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, 2000
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: $1,179,388
The aggregate market value of the Common Stock held by nonaffiliates of the
Registrant as of September 6, 2000 was approximately $899,024 based upon the
average high and low bid prices of the Registrant's Common Stock on such date.
There were 427,600 shares of Common Stock, $0.0l par value, outstanding as of
September 6, 2000.
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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 2000 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.......................................................................10
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...........10
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION..........11
ITEM 7. FINANCIAL STATEMENTS...............................................26
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE..........................................53
PART III......................................................................53
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT................53
ITEM 10. EXECUTIVE COMPENSATION............................................53
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT....54
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................54
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K..................................54
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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
Our operating subsidiary, Northern Star Bank, is a community bank providing
a broad range of commercial and retail banking services designed to meet the
borrowing and depository needs of small and medium sized businesses and
consumers in the communities we serve. We offer a full range of deposit accounts
that are typically available from most banks and savings associations, including
checking accounts, commercial accounts, savings accounts and other time deposit
accounts. We provide a range of lending services including commercial, real
estate and consumer loans to individuals, small or medium-sized businesses and
professional associations.
We believe that businesses and individuals in our market area are
under-served by the larger regional and national lending institutions that have
acquired local banking and savings institutions in our market area. As a
community bank, we seek to provide our banking customers with the technological
and staff support that today's market requires, and make available a broad range
of products while providing personalized service. We are managed by individuals
who have lived and worked in our market for many years and believe that we can
leverage the experience of our management to grow our business. By combining
support with the products and services our customers require and our local
management and personalized service, we seek to foster a business that enables
us to effectively compete in our market with other financial institutions of all
sizes.
Strategy
We believe that rewarding business opportunities exist in the community
banking business. The acquisition and consolidation of many community banks by
large national and regional banks has diminished or eliminated the presence of
community banks from many rural and suburban communities. We believe that there
is a need and support for locally operated and managed community banks in many
of these communities.
Our plan is to grow our community banking business through acquisition and
branching, and diversify our revenue sources by providing other traditional and
non-traditional financial services. We intend to diversify and grow our
community banking business by expanding our geographic presence in and outside
the State of Minnesota. In connection with our geographic expansion, we intend
to expand and diversify our balance sheet to be able to provide a greater level
of commercial and agricultural lending and other financial services.
We intend to grow our community banking business while maintaining the
critical components we believe support successful community banking. We intend
to operate each of our affiliated community banks using local management and
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board of directors. We intend to rely on each local community bank's management
and board of directors to determine the best interests of the community bank
within their particular community and each bank will have authority to make all
decisions affecting credit, pricing and the market of bank service. We believe
the strength and success of a community bank rests, in large part, in the
customer's ability to put a human face and touch to their bank service provider.
As we increase our number of affiliated community banks, we intend to develop
and implement a technology integration strategy to integrate and improve our and
our affiliate banks' information management systems and enhance customer
service.
We intend to diversify and expand our business to provide traditional and
non-traditional banking services. The recent adoption of the Gramm-Leach-Bliley
Act, commonly referred to as the "New Financial Modernization Legislation" may
present new opportunities to us by allowing us to provide non-traditional
banking services such as insurance and securities brokerage services. See
"Supervision and Regulation." We intend to explore our expansion, through
acquisition, internal development and the use of strategic alliances with third
parties, into non-community banking services.
Products and Services
We provide a wide variety of commercial and consumer lending and deposit
services. We offer these traditional banking products and services to our
customers through our loan representatives at our banking office.
Deposits. Deposits are our principal source of funds. We offer a full range
of deposit products that are typically available in most banks and savings
associations, including checking accounts, commercial accounts, tiered money
market and savings accounts, and other time deposits of various types, ranging
from daily money market accounts to longer-term certificates of deposit and
sweep accounts. We attempt to offer transaction accounts and time certificates
at rates competitive to those offered in the Mankato area. In addition, we offer
certain retirement account services and Individual Retirement Accounts (IRAs).
Lending Activities. We emphasize 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 our market area.
We offer a variety of commercial, lease and agricultural loans. 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, 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.
Our Bank also grants a variety of real estate loans secured by first or
second mortgages. 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 the criteria used when making a first mortgage loan. Home equity
lines of credit 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. We
attempt to reduce our credit risk in our 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, we often review the personal financial statements of the principal
owners and require personal guarantees of the principal owners of the collateral
property.
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In addition we provide a variety of consumer 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 consumer loans typically carry balances of less than
$25,000 and, in the case of non-revolving loans, are 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.
Our 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 is considered and
approved, if appropriate, by one of our designated senior loan officers. We have
established a directors' loan committee that has lending limits, and any loan in
excess of this lending limit must be approved by the directors' loan committee.
We do not make any loans to any of our directors, officers, or employees, unless
the loan is approved by our Bank's board of directors and is made on terms not
more favorable to such person than would be available to a person not affiliated
with us.
Our 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 our Bank), in general, our Bank is subject to a
loan-to-one-borrower limit. Since the enactment of the FIRREA in 1989, we
generally may not make loans to one borrower and related entities in an amount
which exceeds 15% of our 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 we are able to sell participations in our loans to other financial
institutions, we will not be able to meet all of the lending needs of loan
customers requiring aggregate extensions of credit above these limits.
Other Banking Services. We provide a variety of other services, including
cash management services, safe deposit boxes, traveler's checks, and direct
deposit of payroll and social security checks. We offer telephone banking and we
intend to provide in the future automatic drafts for various accounts. We are
associated with a shared network of automated teller machines that may be used
by our customers throughout Minnesota and other regions and permit customers to
access their funds 24 hours a day from locations outside our primary market
area. We also offer MasterCard and VISA credit card services through a
correspondent bank as an agent for our Bank.
We entered into a joint venture in July 1999 with First Federal Savings Bank
to form Homeland Mortgage Company, LLC. Homeland was established to serve as a
mortgage servicer and originator. Under the terms of the joint venture
agreement, we acquired a 49% equity interest in Homeland. On September 1, 2000,
we sold our minority interest in Homeland to First Federal Savings Bank for
approximately $68,000.
Locations and Service Area
Our principal market area is the Minnesota counties of Blue Earth and
Nicollet, which includes the communities of Mankato, North Mankato, LeHiller,
Eagle Lake and Skyline, Minnesota, from which we expect to draw a significant
portion of our business. Approximately 85,000 people reside in our principal
market area. The 1997 median household income of residents living in our
principal market area was approximately $43,000.
Marketing Focus
Local bank branches of large regional banks and a limited number of small
community banks provide the majority of the banking services within our
principal market area. We believe there is a need for a locally operated and
managed community bank and that we can successfully fill this need. We focus our
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marketing efforts on attracting and servicing small to medium-sized businesses
and individuals. We have utilized, or plan to utilize in the future, newspaper,
radio and billboard advertising in our principal market area to promote our
products and services and intend to continue to emphasize the customer benefits
of our local management and ownership, our community focus, our commitment to
providing personalized customer service and our competitive products and
services.
Competition
Our business is highly competitive. We compete with community and national
banks, credit unions, thrifts, and non-financial institutions such as insurance
companies and investment banks. Currently, our principal market area, the two
Minnesota counties of Blue Earth and Nicollet, are served by approximately 40
offices of 21 different banks, two federal savings banks and five credit unions.
The Mankato and North Mankato communities 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 us. Most, if not all, of our competitors have
substantially greater financial resources than us. We believe our competitive
strength will lie in providing long-term, relationship-oriented banking services
by management and employees with strong ties to the Mankato area. We attempt to
target all residents of our principal market area, especially local businesses
and homeowners.
SUPERVISION AND REGULATION
The following discussion of statutes and regulations affecting bank
holding companies and banks is a summary thereof and is qualified in its
entirety by reference to such statutes and regulations.
General
Commercial banking is highly regulated at both the federal and state
level. In addition to a variety of generally applicable state and federal laws
governing businesses and employers, we are extensively regulated by special laws
applicable only to financial institutions. Virtually all aspects of our
operations are subject to specific requirements or restrictions and general
regulatory oversight. Deposits, reserves, capital, investments, loans, issuance
of securities, payment of dividends, mergers and consolidations, electronic
funds transfers, management practices, the scope of activities and other aspects
of our operations are subject to regulation. 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 our shareholders.
The highly regulated environment in which we operate is subject to
frequent change. Significantly, on November 12, 1999, President Clinton signed
the Gramm-Leach-Bliley Act. This Act repeals portions of the Glass-Steagall Act,
amends The Bank Holding Company Act of 1956 ("BHC Act"), and modifies other laws
thereby broadening the permissible range of affiliations among banks, securities
firms, insurance companies, and other financial service providers. We cannot
fully predict the nature or the extent of any effects which this new law or
other possible regulatory changes may have on our 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
As noted earlier, Northern Star Financial, Inc. is a bank holding
company. A bank holding company is a form of bank ownership and provides an
alternative to individuals directly owning a bank's stock. In general, a bank
holding company is any company, corporation, or business entity that controls
the operation of a bank, whether through stock ownership or other means.
Individual investors generally hold stock in the parent holding company instead
of directly owning bank stock.
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In addition to serving as a means for holding and owning a bank stock,
the holding company structure can be used as a vehicle for acquiring additional
banks or for expanding into a wide range of activities. Holding companies also
offer a way of consolidating management and operations across these various
interests.
The BHC Act, as amended, is the primary federal law governing the
ownership and control of banks by companies. Under the BHC Act, a company
considered to be a bank holding company is subject to supervision by the Board
of Governors of the Federal Reserve System ("Board"). Further, the Board has
responsibility and authority to issue regulations governing bank holding
companies. A primary regulation issued by the Board under this authority is
Regulation Y.
Supervision. As a bank holding company, we are subject to supervision
by the Board. This supervision generally consists of financial reporting and
inspections. With respect to financial reporting, we are required to file with
the Board quarterly and annual reports and such additional information as the
Board may require. Inspections can be conducted either off-site or on-site as
deemed necessary and appropriate by the Board. Further, the Board has authority
to take action against us for failing to comply with applicable laws and
regulations. Such action is commonly referred to as "enforcement action" and can
take several different forms. Examples include cease and desist orders, civil
money penalties, and the removal of management officials. The Board may also
require that we terminate an activity or terminate control of or liquidate or
divest certain nonbank subsidiaries or affiliates when the 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 our insured
depository subsidiaries.
Regulation. As indicated above, bank holding companies such as ours are
subject to the BHC Act and Regulation Y, as well as other state and federal laws
and regulations. Thus, the following types of activities are subject to
regulatory requirements:
Payment of Dividends. The 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.
Board policy states that it is inappropriate for a banking organization that is
experiencing serious financial problems or that has inadequate capital to borrow
to pay dividends. Similarly, the payment of dividends based solely or largely on
gains resulting from unusual or nonrecurring events may not be prudent or
warranted. Further, the Board believes that a bank holding company should not
maintain a level of cash dividends to its shareholders that places undue
pressure on the capital of depository institution subsidiaries or are funded
from borrowings or other arrangements that undermine the bank holding company's
ability to serve as a source of strength to the subsidiaries. The Board may, and
in certain circumstances must, prohibit a bank holding company from making any
capital distributions without prior approval of the Board, if the subsidiary
depository institution is undercapitalized. The 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.
In addition to the restrictions on dividends imposed by the Board,
under the Minnesota Business Corporation Act, the discretion of our board of
directors is constrained by Minnesota Statutes, section 302A.551. Under that
section, the board may authorize a dividend only if the directors in good faith,
in a manner they 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, determine that we will be able to
pay our debts in the ordinary course of business after making a distribution.
Regulatory Capital Requirements. The Board's capital guidelines
establish minimum regulatory capital requirements for bank holding companies for
the following categories: (i) a capital leverage measure expressed as a
percentage of total assets, (ii) a risk-based measure expressed as a percentage
of total risk-weighted assets, and (iii) a Tier 1 leverage measure expressed as
a percentage of average total consolidated assets. Tier 1 capital consists of
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common stockholders' equity, qualifying preferred stock, and minority interests
in the equity accounts of consolidated subsidiaries. The failure of a bank
holding company to meet its capital requirements may result in supervisory
action, as well as an inability to obtain approval of any regulatory
applications and, potentially, increased frequency of examinations and
inspections. The federal bank regulators have previously indicated a desire to
raise minimum capital requirements for banking organizations and have suggested
that revisions to the capital requirements should be made. The effect of any
future change in our required capital ratios cannot be determined at this time.
Activity Limitations. Under the BHC Act, we must obtain Board approval
before we acquire direct or indirect ownership or control of any voting
securities of a bank or bank holding company if the acquisition results in our
control of more than 5% of the outstanding shares of any class of voting
securities of the entity, unless we already own a majority of the voting
securities of the entity. We also must obtain prior Federal Reserve approval
before we acquire all or substantially all of the assets of a bank or merge or
consolidate with another bank holding company. The BHC Act also, in general,
limits the activities that we and our subsidiaries may engage in to those so
closely related to banking or managing or controlling banks and activities that
are so closely related to banking as to be a proper incident thereto. The Board,
in making such determinations, considers whether performance of the activities
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. Under
Regulation Y, we may engage, subject to Board guidelines and approvals, in such
closely-related activities as: (1) extending credit and servicing loans; (2)
activities related to extending credit including real estate and personal
property appraising, arranging commercial real estate equity financing,
check-guaranty services, collection agency services, credit bureau services,
asset management, servicing, and collection activities, and acquiring debt in
default; (3) leasing personal or real property; (4) operating nonbank depository
institutions; (5) trust company functions; (6) financial and investment advisory
activities; (7) agency transactional services for customer investments including
securities brokerage, riskless principal transactions, private-placement
services, futures commission merchant, and other transactional services; (8)
investment transactions as principal including underwriting and dealing in
government obligations and money market instruments, investing and trading
activities, buying and selling bullion and related activities; (9) management
consulting and counseling activities; (10) support services including courier
services and printing and selling MICR-encoded items; (11) insurance agency and
underwriting; (12) community development activities; (13) retail sale of money
orders, savings bonds, and traveler's checks; and (14) data processing.
Under the Gramm-Leach-Bliley Act enacted on November 12, 1999, bank
holding companies that decide to become "financial holding companies" and that
meet the qualifying criteria will be able to engage in additional activities.
Specifically, financial holding companies will be able to engage in activities
that are financial in nature or incidental to such financial activities and
activities that are complementary to financial activities. The Act identifies a
number of activities as financial in nature, including insurance, underwriting,
dealing in, or making a market in securities, and merchant banking. These
identified activities are in addition to the closely related activities just
enumerated. To qualify as a financial holding company, all of the company's
subsidiary depository institutions must be well capitalized and well managed and
have a satisfactory rating under the Community Reinvestment Act.
Bank Regulation
The continued earnings and growth of our 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 Board. The
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 from the Federal Reserve System.
The actions of the 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. Our Bank, as a state chartered banking corporation, is
subject to primary supervision, examination and regulation by the Minnesota
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Department of Commerce ("DOC") and the Federal Deposit Insurance Corporation
("FDIC"). Various requirements and restrictions under the laws of the State of
Minnesota and the United States also affect the operation of our Bank. These
statutes and regulations relate to many aspects of the operations of our 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 our 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, our 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
has no tangible capital. We are not aware of any activity or condition that
could result in termination of our Bank's deposit insurance.
Payment of Dividends by our Bank. There are state and federal statutory
and regulatory requirements limiting the amount of dividends which may be paid
to us by our 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 our Bank's capital needs, asset quality and overall financial
condition. The governing regulatory agency has the authority to prohibit our
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 our Bank, that the governing regulatory agency may determine that
the payment of dividends to us by our 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 our Bank to set aside all of its net
profits to a surplus fund until the surplus fund is equal to 20% of our Bank's
capital stock, and 10% of its net profits while the surplus fund is equal to
between 20% and 50% of our Bank's capital stock. Even when the surplus fund
requirements are met, all bank decisions regarding dividends are subject to the
approval of the Department of Commerce.
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. Our Bank is subject to certain
restrictions imposed by federal law on "covered transactions" between our Bank
and its affiliates. These covered transactions are (i) loans or extensions of
credit by our Bank to an affiliate, (ii) a purchase of or investment in
securities issued by an affiliate, (iii) a purchase of assets from an affiliate
(subject to certain exemptions the Board may allow), (iv) the acceptance by our
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Bank of securities issued by the affiliate as security for a loan to any person
or company, and (v) the issuance by our Bank of any guaranty, acceptance, or
letter of credit on behalf of an affiliate. In general, (i) covered transactions
with any one affiliate cannot exceed 10% of our Bank's capital and transactions
with all affiliates cannot exceed 20% of our Bank's capital; (ii) extensions of
credit to an affiliate must be collateralized; (iii) low quality assets cannot
be purchased from an affiliate; and (iv) all transactions must be on safe and
sound terms.
All covered transactions, and certain other transactions between our
bank and our affiliates, must be on terms and under circumstances, including
credit standards, that are substantially the same, or at least as favorable to
our Bank as those prevailing at the time for comparable transactions with
nonaffiliated companies. In the absence of comparable transactions, the terms
and circumstances for the affiliate transaction must be those that in good faith
would be offered to nonaffiliated companies.
Regulatory Capital Requirements. Our Bank is required to comply with
capital adequacy standards set by the FDIC. The FDIC 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 three basic measures of capital adequacy: a total risk-based capital
measure, a Tier 1 risk-based capital ratio, and a leverage ratio.
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.
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) noncumulative perpetual preferred stock,
subject to certain limitations, and (iii) minority interest in the equity
accounts of consolidated subsidiaries. Supplementary capital ("Tier 2" capital)
consists of elements such 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 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 and certain other intangible assets).
Under current capital adequacy standards, our Bank must meet a minimum
ratio of qualifying total capital to risk-weighted assets of 8%. Of that ratio,
at least half, or 4%, must be in the form of Tier 1 capital.
Banks must also meet a leverage capital requirement. In general the
minimum leverage capital requirement is not less than 3 percent Tier 1 capital
to total assets if the bank has the highest regulatory rating and is not
anticipating or experiencing any significant growth. All other banks should have
a minimum of 100 to 200 basis points higher and thus a minimum leverage capital
standard of not less than 4 percent. Thus, banks normally are out of compliance
with regulatory capital requirements if they have a Tier 1 leverage capital
ratio of less than 4 percent.
As a result of the FDIC Improvement Act of 1991, the federal bank
regulatory agencies adopted regulations defining banks as "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized"
and "critically undercapitalized." Under the law, depending upon a bank's
<PAGE>
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%. An institution will be deemed
"undercapitalized" if it has total risk-based capital ratio that is less than 8%
or has a leverage ratio that is less than 4% (or less than 3% if rated CAMEL 1).
Institutions with a total risk-based capital ratio of less than 6%, a Tier 1
risk-based capital ratio of less than 3%, or a leverage ratio that is less than
3% will be deemed "significantly undercapitalized." Finally, the regulations
provide that an institution that has a ratio of tangible equity to total assets
that is equal to or 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
September 30, 1999 our Bank is classified as "well capitalized."
Acquisitions and Branching. Banks, including our 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 state 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. 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, our Bank may not be acquired by an out-of-state bank nor may our 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. 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, 2000, our Bank had eight full-time employees and two
part-time employee. Northern Star Financial has only one employee, Thomas
Stienessen, who is also the President and Chief Executive Officer of our Bank.
Our Bank's employees are not represented by a collective bargaining agreement.
<PAGE>
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.
ITEM 2. DESCRIPTION OF PROPERTY
Our headquarters and our Bank's office is located at 1650 Madison
Avenue, Mankato, Minnesota. We have entered into a 10 year lease agreement to
rent approximately 5,000 square feet. Pursuant to the lease agreement, we pay
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. We have 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. Our 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 us or any of our 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 2000.
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
September 30, 1999 12.00 10.00
December 31, 1999 11.00 10.00
March 31, 2000 10.50 9.00
June 30, 2000 9.00 6.00
On June 30, 2000, there were issued and outstanding 427,600 shares of
our common stock held by 49 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.
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
You should read the following discussion in conjunction with our
consolidated financial statements and the related notes for the years ended June
30, 1999 and 2000 included under "ITEM 7 - Financial Statements." Our
consolidated financial statements include Northern Star Financial, Inc. and
Northern Star Bank, our wholly-owned subsidiary and our minority investment in
Homeland Mortgage Company, LLC.
Business
Northern Star Financial, Inc. is a bank holding company. Our wholly
owned subsidiary, Northern Star Bank, is a Minnesota state-chartered commercial
bank. Our principal business is conducted through our Bank, which attracts
deposits from the general public and uses these deposits, together with
borrowings and other funds, to originate commercial, commercial real estate,
residential, agricultural, automobile and other consumer loans. The Bank also
originates construction loans and invests in securities.
Our results of operations are primarily dependent on the net interest
income earned from the interest rate spread on earning assets and interest
bearing liabilities. The interest rate spread is the difference ("spread")
between the average yield on interest-earning assets, such as loans, and
investment securities and short-term interest bearing deposits and the average
rate paid on interest-bearing liabilities, such as deposits and borrowings. The
spread is affected by regulatory, economic and competitive factors that
influence interest rates, loan demand and deposit flows. In addition to credit
risk, we are subject to interest rate risk to the degree that our
interest-earning assets mature or re-price at different times, or on a different
basis, than its interest-bearing liabilities.
Our results of operations also depend upon the level of non-interest
income earned and expenses, including bank fee income, gains or losses on the
sale of loans and other assets, provisions for possible loan losses, income
derived from subsidiary and investment activities, operating expenses and income
taxes. Our operating expenses principally consist of employee compensation and
benefits, occupancy expenses, federal deposit insurance premiums and other
general and administrative expenses.
Our business is affected by prevailing economic conditions, including
federal monetary and fiscal policies, as well as by federal regulation of
financial institutions. Our deposit balances are influenced by a number of
factors, including interest rates paid on competing personal investments and the
level of personal income and savings within the institutions market area. In
addition, our deposit balances are influenced by the perceptions of customers
regarding the stability of the financial markets and financial services
industry. We expect to retain a significant portion of existing deposit balances
by offering competitive rates on such deposits. We have adopted a strategy of
employing Federal Home Loan Bank (FHLB) advances to supplement deposits. FHLB
advances are expected to augment the liquidity necessary to fund lending
operations and investment opportunities. Our lending activities are influenced
by demand for commercial, consumer and housing loans as well as competition from
other lending institutions. The primary sources of funds for lending activities
include deposits, loan payments, borrowings, the sale of loans and other assets
and funds provided from operations
Our results of operation also reflect income and losses derived from
our minority investment in Homeland Mortgage Company, LLC, our joint venture
with First Federal Savings Bank of Morris, Minnesota. Homeland Mortgage makes
and brokers residential real estate loans and services these loans for a fee.
Results Of Operations
The Bank did not commence operations until January 25, 1999.
Accordingly, a comparison of our operating results for the fiscal year ended
June 30, 2000 and June 30, 1999 may not be meaningful in evaluating our
historical operating
<PAGE>
results and anticipated future operating performance. Our results of operations
as of and for the fiscal year ended June 30, 1999 reflect organizational
activities and the results of five months of operations following the opening of
our Bank on January 25, 1999.
Fiscal Year Ended June 30, 2000 Compared to June 30, 1999
We reported interest income of $1,179,388 for the fiscal year ended
June 30, 2000. Loan interest income of $906,062 represented the largest portion
of our interest income since we had the largest portion of earning assets in our
loan portfolio. The weighted average yield earned on our average
interest-bearing assets of $14,205,941 was 8.30% for the year and the average
rate paid on our interest-bearing liabilities of $10,889,099 was 5.00% 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 3.30%.
Net interest income (the difference between interest income and
interest expense) for the fiscal year ended June 30, 2000, increased $520,020 or
553% to $634,883 from the $114,863 of net interest income earned during fiscal
year ended June 30, 1999. The increase in net interest income was due primarily
to additional interest earned on loans, as our loan balances increased 340% from
$4,882,000 at June 30, 1999, to $16,573,000 at June 30, 2000. Interest income
from loans during fiscal year 2000 was $906,062, an increase of $786,057 or 755%
from fiscal year 1999. In addition, interest income received on securities
available for sale increased by $205,666. Our deposits increased $12,029,362 to
$18,193,931 at June 30, 2000 compared to deposits of $6,164,569 at June 30,
1999. Interest expense increased $504,493 to $544,505 during fiscal year 2000.
Noninterest income, which includes fee income, exclusive of gains or
losses on securities transactions, increased $20,051 to $62,500 in fiscal year
2000 compared to $42,449 in fiscal year 1999.
Noninterest expenses nearly doubled during fiscal year 2000.
Noninterest expenses increased $580,796 to $1,175,530 during fiscal year 2000
compared to $594,734 during fiscal year 1999. The primary reasons for the
increase in non-interest expenses is (i) the Bank was operational for the entire
fiscal year ending June 30, 2000 while it was operational for slightly less than
six months (156 days) during the fiscal year ended June 30, 1999; (ii) $86,799
of expenses incurred in connection with our terminated acquisition of First
Federal Holding Company of Morris, Inc.; (iii) $120,291 of expenses and joint
venture loss associated with our investment in Homeland Mortgage, LLC. Absent
the extended period of operations and the nonrecurring expenses incurred in (ii)
and (iii) above, our monthly noninterest operating expenses have remained
approximately the same since opening the Bank. Our major expense is compensation
and employee benefits, which increased from $247,497 for a part year to $420,352
for a full year. We incurred $55,691 of organizational expenses in fiscal 1999,
which was offset by the costs incurred in fiscal 2000 for being a public
company.
We incurred a net loss of $603,397 or $1.42 per basic share for fiscal
year 2000 compared to a net loss of $493,672 or $1.60 per basic share for fiscal
year 1999. Absent the non-recurring expenses associated with the terminated
merger with First Federal Holding Company and expenses incurred in connection
with our investment in Homeland Mortgage, LLC, we would have incurred a net loss
of $396,307 or ($0.94) per basic share for the fiscal year 2000.
Northern Star Financial, Inc. accounted for $297,845 or $ (0.70) per
share of the operating losses of the Company for fiscal year ended June 30,
2000. Home Land Mortgage, LLC accounted for $113,428 or $ (0.27) per share while
Northern Star Bank accounted for $192,124 or $ (0.45) per share of the operating
losses.
Our total assets at June 30, 2000 were $22,983,734, an increase of
$13,348,126 from $9,635,608 at June 30, 1999. This increase is due to an
increase in securities available for sale at fair value and loans receivable.
Securities available for sale amounted to $4,212,387 at June 30, 2000, an
increase of $3,467,268 from $745,119 at June 30, 1999. The cost of the
<PAGE>
securities available for sale was reduced by $57,335 as a result of a decrease
in the fair value of these securities. Loan receivables net of an allowance for
loan and lease losses increased by $11,691,066 or 340% to $16,572,568 at June
30, 2000 compared to $4,881,502 at June 30, 1999.
Total liabilities were $20,195,330 at June 30, 2000; an increase of
$13,983,424 from $6,211,906 at June 30, 1999 and deposits of $18,193,931
increased $12,029,362 million, or 295%, from $6,164,569 at June 30, 1999. The
Company utilized $1,950,000 in borrowings from the FHLB in order to bridge the
gap between the increase in loan receivables and the increase in deposits.
Total shareholder's equity decreased by $635,298 from $3,423,702 at
June 30, 1999 to $2,788,404 at June 30, 2000.
Financial Condition at June 30, 2000
Assets
Our total assets grew by $13,348,126 or 139 % for fiscal year 2000. The
growth in our total assets since the commencement of bank operations on January
25,1999 has been consistent and significant. We believe that our overall growth
to date is due in part to management's efforts in positioning our Bank as a
local community bank and in part to the continued consolidation of the financial
services industry. We believe that many of our customers joined our Bank after
they became dissatisfied with the character of their previous bank after it was
acquired by a larger national institution.
An increase in our interest earning assets in the form of loan
receivables and securities increased $15,158,000 during the fiscal year ended
June 30, 2000 and accounted for all of the increase in assets on which the Bank
earns interest income . The Bank earned interest on 93% of its average assets
during the fiscal year ending June 30, 2000. Having more of its assets earning
interest helps the Bank improve its level of profitability. The Bank has
achieved this higher percentage by several means. Loans are structured to have
interest payable in most cases each month so that large amounts of accrued
interest receivables (which are non-earning assets) are not built up. In this
manner, the interest received can be invested to earn additional interest. We
lease our facilities under long-term contracts rather than owning them. This
strategy avoids tying up funds that could be earning interest. In addition, we
have not found it necessary to increase our investment in furniture, fixtures,
and equipment.
Asset Quality And The Allowance For Credit Losses
As part of its on-going operations, the Bank incurs an expense in the
form of an allowance for credit losses which is provided in recognition that not
all loans will be fully paid according to their contractual terms. The Bank is
required by regulation, generally accepted accounting principles, and safe and
sound banking practices to maintain an allowance that is adequate to absorb
losses that are inherent in the portfolio of loans and leases, including those
not yet identified.
A provision for loan and lease loss expense in the amount of $125,250
was made for fiscal year ended June 30, 2000. This is an increase of $69,000
from the $56,250 provided for fiscal year ended June 30, 1999. Our loan loss
reserves totaled $181,500 at June 30, 2000 compared to $56,250 at June 30, 1999.
The primary reason for an increase in our loan loss reserve was a result of the
Bank's higher level of new loans originated during fiscal year 2000.
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 the underlying collateral, and current economic
conditions. The Bank has a lower ratio of non-performing loans to total loans
than most of its peers and, since its inception, has not incurred any charge-off
or related collection expense.
<PAGE>
Management believes that the allowance for loan losses at June 30, 2000
was adequate to cover the losses inherent in the loan and lease portfolios as of
that date.
Deposits
Funds held on deposit at the Bank in the form of checking, savings, and
money market accounts are available to customers on demand. As a result, and
because of our relatively small deposit base, total demand deposit account
balances are volatile and may vary substantially from period to period. While
there occasionally may be decreases in average deposits from one quarter to the
next, the overall trend is one of growth. Total deposits held by customers at
the Bank increased by $12,029,362 or 195% from $6,164,569 at June 30, 1999 to
$18,193,931 at June 30, 2000.
Increases in deposits have come by maintaining competitive deposit
rates, introducing new deposit products, and the successful encouragement of
former customers of merged financial institutions to become customers of the
Bank.
Liquidity
Liquidity is the ability to raise funds on a timely basis at acceptable
cost in order to meet cash needs, such as might be caused by fluctuations in
deposit levels, customers' credit needs, and attractive investment
opportunities. The Bank's objective is to maintain adequate liquidity at all
times and has adopted a policy of maintaining a total liquidity position of 15%
of total assets.
The Bank has defined and manages three types of liquidity: (1)
"immediate liquidity," which is the ability to raise funds today to meet today's
cash obligations, (2) "intermediate liquidity," which is the ability to raise
funds during the next few weeks to meet cash obligations over that time period,
and (3) "long term liquidity," which is the ability to raise funds over the
entire planning horizon to meet anticipated cash needs due to strategic balance
sheet changes. Adequate liquidity is achieved by (a) holding liquid assets, (b)
maintaining the ability to raise deposits or borrow funds, and (c) keeping
access open to capital markets. Immediate liquidity is provided by the prior
day's balance of Federal funds sold and repurchase agreements, any cash in
excess of that required to meet customer needs, and unused Federal funds lines
from other banks. As a result of the Bank's plan to aggressively grow the amount
of interest-earning assets, the Bank will periodically accumulate funds in the
form of "Federal funds" while waiting to re-deploy these funds into loans.
Federal funds are interest-earning funds that are sold to other banks on an
overnight basis and are available to meet current cash needs. The Bank attempts
to maintain total sources of immediate liquidity of not less than 5% of total
assets.
Sources of intermediate liquidity include maturities of securities in
the earnings portfolio maturing within three months, advances from the FHLB, and
deposit increases from special programs. The Bank projects intermediate
liquidity needs and sources over the next several weeks based on historical
trends, seasonal factors, and special transactions. Appropriate action is then
taken to cover any anticipated unmet needs. At fiscal year ended June 30, 2000,
the Bank's intermediate liquidity was adequate to meet all projected needs.
Long term liquidity is be provided by special programs to increase core
deposits, reducing the size of the investment portfolios, selling loans, and
accessing capital markets. The Company's policy is to address cash needs over
the entire planning horizon from actions and events such as market expansions,
acquisitions, increased competition for deposits, anticipated loan demand,
economic conditions and the regulatory outlook. At fiscal year ended June 30,
2000, the Company's long term liquidity was adequate to meet cash needs
anticipated over its planning horizon.
<PAGE>
Fiscal Year Ended June 30, 1999
We reported 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 our interest
income, since we had the largest portion of earning assets in our loan
portfolio. The weighted average yield earned on our interest-bearing assets of
$1,866,661 was 8.30% for the period and the average rate paid on our interest
bearing liabilities of $901,088 was 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 our estimate of the amount necessary to adequately reflect
possible loan losses. Our allowance for loan losses as a percentage of our
year-end loans was 1.14%. Our judgment as to the adequacy of the allowance is
based upon an evaluation of the inherent risks in the loan portfolios, which we
believe to be reasonable, which may or may not prove to be accurate. Thus, we
cannot assure you that 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. We had no charge-offs in 1999.
We earned non-interest income of $42,449 for the fiscal year ending
June 30, 1999, 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 our truncated year of operations ended June 30, 1999.
We incurred other non-interest expenses of $594,734 for fiscal year ended
June 30, 1999, inclusive of costs associated with setting up our Bank's
operations. We incurred nonrecurring pre-opening expenses of approximately
$304,000 in organizing our Bank's operations. The pre-opening expenses also
include $248,000 in organizational costs expensed due to a change in accounting.
Staffing at our Bank was at a full-service level beginning the first part of
December 1998 for training in preparation for our Bank's opening on January 25,
1999, and other non-interest expenses were incurred in operating our Bank.
Non-interest expense included $40,364 in salaries and employee benefits incurred
during our initial start-up phase and approximately $15,636 in opening expenses.
As a percentage of average assets, non-interest expenses were 24.8%.
Our net loss for the year ended June 30, 1999 was $493,672.
At June 30, 1999, we had total assets of $9,635,608, which consisted of
cash and due from the banks 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, we had
liabilities of $6,164,569 in deposits and $47,337 in other liabilities.
Stockholders' equity at June 30, 1999 was $3,423,702.
<PAGE>
Average Balances, Yields And Rates
The following tables summarize our weighted average yields earned,
weighted average rates paid, interest rate spread and net yield on earning
assets and interest-bearing liabilities.
<TABLE>
<CAPTION>
Year Ended June 30, 1999 Year Ended June 30, 2000
---------------------------------------- --------------------------------
Average Average
Average Yield or Average Yield or
Balance Interest Rates Balance Interest Rates
<S> <C> <C> <C> <C> <C> <C>
Assets
Federal Funds Sold..........................$ 544,083 $ 26,089 4.79% $1,168,898 $ 64,070 5.48%
Investment Securities........................ 60,531 3,590 5.93% 3,078,085 209,236 6.79%
Loans........................................1,098,410 120,005 10.93% 9,952,085 906,062 9.10%
Other Interest-Earning Assets................ 163,637 5,191 3.17% 6,873 20 0.29%
--------- --------- ----- ---------- --------- ----
Total Interest Earning Assets............1,866,661 154,875 8.30% 14,205,941 1,179,388 8.30%
Non-Interest Earning Assets.................. 526,684 1,102,641
--------- ----------
Total Assets............................$2,393,345 $15,308,582
========== ===========
Liabilities and Stockholders' Equity
Interest Bearing Deposits...................$ 901,088 $ 40,012 4.44% $10,463,689 $ 518,260 4.25%
Other Interest Bearing Liabilities........... - - 0.00% 425,410 26,245 6.17%
--------- ----------- ---------- ----------- ----------- ---------
Total Interest Bearing Liabilities....... 901,088 40,012 4.44% 10,889,099 544,505 5.00%
----------- -----------
Non Interest Bearing Liabilities............. 327,003 1,326,696
--------- -----------
Total Liabilities........................1,228,091 12,215,795
Stockholders' Equity.........................1,165,254 3,092,787
--------- ----------
Total Liability and Stockholders' Equity....$2,393,345 $15,308,582
========== ===========
Net Interest Spread.......................... 3.86% 3.30%
Net Interest Income/Margin................... $ 114,863 6.15% $ 634,883 4.45%
========= ===== ========= ====
Ratio of Average Interest-Earning
Assets to Average Interest-Bearing
Liabilities........................... 2.07x 1.30x
</TABLE>
The average balances for the year ended June 30, 1999 were calculated
on an annualized basis, even though we did not have operations for the entire
fiscal year.
Rate/Volume Analysis
The table below sets forth certain information regarding changes in
interest income and interest expense of the Bank for the periods indicated. For
each category of interest-earning and interest-bearing liabilities, information
is provided on changes attributable to (i) changes in volume (changes in average
volume multiplied by old rate); (ii) changes in rates (changes in rate
multiplied by old average volume); (iii) changes in rate-volume (changes in rate
multiplied by the change in average volume).
<TABLE>
<CAPTION>
Year Ended June 30,
2000 vs 1999
--------------------------------------------------------------------------
Increase (Decrease) Due to
--------------------------------------------------------------------------
Rate/
Volume Rate Volume Net
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Interest income:
Loans receivable $ 968 $ (20) $ (162) $ 786
Investment securities 179 1 26 205
Federal funds sold 30 4 4 38
Other interest-earning assets (5) (5) 5 (5)
----------------- ---------------- --------------- ---------------
Total interest-earning assets 1,172 (20) (127) 1,024
Interest expense:
Deposit Accounts 425 5 49 478
Other Liabilities - - 26 26
----------------- ---------------- --------------- ---------------
Total interest-bearing liabilities 425 5 75 504
----------------- ---------------- --------------- ---------------
Net change in net interest income $ 747 $ (25) $ (202) $ 520
================= ================ =============== ===============
</TABLE>
<PAGE>
Market Risk Management
Market risk is our risk of loss, arising from adverse changes in market
prices and rates, comprised primarily of interest rate risk. Most of our
earnings arise from functioning as a financial intermediary. As such, we take in
funds from depositors and then either lend the funds to borrowers or invest the
funds in securities and other instruments. We earn interest income on the loans
and securities and pay interest expense on deposits and other borrowings.
Net interest income, the primary component of our net income, is
determined by the difference or "spread" between the yield earned on
interest-earning assets and the rates paid on interest-bearing liabilities and
the relative amounts of such assets and liabilities. Because interest-bearing
liabilities consist primarily of shorter-term deposit accounts, our interest
rate spread can be adversely affected by changes in general interest rates if
interest-earning assets are not sufficiently sensitive to changes in interest
rates. We have sought to reduce our exposure to changes in interest rates by
more closely matching the effective maturities and re-pricing periods of
interest-earning assets and interest-bearing liabilities through a variety of
strategies, including the origination and purchase of adjustable-rate loans, and
the sale of long-term fixed-rate loans.
With such large proportions of our balance sheet made up of
interest-earning assets and interest-bearing liabilities, and with such a large
proportion of our earnings dependent on the spread between interest earned and
interest paid, it is critical that we measure and manage our interest rate
sensitivity. Measurement is done by estimating the impact of changes in interest
rates over the next twelve months on net interest income and on net economic
value. Net economic value is the net present value of the cash flows arising
from assets and liabilities discounted at their acquired rate plus or minus
assumed changes.
We seek to manage interest rate risk by monitoring and controlling the
variation in re-pricing intervals between assets and liabilities. To a lesser
extent, we also monitor interest rate sensitivity by analyzing the estimated
changes in market value of assets and liabilities assuming various interest rate
scenarios.
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and by
monitoring our interest rate sensitivity "gap." An asset or liability is said to
be interest rate-sensitive within a specific period if it will mature or
re-price within that period. The interest rate sensitivity gap is defined as the
difference between the amount of interest-earning assets maturing or re-pricing
within a specific period of time and the amount of interest-bearing liabilities
re-pricing within that same time period. A gap is considered positive when the
amount of rate-sensitive assets exceeds the amount of rate-sensitive liabilities
and is considered negative when the amount of interest rate sensitive
liabilities exceeds the amount of rate-sensitive assets.
We have adopted an Interest Rate Risk and Asset Management Policy that
limits the amount of maximum dollar amount of exposure in one-year
rate-sensitive assets and one-year rate-sensitive liabilities to 30% of total
assets at any calendar quarter end. Our interest rate risk exposure position as
of June 30, 2000 was in compliance with this policy.
Interest Rate Sensitivity Analysis
We continually evaluate the asset mix of our balance sheet in terms of
several variables: yields, credit quality, appropriate funding sources and
liquidity. To effectively manage the liability mix of the balance sheet, we
focus on expanding various funding sources. The interest rate sensitivity
position at June 30, 1999 and 2000 is summarized in the following tables. The
difference between rate sensitive assets and rate sensitive liabilities, or the
interest rate sensitivity gap, for each period is shown at the bottom of each
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 tables may not be
indicative of our rate sensitivity position at other points in time.
<PAGE>
<TABLE>
<CAPTION>
As of June 30, 1999
Within After Three After One
Three but within but within After
Months Twelve Months Five Years Five Years Total
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest Earning Assets
Federal Funds Sold........... $ 2,533 $ -- $ -- $ -- $ 2,533
Investment Securities........ -- -- -- 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 $ -- $ -- $ -- $ 127
Regular Savings.............. 3,244 -- -- -- 3,244
Time Deposits................ 30 1,420 329 -- 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>
<TABLE>
<CAPTION>
As of June 30, 2000
Within After Three After One
Three but within but within After
Months Twelve Months Five Years Five Years Total
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest Earning Assets
Federal Funds Sold......... $ 304 $ -- $ -- $ -- $ 304
Investment Securities...... -- -- 3,279 933 4,212
Loans...................... 7596 820 4,832 3,891 17,139
------- ------- ------ ------ --------
Total Earning Assets......... $ 7,900 $ 820 $8,111 $4,824 $ 21,655
======= ======= ====== ====== ========
Interest Bearing Liabilities
Money Market & Now......... $ 1,504 $ -- $ -- $ -- $ 1,504
Regular Savings............ 4,671 -- -- -- 4,671
Time Deposits.............. 808 6,589 3,126 -- 10,523
------- ------- ------ ------ --------
Total Interest Bearing
Liabilities................ $ 6,983 $ 6,589 $3,126 $ -- $ 16,698
======= ======= ====== ====== ========
Interest Sensitivity Gap..... $ 917 $(5,769) $4,985 $4,824 $ 4,957
Cumulative Interest Sensitivity
Gap........................ 917 (4,852) 133 4,957 4,957
Ratio of Interest Sensitivity
Gap to total earning assets.. 4.23% -26.64% 23.02% 22.28% 22.89%
Ratio of Cumulative Interest
Sensitivity Gap to total
earning assets............... 4.23% -22.41% 0.61% 22.89% 22.89%
</TABLE>
As evidenced by the tables above, we are cumulatively
liability-sensitive at one year and asset sensitive thereafter at June 30, 2000.
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. In our case, 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, our intent is to channel a substantial percentage of
our earning assets into the loan category. Total gross loans outstanding,
including loans held for sale, were $5,619,345 as of June 30, 1999 and
$17,116,878 as of June 30, 2000.
<PAGE>
The following table summarizes the composition of our loan portfolio:
<TABLE>
<CAPTION>
As of June 30, 1999 As of June 30, 2000
Amount % of Total Amount % of Total
<S> <C> <C> <C> <C>
Commercial & Agricultural..... $1,843,707 32.81% $2,985,277 17.44%
Real Estate-- individual...... 1,496,460 26.63 3,731,185 21.80
Real Estate-- other........... 843,394 15.01 4,117,578 24.06
Consumer Loans................ 1,435,784 25.55 5,660,632 33.07
Lease Financing............... - 0.00 622,205 3.64
------------ ---------- ------------ ----------
Total Loans................... $5,619,345 100.00% $17,116,878 100.00%
---------- ========== ----------- ==========
Net Deferred Loan fees/(costs) - 22,239
Less: Allowance for Loan Loss. (56,250) (181,500)
---------- ----------
Total Net Loans............... $5,563,095 $16,957,617
========== ===========
</TABLE>
The principal components of our loan portfolio were mortgage loans and
commercial loans which represented 74% of the portfolio at June 30, 1999 and 63%
at June 30, 2000. Due to the short time the portfolio has existed, the current
mix of loans may not be indicative of the ongoing portfolio mix. We 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 tables is based on the contractual
maturities of individual loans, including loans which may be subject to renewal
at their contractual maturity. Renewal of these 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 tables summarize loan maturities, by type, and related interest rate
characteristics:
<TABLE>
<CAPTION>
As of June 30, 1999
One Year After One but After
or Less within Five Years Five Years Total
<S> <C> <C> <C> <C>
Commercial & Agricultural....... $ 916,272 $ 927,435 $ -- $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 -- 1,435,784
Lease Financing................. - - - -
---------- ------------- ----------- ------------
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>
<TABLE>
<CAPTION>
As of June 30, 2000
One Year After One but After
or Less within Five Years Five Years Total
<S> <C> <C> <C> <C>
Commercial & Agricultural...... $1,236,383 $ 966,626 $ 782,268 $2,985,277
Real Estate-- individual....... 65,000 1,050,204 2,615,981 3,731,185
Real Estate-- other............ 1,189,093 2,384,195 544,291 4,117,578
Consumer Loans................. 4,369,053 1,032,415 259,165 5,660,633
Lease Financing 48,159 574,046 - 622,205
---------- ------------- ------------ ------------
Total........................ $6,907,688 $6,007,485 $4,201,705 $17,116,878
========== ========== ========== ===========
Loans maturing after one year
with:
Fixed Interest Rates......... $7,855,057
Floating Interest Rates...... $2,354,133
</TABLE>
Provision and Allowance for Loan Losses
We have developed policies and procedures for evaluating the overall
quality of our 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 our
analysis of the potential risk in the loan portfolio.
On June 30, 1999, our allowance for loan losses was $56,250 or 1.14% of
$4,937,752 in loans receivable (net of loans held for sale). On June 30, 2000,
<PAGE>
our allowance for loan losses was $181,500 or 1.08% of $16,754,068 in loans
receivable (net of loans held for sale). Our Bank has not charged off any loans
since commencing operations. The provision for loan losses was established
primarily as a result of our assessment of general loan loss risk as our Bank
recorded its first loans.
The following tables summarize our Bank's loan loss experience and the
allowance for possible loan losses:
<TABLE>
<CAPTION>
For the Year Ended For the Year Ended
June 30, 1999 June 30, 2000
<S> <C> <C>
Balance at Beginning of Period..... $ -- $ 56,250
Charge-offs........................ -- --
Recoveries......................... -- --
Net Charge Offs.................... -- --
Additions charged to operations.... 56,250 125,250
------- --------
Balance at End of Period........... $56,250 $181,500
======= ========
Ratio of net charge-offs during the
period to average loans outstanding
during the period 0% 0%
</TABLE>
The allowance for loan losses was allocated as follows:
<TABLE>
<CAPTION>
For the Year Ended For the Year Ended
June 30, 1999 June 30, 2000
-------------------------------- -----------------------
Percent of Loans Percent of Loans
in Each Category in Each Category
Amount to Total Loans Amount to Total Loans
<S> <C> <C> <C> <C>
Commercial & Agricultural..... $13,310 32.81% $ 22,155 17.44%
Real Estate-- individual...... 10,974 26.63% 27,611 21.80%
Real Estate-- other........... 5,288 15.01% 27,872 24.06%
Consumer Loans................ 5,808 25.55% 24,744 33.07%
Lease Financing............... -- --% 4,484 3.64%
Unallocated................... 20,870 0.00% 74,634 0.00%
----------- ------------- ------------ -------------
Total......................... $56,250 100.00% $ 181,500 100.00%
======= ====== ========= ======
</TABLE>
Investment Portfolio
At June 30, 1999, our investment securities portfolio represented
approximately 8.42% of our earning assets of $8,897,899. We held 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. We also held investments in stock of the Federal Home Loan Bank in the
amount of $16,400.
At June 30, 2000, our investment securities portfolio represented
approximately 19% of our earning assets of $21,655,000. We held securities
available for sale with a fair market value of $4,212,387 and an amortized cost
of $4,269,722, for an unrealized loss of $57,335. We also held investments in
stock of the Federal Home Loan Bank in the amount of $97,500.
Contractual maturities and yields on our investments (all available for
sale) are summarized 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.
<PAGE>
<TABLE>
<CAPTION>
Over one
Within But within Over Five
One Year Yield Five Years Yield Years Yield Total Yield
<S> <C> <C> <C> <C> <C> <C> <C> <C>
As of June 30,
1999:
US Government
Agencies..... $ -- 0.00% $ 549,286 6.12% $200,000 7.04% $ 749,286 6.36%
========= ===== =========== ===== ========= ===== ========== =====
As of June 30,
2000:
US Government
Agencies..... $ -- 0.00% $ 3,279,684 6.62% $923,703 7.37% $4,212,387 6.79%
========= ===== =========== ===== ========= ===== ========== =====
</TABLE>
Short-term investments in the amount of $2,533,236 at June 30, 1999 and
comprised a significant portion of total earning assets. These funds were
<PAGE>
invested in Federal funds sold on an overnight basis. As our Bank continued to
grow, we shifted from primarily overnight investments into the loan portfolio
and, to a lesser extent, into the investment securities portfolio.
Deposits and Other Interest-Bearing Liabilities
As of June 30, 2000, deposits were 84% of interest-bearing liabilities.
The following tables summarize deposits by category.
<TABLE>
<CAPTION>
As of June 30, 1999
Percentage
Percentage of Total
Ending of Total Average Average Effective
Balance Deposits Balance Deposits Cost
<S> <C> <C> <C> <C> <C>
Demand Deposit.................. $ 998,017 16.19% $ 255,512 22.04% 0.00%
Now............................. 127,387 2.07% 52,395 4.52% 2.56%
Savings......................... 3,244,444 52.63% 375,076 32.35% 3.89%
Time Accounts less than $100,000 1,379,249 22.37% 336,573 29.03% 6.17%
Time Accounts of $100,000 or more 400,000 6.49% 135,342 11.67% 6.24%
Accrued Interest Payable........ 15,472 0.25% 4,541 0.39%
----------- ---------- ---------- ----------
Total Deposits.................. $ 6,164,579 100.00% $1,159,439 100.00%
=========== ========= ========== =========
</TABLE>
<TABLE>
<CAPTION>
As of June 30, 2000
Percentage
Percentage of Total
Ending of Total Average Average Effective
Balance Deposits Balance Deposits Cost
<S> <C> <C> <C> <C> <C>
Demand Deposit.................. $ 1,491,958 8.20% $ 1,175,786 10.01% 0.00%
Now............................. 387,797 2.13% 290,036 2.47% 2.62%
Savings......................... 5,786,894 31.81% 4,580,690 39.01% 4.03%
Time Accounts less than $100,000 $ 8,271,953 45.47% 3,637,155 30.98% 6.15%
Time Accounts of $100,000 or more 2,129,895 11.71% 1,955,807 16.66% 6.02%
Accrued Interest Payable........ 125,436 0.69% 102,385 0.87%
------------ ---------- ----------- ----------
Total Deposits.................. $ 18,193,932 100.00% $11,741,860 100.00%
============ ========= =========== =========
</TABLE>
Core deposits, which exclude time deposits of $100,000 or more, provide
a relatively stable funding source for our loan portfolio and other earning
assets. Our core deposits were $5,749,097 at June 30, 1999 and $16,064,037 at
June 30, 2000. Our loan to deposit ratio was 90% at June 30, 1999 and 91% at
June 30, 2000. The maturity distribution of our time deposits is as follows:
<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>
As of June 30, 1999:
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>
<PAGE>
<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>
As of June 30, 2000:
Time Accounts less than
$100,000................ $ 827,363 $1,703,477 $ 3,411,655 $2,329,459 $ 8,271,953
Time Accounts of $100,000 or
more.................... - 100,000 1,309,895 720,000 2,129,895
--------- ---------- ----------- ---------- -----------
Total................... $ 827,363 $1,803,477 $ 4,721,550 $3,049,459 $10,401,848
========= ========== =========== ========== ===========
</TABLE>
Return on Equity and Assets
The following table summarizes our 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). Since inception, we have not paid any cash dividends.
The payment of dividends by our Bank is subject to limitations imposed by law
and governmental regulations.
<PAGE>
<TABLE>
<CAPTION>
For the For the
Year Ended Year Ended
June 30, 1999 June 30, 2000
<S> <C> <C>
Return (loss) on average
assets...................... (22.61)% (3.70%)
Return (loss) on average
equity...................... (69.87)% (19.43%)
Equity to assets ratio........ 35.53% 19.04%
</TABLE>
Short Term Borrowings
We had no short-term borrowings during fiscal year 1999. The following
table sets forth certain information as to the Bank's FHLB advances as of June
30, 2000. The advances have maturity dates extending from 10/18/00 through
6/25/01.
<TABLE>
<CAPTION>
As of and for the Year Ended
June 3, 2000
<S> <C>
Maximum Balance............. $ 1,950,000
Average Balance............. 425,409
Balance at end of period 1,950,000
Weighted average rate:
at end of period 6.66%
during the period 6.17%
</TABLE>
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, qualifying preferred stock, and minority interests in the equity
accounts of consolidated subsidiaries, less certain items such as goodwill and
certain other intangible assets. Tier 2 capital consists of hybrid capital
instruments, perpetual debt, mandatory convertible debt securities, a limited
amount of subordinated debt, preferred stock that does not qualify as Tier 1
capital, and a limited amount of the allowance for credit losses. 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
<PAGE>
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.
The tables below illustrate our regulatory capital (in thousands) and
ratios:
<TABLE>
<CAPTION>
To Be Well
Capitalized
For Capital Under Prompt
Adequacy Corrective
Actual 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%
Tier I Capital (to Average
Assets).................... $ 2,729 36.50% $ 299 4.00% $ 374 5.00%
As of June 30, 2000:
Total Capital (to Risk
Weighted Assets)........... $ 2,717 15.3% $1,423 8.0% $ 1,779 10.0%
Tier I Capital (to Risk
Weighted Assets)........... $ 2,535 14.2% $ 712 4.0% $ 1,068 6.0%
Tier 1 Capital (to Average
Assets).................... $ 2,535 12.3% $ 823 4.0% $ 1,028 5.0%
</TABLE>
At June 30, 2000, our Bank is classified as well-capitalized and is in
compliance with all regulatory capital requirements. Management anticipates our
Bank will continue to be classified as well-capitalized.
As of June 30, 2000, 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 our financial statements. 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 our 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.
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. We do not currently have any derivative instruments nor are we
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. We elected to adopt SOP
98-5 early for the year ended June 30, 1999 and as a result, recognized
approximately $248,000 in our 1999 consolidated statement of loss which under
previous accounting policies would have been amortized over 60 months.
<PAGE>
Industry Developments
The recent adoption of the Gramm-Leach-Bliley Act, commonly referred to
as the "New Financial Modernization Legislation" may present new opportunities
to us by allowing us to provide non-traditional banking services such as
insurance and securities brokerage services. See "ITEM 1. Description of
Business - Supervision and Regulation."
From time to time, various bills are introduced in the United States
Congress with respect to the regulation of financial institutions. We cannot
predict whether any of these proposals will be adopted or, if adopted, how these
proposals would affect us.
Terminated Merger
On September 30, 1999 the Company entered into an Agreement and Plan of
Reorganization to merge with First Federal Holding Company of Morris, Inc.
Completion of the merger was subject to regulatory approvals and approval by the
shareholders of both companies. On June 26, 2000 the Federal Reserve Board
announced that it had denied our application to merge with First Federal Holding
Company. As a result, our agreement to merge with First Federal Holding has
terminated.
Joint Venture In Homeland Mortgage, LLC.
In July 1999, we entered into a joint venture with First Federal
Savings Bank by acquiring a 49 percent joint interest in Homeland Mortgage
Company, LLC, in exchange for a total cash consideration of $196,000. The
investment in Homeland is being accounted for using the equity method.
Homeland's primary business is originating residential real estate loans that
are secured by first and second mortgages and sold into the secondary mortgage
market.
On August 25, 1999 the Federal Reserve Board initiated a policy of
increasing interest rates in an effort to reduce the rate of inflation in the
economy. The action of the Federal Reserve Board resulted in a slow down in
activity associated with the purchase and refinancing of residential properties
thereby affecting the ability of Homeland to generate new loans and the related
income. For the year ended June 30, 2000, we have incurred a loss from our
investment in Homeland of $113,428. On September 1, 2000, we sold our minority
interest in Homeland to First Federal Savings Bank for approximately $68,000.
Secondary Stock Offering
We filed a Registration Statement on Form SB-2 with the Securities and
Exchange Commission to register the sale of a maximum of 1,000,000 shares of our
common stock. We entered into a an agreement with Banc Stock Financial Services,
Inc. whereby Banc Stock agreed to use its "best efforts" to sell the shares to
the public. In July 2000, we were notified by Banc Stock that it has undergone
an internal reorganization and will no longer be involved in the underwriting or
placement of securities.
We have entered into an agreement with Berthel Fisher & Company
Financial Services, Inc. who agreed to sell, on a "best efforts basis," a
minimum of 50,000 shares and a maximum of 300,000 shares to the public. We
intend to use the proceeds from the offering as working capital and to provide
our Bank with additional capital to make loans and grow its business.
Forward-Looking Information
This Report on Form 10-KSB contains forward-looking statements with
respect to the financial conditions, results of operations and business of the
Company. These include statements about the Company's plans, objectives,
expectations, belief and intentions that are not historical facts. When used in
this report, the words "expects", "anticipates", "plans", "believes", "seeks",
"estimates", and similar expressions are generally intended to identify
<PAGE>
forward-looking statements. These forward-looking statements involve certain
risks and uncertainties. Factors that may cause actual results to differ
materially from those contemplated by such forward-looking statements include,
among others, the following possibilities: (1) competitive pressure among
financial services companies increases or decreases significantly; (2) changes
in the interest rate environment reduce interest margins; (3) general economic
conditions, internationally, nationally or in the State of Minnesota, are less
favorable than expected; and (4) legislation or regulatory requirements or
changes adversely affect the business in which the Company will be engaged.
Management believes that the major challenge that the Company faces
today is pressure on net interest margin, which for the industry as a whole has
been declining during the past five years. The cause of the decline has been
increased competition from non-bank competitors such as insurance companies and
brokerage firms. Management believes that the Company's competitive strength
lies in its knowledge of the market place and in providing long-term,
relationship orientated banking services by management and employees with strong
ties to the Mankato area.
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
NORTHERN STAR FINANCIAL, INC.
AND SUBSIDIARY
TABLE OF CONTENTS
Independent Auditors' Report 27
Consolidated Statements of Financial Condition
as of June 30, 2000 and 1999 28
Consolidated Statements of Operations
for the Year Ended June 30, 2000 and 1999 29
Consolidated Statements of Shareholders' Equity
for the Year Ended June 30, 2000 and 1999 30
Consolidated Statements of Cash Flows
for the Year Ended June 30, 2000 and 1999 31
Notes to Consolidated Financial Statements 33
<PAGE>
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,
2000 and 1999, and the related consolidated statements of operations, changes in
shareholders' equity, and cash flows for the years then ended. These
consolidated financial statements are the responsibility of management. Our
responsibility is to express an opinion on these consolidated 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 consolidated 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, 2000 and 1999, and
the consolidated results of their operations and their cash flows for the years
then ended, in conformity with generally accepted accounting principles.
/s/ Bertram Cooper & Co., LLP
Bertram Cooper & Co., LLP
Waseca, Minnesota
August 10, 2000
<PAGE>
<TABLE>
<CAPTION>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30,
--------------------------------------------
ASSETS 2000 1999
------
-------------------- --------------------
<S> <C> <C>
Cash and cash equivalents:
Cash and due from banks $ 385,098 $ 210,662
Federal funds sold 304,106 2,533,236
-------------------- --------------------
Total cash and cash equivalents 689,204 2,743,898
Securities available for sale, at fair value 4,212,387 745,119
FHLB stock, at cost 97,500 16,400
Loans held for sale 385,050 681,593
Loans receivable, net of allowance for loan losses of
$181,500 in 2000 and $56,250 in 1999 16,572,568 4,881,502
Accrued interest receivable 295,303 59,527
Premises and equipment 431,932 486,685
Other assets 299,790 20,884
-------------------- --------------------
Total Assets $ 22,983,734 $ 9,635,608
==================== ====================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Demand deposits $ 1,880,209 $ 1,121,450
Savings deposits 5,786,894 3,244,444
Time deposits 10,526,828 1,798,675
-------------------- --------------------
Total deposits 18,193,931 6,164,569
Advances from borrowers for taxes and insurance 17,311 23,941
Other borrowings 1,950,000 -
Other liabilities 34,088 23,396
-------------------- --------------------
Total Liabilities 20,195,330 6,211,906
-------------------- --------------------
Shareholders' equity:
Common stock, par value $0.01 per share, 15,000,000 shares
authorized, 427,600 and 425,600 shares issued 4,276 4,256
Undesignated stock, par value $0.01 per share, 5,000,000 shares authorized, no
shares issued - -
Paid in capital 3,939,557 3,919,577
Accumulated deficit (1,101,028) (497,631)
Unearned stock compensation (2,000 shares) (20,000) -
Accumulated comprehensive income (loss) (34,401) (2,500)
-------------------- --------------------
Total shareholders' equity 2,788,404 3,423,702
-------------------- --------------------
Total liabilities and shareholders' equity $ 22,983,734 $ 9,635,608
==================== ====================
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Year Ended June 30,
----------------------------------------
2000 1999
------------------ ------------------
<S> <C> <C>
Interest income:
Loans receivable $ 906,062 $ 120,005
Securities available for sale 209,256 3,590
Due from banks - 5,191
Federal funds sold 64,070 26,089
------------------ ------------------
Total interest income 1,179,388 154,875
Interest expense:
Deposits 518,260 40,012
Other borrowings 26,245 -
------------------ ------------------
Total interest expense 544,505 40,012
Net interest income 634,883 114,863
Provision for loan losses 125,250 56,250
------------------ ------------------
Net interest income after provision for loan losses 509,633 58,613
------------------ ------------------
Noninterest income:
Other fees and service charges 16,918 45,499
Gain (loss) on sale of loans 43,520 (3,050)
Other 2,062 -
------------------ ------------------
Total noninterest income 62,500 42,449
------------------ ------------------
Noninterest expenses:
Compensation and employee benefits 420,352 247,497
Board fees 86,500 70,429
Occupancy 82,669 39,556
Legal and accounting 68,058 35,806
Printing and supplies 23,535 22,261
Furniture, fixtures and equipment depreciation 56,719 19,453
Data processing 51,295 16,758
Organizational expenditures - 55,691
Merger expenditures 86,800 -
Subsidiary loss 113,428 -
Other 186,174 87,283
------------------ ------------------
Total noninterest expense 1,175,530 594,734
------------------ ------------------
Net loss before income tax benefit (603,397) (493,672)
Income tax benefit - -
Net loss $ (603,397) $ (493,672)
================== ==================
Basic (loss) per share of common stock $ (1.42) $ (1.60)
================== ==================
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulative
Unearned Other
Common Paid-in Accumulated Stock Comprehensive
Stock Surplus Deficit Compensation Income Total
------- -------- ----------- ------------ ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1998 $ - $ 100 $ (3,959) $ - $ - $ (3,859)
Comprehensive income:
Net loss for the year
ended June 30, 1999 - - (493,672) - -
Unrealized loss on
available-for-sale securities net
of tax of $1,667 - - - - (2,500)
Comprehensive income (496,172)
Issuance of common stock 4,256 4,251,744 - - - 4,256,000
Offering costs - (332,267) - - - (332,267)
-------- ---------- ------------- ----------- ---------- -------------
Balance, June 30, 1999 4,256 3,919,577 (497,631) - (2,500) 3,423,702
Comprehensive income:
Net loss for the year ended - - (603,397) - -
June 30, 2000
Unrealized loss on
available-for-sale
securities net of tax of
$22,934 - - - - (31,901)
Comprehensive income (635,298)
Restricted stock award 20 19,980 - (20,000) - -
-------- ---------- ------------ ----------- ---------- -------------
Balance, June 30, 2000 $ 4,276 $3,939,557 $(1,101,028) $ (20,000) $ 34,401) $ 2,788,404
======== ========== ============ ========== ========== =============
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year Ended June 30,
------------------------------------------------
2000 1999
----------------------- ----------------------
<S> <C> <C>
Cash flows from operating activities:
Interest received on loans and investments $ 938,453 $ 95,343
Interest paid (438,658) (20,391)
Other fees, commissions, and income received 16,918 42,449
Cash paid to suppliers, employees and others (1,169,057) (552,833)
Contributions to charities (3,730) (185)
Loans originated for sale (3,246,235) (1,863,592)
Proceeds from sale of loans 3,586,298 1,185,050
----------------------- ----------------------
Net cash used in operating activities (316,011) (1,114,159)
----------------------- ----------------------
Cash flows from investing activities:
Purchases of available-for-sale securities (4,358,183) (749,281)
Proceeds from maturities of available-for-sale securities 844,968 -
Purchase of FHLB stock (81,100) (16,400)
Loan originations and principal payments on loans, net (11,794,077) (4,940,802)
Investment in subsidiary (196,000) -
Purchase of property and equipment (12,181) (509,419)
----------------------- ----------------------
Net cash used in investing activities (15,596,573) (6,215,902)
----------------------- ----------------------
Cash flows from financing activities:
Net increase in non-interest bearing demand
and savings deposit accounts 3,591,832 4,365,700
Net increase in time deposits 8,322,688 1,779,250
Net (decrease) increase in mortgage escrow funds (6,630) 23,941
Proceeds from FHLB borrowings 1,950,000 -
(Payment of) advances from organizers - (18,665)
Proceeds from sale of common stock net of offering costs - 3,923,733
----------------------- ----------------------
Net cash provided by financing activities 13,857,890 10,073,959
----------------------- ----------------------
Net (decrease) increase in cash and cash equivalents (2,054,694) 2,743,898
Cash and cash equivalents at beginning of year 2,743,898 -
----------------------- ----------------------
Cash and cash equivalents at end of year $ 689,204 $ 2,743,898
======================= ======================
Non-cash investing and financing activities:
Deferred organization costs expensed $ - $ 9,226
======================= ======================
Undistributed equity loss in subsidiary $ 113,428 $ -
======================= ======================
Common stock issued under restricted stock agreement $ 20,000 $ -
======================= ======================
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the Year Ended June 30,
-----------------------------------------------
2000 1999
---------------------- ----------------------
<S> <C> <C>
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES
Net loss $ (603,397) $ (493,672)
Adjustments:
Depreciation 66,934 22,732
Equity loss of subsidiary 113,428 -
Provision for loan losses 125,250 56,250
Accretion and (amortization) of premiums
and discounts, net (7,221) (5)
Loss on sale of loans - 3,050
(Increase) decrease in:
Loans held for sale 296,543 (681,593)
Accrued interest receivable (235,776) (59,527)
Prepaid income tax - -
Other assets (197,306) (4,411)
Increase (decrease) in:
Accrued interest payable 105,847 19,621
Other liabilities 19,687 23,396
---------------------- ----------------------
Net cash used in operating activities $ (316,011) $ (1,114,159)
====================== ======================
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000 and 1999
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 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 invested $3,000,500 in the
Bank's capital accounts.
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, 2000, the
Bank operated one retail banking office in Mankato, 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
authorities.
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.
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 allowance 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.
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000 and 1999
Note 1. Summary of Significant Accounting Policies - (continued)
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 accreted
(deducted) and amortized (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 required to be
recognized under accounting standards as components of comprehensive
income 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 any deferred fees or
costs on originated loans and unamortized premiums 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 losses 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.
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
interest income equal to all interest previously accrued and income is
subsequently recognized only to the extent cash payments are received
or 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.
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000 and 1999
Note 1. Summary of Significant Accounting Policies - (continued)
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 servicing
assets of $303 and $-0- June 30, 2000 and 1999, respectively.
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 is 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 Company, as
if the Bank portion of income tax liability or benefit was separately
determined based on the Bank's 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
fiscal year ended June 30, 1999.
Reclassifcations - Certain amounts in the financial statements for the
prior year have been reclassified to conform to current financial
statement presentation.
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
of the Business were contingently 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 425,600 and 307,831 weighted average shares
outstanding as of June 30, 2000 and 1999, respectively.
Diluted EPS is the same as basic EPS because the option and warrant
shares were granted at a price greater than the current operating
period market price and those shares are not "in the money".
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000 and 1999
Note 1. Summary of Significant Accounting Policies - (continued)
Nonvested restricted stock compensation is to be considered outstanding
as of its issuance date for computing diluted EPS even though it is
contingent upon future time-related vesting and is not included in
basic EPS until the time-based vesting restriction has lapsed.
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 13, 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
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.
<PAGE>
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.
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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 Fair
Cost Gains Losses Value
-------------- -------------- --------------- ---------------
<S> <C> <C> <C> <C>
June 30, 2000:
Debt securities available for sale:
U.S. Government and agency obligations $ 4,269,722 $ - $ (57,335) $ 4,212,387
================ ================= ================= ===============
June 30, 1999:
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, 2000.
The amortized cost and estimated market value of debt securities at
June 30, 2000, 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 $ 3,319,782 $ 3,279,684
Due from five to ten years 949,940 932,703
----------------- -----------------
Total $ 4,269,722 $ 4,212,387
================= =================
</TABLE>
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 3. Loans Receivable
Loans receivable at June 30, consist of the following:
<TABLE>
<CAPTION>
2000 1999
------------------ ------------------
<S> <C> <C>
Commercial $ 2,913,782 $ 1,843,707
Real Estate 7,415,562 1,658,261
Consumer 6,402,485 1,435,784
------------------ ------------------
Total loans receivable 16,731,829 4,937,752
Add:
Deferred loan costs 29,799 -
Less:
Allowance for loan losses (181,500) (56,250)
Deferred loan fees (7,560) -
------------------ ------------------
Loans receivable, net $ 16,572,568 $ 4,881,502
================== ==================
</TABLE>
A summary of the activity in the allowance for loan losses is as
follows:
<TABLE>
<CAPTION>
2000 1999
------------------ -------------------
<S> <C> <C>
Balance, beginning of period $ 56,250 $ -
Provision for losses 125,250 56,250
------------------ -------------------
Balance, end of period $ 181,500 $ 56,250
================== ===================
</TABLE>
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, is as follows:
<TABLE>
<CAPTION>
2000 1999
------------------ -------------------
<S> <C> <C>
Beginning balance $ 957,542 $ -
New loans 2,996,101 2,380,520
Participations sold (1,772,748) (985,000)
Less: Repayments (1,245,394) (437,978)
------------------ -------------------
Ending balance $ 935,501 $ 957,542
================== ===================
</TABLE>
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 4. Accrued Interest Receivable
Accrued interest receivable at June 30, is summarized as follows:
<TABLE>
<CAPTION>
2000 1999
------------------ -------------------
<S> <C> <C>
Investment securities $ 64,286 $ 12,191
Loans receivable 231,017 47,336
------------------ -------------------
Total $ 295,303 $ 59,527
================== ===================
</TABLE>
Note 5. Premises and Equipment
Premises and equipment at June 30, consists of the following:
<TABLE>
<CAPTION>
2000 1999
------------------ -------------------
<S> <C> <C>
Leasehold improvements $ 205,144 $ 200,035
Furniture and equipment 316,454 309,382
------------------ -------------------
Total 521,598 509,417
Less accumulated depreciation (89,666) (22,732)
------------------ -------------------
Premises and equipment, net $ 431,932 $ 486,685
================== ===================
</TABLE>
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 6. Deposits
The aggregate amount of certificates of deposit with a minimum
denomination of $100,000 was approximately $2,100,000 and $400,000 as of
June 30, 2000 and 1999, respectively. Deposited amounts in excess of
$100,000 are not insured by the Federal Deposit Insurance Company.
At June 30, 2000, the scheduled maturities of time deposits are as
follows:
2001 $ 9,600,627
2002 452,000
2003 389,701
2004 84,500
------------------
Total $ 10,526,828
==================
Interest expense by category follows:
For the Year Ended June 30,
---------------------------------------
2000 1999
------------------ -------------------
Demand deposits $ 7,625 $ 1,430
Savings deposits 169,794 13,363
Time deposits 340,841 25,219
------------------ -------------------
Total interest expense $ 518,260 $ 40,012
================== ===================
Deposits by related parties were approximately $4,082,000 and $658,000 as
of June 30, 2000 and 1999, respectively. In addition, as of June 30, 2000
approximately $3,200,000 of deposits were from one related party and his
corresponding business.
Note 7. Other Borrowed Funds
Borrowed funds consisted of advances from Federal Home Loan Bank (FHLB)
in the amount of $1,950,000 as of June 30, 2000. The advances mature as
follows:
Date of Maturity Amount Rate
--------------- ---------------
September 18, 2000, fixed rate $ 300,000 6.33%
October 18, 2000, fixed rate 425,000 5.85%
February 20, 2001, fixed rate 475,000 7.15%
June 25, 2001, fixed rate 750,000 6.94%
--------------- ---------------
$ 1,950,000 6.85%
=============== ===============
These borrowings are collateralized by the FHLB stock, first and second
mortgage loans of approximately $1,900,000 and mortgage back securities
of approximately $1,000,000.
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 8. Income Taxes
The Company incurred no current tax expense because of its operating
loss and its deferred tax benefit was reduced by a valuation allowance
to zero. A reconciliation of income taxes computed at the federal
statutory income tax rate to total income taxes is as follows:
<TABLE>
<CAPTION>
For the Year Ended June 30,
2000 1999
------------------ -------------------
<S> <C> <C>
Pretax loss $ (603,397) $ (493,672)
------------------ ---------------------
Income tax (benefit) computed at
federal statutory tax rate $ (205,155) $ (167,848)
Increase (decrease) resulting from:
Nondeductible expenses 6,830 718
State income tax benefit, net
of federal tax benefit (42,494) (28,751)
Valuation allowance 240,819 195,881
------------------ ---------------------
Total tax benefit $ - $ -
================== =====================
</TABLE>
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:
<TABLE>
<CAPTION>
June 30, June 30,
2000 1999
------------------ -------------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryover $ 316,000 $ 86,052
Deferred organization expenses 70,709 90,867
Allowance for loan losses 72,600 22,500
Securities unrealized losses 22,934 1,667
Less valuation allowance (436,700) (197,465)
------------------ -------------------
Subtotal 45,543 3,621
------------------ -------------------
Deferred tax liabilities:
Deferred loan fees/costs, net 9,203 -
Depreciation and basis adjustment 13,406 1,954
------------------ -------------------
Subtotal 22,609 1,954
------------------ -------------------
Net deferred tax assets $ 22,934 $ 1,667
================== ===================
</TABLE>
At June 30, 2000 the Company has a cumulative net operating loss
carryover for tax purposes of approximately $800,000 subject to a 20
year limitation.
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 9. 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 nonqualified stock options (collectively stock options).
In October 1999 the Company amended the Plan and reserved an additional
75,000 shares of its common stock for issuance. The options vest over a
period ranging from immediate to 3 years and must be exercised within
10 years of grant date
The following summarizes the stock option activity:
<TABLE>
<CAPTION>
Shares Available Options Shares Weighted Avg.
for Grant Outstanding Exercise Price
--------------------- ------------------ -------------------
<S> <C>
At June 30, 1998 - - -
Organizers shares 30,800 - -
1998 Plan Created 41,700 - -
Granted (54,800) 54,800 10.00
Exercised - - -
--------------------- ------------------ -------------------
At June 30, 1999 17,700 54,800 10.00
1998 Plan Amended 75,000 - -
Granted (24,800) 24,800 10.50
Exercised - - -
--------------------- ------------------ -------------------
At June 30, 2000 67,900 79,600 $ 10.16
===================== ================== ===================
</TABLE>
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 9. Stock Options - (continued)
A summary of the status of the stock options as of and for the year
ended June 30, 2000 is presented below:
Weighted Avg.
Shares Exercise Price
------------------ -------------------
Granted 79,600 $10.16
Outstanding 79,600 $10.16
Exercisable 44,800 $10.00
Stock options Weighted average Weighed average contractual
Issued fair value life of options outstanding
--------------------------------------- ------------------------------
1999 $4.33 8.7
2000 $3.06 9.4
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
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 option under the fair value method of
that statement. Proforma net income/(loss) and earnings/(loss) per
share for fiscal year end 2000 follows:
2000 1999
------------------ ---------------------
Net loss
As reported $ (603,397) $ (493,672)
Pro forma $ (650,684) $ (661,620)
Earnings per common share and common
share equivalent
As reported (1.42) (1.60)
Pro forma (1.53) (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.
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 9. Stock Options - (continued)
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:
Options Issued
-------------------------------
Fiscal 2000 Fiscal 1999
------------- ------------
Risk-free interest rate 5.129% 5.129%
Expected life 5 Yrs. 5 Yrs.
Expected volatility 49.00% 26.00%
Expected dividends None None
Note 10. Employee Benefits
In December 1999 the Bank adopted a salary reduction plan (Simple
IRA) which covers substantially all full time employees. The cost to
the Bank for this plan was approximately $3,100 for the year ended
June 30, 2000.
On December 22, 1999 the Company granted its Chief Executive Officer
a restricted stock award of 2000 shares of the Company's common
stock. The shares are subject to a vesting period ranging from three
to to five years. The unearned compensation, measured by the quoted
price of the stock on the award date ($10 per share), is shown as a
separate reduction of stockholders' equity. The unearned
compensation will be accounted for as expense over the vesting
period.
Note 11. Commitments
At June 30, 2000, 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 $85,846 and $33,945 for
the for the year ended June 30, 2000 and 1999, respectively. The office
space is leased from a lessor entity in which a Company stockholder has
a significant interest. Minimum lease payments under the operating
leases are as follows:
For the Year Office Equipment
Ended lease lease
------------- ------------------ -------------------
2001 $ 77,907 $ 7,956
2002 78,560 5,934
2003 79,212 2,934
2004 79,212 -
2005 79,212 -
2006 and thereafter 283,722 -
------------------ -------------------
Total $ 677,825 $ 16,824
================== ===================
The Bank has an option to renew the office lease for two additional
five year terms. The Bank has an available line of credit available in
the amount of $250,000 at a corresponding bank.
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 12. 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 $12.00 per share at any time prior to October 9, 2003.
Note 13. Financial Instruments With Off-Balance-Sheet Risk
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. The Bank had outstanding commitments for
additional borrowings as follows:
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------
2000 1999
--------------------- ---------------------
<S> <C> <C>
Revolving, open-end lines secured by 1-4 family residential $ 610,000 $ 80,000
Commercial real estate, construction and land development 256,000 -
Other, agricultural real estate, unsecured , & check credit 1,322,000 881,000
--------------------- ---------------------
Total outstanding commitments and additional borrowings $ 2,188,000 $ 961,000
===================== =====================
</TABLE>
Commitments to extend credit which represent credit risk at variable
and fixed rates were $256,000 and $1,932,000, at June 30, 2000,
respectively.
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitments amounts do not necessarily represent future cash
requirements. The Bank examines each customer's creditworthiness on a
case-by-case basis. The amount and type of collateral obtained, if
deemed necessary by the Bank upon extension of credit, varies and is
based on management's credit evaluation of the counterparty.
Commitments to sell loans amounted to $385,050 at June 30, 2000.
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 13. Financial Instruments With Off-Balance-Sheet Risk - (continued)
The estimated fair values of the Company's financial instruments are as
follows:
<TABLE>
<CAPTION>
June 30, 2000 June 30, 1999
---------------------------------------- ---------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------------- ------------------- ------------------- ------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 689,204 $ 689,204 $ 2,743,898 $ 2,743,898
Available for sale securities 4,212,387 4,212,387 745,199 745,119
FHLB stock 97,500 97,500 16,400 16,400
Loans receivable 16,754,067 16,702,710 4,881,502 4,881,502
Loans held for sale 385,050 385,050 681,593 681,593
Accrued interest receivable 295,303 295,303 59,527 59,527
Financial liabilities:
Deposits 18,193,931 18,190,858 6,164,570 6,164,570
Advance payments by borrowers 17,311 17,311 23,941 23,941
Other Borrowings 1,950,000 1,948,809 - -
</TABLE>
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 14. 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 years ended June
30, 2000.
The Bank maintains its cash in bank deposit accounts which at time,
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 15. 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 judgements 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, 2000, that the Bank
meets all of capital adequacy requirements to which it is subject.
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 15. Stockholders Equity and Regulatory Matters - (continued)
As of June 30, 2000 and 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.
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, 2000
Total Capital
(to Risk Weighted Assets) $ 2,717 15.3% $ 1,423 8.0% $ 1,779 10.0%
Tier 1 Capital
(to Risk Weighted Assets) $ 2,535 14.2% $ 712 4.0% $ 1,068 6.0%
Tier 1 Capital
(to Average Assets) $ 2,535 12.3% $ 823 4.0% $ 1,028 5.0%
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.
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 16. 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 17: Joint Venture
In July 1999, the Company acquired a 49 percent joint venture interest
in Homeland Mortgage Company, LLC (Homeland Mortgage), a limited
liability company, in exchange for a total cash consideration of
$196,000. The investment in Homeland Mortgage is being accounted for
using the equity method. Homeland Mortgage's primary business is
originating residential real estate loans that are secured by first and
second mortgages and sold into the secondary mortgage market and
mortgage loan servicing.
Condensed financial information of Homeland Mortgage is as follows:
Balance Sheet June 30, 2000
---------------------
Cash and cash equivalents $ 99,220
Other current assets 34,837
Property and equipment, net 33,900
Other 3,500
---------------------
Total assets $ 136,620
=====================
Current liabilities $ 2,943
Equity 168,514
---------------------
Total liabilities and equity $ 171,457
=====================
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 17: Joint Venture - (continued)
For the
Year Ended
June 30,
Income Statement 2000
-----------------
Income
Interest $ 8,538
Gain on sale of loans 41,781
Fees and service charges 140,977
-----------------
Total income 191,296
Expenses
Operating 416,675
Interest 6,107
-----------------
422,782
-----------------
Net loss $ (231,486)
=================
The Company's 49% investment in Homeland is included in other assets on
the consolidated statement of condition in the amount of $82,572 as of
June 30, 2000 and its 49% share of the net loss is included with
non-interest expenses in the consolidated statement of operations as
subsidiary loss.
Note 18: Merger Expense
On September 30, 1999 the Company and First Federal Holding Company of
Morris, Inc. "Morris" entered into an agreement for the merger of
Morris with and into the Company. The merger was not consummated
because regulatory approval was denied and all expenses incurred that
pertain to the merger attempt are included in non-interest expenses as
merger expenditures.
Note 19: Secondary Stock Offering Initiated
The Company expects to file a post-effective Registration Statement on
Form SB-2 with the Securities and Exchange Commission to register the
sale of up to 300,000 shares of its common stock. The shares will be
offered and sold to the public on a best efforts basis by its sales
agent and they must sell a minimum of 50,000 shares in order to sell
any shares.
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 20. 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.
<TABLE>
<CAPTION>
STATEMENT OF FINANCIAL CONDITION
June 30,
--------------------------------------
ASSETS 2000 1999
------------------ ------------------
<S> <C> <C>
Cash (1) $ 72,768 $ 704,700
Investment in Bank subsidiary 2,500,446 2,726,471
Prepaid assets 161,625 -
Investment in Homeland Mortgage 82,572 -
---------------- ----------------
Total $ 2,817,411 $ 3,431,171
================ ================
LIABILITIES AND SHAREHOLDERS EQUITY
Other liabilities $ 29,007 $ 7,469
Shareholders' equity 2,788,404 3,423,702
---------------- ----------------
Total $ 2,817,411 $ 3,431,171
================ ================
(1) The parent company cash is deposited in the Bank and eliminated on the
consolidated statement of financial condition.
STATEMENT OF INCOME
For the Year Ended June 30,
--------------------------------------
Interest from: 2000 1999
------------------ ------------------
Deposits in subsidiary $ 15,052 $ 7,565
Nonaffiliated bank - 5,191
---------------- ----------------
Total income 15,052 12,756
Expenses:
Non-interest expenses 310,897 234,899
Undistributed equity loss in subsidiary 113,428 -
Income tax (refund) expense - -
---------------- ----------------
Total expenses 424,325 234,899
---------------- ----------------
</TABLE>
<PAGE>
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 20. Parent Only Condensed Financial Information - (continued)
<TABLE>
<CAPTION>
<S> <C> <C>
Loss before equity in undistributed net loss of
Bank subsidiary (409,273) (222,143)
Equity reduction from undistributed net
comprehensive loss of Bank subsidiary (226,025) (274,029)
---------------- ----------------
Net comprehensive loss $ (635,298) $ (496,172)
================ ================
</TABLE>
<TABLE>
<CAPTION>
STATEMENT OF CASH FLOWS
For the Year Ended June 30,
------------------------------------------
2000 1999
------------------- ------------------
<S> <C> <C>
Net loss $ (635,298) $ (496,172)
Adjustments:
Loss on equity investment 113,428 -
Bank operating loss 226,025 274,029
Decrease (Increase) in other assets (161,625) 5,580
Increase in other liabilities 21,538 7,469
---------------- --------------
Net cash (used in) operations (435,932) (209,094)
---------------- --------------
Cash flows from investing activities:
Investment in Bank subsidiary - (3,000,500)
Investment in mortgage company (196,000) -
---------------- --------------
Net cash (used in) investing activities (196,000) (3,000,500)
---------------- --------------
Cash flows from financing activities:
Proceeds from sale of common stock - 4,256,000
Payments for stock issuance costs - (332,267)
Decrease in prepaid organizational costs - 9226
(Refunds to) Advances from organizers - (18,665)
---------------- --------------
Net cash provided by financing activities - 3,914,294
---------------- --------------
(Decrease) increase in cash and cash equivalents (631,932) 704,700
Cash and cash equivalents
Beginning of year 704,700 -
---------------- --------------
End of year $ 72,768 $ 704,700
================ ==============
</TABLE>
<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:
<TABLE>
<CAPTION>
<S> <C> <C>
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.
</TABLE>
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 2000 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 2000 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 2000 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
definitive Proxy Statement for its 2000 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
The following reports on Form 8-K were filed during the last
fiscal quarter of the Registrant's 2000 fiscal year:
(i) Current Report on Form 8-K dated June 28, 2000
announcing the termination of the Company's proposed
merger with First Federal Holding Company of Morris,
Inc.
<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 25, 2000 By: /s
----------------------------------------------
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 September 25, 2000
--------------------------------------------------------
Thomas P. Stienessen, President, Chief Executive
Officer and Director
(Principal Executive Officer)
/s September 25, 2000
--------------------------------------------------------
Frank L. Gazzola, Chief Financial Officer and Director
(Principal Financial and Accounting Officer)
/s September 25, 2000
--------------------------------------------------------
Robert H. Dittrich, Director
/s September 25, 2000
--------------------------------------------------------
Dean M. Doyscher, Director
/s September 25, 2000
--------------------------------------------------------
Steven A. Loehr, Director
/s September 25, 2000
--------------------------------------------------------
Michael P. Reynolds, Director
/s September 25, 2000
--------------------------------------------------------
Thomas J. Reynolds, Director
<PAGE>
NORTHERN STAR FINANCIAL, INC.
EXHIBIT INDEX TO FORM 10-KSB
Exhibit
Number Description
1.1 Underwriting Agreement dated September 9, 2000 between Registrant and
Berthel Fisher & Company Financial Services, Inc. (Incorporated by
reference to Exhibit 1.1 to the Company's Registration Statement on
Form SB-2 Reg. No. 333-94189)*
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
23 Consent of Bertram Cooper & Co., LLP
24 Power of Attorney from Certain Directors (See Signature Page)
27 Financial Data Schedule (filed in electronic format only)
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* 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.
<PAGE>
EXHIBIT 23
INDEPENDENT ACCOUNTANTS' CONSENT
The Board of Directors and Stockholders
Northern Star Financial, Inc.
Mankato, MN 56001
We consent to the use of our report dated August 10, 2000, relating to the
consolidated statements of financial condition of Northern Star Financial, Inc.
and Subsidiary as of June 30, 2000 and 1999 and the related consolidated
statements of operation, stockholders' equity, and cash flows for the years then
ended, which report appears in the June 30, 2000 annual report on Form 10-KSB of
Northern Star Financial, Inc.
/s/ Bertram Cooper & Co., LLP
Bertram Cooper & Co., LLP
Waseca, Minnesota
September 25, 2000
