-----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, PMNyVUn49Rtnsvnsn3NDqn3ZSSKWCsyTrjB8acZITsqGk9QL9Z5WNWb8VR+i7Q5I jJPx/FH4KHS51/5GsrWSfA== 0000945434-04-000027.txt : 20040805 0000945434-04-000027.hdr.sgml : 20040805 20040804173120 ACCESSION NUMBER: 0000945434-04-000027 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040805 FILER: COMPANY DATA: COMPANY CONFORMED NAME: BNCCORP INC CENTRAL INDEX KEY: 0000945434 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 450402816 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-16527 FILM NUMBER: 04952574 BUSINESS ADDRESS: STREET 1: 322 E MAIN STREET 2: PO BOX 4050 CITY: BISMARCK STATE: ND ZIP: 58501 BUSINESS PHONE: 7012503040 MAIL ADDRESS: STREET 1: 322 E MAIN STREET 2: PO BOX 4050 CITY: BISMARCK STATE: ND ZIP: 58501 10-Q 1 q063004.txt QUARTER ENDED 06-30-04 _ U.S. Securities and Exchange Commission Washington, D.C. 20549 ------ FORM 10-Q ------ [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended June 30, 2004 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 0-26290 BNCCORP, INC. (Exact name of registrant as specified in its charter) Delaware 45-0402816 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 322 East Main Bismarck, North Dakota 58501 (Address of principal executive office) (701) 250-3040 (Registrant's telephone number) Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ___ No _X_ The number of shares of the registrant's outstanding common stock on August 2, 2004 was 2,822,111. PART I - FINANCIAL INFORMATION Item 1. Financial Statements
BNCCORP, INC. AND SUBSIDIARIES Consolidated Balance Sheets (In thousands, except share and per share data) June 30, December 31, ASSETS 2004 2003 ------------ ------------- Unaudited) CASH AND DUE FROM BANKS........................... $ 11,905 $ 12,520 ------------ ------------- Cash and cash equivalents.................... 11,905 12,520 INVESTMENT SECURITIES AVAILABLE FOR SALE.......... 263,395 262,568 FEDERAL RESERVE BANK AND FEDERAL HOME LOAN BANK STOCK.................................. 7,442 7,596 LOANS HELD FOR SALE............................... 15,022 -- LOANS AND LEASES, net............................. 273,891 283,555 ALLOWANCE FOR CREDIT LOSSES....................... (3,443) (4,763) ------------ ------------- Net loans and leases......................... 270,448 278,792 PREMISES AND EQUIPMENT, net....................... 20,715 18,570 INTEREST RECEIVABLE............................... 2,491 2,462 OTHER ASSETS...................................... 14,665 15,507 GOODWILL.......................................... 18,432 15,089 OTHER INTANGIBLE ASSETS, net...................... 8,580 8,373 ------------ ------------- $ 633,095 $ 621,477 ============ ============= LIABILITIES AND STOCKHOLDERS' EQUITY DEPOSITS: Noninterest-bearing............................. $ 49,225 $ 44,725 Interest-bearing - Savings, interest checking and money market.. 193,882 215,525 Time deposits $100,000 and over.............. 65,482 46,569 Other time deposits.......................... 96,904 89,123 ------------ ------------- Total deposits.................................. 405,493 395,942 SHORT-TERM BORROWINGS............................. 43,977 31,383 FEDERAL HOME LOAN BANK ADVANCES................... 102,200 112,200 LONG-TERM BORROWINGS.............................. 10,110 8,640 GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY'S SUBORDINATED DEBENTURES.............. 22,440 22,397 OTHER LIABILITIES................................. 8,723 10,729 ------------ ------------- Total liabilities................... 592,943 581,291 STOCKHOLDERS' EQUITY: Preferred stock, $.01 par value - 2,000,000 shares authorized; 0 and 150 shares issued and outstanding on June 30, 2004 and December 31, 2003, respectively.......... -- -- Capital surplus - preferred stock............... -- 1,500 Common stock, $.01 par value - 10,000,000 shares authorized; 2,822,111 and 2,749,196 shares issued and outstanding (excluding 42,880 shares held in treasury) on June 30, 2004 and December 31, 2003, respectively................................. 29 28 Capital surplus - common stock.................. 18,164 17,074 Retained earnings............................... 23,578 21,119 Treasury stock (42,880 shares).................. (513) (513) Accumulated other comprehensive income, net of income taxes.......................... (1,106) 978 ------------ ------------- Total stockholders' equity............. 40,152 40,186 ------------ ------------- $ 633,095 $ 621,477 ============ ============= See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Income (In thousands, except per share data) For the Three Months For the Six Months Ended June 30, Ended June 30, ----------------------------- ---------------------------- 2004 2003 2004 2003 ------------- ------------- ------------ ------------- INTEREST INCOME: (unaudited) (unaudited) Interest and fees on loans.................... $ 4,139 $ 5,238 $ 8,863 $ 10,422 Interest and dividends on investments - Taxable.................................... 2,367 1,584 5,058 3,451 Tax-exempt................................. 402 380 803 735 Dividends.................................. 46 62 89 124 Other......................................... -- 1 -- 1 ------------- ------------- ------------ ------------- Total interest income............. 6,954 7,265 14,813 14,733 ------------- ------------- ------------ ------------- INTEREST EXPENSE: Deposits...................................... 1,538 1,923 3,156 4,029 Short-term borrowings......................... 118 113 217 221 Federal Home Loan Bank advances............... 1,208 1,332 2,461 2,608 Long-term borrowings.......................... 88 96 181 195 Subordinated debentures....................... 427 433 853 870 ------------- ------------- ------------ ------------- Total interest expense............ 3,379 3,897 6,868 7,923 ------------- ------------- ------------ ------------- Net interest income............... 3,575 3,368 7,945 6,810 PROVISION FOR CREDIT LOSSES..................... -- 400 -- 1,175 ------------- ------------- ------------ ------------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES....................... 3,575 2,968 7,945 5,635 ------------- ------------- ------------ ------------- NONINTEREST INCOME: Insurance commissions......................... 4,422 3,423 8,984 7,485 Fees on loans................................. 339 482 915 943 Service charges............................... 210 218 421 428 Brokerage income.............................. 174 99 353 150 Trust and financial services.................. 134 631 258 817 Net gain on sales of securities............... 51 301 51 421 Rental income................................. 26 55 61 77 Other......................................... 699 202 1,019 309 ------------- ------------- ------------ ------------- Total noninterest income.......... 6,055 5,411 12,062 10,630 ------------- ------------- ------------ ------------- NONINTEREST EXPENSE: Salaries and employee benefits................ 5,259 3,997 10,173 7,962 Occupancy..................................... 670 564 1,255 1,186 Professional services......................... 415 309 734 569 Depreciation and amortization................. 412 368 810 716 Office supplies, telephone and postage........ 360 355 671 609 Amortization of intangible assets............. 312 266 620 532 Marketing and promotion....................... 268 176 539 295 FDIC and other assessments.................... 51 51 102 102 Other......................................... 916 615 1,646 1,184 ------------- ------------- ------------ ------------- Total noninterest expense......... 8,663 6,701 16,550 13,155 ------------- ------------- ------------ ------------- Income before income taxes...................... 967 1,678 3,457 3,110 Income tax provision............................ 261 504 938 919 ------------- ------------- ------------ ------------- Net income...................................... $ 706 $ 1,174 $ 2,519 $ 2,191 ============= ============= ============ =============
BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Income, continued (In thousands, except per share data) For the Three Months For the Six Months Ended June 30, Ended June 30, ------------ ------------ ------------- ------------- 2004 2003 2004 2003 ------------ ------------ ------------- ------------- (unaudited) (unaudited) Dividends on preferred stock............. $ 30 $ 30 $ 60 $ 60 ------------ ------------ ------------- ------------- Income available to common stockholders.. $ 676 $ 1,144 $ 2,459 $ 2,131 ============ ============ ============= ============= BASIC EARNINGS PER COMMON SHARE: Basic earnings per common share.......... $ 0.24 $ 0.42 $ 0.89 $ 0.79 ============ ============ ============= ============= DILUTED EARNINGS PER COMMON SHARE: Diluted earnings per common share........ $ 0.23 $ 0.41 $ 0.86 $ 0.78 ============ ============ ============= ============= See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (In thousands) For the Three Months For the Six Months Ended June 30, Ended June 30, ------------------------------ ------------------------------ 2004 2003 2004 2003 ------------- ------------- ------------- ------------- (unaudited) (unaudited) NET INCOME............................................ $ 706 $ 1,174 $ 2,519 $ 2,191 OTHER COMPREHENSIVE INCOME (LOSS) - Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during the period, net of income taxes....... (3,991) 493 (2,047) 202 Less: reclassification adjustment for securities gains included in net income, net of income taxes.............................. (37) (211) (37) (299) ------------- ------------- ------------- ------------- OTHER COMPREHENSIVE INCOME (LOSS)..................... (4,028) 282 (2,084) (97) ------------- ------------- ------------- ------------- COMPREHENSIVE INCOME (LOSS)........................... $ (3,322) $ 1,456 $ 435 $ 2,094 ============= ============= ============= ============= See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity (In thousands, except share data) For the Six Months Ended June 30, 2004 Capital Capital Accumulated Preferred Stock Surplus Common Stock Surplus Other -------------------- Preferred ----------------- Common Retained Treasury Comprehensive Shares Amount Stock Shares Amount Stock Earnings Stock Income Total --------- --------- ---------- --------- ------- --------- --------- --------- -------------- --------- Balance, December 31, 2003.................... 150 $ -- $ 1,500 2,792,076 $ 28 $ 17,074 $ 21,119 $ (513) $ 978 $ 40,186 Net income (unaudited).. -- -- -- -- -- -- 2,519 -- -- 2,519 Other comprehensive income - Change in unrealized holding gains on securities available for sale, net of income taxes and reclassification adjustment (unaudited)......... -- -- -- -- -- -- -- -- (2,084) (2,084) Preferred stock dividends (unaudited).. -- -- -- -- -- -- (60) -- -- (60) Repurchase of preferred stock (unaudited)...... (150) -- (1,500) -- -- -- -- -- -- (1,500) Other (unaudited) ....... -- -- -- 72,915 1 1,090 -- -- -- 1,091 --------- --------- ---------- --------- ------- --------- --------- --------- -------------- --------- Balance, June 30, 2004 (unaudited)........... -- $ -- $ -- 2,864,991 $ 29 $ 18,164 $ 23,578 $ (513) $ (1,106) $ 40,152 ========= ========= ========== ========= ======= ========= ========= ========= ============== =========
For the Six Months Ended June 30, 2003 Capital Capital Accumulated Preferred Stock Surplus Common Stock Surplus Other -------------------- Preferred ----------------- Common Retained Treasury Comprehensive Shares Amount Stock Shares Amount Stock Earnings Stock Income Total --------- --------- ---------- --------- ------- --------- --------- --------- -------------- --------- Balance, December 31, 2002.................... 150 $ -- $ 1,500 2,743,809 $ 27 $ 16,614 $ 17,395 $ (513) $ 2,700 $ 37,723 Net income (unaudited).. -- -- -- -- -- -- 2,191 -- -- 2,191 Other comprehensive income - Change in unrealized holding gains on securities available for sale, net of income taxes and reclassification adjustment (unaudited)......... -- -- -- -- -- -- -- -- (97) (97) Preferred stock dividends (unaudited)........... -- -- -- -- -- -- (60) -- -- (60) Other (unaudited) ....... -- -- -- 2,366 -- 20 -- -- -- 20 --------- --------- ---------- --------- ------- --------- --------- --------- -------------- --------- Balance, June 30, 2003 (unaudited)........... 150 $ -- $ 1,500 2,746,175 $ 27 $ 16,634 $ 19,526 $ (513) $ 2,603 $ 39,777 ========= ========= ========== ========= ======= ========= ========= ========= ============== ========= See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Six Months Ended June 30 (In thousands) 2004 2003 -------------- -------------- OPERATING ACTIVITIES: (unaudited) (unaudited) Net income....................................................... $ 2,519 $ 2,191 Adjustments to reconcile net income to net cash provided by operating activities - Provision for credit losses.................................. -- 1,175 Depreciation and amortization................................ 810 716 Amortization of intangible assets............................ 620 532 Net premium amortization on investment securities............ 1,567 2,224 Proceeds from loans recovered................................ 254 59 Write down of other real estate owned and repossessed assets. 31 4 Change in interest receivable and other assets, net.......... (1,793) (2,472) (Gain) loss on sale of bank premises and equipment........... 2 (6) Net realized gains on sales of investment securities......... (51) (421) Deferred income taxes........................................ 639 272 Change in dividend distribution payable...................... -- (12) Change in other liabilities, net............................. (1,386) 532 Originations of loans to be sold............................. (32,716) (31,094) Proceeds from sale of loans.................................. 32,716 31,094 -------------- -------------- Net cash provided by operating activities.............. 3,212 4,794 -------------- -------------- INVESTING ACTIVITIES: Purchases of investment securities............................... (45,544) (62,963) Proceeds from sales of investment securities..................... 16,601 32,817 Proceeds from maturities of investment securities................ 23,206 26,372 Purchases of Federal Reserve and Federal Home Loan Bank Stock.... (4,107) -- Sales of Federal Reserve and Federal Home Loan Bank Stock........ 4,261 -- Net (increase) decrease in loans................................. (6,932) 12,094 Additions to premises and equipment.............................. (2,972) (5,775) Proceeds from sale of premises and equipment..................... 23 99 Cash paid for acquisition of insurance subsidiaries.............. (545) -- Cash paid for acquisition of mortgage company.................... (150) -- -------------- -------------- Net cash provided by (used in) investing activities.... (16,159) 2,644 -------------- -------------- FINANCING ACTIVITIES: Net decrease in demand, savings, interest checking and money market accounts.............................................. (17,143) (8,612) Net increase (decrease) in time deposits......................... 26,694 (18,330) Net increase in short-term borrowings............................ 12,594 4,450 Repayments of Federal Home Loan Bank advances.................... (260,000) (97,300) Proceeds from Federal Home Loan Bank advances.................... 250,000 107,300 Repayments of long-term borrowings............................... (30) (29) Proceeds from long-term borrowings............................... 1,500 140 Payment of preferred stock dividends............................. (60) (60) Repurchase of preferred stock.................................... (1,500) -- Amortization of discount on subordinated debentures.............. 43 43 Other, net....................................................... 234 20 -------------- -------------- Net cash provided by (used in) financing activities.... 12,332 (12,378) -------------- -------------- NET DECREASE IN CASH AND CASH EQUIVALENTS........................... (615) (4,940) CASH AND CASH EQUIVALENTS, beginning of period...................... 12,520 17,137 -------------- -------------- CASH AND CASH EQUIVALENTS, end of period............................ $ 11,905 $ 12,197 ============== ============== SUPPLEMENTAL CASH FLOW INFORMATION: Interest paid.................................................... $ 7,022 $ 8,210 ============== ============== Income taxes paid................................................ $ 566 $ 678 ============== ============== See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) June 30, 2004 NOTE 1 - BNCCORP, Inc. BNCCORP, Inc. ("BNCCORP") is a registered bank holding company incorporated under the laws of Delaware. It is the parent company of BNC National Bank (together with its wholly owned subsidiaries, Milne Scali & Company, Inc. and BNC Asset Management, Inc., the "Bank"). BNCCORP, through these wholly owned subsidiaries, which operate from 24 locations in Arizona, Minnesota, North Dakota, Utah and Colorado, provides a broad range of banking, insurance, brokerage, trust and other financial services to small- and mid-sized businesses and individuals. The accounting and reporting policies of BNCCORP and its subsidiaries (collectively, the "Company") conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. The consolidated financial statements included herein are for BNCCORP and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. NOTE 2 - Basis of Presentation The accompanying interim consolidated financial statements have been prepared by the Company, without audit, in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures made are adequate to make the information presented not misleading. The unaudited consolidated financial statements as of June 30, 2004 and for the three-month and six-month periods ended June 30, 2004 and 2003 include, in the opinion of management, all adjustments, consisting solely of normal recurring adjustments, necessary for a fair presentation of the financial results for the respective interim periods and are not necessarily indicative of results of operations to be expected for the entire fiscal year ending December 31, 2004. The accompanying interim consolidated financial statements have been prepared under the presumption that users of the interim consolidated financial information have either read or have access to the audited consolidated financial statements for the year ended December 31, 2003. Accordingly, footnote disclosures which would substantially duplicate the disclosures contained in the December 31, 2003 audited consolidated financial statements have been omitted from these interim consolidated financial statements. It is suggested that these interim consolidated financial statements be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2003 and the notes thereto. NOTE 3 - Reclassifications Certain of the 2003 amounts may have been reclassified to conform to the 2004 presentations. These reclassifications had no effect on net income or stockholders' equity. NOTE 4 - Earnings Per Share The following table shows the amounts used in computing earnings per share ("EPS") and the effect on weighted average number of shares of potential dilutive common stock issuances for the three-month periods ended June 30:
Net Per-Share Income Shares Amount ---------------- ---------------- --------------- 2004 Basic earnings per common share: Net income................................ $ 706,000 Less: Preferred stock dividends........... (30,000) ---------------- Income available to common stockholders... $ 676,000 2,793,045 $ 0.24 ================ =============== Effect of dilutive shares - Options and contingent stock........... 89,522 ---------------- Diluted earnings per common share: Net income................................ $ 706,000 Less: Preferred stock dividends........... (30,000) ---------------- Income available to common stockholders... $ 676,000 2,882,567 $ 0.23 ================ =============== 2003 Basic earnings per common share: Net income................................ $ 1,174,000 Less: Preferred stock dividends........... (30,000) ---------------- Income available to common stockholders... $ 1,144,000 2,703,071 $ 0.42 ================ =============== Effect of dilutive shares - Options................................ 55,100 ---------------- Diluted earnings per common share: Net income................................ $ 1,174,000 Less: Preferred stock dividends........... (30,000) ---------------- Income available to common stockholders... $ 1,144,000 2,758,171 $ 0.41 ================ ===============
The following table shows the amounts used in computing EPS and the effect on weighted average number of shares of potential dilutive common stock issuances for the six-month periods ended June 30:
Net Per-Share Income Shares Amount ---------------- ---------------- --------------- 2004 Basic earnings per common share: Net income.................................. $ 2,519,000 Less: Preferred stock dividends............. (60,000) ---------------- Income available to common stockholders..... $ 2,459,000 2,775,464 $ 0.89 ================ =============== Effect of dilutive shares - Options and contingent stock............. 91,976 ---------------- Diluted earnings per common share: Net income.................................. $ 2,519,000 Less: Preferred stock dividends............. (60,000) ---------------- Income available to common stockholders..... $ 2,459,000 2,867,440 $ 0.86 ================ =============== 2003 Basic earnings per common share: Net income.................................. $ 2,191,000 Less: Preferred stock dividends............. (60,000) ---------------- Net income available to common stockholders. $ 2,131,000 2,702,183 $ 0.79 ================ =============== Effect of dilutive shares - Options.................................. 42,515 ---------------- Diluted earnings per common share: Net income.................................. $ 2,191,000 Less: Preferred stock dividends............. (60,000) ---------------- Net income available to common stockholders. $ 2,131,000 2,744,698 $ 0.78 ================ ===============
The following number of options, with exercise prices ranging from $10.00 to $17.75, were outstanding during the periods indicated but were not included in the computation of diluted EPS because their exercise prices were higher than the average price of BNCCORP's common stock for the period:
2004 2003 ---------------- --------------- Quarter ended March 31............. 3,250 77,185 Quarter ended June 30.............. 61,850 63,500
NOTE 5 - Segment Disclosures The Company segments its operations into three separate business activities, based on the nature of the products and services for each segment: banking operations, insurance operations and brokerage, trust and financial services operations. Banking operations provide traditional banking services to individuals and small- and mid-sized businesses, such as accepting deposits, consumer and mortgage banking activities and making commercial loans. The mortgage and commercial banking activities include the origination and purchase of loans as well as the sale to and servicing of commercial loans for other institutions. Insurance operations provide a full range of insurance brokerage services, including commercial insurance, surety bonds, employee benefits-related insurance, personal insurance and claims management. Brokerage, trust and financial services operations provide securities brokerage, trust and other financial services to individuals and businesses. Brokerage investment options include individual equities, fixed income investments and mutual funds. Trust and financial services operations provide a wide array of trust and other financial services including personal trust administration services, financial, tax, business and estate planning, estate administration, agency accounts, employee benefit plan design and administration, individual retirement accounts ("IRAs"), including custodial self-directed IRAs, asset management, tax preparation, accounting and payroll services. The accounting policies of the three segments are the same as those described in the summary of significant accounting policies included in Note 1 to the consolidated financial statements for the year ended December 31, 2003. The Company's financial information for each segment is derived from the internal profitability reporting system used by management to monitor and manage the financial performance of the Company. The operating segments have been determined by how executive management has organized the Company's business for making operating decisions and assessing performance. The following tables present segment profit or loss, assets and a reconciliation of segment information as of, and for the three months ended June 30 (in thousands):
2004 2004 -------------------------------------------------------- -------------------------------------------------- Brokerage/ Trust/ Reportable Intersegment Consolidated Banking Insurance Financial Other (a) Totals Segments Other (a) Elimination Total --------- ---------- ---------- --------- --------- ---------- --------- ------------ ------------- Net interest income.....$ 4,041 $ 18 $ 23 $ (520) $ 3,562 $ 4,082 $ (520) $ 13 $ 3,575 Other revenue-external customers.............. 1,847 4,991 306 21 7,165 7,144 21 (1,110) 6,055 Other revenue-from other segments......... 165 -- 20 230 415 185 230 (415) -- Depreciation and amortization........... 417 271 33 3 724 721 3 -- 724 Equity in the net income of investees.... 751 -- -- 1,179 1,930 751 1,179 (1,930) -- Other significant noncash items: Provision for credit losses........ -- -- -- -- -- -- -- -- -- Segment pre-tax profit (loss).......... 433 1,261 (51) (676) 967 1,643 (676) -- 967 Income tax provision (benefit).... (8) 492 (20) (203) 261 464 (203) -- 261 Segment profit (loss)... 441 769 (31) (473) 706 1,179 (473) -- 706 Segment assets.......... 611,797 31,914 19,283 75,081 738,075 662,994 75,081 (104,980) 663,095
2003 2003 -------------------------------------------------------- -------------------------------------------------- Brokerage/ Trust/ Reportable Intersegment Consolidated Banking Insurance Financial Other (a) Totals Segments Other (a) Elimination Total --------- ---------- ---------- --------- --------- ---------- --------- ------------ ------------- Net interest income.....$ 3,865 $ 22 $ -- $ (531) $ 3,356 $ 3,887 $ (531) $ 12 $ 3,368 Other revenue-external customers.............. 1,599 3,461 732 54 5,846 5,792 54 (435) 5,411 Other revenue-from other segments......... 35 -- 10 164 209 45 164 (209) -- Depreciation and amortization........... 413 214 3 4 634 630 4 -- 634 Equity in the net income of investees.... 422 -- -- 1,501 1,923 422 1,501 (1,923) -- Other significant noncash items: Provision for credit losses....... 400 -- -- -- 400 400 -- -- 400 Segment pre-tax profit (loss).......... 1,006 803 466 (597) 1,678 2,275 (597) -- 1,678 Income tax provision (benefit).............. 267 361 146 (270) 504 774 (270) -- 504 Segment profit (loss)... 739 442 320 (327) 1,174 1,501 (327) -- 1,174 Segment assets.......... 588,635 28,643 1,396 69,164 687,838 618,674 69,164 (95,156) 592,682 - ------------- (a) The financial information in the "Other" column is for the bank holding company.
The following tables present segment profit or loss, assets and a reconciliation of segment information as of, and for the six months ended June 30 (in thousands):
2004 2004 -------------------------------------------------------- -------------------------------------------------- Brokerage/ Trust/ Reportable Intersegment Consolidated Banking Insurance Financial Other (a) Totals Segments Other (a) Elimination Total --------- ---------- ---------- --------- --------- ---------- --------- ------------ ------------- Net interest income.....$ 8,908 $ 31 $ 23 $ (1,043) $ 7,919 $ 8,962 $(1,043) $ 26 $ 7,945 Other revenue-external customers.............. 3,961 9,621 610 44 14,236 14,192 44 (2,174) 12,062 Other revenue-from other segments......... 315 -- 41 416 772 356 416 (772) -- Depreciation and amortization........... 820 539 65 6 1,430 1,424 6 -- 1,430 Equity in the net income of investees.... 1,485 -- -- 3,294 4,779 1,485 3,294 (4,779) -- Other significant noncash items: Provision for credit losses....... -- -- -- -- -- -- -- -- -- Segment pre-tax profit (loss).......... 2,401 2,488 (138) (1,294) 3,457 4,751 (1,294) -- 3,457 Income tax provision (benefit).... 545 967 (55) (519) 938 1,457 (519) -- 938 Segment profit (loss)... 1,856 1,521 (83) (775) 2,519 3,294 (775) -- 2,519 Segment assets.......... 611,797 31,914 19,283 75,081 738,075 662,994 75,081 (104,980) 663,095
2003 2003 -------------------------------------------------------- -------------------------------------------------- Brokerage/ Trust/ Reportable Intersegment Consolidated Banking Insurance Financial Other (a) Totals Segments Other (a) Elimination Total --------- ---------- ---------- --------- --------- ---------- --------- ------------ ------------- Net interest income.....$ 7,808 $ 44 $ -- $ (1,067) $ 6,785 $ 7,852 $(1,067) $ 25 $ 6,810 Other revenue-external customers.............. 2,797 7,554 977 80 11,408 11,328 80 (778) 10,630 Other revenue-from other segments......... 67 -- 22 319 408 89 319 (408) -- Depreciation and amortization........... 803 430 6 9 1,248 1,239 9 -- 1,248 Equity in the net income of investees.... 1,475 -- -- 2,962 4,437 1,475 2,962 (4,437) -- Other significant noncash items: Provision for credit losses........ 1,175 -- -- -- 1,175 1,175 -- -- 1,175 Segment pre-tax profit (loss).......... 1,543 2,299 473 (1,205) 3,110 4,315 (1,205) -- 3,110 Income tax provision (benefit).............. 420 790 143 (434) 919 1,353 (434) -- 919 Segment profit (loss)... 1,123 1,509 330 (771) 2,191 2,962 (771) -- 2,191 Segment assets.......... 588,635 28,643 1,396 69,164 687,838 618,674 69,164 (95,156) 592,682 - ------------- (a) The financial information in the "Other" column is for the bank holding company.
NOTE 6 - Stock-Based Compensation At June 30, 2004, the Company had two stock-based employee compensation plans. The Company applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for those plans. No stock-based employee compensation expense is reflected in net income for stock options granted under the plans as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Compensation expense is reflected in net income for the periods presented below for restricted stock issued under the stock plans and its net effect on net income is reflected in the table below. The following table illustrates the effect on net income and EPS if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" to stock-based employee compensation (dollars in thousands):
For the three months ended For the six months ended June 30, June 30, -------------------------------- ----------------------------- 2004 2003 2004 2003 ---------------- ------------ -------------- ----------- Net income, as reported................................ $ 706 $ 1,174 $ 2,519 $ 2,191 Add: total stock-based employee compensation expense included in reported net income, net of related tax effects....................................... 24 3 46 5 Deduct: total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects............ (34) (11) (66) (21) ---------------- ------------ -------------- ----------- Pro forma net income................................... $ 696 $ 1,166 $ 2,499 $ 2,175 ================ ============ ============== =========== Earnings per share: Basic - as reported............................... $ 0.24 $ 0.42 $ 0.89 $ 0.79 Basic - pro forma................................. $ 0.23 $ 0.42 $ 0.83 $ 0.78 Diluted - as reported............................. $ 0.23 $ 0.41 $ 0.86 $ 0.78 Diluted - pro forma............................... $ 0.22 $ 0.41 $ 0.81 $ 0.77
NOTE 7 - Derivative Activities The Company has interest rate cap contracts with notional amounts totaling $20.0 million that were purchased to mitigate interest rate risk in rising-rate scenarios. The referenced interest rate is three-month LIBOR with the 5.50 percent contracts having five-year maturities (maturing during May and June of 2006). An additional $20.0 million of 4.50 percent contracts having three-year original maturities expired during May and June of 2004. The total amount paid for the contracts was $1.2 million. The remaining contracts are reflected in the Company's consolidated balance sheet at their current combined fair value of approximately $29,000. The contracts are not being accounted for as hedges under Statement of Financial Accounting Standards No. 133, "Accounting for Derivatives and Hedging Activities." As a result, the impact of marking the contracts to fair value has been, and will continue to be, included in net interest income. During the three months ended June 30, 2004 and 2003, the impact of marking the contracts to market, reflected as additional (or reduced) interest expense on Federal Home Loan Bank ("FHLB") advances, was an increase (reduction) to net interest income of approximately $9,000 and ($70,000), respectively. During the six months ended June 30, 2004 and 2003, the impact of marking the contracts to market was a reduction to net interest income of approximately ($28,000) and ($97,000), respectively. NOTE 8 - Annual Goodwill Impairment Assessment In accordance with its accounting policy, during the second quarter of 2004 the Company completed the annual assessment of its goodwill asset and such assessment did not indicate any impairment. NOTE 9 - Change in Goodwill During the second quarter of 2004, the Company paid the second earnout payment related to the acquisition of Milne Scali & Company ("Milne Scali") in April 2002. The earnout payment was approximately $2.6 million and increased goodwill by that amount. NOTE 10 - Acquisition On June 30, 2004, in order to further grow its insurance segment, Milne Scali acquired certain assets and assumed certain liabilities of Finkbeiner Insurance, Inc., a Prescott Valley, Arizona-based insurance agency, for 26,607 shares of newly issued BNCCORP common stock (valued at $ 466,000) and $545,000 of cash. Acquisitions of insurance agencies generally result in the recognition of goodwill due to the service nature of the business, the lack of tangible assets acquired and the profitability of the acquired agency. Of the total $1.0 million purchase price, $487,000 was allocated to the net assets acquired (including intangible assets) and the excess of the purchase price of approximately $523,000 over the fair value of the net assets was recorded as goodwill. Additional consideration of up to $180,000 is payable to Finkbeiner Insurance, Inc. subject to the insurance operation achieving certain performance targets. In accordance with purchase method accounting requirements, such payments would increase the cost of the transaction in future periods and are not reflected as liabilities in the Company's current consolidated balance sheet. The goodwill, all of which is attributable to the Company's insurance segment, will be evaluated for possible impairment under the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." Other acquired intangible assets related to personal and commercial insurance lines books of business and totaling approximately $459,300, will be amortized using a method that approximates the anticipated useful life of the associated customer lists, which will cover a period of 10 years. The results of operations of the acquired assets are being included in the Company's consolidated financial statements effective July 1, 2004. NOTE 11 - Loans Held for Sale Loans held for sale at June 30, 2004 consist of $15.0 million of residential mortgage loans. It is expected that such loans will be sold within 90 days. Additional loans are anticipated as the Bank has initiated a financing program in which the Bank purchases short-term participation interests in residential mortgage loans originated by a mortgage company. NOTE 12 - Related Party Transaction On June 30, 2004, BNCCORP repurchased the then-outstanding 150 shares of its noncumulative preferred stock from Richard W. Milne, Jr. and Terrence M. Scali, executive officers of the Company. The repurchased shares had a preferential noncumulative dividend at an annual rate of 8.00 percent and a preferred liquidation value of $10,000 per share. NOTE 13 - Recently Issued or Adopted Accounting Standards In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 addressed consolidation by business enterprises of variable interest entities which have certain characteristics by requiring that if a business enterprise has a controlling interest in a variable interest entity (as defined by FIN 46), the assets, liabilities and results of activities of the variable interest entity be included in the consolidated financial statements with those of the business enterprise. FIN 46 applied immediately to variable interest entities created after January 31, 2003 and to variable interest entities in which an enterprise obtains an interest after that date. For variable interests acquired before February 1, 2003, FIN 46 applied in the first fiscal year or interim period beginning after June 15, 2003. The Company has adopted the various provisions of FIN 46 as indicated above but presently does not have any variable interest entities that would be required to be included in its consolidated financial statements. On December 24, 2003, the FASB issued Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities" ("FIN 46R") which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FIN 46. FIN 46R indicates that when voting interests are not effective in identifying whether an entity is controlled by another party, the economic risks and rewards inherent in the entity's assets and liabilities and the way in which the various parties that have involvement with the entity share in those economic risks and rewards should be used to determine whether the entity should be consolidated. An enterprise that is involved with another entity generally must assess whether that involvement requires consolidation under FIN 46R. That involvement may arise in a variety of ways, such as (a) lending to the entity, (b) investing in equity (voting or nonvoting) of the entity, (c) issuing guarantees related to the assets or liabilities of the entity, or both, (d) retaining a beneficial interest in (or providing financial support for) assets transferred or sold to the entity, (e) managing the assets of the entity, (f) leasing assets to or from the entity and (g) entering into a derivative contract with the entity. The objective of FIN 46R is to provide consolidation guidance for situations in which voting equity interests do not adequately reflect the controlling interests in an entity. Public entities are required to apply FIN 46 or FIN 46R to all entities that are considered special purpose entities in practice and under the FASB literature that was applied before the issuance of FIN 46 by the end of the first reporting period that ends after December 31, 2003. Public companies that are not small business issuers are required to adopt the accounting requirements of FIN 46R by the end of the first reporting period that ends after March 15, 2004. The Company has adopted the various provisions of FIN 46R as indicated above but presently does not have any variable interest entities that would be required to be included in its consolidated financial statements. On December 12, 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer" ("SOP 03-3"). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities ("loans") acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes such loans acquired in purchase business combinations and applies to all nongovernmental entities. SOP 03-3 does not apply to loans originated by the entity. SOP 03-3 limits the yield that may be accreted ("accretable yield") to the excess of the investor's estimate of undiscounted expected principal, interest and other cash flows (cash flows expected at acquisition to be collected) over the investor's initial investment in the loan. SOP 03-3 requires that the excess of contractual cash flows over cash flows expected to be collected ("nonaccretable difference") not be recognized as an adjustment of yield, loss accrual or valuation allowance. SOP 03-3 prohibits investors from displaying accretable yield and nonaccretable difference in the balance sheet. Subsequent increases in cash flows expected to be collected generally should be recognized prospectively through adjustment of the loan's yield over its remaining life. Decreases in cash flows expected to be collected should be recognized as impairment. SOP 03-3 prohibits "carrying over" or creation of valuation allowances in the initial accounting of all loans acquired in a transfer that are within the scope of SOP 03-3. This prohibition of the valuation allowance carryover applies to the purchase of an individual loan, a pool of loans, a group of loans and loans acquired in a purchase business combination. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004. Early adoption is encouraged. The Company expects to adopt SOP 03-3 on January 1, 2005. Adoption of SOP 03-3 is not expected to have a material impact on the Company's financial position or results of operations. On March 9, 2004, the SEC issued Staff Accounting Bulletin No. 105, "Application of Accounting Principles to Loan Commitments" ("SAB 105"). SAB 105 summarizes the views of the SEC staff regarding the application of generally accepted accounting principles to loan commitments accounted for as derivative instruments. SAB 105 will act to significantly limit opportunities to recognize an asset related to a commitment to originate a mortgage loan that will be held for sale prior to funding the loan. SAB 105 pertains to recognizing and disclosing the loan commitments and is effective for commitments to originate mortgage loans to be held for sale that are entered into after March 31, 2004. The Company adopted the provisions of SAB 105 beginning April 1, 2004. Adoption of SAB 105 did not have a material impact on the Company's financial position or results of operations. At its March 2004 meetings, the Emerging Issues Task Force ("EITF") revisited EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments" (EITF No. 03-1). Effective with reporting periods beginning after June 15, 2004, companies carrying certain types of debt and equity securities at amounts higher than the securities' fair values will have to use more detailed criteria to evaluate whether to record a loss and will have to disclose additional information about unrealized losses. The Company has reviewed the revised EITF No. 03-1 and plans to implement these additional procedures effective with the quarter beginning on July 1, 2004. Adoption of the new issuance could have an impact on the Company's financial position and results of operations but the extent of any impact will vary due to the fact that the model calls for many judgments and additional evidence gathering as such evidence exists at each securities valuation date. NOTE 14 - Subsequent Event In July 2004, Terrence M. Scali ceased to be employed as the president of Milne Scali & Company, Inc. ("Milne Scali"). Promptly following this event, the Company paid Mr. Scali approximately $688,000, which represents the salary Mr. Scali would have been entitled to for the remaining term of his employment agreement. Milne Scali and Mr. Scali are currently in good faith negotiations regarding the payment of any other amounts that Mr. Scali is contractually entitled to under the terms of his employment agreement. The amount paid to Mr. Scali and any other amounts that Milne Scali agrees to pay are expected to accrue in and impact the Company's quarter ending September 30, 2004. Under the terms of the Stock Purchase Agreement pursuant to which the Company acquired Milne Scali, Mr. Scali's departure triggers the rights of Mr. Scali and Richard W. Milne, Jr., individually and as representatives of the former stockholders of Milne Scali, to elect to accelerate the payment of the remaining balance of earnout payments due to the former stockholders in future periods. The earnout payments are partially based on the post-acquisition financial performance of Milne Scali and represent additional consideration payable to the former stockholders. In accordance with purchase method accounting requirements, if Mr. Scali and Mr. Milne elect to accelerate the earnout payments, the accelerated payments, which are expected to aggregate approximately $3.4 million, are expected to accrue in and impact the Company's quarter ending September 30, 2004 by increasing the goodwill associated with the Milne Scali acquisition by the amount actually paid. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations For purposes of Items 2, 3 and 4 of Part I of this Form 10-Q, we refer to "we," "our" or the "Company" when such reference includes BNCCORP, Inc. and its consolidated subsidiaries, collectively; "BNCCORP" when referring only to BNCCORP, Inc.; the "Bank" when referring only to BNC National Bank; "Milne Scali" when referring only to Milne Scali & Company, Inc.; and "BNC AMI" when referring only to BNC Asset Management, Inc. Comparison of Financial Condition at June 30, 2004 and December 31, 2003 Assets. Our total assets increased $11.6 million, from $621.5 million at December 31, 2003 to $633.1 million at June 30, 2004. The following table presents our assets by category as of June 30, 2004 and December 31, 2003, as well as the amount and percent of change between the two dates. Significant changes are discussed in lettered explanations below the table (amounts are in thousands):
Change ---------------------------- June 30, December 31, Assets 2004 2003 $ % - ------------------------------------------- -------------- ---------------- ------------- ----------- Cash and due from banks.................... $ 11,905 $ 12,520 $ (615) (4.9)% Investment securities available for sale.................................. 263,395 262,568 827 0.3% Federal Reserve Bank and Federal Home Loan Bank Stock...................... 7,442 7,596 (154) (2.0)% Loans held for sale........................ 15,022 -- 15,022 100.0% (a) Loans and leases, net...................... 270,448 278,792 (8,344) (3.0)% (b) Premises and equipment, net................ 20,715 18,570 2,145 11.6% (c) Interest receivable........................ 2,491 2,462 29 1.2% Other assets............................... 14,665 15,507 (842) (5.4)% Goodwill................................... 18,432 15,089 3,343 22.2% (d) Other intangible assets, net............... 8,580 8,373 207 2.5% ------------- --------------- ------------- ----------- Total assets...................... $ 633,095 $ 621,477 $ 11,618 1.9% ============= =============== ============= =========== - ------------------- (a) The Bank initiated a financing program in which the Bank purchases short-term participation interests in residential mortgage loans originated by a mortgage company, which, along with other loans held for sale at June 30, 2004, included $15.0 million of loans awaiting purchase by secondary market lenders. (b) Increased commercial real estate loan production in our Minnesota and Arizona markets was more than offset by pay-downs on commercial lines of credit along with planned loan reductions and pay-downs due to refinancings. Given the gradually improving economic conditions, loan demand in upcoming periods may exceed the soft loan demand conditions experienced during 2003. (c) The increase in premises and equipment is primarily attributable to the renovation of a banking facility in Golden Valley, Minnesota. (d) Goodwill increased due to the 2004 earnout payment related to the acquisition of Milne Scali as well as the goodwill generated by two insurance agency acquisitions and a mortgage company acquisition between December 31, 2003 and June 30, 2004.
Allowance for Credit Losses. The following table sets forth information regarding changes in our allowance for credit losses for the three- and six-month periods ended June 30, 2004 and 2003 (amounts are in thousands):
Three Months Six Months Ended June 30, Ended June 30, ----------------------------------- ----------------------------------- 2004 2003 2004 2003 ------------------ ---------------- ----------------- ----------------- Balance, beginning of period..... $ 3,545 $ 5,219 $ 4,763 $ 5,006 Provision for credit losses...... -- 400 -- 1,175 Loans charged off................ (300) (690) (1,573) (1,287) Loans recovered.................. 198 24 253 59 ------------------ ---------------- ----------------- ----------------- Balance, end of period........... $ 3,443 $ 4,953 $ 3,443 $ 4,953 ================== ================ ================= ================= Ending loan portfolio ........... $ 288,913 $ 322,413 ================== ================ Allowance for credit losses as a percentage of ending loan portfolio........................ 1.19% 1.54%
As of June 30, 2004, our allowance for credit losses was 1.19 percent of total loans as compared to 1.54 percent at June 30, 2003. The decrease is reflective of approximately $1.6 million of charge-offs and the reduced reserve requirement related to a significant decline in nonperforming loans between December 31, 2003 and June 30, 2004. Nonperforming loans declined from approximately $8.0 million to $662,000 over the six-month period ended June 30, 2004. There was no provision for loan losses for the three- or six-month periods ended June 30, 2004 compared to $400,000 and $1.2 million, respectively, for the three- and six-month periods ended June 30, 2003. This decrease is a direct response to a significant reduction in nonperforming loans between December 31, 2003 and June 30, 2004. See "-Nonperforming Assets" below. Loans charged off during the first and second quarters of 2004 totaled $1.6 million, representing a $286,000 increase over loans charged off during the first and second quarters of 2003. The increase was primarily attributable to charge-offs related to one commercial loan. The loan was to a contractor on which we charged off, in the first quarter of 2004, approximately $1.2 million. $975,000 of the $1.2 million was reserved for as of December 31, 2003. $162,000 related to this loan was collected in June 2004. During the second quarter of 2004, we also charged off $264,000 related to a business loan. Net charge-offs as a percentage of average total loans for the three- and six-month periods ended June 30, 2004 and 2003 were as follows:
Three Months Ended Six Months Ended June 30, June 30, ------------------------ -------------------------- 2004 2003 2004 2003 ----------- ----------- ------------ ------------ Ratio of net charge-offs to average total loans..... (0.04)% (0.20)% (0.49)% (0.37)% Ratio of net charge-offs to average total loans, annualized................. (0.15)% (0.82)% (0.99)% (0.75)%
We maintain our allowance for credit losses at a level considered adequate to provide for an estimate of probable losses related to specifically identified loans as well as probable losses in the remaining loan and lease portfolio that have been incurred as of each balance sheet date. The loan and lease portfolio and other credit exposures are reviewed regularly to evaluate the adequacy of the allowance for credit losses. In determining the level of the allowance, we evaluate the allowance necessary for specific nonperforming loans and also estimate losses in other credit exposures. The resultant three allowance components are as follows: Specific Reserves. The amount of specific reserves is determined through a loan-by-loan analysis of problem loans over a minimum size that considers expected future cash flows, the value of collateral and other factors that may impact the borrower's ability to make payments when due. Included in this group are those nonaccrual or renegotiated loans that meet the criteria as being "impaired" under the definition in Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS 114"). A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Problem loans also include those credits that have been internally classified as credits requiring management's attention due to underlying problems in the borrower's business or collateral concerns. Under SFAS 114, any allowance on impaired loans is generally based on one of three methods. The accounting standard requires that impaired loans be measured at either the present value of expected cash flows at the loan's effective interest rate, the loan's observable market price or the fair value of the collateral of the loan. Specific reserves totaled $992,000 at June 30, 2004. Reserves for Homogeneous Loan Pools. We make a significant number of loans and leases that, due to their underlying similar characteristics, are assessed for loss as "homogeneous" pools. Included in the homogeneous pools are consumer loans and commercial loans under a certain size, which have been excluded from the specific reserve allocation previously discussed. We segment the pools by type of loan or lease and, using historical loss information, estimate a loss reserve for each pool. Reserves for homogeneous loan pools totaled approximately $2.3 million at June 30, 2004. Qualitative Reserve. Our senior lending management also allocates reserves for special situations, which are unique to the measurement period. These include, among other things, prevailing and anticipated economic trends, such as economic conditions in certain geographical or industry segments of the portfolio and economic trends in the retail-lending sector, management's assessment of credit risk inherent in the loan portfolio, delinquency trends, historical loss experience and peer-group loss history. Our qualitative reserve totaled $169,000 at June 30, 2004. Continuous credit monitoring processes and the analysis of loss components is the principal method relied upon by management to ensure that changes in estimated credit loss levels are reflected in our allowance for credit losses on a timely basis. Management also considers experience of peer institutions and regulatory guidance in addition to our own experience. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for credit losses. Such agencies may require additions to the allowance based on their judgment about information available to them at the time of their examination. Loans, leases and other extensions of credit deemed uncollectible are charged to the allowance. Subsequent recoveries, if any, are credited to the allowance. The amount of the allowance for credit losses is highly dependent upon management's estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to frequent adjustments due to changing economic prospects of borrowers, lessees or properties. These estimates are reviewed periodically. Actual losses may vary from current estimates and the amount of the provision may be either greater than or less than actual net charge-offs. The related provision for credit losses, which is charged to income, is the amount necessary to adjust the allowance to the level determined appropriate through application of the above processes. Further information on the allowance for credit losses is included under "-Critical Accounting Policies." Nonperforming Assets. The following table sets forth information concerning our nonperforming assets as of the dates indicated (amounts are in thousands):
June 30, December 31, 2004 2003 ------------ ------------ Nonperforming loans: Loans 90 days or more delinquent and still accruing interest................................. $ 12 $ 38 Nonaccrual loans................................... 650 7,913 Restructured loans................................. -- -- ------------ ------------ Total nonperforming loans............................. 662 7,951 Other real estate owned and repossessed assets..... -- -- ------------ ------------ Total nonperforming assets............................ $ 662 $ 7,951 ============ ============ Allowance for credit losses........................... $ 3,443 $ 4,763 ============ ============ Ratio of total nonperforming assets to total assets... 0.10% 1.28% Ratio of total nonperforming loans to total loans..... 0.23% 2.80% Ratio of allowance for credit losses to total nonperforming loans................................ 520% 60%
Loans 90 days or more delinquent and still accruing interest include loans over 90 days past due which we believe, based on our specific analysis of the loans, do not present doubt about the collection of interest and principal in accordance with the loan contract. Loans in this category must be well-secured and in the process of collection. Our lending and management personnel monitor these loans closely. Nonaccrual loans include loans on which the accrual of interest has been discontinued. Accrual of interest is discontinued when we believe, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that the collection of interest is doubtful. A delinquent loan is generally placed on nonaccrual status when it becomes 90 days or more past due unless the loan is well-secured and in the process of collection. When a loan is placed on nonaccrual status, accrued but uncollected interest income applicable to the current reporting period is reversed against interest income of the current period. Accrued but uncollected interest income applicable to previous reporting periods is charged against the allowance for credit losses. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain. When a problem loan is finally resolved, there may ultimately be an actual write-down or charge-off of the principal balance of the loan which may necessitate additional charges to earnings. During the quarter ended March 31, 2004, two loans totaling approximately $6.7 million and reflected as nonaccrual loans at December 31, 2003 were resolved. The first was a $4.5 million loan secured by commercial real estate on which we received full payoff, including collection of cash basis interest income of approximately $408,000. The second loan of approximately $2.2 million was resolved resulting in a charge-off of approximately $1.2 million. $975,000 of the $1.2 million was reserved for at December 31, 2003. $162,000 related to this loan was collected in June 2004. Restructured loans are those for which concessions, including a reduction of the interest rate or the deferral of interest or principal, have been granted due to the borrower's weakened financial condition. Interest on restructured loans is accrued at the restructured rates when it is anticipated that no loss of original principal will occur. We had no restructured loans in our portfolio at June 30, 2004 or December 31, 2003. Other real estate owned and repossessed assets represents properties and other assets acquired through, or in lieu of, loan foreclosure. Such properties and assets are included in other assets in the consolidated balance sheets. They are initially recorded at fair value at the date of acquisition establishing a new cost basis. Write-downs to fair value at the time of acquisition are charged to the allowance for credit losses. After foreclosure, we perform valuations periodically and the real estate or assets are carried at the lower of carrying amount or fair value less cost to sell. Write-downs, revenues and expenses incurred subsequent to foreclosure are charged to operations as recognized/incurred. We had no other real estate owned and repossessed assets at June 30, 2004 or at December 31, 2003. Liabilities. Our total liabilities increased approximately $11.6 million, from $581.3 million at December 31, 2003 to $592.9 million at June 30, 2004. The following table presents our liabilities by category as of June 30, 2004 and December 31, 2003 as well as the amount and percent of change between the two dates. Significant changes are discussed in lettered explanations below the table (amounts are in thousands):
Change -------------------------- June 30, December 31, Liabilities 2004 2003 $ % - ----------------------------------- ------------ ------------- ------------ ------------ DEPOSITS: Noninterest-bearing................ $ 49,225 $ 44,725 $ 4,500 10.1% (a) Interest-bearing - Savings, interest checking and money market................ 193,882 215,525 (21,643) (10.0)% (b) Time deposits $100,000 and over.. 65,482 46,569 18,913 40.6% (c) Other time deposits.............. 96,904 89,123 7,781 8.7% (c) Short-term borrowings.............. 43,977 31,383 12,594 40.1% (d) Federal Home Loan Bank advances.... 102,200 112,200 (10,000) (8.9)% (e) Long-term borrowings............... 10,110 8,640 1,470 17.0% (f) Guaranteed preferred beneficial interests in company's subordinated debentures.......... 22,440 22,397 43 1.9% Other liabilities.................. 8,723 10,729 (2,006) (18.7)% (g) ------------ ------------- ------------ Total liabilities......... $ 592,943 $ 581,291 $ 11,652 2.0% ============ ============= ============ - ------------------- (a) Noninterest-bearing deposits can fluctuate widely on a day-to-day basis due to the number of commercial customers we serve and the nature of their transaction account activity. (b) The decrease in savings, interest checking and money market deposits is attributable to the fact that, at December 31, 2003, several accounts had funds in our Wealthbuilder accounts awaiting placement into the CDARSsm certificates of deposit program. These balances were transferred during the first part of 2004. Decreases in this category early in the year can also be attributable to the fact that, at year-end, commercial customers often draw down on their lines of credit and place the money in their deposit accounts. Subsequently, during the first part of the following year, the deposits are used to pay down the lines of credit. (c) Certificates of deposit increased due to a $14.7 million increase in brokered deposits and a $14.5 million increase in deposits made under the CDARSsm program, including some of the deposits noted in (b) above. The CDARSsm program was implemented during the second half of 2003. These increases were offset by a $5.7 million decrease in national market certificates of deposit. (d) Short-term borrowings increased primarily because there was $28.3 million of Federal funds purchased outstanding at June 30, 2004 (an increase of $11.2 million over the December 31, 2003 level), including $20.1 million of Federal funds purchased from the FHLB and a $1.4 million increase in customer repurchase agreements between December 31, 2003 and June 30, 2004. (e) $10.0 million of FHLB advances held at December 31, 2003 matured in January 2004. (f) The increase in long-term borrowings is attributable to a $1.5 million advance made in June 2004 for the purpose of repurchasing our preferred stock of $1.5 million. (g) The reduction in other liabilities resulted from decreases in multiple items in this category including accrued interest payable, accrued expenses and accounts payable.
Stockholders' Equity. Our stockholders' equity decreased $34,000 between December 31, 2003 and June 30, 2004. This decrease was attributable to earnings of approximately $2.5 million coupled with approximately $1.1 million of other transactions such as stock option exercises, vesting of restricted stock and stock issued in the acquisition of two insurance agencies. These increases were offset by a $2.1 million decrease in accumulated other comprehensive income, the repurchase of $1.5 million of preferred stock and the payment of $60,000 of preferred stock dividends. Capital Adequacy and Expenditures. We actively monitor compliance with regulatory capital requirements, including risk-based and leverage capital measures. Under the risk-based capital method of capital measurement, the ratio computed is dependent on the amount and composition of assets recorded on the balance sheet, and the amount and composition of off-balance-sheet items, in addition to the level of capital. The following table includes the risk-based and leverage capital ratios of the Company and the Bank as of June 30, 2004:
Tier 1 Total Risk- Risk- Tier 1 Based Based Leverage Ratio Ratio Ratio -------------- -------------- -------------- BNCCORP, consolidated.......... 6.78% 9.72% 4.67% BNC National Bank.............. 10.65% 11.48% 7.37%
As of June 30, 2004, the Company and the Bank exceeded capital adequacy requirements and the Bank was considered "well capitalized" under prompt corrective action provisions. Capital expenditures expected in 2004 could consist of the purchase or leasing of additional facilities in our various market areas should such facilities or properties be deemed to add additional franchise value. Such capital expenditures will be paid through cash generated from operations. Additionally, potential acquisitions could increase capital expenditures as such transactions are consummated. Such capital expenditures would likely be paid through cash generated from operations or the issuance of BNCCORP stock. Comparison of Operating Results for the Three and Six Months Ended June 30, 2004 and 2003 General. We reported net income of $706,000, or $0.23 per share on a diluted basis, for the second quarter ended June 30, 2004. For the same quarter of 2003, we reported net income of $1.17 million, or $0.41 per diluted share. Net interest income for the second quarter of 2004 was $3.58 million, up 6.1 percent from $3.37 million in the same period of 2003. This increase reflected a widening of the net interest margin to 2.61 percent for the quarter ended June 30, 2004, from 2.54 percent for the same period in 2003. Adjusted for the impact of derivative contract-related transactions during the period (an increase in net interest income of $9,000 for 2004 and a decrease in net interest income of ($70,000) for 2003), the net interest margin would have been 2.60 percent for the quarter ended June 30, 2004, versus 2.59 percent for the quarter ended June 30, 2003. Noninterest income was $6.06 million for the 2004 second quarter, an increase of 11.9 percent from $5.41 million for the year-ago period. Commissions generated by our insurance agency subsidiary, Milne Scali, were the largest contributor to noninterest income, and rose nearly $1.0 million from the year-ago quarter. We also recorded a nonrecurring gain of $527,000 from the final resolution of a reinsurance program previously associated with Milne Scali, which was reflected in other income during the recent quarter. Brokerage income increased in the 2004 second quarter versus the year-ago period, while loan fees, service charges and net gain on the sale of securities decreased. Trust and financial services income also decreased mostly due to a $488,000 fee collected by the Bank's financial services division during the second quarter of 2003. Noninterest income represented 62.88 percent of gross revenues for the recent quarter, up from 61.64 percent a year ago. Noninterest expense for the second quarter of 2004 was $8.66 million, compared with $6.70 million in the same quarter of 2003. The increase of 29.3 percent primarily reflected higher employee and occupancy expenses associated with the Company's growth initiatives, including the creation of some senior management positions, the addition of branch offices in Arizona and Minnesota and the expansion of our insurance agency operations. For the first six months of 2004, we reported net income of $2.52 million, or $0.86 per diluted share, an increase from net income of $2.19 million, or $0.78 per diluted share, reported in the same period of 2003. Net interest income was $7.95 million for the first six months of 2004, rising 16.7 percent from $6.81 million in the year-ago period. The net interest margin widened to 2.91 percent for the first six months of 2004, from 2.56 percent for the same period in 2003. Some nonrecurring items impacted net interest income and margin for the six months ended June 30, 2004 and those are discussed in the section that follows. Noninterest income increased to $12.06 million for the first six months of 2004, up 13.5 percent from $10.63 million in the same period of 2003. The increase largely reflected insurance commissions generated by Milne Scali and the nonrecurring gain noted previously. Noninterest income represented 60.29 percent of gross revenues for the recent period, compared with 60.95 percent for the same 2003 period. Noninterest expense for the first six months of 2004 was $16.55 million, an increase of 25.8 percent compared with $13.16 million in the year-ago period, largely due to expenses associated with investments in staffing and locations, as described previously. Our return on average common stockholders equity for the three- and six-month periods ended June 30, 2004 was 6.68 and 12.12 percent, respectively. This compared with 11.99 and 11.44 percent for the three- and six-month periods ended June 30, 2003, respectively. Our return on average assets for the three- and six-month periods ended June 30, 2004 was 0.46 and 0.82 percent, respectively. This compared with 0.80 and 0.75 percent for the three- and six-month periods ended June 30, 2003, respectively. No provision for credit losses was required for the first half of 2004, compared with provisions of $400,000 for the second quarter and $1.18 million for the six months ended June 30, 2003, respectively. The ratio of total nonperforming assets to total assets improved significantly to 0.10 percent at June 30, 2004 compared with 1.28 percent at December 31, 2003. The ratio of the allowance for credit losses to total nonperforming loans was 520 percent at June 30, 2004, strengthening from 60 percent at December 31, 2003. These asset quality ratios improved during 2004 primarily because of a sharp decrease in nonperforming loans during the period. Nonperforming loans decreased from $7.95 million to $662,000 during the six-month period ending June 30, 2004. The decrease in nonperforming loans was caused primarily by the full payment of a $4.5 million loan and the resolution of a $2.2 million loan that resulted in a charge-off of $1.2 million (of which $975,000 was reserved for at December 31, 2003). The allowance for credit losses as a percentage of total loans was 1.19 percent at June 30, 2004 compared with 1.68 percent at December 31, 2003. The ratio at June 30, 2004 is reflective of $1.57 million of charge-offs over the course of the six-month period ended June 30, 2004 as well as the reduced reserve requirement related to the sharp decrease in nonperforming loans during the period. Our profitability for the second quarter of 2004 reflected our building of a foundation for the future by investing in people, facilities and operations that we believe are necessary for our continued growth. Over the course of the past 18 months, we have expanded our banking segment by opening a branch office at the Esplanade in Phoenix, a branch office in Scottsdale and an additional branch office in Golden Valley, Minnesota. We expect to continue our branching strategy at a pace of about one or two branches per year. This branching strategy is part of our initiative to continue to grow core deposits, thereby enhancing the future franchise value of our organization. Industry statistics have shown that new branch offices often take two to three years before they begin to contribute to the overall profitability of growing financial organizations. In addition to banking branches, we have also continued to expand our insurance segment with the asset acquisition of Finkbeiner Insurance, Inc. of Prescott Valley, Arizona, further expanding our insurance presence in the greater Phoenix market. Such investments are expected to have an impact on our overall profitability in the near term due to expenses associated with internal growth, however, we believe that these are the right growth initiatives for the long term. Net Interest Income. Net interest income for the three-month period ended June 30, 2004 increased approximately $206,000, or 6.11 percent, from approximately $3.37 million to approximately $3.58 million. Net interest margin increased to 2.61 percent for the quarter ended June 30, 2004 from 2.54 percent for the same period one year earlier. Net interest income and margin for the three-month periods ended June 30, 2004 and 2003 were positively (negatively) impacted by derivative contract-related transactions during the periods totaling approximately $9,000 and ($70,000), respectively. Without these derivative transactions, net interest income for the periods would have been approximately $3.57 and $3.44 million, respectively, and net interest margin would have been 2.60 and 2.59 percent, respectively. Net interest income for the six-month period ended June 30, 2004 increased approximately $1.1 million, or 16.7 percent, from approximately $6.81 million to approximately $7.94 million. Net interest margin increased to 2.91 percent for the six months ended June 30, 2004 from 2.56 percent for the same period one year earlier. Net interest income and margin for the six-month period ended June 30, 2004 were favorably impacted by the recovery of cash basis interest income of approximately $408,000 on a $4.5 million loan that had been classified as nonaccrual at December 31, 2003. Net interest income and margin for the six-month period ended June 30, 2003 were negatively impacted by the charge-off of interest income of approximately $287,000 on the same loan. Additionally, net interest income and margin for the six-month periods ended June 30, 2004 and 2003 were negatively impacted by derivative contract-related transactions during the periods totaling approximately ($28,000) and ($97,000), respectively. Without these interest income variances and derivative transactions, net interest income for the periods would have been approximately $7.56 and $7.19 million, respectively, and net interest margin would have been 2.77 and 2.70 percent, respectively. The following tables present average balances, interest earned or paid, associated yields on interest-earning assets and costs on interest-bearing liabilities for the three- and six-month periods ended June 30, 2004 and 2003, as well as the changes between the periods presented. Significant factors contributing to the increase in net interest income and net interest margin are discussed in lettered notes below the tables (amounts are in thousands):
Three Months Ended June 30, ---------------------------------------------------------------------- 2004 2003 Change ---------------------------------- ---------------------------------- --------------------------------- Interest Average Interest Average Interest Average Average earned yield or Average earned yield or Average earned yield balance or paid cost balance or paid cost balance or paid or cost ---------- ---------- ---------- ---------- ----------- ---------- ----------- ----------- --------- Interest-earning assets Federal funds sold/interest bearing due from..........$ 116 $ -- -- $ 427 $ 1 0.94% $ (311) $ (1) -0.94% Investments................ 287,709 2,815 3.94% 210,380 2,026 3.86% 77,329 789 0.08%(a) Loans...................... 266,668 4,139 6.24% 326,936 5,238 6.43% (60,268) (1,099) -0.19%(b) Allowance for loan losses............. (3,568) -- (5,130) -- 1,562 -- ---------- ---------- ---------- ----------- ----------- ----------- Total interest- earning assets........$ 550,925 6,954 5.08% $ 532,613 7,265 5.47% $ 18,312 (311) -0.39% ========== ---------- ========== ----------- =========== ----------- Interest-bearing liabilities Interest checking & money market accounts.................$188, 409 470 1.00% $ 179,908 563 1.26% $ 8,501 (93) -0.26%(c) Savings.................... 6,743 12 0.72% 6,037 13 0.86% 706 (1) -0.14% Certificates of deposit under $100,000.................. 96,264 605 2.53% 96,384 779 3.24% (120) (174) -0.71% Certificates of deposit $100,000 and over.................. 52,753 451 3.44% 57,149 568 3.99% (4,396) (117) -0.55%(d) ---------- ---------- ---------- ----------- ----------- ----------- Interest-bearing deposits................ 344,169 1,538 1.80% 339,478 1,923 2.27% 4,691 (385) -0.47% Short-term borrowings...... 32,969 118 1.44% 25,972 113 1.75% 6,997 5 -0.31%(e) Federal Home Loan Bank advances.................. 115,241 1,208 4.22% 102,222 1,332 5.23% 13,019 (124) -1.01%(f) Long-term borrowings....... 8,665 88 4.08% 8,634 96 4.46% 31 (8) -0.38% Subordinated debentures.... 22,290 427 7.70% 22,199 432 7.81% 91 (5) -0.12% ---------- ---------- ---------- ----------- ----------- ----------- Total borrowings......... 179,165 1,841 4.13% 159,027 1,973 4.98% 20,138 (132) -0.85% ---------- ---------- ---------- ----------- ----------- ----------- Total interest-bearing liabilities.............$ 523,334 3,379 2.60% $ 498,505 3,896 3.13% $ 24,829 (517) -0.54% ========== ---------- ========== ----------- =========== ----------- Net interest income/spread........... $ 3,575 2.48% $ 3,369 2.34% $ 206 0.15% ========== =========== =========== Net interest margin...... 2.61% 2.54% 0.07%(g) Notation: Noninterest-bearing deposits..................$ 48,064 -- $ 38,858 -- $ 9,206 -- ---------- ---------- ----------- Total deposits...........$ 392,233 $ 1,538 1.58% $ 378,336 $ 1,923 2.04% $ 13,897 $ (385) -0.46% ========== ========== ========== =========== =========== =========== Taxable equivalents: Total interest- earning assets..........$ 550,925 $ 7,162 5.23% $ 532,613 $ 7,462 5.62% $ 18,312 $ (300) -0.39% Net interest income/spread........... -- $ 3,783 2.63% -- $ 3,565 2.48% -- $ 218 0.15% Net interest margin...... -- -- 2.76% -- -- 2.69% -- -- -0.07% - ---------------------------
Six Months Ended June 30, ---------------------------------------------------------------------- 2004 2003 Change ---------------------------------- ---------------------------------- --------------------------------- Interest Average Interest Average Interest Average Average earned yield or Average earned yield or Average earned yield balance or paid cost balance or paid cost balance or paid or cost ---------- ---------- ---------- ---------- ----------- ---------- ----------- ----------- --------- Interest-earning assets Federal funds sold/interest bearing due from..................$ 172 $ -- -- $ 383 $ 1 0.53% $ (211) $ (1) -0.53% Investments................ 284,587 5,950 4.20% 213,098 4,310 4.08% 71,489 1,640 0.12%(a) Loans...................... 268,048 8,863 6.65% 328,972 10,422 6.39% (60,924) (1,559) 0.26%(b) Allowance for loan losses............. (4,160) -- (5,035) -- 875 -- ---------- ---------- ---------- ----------- ----------- ----------- Total interest-earning assets..................$ 548,647 14,813 5.43% $ 537,418 14,733 5.53% $ 11,229 80 -0.10% ========== ---------- ========== ----------- =========== ----------- Interest-bearing liabilities Interest checking & money market accounts.................$ 198,443 1,010 1.02% $ 182,347 1,158 1.28% $ 16,096 (148) -0.26%(c) Savings.................... 6,655 23 0.70% 5,675 25 0.89% 980 (2) -0.19% Certificates of deposit under $100,000.................. 94,981 1,239 2.63% 98,881 1,637 3.34% (3,900) (398) -0.71% Certificates of deposit $100,000 and over.................. 49,932 884 3.56% 60,124 1,209 4.06% (10,192) (325) -0.50%(d) ---------- ---------- ---------- ----------- ----------- ----------- Interest-bearing deposits................ 350,011 3,156 1.81% 347,027 4,029 2.34% 2,984 (873) -0.53% Short-term borrowings...... 29,681 217 1.47% 22,771 221 1.96% 6,910 (4) -0.49%(e) Federal Home Loan Bank advances............ 112,350 2,461 4.41% 103,072 2,608 5.10% 9,278 (147) -0.69%(f) Long-term borrowings....... 8,648 181 4.21% 8,591 195 4.58% 57 (14) -0.37% Subordinated debentures.... 22,213 853 7.72% 22,110 870 7.93% 103 (17) -0.21% ---------- ---------- ---------- ----------- ----------- ----------- Total borrowings......... 172,892 3,712 4.32% 156,544 3,894 5.02% 16,348 (182) -0.70% ---------- ---------- ---------- ----------- ----------- ----------- Total interest-bearing liabilities.............$ 522,903 6,868 2.64% $ 503,571 7,923 3.17% $ 19,332 (1,055) -0.53% ========== ---------- ========== ----------- =========== ---------- Net interest income/spread........... $ 7,945 2.79% $ 6,810 2.36% $ 1,135 0.43% ========== =========== =========== Net interest margin...... 2.91% 2.56% 0.35%(g) Notation: Noninterest-bearing deposits................. $ 44,957 -- $ 38,348 -- $ 6,609 -- ---------- ---------- ----------- Total deposits.......... $ 394,968 $ 3,157 1.61% $ 385,375 $ 4,029 2.11% $ 9,593 $ (872) -0.50% ========== ========== ========== =========== =========== =========== Taxable equivalents: Total interest-earning assets..................$ 548,647 $ 15,227 5.58% $ 537,418 $ 15,112 5.67% $ 11,229 $ 115 -0.09% Net interest income/spread........... -- $ 8,358 2.94% -- 7,189 2.50% -- $ 1,169 0.44% Net interest margin...... -- -- 3.06% -- -- 2.69% -- -- -0.37% - --------------------------------- (a) Average investments during the three- and six-month periods ended June 30, 2004 exceeded those for the same periods in 2003 due to our portfolio and liquidity management strategies, including the purchase of investment securities to offset a decrease in the earning asset portfolio that resulted from a net decrease in loan volume. Total investments at June 30, 2004 were $263.4 million compared with $209.9 million at June 30, 2003. (b) Average loans decreased primarily as a result of general planned loan payoffs and paydowns of commercial revolving lines of credit. Actual loan balances at June 30, 2004 and June 30, 2003 were $288.9 and $322.4 million, respectively. Loan yield for the six-month period ended June 30, 2004 was favorably impacted by the recovery of $408,000 of cash basis interest income on a $4.5 million loan that was classified as nonaccrual at December 31, 2003 and was paid in full during the first quarter of 2004. Without this recovery, interest income on loans for the six-month period ended June 30, 2004 would have been approximately $8.5 million and the yield on loans would have been 6.34 percent. Loan yield for the six-month period ended June 30, 2003 was negatively impacted by the charge-off of $287,000 of interest income on the same loan. Without this charge-off, interest income on loans for the six-month period ended June 30, 2003 would have been approximately $10.7 million and the yield on loans would have been 6.56 percent. (c) Increased average balances of interest checking and money market accounts represents additional growth in our floating-rate Wealthbuilder deposit products. These transaction accounts can fluctuate significantly based on the cash management activities of our commercial customers. This is evidenced by the fact that, as indicated earlier, the period-end balance in these accounts at June 30, 2004 is down from the period-end balance at December 31, 2003. Commercial customers often draw down on their lines of credit at year-end and place these funds in interest checking and money market accounts. After year-end, customers pay down on their lines of credit using these funds. While this negatively impacts the period end numbers in the early part of the year, averages for the presented periods were actually up in 2004 versus the same periods in 2003. (d) For the three months ended June 30, 2004, average balances in brokered, national market and CDARSsm certificates of deposit totaled $21.5, $7.7 and $13.8 million, respectively. Average balances in brokered and national market certificates of deposit totaled $25.0 and 20.9 million, respectively, for the three months ended June 30, 2003. There were no CDARSsm deposits during the quarter ended June 30, 2003. For the six months ended June 30, 2004, average balances of brokered, national market and CDARSsm certificates of deposit were $19.4, $10.0 and $10.6 million, respectively. For the same period during 2003, average balances of brokered and national market certificates of deposit totaled $27.3 and $23.8 million, respectively. There were no CDARSsm certificates of deposit during the first half of 2003. The reduced cost of these certificates of deposit reflects the maturity of higher rate certificates of deposit and renewal or origination of new certificates of deposit at lower current rates. (e) Average short-term borrowings increased during the three- and six-month periods ended June 30, 2004 over the same periods in 2003 due to an increase in average Federal funds purchased. For the three-month periods ended June 30, 2004 and 2003, average Federal funds purchased were $16.0 and $9.2 million, respectively. For the six-month periods ended June 30, 2004 and 2003, average Federal funds purchased were $13.5 and $7.8 million, respectively. Reduced costs of short-term borrowings reflect the current interest rate environment in 2004 versus 2003. (f) The increase in volume of FHLB advances resulted from the use of additional short-term FHLB advances in early 2004. Short-term FHLB advances are used to manage liquidity similar to how Federal funds purchased are used on a day-to-day basis. The short-term advances provide us with a slightly more cost-effective way of managing short-term liquidity needs since the FHLB gives a discount for advances of $10.0 million or more. The lower costs of FHLB advances reflect the lower rate structure in 2004 versus 2003. (g) Net interest margin for the six months ended June 30, 2004 was favorably impacted by the previously mentioned recovery of cash basis interest income of $408,000 during the quarter ended March 31, 2004. Without this recovery, and without the impact of derivative contract adjustments, net interest margin would have been 2.77 percent for the six months ended June 30, 2004. Additionally, net interest margin for the six months ended June 30, 2003 was negatively impacted by the charge-off of interest income on the same loan of $287,000 during the quarter ended March 31, 2003. Without this charge-off and without the impact of derivative contract adjustments, net interest margin would have been 2.70 percent for the six months ended June 30, 2003.
Provision for Credit Losses. There was no provision for credit losses for the three- or six-month periods ended June 30, 2004 as compared to $400,000 and $1.2 million, respectively, for the three- and six-month periods ended June 30, 2003. No provisions for credit losses have been necessary during 2004 largely due to the significant decline in nonperforming assets between December 31, 2003 and June 30, 2004. See "Comparison of Financial Condition at June 30, 2004 and December 31, 2003 - Allowance for Credit Losses." Noninterest Income. The following table presents the major categories of our noninterest income for the three- and six-month periods ended June 30, 2004 and 2003 as well as the amount and percent of change between the periods. Significant changes are discussed in lettered explanations following the table (amounts are in thousands):
Three Months Ended Six Months Ended Noninterest Income June 30, Change June 30, Change ----------------------- --------------------- ------------------------ --------------------- 2004 2003 $ % 2004 2003 $ % ---------- ----------- ---------- ---------- ----------- ----------- ---------- ---------- Insurance commissions.............. $ 4,422 $ 3,423 $ 999 29.2% $ 8,984 $ 7,485 $ 1,499 20.0% (a) Fees on loans...................... 339 482 (143) (29.7)% 915 943 (28) (3.0)% (b) Service charges.................... 210 218 (8) (3.7)% 421 428 (7) (1.6)% Brokerage income................... 174 99 75 75.8% 353 150 203 135.3% (c) Trust and financial services....... 134 631 (497) (78.8)% 258 817 (559) (68.4)% (d) Net gain on sales of securities.... 51 301 (250) (83.1)% 51 421 (370) (87.9)% (e) Rental income...................... 26 55 (29) (52.7)% 61 77 (16) (20.8)% Other.............................. 699 202 497 246.0% 1,019 309 710 229.8% (f) ---------- ----------- ---------- ----------- ----------- ---------- Total noninterest income........ $ 6,055 $ 5,411 $ 644 11.9% $ 12,062 $ 10,630 $ 1,432 13.5% ========== =========== ========== =========== =========== ========== Noninterest income as a percent of gross revenues.................. 62.9% 61.6% 1.3% 60.3% 61.0% (0.7)% ========== =========== =========== =========== - ----------------- (a) Insurance commissions increased due to growth in the insurance segment, including production from the Tucson location acquired on December 31, 2003 and the Salt Lake City location acquired on March 31, 2004. Additionally, there was an increase in contingency fee income received from insurance companies. Contingency fee income recognized during the six months ended June 30, 2004 was $1.27 million compared to $932,000 for the same period in 2003. (b) Loan fees included in noninterest income decreased during the three- and six-month periods ended June 30, 2004 due to the amount and nature of loan transactions completed during the periods as compared to the same periods in 2003. (c) Brokerage revenue has increased primarily due to increased production in the Minnesota market. (d) Trust and financial services revenues have decreased in 2004 primarily due to a $488,000 fee received (during the second quarter of 2003) by the Bank's financial services division for the management of the sale of two companies on behalf of a customer. (e) Gains and/or losses on the sale of investment securities vary from period to period due to the volume and nature of the securities transactions affected during the period. Investment securities sales for the six-month period ended June 30, 2004 totaled $16.6 million while sales for the six-month period ended June 30, 2003 totaled $32.8 million. (f) Other noninterest income increased during the three- and six-month periods ended June 30, 2004 primarily due to the receipt of $527,000 by Milne Scali. The payment related to the final resolution of a reinsurance program previously associated with Milne Scali.
Noninterest Expense. The following table presents the major categories of our noninterest expense for the three- and six-month periods ended June 30, 2004 and 2003 as well as the amount and percent of change between the periods. Significant changes are discussed in lettered explanations following the table (amounts are in thousands):
Three Months Ended Six Months Ended Noninterest Expense June 30, Change June 30, Change ---------------------- -------------------- ----------------------- --------------------- 2004 2003 $ % 2004 2003 $ % ---------- --------- -------- ---------- ---------- ---------- --------- ---------- Salaries and employee benefits.. $ 5,259 $ 3,997 $1,262 31.6% $10,173 $ 7,962 $ 2,211 27.8% (a) Occupancy....................... 670 564 106 18.8% 1,255 1,186 69 5.8% (b) Professional services........... 415 309 106 34.3% 734 569 165 29.0% (c) Depreciation and amortization... 412 368 44 12.0% 810 716 94 13.1% (d) Office supplies, telephone and postage....................... 360 355 5 1.4% 671 609 62 10.2% Amortization of intangible assets........................ 312 266 46 17.3% 620 532 88 16.5% (e) Marketing and promotion......... 268 176 92 52.3% 539 295 244 82.7% (f) FDIC and other assessments...... 51 51 -- -- 102 102 -- -- Other........................... 916 615 301 48.9% 1,646 1,184 462 39.0% (g) ---------- --------- -------- ---------- --------- --------- Total noninterest expense..... $ 8,663 $ 6,701 $1,962 29.3% $16,550 $ 13,155 $ 3,395 25.8% ========== ========= ======== ========== ========= ========= Efficiency ratio............. 90.0% 76.3% 13.7% 82.7% 75.4% 7.3% ========== ========= ========== ========= Total operating expenses as a percent of average assets, annualized.................... 5.6% 4.6% 1.0% 5.4% 4.5% 0.9% ========== ========= ========== ========= (a) Salaries and employee benefits expenses increased in the three- and six-month periods ended June 30, 2004 due to growth and expansion, particularly in our Minnesota and Arizona markets. Average full time equivalents for the three- and six-month periods ended June 30, 2004 were 317 and 309, respectively, compared to 276 and 271, respectively, for the same periods in 2003. (b) Occupancy expenses have increased due to the addition of new locations such as the Esplanade location in Phoenix, the Golden Valley location in Minnesota along with the acquisition of the Tucson insurance agency on December 31, 2003 and the Salt Lake City agency on March 31, 2004. (c) The increase in professional services expenses is attributable to an increase in brokerage retainage and clearing fees (resulting from the increase in brokerage production), as well as increases in legal, appraisal and recording and other consulting fees. (d) Depreciation and amortization expenses related to fixed assets have increased due to the expansion noted above, primarily in our Arizona and Minnesota markets. (e) Amortization of intangible assets increased primarily due to amortization of the insurance books of business intangibles acquired in the insurance agency acquisitions of December 31, 2003 and March 31, 2004. (f) Marketing and promotion expenses increased primarily due to market expansion and the associated advertising and marketing. (g) The increase in other noninterest expense is due to increases in several different items included in this category such as travel expenses, other employee benefits expenses, insurance expenses, business meals and entertainment expenses, dues and publications expenses and correspondent bank charges.
Income Tax Provision. Our provision for income taxes for the quarter ended June 30, 2004 decreased $243,000 as compared to the same period in 2003 due to the decrease in pre-tax income. The estimated effective tax rate for the three-month period ended June 30, 2004 was 27.0 percent. Our provision for income taxes for the six months ended June 30, 2004 increased $19,000 as compared to the same period in 2003 due to the increase in pre-tax income. The estimated effective tax rate for the six-month period ended June 30, 2004 was 27.1 percent. Earnings per Common Share. See Note 4 to the interim consolidated financial statements included under Item 1 for a summary of the EPS calculations for the three- and six-month periods ended June 30, 2004 and 2003. Liquidity Liquidity. Liquidity risk management encompasses our ability to meet all present and future financial obligations in a timely manner. The objectives of liquidity management policies are to maintain adequate liquid assets, liability diversification among instruments, maturities and customers and a presence in both the wholesale purchased funds market and the retail deposit market. The consolidated statements of cash flows in the consolidated financial statements included under Item 1 present data on cash and cash equivalents provided by and used in operating, investing and financing activities. In addition to liquidity from core deposit growth, together with repayments and maturities of loans and investments, we utilize brokered deposits, sell securities under agreements to repurchase and borrow overnight Federal funds. The Bank is a member of the FHLB, which affords it the opportunity to borrow funds on terms ranging from overnight to 10 years and beyond. Advances from the FHLB are generally collateralized by the Bank's mortgage loans and various investment securities. We have also obtained funding through the issuance of subordinated notes, subordinated debentures and long-term borrowings. The following table sets forth, for the six months ended June 30, 2004 and 2003, a summary of our major sources and (uses) of funds. The summary information is derived from the consolidated statements of cash flows included under Item 1 (amounts are in thousands):
For the Six Months Ended June 30, ---------------------------- Major Sources and (Uses) of Funds 2004 2003 ------------- ------------ Proceeds from FHLB advances........................ $ 250,000 $ 107,300 Proceeds from maturities of investment securities.. 23,206 26,372 Proceeds from sales of investment securities....... 16,601 32,817 Net increase in short-term borrowings.............. 12,594 4,450 Net increase (decrease) in deposits................ 9,551 (26,942) Proceeds from long-term borrowings................. 1,500 140 Repayments of FHLB advances........................ (260,000) (97,300) Purchases of investment securities................. (45,544) (62,963) Net (increase) decrease in loans................... (6,932) 12,094 Additions to premises and equipment................ (2,972) (5,775) Repurchase of preferred stock...................... (1,500) --
Our liquidity is measured by our ability to raise cash when we need it at a reasonable cost and with a minimum of loss. Given the uncertain nature of our customers' demands as well as our desire to take advantage of earnings enhancement opportunities, we must have adequate sources of on- and off-balance-sheet funds that can be acquired in time of need. Accordingly, in addition to the liquidity provided by balance sheet cash flows, liquidity is supplemented with additional sources such as credit lines with the FHLB, credit lines with correspondent banks for Federal funds, wholesale and retail repurchase agreements, brokered certificates of deposit and direct non-brokered national certificates of deposit through national deposit networks. We measure our liquidity position on a monthly basis. Key factors that determine our liquidity are the reliability or stability of our deposit base, the pledged/non-pledged status of our investments and potential loan demand. Our liquidity management system divides the balance sheet into liquid assets, and short-term liabilities that are assumed to be vulnerable to non-replacement under abnormally stringent conditions. The excess of liquid assets over short-term liabilities is measured over a 30-day planning horizon. Assumptions for short-term liabilities vulnerable to non-replacement under abnormally stringent conditions are based on a historical analysis of the month-to-month percentage changes in deposits. The excess of liquid assets over short-term liabilities and other key factors such as expected loan demand as well as access to other sources of liquidity such as lines with the FHLB, Federal funds and those other supplemental sources listed above are tied together to provide a measure of our liquidity. We have a targeted range and manage our operations such that these targets can be achieved. We believe that our prudent management policies and guidelines will ensure adequate levels of liquidity to fund anticipated needs of on- and off-balance sheet items. In addition, a contingency funding policy statement identifies actions to be taken in response to an adverse liquidity event. As of June 30, 2004, we had established three revolving lines of credit with banks totaling $17.5 million of which $7.0 million had been advanced and $10.5 million remained available for advance. The lines, if drawn upon, mature daily with interest rates that float at the Federal funds rate. At June 30, 2004, we also had the ability to draw additional FHLB advances of $79.5 million based upon the mortgage loans and securities that were then pledged, subject to a requirement to purchase additional FHLB stock. Subsequent to June 30, 2004, the Bank was approved for repurchase agreement lines of up to $100.0 million with a major financial institution. The lines, if utilized, would be collateralized by investment securities. Critical Accounting Policies Critical accounting policies are dependent on estimates that are particularly susceptible to significant change and include the determination of the allowance for credit losses and income taxes. The following have been identified as "critical accounting policies." Allowance for Credit Losses. Our accounting policy for determining the allowance for credit losses is set forth under "Comparison of Financial Condition at June 30, 2004 and December 31, 2003 - Allowance for Credit Losses." As indicated in that policy statement, we employ a systematic methodology for determining our allowance for credit losses that includes an ongoing review process and quarterly adjustment of the allowance. Our process includes periodic loan-by-loan review for loans that are individually evaluated for impairment as well as detailed reviews of other loans (either individually or in pools). This includes an assessment of known problem loans, potential problem loans and other loans that exhibit indicators of deterioration. Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for credit losses that we believe is appropriate at each reporting date. Quantitative factors include our historical loss experience, delinquency and charge-off trends, collateral values, changes in non-performing loans and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers' sensitivity to interest rate movements and borrowers' sensitivity to quantifiable external factors including commodity and finished goods prices as well as acts of nature (violent weather, fires, etc.) that occur in a particular period. Qualitative factors include the general economic environment in our markets and, in particular, the state of certain industries in our market areas. Size and complexity of individual credits in relation to lending officers' background and experience levels, loan structure, extent and nature of waivers of existing loan policies and pace of portfolio growth are other qualitative factors that are considered in our methodology. Our methodology is, and has been, consistently applied. However, as we add new products, increase in complexity and expand our geographical coverage, we will enhance our methodology to keep pace with the size and complexity of the loan and lease portfolio. In this regard, we may, if deemed appropriate, engage outside firms to independently assess our methodology. On an ongoing basis we perform independent credit reviews of our loan portfolio. We believe that our systematic methodology continues to be appropriate given our size and level of complexity. While our methodology utilizes historical and other objective information, the establishment of the allowance for credit losses and the classification of loans is, to some extent, based on our judgment and experience. We believe that the allowance for credit losses is adequate as of June 30, 2004 to cover known and inherent risks in the loan and lease portfolio. However, future changes in circumstances, economic conditions or other factors could cause us to increase or decrease the allowance for credit losses as necessary. Allowance for credit losses - Impact on Earnings. As indicated above, the determined level of the allowance for credit losses involves assumptions underlying our estimates that reflect highly uncertain matters in the current period. Additionally, a different estimate that could have been used in the current period could have had a material impact on reported financial condition or results of operations. We are not aware, at this time, of known trends, commitments, events or other uncertainties reasonably likely to occur that would materially affect our methodology or the assumptions used, although changes in the qualitative and quantitative factors noted above could occur at any time and such changes could be of a material nature. We have used our assumptions to arrive at the level of the allowance for credit losses that we consider adequate to provide for an estimate of probable losses related to specifically identified loans as well as probable losses in the remaining loan and lease portfolio that have been incurred as of June 30, 2004. The qualitative and quantitative factors noted above can reasonably be expected to impact the estimates applied and cause such estimates to change from period to period. Our allowance for credit losses of approximately $3.4 million did not necessitate that a provision for credit losses be made for the three- and six-month periods ended June 30, 2004. Should our analysis have resulted in the need for a higher or lower allowance for loan losses, a provision for loan losses would have been charged to earnings or, in the case of the need for a lower allowance for credit losses, a reversal of some of the allowance would have been credited to earnings. For example, should our analysis have indicated the need for an allowance for credit losses of $3.6 million, an additional $200,000 would have been charged to the provision for loan losses resulting in net income of approximately $560,000 as compared to the $706,000 recorded for the quarter ended June 30, 2004. Had our analysis indicated the need for an allowance for credit losses of $3.2 million, $200,000 of the allowance would have been reversed and credited to earnings resulting in net income of approximately $852,000 as compared to the $706,000 recorded for the period. In recent periods there have been changes in the qualitative and quantitative factors noted above. From period to period, economic situations change, credits may deteriorate or improve and the other factors we consider in arriving at our estimates may change. However, our basic methodology for determining an appropriate allowance for credit losses has remained relatively stable. This methodology has resulted in allowance for credit losses levels of $3.4 and $4.8 million at June 30, 2004 and December 31, 2003, respectively. As noted above, the amount of the provision for credit losses charged to operations is directly related to our estimates of the appropriate level of the allowance for credit losses. Charge-offs and recoveries during the applicable periods also impact the level of the allowance for credit losses resulting in a provision for credit losses that could be higher or lower in order to bring the allowance for credit losses in line with our estimates. Income Taxes. We file consolidated Federal and unitary state income tax returns. Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Such differences can relate to differences in accounting for credit losses, depreciation timing differences, unrealized gains and losses on investment securities, deferred compensation and leases, which are treated as operating leases for tax purposes and loans for financial statement purposes. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The determination of current and deferred income taxes is based on complex analyses of many factors including interpretation of Federal and state income tax laws, the difference between tax and financial reporting basis of assets and liabilities (temporary differences), estimates of amounts due or owed such as the timing of reversals of temporary differences and current financial accounting standards. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities. Forward-Looking Statements Statements included in Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" which are not historical in nature are intended to be, and are hereby identified as "forward-looking statements" for purposes of the safe harbor provided by Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). We caution readers that these forward-looking statements, including without limitation, those relating to our future business prospects, revenues, working capital, liquidity, capital needs, interest costs and income, are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements due to several important factors. These factors include, but are not limited to: risks of loans and investments, including dependence on local and regional economic conditions; competition for our customers from other providers of financial services; possible adverse effects of changes in interest rates including the effects of such changes on derivative contracts and associated accounting consequences; risks associated with our acquisition and growth strategies; and other risks which are difficult to predict and many of which are beyond our control. Item 3. Quantitative and Qualitative Disclosures About Market Risk Market risk arises from changes in interest rates, exchange rates, and commodity prices and equity prices and represents the possibility that changes in future market rates or prices will have a negative impact on our earnings or value. Our principal market risk is interest rate risk. Interest rate risk arises from changes in interest rates. Interest rate risk can result from: (1) Repricing risk - timing differences in the maturity/repricing of assets, liabilities, and off-balance-sheet contracts; (2) Options risk - the effect of embedded options, such as loan prepayments, interest rate caps/floors, and deposit withdrawals; (3) Basis risk - risk resulting from unexpected changes in the spread between two or more different rates of similar maturity, and the resulting impact on the behavior of lending and funding rates; and (4) Yield curve risk - risk resulting from unexpected changes in the spread between two or more rates of different maturities from the same type of instrument. We have risk management policies to monitor and limit exposure to interest rate risk. To date we have not conducted trading activities as a means of managing interest rate risk. Our asset/liability management process is utilized to manage our interest rate risk. The measurement of interest rate risk associated with financial instruments is meaningful only when all related and offsetting on-and off-balance-sheet transactions are aggregated, and the resulting net positions are identified. Our interest rate risk exposure is actively managed with the objective of managing the level and potential volatility of net interest income in addition to the long-term growth of equity, bearing in mind that we will always be in the business of taking on rate risk and that rate risk immunization is not entirely possible. Also, it is recognized that as exposure to interest rate risk is reduced, so too may the overall level of net interest income and equity. In general, the assets and liabilities generated through ordinary business activities do not naturally create offsetting positions with respect to repricing or maturity characteristics. Access to the derivatives market can be an important element in maintaining our interest rate risk position within policy guidelines. Using derivative instruments, principally interest rate floors and caps, the interest rate sensitivity of specific transactions, as well as pools of assets or liabilities, is adjusted to maintain the desired interest rate risk profile. Our primary tool in measuring and managing interest rate risk is net interest income simulation. This exercise includes our assumptions regarding the level of interest rates and their impact on our current balance sheet. Interest rate caps and floors are included to the extent that they are exercised in the 12-month simulation period. Additionally, changes in prepayment behavior of the residential mortgage, collateralized mortgage obligation, and mortgage-backed securities portfolios in each rate environment are captured using industry estimates of prepayment speeds for various coupon segments of the portfolio. For purposes of this simulation, projected month-end balances of the various balance sheet planning accounts are held constant at their June 30, 2004 levels. Cash flows from a given planning account are reinvested back into the same planning account so as to keep the month-end balance constant at its June 30, 2004 level. The static balance sheet assumption is made so as to project the interest rate risk to net interest income embedded in the existing balance sheet. With knowledge of the balance sheet's existing net interest income profile, more informed strategies and tactics may be developed as it relates to the structure/mix of growth. We monitor the results of net interest income simulation on a quarterly basis at regularly scheduled asset/liability committee ("ALCO") meetings. Each quarter net interest income is generally simulated for the upcoming 12-month horizon in seven interest scenarios. The scenarios generally modeled are parallel interest ramps of +/- 100bp, 200bp, and 300bp along with a rates unchanged scenario. The parallel movement of interest rates means all projected market interest rates move up or down by the same amount. A ramp in interest rates means that the projected change in market interest rates occurs over the 12-month horizon projected. For example, in the -100bp scenario, the projected prime rate will decrease from its starting point at June 30, 2004 of 4.25 percent to 3.25 percent 12 months later. The prime rate in this example will decrease 1/12th of the overall decrease of 100 basis points each month. Given the historically low absolute level of market interest rates as of June 30, 2004, the declining rate scenario analysis was limited to -100bp for the summary table presented below and a +400bp scenario was added. The net interest income simulation result for the 12-month horizon is shown below. The impact of each interest rate scenario on projected net interest income is displayed before and after the impact of the $20.0 million cumulative notional original five-year interest rate cap positions on three-month LIBOR with a 5.50 percent strike. The impact of the cap positions is calculated by determining the fair value of the contracts at the end of the 12-month horizon using an interest rate option valuation model. The change in fair value plus any expected cash flow in the various rate scenarios is summed to determine the total net benefit/(cost) of the portfolio of interest rate cap contracts.
Net Interest Income Simulation (amounts in thousands) Movement in interest rates -100bp Unchanged +100bp +200bp +300bp +400bp -------- --------- -------- -------- -------- -------- Projected 12-month net interest income.........$ 14,904 $ 15,901 $15,973 $ 15,863 $ 15,774 $ 15,586 Dollar change from rates unchanged scenario....$ (997) -- $ 72 $ (38) $ (127) $ (315) Percentage change from rates unchanged scenario.................................... (6.27)% -- 0.45% (0.24)% (0.80)% (1.98)% Net benefit/(cost) of cumulative $20.0 million interest rate caps (1)..............$ (29) $ (28) $ (22) -- $ 51 $ 141 Total net interest income impact with caps.....$ 14,875 $ 15,873 $15,951 $ 15,863 $ 15,825 $ 15,727 Dollar change from unchanged w/caps............$ (998) -- $ 78 $ (10) $ (48) $ (146) Percentage change from unchanged w/caps........ (6.29)% -- 0.49% (0.06)% (0.30)% (0.92)% Policy guidelines (decline limited to)......... 5.00% -- 5.00% 10.00% 15.00% 20.00% (1) In May and June 2001, we purchased four interest rate cap contracts on three-month LIBOR with strikes at 5.50 percent each in the amount of $5.0 million notional with original terms of five years for total notional of $20.0 million. These contracts will expire in May and June 2006.
Because one of the objectives of asset/liability management is to manage net interest income over a one-year planning horizon, policy guidelines are stated in terms of maximum potential reduction in net interest income resulting from changes in interest rates over the 12-month period. It is no less important, however, to give attention to the absolute dollar level of projected net interest income over the 12-month period. For example, while in the -100bp scenario, net interest income declines $998,000, or 6.3 percent, from the unchanged scenario, the level of net interest income of $14.9 million is still 9.0 percent above the $13.6 million of net interest income recorded for the 12-month period ended June 30, 2004. Our general policy is to limit the percentage decrease in projected net interest income to 5, 10, 15 and 20 percent from the rates unchanged scenario for the +/- 100bp, 200bp, 300bp and 400bp interest rate ramp scenarios, respectively. When a given scenario falls outside of these limits, such as is the case with the - 100bp scenario above, the ALCO reviews the circumstances surrounding the exception and, considering the level of net interest income generated in the scenario and other related factors, may approve the exception to the general policy or recommend actions aimed at bringing the respective scenario within the general limits noted above. A targeted level of net interest income is established and approved by the Board of Directors and ALCO. This target is reevaluated and reset at each quarterly ALCO meeting. Since there are limitations inherent in any methodology used to estimate the exposure to changes in market interest rates, this analysis is not intended to be a forecast of the actual effect of changes in market interest rates such as those indicated above on the Company. Further, this analysis is based on our assets and liabilities as of June 30, 2004 and does not contemplate any actions we might undertake in response to changes in market interest rates. Item 4. Controls and Procedures Quarterly evaluation of the Company's Disclosure Controls and Internal Controls. As of the end of the period covered by this quarterly report on Form 10-Q, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures ("Disclosure Controls"), and our internal control over financial reporting ("Internal Controls"). This evaluation (the "Controls Evaluation") was done under the supervision and with the participation of management, including our President and Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"). Rules adopted by the SEC require that in this section of the quarterly report we present the conclusions of the CEO and the CFO about the effectiveness of our Disclosure Controls and any change in our Internal Controls that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect our Internal Controls based on and as of the date of the Controls Evaluation. CEO and CFO Certifications. Appearing, as Exhibits 31.1 and 31.2 to this quarterly report, there are "Certifications" of the CEO and the CFO. The Certifications are required in accordance with the Exchange Act and the SEC's implementing Rule 13a-14 (the "Rule 13a-14 Certifications"). This section of the quarterly report is the information concerning the Controls Evaluation referred to in the Rule 13a-14 Certifications and this information should be read in conjunction with the Rule 13a-14 Certifications for a more complete understanding of the topics presented. Disclosure Controls and Internal Controls. Disclosure controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this quarterly report, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure Controls are also designed with the objective of ensuring that material information relating to BNCCORP, including its consolidated subsidiaries is made known to the CEO and CFO by others within those entities, particularly during the period in which the applicable report is being prepared. Internal Controls are procedures which are designed with the objective of providing reasonable assurance that (1) our transactions are properly authorized; (2) our assets are safeguarded against unauthorized or improper use; and (3) our transactions are properly recorded and reported, all to permit the preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America. Limitations on the Effectiveness of Controls. Our management, including the CEO and CFO, does not expect that our Disclosure Controls or our Internal Controls will prevent all error and all fraud. A control system, no matter how well developed and operated, can provide only reasonable, but not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Scope of the Controls Evaluation. The CEO/CFO evaluation of our Disclosure Controls and our Internal Controls included a review of the controls' objectives and design, our controls' implementation and the effect of the controls on the information generated for use in this quarterly report. In the course of the Controls Evaluation, we sought to identify data errors, controls problems or acts of fraud and to confirm that appropriate corrective action, including process improvements, were being undertaken. This type of evaluation is done on a quarterly basis so that the conclusions concerning controls effectiveness can be reported in our quarterly reports on Form 10-Q and annual report on Form 10-K. Our Internal Controls are also evaluated on an ongoing basis by our internal audit and credit review departments in connection with their audit and review activities. The overall goal of these various evaluation activities is to monitor our Disclosure Controls and our Internal Controls and to make modifications as necessary. Our external auditors also review Internal Controls in connection with their audit and review activities. Our intent in this regard is that the Disclosure Controls and Internal Controls will be maintained as dynamic systems that change (including with improvements and corrections) as conditions warrant. Among other matters, we sought in our evaluation to determine whether there were any "significant deficiencies" or "material weaknesses" in our Internal Controls which are reasonably likely to adversely affect our ability to record, process, summarize and report financial information, or whether we had identified any acts of fraud, whether or not material, involving management or other employees who have a significant role in our Internal Controls. This information was important both for the Controls Evaluation generally and because item 5 in the Rule 13a-14 Certifications of the CEO and CFO require that the CEO and CFO disclose that information to our board's audit committee and to our independent auditors and to report on related matters in this section of the quarterly report. In the professional auditing literature, "significant deficiencies" are referred to as "reportable conditions." These are control issues that could have a significant adverse effect on the ability to record, process, summarize and report financial data in the financial statements. A "material weakness" is defined in the auditing literature as a particularly serious reportable condition where the internal control does not reduce to a relatively low level the risk that misstatements caused by error or fraud may occur in amounts that would be material in relation to the financial statements and not be detected within a timely period by employees in the normal course of performing their assigned functions. We also sought to deal with other controls matters in the Controls Evaluation, and in each case if a problem was identified, we considered what revision, improvement and/or correction to make in accordance with our ongoing procedures. Conclusions. Based upon the Controls Evaluation, our CEO and CFO have concluded that, subject to the limitations noted above, our Disclosure Controls are effective to ensure that material information relating to BNCCORP and its consolidated subsidiaries is made known to management, including the CEO and CFO, particularly during the period when our periodic reports are being prepared, and that our Internal Controls are effective to provide reasonable assurance that our financial statements are fairly presented in conformity with accounting principles generally accepted in the United States of America. Additionally, there has been no change in our Internal Controls that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our Internal Controls. Part II - Other Information Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities Pursuant to an Asset Purchase and Sale Agreement, on June 30, 2004, BNCCORP issued 26,607 shares of its common stock to Finkbeiner Insurance, Inc. of Prescott Valley, Arizona in connection with Milne Scali's acquisition of certain assets and assumption of certain liabilities of Finkbeiner Insurance, Inc. The shares of common stock were issued in reliance upon the exemption from registration provided by Section 4(2) of the Securities Act. On June 30, 2004, BNCCORP repurchased the then-outstanding 150 shares of its noncumulative preferred stock from Richard W. Milne, Jr. and Terrence M. Scali, executive officers of the Company. The repurchased shares had a preferential noncumulative dividend at an annual rate of 8.00 percent and a preferred liquidation value of $10,000 per share. Item 4. Submission of Matters to a Vote of Securities Holders The annual meeting of stockholders of the Company was held on June 16, 2004 (the "Annual Meeting"). Proxies were solicited pursuant to the Exchange Act. At the Annual Meeting, Gregory K. Cleveland, John A. Hipp, M.D. and Tracy Scott were elected to serve as directors until the 2007 annual meeting of stockholders. The number of votes cast for or withheld from each nominee were as follows:
Name For Withheld ---------------------------- --------------- -------------- Cleveland 2,272,641 178,855 Hipp 2,089,547 361,949 Scott 2,028,851 422,645
In addition to the directors elected at the Annual Meeting, the terms of the following directors continued after the Annual Meeting: Brenda L. Rebel, Denise Forte-Pathroff, M.D., Terrence M. Scali, Richard M. Johnsen Jr., Gaylen A. Ghylin and Jerry R. Woodcox. At the Annual Meeting, the stockholders also voted on and approved a proposal to ratify the appointment of KPMG LLP as the Company's independent public accountants for 2004. Holders of 2,426,623 shares voted for, holders of 6,300 shares voted against and holders of 18,752 shares abstained from voting on the proposal. There was one non-vote with respect to the proposal. Item 6. Exhibits and Reports on Form 8-K (a) Exhibit 31.1 Chief Executive Officer's Certification Under Rule 13a-14(a) of the Exchange Act Exhibit 31.2 Chief Financial Officer's Certification Under Rule 13a-14(a) of the Exchange Act Exhibit 32.1 Chief Executive Officer and Chief Financial Officer Certifications Under Rule 13a-14(b) of the Exchange Act (b) Reports on Form 8-K On April 16, 2004, we filed a Form 8-K, furnishing, under Item 7, our earnings press release for the quarter ended March 31, 2004. Signatures Pursuant to the requirements 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. BNCCORP, Inc. Date: August 4, 2004 By /s/ Gregory K. Cleveland ------------------------------------------ Gregory K. Cleveland President and Chief Executive Officer By /s/ Brenda L. Rebel ------------------------------------------ Brenda L. Rebel Treasurer and Chief Financial Officer
EX-31 2 exhibit311.txt CERTIFICATION OF CEO Exhibit No. 31.1 CHIEF EXECUTIVE OFFICER'S CERTIFICATION UNDER RULE 13a-14(a) OF THE SECURITIES EXCHANGE ACT OF 1934 I, Gregory K. Cleveland, President and Chief Executive Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of BNCCORP, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 4, 2004 By /s/ Gregory K. Cleveland ---------------------------------- Gregory K. Cleveland Chief Executive Officer EX-31 3 exhibit312.txt CERTIFICATION OF CFO Exhibit No. 31.2 CHIEF FINANCIAL OFFICER'S CERTIFICATION UNDER RULE 13a-14(a) OF THE SECURITIES EXCHANGE ACT OF 1934 I, Brenda L. Rebel, Chief Financial Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of BNCCORP, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 4, 2004 By /s/ Brenda L. Rebel --------------------------------- Brenda L. Rebel Chief Financial Officer EX-32 4 exhibit321.txt CERTIFICATIONS UNDER SECTION 906 Exhibit No. 32.1 CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER CERTIFICATIONS UNDER RULE 13a-14(b) OF THE EXCHANGE ACT Pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934, each of the undersigned certifies that this periodic report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in this periodic report fairly presents, in all material respects, the financial condition and results of operations of BNCCORP, Inc. and Subsidiaries. Date: August 4, 2004 BNCCORP, Inc. By /s/ Gregory K. Cleveland ----------------------------------- Gregory K. Cleveland Chief Executive Officer By /s/ Brenda L. Rebel ----------------------------------- Brenda L. Rebel Chief Financial Officer
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