<PAGE>
===============================================================================
United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________________________
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ending June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to __________
_________________________________________________________
NORTHERN STATES FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 0-19300 36-3449727
(State of Incorporation) (Commission (I.R.S. Employer
File Number) 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)
_________________________________________________________
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 shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days.
YES: XXX NO: _______
---
4,450,865 shares of common stock were outstanding
as of June 30, 1998
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q
JUNE 30, 1998
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page Number
<S> <C>
Condensed consolidated balance sheets at June 30,
1998, December 31, 1997, and June 30, 1997 2
Condensed consolidated statements of income for the three
and six months ended June 30, 1998 and 1997 3
Condensed consolidated statements of comprehenesive income
the three and six months ended June 30, 1998 and 1997 4
Condensed consolidated statements of cash flows for
the six months ended June 30, 1998 and 1997 5
Notes to condensed consolidated financial statements 6 - 14
Item 2. Management's discussion and analysis of financial
condition and results of operations 15 - 24
Item 7A. Quantitative and qualitative disclosures
about market risk 24 - 26
PART II. OTHER INFORMATION
Signatures 27
</TABLE>
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, 1998, December 31, 1997 and June 30, 1997
(In thousands of dollars, except per share data)
<TABLE>
<CAPTION>
June 30, December 31, June 30,
Assets 1998 1997 1997
------- ------- -------
<S> <C> <C> <C>
Cash and due from banks..................................... $13,767 $14,200 $15,816
Interest bearing deposits in financial institutions......... 230 106 240
Federal funds sold.......................................... 31,000 11,200 13,900
------- ------- -------
Total cash and cash equivalents.......................... 44,997 25,506 29,956
Interest bearing deposits in financial institutions -
maturities over 90 days................................. 100 100 100
Securities available for sale............................... 180,051 180,672 146,195
Loans....................................................... 236,876 242,224 240,845
Less: Allowance for loan losses............................. (5,466) (5,430) (5,389)
------- ------- -------
Loans, net............................................... 231,410 236,794 235,456
Direct lease financing...................................... 1,176 1,274 959
Office buildings and equipment, net......................... 5,668 5,899 6,120
Other real estate owned, net of allowance for losses
of $552, $544 and $535................................... 2,547 2,555 2,672
Accrued interest receivable................................. 4,615 4,308 4,037
Other assets................................................ 1,698 1,878 2,495
------- ------- -------
Total assets............................................. $472,262 $458,986 $427,990
------- ------- -------
------- ------- -------
Liabilities and Stockholders' Equity
Liabilities
Deposits
Demand - noninterest-bearing............................. $39,663 $41,388 $38,218
NOW accounts............................................. 49,295 36,455 36,378
Money market accounts.................................... 40,446 38,790 44,877
Savings.................................................. 44,208 43,923 45,285
Time, $100,000 and over.................................. 91,855 93,469 76,330
Time, under $100,000..................................... 94,685 93,925 92,220
------- ------- -------
Total deposits........................................ 360,152 347,950 333,308
Securities sold under repurchase agreements
and other short-term borrowings.......................... 31,512 38,504 31,389
Federal Home Loan Bank term advances........................ 10,000 5,000 0
Advances from borrowers for taxes and insurance............. 901 1,166 911
Accrued interest payable and other liabilities.............. 7,093 6,171 5,307
------- ------- -------
Total liabilities..................................... 409,658 398,791 370,915
Stockholders' Equity
Common stock................................................ 1,780 1,779 1,779
Additional paid-in capital.................................. 11,254 11,222 11,216
Retained earnings........................................... 49,001 46,725 44,038
Unrealized gain on securities available for sale, net....... 569 469 42
------- ------- -------
Total stockholders' equity............................... 62,604 60,195 57,075
------- ------- -------
Total liabilities and stockholders' equity............... $472,262 $458,986 $427,990
------- ------- -------
------- ------- -------
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three months and six months ended June 30, 1998 and 1997
(In thousands of dollars, except per share data)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30, June 30, June 30,
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Interest income
Loans (including fee income)............................. $5,553 $5,552 $11,102 $10,834
Securities
Taxable................................................ 2,535 2,027 5,039 3,995
Exempt from federal income tax........................ 248 290 505 586
Interest bearing deposits in financial
institutions........................................... 10 8 19 16
Federal funds sold....................................... 235 126 453 355
-------- -------- -------- --------
Total interest income................................. 8,581 8,003 17,118 15,786
-------- -------- -------- --------
Interest expense
Time deposits............................................ 2,545 2,284 5,154 4,516
Other deposits........................................... 1,024 1,010 2,045 2,032
Other borrowings......................................... 583 414 1,143 818
-------- -------- -------- --------
Total interest expense................................ 4,152 3,708 8,342 7,366
-------- -------- -------- --------
Net interest income......................................... 4,429 4,295 8,776 8,420
Provision for loan losses................................... 0 180 10 360
-------- -------- -------- --------
Net interest income after provision for
loan losses.............................................. 4,429 4,115 8,766 8,060
-------- -------- -------- --------
Noninterest income
Service fees on deposits................................. 284 309 551 643
Trust income............................................. 171 154 342 298
Net gains on sales of loans.............................. 96 25 160 60
Other operating income................................... 112 140 235 375
-------- -------- -------- --------
Total noninterest income.............................. 663 628 1,288 1,376
-------- -------- -------- --------
Noninterest expenses
Salaries and employee benefits........................... 1,471 1,344 3,009 2,666
Occupancy and equipment expenses, net.................... 322 337 612 670
Data processing expense.................................. 145 125 261 265
FDIC deposit insurance expense........................... 22 22 43 44
Other real estate owned expenses......................... 37 58 61 126
Other operating expenses................................. 478 492 959 1,016
-------- -------- -------- --------
Total noninterest expenses............................ 2,475 2,378 4,945 4,787
-------- -------- -------- --------
Income before income taxes.................................. 2,617 2,365 5,109 4,649
Provision for income taxes.................................. 821 735 1,587 1,437
-------- -------- -------- --------
Net income.................................................. $1,796 $1,630 $3,522 $3,212
-------- -------- -------- --------
-------- -------- -------- --------
Basic earnings per common share............................. $ 0.40 $ 0.37 $ 0.79 $ 0.72
Diluted earnings per common share........................... $ 0.40 $ 0.37 $ 0.79 $ 0.72
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three months and six months ended June 30, 1998 and 1997
(In thousands of dollars, except per share data)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30, June 30, June 30,
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income............................................. $1,796 $1,630 $3,522 $3,212
Other comprehensive income:
Unrealized gains (losses) arising during period
on securities available for sale, net of tax
of ($10), $349, $64, and $50................... (13) 554 100 51
-------- -------- -------- --------
Comprehensive income................................... $1,783 $2,184 $3,622 $3,263
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six months ended June 30, 1998 and 1997
(In thousands of dollars)
<TABLE>
<CAPTION>
June 30, June 30,
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities
Net income.......................................... $3,522 $3,212
Adjustments to reconcile net income to cash from
operating activities:
Depreciation..................................... 276 269
Provision for loan losses........................ 10 360
Provision for losses on other real estate owned.. 8 3
Deferred loan fees............................... (50) (55)
Proceeds from sales of loans..................... 12,084 4,586
Loans originated for sale........................ (13,433) (4,667)
Net gains on sales of loans...................... (160) (60)
Net gains on sales of other real estate owned.... 0 (142)
Amortization of mortgage servicing rights........ 28 0
Net change in interest receivable................ (307) (82)
Net change in interest payable................... (77) 89
Net change in other assets....................... 57 323
Net change in other liabilities.................. 1,030 63
-------- --------
Net cash from operating activities............ 2,988 3,899
-------- --------
Cash flows from investing activities
Proceeds from maturities of securities
available for sale............................. 78,931 21,082
Purchases of securities available for sale....... (78,146) (17,426)
Change in loans made to customers................ 6,933 (7,972)
Property and equipment expenditures.............. (45) (139)
Net change in direct lease financing............. 98 40
Proceeds from sales of other real estate owned... 0 479
-------- --------
Net cash from investing activities............ 7,771 (3,936)
-------- --------
Cash flows from financing activities
Net change in:
Deposits....................................... 12,202 4,513
Securities sold under repurchase agreements
and other short-term borrowings.............. (1,992) (5,369)
Advances from borrowers for taxes and
insurance.................................... (265) (110)
Net proceeds from exercise of stock options...... 33 0
Dividends paid................................... (1,246) (1,023)
-------- --------
Net cash from financing activities............ 8,732 (1,989)
-------- --------
Net change in cash and cash equivalents................ 19,491 (2,026)
Cash and cash equivalents at beginning of period....... 25,506 31,982
-------- --------
Cash and cash equivalents at end of period............. $44,997 $29,956
-------- --------
-------- --------
Supplemental disclosures
Cash paid during the period for
Interest...................................... $8,419 $7,277
Income taxes.................................. 1,654 1,665
Noncash investing activities
Transfers made from loans to other real
estate owned................................ 0 166
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE>
NORTHERN STATES FINANCIAL CORPORTATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
(Dollar amounts in thousands, except per share data)
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying interim condensed consolidated financial statements are
prepared without audit and reflect all adjustments which are of a normal and
recurring nature and, in the opinion of management, are necessary to present
interim financial statements of Northern States Financial Corporation (the
"Company") in accordance with generally accepted accounting principles. The
interim financial statements do not purport to contain all the necessary
financial disclosures covered by generally accepted accounting principles
that might otherwise be necessary for complete financial statements.
The condensed consolidated balance sheets are as of June 30, 1998, December
31, 1997 and June 30, 1997. The condensed consolidated statements of income and
the condensed consolidated statements of comprehensive income are for the three
and six months ended June 30, 1998 and 1997. The condensed consolidated
statements of cash flows are for the six months ended June 30, 1998 and 1997.
On December 17, 1997 the Company's Board of Directors announced that it had
approved the merger of its two wholly owned subsidiaries, Bank of Waukegan and
First Federal Bank, fsb. The merger became effective April 21, 1998 with the
Bank of Waukegan being the surviving entity.
The interim condensed financial statements should be read in conjunction
with the audited financial statements and accompanying notes (or "notes
thereto") of the Company for the years ended December 31, 1997, 1996 and
1995.
The results of operations for the three and six month periods ended June
30, 1998, are not necessarily indicative of the results to be expected for the
full year.
Basic earnings per share is based on weighted-average shares outstanding.
Diluted earnings per share further assumes issue of any dilutive potential
common shares. On April 23, 1998 the stockholders approved an amendment to
effect a 5-for-1 stock split. The split became effective to stockholders of
record on May 5, 1998 and an additional 4 shares for each share were mailed on
May 15, 1998. Basic earnings per share, diluted earnings per share and all
omnibus incentive plan information have been restated for all periods to reflect
the effect of the 5-for-1 stock split. Common stock information is summarized
as follows:
<TABLE>
<CAPTION>
June 30, December 31, June 30,
1998 1997 1997
--------- ---------- ---------
<S> <C> <C> <C>
Common shares authorized..... 6,500,000 1,750,000 1,750,000
Common shares outstanding.... 4,450,865 889,373 889,273
Par value per share.......... $0.40 $2.00 $2.00
</TABLE>
6
<PAGE>
NORTHERN STATES FINANCIAL CORPORTATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
(Dollar amounts in thousands, except per share data)
(Unaudited)
NOTE 2 - SECURITIES
The amortized cost, gross unrealized gains and losses and fair value of
securities available for sale as of June 30, 1998, December 31, 1997 and June
30, 1997 are as follows:
<TABLE>
<CAPTION>
JUNE 30, 1998
Amortized Gross Unrealized Fair
Securities available for sale Cost Gains Losses Value
--------- ------- --------- --------
<S> <C> <C> <C> <C>
U.S. Treasury............................... $18,043 $21 ($1) $18,063
U.S. Government agencies and corporations... 126,857 70 (173) 126,754
States and political subdivisions........... 20,862 649 (4) 21,507
Mortgage-backed securities.................. 11,366 123 (6) 11,483
Equity securities........................... 1,995 249 0 2,244
--------- ------- --------- --------
Total.................................... $179,123 $1,112 ($184) $180,051
--------- ------- --------- --------
--------- ------- --------- --------
DECEMBER 31, 1997
Amortized Gross Unrealized Fair
Securities available for sale Cost Gains Losses Value
--------- ------- --------- --------
U.S. Treasury............................... $14,017 $15 ($1) $14,031
U.S. Government agencies and corporations... 129,077 45 (250) 128,872
States and political subdivisions........... 21,712 720 (24) 22,408
Mortgage-backed securities.................. 13,033 137 (47) 13,123
Equity securities........................... 2,069 196 (27) 2,238
--------- ------- --------- --------
Total.................................... $179,908 $1,113 ($349) $180,672
--------- ------- --------- --------
--------- ------- --------- --------
JUNE 30, 1997
Amortized Gross Unrealized Fair
Securities available for sale Cost Gains Losses Value
--------- ------- --------- --------
U.S. Treasury............................... $11,070 $15 ($4) $11,081
U.S. Government agencies and corporations... 94,359 30 (643) 93,746
States and political subdivisions........... 23,907 583 (43) 24,447
Mortgage-backed securities.................. 14,722 151 (116) 14,757
Equity securities and mutual fund
investment in debt securities............ 2,069 181 (86) 2,164
--------- ------- --------- --------
Total.................................... $146,127 $960 ($892) $146,195
--------- ------- --------- --------
--------- ------- --------- --------
</TABLE>
7
<PAGE>
NORTHERN STATES FINANCIAL CORPORTATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
(Dollar amounts in thousands, except per share data)
(Unaudited)
Contractual maturities of debt securities at June 30, 1998 were as
follows. Securities not due at a single maturity date, primarily
mortgage-backed securities, are shown separately.
<TABLE>
<CAPTION>
Amortized Fair
Securities available for sale Cost Value
-------------------
<S> <C> <C>
Due in one year of less..................... $17,594 $17,609
Due after one year through five years....... 132,498 132,805
Due after five years through ten years...... 15,670 15,910
-------------------
165,762 166,324
Mortgage-backed securities.................. 11,366 11,483
Equity securities........................... 1,995 2,244
-------------------
Total.................................. $179,123 $180,051
-------------------
-------------------
</TABLE>
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 Government National
Mortgage Corporation (GNMA) or the Federal National Mortgage Association
(FNMA).
Agency securities with call options totalled $123,345 at June 30, 1998.
As of June 30, 1998, the Company held structured notes with an amortized cost
of $2,000 and fair value of $1,999. These securities were issued by the
Federal Home Loan Bank (FHLB) and the FHLMC. The structured notes are
comprised of securities which have coupon interest rates which "step up"
periodically during the term to maturity.
There were no sales of securities during the three or six months ended
June 30, 1998 and 1997.
Securities carried at $111,237 and $96,822 at June 30, 1998 and 1997 were
pledged to secure public deposits, repurchase agreements and for other
purposes as required or permitted by law.
8
<PAGE>
NORTHERN STATES FINANCIAL CORPORTATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
(Dollar amounts in thousands, except per share data)
(UNAUDITED)
NOTE 3 - LOANS
The Company makes loan to, and obtains deposits from, customers
primarily in Lake County, Illinois and surrounding areas. Most loans are
secured by specific items of collateral, including commercial and residential
real estate and other business and consumer assets.
Loans at June 30, 1998, December 31, 1997 and June 30, 1997 were as
follows:
<TABLE>
<CAPTION>
June 30, December 31, June 30,
1998 1997 1997
----------------------------------
<S> <C> <C> <C>
Commercial............................. $56,519 $54,701 $54,426
Real estate - construction............. 25,515 26,768 26,795
Real estate - mortgage................. 146,720 152,856 151,309
Installment............................ 8,684 8,544 8,962
----------------------------------
Total loans.......................... 237,438 242,869 241,492
Unearned income........................ (121) (154) (173)
Deferred loan fees..................... (441) (491) (474)
----------------------------------
Loans, net of unearned income
and deferred loan fees............... 236,876 242,224 240,845
Allowance for loan losses.............. (5,466) (5,430) (5,389)
----------------------------------
Loans, net........................... $231,410 $236,794 $235,456
----------------------------------
----------------------------------
</TABLE>
Loans held for sale on June 30, 1998, December 31, 1997 and June 30,
1997 were $2,847, $1,338 and $1,034 and are classified as real estate -
mortgage loans.
Real estate - mortgage loans with a carrying value of $22,315,
$24,807 and $16,055 were pledged to secure public deposits at June 30, 1998,
December 31, 1997 and June 30, 1997. The Company has pledged real estate -
mortgage loans on residential property in an amount equal to at least 167%
of the outstanding Federal Home Loan Bank advances.
Non-performing loans, which includes loans contractually past due ninety
days or more, loans accounted for on a nonaccrual basis, and loans whose
terms have been renegotiated to provide a reduction or deferral of interest
or principal because of deterioration in the financial position of the
borrower, amounted to $856 at June 30, 1998, $1,006 at December 31, 1997 and
$1,528 at June 30, 1997.
9
<PAGE>
NORTHERN STATES FINANCIAL CORPORTATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
(Dollar amounts in thousands, except per share data)
(Unaudited)
Impaired loans were as follows for June 30, 1998, December 31, 1997 and
June 30, 1997:
<TABLE>
<CAPTION>
June 30, December 31, June 30,
1998 1997 1997
------- ------------ --------
<S> <C> <C> <C>
Loans with no allowance
for losses allocated....... $0 $0 $0
Loans with allowance
for losses allocated....... 620 754 739
Amount of the allowance
allocated.................. 94 125 100
</TABLE>
Average balance and income recognized on impaired loans were as follows
for the three and six months ended June 30, 1998 and June 30, 1997:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30, June 30, June 30,
1998 1997 1998 1997
--------------------------------------
<S> <C> <C> <C> <C>
Average of impaired
loans during the period........... $621 $778 $666 $902
Interest income recognized
during the impairment period...... 0 13 8 16
Cash-basis interest income recognized
during the impairment period...... 0 13 8 16
</TABLE>
The Company is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet financing needs of its
customers. These financial instruments include commitments to make loans,
standby letters of credit, and unused lines of credit. The Company's
exposure to credit loss in the event of nonperformance by the other parties
to these financial instruments is represented by the contractual amount of
the instruments. The Company uses the same credit policy to make such
commitments as it uses for on-balance-sheet items.
10
<PAGE>
NORTHERN STATES FINANCIAL CORPORTATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
(Dollar amounts in thousands, except per share data)
(Unaudited)
At June 30, 1998, December 31, 1997 and June 30, 1997, the contract
amount of the Company's off-balance sheet commitments was as follows:
<TABLE>
<CAPTION>
June 30, December 31, June 30,
1998 1997 1997
------------------------------------
<S> <C> <C> <C>
Unused lines of credit and
commitments to make loans:
Fixed rate........................ $25,907 $20,388 $17,795
Variable rate..................... 65,909 54,339 53,022
------------------------------------
Total.......................... $91,816 $74,727 $70,817
------------------------------------
------------------------------------
Standby letters of credit............ $7,204 $6,891 $6,237
</TABLE>
Since many commitments to make loans expire without being used, the
amounts above do not necessarily represent future cash commitments.
Collateral obtained upon exercise of the commitments is determined using
management's credit evaluation of the borrower, and may include commercial
and residential real estate and other business and consumer assets.
11
<PAGE>
NORTHERN STATES FINANCIAL CORPORTATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
(Dollar amounts in thousands, except per share data)
(Unaudited)
NOTE 4 - ALLOWANCES FOR LOAN LOSSES AND OTHER REAL ESTATE OWNED LOSSES
Activity in the allowance for loan losses for the six months ended June
30, 1998, twelve months ended December 31, 1997 and six months ended June 30,
1997 is as follows:
<TABLE>
<CAPTION>
June 30, December 31, June 30,
1998 1997 1997
--------------------------------
<S> <C> <C> <C>
Balance at beginning of period........... $5,430 $4,839 $4,839
Provision charged to operating expense... 10 480 360
Loans charged off........................ (6) (209) (79)
Recoveries on loans
previously charged off................. 32 320 269
--------------------------------
Balance at end of period.............. $5,466 $5,430 $5,389
--------------------------------
--------------------------------
</TABLE>
Activity in the allowance for other real estate owned losses for the six
months ended June 30, 1998, twelve months ended December 31, 1997 and six
months ended June 30, 1997 is as follows:
<TABLE>
<CAPTION>
June 30, December 31, June 30,
1998 1997 1997
--------------------------------
<S> <C> <C> <C>
Balance at beginning of period.......... $544 $532 $532
Provision charged to operating expense.. 8 21 11
Losses on other real estate owned....... 0 (9) (8)
--------------------------------
Balance at end of period............. $552 $544 $535
--------------------------------
--------------------------------
</TABLE>
12
<PAGE>
NORTHERN STATES FINANCIAL CORPORTATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
(Dollar amounts in thousands, except per share data)
(Unaudited)
NOTE 5 - PROVISION FOR INCOME TAX
The provision for income taxes represents federal and state income tax
expense calculated using annualized rates on taxable income generated during
the respective periods.
NOTE 6 - STOCKHOLDERS' EQUITY
For the six months ended June 30, 1998 total stockholders' equity
increased $2,409. The increase is a result of net income of $3,522, plus the
change in the valuation allowance from December 31, 1997 for the fair value
of securities available for sale, net of tax, of $100, plus $33 due to the
exercise of 4,000 stock options pursuant to the Omnibus Incentive Plan, less
cash dividends of $1,246.
For the six months ended June 30, 1997 total stockholders' equity
increased $2,240 due to net income of $3,212, less the change in the
valuation allowance from December 31, 1996 for the fair value of securities
available for sale, net of tax, of $51, less cash dividends paid $1,023.
NOTE 7 - OMNIBUS INCENTIVE PLAN INSTRUMENTS
The 1992 Omnibus Incentive Plan (the "Plan") authorizes the issuance of
up to 375,000 shares of the Company's common stock, including the granting of
non-qualified stock options, restricted stock and stock appreciation rights.
Statement of Financial Accounting Standards No. 123 which became
effective for 1996, requires pro forma disclosures for companies that do not
adopt its fair value accounting method for stockbased employee compensation.
The Company did not grant any stock options during the six months ended June
30, 1998 or during the entire year, 1997.
13
<PAGE>
NORTHERN STATES FINANCIAL CORPORTATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
(Dollar amounts in thousands, except per share data)
(Unaudited)
Stock options may be used to reward directors and employees and provide
them with an additional equity interest in the Company. Options have been
issued for 10 year periods and are fully vested when granted.
<TABLE>
<CAPTION>
Weighted-Avg.
Number of Exercise
Options Price
-----------------------
<S> <C> <C>
Outstanding at January 1, 1997......... 25,890 $8.32
Exercised during period ended
June 30, 1997.......................... 0 0
-----------------------
Outstanding at June 30, 1997........... 25,890 $8.32
----------
----------
Outstanding at January 1, 1998......... 25,390 $8.32
Exercised during period ended
June 30, 1998.......................... (4,000) 8.34
-----------------------
Outstanding at June 30, 1998........... 21,390 $8.32
----------
----------
</TABLE>
At June 30, 1998, all remaining options had an exercise price of $8.32.
The options outstanding had a remaining life of 3.5 years.
The Company 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 a grant over
the grant price. During the six months ended June 30, 1998 and 1997 no stock
appreciation rights were exercised. As of June 30, 1998 and 1997, 16,240
stock appreciation rights were outstanding that had been granted at $8.32.
The Company's expense was $40 and $(3) for the three months ended June 30,
1998 and 1997 and $180 and $16 for the six months ended June 30, 1998 and
1997. The stock appreciation rights will expire in 2002.
14
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion focuses on the consolidated financial conditions
of the Northern States Financial Corporation (the"Company") at June 30, 1998 and
the consolidated results of operations for the three and six month periods
ending June 30, 1998, compared to the same periods of 1997. The purpose of this
discussion is to provide a better understanding of the condensed consolidated
financial statements and the operations of its subsidiary, the Bank of Waukegan
(the "Bank"). This discussion should be read in conjunction with the interim
condensed consolidated financial statements and notes thereto included herein.
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 report that a number of important factors could
cause the Company's actual results subsequent to June 30, 1998 to differ
materially from those expressed in any such forward-looking statements.
On December 17, 1997 the Company's Board of Directors announced that it had
approved the merger of its two wholly owned subsidiaries, Bank of Waukegan and
First Federal Bank, fsb. The merger became effective April 21, 1998 with the
Bank of Waukegan as the surviving entity in the merger. Management believes that
the merger will increase efficiencies and lower noninterest expenses in future
years.
On February 17, 1998, the Company's Board of Directors approved a proposal
to amend the Company's certificate of incorporation to increase the authorized
common shares from 1,750,000 to 6,500,000 and effect a 5-for-1 stock split. The
amendment was approved by the stockholders at the annual meeting of stockholders
that was held on April 23, 1998. The split became effective to stockholders of
record on May 5, 1998 and an additional 4 shares of common stock for each share
held were mailed on May 15, 1998. Book value per share, basic earnings per
share, diluted earnings per share and all omnibus incentive plan information
have been restated for all periods to reflect the effect of the 5-for-1 stock
split.
FINANCIAL CONDITION
The consolidated total assets for the Company were $472.3 million at June
30, 1998, increasing $13.3 million from the Company's year-end, December 31,
1997.
The Company's federal funds sold at June 30, 1998 was $31.0 million which
is an increase of $19.8 million from December 31, 1997. The Company's federal
funds sold position increased for liquidity purposes as some seasonal deposit
runoff is expected during the third quarter of 1998.
Securities in total were $180.1 million decreasing slightly by $.6 million
from the previous year-end. The securities available for sale portfolio showed
increases in U.S. Treasury securities of $4.0 million which was offset by
decreases of U.S. Government agency issues of $2.1 million, state and
political subdivision securities of $.9 millions and mortgage-backed securities
of $1.6 million.
15
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Company's loans decreased $5.3 million or 2.21% from December 31, 1997.
The decrease in loans occurred primarily in the real estate - mortgage loan
portfolio which decreased $6.1 million. The decline in the real estate -
mortgages was due to payoffs on several large commercial mortgages as a result
of businesses being sold or refinanced. Real estate - construction loans
declined $1.3 million while commercial loans increased $1.8 million. There was
no change in the consumer installment loan portfolio from year end.
During the first six months of 1998 deposits at the Company grew $12.2
million. NOW accounts increased $12.8 million as a result of public depositors
temporarily concentrating funds in NOW accounts at June 30, 1998 after the
collection of real estate taxes in June, 1998. During the third quarter of 1998
the NOW balance is expected to decrease as the public depositors make investment
decisions. Noninterest-bearing deposits declined $1.7 million from year-end
while savings and money market accounts increased $1.9 million. Total time
deposits declined $.9 million attributable to decreases in time deposits of
$100,000 and over.
Securities sold under repurchase agreements and other short-term
borrowings at the Company declined $7.0 million from December 31, 1997 to
$31.5 million at June 30, 1998. These funds mainly consist of securities sold
under repurchase agreement that are offered through an overnight repurchase
agreement product and a term product with maturities from 7 days to one year.
Repurchase agreements provide a source of funds to the Company that do not
increase reserve requirements with the Federal Reserve Bank or create an
expense relating to FDIC insurance and, therefore, are less costly to the
Company. The decrease in repurchase agreement funds has been the result of
commercial customers drawing down their balances.
The Company has received term advances from the Federal Home Loan Bank in
the amount of $10,000,000. These funds were used to purchased U.S. Government
agency securities that have call provisions on the same date that the advances
are due to be repaid.
Total stockholders' equity increased $2,409,000 during the six months ended
June 30, 1998. The increase is the result of net income of $3,522,000, plus the
adjustment in the valuation allowance for the market value of securities
available-for-sale, net of tax, of $100,000, plus $33,000 due to the exercise of
4,000 stock options pursuant to the Omnibus Incentive Plan, less cash dividends
paid of $1,246,000.
The tier 1 capital to average asset ratio at June 30, 1998 was 14.24% and
the total capital to asset ratio, on a risk adjusted basis, amounted to 21.49%,
exceeding the minimum required to be capitalized under prompt corrective action
regulations, which minimums are 5.00% and 10.00%. Book value per share, was
$14.07 at June 30, 1998 as compared to $13.54 at December 31, 1997. On June 30,
1998, the Company and its subsidiary were in compliance with all applicable
regulatory capital requirements.
16
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
NET INCOME
The consolidated net income for the quarter ended June 30, 1998 was
$1,796,000, an increase of $166,000 or 10.18%, as compared to net income of
$1,630,000 for the same period the previous year. The annualized return on
average assets was 1.55% for the quarter which was the same as the return on
average assets for the quarter the previous year. The consolidated net income
for the six months ended June 30, 1998 was $3,522,000, an increase of $310,000,
over the first half of 1997. The annualized return on average assets for the
first six months of 1998 was 1.53% which was the same as the return on average
assets for the same period the previous year.
NET INTEREST INCOME
Net interest income, the difference between interest income earned on
average interest earning assets and interest expense on average interest
bearing liabilities, increased $134,000 or 3.12% during the three months
ended June 30, 1998, compared to the same three months in 1997. The increase
in net interest income for the second quarter of 1998 resulted from increased
volume of interest earning assets compared to interest earning assets during
the same period last year. As evidenced in Table 1, "Analysis of Average
Balance and Tax Equivalent Rates for the Three Months ended June 30, 1998 and
1997", average interest earning assets during the second quarter of 1998 were
$442.3 million as compared to $399.1 million last year. Table 1 shows the
yield on interest earning assets declined to 7.92% during the second quarter
of 1998 as compared to 8.19% last year. Table 1 also indicates that rates
paid on interest bearing liabilities increased to 4.72% during the three
months ended June 30, 1998 as compared to 4.68% for the same period last year
as increased rates were paid on other borrowings. The net yield on interest
earning assets declined 32 basis points to 4.16% during the second quarter of
1998 as compared to 4.48% last year. Even though the net yield declined, the
increased volume of interest earning assets increased overall net interest
income during the quarter. Since the beginning of 1998 management has
decreased the rates offered on time deposits by 40 basis points in order to
increase the net yield on interest earning assets. As time deposits mature
and renew the impact of this reduction in time deposit rates will begin to be
observed.
During the first six months of 1998, net interest income increased $356,000
or 4.32% over the same period of 1997. Table 2, "Analysis of Average Balance
and Tax Equivalent Rates for the Six Months ended June 30, 1998 and 1997" shows
that the Company's net yield on interest earning assets was 4.15% for the first
six months of 1998 as compared to 4.41% in 1997. Despite the decline in the
net yield by 26 basis points, net interest income increased as a result of
increased volumes in interest earning assets which were $41.8 million higher
during the first half of 1998 as compared to the same period last year.
Management's lowering of time deposit rates by 40 basis points in 1998 will have
an impact on the net yield on earning assets as time deposits mature and renew
at the lower rates.
17
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
TABLE 1
NORTHERN STATES FINANCIAL CORPORATION
ANALYSIS OF AVERAGE BALANCE AND TAX EQUIVALENT RATES
For the Three Months Ended June 30, 1998 and 1997
($ 000s)
<TABLE>
<CAPTION>
1998 1997
------------------------------- --------------------------------
Average Average
Balance Interest Rate Balance Interest Rate
------------------------------- --------------------------------
<S> <C> <C> <C> <C> <C> <C>
Assets
Loans (1)(2)(3) $242,050 $5,582 9.22% $242,576 $5,591 9.22%
Taxable securities 163,768 2,535 6.20% 125,873 2,027 6.38%
Securities exempt from
taxes (2) 18,797 376 8.28% 21,415 439 8.33%
Interest bearing deposits in banks 438 10 9.13% 468 8 6.84%
Federal funds sold 17,212 235 5.46% 8,731 126 5.77%
-------------------- --------------------
Interest earning assets 442,265 8,738 7.92% 399,063 8,191 8.19%
------------ ------------
Noninterest earning assets 21,160 22,093
-------- --------
Average assets $463,425 $421,156
-------- --------
-------- --------
Liabilities and stockholders' equity
NOW deposits $40,052 285 2.85% $37,305 279 2.99%
Money market deposits 40,953 406 3.97% 39,883 396 3.97%
Savings deposits 44,799 333 2.97% 45,332 335 2.96%
Time deposits 181,478 2,545 5.61% 161,678 2,284 5.65%
Other borrowings 44,463 583 5.24% 32,548 414 5.09%
-------------------- --------------------
Interest bearing
liabilities 351,745 4,152 4.72% 316,746 3,708 4.68%
------------ ------------
Demand deposits 40,553 40,601
Other noninterest bearing liabilities 9,452 7,991
Stockholders' equity 61,675 55,818
-------- --------
Average liabilities and
stockholders' equity $463,425 $421,156
-------- --------
-------- --------
Net interest income $4,586 $4,483
------------ ------------
------------ ------------
Net yield on interest
earning assets 4.16% 4.48%
------------ ------------
------------ ------------
Liabilities to earning
assets ratio 79.68% 79.18%
------------ ------------
------------ ------------
</TABLE>
(1) - Interest income on loans includes loan origination fees of $160 and
$115 for the three months ended June 30, 1998 and 1997.
(2) - Tax-exempt income is reflected on a fully tax equivalent basis
utilizing a 34% rate.
(3) - Non-accrual loans are included in average loans.
18
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
TABLE 2
NORTHERN STATES FINANCIAL CORPORATION
ANALYSIS OF AVERAGE BALANCE AND TAX EQUIVALENT RATES
For the Six Months Ended June 30, 1998 and 1997
($ 000s)
<TABLE>
<CAPTION>
1998 1997
------------------------------- --------------------------------
Average Average
Balance Interest Rate Balance Interest Rate
------------------------------- --------------------------------
<S> <C> <C> <C> <C> <C> <C>
Assets
Loans (1)(2)(3) $242,036 $11,166 9.23% $238,036 $10,904 9.16%
Taxable securities 161,692 5,039 6.24% 124,788 3,995 6.35%
Securities exempt from
federal income taxes (2) 19,209 765 8.26% 21,711 888 8.36%
Interest bearing deposits in banks 569 19 6.68% 569 16 5.62%
Federal funds sold 16,534 453 5.48% 13,172 355 5.39%
-------------------- --------------------
Interest earning assets 440,040 17,442 7.94% 398,276 16,158 8.10%
------------ ------------
Noninterest earning assets 21,072 22,684
-------- --------
Average assets $461,112 $420,960
-------- --------
-------- --------
Liabilities and stockholders' equity
NOW deposits $38,717 576 2.98% $37,242 549 2.95%
Money market deposits 41,120 813 3.95% 41,627 823 3.95%
Savings deposits 44,494 656 2.95% 44,783 660 2.95%
Time deposits 183,303 5,154 5.62% 161,403 4,516 5.60%
Other borrowings 43,590 1,143 5.24% 33,036 818 4.95%
-------------------- --------------------
Interest bearing liabilities 351,224 8,342 4.75% 318,091 7,366 4.63%
------------ ------------
Demand deposits 39,538 39,986
Other noninterest bearing liabilities 9,014 7,288
Stockholders' equity 61,336 55,595
-------- --------
Average liabilities and
stockholders' equity $461,112 $420,960
-------- --------
-------- --------
Net interest income $9,100 $8,792
------------ ------------
------------ ------------
Net yield on interest
earning assets 4.15% 4.41%
------------ ------------
------------ ------------
Interest-bearing liabilities to
earning assets ratio 79.99% 79.75%
------------ ------------
------------ ------------
</TABLE>
(1) - Interest income on loans includes loan origination fees of $290 and
$203 for the six months ended June 30, 1998 and 1997.
(2) - Tax-exempt income is reflected on a fully tax equivalent basis
utilizing a 34% rate.
(3) - Non-accrual loans are included in average loans.
19
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
PROVISION FOR LOAN LOSSES
There was no provision for loan losses during the three months ended June
30, 1998 as compared to $180,000 for the same period the previous year. For the
six months ended June 30, 1998, the provision for loan losses was $10,000
compared to $360,000 for the six months ended June 30, 1997. Management, with
the concurrence of the Board of Directors, lowered the provision for loan losses
during 1998 after a careful review of the adequacy of the allowance for loan
losses and the levels of non-performing and impaired loans.
At June 30, 1998, the allowance for loan losses was $5,466,000 or 2.31% of
loans as compared to 2.24% of loans at June 30, 1997. Nonperforming loans, at
June 30, 1998, were $856,000, down from $1,528,000 at June 30, 1997. Impaired
loans were only $620,000 or .26 % of loans at June 30, 1998 as compared to
impaired loans of $739,000 at June 30, 1997 or .31% of loans. The amount of the
allowance for loan losses allocated for impaired loans at June 30, 1998 declined
to $94,000 from $100,000 at June 30, 1997. Loan charge offs to the allowance
for loan losses have decreased in 1998. During the first six months of 1998
only $6,000 in loans were charged off to the allowance for loan losses as
compared to $79,000 during the same period of 1997. During the first six months
of 1998 recoveries of loans previously charged off were $32,000 as compared to
$269,000 during the same period in 1997.
The adequacy of the allowance for loan losses is analyzed by management and
the Board of Directors at least quarterly. Loans judged to be impaired, loans
with potential loss exposure, loans that are no longer accruing interest, and
historical net loan loss percentages are reviewed in the analysis of the
allowance for loan losses. Based on management's and the Board of Directors'
analysis, the allowance for loan losses at June 30, 1998 is adequate to cover
future possible loan losses. If the level of impaired and nonperforming
remains low during the remainder of 1998, no additional loan loss provision is
budgeted for the remainder of 1998.
NONINTEREST INCOME
Noninterest income for the three months ended June 30, 1998 was $663,000 as
compared to $628,000 for the three months ended June 30, 1997, an increase of
$35,000. Service fees on deposits decreased by $25,000 as compared to the same
quarter last year because of overdraft fee income being $13,000 lower and other
service charges on deposit being $12,000 less than last year. Trust fee income
increased $17,000 during the three months ended June 30, 1998 due to increased
trust business. Other income from gains on sales on loans increased $71,000
during the second quarter of 1998 as there were increased loan sales as
compared to last year. Miscellaneous operating income during the second quarter
of 1998 was $28,000 less than the same period last year in part resulting from
lower loan fee income of $12,000 and an $8,000 gain on the sale of other real
estate owned during the second quarter of 1997.
For the first six months of 1998 noninterest income was $1,288,000 as
compared to $1,376,000 for the same period of 1997, a decrease of $88,000.
Service fees on deposits were $92,000 less during the first half of 1998 as
compared to the same period last year because of decreased overdraft fee income
of $51,000 and service charge income on checking and NOW accounts of $37,000.
The decreased overdraft
20
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
fee income and service charge income can in part be explained by the decline
in the number of checking and NOW accounts at the Company which decreased 576
accounts or 5.65% from June 30, 1997. These accounts belonged to customers
with lower balances who became overdrawn more often and were assessed higher
service charges. Many of these account customers were lost to competitors
such as the local credit unions which have lower balance requirements and
fees. Trust income for the six months ended June 30, 1998 increased $44,000
as a result of increased fiduciary activities. Gains on sales of loans
increased $100,000 during the first half of 1998 compared to the same period
of 1997 due to the increased volume of loan sales as proceeds from loan sales
during the first six months of 1998 totaled $12,084,000 as compared to
$4,586,000 last year. Other operating income declined $140,000 during the six
months ended June 30, 1998 as there were $142,000 on one-time gains on sales
of other real estate owned which occurred during the first half of 1997.
NONINTEREST EXPENSES
Noninterest expenses increased $97,000 or 4.08% during the three months
ended June 30, 1998. The Company's efficiency ratio, noninterest expenses
divided by the sum of net interest income and noninterest income, was 48.61% for
the second quarter of 1998 as compared to 48.30% for the same quarter of 1997.
The efficiency ratio is frequently used as an indicator as to how well a
financial institution manages its noninterest expenses with a decreasing ratio
indicating improved performance. Compared to its peers, the Company's ability
to control overhead is one of its operating strengths.
Increases in salary and employee benefit expenses of $127,000 occurred
during the second quarter of 1998 compared to the same period last year. Salary
expense relating to stock appreciation rights issued under the Omnibus Incentive
Plan were $44,000 greater during the three months ended June 30, 1998 than in
the same three months last year. The balance of the increase is attributable to
annual salary increases and to the hiring of a new senior lender during the
third quarter of 1997.
Occupancy expenses for the second quarter of 1998 were $322,000 which was
a decline of $15,000 from the second quarter of 1997. This decline in occupancy
expenses is attributable to decreased property taxes at the Bank where the
assessed valuation of one location was lowered.
Data processing expense increased $20,000 during the three months ended
June 30, 1998 to $145,000. This increase was related to the merger between the
Bank of Waukegan and First Federal Bank, fsb that became effective April 21,
1998 as data processing merger expenses were incurred.
FDIC insurance was $22,000 during the three months ended June 30, 1998
which remained unchanged from the same period last year.
Other real estate owned expenses declined during the second quarter of
1998 by $21,000. Real estate taxes on other real estate owned declined due to
lower assessed valuation to one of the properties. The decline in expenses
also reflects the slightly smaller real estate owned portfolio that amounted
to $2,547,000 at June 30, 1998 as compared to $2,672,000 at June 30, 1997.
21
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Miscellaneous other operating expenses decreased $14,000 compared to the
same quarter last year. Expenses relating to charged off checking accounts and
bad checks were $29,000 less during the second quarter of 1998 as compared to
last year. Business development expenses were lower during the three months
ended June 30, 1998 by $23,000 as a consequence of the merger as advertising was
no longer needed for two institutions. Legal expenses increased $18,000 during
the second quarter of 1998 and were the result of legal work done to consummate
the merger between the two subsidiaries and to effect the five-for-one stock
split. Loan and collection expenses increased $16,000 due to the increases in
loans sold on the secondary market.
During the six months ended June 30, 1998, total noninterest expenses were
$4,945,000 or $158,000 more than during the same period last year, an increase
of 3.30%. The Company's efficiency ratio was 49.14% for the first half of 1998
as compared to 48.87% for the first half of 1997.
Salaries and employee benefit expense was $343,000 more during the six
months ending June 30, 1998 as compared to the same period last year. Increases
to the Company's stock price increased salary expenses relating to stock
appreciation rights by $164,000 during the six months ended June 30, 1998
compared to the same period last year. Annual salary increases and the payment
of increased commissions due to greater sales of loans on the secondary market
increased salary and employee benefit expense. A final factor increasing salary
expense was that during the third quarter of 1997, a senior lender was added to
staff.
Occupancy expenses were $58,000 less during the first six months of 1998
when compared to the same period of 1997. Decreased property taxes of $29,000
were due to lower assessed valuation of the Company's properties. Utilities
expense was lower during the first half of 1998 by $15,000 due to mild weather.
Data processing expense was $4,000 lower during the first six months of
1998 when compared to the same period of 1997. Increases to data processing
expense relating to the merger were offset by deleting some programming that was
not being utilized.
FDIC deposit insurance expense was $261,000 for the first two quarters of
1998, a slight decrease of $4,000 from the same period last year.
Other real estate owned expenses declined $65,000 during the six months
ending June 30, 1998 as compared to the same period last year as property taxes
on the other real estate owned portfolio declined due to decreases in the
assessed valuation of other real estate owned. The lower other real estate
owned expenses also reflects the slightly smaller real estate owned portfolio
that amounted to $2,547,000 at June 30, 1998 as compared to $2,672,000 at June
30, 1997.
22
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Miscellaneous other operating expenses were $57,000 lower for the six
months ending June 30, 1998 as compared to the same period last year.
Expenses relating to charged off checking accounts and bad checks were
$68,000 less during the first half of 1998 as compared to last year.
Business development expenses were lower during the six months ended June 30,
1998 by $49,000 as a result of the merger. Expenses relating to
correspondent bank accounts were $27,000 less during the six months ended
June 30, 1998 as compared to last year as correspondent bank balances were
larger and earning allowances were greater, thus reducing this expense.
Legal expenses increased $69,000 during the first half 1998 resulting from
the merger between the two subsidiaries and the five-for-one stock split.
Due to the increases in loans sold on the secondary market loan and
collection expenses increased $30,000.
The Company, in compliance with the FFIEC's (Federal Financial
Institutions Examination Council) guidelines, has established a "Year 2000
Action Plan" in order to deal with risks associated with the new millennium
especially in the area of data processing. As part of the "Year 2000 Action
Plan" the Company's Board of Directors is regularly updated as to the
Company's ability to deal with the year 2000 risks.
The "Year 2000 Policy and Action Plan" includes the five basic steps or
phases recommended by the FFIEC: awareness, assessment, renovation, validation
(testing) and implementation. At this time, the Company has completed both the
awareness and assessment phases of its action plan, and the renovation and
testing phases are well under way. It has been determined that both the
Company's item processing system and its teller platform system are not year
2000 compliant. The Company has contracted for the purchase of new hardware and
software for both systems and during the second quarter of 1998 installed the
new item processing system. The combined cost of these projects approximate
$200,000.
The risk the Company has is that the date related accrual of interest on
loans and deposits will adversely be effected by the year 2000. Another risk to
the Company is that its loan customers' businesses will be impaired by the year
2000 in such a way that payments will not be made in a timely fashion.
The Company is developing contingency plans to deal with year 2000
problems if they should happen on January 1, 2000. Methods of recalculting
interest and adjusting customer records are being looked into in the event that
problems result despite our implementations to avoid such problems.
The Company expects to complete its "Year 2000 Action Plan" during the
first quarter of 1999. A majority of the Company's data processing system is
performed by an outside bank data processing service bureau which expects to be
fully year 2000 compliant by December 31, 1998. After the service bureau
completes its year 2000 compliance the Company will complete its "Year 2000
Action Plan" by doing additional testing of the service bureau for year 2000
compliance.
FEDERAL AND STATE INCOME TAXES
For the three months ended June 30, 1998 and 1997, the Company's provision
for federal and state income taxes was $821,000 and $735,000 which as a
percentage of pretax earnings was 31.37% and 31.08%. For the six months ended
June 30, 1998, the Company's provision for federal and state taxes was
$1,587,000 or 31.06% of pretax earnings as compared to $1,437,000 or 30.91% of
pretax earnings for the six months ending June 30, 1997.
23
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 131, "Disclosure about Segments of an Enterprise and
Related Information" which will become effective for fiscal years beginning
after December 15, 1997. The statement establishes standards for the way public
companies report information about operating segments in annual financial
statements and requires that those enterprises report selected financial
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. Management does
not expect that the effect of this statement on its financial reporting will be
material.
NORTHERN STATES FINANCIAL CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
The Company's primary market risk exposure is interest rate risk and, to
a lesser extent, liquidity risk. Interest-rate risk ("IRR") is the exposure
of a banking organization's financial condition to adverse movements in
interest rates. Accepting this risk can be an important source of
profitability and stockholder value, however excessive levels of IRR can pose
a significant threat to the Company's earnings and capital base. Accordingly,
effective risk management that maintains IRR at prudent levels is essential
to the Company's safety and soundness.
Evaluating a financial institution's exposure to changes in interest rates
includes assessing both the adequacy of the management process used to control
IRR and the organization's quantitative level of exposure. When assessing the
IRR management process, the Company seeks to ensure that appropriate policies,
procedures, management information systems and internal controls are in place to
maintain IRR at prudent levels with consistency and continuity. Evaluating the
quantitative level of IRR exposure requires the Company to assess the existing
and potential future effects of changes in interest rates on its consolidated
financial condition, including capital adequacy, earnings, liquidity, and, where
appropriate, asset quality.
The Federal Reserve Board, together with the Office of the Comptroller of the
Currency and the Federal Deposit Insurance Corporation, adopted a Joint Agency
Policy Statement on Interest-Rate Risk, effective June 26, 1996. The policy
statement provides guidance to examiners and bankers on sound practices for
managing interest rate risk, which will form the basis for ongoing evaluation of
the adequacy of interest-rate risk management at supervised institutions. The
policy statement also outlines fundamental elements of sound management that
have been identified in prior Federal Reserve guidance and discusses the
importance of these elements in the context of managing interest-rate risk.
Specifically, the guidance emphasizes the need for active board of director and
senior management oversight and a comprehensive risk-management process that
effectively
24
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
identifies, measures, and controls interest-rate risk. Several techniques might
be used by an institution to minimize interest-rate risk. One approach used by
the Company is to periodically analyze its assets and liabilities and make
future financing and investment decisions based on payment streams, interest
rates, contractual maturities, and estimated sensitivity to actual or potential
changes in market interest rates. Such activities fall under the broad
definition of asset/liability management. The Company's primary asset/liability
management technique is the measurement of the Company's asset/liability gap,
that is, the difference between the cash flow amounts of interest-sensitive
assets and liabilities that will be repriced during a given period.
Several ways an institution can manage interest-rate risk include: selling
existing assets or repaying certain liabilities; matching repricing periods for
new assets and liabilities for example, by shortening terms of new loans or
investments. Financial institutions are also subject to prepayment risk in
falling rate environments. For example, mortgage loans and other financial
assets may be prepaid by a debtor so that the debtor may refund its obligations
at new, lower rates. Prepayments of assets carrying higher rates reduce the
Company's interest income and overall asset yields. A large portion of an
institution's liabilities may be short term or due on demand, while most of its
assets may be invested in long-term loans or investments. Accordingly, the
Company seeks to have in place sources of cash to meet short-term demands. These
funds can be obtained by increasing deposits, borrowing, or selling assets.
The following table provides information about the Company's financial
instruments that are sensitive to changes in interest rates as of December 31,
1997. The table uses December 31, 1997 as there has been no material changes to
the Company's balance sheet and to market interest rate levels from
December 31, 1997. The Company believes that the assumptions utilized are
reasonable. The Company had no derivative financial instruments, or trading
portfolio, as of December 31, 1997. The expected maturity date values for loans
receivable, mortgage-backed securities, and investment securities were
calculated by adjusting the instrument's contractual maturity date for
expectations of prepayments. Expected maturity for interest-bearing core
deposits such as NOW, money market and savings accounts are assumed to be 1998
as these may be withdrawn in a very short time period even though it may be
unlikely. With respect to the Company's adjustable rate instruments, expected
maturity date values were measured by adjusting the instrument's contractual
maturity date for expectations of prepayments. From a risk management
perspective, however, the Company believes that repricing dates, as opposed to
expected maturity dates, may be a more relevant in analyzing the value of such
instruments. Similarly, 42.7% of the Company's investment securities portfolio
at December 31, 1997 is comprised of callable securities. Company borrowings
consist of securities sold under repurchase agreements and a Federal Home Loan
Bank term advance and were tabulated by contractual maturity dates and without
regard to any conversion or repricing dates.
25
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
TABLE 3
NORTHERN STATES FINANCIAL CORPORATION
EXPECTED MATURITY DATES OF ON BALANCE SHEET
FINANCIAL INSTRUMENTS AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
_____________________________ Maturing In____________________________
($ 000s) 1998 1999 2000 2001 2002 Thereafter Totals Fair Value
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest earning assets:
Loans (1) (2)
Fixed rate $17,753 $10,862 $15,771 $24,867 $16,685 $20,776 $106,714 107,151
Average interest rate 8.88% 8.93% 8.98% 9.03% 8.98% 7.86% 8.75%
Adjustable rate 55,486 12,365 13,052 9,012 13,816 32,424 136,155 136,155
Average interest rate 9.17% 9.27% 9.21% 8.98% 9.29% 9.27% 9.21%
Securities
Fixed rate 24,446 19,081 43,344 33,821 33,324 19,625 173,641 173,641
Average interest rate 6.01% 6.30% 6.50% 6.47% 6.55% 7.33% 6.51%
Adjustable rate 0 0 0 0 0 7,031 7,031 7,031
Average interest rate 0.00% 0.00% 0.00% 0.00% 0.00% 6.76% 6.76%
Interest bearing deposits
and federal funds sold
Fixed rate 0 0 100 0 0 0 100 100
Average interest rate 0.00% 0.00% 7.30% 0.00% 0.00% 0.00% 7.30%
Adjustable rate 11,306 0 0 0 0 0 11,306 11,306
Average interest rate 5.57% 0.00% 0.00% 0.00% 0.00% 0.00% 5.57%
Direct lease financing
Fixed rate 749 202 67 149 107 0 1,274 1,274
Average interest rate 7.74% 7.80% 8.74% 7.30% 7.14% 0.00% 7.70%
-------------------------------------------------------------------------------------------
Total $109,740 $42,510 $72,334 $67,849 $63,932 $79,856 $436,221 $436,658
-------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------
Interest bearing liabilities:
Interest bearing deposits (3)
Balances $280,967 $19,952 $5,580 $19 $6 $38 $306,562 $306,958
Average interest rate 4.69% 6.06% 6.22% 5.48% 6.80% 6.01% 4.80%
Borrowings
Balances 37,504 6,000 0 0 0 0 43,504 43,519
Average interest rate 5.27% 5.92% 0.00% 0.00% 0.00% 0.00% 5.36%
-------------------------------------------------------------------------------------------
Total $318,471 $25,952 $5,580 $19 $6 $38 $350,066 $350,477
-------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------
</TABLE>
(1) Does not include net deferred loan fees, unearned income or the allowance
for loan losses.
(2) For fixed rate loans maturities are based on projected scheduled payments.
(3) For NOW, money market and savings deposits all balances assumed mature in
1998.
26
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to sign on its behalf by the undersigned
hereunto duly authorized, on this 13th day of August, 1998.
NORTHERN STATES FINANCIAL CORPORATION
(Registrant)
Date: August 13, 1998 By: /s/ Fred Abdula
-------------------- --------------------------------
Fred Abdula
Chairman if the Board of
Directors and President
Date: August 13, 1998 By: /s/ Thomas M. Nemeth
---------------------- ---------------------------------
Thomas M. Nemeth
Assistant Vice President
27
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 13,767
<INT-BEARING-DEPOSITS> 230
<FED-FUNDS-SOLD> 31,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 180,051
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 238,052
<ALLOWANCE> 5,466
<TOTAL-ASSETS> 472,262
<DEPOSITS> 360,152
<SHORT-TERM> 31,512
<LIABILITIES-OTHER> 7,994
<LONG-TERM> 10,000
0
0
<COMMON> 1,780
<OTHER-SE> 60,824
<TOTAL-LIABILITIES-AND-EQUITY> 472,262
<INTEREST-LOAN> 11,102
<INTEREST-INVEST> 5,544
<INTEREST-OTHER> 472
<INTEREST-TOTAL> 17,118
<INTEREST-DEPOSIT> 7,199
<INTEREST-EXPENSE> 8,342
<INTEREST-INCOME-NET> 8,776
<LOAN-LOSSES> 10
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 4,945
<INCOME-PRETAX> 5,109
<INCOME-PRE-EXTRAORDINARY> 5,109
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,522
<EPS-PRIMARY> .79
<EPS-DILUTED> .79
<YIELD-ACTUAL> 4.15
<LOANS-NON> 771
<LOANS-PAST> 85
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 5,430
<CHARGE-OFFS> 6
<RECOVERIES> 32
<ALLOWANCE-CLOSE> 5,466
<ALLOWANCE-DOMESTIC> 2,895
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 2,570
</TABLE>
