<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 or 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended SEPTEMBER 30, 1998
Commission file number 0-18166
STATE FINANCIAL SERVICES CORPORATION
------------------------------------
(Exact name of registrant as specified in its charter)
WISCONSIN 39-1489983
--------- ----------
(State or other jurisdiction of (I.R.S. Employer identification No.)
incorporation or organization)
10708 WEST JANESVILLE ROAD, HALES CORNERS, WISCONSIN 53130
----------------------------------------------------------
(Address and Zip Code of principal executive offices)
Not applicable
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
(414) 425-1600
---------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of November 2, 1998, there were 4,007,948 shares of Registrant's
$0.10 Par Value Common Stock outstanding.
<PAGE> 2
FORM 10-Q
STATE FINANCIAL SERVICES CORPORATION
INDEX
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page No.
<S> <C> <C>
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of
September 30, 1998 and December 31, 1997 2
Consolidated Statements of Income for the
Three Months ended September 30, 1998 and 1997 3
Consolidated Statements of Income for the
Nine Months ended September 30, 1998 and 1997 4
Consolidated Statements of Cash Flows for the
Nine Months ended September 30, 1998 and 1997 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II - OTHER INFORMATION
Items 1-6 21
Signatures 22
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STATE FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- --------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 17,658,220 $ 27,506,201
Federal funds sold 4,474,371 11,273,835
Other short-term investments 12,300,000 -0-
------------- --------------
Cash and cash equivalents 34,432,591 38,780,036
Investment securities
Held-to-maturity (fair value $ 13,654,000 - September 30, 1998
and $21,208,000 - December 31, 1997) 13,451,412 20,997,095
Available for sale (at fair value) 86,474,161 74,254,433
Loans (net of allowance for loan losses of $3,336,244-1998
and $3,306,168-1997) 258,176,811 264,513,049
Premises and equipment 6,590,087 6,914,446
Accrued interest receivable 3,183,814 2,943,801
Other assets 14,846,747 12,875,193
------------- --------------
TOTAL ASSETS $ 417,155,623 $ 421,278,053
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand 67,990,958 69,170,535
Savings 80,940,761 83,759,867
Money market 95,953,240 89,853,817
Other time 114,312,735 124,707,670
------------- --------------
TOTAL DEPOSITS 359,197,694 367,491,889
Notes payable 1,450.000 5,300,000
Securities sold under agreements to repurchase 8,468,371 4,850,160
Federal funds purchased -0- -0-
Accrued expenses and other liabilities 3,067,689 3,213,441
Accrued interest payable 1,581,790 1,874,197
------------- --------------
TOTAL LIABILITIES 373,765,544 382,729,687
Stockholders' equity:
Preferred stock, $1 par value; authorized--100,000 shares;
issued and outstanding--none
Common stock, $0.10 par value; authorized--10,000,000 shares
issued and outstanding--4,004,372 shares in 1998
and 3,872,553 in 1997 400,437 387,256
Capital surplus 31,557,777 28,964,328
Accumulated other comprehensive income 1,015,954 888,649
Retained earnings 11,798,544 9,787,620
Less: Guaranteed ESOP obligation (1,382,633) (1,479,487)
------------- --------------
TOTAL STOCKHOLDERS' EQUITY 43,390,079 38,548,366
------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 417,155,623 $ 421,278,053
============= ==============
</TABLE>
See notes to unaudited consolidated financial statements.
2
<PAGE> 4
STATE FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
<TABLE>
<CAPTION>
Three months ended September 30,
1998 1997
------------- -------------
<S> <C> <C>
INTEREST INCOME:
Loans, including fees $ 6,090,341 $ 4,963,805
Investment securities
Taxable 1,206,296 849,024
Tax-exempt 361,328 205,675
Federal funds sold 168,412 30,927
------------- -------------
TOTAL INTEREST INCOME 7,826,377 6,049,431
INTEREST EXPENSE:
Deposits 3,403,185 2,352,856
Notes payable and other borrows 148,605 71,380
------------- -------------
TOTAL INTEREST EXPENSE 3,551,790 2,424,236
------------- -------------
NET INTEREST INCOME 4,274,587 3,625,195
Provision for loan losses 142,500 82,500
------------- -------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 4,132,087 3,542,695
OTHER INCOME:
Service charges on deposit accounts 326,597 264,368
Merchant service fees 320,790 296,646
Building rent 70,024 77,684
ATM fees 124,933 60,639
Security transaction commissions 137,093 31,377
Gains on sale of loans 258,204 73,178
Investment security gains 13,628 -0-
Other 278,332 81,242
------------- -------------
TOTAL OTHER INCOME 1,529,601 885,134
OTHER EXPENSES:
Salaries and employee benefits 1,864,233 1,230,988
Net occupancy expense 235,097 231,496
Equipment rentals, depreciation and maintenance 329,057 277,557
Data processing 250,558 197,634
Legal and professional 139,408 91,277
Merchant service charges 242,191 232,796
ATM charges 54,672 52,393
Advertising 109,967 97,525
Goodwill amortization 159,263 37,856
Other 527,674 362,435
------------- -------------
TOTAL OTHER EXPENSES 3,912,120 2,811,957
INCOME BEFORE INCOME TAXES 1,749,568 1,615,872
Income taxes 581,308 546,710
------------- -------------
NET INCOME $ 1,168,260 $ 1,069,162
============= =============
Basic earnings per common share $ 0.31 $ 0.28
Diluted earnings per common share 0.30 0.28
Dividends per common share 0.12 0.10
Weighted average common shares outstanding
Basic 3,821,814 3,764,984
Diluted 3,855,761 3,826,490
</TABLE>
See notes to unaudited consolidated financial statements.
3
<PAGE> 5
STATE FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
<TABLE>
<CAPTION>
Nine months ended September 30,
1998 1997
------------ ------------
<S> <C> <C>
INTEREST INCOME:
Loans, including fees $ 18,466,257 $ 14,772,013
Investment securities
Taxable 3,486,753 2,569,164
Tax-exempt 989,773 585,065
Federal funds sold 517,292 43,610
------------ ------------
TOTAL INTEREST INCOME 23,460,075 17,969,852
INTEREST EXPENSE:
Deposits 10,239,402 6,610,585
Notes payable and other borrowings 448,152 394,709
------------ ------------
TOTAL INTEREST EXPENSE 10,687,554 7,005,294
------------ ------------
NET INTEREST INCOME 12,772,521 10,964,558
Provision for loan losses 427,500 247,500
------------ ------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 12,345,021 10,717,058
OTHER INCOME:
Service charges on deposit accounts 939,541 777,095
Merchant service fees 920,339 855,551
Building rent 212,252 232,777
ATM fees 360,310 155,968
Security transaction commissions 319,931 92,243
Gains on sale of loans 634,098 153,793
Investment security gains 420,817 -0-
Other 546,301 211,608
------------ ------------
TOTAL OTHER INCOME 4,353,589 2,479,035
OTHER EXPENSES:
Salaries and employee benefits 5,409,860 3,684,914
Net occupancy expense 721,277 714,900
Equipment rentals, depreciation and maintenance 1,070,836 813,273
Data processing 748,728 565,937
Legal and professional 419,578 271,490
Merchant service charges 701,870 693,922
ATM charges 153,639 150,384
Advertising 341,630 287,700
Goodwill amortization 444,703 113,569
Other 1,582,517 1,094,541
------------ ------------
TOTAL OTHER EXPENSES 11,594,638 8,390,630
INCOME BEFORE INCOME TAXES 5,103,972 4,805,463
Income taxes 1,708,906 1,636,769
------------ ------------
NET INCOME $ 3,395,066 $ 3,168,694
============ ============
Basic earnings per common share $ 0.89 $ 0.84
Diluted earnings per common share 0.89 0.82
Dividends per common share 0.36 0.30
Weighted average common shares outstanding
Basic 3,793,692 3,791,638
Diluted 3,831,576 3,852,432
</TABLE>
See notes to unaudited consolidated financial statements.
4
<PAGE> 6
STATE FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Nine months ended September 30,
1998 1997
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 3,395,066 $ 3,168,694
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 427,500 247,500
Provision for depreciation 708,096 525,089
Amortization of investment security
premiums and accretion of discounts-net 122,122 28,895
Amortization of goodwill 444,703 113,569
Amortization of branch acquisition premium -0- 22,249
Increase in interest receivable (240,013) (151,906)
Increase (decrease) in interest payable (292,407) 343,763
Realized investment security gains-net (420,817) -0-
Other (122,073) 379,938
----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 4,022,177 4,677,791
INVESTING ACTIVITIES
Purchases of investment securities -0- -0-
Maturities of investment securities 7,515,000 7,150,000
Purchases of securities available for sale (39,341,243) (23,860,010)
Maturities of securities available for sale 13,953,999 15,127,663
Sales of securities available for sale 13,729,777 -0-
Net decrease (increase) in loans 5,908,738 (10,220,202)
Purchases of premises and equipment (315,551) (698,079)
Business acquisitions (net of cash and cash
equivalents acquired of $1,400 in 1998)
Premises and equipment (68,186) -0-
Goodwill (2,571,281) -0-
Notes payable 204,902 -0-
Other 25,766 -0-
----------- -----------
NET CASH USED BY INVESTING ACTIVITIES (958,079) (12,500,628)
FINANCING ACTIVITIES
Increase (decrease) in deposits (8,294,195) 13,310,630
Decrease in notes payable (4,054,902) (961,844)
Decrease (increase) in guaranteed ESOP obligation 96,854 (1,003,222)
Net proceeds from securities sold under agreement to repurchase 3,618,211 1,300,000
Net proceeds from federal funds purchased -0- (5,600,000)
Cash dividends (1,384,142) (1,143,007)
Issuance of common stock in acquisition 2,410,199 -0-
Issuance of common stock under Dividend Reinvestment Plan -0- 204,818
Proceeds from exercise of stock options 196,432 103,706
----------- -----------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES (7,411,543) 6,211,081
----------- -----------
DECREASE IN CASH AND CASH EQUIVALENTS (4,347,445) (1,611,756)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 38,780,036 21,280,918
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $34,432,591 $19,669,162
=========== ===========
Supplemental information:
Interest paid $10,981,284 $ 6,661,531
Income taxes paid 1,737,000 1,760,251
</TABLE>
See notes to unaudited consolidated financial statements.
5
<PAGE> 7
STATE FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
NOTE A--BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include the
accounts of State Financial Services Corporation (the "Company") and its
subsidiaries - State Financial Bank (Wisconsin), State Financial Bank -Waterford
("Waterford"), State Financial Mortgage Company, Richmond Bancorp, Inc.
("Bancorp") and Lokken, Chesnut and Cape "(LCC"). State Financial Bank also
includes the accounts of its wholly owned subsidiaries, Hales Corners
Development Corporation and Hales Corners Investment Corporation. Waterford also
includes the accounts of its wholly owned subsidiary, Waterford Investment
Corporation. Bancorp also includes the accounts of its wholly owned
subsidiaries, State Financial Bank (Illinois, "Richmond") and State Financial
Investments, Inc. Richmond also includes the accounts of its wholly owned
subsidiary, State Financial Insurance Agency. All significant intercompany
balances and transactions have been eliminated.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and nine month period ending
September 30, 1998 are not necessarily indicative of the results that may be
expected for the year ended December 31, 1998. For further information, refer to
the consolidated financial statements and footnotes thereto included in the
Company's annual report to stockholders for the year ended December 31, 1997.
NOTE B--ACQUISITIONS
On December 31, 1997, the Company completed its acquisition of Bancorp
located in Richmond, Illinois. The Company purchased the outstanding common
stock of Bancorp for $10,787,000 in cash. In connection with the acquisition,
the Company borrowed $3,900,000 on its line of credit and assumed $1,400,000 of
Bancorp's outstanding debt. At September 30, 1998, the amount of debt
outstanding from the Bancorp acquisition had been reduced to $900,000. The
acquisition was recorded using purchase accounting. Application of purchase
accounting requires the inclusion of Bancorp's operating results in the
consolidated statements of income from the date of acquisition. Accordingly,
Bancorp's operating results are included in the Company's consolidated
statements of income for the three and nine months ended September 30, 1998 and
Bancorp's financial condition is included in the Company's consolidated balance
sheets dated September 30, 1998 and December 31, 1997. No operating results of
Bancorp are included in the Company's consolidated statements of income for the
three and nine months ended September 30, 1997.
On September 8, 1998, the Company completed its acquisition of LCC, an
asset management firm located in LaCrosse, Wisconsin. The Company purchased the
outstanding common stock of LCC in exchange for 113,241 shares of its common
stock valued at $21.19 per share on the transaction date. An additional 28,310
shares of common stock may be issued on January 31, 2002 subject to LCC meeting
or exceeding certain operating performance targets in 1999, 2000, and 2001. The
acquisition was recorded as a purchase. Application of purchase accounting
requires the inclusion of LCC's operating results in the consolidated statements
of income from the date of acquisition. Accordingly, LCC's operating results for
the period September 8, 1998 through September 30, 1998 are included in the
Company's consolidated statements of income for the three and nine months ended
September 30, 1998. LCC's financial condition is included in the Company's
consolidated balance sheets dated September 30, 1998. No operating results of
LCC are included in the Company's consolidated statements of income for the
three and nine months ended September 30, 1997.
6
<PAGE> 8
On a pro form basis, total income, net income, basic and fully diluted
earnings per share for the three and nine months ended September 30, 1997, after
giving effect to the acquisition of Bancorp and LCC as if it had occurred on
January 1, 1997 and giving effect to the LCC acquisition as if it had occurred
on January 1, 1998 are as follows:
<TABLE>
<CAPTION>
For the three For the three For the nine For the nine
months ended months ended months ended months ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Total income $9,479,325 $9,048,525 $28,396,776 $26,690,740
Net income 1,132,996 834,650 3,432,476 2,679,996
Basic earnings per share $ 0.29 $ 0.22 $ 0.88 $ 0.69
Diluted earnings per share $ 0.29 $ 0.21 $ 0.87 $ 0.68
</TABLE>
NOTE C - COMPREHENSIVE INCOME
On January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." This statement
establishes standards for reporting and display of comprehensive income and its
components in a complete set of financial statements. Comprehensive income is
the total of reported net income and all other revenues, expenses, gains and
losses that under generally accepted accounting principles are not includable in
reported net income but are reflected in shareholders' equity. The standard
permits the statement of changes in shareholders' equity to be used to satisfy
its requirements and requires companies to report comparative totals for
comprehensive income in interim reports.
<TABLE>
<CAPTION>
For the three months ended For the nine months ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
--------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $1,168,260 $1,068,162 $3,395,066 $3,168,694
Other comprehensive income
Change in unrealized securities
gains (losses), net of tax 474,085 318,334 548,122 474,857
Reclassification adjustment for
realized gains included in
net income (13,628) -0- (420,817) -0-
--------------------------------------------------------------------------
Total comprehensive income $1,628,717 $1,386,496 $3,522,371 $3,643,551
==========================================================================
</TABLE>
NOTE D--PENDING ACQUISITION
On June 1, 1998, the Company entered into an Agreement and Plan of
Merger (the "Agreement") with Home Bancorp of Elgin, Inc., ("Home"), Elgin,
Illinois. Home is the parent thrift holding company of Home Federal Savings, a
thrift institution which operates five offices in Elgin, South Elgin, Bartlett,
Roselle, and Crystal Lake, Illinois. The merger will be treated as a
reorganization under Section 368 of the Internal Revenue Code and a pooling for
purposes of generally accepted accounting principles.
The Merger requires approval by shareholders of both companies and
regulatory authorities. The Company has received the necessary regulatory
approvals to effectuate the transaction. Both the Company and Bancorp have
scheduled Special Meetings of their respective Shareholders on November 5, 1998
for the purpose of voting on the transaction.
7
<PAGE> 9
Pursuant to the Agreement, the exchange ratio in the transaction is
subject to certain caps and will be based on the Company's average closing price
for the twenty consecutive trading days prior to closing based on the following
schedule:
The Company's
Average Share Price Exchange Ratio
------------------- --------------
$20.00 - $21.125 Fixed at 0.86
$21.126 - $22.625 Fixed at 0.857143
$22.626 - $30.00 The quotient obtained by dividing $19.50
by the market value of SFSC common
stock
$30.01 - $31.375 Fixed at 0.65
Greater than $31.375 Fixed at 0.64
In the event the Company's average share price is below $20.00, the
Company can elect to close the transaction at the 0.86 exchange ratio or an
exchange ratio assigning $17.25 as the value of Home's shares, subject to Home's
acceptance. Home has also granted the Company an option to acquire up to 19.9%
of its common stock.
The Company estimates that it will take a $12 million pre-tax
restructuring charge at closing related to the acquisition. These include costs
related to professional fees, employment contracts, and investment banking fees
aggregating $7.5 million and $4.5 million related to the change in control
provisions of Home's Employee Stock Ownership Plan.
At September 30, 1998, Home had total assets of $386.1 million. Home's
shares are traded on the Nasdaq National Market under the symbol "HBEI".
8
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CHANGES IN FINANCIAL CONDITION
At September 30, 1998, total assets were $417,155,000 compared to
$421,278,000 at December 31, 1997. At September 30, 1998, total deposits
decreased $8,294,000 compared to December 31, 1997 mainly due to declines in
time deposits as the Company strategically reduced its municipal and state
funding sources. Other significant uses of funds during the first nine months of
1998 consisted of $4,142,000 in net investment securities purchases, the
repayment of $3,850,000 in notes payable resulting from the Richmond acquisition
and $205,000 resulting from debt assumed in the LCC acquisition, the payment of
$1,384,000 in cash dividends, and the purchase of $316,000 in fixed assets.
Funding sources came from a $5,908,000 contraction in loans during the first
nine months of 1998 mainly due to softer loan demand and intense competition at
the Company's Wisconsin banking operations. Additional funding sources came from
$3,618,000 in repurchase agreement proceeds, $4,347,000 in cash and cash
equivalents contraction, $4,022,000 in net cash from operating activities,
$196,000 in proceeds from exercised stock options, and $97,000 in ESOP loan
repayments. Additionally, the Company completed its acquisition of LCC in the
third quarter of 1998, issuing $2,410,000 of its common stock and assuming
$205,000 in notes payable and $26,000 in net other liabilities in exchange for
$68,000 in net fixed assets and $2,571,000 in goodwill related to the
acquisition.
ASSET QUALITY
At September 30, 1998, non-performing assets were $2,525,000, an
increase of $67,000 from June 30, 1998 due to an increase of $318,000 in
accruing loans past due 90 days or more offset by a decrease of $251,000 in
nonaccrual loans. Total non-performing assets as a percentage of total assets
increased to 0.61% at September 30, 1998 from 0.59% at June 30, 1998 due to the
increase in the amount of total non-performing and restructured loans and a
slight decrease in the level of outstanding total assets at September 30, 1998
as compared to June 30, 1998 As a percentage of total loans outstanding, the
level of non-performing loans increased to 0.96% at September 30, 1998 from
0.94% at June 30, 1998 due the increase in non-performing loans and a decline in
the balance of loans outstanding between second and third quarter 1998.
At September 30, 1998, available information would suggest that
additional loans totaling approximately $550,000 would likely be included as
nonaccrual, past due or restructured during the fourth quarter of 1998.
The following table summarizes non-performing assets on the dates
indicated (dollars in thousands).
<TABLE>
<CAPTION>
Sep. 30 Jun. 30 Mar. 31 Dec. 31 Sep. 30
1998 1998 1998 1997 1997
-----------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Nonaccrual loans......................... $ 2,084 $ 2,335 2,389 $ 2,537 $ 1,981
Accruing loans past due 90 days or more.. 436 118 68 20 27
Restructured loans....................... 0 0 0 0 0
-----------------------------------------------------------
Total non-performing and restructured loans 2,520 2,453 2,457 2,557 2,008
-----------------------------------------------------------
Other real estate owned.................. 5 5 454 334 15
-----------------------------------------------------------
Total non-performing assets.............. $ 2,525 $ 2,458 2,911 2,891 $ 2,023
===========================================================
Ratios:
Non-performing loans to total loans.... 0.96% 0.94% 0.93% 0.95% 0.95%
Allowance to non-performing loans...... 132.39 137.44 135.81 129.29 134.86
Non-performing assets to total assets.. 0.61 0.59 0.69 0.69 0.65
===========================================================
</TABLE>
9
<PAGE> 11
When, in the opinion of management, serious doubt exists as to the
collectibility of a loan, the loan is placed on nonaccrual status. At the time a
loan is classified as nonaccrual, interest income accrued in the current year is
reversed and interest income accrued in the prior year is charged to the
allowance for loan losses. With the exception of credit cards, the Company does
not recognize income on loans past due 90 days or more.
ALLOWANCE FOR LOAN LOSSES AND NET CHARGE-OFFS
Management maintains the allowance for loan losses (the "Allowance") at
a level considered adequate to provide for future loan losses. The Allowance is
increased by provisions charged to earnings and is reduced by charge-offs, net
of recoveries. At September 30, 1998, the Allowance was $3,336,000, an increase
of $30,000 from the balance at December 31, 1997. This increase was due to loan
loss provisions exceeding net charge-offs through the first nine months of 1998.
The determination of Allowance adequacy is determined quarterly based
upon an evaluation of the Company's loan portfolio by the internal loan review
officer and management. These evaluations consider a variety of factors,
including, but not limited to, general economic conditions, loan portfolio size
and composition, previous loss experience, the borrower's financial condition,
collateral adequacy, the level of non-performing loans, and management's
estimation of future losses. As a percentage of loans, the Allowance was 1.28%
at September 30, 1998 compared to 1.23% at December 31, 1997. Based upon its
analyses, management considers the Allowance adequate to recognize the risk
inherent in the Company's loan portfolio at September 30, 1998.
[THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK]
10
<PAGE> 12
The following table sets forth an analysis of the Company's Allowance
and actual loss experience for the periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
Nine months
ended Year ended
September 30, Dec. 31, 1997
1998
-----------------------------------------
<S> <C> <C>
Balance at beginning of period............ $ 3,306 $ 2,608
Charge-offs:
Commercial............................. 57 123
Real estate............................ 30 40
Installment............................ 352 71
Other.................................. 140 146
-----------------------------------------
Total charge-offs...................... 579 380
-----------------------------------------
Recoveries:
Commercial............................. 67 8
Real estate............................ 48 29
Installment............................ 44 16
Other.................................. 22 17
-----------------------------------------
Total recoveries....................... 181 70
-----------------------------------------
Net charge-offs........................... 398 310
Balance of acquired allowance
at date of acquisition................... 0 678
Additions charged to operations........... 428 330
-----------------------------------------
Balance at end of period $ 3,336 $ 3,306
=========================================
Ratios:
Net charge-offs to
average loans outstanding1........... 0.20% 0.15%
Net charge-offs to total allowance1..... 15.91 9.38
Allowance to period end
loans outstanding.................... 1.28 1.23
- ---------------------------------------------=========================================
</TABLE>
1. Annualized
Net charge-offs to average loans outstanding increased to 0.20% on an
annualized basis compared to 0.15% for the year ended December 31, 1997. This
increase was primarily due to additional installment loan charge-offs incurred
through the first nine months of 1998 emanating mainly from a $2 million
indirect subprime auto loan portfolio acquired with Richmond and an increase in
other loan charge-offs mainly from credit card losses at the Company's Wisconsin
banking operations. At September 30, 1998, the subprime indirect auto portfolio
had decreased to approximately $1.25 million. During the third quarter of 1998,
the Company sold its $3 million credit card portfolio to an unrelated third
party. Accordingly, the Company expects to experience a reduction in future
other loan charge-offs.
RESULTS OF OPERATION - COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 1998
AND 1997
GENERAL
For the quarter ended September 30, 1998, the Company reported net
income of $1,168,000, an increase of $99,000 or 9.3% from the $1,069,000
reported for the quarter ended September 30, 1997. Increased net interest income
and non-interest income during third quarter 1998 were sufficient to cover
increases in non-interest expenses and loan loss provisions to produce the
Company's improved bottom line.
11
<PAGE> 13
NET INTEREST INCOME
The following table sets forth average balances, related interest income
and expenses, and effective interest yields and rates for the three months ended
September 30, 1998 and September 30, 1997 (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
-------------------------------------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate(4) Balance Interest Rate(4)
-------------------------------- -------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans 1,2,3........................... $259,870 6,121 9.34% $210,177 $4,982 9.40%
Taxable investment securities......... 78,376 1,206 6.10 54,485 849 6.18
Tax-exempt investment securities 3.... 31,835 547 6.82 16,943 312 7.31
Federal funds sold.................... 12,365 168 5.40 2,286 31 5.38
----------------------------- ----------------------------
Total interest-earning assets........... 382,446 8,042 8.34 283,891 6,174 8.63
Non-interest-earning assets:
Cash and due from banks............... 16,383 15,821
Premises and equipment, net........... 6,579 4,860
Other assets.......................... 15,938 7,106
Less: Allowance for loan losses......... (3,354) (2,682)
-------- --------
TOTAL $417,992 $308,996
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Now accounts.......................... $ 38,696 259 2.66% $ 22,835 109 1.89%
Money market accounts................. 94,662 1,102 4.62 70,450 836 4.71
Savings deposits...................... 44,770 311 2.75 37,798 263 2.76
Time deposits......................... 117,209 1,731 5.86 79,862 1,145 5.69
Notes payable......................... 1,262 24 7.54 810 14 6.86
Federal funds purchased............... 48 1 8.30 253 4 6.27
Securities sold under
agreement to repurchase............. 9,242 123 5.28 4,015 53 5.24
----------------------------- ----------------------------
Total interest-bearing liabilities...... 305,889 3,551 4.61 216,023 2,424 4.45
----------------------------- ----------------------------
Non-interest-bearing liabilities:
Demand deposits....................... 66,909 53,497
Other................................. 4,016 2,331
-------- --------
Total liabilities....................... 376,814 271,851
-------- --------
Stockholders' equity.................... 41,178 37,145
-------- --------
TOTAL................................... $417,992 $308,996
======== ========
Net interest earning and interest rate spread 4,491 3.73% $3,750 4.18%
================ ================
Net yield on interest-earning assets.... 4.66% 5.24%
- ------------------------------------------ ===== =====
</TABLE>
1. For the purposes of these computations, nonaccrual loans are included in
the daily average loan amounts outstanding.
2. Interest earned on loans includes loan fees (which are not material in
amount) and interest income which has been received from borrowers whose
loans were removed from nonaccrual during the period indicated.
3. Taxable-equivalent adjustments are made in calculating interest income and
yields using a 34% rate for all years presented.
4. Annualized
For the quarter ended September 30, 1998, the Company reported
taxable-equivalent net interest income of $4,491,000, an increase of $741,000 or
19.8% from the $3,750,000 reported for the quarter ended September 30, 1997. The
inclusion of Richmond added $691,000 to the Company's consolidated
taxable-equivalent net interest income. Exclusive of Richmond,
taxable-equivalent net interest income increased $50,000 or 1.3% between third
quarter 1998 and 1997. The Company's taxable-equivalent yield on
interest-earning assets (net interest margin) declined to 4.66% in third quarter
1998 from 5.24% in third quarter 1997. The decline was due to the incorporation
of Richmond's comparatively lower net interest margin into the Company's
consolidated operations, reduced loan yields at the Company's Wisconsin banks
resulting from intense pricing competition, and consistent funding costs at the
Company's
12
<PAGE> 14
Wisconsin banking operations resulting mainly from a greater percentage of their
funding sources in higher costing money market and time deposits in 1998
compared to 1997. Richmond's lower margin was mainly related to its higher
funding costs as compared to the Company's other banking operations. Exclusive
of Richmond and its comparatively lower net interest margin, the Company's third
quarter 1998 net interest margin was 4.91%.
Taxable-equivalent total interest income increased $1,868,000 in total
and $311,000 exclusive of Richmond for the quarter ended September 30, 1998
compared to the third quarter of 1997. These improvements were mainly due to
volume increases in interest-earning assets over the preceding twelve months.
The Company reported a $98,555,000 or 34.7% increase in the volume of average
interest-earning assets in third quarter 1998 over third quarter 1997. Richmond
accounted for $75,566,000 of this increase with the remaining $22,989,000 due to
growth at State Financial Bank and State Financial Bank - Waterford over the
preceding twelve months. The Company continued to experience a decline in the
overall yield on interest-earning assets between third quarter 1997 and third
quarter 1998. The Company's yield on interest-earning assets was 8.34% in total
and 8.38% exclusive of Richmond for third quarter 1998 compared to 8.63% for
third quarter 1997. The yield decline was due to decreases in the Company's loan
yield at its Wisconsin banks, a lower concentration of loans as a percentage of
interest-earning assets, and reduced returns on taxable and tax-exempt
investment securities. For the quarter ended September 30, 1998, the Company's
consolidated loan yield declined to 9.34% from 9.40% in 1997 mainly due to
intense loan pricing competition in the Company's Wisconsin market. Also
impacting the decline in the Company's overall yield on interest-earning assets
was a decrease in loans as a percentage of interest-earning assets. For the
quarter ended September 30, 1998, average loans decreased to 67.9% of
interest-earning assets from 74.0% for the quarter ended September 30, 1997,
mainly due to the inclusion of Richmond's proportionately lower concentration of
loans as a percentage of interest-earnings assets in the Company's 1998
consolidated averages.. The yield on taxable investment securities declined to
6.10% and tax-exempt investment yields declined to 6.82% for third quarter 1998
from 6.18% and 7.30%, respectively for third quarter 1997 mainly due to maturing
securities repricing into a comparatively lower interest rate environment.
The Company also continued to experience an increase in its funding
costs comparing third quarter 1998 to third quarter 1997. The cost of
interest-bearing liabilities rose to 4.61% for third quarter 1998 from 4.45% for
third quarter 1997. This 16 basis point increase between third quarter 1998 and
1997 compared to a 23 basis point increase between second quarter 1998 and 1997
and a 46 basis point increase between first quarter 1998 and 1997. The Company
expected to experience an increase in its cost of funds as it incorporated
Richmond and its proportionately higher cost of funds into the Company's
consolidated operations. Also impacting the increased funding cost was a greater
percentage of interest-bearing liabilities concentrated in higher costing money
market and time deposits in 1998 compared to 1997. For the quarter ended
September 30, 1998, interest expense increased $1,180,000 over the third quarter
of 1997. The inclusion of Richmond's operations accounted for $907,000 of this
increase with the remaining $273,000 the result of greater funding costs
incurred at State Financial Bank and State Financial Bank-Waterford between the
two periods. For the quarter ended September 30, 1998, Richmond's average cost
of interest-bearing liabilities was 5.13% compared to 4.46% for the Company,
exclusive of Richmond. Richmond's higher funding costs were mainly the result of
a lower percentage of its deposits in non-interest bearing demand accounts and
historically more aggressive deposit pricing strategies on its interest-bearing
deposit products. The Company is working to reduce Richmond's average cost of
funds by furthering the bank's business development efforts to attract
additional commercial customers which would commensurately result in increased
non-interest-bearing business demand account balances, as well as prudently
adjusting deposit pricing on the bank's interest-bearing deposit products.
Comparison of Richmond's first , second, and third quarter 1998 cost of funds
would indicate initial success in implementing this strategy as Richmond's third
quarter 1998 cost of interest-bearing liabilities declined to 5.13% from 5.16%
and 5.29% in second and first quarter 1998, respectively. In addition to the
Richmond impact, the Company also experienced an increase in its funding costs
from volume increases in time and money market deposits and higher money market
costs at its existing banking operations. Exclusive of Richmond, average
interest-bearing liabilities increased $22,829,000 or 10.6% for the quarter
ended September 30, 1998 over the quarter ended September 30, 1997. Average
money market and time deposits, historically the Company's highest funding cost
represented $20,483,000 of this increase. Exclusive of Richmond, the percentage
of the Company's average interest-bearing liabilities in money market accounts
and time deposits increased to 71.5% of total interest-bearing liabilities for
third quarter 1998 from 69.6% for third quarter 1997. The Company experienced
some funding cost relief as third quarter 1998's cost of money market accounts
declined to 4.62% in total and 4.66% excluding Richmond in third quarter 1998
from 4.71% in third quarter 1997. However, the greater volume of average money
market balances offset any improvements resulting from interest rate reductions.
The third quarter increase in time deposit rates to 5.86% from 5.69% in third
quarter 1997 was all the
13
<PAGE> 15
result of the inclusion of Richmond's higher average funding cost in the
Company's consolidated operating performance. Exclusive of Richmond, the cost of
time deposits declined to 5.61% in third quarter 1998.
PROVISION FOR LOAN LOSSES
The provision for loan losses increased $60,000 in the third quarter of
1998 due to the inclusion of Richmond in the Company's consolidated operations.
OTHER INCOME
Total other income increased $644,000 for the quarter ended September
30, 1998 compared to the same period in 1997. The inclusion of Richmond in the
Company's consolidated operations accounted for $352,000 of this increase and
the inclusion of LCC represented $34,000. Exclusive of Richmond and LCC, total
other income increased $258,000 or 29.2% between third quarter 1998 and third
quarter 1997. Increases in loan sale gains, ATM fees, merchant services,
security transaction commissions, and other income (mainly the gain resulting
from the sale of the Company's credit card portfolio) were offset by declines in
service charges on deposit accounts and building rent at State's Wisconsin banks
to produce the improvement in third quarter 1998 total other income. Third
quarter 1998 loan sale gains increased $185,000, $46,000 of which was due to
volume increases at State Financial Mortgage Company and $20,000 due to the
inclusion of Richmond's operating results in this area. ATM fees increased
$64,000 in total $47,000 exclusive of Richmond mainly due to the Company's
recently instituted (November 1997) fees for usage of its ATM's by
non-customers. Merchant services increased $24,000 in total and $21,000
exclusive of Richmond due to volume increases at State Financial Bank and State
Financial Bank - Waterford as the Company continues to market this product line
to local business. Security transaction commissions increased $106,000 due to
the inclusion of Richmond ($57,000), the inclusion of LCC for the first time in
third quarter 1998 ($31,000), and volume increases at State Financial Bank
($18,000). Other income increased $197,000 in total and $159,000 exclusive of
Richmond. In July, the Company sold its $3 million credit card portfolio
realizing a $147,000 gain, net of selling expenses, which accounted for the
majority of the increase in other income. Service charges on deposit accounts
increased $62,000 in total, but decreased $14,000 exclusive of Richmond mainly
due to lower business service charge income, as compensating balances have
increased over the preceding twelve months, and the volume of checks returned
for insufficient funds declined. The $8,000 decline in building rent was mainly
the result of a reduction in the amount of space the Company occupied at its
Greenfield location effective at the beginning of 1998 which was previously
subleased to an outside tenant and two small office vacancies at the Company's
Hales Corners location.
OTHER EXPENSES
Total other expenses increased $1,100,000 for the three months ended
September 30, 1998 compared to the same period in 1997. Of this increase, the
inclusion of Richmond accounted for $1,007,000 and the inclusion of LCC
accounted for $50,000. Exclusive of Richmond and LCC, total other expenses
increased $43,000 or 1.53% for the quarter ended September 30, 1998 compared to
September 30, 1997. Salaries and employee benefits increased $633,000 in total
and $101,000 exclusive of Richmond and LCC, mainly due to annual salary
adjustments and increases in health insurance costs related to premium increases
and a greater percentage of employees electing this benefit in 1998 as compared
to 1997. Expenses for occupancy and equipment increased $55,000 in total, of
which Richmond and LCC represented $112,000 of this increase. Exclusive of
Richmond, occupancy expenses declined $57,000 due to a reduction in rental space
occupied at the Company's Greenfield office and a reduction in common area
assessments at the Company's leased facilities. Data processing expense
increased $53,000 in total and $16,000 exclusive of Richmond due to rate
increases from the Company's service provider, costs resulting from additional
computer based delivery products offered in 1998, and volume increases in
electronic funds transfer products, primarily debit cards. Legal and
professional fees increased $48,000, $69,000 of which was related to Richmond.
Exclusive of Richmond, legal and professional fees decreased $21,000 mainly due
to a reduction in legal fees incurred for collection efforts. Advertising
expense increased $12,000 all due to the inclusion of Richmond. Goodwill
amortization, a noncash expense, increased $121,000, of which $107,000 was
related to the Richmond acquisition and $14,000 was related to the LCC
acquisition. Other expenses increased $165,000 in total and $10,000 exclusive of
Richmond and LCC mainly due to increased expenses for correspondent bank fees,
office supplies and bad check charge-offs.
14
<PAGE> 16
INCOME TAXES
Income taxes for the quarter ended September 30, 1998 increased $35,000
compared to third quarter of 1997. Although pre-tax book income increased
$134,000, for tax calculation purposes pre-tax income increased $77,000 due to
an increase in tax-exempt interest income, partially offset by an increase
goodwill amortization which are excluded in the calculation of the Company's
income tax expense.
RESULTS OF OPERATION - COMPARISON OF THE NInE MONTHS ENDED SEPTEMBER 30, 1998
AND 1997
GENERAL
For the nine months ended September 30, 1998, the Company reported net
income of $3,395,000, an increase of $226,000 or 7.1% from the $3,169,000
reported for the nine months ended September 30, 1997. Improvements in net
interest income and non-interest income, partially offset by increased
non-interest expenses and loan loss provisions, were the primary reasons the
Company showed improved operating performance through the first nine months of
1998.
[THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK]
15
<PAGE> 17
NET INTEREST INCOME
The following table sets forth average balances, related interest income
and expenses, and effective interest yields and rates for the nine months ended
September 30, 1998 and September 30, 1997 (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
----------------------------------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate(4) Balance Interest Rate(4)
---------- --------- ------- --------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans (1,2,3)......................... $262,838 $18,553 9.44% $ 209,295 $14,830 9.47%
Taxable investment securities......... 76,239 3,486 6.11 55,881 2,569 6.15
Tax-exempt investment securities (3).. 28,908 1,500 6.94 15,918 886 7.45
Federal funds sold.................... 12,513 517 5.53 1,087 44 5.41
--------------------------- --------------------------
Total interest-earning assets........... 380,498 24,056 8.45 282,181 18,329 8.68
Non-interest-earning assets:
Cash and due from banks............... 16,005 12,993
Premises and equipment, net........... 6,651 4,700
Other assets.......................... 14,811 7,185
Less: Allowance for loan losses......... (3,342) (2,652)
-------- ---------
TOTAL $414,623 $ 304,407
======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
NOW accounts.......................... $ 38,942 $ 756 2.60% $ 23,325 324 1.86%
Money market accounts................. 91,409 3,198 4.68 66,733 2,291 4.59
Savings deposits...................... 43,875 911 2.78 38,293 793 2.77
Time deposits......................... 121,714 5,374 5.90 75,758 3,203 5.65
Notes payable......................... 1,164 68 7.81 893 46 6.88
Federal funds purchased............... 76 4 7.04 2,436 106 5.82
Securities sold under
agreement to repurchase............. 9,471 376 5.31 6,188 243 5.25
--------------------------- --------------------------
Total interest-bearing liabilities...... 306,651 10,687 4.66 213,626 7,006 4.38
--------------------------- --------------------------
Non-interest-bearing liabilities:
Demand deposits....................... 64,520 52,051
Other................................. 4,136 2,024
-------- ---------
Total liabilities....................... 375,307 267,701
-------- ---------
Stockholders' equity.................... 39,316 36,706
-------- ---------
TOTAL................................... $414,623 $ 304,407
======== =========
Net interest earning and interest rate spread $13,369 3.79% $11,323 4.30%
=============== ==============
Net yield on interest-earning assets.... 4.70% 5.37%
- ------------------------------------------ ===== =====
</TABLE>
1. For the purposes of these computations, nonaccrual loans are included in
the daily average loan amounts outstanding.
2. Interest earned on loans includes loan fees (which are not material in
amount) and interest income which has been received from borrowers whose
loans were removed from nonaccrual during the period indicated.
3. Taxable-equivalent adjustments are made in calculating interest income and
yields using a 34% rate for all years presented.
4. Annualized
The Company reported taxable-equivalent net interest income of
$13,369,000 for the nine months ended September 30, 1998, an increase of
$2,046,000 or 18.1% from the $11,323,000 reported for the nine months ended
September 30, 1997. The Richmond acquisition accounted for $2,188,000 of this
increase. Exclusive of Richmond, taxable-equivalent net interest income
decreased $142,000 or 1.25% between the first nine months of 1997 and 1998. The
decline was due to reduced loan yields resulting from intense pricing
competition and increased funding costs resulting mainly from a greater
percentage of the Company's funding sources in higher costing money market and
time deposits in 1998 compared to 1997. As a result of the aforementioned
changes, the Company's taxable-equivalent yield on interest-earning assets (net
interest margin) narrowed to 4.70% for the nine months ended September 30, 1998
16
<PAGE> 18
from 5.37% for the comparable period in 1997. Exclusive of Richmond and its
comparatively lower net interest margin, the Company's net interest margin
through the first nine months of 1998 was 4.95%.
Year-to-date, total taxable-equivalent interest income improved
$5,727,000 a 31.2% increase. Richmond added $4,889,000 with the remaining
$838,000 increase the result of increased interest income resulting from volume
increases in loans and tax-exempt investment securities at the Company's
Wisconsin operations over the preceding twelve months. The tax-equivalent yield
on interest-earning assets declined to 8.45% in 1998 from 8.68% in 1997. The
inclusion of Richmond, and its proportionately lower concentration of average
interest-earning assets in loans (59.9% for Richmond compared with 71.5% for the
Company's Wisconsin banks), and intense loan pricing competition in the
Company's Wisconsin markets were the main reasons for the yield decline.
Exclusive of Richmond, the tax-equivalent on interest-earning assets was 8.48%
for the first nine months of 1998 as loan yields contracted to 9.34% for the
nine months ended September 30, 1998 from 9.47% for the comparable 1997 period
and the percentage of the Company's average Wisconsin interest-earning assets in
outstanding loans shrunk to 71.5% in 1998 from 74.2% in 1997. Offsetting this
yield contraction was a $19,920,000 increase in the volume of average
interest-earning assets outstanding in Wisconsin, mainly in tax-exempt
investment securities, federal funds sold, and loans.
The Company's funding costs increased $3,381,000 in the first nine
months of 1998 compared to the first nine months of 1997. The inclusion of
Richmond added $2,708,000 in interest expense with the remaining $973,000 due to
increased funding costs in Wisconsin. Compared to the first nine months of 1997,
cost of funds increased overall and exclusive of Richmond. For the first nine
months of 1998, costs of funds were 4.66% overall and 4.50% exclusive of
Richmond, compared to 4.38% for the first nine months of 1997. Comparatively
Richmond had a higher funding cost as evidenced by its year-to-date rate on
interest-bearing liabilities of 5.20%. This higher cost was due mainly to
Richmond's previously aggressive time deposit pricing. Funding costs at the
Company's Wisconsin operations increased mainly due to a greater percentage of
its growth in average interest-bearing liabilities coming in higher costing
money market accounts and time deposits resulting in a larger percentage of its
funding sources concentrated in these categories in 1998 compared to 1997. For
the nine months ended September 30, 1998, average money market accounts and time
deposits comprised 71.1% of the Company's average Wisconsin interest-bearing
liabilities compared to 66.7% for the first nine months of 1997.
PROVISION FOR LOAN LOSSES
The provision for loan losses increased $180,000 through the first nine
months of 1998 as compared to the first nine months of 1997. The inclusion of
Richmond in the Company's consolidated operating performance accounted for all
of this increase.
OTHER INCOME
Year-to-date total other income increased $1,875,000 or 75.6% in 1998
over 1997. Richmond and LCC accounted for $940,000 of this increase. Exclusive
of Richmond, total other income improved $935,000 or 37.7% between the first
nine months of 1998 and 1997. Investment securities gains combined with
increases in gains from mortgage origination sales, ATM fees, merchant services,
investment securities commissions, gains from the credit card portfolio sale,
and other real estate sales to offset declines in services charges and building
rent to produce the 1998 improvement, exclusive of Richmond. The following
comparisons discuss changes in the Company's total other income exclusive of the
additional impacts resulting from the Richmond acquisition. The Company reported
$399,000 of investment securities gains due to the sale of marketable equity
securities in first and second quarter 1998. Gains from mortgage origination
sales increased $160,000 due to continued development of State Financial
Mortgage Company and an increase in the amount of mortgage refinancings during
the first nine months of 1998. ATM fees increased $153,000 in the first nine
months of 1998 as the Company began charging noncustomers for ATM usage in
November 1997. Merchant services income improved $552,000 mainly due to volume
increases at State Financial Bank and State Financial Bank - Waterford. Security
transaction commissions grew $55,000 due to continued development of this
product line. In third quarter 1998, the Company sold its $3 million credit card
portfolio, recognizing a gain, net of selling expenses, of $147,000. Other real
estate gains increased $38,000 mainly due to the sale of one property at State
Financial Bank in the first quarter. Service charge income declined $59,000
mainly due to reduced revenue from business services charges as customers have
increased their compensating balances and a reduced volume of fees
17
<PAGE> 19
from checks returned for insufficient funds. Building rent decreased $41,000 due
to a reduction in space occupied at the Company's Greenfield office which was
previously subleased to an outside tenant.
OTHER EXPENSES
For the nine months ended September 30, 1998, total other expenses
increased $3,204,000 or 38.2% as compared to the same period in 1997. The
inclusion of Richmond and LCC accounted for $2,841,000 of this increase.
Exclusive of Richmond and LCC, total other expenses increased $363,000 or 4.3%
in the first nine months over 1998 over the first nine months of 1997. Salaries
and employee benefits increased $1,725,000 in total and $364,000 exclusive of
Richmond and LCC mainly due to annual salary adjustments, the additional staff
related to State Financial Bank - Waterford's new Burlington location which
opened in May 1997, and increases in health insurance costs related to premium
increases and a greater percentage of employees electing this benefit in 1998 as
compared to 1997. Occupancy and equipment expense increased $264,000 in total,
of which Richmond and LCC comprised $359,000 of the increase. Absent Richmond,
occupancy and equipment expenses declined $95,000 as the Company incurred less
rent expense at its Greenfield office due to a reduction in occupied space and a
reduction in common area assessments at the Company's leased facilities. Data
processing expenses increased $183,000 in total and $66,000 exclusive of
Richmond due to rate increases from the Company's service provider, volume
increases mainly related to the opening of the new Burlington office, costs
associated with providing additional computer based delivery products, and
volume increases in electronic funds transfer products, primarily debit cards.
Legal and professional fees increased $148,000 all of which was related to
including Richmond and LCC in the Company's consolidated operating results.
Advertising expense increased $54,000 all due to the inclusion of Richmond.
Goodwill amortization increased $331,000 due to $317,000 in this additional
noncash expense resulting from the Richmond acquisition and $14,000 in
additional amortization from the LCC acquisition. Other expenses increased
$488,000 in total and $46,000 exclusive of Richmond mainly due to increased
expenses for office supplies and bad check charge-offs.
INCOME TAXES
Income taxes for the nine months ended September 30, 1998 increased
$72,000 compared to the nine months ended September 30, 1997. The increase in
income tax expense was mainly the result of a $169,000 increase in income before
income taxes, adjusted for tax-exempt interest income and goodwill amortization
which are excluded in the calculation of the Company's consolidated income tax
expense.
LIQUIDITY
Liquidity management involves the ability to meet the cash flow
requirement of customers who may be either depositors wanting to withdraw funds
or borrowers needing assurance that sufficient funds will be available to meet
their credit needs. Liquid assets (including cash deposits with banks, and
federal funds sold) are maintained to meet customers needs. The Company had
liquid assets of $34,433,000 and $38,780,000 at September 30, 1998 and December
31, 1997, respectively.
YEAR 2000 PROBLEM
At midnight on December 31, 1999, unless the proper modifications have
been made, the program logic in many computer systems will start to produce
erroneous results because, among other things, the systems will incorrectly read
the date "01/01/00" as being January 1 of the year 1900 or another incorrect
date. In addition, certain systems may fail to detect that the year 2000 is a
leap year. Problems can also arise earlier than January 1 , 2000 as dates in the
next millennium are entered into non-Year 2000 compliant programs (collectively,
such issues are referred to herein as the "Year 2000 Problem"). Like most
financial service providers, the Company may be significantly affected by the
Year 2000 Problem due to the nature of financial information.
COMPLIANCE PROGRAM. In order to address the Year 2000 Problem and to
minimize its potential adverse impact, in 1997 the Company initiated a corporate
wide project to address the impact of the Year 2000 Problem on its computer
application systems, information technology ("IT") related equipment, system
software, building controls, and
18
<PAGE> 20
non-IT embedded systems found in such equipment as security systems, currency
counters, and elevators. The evaluation of Year 2000 issues included an
assessment of the potential impact of the Year 2000 Problem on the Company,
including monitoring significant customers, key vendors, service suppliers and
other parties material to the Company's operations; testing changes provided by
these vendors; and developing contingency plans for any critical systems that
are not effectively reprogrammed. In the course of this evaluation, the Company
has sought written assurances from such third parties as to their state of Year
2000 readiness. The Company's Year 2000 Compliance Program is divided into five
phases: (1) awareness; (2) assessment; (3) renovation; (4) validation; and (5)
implementation.
THE COMPANY'S STATE OF READINESS. Work on the Year 2000 Compliance
Program has been prioritized in accordance with risk. The highest priority has
been assigned to activities that would disrupt the accuracy and delivery of the
Company's banking services to its customers; next is an assessment of the
potential credit risk to the Company resulting from its credit customers' state
of Year 2000 readiness, or lack thereof, and the potential impact of those
efforts on the customers' ability to meet contractual payment obligations; the
lowest priority has been assigned to activities that would cause inconvenience
or productivity loss in normal business operations such as issues related to
internal office machinery, heating and air conditions systems, and elevators.
The Company has substantially completed the first two phases of the plan
and is currently working internally and with external vendors on the final three
phases. Because the Company outsources its data processing, a significant
component of the Year 2000 Compliance Program is working with external vendors
to test and certify that their systems are Year 2000 compliant. During the
weekend of October 3, 1998, the Company's primary data service provider
converted State Financial Bank and State Financial Bank - Waterford to its Year
2000-ready platform. As part of the conversion, the Company performed a variety
of tests to determine the proper functionality of the new platform. No problems
were encountered. The Company's other external vendors have surveyed their
programs to inventory the necessary changes and have begun correcting the
applicable computer programs and replacing equipment so that the Company's
information systems will be Year 2000 compliant prior to December 31, 1998. This
will enable the Company to devote substantial time to the testing of the
upgraded systems prior to the arrival of the new millennium. The Company expects
to complete its timetable for carrying out its plans to address Year 2000
issues, and to finish initial testing by March 31, 1999.
The Company has also conducted a survey of its significant credit
customers to determine their state of Year 2000 readiness. Surveys were mailed
to all customers whose outstanding loan balance or loan commitment exceeded
$200,000. In addition, as part of its ongoing credit underwriting practices, all
new and renewed loans must have a Year 2000 risk assessment completed and
reported as part of the loan approval process. Based upon the information
received from these surveys, the Company does not expect to experience any
material collection problems resulting from its customers Year 2000 readiness,
or lack thereof.
COST TO ADDRESS YEAR 2000 COMPLIANCE ISSUES. Managing the Year 2000
Compliance Program will result in additional direct and indirect costs to the
Company. Based upon current internal studies, as well as recently solicited bids
from various computer hardware and software vendors, the Company estimates that
the total direct cost of resolving the Year 2000 Problem will be between
$500,000 and $600,000. This estimate includes approximately $450,000 in hardware
purchases that the Company expects to capitalize. To date the Company has
incurred $75,000 in costs related to addressing the Year 2000 Problem, all of
which has been related to hardware purchases. The majority of the remaining
costs related to resolving the Year 2000 Problem are expected to be incurred in
1999. The Company expects to fund these expenditures through internal sources.
The estimated costs of, and timetable for, becoming Year 2000 compliant
constitute "forward looking statements" as defined in the Private Securities
Litigation Reform Act of 1995. Investors are cautioned that such estimates are
based on numerous assumptions by management, including assumptions regarding the
continued availability of certain resources, the accuracy of representations
made by third parties concerning their compliance with Year 2000 issues, and
other factors. The estimated costs of Year 2000 compliance also do not give
effect to any future corporate acquisitions made by the Company or its
subsidiaries.
RISK OF NON-COMPLIANCE AND CONTINGENCY PLANS. The major applications
which pose the greatest Year 2000 risk to the Company if the implementation of
the Year 2000 Compliance Program is not successful are the Company's data
services systems supported by third party vendors, loan customers ability to
meet contractual payment obligations in the event the Year 2000 Problem has a
significant negative impact on their business, internal computer networks,
19
<PAGE> 21
and, items processing equipment which renders customers bank statements and
banking transactions. The potential problems which could result from the
inability of these applications to correctly process the Year 2000 are the
inaccurate calculation of interest income and expense, service delivery
interruptions to the Company's banking customers, credit losses resulting from
the Company's loan customers inability to make contractual credit obligations,
interrupted financial data gathering, and poor customer relations resulting from
inaccurate or delayed transaction processing, respectively.
Although the Company intends to complete all Year 2000 remediation and
testing activities by December 31, 1998, and although the Company has initiated
Year 2000 communications with significant customers, key vendors, service
providers, and other parties material to the Company's operations and is
diligently monitoring the progress of such third parties in their Year 2000
compliance, such third parties nonetheless represent a risk that cannot be
assessed with precision or controlled with certainty. For that reason, the
Company intends to develop contingency plans to address alternatives in the
event that Year 2000 failures of automatic systems and equipment occur.
Preliminary discussions have been held regarding the contingency plan and a
final contingency plan is scheduled to be completed by the end of the first
quarter of 1999.
FORWARD LOOKING STATEMENTS
When used in this report, the words "believes," "expects," and similar
expressions are intended to identify forward-looking statements. The Company's
actual results may differ materially from those described in the forward-looking
statements. Factors which could cause such a variance to occur include, but are
not limited to, changes in interest rates, levels of consumer bankruptcies,
issues associated with achieving Year 2000 compliance, customer loan and deposit
preferences, issues related to integrating acquired operations, and changes in
other general economic conditions.
CAPITAL RESOURCES
There are certain regulatory constraints which affect the Company's
level of capital. The following table sets forth these requirements and the
Company's capital levels and ratios at September 30, 1998, including the Tier 1
leverage ratio, the risk-based capital ratios based upon Tier 1 capital, and
total risk-based capital:
<TABLE>
<CAPTION>
Regulatory Regulatory
Minimum Well-capitalized
Actual Requirement Requirement
-------- ----------- ----------------
(dollars in thousands)
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Tier 1 leverage 32,316 7.9% 16,317 4.0% 20,397 5.0%
Tier 1 risk-based capital 32,316 11.6% 11,181 4.0% 16,772 6.0%
Risk-based capital 35,652 12.8% 22,363 8.0% 27,953 10.0%
</TABLE>
The Company is pursuing a policy of continued asset growth which
requires the maintenance of appropriate ratios of capital to assets. The
existing capital levels allow for additional asset growth without further
capital injection. It is the Company's desire to maintain its capital position
at or in excess of the "well-capitalized" definition. The Company seeks to
obtain additional capital growth through earnings retention and a conservative
dividend policy.
20
<PAGE> 22
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As of September 30, 1998, the Company is involved in various pending
legal proceedings consisting of ordinary routine litigation incidental to the
business of the Company. None of these proceedings is considered material,
either in part or in the aggregate, and are therefore not expected to have a
material adverse impact on the Company's financial condition, results of
operations, cash flows, and capital ratios.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
The deadline for submission of shareholder proposals pursuant to Rule
14a-8 under the Securities Exchange Act of 1934, as amended, for inclusion in
the Company's proxy statement for its 1999 Annual Meeting of Shareholders is
November 14, 1998. Additionally, if the Company receives notice of a shareholder
proposal after January 27, 1999, the persons named in proxies solicited by the
Board of Directors of the Company for its 1999 Annual Meeting of Shareholders
may exercise discretionary voting power with respect to such proposal.
ITEM 6. EXHIBITS ANd REPORTS ON FORM 8-K
None
21
<PAGE> 23
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
STATE FINANCIAL SERVICES CORPORATION
------------------------------------
(Registrant)
Date: November 2, 1998
------------------
By /s/ Michael J. Falbo
------------------------
Michael J. Falbo
President and Chief Executive Officer
Date: November 2, 1998
------------------
By /s/ Michael A. Reindl
-------------------------
Michael A. Reindl
Senior Vice President, Controller, and
Chief Financial Officer
22
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 17,658,220
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 4,474,371
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 86,474,161
<INVESTMENTS-CARRYING> 13,451,412
<INVESTMENTS-MARKET> 13,654,000
<LOANS> 261,513,055
<ALLOWANCE> 3,336,244
<TOTAL-ASSETS> 417,155,623
<DEPOSITS> 359,197,694
<SHORT-TERM> 8,468,371
<LIABILITIES-OTHER> 4,649,479
<LONG-TERM> 1,450,000
0
0
<COMMON> 400,437
<OTHER-SE> 42,989,642
<TOTAL-LIABILITIES-AND-EQUITY> 417,155,623
<INTEREST-LOAN> 18,466,257
<INTEREST-INVEST> 4,476,526
<INTEREST-OTHER> 517,292
<INTEREST-TOTAL> 23,460,075
<INTEREST-DEPOSIT> 10,239,402
<INTEREST-EXPENSE> 10,687,554
<INTEREST-INCOME-NET> 12,772,521
<LOAN-LOSSES> 427,500
<SECURITIES-GAINS> 420,817
<EXPENSE-OTHER> 11,594,638
<INCOME-PRETAX> 5,103,972
<INCOME-PRE-EXTRAORDINARY> 5,103,972
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,395,066
<EPS-PRIMARY> 0.89
<EPS-DILUTED> 0.89
<YIELD-ACTUAL> 4.70
<LOANS-NON> 2,084,000
<LOANS-PAST> 436,000
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 550,000
<ALLOWANCE-OPEN> 3,306,168
<CHARGE-OFFS> 579,098
<RECOVERIES> 181,674
<ALLOWANCE-CLOSE> 3,336,244
<ALLOWANCE-DOMESTIC> 3,336,244
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
