<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------------------------------------
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED September 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE
TRANSITION PERIOD FROM _________ TO ___________
---------------------------------------------------
Commission File No. 0-25914
---------------------------------------------------
CASTLE BANCGROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<CAPTION>
<S> <C>
Delaware 36-3238190
(STATE OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYER IDENTIFICATION
ORGANIZATION) NUMBER)
121 West Lincoln Highway 60115-3609
DeKalb, Illinois (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
</TABLE>
Registrant's telephone number, including area code: (815) 758-7007
---------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days: Yes x No
--- ---
The registrant had 2,170,475 shares of Common Stock outstanding as of
October 31, 1998.
1
<PAGE>
PART I
ITEM 1 - FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
- -------------------------------------------------------------------------------------------------------------
ASSETS September 30, December 31,
1998 1997
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and due from banks $ 11,431 11,377
- -------------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 11,431 11,377
- -------------------------------------------------------------------------------------------------------------
Investment securities (note 2) 138,499 129,479
Mortgage loans held for sale, lower of cost or market 24,663 44,761
Loans (note 3) 319,854 315,540
Less:
Allowance for possible loan losses (note 3) 4,665 4,646
Unearned income and deferred loan fees, net 2,484 2,352
- -------------------------------------------------------------------------------------------------------------
Net loans 312,705 308,542
Premises and equipment 11,453 10,854
Goodwill, net of amortization 4,096 4,495
Other assets 6,798 6,042
- -------------------------------------------------------------------------------------------------------------
$509,645 515,550
- -------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
- -------------------------------------------------------------------------------------------------------------
Liabilities:
Deposits:
Noninterest-bearing $ 43,176 42,589
Interest-bearing 396,905 381,094
- -------------------------------------------------------------------------------------------------------------
Total deposits 440,081 423,683
Short-term borrowings 11,284 39,057
Long-term debt 10,775 10,250
Other liabilities 5,670 5,698
- -------------------------------------------------------------------------------------------------------------
Total liabilities 467,810 478,688
- -------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock, no par value; authorized 100,000 shares
7.75% cumulative; 300 shares issued and outstanding 300 300
Common stock, $.33 par value; 5,000,000 shares authorized, 2,169,508 and
2,152,593 shares issued and outstanding in 1998 and 1997, respectively 723 718
Additional paid-in capital 7,098 6,691
Accumulated other comprehensive earnings 1,541 577
Retained earnings 32,173 28,576
- -------------------------------------------------------------------------------------------------------------
Total stockholders' equity 41,835 36,862
Commitments and contingent liabilities
- -------------------------------------------------------------------------------------------------------------
$509,645 515,550
- -------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENT OF EARNINGS (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
- -----------------------------------------------------------------------------------------------------------------
3 Months Ended
Sept. 30, 1998 Sept. 30, 1997
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest income:
Interest and fees on loans $ 7,729 7,306
Interest and dividends on investment securities:
Taxable 1,989 2,128
Nontaxable 165 137
Interest on excess funds sold 55 (43)
Interest on mortgage loans held for sale 379 457
- -----------------------------------------------------------------------------------------------------------------
Total interest income 10,317 9,985
- -----------------------------------------------------------------------------------------------------------------
Interest expense:
Interest on deposits 4,465 4,389
Interest on short-term borrowings 207 452
Interest on long-term debt 164 158
- -----------------------------------------------------------------------------------------------------------------
Total interest expense 4,836 4,999
- -----------------------------------------------------------------------------------------------------------------
Net interest income before provision for possible loan losses 5,481 4,986
Provision for possible loan losses 147 291
- -----------------------------------------------------------------------------------------------------------------
Net interest income after provision for possible loan losses 5,334 4,695
- -----------------------------------------------------------------------------------------------------------------
Other operating income
Trust fees 208 165
Deposit service charges 85 97
Other service charges 304 305
Investment securities gains/(losses), net (note 2) (1) 81
Mortgage loan origination income, net 2,698 1,980
Other income 299 137
- -----------------------------------------------------------------------------------------------------------------
Total other operating income 3,593 2,765
- -----------------------------------------------------------------------------------------------------------------
Other operating expenses:
Salaries and employee benefits 4,678 4,013
Net occupancy expense of premises 450 407
Furniture and fixtures 403 436
Office supplies 134 102
Outside services 358 239
Advertising expense 153 124
FDIC insurance assessment 12 13
Postage and courier 164 121
Amortization expense - goodwill 172 128
Other expenses 498 435
- -----------------------------------------------------------------------------------------------------------------
Total other operating expenses 7,022 6,018
- -----------------------------------------------------------------------------------------------------------------
Earnings before income taxes 1,905 1,442
Income tax expense 645 501
- -----------------------------------------------------------------------------------------------------------------
Net earnings $ 1,260 941
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
Net earnings applicable to common stock $ 1,254 890
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
Basic earnings per common share $ .58 .43
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
Diluted earnings per common share $ .57 .42
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENT OF EARNINGS (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
- -------------------------------------------------------------------------------------------------
9 Months Ended
Sept. 30, 1998 Sept. 30, 1997
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest income:
Interest and fees on loans $ 22,010 21,317
Interest and dividends on investment securities:
Taxable 6,161 6,284
Nontaxable 470 444
Interest on excess funds sold 71 31
Interest on mortgage loans held for sale 1,453 914
- -------------------------------------------------------------------------------------------------
Total interest income 30,165 28,990
- -------------------------------------------------------------------------------------------------
Interest expense:
Interest on deposits 13,195 12,700
Interest on short-term borrowings 1,023 1,112
Interest on long-term debt 516 531
- -------------------------------------------------------------------------------------------------
Total interest expense 14,734 14,343
- -------------------------------------------------------------------------------------------------
Net interest income before provision for possible loan losses 15,431 14,647
Provision for possible loan losses 421 735
- -------------------------------------------------------------------------------------------------
Net interest income after provision for possible loan losses 15,010 13,912
- -------------------------------------------------------------------------------------------------
Other operating income
Trust fees 582 470
Deposit service charges 261 274
Other service charges 901 847
Investment securities gains, net (note 2) 71 209
Mortgage loan origination income, net 8,139 4,356
Other income 875 592
- -------------------------------------------------------------------------------------------------
Total other operating income 10,829 6,748
- -------------------------------------------------------------------------------------------------
Other operating expenses:
Salaries and employee benefits 13,198 11,483
Net occupancy expense of premises 1,309 1,275
Furniture and fixtures 1,117 1,187
Office supplies 401 309
Outside services 832 597
Advertising expense 467 387
FDIC insurance assessment 41 40
Postage and courier 443 344
Amortization expense - goodwill 390 390
Other expenses 1,753 1,633
- -------------------------------------------------------------------------------------------------
Total other operating expenses 19,951 17,645
- -------------------------------------------------------------------------------------------------
Earnings before income taxes 5,888 3,015
Income tax expense 2,013 997
- -------------------------------------------------------------------------------------------------
Net earnings $ 3,875 2,018
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
Net earnings applicable to common stock $ 3,857 1,867
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
Basic earnings per common share $ 1.78 .90
- -------------------------------------------------------------------------------------------------
Diluted earnings per common share $ 1.77 .89
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DOLLARS IN THOUSANDS)
- ---------------------------------------------------------------------------------------------------------------
Accumulated
Other
Retained Comprehensive Preferred Common
Total Earnings Earnings Stock Stock Surplus
- ------------------------------ ------------- ------------- ------------------ ------------ -------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1998 $36,862 $28,576 $577 $300 $718 $6,691
Comprehensive Earnings
Net Earnings 3,875 3,875
Unrealized gain on
investment securities
(net of deferred tax
benefit of $593) 964 964
---
Total comprehensive earnings 4,839
-----
Issuance of 16,915 shares
of common stock 412 5 407
Cash dividends on
preferred stock (18) (18)
Cash dividends on common
stock (260) (260)
- ------------------------------ ------------- ------------- ------------------ ------------ -------- -----------
Balance at September 30, 1998 $41,835 $32,173 $1,541 $300 $723 $7,098
- ------------------------------ ------------- ------------- ------------------ ------------ -------- -----------
Disclosure of reclassification amount:
Unrealized holding gains arising during the period $1,035
Less: reclassification adjustment for gains
included in net income 71
------
Net unrealized gains on securities $964
------
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENT OF CASH FLOWS (DOLLARS IN THOUSANDS)
- ------------------------------------------------------------------------------------------------------------------------
9 Months Ended
--------------
Sept. 30, 1998 Sept. 30, 1997
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Interest received $ 28,564 27,677
Fees received 11,337 6,682
Net (increase) / decrease in mortgage loans held for sale 20,098 (14,326)
Interest paid (14,709) (13,907)
Cash paid to suppliers and employees (18,874) (15,915)
Income taxes paid (1,871) (1,269)
- ------------------------------------------------------------------------------------------------------------------------
Net cash provided/(used in) by operating activities 24,545 (11,058)
- ------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from:
Maturities and calls of investment securities 42,315 23,076
Sales of investment securities 22,050 43,691
Purchases of investment securities (71,561) (59,191)
Net (increase) in loans (4,881) (17,154)
Premises and equipment expenditures (1,448) (1,811)
- ------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (13,525) (11,389)
- ------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase/(decrease) in demand deposits, NOW accounts, and savings accounts 22,846 (5,430)
Net increase / (decrease) in certificates of deposit (6,448) 15,196
Dividends paid on preferred stock (18) (151)
Dividends paid on common stock (510) (208)
Net change in short-term debt (27,773) 9,208
Proceeds from issuance of common stock 412 133
Net proceeds of long-term debt 525 (450)
- ------------------------------------------------------------------------------------------------------------------------
Net cash (used in)/provided by financing activities (10,966) 18,298
- ------------------------------------------------------------------------------------------------------------------------
Net change in cash and cash equivalents 54 (4,149)
Cash and cash equivalents at beginning of year 11,377 12,566
- ------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of the period $ 11,431 8,417
- ------------------------------------------------------------------------------------------------------------------------
Reconciliation of net earnings to net cash provided by operating activities:
Net earnings $ 3,875 2,018
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Depreciation and amortization 1,239 1,567
Provision for possible loan losses 421 735
Gains on sale of investment securities (71) (209)
Increase (decrease) in:
Income taxes payable 145 (272)
Interest payable 25 436
Unearned income 132 (674)
Other liabilities (532) 161
Decrease (increase) in:
Interest receivable (958) (635)
Other assets 367 143
Decrease/ (increase) in mortgage loans held for sale 20,098 (14,326)
Discount accretion recorded as income (425) (229)
Premium amortization charged against income 229 227
- ------------------------------------------------------------------------------------------------------------------------
$ 24,545 (11,058)
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The unaudited consolidated financial statements of Castle BancGroup,
Inc. (Company) and subsidiaries are prepared in conformity with
generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. These financial statements should be read in
conjunction with the Company's 1997 Annual Report on Form 10-K. In the
opinion of management, all normal recurring adjustments necessary for
a fair presentation of the financial position and the results of
operations for the periods presented have been included. Results of
operations for interim periods are not necessarily indicative of the
results that may be expected for the year.
(2) INVESTMENT SECURITIES
Investments in debt and equity securities have been classified as
available for sale and reported at fair value. The amortized value is
adjusted for amortization of premiums and accretion of discounts using
a method that approximates level yield. Unrealized gains and losses,
net of related deferred income taxes, are reported in stockholders'
equity.
A comparison of amortized cost and fair value of investment securities
available-for-sale at September 30, 1998 and December 31, 1997 follows
(DOLLARS IN THOUSANDS):
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
September 30, 1998
-------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
cost gains losses value
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury and agency obligations $ 85,311 1,683 (16) 86,978
Obligations of state and political subdivisions 13,301 300 (4) 13,597
Mortgage-backed securities 35,313 530 (28) 35,815
- -------------------------------------------------------------------------------------------------------------------------
Total debt securities 133,925 2,513 (48) 136,390
- -------------------------------------------------------------------------------------------------------------------------
Federal Home Loan Bank stock 1,687 -- -- 1,687
Other Equity securities 422 -- -- 422
- -------------------------------------------------------------------------------------------------------------------------
Total securities 136,034 2,513 (48) 138,499
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
7
<PAGE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
December 31, 1997
---------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
cost gains losses value
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury and agency obligations $ 101,495 657 (173) 101,979
Obligations of state and political subdivisions 9,873 253 (2) 10,124
Mortgage-backed securities 15,397 218 (45) 15,570
- ---------------------------------------------------------------------------------------------------------------------------
Total debt securities 126,765 1,128 (220) 127,673
Federal Home Loan Bank stock 1,472 0 0 1,472
Other Equity securities 334 0 0 334
- ---------------------------------------------------------------------------------------------------------------------------
Total securities $ 128,571 1,128 (220) 129,479
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
The amortized cost and fair value of securities available-for-sale at
September 30, 1998 and December 31, 1997 by contractual maturity, are
shown below (DOLLARS IN THOUSANDS). Actual maturities may differ from
contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
September 30, 1998 December 31, 1997
---------------------------- ------------------------------
Amortized Fair Amortized Fair
cost value cost value
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Due in one year or less $ 13,390 13,490 9,033 9,076
Due after one year through five years 26,494 27,025 35,121 35,460
Due after five years through ten years 40,005 40,933 32,474 32,731
Due after ten years 18,723 19,127 34,740 34,836
- -------------------------------------------------------------------------------------------------------------------------
98,612 100,575 111,368 112,103
Mortgage-backed securities 35,313 35,815 15,397 15,570
- -------------------------------------------------------------------------------------------------------------------------
Total debt securities 133,925 136,390 126,765 127,673
- -------------------------------------------------------------------------------------------------------------------------
Federal Home Loan Bank stock 1,687 1,687 1,472 1,472
Other Equity securities 422 422 334 334
- -------------------------------------------------------------------------------------------------------------------------
Total securities $ 136,034 138,499 128,571 129,479
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
Gross losses of approximately $5,477 and $162,657 occurred from security
activity during the nine months ended September 30, 1998 and 1997,
respectively. Gross gains of $76,551 and $371,887 occurred from security
activity during the nine month period that ended September 30, 1998 and
1997, respectively. All security gains and losses that occurred during
1998 and 1997 were as a result of transactions involving
available-for-sale securities.
Investment securities carried at approximately $80,626,000 and
$66,445,000 at September 30, 1998 and December 31, 1997, respectively,
were pledged to secure deposits and for other purposes permitted or
required by law.
8
<PAGE>
(3) LOANS
<TABLE>
<CAPTION>
The composition of the loan portfolio at the dates shown is as follows (DOLLARS IN THOUSANDS):
- ----------------------------------------------------------------------------------------------------------------------
Sept. 30, 1998 Dec. 31, 1997
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Commercial, financial, and agricultural $ 85,085 73,908
Real estate mortgage 204,194 208,502
Consumer 29,902 32,606
Lease financing receivables 673 524
- ----------------------------------------------------------------------------------------------------------------------
Total loans, gross $ 319,854 315,540
- ----------------------------------------------------------------------------------------------------------------------
At September 30, 1998 and December 31, 1997, the following items existed (DOLLARS IN THOUSANDS):
- ----------------------------------------------------------------------------------------------------------------------
Sept. 30, 1998 Dec. 31, 1997
- ----------------------------------------------------------------------------------------------------------------------
Non-accrual loans and leases $ 2,497 3,968
Loans past due 90 days or more and still accruing 708 500
Restructured loans still accruing and less than 90 days past due 214 139
- ----------------------------------------------------------------------------------------------------------------------
Total non-performing loans and leases $ 3,419 4,607
- ----------------------------------------------------------------------------------------------------------------------
The following is a summary of activity in the allowance for possible loan losses (DOLLARS IN THOUSANDS):
- ----------------------------------------------------------------------------------------------------------------------
9 months ended Year ended
Sept. 30, 1998 Dec.31, 1997
- ----------------------------------------------------------------------------------------------------------------------
Balance, beginning of year $ 4,646 3,775
Provision charged to expense 421 1,128
Additions to dealer reserves 0 33
Recoveries on loans previously charged off 356 448
- ----------------------------------------------------------------------------------------------------------------------
5,423 5,384
Less loans charged off 758 738
- ----------------------------------------------------------------------------------------------------------------------
Balance, end of period $ 4,665 4,646
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
The following is a summary of loan loss experience for the nine months
ended September 30, 1998, including an allocation of the allowance, by
loan category, at period end: (DOLLARS IN THOUSANDS)
- -----------------------------------------------------------------------------------------------------------------------
Commercial Real
and Agricultural Estate Consumer Leases Unalloc. Total
- -----------------------------------------------------------------------------------------------------------------------
<S> <C>
Balance, December 31, 1997 $ 1,779 1,407 1,247 13 200 4,646
Provision charged to expense 0 0 421 0 0 421
Recoveries on loans previously
charged off 197 18 142 0 0 357
- -----------------------------------------------------------------------------------------------------------------------
1,976 1,425 1,810 13 200 5,424
Less loans charged off (11) (275) (473) 0 0 759
- -----------------------------------------------------------------------------------------------------------------------
1,965 1,150 1,337 13 200 4,665
Reallocation (200) 200 0 0 0
- -----------------------------------------------------------------------------------------------------------------------
Balance, Sept. 30, 1998 $ 1,765 1,150 1,537 13 200 4,665
- -----------------------------------------------------------------------------------------------------------------------
Ratios:
Loans in category to total loans 26.60% 63.84% 9.35% .21% N/A 100.00%
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
The allocation of the allowance for loan losses is based on historical trends in
charge-offs, general economic conditions, peer comparisons and management
experience.
10
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The Company posted year-to-date net earnings of $3,875,000 at September 30,
1998, an increase of $1,857,000, or 92%, from year-to-date earnings of
$2,018,000 at September 30, 1997. This increase in earnings is largely
attributable to an increase in the volume of mortgage loan originations and
sales at the bank subsidiaries and CasBanc Mortgage, Inc. The increased mortgage
loan activity is a result of the favorable low interest rate environment in
effect for fifteen and thirty year mortgages on one to four family residential
properties. If interest rates for fifteen and thirty year mortgages increase,
the subsidiaries may not be able to maintain origination volume at the present
level and earnings may be adversely impacted. Mortgage loan origination income
for the first nine months of 1998 increased 87% to $8,139,000 as compared to
$4,356,000 for the first nine months of 1997. In units, the year-to-date
mortgage loans sales for the first nine months of 1998 were 3,396 versus 1,995
during the first nine months of 1997.
Year-to-date basic earnings per common share were $1.78 at September 30, 1998,
up $.88 per share from September 30, 1997 basic earnings per common share of
$.90. The increase in basic earnings per share is due primarily to the increased
mortgage loan origination income as described above. Diluted earnings per share
were $1.77.
Net earnings applicable to common stock of $3,857,000 year-to-date at September
30, 1998 compares to $1,867,000 at September 30, 1997. This represents a 107%
increase. Year-to-date preferred stock dividends were $18,000 at September 30,
1998 as compared to $151,000 at September 30, 1997. The decrease was due to the
preferred stock redemption which occurred in December, 1997.
Net earnings applicable to common stock of $1,254,000 for the three months ended
September 30, 1998 is an increase of $364,000 or 41% over the same three month
period ending September 30, 1997. This is also related to the increased volume
of mortgage loan originations in 1998 versus 1997.
The following discussion of performance for the three month and nine month
periods ending September 30, 1998 as compared to the corresponding periods in
1997 highlights significant points of interest, trends in operations, and
management's operating philosophies. (Unless otherwise stated, all averages are
simple daily averages.)
INTEREST INCOME
Net interest income before provision for possible loan losses for the third
quarter of 1998 was $5,481,000 versus $4,986,000 in the third quarter of 1997
for an increase of 10% or $495,000. This increase is primarily attributed to an
increase in interest and fees on loans which was positively affected by the
collection of interest previously foregone on a non-accrual loan. Net interest
income before provision for possible loan losses for the first nine months of
1998 increased 5% to $15,431,000 as compared to $14,647,000 for the first nine
months of 1997. This increase is attributed to both increases in interest and
fees on loans and interest on mortgage loans held for sale. Interest on mortgage
loans held for sale is generated as a result of loans that have been originated
through CasBanc Mortgage, Inc. (CMI), but not yet sold in the secondary market.
The subsidiary banks purchase these loans from CMI when the loans are made to
the borrowers. The subsidiary banks then hold these interest earning assets
until they are sold into the secondary market, providing short-term liquid
investments for the banks.
11
<PAGE>
The average net interest margin, on a federal tax equivalent basis (including
non-accruing loans), increased for the first nine months of 1998 at 4.51% as
compared to 4.38% in 1997. This increase can primarily be attributed to the
collection of interest previously foregone on a non-accrual loan, as mentioned
above.
The ratio of average earning assets to average total assets increased slightly
to 93.48% for the first nine months of 1998 as compared to 93.11% for the same
period in 1997.
Competition from both financial institutions and non-traditional competitors, as
well as general economic trends, will continue to impact future earnings. The
earning asset mix, as well as the net interest margin, are monitored and
evaluated by management to develop strategies to help maintain and improve
earnings.
PROVISION FOR POSSIBLE LOAN LOSSES
The subsidiaries establish a provision for loan losses which management believes
is sufficient to maintain adequate reserve levels. The provision is a result of
credit analysis, historical trends in net charges to the allowance, loan
portfolio configuration and loan growth. Management closely monitors loan
quality to minimize loan losses. The Company's loan review program closely
monitors credit conditions of specific loans, historical trends in charge-offs
at the subsidiaries as well as companies within their peer group, experience and
quality of lending staff, and general economic conditions in the communities
that the subsidiaries serve. This system allows management to assess the
adequacy of the allowance for loan losses. The allowance for loan losses as a
percentage of total outstanding loans decreased slightly to 1.47% at September
30, 1998 as compared to 1.48% at December 31, 1997. The provision for loan
losses recorded during the first nine months of 1998 was $421,000 as compared to
$735,000 during the same period in 1997. The balance in the allowance for loan
loss account is derived from the quarterly assessment of adequacy performed in
the ordinary course of business by management. The allowance for loan loss
balance reflects the underlying credit risk in the loan and lease portfolio. As
such, fluctuations are expected in the allowance balance, however, as noted, the
fluctuations have not been material. The Company's allowance for loan losses are
deemed to be sufficient based on the evaluation of the above factors.
Management continues to closely monitor and control asset quality.
Non-performing assets, defined as loans 90 days or more past due and still
accruing, loans in non-accrual status, restructured loans, and other real estate
owned, represented .70% of total assets as of September 30, 1998, which has
decreased from .89% at December 31, 1997. The following table summarizes the
components of non-performing assets at September 30, 1998 and at December 31,
1997:
<TABLE>
<CAPTION>
SEPT. 30, 1998 DECEMBER 31, 1997
-------------- -----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Non-accrual loans $2,497 $3,968
Loans past due 90+ days & still accruing 708 500
Restructured loans, performing according
to terms of restructure agreement 214 139
Other real estate owned 165 0
--- -
TOTAL NON-PERFORMING ASSETS $3,584 $4,607
------ ------
------ ------
</TABLE>
The decrease in non-accrual loans was primarily due to paydowns of non-accrual
loans, especially at Castle Bank Harvard, N.A. (CBH). The majority of loans 90
days or more past due and still accruing at September 30, 1998 relate to
residential real estate loans at CasBanc Mortgage, Inc. and consumer loans at
Castle Finance Company (CFC). Foreclosure proceedings have started on all the
properties
12
<PAGE>
representing the real estate loans. Based on the collateral value of the
loans, complete recovery of the principal, interest, and collection costs are
anticipated and, as a result, in accordance with Company policy, interest
income is still being accrued. In accordance with the policy at CFC, loans
remain on accrual-status until time of charge-off. Other real estate owned
consists of one parcel of commercial property.
Year-to-date net charge-offs at September 30, 1998 totaled $402,000 as compared
to $127,000 at September 30, 1997. The increase in net charge-offs was due to a
charge-off at CBH in 1998 and a recovery at The Sandwich State Bank in 1997. In
the first quarter, a $200,000 reallocation of the allowance account was made
from the commercial and agricultural portfolio to the consumer portfolio. This
reallocation was done based on a historical analysis of the charge-off history
for both portfolios. Management continues to closely monitor all past dues and
to improve collection efforts.
OTHER OPERATING INCOME
Other income, excluding security gains and losses, totaled $10,758,000 for
the first nine months of 1998 as compared to $6,539,000 for the same period
in 1997. As mentioned above, $3,783,000 of the $4,219,000 increase over the
prior year period relates to fee income earned by CasBanc Mortgage, Inc. and
the other subsidiaries on the origination of mortgages sold in the secondary
market. If interest rates for fifteen and thirty year mortgages increase,
mortgage origination activities and earnings may be adversely impacted.
$71,000 in net securities gains were recognized in the first nine months of 1998
as compared to net gains of $209,000 during the first nine months of 1997. For
1998 and 1997, all recognized gains and losses related to the sale or call of
securities classified as available for sale.
OTHER OPERATING EXPENSES
Other operating expenses increased approximately $2,306,000 year to date at
September 30, 1998 over the corresponding nine month period in 1997. Increases
in employee salaries and benefit expense accounted for $1,715,000 of the
increase. The majority of the salary increase was due to higher mortgage loan
origination production during the first nine months of 1998, which caused higher
commission expense to be paid to commissioned employees. Salary and employee
benefits expense also increased due to normal salary increases granted during
the year.
FINANCIAL CONDITION
From December 31, 1997 to September 30, 1998, total assets decreased $5,905,000.
At September 30, 1998 the portfolio of mortgage loans held for sale was down
$20,098,000 from December 31, 1997. This reduction was off-set by an increase in
the investment portfolio of $9,020,000 and an increase in net loans of
$4,163,000 for the same period. An increase in total deposits of $16,398,000
from December 31, 1997 to September 30, 1998, has helped reduce reliance on
short term borrowings.
13
<PAGE>
CAPITAL
The Company is committed to maintaining strong capital positions in each of its
subsidiaries and on a consolidated basis. Management monitors, analyzes and
forecasts capital positions for each entity to ensure that adequate capital is
available to support growth and maintain financial soundness. The Company's Tier
1 leverage ratio as of September 30, 1998 was 7.18%, an increase from 6.38% at
December 31, 1997. The ratio exceeds the regulatory well capitalized levels. The
Company's September 30, 1998 total risk weighted capital ratio also increased to
11.73% from 10.67% at December 31, 1997. The Tier 1 capital ratio at September
30, 1998 increased to 10.48% from 9.42% at December 31, 1997. Both the total
risk weighted and Tier 1 Capital ratios also continue to exceed regulatory well
capitalized levels.
LIQUIDITY
The Company ensures the subsidiary banks maintain appropriate liquidity and
provides access to secondary sources of liquidity in case of unusual or
unanticipated demand for funds. Primary bank sources of liquidity are repayments
of loans, high-quality marketable investment securities available for sale, and
the bank's federal funds position which, together, are more than sufficient to
satisfy liquidity needs arising in the normal course of business. The Company is
a secondary source of liquidity for its subsidiary banks through its
discretionary access to short-term funding in case of unanticipated demand for
funds.
As presented in the Consolidated Statement of Cash Flows, the Company has
experienced significant changes in the cash flows from operating, investing and
financing activities during the first nine months of 1998 as compared to the
same period in 1997. These fluctuations primarily relate to the changes in the
loan, investment, and mortgage loans held for sale portfolios, as explained
above.
INTEREST RATE SENSITIVITY
The Company's overall success is dependent upon its ability to manage interest
rate risk. Interest rate risk can be defined as the exposure of the Company's
net interest income to adverse movements in interest rates. Because the Company
has no trading portfolio, the Company is not exposed to significant market risk
from trading activities. Other types of market risk, such as foreign currency
exchange and commodity price risk, do not arise in the normal course of the
Company's business activities. The Company does not currently use derivatives to
manage market and interest rate risks. A derivative financial instrument
includes futures, forwards, interest rate swaps, option contracts, and other
financial instruments with similar characteristics.
The Company is 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 include commitments to extend credit and standby letters
of credit. These instruments involve to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the consolidated
balance sheets. Commitments to extend credit are arrangements to lend to a
customer as long as there is no violation of any condition in the contract.
Commitments generally have fixed expiration dates and may require collateral
from the borrower if deemed necessary by the Company. Standby letters of credit
are conditional commitments issued by the Company to guarantee the performance
of a customer to a third party up to a stipulated amount and with specified
terms and conditions. Commitments to extend credit and standby letters of credit
are not recorded as an asset or liability by the Company until the instrument is
exercised.
14
<PAGE>
The subsidiary bank's interest rate exposure is reviewed on a regular basis by
the Asset/Liability Committee (ALCO) for each bank. The principal objective of
the Company's interest rate risk management function is to evaluate the interest
rate risk included in certain balance sheet accounts, determine the level of
risk appropriate given the Company's business strategy, operating environment,
capital and liquidity requirements and performance objectives, and manage the
risk consistent with the funds management policy of the Company. Through such
management, the Company seeks to monitor the vulnerability of its operations to
changes in interest rates. The extent of the movement of interest rates is an
uncertainty that could have a negative effect on the earnings of the Company.
YEAR 2000
Like other businesses dependent upon computerized information processing, the
Company must deal with "Year 2000" issues, which stem from using two digits to
reflect the year in many computer programs and data. Computer programmers and
other designers of equipment that use microprocessors have long abbreviated
dates by eliminating the first two digits of the year. As the year 2000
approaches, many systems may be unable to distinguish years beginning with 20
from years beginning with 19, and so may not accurately process certain
date-based information, which could cause a variety of operational problems for
businesses.
The Year 2000 project has been a top priority for the Company. Failure of a
mission critical system used by the Company could have a materially adverse
effect on the Company's operations and financial performance, as could Year 2000
problems experienced by others with whom the Company does business. Because of
the range of possible issues and the large number of variables involved, it is
impossible to quantify the potential cost of problems should the Company's Year
2000 efforts or the efforts of those with whom it does business not be
successful.
The Company began its Year 2000 efforts in May 1997. A dedicated Year 2000
Project Team was formed and the team meets on a monthly basis. Each major
operational area of the Company is represented on the team, including internal
audit. The status of the project is reported to the Board of Directors at each
meeting. Results of all exams performed by all external agencies are reported to
the Board at the next available meeting. Status reports are also presented to
the Internal Audit Committee by the Internal Auditor. The Company partnered with
a major consulting firm beginning in February 1998 to assist the Company in
testing core mission critical systems (i.e., the loan and deposit systems). The
Company performs no programming in house and controls no source codes. All
software used by the Company is purchased from third parties including core
applications. The core application software is provided by a highly recognized
bank software provider with well over 1,000 banks using their software country
wide.
The Company completed the assessment phase of the project by June 1997. The
Company completed the inventory phases of the project by September 1997. Testing
and remediation efforts have been underway on mission critical applications
since early 1998. Some mission critical applications have been discovered to be
non-compliant. These systems will be replaced with new compliant systems by
December 31, 1998. The Company's goal is to have all mission critical
applications tested by December 31, 1998. The Company is well on its way to
achieving that goal, but the Company is participating in proxy testing with one
vendor where the testing will not take place until the first quarter of 1999.
Also, the Company has purchased new compliant processing software for CasBanc
Mortgage, Inc. that is scheduled to be functional on December 1, 1998, but the
testing will not take place until the first quarter 1999. The Company performed
extensive core application testing in July 1998 which was overseen by a major
15
<PAGE>
consulting firm. The project team has had extensive contact with all mission
critical vendors and continues to monitor their progress as diligently as
possible. Although the Company is attempting to monitor and validate the
efforts of other parties, it cannot control the success of these efforts.
Contingency plans have been developed where practical to provide the Company
with alternatives in situations where an entity furnishing a critical product
or service experiences significant Year 2000 difficulties that will affect
the Company. With respect to non-mission critical applications, the Company's
target for completion of Year 2000 work is September 1999.
The Year 2000 project team has also been working on issues that are not directly
related to data processing systems. The team is reviewing various infrastructure
issues, such as checking elevators and heating, ventilation and air-conditioning
equipment, some of which include embedded systems, to verify that they will
function in the Year 2000. The team is also reviewing the status of power and
telecommunications providers. Possible problems in these areas are continuing to
be addressed by the Company.
As part of the Company's credit analysis process, it has developed a plan for
assessing the Year 2000 readiness of its major credit customers. Year 2000
issues have also been included in the loan review process and in the adequacy of
the reserve analysis. In addition, as part of the Company's fiduciary
responsibilities in the asset and trust management area, The Company has been
working very closely with the Company's third-party servicer to verify that
their product is Year 2000 compliant. The Company will be participating in proxy
testing of this servicer in the first quarter of 1999. The proxy testing is
being coordinated by a major public accounting firm. The Company has also sent
an FDIC prepared statement stuffer to all checking and savings account customers
which describes the Year 2000 problem in detail and provides guidance regarding
FDIC insurance.
The Company still estimates the cost of the Year 2000 project to be $350,000.
This includes costs which will be capitalized and costs which will be
immediately expensed. This estimate does not include the cost of internal staff
time; $150,000 of costs have been incurred to date, $100,000 of which will be
capitalized as a entirely new system was purchased to replace one non-compliant
mission critical system. It is expected that the remaining $200,000 will be
incurred by September 30, 1999. It is anticipated that there may be various
miscellaneous contingency plan expenditures made in the fourth quarter of 1999
which cannot be estimated at this time.
The discussion above incorporates the Company's best estimates of the costs and
completion date of the Year 2000 project. The Company derived these estimates
using numerous assumptions of future events, including the continued
availability of certain resources and other factors. There can be no guarantee
that the Company will achieve these estimates. Therefore, actual results could
differ materially from those plans. Specific factors that might cause such
material differences include, but are not limited to, the availability and cost
of personnel trained in this area, the ability to locate and correct all
relevant computer codes, and similar uncertainties.
ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting 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 general-purpose
financial statements. This statement requires that all items that are required
to be recognized under accounting standards as components of comprehensive
income, be reported in a financial statement that is displayed with the same
prominence as other financial statements. The statement is effective for fiscal
years
16
<PAGE>
beginning after December 15, 1997. Reclassification of financial statements
for earlier periods provided for comparative purposes is required. The
Company has adopted this statement in the first quarter of 1998.
In June, 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." The statement establishes standards for the
way that public business enterprises report information about operating segments
and certain other information in annual financial statements and requires that
those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. The statement is effective for
financial statements for periods beginning after December 15, 1997. The Company
will adopt this statement during 1998.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits". SFAS No. 132 amends the disclosure
requirements of SFAS No. 87, "Employers' Accounting for Pensions", SFAS No. 88,
"Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits", and SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions". This statement
standardizes the disclosure requirements of SFAS No. 87 and No. 106 to the
extent practicable and recommends a parallel format for presenting information
about pensions and other postretirement benefits. The statement does not change
any of the measurement or recognition provisions provided for in SFAS No. 87,
No. 88, or No. 106. The statement is effective for fiscal years beginning after
December 15, 1997. This statement will have no effect on the Company.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 standardizes the accounting for
derivative instruments, including certain derivative instruments embedded in
other contracts. Under the standard, entities are required to carry all
derivative instruments in the statement of financial position at fair value. The
accounting for changes in the fair value (i.e., gains or losses) of a derivative
instrument depends on whether it has been designated and qualifies as part of a
hedging relationship and, if so, on the reason for holding it. If certain
conditions are met, entities may elect to designate a derivative instrument as a
hedge of exposures to changes in fair values, cash flows, or foreign currencies.
If the hedged exposure is a fair value exposure, the gain or loss on the
derivative instrument is recognized in earnings in the period of change together
with the offsetting loss or gain on the hedged item attributable to the risk
being hedged. If the hedged exposure is a cash flow exposure, the effective
portion of the gain or loss on the derivative instrument is reported initially
as a component of other comprehensive income (outside earnings) and subsequently
reclassified into earnings when the forecasted transaction affects earnings. Any
amounts excluded from the assessment of hedge effectiveness as well as the
ineffective portion of the gain or loss is reported in earnings immediately.
Accounting for foreign currency hedges is similar to accounting for fair value
and cash flow hedges. If the derivative instrument is not designated as a hedge,
the gain or loss is recognized in earnings in the period of change. This
statement will have no effect on the Company.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the market risks faced by the Company
since December 31, 1997. For information regarding the Company's market risk,
refer to its Annual Report on Form 10-K for the year ended December 31, 1997.
17
<PAGE>
PART II
ITEM 1--LEGAL PROCEEDINGS
Neither the Company nor any subsidiary is a party to any material legal
proceedings at this time. However, the Company and its subsidiaries are from
time to time parties to routine litigation incidental to their businesses.
ITEM 2--CHANGES IN SECURITIES
Not applicable.
ITEM 3--DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4--SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5--OTHER INFORMATION
Not applicable.
ITEM 6--EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
--------
11 Computation of Per Share Earnings
27 Financial Data Schedule
(b) Reports on Form 8-K
-------------------
The Company filed a report on Form 8-K on July 1, 1998 with respect
to, among other things, its new relationship with ABN-AMRO, a
Chicago, Illinois based investment and brokerage firm being used to
provide a primary market in the Company's common stock.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
/s/ John W. Castle
- -------------------------------------------------
By: John W. Castle, Chairman of the Board
Chief Executive Officer and Director
Castle BancGroup, Inc.
Date: November 13, 1998
/s/ Micah R. Bartlett
- -------------------------------------------------
By: Micah R. Bartlett, Chief Accounting Officer
and Controller
Castle BancGroup, Inc.
Date: November 13, 1998
19
<PAGE>
EXHIBIT INDEX
EXHIBIT 11 Computation of Per Share Earnings
EXHIBIT 27 Financial Data Schedule
20
<PAGE>
EXHIBIT 11
CASTLE BANCGROUP, INC.
COMPUTATION OF PER SHARE EARNINGS
The components of basic and diluted EPS for the periods ended September 30, 1998
and 1997 were as follows: (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
1998 1997
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
Basic EPS:
Net Income 3,875 2,018
Less: preferred stock dividends: (18) (151)
--------- ----------
Income available to common stockholders 3,857 1,867
--------- ----------
Average common shares 2,161,314 2,077,795
--------- ----------
Basic EPS 1.78 .90
--------- ----------
Diluted EPS:
Income available to common stockholders 3,857 1,867
Assumed conversion of preferred stock (anti-dilutive in 1997) 18 N/A
--------- ----------
Income available to common stockholders after assumed conversion 3,875 1,867
--------- ----------
Average common shares 2,161,314 2,077,795
Assumed conversion of preferred stock (anti-dilutive in 1997) 11,392 N/A
Assumed exercise of stock options 17,492 17,118
--------- ----------
Average common shares after assumed conversions 2,190,198 2,094,913
--------- ----------
Diluted EPS 1.77 .89
--------- ----------
- -------------------------------------------------------------------------------------------------
</TABLE>
21
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 11,431
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 138,499
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 342,033
<ALLOWANCE> 4,665
<TOTAL-ASSETS> 509,645
<DEPOSITS> 440,081
<SHORT-TERM> 11,284
<LIABILITIES-OTHER> 5,670
<LONG-TERM> 10,775
0
300
<COMMON> 723
<OTHER-SE> 40,812
<TOTAL-LIABILITIES-AND-EQUITY> 509,645
<INTEREST-LOAN> 23,463
<INTEREST-INVEST> 6,631
<INTEREST-OTHER> 71
<INTEREST-TOTAL> 30,165
<INTEREST-DEPOSIT> 13,195
<INTEREST-EXPENSE> 14,734
<INTEREST-INCOME-NET> 15,431
<LOAN-LOSSES> 421
<SECURITIES-GAINS> 71
<EXPENSE-OTHER> 19,951
<INCOME-PRETAX> 5,888
<INCOME-PRE-EXTRAORDINARY> 5,888
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,875
<EPS-PRIMARY> 1.78
<EPS-DILUTED> 1.77
<YIELD-ACTUAL> 4.51
<LOANS-NON> 2,497
<LOANS-PAST> 708
<LOANS-TROUBLED> 214
<LOANS-PROBLEM> 289
<ALLOWANCE-OPEN> 4,646
<CHARGE-OFFS> 758
<RECOVERIES> 356
<ALLOWANCE-CLOSE> 4,665
<ALLOWANCE-DOMESTIC> 4,665
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 200
</TABLE>
