-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, O1WRbZmGhFlrqJRJS/p1SbrhgP7rXbctm24Avj1azGbRuQSPp+lsMb7xstTiCd7U zkeqVRzMhACo7YzF0ukfxw== 0000897101-99-000215.txt : 19990315 0000897101-99-000215.hdr.sgml : 19990315 ACCESSION NUMBER: 0000897101-99-000215 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990312 FILER: COMPANY DATA: COMPANY CONFORMED NAME: BREMER FINANCIAL CORPORATION CENTRAL INDEX KEY: 0000846616 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 410715583 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-18342 FILM NUMBER: 99563828 BUSINESS ADDRESS: STREET 1: 445 MINNESOTA ST STE 2000 CITY: SAINT PAUL STATE: MN ZIP: 55418 BUSINESS PHONE: 6122277621 MAIL ADDRESS: STREET 1: 445 MINNESOTA STREET STREET 2: SUITE 2000 CITY: ST PAUL STATE: MN ZIP: 55418 10-K 1 ================================================================================ 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, 1998 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. [ ] Based upon the $25.28 per share book value of the shares of class A common stock of the Company as of December 31, 1998, the aggregate value of the Company's shares of class A common stock held by employees and directors as of such date was approximately $24.3 million. As of March 12, 1999, 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, 1998 INDEX PAGE ---- Documents Incorporated by Reference ........................................ ii Cross Reference Sheet ...................................................... iii PART I Item 1. Business ........................................................ 1 Item 2. Properties ...................................................... 3 Item 3. Legal Proceedings ............................................... 3 Item 4. Submission of Matters to a Vote of Security Holders ............. 3 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ......................................................... 3 Item 6. Selected Financial Data ......................................... 7 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ....................................... 8 Item 8. Financial Statements and Supplementary Data ..................... 26 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ........................................ 46 PART III Item 10 through Item 13. See "Documents Incorporated by Reference" (Page ii) ....................................................... 46 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ........................................................ 46 Signatures ................................................................. 49 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 - ----------------------------------- ----------------------------------- PART II Item 5. Market for Registrant's Common Reference is made to the portions described Equity and Related Stockholder herein of the final Prospectus of the Company Matters. 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, 1998. Item 11. Executive Compensation. Reference is made to the Registrant's Proxy Statement. Item 12. Security Ownership of Certain Reference is made to the Registrant's Proxy Beneficial 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. Election of Directors Item 11. Executive Compensation. Election of Directors Item 12. Security Ownership of Certain Beneficial Owners and Management. Principal Stockholders Item 13. Certain Relationships and Related Transactions. Election of Directors
(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," "expects" and similar expressions are intended to identify forward-looking statements. ITEM 1. BUSINESS. GENERAL Bremer Financial Corporation (the "Company") is a privately-held regional financial services company headquartered in St. Paul, Minnesota, and incorporated under Minnesota law on December 7, 1943. As of March 12, 1999, the Company owned at least 99.7% of the total outstanding capital stock of its 14 subsidiary banks (collectively, "Subsidiary Banks"). As a bank holding company, the Company is subject to the federal Bank Holding Company Act of 1956, as amended ("Holding Company Act"), and to regulation and supervision by the Federal Reserve System (including the Board of Governors of the Federal Reserve System). The Subsidiary Banks are located in Minnesota, Wisconsin and North Dakota and have a total of 86 offices throughout these states. The Subsidiary Banks draw most of their deposits from and make substantially all of their loans within the states of Minnesota, Wisconsin and North Dakota and have no foreign loans. At December 31, 1998, the Company and its subsidiaries (including the Subsidiary Banks) had consolidated assets of approximately $3.4 billion and consolidated deposits of approximately $2.6 billion. The Subsidiary Banks ranged in size from $69.6 million to $419.9 million in total assets and from $62.9 million to $349.1 million in total deposits as of December 31, 1998. See the portion of this Form 10-K, Item 1. entitled "Business Developments in 1998." The Company also owns several financial services subsidiaries. It owns all of the outstanding capital stock of Bremer Trust, National Association ("Bremer Trust"), which provides trust and other fiduciary services to most of the Minnesota Subsidiary Banks' communities; Bremer Insurance Agencies, Inc. ("Bremer Insurance Agencies"), which provides insurance agency services to the Subsidiary Banks' communities; Bremer Financial Services, Inc. ("Bremer Financial"), which provides management and support services to the Company and its subsidiaries; Bremer Premium Finance Corporation ("Bremer Premium Finance"), which provides commercial insurance premium financing services in Wisconsin, Minnesota, and North Dakota; Bremer Business Finance Corporation ("BBFC"), which provides asset-based lending and leasing services; and Bremer Services, Inc. ("Bremer Services"), which provides operations and support services to the Subsidiary Banks. The Company also owns a controlling portion of the capital stock of Bremer First American Life Insurance Company, which is engaged in the underwriting and reinsurance of credit life and health insurance sold in conjunction with the extension of credit by the Subsidiary Banks. Consumer investment products and services are available at the Subsidiary Banks through INVEST Financial Corporation of Tampa, Florida ("INVEST"). The Company and its Subsidiary Banks have entered into a fully disclosed agreement with INVEST whereby the Company and its subsidiaries deliver investment services to its customers through a network of Subsidiary Banks' offices and receive a portion of the commissions earned by the investment representatives. The operations of the financial services subsidiaries, while an integral part of the Company's ability to deliver a full range of financial services, taken as a whole, are not significant enough to meet the requirements of additional segment reporting. The Otto Bremer Foundation (the "Foundation") owns 20% of the outstanding shares of the Company's class A common stock and 100% of the outstanding shares of its class B common stock, for a total of 92% of the outstanding shares of the Company's capital stock, consisting only of the class A and class B common stock. Accordingly, the Foundation is, and is subject to regulation as, a bank holding company within the meaning of the Holding Company Act. 1 COMPETITION The banking business is highly competitive. As the financial service industry expands, the scope of potential competition for the Subsidiary Banks also expands. The Subsidiary Banks compete with other commercial banks, savings and loan associations, and credit unions for loans and deposits, with money market funds for deposits, and with brokerage firms for investment products and services. Consumer and commercial finance companies, department stores, mortgage banks and insurance companies are also important competitors for various types of loans. Some of these entities and institutions are not subject to the same regulatory restrictions as the Company and the Subsidiary Banks. In addition, competition has intensified as local institutions become part of larger national associations as a result of amendments to interstate banking laws. Management believes that each Subsidiary Bank will be able to continue to compete successfully in its community. Management further believes that the Company's emphasis on local management and the ability of the Subsidiary Banks to make decisions close to the marketplace, the Subsidiary Banks' community commitment and involvement, and the commitment to a strong sales culture and to providing quality banking services, are factors that should allow the Subsidiary Banks to continue to maintain and improve their competitive position. TRADEMARKS In 1998, in conjunction with the Company's legal name changes of its Subsidiary Banks and other subsidiaries, the Company modified its stylized "Bremer Eagle" symbol and registered it with the United States Patent and Trademark Office. As part of this modification, the Company also registered a stylized version of the word "Bremer" for use in identifying and advertising a common identity among the Company's affiliates. These trademarks are used by substantially all of the Company's affiliates, including the Subsidiary Banks. The Company has registered no other trademarks, patents or copyrights. While management believes that a trademark is useful in identifying and advertising a common identity among the Company's affiliates, it also believes that the "Bremer Eagle" symbol, the "Bremer" name, or any other trademark, patent or copyright, or the registration thereof, is not material to the business of the Company or its subsidiaries. BUSINESS DEVELOPMENTS IN 1998 During 1998, the Company expanded its operations into new markets via the addition of de novo branches. These branch additions consisted of locations in Sartell, Minnesota (opened in January 1998) and in downtown St. Paul, Minnesota (opened in July 1998). In addition, in 1998, the Company began construction of a Business Banking Center to be located on the 21st floor of the North Central Life tower in downtown St. Paul, Minnesota. This facility is scheduled to be completed by March 1999. On January 1, 1998, First American Insurance Agencies, Inc. of St. Paul, Minnesota (a wholly-owned subsidiary of the Company) merged with First American Insurance Agencies, Inc. of Casselton, North Dakota (another wholly-owned subsidiary of the Company). Subsequently, on November 2, 1998, First American Insurance Agencies, Inc. changed its legal name to Bremer Insurance Agencies, Inc. This name change was consistent with the name change of the Subsidiary Banks, as discussed below. On April 30, 1998, six of the Company's 14 Subsidiary Banks consummated interim bank mergers pursuant to 12 U.S.C. paragraph 215a. Subsequently, on November 2, 1998, five of the remaining eight Subsidiary Banks consummated similar interim bank mergers. As a result of the interim mergers, the common stock owned by the minority shareholders of each of the Subsidiary Banks was canceled and converted into the right to receive cash. On July 1, 1998, the Company's Subsidiary Bank in South St. Paul, Minnesota changed its legal name from "First American Bank, National Association" to "Bremer Bank, National Association." Subsequently, on November 2, 1998, substantially all of the Company's other subsidiaries, including the Subsidiary Banks, had similar name changes. See the portion of this Form 10-K, Item 1. entitled "General." 2 On January 25, 1999, the Company and the shareholders of Dean Financial Services, Inc. ("Dean") entered into a Stock Purchase Agreement (the "Agreement") under which the Company is to acquire all of the shares of capital stock of Dean. The acquisition under the Agreement is subject to the receipt of various governmental approvals and other customary closing conditions. The acquisition is expected to close in April 1999. Dean is a privately-held bank holding company with approximately $312 million in assets with four charter banks serving 11 locations in Minnesota. On February 16, 1999, the Company signed a definitive agreement to purchase Northwest Equity Corp. of Amery, Wisconsin, and its subsidiary, Northwest Savings Bank. The closing of the acquisition is expected in the third quarter of 1999 and is subject to customary regulatory approvals and the approval of the shareholders of Northwest Equity Corp. Northwest Savings Bank has assets of approximately $100 million with three locations in Amery, New Richmond, and Siren, Wisconsin. EMPLOYEES As of March 12, 1999, the Company and its subsidiaries (including the Subsidiary Banks) had a total of 1,400 full-time equivalent positions. The Company and each of its subsidiaries considers its relations with employees to be good. None of the Company's employees is a member of a collective bargaining unit. ITEM 2. PROPERTIES. The Company leases its principal offices at 445 Minnesota Street, Suite 2000, St. Paul, Minnesota 55101, which consist of approximately 25,000 square feet of space. Management believes that these facilities will be sufficient for the Company's needs in the foreseeable future. Each of the Subsidiary Banks owns its main office and its branches, if any, except for those located in leased retail space in downtown St. Paul, Minnesota, and leased space in supermarkets. The facilities are all well maintained and range in size from 391 square feet to 52,280 square feet. Certain properties of the Subsidiary Banks may be subject to pledges or mortgages. However, the amount of long-term debt secured by mortgages on the Subsidiary Banks' properties is not material. See Notes F and H in the Notes to Consolidated Financial Statements of the Company set forth in Item 8 of Part II of this Form 10-K. ITEM 3. LEGAL PROCEEDINGS. The Company and certain of its Subsidiary Banks are involved in legal actions in various stages of litigation and investigation. After reviewing all actions, pending or threatened, involving the Company and such Subsidiary Banks, management believes that such legal actions, whether pending or threatened, constitute ordinary routine litigation incidental to the business of the Company and the Subsidiary Banks and that the ultimate resolution of these matters should not materially affect the Company's consolidated financial position or operations. 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, 1998 to a vote of the Company's security holders, through the solicitation of proxies or otherwise. 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 the Company's class A common stock. To the best of the Company's knowledge, during the period from May 18, 1989 (the closing date of the registered initial public offering of the Company's class A common stock) through and including March 5, 1999, 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 the 3 Company'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). The Company is 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 the Company's net worth as of the date of such purchase. As of December 31, 1998, the Company's net worth, including redeemable class A common stock, was $303.4 million and 10% of the Company's net worth and redeemable class A common stock was $30.3 million. During the period from January 1, 1998 and through and including March 5, 1999, the Company did not directly purchase any shares of class A common stock but assigned to its Employee Stock Ownership Plan ("ESOP") and the Bremer Banks Profit Sharing Plus Plan ("Profit Sharing Plan") its options to purchase a total of 42,131.7213 shares. The ESOP and the Profit Sharing Plan purchased these shares and then transferred them to employees of the Company and its subsidiaries through the ESOP and the Profit Sharing Plan. In addition, 5,200.0 shares of class A common stock were transferred directly between individuals at various times throughout the year. To the best of the Company's knowledge, these were the only transfers of shares of class A common stock effected during the period from January 1, 1998 through and including March 5, 1999. The sales price of the shares of class A common stock in such transactions ranged from $23.24 to $37.50 per share. These prices were equal to either the per share book value of the class A common stock as shown in the Company's 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 values of $31.20, $37.50, and $36.85 as of June 30, 1997, December 31, 1997, and June 30, 1998, respectively, as determined by an independent appraiser. At December 31, 1998, the most recent date for which a per share book value for the class A common stock is available, such value was $25.28. To the best of the Company's 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 March 5, 1999, there were approximately 1,200 holders of record of the shares of class A common stock. DIVIDENDS The Subsidiary Banks' ability to pay dividends to the Company and the Company'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 O of the Company's 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 ("Comptroller"). In addition, because the deposits of the Company's Subsidiary Banks are insured up to the applicable limit (currently $100,000) by the Federal Deposit Insurance Corporation ("FDIC"), all of the Subsidiary Banks are subject to regulation by the FDIC. The Company and the Foundation, as bank holding companies, are regulated by the Board of Governors of the Federal Reserve System ("Federal Reserve Board"). DIVIDENDS FROM SUBSIDIARY BANKS. A substantial portion of the Company's cash flow and income is derived from dividends paid to it by the Subsidiary Banks, and restrictions on the payment of such dividends could affect the payment of dividends by the Company. 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 4 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 3.00% 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 the Company's ability to obtain funds from such dividends for its 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, the Company has been able to obtain dividends sufficient to meet its cash flow needs. As of December 31, 1998, the Subsidiary Banks had retained earnings of $47.7 million which were available for distribution to the Company as dividends in 1999 subject to regulatory and administrative restrictions. Of this amount, approximately $38.1 million was available for distribution without obtaining the prior approval of the appropriate bank regulator. In 1997 and 1998, the Subsidiary Banks paid total dividends to the Company of $32.2 million and $32.7 million, respectively. Thirteen of the fourteen banks that were Subsidiary Banks in 1997 and 1998 paid dividends in both years. Of the Subsidiary Banks that paid dividends in 1997 and/or 1998, the range of dividend payouts (dividends paid divided by net income) was 5.8% to 323.0% in 1997 and 49.3% to 100.9% in 1998. 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 the Company. 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. DIVIDENDS FROM COMPANY. The payment of dividends by the Company, as a bank holding company, 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 5 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. The Company declared and paid dividends to the Foundation and all other holders of its class A common stock of $14.4 million in 1997 and $15.8 million in 1998. In 1997, $3.6 million of dividends were paid in each of the four quarters. In 1998, $3.96 million of dividends were paid in each of the four quarters. The dividend yield, which consists of dividends paid during the year divided by shareholder's equity as of the last day of the preceding year, was 5.7% for both years ended December 31, 1997 and 1998. MARKET RISK Market risk is the risk of loss due to adverse changes in market prices and rates. The management of this risk is an integral part of the Company's financial objectives. Interest rate risk is the risk that changing interest rates will adversely affect net interest income and balance sheet valuations due to differences in the repricing and maturity characteristics of assets and liabilities. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities. Responsibility for management of the Company's overall interest rate risk rests with the asset/liability committee ("ALCO"). ALCO is responsible for the development of appropriate risk management policies and for the monitoring of asset liability activities to insure that they are conducted within established risk parameters. The tools used to measure interest rate risk include gap analysis, simulation of future net interest income, and a valuation model which measures the sensitivity of balance sheet valuations to changes in interest rates. 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 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 as of December 31, 1998. 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 3% 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 8%. This is within the Company's maximum risk limit of 15% for this risk measure. 6 ITEM 6. SELECTED FINANCIAL DATA. BREMER FINANCIAL CORPORATION AND SUBSIDIARIES FINANCIAL HIGHLIGHTS
1998 CHANGE 1997 1996 1995 1994 ----------- ------ ---------- --------- --------- ---------- OPERATING RESULTS (in thousands) Total interest income ................... $ 245,525 8.4% $ 226,550 210,703 199,781 162,267 Net interest income ..................... 124,101 6.5 116,581 108,193 100,645 94,083 Net interest income (1) ................. 131,678 6.0 124,169 115,862 107,898 100,698 Provision for credit losses ............. 5,570 17.4 4,746 2,756 1,780 (1,300) Noninterest income ...................... 51,270 32.5 38,681 33,842 27,892 26,768 Noninterest expense ..................... 107,013 8.9 98,255 92,325 87,296 85,636 Net income .............................. 41,511 18.4 35,060 31,817 27,136 25,797 Dividends ............................... 15,840 10.0 14,400 12,600 9,600 9,360 AVERAGE BALANCES (in thousands) Assets .................................. 3,248,180 8.8 2,986,600 2,817,062 2,647,758 2,356,426 Loans and leases ........................ 2,084,462 13.4 1,838,218 1,687,900 1,545,693 1,330,802 Securities .............................. 954,994 (0.9) 963,806 959,278 944,113 893,727 Deposits ................................ 2,456,827 6.8 2,300,311 2,211,280 2,113,070 1,903,284 Redeemable class A common stock ......... 23,205 8.8 21,322 19,686 17,672 16,347 Shareholder's equity .................... 266,862 8.8 245,206 226,388 203,222 187,986 PERIOD-END BALANCES (in thousands) Assets .................................. 3,398,079 7.1 3,173,701 2,925,651 2,812,232 2,537,712 Loans and leases ........................ 2,172,631 10.6 1,964,127 1,756,146 1,627,013 1,443,671 Securities .............................. 996,673 0.4 992,249 935,774 984,768 907,211 Deposits ................................ 2,570,650 5.2 2,442,498 2,283,446 2,242,307 2,024,464 Redeemable class A common stock ......... 24,270 8.8 22,308 20,337 19,035 16,308 Shareholder's equity .................... 279,108 8.8 256,541 233,870 218,906 187,538 FINANCIAL RATIOS Return on average assets (2) ............ 1.30% -- 1.22% 1.18 1.07 1.15 Return on average realized equity (3)(4) .......................... 14.55 -- 13.32 13.08 12.06 12.41 Average equity to average assets (3)(4) .......................... 8.79 -- 8.81 8.64 8.50 8.93 Tangible equity to assets (3)(4) ........ 8.41 -- 8.50 8.58 8.24 8.50 Dividend payout ......................... 38.16 -- 41.07 39.60 35.38 36.28 Net interest margin (1) ................. 4.31 -- 4.43 4.37 4.33 4.52 Efficiency ratio ........................ 59.09 -- 58.43 59.87 63.03 64.54 Net charge-offs to average loans and leases ....................... 0.13 -- 0.09 0.03 0.08 0.02 Reserve for credit losses to loans and leases ....................... 1.70 -- 1.74 1.74 1.74 1.87 PER SHARE OF COMMON STOCK (3) Net income-basic ........................ $ 3.46 18.4 $ 2.92 2.65 2.26 2.15 Dividends paid .......................... 1.32 10.0 1.20 1.05 0.80 0.78 Book value .............................. 25.28 8.8 23.24 21.18 19.83 16.99 Realized book value (4) ................. 24.94 9.4 22.80 21.08 19.47 18.01
- ------------------ (1) Tax-equivalent basis (TEB). (2) Calculation is based on income before minority interests. (3) Calculation is based on 12,000,000 shares, including redeemable class A common stock. (4) Excluding net unrealized gain (loss) on securities available for sale. 7 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS HIGHLIGHTS EARNINGS. The Company reported net income of $41.5 million for the year ended December 31, 1998, a $6.4 million or 18.4% increase from the $35.1 million earned in 1997. Basic earnings per share was $3.46 in 1998 compared to $2.92 in 1997. Return on realized equity was 14.55% in 1998, as compared to the 13.32% return in 1997. Return on average assets was 1.30% in 1998, versus 1.22% in 1997. To facilitate comparisons, net interest income and net interest margin in the accompanying discussion and tables have been adjusted to show tax-exempt income, such as interest on municipal securities, loans, and leases on a tax-equivalent basis. Table I presents a comparative summary of operating data for 1994 through 1998. Table II presents the major components affecting the changes in return on assets for 1998. TABLE I SUMMARY INCOME STATEMENT (TAX-EQUIVALENT BASIS)
1998 CHANGE 1997 1996 1995 1994 --------- ------ --------- -------- -------- -------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Interest income ....................... $ 245,525 8.4% $ 226,550 210,703 199,781 162,267 Taxable-equivalent adjustment ......... 7,577 (0.1) 7,588 7,669 7,253 6,615 --------- --------- ------- ------- ------- Interest income -- taxable-equivalent .................. 253,102 8.1 234,138 218,372 207,034 168,882 Interest expense ...................... 121,424 10.4 109,969 102,510 99,136 68,184 --------- --------- ------- ------- ------- Net interest income -- taxable-equivalent .................. 131,678 6.0 124,169 115,862 107,898 100,698 Provision for credit losses ........... 5,570 17.4 4,746 2,756 1,780 (1,300) --------- --------- ------- ------- ------- Net funds function ................... 126,108 5.6 119,423 113,106 106,118 101,998 Noninterest income .................... 51,270 32.5 38,681 33,842 27,892 26,768 --------- --------- ------- ------- ------- Adjusted gross income ................ 177,378 12.2 158,104 146,948 134,010 128,766 Noninterest expense ................... 107,013 8.9 98,255 92,325 87,296 85,636 --------- --------- ------- ------- ------- Income before taxes .................. 70,365 17.6 59,849 54,623 46,714 43,130 Income taxes .......................... 21,277 23.7 17,201 15,137 12,325 10,718 Taxable-equivalent adjustment ......... 7,577 (0.1) 7,588 7,669 7,253 6,615 --------- --------- ------- ------- ------- Net income ........................... $ 41,511 18.4% $ 35,060 31,817 27,136 25,797 ========= ========= ======= ======= ======= Earnings per share - basic ............ $ 3.46 18.4% $ 2.92 2.65 2.26 2.15 Dividends paid per share .............. $ 1.32 10.0% $ 1.20 1.05 0.80 0.78
8 TABLE II CHANGES IN RETURN ON ASSETS 1998 VS 1997 ------------ Return on assets, prior year ..................................... 1.22% Increases State tax refund ................................................ 0.14 Gain on sale of loans ........................................... 0.07 Gain on sale of securities ...................................... 0.04 Gain on sale of other assets .................................... 0.02 Brokerage ....................................................... 0.02 Data processing fees ............................................ 0.03 Minority interest in earnings ................................... 0.03 ---- Total increases ............................................... 0.35 ---- Decreases Net interest income (TEB) ....................................... 0.10 Provision for income taxes ...................................... 0.06 Marketing ....................................................... 0.03 Professional fees ............................................... 0.03 FDIC premiums and examination fees .............................. 0.02 Provision for credit losses ..................................... 0.01 Other noninterest expense, net .................................. 0.02 ---- Total decreases ............................................... 0.27 ---- Return on assets, current year ................................... 1.30% ==== EQUITY OF SHAREHOLDERS. Shareholder's equity and redeemable class A common stock totaled $303.4 million at December 31, 1998. Book value per share increased from $23.24 at December 31, 1997 to $25.28 at December 31, 1998, while dividends paid per share increased from $1.20 to $1.32. The 1998 dividends paid of $15.8 million represented 5.7% of the equity of shareholders at December 31, 1997 and 38.2% of 1998 net income. Realized book value per share, which excludes the impact of the net unrealized gain or loss on securities available for sale, increased from $22.80 at December 31, 1997 to $24.94 at December 31, 1998. INCOME STATEMENT ANALYSIS NET INTEREST INCOME. The most significant component of the Company's earnings is net interest income, which is the difference between interest earned on assets and interest paid on liabilities. Net interest margin measures the effectiveness of generating net interest income on earning assets and is calculated by dividing net interest income by earning assets. Table III sets forth certain information regarding changes in net interest income (tax-equivalent basis, "TEB"), by volume and rate, of the Company for the periods indicated. 9 TABLE III CHANGES IN NET INTEREST INCOME (TEB)
1998 VS 1997 1997 VS 1996 ------------------------------------------ -------------------------------------- VOLUME YIELD/RATE* TOTAL VOLUME YIELD/RATE* TOTAL ---------- ------------- ------------- ---------- ------------- --------- (IN THOUSANDS) Increase (decrease) in: Interest income Loans and leases .............. $22,575 (1,499) 21,076 13,628 305 13,933 Taxable securities ............ (311) (2,259) (2,570) 408 1,559 1,967 Tax-exempt securities ......... (155) (85) (240) 31 (167) (136) Federal funds sold ............ -- 701 701 -- -- -- Other earning assets .......... 37 (41) (4) (29) 31 2 ------- ------ ------ ------ ----- ------ Total ........................ 22,146 (3,183) 18,963 14,038 1,728 15,766 ------- ------ ------ ------ ----- ------ Interest expense Savings deposits .............. 2,422 1,956 4,378 469 585 1,054 Other time deposits ........... 2,860 27 2,887 2,689 422 3,111 Short-term borrowings ......... 3,399 (283) 3,116 1,133 373 1,506 Long-term debt ................ 1,171 (98) 1,073 1,996 (208) 1,788 ------- ------ ------ ------ ----- ------ Total ........................ 9,852 1,602 11,454 6,287 1,172 7,459 ------- ------ ------ ------ ----- ------ Net interest income .............. $12,294 (4,785) 7,509 7,751 556 8,307 ======= ====== ====== ====== ===== ======
- ------------------ * All changes in net interest income, other than those due to volume, have been allocated to yield/rate. Tax-equivalent net interest income for 1998 was $131.7 million, an increase of $7.5 million or 6.0% from 1997. The increase in net interest income resulted from a $250.3 million or 8.9% increase in average earning assets, driven by average loan growth of $246.2 million or 13.4%. Offsetting the increase in earning assets was a decrease in the net interest margin, which declined 12 basis points from 4.43% in 1997 to 4.31% in 1998. The decrease in net interest margin was primarily due to a reduced spread in rates during 1998, as yields on earning assets decreased 6 basis points and costs on interest bearing liabilities increased 5 basis points. The interest bearing liabilities costs and net interest margin were impacted significantly by increased rates paid on money market savings products. Contributing positively to net interest margin, but not enough to offset the reduced yields on earning assets and increased cost on interest bearing liabilities, were a more favorable product mix of both earning assets and interest bearing liabilities and an increase in yield-related loan fees. PROVISION FOR CREDIT LOSSES. The provision for credit losses reflects the costs associated with the risks inherent in the loan and lease portfolio, taking into consideration an evaluation of economic conditions, changes in the size, composition, and risk profile of the loan portfolio, net charge-offs, and the level of nonperforming and other problem loans and leases. From December 31, 1997 to December 31, 1998, nonperforming loans and leases increased $3.4 million to $13.3 million. Meanwhile, the quality of the loan portfolio, as measured by the ratio of classified loans and leases to total loans and leases, reflected improvement from 5.84% at December 31, 1997, to 5.03% at December 31, 1998, despite continued stress on the Company's agricultural portfolio. The improvement reflects strong business conditions, other than agriculture, in the Company's markets, resulting in a general decline in classified commercial credit. The Company's agricultural portfolio deteriorated in early 1998 as a result of poor 1997 growing conditions in several of the Company's markets. Crop results for 1998 are preliminary, but indicate a stabilizing of this portfolio. The reserve to outstanding loans and leases decreased slightly in 1998 to 1.70%, and the reserve to nonperforming loans and leases decreased from 347.1% to 279.3%. The reserve for credit losses remains above average as compared to similar institutions. A complete discussion of asset quality and credit management can be found in the Corporate Risk Profile section of Item 7 in this Form 10-K. 10 NONINTEREST INCOME. Noninterest income was $51.3 million in 1998 compared to $38.7 million in 1997, representing a $12.6 million or 32.5% increase. Contributing to this increase in noninterest income were strong growth in service charge income of $1.3 million or 7.9% and in brokerage commissions of $817 thousand or 27.8%. Also contributing to the increase in noninterest income was an increase in trust commissions of $725 thousand or 11.6% and in gain on the sale of other assets of $783 thousand. The gain on sale of other assets is primarily attributable to insurance proceeds received from the damages sustained to bank facilities in 1997 from the flooding in the Red River Valley area of North Dakota and Minnesota, and gains on the sale of OREO property. Gains on loans sold in the secondary market increased $2.4 million or 95.2% as the volume of real estate mortgage financing increased in 1998 driven by a more favorable interest rate environment. In addition, the Company posted an increase of $1.4 million of investment securities gains and recorded a non-recurring state tax refund of nearly $4.5 million, including interest. The state tax refund reflects a refund of state income taxes paid to the state of Minnesota from 1980 through 1983. Table IV presents the components of noninterest income. TABLE IV NONINTEREST INCOME
1998 CHANGE 1997 1996 1995 1994 ------- -------- -------- -------- -------- -------- (IN THOUSANDS) Service charges ........................... $17,037 7.9% $15,787 12,837 11,047 9,627 Insurance ................................. 7,804 4.0 7,503 7,082 5,503 4,716 Trust ..................................... 6,990 11.6 6,265 5,332 4,784 4,502 Brokerage ................................. 3,752 27.8 2,935 2,531 1,243 1,865 Gain on sale of loans ..................... 4,977 95.2 2,550 2,138 1,302 1,649 Gain on sale of other assets .............. 966 NM 183 135 709 1,548 Gain (loss) on sale of securities ......... 1,296 NM (125) 147 304 (270) State tax refund .......................... 4,476 NM -- -- -- -- Other ..................................... 3,972 10.9 3,583 3,640 3,000 3,131 ------- ------- ------ ------ ----- Total .................................... $51,270 32.5% $38,681 33,842 27,892 26,768 ======= ======= ====== ====== ======
NONINTEREST EXPENSE. Noninterest expense increased $8.8 million or 8.9% from 1997 to 1998. The following table summarizes the components of noninterest expense from 1994 to 1998. TABLE V NONINTEREST EXPENSE
1998 CHANGE 1997 1996 1995 1994 -------- -------- --------- -------- -------- -------- (IN THOUSANDS) Salaries and wages ........................ $ 49,287 9.7% $44,912 40,676 37,325 36,556 Employee benefits ......................... 12,572 7.5 11,690 10,739 10,878 11,254 Occupancy ................................. 6,128 2.0 6,005 5,756 5,433 4,871 Furniture and equipment ................... 7,621 11.8 6,819 6,294 5,216 4,507 Printing, postage and office supplies ..... 5,487 5.7 5,189 4,802 4,584 3,910 Marketing ................................. 4,756 31.8 3,609 3,306 3,041 2,954 Data processing fees ...................... 6,046 (7.2) 6,513 7,428 7,153 6,852 Professional fees ......................... 1,786 105.8 868 1,407 1,258 1,512 Other real estate owned ................... 91 (38.9) 149 56 84 (63) Minority interest in earnings ............. 747 (49.7) 1,486 1,400 1,277 1,271 FDIC premiums and examination fees ........ 1,157 108.5 555 1,075 2,901 4,719 Goodwill and other intangibles ............ 1,711 14.1 1,499 1,351 1,152 702 Other ..................................... 9,624 7.4 8,961 8,035 6,994 6,591 -------- ------- ------ ------ ------ Total .................................... $107,013 8.9% $98,255 92,325 87,296 85,636 ======== ======= ====== ====== ======
11 Personnel costs, which accounted for 57.8% of noninterest expense, increased $5.3 million or 9.3%, as salaries and wages increased 9.7%, reflecting tight labor markets. Affecting the increase in personnel costs in 1998 was an increase of approximately $947 thousand in salaries and benefits relating to acquisitions and expansion into new markets. Excluding these costs, personnel costs would have increased $4.3 million or 7.8%. Excluding personnel costs, noninterest expense increased $3.5 million or 8.4%. Contributing to this increase was a $1.1 million increase in marketing expenses, which is primarily attributable to the Company's strategic initiative in promoting the legal name change of its Subsidiary Banks and other subsidiaries. Also contributing to the increase in noninterest expense was a $918 thousand increase in professional fees driven primarily by an increase in consulting fees associated with improving key business processes and implementing the Company's efforts in relationship management. In addition, furniture and equipment expense increased $802 thousand due to the depreciation expense associated with the upgrading of technology throughout the Company and expansion into new markets, and FDIC premiums and examination fees increased $602 thousand, which is primarily attributable to a one-time reduction in examination fees experienced in 1997. A common industry statistic used to measure the productivity of banking organizations is the efficiency ratio. The 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. The Company's efficiency ratio increased slightly from 58.4% in 1997 to 59.1% in 1998. Contributing to this change were significant increases in recurring noninterest income of 15.0% and tax-equivalent net interest income of 6.0%, and growth in recurring noninterest expense of 9.3%. The Company will continue its strategic focus to operate with an efficiency ratio below 60%. INCOME TAXES. Income tax expense, which consists of provisions for federal and state income taxes, was $21.3 million for 1998, representing an increase of $4.1 million from 1997. Comparing 1998 to 1997, the Company's effective tax rate also increased, from 32.9% to 33.9%, reflecting the impact of proportionately more taxable than tax-exempt income in 1998. For further discussion and detail on the Company's income taxes, refer to Notes A and M to the Consolidated Financial Statements found in the portion of Part II of this Form 10-K entitled "Item 8. Financial Statements and Supplementary Data." CORPORATE RISK PROFILE MANAGEMENT OF RISK. Managing risk is an essential part of the operation of a banking organization. When risk is undertaken, the Company expects a return commensurate with the risk. If the risk profile is lowered, expectations of returns also are reduced. By effectively managing and balancing the many risks involved in its business, the Company believes consistent growth in earnings will occur. The most prominent risks facing the Company are credit risk, interest rate risk, and liquidity risk. Credit risk involves the risk of either not collecting interest when it is due or not receiving the principal balance of a loan or investment when it matures. Credit risk is the most significant risk the Company must manage. Interest rate risk is the risk to net interest income caused by differences in the repricing and maturing characteristics of assets and liabilities. Liquidity risk is the risk that the Company will not be able to fund its obligations and is largely a function of how effectively the Company manages its other risks. The Company has established policies, procedures, and constraint levels to enable it to contain, accurately measure, monitor, and have senior management regularly review the Company's total risk position. CREDIT RISK MANAGEMENT. The Company manages asset quality and controls credit risk through standardized lending policies and procedures and an internal loan review system. The Company, through its corporate credit administration and review department in cooperation with the Subsidiary Banks, has developed a credit philosophy aimed at minimizing credit risk by emphasizing the importance of a strong credit management process. This process is essentially aimed at managing credit risk from the initial request through the life of the loan. 12 LOAN AND LEASE PORTFOLIO REVIEW. One of the ways the Company manages its credit risk is by maintaining a loan and lease portfolio that is well diversified by industry, size, and loan type. Credit risk is managed through internal credit policies and loan review procedures. Portfolio diversity among Subsidiary Banks further benefits the Company's credit risk posture. As a result, concentrations and risks in any single category are acceptable, as indicated by the following table summarizing the composition of the portfolio. TABLE VI LOAN AND LEASE PORTFOLIO
DECEMBER 31 ----------------------------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------------- ------------------- ------------------- ------------------- ------------------- AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT % ---------- ------- ---------- ------- ---------- ------- ---------- ------- ---------- ------- (IN THOUSANDS) Commercial and other .. $ 475,554 21.83% $ 387,048 19.66% $ 346,602 19.68% $ 331,641 20.34% $ 292,695 20.22% Commercial real estate 501,204 23.01 419,063 21.28 340,621 19.35 313,287 19.21 282,203 19.50 Construction ......... 59,913 2.75 36,518 1.85 30,039 1.71 31,952 1.96 26,421 1.83 Agricultural .......... 444,784 20.42 409,875 20.82 378,399 21.50 350,786 21.51 299,127 20.67 Residential real estate 376,652 17.30 387,549 19.68 351,946 20.00 322,296 19.77 293,671 20.29 Construction ......... 13,397 0.62 12,609 0.64 11,904 0.68 11,511 0.71 10,577 0.73 Consumer .............. 250,803 11.52 263,469 13.38 247,511 14.06 221,727 13.60 192,865 13.33 Tax-exempt ............ 55,477 2.55 52,954 2.69 53,078 3.02 47,297 2.90 49,626 3.43 ---------- ------- ---------- ------- ---------- ------- ---------- ------- ---------- ------- Total ................ $2,177,784 100.00% $1,969,085 100.00% $1,760,100 100.00% $1,630,497 100.00% $1,447,185 100.00% ========== ======= ========== ======= ========== ======= ========== ======= ========== =======
The Company's loan and lease portfolio increased $208.7 million to $2.2 billion at December 31, 1998, from $2.0 billion at December 31, 1997. Growth occurred in all major portfolio segments, with the exception of the retail-consumer segment, reflecting results of the Company's internal growth strategy. The commercial and commercial real estate portfolios accounted for most of the growth, with increases of $88.5 million and $105.5 million, respectively. In recent years, the composition of the Company's portfolio has reflected a slight shift away from the retail segment and toward business-related credit. The Company's loan and lease portfolio consists of 71% business-purpose loans at December 31, 1998, as compared to 66% at December 31, 1997 and 65% at December 31, 1996. The change in portfolio mix is primarily due to increased commercial and commercial real estate activity. The Company's Subsidiary Banks and Bremer Business Finance Corporation ("BBFC") continue to seek credit opportunities of all loan types, yet growth opportunities in the Company's markets favor the business sector. During 1998, the Company generated approximately $37 million in new loan originations in its asset-based lending and leasing subsidiary, BBFC. While these transactions are of acceptable quality, they tend to be somewhat less conventional than the loans originated by the Subsidiary Banks. These transactions are managed through the same internal credit policies and loan review procedures as those of the Subsidiary Banks. Of the Company's real estate lending, approximately 59% is in commercial real estate loans, as compared to 53% in 1997 and 50% in 1996. These commercial real estate loans continue to consist primarily of loans to business customers who occupy the property or use it for income production. The remaining 41% of real estate loans are in the form of residential mortgages and home equity loans. The commercial real estate loan portfolio experienced growth of $105.5 million or 23.2% between 1997 and 1998, reflecting continued strong business loan demand. The residential real estate loan portfolio experienced a decline of $10.1 million or 2.5% as the current low interest rate environment lead to increased loan originations and sales to the secondary market. The Company is not involved in lending to foreign countries. For the Company's agricultural customers, 1998 was generally a good year from a production standpoint. Favorable crop conditions helped mitigate the negative effect of low commodity prices experienced in this industry in 1998. Geographic dispersion of the Subsidiary Banks and diversification of agricultural products help insulate the Company from difficulties experienced in isolated segments of the Company's trade area. As of December 31, 1998, the Company has experienced limited losses 13 resulting from the flooding in the Red River Valley areas of North Dakota and Minnesota in April 1997. The impact of the flood on the Company's portfolio continues to be minimal. The Company has a Year 2000 project in place and includes the results of its customers assessments into its credit review and approval process. A complete discussion of the impact of the Year 2000 issue can be found in the "Year 2000 Issue" section of Item 7 in this Form 10-K. NET LOAN CHARGE-OFFS. Net loan charge-offs increased to $2.8 million in 1998 from $1.7 million in 1997 and $527 thousand in 1996. Correspondingly, net charge-offs as a percentage of average loans and leases increased to .13% in 1998 from .09% in 1997 and .03% in 1996. The increase in net charge-offs can be attributed to increased net charge-offs in the consumer, commercial, and agricultural portfolios. No individual charge-off represented more than 5% of the total. Table VIII includes a summary of the charge-offs by loan category for the past five years. NONPERFORMING ASSETS. Nonperforming assets include nonaccrual loans and leases, restructured loans and leases, and other real estate acquired in loan settlements. The accrual of interest on loans is suspended when the credit becomes 90 days or more past due, unless the loan is fully secured and in the process of collection. Payments received are typically applied to principal and not recorded as income. Restructured loans continue to accrue interest, but include concessions in terms which have been made as a result of deterioration in the borrower's financial condition. Table VII summarizes the nonperforming assets as of December 31 for the past five years. TABLE VII NON-PERFORMING ASSETS AT DECEMBER 31
1998 CHANGE 1997 1996 1995 1994 ----------- ---------- ----------- --------- -------- --------- (DOLLARS IN THOUSANDS) Nonaccrual loans and leases ................. $ 13,074 45.9% $ 8,958 10,830 8,392 10,401 Restructured loans and leases ............... 178 (80.4) 910 414 634 764 --------- --------- ------ ----- ------ Total nonperforming loans and leases ................................ 13,252 34.3 9,868 11,244 9,026 11,165 Other real estate owned (OREO) .............. 620 (10.3) 691 240 380 1,208 --------- --------- ------ ----- ------ Total nonperforming assets ................. $ 13,872 31.4% $ 10,559 11,484 9,406 12,373 ========= ========= ====== ===== ====== Past due loans and leases* .................. $ 1,142 (68.0)% $ 3,573 2,205 2,504 1,563 ========= ========= ====== ===== ====== Nonperforming loans and leases to total loans and leases ..................... 0.61% -- 0.50% 0.64 0.55 0.77 Nonperforming assets to total loans, leases and OREO ............................ 0.64 -- 0.54 0.65 0.58 0.86 Nonperforming assets and past due loans and leases* to total loans, leases and OREO ............................ 0.69 -- 0.72 0.78 0.73 0.96 Reserve to nonperforming loans and leases ................................. 279.32 -- 347.11 271.10 313.02 241.34 Reserve to total loans and leases ........... 1.70 -- 1.74 1.74 1.74 1.87 Reserve for Credit Losses Beginning of year .......................... $ 34,253 12.4% $ 30,482 28,253 26,946 27,624 Charge-offs ............................... (3,971) 43.9 (2,759) (2,230) (2,834) (2,065) Recoveries ................................ 1,164 13.5 1,026 1,703 1,610 1,814 --------- --------- ------- ------- ------- Net charge-offs .......................... (2,807) 62.0 (1,733) (527) (1,224) (251) Provision for credit losses ................ 5,570 17.4 4,746 2,756 1,780 (1,300) Reserve related to acquired assets ......... -- NM 758 -- 751 873 --------- --------- ------- ------- ------- End of year ................................ $ 37,016 8.1% $ 34,253 30,482 28,253 26,946 ========= ========= ======= ======= =======
- ----------------------- * Past due loans and leases include accruing loans and leases 90 days or more past due. 14 Nonperforming assets were $13.9 million at December 31, 1998, compared to $10.6 million at December 31, 1997, and $11.5 million at December 31, 1996. Correspondingly, nonperforming assets as a percentage of total loans, leases and other real estate owned increased to .64% in 1998 from .54% in 1997, and decreased from .65% in 1996. Nonperforming loans and leases were $13.3 million and .61% of total loans and leases at December 31, 1998, compared to $9.9 million and .50% of total loans and leases at December 31, 1997, and $11.2 million and .64% of total loans and leases at December 31, 1996. The increase in nonperforming loans and leases from 1997 to 1998 is a function of the stress within the Company's agricultural portfolio. The Company will continue to enhance systems for monitoring portfolio segments to identify deterioration and nonperformance at the earliest possible stages. RESERVE FOR CREDIT LOSSES. The purpose of the reserve for credit losses is to provide for loan and lease losses inherent in the Company's loan portfolio. Even in the presence of credit policies and procedures, credit quality is subject to many economic and non-economic factors that influence a borrower's financial condition over time. Table VIII summarizes the activity in the reserve for credit losses along with the credit loss reserve allocation from 1994 through 1998. (The remainder of this page was intentionally left blank.) 15 TABLE VIII RESERVE FOR CREDIT LOSSES
DECEMBER 31 ------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS) Beginning of year ................................ $ 34,253 30,482 28,253 26,946 27,624 Charge-offs Commercial and other ............................ 823 604 480 532 680 Commercial real estate .......................... 152 427 117 381 67 Construction .................................. 25 2 -- -- -- Agricultural .................................... 835 288 489 375 675 Residential real estate ......................... 328 100 47 170 157 Construction .................................. -- -- -- 10 -- Consumer ........................................ 1,808 1,338 1,097 835 486 Tax-exempt ...................................... -- -- -- 531 -- ---------- ---------- ---------- ---------- ---------- Total ......................................... 3,971 2,759 2,230 2,834 2,065 ---------- ---------- ---------- ---------- ---------- Recoveries Commercial and other ............................ 218 379 911 352 688 Commercial real estate .......................... 322 173 194 389 466 Construction .................................. -- 10 -- -- -- Agricultural .................................... 102 65 159 232 184 Residential real estate ......................... 30 104 58 313 81 Construction .................................. -- -- -- 10 13 Consumer ........................................ 492 295 381 280 236 Tax-exempt ...................................... -- -- -- 34 146 ---------- ---------- ---------- ---------- ---------- Total ......................................... 1,164 1,026 1,703 1,610 1,814 ---------- ---------- ---------- ---------- ---------- Net charge-offs .................................. 2,807 1,733 527 1,224 251 Provision for credit losses ...................... 5,570 4,746 2,756 1,780 (1,300) Reserve related to acquired assets ............... -- 758 -- 751 873 ---------- ---------- ---------- ---------- ---------- End of year ...................................... $ 37,016 34,253 30,482 28,253 26,946 ========== ========== ========== ========== ========== Average loans and leases ......................... $2,084,462 1,838,218 1,687,900 1,545,693 1,330,802 Net charge-offs/average loans and leases ......... 0.13% 0.09 0.03 0.08 0.02 ALLOCATION OF RESERVE FOR CREDIT LOSSES Commercial and other ............................. $ 8,300 7,700 6,800 5,500 4,700 Commercial real estate ........................... 9,500 8,700 7,000 7,000 6,700 Construction .................................... 600 600 500 500 300 Agricultural ..................................... 8,200 7,000 6,400 5,500 4,100 Residential real estate .......................... 2,600 2,300 2,100 2,000 1,800 Construction .................................... 100 100 100 100 100 Consumer ......................................... 1,500 1,700 1,500 1,200 1,100 Tax-exempt ....................................... 300 300 300 400 500 ---------- ---------- ---------- ---------- ---------- Total allocated ................................. 31,100 28,400 24,700 22,200 19,300 Unallocated ...................................... 5,916 5,853 5,782 6,053 7,646 ---------- ---------- ---------- ---------- ---------- Total ........................................... $ 37,016 34,253 30,482 28,253 26,946 ========== ========== ========== ========== ========== Reserve to total loans and leases ................ 1.70% 1.74 1.74 1.74 1.87
The reserve for credit losses was $37.0 million, or 1.70% of total loans and leases as of December 31, 1998, compared to $34.3 million, or 1.74% of total loans and leases at December 31, 1997. In establishing the reserve, management has considered its current credit practices, changing industry conditions, economic and environmental considerations, continued loan growth in 1998, the Company's level of unfunded commitments, and the type of credit extended. Management evaluates the reserve 16 each quarter to determine if the level is adequate to absorb potential losses. As of December 31, 1998, management believes the reserve is adequate to cover the risks inherent in the portfolio. Although the Company has prepared an allocation of the reserve based on loan- and industry-specific risk parameters, this allocation does not represent the total amount available for actual future loan and lease losses in any single category, nor does it prohibit losses from being absorbed by the unallocated portion. Commercial purpose allocations are based on individual loans, as well as on groups of loans with similar risk characteristics. Retail allocations are based primarily on delinquency and historical loss experience. INTEREST RATE RISK MANAGEMENT. Interest rate risk is the risk that changing interest rates will adversely affect net interest 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 the Company's asset/liability committee ("ALCO"). ALCO establishes appropriate risk management policies and monitors asset liability activities to minimize Company-wide exposure to adverse interest rate trends. The tools used to measure interest rate risk include gap analysis, simulation of future net interest income, and a valuation model which measures the sensitivity of balance sheet valuations to changes in interest rates. A discussion of the valuation model can be found in the "Market Risk" section of Item 5 in this Form 10-K. Table IX summarizes the Company's repricing gap for various time intervals. TABLE IX INTEREST RATE SENSITIVITY AT DECEMBER 31, 1998
REPRICING OR MATURING ----------------------------------------------------------------- WITHIN 3 -12 1 -5 OVER 5 3 MONTHS MONTHS YEARS YEARS TOTAL ---------- --------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) INTEREST SENSITIVE ASSETS Loans and leases ...................... $ 852,998 348,785 809,590 161,258 2,172,631 Securities ............................ 298,006 232,846 318,631 147,190 996,673 Other assets .......................... 145,543 -- -- 83,232 228,775 ---------- -------- --------- ------- --------- Total ............................... 1,296,547 581,631 1,128,221 391,680 3,398,079 ---------- -------- --------- ------- --------- INTEREST SENSITIVE LIABILITIES Noninterest bearing deposits .......... 155,100 33,808 180,307 -- 369,215 Interest bearing deposits ............. 658,055 736,390 803,069 3,921 2,201,435 Short-term borrowings ................. 336,573 16,024 616 -- 353,213 Long-term debt ........................ 1,034 10,767 8,956 95,529 116,286 Other liabilities and shareholder's equity ................. -- -- -- 357,930 357,930 ---------- -------- --------- ------- --------- Total ............................... 1,150,762 796,989 992,948 457,380 3,398,079 ---------- -------- --------- ------- --------- REPRICING GAP .......................... $ 145,785 (215,358) 135,273 (65,700) 0 ========== ======== ========= ======= ========= CUMULATIVE REPRICING GAP ............... $ 145,785 (69,573) 65,700 0 ========== ======== ========= ======= CUMULATIVE GAP TO TOTAL ASSETS ......... 4.29% (2.05) 1.93 0.00
As indicated in Table IX above, asset and liability repricing is well balanced as of December 31, 1998. The repricing gaps are well within the Company's risk tolerances, which limit the maximum 90-day and one-year gaps to 15% of total assets. The Company also uses simulation modeling of future net interest income as a risk management tool. Simulation modeling results indicate that net interest income would not change by more than 2% over the next year with a 200 basis point change in the level of rates. The projected change in net interest income is well within the current policy limit which requires that the change in net interest income over the next 12 months not exceed 15%. 17 LIQUIDITY MANAGEMENT. The objective of liquidity management is to ensure the continuous availability of funds to meet the commitments of the Company. ALCO is responsible for managing balance sheet and off-balance sheet commitments to meet the needs of customers while achieving the Company's financial objectives. ALCO meets regularly to review funding capacity, current and forecasted loan demand, investment opportunities, and liquidity positions as outlined in the Company's asset liability policy. With this information, ALCO guides changes in the balance sheet structure to provide for adequate ongoing liquidity. Several factors provide a favorable liquidity position for the Company. The first is the ability to acquire and retain funds in the Company's local markets. This in-market funding provides a historically stable source of funding and represented approximately 89% of total liabilities during 1998. The Company's available for sale securities portfolio is a secondary source of liquidity because of its readily marketable nature and predictable stream of maturities, as approximately 33% of the portfolio matures within 1999. While the Company prefers to fund its balance sheet with in-market funding sources, another source of liquidity is the Company's ready access to regional and national wholesale funding markets, including federal funds purchased, Federal Home Loan Bank ("FHLB") advances, and brokered deposits. As of January 1999, the Company also had available a $120 million unsecured credit facility which is used primarily to provide funding availability for non-bank activities. CAPITAL MANAGEMENT. The Company's capital position is both a strength and an opportunity, as it provides a degree of safety and soundness and a foundation for future growth. The capital position of the Company and the Subsidiary Banks reflects management's commitment to maintain ratios above the regulatory minimums. TABLE X CAPITAL RATIOS (1)(2) REGULATORY 1998 1997 REQUIREMENT ---------- --------- ------------ Equity to assets ................... 8.81% 8.62 -- Tangible equity to assets .......... 8.41 8.50 -- Tier I capital ..................... 12.13 12.69 4.00 Tier I and tier II capital ......... 13.39 13.94 8.00 Leverage ratio ..................... 8.58 8.70 3.00 ------------------ (1) Calculations include redeemable class A common stock. (2) Computed in accordance with generally accepted accounting principles, excluding the unrealized market value adjustment of securities available for sale. The Company's Tier I capital ratio at December 31, 1998 was 12.13%, its total risk-adjusted capital ratio (Tier I plus Tier II) was 13.39%, and its Tier I leverage ratio was 8.58%. 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, 1998. IMPACT OF INFLATION. The assets and liabilities of a financial institution are primarily monetary in nature. Because banks generally have an excess of monetary assets over monetary liabilities, inflation, in theory, will cause a loss of purchasing power in the value of shareholder's equity. Other sections of this financial review provide the information necessary for an understanding of the Company's ability to react to changing interest rates. 18 BALANCE SHEET ANALYSIS Table XII on pages 20 and 21 sets forth for the periods indicated the average balance sheets and related yields and rates on earning assets and interest bearing liabilities. SOURCES OF FUNDS The Company's balance sheet strength rests in its strong capital position and its share of the deposit base in the communities served. The Company relies on three major sources of funding: total deposits, short-term borrowings, and equity capital. The diversity and supply of this funding base enable the Company to replace maturing liabilities and finance asset growth on an ongoing basis. TOTAL DEPOSITS. Average total deposits increased $156.5 million or 6.8% in 1998. Within total deposits, money market savings accounts had the strongest growth, increasing $94.9 million or 37.3%, while savings certificates increased $33.7 million or 3.0%, noninterest bearing deposits increased $20.3 million or 7.1%, certificates over $100,000 increased $16.7 million or 10.0%, and money market checking accounts increased $2.6 million or 1.7%. Savings and NOW accounts was the only category experiencing a decline, decreasing $11.7 million or 3.9%. The table below sets forth the amount and maturity of time deposits that had balances of more than $100,000 at December 31, 1998. TABLE XI MATURITY OF TIME DEPOSITS OVER $100,000 DECEMBER 31 ---------------------- 1998 1997 ---------- --------- (IN THOUSANDS) Within 3 months .............................. $ 62,791 62,368 3 - 6 months ................................. 49,207 34,754 6 - 12 months ................................ 54,925 48,418 After 12 months .............................. 45,615 43,186 -------- ------ Total ....................................... $212,538 188,726 ======== ======= SHORT-TERM BORROWINGS. Average short-term borrowings, which include federal funds purchased, securities sold under agreements to repurchase, treasury tax and loan notes, FHLB advances with maturities of one year or less, and advances under an unsecured revolving credit facility, increased 20.8% from $304.4 million in 1997 to $367.6 million in 1998. This increase can be attributed to increases in the Company's use of securities sold under agreements to repurchase and the revolving credit facility. While average total deposits increased $156.5 million in 1998, average earning assets increased $250.3 million, creating the need for this funding source. The associated interest rate risk was monitored closely and steps were taken to match the repricability of assets and liabilities. LONG-TERM DEBT. Average long-term debt, which includes FHLB advances with maturities of greater than one year, and installment promissory notes, increased $19.6 million or 36.6%. This increase can be attributed to an increase in the Company's use of FHLB advances to fund the strong asset growth. 19 TABLE XII CONSOLIDATED AVERAGE BALANCE SHEETS AND RELATED YIELDS AND RATES
1998 1997 -------------------------------- --------------------------------- AVERAGE RATE/ AVERAGE RATE/ BALANCE INTEREST YIELD BALANCE INTEREST YIELD (DOLLARS IN THOUSANDS) ---------- ---------- ------- ----------- ---------- ------- ASSETS Loans and leases (net of unearned discount)* Commercial and other ............................... $ 431,459 $ 39,417 9.14% $ 360,777 $ 33,298 9.23% Commercial real estate ............................. 501,802 45,277 9.02 398,825 36,319 9.11 Agricultural ....................................... 446,859 40,610 9.09 394,868 36,542 9.25 Residential real estate ............................ 394,944 34,758 8.80 380,689 33,461 8.79 Consumer ........................................... 254,685 23,285 9.14 251,305 22,860 9.10 Tax-exempt ......................................... 54,713 5,497 10.05 51,754 5,287 10.22 ---------- -------- ---------- -------- TOTAL LOANS AND LEASES ........................... 2,084,462 188,844 9.06 1,838,218 167,767 9.13 Reserve for credit losses .......................... (35,870) (32,618) ---------- ---------- NET LOANS AND LEASES ............................. 2,048,592 1,805,600 Securities Mortgage-backed .................................... 670,505 41,935 6.25 620,552 40,610 6.54 Other taxable ...................................... 77,582 4,763 6.14 134,440 8,654 6.44 Tax-exempt ......................................... 206,907 16,733 8.09 208,814 16,976 8.13 ---------- -------- ---------- -------- TOTAL SECURITIES ................................. 954,994 63,431 6.64 963,806 66,240 6.87 Federal funds sold .................................. 12,312 701 5.69 -- -- -- Other earning assets ................................ 2,341 126 5.38 1,829 131 7.16 ---------- -------- ---------- -------- TOTAL EARNING ASSETS** ........................... 3,054,109 253,102 8.29 2,803,853 234,138 8.35 Cash and due from banks ............................. 107,585 101,990 Nonearning assets ................................... 122,356 113,375 ---------- ---------- TOTAL ASSETS ..................................... $3,248,180 $2,986,600 ========== ========== LIABILITIES AND SHAREHOLDER'S EQUITY Noninterest bearing deposits ........................ $ 304,990 $ 284,710 Interest bearing deposits Savings and NOW accounts ........................... 290,260 4,424 1.52 301,932 5,112 1.69 Money market checking .............................. 156,421 2,079 1.33 153,777 2,352 1.53 Money market savings ............................... 349,190 13,953 4.00 254,326 8,616 3.39 Savings certificates ............................... 1,171,896 66,835 5.70 1,138,167 64,933 5.71 Certificates over $100,000 ......................... 184,070 10,369 5.63 167,399 9,398 5.61 ---------- -------- ---------- -------- TOTAL INTEREST BEARING DEPOSITS .................. 2,151,837 97,660 4.54 2,015,601 90,411 4.49 TOTAL DEPOSITS ................................... 2,456,827 2,300,311 Short-term borrowings ............................... 367,580 19,488 5.30 304,384 16,356 5.37 Long-term debt ...................................... 73,047 4,276 5.85 53,486 3,202 5.99 ---------- -------- ---------- -------- TOTAL INTEREST BEARING LIABILITIES ............... 2,592,464 121,424 4.68 2,373,471 109,969 4.63 Other liabilities ................................... 53,105 50,082 ---------- ---------- TOTAL LIABILITIES ................................ 2,950,559 2,708,263 Minority interest ................................... 5,458 9,665 Redeemable preferred stock .......................... 2,096 2,144 Redeemable class A common stock ..................... 23,205 21,322 Shareholder's equity ................................ 266,862 245,206 ---------- ---------- TOTAL LIABILITIES AND EQUITY ..................... $3,248,180 $2,986,600 ========== ========== Net interest income ................................. $131,678 $124,169 ======== ======== Gross spread ........................................ 3.60% 3.72% Percent of earning assets Interest income .................................... 8.29 8.35 Interest cost ...................................... 3.98 3.92 ------ ----- NET INTEREST MARGIN .............................. 4.31% 4.43% Interest bearing liabilities to earning assets ..... 84.88% 84.65% Profitability Net income ......................................... $ 41,511 $ 35,060 Return on average assets ........................... 1.30% 1.22% Leverage ........................................... 11.38 11.12 Return on average realized equity .................. 14.55 13.32
- ----------------- INTEREST AND RATES ARE REALIZED ON A FULLY TAXABLE EQUIVALENT BASIS USING A 35% TAX RATE. * LOAN AND LEASE AMOUNTS INCLUDE NONACCRUAL LOANS AND LEASES. ** BEFORE DEDUCTING THE RESERVE FOR CREDIT LOSSES. 20
1996 1995 1994 AVERAGE BALANCE - -------------------------------- ------------------------------- ------------------------------- --------------------- AVERAGE RATE/ AVERAGE RATE/ AVERAGE RATE/ 1998 VS FIVE-YEAR BALANCE INTEREST YIELD BALANCE INTEREST YIELD BALANCE INTEREST YIELD 1997 GROWTH RATE - ---------- -------- -------- ---------- -------- ------- ---------- -------- ------- ------- ----------- $ 341,793 $ 31,265 9.15% $ 314,949 $ 30,096 9.56% $ 270,499 $ 22,312 8.25% 19.59% 14.21 354,614 32,262 9.10 328,163 30,542 9.31 295,579 25,955 8.78 25.82 11.82 361,401 33,461 9.26 330,422 31,615 9.57 269,266 23,696 8.80 13.17 13.85 346,875 30,211 8.71 318,447 27,638 8.68 276,860 23,268 8.40 3.74 10.05 232,168 21,244 9.15 205,766 18,706 9.09 173,193 15,044 8.69 1.34 12.98 51,049 5,391 10.56 47,946 4,825 10.06 45,405 4,615 10.16 5.72 2.66 - ---------- -------- ---------- -------- ---------- -------- 1,687,900 153,834 9.11 1,545,693 143,422 9.28 1,330,802 114,890 8.63 13.40 12.17 (29,689) (27,858) (28,632) 9.97 4.42 - ---------- ---------- ---------- 1,658,211 1,517,835 1,302,170 13.46 12.34 577,758 36,538 6.32 528,288 33,883 6.41 489,508 27,643 5.65 8.05 8.13 173,084 10,759 6.22 218,163 13,211 6.06 222,252 11,466 5.16 (42.29) (19.35) 208,436 17,112 8.21 197,662 16,444 8.32 181,967 14,792 8.13 (0.91) 4.95 - ---------- -------- ---------- -------- ---------- -------- 959,278 64,409 6.71 944,113 63,538 6.73 893,727 53,901 6.03 (0.91) 2.52 -- -- -- -- -- -- 789 37 4.69 N/M 48.76 2,356 129 5.48 1,029 74 7.19 1,100 54 4.91 27.99 9.49 - ---------- -------- ---------- -------- ---------- -------- 2,649,534 218,372 8.24 2,490,835 207,034 8.31 2,226,418 168,882 7.59 8.93 8.62 94,912 69,625 64,141 5.49 7.81 102,305 115,156 94,499 7.92 10.98 - ---------- ---------- ---------- $2,817,062 $2,647,758 $2,356,426 8.76 8.72 ========== ========== ========== $ 276,948 $ 257,888 $ 242,439 7.12 7.71 257,166 4,331 1.68 255,104 5,160 2.02 259,947 4,424 1.70 (3.87) 4.61 176,078 2,964 1.68 172,994 3,507 2.03 156,658 2,827 1.80 1.72 (0.02) 243,208 7,731 3.18 241,417 8,343 3.46 270,850 7,381 2.73 37.30 6.45 1,102,819 62,671 5.68 1,035,354 59,461 5.74 886,245 40,719 4.59 2.96 6.58 155,061 8,549 5.51 150,313 8,401 5.59 87,145 3,836 4.40 9.96 21.27 - ---------- -------- ---------- -------- ---------- -------- 1,934,332 86,246 4.46 1,855,182 84,872 4.57 1,660,845 59,187 3.56 6.76 6.56 2,211,280 2,113,070 1,903,284 6.80 6.70 282,813 14,850 5.25 229,935 12,678 5.51 199,186 8,616 4.33 20.76 21.45 22,178 1,414 6.38 23,306 1,586 6.81 8,813 381 4.32 36.57 189.86 - ---------- -------- ---------- -------- ---------- -------- 2,239,323 102,510 4.58 2,108,423 99,136 4.70 1,868,844 68,184 3.65 9.23 8.74 43,357 47,179 29,850 6.04 17.76 - ---------- ---------- ---------- 2,559,628 2,413,490 2,141,133 8.95 8.76 9,216 8,676 8,536 (43.53) (8.99) 2,144 4,698 2,424 (2.24) N/M 19,686 17,672 16,347 8.83 8.84 226,388 203,222 187,986 8.83 8.84 - ---------- ---------- ---------- $2,817,062 $2,647,758 $2,356,426 8.76 8.72 ========== ========== ========== $115,862 $107,898 $100,698 ======== ======== ======== 3.66% 3.61% 3.94% 8.24 8.31 7.59 3.87 3.98 3.07 ------ ------ ------ 4.37% 4.33% 4.52% 84.52% 84.65% 83.94% $ 31,817 $ 27,136 $ 25,797 1.18% 1.07% 1.15% 11.35 11.74 11.40 13.08 12.06 12.41
21 USES OF FUNDS Between 1997 and 1998, average total assets increased $261.6 million or 8.8%, and average earning assets increased $250.3 million or 8.9%. Strong loan growth, which the Company has been experiencing since 1994, increased loans as a percent of average earning assets from 65.6% in 1997 to 68.3% in 1998, while securities decreased from 34.4% to 31.3%. LOAN AND LEASE PORTFOLIO. The increase in average loans and leases from 1997 to 1998 was $246.2 million, with all categories of loans experiencing increases as loan demand remained strong in the Company's markets. Commercial real estate loans led the loan growth in 1998, increasing $103.0 million or 25.8%. Of the remaining loan categories, commercial loans increased $70.7 million, agricultural loans increased $52.0 million, residential real estate loans increased $14.3 million, consumer loans increased $3.4 million and tax-exempt loans increased $3.0 million. The following table summarizes the amount and maturity of the loan and lease portfolio as of December 31, 1998. TABLE XIII MATURITY OF LOANS AND LEASES
WITHIN 1-5 AFTER 5 1 YEAR YEARS YEARS TOTAL ---------- ---------- --------- --------- (IN THOUSANDS) Commercial and other ................... $260,365 180,592 34,597 475,554 Commercial real estate ................. 108,695 307,025 85,484 501,204 Construction .......................... 21,099 28,258 10,556 59,913 Agricultural ........................... 218,061 159,007 67,716 444,784 Residential real estate ................ 67,203 206,240 103,209 376,652 Construction .......................... 12,125 1,052 220 13,397 Consumer ............................... 104,602 135,868 10,333 250,803 Tax-exempt ............................. 13,668 25,519 16,290 55,477 -------- ------- ------- ------- Total ................................. $805,818 1,043,561 328,405 2,177,784 ======== ========= ======= ========= Loans and leases maturing after one year Fixed interest rate ................... $ 598,885 137,496 736,381 Variable interest rate ................ 444,676 190,909 635,585 ---------- ------- --------- Total ................................. $1,043,561 328,405 1,371,966 ========== ======= =========
SECURITIES. Average total securities decreased $8.8 million or .9% from 1997 to 1998, with mortgage-backed and other taxable securities decreasing $6.9 million or .9%. The decrease in tax-exempt securities was $1.9 million or .9%. Mortgage-backed securities represented 70.2% of total securities during 1998 compared to 64.4% in 1997. One of the risks with these types of securities is that their maturity is dependent upon the rate of prepayment of the underlying mortgages. This variability creates interest rate risk, which is continuously monitored to assess the impact on the Company. While the Company believes the yield on these securities adequately compensates for the risks unique to this type of investment, it is the Company's position to acquire securities that carry limited risk of loss due to prepayment. 22 The table below sets forth the maturities of the Company's investment and mortgage-backed securities to include projected principal payments of mortgage-backed securities at December 31, 1998 and the weighted average yields of such securities. TABLE XIV MATURITY OF INVESTMENT AND MORTGAGE-BACKED SECURITIES
AMORTIZED COST --------------------------------------------------------------------------------------------------------- WITHIN 1 YEAR 1-5 YEARS 5-10 YEARS AFTER 10 YEARS TOTAL ------------------- ------------------- ------------------ ------------------ ------------------- AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD -------- -------- -------- ------- -------- ------- -------- ------- -------- ------- (IN THOUSANDS) Governments and agencies ............. $ 10,752 5.47% $ 12,469 6.12% $ -- --% $ -- --% $ 23,221 5.82% State and political subdivisions ......... 21,183 7.98 121,308 7.78 39,750 7.51 990 8.50 183,231 7.75 Corporate bonds ....... 8,602 4.49 -- -- -- -- -- -- 8,602 4.49 Mortgage-backed securities ........... 234,688 5.38 347,897 6.29 53,791 6.25 69,901 6.60 706,277 6.35 Equity securities ..... 18,276 9.50 4,415 9.80 -- -- 20,934 6.36 43,625 8.03 Commercial paper ...... 20,575 5.94 -- -- -- -- -- -- 20,575 5.94 Other securities ...... 3,977 5.00 -- -- -- -- -- -- 3,977 5.00 -------- ---- -------- ---- ------- ---- ------- ---- -------- ---- Total ................ $318,053 6.54% $486,089 6.69% $93,541 6.79% $91,825 6.57% $989,508 6.64% ======== ==== ======== ==== ======= ==== ======= ==== ======== ====
The average maturity of the portfolio was 41 months at December 31, 1998, with an average tax-equivalent yield to maturity on the $989.5 million portfolio of 6.64%, unrealized gains of $14.3 million and unrealized losses of $1.2 million. This compares to an average maturity of 56 months at December 31, 1997, and an average tax-equivalent yield to maturity of 6.96%, unrealized gains of $15.7 million, and unrealized losses of $1.3 million. At December 31, 1998, the market value of the Company's securities was $1,002.6 million or $13.1 million over its amortized cost. This compares to a market value of $997.5 million or $14.4 million over amortized cost at December 31, 1997. In accordance with FAS 115, the available for sale securities are recorded at market value. For further discussion and detail on the Company's securities portfolio, refer to Note C to the Consolidated Financial Statements. ANALYSIS OF 1997 COMPARED WITH 1996 The following analysis compares 1997 consolidated financial results with 1996 results. EARNINGS. Net income was $35.1 million or $2.92 basic earnings per share in 1997 compared to $31.8 million or $2.65 basic earnings per share in 1996. Return on realized equity was 13.32% in 1997, as compared to the 13.08% return in 1996. Return on average assets was 1.22% in 1997, versus 1.18% in 1996. NET INTEREST INCOME. Tax-equivalent net interest income for 1997 was $124.2 million, an increase of $8.3 million or 7.2% from 1996. The increase in net interest income in 1997 resulted primarily from a $154.3 million increase in average earning assets and an increase in the net interest margin, which improved 6 basis points from 4.37% in 1996 to 4.43% in 1997. The increase in net interest margin was primarily due to an increased spread in rates during 1997, as costs on interest bearing liabilities increased less than yields on earnings assets. The interest bearing liabilities cost and net interest margin were impacted by increased rates paid on interest bearing savings deposits and certificates, as well as the increased use of other borrowings, with higher costs, to fund a portion of the earning asset growth experienced in 1997. Favorably impacting the net interest margin was an increase in the earning asset yield of 11 basis points, resulting from a 16 basis point increase in securities yields, coupled with a favorable change in the mix of earning assets. 23 PROVISION FOR CREDIT LOSSES. From December 31, 1996 to December 31, 1997, nonperforming loans and leases decreased by $1.4 million to $9.9 million. Meanwhile, the quality of the portfolio, as measured by the ratio of classified loans and leases to total loans and leases, reflected only modest deterioration during each quarter of 1997, despite strong loan growth. The ratio of classified loans and leases to total loans and leases increased from 5.16% at December 31, 1996, to 5.84% at December 31, 1997. The deterioration in credit quality was focused in the agricultural portfolio of three of the Company's Subsidiary Banks and in segments of the Company's retail portfolio. Farmers in a few of the Company's markets experienced another season of adverse growing conditions, particularly for small grain crops. The Company also experienced some weakening in general consumer loans and credit card debt. The reserve to outstanding loans and leases ratio remained at 1.74% in 1997, while the reserve to nonperforming loan coverage increased from 271.1% to 347.1% from 1996 to 1997. NONINTEREST INCOME. Noninterest income was $38.7 million in 1997 compared to $33.8 million in 1996, representing a $4.9 million or 14.3% increase. Contributing to this increase in noninterest income were strong growth in service charge income of $3.0 million or 23.0% and trust commissions of $933 thousand or 17.5%. Also contributing to the increase in noninterest income was an increase in brokerage commissions of $404 thousand or 16.0% and in increase in insurance commissions of $421 thousand or 5.9%. Gains on loans sold in the secondary market grew as the volume of real estate mortgage financing increased in 1997 driven by a more favorable interest rate environment. NONINTEREST EXPENSE. Noninterest expense increased $5.9 million or 6.4% from 1996 to 1997. Personnel costs, which accounted for 57.6% of noninterest expense, increased $5.2 million or 10.1%, as salaries and wages increased 10.4%. Affecting 1997 personnel costs were approximately $2.2 million in salaries and benefits relating to acquisitions and expansion into new markets. Excluding these costs, personnel costs would have increased $3.0 million or 5.9% over 1996. Excluding personnel costs, noninterest expense increased $743 thousand or 1.8%. Contributing to this increase was a $525 thousand increase in furniture and equipment expense primarily due to the depreciation expense associated with the upgrading of technology throughout the Company and expansion into new markets. Also contributing to the increase in noninterest expense was a $535 thousand increase in other expenses driven primarily by an increase of $246 thousand in lending costs associated with the growth experienced in real estate mortgage lending and a $95 thousand increase in amortization of intangible assets. Offsetting some of the increase in noninterest expense was a decrease of $915 thousand in data processing expenses as the Company began to realize cost savings associated with the execution of a new data processing contract in early 1997. Also offsetting some of the increase in noninterest expense was a $520 thousand decrease in FDIC premiums and examination fees as FDIC insurance premiums continued to decline and the Company experienced a one-time reduction in examination fees due to the conversion of its state-chartered Subsidiary Banks to national charters. INCOME TAXES. Income tax expense was $17.2 million for 1997, representing an increase of $2.1 million from 1996. Comparing 1997 to 1996, the Company's effective tax rate increased from 32.2% to 32.9%, reflecting the impact of proportionately more taxable than tax-exempt income in 1997. YEAR 2000 ISSUE The Year 2000 issue is the result of computer systems being written using two digits rather than four to define the applicable year. Any of the computer programs used by the Company that have date-sensitive software may recognize a date using "00" for the year as the year 1900 rather than the year 2000, or vice versa. This could result in a system failure or miscalculations causing disruptions of operations including an inability to process transactions, calculate interest accruals, or engage in similar normal business activities. The Company has a Year 2000 project in place to anticipate, correct, and plan for the many ways the century date change may affect its systems, customers, and business infrastructure. The Company's definition of Year 2000 readiness requires that all systems and services are reasonably assured to function effectively through all Year 2000 related date issues, with contingency plans for all medium and high priority systems. At December 31, 1998, the Company was 92% complete with this process, based on number of services, and is scheduled to be 100% complete at June 30, 1999. The Company's Year 2000 issues relating to third parties with which it holds a material relationship are discussed below: 24 CORE APPLICATIONS. The Company's core application systems, which include loans, deposits, investments, and general ledger, are handled by Information Technologies, Inc. (ITI), which is owned by FiServ, one of the largest distributors of bank software in the world. The Company is working closely with this vendor to resolve the Year 2000 issue, including one completed expansive test of all modules. The Company conducted a test of 172 components in October 1998, finding 9 non-critical issue areas. The Company plans additional testing in early 1999 to verify that these issues are resolved in their new release, which was issued in December 1998. DATA AND ITEM PROCESSING. The two most transaction-intensive and system-critical operations in banking are related to data and item processing. Data processing is managed off site by Electronic Data Services, Inc. (EDS), the largest processor of bank data in the world. EDS has extensive disaster recovery plans that include a remote processing site. EDS has also helped the Company coordinate an extensive integrated test of the Company's core systems, as well as all ITI interfaced systems. In early 1999, item processing (handling of all checks and other paper items) will also be managed by EDS within the Company's facilities in West St. Paul, Minnesota. CUSTOMERS. The Company has assessed the Year 2000 readiness of most of its major customers and included the results of Year 2000 assessments into its credit review and approval process. In 1998, the Company expended approximately $500 thousand on specific Year 2000 issues. These costs were primarily for software upgrades, infrastructure changes, and testing. The Company is also spending approximately $3.9 million on a new PC network infrastructure, due to be completed by May 1999, some of which is directly related to Year 2000 issues and some of which is additional investments in technology. The Company estimates an additional $20-$100 thousand may be expended in 1999 for costs associated with Year 2000 issues. The Company has identified three worst case scenarios that it has been addressing and will continue to address through June 1999, as described below: POWER OUTAGES. Bremer Services, which provides operations and support services to the Subsidiary Banks, can operate as a contingency bank for any of the Company's Subsidiary Banks through the phone bank. This means that any branch within the Company's system that cannot operate due to power outages need only find a bank of telephones to conduct all core applications. Bremer Services has a diesel generator which can run the entire building as long as fuel is available. If this facility still has power issues, all core application transactions from the Company's branch network can be re-routed through the Subsidiary Bank in South St. Paul, Minnesota. BREMER SERVICES FAILURE. Bremer Services houses the Company's connection to its data processor and the staff to deal with customer service, phone banking, and other operational issues. If Bremer Services is incapacitated, the Company has a separate route for all Subsidiary Banks to get to EDS through one of the Company's Subsidiary Banks located in South St. Paul, Minnesota. The Company has standby T1 lines in place ready to re-route bank transactions to EDS. DATA PROCESSOR (EDS) FAILURE. EDS has a disaster recovery system that includes a remote processing site for a complete replication of the Company's information. If EDS is completely unavailable, the Company has manual procedures in place to keep its doors open and serve customers. EDS has a "hot site" standing by to handle all transactions if the main site is down. 25 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. BREMER FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DECEMBER 31 ---------------------------- 1998 1997 ----------- ----------- (IN THOUSANDS) ASSETS Cash and due from banks ........................................... $ 143,831 135,966 Interest bearing deposits ......................................... 1,712 1,886 Investment securities held to maturity (fair value of $185,398 and $185,402, respectively) ............................. 179,359 179,631 Mortgage-backed securities held to maturity (fair value of $27,070 and $91,508, respectively) ............................... 27,143 91,994 ----------- ----------- TOTAL SECURITIES HELD TO MATURITY ............................... 206,502 271,625 Investment securities available for sale (amortized cost of $103,872 and $141,147, respectively) ............................. 105,491 142,051 Mortgage-backed securities available for sale (amortized cost of $679,134 and $570,363, respectively) ............................. 684,680 578,573 ----------- ----------- TOTAL SECURITIES AVAILABLE FOR SALE ............................. 790,171 720,624 Loans and leases .................................................. 2,177,784 1,969,085 Reserve for credit losses ........................................ (37,016) (34,253) Unearned discount ............................................... (5,153) (4,958) ----------- ----------- NET LOANS AND LEASES ............................................ 2,135,615 1,929,874 Premises and equipment, net ....................................... 54,390 51,879 Interest receivable and other assets .............................. 65,858 61,847 ----------- ----------- TOTAL ASSETS .................................................... $ 3,398,079 3,173,701 =========== =========== LIABILITIES AND SHAREHOLDER'S EQUITY Noninterest bearing deposits ...................................... $ 369,215 344,521 Interest bearing deposits ......................................... 2,201,435 2,097,977 ----------- ----------- TOTAL DEPOSITS .................................................. 2,570,650 2,442,498 Federal funds purchased and repurchase agreements ................. 221,419 167,174 Other short-term borrowings ....................................... 131,794 198,090 Long-term debt .................................................... 116,286 30,238 Accrued expenses and other liabilities ............................ 51,568 44,697 ----------- ----------- TOTAL LIABILITIES ............................................... 3,091,717 2,882,697 Minority interests ................................................ 905 10,011 Redeemable preferred stock, $100 par, 80,000 shares authorized; 71,594 shares issued; and outstanding shares of 20,787 and 21,437, respectively ......................................... 2,079 2,144 Redeemable class A common stock, 960,000 shares issued and outstanding ........................................... 24,270 22,308 Shareholder's 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 ................................................. 272,696 249,079 Accumulated other comprehensive income ............................ 3,793 4,843 ----------- ----------- TOTAL SHAREHOLDER'S EQUITY ...................................... 279,108 256,541 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY ...................... $ 3,398,079 3,173,701 =========== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 26 BREMER FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31 -------------------------------------- 1998 1997 1996 --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) INTEREST INCOME Loans and leases, including fees ........... $ 186,963 165,958 151,991 Securities Taxable ................................... 46,698 49,264 47,297 Tax-exempt ................................ 11,036 11,197 11,285 Federal funds sold ......................... 701 -- -- Other ...................................... 127 131 130 --------- --------- --------- Total interest income ................... 245,525 226,550 210,703 --------- --------- --------- INTEREST EXPENSE Deposits ................................... 97,660 90,410 86,246 Federal funds purchased and repurchase agreements ..................... 9,836 6,843 8,823 Other short-term borrowings ................ 9,652 9,514 6,027 Long-term debt ............................. 4,276 3,202 1,414 --------- --------- --------- Total interest expense .................. 121,424 109,969 102,510 --------- --------- --------- Net interest income ....................... 124,101 116,581 108,193 Provision for credit losses ................ 5,570 4,746 2,756 --------- --------- --------- Net interest income after provision for credit losses ....................... 118,531 111,835 105,437 --------- --------- --------- NONINTEREST INCOME Service charges ............................ 17,037 15,787 12,837 Insurance .................................. 7,804 7,503 7,082 Trust ...................................... 6,990 6,265 5,332 Brokerage .................................. 3,752 2,935 2,531 Gain on sale of loans ...................... 4,977 2,550 2,138 Gain (loss) on sale of securities .......... 1,296 (125) 147 State tax refund ........................... 4,476 -- -- Other ...................................... 4,938 3,766 3,775 --------- --------- --------- Total noninterest income ................ 51,270 38,681 33,842 --------- --------- --------- NONINTEREST EXPENSE Salaries and wages ......................... 49,287 44,912 40,676 Employee benefits .......................... 12,572 11,690 10,739 Occupancy .................................. 6,128 6,005 5,756 Furniture and equipment .................... 7,621 6,819 6,294 Data processing fees ....................... 6,046 6,513 7,428 FDIC premiums and examination fees ......... 1,157 555 1,075 Goodwill and other intangibles ............. 1,711 1,499 1,351 Other ...................................... 22,491 20,262 19,006 --------- --------- --------- Total noninterest expense ............... 107,013 98,255 92,325 --------- --------- --------- INCOME BEFORE INCOME TAX EXPENSE ............ 62,788 52,261 46,954 Income tax expense ......................... 21,277 17,201 15,137 --------- --------- --------- NET INCOME .................................. $ 41,511 35,060 31,817 ========= ========= ========= Per common share amounts: Net income-basic .......................... $ 3.46 2.92 2.65 Dividends paid ............................ $ 1.32 1.20 1.05
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 27 BREMER FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
ACCUMULATED COMMON STOCK OTHER ----------------- COMPREHENSIVE COMPREHENSIVE RETAINED CLASS A CLASS B INCOME INCOME EARNINGS TOTAL ------- ------- ------------- ------------- -------- --------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) BALANCE, DECEMBER 31, 1995 ................ $57 2,562 3,895 212,392 218,906 Comprehensive income Net income .............................. 31,817 31,817 31,817 Other comprehensive income Change in net unrealized gain (loss) on securities available for sale, net of $1,967 tax benefit ...... (2,951) (2,951) (2,951) ------ Comprehensive income .................... 28,866 ====== Dividends, $1.05 per share ............... (12,600) (12,600) 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 .................... 236 (1,538) (1,302) ---- ------ ------ ------- ------- BALANCE, DECEMBER 31, 1996 ................ 57 2,562 1,180 230,071 233,870 Comprehensive income Net income .............................. 35,060 35,060 35,060 Other comprehensive income .............. Change in net unrealized gain (loss) on securities available for sale, net of $2,655 tax expense....... 3,982 3,982 3,982 ------ Comprehensive income .................... 39,042 ====== Dividends, $1.20 per share ............... (14,400) (14,400) 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 .................... (319) (1,652) (1,971) ---- ------ ------ ------- ------- BALANCE, DECEMBER 31, 1997 ................ 57 2,562 4,843 249,079 256,541 Comprehensive income Net income .............................. 41,511 41,511 41,511 Other comprehensive income Change in net unrealized gain (loss) on securities available for sale, net of $761 tax benefit ........ (1,141) (1,141) (1,141) ------ Comprehensive income .................... 40,370 ====== 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 .................... 91 (2,054) (1,963) ---- ------ ------ ------- ------- BALANCE, DECEMBER 31, 1998 ................ $57 2,562 3,793 272,696 279,108 === ===== ====== ======= =======
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 28 BREMER FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31 --------------------------------------- 1998 1997 1996 --------- --------- --------- (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net income ........................................................ $ 41,511 35,060 31,817 Adjustments to reconcile net income to net cash provided by operating activities Provision for credit losses ..................................... 5,570 4,746 2,756 Depreciation and amortization ................................... 9,081 7,159 7,135 Deferred income taxes ........................................... 2,283 279 (1,204) Minority interests in earnings of subsidiaries .................. 747 1,486 1,400 (Gain) loss on sale of securities ............................... (1,296) 125 (147) Gain on sale of other real estate owned, net .................... (242) (42) (33) Other assets and liabilities, net ............................... 1,656 (425) (915) Proceeds from sales of other real estate owned .................. 862 643 269 Cash receipts related to loans originated specifically for resale ........................................ 289,472 139,003 123,549 Cash payments related to loans originated specifically for resale ........................................ (290,493) (139,388) (123,397) --------- --------- --------- Net cash provided by operating activities .................... 59,151 48,646 41,230 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Deposits in other banks, net ...................................... 174 (108) 1,230 Purchases of securities available for sale ........................ (359,454) (292,205) (208,159) Purchases of securities held to maturity .......................... (34,381) (28,549) (33,762) Proceeds from maturities of securities available for sale ......... 221,601 114,696 128,539 Proceeds from maturities of securities held to maturity ........... 99,379 41,560 59,942 Proceeds from sales of securities available for sale .............. 67,179 132,230 97,713 Loans and leases, net ............................................. (210,289) (169,560) (129,819) Acquisition of minority interests ................................. (12,149) (31) (5) Acquisitions, net of cash acquired ................................ -- (8,203) -- Acquisition of premises and equipment ............................. (9,264) (11,418) (7,637) --------- --------- --------- Net cash used by investing activities ........................ (237,204) (221,588) (91,958) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Noninterest bearing deposits, net ................................. 24,694 5,843 5,612 Interest bearing deposits (excluding certificates of deposit), net ................................................. 125,907 66,386 (7,416) Certificates of deposits, net ..................................... (22,449) 33,894 42,943 Federal funds purchased and repurchase agreements, net ............ 54,245 (19,607) 1,029 Other short-term borrowings, net .................................. (66,296) 110,021 17,465 Proceeds from issuance of long-term debt .......................... 97,298 10,609 54,564 Repayments of long-term debt ...................................... (11,250) (42,760) (17,743) Dividends paid to minority interests .............................. (326) (910) (1,080) Redeemable preferred stock ........................................ (65) -- -- Dividends paid .................................................... (15,840) (14,400) (12,600) --------- --------- --------- Net cash provided by financing activities .................... 185,918 149,076 82,774 --------- --------- --------- Net increase (decrease) in cash and due from banks ........... 7,865 (23,866) 32,046 Cash and due from banks Beginning of year ................................................ 135,966 159,832 127,786 --------- --------- --------- End of year ...................................................... $ 143,831 135,966 159,832 ========= ========= ========= Supplemental disclosures of cash flow information Cash paid during the year for interest ............................ $ 121,198 106,367 103,494 Cash paid during the year for income taxes ........................ 19,079 16,451 16,229
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 29 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 a majority owner of 14 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. 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 generally accepted accounting principles 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 financial service 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, 1998, 1997, and 1996, the Company received real estate valued at $776,000, $835,000, and $481,000, respectively, in satisfaction of outstanding loan balances. During the years ended December 31, 1997 and 1996, the Company issued installment notes totaling $60,000 and $250,000, respectively, in connection with acquisitions. No installment notes related to acquisitions were issued for the year ended December 31, 1998. 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, increased for accretion of discounts and reduced by amortization of premiums, computed by the constant-yield method. 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 minority interest effects and the resultant allocation to redeemable class A common stock, as a separate component of shareholder's equity until realized. Gains or losses on these securities are computed based on the adjusted cost of the specific securities 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. 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 30 identified by the Company, meet the definition of impaired loans under Statements of Financial Accounting Standard ("FAS") Nos. 114 and 118. Impaired loans as defined by FAS 114 and 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. 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. 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 primarily of goodwill. The remaining unamortized balances at December 31, 1998 and 1997 were approximately $16,545,000 and $15,074,000, respectively, which are 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. Such differences are primarily related to the differences between providing for credit losses for financial reporting purposes while deducting charged-off loans and leases for tax purposes. STATE INCOME TAX REFUND -- In 1998, the Company recorded a non-recurring state tax refund of nearly $4.5 million, including interest. The state tax refund reflects a refund of state income taxes paid to the state of Minnesota from 1980 through 1983. COMPREHENSIVE INCOME -- In 1998, the Company adopted FAS No. 130, "Reporting Comprehensive Income." Comprehensive income is defined as the change in equity of a business enterprise during a period 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 securities available for sale. SEGMENT REPORTING -- In 1998, the Company adopted FAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." The Company evaluated this statement and determined that no additional disclosures about segments were necessary. The Company does not manage based on operating segments. ACCOUNTING FOR DERIVATIVES -- In June 1998, the Financial Accounting Standards Board issued FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement is effective for fiscal years beginning after June 15, 1999. The Company has not yet evaluated the full impact of adoption. ESTIMATES -- The preparation of consolidated financial statements in conformity with generally accepted accounting principles 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 O. 31 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 shareholder's equity. NOTE B: RESTRICTIONS ON CASH AND DUE FROM BANKS The Subsidiary Banks are required to maintain average reserve balances in accordance with the Federal Reserve Bank requirements. The amount of those reserve balances was approximately $22,305,000 and $21,084,000 as of December 31, 1998 and 1997, respectively. NOTE C: INVESTMENT AND MORTGAGE-BACKED SECURITIES At December 31, 1998 and 1997, investment and mortgage-backed securities with amortized cost of $703,857,000 and $740,266,000, respectively, were pledged as collateral to secure public deposits and for other purposes. The amortized cost and estimated fair value by maturity at December 31, 1998, 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 ............... $ 57,599 57,711 260,454 261,908 1 - 5 years ................. 118,168 123,007 367,921 371,816 5 - 10 years ................ 25,233 26,238 68,308 69,292 After 10 years .............. 5,502 5,512 86,323 87,155 -------- ------- ------- ------- Total ...................... $206,502 212,468 783,006 790,171 ======== ======= ======= =======
The amortized cost and fair value of investment and mortgage-backed securities available for sale as of December 31 consisted of the following:
1998 1997 -------------------------------------------- -------------------------------------------- GROSS GROSS GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE -------- -------- -------- -------- -------- -------- -------- -------- (IN THOUSANDS) Governments ............. $ 12,742 207 3 12,946 25,858 196 2 26,052 State and political subdivisions ........... 34,925 902 -- 35,827 33,315 596 -- 33,911 Corporate bonds ......... 8,602 -- 14 8,588 9,058 -- 31 9,027 Mortgage-backed securities ............. 679,135 6,619 1,074 684,680 570,363 8,601 391 578,573 Equity securities ....... 43,625 480 -- 44,105 63,003 446 23 63,426 Other ................... 3,977 49 1 4,025 9,913 44 322 9,635 -------- -------- -------- -------- -------- -------- -------- -------- Total .................. $783,006 8,257 1,092 790,171 711,510 9,883 769 720,624 ======== ======== ======== ======== ======== ======== ======== ========
Proceeds from sales of investments and mortgage-backed securities were $67,179,000, $132,230,000, and $97,713,000 for 1998, 1997, and 1996, respectively. Gross gains of $1,563,000, $391,000, and $727,000 and gross losses of $267,000, $516,000, and $580,000 were realized on those sales for 1998, 1997, and 1996, respectively. 32 A summary of amortized cost and fair value of investment and mortgage-backed securities held to maturity at December 31 consisted of the following:
1998 1997 -------------------------------------------- -------------------------------------------- GROSS GROSS GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE -------- -------- -------- -------- -------- -------- -------- -------- (IN THOUSANDS) Government agencies .............. $ 10,478 135 -- 10,613 26,474 131 15 26,590 State and political subdivisions .......... 148,306 5,894 16 154,184 153,157 5,667 12 158,812 Mortgage-backed securities ............ 27,143 3 76 27,070 91,994 4 490 91,508 Other .................. 20,575 26 -- 20,601 -- -- -- -- -------- -------- -------- -------- -------- -------- -------- -------- Total ................. $206,502 6,058 92 212,468 271,625 5,802 517 276,910 ======== ======== ======== ======== ======== ======== ======== ========
State and political subdivision investments largely involve governmental entities within the Company's market area. NOTE D: 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. Loans and leases at December 31 consisted of the following:
1998 1997 ---------- ---------- (IN THOUSANDS) Commercial and other ............................ $ 475,554 387,048 Commercial real estate .......................... 501,204 419,063 Construction ................................... 59,913 36,518 Agricultural .................................... 444,784 409,875 Residential real estate ......................... 376,652 387,549 Construction ................................... 13,397 12,609 Consumer ........................................ 250,803 263,469 Tax-exempt ...................................... 55,477 52,954 ---------- ---------- Total ......................................... $2,177,784 1,969,085 ========== ==========
Impaired loans and leases were $13,252,000 and $9,868,000 at December 31, 1998 and 1997, 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 $1,725,000 and $1,751,000 relating to impaired loans and leases at December 31, 1998 and 1997, respectively. The effect of nonaccrual and restructured loans and leases on interest income for each of the three years ended December 31 was as follows:
1998 1997 1996 --------- --------- --------- (IN THOUSANDS) Interest income As originally contracted ................ $1,708 794 1,227 As recognized ........................... (324) (276) (291) ------ ---- ----- Reduction of interest income ............. $1,384 518 936 ====== ==== =====
Other nonperforming assets, consisting of other real estate owned, amounted to $620,000 and $691,000 at December 31, 1998 and 1997, respectively. 33 Loans totaling $244,851,000 and $185,774,000 had been pledged to secure Federal Home Loan Bank (FHLB) advances at December 31, 1998 and 1997, respectively. These loans consist of certain qualified residential real estate mortgages, as defined by the FHLB. 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 $16,432,000 and $16,689,000 at December 31, 1998 and 1997, respectively. During 1998, $74,024,000 of new loans were made, repayments totaled $74,593,000, and changes in the composition of the Group or their associations increased loans outstanding by $312,000. These loans were made at the prevailing market interest rates. NOTE E: RESERVE FOR CREDIT LOSSES Changes in the reserve for credit losses are as follows:
1998 1997 1996 -------- -------- -------- (IN THOUSANDS) Beginning of year ........................... $ 34,253 30,482 28,253 Charge-offs ................................ (3,971) (2,759) (2,230) Recoveries ................................. 1,164 1,026 1,703 -------- ------ ------ Net charge-offs ........................... (2,807) (1,733) (527) Provision for credit losses ................ 5,570 4,746 2,756 Reserve related to acquired assets ......... -- 758 -- -------- ------ ------ End of year ................................. $ 37,016 34,253 30,482 ======== ====== ======
NOTE F: PREMISES AND EQUIPMENT Premises and equipment at December 31 consisted of the following:
1998 1997 -------- ------- (IN THOUSANDS) Land .......................................................... $ 7,430 7,530 Buildings and improvements .................................... 58,113 54,573 Furniture and equipment ....................................... 44,814 41,899 -------- ------- Total premises and equipment ................................. 110,357 104,002 Less: accumulated depreciation and amortization ............... 55,967 52,123 -------- ------- Premises and equipment, net ................................... $ 54,390 51,879 ======== =======
NOTE G: 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. In January 1999, the size of the credit facility available was $120.0 million, of which $33.0 million was used at December 31, 1998. The facility contains covenants which require the Company to maintain certain levels of capitalization. 34 Information related to short-term borrowings for the two 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 1997 .................................................. $ 167,174 177,658 14,432 6,000 1998 .................................................. 221,419 89,500 9,294 33,000 Weighted average interest rate at December 31 1997 .................................................. 5.41% 5.89 5.00 6.31 1998 .................................................. 4.96 5.22 4.62 6.52 Maximum amount outstanding at any month end 1997 .................................................. $ 206,275 245,372 14,878 18,000 1998 .................................................. 288,312 178,658 15,167 35,000 Average amount outstanding during the year 1997 .................................................. $ 136,924 156,910 8,350 2,200 1998 .................................................. 196,731 139,520 8,587 22,742 Weighted average interest cost during the year 1997 .................................................. 5.00% 5.70 4.99 6.36 1998 .................................................. 5.00 5.55 4.76 6.55
NOTE H: LONG-TERM DEBT Long-term debt (debt with original maturities of more than one year) at December 31 consisted of the following:
1998 1997 -------- -------- (IN THOUSANDS) Federal Home Loan Bank borrowings ..................... $111,318 24,051 Installment promissory notes .......................... 4,968 6,187 -------- ------ Total ................................................ $116,286 30,238 ======== ======
The FHLB borrowings bear interest at rates ranging from 4.75% to 7.83%, with maturity dates from 1999 through 2013, and are secured by certain loans and investment securities. The installment promissory notes bear interest at rates ranging from 6.94% to 8.53%, paid predominantly in annual installments through 2007. Maturities of long-term debt outstanding at December 31, 1998, were as follows:
(IN THOUSANDS) 1999 ....................................................... $ 12,090 2000 ....................................................... 3,770 2001 ....................................................... 1,423 2002 ....................................................... 1,050 2003 ....................................................... 2,423 Beyond 2003 ................................................ 95,530 -------- Total ..................................................... $116,286 ========
At December 31, 1998, $88.5 million of the FHLB borrowings due in years beyond 2003 were subject to call prior to maturity at the option of the FHLB. Of this amount, $21.5 million, $14.0 million, and $53.0 million is callable in 1999, 2001, and 2003, respectively. NOTE I: DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS Most of the Company's assets and liabilities are considered financial instruments as defined in FAS 107. Many of the Company's financial instruments, however, lack an available trading market which is 35 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, 1998 and 1997. 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, 1998 and, therefore, current estimates of fair value may differ from the amounts presented. As of December 31, carrying amounts and estimated fair values were:
1998 1997 ------------------------- ------------------------ ESTIMATED ESTIMATED CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE ----------- ---------- ---------- ---------- (IN THOUSANDS) ASSETS Cash and due from banks ............... $ 143,831 143,831 135,966 135,966 Interest bearing deposits ............. 1,712 1,712 1,886 1,886 Securities held to maturity ........... 206,502 212,468 271,625 276,910 Securities available for sale ......... 790,171 790,171 720,624 720,624 Loans and leases ...................... 2,135,615 2,163,881 1,929,874 1,935,749 LIABILITIES Demand deposits ....................... 1,235,095 1,235,095 1,089,928 1,089,928 Time deposits ......................... 1,335,555 1,339,780 1,352,570 1,359,277 Short-term borrowings ................. 353,213 353,213 365,264 365,264 Long-term debt ........................ 116,286 120,549 30,238 30,521
CASH AND DUE FROM BANKS AND INTEREST BEARING DEPOSITS -- The carrying values 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 FAS 115, securities available for sale are carried at fair market value. LOANS AND LEASES -- The fair value of loans (net of unearned discount) and leases is estimated by discounting the future cash flows using the current rates at which similar loans or leases would be made to qualified borrowers and for the same remaining maturities, adjusted by a related portion of the reserve for credit losses. 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 is considered 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. 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. 36 NOTE J: 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 employee's highest average compensation during 60 consecutive months of the last 120 months of employment. In recent years, the 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. The following table sets forth the plan's funded status and amount recognized in the Company's balance sheet at December 31 (based on a valuation date of September 30):
1998 1997 ---------- --------- (IN THOUSANDS) Accumulated benefit obligation, including vested benefits of $20,418 in 1998, and $16,892 in 1997 .......................................... $ 23,022 19,150 Increase due to salary projections ..................................... 7,112 6,487 --------- ------ Projected benefit obligation for service rendered to date .............. 30,134 25,637 Plan assets, primarily mutual funds, at fair value ..................... (29,782) (27,783) --------- ------- Projected benefit obligation in excess of (less than) plan assets ...... 352 (2,146) Unrecognized actuarial (loss) gain ..................................... (1,038) 2,263 Prior service cost not yet recognized in net periodic expense .......... (467) (597) --------- ------- Accrued pension benefit ............................................... $ (1,153) (480) ========= =======
Net periodic pension cost at December 31 included the following components:
1998 1997 1996 ---------- ---------- ---------- (IN THOUSANDS) Service cost -- benefits earned during the period ........... $ 1,408 1,118 1,145 Interest cost on projected benefit obligation ............... 1,937 1,715 1,597 Actual return on plan assets ................................ (946) (5,495) (1,240) Net amortization and deferral ............................... (1,363) 3,783 (297) -------- ------ ------ Net pension cost ........................................... $ 1,036 1,121 1,205 ======== ====== ======
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 were 6.75% and 4.25%, respectively, at December 31, 1998, and 7.25% and 4.50%, respectively, at December 31, 1997. The expected long-term rate of return on assets in 1998, 1997, and 1996 was 9.0%. 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 FAS No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions," the Company accrues the cost of these benefits during the employees' active service. 37 The following table sets forth the unfunded plan's accumulated postretirement obligation on the Company's balance sheet at December 31 (based on a valuation date of September 30):
1998 1997 -------- -------- (IN THOUSANDS) Retirees ........................................................................ $ 327 475 Fully eligible active plan participants ......................................... 368 378 Other active plan participants .................................................. 1,377 1,403 ------ ----- Total ......................................................................... $2,072 2,256 ====== ===== Accumulated postretirement benefit obligation in excess of plan assets ....................................................... $2,072 2,256 Unrecognized net gain from past experience different from that assumed and from changes in assumptions ........................................ 1,299 944 Prior service cost not yet recognized in net periodic postretirement benefit cost .................................................... 128 134 ------ ----- Accrued postretirement benefit cost ........................................... $3,499 3,334 ====== =====
Net periodic postretirement benefit cost at December 31 included the following components:
1998 1997 1996 -------- -------- -------- (IN THOUSANDS) Service cost -- benefits earned during the period ..................... $ 157 130 122 Interest cost on accumulated postretirement benefit obligation ........ 171 158 148 Net amortization and deferral ......................................... (53) (69) (82) ----- --- --- Net postretirement benefit cost ..................................... $ 275 219 188 ===== === ===
For the 1998 measurements, the assumed annual rate of increase in the per capita cost of covered health care benefits was 7.7% for 1998 and 8.6% for 1997; the rate was assumed to decrease gradually to 5.0% for 2001 and remain at that level thereafter. The health care cost trend assumption has a significant effect on the amounts reported. The weighted average discount rates used in determining the accumulated postretirement benefit obligation at December 31, 1998 and 1997 were 6.75% and 7.25%, respectively. OTHER POSTEMPLOYMENT BENEFITS -- The Company accounts for postemployment benefits in accordance with FAS No. 112, "Employer's Accounting for Postemployment Benefits," adopted in 1994. 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. The expense for 1998, 1997, and 1996 was approximately $2,465,000, $2,264,000 and $1,757,000, 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 for 1998, 1997, and 1996 was approximately $250,000, $250,000 and $350,000, respectively. 38 NOTE K: OTHER NONINTEREST INCOME Other noninterest income at December 31 consisted of the following:
1998 1997 1996 -------- -------- -------- (IN THOUSANDS) Fees on loans .................................................. $2,944 2,452 2,484 Other .......................................................... 1,994 1,314 1,291 ------ ----- ----- Total ......................................................... $4,938 3,766 3,775 ====== ===== =====
NOTE L: OTHER NONINTEREST EXPENSE Other noninterest expense at December 31 consisted of the following:
1998 1997 1996 --------- -------- -------- (IN THOUSANDS) Printing, postage and office supplies ......................... $ 5,487 5,189 4,802 Marketing ..................................................... 4,756 3,609 3,306 Other real estate owned ....................................... 91 149 56 Other ......................................................... 12,157 11,315 10,842 ------- ------ ------ Total ........................................................ $22,491 20,262 19,006 ======= ====== ======
NOTE M: INCOME TAXES The components of the provision for income taxes at December 31 were as follows:
1998 1997 1996 --------- --------- --------- (IN THOUSANDS) Current Federal ................................................... $14,713 12,941 12,290 State ..................................................... 4,281 3,981 4,051 Deferred ................................................... 2,283 279 (1,204) ------- ------ ------ Total .................................................... $21,277 17,201 15,137 ======= ====== ======
A reconciliation between income tax expense and the amount computed by applying the statutory federal income tax rate at December 31 was as follows:
1998 1997 1996 ---------- ---------- -------- (IN THOUSANDS) Tax at statutory rate ...................................... $21,976 18,291 16,434 Plus state income tax, net of federal tax benefits ......... 3,083 2,588 2,634 ------- ------ ------ 25,059 20,879 19,068 Less tax effect of: Interest on state and political subdivision securities ................................... 2,972 2,955 3,003 Other tax-exempt interest ................................. 1,483 1,471 1,499 Amortization .............................................. (330) (260) (249) Minority interest in earnings ............................. (262) (520) (560) Other ..................................................... (81) 32 238 ------- ------ ------ 3,782 3,678 3,931 ------- ------ ------ Income tax expense ......................................... $21,277 17,201 15,137 ======= ====== ======
39 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:
1998 1997 ---------- --------- (IN THOUSANDS) Deferred tax assets Provision for credit losses ............................... $14,804 13,485 Employee compensation and benefits accruals ............... 1,872 1,562 Deferred income ........................................... 813 584 Other ..................................................... 55 103 ------- ------ Total .................................................... 17,544 15,734 ======= ====== Deferred tax liabilities Deferred expense .......................................... 1,900 1,511 Depreciation .............................................. 6,767 3,264 Unrealized gains on securities available for sale ......... 2,859 3,642 Other ..................................................... 261 444 ------- ------ Total .................................................... 11,787 8,861 ------- ------ Net deferred tax assets .................................... $ 5,757 6,873 ======= ======
NOTE N: 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:
1998 1997 ---------- --------- (IN THOUSANDS) Standby letters of credit ............................... $ 27,217 23,392 Loan commitments ........................................ 489,347 418,101
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; 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 a substantially noncancelable contract, the Company is obligated to pay approximately $2 million in annual fees, through February 2004, to its data processing provider. In addition, in early 1999, the Company's data processing provider will also be providing item processing services to the Company's Subsidiary Banks through March 2006. The costs under this 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. The Company issued redeemable preferred stock of Dunn County Bankshares, Inc. ("DCBI") in connection with the acquisition of DCBI's operations in Menomonie, Wisconsin on September 1, 1994. 40 This stock is cumulative, pays dividends of 3.85% annually, and is generally redeemable at par value plus unpaid dividends after the earlier to occur of (i) the death of the holder, or (ii) the lapse of 5 years from the date of issuance. The Company intends to redeem this preferred stock when it expires in 1999. NOTE O: 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, 1998 and 1997, 960,000 shares of redeemable class A common stock were issued and outstanding. With the exception of shares held in the Company's ESOP, these shares were subject to redemption at a price of $25.28 and $23.24 per share, respectively, which approximated book value. Shares held in the Company's ESOP were redeemed at a price of $36.85 and $31.20 per share, respectively, as determined by an independent appraiser. 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. The shares have been classified as redeemable class A common stock subject to redemption at a price, which approximates book value. 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 or its subsidiaries and not be directly repurchased by the Company or the Otto Bremer Foundation. Certain restrictions exist regarding the extent to which banks may transfer funds to the Company in the form of dividends. 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, 1998, 1997 and 1996, 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, 1998, $47,692,000 of retained earnings of the Subsidiary Banks was available for distribution to the Company as dividends subject to these limitations. Approximately $38,102,000 was available for distribution without obtaining the prior approval of the appropriate bank regulator. NOTE P: 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 regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines, 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. 41 Qualitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below and as defined in the regulations) of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets. Management believes, as of December 31, 1998, that the Company meets all capital adequacy requirements to which it is subject. The Company's actual capital amounts and ratios as of December 31 are also presented below.
FOR CAPITAL ACTUAL ADEQUACY PURPOSES ------------------------ ---------------------- AMOUNT RATIO AMOUNT RATIO ---------- --------- ---------- --------- AS OF DECEMBER 31, 1998: TOTAL CAPITAL (TO RISK WEIGHTED ASSETS) .......... $313,708 13.39% $187,475 8.00% TIER I CAPITAL (TO RISK WEIGHTED ASSETS) ......... 284,319 12.13 93,738 4.00 TIER I CAPITAL (TO AVERAGE ASSETS) ............... 284,319 8.58 99,359 3.00 As of December 31, 1997: Total Capital (to Risk Weighted Assets) .......... 295,722 13.94 169,669 8.00 Tier I Capital (to Risk Weighted Assets) ......... 269,116 12.69 84,834 4.00 Tier I Capital (to Average Assets) ............... 269,116 8.70 92,839 3.00
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, 1998. NOTE Q: BREMER FINANCIAL CORPORATION (PARENT COMPANY ONLY) CONDENSED STATEMENTS: BALANCE SHEETS
DECEMBER 31 ----------------------- 1998 1997 ---------- --------- (IN THOUSANDS) ASSETS Cash and cash equivalents ........................... $ 5,994 10,060 Investment in and advances to: Bank subsidiaries .................................. 262,135 244,780 Non-bank subsidiaries .............................. 67,831 33,211 Other assets ........................................ 5,917 2,534 -------- ------- Total assets ...................................... $341,877 290,585 ======== ======= LIABILITIES AND SHAREHOLDER'S EQUITY Short-term borrowings ............................... $ 33,000 6,000 Long-term debt ...................................... 3,599 4,022 Accrued expenses and other liabilities .............. 1,900 1,714 Redeemable class A common stock ..................... 24,270 22,308 Shareholder's equity ................................ 279,108 256,541 -------- ------- Total liabilities and shareholder's equity ......... $341,877 290,585 ======== =======
42 NOTE Q: BREMER FINANCIAL CORPORATION (PARENT COMPANY ONLY) CONDENSED STATEMENTS (CONTINUED): STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31 ---------------------------------- 1998 1997 1996 -------- -------- -------- (IN THOUSANDS) INCOME Dividends from: Bank subsidiaries ..................................... $ 28,173 28,274 19,281 Non-bank subsidiaries ................................. 4,300 12,850 603 Interest from subsidiaries ............................. 3,060 863 313 Other interest income .................................. -- 405 1,363 Gain on sale of securities ............................. -- 54 200 Other income ........................................... 353 274 14 -------- -------- -------- Total income .......................................... 35,886 42,720 21,774 EXPENSES Interest expense: Short-term borrowings ................................. 1,489 154 -- Long-term debt ........................................ 305 339 373 Salaries and benefits .................................. 685 1,083 702 Operating expense paid to subsidiaries ................. 1,083 1,148 1,190 Other operating expenses ............................... 538 679 1,105 -------- -------- -------- Total expenses ........................................ 4,100 3,403 3,370 -------- -------- -------- Income before income tax benefit ...................... 31,786 39,317 18,404 Income tax benefit ..................................... 208 1,181 788 -------- -------- -------- Income of parent company only ......................... 31,994 40,498 19,192 Equity in undistributed earnings (losses) of subsidiaries ....................................... 9,517 (5,438) 12,625 -------- -------- -------- NET INCOME .............................................. $ 41,511 35,060 31,817 ======== ======== ========
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31 ---------------------------------- 1998 1997 1996 -------- -------- -------- (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net income .............................................. $ 41,511 35,060 31,817 Adjustments to reconcile net income to net cash provided by operating activities Equity in undistributed (earnings) losses of subsidiaries ...................................... (9,517) 5,438 (12,625) Gain on sale of securities ............................. -- (54) (200) Securities amortization ................................ -- 115 470 Other, net ............................................. (3,197) 1,108 (262) -------- -------- -------- Net cash provided by operating activities ............. 28,797 41,667 19,200 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Investment in and advances to subsidiaries, net ......... (43,600) (47,104) (7,624) Purchases of securities, net ............................ -- (18,644) (22,746) Proceeds from maturities of securities .................. -- 23,075 5,303 Proceeds from sales of securities ....................... -- 17,842 15,540 -------- -------- -------- Net cash used by investing activities ................. (43,600) (24,831) (9,527) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Short-term borrowings, net .............................. 27,000 6,000 -- Repayments of long-term debt ............................ (423) (424) (424) Dividends paid .......................................... (15,840) (14,400) (12,600) -------- -------- -------- Net cash provided (used) by financing activities ...... 10,737 (8,824) (13,024) -------- -------- -------- (Decrease) increase in cash and cash equivalents ......... (4,066) 8,012 (3,351) Cash and cash equivalents Beginning of year ...................................... 10,060 2,048 5,399 -------- -------- -------- End of year ............................................ $ 5,994 10,060 2,048 ======== ======== ========
43 NOTE R: SUBSEQUENT EVENTS Subsequent to December 31, 1998, the Company and the shareholders of Dean Financial Services, Inc. ("Dean") entered into a Stock Purchase Agreement (the "Agreement") under which the Company is to acquire all of the shares of capital stock of Dean. The acquisition under the Agreement is subject to the receipt of various governmental approvals and other customary closing conditions. The acquisition is expected to close in April 1999. Dean is a privately-held bank holding company with approximately $312 million in assets with four charter banks serving 11 locations in Minnesota. Subsequent to December 31, 1998, the Company was engaged in discussions to purchase Northwest Equity Corp. of Amery, Wisconsin, and its subsidiary, Northwest Savings Bank. Northwest Savings Bank has assets of approximately $100 million with three locations in Amery, New Richmond, and Siren, Wisconsin. (The remainder of this page was intentionally left blank.) 44 INDEPENDENT AUDITORS' REPORT TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF BREMER FINANCIAL CORPORATION 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, 1998 and 1997, and the related consolidated statements of income, shareholder's equity and cash flows for each of the three years in the period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Bremer Financial Corporation and subsidiaries as of December 31, 1998 and 1997 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. /s/ Deloitte & Touche LLP January 26, 1999 Minneapolis, Minnesota 45 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, 1998. PART III. Items 10 through 13 of the Form 10-K are omitted because the Company will file before April 30, 1999 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. ITEM 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, 1998 and December 31, 1997 Consolidated Statements of Income -- Years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Shareholder's Equity -- Years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows -- Years ended December 31, 1998, 1997 and 1996 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 1998 Executive Annual Incentive Compensation Plan for Chief Credit Officer; Chief Financial Officer; Chief Information Officer; Human Resources Director; and Operations Director. 10.2 Bremer Financial Corporation 1998 Executive Annual Incentive Compensation Plan for Group Presidents. 10.3 Bremer Financial Corporation 1998 Executive Annual Incentive Compensation Plan for Chairman of the Board of Bremer Financial Corporation. 10.4 Bremer Financial Corporation 1998 Executive Annual Incentive Compensation Plan for President and CEO of Bremer Financial Corporation. 21 Subsidiaries of the Company. 27 Financial Data Schedule. 46 The following exhibits are incorporated by reference to Exhibits 10.1, 10.2, 10.3, and 10.4, respectively, to the Company's Annual Report on Form 10-K for the year ended December 31, 1997: 10.5 Bremer Financial Corporation 1997 Executive Incentive Compensation Plan for Director, Operations & Technology; Retail Banking Services Director; Chief Information Officer; Chief Financial Officer, Chief Credit Officer, and Human Resources Director. 10.6 Bremer Financial Corporation 1997 Executive Incentive Compensation Plan for Group Presidents. 10.7 Bremer Financial Corporation 1997 Executive Incentive Compensation Plan for Chief Operating Officer. 10.8 Bremer Financial Corporation 1997 Executive Incentive Compensation Plan for President and CEO. 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, 1996: 10.9 Bremer Financial Corporation 1996 Executive Incentive Compensation Plan for Chief Financial Officer; Chief Credit Officer; and Human Resources Director. 10.10 Bremer Financial Corporation 1996 Executive Incentive Compensation Plan for Group Presidents. 10.11 Bremer Financial Corporation 1996 Executive Incentive Compensation Plan for Chief Operating Officer. 10.12 Bremer Financial Corporation 1996 Executive Incentive Compensation Plan for President and CEO. 10.13 Bremer Financial Corporation 1996 Long-Term Compensation Plan for Group Presidents and Chief Operating Officer. 10.14 Bremer Financial Corporation 1996 Long-Term Incentive Compensation Plan for President and CEO. 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. 99.1 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." 99.2 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. 47 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. 10.15 Bremer Financial Corporation Employee Stock Ownership Plan and Trust Agreement. 10.16 Bremer Banks Profit Sharing Plus Plan, as amended and restated effective January 1, 1986, and Amendment No. 1 thereto. 10.17 Bremer Banks Profit Sharing Plus Trust Agreement dated October 1, 1986 and Amendment No. 1 thereto. 10.18 Bremer Banks Retirement Plan as effective April 1, 1985. 10.19 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: 4.1 Specimen of Stock Certificate evidencing Class A Common Stock. 4.2 Specimen of Stock Certificate evidencing Class B Common Stock. 99.3 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 1998, which ended December 31, 1998. The Company did file the following Current Reports on Form 8-K subsequent to December 31, 1998 but before the filing of this Form 10-K dated March 12, 1999: Form 8-K filed January 28, 1999 relating to the Company entering into a Stock Purchase Agreement with Dean Financial Services, Inc. under which the Company is to acquire all of the shares of capital stock of Dean. Form 8-K filed February 22, 1999 relating to the Company signing a definitive agreement to purchase Northwest Equity Corp. and its subsidiary, Northwest Savings Bank. A copy of this Form 10-K and exhibits herein can be obtained by writing Robert B. Buck, Senior Vice President and Chief Financial Officer, Bremer Financial Corporation, 445 Minnesota Street, Suite 2000, St. Paul, MN 55101. 48 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 12, 1999. 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 12, 1999 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/ ROBERT B. BUCK --------------------------------------------- Robert B. Buck SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER (PRINCIPAL FINANCIAL OFFICER) /S/ STUART F. BRADT --------------------------------------------- Stuart F. Bradt CONTROLLER (PRINCIPAL ACCOUNTING OFFICER) 49 INDEX TO EXHIBITS Description of Exhibits Page 10.1 Bremer Financial Corporation 1998 Executive Annual Incentive Compensation Plan for Chief Credit Officer; Chief Financial Officer; Chief Information Officer; Human Resources Director; and Operations Director. 51 10.2 Bremer Financial Corporation 1998 Executive Annual Incentive Compensation Plan for Group Presidents. 55 10.3 Bremer Financial Corporation 1998 Executive Annual Incentive Compensation Plan for Chairman of the Board of Bremer Financial Corporation. 58 10.4 Bremer Financial Corporation 1998 Executive Annual Incentive Compensation Plan for President and CEO of Bremer Financial Corporation. 61 21 Subsidiaries of the Company. 64 27 Financial Data Schedule. 50 EX-10.1 2 1998 EXECUTIVE ANNUAL INCENTIVE COMPENSATION PLAN EXHIBIT 10.1 BREMER FINANCIAL CORPORATION 1998 EXECUTIVE ANNUAL INCENTIVE COMPENSATION PLAN Chief Credit Officer Chief Financial Officer Chief Information Officer Human Resources Director Operations Director Contained herein is a detailed outline of the Executive Annual Incentive Compensation Plan which has been designed for the Chief Credit Officer, Chief Financial Officer, Chief Information Officer, Human Resources Director and Operations Director. A. Purpose 1) To provide an annual incentive award to the Chief Credit Officer, Chief Financial Officer, Chief Information Officer, Human Resources Director, and Operations Director for the achievement of Bremer Financial Corporation's goals and objectives. 2) To focus attention on those activities which will positively affect the Corporation's financial well-being. B. Eligibility 1) The Chief Credit Officer, Chief Financial Officer, Chief Information Officer, Human Resources Director, and Operations Director are the participants in this plan. C. Plan Year 1) The Executive Annual Incentive Compensation program will begin on January 1 and will end on December 31. D. Payment of Award 1) At year end, formal reviews will be conducted by the appropriate designated management to determine and measure performance. Upon completion of the measurement of the participants' goals and objectives, awards will be approved. 2) Award payments will be made in the first quarter, following the end of defined incentive plan year. E. Potential Awards 1) The maximum potential award, stated as a percentage of base salary, will be 30%. F. Performance Measures and Determination of Award 1) 70% of the incentive award will be based upon Corporate RORE. The following table will be utilized to determine the actual percentage of salary to be granted. When performance falls between the RORE percentages shown, interpolation will be utilized to determine the actual percentage of salary to be awarded. Corporate RORE Percentage Award -------------- ---------------- Below 13.00 -0- 13.00 THRESHOLD 7.00% 13.76 2/3 OF MAXIMUM 14.00% 51 14.20 PLAN 17.62% 14.61 and over MAXIMUM 21.00% 2) Work Plan Objectives 30% of the incentive award will be based on work plan objectives. The work plan objectives should be submitted to the President and CEO of Bremer Financial Corporation for approval ("CEO"). The maximum percentage award for achieving work plan objectives is 9%. G. Administration 1) The plan shall be subject to the approval of the Board of Directors of Bremer Financial Corporation ("Board") which shall have sole authority to establish the terms and conditions under which the plan will be administered. 2) The Executive Incentive Compensation Plan and awards are not transferable or assignable. 3) Awards may not be deferred. H. Administrative Procedures 1) Additions to Plan -- Eligible individuals will be added to the plan at any time upon the approval of the Board. However, the size of their awards will be prorated by the number of months they were eligible to receive an award. An example would be: - Employee "A" is added to plan in mid-year so s/he has six (6) months of eligible service. - Calculated incentive award is $15,000 - $15,000 X 6/12 = $7,500 2) Terminations -- If the eligible participant terminates during the plan year, the incentive award will be handled as follows: - Voluntary resignations -- no incentive award. - Involuntary terminations for cause -- no incentive award. - Involuntary termination without cause -- incentive award prorated by number of months service during current incentive plan year, based on approval by the CEO. - Retirement/disability -- incentive award prorated by number of months of service during current incentive plan year. 3) Change in Position -- If the eligible participant has a change in position during a plan year, their incentive award will be calculated under both plan award levels and prorated by the months of service at each level. 4) Interpolation -- When actual performance falls between cells on the appropriate element, the individual completing the formula should interpolate to the actual percentage to be awarded. 5) Performance -- If a participant's performance rating for the plan year is less than fully competent and/or certain performance goals are not met, the CEO has the authority to reduce partially or totally the incentive payout that would normally be due the participant. 6) Exceptions -- Upon occasion, there may be specific reasons for exceptions to the incentive compensation program for events beyond the control of the participant in the plan. The CEO has the authority to determine and approve all such exceptions. I. Amendment and termination 52 1) The Board may at any time amend the plan for the purposes of satisfying the requirements of any changes in applicable laws or for any purpose which may be permitted by law. The Board may also terminate the plan at any time. No such amendment or termination shall, however, adversely affect the rights of any participant (without his/her prior consent) to any award previously approved. 53 CALCULATION OF EXECUTIVE INCENTIVE AWARD Plan Year 1998 - ------------------------------ ------------------ NAME TITLE Percentage of Salary To Be Awarded ------------- F-1 - Corporate RORE - -------------------- Corporate RORE (70% of total award) ______% ______________% Work Plan Objectives Achievement Level ______ ______________% (30% of total award) Attach a description of work plan objectives and how they will be measured. Total Award Earned as % of Salary ______________% - --------------------------------- X 1998 Salary $______________ = 1998 INCENTIVE AWARD $______________ Approved: - -------------------------- ------------------------------------------------- DATE President and CEO of Bremer Financial Corporation - -------------------------- ------------------------------------------------- DATE Chairman of Board of Bremer Financial Corporation 54 EX-10.2 3 1998 EXECUTIVE ANNUAL INCENTIVE COMPENSATION PLAN EXHIBIT 10.2 BREMER FINANCIAL CORPORATION 1998 EXECUTIVE ANNUAL INCENTIVE COMPENSATION PLAN Group Presidents Contained herein is a detailed outline of the Executive Annual Incentive Compensation Plan which has been designed for Bremer Group Presidents. A. Purpose 1) To provide an annual incentive award to Group Presidents who contribute significantly toward the achievement of Bremer Financial Corporation's goals and objectives. 2) To focus attention on those activities which will positively affect the Corporation's financial well-being. B. Eligibility 1) Participants will be Group Presidents. C. Plan Year 1) The Executive Annual Incentive Compensation program will begin on January 1 and will end on December 31. D. Payment of Award 1) At year end, formal reviews will be conducted by the appropriate designated management to determine and measure performance. Upon completion of the measurement of the participant's goals and objectives, award payments will be recommended and approved. 2) Award payments will be made in the first quarter, following the end of defined incentive plan year. E. Potential Awards 1) The maximum potential award, stated as a percentage of base salary, will be 40%. F. Performance Measures and Determination of Award 1) Corporate RORE 70% of the incentive award will be based upon Corporate RORE. The following table will be utilized to determine the actual percentage of salary to be granted. When performance falls between the RORE percentages shown, interpolation will be utilized to determine the actual percentage of salary to be awarded. Corporate RORE Percentage Award -------------- ---------------- Below 13.00 0% 13.00 THRESHOLD 9.33% 13.76 2/3 OF MAXIMUM 18.67% 14.20 PLAN 23.50% 14.61 and over MAXIMUM 28.00% 55 2) Work Plan Objectives 30% of the incentive award will be based on achievement of work plan objectives. The work plan objectives should be submitted to the President and CEO of Bremer Financial Corporation ("CEO") for approval. The maximum percentage award for achieving work plan objectives is 12.0%. G. Administration 1) The plan shall be subject to the approval of the Board of Directors of Bremer Financial Corporation ("CEO") which shall have sole authority to establish the terms and conditions under which the plan will be administered. 2) The Executive Incentive Compensation Plan and awards are not transferable or assignable. 3) Award may be deferred. H. Administrative Procedures 1) Additions to Plan -- Eligible individuals will be added to the plan at any time upon the approval of the Board. However, the size of their awards will be prorated by the number of months they are eligible to receive an award. An example would be: - Employee "A" is added to plan in mid-year so s/he has six (6) months of eligible service. - Calculated incentive award is $15,000 - $15,000 X 6/12 = $7,500 2) Terminations -- Eligible employees who terminate during the plan year will be handled as follows: - Voluntary resignations -- no incentive award. - Involuntary terminations for cause -- no incentive award. - Involuntary termination without cause -- incentive award prorated by number of month service during current incentive plan year, based on approval by President of BFC. - Retirement/disability -- incentive award prorated by number of months of service during current incentive plan year. 3) Change in Position -- Eligible employees who have a change in position during a plan year will have their incentive award calculated under both plan award levels and prorated by the months of service at each level. 4) Interpolation -- When actual performance falls between cells on the appropriate element, the individual completing the formula should interpolate to the actual percentage to be awarded. 5) Performance -- If a participant's performance rating for the plan year is less than fully competent and/or certain performance goals are not met, the CEO has the authority to reduce partially or totally the incentive payout that would normally be due the participant. 6) Exceptions -- Upon occasion, there may be specific reasons for exceptions to the incentive compensation program for events beyond the control of the participant in the plan. The CEO has the authority to determine and approve all such exceptions. I. Amendment and termination 1) The Board may at any time amend the plan for the purposes of satisfying the requirements of any changes in applicable laws or for any purpose which may be permitted by law. The Board may also terminate the plan at any time. No such amendment or termination shall, however, adversely affect the rights of any participant (without his/her prior consent) to any award previously approved. 56 CALCULATION OF EXECUTIVE INCENTIVE AWARD ---------------------------------------- Plan Year 1998 - ------------------------------ ------------------ NAME TITLE Percentage of Salary To Be Awarded ------------- F-1 - Corporate RORE - -------------------- Corporate RORE (70% of total award) ______% ______________% Work Plan Objectives Achievement Level ______ ______________% (30% of total award) Attach a description of work plan objectives and how they will be measured. Total Award Earned as % of Salary ______________% - --------------------------------- X 1998 Salary $______________ = 1998 INCENTIVE AWARD $______________ Approved: - ------------------------ ----------------------------------------------------- DATE President and CEO of Bremer Financial Corporation - ------------------------ ----------------------------------------------------- DATE Chairman of the Board of Bremer Financial Corporation 57 EX-10.3 4 1998 EXEC ANNUAL INCENTIVE COMP PLAN-CHAIRMAN EXHIBIT 10.3 BREMER FINANCIAL CORPORATION 1998 EXECUTIVE ANNUAL INCENTIVE COMPENSATION PLAN Chairman of the Board of Bremer Financial Corporation Contained herein is a detailed outline of the Executive Annual Incentive Compensation Plan which has been designed for the Chief Chairman of the Board of Directors of Bremer Financial Corporation ("Chairman"). A. Purpose 1) To provide an annual incentive award to the Chairman for the achievement of Bremer Financial Corporation's goals and objectives. 2) To focus attention on those activities which will positively affect the Corporation's financial well-being. B. Eligibility 1) The Chairman of the Board of Directors of Bremer Financial Corporation is the participant in this plan. C. Plan Year 1) The Executive Annual Incentive Compensation program will begin on January 1 and will end on December 31. D. Payment of Award 1) At year end, formal reviews will be conducted by the Bremer Financial Corporation Board of Directors ("Board") to determine and measure performance. Upon completion of the measurement of the participant's goals and objectives, an award will be approved. 2) Award payments will be made in the first quarter, following the end of defined incentive plan year. E. Potential Awards 1) The maximum potential award, stated as a percentage of base salary, will be 60%. F. Performance Measures and Determination of Award 1) 100% of the incentive award will be based upon Corporate RORE. The following table will be utilized to determine the actual percentage of salary to be granted. When performance falls between the RORE percentages shown, interpolation will be utilized to determine the actual percentage of salary to be awarded. Corporate RORE Percentage Award -------------- ---------------- Below 13.00 0% 13.00 THRESHOLD 20.00% 13.76 2/3 OF MAXIMUM 40.00% 14.20 PLAN 50.35% 14.61 and over MAXIMUM 60.0% 58 G. Administration 1) The plan shall be subject to the approval of the Board which shall have sole authority to establish the terms and conditions under which the plan will be administered. 2) The Executive Incentive Compensation Plan and awards are not transferable or assignable. 3) Award may be deferred. H. Administrative Procedures 1) Addition to Plan -- Eligible individuals will be added to the plan at any time upon the approval of the Board. However, the size of their awards will be prorated by the number of months they were eligible to receive an award. An example would be: - Employee "A" is added to plan in mid-year so s/he has six (6) months of eligible service. - Calculated incentive award is $15,000 - $15,000 X 6/12 = $7,500 2) Terminations - If the eligible participant terminates during the plan year will be handled as follows: - Voluntary resignations -- no incentive award. - Involuntary terminations for cause -- no incentive award. - Involuntary termination without cause -- incentive award prorated by number of months service during current incentive plan year, based on approval by the Board. - Retirement/disability -- incentive award prorated by number of months of service during current incentive plan year. 3) Change in Position -- Eligible employees who have a change in position during a plan year will have their incentive award calculated under both plan award levels and prorated by the months of service at each level. 4) Interpolation -- When actual performance falls between cells on the appropriate element, the individual completing the formula should interpolate to the actual percentage to be awarded. 5) Performance -- If a participant's performance rating for the plan year is less than fully competent and/or certain performance goals are not met, the Board has the authority to reduce partially or totally the incentive payout that would normally be due the participant. 6) Exceptions -- Upon occasion, there may be specific reasons for exceptions to the incentive compensation program for events beyond the control of the participant in the plan. The Board has the authority to determine and approve all such exceptions. I. Amendment and termination 1) The Board may at any time amend the plan for the purposes of satisfying the requirements of any changes in applicable laws or for any purpose which may be permitted by law. The Board may also terminate the plan at any time. No such amendment or termination shall, however, adversely affect the rights of any participant (without his/her prior consent) to any award previously approved. 59 CALCULATION OF EXECUTIVE INCENTIVE AWARD Plan Year 1998 NAME _________________________ TITLE: Chairman of the Board of Directors of Bremer Financial Corporation Percentage of Salary To Be Awarded ------------- F-1 - Corporate RORE - -------------------- Corporate RORE _______% ______________% Total Award Earned as % of Salary ______________% - --------------------------------- X 1998 Salary $______________ = 1998 INCENTIVE AWARD $______________ Approved: - -------------------------- -------------------------------------------------- DATE Board of Directors of Bremer Financial Corporation 60 EX-10.4 5 1998 EXECUTIVE ANNUAL INCENTIVE COMPENSATION PLAN EXHIBIT 10.4 BREMER FINANCIAL CORPORATION 1998 EXECUTIVE ANNUAL INCENTIVE COMPENSATION PLAN President and CEO of Bremer Financial Corporation Contained herein is a detailed outline of the Executive Annual Incentive Compensation Plan which has been designed for the President and CEO of Bremer Financial Corporation ("CEO"). A. Purpose 1) To provide an annual incentive award to the CEO for the achievement of Bremer Financial Corporation's goals and objectives. 2) To focus attention on those activities which will positively affect the Corporation's financial well-being. B. Eligibility 1) The CEO of Bremer Financial Corporation is the participant in this plan. C. Plan Year 1) The Executive Annual Incentive Compensation program will begin on January 1 and will end on December 31. D. Payment of Award 1) At year end, formal reviews will be conducted by the Chairman of the Board Directors of Bremer Financial Corporation ("Chairman") to determine and measure performance. Upon completion of the measurement of the participant's goals and objectives, an award will be approved. 2) Award payments will be made in the first quarter, following the end of defined incentive plan year. E. Potential Awards 1) The maximum potential award, stated as a percentage of base salary, will be 60%. F. Performance Measures and Determination of Award 1) 100% of the incentive award will be based upon Corporate RORE. The following table will be utilized to determine the actual percentage of salary to be granted. When performance falls between the RORE percentages shown, interpolation will be utilized to determine the actual percentage of salary to be awarded. Corporate RORE Percentage Award -------------- ---------------- Below 13.00 0.00% 13.00 THRESHOLD 20.00% 13.76 2/3 OF MAXIMUM 40.00% 14.20 PLAN 50.35% 14.61 and over MAXIMUM 60.00% 61 G. Administration 1) The plan shall be subject to the approval of the Board of Directors of Bremer Financial Corporation ("Board") which shall have sole authority to establish the terms and conditions under which the plan will be administered. 2) The Executive Incentive Compensation Plan and awards are not transferable or assignable. 3) Award may be deferred. H. Administrative Procedures 1) Additions to Plan -- Eligible individuals will be added to the plan at any time upon the approval of the Board. However, the size of their awards will be prorated by the number of months they were eligible to receive an award. An example would be: - Employee "A" is added to plan in mid-year so s/he has six (6) months of eligible service. - Calculated incentive award is $15,000 - $15,000 X 6/12 = $7,500 2) Terminations -- If the eligible participant terminates during the plan year, the incentive award will be handled as follows: - Voluntary resignation -- no incentive award. - Involuntary termination for cause -- no incentive award. - Involuntary termination without cause -- incentive award prorated by number of months service during current incentive plan year, based on approval of the Chairman. - Retirement/disability -- incentive award prorated by number of months of service during current incentive plan year. 3) Change in Position -- If the eligible participant has a change in position during a plan year, the incentive award will be calculated under both plan award levels and prorated by the months of service at each level. 4) Interpolation -- When actual performance falls between cells on the appropriate element, the individual completing the formula should interpolate to the actual percentage to be awarded. 5) Performance -- If a participant's performance rating for the plan year is less than fully competent, the Chairman has the authority to reduce partially or totally the incentive payout that would normally be due the participant. 6) Exceptions -- Upon occasion, there may be specific reasons for exceptions to the incentive compensation program for events beyond the control of the participant in the plan. The Chairman has the authority to determine and approve all such exceptions. I. Amendment and termination 1) The Board may at any time amend the plan for the purposes of satisfying the requirements of any changes in applicable laws or for any purpose which may be permitted by law. The Board may also terminate the plan at any time. No such amendment or termination shall, however, adversely affect the rights of any participant (without his/her prior consent) to any award previously approved. 62 CALCULATION OF EXECUTIVE INCENTIVE AWARD Plan Year 1998 ______________________________ TITLE: President and CEO of NAME Bremer Financial Corporation Percentage of Salary To Be Awarded ------------- F-1 - Corporate RORE - -------------------- Corporate RORE _______% ______________% Total Award Earned as % of Salary ______________% (F-1) X 1998 Salary $______________ = 1998 INCENTIVE AWARD $______________ Approved: - -------------------------- --------------------------------------------- DATE Chairman of the Board of Directors of Bremer Financial Corporation 63 EX-21 6 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21 Subsidiaries of Bremer Financial Corporation Name of Subsidiaries and State or Other Jurisdiction of Incorporation as of March 12, 1999: State of Minnesota: Bremer Business Finance Corporation Bremer Financial Services, Inc. Bremer Insurance Agencies, Inc. Bremer Services, Inc. Bremer Trust, National Association State of Wisconsin: Dunn County Bankshares, Inc., parent of Bremer Bank, National Association (Menomonie, WI) Bremer Premium Finance Corporation State of Arizona: Bremer First American Life Insurance Company United States (National Bank Act): Bremer Bank, National Association (Alexandria, MN) Bremer Bank, National Association (Brainerd, MN) Bremer Bank, National Association (Breckenridge, MN) Bremer Bank, National Association (Crookston, MN) Bremer Bank, National Association (Detroit Lakes, MN) Bremer Bank, National Association (Grand Forks, ND) Bremer Bank, National Association (International Falls, MN) Bremer Bank, National Association (Marshall, MN) Bremer Bank, National Association (Menomonie, WI) Bremer Bank, National Association (Minot, ND) Bremer Bank, National Association (Moorhead, MN) Bremer Bank, National Association (St. Cloud, MN) Bremer Bank, National Association (South Saint Paul, MN) Bremer Bank, National Association (Willmar, MN) 64 EX-27 7 ARTICLE 9-FINANCIAL DATA SCHEDULE
9 TWELVE MONTHS ENDED DECEMBER 31, 1998 0000846616 BREMER FINANCIAL CORPORATION 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 143,831 1,712 0 0 790,171 206,502 212,468 2,172,631 37,016 3,398,079 2,570,650 353,213 51,568 116,286 2,079 0 26,889 277,394 3,398,079 186,963 57,734 828 245,525 97,660 121,424 124,101 5,570 1,296 107,013 62,788 41,511 0 0 41,511 3.46 3.46 4.06 13,074 1,142 178 110,195 34,253 3,971 1,164 37,016 31,100 0 5,916
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