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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
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COMMISSION FILE NUMBER 0 - 19300
NORTHERN STATES FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 36-3449727
(State of incorporation) (I.R.S. Employer
Identification No.)
1601 North Lewis Avenue
Waukegan, Illinois 60085
(847) 244-6000
(Address, including zip code, and telephone number, including
area code, of principal executive office)
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Securities registered pursuant to Section 12(g) of the Act:
Name of each exchange on
Title of each class which registered
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Common Stock $2.00 par value NASDAQ Small-Cap Market
Cover Page 1 of 2
Page 1 of 88 Pages
Exhibit Index Appears on Page 29
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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. [ X ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K 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-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting shares held by nonaffiliates of
the Registrant is $57,513,897, as of March 18, 1997. Solely for the purpose of
this computation, it has been assumed that executive officers and directors of
the Registrant are "affiliates" and that the last price known to management was
a sale on March 18, 1997, of $93.00 per share.
889,273 shares of common stock were outstanding as of March 18, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Parts II and IV are incorporated by reference from the
Registrant's 1996 Annual Report to Stockholders; and a portion of Part III is
incorporated by reference from the Registrant's Proxy Statement dated March 21,
1997, for the Annual Meeting of Stockholders to be held April 24, 1997.
Except for those portions of the 1996 Annual Report incorporated by
reference, the Annual Report is not deemed filed as part of this Report.
Cover Page 2 of 2
INDEX
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PART I PAGE NO.
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Item 1 Business 4
Item 2 Properties 14
Item 3 Legal Proceedings 14
Item 4 Submission of Matters to a Vote
of Security Holders 14
PART II
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Item 5 Market for the Registrant's Common Stock
and Related Stockholder Matters 15
Item 6 Selected Financial Data 15
Item 7 Management's Discussion and Analysis
of Financial Condition and
Results of Operations 15
Item 8 Financial Statements and Supplementary Data 16
Item 9 Changes in and Disagreements with
Accountants on Accounting
and Financial Disclosure 16
PART III
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Item 10 Directors and Executive Officers of the
Registrant 17
Item 11 Executive Compensation 17
Item 12 Security Ownership of Certain Beneficial
Owners and Management 17
Item 13 Certain Relationships and Related
Transactions 17
PART IV
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Item 14 Exhibits, Financial Statement Schedules
and Reports on Form 8-K 18
Signatures 19
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PART I
Item 1. BUSINESS
THE COMPANY
OVERVIEW
Northern States Financial Corporation (the "Registrant" or the "Company")
is a bank holding company organized in 1984 under the laws of Delaware, for the
purpose of becoming the parent bank holding company of the Bank of Waukegan (the
"Bank"). In 1984, the Company acquired Northern States Trust Company (the
"Trust Company"). On January 1, 1992, the Trust Company's accounts and
operations were assumed by the Bank. By combining the operations of the Trust
Company and the Bank's Trust Department, the Company provides more efficient and
effective service to its trust customers. During 1994, the Trust Company
charter was surrendered and the Trust Company was liquidated. In 1991, the
Registrant acquired First Federal Bank, fsb ("First Federal" or the "Thrift").
The Registrant is registered under the Bank Holding Company Act of 1956, as
amended, and owns all the outstanding stock of the Bank and First Federal. At
December 31, 1996, the Company had approximately 452 registered shareholders of
record, 889,273 shares of Common Stock outstanding, and total consolidated
assets of approximately $427 million. Aside from the stock of the Bank, First
Federal and cash, the Registrant has no other substantial assets.
As a large, community-oriented, independent banking organization in the
Waukegan-Gurnee area in the State of Illinois, the Company is well positioned to
take advantage of the growth in Waukegan-Gurnee and its surrounding communities.
The Company has continuously served the community since 1919 when First Federal
was chartered; complemented by the Bank when it was chartered in 1962. The
Company's local management, coupled with its long record of service, has allowed
it to compete successfully in the banking market. The Company operates
traditional community and savings banks with conveniently located facilities and
a professional staff.
The Registrant, Bank and First Federal have no material patents,
trademarks, licenses or franchises except the corporate franchises which permit
them to engage in banking and trust practices pursuant to law.
The following table shows loans and deposits of the Bank and First Federal
as of December 31, 1996 (in thousands of dollars):
LOANS DEPOSITS
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Bank of Waukegan $164,794 $237,589
First Federal Bank, fsb 66,966 92,013
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The principal business of the Registrant, operating through the Bank and
First Federal, consists of attracting deposits and securities sold under
repurchase agreements from the general public, making commercial loans, loans
secured by residential and commercial real estate and consumer loans, and
operating a trust business.
SUBSIDIARY OPERATIONS
THE BANK OF WAUKEGAN
The Bank of Waukegan was chartered as a state bank in 1962 and is located
in Waukegan, Illinois. Waukegan is located approximately 37 miles north of
Chicago, Illinois and has a population of approximately 70,000. At December 31,
1996 the Bank of Waukegan had total assets of approximately $318.8 million,
deposits of approximately $237.6 million and stockholder's equity of
approximately $40.6 million. The Bank has two banking offices located in
Waukegan and one office located in Antioch, Illinois.
The Bank provides services to individuals, businesses and local
governmental units in northeastern Illinois and southeastern Wisconsin.
The Bank's full service banking business includes the customary consumer
and commercial products and services which banks provide, including the
following: demand, savings, time, securities sold under repurchase agreements,
individual retirement accounts; commercial, consumer and real estate lending,
including installment loans, student loans, lines of credit and overdraft
checking; safe deposit operations; trust services; and a variety of additional
services tailored to the needs of individual customers, such as the acquisition
of U.S. Treasury notes and bonds, the sale of traveler's checks, money orders,
cashier's checks and foreign currency, direct deposit, and other special
services.
Commercial and consumer loans are made to corporations, partnerships and
individuals, primarily on a secured basis. Commercial lending focuses on
business, capital, construction, inventory and real estate. The installment
loan department of the Bank makes direct and indirect loans to consumers and
commercial customers. The mortgage division originates and services commercial
and residential mortgages.
The Bank's trust department acts as executor, administrator, trustee,
conservator, guardian, custodian and agent.
At December 31, 1996, the Trust Department had assets under management or
custodial arrangements of approximately $176 million. Its office is located in
Waukegan, Illinois.
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FIRST FEDERAL BANK
First Federal, headquartered in Waukegan, Illinois was incorporated in
Illinois in 1919 as Waukegan Building and Loan Association, a state chartered
mutual savings and loan association. It converted to a federally chartered
mutual savings and loan association in 1934 and changed its name to First
Federal Savings & Loan Association of Waukegan.
In 1990, First Federal converted to a federal mutual savings bank and
changed its name to First Federal Bank, fsb. First Federal is a member of the
Federal Home Loan Bank System and its deposit accounts are insured by the
Federal Deposit Insurance Corporation ("FDIC").
First Federal had total assets of approximately $107.5 million, deposits of
approximately $92.0 million, and stockholder's equity of approximately $13.4
million at December 31, 1996. First Federal's market area is comprised of
sections of northeastern Illinois, including Waukegan and Gurnee, and is
situated in the center of the Chicago-Milwaukee corridor.
First Federal operates as a traditional savings institution. Its business
consists primarily of acquiring retail savings and checking deposits,
originating residential and nonresidential real estate mortgage loans for both
its portfolio and sale into the secondary market, and investing in government
and other debt securities. First Federal has two offices located in Waukegan,
Illinois and one office located in Gurnee, Illinois.
COMPANY OPERATING STRATEGY
Corporate policy, strategy and goals are established by the Board of
Directors of the Company. Pursuant to the Company's philosophy, operational and
administrative policies for the Bank and Thrift are also established by the
Company. Within this framework, both subsidiaries focus on providing
personalized services and quality products to customers to meet the needs of the
communities in which they operate.
As part of its community banking approach, the Company encourages the
officers of both institutions to actively participate in community
organizations. In addition, within credit and rate of return parameters, the
Company attempts to ensure that each institution meets the credit needs of the
community. In addition, the Bank (and the Thrift to a lesser extent) invests in
local municipal securities.
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LENDING ACTIVITIES
GENERAL - Both banks provide a range of commercial and retail lending
services to corporations, partnerships and individuals, including, but not
limited to, commercial business loans, commercial and residential real estate
construction and mortgage loans, consumer loans, revolving lines of credit and
letters of credit. The installment loan departments of each bank makes direct
and indirect loans to consumers and commercial customers. The mortgage
departments originate and service commercial and residential mortgages. The
majority of commercial mortgages are originated by the Bank, while the Thrift
originates most of the residential mortgages.
Each bank aggressively markets its services to qualified lending customers
in both the commercial and consumer sectors. The Bank's commercial lending
officers actively solicit the business of new companies entering the surrounding
market as well as longstanding members of the business community. Through
personalized professional service and competitive pricing, the Bank has been
successful in attracting new commercial lending customers. At the same time,
the Bank actively advertises its consumer loan products and continually attempts
to make its lending officers more accessible.
COMMERCIAL LOANS - The Bank seeks new commercial loans in its market area
and much of the increase in these loans in recent years can be attributed to the
successful solicitation of new business. The Bank's areas of emphasis include,
but are not limited to, loans to manufacturers, building contractors,
developers, business services companies and retailers. The Bank provides a wide
range of commercial business loans, including lines of credit for working
capital purposes and term loans for the acquisition of equipment and other
purposes. Collateral for these loans generally includes accounts receivable,
inventory, equipment and real estate. Loans may be made on an unsecured basis
where warranted by the overall financial condition of the borrower. Terms of
commercial business loans generally range from one to five years. The majority
of the Bank's commercial business loans have floating interest rates or reprice
within one year. The primary repayment risk for commercial loans is the failure
of the business due to economic or financial factors. In most cases, the Bank
has collateralized these loans and/or taken personal guarantees to help assure
repayment.
Both the Bank and the Thrift regularly provide financing to developers who
have demonstrated a favorable record of performance for the construction of
homes. Sales of these homes have remained very strong in Lake County due to the
growth in population.
MORTGAGE BANKING - The Thrift conducts a mortgage origination operation
through its mortgage division. Since 1991, the Thrift began funding all long-
term residential mortgage loans and selling them in the secondary market with
servicing retained. The Bank will also originate residential mortgages. As a
result of such actions, the Thrift has built its mortgage servicing portfolio to
approximately $64.9 million at December 31, 1996. Management believes that the
retention of mortgage servicing provides First Federal with a relatively steady
source of fee income as compared to fees generated solely from mortgage
origination operations, while maintaining the customer relationship.
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CONSUMER LENDING - The Company's consumer lending departments provide all
types of consumer loans including motor vehicle, home improvement, home equity,
student loans, unsecured loans and small personal credit lines.
TRUST DEPARTMENT - The Bank's trust department has been providing trust
services to the community for over 10 years. Currently, the Bank has over $176
million of trust assets and provides a full complement of trust services for
individuals and corporations including land trust services.
To build on the trust department's mainstay of personal trust
administration, the trust department's focus is in two major areas: (i)
investment management for individuals and (ii) administration and investment
services for employee benefit plans.
COMPETITION
The Registrant and its subsidiaries encounter significant competition in
all of their activities. The Chicago metropolitan area and suburban Lake County
have a high density of financial institutions, many of which are significantly
larger and have substantially greater financial resources than the Company and
its subsidiaries, and all of which are competitors of the Company and its
subsidiaries to varying degrees. The Registrant and its subsidiaries are
subject to competition from various financial institutions, including state and
national banks, state and federal savings associations, credit unions, certain
non-banking consumer lenders, and other companies or firms, including brokerage
houses and mortgage brokers, that provide similar services in northeastern
Illinois. In total, there are 22 financial institutions located in the Waukegan-
Gurnee area, including the Company's two subsidiaries. These financial
institutions consist of 9 banks, 6 savings associations and 7 credit unions.
The Company also competes with money funds and with insurance companies with
respect to its individual retirement accounts.
Competition may increase as a result of the continuing reduction in the
effective restrictions on the interstate operations of financial institutions.
The Registrant and its subsidiaries face additional competition for deposits
from short-term money market mutual funds and other corporate and government
securities funds. Since the elimination of federal interest rate controls on
deposits, the competition from other financial institutions for deposits has
increased.
The primary factors influencing competition for deposits are interest
rates, service, and convenience of office locations. The Company competes for
loans principally through the range and quality of the services it provides,
interest rate and loan fee terms. The Company believes that its long-standing
presence in the community and personal service philosophy enhances its ability
to compete favorably in attracting and retaining individual and business
customers. The Company actively solicits deposit-related clients and competes
for deposits by offering customers personal attention, professional service and
competitive interest rates.
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EMPLOYEES
The Registrant and its subsidiaries employed 119 full-time and 26
part-time employees as of December 31, 1996. None of the Registrant's employees
is represented by any collective bargaining group. The Company offers a variety
of employee benefits and management considers its employee relations to be good.
GOVERNMENTAL MONETARY POLICY AND ECONOMIC CONDITIONS
The earnings and growth of the Company are affected not only by general
economic conditions, but also by the fiscal and monetary policies of the federal
government and its agencies. In particular, the Federal Reserve Board regulates
monetary and credit conditions and interest rates in order to influence general
economic conditions, primarily through open-market operations in U.S. Government
securities, varying the discount rate on bank borrowings, and setting reserve
requirements against bank deposits.
These policies have a significant influence on overall growth and
distribution of the Company's loans, investments and deposits, and affect
interest rates charged on loans and earned on investments or paid for deposits.
The monetary policies of the Federal Reserve Board are expected to continue
their substantial influence on the operating results of banks.
The general effect, if any, of such policies upon the future business and
earnings of the Company and its subsidiaries cannot accurately be predicted.
SUPERVISION AND REGULATION
Financial institutions and their holding companies are extensively regulate
under federal and state laws. As a result, the business, financial condition
and prospects of the Company, the Bank and First Federal can be materially
affected not only by management decisions and general economic conditions, but
also by applicable statutes and regulations and other regulatory pronouncements
and policies promulgated by regulatory agencies with jurisdiction over the
Comapany, the Bank and First Federal, such as the Board of Governors of the
Federal Reserve System ("FRB"), the Office of Thrift Supervsion (the "OTS"), the
Federal Deposit Insurance Corporation ("FDIC") and the Office of the Illinois
Commissioner of Banks and Real Estate (the "Commissioner"). The effect of such
statutes, regulations and other pronouncements and policies are intended to
protect depositors and the FDIC's deposit insurance funds, not to protect
stockholders.
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The Company and its subidiarires are "affiliates" within the meaning of the
Federal Reserve Act so that the Bank and First Federal are subject to certain
restrictions with respect to loans to the Company and certain other transactions
with the Company or involving it securities.
The Company is a bank holding company subject to the Bank Holding Company
Act of 1956, as amended (the "Act"), and to regulation by the FRB. The Act
limits the activities which may be engaged in by bank holding companies and
their nonbank subsidiaries, with certain exceptions, to those so closely related
to banking or managing or controlling banks as to be a proper incident thereto.
Also, under the Act and the FRB's regulations, a bank holding company, as well
as certain of its subsidiaries, are prohibited from engaging in certain tie-in
arrangements in connection with any extension of credit or provision of any
property or services.
The Act also prohibits bank holding companies from acquiring substantially
all the assets of or owning more than 5% of the voting shares of any bank or
nonbanking company, which is not already majority owned, without the prior
approval of the FRB. Beginning September 29, 1995 the Reigle-Neal Interstate
Banking and Branching Efficiency Act of 1994 (the "Interstate Act") permits an
adequately capitalized and adequately managed bank holding company to acquire,
with FRB approval, a bank located in a state other than the bank holding
company's home state, without regard to whether the transaction is permitted
under any state law, except that a host state may establish by statute the
minimum age of its banks (up to a maximum of 5 years) subject to acquisition by
out-of-state bank holding companies. The FRB may not approve the acquisition if
the applicant bank holding company, upon consumation, would control more that
10% of total U.S. insured depository institution deposits or more than 30% of
the host state's total insured depository institution deposits. Effective as of
September 29, 1994, the Interstate Act permits a bank, with the approval of the
appropriate Federal bank regulatory agency, to establish a de novo branch in a
state, other than the bank's home state, in which the bank does not presently
maintain a branch if the host state has enacted a law that applies equally to
all banks and expressly permits all out-of-state banks to branch de novo into
the host state. Commencing June 1, 1997, banks having different home states
may, with approval of the appropriate Federal bank regulatory agency, merge
accross state lines, unless the home state of a participating bank has opted-
out. The Interstate Act permits, as of September 29, 1995, any bank subsidiary
of a bank holding company to receive deposits, renew time deposits, close loans,
service loans and receive payments on loans and other obligations as agent for a
bank or thrift affiliate, whether such affiliate is located in a different state
or in the same state. Illinois law allows the Bank to establish branches
anywhere in the state.
The Illinois Bank Holding Company Act (the "IBHCA") permits Illinois bank
holding companies to acquire control of banks in any state that permits bank
holding companies whose principal place of business is in another state to
acquire control of Illinois banks or bank holding companies upon satisfactory
application to the Commissioner. In reviewing any such application, the
Commissioner will review, amoung other things, compliance by the applicant banks
with the requirements of the Community Reinvestment Act (the "CRA") and other
information designed to determine such banks' abilities to meet community credit
needs.
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The Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") amended the Act to authorize the FRB to allow bank holding companies
to acquire any savings association (whether healthy, failed or failing) and
removed "tandem operations" restrictions, which previously prohibited savings
associations from being operated in tandem with a bank holding company's other
subsidiaries. As a result, bank holding companies now have expanded
opportunities to acquire savings associations.
Under FIRREA, and insured depository institution which is commonly
controlled with another insured depository institution shall generally be liable
for any loss incurred, or reasonably anticipated to be incurred, by the FDIC in
connection with the default of such commonly controlled institution, or for any
assistance provided by the FDIC to such commonly controlled institution, which
is in danger of default. The term "default" is defined to mean the appointment
of a conservator or receiver for such institution. Such liability is
subordinated in right of payment to deposit liabilities, secured obligations,
any other general or senior liability and any obligation subordinated to
depositors and or other general creditors, other than obligations owed to any
affiliate of the depository institution (with certain exceptions) and any
obligations to stockholders in such capacity.
The Company, as part of its acquisition of First Federal, became a savings
and loan holding company within the meaning of the Home Owners' Loan Act of
1933, as amended (the "HOLA"). As such, the Company was required to register
with the OTS and is subject to OTS regulations, examinations, supervsion and
reporting requirements. In addition, the OTS has enforcement authority over the
Company in significant aspects of its business. Among other things, this
authority permits the OTS to restrict or prohibit activities that are determined
to be a serious risk to the subsidiary savings institution. The HOLA prohibits
a savings and loan company, directly or indirectly, or through one or more
subsidiaries, or through one or more transactions, from (i) acquiring control
of, or acquiring by merger or purchase of assets, another savings institution or
holding company therof, withour prior written OTS approval; (ii) acquiring or
retaining, with certain exceptions, more than 5% of the voting shares of a
nonsubsidiary savings institution or holding company thereof; or (iii) acquiring
or retaining control of a financial institution not federally insured.
The Bank is a member of the Federal Reserve System, its deposits are
insured by the FDIC and it is subject to regulation by both these entities, as
well as by the Commissioner. First Federal is primarily regulated by the OTS.
Under the Illinois Banking Act (the "IBA"), the Bank is permitted to
declare and pay dividends in amounts up to the amount of its accumulated net
profits provided that it shall retain in its surplus at least one-tenth of its
net profits since the date of the declaration of its most recent previous
dividend until such additions to surplus, in the aggregate, equal at least the
paid-in capital of the Bank. In no event may the Bank, while it continues its
banking business, pay dividends in excess of its net profits then on hand (after
deductions for losses and bad debts).
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Under the FDIC's risk-based insurance assessment system, each insured
depository institution is placed in one of nine risk categories based on its
level of capital and other relevant information. Each insured depository
institution's insurance assessment rate is then determined by the risk category
in which it has been classified by the FDIC. At December 31, 1996 the Bank
exceeded applicable minimum capital requirements. During 1996, the Thrift was
assessed at the rate of .23%, the lowest factor, of deposits under the
assessment system.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FIDICIA") substantially revised the bank regulatory and funding provisions of
the Federal Deposit Insurance Act and made revisions to several other federal
banking statutes. In general, FDICIA subjects depository institutions to
significantly increased regulation and supervision. Among other things, FDICIA
requires federal bank regulatory authorities to take "prompt corrective action"
with respect to depository institutions that do not meet minimum capital
requirements, and imposes certain restrictions upon depository institutions
which meet minimum capital requirements but are not "well capitalized" for
purposes of FDICIA. FDICIA and the regulations adopted under it establish five
capital categories as follows, with the category for any institution determined
by the lowest of any of these ratios:
TIER 1 TOTAL
LEVERAGE RATIO RISKED-BASED RATIO RISKED-BASED RATIO
Well Capitalized 5% or above 6% or above 10% or above
Adequately
Capitalized 4% or above* 4% of above 8% or above
Undercapitalized Less than 4% Less than 4% Less than 8%
Significantly
Capitalized Less than 3% Less than 3% Less than 6%
RATIO OF
TANGIBLE EQUITY
TO TOTAL ASSETS
Critically Undercapitalized 2% or below
*3% for banks with the highest CAMEL (supervisory) rating.
An insured depository institution may be deemed to be in a capital category
that is lower than is indicated by its capital ratios if it receives an
unsatisfactory rating by its examiners with respect to its assets, management,
earnings or liquidity.
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Under FIDCIA, a bank that is not well capitalized is generally prohibited
from accepting or renewing brokered deposits and offering interest rates on
deposits significantly higher than the prevailing rate in its normal market area
or nationally (depending upon where the deposits are solicited); in addition,
"pass through" insurance coverage may not be available for certain employee
benefit accounts.
FIDICIA generally prohibits a depository institution from mking any capital
distribution (including payment of a dividend) or paying any management fee to
its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized depository institutions are subject to
limitations on growth and are required to submit a capital restoration plan,
which must be gauranteed by the institution's parent company. Institutions that
fail to submit an acceptable plan, or that are significantly undercapitalized,
are subject to a host of more drastic regulatory restrictions and measures.
The Bank and First Federal are considered "well capitalized" according to
FDICIA guidelines.
FIDICIA directs that each federal banking agency prescribe standards for
depository institutions or depository institutions' holding companies relating
to internal controls, information systems, internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth,
compensation, a maximum ratio of classified assets to capital, minimum earnings
sufficient to absorb losses and other standards as they deem appropriate. Many
regulations implementing these directives have been adopted by the agencies
BUSINESS-STATISTICAL DISCLOSURE
The information set forth under the caption "Management's Discussion and
Analysis of Financial Condition and the Results of Operations" on Pages 11
through 27 of the 1996 Annual Report to Stockholders (filed as Exhibit 13, pages
23 through 39 of this report) is incorporated herein by reference.
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ITEM 2. PROPERTIES
The Bank conducts its operations through its main office and two branches.
The Company's office is located in the main office of the Bank. All of such
offices are owned by the Bank and are located in Lake County, Illinois. The
Bank believes that its current facilities are adequate for the conduct of its
business.
First Federal conducts its business through its main office and two branch
offices. All offices are located in Lake County and have drive-up facilities.
With the addition of its newest branch office in Gurnee, which opened in
December 1990, First Federal believes that its facilities are adequate to meet
its present and immediately foreseeable needs.
The following table sets forth information relating to each of such
offices:
Bank of Waukegan:
Main Office: Trust Department:
1601 North Lewis Avenue 1601 North Lewis Avenue
Waukegan, Illinois 60085 Waukegan, Illinois 60085
Branches:
3233 Grand Avenue 40220 N. Route 59
Waukegan, Illinois 60085 Antioch, Illinois 60002
First Federal Bank, fsb:
Main Office:
216 Madison Street
Waukegan, Illinois 60085
Branches:
1428 N. Lewis Avenue 5384 Grand Avenue
Waukegan, Illinois 60085 Gurnee, Illinois 60031
ITEM 3. LEGAL PROCEEDINGS
Due to the nature of their business, the Registrant and its subsidiaries
are often subject to various legal actions. These legal actions, whether
pending or threatened, arise through the normal course of business and are not
considered unusual or material.
Currently, no material legal procedures are pending which involve the
Registrant, the Bank, or First Federal.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTER
The information set forth under the captions "Stock Market Information";
"Price Summary"; and "Cash Dividends" on Page 46 of the 1996 Annual Report to
Stockholders (filed as Exhibit 13, page 58 of this report) is incorporated
herein by reference.
ITEM 6. SELECTED FINANCIAL AND OTHER DATA
The information set forth under the caption "Selected Consolidated
Financial Data" on Page 10 of the 1996 Annual Report to Stockholders (filed as
Exhibit 13, page 22 of this report) is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The information set forth under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations" on Pages 11 through
27 of the 1996 Annual Report to Stockholders (filed as Exhibit 13, pages 23
through 39 of this report) is incorporated herein by reference.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Registrant and the Independent
Auditors' Report as set forth on the following pages of the 1996 Annual Report
to Stockholders (filed as Exhibit 13, to this report) are incorporated herein by
reference:
Annual Report
to Stockholders
Page
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Independent Auditors' Report 28
Consolidated Balance Sheets as of
December 31, 1996 and 1995 29
Consolidated Statements of Income for the
Years ended December 31, 1996, 1995 and 1994 30
Consolidated Statements of Cash Flows for the
Years ended December 31, 1996, 1995 and 1994 31
Consolidated Statements of Stockholders'
Equity for the Years ended
December 31, 1996, 1995 and 1994 32
Notes to the Consolidated Financial Statements 33
Parent Company only financial statements 45
The portions of the 1996 Annual Report to Stockholders which are not
specifically incorporated by reference as a part of this Form 10-K are not
deemed to be a part of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS - The information with respect to Directors of the Registrant set
forth under the caption "Directors and Executive Management" on pages 2 of the
Registrant's Proxy Statement, dated March 21, 1997, relating to the April 24,
1997 Annual Meeting of Stockholders is incorporated herein by reference.
EXECUTIVE OFFICERS - The Company's only executive officers are Mr. Fred Abdula,
the President of the Company, and Mr. Kenneth W. Balza, the Vice President and
Treasurer of the Company. The information with respect to Mr. Abdula and Mr.
Balza is set forth under the caption "Directors and Executive Management" on
page 2 of the Registrant's Proxy Statement, dated March 21, 1997, relating to
the April 24, 1997 Annual Meeting of Stockholders is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION.
The information set forth under the caption "Executive Compensation" and
"Summary Compensation Table" on page 5 of the Registrant's Proxy Statement,
dated March 21, 1997, relating to the April 24, 1997 Annual Meeting of
Stockholders is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT.
The information set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" on page 4 through 5 of the Registrant's Proxy
Statement, dated March 21, 1997, relating to the April 24, 1997 Annual Meeting
of Stockholders is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the caption "Compensation Committee Interlocks
and Insider Participation" on page 9 of the Registrant's Proxy Statement, dated
March 21, 1997, relating to the April 24, 1997 Annual Meeting of Stockholders is
incorporated herein by reference.
17
<PAGE>
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS
All financial statements of the Registrant are incorporated herein
by reference as set forth under Item 8, Part II of this report on
Form 10-K.
2. FINANCIAL STATEMENT SCHEDULES Not applicable
3. EXHIBITS (Numbered in accordance with Item 601 of Regulation S-K)
The following exhibits are filed as part of this
report:
3-A Articles of Incorporation of the Company,
as amended to date. (Filed with Registrant's annual
report on Form 10-K for the year ended December 31,
1994 Commission File 0-19300 and incorporated here by
reference.)
3-B Bylaws of the Company, as amended to date.
(Filed with Registrant's annual report on Form 10-K
for the year ended December 31, 1994 Commission
File 0-19300 and incorporated here by reference.)
10 1992 Northern States Omnibus Incentive Plan.
(Filed with Registrant's annual report on Form 10-K
for the year ended December 31, 1994 Commission
File 0-19300 and incorporated here by reference.)
11 Statement of Computation of per share earnings.
Contained in Note 1 to the consolidated financial
statements, page 34, 1996 Annual Report to
Stockholders (filed as Exhibit 13 to this report)
is incorporated by reference.
13 Copy of the Company's Annual Report to Stockholders
for the year ended December 31, 1996. This exhibit,
except for portions thereof that have been specifically
incorporated by reference into this report, is
furnished for the information of the Commission and
shall not be deemed "filed" as part hereof.
21 List of Subsidiaries.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the fourth
quarter of the year ended December 31, 1996.
(c) Exhibit List and Index
18
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned hereunto duly authorized, on this
18th day of March 1997.
NORTHERN STATES FINANCIAL CORPORATION
(Registrant)
Fred Abdula,
Chairman of the Board
and President
/S/ FRED ABDULA (Principal Executive Officer)
- ----------------------------
Thomas M. Nemeth,
Assistant Vice President
(Principal Financial Officer and
/S/ THOMAS M. NEMETH Principal Accounting Officer)
- ----------------------------
19
<PAGE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated. Each director of
the Registrant, whose signature appears below, hereby appoints Fred Abdula and
Thomas M. Nemeth and each of them severally, as his attorney-in-fact, to sign in
his name and on his behalf, as a director of the Registrant, and to file with
the Commission any and all Amendments to this Report on Form 10-K, on this 18th
day of March 1997.
Fred Abdula, Director /s/ Fred Abdula
-------------------------------
Kenneth W. Balza, Director /s/ Kenneth W. Balza
-------------------------------
Jack H. Blumberg, Director /s/ Jack H. Blumberg
-------------------------------
Frank Furlan, Director /s/ Frank Furlan
-------------------------------
Harry S. Gaples, Director /s/ Harry S. Gaples
-------------------------------
Laurance A. Guthrie, Director /s/ Laurance A. Guthrie
-------------------------------
James A. Hollensteiner, Director /s/ James A. Hollensteiner
-------------------------------
Raymond M. Mota, Director /s/ Raymond M. Mota
-------------------------------
Helen Rumsa, Director /s/ Helen Rumsa
-------------------------------
Frank Ryskiewicz, Director /s/ Frank Ryskiewicz
-------------------------------
Henry G. Tewes, Director /s/ Henry G. Tewes
-------------------------------
Arthur J. Wagner, Director /s/ Arthur J. Wagner
-------------------------------
20
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
EXHIBIT INDEX
Exhibits Page(s)
- -------- -------
3-A Articles of Incorporation of the Company,
as amended to date.
(Filed with Registrant's annual report on
Form 10-K for the year ended December 31, 1994
Commission File 0-19300 and incorporated here
by reference.)
3-B Bylaws of the Company, as amended to date.
(Filed with Registrant's annual report on
Form 10-K for the year ended December 31, 1994
Commission File 0-19300 and incorporated here
by reference.)
10 1992 Northern States Omnibus Incentive Plan.
(Filed with Registrant's annual report on
Form 10-K for the year ended December 31, 1994
Commission File 0-19300 and incorporated here
by reference.)
11 Statement of Computation of per share earnings.
Contained in Note 1 to the consolidated
financial statements, Page 34, 1996 Annual
Report to Stockholders (filed as Exhibit 13 to
this report) is incorporated by reference. 46
13 Copy of the Company's Annual Report to
Stockholders for the year ended December 31,
1996. This exhibit, except for portions
thereof that have been specifically incorporated
by reference into this Report, is furnished for
the information of the Commission and shall
not be deemed "filed" as part hereof. 22
21 List of Subsidiaries. 59
27 Financial Data Schedule
21
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
($000'S, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED DECEMBER 31, 1996 1995 1994 1993 1992
- ------------------------------------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Interest income $ 31,671 $ 30,893 $ 27,375 $ 26,836 $ 29,598
Interest expense 14,808 14,705 11,429 11,708 14,583
-------- -------- -------- -------- --------
Net interest income 16,863 16,188 15,946 15,128 15,015
Provision for loan losses 1,190 1,480 1,440 1,481 1,474
-------- -------- -------- -------- --------
Net interest income after
provision for loan losses 15,673 14,708 14,506 13,647 13,541
Noninterest income 3,239 2,702 2,764 3,540 3,431
Noninterest expenses 10,372 10,433 11,010 11,387 11,169
-------- -------- -------- -------- --------
Income before income taxes 8,540 6,977 6,260 5,800 5,803
Provision for income taxes 2,529 2,040 1,785 1,366 1,633
-------- -------- -------- -------- --------
NET INCOME $ 6,011 $ 4,937 $ 4,475 $ 4,434 $ 4,170
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
BALANCE SHEET DATA:
Cash and due from banks $ 15,247 $ 18,119 $ 16,539 $ 19,133 $ 15,717
Investments (2) 166,585 171,125 164,254 164,542 150,233
Loans, net 227,814 220,865 212,823 216,163 229,807
Direct lease financing 999 622 373 993 1,281
All other assets 15,919 17,160 17,646 15,298 15,440
-------- -------- -------- -------- --------
TOTAL ASSETS $426,564 $427,891 $411,635 $416,129 $412,478
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Deposits $328,795 $327,555 $329,363 $349,360 $352,623
Other borrowings 36,758 43,278 30,654 18,113 15,080
All other liabilities 6,176 6,053 5,918 4,858 4,491
Stockholders' equity 54,835 51,005 45,700 43,798 40,284
-------- -------- -------- -------- --------
Total liabilities and
stockholders' equity $426,564 $427,891 $411,635 $416,129 $412,478
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
PER SHARE DATA:
Net income $ 6.76 $ 5.57 $ 5.05 $ 5.01 $ 4.71
Cash dividends declared 2.00 1.65 1.45 1.30 1.15
Book value (at end of year) 61.66 57.47 51.57 49.43 45.47
SELECTED FINANCIAL AND OTHER RATIOS:
Return on average assets (1) 1.43% 1.21% 1.08% 1.09% 1.03%
Return on average equity (1) 11.47 10.15 9.89 10.35 10.68
Average stockholders' equity
to average assets (1) 12.47 11.93 10.96 10.53 9.63
Tax equivalent interest
rate spread 3.64 3.62 3.78 3.73 3.62
Tax equivalent net interest income
to average earning assets (1) 4.50 4.46 4.34 4.23 4.20
Non-performing loans and other
real estate owned to total assets 0.94 2.25 2.39 2.72 1.72
Dividend payout ratio (3) 29.60 29.63 28.72 25.98 24.44
</TABLE>
(1) Does not reflect impact of securities available-for-sale fair values on
average balances.
(2) Includes interest-bearing deposits in other financial institutions,
federal funds sold, securities available-for-sale and securities
held-to-maturity.
(3) Total cash dividends divided by net income.
Page 22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion and analysis of Northern States Financial
Corporation's (Company) financial position and results of operations. It
should be read in conjunction with the consolidated financial statements and
notes thereto appearing elsewhere in this report. The Company has two
wholly-owned subsidiaries (the Subsidiaries): The Bank of Waukegan (Bank), a
commercial banking company providing traditional banking services, including
trust services, to corporate, retail and civic entities in the market; and
First Federal Bank, fsb, (Thrift), a savings institution providing
traditional thrift services primarily to individuals and small businesses in
the local market area.
The Company and its subsidiaries are subject to regulation by numerous
agencies including the Federal Reserve Board, the Federal Deposit Insurance
Corporation, the Illinois Office of Banks and Real Estate and the Office of
Thrift Supervision. Among other things, these agencies limit the activities
in which the Company and its Subsidiaries may engage, the investments and
loans which the Bank and/or Thrift funds, and the reserves against deposits
which the Bank and Thrift must maintain.
The reader should recognize that the financial results vary
significantly between a commercial bank and a traditional savings and loan
entity. A savings and loan institution normally has a higher percentage of
fixed rate loans to total earning assets, a much lower volume of noninterest
bearing transaction accounts, and a relatively low allowance for loan losses
to total loans. Approximately 25% of the Company's assets are invested in the
Thrift.
The statements contained in this management's discussion and analysis
that are not historical facts are forward-looking statements subject to the
safe harbor created by the Private Securities Litigation Reform Act of 1995.
The Company cautions readers of this Annual Report that a number of important
factors could cause the Company's actual results in 1997 and beyond to differ
materially from those expressed in any such forward-looking statements.
TABLE 1 ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES
($000's)
<TABLE>
<CAPTION>
1996 1995 1994
--------------------------- --------------------------- ---------------------------
AVERAGE AVERAGE AVERAGE
FOR THE YEARS ENDED DECEMBER 31, BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
- -------------------------------- ------- -------- ---- ------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Loans (1) (2) (3) $233,167 $ 22,296 9.56% $223,806 $ 21,788 9.74% $214,922 $ 19,006 8.84%
Taxable securities (5) 124,271 7,663 6.12 122,401 7,313 5.95 127,328 6,428 5.02
Securities exempt
from federal
income taxes (2) (5) 22,058 1,799 8.36 20,838 1,751 8.43 21,769 1,893 8.70
Interest-bearing deposits
in financial institutions 504 28 5.56 1,572 117 7.44 9,520 381 4.00
Bankers' acceptances 0 0 0.00 0 0 0.00 564 21 3.72
Federal funds sold 13,844 742 5.36 12,541 740 5.90 9,590 383 3.99
-------- -------- ----- -------- ------- ----- -------- -------- -----
Interest-earning assets 393,844 32,528 8.25 381,158 31,709 8.31 383,693 28,112 7.31
Noninterest earning assets 25,818 26,018 28,469
-------- -------- ----- -------- ------- ----- -------- -------- -----
Average assets (4) $419,662 $407,176 $412,162
-------- -------- --------
-------- -------- --------
LIABILITIES AND
STOCKHOLDERS' EQUITY
NOW deposits $ 39,474 1,177 2.98 $ 39,361 1,149 2.92 $ 36,911 982 2.66
Money market deposits 44,272 1,792 4.05 39,980 1,866 4.67 52,029 1,442 2.77
Savings deposits 46,828 1,395 2.98 48,796 1,436 2.94 55,585 1,573 2.83
Time deposits 155,378 8,720 5.61 150,994 8,381 5.55 152,933 6,349 4.15
Other borrowings 35,006 1,724 4.92 34,633 1,873 5.41 26,086 1,083 4.15
-------- -------- ----- -------- ------- ----- -------- -------- -----
Interest-bearing
liabilities 320,958 14,808 4.61 313,764 14,705 4.69 323,544 11,429 3.53
-------- -------- ----- -------- ------- ----- -------- -------- -----
Demand deposits and
other noninterest bear-
ing liabilities 46,580 45,125 43,797
Stockholders' equity 52,124 48,287 44,821
-------- -------- ----- -------- ------- ----- -------- -------- -----
Average liabilities and
stockholders' equity $419,662 $407,176 $412,162
-------- -------- --------
-------- -------- --------
Net interest income $17,720 $17,004 $16,683
------- ------- -------
------- ------- -------
Net yield on interest
earning assets 4.50% 4.46% 4.34%
------ ------ ------
------ ------ ------
Interest-bearing liabilities
to earning assets ratio 81.40% 82.22% 84.19%
------ ------ ------
------ ------ ------
</TABLE>
(1) - Interest income on loans includes loan origination and other fees of
$443 for 1996, $540 for 1995 and $706 for 1994.
Average loans include direct lease financing.
(2) - Tax exempt income is reflected on a fully tax equivalent basis
utilizing a 34% rate for all years presented.
(3) - Nonaccrual loans are included in average loans.
(4) - Average balances are derived from the average daily balances.
(5) - Rate information was calculated based on the average amortized cost for
securities. The 1996, 1995 and 1994 average balance information includes
an average valuation allowance for taxable securities of $(985), $(521)
and $(623). The 1996 and 1995 average balance information includes an
average valuation allowance of $540 and $58 for tax-exempt securities.
Page 23
<PAGE>
NET INTEREST INCOME
Table 1 shows a comparison of net interest income and average volumes,
together with effective yields earned and rates paid on such funds. The
results shown reflect the excess of interest earned on assets over the
interest paid for funds.
Interest income is the primary source of revenue for the Company. It
comprised 90.7% of the Company's total revenues in 1996, 92.0% in 1995 and
90.8% in 1994.
Net interest income is the difference between interest income earned on
average interest-earning assets, such as loans and securities, and interest
expense on average interest-bearing liabilities, such as deposits and other
borrowings. In table 1, interest income on non-taxable securities and loans
has been adjusted to be fully taxable equivalent so as to be comparable with
rates earned and paid elsewhere. In addition, rates earned on securities are
calculated based upon the average amortized cost of the related securities.
Several factors affect net interest income of which one factor is
changes in interest rates which are usually indicated by the changes in the
prime lending rate. The prime rate decreased and stabilized in 1996, peaked
in 1995, and significantly increased in 1994. The weighted average prime
lending rate in 1996 was 8.27%, a decrease of 56 basis points from 8.83% in
1995, and was 7.15% in 1994. During 1996 the prime lending rate began the
year at 8.50% and dropped to 8.25% on February 1, 1996 where it remained for
the balance of the year. The decline in the prime lending rate in 1996 caused
corresponding decreases in rates earned on variable rate loans that were tied
to the prime rate and on fixed rate loans as they were renewed or new fixed
rate loans were made. Table 1 shows that rates earned on average loans in
1996 decreased to 9.56% in 1996 from 9.74% in 1995 after increasing in 1995
from 8.84% in 1994. The general decline in rates in 1996 is evidenced by the
decline in yields on total average interest-earning assets which declined 6
basis points in 1996 while rates on average interest-bearing liabilities
dropped 8 basis points in 1996 after increasing 116 basis points in 1995.
Another important factor affecting net interest income is the average
earning asset ratio, which is the percentage of average assets that earn
interest income to total average assets. For the Company this ratio exceeded
93% for all periods shown in table 1.
As indicated in table 1, the Company's net interest income rose in 1996,
with a higher growth rate than experienced in 1995 compared to 1994. Net
interest income increased $716,000 in 1996 or 4.21% as compared to 1995 net
interest income which had increased $321,000 or 1.92% over 1994. A
significant reason for the 1996 increase was that average interest-earning
assets increased $12.7 million in 1996 while average interest-bearing
liabilities only increased $7.2 million. This is further evidenced in Table
2 which shows that the 1996 increase in net interest income is primarily
attributable to changes due to volume.
Another factor that influenced net interest income in 1996 was a slight
increase in the interest rate spread. The interest rate spread is the
difference between the yield earned on assets less the rates paid on
liabilities. The interest rate spread was 3.64% in 1996 as compared to 3.62%
in 1995 and 3.78% in 1994.
The Company's average deposit and other borrowing rates were 4.61% in
1996, a slight drop from 4.69% in 1995 which had increased from 3.53% in
1994. The rates earned on average earning assets during 1996 decreased
slightly to 8.25% from 8.31% in 1995 which had risen from 7.31% in 1994. In
1996 the Company had more interest-bearing liabilities repricing than assets.
On a forward looking basis, the Company is "liability sensitive" out to at
least one year. This means that in a decreasing rate environment,
interest-bearing deposits and other liabilities will reprice downward faster
than our interest-earning assets. This is evidenced in 1996 that as rates
declined and stabilized, yields on interest-earning assets declined only 6
basis points while the rates on interest-bearing liabilities declined 8 basis
points.
Another factor influencing net interest income is the "interest-bearing
liabilities to earning assets ratio" as shown in table 1 which indicates how
many cents of each dollar of earning assets are funded by an interest-bearing
liability. As table 1 indicates, this relationship has declined to less than
82% in 1996 from 84% in 1994. The decline in this ratio has a positive impact
on interest income.
The mix of assets and liabilities also affects net interest income.
Average assets increased by 3.1% in 1996, as compared with a decrease of 1.2%
in 1995. Local economic conditions continued to improve in 1996 as evidenced
by the increase in average loans. Average loan volume increased 4.2% in 1996
after an increase of 4.1% in 1995. Average total securities increased 2.2%
in 1996 after declining 3.9% in 1995.
In 1996, total average interest-bearing deposits increased $6.8 million
from 1995 levels while average other borrowings, which consists primarily of
repurchase agreement products, increased only $373,000 from 1995. The
increase in average interest-bearing deposits occurred at the Bank where
average interest-bearing deposits increased $8.2 million. At the Thrift
average interest-bearing deposits declined $1.4 million in 1996 while the
decline in 1995 was $7.8 million. Thrifts traditionally have paid slightly
higher rates on deposits. In 1995, the Company adjusted the Thrift's deposit
rate structure to be in line with the Bank's and as a consequence some
deposits left the Thrift. In 1996, customers at both institutions continued
to increase their deposits in money market accounts which had higher yields
compared to savings deposits, which balances decreased.
Interest rates paid on deposits and charged for loans dur-
Page 24
<PAGE>
NET INTEREST INCOME (CONTINUED)
ing 1996 remained comparable with other local financial institutions during
the year. In spite of the many non-bank investment products available to our
customers today, as well as from other financial institutions, the Company is
pleased in its ability to maintain the level of interest-bearing liabilities.
As table 1 indicates, the average balances of other borrowings increased
only slightly in 1996 after increasing $8.5 million in 1995. Most of the
other borrowings are in the form of securities sold under repurchase
agreements (repurchase agreements) which the Company continues to offer as an
alternative to certificates of deposit. A repurchase agreement is not
subject to FDIC insurance and to reserve requirements, and therefore is less
costly to the Company. The repurchase agreement also gives the customer added
security for the borrowing in the form of a security pledged by the Company.
Management expects to continue to offer repurchase agreements as an
alternative to certificates of deposit in the future.
Many other factors beyond Management's control can have a significant
impact on changes in net interest income from one period to another.
Examples of such factors are: (1) credit demands by customers; (2) fiscal
and debt management policy of federal and state governments; (3) monetary
policy of the Federal Reserve Board; and (4) changes in regulations.
The components of the changes in net interest income are shown in table
2. Table 2 allocates changes in net interest income between amounts
attributable to changes in rate and changes in volume for the various
categories of interest-earning assets and interest-bearing liabilities.
TABLE 2 ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE
($ 000'S)
<TABLE>
<CAPTION>
1996 COMPARED TO 1995 1995 COMPARED TO 1994
-------------------------- --------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
-------------------------- --------------------------
CHANGE CHANGE CHANGE CHANGE
TOTAL DUE TO DUE TO TOTAL DUE TO DUE TO
FOR THE YEAR ENDED DECEMBER 31 CHANGE VOLUME RATE CHANGE VOLUME RATE
- ------------------------------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Loans $ 508 $ 902 $(394) $2,782 $ 809 $1,973
Taxable securities 350 140 210 885 (261) 1,146
Securities exempt from
federal income taxes 48 62 (14) (142) (84) (58)
Interest-bearing deposits
in financial institutions (89) (65) (24) (264) (453) 189
Bankers' acceptances 0 0 0 (21) (21) 0
Federal funds sold 2 73 (71) 357 140 217
------ ----- ----- ------ ----- ------
Total interest income 819 1,112 (293) 3,597 130 3,467
------ ----- ----- ------ ----- ------
INTEREST EXPENSE
NOW deposits 28 3 25 167 68 99
Money market deposits (74) 188 (262) 424 (392) 816
Savings deposits (41) (58) 17 (137) (198) 61
Time deposits 339 245 94 2,032 (81) 2,113
Other borrowings (149) 20 (169) 790 411 379
------ ----- ----- ------ ----- ------
Total interest expense 103 398 (295) 3,276 (192) 3,468
------ ----- ----- ------ ----- ------
NET INTEREST INCOME $ 716 $ 714 $ 2 $ 321 $ 322 $ (1)
------ ----- ----- ------ ----- ------
------ ----- ----- ------ ----- ------
</TABLE>
Rate/volume variances are allocated to the rate variance and the volume
variance on an absolute basis.
Tax-exempt income is reflected on a fully tax equivalent basis utilizing a
34% rate.
Page 25
<PAGE>
TABLE 3 SECURITIES
($ 000'S)
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995 1994
- ----------- ------------------- ------------------- -------------------
% OF TOTAL % OF TOTAL % OF TOTAL
SECURITIES AVAILABLE-FOR-SALE AMOUNT PORTFOLIO AMOUNT PORTFOLIO AMOUNT PORTFOLIO
- ----------------------------- ------ ---------- ------ ---------- ------ ----------
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury $ 16,114 10.76% $ 37,248 24.01% $40,448 56.06%
U.S. Government agencies
and corporations 89,604 59.84 71,581 46.13 17,233 23.88
States and political
subdivisions 25,482 17.02 22,065 14.22 0 0.00
Mortgage-backed securities 16,430 10.97 20,472 13.19 10,979 15.22
Equity securities and
mutual fund investment
in debt securities 2,120 1.41 3,804 2.45 3,493 4.84
-------- ------- -------- ------- ------- -------
Total $149,750 100.00% $155,170 100.00% $72,153 100.00%
-------- ------- -------- ------- ------- -------
-------- ------- -------- ------- ------- -------
</TABLE>
($ 000'S)
DECEMBER 31, 1994
- ------------ -------------------
% OF TOTAL
SECURITIES HELD-TO-MATURITY AMOUNT PORTFOLIO
- --------------------------- ------ ----------
U.S. Treasury $19,224 24.50%
U.S. Government agencies
and corporations 23,352 29.75
States and political
subdivisions 23,838 30.37
Mortgage-backed securities 12,074 15.38
------- -------
Total $78,488 100.00%
------- -------
------- -------
As of December 31, 1996, the Company held no securities of any single issuer,
other than the U.S. Treasury and U.S. Government agencies and corporations,
including the Federal Home Loan Mortgage Corporation (FHLMC), the Federal
Home Loan Bank (FHLB), the Federal National Mortgage Association (FNMA), and
the Government National Mortgage Association (GNMA), that exceeded 10% of
consolidated stockholders' equity. Virtually all of the Company's securities
at December 31, 1996 are considered investment grade. Although the Company
holds securities issued by municipalities within the state of Illinois which
in the aggregate exceed 10% of consolidated stockholders' equity, none of the
holdings from individual municipal issuers exceed this threshold.
The Company also holds local municipal bonds which, although not rated, are
considered low risk investments.
The carrying value of interest-bearing balances with banks and federal funds
sold consisted of the following at December 31, 1996:
First USA Bank, Dallas $ 8,000
LaSalle National Bank, Chicago 7,500
Federal Home Loan Bank, Chicago 1,200
Bank of America, Illinois 100
Harris Bank, Chicago 35
-------
Total carrying value $16,835
-------
-------
Page 26
<PAGE>
SECURITIES
All securities of the Company at December 31, 1996 are classified as
available-for-sale. The Company classifies its securities as
available-for-sale to provide flexibility in the event that it may be
necessary to sell securities to raise cash for liquidity purposes, to adjust
the portfolio for interest rate risk purposes or to adjust for income tax
purposes. In previous years, until late in 1995, securities that were subject
to repricing or had an original maturity of two years or less were classified
as available-for-sale while all other securities were classified as
held-to-maturity.
Late in 1995, the Company, as permitted by the Statement of Financial
Accounting Standards ("SFAS") No. 115 implementation guide released in 1995,
exercised a one time opportunity to reassess the appropriateness of the
classification of all securities held. Based on this review, the Company
reclassified securities, having an amortized cost of $96,547,000 and a net
unrealized gain of $772,000 during 1995, from held-to-maturity to
available-for-sale. This reclassification transferred all held-to-maturity
securities to the available-for-sale classification and provided the Company
with an improved ability to manage its securities portfolio.
The securities portfolio decreased $5.4 million at year end 1996 from
1995, after an increase of $4.5 million at year-end 1995 from 1994. However,
average securities, as shown in table 1, increased in 1996 from 1995 by $3.1
million. The increase was the result of increased average interest-bearing
liabilities, of which the excess, after being used to increase our loans, was
invested in securities. Holdings of U.S. Treasury securities declined $21.1
million at December 31, 1996 compared to December 31, 1995. As U.S. Treasury
securities matured they were reinvested into U.S. Government agency issues
which increased by $18.0 million to $89.6 million at December 31, 1996, from
$71.6 million at December 31, 1995. The increase in U.S. Government agency
issues is the result of the Company investing in higher yielding agency
issues that have call provisions in order to maximize yields on the Company's
securities portfolio while helping to minimize state income taxes.
The Company attempts to keep at least half its portfolio in U.S.
Treasury and U.S. Government agency issues, which was the case for all
periods reported in table 3. This allows the Company to better manage its
exposure to changing interest rates, while minimizing credit risk within the
portfolio. U.S. Treasury and U.S. Government agency issues comprised over 70%
of the total portfolio at December 31, 1996.
Holdings of tax-exempt securities had an increase of $3.4 million to
$25.5 million at December 31, 1996. Reflecting the change applicable to
commercial banks in the federal tax law, a bank is not allowed an interest
deduction for the cost of deposits or borrowings used to fund most tax-exempt
issues acquired after August 7, 1986. However, the Company was able to
purchase "bank qualified" tax-exempt issues from local taxing bodies. The
Company will continue to buy securities issued by local tax-exempt entities,
in an effort to support the local community, consistent with the investment
standards contained in the investment policy. During 1996 a loan that was
made to a local taxing body was converted by the Bank into a "bank qualified"
tax-exempt security in the amount of $4.7 million.
In as much as the Thrift is required, by regulation, to have 65% of its
assets invested in mortgage related product, the Thrift invests in pools of
collateralized mortgage obligations and other mortgage-backed securities as
an alternative to keeping mortgage loans originated at long-term fixed-rates
in their portfolio. As a result, mortgage-backed securities balances at
December 31, 1996 were $16.4 million, a decrease of $4.0 million from the
previous year. The majority of the mortgage-backed securities portfolio is
at the Thrift and the decrease is consistent with the Thrift's decrease in
total assets during 1996.
First Federal sold its investment in a mutual fund during 1996 with
proceeds of $2,675,000 and a gain of $5,000. The Company's equity securities
at December 31, 1996 consist of Student Loan Marketing Association (SLMA) and
Federal Home Loan Bank (FHLB) stock.
Efforts by the Company to maintain appropriate liquidity includes
periodic adjustments to the securities portfolio as management considers
necessary, typically accomplished through the maturity schedule of securities
purchased.
The maturity distribution and average yields, on a fully tax equivalent
basis, of the securities portfolio at December 31, 1996 is shown in table 4.
Page 27
<PAGE>
TABLE 4 SECURITIES MATURITY SCHEDULE & YIELDS
<TABLE>
<CAPTION>
GREATER THAN 1 YR. GREATER THAN 5 YRS.
SECURITIES AVAILABLE-FOR-SALE LESS THAN OR AND LESS THAN OR AND LESS THAN OR GREATER
($ 000'S) EQUAL TO 1 YR. EQUAL TO 5 YRS. EQUAL TO 10 YRS. THAN 10 YRS. TOTALS
- ----------------------------- --------------- ----------------- ------------------- -------------- ---------------
AS OF DECEMBER 31, 1996 BALANCE YIELD BALANCE YIELD BALANCE YIELD BALANCE YIELD BALANCE YIELD
- ----------------------------- ------- ----- ------- ----- ------- ----- ------- ----- ------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury $11,033 5.62% $ 5,081 5.69% $ 0 0.00% $ 0 0.00% $ 16,114 5.64%
U.S. Government
agencies and
corporations 6,490 5.00 78,095 6.38 5,019 7.09 0 0.00 89,604 6.32
States and political
subdivisions (1) 2,285 7.95 14,730 8.02 8,467 8.74 0 0.00 25,482 8.25
Mortgage-backed
securities (2) 8,463 6.22 5,031 7.05 859 6.36 2,077 7.12 16,430 6.60
Equity and other
securities 2,120 6.49 0 0.00 0 0.00 0 0.00 2,120 6.49
------- ----- -------- ----- -------- ---- ------ ----- -------- -----
Total $30,391 5.89% $102,937 6.61% $14,345 8.02% $2,077 7.12% $149,750 6.61%
------- ----- -------- ----- -------- ---- ------ ----- -------- -----
------- ----- -------- ----- -------- ---- ------ ----- -------- -----
</TABLE>
(1) - The yield is reflected on a fully tax equivalent basis utilizing a 34%
tax rate.
(2) - Mortgage-backed securities reflect the contractual maturity of the
related instrument.
TABLE 5 LOAN PORTFOLIO
$000'S)
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995 1994 1993 1992
- ------------ ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Commercial $ 50,762 $ 53,886 $ 50,495 $ 54,902 $ 56,393
Real estate-construction 26,905 23,720 21,815 19,719 18,369
Real estate-mortgage 146,552 137,941 132,830 135,224 144,408
Installment 9,203 10,903 13,069 11,761 15,793
-------- -------- -------- -------- --------
Total loans 233,422 226,450 218,209 221,606 234,963
Unearned income (240) (370) (592) (755) (1,261)
Deferred loan fees (529) (701) (829) (924) (1,086)
-------- -------- -------- -------- --------
Loans, net of unearned income
and deferred loan fees 232,653 225,379 216,788 219,927 232,616
Allowance for loan losses (4,839) (4,514) (3,965) (3,764) (2,809)
-------- -------- -------- -------- --------
Loans, net $227,814 $220,865 $212,823 $216,163 $229,807
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
The Company had one foreign loan outstanding in the amount of $188 at
December 31, 1996.
Page 28
<PAGE>
LOAN PORTFOLIO
Loans for the Company continued to grow in 1996 due to lower loan
interest rates and a strong local economy. As shown in table 5, gross loans
increased $6,972,000 or 3.1% at year end 1996, following an increase of
$8,241,000 or 3.8% in 1995. Table 1 shows that average loans in 1996 were
$233,167,000 an increase of $9,361,000 over the average loans in 1995.
The Company's commercial loans at year end declined $3.1 million after
growing $3.4 million in 1995. During 1996 one commercial loan to a local
taxing body was converted by the Bank into a "bank qualified" tax-exempt
security in the amount of $4.7 million which contributed to the decrease in
commercial loans. As projects funded by short-term commercial loans during
1996 were completed, the loans were transferred to the longer term mortgage
loan portfolio.
Increases in the Company's real estate construction lending portfolio
reflected the strong local economy in 1996. Construction lending at year end
1996 increased by 13.4% to $26,905,000.
The Company has developed an expertise in construction lending and has
developed a portfolio of construction and construction-related loans. This
portfolio has averaged approximately $22 million over the last five years.
The construction portfolio consists of loans to residential builders, housing
developers, and for commercial building projects. The Bank recognizes that
successful construction lending is dependent upon the successful completion
of construction contracts and good management of the construction company.
Construction loans are generally made on properties which have been sold on
contract. Loans are secured by first lien positions on the real estate and
have loan to value ratios between 50% - 80% of appraised value. These loans
are usually processed through a title company construction escrow. Terms
generally range from six months to three years. The Bank attempts to
minimize the risk of construction lending by granting credit to established
customers and restricting these loans to our market area.
The Company increased its mortgage loan portfolio in 1996 as shown in
table 5 by $8,611,000. A large percentage of the mortgages booked were
commercial related mortgages that had initially been short-term commercial
loans or construction loans in which the related projects were completed and
transferred to mortgage loans. These commercial mortgages were primarily
made at fixed rates with call features after five years.
The home equity loan program, classified as real estate-mortgage in
table 5, is a product that allows consumers to use the equity in their homes
to finance purchases and to receive an interest deduction on their tax
return. This product is new since the 1986 Reform Act phased out interest
deductions on consumer loans. The interest deduction has made this product
an attractive alternative to traditional consumer financing and is a product
that the Company expects to grow in the future. The home equity portfolio
continued to grow during 1996 with balances of approximately $13.0 million at
December 31, 1996, an increase of 11.3% over last year.
At First Federal, mortgage loans originated for sale increased to $9.2
million in 1996 from $8.3 million in 1995. First Federal's loans originated
for sale are normally sold through the Federal Home Loan Mortgage Corporation
(FHLMC) gold or Federal National Mortgage Association (FNMA) live pricing
programs.
Mortgage loans originated and held for sale in the secondary market are
carried at the lower of cost, net of loan fees collected, or estimated market
value in the aggregate. These loans are Company financed mortgage loans
awaiting sale to FHLMC or FNMA. The sale generally occurs approximately
three days after funding. Loans held for sale on December 31, 1996 and 1995
were $893,000 and $3,641,000, and are classified as real estate mortgage
loans.
The Company services the mortgages sold on the secondary market, which
generates additional fee income. The unpaid principal balances of these
loans at December 31, 1996 and 1995 were $65.3 million and $64.5 million.
Installment lending decreased by $1.7 million during 1996, a decline of
15.6%, as consumers were provided with lower cost loan incentives to purchase
consumer goods. Prior to 1995, half of the consumer loan portfolio was made
up of indirect automobile paper. At December 31, 1996 this percentage had
decreased to less than 15%. There are three primary factors for the decline
in indirect paper that have negatively impacted consumer loan volume. Dealer
incentives have driven the interest rate spread lower, the customer has lost
the interest deduction for taxes, and other institutions have securitized
these portfolios for sale in the bond market, thereby making loan rates
unattractive. It is expected that the consumer loan portfolio will decline
in 1997, but at a smaller rate.
The Company has a small direct lease financing portfolio, which
increased in 1996 to $999,000. While the Company does not presently solicit
leasing business, the Company does occasional make leases to provide
customers with financial alternatives.
_______________________________________________________________________________
MATURITY OF LOANS
Table 6 highlights the maturity distribution of the Company's loan
portfolio, excluding mortgage and installment loans.
The short-term sensitivity of the portfolio to interest rate changes is
reflected in the fact that approximately 53.1% of the loans are scheduled to
mature or are subject to rate change within one year. Of the remaining loans
maturing beyond one year, 73.2% of that total are loans subject to immediate
repricing.
Page 29
<PAGE>
TABLE 6 LOAN MATURITY SCHEDULE
<TABLE>
<CAPTION>
MATURING AFTER
($ 000'S) LESS THAN OR 1 YR.AND LESS THAN MATURING
AS OF DECEMBER 31, 1996 EQUAL TO 1 YR. OR EQUAL TO 5 YRS. AFTER 5 YRS. TOTAL
- ----------------------- -------------- ------------------- ------------ -----
<S> <C> <C> <C> <C>
Commercial $22,083 $23,710 $4,969 $50,762
Real estate-construction 19,180 5,140 2,585 26,905
------- ------- ------ -------
Total $41,263 $28,850 $7,554 $77,667
------- ------- ------ -------
------- ------- ------ -------
Percent of total 53.13% 37.15% 9.72% 100.00%
------- ------- ------ -------
------- ------- ------ -------
</TABLE>
Commercial and construction loans maturing after one year:
Fixed rate $ 9,746
Variable rate 26,658
-------
Total $36,404
-------
-------
Real estate-construction loans reflect the contractual maturity of the
related note. Due to anticipated rollovers of real estate-construction
notes, management estimates that the loans will actually mature between one
and five years based upon the related types of construction. Loans that
mature within one year are considered to be variable rate loans as they can
be repriced upon maturity.
_______________________________________________________________________________
NON-PERFORMING ASSETS
Non-performing assets consist of non-performing loans and other real
estate owned. Non-performing loans, which include impaired loans, are: (1)
loans accounted for on a non-interest accrual basis; (2) accruing loans
contractually past due ninety days or more as to interest or principal
payment; and (3) loans with terms that have been renegotiated to provide a
reduction or deferral of interest or principal because of a deterioration in
the financial condition of the borrower. Total non-performing loans at
December 31, 1996 were $1,166,000.
Impaired loans, as defined by Statement of Financial Accounting
Standards (SFAS) No. 114 and No. 118, are included in non-performing loans
and totaled $828,000 and $5,161,000 at December 31, 1996 and December 31,
1995. SFAS No. 114 and No. 118 became effective January 1, 1995 and
consider a loan to be impaired if full principal or interest payments are not
anticipated. Impaired loans are carried at the present value of expected
cash flows discounted at the loan's effective interest rate or at the fair
value of the collateral, if the loan is collateral dependent. At December
31, 1996 approximately 3.0% of the allowance for loan losses is specifically
allocated for impaired loans as compared to 21.6% at December 31, 1995.
Other real estate owned includes assets acquired through loan
foreclosure and repossession. The carrying value of other real estate owned
is reviewed by management at least quarterly to assure the reasonableness of
its carrying value, which is lower of cost (fair value at date of
foreclosure) or fair value less estimated selling costs.
Loans are placed in nonaccrual status when they are 90 days past due,
unless they are fully secured and in the process of collection.
As illustrated in table 7, non-performing assets decreased significantly
by $5,644,000 or 58.5% in 1996. This reduction follows a slight decrease of
$163,000, or 1.7% in 1995. The loans on nonaccrual status decreased to
$1,108,000 in 1996 from $5,692,000 in 1995. Loans 90 days or more past due
still accruing were reduced to $58,000 in 1996 as compared to $1,653,000 in
1995. These reductions can be primarily attributed to the Company charging
off $1,141,000 in loans and the foreclosure and transfer of $2,432,000 in
loans to other real estate owned during 1996. Collection efforts resulted
in additional payoffs or the bringing of payments up to date on nonaccrual
loans or 90 days or more past due still accruing loans, which further reduced
the non-performing loans at December 31, 1996.
During 1996, the Company resumed accruing interest on a loan that was
classified as nonaccrual as of December 31, 1995. This loan was delinquent
in prior years, which prompted classification as nonaccrual. However, all
payments were brought current and the loan was being paid in accordance with
the loan agreement during 1996. Therefore, the loan was returned to accrual
status in the third quarter of 1996 and the Company recorded $494,000 of
previously unrecognized interest income.
Despite the foreclosure and transfer of $2.4 million of loans to other
real estate owned during 1996, other real estate owned increased only
$535,000 at December 31, 1996. The Company was able to liquidate a major
portion of its other real estate, realizing sale proceeds of $2.2 million
with gains of $305,000 on the sale of other real estate owned in 1996.
Management continues to be conservative in placing loans on nonaccrual
status. This conservative approach eliminates any unearned interest income
which would inflate the Company's earnings. Management will continue its
emphasis on the collection of all non-performing loans, including the
collection of unpaid interest.
On December 31, 1996, one piece of property accounted for approximately
62.6% of the total of other real estate owned. The property was acquired by
the Bank through the receipt of a deed in lieu of foreclosure in 1987. The
parcel consists of approximately 525,000 square feet of land situated on Lake
Michigan in Waukegan.
During 1994, a purchase agreement for the property, along with some
neighboring parcels, was negotiated for an amount that satisfies the current
carrying value. The agreement provides for the sale of the property and
provides for a fee to be paid to the Bank for the agreement and any 6 month
extensions of the agreement. During 1996 all option and extension fees have
been received by the Bank at the appropriate time and the agreement remains
in force. Conditions necessary to finalize the purchase include approvals
from the City of Waukegan and favorable legislative action by the State of
Illinois Senate and House of Representatives. It is still uncertain as to
when the state legislature will consider approval of the required legislation.
Management continues to emphasize the early identification of loan
related problems. Management is not currently aware of any other significant
loan, group of loans, or segment of the loan portfolio not included in the
discussion above as to which there are serious doubts as to the ability of
the borrower(s) to comply with the present loan payment terms.
There were no other interest-bearing assets at December 31, 1996 that
would be required to be disclosed as non-performing if such assets were loans.
Page 30
<PAGE>
TABLE 7 NON-PERFORMING ASSETS
$000'S)
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995 1994 1993 1992
- ------------ ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
LOANS
Nonaccrual status $1,108 $5,692 $4,912 $ 7,873 $2,962
90 days or more past due,
still accruing 58 1,653 2,179 557 519
------ ------ ------ ------- ------
Total non-performing loans 1,166 7,345 7,091 8,430 3,481
Other real estate owned 2,846 2,311 2,728 2,891 3,607
------ ------ ------ ------- ------
Total non-performing assets $4,012 $9,656 $9,819 $11,321 $7,088
------ ------ ------ ------- ------
------ ------ ------ ------- ------
Non-performing loans as a percentage
of total loans, net of unearned
income and deferred loan fees .50% 3.24% 3.27% 3.83% 1.50%
Non-performing assets as a
percentage of total assets .94 2.25 2.39 2.72 1.72
Non-performing loans as a percentage
of the allowance for loan losses 24.10 161.74 178.84 223.96 123.92
</TABLE>
Loans are placed in nonaccrual status when they are 90 days past due, unless
they are fully secured and in the process of collection.
Impaired Loans - At December 31, 1996 and 1995 impaired loans totaled
$828 and $5,161 and are included in nonaccrual loans.
Potential Problem Loans - At December 31, 1996 there were no other loans
classified as problem loans that are not included above.
Other Problem Assets - At December 31, 1996, there were no other classified
assets, including direct lease financing, other than the loans and other real
estate owned shown above.
_______________________________________________________________________________
PROVISION FOR LOAN LOSSES
A provision is credited to an allowance for loan losses, which is
maintained at a level considered by management to be adequate to absorb
future loan losses. The adequacy of the loan loss allowance is analyzed at
least quarterly. Factors considered in assessing the adequacy of the
allowance include: changes in the type and volume of the loan portfolio;
review of the larger credits within each subsidiary; historical loss
experience; current economic trends and conditions; review of the present
value of expected cash flows and fair value of collateral on impaired loans;
loan growth; and other factors management deems appropriate.
As mentioned previously, SFAS No. 114 and SFAS No. 118 were adopted in
January, 1995. The standards require management to discount impaired loans
based on expected cash flows or collateral values. A portion of the
allowance for loan losses is then allocated to each impaired loan.
Throughout the year, management determines the level of provision
necessary to maintain an adequate allowance based upon current conditions and
outstanding loan volumes.
The level of non-performing loans at December 31, 1996 was significantly
lower than the Company's historical average between 1995 and 1992.
Therefore, management during 1996 lowered the loan loss provision to
$1,190,000 from $1,480,000 in 1995 which was increased from $1,440,000 in
1994. If the level of non-performing assets remains low in 1997 it is
expected that there will be further reductions to the loan loss provision.
In 1996, the loan loss provision of $1,190,000 exceeded actual net
charged-off loans by $325,000. As a result, the allowance for loan losses
increased to 2.08% of total loans outstanding at December 31, 1996 from 2.00%
of total loans outstanding at December 31, 1995.
First Federal has experienced few loan losses in its history; therefore,
like most savings institutions, it had little or no loan loss allowance prior
to 1990. Management recognizes the importance of having a general allowance
for loan losses at the Thrift and has built its allowance to $1,138,000 or
1.7% of total loans compared to 1.4% of total loans last year. The Bank's
allowance as a percentage of loans on December 31, 1996 was 2.2% of total
loans outstanding, compared to 2.3% on December 31, 1995.
Table 8 indicates the types of loans charged-off and recovered for the
five years ending in 1996 as well as each year's provision.
Because management is not certain as to the full collectibility of the
non-performing loans, potential loss exposure has been provided in the
Company's allocation of the allowance for loan losses. As illustrated in
table 9, the unallocated portion of the allowance, the portion of the
allowance that is not specifically reserved for any particular problem
credit, was 59.0% of the total allowance at December 31, 1996 as compared to
an average of 36.9% over the previous four years. The December 31, 1996
increase in the level of unallocated allowance was a result of management's
assessment of non-performing loans which required a lesser percentage of the
allowance to be allocated to those credits identified as impaired per SFAS
No. 114 and No. 118. The allocation of the allowance for installment loans
continued to decline from the previous years' levels due to the continued
decline in the installment portfolio. The allocation for real
estate-construction loans declined significantly by $543,000 due to the
reduction in non-performing real estate-construction loans during 1996 due to
collection efforts which included foreclosure and transferring of loans to
other real estate owned. The allocation for commercial loans for similar
reasons was reduced in 1996. The allocation of the allowance for mortgage
loans increased during 1996 by $165,000 as a result of the increases made in
the mortgage loan portfolio.
Based upon management's analysis, the allowance for loan losses at
December 31, 1996, is adequate to cover future possible loan losses.
Page 31
<PAGE>
TABLE 8 ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
($000'S)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1996 1995 1994 1993 1992
- ------------------------ ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Balance at the beginning of year $4,514 $3,965 $3,764 $2,809 $2,296
------ ------ ------ ------ ------
Charge-offs:
Commercial 288 145 687 488 946
Real estate-construction 523 334 22 8 0
Real estate-mortgage 145 473 496 0 13
Installment 185 57 110 147 245
------ ------ ------ ------ ------
Total charge-offs 1,141 1,009 1,315 643 1,204
------ ------ ------ ------ ------
Recoveries:
Commercial 183 18 9 14 125
Real estate-construction 50 0 0 0 0
Real estate-mortgage 0 0 0 0 0
Installment 43 60 67 103 118
------ ------ ------ ------ ------
Total recoveries 276 78 76 117 243
------ ------ ------ ------ ------
Net charge-offs 865 931 1,239 526 961
------ ------ ------ ------ ------
Additions charged to operations 1,190 1,480 1,440 1,481 1,474
------ ------ ------ ------ ------
Balance at end of year $4,839 $4,514 $3,965 $3,764 $2,809
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Allowance as a % of total
loans, net of unearned
income and deferred loan fees 2.08% 2.00% 1.83% 1.71% 1.21%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Net charge-offs
during the year to average loans
outstanding during the year .37% 0.42% 0.58% 0.23% 0.40%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
</TABLE>
In addition to management's assessment, loans are examined periodically by
federal and state banking authorities.
TABLE 9 ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
($000'S)
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995 1994
- ----------- --------------------- --------------------- -----------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH LOANS IN EACH
CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ------------- ------ ------------- ------ -------------
<S> <C> <C> <C> <C> <C> <C>
Commercial $ 947 21.75% $1,741 23.80% $1,468 23.14%
Real estate-construction 184 11.53 727 10.47 168 10.00
Real estate-mortgage 809 62.78 644 60.92 813 60.87
Installment 45 3.94 87 4.81 116 5.99
Unallocated 2,854 NA 1,315 NA 1,400 NA
------ ------- ------ ------- ------ -------
Total $4,839 100.00% $4,514 100.00% $3,965 100.00%
------ ------- ------ ------- ------ -------
------ ------- ------ ------- ------ -------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1993 1992
- ----------- --------------------- ---------------------
PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH
CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ------------- ------ -------------
<S> <C> <C> <C> <C>
Commercial $1,553 24.77% $ 865 24.00%
Real estate-construction 95 8.90 50 7.82
Real estate-mortgage 609 61.02 224 61.46
Installment 138 5.31 206 6.72
Unallocated 1,369 NA 1,464 NA
------ ------- ------ -------
Total $3,764 100.00% $2,809 100.00%
------ ------- ------ -------
------ ------- ------ -------
</TABLE>
Page 32
<PAGE>
NONINTEREST INCOME
Noninterest income increased by $537,000 or 19.9% during 1996 following
a decrease of $62,000 or 2.2% during 1995.
Service fees on deposits declined by $76,000 in 1996. The major portion
of this decline occurred at the Bank where overdraft fee income fell $66,000
from 1995 as average customer demand deposit balances increased in 1996 from
1995.
Trust income increased $62,000 or 13.4% from the same period in 1995 due
to increased fees and additional trust business.
During 1996 a sale of equity securities classified as available-for-sale
took place at the Thrift for liquidity purposes which realized proceeds of
$2,675,000 and a resulting gain of $5,000.
Effective January 1, 1996 the Company adopted SFAS No. 122,
"Accounting for Mortgage Servicing Rights." For mortgage sales during 1996 a
cost basis or value was added to the servicing rights which resulted in
additional net gains on the sale of loans of approximately $96,000. Total
net gains on sales of loans were $210,000 for 1996 an increase of $85,000
over 1995 which had declined $194,000 from 1994.
Other operating income rose $461,000 or 67.5% in 1996. The majority of
this increase is attributable to the Company booking, during 1996, gains on
sales of other real estate owned totaling $305,000. Other income also
increased $131,000 due to the one-time collection of back interest and fees
on a loan in excess of the amount charged off by the Bank.
Comparing 1995 to 1994, noninterest income declined slightly by $62,000
or 2.2%. Much of the decrease is attributable to declines in gains on loans
sold which decreased $194,000 in 1995 from 1994. This is the result of
higher loan interest rates in 1995 which created lower levels of home
mortgage refinancing. Loans originated for sale at First Federal decreased
in 1995 to $8.2 million from $15.4 million in 1994.
Service fees on deposits remained stable in 1995 increasing only $8,000
from 1994.
Trust fees declined due to decreased fiduciary activity levels in 1995
as compared to 1994. The decrease amounted to $91,000 or 16.5%.
Other operating income rose $147,000 in 1995 from 1994. Much of this
increase was attributable to gains on sales of other real estate owned
totaling $93,000.
_______________________________________________________________________________
NONINTEREST EXPENSES
In 1996, total noninterest expenses remained stable and declined
slightly by $61,000 to $10,372,000. Over the last three years total other
expenses averaged $10,605,000 as the Company emphasized its desire to control
operating expenses. As a percent of average assets, noninterest expense was
2.5% in 1996 compared to 2.6% in 1995 and 2.7% in 1994. Compared to its
bank holding company peers, the Company's ability to control overhead
expenses is one of its operating strengths.
Salaries and other employee expenses decreased $222,000 or 3.9% in 1996.
This decrease is primarily related to First Federal, which continued to
experience staff reductions during 1996 due to increased efficiencies. No
layoffs of staff occurred, but as employees left or retired their
responsibilities were closely examined by management and delegated to others
if possible. Benefit costs were approximately the same in 1996 as 1995 and
1994. Management will continue to monitor this expense closely in 1997 and
seek out ways to increase efficiencies. Management expects that the decline
in salaries and other employee expenses will not continue to the extent that
it has in 1996 and 1995 and expects an approximate increase of 4.0% during
1997 in this area.
Occupancy expenses declined slightly by $32,000 or 2.4% during 1996 as
compared to the same period in 1995. This is the result of a reduction of
depreciation expense of $41,000 which occurred at the Thrift as building and
equipment became fully depreciated.
Data processing expense increased $15,000 or 2.8% during 1996 as
compared to the same period in 1995. This is due to a small increase in our
data processing service bureau charges. It is expected that data processing
expenses will increase 4.5% in 1997 due to contractual yearly data processing
service bureau price increases and data processing disaster plan
implementation.
FDIC deposit insurance expense increased significantly in 1996 by
$334,000 or 69.2% as compared to 1995. This increase is a result of First
Federal booking a $603,000 one-time FDIC expense due to legislation requiring
recapitalization of the FDIC Savings Association Insurance Fund (SAIF) during
1996. The Bank had only nominal FDIC insurance premiums during 1996 as the
Bank Insurance Fund (BIF) was fully funded. With both FDIC SAIF and BIF
being funded it is expected that FDIC expense in 1997 will decline
significantly.
Other real estate owned expenses increased $51,000 or 29.7% during 1996
compared to last year due to the increase in transfers of loans to other real
estate owned which occurred in 1996. During 1996, loans totaling $2,432,000
were transferred to other real estate owned compared to $981,000 during 1995.
Balances held in other real estate owned increased $535,000 at December 31,
1996 as compared to December 31, 1995.
Other operating expenses for 1996 declined by $207,000 or 9.3% as
compared to last year. Much of this decrease is attributable to one-time
expenses during the early
Page 33
<PAGE>
NONINTEREST EXPENSES (CONTINUED)
part of 1995 related to the conversion to a new data processing service
bureau and the installation of new data processing equipment that went along
with the conversion. Printing and supplies declined $31,000 as last year
new forms had to be ordered for the new data processing system. Professional
fees declined $110,000 as consultants were used during the conversion to
assist and train Company personnel on the new system and equipment. Other
expenses related to the employment of new employees decreased $21,000 in 1996
and other expenses pertaining to goodwill decreased $24,000 as goodwill
associated with the purchase of a branch office were fully amortized in 1995.
Comparing 1995 to 1994, total noninterest expenses declined $577,000 or
5.2% to $10,433,000.
Salaries and other employee expenses decreased $233,000 or 3.9% in 1995.
This decrease from 1994 resulted from staff reductions at First Federal due
to increased efficiencies. No layoffs of staff occurred, but management
closely scrutinized job responsibilities as employees left or retired and
whenever possible the job tasks were delegated to others.
Occupancy expenses increased $116,000 during 1995 as compared to 1994.
This is the result of new equipment purchases made during the fourth quarter
of 1994 in which a full years depreciation was taken in 1995 and increased
maintenance costs which were incurred in 1995 as the warranty period ended.
Data processing expense declined $181,000 or 25.6% during 1995 compared
to the same period in 1994 due to lower data processing service bureau
charges brought about by utilizing a new data processing service bureau and
by putting all Subsidiaries on the same data processing system. The data
processing conversion took place in the fourth quarter in 1994 at both the
Bank and the Thrift.
FDIC deposit insurance expense declined significantly in 1995 by
$301,000 or 38.4% as compared to 1994. This decrease is a result of the
FDIC deposit Bank Insurance Fund (BIF) becoming fully funded during 1995 with
the FDIC issuing banks a one time refund of which the Bank received a refund
of $137,000. As a result of the funding of the BIF the 1995 Bank FDIC
insurance premiums were also significantly reduced.
Other real estate owned expenses decreased $36,000 or 17.31% during
1995 compared to 1994. This is the result of lower balances held in other
real estate owned which declined $417,000 at December 31, 1995 as compared to
December 31, 1994, a decrease of 15.3%.
Other operating expenses for 1995 increased slightly by $58,000 or 2.7%
as compared to the previous year. The Company experienced increases to
professional and consulting fees of $114,000 during 1995 related to the
changes to our operations during 1995 as a result of the data processing
conversion which occurred during the fourth quarter of 1994. Business
development expenses decreased $35,000 during 1995 as the Bank and Thrift
were able in certain situations experience economies of scale through
combined advertising.
_______________________________________________________________________________
FEDERAL AND STATE INCOME TAXES
For the years ended December 31, 1996 and 1995, the Company's provision
for federal and state taxes as a percentage of pretax earnings were 29.6% and
29.2%.
The actual tax rates differ from the statutory rates because the pretax
earnings include significant amounts of interest on United States Government
securities, which are nontaxable for state income tax purposes, qualified
interest on loans to local political subdivisions, which are nontaxable for
federal income tax purposes, and interest on qualified state and local
political subdivision securities, which are nontaxable for federal income tax
purposes.
Page 34
<PAGE>
TABLE 10 MATURITY OR REPRICING OF ASSETS AND LIABILITIES
<TABLE>
<CAPTION>
SUBJECT TO REPRICING WITHIN
-----------------------------------------------------------------------------
($000)s IMMEDIATE 91 DAYS 181 DAYS 1 - 3 3 - 5 5 - 10
DECEMBER 31, 1996 BALANCES TO 90 DAYS TO 180 DAYS TO 365 DAYS YEARS YEARS YEARS
- ----------------- -------- ---------- ----------- ----------- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Assets:
Interest-bearing deposits
in financial institutions $ 1,335 $ 1,235 $ 0 $ 0 $ 0 $ 0 $ 100
Federal funds sold 15,500 15,500 0 0 0 0 0
Securities:
U.S. Treasury 16,114 4,009 3,020 4,004 5,081 0 0
U.S. Government agencies
and corporations 89,604 9,073 0 0 18,628 56,884 5,019
States & political
subdivisions 25,482 185 284 1,816 5,676 9,054 8,467
Equity securities 2,120 1,622 498 0 0 0 0
Mortgage-backed securities (1) 16,430 5,519 78 3,012 6,185 1,636 0
Loans:
Commercial 50,762 39,009 274 1,098 2,988 6,804 589
Real estate - construction 26,905 25,479 1,054 122 0 0 250
Real estate - mortgage 146,552 57,559 6,580 5,155 27,480 29,957 19,821
Installment, net of unearned income 8,963 3,608 736 1,094 2,208 1,220 97
Direct lease financing 999 325 30 120 290 234 0
-------- -------- ------- ------- ------- --------- -------
TOTAL INTEREST-EARNING ASSETS $400,766 $163,123 $12,554 $16,421 $68,536 $105,789 $34,343
-------- -------- ------- ------- ------- --------- -------
-------- -------- ------- ------- ------- --------- -------
Liabilities:
Now accounts $ 38,159 $ 38,159 $ 0 $ 0 $ 0 $ 0 $ 0
Money market accounts 44,426 44,426 0 0 0 0 0
Savings 44,843 44,843 0 0 0 0 0
Time deposits, $100,000 and over 69,052 31,814 22,348 11,105 3,785 0 0
Time deposits, under $100,000 89,092 34,392 18,973 19,517 16,015 184 11
Other interest-bearing liabilities 36,758 25,918 4,515 3,225 3,100 0 0
-------- -------- ------- ------- ------- --------- -------
TOTAL INTEREST-BEARING LIABILITIES $322,330 $219,552 $ 45,836 $ 33,847 $22,900 $ 184 $ 11
-------- -------- ------- ------- ------- --------- -------
-------- -------- ------- ------- ------- --------- -------
EXCESS INTEREST-EARNING ASSETS (LIABILITIES) $(56,429) $ (33,282) $(17,426) $45,636 $105,605 $34,332
CUMULATIVE EXCESS INTEREST-EARNING
ASSETS (LIABILITIES) (56,429) (89,711) (107,137) (61,501) 44,104 78,436
CUMULATIVE INTEREST RATE SENSITIVITY RATIO (2) 0.74 0.66 0.64 0.81 1.14 1.24
</TABLE>
(1) Mortgage-backed securities reflect the time horizon when these financial
instruments are subject to rate change or repricing.
(2) Interest-earning assets divided by interest-bearing liabilities.
This table does not necessarily indicate the impact of general interest rate
movements on the Company's net interest income because the repricing of
certain assets and liabilities is discretionary and is subject to competitive
and other pressures. As a result, assets and liabilities indicated as
repricing within the same period may in fact reprice at different times and
at different rate levels.
Page 35
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
LIQUIDITY AND INTEREST RATE SENSITIVITY ANALYSIS
The primary functions of asset/liability management are to assure adequate
liquidity and maintain an appropriate balance between interest sensitive earning
assets and interest-bearing liabilities.
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 an institution's interest rate sensitivity "gap." An asset or
liability is said to be interest rate sensitive within a specific time period if
it will mature or reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within that
time period. A gap is considered positive when the amount of interest rate
sensitive assets exceeds the amount of interest rate sensitive liabilities.
A gap is considered negative when the amount of interest rate sensitive
liabilities exceeds the amount of interest rate sensitive assets. During a
period of rising interest rates, a negative gap would tend to adversely affect
net interest income while a positive gap would tend to result in an increase in
net interest income. During a period of falling interest rates, a negative gap
would tend to result in an increase in net interest income while a positive gap
would tend to adversely affect net interest income. The Company's gap position
is illustrated in table 10.
Liquidity management involves the ability to meet the cash flow
requirements of customers who may be either depositors wanting to withdraw funds
or borrowers knowing that sufficient funds will be available to meet their
credit needs.
In addition to federal funds sold and interest-bearing deposits in banks,
marketable securities, particularly those of shorter maturities, are a principal
source of asset liquidity. The Company classifies all of its securities as
available-for-sale which increases the Company's flexibility in that the Company
can sell any of its unpledged securities to meet liquidity requirements.
Securities available-for-sale amounted to $149,750,000 at December 31, 1996,
representing 100% of the securities portfolio. Securities at December 31, 1996
in the amount of $97,052,000 were pledged to secure public deposits and
repurchase agreements.
Rate sensitivity varies with different types of interest-earning assets and
interest-bearing liabilities. Federal funds sold on which the rate varies
daily and loans tied to the prime rate differ considerably from long-term
securities and fixed rate loans. Time deposits over $100,000 are more rate
sensitive than savings accounts. Management has portrayed savings accounts as
immediately repriceable, because of management's ability to change the savings
interest rate.
Table 11 illustrates the maturity schedule as of December 31, 1996 of the
time deposits $100,000 and over portfolio. As shown, 5.5% of the time deposits
$100,000 and over mature after a year. At December 31, 1995, 16.5% of time
deposits matured after a year showing a shift by large time deposit customers to
shorter term certificates of deposit. This shortening of maturity lengths on
time deposits of $100,000 and over has increased the Company's negative gap
position in 1996.
The Company historically has a high level of time deposits and other
borrowings over $100,000. As of December 31, 1996, time deposits and other
borrowings over $100,000 were 28.9% of total deposits and other borrowings, a
slight increase from the 28.5% total in 1995. This level of deposits and
borrowings is stable and has not fluctuated significantly year-to-year. Being
located in the county seat, the Company accepts time deposits over $100,000 from
various government agencies.
With 53.8% of the Company's loan portfolio floating with the prime rate or
repriceable within 90 days, the effect on interest income when rates rise or
fall is felt quickly while expense changes more slowly as certificates of
deposit mature.
As the gap table shows, the Company is liability sensitive through the
three year time horizon by $61.5 million. This is a change from last year,
where the Company was liability sensitive through the three year time horizon by
$40.5 million. Although management has attempted during the past year to
reduce its liability sensitive gap position, its efforts continue to be
restricted by competitive pressures in the area of commercial and commercial
real estate loans which have increased the level of fixed rate loans with
intermediate term balloon maturities at the Bank. The Bank has increased the
maturity time horizon on its securities by purchasing intermediate term U.S.
Government agency securities that have call provisions in order to maximize
yields on its securities portfolio. Management has continued its efforts to
reduced its liability sensitive position at First Federal by continuing to sell
a majority of fixed rate loans originated there. First Federal continues to
maintain fixed rate business and nonconforming owner-occupied residential real
estate and ARM loans in its portfolio. It is management's desire to reduce the
liability gap position during the upcoming year.
- --------------------------------------------------------------------------------
TABLE 11
TIME DEPOSITS, $100,000 AND OVER MATURITY SCHEDULE
<TABLE>
<CAPTION>
GREATER THAN GREATER THAN
($ 000's) LESS THAN OR 3 MOS. & LESS THAN 6 MOS. & LESS THAN GREATER THAN
AS OF DECEMBER 31, 1996 EQUAL TO 3 MOS. OR EQUAL TO 6 MOS. OR EQUAL TO 12 MOS. 12 MOS. TOTAL
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Time deposits, $100,000 and over:
Retail deposits $ 11,039 $ 6,212 $ 6,837 $ 2,518 $ 26,606
Corporate deposits 5,618 8,298 550 950 15,416
Public fund deposits 15,157 7,838 3,718 317 27,030
------------------------------------------------------------------------------------------
Total time deposits,
$100,000 and over $ 31,814 $ 22,348 $ 11,105 $ 3,785 $ 69,052
------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------
</TABLE>
The Company has no foreign banking offices or deposits.
Page 36
<PAGE>
- --------------------------------------------------------------------------------
SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER SHORT-TERM BORROWINGS
Securities sold under repurchase agreements (repurchase agreements) and
other short-term borrowings during 1996 have continued to be an alternative to
certificates of deposit as a source of funds. At December 31, 1996 the Company
had other borrowings balances of $36,758,000 which were entirely made up of
repurchase agreements. Most municipalities, other public entities and some
other organizations, require that their funds are insured or collateralized as a
matter of their policies. Commercial depositors also find the collateralization
of repurchase agreements attractive as an alternative to certificates of
deposits. Repurchase agreements provide a source of funds and do not increase
the Company's reserve requirements with the Federal Reserve Bank or create an
expense relating to FDIC insurance. Repurchase agreements consequently are less
costly to the Company. Management expects to continue to offer repurchase
agreements as an alternative to certificates of deposit in the future.
Table 12 shows that the average balances of repurchase agreements increased
$373,000 in 1996 after an increase of $8.5 million in 1995. Growth slowed in
repurchase agreements at the Bank. This decline in growth is because as the
Bank's FDIC insurance rate declined the rate differential between repurchase
agreements and certificates of deposit narrowed making repurchase agreements
less attractive in 1996 than in previous years.
Table 12 provides information as to balances and interest rates pertaining
to securities sold under repurchase agreements and other short-term borrowings.
- --------------------------------------------------------------------------------
TABLE 12
SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER SHORT-TERM BORROWINGS
<TABLE>
<CAPTION>
($ 000's)
AT OR FOR THE YEAR ENDED DECEMBER 31, 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at end of year $ 36,758 $ 43,278 $ 30,654
Weighted average interest rate at end of year 4.93% 5.28% 4.62%
Maximum amount outstanding $ 44,135 $ 78,116 $ 37,891
Average amount outstanding 35,006 34,633 26,086
Weighted average interest rate 4.92% 5.41% 4.15%
</TABLE>
- --------------------------------------------------------------------------------
CAPITAL RESOURCES
Capital provides the foundation for future growth. Regulatory agencies
have developed minimum guidelines by which the adequacy of a financial
institution's capital may be evaluated.
Northern States' capital ratios exceed these minimum guidelines, both in
terms of Tier I capital (stockholders' equity of the Company less intangible
assets), and in terms of Tier II capital (Tier I capital plus qualifying
long-term debt and the allowance for loan losses). The portion of the allowance
for loan losses qualifying as Tier II capital is limited to 1.25% of risk
weighted assets. The effect of the unrealized gains (losses) on securities
available-for-sale is excluded from the capital ratio calculations. The
Company has never had any long-term debt outstanding. Regulatory capital
guidelines require that the amount of capital increase with the amount of risk
inherent in a company's balance sheet and off-balance sheet exposure. Capital
requirements in order for the Company to be considered well capitalized are that
Tier I capital to average assets must be 5.00% and Tier I capital to risk
weighted assets must be 6.00%. The requirements are that Tier II capital must
be 10.00% of risk adjusted assets in order for the Company to be considered well
capitalized.
All of the Company's capital ratios exceed the level required under
regulatory guidelines as shown in table 13.
Page 37
<PAGE>
- --------------------------------------------------------------------------------
TABLE 13
CAPITAL STANDARDS
($ 000'S) AS OF DECEMBER 31, 1996
TIER I CAPITAL:
- ---------------
Common stock $ 1,779
Surplus 11,216
Retained earnings 41,849
Less - Intangible assets (140)
---------
TOTAL QUALIFYING TIER I CAPITAL 54,704
QUALIFYING FOR TIER II CAPITAL:
- -------------------------------
Allowance for loan losses 3,432
---------
TOTAL QUALIFYING TIER II CAPITAL $ 58,136
---------
---------
TOTAL ASSETS $ 426,597
---------
---------
RISK-BASED ASSETS TOTAL RISK-BASED
- ---------------------------------------------------------------------------
Zero percent risk $ 21,304 $ 0
------------------------
Twenty percent risk 158,339 31,668
Fifty percent risk 106,618 53,309
One hundred percent risk (1) 189,565 189,565
------------------------
TOTAL RISK-WEIGHTED ASSETS $ 475,826 $ 274,542
------------------------
------------------------
(1) Includes off-balance-sheet items
CAPITAL REQUIREMENTS $ %
- ---------------------------------------------------------------------------
(Tier I Capital to Average Assets)
REQUIRED $ 21,005 5.00%
ACTUAL 54,704 13.02
RISK-BASED CAPITAL:
Tier I:
REQUIRED $ 16,473 6.00%
ACTUAL 54,704 19.93
Tier II:
REQUIRED $ 27,454 10.00%
------------------------
ACTUAL 58,136 21.18
------------------------
------------------------
Page 38
<PAGE>
- --------------------------------------------------------------------------------
CASH FLOWS
Cash flows from operating activities were greater than accrual basis net
income by $6.2 million in 1996. In 1995, cash flows from operating income were
below net income by $.2 million. In 1994, cash flows from operating income
exceeded net income by $2.1 million. Cash flows from the change in loans held
for sale significantly increased by $2.8 million in 1996.
Management expects ongoing operating activities to continue to be a primary
source of cash flow for the Company.
Deposits increased $1.2 million or .38% in 1996. The Company has
experienced a stable deposit level over the past several years, which has helped
maintain an adequate level of cash for the Company's activities. While
competition for deposits is expected to remain keen and future deposit growth
cannot be predicted with any certainty, the Company plans to continue to
actively seek profitable new deposit business.
The increase in loans during 1996 provided greater interest income revenues
for the Company. These increases to loans were funded through cash flows from
operating activities, proceeds of maturities and sales of securities
available-for-sale, and increases to deposits.
To insure the ability to meet its funding needs, including any unexpected
strain on liquidity, the Company has $20 million in federal funds lines of
credit from two independent banks. In addition, the Company, through its
Subsidiaries, also has the ability to borrow funds, if necessary, directly from
the Federal Reserve Bank and the Federal Home Loan Bank.
The Company has no notes payable or similar debt on its balance sheet.
The lack of a debt service requirement allows the Company to use its funds for
other operating purposes.
Equity capital is in excess of regulatory requirements, as determined on
both risk-based and leverage ratio criteria. Cash dividends have been a
relatively modest percentage of net income for the past three years, ranging
from 29.6% in 1996 to 28.7% in 1994.
During 1996 the Bank made a $61,000 outlay for an updated new telephone
system and $49,000 to replace 2 ATMs that were over 10 years old. During 1994,
$700,000 was expended on new data processing equipment necessary as part of the
Company's conversion to a new data processing service bureau. There are no
planned significant capital outlays in 1997 which would be a significant burden
on the Company's cash flows.
- --------------------------------------------------------------------------------
RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities",
was issued by the Financial Accounting Standards Board in 1996. It revises the
accounting for transfers of financial assets, such as loans and securities, and
for distinguishing between sales and secured borrowings. It is effective for
some transactions in 1997 and others in 1998. The effect of on the financial
statements has not yet been determined.
Page 39
<PAGE>
- --------------------------------------------------------------------------------
STATEMENT OF MANAGEMENT RESPONSIBILITY
Northern States Financial Corporation's management is responsible for the
accompanying consolidated financial statements which have been prepared in
conformity with generally accepted accounting principles. They are based on
our best estimates and judgments. Financial information elsewhere in this
annual report is consistent with the data presented in these statements.
We acknowledge the integrity and objectivity of published financial data.
To this end, we maintain an accounting system and related internal controls
which we believe sufficient in all material respects to provide reasonable
assurance that financial records are reliable for preparing financial statements
and that assets are safeguarded from loss or unauthorized use.
Our independent auditing firm, Crowe, Chizek and Company LLP, provides an
objective review as to management's discharge of its responsibilities insofar as
they relate to the fairness of reported operating results and the financial
condition of the Company. This firm obtains and maintains an understanding of
our accounting and financial controls and employs such testing and verification
procedures as it deems necessary to arrive at an opinion on the fairness of the
consolidated financial statements.
The Board of Directors pursues its responsibilities for the accompanying
consolidated financial statements through its Audit Committee. The Committee
meets periodically with Northern States Financial Corporation's internal auditor
and/or independent auditors to review and approve the scope and timing of the
internal and external audits and the findings therefrom. The Committee
recommends to the Board of Directors the engagement of the independent auditors
and the auditors have direct access to the Audit Committee.
/s/ Fred Abdula /s/ Thomas M. Nemeth
FRED ABDULA THOMAS M. NEMETH
CHAIRMAN OF THE BOARD & CHIEF ASSISTANT VICE PRESIDENT
EXECUTIVE OFFICER
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Northern States Financial Corporation
Waukegan, Illinois
We have audited the accompanying consolidated balance sheets of NORTHERN
STATES FINANCIAL CORPORATION as of December 31, 1996 and 1995 and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of NORTHERN
STATES FINANCIAL CORPORATION as of December 31, 1996 and 1995, and the results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1996 in conformity with generally accepted accounting
principles.
/s/ Crowe, Chizek and Company LLP
CROWE, CHIZEK AND COMPANY LLP
OAK BROOK, ILLINOIS
FEBRUARY 13, 1997
Page 40
<PAGE>
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
($ 000's, EXCEPT PER SHARE DATA)
DECEMBER 31, 1996 1995
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and due from banks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 15,247 $ 18,119
Interest-bearing deposits in financial institutions - maturities less than 90 days . . . . 1,235 355
Federal funds sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,500 15,500
-------------------------
Total cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31,982 33,974
Interest-bearing deposits in financial institutions - maturities over 90 days. . . . . . . 100 100
Securities available-for-sale. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149,750 155,170
Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232,653 225,379
Less: Allowance for loan losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,839) (4,514)
-------------------------
Loans, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227,814 220,865
Direct lease financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 999 622
Office buildings and equipment, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,250 6,587
Other real estate owned, net of allowance for losses of $532 and $510. . . . . . . . . . . 2,846 2,311
Accrued interest receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,955 4,366
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,868 3,896
-------------------------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 426,564 $ 427,891
-------------------------
-------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits
Demand - noninterest-bearing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 43,223 $ 43,774
NOW accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,159 39,818
Money market accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,426 43,639
Savings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,843 47,259
Time, $100,000 and over. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69,052 62,309
Time, under $100,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89,092 90,756
-------------------------
Total deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 328,795 327,555
Securities sold under repurchase agreements and other short-term borrowings. . . . . . . . 36,758 43,278
Advances from borrowers for taxes and insurance. . . . . . . . . . . . . . . . . . . . . . 1,021 1,281
Accrued interest payable and other liabilities . . . . . . . . . . . . . . . . . . . . . . 5,155 4,772
-------------------------
Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 371,729 376,886
-------------------------
STOCKHOLDERS' EQUITY
Common stock - $2 par value: 1,750,000 shares authorized;
889,273 and 887,431 shares issued and outstanding
at December 31, 1996 and 1995. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,779 1,775
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,216 11,123
Retained earnings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41,849 37,617
Unrealized gain (loss) on securities available-for-sale, net . . . . . . . . . . . . . . (9) 490
-------------------------
Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54,835 51,005
-------------------------
Total liabilities and stockholders' equity . . . . . . . . . . . . . . . . . . . . . . $ 426,564 $ 427,891
-------------------------
-------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Page 41
<PAGE>
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
($ 000's, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31, 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INTEREST INCOME
Loans (including fee income) . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 22,050 $ 21,567 $ 18,913
Securities
Taxable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,663 7,313 6,428
Exempt from federal income tax . . . . . . . . . . . . . . . . . . . . . . . . . 1,188 1,156 1,249
Interest-bearing deposits in financial institutions. . . . . . . . . . . . . . . . 28 117 381
Bankers' acceptances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 21
Federal funds sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 742 740 383
----------------------------------------
Total interest income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31,671 30,893 27,375
----------------------------------------
INTEREST EXPENSE
Time deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,720 8,381 6,349
Other deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,364 4,451 3,997
Other borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,724 1,873 1,083
----------------------------------------
Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,808 14,705 11,429
----------------------------------------
NET INTEREST INCOME. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,863 16,188 15,946
Provision for loan losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,190 1,480 1,440
----------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES. . . . . . . . . . . . . . . . . 15,673 14,708 14,506
----------------------------------------
NONINTEREST INCOME
Service fees on deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,357 1,433 1,425
Trust income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 523 461 552
Net security gains (losses). . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 0 (68)
Net gains on sales of loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . 210 125 319
Other operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,144 683 536
----------------------------------------
Total noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,239 2,702 2,764
----------------------------------------
NONINTEREST EXPENSES
Salaries and employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . . 5,477 5,699 5,932
Occupancy and equipment expenses, net. . . . . . . . . . . . . . . . . . . . . . . 1,301 1,333 1,217
Data processing expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 542 527 708
FDIC deposit insurance expense . . . . . . . . . . . . . . . . . . . . . . . . . . 817 483 784
Other real estate owned expenses . . . . . . . . . . . . . . . . . . . . . . . . . 223 172 208
Other operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,012 2,219 2,161
----------------------------------------
Total noninterest expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,372 10,433 11,010
----------------------------------------
INCOME BEFORE INCOME TAXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,540 6,977 6,260
Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,529 2,040 1,785
----------------------------------------
NET INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,011 $ 4,937 $ 4,475
----------------------------------------
----------------------------------------
Earnings per common share. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6.76 $ 5.57 $ 5.05
Weighted average common shares outstanding . . . . . . . . . . . . . . . . . . . . . 888,913 887,081 886,131
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Page 42
<PAGE>
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
($ 000's)
YEARS ENDED DECEMBER 31, 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,011 $ 4,937 $ 4,475
Adjustments to reconcile net income to cash from operating activities:
Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 546 621 557
Provision for loan losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,190 1,480 1,440
Provision for losses on other real estate owned. . . . . . . . . . . . . . . . . 22 23 25
Amortization of unearned portion of restricted stock awards. . . . . . . . . . . 0 0 14
Deferred loan fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (172) (128) (95)
Net (gain) loss on sales of securities . . . . . . . . . . . . . . . . . . . . . (5) 0 68
Net change in loans held for sale. . . . . . . . . . . . . . . . . . . . . . . . 2,863 (1,029) 851
Net gains on sales of loans. . . . . . . . . . . . . . . . . . . . . . . . . . . (115) (125) (319)
Net gains on sales of other real estate owned. . . . . . . . . . . . . . . . . . (305) 0 0
Net change in interest receivable. . . . . . . . . . . . . . . . . . . . . . . . 411 (579) (756)
Net change in interest payable . . . . . . . . . . . . . . . . . . . . . . . . . 342 428 373
Net change in other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,138 (656) (582)
Net change in other liabilities. . . . . . . . . . . . . . . . . . . . . . . . . 290 (269) 565
----------------------------------------
Net cash from operating activities . . . . . . . . . . . . . . . . . . . . . . 12,216 4,703 6,616
----------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in interest-bearing deposits in financial institutions -
maturities over 90 days. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 4,100 13,895
Proceeds from sales of securities available-for-sale . . . . . . . . . . . . . . . 2,675 0 4,501
Proceeds from maturities of securities available-for-sale. . . . . . . . . . . . . 90,571 66,116 36,777
Proceeds from maturities of securities held-to-maturity. . . . . . . . . . . . . . 0 27,584 29,054
Purchases of securities available-for-sale . . . . . . . . . . . . . . . . . . . . (83,959) (49,799) (67,741)
Purchases of securities held-to-maturity . . . . . . . . . . . . . . . . . . . . . 0 (45,642) (27,177)
Change in loans made to customers. . . . . . . . . . . . . . . . . . . . . . . . . (17,847) (9,221) 537
Property and equipment expenditures. . . . . . . . . . . . . . . . . . . . . . . . (209) (97) (993)
Net change in direct lease financing . . . . . . . . . . . . . . . . . . . . . . . (377) (249) 620
Proceeds from sales of other real estate owned . . . . . . . . . . . . . . . . . . 2,180 1,375 1,064
----------------------------------------
Net cash from investing activities . . . . . . . . . . . . . . . . . . . . . . (6,966) (5,833) (9,463)
----------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in:
Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,240 (1,808) (19,997)
Securities sold under repurchase agreements and other short-term borrowings. . . (6,520) 12,624 12,541
Advances from borrowers for taxes and insurance. . . . . . . . . . . . . . . . . (260) (255) 126
Net proceeds from exercise of stock options. . . . . . . . . . . . . . . . . . . . 77 54 0
Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,779) (1,463) (1,285)
----------------------------------------
Net cash from financing activities . . . . . . . . . . . . . . . . . . . . . . (7,242) 9,152 (8,615)
----------------------------------------
Net change in cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . (1,992) 8,022 (11,462)
Cash and cash equivalents at beginning of year . . . . . . . . . . . . . . . . . . . 33,974 25,952 37,414
----------------------------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR . . . . . . . . . . . . . . . . . . . . . . $ 31,982 $ 33,974 $ 25,952
----------------------------------------
----------------------------------------
Supplemental disclosures
Cash paid during the year for
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 14,466 $ 14,277 $ 11,056
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,335 1,833 2,159
Noncash investing activities
Transfers from loans to other real estate owned. . . . . . . . . . . . . . . . . 2,432 981 926
Transfers made from securities held-to-maturity to securities
available-for-sale, at fair value. . . . . . . . . . . . . . . . . . . . . . . 0 97,319 0
Transfers made from tax-exempt loans to securities available-for-sale,
at fair value. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,700 0 0
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Page 43
<PAGE>
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
UNREALIZED GAIN
(LOSS) ON
ADDITIONAL SECURITIES UNEARNED TOTAL
($ 000's, EXCEPT PER SHARE DATA) COMMON PAID-IN RETAINED AVAILABLE, RESTRICTED STOCKHOLDERS'
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 STOCK CAPITAL EARNINGS FOR-SALE, NET STOCK AWARDS EQUITY
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1994 . . . . . . . . . . . $ 1,772 $ 11,050 $ 30,953 $ 37 $ (14) $ 43,798
Net income . . . . . . . . . . . . . . . . . . 4,475 4,475
Cash dividends ($1.45 per share) . . . . . . . (1,285) (1,285)
Tax benefit from the increase in the fair
value of restricted stock issued . . . . . . 4 4
Amortization of unearned portion of restricted
stock awards . . . . . . . . . . . . . . . . 14 14
Unrealized net loss on securities
available-for-sale . . . . . . . . . . . . . (1,306) (1,306)
-------------------------------------------------------------------------------
Balance, December 31, 1994 . . . . . . . . . . 1,772 11,054 34,143 (1,269) 0 45,700
Net income . . . . . . . . . . . . . . . . . . 4,937 4,937
Cash dividends ($1.65 per share) . . . . . . . (1,463) (1,463)
Exercise of stock options on 1,300 shares
of common stock. . . . . . . . . . . . . . . 3 51 54
Tax benefit from the increase in the fair
value of restricted stock issued . . . . . . 7 7
Tax benefit from the exercise of stock options 11 11
Transfer of securities from held-to-maturity
to available-for-sale. . . . . . . . . . . . 473 473
Unrealized net gain on securities
available-for-sale . . . . . . . . . . . . . 1,286 1,286
-------------------------------------------------------------------------------
Balance, December 31, 1995 . . . . . . . . . . 1,775 11,123 37,617 490 0 51,005
Net income . . . . . . . . . . . . . . . . . . 6,011 6,011
Cash dividends ($2.00 per share) . . . . . . . (1,779) (1,779)
Exercise of stock options on 1,842 shares
of common stock. . . . . . . . . . . . . . . 4 73 77
Tax benefit from the exercise of stock options 20 20
Unrealized net loss on securities
available-for-sale . . . . . . . . . . . . . (499) (499)
-------------------------------------------------------------------------------
Balance, December 31, 1996 . . . . . . . . . . $ 1,779 $ 11,216 $ 41,849 $ (9) $ 0 $ 54,835
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Page 44
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995 & 1994
- --------------------------------------------------------------------------------
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include
the accounts of Northern States Financial Corporation (Company) and its wholly
owned subsidiaries, Bank of Waukegan (Bank) and First Federal Bank, fsb
(Thrift). The Bank and the Thrift are referred to collectively as "the
Subsidiaries". All significant intercompany transactions and balances have
been eliminated in consolidation.
NATURE OF OPERATIONS: The Company's and the Subsidiaries' revenues and
assets are primarily from the banking industry. Loan customers are mainly
located in Lake County, Illinois, and surrounding areas, and include a wide
range of individuals, businesses, and other organizations. A major portion of
loans are secured by various forms of collateral including real estate, business
assets, consumer property, and other items. The Thrift also engages in mortgage
banking operations.
USE OF ESTIMATES: To prepare financial statements in conformity with
generally accepted accounting principles, management makes estimates and
assumptions based on available information. These estimates and assumptions
affect the amounts reported in the financial statements and the disclosures
provided, and future results could differ. The collectibility of loans, fair
values of financial instruments, and status of contingencies are particularly
subject to change.
CASH FLOW REPORTING: Cash and cash equivalents are defined as cash and due
from banks, federal funds sold, and interest-bearing deposits in financial
institutions with original maturities under 90 days. Net cash flows are
reported for customer loan and deposit transactions, securities sold under
agreements to repurchase and other short-term borrowings, and interest bearing
deposits in financial institutions with maturities over 90 days.
SECURITIES: Securities are classified as held-to-maturity and carried at
amortized cost when management has the positive intent and ability to hold them
to maturity. Securities are classified as available-for-sale when they might
be sold before maturity. Securities available-for-sale are carried at fair
value, with unrealized holding gains and losses reported separately in
shareholders' equity, net of tax. Securities are written down to fair value by
charges to income when a decline in fair value is not temporary.
Gains and losses on sales are determined using the amortized cost of the
specific security sold. Interest income includes amortization of purchase
premiums and discounts.
As permitted by the Statement of Financial Accounting Standards (SFAS) No.
115 implementation guide released in 1995, the Company exercised a one time
opportunity to reassess the appropriateness of the classifications of all
securities held. Based on this review, the Company reclassified securities
having an amortized cost of $96,547,000 and a net unrealized gain of $772,000
during 1995 from held-to-maturity to available-for-sale.
LOANS HELD FOR SALE: Loans held for sale are reported at the lower of cost
or market value in the aggregate.
LOANS. Loans are reported at the principal balance outstanding, net of
deferred loan fees and costs and the allowance for loan losses. Interest
income is reported on the interest method and includes amortization of net
deferred loan fees and costs over the loan term.
Interest income is not reported when full loan repayment is in doubt,
typically when payments are past due over 90 days. Payments received on such
loans are reported as principal reductions.
ALLOWANCE FOR LOAN LOSSES. Because some loans may not be repaid in full, an
allowance for loan losses is recorded. Increases to the allowance are recorded
by a provision for loan losses charged to expense. Estimating the risk of loss
and the amount of loss on any loan is necessarily subjective. Accordingly, the
allowance is maintained by management at a level considered adequate to cover
possible losses that are currently anticipated based on past loss experience,
general economic conditions, information about specific borrower situations
including their financial position and collateral values, and other factors and
estimates which are subject to change over time. While management may
periodically allocate portions of the allowance for specific problem loan
situations, the whole allowance is available for any loan charge-offs that
occur. A loan is charged-off by management as a loss when deemed
uncollectible, although collection efforts continue and future recoveries may
occur.
While management uses available information to recognize losses on loans,
future additions to the allowance may be necessary based on changes in economic
conditions. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Bank's and the Thrift's
allowances for loan losses. Such agencies may require the Bank and the Thrift
to provide additions to the allowance based on their judgements at the time of
their examinations.
SFAS No. 114 and No. 118 became effective January 1, 1995 regarding loan
impairment. Loans are considered impaired if full principal or interest
payments are not anticipated. Impaired loans are carried at the present value
of expected cash flows discounted at the loan's effective interest rate or at
fair value of the collateral if the loan is collateral dependent.
Page 45
<PAGE>
- --------------------------------------------------------------------------------
NOTE 1 (CONTINUED)
A portion of the allowance for loan losses is allocated to impaired loans.
The effect of adopting these new accounting standards was not material to the
financial statements.
Smaller-balance homogeneous loans are evaluated for impairment in total.
Such loans include residential first mortgage loans secured by one-to-four
family residences, residential construction loans, and automobile, home equity
and second mortgage loans. Commercial loans and mortgage loans secured by other
properties are evaluated individually for impairment. All loans in nonaccrual
status and other selected watch list loans are considered impaired. Impaired
loans or portions thereof are charged off when deemed uncollectible.
The nature of disclosures for impaired loans is considered generally
comparable to prior nonaccrual, renegotiated, non-performing and past-due loan
disclosures. Increases or decreases in the valuation allowance for an impaired
loan are reported as reductions or increases to the provision of loan losses.
OFFICE BUILDINGS AND EQUIPMENT. Asset cost is reported net of
accumulated depreciation. Depreciation expense is calculated on the
straight-line method over asset useful lives.
OTHER REAL ESTATE: Real estate acquired in settlement of loans is
initially reported at estimated fair value at acquisition. After
acquisition, a valuation allowance reduces the reported amount to the lower
of the initial amount or fair value less costs to sell. Revenue and
expenses from operations and changes in the valuation allowance are included
in other real estate owned expenses.
SERVICING RIGHTS: The Company has not purchased rights to service loans
for others. Subsequent to adopting Financial Accounting Standard No. 122 at
the start of 1996, servicing rights represent the allocated value of servicing
rights retained on loans sold. Servicing rights are expensed in proportion to,
and over the period of, estimated net servicing revenues. Impairment is
evaluated based on the fair value of the rights, using groupings of the
underlying loans as to interest rates. Any impairment of a grouping is
reported as a valuation allowance. The effect of adopting SFAS No. 122 was
not material to the Company's consolidated net income.
GOODWILL AND IDENTIFIED INTANGIBLES: Goodwill is the excess of purchase
price over the fair value of net assets in business acquisitions. Goodwill is
expensed on the straight-line method over 25 years. Identified intangibles
represent the value of depositor relationships purchased and was expensed over 7
years ending in 1995, with expense of $24,000 and $29,000 in 1995 and 1994.
Goodwill and identified intangibles are assessed for impairment based on
estimated undiscounted cash flows, and written down if necessary.
EMPLOYEE BENEFITS: A profit sharing plan covers substantially all
employees. Contributions are expensed annually and are made at the discretion
of the Board of Directors. Contributions totaled $255,000, $224,000 and
$251,000 in 1996, 1995 and 1994. The plan allows employees to make voluntary
contributions, although such contributions are not matched by the Company.
STOCK COMPENSATION. Expense for employee compensation under stock option
plans is based on Accounting Principles Board Opinion 25, with expense reported
only if options are granted below market price at grant date. Pro forma
disclosures of net income and earnings per share are provided as if the fair
value method of SFAS No. 123 are used for any stock-based compensation awarded
after January 1, 1995.
INCOME TAXES: Income tax expense is the sum of the current year income tax
due or refundable and the change in deferred tax assets and liabilities.
Deferred tax assets and liabilities are the expected future tax consequences of
temporary differences between the carrying amounts and tax bases of assets and
liabilities, computed using enacted tax rates. A valuation allowance, if
needed, reduces deferred tax assets to the amount expected to be realized.
FAIR VALUES OF FINANCIAL INSTRUMENTS: Fair values of financial instruments
are estimated using relevant market information and other assumptions, as more
fully disclosed separately. Fair value estimates involve uncertainties and
matters of significant judgment regarding interest rates, credit risk,
prepayments, and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or in market conditions could
significantly affect the estimates. The fair value estimates of existing on
and off-balance sheet financial instruments do not include the value of
anticipated future business or the values of assets and liabilities not
considered financial instruments.
EARNINGS PER SHARE: Earnings per share are based on weighted-average
outstanding shares during the year. The effect of stock options was not
material to earnings per share for any years presented.
Page 46
<PAGE>
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 2 SECURITIES
Year-end securities were as follows:
<TABLE>
<CAPTION>
AMORTIZED GROSS UNREALIZED
DECEMBER 31, 1996 COST GAINS LOSSES FAIR VALUE
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
SECURITIES AVAILABLE-FOR-SALE
U.S. Treasury $ 16,098 $ 25 $ (9) $ 16,114
U.S. Government agencies and corporations 90,359 32 (787) 89,604
States and political subdivisions 24,827 699 (44) 25,482
Mortgage-backed securities 16,408 131 (109) 16,430
Equity securities and mutual fund
investment in debt securities 2,091 128 (99) 2,120
-------------------------------------------------------
Total $ 149,783 $ 1,015 $ (1,048) $ 149,750
-------------------------------------------------------
-------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AMORTIZED GROSS UNREALIZED
DECEMBER 31, 1996 COST GAINS LOSSES FAIR VALUE
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
SECURITIES AVAILABLE-FOR-SALE
U.S. Treasury $ 37,176 $ 93 $ (21) $ 37,248
U.S. Government agencies and corporations 71,718 162 (299) 71,581
States and political subdivisions 21,337 763 (35) 22,065
Mortgage-backed securities 20,320 211 (59) 20,472
Equity securities and mutual fund
investment in debt securities 3,814 89 (99) 3,804
-------------------------------------------------------
Total $ 154,365 $ 1,318 $ (513) $ 155,170
-------------------------------------------------------
-------------------------------------------------------
</TABLE>
Page 47
<PAGE>
- --------------------------------------------------------------------------------
NOTE 2 (CONTINUED)
Contractual maturities of debt securities at year end 1996 were as follows.
Securities not due at a single maturity date, primarily mortgage-backed
securities, are shown separately.
AMORTIZED
COST FAIR VALUE
- --------------------------------------------------------------------------------
Due in one year or less $ 19,793 $ 19,808
Due after one year through five years 98,296 97,906
Due after five years through ten years 13,195 13,486
-------------------------
131,284 131,200
Mortgage-backed securities 16,408 16,430
Equity securities and mutual fund investment
in debt securities 2,091 2,120
-------------------------
Total $ 149,783 $ 149,750
-------------------------
-------------------------
Mortgage-backed securities are comprised of investments in pools of
residential mortgages. The mortgage pools are issued and guaranteed by the
Federal Home Loan Mortgage Corporation (FHLMC), the Federal National Mortgage
Association (FNMA), and the Government National Mortgage Association (GNMA).
As of December 31, 1996, the Company held structured notes with an
amortized cost of $3,101,000 and a fair value of $3,082,000. These securities
were issued by the Federal Home Loan Bank (FHLB). The structured notes are
comprised primarily of securities which have coupon interest rates which "step
up" periodically during the term to maturity.
There were no sales of debt securities during the years ended December 31,
1996, 1995, and 1994. Proceeds from sales of equity securities in 1996 and 1994
totaled $2,675,000 and $4,501,000 with a resulting gain of $5,000 in 1996 and a
loss of $68,000 in 1994. During 1996 and 1994, the Federal Home Loan Bank of
Chicago redeemed 250 and 2,201 shares of its stock held by the Thrift, with
proceeds of $25,000 and $220,100 and with no resulting gain or loss.
Securities carried at $97,052,000 and 97,970,000 at year-end 1996 and 1995
were pledged to secure public deposits, repurchase agreements and for other
purposes as required or permitted by law.
As of December 31, 1996, the Company had no securities of a single issuer,
other than U.S. Treasury and U.S. Government agencies and corporations including
FHLB, FHLMC, FNMA, and GNMA, that exceeded 10% of stockholders' equity.
Although the Company holds securities issued by municipalities within the state
of Illinois which in the aggregate exceed 10% of stockholders' equity, none of
the holdings from individual municipal issuers exceeded this threshold.
Interest-bearing balances with other financial institutions and federal
funds sold consisted of the following at December 31, 1996:
First USA Bank, Dallas $ 8,000
LaSalle National Bank, Chicago 7,500
Federal Home Loan Bank, Chicago 1,200
Bank of America, Illinois 100
Harris Bank, Chicago 35
----------
Total $ 16,835
----------
----------
Page 48
<PAGE>
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 3 LOANS
Year end loans were as follows:
1996 1995
- -------------------------------------------------------------------------------
Commercial $ 50,762 $ 53,886
Real estate - construction 26,905 23,720
Real estate - mortgage 146,552 137,941
Installment 9,203 10,903
-------------------------
Total loans 233,422 226,450
Less:
Unearned income (240) (370)
Deferred loan fees (529) (701)
-------------------------
Loans, net of unearned income and
deferred loan fees 232,653 225,379
Allowance for loan losses (4,839) (4,514)
-------------------------
Total loans, net $ 227,814 $ 220,865
-------------------------
-------------------------
Impaired loans were as follows:
1996 1995
- -------------------------------------------------------------------------------
Year-end loans with no allowance for
losses allocated $ 0 $ 0
Year-end loans with allowance for
losses allocated 828 5,161
Amount of the allowance allocated 146 975
Average of impaired loans during the year 2,620 5,111
Interest income recognized during impairment 587 113
Cash-basis interest income recognized 218 111
Loans on nonaccrual status amounted to $4,912,000 at December 31, 1994.
Interest income which would have been recognized had these loans been on an
accrual basis throughout the year approximated $545,000 in 1994. Interest
recognized on nonaccrual loans in 1994 amounted to $108,000.
Related party loans were as follows for 1996:
Total loans at beginning of year $ 413
New loans 925
Repayments (354)
Other Changes 7
----------
Total loans at end of year $ 991
----------
----------
Real estate loans with a carrying value of $15,454,000 and $14,624,000 were
pledged to secure public deposits at December 31, 1996 and 1995.
Loans held for sale at year-end 1996 and 1995 were approximately $893,000
and $3,641,000 and are classified as real estate mortgage loans.
Page 49
<PAGE>
- --------------------------------------------------------------------------------
NOTE 4 ALLOWANCES FOR LOAN AND OTHER REAL ESTATE OWNED LOSSES
Activity in the allowance for loan losses for the year ended December 31,
follows:
<TABLE>
<CAPTION>
1996 1995 1994
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year $ 4,514 $ 3,965 $ 3,764
Provision charged to operating expense 1,190 1,480 1,440
Loans charged off (1,141) (1,009) (1,315)
Recoveries on loans previously charged-off 276 78 76
----------------------------------------
Balance at end of year $ 4,839 $ 4,514 $ 3,965
----------------------------------------
----------------------------------------
</TABLE>
Activity in the allowance for other real estate owned losses for the year
ended December 31, follows:
<TABLE>
<CAPTION>
1996 1995 1994
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year $ 510 $ 526 $ 679
Provision charged to operating expense 22 23 25
Losses on other real estate owned 0 (39) (178)
----------------------------------------
Balance at end of year $ 532 $ 510 $ 526
----------------------------------------
----------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
NOTE 5 OFFICE BUILDINGS AND EQUIPMENT
Office buildings and equipment consisted of the following at
December 31, 1996 and 1995:
1996 1995
- -----------------------------------------------------------------
Land $ 1,489 $ 1,489
Office buildings and improvements 7,203 7,248
Furniture and equipment 3,802 3,824
-------------------------
Total cost 12,494 12,561
Accumulated depreciation (6,244) (5,974)
-------------------------
Net book value $ 6,250 $ 6,587
-------------------------
-------------------------
Depreciation expense amounted to $546,000 in 1996, $621,000 in 1995 and
$557,000 in 1994.
- --------------------------------------------------------------------------------
NOTE 6 LOAN SERVICING
Mortgage loans serviced for others are not reported as assets. These loans
totalled $65,321,000 and $64,519,000 at year-end 1996 and 1995. Related escrow
deposit balances were $612,000 and $594,000 at year-end 1996 and 1995.
Activity for capitalized mortgage servicing rights was as follows for 1996:
Beginning of year $ 0
Additions 95
Amortized to expense (15)
----------
End of year $ 80
----------
----------
Page 50
<PAGE>
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 7 DEPOSITS
At year-end 1996, stated maturities of time deposits were:
1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 138,149
1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,693
1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,107
2000 and thereafter. . . . . . . . . . . . . . . . . . . . . . . . . 195
----------
$ 158,144
----------
----------
Related party deposits at year-end 1996 totalled $10,953,000.
- --------------------------------------------------------------------------------
NOTE 8 SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER SHORT-TERM
BORROWINGS
Securities sold under repurchase agreements and other short-term borrowings
are financing arrangements. Physical control is maintained for all securities
sold under repurchase agreements. Information concerning securities sold under
repurchase agreements is summarized as follows:
1996 1995
- -------------------------------------------------------------------------------
Average daily balance during the year $ 35,006 $ 34,633
Average interest rate during the year 4.92% 5.41%
Maximum month end balance during the year $ 37,804 $ 43,278
Securities sold under repurchase agreements with directors of the Company
and related interests totaled $18,757,000 at December 31, 1996 and have a
weighted maturity of 3 months.
Page 51
<PAGE>
- --------------------------------------------------------------------------------
NOTE 9 INCOME TAXES
A summary of federal and state income taxes on operations follows:
1996 1995 1994
- -------------------------------------------------------------------------------
Current payable
Federal $ 2,184 $ 1,877 $ 1,652
State 151 316 116
Deferred income tax benefit 194 (153) 17
----------------------------------------
Provision for income taxes $ 2,529 $ 2,040 $ 1,785
----------------------------------------
----------------------------------------
The components of the deferred tax assets and liabilities at December 31,
1996 and 1995 follow:
1996 1995
- -------------------------------------------------------------------------------
Deferred tax assets:
Allowances for loan and other real estate losses $ 1,791 $ 1,660
Deferred loan fees 134 215
Deferred compensation and directors' fees 148 150
Unrealized net loss on securities
available-for-sale 25 0
Taxable income on non-performing loans not
recorded for book purposes 7 192
-------------------------
Gross deferred tax assets 2,105 2,217
Deferred tax liabilities:
Depreciation (575) (538)
Federal Home Loan Bank stock dividend (37) (37)
Unrealized net gain on securities
available-for-sale 0 (315)
Other items (61) (41)
-------------------------
Gross deferred tax liabilities (673) (931)
-------------------------
Net deferred tax asset $ 1,432 $ 1,286
-------------------------
-------------------------
The Thrift has qualified under provisions of the Internal Revenue Code
which permit it to deduct from taxable income a provision for bad debts which
differs from the provision charged to income in the financial statements. Tax
legislation passed in 1996 now requires all thrift institutions to deduct a
provision for bad debts for tax purposes based on actual loss experience and
recapture of the excess bad debt reserve accumulated in tax years after 1987.
The related amount of deferred tax liability which must be recaptured is $1,400
and is payable over a six-year period beginning no later than 1998. Retained
earnings at December 31, 1996 includes approximately $3,269,000 for which no pro
vision for federal income taxes has been made. If, in the future, this portion
of retained earnings is used for any purpose other than to absorb bad debt
losses, federal income taxes would be imposed at the then prevailing rates,
resulting in approximately $1,266,000 of deferred tax liability.
52
<PAGE>
- --------------------------------------------------------------------------------
NOTE 9 INCOME TAXES CONTINUED
No valuation allowance is required for deferred tax assets.
The provision for income taxes differs from that computed at the statutory
federal corporate tax rate as follows:
1996 1995 1994
- -------------------------------------------------------------------------------
Income tax calculated at
statutory rate (34%) $ 2,904 $ 2,372 $ 2,128
Add (subtract) tax effect of:
Tax-exempt income, net of disallowed
interest expense (503) (483) (436)
State income tax, net of
federal tax benefit 120 186 61
Other items, net 8 (35) 32
----------------------------------------
Provision for income taxes $ 2,529 $ 2,040 $ 1,785
----------------------------------------
----------------------------------------
- --------------------------------------------------------------------------------
NOTE 10 OMNIBUS INCENTIVE PLAN INSTRUMENTS
The 1992 Omnibus Incentive Plan (the "Plan") authorizes the issuance of up
to 75,000 shares of the Company's common stock, including the granting of
non-qualified stock options, restricted stock and stock appreciation rights.
Financial Accounting Standard No. 123, which became effective for 1996,
requires pro forma disclosures for companies that do not adopt its fair value
accounting method for stock-based employee compensation. The Company did not
grant any stock options during 1996 or 1995.
Stock options are used to reward directors and employees and provide them
with an additional equity interest. Options are issued for 10 year periods and
are fully vested when granted. Information about option grants follow:
NUMBER OF WEIGHTED-AVG.
OPTIONS EXERCISE PRICE
--------- --------------
Outstanding, beginning of 1994 8,320 $41.64
Exercised 1994 0 0
---------
Outstanding, end of 1994 8,320 41.64
Exercised 1995 (1,300) 41.69
---------
Outstanding, end of 1995 7,020 41.63
Exercised 1996 (1,842) 41.64
---------
Outstanding, end of 1996 5,178 41.62
---------
---------
At year-end 1996, options outstanding ranged in exercise price from $41.60
to $42.00 and had a weighted average remaining option life of 5.1 years.
On May 1, 1992, 2,950 restricted stock shares were awarded without payment
to the Company. Recipients have all of the rights of stockholders, except that
the shares cannot be disposed of until the restrictions have lapsed. On the date
of grant, the estimated market price of the shares was added to common stock and
capital surplus and an equal amount was deducted from stockholders' equity
(unearned portion of restricted stock awards). The unearned portion was
amortized to expense over the three-year vesting period on the straight-line
method and was completely amortized at December 31, 1994. Amortization of the
restricted stock awards was approximately $14,000 for the year ended December
31, 1994.
The Committee at its discretion may grant stock appreciation rights under
the Plan. A stock appreciation right entitles the holder to receive from the
Company an amount equal to the excess, if any, of the aggregate fair market
value of the Company's common stock which is the subject of such grant over the
grant price. As of December 31, 1996 and 1995, 3,904 and 6,812 stock
appreciation rights were awarded at $41.60. The Company's expense was $70,000,
$21,000 and $117,000 for the years ended December 31, 1996, 1995 and 1994. The
stock appreciation rights will expire on April 30, 2002.
53
<PAGE>
- --------------------------------------------------------------------------------
NOTE 11 COMMITMENTS, OFF BALANCE SHEET RISK, AND CONTINGENCIES
There are various contingent liabilities that are not reflected in the
financial statements, including claims and legal actions arising in the ordinary
course of business. In the opinion of management, after consultation with legal
counsel, the ultimate disposition of these matters is not expected to have a
material effect on financial condition or results of operations.
At year-end 1996 and 1995 reserves of $2,756,000 and $2,757,000 were
required as deposits with the Federal Reserve or as cash on hand. These
reserves do not earn interest.
Some financial instruments are used in the normal course of business to
meet the financing needs of customers and to reduce exposure to interest rate
changes. These financial instruments include commitments to extend credit,
standby letters of credit, and financial guarantees. These involve to varying
degrees, credit and interest-rate risk in excess of the amount reported in the
financial statements.
Exposure to credit loss if the other party does not perform is represented
by the contractual amount for commitments to extend credit, standby letters of
credit, and financial guarantees written. The same credit policies are used for
commitments and conditional obligations as are used for loans. Collateral or
other security is normally not required to support financial instruments with
credit risk.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the commitment.
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 used, the commitments do not necessarily represent future
cash requirements. Standby letters of credit and financial guarantees written
are conditional commitments to guarantee a customer's performance to a third
party.
A summary of the notional or contractual amounts of financial instruments
with off balance sheet risk at year-end follows:
1996 1995
----------------------------------------------------------------------
Unused lines of credit and
commitments to make loans:
Fixed rate $ 17,696 $ 12,995
Variable rate 57,979 49,984
-------------------------
Total $ 75,675 $ 62,979
-------------------------
-------------------------
Standby letters of credit $ 6,250 $ 5,579
Commitments to make loans at a fixed rate have interest rates ranging
primarily from 6.00% to 9.00%.
- --------------------------------------------------------------------------------
NOTE 12 FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate fair values for
financial instruments. The carrying amount is considered to estimate fair value
for cash and cash equivalents, interest-bearing deposits in financial
institutions, demand deposits, advances from borrowers for taxes and insurance,
and accrued interest. Securities' fair values are based on quoted market prices
or, if no quotes are available, on the rate and term of the security and/or
information about the issuer. For fixed rate loans or deposits and securities
sold under repurchase agreements, the fair value is estimated by discounted cash
flow analysis using current market rates for the estimated life and credit
risk. Fair values for impaired loans are estimated using discounted cash flow
analysis or underlying collateral values where applicable. Fair value of loans
held for sale is based on market estimates. The fair value of off balance sheet
items is based on the fees or cost that would currently be charged to enter or
terminate such arrangements.
The estimated year-end fair values of financial instruments were:
<TABLE>
<CAPTION>
ESTIMATED
1996 CARRYING VALUE FAIR VALUE
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Financial assets:
Cash and cash equivalents $ 31,982 $ 31,982
Interest-bearing deposits in financial institutions - maturities over 90 days 100 100
Securities available-for-sale 149,750 149,750
Loans 232,653 233,017
Allowance for loan losses (4,839) (4,839)
Direct lease financing 999 999
Accrued interest receivable 3,955 3,955
Financial liabilities:
Deposits $ (328,795) $ (328,909)
Securities sold under repurchase agreements and other short-term borrowings (36,758) (36,770)
Advances from borrowers for taxes and insurance (1,021) (1,021)
Accrued interest payable (2,498) (2,498)
</TABLE>
Page 54
<PAGE>
- --------------------------------------------------------------------------------
NOTE 12 (CONTINUED)
<TABLE>
<CAPTION>
ESTIMATED
1995 CARRYING VALUE FAIR VALUE
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Financial assets:
Cash and cash equivalents $ 33,974 $ 33,974
Interest-bearing deposits in financial institutions -maturities over 90 days 100 100
Securities available-for-sale 155,170 155,170
Loans 225,379 226,415
Allowance for loan losses (4,514) (4,514)
Direct lease financing 622 622
Accrued interest receivable 4,366 4,366
Financial liabilities:
Deposits $ (327,555) $ (328,109)
Securities sold under repurchase agreements and other short-term borrowings (43,278) (43,310)
Advances from borrowers for taxes and insurance (1,281) (1,281)
Accrued interest payable (1,741) (1,741)
</TABLE>
- --------------------------------------------------------------------------------
NOTE 13 REGULATORY MATTERS
The Company and Subsidiaries are subject to regulatory capital requirements
administered by federal banking agencies. Capital adequacy guidelines and prompt
corrective action regulations involve quantitative measures of assets,
liabilities, and certain off balance sheet items calculated under regulatory
accounting practices. Capital amounts and classifications are also subject to
qualitative judgements by regulators about components, risk weightings, and
other factors, and the regulators can lower classifications in certain cases.
Failure to meet various capital requirements can initiate regulatory action that
could have a direct material effect on the financial statements.
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized, although these
terms are not used to represent overall financial condition. If adequately
capitalized, regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required. The minimum
requirements are:
TIER 1
CAPITAL TO RISK-WEIGHTED ASSETS CAPITAL TO
TOTAL TIER I AVERAGE ASSETS
- -------------------------------------------------------------------------------
Well capitalized 10.00% 6.00% 5.00%
Adequately capitalized 8.00% 4.00% 4.00%
Undercapitalized 6.00% 3.00% 3.00%
Page 55
<PAGE>
- --------------------------------------------------------------------------------
NOTE 13 (CONTINUED)
At year end, actual capital levels and minimum required levels were:
<TABLE>
<CAPTION>
MINIMUM REQUIRED TO BE
MINIMUM REQUIRED WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION REGULATIONS
- --------------------------------------------------------------------------------------------------------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1996
Total Capital
(to risk weighted assets)
Consolidated $ 58,136 21.18% $ 21,963 8.00% $ 27,454 10.00%
Bank 43,335 20.18 17,182 8.00 21,478 10.00
Tier I Capital
(to risk weighted assets)
Consolidated 54,704 19.93 10,982 4.00 16,473 6.00
Bank 40,650 18.93 8,591 4.00 12,887 6.00
Tier I Capital
(to average assets)
Consolidated 54,704 13.02 16,804 4.00 21,005 5.00
Bank 40,650 12.98 12,523 4.00 15,654 5.00
1995
Total Capital
(to risk weighted assets)
Consolidated $ 53,674 20.22% $ 21,228 8.00% $ 26,536 10.00%
Bank 39,272 19.29 16,289 8.00 20,361 10.00
Tier I Capital
(to risk weighted assets)
Consolidated 50,365 19.98 10,614 4.00 15,921 6.00
Bank 36,727 18.04 8,144 4.00 12,217 6.00
Tier I Capital
(to average assets)
Consolidated 50,365 11.79 16,305 4.00 20,381 5.00
Bank 36,727 12.32 11,929 4.00 14,911 5.00
</TABLE>
The Company and the Subsidiaries at year end 1996 were categorized as well
capitalized. Management knows of no circumstances or events which would change
these categorizations.
The Company's primary source of funds to pay dividends to shareholders is
the dividends it receives from the Subsidiaries. The Subsidiaries are subject
to certain restrictions on the amount of dividends that they may declare without
prior regulatory approval. At December 31, 1996, $24,900,000 of the
Subsidiaries' retained earnings were available for dividend declaration without
prior regulatory approval.
Page 56
<PAGE>
- --------------------------------------------------------------------------------
NOTE 14 PARENT COMPANY CONDENSED FINANCIAL STATEMENTS
Following are condensed parent company financial statements:
CONDENSED BALANCE SHEETS
DECEMBER 31, 1996 1995
- --------------------------------------------------------------------------------
Assets
Cash on deposit at subsidiary
bank - noninterest-bearing $ 807 $ 831
Interest-bearing deposits in unaffiliated bank 35 34
-------------------------
Total cash and cash equivalents 842 865
Investment in wholly-owned subsidiaries
Equity in underlying book value:
Bank of Waukegan 40,645 37,109
First Federal Bank, fsb 13,445 13,079
Goodwill, net 140 150
-------------------------
Total investment in subsidiaries 54,230 50,338
Other assets 419 270
-------------------------
Total assets $ 55,491 $ 51,473
-------------------------
-------------------------
Liabilities and Stockholders' Equity
Accounts payable and other liabilities $ 656 $ 468
Stockholders' equity 54,835 51,005
-------------------------
Total liabilities and stockholders' equity $ 55,491 $ 51,473
-------------------------
-------------------------
CONDENSED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1996 1995 1994
- -------------------------------------------------------------------------------
Operating Income
Dividends from subsidiaries $ 1,745 $ 758 $ 1,261
Interest income 1 1 0
------------------------------
Total operating income 1,746 759 1,261
Operating expenses 214 293 257
------------------------------
Income before income taxes and equity in
undistributed earnings of subsidiaries 1,532 466 1,004
Income tax benefit 78 130 55
------------------------------
Income before equity in undistributed
earnings of subsidiaries 1,610 596 1,059
Equity in undistributed
earnings of subsidiaries 4,401 4,341 3,416
------------------------------
Net income $ 6,011 $ 4,937 $ 4,475
------------------------------
------------------------------
CONDENSED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 1995 1994
- -------------------------------------------------------------------------------
Cash flows from operating activities
Net income $ 6,011 $ 4,937 $ 4,475
Adjustments to reconcile net income to
net cash from operating activities
Equity in undistributed earnings of
subsidiaries (4,401) (4,341) (3,416)
Amortization of unearned portion
of restricted stock award 0 0 14
Goodwill amortization 10 11 11
(Increase) decrease in other assets (149) 321 226
Increase in other liabilities 208 110 125
------------------------------
Net cash provided by operating activities 1,679 1,038 1,435
------------------------------
Cash flows provided by investing activities
Capital distribution from
Northern States Trust Company 0 0 1
------------------------------
Cash flows from financing activities
Exercise of stock options 77 54 0
Dividends paid (1,779) (1,463) (1,285)
------------------------------
Net cash used in financing activities (1,702) (1,409) (1,285)
------------------------------
Increase (decrease) in cash and cash equivalents (23) (371) 151
Cash and cash equivalents at beginning of year 865 1,236 1,085
------------------------------
Cash and cash equivalents at end of year $ 842 $ 865 $ 1,236
------------------------------
------------------------------
Page 57
<PAGE>
STOCKHOLDER INFORMATION
ANNUAL MEETING: All stockholders are invited to attend our annual meeting,
which will be held at 4:30 P.M., on Thursday, April 24, 1997 in the lobby of the
Bank of Waukegan, 1601 N. Lewis Avenue, Waukegan, Illinois 60085.
We look forward to meeting all stockholders and welcome your questions at
the annual meeting. Any shareholder unable to attend this year's meeting is
invited to send questions and comments in writing to Fred Abdula, Chairman of
the Board and Chief Executive Officer, at Northern States Financial Corporation.
FORM 10-K: Stockholders who wish to obtain a copy at no charge of
Northern States Financial Corporation's Form 10-K for the fiscal year ended
December 31, 1996, as filed with the Securities and Exchange Commission, may do
so by writing Thomas M. Nemeth, Assistant Vice President, at Northern States
Financial Corporation.
FOR FURTHER INFORMATION: Stockholders and prospective investors are
welcome to call or write Northern States Financial Corporation with questions or
requests for additional information. Please direct inquiries to:
Thomas M. Nemeth
Assistant Vice President
Northern States Financial Corporation
1601 N. Lewis Avenue
Waukegan, Illinois 60085
(847) 244-6000 ext. 269
TRANSFER AGENT, REGISTRAR & DIVIDEND DISBURSEMENTS: Stockholders with a
change of address or related inquiries should contact:
Investors Services Unit
Firstar Trust Company
615 E. Michigan Street, 4th Floor
Milwaukee, Wisconsin 53202
(800) 637-7549
QUARTERLY CALENDAR: The Company operates on a fiscal year ending
December 31. Quarterly results are announced within 45 days after the end of
each quarter, and audited results are announced within 90 days after year end.
SEMI-ANNUAL DIVIDEND DATES: Dividends are expected to be announced and
paid on the following schedule during 1997:
HALF RECORD DATE PAYMENT DATE
- --------------------------------------------------------------------------------
First May 16 June 1
Second November 15 December 1
STOCK MARKET INFORMATION: The common stock of Northern States Financial
Corporation is traded on the National Association of Securities Dealers
Automated Quotation System (NASDAQ Small-Cap Market) under the ticker symbol
NSFC. Stock price quotations are published daily in the Chicago Tribune and
Chicago Sun-Times newspapers and, when traded, in The Wall Street Journal. The
stock is commonly listed as NthStat.
As of December 31, 1996, there were 1,750,000 common shares authorized;
889,273 common shares were outstanding, held by approximately 452 registered
stockholders.
As of December 31, 1996, the following securities firms indicated they were
maintaining an inventory of Northern States Financial Corporation common stock
and acting as market makers:
ABN AMRO Chicago Corp. Howe Barnes & Johnson, Inc.
Chicago, Illinois Chicago, Illinois
(800) 621-0686 ext. 6195 (800) 800-4693
(312) 855-6195 (312) 655-2954
PRICE SUMMARY: The following schedule details our stock's quarter ending
bid and ask price.
1996 1995
- ------------------------------------------------------------
BID ASK BID ASK
--- --- --- ---
Quarter Ended:
March 31 $69 $74 $63 $68
June 30 71 76 63 68
September 30 74 79 64 69
December 31 83 87 66 71
CASH DIVIDENDS: Northern States Financial Corporation pays semi-annual
cash dividends in June and December. Uninterrupted cash dividends have been
paid since the Company's formation in 1984 and have been increased each year
since then. The table below shows semi-annual cash dividends per share for the
past seven years. Dividends have been restated to reflect the five-for-one
stock split which occurred in June of 1991.
JUNE 1 DECEMBER 1 TOTAL
- ------------------------------------------------------------
1990 $ .46 $ .46 $ .92
1991 .47 .53 1.00
1992 .55 .60 1.15
1993 .63 .67 1.30
1994 .70 .75 1.45
1995 .80 .85 1.65
1996 .95 1.05 2.00
INDEPENDENT AUDITORS
Crowe, Chizek and Company LLP
Oak Brook, Illinois
Page 58
<PAGE>
EXHIBIT 21.
SUBSIDIARIES OF NORTHERN STATES FINANCIAL CORPORATION
Bank of Waukegan
1601 N. Lewis Avenue
Waukegan, Illinois 60085
State of Incorporation - Illinois
A Wholly-Owned Subsidiary of
Northern States Financial Corporation
First Federal Bank, fsb
216 Madison Street
Waukegan, Illinois 60085
State of Incorporation - Illinois
A Wholly-Owned Subsidiary of
Northern States Financial Corporation
59
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 15,247
<INT-BEARING-DEPOSITS> 1,325
<FED-FUNDS-SOLD> 15,500
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 149,759
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 232,653
<ALLOWANCE> 4,839
<TOTAL-ASSETS> 426,564
<DEPOSITS> 328,795
<SHORT-TERM> 36,758
<LIABILITIES-OTHER> 6,176
<LONG-TERM> 0
0
0
<COMMON> 1,779
<OTHER-SE> 53,056
<TOTAL-LIABILITIES-AND-EQUITY> 426,564
<INTEREST-LOAN> 22,050
<INTEREST-INVEST> 8,851
<INTEREST-OTHER> 770
<INTEREST-TOTAL> 31,671
<INTEREST-DEPOSIT> 13,084
<INTEREST-EXPENSE> 14,808
<INTEREST-INCOME-NET> 16,863
<LOAN-LOSSES> 1,190
<SECURITIES-GAINS> 5
<EXPENSE-OTHER> 10,372
<INCOME-PRETAX> 8,540
<INCOME-PRE-EXTRAORDINARY> 6,011
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,011
<EPS-PRIMARY> 6.76
<EPS-DILUTED> 6.76
<YIELD-ACTUAL> 4.50
<LOANS-NON> 1,108
<LOANS-PAST> 58
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 4,514
<CHARGE-OFFS> 1,141
<RECOVERIES> 276
<ALLOWANCE-CLOSE> 4,839
<ALLOWANCE-DOMESTIC> 1,985
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 2,854
</TABLE>
