<PAGE> 1
================================================================
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, 1999
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:
------- -------
4,458,345 shares of common stock were outstanding
as of September 30, 1999
<PAGE> 2
NORTHERN STATES FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q
SEPTEMBER 30, 1999
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page Number
<S> <C>
Condensed consolidated balance sheets as of September 30,
1999, December 31, 1998, and September 30, 1998.......................................... 2
Condensed consolidated statements of income for the three and
nine months ended September 30, 1999 and 1998............................................ 3
Condensed consolidated statements of comprehensive income
the three and nine months ended September 30, 1999 and 1998.............................. 4
Condensed consolidated statements of cash flows for
the nine months ended September 30, 1999 and 1998........................................ 5
Notes to condensed consolidated financial statements.................................. 6 -16
Item 2. Management's discussion and analysis of financial
condition and results of operations....................................... 17 - 27
Item 7A. Quantitative and qualitative disclosures
about market risk...................................................... 27 - 29
PART II. OTHER INFORMATION
Signatures............................................................................... 30
</TABLE>
1
<PAGE> 3
NORTHERN STATES FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, 1999, December 31, 1998 and September 30, 1998
(In thousands of dollars)
<TABLE>
<CAPTION>
September 30, December 31, September 30,
Assets 1999 1998 1998
--------------- ---------------- ---------------
<S> <C> <C> <C>
Cash and due from banks............................................. $ 18,224 $ 15,176 $ 11,403
Interest bearing deposits in financial institutions -
maturities less than 90 days.................................... 185 183 74
Federal funds sold.................................................. 0 12,600 34,000
--------------- ---------------- ---------------
Total cash and cash equivalents.................................. 18,409 27,959 45,477
Interest bearing deposits in financial institutions -
maturities over 90 days......................................... 100 100 100
Securities available for sale....................................... 201,247 200,861 193,682
Loans............................................................... 242,409 246,209 238,394
Less: Allowance for loan losses..................................... (5,335) (5,433) (5,478)
--------------- ---------------- ---------------
Loans, net....................................................... 237,074 240,776 232,916
Direct lease financing.............................................. 1,449 987 1,090
Office buildings and equipment, net................................. 6,259 6,647 5,695
Other real estate owned, net of allowance for losses
of $552, $552 and $552........................................... 2,497 2,497 2,497
Accrued interest receivable......................................... 4,862 4,408 4,188
Other assets........................................................ 3,547 1,686 1,542
--------------- ---------------- ---------------
Total assets..................................................... $475,444 $485,921 $487,187
=============== ================ ===============
Liabilities and Stockholders' Equity
Liabilities
Deposits
Demand - noninterest-bearing..................................... $ 41,666 $ 44,075 $ 38,808
NOW accounts..................................................... 56,103 39,180 45,687
Money market accounts............................................ 38,909 41,003 45,641
Savings.......................................................... 45,888 45,333 42,605
Time, $100,000 and over.......................................... 85,162 98,338 108,351
Time, under $100,000............................................. 85,361 87,827 88,834
--------------- ---------------- ---------------
Total deposits................................................ 353,089 355,756 369,926
Securities sold under repurchase agreements
and other short-term borrowings.................................. 45,608 47,990 36,152
Federal Home Loan Bank term advance................................. 5,000 10,000 10,000
Advances from borrowers for taxes and insurance..................... 436 992 437
Accrued interest payable and other liabilities...................... 5,261 6,070 5,979
--------------- ---------------- ---------------
Total liabilities............................................. 409,394 420,808 422,494
Stockholders' Equity
Common stock........................................................ 1,783 1,781 1,780
Additional paid-in capital.......................................... 11,376 11,336 11,254
Retained earnings................................................... 55,449 51,358 50,870
Accumulated other comprehensive income (loss), net.................. (2,558) 638 789
--------------- ---------------- ---------------
Total stockholders' equity....................................... 66,050 65,113 64,693
--------------- ---------------- ---------------
Total liabilities and stockholders' equity....................... $475,444 $485,921 $487,187
=============== ================ ===============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
<PAGE> 4
NORTHERN STATES FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three months and nine months ended September 30, 1999 and 1998
(In thousands of dollars, except per share data)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Interest income
Loans (including fee income).....................................$ 5,213 $ 5,344 $ 15,427 $ 16,446
Securities
Taxable........................................................ 2,790 2,594 7,847 7,633
Exempt from federal income tax................................. 257 244 784 749
Interest bearing deposits in financial institutions.............. 4 2 13 21
Federal funds sold............................................... 26 373 279 826
-------------- -------------- -------------- --------------
Total interest income......................................... 8,290 8,557 24,350 25,675
-------------- -------------- -------------- --------------
Interest expense
Time deposits.................................................... 2,088 2,624 6,357 7,778
Other deposits................................................... 959 1,090 2,920 3,135
Other borrowings................................................. 654 578 1,874 1,721
-------------- -------------- -------------- --------------
Total interest expense........................................ 3,701 4,292 11,151 12,634
-------------- -------------- -------------- --------------
Net interest income................................................. 4,589 4,265 13,199 13,041
Provision for loan losses........................................... 0 0 0 10
-------------- -------------- -------------- --------------
Net interest income after provision for
loan losses...................................................... 4,589 4,265 13,199 13,031
-------------- -------------- -------------- --------------
Noninterest income
Service fees on deposits......................................... 306 283 845 834
Trust income..................................................... 174 156 555 498
Mortgage banking income.......................................... 22 75 239 98
Net gains on sales of loans...................................... 7 102 162 262
Other operating income........................................... 294 120 627 332
-------------- -------------- -------------- --------------
Total noninterest income...................................... 803 736 2,428 2,024
-------------- -------------- -------------- --------------
Noninterest expenses
Salaries and employee benefits................................... 1,464 1,314 4,520 4,323
Occupancy and equipment, net..................................... 335 309 1,019 921
Data processing.................................................. 120 116 372 377
FDIC deposit insurance........................................... 20 21 63 64
Other real estate owned.......................................... 15 12 53 73
Other operating expenses......................................... 474 504 1,400 1,463
-------------- -------------- -------------- --------------
Total noninterest expenses.................................... 2,428 2,276 7,427 7,221
-------------- -------------- -------------- --------------
Income before income taxes.......................................... 2,964 2,725 8,200 7,834
Provision for income taxes.......................................... 932 856 2,548 2,443
-------------- -------------- -------------- --------------
Net income..........................................................$ 2,032 $ 1,869 $ 5,652 $ 5,391
============== ============== ============== ==============
Basic earnings per common share.....................................$ 0.46 $ 0.42 $ 1.27 $ 1.21
Diluted earnings per common share...................................$ 0.46 $ 0.42 $ 1.27 $ 1.21
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE> 5
NORTHERN STATES FINANCIAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME
Three months and nine months ended September 30, 1999 and 1998
(In thousands of dollars)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net income..........................................................$ 2,032 $ 1,869 $ 5,652 $ 5,391
Other comprehensive income:
Unrealized gains (losses) arising during period
on securities available for sale, net of tax
of ($323), $140, ($2,021), and $204 (510) 220 (3,196) 320
-------------- -------------- -------------- --------------
Comprehensive income................................................$ 1,522 $ 2,089 $ 2,456 $ 5,711
============== ============== ============== ==============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
</TABLE>
4
<PAGE> 6
NORTHERN STATES FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30, 1999 and 1998
(In thousands of dollars)
<TABLE>
<CAPTION>
1999 1998
----------------- -----------------
<S> <C> <C>
Cash flows from operating activities
Net income...............................................................$ 5,652 $ 5,391
Adjustments to reconcile net income to cash from
operating activities:
Depreciation.......................................................... 478 425
Provision for loan losses............................................. 0 10
Provision for losses on other real estate owned....................... 0 10
Deferred loan fees.................................................... (8) (60)
Gains on sales of property and equipment.............................. (74) 0
Net change in loans held for sale..................................... 3,441 (195)
Net gains on sales of loans........................................... (162) (262)
Net gains on sales of other real estate owned......................... (157) 2
Amortization of mortgage servicing rights............................. 52 46
Net change in interest receivable..................................... (454) 120
Net change in interest payable........................................ 911 (28)
Net change in other assets............................................ 108 55
Net change in other liabilities....................................... (1,720) (133)
----------------- -----------------
Net cash from operating activities................................. 8,067 5,381
----------------- -----------------
Cash flows from investing activities
Proceeds from maturities and calls of securities available for sale... 70,677 119,519
Purchases of securities available for sale............................ (76,280) (132,005)
Change in loans made to customers..................................... (2,079) 4,385
Proceeds from sales of property and equipment ........................ 257 0
Property and equipment expenditures................................... (273) (221)
Net change in direct lease financing.................................. (462) 184
Proceeds from sales of other real estate owned........................ 2,667 46
----------------- -----------------
Net cash from investing activities................................. (5,493) (8,092)
----------------- -----------------
Cash flows from financing activities Net change in:
Deposits............................................................ (2,667) 21,976
Securities sold under repurchase agreements
and other short-term borrowings................................... (2,382) 2,648
Advances from borrowers for taxes and insurance..................... (556) (729)
Net change in Federal Home Loan Bank term advance..................... (5,000) 0
Net proceeds from exercise of stock options........................... 42 33
Dividends paid........................................................ (1,561) (1,246)
----------------- -----------------
Net cash from financing activities................................. (12,124) 22,682
----------------- -----------------
Net change in cash and cash equivalents......................................... (9,550) 19,971
Cash and cash equivalents at beginning of period................................ 27,959 25,506
----------------- -----------------
Cash and cash equivalents at end of period......................................$ 18,409 $ 45,477
================= =================
Supplemental disclosures
Cash paid during the period for
Interest...........................................................$ 10,240 $ 12,662
Income taxes....................................................... 2,498 2,439
Noncash investing activities
Transfers made from loans to other real estate owned............... 2,510 0
Transfers made from loans held for sale to portfolio............... 2,520 0
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE> 7
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(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, 1999,
December 31, 1998 and September 30, 1998. The condensed consolidated statements
of income and the condensed consolidated statements of comprehensive income are
for the three months and nine months ended September 30, 1999 and 1998. The
condensed consolidated statements of cash flows are for the nine months ended
September 30, 1999 and 1998.
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, 1998, 1997 and 1996.
The results of operations for the three and nine month periods ended
September 30, 1999, 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,
1999 1998 1998
----------------------------------------------
<S> <C> <C> <C>
Common shares authorized................. 6,500,000 6,500,000 6,500,000
Common shares outstanding................ 4,458,345 4,453,400 4,450,865
Par value per share......................$ 0.40 $ 0.40 $ 0.40
</TABLE>
6
<PAGE> 8
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(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, 1999, December 31, 1998 and
September 30, 1998 are as follows:
<TABLE>
<CAPTION>
September 30, 1999
- ------------------ Amortized Gross Unrealized Fair
Cost Gains Losses Value
-------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury..............................................$ 4,997 $ 7 $ 0 $ 5,004
U.S. Government agencies and corporations.................. 170,028 1 (4,456) 165,573
States and political subdivisions.......................... 21,108 253 (127) 21,234
Mortgage-backed securities................................. 7,324 19 (72) 7,271
Equity securities.......................................... 1,966 216 (17) 2,165
-------------------------------------------------------------
Total...................................................$ 205,423 $496 ($4,672) $ 201,247
=============================================================
December 31, 1998
- ----------------- Amortized Gross Unrealized Fair
Cost Gains Losses Value
-------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury..............................................$ 13,022 $ 87 $ 0 $ 13,109
U.S. Government agencies and corporations.................. 152,558 208 (326) 152,440
States and political subdivisions.......................... 22,693 737 (2) 23,428
Mortgage-backed securities................................. 9,622 106 0 9,728
Equity securities.......................................... 1,925 242 (11) 2,156
-------------------------------------------------------------
Total...................................................$ 199,820 $1,380 ($339) $ 200,861
=============================================================
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
=============================================================
</TABLE>
7
<PAGE> 9
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Dollar amounts in thousands, except per share data)
(Unaudited)
Contractual maturities of debt securities at September 30, 1999 were as
follows. Securities not due at a single maturity date, primarily mortgage-backed
securities and equity securities are shown separately.
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
------------------------------
<S> <C> <C>
Due in one year of less................................................$ 10,670 $ 10,693
Due after one year through five years.................................. 140,402 137,261
Due after five years through ten years................................. 45,061 43,857
------------------------------
196,133 191,811
Mortgage-backed securities............................................. 7,324 7,271
Equity securities...................................................... 1,966 2,165
------------------------------
Total..................................................................$ 205,423 $ 201,247
==============================
</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 totaled $162,574 at
September 30, 1999. As of September 30, 1999, the Company held no structured
notes.
There were no sales of securities during the three and nine months ended
September 30, 1999 and 1998.
Securities carried at $133,612 and $135,401 at September 30, 1999 and 1998
were pledged to secure public deposits, repurchase agreements and for other
purposes as required or permitted by law.
8
<PAGE> 10
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Dollar amounts in thousands, except per share data)
(Unaudited)
Note 3 - Loans
The Company makes loans to, and obtains deposits from, customers primarily
in Lake County, Illinois and surrounding areas. Most loans are secured by
specific items of collateral, including commercial and residential real estate
and other business and consumer assets.
Loans at September 30, 1999, December 31, 1998 and September 30, 1998 were
as follows:
<TABLE>
<CAPTION>
September 30, December 31, September 30,
1999 1998 1998
--------------------------------------------
<S> <C> <C> <C>
Commercial.............................................................$ 54,817 $ 64,043 $ 58,311
Real estate - construction............................................. 19,335 17,328 24,855
Real estate - mortgage................................................. 145,723 141,241 131,790
Home equity............................................................ 16,223 15,579 15,870
Installment............................................................ 6,803 8,530 8,106
--------------------------------------------
Total loans............................................................ 242,901 246,721 238,932
Unearned income........................................................ (87) (99) (107)
Deferred loan fees..................................................... (405) (413) (431)
--------------------------------------------
Loans, net of unearned income
and deferred loan fees................................................ 242,409 246,209 238,394
Allowance for loan losses.............................................. (5,335) (5,433) (5,478)
--------------------------------------------
Loans, net............................................................$ 237,074 $ 240,776 $ 232,916
============================================
</TABLE>
The were no loans held for sale on September 30, 1999. During the first
nine months of 1999 the Company transferred loans held for sale with a book
value and fair value of $2,520 to portfolio loans. Loans held for sale on
December 31, 1998 and September 30, 1998 were approximately $5,799 and $1,795
and are classified as real estate loans.
Real estate - mortgage loans with a carrying value of $20,303, $20,596 and
$21,646 were pledged to secure public deposits at September 30, 1999, December
31, 1998 and September 30, 1998. 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 $449 at September 30, 1999, $4,117 at December 31, 1998 and $4,306
at September 30, 1998.
9
<PAGE> 11
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Dollar amounts in thousands, except per share data)
(Unaudited)
Impaired loans were as follows for September 30, 1999, December 31, 1998
and September 30, 1998:
<TABLE>
<CAPTION>
September 30, December 31, September 30,
1999 1998 1999
----------------------------------------------
<S> <C> <C> <C>
Loans with no allowance
for losses allocated...................................... $ 0 $ 0 $ 0
Loans with allowance
for losses allocated...................................... 265 3,515 3,949
Amount of the allowance
allocated................................................. 40 544 593
</TABLE>
The average balance and income recognized on impaired loans were as follows
for the three and nine months ended September 30, 1999 and September 30, 1998:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
-------------------------------------------------------------
<S> <C> <C> <C> <C>
Average of impaired
loans during the period....................................... $415 $1,734 $933 $1,022
Interest income recognized
during the impairment period.................................. 12 0 30 8
Cash-basis interest income recognized
during the impairment period.................................. 12 0 30 8
</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> 12
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Dollar amounts in thousands, except per share data)
(Unaudited)
At September 30, 1999, December 31, 1998 and September 30, 1998, the
contract amount of the Company's off-balance sheet commitments was as follows:
<TABLE>
<CAPTION>
September 30, December 30, September 30,
1999 1998 1998
-------------------------------------------
<S> <C> <C> <C>
Unused lines of credit and commitments to make loans:
Fixed rate......................................................... $17,540 $19,999 $31,264
Variable rate...................................................... 67,571 60,009 64,499
--------------------------------------
Total........................................................... $85,111 $80,008 $95,763
======================================
Standby letters of credit............................................. $ 5,742 $6,598 $6,631
</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> 13
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(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, 1999, twelve months ended December 31, 1998 and nine months ended
September 30, 1998 is as follows:
<TABLE>
<CAPTION>
September 30, December 31, September 30,
1999 1998 1998
---------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year................................ $5,433 $5,430 $5,430
Provision charged to operating expense...................... 0 10 10
Loans charged off........................................... (670) (73) (11)
Recoveries on loans
previously charged off.................................... 572 66 49
---------------------------------------------
Balance at end of period................................. $5,335 $5,433 $5,478
=============================================
</TABLE>
Activity in the allowance for other realize estate owned losses for the
nine months ended September 30 1999, twelve months ended December 31, 1998 and
nine months ended September 30, 1998 is as follows:
<TABLE>
<CAPTION>
September 30, December 31, September 30,
1999 1998 1998
---------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year................................ $552 $544 $544
Provision charged to operating expense...................... 0 10 10
Losses on other real estate owned........................... 0 (2) (2)
---------------------------------------------
Balance at end of period................................. $552 $552 $552
=============================================
</TABLE>
12
<PAGE> 14
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(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, 1999 total stockholders' equity
increased $937. The increase is a result of net income of $5,652, less the
change in the valuation allowance from December 31, 1998 for the fair value of
securities available for sale, net of tax, of $3,196, plus $42 due to the
exercise of 4,945 stock options pursuant to the Omnibus Incentive Plan, less
cash dividends of $1,561.
For the nine months ended September 30, 1998 total stockholders' equity
increased $4,498 due to 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.
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 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, 1999 or during the entire year 1998.
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.
13
<PAGE> 15
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Dollar amounts in thousands, except per share data)
(Unaudited)
Information about option grants follow:
<TABLE>
<CAPTION>
Number of Weighted-Avg.
Options Exercise Price
--------------------------
<S> <C> <C>
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
======
Outstanding at January 1, 1999...................................... 18,855 $8.32
Exercised during period ended
September 30, 1999.............................................. (4,945) 8.32
----------------------
Outstanding at September 30, 1999................................... 13,910 $8.32
=======
</TABLE>
At September 30, 1999, all remaining options had an exercise price of
$8.32. The options outstanding had a remaining life of 2.25 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, 1999, 2,710 stock appreciation
rights were exercised and payment was made to the holders. As of September 30,
1999 and 1998, 12,280 and 16,240 stock appreciation rights were outstanding at
the grant price of $8.32 per share. The Company's expense/(benefit) was ($6) and
($117) for the three months ended September 30, 1999 and 1998 and ($24) and $42
for the nine months ended September 30, 1999 and 1998. The stock appreciation
rights will expire during 2002.
14
<PAGE> 16
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Dollar amounts in thousands, except per share data)
(Unaudited)
Note 8 - Other Comprehensive Income
Other comprehensive income components and related taxes for the three and
nine months ended September 30, 1999 and 1998 follows:
<TABLE>
<CAPTION>
For three months ended Nine months ended
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
------------------------------------------------------------
<S> <C> <C> <C> <C>
Unrealized holding gains (losses) on
on securities available for sale.............. ($833) $360 ($5,217) $524
Tax effect....................................... (323) 140 (2,021) 204
-------------------------------------------------------
Other comprehensive income (loss)............. ($510) $220 ($3,196) $320
=======================================================
</TABLE>
Note 9 - Segment Information
The operating segments are determined by the products and services offered,
primarily distinguished between banking, mortgage banking and trust operations.
Loans, securities and deposits provide the revenues in the banking operation,
servicing fees and loan sales provide the revenues in mortgage banking, and
trust fees provide the revenues in trust operations. All operations are
domestic.
Management began evaluating mortgage banking as a separate segment in
August, 1998. Mortgage banking and trust segment performance is evaluated using
fee income net of direct expenses. Income taxes are not allocated to these
segments and selected indirect expenses are allocated. There are no transactions
among segments. Substantially all assets are related to the banking segment.
Neither mortgage banking nor trust pre-tax revenues exceeded 10% of total
pre-tax income for the three months or nine months ended September 30, 1999 or
1998.
Information reported internally for performance assessment of operating
segments for the three months and nine months ended September 30, 1999 and 1998
follows:
<TABLE>
<CAPTION>
Three months ended September 30, 1999
--------------------------------------
Other Total
Banking Segments Segments
--------------------------------------
<S> <C> <C> <C>
Net interest income.................... $4,589 $ 0 $4,589
Provision for loan losses.............. 0 0 0
Other revenue.......................... 600 203 803
Other expenses......................... 2,210 218 2,428
-------------------------------------
Segment profit...................... $2,979 ($15) $2,964
=====================================
</TABLE>
15
<PAGE> 17
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Dollar amounts in thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended September 30, 1998
---------------------------------------
Other Total
Banking Segments Segments
---------------------------------------
<S> <C> <C> <C>
Net interest income...................................... $4,265 $ 0 $4,265
Provision for loan losses................................ 0 0 0
Other revenue............................................ 493 243 736
Other expenses........................................... 2,057 219 2,276
---------------------------------------
Segment profit........................................ $2,701 $ 24 $2,725
=======================================
<CAPTION>
Nine months ended September 30, 1999
Other Total
Banking Segments Segments
-----------------------------------------
<S> <C> <C> <C>
Net interest income...................................... $13,199 $ 0 $13,199
Provision for loan losses................................ 0 0 0
Other revenue............................................ 1,474 954 2,428
Other expenses........................................... 6,419 1,008 7,427
----------------------------------------
Segment profit........................................ $8,254 ($54) $8,200
========================================
<CAPTION>
Nine months ended September 30, 1998
Other Total
Banking Segments Segments
----------------------------------------
<S> <C> <C> <C>
Net interest income...................................... $13,041 $ 0 $13,041
Provision for loan losses................................ 10 0 10
Other revenue............................................ 1,439 585 2,024
Other expenses........................................... 6,749 472 7,221
---------------------------------------
Segment profit........................................ $ 7,721 $113 $7,834
=======================================
</TABLE>
16
<PAGE> 18
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,
1999 and the consolidated results of operations for the three and nine month
periods ending September 30, 1999, compared to the same periods of 1998. 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, 1999 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.
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
stockholders approved the amendment 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 $475.4 million at
September 30, 1999, decreasing $10.5 million from the Company's year-end,
December 31, 1998.
The Company held no federal funds sold at September 30, 1999 which is a
decline of $12.6 million from December 31, 1998. The Company's federal funds
sold position has decreased as a result of the decline in deposits.
The fair value of securities available for sale were $201.2 million at
September 30, 1999 increasing only slightly by $.4 million from the previous
year-end. Actual amortized cost increases to the securities portfolio totaled
$5.6 million from year-end. The net unrealized losses of the portfolio, however,
were $5.2 million for the nine months ended September 30, 1999. The securities
portfolio went to a net unrealized loss at September 30, 1999 of $4.2 million
from a net unrealized gain at December 31, 1998 of $1.0 million. This shift is
attributable to bond market rate increases. The amortized cost of the securities
portfolio showed decreases to U.S. Treasury securities of $8.0 million, to
mortgage-backed securities of $2.3 million and to securities issued by state and
political subdivisions of $1.6 million. These declined were offset by increases
to the amortized cost of U.S. Government agency issues of $17.5 million.
17
<PAGE> 19
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 1.54% from December 31, 1998.
The decrease in loans occurred primarily in the commercial loan portfolio, which
decreased $9.2 million. The decline in commercial loans was the result of the
cyclical nature of construction related commercial loans. Increased competition
from larger financial institutions also played a part in the reduction in
commercial loans. Real estate - construction loans increased $2.0 million from
December 31, 1998 but as projects become completed with the coming of winter
management expects these loans to decrease during the fourth quarter of 1999.
Real estate - mortgages and home equity loans increased $4.5 million and $.6
million from year-end. The consumer installment loan portfolio also declined
$1.7 million from year-end as consumers have lower cost financing alternatives
available to them for purchasing consumer goods.
During the first nine months of 1999 deposits at the Company declined $2.7
million from December 31, 1998. Deposits declined as the Company offered rates
on time deposit that were lower than competition as deposits to fund loans were
not needed due to the lower loan demand. The greatest decrease in deposits
occurred to time deposits, $100,000 and over that declined $13.2 million from
December 31, 1999. Smaller time deposits, under $100,000 declined slightly by
$2.5 million. Money market deposits declined $2.1 million due to decreases from
commercial and public depositors. Noninterest bearing demand deposits also
declined by $2.4 million. NOW accounts increased $16.9 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. Savings deposits increased slightly by $.6
million.
During the third quarter of 1999 the Company came out with two new deposit
products. The first product is a retail checking account product that packages
banking services and offers common carrier and accidental death insurance. The
second product is a checking account that pays a nominal rate of interest of 1%
and offers an expanded package of features for a monthly membership fee.
Management expects these products to increase and retain core deposits while
increasing service fees on deposits.
Securities sold under repurchase agreements and other short-term borrowings
at the Company declined $2.4 million from December 31, 1998 to $45.6 million at
September 30, 1999. 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 lower rates offered on these
instruments.
At September 30, 1999 the Company had term advances from the Federal Home
Loan Bank in the amount of $5.0 million, a decrease of $5.0 million from
December 31, 1998. The funds provided by the term advances have been used to
purchase U.S. Government agency securities with call provisions on the same date
that the advances are due to be repaid. During the second quarter a term advance
of $5.0 million came due and the underlying U.S. Government agency securities
were called and used to retire the term advance.
Total stockholders' equity increased $937,000 during the nine months ended
September 30, 1999. The increase is the result of net income of $5,652,000, less
the adjustment in the valuation allowance for the market value of securities
available for sale, net of tax, of $3,196,000, plus $42,000 due to the exercise
of 4,945 stock options pursuant to the Omnibus Incentive Plan, less cash
dividends paid of $1,561,000.
18
<PAGE> 20
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The tier 1 capital to average asset ratio at September 30, 1999 was 14.49%
and the total tier 2 capital to asset ratio, on a risk adjusted basis, amounted
to 23.00%, 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 $14.81 at September 30, 1999 as compared to $14.63 at December 31,
1998. On September 30, 1999, the Company and its subsidiary were in compliance
with all applicable regulatory capital requirements.
RESULTS OF OPERATIONS
NET INCOME
The consolidated net income for the quarter ended September 30, 1999 was
$2,032,000, an increase of $163,000 or 8.72%, as compared to net income of
$1,869,000 for the same period the previous year. The annualized return on
average assets was 1.70% for the quarter, up from 1.58%, the return on average
assets for the quarter the previous year. The consolidated net income for the
nine months ended September 30, 1999 was $5,652,000, an increase of $261,000 or
4.84%, over the first nine months of 1998. The annualized return on average
assets for the first nine months of 1999 was 1.59% increasing slightly from
1.55%, 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 $324,000 or 7.60% during the three months ended September
30, 1999, compared to the same three months in 1998. Although yields earned on
interest earning assets were 18 basis points lower during the third quarter 1999
compared to the third quarter 1998, net interest income increased because rates
paid on interest bearing liabilities declined to a greater extent. Table 1,
"Analysis of Average Balance and Tax Equivalent Rates for the Three Months ended
September 30, 1999 and 1998", shows the rates paid on interest bearing
liabilities declined to 4.14% during the third quarter of 1999 as compared to
4.73% last year, a decline of 59 basis points. Rates paid on NOW, money market,
and savings deposits declined 54, 50, and 26 basis points from the same quarter
last year. Due to the slowdown in loan demand the Company offered time deposit
rates that were lower than competition. Rates on time deposits and other
borrowings were 57 and 59 basis points lower than the same quarter last year.
Average federal funds sold balances decreased almost $22 million during the
three months ended September 30, 1999 compared to the same period last year.
Although a level of federal funds sold is necessary for liquidity purposes,
excessive federal funds sold can result in no or decreased earnings. For example
during the three months ended September 30, 1998 yields earned on fed funds sold
were 5.56% while rates paid on time deposits used to fund the fed funds sold
were 5.56%, a spread of 0.00%. During the third quarter 1999 rates have
generally risen as evidenced by the prime rate increasing 50 basis points during
the period with time deposit rates increasing as well. As time deposits mature
and reprice at the higher rates it is expected that the net yield on interest
earning assets will begin to contract.
19
<PAGE> 21
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
TABLE 1
NORTHERN STATES FINANCIAL CORPORATION
ANALYSIS OF AVERAGE BALANCE AND TAX EQUIVALENT RATES
For the Three Months Ended September 30, 1999 and 1998
($ 000s)
<TABLE>
<CAPTION>
1999 1998
--------------------------------------- ----------------------------------------
Average Average
Balance Interest Rate Balance Interest Rate
--------------------------------------- ----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Assets
Loans (1)(2)(3) $243,500 $5,244 8.61% $239,615 $5,380 8.98%
Taxable securities 181,358 2,790 6.03% 169,645 2,594 6.13%
Securities exempt from
Taxes (2) 20,522 389 7.66% 18,678 370 8.19%
Interest bearing deposits in banks 296 4 5.41% 173 2 4.62%
Federal funds sold 1,868 26 5.57% 26,824 373 5.56%
---------------------------- ----------------------------
Interest earning assets 447,544 8,453 7.50% 454,935 8,719 7.68%
-------------- --------------
Noninterest earning assets 26,474 20,184
-------------- --------------
Average assets $474,018 $475,119
============== ==============
Liabilities and stockholders' equity
NOW deposits $48,038 297 2.47% $41,858 315 3.01%
Money market deposits 39,567 348 3.52% 44,789 450 4.02%
Savings deposits 45,901 314 2.74% 43,321 325 3.00%
Time deposits 167,352 2,088 4.99% 188,637 2,624 5.56%
Other borrowings 56,937 654 4.59% 44,628 578 5.18%
---------------------------- ----------------------------
Interest bearing
Liabilities 357,795 3,701 4.14% 363,233 4,292 4.73%
-------------- --------------
Demand deposits 44,882 40,807
Other noninterest bearing liabilities 6,100 7,697
Stockholders' equity 65,241 63,382
-------------- --------------
Average liabilities and
Stockholders' equity $474,018 $475,119
============== ==============
Net interest income $4,752 $4,427
============== ==============
Net yield on interest
earning assets 4.22% 3.90%
=========== ============
Interest bearing liabilities to
earning assets Ratio 79.34% 80.02%
=========== ============
</TABLE>
(1) - Interest income on loans includes loan origination fees of $81 and $103
for the three months ended September 30, 1999 and 1998.
(2) - Tax-exempt income is reflected on a fully tax equivalent basis utilizing a
34% rate.
(3) - Non-accrual loans are included in average loans.
20
<PAGE> 22
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
TABLE 2
NORTHERN STATES FINANCIAL CORPORATION
ANALYSIS OF AVERAGE BALANCE AND TAX EQUIVALENT RATES
For the Nine Months Ended September 30, 1999 and 1998
($ 000s)
<TABLE>
<CAPTION>
1999 1998
--------------------------------------- -------------------------------------------
Average Average
Balance Interest Rate Balance Interest Rate
--------------------------------------- -------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Assets
Loans (1)(2)(3) $243,318 $15,528 8.51% $241,229 $16,546 9.15%
Taxable securities 173,348 7,847 5.98% 164,343 7,633 6.20%
Securities exempt from
Federal income taxes (2) 21,066 1,188 7.68% 19,032 1,135 8.24%
Interest bearing deposits in banks 306 13 5.66% 437 21 6.41%
Federal funds sold 7,784 279 4.78% 19,964 826 5.52%
---------------------------- -------------------------------
Interest earning assets 445,822 24,855 7.42% 445,005 26,161 7.86%
-------------- ---------------
Noninterest earning assets 25,748 20,776
-------------- ----------------
Average assets $471,570 $465,781
============== ================
Liabilities and stockholders' equity
NOW deposits $45,102 880 2.60% $39,764 891 2.99%
Money market deposits 41,071 1,073 3.48% 42,343 1,263 3.98%
Savings deposits 45,733 967 2.82% 44,103 981 2.97%
Time deposits 170,622 6,357 4.97% 185,081 7,778 5.60%
Other borrowings 53,407 1,874 4.68% 43,936 1,721 5.22%
---------------------------- -------------------------------
Interest bearing liabilities 355,935 11,151 4.18% 355,227 12,634 4.74%
-------------- ---------------
Demand deposits 43,340 39,961
Other noninterest bearing liabilities 6,706 8,575
Stockholders' equity 65,589 62,018
-------------- ----------------
Average liabilities and
Stockholders' equity $471,570 $465,781
============== ================
Net interest income $13,704 $13,527
============== ===============
Net yield on interest
earning assets 4.09% 4.06%
=========== ============
Interest-bearing liabilities to
earning assets ratio 79.64% 80.00%
=========== ============
</TABLE>
(1) - Interest income on loans includes loan origination fees of $256 and $393
for the nine months ended September 30, 1999 and 1998.
(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.
21
<PAGE> 23
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
During the first nine months of 1999, net interest income increased
$158,000 or 1.21% over the same period of 1998. Table 2, "Analysis of Average
Balance and Tax Equivalent Rates for the Nine Months ended September 30, 1999
and 1998" shows that the Company's net yield on interest earning assets was
4.09% for the first nine months of 1999 as compared to 4.06% in 1998. The yield
on interest earning assets was 44 basis points lower for the nine months ended
September 30, 1999 as compared to the same nine month period last year. Rates
paid on interest bearing liabilities decreased by a greater extent however,
declining 56 basis points from the previous year, contributing to the increased
net yield on interest earning assets.
PROVISION FOR LOAN LOSSES
There was no provision for loan losses during the three months ended
September 30, 1999 or September 30, 1998. For the nine months ended September
30, 1999, there was no provision for loan losses as compared to $10,000 for the
nine months ended September 30, 1998. Management, with the concurrence of the
Board of Directors, lowered the provision for loan losses during 1999 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, 1999, the allowance for loan losses was $5,335,000 or
2.20% of loans as compared to 2.21% of loans at December 31, 1998. Nonperforming
loans at September 30, 1999 were $449,000, down from $4,117,000 at December 31,
1998. Impaired loans at September 30, 1999 were $265,000 down from $3,515,000 at
December 31, 1998. The amount of the allowance for loan losses allocated for
impaired loans was $40,000 declining $504,000 from December 31, 1998. During the
first nine months of 1999 $670,000 in loans have been charged off to the
allowance compared to $11,000 during the same period last year. Recoveries of
loans previously charged off were $572,000 during the first nine months of 1999
compared to $49,000 during the same period in 1998.
At December 31, 1998 the majority of the nonperforming loans consisted of
one nonaccrual credit totaling $3,010,000 that was secured by a 57,000 square
foot office building located in Northbrook, Illinois. Management, during the
first quarter of 1999, charged off $500,000 of this credit based on preliminary
bids that had been received at that time for the building. The balance of this
credit, $2,510,000, was transferred to other real estate owned during the first
quarter of 1999 when foreclosure proceedings provided the Bank with title to the
property. During the third quarter of 1999 the building was sold netting
proceeds of $3,167,000, with $500,000 credited as a recovery to the allowance
for loan losses and $157,000 being credited as a gain on the sale.
Management and the Board of Directors analyze the adequacy of the allowance
for loan losses 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, 1999 is adequate to
cover future possible loan losses. If the level of impaired and nonperforming
loans remains stable during the remainder of 1999, no additional loan loss
provision is budgeted during 1999.
22
<PAGE> 24
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
NONINTEREST INCOME
Noninterest income for the three months ended September 30, 1999 was
$803,000 as compared to $736,000 for the three months ended September 30, 1998,
an increase of $67,000. Service fees on deposits increased by $23,000 as
compared to the same quarter last year because of increased overdraft fee
income. Trust fee income increased $18,000 during the quarter ended September
30, 1999 as compared to the same quarter last year as trust business increased.
Mortgage banking income declined $53,000 during the third quarter of 1999 as
compared to last year as increased home mortgage rates caused the levels of
mortgage activity to decrease. Other income from gains on sales on loans also
declined $95,000 during the third quarter of 1999 because of the higher home
mortgage rates. Miscellaneous operating income during the third quarter of 1999
was $174,000 greater than the same period last year. During the third quarter of
1999 the 57,000 square foot office building located in Northbrook, Illinois that
had been foreclosed upon was sold that resulted in a gain of $157,000.
For the first nine months of 1999 noninterest income was $2,428,000 as
compared to $2,024,000 for the same period of 1998, an increase of $404,000.
Service fees on deposits were $11,000 more during the first nine months of 1999
as compared to the same period last year because of increased overdraft fee
income. Trust income for the nine months ended September 30, 1999 increased
$57,000 as a result of increased fiduciary activities. Mortgage banking income
was $239,000 during the first nine months of 1999, increasing $141,000 from last
year as management expanded this operating segment beginning in August 1998. The
mortgage banking income consisted of fees earned by the Bank on "table funded'
loans as well as fees for appraisals and credit bureau costs from borrowers of
both "table funded" and loans originated and funded by the Bank that were then
sold on the secondary market. Lower home mortgage rates during the fourth
quarter of 1998 and the first quarter of 1999 generated increased mortgage
banking income. During the second and continuing through the third quarters of
1999 higher home mortgage rates caused mortgage banking income to decline
sharply during those time periods. Gains on sales of loans were also affected by
the higher home mortgage rates decreasing $100,000 during the first nine months
of 1999 compared to the same period of 1998. Other operating income increased
$295,000 during the nine months ended September 30, 1999 compared to last year.
During the third quarter of 1999 there was a one-time gain on the sale of other
real estate owned which totaled $157,000. The Company also realized a $74,000
gain on the sale of a branch office during the first quarter of 1999. With the
merging of First Federal Bank, fsb with the Bank of Waukegan in April 1998 the
Bank had two branches within two city blocks of one another. The Bank closed the
smaller of the two branches during 1998 and entered into a sales contract with a
party who wished to purchase the branch for a purpose other than banking. The
sale was completed during January 1999 with proceeds from the sale of $257,000.
Other operating income also increased by $68,000 as the Company during 1999
began charging noncustomers for use of Company owned automated teller machines.
NONINTEREST EXPENSES
Noninterest expenses for the quarter ended September 30, 1999 were
$2,428,000 increasing $152,000 from the same quarter last year. The Company's
efficiency ratio, noninterest expenses divided by the sum of net interest income
and noninterest income, was 45.03% for the third quarter of 1999 as compared to
45.51% for the same quarter of 1998. 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.
23
<PAGE> 25
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
Increases in salary and employee benefit expenses of $150,000 occurred
during the third quarter of 1999 compared to the same period last year. Salary
expense relating to stock appreciation rights were $111,000 more during the
three months ended September 30, 1999 than in the same three months last year.
This is directly attributable to changes in the Company's stock price. Group
insurance expense increased $21,000 during the third quarter of 1999 compared to
the same period last year due to premium rate increases. Overtime expense
increased $11,000 during the three months ended September 30, 1999 as there were
training sessions for employees on the new deposit products.
Occupancy expenses for the third quarter of 1999 were $335,000, which was
an increase of $26,000 from the third quarter of 1998. This increase in
occupancy expenses is attributable to $30,000 in increased maintenance expenses
during the three months ended September 30, 1999.
Data processing expense increased $4,000 during the three months ended
September 30, 1999 to $120,000.
FDIC insurance expense was $20,000 during the three months ended September
30, 1999 decreasing slightly from $21,000 during the same period last year.
Other real estate owned expenses increased during the third quarter of 1999
by $3,000 to $15,000.
Miscellaneous other operating expenses for the third quarter of 1999
decreased $30,000 to $474,000 compared to the same quarter last year. Legal
expenses were $60,000 less during the third quarter if 1999 compared to same
quarter last year as the Company had increased legal fees during the third
quarter of 1998 in connection with the agreement to purchase a branch office and
to close one of its other branches. Printing and supplies expenses were $14,000
greater during the third quarter of 1999 in part related to the Bank's
preparation for Year 2000 as backup manual forms were ordered in the event that
the computers were unable to print the necessary documents. During the third
quarter of 1999 the Company had increased audit and examination expenses of
$11,000, of which a portion was related to independent auditing of Year 2000
testing results.
During the nine months ended September 30, 1999, total noninterest expenses
were $7,427,000 or $206,000 more than during the same period last year, an
increase of 2.85%. The Company's efficiency ratio was 47.53% for the first nine
months of 1999 as compared to 47.93% for the first nine months of 1998.
Salaries and employee benefits expense was $197,000 more during the nine
months ending September 30, 1999 as compared to the same period last year.
Commissions relating to the expansion of the mortgage banking department were
$155,000 higher during the nine months ended September 30, 1999 compared to the
same period last year. Group insurance expense increased $116,000 during the
first nine months of 1999 compared to the same period last year due to premium
rate increases. Decreases to the Company's stock price lowered salary expenses
relating to stock appreciation rights by $87,000 from last year.
24
<PAGE> 26
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Occupancy expenses were $98,000 more during the first nine months of 1999
when compared to the same period of 1998. Depreciation expenses for building and
equipment were $53,000 higher than for the same period of 1998. The purchase and
opening of a new branch office in the neighboring community of Winthrop Harbor,
Illinois accounts for much of the increases in depreciation expenses. Building
and equipment maintenance costs, many related to the new branch office, also
increased $51,000 during the first nine months of 1999 compared to 1998.
Data processing expense decreased slightly by $5,000 during the first nine
months of 1999 when compared to the same period of 1998.
FDIC deposit insurance expense was $63,000 for the first three quarters of
1999, $1,000 less than for the same period last year.
Other real estate owned expenses declined $20,000 during the nine months
ending September 30, 1999 as compared to the same period last year as rents from
other real estate increased when the Northbrook, Illinois building was added to
the other real estate owned portfolio. Lower property taxes on the other real
estate owned portfolio also contributed to the decreases in other real estate
owned expenses. With the sale of the Northbrook, Illinois building it is
expected that other real estate owned expenses will increase as the rent credits
will decline.
Miscellaneous other operating expenses were $63,000 less for the nine
months ending September 30, 1999 as compared to the same period last year. Legal
expenses declined $157,000 during the first nine months of 1999 as there were
increases to legal fees during 1998 resulting from the merger between the two
subsidiaries, the five-for-one stock split, the purchase of a branch office and
the closing of another branch office. Due to the expansion of the mortgage
banking area there were increases during the first nine months of 1999 to loan
expenses of $69,000. Printing and supplies expenses were $36,000 greater during
the first nine months 1999 in part related to the Bank's preparation for Year
2000 as backup manual forms were ordered.
YEAR 2000
The Company, in compliance with the Federal Financial Institutions
Examination Council (FFIEC) 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 the
awareness, assessment and renovation phases of its action plan, and the testing
phase is well under way. During 1998 the Company purchased and installed new
hardware and software for its item processing and teller platform systems in
order to bring them up to Year 2000 standards. The combined cost of these
projects was $216,000. It is anticipated that the Company will incur $50,000 in
additional Year 2000 costs in 1999.
25
<PAGE> 27
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The major risk to the Company is that 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.
The Company has completed a risk assessment of its entire loan portfolio rating
each loan customer as to how susceptible the customer's business may be to Year
2000 risks. Those loan customers which were assessed as having medium to high
Year 2000 risks have been contacted to make them aware of possible problems
caused by the Year 2000 and to request information as to the borrower's state of
preparedness to Year 2000 issues. Information provided by our customers will
allow the Company to better determine possible external risks caused by the Year
2000. The Company continues to monitor and work with these borrowers.
The Company has instituted a customer awareness program in which information
regarding the Year 2000 is provided to customers through various media. This
information includes material such as a general explanation as to the century
date change, disclosure of the Bank's state of preparedness for the Year 2000,
suggested preparations that our customers might employ, and fraud alerts. These
efforts to prepare our customers and to alleviate their fears will continue
through the end of 1999.
A majority of the Company's data processing is performed by an outside bank
data processing service bureau which has assured the Company that their core
products are fully Year 2000 compliant. Despite these assurances, the Company
did participate in an in depth proxy testing program, which was conducted by the
service bureau's User's Group. The results of this testing were reviewed by an
independent auditing firm and have confirmed the service bureau's statements of
Year 2000 compliance.
The Company has developed both Remediation and Business Resumption
contingency plans to deal with possible Year 2000 problems, both prior to and
immediately following the century date change. Some strategies of these plans
include: 1) printing, prior to December 31, 1999, trial balances and other
internal reports, 2) printing account histories prior to December 31, 1999, 3)
modification of the Bank's liquidity policy to take into consideration the Year
2000 as it relates to the Bank's liquidity, and 4) testing and training of staff
on contingency plan procedures. These plans and strategies serve as a way of
dealing with Year 2000 problems if they should result despite our best efforts
to anticipate and avoid them.
Although management is confident that the Company has identified all
necessary upgrades to it's equipment, and budgeted accordingly, no assurance can
be made that Year 2000 compliance can be achieved without additional
unanticipated expenditures. It is not possible at this time to quantify the
estimated costs due to business disruption caused by vendors, suppliers,
customers or even the loss of electric power or telephone service; however, such
costs could be substantial. As a result of the Year 2000 project, the Company
has not had any material delay regarding its information systems projects.
FEDERAL AND STATE INCOME TAXES
For the three months ended September 30, 1999 and 1998, the Company's
provision for federal and state income taxes was $932,000 and $856,000, which as
a percentage of pretax earnings was 31.44% and 31.41%. For the nine months ended
September 30, 1999, the Company's provision for federal and state taxes was
$2,548,000 or 31.07% of pretax earnings as compared to $2,443,000 or 31.18% of
pretax earnings for the nine months ending September 30, 1998.
26
<PAGE> 28
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standard (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities" was issued by the Financial
Accounting Standards Board (FASB) in 1998 and is effective for the Company on
January 1, 2000. It requires that all derivatives be recorded at fair value in
the balance sheet, with changes to fair value charged or credited to income. If
derivatives are documented and effective as hedges, the change in derivative
fair value will be offset by an equal change in the fair value of the hedged
item. Since the Company has no derivative or hedging activities, adoption of
Statement 133 will have no material impact on the Company's financial
statements.
SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise", became effective for the Company as of January 1, 1999. The
statement allows securitized mortgage loans to be classified as trading,
available for sale, or in certain circumstances, held to maturity. Previously,
these had to be classified as trading. Since the Company has not securitized
mortgage loans, Statement 134 has not affected the Company.
American Institute of Certified Public Accountants Statement of Position
(SOP) 98-1, which became effective in 1999, sets the accounting requirements to
capitalize costs incurred to develop or obtain software that is to be used
solely to meet internal needs. Costs to capitalize are those direct costs
incurred after the preliminary project stage, up to the date when all testing
has been completed, and the software is substantially ready for use. All
training costs, research and development costs, costs incurred to convert data,
and all other general and administrative costs are expensed as incurred. The
capitalized cost of internal use software is to be amortized over its useful
life and reviewed for impairment using the criteria in Statement No. 121. SOP
98-1 has not had an impact on the Company.
SOP 98-5, which became effective in 1999, requires all start up, preopening
and organization costs to be expensed as incurred. Any such costs previously
capitalized for financial reporting purposes must be written off to income at
the start of the year. SOP 98-5 has not had an impact on the Company.
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.
27
<PAGE> 29
NORTHERN STATES FINANCIAL CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
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 IRR, which will form the basis for ongoing evaluation of the
adequacy of IRR 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 IRR. Specifically, the guidance emphasizes the need for
active board of director and management oversight and a comprehensive
risk-management process that effectively identifies, measures, and controls IRR.
One approach used by management is to minimize IRR is to periodically shock the
balance sheet by decreasing rates 2% and increasing rates 2% using computer
simulation to show the effect of rate changes on the fair value of the Company.
This approach falls under the broad definition of asset/liability management.
The Company's primary asset/liability management technique is the interest rate
shock.
Several ways an institution can manage IRR 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, a debtor may prepay other financial assets so that
the debtor may refinance their 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. Increasing deposits, borrowing, or selling assets can
obtain these funds.
The following Table 3 shows information as of June 30, 1999 and December
31, 1998 about how interest rate shocks of decreasing rates 2% and increasing
rates 2% effect the fair value of the Company's balance sheet. The data shown in
Table 3 is as of June 30, 1999 as it is the most current available financial
information from the computer simulation model used. At June 30, 1999 the fair
value of the Company's assets was $474.6 million compared to the book value on
the Company's financial statements at June 30, 1999 of $471.5 million. Table 3
shows that at June 30, 1999 the fair value of the Company's assets would
increase $20.4 million if rates would immediately drop 2%. If rates would
immediately rise 2% at June 30, 1999 the assets fair value would decrease $20.1
million. The table also shows that the fair value of the Company's equity would
increase by $12.1 million if rates drop 2%. If at June 30, 1999, rates increase
2% immediately the fair value of the Company's equity would decline by $6.1
million. Table 3 also shows for comparison what the effect of interest rate
shocks would do to the fair value of the Company's balance sheet at December 31,
1998. The fair value of the Company's assets would increase at December 31, 1998
if rates drop and decrease if rates rise. The Company believes that the
assumptions utilized for Table 3 are reasonable.
28
<PAGE> 30
NORTHERN STATES FINANCIAL CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
TABLE 3
NORTHERN STATES FINANCIAL CORPORATION
EFFECT OF INTEREST SHOCKS ON FINANCIAL INSTRUMENTS
as of June 30, 1999 and December 31, 1998
<TABLE>
<CAPTION>
Fair Value at June 30, 1999
--------------------------------------------------
Down 2% Current Up 2%
--------------------------------------------------
<S> <C> <C> <C>
Assets
Cash and cash equivalents $14,309 $14,309 $14,309
Interest bearing deposits in financial
institutions - maturities over 90 days 101 100 99
Securities available for sale 211,472 199,865 188,112
Loans 249,592 240,767 232,476
Direct lease financing 950 936 924
Other assets 18,631 18,632 18,631
--------------------------------------------------
Total assets $495,055 $474,609 $454,551
==================================================
Financial liabilities:
Deposits $349,125 $345,663 $336,272
Securities sold under repurchase agreements
and other short-term borrowings 51,086 51,083 51,080
Federal Home Loan Bank term advances 7,972 7,160 6,449
Other liabilities 9,220 5,116 1,278
--------------------------------------------------
Total liabilities 417,403 409,022 395,079
Total equity 77,652 65,587 59,472
--------------------------------------------------
Total liabilities and equity $495,055 $474,609 $454,551
==================================================
<CAPTION>
Fair Value at December 31, 1998
--------------------------------------------------
Down 2% Current Up 2%
--------------------------------------------------
<S> <C> <C> <C>
Assets
Cash and cash equivalents $27,960 $27,959 $27,958
Interest bearing deposits in financial
institutions - maturities over 90 days 101 100 99
Securities available for sale 213,608 200,861 189,199
Loans 259,503 250,721 242,283
Direct lease financing 1,017 1,001 987
Other assets 15,238 15,238 15,238
--------------------------------------------------
Total assets $517,427 $495,880 $475,764
==================================================
Financial liabilities:
Deposits $363,356 $356,971 $350,093
Securities sold under repurchase agreements
and other short-term borrowings 47,994 47,990 47,986
Federal Home Loan Bank term advances 9,039 8,482 8,005
Other liabilities 7,062 7,062 7,062
--------------------------------------------------
Total liabilities 427,451 420,505 413,146
Total equity 89,976 75,375 62,618
--------------------------------------------------
Total liabilities and equity $517,427 $495,880 $475,764
==================================================
</TABLE>
29
<PAGE> 31
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 1999.
NORTHERN STATES FINANCIAL CORPORATION
(Registrant)
<TABLE>
<S> <C>
Date: November 10, 1999 By: /s/ Fred Abdula
-------------------------------------- -------------------------------------------------
Fred Abdula
Chairman of the Board of
Directors and President
Date: November 10, 1999 By: /s/ Thomas M. Nemeth
-------------------------------------- -------------------------------------------------
Thomas M. Nemeth
Vice President and Treasurer
</TABLE>
30
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 18,224
<INT-BEARING-DEPOSITS> 285
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 201,247
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 243,858
<ALLOWANCE> 5,335
<TOTAL-ASSETS> 475,444
<DEPOSITS> 353,089
<SHORT-TERM> 45,608
<LIABILITIES-OTHER> 5,697
<LONG-TERM> 5,000
0
0
<COMMON> 1,783
<OTHER-SE> 64,267
<TOTAL-LIABILITIES-AND-EQUITY> 475,444
<INTEREST-LOAN> 15,427
<INTEREST-INVEST> 8,631
<INTEREST-OTHER> 292
<INTEREST-TOTAL> 24,350
<INTEREST-DEPOSIT> 9,277
<INTEREST-EXPENSE> 11,151
<INTEREST-INCOME-NET> 13,199
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 7,427
<INCOME-PRETAX> 8,200
<INCOME-PRE-EXTRAORDINARY> 8,200
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,652
<EPS-BASIC> 1.27
<EPS-DILUTED> 1.27
<YIELD-ACTUAL> 4.09
<LOANS-NON> 265
<LOANS-PAST> 184
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 5,433
<CHARGE-OFFS> 670
<RECOVERIES> 572
<ALLOWANCE-CLOSE> 5,335
<ALLOWANCE-DOMESTIC> 2,820
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 2,515
</TABLE>
