ITEM 1. BUSINESS
GENERAL
First Manitowoc Bancorp, Inc. is a Wisconsin corporation and registered bank holding company. The Corporation engages in its business through its sole subsidiary, First National Bank in Manitowoc (the "Bank"), a national banking association. The Bank has a wholly owned investment subsidiary, FNBM Investment Corp. and a wholly-owned insurance subsidiary, Insurance Center of Manitowoc, Inc.. Insurance Center of Manitowoc, Inc. also operates an office known as Gary Vincent and Associates in Green Bay, Wisconsin. The Insurance Center is an independent agency offering commercial, personal, life and health insurance.
The Corporation acquired the Bank through the merger of the Bank into an interim national banking association formed as a Corporation subsidiary for the purpose of the merger, pursuant to a Plan of Reorganization and Agreement to Merge (the "Plan") proposed by Bank management and approved by the Bank's shareholders in 1982. Pursuant to the Plan, each outstanding share of Bank common stock was exchanged for three shares of the Corporation's common stock. The Bank's charter was not affected by the merger. Currently, the Corporation has outstanding 6,937,268 shares of common stock, par value $1.00 per share ("Shares"). Shares were held by 635 holders of record on February 27, 2004.
As of December 31, 2003, the Corporation had assets of approximately $582.0 million, net loans of approximately $367.1 million, and deposits of $428.3 million. For additional financial information, see the Consolidated Financial Statements and Notes beginning at Item 8 of this Form 10-K.
The Corporation's and the Bank's main office is located at 402 North Eighth Street, Manitowoc, Wisconsin. The Bank has twelve full service branch offices located in Francis Creek, St. Nazianz, Two Rivers, Mishicot, Manitowoc, Kiel, Newton, New Holstein, Plymouth, Bellevue, and Ashwaubenon, Wisconsin. The Corporation's home page on the Internet is www.bankfirstnational.com. The Corporation's web site content is for information purposes only, and it should not be relied upon for investment purposes, nor is it incorporated by reference into this Form 10-K.
Throughout this Form 10-K information from parts of other documents filed with the Securities and Exchange Commission ("SEC") is incorporated by reference. The SEC allows us to disclose important information by referring to it in this manner, and you should review this information.
We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy statement for our annual shareholders' meeting, as well as any amendments to those reports filed pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, available free of charge through our web site as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our SEC reports can be accessed through the "Investor Relations, SEC web site" link of our web site. The SEC also maintains a web site at www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants.
STATEMENT ON CORPORATE GOVERNANCE
We have reviewed the provisions of the Sarbanes-Oxley Act of 2002 and the SEC rules regarding corporate governance policies and processes and are in compliance with the rules and listing standards. We have adopted a Code of Business Conduct and Ethics which is applicable to all of our directors, officers and employees. You can access our Nominating Committee Charter, Audit Committee Charter and Code of Business Conduct and Ethics on our Website at http://www.bankfirstnational.com or by writing to us at 402 North Eighth Street, Manitowoc, Wisconsin 54221 Attention: Rachel Wiegert, Secretary.
BUSINESS STRATEGY
The Bank's strategy is to provide high quality financial products and services to individuals, businesses, and governmental entities. The Bank employs a well-trained, qualified staff and maximizes automation to provide fast, efficient, convenient delivery of its products and services.
BANKING PRODUCTS AND SERVICES
The Bank has been doing business in Wisconsin since 1894 and is engaged in both the commercial and consumer banking business. The Bank provides a wide range of personal banking services designed to meet the needs of local consumers. As a convenience to its customers, the Bank offers Saturday banking hours; drive-thru teller windows; "Telebanc," a telephone banking service; and 24-hour automated teller machines. Additionally, the Bank offers an Internet web site, which includes on-line banking, bill payment, e-mail statements, account transfers, check ordering, and check copies among other services. Services provided include checking accounts, savings and time accounts, and safe deposit boxes.
The Bank makes loans in the following categories: Commercial and Agricultural loans, Commercial Real Estate, Residential Real Estate, and Consumer and Other loans.
COMMERCIAL AND AGRICULTURAL BUSINESS LENDING
As of December 31, 2003, commercial and agricultural business loans accounted for approximately 29.4% of the Bank's gross loans. These loans may take the form of lines of credit, single payment loans, or term payment loans, and may be secured or unsecured depending on the creditworthiness of the borrower. The Bank operates under a commercial business lending policy that establishes guidelines for management in making commercial lending decisions. Among these guidelines are the purpose of the loan, the source of repayment, and an alternate source of repayment (generally in the form of collateral or guarantee). Applications for commercial and agricultural business loans are accepted at the Bank's main and branch offices. It is the Bank's general policy to restrict its commercial and agricultural business lending to a market area defined as within a 100-mile radius of any office location where business banking products and services are sold.
Commercial and agricultural business loans are generally made for business expansion or ongoing business needs. The purpose of commercial and agricultural business loans can include the purchase of equipment or the provision of operating capital for the financing of accounts receivable and inventory. Commercial business loans are not generally made for the purpose of acquiring real estate, although real estate may occasionally be accepted as incidental collateral on a loan made for another business purpose. Agricultural business loans, however, may include loans for farmland, including a farm residence and other improvements.
Credit risk is controlled and monitored through active asset quality management and the use of lending standards, thorough review of potential borrowers, and active asset quality administration. Active asset quality administration, including early problem loan identification and timely resolution of problems, further ensures appropriate management of credit risk and minimization of loan losses.
The Bank occasionally participates in commercial business loans originated by third-party financial institutions. The Corporation, however, does not generally service such loans.
The Bank believes that the higher yields earned on commercial business loans compensate for the increased risk associated with such loans and that commercial business loans are important to the Bank's efforts to increase the interest rate sensitivity and shorten the average maturity of its loan portfolio.
COMMERCIAL REAL ESTATE LENDING
Non-residential real estate loans accounted for approximately 30.0% of the Bank's gross loans as of December 31, 2003. Such loans are subject to the general policies and procedures outlined in "Commercial Business Lending", below. It is the Bank's general policy to restrict its commercial real estate lending to loans secured by properties located within a 100-mile radius of Manitowoc. There are no policy restrictions on the amount of loan funds secured by property type.
Applications for commercial real estate loans are generally obtained from existing borrowers, direct contacts by loan officers, and referrals. In general, these loans have amortization periods ranging from 10 to 25 years, mature in five years or less, and have interest rates which are fixed or variable. Loan-to-value ratios on the Bank's commercial real estate loans follow OCC requirements. It is also the Bank's general policy to obtain personal guarantees on its commercial real estate loans and, when such guarantees cannot be obtained, to impose more stringent loan-to-value ratios, debt coverage ratios, and other underwriting requirements.
From time-to-time the Bank originates loans to construct multi-family residential and non-residential real estate properties. Construction loans are generally considered to involve a higher degree of risk than mortgage loans on completed properties. The Bank's risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction, the reputation of the contractor, the estimated cost of construction, and the borrower's ability to advance additional construction funds if such should become necessary.
Commercial real estate lending is generally considered to involve a higher level of risk than single-family residential lending. This is due to the concentration of principal in a limited number of loans and borrowers, and the effects of general economic conditions on real estate developers and managers and on income producing properties. In addition, loans secured by properties located outside of the Corporation's immediate market area may involve a higher degree of risk. This is because the Bank may not be as familiar with market conditions and other relevant factors as it would be in the case of loans secured by properties located within its market areas. The Bank does not have a material concentration of commercial real estate loans outside of its immediate market area.
RESIDENTIAL REAL ESTATE LENDING
Single-family residential loans accounted for approximately 34.8% of the Bank's gross loans as of December 31, 2003. Applications for single-family residential loans are accepted by qualified lenders at all offices except the Plymouth West office. The Bank makes predominantly fixed-rate loans for terms ranging from ten to thirty years, but does also make loans that provide for periodic adjustments of the interest rate ("adjustable rate loans"). In general, the Bank looks to sell to the secondary market but will do an in house loan on occasion.
Although the Corporation generally does not retain residential loans in its portfolio, it continues to originate and service residential loans in order to provide a full range of products to its customers. In general, such loans are originated only under terms, conditions, and documentation standards that make such loans eligible for sale to the Federal National Mortgage Association ("Fannie Mae"). Sales or securitizations of mortgage loans through Freddie Mac and Fannie Mae have generally been under terms that do not provide for any recourse against the Bank by the investor. The Bank generally sells these loans at the time they are originated, but continues to service these loans for its customers. Sales of mortgage loans provide additional funds for lending and other business purposes.
The Bank's general policy is to lend up to 80% of the independently appraised value of the property (referred to as the "loan-to-value ratio"). The Bank will occasionally lend in excess of an 80% loan-to-value ratio on a first mortgage loan, but will generally require the borrower to obtain private mortgage insurance on the portion of the loan that exceeds 80%.
The Bank also originates loans to individuals to construct single-family residences. The borrower must have take-out commitments for permanent financing on hand at the time of origination. Construction loans generally have a maturity of 6 to 12 months and a fixed rate of interest, with payments being made monthly on an interest-only basis. Construction loans are otherwise underwritten and approved in the same manner as other single-family residential loans. Construction loans, however, are generally considered to involve a higher degree of risk than conventional residential mortgage loans. This is because the risk of loss is largely dependent on the accuracy of the initial estimate of the property's value at completion of construction, the reputation of the contractor, the estimated cost of construction, and the borrower's ability to advance additional construction funds, if necessary. This risk has not had any adverse effect on the Bank to date, although no assurances can be made with respect to future periods.
The Bank continues to service most of the loans that it sells to third-party investors (commonly referred to as "loans serviced for others"). Servicing mortgage loans, whether for its own portfolio or for others, includes such functions as collecting monthly principal and interest payments from borrowers, maintaining escrow accounts for real estate taxes and insurance, and making such payments on behalf of borrowers when they are due. When necessary, servicing of mortgage loans also includes functions related to the collection of delinquent principal and interest payments, loan foreclosure proceedings, and disposition of foreclosed real estate. As of December 31, 2003, loans serviced for others were $178.7 million. The amount of capitalized mortgage servicing rights as of December 31, 2003 was $1.8 million.
When the Bank services loans for others, it is compensated for these services through the retention of a servicing fee from borrowers' monthly payments. The Bank pays the third-party investors an agreed-upon yield on the loans, which is generally less than the interest agreed to be paid by the borrowers. The difference is retained by the Bank and recognized as servicing fee income over the lives of the loans, net of amortization of capitalized mortgage servicing rights. The Bank also receives fees and interest income from ancillary sources such as delinquency charges and float on escrow and other funds.
Management believes that servicing mortgage loans for third parties provides a natural hedge against other risks inherent in the Bank's mortgage banking operations. That is, fluctuations in volumes of mortgage loan originations and resulting gains on sales of such loans caused by changes in market interest rates will generally be offset in part by an opposite change in loan servicing fee income. These fluctuations are usually the result of actual loan prepayment activity that is different from that which was anticipated when the related servicing rights were originally recorded. However, fluctuations in the value of mortgage servicing rights may also be caused by mark-to-market adjustments under generally accepted accounting principles ("GAAP"). That is, the value of servicing rights may fluctuate because of changes in the future prepayment assumptions or discount rates used to periodically value servicing rights. Although management believes that most of the Bank's loans that prepay are replaced by a new loan to the same customer or even a different customer (thus preserving the future servicing cash flow), GAAP requires mark-to-market gains or losses resulting from a change in future prepayment assumptions to be recorded in the period in which the change occurs. However, the offsetting gain on the sale of the new loan, if any, cannot be recorded under GAAP until the customer actually prepays the old loan and the new loan is sold in the secondary market. Mortgage servicing rights are particularly susceptible to unfavorable mark-to-market adjustments during periods of declining interest rates during which prepayment activity typically accelerates to levels above that which had been anticipated when the servicing rights were originally recorded. During periods of rising rates, mark-to-market adjustments tend to result in gains to the value of servicing rights as the assumption is adjusted to reflect a declaration in payments.
CONSUMER AND OTHER LENDING
The Bank offers consumer and other loans in order to provide a full range of financial services to its customers. Such loans accounted for approximately 5.8% of the Corporation's gross loans as of December 31, 2003. Most of the Bank's consumer loan portfolio consists of second mortgage loans and home equity lines of credit, but also includes automobile loans, recreational vehicle and mobile home loans, deposit account secured loans, and unsecured lines of credit or signature loans. The Bank services all of its own consumer loans.
Applications for consumer loans are taken at all of the Bank's offices. Applications for automobile loans are also accepted through relationships established with a limited number of qualifying automobile dealerships ("indirect automobile lending"). The majority of consumer loans are underwritten, approved, and serviced on an on-going basis by loan officers.
Consumer loans generally have shorter terms and higher rates of interest than conventional mortgage loans, but typically involve more credit risk than such loans because of the nature of the collateral and, in some instances, the absence of collateral. In general, consumer loans are more dependent upon the borrower's continuing financial stability, are more likely to be affected by adverse personal circumstances, and are often secured by rapidly depreciating personal property such as automobiles. In addition, various laws, including bankruptcy and insolvency laws, may limit the amount that may be recovered from a borrower. However, such risks are mitigated to some extent in the case of second mortgage loans and home-equity lines of credit. These types of loans are secured in part or in full by a second mortgage on the borrower's residence.
The Bank believes that the higher yields earned on consumer loans compensate for the increased risk associated with such loans and that consumer loans are important to the Bank's efforts to increase the interest rate sensitivity and shorten the average maturity of its loan portfolio. Furthermore, the Bank's net charge-offs on consumer loans as a percentage of gross loans have not been significant in recent years, despite the risks inherent in consumer lending.
In conjunction with its consumer lending activities, the Corporation offers customers credit life and disability insurance products. The Bank and its loan officers receive commission revenue related to the sales of these products. In addition, a wholly-owned subsidiary of the Bank receives premium revenue in exchange for the portion of the insurance risk it has reinsured on these sales. Refer to "Subsidiaries", below, for additional discussion.
The Bank offers a full range of trust services that include trust under agreement, testamentary trust, guardianships and conservatorships, probate estates, estate planning, and financial planning. The Bank employs a licensed investment representative who provides a variety of investment and insurance products through arrangements with other service providers. These products include mutual funds, stocks, bonds, annuities, and life insurance products.
Insurance products, including commercial, personal, life, and health insurance, are offered through Insurance Center of Manitowoc, Inc.
To attract new business and retain existing customers, the Bank relies on local marketing promotions, personal contact by its officers, staff and directors, referrals by current customers, extended banking hours, personalized service, and contact with on-line customers via the Bank's website or e-mail statements.
NON-PERFORMING AND OTHER CLASSIFIED ASSETS
Loans are generally placed on non-accrual status and considered "non-performing" when, in the judgment of management, the probability of collection of principal or interest is deemed to be insufficient to warrant further accrual of interest. When a loan is placed on non-accrual and/or non-performing status, previously accrued but unpaid interest is deducted from interest income. In general, the Bank does not record accrued interest on loans 90 or more days past due. For additional information, refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Notes 1 and 4 of the Bank's Audited Consolidated Financial Statements, included herein under Part II, Item 8, "Financial Statements and Supplementary Data".
When a loan is placed on non-accrual and/or non-performing status, the Bank generally institutes foreclosure or other collection proceedings. Real estate acquired by the Bank as a result of foreclosure or deed-in-lieu of foreclosure is classified as "other real estate" and is considered "non-performing" until sold. Other property acquired through adverse judgment, such as automobiles and other depreciable assets, are generally classified as "other personal property".
The Bank has internal policies and procedures in place to evaluate risk ratings on all loans. In addition, in connection with examinations of banks, federal examiners have authority to classify problem assets as "Substandard", "Doubtful", or "Loss". An asset is classified as "Substandard" if it is determined to involve a distinct possibility that the Bank could sustain some loss if deficiencies associated with the loan are not corrected. An asset is classified as "Doubtful" if full collection is highly questionable or improbable. An asset is classified as "Loss" if it is considered uncollectible, even if a partial recovery could be expected in the future. If an asset or portion thereof is classified as "Loss", the Bank must either establish a specific allowance for the portion of the asset classified as "Loss", or charge off such amount. Refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for additional discussion.
ALLOWANCES FOR LOSSES ON LOANS AND REAL ESTATE
The Bank's policy is to establish allowances for estimated losses on specific loans and real estate when it determines that losses are probable and estimable. In addition, the Corporation maintains a general loss allowance against its loan and real estate portfolios that is based on its own loss experience, management's ongoing assessment of current economic conditions, the credit risk inherent in the portfolios, and the experience of the financial services industry. For additional information, refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Notes 1 and 4 of the Corporation's Audited Consolidated Financial Statements, included herein under Part II, Item 8, "Financial Statements and Supplementary Data".
Management of the Bank believes that the current allowances established by the Bank are adequate to cover probable and estimable losses in the Bank's loan and real estate portfolios. However, future adjustments to these allowances may be necessary and the Bank's results of operations could be adversely affected if circumstances differ substantially from the assumptions used by management in making its determinations in this regard.
SOURCES OF FUNDS
DEPOSIT LIABILITIES
The Bank's current deposit products include regular savings accounts, checking accounts, money market deposit accounts, individual retirement accounts, and certificates of deposit ranging in terms from three months to five years. As of December 31, 2003, deposit liabilities accounted for approximately 73.6% of the Corporation's total liabilities and equity.
In addition to serving as the Bank's primary source of funds, deposit liabilities (especially checking accounts) are a substantial source of non-interest income. This income is generally received in the form of overdraft fees, periodic service charges, automated teller machine ("ATM") and debit card fees, and other transaction charges. The Bank's extensive branch network also creates opportunities for sales of non-deposit products such as tax-deferred annuities, mutual funds, and other investment products. In exchange for these sales, the Bank receives commission revenue from the third-party providers of the financial products and/or services.
The principal methods used by the Bank to attract deposit accounts include offering a variety of products and services, competitive interest rates, and convenient office locations and hours. All of the Bank's offices have drive-up facilities and, the Bank owns eleven ATM machines, all of which are located in the Bank's primary markets. Depositors may also obtain a debit card from the Bank, which allows them to purchase goods and services directly from merchants. The same debit card also provides access to the ATM network.
FEDERAL HOME LOAN BANK ADVANCES
The Bank obtains advances from the FHLB secured by certain of its home mortgage loans and mortgage-related securities, as well as stock in the FHLB, a minimum amount of which the Bank is required to own. Such advances may be made pursuant to several different credit programs, each with its own interest rate and range of maturity dates. As of December 31, 2003, FHLB advances accounted for approximately 5.2% of the Bank's total liabilities and equity.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Bank regularly enters into sales of securities under agreements to repurchase. In form, these transactions are an arrangement in which the sale of securities is accompanied by a simultaneous agreement to repurchase the identical securities (or substantially the same securities) at a future date. In substance, however, these arrangements are borrowings secured by high-quality, highly-liquid securities such as Fannie Mae or Freddie Mac MBSs. Accordingly, these arrangements are accounted for as borrowings in the Bank's financial statements.
FEDERAL FUNDS PURCHASED AND OTHER BORROWINGS
The Corporation has lines of credit with three financial institutions. These lines, which amount to $25 million in the aggregate, permit the overnight purchase of federal funds. As of December 31, 2003, there was $0 outstanding under these lines of credit.
BANK SUBSIDIARY CORPORATIONS
FNBM Investment Corporation - FNBM Investment Corporation - ("FNBM") was incorporated in the State of Nevada in December 1993. FNBM is located in Las Vegas, Nevada. The Bank owns 100% of the outstanding common stock of FNBM. FNBM was formed to consolidate and improve the efficiency, management, safekeeping, and operations of the Bank's investment securities portfolio and certain other holdings.
Insurance Center of Manitowoc, Inc - Insurance Center of Manitowoc, Inc. - ("ICM") was incorporated in the State of Wisconsin in 1932. Bank acquired 100% of the outstanding common stock of the ICM in January 2001. ICM has an office in Manitowoc, Wisconsin that operates under the trade name Insurance Center of Manitowoc, Inc. and an office in Green Bay, Wisconsin that operates under the trade name Gary Vincent & Associates, Inc. ICM is a regional independent agency offering commercial, personal, life, and health insurance. ICM provides various bank-related insurance coverages for the Bank including Directors & Officers Liability, Trust, and Blanket Bond.
United Financial Services, Inc - United Financial Services, Inc. - ("UFS") was incorporated in the State of Wisconsin in September 1991. UFS is located in Grafton, Wisconsin. The Bank owns 49.8% of the outstanding common stock of UFS. The subsidiary, UFS, was formed to provide data processing services to the banking industry. UFS provides data processing services to owner banks Baylake Bank and the Bank in addition to 52 other banks located in Wisconsin. The Bank's investment in UFS is accounted for under the equity method.
SEASONALITY
The management of the Bank does not believe that the deposits or business of the Bank in general are seasonal in nature. The deposits may, however, vary with local and national economic conditions but not enough to have a material effect on planning and policy making.
FOREIGN OPERATIONS
The Bank does not engage in operations in foreign countries.
EMPLOYEES
As of February 27, 2004, the Corporation employed 210 individuals, 84 of whom worked part-time.
COMPETITION
The Bank offers many personalized services and attracts customers by being responsive and sensitive to the needs of the community. The Bank relies on goodwill and referrals from satisfied customers as well as traditional media advertising to attract new customers. To enhance a positive image in the community, the Bank supports and participates in many local events, such as the Manitowoc County Fair, Manitowoc County Airport Day, First National Bank Maritime Bay Bike Classic, Two Rivers Ethnic Festival, and French Creek Days. Employees, officers, and directors represent the Bank on many boards and local civic and charitable organizations.
The primary factors in competing for deposits are interest rates, personalized services, the quality and range of financial services, convenience of office locations and office hours. Competition for deposits comes primarily from other commercial banks, savings associations, credit unions, money market funds and other investment alternatives. The primary factors in competing for loans are interest rates, loan origination fees, the quality and range of lending services and personalized services. Competition for loans comes primarily from other commercial banks, savings associations, mortgage banking firms, credit unions and other financial intermediaries. Competition in the Bank's market area is expected to continue for the foreseeable future.
SUPERVISION AND REGULATION
General - The Corporation and the Bank are extensively regulated under federal and state law. Generally, these laws and regulations are intended to protect depositors, not shareholders. The following is a summary description of certain provisions of certain laws which affect the regulation of bank holding companies and banks. The discussion is qualified in its entirety by reference to applicable laws and regulation. Changes in such laws and regulations may have a material effect on the business and prospects of the Corporation and the Bank.
Federal Bank Holding Company Regulation and Structure - The Corporation is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "Act"). As such, it is subject to regulation, supervision, and examination by the Federal Reserve Board ("FRB"). The Corporation is required to file annual and quarterly reports with the FRB and to provide the FRB with such additional information as the FRB may require. The FRB may conduct examinations of the Corporation and its subsidiaries.
With certain limited exceptions, the Corporation is required to obtain prior approval from the FRB before acquiring direct or indirect ownership or control of more than 5% of any voting securities or substantially all of the assets of a bank or bank holding company, or before merging or consolidating with another bank holding company. Additionally, with certain exceptions, any person proposing to acquire control through direct or indirect ownership of 25% or more of any voting securities of the Corporation is required to give 60 days' written notice of the acquisition to the FRB, which may prohibit the transaction, and to publish notice to the public.
Generally, a bank holding company may not engage in any activities other than banking, managing or controlling its bank and other authorized subsidiaries, and providing services to these subsidiaries. With prior approval of the FRB, the Corporation may acquire more than 5% of the assets or outstanding shares of a company engaging in non-bank activities determined by the FRB to be closely related to the business of banking or of managing or controlling banks. The FRB provides expedited procedures for expansion into approved categories of non-bank activities.
Subsidiary banks of a bank holding company are subject to certain quantitative and qualitative restrictions on extensions of credit to the bank holding company or its subsidiaries, on investments in their securities and on the use of their securities as collateral for loans to any borrower. These regulations and restrictions may limit the Corporation's ability to obtain funds from the Bank for its cash needs, including funds for the payment of dividends, interest and operating expenses. Further, subject to certain exceptions, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. For example, the Bank may not generally require a customer to obtain other services from itself or the Corporation, and may not require that a customer promise not to obtain other services from a competitor as a condition to an extension of credit to the customer.
Under FRB policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to make capital injections into a troubled subsidiary bank, and the FRB may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. A required capital injection may be called for when the holding company does not have the resources to provide it.
Federal Bank Regulation - The Corporation's banking subsidiary is a federally-chartered national bank regulated by the Office of Comptroller of Currency ("OCC"). The OCC may prohibit the institutions over which it has supervisory authority from engaging in activities or investments that the agency believes constitutes unsafe or unsound banking practices. Federal banking regulators have extensive enforcement authority over the institutions they regulate to prohibit or correct activities which violate law, regulation or a regulatory agreement or which are deemed to constitute unsafe or unsound practices. Enforcement actions may include the appointment of a conservator or receiver, the issuance of a cease and desist order, the termination of deposit insurance, the imposition of civil money penalties on the institution, its directors, officers, employees and institution-affiliated parties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the removal of or restrictions on directors, officers, employees and institution-affiliated parties, and the enforcement of any such mechanisms through restraining orders or other court actions.
The Bank is subject to certain restrictions on extensions of credit to executive officers, directors, principal shareholders or any related interest of such persons which generally require that such credit extensions be made on substantially the same terms as are available to third persons dealing with the Bank and not involve more than the normal risk of repayment. Other laws tie the maximum amount which may be loaned to any one customer and its related interests to capital levels.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), each federal banking agency is required to prescribe, by regulation, non-capital safety and soundness standards for institutions under its authority. The federal banking agencies, including the OCC, have adopted standards covering internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. An institution which fails to meet those standards may be required by the agency to develop a plan acceptable to the agency, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. The Corporation, on behalf of the Bank, believes that it meets substantially all standards which have been adopted. FDICIA also imposed new capital standards on insured depository institutions.
Before establishing new branch offices, the Bank must meet certain minimum capital stock and surplus requirements and the Bank must obtain OCC approval.
Deposit Insurance - As a FDIC member institution, the Bank's deposits are insured to a maximum of $100,000 per depositor through the Bank Insurance Fund ("BIF"), administered by the FDIC. The Bank pays a quarterly deposit insurance premium assessment to the FDIC. The insurance premium assessment is based upon the FDIC's risk-based assessment system by which institutions are assigned to one of three categories based on their capitalization and one of three subcategories based on examination ratings and other supervisory information. An institution's assessment rate depends on the "supervisory rating" it receives from the FDIC ("A," "B," or "C") and on their regulatory capital level ("well capitalized," "adequately capitalized," or "undercapitalized"). Assessment rates for insured institutions are determined semiannually by the FDIC and currently range from zero basis points for the healthiest institutions to 27 basis points for the riskiest. The FDIC has authority to increase insurance assessments and is required under federal law to establish assessment rates that will maintain the insurance fund's ratio of reserves to insured deposits at $1.25 per $100. The Bank was classified as "well capitalized" at December 31, 2003.
Capital Requirements - The federal banking regulators have adopted certain risk-based capital guidelines to assist in the assessment of the capital adequacy of a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans.
A banking organization's risk-based capital ratios are obtained by dividing its qualifying capital by its total risk-adjusted assets. The regulators measure risk-adjusted assets, which include off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. "Tier 1," or core capital, includes common equity, less goodwill and other intangibles, subject to certain exceptions. "Tier 2," or supplementary capital, includes the allowance for loan and lease losses, subject to certain limitations. Banks and bank holding companies subject to the risk-based capital guidelines are required to maintain a ratio of Tier 1 capital to risk-weighted assets of at least 4.0% and a ratio of total capital to risk-weighted assets of at least 8.0%. The appropriate regulatory authority may set higher capital requirements when particular circumstances warrant. In addition to risk-based capital, banks and bank holding companies are required to maintain a minimum amount of Tier 1 capital to total average assets, referred to as the leverage capital ratio, of at least 4.0%.
Federal banking agencies include in their evaluations of a bank's capital adequacy, an assessment of the Bank's interest rate risk ("IRR") exposure. The standards for measuring the adequacy and effectiveness of a banking organization's interest rate risk management includes a measurement of board of director and senior management oversight, and a determination of whether a banking organization's procedures for comprehensive risk management are appropriate to the circumstances of the specific banking organization. The Bank has internal IRR models that are used to measure and monitor IRR.
Failure to meet applicable capital guidelines could subject a banking organization to a variety of enforcement actions, including limitations on its ability to pay dividends, the issuance by the applicable regulatory authority of a capital directive to increase capital and, in the case of depository institutions, the termination of deposit insurance by the FDIC. In addition, future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Bank to grow and could restrict the amount of profits, if any, available for the payment of dividends to the Corporation.
Monetary Policy - The earnings of a bank holding company are affected by the policies of regulatory authorities, including the FRB, in connection with the FRB's regulation of the money supply. Various methods employed by the FRB are open market operations in United States Government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These methods are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may also affect interest rates charged on loans or paid on deposits. Because of ongoing change in the national economy and in the money markets, as well as the effect of monetary and fiscal policies of the Federal Reserve System and Federal government, prediction cannot be made as to future changes in interest rates, loan demand, deposit levels or the effect on the earnings of the Corporation.
Federal Taxation - The Corporation is subject to those rules of federal income taxation generally applicable to corporations under the Internal Revenue Code of 1986, as amended (the "IRC"). The Corporation, the Bank, and the Bank's wholly-owned subsidiaries file a consolidated federal income tax return. This has the effect of eliminating or deferring the tax consequences of intercompany distributions, including dividends, in the computation of consolidated taxable income. The consolidated entity pays taxes at the federal statutory rate of 34% of its taxable income, as defined in the IRC.
State Taxation - The State of Wisconsin imposes a tax on the Corporation's taxable income at the rate of 7.9%. State income taxes are deductible on the Corporation's federal income tax return. Wisconsin's definition of taxable income is generally similar to the federal definition, except that interest from state and municipal obligations is taxable. In Wisconsin, net operating losses may be carried forward but not back.
FNBM is incorporated in the State of Nevada, which does not currently impose a corporate income tax. Although the earnings of FNBM are not currently subject to taxation in the State of Wisconsin, from time-to-time legislation is proposed which, if adopted, would require consolidated income tax returns for entities headquartered in the state and result in taxation of FNBM's earnings. To date, none of these legislative proposals have been adopted. In addition, from time-to-time the Wisconsin Department of Revenue ("WDR") attempts to impose income tax on out-of-state investment subsidiaries like FNBM. Indeed, in 2003 the WDR began examinations of a number of financial institutions, including the Bank, specifically aimed at their relationships with their investment subsidiaries. Management believes the WDR may take the position that the income of FNBM is taxable in Wisconsin. Management believes the Bank, as well as FNBM, have complied with the tax rules relating to the income of out-of-state subsidiaries. The WDR has indicated that it may repudiate these rulings and management is uncertain at this time whether the WDR exam will result in an assessment. The Bank will vigorously oppose an assessment, if any.
Anti-Terrorism Act - On October 6, 2002, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (the "Patriot Act") was signed into law. While not primarily banking legislation, the Patriot Act contained provisions requiring financial institutions to adopt a variety of policies aimed at preventing money-laundering. The OCC is the primary regulator for purposes of insuring compliance by the Bank with Patriot Act requirements and certain of those requirements will not become effective until adoption of implementing regulations by the OCC. Management of the Bank does not believe that compliance with the Patriot Act and its implementing regulations has a significant impact on the Bank's business.
ITEM 2.
ITEM 2. PROPERTIES
The Corporation owns real property at two branch locations at: 1509 Washington Street, Two Rivers, Wisconsin 54241 ("Two Rivers Branch Office"); and
2915 Custer Street, Manitowoc, Wisconsin 54220 ("Custer Street Branch Office").
The Bank owns real property at the location of its main office at 402 North Eighth Street, Manitowoc, Wisconsin 54220; and at nine of its branch locations at: 106 South Packer Drive, Francis Creek, Wisconsin 54214 ("Francis Creek Branch Office");
109 South Fourth Avenue, St. Nazianz, Wisconsin 54232 ("St. Nazianz Branch Office");
110 Baugniet Street, Mishicot, Wisconsin 54228 ("Mishicot Branch Office");
108 Fremont Street, Kiel, Wisconsin 53042 ("Kiel Branch Office");
5724 CTH U, Newton, Wisconsin 53063 ("Newton Branch Office");
2210 Calumet Drive, New Holstein, Wisconsin 53061 ("New Holstein Branch Office");
2323 Eastern Avenue, Plymouth, Wisconsin 53073 ("Plymouth East Branch Office");
300 East Mill Street, Plymouth, Wisconsin 53073 ("Plymouth West Branch Office"); and
2747 Manitowoc Road, Green Bay, Wisconsin 54311 ("Bellevue Branch Office").
The Bank leases real property at one branch location: 2865 South Ridge Road, Green Bay, Wisconsin, 54304 ("Ashwaubenon Branch Office").
Insurance Center of Manitowoc, Inc. owns real property located at: 4712 Expo Drive, Manitowoc, Wisconsin 54220 ("Insurance Center of Manitowoc, Inc. Office").
Insurance Center of Manitowoc, Inc. leases real property at: 425 South Adams Street, Green Bay, Wisconsin, 54301 ("Gary G. Vincent & Associates, Inc. Office").
There are no encumbrances on any of these properties.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Corporation is involved in various legal actions arising in the normal course of its business. While the ultimate outcome of these various legal proceedings cannot be predicted with certainty, it is the opinion of management and through consultation with legal counsel that the resolution of these legal actions will not have a material effect on the Corporation's consolidated financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to security holders for a vote during the fourth quarter of 2003.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
MARKET INFORMATION
There is no established public trading market for the Corporation's common stock ("Shares"). Accordingly, there is no comprehensive record of trades or the prices of any such trades. The following tables reflect stock prices for Shares to the extent such information is made known and available to management of the Corporation, and the dividends declared with respect thereto during the preceding two years.
All market information shown above has been restated for stock dividends and stock splits.
CASH DIVIDENDS
All cash dividends shown above have been restated for stock dividends and stock splits.
HOLDERS
As of February 27, 2004, there were approximately 635 holders of record of the Corporation's Shares.
DIVIDENDS
The Corporation declared and paid cash dividends per share totaling $0.210 per share or $1.5 million during fiscal 2003, and $0.183 per share or $1.3 million during fiscal 2002. The Corporation currently expects that comparable cash dividends will continue in the future.
Dividends may be paid to the holders of the Corporation's shares, when, as, and if declared by the Corporation's Board of Directors, subject to the restrictions imposed by Wisconsin law. The only statutory limitation applicable to the Corporation is that dividends may not be paid if the Corporation is insolvent or if the dividend would cause the Corporation to become insolvent. There are no contractual restrictions that currently limit the Corporation's ability to pay dividends or that the Corporation reasonably believes are likely to limit materially the future payment of dividends on the Corporation's shares. Currently, its only source of income is from the dividends paid by the Bank to the Corporation. Therefore, the dividend restrictions applicable to national banks will impact the Corporation's ability to pay dividends.
Under the National Bank Act, dividends may be paid only out of retained earnings as defined in the statute. The approval of the OCC is required if the dividends for any year exceed the net profits, as defined, for that year plus the retained net profits for the preceding two years. In addition, unless a national bank's capital surplus equals or exceeds the stated capital for its common stock, no dividends may be declared unless the bank makes transfers from retained earnings to capital surplus.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with the Corporation's Consolidated Financial Statements and the related notes and with the Corporation's Management's Discussion and Analysis of Financial Condition and Results of Operations, provided elsewhere herein. In thousands, except per share amounts.
* Per share data for 1999 through 2002 is restated to reflect the 25% stock dividend (five-for-four stock split) effective April 16, 1999, and the two-for-one stock splits effective June 30, 2000 and October 18, 2002.
SUMMARY QUARTERLY FINANCIAL INFORMATION In thousands, except per share amounts
*Per share data has been adjusted to reflect the two-for-one stock split effective October 18, 2002.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussion and analysis in this section should be read in conjunction with Item 8, Financial Statements and Supplemental Data as well as with the selected financial data found elsewhere in this report.
Critical Accounting Policies
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Estimates that are particularly susceptible to significant change include the determination of the allowance for loan losses and mortgage servicing rights valuation.
The consolidated financial statements of the Corporation are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industries in which it operates. This preparation requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Management believes the following policies are both important to the portrayal of the Corporation's financial condition and results and require subjective or complex judgments and, therefore, management considers the following to be critical accounting policies.
Allowance for Loan Losses - Management's evaluation process used to determine the adequacy of the allowance for loan losses is subject to the use of estimates, assumptions, and judgments including management's ongoing review and grading of the loan portfolio, consideration of past loan loss experience, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect probable credit losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly. As an integral part of their examination process, various regulatory agencies also review the allowance for loan losses. Such agencies may require that certain loan balances be charged off when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. The Corporation believes the allowance for loan losses is adequate and properly recorded in the financial statements. See section "Allowance for Loan Losses."
Mortgage Servicing Rights Valuation - The fair value of the Corporation's mortgage servicing rights asset is important to the presentation of the consolidated financial statements in that mortgage servicing rights are subject to a fair value-based impairment standard. Mortgage servicing rights do not trade in an active open market with readily observable prices. As such, like other participants in the mortgage banking business, the Corporation relies on an internal estimated cash flow model to establish the fair value of its mortgage servicing rights. While the Corporation believes that the values produced by its internal model are indicative of the fair value of its mortgage servicing rights portfolio, these values can change significantly depending upon the then current interest rate environment, estimated prepayment speeds of the underlying mortgages serviced, and other economic conditions. The proceeds that might be received should the Corporation actually consider a sale of the mortgage servicing rights portfolio could differ from the amounts reported at any point in time. The Corporation believes the mortgage servicing rights asset is properly recorded in the financial statements.
For additional information concerning critical accounting policies, see Notes to Consolidated Financial Statements, "Note 1, Summary of Significant Accounting Policies" and "Note 2, Changes in Accounting Principles".
Results of Operations
INCOME STATEMENT
The Corporation recorded net income of $7.6 million for the year ended December 31, 2003, an increase of 7.0% over the $7.1 million earned in 2002. These amounts represented returns on average assets of 1.35% for 2003 and 1.33% for 2002. Returns on average equity were 13.34% for 2003 and 13.97% for 2002. Earnings per share in 2003 (basic and diluted) were $1.10, an increase of 7.8% over 2002 earnings per share of $1.02.
Interest income decreased $3.6 million, from $30.8 million in 2002 to $27.2 million in 2003. Interest expense decreased from $12.0 million in 2002 to $9.7 million in 2003. These items continue to be affected by the low interest rate environment in 2003. As a result, net interest income decreased $1.3 million in 2003. However, as mentioned previously, net income increased for the year. The decrease in net interest income was offset by the increase in other income as detailed below.
Other income increased $1.3 million in 2003, from $6.6 million in 2002 to $7.9 million in 2003. A sustained decrease in mortgage rates led to significant gains on sales of these loans to the secondary market and the corresponding servicing income. Other expense held steady: increases in employee compensation were offset by decreases in other expense categories such as occupancy expense.
BALANCE SHEET
Total assets at December 31, 2003 increased $16.2 million from $565.8 million in 2002 to $582.0 million in 2003. Loans were $371.1 million at December 31, 2003, an increase of $27.0 million or 7.8% over December 31, 2002. Significant increases in loans were as follows: Commercial loans increased $7.5 million, commercial real estate loans increased $7.4 million, and consumer loans increased $8.8 million.
Challenging economic conditions continue to affect the Bank's customers. The allowance for loan losses increased to $4.0 million at December 31, 2003 from $3.3 million at December 31, 2002. The ratio of allowance for loan losses to total loans was 1.08% for 2003 and 0.98% for 2002. Non-performing loans were $3.3 million, representing 0.9% of total loans at year end 2003, compared to $1.8 million or 0.5% of total loans last year. The increase in non-performing loans came primarily from the commercial loan sector of the Bank's loan portfolio.
Deposits increased $12.1 million, from $416.1 million at December 31, 2002 to $428.2 million at December 31, 2003. The bank continues to experience strong competition from other commercial banks, credit unions, the stock market, and mutual funds. There are no predetermined divisions in the asset/liability policy for the mix of deposits. Repurchase agreements increased $4.5 million or 8.8% over 2002 due to increased deposits by municipalities at year end as a result of tax collections. Borrowed funds decreased $6.2 million to $31.9 million at December 31, 2003 from $38.1 million at December 31, 2002. An FHLB borrowing in the amount of $5.0 million reached maturity during the year 2003.
Results of Operations Overview for fiscal years 2003, 2002 and 2001
The Corporation reported $7.6 million in net income for 2003 or $1.10 per share compared to 2002 net income of $7.1 million or $1.02 per share, and $5.4 million or $0.78 per share for 2001. Earnings for the year represent a record level of performance for the Corporation, exceeding the previous record of $7.1 million achieved in 2002. The improvement was primarily attributed to other operating income. Return on average assets was 1.35%, 1.33% and 1.07% in 2003, 2002 and 2001, respectively. Return on average equity was 13.34% for 2003, 13.97% for 2002, and 12.07% for 2001.
Net Interest Income, Interest Rate Spread, and Net Interest Margin
Management and the Board of Directors of the Bank monitor interest rates on a regular basis to assess the Bank's competitive position and to maintain a reasonable and profitable interest rate spread. The Bank also considers the maturity distribution of loans, investments, and deposits and its effect on net interest income as interest rates rise and fall over time.
Tables 1 and 2 do not include financial data for the Corporation as they include only Bank financial information. In Table 1, nonaccrual loans have been included in the average balances, loan fees are included in interest income and the yield on tax exempt loans and securities is computed on a tax-equivalent basis using a tax rate of 34%.
Table 1 provides average balances of earning assets and interest-bearing liabilities, the associated interest income and expense and the corresponding interest rates earned and paid. Net interest income, interest rate spread and net interest margin on a tax-equivalent basis are shown for the three years ended December 31, 2003, 2002, and 2001, respectively.
Net interest income is the principal source of earnings for a banking company. It represents the differences between interest and fees earned on the loan and investment portfolios and interest-bearing deposits offset by the interest paid on deposits and borrowings. The amount of net interest income is affected by changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities. Interest rates fell during 2003 and 2002. Net interest income (on a tax equivalent basis) for 2003 decreased by $1.3 million or 7.0% compared to the year ended December 31, 2002, while 2002 net interest income increased by $1.4 million or 8.0% from the previous year ended December 31, 2001. (See Tables 1 and 2)
Interest rate spread and net interest margin are utilized to measure and explain changes in net interest income. Interest rate spread is the difference between the average yield on interest earning assets and the average rate paid on interest bearing liabilities. Interest rate spread for the years ended December 31, 2003, 2002 and 2001 was 2.97%, 3.37%, and 3.07%, respectively. Net interest margin is calculated as tax equivalent net interest income divided by average earning assets and represents the Bank's net yield on its earning assets. The net interest margin exceeds the interest rate spread because non-interest bearing sources of funds, primarily demand deposits and shareholder's equity, also support earning assets. For 2003, the net interest margin was 3.35% compared to 3.81% in 2002. The net interest margin for 2001 was 3.74%. These changes are the result of repricing and volume changes as previously discussed and illustrated in Table 2 "Rate and Volume Variance Analysis Based on Average Balances."
As shown in the rate/volume analysis in Table 2, changes in the rates resulted in a $2.4 million decrease in taxable equivalent net interest income. Decreases in volume and changes in the mix of both earning assets and interest-bearing liabilities added $1.0 million for a combined decrease of $1.3 million in taxable equivalent net interest income. Rate changes on interest-bearing liabilities lowered interest expense by $2.6 million, while rate changes on earning assets reduced interest income by $4.9 million.
For 2003, the cost of interest-bearing liabilities decreased 64 basis points to 2.22% aided by the low interest rate environment. The most significant rate decrease occurred in the CD and IRA deposit category, a decline of 94 basis points.
The yield on earning assets fell 93 basis points to 5.69% for 2003. The average loan yield was 6.27%. The lower rate environment for new originations, competitive pricing pressure and refinancing in many loan categories contributed to the downward trend in loan yields. The yield on securities was down 107 basis points to 5.13%. The earning asset rate changes reduced interest income by $3.0 million, a combination of $1.7 million in lower interest on loans and $1.3 million in lower interest on securities.
From a volume perspective, earning assets contributed $1.4 million to taxable equivalent net interest income while interest-bearing liabilities cost $0.2 million, netting a $1.2 million increase to taxable equivalent net interest income.
Average earning assets were $522.9 million in 2003, an increase of $28.1 million from 2002. Loans accounted for the majority of the growth in earning assets. Loans increased $17.7 million or 5.2% to $353.3 million on average in 2003. Securities increased $3.4 million and Federal Funds Sold increased $7.0 million on average in 2003.
Average interest-bearing liabilities were $434.5 million in 2003, an increase of $15.6 million from 2002. Certificates of deposit and IRA deposits accounted for a $9.9 million increase on average over 2002.
Table 1 displays the average balances and average rates paid on all major deposit classifications for 2003, 2002, and 2001.
AVERAGE BALANCES, YIELD AND RATES (In thousands)
Table 1
The following table sets forth the effects of changing rates and volumes on net interest income of the Corporation for the periods indicated. Information is provided with respect to (1) effects on net interest income attributable to changes in volume (changes in volume multiplied by prior rate); (2) effects on net interest income attributable to changes in rate (changes in rate multiplied by prior volume); and (3) the net change in interest income.
RATE AND VOLUME VARIANCE ANALYSIS BASED ON AVERAGE BALANCES (IN THOUSANDS)
Table 2
Provision and Allowance for Loan Losses
For the year ended December 31, 2003, the Bank recorded net charge-offs of $635,000 compared to net charge- offs of $1,303,000 in 2002 and $4,087,000 in 2001. Net charge-offs in 2001 included one commercial loan charge-off in the amount of $2,073,000. Internal loan review, in particular, has been effective in identifying problem credits and in achieving timely recognition of potential and actual losses within the loan portfolio.
Gross charge-offs amounted to $749,000 in 2003, $1,578,000 in 2002, and $4,134,000 in 2001, the majority of which were commercial loans. Loans charged off are subject to ongoing review and effort is made to maximize recovery of principal, interest and related expenses. Recoveries were $114,000 in 2003, $275,000 in 2002, and $47,000 in 2001.
The methodology used in determining the allowance for loan losses is based on guidelines provided by the Financial Accounting Standards Board. The allowance for loan losses is maintained at a level believed adequate by management to absorb estimated loan losses. There are several factors that are included in the analysis of the adequacy of the allowance for loan losses. Management considers loan volume trends, levels and trends in delinquencies and nonaccruals, current problem credits, national and local economic trends and conditions, concentrations of credit by industry, current and historical levels of charge-offs, the experience and ability of the lending staff, and other miscellaneous factors.
The factor of loan volume trends is based on actual lending activity. This factor is for estimated losses that are believed to be inherently part of the loan portfolio but that have not yet been identified as specific problem credits. The current problem credits factor includes the exposure believed to exist for specifically identified problem loans determined on a loan-by-loan basis. Specific problem loans are subject to classification according to one of two categories: "Substandard" or "Doubtful". An institution is required to develop its own program to classify its assets on a regular basis and to set aside appropriate loss reserves on the basis of such classification. The allocation of the allowance among the various loan categories is based on the average proportion within those categories using a three year historical loss percentage. The unallocated portion of the allowance consists of the other factors included in the analysis because those factors cannot be tied to specific loans or loan categories.
The allocation of the allowance for loan losses is shown in the following table.
Table 3
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES (IN THOUSANDS) DECEMBER 31,
Local economic concerns continue to affect the bank's customers. These concerns are reflected in the increase shown in the allocation of allowance for loan losses. An increase in local unemployment rates since December 31, 2002 was taken into consideration when determining the increase in the unallocated portion of the allowance.
The allocation and total for the allowance for loan losses is not to be interpreted as a single year's exposure for loss nor the loss for any specified time period.
Table 4 ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES (IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
The allowance for loan losses of $3,999,000 as of December 31, 2003 amounted to 1.08% of the outstanding loan portfolio. As of December 31, 2002, the $3,384,000 allowance for loan losses was 0.98% of gross loans and the allowance for loan losses of $2,737,000 as of December 31, 2001 represented 0.84% of gross loans. Net charge-offs for the year ended December 31, 2003 were less than the provision for loan losses for 2003. This accounts for the increase in the allowance for loan losses from $3,384,000 at December 31, 2002 to $3,999,000 at December 31, 2003. Analysis by internal loan review supports the adequacy of the allowance. Management has determined that the allowance for loan losses is adequate to absorb probable loan losses as of December 31, 2003. See Note 4 in the Consolidated Financial Statements.
Other Income
Other income increased $1.3 million, or 19.8%, from 2002 to 2003. The increased volume of mortgage loans and refinancings processed and sold to the FNMA secondary market led to increased gains on loans sold and servicing fees associated with them.
Other income increased $1.2 million, or 23.2%, from 2001 to 2002. The growth resulted primarily from an increase in Trust service fees, an increase in loan servicing income, and increases in gain on sales of mortgage loans held for sale. Increases in gain on sales of mortgage loans resulted from the lower interest rate environment that increased loan demand and related fee income.
Other Expense
Other expense decreased by $109,000, or 0.8%, from 2002 to 2003.
Other expense increased by $1.1 million, or 8.1%, from 2001 to 2002. This change was primarily a result of increases in salaries and employee benefits due to annual merit increases for employees. Other accounts with significantly higher expenses included data processing, occupancy expense, insurance commissions, software amortization, legal and professional fees, marketing, and telephone expenses.
Income Taxes
The effective tax rates for the Corporation were 21.40%, 20.58%, and 14.59%, for 2003, 2002, and 2001, respectively. The increase in the effective tax rate for 2003 is a result of higher taxable income in 2003. The primary reason for higher taxable income is that the tax benefit from non-taxable municipal interest income is much less as a percent of total income than in past years dropping from 17% of pretax net income in 2001 to 12% in 2002 to 11% in 2003. See Note 13 in the Consolidated Financial Statements.
Securities
Securities available for sale are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions as part of the asset/liability management strategy. Securities available for sale are carried at fair value, with unrealized holding gains and losses, net of the related tax effect, reported as a separate component of accumulated other comprehensive income. Securities held to maturity are those that management has both the positive intent and ability to hold to maturity, and are reported at amortized cost. The Bank does not own trading or held to maturity securities.
Total securities were $138.3 million, $135.7 million, and $126.8 million as of December 31, 2003, 2002, and 2001, respectively. The higher level of investments in securities resulted primarily from the increase in available funds derived from increases in deposits and securities sold under repurchase agreements.
The Bank manages its investment portfolios within policies that seek to achieve desired levels of liquidity, manage interest rate sensitivity risk, meet earnings objectives, and provide required collateral support for deposit activities. The Bank had no concentrations of securities from any single issues that exceeded 10% of shareholders' equity. Table 5 exhibits the distribution, by type, of the investment portfolio as of December 31.
Table 5 SECURITIES AVAILABLE FOR SALE (IN THOUSANDS)
The following table presents the maturity by type of the investment portfolio for the year ended December 31, 2003.
Table 6
INVESTMENT PORTFOLIO ANALYSIS DECEMBER 31, 2003 (IN THOUSANDS)
Loan Portfolio
The Bank is actively engaged in originating loans to customers in Manitowoc, Calumet, Sheboygan and Brown counties. The Bank has policies and procedures designed to mitigate credit risk and to maintain the quality of the loan portfolio. These policies include underwriting standards for new credits as well as the continuous monitoring and reporting of asset quality and the adequacy of the allowance for loan losses. These polices, coupled with continuous training efforts, have provided effective checks and balances for the risk associated with the lending process. Lending authority is based on the level of risk, size of the loan and the experience of the lending officer.
Bank underwriting procedures are based on a process which evaluates the management, repayment ability, collateral support, credit history, and overall financial strength of prospective and current customers from a relationship oriented perspective. Residential mortgage loans are predominantly underwritten to general FNMA guidelines.
The Bank extends the following types of credit: commercial loans, agricultural loans, real estate loans and consumer loans.
Commercial loans are often secured with first liens on accounts receivable, inventory and/or equipment. Commercial loans generally have loan to value ratios of 80% or less. Agricultural loans are collateralized with first liens on crops, farm products, farm personal property and/or real estate. Agricultural loans generally have loan to value ratios of 70% or less, except for agricultural real estate loans which have loan to value ratios of 80% or less. Real estate loans include commercial real estate loans and residential real estate loans. Real estate loans are collateralized with first mortgages. Commercial real estate loans generally have loan to value ratios of 80% or less while residential real estate loans have loan to value ratios of 90% or less. Consumer loans include loans to individuals for personal, family or household purposes. Consumer loans may be secured with first lien positions or be unsecured depending upon the credit quality. The Bank will make subordinate loans in any category if the borrower's financial position justifies it. The Bank is not involved in credit risk insurance.
Bank management assesses the loan portfolio mix at least annually as part of its planning and budget process. While there are no predetermined fixed targets for various loan types established in the loan policy, general guidelines are established annually for new loan activity based on loan portfolio mix and credit needs in the Bank's main markets.
The risks associated with the Bank's loan categories are as follows:
Commercial and Agricultural. Credit risk is considered moderate. Past due loans are below industry averages. The portfolio is fairly diversified with no significant concentrations within one industry. Agricultural loans represent approximately 5% of total loans.
Real Estate. Credit risk is considered low, with delinquency ratios and non-performing loans at low levels.
Consumer. Credit risk is considered moderate, with delinquency ratios and non-performing loans at low levels.
No loan customer exceeds the legal lending limit among the loan categories. The Bank's legal and internal lending limit as of December 31, 2003 was $7.3 million.
Extensions of credit used predominantly for business or agricultural purposes are classified as commercial and agricultural loans. Commercial loans include lines of credit for seasonal requirements of businesses, short-term loans payable within 12 months for one time specific purposes and term loans with maturities greater than 12 months for capital assets and fixed assets which are amortized and repaid from cash flow. Agricultural loans include short-term farm operating loans, intermediate-term farm personal property loans and long-term agricultural real estate loans. Agricultural real estate loans generally are written for one to two year terms with amortizations exceeding five years. Commercial term loans for capital assets and fixed assets and commercial real estate loans that have maturities of more than five years are generally arranged through government assisted financing programs such as SBA.
The increase in commercial loans and commercial real estate loans resulted mainly from the general credit needs within the Bank's primary markets. The Bank also made it a priority to sell residential mortgage loans to the FNMA secondary market.
Table 7 "Summary of Loan Portfolio" presents the composition of the Bank's loan portfolio by significant concentration.
Table 7 SUMMARY OF LOAN PORTFOLIO (IN THOUSANDS) LOANS OUTSTANDING AS OF DECEMBER 31,
Table 8
MATURITIES OF LOAN PORTFOLIO DECEMBER 31, 2003 (IN THOUSANDS)
The Bank's policy is to make the majority of its loan commitments in the market area it serves. This tends to reduce risk because management is familiar with the credit histories of loan applicants and has an in-depth knowledge of the risk to which a given credit is subject. The Bank had no foreign loans in its portfolio as of December 31, 2003.
It is the policy of the Bank to place a loan on nonaccrual status whenever there is substantial doubt about the ability of a borrower to pay principal or interest on any outstanding credit. Management considers such factors as payment history, the nature and value of collateral securing the loan and the overall economic situation of the borrower when making a nonaccrual decision. Nonaccrual loans are closely monitored by management. A nonaccrual loan is restored to current status when the prospects of future contractual payments are no longer in doubt. Nonaccrual loans at December 31, 2003 and 2002 were $3.3 million and $1.8 million, respectively. The fluctuation in the level of nonaccrual loans over the past five years is attributed mainly to isolated credit deterioration in a few larger account relationships. These included consumer loans, commercial loans, agricultural loans and residential real estate loans. However, no trend in economic, industrial, geographical or other factors could be identified to account for the fluctuations in the level of nonaccrual loans. Accruing loans 90 days or more past due include loans that are both well secured and in the process of collection.
Table 9
RISK ELEMENTS OF LOAN PORTFOLIO (IN THOUSANDS) DECEMBER 31,
Total nonperforming loans at December 31, 2003 were $3.3 million, an increase of $1.5 million from $1.8 million at December 31, 2002. The increase in non-performing loans came primarily from the consumer loan portfolio.
Management maintains a listing of potential problem loans. The decision of management to place loans in this category does not necessarily indicate that the Bank expects losses to occur, but that management recognizes that a higher degree of risk is associated with these performing loans. The loans that have been reported as potential problem loans are not concentrated in a particular industry, but rather cover a diverse range of businesses. Management does not presently expect significant losses from credits in the potential problem loan category.
The following table represents maturities of time deposits in denominations of $100,000 or more for the years ended December 31, 2003 and 2002.
Table 10
MATURITY OF TIME DEPOSITS $100,000 OR MORE (IN THOUSANDS) FOR THE YEARS ENDED DECEMBER 31,
Table 11
Contractual Obligations
Payments due by period as of 12/31/2003
Borrowings
FHLB advances decreased from $35.0 million at December 31, 2002 to $30.0 million at December 31, 2003, a decrease of $5.0 million or 14.3%. FHLB advances are subject to a prepayment penalty if they are repaid prior to maturity. FHLB advances are callable either six months or one year after origination and quarterly thereafter. Promissory notes to former shareholders of the Insurance Center at 9% maturing July 1, 2008 totaled $345,000 at December 31, 2003.
Off-Balance Sheet Arrangements
The Corporation has become a party to financial instruments with off-balance sheet risk in the normal course of its business in order to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit.
Off-balance sheet financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the Statement of Financial Condition. In the event of non-performance by the other party to a financial instrument, the Corporation's exposure to credit loss is represented by the contractual amount of the instrument. The Corporation uses the same credit policies in granting commitments and letters of credit as it does for on-balance sheet financial instruments. See Note 18 of the consolidated financial statements for specifics on the Corporation's off-balance sheet arrangements.
Liquidity Management
Liquidity management describes the ability of the Bank to access funding sources at a minimum cost to meet fluctuating deposit, withdrawal, and loan demand needs and to fund current and planned expenditures. The Bank maintains its asset liquidity position internally through short-term investments, the maturity distribution of the investment portfolio, loan repayments and income from interest earning assets. A substantial portion of the investment portfolio contains readily marketable securities that could be converted to cash immediately. Refer to Note 3 in the Consolidated Financial Statements for a table showing the maturity distribution of the Bank's securities portfolio and the related estimated fair value. On the liability side of the balance sheet, liquidity is affected by the timing of maturing liabilities and the ability to generate new deposits or borrowings as needed. Other sources are available through borrowings from the Federal Reserve Bank, the Federal Home Loan Bank and from lines of credit approved at correspondent banks. Management knows of no trend or event that will have a material impact on the Bank's ability to maintain liquidity at satisfactory levels.
Capital Resources and Adequacy
Total shareholders' equity increased $5.9 million or 10.9% in 2003 to $60.2 million at the end of the year from $54.3 million at December 31, 2002. Net income of $7.6 million less an other comprehensive loss of $0.2 million and $1.5 million in dividends paid contributed to this increase.
One measure of capital adequacy is the leverage ratio which is calculated by dividing average total assets for the most recent quarter into Tier 1 capital. The regulatory minimum for this ratio is 4.0%. The Bank's leverage ratio for the years ended December 31, 2003, 2002, and 2001 was 8.4%, 7.5%, and 6.8%, respectively. The bank is also required to maintain a ratio of Tier 1 capital to risk-weighted assets of at least 4.0%. The Bank's Tier 1 capital (to risk-weighted assets) ratio for the years ended December 31, 2003, 2002, and 2001 was 12.0%, 11.1%, and 10.4% respectively.
Another measure of capital adequacy is the risk-based capital ratio or the ratio of total capital to risk-adjusted assets. Total capital is composed of both core capital (Tier 1) and supplemental capital (Tier 2) including adjustments for off balance sheet items such as letters of credit and taking into account the different degrees of risk among various assets. Regulators require a minimum total risk-based capital ratio of 8.0%. The Bank's ratio at December 31, 2003, and for each of the two preceding years was 13.1%, 12.0%, and 11.3%, respectively. According to FDIC capital guidelines, the Bank is considered to be "well capitalized" as of December 31, 2003.
Management knows of no other trend or event which will have a material impact on capital. Please also refer to Note 15 in the Consolidated Financial Statements for additional discussion of regulatory matters.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Corporation's primary exposure to market risk relates to changes in interest rates, exchange rates, commodity prices, and other relevant market rate or price risk through our banking operations. The Bank monitors interest rate factors on a monthly basis to assess interest rate risk of the portfolio of assets and liabilities. Maturity terms of assets are matched to the maturity terms of liabilities to the extent possible. The maturity structure of the municipal securities, however, is long term to optimize tax advantages and yield returns within an acceptable level of market risk. In addition, based on prior experience, the average life of the mortgage backed securities has been shorter than the scheduled maturities. There are no interest rate caps or floors on variable rate instruments that could affect the cash flows on those instruments. Variable rate loans, investments and deposits reprice immediately because they are related to changes in the prime rate of interest. Fixed rate commercial loans reprice at least annually. Fixed rate real estate loans are scheduled for 1 to 2 year terms with balloon payments. Loans do not have prepayment penalty clauses. The following table also assumes all loans and deposits will be renewed under the same terms. Interest rates on those renewals are based on anticipated rates at the date of renewal. There is a 20% prepayment assumption for the entire loan portfolio based on historical trends.
Interest Rate Risk
In order to measure earnings sensitivity to changing rates, the Corporation uses three different measurement tools: static gap analysis, simulation of earnings, and economic value of equity. The static gap analysis starts with contractual repricing information for assets, liabilities, and off-balance sheet instruments. These items are then combined with repricing estimations for administered rate (interest-bearing demand deposits, savings, and money market accounts) and non-rate related products (demand deposit accounts, other assets, and other liabilities) to create a baseline repricing balance sheet. In addition to the contractual information, residential mortgage whole loan products and mortgage-backed securities are adjusted based on industry estimates of prepayment speeds that capture the expected prepayment of principal above the contractual amount based on how far away the contractual coupon is from market coupon rates. There is no guaranty that prepayment speeds of mortgage backed securities will continue to be accelerated.
The following table represents the Corporation's consolidated static gap position as of December 31, 2003.
Table 12: Interest Rate Sensitivity Analysis
*Based on historical evidence 90% of non-interest bearing deposits have a 1-5 year life while 10% have a 0-12 month life.
(1) The interest rate sensitivity assumptions for demand deposits, savings accounts, money market accounts, and interest-bearing demand deposit accounts are based on current and historical experiences regarding portfolio retention and interest rate repricing behavior. Based on these experiences, a portion of these balances are considered to be long-term and fairly stable and are therefore included in the "1 - 5 year" category.
The static gap analysis in Table 11 provides a representation of the Corporation's earnings sensitivity to changes in interest rates. It is a static indicator that does not reflect various repricing characteristics and may not necessarily indicate the sensitivity of net interest income in a changing interest rate environment.
At the end of 2003, the Corporation's balance sheet was relatively neutral to interest rate movements. In the 1 - 5 year category, liabilities are repricing faster than assets.
Interest rate risk of embedded positions (including prepayment and early withdrawal options, lagged interest rate changes, administered interest rate products, and cap and floor options within products) require a more dynamic measuring tool to capture earnings risk. Earnings simulation and economic value of equity are used to more completely assess interest rate risk.
Along with the static gap analysis, determining the sensitivity of short-term future earnings to a hypothetical plus or minus 100, 200, and 300 basis point parallel rate shock can be accomplished through the use of simulation modeling. In addition to the assumptions used to create the static gap, simulation of earnings includes the modeling of the balance sheet as an ongoing entity. Future business assumptions involving administered rate products, prepayments for future rate-sensitive balances, and the reinvestment of maturing assets and liabilities are included. These items are then modeled to project net interest income based on a hypothetical change in interest rates. The resulting net interest income for the next 12-month period is compared to the net interest income amount calculated using the flat rates. This difference represents the Corporation's earnings sensitivity to a plus or minus 100 basis point parallel rate shock.
The resulting simulations for December 31, 2003, projected that net interest income would decrease by approximately 0.2% of budgeted net interest income if rates rose by a 100 basis point shock, and projected that the net interest income would decrease by approximately 2.5% if rates fell by a 100 basis point shock.
Economic value of equity is another tool used to measure the impact of interest rates on the present value of assets, liabilities and off-balance sheet financial instruments. This measurement is a longer-term analysis of interest rate risk as it evaluates every cash flow produced by the current balance sheet. The projected changes for earnings simulation and economic value of equity for 2003 were within the Corporation's interest rate risk policy. The results of the 2003 modeling mirrored the other interest rate risk tests discussed above, as the Corporation maintained a relatively neutral position at December 31, 2003.
These results are based solely on immediate and sustained parallel changes in market rates and do not reflect the earnings sensitivity that may arise from other factors. These factors may include changes in the shape of the yield curve, the change in spread between key market rates, or accounting recognition of the impairment of certain intangibles. The above results are also considered to be conservative estimates due to the fact that no management actions to mitigate potential income variances are included within the simulation process. This action could include, but would not be limited to, delaying an increase in deposit rates, extending liabilities, changing the pricing characteristics of loans, or changing the growth rate of certain assets and liabilities.
ITEM 8
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
[WIPFLI LLP LOGO]
Independent Auditor's Report
Board of Directors and Stockholders First Manitowoc Bancorp, Inc. Manitowoc, Wisconsin
We have audited the accompanying consolidated balance sheets of First Manitowoc Bancorp, Inc. and Subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2003. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Manitowoc Bancorp, Inc. and Subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States.
Wipfli LLP
January 23, 2004 Green Bay, Wisconsin
First Manitowoc Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
See accompanying notes to consolidated financial statements.
First Manitowoc Bancorp, Inc. and Subsidiaries
Consolidated Statements of Income
See accompanying notes to consolidated financial statements.
First Manitowoc Bancorp, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
See accompanying notes to consolidated financial statements.
First Manitowoc Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
See accompanying notes to consolidated financial statements.
First Manitowoc Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Continued)
See accompanying notes to consolidated financial statements.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1 Summary of Significant Accounting Policies
The accounting and reporting policies of First Manitowoc Bancorp, Inc. and Subsidiaries (the "Corporation") conform to generally accepted accounting principles and general practices within the financial institution industry. Significant accounting and reporting policies are summarized below.
Principles of Consolidation - The accompanying consolidated financial statements include the accounts of First Manitowoc Bancorp, Inc., its wholly owned subsidiary, First National Bank in Manitowoc (the "Bank"), and the Bank's wholly owned subsidiaries, FNBM Investment Corp. and Insurance Center of Manitowoc, Inc. (the "Insurance Center"). All significant intercompany balances and transactions have been eliminated. Investment in United Financial Services, Inc., the Bank's 49.8% owned subsidiary, is accounted for on the equity method.
Business - The Corporation provides a full range of financial services to individual and corporate customers in Northeastern Wisconsin through First National Bank in Manitowoc. The Corporation is subject to competition from other traditional and nontraditional financial institutions and is also subject to the regulations of certain federal agencies and undergoes periodic examinations by those regulatory authorities.
Use of Estimates in Preparation of Financial Statements - The preparation of the accompanying consolidated financial statements of First Manitowoc Bancorp, Inc. and Subsidiaries in conformity with generally accepted accounting principles requires management to make estimates and assumptions that directly affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates.
Cash and Cash Equivalents - For purposes of reporting cash flows, cash and cash equivalents include cash on hand, due from banks, interest-bearing deposits, and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.
The Bank is required to maintain non-interest-bearing deposits on hand or with the Federal Reserve Bank. At December 31, 2003, those required reserves of $1,637,000 were satisfied by currency and coin holdings.
In the normal course of business, the Bank maintains cash and due from bank balances with correspondent banks. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $100,000. Total uninsured balances at December 31, 2003, were approximately $11,881,000.
Investment Securities - The Corporation's securities are classified and accounted for as securities available for sale. Available-for-sale securities are stated at fair value with the unrealized gains and losses, net of tax, reported as accumulated other comprehensive income (loss) within stockholders' equity until realized. Interest and dividends are included in interest income from securities as earned. Premiums are recognized in interest income using the interest method over the period to the call date. Discounts are recognized in interest income using the interest method over the period to maturity. Realized gains and losses and declines in value judged to be other than temporary are included in net gains and losses from sales of investment and mortgage-related securities. The cost of securities sold is based on the specific-identification method.
Fair values of many securities are estimates based on financial methods or prices paid for similar securities. It is possible interest rates could change considerably resulting in a material change in the estimated fair value.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1 Summary of Significant Accounting Policies (Continued)
Other Investments - Other investments are carried at cost and consist of Federal Home Loan Bank stock, Federal Reserve stock, Bankers Bancorporation stock, and preferred stock in a community development project. Other investments are evaluated for impairment on an annual basis.
Loans Held for Sale - Loans held for sale consist of the current origination of certain fixed-rate mortgage loans which are recorded at the lower of aggregate cost or fair value. A gain or loss is recognized at the time of the sale reflecting the present value of the difference between the contractual interest rate of the loans sold and the yield to the investor, adjusted for the initial value of mortgage servicing rights.
Loans and Related Interest Income - Loans are carried at their unpaid principal balance. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding and is recognized in the period earned.
Interest on loans is accrued and credited to income as earned. Accrual of interest is generally discontinued either when reasonable doubt exists as to the full, timely collection of interest or principal or generally when a loan becomes contractually past due by 90 days or more with respect to interest or principal. At that time, any accrued but uncollected interest is reversed and additional income is recorded only to the extent that payments are received and the collection of principal is reasonably assured. Loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectibility of the total contractual principal and interest is reasonably assured.
Loan Fees and Related Costs - Loan-origination fees are credited to income when received and the related loan-origination costs are expensed as incurred. Capitalization of the fees net of the related costs would not have a material effect on the consolidated financial statements.
Allowance for Loan Losses - The allowance for loan losses is provided for based on past experience and prevailing market conditions. Management's evaluation of loss considers various factors including, but not limited to, general economic conditions, loan portfolio composition, and prior loss experience. This evaluation is inherently subjective since it requires material estimates that may be susceptible to significant change. Loans are charged against the allowance for loan losses when management believes the collectibility of the principal is unlikely. In addition, various regulatory agencies periodically review the allowance for loan losses. These agencies may require additions to the allowance for loan losses based on their judgments of collectibility.
The Corporation considers loans secured by one- to four-unit residential properties and all consumer loans to be large groups of smaller-balance homogenous loans. These loans are collectively evaluated in the analysis of the adequacy of the allowance for loan losses.
The Corporation's commercial portfolio is subject to a loan-by-loan analysis of the adequacy of the allowance for loan losses and impairment. These loans are considered impaired when, based on current information, it is probable the Corporation will not collect all amounts due in accordance with the contractual terms of the loan agreement. The value of impaired loans is based on discounted cash flows of expected future payments using the loan's internal effective interest rate or the fair value of the collateral if the loan is collateral dependent. Interest income on impaired loans is recorded when cash is received and only if principal is considered to be fully collectible.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1 Summary of Significant Accounting Policies (Continued)
In management's judgment, the allowance for loan losses is adequate to cover probable losses relating to specifically identified loans, as well as probable losses inherent in the balance of the loan portfolio.
Mortgage Servicing Rights - The Corporation recognizes mortgage servicing rights on loans that are originated and subsequently sold or securitized and servicing is retained. A portion of the cost of the loans is required to be allocated to the servicing rights based on the relative fair values of the loans and the servicing rights. The Corporation amortizes these mortgage servicing rights over the period of estimated net servicing revenue. Impairment of mortgage servicing rights is assessed based on the fair value of those rights. Fair values are estimated using discounted cash flows based on a current market interest rate.
Premises and Equipment - Premises and equipment are stated at cost. Maintenance and repair costs are charged to expense as incurred. Gains or losses on disposition of premises and equipment are reflected in income. Depreciation is computed on the straight-line method and is based on the estimated useful lives of the assets.
Foreclosed Properties - Foreclosed properties acquired by the Corporation through foreclosure or deed in lieu of foreclosure on loans for which the borrowers have defaulted as to the payment of principal and interest are initially recorded at the lower of the fair value of the asset, less the estimated costs to sell the asset, or the carrying value of the related loan balance. Costs relating to the development and improvement of the property are capitalized. Income and expenses incurred in connection with holding and operating the property are charged to expense. Valuations are periodically performed by management and third parties and a charge to expense is taken for the excess of the carrying value of a property over its fair value less costs to sell.
Intangible Assets and Goodwill - Intangible assets consist of the value of core deposits purchased as part of the bank acquisitions, servicing assets, and trade name and customer base intangibles acquired in the acquisition of the Insurance Center. Intangible assets are stated at cost less accumulated amortization and are amortized over a period of one to ten years. Intangible assets that have finite useful lives are amortized using a straight-line method over their useful lives, and are tested at least annually for impairment. Intangible assets are considered impaired if the fair value of the intangible asset is lower than cost. The Corporation reviews intangible assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Adjustments are recorded if it is determined that the fair value of the intangible asset has decreased in comparison to the carrying amount.
The excess of cost over the assets acquired (goodwill) was amortized using the straight-line method over periods of 15 to 20 years. Amortization of goodwill ceased on January 1, 2002, in accordance with the change in accounting discussed below. The Corporation tested goodwill for impairment during the fourth quarter and determined that there was no impairment during 2003 and 2002. No amortization or impairment expense was recognized in 2003 or 2002.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1 Summary of Significant Accounting Policies (Continued)
Income Taxes - The Corporation files one consolidated federal income tax return. Federal income tax expense (credit) is allocated to each subsidiary based on an intercompany tax sharing agreement. The subsidiaries file separate state tax returns as applicable.
Deferred income taxes have been provided under the liability method. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the current enacted tax rates which will be in effect when these differences are expected to reverse. Deferred tax expense (benefit) is the result of changes in the deferred tax asset and liability.
Off-Balance-Sheet Financial Instruments - In the ordinary course of business, the Corporation has entered into off-balance-sheet financial instruments consisting of commitments to extend credit, commitments under commercial letters of credit, and standby letters of credit. Such financial instruments are recorded in the consolidated financial statements when they become payable.
Rate Lock Commitments - The Corporation enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. Accordingly, such commitments, along with any related fees received from potential borrowers, are recorded at fair value as derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans. Fair value is based on fees currently charged to enter into similar agreements, and for fixed-rate commitments also considers the difference between current levels of interest rates and the committed rates. The notional amount of rate lock commitments at December 31, 2003, was $5,360,000. The fair value of these derivatives was immaterial to the financial statements.
Advertising Costs - Advertising costs are expensed as incurred.
Comprehensive Income - Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale, net of tax, which are recognized as a separate component of equity, accumulated other comprehensive income (loss).
Per Share Computations - All per share financial information and equity accounts have been adjusted to reflect the 2-for-1 stock split declared in October 2002. Weighted average shares outstanding were 6,937,268 for the years ended December 31, 2003, 2002, and 2001.
Reclassifications - Certain reclassifications have been made to the 2002 and 2001 consolidated financial statements to conform to the 2003 classifications.
New Accounting Pronouncements - In April 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement amends SFAS No. 133 for decisions made as part of the Derivatives Implementation Group process and in connection with implementation issues raised in relation to the application of the definition of a derivative. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. The adoption had no material impact on the Corporation's results of operations, financial position, or liquidity.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1 Summary of Significant Accounting Policies (Continued)
New Accounting Pronouncements (Continued) - In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments With Characteristics of Both Liabilities and Equity. SFAS No. 150 establishes standards on how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003; otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The adoption had no effect on the Company's results of operations, financial position, or liquidity.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). The objective of this interpretation is to provide guidance on how to identify a variable interest entity and determine when the assets, liabilities, noncontrolling interests, and results of operations of a variable interest entity need to be included in a company's consolidated financial statements. A company that holds variable interests in an entity will need to consolidate the entity if the company's interest in the variable interest entity is such that the company will absorb a majority of the variable interest entity's losses and/or receive a majority of the entity's expected residual returns, if they occur. FIN 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders. The provisions of this interpretation, as subsequently amended, were effective upon issuance for new variable interest entities and for fiscal years ending after December 15, 2003, for existing variable interest entities. The requirements of FIN 46 did not have a material impact on the results of operations, financial position, or liquidity.
In November 2002, the FASB issued Interpretation No. 45, an interpretation of FASB Statements Nos. 5, 57, and 107, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). This interpretation elaborates on the disclosures to be made by a guarantor in its financial statements regarding certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The disclosure requirements of FIN 45 were effective as of December 31, 2002, and require disclosure of the nature of the guarantee, the maximum potential amount of future payments that the guarantor could be required to make under the guarantee, and the current amount of the liability, if any, for the guarantor's obligations under the guarantee. The recognition requirements of FIN 45 were effective beginning January 1, 2003. The requirements of FIN 45 did not have a material impact on the results of operations, financial position, or liquidity.
Note 2 Changes in Accounting Principles
Effective January 1, 2002, the Corporation adopted SFAS No. 147, Acquisitions of Certain Financial Institutions. Except for transactions between two or more mutual enterprises, this statement removes acquisitions of financial institutions from the scope of both SFAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, and the Financial Accounting Standards Board (FASB) Interpretation No. 9, Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a Similar Institution Is Acquired in a Business Combination Accounted for by the Purchase Method, and requires that those transactions be accounted for in accordance with SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS No. 141 supersedes Accounting Principles Board (APB) Opinion No. 16, Business Combinations, and SFAS No. 38, Accounting for Preacquisition Contingencies of Purchased Enterprises. SFAS No. 141 requires the use of the purchase method of accounting for business combinations initiated after June 30, 2001.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 2 Changes in Accounting Principles (Continued)
SFAS No. 142 supersedes APB Opinion No. 17, Intangible Assets. SFAS No. 142 addresses how intangible assets acquired outside of a business combination should be initially recognized. SFAS No. 142 eliminates the amortization for goodwill and other intangible assets with indefinite lives. Other intangible assets with a finite life will be amortized over their useful life. Goodwill and other intangible assets with indefinite useful lives shall be tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset may be impaired.
SFAS No. 147 also amends SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, to include in its scope long-term, customer-relationship intangible assets of financial institutions, such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets. Consequently, those intangible assets are subject to the same undiscounted cash flow recoverability test and impairment loss recognition and measurement provision that SFAS No. 144 requires for other long-lived assets that are held and used.
The effect of the adoption of SFAS No. 142 is detailed in Note 9.
Note 3 Securities Available for Sale
The amortized cost and estimated fair value of securities available for sale are as follows:
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 3 Securities Available for Sale (Continued)
The following table shows the securities' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2003:
All unrealized losses in the portfolio are considered to be temporarily impaired due to the current interest rate environment and the stated rate on the individual securities. The temporary impairment is not considered to be severe and duration of the impairment is considered to be manageable at this time.
The amortized cost and estimated fair value of securities at December 31, 2003, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
There were no sales of securities in 2003, 2002, and 2001.
The amortized cost and estimated fair value of investment securities available for sale pledged to secure public deposits, securities sold under repurchase agreements, FHLB advances, and for other purposes required by law were $70,148,000 and $70,825,000, respectively, as of December 31, 2003.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 4 Loans
The composition of loans at December 31 follows:
An analysis of the allowance for loan losses for the years ended December 31 follows:
The aggregate amount of nonperforming loans was approximately $3,278,000 and $1,803,000 at December 31, 2003 and 2002, respectively. Nonperforming loans are those which are contractually past due 90 days or more as to interest or principal payments, on nonaccrual of interest status, or loans the terms of which have been renegotiated to provide a reduction or deferral of interest or principal. If nonperforming loans had been current, approximately $308,000, $234,000, and $322,000 of interest income would have been recorded for the years ended December 31, 2003, 2002, and 2001, respectively. Interest income on nonperforming loans of $87,000, $54,000, and $155,000 was recognized for cash payments received in 2003, 2002, and 2001, respectively.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 4 Loans (Continued)
Information regarding impaired loans as of December 31 follows:
The Bank, in the ordinary course of banking business, grants loans to the Corporation's executive officers and directors, including their immediate families and affiliated companies in which they are principal owners. Substantially all loans to officers, directors, and stockholders owning 5% or more of the Corporation were made on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others and did not involve more than the normal risk of collectibility or present other unfavorable features.
Activity in such loans during 2003 is summarized below (in thousands):
Note 5 Loan Servicing
Mortgage loans of $178,722,000 and $151,963,000 as of December 31, 2003 and 2002, respectively, were serviced for others. These loans are not included in the accompanying consolidated balance sheets. Mortgage servicing rights are capitalized when the serviced loans are sold. This asset is amortized over the estimated period that servicing income is recognized. The following is an analysis of changes in mortgage servicing rights:
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 5 Loan Servicing (Continued)
No impairment of mortgage servicing rights existed at December 31, 2003 or 2002; therefore, no valuation allowance was recorded.
The carrying value of the mortgage servicing rights is included with intangible assets and approximates fair market value at December 31, 2003 and 2002. The fair value of mortgage servicing rights was determined using the present value of future cash flows method.
Note 6 Premises and Equipment
Premises and equipment at December 31 consist of the following:
Depreciation and amortization expense was $736,000, $946,000, and $870,000 for the years ended December 31, 2003, 2002, and 2001, respectively.
Note 7 Investment in Corporation
The Bank owns 49.8% of the stock of a corporation ("venture") whose business is developing and providing data processing services to the Bank and other financial institutions. The venture has total assets of $5,445,000 and liabilities of $1,252,000. The Bank's earnings from its investment in the venture were approximately $369,000, $378,000, and $282,000 for the years ended December 31, 2003, 2002, and 2001, respectively. Data processing service fees paid by the Bank to the venture were approximately $787,000, $843,000, and $824,000 for the years ended December 31, 2003, 2002, and 2001, respectively.
The Bank has a contract with the venture that extends through December 2004. At that time, the contract is automatically renewed for a period of one year. The Bank has the option to terminate the contract at any time, but would incur a termination penalty of approximately $450,000 at December 31, 2003. The termination penalty is calculated using the greater of 50% of the total estimated remaining unpaid monthly processing fees or six times the average monthly fee over the prior three months. A termination penalty is not incurred if the Bank provides 180 days' notice and continues processing up to the end of that period.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 8 Intangible Assets
Intangible assets consist of the following at December 31:
Amortization expense for intangible assets, excluding servicing rights, was $274,000 in 2003, $303,000 in 2002, and $223,000 in 2001.
The following table shows the estimated future amortization expense for amortizing intangible assets. The projections of amortization expense are based on existing asset balances as of December 31, 2003.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 9 Goodwill
There were no changes in goodwill for the years ended December 31, 2003 and 2002.
The following table illustrates the effect amortization of goodwill had on net income previous to the adoption of Statement of Financial Accounting Standards No. 142 for the years ended December 31:
Note 10 Deposits
The distribution of deposits at December 31 is as follows:
Time deposits of $100,000 or more were approximately $48,532,000 and $45,269,000 at December 31, 2003 and 2002, respectively. Interest expense on time deposits of $100,000 or more was approximately $1,340,000, $1,505,000, and $1,978,000 for the years ended December 31, 2003, 2002, and 2001, respectively.
At December 31, 2003, the scheduled maturities of time deposits are as follows (in thousands):
Deposit balances with the Corporation's executive officers, directors, and affiliated companies in which they are principal owners were $1,120,000 at December 31, 2003.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 11 Securities Sold Under Repurchase Agreements
Securities sold under agreements to repurchase have contractual maturities up to one year from the transaction date with variable and fixed-rate terms. The agreements to repurchase securities require that the Corporation (seller) repurchase identical securities as those that are sold. The securities underlying the agreements were under the Corporation's control.
Information concerning securities sold under agreements to repurchase consist of the following:
Securities sold under agreements to repurchase with the Corporation's executive officers, directors, and affiliated companies in which they are principal owners were $3,493,000 and $2,890,000 at December 31, 2003 and 2002, respectively.
Note 12 Borrowed Funds
Borrowed funds are summarized as follows at December 31:
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 12 Borrowed Funds (Continued)
The Corporation is a Treasury, Tax & Loan (TT&L) depository for the Federal Reserve Bank (FRB) and, as such, it accepts TT&L deposits. The Corporation is allowed to borrow these funds until they are called. The average rate paid on the treasury, tax, and loan account was 1.08% in 2003, 1.46% in 2002, and 3.70% in 2001. U.S. Agency Securities with a face value greater than or equal to the amount borrowed are pledged as a condition of borrowing TT&L deposits.
FHLB advances are subject to a prepayment penalty if they are repaid prior to maturity. The FHLB advances are callable either six months or one year after origination and quarterly thereafter. The Corporation is required to maintain as collateral unencumbered first mortgage loans in its portfolio aggregating at least 167% of the amount of outstanding advances from the FHLB. Total loans pledged as collateral were approximately $105,892,000 and $106,018,000 at December 31, 2003 and 2002, respectively. The FHLB advances are also collateralized by $4,631,700 and $2,435,100 of FHLB stock owned by the Corporation and included in other investments at December 31, 2003 and 2002, respectively. This stock is recorded at cost, which approximates fair value. Transfer of the stock is substantially restricted.
Scheduled maturities of borrowed funds outstanding at December 31, 2003, are as follows (in thousands):
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 13 Income Taxes
The provision for income taxes consists of the following:
A summary of the source of differences between income taxes at the federal statutory rate and the provision for income taxes for the years ended December 31 follows:
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 13 Income Taxes (Continued)
Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Corporation's assets and liabilities. The major components of net deferred tax assets at December 31 are as follows:
The Bank has state net operating loss carryforwards of approximately $2,609,000. The Bank's net operating losses begin to expire in 2014.
Note 14 Benefit Plans
Effective January 1, 2002, the Corporation merged its defined contribution money purchase plan into its defined contribution profit sharing 401(k) plan, and effective January 1, 2003, the plan was amended to include provisions for an employee stock ownership plan (ESOP). All participants of the 401(k) plan are eligible for the ESOP. As of December 31, 2003, shares are purchased on the open market as they become available. The plan held 537,719 shares. These shares are included in the calculation of the Corporation's earnings per share. The plan is available to all employees after completion of six months of service. Employees participating in the plan may elect to defer a minimum of 2% of compensation up to the limits specified by law. The Corporation may make discretionary contributions up to the limits established by IRS regulations. The discretionary match was 35% of participant tax deferred contributions up to 10% in 2003, 2002, and 2001. The Corporation made additional discretionary contributions to the plan of $333,000, $323,000, and $283,000 in 2003, 2002, and 2001, respectively. All discretionary contributions are at the direction of the Board of Directors. Total expense associated with the plans was approximately $508,000, $487,000, and $411,000 in 2003, 2002, and 2001, respectively.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 14 Benefit Plans (Continued)
The Corporation has a deferred compensation agreement with one of its officers. Under the terms of the agreement, benefits to be received in the future vest over each year until the officer reaches retirement age. The benefits are generally payable beginning with the date of termination of employment with the Corporation. The agreement requires an annual payment of $80,600 over 15 years. The annual payment increases 5% per year from 2004 through 2008. Related expense for this agreement was approximately $107,000, $107,000, and $108,000 for the years ended December 31, 2003, 2002, and 2001, respectively. Included in other liabilities is the vested present value of future payments of approximately $643,000 and $536,000 at December 31, 2003 and 2002, respectively.
The Corporation has a nonqualified deferred directors' fee compensation plan which permits directors to defer a portion of their compensation. The benefits are generally payable beginning with the earlier of attaining age 70 or resignation from the Board of the Corporation. Included in other liabilities is the estimated present value of future payments of approximately $1,641,000 and $1,443,000 at December 31, 2003 and 2002, respectively. Expense associated with this plan was approximately $210,000, $200,000, and $188,000 in 2003, 2002, and 2001, respectively.
Note 15 Stockholders' Equity
The Corporation is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Corporation's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation must meet specific capital guidelines that involve quantitative measures of the Corporation's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Corporation's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Corporation to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets and of Tier I capital to average assets. Management believes, as of December 31, 2003, that the Corporation meets all capital adequacy requirements to which it is subject.
As of December 31, 2003, the most recent notification from the regulatory agencies categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 15 Stockholders' Equity (Continued)
The Corporation's and the Bank's actual and regulatory capital amounts and ratios are as follows:
The payment of dividends is restricted by certain statutory and regulatory limitations. The Bank could have paid an additional $11,962,000 of dividends to the Corporation and still maintained capital ratios satisfactory to applicable regulatory agencies.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 16 Accumulated Other Comprehensive Income
Comprehensive income is shown in the consolidated statements of stockholders' equity. The Corporation's accumulated other comprehensive income is comprised of the unrealized gain or loss on securities available for sale. The following shows the activity in accumulated other comprehensive income:
Note 17 Segment Information
First Manitowoc Bancorp, Inc., through a branch network of its subsidiary, First National Bank in Manitowoc, provides a full range of consumer and commercial financial institution services to individuals and businesses in Northeastern Wisconsin. These services include demand, time, and savings deposits; ATM processing; insurance services; and trust services.
While the Corporation's chief decision-makers monitor the revenue streams of various Corporation products and services, operations are managed and financial performance is evaluated on a Corporationwide basis. Accordingly, all of the Corporation's financial institution operations are considered by management to be aggregated in one reportable operating segment.
Note 18 Commitments and Contingencies
The Corporation is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist of commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts reflect the extent of involvement the Corporation has in the particular class of financial instrument. The Corporation's maximum exposure to credit loss for commitments to extend credit is represented by the contract amount of those instruments.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 18 Commitments and Contingencies (Continued)
Off-balance-sheet financial instruments whose contract amounts represent credit and/or interest rate risk at December 31 are as follows:
Commitments to extend credit and credit card arrangements are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. A portion of the commitments are expected to be drawn upon, thus representing future cash requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable; inventory; property, plant, and equipment; real estate; and stocks and bonds.
Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation holds collateral supporting those commitments for which collateral is deemed necessary. Because these instruments have fixed maturity dates and because many of them expire without being drawn upon, they do not generally present any significant liquidity risk to the Corporation.
The Corporation has no investments in nor is a party to transactions involving derivative instruments, except mortgage-related securities which represent minimal risk to the Corporation.
Like many Wisconsin financial institutions, the Corporation has a non-Wisconsin subsidiary that holds and manages investment assets which have not been subject to Wisconsin tax. The Wisconsin Department of Revenue has instituted an audit program specifically aimed at out-of-state bank subsidiaries and has indicated that it may withdraw favorable rulings previously issued in connection with such subsidiaries. As a result of these developments, the Department may take the position that the income of the out-of-state subsidiaries is taxable in Wisconsin, which will likely be challenged by financial institutions in the state. If the Department is successful in its efforts, it would result in a negative impact on the earnings of the Corporation.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 19 Fair Value of Financial Instruments
Fair value estimates, methods, and assumptions for the Corporation's financial instruments are summarized below.
Cash and Cash Equivalents - The carrying values approximate the fair values for these assets.
Securities Available for Sale - Fair values are based on quoted market prices where available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Other Investments - The carrying amount reported in the consolidated balance sheets for other investments approximates the fair value of these assets.
Loans and Loans Held for Sale - For certain homogeneous categories of loans, such as fixed-rate residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings.
The methodology in determining fair value of nonaccrual loans is to average them into the blended interest rate at 0% interest. This has the effect of decreasing the carrying amount below the risk-free rate amount and therefore discounts the estimated fair value.
Impaired loans are measured at the estimated fair value of the expected future cash flows at the loan's effective interest rate or the fair value of the collateral for loans which are collateral dependent. Therefore, the carrying values of impaired loans approximate the estimated fair values for these assets.
Mortgage Servicing Rights - Fair values were determined using the present value of future cash flows method. Carrying value approximates fair value.
Deposits - The fair value of deposits with no stated maturity, such as passbooks, negotiable order of withdrawal accounts, and variable rate insured money market accounts, is the amount payable on demand on the reporting date. The fair value of fixed-rate, fixed-maturity certificate accounts is estimated using discounted cash flows with discount rates at interest rates currently offered for deposits of similar remaining maturities.
Securities Sold Under Repurchase Agreements - The fair value of securities sold under repurchase agreements with variable rates or due on demand is the amount payable at the reporting date. The fair value of securities sold under repurchase agreements with fixed terms is estimated using discounted cash flows with discount rates at interest rates currently offered for securities sold under repurchase agreements of similar remaining maturities.
Borrowed Funds - Rates currently available to the Corporation for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. The fair value of borrowed funds due on demand is the amount payable at the reporting date. The fair value of borrowed funds with fixed terms is estimated using discounted cash flows with discount rates at interest rates currently offered by lenders for similar remaining maturities.
Accrued Interest - The carrying amount of accrued interest approximates its fair value.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 19 Fair Value of Financial Instruments (Continued)
Off-Balance-Sheet Instruments - The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the current interest rates, and the present creditworthiness of the counterparties. Since this amount is immaterial, no amounts for fair value are presented.
The carrying amount and estimated fair value of financial instruments at December 31 were as follows:
Limitations - Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation's entire holdings of a particular instrument. Because no market exists for a significant portion of the Corporation's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters that could affect the estimates. Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Deposits with no stated maturities are defined as having a fair value equivalent to the amount payable on demand. This prohibits adjusting fair value derived from retaining those deposits for an expected future period of time. This component, commonly referred to as a deposit base intangible, is neither considered in the above amounts nor is it recorded as an intangible asset on the consolidated balance sheets. Significant assets and liabilities that are not considered financial assets and liabilities include premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 20 Condensed Parent Company Only Financial Statements
Balance Sheets
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 20 Condensed Parent Company Only Financial Statements (Continued)
Statements of Income
First Manitowoc Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 20 Condensed Parent Company Only Financial Statements (Continued)
Statements of Cash Flows
ITEM 9.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
The Corporation maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in our periodic filings with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management. Within the 90-day period preceding the filing date of this report, an evaluation of the Corporation's disclosure controls and procedures (as defined in Section 13(a)-14(c) of the Securities Exchange Act of 1934 (the "Act") was carried out under the supervision and with the participation of the Corporation's Chief Executive Officer, Chief Financial Officer and several other members of the Corporation's senior management, as appropriate. Based on the evaluation, the Corporation's Chief Executive Officer and Chief Financial Officer concluded that the Corporation's disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Corporation in the reports it files or submits under the Act is (i) accumulated and communicated to the Corporation's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.
For the quarter ended December 31, 2003, the Corporation did not make any significant changes in, nor take any corrective actions regarding, its internal controls or other factors that could significantly affect these controls subsequent to the date of their evaluation.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 401 of Regulation S-K is included in the Corporation's definitive Proxy Statement, prepared for the 2004 Annual Meeting of Shareholders, under the caption "Election of Directors," and the information concerning executive officers of the registrant, under the caption "Executive Officers Who Are Not Directors," which is incorporated herein by reference. The information required by Item 405 of Regulation S-K concerning compliance with Section 16(a) of the Exchange Act is included in the Corporation's definitive Proxy Statement, prepared for the 2004 Annual Meeting of Shareholders, under the caption "Section 16(a) Beneficial Ownership Reporting Compliance," which is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is included under the heading "Compensation of Executive Officers and Directors" in the Corporation's definitive Proxy Statement, prepared for the 2004 Annual Meeting of Shareholders, which is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDERS MATTERS
The information required by this item is included under the heading "Security Ownership of Certain Beneficial Owners and Management" in the Corporation's definitive Proxy Statement, prepared for the 2004 Annual Meeting of Shareholders, which is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is included under the heading "Indebtedness of Management and Certain Transactions" in the Corporation's definitive Proxy Statement, prepared for the 2004 Annual Meeting of Shareholders, which is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is included under the heading "Principal Accountant Fees and Services" in the Corporation's definitive Proxy Statement, prepared for the 2004 Annual Meeting of Shareholders, which is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements
The following financial statements and financial statement schedules are included under a separate caption "Financial Statements and Supplementary Data" in Part II, Item 8 hereof and are incorporated herein by reference:
Independent Auditors' Report
Consolidated Balance Sheets---December 31, 2003 and 2002
Consolidated Statements of Income---For the Years Ended December 31, 2003, 2002, and 2001
Consolidated Statements of Shareholders' Equity---For the Years Ended December 31, 2003, 2002, and 2001
Consolidated Statements of Cash Flows---For the Years Ended December 31, 2003, 2002, and 2001
Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules
All financial statement schedules have been omitted because they are not applicable, not required, or the information has been otherwise supplied in the Consolidated Financial Statements or notes to the Consolidated Financial Statements.
(a)(3) Exhibits
EXHIBIT NUMBER DESCRIPTION OF DOCUMENTS
3.1 Articles of Incorporation (incorporated by reference to Exhibit (3)(1) to the Corporation's Report on Form 10 filed May 5, 1999).
3.2 Bylaws of First Manitowoc Bancorp, Inc. as amended on February 11, 2003 (incorporated by reference to Exhibit (3)(2) to the Corporation's Report on Form 10-K filed March 14, 2003).
10.1 First Manitowoc Bancorp, Inc. 401(k) Profit Sharing Plan (incorporated by reference to Exhibit (10)(1) to the Corporation's Report on Form 10-Q filed May 15, 2003).
10.2 Executive Employee Salary Continuation Plan for Thomas J. Bare, dated March 19, 1998, between First National Bank in Manitowoc and Thomas J. Bare (incorporated by reference to Exhibit (10)(2) to the Corporation's Report on Form 10-K filed March 14, 2003).
10.3 First National Bank in Manitowoc Voluntary Deferred Compensation Plan (incorporated by reference to Exhibit (10)(3) to the Corporation's Report on Form 10-K filed March 14, 2003).
11 Statement Re Computation of Per Share Earnings. See Note 1 in Part II Item 8.
12 Annual Report of First Manitowoc Bancorp, Inc. to Shareholders for the period ended December 31, 2003.
21 Subsidiaries of the Corporation.
23 Consent of Independent Auditors.
31.1 Certification of Thomas J. Bare pursuant to Rule 13a-14(a) or 15(d)-14(a)
31.2 Certification of Thomas J. Bare pursuant to Rule 13a-14(a) or 15(d)-14(a)
32.1 Section 1350 Certification of Thomas J. Bare
99.1 Proxy Statement of First Manitowoc Bancorp, Inc. for 2004 Annual Meeting of Shareholders.
A copy of one or more of the exhibits listed herein can be obtained by writing Thomas J. Bare, Chief Financial Officer, First Manitowoc Bancorp, 402 North Eighth Street, Manitowoc, Manitowoc County, Wisconsin.
(b) Reports on Form 8-K
During the fourth quarter of 2003, the Corporation did not file any current reports on Form 8-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
FIRST MANITOWOC BANCORP, INC.
Date: March 12, 2004 /s/ Thomas J. Bare ------------------------------------- Thomas J. Bare Chief Executive Officer and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Thomas J. Bare /s/ Robert S. Weinert - --------------------------------------- ------------------------------------- Thomas J. Bare, President and Treasurer Robert S. Weinert, Chairman
Date: March 12, 2004 Date: March 12, 2004
/s/ John J. Zimmer /s/ John M. Jagemann - --------------------------------------- ------------------------------------- John J. Zimmer, Vice President John M. Jagemann, Director
Date: March 12, 2004 Date: March 12, 2004
/s/ John C. Miller /s/ John E. Nordstrom - --------------------------------------- ------------------------------------- John C. Miller, Director John E. Nordstrom, Director
Date: March 12, 2004 Date: March 12, 2004
/s/ Craig A. Pauly /s/ Katherine M. Reynolds - --------------------------------------- ------------------------------------- Craig A. Pauly, Director Katherine M. Reynolds, Director
Date: March 12, 2004 Date: March 12, 2004
/s/ John M. Webster - --------------------------------------- John M. Webster, Director
Date: March 12, 2004