SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1999
Commission File No.: 000-25231
NORTHERN STAR FINANCIAL, INC.
(Name of Small Business Issuer as specified in its charter)
Minnesota 41-1912467
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
1650 Madison Avenue, Mankato, Minnesota 56001
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (507) 387-2265
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, $.0l par value per share
Check whether the Issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act 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 [ ]
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained herein, and will not be contained, to the best of
Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ ]
Issuer's revenues for its most recent fiscal year: $154,875
The aggregate market value of the Common Stock held by nonaffiliates of the
Registrant as of September 3, 1999 was approximately $1,906,500 based upon the
average high and low bid prices of the Registrant's Common Stock on such date.
There were 425,600 shares of Common Stock, $.0l par value, outstanding as of
September 3, 1999.
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DOCUMENTS INCORPORATED BY REFERENCE
Documents incorporated by reference pursuant to Rule 12b-23: Portions of the
Registrant's Proxy Statement for its 1999 Annual Meeting are incorporated by
reference into Items 9, 10, 11 and 12 of Part III.
Transitional Small Business Disclosure Format (check one). Yes [ ] No [ X ]
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INDEX
Description Page
PART I.........................................................................1
ITEM 1. DESCRIPTION OF BUSINESS.............................................1
ITEM 2. DESCRIPTION OF PROPERTY............................................10
ITEM 3. LEGAL PROCEEDINGS..................................................10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................10
PART II.......................................................................11
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...........11
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION..........11
ITEM 7. FINANCIAL STATEMENTS...............................................25
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE...........................................46
PART III......................................................................46
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.............46
ITEM 10. EXECUTIVE COMPENSATION............................................46
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT....46
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................47
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K..................................47
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
This Report contains statements, which constitute forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
the Securities Exchange Act of 1934. These statements appear in a number of
places in this Report and include all statements regarding the intent, belief or
current expectations of the Company, its directors or its officers with respect
to, among other things: (i) the Company's financing plans; (ii) trends affecting
the Company's financial condition or results of operations; (iii) the Company's
growth strategy and operating strategy; and (iv) the declaration and payment of
dividends. Investors are cautioned that any such forward-looking statements are
not guarantees of future performance and involve risks and uncertainties, and
that actual results may differ materially from those projected in the
forward-looking statements as a result of varies factors discussed herein and
those factors discussed in detail in the Company's filings with the Securities
and Exchange Commission.
GENERAL
Northern Star Financial Inc., a Minnesota corporation, (the "Company")
is a one-bank holding company registered under the Bank Holding Company Act of
1956 ("BHC Act"). On January 25, 1999, the Company acquired all the outstanding
shares of Northern Star Bank (the "Bank"). As a bank holding company, the
Company is a legal entity separate and distinct from the Bank. The Company's
revenues and net income are derived solely from the Bank through dividends and
management fees.
The Bank commenced operation on January 25, 1999. The Bank serves the
banking needs of residents of the Minnesota counties of Blue Earth and Nicollet,
which include the Mankato, Minnesota area. The Bank conducts its operations from
a single bank office located at 1650 Madison Avenue, Mankato, Minnesota. The
Bank is a Minnesota State Chartered Bank and its deposits are insured by the
Federal Deposit Insurance Corporation ("FDIC"). The Bank is primarily engaged in
the business of attracting deposits from the general public and local businesses
and providing credit services in the form of commercial, agricultural, real
estate and consumer loans. The Bank provides a full range of deposit accounts
and credit services, along with other traditional commercial and consumer
banking services, including safe deposit services and automated teller cards.
DEPOSITS
The Bank offers a full range of deposit services that are typically
available in most banks and savings associations, including checking accounts,
commercial accounts, savings accounts, and other time deposits of various types,
ranging from daily money market accounts to longer-term certificates of deposit.
The transaction accounts and time certificates are tailored to the Bank's
principal market area at rates competitive to those offered in the Mankato area.
In addition, the Bank offers certain retirement account services and sweep
accounts, such as Individual Retirement Accounts (IRAs).
LENDING ACTIVITIES
General. The Bank emphasizes a range of lending services, including
commercial, real estate, and consumer loans, to individuals and small to
medium-sized businesses and professional concerns that are located in or conduct
a substantial portion of their business in the Bank's market area.
Commercial, Lease and Agricultural Loans. The Bank makes loans for
commercial purposes in various lines of businesses. Equipment loans are
typically for a term of five years or less at fixed or variable rates, with the
loan fully amortized over the term and secured by the financed equipment and
with a loan-to-value ratio of 80% or less. Working capital loans typically have
terms not exceeding one year and will usually be secured by accounts receivable,
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inventory, or personal guarantees of the principal owners of the business. For
loans secured by accounts receivable or inventory, the principal amount of a
loan will typically be repaid as the assets securing the loan are converted into
cash, and in other cases, the principal amount of a loan will typically be due
at maturity. The primary economic risk associated with each category of loans,
including commercial loans, is the creditworthiness of the Bank's borrowers. The
risks associated with commercial loans vary with many economic factors,
including the economy in the Bank's principal market area. The Bank expects that
it will make a significant portion of its commercial loans to small to
medium-sized businesses which may be less able to withstand competitive,
economic, and financial conditions than larger borrowers.
Real Estate Loans. One of the primary components of the Bank's loan
portfolio is loans secured by first or second mortgages on real estate. These
loans generally consist of commercial real estate loans, construction and
development loans, and residential real estate loans (home equity loans are
included as they are classified as consumer loans). The underwriting criteria
for home equity loans and lines of credit will generally be the same as applied
by the Bank when making a first mortgage loan, as described above. Home equity
lines of credit will typically expire ten years or sooner after origination.
Loan terms generally are limited to five years or less, although payments may be
structured on a longer amortization basis. Interest rates may be fixed or
adjustable, and will more likely be fixed in the case of short-term loans.
Management attempts to reduce the Bank's credit risk in its commercial real
estate portfolio by emphasizing loans on owner-occupied office and retail
buildings where the loan-to-value ratio, established by independent appraisals,
does not exceed 80%. In addition, the Bank typically requires personal
guarantees of the principal owners of the collateral property, combined with a
review by the Bank of the personal financial statements of the principal owners.
The principal economic risk associated with each category of anticipated loans,
including real estate loans, is the creditworthiness of the Bank's borrowers.
The risks associated with real estate loans vary with many economic factors,
including employment levels and fluctuations in the value of real estate.
Consumer Loans. The Bank makes a variety of loans to individuals for
personal and household purposes, including secured and unsecured installment and
term loans, home equity loans and lines of credit, and revolving lines of credit
such as credit cards. These loans typically will carry balances of less than
$25,000 and, in the case of non-revolving loans, will be amortized over a period
not to exceed 60 months. Ninety-day term loans typically bear interest at a
fixed rate. The revolving loans typically bear interest at a fixed rate and
require monthly payments of interest and a portion of the principal balance. As
with the other categories of loans, the principal economic risk associated with
consumer loans is the creditworthiness of the Bank's borrowers. The principal
competitors of consumer loans will be the established banks in the Bank's
principal market area.
Loan Approval and Review. The Bank's loan approval policies provide for
various levels of officer lending authority. When the amount of aggregate loans
to a single borrower exceeds that individual officer's lending authority, the
loan request will be considered and approved by an officer with a higher lending
limit. The Bank has established a directors' loan committee that has lending
limits, and any loan in excess of this lending limit will be approved by the
directors' loan committee. The Bank will not make any loans to any director,
officer, or employee of the Bank unless the loan is approved by the board of
directors of the Bank and is made on terms not more favorable to such person
than would be available to a person not affiliated with the Bank.
Lending Limits. The Bank's lending activities are subject to a variety
of lending limits imposed by federal law. While differing lending limits apply
in certain circumstances based on the type of loan or the nature of the borrower
(including the borrower's relationship to the Bank), in general, the Bank is
subject to a loan-to-one-borrower limit. Since the enactment of the FIRREA in
1989, the Bank generally may not make loans to one borrower and related entities
in an amount which exceeds 15% of its unimpaired capital and surplus, although
loans in an amount equal to an additional 10% of unimpaired capital and surplus
may be made to a borrower if the loans are fully secured by readily marketable
securities. Unless the Bank is able to sell participations in its loans to other
financial institutions, the Bank will not be able to meet all of the lending
needs of loan customers requiring aggregate extensions of credit above these
limits.
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OTHER BANKING SERVICES
Other services the Bank provides include cash management services, safe
deposit boxes, traveler's checks, and direct deposit of payroll and social
security checks. The Bank expects to provide in the future telebanc and
automatic drafts for various accounts. The Bank is associated with a shared
network of automated teller machines that may be used by Bank customers
throughout Minnesota and other regions and permit customers to access their
funds 24 hours a day from locations outside the Bank's primary market area. The
Bank also offers MasterCard and VISA credit card services through a
correspondent bank as an agent for the Bank.
The Company entered into a joint venture in July 1999 to form Homeland
Mortgage Company, LLC. Homeland Mortgage Company, LLC was established to serve
as a mortgage servicer and originator. Under the terms of the joint venture
agreement, the Company acquired a 49% equity interest in Homeland Mortgage
Company, LLC.
LOCATION AND SERVICE AREA
The Bank's principal market area is the Minnesota counties of Blue
Earth and Nicollet, which includes the communities of Mankato, North Mankato,
LeHiller and Skyline, Minnesota, from which the Bank is expected to draw a
significant portion of its business. Approximately 85,000 people reside in the
Bank's principal market area. The 1997 median household income of residents
living in the Bank's principal market area was approximately $43,000.
MARKETING FOCUS
The Company believes that local bank branches of large regional banks
and a limited number of small community banks provide the majority of the
banking services within its principal market area. The Company believes there is
a need for a locally operated and managed community bank and believes that the
Bank can successfully fill this need. The Company generally will concentrate its
efforts on attracting and servicing small to medium-sized businesses and
individuals. The Company plans to utilize newspaper, radio and billboard
advertising in its principal market area to promote the Bank. The Company
intends to emphasize the Company's local management and ownership and the Bank's
community focus, its ability to provide personalized service and its competitive
products and services.
COMPETITION
The business of operating a community bank is highly competitive. The
Bank will compete with community and national banks, credit unions, thrifts, and
non-financial institutions such as insurance companies and investment banks. The
Bank's principal market area, the two Minnesota counties of Blue Earth and
Nicollet, are served by 40 offices of 21 different banks, two federal savings
banks and five credit unions. The communities of Mankato and North Mankato are
served by four locally chartered commercial banks. During 1999 two of the four
bank charters were acquired and a savings bank charter was converted to a
commercial bank charter and relocated. Banks and credit unions located outside
of the counties of Blue Earth and Nicollet also compete with the Bank. Most, if
not all, of the Bank's competitors have substantially greater financial
resources than the Company. The Company believes the Bank's competitive strength
will lie in providing long-term, relationship-oriented banking services by
management and employees with strong ties to the Mankato area. The Bank expects
to target all residents of its principal market area, especially local
businesses and homeowners.
SUPERVISION AND REGULATION
General
Commercial banking is highly regulated at both the federal and state
level. Deposits, reserves, investments, loans, consumer law compliance, issuance
of securities, payment of dividends, mergers and consolidations, electronic
funds transfers, management practices and other aspects of the Company's and the
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Bank's operations are subject to regulation. This regulation is designed
primarily to protect depositors and not to benefit owners of the Company or the
Bank. The highly regulated environment in which the Company and the Bank operate
is subject to frequent change. Federal banking bills are currently under
consideration in Congress which, if enacted, could have a variety of effects on
this regulatory environment. In general, pending legislation would repeal
portions of the Glass-Steagall Act and would broaden the permissible range of
affiliations between commercial banks and investment banks. In addition, these
bills could limit the authority of the Office of the Comptroller of the Currency
to authorize new insurance activities for banks, and could provide relief from a
variety of federal banking regulations. The Company cannot fully predict the
nature or the extent of any effects which these proposed regulatory changes or
other possible regulatory changes may have on its business and earnings. Such
changes may have the effect of increasing or decreasing the cost of doing
business, modifying permissible activities, or enhancing the competitive
position of other financial institutions.
Bank Holding Company Regulation
In addition to a variety of generally applicable state and federal laws
governing businesses and employers, the Company is extensively regulated by
special laws applicable only to financial institutions. Virtually all aspects of
the Company's operations are subject to specific requirements or restrictions
and general regulatory oversight. With few exceptions, state and federal banking
laws have as their principal objective either the maintenance of the safety and
soundness of the financial institution and the federal deposit insurance system
or the protection of consumers or classes of consumers, rather than the specific
protection of shareholders of the Company.
Supervision. As a bank holding company, the Company is subject to
regulation by the Federal Reserve Board under the BHC Act and various
regulations adopted by the Federal Reserve Board. The Company is required to
file with the Federal Reserve Board quarterly and annual reports and such
additional information as the Federal Reserve Board may require pursuant
currently to the BHC Act. The Federal Reserve Board also may examine the
Company. The Company is not currently subject to any formal or informal
enforcement actions by any bank regulatory office as a result of such
examination or for any other reason. The Federal Reserve Board also has
authority, in certain circumstances, to approve or disapprove stock redemptions,
changes in ownership or control, and dividend payments. The Federal Reserve
Board may also require that the Company terminate an activity or terminate
control of or liquidate or divest certain non-bank subsidiaries or affiliates
when the Federal Reserve Board believes the activity or the control of the
subsidiary or affiliate constitutes a significant risk to the financial safety,
soundness or stability of any of its banking subsidiaries. Under the BHC Act and
regulations adopted by the Federal Reserve Board, a bank holding company and its
non-banking subsidiaries are prohibited from requiring certain tie-in
arrangements in connection with any extension of credit, lease or sale of
property or furnishing of services. Further, the Company is required by the
Federal Reserve Board to maintain certain levels of capital.
Payment of Dividends by the Company. The Federal Reserve Board has
indicated that banking organizations should generally pay cash dividends out of
current operating earnings and the current rate of earnings retention should be
consistent with the organization's capital needs, asset quality and overall
financial condition. The Federal Reserve Board policy strongly discourages a
bank holding company from declaring or paying a cash dividend which would impose
undue pressure on the capital of subsidiary banks or would be funded only
through borrowings or other arrangements that might adversely affect the holding
company's financial position. The Federal Reserve may, and in certain
circumstances must, prohibit a bank holding company from making any capital
distributions without prior approval of the Federal Reserve Board, if the
subsidiary institution is undercapitalized. The Federal Reserve Board also may
impose limitations on the payment of dividends as a condition to its approval of
certain applications, including applications for approval of mergers or
acquisitions.
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In addition to the restrictions on dividends imposed by the Federal
Reserve, under the Minnesota Business Corporation Act, the discretion of the
Company's Board of Directors is constrained by Minnesota Statutes, section
302A.551. Under that section, the Board may only authorize a dividend if in good
faith, in a manner that the directors reasonably believe to be in the best
interests of the corporation, and with the care an ordinarily prudent person in
a like position would exercise under similar circumstances, the board determines
that the corporation will be able to pay its debts in the ordinary course of
business after making a distribution.
Regulatory Capital Requirements. The Federal Reserve Board's capital
guidelines establish the following minimum regulatory capital requirements for
bank holding companies: (i) a capital leverage requirement expressed as a
percentage of total assets, (ii) a risk-based requirement expressed as a
percentage of total risk-weighted assets, and (iii) a Tier 1 leverage
requirement expressed as a percentage of total assets. Tier 1 capital consists
of common stockholders' equity, qualifying preferred stock, and minority
interests in the equity accounts of consolidated subsidiaries. The Federal
Reserve Board approved the use of certain cumulative preferred stock instruments
in Tier 1 capital as minority interest in the equity accounts of consolidated
subsidiaries. The failure of a bank holding company to meet its risk-weighted
capital ratios may result in supervisory action, as well as an inability to
obtain approval of any regulatory applications and, potentially, increased
frequency of examination. The federal bank regulators have previously indicated
a desire to raise minimum capital requirements for banking organizations and
have suggested that revisions to the risk-based capital requirements should be
made. The effect of any future change in the required capital ratios of the
Company cannot be determined at this time.
Activity Limitations. The BHC Act, in general, limits the activities
that may be engaged in by the Company and the Bank and the Company's other
subsidiaries to those so closely related to banking, managing or controlling
banks as to be a proper incident thereto. The Federal Reserve Board, in making
such determinations, considers whether performance of the activities by the
Company can reasonably be expected to produce benefits to the public without any
adverse effects such as undue concentration of resources, decreased or unfair
competition, conflicts of interest or unsound banking practices. The Company may
engage, subject to Federal Reserve Board guidelines and approvals, in such
closely-related activities as: (1) making or acquiring loans and other
extensions of credit of the type made by mortgage, finance, credit card, or
factoring companies; (2) operating an industrial bank; (3) servicing loans and
other extensions of credit; (4) performing the functions of a trust company; (5)
acting as an investment or financial advisor; (6) leasing certain real estate or
personal property; (7) making investments to promote community welfare; (8)
providing data processing and data transmission services; (9) acting as an
underwriter for credit life insurance and credit health and accident insurance
directly related to extensions of credit by the holding company system; (10)
providing courier services for checks and certain other instrument exchanges
among banks and for audit and accounting media of a banking or financial nature;
(11) providing certain kinds of management consulting advice; (12) selling, at
retail, money orders, travelers' checks and U.S. savings bonds; (13) performing
real estate appraisals; (14) arranging commercial real estate equity financing;
(15) providing securities brokerage services; (16) underwriting or dealing in
government obligations and money market instruments; (17) engaging in foreign
exchange advisory and transactional services; and (18) acting as a futures
commission merchant. Recently enacted legislation allows well capitalized bank
holding companies to engage in certain activities without the advance approval
of the Federal Reserve Board. Well capitalized bank holding companies are
required merely to notify the Federal Reserve Board within ten business days of
engaging in such activity. The Federal Reserve Board recently proposed
amendments to its regulations defining the scope of permissible bank holding
company activities which will, if adopted, broaden the scope of such activities.
The Company may, in the future, if appropriate opportunities arise, engage in
the acquisition of additional banks, subject to the approval of the Federal
Reserve Board.
Under the BHC Act, the Company must obtain prior Federal Reserve
approval before it acquires direct or indirect ownership or control of any
voting shares of any bank or other bank holding company if, after such
acquisition, it will own or control directly or indirectly more than 5% of the
voting stock of the entity, unless it already owns a majority of the voting
stock of the entity. The Company also must obtain prior Federal Reserve approval
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before it acquires all or substantially all of the assets of a bank or merges or
consolidates with another bank holding company. The Company will be, with
limited exceptions, prohibited from acquiring direct or indirect ownership or
control of a company which is not a bank or a bank holding company, and must
engage in the business of banking or managing or controlling banks or furnishing
services to or performing services for its subsidiary Banks. The Federal
Reserve, by order or regulation, may authorize the Company to engage in or
acquire stock in a company engaged in activities so closely related to banking
or managing or controlling banks as to be a proper incident thereto. In
reviewing any application or proposal by the Company, the Federal Reserve is
required to consider the financial and managerial resources and future prospects
of the Company and the banks concerned, the convenience and needs of the
community to be served, as well as the probable effect of the transaction upon
competition. Recent decisions by the Federal Reserve under the BHC Act have
underscored the importance placed by the Federal Reserve upon the record of the
applicant and its subsidiary banks in meeting the credit needs of its community
in accordance with the Community Reinvestment Act of 1977. See "Community
Reinvestment Act and Other Consumer Protection Statutes" below.
Bank Regulation
The continued earnings and growth of the Bank will be influenced by
general economic conditions, the monetary and fiscal policies of the federal
government and the policies of regulatory agencies, particularly the Federal
Reserve Board. The Federal Reserve Board implements national monetary policies
by its open-market operations in United States Government securities, by
adjusting the required level of reserves for financial institutions subject to
its reserve requirement and by varying the discount rate applicable to
borrowings by banks which are members of the Federal Reserve System. The actions
of the Federal Reserve Board in these areas influence the growth of bank loans,
investments and deposits and also affect interest rates charged on loans and
deposits. The nature and impact of any future changes in monetary policies
cannot be predicted.
Supervision. The Bank, as a state chartered banking corporation, is
subject to primary supervision, examination and regulation by the Minnesota
Department of Commerce ("DOC") and the Federal Deposit Insurance Corporation.
Various requirements and restrictions under the laws of the State of Minnesota
and the United States also affect the operation of the Bank. These statutes and
regulations relate to many aspects of the operations of the Bank, including
reserves against deposits, loans, investments, mergers and acquisitions,
borrowings, dividends and locations of branch offices. Some of these statutes
and regulations and their effect on the Bank are discussed below. Moreover, from
time to time, legislation is enacted which has the effect of increasing the cost
of doing business, limiting or expanding permissible activities or affecting the
competitive balance between banks and other financial intermediaries. Proposals
to change the laws and regulations governing the operations and taxation of
banks, bank holding companies and other financial intermediaries are frequently
made. The likelihood of any major changes and the impact of such changes are
impossible to predict.
Deposit Insurance. As an FDIC-insured institution, the Bank will be
required to pay deposit insurance premium assessments to the FDIC. The amount
each insured depository institution pays for FDIC deposit insurance coverage is
determined in accordance with a risk-based assessment system under which all
insured depository institutions are placed into one of nine categories and
assessed insurance premiums based upon their level of capital and supervisory
evaluation. BIF-member institutions classified as well capitalized (as defined
by the FDIC) and considered healthy pay the lowest premium (currently 0% of
deposits) while BIF-member institutions that are under capitalized (as defined
by the FDIC) and considered of substantial supervisory concern pay the highest
premium (currently up to 0.27% of deposits).
The FDIC may terminate the deposit insurance of any insured depository
institution if the FDIC determines, after a hearing, that the institution has
engaged in or is engaging in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, order, or any condition imposed in writing by, or under agreement
with, the FDIC. The FDIC may also suspend deposit insurance temporarily during
the hearing process for a permanent termination of insurance if the institution
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has no tangible capital. Management of the Company is not aware of any activity
or condition that could result in termination of the deposit insurance of the
Bank.
Payment of Dividends by the Bank. There are state and federal statutory
and regulatory requirements limiting the amount of dividends which may be paid
to the Company by the Bank. Generally, a bank may pay cash dividends out of
current operating earnings to the extent that the current rate of earnings
retention is consistent with the bank's capital needs, asset quality and overall
financial condition. The governing regulatory agency has the authority to
prohibit the Bank from engaging in business practices which the governing
regulatory agency considers to be unsafe or unsound. It is possible, depending
upon the financial condition of the Bank, that the governing regulatory agency
may assert that the payment of dividends to the Company by the Bank might, under
some circumstances, be such an unsafe and unsound practice.
For example, as a prerequisite to the payment of dividends, Minnesota
Statutes, section 48.09, subd. 1, requires the Bank to set aside all of its net
profits to a surplus fund until the surplus fund is equal to 20% of the Bank's
capital stock, and 10% of its net profits while the surplus fund is equal to
between 20% and 50% of the Bank's capital stock. Even when the surplus fund
requirements are met, all bank decisions regarding dividends are subject to the
DOC approval.
Common Liability. Under federal law, a depository institution insured
by the FDIC can be held liable for any loss incurred by, or reasonably expected
to be incurred by, the FDIC in connection with the default of a commonly
controlled FDIC-insured depository institution or any assistance provided by the
FDIC to a commonly controlled FDIC-insured institution in danger of default.
Affiliate Transaction Limitations. Financial institutions are subject
to certain restrictions imposed by federal law on any extensions of credit to,
or the issuance of a guarantee or letter of credit on behalf of, the Company or
other affiliates, the purchase of or investment in stock or other securities
thereof, the taking of such securities as collateral for loans and the purchase
of assets from the Company or other affiliates. Such restrictions prevent the
Company and such other affiliates from borrowing from the Bank and any other
subsequently acquired bank unless the loans are secured by marketable
obligations of specified amounts. Further, such secured loans, investments and
other transactions between any of the Bank and the Company or any other
affiliate are limited to 10% of the Bank's capital and surplus (as defined by
federal regulations) and such secured loans, investments and other transactions
are limited, in the aggregate, to 20% of the Bank's capital and surplus (as
defined by federal regulations). Such transactions must also comply with
regulations prohibiting terms that would be preferential to the Company or other
affiliates of the Bank.
Regulatory Capital Requirements. The Bank is required to comply with
capital adequacy standards set by the respective primary federal regulatory
agency. The regulations may establish higher minimum requirements if, for
example, a bank has previously received special attention or has a high
susceptibility to interest rate risk. Banks with capital ratios below the
required minimum are subject to certain administrative actions. More than one
capital adequacy standard applies, and all applicable standards must be
satisfied for an institution to be considered to be in compliance. There are two
basic measures of capital adequacy: a risk-based capital measure, and a Tier 1
leverage measure.
The risk-based capital measure was adopted to assist in the assessment
of capital adequacy of financial institutions by, (i) making regulatory capital
requirements more sensitive to differences in risk profiles among organizations;
(ii) introducing off-balance-sheet items into the assessment of capital
adequacy; (iii) reducing the disincentive to holding liquid, low-risk assets;
and (iv) achieving greater consistency in evaluation of capital adequacy of
major banking organizations throughout the world. The risk-based guidelines
include both a definition of capital and a framework for calculating
risk-weighted assets by assigning assets and off-balance-sheet items to broad
risk categories. An institution's risk-based capital ratios are calculated by
dividing its qualifying capital by its risk-weighted assets.
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Qualifying capital consists of two types of capital components: "core
capital elements" ("Tier 1" capital) and "supplementary capital elements" ("Tier
2" capital). Tier 1 capital is generally defined as the sum of core capital
elements less goodwill and other intangibles. Core capital elements consist of
(i) common shareholders' equity, (ii) qualifying perpetual preferred stock,
subject to certain limitations, and (iii) minority interests in the equity
accounts of consolidated subsidiaries. Supplementary capital ("Tier 2" capital)
consists of such additional capital elements as (i) allowance for loan and lease
losses (subject to limitations); (ii) perpetual preferred stock which does not
qualify as Tier 1 capital (subject to certain conditions); (iii) hybrid capital
instruments, perpetual debt and mandatory convertible debt securities; and (iv)
term subordinated debt and intermediate-term preferred stock (subject to
limitations). The maximum amount of Tier 2 capital that may be included in
qualifying total capital is limited to 100% of Tier 1 capital (net of goodwill).
Under current capital adequacy standards, financial institutions must
meet a minimum ratio of qualifying capital to risk-weighted assets of 8%. Of
that ratio, at least half, or 4%, must be in the form of Tier 1 capital.
The Bank also must maintain an allowable leverage ratio. The leverage
ratio is defined as the ratio of Tier 1 capital to average total assets. Under
current capital adequacy standards, financial institutions must meet a minimum
leverage ratio of 4%.
As a result of the FDIC Improvement Act of 1991, the federal bank
regulatory agencies are directed to adopt regulations defining banks as "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." Under the law, depending
upon the bank's classification, a bank may be directed to prepare and implement
a capital restoration plan, to be guaranteed by its parent bank holding company.
Further, banks are subject to increased restrictions upon activities and
heightened regulatory management as capital classifications decline.
Generally, under regulations adopted by all of the bank federal
regulatory agencies, "well capitalized" has been defined as an institution with
a total capital to risk-based asset ratio of 10%, a Tier 1 capital to risk-based
asset ratio of 6% and a Tier 1 leverage ratio of 5%. The regulations further
provide that an "adequately capitalized" institution must have a total capital
to risk-based asset ratio of at least 8%, a Tier 1 capital to risk-based asset
ratio of 4% and a Tier 1 leverage ratio of 4%. Institutions not satisfying the
requirements for "adequately capitalized" will be deemed "undercapitalized."
Institutions with a total capital to risk-based asset ratio of 6% or less, a
Tier 1 capital to risk-based asset ratio of 3% or less, or a Tier 1 leverage
ratio of 3% or less will be deemed "significantly undercapitalized." Finally,
the regulations provide that an institution with a Tier 1 leverage ratio of less
than 2% will be deemed "critically undercapitalized." Federal bank regulatory
agencies, including the FDIC, are authorized to down-grade a financial
institution from one capital category to the next if an examination reveals that
the asset quality, management, earnings or liquidity of that institution are
less than satisfactory. Under the regulations, as of June 30, 1999 the Bank is
classified as "well capitalized."
Standards for Safety and Soundness. Federal law requires each federal
banking agency to prescribe for depository institutions under its jurisdiction
standards relating to, among other things: internal controls; information
systems and audit systems; loan documentation; credit underwriting; interest
rate risk exposure; asset growth; compensation; fees and benefits; and such
other operational and managerial standards as the agency deems appropriate. The
federal banking agencies adopted final regulations and Interagency Guidelines
Establishing Standards for Safety and Soundness (the "Guidelines") to implement
these safety and soundness standards. The Guidelines set forth the safety and
soundness standards that the federal banking agencies use to identify and
address problems at insured depository institutions before capital becomes
impaired. The Guidelines address internal controls and information systems,
internal audit systems, credit writing, loan documentation, interest rate risk
exposure, asset growth, asset quality, earnings and compensation, and fees and
<PAGE>
benefits. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the Guidelines, the agency
may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard.
Acquisitions and Branching. Banks, including the Bank, have the
authority under Minnesota law to establish branches (referred to under Minnesota
law as "detached facilities") in any municipality in the state of Minnesota,
subject to receipt of all required regulatory approvals, except a municipality
having a population of 10,000 or less, unless all the banks having a principal
office in the municipality have consented in writing to the establishment of the
branch (this rule is often called the "home town protection rule.")
Effective June 1, 1997, the Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "RNA") allows the responsible Federal
banking agency to approve applications for mergers of depository institutions
across state lines without regard to whether such activity is contrary to state
law. Any statue could, however, by adoption of a non-discriminatory law after
September 29, 1994 and before June 1, 1997, either elect to have this provision
take effect before June 1, 1997 or opt-out of the provision. The effect of
opting out is to prevent banks chartered by, or having their main office located
in, such state from participating in any interstate branch merger. Each state is
permitted to retain a minimum age requirement of up to five years, a
non-discriminatory deposit cap, and non-discriminatory notice or filing
requirements. The RNA also imposes limitations on the aggregate amount of
depository that may be held by the surviving bank and all of its insured
depository institution affiliates. Only Texas opted-out of the interstate merger
provision. The Minnesota legislature has taken action to opt in and has
authorized interstate branching effective June 1, 1997. It exercised its
discretion, however, to retain a minimum age requirement (or "seasoning
requirement") of 5 years. Therefore, the Bank may not be acquired by an
out-of-state bank nor may the Bank merge into an out-of-state bank for 5 years
after its creation. Nevertheless, the RNA could present acquisition and
branching opportunities to the Company, and could allow out-of-state banks easy
access to markets currently served by the Company thereby increasing
competition.
Community Reinvestment Act. The Community Reinvestment Act of 1977
("CRA") requires a financial institution to help meet the credit needs of its
entire community, including low-income and moderate-income areas. On May 3,
1995, the federal banking agencies issued final regulations which change the
manner in which they measure a bank's compliance with its CRA obligations. The
final regulations adopt a performance-based evaluation system which bases CRA
ratings on an institution's actual lending, service and investment performance,
rather than the extent to which the institution conducts needs assessments,
documents community outreach or complies with other procedural requirements.
Federal banking agencies may take CRA compliance into account when regulating
and supervising bank and holding company activities; for example, CRA
performance may be considered in approving proposed bank acquisitions. The Banks
are also subject to a variety of consumer protection laws and fair lending laws.
Violations of these laws may cause regulators to impose substantial penalties or
take other administrative action.
EMPLOYEES
As of June 30, 1999, the Bank had 8 full-time employees and one
part-time employee. The Company has only one employee, Thomas Stienessen, who is
also the President and Chief Executive Officer of the Bank. The Bank's employees
are not represented by a collective bargaining agreement.
STATISTICAL PROFILE AND OTHER FINANCIAL DATA
Reference is made to the statistical and financial data contained in
"ITEM 6 - MANAGEMENT DISCUSSION AND ANALYSIS OR PLAN OF OPERATION," for
statistical and financial data providing a review of the Company's business
activities.
<PAGE>
ITEM 2. DESCRIPTION OF PROPERTY
The Company's and Bank's office is located at 1650 Madison Avenue,
Mankato, Minnesota. The Bank has entered into a 10 year lease agreement to rent
approximately 5,000 square feet. Pursuant to the lease agreement, the Bank pays
monthly rent of approximately $6,042 during the first three years of the lease,
$6,250 a month for the next three years, and $6,458 per month for the last four
years of the lease term. The Bank has the option to extend the lease term for
two consecutive five year periods with a right of first refusal on any
additional space that becomes available. The Bank's office includes a teller
line with three tellers, two platform positions, a drive-through window and
executive and administrative offices.
ITEM 3. LEGAL PROCEEDINGS
There are no material litigation or other legal proceedings pending
against the Company or the Bank or any of their property.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of shareholders of the
Company during the fourth quarter of 1999.
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been quoted on the OTC Bulletin Board
under the symbol "NSBK" since February 2, 1999. Quotations in the following
table represent inter-dealer prices, without retail markup, markdown or
commission, and do not necessarily represent actual transactions.
Common Stock
------------------------------
Fiscal Quarter Ended High Bid Low Bid
- -------------------------------------------------------
March 31, 1999 $10.00 $10.00
June 30, 1999 11.50 9.50
At September 3, 1999 the last sale price for the Company's Common Stock
was $10.25 per share. At September 3, 1999, there were issued and outstanding
425,600 shares of Common Stock of the Company held by 43 shareholders of record.
Record ownership includes ownership by nominees who may hold for multiple
owners.
The Company has paid no dividends on its Common Stock and does not
anticipate paying any such dividends in the foreseeable future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
This discussion and analysis is intended to assist the reader in
understanding the financial condition and results of operations of Northern Star
Financial, Inc. This commentary should be read in conjunction with the Company's
audited consolidated financial statements and the related notes for the years
ended June 30, 1998 and 1999 included under Item 7 - FINANCIAL STATEMENTS of
this report. The consolidated entity includes Northern Star Financial, Inc. and
its wholly-owned subsidiary, Northern Star Bank, Inc. Collectively, unless the
context states otherwise, the consolidated entity is referred to as the Company.
OVERVIEW
Northern Star Financial, Inc. (the "Company"), a Minnesota corporation,
was incorporated on January 22, 1998. The Company is a bank holding company and
owns all of the outstanding capital stock of Northern Star Bank, Inc. (the
"Bank"). The Company's operations, during the period from its inception through
January 25, 1999 when the Bank commenced operations, consisted solely of
organizing activities. The Company's organizing activities consisted primarily
of: (i) preparing and coordinating its application for deposit insurance with
the Federal Deposit Insurance Corporation ("FDIC"); (ii) preparing and
coordinating the Bank's application with the Minnesota Department of Commerce
("DOC"); (iii) conducting the private placement of shares of its Common Stock to
the Company's officers and directors; and (iv) preparing, filing and
coordinating the Company's Registration Statement (the "Registration Statement")
with the Securities and Exchange Commission pursuant to the Company's initial
public offering of up to 329,000 shares of its Common Stock at an offering price
of $10.00 per share. The Company's Registration Statement was declared effective
by the Securities and Exchange Commission on October 9, 1998. On October 16,
1998, the DOC approved the application of the Bank to become a state-chartered
community bank, and on December 24, 1998, the FDIC approved the Company's
application for deposit insurance for the Bank. On December 31, 1998, the
Company closed on the private placement of 154,000 shares of Common Stock to its
officers and directors and 146,000 shares of Common Stock to the public pursuant
to the Company's public offering. The Bank began operations on January 25, 1999
at its only banking location in Mankato, Minnesota. On April 1, 1999, the
<PAGE>
Company completed the sale of an additional 125,600 shares of its Common Stock
to complete its initial public offering. In connection with the Company's
private offering and initial public offering of its Common Stock, the Company
raised net proceeds $3,923,733.
During the development stage, from January 1998 ("Inception") to
January 25, 1999 (the "Bank Opening"), the Company accumulated a net loss of
$226,103. The net loss from the bank opening January 25, 1999 to June 30, 1999
amounted to $271,529. During fiscal 1999 total assets of the Company grew from
$14,806 to $9,635,608, and the net loss amounted to $493,672 or $1.60 per share.
RESULTS OF OPERATIONS
The operating results of the Company depend primarily on net interest
income. The Company's net interest income is determined by interest rate spread,
the relative amounts of interest-earning assets and interest-bearing
liabilities, and the degree of mismatch in the maturing and repricing
characteristics of interest earning assets and interest-bearing liabilities.
Interest rate spread is the difference between the yield earned on
interest-bearing assets and the rates paid on interest-bearing liabilities. The
Company's operations are also affected by the establishment of provisions for
loan losses and the level of its other income, including service charges on
deposit accounts and sold real estate loan fees, as well as its other expenses
and income tax provisions.
The results of operations of the Company as of and for the fiscal year
ended June 30, 1999, reflect the activities of the Company in organizing the
Company and the Bank and its five months results of operations following the
opening of the Bank on January 25, 1999. The Company does not have any results
of operations to report for the fiscal year ended June 30, 1998 since it did not
engage in any operating activity for such period, other than those organizing
activities described above.
The Company had interest income of $154,875 for the fiscal year ended
June 30, 1999. Net interest income before the provision for loan losses of
$114,863 was earned for the period after incurring an interest expense of
$40,012. Loan interest income of $120,005 represented the largest portion of the
Company's interest income, since the Company had the largest portion of earning
assets in its loan portfolio. The weighted average yields earned on the
Company's interest-bearing assets of $1,866,661 were 8.30% for the period and
the average rates paid on the Company's interest bearing liabilities of $901,088
were 4.44% for the period. The net interest spread, the difference between the
average yield earned on interest earning assets and the average rate paid on
interest-bearing liabilities was 3.86%.
The provision for loan losses was established at $56,250 at June 30,
1999, reflecting management's estimate of the amount necessary to adequately
reflect possible loan losses. The Company's allowance for loan losses as a
percentage of its year-end loans was 1.14%. Management's judgment as to the
adequacy of the allowance is based upon an evaluation of the inherent risks in
the loan portfolios, which it believes to be reasonable, which may or may not
prove to be accurate. Thus, there can be no assurance that the Company's
charge-offs in future periods will not exceed the allowance for loan losses or
that an additional increase in the loan loss allowance will not be required. The
Company had no charge-offs in 1999.
The Company earned non-interest income of $45,499 for the period
representing service charges on deposit accounts and gains on the sale of
residential mortgage loans, partially offset by a loss on the sale of loans of
$3,050. As a percentage of average assets, non-interest income was 1.77% for the
Company's truncated year of operations ended June 30, 1999.
The Company incurred other non-interest expenses of $594,734 for fiscal
year ended June 30, 1999, inclusive of costs associated with setting up the
Bank's operations. The Company incurred nonrecurring pre-opening expenses of
approximately $304,000 in organizing the Bank's operations. The pre-opening
expenses also include $248,000 in organizational costs expensed due to a change
in accounting. Staffing at the Bank was at a full-service level beginning the
first part of December 1998 for training in preparation for the Bank's opening
<PAGE>
on January 25, 1999 and other non-interest expenses were incurred in operating
the Bank. Non-interest expense included $40,364 in salaries and employee
benefits incurred during the initial start-up phase of the Company and
approximately $15,636 in opening expenses. As a percentage of average assets,
non-interest expenses were 24.8%.
The Company's net loss for the year-ended June 30, 1999 was $493,672.
At June 30, 1999, the Company had total assets of $9,635,608, which
consisted of cash and due from the Bank of $210,662, federal funds sold of
$2,533,236, securities and short-term investments of $745,119, FHLB stock of
$16,400, net loans of $5,563,095, accrued interest receivable of $59,527,
property and equipment of $486,685 and other assets of $20,884. At June 30,
1999, the Company had liabilities of $6,164,569 in deposits and $47,337 in other
liabilities. Stockholders' equity at June 30, 1999 was $3,423,702.
AVERAGE BALANCES, YIELDS AND RATES
The following table sets forth, for the fiscal year ended June 30,
1999, the weighted average yields earned, the weighted average rates paid, the
interest rate spread and the net yield on earning assets and interest-bearing
liabilities, on an annualized basis.
<TABLE>
<CAPTION>
Fiscal 1999
----------------------------------------------
Average
Average Yield or
Balance Interest Rates
ASSETS
<S> <C> <C> <C>
Federal Funds Sold $ 544,083 $ 26,089 4.79%
Investment Securities 60,531 3,590 5.93%
Loans 1,098,420 120,005 10.93%
Other Interest-Earning Assets 163,637 5,191 3.17%
----------- ---------- ------
Total Earning Assets 1,866,661 $154,875 8.30%
--------
Cash & Due From Banks 353,297
Premises & Equipment 167,622
Other, Less Allowance for Loan Loss 5,765
-------------
Total Assets $2,393,345
==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest Bearing Deposits $ 901,088 $ 40,012 4.44%
Non Interest Bearing Deposits 255,238
Other Liabilities 71,765
Stockholders' Equity 1,165,254
----------
Total Liability and Stockholders' Equity $2,393,345
==========
Net Interest Spread 3.86%
Net Interest Income/Margin $114,863 6.15%
========
Ratio of Average Interest
Earning Assets to Average Interest-Bearing Liabilities 2.07x
</TABLE>
<PAGE>
As shown in the above table, the average yield on earning assets was
8.30%, while the average cost of funds was 4.44% for a net interest spread of
3.86%. The net interest margin as a percentage of interest-earning assets was
6.15%. The average balances above were calculated on an annualized basis, even
though the Company was not in operations for the entire fiscal year. Income on
loans includes loan fees of $45,559.
RATE/VOLUME ANALYSIS
Net interest income can be analyzed in terms of the impact of changing
rates and changing volume. As this was the first period of operations for the
Company, all interest income and expense is attributable to volume. Therefore,
the Company has omitted the table analyzing the changes in net interest income,
as it would not be meaningful since there are no 1998 results.
LIQUIDITY AND RATE SENSITIVITY
Asset/liability management is the process by which the Company monitors
and controls the mix and maturities of its assets and liabilities. The essential
purposes of asset/liability management are to ensure adequate liquidity and to
maintain an appropriate balance between interest sensitive assets and
liabilities to minimize potentially adverse impacts on earnings from changes in
market interest rates.
Primary sources of liquidity for the Company are a stable base of
deposits, scheduled repayments on the Company's loans, and interest and
maturities of its investments. These funds are held in various forms of
investments with various degrees of liquidity. All securities of the Company
have been classified as available-for-sale. If necessary, the Company has the
ability to sell a portion of its investment securities to manage its interest
sensitivity gap or liquidity. The Company also may utilize its cash and due from
banks and federal funds sold to meet liquidity needs. Additionally, the Company
has an unsecured line of credit with a correspondent bank in the amount of
$250,000. No borrowings have been drawn on this line of credit.
The principal monitoring technique employed by the Company is the
measurement of the Company's interest sensitivity "gap", which is the positive
or negative dollar difference between assets and liabilities that are subject to
interest rate repricing within a given period of time. Interest rate sensitivity
can be managed by repricing assets or liabilities, selling securities
available-for-sale, replacing an asset or liability at maturity, or adjusting
the interest rate during the life of an asset or liability. Managing the amount
of assets and liabilities repricing in this same time interval helps to minimize
interest rate risk and manage net interest income in changing interest rate
environments. The Company's net interest income generally would benefit from
rising interest rates when it has an asset-sensitive gap position. Conversely,
the Company's net interest income generally would benefit from decreasing rates
of interest when it has a liability-sensitive gap position.
Because the Bank has only been open since January 25, 1999, and not yet
generated a substantial amount of loans, the Company is currently asset
sensitive over all time frames. However, the Company's gap analysis is not a
precise indicator of its interest sensitivity position. The analysis presents
only a static view of the timing of maturities and repricing opportunities
without taking into consideration that changes in interest rates do not affect
all assets and liabilities equally. For example, rates paid on a substantial
portion of core deposits may change contractually within a relatively short time
frame, but those rates are viewed by management as significantly less
interest-sensitive than market-based rates such as those paid on non-core
deposits. Net interest income may be impacted by other significant factors in a
given interest rate environment, including changes in the volume and mix of
earning assets and interest-bearing liabilities.
INTEREST RATE SENSITIVITY ANALYSIS
The asset mix of the balance sheet is continually evaluated in terms of
several variables: yields, credit quality, appropriate funding sources and
liquidity. To effectively manage the liability mix of the balance sheet, there
should be a focus on expanding various funding sources. The interest rate
<PAGE>
sensitivity position at June 30, 1999 is presented in the following table. The
difference between rate sensitive assets and rate sensitive liabilities, or the
interest rate sensitivity gap, is shown at the bottom of the table. Since all
interest rates and yields do not adjust at the same velocity, the gap is only a
general indicator of rate sensitivity. The table may not be indicative of the
Company's rate sensitivity position at other points in time.
INTEREST RATE SENSITIVITY ANALYSIS
<TABLE>
<CAPTION>
After Three
Within Three but within After One but
Months Twelve within Five After
Months Years Five Years TOTAL
------- ------- ------- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Interest Earning Assets
Federal Funds Sold $ 2,533 $ 0 $ 0 $ 0 $ 2,533
Investment Securities 0 0 0 745 745
Loans 2,877 241 1,488 1,014 5,620
------- ------- ------- ------- -------
Total Earning Assets $ 5,410 $ 241 $ 1,488 $ 1,759 $ 8,898
======= ======= ======= ======= =======
Interest Bearing Liabilities
Money Market & Now $ 127 $ 0 $ 0 $ 0 $ 127
Regular Savings 3,244 0 0 0 3,244
Time Deposits 30 1,420 329 0 1,779
------- ------- ------- ------- -------
Total Interest Bearing Liabilities $ 3,401 $ 1,420 $ 329 $ 0 $ 5,150
======= ======= ======= ======= =======
Interest Sensitivity Gap $ 2,009 ($ 1,179) $ 1,159 $ 1,759 $ 3,748
Cumulative Interest Sensitivity Gap $ 2,009 $830 $ 1,989 $ 3,748 $ 3,748
Ratio of Interest Sensitivity Gap to
total earning assets 22.58% (13.25%) 13.03% 19.77% 42.13%
Ratio of Cumulative Interest
Sensitivity Gap to total earning
assets 22.58% 9.33% 22.36% 42.13% 42.13%
</TABLE>
As evidenced by the table above, the Company is cumulatively
asset-sensitive at one year. In a rising interest rate environment, an
asset-sensitive position (a positive gap ratio) is generally more advantageous
since assets re-price sooner than liabilities. Conversely, in a declining
interest rate environment, a liability-sensitive position (a negative gap ratio)
is generally more advantageous as interest-bearing liabilities re-price sooner
than earning assets. With respect to the Company, an increase in interest rates
would result in increased earnings, while a decline in interest rates would
decrease income. This, however, assumes that all other factors affecting income
remain constant.
LOAN PORTFOLIO
Since loans typically provide higher interest yields than do other
types of earning assets, the Company's intent is to channel a substantial
percentage of its earning assets into the loan category. However since the Bank
only commenced operations in January 1999, that category has not yet grown to a
percentage of total earning assets, comparable to other banks that are well
established. Average loans on an annualized basis were $1,098,222 for 1999.
Total gross loans outstanding at June 30, 1999, including loans held for sale,
were $5,619,345.
<PAGE>
The following table summarizes the composition of the loan portfolio:
Amount % of Total
----------- ------
Commercial, Lease & Agricultural $1,843,707 32.81%
Real Estate - individual 1,496,460 26.63%
Real Estate - other 843,394 15.01%
Consumer Loans 1,435,784 25.55%
----------- ------
Total Loans $5,619,345 100%
----------- ======
Less: Allowance for Loan Loss (56,250)
Total Net Loans $5,563,095
The principal components of the Company's loan portfolio at year-end
were mortgage loans and commercial loans which represented 74% of the portfolio.
Due to the short time the portfolio has existed, the current mix of loans may
not be indicative of the ongoing portfolio mix. Management will attempt to
maintain a relatively diversified loan portfolio to help reduce the risk
inherent in concentration of collateral.
MATURITIES AND SENSITIVITY OF LOANS TO CHANGES IN INTEREST RATES
The information in the following table is based on the contractual
maturities of individual loans, including loans which may be subject to renewal
at their contractual maturity. Renewal of such loans is subject to review and
credit approval, as well as modification of terms upon their maturity. Actual
repayments of loans may differ from maturities reflected below because borrowers
have the right to prepay obligations with or without prepayment penalties. The
following table summarizes loan maturities, by type, and related interest rate
characteristics at June 30, 1999:
<PAGE>
<TABLE>
<CAPTION>
After One but within
One Year Five Years After
or Less Five Years Total
<S> <C> <C> <C> <C>
Commercial, Lease & Agricultural $ 916,272 $ 927,435 $ 0 $1,843,707
Real Estate - individual 812,173 334,318 349,969 1,496,460
Real Estate - other 448,020 297,574 97,800 843,394
Consumer Loans 1,144,982 290,802 0 1,435,784
----------- ------------ ----------- ----------
Total $3,321,447 $1,850,129 $447,769 $5,619,345
========== ========== ======== ==========
Loans maturing after one year with:
Fixed Interest Rates $ 903,715
Floating Interest Rates $1,394,183
</TABLE>
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The Company has developed policies and procedures for evaluating the
overall quality of its credit portfolio and the timely identification of
potential credit problems. Additions to the allowance for loan losses will be
made periodically to maintain the allowance at an appropriate level based on
management's analysis of the potential risk in the loan portfolio.
At June 30, 1999, the allowance for loan losses was $56,250 or 1.14% of
$4,937,752 in loans receivable (net of loans held for sale). The Bank has not
charged off any loans since commencing operations. The provision for loan losses
was made primarily as a result of management's assessment of general loan loss
risk as the Bank recorded its first loans.
SUMMARY OF LOAN LOSS EXPERIENCE
An analysis of the Bank's loss experience is furnished in the following
table for the year ended June 30, 1999, as well as a breakdown of the allowance
for possible loan losses:
Year Ended June 30,
1999
--------
Balance at Beginning of Period $ 0
Charge-offs 0
Recoveries 0
Net Charge Offs 0
Additions charged to operations 56,250
--------
Balance at End of Period $ 56,250
Ratio of net charge-offs during the period to
average loans outstanding during the period 0%
<PAGE>
At June 30, 1999, the allowance was allocated as follows:
Percent of Loans in
Year Ended Each Category
June 30, 1999 to Total Loans
------------- -------------------
Commercial Lease & Agricultural $13,310 32.81%
Real Estate - individual 10,974 26.63%
Real Estate - other 5,288 15.01%
Consumer Loans 5,808 25.55%
Unallocated 20,870
------- -------
Total $56,250 100.00%
======= =======
INVESTMENT PORTFOLIO
At June 30, 1999, the investment securities portfolio represented
approximately 8.42% of the Company's earning assets of $8,897,899. The Company
had investments in U.S. Government agency securities with a fair market value of
$745,119 and an amortized cost of $749,286, for an unrealized loss of $2,500,
net of income taxes. The Company also invested in stock of the Federal Home Loan
Bank in the amount of $16,400.
Contractual maturities and yields on the Company's investments (all
available for sale) at June 30, 1999 are shown in the following table. Expected
maturities may differ from contractual maturities because issuers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
Within One But within Over Five
Year Yield Five Years Yield Years Yield Total Yield
----- ----- ---------- ----- --------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
US Government
Agencies $ 0 0.00% $549,286 6.12% $200,000 7.04% $749,286 6.36%
----- ----- -------- ----- --------- ----- -------- -----
Total $ 0 0.00% $549,286 6.12% $200,000 7.04% $749,286 6.36%
===== ===== ======== ===== ========= ===== ======== =====
</TABLE>
At June 30, 1999, short-term investments comprised a significant
portion of total earning assets of $2,533,236. These funds were invested in
Federal funds sold on an overnight basis. As the Bank continues to grow,
management expects a shift from primarily overnight investments into the loan
portfolio and, to a lesser extent, into the investment securities portfolio.
<PAGE>
DEPOSITS AND OTHER INTEREST-BEARING LIABILITIES
As of June 30, 1999, deposits were the only component of
interest-bearing liabilities. Average total deposits were $899,386 and average
interest-bearing deposits were $1,154,898 in fiscal 1999, on an annualized
basis. The following is a table of deposits by category at year-end.
<TABLE>
<CAPTION>
Percentage Percentage of
of Total Total Average Effective
Ending Balance Deposits Average Balance Deposits Cost
----------- -------- ------------ -------- -----
<S> <C> <C> <C> <C> <C>
Demand Deposit $ 998,017 16.20% $ 255,512 22.20% --%
Now 127,387 2.10% 52,395 4.50% 2.46%
Savings 3,244,444 52.60% 375,076 32.40% 3.55%
Time Accounts less than $100,000 1,379,249 22.50% 336,573 29.20% 5.30%
Time Accounts of $100,000 or
more 400,000 6.60% 135,342 11.70% 5.45%
----------- -------- ------------ -------- -----
Total Deposits $6,149,097 100.00% $1,154,898 100.00%
=========== ======= =========== =======
</TABLE>
Core deposits, which exclude time deposits of $100,000 or more, provide
a relatively stable funding source for the Company's loan portfolio and other
earning assets. The Company's core deposits were $5,749,097 at June 30, 1999.
The Company's loan to deposit ratio was 90% at year-end. The maturity
distribution of the Company's time deposits at June 30, 1999 is as follows:
Time Deposit Remaining Maturity Schedule
<TABLE>
<CAPTION>
Over 3 Over 6
3 Months Months to Months to Over 12
or Less 6 Months 12 Months Months TOTAL
------- -------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C>
Time Accounts less than 100,000 $30,000 $133,787 $ 866,625 $348,837 $1,379,249
Time Accounts of $100,000 or
more 400,000 400,000
------- -------- ---------- -------- ----------
Total $30,000 $133,787 $1,266,625 $348,837 $1,779,249
======= ======== ========== ======== ==========
</TABLE>
RETURN ON EQUITY AND ASSETS
The following table shows the return (loss) on average assets (net loss
divided by average total assets), return on average equity (net loss divided by
average equity), and equity to assets ratio (average equity divided by average
total assets) for fiscal 1999. Since its inception, the Company has not paid any
cash dividends. The payment of dividends by the Bank is subject to limitations
imposed by law and governmental regulations.
Return (loss) on average assets (22.61)%
Return (loss) on average equity (69.87)%
Equity to assets ratio 35.53 %
<PAGE>
SHORT TERM BORROWINGS
At June 30, 1999 and for the fiscal year then ended, the Company had no
outstanding balances under short-term borrowings.
CAPITAL ADEQUACY
There are now two primary measures of capital adequacy for banks and
banking holding companies: (i) risk-based capital guidelines and (ii) leverage
ratio.
The risk based capital guidelines measure the amount of a bank's
required capital in relation to the degree of risk perceived in its assets and
its off-balance sheet items. Under the risk-based capital guidelines, capital is
divided into two "tiers". Tier 1 capital consists of common stockholders'
equity, non-cumulative and cumulative perpetual preferred stock (bank holding
companies only) and minority interest. Goodwill which is subtracted from the
total. Tier 2 capital, consists of the allowance for loan loss, hybrid capital
instruments, and term subordinated debt and intermediate term preferred stock.
Banks are required to maintain a minimum risk-based capital ratio of 8.0% with
at least 4.0% consisting of Tier 1 capital.
The second measure of capital adequacy relates to the leverage ratio.
The Federal Deposit Insurance Corporation has established a 3.0% minimum
leverage ratio requirement. Note that the leverage ratio is computed by dividing
Tier 1 capital into average assets. For all except the highest rated banks, the
minimum leverage ratio should be 3.0% plus an additional cushion of at least 1
to 2 percent, depending upon risk profiles and other factors.
The Federal Reserve Board and the FDIC rules add a measure of interest
rate risk to the determination of supervisory capital adequacy. In connection
with this rule, the agencies have adopted a measurement process to measure
interest rate risk. Under this rule, all items reported on the balance sheet, as
well as off-balance sheet items, are reported according to maturity, re-pricing
dates and cash flow characteristics. A bank's weighted position is used in
assessing capital adequacy. The objective of this complex rule is to determine
the sensitivity of banks to various rising and declining interest rate
scenarios.
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA"),
as well as other requirements, established five capital tiers: well-capitalized,
adequately capitalized, under capitalized, significantly under capitalized, and
critically under capitalized. A depository institution's capital tier depends on
its capital levels in relation to various relevant capital measures and certain
other factors. Depository institutions that are not classified as well
capitalized are subject to various restrictions regarding capital distributions,
payment of management fees, acceptance of brokered deposits and other operating
activities.
<PAGE>
The table below illustrates the Bank's and Company's regulatory capital
(in thousands) and ratios at June 30, 1999:
<TABLE>
<CAPTION>
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provision
------------------ ------------------- --------------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1999:
Tier II Capital
(to Risk Weighted Assets) $2,785 44.20% $504 8.00% $630 10.00%
Tier I Capital
(to Risk Weighted Assets) $2,729 43.30% $252 4.00% $378 6.00%
Leverage Ratio
Tier I Capital
(to Average Assets) $2,729 36.50% $299 4.00% $374 5.00%
</TABLE>
At June 30, 1999, the Bank is classified as well-capitalized and is in
compliance with all regulatory capital requirements. Management anticipates the
Bank will continue to be classified as well-capitalized.
A condition of the original offering was that a minimum 157,000 shares
of common stock be sold. There were a total of 425,600 shares sold during the
offering period with net proceeds after offering expenses of $3,923,633. Of the
proceeds, $3,000,500 were used to capitalize the Bank. The Company believes that
this amount is sufficient to fund the activities of the Bank in its initial
stages of operations and that the Bank will generate sufficient income from
operations to fund its activities on an ongoing basis. The remaining offering
proceeds were retained in the Company to fund activities which may from time to
time be considered appropriate investments of capital at some point in the
future.
As of June 30, 1999, there were no significant commitments outstanding
for capital expenditures.
IMPACT OF INFLATION AND CHANGING PRICES
The effect of relative purchasing power over time due to inflation has
not been taken into effect in the financial statements of the Company. Rather,
the statements have been prepared on an historical cost basis in accordance with
generally accepted accounting principles.
Since most of the assets and liabilities of a financial institution are
monetary in nature, the effect of changes in interest rates will have a more
significant impact on the Company's performance than will the effect of changing
prices and inflation in general. Interest rates may generally increase as the
rate of inflation increases, although not necessarily in the same magnitude.
<PAGE>
ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). This statement establishes
accounting and reporting standards for derivative instruments and hedging
activities. SFAS No. 133 is effective for fiscal years beginning after June 15,
2000. Retroactive application to financial statements of prior periods is not
required. The Company does not currently have any derivative instruments nor is
it involved in hedging activities.
In April 1998, the Accounting Standards Executive Committee issued
Statement of Position 98-5, "Reporting on the Cost of Start-up Activities" ("SOP
98-5"), which requires costs of start-up activities and organization costs to be
expenses as incurred. SOP 98-5 is effective for fiscal years beginning after
December 15, 1998, with earlier application encouraged. The Company elected to
early adopt SOP 98-5 for the year ended June 30, 1999 and as a result,
recognized approximately $248,000 in its 1999 consolidated Statement of Loss
which under previous accounting policies would have been amortized over 60
months.
INDUSTRY DEVELOPMENTS
From time to time, various bills are introduced in the United States
Congress with respect to the regulation of financial institutions. Certain of
these proposals, if adopted, could significantly change the regulation of banks
and the financial services industry. The Company cannot predict whether any of
these proposals will be adopted or, if adopted, how these proposals would affect
the Company.
YEAR 2000
Like many financial institutions, we rely on computers to conduct our
business and information systems processing. Industry experts are concerned that
on January 1, 2000, some computers may not be able to interpret the new year
properly, causing computer malfunctions. As described in more detail below, we
have developed and are executing a plan to ensure that our computer and
telecommunication systems do not have these Year 2000 problems. We do not
anticipate that the Year 2000 issues will materially impact our business or
operations. We rely on third party vendors to supply our computer and
telecommunication systems and other office equipment. We also rely on a third
party to process our data and account information. Because we just recently
commenced operations, we had the ability to choose only those vendors which we
believe are ready for the Year 2000, thereby relieving any additional costs
associated with the conversion of older computer systems. Although we believe we
have addressed the Year 2000 issue, we cannot be entirely sure that the Year
2000 will not have any adverse effect on the Company.
We have prepared a comprehensive Year 2000 plan to monitor and ensure
the Year 2000 compliance of our third party vendors of computer and
telecommunication systems, data processing services, and other office equipment.
We have budgeted for the execution of this plan and we believe all systems are
in place and are fully Year 2000 compliant. The plan also calls for us to
continue to monitor the situation through the end of the year and beyond. We are
executing this plan under the supervision of the Bank's lending officer and vice
president of operations, with oversight from our Board of Directors. Under this
plan, we will investigate the Year 2000 readiness of each vendor, review Year
2000 testing completed by each vendor, test our own systems, if necessary and
reasonable, and require comprehensive Year 2000 warranties from each vendor. Our
investigation of each vendor will consist primarily of requesting and reviewing
its Year 2000 test results.
ON-LINE Financial Services, Inc. ("ON-LINE") provides our mission
critical computer software and data processing services. ON-LINE is a
well-established company and provides computer systems and data processing
services to many financial institutions throughout the nation. ON-LINE is
<PAGE>
continually testing its systems for Year 2000 issues and has tested our database
for Year 2000 compliance. The ON-LINE system includes interfaces to other
systems provided by other vendors, such as our ATM hardware.
Our Year 2000 plan extends to our other less critical vendors as well,
including our vendors for ATM hardware, account origination software, telephone
systems and suppliers of office equipment, such as copy and fax machines. Under
our plan, we are reviewing the test results, assurances and warranties of all
these vendors, and we are satisfied that these systems are Year 2000 compliant.
Based on our review of our vendor's systems and Year 2000 testing results to
date, we do not believe that any of them will have any significant Year 2000
problems. The Minnesota Department of Commerce and the FDIC are also monitoring
the Year 2000 readiness of the banking industry.
Our agreements with each of our vendors, including ON-LINE, include
contractual assurances and warranties regarding Year 2000 compliance. Some of
these warranties are limited by disclaimers of liability, which specifically
exclude special, incidental, indirect, and consequential damages. These
limitations could limit our ability to obtain recourse against a vendor who is
not Year 2000 compliant by excluding damages for things such as lost profits and
customer lawsuits. We are also in the process of evaluating our worst case
scenario and developing contingency plans in case Year 2000 issues do arise.
Based on the information currently available, we do not believe that we that we
have significant Year 2000 exposure and believe that we will be able to continue
to operate the business if one or more of our vendors experience unanticipated
Year 2000 problems, although we cannot be certain.
Our customers may also have Year 2000 issues. These issues could
disrupt certain businesses with high Year 2000 risk and affect their deposit
balances and their ability to repay their loans. We intend to review our
customers' exposure and assess Year 2000 readiness through Year 2000 surveys.
For those customers with high credit risk and high potential exposure, we may
require more substantial proof of Year 2000 compliance. Although these surveys
will be helpful, it would be very difficult for us to accurately assess the Year
2000 readiness of any particular borrower or depositor. Additionally, there may
be a higher than usual demand for liquidity immediately prior to the century
change due to deposit withdrawals by customers concerned about Year 2000 issues.
To address this possible demand, we plan to have a high percentage of our
investment portfolio in readily accessible funds during this time frame.
FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 (the "Act")
provides a safe harbor for forward-looking statements made by or on behalf of
the Company. The Company has made, and may continue to make, various written or
verbal forward-looking statements with respect to business and financial
matters, including statements contained in this report, filings with the
Securities and Exchange Commission, and reports to stockholders. All statements
which address operating performance, Year 2000, events or developments that we
expect or anticipate will occur in the future, including statements related to
loan growth, deposit growth, per share growth, and statements expressing general
sentiment about future operating results and non-historical information, are
forward-looking statements within the meaning of the Act. The forward-looking
statements are and will be based on management's then current views and
assumptions regarding future events and operating performance. Certain factors
that could affect financial performance or cause actual results to vary
significantly from estimates contained in or underlying forward looking
statements include:
o Interest rate fluctuations and other market conditions.
o Strength of the consumer and commercial credit sectors, as well as real
estate markets.
o Changes in laws and regulations, including changes in accounting
standards and taxation requirements (including tax rate changes, new
tax laws, and revised tax law interpretation).
o Competitive pricing and other pressures on loans and deposits and the
Company's ability to maintain market shares in its trade areas.
o The inherent uncertainties in achieving Year 2000 compliance with
respect to the Company and its vendors, suppliers, and loan customers.
o Other risks and uncertainties as detailed from time to time in Company
filings with the Securities and Exchange Commission.
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
Northern Star Financial, Inc. and Subsidiary
Mankato, Minnesota 56001
We have audited the accompanying consolidated statements of financial
condition of Northern Star Financial, Inc. and Subsidiary (the Company) as of
June 30, 1999 and 1998 and the related consolidated statements of operations,
changes in shareholders' equity, and cash flows for the year ended June 30, 1999
and for the period from inception, January 22, 1998 to June 30, 1998. These
financial statements are the responsibility of management. Our responsibility is
to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Northern Star Financial, Inc. and Subsidiary as of June 30, 1999 and 1998, and
the consolidated results of their operations and their cash flows for the
respective year and period then ended, in conformity with generally accepted
accounting principles.
As discussed in Note 1 to the consolidated financial statements, the
Company changed its method of accounting for organization costs.
Bertram Cooper & Co., LLP
Waseca, Minnesota
August 5, 1999
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
June 30,
-----------------------------
ASSETS 1999 1998
----------- -----------
<S> <C> <C>
Cash and cash equivalents:
Cash and due from banks $ 210,662 $ --
Federal funds sold 2,533,236 --
----------- -----------
Total cash and cash equivalents 2,743,898 --
Securities available for sale, at fair value 745,119 --
FHLB stock, at cost 16,400 --
Loans held for sale 681,593 --
Loans receivable, net of allowance for loan losses of $56,250 in 1999
and $-0- in 1998 4,881,502 --
Accrued interest receivable 59,527 --
Premises and equipment, net 486,685 --
Other assets 20,884 14,806
----------- -----------
Total Assets $ 9,635,608 $ 14,806
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Demand deposits $ 1,121,450 $ --
Savings deposits 3,244,444 --
Time deposits 1,798,675 --
----------- -----------
Total deposits 6,164,569 --
Advances from borrowers for taxes and insurance 23,941 --
Other liabilities 23,396 18,665
----------- -----------
Total Liabilities 6,211,906 18,665
----------- -----------
Shareholders' equity:
Common stock, par value $0.01 per share, 15,000,000 shares authorized,
425,600 shares issued 4,256 --
Undesignated stock, par value $0.01 per share, 5,000,000 shares
authorized, no shares issued -- --
Paid in capital 3,919,577 100
Accumulated deficit (497,631) (3,959)
Accumulated comprehensive income (loss) (2,500) --
----------- -----------
Total shareholders' equity 3,423,702 (3,859)
----------- -----------
Total liabilities and shareholders equity $ 9,635,608 $ 14,806
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Period From
For the Year Ended Inception to
June 30, 1999 June 30, 1998
--------- ---------
<S> <C> <C>
Interest Income:
Loans receivable $ 120,005 $ --
Securities available for sale 3,590 --
Due from banks 5,191 --
Federal funds sold 26,089 --
--------- ---------
Total interest income 154,875 --
Interest expense:
Demand deposits 1,430 --
Savings deposits 13,363 --
Time deposits 25,219 --
--------- ---------
Total interest expense 40,012 --
Net interest income 114,863 --
Provision for loan losses 56,250 --
--------- ---------
Net interest income after provision for loan losses 58,613 --
--------- ---------
Noninterest income:
Other fees and service charges 45,499 --
Loss on sale of loans (3,050) --
--------- ---------
Total noninterest income 42,449 --
--------- ---------
Noninterest expenses:
Compensation and employee benefits 247,497 --
Board fees 70,429 --
Occupancy 39,556 --
Legal and accounting 35,806 --
Printing and supplies 22,261 --
Furniture, fixtures and equipment depreciation 19,453 --
Data processing 16,758 --
Organizational expenditures 55,691 --
Other 87,283 3,959
--------- ---------
Total noninterest expense 594,734 3,959
--------- ---------
Net loss before income tax benefit (493,672) (3,959)
Income tax benefit -- --
--------- ---------
Net loss $(493,672) $ (3,959)
========= =========
Basic (loss) per share of common stock $ (1.60) $ N/A
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Accumulated
Other
Comprehensive
Undesignated Paid-in Accumulated Income Comprehensive
Common Stock Stock Surplus Deficit Net of Tax Income Total
----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1997 $ -- $ -- $ -- $ -- $ -- $ -- $ --
Issuance of common stock -- 100 -- -- -- 100
Net loss for a period of
inception to June 30, 1998 -- -- -- (3,959) -- (3,959) (3,959)
Comprehensive loss -- -- -- -- -- $ (3,959) --
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, June 30, 1998 -- 100 (3,959) -- (3,859)
Issuance of common stock 4,256 -- 4,251,744 -- -- -- 4,256,000
Offering costs -- -- (332,267) -- -- -- (332,267)
Net loss for the year ended
June 30, 1999 -- -- -- (493,672) (493,672) (493,672)
Unrealized loss on
available-for-sale
securities net of tax of -- -- -- -- (2,500) (2,500) (2,500)
$1,667
Comprehensive loss -- -- -- -- -- -- --
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, June 30, 1999 $ 4,256 $ -- $ 3,919,577 $ (497,631) $ (2,500) $ (496,172) $ 3,423,702
=========== =========== =========== =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Period From
For the Year Ended Inception to
June 30, 1999 June 30, 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Interest received on loans and investments $ 95,343 $ --
Interest paid (20,391)
Other fees, commissions, and income received 42,449 --
Cash paid to suppliers, employees and others (552,833) (9,539)
Contributions to charities (185) --
Loans originated for sale (1,866,642) --
Proceeds from sale of loans 1,188,100 --
------------ ------------
Net cash used in operating activities (1,114,159) (9,539)
------------ ------------
Cash flows from investing activities:
Purchases of available-for-sale securities (749,281) --
Purchase of FHLB stock (16,400) --
Loan originations and principal payments on loans, net (4,940,802) --
Deferred organizational costs -- (9,226)
Purchase of property and equipment (509,419) --
------------ ------------
Net cash used in investing activities (6,215,902) (9,226)
------------ ------------
Cash flows from financing activities:
Net increase in non-interest bearing demand and savings deposit
accounts 4,365,700 --
Net increase in time deposits 1,779,250 --
Net increase in mortgage escrow funds 23,941 --
(Payment of) advances from organizers (18,665) 18,665
Proceeds from sale of common stock net of offering costs
3,923,733 100
------------ ------------
Net cash provided by financing activities 10,073,959 18,765
------------ ------------
Net increase in cash and cash equivalents 2,743,898 --
Cash and cash equivalents at beginning of year -- --
------------ ------------
Cash and cash equivalents at end of year $ 2,743,898 $ --
============ ============
Non-cash investing activities
Deferred organization costs expensed $ 9,226 $ --
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
<TABLE>
<CAPTION>
For the Period From
For the Year Ended Inception to
June 30, 1999 June 30, 1998
---------------------- -----------------------
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING
ACTIVITIES
<S> <C> <C>
Net loss $ (493,672) $ (3,959)
Adjustments:
Depreciation 22,732 --
Net loan fees deferred and amortized 0 --
Net mortgage loan servicing fees deferred 0 --
Provision for loan losses 56,250
Premiums accretion on investments (39)
Discount amortization on investment 34
Loss on sale of loans 3,050
(Increase) decrease in: --
Loans held for sale (681,593) --
Accrued interest receivable (59,527) --
Prepaid income tax -- --
Other assets (4,411) (5,580)
Increase in:
Accrued interest payable 19,621 --
Other liabilities 23,396 --
------------ ------------
Net cash used in operating activities $(1,114,159) $ (9,539)
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
Note 1. Summary of Significant Accounting Policies
The following summarizes the significant accounting policies Northern
Star Financial, Inc. (the Company) follows in presenting its financial
statements.
Principles of Consolidation - The consolidated financial statements
include the accounts of the Company and its wholly owned subsidiary
Northern Star Bank (the Bank). All significant intercompany
transactions and balances are eliminated in consolidation.
Organization of the Business - The Company was incorporated under the
laws of the State of Minnesota on January 22, 1998, for the purpose of
becoming a bank holding company for a state chartered commercial bank.
On October 9, 1998, the Company commenced an initial public offering of
its Common Stock at $10.00 per share. The Company accepted
subscriptions (including subscriptions from the Bank's organizers to
purchase an aggregate of 154,000 shares) to purchase an aggregate of
425,600 shares of its Common Stock. The proceeds from the stock
subscriptions amounted to $3,923,733, net of selling expenses. The
Bank's charter became effective January 25, 1999 and the Company
injected $3,000,500 into the Bank's capital accounts.
The Company prior to January 25, 1999, reported as a development stage
enterprise because its activities included raising capital and
establishing a new bank. Upon opening, the Bank and the Company's
primary attention turned to routine, ongoing bank activities and it
ceases to be a development stage enterprise.
Nature of Business - The Company is a bank holding company whose
subsidiary provides financial services. The Bank's business is that of
a financial intermediary and consists primarily of attracting deposits
from the general public and using such deposits, together with
borrowings and other funds, to make secured and unsecured loans to
business and professional concerns and mortgage loans secured by
residential real estate and other consumer loans. At June 30, 1999, the
Bank operated one retail banking office in Minnesota. The Bank is
subject to significant competition from other financial institutions,
and is also subject to regulation by certain federal and state agencies
and undergoes periodic examinations by those regulatory authors.
Use of Estimates - In preparing the consolidated financial statements,
management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities as of the date of the
balance sheets, and income and expenses for the period. Actual results
could differ from those estimates. Material estimates that are
particularly susceptible to significant change relate to the
determination of the allowance for losses on loans and the valuation of
real estate acquired in connection with foreclosures or in satisfaction
of loans. In connection with the determination of the allowance for
losses on loans and foreclosed real estate, management obtains
independent appraisals for significant properties.
<PAGE>
While management uses available information to recognize losses on
loans and foreclosed assets, future additions to the allowances may be
necessary based on changes in local economic conditions. In addition,
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for losses on loans and
foreclosed real estate. Such agencies may require the Bank to recognize
additions to the allowances based on their judgments about information
available to them at the time of their examination.
Cash Equivalents - For purposes of reporting cash flows, cash and cash
equivalents include cash on hand, amounts due from banks and federal
funds sold. Generally, federal funds are purchased and sold for one-day
periods.
Investment Securities - Investment securities available for sale are
reported at fair market value, with unrealized gains and losses
reported as a separate component of stockholders' equity, net of the
related tax effect.
Premiums and discounts on all investment securities are amortized
(deducted) and accreted (added), respectively, to interest income on
the straight-line and interest methods over the period to the maturity
of the related security.
The Bank, as a member of the Federal Home Loan Bank System, is required
to maintain an investment in capital stock of the Federal Home Loan
Bank of Des Moines. Because no ready market exists for this stock, and
it has no quoted market value, the Bank's investment in this stock is
carried at cost.
Effective July 1, 1998, the Company adopted Statement of Financial
Standards ("SFAS") No. 130, "Reporting Comprehensive Income." The
statement establishes standards for reporting and display of
comprehensive income and its components in a full set of financial
statements. The statement requires that all items that are required to
be recognized under accounting standards as components of comprehensive
income to be disclosed in the financial statements. Comprehensive
income is defined as the change in equity during a period from
transactions and other events from non-owner sources. Comprehensive
income is the total of net income and other comprehensive income, which
for the Company is comprised entirely of unrealized gains and losses on
securities available for sale.
Loans Held for Sale - Mortgage loans originated and intended for sale
in the secondary market are carried at the lower of cost or estimated
market value in the aggregate. Net unrealized losses are recognized
through a valuation allowance by charges to income. Gains or losses on
the sale of loans are recorded in noninterest income, based on the net
proceeds received and the recorded investment in the loan.
Loans Receivable - Loans receivable that management has the intent and
ability to hold for the foreseeable future or until maturity or pay-off
are reported at their outstanding principal balance adjusted for any
charge-off, the allowance for loan losses, and unamortized premiums any
deferred fees or costs on originated loans and or discounts on
purchased loans. Discounts and premiums on purchased residential real
estate loans are amortized to income using the interest method over the
remaining period to contractual maturity, adjusted for anticipated
prepayments. Discounts and premiums on purchased consumer loans are
recognized over the expected lives of the loans using the level yield
method.
The allowance for loan loss was established by a charge to income based
on management's evaluation of the known and inherent risks in the loan
portfolio, adverse situations that may affect the borrower's ability to
repay, the estimated value of any underlying collateral, and current
economic conditions.
<PAGE>
Uncollectible interest on loans contractually past due for three months
is charged off or an allowance is established based on management's
periodic evaluation. The allowance is established by a charge to or
against interest income equal to all interest previously accrued.
Income is subsequently recognized only to the extent cash payments are
received until, in management's judgment, the borrower's ability to
make periodic interest and principal payments returns to normal, in
which case the loan is returned to accrual status.
Loan origination fees and certain direct origination costs are
capitalized, with the net fee or cost recognized as an adjustment to
interest income using the interest method.
Mortgage Loan-Servicing Rights - The Bank has established accounting
and reporting standards for transfers and servicing of financial assets
and extinguishments of liabilities based on the consistent application
of the financial-components approach. This approach requires the
recognition of financial assets and servicing assets that are
controlled by the Bank, and the derecognition of financial assets and
liabilities when control is extinguished. Liabilities and derivatives
incurred or obtained in conjunction with the transfer of financial
assets are measured at fair value, if practicable. Servicing assets and
other retained interest in transferred assets are measured by
allocating the carrying amount between the assets sold and the interest
retained, based on their relative fair value. The Bank had no servicing
assets as of June 30, 1999.
Premises and Equipment - Leasehold improvements, furniture and
equipment are carried at cost less accumulated depreciation.
Depreciation is computed by the straight-line method over the estimated
useful lives of the assets, which range from three to forty years.
Income Taxes - Deferred income taxes are recognized for the tax
consequences of temporary differences by applying enacted statutory tax
rates applicable to future years to differences between the financial
statement carrying amounts and the tax basis of existing assets and
liabilities. The effect on deferred taxes of a change in tax rates is
recognized in income in the period that includes the enactment date.
The measurement of deferred tax assets as reduced, if necessary, by the
amount of any tax benefits that, based on available evidence, are not
expected to be realized. The effect of a change in the
beginning-of-the-year balance of a valuation allowance that results
from a change in judgment about the realizability of deferred tax
assets, is included in income.
The Company files consolidated income tax returns with the Bank and
they have entered into a tax sharing agreement which provides that the
Bank will pay to the Company, or receive a refund from the Bank's
taxable income, as if the Bank portion of income tax liability or
benefit was separately determined based on taxable income or loss.
Organizational Costs - The Company has elected early adoption of
Statement of Position 98-5 ("Reporting on the Costs of Start-up
Activities" issued April 3, 1998 by the Accounting Standards Executive
Committee of the American Institute of Certified Public Accountants)
and has expensed its cumulative organization and start-up costs. Costs
deferred in the period ended June 30, 1998, of $9,226 were expensed in
the current period.
Earnings Per Share - Basic earnings per share (EPS) is based on the
weighted average outstanding common shares. Diluted EPS is based on the
weighted average outstanding shares reduced by the effect of stock
options and warrants. The stock subscriptions described in Organization
<PAGE>
of the Business were continently issuable subject to the Bank charter
approval which occurred January 25, 1999 and included in the
denominator of EPS as of the date of the Company's Registration
Statement, resulting in 307,831 weighted average shares.
Diluted EPS is the same as basic EPS because the option and warrant
shares were granted at a price which is equal to the current operating
period market price and those shares are not "in the money."
Ten shares were outstanding at June 30, 1998 and presentation of EPS
for the initial development period from inception would not be
meaningful.
Fair Values of Financial Instruments - SFAS No. 107, "Disclosures about
Fair Value of Financial Instruments," requires disclosure of fair value
information about financial instruments, whether or not recognized in
the statement of financial condition. In cases where quoted market
prices are not available, fair values are based on estimates using
present value or other valuation techniques. Those techniques are
significantly affected by the assumptions used, including the discount
rate and estimates of future cash flows. In that regard, the derived
fair value estimated cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in
immediate settlement of the instruments. SFAS No. 107 excludes certain
financial instruments and all nonfinancial assets and liabilities from
its disclosure requirements. Accordingly, the aggregate fair value
amounts presented do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in
estimating its fair value disclosures presented in Note 11, for
financial instruments:
Cash and cash equivalents: The carrying amounts reported in the
statements of financial condition for cash and cash equivalents equal
their fair values.
Debt and equity securities: Fair values for debt and equity securities
are based on quoted market prices, where available. If quoted market
prices are not available, fair values are based on quoted market prices
of comparable instruments.
FHLB stock: The carrying amount of FHLB stock approximates fair value.
Loans: For variable-rate loans that reprice frequently with no
significant change in credit risk, fair values are based on carrying
amounts. The fair values for other loans (for example, fixed rate
commercial real estate, rental property mortgage loans, and commercial
and industrial loans) are estimated using discounted cash flow
analyses, based on interest rates currently being offered for loans
with similar terms to borrowers of similar credit quality giving
consideration to estimated prepayment and credit loss factors. Loan
fair value estimates include judgments regarding future expected loss
experience and risk characteristics. Fair values for impaired loans are
estimated using discounted cash flow analysis or underlying collateral
values, where applicable.
Accrued interest receivable: The carrying amount of accrued interest
receivable approximates fair value.
Deposits: The fair values disclosed for demand deposits are, by
definition, equal to the amount payable on demand at the reporting date
(that is, their carrying amounts). Fair values for time deposits are
<PAGE>
estimated using a discounted cash flow calculation that applies
interest rates currently offered on certificates to a schedule of
aggregated expected monthly maturities on time deposits. The carrying
amount of accrued interest payable approximates fair value.
Advance payments by borrowers for taxes and insurance (escrow
accounts): The carrying amount of escrow accounts approximate fair
value.
Loan commitments: Commitments to extend credit were evaluated and fair
value was estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counterparties. For
fixed-rate loan commitments, fair value also considers the difference
between current levels of interest rates and the committed rates. The
carrying value and fair value of commitments to extend credit are not
considered material for disclosure.
Note 2. Debt and Equity Securities
The amortized costs and approximate fair values of debt and equity
securities are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
--------- ----------- ---------- ----------
June 30, 1999:
<S> <C> <C> <C> <C>
Debt securities available for sale:
U.S. Government and agency
obligations $ 749,286 $ - $ (4,167) $ 745,119
========= =========== ========== ==========
</TABLE>
There were no sales of securities during the year ended June 30, 1999.
The amortized cost and estimated market value of debt securities at June 30,
1999, by contractual maturity, are shown below.
<TABLE>
<CAPTION>
Available for Sale
Amortized Estimated
Cost Fair Value
---------- ----------
<S> <C> <C>
Due from one to five years $ 549,286 $ 545,119
Due from five to ten years 200,000 200,000
---------- ----------
Total $ 749,286 $ 745,119
=========== ===========
</TABLE>
<PAGE>
Note 3. Loans Receivable
Loans receivable at June 30, 1999, consist of the following:
Commercial $ 1,843,707
Real Estate 1,658,261
Consumer 1,435,784
--------------
Total loans receivable $ 4,937,752
Less:
Allowance for loan losses (56,250)
Loans receivable, net $ 4,881,502
=============
A summary of the activity in the allowance for loan losses is as
follows:
Year ended
June 30, 1999
--------------
Balance, beginning of period $ -0-
Provision for losses 56,250
Balance, end of period $ 56,250
===============
In the ordinary course of business, the Bank has granted loans to
certain executive officers, directors and their related interests.
Related party loans are made on substantially the same terms as those
prevailing at the time for comparable transactions with unrelated
persons and do not involve more than the normal risk of collectibility.
Loan activity in these accounts for the year ended June 30, 1999, is as
follows:
Beginning balance $ -0-
New loans 1,569,076
Less: Repayments (321,940)
-------------
Ending balance $ 1,247,136
=============
Note 4. Accrued Interest Receivable
Accrued interest receivable at June 30, 1999, is summarized as follows:
Investment securities $ 12,191
Loans receivable 47,336
----------------
Total $ 59,527
===============
<PAGE>
Note 5. Premises and Equipment
Premises and equipment at June 30, 1999, consists of the following:
Leasehold improvements $ 200,035
Furniture and equipment 309,382
--------------
Total 509,417
Less accumulated depreciation (22,732)
Premises and equipment, net $ 486,685
==============
Note 6. Deposits
The aggregate amount of certificates of deposit with a minimum
denomination of $100,000 was approximately $400,000 at June 30, 1999.
Deposited amounts in excess of $100,000 per account holder are not
insured by the Federal Deposit Insurance Company.
At June 30, 1999, the scheduled maturities of time deposits are as
follows:
2000 $ 1,449,748
2001 348,837
---------------
Total $ 1,798,585
==============
Deposits by related parties were approximately $658,000 at June 30,
1999.
<PAGE>
Note 7. Income Taxes
The following are the components of income tax expense as provided:
For the Period
For the Year Ended from Inception
June 30, 1999 to June 30, 1998
----------- ------------
$ $
Current income tax provision - -
Deferred income tax benefit - -
----------- ------------
$ - $ -
=========== ============
A reconciliation of income taxes computed at the federal statutory
income tax rate to total income taxes is as follows:
<TABLE>
<CAPTION>
For the Period
For the Year Ended from Inception
June 30, 1999 to June 30, 1998
----------- ------------
<S> <C> <C>
Pretax loss $(493,672) $ (3,959)
---------- ----------
Income tax (benefit) computed at federal
statutory tax rate $(167,848) $ (1,346)
Increase (decrease) resulting from:
Nondeductible expenses 718 -
State income tax benefit, net of federal
tax benefit (28,751) (238)
Valuation allowance 195,881 1,584
--------- ----------
$ - $ -
========= ==========
</TABLE>
<PAGE>
Temporary differences between financial statement carrying amounts and
the tax basis of assets and liabilities that create deferred tax assets
and liabilities are as follows:
June 30, June 30,
1999 1998
--------- ---------
Deferred tax assets:
Net operating loss carryforward $ 131,400 $ 1,584
Deferred organization expenses 48,450 --
Allowance for loan losses 22,500 --
Securities unrealized losses 1,667 --
Less valuation allowance (197,465) (1,584)
--------- ---------
Subtotal 6,552 --
--------- ---------
Deferred tax liabilities:
Depreciation and basis adjustment 4,885 --
--------- ---------
Subtotal 4,885 --
--------- ---------
Net deferred tax assets $ 1,667 $ --
========= =========
At June 30, 1999, the Company had cumulative net operating loss
carryforward for tax purposes of approximately $320,000 subject to a 20
year limitation.
Note 8. Stock Options
In August 1998, the Company adopted the 1998 Equity Incentive Plan (the
"Plan") and reserved 41,700 shares of common stock for issuance
pursuant to the Plan to certain employees and directors of the Company
and its subsidiary. In addition, the Company granted to its organizing
directors options to purchase an aggregate 30,800 shares outside the
Plan. These plans provide for the granting of incentive stock options
as defined in Section 422 of the Internal Revenue Service Code as well
as nonincentive stock options (collectively stock options). The options
vest over a period ranging from immediate (36,800 shares) to 3 years
(18,000 shares) and must be exercised within 10 years of grant date.
A summary of the status of the stock options as of and for the year
ended June 30, 1999 is presented below:
Weighted Avg.
Shares Exercise Price
Granted 54,800 $10.00
Outstanding 54,800 $10.00
Exercisable 36,800 $10.00
The weighted average fair value of the options granted is $4.33 per
share and the weighted average remaining contractual life of options
outstanding is 9.7 years.
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), provides for companies to
recognize compensation expense associated with stock-based compensation
<PAGE>
plans over the anticipated service period based on the fair value of
the award on the date of grant. However, SFAS 123 allows companies to
continue to measure compensation costs prescribed by Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25").
The Company elected to follow APB 25 and related interpretations in
accounting for its employee stock options. Under APB 25, the exercise
price of the Company's employee stock options equal the market price of
the underlying stock on the date of grant and, therefore, no
compensation expense is recognized. Proforma information regarding net
income and earnings per share is required by SFAS No. 123, and has been
determined as if the Company had accounted for its employee stock
options under the fair value method of that statement. Proforma net
income/(loss) and earnings/(loss) per share for fiscal 1999 follows:
Loss per
Net Loss Common Share
As reported $ (493,672) $ (1.60)
Pro forma $ (661,584) $ (2.15)
The above disclosed pro forma effects of applying SFAS No. 123 to
compensation costs may not be representative of the effects on reported
pro forma net income for future years.
The fair value for each option grant is estimated on the date of the
grant using the Black Scholes Model. The model incorporates the
following assumptions:
Risk-free interest rate 5.129%
Expected life 5 Yrs.
Expected volatility 26.00%
Expected dividends None
<PAGE>
Note 9. Commitments
At June 30, 1999, the Bank was obligated under operating leases for
office space and equipment. Net rental expense under these operating
leases, included in occupancy and other, was $33,945 for the year ended
June 30, 1999. The office space is leased from a lessor entity in which
a Company board member has a significant interest. Minimum lease
payments under the operating leases are as follows:
For the Year Office Equipment
Ended lease lease
------------ -------- --------
2000 $ 77,907 $ 4,044
2001 77,907 4,044
2002 78,560 2,022
2003 79,212 --
2004 79,212 --
2005 and thereafter 365,526 --
-------- --------
Total $758,324 $ 10,110
======== ========
The Bank has an option to renew the office lease for two additional
five year terms.
Note 10. Stock Warrants
On October 9, 1998, the Company entered into an agency agreement for
services to sell the Company's common stock. The Agent was compensated,
in part, with warrants to acquire 10,000 shares of the Company's stock
at $10.00 per share at any time prior to October 9, 2003.
Note 11. Financial Instruments
The Bank is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of
its customers. These financial instruments are commitments to extend
credit and involve, to varying degrees, elements of credit risk in
excess of the amount recognized in the balance sheet. The Bank's
exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Bank
uses the same credit policies in making commitments as it does for
on-balance sheet instruments.
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. Commitments to
extend credit represent credit risk totaled $961,207 for unused lines
of credit at June 30, 1999.
Commitments to sell loans amounted to $681,593 at June 30, 1999.
<PAGE>
The estimated fair values of the Company's financial instruments are as
follows:
June 30, 1999
----------------------------
Carrying Fair
Financial assets: Amount Value
------------ -----------
Cash and cash equivalents $ 2,816,398 $ 2,816,398
Investment securities 745,199 745,119
FHLB stock 16,400 16,400
Loans receivable 4,790,752 4,790,752
Loans held for sale 681,593 681,593
Accrued interest receivable 59,527 59,527
Financial liabilities:
Deposits $ 6,164,570 $ 6,164,570
Advance payments by borrowers 23,941 23,941
The market rates on loans and deposits at June 30, 1999 did not change
materially from their contractual rates resulting in fair value being
equal to the carrying amount.
Note 12. Significant Concentration of Credit Risk
A significant portion of the Bank's loans receivable are to borrowers
located in Mankato, Minnesota and the surrounding counties. This
geographic concentration amounted to approximately 70% of the total
loans receivable balance for the year ended June 30, 1999.
The Bank maintains its cash in bank deposit accounts which at times,
may exceed federal deposit insurance limits. The Bank has not
experienced any losses in such accounts and believes it is not exposed
to any significant credit risk on cash.
Note 13. Stockholders' Equity and Regulatory Matters
The Bank is subject to various regulatory capital requirements
administered by the Federal Deposit Insurance Corporation (FDIC).
Failure to meet minimum capital requirements can initiate certain
mandatory and possible additional discretionary actions by regulators
that, if undertaken, could have a direct material effect on the Bank's
financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities and certain off-balance sheet items as
calculated under regulatory accounting practices. The Bank's capital
amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set
forth in the following table below) of total and Tier 1 capital (as
defined in the regulation), to risk-weighted assets (as defined), and
of Tier 1 capital (as defined) to average assets (as defined).
Management believes, as of June 30, 1999, that the Bank meets all of
capital adequacy requirements to which it is subject.
<PAGE>
As of June 30, 1999, the most recent notification from the FDIC
categorized the Bank as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well capitalized the
Bank must maintain minimum total risk-based, Tier 1 risk-based, Tier 1
leverage ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed
the Bank's category.
Note 13. Stockholders' Equity and Regulatory Matters
The Bank's actual capital amounts and ratios are also presented in the
table below (in thousands):
<TABLE>
<CAPTION>
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provision
-------------------------- --------------------------- ---------------------------
Amount Percent Amount Percent Amount Percent
--------- ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1999:
Total Capital
(to Risk Weighted Assets) $ 2,785 44.2% $ 504 8.0% $ 630 10.0%
Tier 1 Capital
(to Risk Weighted Assets) $ 2,729 43.3% $ 252 4.0% $ 378 6.0%
Tier 1 Capital
(to Average Assets) $ 2,729 36.5% $ 299 4.0% $ 374 5.0%
</TABLE>
The Bank may not declare or pay cash dividends to the Company if the
effect would be to reduce capital below applicable regulatory
requirements or if such declaration and payment would otherwise violate
regulatory requirements.
Note 14. Effects of New Financial Accounting Standards
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" - Issued June 1998, establishes accounting and reporting
standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair
value. This statement is effective for the fiscal year beginning July
1, 2000, and management believes adoption will not have a material
effect.
Note 15. Parent Only Condensed Financial Information
This information should be read in conjunction with the other Notes to
Consolidated Financial Statements. On January 25 1999, the Company
issued $4.3 million of common stock and contributed $3,000,500 of the
net proceeds to the Bank as equity capital.
<PAGE>
STATEMENTS OF FINANCIAL CONDITION
----------- -----------
June 30, June 30,
ASSETS 1999 1998
----------- -----------
Cash (1) $ 704,700 $ --
Investment in Bank subsidiary 2,726,471 --
Prepaid assets -- 5,580
Deferred organizational costs -- 9,226
----------- -----------
Total $ 3,431,171 $ 14,806
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Other liabilities $ 7,469 $ 18,665
Shareholder's equity
3,423,702 (3,859)
=========== ===========
Total $ 3,431,171 $ 14,806
=========== ===========
(1) The parent company cash is deposited in the Bank and eliminated on
the consolidated statements of financial condition.
STATEMENTS OF INCOME
--------- ---------
For the Year For the
Ended Year Ended
June 30, June 30
Interest from: 1999 1998
--------- ---------
Deposits in subsidiary $ 7,565 $ --
Nonaffiliated bank 5,191 --
--------- ---------
Total income $ 12,756 --
Expenses:
Non-interest expenses 234,899 3,959
Income tax (refund) expense -- --
--------- ---------
Total expenses 234,899 3,959
--------- ---------
Loss before equity in undistributed net loss
of Bank subsidiary (222,143) (3,959)
Equity reduction from undistributed net
comprehensive loss of Bank subsidiary (274,029) --
--------- ---------
Net comprehensive loss $(496,172) $ (3,959)
========= =========
<PAGE>
Note 15. Parent Only Condensed Financial Information (continued)
STATEMENTS OF CASH FLOWS
For the For the
Year Ended Year Ended
June 30, June 30
1999 1998
----------- -----------
Net loss $ (222,143) $ (3,959)
Adjustments:
Decrease (increase) in other assets 5,580 (5,580)
Increase in other liabilities 7,469 --
----------- -----------
Net cash used in operations (209,094) (9,539)
----------- -----------
Cash flows from investing activities:
Investment in Bank subsidiary (3,000,500) --
Deferred organizational costs -- (9,226)
----------- -----------
Net cash (used in) investing activities (3,000,500) (9,226)
----------- -----------
Cash flows from financing activities:
Proceeds from sale of common stock 4,256,000 100
Payments for stock issuance costs (332,267) --
Decrease in prepaid organizational costs 9226 --
(Refunds to) Advances from organizers (18,665) 18,665
----------- -----------
Net cash provided by financing activities 3,914,294 18,765
----------- -----------
Increase in cash and cash equivalents 704,700 --
Cash and cash equivalents
Beginning of year -- --
----------- -----------
End of year $ 704,700 $
=========== ===========
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The names and ages of the executive officers of the Registrant and
their positions and offices held are as follows:
Name Age Position with Company
Thomas P. Stienessen 53 Chief Executive Officer, President and a
Director of the Registrant since its
formation. From January 1991 to January
1998, Chief Executive Officer and President
of SGL, Inc., a holding company for Family
Bank, and Chairman, Chief Executive Officer,
President and a Director of Family Bank.
Frank L. Gazzola 71 Chief Financial Officer, Treasurer,
Secretary and a Director of the Registrant
since its formation. President of Frank L.
Gazzola, Chartered, Certified Public
Accountants since 1987.
The information required by Item 9 relating to directors, family
relationships and compliance with Section 16(a) of the Exchange Act is
incorporated herein by reference to the sections labeled "Election of Directors"
and "Section 16(a) Beneficial Ownership Reporting Compliance," respectively,
which appear in the Company's definitive Proxy Statement for its 1999 Annual
Meeting of Shareholders.
ITEM 10. EXECUTIVE COMPENSATION
The information required by Item 10 is incorporated herein by reference
to the section labeled "Executive Compensation" which appears in the
Registrant's definitive Proxy Statement for its 1999 Annual Meeting of
Shareholders.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 11 is incorporated herein by reference
to the section labeled "Shareholdings of Principal Shareholders and Management,"
which appears in the Registrant's definitive Proxy Statement for its 1999 Annual
Meeting of Shareholders.
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 12 is incorporated by reference to the
section labeled "Certain Transactions" which appears in the Registrant's
definite Proxy Statement for its 1999 Annual Meeting of Shareholders.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibits are numbered in accordance with Item 601 of
Regulation S-B. See "Exhibit Index" immediately following the
signature page of this Form 10-KSB.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last fiscal
quarter of the Registrant's 1999 fiscal year.
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
NORTHERN STAR FINANCIAL, INC.
Dated: September 15, 1999 By: /s/ Thomas P. Stienessen
Thomas P. Stienessen, Chief Executive Officer
In accordance with the Exchange Act, this Report has been signed by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
(Power of Attorney)
Each person whose signature appears below constitutes and appoints
THOMAS P. STIENESSEN and FRANK L. GAZZOLA as true and lawful attorneys-in-fact
and agents, each acting alone, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments to this Annual Report on Form 10-KSB
and to file the same, with all exhibits thereto, and other documents in
connection thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, each acting alone, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all said attorneys-in-fact and agents,
each acting alone, or his substitute or substitutes, may lawfully do or cause to
be done by virtue thereof.
Signature and Title Date
/s/ Thomas P. Stienessen September 15, 1999
Thomas P. Stienessen, President, Chief Executive
Officer and Director
(Principal Executive Officer)
/s/ Frank L. Gazzola September 15, 1999
Frank L. Gazzola, Chief Financial Officer and Director
(Principal Financial and Accounting Officer)
/s/ Robert H. Dittrich September 15, 1999
Robert H. Dittrich, Director
/s/ Dean M. Doyscher September 15, 1999
Dean M. Doyscher, Director
/s/ Steven A. Loehr September 15, 1999
Steven A. Loehr, Director
/s/ Michael P. Reynolds September 15, 1999
Michael P. Reynolds, Director
/s/ Thomas J. Reynolds September 15, 1999
Thomas J. Reynolds, Director
<PAGE>
NORTHERN STAR FINANCIAL, INC.
EXHIBIT INDEX TO FORM 10-KSB
Exhibit
Number Description
3.1 Amended and Restated Articles of Incorporation, as amended to date.
(Incorporated by reference to Exhibit 2.1 to the Company's Registration
Statement on Form SB-1, Reg. No. 333-61655)*
3.2 By-Laws, as amended to date. (Incorporated by reference to Exhibit 2.2
to the Company's Registration Statement on Form SB-2, Reg. No.
333-61655)*
10.1 Lease Agreement between Northern Star Bank (the "Bank") and Colonial
Square Partners relating to the space located at 1650 Madison Avenue,
Mankato, Minnesota. (Incorporated by reference to Exhibit 6.1 to the
Company's Registration Statement on Form SB-1, Reg. No. 333-61655)*
10.2** Employment Agreement between the Bank and Thomas P. Stienessen.
(Incorporated by reference to Exhibit 6.2 to the Company's Registration
Statement on Form SB-1, Reg. No. 333-61655)*
10.3** 1998 Equity Incentive Plan, including specimen of Incentive Stock
Option Agreement and Nonqualified Stock Option Agreement. (Incorporated
by reference to Exhibit 6.5 to the Company's Registration Statement on
Form SB-1, Reg. No. 333-61655)*
10.4** Form of Nonqualified Stock Option Agreement governing options granted
to Organizers. (Incorporated by reference to Exhibit 6.6 to the
Company's Registration Statement on Form SB-1, Reg. No. 333-61655)*
11 Statement re: Computation of Earnings Per Share (included in Notes to
Financial Statements)
21 Subsidiaries of the Registrant:
Name State of Organization
Northern Star Bank, Inc. Minnesota
24 Power of Attorney from Certain Directors (See Signature Page)
27 Financial Data Schedule (filed in electronic format only)
- ------------------------------
* Incorporated by reference - Commission File No. 000-25231 unless otherwise
indicated.
**Indicates a management contract or compensatory plan or arrangement
required to be filed as an exhibit to this Form 10-KSB.
