U.S. Securities and Exchange Commission
Washington, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarter ended March 31, 2004
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission File No. 0-26290
BNCCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 45-0402816
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
322 East Main
Bismarck, North Dakota 58501
(Address of principal executive office)
(701) 250-3040
(Registrant's telephone number)
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes X No ___
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes ___ No _X_
The number of shares of the registrant's outstanding common stock on April
26, 2004 was 2,788,604.
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 2004 2003
--------------- --------------
(unaudited)
CASH AND DUE FROM BANKS.............................................................. $ 23,697 $ 12,520
--------------- --------------
Cash and cash equivalents....................................................... 23,697 12,520
INVESTMENT SECURITIES AVAILABLE FOR SALE............................................. 288,359 262,568
FEDERAL RESERVE BANK AND FEDERAL HOME LOAN BANK STOCK................................ 7,817 7,596
LOANS AND LEASES, net................................................................ 253,992 283,555
ALLOWANCE FOR CREDIT LOSSES.......................................................... (3,545) (4,763)
--------------- --------------
Net loans and leases............................................................ 250,447 278,792
PREMISES AND EQUIPMENT, net.......................................................... 19,792 18,570
INTEREST RECEIVABLE.................................................................. 2,650 2,462
OTHER ASSETS......................................................................... 19,232 15,507
GOODWILL............................................................................. 15,291 15,089
OTHER INTANGIBLE ASSETS, net......................................................... 8,408 8,373
--------------- --------------
$ 635,693 $ 621,477
=============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
DEPOSITS:
Noninterest-bearing............................................................. $ 45,009 $ 44,725
Interest-bearing -
Savings, interest checking and money market................................. 207,991 215,525
Time deposits $100,000 and over............................................. 53,206 46,569
Other time deposits......................................................... 96,111 89,123
--------------- --------------
Total deposits.................................................................. 402,317 395,942
SHORT-TERM BORROWINGS................................................................ 33,815 31,383
FEDERAL HOME LOAN BANK ADVANCES...................................................... 112,200 112,200
LONG-TERM BORROWINGS................................................................. 8,625 8,640
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY'S
SUBORDINATED DEBENTURES.......................................................... 22,189 22,397
OTHER LIABILITIES.................................................................... 12,142 10,729
--------------- --------------
Total liabilities...................................................... 591,288 581,291
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value - 2,000,000 shares authorized;
150 shares issued and outstanding........................................... -- --
Capital surplus - preferred stock............................................... 1,500 1,500
Common stock, $.01 par value - 10,000,000 shares authorized; 2,787,304 and
2,749,196 shares issued and outstanding (excluding
42,880 shares held in treasury)............................................. 28 28
Capital surplus - common stock.................................................. 17,566 17,074
Retained earnings............................................................... 22,902 21,119
Treasury stock (42,880 shares).................................................. (513) (513)
Accumulated other comprehensive income, net of income taxes................... 2,922 978
--------------- --------------
Total stockholders' equity............................................. 44,405 40,186
--------------- --------------
$ 635,693 $ 621,477
================ ==============
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)
2004 2003
------------ ------------
INTEREST INCOME: (unaudited) (unaudited)
Interest and fees on loans.................... $ 4,724 $ 5,184
Interest and dividends on investments -
Taxable..................................... 2,691 1,867
Tax-exempt.................................. 401 355
Dividends................................... 43 62
------------ ------------
Total interest income.............. 7,859 7,468
------------ ------------
INTEREST EXPENSE:
Deposits...................................... 1,618 2,106
Short-term borrowings......................... 99 108
Federal Home Loan Bank advances............... 1,253 1,276
Long-term borrowings.......................... 93 99
Subordinated debentures....................... 426 437
------------ ------------
Total interest expense............. 3,489 4,026
------------ ------------
Net interest income................ 4,370 3,442
PROVISION FOR CREDIT LOSSES...................... -- 775
------------ ------------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES........................ 4,370 2,667
------------ ------------
NONINTEREST INCOME:
Insurance commissions......................... 4,562 4,062
Fees on loans................................. 576 461
Service charges............................... 211 210
Brokerage income.............................. 179 51
Trust and financial services.................. 124 186
Rental income................................. 35 22
Net gain on sales of securities............... -- 120
Other......................................... 320 107
------------ ------------
Total noninterest income........... 6,007 5,219
------------ ------------
NONINTEREST EXPENSE:
Salaries and employee benefits................ 4,914 3,965
Occupancy..................................... 585 622
Depreciation and amortization................. 398 348
Professional services......................... 319 260
Office supplies, telephone and postage........ 311 254
Amortization of intangible assets............. 308 266
Marketing and promotion....................... 271 119
FDIC and other assessments.................... 51 51
Other......................................... 730 569
------------ ------------
Total noninterest expense.......... 7,887 6,454
------------ ------------
Income before income taxes....................... 2,490 1,432
Income tax provision............................. 677 415
------------ ------------
Net income....................................... 1,813 1,017
============ ============
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)
2004 2003
------------ -------------
(unaudited) (unaudited)
Dividends on preferred stock.................. $ 30 $ 30
------------ -------------
Income available to common stockholders....... $ 1,783 $ 987
============ =============
BASIC EARNINGS PER COMMON SHARE:
Basic earnings per common share............... $ 0.65 $ 0.37
============ =============
DILUTED EARNINGS PER COMMON SHARE:
Diluted earnings per common share............. $ 0.63 $ 0.36
============ =============
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)
2004 2003
------------- ------------
(unaudited) (unaudited)
NET INCOME....................................... $ 1,813 $ 1,017
OTHER COMPREHENSIVE INCOME (LOSS) -
Unrealized gains (losses) on investment
securities:
Unrealized holding gains (losses)
arising during the period,
net of income taxes..................... 1,944 (294)
Less: reclassification adjustment
for gains included in net income,
net of income taxes..................... -- (85)
------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS)................ 1,944 (379)
------------- -------------
COMPREHENSIVE INCOME ............................ $ 3,757 $ 638
============= =============
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, 2002.. 150 $ -- $ 1,500 2,743,809 $ 27 $ 16,614 $ 17,395 $ (513) $ 2,700 $ 37,723
Net income (unaudited)..... -- -- -- -- -- -- 1,017 -- -- 1,017
Other comprehensive
income -
Change in unrealized
holding gains on
securities available
for sale, net of
income taxes and
reclassification
adjustment (unaudited)... -- -- -- -- -- -- -- -- (379) (379)
Preferred stock
dividends (unaudited)... -- -- -- -- -- -- (30) -- -- (30)
Other (unaudited) ........ -- -- -- 1,100 -- 9 -- -- -- 9
-------- ------- --------- --------- ------- -------- --------- -------- ------------- --------
BALANCE, March 31, 2003
(unaudited)............. 150 $ -- $ 1,500 2,744,909 $ 27 $ 16,623 $ 18,382 $ (513) $ 2,321 $ 38,340
-------- ------- --------- --------- ------- -------- --------- -------- ------------- --------
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
-------- ------- --------- --------- ------- -------- --------- -------- ------------- --------
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Three Months Ended March 31
(In thousands)
2004 2003
-------------- --------------
OPERATING ACTIVITIES: (unaudited) (unaudited)
Net income......................................................... $ 1,813 $ 1,017
Adjustments to reconcile net income to net cash provided by (used
in) operating activities -
Provision for credit losses.................................... -- 775
Depreciation and amortization.................................. 398 348
Amortization of intangible assets.............................. 308 266
Net premium amortization on investment securities.............. 587 1,091
Proceeds from loans recovered.................................. 55 35
Write-down of other real estate owned and repossessed assets... 1 4
Change in interest receivable and other assets, net............ (4,466) 365
(Gain) loss on sale of bank premises and equipment............. 2 (5)
Net realized gains on sales of investment securities........... -- (120)
Deferred income taxes.......................................... 522 423
Change in dividend distribution payable........................ (229) (248)
Change in other liabilities, net............................... (305) (422)
Originations of loans to be sold............................... (23,080) (14,602)
Proceeds from sale of loans.................................... 23,080 14,602
-------------- --------------
Net cash provided by (used in) operating activities...... (1,314) 3,529
-------------- --------------
INVESTING ACTIVITIES:
Purchases of investment securities................................. (32,269) (13,158)
Proceeds from sales of investment securities....................... -- 5,079
Proceeds from maturities of investment securities.................. 9,040 12,208
Purchases of Federal Reserve and Federal Home Loan Bank stock ..... (1,905) --
Sales of Federal Reserve and Federal Home Loan Bank stock.......... 1,684 --
Net decrease in loans.............................................. 28,290 5,736
Additions to premises and equipment................................ (1,633) (4,645)
Proceeds from sale of premises and equipment....................... 10 88
Stock issued for acquisition of insurance subsidiary............... 340 --
Stock issued for acquisition of mortgage company................... 50 --
-------------- --------------
Net cash provided by investing activities................ 3,607 5,308
-------------- --------------
FINANCING ACTIVITIES:
Net decrease in demand, savings, interest checking and money
market accounts.............................................. (7,250) (4,344)
Net increase (decrease) in time deposits......................... 13,625 (6,632)
Net increase (decrease) in short-term borrowings................. 2,432 (7,781)
Repayments of Federal Home Loan Bank advances.................... (85,000) (10,000)
Proceeds from Federal Home Loan Bank advances.................... 85,000 20,000
Repayments of long-term borrowings............................... (15) (18)
Payment of preferred stock dividends............................. (30) (30)
Amortization of discount on subordinated debentures.............. 21 22
Other, net....................................................... 101 9
-------------- --------------
Net cash provided by (used in) financing activities.... 8,884 (8,774)
-------------- --------------
NET INCREASE IN CASH AND CASH EQUIVALENTS........................... 11,177 63
CASH AND CASH EQUIVALENTS, beginning of period...................... 12,520 17,137
-------------- --------------
CASH AND CASH EQUIVALENTS, end of period............................ $ 23,697 $ 17,200
============== ==============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid.................................................... $ 3,367 $ 4,090
============== ==============
Income taxes paid................................................ $ 57 $ 68
============== ==============
See accompanying notes to consolidated financial statements.
BNCCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 2004
NOTE 1 - BNCCORP, Inc.
BNCCORP, Inc. ("BNCCORP") is a registered bank holding company incorporated
under the laws of Delaware. It is the parent company of BNC National Bank
(together with its wholly owned subsidiaries, Milne Scali & Company, Inc. and
BNC Asset Management, Inc., the "Bank"). BNCCORP, through these wholly owned
subsidiaries, which operate from 23 locations in Arizona, Minnesota, North
Dakota and Utah, provides a broad range of banking, insurance, brokerage, trust
and other financial services to small- and mid-sized businesses and individuals.
The accounting and reporting policies of BNCCORP and its subsidiaries
(collectively, the "Company") conform to accounting principles generally
accepted in the United States of America and general practices within the
financial services industry. The consolidated financial statements included
herein are for BNCCORP and its subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
NOTE 2 - Basis of Presentation
The accompanying interim consolidated financial statements have been prepared by
the Company, without audit, in accordance with accounting principles generally
accepted in the United States of America for interim financial information and
pursuant to the rules and regulations of the Securities and Exchange Commission
("SEC"). Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures made are
adequate to make the information presented not misleading.
The unaudited consolidated financial statements as of March 31, 2004 and for the
three-month periods ended March 31, 2004 and 2003 include, in the opinion of
management, all adjustments, consisting solely of normal recurring adjustments,
necessary for a fair presentation of the financial results for the respective
interim periods and are not necessarily indicative of results of operations to
be expected for the entire fiscal year ending December 31, 2004.
The accompanying interim consolidated financial statements have been prepared
under the presumption that users of the interim consolidated financial
information have either read or have access to the audited consolidated
financial statements for the year ended December 31, 2003. Accordingly, footnote
disclosures which would substantially duplicate the disclosures contained in the
December 31, 2003 audited consolidated financial statements have been omitted
from these interim consolidated financial statements. It is suggested that these
interim consolidated financial statements be read in conjunction with the
audited consolidated financial statements for the year ended December 31, 2003
and the notes thereto.
NOTE 3 - Reclassifications
Certain of the 2003 amounts may have been reclassified to conform to the 2004
presentations. These reclassifications had no effect on net income or
stockholders' equity.
NOTE 4 - Earnings Per Share
The following table shows the amounts used in computing earnings per share
("EPS") and the effect on weighted average number of shares of potential
dilutive common stock issuances for the three-month periods ended March 31:
Net Per-Share
Income Shares Amount
---------------- ---------------- ---------------
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 and contingent stock.............. 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
================ ===============
2003
Basic earnings per common share:
Net income................................... $1,017,000
Less: Preferred stock dividends.............. 30,000
----------------
Income available to common stockholders...... $ 987,000 2,701,274 $ 0.37
================ ===============
Effect of dilutive shares -
Options................................... 29,939
----------------
Diluted earnings per common share:
Net income................................... $1,017,000
Less: Preferred stock dividends.............. 30,000
----------------
Income available to common stockholders...... $ 987,000 2,731,213 $ 0.36
================ ===============
The following number of options, with exercise prices ranging from $10.00 to
$17.75, were outstanding during the periods indicated but were not included in
the computation of diluted EPS because their exercise prices were higher than
the average price of BNCCORP's common stock for the period:
2004 2003
---------------- ---------------
Quarter ended March 31........... 3,250 77,185
NOTE 5 - Segment Disclosures
The Company segments its operations into three separate business activities,
based on the nature of the products and services for each segment: banking
operations, insurance operations and brokerage, trust and financial services
operations.
Banking operations provide traditional banking services to individuals and
small- and mid-sized businesses, such as accepting deposits, consumer and
mortgage banking activities and making commercial loans. The mortgage and
commercial banking activities include the origination and purchase of loans as
well as the sale to and servicing of commercial loans for other institutions.
Insurance operations provide a full range of insurance brokerage services,
including commercial insurance, surety bonds, employee benefits-related
insurance, personal insurance and claims management.
Brokerage, trust and financial services operations provide securities brokerage,
trust and other financial services to individuals and businesses. Brokerage
investment options include individual equities, fixed income investments and
mutual funds. Trust and financial services operations provide a wide array of
trust and other financial services, including personal trust administration
services, financial, tax, business and estate planning, estate administration,
agency accounts, employee benefit plan design and administration, individual
retirement accounts ("IRAs"), including custodial self-directed IRAs, asset
management, tax preparation, accounting and payroll services.
The accounting policies of the three segments are the same as those described in
the summary of significant accounting policies included in Note 1 to the
consolidated financial statements for the year ended December 31, 2003.
The Company's financial information for each segment is derived from the
internal profitability reporting system used by management to monitor and manage
the financial performance of the Company. The operating segments have been
determined by how executive management has organized the Company's business for
making operating decisions and assessing performance.
The following tables present segment profit or loss, assets and a reconciliation
of segment information as of, and for the three months ended March 31 (in
thousands):
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 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
2003 2003
--------------------------------------------------- ----------------------------------------------
Brokerage/
Trust/ Reportable Intersegment Consolidated
Banking Insurance Financial Other (a) Totals Segments Other(a) Elimination Total
---------- --------- --------- --------- -------- ---------- -------- ------------ -------------
Net interest income.............. $ 3,943 $ 22 $ -- $ (536) $ 3,429 $ 3,965 $ (536) $ 13 $ 3,442
Other revenue-external customers. 1,198 4,093 245 26 5,562 5,536 26 (343) 5,219
Other revenue-from other segments 32 -- 12 155 199 44 155 (199) --
Depreciation and amortization.... 390 216 3 5 614 609 5 -- 614
Equity in the net income (loss)
of investees.................. 1,053 -- -- 1,461 2,514 1,053 1,461 (2,514) --
Other significant noncash items:
Provision for credit losses 775 -- -- -- 775 775 -- -- 775
Segment profit (loss) from
continuing operations......... 537 1,496 7 (608) 1,432 2,040 (608) -- 1,432
Income tax provision (benefit)... 153 429 (3) (164) 415 579 (164) -- 415
Segment profit (loss)............ 384 1,067 10 (444) 1,017 1,461 (444) -- 1,017
Segment assets................... 593,097 27,782 1,327 67,837 690,043 622,206 67,837 (96,310) 593,733
-------------
(a) The financial information in the "Other" column is for the bank holding
company.
NOTE 6 - Stock-Based Compensation
At March 31, 2004, the Company had two stock-based employee compensation plans.
The Company applies the recognition and measurement principles of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and
related interpretations in accounting for those plans. No stock-based employee
compensation expense is reflected in net income for stock options granted under
the plans as all options granted under those plans had an exercise price equal
to the market value of the underlying common stock on the date of grant.
Compensation expense is reflected in net income for the periods presented below
for restricted stock issued under the stock plans and its net effect on net
income is reflected in the table below.
The following table illustrates the effect on net income and EPS if the Company
had applied the fair value recognition provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" to
stock-based employee compensation for the three-month periods ended March 31:
2004 2003
---------------- ---------------
Net income, as reported................................ $ 1,813,000 $ 1,017,000
Add: total stock-based employee compensation expense
included in reported net income, net of related tax
effects............................................. 22,000 2,000
Deduct: total stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects.......................... (32,000) (10,000)
---------------- ---------------
Pro forma net income................................... $ 1,803,000 $ 1,009,000
================ ===============
Earnings per share:
Basic - as reported.................................. $ 0.65 $ 0.37
Basic - pro forma.................................... 0.61 0.35
Diluted - as reported................................ 0.63 0.36
Diluted - pro forma.................................. 0.59 0.35
NOTE 7 - Derivative Activities
The Company has interest rate cap contracts with notional amounts totaling $40.0
million that 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 (maturing during
April and May 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 contracts was $1.2 million. The contracts are reflected in the
Company's consolidated balance sheet at their current combined fair value of
approximately $19,000. The contracts are not being accounted for as hedges under
Statement of Financial Accounting Standards No. 133, "Accounting for Derivatives
and Hedging Activities." As a result, the impact of marking the contracts to
fair value has been, and will continue to be, included in net interest income.
During the three months ended March 31, 2004 and 2003, 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
approximately $37,000 and $27,000, respectively.
NOTE 8 - Mergers and Acquisitions
On March 31, 2004, in order to further grow its insurance segment, Milne Scali &
Company, Inc. acquired certain assets and assumed certain liabilities of The
Richard Q. Perry Agency, a Salt Lake City, Utah-based insurance agency, for
22,470 shares of newly issued BNCCORP common stock (valued at $341,000).
Acquisitions of insurance agencies generally result in the recognition of
goodwill due to the service nature of the business, the lack of tangible assets
acquired and the profitability of the acquired agency. Of the total $341,000
purchase price, $166,000 was allocated to the net assets acquired (all
intangible assets) and the excess of the purchase price of approximately
$175,000 over the fair value of the net assets was recorded as goodwill. The
goodwill, all of which is attributable to the Company's insurance segment, will
be evaluated for possible impairment under the provisions of Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets."
Other acquired intangible assets related to personal and commercial insurance
lines books of business and totaling approximately $166,000 will be amortized
using a method that approximates the anticipated useful life of the associated
customer lists, which will cover a period of 10 years. The results of operations
of the acquired assets are being included in the Company's consolidated
financial statements effective April 1, 2004.
On March 31, 2004, BNC Insurance, Inc., a subsidiary of the Bank, was merged
with and into Milne & Company Insurance, Inc. and the name of Milne & Company
Insurance, Inc. was changed to Milne Scali & Company, Inc. Milne Scali &
Company, Inc. is a subsidiary of the Bank.
NOTE 9 - Recently Issued or Adopted Accounting Standards
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46").
FIN 46 addressed consolidation by business enterprises of variable interest
entities which have certain characteristics by requiring that if a business
enterprise has a controlling interest in a variable interest entity (as defined
by FIN 46), the assets, liabilities and results of activities of the variable
interest entity be included in the consolidated financial statements with those
of the business enterprise. FIN 46 applied immediately to variable interest
entities created after January 31, 2003 and to variable interest entities in
which an enterprise obtains an interest after that date. For variable interests
acquired before February 1, 2003, FIN 46 applied in the first fiscal year or
interim period beginning after June 15, 2003. The Company has adopted the
various provisions of FIN 46 as indicated above but presently does not have any
variable interest entities that would be required to be included in its
consolidated financial statements.
On December 24, 2003, the FASB issued Interpretation No. 46 (revised December
2003), "Consolidation of Variable Interest Entities" ("FIN 46R") which addresses
how a business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FIN 46. FIN 46R indicates that
when voting interests are not effective in identifying whether an entity is
controlled by another party, the economic risks and rewards inherent in the
entity's assets and liabilities and the way in which the various parties that
have involvement with the entity share in those economic risks and rewards
should be used to determine whether the entity should be consolidated. An
enterprise that is involved with another entity generally must assess whether
that involvement requires consolidation under FIN 46R. That involvement may
arise in a variety of ways, such as (a) lending to the entity, (b) investing in
equity (voting or nonvoting) of the entity, (c) issuing guarantees related to
the assets or liabilities of the entity, or both, (d) retaining a beneficial
interest in (or providing financial support for) assets transferred or sold to
the entity, (e) managing the assets of the entity, (f) leasing assets to or from
the entity and (g) entering into a derivative contract with the entity. The
objective of FIN 46R is to provide consolidation guidance for situations in
which voting equity interests do not adequately reflect the controlling
interests in an entity. Public entities are required to apply FIN 46 or FIN 46R
to all entities that are considered special purpose entities in practice and
under the FASB literature that was applied before the issuance of FIN 46 by the
end of the first reporting period that ends after December 31, 2003. Public
companies that are not small business issuers are required to adopt the
accounting requirements of FIN 46R by the end of the first reporting period that
ends after March 15, 2004. The Company has adopted the various provisions of FIN
46R as indicated above but presently does not have any variable interest
entities that would be required to be included in its consolidated financial
statements.
On December 12, 2003, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer"
("SOP 03-3"). SOP 03-3 addresses accounting for differences between contractual
cash flows and cash flows expected to be collected from an investor's initial
investment in loans or debt securities ("loans") acquired in a transfer if those
differences are attributable, at least in part, to credit quality. It includes
such loans acquired in purchase business combinations and applies to all
nongovernmental entities. SOP 03-3 does not apply to loans originated by the
entity. SOP 03-3 limits the yield that may be accreted ("accretable yield") to
the excess of the investor's estimate of undiscounted expected principal,
interest and other cash flows (cash flows expected at acquisition to be
collected) over the investor's initial investment in the loan. SOP 03-3 requires
that the excess of contractual cash flows over cash flows expected to be
collected ("nonaccretable difference") not be recognized as an adjustment of
yield, loss accrual or valuation allowance. SOP 03-3 prohibits investors from
displaying accretable yield and nonaccretable difference in the balance sheet.
Subsequent increases in cash flows expected to be collected generally should be
recognized prospectively through adjustment of the loan's yield over its
remaining life. Decreases in cash flows expected to be collected should be
recognized as impairment. SOP 03-3 prohibits "carrying over" or creation of
valuation allowances in the initial accounting of all loans acquired in a
transfer that are within the scope of SOP 03-3. This prohibition of the
valuation allowance carryover applies to the purchase of an individual loan, a
pool of loans, a group of loans and loans acquired in a purchase business
combination. SOP 03-3 is effective for loans acquired in fiscal years beginning
after December 15, 2004. Early adoption is encouraged. The Company expects to
adopt SOP 03-3 on January 1, 2005. Adoption of SOP 03-3 is not expected to have
a material impact on the Company's financial position or results of operations.
On March 9, 2004, the SEC issued Staff Accounting Bulletin No. 105, "Application
of Accounting Principles to Loan Commitments" ("SAB 105"). SAB 105 summarizes
the views of the SEC staff regarding the application of generally accepted
accounting principles to loan commitments accounted for as derivative
instruments. SAB 105 will act to significantly limit opportunities to recognize
an asset related to a commitment to originate a mortgage loan that will be held
for sale prior to funding the loan. SAB 105 pertains to recognizing and
disclosing the loan commitments and is effective for commitments to originate
mortgage loans to be held for sale that are entered into after March 31, 2004.
The Company will adopt the provisions of SAB 105 beginning April 1, 2004.
Adoption of SAB 105 is not expected to have a material impact on the Company's
financial position or results of operations.
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, 2004 and December 31, 2003
Assets. Our total assets increased $14.2 million, from $621.5 million at
December 31, 2003 to $635.7 million at March 31, 2004. The following table
presents our assets by category as of March 31, 2004 and December 31, 2003, as
well as the amount and percent of change between the two dates. Significant
changes are discussed in lettered explanations below the table (amounts are in
thousands):
Change
----------------------------
Assets March 31, December 31,
2004 2003 $ %
------------------------------------------- ---------------- ------------------ ------------- -----------
Cash and due from banks.................... $ 23,697 $ 12,520 $ 11,177 89.3% (a)
Investment securities available
for sale............................... 288,359 262,568 25,791 9.8% (b)
Federal Reserve Bank and Federal Home Loan
Bank Stock............................. 7,817 7,596 221 2.9%
Loans and leases, net...................... 250,447 278,792 (28,345) (10.2)% (c)
Premises and equipment, net................ 19,792 18,570 1,222 6.6%
Interest receivable........................ 2,650 2,462 188 7.6%
Other assets............................... 19,232 15,507 3,725 24.0%
Goodwill................................... 15,291 15,089 202 1.3%
Other intangible assets, net............... 8,408 8,373 35 0.4%
---------------- ------------------ -------------
Total assets...................... $ 635,693 $ 621,477 $ 14,216 2.3%
================ ================== =============
-------------------
(a) This balance was higher than normal at March 31, 2004 due to $12.0 million
of loan payoffs where the checks were drawn on another bank and the
payments hadn't cleared at the close of business on March 31, 2004.
(b) Investment securities available for sale increased as loan volume decreased
(see (c) below) and we maintained a static earning asset portfolio.
(c) Loans and leases decreased $28.3 million due to general planned loan
payoffs of approximately $15.0 million, general pay downs on revolving
lines of credit of approximately $8.4 million and the payoff of a $4.5
million loan that was on nonaccrual status at December 31, 2003. Loan
volume declined during the quarter ended March 31, 2004 despite significant
activity, particularly in the Minnesota market, because many of the newly
generated loans, primarily commercial real estate loans, were sold to other
financial institutions.
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, 2004 and 2003 (amounts are in thousands):
Three Months
Ended March 31,
-------------------------------------
2004 2003
----------------- -------------------
Balance, beginning of period...... $ 4,763 $ 5,006
Provision for credit losses....... -- 775
Loans charged off................. (1,273) (597)
Loans recovered................... 55 35
----------------- -------------------
Balance, end of period............ $ 3,545 $ 5,219
================= ===================
Ending loan portfolio ............ $ 253,992 $ 329,461
================= ===================
Allowance for credit losses as a
percentage of ending loan
portfolio........................ 1.40% 1.58%
As of March 31, 2004, our allowance for credit losses was 1.40 percent of total
loans as compared to 1.68 percent at December 31, 2003 and 1.58 percent at March
31, 2003.
There was no provision for loan losses for the three-month period ended March
31, 2004 compared to $775,000 for the same period in 2003. This decrease is a
direct response to the reduction in loan volume and a significant reduction in
nonperforming loans between December 31, 2003 and March 31, 2004. See
"-Nonperforming Assets" below.
Loans charged off during the first quarter of 2004 totaled $1.3 million,
representing a $676,000 increase over loans charged off during the first quarter
of 2003. The increase was primarily attributable to charge-offs related to one
commercial loan. The loan was to a contractor on which we charged off
approximately $1.2 million. $975,000 of the $1.2 million was reserved for as of
December 31, 2003.
Net charge-offs as a percentage of average total loans for the three-month
periods ended March 31, 2004 and 2003 were as follows:
Three Months
Ended March 31,
-----------------------------
2004 2003
-------------- --------------
Ratio of net charge-offs
to average total loans......................... (0.45)% (0.17)%
Ratio of net charge-offs
to average total loans, annualized............. (1.82)% (0.69)%
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,
2004 2003
---------- ------------
Nonperforming loans:
Loans 90 days or more delinquent and still
accruing interest................................$ -- $ 38
Nonaccrual loans.................................... 1,263 7,913
Restructured loans.................................. -- --
---------- ------------
Total nonperforming loans.............................. 1,263 7,951
Other real estate owned and repossessed assets...... -- --
---------- ------------
Total nonperforming assets.............................$ 1,263 $ 7,951
---------- ------------
Allowance for credit losses............................$ 3,545 $ 4,763
---------- ------------
Ratio of total nonperforming assets to total assets ... 0.20% 1.28%
Ratio of total nonperforming loans to total loans...... 0.50% 2.80%
Ratio of allowance for credit losses to total
nonperforming loans................................. 281% 60%
Loans 90 days or more delinquent and still accruing interest include loans over
90 days past due which we believe, based on our specific analysis of the loans,
do not present doubt about the collection of interest and principal in
accordance with the loan contract. Loans in this category must be well-secured
and in the process of collection. Our lending and management personnel monitor
these loans closely.
Nonaccrual loans include loans on which the accrual of interest has been
discontinued. Accrual of interest is discontinued when we believe, after
considering economic and business conditions and collection efforts, that the
borrower's financial condition is such that the collection of interest is
doubtful. A delinquent loan is generally placed on nonaccrual status when it
becomes 90 days or more past due unless the loan is well-secured and in the
process of collection. When a loan is placed on nonaccrual status, accrued but
uncollected interest income applicable to the current reporting period is
reversed against interest income of the current period. Accrued but uncollected
interest income applicable to previous reporting periods is charged against the
allowance for credit losses. No additional interest is accrued on the loan
balance until the collection of both principal and interest becomes reasonably
certain. When a problem loan is finally resolved, there may ultimately be an
actual write-down or charge-off of the principal balance of the loan which may
necessitate additional charges to earnings.
During the quarter ended March 31, 2004, two loans totaling approximately $6.7
million and reflected as nonaccrual loans at December 31, 2003 were resolved.
The first was a $4.5 million loan secured by commercial real estate on which we
received full payoff, including collection of cash basis interest income of
approximately $408,000. The second loan of approximately $2.2 million was
resolved resulting in a charge-off of approximately $1.2 million. $975,000 of
the $1.2 million was reserved for at December 31, 2003.
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, 2004 or December 31, 2003.
Other real estate owned and repossessed assets represents properties and other
assets acquired through, or in lieu of, loan foreclosure. Such properties and
assets are included in other assets in the consolidated balance sheets. They are
initially recorded at fair value at the date of acquisition establishing a new
cost basis. Write-downs to fair value at the time of acquisition are charged to
the allowance for credit losses. After foreclosure, we perform valuations
periodically and the real estate or assets are carried at the lower of carrying
amount or fair value less cost to sell. Write-downs, revenues and expenses
incurred subsequent to foreclosure are charged to operations as
recognized/incurred. We had no other real estate owned and repossessed assets at
March 31, 2004 or December 31, 2003.
The ratio of the allowance for credit losses to total nonperforming loans was
281 percent at March 31, 2004 compared to 60 percent at December 31, 2003. The
increase in this ratio is reflective of the resolution of the above-mentioned
credits during the quarter ended March 31, 2004.
Liabilities. Our total liabilities increased $10.0 million, from $581.3 million
at December 31, 2003 to $591.3 million at March 31, 2004. The following table
presents our liabilities by category as of March 31, 2004 and December 31, 2003
as well as the amount and percent of change between the two dates. Significant
changes are discussed in lettered explanations below the table (amounts are in
thousands):
Change
-------------------------------
March 31, December 31,
Liabilities 2004 2003 $ %
--------------------------------------- ------------------ ------------------ -------------- ------------
DEPOSITS:
Noninterest-bearing.................... $ 45,009 $ 44,725 $ 284 0.6%
Interest-bearing -
Savings, interest checking and money
market............................ 207,991 215,525 (7,534) (3.5)% (a)
Time deposits $100,000 and over...... 53,206 46,569 6,637 14.3% (b)
Other time deposits.................. 96,111 89,123 6,988 7.8% (b)
Short-term borrowings.................. 33,815 31,383 2,432 7.7%
Federal Home Loan Bank advances........ 112,200 112,200 -- --
Long-term borrowings................... 8,625 8,640 (15) (0.2)%
Guaranteed preferred beneficial
interests in company's subordinated
debentures........................... 22,189 22,397 (208) (0.9)%
Other liabilities...................... 12,142 10,729 1,413 13.2%
------------------ ------------------ --------------
Total liabilities............. $ 591,288 $ 581,291 $ 9,997 1.7%
================== ================== ==============
-------------------
(a) These accounts generally fluctuate daily due to the cash management
activities of our commercial customers. Additionally, some commercial
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 transaction
accounts. This causes a seasonal fluctuation in this account category such
as that noted above.
(b) The increase in time deposits primarily reflects a $5.1 million increase in
brokered certificates of deposit and a $10.6 million increase in
Certificates of Deposit Account Registry ServicesSM (CDARSSM) deposits.
These increases were offset by a $2.9 million decrease in national market
certificates of deposit.
Stockholders' Equity. Our stockholders' equity increased $4.2 million between
December 31, 2003 and March 31, 2004. This increase was primarily attributable
to earnings of $1.8 million, a $1.9 million increase in accumulated other
comprehensive income and $462,000 of other transactions including payment of
preferred stock dividends, stock option exercises, vesting of restricted stock
and stock issued for an insurance agency acquisition.
Capital Adequacy and Expenditures. We actively monitor compliance with
regulatory capital requirements, including risk-based and leverage capital
measures. Under the risk-based capital method of capital measurement, the ratio
computed is dependent on the amount and composition of assets recorded on the
balance sheet, and the amount and composition of off-balance-sheet items, in
addition to the level of capital. The following table includes the risk-based
and leverage capital ratios of the Company and the Bank as of March 31, 2004:
Tier 1 Total
Risk- Risk- Tier 1
Based Based Leverage
Ratio Ratio Ratio
--------------- ---------------- --------------
BNCCORP, consolidated...... 7.91% 10.88% 5.32%
BNC National Bank.......... 11.41% 12.30% 7.68%
As of March 31, 2004, BNCCORP and the Bank exceeded capital adequacy
requirements and the Bank was considered "well-capitalized" under prompt
corrective action provisions.
Capital expenditures expected in 2004 consist of the completion of remodeling of
the Golden Valley, Minnesota facility and could include purchase or leasing of
additional facilities in our various market areas should such 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, 2004 and 2003
General. Record net income of $1.81 million, or $0.63 per share on a diluted
basis, was reported for the quarter ended March 31, 2004. This represents a 78
percent increase from the $1.02 million, or $0.36 per diluted share, in net
income reported for the same period of 2003.
Rising insurance commissions were again the largest component of noninterest
income, while brokerage income also increased over the year-ago period. Our
banking operations also produced higher net interest income and loan fees, while
strengthening asset quality.
The financial performance of our insurance segment is typically strongest in the
first quarter due to contingency payments received from insurance carriers.
Insurance revenues were $4.56 million for the quarter ended March 31, 2004
compared with $4.06 million for the same period one year earlier. Contingency
payments totaled $1.04 million for the quarter ended March 31, 2004 compared to
$817,000 for the quarter ended March 31, 2003.
Net interest income rose 27 percent, to $4.37 million for the first quarter of
2004, compared with $3.44 million for the first quarter of 2003. The increase
reflected a widening of the net interest margin to 3.22 percent for the quarter
ended March 31, 2004, from 2.57 percent for the same period in 2003. 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 and
that has now been 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. Net interest income for the
quarter ended March 31, 2003 was negatively impacted by the charge-off of
$287,000 of interest income on the same loan discussed above. Without this
charge-off, net interest income for the quarter ended March 31, 2003 would have
been approximately $3.73 million resulting in a net interest margin of 2.79
percent.
Noninterest income was $6.01 million for the 2004 first quarter, an increase of
15 percent from $5.22 million in the year-ago period. As noted earlier, higher
insurance commissions were a key factor in the increase. Loan fees also rose,
due primarily to strong activity in the commercial real estate portfolio of the
Minneapolis market. The increase in brokerage income was due to greater
productivity in that business. Noninterest income represented 57.89 percent of
gross revenues for the recent quarter, compared with 60.26 percent for the
comparable period of 2003. 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 gross revenues. Without the charge-off of the
$287,000 of interest income on the same loan, noninterest income for the first
quarter of 2003 represented 58.33 percent of gross revenues.
Noninterest expense for the first quarter of 2004 was $7.89 million, and
increased 22 percent from $6.45 million a year ago, due to staffing and other
increases to support growth.
Total assets rose to $635.7 million at March 31, 2004 versus $621.5 million at
December 31, 2003. Total loans at the end of the 2004 first quarter were $254.0
million compared with $283.6 million at December 31, 2003, reflecting a
significant level of loan reductions. Investment securities available for sale
were $288.4 million at March 31, 2004 compared with $262.6 million at December
31, 2003 as a result of the Company's investment management strategies. Total
deposits at March 31, 2004 were $402.3 million, up from $395.9 million at
December 31, 2003. Brokered and national market certificates of deposit
increased approximately $12.3 million between December 31, 2003 and March 31,
2004.
Total common stockholders' equity for BNCCORP was $42.9 million at March 31,
2004, equivalent to book value per common share of $15.39 (tangible book value
per common share of $6.89). Net unrealized gains in the investment portfolio as
of that date were $4.8 million, or approximately $1.71 per share, on a pretax
basis.
Due to the resolution of $6.7 million of loans classified as nonaccrual at
December 31, 2003, the ratio of nonperforming assets to total assets was 0.20
percent at March 31, 2004, down significantly from the year-ago level of 1.50
percent. Additionally no provision for credit losses was required for the
quarter ended March 31, 2004 primarily due to this sharp reduction in the level
of nonperforming loans. For the year-ago period, the provision for credit losses
was $775,000. Charge-offs for the quarter ended March 31, 2004 were $1.3 million
compared with $597,000 for the same period one year earlier. $1.2 million of the
charge-offs related to the final resolution of one commercial loan that was
included as a nonaccrual loan at December 31, 2003. $975,000 of the $1.2 million
was reserved for at December 31, 2003. The ratio of allowance for credit losses
to total nonperforming loans strengthened to 281 percent at March 31, 2004,
compared with 59 percent one year earlier. The allowance for credit losses as a
percentage of total loans at March 31, 2004 was 1.40 percent, compared with 1.58
percent a year ago.
Net Interest Income. Net interest income for the three-month period ended March
31, 2004 increased approximately $928,000, or 27.0 percent, from approximately
$3.44 million to approximately $4.37 million. Net interest margin increased to
3.22 percent for the quarter ended March 31, 2004 from 2.57 percent for the same
period one year earlier. 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.
Net interest income and margin for the three-month period ended March 31, 2003
were negatively impacted by the charge-off of interest income of approximately
$287,000 on the same loan. Without this charge-off, net interest income for the
quarter ended March 31, 2003 would have been approximately $3.73 million
resulting in a net interest margin of 2.79 percent.
The following table presents average balances, interest earned or paid,
associated yields on interest-earning assets and costs on interest-bearing
liabilities for the three-month periods ended March 31, 2004 and 2003, as well
as the changes between the periods presented. Significant factors contributing
to the increase in net interest income and net interest margin are discussed in
lettered notes below the table (amounts are in thousands):
Three Months Ended March 31,
----------------------------------------------------------------------
2004 2003 Change
---------------------------------- ---------------------------------- ---------------------------
Interest Average Interest Average Interest Average
Average earned yield or Average earned yield or Average earned yield
balance or paid cost balance or paid cost balance or paid or cost
---------- ---------- -------- ---------- --------- ---------- ---------- --------- ---------
Interest-earning assets
Federal funds sold/interest
bearing due from...............$ 480 $ -- -- $ 340 $ -- -- $ 140 $ -- --
Investments..................... 281,463 3,135 4.48% 215,816 2,284 4.29% 65,647 851 0.19%(a)
Loans........................... 269,428 4,724 7.05% 331,007 5,184 6.35% (61,579) (460) 0.70%(b)
Allowance for loan losses..... (4,751) -- (4,939) -- 188 --
---------- ---------- ---------- --------- ---------- ----------
Total interest-earning
assets.......................$ 546,620 7,859 5.78% $ 542,224 7,468 5.59% $ 4,396 391 0.19%
========== ---------- ========== ----------- ========== ----------
Interest-bearing
liabilities
Interest checking & money
market accounts................$ 208,478 539 1.04% $ 184,785 596 1.31% $ 23,693 (57) -0.27%(c)
Savings......................... 6,566 12 0.74% 5,313 12 0.92% 1,253 -- -0.18%
Certificates of deposit
under $100,000................. 93,699 635 2.73% 101,379 858 3.43% (7,680) (223) -0.70%(d)
Certificates of deposit
$100,000 and over.............. 47,110 432 3.69% 63,099 640 4.11% (15,989) (208) -0.42%(e)
---------- ---------- ---------- ----------- ---------- ----------
Interest-bearing
deposits..................... 355,853 1,618 1.83% 354,576 2,106 2.41% 1,277 (488) -0.58%
Short-term borrowings........... 26,394 99 1.51% 19,568 108 2.24% 6,826 (9) -0.73%(f)
Federal Home Loan Bank
advances....................... 109,458 1,253 4.60% 103,923 1,276 4.98% 5,535 (23) -0.38%(g)
Long-term borrowings............ 8,631 93 4.33% 8,549 99 4.70% 82 (6) -0.37%
Subordinated debentures......... 22,137 426 7.74% 22,022 437 8.05% 115 (11) -0.31%
---------- ---------- ---------- ----------- ---------- ----------
Total borrowings............... 166,620 1,871 4.52% 154,062 1,920 5.05% 12,558 (49) -0.53%
---------- ---------- ---------- ----------- ---------- ----------
Total interest-bearing
liabilities...................$ 522,473 3,489 2.69% $ 508,638 4,026 3.21% $ 13,835 (537) -0.52%
========== ---------- ========== ---------- ========== ----------
Net interest income/spread $ 4,370 3.09% $ 3,442 2.38% $ 928 0.71%
========== =========== ==========
Net interest margin........ 3.22% 2.57% 0.65%(h)
Notation:
Noninterest-bearing deposits....$ 41,850 -- $ 37,838 -- $ 4,012 --
---------- ---------- -----------
Total deposits..............$ 397,703 $ 1,618 1.64% $ 392,414 $ 2,106 2.18% $ 5,289 $ (488) -0.54%
========== ========== ========== =========== =========== ==========
Taxable equivalents:
Total interest-earning assets..$ 546,620 $ 8,066 5.93% $ 542,224 $ 7,651 5.72% $ 4,397 $ 415 0.21%
Net interest income/spread..... -- $ 4,577 3.24% -- $ 3,625 2.51% -- $ 952 0.73%
Net interest margin............ -- -- 3.37% -- -- 2.71% -- -- 0.66%
---------------------------------
(a) Average investments during the first quarter of 2004 exceeded those for the
same period in 2003 due to our portfolio and liquidity management
strategies, including the purchase of investment securities to offset a
decrease in the earning asset portfolio that resulted from a net decrease
in loan volume. Total investments at March 31, 2004 were $288.4 million
compared with $202.4 million at March 31, 2003.
(b) Average loans decreased primarily as a result of general planned loan
payoffs and paydowns of commercial revolving lines of credit. Actual loan
balances at March 31, 2004 and March 31, 2003 were $254.0 and $329.5
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 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. Loan yield for the quarter ended March 31, 2003 was
negatively impacted by the charge-off of $287,000 of interest income on the
same loan. Without this charge-off, interest income on loans for the first
quarter of 2003 would have been approximately $5.5 million and the yield on
loans would have been 6.70 percent.
(c) Increased average balances of interest checking and money market accounts
represents additional growth in our floating-rate Wealthbuilder deposit
products. These transaction accounts can fluctuate significantly based on
the cash management activities of our commercial customers. On a
year-over-year basis, however, we experienced growth in these accounts,
primarily driven by deposit production in the Arizona market.
(d) The decrease in average certificates of deposit under $100,000 is primarily
attributable to run-off of some certificates of deposit during the first
quarter of 2004, including maturity of some national market certificates of
deposit that were not reinvested. The reduced cost of these certificates of
deposit reflects the maturity of higher rate certificates of deposit and
renewal or origination of new certificates of deposit at lower current
interest rates.
(e) During the quarter ended March 31, 2004, average balances of brokered and
national market CDs were $36.6 million as compared to $56.4 million for the
same period one year earlier. The reduced cost of these certificates of
deposit reflects the maturity of higher rate certificates of deposit and
renewal or origination of new certificates of deposit at lower current
interest rates.
(f) Average short-term borrowings increased during the three-month period ended
March 31, 2004 compared to the same period in 2003 due to an increase in
average Federal funds purchased as well as an increase in average customer
repurchase agreements. Reduced costs of short-term borrowings reflects the
current interest rate environment in 2004 versus 2003.
(g) The increased volume of FHLB advances resulted from the use of additional
short-term FHLB advances in early 2004. Short-term FHLB advances are used
to manage liquidity similar to how Federal funds purchased are used on a
day-to-day basis. The short-term advances provide us with a slightly more
cost-effective way of managing short-term liquidity needs since the FHLB
gives a discount for advances of $10.0 million or more.
(h) Net interest margin was favorably impacted by the previously mentioned
recovery of cash basis interest income of $408,000 during the quarter ended
March 31, 2004. Without this recovery, net interest margin would have been
2.92 percent for the quarter ended March 31, 2004. Additionally, net
interest margin was negatively impacted by the charge-off of interest
income on the same loan of $287,000 during the quarter ended March 31,
2003. Without this charge-off, net interest margin would have been 2.79
percent for the quarter ended March 31, 2003.
Provision for Credit Losses. There was no provision for credit losses for the
quarter ended March 31, 2004 as compared to $775,000 for the same period one
year earlier. This largely reflected the significant decline in nonperforming
assets between the two dates as well as a decrease in loan volume. See
"Comparison of Financial Condition at March 31, 2004 and December 31, 2003 -
Allowance for Credit Losses."
Noninterest Income. The following table presents the major categories of our
noninterest income for the three-month periods ended March 31, 2004 and 2003 as
well as the amount and percent of change between the periods. Significant
changes are discussed in lettered explanations following the table (amounts are
in thousands):
For the Three Months Ended Increase (Decrease)
March 31, 2004 - 2003
---------------------------- ----------------------------
Noninterest Income 2004 2003 $ %
------------- ------------- -------------- ------------
Insurance commissions................. $ 4,562 $ 4,062 $ 500 12.3% (a)
Fees on loans......................... 576 461 115 24.9% (b)
Service charges....................... 211 210 1 0.5%
Brokerage income...................... 179 51 128 251.0% (c)
Trust and financial services.......... 124 186 (62) (33.3)% (d)
Rental income......................... 35 22 13 59.1%
Net gain on sales of securities ...... -- 120 (120) (100.0)% (e)
Other................................. 320 107 213 199.1% (f)
------------- ------------- --------------
Total noninterest income........... $ 6,007 $ 5,219 $ 788 15.1%
============= ============= ==============
Noninterest income as a percent of
gross revenues...................... 57.89% 60.26% (2.4)%
-------------------------
(a) Insurance commissions increased due to an increase in contingency fee
income received from insurance companies as well as growth in the insurance
segment, including production from the Tucson location acquired on December
31, 2003. Most contingency fee income from insurance companies is recorded
during the first quarter of the year. Contingency fee income recognized
during the quarter ended March 31, 2004 was $1.04 million compared to
$817,000 for the same period in 2003.
(b) Loan fees included in noninterest income increased primarily due to an
increase in the origination and sale of commercial real estate loans during
the quarter ended March 31, 2004 as compared to the same quarter in the
prior year.
(c) Brokerage revenue increased primarily due to increased production in the
Minnesota market.
(d) Trust and financial services income declined during the quarter ended March
31, 2004 as compared to the same period one year earlier due to a decrease
in trust revenue that was partially offset by an increase in professional
services fees. Additionally, the BNC U.S. Opportunities Fund LLC was
discontinued during 2003 removing management fee income from the trust and
financial services division's revenue stream.
(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
effected during the period. There were no sales of investment securities
during the quarter ended March 31, 2004.
(f) Other income increased for the quarter ended March 31, 2004 primarily due
to the income received on $10.0 million of bank-owned life insurance
purchased in mid-2003.
Noninterest Expense. The following table presents the major categories of our
noninterest expense for the three-month periods ended March 31, 2004 and 2003 as
well as the amount and percent of change between the periods. Significant
changes are discussed in lettered explanations following the table (amounts are
in thousands):
For the Three Months Increase (Decrease)
Ended March 31 2004 - 2003
--------------------------- -----------------------------
Noninterest Expense 2004 2003 $ %
----------- ----------- ----------- --------------
Salaries and employee benefits............... $ 4,914 $ 3,965 $ 949 23.9% (a)
Occupancy.................................... 585 622 (37) (5.9)%
Depreciation and amortization................ 398 348 50 14.4% (b)
Professional services........................ 319 260 59 22.7% (c)
Office supplies, telephone and postage....... 311 254 57 22.4% (d)
Amortization of intangible assets............ 308 266 42 15.8% (e)
Marketing and promotion...................... 271 119 152 127.7% (f)
FDIC and other assessments................... 51 51 -- --
Other........................................ 730 569 161 28.3% (g)
----------- ----------- -----------
Total noninterest expense................. $ 7,887 $ 6,454 $ 1,433 22.2%
=========== =========== ===========
Efficiency ratio ............................ 76.00% 74.52% 1.5%
=========== ===========
Total operating expenses as a percent of
average assets, annualized................ 5.13% 4.39% 0.7% (h)
=========== ===========
---------------
(a) Salaries and employee benefits expenses increased primarily due to growth
and expansion in the Minnesota and Arizona markets. Average full time
equivalent employees for the quarter ended March 31, 2004 were 301 as
compared to 267 for the same period one year earlier.
(b) Depreciation and amortization expenses increased due to expansion,
primarily in the Arizona market.
(c) The increase in professional services expenses is primarily attributable to
an increase in brokerage retainage and clearing fees (resulting from the
increase in brokerage production), appraisal and recording fees and
consulting fees offset by a decrease in legal and collection expenses.
(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 in an acquisition
on December 31, 2003.
(f) Marketing and promotion expense increased primarily due to market expansion
and the associated advertising and marketing.
(g) The increase in other noninterest expense is due to the increase in several
different items included in this category such as insurance expense, travel
expense, meals and entertainment, dues and publications and other
miscellaneous items.
(h) Total operating expenses as a percent of average assets have increased as
we have expanded our base of financial product and service offerings.
Income Tax Provision. Our provision for income taxes for the quarter ended March
31, 2004 increased $262,000 as compared to the same period in 2003 due to the
increase in pre-tax income. The estimated effective tax rates for the
three-month periods ended March 31, 2004 and 2003 were 27.2 and 29.0 percent,
respectively. The reduction in our effective tax rate is primarily attributable
to an increase in the amount of tax-exempt income in the 2004 period as compared
to the 2003 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, 2004 and 2003.
Liquidity
Liquidity. Liquidity risk management encompasses our ability to meet all present
and future financial obligations in a timely manner. The objectives of liquidity
management policies are to maintain adequate liquid assets, liability
diversification among instruments, maturities and customers and a presence in
both the wholesale purchased funds market and the retail deposit market.
The consolidated statements of cash flows in the consolidated financial
statements included under Item 1 present data on cash and cash equivalents
provided by and used in operating, investing and financing activities. In
addition to liquidity from core deposit growth, together with repayments and
maturities of loans and investments, we utilize brokered deposits, sell
securities under agreements to repurchase and borrow overnight Federal funds.
The Bank is a member of the FHLB, which affords it the opportunity to borrow
funds on terms ranging from overnight to 10 years and beyond. Advances from the
FHLB are generally collateralized by the Bank's mortgage loans and various
investment securities. We have also obtained funding through the issuance of
subordinated notes, subordinated debentures and long-term borrowings.
The following table sets forth, for the three months ended March 31, 2004 and
2003, a summary of our major sources and (uses) of funds. The summary
information is derived from the consolidated statements of cash flows included
under Item 1 (amounts are in thousands):
For the Three Months Ended
March 31,
---------------------------
Major Sources and (Uses) of Funds 2004 2003
------------ ------------
Proceeds from FHLB advances......................... $ 85,000 $ 20,000
Net decrease in loans............................... 28,290 5,736
Net increase (decrease) in deposits................. 6,375 (10,976)
Proceeds from maturities of investment securities... 9,040 12,208
Net increase (decrease) in short-term borrowings.... 2,432 (7,781)
Proceeds from sales of investment securities........ -- 5,079
Repayments of FHLB advances......................... (85,000) (10,000)
Purchases of investment securities.................. (32,269) (13,158)
Our liquidity is measured by our ability to raise cash when we need it at a
reasonable cost and with a minimum of loss. Given the uncertain nature of our
customers' demands as well as our desire to take advantage of earnings
enhancement opportunities, we must have adequate sources of on- and off-balance
sheet funds that can be acquired in time of need. Accordingly, in addition to
the liquidity provided by balance sheet cash flows, liquidity is supplemented
with additional sources such as credit lines with the FHLB, credit lines with
correspondent banks for Federal funds, wholesale and retail repurchase
agreements, brokered certificates of deposit and direct non-brokered national
certificates of deposit 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, 2004, we had established three revolving lines of credit with
banks totaling $16.5 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, 2004, we also had the ability to draw additional FHLB
advances of $102.9 million based upon the mortgage loans and securities that
were then pledged, subject to a requirement to purchase additional FHLB stock.
Critical Accounting Policies
Critical accounting policies are dependent on estimates that are particularly
susceptible to significant change and include the determination of the allowance
for credit losses and income taxes. The following have been identified as
"critical accounting policies."
Allowance for Credit Losses. 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 SFAS 114. A loan is
impaired when, based on current information and events, it is probable that
a creditor will be unable to collect all amounts due according to the
contractual terms of the loan agreement. Problem loans also include those
credits that have been internally classified as credits requiring
management's attention due to underlying problems in the borrower's
business or collateral concerns. Under SFAS 114, any allowance on impaired
loans is generally based on one of three methods. The accounting standard
requires that impaired loans be measured at either the present value of
expected cash flows at the loan's effective interest rate, the loan's
observable market price or the fair value of the collateral of the loan.
Specific reserves totaled $1.0 million at March 31, 2004.
Reserves for Homogeneous Loan Pools. We make a significant number of loans
and leases that, due to their underlying similar characteristics, are
assessed for loss as "homogeneous" pools. Included in the homogeneous pools
are consumer loans and commercial loans under a certain size that have been
excluded from the specific reserve allocation previously discussed. We
segment the pools by type of loan or lease and using historical loss
information estimate a loss reserve for each pool. Reserves for homogeneous
loan pools totaled $2.2 million at March 31, 2004.
Qualitative Reserve. Our senior lending management also allocates reserves
for special situations that 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.
Our qualitative reserve totaled $341,000 at March 31, 2004.
Continuous credit monitoring processes and the analysis of loss components is
the principal method we rely upon to ensure that changes in estimated credit
loss levels are reflected in our allowance for credit losses on a timely basis.
We also consider 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 our 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.
As indicated above, we employ a systematic methodology for determining our
allowance for credit losses that includes an ongoing review process and
quarterly adjustment of the allowance. Our process includes periodic
loan-by-loan review for loans that are individually evaluated for impairment as
well as detailed reviews of other loans (either individually or in pools). This
includes an assessment of known problem loans, potential problem loans and other
loans that exhibit indicators of deterioration.
Our methodology incorporates a variety of risk considerations, both quantitative
and qualitative, in establishing an allowance for credit losses that we believe
is appropriate at each reporting date. Quantitative factors include our
historical loss experience, delinquency and charge-off trends, collateral
values, changes in nonperforming loans and other factors. Quantitative factors
also incorporate known information about individual loans, including borrowers'
sensitivity to interest rate movements and borrowers' sensitivity to
quantifiable external factors including commodity and finished goods prices as
well as acts of nature (violent weather, fires, etc.) that occur in a particular
period.
Qualitative factors include the general economic environment in our markets and,
in particular, the state of certain industries in our market areas. Size and
complexity of individual credits in relation to lending officers' background and
experience levels, loan structure, extent and nature of waivers of existing loan
policies and pace of portfolio growth are other qualitative factors that are
considered in our methodology.
Our methodology is, and has been, consistently applied. However, as we add new
products, increase in complexity and expand our geographical coverage, we will
enhance our methodology to keep pace with the size and complexity of the loan
and lease portfolio. In this regard, we may, if deemed appropriate, engage
outside firms to independently assess our methodology. On an ongoing basis we
perform independent credit reviews of our loan portfolio. We believe that our
systematic methodology continues to be appropriate given our size and level of
complexity.
While our methodology utilizes historical and other objective information, the
establishment of the allowance for credit losses and the classification of loans
is, to some extent, based on our judgment and experience. We believe that the
allowance for credit losses is adequate as of March 31, 2004 to cover known and
inherent risks in the loan and lease portfolio. However, future changes in
circumstances, economic conditions or other factors could cause us to increase
or decrease the allowance for credit losses as necessary.
Allowance for credit losses - Impact on Earnings. As indicated above, the
determined level of the allowance for credit losses involves assumptions
underlying our estimates that reflect highly uncertain matters in the current
period. Additionally, a different estimate that could have been used in the
current period could have had a material impact on reported financial condition
or results of operations. We are not aware, at this time, of known trends,
commitments, events or other uncertainties reasonably likely to occur that would
materially affect our methodology or the assumptions used, although changes in
the qualitative and quantitative factors noted above could occur at any time and
such changes could be of a material nature. We have used our assumptions to
arrive at the level of the allowance for credit losses that we consider adequate
to provide for an estimate of probable losses related to specifically identified
loans as well as probable losses in the remaining loan and lease portfolio that
have been incurred as of March 31, 2004. The qualitative and quantitative
factors noted above can reasonably be expected to impact the estimates applied
and cause such estimates to change from period to period.
Our allowance for credit losses of approximately $3.5 million did not
necessitate that a provision for credit losses be made for the quarter ended
March 31, 2004. Should our analysis have resulted in the need for a higher or
lower allowance for loan losses, a provision for loan losses would have been
charged to earnings or, in the case of the need for a lower allowance for credit
losses, a reversal of some of the allowance would have been credited to
earnings. For example, should our analysis have indicated the need for an
allowance for credit losses of $3.8 million, an additional $300,000 would have
been charged to the provision for loan losses resulting in net income of
approximately $1.6 million as compared to the $1.8 million recorded for the
quarter ended March 31, 2004. Had our analysis indicated the need for an
allowance for credit losses of $3.2 million, $300,000 of the allowance would
have been reversed and credited to earnings resulting in net income of
approximately $2.0 million as compared to the $1.8 million recorded for the
period.
In recent periods there have been changes in the qualitative and quantitative
factors noted above. From period to period, economic situations change, credits
may deteriorate or improve and the other factors we consider in arriving at our
estimates may change. However, our basic methodology for determining an
appropriate allowance for credit losses has remained relatively stable. This
methodology has resulted in allowance for credit losses levels of $3.5 and $5.2
million at March 31, 2004 and March 31, 2003, respectively. As noted above, the
amount of the provision for credit losses charged to operations is directly
related to our estimates of the appropriate level of the allowance for credit
losses. Charge-offs and recoveries during the applicable periods also impact the
level of the allowance for credit losses resulting in a provision for credit
losses that could be higher or lower in order to bring the allowance for credit
losses in line with our estimates.
Income Taxes. We file consolidated Federal and unitary state income tax returns.
Income taxes are accounted for using the asset and liability method. Under this
method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Such differences can relate to differences in accounting for credit
losses, depreciation timing differences, unrealized gains and losses on
investment securities, deferred compensation and leases, which are treated as
operating leases for tax purposes and loans for financial statement purposes.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
The determination of current and deferred income taxes is based on complex
analyses of many factors including interpretation of Federal and state income
tax laws, the difference between tax and financial reporting basis of assets and
liabilities (temporary differences), estimates of amounts due or owed, the
timing of reversals of temporary differences and current financial accounting
standards. Actual results could differ significantly from the estimates and
interpretations used in determining the current and deferred income tax
liabilities.
Forward-Looking Statements
Statements included in Item 2, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" which are not historical in
nature are intended to be, and are hereby identified as "forward-looking
statements" for purposes of the safe harbor provided by Section 27A of the
Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). We caution
readers that these forward-looking statements, including without limitation,
those relating to our future business prospects, revenues, working capital,
liquidity, capital needs, interest costs and income, are subject to certain
risks and uncertainties that could cause actual results to differ materially
from those indicated in the forward-looking statements due to several important
factors. These factors include, but are not limited to: risks of loans and
investments, including dependence on local and regional economic conditions;
competition for our customers from other providers of financial services;
possible adverse effects of changes in interest rates including the effects of
such changes on derivative contracts and associated accounting consequences;
risks associated with our acquisition and growth strategies; and other risks
which are difficult to predict and many of which are beyond our control.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk arises from changes in interest rates, exchange rates, and commodity
prices and equity prices and represents the possibility that changes in future
market rates or prices will have a negative impact on our earnings or value. Our
principal market risk is interest rate risk.
Interest rate risk arises from changes in interest rates. Interest rate risk can
result from: (1) Repricing risk - timing differences in the maturity/repricing
of assets, liabilities, and off-balance sheet contracts; (2) Options risk - the
effect of embedded options, such as loan prepayments, interest rate caps/floors,
and deposit withdrawals; (3) Basis risk - risk resulting from unexpected changes
in the spread between two or more different rates of similar maturity, and the
resulting impact on the behavior of lending and funding rates; and (4) Yield
curve risk - risk resulting from unexpected changes in the spread between two or
more rates of different maturities from the same type of instrument. We have
risk management policies to monitor and limit exposure to interest rate risk. To
date we have not conducted trading activities as a means of managing interest
rate risk. Our asset/liability management process is utilized to manage our
interest rate risk. The measurement of interest rate risk associated with
financial instruments is meaningful only when all related and offsetting on-and
off-balance sheet transactions are aggregated, and the resulting net positions
are identified.
Our interest rate risk exposure is actively managed with the objective of
managing the level and potential volatility of net interest income in addition
to the long-term growth of equity, bearing in mind that we will always be in the
business of taking on rate risk and that rate risk immunization is not entirely
possible. Also, it is recognized that as exposure to interest rate risk is
reduced, so too may the overall level of net interest income and equity. In
general, the assets and liabilities generated through ordinary business
activities do not naturally create offsetting positions with respect to
repricing or maturity characteristics. Access to the derivatives market can be
an important element in maintaining our interest rate risk position within
policy guidelines. Using derivative instruments, principally interest rate
floors and caps, the interest rate sensitivity of specific transactions, as well
as pools of assets or liabilities, is adjusted to maintain the desired interest
rate risk profile.
Our primary tool in measuring and managing interest rate risk is net interest
income simulation. This exercise includes our assumptions regarding the level of
interest rates and their impact on our current balance sheet. Interest rate caps
and floors are included to the extent that they are exercised in the 12-month
simulation period. Additionally, changes in prepayment behavior of the
residential mortgage, collateralized mortgage obligation, and mortgage-backed
securities portfolios in each rate environment are captured using industry
estimates of prepayment speeds for various coupon segments of the portfolio. For
purposes of this simulation, projected month-end balances of the various balance
sheet accounts are held constant at their March 31, 2004 levels. Cash flows from
a given planning account are reinvested back into the same planning account so
as to keep the month-end balance constant at its March 31, 2004 level. The
static balance sheet assumption is made so as to project the interest rate risk
to net interest income embedded in the existing balance sheet. With knowledge of
the balance sheet's existing net interest income profile, more informed
strategies and tactics may be developed as it relates to the structure/mix of
growth.
We monitor the results of net interest income simulation on a quarterly basis at
regularly scheduled asset/liability committee ("ALCO") meetings. Each quarter
net interest income is generally simulated for the upcoming 12-month horizon in
seven interest scenarios. The scenarios generally modeled are parallel interest
ramps of +/- 100bp, 200bp, and 300bp along with a rates unchanged scenario. The
parallel movement of interest rates means all projected market interest rates
move up or down by the same amount. A ramp in interest rates means that the
projected change in market interest rates occurs over the 12-month horizon
projected. For example, in the -100bp scenario, the projected prime rate will
decrease from its starting point at March 31, 2004 of 4.00 percent to 3.00
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, 2004, the declining rate
scenario analysis was limited to -100bp for the summary table presented below
and a +400bp scenario was added.
The net interest income simulation result for the 12-month horizon is shown
below. The impact of each interest rate scenario on projected net interest
income is displayed before and after the impact of the $20.0 million cumulative
notional original three-year interest rate cap positions on three-month LIBOR
with a 4.50 percent strike and 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 -100bp Unchanged +100bp +200bp +300bp +400bp
------ --------- ------ ------ ------ ------
Projected 12-month net interest income........ $ 12,445 $ 14,062 $ 14,465 $14,119 $ 13,551 $ 12,905
Dollar change from rates unchanged scenario... $ (1,617) -- $ 403 $ 57 $ (511) $(1,157)
Percentage change from rates unchanged
scenario................................... 11.50% -- 2.87% 0.41% (3.63)% (8.23)%
Net benefit/(cost) of cumulative $40.0
million interest rate caps (1)............. $ (19) $ (19) $ (16) $ (1) $ 37 $ 113
Total net interest income impact with caps.... $ 12,426 $ 14,043 $ 14,449 $14,118 $ 13,588 $ 13,018
Dollar change from unchanged w/caps........... $ (1,617) -- $ 406 $ 75 $ (455) $(1,025)
Percentage change from unchanged w/caps....... (11.51)% -- 2.89% 0.53% (3.24)% (7.30)%
Policy guidelines (decline limited to)........ 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 4.50 percent each in the amount of $5.0 million notional with original terms
of three years for total notional of $20.0 million. These contracts will expire
in May and June 2004. We also have four interest rate cap contracts on
three-month LIBOR with strikes at 5.50 percent each in the amount of $5.0
million notional with original terms of five years for total notional of $20.0
million. These contracts will expire in May and June 2006.
Because one of the objectives of asset/liability management is to manage net
interest income over a one-year planning horizon, policy guidelines are stated
in terms of maximum potential reduction in net interest income resulting from
changes in interest rates over the 12-month period. It is no less important,
however, to give attention to the absolute dollar level of projected net
interest income over the 12-month period. For example, even though in the -100bp
scenario, net interest income declines $1.6 million, or 11.5 percent, from the
unchanged scenario, the level of net interest income of $12.4 million is only
7.1 percent below the $13.4 million of net interest income recorded for the year
ended December 31, 2003.
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, 2004 (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.
Part II - Other Information
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
Pursuant to an Asset Purchase and Sale Agreement, on March 31, 2004, BNCCORP
issued 22,470 shares of its common stock to The Insurance Management Corporation
of Salt Lake City in connection with Milne Scali's acquisition of certain assets
and assumption of certain liabilities of The Richard Q. Perry Agency. The shares
of common stock were issued in reliance upon the exemption from registration
provided by Section 4(2) of the Securities Act.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 31.1 Chief Executive Officer's Certification Under Rule
13a-14(a) of the Exchange Act
Exhibit 31.2 Chief Financial Officer's Certification Under Rule
13a-14(a) of the Exchange Act
Exhibit 32.1 Chief Executive Officer and Chief Financial Officer
Certifications Under Rule 13a-14(b) of the Exchange Act
(b) Reports on Form 8-K
On January 15, 2004, we filed a Form 8-K, furnishing, under Item
7, our earnings press release for the quarter ended December 31,
2003.
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 5, 2004 By /s/ Gregory K. Cleveland
-----------------------------------------
Gregory K. Cleveland
President and Chief Executive Officer
By /s/ Brenda L. Rebel
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Brenda L. Rebel
Chief Financial Officer