED Data processing expense decreased $31,000 or 5.7% during 1997 as compared to the same period in 1996. The Company changed its accounting treatment for credits received for noncustomers' use of Company owned ATMs. These credits in 1997 amounted to $37,000 and were applied against data processing expense relating to ATM transactions. FDIC deposit insurance expense fell significantly in 1997 by $745,000 or 91.2% as compared to 1996. During 1996 the Thrift subsidiary booked a $603,000 one-time FDIC expense due to legislation requiring recapitalization of the FDIC Savings Association Insurance Fund (SAIF). With both FDIC SAIF and Bank Insurance Fund (BIF) being fully funded the Company's 1997 FDIC expense declined. Other real estate owned expenses decreased $83,000 or 37.2% during 1997 compared to the previous year due to the decline in transfers made from loans to the other real estate owned during 1997 compared to 1996. Only $174,000 in loans were transfered to other real estate owned in 1997 compared to $2,432,000 in 1996. Other operating expenses for 1997 declined by $194,000 or 9.6% as compared to last year. Auditing expenses declined $35,000 from last year as the internal audit staff took on some of the audit functions that previously were performed by the outside auditors. Loan and collection expenses declined $32,000 in 1997 resulting from the decrease in non-performing loans. Printing expenses declined $32,000 as the Company's loan and customer service areas continued to automate so that forms are printed internally by laser printers as needed, reducing inventories of forms. Business development expenses declined $34,000 during 1997 as greater use of joint advertisement of Bank and Thrift products occurred. Expenses relating to correspondent bank accounts were $18,000 less in 1997 as higher balances were maintained and earnings credit allowances were greater, thus reducing this expense. In 1996, total noninterest expenses declined slightly by $61,000 to $10,372,000 from 1995 levels. Salaries and other employee expenses decreased $222,000 or 3.9% in 1996. Staff reductions occurred during 1996 due to increased efficiencies. 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 from building and equipment items becoming 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. FDIC deposit insurance expense increased significantly in 1996 by $334,000 or 69.2% as compared to 1995. This increase is a result of the Thrift booking a $603,000 one-time FDIC expense due to legislation requiring recapitalization of the FDIC Savings Association Insurance Fund (SAIF) during 1996. Other real estate owned expenses increased $51,000 or 29.7% during 1996 compared to 1995 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 only $981,000 during 1995. Other operating expenses for 1996 declined by $207,000 or 9.3% as compared to 1995. Much of this decrease is attributable to one-time expenses during the early 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 in 1996 as during 1995 new forms had to be ordered for the new data processing system. Professional fees declined $110,000 as consultants were used in 1995 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. On December 17, 1997 the Company's Board of Directors announced that it had approved the merger of its two wholly owned subsidiaries, Bank of Waukegan and First Federal Bank, fsb. The Bank of Waukegan will be the surviving entity in the merger. The proposed merger is subject to the receipt of various bank regulatory approvals. Subject to regulatory approval, the merger will become effective during the second quarter of 1998. Management believes that the merger will increase efficiencies and lower noninterest expenses in future years. The Company expects increases to other operating expenses as a result of the merger during 1998. Legal and other professional expenses related to the merger are estimated to be $60,000 during 1998. Merger expenses relating to data processing are estimated at $33,000. It is expected that marketing expenses for signs and notices to our customers will be approximately $35,000. Printing expenses may increase during 1998 as a result of the merger. The Company has established a "Year 2000 Team" made up of management in order to deal with risks associated with the new millennium especially in the area of data processing. This "Year 2000 Team" regularly updates the Company's Board of Directors as to the Company's ability to deal with year 2000 issues. An inventory of all computer hardware and software utilized by the Company has been conducted and the hardware and software vendors have been contacted requesting the status of the vendors' compliance with year 2000 issues. The Company contracts with an outside data processing service bureau for most of its data processing needs. The data processing service bureau has been testing for year 2000 compliance and expects to be prepared for all year 2000 issues. The Company's item processing system has been found not to be year 2000 compliant and new hardware and software will be installed during 1998 at an expected cost of $50,000. The teller platform system used by the Company has been determined as not compliant for the year 2000. Updating the teller platform will entail an expenditure for hardware and software of approximately $100,000. FEDERAL AND STATE INCOME TAXES For the years ended December 31, 1997, 1996 and 1995, the Company's provision for federal and state taxes as a percentage of pretax earnings were 31.4%, 29.6% and 29.2%. The actual tax rates differ from the statutory rates because the pretax earnings include significant amounts of interest on United States Government securities, which are nontaxable for state income tax purposes, qualified interest on loans to local political subdivisions, which are nontaxable for federal income tax purposes, and interest on qualified state and local political subdivision securities, which are nontaxable for federal income tax purposes. NSFC ANNUAL REPORT 1997 21 33 NORTHERN STATES FINANCIAL CORPORATION TABLE 10 MATURITY OR REPRICING OF ASSETS AND LIABILITIES
-------------------SUBJECT TO REPRICING WITHIN ------------------------------- ($ 000)s IMMEDIATE 91 DAYS 181 DAYS 1 - 3 3 - 5 5 - 10 - -------------------------------------------------------------------------------------------------------------------------------- DECEMBER 31, 1997 BALANCES TO 90 DAYS TO 180 DAYS TO 365 DAYS YEARS YEARS YEARS - -------------------------------------------------------------------------------------------------------------------------------- ASSETS: Interest bearing deposits in financial institutions $ 206 $ 106 $ 0 $ 0 $ 100 $ 0 $ 0 Federal funds sold 11,200 11,200 0 0 0 0 0 SECURITIES: U.S. Treasury 14,031 3,002 2,013 5,007 4,009 0 0 U.S. Government agencies and corporations 128,872 3,000 1,745 4,978 50,220 60,354 8,575 States & political subdivisions 22,408 701 322 2,117 7,147 6,590 5,531 Equity securities 2,238 1,561 0 0 0 677 0 Mortgage-backed securities (1) 13,123 3,781 70 2,921 551 22 5,778 LOANS: Commercial 54,701 41,400 1,171 683 3,697 6,749 1,001 Real estate - construction 26,768 24,653 594 423 69 82 947 Real estate - mortgage 152,856 55,728 3,918 10,818 28,866 35,095 18,431 Installment, net of unearned income 8,390 3,056 834 1,343 1,684 1,377 96 Direct lease financing 1,274 571 45 133 269 256 0 ------------------------------------------------------------------------------ TOTAL INTEREST EARNING ASSETS $436,067 $ 148,759 $ 10,712 $ 28,423 $96,612 $111,202 $40,359 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ LIABILITIES: NOW accounts $ 36,455 $ 36,455 $ 0 $ 0 $ 0 $ 0 $ 0 Money market accounts 38,790 38,790 0 0 0 0 0 Savings 43,923 43,923 0 0 0 0 0 Time deposits, $100,000 and over 93,469 39,775 19,509 28,106 6,079 0 0 Time deposits, under $100,000 93,925 34,950 19,124 20,335 19,453 25 38 Other interest bearing liabilities 43,504 23,618 8,784 5,102 6,000 0 0 ------------------------------------------------------------------------------ TOTAL INTEREST BEARING LIABILITIES $350,066 $ 217,511 $ 47,417 $ 53,543 $31,532 $ 25 $ 38 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ EXCESS INTEREST EARNING ASSETS (LIABILITIES) $ (68,752) $ (36,705) $ (25,120) $65,080 $111,177 $40,321 CUMULATIVE EXCESS INTEREST EARNING ASSETS (LIABILITIES) (68,752) (105,457) (130,577) (65,497) 45,680 86,001 CUMULATIVE INTEREST RATE SENSITIVITY RATIO (2) 0.68 0.60 0.59 0.81 1.13 1.25
(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. 22 NSFC ANNUAL REPORT 1997 34 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 $180,672,000 at December 31, 1997. Securities at December 31, 1997 in the amount of $122,418,000 were pledged to secure public deposits and repurchase agreements. During 1997, the Company received a term advance from the Federal Home Loan Bank in the amount of $5,000,000. These funds were used to purchase a U.S. Government agency security that has a call provision on the same date as the advance is due to be repaid. 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 repricable, because of management's ability to change the savings interest rate. Table 11 illustrates the maturity schedule as of December 31, 1997 of the time deposits $100,000 and over portfolio. At December 31, 1997 6.5% of the time deposits $100,000 and over mature after a year. At December 31, 1996 only 5.5% of time deposits matured after a year showing a slight shift by large time deposit customers to long term certificates of deposit. This lengthening of maturity lengths on time deposits of $100,000 assists in lowering the Company's negative gap position. The Company historically has a high level of time deposits over $100,000 and securities sold under repurchase agreements and other short-term borrowings. As of December 31, 1997, time deposits over $100,000 and repurchase agreements were 33.7% of total deposits and other borrowings, an increase from 28.9% in 1996. The increase in time deposits over $100,000 was from existing local public depositors. Being located in the county seat, the Company accepts time deposits over $100,000 from various government agencies. With approximately 51.4% of the Company's loan and lease portfolio floating with the prime rate or repricable within 90 days, the effect on interest income when rates rise or fall is felt quickly. As Table 10 shows, the Company is liability sensitive through the three year time horizon by $65.5 million. This is a change from last year, where the Company was liability sensitive through the three year time horizon by $61.5 million. Although management has attempted during the past year to reduce its liability sensitive gap position, its efforts continued 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. The Company 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. Securities carried at $77,088,000 have call options allowing the issuers to redeem the securities prior to the contractual maturity date. Management has continued its efforts to reduced its liability sensitive position by continuing to sell fixed rate mortgage loans originated on the secondary market. Management has made efforts to reduce its liability sensitive position by lengthening the maturities of its time deposit. Time deposits maturing after one year as a percentage of total time deposits increased to 13.7% at December 31, 1997 from 12.6% last year. It is management's desire to reduce the liability gap position during the upcoming year. TABLE 11 TIME DEPOSITS, $100,00 AND OVER MATURITY SCHEDULE
Greater than Greater than ($ 000's) Less than or 3 mos. & less than 3 mos. & less than Greater than - --------------------------------------------------------------------------------------------------------------------------- As of December 31, 1997 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 $10,399 $ 6,041 $ 8,188 $4,632 $29,260 Corporate deposits 6,712 2,739 950 909 11,310 Public fund deposits 22,664 10,729 18,968 538 52,899 ------------------------------------------------------------------------------------ Total time deposits, $100,000 and over $39,775 $19,509 $28,106 $6,079 $93,469 ------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------
The Company has no foreign banking offices or deposits. NSFC ANNUAL REPORT 1997 23 35 NORTHERN STATES FINANCIAL CORPORATION SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER SHORT-TERM BORROWINGS Securities sold under repurchase agreements (repurchase agreements) and other short-term borrowings during 1997 have continued to be an alternative to certificates of deposit as a source of funds. At December 31, 1997 the Company had $38,504,000 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. Although the Company experienced a $1.7 million increase in its repurchase agreements and short term borrowing at year end 1997, average repurchase agreements during 1997 declined slightly by $830,000 from 1996. Average repurchase agreements increased during 1996 from 1995 levels by $373,000. These slight changes in average balances indicate that repurchase agreements are a stable source of funds to the Company. Table 12 provides information as to balances and interest rates pertaining to securities sold under repurchase agreements and other short-term borrowings. TABLE 12 SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER SHORT-TERM BORROWINGS
($ 000's) - ---------------------------------------------------------------------------------- At or for the Year Ended December 31, 1997 1996 1995 - ---------------------------------------------------------------------------------- Balance at end of year $38,504 $36,758 $43,278 Weighted average interest rate at end of year 5.29% 4.93% 5.28% Maximum amount outstanding $39,995 $44,135 $78,116 Average amount outstanding 34,176 35,006 34,633 Weighted average interest rate 5.07% 4.92% 5.41%
CAPITAL RESOURCES Capital provides the foundation for future growth. Regulatory agencies have developed minimum guidelines by which the adequacy of a financial institution's capital may be evaluated. Northern States' capital ratios exceed these minimum guidelines, both in terms of Tier I capital (stockholders' equity of the Company less intangible assets), and in terms of Tier II capital (Tier I capital plus qualifying long-term debt and the allowance for loan losses). The portion of the allowance for loan losses qualifying as Tier II capital is limited to 1.25% of risk weighted assets. The effect of the unrealized gains (losses) on securities available for sale is excluded from the capital ratio calculations. Regulatory capital guidelines require that the amount of capital increase with the amount of risk inherent in a company's balance sheet and off-balance sheet exposure. Capital requirements in order for the Company to be considered well capitalized are that Tier I capital to average assets must be at least 5.00% and Tier I capital to risk weighted assets must be at least 6.00%. The requirements are that Tier II capital must be 10.00% of risk adjusted assets in order for the Company to be considered well capitalized. All of the Company's capital ratios exceed the level required under regulatory guidelines as shown in Table 13. 24 NSFC ANNUAL REPORT 1997 36 NORTHERN STATES FINANCIAL CORPORATION
($ 000's) As of December 31, 1997 - ---------------------------------------------------------- QUALIFYING FOR TIER I CAPITAL: - ---------------------------------------------------------- Common stock $ 1,779 Surplus 11,222 Retained earnings 46,725 Less - Intangible assets (129) -------- TOTAL QUALIFYING TIER I CAPITAL $59,597 -------- --------
($ 000's) As of December 31, 1997 - ----------------------------------------------------------- QUALIFYING FOR TIER II CAPITAL: - ----------------------------------------------------------- Total Qualifying Tier I Capital $ 59,597 Allowance for loan losses 3,652 -------- TOTAL QUALIFYING TIER II CAPITAL $ 63,249 -------- TOTAL ASSETS $458,222 -------- --------
($ 000's) As of December 31, 1997 - --------------------------------------------------------------------------- RISK-BASED ASSETS TOTAL RISK-BASED - --------------------------------------------------------------------------- Zero percent risk $ 20,111 $ 0 Twenty percent risk 183,275 36,655 Fifty percent risk 101,019 50,510 One hundred percent risk (1) 205,034 205,034 ------------------------- TOTAL RISK-WEIGHTED ASSETS $509,439 $292,199 ------------------------- -------------------------
(1) Includes off-balance-sheet items
($ 000's) As of December 31, 1997 - ---------------------------------------------------------------- CAPITAL REQUIREMENTS $ % - ---------------------------------------------------------------- (Tier I Capital to Average Assets) REQUIRED $21,742 5.00% ACTUAL 59,597 13.71 RISK-BASED CAPITAL: Tier I: REQUIRED $17,532 6.00% ACTUAL 59,597 20.40 Tier II: REQUIRED $29,220 10.00% ACTUAL 63,249 21.65
CASH FLOWS Cash flows from operating activities were above accrual basis net income by $1.8 million in 1997. In 1996 cash flows from operating income exceeded net income by $6.2 million and in 1995 cash flows from operating income were below net income by $.2 million. Management expects ongoing operating activities to continue to be a primary source of cash flow for the Company. Interest bearing deposits increased $21.0 million or 7.35% in 1997. The Company has experienced growth in its time deposits over $100,000 from existing local public depositors. Interest bearing deposits help the Company to 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 1997 provided greater interest income revenues for the Company. These increases to loans were funded through cash flows from operating activities and increases to deposits. Securities available for sale increased $30.9 million during 1997 and also provided increased interest income revenues to the Company. The increase in securities available for sale came from proceeds from maturing securities available for sale, operating activities, a term advance of $5.0 million from the Federal Home Loan Bank and increases to deposits. To insure the ability to meet its funding needs, including any unexpected strain on liquidity, the Company has a $23 million in federal funds lines of credit from two independent banks. In addition, the Company has the ability to borrow funds, if necessary, directly from the Federal Reserve Bank and the Federal Home Loan Bank. The Company has a term advance of $5.0 million from the Federal Home Loan Bank which has been used to purchase a U.S. Government agency security that has a call provision on the same date as the advance is due to be repaid. Interest earned on the U.S. Government agency security is used to service the debt to the Federal Home Loan Bank. The Company has no other 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 to 30.4% in 1997 from 29.6% in both 1996 and 1995. During 1997 the Company made a $64,000 outlay for expansion of its new telephone system to all its offices. Expenditures of $76,000 were made in 1997 to remodel and add offices at two of the Company's locations and addtional $77,000 was expended to update data processing equipment and printers. During 1996 a $61,000 outlay was made for new telephone equipment and $49,000 was used to purchase 2 new ATMs. There are planned expenditures during 1998 of $50,000 to purchase hardware and software to update the Company's item processing system in order to meet the year 2000 issues. It is possible that another $100,000 to update the Company's teller platform system to be compliant for the year 2000 may be expended during 1998. NSFC ANNUAL REPORT 1997 25 37 NORTHERN STATES FINANCIAL CORPORATION RECENT ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income", which will be effective for fiscal years beginning after December 15, 1997. The statement establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The statement does not address when transactions are recorded, how they are measured in the financial statements or whether they should be included in net income or other comprehensive income. The effect of this statement on future financial statements is not expected to be material. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosure about Segments of an Enterprise and Related Information", which will become effective for fiscal years beginning after December 15, 1997. The statement establishes standards for the way public companies report information about operating segments in annual financial statements and requires that those enterprises report selected financial information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. Management does not expect that the effect of this statement on its financial reporting will be material. QUANTITIVE AND QUALITIVE DISCLOSURES ABOUT MARKET RISK The Company's primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. Interest-rate risk ("IRR") is the exposure of a banking organization's financial condition to adverse movements in interest rates. Accepting this risk can be an important source of profitability and stockholder value, however excessive levels of IRR can pose a significant threat to the Company's earnings and capital base. Accordingly, effective risk management that maintains IRR at prudent levels is essential to the Company's safety and soundness. Evaluating a financial institution's exposure to changes in interest rates includes assessing both the adequacy of the management process used to control IRR and the organization's quantitative level of exposure. When assessing the IRR management process, the Company seeks to ensure that appropriate policies, procedures, management information systems and internal controls are in place to maintain IRR at prudent levels with consistency and continuity. Evaluating the quantitative level of IRR exposure requires the Company to assess the existing and potential future effects of changes in interest rates on its consolidated financial condition, including capital adequacy, earnings, liquidity, and, where appropriate, asset quality. The Federal Reserve Board, together with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation, adopted a Joint Agency Policy Statement on Interest-Rate Risk, effective June 26, 1996. The policy statement provides guidance to examiners and bankers on sound practices for managing interest rate risk, which will form the basis for ongoing evaluation of the adequacy of interest-rate risk management at supervised institutions. The policy statement also outlines fundamental elements of sound management that have been identified in prior Federal Reserve guidance and discusses the importance of these elements in the context of managing interest-rate risk. Specifically, the guidance emphasizes the need for active board of director and senior management oversight and a comprehensive risk-management process that effectively identifies, measures, and controls interest-rate risk. Several techniques might be used by an institution to minimize interest-rate risk. Such activities fall under the broad definition of asset/liability management. The Company's primary asset/liability management technique is the measurement of the Company's asset/liability gap, that is, the difference between the cash flow amounts of interest-sensitive assets and liabilities that will be repriced during a given period. Several ways an institution can manage interest-rate risk include: selling existing assets or repaying certain liabilities; matching repricing periods for new assets and liabilities, for example, and by shortening terms of new loans or investments. Financial institutions are also subject to prepayment risk in falling rate environments. For example, mortgage loans and other financial assets may be prepaid by a debtor so that the debtor may refund its obligations at new, lower rates. Prepayments of assets carrying higher rates reduce the Company's interest income and overall asset yields. A large portion of an institution's liabilities may be short term or due on demand, while most of its assets may be invested in long-term loans or investments. Accordingly, the Company seeks to have in place sources of cash to meet short-term demands. These funds can be obtained by increasing deposits, borrowing, or selling assets. Table 14 provides information about the Company's financial instruments that are sensitive to changes in interest rates as of December 31, 1997 based on the information and assumptions set forth in the notes. The Company believes that the assumptions utilized are reasonable. The Company had no derivative financial instruments, or trading portfolio, as of December 31, 1997. The expected maturity date values for loans receivable, mortgage-backed securities, and investment securities were calculated by adjusting the instrument's contractual maturity date for expectations of prepayments, as set forth in the notes. Expected maturity for interest bearing core deposits such as NOW, money market and savings accounts are assumed to be 5% each year. With respect to the Company's adjustable rate instruments, expected maturity date values were measured by adjusting the instrument's contractual maturity date for expectations of prepayments, as set forth in the notes. From a risk management perspective, however, the Company believes that repricing dates, as opposed to expected maturity dates, may be more relevant in analyzing the value of such instruments. Similarly, 42.7% of the Company's securities portfolio is comprised of callable securities. Company borrowings consist of securities sold under repurchase agreements and a Federal Home Loan Bank term advance and were tabulated by contractual maturity dates and without regard to any conversion or repricing dates. 26 NSFC ANNUAL REPORT 1997 38 NORTHERN STATES FINANCIAL CORPORATION TABLE 14 EXPECTED MATURITY DATES OF ON BALANCE SHEET ITEMS
($ 000's) ---------------------------------------- Maturing In -------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- As of December 31, 1997 1998 1999 2000 2001 2002 Thereafter Totals Fair Value - ---------------------------------------------------------------------------------------------------------------------------------- Interest earning assets: Loans (1) (2) Fixed rate $ 17,753 $10,862 $15,771 $24,867 $16,685 $20,776 $106,714 $107,151 Average interest rate 8.88% 8.93% 8.98% 9.03% 8.98% 7.86% 8.75% Adjustable rate 55,486 12,365 13,052 9,012 13,816 32,424 136,155 136,155 Average interest rate 9.17 9.27 9.21 8.98 9.29 9.27 9.21 Securities Fixed rate 24,446 19,081 43,344 33,821 33,324 19,625 173,641 173,641 Average interest rate 6.01 6.30 6.50 6.47 6.55 7.33 6.51 Adjustable rate 0 0 0 0 0 7,031 7,031 7,031 Average interest rate 0.00 0.00 0.00 0.00 0.00 6.76 6.76 Interest bearing deposits and federal funds sold Fixed rate 0 0 100 0 0 0 100 100 Average interest rate 0.00 0.00 7.30 0.00 0.00 0.00 7.30 Adjustable rate 11,306 0 0 0 0 0 11,306 11,306 Average interest rate 5.57 0.00 0.00 0.00 0.00 0.00 5.57 Direct lease financing Fixed rate 749 202 67 149 107 0 1,274 1,274 Average interest rate 7.74 7.80 8.74 7.30 7.14 0.00 7.70 ------------------------------------------------------------------------------------------- Total $109,740 $42,510 $72,334 $67,849 $63,932 $79,856 $436,221 $436,658 ------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------- Interest bearing liabilities: Interest bearing deposits (3) Balances $167,753 $25,613 $10,958 $ 5,128 $ 4,859 $92,251 $306,562 $306,958 Average interest rate 5.60% 5.46% 4.80% 3.35% 3.34% 3.34% 4.80% Borrowings Balances 37,504 6,000 0 0 0 0 43,504 43,519 Average interest rate 5.27 5.92 0.00 0.00 0.00 0.00 5.36 ------------------------------------------------------------------------------------------- Total $205,257 $31,613 $10,958 $ 5,128 $ 4,859 $92,251 $350,066 $350,477 ------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------
(1) Does not include net deferred loan fees, unearned income or the allowance for loan losses. (2) For fixed rate loans, amortization is based on aggregate payments due. (3) NOW, money market and savings deposits assume 5% maturity each year. NSFC ANNUAL REPORT 1997 27 39 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 & 1995 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 & Assistant Vice President Chief 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, 1997 and 1996 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based upon 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, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. /s/ Crowe, Chizek and Company LLP - ---------------------------------- Crowe, Chizek and Company LLP Oak Brook, Illinois February 12, 1998, except for Note 14, as to which the date is February 17, 1998 28 NSFC ANNUAL REPORT 1997 40 NORTHERN STATES FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEETS
($ 000's, except per share data) - ------------------------------------------------------------------------------------------------------------ December 31, 1997 1996 - ------------------------------------------------------------------------------------------------------------ Assets Cash and due from banks ............................................................ $ 14,200 $ 15,247 Interest bearing deposits in financial institutions - maturities less than 90 days.. 106 1,235 Federal funds sold ................................................................. 11,200 15,500 ---------------------- Total cash and cash equivalents ................................................ 25,506 31,982 Interest bearing deposits in financial institutions - maturities over 90 days ...... 100 100 Securities available for sale ...................................................... 180,672 149,750 Loans .............................................................................. 242,224 232,653 Less: Allowance for loan losses .................................................... (5,430) (4,839) ---------------------- Loans, net ..................................................................... 236,794 227,814 Direct lease financing ............................................................. 1,274 999 Office buildings and equipment, net ................................................ 5,899 6,250 Other real estate owned, net of allowance for losses of $544 and $532 .............. 2,555 2,846 Accrued interest receivable ........................................................ 4,308 3,955 Other assets ....................................................................... 1,878 2,868 ---------------------- Total assets ............................................................... $458,986 $426,564 ---------------------- ---------------------- Liabilities and Stockholders' Equity Liabilities Deposits Demand - noninterest bearing ................................................... $ 41,388 $ 43,223 NOW accounts ................................................................... 36,455 38,159 Money market accounts .......................................................... 38,790 44,426 Savings ........................................................................ 43,923 44,843 Time, $100,000 and over ........................................................ 93,469 69,052 Time, under $100,000 ........................................................... 93,925 89,092 ---------------------- Total deposits ............................................................. 347,950 328,795 Securities sold under repurchase agreements and other short-term borrowings ........ 38,504 36,758 Federal Home Loan Bank term advance ................................................ 5,000 0 Advances from borrowers for taxes and insurance .................................... 1,166 1,021 Accrued interest payable and other liabilities ..................................... 6,171 5,155 ---------------------- Total liabilities .......................................................... 398,791 371,729 ---------------------- Stockholders' Equity Common stock - $2 par value: 1,750,000 shares authorized; 889,373 and 889,273 shares issued and outstanding .............................. 1,779 1,779 Additional paid-in capital ......................................................... 11,222 11,216 Retained earnings .................................................................. 46,725 41,849 Unrealized gain (loss) on securities available for sale, net ....................... 469 (9) ---------------------- Total stockholders' equity ..................................................... 60,195 54,835 ---------------------- Total liabilities and stockholders' equity ..................................... $458,986 $426,564 ---------------------- ----------------------
The accompanying notes are an integral part of these consolidated financial statements. NSFC ANNUAL REPORT 1997 29 41 NORTHERN STATES FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME
($ 000's, except per share data) - ------------------------------------------------------------------------------------------- Years Ended December 31, 1997 1996 1995 - ------------------------------------------------------------------------------------------- Interest income Loans (including fee income)............................. $22,199 $22,050 $21,567 Securities Taxable.............................................. 8,411 7,663 7,313 Exempt from federal income tax....................... 1,149 1,188 1,156 Interest bearing deposits in financial institutions...... 35 28 117 Federal funds sold....................................... 965 742 740 --------------------------- Total interest income................................ 32,759 31,671 30,893 --------------------------- Interest expense Time deposits............................................ 9,714 8,720 8,381 Other deposits........................................... 4,114 4,364 4,451 Other borrowings......................................... 1,787 1,724 1,873 --------------------------- Total interest expense............................... 15,615 14,808 14,705 --------------------------- Net interest income.......................................... 17,144 16,863 16,188 Provision for loan losses.................................... 480 1,190 1,480 --------------------------- Net interest income after provision for loan losses.......... 16,664 15,673 14,708 --------------------------- Noninterest income Service fees on deposits................................. 1,264 1,357 1,433 Trust income............................................. 625 523 461 Net security gains....................................... 0 5 0 Net gains on sales of loans.............................. 172 210 125 Other operating income................................... 626 1,144 683 --------------------------- Total noninterest income............................. 2,687 3,239 2,702 --------------------------- Noninterest expenses Salaries and employee benefits........................... 5,407 5,477 5,699 Occupancy and equipment expenses, net.................... 1,184 1,301 1,333 Data processing expense.................................. 511 542 527 FDIC deposit insurance expense........................... 72 817 483 Other real estate owned expenses......................... 140 223 172 Other operating expenses................................. 1,818 2,012 2,219 --------------------------- Total noninterest expenses........................... 9,132 10,372 10,433 --------------------------- Income before income taxes................................... 10,219 8,540 6,977 Provision for income taxes................................... 3,209 2,529 2,040 --------------------------- Net income................................................... $ 7,010 $ 6,011 $ 4,937 --------------------------- --------------------------- Basic earnings per common share.............................. $ 7.88 $ 6.76 $ 5.57 Diluted earnings per share................................... $ 7.87 $ 6.75 $ 5.56
The accompanying notes are an integral part of these consolidated financial statements. 30 NSFC ANNUAL REPORT 1997 42 NORTHERN STATES FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
($ 000's) - -------------------------------------------------------------------------------------------------------- Years Ended December 31, 1997 1996 1995 - -------------------------------------------------------------------------------------------------------- Cash flows from operating activities Net income...................................................... $ 7,010 $ 6,011 $ 4,937 Adjustments to reconcile net income to cash from operating activities: Depreciation................................................ 568 546 621 Provision for loan losses................................... 480 1,190 1,480 Provision for losses on other real estate owned............. 21 22 23 Deferred loan fees.......................................... (38) (172) (128) Net gains on sales of securities............................ 0 (5) 0 Net change in loans held for sale........................... (349) 2,863 (1,029) Net gains on sales of loans................................. (172) (210) (125) Net gains on sales of other real estate owned............... (142) (305) 0 Amortization of mortgage servicing rights................... 36 15 0 Net change in interest receivable........................... (353) 411 (579) Net change in interest payable.............................. 1,192 342 428 Net change in other assets.................................. 742 1,218 (656) Net change in other liabilities............................. (205) 290 (269) -------------------------------- Net cash from operating activities...................... 8,790 12,216 4,703 -------------------------------- Cash flows from investing activities Net change in interest bearing deposits in financial institutions - maturities over 90 days...................... 0 0 4,100 Proceeds from sales of securities available for sale........ 0 2,675 0 Proceeds from maturities of securities available for sale... 90,148 90,571 66,116 Proceeds from maturities of securities held to maturity..... 0 0 27,584 Purchases of securities available for sale.................. (120,273) (83,959) (49,799) Purchases of securities held to maturity.................... 0 0 (45,642) Change in loans made to customers........................... (9,151) (17,847) (9,221) Property and equipment expenditures......................... (217) (209) (97) Net change in direct lease financing........................ (275) (377) (249) Proceeds from sales of other real estate owned.............. 586 2,180 1,375 -------------------------------- Net cash from investing activities...................... (39,182) (6,966) (5,833) -------------------------------- Cash flows from financing activities Net increase (decrease) in: Deposits................................................. 19,155 1,240 (1,808) Securities sold under repurchase agreements and other short-term borrowings.......................... 1,746 (6,520) 12,624 Advances from borrowers for taxes and insurance.......... 145 (260) (255) Federal Home Loan Bank term advance......................... 5,000 0 0 Net proceeds from exercise of stock options................. 4 77 54 Dividends paid.............................................. (2,134) (1,779) (1,463) -------------------------------- Net cash from financing activities...................... 23,916 (7,242) 9,152 -------------------------------- Net change in cash and cash equivalents............................. (6,476) (1,992) 8,022 Cash and cash equivalents at beginning of year...................... 31,982 33,974 25,952 -------------------------------- Cash and cash equivalents at end of year............................ $ 25,506 $ 31,982 $ 33,974 -------------------------------- -------------------------------- Supplemental disclosures Cash paid during the year for Interest.................................................... $ 14,423 $ 14,466 $ 14,277 Income taxes................................................ 3,089 2,335 1,833 Noncash investing activities Transfers made from loans to other real estate owned........ 174 2,432 981 Transfers made from securities held to maturity to securities available for sale, at fair value............ 0 0 97,319 Transfers made from tax-exempt loans to securities available for sale, at fair value....................... 0 4,700 0
The accompanying notes are an integral part of these consolidated financial statements. NSFC ANNUAL REPORT 1997 31 43 NORTHERN STATES FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Unrealized Gain (Loss) on Securities Total ($ 000's, except per share data) Common Additional Retained Available for Sale Stockholders' - ----------------------------------------------------------------------------------------------------------------------------------- Years Ended December 31, 1997, 1996 and 1995 Stock Paid-In Capital Earnings Net Equity - ----------------------------------------------------------------------------------------------------------------------------------- Balance, January 1, 1995............................. $1,772 $11,054 $34,143 $(1,269) $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 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) 54,835 Net income........................................... 7,010 7,010 Cash dividends ($2.40 per share)..................... (2,134) (2,134) Exercise of stock options on 100 shares of common stock..................................... 4 4 Tax benefit from the exercise of stock options....... 2 2 Unrealized net gain on securities available for sale............................... 478 478 ---------------------------------------------------------------------- Balance, December 31, 1997........................... $1,779 $11,222 $46,725 $ 469 $60,195 ---------------------------------------------------------------------- ----------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. 32 NSFC ANNUAL REPORT 1997 44 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 & 1995 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, operating income, 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 stockholders' equity, net of tax. Other securities, such as Federal Home Loan Bank stock and Federal Reserve Bank stock, are carried at cost. Securities are written down to fair value 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. A transfer of securities to available for sale was made in 1995 under new interpretive guidance. 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. 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 the fair value of the collateral if the loan is collateral dependent. A portion of the allowance for loan losses is allocated to impaired loans. 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. Increases or decreases in the carrying value of impaired loans are reported as reductions or increases to the provision for 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. Expenses, gains and losses on disposition, and changes in the valuation allowance are reported in net loss on other real estate. SERVICING RIGHTS: The Company has not purchased rights to service loans for others. Subsequent to adopting Financial Accounting Standard (SFAS) No. 122, as amended by SFAS No. 125, 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 and SFAS No. 125 was not material to the Company's consolidated net income. NSFC ANNUAL REPORT 1997 33 45 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 & 1995 NOTE 1 (CONTINUED) GOODWILL: Goodwill is the excess of purchase price over identified net assets in business acquisitions. Goodwill is expensed on the straight-line method over 25 years. Goodwill is 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 $260,000, $255,000, and $224,000 in 1997, 1996, and 1995. 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 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 was used for 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 does not include the value of anticipated future business or the values of assets and liabilities not considered financial instruments. EARNINGS PER SHARE: Basic earnings per share is based on weighted-average common shares outstanding. Diluted earnings per share further assumes issue of any dilutive potential common shares. The accounting standard for computing earnings per share was revised for 1997, and all earnings per share previously reported are restated to follow the new standard. FUTURE ACCOUNTING CHANGES: New accounting standards have been issued which will require future reporting of comprehensive income (net income plus changes in holding gains and losses on available for sale securities) and may require redetermination of industry segment financial information. 34 NSFC ANNUAL REPORT 1997 46 (TABLE AMOUNTS IN THOUSANDS OF DOLLARS) NORTHERN STATES FINANCIAL CORPORATION NOTE 2 SECURITIES Year end securities available for sale were as follows:
Amortized Gross Unrealized - -------------------------------------------------------------------------------------------------------------------------- December 31, 1997 Cost Gains Losses Fair Value - -------------------------------------------------------------------------------------------------------------------------- U.S. Treasury $ 14,017 $ 15 $ (1) 14,031 U.S. Government agencies and corporations 129,077 45 (250) 128,872 States and political subdivisions 21,712 720 (24) 22,408 Mortgage-backed securities 13,033 137 (47) 13,123 Equity securities 2,069 196 (27) 2,238 ------------------------------------------------------------ Total $179,908 $1,113 $ (349) 180,672 ------------------------------------------------------------ ------------------------------------------------------------
Amortized Gross Unrealized - -------------------------------------------------------------------------------------------------------------------------- December 31, 1996 Cost Gains Losses Fair Value - -------------------------------------------------------------------------------------------------------------------------- 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 and mutual fund investment in debt securities 2,091 128 (99) 2,120 ------------------------------------------------------------ Total $149,783 $1,015 $(1,048) $149,750 ------------------------------------------------------------ ------------------------------------------------------------
Contractual maturities of debt securities available for sale at year-end 1997 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 $ 22,883 $ 22,885 Due after one year through five years 127,639 127,821 Due after five years through ten years 14,284 14,605 ------------------------------- 164,806 165,311 Mortgage-backed securities 13,033 13,123 Equity securities 2,069 2,238 ------------------------------- Total $179,908 $180,672 ------------------------------- -------------------------------
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 Government National Mortgage Association (GNMA) or the Federal National Mortgage Association (FNMA). Agency securities with call options totaled $77,088,000 at December 31, 1997. As of December 31, 1997, the Company held structured notes with an amortized cost of $2,000,000 and fair value of $1,995,000. These securities were issued by the Federal Home Loan Bank (FHLB) and the FHLMC. 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 1997, 1996, and 1995. Proceeds from sales of equity securities in 1996 totaled $2,675,000 with a resulting gain of $5,000. During 1997 and 1996, the Federal Home Loan Bank of Chicago redeemed 220 and 250 shares of its stock from the Thrift, with proceeds of $22,000 and $25,000 and with no resulting gain or loss. Securities carried at $122,418,000 and $97,052,000 at year-end 1997 and 1996, were pledged to secure public deposits, repurchase agreements and for other purposes as required or permitted by law. As of December 31, 1997, the Company had no securities of a single issuer, other than the U.S. Treasury and U.S. Government agencies and corporations, including the FHLB, FHLMC, FNMA, GNMA, the Federal Farm Credit Bank (FFCB), and the Student Loan Marketing Association (SLMA) that exceeded 10% of stockholders' equity. Although the Company holds securities issued by municipalities within the state of Illinois which in aggregate exceed 10% of stockholders' equity, none of the holdings from individual municipal issuers exceeded this threshold. Interest-bearing balances with banks and federal funds sold consisted of the following at December 31, 1997: First USA Bank, Dallas $ 5,500 LaSalle National Bank, Chicago 4,000 Harris Bank, Chicago 1,736 Bank of America, Illinois 100 Federal Home Loan Bank, Chicago 70 ------- Total $11,406 ------- -------
NSFC ANNUAL REPORT 1997 35 47 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 & 1995 NOTE 3 LOANS Year end loans were as follows:
- ------------------------------------------------------------------- 1997 1996 - ------------------------------------------------------------------- Commercial $ 54,701 $ 50,762 Real estate - construction 26,768 26,905 Real estate - mortgage 152,856 146,552 Installment 8,544 9,203 -------------------------- Total loans 242,869 233,422 Less: Unearned income (154) (240) Deferred loan fees (491) (529) -------------------------- Loans, net of unearned income and deferred loan fees 242,224 232,653 Allowance for loan losses (5,430) (4,839) -------------------------- Total loans, net $236,794 $227,814 -------------------------- --------------------------
Related party loans were as follows:
- ------------------------------------------------------------------- 1997 - ------------------------------------------------------------------- Total loans at beginning of year $ 991 New Loans 218 Repayments (685) Other changes (15) ------ Total loans at end of year $ 509 ------ ------
Real estate loans with a carrying value of $24,807,000 and $15,454,000 were pledged to secure public deposits at December 31, 1997 and 1996. Loans held for sale at year-end were approximately $1,338,000 and $893,000 and are classified as real estate mortgage loans. Impaired loans were as follows:
- ------------------------------------------------------------------------------------------- 1997 1996 1995 - ------------------------------------------------------------------------------------------- Year-end loans with no allowance for loan losses allocated $ 0 $ 0 $ 0 Year-end loans with allowance for loan losses allocated 754 828 5,161 Amount of allowance allocated 125 146 975 Average of impaired loans during the year 776 2,620 5,111 Interest income recognized during impairment 36 587 113 Cash-basis interest income recognized 36 218 111
36 NSFC ANNUAL REPORT 1997 48 (TABLE AMOUNTS IN THOUSANDS OF DOLLARS) NORTHERN STATES FINANCIAL CORPORATION 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:
- ----------------------------------------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------------- Balance at beginning of year $4,839 $ 4,514 $ 3,965 Provision charged to operating expense 480 1,190 1,480 Loans charged off (209) (1,141) (1,009) Recoveries on loans previously charged-off 320 276 78 --------------------------------- Balance at end of year $5,430 $ 4,839 $ 4,514 --------------------------------- ---------------------------------
Activity in the allowance for other real estate owned losses for the year ended December 31, follows:
- ---------------------------------------------------------------- 1997 1996 1995 - ---------------------------------------------------------------- Balance at beginning of year $532 $510 $526 Provision charged to operating expense 21 22 23 Losses on other real estate owned (9) 0 (39) --------------------------- Balance at end of year $544 $532 $510 --------------------------- ---------------------------
NOTE 5 OFFICE BUILDINGS AND EQUIPMENT Office buildings and equipment consisted of the following at December 31, 1997 and 1996:
- ----------------------------------------------------------- 1997 1996 - ----------------------------------------------------------- Land $ 1,489 $ 1,489 Office buildings and improvements 7,239 7,203 Furniture and equipment 3,622 3,802 --------------------- Total cost 12,350 12,494 Accumulated depreciation (6,451) (6,244) --------------------- Net book value $ 5,899 $ 6,250 --------------------- ---------------------
Depreciation expense amounted to $568,000 in 1997, $546,000 in 1996 and $621,000 in 1995. NOTE 6 LOAN SERVICING Mortgage loans serviced for others are not reported as assets. These loans totaled $64,924,000 and $65,321,000 at year-end 1997 and 1996. Related escrow deposit balances were $639,000 and $612,000 at year-end 1997 and 1996. Activity for capitalized mortgage servicing rights was as follows for 1997 and 1996:
- --------------------------------------------- 1997 1996 - --------------------------------------------- Beginning of year $ 80 $ 0 Additions 76 95 Amortized to expense (36) (15) ----- ----- End of year $120 $ 80 ----- ----- ----- -----
NSFC ANNUAL REPORT 1997 37 49 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 & 1995 NOTE 7 DEPOSITS At year-end 1997, stated maturities of time deposits were: 1998 .............................. $161,799 1999 .............................. 19,952 2000 .............................. 5,580 2001 and thereafter ............... 63 -------- $187,394 -------- --------
Related party deposits at year-end 1997 totaled $10,229,000. NOTE 8 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:
- ---------------------------------------------------------------------------- 1997 1996 - ---------------------------------------------------------------------------- Average daily balance during the year $34,176 $35,006 Average interest rate during the year 5.07% 4.92% Maximum month end balance during the year $38,504 $37,804
Securities sold under repurchase agreements to directors of the Company and related interests totaled $22,088,000 at December 31, 1997, and have a weighted remaining maturity of 4 months. The Company had a fixed rate advance from the Federal Home Loan Bank of Chicago (the "FHLB") at December 31, 1997, as follows:
-------------------------------------------------------------- Maturity Date Interest Rate Balance -------------------------------------------------------------- April 30, 1999 5.90% $5,000,000
The Thrift maintains a collateral pledge agreement with the FHLB covering secured advances whereby the Thrift agrees to retain first mortgage loans with an unpaid principal balances aggregating no less than 167% of the outstanding secured advance from the FHLB. 38 NSFC ANNUAL REPORT 1997 50 (TABLE AMOUNTS IN THOUSANDS OF DOLLARS) NORTHERN STATES FINANCIAL CORPORATION NOTE 9 INCOME TAXES A summary of federal and state income taxes on operations follows:
- ---------------------------------------------------------------------------- 1997 1996 1995 - ---------------------------------------------------------------------------- Current payable Federal $2,940 $2,184 $1,877 State 262 151 316 Deferred income tax (benefit) 7 194 (153) ----------------------------- Provision for income taxes $3,209 $2,529 $2,040 ----------------------------- -----------------------------
The components of deferred tax assets and liabilities at December 31, 1997 and 1996 follows:
- --------------------------------------------------------------------------------- 1997 1996 - --------------------------------------------------------------------------------- Deferred tax assets: Allowances for loan and other real estate owned losses $ 1,922 $1,791 Deferred loan fees 25 134 Deferred compensation and directors' fees 182 148 Unrealized net loss on securities available for sale 0 25 Taxable income on nonperforming loans not recorded for book purposes 5 7 ------- ------- Gross deferred tax assets 2,134 2,105 ------- ------- Deferred tax liabilities: Depreciation (586) (575) Federal Home Loan Bank stock dividend (37) (37) Unrealized net gain on securities available for sale (296) 0 Other items (111) (61) ------- ------- Gross deferred tax liabilities (1,030) (673) ------- ------- Net deferred tax asset $ 1,104 $1,432 ------- ------- ------- -------
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:
- ----------------------------------------------------------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------------------------------- Income tax calculated at statutory rate (34%) $3,474 $2,904 $2,372 Add (subtract) tax effect of: Tax-exempt income, net of disallowed interest expense (431) (503) (483) State income tax, net of federal tax benefit 156 120 186 Other items, net 10 8 (35) ----------------------------- Provision for income taxes $3,209 $2,529 $2,040 ----------------------------- -----------------------------
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 reserve accumulated in tax years after 1987. The related amount of deferred tax liability which must be recaptured is not material. Retained earnings at December 31, 1997 includes approximately $3,269,000 for which no provision 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. NSFC ANNUAL REPORT 1997 39 51 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 & 1995 NOTE 10 OMNIBUS INCENTIVE PLANS 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 has not granted any stock options since January 1, 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-average - ----------------------------------------------------------------------- options exercise price - ----------------------------------------------------------------------- Outstanding, beginning of 1995 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 Exercised 1997 (100) 42.00 ------- Outstanding, end of 1997 5,078 41.62 ------- -------
At year-end 1997, options outstanding ranged in exercise price from $41.60 to $42.00 and had a weighted average remaining option life of 4 years. The Committee of the Board of Directors 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, 1997 and 1996, 3,248 and 3,904 stock appreciation rights were outstanding, granted at $41.60. The Company's expense was $114,000, $70,000 and $21,000 for the years ended December 31, 1997, 1996 and 1995. The stock appreciation rights will expire during 2002. 40 NSFC ANNUAL REPORT 1997 52 (TABLE AMOUNTS IN THOUSANDS OF DOLLARS) NORTHERN STATES FINANCIAL CORPORATION 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 1997 and 1996, reserves of $2,735,000 and $2,756,000 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 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 commitment does 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:
- ------------------------------------------------------------- 1997 1996 - ------------------------------------------------------------- Unused lines of credit and commitments to make loans: Fixed rate $20,388 $17,696 Variable rate 54,339 57,979 -------------------- Total $74,727 $75,675 -------------------- -------------------- Standby letters of credit $ 6,891 $ 6,250
Commitments to make loans at a fixed rate have interest rates ranging primarily from 6.00% to 9.00%. NOTE 12 FAIR VALUES 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, and advances from borrowers for taxes and insurance. 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, securities sold under repurchase agreements, and Federal Home Loan Bank term advances, 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, and the fair value is not materal. The estimated year-end fair values of financial instruments were:
- ------------------------------------------------------------------------------------------------------------------------- 1997 Carrying Value Estimated Fair Value - ------------------------------------------------------------------------------------------------------------------------- Financial assets: Cash and cash equivalents $ 25,506 $ 25,506 Interest bearing deposits in financial institutions - maturities over 90 days 100 100 Securities available for sale 180,672 180,672 Loans, net 236,794 237,231 Direct lease financing 1,274 1,274 Accrued interest receivable 4,308 4,308 Financial liabilities: Deposits $(347,950) $(348,346) Securities sold under repurchase agreements and other short-term borrowings (38,504) (38,519) Federal Home Loan Bank term advances (5,000) (5,000) Advances from borrowers for taxes and insurance (1,166) (1,166) Accrued interest payable (3,691) (3,691)
NSFC ANNUAL REPORT 1997 41 53 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 & 1995 NOTE 12 CONTINUED
- ------------------------------------------------------------------------------------------------------------------------- 1996 Carrying Value Estimated 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, net 227,814 228,178 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)
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:
Capital to risk-weighted assets Tier 1 capital to - ------------------------------------------------------------------------------- Total Tier I average assets - ------------------------------------------------------------------------------- Well capitalized 10.00% 6.00% 5.00% Adequately capitalized 8.00% 4.00% 4.00% Undercapitalized 8.00% 3.00% 3.00%
42 NSFC ANNUAL REPORT 1997 54 (TABLE AMOUNTS IN THOUSANDS OF DOLLARS) NORTHERN STATES FINANCIAL CORPORATION NOTE 13 CONTINUED At year end, actual capital levels and minimum required levels were:
Minimum Required For Minimum Required For Well Capitalized Under Prompt Actual Capital Adequacy Purposes Corrective Action Regulations - -------------------------------------------------------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio - -------------------------------------------------------------------------------------------------------------------- 1997 Total Capital (to risk weighted assets) Consolidated $63,249 21.65% $23,376 8.00% $29,220 10.00% Bank 47,947 20.72 18,513 8.00 23,142 10.00 Tier I Capital (to risk weighted assets) Consolidated 59,597 20.40 11,688 4.00 17,532 6.00 Bank 45,054 19.47 9,257 4.00 13,885 6.00 Tier I Capital (to average assets) Consolidated 59,597 13.71 17,394 4.00 21,742 5.00 Bank 45,054 13.67 13,186 4.00 16,483 5.00 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
The Company and the Subsidiaries at year end 1997 were categorized as well capitalized. Management knows of no circumstances or events which would change the categorizations. The Company's primary source of funds to pay dividends to stockholders is the dividends it receives from the Subsidiaries. The Subsidiaries are subject to certain restrictions on the amount of dividends that may be declared without regulatory approval. At December 31, 1997, $30,648,000 of the Subsidiaries' retained earnings were available for dividend declaration without prior regulatory approval. NSFC ANNUAL REPORT 1997 43 55 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 & 1995 NOTE 14 EARNINGS PER SHARE AND SUBSEQUENT EVENT Net income was utilized to calculate both basic and diluted earnings per share for all years presented. Information regarding weighted average shares utilized in computing basic and diluted earnings per share is as follows:
- ---------------------------------------------------------------------------------------------------- 1997 1996 1995 - ---------------------------------------------------------------------------------------------------- Average outstanding common shares 889,290 888,913 887,081 Effect of stock options 1,811 1,464 1,570 ------------------------------------ Average outstanding shares for diluted earnings per share 891,101 890,377 888,651 ------------------------------------ ------------------------------------
On February 17, 1998, the Company's Board of Directors approved a proposal to amend the Company's certificate of incorporation to increase the authorized common shares from 1,750,000 to 6,500,000 and to effect a 5-for-1 stock split. The split is contingent upon stockholder approval at the April 23, 1998, annual meeting of stockholders. If ultimate approval is received, it is expected that the stock split will be effective to stockholders of record approximately ten days after the annual meeting. Because ultimate approval is pending until April 23, 1998, financial information contained in this report has not been adjusted to reflect the impact of the proposed stock split. Earnings per common share amounts, after giving retroactive effect to the 5-for-1 stock split, are presented below for all of the earnings per share amounts disclosed in the financial statements and the notes to the financial statements:
- ------------------------------------------------------------------------------------------------------- 1997 1996 1995 - ------------------------------------------------------------------------------------------------------- Basic earnings per share $ 1.58 $ 1.35 $ 1.11 Diluted earnings per share $ 1.57 $ 1.35 $ 1.11 Average outstanding common shares 4,446,450 4,444,565 4,435,405 Effect of stock options 9,055 7,320 7,850 --------------------------------------- Average outstanding shares for diluted earnings per share 4,455,505 4,451,885 4,443,255 --------------------------------------- ---------------------------------------
44 NSFC ANNUAL REPORT 1997 56 (TABLE AMOUNTS IN THOUSANDS OF DOLLARS) NORTHERN STATES FINANCIAL CORPORATION NOTE 15 PARENT COMPANY CONDENSED FINANCIAL STATEMENTS Following are condensed parent company financial statements: CONDENSED BALANCE SHEETS
- ------------------------------------------------------------------- December 31, 1997 1996 - ------------------------------------------------------------------- Assets Cash on deposit at subsidiary bank - noninterest-bearing $ 874 $ 807 Interest-bearing deposits in unaffiliated bank 36 35 -------------------- Total cash and cash equivalents 910 842 Investment in wholly-owned subsidiaries Equity in underlying book value: Bank of Waukegan 45,472 40,645 First Federal Bank, fsb 14,119 13,445 Goodwill, net 129 140 -------------------- Total investment in subsidiaries 59,720 54,230 Other assets 108 419 -------------------- Total assets $60,738 $55,491 -------------------- -------------------- Liabilities and Stockholders' Equity Accounts payable and other liabilities $ 543 $ 656 Stockholders' equity 60,195 54,835 -------------------- Total liabilities and stockholders' equity $60,738 $55,491 -------------------- --------------------
CONDENSED STATEMENTS OF INCOME
- ------------------------------------------------------------------- Years ended December 31, 1997 1996 1995 - ------------------------------------------------------------------- Operating Income Dividends from subsidiaries $2,124 $1,745 $ 758 Interest income 1 1 1 ------------------------ Total operating income 2,125 1,746 759 Operating expenses 218 214 293 ------------------------ Income before income taxes and equity in undistributed earnings of subsidiaries 1,907 1,532 466 Income tax benefit 80 78 130 ------------------------ Income before equity in undistributed earnings of subsidiaries 1,987 1,610 596 Equity in undistributed earnings of subsidiaries 5,023 4,401 4,341 ------------------------ Net income $7,010 $6,011 $4,937 ------------------------ ------------------------
CONDENSED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------- Years ended December 31, 1997 1996 1995 - --------------------------------------------------------------------- Cash flows from operating activities Net income $ 7,010 $ 6,011 $ 4,937 Adjustments to reconcile net income to net cash from operating activities: Equity in undistributed earnings of subsidiaries (5,023) (4,401) (4,341) Goodwill amortization 11 10 11 (Increase) decrease in other assets 311 (149) 321 Increase (decrease) in other liabilities (111) 208 110 ---------------------------- Net cash from operating activities 2,198 1,679 1,038 ---------------------------- Cash flows from financing activities Exercise of stock options 4 77 54 Dividends paid (2,134) (1,779) (1,463) ---------------------------- Net cash from financing activities (2,130) (1,702) (1,409) Increase (decrease) in cash and cash equivalents 68 (23) (371) Cash and cash equivalents at beginning of year 842 865 1,236 ---------------------------- Cash and cash equivalents at end of year $ 910 $ 842 $ 865 ---------------------------- ----------------------------
NSFC ANNUAL REPORT 1997 45 57 NORTHERN STATES FINANCIAL CORPORATION 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 23, 1998 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, 1997, 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: Firstar Trust Company Investors Services Unit 1555 N. Rivercenter Dr., Suite 301 Milwaukee, Wisconsin 53212 (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 1998:
- ------------------------------------------------------------------------- Half Record Date Payment Date - ------------------------------------------------------------------------- First May 15 June 1 Second November 16 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, 1997, there were 1,750,000 common shares authorized; 889,373 common shares were outstanding, held by approximately 438 registered stockholders. As of February 28, 1998, the following securities firms indicated they were maintaining an inventory of Northern States Financial Corporation common stock and acting as market makers: Herzog, Heine, Geduld, Inc. Howe Barnes Investments, Inc. Miami, Florida Chicago, Illinois (800) 966-7022 (800) 800-4693 (305) 932-5880 (312) 655-2946 PRICE SUMMARY: The following schedule details our stock's quarter ending bid and ask price.
- ------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------ BID ASK BID ASK --- --- --- --- Quarter Ended: March 31 $ 88 $ 93 $ 69 $ 74 June 30 87 92 71 76 September 30 95 100 74 79 December 31 117 130 3/4 83 87
- ------------------------------------------------------------------------ 1998 - ------------------------------------------------------------------------ BID ASK --- --- For the First Quarter (through March 6, 1998) $ 161 $ 166
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 - ------------------------------------------------------------------- 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 1997 1.15 1.25 2.40
INDEPENDENT AUDITORS Crowe, Chizek and Company LLP Oak Brook, Illinois 46 NSFC ANNUAL REPORT 1997 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 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 14,200 206 11,200 0 180,672 0 0 243,498 5,430 458,986 347,950 38,504 7,337 5,000 0 0 1,779 58,416 458,986 22,199 9,560 1,000 32,759 13,828 15,615 17,144 480 0 9,132 10,219 0 0 0 7,010 7.88 7.87 4.33 1,033 3 0 0 4,839 209 320 5,430 2,728 0 2,702
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