UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-11132
FIRST BANKING CENTER, INC.
(Exact name of registrant as specified in its charter)
Wisconsin 39-1391327
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
400 Milwaukee Ave., Burlington, WI 53105
(Address of principal executive offices) (Zip Code)
(262) 763-3581
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ ] No [ X ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of November 8, 2004, Common stock, $1.00 par value, 1,495,811
shares outstanding.
1
FIRST BANKING CENTER, INC AND SUBSIDIARY
TABLE OF CONTENTS
September 30, 2004
Part I Financial Information Page
----
Item 1 Consolidated Financial Statements
Unaudited Consolidated Balance Sheets,
September 30, 2004 and December 31, 2003 3
Unaudited Consolidated Statements of Income,
For the three and nine month periods ended
September 30, 2004 and 2003 4
Unaudited Consolidated Statements of Cash Flows,
For the nine months ended September 30, 2004 and 2003 5
Notes to Unaudited Consolidated Financial Statements 6-10
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 11-21
Item 3 Quantitative and Qualitative Disclosures about Market Risk 22
Item 4 Controls and Procedures 23
Part II Other Information
Item 1 Legal Proceedings 23
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 23
Item 3 Defaults upon Senior Securities 23
Item 4 Submission of Matters to a Vote of Security Holders 23
Item 5 Other Information 23
Item 6 Exhibits 24
Signatures 25
2
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
FIRST BANKING CENTER, INC. AND SUBSIDIARY
UNAUDITED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
ASSETS 2004 2003
--------------------------------
(Dollars in thousands)
Cash and due from banks $ 13,816 $ 19,960
Federal funds sold 3,927 3,047
Interest-bearing deposits in banks 307 274
Available for sale securities 68,764 82,672
Loans, less allowance for loan losses of $4,672 and
$4,617 at 2004 and 2003, respectively 456,246 403,252
Office buildings and equipment, net 12,882 11,818
Other real estate owned 1,750 1,899
Federal Home Loan Bank stock 12,281 11,755
Other assets 9,446 9,240
--------------------------------
TOTAL ASSETS $ 579,419 $ 543,917
================================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits
Demand $ 67,527 $ 67,961
Savings and NOW accounts 200,478 194,419
Time 164,253 145,072
--------------------------------
Total deposits 432,258 407,452
Short-term borrowings 60,289 34,176
Other borrowings 26,012 44,673
Other liabilities 4,067 4,076
--------------------------------
TOTAL LIABILITIES $ 522,626 $ 490,377
--------------------------------
STOCKHOLDERS' EQUITY
Common stock, $1.00 par value 3,000,000 shares authorized;
1,502,543 and 1,501,277 shares issued as of September 30,
2004 and December 31, 2003, respectively; 1,494,886 and
1,500,760 shares outstanding as of September 30, 2004 and
December 31, 2003, respectively 1,503 1,501
Surplus 4,624 4,612
Retained earnings 50,133 46,161
Accumulated other comprehensive income 912 1,290
Common stock in treasury, at cost- 7,657 and 517 shares as
of September 30, 2004 and December 31, 2003, respectively (379) (24)
--------------------------------
TOTAL STOCKHOLDERS' EQUITY $ 56,793 $ 53,540
--------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 579,419 $ 543,917
================================
See accompanying notes to unaudited consolidated financial statements
3
FIRST BANKING CENTER, INC. AND SUBSIDIARY
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
----------------------------------------------------------
(Dollars in thousands, (Dollars in thousands,
except per share data) except per share data)
INTEREST AND DIVIDEND INCOME
Interest and fees on loans $ 6,502 $ 5,925 $ 18,197 $ 16,884
Interest and dividends on securities:
Taxable 229 275 739 956
Non-taxable 364 408 1,122 1,242
Interest on federal funds sold 5 13 14 73
Interest on interest-bearing deposits in banks 1 1 3 16
Other interest and dividends 159 183 524 582
----------------------------------------------------------
TOTAL INTEREST AND DIVIDEND INCOME 7,260 6,805 20,599 19,753
----------------------------------------------------------
INTEREST EXPENSE
Interest on deposits 1,355 1,243 3,687 4,079
Interest on short-term borrowings 214 44 525 171
Interest on other borrowings 326 442 1,198 1,365
----------------------------------------------------------
TOTAL INTEREST EXPENSE 1,895 1,729 5,410 5,615
----------------------------------------------------------
NET INTEREST INCOME 5,365 5,076 15,189 14,138
Provision for loan losses 77 0 177 90
----------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES 5,288 5,076 15,012 14,048
----------------------------------------------------------
NON-INTEREST INCOME
Trust fees 150 119 488 377
Service charges on deposit accounts 743 478 1,781 1,423
Commissions 18 48 101 135
Automated banking fees 132 106 314 284
Securities gains, net 0 107 123 107
Loan gains, net 161 479 649 1,593
Other 302 280 790 621
----------------------------------------------------------
TOTAL NON-INTEREST INCOME 1,506 1,617 4,246 4,540
----------------------------------------------------------
NON-INTEREST EXPENSE
Salary and employee benefits 2,401 2,239 7,104 6,673
Occupancy 332 262 986 838
Equipment 362 355 1,066 1,049
Data processing services 295 261 844 763
Other 975 927 2,698 2,465
----------------------------------------------------------
TOTAL NON-INTEREST EXPENSE 4,365 4,044 12,698 11,788
----------------------------------------------------------
INCOME BEFORE INCOME TAXES 2,429 2,649 6,560 6,800
Income taxes 774 796 1,945 1,926
----------------------------------------------------------
NET INCOME $ 1,655 $ 1,853 $ 4,615 $ 4,874
==========================================================
Basic earnings per share $ 1.11 $ 1.24 $ 3.09 $ 3.26
Diluted earnings per share $ 1.06 $ 1.21 $ 2.97 $ 3.19
See accompanying notes to unaudited consolidated financial statements
4
FIRST BANKING CENTER, INC. AND SUBSIDIARY
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
2004 2003
---------------------------
(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,615 $ 4,874
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation 789 686
Provision for loan losses 177 90
Loan gains, net (649) (1,593)
Amortization of premiums and accretion of discounts
on securities, net 207 384
Amortization 135 113
Securities gains, net (123) (107)
Tax benefit of nonqualified stock options exercised 20 -
Increase in other assets (523) (3,346)
Decrease in other liabilities (8) (349)
---------------------------
Net cash provided by operating activities before loan originations and sales 4,640 752
Loans originated for sale (39,026) (57,898)
Proceeds from sale of loans 39,670 63,605
---------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 5,284 6,459
---------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in interest-bearing deposits in banks (32) 213
Net (increase) decrease in federal funds sold (880) 3,853
Proceeds from sales of available-for-sale securities 6,297 9,135
Proceeds from maturities and calls of available-for-sale securities 71,009 54,808
Purchase of available-for-sale securities (64,057) (56,792)
Net increase in loans (53,166) (13,604)
Purchase of office buildings and equipment, net (1,853) (1,508)
---------------------------
NET CASH USED IN INVESTING ACTIVITIES (42,682) (3,895)
---------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits 24,806 (15,829)
Dividends paid (643) (583)
Proceeds from other borrowings - 9,084
Payments on other borrowings (18,661) (2,063)
Net increase (decrease) in short-term borrowings 26,113 (246)
Sale of common stock for the exercise of stock options 30 62
Purchase of treasury stock (634) (10)
Sale of treasury stock for the exercise of stock options 243 -
---------------------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 31,254 (9,585)
---------------------------
NET DECREASE IN CASH AND DUE FROM BANKS (6,144) (7,021)
CASH AND DUE FROM BANKS:
Beginning 19,960 22,203
---------------------------
Ending $ 13,816 $ 15,182
===========================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 5,385 $ 5,894
Income taxes $ 1,557 $ 1,058
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES
Change in accumulated other comprehensive income,
Unrealized gains (losses) on available-for-sale securities, net $ (378) $ (224)
Other real estate aquired in settlement of loans $ - $ 1,750
See accompanying notes to unaudited consolidated financial statements
5
FIRST BANKING CENTER, INC AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
NOTE 1 - Basis of Presentation
The unaudited consolidated financial statements include the accounts of First
Banking Center, Inc. (the "Company") and First Banking Center, its wholly owned
subsidiary. In the opinion of management, all adjustments (consisting only of
normal recurring adjustments) necessary for a fair presentation of the financial
position, results of operation and cash flows for the interim periods have been
made. The results of operations for the three and nine months ended September
30, 2004 are not necessarily indicative of the results to be expected for the
entire fiscal year.
The unaudited interim financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America and
industry practice. Certain information in footnote disclosure normally included
in financial statements prepared in accordance with accounting principles
generally accepted in the United States of America and industry practice has
been condensed or omitted pursuant to rules and regulations of the Securities
and Exchange Commission. These financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's December 31, 2003 audited financial statements.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions which affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the financial statements, as well as the reported amounts of income and
expenses during the reported periods. Actual results could differ from those
estimates.
NOTE 2 - Earnings per Share
The following information calculates the computation of earnings per share on a
basic and diluted basis:
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
-------------------------------------------
(Amounts in (Amounts in
thousands, except thousands, except
per share data) per share data)
Basic
Net income $ 1,655 $ 1,853 $ 4,615 $ 4,874
Weighted average shares outstanding 1,496 1,496 1,496 1,496
Basic earnings per share $ 1.11 $ 1.24 $ 3.09 $ 3.26
Diluted
Net income $ 1,655 $ 1,853 $ 4,615 $ 4,874
Weighted average shares outstanding 1,496 1,496 1,496 1,496
Effect of dilutive stock options outstanding - 2 59 32
-------------------------------------------
Diluted weighted average shares outstanding 1,496 1,498 1,555 1,528
Diluted earnings per share $ 1.06 $ 1.21 $ 2.97 $ 3.19
NOTE 3 - Comprehensive Income
The following table presents our comprehensive income:
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
-------------------------------------------
(Dollars in (Dollars in
thousands) thousands)
Net income $ 1,655 $ 1,853 $ 4,615 $ 4,874
Other comprehensive income
Net change in unrealized gain (loss) on available
for sale securities 578 (762) (378) (224)
-------------------------------------------
Total comprehensive income $ 2,233 $ 1,091 $ 4,237 $ 4,650
===========================================
6
NOTE 4 - Stock-based Compensation Plan:
For the nine months ended September 30, 2004, and September 30, 2003, the
Company had one stock-based compensation plan for officers and key employees.
The Company accounts for this plan under the recognitions and measurement
principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and
related Interpretations. No stock-based employee compensation cost is reflected
in the income, 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.
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of Financial
Accounting Standards Board (FASB) Statement No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation:
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
-------------------------------------------
(Dollars in (Dollars in
thousands, except thousands, except
for per share data) for per share data)
Net income, as reported $ 1,655 $ 1,853 $ 4,615 $ 4,874
Deduct total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects - - (160) (193)
-------------------------------------------
Pro forma net income $ 1,655 $ 1,853 $ 4,455 $ 4,681
===========================================
Earnings per share:
Basic:
As reported $ 1.11 $ 1.24 $ 3.09 $ 3.26
Pro forma 1.11 1.24 2.98 3.13
Diluted:
As reported $ 1.06 $ 1.21 $ 2.97 $ 3.19
Pro forma 1.06 1.21 2.87 3.06
In determining compensation cost using the fair value method prescribed in
Statement No. 123, the value of each grant is estimated at the grant date with
the following weighted-average assumptions used for grants on September 30,
2004, and September 30, 2003, respectively: dividend yield of 1.7 percent and
1.7 percent; expected price volatility of 5.3 percent and 5.2 percent, blended
risk-free interest rates of 4.14 percent and 4.22 percent; and expected lives of
10 years, respectively.
NOTE 5 - Commitments and Contingencies
Information in the following table provides a summary of the Company's other
contractual obligations and commercial commitments as of September 30, 2004, as
well as that information for its depository products:
Payments Due by Fiscal Period
(in thousands)
---------------------------------------------------------------
Contractual Obligations (a) Remaining in 2005- 2007- 2009 and
Total 2004 2006 2008 thereafter
---------------------------------------------------------------
Time deposits, certificates of deposit $ 164,253 $ 20,518 $ 105,367 $ 15,983 $ 22,385
and similar products (b)
Short-term obligations (c) 60,289 60,289 - - -
Other borrowings (d) 26,012 3,741 11,060 11,211 -
Operating leases 332 95 174 63 -
Other long-term obligations (e) 2,270 66 497 427 1,280
---------------------------------------------------------------
Total contractual cash obligations $ 253,156 $ 84,709 $ 117,098 $ 27,684 $ 23,665
===============================================================
7
Notes
a. Excluding the "off balance sheet" lending commitments discussed below.
b. Excludes demand, savings and money market deposits.
c. See Note 8 in the Notes to Consolidated Financial Statements for the year
ended December 31, 2003 for a description of the Company's various
short-term borrowings. Many short-term borrowings such as federal funds
purchased and security repurchase agreements are expected to be reissued
and, therefore, do not necessarily represent an immediate need for cash.
d. See Note 9 in the Notes to Consolidated Financial Statements for the year
ended December 31, 2003 for a description of the Company's various other
borrowings.
e. Other long-term obligations consisted primarily of salary continuation
agreements and benefit plans. See Exhibits 10.1, 10.2, 10.3 and 10.4 to the
Form 10-K as of December 31, 2003 for a detailed description of the
Company's salary continuation agreements and benefit plans.
In the ordinary course of business, the Company is involved in various legal
proceedings. In the opinion of management, any liability resulting from such
proceedings would not have a material adverse effect on the consolidated
financial statements.
The Company is party to financial instruments with off-balance-sheet risk in the
ordinary course of its banking business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit,
financial guarantees, and standby letters of credit. They involve, to varying
degrees, elements of credit risk in excess of amounts recognized on the
consolidated balance sheets.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments. The Company uses the same credit policies in making
commitments and issuing letters of credit as they do for on-balance-sheet
instruments.
Information in the following table provides a summary of the contract or
notional amount of the Company's exposure to off-balance-sheet risk as of
September 30:
2004 2003
-----------------------------
(Dollars in thousands)
Commitments to extend credit
Unused revolving home equity, consumer lines of credit $ 21,867 $ 17,708
Unused commercial lines of of credit 74,815 61,172
Standby letters of credit 4,392 3,087
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third-party. Those guarantees are
primarily issued to support public and private borrowing arrangements and,
generally, have terms of one year or less. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
facilities to customers. The Bank holds collateral, which may include accounts
8
receivable, inventory, property, equipment, and income-producing properties,
supporting those commitments if deemed necessary. In the event the customer does
not perform in accordance with the terms of the agreement with the third-party,
the Bank would be required to fund the commitment. The maximum potential amount
of future payments the Bank could be required to make is represented by the
contractual amount shown earlier in the summary. If the commitment is funded the
Bank would be entitled to seek recovery from the customer. At September 30, 2004
and December 31, 2003, no amounts have been recorded as liabilities for the
Bank's potential obligations under these guarantees.
NOTE 6 - Derivative Instruments
At September 30, 2004, the Company was entered in two interest rate swap
transactions which, in effect, resulted in the Company converting $20.0 million
of fixed rate brokered CD's into variable rate debt. These swap transactions
require the payment of interest by the Company at a variable interest rate
payment based on the one month LIBOR rate adjusted monthly. In turn, the Company
receives fixed rate interest payments equal to 5.0% and 4.0% using an actual/365
day basis.
Summary information about the interest rate swaps at September 30 is as follows:
2004 2003
-------------------------------
(Dollars in thousands)
Notional amount $ 10,000 $ -
Weighted average fixed rate 5.00% -
Weighted average variable rate 1.53% -
Weighted average maturity, years 7.5 -
Fair value (19) -
2004 2003
-------------------------------
(Dollars in thousands)
Notional amount $ 10,000 $ -
Weighted average fixed rate 4.00% -
Weighted average variable rate 1.63% -
Weighted average maturity, years 7.0 -
Fair value (1) -
In October and November 2004, the Company was entered in three new interest rate
swap transactions that convert an additional $20.0 million of fixed rate
brokered CD's into variable rate debt. These swaps require the payment of
interest by the Company at a variable interest rate payment based on the one
month LIBOR rate adjusted monthly. In turn, the Company receives fixed rate
interest payments equal to 5.0% and 3.0% using an actual/365 day basis.
NOTE 7 - Recent Accounting Pronouncements
At the March 17-18, 2004 Emerging Issues Task Force ("EITF") meeting, the Task
Force reached a consensus on Issue No. 03-1, The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments. EITF 03-1 provides
guidance for determining the meaning of "other-than-temporarily impaired" and
its application to certain debt and equity securities within the scope of
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities ("SFAS 115") and investments accounted
for under the cost method. The guidance set forth in the Statement was
originally effective for the Company in the September 30, 2004 consolidated
financial statements. However, in September 2004, the effective dates of certain
parts of the Statement were delayed. Management is currently assessing the
impact of Issue 03-1 on the consolidated financial statements.
9
In March 2004, the Financial Accounting Standards Board ("FASB") issued an
Exposure Draft, Share-Base Payment - an amendment of Statements No. 123 and 95.
This Statement amends SFAS Statement No. 123, Accounting for Stock-Based
Compensation, SFAS Statement No. 95, Statement of Cash Flows, and APB Opinion
No. 125, Accounting for Stock Issued to Employees. The objective of the
amendment to SFAS No. 123 is to recognize in the financial statements the cost
of employee services received in exchange for equity instruments and liabilities
incurred as the result of such transactions. The grant-date fair value of stock
options would be determined using an option-pricing model, and expense would be
recognized over the vesting period. In October 2004, the FASB postponed the
effective date of the proposed standard from fiscal years beginning after
December 15, 2004 to periods beginning after June 15, 2005. The FASB is expected
to issue a final standard by the end of calendar 2004. Management is reviewing
the proposed standard to determine the impact on the financial statements.
NOTE 8 - Proposed Going Private Transaction
On August 12, 2004 the company's board of directors announced a going private
transaction by means of a 1-for-2,000 reverse split of the company's common
stock, followed immediately by a 2,000-for-1 forward split. The effect of this
transaction would be to reduce the number of shareholders of record to fewer
than 300, thereby eliminating the company's obligation to file reports with the
SEC. Shareholders with fewer than 2,000 shares of First Banking Center, Inc.
common stock, held of record in their name, immediately before the split will
receive a cash payment equal to $60.00 per pre-split share. Shareholders with
2,000 or more shares of record in their name immediately before the split will
continue to hold the same number of shares after completion of the split
transaction.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward Looking Statements- Safe Harbor Statement under the Private Securities
Litigation Reform Act of 1995
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended and Section 21E of the
Securities Exchange Act of 1934, as amended. We intend such forward-looking
statements to be covered by the safe harbor provisions for forward-looking
statements contained in the Private Securities Reform Act of 1995, and include
this statement for purposes of these safe harbor provisions. Forward-looking
statements, which are based on certain assumptions and describe our future
plans, strategies and expectations are generally identifiable by use of the
words "believe," "expect," "intend," "anticipate," "estimate," "project" or
similar expressions. First Banking Center's ability to predict results or the
actual effect of future plans or strategies is inherently uncertain. Factors
which could have a material adverse affect on our operations and future
prospects include, but are not limited to, changes in: interest rates, general
economic conditions, legislative/regulatory changes, acts of terrorism,
challenges by tax authorities, monetary and fiscal policies of the U.S.
Government, including policies of the U.S. Treasury and the Federal Reserve
Board, the quality or composition of the loan or investment portfolios, demand
for loan products, deposit flows, competition, demand for financial services in
our market area, our implementation of new technologies, our ability to develop
and maintain secure and reliable electronic systems and accounting principles,
policies and guidelines. These risks and uncertainties should be considered in
evaluating forward-looking statements and undue reliance should not be placed on
such statements.
FIRST BANKING CENTER, INC AND SUBSIDIARY
MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
As of September 30, 2004
The following discussion provides additional analysis of the financial condition
and results of operations of the Company for the three and the nine months ended
September 30, 2004. This discussion focuses on the significant factors that
affected the Company's earnings so far in 2004, with comparisons to 2003. As of
September 30, 2004, First Banking Center (the "Bank") was the only direct
subsidiary of the Company and its operations contributed nearly all of the
revenue for the year. The Company provides various support functions for the
Bank and receives payment from the Bank for these services. These intercompany
payments are eliminated for the purpose of these consolidated financial
statements. The Bank has three wholly owned subsidiaries, FBC Financial
Services, Corp., a brokerage and financial services subsidiary, FBC-Burlington,
Inc., an investment subsidiary located in Nevada and Burco Holdings, LLC, a real
estate subsidiary for the purpose of holding and liquidating property acquired
as other real estate.
Overview
As of September 30, 2004, total Company assets were $579.4 million, increasing
6.53% from $543.9 million as of December 31, 2003. Net income for the quarter
ended September 30, 2004 was $1.7 million or $1.06 per diluted share, decreasing
$198,000 or 10.69% from $1.9 million or $1.21 per diluted share in the third
quarter of 2003. Net income for the nine months ended September 30, 2004 was
$4.6 million or $2.97 per diluted share, decreasing $259,000 or 5.31% from $4.9
million or $3.19 per diluted share in the first nine months of 2003. The
significant items resulting in these results are discussed below.
Financial Condition
Loans
Loans outstanding were $460.9 million and $407.9 million on September 30, 2004
and December 31, 2003 respectively. This represented an increase of $53.0
million or 13.0%. The increase was primarily the result of continued strong
demand for commercial loans secured by real estate and construction and land
development loans. The increase in agricultural real estate loans was primarily
the reclassification of farm residential property from residential real estate
to agricultural real estate. Loan demand outpaced the growth in deposits in the
first nine months of 2004; therefore, the Company also sold some investment
securities and borrowed additional funds to fund a portion of this increased
loan demand.
11
The following table summarizes the changes to date in the major loan
classifications:
As a % of Total Loans
September 30, December 31, Change in September 30, December 31,
2004 2003 Balance 2004 2003
---------------------------------------------- -------------------------------
(Dollars in millions)
Residential Real Estate $155.1 $178.5 ($23.4) 33.7% 43.8%
Commercial Real Estate $128.0 $101.1 $26.9 27.8% 24.8%
Construction and Land Development $63.7 $43.0 $20.7 13.8% 10.5%
Commercial $32.6 $27.6 $5.0 7.1% 6.8%
Agricultural Real Estate $54.4 $25.9 $28.5 11.8% 6.4%
Allowance for Loan Losses
One measure of the adequacy of the allowance for loan losses is the ratio of the
allowance for loan losses to total loans. The allowance for loan losses was $4.7
million or 1.01% of gross loans on September 30, 2004, compared with $4.6
million or 1.13% of gross loans on December 31, 2003. Net charge-offs were
$122,000 or .03% of gross loans and $351,000 or .09% of gross loans for the nine
months ended September 30, 2004 and 2003, respectively. The allowance for loan
losses was 123.17% of non-accrual loans at September 30, 2004 as compared to
226.1% at December 31, 2003. See below for further information regarding the
increase in non-accrual loans and "Results of Operations-Provision for Loan
Losses" for matters relating to the determination of the provision for loan
losses in the first nine months of 2004.
The allowance for loan losses is established through a provision for loan losses
charged to expense. See "Provision for Loan Losses" below for information on the
provision during the periods. Loans are charged against the allowance for loan
losses when management believes that the collectibility of the principal is
unlikely. Not withstanding the increase in non-accrual loans, it is management's
belief that the allowance for loan losses is adequate to cover probable credit
losses relating to specifically identified loans, as well as probable credit
losses inherent in the balance of the loan portfolio. However, there can be no
assurance that the allowance for loan losses will be adequate to cover all
losses that actually occur. In accordance with FASB Statements 5 and 114, the
allowance is provided for losses that have been incurred as of the balance sheet
date. The allowance is based on past events and current economic conditions, and
does not include the effects of expected losses on specific loans or groups of
loans that are related to future events or expected changes in economic
conditions. Management reviews a calculation of the allowance for loan losses on
a quarterly basis. While management uses the best information available to make
its evaluation, future adjustments to the allowance may be necessary if there
are significant changes in economic conditions or trends, potential exposure in
the loan portfolio or other factors. Impaired loans are measured based on the
present value of expected future cash flows discounted at the loan's effective
interest rate or, as a practical expedient, at the loan's observable market
price or the fair value of the collateral if the loan is collateral dependent. A
loan is impaired when it is probable the Company will be unable to collect all
contractual principal and interest payments due in accordance with the terms of
the loan agreement.
In addition, various regulatory agencies periodically review the allowance for
loan losses. These agencies may require the Bank to make additions to the
allowance for loan losses based on their judgments of collectibility based on
information available to them at the time of their examination.
12
The following table provides a detailed analysis of changes in the indicated
periods in the allowance for estimated loan losses:
Nine Months Ended
September 30,
2004 2003
----------------------------------
(Dollars in thousands)
Balance, beginning of fiscal year $ 4,617 $ 4,988
Charge-offs:
Commercial 18 7
Agricultural production 0 42
Real estate:
Construction 0 0
Commercial 0 257
Agriculture 93 0
Other mortgages 46 42
Consumer (including installmment loans) 6 11
----------------------------------
Total Charge-offs 163 359
----------------------------------
Recoveries:
Commercial 0 2
Agricultural production 0 0
Real estate:
Construction 0 0
Commercial 0 0
Agriculture 20 0
Other mortgages 8 0
Consumer (including installment loans) 13 6
----------------------------------
Total Recoveries 41 8
----------------------------------
Net Charge-offs 122 351
Provision charged to operations 177 90
----------------------------------
Balance, end of period $ 4,672 $ 4,727
==================================
Average amount of loans outstanding
before allowance for estimated losses on loans $ 437,273 $ 371,448
==================================
Ratio of net charge-offs during the
period to average loans outstanding
during the period 0.028% 0.094%
==================================
13
Non-accrual, Past Due and Renegotiated Loans
September 30, December 31,
2004 2003
---------------- ----------------
(Dollars in thousands)
Non-accrual Loans (a) $3,793 $2,041
Past Due 90 days + (b) 0 0
Restructured Loans 0 0
The policy of the Company is to place a loan on non-accrual status if:
(a) payment in full of interest and principal is not expected, or
(b) principal or interest has been in default for a period of 90 days or more
unless the obligation is both in the process of collection and well
secured. Well secured is defined as collateral with sufficient market value
to repay principal and all accrued interest. A debt is in the process of
collection if collection of the debt is proceeding in due course either
through legal action, including judgment enforcement procedures, or in
appropriate circumstances, through collection efforts not involving legal
action which are reasonably expected to result in repayment of the debt or
in its restoration to current status.
The non-accrual loans consisted primarily of $2.3 million of residential real
estate loans, $378,000 of farmland, $487,000 of agricultural production loans
and $546,000 of commercial and commercial real estate loans. The increase during
the first nine months of 2004 was the result of non-accrual residential real
estate loans increasing $838,000, non-accrual farmland loans increasing
$303,000, non-accrual agricultural production loans increasing $484,000 and
non-accrual commercial and commercial real estate loans of $38,000. The bulk of
the increase related to factors involving specific loans in the foreclosure
process. The legal aspects of the foreclosure process increasingly extend the
period of final collection of the loan, causing loans to be in non-accrual
status for longer periods of time.
As of September 30, 2004, the Company had loans totaling $24.2 million (in
addition to those listed as non-accrual, past due or restructured) that were
identified by the Bank's internal asset rating system as classified assets and
loans which management has determined require additional monitoring. This
represented an increase of $5.8 million or 31.2% from December 31, 2003. The
increase was primarily the result of the Company modifying its standards,
beginning in the first quarter of 2004, whereby it now identifies potential
problem loans earlier in the process than in the past. By identifying the loans
earlier, they can be monitored more closely with the idea that action can be
taken before they become problem loans. A portion of the increase, $1.2 million,
represented a change in the way the Company treats the guaranteed portion of a
loan. Beginning with the first quarter of 2004, the Company included the
guaranteed portion of a classified loan in the classified loan total. The
Company believes it has adequate reserves for anticipated losses that could
result from the increase in classified assets; however, there can be no
assurance that the allowance for loan losses will be adequate to cover all
losses that actually occur. Management is not aware of any significant loans,
group of loans or segments of the loan portfolio not included above, where full
collectibility cannot reasonably be expected. Management has committed resources
and is focusing on efforts designed to control the amount of classified assets.
The Company does not have a substantial portion of its loans concentrated in one
or a few industries nor does it have any foreign loans outstanding as of
September 30, 2004. The Company's loans are concentrated geographically in the
Wisconsin counties of Racine, Walworth, Kenosha, Lafayette and Green.
Investment Securities - Available for Sale
The fair value of the securities available-for-sale portfolio at September 30,
2004, decreased $13.9 million or 16.8% from December 31, 2003. During the
period, the Company sold securities in the investment portfolio in part to fund
the increase in loans.
For the purposes of this discussion, changes in investment security balances are
based on amortized costs. The decrease came from three areas of the portfolio.
The Company purchased $60.5 million of U.S. government agency securities and
$3.6 million of municipal securities. The Company sold $4.6 million of U.S.
14
government agency notes and $1.7 million of municipal securities. There were
maturities and calls of $66.1 million of U.S. government agency notes and U.S.
government agency mortgage-backed securities and $4.9 million of municipal
securities.
Deposits
Total deposits were $432.3 million on September 30, 2004 compared to $407.5
million on December 31, 2003. This was an increase of $24.8 million or 6.1%. The
net gain in deposits of $24.8 million was mainly a result of the Company issuing
$20.0 million in brokered time deposits. Brokered deposits are deposits
generated outside of the Company's market area. They are sold by a broker to
individuals who have no other relationships with the Company, and are therefore
inherently less stable a source of funds than locally generated deposits. The
brokered deposits have a 7.0 - 7.5 year maturity, which exposes the Company to
interest rate risk for a period of time longer than the Company is accustomed to
when issuing time deposits in its market. To offset this risk, the deposits are
callable every six months and the Company has also entered into two callable
interest rate swaps that effectively convert the 7.0 - 7.5 year fixed rate
liabilities to one month LIBOR based variable rate liabilities. See Item 1,
"NOTE 6 - Derivative Instruments" for more information regarding the swaps. The
Bank's brokered deposits totaled $40.0 million at September 30, 2004. The
following table summarizes changes during 2004 in the major classifications of
deposits:
September 30, December 31, Change in
2004 2003 Balance
----------------------------------- --------------
(Amounts in millions)
Money Market and Savings $ 154.4 $ 149.2 $ 5.2
NOW Accounts 46.1 45.2 0.9
Demand Deposits 67.5 68.0 (0.5)
Time Deposits less than $100,000 91.0 87.1 3.9
Time Deposits equal or greater than $100,000 73.3 57.9 15.4
Borrowed Funds
Total borrowed funds were $86.3 million on September 30, 2004, compared to $78.8
million on December 31, 2003. This was an increase of $7.5 million or 9.5%.
Federal Home Loan borrowings decreased $18.5 million as maturities were not
replaced. The Company replaced these funds with brokered time deposits. Federal
funds borrowed increased by $25.7 million to fund the demand for loans. The
following table summarizes changes during 2004 in the major classifications of
borrowed funds:
September 30, December 31, Change in
2004 2003 Balance
----------------------------------- --------------
(Amounts in millions)
Securities sold under agreement to repurchase $ 27.9 $ 27.4 $ 0.5
Federal Home Loan Borrowings 25.7 44.2 (18.5)
Federal Funds Borrowed 32.3 6.7 25.6
Further information regarding our FHLB borrowings as of December 31, 2003 is
included in Note 9 of our Consolidated Financial Statements in our annual report
on Form 10-K for the year ended December 31, 2003.
Capital resources
As of September 30, 2004, the Company's stockholders' equity increased $3.3
million or 6.1% from December 31, 2003. Net income of $4.6 million was the
primary reason for the increase. In addition, the Company issued $243,000 of
common stock through its incentive stock option plan. These increases were
partially offset by the Company's repurchase of $634,000 of common stock into
treasury, cash dividends of $643,000 (or $.43 per share for the period ended
June 30, 2004), and a decrease in accumulated other comprehensive income of
$378,000, to $912,000 at September 30, 2004 from $1.3 million at year end.
Under the Federal Reserve Board's risk-based guidelines, capital is measured
against the Company's subsidiary bank's risk-weighted assets. The Company's tier
15
1 capital (common stockholders' equity less goodwill) to risk-weighted assets
was 11.4% at September 30, 2004, well above the 4% minimum required. Total
capital to risk-adjusted assets was 12.4 %; also well above the 8% minimum
requirement. The leverage ratio was at 9.5% compared to the 4% minimum
requirement. According to FDIC capital guidelines, the Company and the Bank were
considered to be "well capitalized" at September 30, 2004.
On October 15, 2004, the Company completed an offering of $7.5 million of
variable rate cumulative trust preferred securities representing undivided
beneficial interests in First Banking Center Trust I. The proceeds from the
offering were used by the trust to purchase junior subordinated debentures from
the Company. The proceeds will be used for general corporate purposes, including
future transactions or the retirement of debt. Interest is payable quarterly on
January 7, April 7, July 7 and October 7 of each year, commencing January 7,
2005 at a variable rate reset quarterly equal to three month LIBOR plus 2.50%.
The debentures will mature and the trust preferred securities must be redeemed
on January 7, 2035. The Company has the option to shorten the maturity date to a
date not earlier than January 7, 2010. The Company may not shorten the maturity
date without prior approval of the Board of Governors of the Federal Reserve
System, if required. Prior redemption is permitted under certain circumstances,
such as changes in tax or regulatory capital rules.
Asset/liability management
The principal function of asset/liability management is to manage the balance
sheet mix, maturities, repricing characteristics and pricing components to
provide an adequate and stable net interest margin with an acceptable level of
risk over time and through interest rate cycles.
Interest-sensitive assets and liabilities are those that are subject to
repricing within a specific relevant time horizon. The Bank measures
interest-sensitive assets and liabilities, and their relationship with each
other at terms of immediate, quarterly intervals up to 1 year, and over 1 year.
Changes in net interest income, other than volume related, arise when interest
rates on assets reprice in a time frame or interest rate environment that is
different from the repricing period for liabilities. Changes in net interest
income also arise from changes in the mix of interest earning assets and
interest-bearing liabilities.
The Bank's strategy with respect to asset/liability management is to maximize
net interest income while limiting its exposure to a potential downward
movement. This strategy is implemented by the Bank's management, which takes
action based upon its analysis of a number of factors, including the Bank's
present positioning, its desired future positioning, economic forecasts, and its
goals. It is the Bank's desire to maintain a cumulative gap of positive or
negative 15% of rate sensitive assets at the 1-year time frame. The percentage
at September 30, 2004 was a positive 16%, which compared to a positive 20% as of
December 31, 2003. Although these ratios were outside the Bank's target range,
and the Bank would therefore be somewhat exposed to declining rates, management
felt the ratios were appropriate due to management's projection for future
interest rates.
Liquidity
Liquidity measures the ability to meet maturing obligations and existing
commitments, to withstand fluctuations in deposit levels, to fund operations,
and to provide for customers' credit needs. One source of liquidity is cash and
short-term assets, such as interest-bearing deposits in other banks and federal
funds sold, which totaled $18.1 million at September 30, 2004, compared with
$23.3 million at December 31, 2003. The Bank has a variety of sources of
short-term liquidity available to it, including federal funds purchased from
correspondent banks, sales of securities available for sale, FHLB advances,
lines of credit and loan participations or sales. As in the second and third
quarters, the Bank can also use brokered deposits to raise additional cash. In
addition, brokered deposits are inherently less stable than locally generated
ones because they are not generated from local customers having other
relationships with the Bank. See "Financial Condition - Deposits" above. During
the third quarter of 2004, the Bank became increasingly dependent upon borrowed
funds as its loans outstanding increased at a higher rate than deposits. While
management believes that these types of brokered deposits and borrowings are
available on reasonable terms, there can be no assurance they will continue to
be. The Bank also generates liquidity from the regular principal payments and
prepayments made on its portfolio of loans and mortgage-backed securities and,
if appropriate, by selling available for sale securities. Although changes in
interest rates could negatively impact liquidity, management feels the Bank has
adequate sources to meet its liquidity needs. Any effects that changes in
interest rates have on income should have minimal impact on liquidity.
16
The cash position of the Bank is determined by activity in three primary
classifications: cash flows from operating activities, cash flows from investing
activities, and cash flows from financing activities. As a net result of these
activities, the Bank's cash decreased for the nine months of 2004. Net cash
provided by operating activities was $5.3 million. This was primarily a result
of net income, normal increases and decreases in operations offset by net
secondary market loan proceeds over originating secondary market loans. Net cash
used in investing activities, consisting primarily of loan funding and purchases
of securities, was $42.7 million. Net cash provided by financing activities,
consisting primarily of a $26.1 million increase in short term borrowings and
deposit growth of $24.8 million offset by $18.7 million in payments on other
borrowings, was $31.3 million for the nine months ended September 30, 2004.
As an additional source of liquidity, the Company received proceeds from its
trust preferred securities transaction as previously discussed in Item 2.
Capital Resources. The Company believes that it has sufficient resources to fund
its proposed going private transaction as discussed in Item 1. Note 8-Proposed
Going Private Transaction.
For the nine months ended September 30, 2003, net cash provided by operating
activities was $6.5 million. This was primarily a result of net secondary market
loan proceeds over originating secondary market loans. Net cash used in by
investing activities, consisting primarily of loans funding, federal funds sold
and proceeds from security transactions, was $3.9 million. Net cash used in
financing activities, consisting primarily of decreased deposits and proceeds
from other borrowings, was $9.6 million.
Off-Balance Sheet Liabilities and Contractual Obligations
Because the Company is a holding company for a financial institution, it
inherently has lending and other off-balance sheet financial commitments. It
also has substantial contractual obligations to pay monies deposited with it, in
addition to the types of long-term contractual obligations which other companies
incur. Information regarding the Company's off-balance sheet arrangements and a
summary of future contractual commitments is included in Note 5 - Commitments
and Contingencies in the interim financial statements included in this report in
Item 1. The information included in Note 5 is incorporated by reference in this
management's discussion and analysis.
Impact of Inflation and Changing Prices
The consolidated financial statements and the accompanying notes have been
prepared in accordance with accounting principles generally accepted in the
United States of America, which require the measurement of financial position
and operating results in terms of historical dollar amounts without considering
the changes in the relative purchasing power of money over time due to
inflation. The impact of inflation is reflected in the increased cost of our
operations. Unlike industrial companies, nearly all of our assets and
liabilities are monetary in nature. As a result, interest rates have a greater
impact on our performance than do the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same
extent as the price of goods and services.
Results of operations
Net Interest Income
Net interest income is the difference between interest income and fees on loans
and interest expense, and is the largest contributing factor to net income for
the Company. All discussions of rate are on an annualized tax-equivalent basis,
which accounts for income earned on nontaxable loans and securities that are not
fully subject to federal taxes. Net interest income was $4.6 million in the
third quarter of 2004, a decrease of $259,000 from $4.9 million in the same
period in 2003. For the nine month period ended September 30, 2004, net interest
income was $15.2 million, an increase of $1.1 million from $14.1 million in that
period in 2003. Net interest margin as a percentage of average earning assets
(includes loans placed on nonaccrual status) declined to 4.08% from 4.45% and to
4.01% from 4.12% for the three months and nine months ended September 30, 2004
and 2003, respectively.
The major component of interest income and fees on loans is the income generated
by loans. Although average yield declined to 5.72% from 6.32% and to 5.56% from
17
6.09% for the three months and nine months ended September 30, 2004 and 2003,
respectively, interest income and fees on loans increased as a result of
increased average loan balances.
The major components of interest expense are interest paid on certificates of
deposit (time deposits) and on money market deposits. The average interest rate
declined to 1.67% from 1.79% and to 1.64% from 1.94% for the three months and
nine months ended September 30, 2004 and 2003, respectively. Interest expense
decreased due to decreased rates paid on increased average balances.
The following table summarizes the changes and reasons for the changes in
interest earned and paid during the three and nine months ended September 30,
2004 and 2003:
18
Three months ended
September 30,
2004 2003
-------------------------------------------------------------
Interest Average Interest Average
Average Earned Yield Average Earned Yield
Balance or Paid or Cost Balance or Paid or Cost
-------------------------------------------------------------
(Dollars in thousands)
Interest Income:
Interest and fees on loans (a) (b) $ 455,383 6,511 5.72% 375,757 5,937 6.32%
Interest and dividends on securities:
Taxable 47,436 338 2.85% 58,044 458 3.16%
Nontaxable (a) 35,187 552 6.28% 36,392 618 6.79%
Interest on Fed funds sold 1,794 1 0.22% 5,987 13 0.87%
Interest on interest-bearing deposits in banks 294 5 6.80% 382 1 1.05%
-------------------------------------------------------------
Total Interest Income $ 540,094 7,407 5.49% 476,562 7,027 5.90%
=============================================================
Interest Expense
Interest on deposits $ 368,184 1,355 1.47% 314,871 1,243 1.58%
Interest on short-term borrowings 49,270 216 1.75% 25,413 44 0.69%
Interest on other borrowings 37,167 325 3.50% 45,101 442 3.92%
-------------------------------------------------------------
Total Interest Expense $ 454,621 1,896 1.67% 385,385 1,729 1.79%
=============================================================
Net interest margin $ 5,511 4.08% $ 5,298 4.45%
==================== ===================
Nine months ended
September 30,
2004 2003
-------------------------------------------------------------
Interest Average Interest Average
Average Earned Yield Average Earned Yield
Balance or Paid or Cost Balance or Paid or Cost
-------------------------------------------------------------
(Dollars in thousands)
Interest Income:
Interest and fees on loans (a) (b) $ 437,273 18,224 5.56% 370,589 16,916 6.09%
Interest and dividends on securities:
Taxable 50,105 1,263 3.36% 60,984 1,538 3.36%
Nontaxable (a) 35,896 1,700 6.31% 36,391 1,882 6.90%
Interest on Fed funds sold 2,059 14 0.91% 9,530 73 1.02%
Interest on interest-bearing deposits in banks 284 3 1.41% 1,751 16 1.22%
-------------------------------------------------------------
Total Interest Income $ 525,617 21,204 5.38% 479,245 20,425 5.68%
=============================================================
Interest Expense
Interest on deposits $ 348,733 3,687 1.41% 315,984 4,079 1.72%
Interest on short-term borrowings 49,634 526 1.41% 24,391 171 0.93%
Interest on other borrowings 41,879 1,197 3.81% 45,962 1,365 3.96%
-------------------------------------------------------------
Total Interest Expense $ 440,246 5,410 1.64% 386,337 5,615 1.94%
=============================================================
Net interest margin $ 15,794 4.01% $ 14,810 4.12%
==================== ===================
(a) The interest and average yield for nontaxable loans and investments are
presented on an annualized federal taxable equivalent basis assuming a 34%
tax rate.
(b) Interest and fees on loans decreased $479,000 and $1.593 million for the
three and nine months ending September 30, 2003 respectively due to a
reclassification of gains on the sales of loans.
19
Provision for Loan Losses
For the nine months ended September 30, 2004, $177,000 was charged to current
earnings and added to the allowance for loan losses compared to $90,000 during
the first nine months of 2003. In the third quarter of 2004, $77,000 was
expensed to the provision, as compared to no addition in the comparable period
in 2003. Net charge-offs decreased to $122,000 from $351,000 for the nine months
ended September 30, 2004 as compared to the nine months ended September 30,
2003. Non-accrual loans and classified loans increased $975,000 and $1.8
million, respectively, during the third quarter of 2004, and at the same time,
increased $1.8 million and $5.8 million, respectively, in the first nine months
of 2004. As a result of the increase in total loans and non-performing and
classified assets, charges to earnings rose during the nine months ended
September 30, 2004 versus 2003. The majority of existing and new non-accrual
loans are secured by real estate. These are loans the Company has had in its
collection process before they became non-accrual loans. The legal aspect of the
collections process often extends the collection period to the point that these
loans become past due greater than 90 days, thus causing them to go to
non-accrual status. Management believes the exposure to loss on the increased
non-performing and classified loans is minimal and that, there is adequate
collateral to cover the loan balances.
See "Allowance for Loan Losses" above for a description of the processes which
the Company uses in determining the amount of the provision and the allowance
for loan losses.
Non-interest Income
Non-interest income decreased $111,000 or 6.9% for the three months ended
September 30, 2004 compared to the three months ended September 30, 2003. The
decrease was primarily the result of decreased gains from the sale of loans
offset by an increase in service charge income on deposit accounts. Non-interest
income decreased $294,000 or 6.5% for the nine months ended September 30, 2004
compared to the nine months ended September 30, 2003. The decrease was primarily
the result of $944,000 in decreased gains from the sales of loans offset by a
$358,000 increase in service charge income on deposit accounts, $111,000 from
trust fees and $74,000 of income from other real estate owned. The decreased
income from the sale of loans was the result of increased interest rates on
fixed rate residential real estate loans. The increased interest rates caused a
decline in the volume of fixed rate residential real estate loans which the
Company sells to the secondary market.
Non-interest Expense
Non-interest expense increased $321,000 or 7.9% and $910,000 or 7.7% for the
three and nine months ended September 30, 2004 compared to the three and nine
months ended September 30, 2003. Salaries and benefit costs, which is the
largest component of non-interest expense, accounted for $162,000 and $431,000
of the increase for the three and nine months ended September 30, 2004 compared
to the three and nine months ended September 30, 2003. The increase in salaries
and costs can be attributed primarily to normal wage increases and increased
health insurance costs. Occupancy expense increased $70,000 and $148,000 for the
three and nine months ended September 30, 2004 compared to the three and nine
months ended September 30, 2003 due to increases in real estate taxes,
depreciation and utilities. Other expense increased $48,000 and $233,000 for the
three and nine months ended September 30, 2004 compared to the three and nine
months ended September 30, 2003. The bulk of the increase in other expense was
twofold. Professional service fees increased due to additional regulatory
requirements. Amortization expense increased due to the acquisition of a branch
in the second quarter of 2003.
Income Taxes
Income tax expense for the nine months ending September 30, 2004 was $1,945,000
compared to $1,926,000 for the nine months ending September 30, 2003. The
effective tax rate increased to 29.7% for the nine months ending September 30,
2004 compared to 28.3% for the nine months ending September 30, 2003. The
increase was primarily a result of an increase in taxable interest income.
Like many Wisconsin financial institutions, the Bank has a non-Wisconsin
subsidiary which holds and manages investments assets, the income from which has
not yet been subject to Wisconsin tax. The Wisconsin Department of Revenue
instituted an audit program, including an audit of the Bank, specifically aimed
at out of state bank subsidiaries and indicated that it may withdraw favorable
20
rulings previously issued in connection with such subsidiaries. As a result of
these developments, the Department may take the position that some or all of the
income of the out of state subsidiary is taxable in Wisconsin, which will likely
be challenged by financial institutions in the state. If the Department is
successful in its efforts, it could result in a substantial negative impact on
the earnings of the Bank.
In late July 2004, the Department sent letters to financial institutions in
Wisconsin (whether or not undergoing an audit) reporting on settlements
involving 17 banks and their out-of-state investment subsidiaries. The letter
provided a summary of the Department's currently available settlement
parameters. For prior periods they include: restrictions on the types of
subsidiary income excluded from Wisconsin taxation; assessment of certain back
taxes for a limited period of time; limitations on net operating loss
carryforwards and interest deductions related to subsidiary loans; and interest
(but not penalties) on past-due taxes. For 2004 and going forward, the letter
states similar provisions, including limits on subsidiaries' assets. Settlement
on the terms outlined would result in the rescission of prior letter rulings,
and purport to be binding going forward except for future legislation or change
by mutual agreement. Implicit in the letter appears to be an acceptance of the
general proposition that some out-of-state investment subsidiary income is not
subject to Wisconsin taxes.
The Company has advised the Department that it wishes to obtain and consider a
settlement proposal from the Department and will provide requested information.
The Company has not yet received a specific proposal nor has an assessment been
made against the Company or its subsidiaries. The Company will need more
specific detail to quantify in any definitive way the Department's view of its
exposure and to evaluate alternatives. The Company continues to believe that it
has reported income and paid Wisconsin taxes correctly in accordance with
applicable tax laws and the Department's prior longstanding interpretations
thereof. However, as a result of the Department's changes in position and
aggressive stance, any final resolution of these matters could have a
substantial adverse affect relating to prior periods and/or practices going
forward.
Critical Accounting Policies
Allowance for Loan Losses
Management believes the allowance for loan losses accounting policy is critical
to the portrayal and understanding of our financial condition and results of
operations. As such, selection and application of this "critical accounting
policy" inherently involves judgments, estimates, and uncertainties that are
susceptible to change. In the event that different assumptions or conditions
were to prevail, and depending upon the severity of such changes, the
possibility of materially different financial condition or results or operations
is a reasonable likelihood. For further detail, see the explanations under
"Financial Condition-Loans" above.
Income Taxes
See Note 1 of the notes to our audited consolidated financial statements for the
year ended December 31, 2003 for our income tax accounting policy. Income tax
expense recorded in the consolidated income statement involves interpretation
and application of certain accounting pronouncements and federal and state tax
codes, and is, therefore, considered a critical accounting policy. We undergo
examinations by various regulatory taxing authorities. Such agencies may require
that changes in the amount of tax expense or valuation allowance be recognized
when their interpretations differ from those of management, based on their
judgments about information available to them at the time of their examinations.
In addition, as noted above, the Bank is undergoing a state tax audit relating
to the activities and holdings of one of its subsidiaries; we must make
judgments as to the expected effect of that audit. See "Results of
Operations-Income Taxes" and Note 12 of the notes to our audited consolidated
financial statements for the year ended December 31, 2003 for more income tax
information.
21
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company, like other financial institutions, is subject to direct and
indirect market risk. Direct market risk exists from changes in interest rates.
The Company's net income is dependent on its net interest income. Net interest
income is susceptible to interest rate risk to the degree that interest-bearing
liabilities mature or reprice on a different basis than interest-earning assets.
When interest-bearing liabilities mature or reprice more quickly than
interest-earning assets in a given period, a significant increase in market
rates of interest could adversely affect net interest income.
Similarly, when interest-earning assets mature or reprice more quickly than
interest-bearing liabilities, falling interest rates could result in a decrease
in net income.
In an attempt to manage exposure to changes in interest rates, management
monitors interest rate risk. The Asset/Liability Committee meets quarterly to
review the interest rate risk position and profitability, and to make or
recommend adjustments. Management also reviews the securities portfolio,
formulates investment strategies, and oversees the timing and implementation of
transactions to assure attainment of the Company's objectives in the most
effective manner. Notwithstanding our interest rate risk management activities,
the potential for changing interest rates is an uncertainty that can have an
adverse effect on net income.
In adjusting the asset/liability position, management attempts to manage
interest rate risk while maintaining or enhancing net interest margins. At
times, depending on the level of general interest rates, the relationship
between long-term and short-term interest rates, market conditions and
competitive factors, management may decide to increase the interest rate risk
position somewhat in order to increase the net interest margin. The Company's
results of operations and net portfolio values remain vulnerable to increases in
interest rates and to fluctuations in the difference between long-term and
short-term interest rates.
One approach used to quantify interest rate risk is the net portfolio value
("NPV") analysis. In essence, this analysis calculates the difference between
the present value of liabilities and the present value of expected cash flows
from assets and off-balance-sheet contracts. The most recent NPV analysis, as of
September 30, 2004, projected that net portfolio value would decrease by
approximately 6.64% if interest rates would rise 200 basis points and would
decrease by approximately 2.42% if interest rates would rise 100 basis points
over the next year. It projects an increase in net portfolio value of
approximately 4.85% if interest rates would drop 200 basis points and an
increase of approximately 2.91% if interest rates would drop 100 basis points.
Both simulations are within board-established policy limits. The Company has not
experienced any material changes to its market risk position since December 31,
2003, as disclosed in the Company's 2003 Form 10-K Annual Report. The Company's
policy is to limit the effect of a 200 basis point rate shock to plus or minus
20% of projected net interest income and to minus 20% of the market value of
portfolio equity.
The Company does not currently engage in trading activities to control interest
rates. Even though such activities may be permitted with the approval of the
Board of Directors, the Company does not intend to engage in such activities in
the immediate future. However, the Company has engaged in the use of derivative
instruments for the period ended September 30, 2004 and intends to engage in
such activities going forward.
Interest rate risk is the most significant market risk affecting the Company.
Other types of market risk, such as foreign currency exchange rate risk and
commodity price risk, do not arise in the normal course of the Company's
business activities.
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Item 4. Controls and Procedures
The Company maintains disclosure controls and procedures designed to ensure that
the information the Company must disclose in its filings with the Securities and
Exchange Commission is recorded, processed, summarized and reported on a timely
basis. The Company's principal executive officer and principal financial officer
have reviewed and evaluated the Company's disclosure controls and procedures as
defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act
of 1934, as amended (the "Exchange Act"), as of the end of the period covered by
this report (the "Evaluation Date"). Based on such evaluation, such officers
have concluded that, as of the Evaluation Date, the Company's disclosure
controls and procedures are effective in bringing to their attention, on a
timely basis, material information relating to the Company required to be
included in the Company's periodic filings under the Exchange Act.
There have not been any changes in the Company's internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that
occurred during the Company's most recent fiscal quarter that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
Part II-OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
On October 15, 2004, the Company completed an offering of $7.5 million
of variable rate cumulative trust preferred securities representing
undivided beneficial interests in First Banking Center Trust I. The
proceeds from the offering were used by the trust to purchase junior
subordinated debentures from the Company. The proceeds will be used
for general corporate purposes, including future transactions or the
retirement of debt. Interest is payable quarterly on January 7, April
7, July 7 and October 7 of each year, commencing January 7, 2005 at a
variable rate reset quarterly equal to three month LIBOR plus 2.50%.
The debentures will mature and the trust preferred securities must be
redeemed on January 7, 2035. The Company has the option to shorten the
maturity date to a date not earlier than January 7, 2010. The Company
may not shorten the maturity date without prior approval of the Board
of Governors of the Federal Reserve System, if required. Prior
redemption is permitted under certain circumstances, such as changes
in tax or regulatory capital rules.
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Item 6. Exhibits
10.1 Indenture dated as of October 15, 2004, between First Banking
Center, Inc. and Wells Fargo Bank, National Association.
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a-14(a)/15(d)-14(a) as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (exhibit is being filed herewith).
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a-14(a)/15(d)-14(a) as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (exhibit is being filed herewith).
32.1 Certification of the Chief Executive Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (exhibit is being filed herewith).
32.2 Certification of the Chief Executive Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (exhibit is being filed herewith).
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FIRST BANKING CENTER, INC AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1943, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
First Banking Center, Inc.
November 15, 2004 /s/ Brantly Chappell
Date -----------------------
Brantly Chappell
Chief Executive Officer
November 15, 2004 /s/ James Schuster
Date -----------------------
James Schuster
Chief Financial Officer
25