10-K 1 c83758e10vk.txt ANNUAL REPORT SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ----------------- --------------------- Commission file number 0-21292 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. ------------------------------------------------------- (Exact name of registrant as specified in its charter) Wisconsin 39-1413328 ------------------------------------------------ ---------------------- (State or other jurisdiction of incorporation or (I.R.S. Employer organization) Identification Number) 19105 West Capitol Drive, Suite 200 Brookfield, Wisconsin 53045 --------------------------------------- (Address of principal executive office) Registrant's telephone number, including area code: (262) 790-2120 Securities registered pursuant to Section 12(b) of the Act: Not Applicable Securities registered pursuant to section 12(g) of the Act: COMMON STOCK, PAR VALUE $1.00 PER SHARE ---------------------------------------- (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]. Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes [X] No [ ]. As of June 30, 2003 (the last business day of the Registrant's most recently completed second fiscal quarter) the aggregate market value of the shares (based upon the average bid/ask price) held by non-affiliates was approximately $85,412,000. As of March 1, 2004, 3,335,372 shares of Common Stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the 2004 Annual Meeting of Shareholders of the Registrant are incorporated by reference into Part III of this report. MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. ***** ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2003
PAGE ---- PART I Item 1. Business 3 Item 2. Properties 9 Item 3. Legal Proceedings 9 Item 4. Submission of Matters to a Vote of Security Holders 9 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 10 Item 6. Selected Financial Data 11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 7a. Quantitative and Qualitative Disclosures About Market Risk 26 Item 8. Financial Statements and Supplementary Data 27 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 27 Item 9(a). Controls and Procedures 28 PART III Item 10. Directors and Executive Officers of the Registrant 28 Item 11. Executive Compensation 28 Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 28 Item 13. Certain Relationships and Related Transactions 28 Item 14. Principal Accountant Fees and Services 29 PART IV Item 15. Exhibits, Financial Statements Schedules and Reports on Form 8-K 29 Signatures
2 PART I ITEM 1. BUSINESS GENERAL Merchants and Manufacturers Bancorporation, Inc. ("Merchants") was incorporated in Wisconsin in 1983 and is a registered bank holding company under the Bank Holding Company Act of 1956. As of December 31, 2003, we had total consolidated assets of $1.1 billion, consolidated loans of $857.1 million and consolidated deposits of $911.9 million. Our executive offices are located at 19105 West Capitol Drive, Brookfield, Wisconsin 53045 (telephone number (262) 790-2120). We are engaged in the community banking business through our Community BancGroup(TM), which includes our eight bank subsidiaries. We operate six bank subsidiaries in Wisconsin including; Lincoln State Bank; Grafton State Bank; Franklin State Bank; Community Bank of Oconto County; Fortress Bank of Westby and the Reedsburg Bank. We also operate two additional bank subsidiaries, Fortress Bank of Cresco and Fortress Bank, N.A., which operate in Iowa and Minnesota, respectively. Through our banks, we provide a broad range of services to individual and commercial customers. Collectively, our subsidiary banks enjoy the competitive advantages of being able to offer the products, services, operational capacity and the lending limit of a larger institution with the timely personal customer service typically offered by a community bank. In addition to traditional bank products, we offer our customers a broad range of residential mortgage services through CBG Mortgage, Inc., and a full range of investment, tax and life insurance products through CBG Financial Services, Inc. Each of these subsidiaries enable our member banks to provide a full range of financial products to their customers as well as contribute non-interest income to us. We also operate four additional non-bank operating subsidiaries: Lincoln Neighborhood Redevelopment Corporation, which was organized in 1988 for the purpose of redeveloping and rehabilitating certain areas located primarily on the near south side of Milwaukee; CBG Services, Inc., which was formed in 1994 to provide operational services to our banks; Merchants Merger Corporation which was formed in 1999 to facilitate bank acquisitions and Merchants New Merger Corporation which was formed to facilitate the Reedsburg Bank acquisition. GROWTH STRATEGY Over the last four years, our total assets have increased from $533 million as of December 31, 1999 to $1.1 billion as of December 31, 2003. During the same four-year period, our earnings per share on a diluted basis has increased from $1.41 to $2.56. The substantial increase in both total assets and earnings per share is a direct result of the implementation of our growth strategy. The key elements of our growth strategy include acquisitions, internal growth and a focus on expanding our non-interest income. ACQUISITIONS. We believe there are significant opportunities to establish our presence in additional markets through the acquisition of selected community banks, individual branches and other financial service businesses, primarily in Wisconsin. We generally look at four things when analyzing a potential acquisition: - the profitability of the institution on a historical and forward looking basis; - the stability and experience of the management team and board of directors; - the growth potential of the geographical markets in which the institution operates; and - the asset quality track record of the institution and management. INTERNAL GROWTH. While we made acquisitions in 1999, 2001, 2002 and 2003, significant opportunities exist to expand through internal growth by delivering quality products and by providing personal service to individuals and small to mid-sized businesses. By focusing on customer service and convenience, we provide the opportunity for customers to receive the personalized service that they find attractive in smaller organizations and still realize many of the efficiencies available to larger organizations. In addition, we intend to expand through internal growth with the addition of quality employees and through de novo branching into new markets by our existing bank subsidiaries. During this growth period Merchants has made a significant investment in recruiting and developing highly qualified and productive loan officers. Merchants also plans to enter high growth markets through branching. NON-INTEREST INCOME. Through CBG Financial Services, Inc., and its Link Community Financial Services, LLC subsidiary, we have significantly enhanced our ability to provide investment and insurance products to our current customer base. For example, as of December 31, 2003, Link had seven representatives strategically located and dedicated to providing customers with a full range of financial services. Over time, we expect this line of business to significantly enhance our relationships with current bank customers and also provide the subsidiary banks with additional opportunities for deposit and loan growth as our investment and insurance customer base expands over time. In 2003 we acquired Integrated Financial Services, Inc. ("IFS") and Keith C. Winters & Associates ("KCW"). IFS is an insurance agency that was organized in 1999. KCW is a tax preparation and tax-consulting firm with two offices in Franklin, Wisconsin and has been in business for more than 30 years. 3 RECENT ACQUISITIONS During 2003, we expanded our operations into Reedsburg, Wisconsin market, through an acquisition. On November 1, 2003, we acquired Reedsburg Bancorporation. ("Reedsburg") and its wholly-owned subsidiary, the Reedsburg Bank. The purchase price for Reedsburg was $36.0 million including $17.8 million in cash, $12.8 million in promissory notes and 146,800 shares of common stock valued at $5.4 million based on the average price over the contractual pricing period. At the date of the acquisition Reedsburg had assets of $141.8 million, loans of $97.2 million and deposits of $120.6 million. OUR BANK SUBSIDIARIES We currently provide community-oriented, commercial and retail banking services to individuals as well as to small to mid-size businesses in our communities through 38 banking facilities in Wisconsin, Iowa & Minnesota. The Banks have consistent products, services and delivery systems and comply with similar regulatory guidance. As such they are not segments as that term is defined in Financial Accounting Standards Board Statement 131. The table below provides information regarding each of our banks and their respective markets.
TOTAL ASSETS AT NUMBER OF BANK YEAR ORGANIZED YEAR ACQUIRED DECEMBER 31, 2002 COMMUNITIES SERVED FACILITIES ---- -------------- ------------- ----------------- ------------------ ---------- (DOLLARS IN THOUSANDS) Lincoln State Bank 1919 1983 $392,795 Milwaukee, WI 7 Muskego, WI 2 Brookfield, WI 1 Greenfield, WI 2 Hales Corners, WI 1 New Berlin, WI 2 Pewaukee, WI 1 West Allis, WI 1 Grafton State Bank 1906 1999 $163,650 Grafton, WI 2 Saukville, WI 1 Franklin State Bank 1982 1984 $ 92,779 Franklin, WI 3 Community Bank of Oconto 1989 2001 $ 85,805 Oconto Falls, WI 1 County Gillett, WI 1 Little Suamico, WI 1 Fortress Bank of Westby 1992 2002 $121,601 Westby, WI 2 Coon Valley, WI 1 West Salem, WI 1 Chaseburg, WI 1 Fortress Bank of Cresco 1996 2002 $ 64,180 Cresco, IA 1 Fortress Bank, N.A. 1993 2002 $ 54,530 Houston, MN 1 Winona, WI 1 The Reedsburg Bank 1867 2003 $157,781 Reedsburg, WI 2 North Freedom, WI 1 Lime Ridge, WI 1
OUR BANKS Through our banks, we provide a broad range of services to individual and commercial customers. These services include accepting demand, savings and time deposits, including regular checking accounts, NOW accounts, money market accounts, savings accounts, certificates of deposit, individual retirement accounts and club accounts. Our banks also make secured and unsecured commercial, mortgage, construction and consumer term loans on both a fixed and variable rate basis. The terms on the loans retained in the banks' portfolios generally range from one month to five years. Our banks also provide lines of credit to commercial borrowers and to individuals through home equity loans. Lincoln State Bank. Lincoln State Bank was organized as a state banking association under the laws of the State of Wisconsin in 1919. It operates seven full service branch offices in the southeastern Wisconsin communities of Milwaukee, Muskego, New Berlin, Brookfield and Pewaukee. In addition it operates ten limited hours facilities in Milwaukee and Waukesha Counties. At December 31, 2003, Lincoln State Bank comprised 34.3% of our consolidated assets. Grafton State Bank. Grafton State Bank was organized as a state banking association under the laws of the State of Wisconsin in 1906. Its principal office and a branch office are located in Grafton, Wisconsin and another branch office is located in Saukville, Wisconsin. At December 31, 2003, Grafton State Bank comprised 14.3% of our consolidated assets. 4 Franklin State Bank. Franklin State Bank was organized as a state banking association under the laws of the State of Wisconsin in 1982. Its principal office and a branch office are located in Franklin, Wisconsin. At December 31, 2003, Franklin State Bank comprised 8.1% of our consolidated assets. In addition it also operates a limited hours facility in Franklin. Community Bank of Oconto County. Community Bank of Oconto County is a full service commercial bank serving all of Oconto County and the eastern portion of Shawano County. In addition to the main office in the city of Oconto Falls, which is located approximately 25 miles north of Green Bay, Wisconsin, Community Bank of Oconto County operates two branch offices, one located in the city of Gillett and another located in the town of Little Suamico. At December 31, 2003, Community Bank of Oconto County comprised 7.5% of our consolidated assets. Fortress Bank of Westby. Fortress Bank of Westby is a full service commercial bank serving the banking needs of LaCrosse County, southeastern Monroe County and northern Vernon County, Wisconsin. Fortress Bank of Westby has offices in the southwestern Wisconsin communities of Westby, Coon Valley, Chaseburg, and West Salem. At December 31, 2003, the Fortress Bank of Westby comprised 10.6% of our consolidated assets. Fortress Bank of Cresco. Fortress Bank of Cresco is a full service commercial bank serving the banking needs of eastern Howard County and western Winneshiek County, Iowa from its office in Cresco, Iowa. At December 31, 2003, Fortress Bank of Cresco comprised 5.6% of our consolidated assets. Fortress Bank, N.A. Fortress Bank, N.A., Houston, Minnesota is a full service commercial bank serving the customers in Houston, Minnesota and northeast Winona Counties in Minnesota from offices in Houston and Winona. At December 31, 2003, Fortress Bank, N.A. comprised 4.8% of our consolidated assets. The Reedsburg Bank. The Reedsburg Bank is a full service commercial bank serving the banking needs of Sauk County, and portions of Juneau, Richland, and Adams Counties, Wisconsin. The Reedsburg Bank has offices in the Wisconsin communities of Reedsburg, North Freedom and Lime Ridge. At December 31, 2003, the Reedsburg Bank comprised 13.8% of our consolidated assets. OUR OPERATING SUBSIDIARIES CBG Financial Services, Inc. was formed in 2002 to provide tax as well as non-insured investment and insurance products to customers of the Banks. For the twelve months ended December 31, 2003, CBG Financial Services had revenues of $1.2 million. CBG Mortgage, Inc. was formed in 2002 to act as our mortgage broker. As of December 31, 2003, CBG Mortgage services $160.5 million of residential mortgages. Fortress Mortgage Services Company acts as the mortgage broker for the Fortress Banks. As of December 31, 2003, Fortress Mortgage services $74.0 million of residential mortgages. Lincoln Neighborhood Redevelopment Corporation. The Lincoln Neighborhood Redevelopment Corporation was formed in June 1988. The Redevelopment Corporation was established to redevelop and rehabilitate certain areas located on the south-side of Milwaukee by, among other things: - providing home mortgage loans to customers with low to moderate income; - working with local businesses to keep commercial areas strong and attractive; - pursuing means to preserve and create jobs; - encouraging appropriate land-use; - involving community residents in economic planning; and - retaining and attracting businesses. As of December 31, 2003, the Redevelopment Corporation had assets of $913,000, $558,000 in liabilities and equity of $355,000. CBG Services, Inc. M&M Services was formed in January 1994 and changed its name to CBG Services, Inc. in 2002. CBG Services provides operational services to our banks. These services include, but are not limited to: - human resources; - auditing; - marketing; - financial analysis; - loan document preparation; - loan credit analysis; - item processing; - compliance; - training; and - operations. 5 Merchants Merger Corp. Merchants Merger Corp. was formed in 1999 to facilitate mergers and future acquisitions. Merchants New Merger Corp. Merchants New Merger Corp. is the historical Reedsburg Bancorporation parent company that was renamed following the acquisition. OTHER SUBSIDIARIES Lincoln State Bank, Grafton State Bank, Community Bank of Oconto County, Fortress Bank of Westby and the Reedsburg Bank each have a wholly owned subsidiary. In 1991 an investment subsidiary known as M&M - Lincoln Investment Corporation was formed to manage the majority of Lincoln State Bank's investment portfolio and to enhance the overall return of the portfolio. The subsidiary received a capital contribution of approximately $13 million of mortgage-backed and other investment securities from Lincoln State Bank in exchange for 100% of the stock of the subsidiary. In 1992 an investment subsidiary known as Westby Investment Company, Inc. was formed to manage the majority of the Fortress Bank of Westby's investment portfolio and to enhance the overall return of the portfolio. The subsidiary received a capital contribution of approximately $10 million of municipal and other investment securities from the Fortress Bank of Westby in exchange for 100% of the stock of the subsidiary. In 1992 an investment subsidiary known as Reedsburg Investment Corp. was formed to manage the majority of the Reedsburg Bank's investment portfolio and to enhance the overall return of the portfolio. The subsidiary received a capital contribution of approximately $13 million of municipal and other investment securities from the Reedsburg Bank in exchange for 100% of the stock of the subsidiary. In 1996 an investment subsidiary known as GSB Investments, Inc. was formed to manage the majority of Grafton State Bank's investment portfolio and to enhance the overall return of the portfolio. The subsidiary received a capital contribution of approximately $10 million of mortgage-backed and other investment securities from Grafton State Bank in exchange for 100% of the stock of the subsidiary. In 2001 an investment subsidiary known as CBOC Investments, Inc. was formed to manage the majority of the Community Bank of Oconto County's investment portfolio and to enhance the overall return of the portfolio. The subsidiary received a capital contribution of approximately $11 million of municipal and other investment securities from Community Bank of Oconto County in exchange for 100% of the stock of the subsidiary. These subsidiaries are an intrinsic component of their respective parent banks and assets thereof are included in the total assets of the respective Banks above. COMPETITION Our banks serve their surrounding communities in their respective markets located in Wisconsin, Iowa and Minnesota. There are presently in excess of one hundred other financial institutions in our service areas that directly compete with one or more of our banks. Our banks compete with other commercial banks, savings banks, credit unions, mortgage brokers, small-loan companies, insurance companies, investment banking firms and large retail companies. The principal methods of competition include, interest rates paid on deposits and charged on loans, personal contacts and efforts to obtain deposits and loans and types and quality of services provided and convenience of the locations. EMPLOYEES At December 31, 2003, we (along with our subsidiaries) employed 381 full-time and 104 part-time employees. We provide a wide range of benefits to employees, including educational activities, and consider our employee relations to be excellent. We conduct extensive training programs in order to enhance job-related knowledge and skills of our people and to train our employees with a sales-oriented approach to customers. Eligible employees participate in a 401(k) plan as well as group life and major medical insurance programs. None of our employees are represented by a labor union. SUPERVISION AND REGULATION We are extensively regulated under both federal and state laws. Laws and regulations to which Merchants and Manufacturers and our banks are subject govern, among other things, the scope of business, investments, reserve levels, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers and consolidations and the payment of dividends. These laws and regulations are intended to protect our depositors. Any change in applicable laws or regulations may have a material effect on our business and prospects, and legislative and policy changes may affect our operations. We cannot predict the nature or the extent of the effects on our business and earnings that fiscal or monetary policies, economic controls or new federal or state legislation may have in the future. The following references to statutes and regulations affecting us and the banks are brief summaries only and do not claim to be complete and are qualified in their entirety by reference to the statutes and regulations. 6 RECENT LEGISLATION In 2001, Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA PATRIOT Act"). The USA PATRIOT Act is designed to deny terrorists and criminals the ability to obtain access to the United States financial system, and has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money. The USA PATRIOT Act mandates or will require financial services companies to implement additional policies and procedures with respect to, or additional measures designed to address, any or all of the following matters, among others: money laundering, terrorist financing, identifying and reporting suspicious activities and currency transactions, and currency crimes. On July 30, 2002, President Bush signed the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"). This legislation impacts corporate governance of public companies, affecting their officers and directors, their audit committees, their relationships with their accountants and the audit function itself. Certain provisions of the Act became effective on July 30, 2002. Others will become effective as the SEC adopts appropriate rules. The Sarbanes-Oxley Act implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in corporate America and better protect investors from corporate wrongdoing. The Sarbanes-Oxley Act's principal legislation includes: a) The creation of an independent accounting oversight board to oversee the audit of public companies and auditors who perform such audits; b) Auditor independence provisions which restrict non-audit services that independent accountants may provide to their audit clients; c) Additional corporate governance and responsibility measures, including: (i) requiring a company's chief executive officer and chief financial officer to certify financial statements; (ii) prohibiting trading of securities by officers and directors during periods in which certain employee benefit plans are prohibited from trading; (iii) requiring a company's chief executive officer and chief financial officer to forfeit salary and bonuses, including profits on the sale of company securities, in certain situations; and (iv) protecting whistleblowers and informants; d) Expansion of power of the audit committee, including the requirements that the audit committee: (i) have direct control of the engagement of the outside auditor; (ii) be able to hire and fire the auditor, and (iii) approve all non-audit services; e) Expanded disclosure requirements, including accelerated reporting of stock transactions by insiders and the prohibition of most loans to directors and executive officers of non-financial institutions; mandatory disclosure by analysts of potential conflicts of interest; and f) a range of enhanced penalties for fraud and other violations. The earnings and business of Merchants and Manufacturers Bancorporation and its bank subsidiaries also are affected by the general economic and political conditions in the United States and abroad and by monetary and fiscal policies of various federal agencies. The Federal Reserve Board impacts the competitive conditions under which we operate by determining the cost of funds obtained from money market sources for lending and investing and by exerting influence on interest rates and credit conditions. In addition, legislative and economic factors can be expected to have an ongoing impact on the competitive environment within the financial services industry. The impact of fluctuating economic conditions and federal regulatory policies on the future profitability of our organization cannot be predicted with certainty. BANK HOLDING COMPANY REGULATION We are a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Under the Bank Holding Company Act, we are subject to periodic examination by the Federal Reserve and are required to file periodic reports of our operations and such additional information as the Federal Reserve may require. Investments and Activities. A bank holding company must obtain approval from the Federal Reserve before: - acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after the acquisition, it would own or control more than 5% of the shares of the bank or bank holding company (unless it already owns or controls the majority of the shares); - acquiring all or substantially all of the assets of another bank or bank holding company; or - merging or consolidating with another bank holding company. The Federal Reserve will not approve any acquisition, merger or consolidation that would have a substantially anticompetitive result unless the anticompetitive effects of the proposed transaction are clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The Federal Reserve also considers capital adequacy and other financial and managerial factors in reviewing acquisitions or mergers. With certain exceptions, a bank holding company is also prohibited from: - acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company; and - engaging, directly or indirectly, in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. Bank holding companies may, however, engage in businesses found by the Federal Reserve to be closely related to the business of banking or of managing or controlling banks. These activities include: 7 - making or servicing loans and certain types of leases; - engaging in certain insurance and discount brokerage activities; - performing certain data processing services; - acting in certain circumstances as a fiduciary or investment or financial advisor; - owning savings associations; and - making investments in corporations or projects designed to promote community welfare. We are also authorized to engage in the expanded activities permitted under the Gramm-Leach-Bliley Act since we elected to become a "financial holding company" and to otherwise qualify for financial holding company status. Finally, subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act, and the Federal Reserve's implementing regulations, require Federal Reserve approval prior to any acquisition of "control" of a bank holding company, such as Merchants and Manufacturers. In general, a person or company is presumed to have acquired control if it acquires as little as 5% of the outstanding shares of a bank or bank holding company and is conclusively determined to have acquired control if it acquires 25% or more of the outstanding shares of a bank or bank holding company. Source of Strength. The Federal Reserve expects us to act as a source of financial strength and support for our bank subsidiaries and to take measures to preserve and protect the banks in situations where additional investments in the banks may not otherwise be warranted. The Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the Federal Reserve's determination that the activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiary if the agency determines that divestiture may aid the depository institution's financial condition. Capital Requirements. The Federal Reserve uses capital adequacy guidelines in its examination and regulation of bank holding companies and banks. If the capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses. The Federal Reserve's capital guidelines establish a risk-based requirement expressed as a percentage of total risk-weighted assets and a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least one-half must be Tier 1 capital (which consists principally of shareholders' equity). The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for strong bank holding companies and for bank holding companies that have implemented the Federal Reserve's risk based capital measure for market risk (otherwise the minimum ratio is 4%). The risk-based and leverage standards presently used by the Federal Reserve are minimum requirements, and higher capital levels may be required if warranted by the particular circumstances or risk profiles of individual banking organizations. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions, which is Tier 1 capital less all intangible assets, well above the minimum levels. Dividends. The Federal Reserve has issued a policy statement concerning the payment of cash dividends by bank holding companies. The policy statement provides that a bank holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income or which could only be funded in ways that weakened the bank holding company's financial health, such as by borrowing. Also, the Federal Reserve possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies. BANK REGULATIONS Lincoln State Bank, Grafton State Bank, Franklin State Bank, Community Bank of Oconto County and the Reedsburg Bank operate under Wisconsin state bank charters and are subject to regulation by the Wisconsin Department of Financial Institutions Division of Banking and the FDIC. Fortress Bank of Westby operates under a Wisconsin state bank charter and as a member of the Federal Reserve Bank and is therefore regulated by that agency and the Wisconsin Department of Financial Institutions Division of Banking. The Fortress Bank of Cresco, Iowa operates under an Iowa state bank charter and is a member of the Federal Reserve Bank and is subject to regulation by that agency and the Iowa Division of Banking. Fortress Bank, N.A., operates as a national banking association and is subject to regulation by the Office of the Comptroller of the Currency. The state banking regulators detailed above, the FDIC, the Comptroller of the Currency, and the Federal Reserve Bank regulate or monitor all areas of the banks' operations, including capital requirements, issuance of stock, declaration of dividends, interest rates, deposits, record keeping, establishment of branches, acquisitions, mergers, loans, investments, borrowing, security devices and procedures and employee responsibility and conduct. The regulators place limitations on activities of the banks including the issuance of capital notes or debentures and the holding of real estate and personal property and require the banks to maintain a certain ratio of reserves against deposits. The regulators also require the banks to file reports annually showing receipts and disbursements of the banks, in addition to any periodic reports requested. 8 AVAILABLE INFORMATION We maintain our corporate website at www.mmbancorp.com and we make available, free of charge, through this website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports that we file with or furnish to the Securities and Exchange Commission, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. ITEM 2. PROPERTIES In 2003 our corporate headquarters relocated to an office building located in Brookfield, Wisconsin. We lease approximately 5,000 square feet from the building's owner. At this location, we maintain our corporate operations and personnel. The main office of Lincoln State Bank is at located at 3131 South 13th Street, Milwaukee, Wisconsin in a one-story building. Lincoln State Bank also operates branch offices at 2266 South 13th Street and 5400 West Forest Home Avenue. Both of theses offices are located in Milwaukee. Another branch of Lincoln State Bank is located in a one-story, 1,700 square foot building at 13510 Janesville Road, Muskego, Wisconsin. While another branch of Lincoln State Bank is located at 14000 West National Avenue, New Berlin, Wisconsin. The New Berlin branch is approximately 7,000 square feet. In 1995 Lincoln State Bank opened two other full-service branches one located Brookfield, Wisconsin and the other in Pewaukee, Wisconsin. Lincoln State Bank owns all of its facilities except the New Berlin branch and Brookfield branch which it leases from the buildings' owners. In addition, Lincoln State Bank operates limited hour facilities at Villa St. Francis located at South 20th and Ohio Streets in Milwaukee, at Clement Manor located at South 92nd Street and West Howard Avenue in Milwaukee, at Friendship Village located at North 73rd and West Dean Road in Milwaukee, at Stoney Creek Adult Community in Muskego, at the Milwaukee Protestant Home located on North Downer Avenue in Milwaukee, at Forest Ridge located in Hales Corners, Wisconsin, at the Landmark located in West Allis, Wisconsin at Deer Creek located in New Berlin, Wisconsin and at Lexington Village located in the City of Greenfield, Wisconsin. Lincoln State Bank leases facilities at all of the limited hour locations. Grafton State Bank's main office is located at 101 Falls Road, Grafton, Wisconsin in a seven-story building. Portions of the building that are not used by Grafton State Bank are leased to various tenants. Grafton State Bank owns the facility. Grafton State Bank also operates two branch facilities. One branch of Grafton State Bank is located at 112 North Port Washington Road in Grafton, while the other is located at 524 East Green Bay Avenue in Saukville, Wisconsin. Grafton State Bank owns the Saukville location while it leases the other branch facility. Franklin State Bank's main office is located in a three-story building at 7000 South 76th Street in Franklin, Wisconsin. The bank leases 5,700 square feet from the building's owner. The building was sold in 1999 to a group of investors and subsequently sub-leased back to Merchants and Manufacturers. Portions of the building that are not used by Franklin State Bank are leased to various tenants. In 1998 Franklin State Bank opened a branch facility at 9719 South Franklin Drive in the Franklin Business Park, Franklin, Wisconsin. Franklin State Bank owns the facility. In addition, Franklin State Bank operates a limited hour facility at Brenwood Park, also located in Franklin. Franklin State Bank leases its limited hour facility. The Community Bank of Oconto County's main office is located in a one-story building at 500 Cherry Avenue, Oconto Falls, Wisconsin. Community Bank of Oconto County operates branch facilities at 202 East Main Street, Gillett, Wisconsin and at 1288 East Frontage Road, in the town of Little Suamico, Wisconsin. The Community Bank of Oconto County owns all of its facilities. The Fortress Bank of Westby's main office is located in a two-story building at 100 North Main Street, Westby, Wisconsin. The Fortress Bank of Westby also operates branch offices in the Wisconsin communities of Coon Valley, Chaseburg and West Salem. The Fortress Bank of Westby owns all of its properties. The Fortress Bank of Cresco's main office is located in a one-story building at 130 North Park Place, Cresco, Iowa. The Fortress Bank of Cresco owns its facility. The Fortress Bank, N.A. main office is located in a two-story building at 225 Lafayette, Houston, Minnesota. Fortress Bank, N.A. also operates a branch office in the Minnesota community of Winona. The Fortress Bank, N.A. owns both facilities. The Reedsburg Bank's main office is located in a two-story building at 201 Main Street, Reedsburg, Wisconsin. The Reedsburg Bank also operates branch offices in the Wisconsin communities of North Freedom and Lime Ridge. The Reedsburg Bank owns all of its properties. ITEM 3. LEGAL PROCEEDINGS From time to time, we and our subsidiaries are party to legal proceedings arising out of our general lending activities and other operations. However, as of the date of this report, there are no pending legal proceedings to which we or our subsidiaries are a party, or to which their property is subject, which, if determined adversely to us, would individually or in the aggregate have a material adverse effect on our consolidated financial position. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 2003. 9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS Our stock is not listed on any stock exchange or quoted on the National Association of Securities Dealers Quotation Automated Quotation System. Our stock has been quoted on "Pink Sheets", an inter-broker quotation medium, since April 1993, and in the Over The Counter Bulletin Board, an electronic quotation service. Robert W. Baird & Co., Incorporated, a regional securities and investment banking firm headquartered in Milwaukee, Wisconsin, and Howe Barnes Investments, Incorporated, headquartered in Chicago, Illinois, act as the market makers for the Corporation's stock. Our stock is quoted in the "Other Stocks" section of the Milwaukee Journal/Sentinel. Our common stock trading symbol is "MMBI." The following table sets forth the quarterly high and low bid prices for the period indicated. The quotations below reflect inter-dealer prices, without retail mark-ups, mark-downs or commissions and do not necessarily represent actual transactions.
Quotation or Price Quarter Ended Low Bid High Bid --------------------------- ------- -------- March 31, 2002 $ 24.32 $ 26.36 June 30, 2002 25.00 30.82 September 30, 2002 27.27 29.09 December 31, 2002 26.45 27.64 MARCH 31, 2003 $ 26.55 $ 28.64 JUNE 30, 2003 27.59 31.80 SEPTEMBER 30, 2003 31.27 33.18 DECEMBER 31, 2003 32.86 46.35
The approximate number of holders of record of our common stock is 1,054 as of December 31, 2003. Holders of the our stock are entitled to receive such dividends as may be declared from time to time by the Board of Directors from funds legally available for such payments. Our ability to pay cash dividends is dependent primarily on the ability of each subsidiary to pay dividends to us. The ability of each subsidiary to pay dividends depends on its earnings and financial condition and on compliance with banking statutes and regulations. Quarterly dividends for the years ended December 31, 2003 and 2002 are shown in Item 6 "Selected Financial Data." On October 15, 2003, Merchants and Manufacturers Statutory Trust III, a Connecticut statutory trust wholly owned by the Corporation, issued $7.5 million of fixed rate capital securities to one accredited investor. The Trust used the proceeds from the Capital Securities to purchase a like amount of fixed rate junior subordinated debentures of the Corporation. The Capital Securities accrue and pay dividends quarterly at a fixed rate equal to 8.25%. The Corporation has fully and unconditionally guaranteed all of the obligations of the Trust. The Capital Securities are mandatorily redeemable upon maturity of the Debentures on October 15, 2033 or earlier as provided in the indenture with respect to the Debentures. The Corporation has the right to redeem the Debentures on or after October 15, 2008. The Corporation believes it has satisfied the exemption from the securities registration requirement provided by section 4(2) of the Securities Act of 1933 and Regulation D promulgated thereunder in this offering since the securities were sold in a private placement to an accredited investor, who provided representations which Merchants deemed necessary to satisfy itself that it was an accredited investor and was purchasing for investment and not with a view to resale in connection with a public offering. On October 15, 2003, Merchants and Manufacturers Statutory Trust IV, a Connecticut statutory trust wholly owned by the Corporation, issued $7.5 million of floating rate capital securities to one accredited investor. The Trust used the proceeds from the Capital Securities to purchase a like amount of floating rate junior subordinated debentures of the Corporation. The Capital Securities accrue and pay dividends quarterly at a variable rate, reset quarterly, equal to 3-month LIBOR plus 2.95%. The Corporation has fully and unconditionally guaranteed all of the obligations of the Trust. The Capital Securities are mandatorily redeemable upon maturity of the Debentures on October 15, 2033 or earlier as provided in the indenture with respect to the Debentures. The Corporation has the right to redeem the Debentures on or after October 15, 2008. The Corporation believes it has satisfied the exemption from the securities registration requirement provided by section 4(2) of the Securities Act of 1933 and Regulation D promulgated thereunder in this offering since the securities were sold in a private placement to an accredited investor, who provided representations which Merchants deemed necessary to satisfy itself that it was an accredited investor and was purchasing for investment and not with a view to resale in connection with a public offering. Effective November 1, 2003, the Corporation issued approximately $12.8 million of promissory notes to certain of the shareholders of Reedsburg pursuant to the Reedsburg acquisition. The promissory notes will mature on the fifth anniversary of the date of issuance, and principal on the promissory notes is due in five equal annual installments on November 1 of each year from 2004 through 2008. The promissory notes bear interest at the rate of 5.35% per year, payable quarterly. The promissory notes are secured by an irrevocable letter of credit issued by M&I Marshall & Ilsley Bank. The Corporation believes it has satisfied the exemption from the securities registration requirement provided by section 3(a)(2) of the Securities Act of 1933 since the promissory notes are guaranteed by a bank pursuant to the irrevocable letter of credit. 10 ITEM 6. SELECTED FINANCIAL DATA The following table summarizes our certain historical financial data. This information is derived in part from, and should be read in conjunction with, the our Consolidated Financial Statements presented elsewhere herein (dollars in thousands, except per share data):
AT OR FOR THE YEAR ENDED DECEMBER 31, 2003(1) 2002(2) 2001(3) 2000 1999(3) --------- -------- -------- -------- -------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) INCOME STATEMENT DATA: Interest income (taxable equivalent) (4)............. $ 51,871 $ 40,421 $ 43,782 $ 43,256 $ 36,092 Interest expense..................................... 15,871 13,106 19,798 21,718 15,863 ---------- --------- -------- -------- -------- Net interest income.................................. 36,000 27,315 23,984 21,538 20,229 Provision for loan losses............................ 1,311 1,156 1,125 1,239 974 ---------- --------- -------- -------- -------- Net interest income after provision for loan losses 34,689 26,159 22,859 20,299 19,255 Noninterest income.................................. 11,163 6,127 4,682 4,395 3,815 Merger related expenses............................. -- -- -- 296 490 Noninterest expense................................. 32,736 22,139 18,554 16,757 15,793 ---------- --------- -------- -------- -------- Income before provision for income taxes............ 13,116 10,147 8,987 7,641 6,787 Provision for income taxes.......................... 4,067 3,244 2,733 2,267 2,129 Less taxable equivalent adjustment.................. 821 518 546 606 594 ---------- --------- -------- -------- -------- Net income.......................................... $ 8,228 $ 6,385 $ 5,708 $ 4,768 $ 4,064 ========== ========= ======== ======== ======== DIVIDENDS: Common stock........................................ $ 2,213 $ 1,790 $ 1,802 $ 1,599 $ 1,432 Dividend payout ratio............................... 26.90% 28.03% 31.57% 33.54% 35.24% PER SHARE DATA: (5) Net income-Basic ................................... $ 2.58 $ 2.30 $ 2.05 $ 1.70 $ 1.44 Net income-Diluted ................................. 2.56 2.29 2.04 1.69 1.41 Book value.......................................... 24.04 21.92 19.07 17.50 16.18 BALANCE SHEET DATA: Investment securities............................... $ 156,597 $ 130,125 $ 66,143 $ 78,847 $ 83,997 Loans, net.......................................... 847,938 657,775 477,332 473,161 395,533 Total assets........................................ 1,144,523 909,095 608,020 600,460 533,268 Total deposits...................................... 911,948 729,456 477,785 458,051 430,225 Short-term borrowings............................... 34,007 18,088 17,046 43,928 14,879 Long-term borrowings................................ 59,528 72,322 55,800 44,700 38,900 Company-obligated mandatorily redeemable preferred securities......................................... 35,000 10,000 -- -- -- Total stockholders' equity.......................... 79,974 69,329 52,929 48,515 45,735 EARNINGS RATIOS: Return on average total assets ..................... 0.86% 0.99% 0.95% 0.84% 0.81% Return on average total stockholder' equity ........ 11.29 11.55 11.15 10.18 9.00 Net interest margin (6)............................. 4.03 4.48 4.21 4.05 4.34 Efficiency ratio (7)................................ 70.64 67.24 65.98 67.33 69.44 ASSET QUALITY RATIOS: Allowance for loan losses to loans.................. 1.07 1.15 1.15 1.05 1.01 Nonaccrual loans to loans (8)....................... 0.62 0.48 0.92 0.38 0.56 Allowance for loan losses to nonperforming loans (8) 172.96 239.24 125.60 276.03 179.79 Nonperforming assets to total assets (9)............ 0.63 0.61 0.75 0.32 0.44 Net loan charge-offs to average loans............... 0.14 0.21 0.12 0.06 0.11 CAPITAL RATIOS: Total stockholders' equity to total assets.......... 6.99 7.63 8.71 8.08 8.58 Total capital to risk-weighted assets ratio......... 10.25 10.71 11.53 11.19 12.42 Tier 1 capital to risk-weighted assets ratio........ 9.24 9.63 10.43 10.14 11.44 Tier 1 capital to average assets ratio.............. 8.02 9.41 8.72 8.25 9.44
1) Year-end data for 2003 includes Reedsburg Bancorporation, Inc. and subsidiaries acquired by Merchants on November 1, 2003. 2) Year-end data for 2002 includes Fortress Bancshares, Inc. and subsidiaries acquired by Merchants on November 30, 2002. 3) Restated to reflect the January 16, 2001 acquisition of CBOC, Inc. and the December 31, 1999 acquisition of Pyramid Bancorp; both acquisitions were accounted for as pooling-of-interests. 4) Taxable-equivalent adjustments to interest income involve the conversion of tax-exempt sources of interest income to the equivalent amounts of interest income that would be necessary to derive the same net return if the investments had been subject to income taxes. A 34% incremental income tax rate, consistent with our historical experience, is used in the conversion of tax-exempt interest income to a tax-equivalent basis. 5) All per share information presented in this report has been retroactively restated to give effect to the 10% stock dividend declared in November 2003, as if each occurred as of January 1, 1999. 6) Net interest margin is the ratio of net interest income (expressed on a tax-equivalent basis) to average interest-earning assets. 7) Efficiency ratio is the ratio of noninterest expense to the sum of net interest income and noninterest income. 8) Nonperforming loans consist of nonaccrual loans and certain loans with restructured terms. 9) Nonperforming assets consist of nonperforming loans and other real estate. 11 Effective January 1, 2002, Merchants adopted Statement of Financial Accounting Standards ("SFAS") No. 142 "Goodwill and Other Intangible Assets". SFAS No. 142 changed the accounting for goodwill from a model that required amortization of goodwill, supplemented by impairment tests, to an accounting model that is based solely upon impairment tests. A reconciliation of Merchants Consolidated Statements of Earnings for each of the five years ending December 31, 2001 from amounts reported to amounts exclusive of goodwill amortization is shown below.
2001(1) 2000 1999(1) ------- ------- ------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Net income as reported ........................... $ 5,708 $ 4,768 $ 4,064 Add: goodwill amortization, net of tax............ 46 46 46 ------- ------- ------- Adjusted net income............................... $ 5,754 $ 4,814 $ 4,018 ======= ======= ======= Basic earnings per share as reported.............. $ 2.25 $ 1.87 $ 1.58 Add: goodwill amortization, net of tax............ 0.02 0.02 0.02 ------- ------- ------- Adjusted basic earnings per share................. $ 2.27 $ 1.89 $ 1.60 ======= ======= ======= Diluted earnings per share as reported............ $ 2.24 $ 1.86 $ 1.55 Add: goodwill amortization, net of tax............ 0.02 0.02 0.02 ------- ------- ------- Adjusted diluted earnings per share............... $ 2.26 $ 1.88 $ 1.57 ======= ======= =======
------------------ (1) Restated to reflect the January 16, 2001 acquisition of CBOC, Inc. and the December 31, 1999 acquisition of Pyramid Bancorp both acquisitions were accounted for as pooling-of-interests. QUARTERLY FINANCIAL DATA The following table sets forth our selected quarterly financial data. The fourth quarter 2003 data includes Reedsburg Bancorporation, Inc. and subsidiaries acquired by Merchants on November 1, 2003.
THREE MONTHS ENDED 2003 THREE MONTHS ENDED 2002 DECEMBER SEPTEMBER JUNE MARCH DECEMBER SEPTEMBER JUNE MARCH -------- --------- -------- -------- -------- ---------------------------- (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) Interest income (taxable-equivalent) (1) $ 13,840 $ 12,657 $ 12,469 $ 12,905 $ 11,106 $ 9,849 $ 9,753 $9,713 Interest expense 4,202 3,770 3,905 3,994 3,488 3,094 3,140 3,384 -------- --------- -------- -------- -------- --------- ------- ------ Net interest income 9,638 8,887 8,564 8,911 7,618 6,755 6,613 6,329 Provision for loan losses 297 372 340 302 312 282 282 280 Noninterest income 2,787 3,043 3,111 2,222 2,092 1,401 1,455 1,179 Noninterest expense 8,954 8,178 8,005 7,599 6,550 5,157 5,144 5,288 -------- --------- -------- -------- -------- --------- ------- ------ Income before taxes 3,174 3,380 3,330 2,232 2,848 2,717 2,642 1,940 Provision for income taxes 867 1,083 1,088 1,029 956 863 844 581 Less taxable-equivalent adjustment 229 194 191 207 147 116 124 131 -------- --------- -------- -------- -------- --------- ------- ------- Net income $ 2,078 $ 2,103 $ 2,051 $ 1,996 $ 1,745 $ 1,738 $ 1,674 $ 1,228 ======== ========= ======== ======== ======== ========= ======= ======= Basic earnings per share $ 0.64 $ 0.66 $ 0.65 $ 0.63 $ 0.61 $ 0.63 $ 0.61 $ 0.45 Diluted earnings per share $ 0.63 $ 0.65 $ 0.65 $ 0.63 $ 0.60 $ 0.63 $ 0.61 $ 0.45 Dividends per share $ 0.17 $ 0.17 $ 0.17 $ 0.17 $ 0.17 $ 0.17 $ 0.15 $ 0.15
------------------ (1) Taxable-equivalent adjustments to interest loans involve the conversion of tax-exempt sources of interest income to the equivalent amounts of interest income that would be necessary to derive the same net return if the investments had been subject to income taxes. A 34% incremental income tax rate, consistent with our historical experience, is used in the conversion of tax-exempt interest income to a tax-equivalent basis. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The following presents management's discussion and analysis of our financial condition and results of operations as of the dates and for the periods indicated. You should read this discussion in conjunction with our "Selected Consolidated Financial Data", our consolidated financial statements and the accompanying notes, and the other financial data contained elsewhere in this report. 12 On November 1, 2003, we acquired Reedsburg Bancorporation, Inc. ("Reedsburg") and its wholly-owned subsidiary, the Reedsburg Bank. The purchase price for Reedsburg was $36.0 million including $17.8 million in cash, $12.8 million in promissory notes and 146,800 shares of common stock valued at $5.4 million based on the average price over the contractual pricing period. The transaction was recorded as a purchase. Application of purchase accounting requires the inclusion of Reedsburg and the Reedsburg Banks' operating results in the consolidated financial statements from the date of the acquisition. Accordingly Reedsburg and the Reedsburg Banks' operating results are included in the consolidation results of operations since November 1, 2003. On November 30, 2002, we acquired Fortress Bancshares, Inc. ("Fortress") and its wholly-owned subsidiaries, Fortress Bank of Westby, Wisconsin, Fortress Bank of Cresco, Iowa and Fortress Bank, N.A. headquartered in Houston, Minnesota ("Fortress Banks"). The purchase price for Fortress was $21.5 million including $9.5 million in cash and 390,000 shares of common stock valued at $11.7 million based on the average price over the contractual pricing period. The transaction was recorded as a purchase. Application of purchase accounting requires the inclusion of Fortress and the Fortress Banks' operating results in the consolidated financial statements from the date of the acquisition. Accordingly Fortress and the Fortress Banks' operating results are included in the consolidation results of operations since November 30, 2002. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in these forward-looking statements as a result of various factors. Important factors that could cause actual results to differ materially from the results anticipated or projected include, but are not limited to, the following: (1) expected cost savings and synergies from our recently completed merger of Reedsburg Bancorporation, Inc., might not be realized within the expected time frame; (2) the credit risks of lending activities, including changes in the level and direction of loan delinquencies and write-offs; (3) changes in management's estimate of the adequacy of the allowance for loan losses; (4) competitive pressures among depository institutions; (5) interest rate movements and their impact on customer behavior and our net interest margin; (6) the impact of repricing and competitors' pricing initiatives on loan and deposit products; (7) our ability to adapt successfully to technological changes to meet customers' needs and developments in the market place; (8) our ability to access cost-effective funding; (9) changes in financial markets and general economic conditions; (10) new legislation or regulatory changes; and (11) changes in accounting principles, policies or guidelines. Certain statements contained in or incorporated by reference into this report constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for purposes of invoking these safe harbor provisions. You can identify these statements from our use of the words "may," "will," "should," "expect," "plan," "intend," "anticipate," "could," "believe," "estimate," "predict," "objective," "potential," "projection," "forecast," "goal," "project," "anticipate," "target" and similar expressions. These forward-looking statements may include, among other things: - statements relating to projected growth, anticipated improvements in earnings, earnings per share and other financial performance measures, and management's long term performance goals; - statements relating to the anticipated effects on results of operations or financial condition from expected developments or events; - statements relating to our business and growth strategies, including potential acquisitions; and - any other statements which are not historical facts. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from our expectations of future results, performance or achievements expressed or implied by such forward-looking statements. Although we believe that the expectations reflected in any forward-looking statements are reasonable, we cannot guarantee future events or results. Except as may be required under federal law, we undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur. In addition, our past results of operations do not necessarily indicate our future results. RESULTS OF OPERATIONS Net income for 2003 was $8.2 million or $2.56 per diluted share, up from $6.4 million or $2.29 per diluted share in 2002 and $5.7 million or $2.04 per diluted share in 2001. NET INTEREST INCOME Net interest income equals the difference between interest earned on assets and the interest paid on liabilities and is a measure of how effectively management has balanced and allocated our interest rate sensitive assets and liabilities. Net interest income is the most significant component of earnings. Taxable-equivalent adjustments to interest income involve the conversion of tax-exempt sources of interest income to the equivalent amounts of interest income that would be necessary to derive the same net return if the investments had been subject to income taxes on a fully tax equivalent basis. A 34% incremental income tax rate, consistent with our historical experience, is used in the conversion of tax-exempt interest income to a taxable-equivalent basis. 13 Net interest income on a fully tax equivalent basis increased to $36.0 million in 2003, compared with $27.3 million in 2002 and $24.0 million in 2001. In 2003, net interest income increased $8.7 million due to organic growth in earning assets, the additional growth from the Reedsburg acquisition and the full year growth impact from the Fortress acquisition partially offset by a lower net interest margin versus the prior year. In 2002, net interest income increased due to organic growth in earning assets as well as the additional growth from the Fortress acquisition. The net interest margin, on a fully tax-equivalent basis, was 4.03% for 2003, compared with 4.48% and 4.21% the preceding two years. The decreasing rate environment that began in 2002, along with the incremental effect of the acquisitions resulted in lower margins in 2003. The following table sets forth, for the periods indicated, information regarding the average balances of assets and liabilities and the total dollar amount of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resulting yields, interest rate spread, ratio of interest-earning assets to interest-bearing liabilities, and net interest margin. Average balances have been calculated using average daily balances during such periods (dollars in thousands):
AT OR FOR THE YEAR ENDED DECEMBER 31, ------------------------------------- 2003 2002 2001 ---- ---- ---- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE ------- -------- ------- -------- -------- ------- ------- -------- ------- (DOLLARS IN THOUSANDS) ASSETS Loans,net (1)(2) $724,469 $ 45,184 6.24% $507,142 $ 35,637 7.03% $477,412 $ 38,402 8.04% Loans exempt from federal income taxes (3) 3,481 279 8.01% 1,573 120 7.63% 1,656 150 9.06% Taxable investment securities (4) 42,486 2,080 4.90% 20,240 893 4.41% 21,653 1,259 5.81% Mortgage-related securities (4) 69,283 1,988 2.87% 39,226 2,050 5.23% 31,638 1,985 6.27% Investment securities exempt from federal income taxes (3)(4) 36,909 2,136 5.79% 21,201 1,403 6.62% 21,311 1,455 6.83% Other securities 16,647 204 1.23% 19,816 318 1.60% 15,377 531 3.45% -------- -------- -------- -------- -------- -------- Interest earning assets 893,275 51,871 5.81% 609,198 40,421 6.64% 569,047 43,782 7.69% -------- -------- -------- Non interest earning assets 67,559 38,600 31,791 -------- -------- -------- Average assets $960,834 $647,798 $600,838 ======== ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY NOW deposits $ 64,578 400 0.62% $ 37,849 334 0.88% $ 32,715 585 1.79% Money market deposits 230,298 3,320 1.44% 108,247 1,857 1.72% 87,213 3,168 3.63% Savings deposits 90,723 623 0.69% 78,357 843 1.08% 72,209 1,224 1.70% Time deposits 283,156 7,316 2.58% 213,791 7,261 3.40% 209,297 10,715 5.12% Short-term borrowings 25,493 594 2.33% 20,802 502 2.41% 24,723 1,260 5.10% Long-term borrowings 67,235 2,463 3.66% 55,692 2,244 4.03% 53,296 2,846 5.34% Company-obligated mandatorily redeemable preferred securities 19,073 1,155 6.06% 1,361 65 4.78% -- -- -- -------- -------- -------- -------- -------- -------- Interest bearing liabilities 780,556 15,871 2.03% 516,099 13,106 2.54% 479,453 19,798 4.13% -------- -------- -------- -------- -------- -------- Demand deposits and other non interest bearing liabilities 107,404 76,400 70,197 Stockholders' equity 72,874 55,299 51,188 -------- -------- -------- Average liabilities and stockholders' equity $960,834 $647,798 $600,838 ======== ======== ======== Net interest spread (5) $ 36,000 3.78% $ 27,315 4.10% $ 23,984 3.56% Net interest earning assets $112,719 $ 93,099 $ 89,594 Net interest margin on a fully tax equivalent basis (6) 4.03% 4.48% 4.21% Net interest margin (6) 3.94% 4.40% 4.12% Ratio of average interest-earning assets to average interest-bearing liabilities 1.14 1.18 1.19
------------------------------ (1) For the purpose of these computations, nonaccrual loans are included in the daily average loan amounts outstanding. (2) Interest earned on loans includes loan fees (which are not material in amount) and interest income which has been received from borrowers whose loans were removed from nonaccrual status during the period indicated. (3) Taxable-equivalent adjustments were made using a 34% corporate tax rate for all years presented in calculating interest income and yields. (4) Average balances of securities available-for-sale are based on amortized cost. (5) Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is represented on a fully tax equivalent basis. (6) Net interest margin represents net interest income as a percentage of average interest earning assets. 14 The following table sets forth the effects of changing interest rates and volumes of interest earning assets and interest bearing liabilities on our net interest income. Information is provided with respect to (i) effect on net interest income attributable to changes in volume (changes in volume multiplied by prior rate), (ii) effects on net interest income attributable to changes in rate (changes in rate multiplied by prior volume), (iii) changes in a combination of rate and volume (changes in rate multiplied by changes in volume), and (iv) net change:
FOR THE YEAR ENDED DECEMBER 31, ------------------------------- 2003 VS. 2002 2002 VS. 2001 ------------- ------------- INCREASE/(DECREASE) INCREASE/(DECREASE) DUE TO DUE TO ------ ------ TOTAL TOTAL VOLUME INCREASE VOLUME INCREASE VOLUME RATE & RATE (DECREASE) VOLUME RATE & RATE (DECREASE) ------- --------- --------- ---------- ------- ------- -------- ---------- (DOLLARS IN THOUSANDS) Interest-Earning Assets: Loans, net (1) $15,271 ($ 4,007) ($ 1,717) $ 9,547 $2,391 ($ 4,854) ($ 302) ($ 2,765) Loans exempt from federal income taxes (2) 146 6 7 159 (7) (24) 1 (30) Taxable investment securities 981 98 108 1,187 (82) (304) 20 (366) Mortgage-related securities 1,570 (924) (708) (62) 477 (332) (80) 65 Investment securities exempt from federal income taxes (2) 1,039 (176) (130) 733 (7) (45) -- (52) Other securities (51) (75) 12 (114) 153 (284) (82) (213) ------- --------- -------- ---------- ------ -------- -------- ---------- Total interest-earning assets $18,956 ($ 5,078) ($ 2,428) $ 11,450 $2,925 ($ 5,843) ($ 443) ($ 3,361) ======= ========= ======== ========== ====== ======== ======== ========== Interest-Bearing Liabilities: NOW deposits $ 236 ($ 100) ($ 70) $ 66 $ 91 ($ 296) ($ 46) ($ 251) Money market deposits 2,093 (296) (334) 1,463 764 (1,672) (403) (1,311) Savings deposits 133 (305) (48) (220) 104 (447) (38) (381) Time deposits 2,356 (1,737) (564) 55 230 (3,607) (77) (3,454) Short-term borrowings 113 (17) (4) 92 (200) (663) 105 (758) Long-term borrowings 465 (204) (42) 219 128 (699) (31) (602) Company-obligated mandatorily redeemable preferred securities 846 17 227 1,090 -- -- 65 65 ------- --------- -------- ---------- ------ -------- -------- ---------- Total interest-bearing liabilities $ 6,242 ($ 2,642) ($ 835) $ 2,765 $1,117 ($ 7,384) ($ 425) ($ 6,692) ======= ========= ======== ========== ====== ======== ======== ========== Net change in net interest income $ 8,685 $ 3,331 ========== ==========
------------------------------ (1) Interest earned on loans includes loan fees (which are not material in amount) and interest income which has been received from borrowers whose loans were removed from nonaccrual during the period indicated. (2) Taxable-equivalent adjustments were made using a 34% corporate tax rate for all years presented in calculating interest income and yields. PROVISION FOR LOAN LOSSES During 2003, we made a provision of $1.3 million to the allowance for loan losses, as compared to a provision of $1.2 million in 2002 and $1.1 million in 2001. The increased 2003 provision reflects the growth in the overall loan portfolio especially in higher risk categories of commercial and commercial real estate loans and management's assessment of general economic conditions. Net loan charge-offs for 2003 were $1.1 million unchanged from the $1.1 million of net charge-offs in 2002. This compares to net charge-offs of $572,000 in 2001. Although we consider the allowance for loan losses to be adequate to provide for potential losses in the loan portfolio, there can be no assurance that losses will not exceed estimated amounts or that the subsidiary banks will not be required to make further and possibly larger additions to their allowance in the future. 15 NON-INTEREST INCOME Total non-interest income increased $5.0 million in 2003 and $1.4 million in 2002. The increase was primarily from growth in mortgage banking revenues and service charges collected on loans to which were the result of higher origination volumes generated in the lower rate environment. Additionally, non-interest income increased during 2003 from growth in tax, brokerage and insurance commissions due to growth in sales and the acquisitions of KCW and IFS during 2003. The growth in non-interest income was also positively impacted by the completed acquisitions of Fortress and Reedsburg. The increase in 2002 was primarily from growth in mortgage banking revenues due to higher origination volumes generated in the lower rate environment as well as growth in non-interest income from the acquisition of Fortress. The composition of non-interest income is shown in the following table (dollars in thousands).
For the Year Ended December 31, 2003 2002 2001 ------- ------ ------ Service charges on deposit accounts $ 2,649 $1,625 $1,302 Service charges on loans 2,565 1,260 722 Securities gains, net 360 111 88 Gain on sale of loans, net 1,859 695 332 Net gain on sale of premises 2 360 557 Other 3,728 2,076 1,681 ------- ------ ------ Total non-interest income $11,163 $6,127 $4,682 ======= ====== ======
Service charge income on deposit accounts increased $1.0 million in 2003 and $323,000 in 2002. The increases in both years continued to reflect the benefits from growth in deposit accounts, both organic and through acquisition and fee structure modifications company wide. Service charges on loans increased $1.3 million from $1.3 million in 2002 to $2.6 million in 2003. The increase is due directly to the amount of mortgage and commercial loans refinanced and originated in 2003. The increase in loan fees from 2001 to 2002 can be attributed to the high volume of new loans generated and refinanced in 2002. We recorded a net gain of $360,000 on the sale of $15.1 million of securities in 2003, a gain of $111,000 on the sale of $7.7 million of securities in 2002 and a gain of $88,000 on the sale of $4.2 million of securities in 2001. The proceeds from the sale of the investments were used to fund loan demand or pay off debt. We recorded $1.9 million in gains on the sale of loans in 2003, compared to $695,000 in 2002 and $332,000 in 2001. All-time low market interest rates led to higher secondary market sales of 15 and 30 year residential mortgage loans in 2003 and 2002. Higher interest rates in 2001 resulted in reduced opportunities to sell loans. It is anticipated that gains on sales of loans will be significantly less in 2004 as mortgage interest rates have begun to rise. In each year, 2000 and 1999, we sold a banking facility and subsequently leased it back from the new owners. The 2000 transaction resulted in an immediate gain of $786,000 while the 1999 transaction resulted in an immediate gain of $566,000 at the time of the sale. The remaining portion of the gains have been recognized monthly over the terms of the leases. During 2002, $360,000 was accreted into income related to the 2000 transaction. During 2001, $201,000 was accreted into income related to the 1999 transaction. Other income in 2003 included commissions on tax, investment and insurance products of $1.2 million in revenues generated from the acquisitions of IFS in April 2003 and KCW in May 2003. NON-INTEREST EXPENSE Non-interest expense increased $10.6 million (47.9%) for the year ended December 31, 2003, and increased $3.6 million (19.3%) for the year ended December 31, 2002. In 2003, the acquisitions of Reedsburg, IFS and KCW and the full year impact of the previous year's fourth quarter acquisition of Fortress contributed to the rise in expenses. In 2002, the Fortress acquisition also contributed to the rise in expenses. The major components of non-interest expense are shown in the following table (dollars in thousands).
For the Year Ended December 31, 2003 2002 2001 ------- ------- ------- Salaries and employee benefits $18,655 $12,439 $10,533 Premises and equipment 4,079 3,419 3,075 Data processing fees 1,193 1,261 951 Marketing and business development 1,509 894 878 Federal deposit insurance premiums 129 102 99 Other 7,171 4,024 3,018 ------- ------- ------- Total noninterest expense $32,736 $22,139 $18,554 ======= ======= =======
16 Salaries and employee benefits increased $6.2 million in 2003 primarily due to acquisitions. Also impacting salaries and employee benefits in 2003 were additional staff hires particularly in the business development and acquisition support staff areas, higher benefit costs, changes in personnel and normal pay raises. Salaries and employee benefits increased $1.9 million in 2002. The increase was due to normal pay increases and staff additions in the loan generation and loan services area. Premises and equipment expense increased $660,000 in 2003 and $344,000 in 2002. The lease payments, depreciation, maintenance of our facilities and acquisitions contributed to the increase. Data processing fees decreased $68,000 in 2003 and increased $310,000 in 2002. The 2003 decrease was due to the efficiencies gained from a larger organization. The 2002 increase was due to the increased reliance on outside consultants for information technology issues as well as equipment and software upgrades. Marketing and business development costs increased $615,000 in 2003, and increased $16,000 in 2002. The increase in 2003 can be attributed to the development of a marketing program associated with the non-insured investment products, advertising of deposit products and effects of the acquisitions. Federal deposit insurance fees represent premiums paid for FDIC insurance on the banks' deposits. The FDIC assesses the banks based on the level of deposits. In 2003 the premiums paid amounted to $129,000 compared to $102,000 in 2002 and $99,000 in 2001. Other expenses increased $3.1 million in 2003 and $1.0 million in 2002. The increases in 2003 are the result of implementing our strategic plan, training our employees sales techniques, maintaining our internet banking program, various consulting fees and legal fees. The acquisitions completed in 2003 and 2002 also impacted other expenses. INCOME TAXES Our consolidated income tax rate varies from statutory rates principally due to interest income from tax-exempt securities and loans and interest income on assets held in the portfolios of M&M Lincoln Investment Corporation, GSB Investments, CBOC Investments, Westby Investment Company and Reedsburg Investment Corp. for which state taxes have not been imposed. Currently, the Wisconsin Department of Revenue is conducting audits at some of our investment subsidiaries which may result in state taxes being imposed, including prior periods. Our recorded provisions for income taxes totaled $4.1 million in 2003, $3.2 million in 2002 and $2.7 million in 2001. The corresponding effective tax rate for the same years were 33.1%, 33.7% and 32.4%. 17 LOANS RECEIVABLE Loans receivable (net of allowance) increased $190.1 million, or 28.9%, from $657.8 million at December 31, 2002, to $847.9 million at December 31, 2003. The 2003 loan growth can be attributed to both organic growth as well as acquisition growth associated with the Reedsburg acquisition. At the time of the acquisition, the Reedsburg Bank had $97.2 million of loans. Low market interest rates offered on single-family residential loans resulted in customers refinancing their adjustable rate mortgages. These adjustable rate mortgages were replaced with lower rate fifteen and thirty-year mortgages. We do not retain the long-term mortgages, choosing to sell these loans on the secondary market. During 2003 we sold $181.3 million of single-family residential loans compared to $108.8 million in 2002. Loans receivable consist mainly of commercial business loans secured by business assets, real estate and guarantees as well as mortgages secured by residential properties located in our primary market area. The following table shows the composition of our loan portfolio on the dates indicated:
FOR THE YEAR ENDED DECEMBER 31, ------------------------------- 2003 2002 2001 2000 1999 -------- -------- -------- -------- -------- (DOLLARS IN THOUSANDS) First mortgage: Conventional single-family residential $113,479 $ 98,075 $ 78,377 $ 98,730 $ 78,278 Commercial and multifamily residential 283,433 198,250 180,102 173,107 148,856 Construction 47,894 32,995 34,744 47,767 32,882 Farmland 43,676 20,847 7,312 7,027 6,363 -------- -------- -------- -------- -------- 488,482 350,167 300,535 326,631 266,379 Commercial business loans 294,645 246,787 140,671 110,291 97,835 Consumer and installment loans 51,886 51,883 32,401 33,327 23,487 Home equity loans 14,664 9,492 6,140 4,545 7,094 Other 7,397 7,109 3,148 3,377 3,788 -------- -------- -------- -------- -------- 368,592 315,271 182,360 151,540 133,200 Less: Allowance for loan losses 9,136 7,663 5,563 5,010 4,046 -------- -------- -------- -------- -------- $847,938 $657,775 $477,332 $473,161 $395,533 ======== ======== ======== ======== ========
The following table presents information as of December 31, 2003 regarding first mortgage and commercial business loan maturities and contractual principal repayments of loans during the periods indicated. Loans with adjustable interest rates are shown maturing in the year of their contractual maturity. Also provided are the amounts due after one year classified according to the sensitivity to changes in interest rates.
AFTER ONE BUT WITHIN FIVE AFTER FIVE WITHIN ONE YEAR YEARS YEARS TOTAL --------------- ------------- ---------- --------- (DOLLARS IN THOUSANDS) Commercial business loans $173,237 $ 116,836 $ 4,572 $ 294,645 First mortgage loans 228,288 247,233 12,961 488,482 -------- --------- ------- --------- $401,525 $ 364,069 $17,533 $ 783,127 ======== ======== ======= ========= Loans maturing after one year with: Fixed interest rates $ 345,893 $17,516 Variable interest rates 18,176 17 --------- ------- $ 364,069 $17,533 ========= =======
ALLOWANCE FOR LOAN LOSSES Management believes the allowance for loan losses accounting policy is critical to the portrayal and understanding of our financial condition and results of operations. As such, selection and application of this "critical accounting policy" involves judgments, estimates, and uncertainties that are susceptible to change. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood. 18 The allowance for loan losses is maintained at an amount that we believe will be adequate to absorb probable losses on existing loans, based on an evaluation of the collectibility of loans and prior loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, the value of underlying collateral, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower's ability to pay. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, as an integral part of their examination process regulatory agencies periodically review our allowance for loan losses and may require us to make additions to the allowance based on their evaluation of information available at the time of their examinations. The allowance for loan losses increased from $7.7 million at December 31, 2002, to $9.1 million at December 31, 2003. The 2003 allowance for loan losses growth can be attributed to both organic growth as well as acquisition growth associated with the Reedsburg acquisition. At the time of the acquisition, the Reedsburg Bank had $1.2 million allowance for loan losses. The remaining increase was due to the growth in the loan portfolio, the general uncertainty regarding economic conditions and the increase in non-performing loans and charge-offs recorded in 2003 and 2002. The ratio of the allowance for loan losses to total loans was 1.07% for 2003 and 1.15% for 2002. Based on the present economic environment and our analysis of the financial condition of the borrowers, we consider the present allowance to be appropriate and adequate to cover probable losses inherent in the loan portfolio, however, changes in future economic conditions and in the financial condition of borrowers cannot be predicted at this time. Deterioration in such conditions could result in increases in charge-offs or adversely classified loans and accordingly, in additional provisions for loan losses. The balance of the allowance for loan losses and actual loss experience for the last five years is summarized in the following table:
AT OR FOR THE YEAR ENDED DECEMBER 31, ------------------------------------- 2003 2002 2001 2000 1999 ------- ------- ------- ------- ------- (DOLLARS IN THOUSANDS) Balance at beginning of year $ 7,663 $ 5,563 $ 5,010 $ 4,047 $ 3,486 Charge-offs: Conventional single-family mortgage residential 84 1 6 91 48 Commercial and multifamily residential 69 647 -- -- -- Commercial business loans 532 99 210 107 290 Consumer and installment loans 746 429 379 92 94 ------- ------- ------- ------- ------- Total charge-offs 1,431 1,176 595 290 432 Recoveries (390) (112) (23) (14) (19) ------- ------- ------- ------- ------- Net charge-offs 1,041 1,064 572 276 413 Increase due to acquisition 1,203 2,008 -- -- -- Provisions charged to operations 1,311 1,156 1,125 1,239 974 ------- ------- ------- ------- ------- Balance at end of year $ 9,136 $ 7,663 $ 5,563 $ 5,010 $ 4,047 ======= ======= ======= ======= ======= Ratios: Net charge-offs to average loans outstanding 0.14% 0.21% 0.11% 0.06% 0.11% Net charge-offs to total allowance 11.39% 13.88% 10.28% 5.51% 10.21% Allowance to year end gross loans outstanding 1.07% 1.15% 1.15% 1.05% 1.01%
NON-PERFORMING AND DELINQUENT LOANS When in the opinion of management, serious doubt exists as to the collectability of a loan, the loan is placed on non-accrual status and interest previously accrued but unpaid is deducted from interest income. We do not recognize income on any loans past due 90 days or more. In 2003, $613,000 of additional income on nonaccrual loans would have been reported if the loans had been current in accordance with their original terms and had been outstanding throughout the year. Additionally, in 2003 we recorded $368,000 of interest income on non-accrual loans. Nonperforming assets increased by $1.6 million from $5.6 million at December 31, 2002 to $7.3 million at December 31, 2003. The increase in non-performing assets can be attributed to the increase in nonaccrual loans, primarily consumer loans, which was partially offset by the sale of property previously held in other real estate owned. Other real estate owned is principally comprised of commercial properties acquired in partial or total satisfaction of problem loans. Management believes that losses on non-performing assets will be minimal due to the collateral position in each situation. 19 The following table summarizes non-performing assets on the dates indicated (dollars in thousands):
AT DECEMBER 31, --------------- 2003 2002 2001 2000 1999 --------- --------- --------- --------- --------- (DOLLARS IN THOUSANDS) Nonaccrual loans $ 5,282 $ 3,203 $ 4,429 $ 1,815 $ 2,251 Other real estate owned 1,945 2,382 139 117 107 --------- --------- --------- --------- --------- Total non-performing assets $ 7,227 $ 5,585 $ 4,568 $ 1,932 $ 2,358 ========= ========= ========= ========= ========= Ratios: Non-accrual loans to total loans 0.62% 0.48% 0.92% 0.38% 0.56% Allowance to non-accrual loans 172.96% 239.24% 125.60% 276.03% 179.79% Non-performing assets to total assets 0.63% 0.61% 0.75% 0.32% 0.44%
POTENTIAL PROBLEM LOANS We utilize an internal asset classification system as a means of reporting problem and potential problem assets. At least quarterly, a watch list is presented to each subsidiary bank's Board of Directors (except one, which is presented upon request of the Board of Directors) showing all loans listed as "Management Attention (or equivalent designation at the various subsidiary banks)", "Substandard", "Doubtful", and "Loss." An asset is classified Substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Assets classified as Loss are those considered uncollectible and viewed as non-bankable assets, worthy of charge-off. Assets that do not currently expose us to sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses that may or may not be within the control of the customer are deemed to be Management Attention (or equivalent designation at the various subsidiary banks). As of December 31, 2003, loans classified as Substandard, Doubtful, or Management Attention, totaled $51.7 million on a consolidated holding company basis. Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by the Banks' primary regulators, which can order the establishment of additional general or specific loss allowances. The FDIC, in conjunction with the other federal banking agencies, has adopted an interagency policy statement on the allowance for loan losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally, the policy statement recommends that (i) institutions have effective systems and controls to identify, monitor and address asset quality problems; (ii) management has analyzed all significant factors that affect the collectibility of the portfolio in a reasonable manner; and (iii) management has established acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. We have established an adequate allowance for probable loan losses. We analyze the process regularly, with modifications made if needed, and report those results four times per year to each subsidiary bank's Board of Directors (except one, which is presented upon request of the Board of Directors). However, there can be no assurance that regulators, in reviewing our loan portfolio, will not request us to materially increase our allowance for loan losses at the time. Although management believes that adequate specific and general loan loss allowances have been established, actual losses are dependent upon future events and, as such, further additions to the level of specific and general loan loss allowances may become necessary. INVESTMENT SECURITIES The investment portfolio is intended to provide us with adequate liquidity, flexibility in asset/liability management and lastly earnings potential. Investment securities at December 31, 2003 were $156.6 million compared to $130.1 million at December 31, 2002. The 2003 investment security growth can be attributed to both organic growth as well as acquisition growth associated with the Reedsburg acquisition. At the time of the acquisition, the Reedsburg Bank had $24.7 million of investment securities. The 2003 growth in investment securities was primarily due to excess funds created through deposit growth. Management determines the appropriate classification of securities (including mortgage-related securities) at the time of purchase. Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of stockholder's equity. See Notes 1 and 4 to Consolidated Financial Statements for further details. 20 The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-related securities, over the estimated life of the security. Such amortization is included in interest income from the related security. Interest and dividends are included in interest income from the related securities. Realized gains and losses, and declines in value judged to be other-than-temporary are included in securities gains (losses). The cost of securities sold is based on the specific identification method. The following table sets forth our estimated fair value of investment securities available-for-sale at the dates indicated:
FOR THE YEAR ENDED DECEMBER 31, -------------------------------------------------- 2003 2002 2001 --------- --------- -------- (DOLLARS IN THOUSANDS) U.S. Treasury and other U.S. government securities $ 32,403 $ 24,064 $ 4,494 State and political subdivision securities 48,985 39,901 24,178 Corporate bonds 75 75 1,614 Mutual funds -- 3,069 3,066 Collateralized mortgage obligations 34,121 28,611 14,116 Mortgage-backed securities 41,013 34,405 17,575 --------- --------- -------- $ 156,597 $ 130,125 $ 66,143 ========= ========= ========
The maturity distribution (based upon the average life) and weighted average yield of our securities portfolio as of December 31, 2003 are summarized in the following table:
WITHIN ONE YEAR ONE TO FIVE YEARS FIVE TO TEN YEARS OVER TEN YEARS ------------------- ------------------ ------------------- --------------------- WEIGHTED WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE AVERAGE AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD -------- -------- -------- -------- ------- -------- -------- --------- U.S. TREASURY AND OTHER GOVERNMENT AGENCY SECURITIES $ 17,874 2.18% $ 8,649 3.73% $ 4,422 5.08% $ 1,049 5.71% STATE AND POLITICAL SUBDIVISION CERTIFICATES 2,323 5.07 15,030 4.56 22,697 4.45 6,751 4.47 CORPORATE BONDS -- -- 75 5.30 -- -- -- -- COLLATERALIZED MORTGAGE OBLIGATIONS 3,934 3.52 28,299 3.62 2,039 4.09 -- -- MORTGAGE-BACKED SECURITIES 584 5.16 31,505 3.89 1,979 4.30 6,744 3.34 -------- ---- -------- ---- ------- ---- -------- ---- $ 24,715 2.74% $ 83,558 3.90% $31,137 4.51% $ 14,544 4.04% ======== ==== ======== ==== ======= ==== ======== ====
Weighted average yield is calculated by dividing income within each maturity range by the outstanding amount of the related investment based on carrying value. TOTAL DEPOSITS We continue to stress core deposit accumulation and retention as a basis for sound growth and profitability. Core deposits consist of all deposits other than public funds and certificates of deposit in excess of $100,000. 21 Total deposits increased $182.5 million to $911.9 million on December 31, 2003, from $729.5 million on December 31, 2002. The 2003 deposit growth can be attributed to both organic growth as well as acquisition growth associated with the Reedsburg acquisition. At the time of the acquisition, the Reedsburg Bank had $120.6 million of deposits. The average increase in time deposits occurred via increases in retail certificates of deposits and retail jumbo certificates of deposits, while the increase in NOW and money market deposits can be attributed to depositors desiring to stay liquid as market interest rates remained at historical lows in 2003. The following table sets forth the average amount of and the average rate paid by the banks on deposits by deposit category:
FOR THE YEAR ENDED DECEMBER 31, ------------------------------- 2003 2002 2001 ---- ---- ---- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE RATE BALANCE RATE BALANCE RATE --------- ------- --------- ------- --------- ------- (DOLLARS IN THOUSANDS) Non-interest-bearing demand deposits $ 95,351 0.00% $ 72,662 0.00% $ 67,165 0.00% NOW and money market deposits 294,876 1.26 146,096 1.50 119,928 3.13 Savings deposits 90,723 0.69 78,357 1.08 72,209 1.70 Time deposits 283,156 2.58 213,791 3.40 209,297 5.12 --------- ----- --------- ----- --------- ------- Total $ 764,106 1.52% $ 510,906 2.02% $ 468,599 3.35% ========= ===== ========= ===== ========= =======
Maturities of time deposits and certificate accounts with balances of $100,000 or more, outstanding at December 31, 2003, are summarized as follows (dollars in thousands): 3 MONTHS OR LESS $17,914 OVER 3 THROUGH 6 MONTHS 15,658 OVER 6 THROUGH 12 MONTHS 21,955 OVER 12 MONTHS 18,628 ------- TOTAL $74,155 =======
BORROWINGS Although deposits are our primary source of funds, it has been our policy to utilize borrowings as an alternative source of funds. We utilize both short-term and long-term borrowings, as well as repurchase agreements as a part of our asset/liability management strategy. Borrowings are secured when we believe we can profitably re-invest those funds for our benefit. A significant component of our borrowings are federal funds purchased and advances from the Federal Home Loan Bank (FHLB). The FHLB advances are collateralized by the capital stock of the FHLB that we hold, certain mortgage loans in our loan portfolio and certain investment securities. Such advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. The following table shows outstanding amounts of borrowings together with the weighted average interest rates, at December 31, for each of the past three years (dollars in thousands).
At December 31, 2003 2002 2001 -------------------- ----------------------- -------------------- BALANCE RATE Balance Rate Balance Rate -------- ----- ----------- ---- ------- ----- Federal Funds purchased $ 24,500 1.29% $ -- --% $ 9,300 2.13% Securities sold under agreements to repurchase 1,588 1.27 3,101 1.53 3,524 2.72 Other short-term borrowings 7,919 2.54 14,987 3.34 4,222 5.18 Long-term borrowings 72,346 4.00 72,322 3.96 55,800 4.77 -- -- -- -- Company-obligated mandatorily redeemable preferred securities 35,000 6.30 10,000 4.75 -- -- -------- ----- ----------- ---- ------- ----- $141,353 3.99% $ 100,410 3.87% $72,846 4.36% ======== ===== =========== ==== ======= =====
22 The following table shows the maximum amounts outstanding of borrowings for each of the past three years (dollars in thousands).
At December 31, 2003 2002 2001 -------- -------- -------- Federal Funds purchased $ 24,500 $ 19,313 $ 35,900 Securities sold under agreements to repurchase 8,425 9,894 7,326 Other short-term borrowings 16,222 14,987 4,222 Long-term borrowings 83,879 72,322 55,800 -- -- Company-obligated mandatorily redeemable preferred securities 35,000 10,000 -- -------- -------- -------- $168,026 $126,516 $103,248 ======== ======== ========
The following table shows for the periods indicated the daily average amount outstanding for the categories of borrowings, the interest paid and the weighted average rates (dollars in thousands).
At December 31, 2003 2002 2001 ---------------- ---------------- ---------------- BALANCE RATE Balance Rate Balance Rate -------- ---- -------- ---- -------- ---- Federal Funds purchased $ 7,245 1.57% $ 8,474 2.07% $ 15,756 5.24% Securities sold under agreements to repurchase 5,059 1.28 7,273 1.88 5,516 3.93 Other short-term borrowings 11,124 2.70 6,189 3.44 3,451 6.29 Long-term borrowings 69,300 3.71 55,692 4.03 53,296 5.34 -- -- -- -- Company-obligated mandatorily redeemable preferred securities 19,073 6.06 1,361 4.75 -- -- -------- ---- -------- ---- -------- ---- $111,801 3.77% $ 78,989 3.59% $ 78,019 5.26% ======== ==== ======== ==== ======== ====
CAPITAL RESOURCES AND ADEQUACY Stockholders' equity increased from $69.3 million at December 31, 2002 to $80.0 million at December 31, 2003. Approximately $5.4 million of capital growth was due to the Reedsburg acquisition. The $8.2 million increase from earnings retention were partially offset by the payment of $2.2 million in cash dividends to shareholders and the $785,000 decrease in the investment portfolio market value. Pursuant to regulations promulgated by the Federal Reserve Board, bank holding companies are required to maintain minimum levels of core capital as a percent of total assets and total capital as a percent of risk-based assets. The minimum core capital requirement ranges from 3% to 5% of total assets, depending upon the Federal Reserve Board's determination of the financial institution's strength. Similar capital guidelines are also established for our individual banking subsidiaries. Most financial institutions are required to meet a minimum core capital requirement of 4% or more of total assets. The regulations assign risk weightings to assets and off-balance sheet items and require minimum risk-based capital ratios. Bank holding companies generally are required to have total capital equal to not less than 8% of risk weighted assets. Core capital consists principally of shareholders' equity less intangibles, while qualifying total capital consists of core capital, portions of trust preferred securities and a portion of the reserve for loan losses. As of December 31, 2003, we had a total capital to risk weighted assets ratio of 10.23%, and Lincoln State Bank, Franklin State Bank, Grafton State Bank, Community Bank of Oconto County, Fortress Bank of Westby, Fortress Bank of Cresco, Fortress Bank, N.A. and the Reedsburg Bank had total capital to risk weighted assets ratios of 10.80%, 10.87%, 12.32%, 11.68%, 11.96%, 15.38%, 14.17% and 12.74% respectively. These ratios are above the 2003 minimum requirements established by regulatory agencies to be well-capitalized. 23 $26.4 million of the trust preferred securities are currently included in the Tier 1 capital, with the remainder included in Tier II capital of the Corporation for regulatory capital purposes. However, because the Trusts will no longer be a part of the Corporation's financial statements, the Federal Reserve Board may in the future disallow inclusion of the trust preferred securities in Tier 1 capital for regulatory capital purposes. In July 2003, the Federal Reserve Board issued a supervisory letter instructing bank holding companies to continue to include the trust preferred securities in their Tier 1 capital for regulatory capital purposes until notice is given to the contrary. The Federal Reserve Board intends to review the regulatory implications of the change in accounting treatment of subsidiary trusts that issue trust preferred securities and, if necessary or warranted, provide further appropriate guidance. There can be no assurance that the Federal Reserve Board will continue to permit institutions to include trust preferred securities in Tier I capital for regulatory capital purposes. As of December 31, 2003, assuming the Corporation was not permitted to include the $35 million in trust preferred securities issued by the Trusts in its Tier 1 and Tier II capital, the Company would still exceed the regulatory required minimums for capital adequacy purposes. If the trust preferred securities were no longer permitted to be included in Tier 1 capital, the Corporation would also be permitted to redeem the capital securities without penalty. For a summary of the banks' regulatory capital ratios at December 31, 2003, please see Note 17 to Consolidated Financial Statements. Management strives to maintain a strong capital position to take advantage of opportunities for profitable geographic and product expansion and to maintain depositor and investor confidence. Conversely, management believes that capital must be maintained at levels that provide adequate returns on the capital employed. Management actively reviews capital strategies for us and for each of our subsidiaries to ensure that capital levels are appropriate based on perceived business risks, growth and regulatory standards. LIQUIDITY AND CAPITAL RESOURCES Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. We had liquid assets of $47.7 million and $61.8 million on December 31, 2003 and December 31, 2002, respectively. The decrease in liquid assets from December 31, 2002 to December 31, 2003 can be largely attributed to a decrease in federal funds sold. Management believes liquidity and capital levels are adequate at December 31, 2003. Our liquidity, represented by cash and cash equivalents, is a product of our operating activities, investing activities and financing activities. These activities are summarized below:
FOR THE YEAR ENDED DECEMBER 31, ------------------------------- 2003 2002 2001 --------- --------- --------- (DOLLARS IN THOUSANDS) Cash and cash equivalents at beginning of period $ 61,755 $ 37,468 $ 23,133 Operating activities: Net income 8,228 6,385 5,708 Adjustments to reconcile net income to net cash provided (used) by operating activities 1,935 4,033 (2,102) --------- --------- --------- Net cash provided by operating activities 10,163 10,418 3,606 Net cash provided (used in) by investing activities (109,462) (57,473) 8,705 Net cash provided by financing activities 85,199 71,342 2,024 --------- --------- --------- Increase (decrease) in cash and cash equivalents $ (14,100) $ 24,287 $ 14,335 ========= ========= ========= Cash and cash equivalents at end of period $ 47,655 $ 61,755 $ 37,468 ========= ========= =========
Net cash was provided by operating activities during the years ended December 31, 2003, 2002 and 2001 primarily as a result of normal ongoing business operations. The non-cash items, such as the provisions for loan losses and depreciation and the net amortization of premiums, also contributed to net cash provided by operating activities during these periods. Liquidity is also necessary at the parent company level. The parent company's primary source of funds are dividends from subsidiaries, borrowings and proceeds from issuance of equity. The parent company manages its liquidity position to provide the funds necessary to pay dividends to shareholders, service debt, invest in subsidiaries and satisfy other operating requirements. Dividends received from subsidiaries totaled $7.3 million, $3.5 million and $3.3 million for the years ended December 31, 2003, 2002 and 2001, respectively, and will continue to be the parent company's main source of long-term liquidity. The dividends from our banks were sufficient to pay cash dividends to our shareholders of $2.2 million, $1.8 million and $1.8 million for the years ended December 31, 2003, 2002 and 2001 respectively. At December 31, 2003, the parent company had $20.0 in million lines of credit with unaffiliated banks available, with $7.4 million balance outstanding. 24 The following table summarizes our significant contractual obligations and other potential funding needs at December 31, 2003 (dollars in thousands).
Time deposits Long-term debt (1) Operating leases Total 2004 $229,641 $ 24,233 $ 1,042 $ 254,916 2005 66,558 14,642 1,032 82,232 2006 18,745 3,000 971 22,716 2007 5,366 6,000 723 12,089 2008 5,815 7,000 721 13,536 Thereafter -- 39,653 -- 39,653 Total $326,125 $ 94,528 $ 4,489 $ 425,142 Commitments to originate mortgage loans $ 29,248 Unused lines of credit $ 139,266 Standby letters of credit $ 10,275
(1) Long-term debt includes company-obligated mandatorily redeemable preferred securities. ASSET/LIABILITY MANAGEMENT Financial institutions are subject to interest rate risk to the extent their interest-bearing liabilities (primarily deposits) mature or reprice at different times and on a different basis than their interest-earning assets (consisting primarily of loans and securities). Interest rate sensitivity management seeks to match maturities on assets and liabilities and avoid fluctuating net interest margins while enhancing net interest income during periods of changing interest rates. 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 the same time period is referred to as an interest rate gap. 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 periods of rising interest rates, a negative gap tends to adversely affect net interest income while a positive gap tends to result in an increase in net interest income. During a period of falling interest rates, a negative gap tends to result in an increase in net interest income while a positive gap tends to adversely affect net interest income. 25 The following table shows the interest rate sensitivity gap for four different time intervals as of December 31, 2003. Certain assumptions regarding prepayment and withdrawal rates are based upon our historical experience, and management believes such assumptions are reasonable.
AMOUNTS MATURING OR REPRICING AS OF DECEMBER 31, 2003 ---------------------------------------------------------------------- WITHIN SIX TO TWELVE ONE TO FIVE OVER SIX MONTHS MONTHS YEARS FIVE YEARS TOTAL ---------- ------------- ----------- ---------- ---------- (DOLLARS IN THOUSANDS) Interest-earning assets: Fixed-rate mortgage loans $ 39,449 $ 78,626 $ 235,783 $ 12,944 $ 366,802 Adjustable-rate mortgage loans 97,029 13,184 11,450 17 121,680 ---------- ------------- ----------- ---------- ---------- Total mortgage loans 136,478 91,810 247,233 12,961 488,482 Commercial business loans 130,853 42,385 116,835 4,572 294,645 Consumer and other loans 17,121 5,964 32,512 3,686 59,283 Home equity loans 14,300 183 79 102 14,664 Mortgage-related securities 19,655 16,989 23,161 15,329 75,134 Fixed rate investment securities and other 14,287 6,246 24,573 36,473 81,579 Variable rate investment securities and other 34,383 0 25 0 49,337 ---------- ------------- ----------- ---------- ---------- Total interest-earning assets $ 367,077 $ 163,577 $ 444,418 $ 73,123 $1,048,195 ========== ============= =========== ========== ========== Interest-bearing liabilities: Deposits Time deposits $ 136,386 $ 100,436 $ 83,535 $ 5,768 $ 326,125 NOW accounts 5,083 5,083 50,828 23,719 84,713 Savings accounts 7,469 7,568 59,581 34,856 109,474 Money market accounts 36,928 15,635 156,353 72,965 281,881 Company-obligated mandatorily redeemable preferred securities 17,500 0 0 17,500 35,000 Borrowings 35,643 35,318 30,741 4,651 106,353 ---------- ------------- ----------- ---------- ---------- Total interest-bearing liabilities $ 239,009 $ 164,040 $ 381,038 $ 159,459 $ 943,546 ========== ============= =========== ========== ========== Interest-earning assets less interest-bearing Liabilities $ 127,186 ($ 463) $ 64,262 ($ 86,336) $ 104,649 ========== ============= =========== ========== ========== Cumulative interest rate sensitivity gap $ 127,186 $ 126,723 $ 190,985 $ 104,649 ========== ============= =========== ========== Cumulative interest rate sensitivity gap as a percentage of total assets 11.11% 11.07% 16.69% 9.14% ========== ============= =========== ==========
At December 31, 2003, our cumulative interest-rate sensitive gap as a percentage of total assets was a positive 11.11% for six months and a positive 11.07% for one-year maturities. Therefore, we are positively gapped and may benefit from rising interest rates. Certain shortcomings are inherent in the method of analysis presented in the above schedule. For example, although certain assets and liabilities have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features that restrict changes in interest rates on a short-term basis over the life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the schedule. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our financial performance is impacted by, among other factors, interest rate risk and credit risk. We utilize no derivatives to mitigate our interest rate risk. To control credit risk we rely instead on loan review and an adequate loan loss reserve. Interest rate risk is the risk of loss of net interest income due to changes in interest rates. This risk is addressed by our Asset Liability Management Committee, which includes senior management representatives. The Asset Liability Management Committee monitors and considers methods of managing interest rate risk by monitoring changes in net interest income under various interest rate scenarios. The Asset Liability Management Committee attempts to manage various components of our balance sheet to minimize the impact of sudden and sustained changes in interest rate on net interest income. 26 Our exposure to interest rate risk is reviewed on at least a quarterly basis by the Asset Liability Management Committee. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine our change in net interest income in the event of hypothetical changes in interest rates and interest liabilities. If potential changes to net interest income resulting from hypothetical interest rate swings are not within the limits established by the Asset Liability Management Committee, the asset and liability mix may be adjusted to bring interest rate risk within approved limits. In order to reduce the exposure to interest rate fluctuations, we have developed strategies to manage our liquidity, shorten the effective maturities of certain interest-earning assets, and increase the effective maturities of certain interest-bearing liabilities. One strategy used is focusing our residential lending on adjustable rate mortgages, which generally reprice within one to three years. Another strategy used is concentrating our non-residential lending on adjustable or floating rate and/or short-term loans. We have also focused our investment activities on short and medium-term securities, while attempting to maintain and increase our savings account and transaction deposit accounts, which are considered to be relatively resistant to changes in interest rates. Along with the analysis of the interest rate sensitivity gap, determining the sensitivity of future earnings to a hypothetical plus 200 basis point rate change or minus 100 basis point change can be accomplished through the use of simulation modeling. In addition to the assumptions used to measure the interest rate sensitivity gap, simulation of earnings includes the modeling of the balance sheet as an ongoing entity. Future business assumptions involving administered rate products, prepayments for future rate sensitive balances, and the reinvestment of maturing assets and liabilities are included. These items are then modeled to project income based on a hypothetical change in interest rates. The resulting pretax income for the next 12-month period is compared to the pretax income calculated using flat rates. This difference represents our earning sensitivity to a plus 200 basis point rate change or minus 100 basis point change. The table below illustrates these amounts as of December 31, 2003.
PERCENT CHANGE IN NET INTEREST INCOME ------------------------------------- CHANGE IN INTEREST RATES 2003 2002 ------------------------ ---- ---- + 200 basis points 8.16% 9.51% + 150 basis points 5.46% 6.65% + 100 basis points 2.76% 3.79% + 50 basis points 1.07% 0.85% Base Scenario 0.00% 0.00% - 50 basis points (5.76)% (5.10)% - 100 basis points (7.55)% (7.26)%
These results are based solely on immediate and sustained parallel changes in market rates and do not reflect the earnings sensitivity that may arise from other factors such as changes in the shape of the yield curve, the change in spread between key market rates, or accounting recognition for impairment of certain intangibles. The above results also do not include any management action to mitigate potential income variances within the simulation process. This action would include, but would not be limited to, adjustments to the repricing characteristics of any on or off balance sheet item with regard to short-term rate projections and current market value assessments. We determine another component of interest rate risk, fair value at risk, through the technique of simulating the fair value of equity in changing rate environment. This technique involves determining the present value of all contractual asset liability cash flows (adjusted for prepayments) based on a predetermined discount rate. The net result of all these balance sheet items determine the fair value of equity. The fair value of equity resulting from the current flat rate scenario is compared to the fair value of equity calculated using discount rates plus 200 basis point rate change or minus 100 basis point change to determine the fair value of equity at risk. Currently, fair value of equity at risk is less than 1.0% of our market value as of December 31, 2003. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated balance sheets of the Corporation and its subsidiaries as of December 31, 2003 and 2002 and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three year period ended December 31, 2003 are attached. Selected quarterly financial data is included in Item 6. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 27 ITEM 9A. CONTROLS AND PROCEDURES As of the end of the period covered by this report, the Corporation carried out an evaluation, under the supervision and with the participation of the Corporation's management, including the Corporation's Chairman of the Board and Principal Executive Officer and the Corporation's Chief Financial Officer, of the Corporation's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15(d)-15(e) under the Securities Exchange Act of 1934, as amended). Based on this evaluation, the Corporation's Chairman of the Board and Principal Executive Officer and the Corporation's Chief Financial Officer concluded that the Corporation's disclosure controls and procedures were effective in timely alerting them to material information relating to the Corporation required to be included in the Corporation's periodic filings with the Securities and Exchange Commission. It should be noted that in designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. The Corporation has designed its disclosure controls and procedures to reach a level of reasonable assurance of achieving the desired control objectives and, based on the evaluation described above, the Corporation's Chairman of the Board and Principal Executive Officer and the Corporation's Chief Financial Officer concluded that the Corporation's disclosure controls and procedures were effective at reaching the level of reasonable assurance. There was no change in the Corporation's internal control over financial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f) under the Securities Exchange Act of 1934, as amended) during the Corporation's most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Corporation's internal control over financial reporting. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information in response to this item is incorporated herein by reference to the Corporation's proxy statement, which shall be filed with the Securities and Exchange Commission no later than 120 days after the Corporation's fiscal year end covered by this report. ITEM 11. EXECUTIVE COMPENSATION The information in response to this item is incorporated herein by reference to the Corporation's proxy statement, which shall be filed with the Securities and Exchange Commission no later than 120 days after the Corporation's fiscal year end covered by this report. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information in response to this item is incorporated herein by reference to the Corporation's proxy statement, which shall be filed with the Securities and Exchange Commission no later than 120 days after the Corporation's fiscal year end covered by this report. EQUITY COMPENSATION PLAN INFORMATION The following table summarizes share information, as of December 31, 2003, for the Corporation's equity compensation plan, the 1996 Incentive Stock Option Plan. This plan has been approved by the Corporation's shareholders.
NUMBER OF NUMBER OF COMMON SHARES TO BE COMMON SHARES ISSUED UPON EXERCISE WEIGHTED-AVERAGE AVAILABLE FOR FUTURE OF OUTSTANDING EXERCISE PRICE OF ISSUANCE UNDER OPTIONS, OUTSTANDING OPTIONS, EQUITY PLAN CATEGORY WARRANTS, AND RIGHTS WARRANTS, AND RIGHTS COMPENSATION PLANS ------------- -------------------- -------------------- ------------------ Equity compensation plans approved by stockholders 73,251 $24.15 136,749 Equity compensation plans not approved by stockholders N/A N/A N/A ------ ------ ------- Total 73,251 $24.15 136,749
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information in response to this item is incorporated herein by reference to the Corporation's proxy statement, which shall be filed with the Securities and Exchange Commission no later than 120 days after the Corporation's fiscal year end covered by this report. 28 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information in response to this item is incorporated herein by reference to the Corporation's proxy statement, which shall be filed with the Securities and Exchange Commission no later than 120 days after the Corporation's fiscal year end covered by this report. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) DOCUMENTS FILED: 1 and 2. Financial Statements and Financial Statement Schedules. The following financial statements of Merchants and Manufacturers Bancorporation, Inc. and subsidiaries are filed as a part of this report under Item 8. "Financial Statements and Supplementary Data": Report of Independent Auditors Consolidated Statements of Financial Condition as of December 31, 2003 and 2002 Consolidated Statements of Income for the years ended December 31, 2003, 2002, and 2001 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2003, 2002, and 2001 Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2003 and 2001 Notes to Consolidated Financial Statements All financial statement schedules have been omitted as they are not applicable or because the information is included in the financial statements or notes thereto. 3. Exhibits. All required exhibits have been furnished in connection with and are incorporated by reference to previous filing, except for the exhibits set forth on the Exhibit List appearing elsewhere in this filing. (b) REPORTS ON FORM 8-K: The Corporation furnished a report Form 8-K on October 20, 2003, pursuant to Items 9 and 12 regarding its press release of its September 30, 2003 earnings report. The Corporation filed a report on Form 8-K on November 6, 2003, reporting pursuant to Item 2 its acquisition of Reedsburg Bancorporation, Inc. and incorporating by reference the required historical financial information of Reedsburg Bancorporation, Inc. and the required pro forma financial information into Item 7. 29 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. By: /s/ Michael J. Murry ------------------------------------------- Michael J. Murry Chairman of the Board of Directors & Principal Executive Officer Date: March 15, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. PRINCIPAL EXECUTIVE OFFICERS /s/ Michael J. Murry Chairman of the Board of Directors March 15, 2004 ------------------------------------ & Principal Executive Officer Michael J. Murry /s/ James C. Mroczkowski Executive Vice President & Chief March 15, 2004 ------------------------------------ Financial Officer James C. Mroczkowski DIRECTORS /s/ Michael J. Murry Chairman of the Board of Directors March 15, 2004 ------------------------------------ Michael J. Murry /s/ James F. Bomberg Director March 15, 2004 ------------------------------------ James F. Bomberg /s/ Nicholas S. Logarakis Director March 15, 2004 ------------------------------------ Nicholas S. Logarakis /s/ Conrad C. Kaminski Director March 15, 2004 ------------------------------------ Conrad C. Kaminski /s/ Keith C. Winters Director March 15, 2004 ------------------------------------ Keith C. Winters /s/ Rodney T. Goodell Director March 15, 2004 ------------------------------------ Rodney Goodell /s/ Donald A. Zellmer Director March 15, 2004 ------------------------------------ Donald Zellmer /s/ Duane H. Bluemke Director March 15, 2004 ------------------------------------ Duane Bluemke /s/ Duane P. Cherek Director March 15, 2004 ------------------------------------ Duane P. Cherek /s/ James A. Sass Director March 15, 2004 ------------------------------------ James A. Sass
30 /s/ Thomas J. Sheehan Director March 15, 2004 ------------------------------------ Thomas J. Sheehan /s/ Jerome T. Sarnowski Director March 15, 2004 ------------------------------------ Jerome T. Sarnowski /s/ J. Michael Bartels Director March 15, 2004 ------------------------------------ J. Michael Bartels /s/ Michael T. Judge Director March 15, 2004 ------------------------------------ Michael T. Judge /s/ Casimir S. Janiszewski Director March 15, 2004 ------------------------------------ Casimir S. Janiszewski /s/ Edward H. Cichurski Director March 15, 2004 ------------------------------------ Edward H. Cichurski /s/ Donald L. Rowland Director March 15, 2004 ------------------------------------ Donald L. Rowland /s/ Erich Mildenberg Director March 15, 2004 ------------------------------------ Erich Mildenberg /s/ Milburn M. Hahs Director March 15, 2004 ------------------------------------ Milburn M. Hahs
31 [MCGLADREY & PULLEN CERTIFIED PUBLIC ACCOUNTANTS LOGO] MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES Consolidated Financial Report 12.31.2003 McGladrey & Pullen, LLP is a member firm of RSM International, an affiliation of separate and independent legal entities. MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES CONTENTS Independent Auditor's Report 1 Consolidated Financial Statements Consolidated Balance Sheets 2 Consolidated Statements of Income 3 Consolidated Statements of Changes in Stockholders' Equity 4 Consolidated Statements of Cash Flows 5-6 Notes to Consolidated Financial Statements 7-38
[MCGLADREY & PULLEN CERTIFIED PUBLIC ACCOUNTANTS LOGO] INDEPENDENT AUDITOR'S REPORT To the Board of Directors Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries New Berlin, Wisconsin We have audited the accompanying consolidated balance sheets of Merchants and Manufacturers Bancorporation, Inc. and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2003. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 Merchants and Manufacturers Bancorporation, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. /s/ McGladrey & Pullen, LLP Madison, Wisconsin February 13, 2004 McGladrey & Pullen, LLP is an independent member firm of RSM International, an affiliation of separate and independent legal entities. 1 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2003 AND 2002
2003 2002 -------------- ------------ (Amounts In Thousands, Except Share and Per Share Amounts) ASSETS Cash and Due From Banks $ 29,376 $ 31,539 Interest Bearing Deposits in Banks 2,647 3,825 Federal Funds Sold 15,632 26,391 ----------- ----------- Cash and cash equivalents 47,655 61,755 Available-for-Sale Securities 156,597 130,125 Loans, less allowance for loan losses of $9,136 and $7,663 at December 31, 2003 and 2002, respectively 847,938 657,775 Accrued Interest Receivable 4,421 4,248 FHLB Stock 16,245 14,935 Premises and Equipment 20,591 15,406 Goodwill and Intangible Assets 30,502 9,681 Other Assets 20,574 15,170 ----------- ----------- TOTAL ASSETS $ 1,144,523 $ 909,095 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits: Non-interest bearing $ 109,755 $ 97,288 Interest bearing 802,193 632,168 ----------- ----------- Total deposits 911,948 729,456 Short-term borrowings 34,007 18,088 Long-term borrowings 72,346 72,322 Company Obligated Mandatorily Redeemable Preferred Securities of subsidiary trusts holding solely subordinated debentures 35,000 10,000 Accrued interest payable 1,417 1,403 Other liabilities 9,831 8,497 ----------- ----------- TOTAL LIABILITIES 1,064,549 839,766 ----------- ----------- Stockholders' Equity Preferred stock, $1.00 par value; 250,000 shares authorized, shares issued and shares outstanding - none - - Common stock $1.00 par value; 6,000,000 shares authorized; shares issued: 3,436,051-2003; 2,977,231-2002; shares outstanding: 3,326,104-2003; 2,875,155-2002 3,436 2,977 Additional paid-in capital 43,691 26,308 Retained earnings 35,007 41,489 Accumulated other comprehensive income 663 1,448 Treasury stock, at cost (109,947 shares-2003; 102,076 shares-2002) (2,823) (2,893) ----------- ----------- TOTAL STOCKHOLDERS' EQUITY 79,974 69,329 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,144,523 $ 909,095 =========== ===========
See Notes to Consolidated Financial Statements. 2 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
2003 2002 2001 -------- -------- -------- (Amounts In Thousands, Except Per Share Amounts) Interest income: Interest and fees on loans $ 45,368 $ 35,716 $ 38,501 Interest and dividends on securities: Taxable 2,080 893 1,259 Tax-exempt 1,410 926 960 Interest on mortgage-backed securities 1,988 2,050 1,985 Interest on interest bearing deposits in banks and federal funds sold 204 318 531 -------- -------- -------- TOTAL INTEREST INCOME 51,050 39,903 43,236 -------- -------- -------- Interest expense: Interest on deposits 11,659 10,295 15,692 Interest on short-term borrowings 479 502 1,260 Interest on long-term borrowings 2,578 2,244 2,846 Interest on Company Obligated Mandatorily Redeemable Preferred Securities 1,155 65 - -------- -------- -------- TOTAL INTEREST EXPENSE 15,871 13,106 19,798 -------- -------- -------- NET INTEREST INCOME 35,179 26,797 23,438 Provision for loan losses 1,311 1,156 1,125 -------- -------- -------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 33,868 25,641 22,313 -------- -------- -------- Noninterest income: Service charges on deposit accounts 2,649 1,625 1,302 Service charges on loans 2,565 1,260 722 Securities gains, net 360 111 88 Gain on sale of loans, net 1,859 695 332 Net gain on sale of premises and equipment 2 360 557 Other 3,728 2,076 1,681 -------- -------- -------- TOTAL NONINTEREST INCOME 11,163 6,127 4,682 -------- -------- -------- Noninterest expenses: Salaries and employee benefits 18,655 12,439 10,533 Premises and equipment 4,079 3,419 3,075 Data processing fees 1,193 1,261 951 Marketing and business development 1,509 894 878 Federal deposit insurance premiums 129 102 99 Other 7,171 4,024 3,018 -------- -------- -------- TOTAL NONINTEREST EXPENSES 32,736 22,139 18,554 -------- -------- -------- INCOME BEFORE INCOME TAXES 12,295 9,629 8,441 Income taxes 4,067 3,244 2,733 -------- -------- -------- NET INCOME $ 8,228 $ 6,385 $ 5,708 ======== ======== ======== Basic earnings per share $ 2.58 $ 2.30 $ 2.05 ======== ======== ======== Diluted earnings per share $ 2.56 $ 2.29 $ 2.04 ======== ======== ========
See Notes to Consolidated Financial Statements. 3 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
Accumulated Additional Other Common Paid-in Retained Comprehensive Treasury Stock Capital Earnings Income (Loss) Stock Total ------ -------- ---------- ------------- -------- -------- (Amounts In Thousands, Except Share and Per Share Amounts) Balance at December 31, 2000 $2,588 $ 15,452 $ 32,988 $ (304) $(2,209) $ 48,515 Comprehensive income: Net income - - 5,708 - - 5,708 Change in net unrealized gains on available-for-sale securities - - - 1,101 - 1,101 Reclassification adjustment for gains included in net income - - - (88) - (88) Income tax effect - - - (379) - (379) -------- TOTAL COMPREHENSIVE INCOME 6,342 -------- Sale of 10,550 shares of treasury stock - - - - 336 336 Purchase of 29,092 shares of treasury stock - - - - (795) (795) Cash dividends paid - $0.71 per share - - (1,802) - - (1,802) Exercise of stock options - (497) - - 830 333 ------ -------- -------- ------- ------- -------- Balance at December 31, 2001 2,588 14,955 36,894 330 (1,838) 52,929 -------- Comprehensive income: Net income - - 6,385 - - 6,385 Change in net unrealized gains on available-for-sale securities - - - 1,799 - 1,799 Reclassification adjustment for gains included in net income - - - (111) - (111) Income tax effect - - - (570) - (570) -------- TOTAL COMPREHENSIVE INCOME 7,503 -------- Issuance of 389,722 shares of stock for acquisition 389 11,356 - - - 11,745 Sale of 525 shares of treasury stock - (3) - - 18 15 Purchase of 38,937 shares of treasury stock - - - - (1,073) (1,073) Cash dividends paid - $0.72 per share - - (1,790) - - (1,790) ------ -------- -------- ------- ------- -------- Balance at December 31, 2002 2,977 26,308 41,489 1,448 (2,893) 69,329 -------- Comprehensive income: Net income - - 8,228 - - 8,228 Change in net unrealized gains on available-for-sale securities - - - (789) - (789) Reclassification adjustment for gains included in net income - - - (360) - (360) Income tax effect - - - 364 - 364 -------- TOTAL COMPREHENSIVE INCOME 7,443 -------- Issuance of 146,792 shares of stock for acquisition 147 5,249 - - - 5,396 Sale of 159 shares of treasury stock - - - - 5 5 Purchase of 25 shares of treasury stock - - - - (1) (1) Stock dividend 312 12,169 (12,497) - - (16) Cash dividends paid - $0.76 per share - - (2,213) - - (2,213) Exercise of stock options - (35) - - 66 31 ------ -------- -------- ------- ------- -------- BALANCE AT DECEMBER 31, 2003 $3,436 $ 43,691 $ 35,007 $ 663 $(2,823) $ 79,974 ====== ======== ======== ======= ======= ========
See Notes to Consolidated Financial Statements. 4 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
2003 2002 2001 ---------- ---------- --------- (Amounts In Thousands) Cash Flows From Operating Activities Net income $ 8,228 $ 6,385 $ 5,708 Adjustments to reconcile net income to cash provided by operating activities: Provision for loan losses 1,311 1,156 1,125 Depreciation 1,681 1,073 889 Amortization and accretion of premiums and discounts, net 817 232 43 Deferred income taxes (46) (361) (475) Securities gains, net (360) (111) (88) Gain on sale of loans, net (1,859) (695) (332) Net gain on sale of premises and equipment - (360) (557) Decrease in accrued interest receivable 414 743 745 Decrease in accrued interest payable (256) (209) (131) Other, net (1,940) 2,227 (928) --------- --------- -------- NET CASH PROVIDED BY OPERATIONS BEFORE LOAN ORIGINATIONS AND SALES 7,990 10,080 5,999 Loans originated for sale (181,297) (108,441) (83,419) Proceeds from sales of loans 183,470 108,779 81,026 --------- --------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES 10,163 10,418 3,606 --------- --------- -------- Cash Flows From Investing Activities Purchase of available-for-sale securities (78,454) (40,190) (51,865) Proceeds from sales of available-for-sale securities 15,093 7,666 4,174 Proceeds from redemptions and maturities of available-for-sale securities 59,701 23,057 61,422 Net increase in loans (95,901) (37,135) (2,708) Purchases of premises and equipment (3,195) (1,852) (1,915) Proceeds from sales of other real estate 817 - - Cash received (paid) in acquisition (6,405) 663 - Purchases of FHLB stock (1,118) (9,682) (403) --------- --------- -------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (109,462) (57,473) 8,705 --------- --------- -------- Cash Flows From Financing activities Net increase in deposits 61,268 75,851 19,734 Net increase (decrease) in short-term borrowings 15,919 1,042 (26,882) Dividends paid (2,213) (1,790) (1,802) Proceeds from long-term borrowings 15,000 6,500 47,500 Repayment of long-term borrowings (29,794) (19,203) (36,400) Issuance of Company Obligated Mandatorily Redeemable Preferred Securities 25,000 10,000 - Stock dividend (16) - - Common stock transactions, net 35 (1,058) (126) --------- --------- -------- NET CASH PROVIDED BY FINANCING ACTIVITIES 85,199 71,342 2,024 --------- --------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (14,100) 24,287 14,335 Cash and cash equivalents at beginning of year 61,755 37,468 23,133 --------- --------- -------- Cash and cash equivalents at end of year $ 47,655 $ 61,755 $ 37,468 ========= ========= ========
(Continued) 5 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
2003 2002 2001 -------- -------- -------- (Amounts In Thousands) Supplemental Cash Flow Information and Noncash Transactions: Interest paid $ 16,127 $ 13,315 $ 19,929 Income taxes paid 4,277 3,209 2,872 Loans transferred to other real estate owned 380 2,234 22 Supplemental Schedules of Noncash Investing Activities: Change in accumulated other comprehensive income, unrealized gains on available-for-sale securities, net $ 785 $ 1,118 $ 634 Acquisitions (Note 2) Assets acquired: Cash and cash equivalents $ 13,956 $ 10,449 Available-for-sale securities 24,715 53,634 Accrued interest receivable 587 2,041 Loans, net 96,267 146,338 FHLB stock 487 1,679 Premises and equipment, net 3,693 4,349 Other 5,573 4,334 Excess of cost over fair value of net assets acquired 19,383 7,232 -------- -------- 164,661 230,056 -------- -------- Liabilities assumed: Deposits 121,224 175,820 Accrued interest payable 270 584 Short-term borrowings - 22,825 Long-term borrowings 2,000 6,400 Other liabilities 2,312 2,896 -------- -------- 125,806 208,525 -------- -------- Net assets acquired $ 38,855 $ 21,531 ======== ======== Cash paid $ 20,361 $ 9,786 Note issued 13,098 - Stock issued 5,396 11,745 -------- -------- Total price paid $ 38,855 $ 21,531 ======== ========
See Notes to Consolidated Financial Statements. 6 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Banking Activities: The consolidated income of Merchants and Manufacturers Bancorporation, Inc. (the Corporation) is principally from the income of its wholly owned subsidiaries. The Banks, as defined in the following paragraph, provide a full range of personal and commercial financial services to customers. The Corporation and the Banks are subject to competition from other financial institutions. Merchants and Manufacturers Statutory Trust I, II, III and IV (the "Trusts"), also wholly-owned subsidiaries, were capitalized November 2002, May 2003, October 2003 and October 2003, respectively, for the purpose of issuing Trust Preferred securities. The Corporation and the Banks are also subject to the regulations of certain federal and state agencies and undergo periodic examinations by those regulatory agencies. Consolidation: The consolidated financial statements of the Corporation include the accounts of its wholly owned subsidiaries: Lincoln State Bank (Lincoln), Franklin State Bank (Franklin), Grafton State Bank (Grafton), Community Bank of Oconto County (Oconto), Fortress Bank of Cresco (Cresco), Fortress Bank of Westby (Westby), Fortress Bank N.A. (Houston), and The Reedsburg Bank (Reedsburg) - collectively referred to as "the Banks," CBG Services, Inc., which provides management services for the Banks, Lincoln Neighborhood Redevelopment Corporation, which provides redevelopment and rehabilitation to certain areas located primarily on the near south side of Milwaukee, Merchants Merger Corp., which is used to facilitate acquisitions, CBG Financial Services, Inc., which provides non-insured investment and insurance products to customers of the Banks and Lincoln's wholly owned subsidiary, M&M Lincoln Investment Corp., Grafton's wholly owned subsidiary, GSB Investments Inc., Oconto's wholly owned subsidiary, CBOC Investments Inc., and Westby's wholly owned subsidiary, Westby Investment Company, Inc., which manage the investment portfolio for the Banks and CBG Mortgage, Inc., which acts as the Corporation's mortgage broker. CBG Financial Services, Inc. also includes the accounts of its wholly-owned subsidiaries Link Community Financial Services and Keith C. Winters and Associates. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements. Use of Estimates: In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the valuation of foreclosed real estate and deferred tax assets. The fair value disclosure of financial instruments is an estimate that can be computed within a range. Presentation of Cash Flows: For purposes of reporting cash flows, cash and due from banks include cash on hand and amounts due from banks, interest bearing deposits in banks and federal funds sold. Cash flows from loans, deposits, and short-term borrowings are treated as net increases or decreases. Cash and Due From Banks: The Banks maintain amounts due from banks which, at times, may exceed federally insured limits. Management monitors these correspondent relationships. The Banks have not experienced any losses in such accounts. 7 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Available-for-Sale Securities: Securities classified as available-for-sale are those debt securities that the Banks intend to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Banks' assets and liabilities, liquidity needs, regulatory capital consideration, and other similar factors. Securities classified as available-for-sale are carried at fair value. Unrealized gains or losses are reported as increases or decreases in accumulated other comprehensive income, net of the related deferred tax effect. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Loans: Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest income is accrued on the unpaid principal balance. The accrual of interest income on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in the process of collection. When interest accrual is discontinued, all unpaid accrued interest is reversed against interest income. Accrual of interest is generally resumed when the customer is current on all principal and interest payments and has been paying on a timely basis for a period of time. Mortgage Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. All sales are made without recourse. The balance of mortgage loans held for sale are included in the loan balance in the financial statements. Mortgage loans held for sale are generally sold with the mortgage servicing rights retained by the Corporation. The carrying value of mortgage loans sold is reduced by the cost allocated to the associated mortgage servicing rights. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold. Allowance for Loan Losses: The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance. The allowance is based on past events and current economic conditions, and does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. A loan is impaired when it is probable the creditor will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Cash collections on impaired loans are credited to the loan receivable balance and no interest income is recognized on those loans until the principal balance is current. 8 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) In addition, various regulatory agencies periodically review the allowance for loan losses. These agencies may require the Banks to make additions to the allowance for loan losses based on their judgments of collectibility based on information available to them at the time of their examination. Credit Related Financial Instruments: In the ordinary course of business the Banks have entered into off-balance-sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded. Transfers of Financial Assets: Transfers of financial assets are accounted for as sales only when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Corporation, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of the right) to pledge or exchange the transferred assets, and (3) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets. Premises and Equipment: Premises and equipment are stated at cost, less accumulated depreciation. Provisions for depreciation are computed using the straight-line or double-declining-balance methods, over the estimated useful lives of the assets ranging from 3 years to 39 years. Goodwill and Intangible Assets: The Corporation's goodwill and intangible assets include the value of ongoing customer relationships (core deposits) and the excess of cost over the fair value of net assets acquired (goodwill) arising from the purchase of certain assets and the assumption of certain liabilities from unrelated entities. Core deposit intangibles are amortized over a 10-year period and goodwill is evaluated on an annual basis to determine impairment, if any. Any impairment in the intangibles would be recorded against income in the period of impairment. Other Real Estate Owned: Other real estate owned, acquired through partial or total satisfaction of loans, is carried at the lower of cost or fair value, less cost to sell. At the date of acquisition losses are charged to the allowance for loan losses. Revenue and expenses from operations and changes in the valuation allowance are included in loss on foreclosed real estate. The balance of other real estate owned is included in other assets in the financial statements. Stock-Based Compensation Plan: At December 31, 2003, the Corporation had a stock-based key officer and employee compensation plan, which is described more fully in Note 11. The Corporation accounts for this plan under the recognitions and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in the income, as all options granted under this plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The table on the following page illustrates the effect on net income and earnings per share if the Corporation had applied the fair value recognition provisions of the Financial Accounting Standards Board (FASB) Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation. 9 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Years Ended December 31, --------------------------------- 2003 2002 2001 --------- --------- --------- (Amounts In Thousands, Except Per Share Data) Net income, as reported $ 8,228 $ 6,385 $ 5,708 Deduct total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects 876 389 306 --------- --------- --------- PRO FORMA NET INCOME $ 7,352 $ 5,996 $ 5,402 ========= ========= ========= Earnings per share: Basic: As reported $ 2.58 $ 2.30 $ 2.05 Pro forma 2.30 2.16 1.94 Diluted: As reported 2.56 2.29 2.04 Pro forma 2.29 2.15 1.93
In determining compensation cost using the fair value method prescribed in Statement No. 123, the value of each grant is estimated at the grant date with the following weighted-average assumptions used for grants in 2003, 2002, and 2001, respectively: dividend yield of 1.50 percent, 2.44 percent, and 2.65 percent; expected price volatility of 16.66 percent, 14.78 percent, and 15.08 percent; blended risk-free interest rates of 2.34 percent, 3.95 percent, and 4.96 percent; and expected lives of 10 years, respectively. Income Taxes: The Corporation files a consolidated federal income tax return and individual subsidiary state income tax returns. Accordingly, amounts equal to tax benefits of those companies having taxable federal losses or credits are reimbursed by the other companies that incur federal tax liabilities. Amounts provided for income tax expense are based on income reported for financial statement purposes, and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Trust Assets: Property held for customers in fiduciary or agency capacities, other than cash on deposit at the Banks, is not included in the accompanying balance sheets, since such items are not assets of the Corporation. 10 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Earnings Per Share: Earnings per share of common stock have been computed based on the weighted-average number of common stock and common stock equivalents, if dilutive, outstanding during each year. In the computation of diluted earnings per share, all dilutive stock options are assumed to be exercised at the beginning of each year and the proceeds are used to purchase shares of the Corporation's common stock at the average market price during the year. On November 21, 2003, the Corporation declared a 10 percent stock dividend payable December 15, 2003 to Shareholders as of December 1, 2003. As a result, earnings per share for the years ended December 31, 2003, 2002 and 2001 have been adjusted to give retroactive effect to the 10 percent stock dividend issued on December 15, 2003 as if the stock dividend had occurred on January 1, 2001. Earnings per common share have been computed for the years ended December 31, 2003, 2002, and 2001 based on the following:
2003 2002 2001 ---------- ---------- ---------- (Amounts In Thousands, Except Share Amounts) Net income $ 8,228 $ 6,385 $ 5,708 ========== ========== ========== Weighted average common shares outstanding 3,190,207 2,522,507 2,539,418 Effect of dilutive options 18,376 16,134 9,124 ---------- ---------- ---------- Weighted average common shares outstanding used to calculate diluted earnings per common share 3,208,583 2,538,641 2,548,542 ========== ========== ==========
Comprehensive Income: Accounting principles generally require that recognized revenue, expenses, gains, and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. Segment Reporting: The Corporation is managed as one unit and does not have separate operating segments. The Corporation's chief operating decision-maker uses consolidated results to make operating and strategic decisions. Adoption of Statement of Financial Accounting Standards (SFAS) No. 142: On January 1, 2002, the Corporation implemented SFAS No. 142, Goodwill and Other Intangible Assets. Under the provisions of SFAS No. 142, goodwill is no longer subject to amortization over its useful life, but instead will be subject to at least annual assessments for impairment by applying a fair value based test. SFAS No. 142 also requires that an acquired intangible asset should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the asset can be sold, transferred, licensed, rented, or exchanged, regardless of the acquirer's intent to do so. The Corporation determined that no transitional impairment loss was required at January 1, 2002. In addition, no impairment loss was required for the year ended December 31, 2003 and 2002. 11 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Had provisions of SFAS No. 142 been applied in fiscal year 2001, the Corporation's net income and net income per share would have been as follows:
Year Ended December 31, 2001 ------------------------------------- Basic Diluted Net Earnings Earnings Income Per Share Per Share -------- --------- --------- (Amounts In Thousands) Net income: As reported $ 5,708 $ 2.05 $ 2.04 Add: Goodwill amortization, net of tax 46 0.02 0.02 -------- --------- --------- PRO FORMA NET INCOME $ 5,754 $ 2.07 $ 2.06 ======== ========= =========
Current Accounting Developments: FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (Revised December 2003): FIN 46 establishes accounting guidance for consolidation of variable interest entities (VIE) that function to support the activities of the primary beneficiary. The primary beneficiary of a VIE entity is the entity that absorbs a majority of the VIE's expected losses, receives a majority of the VIE s expected residual returns, or both, as a result of ownership, controlling interest, contractual relationship or other business relationship with a VIE. Prior to the implementation of FIN 46, VIEs were generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority of voting interest in the entity. The provisions of FIN 46 were effective immediately for all arrangements entered into after January 31, 2003. However, subsequent revisions to the interpretation deferred the implementation date of FIN 46 until the first period ending after March 15, 2004. The Corporation will adopt FIN 46, as revised, in connection with its consolidated financial statements for the quarter ended March 31, 2004. The implementation of FIN 46 will require the Corporation to de-consolidate its investment in the Trusts because the Corporation is not the primary beneficiary. There will be no impact on shareholders equity or net income upon adoption of the standard. The trust preferred securities issued by the Trusts are currently included in the Tier 1 capital of the Corporation for regulatory capital purposes. However, because the financial statements of the Trusts will no longer be included in the Corporation's consolidated financial statements, the Federal Reserve Board may in the future disallow inclusion of the trust preferred securities in Tier 1 capital for regulatory capital purposes. In July 2003, the Federal Reserve Board issued a supervisory letter instructing bank holding companies to continue to include the trust preferred securities in their Tier 1 capital for regulatory capital purposes until notice is given to the contrary. The Federal Reserve Board intends to review the regulatory implications of the change in accounting treatment of subsidiary trusts that issue trust preferred securities and, if necessary or warranted, provide further appropriate guidance. There can be no assurance that the Federal Reserve Board will continue to permit institutions to include trust preferred securities in Tier I capital for regulatory capital purposes. 12 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The Accounting Standards Executive Committee has issued Statement of Position (SOP) 03-3 "Accounting for Certain Loans or Debt Securities Acquired in a Transfer". This Statement applies to all loans acquired in a transfer, including those acquired in the acquisition of a bank or a branch, and provides that such loans be accounted for at fair value with no allowance for loan losses, or other valuation allowance, permitted at the time of acquisition. The difference between cash flows expected at the acquisition date and the investment in the loan should be recognized as interest income over the life of the loan. If contractually required payments for principal and interest are less than expected cash flows, this amount should not be recognized as a yield adjustment, a loss accrual, or a valuation allowance. For the Corporation this Statement is effective for calendar year 2005 and, early adoption, although permitted, is not planned. No significant impact is expected on the consolidated financial statements at the time of adoption. Reclassification: Certain amounts in the prior year financial statements have been reclassified, with no effect on net income, to conform with the 2003 presentation. NOTE 2. BUSINESS COMBINATIONS On November 1, 2003, the Corporation acquired all of the outstanding stock of Reedsburg Bancorporation, Inc. (Reedsburg), a holding company owning a community bank in Reedsburg, Wisconsin. The acquisition was a combination of 85 percent cash and promissory notes and 15 percent common stock. Each shareholder of Reedsburg received $765 of cash or notes and 3.6726 shares of common stock for each share of Reedsburg common stock. The transaction was accounted for under the purchase method of accounting. Accordingly, the results of operations have been included in the Corporation's results of operations since the date of acquisition. Under this method of accounting, the purchase price is allocated to the respective assets acquired and liabilities assumed based on their estimated fair values, net of applicable income tax effects. The excess cost over fair value of net assets acquired of approximately $17.6 million has been recorded as goodwill. On November 30, 2002, the Corporation acquired Fortress Bancshares, Inc. (Fortress), a multi-bank holding company that owns three separately chartered community banks in Wisconsin, Minnesota, and Iowa. The acquisition was a combination of 45 percent cash and 55 percent common stock. Each shareholder of Fortress was paid $30 for each share of common stock held by such shareholders or received 1.0153 shares of common stock for each one share of Fortress common stock. The transaction was accounted for under the purchase method of accounting. Accordingly, the results of operations have been included in the Corporation's results of operations since the date of acquisition. Under this method of accounting, the purchase price is allocated to the respective assets acquired and liabilities assumed based on their estimated fair values, net of applicable income tax effects. The excess cost over fair value of net assets acquired of approximately $7.2 million has been recorded as goodwill. 13 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2. BUSINESS COMBINATIONS (CONTINUED) The unaudited pro forma results of operations, which follow, assume that these acquisitions had occurred on January 1, 2001. In addition to combining the historical results of operations, the pro forma calculations include purchase accounting adjustments related to the acquisition. The pro forma calculations do not include any anticipated cost savings as a result of the acquisition. Unaudited pro forma consolidated results of operations for the years ended December 31, 2003, 2002 and 2001, as though Reedsburg and Fortress had been acquired January 1, 2001 are as follows:
2003 2002 2001 ---------- ---------- ---------- (Amounts In Thousands, Except Per Share Amounts) Net interest income $ 40,277 $ 40,590 $ 30,967 ========== ========== ========== Net income $ 9,856 $ 10,100 $ 7,187 ========== ========== ========== Basic earnings per common share $ 2.98 $ 3.05 $ 2.23 ========== ========== ========== Diluted earnings per common share $ 2.96 $ 3.04 $ 2.23 ========== ========== ==========
The pro forma results of operations are not necessarily indicative of the actual results of operation that would have occurred had the Reedsburg and Fortress acquisitions actually taken place at the beginning of the year ended December 31, 2001, or results that may occur in the future. NOTE 3. CASH AND DUE FROM BANKS The Banks are required to maintain vault cash and reserve balances with the Federal Reserve Bank based upon a percentage of deposits. These requirements approximated $3,503,000 and $3,076,000 at December 31, 2003 and 2002, respectively. 14 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4. AVAILABLE-FOR-SALE SECURITIES Amortized costs and fair values of available-for-sale securities as of December 31, 2003 and 2002 are summarized as follows:
December 31, 2003 ---------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value --------- ---------- ---------- -------- (Amounts In Thousands) U.S. treasury and other U.S. government agency securities $ 32,423 $ 50 $ (71) $ 32,402 State and political subdivisions 47,794 1,175 (110) 48,859 Corporate bonds 75 - - 75 Collateralized mortgage obligations 34,407 140 (298) 34,249 Mortgage-backed securities 40,853 301 (142) 41,012 -------- ------- --------- -------- $155,552 $ 1,666 $ (621) $156,597 ======== ======= ========= ========
December 31, 2002 ---------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value --------- ---------- ---------- -------- (Amounts In Thousands) U.S. treasury and other U.S. government agency securities $ 23,654 $ 410 $ - $ 24,064 State and political subdivisions 39,006 970 (75) 39,901 Corporate bonds 75 - - 75 Mutual funds 3,069 - - 3,069 Collateralized mortgage obligations 28,274 357 (20) 28,611 Mortgage-backed securities 33,853 568 (16) 34,405 -------- ------- --------- -------- $127,931 $ 2,305 $ (111) $130,125 ======== ======= ========= ========
15 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4. AVAILABLE-FOR-SALE SECURITIES (CONTINUED) Unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of December 31, 2003 are summarized as follows:
Less than 12 months 12 Months or More Total --------------------- -------------------- -------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses -------- ---------- ------- ---------- -------- ---------- (Amounts In Thousands) U.S. treasury and other U.S. government agency securities $ 5,126 $ (71) $ - $ - $ 5,126 $ (71) State and political subdivisions 1,159 (104) 286 (6) 1,445 (110) Corporate bonds - - - - - - Collateralized mortgage obligations 21,155 (292) 855 (6) 22,010 (298) Mortgage-backed securities 9,993 (141) 51 (1) 10,044 (142) -------- ------- ------- -------- -------- ----- $ 37,433 $ (608) $ 1,192 $ (13) $ 38,625 $(621) ======== ======= ======= ======== ======== =====
For all of the above investment securities, the unrealized losses are generally due to changes in interest rates and, as such, are considered to be temporary, by the Corporation. The amortized cost and fair value of available-for-sale securities at December 31, 2003, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities in mortgage-related securities, and collateralized mortgage obligations since the anticipated maturities are not readily determinable. Therefore, these securities are not included in the maturity categories in the following summary:
Amortized Fair Cost Value --------- -------- (Amounts In Thousands) Due in one year or less $ 18,856 $ 19,066 Due after one year through five years 24,011 24,775 Due after five years through ten years 29,287 28,122 Due after ten years 8,138 9,373 -------- -------- 80,292 81,336 Collateralized mortgage obligations 34,407 34,249 Mortgage-related securities 40,853 41,012 -------- -------- $155,552 $156,597 ======== ========
Proceeds from sales of available-for-sale securities during the years ended December 31, 2003, 2002, and 2001, were $15,093,000, $7,666,000, and $4,174,000, respectively. Gross gains of $360,000, $215,000, and $96,000 were recorded on those sales for the years ended December 31, 2003, 2002, and 2001, respectively. Gross losses of $0, $104,000, and $8,000 were also recorded in the years ended December 31, 2003, 2002, and 2001, respectively. 16 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4. AVAILABLE-FOR-SALE SECURITIES (CONTINUED) Securities with a fair value of $58,125,000 and $50,548,000 at December 31, 2003 and 2002, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law. NOTE 5. LOANS Major classifications of loans are as follows:
December 31, ---------------------- 2003 2002 ---------- --------- (Amounts In Thousands) First mortgage: Conventional single-family residential $113,479 $ 98,075 Commercial and multi-family residential 283,433 198,250 Construction 47,894 32,995 Farmland 43,676 20,847 -------- -------- 488,482 350,167 -------- -------- Commercial business loans 294,645 246,787 Consumer and installment loans 51,886 51,883 Home equity loans 14,664 9,492 Other 7,397 7,109 -------- -------- 368,592 315,271 -------- -------- Less allowance for loan losses 9,136 7,663 -------- -------- $847,938 $657,775 ======== ========
Changes in the allowance for loan losses for the years ended December 31, 2003, 2002, and 2001 are presented as follows:
December 31, ------------------------------ 2003 2002 2001 -------- -------- -------- (Amounts In Thousands) Balance at beginning of year $ 7,663 $ 5,563 $ 5,010 Increase due to acquisition 1,203 2,008 - Provisions charged to expense 1,311 1,156 1,125 Recoveries 390 112 23 Charge-offs (1,431) (1,176) (595) ------- ------- ------- Balance at end of year $ 9,136 $ 7,663 $ 5,563 ======= ======= =======
17 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5. LOANS (CONTINUED) The following is a summary of information pertaining to impaired loans:
December 31, ---------------------- 2003 2002 ------ ------ (Amounts In Thousands) Impaired loans for which an allowance has been provided $3,288 $3,203 Impaired loans for which no allowance has been provided 1,994 - ------ ------ Total loans determined to be impaired $5,282 $3,203 ====== ====== Allowance provided for impaired loans, included in the allowance for loan losses $ 433 $ 745 ====== ======
Year Ended December 31, ------------------------------ 2003 2002 2001 -------- -------- -------- (Amounts In Thousands) Average investment in impaired loans $ 4,645 $ 3,397 $ 3,276 ======== ======== ========
Nonaccruing loans totaled $5,282,000 and $3,203,000 as of December 31, 2003 and 2002, respectively. Interest income in the amount of approximately $613,000, $311,000, and $48,000 would have been earned on the nonaccrual loans had they been performing in accordance with their original terms during the years ended December 31, 2003, 2002, and 2001, respectively. The interest collected on nonaccrual loans and impaired loans included in income for the years ended December 31, 2003, 2002, and 2001 was approximately $368,000, $350,000, and $104,000, respectively. Certain directors and executive officers of the Corporation, and their related interests, had loans outstanding in the aggregate amounts of $27,654,000 and $25,100,000 at December 2003 and 2002, respectively. During 2003, $10,914,000 of new loans were made, repayments totaled $9,969,000 and there was an increase of $1,609,000 due to changes in related party interests. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other persons, and did not involve more than normal risks of collectibility or present other unfavorable features. The unpaid principal balance of mortgage loans serviced for others, which are not included on the consolidated balance sheet, were approximately $279,107,000 and $187,121,000 at December 31, 2003 and 2002, respectively. Mortgage servicing rights, which are included with other assets, were $1,712,000 and $703,000, respectively, at December 31, 2003 and 2002. The fair value of the servicing rights was determined using a discount rate of 10 percent, prepayment speeds ranging from 1 percent to 8 percent, depending upon the stratification of the specific right, and a weighted average default rate of zero percent. The carrying values of these mortgage servicing rights approximate fair market values as of December 31, 2003 and 2002, respectively. 18 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5. LOANS (CONTINUED) The following summarizes the activity pertaining to mortgage servicing rights:
Years Ended December 31, ---------------------------- 2003 2002 2001 -------- ------- ------ (In Thousands) Balance at beginning of year $ 703 $ - $ - Mortgage servicing rights capitalized 1,542 1,084 - Mortgage servicing rights amortized (533) (381) - Provision for loss in fair value - - - ------- ------- ------ Balance at end of year $ 1,712 $ 703 $ - ======= ======= ======
NOTE 6. PREMISES AND EQUIPMENT Premises and equipment are stated at cost, less accumulated depreciation, and are summarized as follows:
December 31, ---------------------- 2003 2002 --------- --------- (Amounts In Thousands) Land $ 3,554 $ 2,290 Office buildings and improvements 20,240 14,893 Furniture and equipment 17,952 13,814 ------- ------- 41,746 30,997 Less accumulated depreciation 21,155 15,591 ------- ------- $20,591 $15,406 ======= =======
During the year ended December 31, 1999 and 2000, the Corporation sold certain land and buildings and, subsequently, leased a portion of the buildings back from the new owners. The total gain on the sales was $2,600,000, of which $1,352,000 was immediately recognized in income. The remaining gain is being accreted into income over the remaining lease terms. The gains recognized during the years ended December 31, 2003, 2002, and 2001 were $0, $356,000, and $557,000, respectively. 19 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 7. GOODWILL AND INTANGIBLE ASSETS Goodwill and intangible assets consisted of the following at December 31, 2003 and 2002:
2003 2002 ------- ------- (Amounts In Thousands) Goodwill $27,634 $ 8,250 Core deposit intangibles 3,443 2,152 Other intangibles 563 - ------- ------- 31,640 10,402 Less accumulated amortization 1,138 721 ------- ------- Intangibles assets, net $30,502 $ 9,681 ======= =======
The Corporation's goodwill and intangible assets include the excess of cost over fair value of net assets acquired (goodwill), the value of ongoing customer relationships (core deposit and other intangibles) arising from the purchase of certain assets and the assumption of certain liabilities from unrelated entities. For the years ended December 31, 2003 and 2002, the Corporation acquired $19,384,000 and $7,232,000, of goodwill, $1,291,000 and $2,152,000 of core deposit intangibles and $563,000 and $0 of other intangibles, respectively. In accordance with the provisions of SFAS No. 142, goodwill of $27,634,000 related to acquisitions is not being amortized, but is evaluated annually for impairment. Core deposit intangibles of $3,443,000 are being amortized over a 10-year period. Other intangibles of $563,000 are being amortized over a 16-year period. Core deposit intangible assets are periodically reviewed for impairment. Any impairment in the core deposit intangibles, other intangibles or goodwill would be recognized against income in the period of impairment. Amortization of core deposit intangibles was $394,000 and $99,000 during the years ended December 31, 2003 and 2002, respectively. For the years ended December 31, 2003 and 2002, amortization of other intangibles was $23,000 and $0, respectively. Estimated aggregate amortization expense for the core deposit and other intangibles for the next five years is as follows:
Years Ending December 31, ------------------------- 2004 $529,000 2005 434,000 2006 360,000 2007 322,000 2008 322,000
20 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 8. DEPOSITS Deposits consisted of the following as of December 31:
2003 2002 -------- -------- (Amounts In Thousands) Negotiable Order of Withdrawal accounts: Non-interest bearing $109,755 $ 97,288 Interest-bearing 84,713 56,080 Savings deposits 109,474 83,239 Money market investment accounts 281,881 194,196 Time deposits and certificate accounts 326,125 298,653 -------- -------- $911,948 $729,456 ======== ========
The scheduled maturities of time deposits and certificate accounts at December 31, 2003 are as follows (amounts in thousands):
Years Ending December 31, ------------------------- 2004 $229,641 2005 66,558 2006 18,745 2007 5,366 2008 5,815 -------- $326,125 ========
At December 31, 2003 and 2002, time deposits and certificate accounts with balances greater than $100,000 amounted to $74,155,000 and $74,532,000, respectively. 21 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9. BORROWINGS Short-term borrowings consisted of the following at December 31:
2003 2002 -------- -------- (Amounts In Thousands) Short-term borrowings: Federal funds purchased, 1.2857% $24,500 $ - Securities sold under agreements to repurchase with rates ranging from 0.40% to 1.46% 1,588 3,101 Lines of credit with unaffiliated banks with rates ranging from 2.57% to 5.125% 7,736 14,100 Treasury, tax, and loan accounts with the Federal Home Loan Bank (FHLB) of Chicago 183 887 ------- ------- Total short-term borrowings $34,007 $18,088 ======= =======
Securities sold under agreements to repurchase generally mature within 120 days. Information concerning securities sold under agreements to repurchase is summarized as follows:
2003 2002 -------- -------- (Amounts In Thousands) Average daily balance during the year $5,059 $7,273 Average daily interest rate during the year 1.29% 1.88% Maximum month-end balance during the year $8,425 $9,894 Weighted average rate as of December 31 1.27% 1.53% Securities underlying the agreements at year-end: Carrying value $2,017 $3,698 Estimated fair value 2,017 3,698
22 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9. BORROWINGS (CONTINUED) Long-term borrowings consist of the following as of December 31:
2003 2002 ------- -------- (Amounts In Thousands) Long-term borrowings: Acquisition notes payable, 5.35 percent, equal payments of $2,564 until 2008 $12,818 $ - Notes payable to FHLB, maturing during fiscal year 2003 with rates ranging from 1.85% to 6.50% - 29,150 Notes payable to FHLB, maturing during fiscal year 2004 with rates ranging from 1.43% to 5.12% 24,233 21,675 Notes payable to FHLB, maturing during fiscal year 2005 with rates ranging from 1.86% to 6.53% 14,642 9,754 Notes payable to FHLB, maturing during fiscal year 2006 at 2.62% 3,000 - Notes payable to FHLB, maturing during fiscal year 2007 with rates ranging from 3.17% to 3.27% 6,000 - Notes payable to FHLB, maturing during fiscal year 2008 with rates ranging from 4.35% to 5.34% 7,000 7,058 Notes payable to FHLB, maturing thereafter with rates ranging from 4.33% to 5.95% 4,653 4,685 ------- ------- Total long-term borrowings $72,346 $72,322 ======= =======
At December 31, 2003, FHLB borrowings are collateralized by securities with a fair value of $32,839,000 and loans receivable with an outstanding balance of $106,606,000. At December 31, 2002, FHLB borrowings were collateralized by securities with a fair value of $24,825,000 and loans receivable with an outstanding balance of $89,763,000. Of the borrowings due in 2005, $1,000 is callable quarterly, all of the borrowings in 2008 are callable quarterly, $4,000 of the borrowings due thereafter are callable quarterly and $500 of the borrowings due thereafter is callable in 2006. 23 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 10. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY SUBORDINATED DEBENTURES In November 2002, May 2003, October 2003 and October 2003, the Corporation the Trusts, all Connecticut statutory business trusts, and issued $10 million, $10 million, $7.5 million, and $7.5 million, respectively, of three-month LIBOR plus 3.35 percent, 8.25 percent fixed, three-month LIBOR plus 2.95 percent, and 8.25 percent fixed, respectively, Company obligated mandatorily redeemable trust preferred securities (the trust preferred securities). These securities represent preferred beneficial interests in the assets of the Trust. The trust preferred securities will mature on November 11, 2032, May 30, 2033, October 15, 2033, and October 15, 2033, respectively, and are redeemable, in whole or in part, at the option of the Corporation at any time after five years. The Trusts also issued $310 thousand, $310 thousand, $232 thousand, and $232 thousand, respectively, of common equity securities to the Corporation. The Trusts used the proceeds of the offering of the trust preferred securities to purchase $10.3 million, $10.3 million, $7.7 million, and $7.7 million, respectively, of junior subordinated deferrable interest debentures (the debentures) issued by the Corporation, which have interest rates and terms substantially similar to the trust preferred securities. Debt issuance cost totaling $44 thousand, $210 thousand, $9 thousand, and $9 thousand and underwriting fees of $300 thousand, $300 thousand, $169 thousand, and $169 thousand, respectively, were capitalized related to the offerings and are being amortized over the estimated life of the trust preferred securities. Holders of the capital securities have no voting rights, are unsecured, and rank junior in priority of payment to all of the Corporation's indebtedness and senior to the Corporation's capital stock. Payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities are guaranteed by the Corporation on a limited basis. The Corporation also entered into an agreement as to expenses and liabilities with the Trust pursuant to which it agreed, on a subordinated basis, to pay any costs, expenses or liabilities of the Trust other than those arising under the trust preferred securities. The obligations of the Corporation under the junior subordinated debentures, the related indenture, the trust agreement establishing the Trusts, the guarantee and the agreement as to expenses and liabilities, in the aggregate, constitute a full and unconditional guarantee by the Corporation of the Trusts' obligations under the trust preferred securities. The Corporation owns all of the outstanding common stock of the Trusts. The Trusts are considered variable interest entities (VIEs) under Financial Accounting Standards Board Interpretation (FIN) No. 46, "Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51", as revised. Prior to FIN 46, VIEs were generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority of voting interest in the entity. Under FIN 46, a VIE should be consolidated by its primary beneficiary. The Corporation will adopt FIN 46 during the first quarter of 2004. Because the Corporation is not the primary beneficiary of the Trusts, the financial statements of the Trusts will no longer be included in the consolidated financial statements of the Corporation. The Corporation's prior financial statements will be restated to de-consolidate the Corporation's investment in the Trust. See Note 1 -- Summary of Significant Accounting Policies -- Current Accounting Developments. 24 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 10. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY SUBORDINATED DEBENTURES (CONTINUED) $26,437,000 of the trust preferred securities are currently included in the Tier 1 capital, with the remainder included in Tier II capital of the Corporation for regulatory capital purposes. However, because the Trusts will no longer be a part of the Corporation's financial statements, the Federal Reserve Board may in the future disallow inclusion of the trust preferred securities in Tier 1 capital for regulatory capital purposes. In July 2003, the Federal Reserve Board issued a supervisory letter instructing bank holding companies to continue to include the trust preferred securities in their Tier 1 capital for regulatory capital purposes until notice is given to the contrary. The Federal Reserve Board intends to review the regulatory implications of the change in accounting treatment of subsidiary trusts that issue trust preferred securities and, if necessary or warranted, provide further appropriate guidance. There can be no assurance that the Federal Reserve Board will continue to permit institutions to include trust preferred securities in Tier I capital for regulatory capital purposes. As of December 31, 2003, assuming the Corporation was not permitted to include the $35 million in trust preferred securities issued by the Trusts in its Tier 1 and Tier II capital, the Company would still exceed the regulatory required minimums for capital adequacy purposes (see Note 17 -- Capital Requirements). If the trust preferred securities were no longer permitted to be included in Tier 1 capital, the Corporation would also be permitted to redeem the capital securities without penalty. NOTE 11. STOCK BASED COMPENSATION The Corporation has an Incentive Stock Option Plan under which 210,000 shares of common stock are reserved for the grant of options to officers and key employees at a price not less than the fair market value of the stock on the date of the grant. The Incentive Stock Option Plan limits the options that may be granted to each employee to $100,000 (based on aggregate fair market value at the date of the grant) per calendar year, on a cumulative basis. Options must be exercised within ten years of the date of grant and can be regranted if forfeited. 25 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 11. STOCK BASED COMPENSATION (CONTINUED) Activity in the Incentive Stock Option Plan is summarized in the following table:
Weighted- Weighted- Average Average Number Exercise Price Remaining of Shares Per Share Contractual Life Exercisable --------- -------------- ---------------- ----------- Total outstanding at December 31, 2000 68,265 $ 25.11 6.04 68,265 Granted 4,000 28.00 Exercised (21,450) 18.50 Forfeited - ------- Total outstanding at December 31, 2001 50,815 $ 29.60 7.15 50,815 Acquisition 17,767 16.62 Granted - Exercised - Forfeited - ------- Total outstanding at December 31, 2002 68,582 26.24 4.82 68,582 Stock dividend 6,659 Granted - Exercised (1,990) 15.15 Forfeited - ------- Total outstanding at December 31, 2003 73,251 24.15 5.20 73,251 =======
26 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 11. STOCK BASED COMPENSATION (CONTINUED) The following table summarizes information about stock options outstanding and exercisable as of December 31, 2003.
Options Outstanding Options Exercisable ------------------------------------------- ----------------------- Weighted- Average Weighted- Weighted- Remaining Average Average Range of Number Contractual Life Exercise Number Exercise Exercise Price Outstanding (In Years) Price Exercisable Price -------------- ----------- ---------------- --------- ----------- --------- $13.77 to $15.11 21,358 4.2 $15.00 21,358 $ 15.00 $25.45 to $28.31 51,893 5.7 27.92 51,893 27.92 ------- ------- 73,251 73,251 ======= =======
NOTE 12. INCOME TAXES The provision for income taxes consisted of the following:
December 31, ------------------------------ 2003 2002 2001 -------- -------- -------- (Amounts In Thousands) Current $ 4,113 $ 3,605 $ 3,208 Deferred (46) (361) (475) ------- ------- ------- $ 4,067 $ 3,244 $ 2,733 ======= ======= =======
27 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 12. INCOME TAXES (CONTINUED) The provision for income taxes differs from that computed at the federal statutory corporate tax rate as follows:
2003 2002 2001 ------------------ ----------------- ----------------- % of % of % of Pretax Pretax Pretax Amount Income Amount Income Amount Income -------- ------ -------- ------ -------- ------ (Amounts In Thousands) Computed "expected" tax expense $ 4,303 35.0% $ 3,370 35.0% $ 2,954 35.0% Effect of graduated tax rates (123) (1.0) (96) (1.0) (84) (1.0) Tax-exempt income, net (643) (5.2) (384) (4.0) (351) (4.2) State income taxes, net of federal benefit 552 4.5 323 3.4 187 2.2 Other, net (22) (0.2) 31 0.3 27 0.3 ------- ----- ------- ----- ------- ----- $ 4,067 33.1% $ 3,244 33.7% $ 2,733 32.3% ======= ===== ======= ===== ======= =====
The net deferred tax assets included with other assets in the accompanying consolidated balance sheets include the following amounts:
December 31, ---------------------- 2003 2002 -------- -------- (Amounts In Thousands) Deferred tax assets: Allowance for loan losses $ 3,183 $ 2,553 Net operating loss carryforwards 1,549 1,149 Deferred compensation 1,089 700 Other assets 1,220 650 ------- ------- Total deferred tax assets 7,041 5,052 Valuation allowance (1,549) (1,149) ------- ------- 5,492 3,903 ------- ------- Deferred tax liabilities: Depreciation 515 312 Purchase accounting 2,169 904 Unrealized gain on available-for-sale securities 382 746 Other liabilities 2,275 615 ------- ------- Total deferred tax liabilities 5,341 2,577 ------- ------- Net deferred tax asset $ 151 $ 1,326 ======= =======
28 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 13. PROFIT-SHARING AND PENSION PLAN Profit-Sharing Plan: The Corporation has a 401(k) Profit Sharing Plan and Trust which covers substantially all employees with at least six months of service who have attained age twenty and one-half. Participating employees may annually contribute up to 12 percent of their pretax compensation. The Corporation's annual contribution consists of a discretionary matching percentage, limited to 1 percent of employee compensation, and an additional discretionary amount which is determined annually by the Board of Directors. The Corporation's contributions for 2003, 2002 and 2001, were approximately $437,000, $319,000, and $288,000, respectively. Pension Plan: The Corporation has a non-contributory defined contribution pension plan covering substantially all employees of the Cresco, Westby and Houston banks. Total pension expense was approximately $206,000, $195,000, and $189,000 during 2003, 2002, and 2001, respectively. NOTE 14. SALARY CONTINUATION AGREEMENT The Corporation has entered into salary continuation agreements with various executive officers. The agreements provide for the payment of specified amounts upon the employee's retirement or death which is being accrued over the anticipated remaining period of employment. Expense recognized for future benefits under these agreements totaled $183,000, $153,000, and $174,000 during 2003, 2002, and 2001, respectively. Although not part of the agreement, the Corporation purchased insurance on the lives of the officers which could provide funding for the payment of benefits. Included in other assets is $2,693,000 and $2,648,000 of related cash surrender value of life insurance as of December 31, 2003 and 2002, respectively. NOTE 15. COMMITMENTS AND CONTINGENT LIABILITIES In the normal course of business, the Corporation is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the consolidated financial statements. Like many Wisconsin financial institutions, several of our subsidiaries have non-Wisconsin subsidiaries which hold and manage assets, the income for which state taxes are not imposed. Currently, the Wisconsin Department of Revenue is conducting audits at some of our investment subsidiaries which may result in state taxes be imposed, including prior periods. Any settlement amount at this point is undeterminable. The Corporation is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, financial guarantees, and standby letters of credit. They involve, to varying degrees, elements of credit risk in excess of amounts recognized on the consolidated balance sheets. The Corporation's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Corporation uses the same credit policies in making commitments and issuing letters of credit as they do for on-balance-sheet instruments. 29 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 15. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED) Off-balance-sheet financial instruments whose contracts represented credit and/or interest rate risk at December 31, 2003 and 2002, are as follows:
December 31, ---------------------- 2003 2002 -------- ------- (Amounts In Thousands) Commitments to originate mortgage loans $ 29,248 $23,845 Unused lines of credit: Commercial business 108,163 71,074 Home equity 13,957 11,088 Credit cards 17,146 10,832 Standby letters of credit 10,275 9,346
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties. Credit card commitments are unsecured. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and, generally, have terms of one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds collateral, which may include accounts receivable, inventory, property, equipment, and income-producing properties, supporting those commitments if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Bank would be required to fund the commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount shown in the summary above. If the commitment is funded the Bank would be entitled to seek recovery from the customer. At December 31, 2003 and 2002, no amounts have been recorded as liabilities for the Bank's potential obligations under these guarantees. Except for the above-noted commitments to originate loans in the normal course of business, the Corporation and the Banks have not undertaken the use of off-balance-sheet derivative financial instruments for any purpose. 30 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 15. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED) Various subsidiary banks of the Corporation have entered into noncancelable leases for certain branch facilities. The following is a schedule of future minimum rental payments required under the noncancelable lease agreements (dollars in thousands):
Years Ending December 31, ------------------------- 2004 $1,042 2005 1,032 2006 971 2007 723 2008 721 ------ $4,489 ======
NOTE 16. CONCENTRATION OF CREDIT RISK The Corporation and the Banks do not engage in the use of interest-rate swaps, futures, or option contracts as of December 31, 2003. Practically all of the Banks' loans, commitments, and standby letters of credit have been granted to customers in the Banks' market areas. Although the Banks have a diversified loan portfolio, the ability of their debtors to honor their contracts is dependent on the economic conditions of the counties surrounding the Banks. The concentration of credit by type of loan is set forth in Note 5. Investment securities issued by state and political subdivisions (see Note 4) also involve governmental entities within the Banks' market areas. NOTE 17. REGULATORY CAPITAL REQUIREMENTS AND RESTRICTIONS OF DIVIDENDS The Corporation (on a consolidated basis) and Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Banks' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Banks must meet specific capital guidelines that involve quantitative measures of the Banks' assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Corporation and Banks to maintain minimum amounts and ratios (set forth in the table on the following page) of total and Tier I capital (as defined in the regulations), to risk-weighted assets (as defined), and Tier 1 capital (as defined), to average assets (as defined). Management believes, as of December 31, 2003 and 2002, that the Corporation and Banks meet all capital adequacy requirements to which they are subject. 31 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 17. REGULATORY CAPITAL REQUIREMENTS AND RESTRICTIONS OF DIVIDENDS (CONTINUED) As of December 31, 2003, the most recent notification from the Federal Deposit Insurance Corporation categorized all the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Banks must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table on the following page. There are no conditions or events since that notification that management believes have changed the Corporation's or Banks' classification as of December 31, 2003. The Corporation's and Banks' actual capital amounts and ratios as of December 31, 2003 and 2002 are presented in the following table.
To Be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Provisions ------------------ ------------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio -------- ------ -------- ------ --------- ------ (Amounts In Thousands) AS OF DECEMBER 31, 2003 Total capital (to risk-weighted assets): Consolidated $ 92,602 10.23% $ 72,434 8.00% $ 90,543 N/A Lincoln State Bank 38,253 10.80 28,339 8.00 35,424 10.00% Franklin State Bank 9,213 10.87 6,782 8.00 8,478 10.00 Grafton State Bank 14,661 12.32 9,519 8.00 11,898 10.00 Community Bank Oconto County 7,860 11.68 5,383 8.00 6,729 10.00 Fortress Bank of Westby 11,287 11.96 7,551 8.00 9,439 10.00 Fortress Bank of Cresco 6,346 15.38 3,300 8.00 4,126 10.00 Fortress Bank N.A. 5,097 14.17 2,878 8.00 3,598 10.00 Reedsburg 12,888 12.74 8,090 8.00 10,113 10.00 Tier 1 capital (to risk-weighted assets): Consolidated $ 74,903 8.27% $ 36,217 4.00% $ 54,236 N/A Lincoln State Bank 34,909 9.85 14,170 4.00 21,255 6.00% Franklin State Bank 8,322 9.82 3,391 4.00 5,087 6.00 Grafton State Bank 13,598 11.43 4,759 4.00 7,139 6.00 Community Bank Oconto County 7,317 10.87 2,692 4.00 4,038 6.00 Fortress Bank of Westby 10,355 10.97 3,776 4.00 5,663 6.00 Fortress Bank of Cresco 5,830 14.13 1,650 4.00 2,475 6.00 Fortress Bank N.A. 4,647 12.92 1,439 4.00 2,159 6.00 Reedsburg 11,612 11.48 4,045 4.00 6,068 6.00 Tier 1 capital (to average assets): Consolidated $ 74,903 7.19% $ 41,696 4.00% $ 51,120 N/A Lincoln State Bank 34,909 9.06 15,415 4.00 19,269 5.00% Franklin State Bank 8,322 9.09 3,662 4.00 4,578 5.00 Grafton State Bank 13,598 8.60 6,324 4.00 7,904 5.00 Community Bank Oconto County 7,317 8.87 3,300 4.00 4,125 5.00 Fortress Bank of Westby 10,355 8.92 4,644 4.00 5,805 5.00 Fortress Bank of Cresco 5,830 9.72 2,398 4.00 2,998 5.00 Fortress Bank N.A. 4,647 8.79 2,116 4.00 2,645 5.00 Reedsburg 11,612 8.23 5,643 4.00 7,053 5.00
32 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 17. REGULATORY CAPITAL REQUIREMENTS AND RESTRICTIONS OF DIVIDENDS (CONTINUED)
To Be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Provisions ------------------ ------------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio -------- ------ -------- ------ --------- ------ (Amounts In Thousands) AS OF DECEMBER 31, 2002 Total capital (to risk-weighted assets): Consolidated $76,003 10.71% $56,755 8.00% $70,944 N/A Lincoln State Bank 36,104 11.91 24,248 8.00 30,310 10.00% Franklin State Bank 7,583 10.17 5,962 8.00 7,453 10.00 Grafton State Bank 14,236 12.62 9,022 8.00 11,278 10.00 Community Bank Oconto County 7,446 13.32 4,471 8.00 5,589 10.00 Fortress Bank of Westby 10,346 12.57 6,583 8.00 8,229 10.00 Fortress Bank of Cresco 5,766 15.16 3,043 8.00 3,803 10.00 Fortress Bank N.A 4,961 13.15 3,018 8.00 3,772 10.00 Tier 1 capital (to risk-weighted assets): Consolidated $68,340 9.63% $28,378 4.00% $42,566 N/A Lincoln State Bank 32,938 10.87 12,124 4.00 18,186 6.00% Franklin State Bank 6,699 8.99 2,981 4.00 4,472 6.00 Grafton State Bank 13,192 11.70 4,511 4.00 6,767 6.00 Community Bank Oconto County 6,918 12.38 2,235 4.00 3,353 6.00 Fortress Bank of Westby 9,332 11.34 3,292 4.00 4,937 6.00 Fortress Bank of Cresco 5,290 13.91 1,521 4.00 2,282 6.00 Fortress Bank N.A 4,489 11.90 1,509 4.00 2,263 6.00 Tier 1 capital (to average assets): Consolidated $68,340 9.41% $29,440 4.00% $36,801 N/A Lincoln State Bank 32,938 9.54 13,813 4.00 17,267 5.00% Franklin State Bank 6,699 7.91 3,387 4.00 4,234 5.00 Grafton State Bank 13,192 8.73 6,042 4.00 7,553 5.00 Community Bank Oconto County 6,918 9.51 2,910 4.00 3,637 5.00 Fortress Bank of Westby 9,332 8.60 4,342 4.00 5,427 5.00 Fortress Bank of Cresco 5,290 8.92 2,372 4.00 2,966 5.00 Fortress Bank N.A 4,489 8.26 2,173 4.00 2,717 5.00
33 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 17. REGULATORY CAPITAL REQUIREMENTS AND RESTRICTIONS OF DIVIDENDS (CONTINUED) Dividends are paid by the Corporation from funds which are mainly provided by dividends from the Banks. However, certain restrictions exist regarding the ability of the Banks to transfer funds to the Corporation in the form of cash dividends, loans, or advances. Approval of the regulatory authorities is required to pay dividends in excess of certain levels of the Banks' retained earnings. As of December 31, 2003, the subsidiary banks collectively had equity of approximately $125,219,000 of which approximately $12,169,000 was available for distribution to the Corporation as dividends without prior regulatory approval. NOTE 18. FAIR VALUES OF FINANCIAL INSTRUMENTS FASB Statement No. 107, Disclosures About Fair Value of Financial Instruments (SFAS No. 107), requires disclosure of fair value information about financial instruments, whether recognized or not recognized in the balance sheet, for which it is practicable to estimate that value. The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than a forced liquidation. Fair value is best-determined base upon quoted market prices. However, in many instances, there are no quoted market prices for the Corporation's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Corporation. The following methods and assumptions were used by the Corporation in estimating fair value disclosures for financial instruments: Cash and due from banks: The carrying amounts of cash and due from banks equal their fair values. Interest bearing deposits in banks: The carrying amounts of interest bearing deposits in banks equal their fair values. Federal funds sold: The carrying amounts of federal funds sold equal their fair values. Available-for-sale securities: Fair values for securities are based on quoted market prices. Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for all other loans are estimated by discounting contractual cash flows using estimated market discount rates which reflect the credit and interest rate risk inherent in the loan. FHLB stock: FHLB stock is carried at cost which is its redeemable value since the market for this stock is restricted. 34 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 18. FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED) Accrued interest receivable and payable: The carrying amounts of accrued interest receivable and payable equal their fair values. Deposits: The fair values disclosed for demand deposits (interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates within the marketplace. Short-term borrowings: The carrying amounts of short-term borrowings approximate their fair values. Long-term borrowings: The fair values of long-term borrowings are estimated using discounted cash flow analysis based on current interest rates being offered on instruments with similar terms and credit quality. Company Obligated Mandatorily Redeemable Preferred Securities: The carrying amount of the Company Obligated Mandatorily Redeemable Preferred Securities equals its fair value. Off-balance-sheet instruments: The estimated fair value of fee income on letters of credit at December 31, 2003 and 2002 is insignificant. Loan commitments on which the committed interest rate is less that the current market rate are also insignificant at December 31, 2003 and 2002. The estimated fair values of the Corporation's financial instruments are as follows:
2003 2002 -------------------- -------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value -------- ---------- -------- ---------- (Amounts In Thousands) Financial assets: Cash and due from banks $ 29,376 $ 29,376 $ 31,539 $ 31,539 Interest bearing deposits in banks 2,647 2,647 3,825 3,825 Federal funds sold 15,632 15,632 26,391 26,391 Available-for-sale securities 156,597 156,597 130,125 130,125 Loans, net 847,938 852,570 657,775 674,395 Accrued interest receivable 4,421 4,421 4,248 4,248 FHLB stock 16,245 16,245 14,935 14,935 Financial liabilities: Deposits 911,948 911,632 729,456 731,641 Short-term borrowings 34,007 34,007 18,088 18,088 Long-term borrowings 72,346 72,910 72,322 73,266 Company Obligated Mandatorily Redeemable Preferred Securities 35,000 35,000 10,000 10,000 Accrued interest payable 1,417 1,417 1,403 1,403
35 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 19. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION CONDENSED BALANCE SHEETS (PARENT COMPANY ONLY)
December 31, --------------------- 2003 2002 --------- --------- (Amounts In Thousands) ASSETS Cash and cash equivalents $ - $ 223 Loans receivable - 500 Investment in subsidiaries 131,942 83,873 Premises and equipment 1,478 569 Other assets 4,701 3,732 --------- -------- TOTAL ASSETS $ 138,121 $ 88,897 ========= ======== LIABILITIES Short-term borrowings $ 7,375 $ 7,700 Long-term borrowings 12,818 - Subordinated debentures 36,084 10,310 Other liabilities 1,870 1,558 --------- -------- Total liabilities 58,147 19,568 --------- -------- STOCKHOLDERS' EQUITY Common stock 3,436 2,977 Additional paid-in capital 43,691 26,308 Retained earnings 35,007 41,489 Accumulated other comprehensive income 663 1,448 Treasury stock (2,823) (2,893) --------- -------- TOTAL STOCKHOLDERS' EQUITY 79,974 69,329 --------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 138,121 $ 88,897 ========= ========
36 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 19. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (CONTINUED) CONDENSED STATEMENTS OF INCOME (PARENT COMPANY ONLY)
Years Ended December 31, --------------------------- 2003 2003 2001 ------- ------- ------ (Amounts In Thousands) Income: Interest on loans, including fees $ 23 $ - $ 11 Dividends from subsidiaries 7,298 3,459 3,307 Other 2,915 2,273 2,210 ------- ------- ------ 10,236 5,732 5,528 ------- ------- ------ Expenses: Salaries and employee benefits 3,870 3,663 2,990 Occupancy 1,465 1,225 1,146 Interest 1,419 257 198 Other 1,669 1,100 1,073 ------- ------- ------ 8,423 6,245 5,407 ------- ------- ------ Income (loss) before income tax benefit and equity in undistributed net income of subsidiaries 1,813 (513) 121 Income tax benefit 1,876 1,371 1,094 ------- ------- ------ Income before equity in undistributed net income of subsidiaries 3,689 858 1,215 Equity in undistributed net income of subsidiaries 4,539 5,527 4,493 ------- ------- ------ NET INCOME $ 8,228 $ 6,385 $5,708 ======= ======= ======
37 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 19. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (CONTINUED) CONDENSED STATEMENTS OF CASH FLOWS (PARENT COMPANY ONLY)
Years Ended December 31, -------------------------------- 2003 2002 2001 --------- --------- -------- (Amounts In Thousands) Cash Flows From Operating Activities Net income $ 8,228 $ 6,385 $ 5,708 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Equity in undistributed net income of subsidiaries (4,539) (5,527) (4,493) Depreciation 156 131 77 Gain on sale of premises and equipment - (69) (178) Other, net 3,123 (1,255) (714) -------- -------- ------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 6,968 (335) 400 -------- -------- ------- Cash Flows From Investing Activities Payment for acquisition (20,282) (9,786) - Net change in loans 500 (500) 311 Capital infusion, subsidiaries (8,825) - - Investment in Merchants and Manufacturers Statutory Trusts (774) (310) - Purchases of equipment (1,065) (221) (204) -------- -------- ------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (30,446) (10,817) 107 -------- -------- ------- Cash Flows From Financing Activities Net increase (decrease) in short-term borrowings (325) 3,898 1,090 Dividends paid (2,213) (1,790) (1,802) Issuance of subordinated debentures 25,774 10,310 - Stock dividend (16) - - Common stock transactions, net 35 (1,058) (126) -------- -------- ------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 23,255 11,360 (838) -------- -------- ------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (223) 208 (331) Cash and cash equivalents at beginning of year 223 15 346 -------- -------- ------- Cash and cash equivalents at end of year $ - $ 223 $ 15 ======== ======== =======
38 10-K EXHIBIT LIST
EXHIBIT NO. DESCRIPTION ----------- ----------- EXHIBIT 10.1 Employment Agreement between Reedsburg Bank and Milburn Hahs EXHIBIT 21.1 Subsidiaries EXHIBIT 23.1 Independent Auditors' Consent EXHIBIT 31.1 Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 EXHIBIT 31.2 Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 EXHIBIT 32.1* Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 EXHIBIT 32.2* Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
--------------------------- *This certification is not "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended. 32