10-K405 1 dec10k2001.txt ANNUAL REPORT ON FORM 10K 12/31/2001 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, 2001 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 0-18342 Bremer Financial Corporation (Exact name of registrant as specified in its charter) Minnesota 41-0715583 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 445 Minnesota Street 55101 Suite 2000, St. Paul, MN (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (651) 227-7621 Securities registered pursuant to Section 12(b) of the Act: None. Securities registered pursuant to Section 12(g) of the Act: Class A Common Stock, no par value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No -------- ---------- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] Based upon the $32.49 per share book value of the shares of class A common stock of the Company as of December 31, 2001, the aggregate value of the Company's shares of class A common stock held by employees and directors as of such date was approximately $31.2 million. As of March 15, 2002, there were 1,200,000 shares of class A common stock and 10,800,000 shares of class B common stock outstanding. BREMER FINANCIAL CORPORATION Annual Report on Form 10-K for the year ended December 31, 2001
INDEX Page Documents Incorporated by Reference................................................. ii Cross Reference Sheet............................................................... iii PART I Item 1. Business.......................................................... 1 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 andRelated Stockholder Matters 10 Item 6. Selected Financial Data........................................... 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..................... 14 Item 8. Financial Statements and Supplementary Data....................... 34 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................ 57 PART III Item 10 through Item 13. See "Documents Incorporated by Reference" (Page ii)................................. 57 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................................... 57 Signatures .................................................................. 60
i DOCUMENTS INCORPORATED BY REFERENCE The following documents are incorporated by reference to the parts indicated of this Annual Report on Form 10-K:
Parts of Annual Report on Form 10-K Documents Incorporated by Reference Item 5. Market for Registrant's Common Equity Reference is made to the portions described and Related Stockholder Matters herein of the final Prospectus of the Company dated April 20, 1989 filed with the Securities and Exchange Commission on April 20, 1989. Part III Item 10. Directors and Executive Officers Reference is made to the Registrant's definitive of the Registrant proxy statement ("Proxy Statement"), which will be filed with the Securities and Exchange Commission ("Commission") within 120 days after December 31, 2001. Item 11. Executive Compensation Reference is made to the Registrant's Proxy Statement. Item 12. Security Ownership of Certain Beneficial Reference is made to the Registrant's Proxy Owners and Management Statement. Item 13. Certain Relationships and Related Reference is made to the Registrant's Proxy Transactions Statement.
(The remainder of this page was intentionally left blank.) ii CROSS REFERENCE SHEET Between Items in Part III of Form 10-K and Proxy Statement Pursuant to Paragraph G-4 of General Instructions to Form 10-K
Subject Headings Item Number and Caption In Proxy Statement Item 10. Directors and Executive Officers of the Registrant Information About Nominees for Election as Directors, Information About Executive Officers and Other Officers Item 11. Executive Compensation Compensation of Executive Officers and Directors Item 12. Security Ownership of Certain Beneficial Owners and Management Principal Stockholders Item 13. Certain Relationships and Related Transactions Certain Transactions
(The remainder of this page was intentionally left blank.) iii PART I Certain statements in this Annual Report on Form 10-K and in the documents incorporated by reference herein constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21B of the Securities Exchange Act of 1934, as amended ("Exchange Act"). For this purpose, any statements contained herein or incorporated herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes," "anticipates," "plans," "intends," "expects" and similar expressions are intended to identify forward-looking statements. Because these forward-looking statements involve risk and uncertainties, there are important factors, including the factors discussed in "Risk Factors" filed with this Annual Report on Form 10-K as Exhibit 99.1 that could cause actual results to differ materially from those expressed or implied by these forward-looking statements. ITEM 1. BUSINESS General Bremer Financial Corporation is a regional financial services company with $5.1 billion in assets as of December 31, 2001, operating 11 subsidiary banks and 107 offices in Minnesota, Wisconsin and North Dakota. We offer a wide range of banking and related products and services, including transaction and savings deposits, commercial, consumer, agricultural and real estate loans, mortgage origination services, insurance, trust, and retail brokerage services. From December 31, 1997 to December 31, 2001, we increased our asset base from $3.2 billion to $5.1 billion, resulting from a combination of internal growth and growth through bank and branch acquisitions within our three-state market area. During the same period, our loans and leases increased from $2.0 billion to $3.5 billion, and our deposits increased from $2.4 billion to $3.8 billion. Business Developments in 2001 Firstar Branches. On May 11, 2001, we acquired from Firstar Corporation, Milwaukee, Wisconsin, (the "Seller") 11 of its Minneapolis/St. Paul branch locations and a portfolio of commercial loans and related deposits (the "Branch Acquisition"). This transaction came as a result of the Seller's divestiture requirement related to its merger with U.S. Bancorp, Minneapolis, Minnesota. The 11 branch offices and the commercial loan portfolio that were acquired are now operated as part of our subsidiary bank charter in South St. Paul, Minnesota. The acquisition was accounted for as an acquisition of assets and assumption of liabilities and resulted in our recognition of deposit-based intangibles in an amount equal to the purchase price premium. In order to meet the regulatory capital requirements for completion of the Branch Acquisition, we increased our level of Tier I capital by $76.5 million through the completion of a $60 million trust preferred capital securities offering and the issuance of $16.5 million of trust preferred capital securities in an institutional private placement. History Otto Bremer incorporated Bremer Financial Corporation in December 1943 to consolidate his majority stock holdings in community banks located throughout Minnesota, Wisconsin and North Dakota. Mr. Bremer formed the Otto Bremer Foundation in 1944 to own Bremer Financial Corporation's stock. Today we are owned by the foundation and the employees and directors of the company. The foundation is organized as a non-profit trust for charitable, educational and religious purposes for the benefit of individuals and entities who are residents of or are located in Minnesota, Wisconsin, North Dakota and Montana. The foundation is a key part of our community-based philosophy. Earnings from its investment in us and other investments are returned to the bank communities in the form of grants and program-related investments. In 2001, the Otto Bremer Foundation made over $21.0 million in grants to over 750 community organizations and programs. From our incorporation in 1943 and through the late 1980s, we relied on our existing community banks to generate loan and deposit growth in our market area. 1 From 1990 through 2001, we augmented this growth through 11 bank and branch acquisitions totaling approximately $1 billion of assets and $1.4 billion of deposits. We use bank and branch acquisitions to fill in gaps in our geographic markets in order to provide better customer service and leverage existing operations. In recent years, our expansion focus has been primarily in more urban, metropolitan areas, most noticeably in Minneapolis/St. Paul and surrounding communities. Our Strategy We seek to be the preeminent community bank in the markets we serve. Our strategy for achieving this objective includes: o Providing distinctive, community banking to our customers by: >> providing personalized service through a relationship management approach We seek to identify the total financial services needs of our clients and provide them with individualized solutions to those needs. We emphasize a sales approach in which a relationship manager is responsible for selling the entire range of our services to our customer base, as opposed to assigning sales people from each product area to a specific client. In this role, our relationship managers work in tandem with representatives from our product areas to develop an effective client solution. As a result, our relationship managers gain a more thorough understanding of their clients' needs, and clients gain more convenient access to our diverse product line. To implement this relationship management focus, we have instituted a comprehensive training program that must be attended by every customer contact employee. We have also modified our information systems to better measure the breadth of each customer relationship and the effectiveness of our relationship managers' cross selling efforts. >> offering a wide variety of innovative financial products to our customers Our clients use a wide variety of financial services beyond the traditional banking products, and we work with them to identify their particular needs and tailor our services to meet those needs. As our clients' needs have evolved, we have established new competencies in e-commerce, cash management, international banking, specialized financing, estate and financial planning, and asset management. >> granting substantial local autonomy to our subsidiary banks We believe customers in our markets seek banking relationships managed by a decision-maker who can deliver a prompt response to their requests. As smaller, independent banks have been acquired by national, multi-bank holding companies, we believe that the personal relationships that these customers maintained with the management of such banks have increasingly eroded, and the banks' responsiveness and general service levels have declined. Consistent with our long history of community banking, we operate under a management philosophy of local market decision-making by each of our subsidiary banks. Each of our 11 subsidiary banks is separately chartered with its own officers and board of directors who generally are members of the local community. Management of each Bremer subsidiary bank has a high degree of flexibility in responding to local market demands. >> using our unique ownership structure to reinvest in the communities we serve Over the last three years, the foundation has distributed more than $55.0 million in the states we serve in the form of grants and program-related investments. Directing most of its grants to non-profit organizations in the communities we serve not only contributes to the economic well being of those communities, it also improves our brand recognition. o Investing in technology We are committed to investing in technology to improve product offerings, reduce product costs and provide more convenient service to our customers. Over the last few years, we have continued to make significant investments to upgrade our technology infrastructure. This included upgrading most of our 2 1,500 personal computers, effectively connecting them through improvements in the company-wide intranet, making improvements in the customer contact information system, launching Bremer eBank and Bremer ePay, our retail Internet banking and bill payment services, and launching Bremer eBiz and Bremer eACH, a package of Internet-based cash management services for businesses. In the future, we will continue to invest in technologies that allow customers to communicate with us at the time and in the manner that best meets their needs and preference. o Increasing penetration in our existing markets To make us more accessible and convenient to our customers, we pursue a strategy of in-market expansion to fill in gaps in our market coverage through opening new branches, acquiring competing banks or branches, and investing in technology-based delivery channels. Examples of this strategy include: >> our recently completed Branch Acquisition, which substantially improved customer access in the Minneapolis/St. Paul area; and >> the acquisition of Northwest Savings Bank in 2000, which brought our services to New Richmond, Wisconsin, a rapidly-growing community located between St. Paul and our banking offices in western Wisconsin. o Leveraging our holding company structure We have centralized at the holding company level many critical subsidiary bank administrative and support functions. Functions that have been centralized at the holding company include: >> policy development in areas such as loans, investments, asset liability management, compliance, data security, accounting, and personnel, and standardized procedures to support the policies; >> customer support services in areas such as loan servicing, deposit servicing, and call center operations; >> investment portfolio management, interest rate risk management, purchasing, management of insurance coverage, employee benefits, credit examination, technology support, and accounting; >> specialized expertise in areas such as cash management, international banking, loan workout, taxation, and compliance; and >> management of key vendor relationships including those vendors supplying data processing, item processing, ATM services, internal and external audit services, computer software and hardware, equipment and supplies. We believe that by standardizing certain policies, procedures and products, and by centralizing administrative functions, subsidiary bank management and personnel can concentrate on individual customer service and community relations. Further, we reduce bank expenses, and can consistently and efficiently implement system-wide banking policies and practices. 3 Our Banks Our 11 subsidiary banks are located in Minnesota, Wisconsin and North Dakota. At December 31, 2001, they ranged in size from $70.3 million to $1.6 billion in total assets and from $60.5 million to $1.3 billion in total deposits. Each of our banks is a community bank that provides a full range of commercial and consumer banking services, primarily to customers within its market area. All of our banks are nationally chartered, operate under the name of Bremer Bank, National Association, and are regulated by the Office of the Comptroller of the Currency. The locations, total assets and total deposits of our banks as of December 31, 2001, are as follows:
Location of Subsidiary Bank Charter Branch Locations Assets Deposits ----------------------------------- ---------------- ------ -------- (in thousands) Alexandria, MN Alexandria, MN (2) $413,817 $302,167 Brandon, MN Breckenridge, MN Fergus Falls, MN Morris, MN Starbuck, MN Wahpeton, ND Brainerd, MN Brainerd, MN (2) $257,947 $200,015 Aitkin, MN Baxter, MN (2) Grand Forks, ND Grand Forks, ND (2) $524,544 $402,886 Crookston, MN Fisher, MN Fordville, ND Forest River, ND Gilby, ND Grafton, ND Hoople, ND Larimore, ND St. Thomas,ND Shelly, MN Warren, MN International Falls, MN International Falls, MN $70,289 $60,540 Marshall, MN Marshall, MN $218,489 $186,025 Redwood Falls, MN Edgerton, MN Leota, MN Menomonie, WI Menomonie, WI (3) $489,121 $387,308 Amery, WI Bayfield, WI Colfax, WI Danbury, WI Deer Park, WI Eau Galle, WI Elk Mound, WI Frederic, WI Knapp, WI La Pointe, WI New Richmond, WI Rock Falls, WI Siren, WI Washburn, WI 4 Location of Subsidiary Bank Charter Branch Locations Assets Deposits ----------------------------------- ---------------- ------ -------- (in thousands) Minot, ND Minot, ND (3) $402,827 $324,870 Berthold, ND Carrington, ND Devils Lake, ND (2) Max, ND Minnewaukan, ND Richardton, ND Rugby, ND Moorhead, MN Moorhead, MN $417,504 $258,119 Fargo, ND (2) Casselton, ND Detroit Lakes, MN Leonard, ND Lisbon, ND Perham, MN St. Cloud, MN St. Cloud, MN (2) $464,112 $298,497 Rice, MN Sartell, MN Sauk Rapids, MN South St. Paul, MN South St. Paul, MN $1,619,938 $1,251,021 St. Paul, MN (5) Minneapolis, MN (2) Arden Hills, MN Brooklyn Center, MN Brooklyn Park, MN Eagan, MN Eden Prairie, MN Edina, MN Inver Grove Heights, MN Maplewood, MN Milaca, MN Minnetonka, MN Ogilvie, MN Princeton, MN Richfield, MN Roseville, MN St. Anthony, MN St. Louis Park, MN Watertown, MN White Bear Lake, MN Zimmerman, MN Willmar, MN Willmar, MN (2) $195,018 $145,232 Hutchinson, MN
Communities Served By Our Banks We operate in 85 communities across Minnesota, Wisconsin and North Dakota. Over the past few years, we have begun to expand significantly in more urban metropolitan areas, including Minneapolis/St. Paul, Fargo/Moorhead, and St. Cloud. Prior to that time, we had our strongest market presence in communities outside the major metropolitan areas. In Minnesota, these non-metropolitan communities are a blend of agricultural-based areas in the southwestern portion of the state to more recreational and resort-based communities in west central Minnesota. Our North Dakota communities are in primarily agricultural-based areas along the Red River Valley as well as in western North Dakota surrounding the Minot trade area. In Wisconsin, our locations are concentrated on the western side of the state. In our markets located outside the major metropolitan areas, we generally are first or second in deposit market share. 5 Over the past few years, most of our expansion has been in higher-growth metropolitan areas. The primary areas targeted for future expansion are expected to continue to be in the Minneapolis/St. Paul to St. Cloud corridor and the Fargo/Moorhead area. While we have maintained charter banks in St. Cloud and South St. Paul for many years, our metropolitan area market share has not been substantial. The acquisition of Dean Financial Services, Inc. in 1999 added eight additional branch offices in the metropolitan Minneapolis/St. Paul area and the Branch Acquisition added another 11 offices in this area. We have also opened a number of offices in the rapidly growing Fargo/Moorhead area during the last few years. Lending Activities We maintain a diversified loan portfolio consisting of commercial, commercial and residential real estate, agricultural, consumer and tax-exempt loans. Commercial Loans. Loans in this category include term loans and operating lines of credit for primarily manufacturing, wholesale, or retail businesses. While we look to the borrower's business operations as the principal source of repayment, we also generally obtain personal guarantees and security interests in inventory, receivables, and equipment as collateral support for the loans. We utilize standard advance rates in determining amounts that can be advanced for each collateral type. Advances secured by inventory and receivables are normally short-term floating rate advances and constitute about 50% of this portfolio. Equipment loans typically amortize over five years and constitute the remainder of this portfolio. Commercial Real Estate Loans. Our commercial real estate portfolio, which includes interim commercial real estate construction, consists primarily of loans to business customers who occupy the property or use the property for income production. Commercial real estate loans generally are made for up to 80% of appraised value or cost and typically have a term of five years with 15 to 20 year amortization. Approximately 65% of our commercial real estate loans are fixed rate loans and 35% are adjustable rate loans. Agricultural Loans. Our agricultural loans include term loans secured by farm property or equipment, and operating loans used for commodity production. Our agricultural customers and agricultural-based communities are diversified across the three states we serve, and we extend credit to 12 different areas of commodity production including crops, dairy, and livestock. Approximately 50% of our agricultural loans are short-term floating rate loans. The remainder of the agricultural loans are fixed rate loans with terms generally under five years. Residential Real Estate Loans. The residential real estate portfolio includes home equity loans, first mortgage residential real estate loans, and some construction loans. The construction loans are typically made to builders on homes under construction that have been pre-sold. Loan to value ratios for home equity loans typically range from 80% to 100%. Approximately 60% of our home equity loans are fixed rate loans with terms of five to twelve years. The remaining 40% of our home equity loans are floating rate lines of credit. First mortgage residential real estate lending is generally conducted in compliance with secondary market underwriting guidelines, and most newly originated fixed rate first mortgage loans are sold into the secondary market. The first mortgage residential real estate loans that we keep in our portfolio are generally adjustable rate loans, and often involve vacation homes in our recreational and resort-based communities. Consumer Loans. Loans in this category include automobile loans, home improvement loans and personal lines of credit. In addition to our direct lending operations, our subsidiary banks also purchase indirect retail installment sales contracts primarily from automobile dealers, certain recreational vehicle dealers, and certain sport recreation dealers where the selling dealer is well known to us and located in our primary trade area. Most of our consumer loans are fixed rate loans with terms of three to five years. Tax-Exempt Loans. Tax-exempt loans and leases are made to municipalities and qualifying non-profit organizations located within our primary trade area. 6 Deposits We emphasize developing relationships with individuals and business customers in order to increase our deposit base. We offer a broad range of competitively priced deposit products, including checking accounts, money market accounts, savings accounts and certificates of deposit, designed to meet the individual needs of our customers. Deposits in our banks are insured by the Federal Deposit Insurance Corporation ("FDIC") up to statutory limits (currently $100,000). Deposit product development is the primary responsibility of our holding company marketing and retail delivery departments, with input and feedback from the subsidiary banks' market managers. Pricing of products is generally consistent across all of our banks, with bank market managers having some local authority to modify pricing on certain products to meet the market and/or the local competition. Other Products and Services We operate various financial services subsidiaries, which provide trust and other fiduciary services, insurance, and asset-based lending and leasing services. The subsidiaries allow us to offer a full range of products and services to our customers. On a consolidated basis, these other financial services subsidiaries historically have accounted for less than 10% of our annual earnings. Bremer Business Finance Corporation. We formed Bremer Business Finance Corporation in late 1996 to expand the services available to customers that may not qualify for traditional bank financing. Bremer Business Finance Corporation engages in secured lending activities and works closely with the Bremer banks in offering services to customers in the areas of asset-based finance, real estate finance, real estate equity finance, corporate finance, project finance, equipment financing and leasing. As of December 31, 2001, Bremer Business Finance Corporation had a loan portfolio of $78.0 million, with the majority of loans being variable rate credits generally priced approximately 200 basis points over the prime rate. Bremer Trust, National Association. Bremer Trust, National Association has trust powers and offers trust and other fiduciary services in the majority of our markets. Services that Bremer Trust provides to our customers include serving as trustee, investment agent, custodian, personal representative, and as a conservator for individuals, businesses, and public and tax-exempt organizations. Bremer Trust directly serves as an investment advisor for the proprietary stock and bond mutual funds we offer to our trust client accounts. Bremer Trust also operates on a limited basis as a registrar and transfer agent. As of December 31, 2001, Bremer Trust had 85 employees. Our total trust revenues for 2001 were $9.4 million. Bremer Insurance Agencies, Inc. Bremer Insurance Agencies, Inc. is an independent insurance agency with offices in Minnesota, Wisconsin and North Dakota, representing many different insurance companies. This gives agency personnel the ability to tailor coverages to meet the differing needs of our diverse customer base. The agency's book of business is generated by selling personal, life, health, commercial and agricultural insurance products. In 2001, Bremer Insurance generated insurance premium sales of $8.3 million and, as of December 31, 2001, it had 93 employees. Brokerage Services. Consumer investment products and services are available at our subsidiary bank offices through INVEST Financial Corporation of Tampa, Florida. We have an agreement with INVEST to deliver investment services to our customers through our branch network and we receive a portion of the commissions earned by the investment representatives in those branches. We had $4.6 million in brokerage commissions in 2001. Bremer Life Insurance Company. Bremer Life Insurance Company was formed as a reinsurer of credit life and credit accident and health insurance sold by the Bremer banks, in partnership with American General, which owns a preferred stock interest in the life company. Operations and Administration We provide a broad range of services to the individual subsidiaries in order to augment the capacities of the subsidiary banks' management and to achieve many of the synergies of a larger company. Operations Center. Back-office operations for all banks are housed in an operations center in West St. Paul, Minnesota. We use a third-party provider for 7 delivery of most data and item processing services for Bremer and its subsidiaries. We have entered into contracts for these services that extend into the next two to four years. Certain of the operations of these third party providers are located in our operations center. Credit. We evaluate and approve credit at the individual subsidiary bank level through individual and senior lending officer credit authorities. In addition, each bank has a senior credit committee and a director's credit committee that review and approve larger credits. The director's credit committee can approve credit up to the individual bank limit. These bank limits range from $700 thousand to $10.0 million, depending on the size of the individual bank. We also support the credit process at the holding company level through the use of corporate credit committees and staff. Approval is required at the corporate level for loans that exceed the individual limits of the banks and for certain loans that have characteristics that warrant review at the corporate level as defined in our lending policy. We also provide centralized underwriting and internal syndication for credits that exceed the lending limits of individual banks. The special assets group of the holding company handles most loan workouts. To improve distressed credit management practices, we have established a policy that requires the prompt transfer of certain problem loan situations from the subsidiary banks to the special assets group. Risk Management. The risk management division is an independent unit that assists us in managing risk throughout the organization. This is done through consulting, monitoring, and performing independent audits and examinations of banks, other subsidiaries, and corporate support functions. The director of risk management has a direct reporting relationship to the holding company's board of directors and the boards of the operating entities. Risk management is comprised of credit examination, internal audit, and compliance administration and counsel. o Credit examination reviews our loan portfolio on a regular basis. The frequency of examination is based on a risk assessment and provides for more frequent examinations for units exhibiting higher risk factors. o We have outsourced much of our internal audit function, which conducts periodic operational, compliance and internal control reviews of all of our subsidiary banks and system-wide operations. The director of risk management directs the work of internal audit and coordinates all reporting to the boards of directors. o Compliance administration and legal counsel provide assistance to the banks in meeting their consumer compliance responsibilities. Asset Liability and Investment Portfolio Management. We operate using a centralized treasury function. The asset liability committee of the holding company is responsible for developing appropriate risk management policies and for the monitoring of asset liability activities to insure that they are conducted within established risk parameters. The treasurer has day-to-day responsibility for our overall interest rate risk, liquidity, and investment portfolio management. Finance. We have established policies for capital expenditures, accounting policy, capital adequacy and dividends. In addition, we monitor the performance of our individual subsidiaries and coordinate the reporting process, the strategic planning process and annual profit planning. Human Resources. Our human resources division has established standard salary administration procedures, and our subsidiary banks administer these at their level. Employee benefits are standardized and administered by the holding company. Marketing. Our marketing division manages our branding efforts to ensure that consistent messages are communicated in all of our external communications. Competition We do business in the highly competitive financial services industry. The financial services industry in which we compete is comprised of commercial banks, thrifts, credit unions, investment banks, brokerage houses, money 8 managers, mortgage banks, insurance companies and other providers of financial products and services. These firms compete with us for loans, deposits, trust services, investment products and a host of other financial products and services. We believe that our success in competing effectively with these alternative providers of financial services will be partly based on our ability to monitor the local economies, make decisions close to the marketplace, commit to and be involved in the communities we serve, and fully develop our relationship management concepts. We must preserve our ability to focus on providing personalized, quality banking services to maintain or improve our competitive position in our markets. We believe that our size, combined with our support services in specialized areas, adds to the strength of the individual banks, enabling them to compete more effectively. Some of our competitors are not subject to the same degree of regulation as that imposed on bank holding companies and national banks. In addition, the larger banking organizations, investment banks and brokerage houses have significantly greater resources than us. As a result, some of our competitors have advantages over us in name recognition and market penetration. Employees As of February 28, 2002, we had 1,671 full-time equivalent employees. We provide our employees with a comprehensive program of benefits, some of which are on a contributory basis, including comprehensive medical and dental plans, life insurance plans, and 401(k) plans. In addition, all the employees have the opportunity to invest in our class A common stock. We consider our relationship with our employees to be good. ITEM 2. PROPERTIES We lease our principal offices at 445 Minnesota Street, Suite 2000, St. Paul, Minnesota 55101, which consists of approximately 25,000 square feet. In addition, the centralized service operations of the holding company occupy approximately 30,000 square feet of owned property in West St. Paul, Minnesota. We are presently in negotiations to secure a building containing approximately 100,000 square feet of space for an expanded operations center. We expect to move our operations center to this new location in the fall of 2002. After we move the operations center to this new location, we plan to sell the property in West St. Paul that is currently used for our operations center. We believe that the principal offices at 445 Minnesota Street in St. Paul will be sufficient for the holding company's needs in the foreseeable future. Substantially all of the current offices and branches of the subsidiary banks are owned, with the primary exception of those located in leased space in downtown St. Paul, Minnesota and leased space in supermarkets. Our bank facilities range in size from 391 square feet to 52,280 square feet. The Branch Acquisition added four new owned properties and seven leased properties, ranging in size from 3,000 square feet to 31,888 square feet. ITEM 3. LEGAL PROCEEDINGS There are no material legal proceedings pending other than ordinary routine litigation incidental to our business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of the year ended December 31, 2001 to a vote of our security holders, through the solicitation of proxies or otherwise. (The remainder of this page was intentionally left blank.) 9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information There is no established trading market for the shares of our class A common stock. To the best of our knowledge, during the period from May 18, 1989 (the closing date of the registered initial public offering of Bremer's class A common stock) through February 25, 2002, a majority of the purchases and sales of shares of the class A common stock have consisted of transfers effected upon the exercise of the options described in the portions of Bremer's Prospectus dated April 20, 1989 ("Prospectus") entitled "Description of Capital Stock - Description of Class A Common Stock - Restrictions on Transfer" on page 62 of the Prospectus and "Description of Capital Stock - Description of Class A Common Stock First Call Option to Company" on page 64 of the Prospectus (which portions are hereby incorporated by reference pursuant to Rule 12b-23 under the Securities Exchange Act of 1934). We are not obligated to purchase any shares of class A common stock from a holder upon the exercise of a put option if the purchase price paid for the shares subject to the put option, when added to the purchase price paid for all previous purchases of class A common stock during the preceding twelve-month period, would exceed 10% of our net worth as of the date of such purchase. As of December 31, 2001, our net worth, including redeemable class A common stock, was $389.9 million and 10% of our net worth and redeemable class A common stock was $39.0 million. During the period from January 1, 2001 through February 25, 2002, we did not directly purchase any shares of class A common stock but assigned to our Employee Stock Ownership Plan and the Bremer Banks Profit Sharing Plus Plan our options to purchase a total of 170,232.5721 shares. The ESOP and the Profit Sharing Plan purchased these shares and then transferred them to our employees and employees of our subsidiaries through the ESOP and the Profit Sharing Plan. In addition, 5,016 shares of class A common stock were transferred directly between individuals at various times during the same period. To the best of our knowledge, these were the only transfers of shares of class A common stock effected during the period from January 1, 2001 through February 25, 2002. The sales price of the shares of class A common stock in such transactions ranged from $29.50 to $40.00 per share. These prices were equal to either the per share book value of the class A common stock as shown in our consolidated balance sheet dated as of the last day of the immediately preceding fiscal quarter or, and only with respect to shares transferred that had been held for employees in the ESOP, the per share fair market value as determined by an independent appraiser. At December 31, 2001, the most recent date for which a per share book value for the class A common stock is available, such value was $32.49. To the best of our knowledge, no brokers are used to sell the shares of class A common stock, and there are no market makers for the class A common stock. Holders As of February 25, 2002, there were approximately 1,430 holders of record of the shares of class A common stock. Dividends The subsidiary banks' ability to pay dividends to the parent and the parent's ability to pay dividends to holders of the class A common stock are restricted and limited. The restrictions on payments of dividends are also described in Note Q of the Notes to Consolidated Financial Statements set forth in Item 8 of this Form 10-K. Each of the subsidiary banks is subject to extensive regulation regarding the payment of dividends and other matters. All subsidiary banks are nationally chartered and are regulated by the Office of the Comptroller of the Currency. In addition, because the deposits of our subsidiary banks are insured up to the applicable limit (currently $100,000) by the FDIC, all of the subsidiary banks are subject to regulation by the FDIC. The parent and the Foundation, as bank holding companies, are regulated by the Board of Governors of the Federal Reserve System. Dividends from Subsidiary Banks. A substantial portion of our cash flow and income is derived from dividends paid to us by the subsidiary banks, and 10 restrictions on the payment of such dividends could affect the payment of dividends by the parent. With regard to the subsidiary banks, and in addition to the statutory prohibition against the withdrawal of any portion of a national bank's capital and certain statutory limitations on the payment of dividends, the approval of the Comptroller is required for the payment of any dividend by any national bank if the total of all dividends declared by the bank in any calendar year exceeds the total of its net profits (as defined) for that year combined with its retained net profits for the preceding two calendar years, less any required transfer to surplus. The Comptroller also has issued a banking circular emphasizing that the level of cash dividends should bear a direct correlation to the level of a national bank's current and expected earnings stream, the bank's need to maintain an adequate capital base, and other factors. In addition to the foregoing limitations, the appropriate federal banking agency could take the position that it has the power to prohibit a national bank from paying dividends if, in its view, such payments would constitute unsafe or unsound banking practices. The payment of dividends by any national bank also is affected by the requirements to maintain adequate capital pursuant to the capital adequacy guidelines issued by the Comptroller. The Comptroller has issued capital adequacy regulations for national banks subject to the Comptroller's primary supervision. These regulations provide for a minimum Tier 1 capital to total assets (leverage) ratio of 4.00% for the most highly-rated banks and a minimum total capital to risk-weighted assets (total capital) ratio of 8.00%. These guidelines and regulations further provide that capital adequacy is to be considered on a case-by-case basis in view of various qualitative factors that affect a bank's overall financial condition. Most banking organizations are expected to maintain a leverage ratio of 100 to 200 basis points above this minimum depending on their financial condition. The subsidiary banks are in compliance with the Comptroller's minimum capital guidelines. See the discussion of the capital adequacy guidelines set forth in the portion of Part II of this Form 10-K entitled "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Management." The above regulations and restrictions on dividends paid by the subsidiary banks may limit our ability to obtain funds from such dividends for our cash needs, including funds for payment of operating expenses and for the payment of dividends on the class A and class B common stock, as well as funds necessary to facilitate acquisitions. However, because of the capital positions of the subsidiary banks, we have been able to obtain dividends sufficient to meet our cash flow needs. As of December 31, 2001, the subsidiary banks had retained earnings of $22.3 million which were available for distribution to the parent as dividends in 2002 subject to regulatory and administrative restrictions. Of this amount, approximately $18.0 million was available for distribution without obtaining the prior approval of the appropriate bank regulator. In 2001 and 2000, the subsidiary banks paid total dividends to the parent of $47.3 million and $46.5 million. The range of dividend payouts (dividends paid divided by net income) was 0.0% to 210.9% in 2001 and 27.8% to 220.8% in 2000. Under the ESOP, and at the option of the ESOP's Administrator, cash dividends declared on the shares of class A common stock held by the ESOP will be allocated to the ESOP participants. To the extent that cash dividends declared on the class A common stock held by the ESOP are distributed to the participants (whether directly or indirectly), the dividends will be deductible to us. Any dividends paid in the form of class A common stock with respect to shares allocated to the individual participants' accounts will be allocated to such accounts. Under the Profit Sharing Plan, all cash dividends paid on the class A common stock are allocated to the accounts of the participants holding shares of the class A common stock in their profit sharing accounts. All such proceeds are available to the participants for investment under the Profit Sharing Plan in accordance with the terms and conditions of the Profit Sharing Plan. All dividends paid in the form of class A common stock will be allocated to the account of the participant in which the shares are held. In no event will dividends paid on the class A common stock held by the participants' accounts within the Profit Sharing Plan be forfeited or otherwise allocated and held by the trustees of the Profit Sharing Plan. 11 Dividends from the Company. Our payment of dividends, is limited by, among other things, the requirement to maintain adequate capital pursuant to the capital adequacy guidelines issued by the Federal Reserve Board. These guidelines are substantially similar to those promulgated by the Comptroller with respect to national banks, which are discussed above. The payment of dividends by a bank holding company also is subject to the general limitation that the Federal Reserve Board could take the position that it has the power to prohibit the bank holding company from paying dividends if, in its view, such payments would constitute an unsafe or unsound practice. We declared and paid dividends to the foundation and all other holders of its class A common stock of $19.2 million in 2001 and $16.7 million in 2000. $4.8 million of dividends were paid in each of the four quarters of 2001 and the final quarter of 2000, while $4.0 million of dividends were paid in each of the first three quarters of 2000. The dividend yield, which consists of dividends paid during the year divided by shareholders' equity as of the last day of the preceding year, was 5.4% and 5.3% for the years ended December 31, 2001 and 2000. (The remainder of this page was intentionally left blank.) 12 ITEM 6. SELECTED FINANCIAL DATA BREMER FINANCIAL CORPORATION AND SUBSIDIARIES
At or for the year ended December 31, ------------------------------------------------------------------- 2001 2000 1999 1998 1997 ----------- ----------- ----------- ----------- ----------- (dollars in thousands, except per share data) Operating results Total interest income $ 329,078 $ 314,171 $ 263,967 $ 245,525 $ 226,550 Net interest income 171,666 150,989 139,053 124,101 116,581 Net interest income (1) 179,806 159,051 146,370 131,678 124,169 Provision for credit losses 12,054 8,338 8,321 5,570 4,746 Noninterest income 67,738 54,217 52,465 51,270 38,681 Noninterest expense 148,673 126,630 121,944 107,013 98,255 Net income 51,626 45,781 40,111 41,511 35,060 Dividends 19,200 16,680 15,840 15,840 14,400 Average balances Total assets $4,656,013 $4,010,098 $3,584,460 $3,248,180 $2,986,600 Securities (2) 1,104,541 1,001,031 1,043,771 954,994 963,806 Loans and leases (3) 3,210,537 2,749,662 2,315,105 2,084,462 1,838,218 Total deposits 3,461,900 2,982,220 2,679,237 2,456,807 2,300,311 Short-term borrowings 450,407 423,258 391,396 367,601 304,384 Long-term debt 252,929 215,009 156,708 73,047 53,486 Mandatorily redeemable preferred securities 53,164 - - - - Redeemable class A common stock 29,758 26,677 24,650 23,205 21,322 Shareholders' equity 342,216 306,781 283,467 266,862 245,206 Period-end balances Total assets $5,094,064 $4,192,596 $3,851,485 $3,398,079 $3,173,701 Securities (2) 1,201,645 951,627 1,038,372 996,673 992,249 Loans and leases (3) 3,498,839 2,915,601 2,542,897 2,172,631 1,964,127 Total deposits 3,806,018 3,106,082 2,849,946 2,569,904 2,442,498 Short-term borrowings 448,912 441,746 427,431 353,959 365,264 Long-term debt 315,923 232,660 215,832 116,286 30,238 Mandatorily redeemable preferred securities 76,500 - - - - Redeemable class A common stock 31,193 28,324 25,029 24,270 22,308 Shareholders' equity 358,719 325,715 287,847 279,108 256,541 Financial ratios Return on average assets (4) 1.11 % 1.14 % 1.12 % 1.30 % 1.22 % Return on average realized equity (5)(6) 14.00 13.54 12.88 14.55 13.32 Average realized equity to average assets (5)(6) 7.92 8.43 8.69 8.79 8.81 Tangible realized equity to assets (5)(6) 5.56 7.33 7.37 8.38 8.50 Dividend payout 37.19 36.43 39.49 38.16 41.07 Net interest margin (1) 4.15 4.22 4.34 4.31 4.43 Operating efficiency ratio (1)(7) 57.63 57.56 60.51 59.05 58.43 Reserve to total loans and leases 1.54 1.57 1.65 1.70 1.74 Net charge-offs to average loans and leases 0.26 0.17 0.24 0.13 0.09 Per share of common stock (5) Net income-basic and diluted $ 4.30 $ 3.82 $ 3.34 $ 3.46 $ 2.92 Dividends paid per share 1.60 1.39 1.32 1.32 1.20 Book value 32.49 29.50 26.07 25.28 23.24 Realized book value (6) 32.08 29.37 26.95 24.93 22.79 ---------- (1) Tax-equivalent basis (TEB). (2) Includes securities held-to-maturity and securities available-for-sale. (3) Net of unearned discount and includes nonaccrual loans and leases. (4) Calculation is based on income before minority interests. (5) Calculation includes shareholders' equity and redeemable class A common stock (6) Excluding net unrealized gain (loss) on securities available-for-sale. (7) Calculation excludes minority interest, nonrecurring gains and losses, other nonrecurring noninterest income and amortization of intangibles.
13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Critical Accounting Policies In preparing the financial statements, we follow accounting principles generally accepted in the United States of America, which in many cases require us to make assumptions, estimates and judgments that affect the amounts reported. Many of these policies are relatively straightforward. There are, however, a few policies that are critical because they are important in determining the financial condition and results of operations and they can be difficult to apply. We believe that the most critical accounting policies applied in the preparation of our financial statements relate to: >> accounting for the reserve for credit losses; and >> accounting for investments. The difficulty in applying these policies arises from the assumptions, estimates and judgments that have to be made currently about matters that are inherently uncertain, such as future economic conditions, operating results and valuations as well as management intentions. As the difficulty increases, the level of precision decreases, meaning that actual results can and probably will be different from those currently estimated. We base our assumptions, estimates and judgments on a combination of historical experiences and other reasonable factors. Reserves for credit losses include charges to reduce the recorded balances of loans receivable and real estate to their estimated net realizable value or fair value, as applicable. The policy for accounting for the reserves for credit losses is described in the later section titled "Financial Condition - Reserve for Credit Losses" and further addressed at Note A to the consolidated financial statements. Investments in marketable equity and debt securities are classified into three categories - held to maturity, available for sale, or trading - pursuant to Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." As of December 31, 2001, no investments were classified as trading securities. Held-to-maturity securities represent investments for which we have the ability and intent to hold to maturity and may be sold only under very limited circumstances. We currently classify our investments in certain municipal bond obligations and certain U.S. government agency obligations as held-to-maturity securities. Overview Earnings. We reported net income of $51.6 million or $4.30 basic and diluted earnings per share for the year ended December 31, 2001. This compares to net income of $45.8 million or $3.82 basic and diluted earnings per share in 2000 and $40.1 million or $3.34 basic and diluted earnings per share in 1999. Return on average realized equity was 14.00% in 2001, as compared to 13.54% in 2000 and 12.88% in 1999. Realized equity excludes the impact on equity of unrealized gains and losses associated with available-for-sale securities. Return on average assets was 1.11% in 2001, versus 1.14% in 2000 and 1.12% in 1999. Assets. Total assets at December 31, 2001 increased $901.5 million, or 21.5%, to $5.1 billion from $4.2 billion at December 31, 2000. During 2000, assets increased $341.1 million, or 8.9%, from $3.9 billion at December 31, 1999. Loans and leases net of unearned discount as a percentage of total assets were 68.7% at December 31, 2001, compared to 69.5% at December 31, 2000, and 66.0% at December 31, 1999. Acquisitions. Three acquisitions impacted our operating results during the three year period ended December 31, 2001. In July 1999, we acquired, for cash in a purchase transaction, the stock of Dean Financial Services, Inc. Dean was a privately-held bank holding company with approximately $296.9 million in assets and $260.6 million in deposits with four charter banks serving 11 locations in Minnesota. During the latter half of 1999, we merged Dean into Bremer and Dean's four separate charter banks into our previously existing charter banks. In March 2000, we acquired, for cash in a purchase transaction, the stock of Northwest Equity Corp. of Amery, Wisconsin, and its wholly-owned subsidiary, 14 Northwest Savings Bank, with offices in Amery, New Richmond, and Siren, Wisconsin. In May 2000, we merged Northwest Savings Bank with and into our subsidiary bank in Wisconsin, which added about $91.8 million in assets and $61.6 million in deposits to that bank and resulted in the closing of duplicate facilities in Siren and Amery, Wisconsin. In May 2001, we completed the Branch Acquisition. This added approximately $715 million in deposits and $320 million in loans to our subsidiary bank operating in Minneapolis/St. Paul. Of the $320 million of loans acquired, approximately $150 million were loans originated in the branch locations, primarily home equity and other consumer credit. The remaining loans were primarily middle-market commercial loans originated in the commercial banking group. The following pro forma financial information was prepared assuming the Branch Acquisition had been completed at January 1, 2001 and January 1, 2000: Years Ended December 31, ------------------------ 2001 2000 ---- ---- (in thousands, except per share data) Net Interest Income $ 177,191 $ 166,501 Net Income 51,917 45,698 Net Income Per Share $ 4.33 $ 3.81 Results of Operations Net Interest Income. We derive our net income primarily from net interest income. Net interest income is the difference between interest income, principally from loans and investment securities, and interest expense, principally on borrowings and customer deposits. Changes in net interest income result from changes in volume, net interest spread, and net interest margin. Volume refers to the average dollar levels of interest earning assets and interest bearing liabilities. Net interest spread refers to the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities. Net interest margin refers to the net interest income divided by average interest earning assets and is influenced by the level and relative mix of interest earning assets and interest bearing liabilities. (The remainder of this page was intentionally left blank.) 15 The following table sets forth, for the periods indicated, information regarding average balances of assets and liabilities and the total dollar amounts of interest income from interest bearing assets and interest expense on interest bearing liabilities. In addition, the table shows resultant yields or costs, net interest income, net interest spread and net interest margin:
Years ended December 31, ------------------------ 2001 2000 1999 ---- ---- ---- Average Average Average Average Rate/ Average Rate/ Average Rate/ Balance Interest(1) Yield Balance Interest(1) Yield Balance Interest(1) Yield ------- ----------- ----- ------- ----------- ----- ------- ----------- ----- (dollars in thousands) Assets Loans and leases (2) Commercial and other $ 804,688 $ 64,462 8.01% $ 663,494 $ 62,507 9.42% $ 534,954 $ 47,208 8.82% Commercial real estate 923,695 77,063 8.34 753,402 67,881 9.01 609,345 52,648 8.64 Agricultural 409,463 34,535 8.43 421,539 39,384 9.34 447,715 39,295 8.78 Residential real estate 668,943 55,625 8.32 548,876 48,545 8.84 414,510 35,737 8.62 Consumer 318,502 28,885 9.07 289,779 26,351 9.09 251,499 22,584 8.98 Tax-exempt 85,246 7,880 9.24 72,572 6,855 9.45 57,082 5,394 9.45 ------ ----- ------ ----- ------ ----- Total Loans and Leases 3,210,537 268,450 8.36 2,749,662 251,523 9.15 2,315,105 202,866 8.76 Reserve for credit losses (49,964) (44,647) (39,471) ------- ------- ------- Net Loans and Leases 3,160,573 2,705,015 2,275,634 Securities Mortgage-backed 720,043 43,885 6.09 639,065 42,510 6.65 742,299 45,618 6.15 Other taxable 176,825 8,175 4.62 151,890 10,530 6.93 100,633 6,043 6.00 Tax-exempt 207,673 15,961 7.69 210,076 16,799 8.00 200,839 16,050 7.99 ------- ------ ------- ------ ------- ------ Total Securities 1,104,541 68,021 6.16 1,001,031 69,839 6.98 1,043,771 67,711 6.49 Federal funds sold 15,313 569 3.72 9,466 612 6.47 11,853 575 4.85 Other earning assets 4,624 178 3.85 5,763 259 4.49 2,712 132 4.87 ----- --- ----- --- ----- --- Total Earning Assets (3) $4,335,015 $337,218 7.78% $3,765,922 $322,233 8.56% $3,373,441 $271,284 8.04% Cash and due from banks 142,388 122,611 119,695 Other noninterest earning assets 228,574 166,212 130,795 ------- ------- ------- Total Assets $4,656,013 $4,010,098 $3,584,460 ========== ========== ========== Liabilities and Shareholders' Equity Noninterest bearing deposits $ 480,949 $ 386,511 $ 347,900 Interest bearing deposits Savings and NOW accounts 344,738 $ 3,178 0.92% 312,038 $ 3,965 1.27% 304,182 $ 3,640 1.20% Money market checking 195,261 1,123 0.58 164,080 1,557 0.95 163,636 1,493 0.91 Money market savings 892,428 26,999 3.03 596,794 29,469 4.94 483,084 18,338 3.80 Savings certificates 1,264,654 70,683 5.59 1,155,466 66,076 5.72 1,097,425 57,532 5.24 Certificates over $100,000 283,870 16,270 5.73 367,331 22,678 6.17 283,011 15,374 5.43 -------- ------- ------ ------- ------ ------- ------ Total Interest Bearing Deposits 2,980,951 118,253 3.97 2,595,709 123,745 4.77 2,331,338 96,377 4.13 --------- ------- --------- ------- --------- ------ Total Deposits 3,461,900 2,982,220 2,679,238 Short-term borrowings 450,407 17,959 3.99 423,258 25,329 5.98 391,396 19,472 4.98 Long-term debt 252,929 16,215 6.41 215,009 14,108 6.56 156,708 9,065 5.78 Company obligated mandatorily redeemable preferred securities 53,164 4,985 9.38 - - NM - - NM ------ ----- Total Interest Bearing Liabilities $3,737,451 $157,412 4.21% $3,233,976 $163,182 5.05% $2,879,442 $124,914 4.34% Noninterest bearing liabilities 65,489 56,003 46,321 ------ ------ ------ Total Liabilities 4,283,889 3,676,490 3,273,663 Minority interest 150 150 909 Redeemable preferred stock -- 0 1,771 Redeemable class A common stock 29,758 26,677 24,650 Shareholders' equity 342,216 306,781 283,467 ------- ------- ------- Total Liabilities and Equity $4,656,013 $4,010,098 $3,584,460 ========== ========== ========== Net interest income $179,806 $159,051 $146,370 ======== ======== ======== Net interest spread 3.57% 3.51% 3.70% Net Interest margin 4.15% 4.22% 4.34% ---------- (1) Interest income includes $8,140, $8,062 and $7,317, in 2001, 2000, and 1999 to adjust to a fully taxable basis using the federal statutory rate of 35%. (2) Net of unearned discount and includes nonaccrual loans and leases. (3) Before deducting the reserve for credit losses.
16 The following table illustrates, on a tax-equivalent basis, for the periods indicated, the changes in our net interest income due to changes in volume and changes in interest rates. Changes in net interest income other than those due to volume have been included in changes due to rate:
Year Ended December 31, ----------------------- 2001 vs. 2000 2000 vs. 1999 ------------- ------------- Increase (Decrease) Increase (Decrease) Due to Change in Due to Change in Volume Rate Total Volume Rate Total (in thousands) Interest earning assets: Loans and leases (1) $ 42,159 $(25,231) $ 16,928 $ 38,078 $10,579 $ 48,657 Taxable securities 7,102 (8,082) (980) (3,186) 4,565 1,379 Tax-exempt securities (1) (192) (646) (838) 738 11 749 Federal funds sold 378 (421) (43) (116) 153 37 Other interest earning assets (51) (31) (82) 149 (22) 127 --- --- --- --- --- --- Total interest earning assets $ 49,396 $(34,411) $ 14,985 $ 35,663 $15,286 $ 50,949 ======== ======== ======== ======== ======= ======== Interest bearing liabilities: Savings and NOW accounts $ 1,329 $ (2,116) $ (787) $ 467 $ (142) $ 325 Money market accounts 10,396 (13,300) (2,904) 2,545 8,650 11,195 Savings certificates 1,499 (3,300) (1,801) 7,518 8,330 15,848 Short-term borrowings 1,625 (8,995) (7,370) 1,585 4,272 5,857 Long-term debt 2,488 (381) 2,107 3,373 1,670 5,043 Mandatorily redeemable preferred securities 4,985 - 4,985 - - - ----- ----- Total interest bearing liabilities 22,322 (28,092) (5,770) 15,488 22,780 38,268 ------ ------- ------ ------ ------ ------ Change in net interest income $ 27,074 $ (6,319) $ 20,755 $ 20,175 $(7,494) $ 12,681 ======== ======== ======== ======== ======= ======== ---------- (1) Interest income includes $8,140, $8,062 and $7,317, in 2001, 2000 and 1999 to adjust to a fully taxable basis using the federal statutory rate of 35%.
Tax-equivalent net interest income for 2001 was $179.8 million, an increase of 13.0% from the 2000 total of $159.1 million. Tax-equivalent net interest income in 2000 increased 8.7% from $146.4 million in 1999. The increase in net interest income resulted primarily from our average earning assets, which increased by $569.1 million or 15.1% in 2001 from 2000 and by $392.5 million or 11.6% in 2000 from 1999. Most of the increase in average earning assets was due to growth in loans. Average loans and leases increased by $460.9 million, or 16.8%, in 2001 from 2000 and by $434.6 million, or 18.8%, in 2000 from 1999. The Branch Acquisition in 2001, and the acquisitions of Northwest in 2000 and Dean in 1999 contributed significantly to the growth in loans. The positive impact on net interest income due to growth in average loans and leases in 2001 was partially offset by a decline in the net interest margin to 4.15% in 2001 from 4.22% in 2000 and 4.34% in 1999. Reductions in the general level of interest rates and some pricing adjustments on our interest bearing deposits reduced our overall cost of average interest bearing liabilities. The ratio of interest expense to average earning assets declined by 70 basis points to 3.63% in 2001 from 4.33% in 2000. These pricing adjustments were possible partially as a result of the Branch Acquisition, which added approximately $715 million of deposits to our balance sheet, and reduced the need for us to compete as aggressively for deposits. Offsetting this positive impact to the net interest margin was a 78 basis point decline in the average yield of average earning assets between the same two periods. In addition, the cost of funding the non-earning asset created by the premium associated with the Branch Acquisition reduced the 2001 net interest margin by approximately eight basis points compared to 2000. The decline in net interest margin in 2000 from 1999 was caused primarily by a 71 basis point increase in the cost of interest bearing liabilities. This increased cost was only partially offset by a 52 basis point increase in the average yield on earning assets between 1999 and 2000. In 2000, in response to strong competitive pressure in attracting deposits, we 17 emphasized our money market savings product and structured that product to be competitive with other short-term investment alternatives available to customers. Average money market savings grew by 23.5% in 2000 from 1999 and as a result, the increased cost of a more competitively positioned product contributed to the decline in net interest margin. Provision for Credit Losses. We establish the provision for credit losses based on a quarterly assessment of the adequacy of the reserve for credit losses. The provision for credit losses was $12.1 million in 2001 and $8.3 million in both 2000 and 1999. Net charge-offs were $8.2 million in 2001, $4.6 million in 2000, and in $5.6 million in 1999. For further information regarding the provision for credit losses, see the section entitled "Financial Condition - Reserve for Credit Losses." Noninterest Income. Noninterest income was $67.7 million in 2001 compared to $54.2 million in 2000 and $52.5 million in 1999. Recurring noninterest income, which excludes gains from other asset and securities sales, was $65.2 million in 2001 compared to $53.8 million in 2000 and $49.5 million in 1999. Recurring noninterest income increased by 21.3% in 2001 and 8.7% in 2000. The following table summarizes the components of noninterest income: Years Ended December 31, ------------------------ 2001 2000 1999 ---- ---- ---- (in thousands) Service charges $ 26,833 $ 22,284 $ 19,434 Insurance 10,282 10,045 9,703 Trust 9,443 9,139 7,984 Brokerage 4,550 5,481 4,533 Gain on sale of loans 9,375 2,758 3,380 Other recurring noninterest income 4,751 4,063 4,436 ----- ----- ----- Recurring noninterest income 65,234 53,770 49,470 Gain on sale of other assets 376 177 1,142 Gain on sale of securities 2,128 270 1,853 ----- --- ----- Total noninterest income $ 67,738 $ 54,217 $ 52,465 ======== ======== ======== Service charge income increased by 20.4% in 2001 from 2000 and 14.7% in 2000 from 1999. The Branch Acquisition in 2001 and the acquisition of Northwest in 2000 contributed significantly to the growth in service charge income. Brokerage revenue decreased by 17.0% in 2001 after an increase of 20.9% in 2000. Trust revenue increased by 3.3% in 2001 and 14.5% in 2000 while insurance revenue increased by 2.4% in 2001 and 3.5% in 2000. Both brokerage and trust revenue have been negatively impacted by the weak performance of the domestic equity markets over the last couple years. Gains on sales of loans result primarily from the sale of fixed rate residential real estate first mortgages into the secondary market. Volume of loan sales and the resulting income is heavily influenced by the general level of market interest rates and the specific level of customer refinancing activity. Income from loan sales increased by 239.9% in 2001 after a decrease of 18.4% in 2000. During 2001 the level of loan refinancing activity was higher than in 2000 due to the decline in mortgage interest rates. (The remainder of this page was intentionally left blank.) 18 Noninterest Expense. Noninterest expense increased $22.0 million, or 17.4% in 2001 and $4.7 million, or 3.8%, in 2000. The following table summarizes the components of noninterest expense: Years ended December 31, ------------------------ 2001 2000 1999 ---- ---- ---- (in thousands) Salaries and wages $ 65,703 $ 58,331 $ 54,164 Employee benefits 15,992 14,018 14,901 Occupancy 9,662 7,651 6,921 Furniture and equipment 10,075 9,432 9,170 Printing, postage and telephone 6,581 5,850 5,916 Marketing 6,951 4,862 4,760 Data processing fees 8,421 7,244 7,465 Professional fees 3,939 2,878 3,031 Other real estate owned 101 106 104 FDIC premiums and examination fees 1,616 1,652 1,297 Amortization of goodwill and other intangibles 6,653 3,713 2,831 Other noninterest expense 12,979 10,893 11,384 ------ ------ ------ Total noninterest expense $ 148,673 $ 126,630 $ 121,944 ========= ========= ========= Personnel costs, which include salaries, wages and employee benefits, accounted for 54.9% of noninterest expense in 2001, and increased by $9.4 million, or 12.9%, from 2000 and $3.3 million, or 4.8%, from 1999 to 2000. The Branch Acquisition in 2001 and the acquisition of Northwest in 2000 contributed significantly to the growth in personnel costs. Approximately $4.0 million of personnel costs in 2001, or 43.0% of the increase, were related to the Firstar acquisition. Excluding personnel costs, noninterest expense increased $12.7 million, or 23.4%, in 2001. Contributing to the increase in noninterest expense in 2001 were a $2.0 million increase in occupancy expense, a $2.1 million increase in marketing expenses, a $1.2 million increase in data processing fees, and a $2.9 million increase in amortization of goodwill and other intangible, all largely due to the Branch Acquisition. Excluding personnel costs, noninterest expense increased $1.4 million, or 2.7% in 2000. Contributing to the increase in noninterest expense in 2000 was a $1.0 million increase in occupancy and furniture and fixture expense, due in part to the Northwest and Dean acquisitions. The expense associated with goodwill and other intangibles also increased by $882 thousand, or 31.2% as a result of those two acquisitions. A common industry statistic used to measure the productivity of banking organizations is the operating efficiency ratio. The operating efficiency ratio measures the cost required to generate each dollar of revenue and is calculated by dividing recurring noninterest expense by tax-equivalent net interest income and recurring noninterest income. Our operating efficiency ratio was 57.6% in 2001 and 2000, and 60.5% in 1999. Our strategic goal is to move the operating efficiency ratio to 55.0% or below. Income Taxes. Income tax expense, which consists of provisions for federal and state income taxes, was $27.1 million for 2001 compared to $24.5 million in 2000 and $21.1 million in 1999. Our effective tax rate was 34.4% in 2001, a slight decrease from the effective rates of 34.8% in 2000 and 34.5% in 1999. (The remainder of this page was intentionally left blank.) 19 Financial Condition Loan and Lease Portfolio. We maintain a diversified loan and lease portfolio consisting of commercial, commercial real estate, agricultural, residential real estate, consumer, and tax-exempt loans and leases. The following table summarizes the components of our gross loan and lease portfolio:
At December 31, --------------- 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Amount % Amount % Amount % Amount % Amount % ------ - ------ - ------ - ------ - ------ - (dollars in thousands) Commercial and other $ 883,099 25.2% $ 717,936 24.6% $ 596,680 23.4% $ 475,556 21.8% $ 387,048 19.7% Commercial real estate 957,318 27.3 733,746 25.1 648,029 25.4 501,205 23.0 419,063 21.3 Construction 83,388 2.4 68,296 2.3 70,869 2.8 59,913 2.8 36,518 1.8 Agricultural 417,069 11.9 416,660 14.3 433,357 17.0 444,784 20.4 409,875 20.8 Residential real estate 708,334 20.2 578,876 19.8 450,812 17.7 376,652 17.3 387,549 19.7 Construction 19,300 0.6 18,051 0.6 15,274 0.6 13,397 0.6 12,609 0.6 Consumer 334,472 9.6 302,824 10.4 275,320 10.8 250,803 11.5 263,469 13.4 Tax-exempt 97,308 2.8 83,082 2.9 59,815 2.3 55,477 2.6 52,954 2.7 ------ --- ------ --- ------ --- ------ --- ------ --- Total loans and leases $3,500,288 100.0% $2,919,471 100.0% $2,550,156 100.0% $2,177,787 100.0% $1,969,085 100.0% ========== ===== ========== ===== ========== ===== ========= ===== ========== =====
At December 31, 2001, our loan and lease portfolio of $3.5 billion was comprised of 57.7% commercial credit, 30.4% consumer credit and 11.9% agricultural credit. The loan and lease portfolio increased $580.8 million, or 19.9%, in 2001 and $369.3 million, or 14.5%, in 2000. Approximately 53% of the loan growth during 2001 was related to the Branch Acquisition. Our commercial portfolio is primarily secured with collateral consisting of inventory, receivables and equipment. We utilize standard advance rates in determining amounts that can be advanced for each collateral type. Advances secured by inventory and receivables are normally short-term floating rate advances. Equipment loans typically amortize over five years. The commercial portfolio grew by $165.2 million, or 23.0%, to $883.1 million as of December 31, 2001 and has grown in excess of 20.0% for each of the last three years. Our commercial real estate portfolio, which includes interim commercial real estate construction loans, consists primarily of loans and leases to business customers who occupy the property or use the property for income production. Commercial real estate loans are generally made for up to 80.0% of appraised value or cost and typically have a term of five years with 15 to 20 year amortization. The commercial real estate portfolio increased $238.7 million, or 29.8%, in 2001 and $83.1 million, or 11.6%, in 2000. The Branch Acquisition was a significant contributor to the growth of the commercial real estate portfolio in 2001. Our agricultural loans include term loans secured by farmland or equipment, and operating loans used for commodity production. Our agricultural customers and agricultural-based communities are diversified across the three states we serve and we extend credit to 12 different types of commodity producers. Agricultural loans increased slightly to $417.1 million, an increase of $409 thousand, or 0.1%, in 2001 compared to a decrease of $16.7 million, or 3.9%, in 2000. For our agricultural customers, 2001 was a fairly average year with respect to crop conditions and prices. Government support programs continue to play an important role in the overall economics of farm production. At December 31, 2001, agricultural loans represented 11.9% of our total loans and leases, down from 14.3% in 2000 and 17.0% in 1999. This decrease reflects our continuing strategy of placing a reduced emphasis on agricultural lending relative to the portfolio as a whole. Residential real estate loans increased $130.7 million, or 21.9%, in 2001 and $130.8 million, or 28.1%, in 2000. The residential real estate portfolio includes home equity loans, first mortgage residential real estate loans, and some construction loans. The construction loans are typically made to builders on homes under construction that have been pre-sold. Home equity loans comprise approximately 68% of our $727.6 million in residential real estate loans as of December 31, 2001. Combined loan to value ratios for home equity loans typically range from 80.0% to 100.0%. Most of the increase in residential real estate loans in 2001 and 2000 was in home equity loans, which increased $183.5 million, or 59.0%, in 2001 and $82.3 million, or 36.0%, in 2000. A substantial portion of the home equity loan increase in 2001 was due to the Branch Acquisition. First mortgage residential real estate lending is generally conducted in compliance 20 with secondary market underwriting guidelines, and most newly originated fixed rate first mortgage loans are sold into the secondary market. Our consumer loan portfolio increased by $31.6 million, or 10.5%, in 2001 and $27.5 million, or 10.0%, in 2000. As of December 31, 2001, approximately $133.4 million, or 39.9%, of the consumer portfolio consisted of indirect auto loans, generally to borrowers within our market area. The remainder of the portfolio consisted of direct consumer loans, with credit card loans making up only about 1.8% of the total consumer portfolio. Tax-exempt loans and leases, which are made to municipalities and qualifying non-profit organizations, increased by $14.2 million, or 17.1%, in 2000 and $23.3 million, or 38.9%, in 2000. The following table summarizes the amount and maturity of the loan and lease portfolio as of December 31, 2001:
At December 31, 2001, Maturing in --------------------------------- One Year One to Over or Less Five Years Five Years Total ------- ---------- ---------- ----- (in thousands) Commercial and other $ 446,783 $ 383,058 $ 53,258 $ 883,099 Commercial real estate 176,613 572,071 208,634 957,318 Construction 22,967 35,967 24,454 83,388 Agricultural 184,517 176,765 55,787 417,069 Residential real estate 85,744 360,696 261,894 708,334 Construction 18,462 361 477 19,300 Consumer 119,948 205,776 8,748 334,472 Tax-exempt 19,334 24,205 53,769 97,308 ------ ------ ------ ------ Total loans and leases $1,074,368 $1,758,899 $667,021 $3,500,288 ========== ========== ======== ========== Loans and leases maturing after one year Fixed interest rate $1,172,867 $357,681 $1,530,548 Variable interest rate 586,032 309,340 895,372 ------- ------- ------- Total $1,758,899 $667,021 $2,425,920 ========== ======== ==========
(The remainder of this page was intentionally left blank.) 21 Nonperforming Assets. Nonperforming assets include nonaccrual loans, restructured loans, and other real estate acquired in loan settlements. The accrual of interest on loans and leases is suspended when the interest or principal payments are contractually past due 90 days or more, unless the loan is fully secured and in the process of collection. Payments received on nonaccrual loans are typically applied to principal and not recorded as income. Restructured loans generally continue to accrue interest but include concessions in terms as a result of the borrower's deteriorated financial condition. The following table presents comparative data for nonperforming assets:
At December 31, --------------- 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- (dollars in thousands) Nonaccrual loans and leases $ 20,307 $ 13,941 $ 16,608 $ 13,077 $ 8,958 Restructured loans and leases 499 50 48 178 910 --- -- -- --- --- Total nonperforming loans and leases 20,806 13,991 16,656 13,255 9,868 Other real estate owned (OREO) 1,616 3,658 527 620 691 ----- ----- --- --- --- Total nonperforming assets $ 22,422 $ 17,649 $ 17,183 $ 13,875 $ 10,559 ======== ======== ======== ======== ======== Accruing loans and leases 90 days or more past due $ 2,995 $ 3,590 $ 4,753 $ 1,142 $ 3,573 == ======== ======== ======== ======== ======== Nonperforming loans and leases to total loans and leases 0.60 % 0.48 % 0.65 % 0.61 % 0.50 % Nonperforming assets to total loans, leases and OREO 0.64 0.61 0.68 0.64 0.54 Nonperforming assets and accruing loans and leases 90 days or more past due to total loans, leases and OREO 0.73 0.73 0.86 0.69 0.72
Nonperforming assets were $22.4 million at December 31, 2001, compared to $17.6 million at the end of 2000 and $17.2 million at the end of 1999. Correspondingly, nonperforming assets as a percentage of total loans, leases, and other real estate owned increased to 0.64% at December 31, 2001, compared to 0.61% in 2000, but decreased from 0.68% reported in 1999. Nonperforming loans and leases, including nonaccrual and restructured loans and leases, totaled $20.8 million, or 0.60% of total loans and leases, at December 31, 2001, versus $14.0 million, or 0.48% of total loans and leases at December 31, 2000, and $16.7 million, or 0.65% of total loans and leases at December 31, 1999. The $6.8 million increase in nonperforming loans and leases between December 31, 2000 and December 31, 2001 includes a $3.1 million increase in commercial loans, a $2.2 million increase in residential real estate loans, and a $2.1 million increase in commercial real estate loans. These increases are largely the result of a weaker economic environment. Nonperforming assets have increased by an additional $6.4 million during the first quarter of 2002, primarily as a result of a single commercial credit. The $2.7 million decline in nonperforming loans and leases in 2000 from 1999 was primarily due to improvement in the agricultural loan portfolio. Other real estate owned ("OREO") decreased to $1.6 million at December 31, 2001, compared to $3.7 million at December 31, 2000 and $527 thousand at December 31, 1999. The increase in OREO in 2000 was primarily due to a single hotel property with a carrying value of $3.1 million that was acquired through foreclosure in the fourth quarter of 2000 and sold in May 2001. Reserve for Credit Losses. We maintain a reserve for credit losses to absorb losses inherent in the loan and lease portfolio. The reserve is based on ongoing, quarterly assessments of the probable estimated losses inherent in the loan and lease portfolio and, to a lesser extent, on unused commitments to provide financing. The reserve is increased by the provision for credit losses, which is charged against current period operating results and decreased by the amount of charge-offs, net of recoveries. Our methodology for assessing the appropriateness of the reserve consists of several key elements, which include the formula reserve, specific reserves, and the unallocated reserve. 22 The formula reserve is calculated by applying loss factors to our outstanding loans and certain unused commitments. Loss factors for each loan type are based on our historical loss experience through the course of the business cycle and may be adjusted for significant factors that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date. Specific reserves are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicate the probability that a loss has been incurred in excess of the amount determined by the application of the formula reserve. The unallocated reserve is comprised of two elements. The first element recognizes the model and estimation risk associated with the formula and specific reserves. The second element is based upon management's evaluation of various conditions that are not directly measured in the determination of the formula and specific reserves. The conditions evaluated in connection with the unallocated reserve may include existing general economic and business conditions affecting our key lending areas, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, specific industry conditions within portfolio segments, recent duration of the current business cycle, and findings of our internal loan review examiners. The reserve also incorporates the results of measuring impaired loans and leases as provided in Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan," and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures." These accounting standards prescribe the measurement methods, income recognition, and disclosures related to impaired loans and leases. A loan is considered impaired when management determines that it is probable that we will be unable to collect all amounts due according to the original contractual terms of the loan or lease agreement. Impairment is measured by the difference between the recorded investment in the loan or lease (including accrued interest, net deferred loan fees or costs, and unamortized premium or discount) and the estimated present value of total expected future cash flows, discounted at the loan's effective rate, or the fair value of the collateral, if the loan is collateral dependent. Impairment is recognized by adjusting the reserve for credit losses. (The remainder of this page was intentionally left blank.) 23 The reserve for credit losses was $53.7 million, or 1.54% of total loans and leases, at December 31, 2001, compared to $45.9 million, or 1.57% of loans and leases, at December 31, 2000, and $41.9 million, or 1.65% of loans and leases, at December 31, 1999. Activity in the reserve for credit losses for the past five years is shown in the following table:
For the Years Ended December 31, -------------------------------- 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- (dollars in thousands) Beginning of year $ 45,895 $ 41,895 $ 37,019 $ 34,253 $ 30,482 Charge-offs: Commercial and other 6,316 3,273 1,270 820 604 Commercial real estate 174 287 1,445 152 427 Construction - 24 - 25 2 Agricultural 377 518 2,138 835 288 Residential real estate 422 320 351 328 100 Consumer 2,563 1,481 1,860 1,808 1,338 ----- ----- ----- ----- ----- Total charge-offs 9,852 5,903 7,064 3,968 2,759 ----- ----- ----- ----- ----- Recoveries: Commercial and other 555 320 351 218 379 Commercial real estate 100 226 152 322 173 Construction - 5 - - 10 Agricultural 384 165 355 102 65 Residential real estate 35 64 36 30 104 Consumer 545 491 545 492 295 --- --- --- --- --- Total recoveries 1,619 1,271 1,439 1,164 1,026 ----- ----- ----- ----- ----- Net charge-offs 8,233 4,632 5,625 2,804 1,733 Provision for credit losses 12,054 8,338 8,321 5,570 4,746 Reserve related to acquired assets 4,000 294 2,180 - 758 ----- --- ----- --- End of year $ 53,716 $ 45,895 $ 41,895 $ 37,019 $ 34,253 ======== ======== ======== ======== ======== Average loans and leases $3,210,537 $2,749,662 $2,315,105 $2,084,462 $1,838,218 Annualized net charge-offs to average loans and leases 0.26 % 0.17 % 0.24 % 0.13 % 0.09 % ---------- Reserve as a percentage of: Period-end loans and leases 1.54 % 1.57 % 1.65 % 1.70 % 1.74 % Nonperforming loans and leases 258.17 328.03 251.53 279.28 347.11 Nonperforming assets 239.57 260.04 243.82 266.80 324.40
Net charge-offs were $8.2 million in 2001, $4.6 million in 2000, and $5.6 million in 1999. Expressed as a percentage of average loans and leases, net charge-offs increased to 0.26% in 2001 from 0.17% in 2000. Charge-offs of commercial loans increased to $6.3 million in 2001 from $3.3 million in 2000. A single commercial loan in the amount of $2.0 million which was fully charged-off in the first quarter of 2001 accounted for a significant portion of this increase. Charge-offs of consumer loans increased to $2.6 million in 2001 from $1.5 million in 2000. Charge-offs in the agricultural loan portfolio declined to $377 thousand in 2001 from $518 thousand in 2000. The provision for credit losses was $12.1 million in 2001 and $8.3 million in both 2000 and 1999. The reserve to nonperforming loans decreased to 258.17% at December 31, 2001, from 328.03% at December 31, 2000 and 251.53% at December 31, 1999. The ratio of classified loans, which include those loans with an internal loan review rating of substandard, doubtful or loss, to total loans was 3.7% at December 31, 2001 compared to 3.1% at December 31, 2000 and 4.5% at December 31, 1999. 24 Management has allocated the reserve to sectors based on relative risk characteristics of the loan and lease portfolio. Commercial allocations are based on a quarterly review of individual loans outstanding and commitments to extend credit and standby letters of credit. Consumer allocations are based on an analysis of product mix, credit scoring and risk composition of the portfolio, fraud loss and bankruptcy experiences, historical and expected delinquency, and charge-off statistics for each homogenous category or group of loans. The following table shows the allocation of the reserve for credit losses to sectors for each of the last five years:
At December 31, --------------- 2001 2000 1999 1998 1997 Percent of Percent of Percent of Percent of Percent of Loans and Loans and Loans and Loans and Loans and Leases to Leases to Leases to Leases to Leases to Total Loans Total Loans Total Loans Total Loans Total Loans Amount and Leases Amount and Leases Amount and Leases Amount and Leases Amount and Leases (dollars in thousands) Commercial and other $18,800 25.2 % $12,800 24.6 % $10,200 23.4 % $ 8,300 21.8 % $ 7,700 19.7 % Commercial real estate 13,900 29.7 9,900 27.4 9,200 28.2 10,100 25.8 9,300 23.1 Agricultural 8,700 11.9 9,300 14.3 11,900 17.0 8,200 20.4 7,000 20.8 Residential real estate 3,600 20.8 1,900 20.4 1,900 18.3 2,700 17.9 2,400 20.3 Consumer 2,800 9.6 2,500 10.4 2,300 10.8 1,500 11.5 1,700 13.4 Tax-exempt 100 2.8 100 2.9 600 2.3 300 2.6 300 2.7 Unallocated 5,816 - 9,395 - 5,795 - 5,919 - 5,853 - ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- Total reserve $53,716 100.0 % $45,895 100.0 % $41,895 100.0 % $37,019 100.0 % $34,253 100.0 % ======= ===== ======= ===== ======= ===== ======= ===== ======= =====
Approximately $5.8 million, or 10.8%, of the reserve for loan and lease losses is not allocated to specific credits at December 31, 2001, compared to $9.4 million, or 20.5%, at December 31, 2000 and $5.8 million, or 13.8%, at December 31, 1999. Securities. Our investment portfolio consists of investments and mortgage backed securities that we intend to hold to maturity which are valued at amortized cost. Our portfolio also includes debt and equity securities that are available-for-sale which are valued at current market value. The investment portfolio is maintained primarily for liquidity and collateral purposes and to generate interest income. Our investment portfolio consists primarily of low risk government and government agency backed securities and high grade municipal bonds. The securities portfolio increased by $250.0 million, or 26.3%, to $1.2 billion at December 31, 2001 from $951.6 million at December 31, 2000 and $1.0 billion at December 31, 1999. The increase in the portfolio during 2001 was primarily due to the investment of cash received as a result of the Branch Acquisition. (The remainder of this page was intentionally left blank.) 25 The following table presents the amortized cost and fair value of securities held on December 31, 2001:
At December 31, 2001 -------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gain Loss Value ---- ---- ---- ----- (in thousands) Securities available-for-sale: U. S. Treasury securities $ 1,318 $ 68 $ - $ 1,386 U. S. government agency obligations 123,808 1,142 97 124,853 Obligations of state and political subdivisions 33,787 797 1 34,583 Mortgage-backed securities 774,274 7,111 847 780,538 Equity securities 43,201 103 8 43,296 Other 35,842 76 - 35,918 ------ -- -- ------ Total securities available-for-sale $1,012,230 $9,297 $ 953 $1,020,574 ========== ====== ======= ========== Securities held-to-maturity: U. S. government agency obligations $ 5,064 $ 56 $ - $ 5,120 Obligations of state and political subdivisions 176,007 3,199 756 178,450 ------- ----- --- ------- Total securities held-to-maturity $ 181,071 $3,255 $75,655 $ 183,570 ========== ====== ======= ==========
The following table presents the maturity of securities held at December 31, 2001 and the weighted average rates by range of maturity. The table includes projected payments on mortgage-backed securities. Certain equity securities, which include Federal Home Loan Bank stock, Federal Reserve Bank stock, Federal Home Loan Mortgage Corporation preferred stock, and Federal National Mortgage Association preferred stock, do not have a stated face rate or maturity. Equity securities are presented in this table based on estimated rates at December 31, 2001:
Amortized Cost -------------- Within 1 Year 1-5 Years 5-10 Years After 10 Years Totals ------------- --------- ---------- -------------- ------ Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield ------ ----- ------ ----- ------ ----- ------ ----- ------ ----- ( dollars in thousands) U.S. Treasury securities and obligations of U.S. government agencies $ 26,697 2.99 % $ 74,037 2.87 % $ 28,319 2.67 % $ 1,137 2.67 % $ 130,190 2.85 % Obligations of states and political subdivisions (1) 42,142 7.73 105,068 7.43 61,124 7.33 1,460 7.22 209,794 7.45 Mortgage-backed securities 12,863 6.12 337,238 5.72 130,385 4.83 93,788 3.48 774,274 5.41 Equity securities - - - - - - - - 43,201 5.63 Other securities 33,807 3.42 - - 2,035 6.81 - - 35,842 3.42 ------ ---- ---- ---- ----- ---- ---- ---- ------ ---- Total Investment Securities $315,509 5.78 % $516,343 5.66 % $221,863 5.29 % $96,385 4.12 % $1,193,301 5.44 % ======== ==== ======== ==== ======== ==== ======= ==== ========== ==== (1) Yields are presented on a tax-equivalent basis to reflect the tax-exempt nature of these securities. The incremental federal statutory rate applied is 35%.
The average maturity of the portfolio was 50 months at December 31, 2001, with an average tax-equivalent yield to maturity on the portfolio of 5.44%, unrealized gains of $12.6 million and unrealized losses of $1.7 million. This compares to an average maturity of 66 months at December 31, 2000, and an average tax-equivalent yield to maturity of 7.00%, unrealized gains of $8.9 million, and unrealized losses of $3.1 million. At December 31, 2001, the market value of our securities was $1.2 billion, or $10.8 million over its amortized cost. This compares to a market value of $954.8 billion, or $5.7 million over amortized cost, at December 31, 2000. Total Deposits. Deposits increased by $699.9 million, or 22.5% in 2001, and $256.1 million, or 9.0% in 2000. The Branch Acquisition in 2001 and the Northwest acquisition in 2000 were significant contributors to overall deposit 26 growth. Noninterest bearing deposits increased by $200.1 million, or 43.8%, in 2001, and $50.1 million, or 12.3%, in 2000. Savings, NOW, and money market accounts increased $493.4 million, or 43.1%, in 2001, and $113.0 million, or 10.9%, in 2000. As part of our strategy to grow deposits, we have placed a strong emphasis on the money market savings product and have structured that product to be competitive with other short-term investment alternatives available to customers. Money market savings balances increased by $329.2 million, or 50.5%, in 2001, and $147.9 million, or 29.4%, in 2000. Savings certificate balances increased by $6.4 million, or 0.4%, in 2001, and $93.0 million, or 6.6%, in 2000. The lower growth rate for certificate balances compared to other transaction accounts is consistent with our goal to place less emphasis on savings certificates in our deposit funding. The decline in interest rates during 2001 also made savings certificates a less attractive product option for customers. At December 31, 2001, savings certificates included $10.0 million of deposits acquired through brokers. This compares with $76.7 million of brokered deposits at December 31, 2000 and $58.7 million at December 31, 1999. These brokered deposits mature during the first half of 2002 and we do not expect to replace them. The following table sets forth the distribution of our deposits by type:
At December 31, --------------- 2001 2000 1999 ---- ---- ---- Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- (dollars in thousands) Noninterest bearing deposits $ 656,651 17.3 % $ 456,571 14.7 % $ 406,478 14.3 % Savings and NOW accounts 411,193 10.8 318,481 10.3 342,752 12.0 Money market accounts 1,228,282 32.3 827,578 26.6 690,276 24.2 Time certificates of deposit: Less than $100,000 1,241,710 32.6 1,175,006 37.8 1,118,657 39.3 $100,000 or more 268,182 7.0 328,446 10.6 291,783 10.2 -------- ------- --- ------- ---- ------- ---- $3,806,018 100.0 % $3,106,082 100.0 % $2,849,946 100.0 % ========== ===== ========== ===== ========== =====
Included in interest bearing deposits at December 31, 2001 were $268.2 million of time deposits that had balances of $100,000 or more at December 31, 2001. Maturities of these time deposits are summarized as follows: At December 31,2001 ------------------- (in thousands) Three months or less $ 78,811 Over three months to six months 55,403 Over six months to twelve months 67,303 Over twelve months 66,665 ------ Total $ 268,182 ========= Short-Term Borrowings. Short-term borrowings include federal funds purchased, securities sold under agreements to repurchase, treasury tax and loan notes, Federal Home Loan Bank ("FHLB") advances with original maturities of one year or less, and advances under an unsecured revolving credit facility. Short-term borrowings increased 1.6% to $448.9 million at December 31, 2001 from $441.7 million at December 31, 2000 and from $427.4 million at December 31, 1999. Repurchase agreements with customers, which constitute 82.8% of short-term borrowings at December 31, 2001, increased to $371.8 million at the end of 2001 from $285.1 million at the end of 2000 and $261.1 million at the end of 1999. At December 31, 2001, 88.6% of the customer repurchase agreements were related to daily checking account sweep mechanisms that are part of our cash management product line. FHLB advances with maturities of one year or less declined to $35.0 million at the end of 2001 from $95.0 million at the end of 2000 and $107.0 million at the end of 1999. The decline of short-term FHLB advances came as the result of the Branch Acquisition, which increased our deposit base and decreased our need for this type of funding. The total amount that can be 27 borrowed under the unsecured revolving credit facility is $45.0 million. The facility is used primarily to provide funding to the Bremer Business Finance Corporation. Advances under this short-term revolving credit facility were $33.0 million at December 31, 2001, compared to $15.0 million at December 31, 2000 and $16.0 million at December 31, 1999. The following table presents a summary of our short-term borrowings for the periods ended on the dates indicated:
Federal Funds Federal Home Treasury Revolving and Repurchase Loan Bank Tax and Loan Credit Agreements Borrowings Notes Facility ---------- ---------- ----- -------- (dollars in thousands) Balance at December 31 2001 $ 377,762 $ 35,000 $ 3,150 $ 33,000 2000 329,061 95,000 2,685 15,000 1999 300,737 107,000 2,948 16,000 Weighted average interest rate at December 31 2001 2.08 % 3.55 % 1.68 % 2.77 % 2000 6.49 6.55 6.25 7.16 1999 5.41 5.67 5.25 6.74 Maximum amount outstanding at any month end 2001 $ 415,261 $ 331,000 $ 3,150 $ 42,000 2000 329,102 165,419 3,899 40,000 1999 300,737 156,755 12,461 99,000 Average amount outstanding during the year 2001 $ 337,511 $ 84,152 $ 2,188 $ 26,556 2000 287,563 105,428 2,412 27,855 1999 246,666 84,556 3,553 55,875 Weighted average interest rate during the year 2001 3.60 % 5.21 % 3.32 % 5.06 % 2000 5.72 6.28 6.18 7.58 1999 4.53 5.47 4.65 6.23
Long-Term Debt. Long-term debt, which includes senior notes, FHLB advances with original maturities of greater than one year, and installment promissory notes, increased $83.3 million, or 35.8%, in 2001, and $16.8 million, or 7.8%, in 2000. The following table summarizes long-term debt for the last three years: At December 31, --------------- 2001 2000 1999 ---- ---- ---- (in thousands) Senior notes $ 65,000 $ 65,000 $ 65,000 Federal Home Loan Bank borrowings 248,594 164,908 147,587 Installment promissory notes 2,329 2,752 3,245 ----- ----- ----- Total $315,923 $232,660 $215,832 ======== ======== ======== We issued the senior notes in November 1999. The proceeds were used in connection with the Dean and Northwest acquisitions. The installment promissory note obligations were incurred in connection with previous acquisitions. Company Obligated Mandatorily Redeemable Preferred Securities. We issued $76.5 million of mandatorily redeemable preferred securities in two separate transactions in 2001 in conjunction with the Branch Acquisition. On February 22, 2001, we issued $16.5 million of 10.2% Capital Securities through Bremer Statutory Trust I ("BST"), and on May 8, 2001, we issued $60 million of 9.0% Cumulative Capital Securities through Bremer Capital Trust I ("BCT.") The proceeds of both of these offerings, combined with the proceeds from the sale by BST and BCT to the parent of their common securities, were invested by BST and BCT in Junior Subordinated Deferrable Interest Debentures ("debentures") of our parent company. The debentures mature not earlier than July 15, 2006 and not later than July 15, 2031. At December 31, 2001, $76.5 million in Capital Securities qualified as Tier I capital under guidelines of the Federal Reserve. 28 Equity of Shareholders and Redeemable Class A Common Stock. Shareholders' equity and redeemable class A common stock was $389.9 million at December 31, 2001 compared to $354.0 million at December 31, 2000 and $312.9 million at December 31, 1999. Book value per share increased to $32.49 at December 31, 2001 from $29.50 at December 31, 2000 and $26.07 at December 31, 1999. Dividends paid per share increased to $1.60 in 2001 from $1.39 in 2000 and $1.32 in 1999. The dividends paid in 2001 of $19.2 million represented 5.4% of the equity of shareholders at December 31, 2000 and 37.2% of 2001 net income. Realized book value per share, which excludes the impact of the net unrealized gain or loss on securities available-for-sale, increased to $32.08 at December 31, 2001 from $29.37 at December 31, 2000, and $26.95 at December 31, 1999. Capital Management. The Federal Deposit Insurance Corporation Improvement Act ("FDICIA") required the establishment of a capital-based supervisory system of prompt corrective action for all depository institutions. The Federal Reserve Board's implementation of FDICIA defines "well-capitalized" institutions as those whose Tier I capital ratio equals or exceeds 6%, total risk-based capital ratio equals or exceeds 10%, and leverage ratio equals or exceeds 5%. We have maintained our capital at the "well-capitalized" level in each of these categories in the past and expect to do so in the future. The capital ratios of the Subsidiary Banks in each of these categories met or exceeded the "well-capitalized" ratios as of December 31, 2001. The following table compares the consolidated capital ratios with the minimum requirements for well capitalized and adequately capitalized banks as of December 31, 2001: Minimum Requirements -------------------- Well Adequately Capital Category Actual Capitalized Capitalized ---------------- ------ ----------- ----------- Tier I capital to risk-weighted assets 9.94 % 6.00 % 4.00 % Total capital to risk-weighted assets 11.19 10.00 8.00 Tier I capital to average tangible assets 7.27 5.00 4.00 Payment of dividends to us by the subsidiary banks is subject to various limitations by bank regulators, which includes maintenance of certain minimum capital ratios. Asset Liability Management Liquidity Management. The objective of liquidity management is to ensure the continuous availability of funds to meet our financial commitments. We use an asset liability management committee ("ALCO") as part of our risk management process. ALCO is responsible for managing balance sheet and off-balance sheet commitments to meet the needs of customers while achieving our financial objectives. ALCO meets regularly to review funding capacity, current and forecasted loan demand, investment opportunities, and liquidity positions as outlined in our asset liability policy. With this information, ALCO guides changes in the balance sheet structure to provide for adequate ongoing liquidity. Several factors provide for a favorable liquidity position. The first is the ability to acquire and retain funds in the local markets we serve. This in-market funding provides an historically stable source of funding and represented approximately 89% of total liabilities during 2001. Our available-for-sale securities portfolio is a secondary source of liquidity because of its readily marketable nature and predictable stream of maturities. While we prefer to fund the balance sheet with in-market funding sources, another source of liquidity is our ready access to regional and national wholesale funding markets, including federal funds purchased, Federal Home Loan Bank advances, and brokered deposits. As of December 31, 2001, we also had available $12.0 million of borrowing capacity under a $45.0 million unsecured credit facility. As of December 31, 2001, $33.0 million was advanced and outstanding under this facility. This credit facility is used primarily to provide funding availability for non-bank activities. Interest Rate Risk Management. Interest rate risk is the risk that changing interest rates will adversely affect net income and balance sheet valuations. The objective of interest rate risk management is to control this risk exposure. The responsibility for this process rests with ALCO. ALCO establishes appropriate risk management policies and monitors asset liability activities to minimize our exposure to adverse interest rate trends. The tools used to measure interest rate risk include a valuation model which measures the sensitivity of balance sheet valuations to changes in interest rates, gap analysis, and simulation of future net income. 29 In the valuation model, the market value of each asset and liability as of the reporting date is calculated by computing the present value of all cash flows to be generated. In each case, the cash flows are discounted by a market interest rate chosen to reflect as closely as possible the characteristics of the given asset or liability as obtained from independent broker quotations and other public sources. The impact on valuations is then calculated for a 200 basis point rate shock. The rate shock is an instantaneous change in market rates across the yield curve. Significant assumptions required in the use of the valuation model include estimates regarding prepayment activity and the behavior of non-maturity deposits in various interest rate environments. The model does not reflect actions that ALCO could initiate in response to a change in interest rates. The valuation model indicates that the value of assets would decline approximately 2.7% with a 200 basis point increase in interest rates. After considering the impact on liabilities and tax effects, the market value of equity impact from this 200 basis point increase in rates would be a decrease of approximately 4.8%. This is within our maximum risk limit of 20.0% for this risk measure. The matching of assets and liabilities may be analyzed by examining to the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap". An asset or liability is said to be interest rate sensitive within a specific time period if it matures or reprices within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest earning assets anticipated, based on certain assumptions, to mature or reprice within a specific time period and the amount of interest bearing liabilities anticipated, based on certain assumptions, to mature or reprice within that same time period. An interest rate sensitivity gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities that mature or reprice within a specified time period. An interest rate gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets that mature or reprice within a specified time period. (The remainder of this page was intentionally left blank.) 30 The following table sets forth at December 31, 2001 the amounts of interest earning assets and interest bearing liabilities maturing or repricing within the time periods indicated, based on the information and assumptions set forth in the notes thereto:
Amount Repricing or Maturing ---------------------------- Within 3 - 12 1 - 5 Over 5 3 Months Months Years Years Total -------- ------ ----- ----- ----- (dollars in thousands) Interest earning assets (1) Loans and leases $1,505,013 $ 713,350 $1,135,993 $145,932 $3,500,288 Securities 265,058 341,944 432,794 161,849 1,201,645 Other earning assets 6,508 - - - 6,508 ----- ----- Total interest earning assets $1,776,579 $1,055,294 $1,568,787 $307,781 $4,708,441 ========== ========== ========== ======== ========== Interest bearing liabilities Interest bearing deposits (2) $1,340,573 $ 819,270 $ 988,834 $ 690 $3,149,367 Short-term borrowings 436,380 10,353 2,179 - 448,912 Long-term debt (3) 144 19,007 199,758 97,014 315,923 Mandatorily redeemable preferred securities - - - 76,500 76,500 ------ ------ ------ ------ ------ Total interest bearing liabilities $1,777,097 $ 848,630 $1,190,771 $174,204 $3,990,702 ---------- ---------- ---------- -------- ---------- Rate sensitive gap $ (518) $ 206,664 $ 378,016 $133,577 $ 717,739 ====== ========== ========== ======== ========= Cumulative rate sensitive gap $ (518) $ 206,146 $ 584,162 $717,739 ====== ========== ========== ======== Rate sensitive gap % to total assets - 4.1 % 7.4 % 2.6 % 14.1 % Cumulative rate sensitive gap % to total assets - 4.0 11.5 14.1 (1) Adjustable and floating rate assets are included in the period in which interest rates are next scheduled to adjust rather than in the period in which they are due. Fixed rate assets are included in the periods in which they are scheduled to be repaid based on scheduled amortization, except for mortgage backed securities which are adjusted for prepayment assumptions. (2) Includes non-maturity savings and NOW accounts positioned to run off evenly over sixty months and money market savings accounts, most of which are positioned to reprice within three months. (3) Adjustable and floating rate borrowings are included in the period in which their interest rates are next scheduled to adjust rather than in the period in which they are due.
The repricing gaps are well within our risk tolerances, which limit the maximum 90-day and one-year gaps to 15.0% of total assets. We also use simulation modeling of future net interest income and net income as a risk management tool. Simulation modeling results indicate that net income would decrease by approximately 6.3% over the next year with a 300 basis point decline in the level of rates and increase approximately 1.4% with a 300 basis point increase in the level of rates. The projected changes in net income are within the current policy limit that requires that the change in net income over the next 12 months not exceed 8.0%. Other Market Risk. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of our business activities. Impact of Inflation and Changing Prices The consolidated financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The assets and liabilities of a financial institution are primarily monetary in nature. As a result, interest rates have more impact on our performance than the effects of general levels of inflation. Interest rates do not necessarily move 31 in the same direction or in the same magnitude as the prices of goods and services. The liquidity and the maturity structure of our assets and liabilities are important to the maintenance of acceptable performance levels. We disclose the estimated fair values of our financial instruments in accordance with SFAS No. 107, "Disclosures about Fair Value of Financial Instruments." Effects of a Recessionary Economy This past year has been one of substantial economic and market turmoil. During such times, it is not uncommon for borrowers to have cash flow difficulties and stress on their debt servicing abilities. This is one of our greatest risks as a financial services provider in this type of an environment. We have been closely monitoring credit trends and customer situations in order to make necessary adjustments to our loan loss reserves and credit policies. When we first saw signs of a slowing economy in late 2000, we increased our loan loss reserves. In 2001, we increased our provision for loan losses approximately 50% as a reaction to this risk. While we have seen the growth in new lending opportunities slow in recent months, we have continued to maintain our underwriting standards. Conversely, we have seen our net interest margin increase during the latter half of 2001 and early 2002, as our lower cost of wholesale borrowing and customer deposit preferences have had a positive impact on our interest bearing liability costs. At this time, the ultimate effect of the recession on our borrowers and credit quality is unknown. However, we aware of the risks and believe that our diverse loan portfolio and our geographic dispersion will serve to mitigate any significant impact to our organization as the economy struggles to improve. Commitments and Contingencies We utilize various off-balance sheet instruments to satisfy the financing needs of customers. These instruments represent our contractual obligations to provide funding, within a specified time period, to a customer. The following represents the outstanding obligations at December 31: 2001 2000 ---- ---- (in thousands) Standby letters of credit $ 18,394 $ 26,567 Loan commitments 848,391 586,873 Standby letters of credit represent a conditional commitment to satisfy an obligation to a third party, generally to support public and private borrowing arrangements, on behalf of the customer. Loan commitments represent contractual agreements to provide funding to customers over a specified time period as long as there is no violation of any condition of the contract. These loans generally will take the form of operating lines. Our potential exposure to credit loss in the event of nonperformance by the other party is represented by the contractual amount of those instruments. The credit risk associated with letters of credit and loan commitments is substantially the same as extending credit in the form of a loan; therefore, the same credit policies apply in evaluating potential letters of credit or loan commitments. The amount of collateral obtained, if deemed necessary upon the extension of credit, is based on management's credit evaluation. The type of collateral held varies, but includes accounts receivable, inventory, and productive assets. Under substantially noncancelable contracts, we are obligated to pay approximately $4.5 million in annual data processing and item processing fees to third party providers through February 2004 and March 2006, respectively. The costs under the item processing contract are calculated in accordance with a volume-based fee schedule, which is subject to change annually We are routinely involved in legal actions which are incidental to our business. Although it is difficult to predict the ultimate outcome of these cases, management believes, based on discussions with counsel, that any ultimate liability will not materially affect the consolidated financial position or operations. 32 Recent Accounting Pronouncements Accounting for Derivatives. On January 1, 2001, we adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137, "Deferral of the Effective Date of FASB Statement No. 133," and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that all derivatives, including those embedded in other contracts, be recognized as either assets or liabilities and that those financial instruments be measured at fair value. Management has reviewed the requirements of SFAS No. 133 and has determined that we have a minimal amount of derivatives and that there is no material impact to the financial statements due to the adoption of SFAS No. 133. Business combinations. In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations," which replaces Accounting Principles Board Opinion ("APB") No. 16, and requires all business combinations initiated after June 30, 2001 to use the purchase method of accounting; the pooling of interest method of accounting is prohibited except for transactions initiated before July 1, 2001. While SFAS No. 141 will affect how future business combinations, if undertaken, are accounted for and disclosed in the financial statements, the issuance of the new guidance had no effect on our results of operation, financial position or liquidity during 2001. Goodwill and other intangible assets. In conjunction with the issuance of the new guidance for business combinations, the FASB also issued SFAS No. 142, "Goodwill and Other Intangible Assets," which addresses the accounting and reporting for acquired goodwill and other intangible assets and supersedes APB No. 17. Under the provisions of SFAS No. 142, intangible assets acquired in a business combination, which do not possess finite useful lives will no longer be amortized into net income over an estimated useful life but rather will be tested for impairment at least annually based on specific guidance provided in the new standard. We adopted SFAS No. 142 on January 1, 2002. As of December 31, 2001, we had net goodwill of approximately $43 million and other intangible assets of approximately $66 million. Amortization expense recorded during the year ended December 31, 2001 was $6.7 million. The adoption of SFAS No. 142 will have no material impact on our financial statements. The elimination of amortization of goodwill will be offset by recording a full year of amortization of the intangible assets recorded in conjunction with the Branch Acquisition described in Note B. SFAS No. 142, as part of its adoption provisions, requires a transitional impairment test be applied to all goodwill and other indefinite-lived intangible assets within the first half of 2002 and any resulting impairment loss be reported as a change in accounting principle. Management has performed a preliminary transitional impairment test on its goodwill assets and at this time does not expect an impairment loss to be recorded in 2002 as a result of this test. Asset Retirement Obligations. In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which is required to be adopted for fiscal years beginning after June 15, 2002. SFAS No. 143 establishes accounting and reporting standards for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of the fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. We expect to adopt SFAS No. 143 on January 1, 2003. We have not yet determined the impact of SFAS No. 143 on our financial position and results of operations. Accounting for long-lived assets. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which is required to be adopted for fiscal years beginning after December 15, 2001. SFAS No. 144 establishes accounting and reporting standards for the impairment or disposal of long-lived assets. The provisions of SFAS No. 144 became effective for us January 1, 2002 and are not expected to have a material impact on our financial position or results of operations. 33 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA BREMER FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 2001 and 2000 (in thousands except share data)
2001 2000 ---- ---- Assets Cash and due from banks $ 213,101 $ 200,547 Interest bearing deposits 4,250 5,731 Investment securities available-for-sale 240,036 208,630 Mortgage-backed securities available-for-sale 780,538 574,884 ------- ------- Total securities available-for-sale 1,020,574 783,514 Investment securities held-to-maturity (fair value: 12/31/01 - $183,570, 12/31/00 - $171,263) 181,071 168,113 -- -- -- --------- -- -- -- -------- ------- ------- Total securities held-to-maturity 181,071 168,113 Loans and leases 3,500,288 2,919,471 Reserve for credit losses (53,716) (45,895) Unearned discount (1,449) (3,870) ------ ------ Net loans and leases 3,445,123 2,869,706 Interest receivable 37,350 40,822 Premises and equipment, net 65,062 57,742 Goodwill and other intangibles 108,652 49,373 Other assets 18,881 17,048 ------ ------ Total assets $5,094,064 $4,192,596 ========== ========== Liabilities and Shareholders' Equity Noninterest bearing deposits $ 656,651 $ 456,571 Interest bearing deposits 3,149,367 2,649,511 --------- --------- Total deposits 3,806,018 3,106,082 Federal funds purchased and repurchase agreements 377,762 329,061 Other short-term borrowings 71,150 112,685 Long-term debt 315,923 232,660 Company obligated mandatorily redeemable preferred securities of subsidiary trusts holding junior subordinated debentures 76,500 - Accrued expenses and other liabilities 56,649 57,919 ------ ------ Total liabilities 4,704,002 3,838,407 Minority interests 150 150 Redeemable class A common stock, 960,000 shares issued and outstanding 31,193 28,324 Shareholders' equity Common stock Class A, no par, 12,000,000 shares authorized; 240,000 shares issued and outstanding 57 57 Class B, no par, 10,800,000 shares authorized, issued and outstanding 2,562 2,562 Retained earnings 351,497 321,665 Accumulated other comprehensive income 4,603 1,431 ----- ----- Total shareholders' equity 358,719 325,715 ------- ------- Total liabilities and shareholders' equity $5,094,064 $4,192,596 ========== ========== See notes to consolidated financial statements.
34 BREMER FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2001, 2000 and 1999 (in thousands, except per share amounts)
2001 2000 1999 ---- ---- ---- Interest income Loans and leases, including fees $265,758 $249,178 $201,022 Securities Taxable 52,060 53,040 51,661 Tax-exempt ` 10,514 11,082 10,577 Federal funds sold 569 612 575 Other 177 259 132 --- --- --- Total interest income 329,078 314,171 263,967 Interest expense Deposits 118,253 123,745 96,377 Federal funds purchased and repurchase agreements 12,155 16,445 11,226 Other short-term borrowings 5,804 8,884 8,246 Long-term debt 16,215 14,108 9,065 Company obligated manditorily redeemable preferred securities of subsidiary trusts holding junior subordinated debentures 4,985 - - ----- ---- ---- Total interest expense 157,412 163,182 124,914 ------- ------- ------- Net interest income 171,666 150,989 139,053 Provision for credit losses 12,054 8,338 8,321 ------ ----- ----- Net interest income after provision for credit losses 159,612 142,651 130,732 Noninterest income Service charges 26,833 22,284 19,434 Insurance 10,282 10,045 9,703 Trust 9,443 9,139 7,984 Brokerage 4,550 5,481 4,533 Gain on sale of loans 9,375 2,758 3,380 Gain on sale of securities 2,128 270 1,853 Other 5,127 4,240 5,578 ----- ----- ----- Total noninterest income 67,738 54,217 52,465 Noninterest expense Salaries and wages 65,703 58,331 54,164 Employee benefits 15,992 14,018 14,901 Occupancy 9,662 7,651 6,921 Furniture and equipment 10,075 9,432 9,170 Data processing fees 8,421 7,244 7,465 FDIC premiums and examination fees 1,616 1,652 1,297 Amortization of goodwill and other intangibles 6,653 3,713 2,831 Other 30,551 24,589 25,195 ------ ------ ------ Total noninterest expense 148,673 126,630 121,944 ------- ------- ------- Income before income tax expense 78,677 70,238 61,253 Income tax expense 27,051 24,457 21,142 ------ ------ ------ Net income $ 51,626 $ 45,781 $ 40,111 ======== ======== ======== Per common share amounts: Net income-basic and diluted $ 4.30 $ 3.82 $ 3.34 Dividends paid 1.60 1.39 1.32 See notes to consolidated financial statements.
35 BREMER FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years Ended December 31, 2001, 2000 and 1999 ( in thousands, except per share amounts)
Accumulated Common Stock Other ------------ Comprehensive Comprehensive Retained Class A Class B Income (Loss) Income Earnings Total ------- ------- ------------- ------ -------- ----- Balance, December 31, 1998 Comprehensive income $57 $2,562 $ 3,927 $272,562 $279,108 Net income $ 40,111 40,111 40,111 Other comprehensive income, net of tax: Unrealized losses on securities: Unrealized holding losses arising during the period (13,662) (13,662) Less: Reclassified adjustment for gains included in income (1,112) (1,112) ------ ------ Other comprehensive income (14,774) (14,774) (14,774) ------- Comprehensive income 25,337 ====== Dividends, $1.32 per share (15,840) (15,840) Allocation of net income in excess of dividends and change in net unrealized gain (loss) on securities available- for-sale to redeemable class A common stock 1,183 (1,941) (758) --- ----- ----- ----- ---- Balance, December 31, 1999 57 2,562 (9,664) 294,892 287,847 Comprehensive income Net income 45,781 45,781 45,781 Other comprehensive income, net of tax: Unrealized gains on securities: Unrealized holding gains arising during the period 12,222 12,222 Less: Reclassified adjustment for gains included in income (162) (162) ---- ---- Other comprehensive income 12,060 12,060 12,060 ------ Comprehensive income 57,841 ====== Dividends, $1.39 per share (16,680) (16,680) Allocation of net income in excess of dividends and change in net unrealized gain (loss) on securities available- for-sale to redeemable class A common stock (965) (2,328) (3,293) --- ----- ---- ------ ------ Balance, December 31, 2000 57 2,562 1,431 321,665 325,715 Comprehensive income Net income 51,626 51,626 51,626 Other comprehensive income, net of tax: Unrealized gains on securities: Unrealized holding gains arising during the period 4,725 4,725 Less: Reclassified adjustment for gains included in income (1,277) (1,277) ------ ------ Other comprehensive income 3,448 3,448 3,448 ----- Comprehensive income $ 55,074 ======== Dividends, $1.60 per share (19,200) (19,200) Allocation of net income in excess of dividends and change in net unrealized gain (loss) on securities available- for-sale to redeemable class A common stock (276) (2,594) (2,870) --- ----- ---- ------ ------ Balance, December 31, 2001 $57 $2,562 $ 4,603 $351,497 $358,719 === ==== === ====== ======= ======== ======== See notes to consolidated financial statements.
36 BREMER FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2001, 2000 and 1999 (in thousands)
2001 2000 1999 ---- ---- ---- Cash flows from operating activities Net income $ 51,626 $ 45,781 $ 40,111 Adjustments to reconcile net income to net cash provided by operating activities Provision for credit losses 12,054 8,338 8,321 Depreciation and amortization 15,754 11,521 11,001 Deferred income taxes 317 3,825 5,091 Minority interests in earnings of subsidiaries - 21 41 Gain on sale of securities (2,128) (270) (1,853) Gain on sale of other real estate owned, net (52) (72) (405) Other assets and liabilities, net (14,864) 9,683 6,005 Proceeds from loans originated for sale 354,654 135,936 185,448 Loans originated for sale (362,290) (133,404) (186,259) -------- -------- -------- Net cash provided by operating activities 55,071 81,359 67,501 Cash flows from investing activities Interest bearing deposits, net 1,481 (845) (3,174) Purchases of mortgage-backed securities (516,515) (4,909) (315,041) Purchases of available-for-sale investment securities (120,375) (49,338) (79,050) Purchases of held-to-maturity securities (55,570) (12,180) (41,168) Proceeds from maturities of mortgage-backed securities 239,090 91,324 107,776 Proceeds from maturities of available-for-sale investment securities 21,958 14,062 107,274 Proceeds from maturities of held-to-maturity securities 42,655 22,621 62,793 Proceeds from sales of mortage-backed securities 77,353 28,025 4,604 Proceeds from sales of available-for-sale investment securities 69,263 17,495 87,698 Proceeds from sales of other real estate owned 3,779 1,092 919 Loans and leases, net (259,835) (379,574) (372,897) Acquisition of minority interests (225) (458) - Acquisitions, net of cash acquired 326,546 (18,416) (47,789) Purchase of premises and equipment (5,276) (5,717) (12,979) ------ ------ ------- Net cash used in investing activities (175,671) (296,818) (501,034) Cash flows from financing activities Noninterest bearing deposits, net 109,848 50,093 37,263 Savings, NOW and money market accounts, net 132,470 113,030 171,488 Certificates of deposits, net (256,893) 93,013 71,291 Federal funds purchased and repurchase agreements,net 48,701 27,578 79,318 Other short-term borrowings, net (41,535) (13,263) (5,846) Proceeds from issuance of long-term debt 85,000 33,099 142,432 Repayments of long-term debt (1,737) (16,271) (42,886) Proceeds from issuance of trust preferred securities 76,500 - - Dividends paid to minority interests - - (32) Redeemable preferred stock - - (2,079) Common stock dividends paid (19,200) (16,680) (15,840) ------- ------- ------- Net cash provided by financing activities 133,154 270,599 435,109 ------- ------- ------- Net decrease in cash and due from banks 12,554 55,140 1,576 Cash and due from banks at beginning of period 200,547 145,407 143,831 ------- ------- ------- Cash and due from banks at end of period $ 213,101 $ 200,547 $ 145,407 ========= ========= ========= Supplemental disclosures of cash flow information Cash paid during the year for interest $ 164,222 $ 153,534 $ 125,658 Cash paid during the year for income taxes 26,123 17,274 17,534 See notes to consolidated financial statements.
37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note A: Accounting Policies Nature of business - Bremer Financial Corporation (the "Company") is a privately-held regional financial services company headquartered in St. Paul, Minnesota. The Company is the sole shareholder of 11 subsidiary banks ("Subsidiary Banks") which draw most of their deposits from and make substantially all of their loans within the states of Minnesota, North Dakota, and Wisconsin. The Company has identified each of the subsidiary banks as a separate operating segment. These operating segments have been combined for segment information reporting purposes as one reportable segment since the nature and distribution of the products and services, the type of customer, and the regulatory environment are similar. Additionally, the Company provides asset-based lending and leasing, trust and insurance services to its customers through wholly-owned nonbanking subsidiaries, and investment services through a third party relationship. The accounting and reporting policies of the Company and its subsidiaries conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. The more significant accounting policies are summarized below: Consolidation - The consolidated financial statements include the accounts of the Company (a bank holding company majority owned by the Otto Bremer Foundation) and all Subsidiary Banks and other subsidiaries in which the Company has a majority interest. All significant intercompany accounts and transactions have been eliminated. Cash flows - For purposes of this statement, the Company has defined cash equivalents as cash and due from banks. During the years ended December 31, 2001, 2000, and 1999, the Company received real estate valued at $1,166,000, $3,454,000 and $725,000 in satisfaction of outstanding loan balances. Investment and mortgage-backed securities - Held-to-maturity securities consist of debt securities which the Company has the intent and ability to hold to maturity and are valued at amortized historical cost. Under certain circumstances (including the deterioration of the issuer's creditworthiness or a change in tax law or statutory or regulatory requirements), securities held-to-maturity may be sold or transferred to another portfolio. Available-for-sale securities consist of debt and equity securities that will be held for indefinite periods of time, including securities that may be sold in response to changes in market interest or prepayment rates, needs for liquidity, or changes in the availability or yield of alternative investments. These securities are valued at current market value with the resulting unrealized holding gains and losses excluded from earnings and reported, net of tax, and the resultant allocation to redeemable class A common stock reflected as a separate component of shareholders' equity until realized. Gains or losses on these securities are computed based on the amortized cost of the specific securities when sold. The Company does not engage in trading activities. Loans and leases - Interest income is accrued on loan and lease balances based on the principal amount outstanding. Loans and leases are reviewed regularly by management and placed on nonaccrual status when the collection of interest or principal is unlikely. The accrual of interest on loans and leases is suspended when the credit becomes 90 days or more past due, unless the loan or lease is fully secured and in the process of collection. Thereafter, no interest is recognized as income unless received in cash or until such time the borrower demonstrates the ability to pay interest and principal. Certain net loan and commitment fees are deferred and amortized over the life of the related loan or commitment as an adjustment of yield. Loans held-for-sale in the secondary market are recorded at lower of aggregate cost or market. Reserve for credit losses - Management determines the adequacy of the reserve based upon a number of factors, including credit loss experience and a continuous review of the loan and lease portfolio. Being an estimate, the reserve is subject to change through evaluation of the loan and lease composition, economic conditions, and the economic prospects of borrowers. Under the Company's credit policies and practices, all nonaccrual and restructured commercial, agricultural, construction, and commercial real estate loans and leases, plus certain other loans and leases identified by the Company, 38 meet the definition of impaired loans under Statements of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan" and SFAS No. 118 "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures." Impaired loans as defined by SFAS No. 114 and SFAS No. 118 exclude certain large groups of smaller balance homogeneous loans, such as consumer loans and residential real estate loans. Under these statements, loan impairment is required to be 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 observable market price of the loan or the fair value of the collateral if the loan is collateral dependent. The reserve also incorporates the results of measuring impaired loans and leases as provided in SFAS No. 114 and SFAS No. 118. These accounting standards prescribe the measurement methods, income recognition, and disclosures related to impaired loans and leases. A loan is considered impaired when management determines that it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the loan or lease agreement. Impairment is measured by the difference between the recorded investment in the loan or lease (including accrued interest, net deferred loan fees or costs, and unamortized premium or discount) and the estimated present value of total expected future cash flows, discounted at the loan's effective rate, or the fair value of the collateral, if the loan is collateral dependent. Impairment is recognized by adjusting the reserve for credit losses. Premises and equipment - Premises and equipment are stated at cost less accumulated depreciation and amortization computed principally on accelerated methods based on estimated useful lives of the assets which range from three to forty years. Maintenance and repair costs are charged to expense as incurred. Gains or losses on disposition of premises and equipment are reflected in income. Other real estate - Other real estate owned, which is included in other assets, represents properties acquired through foreclosure and other proceedings recorded at the lower of the amount of the loan satisfied or fair value. Any write-down to fair value at the time of foreclosure is charged to the reserve for credit losses. Property is appraised periodically to ensure that the recorded amount is supported by the current fair value. Market write-downs, operating expenses and losses on sales are charged to other expenses. Income, including gains on sales, is credited to other income. Intangible assets - Intangible assets consist of goodwill, core deposit intangibles, and other intangibles. The remaining unamortized balances at December 31, 2001 and 2000 were approximately $108,652,000 and $49,373,000. The core deposit and other intangibles have remaining amortization lives of 5 to 10 years. Goodwill has been amortized over either a 15 year or 25 year period. Income taxes - Bremer Financial Corporation and subsidiaries file a consolidated federal tax return. Deferred taxes are recorded to reflect the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year end . Comprehensive Income - Comprehensive income is defined as the change in equity of a business enterprise during a period resulting from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. For the Company, comprehensive income consists of net income, as reported in the financial statements, and other comprehensive income, which consists of the change in unrealized gains and losses on available-for-sale securities. Recent accounting pronouncements - On January 1, 2001, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137, "Deferral of the Effective Date of FASB Statement No. 133," and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that all derivatives, including those embedded in other contracts, be recognized as either assets or liabilities and that those financial instruments be measured at fair value. Management has reviewed the requirements of SFAS No. 133 and has determined that the Company has a minimal amount of derivatives and that there is no material impact to the financial statements due to the adoption of SFAS No. 133. In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations," which replaces Accounting Principles Board Opinion ("APB") No 16 and requires all business combinations initiated after June 30, 39 2001 to use the purchase method of accounting; the pooling of interest method of accounting is prohibited except for transactions initiated before July 1, 2001. While SFAS No. 141 will affect how future business combinations, if undertaken, are accounted for and disclosed in the financial statements, the issuance of the new guidance had no effect on the Company's results of operation, financial position or liquidity during 2001. In conjunction with the issuance of the new guidance for business combinations, the FASB also issued SFAS No. 142, "Goodwill and Other Intangible Assets," which addresses the accounting and reporting for acquired goodwill and other intangible assets and supersedes APB No. 17. Under the provisions of SFAS No. 142, intangible assets acquired in a business combination, which do not possess finite useful lives, will no longer be amortized into net income over an estimated useful life but rather will be tested for impairment at least annually based on specific guidance provided in the new standard. The Company adopted SFAS No. 142 on January 1, 2002. As of December 31, 2001, the Company had net goodwill of approximately $43 million and other intangible assets of approximately $66 million. Amortization expense recorded during the year ended December 31, 2001 was $6.7 million. The adoption of SFAS No. 142 will have no material impact on the Company's financial statements. The elimination of amortization of goodwill will be offset by recording a full year of amortization of the intangible assets recorded in conjunction with the Branch Acquisition described in Note B. SFAS No. 142, as part of its adoption provisions, requires a transitional impairment test be applied to all goodwill and other indefinite-lived intangible assets within the first half of 2002 and any resulting impairment loss be reported as a change in accounting principle. Management has performed a preliminary transitional impairment test on its goodwill assets and at this time does not expect an impairment loss to be recorded in 2002 as a result of this test. In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which is required to be adopted for fiscal years beginning after June 15, 2002. SFAS No. 143 establishes accounting and reporting standards for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of the fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The Company expects to adopt SFAS No. 143 on January 1, 2003. The Company has not yet determined the impact of SFAS No. 143 on its financial position and results of operations. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which is required to be adopted for fiscal years beginning after December 15, 2001. SFAS No. 144 establishes accounting and reporting standards for the impairment or disposal of long-lived assets. The provisions of SFAS No. 144 became effective for the Company January 1, 2002 and are not expected to have a material impact on its financial position or results of operations. Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for credit losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans and leases. Earnings per share calculations - Basic earnings per common share have been computed using 12,000,000 common shares for all periods. The Company does not have any dilutive securities. See Note Q. Reclassifications - Certain amounts have been reclassified to provide consistent presentation among the various accounting periods shown. The reclassifications have no effect on previously reported net income or total shareholders' equity. Note B: Acquisitions On May 11, 2001, the Company acquired from Firstar Corporation, Milwaukee, Wisconsin, (the "Seller") 11 of its Minneapolis/St. Paul branch locations and a portfolio of commercial loans and related deposits (the "Branch Acquisition"). 40 This transaction came as a result of the Seller's divestiture requirement related to its merger with U.S. Bancorp, Minneapolis, Minnesota. The 11 branch offices and the commercial loan portfolio that were acquired are now operated as part of the Company's subsidiary bank charter in South St. Paul, Minnesota. The acquisition was accounted for as an acquisition of assets and assumption of liabilities and resulted in the recognition of a core deposit premium of approximately $20.0 million and approximately $45.0 million of other intangible assets. The following pro forma financial information was prepared assuming the Branch Acquisition had been completed at January 1, 2001 and January 1, 2000: Years Ended December 31, ------------------------ 2001 2000 ---- ---- (in thousands, except per share data) Net Interest Income $ 177,191 $ 166,501 Net Income 51,917 45,698 Net Income Per Share $ 4.33 $ 3.81 Note C: Restrictions on Cash and Due From Banks The Subsidiary Banks are required to maintain average reserve balances in the form of vault cash or balances maintained either directly with a Reserve Bank or in a pass-through account, in accordance with the Federal Reserve Bank requirements. The amount of those cash reserve balances was approximately $6,920,000 and $31,170,000 as of December 31, 2001 and 2000. Note D: Investment and Mortgage-Backed Securities At December 31, 2001 and 2000, investment and mortgage-backed securities with an amortized cost of $749,497,000 and $661,455,000 were pledged as collateral to secure public deposits and for other purposes. The amortized cost and estimated fair value by maturity at December 31, 2001, are shown below (contractual maturity or, with mortgage-backed securities, projected principal payments are used): Held-to-Maturity Available-for-Sale ---------------- ------------------ Amortized Fair Amortized Fair Cost Value Cost Value ---- ----- ---- ----- (in thousands) Within 1 year $ 44,636 $ 45,209 $ 270,873 $ 273,749 1 - 5 years 77,701 79,615 438,642 442,134 5 - 10 years 57,449 57,495 164,414 165,639 After 10 years 1,285 1,251 95,100 95,756 Equity securities - - 43,201 43,296 ------ ------ ------ ------ Total investment securities $181,071 $183,570 $1,012,230 $1,020,574 ======== ======== ========== ========== 41 The amortized cost and fair value of investment and mortgage-backed securities available-for-sale as of December 31 consisted of the following:
2001 2000 ---- ---- Gross Gross Gross Gross Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair Cost Gains Losses Value Cost Gains Losses Value ---- ----- ------ ----- ---- ----- ------ ----- (in thousands) U.S. Treasury securities $ 1,318 $ 68 $ - $ 1,386 $ 1,915 $ 1 $ 3 $ 1,913 Obligations of U.S. government agencies 123,808 1,142 97 124,853 110,543 672 40 111,175 Obligations of state and political subdivisions 33,787 797 1 34,583 23,047 562 4 23,605 Mortgage-backed securities 774,274 7,111 847 780,538 574,236 3,339 2,691 574,884 Equity securities 43,201 103 8 43,296 55,945 905 114 56,736 Other 35,842 76 - 35,918 15,234 - 33 15,201 ------ -- ------ ------ -- ------ Total securities available- for sale $l,012,230 $9,297 $953 $1,020,574 $780,920 $5,479 $2,885 $783,514 ======== ====== ==== ========== ======== ====== ====== ========
Proceeds from sales of investments and mortgage-backed securities were $146,616,000, $45,520,000, and $83,444,000 for 2001, 2000 and 1999. Gross gains of $2,134,000, $434,000, and $1,866,000 and gross losses of $6,000, $164,000, and $21,000 were realized on those sales for 2001, 2000 and 1999. A summary of amortized cost and fair value of investment securities held-to-maturity at December 31 consisted of the following:
2001 2000 ---- ---- Gross Gross Gross Gross Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair Cost Gains Losses Value Cost Gains Losses Value ---- ----- ------ ----- ---- ----- ------ ----- (in thousands) Obligations of U.S. government agencies $ 5,064 $ 56 $ - $ 5,120 $ 5,491 $ 22 $ 56 $ 5,457 Obligations of state and political subdivisions 176,007 3,199 756 178,450 162,622 3,354 170 165,806 ------- ----- --- ------- ------- ----- --- ------- Total securirties held-to-maturity $181,071 $3,255 $756 $183,570 $168,113 $3,376 $226 $171,263 ======== ====== ==== ======== ======== ====== ==== ========
State and political subdivision investments largely involve governmental entities within the Company's market area. (The remainder of this page was intentionally left blank.) 42 Note E: Loans and Leases The Company is engaged in lending activities with borrowers in a wide variety of industries. Lending is concentrated in the areas in which its Subsidiary Banks are located. A decline in the local economies in these areas could negatively impact the quality of these loans. Loans and leases at December 31 consisted of the following: 2001 2000 ---- ---- (in thousands) Commercial and other $ 883,099 $ 717,936 Commercial real estate 957,318 733,746 Construction 83,388 68,296 Agricultural 417,069 416,660 Residential real estate 708,334 578,876 Construction 19,300 18,051 Consumer 334,472 302,824 Tax-exempt 97,308 83,082 ------ ------ Total loans and leases $3,500,288 $2,919,471 ========== =========== Impaired loans and leases were $20,806,000 and $13,991,000 at December 31, 2001 and 2000, respectively. Impaired loans and leases include nonaccrual and restructured loans and leases. Restructured loans and leases are those for which the terms (principal and/or interest) have been modified as a result of the inability of the borrower to meet the original terms of the loan or lease. The reserve for credit losses included approximately $4,049,000 and $3,056,000 relating to impaired loans and leases at December 31, 2001 and 2000, respectively. Following is a summary of information pertaining to impaired loans and leases. No significant amounts of interest income were recognized during each of the three years ending December 31: 2001 2000 1999 ---- ---- ---- (in thousands) Average investment in impaired loans, net of reserves $12,730 $11,898 $12,671 ======= ======= ======= Interest income as originally contracted $ 1,327 $ 1,335 $ 1,305 ======= ======= ======= Other nonperforming assets, consisting of other real estate owned, amounted to $1,616,000 and $3,658,000 at December 31, 2001 and 2000. At December 31, 2001 and 2000, loans totaling $1,411,135,000 and $935,270,000 had been pledged to secure Federal Home Loan Bank ("FHLB") advances. Acceptable collateral is defined by the FHLB and consists of residential real estate mortgages, agricultural real estate mortgages and commercial real estate mortgages. The Company and its subsidiaries have granted loans to the officers and directors (the "Group") of significant subsidiaries. The aggregate dollar amount of loans to the Group was $24,679,000 and $38,630,000 at December 31, 2001 and 2000. During 2001, $104,228,000 of new loans were made, repayments totaled $120,152,000, and changes in the composition of the Group or their associations increased loans outstanding by $1,973,000. These loans were made at the prevailing market interest rates. 43 Note F: Reserve for Credit Losses Changes in the reserve for credit losses are as follows: 2001 2000 1999 ---- ---- ---- (in thousands) Beginning of year $ 45,895 $ 41,895 $ 37,019 Charge-offs (9,852) (5,903) (7,064) Recoveries 1,619 1,271 1,439 ----- ----- ----- Net charge-offs (8,233) (4,632) (5,625) Provision for credit losses 12,054 8,338 8,321 Reserve related to acquired assets 4,000 294 2,180 ----- --- ----- End of year $ 53,716 $ 45,895 $ 41,895 ======== ======== ======== Note G: Premises and Equipment Premises and equipment at December 31 consisted of the following: 2001 2000 ---- ---- (in thousands) Land $ 9,787 $ 7,969 Buildings and improvements 73,558 66,240 Furniture and equipment 55,844 51,871 ------ ------ Total premises and equipment 139,189 126,080 Less: accumulated depreciation and amortization 74,127 68,338 ------ ------ Premises and equipment, net $ 65,062 $ 57,742 ======== ======== (The remainder of this page was intentionally left blank.) 44 Note H: Short-term Borrowings Short-term borrowings consist of federal funds and repurchase agreements (which generally mature within one to sixty days of the transaction date), treasury tax and loan notes (which generally mature within one to thirty days), FHLB advances (which mature within one year), and advances under an unsecured revolving credit facility agreement. The size of the credit facility available at December 31, 2001, was $45.0 million, of which $12.0 million was unused. The facility agreement contains covenants, including a requirement to maintain certain minimum levels of capitalization. Information related to short-term borrowings for the three years ended December 31 is provided below:
Federal Funds Federal Home Treasury Revolving and Repurchase Loan Bank Tax and Loan Credit Agreements Borrowings Notes Facility ---------- ---------- ----- -------- (dollars in thousands) Balance at December 31 2001 $ 377,762 $ 35,000 $ 3,150 $ 33,000 2000 329,061 95,000 2,685 15,000 1999 300,737 107,000 2,948 16,000 Weighted average interest rate at December 31 2001 2.08 % 3.55 % 1.68 % 2.77 % 2000 6.49 6.55 6.25 7.16 1999 5.41 5.67 5.25 6.74 Maximum amount outstanding at any month end 2001 $ 415,261 $ 331,000 $ 3,150 $ 42,000 2000 329,102 165,419 3,899 40,000 1999 300,737 156,755 12,461 99,000 Average amount outstanding during the year 2001 $ 337,511 $ 84,152 $ 2,188 $ 26,556 2000 287,563 105,428 2,412 27,855 1999 246,666 84,556 3,553 55,875 Weighted average interest rate during the year 2001 3.60 % 5.21 % 3.32 % 5.06 % 2000 5.72 6.28 6.18 7.58 1999 4.53 5.47 4.65 6.23
Note I: Long-term Debt Long-term debt (debt with original maturities of more than one year) at December 31 consisted of the following: At December 31, --------------- 2001 2000 1999 ---- ---- ---- (in thousands) Senior notes $ 65,000 $ 65,000 $ 65,000 Federal Home Loan Bank borrowings 248,594 164,908 147,587 Installment promissory notes 2,329 2,752 3,245 ----- ----- ----- Total $315,923 $232,660 $215,832 ======== ======== ======== The $65 million of senior notes are unsecured and are made up of two tranches. The $46 million first tranche bears an interest rate of 8.27% and matures on November 1, 2004, while the remaining $19 million second tranche bears an interest rate of 8.47% and matures on November 1, 2006. These senior note agreements contain covenants, including a requirement to maintain certain minimum levels of capitalization. The FHLB borrowings bear interest at rates ranging from 3.98% to 7.83%, with maturity dates from 2002 through 2011, and are secured by certain loans. The installment promissory notes bear interest at 7.59% and are payable in semi-annual installments through 2007. 45 Maturities of long-term debt outstanding at December 31, 2001, were as follows: (in thousands) 2002 $ 19,151 2003 50,614 2004 70,627 2005 30,864 2006 47,653 Beyond 2006 97,014 ------ Total $315,923 ======== At December 31, 2001, $71 million of the FHLB borrowings due in years beyond 2006 were subject to call prior to maturity at the option of the FHLB. Of this amount, $57 million is callable in 2003 and $14 million is currently callable on a quarterly basis. Note J: Company Obligated Mandatorily Redeemable Preferred Securities The Company issued $76.5 million of mandatorily redeemable preferred securities in two separate transactions in 2001 in conjunction with the Branch Acquisition. On February 22, 2001, the Company issued $16.5 million of 10.2% Capital Securities through Bremer Statutory Trust I ("BST") and on May 8, 2001, the Company issued $60 million of 9.0% Cumulative Capital Securities through Bremer Capital Trust I ("BCT.") The proceeds of both of these offerings, combined with the proceeds from the sale by BST and BCT to the parent of their common securities, were invested by BST and BCT in Junior Subordinated Deferrable Interest Debentures ("debentures") of the parent company. The debentures mature not earlier than July 15, 2006 and not later than July 15, 2031. At December 31, 2001, $76.5 million in Capital Securities qualified as Tier I capital under guidelines of the Federal Reserve. Note K: Disclosure About Fair Value of Financial Instruments Most of the Company's assets and liabilities are considered financial instruments as defined in SFAS 107. Many of the Company's financial instruments, however, lack an available trading market which is characterized by an exchange transaction of the instrument by a willing buyer and seller. It is also the Company's general practice and intent to hold most of its financial instruments to maturity and not engage in trading activities. Therefore, significant estimations and present value calculations were utilized by the Company for purposes of this disclosure. The use of different market assumptions and/or estimation methodologies may have a material effect on these estimated fair value amounts. The fair value estimates presented herein are based on pertinent information available to the Company as of December 31, 2001 and 2000. Although the Company is not aware of any factors that would significantly affect the estimated fair value amounts, these amounts have not been comprehensively revalued for purposes of these financial statements since December 31, 2001 and, therefore, current estimates of fair value may differ from the amounts presented. As of December 31, carrying amounts and estimated fair values were: 46
2001 2000 ---- ---- Estimated Estimated Carrying Fair Carrying Fair Amount Value Amount Value ------ ----- ------ ----- ( in thousands) Financial assets: Cash and due from banks $ 213,101 $ 213,101 $ 200,547 $ 200,547 Interest bearing deposits 4,250 4,250 5,731 5,731 Investment securities held-to-maturity 181,071 183,570 168,113 171,263 Investment securities available-for-sale 1,020,574 1,020,574 783,514 783,514 Loans and leases 3,445,123 3,508,794 2,869,706 2,890,338 Financial liabilities: Demand deposits $2,296,126 $2,296,126 $1,602,629 $1,602,629 Time deposits 1,509,892 1,530,871 1,503,453 1,520,472 Short-term borrowings 448,912 449,119 441,746 442,094 Long-term debt 315,923 329,083 232,660 236,410 Mandatorily redeemable preferred securities 76,500 79,500 - -
Cash and due from banks and interest bearing deposits - The carrying value for these financial instruments approximates fair value due to the relatively short period of time between the origination of the instruments and their expected realization. Securities - Fair values of these financial instruments were estimated using quoted market prices, when available. If quoted market prices were not available, fair value was estimated using market prices for similar assets. As required by SFAS No. 115, securities available-for-sale are carried at fair market value. Loans and leases - The loan and lease portfolio consists of both variable and fixed rate obligations. The carrying amounts of variable rate loans, a majority of which reprice within the next three months, and for which there has been no significant change in credit risk, are assumed to approximate fair value. The fair values for fixed rate loans and leases are estimated using discounted cash flow analysis. The discount rates applied are based on the current interest rates for loans with similar terms to borrowers of similar credit quality. Deposits - The estimated fair value of deposits with no stated maturity, such as non-interest bearing savings and money-market checking accounts, is the amount payable on demand. The fair value of time deposits is estimated using the rates currently offered for deposits of similar remaining maturities. Short-term borrowings - Due to the short term nature of repricing and maturities of these instruments, fair value approximates carrying value. Long-term debt - For fixed rate debt, the fair value is determined by discounting future cash flows at current rates for debt with similar remaining maturities and call features. For variable rate debt, fair value approximates carrying value. Mandatorily redeemable preferred securities - Fair values of these financial instruments were estimated using quoted market prices, when available. If quoted market prices were not available, fair value was estimated using market prices for similar assets. Off-balance sheet financial instruments - The estimated fair value of these instruments, such as loan commitments and standby letters of credit, approximates their off-balance sheet carrying value due to repricing ability and other terms of the contracts. Note L: Employee Benefit Plans Pension plan - The Company has a defined benefit pension plan covering substantially all of its employees. The benefits are based on age, years of service and the monthly average of the 60 consecutive months' compensation out of the last 120 months that gives the highest average. In recent years, the 47 Company's funding policy is to contribute annually an amount approaching the maximum amount that can be deducted for federal income tax purposes. Contributions are intended to provide for benefits attributed to service to date and for those expected to be earned in the future. Other postretirement benefits - The Company provides certain retiree health care benefits relating primarily to medical insurance co-payments to retired employees between the ages of 55 and 65. In accordance with SFAS No. 106 as amended by SFAS No. 132, "Employers' Accounting for Postretirement Benefits Other than Pensions," the Company accrues the cost of these benefits during the employees' active service. Contributions to the pension plan are intended to provide for benefits attributed to service to date and for those expected to be earned in the future. Benefits under SFAS No. 106 are funded on a pay-as-you-go-basis. The costs of these programs are as follows:
Other Pension Benefits Postretirement Benefits ---------------- ----------------------- 2001 2000 1999 2001 2000 1999 ---- ---- ---- ---- ---- ---- (in thousands) Net pension cost Service cost $ 1,932 $ 1,757 $ 1,674 $ 222 $ 151 $ 152 Interest cost 2,507 2,271 2,178 230 167 146 Expected long-term return on assets (4,052) (3,704) (2,629) - - - Net (gain) recognition (157) (197) - (26) (78) (72) Prior service cost amortization 152 173 173 (12) (6) (6) Loss due to special termination benefits - - 352 - - - --- --- --- --- --- --- Net pension cost $ 382 $ 300 $ 1,748 $ 414 $ 234 $ 220 ======= ======= ======= ===== ===== =====
(The remainder of this page was intentionally left blank.) 48 The following tables set forth the plans' funded status (based on a valuation date of September 30), along with a description of how the status changed during the past two years and the amount recognized on the Company's balance sheet at December 31. The funded status of the plans is equal to the fair value of plan assets less the benefit obligation at end of year.
Other Postretirement Pension Benefits Benefits ---------------- -------- 2001 2000 2001 2000 ---- ---- ---- ---- (in thousands) Change in benefit obligation Benefit obligation at end of prior year (9/30) $ 32,812 $ 29,712 $ 2,825 $ 2,063 Service cost 1,932 1,757 222 151 Interest cost 2,507 2,271 230 167 Amendments 226 - - - Actuarial (gain)/loss 2,708 199 66 638 Benefits paid (1,917) (1,127) (180) (194) ------ ------ ---- ---- Benefit obligation at end of year (9/30) $ 38,268 $ 32,812 $ 3,163 $ 2,825 ======== ======== ======= ======= Change in plan assets Fair value of plan assets at end of prior year (9/30) $ 40,219 $ 34,800 - - Actual return on plan assets (3,814) 4,209 - - Employer contribution 1,149 2,337 - - Benefits paid (1,916) (1,127) - - ------ ------ ------ ------ Fair value of plan assets at end of year (9/30) $ 35,638 $ 40,219 $ - $ - ======== ======== ======= ======= Funded status of plans Funded status of plans $ (2,630) $ 7,407 $(3,163) $(2,825) Unrecognized net loss/(gain) 4,716 (6,014) (570) (662) Unrecognized prior service costs 661 587 (67) (79) Contributions between September 30 and December 31 2,473 1,049 - - ----- ----- ----- ----- Prepaid benefit asset/(accrued benefit liability) $ 5,220 $ 3,029 $(3,800) $(3,566) ======= ======= ======= ========
The weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation and the expected long-term rates of return on assets are as follows:
Other Pension Benefits Postretirement Benefits ---------------- ----------------------- Weighted average assumptions 2001 2000 1999 2001 2000 1999 ---------------------------- ---- ---- ---- ---- ---- ---- Discount rate 7.25 % 7.75 % 7.75 % 7.25 % 7.75 % 7.75 % Expected long-term return on assets 10.00 10.00 10.00 - - - Rate of compensation increase 4.25 4.25 4.25 - - -
For purposes of the 2001 postretirement benefits measurements, the Company has assumed a health-care cost trend rate of 6.75%. The health-care trend rate assumption has a significant effect on the amounts reported. A one (1) percentage point change in the health-care trend rate would have the following effects on 2001 service and interest cost on the accumulated postretirement benefit obligation at December 31, 2001: 49 One (1) Percentage Point ------------------------ Increase Decrease -------- -------- (in thousands) Effect on service and interest cost components of net periodic cost $ 72 $(76) Effect on accumulated postretirement benefit obligation 359 (322) Profit sharing plan - The profit sharing plan is a defined contribution plan with contributions made by the Company. The profit sharing plan is noncontributory at the employee level, except for the employees' option to contribute under a 401(k) savings plan available as part of the profit sharing plan. Contributions are calculated using a formula based primarily upon the Company's earnings. Total contribution expense for 2001, 2000, and 1999 was approximately $4,200,000, $3,291,000 and $2,795,000, respectively. Employee stock ownership plan - The ESOP is a defined contribution plan covering substantially all employees, with contributions made exclusively by the Company on a discretionary year-by-year basis. The expense was $300,000 for 2001 and was $100,000 for both 2000 and 1999. Note M: Other Noninterest Income Other noninterest income at December 31 consisted of the following: 2001 2000 1999 ---- ---- ---- ( in thousands) Fees on loans $ 3,517 $ 3,024 $ 2,841 Other 1,610 1,216 2,737 ----- ----- ----- Total $ 5,127 $ 4,240 $ 5,578 ======= ======= ======= Note N: Other Noninterest Expense Other noninterest expense at December 31 consisted of the following: 2001 2000 1999 ---- ---- ---- ( in thousands) Printing, postage and telephone $ 6,581 $ 5,850 $ 5,916 Marketing 6,951 4,862 4,760 Other real estate owned 101 106 104 Other 16,918 13,771 14,415 ------ ------ ------ Total $ 30,551 $ 24,589 $ 25,195 ======== ======== ======== Note O: Income Taxes The components of the provision for income taxes at December 31 were as follows: 2001 2000 1999 ---- ---- ---- ( in thousands) Current Federal $ 21,822 $ 16,538 $ 12,305 State 4,912 4,094 3,746 Deferred 317 3,825 5,091 --- ----- ----- Total $ 27,051 $ 24,457 $ 21,142 ======== ======== ======== 50 A reconciliation between income tax expense and the amount computed by applying the statutory federal income tax rate at December 31 was as follows: 2001 2000 1999 ---- ---- ---- ( in thousands) Tax at statutory rate $ 27,537 $ 24,583 $ 21,440 Plus state income tax, net of federal tax benefits 3,250 3,110 3,153 ----- ----- ----- 30,787 27,693 24,593 ====== ====== ====== Less tax effect of: Interest on state and political subdivision securities 3,011 2,890 2,939 Other tax-exempt interest 1,706 1,714 1,259 Goodwill amortization (1,225) (1,176) (753) Other 244 (192) 6 --- ---- - 3,736 3,236 3,451 ----- ----- ----- Income tax expense $ 27,051 $ 24,457 $ 21,142 ======== ======== ======== The following table sets forth the temporary differences comprising the net deferred taxes included with interest receivable and other assets on the consolidated balance sheet at December 31: 2001 2000 ---- ---- ( in thousands) Deferred tax assets Provision for credit losses $ 21,298 $ 18,160 Employee compensation and benefits accruals (87) 771 Deferred income 1,001 950 Other 9 9 ------ ------ Total $ 22,221 $ 19,890 ======== ======== Deferred tax liabilities Deferred expense $ 1,724 $ 1,567 Depreciation 20,674 17,355 Unrealized gain on securities available-for-sale 3,325 1,046 Other 85 556 -- --- Total 25,808 20,524 ------ ------ Net deferred tax liabilities $ 3,587 $ 634 ======== ======== Note P: Commitments and Contingencies The Company utilizes various off-balance sheet instruments to satisfy the financing needs of customers. These instruments represent contractual obligations of the Company to provide funding, within a specified time period, to a customer. The following represents the outstanding obligations at December 31: 2001 2000 ---- ---- (in thousands) Standby letters of credit $ 18,394 $ 26,567 Loan commitments 848,391 586,873 Standby letters of credit represent a conditional commitment to satisfy an obligation to a third party, generally to support public and private borrowing arrangements, on behalf of the customer. Loan commitments represent contractual agreements to provide funding to customers over a specified time period as long as there is no violation of any condition of the contract. These loans generally will take the form of operating lines. The Company's potential exposure to credit loss in the event of nonperformance by the other party is represented by the contractual amount of those instruments. The credit risk associated with letters of credit and loan commitments is substantially the same as extending credit in the form of a loan; 51 therefore, the same credit policies apply in evaluating potential letters of credit or loan commitments. The amount of collateral obtained, if deemed necessary upon the extension of credit, is based on management's credit evaluation. The type of collateral held varies, but includes accounts receivable, inventory, and productive assets. Under substantially noncancelable contracts, the Company is obligated to pay approximately $4.5 million in annual data processing and item processing fees to third party providers through February 2004 and March 2006, respectively. The costs under the item processing contract are calculated in accordance with a volume-based fee schedule, which is subject to change annually. The Company is routinely involved in legal actions which are incidental to the business of the Company. Although it is difficult to predict the ultimate outcome of these cases, management believes, based on discussions with counsel, that any ultimate liability will not materially affect the consolidated financial position or operations. Note Q: Common Stock The Company has authorized 12,000,000 shares of class A common stock and 10,800,000 shares of class B common stock. The shares of class A common stock have full rights to vote on all matters properly before the Company's shareholders, including the election of the Company's directors. The class B common stock, all of which is held by the Otto Bremer Foundation, is non-voting except with respect to certain extraordinary corporate transactions, upon which the holders would have the right to vote on an equivalent per share basis with the holders of class A common stock. Each share of class B common stock is convertible into one share of class A common stock upon the occurrence of the following events: (i) at the affirmative election of a third party or entity, upon the transfer of class B common stock from the Otto Bremer Foundation to any third party or entity, or (ii) at the affirmative election of the holder of class B common stock, if cash dividends have not been paid on class A and class B common stock with respect to any year in an amount equal to at least 5% of the Company's net book value as of the last day of the immediately preceding year. The Company has reserved 10,800,000 shares of class A common stock in the event of conversion of the class B common stock. At December 31, 2001 and 2000, 960,000 shares of redeemable class A stock were issued and outstanding. At December 31, 2001, these shares were subject to redemption at a price of $32.49 per share, which approximated book value. These shares are owned by employees and directors of the Company and its subsidiaries and the employee benefit plans of the Company. These holders of class A common stock have the right to require the Company to purchase their shares under certain circumstances. It is the Company's intent that these 960,000 shares will continue to be held by employees, directors, and employee benefit plans of the Company and its subsidiaries and not be directly purchased by the Company or the Otto Bremer Foundation. Federal law prevents the Company and its non-bank subsidiaries from borrowing from the Subsidiary Banks unless the loans are secured by specified U.S. obligations. Further, the secured loans that may be made by Subsidiary Banks are generally limited in amount to 10% of the Subsidiary Bank's equity if made to the Company or any individual affiliate and 20% of the Subsidiary Bank's equity if made to all affiliates and the Company in the aggregate. At December 31, 2001, 2000 and 1999, no Subsidiary Banks had extended credit to the Company. Payment of dividends to the Company by its Subsidiary Banks is subject to various limitations by bank regulators, which includes maintenance of certain minimum capital ratios. As of December 31, 2001, $22,336,000 of retained earnings of the Subsidiary Banks was available for distribution to the Company as dividends subject to these limitations. Approximately $17,995,000 was available for distribution without obtaining the prior approval of the appropriate bank regulator. Note R: Regulatory Matters The Company is 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 52 regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgements by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2001, that the Company meets all capital adequacy requirements to which it is subject. The Company's and Subsidiary Banks' actual capital amounts and ratios as of December 31 are also presented below:
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- (dollars in thousands) As of December 31, 2001: Total capital (to risk weighted assets) Consolidated $ 398,719 11.19 % $ 285,058 > 8.00 % N/A Subsidiary Banks $ 388,413 10.86 % $ 286,103 > 8.00 % $ 357,629 > 10.00 % Tier I capital (to risk weighted assets) Consolidated $ 354,021 9.94 % $ 142,529 > 4.00 % N/A Subsidiary Banks $ 343,588 9.61 % $ 143,051 > 4.00 % $ 214,577 > 6.00 % Tier I capital (to average assets) Consolidated $ 354,021 7.27 % $ 194,904 > 4.00 % N/A Subsidiary Banks $ 343,588 7.18 % $ 191,500 > 4.00 % $ 239,375 > 5.00 % As of December 31, 2000: Total capital (to risk weighted assets) Consolidated $ 341,979 11.28 % $ 242,502 > 8.00 % N/A Subsidiary Banks $ 330,283 11.41 % $ 231,516 > 8.00 % $ 289,395 > 10.00 % Tier I capital (to risk weighted assets) Consolidated $ 303,988 10.03 % $ 121,251 > 4.00 % N/A Subsidiary Banks $ 293,700 10.15 % $ 115,758 > 4.00 % $ 173,637 > 6.00 % Tier I capital (to average assets) Consolidated $ 303,988 7.51 % $ 161,851 > 4.00 % N/A Subsidiary Banks $ 293,700 7.29 % $ 161,225 > 4.00 % $ 201,531 > 5.00 %
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA") required the establishment of a capital-based supervisory system of prompt corrective action for all depository institutions. The Federal Reserve Board's implementation of FDICIA defines "well-capitalized" institutions as those whose Tier I capital ratio equals or exceeds 6%, total risk-based capital ratio equals or exceeds 10%, and leverage ratio equals or exceeds 5%. The Company's Subsidiary Banks ratios in each of these categories met or exceeded the "well-capitalized" ratios as of December 31, 2001. 53 Note S: Bremer Financial Corporation (Parent Company Only) Condensed Statements: Balance Sheets
December 31, ------------ 2001 2000 ---- ---- (in thousands) Assets Cash and cash equivalents $ 149 $ 221 Investment securities available-for-sale 17,814 3,987 Investment in and advances to: Bank subsidiaries 454,754 342,477 Non-bank subsidiaries 94,944 89,086 Other assets 6,215 3,960 ----- ----- Total assets $573,876 $439,731 ======== ======== Liabilities and Shareholders' Equity Short-term borrowings $ 33,000 $ 15,000 Long-term debt 67,329 67,752 Junior subordinated debentures issued to subsidiary trusts 78,867 - Accrued expenses and other liabilities 4,768 2,940 Redeemable class A common stock 31,193 28,324 Shareholders' equity 358,719 325,715 ------- ------- Total liabilities and shareholders' equity $573,876 $439,731 ======== ========
Statements of Income
Years Ended December 31, ------------------------ 2001 2000 1999 ---- ---- ---- (in thousands) Income Dividends from: Bank subsidiaries $ 47,330 $ 46,475 $ 29,049 Non-bank subsidiaries 300 1,300 1,230 Interest from subsidiaries 4,737 5,107 4,288 Interest income on taxable securities 259 222 - Other income 504 - 354 --- --- Total income 53,130 53,104 34,921 Expenses Interest expense: Short-term borrowings 1,344 2,112 3,479 Long-term debt 5,700 5,736 1,149 Junior subordinated debentures issued to subsidiary trusts 5,137 - - Salaries and benefits 961 792 1,505 Operating expense paid to subsidiaries 1,241 998 1,008 Other operating expenses 1,479 1,239 1,184 ----- ----- ----- Total expenses 15,862 10,877 8,325 ------ ------ ----- Income before income tax benefit 37,268 42,227 26,596 Income tax benefit 4,308 2,432 1,341 ----- ----- ----- Income of parent company only 41,576 44,659 27,937 Equity in undistributed earnings of subsidiaries 10,050 1,122 12,174 ------ ----- ------ Net income $ 51,626 $45,781 $ 40,111
54 Note S: Bremer Financial Corporation (Parent Company Only) Condensed Statements (continued): Statements of Cash Flows
Years Ended December 31, ------------------------ 2001 2000 1999 ---- ---- ---- (in thousands) Cash flows from operating activities Net income $ 51,626 $ 45,781 $ 40,111 Adjustments to reconcile net income to net cash provided by operating activities Equity in undistributed (earnings) of subsidiaries (10,050) (1,122) (12,174) Depreciation and amortization 744 662 858 Other, net (860) 232 (1,357) ---- --- ------ Net cash provided by operating activities 41,460 45,553 27,438 ------ ------ ------ Cash flows from investing activities Investment in and advances to subsidiaries, net (104,949) (23,290) (59,226) Purchases of securities, net (15,364) (4,626) - Proceeds from sales of securities 1,537 639 - ----- --- Net cash used by investing activities (118,776) (27,277) (59,226) -------- ------- ------- Cash flows from financing activities Short-term borrowings, net 18,000 (1,000) (17,000) Proceeds of long-term debt - - 65,000 Repayments of long-term debt (423) (424) (423) Proceeds from issuance of junior subordinated debentures 78,867 - - Dividends paid (19,200) (16,680) (15,840) ------- ------- ------- Net cash (used) provided by financing activities 77,244 (18,104) 31,737 ------ ------- ------ Increase (decrease) in cash and cash equivalents (72) 172 (51) Cash and cash equivalents Beginning of year 221 49 100 --- -- --- End of year $ 149 $ 221 $ 49 ========= ========= ========
Note T: Quarterly Consolidated Financial Information(Unaudited):
2001 Quarter Ended ------------------ (dollars in thousands, except per share data) March 31 June 30 September 30 December 31 -------- ------- ------------ ----------- Interest income $ 79,046 $ 83,349 $ 85,919 $ 80,764 Interest expense 41,988 41,968 40,299 33,157 Net interest income 37,058 41,381 45,620 47,607 Net income 11,174 12,466 14,113 13,873 Per share of common stock Net income-basic and diluted $ 0.93 $ 1.04 $ 1.18 $ 1.15 2000 Quarter Ended (dollars in thousands, except per share data) March 31 June 30 September 30 December 31 Interest income $ 72,697 $ 78,537 $ 81,642 $ 81,295 Interest expense 35,762 40,268 43,398 43,754 Net interest income 36,935 38,269 38,244 37,541 Net income 11,016 11,062 11,676 12,027 Per share of common stock Net income-basic and diluted $ 0.92 $ 0.92 $ 0.97 $ 1.01
55 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Bremer Financial Corporation Saint Paul, Minnesota We have audited the accompanying consolidated balance sheets of Bremer Financial Corporation and subsidiaries (the Company), a subsidiary of the Otto Bremer Foundation, as of December 31, 2001 and 2000 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Bremer Financial Corporation and subsidiaries as of December 31, 2001 and 2000 and the results of their operations and their cash flows for the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche Minneapolis, Minnesota January 21, 2002 56 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE No event requiring disclosure pursuant to this Item 9 has occurred during the two years ended December 31, 2001. PART III Items 10 through 13 of the Form 10-K are omitted because the Company will file before April 30, 2002 a definitive Proxy Statement (the "Proxy Statement") conforming to Schedule 14A involving the election of directors. The information required by Items 10, 11, 12 and 13 of Part III of the Form 10-K are hereby incorporated by reference to such Proxy Statement. PART IV 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: (1) The following financial statements of Bremer Financial Corporation are part of this document under Item 8. Financial Statements and Supplementary Data: Consolidated Balance Sheets - December 31, 2001 and December 31, 2000 Consolidated Statements of Income - Years ended December 31, 2001, 2000 and 1999 Consolidated Statements of Shareholders' Equity - Years ended December 31, 2001, 2000 and 1999 Consolidated Statements of Cash Flows - Years ended December 31, 2001, 2000 and 1999 Notes to Consolidated Financial Statements Independent Auditors' Report (2) Financial statement schedules are omitted as they are not applicable, not required, or the required information is included in the financial statements or notes thereto. (3) The following exhibits are filed as a part of this report: 10.1 Bremer Financial Corporation 2001 Variable Compensation Plan. 12.1 Statement Regarding Computation of Ratio of Earnings to Fixed Charges. 21 Subsidiaries of the Company. 99.1 Risk Factors. The following exhibits are incorporated by reference to Exhibits 4.1, 4.2, 4.3, 4.4, 4.5, 4.6, 4.7 and 4.8, respectively, to Amendment No. 1 to the Company's Registration Statement on Form S-2 filed with the Securities and Exchange Commission on April 30, 2001: 4.1 Form of Indenture between Wilmington Trust Company and Bremer Financial Corporation. 4.2 Form of Junior Subordinated Debenture (included as an exhibit to Exhibit 4.1). 4.3 Certificate of Trust for Bremer Capital Trust I. 4.4 Declaration of Trust for Bremer Capital Trust I. 4.5 Form of Amended and Restated Declaration of Trust for Bremer Capital Trust I. 4.6 Form of Capital Securities Certificate (included as an exhibit to Exhibit 4.5). 57 4.7 Form of Capital Securities Guarantee Agreement between Bremer Financial Corporation and Wilmington Trust Company. 4.8 Form of Supplemental Indenture. The following exhibits are incorporated by reference to Exhibits 10.1, 10.2, 10.3, 10.4, 10.5, 10.6 and 10.7, respectively, to the Company's Registration Statement on Form S-2 filed with the Securities and Exchange Commission on April 9, 2001: 10.2 Indenture dated as of February 22, 2001 by and between Bremer Financial Corporation, as issuer, and State Street Bank and Trust Company of Connecticut, National Association ("State Street Bank"), as trustee, with respect to the issuance of $16.5 million of 10.20% Junior Subordinated Deferrable Interest Debentures due 2031. 10.3 Form of Junior Subordinated Deferrable Interest Debenture (included as Exhibit A to Exhibit 10.2). 10.4 Certificate of Trust dated as of January 29, 2001 for Bremer Statutory Trust I. 10.5 Declaration of Trust dated January 26, 2001 by and among Bremer Financial Corporation, State Street Bank (as trustee), and Robert B. Buck and Stuart F. Bradt (as administrators) for Bremer Statutory Trust I. 10.6 Amended and Restated Declaration of Trust dated as of February 22, 2001 by and among State Street Bank (as institutional trustee), Bremer Financial Corporation (as sponsor) and Robert B. Buck and Stuart F. Bradt (as administrators) for Bremer Statutory Trust I. 10.7 Form of Capital Securities Certificate (included as Exhibit A-1 to Exhibit 10.6). 10.8 Guarantee Agreement dated as of February 22, 2001 by and between Bremer Financial Corporation and State Street Bank. The following exhibits are incorporated by reference to Exhibits 10.1, 10.2, 10.3, 10.4, 10.5, 10.6, 10.7, 10.8, 21 and 99.4, respectively, to the Company's Annual Report on Form 10-K for the year ended December 31, 2000: 10.9 Bremer Financial Corporation 2000 Executive Annual Incentive Compensation Plan for President and CEO of Bremer Financial Corporation. 10.10 Bremer Financial Corporation 2000 Executive Annual Incentive Compensation Plan for Community Banking Director. 10.11 Bremer Financial Corporation 2000 Executive Annual Incentive Compensation Plan for Financial Services Director. 10.12 Bremer Financial Corporation 2000 Executive Annual Incentive Compensation Plan for Chief Financial Officer, Chief Credit Officer, Chief Information Officer, and Retail Director. 10.13 Bremer Financial Corporation 2000 Executive Annual Incentive Compensation Plan for Human Resources Director, Marketing Director, Assistant Community Banking Director, and Risk Management Director. 10.14 Bremer Financial Corporation Note Purchase Agreement dated November 1, 1999 - Series A Senior Notes, Tranche 1 and Series A Senior Notes, Tranche 2. 10.15 Bremer Financial Corporation Credit Agreement dated October 21, 1997, as amended - unsecured revolving credit facility. 10.16 Purchase and Assumption Agreement dated as of January 30, 2001. 58 The following exhibits are incorporated by reference to Exhibits 10.1, 10.2, 10.3, 10.4, 10.5, and 10.6, respectively, to the Company's Annual Report on Form 10-K for the year ended December 31, 1999: 10.17 Bremer Financial Corporation 1999 Executive Annual Incentive Compensation Plan for Chairman of the Board of Bremer Financial Corporation. 10.18 Bremer Financial Corporation 1999 Executive Annual Incentive Compensation Plan for President and CEO of Bremer Financial Corporation. 10.19 Bremer Financial Corporation 1999 Executive Annual Incentive Compensation Plan for Community Banking Director. 10.20 Bremer Financial Corporation 1999 Executive Annual Incentive Compensation Plan for Financial Services Director. 10.21 Bremer Financial Corporation 1999 Executive Annual Incentive Compensation Plan for Chief Credit Officer, Chief Financial Officer, and Chief Information Officer. 10.22 Bremer Financial Corporation 1999 Executive Annual Incentive Compensation Plan for other Senior Management Positions. The following exhibits are incorporated by reference to Exhibits 3.1, 28.7, and 28.8, respectively, to the Company's Annual Report on Form 10-K for the year ended December 31, 1989: 3.1 Bylaws of the Company in effect on the date hereof. 99.2 The portion of the final Prospectus of the Company dated April 20, 1989 ("Prospectus"), which was filed with the SEC on April 20, 1989, entitled "Description of Capital Stock Description of Class A Common Stock - Restrictions on Transfer." 99.3 The portion of the Prospectus entitled "Description of Capital Stock - Description of Class A Common Stock - First Call Option to Company" on page 64 of the Prospectus. The following exhibits are incorporated by reference to Exhibits 3.1, 10.12, 10.13, 10.14, 10.15, and 10.16, respectively, to the Company's Registration Statement on Form S-1 filed with the SEC on February 10, 1989: 3.2 Restated Articles of Incorporation of the Company in effect on the date hereof. 10.23 Bremer Financial Corporation Employee Stock Ownership Plan and Trust Agreement. 10.24 Bremer Banks Profit Sharing Plus Plan, as amended and restated effective January 1, 1986, and Amendment No. 1 thereto. 10.25 Bremer Banks Profit Sharing Plus Trust Agreement dated October 1, 1986 and Amendment No. 1 thereto. 10.26 Bremer Banks Retirement Plan as effective April 1, 1985. 10.27 Bremer Banks Retirement Plan Trust Agreement (as revised and restated effective January 1, 1976). The following exhibits are incorporated by reference to Exhibits 4.1, 4.2, and 28.1, respectively, to the Company's Amendment No. 1 to Registration Statement on Form S-1 filed with the SEC on March 29, 1989: 4.9 Specimen of Stock Certificate evidencing Class A Common Stock. 4.10 Specimen of Stock Certificate evidencing Class B Common Stock. 99.4 Otto Bremer Foundation Trust Instrument dated May 22, 1944. (b) The Company filed no Current Reports on Form 8-K during the fourth quarter of 2001, which ended December 31, 2001. A copy of this Form 10-K and exhibits herein can be obtained by writing Robert B. Buck, Executive Vice President and Chief Financial Officer, Bremer Financial Corporation, 445 Minnesota Street, Suite 2000, St. Paul, MN 55101. 59 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. March 15, 2002. Bremer Financial Corporation By: /s/Stan K. Dardis ----------------- Stan K. Dardis Its President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by the following persons on behalf of the registrant on March 15, 2002 in the capacities indicated. /s/Stan K. Dardis ----------------- Stan K. Dardis Its President and Chief Executive Officer and Director /s/Terry M. Cummings -------------------- Terry M. Cummings Chairman of the Board and Director /s/William H. Lipschultz ------------------------ William H. Lipschultz Vice President and Director /s/Charlotte S. Johnson ----------------------- Charlotte S. Johnson Vice President and Director /s/Sherman Winthrop ------------------- Sherman Winthrop Director /s/Daniel C. Reardon -------------------- Daniel C. Reardon Vice President and Director /s/Patrick J. Donovan --------------------- Patrick J. Donovan Director /s/Robert B. Buck ----------------- Robert B. Buck Executive Vice President and Chief Financial Officer (Principal Financial Officer) /s/Stuart F. Bradt ------------------ Stuart F. Bradt Controller (Principal Accounting Officer) 60 INDEX TO EXHIBITS Description of Exhibits 10.1 Bremer Financial Corporation 2001 Variable Compensation Plan. 12.1 Statement Regarding Computation of Ratio of Earnings to Fixed Charges 21 Subsidiaries of the Company. 99.1 Risk Factors