10-Q 1 form10q033105.txt FORM10Q033105 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 March 31, 2005 [ ] 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 May 2, 2005 was 2,885,781. PART I - FINANCIAL INFORMATION Item 1. Financial Statements
BNCCORP, INC. AND SUBSIDIARIES Consolidated Balance Sheets (In thousands, except share and per share data) March 31, December 31, ASSETS 2005 2004 ---------------- ---------------- (unaudited) CASH AND CASH EQUIVALENTS............................................................ $ 15,724 $ 11,881 INVESTMENT SECURITIES AVAILABLE FOR SALE............................................. 232,314 235,916 FEDERAL RESERVE BANK AND FEDERAL HOME LOAN BANK STOCK................................ 7,971 7,541 LOANS HELD FOR SALE.................................................................. 64,997 60,197 LOANS AND LEASES, net................................................................ 292,898 293,814 ALLOWANCE FOR CREDIT LOSSES.......................................................... (3,590) (3,335) ---------------- ---------------- Net loans and leases............................................................ 289,308 290,479 PREMISES AND EQUIPMENT, net.......................................................... 21,871 21,799 INTEREST RECEIVABLE.................................................................. 2,997 2,686 OTHER ASSETS......................................................................... 14,376 13,357 GOODWILL............................................................................. 21,779 21,779 OTHER INTANGIBLE ASSETS, net......................................................... 7,747 8,075 ---------------- ---------------- $ 679,084 $ 673,710 ================= ===============
LIABILITIES AND STOCKHOLDERS' EQUITY DEPOSITS: Noninterest-bearing............................................................. $ 70,066 $ 63,386 Interest-bearing - Savings, interest checking and money market................................. 219,783 210,887 Time deposits $100,000 and over............................................. 75,917 83,952 Other time deposits......................................................... 101,838 97,118 ---------------- ---------------- Total deposits.................................................................. 467,604 455,343 SHORT-TERM BORROWINGS................................................................ 26,899 33,697 FEDERAL HOME LOAN BANK ADVANCES...................................................... 97,200 97,200 LONG-TERM BORROWINGS................................................................. 9,397 10,079 GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY'S SUBORDINATED DEBENTURES.......................................................... 22,314 22,509 OTHER LIABILITIES.................................................................... 12,149 11,036 ---------------- ---------------- Total liabilities...................................................... 635,563 629,864 STOCKHOLDERS' EQUITY: Preferred stock, $.01 par value - 2,000,000 shares authorized; 100 and 125 shares issued and outstanding................................ -- -- Capital surplus - preferred stock............................................... 1,000 1,250 Common stock, $.01 par value - 10,000,000 shares authorized; 2,885,781 and 2,787,304 shares issued and outstanding (excluding 44,096 and 42,880 shares held in treasury).................................. 29 29 Capital surplus - common stock.................................................. 18,664 18,601 Retained earnings............................................................... 26,196 24,430 Treasury stock (44,096 and 42,880 shares)....................................... (533) (530) Accumulated other comprehensive income, net of income taxes................... (1,835) 66 ---------------- ---------------- Total stockholders' equity............................................. 43,521 43,846 ---------------- ---------------- $ 679,084 $ 673,710 ================= ===============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Income For the Three Months Ended March 31 (In thousands, except per share data) 2005 2004 ------------ ------------ INTEREST INCOME: (unaudited) (unaudited) Interest and fees on loans............................... $ 5,797 $ 4,724 Interest and dividends on investments - Taxable................................................ 2,052 2,691 Tax-exempt............................................. 435 401 Dividends.............................................. 73 43 ------------ ------------ Total interest income......................... 8,357 7,859 ------------ ------------ INTEREST EXPENSE: Deposits................................................. 2,245 1,618 Short-term borrowings.................................... 170 99 Federal Home Loan Bank advances.......................... 1,185 1,253 Long-term borrowings..................................... 123 93 Subordinated debentures.................................. 477 426 ------------ ------------ Total interest expense........................ 4,200 3,489 ------------ ------------ Net interest income........................... 4,157 4,370 PROVISION FOR CREDIT LOSSES................................. 250 -- ------------ ------------ NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES....... 3,907 4,370 ------------ ------------ NONINTEREST INCOME: Insurance income......................................... 5,768 4,562 Fees on loans............................................ 1,295 576 Service charges.......................................... 184 211 Trust and financial services............................. 159 124 Brokerage income......................................... 84 179 Rental income............................................ 7 35 Net gain (loss) on sales of securities................... (66) -- Other.................................................... 282 320 ------------ ------------ Total noninterest income...................... 7,713 6,007 ------------ ------------ NONINTEREST EXPENSE: Salaries and employee benefits........................... 5,619 4,914 Occupancy................................................ 755 585 Professional services.................................... 446 319 Depreciation and amortization............................ 408 398 Office supplies, telephone and postage................... 361 311 Amortization of intangible assets........................ 328 308 Marketing and promotion.................................. 281 271 FDIC and other assessments............................... 55 51 Other.................................................... 958 730 ------------ ------------ Total noninterest expense..................... 9,211 7,887 ------------ ------------ Income before income taxes.................................. 2,409 2,490 Income tax provision........................................ 620 677 ------------ ------------ Net income.................................................. 1,789 1,813 ============ ============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Income, continued For the Three Months Ended March 31 (In thousands, except per share data) 2005 2004 ------------ ------------- (unaudited) (unaudited) Dividends on preferred stock.............................................. $ 23 $ 30 ------------ ------------- Income available to common stockholders................................... $ 1,766 $ 1,783 ============ ============= BASIC EARNINGS PER COMMON SHARE: Basic earnings per common share........................................... $ 0.61 $ 0.65 ============ ============= DILUTED EARNINGS PER COMMON SHARE: Diluted earnings per common share......................................... $ 0.60 $ 0.63 ============ =============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income For the Three Months Ended March 31 (In thousands) 2005 2004 ------------- ------------- (unaudited) (unaudited) NET INCOME.............................................. $ 1,789 $ 1,813 OTHER COMPREHENSIVE INCOME (LOSS) - Unrealized gains (losses) on investment securities: Unrealized holding gains (losses) arising during the period, net of income taxes................. (1,950) 1,944 Less: reclassification adjustment for gains/(losses) included in net income, net of income taxes.................................... 49 -- ------------- ------------- OTHER COMPREHENSIVE INCOME (LOSS)....................... (1,901) 1,944 ------------- ------------- COMPREHENSIVE INCOME (LOSS) ............................ $ (112) $ 3,757 ============= =============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES Consolidated Statement of Stockholders' Equity For the Three Months Ended March 31 (In thousands, except share data) 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)... -- -- -- -- -- -- 1,813 -- -- 1,813 Other comprehensive income - Change in unrealized holding gains on securities available for sale, net of income taxes and reclassification adjustment(unaudited).. -- -- -- -- -- -- -- -- 1,944 1,944 Preferred stock dividends (unaudited).. -- -- -- -- -- -- (30) -- -- (30) Other (unaudited) ....... -- -- -- 38,108 -- 492 -- -- -- 492 ------ ------ --------- --------- ------ -------- --------- -------- ------------- -------- BALANCE, March 31, 2004 (unaudited)............. 150 $ -- $ 1,500 2,830,184 $ 28 $ 17,566 $ 22,902 $ (513) $ 2,922 $ 44,405 ====== ====== ========= ========= ====== ======== ========= ======== ============= ========
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, 2004. 125 $ -- $ 1,250 2,928,777 $ 29 $ 18,601 $ 24,430 $ (530) $ 66 $ 43,846 Net income (unaudited).... -- -- -- -- -- -- 1,789 -- -- 1,789 Other comprehensive income - Change in unrealized holding gains on securities available for sale, net of income taxes and reclassification adjustment (unaudited).. -- -- -- -- -- -- -- -- (1,901) (1,901) Preferred stock dividends (unaudited)... -- -- -- -- -- -- (23) -- -- (23) Other (unaudited)......... (25) -- (250) 1,100 -- 63 -- (3) -- (190) ------ ------ --------- --------- ------ -------- --------- -------- ------------- -------- BALANCE, March 31, 2005 (unaudited)............. 100 $ -- $ 1,000 2,929,877 $ 29 $ 18,664 $ 26,196 $ (533) $ (1,835) $ 43,521 ====== ====== ========= ========= ====== ======== ========= ======== ============= ========
See accompanying notes to consolidated financialstatements.
BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Three Months Ended March 31 (In thousands) 2005 2004 -------------- -------------- OPERATING ACTIVITIES: (unaudited) (unaudited) Net income....................................................... $ 1,789 $ 1,813 Adjustments to reconcile net income to net cash provided by (used in) operating activities - Provision for credit losses.................................. 250 -- Depreciation and amortization................................ 408 398 Amortization of intangible assets............................ 328 308 Net premium amortization on investment securities............ 589 587 Proceeds from loans recovered................................ 118 55 Write-down of other real estate owned and repossessed assets. 6 1 Change in interest receivable and other assets, net.......... (216) (4,466) (Gain) loss on sale of bank premises and equipment........... 1 2 Net realized loss on sales of investment securities.......... 66 -- Deferred income taxes........................................ 63 522 Change in dividend distribution payable...................... (217) (229) Change in other liabilities, net............................. 1,091 (305) Originations of loans held for sale.......................... (115,535) -- Proceeds received from sale of loans held for sale........... 110,451 -- Originations paid of loans to be sold........................ (57,551) (23,080) Proceeds received from sale of loans......................... 57,551 23,080 -------------- -------------- Net cash used in operating activities.................. (808) (1,314) -------------- -------------- INVESTING ACTIVITIES: Purchases of investment securities............................... (8,195) (32,269) Proceeds from sales of investment securities..................... 1,631 -- Proceeds from maturities of investment securities................ 6,445 9,040 Purchases of Federal Reserve and Federal Home Loan Bank stock ... (1,844) (1,905) Redemptions of Federal Reserve and Federal Home Loan Bank stock.. 1,414 1,684 Net decrease in loans............................................ 1,089 28,290 Additions to premises and equipment.............................. (481) (1,633) Proceeds from sale of premises and equipment..................... 1 10 Stock issued for acquisition of insurance subsidiary............. -- 340 Stock issued for acquisition of mortgage company................. -- 50 -------------- -------------- Net cash provided by investing activities.............. 60 3,607 -------------- -------------- FINANCING ACTIVITIES: Net increase (decrease) in demand, savings, interest checking and money market accounts........................................... 2,052 (7,250) Net increase (decrease) in time deposits......................... 10,211 13,625 Net increase (decrease) in short-term borrowings................. (6,798) 2,432 Repayments of Federal Home Loan Bank advances.................... (120,000) (85,000) Proceeds from Federal Home Loan Bank advances.................... 120,000 85,000 Repayments of long-term borrowings............................... (682) (15) Redemption of preferred stock.................................... (250) -- Payment of preferred stock dividends............................. (22) (30) Amortization of discount on subordinated debentures.............. 21 21 Other, net....................................................... 59 101 -------------- -------------- Net cash provided by financing activities.............. 4,591 8,884 -------------- -------------- NET INCREASE IN CASH AND CASH EQUIVALENTS........................... 3,843 11,177 CASH AND CASH EQUIVALENTS, beginning of period...................... 11,881 12,520 -------------- -------------- CASH AND CASH EQUIVALENTS, end of period............................ $ 15,724 $ 23,697 ============== ============== SUPPLEMENTAL CASH FLOW INFORMATION: Interest paid.................................................... $ 4,253 $ 3,367 ============== ============== Income taxes paid................................................ $ 61 $ 57 ============== ==============
See accompanying notes to consolidated financial statements. BNCCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) March 31, 2005 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., collectively the "Bank"). BNCCORP, through these wholly owned subsidiaries, which operate from 28 locations in Arizona, Colorado, Minnesota, North Dakota and Utah, provides a broad range of banking, insurance, brokerage, trust and other financial services to individuals and small and mid-sized businesses. 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 March 31, 2005 and for the three-month periods ended March 31, 2005 and 2004 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, 2005. 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, 2004. Accordingly, footnote disclosures which would substantially duplicate the disclosures contained in the December 31, 2004 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, 2004 and the notes thereto. NOTE 3 - Reclassifications Certain of the 2004 amounts have been reclassified to conform to the 2005 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 March 31:
Net Per-Share Income Shares Amount ---------------- ---------------- --------------- 2005 Basic earnings per common share: Net income.................................................. $1,789,000 Less: Preferred stock dividends............................. 23,000 ---------------- Income available to common stockholders..................... $1,766,000 2,885,414 $ 0.61 ================ =============== Effect of dilutive shares - Options and contingent stock............................. 63,771 ---------------- Diluted earnings per common share: Net income.................................................. $1,789,000 Less: Preferred stock dividends............................. 23,000 ---------------- Income available to common stockholders..................... $1,766,000 2,949,185 $ 0.60 ================ =============== 2004 Basic earnings per common share: Net income.................................................. $1,813,000 Less: Preferred stock dividends............................. 30,000 ---------------- Income available to common stockholders..................... $1,783,000 2,757,882 $ 0.65 ================ =============== Effect of dilutive shares - Options.................................................. 94,433 ---------------- Diluted earnings per common share: Net income.................................................. $1,813,000 Less: Preferred stock dividends............................. 30,000 ---------------- Income available to common stockholders..................... $1,783,000 2,852,315 $ 0.63 ================ ===============
The following number of options, with exercise prices ranging from $17.00 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:
2005 2004 ---------------- --------------- Quarter ended March 31........ 60,550 3,250
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 to individuals and small and mid-sized businesses. Brokerage, trust and financial services operations provide securities brokerage, trust and other financial services to individuals and small and mid-sized 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, 2004. 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 March 31 (in thousands):
2005 2005 ------------------------------------------------ ---------------------------------------------- Brokerage/ Trust/ Reportable Intersegment Consolidated Banking Insurance Financial Other (a) Totals Segments Other(a) Elimination Total ------- --------- --------- --------- ------ ---------- --------- ------------ ------------ Net interest income................$ 4,639 $ 8 $ 101 $ (605) $ 4,143 $ 4,748 $ (605) $ 14 $ 4,157 Other revenue-external customers... 2,728 5,841 268 23 8,860 8,837 23 (1,177) 7,683 Other revenue-from other segments.. 220 -- 24 243 487 244 243 (487) -- Depreciation and amortization...... 416 285 32 3 736 733 3 -- 736 Equity in the net income of investees....................... 1,056 -- -- 2,058 3,114 1,056 2,058 (3,114) -- Other significant noncash items: Provision for credit losses...... 250 -- -- -- 250 250 -- -- 250 Segment profit (loss) from continuing operations........... 1,311 1,776 (10) (668) 2,409 3,077 (668) -- 2,409 Income tax provision (benefit)..... 332 690 (4) (398) 620 1,018 (398) -- 620 Segment profit (loss).............. 979 1,086 (6) (270) 1,789 2,059 (270) -- 1,789 Segment assets..................... 661,344 36,068 16,267 78,491 792,170 713,679 78,491 (113,086) 679,084
2004 2004 ------------------------------------------------ ---------------------------------------------- Brokerage/ Trust/ Reportable Intersegment Consolidated Banking Insurance Financial Other (a) Totals Segments Other(a) Elimination Total ------- --------- --------- --------- ------ ---------- --------- ------------ ------------ Net interest income................$ 4,867 $ 13 $ -- $ (523) $ 4,357 $ 4,880 $ (523) $ 13 $ 4,370 Other revenue-external customers... 2,114 4,630 304 23 7,071 7,048 23 (1,064) 6,007 Other revenue-from other segments.. 150 -- 21 186 357 171 186 (357) -- Depreciation and amortization...... 403 268 32 3 706 703 3 -- 706 Equity in the net income (loss) of investees.................... 734 -- -- 2,115 2,849 734 2,115 (2,849) -- Other significant noncash items: Provision for credit losses...... -- -- -- -- -- -- -- -- -- Segment profit (loss) from continuing operations........... 1,968 1,227 (87) (618) 2,490 3,108 (618) -- 2,490 Income tax provision (benefit)..... 553 475 (35) (316) 677 993 (316) -- 677 Segment profit (loss).............. 1,415 752 (52) (302) 1,813 2,115 (302) -- 1,813 Segment assets..................... 632,989 31,700 1,153 73,434 739,276 665,842 73,434 (103,583) 635,693 (a) The financial information in the "Other" column is for the bank holding company.
NOTE 6 - Stock-Based Compensation At March 31, 2005, 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 for the three-month periods ended March 31:
2005 2004 ---------------- --------------- Net income, as reported................................. $ 1,789,000 $ 1,813,000 Add: total stock-based employee compensation expense included in reported net income, net of related tax effects.............................................. 41,000 22,000 Deduct: total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects........................... (51,000) (32,000) ---------------- --------------- Pro forma net income.................................... $ 1,779,000 $ 1,803,000 ================ =============== Earnings per share: Basic - as reported................................... $ 0.61 $ 0.65 Basic - pro forma..................................... 0.59 0.61 Diluted - as reported................................. 0.60 0.63 Diluted - pro forma................................... 0.58 0.59
NOTE 7 - Derivative Activities The Company has interest rate cap contracts with notional amounts that totaled $20 million at March 31, 2005 and $40 million at March 31, 2004. These contracts were purchased to mitigate interest rate risk in rising-rate scenarios. The referenced interest rate is three-month LIBOR with $20.0 million of 4.50 percent contracts having three-year original maturities (matured during May and June of 2004) and $20.0 million of 5.50 percent contracts having five-year maturities (maturing during May and June of 2006). The total amount paid for the original contracts was $1.2 million. The contracts are reflected in the Company's consolidated balance sheet at their current fair value of approximately $1,000 at March 31, 2005 and $19,000 at March 31, 2004. 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 March 31, 2005 and 2004, the impact of marking the contracts to market, reflected as additional interest expense on Federal Home Loan Bank ("FHLB") advances, was a reduction to net interest income of $0 and approximately $37,000, respectively. NOTE 8 - Subsequent Event On April 27, 2005, the Company repurchased the then-outstanding 100 shares of its noncumulative preferred stock, $0.01 par value per share, from a trust controlled by Richard W. Milne, Jr. for cash consideration of $1,006,000.00. Mr. Milne is Chairman, President and CEO of the Companies indirect subsidiary, Milne Scali & Company, Inc. and a director of the Companies subsidiary, BNC National Bank. 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 and were issued on September 14, 2004. NOTE 9 - Recently Issued or Adopted Accounting Standards 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 adopted SOP 03-3 on January 1, 2005. The Adoption of SOP 03-3 did not have a material impact on the Company's financial position or results of operations. In December 2004, the financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R ("SFAS 123R") (revised December 2004), Share-based Payment, which established standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This statement does not change the accounting guidance for share-based payment transactions with parties other than employees provided in SFAS 123, however non-employee directors are scoped into SFAS 123R. This statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. SFAS 123R allows the use of valuation models other than the Black-Scholes model prescribed in SFAS 123, specifically the Binominal Lattice method. Therefore, the pro forma costs of stock option expense estimated in Note 1 using the Black-Scholes method may not be representative of the costs recognized by the Company upon adoption of SFAS 123R. The Company is still in the process of analyzing the cost of stock options under SFAS 123R. On April 14, 2005, the Securities and Exchange Commission delayed the effective date for SFAS 123R, which allows companies to implement the statement at the beginning of their first fiscal year beginning after June 15, 2005, which would be January 1, 2006 for the Company. 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 March 31, 2005 and December 31, 2004 Assets. Our total assets increased $5.4 million, from $673.7 million at December 31, 2004 to $679.1 million at March 31, 2005. The following table presents our assets by category as of March 31, 2005 and December 31, 2004, 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 ---------------------------- March 31, December 31, Assets 2005 2004 $ % -------------------------------------------- ---------------- ------------------ ------------ ------------ Cash and due from banks.................... $ 15,724 $ 11,867 $ 3,857 32.5% (a) Interest-bearing deposits with banks....... -- 14 (14) (100.0)% Investment securities available for sale............................... 232,314 235,916 (3,602) (1.5)% Federal Reserve Bank and Federal Home Loan Bank Stock............................. 7,971 7,541 430 5.7% Loans held for sale........................ 64,997 60,197 4,800 8.0% Loans and leases, net...................... 289,308 290,479 (1,171) (0.4)% Premises and equipment, net................ 21,871 21,799 72 0.3% Interest receivable........................ 2,997 2,686 311 11.6% Other assets............................... 14,376 13,357 1,019 7.6% Goodwill................................... 21,779 21,779 -- -- Other intangible assets, net............... 7,747 8,075 (328) (4.1)% ---------------- ------------------ ------------ Total assets...................... $ 679,084 $ 673,710 $ 5,374 0.8% ================ ================== ============ (a) The increase is attributable to $5.0m of cashletter credits that were processed on March 31, 2005
Allowance for Credit Losses. The following table sets forth information regarding changes in our allowance for credit losses for the three-month periods ending March 31, 2005 and 2004 (amounts are in thousands):
Three Months Ended March 31, ------------------------------------------ 2005 2004 --------------------- -------------------- Balance, beginning of period.................................... $ 3,335 $ 4,763 Provision for credit losses..................................... 250 -- Loans charged off............................................... (113) (1,273) Loans recovered................................................. 118 55 --------------------- -------------------- Balance, end of period.......................................... $ 3,590 $ 3,545 ===================== ==================== Ending loan portfolio .......................................... $ 292,898 $ 253,992 ===================== ==================== Allowance for credit losses as a percentage of ending loan portfolio....................................................... 1.23% 1.40%
As of March 31, 2005, our allowance for credit losses was 1.23 percent of total loans as compared to 1.14 percent at December 31, 2004 and 1.40 percent at March 31, 2004. There was a $250,000 provision for loan losses for the three-month period ended March 31, 2005 based upon the increase of total loans as well as an increase in criticized loans during the quarter. There was no provision for loan losses for the same period in 2004 based on the decrease in total and non-performing loans during that quarter. Loans charged off during the first quarter of 2005 totaled $113,000, representing a $1.16 million decrease over loans charged off during the first quarter of 2004. The decrease was primarily attributable to charge-offs related to one commercial loan in 2004. Net charge-offs as a percentage of average total loans for the three-month periods ended March 31, 2005 and 2004 were as follows:
Three Months Ended March 31, ------------------------------------------ 2005 2004 --------------------- -------------------- Ratio of net charge-offs to average total loans................. 0.00% (0.45)% Ratio of net charge-offs to average total loans, annualized..... 0.00% (1.82)%
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. 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. 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 geographic 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. 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): March 31, December 31, 2005 2004 ------------ ------------ Nonperforming loans: Loans 90 days or more delinquent and still accruing interest................................ $ 20 $ 25 Nonaccrual loans.................................... 71 524 Restructured loans.................................. -- -- ------------ ------------ Total nonperforming loans.............................. 91 549 Other real estate owned and repossessed assets...... -- -- ------------ ------------ Total nonperforming assets............................. $ 91 $ 549 ============ ============ Allowance for credit losses............................ $ 3,590 $ 3,335 ============ ============ Ratio of total nonperforming assets to total assets ... 0.01% 0.08% Ratio of total nonperforming loans to total loans...... 0.03% 0.19% Ratio of allowance for credit losses to total nonperforming loans................................. 3,945% 607%
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. 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 March 31, 2005 or December 31, 2004. Other real estate owned and repossessed assets represent 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 March 31, 2005 or December 31, 2004. Liabilities. Our total liabilities increased $5.7 million, from $629.9 million at December 31, 2004 to $635.6 million at March 31, 2005. The following table presents our liabilities by category as of March 31, 2005 and December 31, 2004 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 ------------------------------- March 31, December 31, Liabilities 2005 2004 $ % ---------------------------------------- ------------------ ------------------ -------------- ------------ DEPOSITS: Noninterest-bearing.................... $ 70,066 $ 63,386 $ 6,680 10.5% (a) Interest-bearing - Savings, interest checking and money market............................ 219,783 210,887 8,896 4.2% Time deposits $100,000 and over...... 75,917 83,952 (8,035) (9.6)% Other time deposits.................. 101,838 97,118 4,720 4.9% Short-term borrowings.................. 26,899 33,697 (6,798) (20.2)% (b) Federal Home Loan Bank advances........ 97,200 97,200 -- -- Long-term borrowings................... 9,397 10,079 (682) (6.8)% Guaranteed preferred beneficial interests in company's subordinated debentures........................... 22,314 22,509 (195) (0.9)% Other liabilities...................... 12,149 11,036 1,113 10.1% ------------------ ------------------ -------------- Total liabilities............. $ 635,563 $ 629,864 $ 5,699 0.9% ================== ================== ============== (a) These accounts generally fluctuate daily due to the cash management activities of our commercial customers. Additionally some customers draw down on their lines of credit at year end and place the funds in their transaction accounts and, during the first quarter of each year, make payments on the lines of credit from these same transactions accounts. This can cause seasonal fluctuations (b) This was a planned decrease in short-term borrowings as a result of an increase in deposits.
Stockholders' Equity. Our stockholders' equity decreased $325,000 between December 31, 2004 and March 31, 2005. The decrease was the result of the unrealized losses on investment securities in accumulated other comprehensive income and payment of a preferred stock dividend being greater than the net income for the period. Also, on February 15, 2005, the Company repurchased 25 shares of its noncumulative preferred stock from a trust controlled by Mr. Milne, an executive officer, for cash consideration of $252,556. All of 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. 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 upon the amount and composition of assets recorded on the balance sheet, 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 March 31, 2005:
Tier 1 Total Risk- Risk- Tier 1 Based Based Leverage Ratio Ratio Ratio --------------- ---------------- -------------- BNCCORP, consolidated...... 7.12% 9.60% 4.71% BNC National Bank.......... 10.48% 11.31% 6.93%
As of March 31, 2005, BNCCORP and the Bank exceeded capital adequacy requirements and the Bank was considered "well-capitalized" under prompt corrective action provisions. Capital expenditures expected in 2005 total $3.2 million and consists of building a new banking branch in Shakopee, MN, computer software and hardware throughout the Company, remodeling several of North Dakota branch offices, remodeling the Phoenix office of Milne Scali and could include purchase or leasing of additional facilities in our various market areas should facilities or properties be deemed to add additional franchise value. Additionally, potential acquisitions could increase capital expenditures as such transactions are consummated. Comparison of Operating Results for the Three Months Ended March 31, 2005 and 2004 General. Net income of $1.79 million, or $0.60 per share on a diluted basis, was reported for the quarter ended March 31, 2005. These 2005 first quarter earnings nearly equaled the record net income of $1.81 million, or $0.63 per diluted share reported for the same period of 2004. The recent quarter benefited from an increase in insurance income as well as loan fees generated by a significant commercial real estate transaction originated by the Minneapolis office and mortgage banking. These increases offset the slight decrease in net interest income and higher noninterest expenses related to our investments in staff and facilities to support the growth of our insurance and banking businesses. The financial performance of our insurance segment is typically strongest in the first quarter due to profit sharing payments received from insurance carriers. Insurance revenues were $5.77 million for the quarter ended March 31, 2005 compared with $4.56 million for the same period one year earlier, an increase of 26.4 percent. Profit sharing payments totaled $1.46 million for the quarter ended March 31, 2005 compared to $1.04 million for the quarter ended March 31, 2004. Net interest income was $4.16 million for the first quarter of 2005, compared with $4.37 million for the first quarter of 2004. Net interest income for the quarter ended March 31, 2004 was 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 but was subsequently paid in full. Without this recovery, net interest income for the quarter ended March 31, 2004 would have been approximately $3.96 million resulting in a net interest margin of 2.92 percent compared to the net interest margin of 2.78 percent for the quarter ended March 31, 2005. Noninterest income was $7.71 million for the 2005 first quarter, an increase of 28.4 percent from $6.01 million in the year-ago period. As noted earlier, higher insurance income was a key factor in this increase. The insurance income increase was generated by the Company's insurance agency subsidiary, Milne Scali & Company, and resulted from growth from existing offices as well as the new offices opened in 2004. Loan fees also rose, due primarily by a significant commercial real estate transaction originated by the Minneapolis office as well as increased mortgage banking fees. Noninterest income represented 64.98 percent of gross revenues for the recent quarter, compared with 57.89 percent for the comparable period of 2004. Without the inclusion of the cash basis interest income recovery of $408,000, noninterest income for the first quarter of 2004 represented 60.26 percent of revenues. Noninterest expense for the first quarter of 2005 was $9.21 million, an increase of 16.8 percent from $7.89 million a year ago, due to staffing and other increases to support growth from new banking branch offices in Arizona and Minnesota and new insurance offices in Arizona, Colorado and Utah. Increased professional services expense and increased other noninterest expenses were attributable to expenses paid and accrued in conjunction with a suit filed by Terrence M. Scali. See Item 5, Legal Proceedings. Total assets rose to $679.1 million at March 31, 2005 versus $673.7 million at December 31, 2004. Total loans held for investment at the end of the 2005 first quarter were $292.9 million compared with $293.8 million at December 31, 2004. Total loans held for sale were $65.0 million at March 31, 2005 compared with $60.2 million at December 31, 2004, reflecting an increase in our student loan financing program implemented during 2004. Investment securities available for sale were $232.3 million at March 31, 2005 compared with $235.9 million at December 31, 2004. Total deposits at March 31, 2005 were $467.6 million, up from $455.3 million at December 31, 2004. Total common stockholders' equity for BNCCORP was $42.5 million at March 31, 2005, equivalent to book value per common share of $14.73 (tangible book value per common share of $4.50). Net unrealized losses in the investment portfolio as of that date were $2.96 million, or a decrease of approximately $0.64 per share, net of tax. Charge-offs for the quarter ended March 31, 2005 were $113,000 compared with $1.3 million for the same period one year earlier. $1.2 million of the charge-offs in the first quarter of 2004 related to the final resolution of one commercial loan. The ratio of allowance for credit losses to total nonperforming loans increased to 3,945 percent at March 31, 2005, compared with 607 percent at December 31, 2004. The allowance for credit losses as a percentage of total loans at March 31, 2005 was 1.23 percent, compared with 1.14 percent a year ago. Total nonperforming loans decreased to $91,000 at March 31, 2005, compared to $549,000 at December 31, 2004. The ratio of nonperforming assets to total assets decreased to 0.01 percent at March 31, 2005 from 0.08 percent at December 31, 2004. The provision for credit losses was $250,000 for the period ended March 31, 2005 and $0 for the same period in 2004. Net Interest Income. Net interest income for the first quarter of 2005 was $4.16 million, a decrease of 4.9 percent, from the $4.37 million reported for the first quarter of 2004. The decrease reflected a reduction in the net interest margin to 2.78 percent for the quarter ended March 31, 2005, from 3.22 percent for the same period in 2004. Net interest income and margin for the three-month period ending March 31, 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. Without this recovery, net interest income for the quarter ended March 31, 2004 would have been approximately $3.96 million resulting in a net interest margin of 2.92 percent. The following table presents average balances; interest earned or paid associated yields on interest-earning assets and costs on interest-bearing liabilities for the three-month periods ended March 31, 2005 and 2004, as well as the changes between the periods presented. Significant factors contributing to the decrease in net interest income and net interest margin are discussed in lettered notes below the table (amounts are in thousands):
Three Months Ended March 31, ------------------------------------------------------------------- 2005 2004 Change --------------------------------- -------------------------------- ------------------------------ Interest Average Interest Average Interest Average Average earned yield or Average earned yield or Average earned yield Balance or paid cost balance or paid cost balance or paid or cost ---------- ---------- --------- --------- --------- --------- -------- -------- ---------- Interest-earning assets Federal funds sold/interest bearing due from...........$ 240 $ -- -- $ 480 $ -- -- $ (240) $ -- -- Investments................... 243,487 2,560 4.26% 281,463 3,135 4.48% (37,976) (575) -0.22%(a) Loans held for sale........... 71,232 821 4.67% 301 4 5.34% 70,931 817 -0.67%(b) Loans and leases held for investment................. 294,110 4,976 6.86% 269,127 4,720 7.05% 24,983 256 -0.19%(b) Allowance for loan losses.. (3,335) -- (4,751) -- 1,416 -- ---------- ---------- --------- --------- -------- -------- Total interest-earning assets.....................$ 605,734 8,357 5.60% $546,620 7,859 5.78% $ 59,114 498 -0.18% ========== ========== ========= ========= ======== ======== Interest-bearing liabilities Interest checking & money market accounts............$ 212,620 804 1.53% $208,478 539 1.04% $ 4,142 265 0.49%(c) Savings....................... 7,353 15 0.83% 6,566 12 0.74% 787 3 0.09% Certificates of deposit under $100,000................... 100,046 678 2.75% 93,699 635 2.73% 6,347 43 0.02% Certificates of deposit $100,000 and over.......... 83,504 748 3.63% 47,110 432 3.69% 36,394 316 -0.06%(d) ---------- ---------- --------- --------- -------- -------- Interest-bearing deposits.. 403,523 2,245 2.26% 355,853 1,618 1.83% 47,670 627 0.43% Short-term borrowings......... 26,342 170 2.62% 26,394 99 1.51% (52) 71 1.11%(e) Federal Home Loan Bank advances................... 106,526 1,185 4.51% 109,458 1,253 4.60% (2,932) (68) -0.09% Long-term borrowings.......... 10,062 123 4.96% 8,631 93 4.33% 1,431 30 0.63%(f) Subordinated debentures....... 22,239 477 8.70% 22,137 426 7.74% 102 51 0.96%(g) ---------- ---------- --------- --------- -------- -------- Total borrowings........... 165,169 1,955 4.80% 166,620 1,871 4.52% (1,451) 84 0.28% ---------- ---------- --------- --------- -------- -------- Total interest-bearing liabilities...............$ 568,692 4,200 3.00% $522,473 3,489 2.69% $ 46,219 711 0.31% ========== ---------- ========= --------- ======== -------- Net interest income/spread. $ 4,157 2.60% $ 4,370 3.09% $(213) -0.49% ========== ========= ======== Net interest margin........ 2.78% 3.22% -0.44%(h) Notation: Noninterest-bearing deposits..$ 62,403 -- $ 41,850 -- $ 20,553 -- ---------- --------- -------- Total deposits............$ 465,926 $ 2,245 1.95% $397,703 $ 1,618 1.64% $ 68,223 $ 627 0.31% ========== ========== ========= ========= ========= ======== Taxable equivalents: Total interest-earning assets....................$ 605,734 $ 8,581 5.75% $546,620 $ 8,066 5.93% $ 59,114 $ 515 -0.18% Net interest income/spread. -- $ 4,381 2.75% -- $ 4,577 3.24% -- $(196) -0.49% Net interest margin........ -- -- 2.93% -- -- 3.37% -- -- -0.44% (a) Average investments during the first quarter of 2005 were less than the same period in 2004. Investment volume decreased during 2004 in order to fund part of the increase in loans outstanding, particularly loans held for sale. Investments available for sale at March 31, 2005 were $232.3 million compared with $288.4 million at March 31, 2004. (b) Actual balances of loans held for sale totaled $65 million and $0 as of March 31, 2005 and March 31, 2004, respectively, reflecting increased amounts of residential mortgage and student loan financing programs. Actual balances of loans held for investment at March 31, 2005 and March 31, 2004 were $292.9 and $254.0 million, respectively. Loan yield for the quarter ended March 31, 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 subsequently paid in full during the first quarter of 2004. Without this recovery, interest income on loans for the first quarter of 2004 would have been approximately $4.3 million and the yield on loans would have been 6.44 percent, compared to 6.86 percent for the first quarter of 2005. The increase is due to the higher short-term interest rate environment in the first quarter of 2005 relative to the first quarter of 2004. (c) Average balances of interest checking and money market accounts increased slightly. The increased costs of interest checking and money market accounts reflect the higher short-term interest rate environment in the first quarter of 2005 versus the first quarter of 2004. (d) During the quarter ended March 31, 2005, average balances of brokered and national market CDs were $54.9 million as compared to $36.6 million for the same period one year earlier, as brokered deposits were increased in order to provide funding for the increase in loans outstanding, particularly loans held for sale. (e) Average short-term borrowings were relatively unchanged for the three-month period ended March 31, 2005 compared to the same period in 2004. The increased cost of short-term borrowings reflects the higher short-term interest rate environment in the first quarter of 2005 versus the first quarter of 2004. (f) The increase in the average balance of long-term borrowing reflects a $1.5 million increase in the level of the Company's long-term borrowing during 2004. The increased cost of long-term borrowings reflects the higher short-term interest rate environment in the first quarter 2005 versus the first quarter of 2004 as the interest rate of the company's long-term borrowings is indexed to one-month LIBOR. (g) The increased cost of subordinated debentures reflects the higher short-term interest rate environment in the first quarter of 2005 relative to the first quarter of 2004 as the interest rate on $15 million of the Company's subordinated debentures is indexed to three-month LIBOR (h) In the first quarter of 2004 net interest margin was favorably impacted by the previously mentioned recovery of cash basis interest income of $408,000. Without this recovery, net interest margin would have been 2.92 percent for the quarter ended March 31, 2004. .
Provision for Credit Losses. The provision for credit losses was $250,000 for the quarter ended March 31, 2005 based upon the increase of total loans as well as an increase in criticized loans during the quarter. There was no provision for loan losses for the same period in 2004 based on the decrease in total and non-performing loans during that quarter. See "Comparison of Financial Condition at March 31, 2005 and December 31, 2004 - Allowance for Credit Losses." Noninterest Income. The following table presents the major categories of our noninterest income for the three-month periods ended March 31, 2005 and 2004 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):
For the Three Months Ended Increase (Decrease) March 31, 2005 - 2004 ---------------------------- ----------- --------------- Noninterest Income 2005 2004 $ % ------------- ------------ ----------- --------------- Insurance commissions................. $ 5,768 $ 4,562 $ 1,206 26.4% (a) Fees on loans......................... 1,295 576 719 124.8% (b) Service charges....................... 184 211 (27) (12.8)% Trust and financial services.......... 159 124 35 28.2% (c) Brokerage income...................... 84 179 (95) (53.1)% (d) Rental income......................... 7 35 (28) (80.0)% Net loss on sales of securities ...... (66) -- (66) (100.0)% (e) Other................................. 282 320 (38) (11.9)% Total noninterest income........... $ 7,713 $ 6,007 $ 1,706 28.4% ============= ============ ============ Noninterest income as a percent of gross revenues.................... 64.98% 57.89% 7.1% Noninterest income as a percent of gross revenues adjusted for cash basis interest income recovered.... 64.98% 60.26%
(a) Insurance revenue increased due to an increase in profit sharing income received from insurance companies as well as growth in the insurance segment. Most profit sharing income from insurance companies is recorded during the first quarter of the year. Profit sharing income recognized during the quarter ended March 31, 2005 was $1.46 million compared to $1.04 million for the same period in 2004. (b) Loan fees included in noninterest income increased primarily due to a commercial real estate transaction originated by the Minneapolis office and mortgage banking fees. Loans sold in the first quarter of 2005 totaled $57.6 million compared to $23.1 million in the same period of 2004. (c) Trust and financial services income increased due to increased trust assets under management. (d) Brokerage revenue decreased primarily due to lower production in the Minneapolis market relative to that of the first quarter of 2004. (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. Sales of investment securities during the quarter ended March 31, 2005 resulted in a net realized loss of $66,000. There were no sales of investment securities in the first quarter of 2004. Noninterest Expense. The following table presents the major categories of our noninterest expense for the three-month periods ended March 31, 2005 and 2004 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):
For the Three Months Increase (Decrease) Ended March 31 2005 - 2004 --------------------------- --------------------------- Noninterest Expense 2005 2004 $ % ----------- ----------- ----------- ------------ Salaries and employee benefits............... $ 5,619 $ 4,914 $ 705 14.3% (a) Occupancy.................................... 755 585 170 29.1% (b) Professional services........................ 446 319 127 39.8% (c) Depreciation and amortization................ 408 398 10 2.5% Office supplies, telephone and postage....... 361 311 50 16.1% (d) Amortization of intangible assets............ 328 308 20 6.5% (e) Marketing and promotion...................... 281 271 10 3.7% FDIC and other assessments................... 55 51 4 7.8% Other........................................ 958 730 228 31.2% (f) ----------- ----------- ----------- Total noninterest expense................. $ 9,211 $ 7,887 $ 1,324 16.8% =========== =========== =========== Efficiency ratio ............................ 77.60% 76.00% 1.6% =========== =========== Total operating expenses as a percent of average assets, annualized................ 5.44% 5.13% 0.3% =========== =========== --------------- (a) Salaries and employee benefits expenses increased primarily due to new banking branch offices in Arizona and Minnesota and new insurance offices in Arizona, Colorado and Utah as well as increased incentive compensation related to the previously mentioned commercial real estate loan fees from the Minneapolis market. Average full time equivalent employees for the quarter ended March 31, 2005 were 320 as compared to 301 for the same period one year earlier. (b) Occupancy expense increased due to new banking branch offices in Arizona and Minnesota and new insurance offices in Arizona, Colorado and Utah. (c) The increase in professional services expense is primarily attributable to legal fees in conjunction with a suit filed by Terrence M Scali. See Item 5, Legal Proceedings. (d) The increase in office supplies, telephone and postage expense is primarily attributable to expansion, including the expenses associated with an increase in the number of locations and personnel. (e) Amortization of intangible assets increased primarily due to amortization of the insurance books of business intangibles acquired from several insurance agency asset acquisitions in 2004. (f) The increase in other noninterest expense is primarily attributable to a potential settlement relating to the legal proceeding.
Income Tax Provision. Our provision for income taxes for the quarter ended March 31, 2005 decreased $57,000 as compared to the same period in 2004. The estimated effective tax rates for the three-month periods ended March 31, 2005 and 2004 were 25.8 and 27.2 percent, respectively. The reduction in our effective tax rate is primarily attributable to an increase in the amount of tax-exempt income in the 2005 period as compared to the 2004 period. Earnings per Common Share. See Note 4 to the interim consolidated financial statements included under Item 1 for a summary of the EPS calculation for the three-month periods ended March 31, 2005 and 2004. 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 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 three months ended March 31, 2005 and 2004, 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 Three Months Ended March 31, -------------------- Major Sources and (Uses) of Funds 2005 2004 --------- -------- Proceeds from FHLB advances...........................$ 120,000 $ 85,000 Net increase (decrease) in deposits................... 12,263 6,375 Proceeds from maturities of investment securities..... 6,445 9,040 Proceeds from sales of investment securities.......... 1,631 -- Net decrease in loans................................. 1,089 28,290 Repayments of FHLB advances........................... (120,000) (85,000) Purchases of investment securities.................... (8,195) (32,269) Net increase (decrease) in short-term borrowings...... (6,798) 2,432
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 deposits and direct non-brokered national certificates of deposit acquired 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 March 31, 2005, we had established three revolving lines of credit with banks totaling $17.5 million all of which remained available for advance. The lines, if drawn upon, mature daily with interest rates that float at the Federal funds rate. At March 31, 2005, we also had the ability to draw additional FHLB advances of $64.3 million based upon the mortgage loans and securities that were then pledged, subject to a requirement to purchase additional FHLB stock. Application of Critical Accounting Policies The Company's significant accounting policies are described in Note 1 to the consolidated financial statements included in the Company's Form 10-K for the year-ended December 31, 2004. The Company considers the following accounting policies and related estimates to be the most critical in their potential effect on its financial position or results of operations: Allowance for Loan Losses. The allowance for loan losses is established through a charge against current earnings to the provision for loan losses. The allowance for loan losses is based on management's estimate of the amount required to reflect the probable inherent losses in the loan portfolio, based on circumstances and conditions known at each reporting date in accordance with Generally Accepted Accounting Principles ("GAAP"). There are three components of the allowance for loan losses: 1) specific reserves for loans considered to be impaired or for other loans for which management considers a specific reserve to be necessary; 2) allocated reserves based upon management's formula-based process for assessing the adequacy of the allowance for loan losses; and 3) a non-specific environmentally-driven allowance considered necessary by management based on its assessment of other qualitative factors. The allowance for loan losses is a significant estimate and is regularly reviewed by the Company for adequacy using a consistent, systematic methodology which assesses such factors as changes in the mix and volume of the loan portfolio; trends in portfolio credit quality, including delinquency and charge-off rates; and current economic conditions that may affect a borrower's ability to repay. Adverse changes in management's assessment of these factors could lead to additional provisions for loan losses. The Company's methodology with respect to the assessment of the adequacy of the allowance for loan losses is more fully discussed in its Form 10-K for the period ended December 31, 2004. Goodwill Impairment. The Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangibles, effective January 1, 2002. The statement addresses the method of identifying and measuring goodwill and other intangible assets acquired in a business combination, eliminates further amortization of goodwill, and require periodic impairment evaluations of goodwill. Impairment evaluations are required to be performed annually and may be required more frequently if certain conditions indicating potential impairment exist. In the event that the Company were to determine that its goodwill were impaired, the recognition of an impairment charge could have an adverse impact on its results of operations in the period that the impairment occurred or on its financial position. Interest Income Recognition . Interest on loans is included in income as earned based upon interest rates applied to unpaid principal. Interest is not accrued on loans 90 days or more past due unless they are adequately secured and in the process of collection or on other loans when management believes collection is doubtful. All loans considered impaired are nonaccruing. Interest on nonaccruing loans is recognized as payments are received when the ultimate collectibility of interest is no longer considered doubtful. When a loan is placed on nonaccrual status, all interest previously accrued is reversed against current-period interest income; therefore an increase in loans on nonaccrual status could have an adverse impact on interest income recognized in future periods. Income Taxes. The Company estimates income tax expense in each of the jurisdictions in which it operates for each period for which a statement of operations is presented. This involves estimating the Company's actual current tax exposure as well as assessing temporary differences resulting from differing treatment of items, such as timing of the deduction of expenses, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company's consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and to the extent that recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of March 31, 2005, there was a valuation allowance set aside against the deferred tax asset. 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 for 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 accounts are held constant at their March 31, 2005 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 March 31, 2005 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 March 31, 2005 of 5.75 percent to 4.75 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 March 31, 2005, the declining rate scenario analysis were limited to -100bp and -200bp 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 are in thousands) Movement in interest rates -200bp -100bp Unchanged +100bp +200bp +300bp +400bp ------ ------ --------- ------ ------ ------ ------ Projected 12-month net interest income........... $ 15,853 $ 16,119 $ 17,071 $ 17,428 $ 17,684 $ 17,828 $17,898 Dollar change from rates unchanged scenario........ $ (1,218) $ (952) -- $ 357 $ 613 $ 757 $ 827 Percentage change from rates unchanged scenario........ (7.13)% (5.58)% -- 2.09% 3.59% 4.43% 4.84% Net benefit/(cost) of cumulative $20.0 million interest rate caps (1).... $ (1) $ (1) $ (1) $ (1) $ (1) $ (1) $ 31 Total net interest income impact with caps.......... $ 15,852 $ 16,118 $ 17,070 $ 17,427 $ 17,683 $ 17,827 $17,929 Dollar change from unchanged w/caps.................... $ (1,218) $ (952) -- $ 357 $ 613 $ 757 $ 859 Percentage change from unchanged w/caps.......... (7.14)% (5.58)% -- 2.09% 3.59% 4.43% 5.03% Policy guidelines (decline limited to)............... 10.00% 5.00% -- 5.00% 10.00% 15.00% 20.00% (1) We have four interest rate cap contracts on three-month LIBOR with strikes at 5.5 percent each in the amount of $5 million notional with original terms of five years for total notional of $20 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 percentage 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, even though in the -100bp scenario, net interest income declines $952,000, or 5.58 percent, from the unchanged scenario, the level of net interest income of $16.1 million is still greater than the $16 million of net interest income recorded for the year ended December 31, 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, these analyses are 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, these analyses are based on our assets and liabilities as of March 31, 2005 (without forward adjustments for planned growth and anticipated business activities) and do 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. Item 5. Legal Proceedings Terrence M. Scali v. BNCCORP, Inc., Milne Scali & Company, Inc., Gregory K. Cleveland and Jacquelyn L. Cleveland, husband and wife, Tracy Scott and Myrt Scott, husband and wife, and Richard W. Milne, Jr. and Robin Jayne Milne, husband and wife, AAA No. 76 166 00014 05 JAFA (the "Arbitration"). The American Arbitration Association is administering the Arbitration. Terrence M. Scali, former executive vice president of BNCCORP, and former President and CEO of Milne Scali, a subsidiary of the Bank, which is a subsidiary of BNCCORP, and a former director of BNCCORP, has commenced arbitration against BNCCORP, Milne Scali, and three current executives and members of the Boards of Directors of BNCCORP and Milne Scali. Mr. Scali alleges that his damages exceed $500,000 and arise out of the termination of his employment with BNCCORP and Milne Scali in July 2004. In his claims against BNCCORP and Milne Scali, Mr. Scali alleges breach of contract, wrongful termination, and conversion. Mr. Scali has also brought a claim for a declaration of his rights under an employment agreement, seeking to have his noncompete, nonsolicitation, and nondisclosure agreements nullified. For his claims against the executives, Mr. Scali alleges tortuous interference with contract and defamation. Mr. Scali has also named the wives of the three executives as respondents to the Arbitration in their capacity as potential holders of community property interests with their husbands. BNCCORP, Milne Scali and the executives deny any wrongdoing and will vigorously defend against Mr. Scali's claims. Terrence M. Scali v. Gregory K. Cleveland and Jane Doe Cleveland, husband and wife, Tracy Scott and Jane Doe Scott, husband and wife, and Richard W. Milne, Jr. and Robin Jayne Milne, husband and wife, State of Arizona Superior Court, Maricopa County, Case No. CV2005-001741. Mr. Scali has commenced a parallel action in Arizona Superior Court against BNCCORP and Milne Scali executives, asserting the same claims in court that were asserted in the Arbitration. The executives intend to vigorously defend against Mr. Scali's claims in the court case, as they will do in the Arbitration. From time to time, we may be a party to legal proceedings arising out of our lending, deposit operations or other activities. We engage in foreclosure proceedings and other collection actions as part of our loan collection activities. From time to time, borrowers may also bring actions against us, in some cases claiming damages. Some financial services companies have been subjected to significant exposure in connection with litigation, including class action litigation and punitive damage claims. While we are not aware of any such actions or allegations that should reasonably give rise to any material adverse effect, it is possible that we could be subjected to such a claim in an amount that could be material. Based upon a review with our legal counsel, we believe that the ultimate disposition of such pending litigation will not have a material effect on our financial condition, results of operations or cash flows. Part II - Other Information Item 2 Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities Pursuant to stock options issued on January 5, 2001, BNCCORP issued 300 shares of its common stock on February 4, 2005 and 800 shares of its common stock on February 5, 2005. Item 6. Exhibits (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 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: May 13, 2005 By /s/ Gregory K. Cleveland ---------------------------------------- Gregory K. Cleveland President and Chief Executive Officer By /s/ Neil M. Brozen ---------------------------------------- Neil M. Brozen Chief Financial Officer