<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 September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to __________
_________________________________________________________
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 September 30, 1998
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
FORM 10-Q
SEPTEMBER 30, 1998
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page Number
Condensed consolidated balance sheets at September 30,
1998, December 31, 1997, and September 30, 1997............... 2
Condensed consolidated statements of income for the three
and nine months ended September 30, 1998 and 1997............ 3
Condensed consolidated statements of comprehenesive income
the three and nine months ended September 30, 1998 and 1997.. 4
Condensed consolidated statements of cash flows for
the nine months ended September 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 - 25
Item 7A. Quantitative and qualitative disclosures about market
risk............................................... 25 - 27
PART II. OTHER INFORMATION
Signatures....................................................... 28
1
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, 1998, December 31, 1997 and September 30, 1997
(In thousands of dollars, except per share data)
<TABLE>
<CAPTION>
September 30, December 31, September 30,
Assets 1998 1997 1997
------------- ------------ -------------
<S> <C> <C> <C>
Cash and due from banks................................. $ 11,403 $ 14,200 $ 15,037
Interest bearing deposits in financial institutions..... 74 106 36
Federal funds sold...................................... 34,000 11,200 30,300
------------- ------------ -----------
Total cash and cash equivalents...................... 45,477 25,506 45,373
Interest bearing deposits in financial institutions -
maturities over 90 days............................. 100 100 100
Securities available for sale........................... 193,682 180,672 155,981
Loans........................................... 238,394 242,224 243,090
Less: Allowance for loan losses......................... (5,478) (5,430) (5,421)
------------- ------------ -----------
Loans, net................................... 232,916 236,794 237,669
Direct lease financing.................................. 1,090 1,274 1,132
Office buildings and equipment, net..................... 5,695 5,899 6,002
Other real estate owned, net of allowance for losses
of $552, $544 and $541............................... 2,497 2,555 2,560
Accrued interest receivable............................. 4,188 4,308 4,079
Other assets.................................... 1,542 1,878 1,777
------------- ------------ ----------
Total assets................................. $487,187 $458,986 $454,673
------------- ------------ ----------
------------- ------------ ----------
Liabilities and Stockholders' Equity
Liabilities
Deposits
Demand - noninterest-bearing................. $ 38,808 $41,388 $ 38,568
NOW accounts................................. 45,687 36,455 38,848
Money market accounts........................ 45,641 38,790 52,527
Savings...................................... 42,605 43,923 43,546
Time, $100,000 and over...................... 108,351 93,469 86,802
Time, under $100,000......................... 88,834 93,925 93,195
------------- ------------ ----------
Total deposits............................ 369,926 347,950 353,486
Securities sold under repurchase agreements
and other short-term borrowings.............. 36,152 38,504 35,690
Federal Home Loan Bank advances................. 10,000 5,000 0
Advances from borrowers for taxes and insurance. 437 1,166 426
Accrued interest payable and other liabilities.. 5,979 6,171 5,692
------------- ------------ ----------
Total liabilities......................... 422,494 398,791 395,294
Stockholders' Equity
Common stock.................................... 1,780 1,779 1,779
Additional paid-in capital...................... 11,254 11,222 11,216
Retained earnings............................... 50,870 46,725 45,809
Unrealized gain on securities available for sale,
net........................................... 789 469 575
------------- ------------ ----------
Total stockholders' equity................... 64,693 60,195 59,379
------------- ------------ ----------
Total liabilities and stockholders' equity... $487,187 $458,986 $454,673
------------- ------------ -------------
------------- ------------ -------------
</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 nine months ended September 30, 1998 and 1997
(In thousands of dollars, except per share data)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Interest income
Loans (including fee income)........... $5,344 $5,618 $16,446 $16,452
Securities
Taxable.............................. 2,594 2,048 7,633 6,043
Exempt from federal income tax...... 244 286 749 872
Interest bearing deposits in financial
institutions......................... 2 7 21 23
Federal funds sold..................... 373 324 826 679
------------- ------------- ------------- -------------
Total interest income............... 8,557 8,283 25,675 24,069
------------- ------------- ------------- -------------
Interest expense
Time deposits.......................... 2,624 2,453 7,778 6,969
Other deposits......................... 1,090 1,071 3,135 3,103
Other borrowings....................... 578 439 1,721 1,257
------------- ------------- ------------- -------------
Total interest expense.............. 4,292 3,963 12,634 11,329
------------- ------------- ------------- -------------
Net interest income....................... 4,265 4,320 13,041 12,740
Provision for loan losses................. 0 120 10 480
------------- ------------- ------------- -------------
Net interest income after provision for
loan losses............................ 4,265 4,200 13,031 12,260
------------- ------------- ------------- -------------
Noninterest income
Service fees on deposits............... 283 322 834 965
Trust income........................... 156 156 498 454
Net gains on sales of loans............ 102 58 262 118
Other operating income................. 195 124 430 499
------------- ------------- ------------- -------------
Total noninterest income............ 736 660 2,024 2,036
------------- ------------- ------------- -------------
Noninterest expenses
Salaries and employee benefits......... 1,314 1,385 4,323 4,051
Occupancy and equipment expenses, net.. 309 289 921 959
Data processing expense................ 116 135 377 400
FDIC deposit insurance expense......... 21 20 64 64
Other real estate owned expenses....... 12 19 73 145
Other operating expenses............... 504 428 1,463 1,444
------------- ------------- ------------- -------------
Total noninterest expenses.......... 2,276 2,276 7,221 7,063
------------- ------------- ------------- -------------
Income before income taxes................ 2,725 2,584 7,834 7,233
Provision for income taxes................ 856 813 2,443 2,250
------------- ------------- ------------- -------------
Net income................................ $1,869 $1,771 $5,391 $4,983
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Basic earnings per common share........... $0.42 $0.40 $1.21 $1.12
Diluted earnings per common share......... $0.42 $0.40 $1.21 $1.12
</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 nine months ended September 30, 1998 and 1997
(In thousands of dollars, except per share data)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net income................................ $1,869 $1,771 $5,391 $4,983
Other comprehensive income:
Unrealized gains arising during period
on securities available for sale, net of tax
of $140, $338, $204, and $388..... 220 533 320 584
------------- ------------- ------------- -------------
Comprehensive income...................... $2,089 $2,304 $5,711 $5,567
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
</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
Nine months ended September 30, 1998 and 1997
(In thousands of dollars)
<TABLE>
<CAPTION>
September 30, September 30,
1998 1997
------------- -------------
<S> <C> <C>
Cash flows from operating activities
Net income................................................ $ 5,391 $ 4,983
Adjustments to reconcile net income to cash from
operating activities:
Depreciation........................................... 425 416
Provision for loan losses.............................. 10 480
Provision for losses on other real estate owned........ 10 17
Deferred loan fees..................................... (60) (53)
Proceeds from sales of loans........................... 18,304 6,990
Loans originated for sale.............................. (18,499) (6,965)
Net gains on sales of loans............................ (262) (118)
Net (gains) losses on sales of other real estate owned. 2 (142)
Amortization of mortgage servicing rights.............. 46 25
Net change in interest receivable...................... 120 (124)
Net change in interest payable......................... (28) 436
Net change in other assets............................. 55 785
Net change in other liabilities........................ (133) 55
--------- ---------
Net cash from operating activities................... 5,381 6,785
--------- ---------
Cash flows from investing activities
Proceeds from maturities and calls
of securities available for sale....................... 119,519 49,434
Purchases of securities available for sale............. (132,005) (54,693)
Change in loans made to customers...................... 4,385 (10,426)
Property and equipment expenditures.................... (221) (168)
Net change in direct lease financing................... 184 (133)
Proceeds from sales of other real estate owned......... 46 587
--------- ---------
Net cash from investing activities................... (8,092) (15,399)
--------- ---------
Cash flows from financing activities
Net change in:
Deposits.............................................. 21,976 24,691
Securities sold under repurchase agreements
and other short-term borrowings..................... 2,648 (1,068)
Advances from borrowers for taxes and insurance....... (729) (595)
Net proceeds from exercise of stock options............. 33 0
Dividends paid.......................................... (1,246) (1,023)
--------- ---------
Net cash from financing activities................... 22,682 22,005
--------- ---------
Net change in cash and cash equivalents..................... 19,971 13,391
Cash and cash equivalents at beginning of period............ 25,506 31,982
--------- ---------
Cash and cash equivalents at end of period.................. $ 45,477 $45,373
--------- ---------
--------- ---------
Supplemental disclosures
Cash paid during the period for
Interest............................................. $12,662 $10,893
Income taxes......................................... 2,439 2,159
Noncash investing activities
Transfers made from loans to other real estate owned.. 0 176
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 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 September 30, 1998,
December 31, 1997 and September 30, 1997. The condensed consolidated
statements of income and the condensed consolidated statements of
comprehensive income are for the three and nine months ended September 30,
1998 and 1997. The condensed consolidated statements of cash flows are for
the nine months ended September 30, 1998 and 1997.
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 nine month periods ended
September 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>
September 30, December 31, September 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 CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 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 September 30, 1998, December 31, 1997 and
September 30, 1997 are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 Amortized Gross Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury............................. $13,033 $86 $0 $ 13,119
U.S. Government agencies and corporations. 144,993 223 (67) 145,149
States and political subdivisions......... 21,815 773 0 22,588
Mortgage-backed securities................ 10,558 117 0 10,675
Equity securities......................... 1,995 161 (5) 2,151
---------------------------------------------------------
Total.................................. $192,394 $1,360 ($72) $193,682
---------------------------------------------------------
---------------------------------------------------------
DECEMBER 31, 1997 Amortized Gross Unrealized Fair
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
---------------------------------------------------------
$179,908 $1,113 ($349) $180,672
---------------------------------------------------------
---------------------------------------------------------
SEPTEMBER 30, 1997 Amortized Gross Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------------
U.S. Treasury............................ $14,031 $16 $0 $ 14,047
U.S. Government agencies and corporations 101,848 117 (134) 101,831
States and political subdivisions........ 23,115 697 (29) 23,783
Mortgage-backed securities............... 13,979 166 (75) 14,070
Equity securities and mutual fund
investment in debt securities......... 2,069 222 (41) 2,250
---------------------------------------------------------
Total................................. $155,042 $1,218 ($279) $155,981
---------------------------------------------------------
---------------------------------------------------------
</TABLE>
7
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(Dollar amounts in thousands, except per share data)
(Unaudited)
Contractual maturities of debt securities at September 30, 1998 were as
follows. Securities not due at a single maturity date, primarily mortgage-
backed securities, are shown separately.
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
-------------------------
<S> <C> <C>
Due in one year of less.................. $18,061 $18,138
Due after one year through five years.... 137,604 138,211
Due after five years through ten years... 24,176 24,507
-------------------------
179,841 180,856
Mortgage-backed securities............... 10,558 10,675
Equity securities........................ 1,995 2,151
-------------------------
Total................................... $192,394 $193,682
-------------------------
-------------------------
</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).
The fair value of agency securities with call options totalled $141,595
at September 30, 1998. As of September 30, 1998, the Company held one
structured note with an amortized cost of $1,000 and fair value of $1,001.
This security was issued by the Federal Home Loan Bank (FHLB) and has a
floating interest rate that may be adjusted periodically during the term to
maturity.
There were no sales of securities during the three or nine months ended
September 30, 1998 and 1997.
Securities carried at $135,401 and $100,062 at September 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 CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(Dollar amounts in thousands, except per share data)
(Unaudited)
NOTE 3 - LOANS
The Company makes loans 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 September 30, 1998, December 31, 1997 and September 30, 1997 were
as follows:
<TABLE>
<CAPTION>
September 30, December 31, September 30,
1998 1997 1997
--------------------------------------------
<S> <C> <C> <C>
Commercial.............................. $58,311 $54,701 $ 56,449
Real estate - construction.............. 24,855 26,768 26,515
Real estate - mortgage.................. 147,660 152,856 151,675
Installment............................. 8,106 8,544 9,088
--------------------------------------------
Total loans........................... 238,932 242,869 243,727
Unearned income......................... (107) (154) (161)
Deferred loan fees...................... (431) (491) (476)
--------------------------------------------
Loans, net of unearned income
and deferred loan fees.............. 238,394 242,224 243,090
Allowance for loan losses............... (5,478) (5,430) (5,421)
--------------------------------------------
Loans, net............................ $232,916 $236,794 $237,669
--------------------------------------------
--------------------------------------------
</TABLE>
Loans held for sale on September 30, 1998, December 31, 1997 and September
30, 1997 were approximately $1,795, $1,338 and $925 and are classified as real
estate loans.
Real estate - mortgage loans with a carrying value of $21,646, $24,807 and
$15,548 were pledged to secure public deposits at September 30, 1998, December
31, 1997 and September 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 $4,306 at September 30, 1998, $1,006 at December 31, 1997 and
$2,270 at September 30, 1997.
9
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(Dollar amounts in thousands, except per share data)
(Unaudited)
Impaired loans were as follows for September 30, 1998, December 31, 1997
and September 30, 1997:
<TABLE>
<CAPTION>
September 30, December 31, September 30,
1998 1997 1997
--------------------------------------------
<S> <C> <C> <C>
Loans with no allowance
for losses allocated.................. $0 $0 $0
Loans with allowance
for losses allocated.................. 3,949 754 647
Amount of the allowance
allocated............................. 593 125 109
</TABLE>
The average balance and income recognized on impaired loans were as
follows for the three and nine months ended September 30, 1998 and
September 30, 1997:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
----------------------------------------------------------
<S> <C> <C> <C> <C>
Average of impaired
loans during the period................. $1,734 $627 $1,022 $810
Interest income recognized
during the impairment period............ 0 18 0 34
Cash-basis interest income recognized
during the impairment period............ 0 18 8 34
</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 CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 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>
September 30, December 31, September 30,
1998 1997 1997
-------------------------------------------
<S> <C> <C> <C>
Unused lines of credit and
commitments to make loans:
Fixed rate......................... $31,264 $20,388 $17,302
Variable rate...................... 64,499 54,339 52,698
-------------------------------------------
Total........................... $95,763 $74,727 $70,000
-------------------------------------------
-------------------------------------------
Standby letters of credit............. $6,631 $6,891 $5,979
</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 CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(Dollar amounts in thousands, except per share data)
(Unaudited)
NOTE 4 - ALLOWANCE FOR LOAN LOSSES AND OTHER REAL ESTATE OWNED LOSSES
Activity in the allowance for loan losses for the nine months ended
September 30, 1998, twelve months ended December 31, 1997 and nine months ended
September 30, 1997 is as follows:
<TABLE>
<CAPTION>
September 30, December 31, September 30,
1998 1997 1997
--------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year............... $5,430 $4,839 $4,839
Provision charged to operating expense..... 10 480 480
Loans charged off.......................... (11) (209) (190)
Recoveries on loans
previously charged off................... 49 320 292
--------------------------------------------
Balance at end of period................ $5,478 $5,430 $5,421
--------------------------------------------
--------------------------------------------
</TABLE>
Activity in the allowance for other reals estate owned losses for the nine
months ended September 30, 1998, twelve months ended December 31, 1997 and nine
months ended September 30, 1997 is as follows:
<TABLE>
<CAPTION>
September 30, December 31, September 30,
1998 1997 1997
--------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year............... $544 $532 $532
Provision charged to operating expense..... 10 21 17
Losses on other real estate owned.......... (2) (9) (8)
--------------------------------------------
Balance at end of period................ $552 $544 $541
--------------------------------------------
--------------------------------------------
</TABLE>
12
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 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 nine months ended September 30, 1998 total stockholders' equity
increased $4,498. The increase is a result of net income of $5,391, plus the
change in the valuation allowance from December 31, 1997 for the fair value of
securities available for sale, net of tax, of $320, 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 nine months ended September 30, 1997 total stockholders' equity
increased $4,544 due to net income of $4,983, plus the change in the valuation
allowance from December 31, 1996 for the fair value of securities available for
sale, net of tax, of $584, 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 nine months ended September 30, 1998
or during the entire year, 1997.
13
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 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>
Number of Weighted-Avg.
Options Exercise Price
---------------------------
<S> <C> <C>
Outstanding at January 1, 1997............ 25,890 $8.32
Exercised during period ended
September 30, 1997...................... 0 0
---------------------------
Outstanding at September 30, 1997......... 25,890 $8.32
---------
---------
Outstanding at January 1, 1998............ 25,390 $8.32
Exercised during period ended
September 30, 1998...................... (4,000) 8.34
---------------------------
Outstanding at September 30, 1998......... 21,390 $8.32
---------
---------
</TABLE>
At September 30, 1998, all remaining options had an exercise price of
$8.32. The options outstanding had a remaining life of 3.25 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 nine months ended September 30, 1998 no stock
appreciation rights were exercised. During the nine months ended September 30,
1997, 3,280 stock appreciation rights were exercised and payment was made to
the holders. As of September 30, 1998 and 1997, 16,240 stock appreciation
rights were outstanding that had been granted at $8.32. The Company's expense
was ($117) and $26 for the three months ended September 30, 1998 and 1997 and
was $63 and $42 for the nine months ended September 30, 1998 and 1997. The
stock appreciation rights will expire during 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
September 30, 1998 and the consolidated results of operations for the three
and nine month periods ending September 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 September 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 $487.2 million at
September 30, 1998, increasing $28.2 million from the Company's year-end,
December 31, 1997.
The Company's federal funds sold at September 30, 1998 was $34.0 million
which is an increase of $22.8 million from December 31, 1997. The Company's
federal funds sold position has been increased for liquidity purposes.
Securities in total were $193.7 million increasing by $13.0 million from
the previous year-end. The securities available for sale portfolio showed
increases in U.S. Government agency issues of $16.2 million and in securities
issued by state and political subdivisions of $.2 million. As a result of
lower loan volume and increased deposits, U.S. Goverment agency issues were
purchased because of the attractive yields earned on them. Mortgage-backed
securities, U.S. Treasury and equity securities decreased by $2.4 million, $.9
million and $.1 million.
15
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Company's loans decreased $3.8 million or 1.58% from December 31,
1997. The decrease in loans occurred primarily in the real estate - mortgage
loan portfolio which decreased $5.1 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 $1.9 million while commercial loans increased $3.6 million.
The consumer installment loan portfolio also declined $.4 million from year
end.
During the first nine months of 1998 deposits at the Company grew $22.0
million or 6.32%. Time deposits of $100,000 and over increased $14.9 million
and NOW accounts increased $9.2 million primarily as a result of the infusion
of public deposits. Being located in the county seat, the Company accepts
deposits from various local governments which collected property taxes in
June and September. Many of the public depositors have long term deposit
relationships with the Bank and the Bank is able meet the public depositors'
need to have securities pledged to secure their deposits. Money market
deposits increased $6.9 million due to increases from commercial and public
depositors. Time deposits, under $100,000 declined $5.1 million from year-end
while noninterest-bearing deposits and savings decreased $2.6 million and
$1.3 million.
Securities sold under repurchase agreements and other short-term
borrowings at the Company declined $2.4 million from December 31, 1997 to
$36.2 million at September 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 which have increased $5,000,000 from year end.
These funds have been 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 $4,498,000 during the nine months
ended September 30, 1998. The increase is the result of net income of
$5,391,000, plus the adjustment in the valuation allowance for the market
value of securities available-for-sale, net of tax, of $320,000, 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 September 30, 1998 was
14.67% and the total capital to asset ratio, on a risk adjusted basis,
amounted to 21.50%, exceeding the minimum required to be well capitalized
under prompt corrective action regulations, which minimums are 5.00% and
10.00%. Book value per share was $14.53 at September 30, 1998 as compared to
$13.54 at December 31, 1997. On September 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
Consolidated net income for the quarter ended September 30, 1998 was
$1,869,000, an increase of $98,000 or 5.53%, as compared to net income of
$1,771,000 for the same period the previous year. The annualized return on
average assets was 1.58% for the quarter which was down slightly from 1.62% for
the quarter the previous year. Consolidated net income for the nine months
ended September 30, 1998 was $5,391,000, an increase of $408,000 or 8.19%, over
the first nine months of 1997. The annualized return on average assets for the
first nine months of 1998 was 1.55% which was the slightly less than 1.56% 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, decreased $55,000 or 1.27% during the three months ended
September 30, 1998, compared to the same three months in 1997. The decrease
in net interest income for the third quarter of 1998 resulted from decreased
yields on interest earning assets compared to yields on 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
September 30, 1998 and 1997", the yield on interest earning assets declined
to 7.68% during the third quarter of 1998 as compared to 8.16% last year, a
decline of 48 basis points. The decline is attributable to yields earned on
loans which declined to 8.98% during the third quarter of 1998 as compared to
9.36% last year. Competition for loans during 1998 has kept loan rates lower
than in the past. Table 1 also indicates that rates paid on interest bearing
liabilities remained fairly stable declining only 3 basis points to 4.73%
from 4.76% last year. The net yield on interest earning assets declined 44
basis points to 3.90% during the third quarter of 1998 as compared to 4.34%
last year. Since the beginning of 1998 management has decreased the rates
offered on time deposits by approximately 60 basis points in order to
increase the net yield on interest earning assets. The impact of the
decrease in time deposit rates has been partially offset by the increases in
time deposits, $100,000 and over which generally are paid higher rates than
other deposit instruments. As time deposits mature and renew the impact of
this reduction in time deposit rates will be observed.
During the first nine months of 1998, net interest income increased
$301,000 or 2.36% over the same period of 1997. Table 2, "Analysis of Average
Balance and Tax Equivalent Rates for the Nine Months ended September 30, 1998
and 1997" shows that the Company's net yield on interest earning assets was
4.06% for the first nine months of 1998 as compared to 4.39% in 1997. Despite
the decline in the net yield by 33 basis points, net interest income increased
as a result of increased volumes in interest earning assets which were $41.0
million higher during the first nine months of 1998 as compared to the same
period last year. Management's lowering of time deposit rates by 60 basis
points in 1998 will have an impact on the net yield on earning assets as time
deposits mature and renew at the lower rates.
17
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
TABLE 1
NORTHERN STATES FINANCIAL CORPORATION
ANALYSIS OF AVERAGE BALANCE AND TAX EQUIVALENT RATES
For the Three Months Ended September 30, 1998 and 1997
($ 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) $239,615 $5,380 8.98% $241,606 $5,655 9.36%
Taxable securities 169,645 2,594 6.13% 129,324 2,048 6.33%
Securities exempt from taxes (2) 18,678 370 8.19% 21,183 434 8.39%
Interest bearing deposits in banks 173 2 4.62% 473 7 5.92%
Federal funds sold 26,824 373 5.56% 23,015 324 5.63%
----------------------- -------------------------
Interest earning assets 454,935 8,719 7.68% 415,601 8,468 8.16%
--------------- ---------------
Noninterest earning assets 20,184 22,441
-------- ---------
Average assets $475,119 $438,042
-------- ---------
-------- ---------
Liabilities and stockholders' equity
NOW deposits $41,858 315 3.01% $38,565 287 2.98%
Money market deposits 44,789 450 4.02% 44,846 451 4.02%
Savings deposits 43,321 325 3.00% 44,450 333 3.00%
Time deposits 188,637 2,624 5.56% 170,988 2,453 5.74%
Other borrowings 44,628 578 5.18% 34,302 439 5.12%
----------------------- -------------------------
Interest bearing
liabilities 363,233 4,292 4.73% 333,151 3,963 4.76%
--------------- ---------------
Demand deposits 40,807 40,298
Other noninterest bearing liabilities 7,697 6,658
Stockholders' equity 63,382 57,935
-------- -------
Average liabilities and
stockholders' equity $475,119 $438,042
-------- --------
-------- --------
Net interest income $4,427 $4,505
-------- --------
-------- --------
Net yield on interest
earning assets 3.90% 4.34%
-------- --------
-------- --------
Liabilities to earning
assets ratio 80.02% 80.24%
-------- --------
-------- --------
</TABLE>
(1) - Interest income on loans includes loan origination fees of $103
and $ 116 for the three months ended September 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 Nine Months Ended September 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) $241,229 $16,546 9.15% $239,226 $16,559 9.23%
Taxable securities 164,343 7,633 6.20% 126,300 6,043 6.34%
Securities exempt from
federal income taxes (2) 19,032 1,135 8.24% 21,535 1,322 8.37%
Interest bearing deposits in banks 437 21 6.41% 537 23 5.71%
Federal funds sold 19,964 826 5.52% 16,453 679 5.50%
------------------------ -------------------------
Interest earning assets 445,005 26,161 7.86% 404,051 24,626 8.12%
--------------- ---------------
Noninterest earning assets 20,776 22,603
--------- ----------
Average assets $465,781 $426,654
--------- ----------
--------- ----------
Liabilities and stockholders' equity
NOW deposits $39,764 891 2.99% $37,683 836 2.96%
Money market deposits 42,343 1,263 3.98% 42,700 1,274 3.98%
Savings deposits 44,103 981 2.97% 44,672 993 2.96%
Time deposits 185,081 7,778 5.60% 164,598 6,969 5.65%
Other borrowings 43,936 1,721 5.22% 33,458 1,257 5.01%
------------------------ -------------------------
Interest bearing liabilities 355,227 12,634 4.74% 323,111 11,329
--------------- --------------- 4.67%
Demand deposits 39,961 40,090
Other noninterest bearing liabilities 8,575 7,078
Stockholders' equity 62,018 56,375
--------- ----------
Average liabilities and
stockholders' equity $465,781 $426,654
--------- ----------
--------- ----------
Net interest income $13,527 $13,297
--------- -------------
--------- -------------
Net yield on interest
earning assets 4.06% 4.39%
--------- -------------
--------- -------------
Interest-bearing liabilities to
earning assets ratio 80.00% 79.92%
--------- -------------
--------- -------------
</TABLE>
(1) - Interest income on loans includes loan origination fees of $ 393
and $ 319 for the nine months ended September 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
September 30, 1998 as compared to $120,000 for the same period the previous
year. For the nine months ended September 30, 1998, the provision for loan
losses was $10,000 compared to $480,000 for the nine months ended September 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 September 30, 1998, the allowance for loan losses was $5,478,000 or
2.30% of loans as compared to 2.23% of loans at September 30, 1997.
Nonperforming loans, at September 30, 1998, were $4,306,000, up from
$2,270,000 at September 30, 1997. The increase is the result of one credit
for approximately $3,000,000 becoming past due. The credit is secured by an
office building in which the Bank is the debtor in possession and steps are
being taken to liquidate the property. Despite the increase in
nonperforming loans and impaired loans, which includes nonperforming loans
deemed to be impaired, the portion of the allowance for loan losses that is
specifically allocated is $3,221,000 leaving $2,257,000 unallocated for other
possible contingencies. During the first nine months of 1998 only $11,000 in
loans has been charged off to the allowance compared to $190,000 during the
same period last year. Recoveries of loans previously charged off were
$49,000 during the first nine months of 1998 compared to $292,000 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 September 30,
1998 is adequate to cover future possible loan losses. If the level of
impaired and nonperforming remains stable during the remainder of 1998, no
additional loan loss provision is budgeted during 1998.
NONINTEREST INCOME
Noninterest income for the three months ended September 30, 1998 was
$736,000 as compared to $660,000 for the three months ended September 30,
1997, an increase of $76,000. Service fees on deposits decreased by $39,000
as compared to the same quarter last year because of overdraft fee income
being $27,000 lower and other service charges on deposit being $12,000 less
than last year. Trust fee income remained unchanged during the quarter
ended September 30, 1998. Other income from gains on sales on loans
increased $44,000 during the third quarter of 1998 as there were increased
loan sales as compared to last year. Miscellaneous operating income during
the third quarter of 1998 was $71,000 greater than the same period last year
in part from $58,000 in mortgage brokerage operation fee income. During the
third quarter the Bank restructured its mortgage brokerage operation which
now originates mortgages for other companies in addition to selling loans
through Federal National Mortgage Association (FNMA) and Federal Home Loan
Mortgage Corporation (FHLMC) programs. Management believes that the
restructuring gives customers a wider range of mortgage products to choose
from. Unlike the loans sold through the FNMA and FHLMC programs, mortgage
loans originated for other companies are not funded or serviced by the Bank
but do provide a source of increased fee income.
20
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the first nine months of 1998 noninterest income was $2,024,000 as
compared to $2,036,000 for the same period of 1997, a decrease of $12,000.
Service fees on deposits were $131,000 less during the first nine months of
1998 as compared to the same period last year because of decreased overdraft
fee income of $78,000 and service charge income on checking and NOW accounts
of $53,000. The decreased overdraft 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 519 accounts or 5.40% from September
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
nine months ended September 30, 1998 increased $44,000 as a result of
increased fiduciary activities. Gains on sales of loans increased $144,000
during the first nine months 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 nine months of 1998 totaled $18,304,000 as compared to $6,909,000 last
year. Other operating income declined $69,000 during the nine months ended
September 30, 1998 as there were $142,000 in one-time gains on sales of other
real estate owned which occurred during the first nine months of 1997.
NONINTEREST EXPENSES
Noninterest expenses remained unchanged during the quarter ended
September 30, 1998 at $2,276,000 compared to the same quarter last year.
The Company's efficiency ratio, noninterest expenses divided by the sum of
net interest income and noninterest income, was 45.51% for the third quarter
of 1998 as compared to 45.70% 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.
Decreases in salary and employee benefit expenses of $71,000 occurred
during the third quarter of 1998 compared to the same period last year.
Salary expense relating to stock appreciation rights issued under the Omnibus
Incentive Plan were $143,000 less during the three months ended September 30,
1998 than in the same three months last year due to decreases to the
Company's stock price.
Occupancy expenses for the third quarter of 1998 were $309,000 which
was an increase of $20,000 from the third quarter of 1997. This increase in
occupancy expenses is attributable to $20,000 in increased maintenance
expenses during the three months ended September 30, 1998.
Data processing expense decreased $19,000 during the three months ended
September 30, 1998 to $116,000. This decrease was related to the merger
between the Bank of Waukegan and First Federal Bank, fsb that became
effective April 21, 1998 as data processing expenses declined as duplication
of services were eliminated.
FDIC insurance was $21,000 during the three months ended September 30,
1998 which increased slightly from $20,000 during the same period last year.
21
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Other real estate owned expenses declined during the third quarter of
1998 by $7,000. 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 $2,497,000 at September 30, 1998 as compared to $2,560,000 at September
30, 1997.
During the third quarter of 1998 management entered into an agreement to
purchase a branch office in the neighboring community of Winthrop Harbor,
Illinois from another institution for the amount of $1,000,000. The purchase
is for the branch building only and is subject to regulatory approval. The
purchase is expected to consummate by November, 1998. Also, the merger
between the two wholly owned subsidiaries, Bank of Waukegan and First Federal
Bank, fsb resulted in the Bank of Waukegan, the surviving entity, having two
branches within two city blocks of one another. In order to improve
efficiencies the Bank closed the smaller of these branches and is currently
attempting to sell the building. The closing of this branch should not
result in any customer inconvenience due to the close proximity of the
remaining branch. The result of the these developments is that the Bank will
continue to have 6 banking offices to service our customers but will expand
its geographic presence.
Miscellaneous other operating expenses increased $76,000 compared to the
same quarter last year. Increases in legal expenses account for the majority
of the miscellaneous other operating expense increases as legal expenses
were $72,000 greater during the third quarter of 1998. The increased legal
fees were partially the result of legal work done in connection with the
agreement to purchase a branch office and to close one of its other branches.
The increases in nonperforming assets also accounts for the greater legal
expenses.
During the nine months ended September 30, 1998, total noninterest
expenses were $7,221,000 or $158,000 more than during the same period last
year, an increase of 2.24%. The Company's efficiency ratio was 47.93% for
the first nine months of 1998 as compared to 47.80% for the first nine months
of 1997.
Salaries and employee benefit expense was $272,000 more during the nine
months ending September 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 $21,000 during the nine months ended September
30, 1998 compared to the same period last year. Annual salary increases and
the payment of increased commissions due to greater mortgage brokerage
activities account for the balance of the increases to salary and employee
benefit expense.
Occupancy expenses were $38,000 less during the first nine months of
1998 when compared to the same period of 1997. Decreases to property taxes of
$32,000 occurred as the result of lower assessed valuation of the Company's
properties. It is expected that occupancy expense will increase in future
periods as a result of the purchase of the Winthrop Harbor, Illinois branch
as well as purchases of new equipment in order to become compliant with the
"Year 2000".
Data processing expense was $23,000 lower during the first nine months
of 1998 when compared to the same period of 1997. Data processing expenses
declined as duplication of services were eliminated as a result of the merger.
22
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FDIC deposit insurance expense was $64,000 for the first three quarters
of 1998 remained unchanged from the same period last year.
Other real estate owned expenses declined $72,000 during the nine months
ending September 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
slightly smaller real estate owned portfolio that amounted to $2,497,000 at
September 30, 1998 as compared to $2,560,000 at September 30, 1997 also
contributed to lower other real estate owned expenses.
Miscellaneous other operating expenses were $19,000 greater for the nine
months ending September 30, 1998 as compared to the same period last year.
Legal expenses increased $142,000 during the first nine months of 1998
resulting from the merger between the two subsidiaries and the five-for-one
stock split as well as from the purchase of a branch office and the closing
of another branch office. Expenses relating to charged off checking accounts
and bad checks were $93,000 less during the first nine months of 1998 as
compared to last year. Expenses relating to correspondent bank accounts were
$29,000 less during the nine months ended September 30, 1998 as compared to
last year as correspondent bank balances were larger and earning allowances
were greater, thus reducing this expense.
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 internal 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 major risk to the Company is its data systems will inaccurately
calculate date related accrual of interest on loans and deposits because of
the year 2000. This would impact customer confidence and Company earnings.
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. A mailing will be sent to borrowers during the fourth quarter
of 1998 requesting information as to the borrower's state of preparedness to
year 2000 issues as it relates to their business so that this external risk
to the Company may be better assessed.
The Company is developing contingency plans to deal with possible year
2000 problems. Some strategies are to print, on December 31, 1999,
subsidiary trials of loan and deposit applications which would provide
balances and accrued interest figures on individual accounts in the event
that difficulties occur on January 1, 2000. Another contingency strategy is
to print, on December 31, 1999, customer loan and deposit account statements
in order to preserve individual account histories if a situation develops.
Using these strategies as a focal point, methods of recalculating interest
and adjusting customer
23
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
records are being looked into in the event that year 2000 problems result
despite our implementations and testing to avoid them.
The Company expects to complete its "Year 2000 Action Plan" during the
first quarter of 1999. A majority of the Company's data processing 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 September 30, 1998 and 1997, the Company's
provision for federal and state income taxes was $856,000 and $813,000 which
as a percentage of pretax earnings was 31.41% and 31.46%. For the nine months
ended September 30, 1998, the Company's provision for federal and state taxes
was $2,443,000 or 31.18% of pretax earnings as compared to $2,250,000 or
31.11% of pretax earnings for the nine months ending September 30, 1997.
STOCKHOLDER PROPOSALS
If a stockholder intends to present a proposal at the Company's Annual
Meeting of Stockholders and desires that the proposal be included in the
Company's Proxy Statement and form of proxy for that meeting, the proposal
must be in compliance with Rule 14a-8 under the Exchange Act and received at
the Company's principal executive offices not later than November 22, 1998.
As to any proposal that a stockholder intends to present to stockholders
without inclusion in the Company's Proxy Statement for the Company's 1999
Annual Meeting of Stockholders, the proxies named in management's proxy for
that meeting will be entitled to exercise their discretionary authority on
that proposal unless the Company receives notice of the matter to be proposed
by February 6, 1999. Even if proper notice is received on or prior to
February 6, 1999, the proxies named in management's proxy for that meeting
may nevertheless exercise their discretionary authority with respect to such
matter by advising stockholders of such proposal and how they intend to
exercise their discretion to vote on such matter, unless the stockholder
making the proposal solicits proxies with respect to the proposal to the
extent required by Rule 13a-4(c)(2) under the Exchange Act.
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" 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
stockholders. 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.
24
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and
Hedging Activities" which will become effective for fiscal years beginning
January 1, 2000. The statement addresses the accounting for derivative
instruments, including certain derivative instruments imbedded in other
contracts, and hedging activities. Management does not expect that the
effect of this statement will have a material impact on the Company's
financial statements.
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 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
25
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
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 3, "Expected Maturity Dates of On Balance Sheet
Financial Instruments as of September 30, 1998" provides information about the
Company's financial instruments that are sensitive to changes in interest
rates. The Company believes that the assumptions utilized are reasonable.
The Company had no derivative financial instruments, or trading portfolio,
as of September 30, 1998. 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 5% each
year. 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, 73.1% of the Company's investment
securities portfolio at September 30, 1998 is comprised of callable
securities. Company borrowings consist of securities sold under repurchase
agreements and Federal Home Loan Bank term advances and were tabulated by
contractual maturity dates and without regard to any conversion or repricing
dates.
26
<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 SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
_____________________________ Maturing In___________________________
($ 000s) 1 Year 2 Years 3 Years 4 Years 5 Years Thereafter Totals Fair Value
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest earning assets:
Loans (1) (2)
Fixed rate $18,885 $11,356 $17,564 $23,108 $20,492 $26,822 $118,227 119,384
Average interest rate 8.72% 8.87% 8.97% 8.65% 8.70% 7.14% 8.40%
Adjustable rate 45,536 16,190 8,514 8,939 9,648 31,878 120,705 120,705
Average interest rate 9.03% 9.14% 8.92% 9.00% 8.84% 8.94% 8.99%
Securities
Fixed rate 17,218 11,929 39,931 34,918 52,462 30,430 186,888 186,888
Average interest rate 6.01% 6.32% 6.33% 6.22% 6.14% 6.54% 6.26%
Adjustable rate 1,001 0 0 0 0 5,793 6,794 6,794
Average interest rate 6.15% 0.00% 0.00% 0.00% 0.00% 6.59% 6.52%
Interest bearing deposits
and federal funds sold
Fixed rate 0 100 0 0 0 0 100 100
Average interest rate 0.00% 7.30% 0.00% 0.00% 0.00% 0.00% 7.30%
Adjustable rate 34,074 0 0 0 0 0 34,074 34,074
Average interest rate 5.64% 0.00% 0.00% 0.00% 0.00% 0.00% 5.64%
Direct lease financing
Fixed rate 723 113 114 140 0 0 1,090 1,090
Average interest rate 7.86% 8.20% 6.56% 4.74% 0.00% 0.00% 7.71%
----------------------------------------------------------------------------------------------------
Total $117,437 $39,688 $66,123 $67,105 $82,602 $94,923 $467,878 $469,035
----------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------
Interest bearing liabilities:
Interest bearing deposits (3)
Balances $182,501 $22,322 $11,422 $5,772 $5,460 $103,641 $331,118 $330,570
Average interest rate 5.31% 5.25% 4.57% 3.35% 3.34% 3.33% 4.60%
Borrowings
Balances 41,152 0 0 0 0 5,000 46,152 46,506
Average interest rate 5.09% 0.00% 0.00% 0.00% 0.00% 4.75% 5.36%
----------------------------------------------------------------------------------------------------
Total $223,653 $22,322 $11,422 $5,772 $5,460 $108,641 $377,270 $377,076
----------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------
</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 aggregate payments due.
(3) For NOW, money market and savings all balances assumed a 5% maturity each
year.
27
<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 10th day of November, 1998.
NORTHERN STATES FINANCIAL CORPORATION
(Registrant)
Date: November 10, 1998 By: /s/ Fred Abdula
--------------------------- ---------------------------------------
Fred Abdula
Chairman if the Board of
Directors and President
Date: November 10, 1998 By: /s/ Thomas M. Nemeth
--------------------------- ---------------------------------------
Thomas M. Nemeth
Assistant Vice President
28
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 11,403
<INT-BEARING-DEPOSITS> 174
<FED-FUNDS-SOLD> 34,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 193,682
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 239,484
<ALLOWANCE> 5,478
<TOTAL-ASSETS> 487,187
<DEPOSITS> 369,926
<SHORT-TERM> 36,152
<LIABILITIES-OTHER> 6,416
<LONG-TERM> 10,000
0
0
<COMMON> 1,780
<OTHER-SE> 62,913
<TOTAL-LIABILITIES-AND-EQUITY> 487,187
<INTEREST-LOAN> 16,446
<INTEREST-INVEST> 8,382
<INTEREST-OTHER> 847
<INTEREST-TOTAL> 25,675
<INTEREST-DEPOSIT> 10,913
<INTEREST-EXPENSE> 12,634
<INTEREST-INCOME-NET> 13,041
<LOAN-LOSSES> 10
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 7,221
<INCOME-PRETAX> 7,834
<INCOME-PRE-EXTRAORDINARY> 7,834
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,391
<EPS-PRIMARY> 1.21
<EPS-DILUTED> 1.21
<YIELD-ACTUAL> 4.06
<LOANS-NON> 4,028
<LOANS-PAST> 278
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 5,430
<CHARGE-OFFS> 11
<RECOVERIES> 49
<ALLOWANCE-CLOSE> 5,478
<ALLOWANCE-DOMESTIC> 3,221
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 2,257
</TABLE>
