ITEM 1 BUSINESS
GENERAL. Blackhawk Bancorp, Inc., (the "Company"), was incorporated under the laws of the state of Wisconsin in November 1989. The Company owns and operates a subsidiary financial institution, Blackhawk State Bank ("Bank"), located in Beloit, Wisconsin.
The Bank is a Wisconsin-chartered commercial bank operating five branches in the Greater Beloit Area, three free-standing branches and two in-store branches. Six additional free-standing branches are in the following cities in Illinois: Belvidere (2), Oregon (1), Rochelle (1), Rockford (1) and Roscoe (1). The Bank has three wholly-owned subsidiaries. Nevahawk Investment, Inc. ("Nevahawk") is an investment subsidiary located in Las Vegas, Nevada. RSL, Inc., a second subsidiary whose activities include the sale of mutual funds and annuities, and in turn owns Midland Acceptance Corporation ("MAC"), a consumer finance company that maintained offices in Rochelle and Rockford, Illinois until December 1999. First Financial Services, Inc. ("FFSI"), the third subsidiary, sells, on an agency basis, mortgage-related insurance products and a variety annuity products.
On April 30, 1997, the Company completed the purchase of all of the outstanding shares of Rochelle Bancorp, Inc. ("Rochelle") of Rochelle, Illinois, for approximately $4.2 million in cash. Rochelle's wholly owned subsidiary, Rochelle Savings Bank S.B., was an Illinois state chartered savings bank with offices in Rochelle and Oregon, Illinois, and assets totaling approximately $51.0 million. This acquisition was accounted for as a purchase transaction. On March 31, 1998, the charter of Rochelle Savings Bank S.B. was merged into the charter of Blackhawk State Bank.
As a part of this purchase, the Company also acquired all of the outstanding shares of Midland Acceptance Corporation ("MAC"), a consumer finance subsidiary whose loan portfolio was sold in December 1999.
Effective September 1, 1998, the Company completed the purchase of all of the outstanding shares of First Financial Bancorp, Inc. ("Belvidere") of Belvidere, Illinois for approximately $12.7 million in cash. Belvidere's wholly owned subsidiary, First Federal Savings Bank, a federal savings bank with two offices in Belvidere and one in Rockford, Illinois, and assets totaling approximately $86.0 million was merged into the Bank, on the effective date of purchase.
The principal sources of funds for the Bank's lending activities are deposit accounts, amortization and prepayment of loans, short-term borrowings, and funds provided from operations. The principal sources of income are interest and fees on loans, interest on investments and non-interest income, consisting of fees for servicing loans, service charges, trust department fees and income from retail non-deposit investment sales.
LENDING ACTIVITIES. A majority of the loans in the Bank's loan portfolio are secured by residential or commercial real estate. Substantially all of the real estate securing the mortgage loans is located within thirty minutes of the Bank's offices. Previously, management of the Company has restructured the loan portfolio of the Greater Beloit Area Bank to decrease the concentration of mortgage loans and increase commercial and installment loans. Management of the Company anticipates the on-going restructuring of the loan portfolio of the acquired institutions. The Analysis of Loan Portfolio, Table 2 of Item 7, shows the changes in the types of loans from 1997 through 1999.
Commercial loans are either collateralized by assets other than real estate or are unsecured. Interest rates on commercial loans are generally tied to an index adjustable monthly and therefore more rate sensitive than mortgage loans. Consumer and installment loans are generally secured by automobiles, boats, or junior liens on real estate. A substantial percentage of automobile and boat loans in the portfolio were purchased from area dealers. The Bank also offers credit cards and home equity lines of credit.
Approximately $130 million in single one-to-four family loans are serviced for others. These were acquired through the purchase transactions mentioned above. Substantially all of these loans are 100% sold to the Federal Home Loan Mortgage Corporation ("Freddie Mac"). MAC is a sub-prime lender, and maintained approximately $2.0 million in outstanding loans until the sale of the portfolio in December 1999.
INVESTMENT ACTIVITIES. The investment policy under which the Company and its subsidiary operates normally limits investments to: 1) U.S. Treasury and government agency securities with maturities of 5 years or less; 2) mortgage-backed securities, limited to no more than 30% of the investment portfolio, with an average life of 5 1/2 years or less; 3) municipal securities rated "A" or better, unless they are tax-anticipation notes issued by Wisconsin issuers whose long-term debt is rated at least "A" or if unrated, are judged by management to possess investment characteristics comparable to "A" rated debt securities; and 4) corporate bonds and notes rated "A" or better with a maturity of 4 years or less. In addition, the Bank may purchase commercial paper, bankers acceptances and bank certificates of deposit as authorized investments to provide additional liquidity in the investment portfolio.
Security investments made to a single entity are limited to 20% of its capital and surplus. This limitation does not apply to investments in obligations of the United States Treasury, Federal Land Banks, Federal Home Loan Banks, Federal Farm Credit Banks, Federal National Mortgage Association, Export-Import Bank of Washington or obligations fully and unconditionally guaranteed by the United States. Generally, the recently purchased taxable securities held by the Company, the Bank and Nevahawk are classified as available-for-sale, while exempt securities have been classified as held-to-maturity.
During 1991, Beloit transferred approximately $21.5 million worth of its investment securities to Nevahawk, it's wholly-owned subsidiary located in Las Vegas, Nevada. In March 1999, an additional $7.0 million in cash was transferred to Nevahawk. Currently, the portfolio under management by Nevahawk is approximately $36.0 million.
The Company can maintain an investment portfolio that consists of securities similar to those mentioned above. At December 31, 1999, the Company had no security holdings.
DEPOSIT ACTIVITIES. Deposits are divided between interest bearing and non-interest bearing. Non-interest bearing deposits consist of checking accounts of individuals and non-personal entities. The interest-bearing deposits include savings accounts, money market deposit accounts, certificates of deposit, individual retirement accounts, NOW accounts and check club accounts. The aggregate balance of accounts with balances in excess of $100,000 was $27.3 million at December 31, 1999. During 1999 the Bank acquired approximately $6.4 million in brokered deposits which mature in 2000. The Bank attracts deposits by offering competitive interest rates for interest-bearing accounts and prices services on a competitive basis for non-interest bearing accounts.
TRUST SERVICES. Through a separate department the Bank provides personal trust services, including acting as trustee for living and testamentary trusts, and as an agent, custodian, guardian, conservator, personal representative or administrator for individuals or their estates. Trust offices are maintained at the Bank's main location in Beloit, Wisconsin.
OTHER SERVICES. The Bank provides a wide range of other banking services for both retail and commercial customers. It also provides full-service brokerage services through Raymond James Securities, Inc. in two locations.
COMPETITION. Banks experience intense competition in both attracting and retaining deposits and in making loans. The Bank's direct competition for deposits has come from other commercial banks, savings and loan associations, credit unions, mutual funds and stock brokerage firms. In addition to offering competitive types of accounts and interest rates, the principal methods used by the Bank to attract deposits included the offering of a variety of services, convenient business hours, and branch locations.
Competition in making real estate loans comes principally from savings and loan associations, mortgage companies and other commercial banks. Consumer loans provided by credit unions, finance companies and other commercial banks provide the competition in this area. Other commercial banks are the major competition for commercial loans.
EMPLOYMENT. As of December 31, 1999, the Company and the Bank had 164 employees, of which 114 were employed on a full time basis. The fringe benefits generally provided to qualified employees include health insurance, long-term disability insurance, group term life insurance, a flexible compensation plan (cafeteria plan), a 401k deferred compensation and profit-sharing plan. Management considers its relations with employees to be excellent.
SUPERVISION AND REGULATION. The Company and the Bank are extensively regulated under federal and state law. Any descriptions of statutory and regulatory provisions contained in the following discussion are qualified in their entirety by reference to the particular statutory and regulatory provisions. Any change in applicable law or regulations may have a material effect on the Company.
THE COMPANY. On March 27, 1990, the Company received approval from the Federal Reserve Board (the "FRB") under the Bank Holding Company Act of 1956, as amended (the "BHC Act"), to become a registered bank holding company by acquiring all of the capital stock of the Bank. As a result, since consummation of the Conversion on May 16, 1990, the Company's activities have been subject to limitations imposed under the BHC Act. Transactions between the Company and the Bank and their affiliates are also subject to certain restrictions. As a registered bank holding company, the Company is subject to various filing requirements of the FRB and is also subject to examination by the FRB.
FRB approval must be obtained before a bank holding company acquires all or substantially all of the assets of a bank or savings association or merges or consolidates with another bank holding company or savings and loan holding company. Wisconsin has also adopted legislation which allows bank holding companies from states that have adopted reciprocal legislation (the "Reciprocal States") to acquire banks in Wisconsin, and allows Wisconsin bank holding companies to acquire banks in the Reciprocal States. The Reciprocal States presently include Illinois, Indiana, Iowa, Kentucky, Michigan, Minnesota, and Ohio.
Under the BHC Act, bank holding companies are prohibited, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company. A bank holding company may, however, own shares of a company, the activities of which the FRB has determined to be so closely related to banking, managing or controlling banks as to be a proper incident thereto; the holding company itself also can engage in such activities. With the acquisition of Rochelle, the Company also acquired the outstanding stock of MAC, which is a finance company, and as such is an activity closely related to banking activities.
The FRB has adopted capital guidelines as to both minimum levels of core capital and risk-based capital. The minimum core capital requirement ranges from 3% to 5% of total assets depending upon the regulator's determination of the holding company's strength. The guidelines assign risk weightings to assets and off-balance sheet items, and have minimum risk-based capital ratios. All bank holding companies are required to have total consolidated capital of 8% of risk-weighted assets. Core capital consists principally of shareholders' equity less intangibles, while qualifying total capital consists of core capital, certain debt instruments and a portion of the allowance for loan losses. Table 12, filed elsewhere in this report, reflects various regulatory measures of capital as of December 31, 1999. The Company's core and risk-based capital ratios, as shown in the table are well above the minimum levels.
Under Wisconsin law, a bank holding company is deemed to be engaged in the banking business and is subject to supervision and examination by the Wisconsin Department of Financial Institutions (the "Commissioner"). The Commissioner is also empowered to issue orders to a bank holding company to remedy any condition or policy which, in the opinion of the Commissioner, endangers the safety of deposits of any subsidiary state bank or trust company. In the event of non-compliance with such an order, the Commissioner has the power to direct the operations of the state bank or trust company and to restrict dividends paid to the bank holding company.
THE BANK. Wisconsin-chartered banks, including the Bank, are regulated and supervised by the Wisconsin Department of Financial Institutions. Each Wisconsin-chartered bank is required to be examined at least once each year by either the Commissioner or its primary federal regulator. The approval of the Commissioner is required to establish or close branches, merge with other banks and undertake many other activities.
Any Wisconsin bank that does not operate in accordance with the regulations, policies and directives of the Commissioner may be subject to sanctions for noncompliance. The Commissioner may, under certain circumstances, suspend or remove directors, officers or employees who have violated the law, conducted the Bank's business in a
manner which is unsafe, unsound or contrary to the depositors' interests or been negligent in the performance of their duties.
Wisconsin state banks are authorized to accept deposits (including demand, savings and time deposits and certificates of deposit). Banks may make a wide variety of loans (including mortgage loans, loans to corporations and other commercial loans and other personal consumer loans). Other federal and state regulations with respect to banks include required reserves, limitations as to the nature and amount, by type and borrower, of lending, regulatory approval of mergers and consolidations, issuance and retirement by a bank of its own securities, and other aspects of banking operations.
Under Wisconsin law, the Commissioner has the authority, by rule or order, to grant Wisconsin state banks the power to conduct any financial service which is being offered by any other financial-related institution; under those provisions, the Commissioner has approved banks engaging in general insurance agency services and securities brokerage services. Each of the above services is not a permitted activity of bank holding companies or bank holding company subsidiaries. The FRB has generally not asserted jurisdiction over the powers of state-chartered bank subsidiaries of bank holding companies.
PAYMENT OF DIVIDENDS. A Wisconsin bank may only pay dividends on its capital stock if such payment would not impair the bank's capital stock and surplus account (as defined under Wisconsin law). If, on the date of declaration of a dividend on common stock, the ratio of capital stock and surplus to total deposits is less than 10%, there must be a transfer from net profits to the surplus account before the dividend may be paid. Based on the Bank's strong financial position, its entire earnings each year could be paid out as dividends.
Nevahawk can pay dividends to the Bank from retained earnings without any tax consequences. There are no plans, at the present, for Nevahawk to pay dividends in 2000. This status will be reviewed by Nevahawk at its regular board meetings.
FEDERAL DEPOSIT INSURANCE CORPORATION. The Bank's deposit accounts are insured by the FDIC. FDIC insurance, at the present time, generally insures up to a maximum of $100,000 per insured depositor. The FDIC imposes an annual assessment on deposits. Effective January 1, 1993, premiums are assessed on the basis of a risk rating assigned by the FDIC. Since that time the Bank's premium has been at the lowest available rate. Beginning in 1997, financial institutions insured by the FDIC were required to contribute to the FICO bond refinancing. This is expected to occur through the year 2003. Beginning January 1, 2000, the Bank's Bank Insurance Fund ("BIF") and Saving Association Insurance Fund ("SAIF") Oaker deposits will be assessed at the same rate.
The FDIC issues regulations, conducts periodic examinations, requires the filing of reports and generally supervises the operations of its insured banks. The approval of the FDIC is required prior to any merger or consolidation, or the establishment or relocation of any branch office. This supervision and regulation is intended primarily for the protection of depositors.
As an FDIC-insured bank, the Bank is subject to certain FDIC requirements designed to maintain the safety and soundness of individual banks and the banking system. The FDIC, based upon appraisals during examinations, may revalue assets of an insured institution and require establishment of specific reserves in amounts equal to the difference between such revaluation and the book value of the assets. In addition, the FDIC has adopted regulations regarding capital adequacy requirements similar to those of the FRB.
OTHER ASPECTS OF FEDERAL AND STATE LAW. The Bank is also subject to federal and state statutory and regulatory provisions covering, among other things, security procedures, currency reporting, insider and affiliated party transactions, management interlocks, community reinvestment, truth-in-lending, electronic funds transfers, truth-in-savings, privacy, and equal credit opportunity.
Proposals for new legislation or rule making affecting the financial services industry are continuously being advanced and considered at both the national and state levels. Proposals are primarily focused upon restructuring and strengthening regulation and supervision to reduce the risks to which assets of banks and savings institutions are exposed.
Although further changes in the regulatory framework may be enacted, specific provisions and their ultimate effect upon the business of the Bank and the Company cannot be reliably anticipated.
GOVERNMENTAL MONETARY POLICIES AND ECONOMIC CONDITIONS. The earnings of the Bank and the Company are affected not only by general economic conditions but also by the policies of various governmental regulatory authorities. In particular, the FRB influences general economic conditions and interest rates through the regulation of money and credit conditions. It does so primarily through open-market operations in U.S. Government Securities, varying the discount rate on member and nonmember bank borrowings, and setting reserve requirements against bank deposits. FRB monetary policies have had a significant effect on the operating results of banks in the past and are likely to continue to have such an effect in the future. The general effect, if any, of such policies upon the future business and earnings of the Bank cannot be accurately predicted. In addition, losses sustained by the federal insurance funds and regulatory costs incurred in connection with failed or failing insured depository institutions continue to be assessed to those within the industry. As such, future earnings will be adversely affected by regulations enacted to cover these losses and costs.
EXECUTIVE OFFICERS
NAME AND AGE PRINCIPAL OCCUPATION
Dennis M. Conerton, 49 President and Chief Executive Officer of the Company and of the Bank. Prior thereto, Vice President-Controller, Regal-Beloit Corporation.
James P. Kelley, 56 Executive Vice President and Secretary of the Company and Executive Vice President of the Bank and the Bank's predecessor, Beloit Savings Bank.
Jesse L. Calkins, 59 Senior Vice President, Treasurer and Chief Financial Officer of the Company and Senior Vice President and Senior Trust Officer of the Bank, and the Bank's predecessor, Beloit Savings Bank.
Richard J. Rusch, 55 Vice President Commercial Lending of the Bank since August 1990. Prior thereto, Vice President Commercial Loans, M & I Bank of Beloit.
David A. Stearns, 53 Senior Vice President of the Bank (October 1998 to Present); President and Chief Executive Officer of the Castle Bank Harvard, N.A., Harvard, IL (1995 - 1997); President and Chief Executive Officer of the Harris Bank Woodstock, Woodstock, IL (1992 - 1995).
ITEM 2.
ITEM 2. PROPERTIES
On December 31, 1999, the Company had eleven locations, of which three were leased. All of these offices are considered by management to be well maintained and adequate for the purpose intended. See the Notes to Consolidated Financial Statements included under Item 7 of this document for further information on properties.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
To management's knowledge no material legal proceedings are contemplated or pending to which it or its affiliates are or threatened to be a party, of which any of their property would be subject, other than routine litigation incidental to its business.
ITEM 4
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of 1999.
PART II
ITEM 5
ITEM 5 MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATE STOCKHOLDERS MATTERS
As of March 21, 2000 there were 368 Registered Stockholders. Information in response to this item, along with a table listing the declaration of dividends is found on page 15 of the Company's Annual Report, and is incorporated herein by reference.
ITEM 6
ITEM 6 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following discussion provides additional analysis of the Company's financial statements presented in its annual report and should be read in conjunction with this information. This discussion focuses on the significant factors which affected the Company's earnings in 1999, with comparisons to 1998 and 1997, where applicable. As of December 31, 1999, Blackhawk State Bank ("the Bank") was the only direct subsidiary of the Company and its operations contribute nearly all of the revenue and the majority of the consolidated expenses for the year. The Bank has three wholly owned subsidiaries. Nevahawk Investments, Inc. ("Nevahawk") is an investment subsidiary located in Nevada. RSL, Inc. operates mutual fund and annuity activities, and in turn owns Midland Acceptance Corp. ("MAC"), a consumer finance company that operated offices in Rochelle and Rockford, IL. First Financial Services of Belvidere, Inc. ("FFSI") administers and sells, on an agency basis, mortgage-related insurance products and a variety of insurance and annuity products.
OVERVIEW On April 30, 1997, the Company completed the purchase of all of the outstanding shares of Rochelle Bancorp, Inc. ("Rochelle") of Rochelle, Illinois, for approximately $4.2 million in cash. Rochelle's wholly owned subsidiary, Rochelle Savings Bank S.B., was an Illinois state chartered savings bank with offices in Rochelle and Oregon, Illinois, and assets totaling approximately $51.0 million. This acquisition was accounted for as a purchase transaction. On March 31, 1998, the charter of Rochelle Savings Bank S.B. merged into the charter of Blackhawk State Bank.
As a part of this purchase, the Company also acquired all of the outstanding shares of Midland Acceptance Corporation ("MAC"), a consumer finance subsidiary. Midland operated as a consumer finance subsidiary through December, 1999 when the outstanding loan portfolio was sold.
Effective September 1, 1998, the Company completed the purchase of all of the outstanding shares of First Financial Bancorp, Inc. ("Belvidere") of Belvidere, Illinois for approximately $12.7 million in cash. Belvidere's wholly owned subsidiary, First Federal Savings Bank, a federal savings bank with two offices in Belvidere and one in Rockford, Illinois, and assets totaling approximately $86.0 million, was merged into the Bank on the effective date of the purchase.
Results of operations of Rochelle and Belvidere are incorporated in the Company's statements from the respective acquisition dates forward.
NET INTEREST INCOME Net interest income ("Interest Margin") is the difference between interest income and fees on loans and interest expense, and is the largest contributing factor to net income for the Company. All discussions of income amounts and rates are on a tax-equivalent basis, which accounts for income earned on loans and securities that are not fully subject to income taxes as if they were fully subject to income taxes. Interest Margin in 1999 was $9.6 million, increasing 7.3% over the 1998 level of $8.9 million. Interest margin as a percent of average earning assets ("Interest margin rate") was 3.64% in 1999, 4.24% in 1998 and 4.52% in 1997. The decrease between 1999 and 1998 is the result of the lower yields on earning assets. A significant contributing factor to the decline in yield was the addition of a full year of the Belvidere operation, which had a lower interest margin rate than the Company upon its acquisition.
Interest income and fees on loans is the largest component of interest income and was the largest factor in the 16.1% increase in interest income during 1999. The inclusion of the Belvidere portfolio for 12 months versus four months in 1998 largely drove this increase. Internal portfolio loan growth did net an 8.0% increase from December 31, 1998 to December 31, 1999. The yield earned on loans decreased to 8.74% in 1999 compared to 9.10% in 1998. The Belvidere portfolio carried a lower average yield than the balance of the Company's loan portfolio. Additionally, yields on new loans added in the first half of 1999 were typically lower than the existing portfolio due to prevailing market interest rates.
Interest income and fees on loans increased 21.4% and was the largest factor in the increase of interest margin in 1998 compared to 1997. Each loan category had an increase in average balances as compared to 1997, the result of the acquisition of Belvidere on September 3, 1998. The yield earned on loans decreased to 9.10% in 1998 compared to 9.25% in 1997. Loan yields were adversely affected in 1998 by the decrease in overall market rates and the addition of the Belvidere loans for four months, which were predominantly one-to-four-family mortgage loans earning lower yields.
Investment income increased 36.1%, to $3.9 million in 1999 compared to $2.9 million in 1998. Average balances for both taxable and exempt securities were higher in 1999 when compared to 1998 as short-term investment balances were redeployed in March and April of 1999 to improve overall asset yield. Yields on taxable and exempt securities declined to 5.93% and 5.91%, respectively, in 1999 from 6.31% and 6.53%, respectively, in 1998 as new investments carried lower yields than the existing portfolio. In addition to scheduled maturities, certain higher-yielding investments were also subject to, and were, called by their issuers in 1999 further contributing to the overall portfolio yield decline. The deployment of short-term funds in March and April served to reduce the overall securities portfolio yield while increasing the yield on those particular funds that had been invested in short-term money market instruments. The Company continued through the early part of 1999 to reinvest maturities into tax exempt securities to take advantage of favorable spreads in such securities.
Investment income increased 12.8%, to $2.9 million in 1998 compared to $2.6 million in 1997. Average balances for both taxable and exempt securities were higher in 1998 when compared to 1997. The Company reinvested maturities from taxable securities into tax-exempt securities to take advantage of the favorable spread between these two investment types. The average balances of taxable investment securities were also affected by the Belvidere acquisition. The yield on taxable investment securities fell to 6.31% in 1998 from 6.52% in 1997, mostly due to lower overall market rates.
Total interest expense was $10.7 million in 1999, increasing 25.4% from $8.5 million in 1998. A 29.6% increase in average interest-bearing liability balances more than offset a 15-basis point drop in the cost of such liabilities. The increased volume was largely a function of 12 months of the Belvidere liabilities, compared to only four months in 1998 and the full year effect of borrowings incurred to complete the Belvidere transaction. Interest on interest-bearing deposits increased 19.6% as a 26.1% increase in volume was partially offset by declining costs. The average rate paid on interest-bearing deposits decreased to 4.39% in 1999 compared to 4.63% in 1998. The favorable repricing of the savings and time deposit portfolios and the shift in mixture of the interest-bearing deposit portfolio towards interest-bearing transaction accounts and savings accounts from time deposits contributed towards that decline. Interest on borrowings increased 71.1% as the Company funded loan growth in the latter three-quarters of the year with non-deposit liabilities. Additionally, the Company carried 12 months of borrowings for the Belvidere acquisition on its balance sheet compared to four months in 1998.
Total interest expense was $8.5 million in 1998, increasing 27.0% from $6.7 million in 1997. Increased volumes were the primary factors for this increase. These increased volumes were attributable to growth of the Bank's deposit base, the acquisition of deposits from Belvidere and the use of borrowings to complete the Belvidere transaction. This increase due to volumes was partially offset by lower rates paid on deposits. The average rate paid on deposits decreased to 4.63% in 1998 compared to 4.70% in 1997.
OTHER OPERATING INCOME AND EXPENSES Other operating income increased 12.2% to $2.8 million in 1999 from $2.5 million in 1998. Increases in service charges on deposit accounts of $199,000, brokerage commissions of $100,000, loan servicing fees of $76,000, gains on sales of available-for-sale securities and portfolio loans of $69,000 and $144,000 respectively, were offset by declines in gains on sales of mortgages held for sale of $206,000 and trust fees of $51,000. The service charge, brokerage and loan servicing increases all related to the inclusion of 12 months of the Belvidere operation in 1999 compared to four months in 1998. The gain on sale of portfolio loans was the result of selling MAC's consumer finance loan portfolio in 1999. The decline in gains on sales of loans held for sale was the result of the increased rates on fixed rate mortgage loans in 1999. Increasing rates deteriorated the prices received on loans as well as reduced the volume of loans originated for sale.
Other operating income increased 62.7% to $2.5 million in 1998 from $1.5 million in 1997. Gain on sale of loans and brokerage and annuity commissions were the most significant factors in the increase. A $517,000 increase in the gain on sales of mortgage loans resulted from the addition of Belvidere for four months and the favorable rate environment that existed for fixed rate mortgage lending during 1998. Brokerage and annuity commissions more than doubled as Belvidere's brokerage operation contributed for four months and sales increased in the existing branches as the performance of the equity markets attracted customers. Additionally, service charges and fees on deposits increased $198,000 or 22.2% and trust fees increased $33,000 or 19.6% between periods. The increase in service charges and fees was largely attributable to the Belvidere acquisition, while the increase in trust fees was the result of a larger volume of assets under management and a higher market value of those assets.
Other operating expenses increased 30.2% to $10.1 million in 1999 from $7.8 million in 1998. The inclusion of Belvidere for a full year in 1999 was the biggest factor in the increase. Also contributing to the increase was the fact that the Bank opened a stand-alone branch in Roscoe, Illinois in March 1998. Salaries and wages increased $652,000 or 19.9% as continued administrative and back-office consolidation partially offset the additional eight months of Belvidere's operations in 1999. Amortization of purchase-accounting intangibles increased $246,000 or 68.7% as Belvidere's amortization began in September of 1998. Furniture and equipment expenditures increased 54.0% as the Company realized increased depreciation on newer equipment related to Y2K purchases and due to the additional eight months of Belvidere's operation. Data processing costs increased 41.0% with the full year effect of Belvidere's operation and Y2K related processing costs. The organization was forced to postpone its data processing consolidation until the year 2000. Other operating expenses increased 36.9% or $516,000. Over $300,000 of the increase is attributable to the additional eight months of Belvidere's operating expenses. The balance of the increase relates to an
approximate 12% increase in miscellaneous operational expenditures. Occupancy expenses and employee benefits increased 15.3% and 21.6%, respectively, as a function of the additional eight months of Belvidere's operations.
Other operating expense increased 31.3% to $7.8 million in 1998 from $5.9 million in 1997. Inclusions of Rochelle for a full year and Belvidere for four months in 1998, along with the amortization of purchased intangibles, were the biggest factors in the increase. Also contributing to the increase was the fact that the Bank opened an in-store facility in July 1997 and a stand-alone branch in the Roscoe, Illinois market in March 1998. Some areas of expense such as data processing and professional fees did not increase as much as overall expenses. This was the result of efficiencies gained as a result of merging charters and merging the data processing system of Rochelle's into Beloit's.
Management monitors three ratios related to other operating income and expense: (1) Net other operating expense as a percentage of average assets, (2) Standard efficiency ratio and (3) Gross efficiency ratio. Net other operating expense to average assets reversed the prior year's trend and increased to 2.54% in 1999 from 2.29% in 1998 and 2.39% in 1997. Considering all assets under management (mortgage loans serviced for others and managed trust assets) this ratio also increased over 1998, but remained under 1997 levels. The adjusted ratio was 1.65% in 1999, compared to 1.56% in 1998 and 1.79% in 1997. The standard efficiency ratio (other operating expense divided by net interest income plus other operating income) increased to 83.02% in 1999, compared to 68.8% in 1998 and 64.8% in 1997. Adjusted for intangible amortization, the ratio increased to 78.06% in 1999 compared to 65.6% in 1998 and 63.3% in 1997. The gross efficiency ratio (other operating expense divided by interest income plus other operating income) increased to 44.2% in 1999 compared to 39.1% in 1998 and 37.3% in 1997. Adjusted for intangible amortization, the ratio increased to 41.5% in 1999, compared to 37.2% in 1998 and 36.4% in 1997.
The downward trend in the efficiency ratios was expected, and is attributable to the newly acquired operations that are not fully integrated into the Company and to the three new branch office locations opened in 1997 and 1998. These operations should begin to have a positive impact on the efficiency ratios as they continue to increase their customer base. The gross efficiency ratio was negatively impacted by lower general market interest rates which have steadily reduced the overall yield on earning assets, while the standard efficiency ratio has been hurt by Belvidere's lower relative margin as compared to the Company's overall margin.
PROVISIONS FOR LOSSES The provision for loan losses was $464,000, $315,000 and $192,000 for 1999, 1998, and 1997, respectively. In 1999, the Bank had net charge-offs of $359,000, (total charge-offs of $408,000 less recoveries of $49,000), compared to 1998 when it had net charge-offs of $375,000, (total charge-offs of $395,000 less recoveries of $20,000). In 1997, Blackhawk experienced net charge-offs of $176,000, (total charge-offs of $215,000 less recoveries of $39,000). Net charge-offs to average loans were 0.20% in 1999, 0.24% in 1998 and 0.14% in 1997.
The allowance for loan losses as a percent of loans was 1.04% at December 31, 1999 compared to 1.08% at December 31, 1998 and to 1.11% at December 31, 1997. This downward trend continues to be a function of the shift in the Company's loan mix. With the acquisition of Rochelle and Belvidere, the Company increased its proportion of one-to-four-family mortgages to total loans. One-to-four-family mortgages are generally lower risk loans. Management feels that the allowance for loan losses is adequate based upon the current portfolio and market conditions. As the loan portfolio shifts and market conditions warrant, the allowance may be adjusted.
INCOME TAXES The effective income tax rate decreased to 30.9% in 1999 from 37.2% in 1998 and 35.3% in 1997. Contributing to the decline in the tax rates were the increased holdings of tax-exempt municipal securities, the percentage of income being generated by the Company's Nevada subsidiary and the increased Illinois state tax-exempt agency investment holdings. Income generated at Nevahawk is not subject to state income taxes while certain U.S. Government Agency investments qualify for state tax exemption for the Bank within Illinois. Offsetting these benefits was the increase in non-deductible amortization of purchase-related premiums and goodwill.
BALANCE SHEET ANALYSIS Total assets as of December 31, 1999 were $295.7 million compared to $291.5 million as of December 31, 1998. Asset growth was subdued in relation to 1998 and 1997 as the Company refrained from acquiring institutions in 1999 and turned the focus to integration and internal growth.
CASH AND CASH EQUIVALENTS Cash and equivalents were $12.0 million as of December 31, 1999 compared to $9.6 million at December 31, 1998. As the end of the century approached, Blackhawk, like other financial institutions, had higher levels of cash on hand in preparation for extraordinary consumer withdrawals. By the century date change weekend depositors had demonstrated their confidence in the Company's preparedness by refraining from withdrawing large sums and the emergency cash went unused. The excess cash was quickly reduced during the month of January 2000 to levels comparable to the end of 1998.
INTEREST-BEARING DEPOSIT ACCOUNTS The reduction of interest-bearing deposits to $4.6 million as of December 31, 1999, from $6.4 million on December 31, 1998 was the result of increasing cash on hand as cash inventories are managed through lower-yielding liquid assets such as interest-bearing deposits.
FEDERAL FUNDS SOLD AND OTHER SHORT-TERM INVESTMENTS Federal funds sold and short-term investments decreased dramatically to $0.1 million as of December 31, 1999 from $22.8 million as of December 31, 1998. In the late first quarter and early second quarter of 1999, short-term liquid funds were invested in short-to-medium-term securities to improve asset yields.
SECURITIES Available-for-sale securities grew $18.1 million, to $49.1 million as of December 31, 1999 from $31.0 million as of December 31, 1998. As mentioned above, much of this increase was the result of redeploying federal funds sold and short-term investments. Securities classified as held-to-maturity declined approximately $2.2 million, or 10%, to $19.7 million from $21.9 million.
LOANS HELD FOR SALE As of December 31, 1999, loans held for sale were approximately $0.5 million compared to nearly $4.4 million on December 31, 1998. These loans are generally long-term fixed-rate loans which lost much of their consumer appeal later in 1999 as rates increased from 1998's 30-year lows.
LOANS Net portfolio loans increased 8.0% during 1999 to $190.2 million at December 31, 1999 from $176.0 million at December 31, 1998. As intended, commercial and consumer lending which achieves the Company's objective of restructuring the balance sheets of its acquired thrift organizations fueled growth in the loan portfolio. Growth rates in commercial (including commercial real estate) and consumer loans were 42.3% and 10.1% respectively during 1999. The consumer portfolio growth occurred in spite of the Company divesting its subsidiary's consumer finance loan portfolio consisting of $1.7 million in outstandings. Residential mortgage loans decreased 5.6% during 1999 as borrowers refinanced out of adjustable rate mortgages early in 1999 to lock in long-term fixed rates. The Company generally sells such loans into the secondary market.
BANK PREMISES AND EQUIPMENT The decrease to $7.1 million as of December 31, 1999 from $7.5 million the previous year-end was the result of depreciation offset partially by the acquisition of new equipment. New equipment purchases totaled $660,000. Most purchases were to replace and upgrade equipment in anticipation of Y2K.
INTANGIBLE ASSETS These assets consist of goodwill and purchase premiums resulting from the purchases of the Rochelle and Belvidere institutions as well as originated mortgage servicing rights. The decrease in intangible assets between December 31, 1999 and December 31, 1998 was primarily the result of the amortization of the purchase-accounting intangible assets.
DEPOSITS Total deposits at December 31, 1999 were $234.1 million. This compares to $241.4 million at December 31, 1998. The Company experienced significant price competition on interest-bearing deposits in several of its markets and elected to shift towards alternative funding sources to attempt to preserve its interest margin. With the exception of money market accounts, the balances in each type of interest-bearing deposit liability decreased during 1999. Pricing pressures continued through the end of 1999 and are expected to persist in the short-term. As a result, time deposits may continue to decline as a percentage of liabilities.
OTHER BORROWINGS The use of alternative funding sources increased during 1999. Other borrowings increased to $35.4 million as of December 31, 1999 compared to $21.7 million as of December 31, 1998. Because of pricing considerations, deposit growth has not been sufficient to fund growth and increases in other borrowings can be expected to continue. The primary source for these borrowings has been, and is expected to continue to be, the Federal Home Loan Bank of Chicago ("FHLB"). Advances from the FHLB as of December 31, 1999 totaled $19.7 million.
ASSET/LIABILITY MANAGEMENT Asset/liability management is the process of identifying, measuring and managing the risk to the Company's earnings and capital resulting from the movements in interest rates. It is the Company's objective to protect earnings and capital while achieving liquidity, profitability and strategic goals.
During 1999 the Company began to focus its measure of interest rate risk on the effect a shift in interest rates would have on earnings rather than on the amount of assets and/or liabilities subject to repricing in a given time period. Since not all assets or liabilities move at the same rate and at the same time, a determination must be made as to how each interest earning asset and each interest bearing liability adjusts with each change in the base rate. The Company develops, evaluates and amends its assumptions on an ongoing basis and analyzes its earnings exposure monthly.
In addition to the effect on earnings, a monthly evaluation is made to determine the change in the economic value of the equity with various changes in interest rates. This determination indicates how much the value of the assets and the value of the liabilities change with a specified change in interest rates. The net of the economic values of the assets and liabilities results in an economic value of equity.
LIQUIDITY Liquidity as it relates to the subsidiary bank is a measure of its ability to fund loans and withdrawals of deposits in a cost-effective manner. The Bank's principal source of funds are deposits, scheduled amortization and prepayment of loan principal, maturities of securities, income from operations, and short-term borrowings. Additional sources include purchasing federal funds, sales of loans, sales of securities, borrowing from the Federal Reserve Bank and the FHLB and capital loans. Current year earnings can be paid to the Bank, from Nevahawk, to provide additional liquidity, without incurring a tax liability under present law.
Generally, the liquidity needs of the Company consist of payment of dividends to its shareholders, the repayment of debt used for the Belvidere acquisition and a limited amount of expenses. The sources of funds to provide this liquidity are income from cash balances, dividends from the Bank and a $2.0 million line of credit with a non-affiliated third-party bank. To date, this line of credit has not been used. Certain restrictions are imposed upon banks, which could limit their ability to pay dividends if they do not generate future net earnings. The Company maintains adequate liquidity to pay its expenses. In addition, the Company may also borrow from external sources leveraging its strong capital base.
CAPITAL Total shareholders equity as of December 31, 1999 was $23.3 million compared to $24.4 million as of December 31, 1998. The decrease primarily resulted from the net decline in the market value of securities available for sale. The capital ratios of the Company are in excess of the regulatory requirements. Core capital as a percent of risk based assets for 1999 is 9.52% compared to a December 31, 1998 ratio of 8.36% and a regulatory requirement of 4.00%. Total capital as a percent of risk based assets for 1999 is 10.61% compared to a December 31, 1998 ratio of 9.31% and a regulatory requirement of 8.00%. The leverage ratio for the Company is 6.10% compared to a December 31, 1998 ratio of 6.00% and a 3.00% regulatory requirement.
IMPACT OF INFLATION AND CHANGING PRICES Unlike most industrial companies, most of the assets and liabilities of the Bank are monetary in nature. Consequently, interest rates have more significant impact on the Company's performance and results of operations than the effect of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services as measured by the Consumer Price Index. As discussed previously under Asset/Liability Management, the Bank's interest rate exposure in conjunction with the direction of the movement in interest rates, is an important factor in the Company's results of operations. The Company's financial statements are prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and
results of operations in terms of historical dollars, without giving consideration to changes in the relative purchasing power of money over time due to inflation.
ACCOUNTING DEVELOPMENTS In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments and for hedging activities. This statement requires and entity to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. The statement is effective for fiscal years beginning after June 15, 2000. Management, at this time, cannot determine the effect adoption of this statement may have on the consolidated financial statements of the Company as the accounting for derivatives is dependent on the amount and nature of derivatives in place at the time of adoption.
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 When used in this report, the words "believes," "expects," and similar expressions are intended to identify forward-looking statements. The Company's actual results may differ materially from those described in the forward-looking statements. Factors which could cause such a variance to occur include, but are not limited to, changes in interest rates, levels of consumer bankruptcies, customer loan and deposit preferences, and other general economic conditions.
ITEM 7
ITEM 7 FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA Incorporated by reference to pages 30 through 49 of this report on Form 10-KSB.
Following are supplemental data tables of the Company: TABLE 1 RATE/VOLUME ANALYSIS
Table 2 ANALYSIS OF LOAN PORTFOLIO
ALLOCATION OF ALLOWANCE FOR LOAN LOSS BY CATEGORY
SUMMARY OF LOAN LOSS EXPERIENCE
Table 2 (Continued)
Table 3 OTHER INCOME AND EXPENSE
Table 4 Three-Year Comparison of Average Balance Sheets
Table 4 (Continued)
Table 5 INVESTMENT SECURITIES
TABLE 6 INVESTMENT SECURITIES
Table 7 MATURITY AND INTEREST SENSITIVITY OF LOANS December 31,1999
Table 8 COMPOSITION OF DEPOSITS AND INTEREST RATES PAID
Table 9 Interest Rate Risk Analysis December 31, 1999
TABLE 10 Short-term Borrowing
Table 10 (Continued)
Table 11 Interest Rate Risk Analysis December 31, 1999
Table 12 Selected Equity Ratios
Table 13 Selected Financial Ratios
ITEM 8
ITEM 8 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable
PART III ITEM 9
ITEM 9 DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
a) Directors of the registrant. The information that will appear under "Election of Directors" in the definitive Proxy Statement to be prepared and filed for the Company's Annual Meeting of Stockholders on May 17, 2000 is incorporated herein by this reference.
b) Executive officers of the Registrant. The information presented in Item I of this report is incorporated herein by this reference.
ITEM 10
ITEM 10 EXECUTIVE COMPENSATION
The information that will appear under "Director and Executive Compensation" in the definitive Proxy Statement to be prepared and filed for the Company's Annual Meeting of Stockholders on May 17, 2000 is incorporated herein by this reference.
ITEM 11
ITEM 11 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information that will appear under "Beneficial Ownership of Securities" in the definitive Proxy Statement to be prepared and filed for the Company's Annual Meeting of Stockholders on May 17, 2000 is incorporated herein by this reference.
ITEM 12
ITEM 12 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information that will appear under "Certain Transactions with Management and Others" in the definitive Proxy Statement to be prepared and filed for the Company's Annual Meeting of Stockholders on May 17, 2000 is incorporated herein by this reference.
ITEM 13
ITEM 13 EXHIBITS AND REPORTS FORM 8-K
a) Documents Filed:
1 and 2. Financial Statements. See the following "Index to Financial Statements," which is incorporated herein by this reference.
3 Exhibits. See "Exhibit Index" which is incorporated herein by this reference.
b) Reports On Form 8-K: There were no reports filed on Form 8-K during the fourth quarter of 1999.
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 on March 30, 2000.
Blackhawk Bancorp, Inc.
By /s/ James P. Kelley ------------------------------------- James P. Kelley Executive Vice President and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated on March 30, 2000.
Principal Executive Officer and Director: Director, President and /s/ Dennis M. Conerton Chief Executive Officer --------------------------------------- Dennis M. Conerton, President and Chief Executive Officer
Principal Financial Officer, Accounting Officer and Director: /s/ Jesse L. Calkins -------------------- Jesse L. Calkins, Senior Vice President Treasurer and Chief Financial Officer
Directors:
/s/ John B. Clark /s/ James P. Kelley - ----------------- ------------------- John B. Clark James P. Kelley
/s/ H. Daniel Green /s/ Fred Klett - ------------------- -------------- Dr. H. Daniel Green Fred Klett
/s/ Charles Hart /s/ George Merchant - ---------------- ------------------- Charles Hart George Merchant
/s/ Kenneth A Hendricks /s/ Roger Taylor - ----------------------- ---------------- Kenneth A. Hendricks Roger Taylor
Blackhawk Bancorp, Inc. Exhibit Index To 1999 Annual Report on Form 10-KSB
BLACKHAWK BANCORP, INC.
Index To Financial Statements And Financial Statement Schedules
The following Consolidated Financial Statements of the Blackhawk Bancorp, Inc. are located in Item 7 of this 10-KSB. 10-KSB page as indicated:
Annual Report Pages -------------
Report of Independent Public Accountants.................................30
Consolidated Balance Sheets - December 31, 1999 and 1998 ..............................................................31
Consolidated Statements of Income for the years ended December 31, 1999, 1998 and 1997 ......................................32
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1999, 1998 and 1997.......................33
Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997 ................................34 Notes to the Consolidated Financial Statements...........................36-49
BLACKHAWK BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL REPORT
DECEMBER 31, 1999
INDEPENDENT AUDITOR'S REPORT
Board of Directors and Shareholders Blackhawk Bancorp, Inc. Beloit, Wisconsin
We have audited the accompanying consolidated balance sheets of Blackhawk Bancorp, Inc. and Subsidiary as of December 31, 1999 and 1998, and the related consolidated statements of income, shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements of Blackhawk Bancorp, Inc. and Subsidiary for the year ended December 31, 1997, was audited by other auditors whose report dated February 20, 1998, expressed an unqualified opinion on those statements.
We conducted our audits in accordance with generally accepted auditing standards. 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 1999 and 1998 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Blackhawk Bancorp, Inc. and Subsidiary at December 31, 1999 and 1998, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.
/s/ Wipfli Ullrich Bertelson LLP
Wipfli Ullrich Bertelson LLP February 4, 2000 Green Bay, Wisconsin
BLACKHAWK BANCORP, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1999 AND 1998
See Notes to Consolidated Financial Statements
BLACKHAWK BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
See Notes to Consolidated Financial Statements
BLACKHAWK BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
See Notes to Consolidated Financial Statements
BLACKHAWK BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
See Notes to Consolidated Financial Statements
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements conform to generally accepted accounting principles and to general practices within the banking industry. The following is a description of the more significant accounting policies:
NATURE OF BANKING ACTIVITIES:
The Company provides a variety of banking services to individuals and businesses through its eleven facilities in Beloit, Wisconsin and Belvidere, Rockford, Roscoe, Oregon and Rochelle, Illinois. Its primary deposit products are demand deposits, savings, and certificates of deposit and its primary lending products are commercial, real estate mortgage and installment loans.
As of December 31, 1999 and 1998, 71% and 74%, respectively, of the gross loan portfolio consisted of real estate loans on real estate located in Southcentral Wisconsin and Northcentral Illinois. Generally, these loans are expected to be repaid from the cash flows of the borrowers and are collateralized by the related property. Credit losses arising from real estate lending transactions compare favorably with Blackhawk's credit loss experience on its loan portfolio as a whole. However, adverse changes in the local economy would have a direct impact on the credit risk in the loan portfolio.
PRINCIPLES OF CONSOLIDATION:
The accompanying consolidated financial statements include the accounts of Blackhawk Bancorp, Inc. and its wholly owned subsidiary, Blackhawk State Bank (Blackhawk) and Blackhawk's wholly owned subsidiaries Nevahawk Investment, Inc., RSL, Inc., and First Financial Services, Inc. RSL, Inc. includes the accounts of its wholly owned subsidiary Midland Acceptance Corporation. All significant intercompany transactions and accounts have been eliminated in consolidation.
On September 1, 1998, the Company acquired for cash all of the outstanding shares of First Financial Bancorp, Inc. and its wholly-owned subsidiaries. The total acquisition cost was $12,690,000. The excess of the total acquisition cost over the fair value of the net assets acquired of $2,951,000 is being amortized over 20 years by the straight-line method. The acquisition has been accounted for as a purchase and the results of operations of First Financial since the date of acquisition are included in the Consolidated Financial Statements. The assets of First Financial were subsequently merged into the Company.
The unaudited proforma effect of the transaction had it occurred prior to 1997 is as follows: (dollars in thousands, except per share information)
USE OF ESTIMATES:
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
RECLASSIFICATIONS:
Certain reclassifications have been made to the 1998 and 1997 historical financial statements to conform to the 1999 presentation.
STATEMENTS OF CASH FLOWS:
For the purpose of reporting cash flows, cash and cash equivalents includes cash on hand and amounts due from banks (including cash items in process of clearing). Cash flows from interest-bearing deposits, federal funds sold, and other short-term investments with an original maturity of less than three months and loans, deposits, and short-term borrowings are reported net under general practices within the banking industry.
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SECURITIES AVAILABLE-FOR-SALE:
Securities classified as available-for-sale are those debt securities that the Company intends to hold for an indefinite period but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities available-for-sale are carried at fair value. Unrealized holding gains and losses on securities available-for-sale are reported as accumulated other comprehensive income within shareholders' equity until realized. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings.
SECURITIES HELD-TO-MATURITY:
Securities classified as held-to-maturity are those debt securities the Company has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for amortization of premium and accretion of discount, computed by the interest method over their contractual lives.
LOANS:
Loans are stated at unpaid principal balances, less the allowance for loan losses and net of deferred loan fees.
Mortgage loans held for sale are recorded at the lower of cost or fair market value. Gains and losses on the sale of mortgage loans are included in other non-interest income.
The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent it is received in cash.
The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values (or the present value of estimated cash flows). Because of uncertainties inherent in the estimation process, management's estimate of credit losses inherent in the loan portfolio and the related allowance may change materially in the near term. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses.
SALES OF FIRST MORTGAGE LOANS AND LOAN SERVICING:
The Company sells first mortgage loans with yield rates to the buyer based upon the current market rates, which may differ from the contractual rate on the loans sold. At the time that loans are sold, a gain or loss is recorded which reflects the difference between the assumed cash flow to be generated by the contractual interest rates of the loans sold and the assumed cash flow resulting from the yield to be paid to the purchaser, adjusted for servicing and discounted to reflect present value. Loan servicing fees are recognized over the lives of the related loans. Real estate loans serviced for others are not included in the accompanying balance sheets.
MORTGAGE SERVICING RIGHTS:
The Company capitalizes the estimated value of mortgage servicing rights through the origination and sale of mortgage loans. When the originated mortgage loans are sold or securitized into the secondary market, the Company allocates the total cost of the mortgage loans between mortgage servicing rights and the loans, based on their relative fair values. The cost of mortgage servicing rights is amortized in proportion to, and over the period of, estimated net servicing revenues. 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 and term. Impairment represents the excess of carrying value of a stratified pool over its fair value, and is recognized 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, to change significantly in the future.
PREMISES AND EQUIPMENT:
Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed principally on a straight-line basis over the estimated useful life of each asset. Expenditures for maintenance and repairs are reflected as expense when incurred. Gains or losses on disposition of premises and equipment are reflected in income.
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OTHER REAL ESTATE:
Other real estate is carried in other assets at the lower of cost or fair value less estimated disposal costs. When the property is acquired through foreclosure, any excess of the related loan balance over market value is charged to the allowance for loan losses. It is Blackhawk's policy to account for collateral that has been substantively repossessed in the same manner as collateral that has been formally repossessed. Subsequent write-downs or losses upon sale are charged to other operating expense.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE:
The Bank enters into sales of securities under agreements to repurchase (reverse-repurchase agreements). Reverse-repurchase agreements are treated as financings, and the obligations to repurchase securities sold are reflected as a liability in the balance sheets. The securities underlying the agreements remain in the asset accounts.
TRUST ASSETS:
Assets held in a fiduciary or agency capacity are not included in the consolidated financial statements as they are not assets of Blackhawk.
INCOME TAXES:
The Company, Blackhawk and Blackhawk's subsidiaries file a consolidated federal income tax return and separate state income tax returns.
Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
EARNINGS PER SHARE DATA:
The per share data is based on the weighted average number of common stock and common stock equivalents outstanding during each year.
COMPREHENSIVE INCOME:
Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale which are recognized as a separate component of equity, accumulated other comprehensive income (deficit).
FUTURE ACCOUNTING CHANGE
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments and for hedging activities. This statement requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. This statement is effective for fiscal years beginning after June 15, 2000. Management, at this time, cannot determine the effect adoption of this statement may have on the consolidated financial statements of the Company as the accounting for derivatives is dependent on the amount and nature of derivatives in place at the time of adoption.
NOTE 2. RESTRICTIONS ON CASH AND CASH EQUIVALENT
Cash and cash equivalents in the amount of $500,000 were restricted at December 31, 1999 and 1998, to meet the reserve requirements of the Federal Reserve System.
NOTE 3. SECURITIES
Debt securities have been classified in the balance sheets according to management's intent as either available for sale or held-to-maturity. The carrying amount of securities and their estimated fair values at December 31, is as follows:
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
NOTE 3. SECURITIES (CONTINUED)
AVAILABLE-FOR-SALE SECURITIES:
The amortized cost and fair value of securities as of December 31, 1999, by contractual maturity, are shown below. Maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be called or prepaid without any penalties. Therefore, these securities are not included in the maturity categories in the following maturity summary:
Fair values of many securities are estimates based on financial methods or prices paid for similar securities. It is possible interest rates could change considerable resulting in a material change in the estimated fair value.
Realized gains and losses on sales of securities available-for-sale totaled $69,000 and $0, respectively in 1999. There were no realized gains or losses on securities available-for-sale for 1998 and 1997.
Investment securities with an amortized cost of $28,447,000 in 1999 and $19,941,000 in 1998 and a fair value of $27,697,000 in
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
NOTE 3. SECURITIES (CONTINUED)
1999 and $20,059,000 in 1998, respectively, were pledged to secure public deposits, short-term borrowings, and other purposes required by law as of December 31.
NOTE 4. LOANS
The composition of the loan portfolio is as follows:
Non-performing loans include loans which have been categorized by management as impaired and non-accruing because collection of interest is not assured, non-accruing loans (not considered impaired loans) and loans which are past-due ninety days or more as to interest and/or principal payments. The following summarizes information concerning nonperforming loans:
The average balance of loans classified as impaired totaled approximately $2,716,000 and $634,000 for the years ended December 31, 1999 and 1998, respectively. The allowance for loan losses related to impaired loans amounted to approximately $0 and $100,000 at December 31, 1999 and 1998, respectively.
The Company has no commitments to loan additional funds to the borrowers of nonperforming loans for the years ended December 31, 1999 and 1998.
The effect on interest income of the non-accruing loans is as follows:
Loans are made, in the normal course of business, to directors, executive officers, their immediate families and affiliated companies in which they are a principal shareholder (commonly referred to as related parties). The terms of these loans, including interest rates and collateral, are similar to those prevailing for comparable transactions and management believes they do not involve more than a normal risk of collectibility. Such direct and indirect loans are summarized as follows:
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
NOTE 4. LOANS (CONTINUED)
In addition, the Company has loan commitments to the aforementioned related parties of $3,303,000 and $2,754,000 as of December 31, 1999 and 1998, respectively.
NOTE 5. MORTGAGE SERVICING RIGHTS:
The unpaid principal balance of mortgage loans serviced for others, which are not included on the consolidated balance sheets, were $127,139,000 and $132,691,000 at December 31, 1999 and 1998, respectively. The carrying value of the mortgage servicing rights is included with intangible assets and approximates fair market value at December 31, 1999 and 1998.
The following is an analysis of the activity for mortgage servicing rights for the years ended December 31.
NOTE 6. PREMISES AND EQUIPMENT
A summary of premises and equipment is as follows:
Depreciation charged to operating expenses was $733,000, $433,000, and $336,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
NOTE 7. DEPOSITS
Deposit accounts at December 31 are summarized as follows:
The aggregate amount of short-term jumbo CDs, each with a minimum denomination of $100,000, was approximately $27,312,000 and $17,470,000 in 1999 and 1998, respectively. Interest expense on time deposits of $100,000 or more was approximately $1,263,000, $724,000 and $389,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
At December 31, 1999, the scheduled maturities of CDs are as follows:
NOTE 8. BORROWED FUNDS
A summary of borrowed funds is as follows:
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
NOTE 8. BORROWED FUNDS (CONTINUED)
The scheduled principal maturities of borrowed funds at December 31, 1999 are as follows:
The term loan consists of a $5,353,000 loan with a fixed interest rate of 6.60% and a variable portion of $1,800,000 with a current rate of 7.96%. The loan requires quarterly principal and interest payments of $225,000 on the fixed portion and quarterly interest only payments on the variable portion. The total loan matures August 21, 2003. Collateral for this loan consists of the stock of the Bank.
A covenant placed upon the Company includes limitations on further mergers without consent of the lender. The lender could also immediately call the loan if the Bank's aggregate outstanding balance of classified assets exceeds 50% of primary capital, if the Bank's tangible capital were less than 5% of total tangible assets, if the Bank's non-performing assets were greater than 25% of primary capital or if the total equity of the Bank were less than $30 million.
The Federal Home Loan Bank Open Line of Credit is an overnight line of credit with rates determined daily. At December 31, 1999, the rate was 4.74% All advances from the Federal Home Loan Bank of Chicago, both term and open line of credit, are collateralized by substantially all one-to-four family real estate loans and Federal Home Loan Bank stock.
NOTE 9. EMPLOYEE BENEFIT PLANS
PENSION AND 401(K) PLANS:
Blackhawk had a noncontributory, defined contribution money-purchase pension plan covering substantially all of its employees until January 1, 1999. Blackhawk contributed, on behalf of the eligible employees, 4.2% of total annual compensation plus 4.2% of compensation in excess of $13,200. Effective January 1, 1999, Blackhawk amended and restated its pension plan to a profit-sharing plan with a 401(k) provision. Rochelle and Belvidere had existing profit-sharing plans, which meet the qualifications of Section 401(k) of the Internal Revenue Code (Code). Effective January 1, 1999 both of these plans were amended and merged into Blackhawk's plan that went into effect January 1, 1999. Under the amended plans, eligible employees are allowed to make voluntary contributions to the plan. Blackhawk makes a matching contribution of 25% of the first 6% of an employee's compensation that they voluntarily contribute. Additionally, Blackhawk may make a discretionary profit sharing contribution. The total expenses for these plans were $146,000, $135,000 and $114,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
EXECUTIVE BONUS PLAN:
The Company has adopted a revised incentive bonus plan for officers providing cash bonuses based upon the financial performance of the Company and performance of the respective officers. Bonus compensation expense was $32,000, $92,000 and $127,000 for the years 1999, 1998 and 1997, respectively.
STOCK OPTION PLANS:
The Company has reserved shares of common stock for issuance to directors and key employees under incentive and non-qualified stock option plans. Options are granted at prices equal to the fair market value and 90% of the fair market value on the dates of grant for directors and key employees, respectively, and are exercisable in cumulative installments over a three year period. Other pertinent information related to the plans is as follows:
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
NOTE 9. EMPLOYEE BENEFIT PLANS (CONTINUED)
Compensation expense related to granting compensatory employee stock options totaled $0, ($1,000), and $36,000 in 1999, 1998 and 1997, respectively.
The Company applies APB Opinion No. 25 in accounting for its stock options. Had compensation costs been determined on the basis of fair value pursuant to FASB Statement No. 123, net income and earnings per share would have been reduced as follows:
The fair value of each stock option grant has been estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
EMPLOYEE STOCK OWNERSHIP PLAN:
The Company has an Employee Stock Ownership Plan for the benefit of employees who meet the eligibility requirements. The Plan was established in 1990. The Plan held 77,530 shares of the Company's common stock, as of December 31, 1999, in a trust established in Blackhawk. The stock was acquired by the Plan by using the proceeds from a loan obtained from a nonrelated commercial lender. The loan was collateralized by the stock which had not been allocated to individual participant accounts. In addition, the Company guaranteed this obligation. Cash payments to the Plan consist of contributions and dividend payments, in
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
NOTE 9. EMPLOYEE BENEFIT PLANS (CONTINUED)
amounts sufficient for it to satisfy the debt service requirements. Accordingly, the debt has been recorded in the accompanying consolidated balance sheets together with the related deferred compensation. The debt and deferred compensation are reduced as the Plan makes principal payments.
The loan required principal payments of $13,000, plus interest each quarter and was paid in full at December 31, 1997.
Cash payments to the Plan during the years ended December 31, 1999, 1998 and 1997 consisted of the following:
For financial statement purposes, expense for the Plan is determined based on the percentage of shares allocated to participants each period (allocations are based on principal and interest payments) times the original amount of the debt plus the interest incurred. The components of the amount charged to expense for the years ended December 31, 1999, 1998 and 1997 are as follows:
In accordance with the applicable federal income tax regulations, Blackhawk is expected to honor the rights of certain participants to diversify their vested account balances or to liquidate their vested ownership of the stock in the event of employment termination. The purchase price of the stock is based on the market value. In addition, the deferred compensation recorded in connection with the debt incurred by the Plan has been offset against the stock.
DEFERRED COMPENSATION PLAN:
As a result of acquisitions, Blackhawk assumed deferred compensation agreements with certain officers of Rochelle and Belvidere. Amounts are accumulated in an account from which benefits will be paid to the officers at termination or retirement. As of December 31, 1999 and 1998 deferred compensation liability totaled $296,000 and $273,000, respectively.
The agreements also provide for an acceleration of benefits upon the deaths of these officers, payable to their beneficiaries. Blackhawk has purchased life insurance policies on the lives of the officers in order to fund the acceleration of benefits at death. Blackhawk is owner and beneficiary of these policies which provide for death benefits totaling $1,307,000 and $1,307,000 as of December 31, 1999 and 1998, respectively. These policies have a cash surrender value of $596,000 and $583,000 as of December 31, 1999 and 1998.
NOTE 10. INCOME TAXES
Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. The major components of net deferred tax assets at December 31 are as follows:
The provision for income taxes consists of the following:
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
NOTE 10. INCOME TAXES (CONTINUED)
A summary of the source of differences between income taxes at the federal statutory rate and the provision for income taxes for the years ended December 31 follows:
NOTE 11. ACCUMULATED OTHER COMPREHENSIVE INCOME
Comprehensive income is shown in the statement of changes in shareholders' equity. The Company's accumulated other comprehensive income is comprised of the unrealized gain or loss on securities available for sale. The following shows the activity in accumulated other comprehensive income:
NOTE 12. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company is a party to financial instruments with off-balance-sheet risk, acquired in the normal course of business to meet the financing needs of its customers. These financial instruments include various commitments to extend credit and standby letters of credit. These instruments involve, to a varying degree, elements of credit risk in excess of the amount recognized in the balance sheet. The contract amounts of these instruments reflect the extent of involvement Company has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Company holds collateral supporting those commitments for which collateral is deemed necessary. Because these instruments have fixed maturity dates and many of them expire without being drawn upon, they do not generally present any significant liquidity risk to the Company.
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
The Company frequently enters into loan sale commitments prior to closing loans in order to limit interest rate risk for the period of time between when a loan is committed and when it is sold. These sale commitments are typically made on a loan by loan basis.
A summary of the amount of Company's exposure to credit loss for loan commitments (unfunded loans and unused lines of credit) and standby letters of credit outstanding at December 31, 1999 and 1998 was as follows:
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 may require payment of a fee. Since the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by Company upon extension of credit, is based on management's credit evaluation. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, income-producing commercial properties and real estate.
NOTE 13. LEASE COMMITMENTS
The Bank leases two branch office locations in Beloit, Wisconsin. The first is currently month-to-month and the other expires in July 2002. The leases can be renewed for an additional five years. Should the Bank not renew the leases, it could be liable for remodeling or removal costs to the leased office spaces if the leases are terminated before the 14th year of the agreements, 2010 and 2012, respectively. The lease that expired in November 1999 has been extended on a month-to-month basis with a 120-day notice of termination by either party.
The Bank also leases an office in Roscoe, Illinois under an operating lease expiring in December 2002. The lease is subject to inflationary adjustments after three years of occupancy. In addition, the Bank is obligated to pay a portion of the real estate taxes, insurance, and common area maintenance.
The Bank leases an administration office in Belvidere, Illinois under a lease expiring in April 2000.
The total minimum rental commitment under the leases at December 31, 1999 is as follows:
Total rent expense for the years ended December 31, 1999, 1998 and 1997 was $108,000, $92,000, and $49,000, respectively.
NOTE 14. EARNINGS PER SHARE
Basic earnings per share are arrived at by dividing net income available to common shareholders by the weighted-average number of common shares outstanding and do not include the impact of any potentially dilutive common stock equivalents. The diluted earnings per share calculation is arrived at by dividing net income by the weighted-average number of shares outstanding, adjusted for the dilutive effect of outstanding stock options, and any other common stock equivalents. The following table shows the computation of the basic and diluted earnings per share:
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
NOTE 15. SEGMENT INFORMATION
The Company, through the branch network of its subsidiary, Blackhawk, provides a full range of consumer and commercial banking services to individuals, businesses, and farms in southern Wisconsin and northern Illinois. These services include demand, time and savings deposits; safe deposit services; credit cards; secured and unsecured consumer, commercial, and real estate loans; ATM processing; cash management; and trust services. While the Company's chief decision makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the Company's banking operations are considered by management to be aggregated in one reportable operating segment.
NOTE 16. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash, cash equivalents, interest-bearing deposit accounts and federal funds sold: For these short-term instruments, the carrying amount is a reasonable estimate of fair value.
Securities: For securities, fair value equals quoted market price, where available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans receivable: The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings for the same remaining maturities.
Deposits: The fair value of demand deposits and savings accounts is the amount payable at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.
Short-term and long-term borrowings: The carrying amounts of variable-rate borrowings and notes payable approximate their fair values. The fair value of fixed rate borrowings is estimated using rates currently available for debt with similar terms and remaining maturities.
Off-balance sheet financial instruments: The fair value of off-balance sheet instruments was estimated based on the amount the Company would pay to terminate the contracts or agreements, using current rates and, when appropriate, the current creditworthiness of the customer.
The estimated fair values of the Company's financial instruments are as follows:
Limitations: Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters that could affect the estimates. Fair value estimates are based on existing on-and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Deposits with no stated maturities are defined as having a fair value equivalent to the amount payable on demand. This prohibits adjusting fair value derived from retaining those deposits for an expected future period of time. This component, commonly referred to as a deposit base intangible, is neither considered in the above amounts nor is it recorded as an intangible asset on the balance sheet. Significant assets and liabilities that are not considered financial assets and liabilities include premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates. With respect to off-balance sheet instruments, the amounts were deemed immaterial and therefore no fair values are presented.
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
NOTE 17. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company and the Bank's financial statements. Under capital adequacy guidelines and regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgements by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total capital and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and the Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1999, that the Company and the Bank meet all capital adequacy requirements to which it is subject.
As of December 31, 1999, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believe have changed the Company and the Bank's category.
The actual capital amounts and ratios as of December 31, are also presented in the table (in thousands).
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
NOTE 18. CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED PARENT COMPANY BALANCE SHEETS:
CONDENSED PARENT COMPANY STATEMENTS OF INCOME:
CONDENSED PARENT COMPANY STATEMENTS OF CASH FLOWS:
BLACKHAWK BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999
CONDENSED PARENT COMPANY STATEMENTS OF CASH FLOWS: (CONTINUED)