10-Q 1 sdc121a.txt 10-Q QUARTERLY RPT - STATE FINANCIAL SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended March 31, 2002 Commission file number 0-18166 STATE FINANCIAL SERVICES CORPORATION (Exact name of registrant as specified in its charter) WISCONSIN 39-1489983 ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer identification No.) incorporation or organization) 10708 WEST JANESVILLE ROAD, HALES CORNERS, WISCONSIN 53130 ---------------------------------------------------------- (Address and Zip Code of principal executive offices) Not applicable ---------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) (414) 425-1600 ---------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. As of March 31, 2002, there were 7,789,965 shares of Registrant's $0.10 Par Value Common Stock outstanding. FORM 10-Q STATE FINANCIAL SERVICES CORPORATION INDEX PART I - FINANCIAL INFORMATION Page No. -------- Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets as of March 31, 2002 and December 31, 2001 2 Consolidated Statements of Income for the Three Months ended March 31, 2002 and 2001 3 Consolidated Statements of Cash Flows for the Three Months ended March 31, 2002 and 2001 4 Notes to Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7 PART II - OTHER INFORMATION Items 1-6 13 Signatures 14 Part I. Financial Information Item 1. Financial Statements STATE FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES Consolidated Statements of Condition (Unaudited) March 31, December 31, 2002 2001 -------------- -------------- ASSETS Cash and due from banks $ 36,816,844 $ 54,541,162 Interest-earning deposits 1,676,729 1,402,789 Federal funds sold 25,221,199 38,605,567 -------------- -------------- Cash and cash equivalents 63,714,772 94,549,518 Investment securities Available for sale (at fair value) 438,936,271 259,841,523 Held-to-maturity (fair value $1,805,932 - March 31, 2002 and $1,953,066 - December 31, 2001) 1,754,676 1,904,547 Loans (net of allowance for loan losses of $8,165,469 - March 31, 2002 and $7,899,922 -December 31, 2001) 608,088,572 722,593,419 Loans held for sale 5,635,205 23,192,133 Premises and equipment 28,509,103 28,694,648 Accrued interest receivable 7,271,076 5,599,880 Goodwill 27,465,062 27,465,062 Other assets 8,014,442 7,212,410 -------------- -------------- TOTAL ASSETS $1,189,389,179 $1,171,053,140 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Demand 140,525,883 147,992,336 Savings 222,594,821 213,328,297 Money market 228,436,175 243,324,258 Time deposits in excess of $100,000 82,011,423 85,574,897 Other time 240,721,524 264,238,960 -------------- -------------- TOTAL DEPOSITS 914,289,826 954,458,748 Federal Home Loan Bank advances 47,500,000 67,700,000 Notes payable 18,430,000 15,652,776 Securities sold under agreements to repurchase 94,593,230 18,586,952 Accrued expenses and other liabilities 5,897,488 5,845,082 Accrued interest payable 2,009,084 2,449,482 -------------- -------------- TOTAL LIABILITIES 1,082,719,628 1,064,693,040 Stockholders' equity: Preferred stock, $1 par value; authorized--100,000 shares; issued and outstanding--none -- -- Common stock, $0.10 par value; authorized--25,000,000 shares; 10,113,005 shares issued and outstanding in 2002 and 10,108,769 in 2001 1,011,301 1,010,877 Capital surplus 94,838,850 94,797,858 Retained earnings 48,307,311 46,587,268 Accumulated other comprehensive income 850,665 2,302,673 Unearned shares held by ESOP (4,473,357) (4,473,357) Treasury Stock - 2,323,040 shares in 2002 and 2001 (33,865,219) (33,865,219) -------------- -------------- TOTAL STOCKHOLDERS' EQUITY 106,669,551 106,360,100 -------------- -------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,189,389,179 $1,171,053,140 ============== ============== See notes to unaudited consolidated financial statements. 2 STATE FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES Consolidated Statements of Income (Unaudited) Three Month Ended March 31, --------------------------------- 2002 2001 -------------- -------------- INTEREST INCOME: Loans, including fees $ 13,131,755 $ 14,135,626 Investment securities Taxable 3,058,913 4,321,217 Tax-exempt 687,208 483,773 Federal funds sold 145,958 52,201 -------------- -------------- TOTAL INTEREST INCOME 17,023,834 18,992,817 INTEREST EXPENSE: Deposits 4,758,159 7,988,244 Notes payable and other borrowings 1,207,288 1,896,254 -------------- -------------- TOTAL INTEREST EXPENSE 5,965,447 9,884,498 -------------- -------------- NET INTEREST INCOME 11,058,387 9,108,319 Provision for loan losses 450,000 270,000 -------------- -------------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,608,387 8,838,319 OTHER INCOME: Service charges on deposit accounts 626,927 450,302 ATM and merchant service fees 701,696 727,955 Security commissions and management fees 101,738 256,751 Investment securities gains 204,009 431,124 Gains on sale of loans 665,230 381,003 Other 346,949 265,988 -------------- -------------- TOTAL OTHER INCOME 2,646,549 2,513,123 OTHER EXPENSES: Salaries and employee benefits 4,329,096 3,968,484 Net occupancy expense 604,008 481,415 Equipment rentals, depreciation and maintenance 964,491 906,296 Data processing 555,336 545,406 Legal and professional 657,218 449,054 ATM and merchant services 475,825 515,505 Advertising 274,375 259,332 Goodwill amortization 0 513,515 Other 1,627,478 956,786 -------------- -------------- TOTAL OTHER EXPENSES 9,487,827 8,595,793 INCOME BEFORE INCOME TAXES 3,767,109 2,755,649 Income tax expense 1,154,171 1,023,460 -------------- -------------- NET INCOME $ 2,612,938 $ 1,732,189 ============== ============== Basic earnings per common share $ 0.35 $ 0.23 Diluted earnings per common share 0.35 0.23 Dividends per common share 0.12 0.12 See notes to unaudited consolidated financial statements. 3 STATE FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows (Unaudited) Three Month Ended March 31, --------------------------------- 2002 2001 -------------- -------------- OPERATING ACTIVITIES Net income $ 2,612,938 $ 1,732,189 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 265,547 270,000 Provision for depreciation 721,562 664,269 Amortization of investment security premiums and accretion of discounts-net 579,063 141,133 Amortization of goodwill 0 513,265 Deferred income taxes 0 1,316,130 Decrease (increase) in accrued interest receivable (1,671,196) 228,262 Increase (decrease) in accrued interest payable (440,398) 1,997 Realized investment securities gains, net (204,009) (431,124) Other (1,621) (925,247) -------------- -------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 1,861,886 3,510,874 INVESTING ACTIVITIES Proceeds from maturities or principal payments of investment securities held-to-maturity 150,499 502,064 Purchases of securities available for sale (263,860,293) (1,940,988) Proceeds from maturities and sales of investment securities available for sale 82,189,849 17,692,789 Net (increase) decrease in loans 131,796,228 (16,886,598) Net purchases of premises and equipment (536,017) (1,614,763) -------------- -------------- NET CASH USED BY INVESTING ACTIVITIES (50,259,734) (2,247,496) FINANCING ACTIVITIES Net decrease in deposits (40,168,922) (17,607,470) Proceeds of notes payable 2,777,224 595,875 Net change in securities sold under agreement to repurchase repurchase 76,006,278 7,103,055 Increase (decrease) in Federal Home Loan Bank advances (20,200,000) 20,000,000 Cash dividends (892,894) (914,003) Decrease in federal funds purchased 0 (10,000,000) Purchase of Treasury Stock 0 (1,659,461) Proceeds from exercise of stock options 41,416 0 -------------- -------------- NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 17,563,102 (2,482,004) -------------- -------------- DECREASE IN CASH AND CASH EQUIVALENTS (30,834,746) (1,218,626) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 94,549,518 50,057,028 -------------- -------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 63,714,772 $ 48,838,402 ============== ============== Supplemental information: Cash paid for Interest $ 6,405,845 $ 9,886,495 Refunds for Income taxes (163,164) (1,087,373) See notes to unaudited consolidated financial statements. 4 STATE FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES Notes to Unaudited Consolidated Financial Statements March 31, 2002 NOTE A--BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements include the accounts of State Financial Services Corporation (the "Company" or "State") and its subsidiaries. All significant intercompany balances and transactions have been eliminated. The unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals considered necessary for a fair presentation have been included. Interim operating results are not necessarily indicative of the results that may be expected for the year. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2001. NOTE B--ACCOUNTING CHANGES Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," 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 implemented the new rules of SFAS No. 142 on January 1, 2002 and the effect to net income was approximately $500,000 for the first quarter of 2002. The Company is in the process of performing the first of the required impairment tests of goodwill by comparing the fair value of the Company's reporting units to their carrying amounts (book value), including goodwill as of January 1, 2002. The Company has not yet determined what the effect of these tests will be on the earnings and financial position of the Company, but anticipates there will not be a material change. For comparative purposes, the following table illustrates net income and net income per share for the first quarter of the prior year adjusted to exclude the effects of adopting the Statement (dollars in thousands except per share data): Three Months Ended March 31, -------------------------- 2002 2001 -------------------------- Reported net income $ 2,613 $ 1,732 Add back: Goodwill amortization - 514 -------------------------- Adjusted net income $ 2,613 $ 2,246 ========================== Basic earnings per common share: Reported net income $ .35 $ .23 Goodwill amortization - .07 -------------------------- Adjusted net income $ .35 $ .30 ========================== Diluted earnings per common share: Reported net income $ .35 $ .23 Goodwill amortization - .07 -------------------------- Adjusted net income $ .35 $ .30 ========================== 5 NOTE C--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 is 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. The denominators for the earnings per share amounts are as follows: For the three months ended March 31, March 31, 2002 2001 --------------------------- Basic: Weighted-average number of shares outstanding 7,788,191 7,970,490 Less: weighted-average number of unearned ESOP shares (349,184) (375,500) --------------------------- Denominator for basic earnings per share 7,439,007 7,594,990 =========================== Fully diluted: Denominator for basic earnings per share 7,439,007 7,594,990 Add: assumed conversion of stock options using treasury stock method 43,520 2,850 --------------------------- Denominator for fully diluted earnings per share 7,482,527 7,597,840 =========================== NOTE D - COMPREHENSIVE INCOME Comprehensive income is the total of reported net income and all other revenues, expenses, gains and losses that under generally accepted accounting principles are not includable in reported net income but are reflected in shareholder's equity. For the three months ended March 31, March 31, 2002 2001 --------------------------- Net Income $ 2,612,938 $ 1,732,189 Other comprehensive income Change in unrealized securities gains (losses), net of tax (1,327,991) 2,190,583 Reclassification adjustment for realized gains included in net income (204,009) (431,124) Estimated income tax expense on realized securities gains 79,992 169,044 --------------------------- Total comprehensive income $ 1,160,930 $ 3,660,692 =========================== NOTE E - STOCK REPURCHASE PROGRAM On March 12, 2001, the Company's Board of Directors authorized the repurchase of approximately 450,000 shares of the Company's Common Stock (the "2001 Repurchase Program"). As of March 31, 2002 the Company had repurchased 194,500 shares at an average price of $12.19. NOTE F - ACQUISITION In July 2001, the Company completed its acquisition of LB Bancorp, Inc. ("LB") and its $93 million, 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. 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Changes in Financial Condition At March 31, 2002 and December 31, 2001 total assets were $1.2 billion. At March 31, 2002, significant uses of funds during the first three month of 2002 were a net increase in investments of $181.5 million mainly due to the sale of approximately $100 million of long-term fixed-rate mortgages during the period, which were replaced with adjustable rate mortgage investment securities. The remaining $80 million increase in investments was funded through two leverage transactions. Other uses of funds during the first three months of 2002 consisted of decreased total deposits of $40.2 million compared to December 31, 2001 mainly due to cyclical declines in demand balances and lower savings and money market balances influenced by competition from non-depository investment options, $30.8 million decrease in cash and cash equivalents, $20.2 million net decrease in Federal Home Loan Bank borrowings, $893 thousand in payment of cash dividends, and $536 thousand in purchases of premises and equipment. Funding sources came from a net decrease of $131.8 million in loans mainly due to the sale of long-term fixed rate mortgages, $76 million increase in securities sold under agreements to repurchase mainly due to the leverage transactions, $2.8 million increase in notes payable, and $1.9 million in net cash provided by operating activities. Asset Quality At March 31, 2002, non-performing assets were $11.1 million, an increase of $580 thousand from December 31, 2001 due to an increase of $732 thousand in nonaccrual loans offset by a decrease of $152 thousand in other real estate owned. Total non-performing assets as a percentage of total assets were 0.93% at March 31, 2002 and 0.89% at December 31, 2001. As a percentage of total loans outstanding, the level of non-performing loans increased to 1.69% at March 31, 2002 from 1.30% at December 31, 2001, due to the increase in total outstanding non-performing assets and the reduced amount of outstanding loans impacted by mortgage securitization. The following table summarizes non-performing assets on the dates indicated (dollars in thousands).
Mar. 31 Dec. 31 Sep. 30 Jun. 30 Mar. 31 2002 2001 2001 2001 2001 ------- ------- ------- ------- ------- Nonaccrual loans $10,532 $ 9,800 $11,671 $ 9,887 $ 9,382 Accruing loans past due 90 days or more 0 0 0 0 0 Restructured loans 0 0 0 0 0 ------- ------- ------- ------- ------- Total non-performing and restructured loans 10,532 9,800 11,671 9,887 9,382 Other real estate owned 519 671 545 433 262 ------- ------- ------- ------- ------- Total non-performing assets $11,051 $10,471 $12,216 $10,320 $ 9,644 ======= ======= ======= ======= ======= Ratios: Non-performing loans to total loans 1.69% 1.30% 1.55% 0.74% 1.37% Allowance to total loans 1.31 1.05 1.00 0.97 1.08 Allowance to non-performing loans 77.53 80.61 64.28 130.54 78.83 Non-performing assets to total assets 0.93 0.89 1.04 0.52 0.89 ======= ======= ======= ======= =======
When, in the opinion of management, serious doubt exists as to the collectibility of a loan, the loan is placed on non-accrual status. At the time a loan is classified as non-accrual, interest income accrued in the current year is reversed and interest income accrued in the prior year is charged to the allowance for loan losses. 7 Allowance for Loan Losses and Net Charge-offs Management maintains the allowance for loan losses (the "Allowance") at a level considered adequate to provide for probable loan losses. The Allowance is increased by provisions charged to earnings and is reduced by charge-offs, net of recoveries. At March 31, 2002, the Allowance was $8.2 million, an increase of $266 thousand from the balance at December 31, 2001. The Allowance increased due to the increase in nonaccrual loans and also the increase in the percentage of commercial loans to total loans. The percentage increase in commercial loans to total loans was due to a decrease in the mortgage category from the sale of $100 million in securitized mortgages. The adequacy of the Allowance is determined quarterly based upon an evaluation of the Company's loan portfolio by internal loan review and management. These evaluations consider a variety of factors, including, but not limited to, general economic conditions, loan portfolio size and composition, previous loss experience, the borrower's financial condition, collateral adequacy, the level of non-performing loans, and management's estimation of future losses. As a percentage of loans, the Allowance was 1.31% at March 31, 2002 compared to 1.05% at December 31, 2001. Based upon its analyses, management considers the Allowance adequate to recognize the risk inherent in the Company's loan portfolio at March 31, 2002. The following table sets forth an analysis of the Company's Allowance for loan losses for the periods indicated (dollars in thousands): Three months Ended Year ended March 31, 2002 Dec. 31, 2001 ---------------------------------- Balance at beginning of period $7,900 $7,149 Charge-offs: Commercial 176 3,558 Real estate 3 77 Installment 51 560 Other 3 51 ---------------------------------- Total charge-offs 233 4,246 Recoveries: Commercial 16 17 Real estate 0 14 Installment 32 211 Other 0 11 ---------------------------------- Total recoveries 49 253 ---------------------------------- Net charge-offs 185 3,993 Balance of acquired allowance at date of acquisition 0 889 Additions charged to operations 450 3,855 ---------------------------------- Balance at end of period $8,165 $7,900 ================================== Ratios: Net charge-offs to average loans outstanding(1) 0.10% 0.55% Net charge-offs to total allowance(1) 9.06 50.54 Allowance to period end loans outstanding 1.31 1.05 ================================== --------------------- 1. Annualized 8 Results of Operations - Comparison of the Three Months Ended March 31, 2002 and 2001 General For the quarter ended March 31, 2002, the Company reported a net income of $2.6 million, compared to net income of $1.7 million reported for the quarter ended March 31, 2001. Net Interest Income The following table sets forth average balances, related interest income and expenses, and effective interest yields and rates for the three months ended March 31, 2002 and March 31, 2001 (dollars in thousands):
2002 2001 ------------------------------------------------------------------- Average Yield/ Average Yield/ Balance Interest Rate(4) Balance Interest Rate(4) ------------------------------------------------------------------- ASSETS Interest-earning assets: Loans(1)(2)(3) $ 731,593 $ 13,151 7.29% $ 674,572 $ 14,167 8.52% Taxable investment securities 232,287 3,023 5.28% 256,694 4,255 6.72% Tax-exempt investment securities(3) 63,105 1,041 6.69% 42,826 733 6.94% Interest-earning deposits 7,917 36 1.83% 6,727 67 4.01% Federal funds sold 36,678 146 1.61% 3,492 52 6.06% ---------- -------- ---- ---------- -------- ---- Total interest-earning assets 1,071,580 17,397 6.58% 984,311 19,274 7.94% Non-interest-earning assets: Cash and due from banks 45,183 38,054 Premises and equipment, net 28,617 25,227 Other assets 40,949 40,723 Less: Allowance for loan losses (8,007) (7,259) ---------- ---------- TOTAL $1,178,322 $1,081,056 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Now accounts $ 95,062 $ 112 0.48% $ 88,554 $ 316 1.45% Money market accounts 234,633 866 1.50% 196,174 2,250 4.65% Savings deposits 121,169 282 0.94% 118,073 706 2.42% Time deposits 340,012 3,498 4.17% 314,214 4,716 6.09% Notes payable 17,162 144 3.40% 7,629 153 8.13% FHLB borrowings 58,268 723 5.03% 94,424 1,331 5.72% Federal funds purchased 0 0 0.00% 8,784 137 6.32% Securities sold under agreement to repurchase 57,892 340 2.38% 17,363 275 6.42% ---------- -------- ---- ---------- -------- ---- Total interest-bearing liabilities 924,198 5,965 2.62% 845,215 9,884 4.74% Non-interest-bearing liabilities: Demand deposits 138,081 117,153 Other 7,632 9,188 ---------- ---------- Total liabilities 1,069,911 971,556 ---------- ---------- Stockholders' equity 108,411 109,500 ---------- ---------- TOTAL $1,178,322 $1,081,056 ========== ========== Net interest earning and interest rate spread $ 11,432 3.96% $ 9,390 3.20% ======== ==== ======== ==== Net yield on interest-earning assets 4.33% 3.87% ==== ==== ---------------- 1 For the purposes of these computations, non-accrual loans are included in the daily average loan amounts outstanding. 2 Interest earned on loans includes loan fees (which are not material in amount) and interest income which has been received from borrowers whose loans were removed from non-accrual during the period indicated. 3 Taxable-equivalent adjustments are made in calculating interest income and yields using a 34% rate for all years presented. 4 Annualized.
9 For the quarter ended March 31, 2002, the Company reported taxable-equivalent net interest income of $11.4 million, an increase of $2.0 million or 21.7% from the $9.4 million reported for the quarter ended March 31, 2001. The increase was mainly due to interest rates on deposits and borrowed funds continuing to reprice to lower rates. The Company's taxable-equivalent yield on interest-earning assets (net interest margin) improved to 4.33% in first quarter 2002 from 3.87% in first quarter 2001. Taxable-equivalent total interest income decreased $1.9 million for the quarter ended March 31, 2002 compared to the first quarter of 2001. The decrease was mainly due to rate decreases in interest-earning assets over the preceding twelve months. Average loans outstanding increased $57 million or 8.5% in first quarter 2002 over first quarter 2001. The increase was due to the acquisition of LB Bancorp in July 2001 offset by the sale of $100 million of long-term fixed-rate mortgages during the first quarter of 2002, which were replaced with adjustable rate mortgage investment securities. For the quarter ended March 31, 2002, the Company's taxable-equivalent yield on interest-earning assets was 6.58% compared to 7.94% for the quarter ended March 31, 2001. The Company's first quarter 2002 loan yield decreased to 7.29% from 8.52% in first quarter 2001, mainly due to the lower interest rate environment. The Company also experienced declines in its investment securities' yields. For the quarter ended March 31, 2002, the yield on taxable investment securities decreased to 5.28% from 6.72% and tax-exempt investment yields decreased to 6.69% from 6.94% for the quarter ended March 31, 2001. Funding costs were also impacted by the lower interest rate environment prevalent over the previous twelve months. The cost of interest-bearing liabilities decreased to 2.62% for first quarter 2002 from 4.74% for first quarter 2001 mainly due to the lower rate environment and a decreased percentage of interest-bearing liabilities in wholesale borrowings. In the first quarter 2002, FHLB borrowings, federal funds purchased, and securities sold under agreements to repurchase comprised 14.5% of the Company's interest-bearing liabilities compared to 15.2% in the first quarter 2001. Provision for Loan Losses The provision for loan losses was $450 thousand in first quarter 2002 and $270 thousand in first quarter 2001. Other Income Total other income increased $133 thousand in the first quarter 2002 over the first quarter 2001, due to increases in service charges on deposit accounts, gains on sale of residential mortgage loans, and other income. These increases were offset by decreases in ATM and merchant services, security commissions and management fees, and investment securities gains. Service charges on deposit accounts increased $177 thousand due to adjustments to fees on business accounts. Gains on sale of residential mortgage loans increased $284 thousand due to the increased demand for refinancing due to the lower rate environment. The increase in other income was mainly due to a gain on sale of other real estate owned, an increase in mortgage origination fees, and increased insurance commissions. Security commissions and management fees decreased $155 thousand due to the liquidation of the Company's asset management company in the fourth quarter of 2001. The Company realized $204 thousand in investment securities gains in the first quarter 2002 compared to $431 in first quarter 2001. Other Expenses Other expenses increased $892 thousand in the first quarter 2002 over the first quarter 2001, due to increases in personnel expenses, occupancy and equipment expenses, data processing, legal and professional fees, advertising, and other expenses, offset by decreases in ATM and merchant 10 services and goodwill amortization. Personnel costs increased $361 thousand due to increased sales commissions as a result of volume increases in the secondary mortgage market sales and increased staff due to the LB acquisition. Net occupancy and equipment expense increased $181 thousand due to the additional five offices acquired with the LB acquisition and the construction and opening of a new office in West Elgin. Data processing increased $10 thousand, legal and professional fees increased $208 thousand, and advertising increased $15 thousand. Other expense increased $671 thousand due to increases in supplies, telephone, correspondent bank service charges, and delivery and postage. ATM and merchant services decreased $40 thousand due to decreased customer volume. Goodwill amortization decreased $514 thousand due to SFAS No. 142. Income Taxes Income tax expense for the quarter ended March 31, 2002 was $1.2 million compared to expense of $1.0 million for the quarter ended March 31, 2001. The effective tax rate was 30.6% for the first quarter of 2002 compared to a rate of 37.1% for the first quarter of 2001. The difference in the effective tax rate for March 31, 2002 and 2001 is mainly due to the amortization of goodwill for the quarter ended March 31, 2001. Excluding the goodwill for March 31, 2001, the effective tax rate would have been 31.3%. Liquidity Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Liquid assets (including cash deposits with banks, short-term investments, interest-earning deposits, and federal funds sold) are maintained to meet customers needs. The Company had liquid assets of $63.7 million and $94.5 million at March 31, 2002 and December 31, 2001, respectively. Capital Resources There are certain regulatory constraints which affect the Company's level of capital. The following table sets forth these requirements and the Company's capital levels and ratios at March 31, 2002, including the Tier 1 leverage ratio, the risk-based capital ratios based upon Tier 1 capital, and total risk-based capital: Regulatory Regulatory Minimum Well-capitalized Actual Requirement Requirement ----------------- ----------------- ----------------- (dollars in thousands) Amount Percent Amount Percent Amount Percent ------- ------- ------- ------- ------- ------- Tier 1 leverage $77,077 6.7% $45,936 4.0% $57,420 5.0% Tier 1 risk-based capital $77,077 10.6% $29,105 4.0% $43,657 6.0% Risk-based capital $85,242 11.7% $58,209 8.0% $72,762 10.0% The Company is pursuing a policy of continued asset growth, which requires the maintenance of appropriate ratios of capital to assets. The existing capital levels allow for additional asset growth without further capital injection. It is the Company's desire to maintain its capital position at or in excess of the "well-capitalized" definition. The Company seeks to obtain additional capital growth through earnings retention and a consistant dividend policy. 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk Refer to the Company's annual report on Form 10-K for the year ended December 31, 2001 for a complete discussion of the Company's market risk. There have been no material changes to the market risk information included in the Company's 2001 annual report on Form 10-K Forward Looking Statements The Company intends that certain matters discussed in this 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 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 Report are only made of the date of this Report, and the Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. 12 Part II. Other Information Item 1. 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 2. Changes in Securities None Item 3. Defaults upon Senior Securities None Item 4. Submission of Matters to Vote of Security Holders None Item 5. Other Information The deadline for submission of shareholder proposals pursuant to Rule 14a-8 under the Securities Exchange Act of 1934, as amended, for inclusion in the Company's proxy statement for its 2003 Annual Meeting of Shareholders is November 22, 2002. Additionally, if the Company receives notice of a shareholder proposal after February 1, 2003, the persons named in proxies solicited by the Board of Directors of the Company for its 2003 Annual Meeting of Shareholders may exercise discretionary voting power with respect to such proposal. Item 6. Exhibits and Reports on Form 8-K None 13 SIGNATURES Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. STATE FINANCIAL SERVICES CORPORATION (Registrant) Date: May 7, 2002 /s/ Michael J. Falbo -------------------- -------------------------------------- Michael J. Falbo President and Chief Executive Officer Date: May 7, 2002 /s/ Timothy L. King -------------------- -------------------------------------- Timothy L. King Senior Vice President and Chief Financial Officer 14