Item 1. Business
General
BNCCORP is a bank holding company registered under the Bank Holding Company Act of 1956 (the “BHCA”) headquartered in Bismarck, North Dakota. BNCCORP operates 28 locations in Arizona, Minnesota, North Dakota, Colorado and Nevada through its subsidiary, BNC National Bank. We provide a range of financial products and services to businesses and consumers within the communities we serve. The Company also provides an array of insurance, brokerage and trust and financial services through the Bank, BNC Insurance and the Bank’s wealth management division.
We began operations in North Dakota in 1987 relying on local banking relationships with small and mid-sized businesses, professionals and consumers. Our vision is to expand our business into attractive markets that complement the North Dakota base. To achieve this vision, we became a public company in 1995 and established operations in Minnesota and Arizona in 1996 and 2001, respectively.
We will continue to emphasize organic growth by focusing on increasing our market share within the market areas we now serve. Acquisitions and de novo branches may also be an important role in our strategy when we believe new opportunities complement our existing businesses. We will also consider divesting certain parts of our business when we believe it will enhance shareholder value.
At December 31, 2006, we had total assets of $692.3 million, total loans held for sale of $1.7 million, total loans held for investment of $390.1 million and total deposits of $529.3 million.
•
Banking - The Bank is a nationally chartered bank headquartered in Phoenix, Arizona. Through the Bank we provide banking products and services to small and mid-sized businesses, business owners, professionals and consumers in Arizona, Minnesota and North Dakota. As of December 31, 2006, the Bank has four locations in Arizona with loans and deposits of $135.2 and $140.9 million, respectively. The Bank also has four locations in Minnesota with loans and deposits of $116.8 and $95.2 million, respectively. The Bank also has twelve locations in North Dakota with loans and deposits of $138.7 and $293.0 million, respectively.
•
Insurance - Through BNC Insurance, we provide a full range of insurance services in offices located in Phoenix, Tucson, Prescott Valley and Cottonwood, Arizona; Bismarck, Mandan and Linton, North Dakota; Englewood, Colorado; and Las Vegas, Nevada. For the year ended December 31, 2006 we have insurance revenue of $18.3 million.
•
Wealth Management - We provide a variety of financial services including, trust, asset management, financial planning, estate planning, estate administration, tax planning, payroll services, employee benefit plan design and employee plan administration. We also offer retirement accounts and prepare tax returns.
Operating Strategy
We provide relationship-based banking and financial services to small and mid-sized businesses, business owners, professionals and consumers in our primary market areas of Arizona, Minnesota and North Dakota. Our goal is to serve as a one-stop financial services provider for our customers by offering traditional bank products and services, insurance and wealth management services. Key elements of our operating strategy are:
•
Emphasize individualized, high-level customer service.
•
Provide diversified products and services.
•
Expand into high growth markets.
•
Manage credit risk.
Core Businesses
As of December 31, 2006, BNCCORP had three core businesses: banking, insurance and wealth management services.
Banking
BNC National Bank operates 20 banking branch offices in Arizona, Minnesota and North Dakota. The Bank’s primary focus is serving small and mid-size businesses.
The banking segment’s loans primarily consist of commercial and industrial loans, real estate mortgage and construction loans, agricultural loans, consumer loans and lease financing, along with our mortgage loan financing program in which the Bank purchases short-term participation interests in residential mortgage loans originated by mortgage banking counterparties. In allocating our assets among loans, investments and other earning assets, we attempt to maximize return while managing risk at acceptable levels. Our primary lending focus is on commercial loans and owner-occupied real estate loans to small and mid-sized businesses and professionals. We offer a broad range of commercial and consumer lending services, including commercial revolving lines of credit, residential and commercial real estate mortgage and construction loans, consumer loans and equipment financing. Interest rates charged on loans may be fixed or variable and vary with the degree of risk, size and maturity of the loans, underwriting and servicing costs, the extent of other banking relationships maintained with customers and the Bank’s cost of funds. Rates are further subject to competitive pressures, the current interest rate environment, availability of funds and government regulations.
Each of our bank branches offers a range of depository products, including checking, savings and money market deposits and certificates of deposit. Our Wealthbuilder family of interest checking and money market deposit accounts continues to be popular. These are competitively priced floating rate accounts with rates variable at our discretion. Rates paid on deposits vary among the categories of deposits due to different terms, the size of the individual deposit, the nature of other banking relationships with the depositor, the current interest rate environment and rates paid by competitors on similar deposits. The Bank also offers customer repurchase agreements to acquire funds from customers where the customers require or desire to have their funds supported by collateral consisting of investment securities of the Bank.
The Bank also accepts brokered deposits and obtains direct non-brokered certificates of deposit through national deposit networks when management believes such transactions are beneficial to the Bank. Additionally, through
the Certificate of Deposit Account Registry Service SM (CDARSSM), the Bank can place large customer deposits into smaller denomination (fully FDIC-insured) certificates of deposit at multiple institutions. This provides the Bank’s large deposit customers with FDIC insurance on their entire balances (up to $30.0 million) and the convenience of managing their certificates of deposit investments through a single bank relationship. We had $57.4 million of such deposits at December 31, 2006.
Our banking segment also offers services such as debit cards, MasterCard and Visa merchant deposit services and, in some markets, safe deposit, lockbox and messenger services.
Insurance
Our insurance subsidiary, BNC Insurance Services, Inc. is an independent insurance agency representing many of the nation’s leading insurance carriers.
BNC Insurance Services, d/b/a Milne & BNC Insurance, serves local, regional and national businesses. Its clients range from large, established companies with hundreds of millions in sales to emerging businesses with growing needs. It serves clients in nearly every industry, including construction, real estate development, manufacturing, distribution and wholesale, professionals, government, financial institutions, retail, and service industries. The only industry in which BNC Insurance has a concentration (defined as 35% of commissions or more) is the construction industry in the Arizona market. This customer base includes general contractors and commercial trade contractors.
BNC Insurance can provide a full range of services from the self-insured multinational client to the local sole proprietor. BNC Insurance provides a wide array of products and services, including but not limited to:
Business insurance - such as property, liability, fleet auto, workers’ compensation, errors and omissions, directors and officers, employment practices, crime and employee dishonesty, umbrella and excess, boiler and machinery, surety and bonds, flood and earthquake.
Risk management - such as risk and loss control services, risk transfer analysis, risk consulting, risk management program design and implementation.
Group benefits insurance - such as health, life, dental, disability, 401(k)s and SEPs, prepaid legal, key man protection, buy/sell protection, estate and business continuation.
Association and affinity group insurance programs - such as group auto and homeowners benefit plans, product liability programs, workers’ compensation groups, self-insured pools, risk retention groups, captive and rent-a-captive operations.
Personal lines - such as homeowners and renters, personal articles floater, automobile, watercraft, aircraft, flood and earthquake, umbrella and life.
The insurance segment will typically have its strongest performance in the first quarter of each fiscal year as contingency payments from insurance carriers are generally received during that quarter.
On March 14, 2007, the Company entered into a purchase and sale agreement to sell assets of its insurance agency operations. See Note 2 to the Consolidated Financial Statements, included under Item 8, for more information.
Wealth Management
The Bank’s trust and financial services divisions provide customers with an extensive complement of financial services options. The trust and financial services divisions, presently operating primarily out of Minneapolis and Bismarck, provide trust, financial, business, estate and tax planning, estate administration, agency accounts, payroll services, accounting services, employee benefit plan design and administration, individual retirement accounts (“IRAs”), individual custodial self-directed IRAs, asset management and tax preparation. The Wealth Management operations also offer financial services alternatives such as securities trading, investment management of institutional and individual accounts, mutual funds and annuities.
Revenues from external customers, measures of profit and/or loss and total assets for each of the segments listed above are presented in Note 16 to the Consolidated Financial Statements included under Item 8 of Part II.
Market Areas
We operate primarily in three distinct markets: Arizona; Minnesota; and North Dakota. While these areas have very different fundamentals, we believe each enjoys a solid economic base and presents long-term growth potential.
The Arizona market has been one of the fastest growing areas of the country in population and personal income for the past several years. We believe the housing sector’s strength is expected to continue due to the Phoenix metropolitan area’s large stretches of undeveloped land, new jobs and resort climate. Tourism, retirement and job creation in such industries as software and biotechnology are among the additional drivers of the economy, according to studies by the University of Arizona. Segments with significant operations in the Arizona market include banking and insurance.
The Twin Cities area is home to a large and growing population. The U.S. census estimates the area’s population will rise by more than 900,000 by 2030, driving business formation and residential construction over the long term. Key growth industries currently include electronics manufacturing, medical and healthcare, education and food processing. The banking and wealth management segments operate in the Twin Cities area.
Bismarck-Mandan (our largest market in North Dakota) is characterized by low unemployment and generally favorable economic conditions. Bismarck is not only the state capital, but also the trade and transportation hub for South Central North Dakota. The area is experiencing strong residential and commercial growth, and its diverse economic base includes energy, health care, agriculture and an expanding data processing/customer service component. Several national retail chains have opened new locations in the Bismarck-Mandan area during 2005 and 2006. The banking, insurance and wealth management services segments are all represented in the North Dakota market.
Individually, we believe each of our key markets presents strong potential demand for our range of financial services offerings. Together, we believe they provide attractive business opportunities and balance our exposure to regional economic cycles.
The following table presents total deposits and net loans outstanding at each of our major locations as of December 31, 2006 (in thousands):
Regional Community Banking Philosophy
In order to meet the demands of the increasingly competitive banking and financial services industries, we employ a regional community banking philosophy. This philosophy is based on our belief that banking and financial services clients value doing business with locally managed institutions that can provide a full service commercial banking relationship through an understanding of the clients’ financial needs and the flexibility to deliver customized solutions through our menu of products and services. With this philosophy we are better able to build successful and broadly based client relationships. The primary focus for our relationship managers is to cultivate and nurture their client relationships. Relationship managers are assigned to each borrowing client to provide continuity in the relationship. This emphasis on personalized relationships requires all relationship managers maintain close ties to the communities in which they serve so they are able to capitalize on their efforts through expanded business opportunities. While client service decisions and day-to-day operations are maintained at each location, our broad base of financial services offers the advantage of affiliation with service providers who can provide extended products and services to our clients. Additionally, BNCCORP and the Bank provide centralized administrative functions, including credit and other policy development and review, internal audit and compliance services, investment management, data processing, accounting, loan servicing and other specialized support functions.
Distribution methods
We offer our banking and financial products and services through our network of offices and other traditional industry distribution methods. Additionally, we offer 24-hour telephone banking services through BNC Bankline.
We also provide Internet banking and bill-pay services through our Internet banking site at www.bncbank.com. This system allows customers to process account transactions, transfer funds, initiate wire transfers, automated clearing house transactions and stop payments and obtain account history and other information. Messenger services in select markets are also of great convenience to our customers.
Competition
The deregulation of the banking industry and the availability of nationwide interstate banking have increased the level of competition in our already intensely competitive market areas. The increasingly competitive environment is a result of changes in regulation, technology and product delivery systems and the pace of consolidation among financial services providers. The Bank and its subsidiaries compete for deposits, loans, insurance and brokerage, trust and financial services as well as customers with numerous providers of similar products and services. Competitors include multi-regional financial institutions as well as large and small thrifts, independent banks, credit unions, many national and regional brokerage companies, mortgage companies, insurance companies, finance companies, money market funds and other nonbank financial service providers. Some of these competitors are much larger in total assets and capitalizations, including the availability of larger legal lending limits, have greater access to capital markets and offer a broader range of financial services than BNC. In addition, some of the nonbank financial institutions that compete with us are not subject to the extensive Federal regulations that govern our operations.
In order to compete with other financial services providers, the Bank and its subsidiaries rely on personal relationships established by officers, directors and employees with their customers, specialized services tailored to meet the needs of the communities served and cross selling efforts among the various segments within our organization. We believe that many of our competitors have emphasized retail banking and financial services for large companies, leaving the small and mid-sized business market underserved. This has allowed us to compete effectively by emphasizing customer service, establishing long-term customer relationships and providing services meeting the needs of such businesses and the individuals associated with them. The banking and financial services industries are highly competitive, and our future profitability will depend on our ability to continue to compete successfully in our market areas.
Supervision and Regulation
General
BNCCORP and the Bank are extensively regulated under Federal and state laws and regulations. These laws and regulations are primarily intended to protect depositors and the Federal deposit insurance funds, not investors in the securities of BNCCORP. From time to time, legislation, as well as regulation, is enacted that has the effect of increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial services providers. Proposals to change laws and regulations governing the operations and taxation of banks, bank holding companies and other financial institutions and financial services providers are frequently made in the U.S. Congress, in the state legislatures and by various regulatory agencies.
The following information briefly summarizes certain material laws and regulations affecting BNCCORP and the Bank and is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable laws, regulations or regulatory policies may have a material effect on our business, operations and future prospects. We are unable to predict the nature or extent of the effects that new or revised Federal or state legislation may have on our business and earnings in the future.
Primary Regulators
BNCCORP is a bank holding company registered under the BHCA, and is subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve System (“Federal Reserve”). BNCCORP is required to file periodic reports with the Federal Reserve and such other reports as the Federal Reserve may require pursuant to the BHCA. The Bank is a national banking association and is subject to supervision, regulation and examination by the Office of the Comptroller of the Currency (“OCC”). Since the Federal Deposit Insurance Corporation (“FDIC”) insures the deposits of the Bank, the Bank is also subject to regulation and
supervision by the FDIC. Additionally, the Bank is a member of the Federal Reserve System. Every state has a Department of Insurance that primarily acts as a consumer advocate. BNC Insurance as a company has an insurance resident license in Arizona, North Dakota, Minnesota, Nevada, and Colorado and a nonresident license in almost every other state. All insurance producers are licensed by the state.
If an agency should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of a bank or bank holding company’s operations are unsatisfactory or that the bank or bank holding company or its management is violating or has violated any law or regulation, various remedies are available to these regulatory agencies. Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the bank, to assess civil monetary penalties, to remove officers and directors and ultimately to terminate the bank’s deposit insurance and/or revoke the bank’s charter or the bank holding company’s registration.
Acquisitions and Permissible Activities
As a registered bank holding company, BNCCORP is restricted in its acquisitions, certain of which are subject to approval by the Federal Reserve. A bank holding company may not acquire, or may be required to give certain notice regarding acquisitions of, companies considered to engage in activities other than those determined by the Federal Reserve to be closely related to banking or managing banks.
Transactions with Affiliates
Under Section 23A of the Federal Reserve Act, certain restrictions are placed on loans and other extensions of credit by the Bank to BNCCORP which is defined as an “affiliate” of the Bank under the Act. Section 23B of the Act places standards of fairness and reasonableness on other transaction of the Bank with its affiliates. The Federal Reserve’s Regulation W implements Sections 23A and 23B of the Act and codifies many previously issued Federal Reserve interpretations of those sections.
Anti-Tying Restrictions
Bank holding companies and their affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to other services offered by a holding company or its affiliates.
Restrictions on Loans to One Borrower
Under Federal law, permissible loans to one borrower by banks are generally limited to 15 percent of the bank’s unimpaired capital, surplus, undivided profits and credit loss reserves. The Bank seeks participations to accommodate borrowers whose financing needs exceed its lending limits or internally established credit concentration limits.
Loans to Executive Officers, Directors and Principal Stockholders
Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to principal stockholders of BNCCORP and to directors and certain executive officers of the Bank (and BNCCORP and its nonbank subsidiaries provided certain criteria are met) and to “related interests” of such principal stockholders, directors and officers. In addition, any director or officer of BNCCORP or the Bank or principal stockholder of BNCCORP may be limited in his or her ability to obtain credit from financial institutions with which the Bank maintains correspondent relationships.
Interstate Banking and Branching
The BHCA permits bank holding companies from any state to acquire banks and bank holding companies located in any other state, subject to certain conditions, including certain nationwide and state imposed concentration limits. The Bank has the ability, subject to certain restrictions, to acquire by acquisition or merger branches outside its home state.
Capital Adequacy
The capital adequacy of BNCCORP and the Bank is monitored by the Federal regulatory agencies using a combination of risk-based and leverage ratios. Failure to meet the applicable capital guidelines could subject BNCCORP or the Bank to supervisory or enforcement actions. In addition, BNCCORP could be required to
guarantee a capital restoration plan of the Bank, should the Bank become “undercapitalized” under capital guidelines. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Financial Condition-Capital Resources and Expenditures” included under Item 7 of Part II and Note 18 to the Consolidated Financial Statements included under Item 8 of Part II for further discussion regarding the capital status of BNCCORP and the Bank.
Prompt Corrective Action and Other Enforcement Mechanisms
Federal banking agencies possess broad powers to take corrective and other supervisory action to resolve the problems of insured depository institutions, including but not limited to those institutions that fall below one or more prescribed minimum capital ratios. Each Federal banking agency has promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on its capital ratios: well capitalized; adequately capitalized; undercapitalized; significantly undercapitalized; and critically undercapitalized. At December 31, 2006, the Bank exceeded the required ratios for classification as well capitalized.
An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized or undercapitalized may be treated as though it were in the next lower capital category if the appropriate Federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The Federal banking agencies, however, may not treat a significantly undercapitalized institution as critically undercapitalized unless its capital ratios actually warrant such treatment.
In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by Federal regulators for unsafe or unsound practices in conducting their business or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency.
Safety and Soundness Standards
The Federal banking agencies have adopted guidelines designed to assist the agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to: internal controls, information systems and internal audit systems; loan documentation; credit underwriting; asset growth; earnings; and compensation, fees and benefits. Additionally, the Federal banking agencies have also adopted safety and soundness guidelines with respect to asset quality and earnings standards. These guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. Under these standards, an insured depository institution should: conduct periodic asset quality reviews to identify problem assets; estimate the inherent losses in problem assets and establish reserves that are sufficient to absorb estimated losses; compare problem asset totals to capital; take appropriate corrective action to resolve problem assets; consider the size and potential risks of material asset concentrations; and provide periodic asset quality reports with adequate information for management and the board of directors to assess the level of asset risk. These guidelines also set forth standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient for the maintenance of adequate capital and reserves.
Dividend Restrictions
Dividends from bank subsidiaries often constitute a principal source of income to a bank holding company. Federal rules limit a bank’s ability to pay dividends to its parent bank holding company in excess of amounts generally equal to the bank’s net profits from the current year plus retained net profits for the preceding two years or if the payment would result in the bank being considered “undercapitalized” under regulatory capital guidelines. Bank regulatory agencies also have authority to prohibit a bank from engaging in activities that, in the opinion of the applicable bank regulatory authority, constitute unsafe or unsound practices in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the applicable bank regulatory authority could assert that the payment of dividends or other payments might, under some circumstances, be such an unsafe or unsound practice. At December 31, 2006 approximately $11.9 million of retained earnings were available for Bank dividend declaration without prior regulatory approval.
Community Reinvestment Act and Fair Lending Developments
The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act (“CRA”) activities. The CRA generally requires the Federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities, including low- and moderate-income areas. A bank may be subject to substantial penalties and corrective measures for a violation of certain fair lending laws. The Federal banking agencies may take compliance with such laws and CRA obligations into account when regulating and supervising other activities of the Bank. A Bank’s compliance with its CRA obligations is based on a performance-based evaluation system that bases CRA ratings on its lending service and investment performance. When a bank holding company applies for approval to acquire a bank or other bank holding company, the Federal Reserve will review the assessment of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application. In connection with its assessment of CRA performance, the appropriate bank regulatory agency assigns a rating of “outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance.” As a result of its most recent CRA assessment, the Bank was rated satisfactory under this rating system.
Deposit Insurance
Through the Bank Insurance Fund (the “BIF”) and the Savings Association Insurance Fund (the “SAIF”), the FDIC insures the deposits of the Bank up to prescribed limits for each depositor. FDIC-insured depository institutions that are members of the BIF and SAIF pay insurance premiums at rates based on their assessment risk classification, which is determined in part based on the institution’s capital ratios and in part on factors that the FDIC deems relevant to determine the risk of loss to the insurance funds. Assessment rates currently range from zero to 27 cents per $100 of deposits. The FDIC may increase or decrease the assessment rate schedule on a semi-annual basis. An increase in the assessment rate could have a material adverse effect on our earnings, depending on the amount of the increase. The FDIC may terminate a depository institution’s deposit insurance upon a finding by the FDIC that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution’s regulatory agency. The termination of deposit insurance for the Bank could have a material adverse effect on our earnings.
All FDIC-insured depository institutions must pay an annual assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation, a Federal corporation chartered under the authority of the Federal Housing Finance Board. The bonds, commonly referred to as FICO bonds, were issued to capitalize the Federal Savings and Loan Insurance Corporation. The FDIC established the FICO assessment rates effective for the fourth quarter of 2006 at approximately $0.0031 per $100 of assessable deposits. The FICO assessments are adjusted quarterly to reflect changes in the assessment bases of the FDIC’s insurance funds and do not vary depending on a depository institution’s capitalization or supervisory evaluations.
Cross-Guarantee
The Financial Institutions, Reform, Recovery and Enforcement Act of 1989 provides for cross-guarantees of the liabilities of insured depository institutions pursuant to which any bank subsidiary of a bank holding company may be required to reimburse the FDIC for any loss or anticipated loss to the FDIC that arises from a default of any of such holding company’s other subsidiary banks or assistance provided to such an institution in danger of default.
Support of Banks
Bank holding companies are also subject to the “source of strength doctrine” which requires such holding companies to serve as a source of “financial and managerial” strength for their subsidiary banks and to conduct its operations in a safe and sound manner. Additionally, it is the Federal Reserve’s policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve’s regulations or both.
Conservator and Receivership Powers
Federal banking regulators have broad authority to place depository institutions into conservator ship or receivership to include, among other things, appointment of the FDIC as conservator or receiver of an undercapitalized institution under certain circumstances. If the Bank were placed into conservator ship or receivership, because of the cross-guarantee provisions of the Federal Deposit Insurance Act, as amended, BNCCORP, as the sole stockholder of the Bank, would likely lose its investment in the Bank.
Bank Secrecy Act
The Bank Secrecy Act requires financial institutions to keep records and file reports that are determined to have a high degree of usefulness in criminal, tax and regulatory matters, and to implement counter-money laundering programs and compliance procedures. The Bank Secrecy Act and its implementing regulations are presently the subject of increased regulatory focus and several financial institutions have been penalized due to deficiencies in their Bank Secrecy Act programs.
Consumer Laws and Regulations
In addition to the laws and regulations discussed herein, the Bank is also subject to certain consumer laws and regulations that are designed to protect customers in transactions with banks. These include, but are not limited to, the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the Fair Credit Reporting Act, the Flood Disaster Protection Act, the Fair Housing Act and the Right to Financial Privacy Act. These laws mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers.
Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act expands the powers of banks and bank holding companies to sell any financial product or service, closes the unitary thrift loophole, reforms the Federal Home Loan Bank (“FHLB”) System to increase community banks’ access to loan funding, protects banks from discriminatory state insurance regulation and establishes a new framework for the regulation of bank and bank holding company securities brokerage and underwriting activities. The Financial Modernization Act also includes provisions in the privacy area, restricting the ability of financial institutions to share nonpublic personal customer information with third parties.
USA Patriot Act of 2001
The USA Patriot Act of 2001 contains sweeping anti-money laundering and financial transparency laws and requires various regulations including: due diligence requirements for financial institutions that administer, maintain or manage private bank accounts or correspondent accounts for non U.S. persons; standards for verifying customer identification at the time of account opening; rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; reports by nonfinancial trades and business filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000 and; filing of suspicious activity reports by brokers and dealers if they believe a customer may be violating U.S. laws and regulations.
Changing Regulatory Structure
The Federal Reserve, OCC and FDIC have extensive authority to police unsafe or unsound practices and violations of applicable laws and regulations by depository institutions and their holding companies. The agencies’ authority has been expanded by Federal legislation in recent years. In addition, state banking authorities possess significant authority to address violations of their state’s banking laws by banks operating in their respective states by enforcement and other supervisory actions.
Employees
At December 31, 2006, we had 324 employees, including 308 full-time equivalent employees. None of our employees is covered by a collective bargaining agreement. We consider our relationships with our employees to be satisfactory. Approximate employees by segment were as follows as of December 31, 2006: banking, 173; insurance, 130; bank holding company, 5; and wealth management services, 16.
Item 1a.
Item 1a. Risk Factors
In addition to the other information contained in this report, the following risks may affect us. If any of these risks occur, our business, financial condition or operating results could be adversely affected.
Failure to successfully execute our growth, operating and cross-selling strategies can negatively impact our profitability. Our financial performance and profitability depends on our ability to execute our corporate growth, operating and cross-selling strategies. Future acquisitions and continued growth can present operating and other issues that could have an adverse effect on our business, financial condition and results of operations. Our financial performance will also depend on our ability to maintain profitable operations through implementation of our banking and financial services philosophies, including our efforts to cross-sell our various products and services, which were described earlier.
Regional presences, related economic conditions and credit concentrations could adversely affect our operating results. Although our operations are presently somewhat geographically dispersed, our focus in the Arizona, Minnesota and North Dakota regions could adversely affect our results of operations if economic and business conditions in any of these regions were to exhibit weaknesses. A prolonged decline in economic or business conditions in our market areas, in particular in those industries in which we have credit concentrations, could have a material impact on the quality of our loan portfolio or the demand for our other products and services, which in turn may have a material adverse effect on our results of operations. Weakening in the national economy might further exacerbate local or regional economic conditions. The extent of the future impact of these events on economic and business conditions cannot be predicted.
Changes in market interest rates can significantly impact our earnings. Changes in interest rates impact the demand for new loans, the credit profile of existing loans, the rates received on loans and investment securities, rates paid on deposits and borrowings and the value of our derivative contracts and their associated impact on earnings. The relationship between the interest income received on loans and investment securities and interest expense paid on deposits and borrowings is known as net interest income. The level of net interest income can fluctuate given changes in market interest rates. We measure interest rate risk under various rate scenarios and using specific criteria and assumptions. A summary of this process, along with the results of our net interest income simulations is presented at “Quantitative and Qualitative Disclosures About Market Risk” included under Item 7A of Part II. Although we believe our current level of interest rate sensitivity is reasonable and effectively managed, significant fluctuations in interest rates may have an adverse effect on our business, financial condition and results of operations.
Changes in market interest rates can directly influence the performance of our insurance segment. Interest rate movements directly affect insurance company investment in bonds and, as a result, the rates they subsequently charge for insurance policies. A rising interest rate environment increases investment returns for insurers and generally allows those insurers to compete more aggressively with lower insurance rates. During the past three years, interest rates have been low and insurance rates were up. Over the next several years, interest rates could move up and lower insurance rates would be expected, which in turn would create lower premiums and commissions. We cannot predict, with any degree of certainty, interest rate developments, and the resulting impact on insurance premiums and commissions, in future periods.
Competition from other financial services providers could adversely impact our results of operations. The banking and financial services business is highly competitive. We face competition in making loans, attracting deposits and providing insurance, brokerage, trust and other financial services. Increased competition in the banking and financial services businesses may reduce our market share, impair our growth or cause the prices we charge for our services to decline. Our results of operations may differ in future periods depending upon the level and nature of competition we encounter in our various market areas.
Failure to perform on behalf of borrowers, guarantors and related parties exposes us to risk of loss that can materially adversely affect our results of operations. We encounter significant sources of risk from the possibility that losses will be sustained if a significant number of our borrowers, guarantors and related parties fail
to perform in accordance with the terms of their loans, commitments or letters of credit. We have adopted underwriting and credit monitoring procedures and credit policies, including the establishment and methodological review and analysis of the allowance for credit losses. We believe these processes and procedures are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our credit portfolio. These policies and procedures, however, may not prevent unexpected losses that could materially adversely affect our results of operations.
Loss of key employees may disrupt relationships with certain customers. Our business is primarily relationship-driven in that many of our key employees have extensive customer relationships. Loss of a key employee with such customer relationships may lead to the loss of business if the customers were to follow that employee to a competitor. While we believe our relationship with our key producers is good, we cannot guarantee that all of our key personnel will remain with our organization. Loss of such key personnel, should they enter into an employment relationship with one of our competitors, could result in the loss of some of our customers.
Impairment of goodwill or other intangible assets could require charges to earnings, which could result in a negative impact on our results of operations. Under current accounting standards, goodwill and certain other intangible assets with indeterminate lives are no longer amortized but, instead, are assessed for impairment periodically or when impairment indicators are present. Assessment of goodwill and such other intangible assets could result in circumstances where the applicable intangible asset is deemed to be impaired for accounting purposes. Under such circumstances, the intangible asset’s impairment would be reflected as a charge to earnings in the period during which such impairment is identified. Further information regarding intangible assets is presented in Note 9 to the Consolidated Financial Statements included under Item 8 of Part II.
Item 1b.
Item 1b. Unresolved Staff Comments
None
Item 2.
Item 2. Properties
The principal offices of BNCCORP are located at 322 East Main Avenue, Bismarck, North Dakota. The Bank owns the building. The principal office of the Bank is located at 2425 East Camelback Road, Phoenix, Arizona, which it is leasing. The Bank owns branch offices at 219 South 3rd Street and 801 East Century Avenue and an additional office building at 116 North 4th Street in Bismarck. The Bank also owns a branch office at 17045 North Scottsdale Road, Scottsdale, Arizona and 650 Douglas Drive, Golden Valley, Minnesota. It also owns its banking facilities in Crosby, Ellendale, Kenmare, Linton, Stanley and Watford City, North Dakota. The Bank has a property at 6515 East Grant Road in Tucson, Arizona. We anticipate construction of a banking branch at this location sometime in the future. The Bank also owns land in Shakopee, Minnesota and Glendale, Arizona and has a lease for land at Gilbert, Arizona.
The Bank’s facilities at 502 West Main Street (Mandan) and Garrison, North Dakota are leased. The facilities occupied by the Bank at 333 South Seventh Street, Minneapolis, Minnesota, and the Bank’s facilities at 640 South Mill Avenue, Tempe, Arizona, along with 2425 East Camelback Road, Phoenix, Arizona are also leased.
Milne & BNC Insurance occupies four locations in Arizona: 1750 East Glendale Avenue, Phoenix; 2400 East Highway 89A, Cottonwood; 6501 East Grant Road, Tucson; and 8101 East Florentine Road, Prescott Valley. They also occupy locations at 8310 South Valley Highway, Englewood, Colorado and 2532 Seascape Drive, Las Vegas, Nevada. The Bank owns the properties in Phoenix and Tucson and the remaining four facilities are presently leased.
We believe that all owned and leased properties are well maintained and considered in good operating condition. They are believed adequate for the Company’s present operations; however, future expansion could result in the leasing or construction of additional facilities. We do not anticipate any difficulty in renewing our leases or leasing additional suitable space upon expiration of present lease terms.
Item 3.
Item 3. Legal Proceedings
From time to time, we may be a party to legal proceedings arising out of our lending, deposit operations or other activities. We engage in foreclosure proceedings and other collection actions as part of our loan collection activities. From time to time, borrowers may also bring actions against us, in some cases claiming damages. Some financial services companies have been subjected to significant exposure in connection with litigation, including class action litigation and punitive damage claims. While we are not aware of any such actions or allegations that should reasonably give rise to any material adverse effect, it is possible that we could be subjected to such a claim in an amount that could be material. Based upon a review with our legal counsel, we believe that the ultimate disposition of such pending litigation will not have a material effect on our financial condition, results of operations or cash flows.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter ended December 31, 2006.
PART II
Item 5.
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
BNCCORP’s common stock, $.01 par value (“Common Stock”), is traded on the Nasdaq Global Market under the symbol “BNCC.”
The following table lists the high and low sales prices of our Common Stock for the periods indicated as reported by the Nasdaq Global Market. The quotes reflect the high and low closing sales prices for our Common Stock as reported by the Nasdaq Global Market.
On March 7, 2007, there were 93 record holders of the Company’s Common Stock as reported by the Company’s stock transfer agent and registrar, American Stock Transfer & Trust Company.
BNCCORP’s policy is to retain its earnings to support the growth of its business. Our board of directors has never declared cash dividends on our Common Stock and does not plan to do so in the foreseeable future. In making the determination to pay dividends, we will consider all relevant factors including, among other things, our capital position and current tax law as it relates to the treatment of dividends. “Supervision and Regulation - Dividend Restrictions” included under Item 1 of Part I discusses regulatory restrictions on dividends payable by the Bank to BNCCORP.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides aggregate information regarding grants under all equity compensation plans of the Company as of December 31, 2006.
Performance Graph
The graph and corresponding table below compares the cumulative total stockholder return on BNC’s Common Stock for the last five years with the cumulative total return on the S&P 500 Index and the Nasdaq Bank Stock Index for the same period. The information in the performance graph is based on the assumption of a $100 investment in BNC’s Common Stock and each of the S&P 500 Index and the Nasdaq Bank Stock Index on December 31, 2001 and, for the two indices, the reinvestment of dividends.
Item 6.
Item 6. Selected Financial Data
The selected consolidated financial data presented below under the captions “Income Statement Data” and “Balance Sheet Data” as of and for the years ended December 31, 2006, 2005, 2004, 2003, and 2002 are derived from the historical audited consolidated financial statements of the Company. The Consolidated Balance Sheets as of December 31, 2006, 2005, 2004, 2003 and 2002 and the related Consolidated Statements of Income, Comprehensive Income, Stockholders’ Equity and Cash Flows for each of the five years in the period ended December 31, 2006 were audited by KPMG LLP, independent registered public accountants. The financial data below should be read in conjunction with and is qualified by the Consolidated Financial Statements and the notes thereto included under Item 8. All data presented is from continuing operations as of and for all periods presented.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
The following table summarizes income from continuing operations, net income and basic and diluted earnings per share for the 12 months ended December 31 (amounts in thousands):
Highlights. The following information highlights key developments during 2006:
•
2006 net income was $3.6 million ($1.03 per share on a diluted basis) compared with $4.1 million ($1.34 per share) for 2005;
•
Net interest income for 2006 rose $1.3 million to $18.8 million compared with $17.5 million in 2005;
•
Net interest margin increased to 3.04% in 2006 from 2.79% in 2005;
•
Non-interest income decreased $1.1 million to $23.8 million compared with $24.9 million in 2005;
•
Non-interest expense rose 2.4 percent to $37.6 million in 2006 compared with $36.7 million in 2005;
•
Loans and leases held for investment, excluding participating interests, increased $23.6 million in 2006, to $333.9 million;
•
Participating interests in mortgage loans declined by $45.2 million to $56.1 million during 2006;
•
Nonperforming assets were $102,000 as of December 31, 2006, representing 0.01% of total assets;
•
Total deposits decreased to $529.2 million at December 31, 2006 from $548.8 million at December 31, 2005;
•
Core deposits grew by $16.5 million in 2006 while brokered and national deposits declined by $36.0 million;
•
Borrowings declined by $34.4 million in 2006;
•
Trust and financial services fees increased by 34.8% in 2006;
•
Assets under administration increased by 17.6% in 2006;
•
Investment in new bank branches in Arizona continues; and
•
Insurance agency profits remain steady.
The Banking segment increased net interest income significantly as core loans and deposits grew at a healthy rate. Credit quality remained excellent. Fees generated by wealth management increased as assets under management continued to grow. The insurance agency continued to post profits.
Results of Operations
Net Interest Income
The following table sets forth, for the periods indicated, certain information relating to our average balance sheet and reflects the yield on average assets and cost of average liabilities. Such yields and costs are derived by dividing income and expense by the average balance of assets and liabilities. All average balances have been derived from monthly averages, which are indicative of daily averages:
Analysis of Changes in Net Interest Income
The following table illustrates, for the periods indicated, the dollar amount of changes in our interest income and interest expense for the major components of interest-earning assets and interest-bearing liabilities and distinguishes between the increase related to higher outstanding balances and the volatility of interest rates. Changes attributable to the combined impact of volume and rate have been allocated proportionately to the change due to volume and the change due to rate:
Year ended December 31, 2006 compared to year ended December 31, 2005.
Net interest income was $18.8 million in 2006 an increase of $1.3 million, or 7.1%, from $17.5 million in 2005. The net interest margin increased to 3.04% for the twelve months ended December 31, 2006, from 2.79% in 2005.
Net interest income, and net interest margin, improved due to management’s strategy to invest in higher yielding assets when permitted; and pay down high cost borrowings and deposits as they matured. Higher balances of federal funds sold and loans and leases held for investment contributed to the increase in interest income. The increases in these assets were partially offset by a decline in the average balance outstanding of participating interests in mortgage loans in 2006 compared to 2005. Interest income also rose as the yield on assets increased with the general increase in interest rates during 2006. Net interest income also benefited from reduced balances in high cost borrowings and brokered deposits. The decreases in these liabilities partially mitigated the impact of the increasing interest rates paid on liabilities during 2006.
(a)
The yield on assets and cost of interest bearing liabilities increased primarily due to a rising interest rate environment during 2006.
(b)
The increase in loans and leases is the result of efforts to grow the core portfolio in all banking markets.
(c)
Federal funds sold increased due to relatively attractive yields resulting from an inverted yield curve.
(d)
Loans held for sale and participating interests in mortgage loans finance mortgage banking activity which was reduced due to softness in the residential real estate market and higher interest rates. Proceeds from reductions in these assets were used to either pay down higher cost borrowings or reinvested in other interest earning assets.
(e)
Amounts in investments declined as proceeds from sales and maturities were used to either pay down higher cost borrowings or reinvested in other higher yielding assets.
(f)
The increase in certificates under $100,000 is the result of efforts to grow core deposits.
(g)
These decreases are the result of efforts to pay down higher cost deposits and borrowings as they mature.
Year ended December 31, 2005 compared to year ended December 31, 2004.
Interest income increased approximately $7.1 million in 2005. The $58.0 million increase in loans contributed to the increase in interest income. The rising interest rate environment also contributed to the increase in interest income. Interest expense increased approximately $5.6 million in 2005. Interest expense increased due to higher balances in checking, money market accounts and certificates of deposits. Lower balances in borrowings and FHLB advances reduced interest expense. The rising interest rate environment caused interest expense to increase significantly. Overall, net interest income increased by approximately $1.5 million.
(a)
Average earning assets increased due to an increase in both average loans held for sale and loans held for investment, offset by a decrease in average investments.
(b)
Average loans held for sale increased due to an increase in mortgage and student loan financing programs initiated in 2004.
(c)
Average loans held for investment increased due to increased activity in our Arizona and Minnesota markets.
(d)
Average investments decreased in order to provide liquidity to support the increase in other earning assets, in particular, the growth in loans held for sale.
(e)
The average yield on assets increased due to the 200bp increase in short-term interest rates that occurred over the course of the year, as much of the portfolio is variable and indexed to the Prime rate.
(f)
Increased cost of interest bearing liabilities due to the 200bp rise in the short-term market interest rates along with a growth in deposits.
(g)
Interest bearing liabilities increased due to the deposit growth in our Arizona and Minnesota markets offset by a reduction of borrowings.
(h)
Deposits increased due to growth in our Arizona and Minnesota markets.
(i)
Borrowing decreased as increases in core deposits were somewhat offset by a decreased borrowing, along with the paydown of borrowings at Bank of North Dakota with the proceeds of the company’s private placement.
Non-interest Income
Non-interest income decreased by $1.1 million, or 4.4%, to $23.8 million in 2006, compared to $24.9 million in 2005. Insurance agency revenues, which may vary from period to period, decreased by $414,000, or 2.2%, in 2006 to $18.3 million compared to $18.8 million in 2005. This decrease is primarily the result of lower contingency income received from insurance companies. Gains on sales of loans, which fluctuate from period to period, decreased $567,000, or 24.5%, in 2006. This decrease is primarily due to an unusually large transaction which resulted in a gain of approximately $800,000 in early 2005. Brokerage income decreased $148,000, or
39.1%, in 2006 as a result of a decision to discontinue brokerage services in the Minnesota market. In contrast to these decreases, trust and financial service income increased by $222,000, or 34.8%, in 2006 reflecting continued growth in the wealth management segment. Overall, non-interest income represented 55.86% of gross revenues in 2006, down from 58.64% a year ago.
Non-interest income rose to $24.9 million for the 12-month period ended December 31, 2005, an increase of $1.4 million over the same period of 2004. The increase reflected increased insurance income from having a full year of contribution from three insurance agencies acquired in 2004, fees on loans, and wealth management income. The Minneapolis commercial real estate department had a record year for loan fees. A nonrecurring gain of $527,000 from the final resolution of a reinsurance program previously associated with BNC Insurance was reflected in other income during the 12-month period ended December 31, 2004.
The following table presents, for the periods indicated, the major categories of our non-interest income (in thousands):
Non-interest Income
(a)
Insurance commissions, which vary from period to period, decreased in 2006 primarily due to a decline in the contingency income received from insurance companies. In 2005, insurance commissions increased due to a full year of earnings from acquisitions that occurred in 2004.
(b)
Gains on sales of loans, which fluctuate from period to period, decreased in 2006 primarily due to an unusually large transaction in 2005 that resulted in a gain of approximately $800,000. This transaction was also the primary reason for larger gains in 2005 compared to 2004.
(c)
Fees from trust and financial services increased in all periods reflecting growth in the wealth management segment.
(d)
Brokerage income has decreased since 2004 as the number of brokers located in Minnesota banking branches steadily declined. In 2006, brokerage services were entirely discontinued in Minnesota.
(e)
Gains and losses on sales of securities vary depending on the nature and volume of transactions.
(f)
Other income in 2004 was much higher than in other years due to resolution of a reinsurance program that resulted in a receipt of $527,000 for the insurance agency.
The ratio of non-interest income to gross revenues was 55.9%, 58.6% and 59.38% in 2006, 2005 and 2004, respectively.
Non-interest Expense
Non-interest expense increased by $893,000, or 2.4%, to $37.6 million in 2006 from $36.7 million in 2005. Increases in employee compensation expenses of $1.0 million can be primarily attributed to the Company’s growth initiatives, particularly in wealth management and Arizona banking, and higher healthcare costs.
In 2005, non-interest expense increased approximately $1.9 million or 5.6 percent. The increases in salary and employee benefits and occupancy expenses were mainly attributable to the expansion of the wealth management business segment and having 12 months of operations for the Golden Valley branch and insurance offices that
were opened or acquired in 2004. The increase in professional services related to legal expenses for two litigation matters that were successfully resolved in 2005.
The following table presents, for the periods indicated, the major categories of our non-interest expense as well as the amount and percent of change between each of the periods presented (in thousands):
Non-interest Expense
(a)
These expenses have increased in all periods due to expansion, or acquisitions, in the banking, wealth management and insurance segments.
(b)
Professional services spiked in 2005 due to legal expenses associated with two matters that were successfully resolved.
(c)
Data processing expenses increase with more locations and expanded electronic products.
Income taxes
We recorded income tax expense of $1.2, $1.4, and $1.1 million for the years ended December 31, 2006, 2005 and 2004, respectively. Our effective tax rates were 24.4, 25.1, and 25.2 percent for the years ended December 31, 2006, 2005 and 2004, respectively. The lower effective tax rate in 2006 is due to the resolution of an uncertain tax position which resulted in a benefit being recorded.
Financial Condition
Overview
Subsequent sections of this discussion and analysis of financial condition address certain aspects of our major assets and liabilities in significant detail. The following two tables are presented as a general overview of the financial condition of the Company.
Assets
Total assets were $692.3 million at December 31, 2006, a decrease of $47.7 million, from $740.0 million at December 31, 2005. This decrease is primarily the result of a decline in participating interests in mortgage loans. In 2005, total assets increased approximately $66.3 million, or 9.8 percent. This increase was primarily the result of an increase in participating interests in mortgage loans.
The following table presents our assets by category as of December 31, 2006, 2005 and 2004, as well as the amount and percent of change between the dates (amounts are in thousands):
Assets
(a)
Cash and equivalents were high at December 31, 2005 due to a large cash wire received late that day.
(b)
Federal funds sold increased in 2006 due to asset/liability strategies intended to capitalize on relatively attractive yields on short term investments resulting from an inverted yield curve.
(c)
The balance of investments declined in 2006 as proceeds from sales and maturities were used to either pay down higher cost borrowings or reinvested in other higher yielding assets.
(d)
In 2004, loans held for sale were higher due to student loans held for sale. This program was discontinued midway through 2005.
(e)
Participating interests in mortgage loans are collateralized by loans held for sale by mortgage banking counterparties. These balances will vary depending on the volume of loans originated by the counterparties.
(f)
The increase in loans and leases is the result of efforts to grow the core portfolio in all banking markets.
(g)
Other assets have increased due to higher accounts receivable at the insurance agency as of December 31, 2006.
Liabilities and Stockholders Equity
Total liabilities decreased in 2006 as higher cost deposits and borrowings were repaid as they matured. Liabilities increased in 2005 due to new bank branches and an emphasis on growing deposits in existing markets.
The following table presents our liabilities and stockholders’ equity by category as of December 31, 2006, 2005 and 2004, as well as the amount and percent of change between the dates (amounts are in thousands):
Liabilities and Stockholders Equity
(a) Core deposits have generally increased as a result of new banking branches and deposit gathering activities at existing branches.
(b) These balances decreased in 2006 as higher cost deposits and borrowings were repaid at maturity.
(c) Long-term borrowings have been repaid as scheduled, or earlier when permissible.
(d) Stockholders’ equity has increased due to earnings and a private placement of common stock in 2005.
Investment Securities Available for Sale
Our investment policy is designed to enhance net income and return on equity through prudent management of risk, ensure liquidity for cash-flow requirements, help manage interest rate risk, ensure collateral is available for public deposits, advances and repurchase agreements and manage asset diversification. In managing the portfolio, we seek a balance between current income (yield) and future market value volatility, while simultaneously managing credit and liquidity risks. The goal of this process is to maximize our longer term profitability as well as the economic performance of the portfolio over the long-term.
The following table presents the composition of the available-for-sale investment portfolio by major category as of the dates indicated (in thousands):
The following table presents maturities for all securities available for sale (other than equity securities) and yields for all securities in our investment portfolio at December 31, 2006:
Investment Portfolio - Maturity and Yields
(1)
Yields include adjustments for tax-exempt income.
(2)
Based on amortized cost rather than fair value.
(3)
Maturities of mortgage-backed securities and collateralized obligations are based on contractual maturities. Actual maturities may vary because obligors may have the right to call or prepay obligations with or without call or prepayment penalties.
As of December 31, 2006, we had $183.0 million of available-for-sale securities in the investment portfolio as compared to $227.2 and $235.9 million at December 31, 2005 and 2004, respectively, based on fair value of the securities on those dates.
During 2006, available-for-sale securities decreased $44.2 million. The decrease in investment securities available-for-sale was the result of management’s decision to use proceeds from the sale and maturity of investments to reduce higher cost borrowings. In 2006, the yield curve inverted. In addition, the spread between taxable equivalent yields of bank-qualified state and municipal bonds and treasuries reached relatively narrow levels compared to recent years. In the process of providing proceeds to reduce higher cost borrowings, brokered deposits, and reinvestment in loans and in the context of managing the risk/reward profile of the available-for-sale portfolio, state and municipal bonds decreased by $27.2 million. During 2006, $84,000 of net losses on sales of securities were realized.
During 2005, the amount of available-for-sale securities decreased $8.7 million. In managing the overall risk/reward profile of the available-for-sale portfolio, in the context of the overall balance sheet, during the first
half of 2005, much of the principal cash flow from collateralized mortgage obligations (CMOs) was utilized to purchase state and municipal bonds. This resulted in an increase in the volume of state and municipal bonds for 2005, relative to 2004, of $11.7 million. During the second half of 2005, most of the proceeds from maturities and principal cash flow from the portfolio provided liquidity to fund growth in other earnings assets, in particular, participating interests in mortgage loans. During 2005, the total volume of CMOs, decreased by $16.0 million relative to 2004. In addition, U.S. government agency securities, corporate bonds, and U.S. government agency mortgage-backed securities decreased by $1.0 million, $2.0 million, and $1.3 million respectively. In the process of managing the risk/reward profile of the portfolio as a whole, during 2005 a limited number of securities were sold, and in the process, $67,000 of book losses were realized.
During the first quarter of 2004, the available-for-sale portfolio increased $25.8 million from $262.6 million as of December 31, 2003 to $288.4 million in order to maintain the level of earning assets while planned loan reductions and the completion of some financed commercial real estate projects reduced the loans held for investment by $29.6 million during the same period. Over the remaining three quarters of 2004, the available-for-sale portfolio decreased by $52.5 million to end the year at $235.9 million as proceeds from sales and maturities, net of new purchases were directed toward an increase in loan volume for the latter three quarters of 2004.
At December 31, 2006, we held no securities of any single issuer, other than U.S. Government agency mortgage-backed securities and CMOs that exceeded 10 percent of stockholders’ equity. A significant portion of our investment securities portfolio (approximately $169.8 million at December 31, 2006) was pledged as collateral for public deposits and borrowings, including borrowings with the FHLB.
Federal Reserve Bank and Federal Home Loan Bank Stock
Our equity securities consisted of $1.3 million of Federal Reserve Bank (“FRB”) stock as of December 31, 2006, 2005 and 2004, and $3.7, $4.5 and $6.3 million of FHLB stock as of December 31, 2006, 2005 and 2004, respectively.
Loan Portfolio
The banking segment’s primary source of income is interest earned on loans and leases held for investment. These assets, excluding participating interest in mortgage loans, increased $23.6 million, or 7.6 percent, to $333.9 million at December 31, 2006 as compared to $310.4 million at December 31, 2005. In 2005, they increased $16.6 million, or 5.6 percent, as compared to December 31, 2004. The following table presents the composition of our loan portfolio as of the dates indicated (in thousands):
Loan Portfolio Composition (1)
(1) From continuing operations in 2002.
The following table presents, for the periods indicated, the amount and percent of change in each category of loans in our loan portfolio (in thousands):
(a)
Commercial and industrial loan growth is primarily related to growth in North Dakota and Arizona banking markets.
(b)
Real estate construction loan growth is related to originations in the commercial real estate divisions located in Minnesota and Arizona.
(c)
Participating interests in mortgage loans are collateralized mortgage loans held for sale by mortgage banking counterparties. These loans will vary significantly depending on the volume of originations by the counterparties.
While prospects for loan growth appear to be favorable in our banking markets, future loan growth potential is subject to volatility. Our loan portfolio is concentrated in commercial, industrial and real estate loans and we have credit concentrations in certain industries (see “Concentrations of Credit”) and certain geographic concentrations that relate to our primary market areas. A downturn in certain sectors of the economy could adversely impact our borrowers. This could, in turn, reduce the demand for loans and impact the borrowers’ ability to repay their loans, while also decreasing our net interest margin. We cannot predict with any degree of certainty the full impact of current or future economic conditions on our ability to generate loan volume or the ultimate impact of economic conditions on our currently existing portfolio of loans. See “Factors That May Affect Future Results of Operations” included under Item 1 of Part I.
Credit Policy, Underwriting, Approval and Review Procedures
We follow a uniform credit policy that sets forth underwriting and loan administration criteria. The Board of Directors (the “Board”) establishes our loan policy, including lending guidelines for the various types of credit we offer based upon the recommendations of senior lending management. We have an Executive Credit Committee that approves loans over a certain size. Our loan policy is reviewed and reaffirmed by the Board at least annually.
We delegate lending decision authority among various lending officers and the Executive Credit Committee based on the size of the customer’s credit relationship with BNC. All loans and commitments approved in excess of $300,000 are presented to the Bank’s Board of Directors on a quarterly basis for summary review. Any exceptions to loan policies and guidelines, to the extent the credit relationship amount exceeds individual loan officer lending authorities, are subject to special approval by the Bank’s Chief Credit Officer or the appropriate credit committee.
Underwriting criteria are based upon the risks associated with each type of credit offered, the related borrowers and types of collateral. In underwriting commercial loans, we emphasize the borrower’s earnings history, capitalization and secondary sources of repayment. In most instances, we require third party guarantees or highly liquid collateral.
Our credit administration function includes an internal loan review department that reviews established levels of our loan portfolio on a continuous basis. Loan review personnel are not involved in any way in the credit underwriting or approval process. Additionally, our lenders, loan review staff, Chief Credit Officer, Executive Credit Committee and various management team members review credit-related information monthly. Such information includes, but may not be limited to, delinquencies, classified and nonperforming assets, and other information. Such reviews are conducted in order to evaluate credit risk within our credit portfolio and to review and establish the adequacy of the allowance for credit losses.
Loan Participations
Pursuant to our lending policy, loans may not exceed 85 percent of the Bank’s legal lending limit (except to the extent collateralized by U.S. Treasury securities or Bank deposits and, accordingly, excluded from the Bank’s legal lending limit) unless the Chief Credit Officer and the Executive Credit Committee grant prior approval. To accommodate customers whose financing needs exceed lending limits and internal loan restrictions relating primarily to industry concentration, the Bank sells loan participations to outside participants without recourse.
The Bank generally retains the right to service the loans as well as the right to receive a portion of the interest income on the loans. Loan participations sold on a nonrecourse basis to outside financial institutions were as follows as of the dates indicated:
Concentrations of Credit
Our credit policies emphasize diversification of risk among industries, geographic areas and borrowers. For purposes of the analysis of concentrations of credit as of December 31, 2006 the total outstanding loans as well as all outstanding loan commitments were included. As of December 31, 2006, we identified three concentrations of loans exceeding 10 percent of total loans and loan commitments outstanding. The real estate loans and commitments exceeding 10% of loans and commitments outstanding were extended to customers who are diversified across our market areas and who can generally be categorized as indicated below:
The participating interests in mortgage loans held for sale has two counterparty relationships. There is no limit to our loan commitment in one of these relationships.
Loans and commitments in the construction category were extended to 75 customers who are located primarily in Minnesota, Iowa, North Dakota and South Dakota and who can generally be categorized as indicated below:
The contractors are involved in various aspects of the construction industry, including highway and street construction, water/sewer drilling, plumbing, heating and air conditioning, commercial painting, electrical, concrete and excavating and foundation contractors. Loans in this category are secured, in many cases, by construction equipment.
Loan Maturities
The following table sets forth the remaining maturities of loans in each major category of our portfolio as of December 31, 2006 (in thousands):
(1)
Maturities are based on contractual maturities. Floating rate loans include loans that would reprice prior to maturity if base rates change.
Actual maturities may differ from the contractual maturities shown above as a result of renewals and prepayments. Loan renewals are evaluated in the same manner as new credit applications.
Nonperforming Loans and Assets
Nonperforming loans consist of loans 90 days or more delinquent and still accruing interest, nonaccrual and restructured loans. Other nonperforming assets includes other real estate owned and repossessed assets. Our lending personnel are responsible for continuous monitoring of the quality of the loan portfolio. Loan officers are expected to maintain loan quality and deal with credit issues in a timely and proactive manner. Loan officers are also responsible for regular reviews of past due loans in their respective portfolios. The loan portfolio is also monitored regularly and examined by our loan review personnel. Loans demonstrating weaknesses are downgraded in a timely fashion and the Board receives a listing of all such loans on a quarterly basis.
The following table sets forth, as of the dates indicated, the amounts of nonperforming loans and other assets, the allowance for credit losses and certain related ratios (in thousands):
Loans 90 days or more delinquent and still accruing interest include loans over 90 days past due which we believe, based on our specific analysis of the loans, do not present doubt about the collection of interest and principal in accordance with the loan contract. Loans in this category must be well secured and in the process of collection. Our lending and management personnel monitor these loans closely.
Nonaccrual loans include loans on which the accrual of interest has been discontinued. Accrual of interest is discontinued when we believe, after considering economic and business conditions and collection efforts that the borrower’s financial condition is such that the collection of interest is doubtful. A delinquent loan is generally placed on nonaccrual status when it becomes 90 days or more past due unless the loan is well secured and in the process of collection. When a loan is placed on nonaccrual status, accrued but uncollected interest income applicable to the current reporting period is reversed against interest income of the current period. Accrued but uncollected interest income applicable to previous reporting periods is charged against the allowance for credit losses. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain. When a problem loan is finally resolved, there may ultimately be an actual write down or charge-off of the principal balance of the loan which may necessitate additional charges to earnings.
Restructured loans are those for which concessions, including a reduction of the interest rate or the deferral of interest or principal, have been granted due to the borrower’s weakened financial condition. Interest on restructured loans is accrued at the restructured rates when it is anticipated that no loss of original principal will occur. We had no restructured loans in our portfolio at December 31, 2006.
Other real estate owned and repossessed assets represent properties and other assets acquired through, or in lieu of, loan foreclosure. They are initially recorded at fair value at the date of acquisition establishing a new cost basis. Write-downs to fair value at the time of acquisition are charged to the allowance for credit losses. After foreclosure, we perform valuations periodically and the real estate or assets are carried at the lower of carrying amount or fair value less cost to sell. Write-downs, revenues and expenses incurred subsequent to foreclosure are charged to operations as recognized/incurred. We had no outstanding other real estate owned or repossessed assets at December 31, 2006.
Our balances of nonperforming loans and assets have been insignificant in recent years. Accordingly, the ratio of the allowance for losses to nonperforming loans has been relatively high.
Impaired loans and Potential Problem Loans
In accordance with accounting standards, we identify loans considered impaired and the valuation allowance attributable to these loans. Impaired loans generally include loans on which we believe, based on current information and events, it is probable that we will not be able to collect all amounts due in accordance with the terms of the loan agreement and which are analyzed for a specific reserve allowance. We generally consider all loans risk-graded substandard and doubtful as well as nonaccrual and restructured loans as impaired. Potential problem loans at December 31, 2006 totaled $1.2 million as compared to $1.3 million at December 31, 2005. A significant portion of these potential problem loans are not in default but may have characteristics such as recent adverse operating cash flows or general risk characteristics that the loan officer feels might jeopardize the future timely collection of principal and interest payments. The ultimate resolution of these credits is subject to changes in economic conditions and other factors. These loans are closely monitored to ensure that our position as creditor is protected to the fullest extent possible.
Provision for Credit Losses
We determine a provision for credit losses which we consider sufficient to maintain our allowance for credit losses at a level considered adequate to provide for an estimate of probable losses related to specifically identified loans as well as probable losses in the remaining loan and lease portfolio that have been incurred as of each balance sheet date. The provision for credit losses for the year ended December 31, 2006 was $210,000 as compared to $250,000 in 2005 and $175,000 in 2004. Net loan and lease charge-offs were $51,000, or 0.008 percent of average loans and leases held for investment in 2006 compared with $589,000, or 0.11 percent in 2005 and $1.9 million, or 0.58 percent in 2004. Of the $1.9 million of charge-offs in 2004, $1.2 million related to one commercial loan.
Allowance for Credit Losses
Credit risk is the risk of loss from a customer default. We have in place a process to identify and manage our credit risk. The process includes initial credit review and approval, periodic monitoring to measure compliance with credit agreements and internal credit policies, internal credit review, monitoring changes in the risk ratings of loans and leases, identification of problem loans and leases and special procedures for collection of problem loans and leases. The risk of loss is difficult to quantify and is subject to fluctuations in values and general economic conditions and other factors. As discussed previously, the determination of the allowance for credit losses is a critical accounting policy, which involves estimates and our judgment on a number of factors such as net charge-offs, delinquencies in the loan and lease portfolio and general and economic conditions.
Our allowance for credit losses was $3.4 million at December 31, 2006. This included a $2.5 million allowance for homogeneous loan pools, $199,000 for specific reserves and $695,000 for qualitative reserves. We consider the allowance for credit losses adequate to cover losses inherent in the loan and lease portfolio as of December 31, 2006. However, no assurance can be given that we will not, in any particular period, sustain loan and lease losses that are sizable in relation to the amount reserved, or that subsequent evaluations of the loan and lease portfolio, in light of factors then prevailing, including economic conditions and our ongoing credit review process, will not require significant increases in the allowance for credit losses. A protracted economic slowdown and/or a decline in commercial, industrial or real estate segments may have an adverse impact on the adequacy of the allowance for credit losses by increasing credit risk and the risk of potential loss. See Notes 1 and 7 to the Consolidated Financial Statements included under Item 8 and “-Critical Accounting Policies” for further information concerning accounting policies associated with the allowance for credit losses.
The following table summarizes, for the periods indicated, activity in the allowance for credit losses, including amounts of loans charged-off, amounts of recoveries, additions to the allowance charged to operating expense, the ratio of net charge-offs to average total loans, the ratio of the allowance to total loans at the end of each period and the ratio of the allowance to nonperforming loans:
Allowance for Credit Losses; Impact on Earnings. As indicated above, the determined level of the allowance for credit losses involves assumptions underlying our estimates that reflect highly uncertain matters in the current period. Additionally, a different estimate that could have been used in the current period could have had a material impact on reported financial condition or results of operations. We are not aware, at this time, of known trends, commitments, events or other uncertainties reasonably likely to occur that would materially affect our methodology or the assumptions used, although changes in the qualitative and quantitative factors noted above could occur at any time and such changes could be of a material nature. We have used our assumptions to arrive at the level of the allowance for credit losses that we consider adequate to provide for an estimate of probable losses related to specifically identified loans as well as probable losses in the remaining loan and lease portfolio that have been incurred as of December 31, 2006.
From period to period, economic situations change, credits may deteriorate or improve and the other factors we consider in arriving at our estimates may change. However, our basic methodology for determining an appropriate allowance for credit losses has remained relatively stable. This methodology has resulted in allowance levels of $3.4, $3.2 and $3.3 million at December 31, 2006, 2005 and 2004, respectively. As noted above, the amount of the provision for credit losses charged to operations is directly related to our estimates of the appropriate level of the allowance for credit losses. Charge-offs and recoveries during the applicable periods also impact the level of the allowance for credit losses resulting in a provision for credit losses that could be higher or lower in order to bring the allowance for credit losses in line with our estimates.
The allowance for credit losses as a percentage of total loans and leases held for investment at December 31, 2006 was 0.86%, compared with 0.77% at December 31, 2005. The allowance for credit losses as a percentage of loans and leases held for investment, excluding the participating interests in mortgage loans, at December 31, 2006 was 1.01%, compared with 1.03% at December 31, 2005.
The table below presents, for the periods indicated an allocation of the allowance for credit losses among the various loan categories and sets forth the percentage of loans in each category to gross loans. The allocation of the allowance for credit losses as shown in the table should neither be interpreted as an indication of future charge-offs, nor as an indication that charge-offs in future periods will necessarily occur in these amounts or in the indicated proportions.
Allocation of the Allowance for Loan Losses
Deposits
Our core deposits consist of non-interest- and interest-bearing demand deposits, savings deposits, money market deposit accounts, certificates of deposit under $100,000, certain certificates of deposit of $100,000 and over, and certain public funds. Total deposits were $529.3 million at December 31, 2006 compared with $548.8 and $455.3 million at December 31, 2005 and 2004, respectively. We use these deposits, along with other borrowed funds, to finance our assets. At December 31, 2006 we had $200,000 of national and brokered deposits compared with $36.2 million at December 31, 2005.
The following table sets forth, for the periods indicated, the distribution of our average deposit account balances and average cost of funds rates on each category of deposits (in thousands).
Average Deposits and Deposits Costs
At times earning asset growth can outpace core deposit growth resulting in the use of brokered deposits and out of market certificates of deposit and other borrowed funds. This trend has been common in the banking industry because of the proliferation of nonbank competitors and the multitude of financial and investment products available to customers as well as the need to utilize such funds in the process of our overall balance sheet
management. At times, access to brokered and out of market deposits is available at maturities and rates more favorable than those available in our local markets
Time deposits, in denominations of $100,000 and more, totaled $45.0 million at December 31, 2006 as compared to $71.3 and $83.9 million at December 31, 2005 and 2004, respectively. The following table sets forth the amount and maturities of time deposits of $100,000 or more as of December 31, 2006 (in thousands):
Borrowed Funds
We use short-term borrowings, FHLB advances and long-term borrowings to finance our asset base. Short-term borrowings include Federal funds purchased and U.S. Treasury tax and loan note option accounts and securities sold under agreements to repurchase. At December 31, 2006, short-term borrowings were $9.7 million compared to $21.4 million at December 31, 2005 and $33.7 million at December 31, 2004.
The following table provides a summary of our short-term borrowings and related cost information as of, or for the periods ended, December 31 (in thousands):
Short-Term Borrowings
Note 11 to the Consolidated Financial Statements included under Item 8 summarizes the general terms of our short-term borrowings outstanding at December 31, 2006 and 2005, including interest rates, maturity dates, weighted average yields and other applicable terms.
FHLB advances totaled $62.2, $82.2, and $97.2 million at December 31, 2006, 2005 and 2004, respectively while long-term borrowings totaled $1.2, $3.9 and $10.1 million, respectively, for the same periods.
Notes 12 and 13 to the Consolidated Financial Statements included under Item 8 summarize the general terms of our FHLB advances and long-term borrowings at December 31, 2006 and 2005, including interest rates, maturity dates, weighted average yields and other applicable terms.
Guaranteed Preferred Beneficial Interests in Company’s Subordinated Debentures
See Note 14 to the Consolidated Financial Statements included under Item 8 for a complete description of the subordinated debentures.
Capital Resources and Expenditures
We actively monitor compliance with regulatory capital requirements, including risk-based and leverage capital measures. Under the risk-based capital method of capital measurement, the ratio computed is dependent on the amount and composition of assets recorded on the balance sheet, and the amount and composition of off-balance-sheet items, in addition to the level of capital. Note 18 to the Consolidated Financial Statements under Item 8
includes a summary of the risk-based and leverage capital ratios of BNCCORP and the Bank as of December 31, 2006 and 2005.
The capital ratios of the Company and the Bank were as follows as of those dates:
The changes in capital ratios between December 31, 2005 and December 31, 2006 are primarily due to earnings in 2006.
Off-Balance-Sheet Arrangements
In the normal course of business, we are a party to various financial instruments with off-balance-sheet risk. These instruments include commitments to extend credit, commercial letters of credit, performance and financial standby letters of credit and interest rate swaps, caps and floors. Such instruments help us to meet the needs of our customers, manage our interest rate risk and effectuate business combination transactions. These instruments and commitments, which we enter into for purposes other than trading, carry varying degrees of credit, interest rate or liquidity risk in excess of the amount reflected in the consolidated balance sheets. We have also entered into certain guarantee arrangements that are not reflected in the consolidated balance sheets. See Notes 20 and 21 to the Consolidated Financial Statements included under Item 8 for a detailed description of each of these instruments.
Contractual Obligations, Contingent Liabilities and Commitments
As disclosed in the Notes to the Consolidated Financial Statements included under Item 8, we have certain contractual obligations, contingent liabilities and commitments. At December 31, 2006, the aggregate contractual obligations (excluding bank deposits), contingent liabilities and commitments were as follows (in thousands):
We are a party to transactions involving financial instruments that create risks that may or may not be reflected on a traditional balance sheet. These financial instruments can be subdivided into two categories:
Cash financial instruments, generally characterized as on-balance-sheet items; include investments, loans, mortgage-backed securities, deposits and debt obligations.
Credit-related financial instruments, generally characterized as off-balance-sheet items, include such instruments as commitments to extend credit, commercial letters of credit and performance and financial standby letters of credit.
Liquidity Risk Management
Liquidity risk is the possibility of being unable to meet all present and future financial obligations in a timely manner. Liquidity risk management encompasses our ability to meet all present and future financial obligations in a timely manner. The objectives of liquidity management policies are to maintain adequate liquid assets, liability diversification among instruments, maturities and customers and a presence in both the wholesale purchased funds market and the retail deposit market.
The Consolidated Statements of Cash Flows in the Consolidated Financial Statements present data on cash and cash equivalents provided by and used in operating, investing and financing activities. In addition to liquidity from core deposit growth, together with repayments and maturities of loans and investments, we utilize brokered deposits, sell securities under agreements to repurchase and borrow overnight Federal funds. The Bank is a member of the FHLB, which affords it the opportunity to borrow funds in terms ranging from overnight to 10 years and beyond. Advances from the FHLB are generally collateralized by the Bank’s mortgage loans and various investment securities. We have also obtained funding through the issuance of subordinated notes, subordinated debentures and long-term borrowings.
The following table sets forth a summary of our major sources and (uses) of funds (in thousands):
Our liquidity is measured by our ability to raise cash when we need it at a reasonable cost and with a minimum of loss. Given the uncertain nature of our customers’ demands as well as our desire to take advantage of earnings enhancement opportunities, we must have adequate sources of on- and off-balance-sheet funds that can be acquired in time of need.
We measure our liquidity position on a monthly basis. Key factors that determine our liquidity are the reliability or stability of our deposit base, the pledged/non-pledged status of our investments and potential loan demand. Our liquidity management system divides the balance sheet into liquid assets, and short-term liabilities that are assumed to be vulnerable to non-replacement under abnormally stringent conditions. The excess of liquid assets over short-term liabilities is measured over a 30-day planning horizon. Assumptions for short-term liabilities
vulnerable to non-replacement under abnormally stringent conditions are based on a historical analysis of the month-to-month percentage changes in deposits. The excess of liquid assets over short-term liabilities and other key factors such as expected loan demand as well as access to other sources of liquidity such as lines with the FHLB, Federal funds and those other supplemental sources listed above are tied together to provide a measure of our liquidity. We have a targeted range and manage our operations such that these targets can be achieved. We believe that our prudent management policies and guidelines will ensure adequate levels of liquidity to fund anticipated needs of on- and off-balance-sheet items. In addition, a contingency funding policy statement identifies actions to be taken in response to an adverse liquidity event.
Forward-Looking Statements
Statements included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” which are not historical in nature are intended to be, and are hereby identified as “forward-looking statements” for purposes of the safe harbor provided by Section 27A of the Securities Act and Section 21E of the Exchange Act. We caution readers that these forward-looking statements, including without limitation, those relating to our future business prospects, revenues, working capital, liquidity, capital needs, interest costs, income and expenses, are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements due to several important factors. These factors include, but are not limited to: risks of loans and investments, including dependence on local and regional economic conditions; competition for our customers from other providers of financial services; possible adverse effects of changes in interest rates including the effects of such changes on derivative contracts and associated accounting consequences; risks associated with our acquisition and growth strategies; and other risks which are difficult to predict and many of which are beyond our control.
Effects of Inflation
Unlike most industrial companies, the assets and liabilities of financial institutions are primarily monetary in nature. Therefore, banking organizations do not necessarily gain or lose due to the effects of inflation. Changes in interest rates, which are a major determinant of a financial service organization’s profitability, do not necessarily correspond to changes in the prices of goods and services; however, interest rates may change in response to changes in expectations of future inflation. An analysis of a banking organization’s asset and liability structure provides the best indication of how the organization is positioned to respond to changing interest rates and maintain profitability.
The financial statements and supplementary financial data have been prepared, primarily, on a historical basis, which is mandated by accounting principles generally accepted in the United States. Fluctuations in the relative value of money due to inflation or recession are generally not considered.
Recently Issued and Adopted Accounting Pronouncements
Note 1 to the Consolidated Financial Statements included under Item 8 includes a summary of recently issued and adopted accounting pronouncements and their related or anticipated impact on the Company.
Critical Accounting Policies
Note 1 to the Consolidated Financial Statements included under Item 8 includes a summary of our critical accounting policies and their related impact on the Company.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk arises from changes in interest rates, exchange rates, and commodity prices and equity prices and represents the possibility that changes in future market rates or prices will have a negative impact on our earnings or value. Our principal market risk is interest rate risk.
Interest rate risk arises from changes in interest rates. Interest rate risk can result from: (1) Repricing risk - timing differences in the maturity/repricing of assets, liabilities, and off-balance-sheet contracts; (2) Options risk - the effect of embedded options, such as loan prepayments, interest rate caps/floors, and deposit withdrawals; (3) Basis risk - risk resulting from unexpected changes in the spread between two or more different rates of similar
maturity, and the resulting impact on the behavior of lending and funding rates; and (4) Yield curve risk - risk resulting from unexpected changes in the spread between two or more rates of different maturities from the same type of instrument. We have risk management policies to monitor and limit exposure to interest rate risk. To date we have not conducted trading activities as a means of managing interest rate risk. Our asset/liability management process is utilized to manage our interest rate risk. The measurement of interest rate risk associated with financial instruments is meaningful only when all related and offsetting on-and off-balance-sheet transactions are aggregated, and the resulting net positions are identified.
Our interest rate risk exposure is actively managed with the objective of managing the level and potential volatility of net interest income in addition to the long-term growth of equity, bearing in mind that we will always be in the business of taking on rate risk and that rate risk immunization is not entirely possible. Also, it is recognized that as exposure to interest rate risk is reduced, so too may the overall level of net interest income and equity. In general, the assets and liabilities generated through ordinary business activities do not naturally create offsetting positions with respect to repricing or maturity characteristics. Access to the derivatives market can be an important element in maintaining our interest rate risk position within policy guidelines. Using derivative instruments, principally interest rate floors, caps, and interest rate sweeps, the interest rate sensitivity of specific transactions, as well as pools of assets or liabilities, can be adjusted to maintain the desired interest rate risk profile. See “-Loan Portfolio-Interest Rate Caps and Floors” “-Borrowings-Interest Rate Caps and Floors” and Notes 1 and 17 to the Consolidated Financial Statements included under Item 8
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
BNCCORP, Inc.:
We have audited the accompanying consolidated balance sheets of BNCCORP, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2006.
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated 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 BNCCORP, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
(signed) KPMG LLP
Minneapolis, MN
March 26, 2007
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
As of December 31
(In thousands, except share data)
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statement of Income
For the Years Ended December 31,
(In thousands, except per share data)
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
For the Years Ended December 31
(In thousands)
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31 (in thousands)
BNCCORP, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders’ Equity
For the Periods Indicated
(In thousands, except share data)
BNCCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 1. Description of Business and Significant Accounting Policies
Description of Business
BNCCORP, Inc. (“BNCCORP”) is a registered bank holding company incorporated under the laws of Delaware. It is the parent company of BNC National Bank (together with its wholly owned subsidiaries, BNC Insurance Services, Inc., and BNC Asset Management, Inc., collectively the “Bank”). BNCCORP operates from 28 locations in Arizona, Colorado, Minnesota, North Dakota and Nevada, providing banking, insurance, and wealth management services to individuals and small and mid-sized businesses.
The consolidated financial statements included herein are for BNCCORP and its subsidiaries. The accounting and reporting policies of BNCCORP and its subsidiaries (collectively, the “Company”) conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. The more significant accounting policies are summarized below.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of BNCCORP and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Ultimate results could differ from those estimates.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are dependent on estimates that are particularly susceptible to significant change and include the determination of the allowance for credit losses, income taxes and impairment testing related to goodwill and other intangible assets. The following have been identified as “critical accounting policies.”
Allowance for Credit Losses
The Bank maintains its allowance for credit losses at an estimated level considered adequate to provide for probable losses related to specifically identified loans as well as the remaining loan and lease portfolio that have been incurred as of each balance sheet date. The loan and lease portfolio and other credit exposures are reviewed regularly to evaluate the adequacy of the allowance for credit losses. The Bank evaluates the allowance necessary for specific nonperforming loans and also estimates losses in other credit exposures. The resultant three allowance components are as follows:
Specific Reserves. The amount of specific reserves is determined through a loan-by-loan analysis of problem loans over a minimum size. Included in problem loans are those nonaccrual or renegotiated loans that meet the criteria as being “impaired” under the definition in Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan” (“SFAS 114”). A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Any allowance on impaired loans is generally based on one of three methods, as SFAS 114 requires that impaired loans be measured at either the present value of expected cash flows at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral of the loan. Problem loans also include those credits that have been internally classified as credits requiring management’s attention due to underlying problems in the borrower’s business or collateral concerns.
Reserves for Homogeneous Loan Pools. The Bank makes a significant number of loans and leases that, due to their underlying similar characteristics, are assessed for loss as “homogeneous” pools. Included in the
homogeneous pools are consumer loans and commercial loans under a certain size which have been excluded from the specific reserve allocation as previously discussed. The Bank segments the homogeneous pools by type of loan or lease and, using historical loss information, estimates a loss reserve for each pool.
Qualitative Reserve. The Bank’s senior lending management also allocates reserves for special circumstances which are unique to the measurement period. These include, among other things, prevailing trends and economic conditions in certain geographic, industry or lending segments of the portfolio; management’s assessment of credit risk inherent in the loan portfolio, delinquency data; historical loss experience and peer-group loss history.
Continuous credit monitoring and analysis of loss components are the principal processes relied upon by management to determine changes in estimated credit losses are reflected in the Bank’s allowance for credit losses on a timely basis. Management also considers experience of peer institutions and regulatory guidance in addition to the Bank’s own experience. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for credit losses. Such agencies may require additions to the allowance based on their judgment about information available to them at the time of their examination.
Loans, leases and other extensions of credit deemed uncollectible are charged to the allowance. Subsequent recoveries, if any, are credited to the allowance. Management’s estimate of the allowance for credit losses is highly dependent upon variables affecting valuation, including, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. These variables are reviewed periodically. Actual losses may vary from the current estimated allowance for credit losses. The provision for credit losses is the amount necessary to adjust the allowance to the level determined appropriate through application of the above processes.
Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for credit losses that we believe is appropriate at each reporting date. Quantitative factors include our historical loss experience, delinquency and charge-off trends, collateral values, changes in nonperforming loans and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers’ sensitivity to interest rate movements and borrowers’ sensitivity to quantifiable external factors that occur in a particular period.
Qualitative factors include the general economic environment in our markets and the state of certain industries in our market areas. Size and complexity of individual credits, loan structure, the extent and nature of waivers of loan policies and pace of portfolio growth are other qualitative factors that are considered in our methodology.
Our methodology is, and has been, consistently applied. However, as we add new products, increase in complexity and expand our geographic coverage, we will enhance our methodology to keep pace with the complexity of the loan and lease portfolio. We believe that our systematic methodology continues to be appropriate given our size and level of complexity.
Income Taxes
The Company files consolidated federal and unitary state income tax returns. Deferred income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Such differences can relate to differences in accounting for credit losses, depreciation, unrealized gains and losses on investment securities, deferred compensation and leases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The determination of current and deferred income taxes is based on complex analyses of many factors including interpretation of federal and state income tax laws, the difference between tax and financial reporting basis of assets and liabilities (temporary differences), estimates of amounts due or owed such as the timing of reversals of
temporary differences and current financial accounting standards. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income taxes.
Impairment Testing Related to Goodwill and Other Intangible Assets
In accordance with SFAS No. 142, the Company tests goodwill and other intangible assets for impairment annually or when impairment indicators are present. These tests are required to be conducted at the reporting unit level.
The Company estimates the fair value of the respective reporting units based on recent transactions; multiples of revenues, earnings, and book value; discounted cash flows; the same methodology used to establish the initial purchase price; or the average of several methods.
Goodwill and other intangible assets are impaired when carrying value exceeds fair value. Assessing impairment of the Company’s goodwill and other intangible assets is highly judgmental, dependant upon specific factors used in the valuation analyses. Identified impairment results in a change to earnings. Such charges could materially affect the Company’s results of operations due to the significant amount of goodwill and other intangible assets that must be assessed periodically or when impairment indicators are present.
The effect of any impairment is recorded in earnings in the period it is determined. There was no goodwill impairment recorded during the reporting periods included in these consolidated financial statements.
OTHER SIGNIFICANT ACCOUNTING POLICIES
Investment Securities
Investment securities that the Bank intends to hold for indefinite periods of time as part of its asset/liability strategy, or that may be sold in response to changes in interest rates, changes in prepayment risk, the need to increase regulatory capital or similar factors are classified as available for sale. Available-for-sale securities are carried at market value. Net unrealized gains and losses, net of deferred income taxes, on investment and mortgage-backed securities available for sale are reported as a separate component of stockholders’ equity until realized (see “Comprehensive Income”). All securities, other than the securities of the Federal Reserve Bank (“FRB”) and the Federal Home Loan Bank (“FHLB”), were classified as available for sale as of December 31, 2006 or 2005.
Investment securities that the Bank intends to hold until maturity are carried at cost, adjusted for amortization of premiums and accretion of discounts using a level yield method over the period to maturity. There were no such securities as of December 31, 2006 or 2005.
Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. Dividend and interest income is recognized when earned. Realized gains and losses on the sale of investment securities are determined using the specific-identification method and recognized in non-interest income on the trade date.
Declines in the fair value of individual available-for-sale or held-to-maturity securities below their cost, which are deemed other than temporary, could result in a charge to earnings and the corresponding establishment of a new cost basis for the security. Such write-downs would be included in non-interest income as realized losses. There were no such write-downs during 2006, 2005 or 2004. Note 4 to these consolidated financial statements includes a summary of investment securities in a loss position at December 31, 2006 and a discussion concerning such securities.
Federal Reserve Bank and Federal Home Loan Bank Stock
Investments in FRB and FHLB stock are carried at cost, which approximates fair value.
Participating Interests in Mortgage Loans
The Bank purchases participating interests in mortgage loans owned by mortgage banking counter parties. The participating interests are generally outstanding for a short duration as funds are advanced to finance loans closed
by the counterparties and are repaid when the counterparties sell the loans. The participating interests are stated at the aggregate amount of the loans financed by the counterparties. An allowance for losses is estimated on the participating interests and is included in the allowance for credit losses.
Loans and Leases
Loans and leases held for investment are stated at their outstanding principal amount net of unearned income, net unamortized deferred fees and costs and an allowance for credit losses. Interest income is recognized on an accrual basis using the interest method prescribed in the loan agreement except when collectibility is in doubt.
Loans and leases, including loans that are considered to be impaired, are reviewed regularly by management and are placed on nonaccrual status when the collection of interest or principal is 90 days or more past due, unless the loan or lease is adequately secured and in the process of collection. When a loan or lease is placed on nonaccrual status, unless collection of all principal and interest is considered to be assured, uncollected interest accrued in prior years is charged off against the allowance for credit losses. Interest accrued in the current year is reversed against interest income of the current period. Interest payments received on nonaccrual loans and leases are generally applied to principal unless the remaining principal balance has been determined to be fully collectible. Accrual of interest is resumed when it can be determined that all amounts due under the contract are expected to be collected and the loan has exhibited a sustained level of performance, generally at least six months.
All impaired loans are measured at the present value of expected future cash flows discounted at the loan’s initial effective interest rate. The fair value of collateral of an impaired collateral-dependent loan or an observable market price may be used as an alternative to discounting. If the measure of the impaired loan is less than the recorded investment in the loan, impairment will be recognized as a charge-off through the allowance for credit losses. A loan is considered impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. All loans are reviewed for impairment on an individual basis.
Loan Origination Fees and Costs
Loan origination fees and costs incurred to extend credit are deferred and amortized over the term of the loan as a yield adjustment. Loan fees representing adjustments of yield are generally deferred and amortized into interest income over the term of the loan using the interest method. Loan commitment fees are generally deferred and amortized into non-interest income on a straight-line basis over the commitment period. Loan fees not representing adjustments of yield are also included in non-interest income.
Mortgage Servicing and Transfers of Financial Assets
The Bank sells loans to others on a non-recourse basis. Sold loans are not included in the accompanying consolidated balance sheets. The Bank generally retains the right to service the loans as well as the right to receive a portion of the interest income on the loans. At December 31, 2006 and 2005, the Bank was servicing loans for the benefit of others with aggregate unpaid principal balances of $189.0 and $183.8 million, respectively. Many of the loans sold by the Bank are commercial lines of credit, or construction loans, for which balances and related payment streams cannot be reasonably estimated in order to determine the fair value of the servicing assets or liabilities and/or future interest income retained by the Bank. Upon sale, unearned net loan fees and/or costs are recognized in non-interest income and included in gains on sale of loans.
Premises and Equipment
Land is carried at cost. Premises and equipment are reported at cost less accumulated depreciation and amortization. Depreciation and amortization for financial reporting purposes is charged to operating expense using the straight-line method over the estimated useful lives of the assets. Estimated useful lives are up to 40 years for buildings and three to 10 years for furniture and equipment. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the improvement. The costs of improvements are capitalized. Maintenance and repairs, as well as gains and losses on dispositions of premises and equipment, are included in non-interest income or expense as incurred.
Other Real Estate Owned and Repossessed Property
Real estate properties and other assets acquired through loan foreclosure are included in other assets in the balance sheets, and are stated at the lower of carrying amount or fair value less estimated costs to sell. When an asset is acquired, the excess of the recorded investment in the asset over fair value less estimated costs to sell, if any, is charged to the allowance for credit losses. Management performs valuations periodically. Fair value is generally determined based upon appraisals of the assets involved. Subsequent declines in the estimated fair value, net operating results and gains and losses on disposition of the asset are included in other non-interest expense. The Bank had no outstanding other real estate owned or repossessed property at either December 31, 2006 or December 31, 2005.
Goodwill
Goodwill represents the aggregate excess of the cost of businesses acquired over the fair value of their net assets at dates of acquisition. Goodwill is not amortized, but instead is tested for impairment annually or when impairment indicators are present. Note 9 to these consolidated financial statements includes other disclosures related to goodwill.
Other Intangible Assets
Other intangible assets include premiums paid for deposits assumed, books of business acquired from insurance agencies and other miscellaneous intangibles.
Core deposit intangibles are amortized over their estimated lives of 10 years. Such accounting treatment is consistent with Statement of Financial Accounting Standards No. 147, “Acquisition of Certain Financial Institutions, an Amendment to FASB Statements No. 72 and 144 and FASB Interpretation No. 9.
Insurance agency intangibles are being amortized over their estimated lives, generally 10 to 12.5 years for commercial lines and 9 to10 years for personal lines.
Under Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”, the Company’s other intangible assets with identifiable lives are monitored to assess recoverability and determine whether events and circumstances require adjustment to the recorded amounts or amortization periods. Intangible assets with indefinite lives are not amortized but are tested for impairment annually or when impairment indicators are present. Note 9 to these consolidated financial statements includes additional information related to the Company’s other intangible assets.
Impairment of Long-Lived Assets
The Company reviews long-lived assets, including property and equipment, certain identifiable intangibles and goodwill for impairment periodically or whenever events or changes in circumstances indicate that the carrying amount of any such asset may not be recoverable. If impairment is identified, the assets are written down to their fair value through a charge to non-interest expense. No such impairment losses were recorded during 2006, 2005 or 2004.
Securities Sold Under Agreements to Repurchase
From time to time, the Bank enters into sales of securities under agreements to repurchase, generally for periods of less than 90 days. These agreements are treated as financings, and the obligations to repurchase securities sold are reflected as a liability in the consolidated balance sheets as short-term borrowings. The costs of securities underlying the agreements remain in the asset accounts.
Fair Values of Financial Instruments
The Company is required to disclose the estimated fair value of financial instruments for which it is practicable to estimate fair value. Fair value estimates are subjective in nature, involving uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Non-financial instruments are excluded from fair value of financial instrument disclosure requirements. The following methods and assumptions are used by the Company in estimating fair value disclosures for its financial instruments, all of which are issued or held for purposes other than trading.
Cash and Cash Equivalents, Non-interest-Bearing Deposits and Demand Deposits. The carrying amounts approximate fair value due to the short maturity of the instruments. The fair value of deposits with no stated maturity, such as interest checking, savings and money market accounts, is equal to the amount payable on demand at the reporting date.
Investment Securities Available for Sale. The fair value of the Company’s securities equals the quoted market price.
Federal Reserve Bank and Federal Home Loan Bank Stock. The carrying amount of FRB and FHLB stock is their cost, which approximates fair value.
Loans held for sale. The fair value of the Company’s loans held for sale is stated as the lower of cost or market value of the loans.
Participating interests in mortgage loans, Loans and leases held for investment. Fair values of these assets are estimated by discounting future cash flow payment streams using rates at which current loans to borrowers with similar credit ratings and similar loan maturities are being made.
Accrued Interest Receivable. The fair value of accrued interest receivable equals the amount receivable due to the current nature of the amounts receivable.
Derivative Financial Instruments. The fair value of the Company’s derivatives equals the quoted market price.
Interest-Bearing Deposits. Fair values of interest-bearing deposit liabilities are estimated by discounting future cash flow payment streams using rates at which comparable current deposits with comparable maturities are being issued. The intangible value of long-term customer relationships with depositors is not taken into account in the fair values disclosed.
Borrowings and Advances. The carrying amount of short-term borrowings approximates fair value due to the short maturity and the instruments’ floating interest rates, which are tied to market conditions. The fair values of long-term borrowings are estimated by discounting future cash flow payment streams using rates at which comparable borrowings are currently being offered.
Accrued Interest Payable. The fair value of accrued interest payable equals the amount payable due to the current nature of the amounts payable.
Guaranteed Preferred Beneficial Interests In Company’s Subordinated Debentures. The fair values of the Company’s subordinated debentures are estimated by discounting future cash flow payment streams using discount rates estimated to reflect those at which comparable instruments could currently be offered.
Financial Instruments with Off-Balance-Sheet Risk. The fair values of the Company’s commitments to extend credit and commercial and standby letters of credit are estimated using fees currently charged to enter into similar agreements.
Derivative Financial Instruments
Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), as amended and interpreted, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. As required by SFAS 133, the Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.
All derivative instruments that qualify for specific hedge accounting are recorded at fair value and classified either as a hedge of the fair value of a recognized asset or liability (“fair value” hedge) or as a hedge of the variability of
cash flows to be received or paid related to a recognized asset or liability or a forecasted transaction (“cash flow” hedge). All relationships between hedging instruments and hedged items are formally documented, including the risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as hedges to specific assets or liabilities on the balance sheet.
Changes in the fair value of a derivative that is highly effective and designated as a fair value hedge and the offsetting changes in the fair value of the hedged item are recorded in income. Changes in the fair value of a derivative that is highly effective and designated as a cash flow hedge are recognized in other comprehensive income until income from the cash flows of the hedged item are recognized. The Company performs an assessment, both at the inception of the hedge and on a quarterly basis thereafter, to determine whether these derivatives are highly effective in offsetting changes in the value of the hedged items. Any change in fair value resulting from hedge ineffectiveness is immediately recorded in income.
Revenue Recognition
The Company recognizes revenue on an accrual basis for interest and dividend income on loans, investment securities, Federal funds sold and interest bearing cash and cash equivalent accounts. Non-interest income is recognized when it has been realized and has been earned. In accordance with existing accounting and industry standards, as well as guidance issued by the Securities and Exchange Commission, the Company considers revenue to be realized or realizable and earned when the following criteria have been met: persuasive evidence of an arrangement exists (generally, there is contractual documentation); delivery has occurred or services have been rendered; the seller’s price to the buyer is fixed or determinable; and collectibility is reasonably assured. Additionally, there can be no outstanding contingencies that could ultimately cause the revenue to be passed back to the payor. In the isolated instances where these criteria have not been met, receipts are generally placed in escrow until such time as they can be recognized as revenue.
Earnings Per Common Share
Basic earnings per share (“EPS”) excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the applicable period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Such potential dilutive instruments include stock options and contingently issuable stock. Note 24 to these consolidated financial statements includes disclosure of the Company’s EPS calculations.
Comprehensive Income
Comprehensive income is the total of net income and other comprehensive income, which for the Company, is generally comprised of unrealized gains and losses on securities available for sale and unrealized gains and losses on hedging instruments qualifying for cash flow hedge accounting treatment pursuant to SFAS 133, as amended. The Company presents consolidated statements of comprehensive income.
Segment Disclosures
BNCCORP segments its operations into separate business activities: banking operations, insurance operations and wealth management operations. Segment disclosures are provided in Note 16 to these consolidated financial statements.
Share-Based Compensation
As of January 1, 2006, the Company adopted SFAS 123R, which requires the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the grant date. The Company adopted SFAS 123R using the modified prospective transition method. In accordance with this method, the Company’s financial statements for prior periods have not been restated to reflect the impact of SFAS 123R.
At December 31, 2006, the Company had three stock-based employee compensation plans, which are described more fully in Note 27 to these consolidated financial statements.
RECENTLY ISSUED OR ADOPTED ACCOUNTING PRONOUNCEMENTS
FIN No. 48, “Accounting for Uncertainty in Income Taxes”, requires that the Company recognize in its financial statements, the impact of a tax position if that position is more likely than not of being sustained on audit based on the technical merits of the position. The provisions of FIN 48 are effective as of January 1, 2007. The adoption of the interpretation will not have a significant effect on the Company’s financial statements.
In March 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 156, Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140. Effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006, an entity is required to recognize a servicing asset or liability each time it undertakes an obligation to service a financial asset. SFAS No. 156 requires that all separately recognized servicing assets and liabilities be initially measured at fair value and permits, but does not require, the subsequent measurement of servicing assets and liabilities at fair value. It also permits a one-time reclassification, at the time of initial adoption, of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under Statement 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity’s exposure to changes in the fair value of servicing assets or liabilities that a servicer elects to subsequently measure at fair value. Separate presentation of servicing assets and liabilities subsequently measured at fair value are required to be disclosed in the statement of financial position. The provisions of SFAS No. 156 were adopted by the Company on January 1, 2007 and did not have a material impact on the Company’s results of operations or financial position.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about the use of fair value to measure assets and liabilities. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. The impact of adopting SFAS No. 157 on January 1, 2008 is not anticipated to have a material impact on the Company’s results of operations or financial position.
REGULATORY ENVIRONMENT
BNCCORP and its subsidiaries are subject to regulations of certain state and federal agencies, including periodic examinations by those regulatory agencies. BNCCORP and the Bank are also subject to minimum regulatory capital requirements. At December 31, 2006, capital levels exceeded minimum capital requirements (see Note 18 to these consolidated financial statements).
RECLASSIFICATIONS
Certain amounts in the financial statements for prior years have been reclassified to conform to the current year’s presentation. These reclassifications had no effect on net income or stockholders’ equity.
NOTE 2. Acquisitions and Divestitures
On March 14, 2007, the Company entered into a purchase and sale agreement with a wholly owned subsidiary of Hub International Limited. Pursuant to the agreement the company expects to sell assets of its insurance agency operations, which have been reported as a segment in Note 16. The transaction is subject to shareholder approval, but is expected to close in the second quarter or early in the third quarter of 2007. In connection with the sale the Company will receive cash proceeds of approximately $37 million and incur costs in excess of $500,000. The following is a summary of the segment results of operations for BNC Insurance for the years ended December 31, (in thousands):
Following is a summary of the balance sheets for BNC Insurance as of December 31, (in thousands):
On May 31, 2006, BNC Insurance acquired substantially all of the assets of an insurance agency located in Phoenix, Arizona. BNCCORP issued 38,485 shares of its common stock in this transaction. The shares were issued as partial consideration for the acquisition. The total purchase price paid for the assets was $2,000,000, of which approximately $1,500,000 was paid in cash and the remainder of which was paid in the shares of BNCCORP common stock. Of the approximately $2.0 million purchase price, approximately $1.1 million was allocated to an identifiable intangible asset and approximately $900,000 was recorded as goodwill. The results of operations of the acquired assets are included in the Company’s consolidated financial statements effective June 1, 2006.
Pursuant to an asset purchase and sale agreement, on December 31, 2005, BNCCORP issued 18,500 shares of common stock to the former owner of an insurance agency for the second installment related to BNC Insurance’s acquisition of certain assets.
NOTE 3. Restrictions on Cash and Cash Equivalents
The Bank is required to maintain reserve balances in cash on hand or with the FRB under the Federal Reserve Act and Federal Reserve Board’s Regulation D. required reserve balances were $25,000 as of December 31, 2006 and 2005.
NOTE 4. Investment Securities Available For Sale
Investment securities have been classified in the consolidated balance sheets according to management’s intent. The Company had no securities designated as trading or held-to-maturity in its portfolio at December 31, 2006 or 2005. The carrying amount of available-for-sale securities and their approximate fair values were as follows as of December 31 (in thousands):
The amortized cost and estimated fair market value of available-for-sale securities classified according to their contractual maturities at December 31, 2006, were as follows (in thousands):
Securities carried at approximately $169.8 million and $214.6 million at December 31, 2006 and 2005, respectively, were pledged as collateral for public and trust deposits and borrowings, including borrowings with the FHLB and repurchase agreements with customers. Sales proceeds and gross realized gains and losses on available-for-sale securities were as follows for the years ended December 31 (in thousands):
The following table shows the Company’s investments’ 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, 2006 (amounts are in thousands):
In reaching the conclusion that the impairments disclosed in the table above are temporary and not other-than-temporary in nature, the Company considered the nature of the securities, the associated guarantees and collateralization, the securities ratings and the level of impairment of the securities. There were eight U.S. government agency mortgage-backed securities with unrealized losses, four issued and guaranteed by GNMA, the other four by FNMA. There were 32 collateralized mortgage obligations with unrealized losses, 30 of which are issued and guaranteed by FNMA or FHLMC and two that were issued and guaranteed by GNMA. The sum of the fair value of the 23 collateralized mortgage obligation positions that have been in a continuous unrealized loss position for 12 months or more as of December 31, 2006 was only 2.76 percent below the sum of their amortized cost. None of the impairments were due to deterioration in credit quality that might result in the non-collection of contractual principal and interest. The cause of the impairments is, in general, attributable to changes in interest rates.
NOTE 5. Federal Reserve Bank and Federal Home Loan Bank Stock
The carrying amounts of FRB and FHLB stock, which approximate their fair values, consisted of the following as of December 31 (in thousands):
There is no contractual maturity on these investments; they represent required regulatory investments.
NOTE 6. Loans and Leases
The composition of loan and leases, including participating interests in mortgage loans was as follows as of December 31 (in thousands):
Geographic Location and Types of Loans
Loans were to borrowers located in the following market areas as of December 31:
Commercial and industrial loan borrowers are generally small- and mid-sized corporations, partnerships and sole proprietors in a wide variety of businesses. Real estate loans are fixed or variable rate and include both amortizing and revolving line-of-credit loans. Real estate mortgage loans include various types of loans for which the Bank holds real property as collateral. Agricultural loans include loans to grain and/or livestock producers, agricultural real estate loans, machinery and equipment and other types of loans. Loans to consumers are both secured and unsecured. Lease financing represents credit to borrowers under direct finance lease obligations. The Bank also extends financing to lease companies, securing the loan with an assignment of lease payments and a security filing against the underlying asset of the lease. These loans are classified as lease financing but are not direct finance lease obligations. Single- and multi-family residential mortgage loans totaling $11.8 and $8.4 million at December 31, 2006 and 2005, respectively, were pledged as collateral for FHLB borrowings. Commercial loans totaling $26.9 and $40.9 million at December 31, 2006 and 2005, respectively, were pledged as collateral for borrowings, including FHLB borrowings.
Concentrations of Credit
The Bank’s credit policies emphasize diversification of risk among industries, geographic areas and borrowers. The only concentrations of loans exceeding 10 percent of total loans at December 31, 2006 were real estate loans, such as loans to non-residential and apartment building operators and lessors of real property ($106.5 million), construction loans ($42.8 million) and mortgage loans in transit ($56.1 million). Loans within these categories are diversified across different types of borrowers, geographically dispersed, and secured by many different types of real estate and other collateral. Participating interests in mortgage loans in transit are collateralized by individual residential loans.
Impaired Loans
As of December 31, the Bank’s recorded investment in impaired loans and the related valuation allowance was as follows (in thousands):
Impaired loans generally include loans on which management believes it is probable that the Bank will not be able to collect all amounts due in accordance with the terms of the loan agreement and which are analyzed for a specific reserve allowance. The Bank generally considers all loans risk-graded substandard and doubtful, as well as nonaccrual and restructured loans, as impaired loans.
The valuation allowance on impaired loans is included in the Bank’s allowance for credit losses. The average recorded investment in impaired loans, and approximate interest income recognized for such loans, were as follows for the years ended December 31 (amounts in thousands):
Past Due, Nonaccrual and Restructured Loans
As of December 31, 2006 and 2005, the Bank had $0 of loans past due 90 days or more and still accruing interest. As of December 31, 2006 and 2005, the Bank had $100,000 and $143,000, respectively, of nonaccrual loans and no restructured loans (included as impaired loans above). The following table indicates the effect on income if interest on such loans outstanding at year end had been recognized at original contractual rates during the year ended December 31 (in thousands):
Loans to Related Parties
Note 22 to these consolidated financial statements includes information relating to loans to executive officers, directors, principal shareholders and associates of such persons.
Leases
The Bank extends credit to borrowers under direct finance lease obligations. The direct finance lease obligations are stated at their outstanding principal amount net of unearned income and net unamortized deferred fees and costs. At December 31, 2006, the total minimum annual lease payments for direct finance lease obligations with remaining terms of greater than one year were as follows (in thousands):
NOTE 7. Allowance for Credit Losses
Transactions in the allowance for credit losses were as follows for the years ended December 31 (in thousands):
NOTE 8. Premises and Equipment
Premises and equipment consisted of the following at December 31 (in thousands):
Depreciation and amortization expense on premises and equipment charged to continuing operations totaled approximately $1.8, $1.6 and $1.6 million for the years ended December 31, 2006, 2005 and 2004, respectively.
NOTE 9. Goodwill and Other Intangible Assets
The Company completed its annual goodwill impairment assessment during the second quarter of 2006 and concluded that goodwill and other intangibles were not impaired as of June 30, 2006. No subsequent events have occurred that would change the conclusion reached.
The gross carrying amount of intangible assets and the associated accumulated amortization at December 31, 2006 is presented in the table below (in thousands):
Amortization expense for intangible assets was $1.0, $1.2 and $1.3 million for the years ended December 31, 2006, 2005 and 2004, respectively.
The following table shows the estimated amortization expense, for the next five years, for amortized intangible assets existing on the Company’s books at December 31, 2006 (in thousands). Projections of amortization expense are based on existing asset balances as of December 31, 2006. Actual amortization expense may differ significantly depending upon changes in market conditions:
The following table shows the change in goodwill, by reporting segment, between January 1, 2006 and December 31, 2006 (in thousands):
NOTE 10. Deposits
The scheduled maturities of time deposits as of December 31, 2006 are as follows (in thousands):
At December 31, 2006 and 2005, the Bank had $200,000 and $1.9 million, respectively, of time deposits that had been acquired in the national market and $0 and $24.3 million, respectively, of time deposits that had been acquired through a broker.
Deposits Received from Related Parties
Note 22 to these consolidated financial statements includes information relating to deposits received from executive officers, directors, principal shareholders and associates of such persons.
NOTE 11. Short-Term Borrowings
The following table sets forth selected information for short-term borrowings (borrowings with an original maturity of less than one year) as of December 31 (in thousands):
The weighted average interest rate on short-term borrowings outstanding as of December 31, 2006 and 2005 was 4.81% and 3.98% respectively.
Customer repurchase agreements are used by the Bank to acquire funds from customers where the customers are required, or desire, to have their funds supported by collateral consisting of government, government agency or other types of securities. The repurchase agreement is a promise to sell these securities to a customer at a certain price and repurchase them at a future date at that same price plus interest accrued at an agreed upon rate. The Bank uses customer repurchase agreements in its liquidity plan as well as an accommodation to customers. At December 31, 2006, $7.4 million of securities sold under repurchase agreements, with a weighted average interest rate of 4.75%, maturing in 2007, were collateralized by government agency collateralized mortgage obligations having a carrying value of $22.3 million, a market value of $22.3 million and unamortized principal balances of $22.8 million.
As of December 31, 2006, the Bank had established three additional federal funds purchased lines with correspondent banks, totaling $17.5 million. At December 31, 2006, the Bank had not drawn on these lines. The lines, if drawn upon, mature daily with interest rates that float at the Federal funds rate. The Bank has also been approved for repurchase agreement lines of up to $100.0 million with a major financial institution. The lines, if utilized, would be collateralized by investment securities.
NOTE 12. Federal Home Loan Bank Advances
FHLB advances consisted of the following at December 31 (amounts are in thousands):
Some of the advances listed above have call provisions that allow the FHLB to request that the advance be paid back or refinanced at the rates then being offered by the FHLB. As of December 31, 2006, the Bank had $62.2 million of callable FHLB advances all callable quarterly during the first quarter of 2007.
At December 31, 2006 the advances from the FHLB were collateralized by the Bank’s mortgage loans with unamortized principal balances of approximately $38.7 million resulting in a FHLB collateral equivalent of $24.5 million. In addition, the advances from the FHLB were collateralized by securities with unamortized principal balances of approximately $111.3 million. The Bank has the ability to draw additional advances of $68.4 million based upon the mortgage loans and securities that are currently pledged, subject to a requirement to purchase additional FHLB stock.
NOTE 13. Long-Term Borrowings
The following table sets forth selected information for long-term borrowings (borrowings with an original maturity of greater than one year) as of December 31 (in thousands):
The maturity schedule of the above note payable is as follows:
$
$
The loan from the Bank of North Dakota includes various covenants that are primarily operational rather than financial in nature. As of December 31, 2006, the Company was in compliance with these covenants.
BNCCORP also has a $6.0 million established line of credit with the Bank of North Dakota. Interest is payable annually at 30-day LIBOR plus 2.20 percent; maturity is October 20, 2008. No funds were drawn on the line as of December 31, 2006 or 2005.
NOTE 14. Guaranteed Preferred Beneficial Interest’s in Company’s Subordinated Debentures
In July 2001, BNCCORP established a special purpose trust, BNC Statutory Trust II, for the purpose of issuing $15.0 million of floating rate trust preferred securities. The floating rate trust preferred securities were issued at an initial rate of 7.29 percent and adjust quarterly to a rate equal to three-month LIBOR plus 3.58 percent. The interest rate at December 31, 2006 was 8.96 percent. Prior to July 31, 2011, the rate shall not exceed 12.50 percent. The proceeds from the issuance, together with the proceeds of the related issuance of $464,000 of common securities of the trust, were invested in $15.5 million of junior subordinated deferrable interest debentures of BNCCORP. The trust preferred securities are subject to mandatory redemption on July 31, 2031. On or after July 31, 2006, the trust preferred securities may be redeemed and the corresponding debentures may be prepaid at the option of BNCCORP, subject to Federal Reserve Board approval, at declining redemption prices.
In July 2000, BNCCORP established a special purpose trust, BNC Capital Trust I, for the purpose of issuing $7.5 million of 12.045 percent trust preferred securities. The proceeds from the issuance, together with the proceeds of the related issuance of $232,000 of 12.045 percent common securities of the trust, were invested in $7.7 million of 12.045 percent junior subordinated deferrable interest debentures of BNCCORP. The trust preferred securities are subject to mandatory redemption on July 19, 2030. On or after July 19, 2010, the trust preferred securities may
be redeemed and the corresponding debentures may be prepaid at the option of BNCCORP, subject to Federal Reserve Board approval, at declining redemption prices.
The trust preferred securities may provide BNCCORP with a more cost-effective means of obtaining Tier 1 capital for regulatory purposes than if BNCCORP itself were to issue preferred stock because BNCCORP is allowed to deduct, for income tax purposes, amounts paid in respect of the debentures and ultimately distributed to the holders of the trust preferred securities. The sole assets of the special purpose trusts are the debentures. BNCCORP owns all of the common securities of the trusts. The common securities and debentures, along with the related income effects, are eliminated within the consolidated financial statements. The preferred securities issued by the trust rank senior to the common securities. For presentation in the consolidated balance sheet, the securities are shown net of discount and direct issuance costs. Concurrent with the issuance of the preferred securities by the trusts, BNCCORP fully and unconditionally guaranteed all obligations of the special purpose trusts related to the trust preferred securities.
The subordinated debentures are presented as debt in the consolidated financial statements. The subordinated debentures qualify as Tier 1 capital for regulatory capital purposes, up to a certain allowed amount. Any excess over the amount allowed in Tier 1 capital can be included in Tier 2 capital, up to certain allowed amounts. (See Note 18 for further discussion of the impact of the subordinated debentures on the Company’s consolidated regulatory capital calculations).
NOTE 15. Stockholders’ Equity
BNCCORP and the Bank are subject to certain minimum capital requirements (see Note 18 to these consolidated financial statements). BNCCORP is also subject to certain restrictions on the amount of dividends it may declare without prior regulatory approval in accordance with the Federal Reserve Act. In addition, certain regulatory restrictions exist regarding the ability of the Bank to transfer funds to BNCCORP in the form of cash dividends. Approval of the Office of the Comptroller of the Currency (“OCC”), the Bank’s principal regulator, is required for the Bank to pay dividends to BNCCORP in excess of the Bank’s net profits from the current year plus retained net profits for the preceding two years. At December 31, 2006 approximately $11.9 million of retained earnings were available for Bank dividend declaration without prior regulatory approval.
On September 21, 2005, BNCCORP issued 575,000 shares of its common stock in a private placement offering resulting in gross proceeds of $6.61 million. Sandler O’Neill & Partners, L.P. served as the exclusive placement agent and received a fee of 7.00 percent of the gross proceeds, plus reasonable out-of-pocket expenses. The net proceeds were approximately $5.84 million.
On April 27, 2005, BNCCORP repurchased 100 shares of its noncumulative preferred stock from a trust controlled by Richard W. Milne, Jr. for cash. The repurchased shares had a preferential noncumulative dividend at an annual rate of 8.00 percent and a preferred liquidation value of $10,000 per share.
On February 15, 2005, BNCCORP repurchased 25 shares of its noncumulative preferred stock from trusts controlled by Richard W. Milne, Jr. and Terrence M. Scali for cash. The repurchased shares had a preferential noncumulative dividend at an annual rate of 8.00 percent and a preferred liquidation value of $10,000 per share.
On May 30, 2001, BNCCORP’s Board of Directors (the “Board”) adopted a rights plan intended to protect stockholder interests in the event BNCCORP becomes the subject of a takeover initiative that BNCCORP’s Board believes could deny BNCCORP’s stockholders the full value of their investment. This plan does not prohibit the Board from considering any offer that it deems advantageous to its stockholders. BNCCORP has no knowledge that anyone is considering a takeover.
The rights were issued to each common stockholder of record on May 30, 2001, and they will be exercisable only if a person acquires, or announces a tender offer that would result in ownership of, 15 percent or more of BNCCORP’s outstanding common stock. The rights will expire on May 30, 2011, unless redeemed or exchanged at an earlier date.
NOTE 16. Segment Disclosures
The Company segments its operations into three separate business activities, based on the nature of the products and services for each segment: banking operations, insurance operations and wealth management operations.
Banking operations provide traditional banking services to individuals and small- and mid-sized businesses, such as accepting deposits, consumer lending, mortgage banking activities and making commercial loans. The mortgage and commercial banking activities include the origination and purchase of loans as well as the sale to and servicing of commercial loans for other institutions.
Insurance operations provide a full range of insurance brokerage services including commercial insurance, surety bonds, employee benefits-related insurance, personal insurance and claims management.
Wealth management operations provide securities brokerage, trust and other financial services to individuals and businesses. Brokerage investment options include individual equities, fixed income investments and mutual funds. Trust and financial services provide a wide array of trust and other financial services including personal trust administration services, financial, tax, business and estate planning, estate administration, agency accounts, employee benefit plan design and administration, individual retirement accounts (“IRAs”), including custodial self-directed IRAs, asset management, tax preparation, accounting and payroll services.
The accounting policies of the three segments are the same as those described in the summary of significant accounting policies included in Note 1 to these consolidated financial statements.
The Company’s financial information for each segment is derived from the internal profitability reporting system used by management to monitor and manage the financial performance of the Company. The operating segments have been determined by how executive management has organized the Company’s business for making operating decisions and assessing performance.
The following tables present segment profit or loss, assets and a reconciliation of segment information as of, and for the years ended December 31 (in thousands):
NOTE 17. Derivatives
The Company entered into an interest rate floor agreement during the first quarter of 2006. The $50.0 million prime rate interest rate floor has an effective date of January 9, 2006 and a maturity date of January 9, 2010. The floor is designated as a cash flow hedge. The terms of the floor result in the Company receiving payments when the prime interest rate is below the strike rate of 7 percent. At December 31, the prime rate was 8.25 percent and the Company was not entitled to receive a payment under the terms of the agreement. The floor was used to hedge the variable cash flows associated with $50.0 million of the Company’s existing variable-rate loans.
At December 31, 2006, the fair value of the floor was $188,000, which was included in other assets. The change in unrealized losses of $363,000, net, during the twelve months ended December 31, 2006, for the derivative designated as a cash flow hedge, is separately disclosed in the statement of changes in comprehensive income. No hedge ineffectiveness on the cash flow hedge was recognized during the year. The entire loss on the derivative was included in the assessment of the effectiveness.
NOTE 18. Regulatory Capital
BNCCORP and the Bank are 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 Company’s financial results. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, BNCCORP and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classifications of BNCCORP and the Bank are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by the regulations to ensure capital adequacy require BNCCORP and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets. Under current regulatory capital regulations, BNCCORP’s subordinated debentures qualify as Tier 1 capital for purposes of the consolidated capital calculations up to 25 percent of Tier 1 capital prior to the deduction of intangible assets. The remainder of the subordinated debentures qualify as Tier 2 capital provided that the total of Tier 2 capital does not exceed Tier 1 capital. As of December 31, 2006, $19.2 million of the subordinated debentures qualified as Tier 1 capital with the remaining $3.5 million qualifying as Tier 2 capital. As of December 31, 2005, $17.7 million of the subordinated debentures qualified as Tier 1 capital with the remaining $4.9 million qualifying as Tier 2 capital.
As of December 31, 2006, the most recent notifications from the OCC 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 1 risk-based and Tier 1 leverage ratios as set forth in the table that follows. There are no conditions or events since that notification that management believes have changed the institution’s category. Actual capital amounts and ratios of BNCCORP and the Bank as of December 31 are also presented in the tables (amounts are in thousands):
The change in capital ratios over the 12-month period ended December 31, 2006 reflected a decrease in total risk-weighted assets, for the consolidated group, to $493.6 million at December 31, 2006 from $495.9 million at December 31, 2005 and, for the bank, to $493.6 million at December 31, 2006 from $496.1 million at December 31, 2005. Earnings also contributed to the increase in capital ratios.
NOTE 19. Fair Value of Financial Instruments
The estimated fair values of the Company’s financial instruments are as follows as of December 31
(in thousands):
NOTE 20. Financial Instruments with Off-Balance-Sheet Risk
In the normal course of business, the Company is a party to various financial instruments with off-balance-sheet risk, primarily to meet the needs of its customers as well as to manage its interest rate risk. These instruments, which are issued by the Company for purposes other than trading, carry varying degrees of credit, interest rate or liquidity risk in excess of the amount reflected in the consolidated balance sheets.
Commitments to Extend Credit
Commitments to extend credit are agreements to lend to a customer, provided there is no violation of any condition in the contract, and are legally binding and generally have fixed expiration dates or other termination clauses and may require payment of a fee. The contractual amount represents the Bank’s exposure to credit loss in the event of default by the borrower; however, at December 31, 2006 based on current information, no losses were anticipated as a result of these commitments. The Bank manages this credit risk by using the same credit policies it applies to loans. Collateral is obtained to secure commitments based on management’s credit assessment of the borrower. The collateral may include marketable securities, receivables, inventory, equipment and real estate. Since the Bank expects many of the commitments to expire without being drawn, total
commitment amounts do not necessarily represent the Bank’s future liquidity requirements related to such commitments.
The participating interests in mortgage loans has two counterparty relationships. There is no limit to our loan commitment in one of these relationships.
Standby and Commercial Letters of Credit
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Commercial letters of credit are issued on behalf of customers to ensure payment or collection in connection with trade transactions. In the event of a customer’s nonperformance, the Bank’s credit loss exposure is the same as in any extension of credit, up to the letter’s contractual amount; however, at December 31, 2006, based on current information, no losses were anticipated as a result of these commitments. Management assesses the borrower’s credit to determine the necessary collateral, which may include marketable securities, real estate, accounts receivable and inventory. Since the conditions requiring the Bank to fund letters of credit may not occur, the Bank expects its liquidity requirements related to such letters of credit to be less than the total outstanding commitments.
The contractual amounts of these financial instruments were as follows as of December 31 (in thousands):
NOTE 21. Guarantees and Contingent Consideration
Guaranteed Preferred Beneficial Interests In Company’s Subordinated Debentures
BNCCORP, concurrent with the issuance of preferred securities by BNC Capital Trust I and by BNC Statutory Trust II, fully and unconditionally guaranteed all obligations of the special purpose trusts related to the trust preferred securities (See Note 14 for a description of the trusts). There are no recourse provisions associated with these guarantees that would enable BNCCORP to recover from third parties any of the amounts paid under the guarantees and there are no assets held either as collateral or by third parties that, upon the occurrence of any triggering event or condition under the guarantees, BNCCORP could obtain and liquidate to recover all or a portion of the amounts paid under the guarantees.
Performance Standby Letters of Credit
As of December 31, 2006 and 2005, the Bank had outstanding $5.7 million and $9.7 million of performance standby letters of credit. Performance standby letters of credit are irrevocable obligations to the beneficiary on the part of the Bank to make payment on account of any default by the account party in the performance of a nonfinancial or commercial obligation. Under these arrangements, the Bank could, in the event of the account party’s nonperformance, be required to pay a maximum of the amount of issued letters of credit. The Bank has recourse against the account party up to and including the amount of the performance standby letter of credit. The Bank evaluates each account party’s creditworthiness on a case-by-case basis and the amount of collateral obtained varies and is based on management’s credit evaluation of the account party. These guarantees are recognized as liabilities at their fair values as they are modified or entered into, in accordance with FIN 45.
Financial Standby Letters of Credit
As of December 31, 2006 and 2005, the Bank had outstanding $46.4 and $36.3 million of financial standby letters of credit. $40.0 million was participated to other financial institutions at December 31, 2006. Financial standby letters of credit are irrevocable obligations to the beneficiary on the part of the Bank to repay money for the account of the account party or to make payment on account of any indebtedness undertaken by the account party, in the event that the account party fails to fulfill its obligation to the beneficiary. Under these arrangements, the Bank could, in the event of the account party’s nonperformance, be required to pay a maximum of the amount of issued letters of credit. The Bank has recourse against the account party up to and including the amount of the financial standby letter of credit. The Bank evaluates each account party’s creditworthiness on a case-by-case
basis and the amount of collateral obtained varies and is based on management’s credit evaluation of the account party. These guarantees are recognized as liabilities at their fair values as they are modified or entered into, in accordance with FIN 45.
NOTE 22. Related-Party/Affiliate Transactions
The Bank has entered into transactions with related parties, such as opening deposit accounts for and extending credit to, employees of the Company. In the opinion of management, such transactions have been fair and reasonable to the Bank and have been entered into under terms and conditions substantially the same as those offered by the Bank to unrelated parties.
In the normal course of business, loans are granted to, and deposits are received from, executive officers, directors, principal stockholders and associates of such persons. The aggregate dollar amount of these loans, which exceeded $60,000, were $1.3 million and $2.7 million at December 31, 2006 and 2005, respectively. During 2006, there was one loan, which was originated and subsequently sold for $1.0 million. The total amount of deposits received from these parties was $1.4 million and $2.9 million at December 31, 2006 and 2005, respectively. Loans to, and deposits received from, these parties were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collection. See Note 15 for additional related party transaction that occurred.
The Federal Reserve Act limits amounts of, and requires collateral on, extensions of credit by the Bank to BNCCORP, and with certain exceptions, its non-bank affiliates. There are also restrictions on the amounts of investment by the Bank in stocks and other subsidiaries of BNCCORP and such affiliates and restrictions on the acceptance of their securities as collateral for loans by the Bank. As of December 31, 2006, BNCCORP and its affiliates were in compliance with these requirements.
NOTE 23. Income Taxes
The provision (benefit) for income taxes consists of the following for the years ended December 31 (in thousands):
The provision for federal income taxes expected at the statutory rate differs from the actual provision for the years ended December 31 (in thousands):
Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that result in significant portions of the Company’s deferred tax assets and liabilities are as follows as of December 31 (in thousands):
The valuation allowance primarily represents the tax benefits of a certain state net operating loss carryforward which may expire without being utilized. During 2006, the valuation allowance decreased $29,000 due to the expiration of a portion of these benefits.
NOTE 24. Earnings Per Share
The following table shows the amounts used in computing EPS and the effect on weighted average number of shares of potential dilutive common stock issuances:
The following options, with exercise prices ranging from $17.00 to $17.75, were outstanding during the periods indicated but were not included in the computation of diluted EPS because their exercise prices were higher than the average price of the Company’s common stock for the period:
NOTE 25. Benefit Plans
BNCCORP has a qualified, tax-exempt 401(k) savings plan covering all employees of BNCCORP and its subsidiaries who meet specified age and service requirements. Under the plan, eligible employees may elect to defer up to 50 percent of compensation each year not to exceed the dollar limit set by law. At their discretion, BNCCORP and its subsidiaries provide matching contributions of up to 50 percent of employee deferrals up to a maximum employer contribution of five percent of employee compensation. Generally, all participant contributions and earnings are fully and immediately vested. The Company makes its matching contribution during the first calendar quarter following the last day of each calendar year and an employee must be employed by the Company on the last day of the calendar year in order to receive the current year’s employer match. The anticipated matching contribution is expensed monthly over the course of the calendar year based on employee contributions made throughout the year. The Company made matching contributions of $551,000, $465,000 and $368,000 for 2006, 2005 and 2004, respectively. In addition, the Company made an employer discretionary contribution of $5,000 for 2005. Under the investment options available under the 401(k) savings plan, employees may elect to invest their salary deferrals in BNCCORP common stock. At December 31, 2006, the assets in the plan totaled $16.7 million and included $2.2 million (172,958 shares) invested in BNCCORP common stock.
NOTE 26. Commitments and Contingencies
Employment Agreements and Noncompete Covenants
The Company has entered into employment agreements with its chairman of the board and president and chief executive officer (the “Executives”). The Executives will be paid minimum annual salaries throughout the terms of the agreements and annual incentive bonuses as may, from time to time, be fixed by the Board. The Executives will also be provided with benefits under any employee benefit plan maintained by BNCCORP for its employees generally, or for its senior executive officers in particular, on the same terms as are applicable to other senior executives of BNCCORP. Under the agreements, if their status as employees with the Company is terminated for any reason other than death, disability, cause, as defined in the agreements, or if they terminate their employment for good reason, as defined in the agreements, or following a change in control of BNCCORP, as defined in the agreements, then the Executives will be paid a lump-sum amount equal to three times their current annual compensation.
In 2006, the company entered into an employment agreement with the chairman and president of BNC Insurance. The Insurance Executive will be paid a minimum annual salary throughout the term of the agreement and annual incentive bonuses as may, from time to time, be fixed by the Board. The Insurance Executive will also be provided with benefits under any employment benefit plan maintained by BNCCORP for its employees generally, or for its senior executive officers in particular, on the same terms as are applicable to other senior executives of BNCCORP. Under the agreements, if their status as employees with the Company is terminated for any reason other than death, disability, cause, as defined in the agreements, or if they terminate their employment for good reason, as defined in the agreements, or following a change in control of BNCCORP, as defined in the agreements, then the Executive will be paid a lump-sum amount equal to two times his current annual compensation.
Leases
The Bank has entered into operating lease agreements for certain facilities and equipment used in its operations. Rent expense for the years ended December 31, 2006, 2005 and 2004, was $1.1 million, $1.0 million and
$993,000, respectively, for facilities, and $225,000, $198,000 and $157,000, respectively, for equipment and other items. At December 31, 2006, the total minimum annual base lease payments for operating leases were as follows (amounts are in thousands):
NOTE 27. Share-Based Compensation
Share-Based Compensation
The Company has three share-based plans for certain key employees and directors whereby shares of common stock have been reserved for awards in the form of stock options or restricted stock awards. Under the 1995 Stock Incentive Plan, the aggregate number of options and shares granted can not exceed 250,000 shares. Under the 2002 Stock Incentive Plan, the aggregate number of shares can not exceed 125,000 shares. Under the 2006 Stock Incentive Plan, the aggregate number of shares can not exceed 200,000 shares. Pursuant to each plan, the compensation committee may grant options at prices equal to the fair value of the stock at the grant date.
As of January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (FAS 123R), which requires the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the grant date. The Company utilizes the Black-Scholes valuation model to determine the fair value of the stock options based on certain assumptions related to expected stock price volatility, expected option life, risk-free interest rate and dividend yield. The Company recognized share-based compensation expense of $338,000 for the 12 months ended December 31, 2006, and $214,000 for the twelve months ended December 31, 2005. No stock options were granted during these periods.
At December 31, 2006, the Company had $1.1 million of unamortized restricted stock compensation. At December 31, 2005 the Company had approximately $627,000 of unamortized restricted stock compensation. Restricted shares of stock issued to employees in the third quarter of 2006 have vesting and amortization periods of at least three years. At December 31, 2006 and December 31, 2005, the company had approximately $0 and $12,000, respectively, of unrecognized share-based compensation expense related to stock options.
Prior to January 1, 2006, the company accounted for the stock options under APB 25, accounting for employee share options at intrinsic value, which provided that no compensation expense was charged for options granted at an exercise price equal to market value of the stock on the grant date. If FAS 123R had been applied for the twelve months ended December 31, 2005 and 2004, the Company’s pro forma net income and earnings per share would have been as follows:
Following is a summary of restricted stock transactions for the years ended December 31:
Following is a summary of stock option transactions for the years ended December 31:
The fair value of each option granted was estimated on the grant date using the Black-Scholes option pricing model. The following assumptions were made in estimating fair value of options granted for the year ended December 31, 2004:
Following is a summary of the status of options outstanding at December 31, 2006:
NOTE 28. Condensed Financial Information-Parent Company Only
Condensed financial information of BNCCORP on a parent company only basis is as follows:
Parent Company Only
Condensed Balance Sheets
As of December 31
(In thousands, except per share data)
Parent Company Only
Condensed Statements of Income
For the Years Ended December 31
(In thousands)
Parent Company Only
Condensed Statements of Cash Flows
For the Years Ended December 31
(In thousands)
NOTE 29. Quarterly Financial Data
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A(T)
Item 9A(T) Controls and Procedures
Quarterly evaluation of the Company’s Disclosure Controls and Internal Controls
As of the end of the period covered by this annual report on Form 10-K, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures and our internal control over financial reporting. This evaluation was done under the supervision and with the participation of management, including our President and Chief Executive Officer and Chief Financial Officer. Rules adopted by the SEC require that in this section of the annual report we present the conclusions of the CEO and the CFO about the effectiveness of our disclosure controls and any change in our internal controls that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls based on and as of the date of the controls evaluation.
CEO and CFO Certifications
Appearing, as Exhibits 31.1 and 31.2 to this annual report, there are “Certifications” of the CEO and the CFO. The Certifications are required in accordance with the Exchange Act and the SEC’s implementing Rule 13a-14. This section of the annual report is the information concerning the controls evaluation referred to in the Rule 13a-14 Certifications and this information should be read in conjunction with the Rule 13a-14 Certifications for a more complete understanding of the topics presented.
Disclosure Controls and Internal Controls
Disclosure controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this annual report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls are also designed with the objective of ensuring that material information relating to BNCCORP, including its consolidated subsidiaries, is made known to the CEO and CFO by others within those entities, particularly during the period in which the applicable report is being prepared. Internal controls are procedures which are designed with the objective of providing reasonable assurance that (1) our transactions are properly authorized; (2) our assets are safeguarded against unauthorized or improper use; and (3) our transactions are properly recorded and reported, all to permit the preparation of our financial statements in conformity with accounting principles generally accepted in the United States.
Limitations on the Effectiveness of Controls
Our management, including the CEO and CFO, does not expect that our disclosure controls or our internal controls will prevent all error and all fraud. A control system, no matter how well developed and operated, can provide only reasonable assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and not be detected.
Scope of the Controls Evaluation
The CEO/CFO evaluation of our disclosure controls and our internal controls included a review of the controls’ objectives and design, our controls’ implementation and the effect of the controls on the information generated for use in this annual report. In the course of the controls evaluation, we sought to identify data errors, controls problems or acts of fraud and to confirm that appropriate corrective action, including process improvements, were being undertaken. This type of evaluation is done on a quarterly basis so that the conclusions concerning controls effectiveness can be reported in our quarterly reports on Form 10-Q and annual report on Form 10-K. Our internal controls are also evaluated on an ongoing basis by our internal audit and credit review departments in connection with their audit and review activities. The overall goals of these various evaluation activities are to monitor our disclosure controls and our internal controls and to make modifications as necessary. Our external auditors also review Internal Controls in connection with their audit and review activities. Our intent in this regard is that the disclosure controls and internal controls will be maintained as dynamic systems that change (including with improvements and corrections) as conditions warrant.
Among other matters, we sought in our evaluation to determine whether there were any “significant deficiencies” or “material weaknesses” in our internal controls which are reasonably likely to adversely affect our ability to record, process, summarize and report financial information, or whether we had identified any acts of fraud, involving management or other employees who have a significant role in our internal controls. This information was important both for the controls evaluation generally and because item 5 in the Rule 13a-14 Certifications of the CEO and CFO require that the CEO and CFO disclose that information to our Board’s audit committee and to our independent auditors and to report on related matters in this section of the annual report. In the professional auditing literature, “significant deficiencies” are referred to as “reportable conditions.” These are control issues that could have a significant adverse effect on the ability to record, process, summarize and report financial data in the financial statements. A “material weakness” is defined in the auditing literature as a particularly serious reportable condition where the internal control does not reduce to a relatively low level the risk that misstatements caused by error or fraud may occur in amounts that would be material in relation to the financial statements and not be detected within a timely period by employees in the normal course of performing their assigned functions. We also sought to deal with other controls matters in the controls evaluation, and in each case if a problem was identified, we considered what revision, improvement and/or correction to make in accordance with our ongoing procedures.
Conclusions
Based upon the Controls Evaluation, our CEO and CFO have concluded that, subject to the limitations noted above, our Disclosure Controls are effective to ensure that material information relating to BNCCORP and its consolidated subsidiaries is made known to management, including the CEO and CFO, particularly during the period when our periodic reports are being prepared, and that our internal controls are effective to provide reasonable assurance that our financial statements are fairly presented in conformity with accounting principles generally accepted in the United States. Additionally, there has been no change in our internal controls that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls.
Item 9B.
Item 9B. Other Information
None
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Information called for by this item will be included in our definitive Proxy Statement prepared in connection with the 2007 Annual Meeting of Stockholders and is incorporated herein by reference.
Code of Ethics and Business Conduct
We have adopted a code of ethics and business conduct that applies to all our directors, officers, employees and representatives. This code is publicly available on our website at www.bnccorp.com. Amendments to the code of ethics and business conduct and any grant of a waiver from a provision of the code requiring disclosure under applicable SEC rules will be disclosed on our website. These materials may also be requested in print, without charge, by writing to our Investor Relations department at BNCCORP, Inc., 322 East Main, P.O. Box 4050, Bismarck, North Dakota 58502. The information posted on or available through our website is not incorporated into this Annual Report on Form 10-K.
Item 11.
Item 11. Executive Compensation
Information called for by this item will be included in our definitive Proxy Statement prepared in connection with the 2007 Annual Meeting of Stockholders and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information called for by this item will be included in our definitive Proxy Statement prepared in connection with the 2007 Annual Meeting of Stockholders and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information called for by this item will be included in our definitive Proxy Statement prepared in connection with the 2007 Annual Meeting of Stockholders and is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services
Information called for by this item will be included in our definitive Proxy Statement prepared in connection with the 2007 Annual Meeting of Stockholders and is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a)
Exhibits.
Reference is made to the Exhibit Index beginning on page E-1 hereby. We will furnish to any eligible stockholder, upon written request of such stockholder, a copy of any exhibit listed upon the payment of a reasonable fee equal to our expenses in furnishing such exhibit.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 27, 2007.
BNCCORP, Inc
By:
/s/ Gregory K. Cleveland
Gregory K. Cleveland
President and Chief Executive 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/ Tracy Scott
Tracy Scott
Chairman of the Board and Director
March 27, 2007
/s/ Gregory K. Cleveland
March 27, 2007
Gregory K. Cleveland
President, Chief Executive Officer and Director (Principal Executive Officer)
/s/ Timothy J. Franz
March 27, 2007
Timothy J. Franz
Chief Financial Officer and Director
(Principal Financial Officer)
(Principal Accounting Officer)
/s/ Stephen H. Roman
March 27, 2007
Stephen H. Roman
Director
/s/ Gaylen Ghylin
March 27, 2007
Gaylen Ghylin
Director
/s/ Richard M. Johnsen, Jr.
March 27, 2007
Richard M. Johnsen, Jr.
Director
/s/ Mark W. Sheffert
March 27, 2007
Mark W. Sheffert
Director
/s/ Jerry R. Woodcox
March 27, 2007
Jerry R. Woodcox
Director
Exhibit
No.
Exhibit Description
3.1
Certificate of Incorporation of the Company, incorporated by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form SB-2 (Registration No. 33-92369).
3.2
Bylaws of the Company, incorporated by reference to Exhibit 3.1 to the Registrant’s Form 8-K dated January 11, 2006.
4.1
Specimen of Common Stock Certificate, incorporated by reference to Exhibit 4 to Amendment No. 1 to the Registrant’s Registration Statement on Form SB-2 (Registration No. 33-92369).
4.2
Rights Agreement, dated as of May 30, 2001, between BNCCORP, Inc. and American Stock Transfer and Trust Company, as Rights Agent, incorporated by reference to Exhibit 1 to the Registrant’s Form 8-A dated June 5, 2001.
10.1
Form of Indemnity Agreement by and between the Company and each of the Company’s Directors, incorporated by reference to Exhibit 10.1 to the Registrant’s Registration Statement on Form SB-2 (Registration No. 33-92369).
10.2
Form of Employment Agreement between the Company and each of Tracy J. Scott and Gregory K. Cleveland, incorporated by reference to Exhibit 10.2 to the Registrant’s Registration Statement on Form SB-2 (Registration No. 33-92369).
10.3
Form of BNCCORP, Inc. 1995 Stock Incentive Plan, incorporated by reference to Exhibit 10.3 to the Registrant’s Registration Statement on Form SB-2 (Registration No. 33-92369).
10.4
Form of Stock Option Agreement for the Grant of Non-Qualified Stock Options Under the BNCCORP, Inc. 1995 Stock Incentive Plan dated as of June 7, 1995, incorporated by reference to Exhibit 10.5 to the Registrant’s Form 10-KSB dated as of March 29, 1996.
10.5
Junior Subordinated Indenture between BNCCORP, Inc. and First Union National Bank as Trustee dated as of July 12, 2000, incorporated by reference to Exhibit 10.1 to the Registrant’s Form 10-Q dated as of August 2, 2000.
10.6
Guarantee Agreement between BNCCORP, Inc. as Guarantor and First Union National Bank as Guarantee Trustee dated as of July 12, 2000 - BNC Capital Trust I, incorporated by reference to Exhibit 10.2 to the Registrant’s Form 10-Q dated as of August 2, 2000.
10.7
Amended and Restated Trust Agreement among BNCCORP, Inc. as Depositor, First Union National Bank as Property Trustee, First Union Trust Company, National Association as Delaware Trustee and the Administrative Trustees dated as of July 12, 2000 - BNC Capital Trust I, incorporated by reference to the Registrant’s Form 10-Q dated as of August 2, 2000.
10.8
Indenture between BNCCORP, Inc., as issuer, and State Street Bank and Trust Company of Connecticut, National Association, as Trustee, Floating Rate Junior Subordinated Deferrable Interest Debentures Due 2031, dated July 31, 2001, incorporated by reference to Exhibit 10.1 to the Registrant’s Form 10-Q dated as of August 13, 2001.
10.9
Guarantee Agreement by and between BNCCORP, Inc. and State Street Bank and Trust Company of Connecticut, National Association, dated July 31, 2001, incorporated by reference to Exhibit 10.2 to the Registrant’s Form 10-Q dated as of August 13, 2001.
10.10
Amended and Restated Declaration of Trust by and among State Street Bank and Trust Company of Connecticut, National Association, as Institutional Trustee, BNCCORP, Inc., as Sponsor, and Gregory K. Cleveland, Tracy Scott and Brenda L. Rebel, as Administrators, dated July 31, 2001, incorporated by reference to Exhibit 10.3 to the Registrant’s Form 10-Q dated as of August 13, 2001.
10.11
Form of BNCCORP, Inc. 2002 Stock Incentive Plan, incorporated by reference to Appendix A to the Company’s Definitive Proxy Statement dated as of May 17, 2002.
10.12
Form of BNCCORP, Inc. 2006 Stock Incentive Plan, incorporated by reference to Appendix B to the Company’s Definitive Proxy Statement dated as of May 1, 2006.
10.13
Restricted Stock Agreement, incorporated by reference to Exhibit 10.1 to Form 8-K dated August 30, 2006.
10.14
Employment Agreement, dated October 1, 2006, by and between BNC Insurance, Inc., and Richard W. Milne, Jr., incorporated by reference to the registrant’s Form 8-K filed on October 25, 2006.
10.15
Purchase and Sale Agreement among the Company, BNC Insurance Services, Inc., an Arizona corporation and wholly-owned indirect subsidiary of the Company, and Hub International of California Insurance Services, Inc., a California corporation, dated as of March 14, 2007, incorporated by reference to the registrant’s Form 8-K filed on March 15, 2007.
14.1
Code of Ethics and Business Conduct.
21.1
Subsidiaries of Company.
23.1
Consent of Independent Auditors.
31.1
Chief Executive Officer’s Certification Under Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Chief Financial Officer’s Certification Under Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification Under Section 906 of the Sarbanes-Oxley Act of 2002.