<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 March 31, 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: _______
4,455,435 shares of common stock were outstanding
as of March 31, 1999
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q
MARCH 31, 1999
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Item 1. Financial Statements Page Number
<S> <C>
Condensed consolidated balance sheets as of March 31,
1999, December 31, 1998, and March 31, 1998.............................................................. 2
Condensed consolidated statements of income for the three
months ended March 31, 1999 and 1998.................................................................... 3
Condensed consolidated statements of comprehenesive income
the three months ended March 31, 1999 and 1998.......................................................... 4
Condensed consolidated statements of cash flows for
the three months ended March 31, 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 - 24
Item 7A. Quantitative and qualitative disclosures
about market risk......................................................................... 25 - 28
PART II. OTHER INFORMATION
Signatures............................................................................................... 29
</TABLE>
1
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, 1999, December 31, 1998 and March 31, 1998
(In thousands of dollars)
<TABLE>
<CAPTION>
March 31, December 31, March 31,
Assets 1999 1998 1998
---------------- --------------- ----------------
<S> <C> <C> <C>
Cash and due from banks...................................... $16,532 $15,176 $13,108
Interest bearing deposits in financial institutions -
maturities less than 90 days............................. 51 183 212
Federal funds sold.......................................... 19,500 12,600 19,500
---------------- --------------- ----------------
Total cash and cash equivalents.......................... 36,083 27,959 32,820
Interest bearing deposits in financial institutions -
maturities over 90 days................................ 100 100 100
Securities available for sale.............................. 181,408 200,861 177,626
Loans...................................................... 239,689 246,209 244,607
Less: Allowance for loan losses............................ (4,791) (5,433) (5,458)
---------------- --------------- ----------------
Loans, net............................................. 234,898 240,776 239,149
Direct lease financing.................................... 956 987 1,264
Office buildings and equipment, net....................... 6,438 6,647 5,801
Other real estate owned, net of allowance for losses
of $552, $552 and $550................................. 5,007 2,497 2,549
Accrued interest receivable............................... 4,296 4,408 4,155
Other assets.............................................. 2,099 1,686 1,743
---------------- --------------- ----------------
Total assets.......................................... $471,285 $485,921 $465,207
---------------- --------------- ----------------
---------------- --------------- ----------------
Liabilities and Stockholders' Equity
Liabilities
Deposits
Demand - noninterest bearing.......................... $42,823 $44,075 $40,866
NOW accounts.......................................... 42,539 39,180 36,738
Money market accounts................................. 42,661 41,003 41,891
Savings............................................... 46,178 45,333 45,304
Time, $100,000 and over............................... 82,029 98,338 88,849
Time, under $100,000.................................. 85,648 87,827 94,301
---------------- --------------- ----------------
Total deposits..................................... 341,878 355,756 347,949
Securities sold under repurchase agreements
and other short-term borrowings....................... 45,815 47,990 35,798
Federal Home Loan Bank term advance....................... 10,000 10,000 10,000
Advances from borrowers for taxes and insurance........... 1,288 992 1,596
Accrued interest payable and other liabilities............ 6,130 6,070 7,830
---------------- --------------- ----------------
Total liabilities................................... 405,111 420,808 403,173
Stockholders' Equity
Common stock............................................. 1,782 1,781 1,779
Additional paid-in capital............................... 11,353 11,336 11,222
Retained earnings........................................ 53,146 51,358 48,451
Accumulated other comprehensive income, net.............. (107) 638 582
---------------- --------------- ----------------
Total stockholders' equity............................ 66,174 65,113 62,034
---------------- --------------- ----------------
Total liabilities and stockholders' equity............ $471,285 $485,921 $465,207
---------------- --------------- ----------------
---------------- --------------- ----------------
</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 ended March 31, 1999 and 1998
(In thousands of dollars, except per share data)
<TABLE>
<CAPTION>
Three months ended
March 31, March 31,
1999 1998
-------------- --------------
<S> <C> <C>
Interest income
Loans (including fee income)................................. $5,136 $5,549
Securities
Taxable.................................................... 2,506 2,504
Exempt from federal income tax............................ 265 257
Interest bearing deposits in financial institutions.......... 3 9
Federal funds sold........................................... 160 218
-------------- -------------
Total interest income..................................... 8,070 8,537
-------------- -------------
Interest expense
Time deposits................................................ 2,200 2,609
Other deposits............................................... 978 1,021
Other borrowings............................................. 629 560
-------------- -------------
Total interest expense.................................... 3,807 4,190
-------------- -------------
Net interest income............................................. 4,263 4,347
Provision for loan losses....................................... 0 10
-------------- -------------
Net interest income after provision for
loan losses.................................................. 4,263 4,337
-------------- -------------
Noninterest income
Service fees on deposits..................................... 262 267
Trust income................................................. 197 171
Mortgage banking income...................................... 182 21
Net gains on sales of loans.................................. 86 64
Other operating income....................................... 185 102
-------------- -------------
Total noninterest income.................................. 912 625
-------------- -------------
Noninterest expenses
Salaries and employee benefits............................... 1,567 1,538
Occupancy and equipment expenses, net........................ 354 290
Data processing expense...................................... 130 116
FDIC deposit insurance expense............................... 21 21
Other real estate owned expenses............................. 21 24
Other operating expenses..................................... 499 481
-------------- -------------
Total noninterest expenses................................ 2,592 2,470
-------------- -------------
Income before income taxes...................................... 2,583 2,492
Provision for income taxes...................................... 795 766
-------------- -------------
Net income...................................................... $1,788 $1,726
-------------- -------------
-------------- -------------
Basic earnings per share........................................ $0.40 $0.39
Diluted earnings per share...................................... $0.40 $0.39
</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 ended March 31, 1999 and 1998
(In thousands of dollars, except per share data)
<TABLE>
<CAPTION>
Three months ended
March 31, March 31,
1999 1998
-------------- --------------
<S> <C> <C>
Net income................................................... $1,788 $1,726
Other comprehensive income:
Unrealized gains arising during period
on securities available for sale, net of tax
of ($471) and $74.................................... (745) 113
-------------- --------------
Comprehensive income......................................... $1,043 $1,839
-------------- --------------
-------------- --------------
</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
Three months ended March 31, 1999 and 1998
(In thousands of dollars)
<TABLE>
<CAPTION>
March 31, March 31,
1999 1998
----------------- -----------------
<S> <C> <C>
Cash flows from operating activities
Net income................................................. $1,788 $1,726
Adjustments to reconcile net income to cash from
operating activities:
Depreciation............................................ 169 137
Provision for loan losses............................... 0 10
Provision for losses on other real estate owned......... 0 6
Deferred loan fees...................................... (11) 18
Gain on sales of property and equipment................. (74) 0
Net change in loans held for sale....................... 863 196
Net gains on sales of loans............................. (85) (64)
Amortization of mortgage servicing rights............... 18 12
Net change in interest receivable....................... 112 153
Net change in interest payable.......................... (444) 25
Net change in other assets.............................. 40 93
Net change in other liabilities......................... 504 1,591
----------------- -----------------
Net cash from operating activities................... 2,880 3,903
----------------- -----------------
Cash flows from investing activities
Proceeds from maturities and calls of securities
available for sale.................................... 42,449 48,002
Purchases of securities available for sale.............. (24,212) (44,770)
Change in loans made to customers....................... 2,601 (2,515)
Proceeds from sales of property and equipment........... 257 0
Property and equipment expenditures..................... (143) (39)
Net change in direct lease financing.................... 31 10
----------------- -----------------
Net cash from investing activities................. 20,983 688
----------------- -----------------
Cash flows from financing activities
Net change in:
Deposits.............................................. (13,878) (1)
Securities sold under repurchase agreements
and other short-term borrowings..................... (2,175) 2,294
Advances from borrowers for taxes and insurance....... 296 430
Net proceeds from exercise of stock options............. 18 0
----------------- -----------------
Net cash from financing activities.................... (15,739) 2,723
----------------- -----------------
Net change in cash and cash equivalents...................... 8,124 7,314
Cash and cash equivalents at beginning of period............. 27,959 25,506
----------------- -----------------
Cash and cash equivalents at end of period................... $36,083 $32,820
----------------- -----------------
----------------- -----------------
Supplemental disclosures
Cash paid during the period for
Interest................................................ $4,251 $4,165
Income taxes............................................ 0 75
Noncash investing activities
Transfers made from loans to other real estate owned.... 2,510 0
Transfers made from loans held for sale to portfolio.... 1,224 0
</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
March 31, 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 March 31, 1999,
December 31, 1998 and March 31, 1998. The condensed consolidated statements of
income and the condensed consolidated statements of comprehensive income and the
condensed consolidated statements of cash flows are for the three months ended
March 31, 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 month period ended March 31, 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>
March 31, December 31, March 31,
1999 1998 1998
-----------------------------------------------
<S> <C> <C> <C>
Common shares authorized........ 6,500,000 6,500,000 1,750,000
Common shares outstanding....... 4,455,435 4,453,400 889,373
Par value per share............. $0.40 $0.40 $2.00
</TABLE>
6
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 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 March 31, 1999, December 31, 1998 and March
31, 1998 are as follows:
<TABLE>
<CAPTION>
March 31, 1999 Amortized Gross Unrealized Fair
- -------------- Cost Gains Losses Value
--------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury............................... $13,009 .$54 $0 $13,063
U.S. Government agencies and corporations... 135,969 53 (1,094) 134,928
States and political subdivisions........... 21,895 535 (23) 22,407
Mortgage-backed securities.................. 8,785 97 (5) 8,877
Equity securities........................... 1,925 210 (2) 2,133
--------------------------------------------------------------
Total.................................... $181,583 $949 ($1,124) $181,408
--------------------------------------------------------------
--------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
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
--------------------------------------------------------------
--------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
March 31, 1998 Amortized Gross Unrealized Fair
- -------------- Cost Gains Losses Value
--------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury.............................. $20,057 $22 ($4) $20,075
U.S. Government agencies and corporations.. 121,099 100 (196) 121,003
States and political subdivisions.......... 21,153 698 (7) 21,844
Mortgage-backed securities................. 12,297 143 (6) 12,434
Equity securities and mutual fund
investment in debt securities........... 2,069 219 (18) 2,270
--------------------------------------------------------------
Total................................... $176,675 $1,182 ($231) $177,626
--------------------------------------------------------------
--------------------------------------------------------------
</TABLE>
7
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1999
(Dollar amounts in thousands, except per share data)
(Unaudited)
Contractual maturities of debt securities at March 31, 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..................... $17,108 $17,199
Due after one year through five years....... 105,654 105,407
Due after five years through ten years...... 48,111 47,792
--------------------------------
170,873 170,398
Mortgage-backed securities.................. 8,785 8,877
Equity securities........................... 1,925 2,133
--------------------------------
Total......................... $181,583 $181,408
--------------------------------
--------------------------------
</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 $131,403 at
March 31, 1999. As of March 31, 1999, the Company held no structured notes.
There were no sales of securities during the three months ended March 31,
1999 and 1998.
Securities carried at $131,957 and $110,368 at March 31, 1999 and 1998 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
March 31, 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 March 31, 1999, December 31, 1998 and March 31, 1998 were as
follows:
<TABLE>
<CAPTION>
March 31, December 31, March 31,
1999 1998 1998
-----------------------------------------------
<S> <C> <C> <C>
Commercial................................ $62,132 $64,043. $56,835
Real estate - construction................ 16,165 17,328 25,084
Real estate - mortgage.................... 137,394 141,241 139,920
Home equity............................... 15,543 15,579 14,265
Installment............................... 8,965 8,530 9,154
-----------------------------------------------
Total loans............................ 240,199 246,721 245,258
Unearned income........................... (108) (99) (142)
Deferred loan fees........................ (402) (413) (509)
-----------------------------------------------
Loans, net of unearned income
and deferred loan fees................. 239,689 246,209 244,607
Allowance for loan losses................. (4,791) (5,433) (5,458)
-----------------------------------------------
Loans, net............................. $234,898 $240,776 $239,149
-----------------------------------------------
-----------------------------------------------
</TABLE>
Loans held for sale on March 31, 1999, December 31, 1998 and March 31, 1998
were approximately $3,797, $5,799 and $1,206 and are classified as real estate
loans. During the first quarter of 1999 the Company transferred loans held for
sale with a book value and fair value of $1,244 to portfolio loans.
Real estate - mortgage loans with a carrying value of $18,047, $20,596 and
$23,861 were pledged to secure public deposits at March 31, 1999, December 31,
1998 and March 31, 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 $465 at March 31, 1999, $4,117 at December 31, 1998 and $1,021 at
March 31, 1998.
9
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1999
(Dollar amounts in thousands, except per share data)
(Unaudited)
Impaired loans were as follows for March 31, 1999, December 31, 1998 and
March 31, 1998:
<TABLE>
<CAPTION>
March 31, December 31, March 31,
1999 1998 1998
-----------------------------------------------
<S> <C> <C> <C>
Loans with no allowance
for losses allocated.......... $0 $0 $0
Loans with allowance
for losses allocated.......... 364 3,515 625
Amount of the allowance
allocated..................... 55 544 97
</TABLE>
The average balance and income recognized on impaired loans were as follows
for the three months ended March 31, 1999 and March 31, 1998:
<TABLE>
<CAPTION>
Three months ended
March 31, March 31,
1999 1998
--------------------------------
<S> <C> <C>
Average of impaired
loans during the period......................... $2,016 $710
Interest income recognized
during the impairment period.................... 14 10
Cash-basis interest income recognized
during the impairment period.................... 14 10
</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
March 31, 1999
(Dollar amounts in thousands, except per share data)
(Unaudited)
At March 31, 1999, December 31, 1998 and March 31, 1998, the contract
amount of the Company's off-balance sheet commitments was as follows:
<TABLE>
<CAPTION>
March 31, December 31, March 31,
1999 1998 1998
-----------------------------------------------
<S> <C> <C> <C>
Unused lines of credit and commitments to make loans:
Fixed rate....................................... $21,155 $19,999 $29,240
Variable rate.................................... 59,776 60,009 56,996
-----------------------------------------------
Total......................................... $80,931 $80,008 $86,236
-----------------------------------------------
-----------------------------------------------
Standby letters of credit........................... $5,658 $6,598 $7,165
</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
March 31, 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 three months ended March
31, 1999, twelve months ended December 31, 1998 and three months ended March 31,
1998 is as follows:
<TABLE>
<CAPTION>
March 31, December 31, March 31,
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......................... (654) (73) (1)
Recoveries on loans
previously charged off.................. 12 66 19
-----------------------------------------------
Balance at end of period............... $4,791 $5,433 $5,458
-----------------------------------------------
-----------------------------------------------
</TABLE>
Activity in the allowance for other realize estate owned losses for the
three months ended March 31, 1999, twelve months ended December 31, 1998 and
three months ended March 31, 1998 is as follows:
<TABLE>
<CAPTION>
March 31, December 31, March 31,
1999 1998 1998
-----------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year............... $552 $544 $544
Provision charged to operating expense..... 0 10 6
Losses on other real estate owned.......... 0 (2) 0
-----------------------------------------------
Balance at end of period................ $552 $552 $550
-----------------------------------------------
-----------------------------------------------
</TABLE>
12
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 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 three months ended March 31, 1999 total stockholders' equity
increased $1,061. The increase is a result of net income of $1,788, less the
change in the valuation allowance from December 31, 1998 for the fair value of
securities available for sale, net of tax, of $745, plus $18 due to the exercise
of 2,035 stock options pursuant to the Omnibus Incentive Plan.
For the three months ended March 31, 1998 total stockholders' equity
increased $1,839 due to net income of $1,726, plus the change in the valuation
allowance from December 31, 1997 for the fair value of securities available for
sale, net of tax, of $113.
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 three months ended March 31, 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>
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 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
March 31, 1998........................... 0 0
--------------------------------
Outstanding at March 31, 1998................ 25,390 $8.32
----------------
----------------
Outstanding at January 1, 1999............... 18,855 $8.32
Exercised during period ended
March 31, 1999........................... (2,035) 8.32
--------------------------------
Outstanding at March 31, 1999................. 16,820 $8.32
----------------
----------------
</TABLE>
At March 31, 1999, all remaining options had an exercise price of $8.32.
The options outstanding had a remaining life of 2.75 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 three months ended March 31, 1999, 2,710 stock appreciation
rights were exercised and payment was made to the holders. As of March 31, 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 was ($14) and $140 for the
three months ended March 31, 1999 and 1998. The stock appreciation rights will
expire during 2002.
14
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 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
months ended March 31, 1999 and 1998 follows:
<TABLE>
<CAPTION>
March 31, March 31,
1999 1998
--------------------------------
<S> <C> <C>
Unrealized holding gains (losses) on
on securities available for sale............. ($1,216) $187
Tax effect...................................... (471) 74
--------------------------------
Other comprehensive income (loss)............ ($745) $113
--------------------------------
--------------------------------
</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 ended March 31, 1999 or 1998.
15
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1999
(Dollar amounts in thousands, except per share data)
(Unaudited)
Information reported internally for performance assessment of operating
segments for the three months ended March 31, 1999 and 1998 follows:
<TABLE>
<CAPTION>
Three months ended March 31, 1999
Other Total
Banking Segments Segments
-----------------------------------------------
<S> <C> <C> <C>
Net interest income..................... $4,263 $0 $4,263
Provision for loan losses............... 0 0 0
Other revenue........................... 448 464 912
Other expenses.......................... 2,119 473 2,592
-----------------------------------------------
Segment profit....................... $2,592 ($9) $2,583
-----------------------------------------------
-----------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Three months ended March 31, 1998
Other Total
Banking Segments Segments
-----------------------------------------------
<S> <C> <C> <C>
Net interest income.................... $4,347 $0 $4,347
Provision for loan losses.............. 10 0 10
Other revenue.......................... 454 171 625
Other expenses......................... 2,344 126 2,470
-----------------------------------------------
Segment profit...................... $2,447 $45 $2,492
-----------------------------------------------
-----------------------------------------------
</TABLE>
16
<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
condition of the Northern States Financial Corporation at March 31, 1999 and the
consolidated results of operations for the three month period ending March 31,
1999, compared to the same period 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 March 31, 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 it 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 $471.3 million at
March 31, 1999, decreasing $14.6 million or 3.01% from the Company's year-end,
December 31, 1998.
Securities in total declined $19.4 million or 9.68% from the previous
year-end. The statement of cashflows shows that $18.2 million more in securities
matured or were called than were purchased during the first quarter of 1999. The
fair value of securities decreased $1.2 million over the same period due to
changes in market conditions. The cash flows from the maturing securities were
used for liquidity purposes to increase Fed funds sold which went up $6.9
million with the balance used to fund the net change in deposits.
Loan demand slowed, causing the Company's loans to decline $6.5 million
or 2.65% from December 31, 1998. Commercial loans declined $1.9 million and real
estate construction loans decreased $1.2 million. Although the economy remains
strong, there is some uncertainty that has affected loan demand, as to whether
the economy will continue to expand or begin to slow down. Another factor
impacting the loan portfolio has been competitive pressures that have
contributed to the decline in loans. Real estate mortgage loans declined $3.8
million from year-end. The majority of this decline is due to one credit for
$3.0 million that was nonperforming at year-end that management, during the
quarter, charged off $.5 million to the allowance for loan losses and
transferred the balance of $2.5 million upon foreclosure to other real estate
owned. At March 31, 1999 there was a sales contract on this property. Home
equity loans remained unchanged from year-end while the Company experienced an
increase of $.4 million to its installment loan portfolio.
17
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
During the first three months of 1999 deposits at the Company decreased
$13.9 million to $341.9 million. Total time deposits declined $18.5 million. The
decline was primarily in time deposits, $100,000 and over which decreased $16.3
million. Time deposits from public entities decreased $16.9 million as a result
the cyclical nature of public depositors taking in taxes during the summer as
tax bills come due and drawing down their deposits for operating purposes during
the winter and spring. Noninterest-bearing demand deposits declined slightly by
$1.3 million. NOW, money market and savings accounts grew $3.4 million, $1.7
million and $.8 million from December 31, 1998 indicating a shift by depositors
to shorter term and more liquid deposits.
Securities sold under repurchase agreements and other short-term
borrowings at the Company declined $2.2 million from December 31, 1998 to $45.8
million at March 31, 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 Company has received term advances from the Federal Home Loan Bank
in the amount of $10,000,000. These funds have been used to purchase 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 $1,061,000 during the three months
ended March 31, 1999. The increase is the result of net income of $1,788,000,
less the adjustment in the valuation allowance for the market value of
securities available for sale, net of tax, of $745,000, plus $18,000 due to the
exercise of 2,035 stock options pursuant to the Omnibus Incentive Plan.
The tier 1 capital to average assets ratio at March 31, 1999 was 15.22%
and the total capital to asset ratio, on a risk adjusted basis, amounted to
23.01%, 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 $14.85 at March 31, 1999 as compared to $14.63 at December 31, 1998. On
March 31, 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 March 31, 1999 was
$1,788,000, an increase of $62,000 or 3.59%, as compared to net income of
$1,726,000 for the same period the previous year. The annualized return on
average assets was 1.51% for the quarter, which was slightly higher than
the1.50% return on average assets for the quarter the previous year.
18
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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 $84,000 or 1.93% during the three months ended March 31,
1999, compared to the same three months in 1998. The decreased net interest
income is the result of rates on interest earning assets declining faster than
rates paid on interest bearing liabilities. As evidenced in Table 1, "Analysis
of Average Balance and Tax Equivalent Rates for the Three Months ended March 31,
1999 and 1998", the yield on interest earning assets declined 61 basis points to
7.36% during the first quarter of 1999 from 7.97% last year. This decrease is
partially the result of prime rate being 75 basis points less at March 31, 1999
as compared to last year when it was at 8.50%. Another factor impacting the
decrease in yields on interest earning assets are competitive pressures, which
have contributed to the decline in loan rates.
Table 1 also indicates that rates paid on interest bearing liabilities have
also declined, but at a slower pace than rates on interest earning assets. Rates
paid on interest bearing liabilities have decreased only 52 basis points to
4.26% during the three months ended March 31, 1999 as compared to 4.78% for the
same period last year. During 1998 management decreased the rates offered on
time deposits and at March 31, 1999 the rates on time deposits were 100 basis
points lower than they were at March 31, 1998. As longer-term time deposits
mature and renew the impact of this reduction on time deposit rates will be
further observed.
PROVISION FOR LOAN LOSSES
There was no provision for loan losses during the quarter ended March
31, 1999 as compared to $10,000 for the same period the previous year.
Management, with the concurrence of the Board of Directors, lowered the
provision for loan losses during the first quarter of 1999 after a careful
review of the adequacy of the allowance for loan losses and the levels of
non-performing and impaired loans.
At March 31, 1999, the allowance for loan losses was $4,791,000 or
2.00% of loans as compared to $5,433,000 or 2.21% of loans at December 31, 1998.
Nonperforming loans, at March 31, 1999, were $465,000, down from $4,117,000 at
December 31, 1998. Impaired loans were $364,000 or .15 % of loans at March 31,
1999 as compared to impaired loans of $3,515,000 or 1.43% of loans at December
31, 1998. The amount of the allowance for loan losses allocated for impaired
loans at March 31, 1999 was $55,000 compared to $544,000 at December 31, 1998.
Much of these changes were the result of management, during the first
quarter of 1999, charging off $500,000 of a nonperforming credit of $3,010,000
secured by a 57,000 square foot office building located in Northbrook, Illinois.
The balance of this credit, $2,510,000, was transferred to other real estate
owned during the quarter when foreclosure proceedings provided the Bank with
title to the property. At March 31, 1999 there was a sales contract on this
property. During the first three months of 1999 $654,000 in loans, including the
credit already mentioned, were charged off to the allowance for loan losses as
compared to $1,000 during the same period of 1998. During the first three months
of 1999 recoveries of loans previously charged off were $12,000 as compared to
$19,000 during the same period in 1998.
19
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
TABLE 1
NORTHERN STATES FINANCIAL CORPORATION
ANALYSIS OF AVERAGE BALANCE AND TAX EQUIVALENT RATES
For the Three Months Ended March 31, 1999 and 1998
($ 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) $244,677 $5,172 8.46% $242,022 $5,584 9.23%
Taxable securities 168,453 2,506 5.95% 159,616 2,504 6.29%
Securities exempt from
taxes (2) 21,526 401 7.69% 19,621 389 8.24%
Interest bearing deposits in 236 3 5.08% 700 9 5.14%
banks
Federal funds sold 13,637 160 4.69% 15,856 218 5.50%
---------------------------- ----------------------------
Interest earning assets 448,529 8,242 7.36% 437,815 8,704 7.97%
-------------- --------------
Noninterest earning assets 23,944 20,984
-------------- --------------
Average assets $472,473 $458,799
-------------- --------------
-------------- --------------
Liabilities and stockholders'
equity
NOW deposits $41,251 281 2.72% $37,382 291 3.11%
Money market deposits 42,461 366 3.45% 41,287 407 3.94%
Savings deposits 45,187 331 2.93% 44,189 323 2.92%
Time deposits 176,461 2,200 4.99% 185,128 2,609 5.64%
Other borrowings 52,174 629 4.82% 42,717 560 5.24%
---------------------------- ----------------------------
Interest bearing 357,534 3,807 4.26% 350,703 4,190 4.78%
liabilities -------------- --------------
Demand deposits 42,315 38,523
Other noninterest bearing 7,049 8,576
liabilities
Stockholders' equity 65,575 60,997
-------------- --------------
Average liabilities and
stockholders' equity $472,473 $458,799
-------------- --------------
-------------- --------------
Net interest income $4,435 $4,514
-------------- --------------
-------------- --------------
Net yield on interest
earning assets 3.96% 4.13%
----------- ------------
----------- ------------
Interest bearing
liabilities to
earning assets ratio 79.84% 80.31%
----------- ------------
----------- ------------
</TABLE>
(1) - Interest income on loans includes loan origination fees of $92 and
$130 for the three months ended March 31, 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>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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 March 31, 1999 is adequate to cover
future possible loan losses. If the level of impaired and nonperforming loans
remains low during the balance of 1999, management has budgeted no additional
provision for loan losses during 1999.
NONINTEREST INCOME
Noninterest income for the three months ended March 31, 1999 was
$912,000 as compared to $625,000 for the three months ended March 31, 1998, an
increase of $287,000. Service fees on deposits declined slightly by $5,000 as
compared to the same quarter last year. Trust fee income increased $26,000
during the three months ended March 31, 1999 due to increased trust business and
greater investment management performance. Income from mortgage banking
activities were $182,000 during the first quarter of 1999, an increase of
$161,000 from last year as management expanded this operating segment beginning
in August, 1998. During the first quarter of 1999 $8,574,000 in "table funded"
loans were processed by the Bank. The $182,000 in mortgage banking income
consist of fees earned by the Bank on these "table funded" loans as well as fees
for appraisals and credit bureau costs from borrowers of both "table funded"
loans and loans originated and funded by the Bank and sold on the secondary
market. Other income from gains on sales on loans increased $22,000 during the
first quarter of 1999 in that proceeds on loans sold on the secondary market
increased to $8,016,000 during the first three months of 1999 as compared to
$3,886,000 during the same period last year. Other operating income during the
first quarter of 1999 was $83,000 greater than the same period last year as the
Company realized a $74,000 gain on the sale of a branch office. 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.
NONINTEREST EXPENSES
Noninterest expenses increased $122,000 or 4.94% during the three
months ended March 31, 1999. The Company's efficiency ratio, noninterest
expenses divided by the sum of net interest income and noninterest income, was
50.09% for the first quarter of 1999 as compared to 49.68% for the first 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.
Expenses relating to salaries and employee benefits increased of
$29,000 during the first quarter of 1999 compared to the same period last year.
Expenses relating to salaries for the mortgage banking segment were $106,000
greater during the first quarter of 1999 as management expanded this operating
segment beginning in August, 1998. As a consequence FICA expenses were $9,000
greater during the first quarter of 1999 as compared to the first quarter of
1998. Group insurance rates increased $67,000 during the first quarter of 1999
compared to the same period last year as coverage provided by a three year
policy expired at December 31, 1998 and new coverage was obtained but at a much
higher rate. Expenses relating to stock appreciation rights declined $154,000
during the first three months of 1999 compared to last year as the result of
decreases in the market price of the Company's stock.
21
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Occupancy expenses for the first quarter of 1999 were $354,000, an
increase of $64,000 from the first quarter of 1998. This increase in occupancy
expenses is attributable to increased depreciation of $34,000 and maintenance
expenses of $29,000. During the fourth quarter of 1998 the Bank purchased a
branch office in the neighboring community of Winthrop Harbor, Illinois, from
another financial institution for $1,000,000 and opened the branch in November,
1998. The Bank did not purchase any assets or liabilities other than the branch
building as part of this transaction. The Bank sold another of its branch
buildings located two blocks from the Bank's main office during the first
quarter of 1999 that had a book value of only $183,000. The result of these
developments was that the Bank operates six branch offices, has expanded its
geographic presence, and has increased its building depreciation expenses during
the first quarter of 1999. During the later part of 1998 the Bank purchased and
installed $216,000 of new computer equipment as part of the Bank's efforts to
address Year 2000 issues, which has also contributed to the greater equipment
depreciation expenses during the first three months of 1999. Maintenance
expenses increased in part from the opening of the new branch as well as snow
removal costs that were higher during the first three months of 1999 due to some
major snowfalls.
Data processing expense increased $14,000 during the first quarter of
1999 to $130,000. Data processing expenses were $13,000 greater than during the
first three months of 1999 compared to the same period last year. This was as a
result of expenses related to new software and testing of our systems for year
2000 compliance as well as for additional year-end processing.
FDIC insurance expense was $21,000 during the three months ended March
31, 1999, which was unchanged from last year.
Other real estate owned expenses declined slightly during the first
quarter of 1999 by $3,000 to $21,000.
Miscellaneous other operating expenses increased $18,000 compared to
the same quarter last year. Expenses relating to loan origination and sales
increased $49,000 resulting from the expanded mortgage banking operation.
Printing and supplies increases $21,000 during the first quarter of 1999 as
compared to the same period last year partially as the result of new forms being
necessary for the new computer equipment installed as part of the Bank's efforts
to address Year 2000 issues. Marketing expenses were up $11,000 over the same
period last year as promotion of our new branch in Winthrop Harbor that opened
in November, 1998 continued into the first quarter of 1999. Legal expenses were
$44,000 less during the first quarter of 1999 as there were additional legal
expenses during the first quarter of 1998 relating to the merger between the
Bank of Waukegan and First Federal Bank, fsb. Directors fees were $11,000 less
during the first three months of 1999 compared to the same period last year as a
result of the merger between the two subsidiaries of the Company. Postage
expense decreased $5,000 due in part to year-end notices that were mailed
directly from our data processor this year with the postage was invoiced as part
of our data processing bill which had not been the case the previous year.
22
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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.
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 has been mailed to customers which discusses the Year 2000 problem
in general and discloses the Bank's state of preparedness for the Year 2000.
Efforts to communicate the Bank's preparedness to customers are expected to
continue during 1999 in order to steady customer fears regarding this issue.
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. Our data processing service bureau
has provided a "Test Bank" environment at a cost of $1,000 per month in order
for tests to be conducted by users to make sure that the system will handle Year
2000 processing. The Bank belongs to a data processing users group that is
jointly testing service bureau compliance for the Year 2000.
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.
23
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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 March 31, 1999 and 1998, the Company's
provision for federal and state income taxes were $795,000 and $766,000, which
as a percentage of pretax earnings was 30.78% for 1999 and 30.74% for 1998.
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 mortgage loans that are securitized 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.
24
<PAGE>
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 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.
Another approach used by the Company is to periodically analyze its assets and
liabilities and make future financing and investment decisions based on payment
streams, interest rates, contractual maturities, and estimated sensitivity to
actual or potential changes in market interest rates. Both approaches fall under
the broad definition of asset/liability management. The Company's primary
asset/liability management techniques are the interest rate shock and 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 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.
25
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
The following Table 2 shows information as of 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. Table 2 shows, because of the
Company's gap position, that the fair value of the Company would increase $21.5
million if rates immediately drop 2% or decrease $20.1 million if rates
immediately rise 2%. Tables 3 and 4 provide information about the Company's
financial instruments that are sensitive to changes in interest rates as of
December 31, 1998 and 1997. The Company believes that the assumptions utilized
by the tables are reasonable. The expected maturity date values for loan
receivable, 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 estimated to be 5% each year although these may be
withdrawn over a very short time period even though it may be unlikely. With
respect to the Company's adjustable rate instruments, expected maturity date
values were measured by adjusting the instrument's contractual maturity date for
expectations of prepayments. From a risk management perspective, however, the
Company believes that repricing dates may be a more relevant in analyzing such
instruments. Similarly, 52.17% of the Company's investment securities portfolio
at December 31, 1998 is comprised of callable securities. The tables use
December 31, 1998 for analysis, as there has been no material changes to the
Company's balance sheets and to market interest rate levels from year-end.
TABLE 2
NORTHERN STATES FINANCIAL CORPORATION
EFFECT OF INTEREST SHOCKS ON
FINANCIAL INSTRUMENTS
<TABLE>
<CAPTION>
($000's) 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 90 101 100 99
days
Securities available for sale 213,608 200,861 189,199
Loans 259,503 250,721 242,283
Direct lease 1,017 1,001 987
financing
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 $475,764
-------------------------------------------------------
-------------------------------------------------------
</TABLE>
26
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
TABLE 3
NORTHERN STATES FINANCIAL CORPORATION
EXPECTED MATURITY DATES OF ON BALANCE SHEET
FINANCIAL INSTRUMENTS AS OF DECEMBER 31, 1998
<TABLE>
<CAPTION>
Maturing In
--------------------------------------------------------------
($ 000s) 1999 2000 2001 2002 2003 Thereafter Totals Fair Value
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans (1)(2)
Fixed rate $23,539 $12,282 $18,001 $24,140 $21,407 $30,352 $129,721 135,604
Average interest 8.48% 8.62% 8.82% 8.44% 8.50% 7.11% 8.22%
rate
Adjustable rate 38,072 15,448 10,279 13,027 6,446 33,728 117,000 121,062
Average interest 8.41% 8.44% 8.25% 8.15% 8.42% 8.20% 8.31%
rate
Securities
Fixed rate 20,677 12,225 24,787 36,620 53,155 47,027 194,491 194,491
Average interest 5.95% 6.64% 6.33% 6.14% 5.92% 6.23% 6.14%
rate
Adjustable rate 1,000 0 0 0 0 5,370 6,370 6,370
Average interest 6.15% 0.00% 0.00% 0.00% 0.00% 6.52% 6.46%
rate
Interest-bearing deposits
and federal funds sold
Fixed rate 0 100 0 0 0 0 100 100
Average interest 0.00% 7.41% 0.00% 0.00% 0.00% 0.00% 7.41%
rate
Adjustable rate 12,783 0 0 0 0 0 12,783 12,783
Average interest 4.59% 0.00% 0.00% 0.00% 0.00% 0.00% 4.59%
rate
Direct lease financing
Fixed rate 665 99 100 123 0 0 987 1,001
Average interest 8.13% 8.02% 6.58% 7.44% 0.00% 0.00% 7.87%
rate
--------------------------------------------------------------------------------------
Total $96,736 $40,154 $53,167 $73,910 $81,008 $116,477 $461,452 $471,411
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
Interest-bearing Liabilities:
Interest-bearing deposits (3)
Balances $171,816 $20,469 $11,729 $5,428 $5,112 $97,127 $311,681 $312,896
Average interest 5.00% 5.03% 4.46% 3.08% 3.06% 3.06% 4.31%
rate
Borrowings
Balances 46,990 6,000 0 0 0 5,000 57,990 56,472
Average interest 5.00% 4.99% 0.00% 0.00% 0.00% 4.75% 4.98%
rate
--------------------------------------------------------------------------------------
Total $218,806 $26,469 $11,729 $5,428 $5,112 $102,127 $369,671 $369,368
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
</TABLE>
(1) Does not include net deferred loan fees, unearned income or the allowance
for loan losses.
(2) For fixed rate loans maturities are based on aggregate
payments due.
(3) For NOW, money market and savings deposits all balances
assumed 5% maturity each yr.
27
<PAGE>
NORTHERN STATES FINANCIAL CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
TABLE 4
NORTHERN STATES FINANCIAL CORPORATION
EXPECTED MATURITY DATES OF ON BALANCE SHEET
FINANCIAL INSTRUMENTS AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
Maturing In
--------------------------------------------------------------
($ 000s) 1998 1999 2000 2001 2002 Thereafter Totals Fair Value
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans (1)(2)
Fixed rate $17,753 $10,862 $15,771 $24,867 $16,685 $20,776 $106,714 107,151
Average interest 8.88% 8.93% 8.98% 9.03% 8.98% 7.86% 8.75%
rate
Adjustable rate 55,486 12,365 13,052 9,012 13,816 32,424 136,155 136,155
Average interest 9.17% 9.27% 9.21% 8.98% 9.29% 9.27% 9.21%
rate
Securities
Fixed rate 24,446 19,081 43,344 33,821 33,324 19,625 173,641 173,641
Average interest 6.01% 6.30% 6.50% 6.47% 6.55% 7.33% 6.51%
rate
Adjustable rate 0 0 0 0 0 7,031 7,031 7,031
Average interest 0.00% 0.00% 0.00% 0.00% 0.00% 6.76% 6.76%
rate
Interest-bearing deposits
and federal funds sold
Fixed rate 0 0 100 0 0 0 100 100
Average interest 0.00% 0.00% 7.30% 0.00% 0.00% 0.00% 7.30%
rate
Adjustable rate 11,306 0 0 0 0 0 11,306 11,306
Average interest 5.57% 0.00% 0.00% 0.00% 0.00% 0.00% 5.57%
rate
Direct lease financing
Fixed rate 749 202 67 149 107 0 1,274 1,274
Average interest 7.74% 7.80% 8.74% 7.30% 7.14% 0.00% 7.70%
rate
--------------------------------------------------------------------------------------
Total $109,740 $42,510 $72,334 $67,849 $63,932 $79,856 $436,221 $436,658
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
Interest-bearing Liabilities:
Interest-bearing deposits(3)
Balances $167,753 $25,613 $10,958 $5,128 $4,859 $92,251 $306,562 $306,958
Average interest 5.60% 5.46% 4.80% 3.35% 3.34% 3.34% 4.80%
rate
Borrowings
Balances 37,504 6,000 0 0 0 0 43,504 43,519
Average interest 5.27% 5.92% 0.00% 0.00% 0.00% 0.00% 5.36%
rate
--------------------------------------------------------------------------------------
Total $205,257 $31,613 $10,958 $5,128 $4,859 $92,251 $350,066 $350,477
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
</TABLE>
(1) Does not include net deferred loan fees, unearned income or the allowance
for loan losses.
(2) For fixed rate loans amortization is based on aggregate payments due.
(3) For NOW, money market and savings deposits all balances assumed 5% maturity
each yr.
28
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to sign on its behalf by the undersigned
hereunto duly authorized, on this 13th day of May 1999.
NORTHERN STATES FINANCIAL CORPORATION
(Registrant)
Date: May 14, 1999 By: /s/ Fred Abdula
-------------------------- -------------------------------
Fred Abdula
Chairman of the Board of
Directors and President
Date: May 14, 1999 By: /s/ Thomas M. Nemeth
-------------------------- -------------------------------
Thomas M. Nemeth
Vice President and Treasurer
29
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 16,532
<INT-BEARING-DEPOSITS> 151
<FED-FUNDS-SOLD> 19,500
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 181,408
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 240,645
<ALLOWANCE> 4,791
<TOTAL-ASSETS> 471,285
<DEPOSITS> 341,878
<SHORT-TERM> 45,815
<LIABILITIES-OTHER> 7,418
<LONG-TERM> 10,000
0
0
<COMMON> 1,782
<OTHER-SE> 64,392
<TOTAL-LIABILITIES-AND-EQUITY> 471,285
<INTEREST-LOAN> 5,136
<INTEREST-INVEST> 2,771
<INTEREST-OTHER> 163
<INTEREST-TOTAL> 8,070
<INTEREST-DEPOSIT> 3,178
<INTEREST-EXPENSE> 3,807
<INTEREST-INCOME-NET> 4,263
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 2,592
<INCOME-PRETAX> 2,583
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,788
<EPS-PRIMARY> .40
<EPS-DILUTED> .40
<YIELD-ACTUAL> 3.96
<LOANS-NON> 386
<LOANS-PAST> 79
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 5,433
<CHARGE-OFFS> 654
<RECOVERIES> 12
<ALLOWANCE-CLOSE> 4,791
<ALLOWANCE-DOMESTIC> 2,836
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 1,955
</TABLE>
