10-K405 1 slp242.txt FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2001 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _________ to __________ Commission File Number 0-18166 STATE FINANCIAL SERVICES CORPORATION -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) WISCONSIN 39-1489983 --------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 10708 WEST JANESVILLE ROAD, HALES CORNERS, WISCONSIN 53130 ---------------------------------------------------------- (Address and zip code of principal executive offices) (414) 425-1600 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.10 par value. Preferred Share Purchase Rights. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ---------- --------- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting and non-voting common equity held by nonaffiliates of the registrant as of February 27, 2002 was approximately $80,385,273, based on the following assumptions: (1) the market value of the Common Stock of $12.95 per share which was equal to the closing price on the Nasdaq Stock Market on February 27, 2002; and (2) 6,207,357 shares of Common Stock held by nonaffiliates as of February 27, 2002. As of February 27, 2002, there were 7,788,669 shares of Common Stock issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for 2002 Annual Meeting (to be filed with the Commission under Regulation 14A within 120 days after the registrant's fiscal year end, and upon such filing, to be incorporated by reference into Part III.) INDEX PART I Page ITEM 1. BUSINESS 1 ITEM 2. PROPERTIES 8 ITEM 3. LEGAL PROCEEDINGS 9 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND 9 RELATED STOCKHOLDER MATTERS ITEM 6. SELECTED FINANCIAL DATA 11 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF 12 FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES 28 ABOUT MARKET RISK ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 30 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS 55 ON ACCOUNTING AND FINANCIAL DISCLOSURE PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 55 ITEM 11. EXECUTIVE COMPENSATION 55 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS 55 AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 55 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND 56 REPORTS ON FORM 8-K SIGNATURES 57 EXHIBITS FILED AS PART OF FORM 10-K Exhibit Index PART I ITEM 1. BUSINESS General State Financial Services Corporation, together with its consolidated subsidiaries is hereinafter referred to as the "Company", "SFSC", or "Registrant". SFSC is a Wisconsin corporation organized in 1984 as a bank holding company headquartered in Hales Corners, Wisconsin. The Company owns State Financial Bank, National Association (the "Bank"), which operates through twenty-eight locations in southeastern Wisconsin and northeastern Illinois. Through its banking network, the Company provides commercial and retail banking products, long-term fixed-rate secondary market mortgage origination and brokerage activities. The Company also operates State Financial Insurance Agency. In the third quarter, 2000, the Company consolidated its five bank and thrift charters into one nationally chartered bank. Prior to the consolidation, SFSC owned and operated State Financial Bank (Wisconsin), State Financial Bank-Waterford, State Financial Bank (Illinois), Bank of Northern Illinois, N.A. and Home Federal Savings and Loan Association of Elgin. Forward Looking Statements The Company intends that certain matters discussed in this Annual Report are "forward-looking statements" intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such because the statements will include words such as "believes," "anticipates," "expects," or words of similar meaning. Similarly, statements that describe future plans, objectives, outlooks, targets or goals are also forward-looking statements. Such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated as of the date of this Annual Report. Factors that could cause such a variance include, but are not limited to, changes in interest rates, local market competition, customer loan and deposit preferences, governmental regulations, and other general economic conditions. Shareholders, potential investors, and other readers are urged to consider these factors in evaluating the forward-looking statements and cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included in this Annual Report are only made as of the date of this Annual Report, and the Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. Business Strategy SFSC is committed to community banking and places a high degree of emphasis on developing full service banking and financial services relationships with its business and retail customers. To capitalize on management's knowledge of its immediate market, SFSC operates each of its offices with substantial independence, supported by centralized administrative and operational functions to promote efficiency, permitting the management responsible for each office the flexibility to concentrate on customer service and business development in its market area. To be an effective community bank, SFSC believes the decision-making process must rest primarily in the offices with respect to their credit decisions and an array of products. SFSC believes the empowerment of the day-to-day decision making to the individual office locations remains critical to its success as an effective community banking organization. The Bank seeks to develop and enhance full-service banking relationships through a systematic calling program directed at both existing customers and referral sources from their customer base, attorneys, accountants and business people. The officers and employees of the Bank are actively involved in a variety of civic, charitable and community organizations both as an additional referral source and as a service to their respective communities. 1 Products and Services Through the Bank, SFSC provides a broad range of services to individual and commercial customers. These services include accepting demand, savings and time deposits, including regular checking accounts, NOW accounts, money market accounts, certificates of deposit, individual retirement accounts and club accounts. SFSC also offers a variety of brokerage, annuity and insurance products through the Bank's in-house securities representatives and through State Financial Insurance Agency ("SFIA"). The Bank's lending products include secured and unsecured commercial, commercial real estate, mortgage, construction and consumer term loans on both a fixed and variable rate basis. Historically, the terms on these loans range from one month to five years and are retained in the Bank's portfolio. The Bank provides lines of credit to commercial accounts and to individuals through home equity products. SFSC also originates residen- tial real estate loans in the form of adjustable and long-term fixed rate first mortgages, selling these originations in the secondary mortgage market with servicing released. The Company's acquisition efforts have focused on expanding its community banking network and providing complimentary financial services such as brokerage, insurance, and asset management to its product offerings. The Company entered these ancillary financial product offerings as part of its strategic objective to capitalize on these growing segments of the financial services industry. The Company believes this strategy is essential if it is to continue to effectively compete in the era of financial deregulation. The Company's goal is to build a large share of this business which is currently being provided to its banking customers by unaffiliated providers and to attract new customer relationships by providing a comprehensive source of financial services delivered in the community banking tradition of attention to personalized service and individual attention. Competition and Market Environment Each of the Bank's offices experience substantial competition from other financial institutions, including other banks, savings banks, credit unions, mortgage banking companies, consumer finance companies, mutual funds, and other financial service providers located in their respective and surrounding communities. The Bank competes for deposits principally by offering depositors a variety of deposit programs, convenient office locations and banking hours, 24- hour account access through telephone and personal computer delivery systems, and other services. The Bank competes for loan originations primarily through the interest rates and loan fees it charges, the efficiency and quality of services it provides borrowers, and the variety of its products. Factors affecting competition include the general and local economic conditions and current interest rate levels. Management believes that continued changes in the local banking industry, including mergers and consolidations involving both commercial and thrift institutions, have resulted in a reduction in the level of competition for small to medium sized business customers in the Bank's market areas, as well as a reduction in the level of service provided to both retail and commercial customers. The Company and the Bank also compete for customers by emphasizing the personalized service and individualized attention each provides to both retail and commercial customers. The Company markets itself as a full- service provider of financial products and services, as well as offering related financial products such as retail and commercial property and casualty insur- ance, asset management and financial planning, and brokerage activities through its other subsidiaries and representatives. Management considers its reputation for customer service as its major competitive advantage in attracting and retaining customers in its market areas. The Company also believes that it benefits from its community orientation, as well as its established deposit base and level of core deposits. Employees At December 31, 2001, the Company employed 313 full-time and 127 part-time employees. The Company considers its relationships with its employees to be good. The Bank and Its Consolidated Subsidiaries At or for the year ended December 31, 2001, the Bank (consolidated with its subsidiaries) had total assets of $1.2 billion, net loans of $745.8 million, total deposits of $954.5 million, stockholders' equity of $116.4 million and net income of $7.5 million. The Bank is engaged in the general commercial and consumer banking business and provides full-service banking to individuals and businesses, including the acceptance of deposits to demand, time, and savings accounts and the servicing of such accounts; commercial, consumer, and mortgage lending; and such other banking 2 services as are usual and customary for commercial banks. The Bank also sells annuities, life insurance products, and other investments through in-house representatives. The Bank also offers property, casualty and life insurance products through SFIA. The following table sets forth the Bank's full-service and loan production office locations:
Year Acquired Community Address County Year Originated by SFSC --------- ------- ------ --------------- ------- Hales Corners, WI 10708 West Janesville Road Milwaukee 1910 (1) Muskego, WI S76 W17655 Janesville Road Waukesha 1968 (1) Milwaukee, WI 2650 North Downer Avenue Milwaukee 1971 1985 Milwaukee, WI (2) 2460 North 6th Street Milwaukee 1994 (1) Milwaukee, WI 815 North Water Street Milwaukee 1989 2001 Milwaukee, WI 4623 West Lisbon Avenue Milwaukee 1986 2001 Greenfield, WI 4811 South 76th Street Milwaukee 1978 1987 Glendale, WI 7020 North Port Washington Road Milwaukee 1990 (1) Whitefish Bay, WI 312 East Silver Spring Drive Milwaukee 1995 2001 Fox Point, WI 8607 North Port Washington Road Milwaukee 1996 2001 New Berlin, WI 15505 West National Avenue Waukesha 1998 2001 Brookfield, WI 12600 West North Avenue Waukesha 1990 1992 Waukesha, WI 400 East Broadway Waukesha 1977 1993 Waukesha, WI 1700 Coral Drive Waukesha 2000 (1) Waterford, WI 217 North Milwaukee Street Racine 1906 1995 Burlington, WI 1050 Milwaukee Avenue Racine 1997 (1) Elkhorn, WI 850 North Wisconsin Street Walworth 1999 (1) Richmond, IL 10910 Main Street McHenry 1920 1997 Elgin, IL 16 North Spring Street Kane 1883 1998 Bartlett, IL 200 Bartlett Avenue Kane 1979 1998 Crystal Lake, IL 180 Virginia Street McHenry 1974 1998 Roselle, IL 56 East Irving Park Road Cook 1975 1998 South Elgin, IL 300 North McLean Blvd. Kane 1996 1998 West Elgin, IL 2001 Larkin Avenue Kane 2001 (1) Waukegan, IL 1 South Genessee Lake 1852 1999 Gurnee, IL 1313 North Delany Lake 1987 1999 Glenview, IL 1301 Waukegan Road Cook 1960 1999 Glenview, IL 1441 Waukegan Road Cook 1968 1999 Libertyville, IL 929 North Milwaukee Avenue Lake 1993 1999 --------------------------- (1) Organized by the Bank or a predecessor thereof. (2) Loan Production Office
The Bank has three wholly-owned subsidiaries that are consolidated into its operations. Hales Corners Investment Corporation is a subsidiary created to manage the majority of the Bank's investment portfolio with the objective of enhancing the overall return on the Bank's investment securities. Hales Corners Development Corporation ("HCDC") is a subsidiary that owns the real estate related to the Hales Corners and Muskego offices, and eight commercial and residential rental properties located adjacent to the Hales Corners office. In February 1999, HCDC accepted an Offer to Purchase the eight rental properties from a local developer, subject to the satisfaction of several contingencies. The developer's expectations are to level the existing properties and construct several retail outlets anchored by a newly constructed major food store. The sale of these properties continues in negotiation and could be completed in 2002. State Financial Funding Corporation ("SFFC") was formed to manage certain real estate loans held by its wholly-owned subsidiary, State Financial Real Estate Investment Corporation ("SFREIC"). 3 Supervision and Regulation Bank holding companies and financial institutions are highly regulated at both the federal and state level. Numerous statutes and regulations affect the businesses of SFSC and the Bank. To the extent that the information below is a summary of statutory provisions or regulations, such information is qualified in its entirety by reference to the statutory provisions or regulations described. There are additional laws and regulations having a direct or indirect effect on the business of SFSC or the Bank. As a bank holding company, business activities of SFSC are regulated by the Federal Reserve Board ("FRB") under the Bank Holding Company Act of 1956 as amended (the "Act"), which imposes various requirements and restrictions on the operations of SFSC. As part of this supervision, SFSC files periodic reports with and is subject to periodic examination by the FRB. The Act requires the FRB's prior approval before SFSC may acquire direct or indirect ownership or control of more than five percent of the voting shares of any bank or bank holding company. The FRB can order bank holding companies and their subsidiaries to cease and desist from any actions which in the opinion of the FRB constitute serious risk to the financial safety, soundness or stability of a subsidiary bank and are inconsistent with sound banking principles or in violation of law. The FRB has adopted regulations that deal with the measure of capitalization for bank holding companies. Such regulations are essentially the same as those adopted by the OCC, described below. The FRB has also issued a policy statement on the payment of cash dividends by bank holding companies, wherein the FRB has stated that a bank holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income or which could only be funded in ways that weaken the bank holding company's financial health, such as by borrowing. Under FRB policy, a bank holding company is expected to act as a source of financial strength to its banking subsidiaries and to commit resources to their support. The Act limits the activities of SFSC and its banking and non-banking subsidiaries to the business of banking and activities closely related or incidental to banking. The Gramm-Leach-Bliley Act or Financial Services Modernization Act of 1999 (the "GLB Act") significantly changed financial services regulation by expanding permissible non-banking activities of bank holding companies and removing barriers to affiliations among banks, insurance companies, securities firms and other financial services entities. These activities can be conducted through a holding company structure or, subject to certain limitations, through a financial subsidiary of a bank. The GLB Act also establishes a system of federal and state regulation based on functional regulation, meaning the primary regulatory oversight for a particular activity will generally reside with the federal or state regulator designated as having the principal responsibility for that activity. Banking is to be supervised by banking regulators, insurance by state insurance regulators and securities activities by the federal and state securities regulators. The GLB Act also establishes a minimum federal standard of financial privacy by, among other provisions, requiring banks to adopt and disclose privacy policies with respect to customer information and prohibiting the disclosure of certain types of customer information to third parties not affiliated with the bank unless the customer has been given an opportunity to block that type of disclosure. The GLB Act also requires the disclosure of agreements reached with community groups that relate to the Community Reinvestment Act, and contains various other provisions designed to improve the delivery of financial services to consumers while maintaining an appropriate level of safety in the financial services industry. The GLB Act repeals the anti-affiliation provision of the Glass-Steagall Act and revises the Act to permit qualifying holding companies, called "financial holding companies," to engage in, or to affiliate with companies engaged in a full range of financial activities including banking, insurance activities (including insurance underwriting and portfolio investing), securities activities, merchant banking and additional activities that are "financial in nature," 4 incidental to financial activities or in certain circumstances, complementary to financial activities. A bank holding company's subsidiary banks must be "well-capitalized" and "well-managed" and have at least a "satisfactory" Community Reinvestment Act rating for the bank holding company to elect status as a financial holding company. SFSC has not elected to become a financial holding company. SFSC expects that the new affiliations and activities permitted financial services organizations may over time change the nature of its competition. At present, however, it is not possible to predict the full nature and effect of the changes that may occur. The Bank is a nationally chartered bank regulated by the Office of the Comptroller of the Currency ("OCC") and subject to periodic examination by the OCC. Additionally, the Bank's deposits are insured by the FDIC and are subject to the provisions of the Federal Deposit Insurance Act. Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or any of its subsidiaries, on investments in stock or other securities of the bank holding company and on the taking of such stock or securities as collateral for loans to any borrower. Under the Federal Reserve Act and regulations of the FRB, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or of any property or service. The activities and operations of banks are subject to a number of additional detailed, complex and sometimes overlapping federal and state laws and regulations. These include state usury and consumer credit laws, state laws relating to fiduciaries, the Federal Truth-in-Lending Act and Regulation Z, the Federal Equal Credit Opportunity act and Regulation B, the Fair Credit Reporting act, the Financial Institutions Reform, Recovery and Enforcement Act of 1989, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, the Community Reinvestment Act, the USA Patriot Act, anti-redlining legislation and the antitrust laws. The Community Reinvestment Act includes provisions under which the federal bank regulatory agencies must consider, in connection with applications for certain required approvals, including applications to acquire control of a bank or holding company or to establish a branch, the records of regulated financial institutions in satisfying their continuing and affirmative obligations to help meet the credit needs of their local communities, including those of low and moderate-income borrowers. FDICIA, among other things, establishes five tiers of capital requirements: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The OCC has adopted regulations which define the relevant capital measures for the five capital categories. An institution is deemed to be "well capitalized" if it has a total risk-based capital ratio (total capital to risk-weighted assets) of 10% or greater, a Tier 1I risk-based capital ratio (Tier I Capital to risk-weighted assets) of 6% or greater, and a Tier I leverage capital ratio (Tier I Capital to total assets) of 5% or greater, and is not subject to a regulatory order, agreement, or directive to meet and maintain a specific capital level for any capital measure. The other categories are identified by descending levels of capitalization. A depository institution's failure to maintain a capital level within the top two categories will result in specific actions from the federal regulatory agencies. These actions could include the inability to pay dividends, restriction of new business activity, prohibiting bank acquisitions, asset growth limitations and other restrictions on a case by case basis. Additionally, FDICIA implemented a risk related assessment system for FDIC insurance premiums based, among other things, on the depository institution's capital adequacy and risk classification. At December 31, 2001, SFSC and the Bank each met the "well-capitalized" definition of capital adequacy. 5 In recent years, the banking and financial industry has been the subject of numerous legislative acts and proposals, administrative rules and regulations at both federal and state regulatory levels. As a result of many of such regulatory changes, the nature of the banking industry in general has changed dramatically as increasing competition and a trend toward deregulation have caused the traditional distinctions among different types of financial institutions to be obscured. The performance and earnings of the Bank, like other commercial banks, are affected not only by general economic conditions but also by the policies of various governmental regulatory authorities. In particular, the Federal Reserve System regulates money and credit conditions and interest rates in order to influence general economic conditions primarily through open-market operations in U.S. Government securities, varying the discount rate on bank borrowings, and setting reserve requirements against bank deposits. The policies of the Federal Reserve have a significant influence on overall growth and distribution of bank loans, investments and deposits, and affect interest rates earned on loans and investments. The general effect, if any, of such policies upon the future business and earnings of the Bank cannot accurately be predicted. Directors Information is provided below with respect to the directors of SFSC. Name Age Positions Held with the Company ---- --- ------------------------------- Jerome J. Holz 74 Chairman of the Board of SFSC and Chairman of the Board of SFBNA Michael J. Falbo 52 President, Chief Executive Officer, and Director of SFSC; Vice Chairman, Chief Executive Officer and Director of SFBNA Robert J. Cera 40 Executive Vice President and Director of SFSC; President, Chief Operating Officer and Director of SFBNA Richard A. Horn 77 Director of SFSC and SFBNA Ulice Payne, Jr. 46 Director of SFSC Thomas S. Rakow 59 Director of SFSC and SFBNA David M. Stamm 53 Director of SFSC and SFBNA Barbara E. Weis 46 Director of SFSC and SFBNA Executive Officers Information is provided below with respect to the executive officers of SFSC who are not directors. Each executive officer is elected annually by the Board of Directors and serves for one year or until his/her successor is appointed. Name Age Positions Held ---- --- -------------- John B. Beckwith 48 Senior Vice President of SFSC President, State Financial Bank, N.A. Metro Milwaukee Market Donna M. Bembenek 40 Senior Vice President, Sales and Marketing of SFSC Timothy L. King 55 Senior Vice President and Chief Financial Officer of SFSC Thomas M. Lilly 42 Senior Vice President of SFSC President, State Financial Bank, N.A. Stateline Market Michael A. Reindl 42 Senior Vice President and Treasurer of SFSC Secretary of SFSC Secretary of State Financial Bank, N.A. Daniel L. Westrope 52 Senior Vice President of SFSC President, State Financial Bank, N.A. Suburban Market 6 John B. Beckwith has served as Senior Vice President of SFSC since 1997. Mr. Beckwith also is President of State Financial Bank, N.A.'s Metro Milwaukee Market, which includes thirteen full service branch locations in Wisconsin. From 1994 to October 2000, Mr. Beckwith was the president of the former State Financial Bank (Wisconsin). Mr. Beckwith has served as a Director of State Financial Bank, N.A., or a predecessor thereof, since 1991. Mr. Beckwith joined the Company in 1990. Donna M. Bembenek has served as Senior Vice President, Sales and Marketing of SFSC since December, 2000. From 1995 to 2000, Ms. Bembenek served as Vice President of Marketing. Ms. Bembenek joined the Company in 1993 with nine years of sales, marketing and sales management experience. Timothy L. King has served as Senior Vice President and Chief Financial Officer since joining the Company in August 2000. Mr. King was previously employed by Bank One Corporation, or a predecessor thereof, for twenty-three years where he was most recently Senior Vice President and National Accounting Director of the Retail Group. Thomas M. Lilly was elected Senior Vice President of SFSC in January 2002. Mr. Lilly also is President of State Financial Bank, N.A.'s Stateline Market, which includes four full service branch locations (three in Wisconsin and one in Illinois). From 1998 to October 2000, Mr. Lilly was the President of the former State Financial Bank-Waterford. Mr. Lilly joined the Company in 1985. Michael A. Reindl has served as Senior Vice President and Treasurer of SFSC since August 2000. From 1993 to 2000, Mr. Reindl was Chief Financial Officer and Controller of SFSC and prior thereto, held various financial positions with SFSC. Mr. Reindl is also the Secretary of SFSC and the Secretary of State Financial Bank, N.A. Mr. Reindl joined the Company in 1984. Daniel L. Westrope has served as Senior Vice President of SFSC since joining the Company in 1998. Mr. Westrope also is President of State Financial Bank, N.A.'s Suburban Market, which includes eleven full service branch locations in Illinois. From December 1998 to October 2000, Mr. Westrope was the president of the former Home Federal Savings and Loan Association of Elgin. Prior to joining the Company, Mr. Westrope was employed by First Union Securities (1995 to 1998) and prior thereto by the Federal Reserve Bank of Chicago. Mr. Westrope has served as a Director of State Financial Bank, N.A. since 2000. 7 ITEM 2. PROPERTIES The following table sets forth the owned/leased locations of the Company's banking offices.
Office Address Sq. Feet Owned/Leased ------ ------- -------- ------------ Hales Corners, WI 10708 W. Janesville Road 37,000 Owned Muskego, WI S76 W17655 Janesville Road 2,680 Owned Milwaukee, WI 2650 N. Downer Avenue 3,000 Leased Milwaukee, WI 2460 N. 6th Street 100 Leased Milwaukee, WI 815 N. Water Street 11,793 Leased Milwaukee, WI 4623 W. Lisbon Avenue 2,000 Owned Whitefish Bay, WI 312 E. Silver Spring 1,300 Leased Fox Point, WI 8607 N. Port Washington Road 1,000 Owned Greenfield, WI (1) 4811 S. 76th Street 9,000 Leased Glendale, WI (2) 7020 N. Port Washington Road 7,500 Leased Brookfield, WI 12600 W. North Avenue 4,800 Owned Waukesha, WI 400 E. Broadway 3,300 Owned Waukesha, WI (5) 1700 Coral Avenue 8,836 Owned New Berlin, WI 15505 W. National Avenue 3,124 Owned Waterford, WI 217 N. Milwaukee Street 10,100 Owned Burlington, WI 1050 Milwaukee Avenue 6,300 Leased Elkhorn, WI (4) 850 North Wisconsin Street 9,200 Owned Richmond, IL (3) 10910 Main Street 16,030 Owned Elgin, IL 16 N. Spring Street 34,169 Owned South Elgin, IL 300 N. McLean Blvd. 5,200 Owned West Elgin, IL 2001 Larkin Avenue 29,380 Owned Bartlett, IL 200 Bartlett Avenue 5,418 Owned Crystal Lake, IL 180 Virginia Street 8,268 Owned Roselle, IL 56 E. Irving Park Road 3,800 Owned Waukegan, IL 1 S. Genessee 21,000 Owned Gurnee, IL 1313 North Delany 15,000 Owned Glenview, IL 1301 Waukegan Road 7,500 Owned Glenview, IL 1441 Waukegan Road 2,500 Leased Libertyville, IL 929 North Milwaukee Avenue 4,200 Owned (1) The Bank leases this property from Edgewood Plaza Joint Venture. See "Certain Transactions and Other Relationships with Management and Principal Shareholders" in the Company's Proxy Statement for further information. (2) The Bank leases approximately 1,200 square feet to a third party. (3) The Bank leases approximately 2,400 square feet to third parties. (4) The Bank leases approximately 5,400 square feet to third parties. (5) The Bank leases approximately 4,800 square feet to third parties.
8 ITEM 3. LEGAL PROCEEDINGS From time to time, the Company and the Bank are party to legal proceedings arising out of their general lending activities and other operations. In February 2002, an action was filed against SFSC in the Circuit Court in Rock County, Wisconsin. The plaintiffs in the litigation allege that in April 2001 an employee of SFSC wrongfully issued and then SFSC refused to honor cashier's checks issued on behalf of a customer of SFSC. The allegations arise out of an apparent scheme perpetrated by a mutual customer of one of the plaintiffs, a credit union, and SFSC. The plaintiffs seek recovery of $1.5 million plus fees and expenses. The Company believes the action is without merit and intends to defend its position vigorously in the litigation. The resolution of this matter is not expected to have a material adverse effect on the Company's financial condition or result of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of our shareholders during the quarter ended December 31, 2001. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Market Price and Dividends for Common Stock At March 15, 2002, there were approximately 1,325 shareholders of record and 3,834 estimated additional beneficial shareholders for an approximate total of 5,159 shareholders of the Company's Common Stock. Holders of Common Stock are entitled to receive dividends as may be declared by the Company's Board of Directors and paid from time to time out of funds legally available therefore. The Company's ability to pay dividends depends upon its subsidiary Bank's ability to pay dividends, which is regulated by banking statutes. The declaration of dividends by the Company is discretionary and will depend on operating results, financial condition, regulatory limitations, tax considerations, and other factors. See Notes to the Consolidated Financial Statements for information concerning restrictions on the payment of dividends. Although the Company has regularly paid dividends since its inception in 1984, there can be no assurance that such dividends will be paid in the future. The following table sets forth the historical market price of and dividends declared with respect to Common Stock since January 1, 2000: Quarter Ended High Low Dividend ------------------------------ ------------ ------------ ----------------- March 31, 2000 $ 12.59 $ 9.19 $0.12 June 30, 2000 10.40 8.53 0.12 September 30, 2000 10.58 8.99 0.12 December 31, 2000 9.48 7.70 0.12 March 31, 2001 $ 11.76 $8.10 0.12 June 30, 2001 12.48 10.91 0.12 September 30, 2001 13.34 10.55 0.12 December 31, 2001 12.12 11.04 0.12 ------------------------------ ------------ ------------ ----------------- 9 Stock Listing State Financial Services Corporation's Common Stock is traded on the Nasdaq National Market tier of the Nasdaq Stock Market ("Nasdaq") under the symbol "SFSW." Nasdaq is a highly-regulated electronic securities market comprised of competing market makers whose trading is supported by a communications network linking them to quotation dissemination, trade reporting, and order execution systems. This market also provides specialized automation services for screen-based negotiations of transactions, on-line comparison of transactions, and a range of informational services tailored to the needs of the securities industry, investors, and issuers. Nasdaq is operated by The Nasdaq Stock Market, Inc., a wholly-owned subsidiary of the National Association of Securities Dealers, Inc. The Company's stock appears in the Wall Street Journal, the Milwaukee Journal/Sentinel, and other publications usually as "State Financial". Dividend Reinvestment Plan The Company has a Dividend Reinvestment Plan (the "DRP") for the benefit of all shareholders. The DRP is administered by Firstar Bank Milwaukee, N.A., Corporate Trust Division. Under the DRP, registered shareholders of the Company can elect to have their dividends reinvested to purchase additional shares of the Company's Common Stock. To receive information on the DRP, please contact Michael A. Reindl, Senior Vice President and Treasurer, State Financial Services Corporation, 10708 West Janesville Road, Hales Corners, Wisconsin 53130, or call (414) 425-1600. Form 10-K The Company's annual report on Form 10-K for the year ended December 31, 2001 as filed with the Securities and Exchange Commission is available upon request without charge to shareholders of record. Please contact Timothy L. King, Senior Vice President and Chief Financial Officer, State Financial Services Corporation, 10708 West Janesville Road, Hales Corners, Wisconsin 53130, or call (414) 425-1600. Annual Meeting The annual meeting of shareholders of State Financial Services Corporation will be held at 4:00 P.M. (CDT) on Wednesday, May 1, 2002 at the Tuckaway Country Club, 6901 West Drexel Avenue, Franklin, WI. Financial Information Timothy L. King Senior Vice President and Chief Financial Officer State Financial Services Corporation 10708 West Janesville Road Hales Corners, Wisconsin 53130 (414) 425-1600 Transfer Agent U.S. Bank, N.A. Corporate Trust Services 1555 North RiverCenter Drive, Suite 301 Milwaukee, WI 53212 (800) 637-7549 (414) 276-3737 10 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected financial data of State Financial Services Corporation (hereinafter referred to as the "Company") and its subsidiaries on a consolidated basis for the last five years (dollars in thousands, except per share data):
As of or for the years ended December 31, ------------------------------------------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------- Condensed Income Statement: Total interest income (taxable equivalent)1 $75,499 $79,039 $66,610 $58,397 $49,743 Total interest expense 35,619 41,693 30,132 25,923 20,072 ------------------------------------------------------------------------------------------------------------------- Net interest income 39,880 37,346 36,478 32,474 29,671 Provision for loan losses 3,855 810 750 690 450 Other income 12,303 5,806 7,993 6,965 4,664 Other expense 39,173 36,297 30,963 34,801 22,195 ------------------------------------------------------------------------------------------------------------------- Income before income tax 9,155 6,045 12,758 3,948 11,690 Income tax 3,724 1,925 4,333 1,981 3,961 Less taxable equivalent adjustment 1,297 1,122 993 810 512 ------------------------------------------------------------------------------------------------------------------- Net income $4,134 $2,998 $7,432 $1,157 $7,217 =================================================================================================================== Per share data: Basic earnings per share $0.55 $0.38 $0.80 $0.12 $0.75 Diluted earnings per share 0.55 0.38 0.80 0.12 0.74 Dividends declared 0.48 0.48 0.48 0.48 0.40 Book Value 13.66 13.33 12.79 13.36 13.19 Balance sheet totals: Total assets $1,171,053 $1,080,786 $1,090,024 $828,369 $773,873 Loans, net of allowance 745,786 660,909 742,196 607,949 563,174 Allowance for loan losses 7,900 7,149 6,905 4,485 4,370 Deposits 954,459 859,356 847,051 652,905 617,995 Borrowed funds 86,287 99,120 89,634 29,117 9,850 Notes payable 15,653 7,309 39,959 6,750 5,300 Shareholders' equity 106,360 106,499 109,668 134,637 133,763 Financial Ratios: Return on average assets 0.36% 0.27% 0.78% 0.15% 1.09% Return on average equity 3.79 2.73 6.00 0.86 5.40 Dividend payout ratio 115.08 125.58 58.77 457.40 49.80 Allowance for loan losses to total loans 1.05 1.07 0.92 0.73 0.77 Non-performing assets to total assets 0.89 0.84 0.50 0.47 0.58 Net charge-offs to average loans 0.55 0.08 0.08 0.10 0.06 ------------------------------------------------------------------------------------------------------------------- 1. Taxable-equivalent adjustments to interest income involve the conversion of tax-exempt sources of interest income to the equivalent amounts of interest income that would be necessary to derive the same net return if the investments had been subject to income taxes. A 34% incremental income tax rate, consistent with the Company's historical experience, is used in the conversion of tax-exempt interest income to a taxable-equivalent basis. 2. All dividends represent the amount per share declared by the Company for each period presented.
11 Selected Quarterly Financial Data The following table sets forth certain unaudited income and expense data on a quarterly basis for the periods indicated (dollars in thousands, except per share data).
2001 2000 --------------------------------------------------------------------------------------------------------------------- 12/31 9/30 6/30 3/31 12/31 9/30 6/30 3/31 --------------------------------------------------------------------------------------------------------------------- Interest income $18,097 $18,950 $18,162 $18,993 $19,639 $19,484 $19,416 $19,379 Interest expense 7,440 9,169 9,125 9,885 11,071 10,691 10,269 9,662 --------------------------------------------------------------------------------------------------------------------- Net interest income 10,657 9,781 9,037 9,108 8,568 8,793 9,147 9,717 Provision for loan losses 3,045 270 270 270 203 202 203 202 Other income (loss) 3,248 2,937 3,517 2,601 2,355 (447) 2,020 1,877 Other expense 11,896 9,459 9,135 8,683 8,129 11,109 8,492 8,567 --------------------------------------------------------------------------------------------------------------------- Income (loss) before income tax (1,036) 2,989 3,149 2,756 2,591 (2,965) 2,472 2,825 Income tax (benefit) 291 1,074 1,335 1,024 983 (1,146) 969 1,119 --------------------------------------------------------------------------------------------------------------------- Net income (loss) ($1,327) $1,915 $1,814 $1,732 $1,608 $(1,819) $1,503 $1,706 ===================================================================================================================== Net income (loss) per share: basic $(0.18) $0.26 $0.24 $0.23 $0.21 $(0.23) $0.19 $0.21 diluted (0.18) 0.26 0.24 0.23 0.21 (0.23) 0.19 0.21 Dividends per share 0.12 0.12 0.12 0.12 0.12 0.12 0.12 0.12 ---------------------------------------------------------------------------------------------------------------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The following discussion is intended as a review of the significant factors affecting the Company's financial condition and results of operations as of and for the year ended December 31, 2001, as well as providing comparisons with previous years. This discussion should be read in conjunction with the Consolidated Financial Statements and accompanying notes and the selected financial data presented elsewhere in this annual report. On July 7, 2001, the Company acquired LB Bancorp, Inc. ("LB") and its wholly-owned subsidiary, Liberty Bank ("Liberty"), Milwaukee, Wisconsin. The Company purchased all of the outstanding common stock of LB for $11.2 million in cash. The acquisition was recorded as a purchase. Application of purchase accounting requires the inclusion of LB's and Liberty's operating results in the consolidated statements of income from the date of acquisition. Accordingly, LB's and Liberty's operating results are included in the consolidation results of operations since July 7, 2001. On June 23,1999, the Company completed its cash acquisition of First Waukegan Corporation ("FWC"), and its subsidiary, Bank of Northern Illinois, N.A. ("BNI"). The acquisition was recorded as a purchase. Application of purchase accounting requires the inclusion of FWC's and BNI's operating results in the consolidated statements of income from the date of acquisition. Accordingly, FWC's and BNI's operating results are included in the consolidation results of operations since June 23, 1999. NET INCOME AND DIVIDENDS For the years ended December 31, 2001, 2000, and 1999, the Company reported net income of $4.1 million, $3.0 million, and $7.4 million, respectively. An additional $2 million provision for loan losses and approximately $2 million loss to liquidate its asset management subsidiary impacted earnings in 2001. Consolidation expense in 2000 of approximately $4.7 million related to the Company's consolidation of its five bank and thrift charters into one nationally chartered bank and merger-related charges of approximately $600 thousand in 1999 impacted each respective years' earnings. Excluding these charges on a tax-effected basis, the Company's operating results would have been $7.4 12 million, $5.9 million, and $8.5 million for the years ended 2001, 2000, and 1999, respectively. The Company's reported return on average assets for the years ended December 31, 2001, 2000, and 1999 was 0.36%, 0.27%, and 0.78%, respectively. Reported return on average equity for the same periods was 3.79%, 2.73%, and 6.00%. Exclusive of the tax-effected loan loss provision and liquidation charges, return on average assets and return on average equity were 0.65% and 6.76%, respectively for the year ended December 31, 2001. Exclusive of the tax-effected consolidation charge in 2000 and the merger related charges in 1999, return on average assets and return on average equity were 0.54% and 5.37%, respectively for the year ended December 31, 2000 and 0.89% and 6.84%, respectively, for the year ended December 31, 1999. On a per share basis, basic earnings were $0.55 for 2001, $0.38 for 2000, and $0.80 for 1999. Exclusive of the one-time charges, basic earnings per share on an operating basis were $0.99 for 2001, $0.74 for 2000, and $0.91 for 1999. The Company declared per share dividends of $0.48 for each year ended December 31, 2001, 2000, and 1999. Income Statement Analysis Net Interest Income Net interest income equals the difference between interest earned on assets and the interest paid on liabilities and is a measurement of the Company's effectiveness in managing its interest rate sensitivity. For the year ended December 31, 2001, taxable-equivalent net interest income improved $2.5 million (6.8%) to $39.9 million. Changes in the volume of outstanding interest-earning assets and interest-bearing liabilities accounted for an increase of $195 thousand while changes in interest rates accounted for an increase of $2.3 million in taxable-equivalent net interest income. Rate changes most fundamentally impacted the components of the Company's consolidated taxable-equivalent net interest income in 2001. Taxable-equivalent total interest income decreased $3.5 million in 2001 mainly due to the significant declining rate environment, offset by the increase in the volume of average total outstanding interest-earning assets resulting from the inclusion of the Liberty acquisition. As a result of the volume increase, interest income improved $1.8 million for the year ended December 31, 2001. Interest income decreased by $5.3 million due to the declining interest rate environment. The combined impact of these changes resulted in a decrease in the Company's taxable-equivalent yield on interest-earning assets to 7.26% in 2001 from 7.84% in 2000. The Company experienced a decrease in its interest rate on its funding costs in 2001 to 4.00% from 4.77% for the year ended December 31, 2000. The decreased funding cost was mainly due to a lower interest rate environment, a decreased percentage of interest-bearing liabilities in wholesale borrowings and decreased debt incurred to fund the Company's stock repurchase activities. Short-term borrowings decreased in 2001 to 13.5% of the Company's average interest-bearing liabilities compared to 16.9% in 2000. For the year ended December 31, 2001, average money market accounts comprised 24.5% of the Company's average interest-bearing liabilities compared to 21.5% for 2000. Time deposits comprised 38.2% of the Company's average interest-bearing liabilities compared to 34.2% in 2000. The Company's net yield on interest-earning assets (net interest margin) increased to 3.84% for the year ended December 31, 2001 from 3.71% for the year ended December 31, 2000 as a result of the aforementioned changes. For the year ended December 31, 2000, taxable-equivalent net interest income increased $868 thousand (2.4%) compared to the year ended December 31, 1999, primarily due to the inclusion of BNI. Change in the volume of outstanding interest-earning assets and interest-bearing liabilities accounted for a $1.7 million increase and change in the rate accounted for a $839 thousand decrease in taxable-equivalent net interest income. The Company's 2000 cost of funds increased to 4.77% from 4.14% for the year ended December 31, 1999, due primarily to a higher interest rate environment, a greater percentage of interest-bearing liabilities in wholesale borrowings and increased debt incurred to fund the Company's stock repurchase activities. Historically these funding sources carry a comparatively higher cost than core deposits and increased in cost over the preceding twelve months due to the higher rate environment. Short-term borrowings increased in 2000 to 16.9% of the Company's average interest-bearing liabilities compared to 10.7% in 1999. For the year ended December 31, 2000, average money market accounts comprised 21.5% of the Company's average interest-bearing liabilities compared to 21.0% for 1999. Time deposits comprised 34.2% of the Company's average interest-bearing liabilities compared to 37.4% in 1999. 13 The following table sets forth average balances, related interest income and expense, and effective interest yields and rates for the years ended December 31, 2001, 2000, and 1999 (dollars in thousands):
2001 2000 1999 -------------------------------------------------------------------------------------------------------------------------- Average Yield/Rate Average Yield/Rate Average Yield/Rate Balance Interest Balance Interest Balance Interest -------------------------------------------------------------------------------------------------------------------------- ASSETS Interest-earning assets: Loans 1,2,3 $724,543 $56,569 7.81% $726,027 $60,018 8.24% $683,095 $54,761 8.02% Taxable investment 229,884 14,437 6.28 221,313 15,141 6.82 123,446 7,600 6.16 securities Tax-exempt investment securities 3 51,873 3,476 6.70 41,710 2,921 6.98 37,033 2,539 6.86 Other short-term 788 31 3.91 591 39 6.66 6,901 357 5.18 investments Interest-earning deposits 8,740 311 3.56 7,697 383 4.95 19,553 964 4.93 Federal funds sold 23,937 676 2.82 7,833 537 6.84 7,254 389 5.36 -------------------------------------------------------------------------------------------------------------------------- Total interest-earning assets 1,039,765 75,499 7.26 1,005,171 79,039 7.84 877,282 66,610 7.59 -------------------------------------------------------------------------------------------------------------------------- Non-interest-earning assets: Cash and due from banks 39,576 35,730 34,046 Premises and equipment, net 27,452 24,519 17,716 Other assets 38,933 40,971 25,688 Less allowance for loan losses (7,651) (7,121) (5,682) -------------------------------------------------------------------------------------------------------------------------- TOTAL $1,138,075 $1,099,270 $949,050 ========================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing liabilities: NOW accounts $89,546 $1,066 1.19% $102,487 $1,714 1.67% $97,797 $1,715 1.75% Money market accounts 220,998 7,213 3.26 187,436 9,274 4.93 152,636 6,155 4.03 Savings deposits 120,275 2,295 1.91 136,672 3,634 2.65 127,524 3,391 2.66 Time deposits 340,441 18,835 5.53 298,187 17,084 5.71 272,194 14,613 5.37 Notes payable 15,999 913 5.71 33,758 2,781 8.22 13,882 938 6.76 FHLB borrowings 83,714 4,303 5.14 89,062 5,600 6.27 45,775 2,399 5.24 Federal funds purchased 2,338 144 6.16 11,525 829 7.17 9,529 493 5.17 Securities sold under agreement to repurchase 17,936 849 4.73 12,440 777 6.23 8,938 428 4.79 -------------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 891,247 35,618 4.00 871,567 41,693 4.77 728,275 30,132 4.14 -------------------------------------------------------------------------------------------------------------------------- Non-interest-bearing liabilities: Demand deposits 130,259 113,305 90,173 Other 7,417 4,723 6,810 -------------------------------------------------------------------------------------------------------------------------- Total liabilities 1,028,923 989,595 825,258 -------------------------------------------------------------------------------------------------------------------------- Shareholders' equity 109,152 109,675 123,792 -------------------------------------------------------------------------------------------------------------------------- TOTAL $1,138,075 $1,099,270 $949,050 ========================================================================================================================== Net interest earning and Interest rate spread $39,881 3.26% $37,346 3.07% $36,478 3.46% ========================================================================================================================== Net yield on interest- earning assets 3.84% 3.71% 4.16% ========================================================================================================================== 1. For the purpose of these computations, nonaccrual loans are included in the daily average loan amounts outstanding. 2. Interest earned on loans includes loan fees, which are not material in amount. 3. Taxable-equivalent adjustments are made in calculating interest income and yields using a 34% tax rate for all years presented.
14 The following table presents the amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities (dollars in thousands). The table distinguishes between the changes related to average outstanding balances (changes in volume holding the initial rate constant) and the changes related to average interest rates (changes in average rate holding the initial balance constant). Change attributable to the combined impact of volume and rate has been allocated proportionately to change due to volume and change due to rate.
2001 Compared to 2000 2000 Compared to 1999 --------------------- --------------------- Increase/(Decrease) Due to Increase/(Decrease) Due to --------------------------------------------------------------------------------------------------------------------- Volume Rate Net Volume Rate Net --------------------------------------------------------------------------------------------------------------------- Interest earned on: Loans 1,2 $(123) $(3,326) $(3,449) $3,514 $1,743 $5,257 Taxable investment securities 569 (1,274) (705) 6,619 922 7,541 Tax-exempt investment securities 2 685 (130) 555 325 57 382 Other short-term investments 11 (19) (8) (396) 78 (318) Interest-earning deposits 47 (118) (71) (588) 6 (582) Federal funds sold 599 (461) 138 33 115 148 ---------------------------------------------------------------------------------------------------------------------- Total interest-earning assets 1,788 (5,328) (3,540) 9,507 2,921 12,428 Interest paid on: NOW accounts (198) (450) (648) 79 (80) (1) Money market accounts 1,463 (3,524) (2,061) 1,559 1,560 3,119 Savings deposits (400) (939) (1,339) 243 0 243 Time deposits 2,362 (611) 1,751 1,451 1,020 2,471 Notes payable, FHLB borrowings, federal funds purchased, and securities sold under agreement to repurchase (1,634) (2,144) (3,778) 4,469 1,260 5,729 ---------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 1,593 (7,668) (6,075) 7,801 3,760 11,561 ====================================================================================================================== Net interest income $195 $2,340 $2,535 $1,706 $(839) $867 ====================================================================================================================== 1. Interest earned on loans includes loan fees, which are not material in amount. 2. Taxable-equivalent adjustments are made in calculating interest income and yields using a 34% tax rate for all years presented.
Provision for Loan Losses The provisions for loan losses were $3.9 million, $810 thousand, and $750 thousand for the years ended December 31, 2001, 2000, and 1999, respectively. The increase in 2001 in comparison to prior years is due to an additional one-time $2 million provision and the Liberty acquisition. The increases in annual provision reflect the change in the total loan portfolio with increases in commercial and commercial real estate loans and decreases in real estate mortgages. Other Income Other income in 2001 increased $6.5 million (111.9%) from 2000 mainly due a loss in 2000 of $2.5 million from the sale of approximately $90 million in fixed-rate mortgage loans and losses on the sale of investment securities that had yields below market interest rates. Exclusive of the losses, total other income increased $4.0 million mainly due to increases in automated teller machine ("ATM") and merchant services, investment securities gains, gain on sale of loans, and other income offset by decreases in service charges on deposit accounts and security commissions and management fees. Other income decreased $2.2 million (27.4%) in 2000 as compared to 1999 due to the $2.5 million loss on the sale of securities in 2000. Exclusive of the loss, total other income increased $251 thousand mainly due to increases in merchant services, asset management commissions and other income offset by decreases in gains on mortgage origination sales and fair market value adjustment on mortgages marked to market. The composition of other income is shown in the following table (dollars in thousands). 15 Years ended December 31, ------------------------------------------------------------------------------- 2001 2000 1999 ------------------------------------------------------------------------------- Service charges on deposit accounts $2,089 $2,134 $2,185 ATM and Merchant services 3,122 2,654 2,213 Security commissions and management fees 738 1,149 1,124 Investment securities gains 1,925 39 992 Gain (loss) on sale of loans 2,315 (1,549) 277 Other 2,114 1,379 1,202 ------------------------------------------------------------------------------- Total other income $12,303 $5,806 $7,993 =============================================================================== For the year ended December 31, 2001 service charges on deposit accounts decreased $45 thousand (2.1%) compared to 2000, and $51 thousand (2.3%) for the year ended December 31, 2000 compared to the year ended December 31, 1999. The majority of the decreases was due to reduced income from service charges on business deposit accounts. ATM service charges are the terminal usage fees charged to non-customers and the fees received from other institutions resulting from their customers' usage of the Company's automated teller machines. Merchant services are the fees the Company charges businesses for processing credit card payments. Income in this category increased $468 thousand (17.6%) in 2001 and $441 thousand (20.0%) in 2000.The increase in 2001 was due to ATM service charges from the acquired Liberty machines and a full year of the added merchant services in the Illinois area. The increase in 2000 was mainly due to added merchant services in the Illinois area. Security commissions and management fees are the fees received from the Company's investment and asset management services and brokerage activities. For the year ended December 31, 2001 security commissions and management fees decreased $411thousand compared to 2000 mainly due to the economic environment and a decline in investment related activities. For the year ended December 31, 2000 security commissions and management fees increased $25 thousand compared to 1999. The Company realized $1.9 million in net investment security gains for the year ended December 31, 2001 due to the sale of approximately $96.7 million of investment securities. For the year ended December 31, 2000, the Company realized $39 thousand in investment security gains. For the year ended December 31, 1999, the Company realized $992 thousand in investment security gains mainly from the sale of marketable equity securities. The gain of $2.3 million on sale of loans for the year ended December 31, 2001 was due to increased refinancing activity on residential mortgages. The loss on sale of loans of $1.5 million for the year ended December 31, 2000 was mainly due to a $2.3 million loss from balance sheet restructuring offset by $751 thousand in gains on mortgage origination sales. During 1999 there was a negative fair market adjustment on mortgages marked to market of $736 thousand. This resulted from marking approximately $45 million of mortgages to market in anticipation of securitizing and selling them to the secondary market in the first quarter 2000. Other income increased $735 thousand (53.3%) in 2001 and $177 thousand (14.7%) in 2000. The increase in 2001 was mainly due to a distribution received on exchange of common stock resulting from the merger of an ATM service provider. In addition to this distribution there were increases in exchange and commission, cashier check commission, deluxe commission, insurance commission, mortgage origination fees, and building rent. The increase in 2000 was mainly due to increased insurance commission, cashier check commission, and safe deposit rent. 16 Other Expense Other expense increased $2.9 million (7.9%) for the year ended December 31, 2001, which includes the $2 million loss from the liquidation of the asset management subsidiary. Other expense increased $5.3 million (17.2%) for the year ended December 31, 2000, which included $2.2 million of charter consolidation expense. Years ended December 31, ---------------------------------------------------------------------------- 2001 2000 1999 ---------------------------------------------------------------------------- Salaries and employee benefits $16,700 $14,671 $13,881 Occupancy and equipment 6,237 6,008 4,877 Data processing 2,047 1,918 2,054 Legal and professional 1,883 1,682 1,241 ATM and Merchant services 2,207 1,847 1,681 Consolidation and merger-related charges 0 2,230 598 Advertising 1,015 1,223 1,133 Goodwill amortization 4,063 2,053 1,387 Other 5,021 4,665 4,111 ---------------------------------------------------------------------------- Total other expense $39,173 $36,297 $30,963 ---------------------------------------------------------------------------- Salaries and employee benefits increased $2.0 million (13.8%) in 2001 mainly due to increased sales commissions from the increased volume of sales of mortgage loans into the secondary mortgage market, the Liberty acquisition, and additional staff associated with opening a new office. In 2000 salaries and employee benefits increased $790 thousand mainly due to additional staff associated with the opening of two new offices and inclusion of a full year of BNI in 2000 compared to a half of year in 1999. Occupancy and equipment expense increased $229 thousand in 2001 due to the additional six locations from the Liberty acquisition and a newly constructed office in West Elgin offset by decreases in repair and maintenance and service contracts. Occupancy and equipment expense increased $1.1 million in 2000, due to increased depreciation expense associated with the new branch offices and the installation of an upgraded computer network, communication system and related equipment in the later part of 1999. During 2001, data processing expense increased $129 thousand due to the additional expense related to the Liberty acquisition. Data processing had a slight decrease in 2000 compared to 1999 due to the conversion of all offices to the Company's third party services provider during 1999 and the related re-negotiation of the Company's service contract. Legal and professional fees increased $201 thousand in 2001 and $442 in 2000, due to certain nonrecurring legal matters, acquisitions and increased audit costs resulting from the Company's growth over the preceding two years. ATM expense is the fees charged by the Company's service provider for the Company's customer use of automated teller machines that are not owned by the Company. Merchant service expense results from providing the Company's business customers the ability to accept credit cards in payment for goods and services. For the year ended December 31, 2001, ATM and merchant services increased $360 thousand due to increased customer volume for merchant services. For the year ended December 31, 2000, ATM and merchant services increased $167 due to increased customer volume for merchant services offset by decreased ATM expense due to the Company converting the service bureau used to drive its ATM's. In the third quarter, 2000, the Company recorded a non-recurring consolidation charge of approximately $2.2 million related to the charter consolidation of the Company's five banks. The charge included expense for employee severance, branch closure and data processing conversion. In 1999, the Company recognized $598 thousand in merger-related charges related to the dissolution of an acquired subsidiary's ESOP. Advertising expense decreased $208 thousand in 2001 and increased $89 thousand in 2000 due primarily to the charter consolidation. 17 Goodwill amortization increased $2.0 million in 2001 due to the liquidation of the asset management subsidiary. Goodwill amortization increased $666 thousand in 2000 due to a full year amortization related to the BNI acquisition. Other expense increased $356 thousand in 2001 mainly due to increases in delivery and postage, office supplies, ORE expense, and charity and donations, offset by decreases in correspondent bank service charges and core deposit intangible. Other expense increased $554 thousand in 2000 mainly due to increased delivery and postage, charity and donations, and correspondent bank service charges. Income Tax The Company's consolidated income tax rate varies from statutory rates principally due to nondeductible goodwill amortization, tax-exempt interest income on investment securities, loans, and nondeductible merger related expenses. The effective tax rate for 2001 was 47.4% compared to 39.1% in 2000 and 36.8% in 1999. The effective tax rate for 2001 was effected by the write-off of goodwill related to the liquidation of the asset management subsidiary. Provisions for income tax were $3.7 million, $1.9 million and $4.3 million for the years 2001, 2000 and 1999, respectively. Income tax expense increased $1.8 million in 2001 due to increased taxable income. Income tax expense decreased $2.4 million in 2000 due to the $6.8 million decline in pre-tax income, which resulted primarily from the $4.7 million non-recurring consolidation charge. BALANCE SHEET ANALYSIS The composition of assets and liabilities are generally the result of management decisions influenced by market forces. The Company reported total assets at December 31, 2001 of $1.2 billion and $1.1 billion at December 31, 2000. Lending Activities The Company's largest asset category continues to be loans. The Company's gross loans, as a percentage of total deposits, were 79.0% at December 31, 2001 compared to 77.7% at December 31, 2000. The following table shows the Company's loan portfolio composition on the dates indicated (dollars in thousands).
At December 31, ---------------------------------------------------------------------------------------------------------------------- % of % of % of % of % of 2001 total 2000 total 1999 total 1998 total 1997 total ---------------------------------------------------------------------------------------------------------------------- Commercial $151,125 20.1% $139,865 20.9% $129,470 17.3% $56,675 9.3% $56,030 9.9% Commercial Real Estate 179,587 23.8 115,427 17.3 100,914 13.5 67,958 11.1 63,992 11.3 Real Estate Mortgage 343,108 45.5 329,658 49.3 445,624 59.5 438,886 71.7 397,708 70.1 Installment 71,797 9.5 70,668 10.6 62,180 8.3 37,519 6.1 37,496 6.6 Other 8,069 1.1 12,440 1.9 10,913 1.5 11,395 1.9 12,318 2.2 ---------------------------------------------------------------------------------------------------------------------- Total Loans $753,686 $668,058 $749,101 $612,433 $567,544 ======================================================================================================================
Total loans outstanding increased $85.6 million (12.8%) in 2001 mainly due to the acquisition of Liberty Bank. Total loans outstanding decreased $81.0 million (10.8%) in 2000 mainly due to the balance sheet restructuring offset by loan growth. Residential real estate mortgages represent the Company's largest loan category, comprising 45.5% of the loan portfolio at December 31, 2001 and 49.4% at December 31, 2000. The percentage decrease in 2001 is due primarily to mortgage refinancings, which are sold into the secondary market, due to the lower interest rate environment. The decrease in 2000 was due to management's decision to restructure the balance sheet through the sales of approximately $115.0 million of mortgage loans during 2000. The Company continues to emphasize commercial and commercial real estate lending. Commercial loans increased $11.2 million (8.1%) in 2001 due to the Liberty acquisition and internal loan growth. Commercial loans increased $10.4 million (8.0%) in 2000 due to internal loan growth. Commercial loans are underwritten according to the Company's loan policy, which sets forth the amount of credit which can be extended based upon the borrower's cash 18 flow, debt service capacity, and discounted collateral value. Commercial loans are typically made on the basis of the borrower's ability to make repayment from the cash flow of the business. As a result, the availability of funds for the repayment of commercial loans may be dependent on the success of the business itself, which, in turn, is likely to be dependent upon the general economic environment. In recognition of this risk, the Company emphasizes capacity to repay the loan, adequacy of the borrower's capital, an evaluation of the industry conditions affecting the borrower, and current credit file documentation. The Company's commercial loans are typically secured by the borrower's business assets such as, inventory, accounts receivable, fixtures, and equipment. Generally, commercial loans carry the personal guaranties of the principals. Commercial real estate activity increased $64.2 million in 2001 compared to 2000 mainly due to the Liberty acquisition and loan growth. Commercial real estate activity increased $14.5 million in 2000 compared to 1999 due to internal growth. The Company's commercial real estate loans continue to be generally secured by owner occupied, improved property such as office buildings, warehouses, small manufacturing operations, and retail facilities located in the Company's primary market areas subject to a maximum 75% loan to value ratio pursuant to its loan policy. Loans for construction and land development are generally secured by the property under construction or development up to a maximum loan to value of 75% of estimated cost or appraisal value of the completed project whichever is less. The Company further monitors construction and land development credits by disbursing draws under the credit commitment upon satisfactory title company inspections of construction progress and evidence of proper lien waivers. The borrower's creditworthiness and the economic feasibility and cash flow abilities of the project are fundamental concerns in the Company's commercial real estate and construction/land development lending. Loans secured by commercial property, whether existing or under construction, and land development are generally larger in size and involve greater risks than residential mortgage loans because payments on loans secured by commercial property are dependent upon the successful operation and management of these properties, businesses, or developments. As a result, the value of properties securing such loans are likely to be subject to the local real estate market and general economic conditions, including movements in interest rates. The Company generally writes commercial real estate loans for maturities up to five years although the total amortization period may be as long as twenty years, amortized monthly. The Company generally writes construction and land development loans on terms up to a maximum of 24 months and requires the borrower to make defined principal reductions at stated intervals during that term. The Company additionally attempts to have construction credits further supported by end mortgage commitments wherever possible. The Company will generally make credit extensions for land development projects to experienced, strong borrowers with adequate outside liquidity to support the project in the event the actual project performance is slower than projection. The Company's real estate loans, like all of the Company's loans, are underwritten according to its written loan policy. The loan policy sets forth the term, debt service capacity, credit extension, and loan to value guidelines, which the Company considers acceptable to recognize the level of risk associated with each specific loan category. The following table sets forth the percentage composition of the real estate loan portfolio as of December 31, 2001: --------------------------------------------------------------------------- 1-4 family first liens on residential real estate 52.85% Multifamily residential 4.45 1-4 family junior liens on residential real estate (including home equity lines of credit) 3.08 Construction, land development, and farmland 5.89 --------------------------------------------------------------------------- Installment loans increased $1.1 million during 2001 due to the Liberty acquisition. Installment loans increased $8.5 million during 2000 due to loan growth. The Company cultivates installment loans primarily through the purchase of loan contracts from its network of auto dealers developed over the years. The Company continues to pursue additional auto dealer contacts to build this network of loan referrals. The Company's indirect auto loan underwriting emphasizes the purchase of the highest quality loan contracts to minimize risk of loss in this lending activity. Other loans decreased $4.4 million in 2001 due to decreases in municipal loans and overdrafts. Other loans increased $1.5 million in 2000 due to increases in municipal loans and overdrafts. 19 The following table shows the maturity of loans (excluding residential mortgages on one-to-four-family residences, and installment loans) outstanding as of December 31, 2001 (dollars in thousands) and are the amounts due after one year classified according to the sensitivity to changes in interest rates:
After One After Within But Within Five One Year Five Years Years Total ------------------------------------------------------------------------------------- Commercial $55,752 $61,404 $4,034 $121,190 Real Estate Mortgage 65,421 147,342 21,874 234,637 ------------------------------------------------------------------------------------- $121,173 $208,746 $25,908 $355,827 ===================================================================================== Loan Maturing after one year with: Fixed Interest Rates $325,307 $142,235 Variable Interest Rates 31,852 0 ------------------------------------------------------------------------------------- Total $357,159 $142,235 =====================================================================================
Risk Elements in the Loan Portfolio Certain risks are inherent in the lending function including a borrower's subsequent inability to pay, insufficient collateral coverage, and changes in interest rates. The Company attempts to reduce these risks by adherence to a written set of loan policies and procedures. Included in these policies and procedures are underwriting practices covering debt-service coverage, loan-to-value ratios, and loan term. Evidence of a specific repayment source is required on each credit extension, with documentation of the borrower's repayment capacity. Generally, this repayment source is the borrower's cash flow, which must demonstrate the ability to service the debt based upon historical results and projections of future performance. Management maintains the Allowance for Loan and Lease Losses (the "Allowance") at a level considered adequate to provide for estimable and probable loan losses. The Allowance is increased by provisions charged to earnings, and is reduced by charge-offs, net of recoveries. At December 31, 2001, the Allowance was $7.9 million. The determination of Allowance adequacy is based upon an on-going evaluations of the Company's loan portfolio conducted by the Internal Loan Review function of the Bank and reviewed by management. These evaluations consider a variety of factors, including, but not limited to, general economic conditions, loan portfolio size and composition, previous loss experience, the borrower's financial condition, collateral adequacy, and the level of non-performing loans. As a percentage of total loans outstanding, the Allowance was 1.05% at the end of 2001 compared to 1.07% at the end of 2000. Net of unused commitments, the percentage of the Allowance to total loans outstanding is 1.11% at December 31, 2001. Based on its analyses, management considers the Allowance adequate to recognize the risk inherent in the consolidated loan portfolio at December 31, 2001. 20 The balance of the Allowance and actual loan loss experience for the last five years is summarized in the following table (dollars in thousands):
Years ended December 31, -------------------------------------------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 -------------------------------------------------------------------------------------------------------------------- Balance at beginning of period $7,149 $6,905 $4,485 $4,370 $3,553 Charge-offs: Commercial 3,558 464 776 146 123 Real estate Mortgage 77 74 57 39 40 Installment 560 255 283 465 71 Other 51 40 48 149 147 -------------------------------------------------------------------------------------------------------------------- Total charge-offs 4,246 833 1,164 799 381 -------------------------------------------------------------------------------------------------------------------- Recoveries: Commercial 17 96 445 79 8 Real estate Mortgage 14 4 14 59 29 Installment 211 160 121 60 16 Other 11 7 25 26 17 -------------------------------------------------------------------------------------------------------------------- Total recoveries 253 267 605 224 70 -------------------------------------------------------------------------------------------------------------------- Net charge-offs 3,993 566 559 575 311 Balance of acquired allowances at date of acquisitions 889 0 2,229 0 678 Additions charged to operations 3,855 810 750 690 450 -------------------------------------------------------------------------------------------------------------------- Balance at end of period $7,900 $7,149 $6,905 $4,485 $4,370 ==================================================================================================================== Ratios: Net charge-offs to average loans outstanding 0.55% 0.08% 0.08% 0.10% 0.06% Net charge-offs to total allowance 50.54 7.92 8.10 12.82 7.12 Allowance to year end loans outstanding 1.05 1.07 0.92 0.73 0.77 ====================================================================================================================
When, in the opinion of management, serious doubt exists as to the collectibility of a loan, the loan is placed on nonaccrual status. At the time a loan is classified as nonaccrual, interest credited to income in the current year is reversed and interest income accrued in the prior year is charged to the Allowance. The Company generally does not recognize income on loans past due 90 days or more. The following table summarizes non-performing assets on the dates indicated (dollars in thousands).
At or for the years ended December 31, --------------------------------------------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 --------------------------------------------------------------------------------------------------------------------- Nonaccrual loans $9,800 $8,729 $4,737 $3,245 $3,500 Accruing loans past due 90 days or more 0 106 14 106 20 Restructured loans 0 0 0 0 0 --------------------------------------------------------------------------------------------------------------------- Total non-performing and restructured loans 9,800 8,835 4,751 3,351 3,520 Other real estate owned 671 267 740 572 620 --------------------------------------------------------------------------------------------------------------------- Total non-performing assets $10,471 $9,102 $5,491 $3,923 $4,140 ===================================================================================================================== Ratios: Non-performing loans to total loans 1.30% 1.32% 0.64% 0.55% 0.62% Allowance to non-performing loans 80.61 80.92 145.34 133.84 124.15 Non-performing assets to total assets 0.89 0.84 0.50 0.47 0.58 Interest income that would have been recorded on nonaccrual loans under original terms $679 $781 $425 $286 $270 Interest income recorded during the period on nonaccrual loans 39 151 71 158 145 =====================================================================================================================
21 The percentage of non-performing loans to total loans remained virtually unchanged at 1.30% at December 31, 2001 compared to 1.32% at December 31, 2000. Financial Accounting Standards Board Statement No. 114 ("FASB 114") defines a loan as impaired if, based on current information or events, it is probable that a creditor will not be able to collect all amounts (both contractual principal and interest) due in accordance with the terms of the original loan agreement. At December 31, 2001, the Company identified approximately $600 thousand in loans considered impaired pursuant to this definition. These loans are included as part of the nonaccrual loans set forth in the table above. Based upon the analyses of the underlying collateral value of these loans and the low percentage of these loans in relation to the gross loan portfolio, management believes the allowance is adequate to provide for the inherent risk associated with these loans. At December 31, 2001, there were no additional loans to borrowers where available information would indicate that such loans were likely to later be included as nonaccrual, impaired (as defined in Financial Accounting Standards Board Statement No. 114), past due, or restructured. Investment Activities Investment securities that the Company has both the positive intent and ability to hold-to-maturity are carried at amortized cost. Investment securities that the Company does not have either the positive intent and/or the ability to hold to maturity and all marketable equity securities are classified as available-for-sale and carried at their respective fair market values. Unrealized holding gains and losses on securities classified as available-for-sale, net of related tax effects, are carried as a component of shareholders' equity. The company has no assets classified as trading. See Note 5 to the Consolidated Financial Statements for additional information. Total investment securities outstanding at December 31, 2001 decreased $45.9 million mainly due to prepayments from mortgage-related securities resulting from the eleven interest rate cuts enacted by the Federal Reserve during 2001. The following table presents the combined amortized cost of the Company's held-to-maturity and available-for-sale investment securities on the dates indicated (dollars in thousands).
At December 31, ------------------------------------------------------------------------------------------------------------------ % of % of %of 2001 total 2000 total 1999 total ------------------------------------------------------------------------------------------------------------------ U.S. Treasury securities and obligations of U.S. government agencies $19,660 7.6% $19,614 6.4% $34,774 15.4% Obligations of states and political subdivisions 62,200 24.1 42,584 14.0 40,401 17.9 Mortgage-related securities 148,312 57.4 224,891 73.9 137,659 60.9 Other securities 28,085 10.9 17,098 5.6 13,238 5.8 --------------------------------------------------------------------------------------------------------------- TOTAL $258,257 $304,187 $226,072 ---------------------------------------------------------------------------------------------------------------
During 2001, balances in mortgage-related securities decreased $76.8 million mainly due to accelerated prepayments impacted by the exceptionally high level of mortgage refinancing that occurred as a result of the multiple interest rate cuts during the year. The Company's mortgage-related securities primarily represent balances outstanding on fixed-rate collateralized-mortgage obligations (CMO's) supported by one-to-four family residential mortgage securities issued by the Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC) and private label issuers rated AAA or better by Moody's or Standard and Poor's. In June 2001, the Company sold $96.7 million in adjustable rate mortgage securities purchased in 2000 with the proceeds of the fixed-rate mortgage securitizations. These investments were purchased in 2000 with the original intent to be a temporary use of cash to ultimately be available as a funding source for loan growth during 2001. As the economy softened in the first half of 2001, it became apparent that loan growth was not occurring as originally projected and that the interest rate cuts were accelerating prepayments on these adjustable rate mortgage-securities. With the expectation in June 2001 that loan growth would continue to be soft for the remainder of 2001 and the probability of further interest rate cuts, which would result in continued prepayments on these securities, the Company sold these securities at a $1.0 million pre-tax gain and invested the proceeds in fixed-rate private label CMO's to protect the rate of return on these funds. At December 31, 2001, mortgage-related securities accounted for 57.4% of the Company's investment portfolio compared to 73.9% at December 31, 2000. 22 Obligations of states and political subdivisions increased $19.6 million at December 31, 2001 compared to December 31, 2000 due to the Company reinvesting mortgage-related security prepayments in municipal investments to enhance its portfolio yield and diversify the composition of the investment portfolio. At December 31, 2001, obligations of states and political subdivisions comprised 24.1% of the Company's investment portfolio as compared to 14.0% at December 31, 2000. U.S. Treasury securities and obligations of U.S. government agencies (Treasuries/Agencies) remained virtually unchanged in dollars outstanding at December 31, 2001 compared to December 31, 2000. As a result of this decline in total investment securities outstanding, the percentage of the Company's investment portfolio invested in Treasuries/Agencies increased to 7.6% at December 31, 2001 from 6.4% at December 31, 2000. Other securities increased $4.0 million in 2001, due to the purchase of $8.7 million in asset-backed securities and an additional $2.7 million investment in Federal Reserve Bank Stock. At December 31, 2001, other securities represented 10.9% of the Company's investment portfolio compared to 5.6% at December 31, 2000. The maturities and weighted-average yield of the Company's investment securities at December 31, 2001 are presented in the following table (dollars in thousands). Taxable-equivalent adjustments (using a 34% tax rate) have been made in calculating the yields on obligations of states and political subdivisions.
After One After Five Within But Within But Within After One Year Five Years Ten Years Ten Years --------------------------------------------------------------------------------------------------------------------- Amount Yield Amount Yield Amount Yield Amount Yield --------------------------------------------------------------------------------------------------------------------- U.S. Treasury securities and obligations of U.S. government agencies $3,058 6.42% $16,302 4.55% $300 7.30% $0 0.00% Obligations of states and political subdivisions 7,467 6.28 24,282 6.39 21,678 6.89 8,772 6.88 Mortgage-related securities 7,658 6.32 116,742 6.43 12,383 6.99 11,533 6.69 Other securities 17,540 5.96 800 7.00 8,992 6.64 750 9.65 --------------------------------------------------------------------------------------------------------------------- TOTAL $35,723 6.14% $158,126 6.23% $43,353 6.87% $21,055 6.87% ---------------------------------------------------------------------------------------------------------------------
At December 31, 2001, the Company had approximately $49 thousand in net unrealized gains on its held-to-maturity securities and approximately $3.5 million in net unrealized gains on its available-for-sale securities. Unrealized gains and losses resulting from marketable equity securities are impacted by the current market price quoted for the underlying security in relation to the price at which the security was acquired by the Company. Unrealized gains and losses on investment securities are the result of changes in market interest rates and the relationship of the Company's investments to those rates for comparable maturities. Unrealized gains generally result from the interest rates on the Company's portfolio of investment securities exceeding market rates for comparable maturities. Conversely, unrealized losses generally result from the interest rates on the Company's portfolio of investment securities falling below market rates for comparable maturities. If material, unrealized losses could negatively impact the Company's future performance as earnings from these investments would be less than alternative investments currently available and may not provide as wide a spread between earnings and funding costs. The Company does not consider its investment portfolio exposed to material adverse impact to future operating performance resulting from market interest rate fluctuations. Deposits Deposits are the Company's principal funding source. Deposit inflows and outflows are significantly influenced by general interest rates, money market conditions, market competition, and the overall condition of the economy. For the year ended December 31, 2001, total average deposits increased $63.4 million (7.6%) mainly due to the Liberty acquisition. Exclusive of Liberty total deposits increased approximately $22 million due to internal deposit growth. For the year ended December 31, 2000, total deposits increased $97.8 million (13.2%) due to internal deposit growth. The following table sets forth the average amount and the average rate paid by the Company by deposit category (dollars in thousands): 23
Years ended December 31, --------------------------------------------------------------------------------------------------------------------- 2001 2000 1999 --------------------------------------------------------------------------------------------------------------------- Average Average % of Average Average % of Average Average % of Amount Rate Total Amount Rate Total Amount Rate Total --------------------------------------------------------------------------------------------------------------------- Non-interest-bearing demand deposits $130,259 14.4% $113,305 13.5% $90,173 12.2% NOW accounts 89,546 1.19% 9.9 102,487 1.67% 12.2 97,797 1.75% 13.2 Money market deposits 220,998 3.26 24.5 187,436 4.93 22.4 152,636 4.03 20.6 Savings 120,275 1.91 13.3 136,672 2.65 16.3 127,523 2.66 17.2 Time deposits 340,441 5.53 37.8 298,187 5.71 35.6 272,194 5.37 36.8 --------------------------------------------------------------------------------------------------------------------- TOTAL $901,519 3.26% $838,087 3.77% $740,323 3.49% ---------------------------------------------------------------------------------------------------------------------
For the year ended December 31, 2001, average non-interest bearing demand deposits increased $17.0 million (15.0%) mainly due to the Liberty acquisition. For the year ended December 31, 2000, average non-interest bearing demand deposits increased $23.1 million (25.7%) due to internal growth. Non-interest bearing demand deposits represent 14.4% of the Company's average deposit portfolio at December 31, 2001 compared to 13.5% at December 31, 2000. Average NOW accounts decreased $12.9 million (12.6%) for the year ended December 31, 2001 over 2000 mainly due to customers transferring their deposits into money market and time deposit accounts because of the higher rate offered on those products. For the year ended December 31, 2000 average NOW accounts increased $4.7 million (4.8%) due to growth in personal, business, and municipal account relationships during the year. At December 31, 2001, NOW accounts represent 9.9% of the Company's average total deposits compared to 12.2% at December 31, 2000. Average money market deposits increased $33.4 million (17.9%) for the year ended December 31, 2001. The Company continues to experience growth from this funding source due to the popularity of the Money Market Index Account. At December 31, 2001, average money market balances of the Company represent 24.5% of average total deposits compared to 22.4% at December 31, 2000. Average savings balances decreased $16.4 million (12.0%). Average savings balances represent 13.3% of average total deposits at December 31, 2001 compared to 16.3% at December 31, 2000. Average time deposit balances increased $42.3 million (14.2%) for the year ended December 31, 2001 compared to the year ended December 31, 2000. At December 31, 2001, average time deposits represent 37.8% of average total deposits compared to 35.6% at December 31, 2000. Maturities of time certificates of deposit and other time deposits of $100,000 or more outstanding at December 31, 2001 are summarized as follows (dollars in thousands). ------------------------------------------------------------ 3 month or less $32,914 Over 3 through 6 months 22,207 Over 6 through 12 months 14,286 Over 12 months 15,851 ------------------------------------------------------------ TOTAL $85,258 ============================================================ Approximately 7.3% of the Company's total assets at December 31, 2001 were supported by time deposits with balances in excess of $100,000 as compared to 6.4% at December 31, 2000. The Company's usage of large balance time deposits to fund its asset base has historically been approximately one-third to one-half of the large liability funding dependence exhibited by its peers. 24 Liquidity The primary functions of asset/liability management are to assure adequate liquidity and to maintain an appropriate balance between interest-earning assets and interest-bearing liabilities. Liquidity management involves the ability to meet the cash flow requirements of depositors and borrowers. The Company's primary funding sources are deposits, loan principal and interest payments, and maturities of loans and investment securities. Contractual maturities and amortization of loans and investment are predictable funding sources, whereas deposit flows and loan prepayments are impacted by market interest rates, economic conditions, and competition. The Company uses wholesale funding sources, such as the Federal Home Loan Bank, to balance the timing differences between its various business funding sources and to support loan origination. The Company's primary funds utilization is loan originations. During 2001, loans increased $13.2 million, net of approximately $50.0 million in fixed-rate mortgage loan refinancings during the year. Exclusive of the refinancing activity, loans increased $63.2 million or 9.5% during 2001. A $14.8 million increase in cash provided by operating activities provided sufficient funding for the $13.2 million increase in loans outstanding. Net contraction in investment securities totaling $50.6 million combined with $12.7 million in deposit growth and $6.7 million in net notes payable proceeds were used to fund the $44.5 million increase in cash and cash equivalents, reduce net wholesale funding (Federal Home Loan Bank advances, repurchase agreements, and federal funds purchased) by $12.8 million, purchase $4.4 million in net fixed assets, pay cash dividends of $3.6 million, and purchase 207,500 shares of the Company's common stock totaling $2.5 million under its stock repurchase program and fund the Liberty acquisition. For the year ended December 31, 2000, the Company had a net decrease in loans of $80.5 million, primarily due to the securtization and sale of approximately $115.0 million in long-term fixed-rate mortgages to shorten the duration of the asset side of its balance sheet. Exclusive of this strategic activity, net loans increased $29.4 million or 4.6% over the comparable loan portfolio at December 31, 1999. Proceeds from the mortgage loan securitization were invested in Fannie Mae and Ginnie Mae mortgage pools with adjustable rates repricable from one to five years. Funding for the loan originations came from maturities and sales of investment securities. Net cash provided from operating activities of $12.2 million combined with $12.3 million in deposit growth and $9.5 million in net increased wholesale funds (Federal Home Loan Bank Advances, repurchase agreements, and federal funds purchased) funded net fixed asset purchases totaling $4.7 million and a reduction of the amount outstanding on the Company's credit line of $32.6 million. Cash contraction of $9.8 million was used to fund shareholder dividends totaling $3.8 million and purchase 600,400 shares of the Company's common stock totaling $6.1 million under its stock repurchase program. Cash and cash equivalents are generally the Company's most liquid assets. The Company's level of operating, financing, and investing activities during a given period impact the resultant level of cash and cash equivalents reported. The Company had liquid assets of $94.5 million and $50.1 million at December 31, 2001 and 2000, respectively. Liquid assets in excess of necessary cash reserves are generally invested in short-term investments such as federal funds sold, commercial paper, and interest-earning deposits. Interest Rate Sensitivity Interest rate risk is an inherent part of the banking business as financial institutions gather deposits and borrow funds to finance interest-earning assets. Interest rate risk results when repricing of rates paid on deposits and other borrowing does not coincide with the repricing of interest-earning assets. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. The following table shows the estimated maturity and repricing structure of the Company's interest-earning assets and interest-bearing liabilities for three different independent and cumulative time intervals as of December 31, 2001 (dollars in millions). For purposes of presentation in the following table, the Company used the national deposit decay rate assumptions published by the Office of the Comptroller of the Currency as of December 31, 2001, which, for NOW accounts, money market accounts, and savings deposits in the one year or less category were 0%, 50%, and 50%, respectively. The table does not necessarily indicate the impact general interest rate movements may have on the Company's net interest income as the actual repricing experience of certain assets and liabilities, such as loan prepayments and deposit withdrawals, is beyond the Company's control. As a result, certain assets and liabilities may reprice at intervals different from the maturities assumed in the following table given the general movement in interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market 25 interest rates, while interest rates on other types may lag behind changes in market rates.
0-30 31-90 91-365 Total days days days 0-365 days -------------------------------------------------------------------------------------------------------------------- ASSETS Loans Fixed $18.7 $19.2 $76.7 $114.6 Variable 177.6 0.0 0.0 177.6 Investments 24.3 32.1 31.5 87.9 Federal Funds 38.6 0.0 0.0 38.6 -------------------------------------------------------------------------------------------------------------------- Total $259.2 $51.3 $108.2 $418.7 ==================================================================================================================== LIABILITIES Savings and NOW deposits $4.9 $9.8 $44.3 $59.0 Time deposits 36.7 81.7 150.0 268.4 Money market deposits 10.1 20.3 91.2 121.6 Other interest-bearing liabilities 0.0 30.2 15.7 45.9 -------------------------------------------------------------------------------------------------------------------- Total $51.7 $142.0 $301.2 $494.9 ==================================================================================================================== Interest sensitivity gap $207.5 $(90.7) $(193.0) $(76.2) Cumulative interest sensitivity gap 207.5 116.8 (76.2) (76.2) Cumulative interest sensitivity gap as a percentage of total earning assets 19.8% 11.1% (7.3)% (7.3)% Cumulative total interest-earning assets as a percentage of cumulative interest-bearing liabilities 501.1% 160.3% 84.6% 84.6% --------------------------------------------------------------------------------------------------------------------
At December 31, 2001, interest-sensitive assets and interest-sensitive liabilities subject to repricing within one year, as a percentage of total assets, were 35.8% and 42.3%, respectively. Variable rate and maturing fixed rate loans are the primary interest-sensitive assets repricing within one year. Time deposits are the most significant liabilities subject to repricing within one year on the funding side of the balance sheet. At December 31, 2001, the Company reported a negative cumulative one-year gap of (7.3)% compared to (11.9)% at December 31, 2000. The Company's less negative cumulative one-year gap at December 31, 2001 was mainly due to an increase in the amount of variable rate loans outstanding and a reduction in the deposit decay rates applied to NOW, money market and savings deposits in the one year or less category at December 31, 2001. The Company's liability-sensitivity at December 31, 2001 would normally indicate that the Company's net interest margin would improve if rates decreased and deteriorate if interest rates increased. Capital Resources Total shareholders' equity was $106.4 million, $106.5 million and $109.7 million in 2001, 2000 and 1999, respectively. The equity decreases are primarily due to the Company's stock repurchase program under which the Company repurchased approximately 200 thousand shares of common stock at a average price of $12.16 per share in 2001; 600 thousand shares at a average price of $10.17 per share in 2000; and, 1.5 million shares at a average price of $16.66 per share in 1999. Total dividends declared were $ $3.6 million in 2001, $3.8 million in 2000, and $4.4 million in 1999. The Company maintained a cash dividend declared amount of $.48 per share in each of these years. The total dollar decreases in each year are the direct result of the stock repurchase program. Total assets increased 8.4% in 2001 in comparison to 2000 primarily due to the acquisition of LB Bancorp, Inc.; were relatively unchanged in 2000 in comparison to 1999, and increased 31.6% in 1999 due primarily to the acquisition of Bank of Northern Illinois. Acquisitions and internal asset growth, coupled with the Company's stock repurchase program, impacted the average equity to asset ratios of 9.59%, 9.98% and 13.04% in the years 2001, 2000 and 1999, respectively. 26 There are certain regulatory constraints which affect the Company's capital levels. At December 31, 2001, the Company's actual regulatory amounts and ratios exceeded those necessary to be defined as "well capitalized" under regulatory framework. See Note 14 and Note 18 to the Consolidated Financial Statements for additional explanation of these regulatory constraints. Impact of Inflation and Changing Prices The Company's Consolidated Financial Statements have been prepared in conformity with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time impacted by inflation. The impact of inflation is reflected in the Company's other expenses which tend to rise during periods of general inflation. The majority of the Company's assets and liabilities are monetary in nature and therefore differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. Consequently, interest rates have a greater impact on the Company's performance than do the general levels of inflation. Management believes the most significant impact on the Company's financial results is its ability to react to interest rate changes and endeavors to maintain an essentially balanced position between interest sensitive assets and liabilities in order to protect against wide fluctuations in the Company's net interest margin. Report of Management The management of State Financial Services Corporation is responsible for the preparation and integrity of the Consolidated Financial Statements and other financial information included in this Annual Report. The financial statements have been prepared in accordance with generally accepted accounting principles and include amounts that are based upon informed judgements and estimates by management. The other financial information in this Annual Report is consistent with the financial statements. The Company maintains a system of controls and management believes that the internal accounting controls provide reasonable assurance that transactions are executed and recorded in accordance with Company policies and procedures and that the accounting records may be relied on as a basis for preparation of the financial statements and other financial information. The Company's independent auditors were engaged to perform an audit of the Consolidated Financial Statements, and the auditor's report expresses their opinion as to the fair presentation of the consolidated financial statements in conformity with generally accepted accounting principles. The Audit Committee of the Board of Directors, comprised of directors who are not employees of the Company, meets with management and the independent auditors to discuss the adequacy of the internal accounting controls. The independent auditors have full and free access to the Audit Committee. /s/ Michael J. Falbo Michael J. Falbo President and Chief Executive Officer /s/ Timothy L. King Timothy L. King Senior Vice President and Chief Financial Officer 27 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Quantitative and Qualitative Disclosures about Market Risk The Company's primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of the Company's transactions are denominated in U.S. currency with no specific foreign exchange exposure. The Company has a limited number of agricultural loans and accordingly has no significant exposure to changes in commodity prices. Any impact that changes in foreign exchange rates and commodity prices would have on interest rates are assumed to be insignificant. Interest rate risk ("IRR") is the exposure of a banking organization's financial condition to adverse movements in interest rates. Accepting this risk can be an important source of profitability and shareholder value, however excessive levels of IRR can significantly impact the Company's earnings and capital base. Accordingly, effective risk management that maintains IRR at prudent levels is essential to the Company's safety and soundness. Evaluating a financial institution's exposure to interest rate changes includes assessing both the adequacy of the management process used to monitor and control IRR and the organization's quantitative exposure level. When assessing the IRR management process, the Company seeks to ensure that appropriate policies, procedures, management information systems, and internal controls are in place to maintain IRR at prudent levels with consistency and continuity. Evaluating the quantitative level of IRR exposure requires the Company to assess the existing and potential future effects of changes in interest rates on its consolidated financial condition, including capital adequacy, earnings, liquidity, and where appropriate, asset quality. The Federal Reserve Board, together with the Office of the Comptroller of the Currency and the FDIC, adopted a Joint Agency Policy Statement on IRR. The policy statement provides guidance to examiners and bankers on sound practices for managing IRR, which forms the basis for an ongoing evaluation of the adequacy of IRR management at institutions under their respective supervision. The policy statement also outlines fundamental elements of sound management that have been identified in prior Federal Reserve guidance and discusses the importance of these elements in the context of managing IRR. Specifically, the guidance emphasizes the need for active board of director and senior management oversight and a comprehensive risk management process which effectively identifies, measures, and controls IRR. Financial institutions derive their income primarily from the excess of interest collected over interest paid. The rates of interest an institution earns on its assets and owes on its liabilities generally are established contractually for a period of time. Since market interest rates change over time, an institution is exposed to lower profit margins (or losses) if it cannot adapt to interest rate changes. For example, assume that an institution's assets carry intermediate or long-term fixed rates and that those assets are funded with short-term liabilities. If market interest rates rise by the time the short-term liabilities must be refinanced, the increase in the institution's interest expense on its liabilities may not be sufficiently offset if assets continue to earn at the contractual long-term fixed rates. Accordingly, an institution's profits could decrease on existing assets because the institution will either have lower net interest income or, possibly, higher net interest expense. Similar risks exist when assets are subject to contractual interest rate ceilings, or rate sensitive assets are funded by longer-term fixed-rate liabilities in a decreasing rate environment. An institution might use various techniques to minimize IRR. One approach used by the Company is to analyze its assets and liabilities and make future financing and investment decisions based on payment streams, interest rates, contractual maturities, and estimate sensitivity to actual or potential market interest rate changes. Such activities fall under the broad definition of asset/liability management. The Company's primary asset/liability management technique is the measurement of its asset/liability gap which is defined as the difference between the cash flow amounts of interest-sensitive assets and liabilities that will be refinanced or repriced over a given time period. For example, if the asset amount to be repriced exceeds the corresponding liability amount subject to repricing for a given day, month, year, or longer period, the institution is in an asset-sensitive gap position. In this situation, net interest income would increase if market interest rates rose and conversely decrease if market interest rates fell. Alternatively, if more liabilities than assets will reprice, the institution is in a liability-sensitive position. Accordingly, net interest income would decline when rates rose and improve when rates fell. Also, these examples assume that interest rate changes for assets and liabilities are of the same magnitude, whereas actual interest rate changes generally differ in magnitude for assets and liabilities. 28 Several ways an institution can manage IRR include selling existing assets or repaying certain liabilities; matching repricing periods for new assets and liabilities for example by, shortening terms of new loans or investments; and hedging existing assets, liabilities, or anticipated transactions. An institution might also invest in more complex financial instruments intended to hedge or otherwise change IRR. Interest rate swaps, futures contracts, options on futures, and other such derivative financial instruments are often used for this purpose. Because these instruments are sensitive to interest rate changes, they require management expertise to be effective. SFSC has not purchased derivative financial instruments in the past. Financial institutions are also subject to prepayment risk in falling interest rate environments. For example, mortgage loans and other financial assets may be prepaid by a debtor so that the debtor may refinance its obligations at new, lower interest rates. Prepayments of assets carrying higher rates reduce the Company's interest income and overall asset yields. Certain portions of an institution's liabilities may be short-term or due on demand, while most of its assets may be invested in long-term loans or investments. Accordingly, the Company seeks to have in place sources of cash to meet short-term demands. These funds can be obtained by increasing deposits, borrowing, or selling assets. Federal Home Loan Bank advances and short-term borrowings provide additional sources of liquidity for the Company. SFSC also has a $40.0 million line of credit available through a third party financial institution. The following table sets forth information about the Company's financial instruments that are sensitive to changes in interest rates as of December 31, 2001. The Company had no derivative financial instruments, or trading portfolio, as of that date. The expected maturity date values for loans, mortgage backed securities, and investment securities were calculated adjusting the underlying instrument's contractual maturity date for prepayment expectations. Expected maturity date values for interest-bearing deposits were not based upon estimates of the period over which the deposits would be outstanding, but rather the opportunity for repricing. Similarly, with respect to its variable rate instruments, the Company believes that repricing dates, as opposed to maturity dates are more relevant in analyzing the value of such instruments and are reported as such in the following table. Company borrowings are also reported based on conversion or repricing dates. Quantitative Disclosures of Market Risk
Fair Value Maturity Date 2002 2003 2004 2005 2006 Thereafter Total 12/31/01 -------------------------- ---------- ---------- ----------- ---------- ----------- ---------- ---------- ----------- Rate sensitive assets: Fixed rate loans $114,693 $83,164 $135,039 $39,694 $60,164 $110,952 $543,705 $545,515 Average interest rate 8.09% 8.26% 7.72% 8.28% 7.51% 7.13% 7.78% Variable rate loans $126,731 $9,107 $9,992 $14,684 $9,312 $40,154 $209,980 $209,980 Average interest rate 5.77% 5.48% 5.54% 4.74% 5.63% 7.44% 5.99% Investment securities $35,723 $61,252 $76,950 $18,052 $11,995 $54,286 $258,257 $261,795 Average interest rate 6.14% 6.29% 5.99% 5.96% 5.99% 7.13% 6.32% -------------------------- ---------- ---------- ----------- ---------- ----------- ---------- ---------- ----------- Rate sensitive liabilities: Savings & interest- bearing Checking $456,653 --- --- --- --- --- $456,653 $456,653 Average interest rate 3.58% --- --- --- --- --- 3.58% Time deposits $267,520 $49,835 $13,881 $10,813 $6,669 1,095 $349,814 $356,425 Average interest rate 4.43% 4.87% 5.61% 6.07% 5.60% 6.90% 4.62% Variable rate borrowings $101,940 --- --- --- --- --- $101,940 $101,940 Average interest rate 4.06% --- --- --- --- --- 4.06% -------------------------- ---------- ---------- ----------- ---------- ----------- ---------- ---------- -----------
29 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Ernst & Young LLP, Independent Auditors Board of Directors and Shareholders State Financial Services Corporation We have audited the accompanying consolidated statements of condition of State Financial Services Corporation and subsidiaries (the Company) as of December 31, 2001 and 2000, and the related consolidated statements of income, shareholder's equity and cash flows for each of the three years in the period ended December 31, 2001. 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 auditing standards generally accepted in the 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 consolidated financial position of the Company at December 31, 2001 and 2000, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young Chicago, Illinois January 17, 2002 30 State Financial Services Corporation and Subsidiaries Consolidated Statements of Condition
December 31 2001 2000 -------------------------------------- Assets Cash and due from banks $54,541,162 $44,993,586 Interest-bearing bank balances 1,402,789 3,303,170 Federal funds sold 38,605,567 1,760,272 -------------------------------------- Cash and cash equivalents 94,549,518 50,057,028 Investment securities: Available-for-sale (at fair value) 259,841,523 300,668,224 Held-to-maturity (fair value of $1,953,066--2001 and $3,015,242--2000) 1,904,547 2,973,224 Loans (net of allowance for loan losses of $7,899,922--2001 and $7,149,147--2000) 722,593,419 654,837,747 Loans held for sale 23,192,133 6,071,482 Premises and equipment 28,694,648 24,885,632 Accrued interest receivable 5,599,880 6,978,744 Goodwill 27,465,062 26,787,184 Other assets 7,212,410 7,527,086 -------------------------------------- Total Assets $1,171,053,140 $1,080,786,351 ====================================== Liabilities and Shareholders' Equity Deposits: Demand $147,992,336 $134,788,576 Savings 213,328,297 210,740,973 Money market 243,324,258 206,484,681 Time deposits in excess of $100,000 85,574,897 69,772,101 Other time deposits 264,238,960 237,569,457 -------------------------------------- Total deposits 954,458,748 859,355,788 Federal Home Loan Bank advances 67,700,000 77,700,000 Note payable 15,652,776 7,309,250 Securities sold under agreement to repurchase 18,586,952 11,419,510 Federal funds purchased - 10,000,000 Accrued expenses and other liabilities 5,845,082 5,591,897 Accrued interest payable 2,449,482 2,910,649 -------------------------------------- Total Liabilities 1,064,693,040 974,287,094 Shareholders' Equity: Preferred stock, $1 par value; authorized-- 100,000 shares; issued and outstanding--none - - Common stock, $.10 par value; authorized 25,000,000 shares; 10,108,769 shares issued and outstanding in 2001 and 10,107,728 in 2000 1,010,877 1,010,773 Additional paid-in capital 94,797,858 95,027,591 Retained earnings 46,587,268 46,045,533 Accumulated other comprehensive income 2,302,673 888,394 Unearned shares held by ESOP (4,473,357) (5,131,608) Treasury stock 2,323,040 shares in 2001 and 2,115,540 shares in 2000 (33,865,219) (31,341,426) -------------------------------------- Total Shareholders' Equity 106,360,100 106,499,257 -------------------------------------- Total Liabilities and Shareholders' Equity $1,171,053,140 $1,080,786,351 ======================================
31 State Financial Services Corporation and Subsidiaries Consolidated Statements of Income
Year ended December 31 2001 2000 1999 ------------------------------------------------ Interest income: Loans $56,453,228 $59,891,105 $54,631,410 Investment securities: Taxable 14,778,546 15,563,104 8,921,184 Tax-exempt 2,293,839 1,927,597 1,675,685 Federal funds sold and other short-term investments 676,029 536,995 388,961 ------------------------------------------------ Total interest income 74,201,642 77,918,801 65,617,240 Interest expense: Deposits 29,409,899 31,705,889 25,873,922 Note payable and other borrowings 6,208,370 9,988,048 4,258,120 ------------------------------------------------ Total interest expense 35,618,269 41,693,937 30,132,042 ------------------------------------------------ Net interest income 38,583,373 36,224,864 35,485,198 Provision for loan losses 3,855,130 810,000 750,000 ------------------------------------------------ Net interest income after provision for loan losses 34,728,243 35,414,864 34,735,198 Other income: Service charges on deposit accounts 2,089,093 2,133,802 2,185,081 ATM and merchant services 3,122,031 2,653,995 2,212,351 Security commissions and management fees 737,791 1,148,425 1,124,107 Investment securities gains, net 1,925,380 39,172 992,469 Gain (loss) on sale of loans 2,314,563 (1,549,206) 277,000 Other 2,114,445 1,379,372 1,202,158 ------------------------------------------------ 12,303,303 5,805,560 7,993,166 Other expenses: Salaries and employee benefits 16,699,900 14,670,735 13,881,079 Net occupancy expense 2,433,629 2,047,317 1,465,792 Equipment rentals, depreciation and maintenance 3,803,061 3,961,304 3,410,883 Data processing 2,047,047 1,918,119 2,053,887 Legal and professional 1,882,828 1,682,563 1,241,124 ATM and merchant services 2,206,614 1,846,716 1,680,421 Consolidation and merger-related charges -- 2,230,000 598,291 Advertising 1,015,257 1,222,654 1,133,258 Goodwill 4,063,373 2,053,155 1,387,127 Other 5,021,180 4,664,740 4,111,023 ------------------------------------------------ 39,172,889 36,297,303 30,962,885 ------------------------------------------------ Income before income taxes 7,858,657 4,923,121 11,765,479 Income taxes 3,724,415 1,925,283 4,332,997 ------------------------------------------------ Net income $4,134,242 $ 2,997,838 $ 7,432,482 ================================================ Basic earnings per share $.55 $.38 $.80 Diluted earnings per share .55 .38 .80 ================================================
32 State Financial Services Corporation and Subsidiaries Consolidated Statements of Shareholders' Equity
Accumulated Additional Other Unearned Common Paid-In Retained Comprehensive ESOP Treasury Stock Capital Earnings Income Shares Stock Total ------------------------------------------------------------------------------------------------ Balance at December 31, 1998 $1,007,602 $94,153,564 $43,748,273 $ 1,080,549 $(5,352,709) $ - $134,637,279 Comprehensive income: Net income - - 7,432,482 - - - 7,432,482 Change in net unrealized gain/(loss) on securities available-for-sale, net of income taxes of $2,013,224 - - - (3,789,859) - - (3,789,859) ------------------------------------------------------------------------------------------------ Total comprehensive income - - 7,432,482 (3,789,859) - - 3,642,623 Cash dividends declared - $0.48 per share - - (4,368,258) - - - (4,368,258) Issuance of 16,657 shares under stock plans 1,667 171,332 - - - - 172,999 Purchase of 1,515,140 shares of treasury stock - - - - - (25,236,482) (25,236,482) ESOP shares earned - 598,291 - - 221,101 - 819,392 ------------------------------------------------------------------------------------------------ Balances at December 31, 1999 $1,009,269 $94,923,187 $46,812,497 $(2,709,310) $(5,131,608) $(25,236,482) $109,667,553 ================================================================================================ Comprehensive income: Net income - - 2,997,838 - - - 2,997,838 Change in net unrealized gain/(loss) on securities available-for-sale, net of income taxes of $919,181 - - - 3,597,704 - - 3,597,704 ------------------------------------------------------------------------------------------------ Total comprehensive income - - 2,997,838 3,597,704 - - 6,595,542 Cash dividends declared - $0.48 per share - - (3,764,802) - - - (3,764,802) Issuance of 15,040 shares under stock plans 1,504 104,404 - - - - 105,908 Purchase of 600,400 shares of treasury stock - - - - - (6,104,944) (6,104,944) ------------------------------------------------------------------------------------------------ Balance at December 31, 2000 $1,010,773 $95,027,591 $46,045,533 $888,394 $(5,131,608) $(31,341,426) $106,499,257 ================================================================================================ Comprehensive income: Net income - - 4,134,242 - - - 4,134,242 Change in net unrealized gain/(loss) on securities available-for-sale, net of income taxes of $2,619,770 - - - 1,414,279 - - 1,414,279 ------------------------------------------------------------------------------------------------ Total comprehensive income - - 4,134,242 1,414,279 - - 5,548,521 Cash dividends declared - $0.48 per share - - (3,592,507) - - - (3,592,507) Issuance of 1,041 shares under stock plans 104 10,072 - - - - 10,176 Purchase of 207,500 shares of treasury stock - - - - - (2,523,793) (2,523,793) ESOP shares earned - (239,805) - - 658,251 - 418,446 ------------------------------------------------------------------------------------------------ Balance at December 31, 2001 $1,010,877 $94,797,858 $46,587,268 $2,302,673 $(4,473,357) $(33,865,219) $106,360,100 ================================================================================================
33 State Financial Services Corporation and Subsidiaries Consolidated Statements of Cash Flows
Year ended December 31 2001 2000 1999 ----------------------------------------------------- Operating activities: Net income $4,134,242 $2,997,838 $7,432,482 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 3,855,130 810,000 750,000 Provision for depreciation 2,743,818 2,636,047 1,875,639 Amortization of premiums and accretion of discounts on investment securities 576,376 (34,291) 667,023 Amortization of goodwill 4,063,373 2,053,155 1,387,127 Deferred income tax provision 1,013,721 572,000 124,000 Market adjustment for committed ESOP shares (239,805) - 598,291 Fair market value adjustment-loans held for sale -- - 735,538 Decrease (increase) in accrued interest receivable 1,825,645 (1,168,206) (1,325,206) Increase (decrease) in accrued interest payable (799,756) 717,094 (2,240,365) Realized investment securities gains (1,925,380) (39,172) (992,469) Other (483,106) 3,691,383 (480,623) ----------------------------------------------------- Net cash provided by operating activities 14,764,258 12,235,848 8,531,437 Investing activities: Proceeds from maturities or principal payments of investment securities held-to-maturity 997,523 345,063 6,920,216 Purchases of securities available-for-sale (160,228,303) (159,358,500) (57,962,731) Proceeds from maturities and sales of investment securities available-for-sale 209,612,811 81,898,298 33,249,508 Net decrease (increase) in loans (13,198,067) 80,476,890 (49,058,772) Net purchases of premises and equipment (4,362,792) (4,702,332) (4,877,569) Business acquisitions, net of cash and cash equivalents acquired of $6,952,438 in 2001 and $7,721,000 in 1999 (4,183,444) - (25,965,273) ----------------------------------------------------- Net cash provided (used) by investing activities 28,637,728 (1,340,581) (97,694,621) Financing activities: Net increase in deposits $12,693,409 $12,305,224 $9,156,285 Repayment of notes payable (13,769,224) (42,500,000) (6,750,000) Proceeds of notes payable 20,446,750 9,850,641 39,958,609 Net decrease in guaranteed ESOP obligation 658,251 - 221,101 Increase (decrease) in securities sold under agreements to 7,167,442 (4,314,299) 5,617,132 repurchase Increase (decrease) in Federal Home Loan Bank advances (10,000,000) 16,200,000 36,500,000 Cash dividends (3,592,507) (3,764,803) (4,368,258) Proceeds (repayments) of federal funds purchased (10,000,000) (2,400,000) 11,446,000 Purchase of treasury stock (2,523,793) (6,104,944) (25,236,482) Proceeds from exercise of stock options and restricted stock awards 10,176 105,909 179,999 ----------------------------------------------------- Net cash (used) provided by financing activities 1,090,504 (20,622,272) 66,717,386 ----------------------------------------------------- Increase (decrease) in cash and cash equivalents 44,492,490 (9,727,005) (22,445,798) Cash and cash equivalents at beginning of year 50,057,028 59,784,033 82,229,831 ----------------------------------------------------- Cash and cash equivalents at end of year $94,549,518 $50,057,028 $59,784,033 ===================================================== Supplementary information: Interest paid $36,079,436 $40,976,843 $33,372,407 Income taxes paid 2,486,022 1,528,301 4,396,500
34 1. Accounting Policies The accounting policies followed by State Financial Services Corporation (the Company) and the methods of applying those principles which materially affect the determination of its financial position, cash flows or results of operations are summarized below. Organization The Company is a financial services company operating through twenty-eight locations in southeastern Wisconsin and northeastern Illinois. Through its banking network, the Company provides commercial and retail banking products, long-term fixed-rate secondary market mortgage origination and brokerage activities. The Company also operates State Financial Insurance Agency and provides asset management services. The Company and its subsidiaries are subject to competition from other financial institutions and financial service providers, and are subject to certain federal and state regulations and undergo periodic examinations by regulatory agencies. In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related information," which establishes annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas and major customers. The Company's operations are within one reportable segment. Basis of Presentation The consolidated statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions have been eliminated. The financial statements are prepared in accordance with generally accepted accounting principles and include amounts based on management's prudent judgments and estimates. Actual results may differ from these estimates. Cash and Cash Equivalents Cash and cash equivalents include cash and due from banks, interest-bearing bank balances and federal funds sold, all with an original maturity of three months or less. Investment Securities Securities are classified as available-for-sale and reported at fair value, with unrealized gains and losses, net of tax, excluded from earnings and reported as other comprehensive income. All other securities are classified as held-to-maturity and reported at amortized cost if management has the intent and ability to hold the securities to maturity. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage related securities, over the estimated life of the security. Such amortization is calculated using the level-yield method, adjusted for prepayments and is included in interest income from investments. Realized gains and losses, and declines in value judged to be other than temporary are included in net securities gains and losses. The cost of securities is based on the specific identification method. 35 1. Accounting Policies (continued) Interest on Loans Interest income on loans is accrued and credited to operations based on the principal amount outstanding. The accrual of interest income is generally discontinued when a loan becomes 90 days past due as to principal or interest and/or when, in the opinion of management, full collection is questionable. When interest accruals are discontinued, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in the prior year is charged to the allowance for loan losses. Management may elect to continue the accrual of interest when the loan is in the process of collection and the fair value of collateral is sufficient to cover the principal balance and accrued interest. Interest received on nonaccrual loans is either applied against principal or reported as interest income according to management's judgment regarding the collectibility of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. Loan Fees and Related Costs Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amounts are amortized as an adjustment of the related loan yield. The Company is generally amortizing these amounts using the level-yield method over the contractual life of the related loans. Fees related to standby letters of credit are recognized over the commitment period. Loans Held for Sale Loans held for sale consist of residential mortgages and are carried at the lower of cost or aggregate market value. Net unrealized losses are recognized through a valuation allowance and charged to income. Mortgage Servicing Rights The Company has originated and sold mortgage loans with servicing rights retained. The rights to service these loans are capitalized at the time of sale. The capitalized cost of loan servicing rights is amortized in proportion to, and over the period of, estimated net future servicing revenue. Mortgage servicing rights are periodically evaluated for impairment. For purposes of measuring impairment, the servicing rights are stratified into pools based on one or more predominant risk characteristics of the underlying loans including loan type, interest rate, term and geographic location, if applicable. Impairment represents the excess of the remaining capitalized cost of a stratified pool over its fair value and is recorded through a valuation allowance. The fair value of each servicing rights pool is evaluated based on the present value of estimated future cash flows using a discount rate commensurate with the risk associated with that pool, given current market conditions. Estimates of fair value include assumptions about prepayment speeds, interest rates and other factors which are subject to change over time. Changes in these underlying assumptions could cause the fair value of mortgage servicing rights, and the related valuation allowance, if any, to change significantly in the future. Allowance for Loan Losses The allowance for loan losses is composed of specific and general valuation allowances. The Company establishes specific valuation allowances on loans considered impaired equal to the amount of the impairment. A loan is considered impaired when the carrying amount of the loan exceeds the present value of the expected future cash flows, discounted at the loan's original effective interest rate or the fair value of the underlying collateral. 36 1. Accounting Policies (continued) General valuation allowances are based on an evaluation of the various risk components that are inherent in the loan portfolio. The risk components that are evaluated include past loan loss experience; the level of nonperforming and classified loans; current economic conditions; volume, growth and composition of the loan portfolio; adverse situations that may affect the borrower's ability to repay; the estimated value of any underlying collateral; peer group comparisons; regulatory guidance; and other relevant factors. The allowance is increased by provisions charged to earnings and reduced by charge-offs, net of recoveries. Management may transfer reserves between specific and general valuation allowances as considered necessary. The allowance for loan losses reflects management's best estimate of the reserves needed to provide for the impairment of income-producing loans and is based on a risk model developed and implemented by management. Actual results could differ from estimates and future additions to the allowance may be necessary based on unforeseen changes in economic conditions. In addition, federal regulators annually review the loan portfolio and the allowance for loan losses. Such regulators have the authority to require the Company to recognize additions to the allowance at the time of their examination. Premises and Equipment Premises and equipment are carried at cost less accumulated depreciation. The provision for depreciation is computed using both accelerated and straight-line methods over the estimated useful lives of the respective assets. Leasehold improvements are amortized using both accelerated and straight-line methods over the shorter of the useful life of the leasehold asset or lease term. Land is carried at cost. Intangibles The excess of the purchase price over the fair value of net assets of companies acquired is being amortized on straight-line basis to operating expense over 15 years. The carrying amount of goodwill is reviewed if facts and circumstances suggest that it may be impaired. If this review indicates that it is not recoverable, as determined based on the estimated undiscounted cash flows of the entity acquired over the remaining amortization period, the carrying amount of the goodwill is reduced by the estimated shortfall of the cash flows discounted to reflect the Company's cost of capital. Treasury Stock Common stock purchased for treasury stock is recorded at cost. At the date of subsequent reissueance, the treasury stock account is reduced by the cost of such stock on a first-in, first-out basis. Employee Stock Ownership Plan (ESOP) Compensation expense under the ESOP is equal to the fair value of common shares released or committed to be released to participants in the ESOP in each respective period. Common stock purchased by the ESOP and not committed to be released to participants is included in the consolidated statements of condition at cost as a reduction of shareholders' equity. Earnings Per Share Basic earnings per share is computed by dividing net income by the weighted-average common shares outstanding less unearned ESOP shares. Diluted earnings per share are computed by dividing net income by the weighted-average common shares outstanding less unallocated ESOP shares plus the assumed conversion of all potentially dilutive securities using the treasury stock method. 37 1. Accounting Policies (continued) The denominators for the earnings per share amounts are as follows:
2001 2000 1999 ----------------- ------------------ ---------------- Basic: Weighted-average number of shares outstanding 7,844,094 8,288,947 9,711,923 Less: weighted-average number of unearned ESOP shares (362,883) (379,468) (408,631) ----------------- ------------------ ---------------- Denominator for basic earnings per share 7,481,211 7,909,479 9,303,292 ================= ================== ================ Fully diluted: Denominator for basic earnings per share 7,481,211 7,909,479 9,303,292 Add: assumed conversion of stock options using the treasury stock method 31,905 3,559 16,383 ----------------- ------------------ ---------------- Denominator for fully diluted earnings per share 7,513,116 7,913,038 9,319,675 ================= ================== ================
At December 31, 2001, 231,186 stock options with a weighted-average exercise price of $16.20 were excluded from the calculation of fully diluted earnings per share as their impact was anti-dilutive. Stock Option Plan Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," allows entities to apply the provisions of Accounting Principles Board (APB) Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made as if the fair value based method defined in SFAS No. 123 had been applied. The Company accounts for its stock option plans in accordance with the provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. As such, compensation expense is recorded for stock options only to the extent that the current market price of the underlying stock exceeded the exercise price on the date of grant. The fair value of the stock options granted was not material for the years ended December 31, 2001, 2000 and 1999. Income Taxes The Company accounts for income taxes using the liability method. Deferred income tax assets and liabilities are adjusted regularly to amounts estimated to be receivable or payable based on current tax law and the Company's tax status. Valuation allowances are established for deferred tax assets for amounts for which it is more likely than not that they will be realized. Accounting Changes Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," and SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities and Deferral of the Effective Date of SFAS No. 133" provide a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. SFAS No. 133 requires all derivatives to be recorded on the balance sheet at fair value, and provides for special accounting for certain derivatives that meet the definition of hedges. The Company does not use derivative financial instruments such as futures, swaps, caps, floors, options, interest only or principal only strips or similar financial instruments. The Company implemented SFAS No. 133 on January 1, 2001, and had no transition adjustment. 38 1. Accounting Policies (continued) SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinquishments of Liabilities", changed many of the rules regarding securitizations and continues to require an entity to recognize the financial and servicing assets it controls and the liabilities it has incurred and to derecognize financial assets when control has been surrendered in accordance with the criteria provided in the Statement. The Company implemented SFAS No. 140 beginning in the second quarter of 2001 and the application of the new rules did not have a material impact on its financial statements. SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets," were issued in July 2001. SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, as well as, all purchase method business combinations completed after June 30, 2001. The Statement also specifies criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of the Statement. SFAS No. 142 requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with FAS Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The Company recorded its July, 2001 acquisition of LB Bancorp using the purchase method of accounting. The Company will adopt the new rules of SFAS No. 142 effective January 1, 2002. 2. Acquisition On July 7, 2001, the Company acquired LB Bancorp, Inc. ("LB") and its wholly-owned subsidiary Liberty Bank ("Liberty"), Milwaukee, Wisconsin. The Company purchased all of the outstanding common stock of LB for $11.2 million in cash. This "in-market" acquisition increased the Company's share of the metro-Milwaukee banking market. Liberty and its five branch locations have been merged into State Financial Bank, N.A. Application of purchase accounting requires the inclusion of LB's and Liberty's operating results in the consolidated statements of income from the date of acquisition. Accordingly, LB's and Liberty's operating results for the period July 7, 2001 through December 31, 2001 are included in the Company's consolidated statement of income for twelve months ended December 31, 2001. LB and Liberty's financial condition is included in the Company's consolidated balance sheet dated December 31, 2001. The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition (dollars in thousands): Cash and due from banks $3,809 Investments 7,761 Net loans 75,535 Other assets 3,447 Goodwill 5,132 ------------------- Total assets acquired 95,684 Deposits 82,410 Long-term debt 1,666 Other liabilities 378 ------------------- Total liabilities assumed 84,454 ------------------- Net assets acquired $11,230 =================== 39 2. Acquisitions (continued) On a pro forma basis, total income, net income, basic and fully diluted earnings per share for the twelve months ended December 31, 2001 and December 31, 2000, after giving effect to the acquisition of LB as if it had occurred on January 1, 2000 are as follows (dollars in thousands): 2001 2000 ------------------------------------ ------------------ ----------------- Total income $90,504 $91,438 ------------------------------------ ------------------ ----------------- Net income 3,526 3,603 ------------------------------------ ------------------ ----------------- Basic earnings per share $0.47 $0.46 ------------------------------------ ------------------ ----------------- Diluted earnings per share $0.47 $0.46 ------------------------------------ ------------------ ----------------- 3. Non-recurring Charges In the fourth quarter, 2001, the Company recorded a pretax charge of approximately $4.0 million related to the liquidation of its asset management subsidiary ($2.0 million) and an additional provision for loan losses ($2.0 million). In the third quarter, 2000, the Company recorded a non-recurring consolidation charge of approximately $4.7 million related to the consolidation of the Company's five bank and thrift charters into one nationally chartered bank and a restructuring of the balance sheet. Approximately $2.2 million of the charge was related to the charter consolidation and included expenses for employee severance, branch closure and data processing conversion. The balance sheet restructuring charge of $2.5 million related to the sale of approximately $90 million in fixed-rate mortgage loans and investment securities that had yields below market interest rates. 4. Restrictions on Cash and Due From Bank Accounts The State Financial Bank, N.A. (Bank) is required to maintain reserve balances with the Federal Reserve Bank. The average amount of reserve balances for the years ended December 31, 2001 and 2000, was approximately $14.4 million and $8.7 million, respectively. 40 5. Investment Securities The amortized cost and estimated fair values of investment securities follow:
Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Fair Value --------------------------------------------------------------- Held-to-Maturity December 31, 2001: Obligations of state and political subdivisions 1,404,547 48,509 0 1,453,056 Other securities 500,000 120 (110) 500,010 --------------------------------------------------------------- $1,904,547 $48,629 $(110) $1,953,066 =============================================================== December 31, 2000: U.S. Treasury securities and obligations of U.S. government agencies $668,487 $3,289 $(9,933) $661,843 Obligations of state and political subdivisions 1,804,737 49,542 - 1,854,279 Other securities 500,000 1,200 (2,080) 499,120 --------------------------------------------------------------- $2,973,224 $54,031 $(12,013) $3,015,242 =============================================================== Available-for-Sale December 31, 2001: U.S. Treasury securities and obligations of U.S. government agencies $19,659,243 $313,609 $(25,969) $19,946,883 Obligations of state and political subdivisions 60,795,837 852,700 (272,409) 61,376,128 Mortgage-related securities 148,316,045 2,997,555 (110,813) 151,202,787 Other securities 27,581,499 184,372 (450,146) 27,315,725 --------------------------------------------------------------- $256,352,624 $4,348,236 $(859,337) $259,841,523 =============================================================== December 31, 2000: U.S. Treasury securities and obligations of U.S. government agencies $18,946,699 $71,822 $(104,769) $18,913,752 Obligations of state and political subdivisions 40,778,681 329,011 (383,614) 40,724,078 Mortgage-related securities 224,889,820 541,786 (1,207,050) 224,224,556 Other securities 16,598,174 463,506 (255,842) 16,805,838 --------------------------------------------------------------- $301,213,374 $1,406,125 $(1,951,275) $300,668,224 ===============================================================
The amortized cost and estimated fair value of investment securities at December 31, 2001, by contractual maturity, are as follows:
Held-to-Maturity Available-for-Sale Amortized Estimated Amortized Estimated Cost Fair Value Cost Fair Value -------------------------------------------------------------------- Due in one year or less $200,000 $200,954 $35,522,862 $35,425,982 Due after one year through five years 1,070,698 1,107,866 157,055,664 160,357,528 Due after five years through ten years 484,271 492,254 42,868,242 43,104,822 Due after ten years 149,578 151,992 20,905,856 20,953,191 -------------------------------------------------------------------- $1,904,547 $1,953,066 $256,352,624 $259,841,523 ====================================================================
Expected maturities may differ from contractual maturities because borrowers or issuers may have the right to call or prepay obligations with or without call or prepayment penalties. The Company's investments in mortgage-related securities have been allocated to the various maturity categories based on expected maturities using current prepayment estimates 41 5. Investment Securities (continued) Proceeds from sales of investments in available-for-sale securities were approximately $94.7 million and $51.0 million during 2001 and 2000, respectively. Gross gains of approximately $1.9 million and $178 thousand were realized on the 2001 and 2000 sales, respectively. There were no losses recognized on investment security sales in 2001 and gross losses of approximately $139 thousand on investment security sales were recognized in 2000. A schedule of the unrealized gains (losses) on available-for-sale securities is as follows:
2001 --------------------------------------------------------------- Before Tax (Benefit) Net-of- Tax Amount Expense Tax Amount --------------------------------------------------------------- Unrealized gains on available-for-sale securities $5,959,429 $3,374,711 $2,584,718 Less: reclassification adjustment for gains realized in net income (1,925,380) (754,941) (1,170,439) --------------------------------------------------------------- Net unrealized gains $4,034,049 $2,619,770 $1,414,279 =============================================================== 2000 --------------------------------------------------------------- Before Tax (Benefit) Net-of- Tax Amount Expense Tax Amount --------------------------------------------------------------- Unrealized losses on available-for-sale securities $4,556,057 $934,541 $3,621,517 Less: reclassification adjustment for gains realized in net income (39,172) (15,359) (23,813) --------------------------------------------------------------- Net unrealized losses $4,516,885 $919,181 $3,597,704 =============================================================== 1999 --------------------------------------------------------------- Before Tax (Benefit) Net-of- Tax Amount Expense Tax Amount --------------------------------------------------------------- Unrealized gains on available-for-sale securities $(4,810,614) $(1,624,076) $(3,186,538) Less: reclassification adjustment for gains realized in net income (992,469) (389,148) (603,321) --------------------------------------------------------------- Net unrealized gains $(5,803,083) $(2,013,224) $(3,789,859) ===============================================================
At December 31, 2001 and 2000, investment securities with a carrying value of approximately $50.0 million and $54.7 million, respectively, were pledged as collateral to secure repurchase agreements, public deposits and for other purposes. 42 6. Loans A summary of loans outstanding at December 31, 2001 and 2000 is as follows: 2001 2000 ----------------------------------------- Commercial $151,124,639 $139,864,714 Commercial real estate 179,587,403 115,427,022 Real estate mortgage 319,915,569 323,586,607 Consumer 71,796,544 70,668,112 Other 8,069,186 12,440,438 ----------------------------------------- $730,493,341 $661,986,893 ========================================= 7. Allowance for Loan Losses Changes in the allowance for loan losses for each of the three years in the period ended December 31, 2001 are as follows:
2001 2000 1999 ----------------------------------------------------- Balance at beginning of year $7,149,147 $6,904,980 $4,484,504 Allowance from acquired bank 889,330 - 2,228,482 Provision for loan losses 3,855,130 810,000 750,000 Charge-offs (4,246,294) (832,710) (1,163,057) Recoveries 252,609 266,877 605,051 ----------------------------------------------------- Net charge-offs (3,993,565) (565,833) (558,006) ----------------------------------------------------- Balance at end of year $7,899,922 $7,149,147 $6,904,980 =====================================================
Total nonaccrual loans were $9.8 million and $8.7 million at December 31, 2001 and 2000, respectively. 8. Loans to Related Parties In the ordinary course of business the Bank extends credit to directors, principal shareholders and executive officers of the Bank, the Company and its subsidiaries, and to the related interests of the aforementioned persons. "Related interest," means a company, or political or campaign committee, that is directly or indirectly controlled by a director, principal shareholder or executive officer. All of these individuals and related interests, collectively, are called insiders. Credit extended to insiders must be on substantially the same terms, including interest rate, collateral and repayment, as those prevailing for comparable transactions with unrelated persons. Insider credit may not involve more than the normal risk associated with lending money. The Bank may extend aggregated credit to any one insider up to the Bank's legal lending limit. The Bank may not extend credit to an insider unless that credit, when aggregated with extensions of credit to all Bank insiders, does not exceed the Bank's unimpaired capital and unimpaired surplus. The combined balance of loans outstanding and commitments to lend to insiders as of December 31, 2001 and 2000 was $23.0 million and $25.4 million, respectively. 43 9. Premises and Equipment A summary of premises and equipment at December 31, 2001 and 2000, is as follows: 2001 2000 -------------------------------------- Buildings $25,227,644 $22,897,891 Furniture and equipment 21,449,098 17,638,975 Leasehold improvements 3,166,831 2,764,387 -------------------------------------- 49,843,573 43,301,253 Less accumulated depreciation (26,801,517) (23,256,337) Land 5,652,592 4,840,716 -------------------------------------- $28,694,648 $24,885,632 ====================================== 10. Federal Home Loan Bank and Other Borrowings Federal Home Loan Bank (FHLB) advances and other borrowings at December 31, 2001 and 2000 are summarized as follows:
2001 2000 ------------------------------------------------------------------------ Weighted Weighted Balance Average Rate Balance Average Rate ------------------------------------------------------------------------ 2001 $ - $60,200,000 6.74% 2002 30,200,000 4.26 - - 2004 7,500,000 5.63 7,500,000 5.63 2005 10,000,000 6.18 10,000,000 6.16 2011 20,000,000 4.55 - - ------------------------------------------------------------------------ Total FHLB advances 67,700,000 4.78 77,700,000 6.56 Note payable 15,652,776 3.38 7,309,250 8.04 Securities sold under agreement to repurchase 18,586,953 2.01 11,419,510 6.27 Federal funds purchased - - 10,000,000 6.63 ------------------------------------------------------------------------ Total $101,939,729 4.06% $106,428,760 6.64% ========================================================================
The Company has a collateral pledge agreement whereby it agrees to keep on hand, free of all other pledges, loans and encumbrances, performing loans with unpaid principal balances aggregating no less than 167% of the outstanding FHLB advances. All stock in the Federal Home Loan Bank of Chicago is also pledged as additional collateral for advances. The Company has a $40 million line of credit available through October 31, 2002, at 90-day LIBOR plus 1.35%. Outstanding advances under this line were approximately $15.7 million and $7.3 million at December 31, 2001 and 2000, respectively. The Company also has securities sold under repurchase agreements. Securities sold under agreements to repurchase are entered into with customers and nationally recognized securities dealers. Securities sold under agreements to repurchase can have varying maturities. In exchange for the loan, the Company pledges designated collateral, which consists generally of investment securities, to the customer or securities dealer. 44 11. Deposits Remaining contractual maturities of time deposits for the years 2002 through 2006 and thereafter are $267.5 million, $49.8 million, $13.9 million, $10.8 million and $7.8 million, respectively. 12. Employee Benefit Plans The Company has a noncontributory money purchase pension plan covering substantially all employees who meet certain minimum age and service requirements. Annual contributions are fixed based on compensation of participants. The Company's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Company contributions are made annually at the discretion of the board of directors and amounted to $420,000 in 2001, $365,000 in 2000 and $269,000 in 1999. Plan assets are invested in a diversified portfolio of high-quality debt and equity investments. The Company sponsors a 401(k) savings plan which covers all full-time employees who have completed certain minimum age and service requirements. Company contributions are discretionary. The Company has not made any contributions for 2001, 2000 or 1999. The Company has an Employee Stock Ownership Plan (ESOP) for the benefit of employees meeting certain minimum age and service requirements. Company contributions to the ESOP trust, which was established to fund the plan, are made on a discretionary basis and are expensed to operations in the year committed. The number of shares released to participants is determined based on the annual contribution amount plus any dividends paid on unearned shares divided by the market price of the stock at the contribution date. The aggregate activity in the number of unearned ESOP shares follows:
2001 2000 1999 ----------------------------------------------------- Balance at beginning of year 375,501 375,501 445,696 Shares committed to be released 26,314 -- 70,195 ----------------------------------------------------- Balance at end of year 349,187 375,501 375,501 =====================================================
At December 31, 2001, the fair value of unearned ESOP shares is $4.0 million. Total ESOP expense recognized for the years ended December 31, 2001, 2000, and 1999, was $315,000, $230,000 and $270,000, respectively. 13. Income Taxes The Company and its subsidiaries file a consolidated federal income tax return. The subsidiaries provide for income taxes on a separate-return basis and remit to the Company amounts determined to be currently payable or realize the benefit they would be entitled to on such a basis. The Company and subsidiaries file separate state income tax returns for Wisconsin and a combined state return for Illinois. Significant components of the provision for income taxes attributable to continuing operations are as follows:
2001 2000 1999 ----------------------------------------------------- Current Federal $3,131,415 $1,078,388 $3,647,997 Current State 826,000 275,000 561,000 ----------------------------------------------------- 3,957,415 1,353,388 4,208,997 Deferred (credit) Federal (147,000) 469,000 26,000 Deferred (credit) State (86,000) 103,000 98,000 ----------------------------------------------------- (233,000) 572,000 124,000 ----------------------------------------------------- $3,724,415 $1,925,388 $4,332,997 =====================================================
45 13. Income Taxes (continued) Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities as of December 31, 2001 and 2000, are as follows:
2001 2000 ------------------------------------- Deferred tax assets: Federal net operating loss carryforwards $244,000 $81,000 State net operating loss carryforwards 805,000 714,000 Allowance for loan loss 2,211,000 1,475,000 Unrealized loss on investment securities -- 354,000 Accumulated depreciation 218,000 383,000 Unearned income 35,000 104,000 Deferred loan fees 68,000 22,000 Other 139,000 246,000 ------------------------------------- 3,720,000 3,379,000 Valuation allowance for deferred tax assets (842,000) (790,000) ------------------------------------- Net deferred tax assets 2,878,000 2,589,000 Deferred tax liabilities: Unrealized gain on investment securities 1,186,000 -- FHLB dividends 521,000 2,000 Purchase accounting 1,015,000 1,124,000 ------------------------------------- Total deferred tax liabilities 2,722,000 1,126,000 ------------------------------------- Net deferred tax asset $156,000 $1,463,000 =====================================
Income tax expense differs from that computed at the federal statutory corporate tax rate as follows:
2001 2000 1999 ---------------------------------------------------- Income before income taxes $7,858,657 $4,923,121 $11,765,479 ==================================================== Income tax expense at the federal statutory rate $2,671,943 $1,673,861 $4,117,918 Increase (decrease) resulting from: Tax-exempt interest income (832,000) (679,000) (600,000) State income taxes, net of federal income tax benefit 488,000 267,000 429,000 Nondeductible merger-related expenses 32,000 - 228,000 Goodwill amortization 1,382,000 698,000 486,000 Increase (decrease) in valuation allowance for deferred tax assets 62,000 33,000 (35,000) Other (79,528) (67,578) (292,921) ---------------------------------------------------- Income taxes $3,724,415 $1,925,283 $4,332,997 ====================================================
At December 31, 2001, the Company had federal net operating loss carryforwards of approximately $625 thousand and state net operating loss carryforwards of approximately $16.1 million. The federal net operating loss carryforwards and $694 thousand of state net operating loss carryforwards are subject to an annual limitation of approximately $230 thousand and are available to reduce future tax expense through the year ending December 31, 2009. The remaining state net operating loss carryforwards expire in years 2002 through 2016. 46 13. Income Taxes (continued) Retained earnings at December 31, 2001 and 2000, include $4.8 million for which no provision for federal income tax has been made. A prior subsidiary acquisition qualified under provisions of the Internal Revenue Code that permitted it to deduct from taxable income an allowance for bad debts that differed from the provision for losses charged to income for financial reporting purposes. If income taxes had been provided, the deferred tax liability would have been approximately $1.8 million. 14. Restrictions on Subsidiary Dividends, Loans or Advances Dividends paid by the Company are derived, mainly, from dividends provided by the Bank. Certain restrictions exist limiting the ability of the Bank to transfer funds to the Company in the form of cash dividends, loans or advances. The Bank's primary regulator must approve the payment of dividends in excess of certain levels of the Bank's retained earnings. As of December 31, 2001, the Bank had net retained earnings of approximately $1.3 million, available for distribution to the Company without prior regulatory approval. Federal Reserve Bank regulations place limits on loans to affiliates, including the Company, unless such loans are collateralized by specific obligations. The aggregate limit for any one affiliate is 10% of the Bank's capital stock and surplus. In the case of all affiliates, the aggregate amount to all affiliates may not exceed 20% of the capital stock and surplus of the Bank. 15. Shareholders' Equity - Preferred Share Purchase Rights On July 27, 1999, the Board of Directors of the Company declared a dividend of one preferred share purchase right (a Right) for each outstanding share of common stock, $.10 par value, of the Company. Each Right entitles the registered holder to purchase from the Company one one-thousandth of a share of Class A Preferred Stock, $1.00 par value (the Preferred Shares), of the Company at a price of $70 per one one-thousandth of a Preferred Share, subject to adjustment. The Rights are not exercisable until the earlier to occur of (i) a public announcement that a person or group of affiliated or associated persons has acquired beneficial ownership of 15% or more of the outstanding Common Shares or (ii) ten business days following the commencement of, or announcement of an intention to make, a tender offer or exchange offer the consummation of which would result in the beneficial ownership by a person or group of 15% or more of such outstanding Common Shares. The Rights will expire on July 27, 2009. Each Preferred Share will be entitled to a minimum preferential quarterly dividend payment of $10.00 per share but will be entitled to an aggregate dividend of 1,000 times the dividend declared per Common Share. In the event of liquidation, the holders of the Preferred Shares will be entitled to a minimum preferential liquidation payment of $1,000 per share but will be entitled to an aggregate payment of 1,000 times the payment made per Common Share. Each Preferred Share will have 1,000 votes, voting together with the Common Shares. Finally, in the event of any merger, consolidation or other transaction in which Common Shares are exchanged, each Preferred Share will be entitled to receive 1,000 times the amount received per Common Share. These rights are protected by customary antidilution provisions. Because of the nature of the Preferred Shares' dividend, voting and liquidation rights, the value of the one one-thousandth interest in a Preferred Share purchasable upon exercise of each Right should approximate the value of one Common Share. 47 16. Financial Instruments With Off-Balance-Sheet Risk Loan commitments and standby letters of credit are credit facilities the Bank offers to its customers. These facilities commit the Bank to lend money to, or make payments on behalf of its customers if certain specified events occur at a future date. Both facilities are subject to credit risk. Management recognizes this risk and requires that all requests be underwritten following the Bank's standard credit underwriting guidelines. As of December 31, 2001, the Bank had outstanding loan commitments and letters of credit of $127.4 million and $4.6 million, respectively. Loan commitments and standby letters of credit were $115.0 million and $3.4 million, respectively, at December 31, 2000. 17. Leases The Company rents space for some of its banking facilities under operating leases. Certain leases include renewal options and provide for the payment of building operating expenses and additional rentals based on adjustments due to inflation. Rent expense under operating leases totaled approximately $637,000, $552,000 and $518,000 in 2001, 2000 and 1999, respectively. Future minimum payments for the years indicated under noncancellable operating leases with initial terms of one year or more consisted of the following at December 31, 2001: 2002 $ 635,000 2003 648,000 2004 621,000 2005 572,000 2006 515,000 Thereafter 2,326,000 ----------------- $5,317,000 ================= Minimum rentals for 2002 include $108,000 relative to space used by the Company, which is leased from a partnership, two partners of which are also directors of the Company. 18. Regulatory Capital National banks and bank holding companies are subject to various capital guidelines as set forth by regulation. Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, banks and holding companies must meet specific standards that involve quantitative measures of the bank's assets, liabilities and certain off-balance sheet items as calculated under accepted accounting practices. These assets and liabilities of the Company and Bank are also subject to qualitative assessment by regulators Minimum capital standards are established by regulation, however, the Office of the Comptroller of the Currency (OCC) is authorized to establish minimum capital requirements for a bank, at its discretion, that it deems appropriate in light of the particular circumstances for a given bank. In either case, the OCC will implement mandatory corrective action if capital ratios fall below the minimum standards. Quantitative measures require the Bank and Company to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets, and Tier I capital to average assets (as defined in the regulations and set forth in the table below). Management believes that, as of December 31, 2001, the Bank and Company meet or exceed all regulatory capital adequacy requirements. 48 18. Regulatory Capital (continued) A 2001 notification provided by the Bank's regulators, categorized the Bank and Company as "well capitalized" under the regulatory framework. The categories are set forth in the table. There have been no changes in the financial condition of the Bank or Company, since receiving the notification that would cause a change in the category of either entity. The Bank's and Company's "minimum," "well capitalized" and actual capital amounts and ratios are presented in the table (dollars in thousands):
Minimum Well Capitalized For Capital For Capital Adequacy Adequacy Purposes Purposes Actual ----------------------- ----------------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio ----------- ----------- ----------- ----------- ----------- ----------- As of December 31, 2001 Total Capital (to Risk Weighted Assets): Consolidated $59,754 8% $74,692 10% $83,919 11.2% Bank 59,263 8 74,078 10 94,204 12.7 Tier I Capital (to Risk Weighted Assets): Consolidated 29,877 4 44,815 6 76,019 10.2 Bank 29,631 4 44,447 6 86,304 11.7 Tier I Capital (to Average Assets): Consolidated 46,065 4 57,582 5 76,019 6.6 Bank 45,697 4 57,121 5 86,304 7.6 As of December 31, 2000 Total Capital (to Risk Weighted Assets): Consolidated 50,720 8 63,400 10 85,973 13.6 Bank 50,725 8 63,407 10 84,972 13.4 Tier I Capital (to Risk Weighted Assets): Consolidated 25,360 4 38,040 6 78,824 12.4 Bank 25,363 4 38,044 6 77,823 12.3 Tier I Capital (to Average Assets): Consolidated 44,142 4 55,178 5 78,824 7.1 Bank 43,785 4 54,731 5 77,823 7.1
49 19. Stock Plans and Options The Company's Stock Incentive Plan allows for grants of restricted stock, incentive stock options and nonqualified options to officers, directors and key consultants of the Company. Options are exercisable at a price equal to the fair market value of the shares at the time of the grant. Options must be exercised within ten years after grant. A summary of all restricted stock and stock option transactions follows:
Number of Shares of Number Total Restricted of Stock Number Stock Price Options Price of Shares ------------------------------------------------------------------------ Balance at December 31, 1998 1,653 $7.67-$21.88 700,948 $3.86-$21.88 702,601 Granted 1,500 15.69 2,950 15.69 4,450 Vested restricted stock - - - - - Exercised - - (15,167) 4.23-13.03 (15,167) Canceled - - (1,361) 13.03-15.53 (1,361) ------------------------------------------------------------------------ Balance at December 31, 1999 3,153 $7.67-$21.88 687,370 $3.86-$21.88 690,523 Granted - - - - - Vested restricted stock 943 7.67-21.88 - - 943 Exercised - - 15,334 3.86-8.10 15,334 Canceled 290 8.10 358,858 9.26-21.88 359,148 ------------------------------------------------------------------------ Balance at December 31, 2000 1,920 $15.69-$21.88 313,178 $6.63-$21.88 315,098 Granted - - 134,410 10.13 134,410 Acquired - - 23,027 5.28-6.55 23,027 Vested restricted stock - - - - - Exercised - - 1,041 8.11-10.13 1,041 Canceled - - 12,234 9.26-15.69 12,234 ------------------------------------------------------------------------ Balance at December 31, 2001 1,920 $15.69-$21.88 457,340 $6.63-$21.88 459,260 ========================================================================
At December 31, 2001, the weighted-average remaining contractual life of outstanding options was seven years at a weighted-average exercisable price of $13.78 per share compared to six years and a price of $15.76 per share at December 31, 2000. 20. Fair Values of Financial Instruments Fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value follows. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from the following disclosures. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The Company does not routinely measure the market value of financial instruments, because such measurements represent point-in-time estimates of value. It is not the intent of the Company to liquidate and therefore realize the difference between market value and carrying value and, even if it were, there is no assurance that the estimated market values could be realized. Thus, the information presented is not particularly relevant to predicting the Company's future earnings or cash flows. 50 20. Fair Values of Financial Instruments (continued) The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: Cash and Cash Equivalents. The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values. Investment Securities. Fair values for investment securities are based on quoted market prices, where available. Loans. For variable-rate mortgage loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for commercial, commercial real estate and fixed-rate mortgage, consumer and other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Deposits. The fair values disclosed for interest and noninterest checking accounts, savings accounts and money market accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities of the outstanding certificates of deposit. Securities Sold Under Agreement to Repurchase and Federal Funds Purchased. The carrying amounts of securities sold under agreement to repurchase and federal funds purchased approximate their fair value. Accrued Interest Receivable and Payable. The carrying amounts reported in the balance sheet for accrued interest receivable and payable approximate their fair values. Note Payable. The carrying values of the Company's note payable approximate fair value. Off-Balance-Sheet Instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and generally require payment of a fee. As a consequence, the estimated fair value of the commitments is approximately equal to the related fee received, which is nominal. The carrying amounts and fair values of the Company's financial instruments consist of the following at December 31, 2001 and 2000:
2001 2000 ------------------------------------- ---------------------------------------- Carrying Amount Fair Value Carrying Amount Fair Value ------------------------------------- ---------------------------------------- Cash and due from banks $54,541,162 $54,541,162 $44,993,586 $44,993,586 Interest-bearing bank balances 1,402,789 1,402,789 3,303,170 3,303,170 Federal funds sold 38,605,567 38,605,567 1,760,272 1,760,272 Investment securities 261,746,070 261,794,589 303,641,448 306,656,689 Loans held for sale 23,192,133 23,192,133 6,071,482 6,071,482 Loans 722,593,419 732,303,259 654,837,747 654,010,857 Accrued interest receivable 5,599,880 5,599,880 6,978,744 6,978,744 Deposits 954,458,748 961,070,083 859,355,788 861,925,542 Notes payable 15,652,776 15,652,776 7,309,250 7,309,250 Securities sold under agreement to repurchase 18,586,952 18,586,952 11,419,510 11,419,510 Federal funds purchased - - 10,000,000 10,000,000 Federal Home Loan Bank advances 67,700,000 67,700,000 77,700,000 77,700,000 Accrued interest payable 2,449,482 2,449,482 2,910,649 2,910,649
51 21. State Financial Services Corporation (Parent Company Only) Financial Information Financial statements of the Parent Company Only at December 31, 2001 and 2000, and for the three years ended December 31, 2001, follow:
STATEMENTS OF CONDITION December 31 2001 2000 ---------------------------------------- Assets Cash and cash equivalents $753,995 $119,639 Investments: Available-for-sale 3,528,758 5,702,263 Held-to-maturity 100,000 100,000 Investment in Subsidiaries 116,614,125 105,145,829 Loans receivable from subsidiaries - 288,840 Recoverable income taxes 1,098,628 2,630,274 Fixed assets 185,023 255,275 Other assets 1,316,900 1,320,326 ---------------------------------------- Total assets $123,597,429 $115,562,446 ======================================== Liabilities Accrued expenses and other liabilities $1,584,553 $1,753,939 Notes payable 15,652,776 7,309,250 ---------------------------------------- Total liabilities 17,237,329 9,063,189 Shareholders' equity Common stock 1,010,877 1,010,773 Additional paid-in capital 94,797,858 95,027,591 Retained earnings 46,587,268 46,045,533 Accumulated other comprehensive income 2,302,673 888,394 Unearned shares held by ESOP (4,473,357) (5,131,608) Treasury stock (33,865,219) (31,341,426) ---------------------------------------- Total shareholders' equity 106,360,100 106,499,257 ---------------------------------------- Total liabilities and shareholders' equity $123,597,429 $115,562,446 ========================================
52 21. State Financial Services Corporation (Parent Company Only) Financial Information (continued)
STATEMENTS OF INCOME Year ended December 31 2001 2000 1999 ------------------------------------------------------- Income: Dividends $8,800,000 $42,800,000 $19,300,000 Interest 561,421 689,551 682,157 Management fees 1,592,244 1,596,031 1,404,738 Other 936,861 207,483 780,540 ------------------------------------------------------- 11,890,526 45,293,065 22,167,435 Expenses: Interest 1,275,554 3,145,229 1,160,430 Other 3,402,920 2,316,311 2,492,910 ------------------------------------------------------- 4,678,474 5,461,540 3,653,340 ------------------------------------------------------- Income before income tax credit and equity in undistributed net income of subsidiaries 7,212,052 39,831,525 18,514,095 Income tax credit 521,880 1,003,289 273,166 ------------------------------------------------------- 7,733,932 40,834,814 18,787,261 ------------------------------------------------------- Equity in undistributed net income of subsidiaries (3,599,690) (37,836,976) (11,354,779) ------------------------------------------------------- Net income $4,134,242 $2,997,838 $ 7,432,482 =======================================================
53 21. State Financial Services Corporation (Parent Company Only) Financial Information (continued)
STATEMENTS OF CASH FLOWS Year ended December 31 2001 2000 1999 ----------------------------------------------------- Operating activities: Net income $4,134,242 $2,997,838 $7,432,482 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed income 3,599,690 37,836,976 11,354,779 Provision for depreciation 105,347 107,774 70,110 Decrease (increase) in recoverable income 1,531,646 542,657 (529,038) Realized investment securities gains, net (879,148) (167,561) (739,095) Other (266,274) 777,089 (340,523) ----------------------------------------------------- Net cash provided by operating activities 8,225,503 42,094,773 17,248,715 Investing activities: Purchases of securities available-for-sale (2,488,148) (1,376,608) (6,498,828) Maturities of securities available-for-sale - 22,674 2,810,092 Sales of securities available for sale 5,077,456 769,564 3,196,977 Decrease (increase) in loans receivable from subsidiaries 288,840 (46,854) 3,965,077 Retirement of former ESOP - - (3,970,077) Purchases of premises and equipment (35,095) (173,206) (86,644) Acquisition of subsidiaries (11,230,387) - (33,686,273) Additional investment in subsidiaries (433,465) - (343,209) ----------------------------------------------------- Net cash used by investing activities (8,820,799) (804,430) (34,612,885) Financing activities: Proceeds (repayment) of note payable 6,677,526 (32,649,359) 33,208,609 Decrease in guaranteed ESOP obligation 658,251 - 221,101 Cash dividends (3,592,508) (3,764,804) (4,368,257) Purchase of treasury stock (2,523,793) (6,104,944) (25,236,482) Proceeds from exercise of stock options 10,176 105,908 173,000 ----------------------------------------------------- Net cash provided (used) by financing activities 1,229,652 (42,413,199) 3,997,971 ----------------------------------------------------- Increase (decrease) in cash and cash equivalents 634,356 (1,122,856) (13,366,199) Cash and cash equivalents at beginning of year 119,639 1,242,495 14,608,694 ----------------------------------------------------- Cash and cash equivalents at end of year $753,995 $119,639 $1,242,495 =====================================================
54 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Directors. The information required by this item with respect to directors and Section 16 compliance is contained under the captions Proposal No.1. "Election of Directors--Directors" and "Miscellaneous Section 16(a) Beneficial Ownership Reporting Compliance," respectively, in the Proxy Statement and is hereby incorporated by reference. Executive Officers. The information required by this item with respect to executive officers appears in Part I of this Annual Report. ITEM 11. EXECUTIVE COMPENSATION The information contained under the captions "Proposal No.1. Election of Directors-- Compensation of Directors" and "Compensation of Executive Officers" in the Proxy Statement is incorporated herein by reference; provided, however, that the information under the subheading "Board of Directors Report on Executive Compensation" shall not be deemed to be incorporated by reference. ITEM 12. SECURITY OWNERSHIP OF DIRECTORS, EXECUTIVE OFFICERS, AND BENEFICIAL OWNERS The information contained under the caption "Proposal 1. Election of Directors--Security Ownership of Management and Certain Beneficial Owners" in the Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information contained under the caption "Proposal 1. Election of Directors--Certain Transactions and Other Relationships with Management and Principal Shareholders" in the Proxy Statement is incorporated herein by reference. 55 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Documents filed: 1. Financial Statements. The Consolidated Financial Statements of the Company and subsidiaries, for the year ended December 31, 2001, are set forth in Item 8. 2. Financial Statement Schedules. Schedules to the Consolidated Financial Statements required by Article 9 of Regulation S-X are not required under the related instructions or are inapplicable, and therefore have been omitted. 3. Exhibits. See Exhibit Index, which is filed with this Form 10-K following the signature page and is incorporated herein by reference. (b) Reports on Form 8-K: None. (c) Exhibits: See Exhibit Index, which is filed with this Form 10-K following the signature page and is incorporated herein by reference. (d) Financial Statement Schedules: None. 56 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. STATE FINANCIAL SERVICES CORPORATION By: /s/ Michael J. Falbo ------------------------------------ Michael J. Falbo, President and Chief Executive Officer Date: March 15, 2002 Pursuant to the requirements of the Securities and 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. Principal Executive and Financial Officers /s/ Michael J. Falbo President and Chief ---------------------------- Executive Officer Michael J. Falbo March 15, 2002 /s/ Timothy L. King Senior Vice President and ---------------------------- Chief Financial Officer Timothy L. King March 15, 2002 /s/ Michael A. Reindl Senior Vice President and ---------------------------- Treasurer Michael A. Reindl March 15, 2002 Directors /s/ Jerome J. Holz Director ---------------------------- Jerome J. Holz March 15, 2002 /s/ Michael J. Falbo Director ---------------------------- Michael J. Falbo March 15, 2002 /s/ Robert J. Cera Director ---------------------------- Robert J. Cera March 15, 2002 /s/ Richard A. Horn Director ---------------------------- Richard A. Horn March 15, 2002 /s/ Ulice Payne, Jr. Director ---------------------------- Ulice Payne, Jr. March 15, 2002 /s/ Thomas S. Rakow Director ---------------------------- Thomas S. Rakow March 15, 2002 /s/ David M. Stamm Director ---------------------------- David M. Stamm March 15, 2002 /s/ Barbara E. Weis Director ---------------------------- Barbara E. Weis March 15, 2002 57 STATE FINANCIAL SERVICES CORPORATION ------------------------------------ EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K FOR YEAR ENDED December 31, 2001 NOTE: To maintain a set of exhibit reference numbers consistent with Registrant's prior filings under the Securities Act of 1933 and the Securities Act of 1934, Registrant has intentionally omitted exhibit reference numbers which pertain to exhibits which are not applicable or in effect. Except as specifically noted below, all of the exhibits identified are filed herewith. Exhibit Number Description 2.1 Agreement and Plan of Merger, dated as of June 1, 1998, by and between Registrant and Home Bancorp of Elgin, Inc. (11) 2.2 Agreement and Plan of Reorganization between Registrant and Eastbrook State Bank, dated January 22, 1992, as amended and restated. (5) 2.3 Branch Purchase and Assumption Agreement between Eastbrook State Bank and North Shore Bank, FSB, dated December 29, 1992. (1) 2.4 Agreement and Plan of Merger By and Among Registrant, WBAC, Inc., and Waterford Bancshares, Inc. dated April 12, 1995. (6) 2.5 Agreement and Plan of Merger By and Among Registrant, RBI, Inc. and Richmond Bancorp, Inc. (8) 2.6 Agreement and Plan of Merger By and Among Registrant, FWC Acquisition Corp., and First Waukegan Corporation dated March 12, 1999. (12) 2.7 Agreement to Merge between State Financial Bank (Wisconsin), State Financial Bank - Waterford (Wisconsin), State Financial Bank (Illinois), Home Federal Savings and Loan Association of Elgin and Bank of Northern Illinois, National Association under the charter of Bank of Northern Illinois, National Association under the title of State Financial Bank, National Association. (17) 2.8 Agreement and Plan of Merger, dated as of March 7, 2001, by and among State Financial Services Corporation, State Financial Bank, National Association, LB Bancorp, Inc. and Liberty Bank. (16) 3.1 Articles of Incorporation of the Registrant as Amended and Restated. (14) 3.2 Bylaws of Registrant, as amended and restated effective January 27, 1998. (10) 4.1 Rights Agreement between State Financial Services Corporation and Firstar Bank, N.A. dated July 27, 1999. (13) 10.1 Lease between SFB (formerly State Bank, Hales Corners) and Hales Corners Development Corporation (10708 West Janesville Road, Hales Corners, Wisconsin). (2) 10.2 Lease between SFB (formerly State Bank, Hales Corners) and Hales Corners Development Corporation (S76 W17655 Janesville Road, Muskego, Wisconsin). (3) 58 10.3 Lease between SFB (formerly Edgewood Bank) and Edgewood Plaza Joint Venture (4811 South 76th Street, Greenfield, Wisconsin). (3) 10.4 Lease between SFB (formerly University National Bank) and Northeast Corporate Center (7020 North Port Washington Road, Milwaukee, Wisconsin). (3) 10.5 Lease between SFB (formerly University National Bank) and Downer Investments (2650 North Downer Avenue, Milwaukee, Wisconsin) (4) 10.6 Lease between SFB-Waterford and Mangold Investments, LLP (1050 North Milwaukee Avenue, Burlington, Wisconsin). (9) 10.7 State Financial Services Corporation 1990 Stock Option/Stock Appreciation Rights and Restricted Stock Plan for Key Officers and Employees, as amended on March 10, 1993. (1) 10.8 State Financial Services Corporation 1990 Director Stock Option Plan, as amended March 10, 1993. (1) 10.9 State Financial Services Corporation Supplemental Executive Retirement Plan for Michael J. Falbo effective November 22, 1994. (7) 10.10 State Financial Services Corporation 1998 Stock Incentive Plan, as amended. (14) 10.11 Liberty Bank 1994 Stock Option Plan (15) 10.12 Executive Employment and Consulting Agreement between State Financial Services Corporation and Jerome J. Holz. (14) 10.13 Form of Key Executive Employment and Severance Agreement between State Financial Services Corporation and each of Michael J. Falbo, Robert J. Cera, Timothy L. King, Michael A. Reindl and Daniel L. Westrope. (14) 10.14 Form of Key Executive Employment and Severance Agreement between State Financial Services Corporation and each of John B. Beckwith, Jeryl M Sturino, Donna M. Bembenek, Thomas A. Lilly, and David G. Towe. (14) 21 Subsidiaries of Registrant. 23.1 Consent of Ernst & Young LLP. 59 (1) Incorporated by reference from Registrant's annual report on Form 10-K for the fiscal year ended December 31, 1992. (2) Incorporated by reference from Registrant's registration statement on Form S-1, Registration Number 33-31517, dated October 11, 1989. (3) Incorporated by reference from Amendment No. 1 to the registration statement on Form S-1, dated December 6, 1989. (4) Incorporated by reference from Registrant's annual report on Form 10-K for the fiscal year ended December 31, 1991. (5) Incorporated by reference from Exhibit 2.1 to Amendment No. 3 to Registrant's registration statement on Form S-4, Registration Number 33-46280, dated May 3, 1992. (6) Incorporated by reference from Amendment No. 2 to the Registrant's registration statement on Form S-4, Registration Number 33-59665, dated July 18, 1995. (7) Incorporated by reference from Registrant's annual report on Form 10-K for the fiscal year ended December 31, 1994. (8) Incorporated by reference from Registrant's Report on Form 8-K, dated January 14, 1998. (9) Incorporated by reference from Registrant's annual report on Form 10-K for the fiscal year ended December 31, 1996. (10) Incorporated by reference from Registrant's annual report on Form 10-K for the fiscal year ended December 31, 1997. (11) Incorporated by reference from Registrant's registration statement on Form S-4, Registration Number 33-64375, dated September 25, 1998. (12) Incorporated by reference from Registrant's Report on Form 8-K, dated March 12, 1999. (13) Incorporated by reference from Registrant's Report on Form 8-K, dated July 27, 1999. (14) Incorporated by reference from Registrant's Report on Form 10-K for the year ended December 31, 1999. (15) Incorporated by reference from Registrant's registration statement on Form S-8, Registration Number 333-67486, dated September 14, 2001. (16) Incorporated by reference from Exhibit 2.1 of Registrant's Report of Form 8-K, dated March 7, 2001. (17) Incorporated by reference from Exhibit 2.7 of Registrant's Report on Form 10-K, dated March 23, 2001. 60