FORM 10-QSB
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ---- TO ----
COMMISSION FILE NUMBER 0-18599
BLACKHAWK BANCORP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WISCONSIN 39-1659424
(STATE OR OTHER JURISDICTION OF (I. R. S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
400 BROAD STREET
BELOIT, WISCONSIN 53511
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(608) 364-8911
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NOT APPLICABLE
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST
REPORT)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.
YES X NO
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
OUTSTANDING AT
CLASS OF COMMON STOCK NOVEMBER 7, 2003
--------------------- ----------------
$.01 PAR VALUE 2,522,995 SHARES
INDEX
PART I - FINANCIAL INFORMATION
Page
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ITEM 1. FINANCIAL STATEMENTS
Unaudited Consolidated Balance Sheets as of
September 30, 2003 and December 31, 2002 4
Unaudited Consolidated Statements of Income for the
Three Months Ended September 30, 2003 and 2002 5
Unaudited Consolidated Statements of Income for the
Nine Months Ended September 30, 2003 and 2002 6
Unaudited Consolidated Statements of Stockholders'
Equity for the Nine Months Ended September 30, 2003 and 2002 7
Unaudited Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2003 and 2002 8-10
Notes to Unaudited Consolidated Financial Statements 11-16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION 17-29
ITEM 3. CONTROLS AND PROCEDURES 29
PART II - OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS 30
ITEM 2 CHANGES IN SECURITIES 30
ITEM 3 DEFAULTS UPON SENIOR SECURITIES 30
ITEM 4 SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS 30
ITEM 5 OTHER INFORMATION 30
ITEM 6 A) EXHIBITS 30
B) REPORTS ON FORM 8-K 30
SIGNATURES 31
INDEX TO EXHIBITS 32
BLACKHAWK BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
(Dollars in thousands)
ASSETS
------
Cash and due from banks $ 17,252 $ 12,572
Federal funds sold and securities purchased under agreements to resell 9,572 13,120
Interest-bearing deposits in banks 3,679 8,472
Available-for-sale securities 108,917 83,897
Held to maturity securities, at amortized cost 18,691 23,002
Loans, less allowance for loan losses of $3,305 and $2,079
at September 30, 2003 and December 31, 2002, respectively 241,187 186,300
Office buildings and equipment, net 9,769 6,770
Intangible assets 7,363 4,598
Other assets 15,390 13,646
-------- --------
Total Assets $431,820 $352,377
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
LIABILITIES:
Deposits:
Noninterest-bearing $ 48,423 $ 35,274
Interest-bearing 268,757 227,811
-------- --------
Total deposits 317,180 263,085
Short-term borrowings 18,485 13,454
Long-term borrowings 58,596 38,900
Company Obligated Mandatorily Redeemable Preferred Securities
of subsidiary trust holding solely subordinated debentures 7,000 7,000
Other liabilities 4,723 4,140
-------- --------
Total Liabilities 405,984 326,579
-------- --------
STOCKHOLDERS' EQUITY:
Preferred stock
1,000,000 shares, $.01 par value per share
authorized, none issued or outstanding -- --
Common stock
10,000,000 shares, $.01 par value per share authorized,
shares issued and outstanding: 2,522,995 at September 30, 2003, 2,507,065
at December 31, 2002 25 25
Surplus 8,818 8,698
Retained earnings 16,073 15,788
Accumulated other comprehensive income 920 1,287
-------- --------
Total Stockholders' Equity 25,836 25,798
-------- --------
Total Liabilities and Stockholders' Equity $431,820 $352,377
-------- --------
-------- --------
See Notes to Unaudited Consolidated Financial Statements
BLACKHAWK BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED SEPTEMBER 30,
2003 2002
---- ----
(Dollars in thousands,
except per share data)
INTEREST INCOME:
Interest and fees on loans $2,993 $3,608
Interest and dividends on securities:
Taxable 745 946
Nontaxable 286 210
Interest on fed funds sold and securities purchased under
agreements to resell 5 59
Interest on interest-bearing deposits in banks 14 6
------ ------
Total Interest Income 4,043 4,829
------ ------
INTEREST EXPENSE:
Interest on deposits 1,180 1,459
Interest on short-term borrowings 20 89
Interest on long-term borrowings 549 533
Interest on Company Obligated Mandatorily Redeemable
Preferred Securities 102 --
------ ------
Total Interest Expense 1,851 2,081
------ ------
Net Interest Income 2,192 2,748
Provision for loan losses 142 422
------ ------
Net Interest Income after Provision for Loan Losses 2,050 2,326
------ ------
NONINTEREST INCOME:
Service charges on deposit accounts 372 396
Gain on sale of loans 158 95
Securities gains, net 50 --
Other 247 210
------ ------
Total Noninterest Income 827 701
------ ------
NONINTEREST EXPENSES:
Salaries and employee benefits 1,322 1,233
Occupancy 172 193
Equipment 202 225
Data processing services 221 184
Advertising and marketing 47 93
Amortization of intangibles 79 78
Professional fees 92 116
Office supplies 69 63
Telephone 79 77
Transportation and postage 105 101
Other 281 277
------ ------
Total Noninterest Expenses 2,669 2,640
------ ------
Income before Income Taxes 208 387
Income Taxes (Benefit) (30) 85
------ ------
Net Income $ 238 $ 302
------ ------
------ ------
Basic Earnings Per Share $ 0.09 $ 0.12
------ ------
------ ------
Diluted Earnings per Share $ 0.09 $ 0.12
------ ------
------ ------
Dividends Per Share $ 0.09 $ 0.09
------ ------
------ ------
See Notes to Unaudited Consolidated Financial Statements
BLACKHAWK BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
NINE MONTHS ENDED SEPTEMBER 30,
2003 2002
---- ----
(Dollars in thousands,
except per share data)
INTEREST INCOME:
Interest and fees on loans $ 9,261 $11,188
Interest and dividends on securities:
Taxable 2,602 2,559
Nontaxable 821 627
Interest on fed funds sold and securities purchased under
agreements to resell 54 109
Interest on interest-bearing deposits in banks 31 40
------- -------
Total Interest Income 12,769 14,523
------- -------
INTEREST EXPENSE:
Interest on deposits 3,676 4,567
Interest on short-term borrowings 96 184
Interest on long-term borrowings 1,584 1,652
Interest on Company Obligated Mandatorily Redeemable
Preferred Securities 265 --
------- -------
Total Interest Expense 5,621 6,403
------- -------
Net Interest Income 7,148 8,120
Provision for loan losses 508 683
------- -------
Net Interest Income after Provision for Loan Losses 6,640 7,437
------- -------
NONINTEREST INCOME:
Service charges on deposit accounts 1,072 1,142
Gain on sale of loans 459 221
Securities gains, net 475 229
Other 739 621
------- -------
Total Noninterest Income 2,745 2,213
------- -------
NONINTEREST EXPENSES:
Salaries and employee benefits 4,140 3,964
Occupancy 541 641
Equipment 663 654
Data processing services 619 570
Advertising and marketing 254 256
Amortization of intangibles 238 232
Professional fees 393 412
Office supplies 186 188
Telephone 232 227
Transportation and postage 317 282
Other 805 834
------- -------
Total Noninterest Expenses 8,388 8,260
------- -------
Income before Income Taxes 997 1,390
Income Taxes 31 341
------- -------
Net Income $ 966 $ 1,049
------- -------
------- -------
Basic Earnings Per Share $ 0.38 $ 0.43
------- -------
------- -------
Diluted Earnings per Share $ 0.38 $ 0.43
------- -------
------- -------
Dividends Per Share $ 0.27 $ 0.27
------- -------
------- -------
See Notes to Unaudited Consolidated Financial Statements
BLACKHAWK BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30,
2003 2002
---- ----
(Dollars in thousands)
Common Stock:
Balance at beginning of period $ 25 $ 24
Stock options exercised -- 1
------- -------
Balance at end of period 25 25
------- -------
Surplus:
Balance at beginning of period 8,698 7,555
Stock options exercised 120 1,152
Sale of treasury stock -- (7)
------- -------
Balance at end of period 8,818 8,700
------- -------
Retained Earnings:
Balance at beginning of period 15,788 15,447
Net income 966 1,049
Dividends declared on common stock (681) (669)
------- -------
Balance at end of period 16,073 15,827
------- -------
Treasury Stock, at cost:
Balance at beginning of period -- (58)
Sale of treasury stock -- 48
------- -------
Balance at end of period -- (10)
------- -------
Accumulated other comprehensive income:
Balance at beginning of period 1,287 773
Other comprehensive income (loss):
Change in net unrealized gains on
available-for-sale securities (457) 1,079
Change in net unrealized gains on
interest rate SWAP contract 325 --
Reclassification adjustment for securities
gains included in net income (475) (229)
Income tax effects 240 (321)
------- -------
Balance at end of period 920 1,302
------- -------
Total Stockholders' Equity $25,836 $25,844
------- -------
------- -------
See Notes to Unaudited Consolidated Financial Statements
BLACKHAWK BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30,
2003 2002
---- ----
(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 966 $ 1,049
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 931 939
Provision for loan losses 508 683
Gain on sale of loans (459) (221)
FHLB stock dividends (202) (92)
Amortization of premiums on securities, net 744 105
Securities gains, net (475) (229)
Decrease (increase) in accrued interest receivable 201 (22)
Decrease in accrued interest payable (44) (182)
Decrease (increase) in other assets (503) 549
Decrease in other liabilities (631) (182)
-------- --------
Net cash provided by operations before
loan originations and sales 1,036 2,397
Origination of loans for sale (24,385) (18,094)
Proceeds from sale of loans 26,550 18,468
-------- --------
Net cash provided by operating activities 3,201 2,771
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease in interest-bearing deposits in banks 6,184 7,521
Net decrease in federal funds sold and securities
purchased under agreements to resell 13,120 12,409
Proceeds from sales of available-for-sale securities 33,631 8,523
Proceeds from maturities and calls of available-for-sale securities 34,096 7,886
Proceeds from maturities and calls of held-to-maturity securities 4,553 2,914
Purchase of available-for-sale securities (82,773) (46,757)
Purchase of held-to-maturity securities (284) (3,522)
Net decrease (increase) in loans (11,481) 16,547
Purchase of bank owned life insurance -- (5,000)
Net cash used in acquisition (4,533) --
Proceeds from the sale of office buildings, equipment, and
other real estate owned 369 430
Purchase of office buildings and equipment, net (910) (669)
-------- --------
Net cash provided by (used in) investing activities (8,028) 282
-------- --------
See Notes to Unaudited Consolidated Financial Statements
BLACKHAWK BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
NINE MONTHS ENDED SEPTEMBER 30,
2003 2002
---- ----
(Dollars in thousands)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in deposits $(10,141) $ (9,654)
Dividends paid (679) (657)
Proceeds from other borrowings 15,500 --
Payments on other borrowings (300) (12,488)
Net increase in short-term borrowings 5,030 18,281
Proceeds from exercise of stock options 97 1,153
Sale of treasury stock -- 41
-------- --------
Net cash provided by (used in) financing activities 9,507 (3,324)
-------- --------
Net increase (decrease) in cash and due from banks 4,680 (271)
CASH AND DUE FROM BANKS:
Beginning 12,572 11,746
-------- --------
Ending $ 17,252 $ 11,475
-------- --------
-------- --------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid (refunded) during the period for:
Interest $ 5,688 $ 6,586
Income taxes $ (21) $ (50)
SUPPLEMENTAL SCHEDULES OF NON-CASH INVESTING
ACTIVITIES:
Change in accumulated other comprehensive income:
Unrealized gains (losses) on available-for-sale securities, net $ (581) $ 529
Unrealized gains (losses) on interest rate SWAP contract, net $ 214 $ --
Other assets acquired in settlement of loans $ 273 $ 335
See Notes to Unaudited Consolidated Financial Statements
BLACKHAWK BANCORP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
SUPPLEMENTAL SCHEDULES OF NON-CASH INVESTING ACTIVITIES
(CONTINUED):
Acquisition of DunC Corp.
Assets acquired:
Cash and due from banks $ 2,686
Federal funds sold 9,572
Interest-bearing deposits in banks 1,391
Available-for-sale securities 11,104
Loans 45,892
Office buildings and equipment, net 2,741
Intangible assets 3,069
Other assets 1,271
-------
Total assets $77,726
-------
Liabilities assumed:
Deposits $64,237
Borrowings 3,631
Other liabilities 1,401
-------
Total liabilities $69,269
-------
Net assets acquired $ 8,457
-------
-------
Cash paid $ 7,223
-------
Cash acquired:
DunC Corp. 4
First Banc bc 2,686
-------
Total cash received $ 2,690
-------
Net cash used in acquisition $ 4,533
-------
-------
See Notes to Unaudited Consolidated Financial Statements
BLACKHAWK BANCORP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
Note 1. General:
The unaudited consolidated financial statements include the accounts of
Blackhawk Bancorp, Inc. and its subsidiaries. Effective September 30,
2003, Blackhawk Bancorp, Inc. acquired the assets of DunC Corp and its
subsidiary, First Bank bc., in a transaction accounted for as a
purchase. The assets and liabilities of those acquired companies have
been included in the September 30, 2003 Unaudited Consolidated Balance
Sheet of Blackhawk Bancorp, Inc.
In the opinion of management, all adjustments (consisting only of
normal recurring adjustments) necessary for a fair presentation of the
financial position, results of operation and cash flows for the interim
periods have been made. The results of operations for the nine months
ended September 30, 2003 are not necessarily indicative of the results
to be expected for the entire fiscal year.
The unaudited interim financial statements have been prepared in
conformity with accounting principles generally accepted in the United
States of America and industry practice. Certain information in
footnote disclosure normally included in financial statements prepared
in accordance with accounting principles generally accepted in the
United States of America and industry practice has been condensed or
omitted pursuant to rules and regulations of the Securities and
Exchange Commission. The more significant policies used by the Company
in preparing and presenting its financial statements are stated in the
Corporation's Form 10-KSB. These financial statements should be read in
conjunction with the consolidated financial statements and notes
thereto included in the Company's December 31, 2002 audited financial
statements.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions which affect the reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities as of the date of the financial statements, as well as
the reported amounts of income and expenses during the reported
periods. Actual results could differ from those estimates.
Certain reclassifications have been made to the 2002 historical
financial statements to conform to the 2003 presentation.
Stock-Based Compensation Plan: At September 30, 2003, the Company had
-----------------------------
a stock-based director, key officer and employee compensation plan.
The Company accounts for this plan under the recognition and
measurement principles of APB Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations. No stock-based
employee compensation cost is reflected in income, as all options
granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of grant. The table
on the following page illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition
provisions of Financial Accounting Standards Board (FASB) Statement No.
123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
(Dollars in thousands, except per share data) Three Months Ended
September 30,
2003 2002
---- ----
Net income, as reported $ 238 $ 302
Deduct total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects (29) (19)
----- -----
PRO FORMA NET INCOME $ 209 $ 283
----- -----
----- -----
Earnings per share:
Basic:
As reported $0.09 $0.12
Pro forma 0.08 0.11
Diluted:
As reported 0.09 0.12
Pro forma 0.08 0.11
(Dollars in thousands, except per share data) Nine Months Ended
September 30,
2003 2002
---- ----
Net income, as reported $ 966 $1,049
Deduct total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects (71) (56)
----- ------
PRO FORMA NET INCOME $ 895 $ 993
----- ------
----- ------
Earnings per share:
Basic:
As reported $0.38 $ 0.43
Pro forma 0.36 0.40
Diluted:
As reported 0.38 0.43
Pro forma 0.35 0.40
In determining compensation cost using the fair value method prescribed
in Statement No. 123, the value of each grant is estimated at the grant
date with the following weighted-average assumptions used for grants:
dividend yield of 4 percent; expected price volatility of 25 percent;
risk-free interest rates of 4 percent; and expected lives of 10 years.
Note 2. Allowance for Loan Losses
A summary of transactions in the allowance for loan losses is as
follows:
THREE MONTHS ENDED
SEPTEMBER 30,
------------------
(Dollars in thousands)
2003 2002
---- ----
Balance at beginning of period $2,342 $2,519
Reserve acquired in merger 889 --
Provision charged to expense 142 422
Loans charged off 105 237
Recoveries 37 2
------ ------
Balance at end of period $3,305 $2,706
------ ------
------ ------
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
(Dollars in thousands)
2003 2002
---- ----
Balance at beginning of period $2,079 $2,404
Reserve acquired in merger 889 --
Provision charged to expense 508 683
Loans charged off 353 419
Recoveries 182 38
------ ------
Balance at end of period $3,305 $2,706
------ ------
------ ------
Note 3. Earnings per Share
Presented below are the calculations for basic and diluted earnings per
share:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
Basic: ---- ---- ---- ----
Net income available to common stockholders $ 238,000 $ 302,000 $ 966,000 $1,049,000
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Weighted average shares outstanding 2,520,443 2,503,832 2,517,250 2,455,923
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Basic earnings per share $ 0.09 $ 0.12 $ 0.38 $ 0.43
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted:
Net income available to common stockholders $ 238,000 $ 302,000 $ 966,000 $1,049,000
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Weighted average shares outstanding 2,520,443 2,503,832 2,517,250 2,455,923
Effect of dilutive stock options outstanding 14,126 6,176 14,126 6,176
---------- ---------- ---------- ----------
Diluted weighted average shares outstanding 2,534,569 2,510,008 2,531,376 2,462,099
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted earnings per share $ 0.09 $ 0.12 $ 0.38 $ 0.43
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Note 4. Derivative Instrument
During June, 2003, the Company entered into an interest rate swap
transaction, which resulted in the Company converting its $7,000,000 of
variable rate Company Obligated Mandatorily Redeemable Preferred
Securities into fixed rate debt. This swap transaction requires the
payment of interest by the Company at a fixed rate equal to 2.47% using
an actual/360 day basis. In turn the Company receives a variable rate
interest payment based on the 90 day LIBOR rate adjusted quarterly.
Summary information about the interest rate swap at September 30 is as
follows:
2003 2002
---- ----
(Dollars in thousands)
Notional amount $7,000 --
Weighted average fixed rate 2.51% --
Weighted average variable rate 1.16% --
Weighted average maturity 4.25 years --
Fair value $325 --
Note 5. Acquisition of DunC Corp.
As more fully described in Item 2 of this report under the caption
"Acquisition or Disposition of Assets", Blackhawk Bancorp, Inc.
acquired DunC Corp on September 30, 2003 in a transaction accounted for
as a purchase. The assets and liabilities of DunC Corp., valued at fair
market value, on the date of acquisition, September 30, 2003, were
included in the unaudited consolidated balance sheet of Blackhawk
Bancorp, Inc. and Subsidiaries at September 30, 2003. Since the
transaction was accounted for as a purchased no amounts have been
included in the unaudited consolidated statement of income for either
of the periods presented.
Note 6. Recent Accounting Developments
The Financial Accounting Standards Board has issued Statement 149,
"Amendment of Statement 133 on Derivative Instruments and Hedging".
This Statement amends and clarifies financial accounting and reporting
for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under Statement
133. The Statement is effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after June
30, 2003. Implementation of the Statement is not expected to have a
material impact on the company's financial statements.
The Financial Accounting Standards Board has issued Statement 150,
"Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity". This Statement establishes standards for
how an issuer classifies and measures certain financial instruments
with characteristics of both liabilities and equity and requires that
certain freestanding financial instruments be reported as liabilities
in the balance sheet. Depending on the type of financial instrument,
it is required to be accounted for at either fair value or the present
value of future cash flows determined at each balance sheet date with
the change in that value reported as interest expense in the income
statement. Prior to the application of Statement No. 150, either those
financial instruments were not required to be recognized, or if
recognized were reported in the balance sheet as equity and changes in
the value of those instruments were normally not recognized in net
income. For the Company, the Statement is effective July 1, 2003 and
implementation is not expected to have a material impact on the
consolidated financial statements.
FIN No. 46 "Consolidation of Variable Interest Entities, an
interpretation of Accounting Research Bulletin No. 51." establishes
accounting guidance for consolidation of variable interest entities
(VIE) that function to support the activities of the primary
beneficiary. The primary beneficiary of a VIE entity is the entity that
absorbs a majority of the VIE's expected losses, receives a majority of
the VIE's expected residual returns, or both, as a result of ownership,
controlling interest, contractual relationship or other business
relationship with a VIE. Prior to the implementation of FIN 46, VIEs
were generally consolidated by an enterprise when the enterprise had a
controlling financial interest through ownership of a majority of
voting interest in the entity. The provisions of FIN 46 were effective
immediately for all arrangements entered into after January 31, 2003.
If a VIE existed prior to February 1, 2003, FIN 46 was effective at the
beginning of the first interim period beginning after June 15, 2003.
However, on October 8, 2003, the Financial Accounting Standards Board
(FASB) deferred the implementation date of FIN 46 until the first
period ending after December 15, 2003.
The interpretations of FIN 46 and its application to various
transaction types and structures are evolving. Management continuously
monitors emerging issues related to FIN 46, some of which could
potentially impact the Corporation's financial statements. The
Corporation currently consolidates its VIE, Blackhawk Statutory Trust
I, in its unaudited consolidated financial statements and treats its
Trust Preferred Securities as debt.
Note 7. Recent Regulatory Developments
On July 30, 2002, President Bush signed the Sarbanes-Oxley Act of 2002
(the "Act"). This legislation impacts corporate governance of public
companies, affecting their officers and directors, their audit
committees, their relationships with their accountants and the audit
function itself. Certain provisions of the Act became effective on July
30, 2002. Other provisions will become effective as the SEC adopts
appropriate rules.
The Act implements a broad range of corporate governance and accounting
measures for public companies designed to promote honesty and
transparency in corporate America and better protect investors from
corporate wrongdoing. The Act includes the creation of an independent
accounting oversight board to oversee the audit of public companies and
their auditors, provisions restricting non-audit services performed by
independent accountants for public companies and additional corporate
governance and responsibility provisions.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION
The purpose of Management's discussion and analysis is to provide relevant
information regarding the Registrant's financial condition and its results of
operations. The information included herein should be read in conjunction
with the company's consolidated financial statements and footnotes thereto for
the year ended December 31, 2002.
This report contains certain forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995 with respect to the
financial condition, results of operations, plans, objectives, future
performance and business of Blackhawk Bancorp, Inc. Statements that are not
historical facts, including statements about beliefs and expectations, are
forward-looking statements. These statements are based upon beliefs and
assumptions of Blackhawk's management and on information currently available
to such management. The use of the words "believe", "expect", "anticipate",
"plan", "estimate", "may", "will" or similar expressions are forward-looking
statements.
Contemplated, projected, forecasted or estimated results in such forward-
looking statements involve certain inherent risks and uncertainties. A number
of factors - many of which are beyond the ability of the company to control or
predict - could cause actual results to 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: heightened competition; adverse
state and federal regulation; failure to obtain new or retain existing
customers; ability to attract and retain key executives and personnel; changes
in interest rates; unanticipated changes in industry trends; unanticipated
changes in credit quality and risk factors, including general economic
conditions; success in gaining regulatory approvals when required; changes in
the Federal Reserve Board monetary policies; unexpected outcomes of new and
existing litigation in which Blackhawk or its subsidiaries, officers,
directors or employees is named defendants; technological changes; changes in
accounting principles generally accepted in the United States; changes in
assumptions or conditions affecting the application of critical accounting
policies; and the inability of third party vendors to perform critical
services for the company or its customers.
The Company does not undertake, and specifically declines any obligation, to
publicly release the results of any revisions which may be made to any
forward-looking statements to reflect events or circumstances after the date
of such statements or to reflect the occurrence of anticipated or
unanticipated events.
ACQUISITION OR DISPOSITION OF ASSETS
On September 30, 2003 (the "Effective Date"), Blackhawk Bancorp, Inc., (the
"Corporation") consummated its acquisition of DunC Corp. ("DunC"), a bank
holding company registered under the Bank Holding Company Act of 1956, as
amended, and DunC's wholly owned subsidiary, First Bank, bc ("First Bank"),
an Illinois state bank.
The Corporation acquired DunC and First Bank pursuant to an Agreement and Plan
of Merger dated as of March 17, 2003 (the "Merger Agreement"), between the
Corporation, DunC Merger Corporation ("Merger Corp"), a wholly owned
subsidiary of the Corporation, and DunC through a series of mergers.
Pursuant to the Merger Agreement, Merger Corp was merged with and into DunC at
the close of business on the Effective Date, and DunC became a wholly owned
subsidiary of the Corporation. The merger consideration was cash in the
aggregate amount of $7,222,941, which was paid to former DunC shareholders.
The price paid by the Corporation for the DunC common stock was arrived at
through arms-length negotiations.
The terms of the merger of Merger Corp with and into DunC are described more
fully in the Merger Agreement filed as Exhibit 2.1 to the Corporation's Form
10-QSB for the quarterly period ended March 31, 2003, which is incorporated
herein by reference. The description of the transaction set forth above is
qualified in its entirety by the terms set forth in the Merger Agreement.
Immediately following the merger of Merger Corp into DunC, DunC merged with
and into the Corporation, and First Bank merged with and into Blackhawk State
Bank, a wholly owned subsidiary of the Corporation. As a result of these
mergers the Corporation and Blackhawk State Bank were the surviving entities,
and DunC and First Bank ceased to exist.
The merger consideration paid to the former shareholders of DunC was funded
through a term loan with U.S. Bank National Association, Milwaukee,
Wisconsin. The term loan for $7.5 million was entered into in the ordinary
course of business and on terms commensurate with prevailing market
conditions on September 26, 2003. The term loan matures on September 26,
2008. A copy of the term loan agreement was filed as an exhibit on the
Corporation's Current Report on Form 8-K dated September 30, 2003 and is
incorporated herein by reference.
The merger was accounted for as a purchase. The assets of the acquired
companies (as detailed on page 10 of this report on Form 10-QSB) are included
in the September 30, 2003 Unaudited Consolidated Balance Sheet. The results
of operations subsequent to the acquisition date will be reflected in future
filings.
RESULTS OF OPERATIONS
The company reported net income of $238,000 for the three months ended
September 30, 2003, a decrease of $64,000 or 21.2% from the $302,000 reported
for the same three month period in 2002. Net income for the nine month
period ended September 30, 2003 was $966,000, a decrease of $83,000, or 7.9%
from the $1,049,000 reported for the same period in 2002.
Diluted earnings per share were $0.09 and $0.38 for the three and nine months
ended September 30, 2003, respectively, compared to $0.12 and $0.43 for the
same periods in 2002. This represents a decrease of 25.0% and 11.6% for the
three month and nine month periods, respectively.
NET INTEREST INCOME
Net interest income, which is the sum of interest and certain fees generated
by earning assets minus interest paid on deposits and other funding sources,
is the primary source of the company's earnings. All discussions of interest
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. The following table sets
forth the company's consolidated average balances of assets, liabilities and
stockholders' equity, interest income and expense on related items, and the
company's average rate for the three and nine month periods ended September
30, 2003 and 2002. The tax-equivalent yield calculations assume a Federal Tax
Rate of 34%:
AVERAGE BALANCE SHEET WITH RESULTANT INTEREST AND RATES
(yields on a tax-equivalent basis) Three Months ended Three Months ended
September 30, 2003 September 30, 2002
------------------------------ ------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- -------
INTEREST EARNING ASSETS:
Interest-bearing deposits
in banks $ 2,548 $ 14 2.18% $ 987 $ 6 2.41%
Federal funds sold &
securities purchased under
agreements to resell 2,047 5 .97% 9,687 59 2.42%
Investment securities:
Taxable investment securities 92,312 745 3.20% 77,182 946 4.86%
Tax-exempt investment
securities 29,560 433 5.81% 19,784 318 6.38%
-------- ------ ----- -------- ------ -----
Total investment securities 121,872 1,178 3.83% 96,966 1,264 5.17%
Loans 192,758 2,994 6.16% 193,773 3,609 7.39%
-------- ------ ----- -------- ------ -----
TOTAL EARNING ASSETS $319,225 $4,191 5.21% $301,413 $4,938 6.50%
------ ----- ------ -----
Allowance for loan losses (2,402) (2,491)
Cash and due from banks 11,287 10,569
Other assets 21,093 17,013
-------- --------
TOTAL ASSETS $349,203 $326,504
-------- --------
-------- --------
INTEREST BEARING LIABILITIES:
Interest bearing checking accounts $ 36,396 $ 62 .68% $ 32,461 $ 86 1.05%
Savings deposits 54,793 93 .67% 53,901 153 1.13%
Time deposits 130,867 1,025 3.11% 123,716 1,220 3.91%
-------- ------ ----- -------- ------ -----
Total interest bearing deposits 222,056 1,180 2.11% 210,078 1,459 2.76%
Short-term borrowings 11,254 20 .71% 18,405 89 1.92%
Long-term borrowings 48,388 549 4.50% 39,442 533 5.36%
Trust preferred securities 7,000 102 5.78% -0- -0- -0-%
-------- ------ ----- -------- ------ -----
TOTAL INTEREST-BEARING LIABILITIES $288,698 $1,851 2.54% $267,925 $2,081 3.08%
------ ----- ------ -----
NET INTEREST SPREAD 2.66% 3.42%
----- -----
----- -----
Noninterest bearing deposits 32,998 30,641
Other liabilities 1,809 2,217
-------- --------
Total liabilities 323,505 300,783
Stockholders' equity 25,698 25,721
-------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $349,203 $326,504
-------- --------
-------- --------
NET INTEREST MARGIN $2,340 2.91% $2,857 3.76%
------ ----- ------ -----
------ ----- ------ -----
AVERAGE BALANCE SHEET WITH RESULTANT INTEREST AND RATES
(yields on a tax-equivalent basis) Nine Months ended Nine Months ended
September 30, 2003 September 30, 2002
------------------------------ ------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- -------
INTEREST EARNING ASSETS:
Interest-bearing deposits
in banks $ 2,035 $ 31 2.04% $ 2,880 $ 40 1.86%
Federal funds sold &
securities purchased under
agreements to resell 4,053 54 1.78% 7,345 109 1.98%
Investment securities:
Taxable investment securities 91,702 2,602 3.79% 66,734 2,559 5.13%
Tax-exempt investment securities
27,658 1,242 6.00% 19,564 949 6.49%
-------- ------- ----- -------- ------- -----
Total investment securities 119,360 3,844 4.31% 86,298 3,508 5.43%
Loans 186,262 9,262 6.65% 197,863 11,192 7.56%
-------- ------- ----- -------- ------- -----
TOTAL EARNING ASSETS $311,710 $13,191 5.66% $294,386 $14,849 6.74%
------- ----- ------- -----
Allowance for loan losses (2,276) (2,509)
Cash and due from banks 11,004 10,070
Other assets 21,372 17,153
-------- --------
TOTAL ASSETS $341,810 $319,100
-------- --------
-------- --------
INTEREST BEARING LIABILITIES:
Interest bearing checking accounts $ 37,800 $ 224 .79% $ 32,255 $ 259 1.07%
Savings deposits 53,953 305 .76% 53,820 474 1.18%
Time deposits 125,995 3,147 3.34% 122,201 3,834 4.19%
-------- ------- ----- -------- ------- -----
Total interest bearing deposits 217,748 3,676 2.26% 208,276 4,567 2.93%
Short-term borrowings 12,384 96 1.04% 13,053 184 1.88%
Long-term borrowings 44,448 1,584 4.76% 41,035 1,652 5.38%
Trust preferred securities 7,000 265 5.06% -0- -0- -0-%
-------- ------- ----- -------- ------- -----
TOTAL INTEREST-BEARING
LIABILITIES $281,580 $ 5,621 2.67% $262,364 $ 6,403 3.26%
------- ----- ------- -----
NET INTEREST SPREAD 2.99% 3.48%
----- -----
----- -----
Noninterest bearing deposits 32,445 29,725
Other liabilities 1,966 2,162
-------- --------
Total liabilities 315,991 294,251
Stockholders' equity 25,819 24,849
-------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $341,810 $319,100
-------- --------
-------- --------
NET INTEREST MARGIN $ 7,570 3.25% $ 8,446 3.84%
------- ----- ------- -----
------- ----- ------- -----
Net interest income decreased by $517,000, or 18.1%, to $2,340,000 for the
quarter ended September 30, 2003, compared to $2,857,000 for the comparable
period in 2002. On a year to date basis net interest income decreased by
$876,000, or 10.4%, to $7,570,000 compared to $8,446,000 for the first nine
months of 2002. These decreases are primarily due to decreases in yields on
interest earning assets, which were only partially offset with decreases in
costs of interest bearing liabilities. The net interest margin, which is the
tax equivalent net interest income divided by average interest earning assets
was 2.91% and 3.25% for the three and nine month periods ended September 30,
2003. The third quarter net interest margin represents an 85 basis point
decrease compared to the 2002 third quarter net interest margin of 3.76%.
The year to date net interest margin of 3.25% represents a 59 basis point
decrease compared to the 3.84% net interest margin realized for the same
period in 2002.
For the three months ended September 30, 2003, total interest income
decreased by $747,000, or 15.1%, to $4,191,000 compared to $4,938,000 for the
same period in 2002. The decrease in interest income is due to a 129 basis
point decrease in the yield on average earning assets to 5.21% for the third
quarter of 2003, compared to 6.50% for the same period in 2002. The decrease
in the yield on average earning assets for the third quarter of 2003 compared
to the third quarter of 2002 is offset by a $17,812,000 increase in average
earning assets. For the nine months ended September 30, 2003, total interest
income decreased by $1,658,000, or 11.2%, to $13,191,000 compared to
$14,849,000 for the same period in 2002. The decrease in interest income is
due to a 108 basis point decrease in the yield on average earning assets to
5.66% compared to 6.74% for the same period in 2002 partially offset by a
5.9% increase in average earning assets. The decrease in yield on average
earning assets for the three months ended September 30, 2003 reflects the
investment of available liquidity into lower yielding investment securities
and the continued re-pricing of loans and investments in this historically
low interest rate environment.
Interest income on loans decreased 17.0% to $2,994,000 for the third quarter
of 2003 compared to $3,609,000 for the same period in 2002. This decrease
primarily is due to lower rates earned on the bank's loans due to continued
repricing and the sustained low interest rate environment. Average loans
outstanding for the three months ended September 30, 2003 decreased .5%
compared to the same period in 2002. Interest and fees on loans decreased
17.2% to $9,262,000 for the nine months ended September 30, 2003 compared to
$11,192,000 in same period of 2002. This decrease was the result of an
$11,601,000 or 5.9% decrease in average loans outstanding and a 91 basis
point decrease in yield on the portfolio. The decrease in average loans
outstanding for the nine month period ended September 30, 2003 compared to
the same period in 2002 is largely attributable to the refinancing activity
in the residential real estate market, weak commercial and consumer loan
demand and competitive pricing pressure for quality credits.
Interest income on taxable securities deincreased by $201,000 or 21.2% in the
third quarter of 2003 to $745,000 compared to $946,000 for the same period in
2002. The average balances of taxable investment securities increased 19.6%
to $92,312,000 for the quarter ended September 30, 2003 compared to
$77,182,000 for the same period in the prior year. However, the yield on
average taxable investment securities decreased 166 basis points to 3.20% for
the third quarter of 2003 compared to 4.86% for the third quarter of 2002.
Interest income on taxable securities increased by $43,000, or 1.7%, in the
first nine months of 2003 to $2,602,000 from $2,559,000 for the same period
in 2002. Average balances of taxable investment securities increased 37.4%
to $91,702,000 for the nine months ended September 30, 2003 compared to
$66,734,000 for the same period in the prior year. The increase in average
balances outstanding was offset by a decrease of 134 basis points in average
yield to 3.79% for the first nine months of 2003 compared to 5.13% for the
first nine months of 2002. The decrease in the yield on taxable investments
for the three and nine months ended September 30, 2003 compared to the same
periods a year ago is primarily due to the investment of proceeds from the
maturity and sale of investments and additional liquidity into the investment
portfolio during the historically low interest rate environment. The yield
was further impacted by accelerated amortization of purchase premium on
mortgage-backed securities and collateralized mortgage obligations due to
increased prepayment speeds on the underlying collateral.
Tax exempt investment securities increased $9,776,000, or 49.4% to an average
balance of $29,560,000 for the three months ended September 30, 2003 compared
to $19,784,000 for the same period in 2002. Interest income on tax exempt
securities increased $115,000 or 36.2% to $433,000 for the third quarter of
2003 compared to $318,000 for the third quarter of 2002. Average tax exempt
securities increased to $27,658,000 for the nine months ended September 30,
2003 compared to $19,564,000 for the same period in 2002 and their average
tax equivalent yield decreased from 6.49% for the nine months ended September
30, 2002 to 6.00% for the same period in 2003.
Interest from fed funds sold and securities purchased under agreements to
resell decreased to $5,000 and $54,000 for the three and nine month periods
ended September 30, 2003, respectively, compared to $59,000 and $109,000
during the same periods in 2002. The quarterly and year to date decreases in
interest on fed funds sold and securities purchased under agreements to
resell were due to lower market rates and lower average balances outstanding.
Total interest expense decreased by $230,000, or 11.1%, to $1,851,000 for the
three months ended September 30, 2003 compared to $2,081,000 for the same
period in 2002. For the nine months ended September 30, 2003 total interest
expense decreased by $782,000, or 12.2%, to $5,621,000 compared to $6,403,000
for the same period in 2002. The decrease in total interest expense is the
result of the aforementioned lower interest rate environment offset by higher
average balances outstanding.
While interest paid on deposits decreased $279,000, or 19.1% to $1,180,000
during the three months ended September 30, 2003 compared to $1,459,000 for
the same period in 2002, average interest bearing deposits increased
$11,978,000 quarter over quarter. Year to date interest paid on deposits
decreased $891,000, or 19.5% to $3,676,000 compared to $4,567,000 for the
same period in 2002 while average total interest bearing deposits increased
by $9,472,000.
Interest on short-term borrowings decreased $69,000 to $20,000 for the three
months ended September 30, 2003 compared to $89,000 for the same period in
2002. For the nine months ended September 30, 2003 interest on short-term
borrowings decreased $88,000 to $96,000 compared to $184,000 for the same
period in 2002. Both decreases are the result of lower average balances
outstanding in 2003 coupled with the lower interest rate environment in 2003
compared to 2002. They also reflect the liquidation of the holding company's
bank line of credit during December 2002 coincident with the issuance of the
company's Trust Preferred Securities.
Interest expense on long-term borrowings increased $16,000 to $549,000 for
the three months ended September 30, 2003 compared to $533,000 for the third
quarter of 2002. The increase is primarily the result of additional Federal
Home Loan Bank advances in 2003, at lower market interest rates, offset by
the pay-off of the bank debt of Blackhawk Bancorp, Inc. during December, 2002
co-incident with the issuance of the company's Trust Preferred Securities.
Interest expense on long-term borrowings decreased $68,000 to $1,584,000 for
the nine months ended September 30, 2003 compared to $1,652,000 for the third
quarter of 2002 primarily from the liquidation of the holding company debt in
December 2002 offset by additional interest, at lower market rates, on
additional Federal Home Loan Bank advances outstanding in 2003.
PROVISION FOR LOAN LOSSES
The provision for loan losses (provision) is an amount added to the allowance
for loan losses (allowance) to provide for the known and estimated amount of
loans that will not be collected. Actual loan losses are charged against
(reduce) the allowance when management believes that the collection of
principal will not occur. Subsequent recoveries of amounts previously charged
to the allowance, if any, are credited to (increase) the allowance.
Management determines the appropriate provision based upon a number of
criteria, including a detailed evaluation of certain credits, historical
performance, economic conditions and overall quality of the loan portfolio.
The provision was $142,000 in the third quarter of 2003, a decrease of
$280,000 or 66.4% from the $422,000 in the third quarter of 2002. The bank
provided an additional provision of $300,000 during the third quarter of 2002
to adequately value its loan portfolio for problem loans identified during
the quarter. For the first nine months of 2003, the provision was $508,000
compared to $683,000 during the same time period a year ago.
Activity in the allowance for loan losses is detailed in footnote 2 to the
unaudited consolidated financial statements. Charge-offs, net of recoveries
for the third quarter of 2003 decreased by $167,000 to net charge-offs of
$68,000 compared to net charge-offs of $235,000 for the third quarter of
2002. Year to date net charge-offs decreased $210,000 or 55.1% to $171,000
compared to $381,000 for the first nine months of 2002.
The ratio of the allowance to total loans was 1.35% at September 30, 2003
compared to 1.10% at December 31, 2002. The allowance for loan losses totaled
$3,305,000 at September 30, 2003 and included $889,000, which was acquired as
part of the DunC Corp. and First Bank, bc acquisition.
NONINTEREST INCOME
Total noninterest income increased $126,000, or 18.0%, to $827,000 for the
three months ended September 30, 2003 compared to $701,000 for the same
period in 2002. Year to date total noninterest income increased $532,000, or
24.0%, to $2,745,000 compared to $2,213,000 for the same period in 2002.
Service charges on deposit accounts totaled $372,000 for the quarter ended
September 30, 2003 compared to $396,000 for the third quarter of 2002. The
decrease is primarily due to lower overdraft fees collected which decreased
by $22,000 or 8.6% to $235,000 for the quarter ended September 30, 2003
compared to $257,000 for the third quarter of 2002. Year to date service
charges on deposits decreased $70,000, or 6.1%, to $1,072,000 compared to
$1,142,000 in the prior year primarily due to lower levels of overdraft fees
collected for the nine months ended September 30, 2003.
Gain on the sale of mortgage loans increased $63,000 or 66.3% to $158,000 for
the third quarter of 2003 compared to the $95,000 of gains recognized during
the third quarter of 2002. The increase was primarily due to higher volumes
sold during the third quarter of 2003. In the third quarter of 2003,
$9,842,000 of loans were sold to the secondary market compared to $6,242,000
for the same period in 2002. Year to date gain on sale of mortgage loans
increased $238,000 or 107.7% to $459,000 compared to $221,000 for the same
period in 2002. The increase is due to a higher volume of loans sold and
higher margins. The average gain in 2003 was 1.73% on $26,550,000 in loans
sold to the secondary market compared to an average gain of 1.20% on the
$18,468,000 of loans sold in the same period in 2002. The level of gains
realized is dependent on market interest rates which impacts the level of
home loan refinancings. Should market interest rates increase from their
current 45-year historical lows, the amount of loans sold to the secondary
market and the level of gains realized is anticipated to decrease.
The Company recognized $50,000 in securities gains in the third quarter of
2003. No gains were recognized in the third quarter of 2002. Year to date
the company has realized $475,000 in securities gains, a $246,000 or 107.4%
increase over the $229,000 realized for the nine months ended September 30,
2002.
Other noninterest income increased $37,000 or 17.6% to $247,000 for the
quarter ended September 30, 2003 compared to $210,000 for the third quarter
of 2002. The increase is primarily due to additional income on the bank's
investment in bank owned life insurance. The increase in the cash surrender
value of life insurance increased by $68,000 in the third quarter of 2003
compared to the third quarter of 2002. The bank invested $5,000,000 in bank
owned life insurance on September 30, 2002. Year to date other noninterest
income increased by $118,000 or 19.0% to $739,000 for the nine months ended
September 30, 2003 from $621,000 for the nine months ended September 30,
2002. The year to date increase is due to an increase in cash surrender value
of bank owned life insurance of $203,000 offset by a 32.9% decrease in
brokerage and annuity commissions realized in 2003 from $130,000 in 2002 to
$87,000 in 2003.
NONINTEREST EXPENSES
Total operating expenses increased $29,000, or 1.1%, to $2,669,000 for the
three months ended September 30, 2003 compared to $2,640,000 for the same
period in 2002. The third quarter of 2002 included a reversal of $157,000 in
accrued vacation as a result of a change in the company's vacation policy.
Excluding this non-recurring item, operating expenses decreased by $128,000
for the quarter. The decrease in operating expenses, net of the non-
recurring item, reflects senior management's efforts to control discretionary
spending to offset lower net interest margin. For the first nine months of
2002 total operating expenses increased $128,000, or 1.5%, to $8,388,000
compared to $8,260,000 for the same period in 2002. Adjusting for the one
time year to date impact on the 2002 change in vacation policy of $145,000,
operating expenses decreased by $17,000 year over year.
Salaries and employee benefits for 2002 included the one time adjustment, due
to the change in the company's vacation policy, of $157,000 and $145,000 for
the three and nine months ended September 30, 2003. Excluding this
adjustment, salaries and employee benefits decreased $68,000 or 4.9% to
$1,322,000 for the quarter ended September 30, 2003, compared to $1,390,000
for the third quarter of 2002. For the first nine months of 2002 total
salaries and employee benefits increased $31,000 or 0.8% to $4,140,000
compared to $4,109,000 for the same period in 2002.
Occupancy expenses for the three months ended September 30, 2003 decreased to
$172,000 from $193,000 for the third quarter of 2002 primarily due to lower
maintenance costs and the closure of the Wal-Mart branch. Occupancy expenses
for the nine months ended September 30, 2003 decreased to $541,000 compared
to $641,000 for the same period in 2002 primarily as a result of the one time
charge in 2002 of $75,000 due to the closure of the company's Wal-Mart branch
and the reduction in rent expense for the closed branch.
Furniture and equipment expenses decreased $23,000 or 10.2% to $202,000 for
the quarter ended September 30, 2003 compared to $225,000 for the same
quarter in 2002 primarily due to lower depreciation on computer equipment.
For the first nine months of 2002 furniture and equipment expense increased
$9,000, or 1.4%, to $663,000 compared to $654,000 for the same period in
2002.
Data processing costs increased $37,000, or 20.1%, to $221,000 for the
quarter ended September 30, 2003 and $49,000, or 8.6%, to $663,000 for the
nine months ended September 30, 2003. These increases reflect increases in
core processing costs and the outsourcing of certain network administration
and support functions midway through 2003.
Advertising and marketing costs decreased $46,000, or 49.5% to $47,000 for
the third quarter of 2003 compared to $93,000 for the same period in 2002.
Year to date advertising and marketing costs decreased $2,000, or 0.8% to
254,000 from $256,000. The third quarter decrease is primarily due to the
timing of expenses as a number of major marketing campaigns occurred during
the second quarter of 2003.
Transportation and postage increased $4,000 or 4.0% to $105,000 for the third
quarter of 2003 compared to $101,000 for the third quarter of 2002. For the
first nine months of 2003 transportation and postage increased $35,000 or
12.4% to $317,000 compared to $282,000 for the same period in 2002. The
increase is primarily due to additional costs from an expansion of the bank's
courier program in 2003 and increased communication with customers regarding
the acquisition of DunC Corp. and First Bank, bc..
Other noninterest expenses increased $4,000 or 1.4% to $281,000 for the three
months ended September 30, 2003 compared to $277,000 for the same period a
year ago. For the first nine months of 2003 other noninterest expenses
decreased $29,000 or 3.5% to $805,000 compared to $834,000 for the same
period in 2002. Other noninterest expenses in 2002 included $117,000 of
charges to accrue severance payments for executive officers that left the
company in 2002 partially offset by an $87,000 credit from adjustment of
stale reconciling items.
Income taxes decreased $115,000, or 135.3%, to a tax benefit of $30,000 for
the three months ended September 30, 2003 from income taxes of $85,000 for
the same period in 2002. For the nine months ended September 30, 2003 income
taxes decreased $310,000, or 90.9%, to $31,000 from $341,000 for the same
period in 2002. The decrease reflects greater tax efficiency brought about by
an increase in non-taxable interest from the municipal bond portfolio and the
purchase of bank owned life insurance on September 30, 2002 and the lower
level of pre-tax income in 2003.
BALANCE SHEET ANALYSIS
OVERVIEW
Total assets increased to $431,820,000 at September 30, 2003, including
$77,726,000 in assets acquired from First Bank, compared to assets of
$352,377,000 at December 31, 2002, an increase of 22.5%. The December 31,
2002 balance sheet included short-term year-end deposits of $18,600,000,
which were invested in federal funds sold and interest bearing deposits in
banks at December 31, 2002. Excluding these deposits, total assets increased
29.4% from December 31, 2002 to September 30, 2003.
LOANS
Gross loans increased $56,113,000, or 29.8%, to $244,492,000 on September 30,
2003, including gross loans of $46,781,000 received in the First Bank
acquisition, compared to $188,379,000 on December 31, 2002. The composition
of loans is shown in the following table:
As a % of Total Loans
September 30, December 31, Change in September 30, December 31,
2003 2002 Balance 2003 2002
------------- ------------ --------- ------------- ------------
(Dollars in millions)
Residential Real Estate $100.9 $71.8 $29.1 41.3% 38.1%
Commercial Real Estate $ 70.5 $59.0 $11.5 28.8% 31.4%
Construction and Land
Development $ 12.3 $ 6.4 $ 5.9 5.0% 3.4%
Commercial $ 37.5 $28.3 $ 9.2 15.3% 15.0%
Consumer $ 21.3 $22.3 ($ 1.0) 8.7% 11.8%
Other $ 2.0 $ 0.6 $ 1.4 0.9% 0.3%
The historically low interest rate environment has led to substantial
prepayments on the company's 1-4 family residential real estate loan
portfolio. To offset this loan run-off, the bank has retained new adjustable
and fixed rate mortgages with lives of 15 years or less. This has lead to an
increase of $15,900,000 or 22.1% in residential real estate loans, exclusive
of the First Bank acquisition, for the nine months ended September 30, 2003.
This increase has partially offset decreases, exclusive of the First Bank
acquisition, of $3,800,000 in Commercial and Commercial Real Estate loans and
$4,800,000 in Consumer loans over the same period. In addition, the company's
focus on relationship banking has resulted in the subsidiary bank not pursuing
certain "transactions" that may have resulted in increased loan balances, but
offered no opportunity to form other relationships with the client.
NON-PERFORMING LOANS
Non-performing loans includes loans which have been categorized by management
as non-accruing because collection of interest is not assured, and loans which
are past-due ninety days or more as to interest and/or principal payments.
The following summarizes information concerning non-performing loans:
SEPTEMBER 30, DECEMBER 31,
(Dollars in thousands) 2003 2002
------------- ------------
Non-accruing loans $3,668 $2,560
Past due 90 days or more and still accruing 154 26
------ ------
Total non-performing loans $3,822 $2,586
------ ------
------ ------
Restructured loans performing in accordance
with modified terms $ 389 $ 418
ASSET QUALITY
The allowance for loan losses was $3,305,000 or 1.35% of total loans at
September 30, 2003 compared to $2,079,000 or 1.10% of total loans at December
31, 2002 and includes $889,000 acquired in the First Bank acquisition. As of
September 30, 2003, non-performing loans and restructured loans performing in
accordance with modified terms totaled $4,211,000 compared to $3,004,000 at
December 31, 2002. The allowance for loan losses is established through a
provision for loan losses charged to expense. Loans are charged against the
allowance for loan losses when management believes that the collectibility of
the principal is unlikely. The allowance for loan losses is adequate to cover
probable credit losses relating to specifically identified loans, as well as
probable credit losses inherent in the balance of the loan portfolio. In
accordance with FASB Statements 5 and 114, the allowance is provided for
losses that have been incurred as of the balance sheet date. The allowance
is based on past events and current economic conditions, and does not include
the effects of expected losses on specific loans or groups of loans that are
related to future events or expected changes in economic conditions.
Management reviews a calculation of the allowance for loan losses on a
quarterly basis. While management uses the best information available to make
its evaluation, future adjustments to the allowance may be necessary if there
are significant changes in economic conditions.
In addition, various regulatory agencies periodically review the allowance
for loan losses. These agencies may require the bank to make additions to
the allowance for loan losses based on their judgments of collectibility
based on information available to them at the time of their examination. The
policy of the Company is to place a loan on non-accrual status if: (a)
payment in full of interest and principal is not expected, or (b) principal
or interest has been in default for a period of 90 days or more, unless the
obligation is both in the process of collection and well secured. Well
secured is defined as collateral with sufficient market value to repay
principal and all accrued interest. A debt is in the process of collection if
collection of the debt is proceeding in due course either through legal
action, including judgement enforcement procedures, or in appropriate
circumstances, through collection efforts not involving legal action which
are reasonably expected to result in repayment of the debt or in its
restoration to current status.
At September 30, 2003 the allowance for loan losses to total non-performing
and restructured loans equaled 78.5% compared to 69.2% at December 31, 2002.
Total nonperforming and restructured loans increased by $1,207,000;$446,000
due to the First Bank acquisition and the balance as the result of two large
loans. One is a commercial real estate loan and the other is a single family
residence. Both loans are in foreclosure.
SHORT-TERM INVESTMENTS
Fed funds sold and securities purchased under agreements to resell decreased
$3,548,000 to $9,572,000 at September 30, 2003 compared to $13,120,000 at
December 31, 2002. The decrease reflects the liquidation of short-term year-
end investments on January 2, 2003 associated with the December 31, 2002
year-end deposits of $18,600,000 offset by $9,572,000 of fed funds sold
acquired in the First Bank acquisition.
INVESTMENT SECURITIES
Securities available for sale increased $25,020,000, or 29.8%, to
$108,917,000 at September 30, 2003 compared to $83,897,000 at December 31,
2002. $11,104,000 of the increase represents securities acquired in the First
Bank acquisition. The balance of the increase in investments in securities
available for sale resulted from the redeployment of short-term investments
and cash flows from held to maturity securities.
DEPOSITS
Total deposits increased $54,983,000 to $318,068,000 at September 30, 2003
compared to $263,085,000 at December 31, 2002. As noted above, the Company's
December 31, 2002 financial statements reflect short-term year-end interest-
bearing deposits of $18,600,000. The Company assumed $13,899,000 of
noninterest-bearing deposits and $50,338,000 of interest bearing deposits
from First Bank bc. Excluding the short-term year-end deposits and deposits
of $64,237,000 assumed in the First Bank acquisition, total deposits
increased 3.8% from December 31, 2002. Excluding the First Bank bc. and
short-term year-end deposits, non-interest bearing deposits decreased by
$749,000 and interest bearing deposits increased by $10,095,000 at September
30, 2003 compared to December 31, 2002.
BORROWINGS
Short-term borrowings increased $5,031,000 to $18,485,000 at September 30,
2003 from $13,454,000 at year-end. The increase is due to $9,594,000 of fed
funds purchased at September 30, 2003 offset by lower outstanding balances of
repurchase agreements with commercial customers.
Long-term borrowings at September 30, 2003 total $57,731,000 and consist of a
$7,500,000 commercial bank loan and term advances from the Federal Home Loan
Bank ("FHLB"). The FHLB advances were $50,231,000 at September 30, 2003
compared to $38,900,000 at December 31, 2002 and include $3,631,000 of
borrowings assumed in the First Bank acquisition. The increase reflects an
additional $8,000,000 in FHLB advances net of a $300,000 repayment invested
into securities during 2003 and the $7,500,000 term loan used to finance the
First Bank acquisition.
STOCKHOLDERS' EQUITY
Total stockholders' equity increased $38,000 to $25,836,000 at September 30,
2003 compared to $25,798,000 at December 31, 2002. During the first nine
months of 2003 additional paid in capital increased by $120,000 from stock
options exercised. Accumulated other comprehensive income, which is comprised
of the adjustment of securities available for sale to market value, net of
tax, and the fair value of Blackhawk Bancorp, Inc.' s interest rate SWAP
contract, net of tax, was $920,000 at September 30, 2003 compared to
$1,287,000 at December 31, 2002. In addition the company declared three
quarterly dividends of $0.09 per share on its common stock, which totaled
$681,000.
The Company is subject to certain regulatory capital requirements and
continues to remain in compliance with the requirements. The following table
shows the company's capital ratios and regulatory requirements.
September 30, December 31, Regulatory
2003 2002 Requirements
------------- ------------ ------------
Total Capital (To Risk-Weighted Assets) 10.7% 13.9% 8.0%
Tier I Capital (To Risk-Weighted Assets) 9.5% 12.9% 4.0%
Tier I Capital (To Average Assets) 5.9% 8.3% 4.0%
The decreases in the capital ratios at September 30, 2003 compared to December
31, 2002 were due to the First Bank acquisition, which increased average assets
and risk-weighted assets by $73,516,000 and $50,692,000 respectively.
The Company's subsidiary bank meets regulatory capital requirements to be
considered well capitalized.
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.
The Company focuses 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 quarterly.
In addition to the effect on earnings, quarterly 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 difference between the economic values of the assets
and liabilities results in an economic value of equity.
During June 2003, the Company entered into an interest rate SWAP agreement
related to the company obligated mandatorily redeemable preferred securities.
This SWAP is utilized to manage variable interest rate exposure and is
designated as a highly effective cash flow hedge. The differential to be
paid or received on the SWAP agreement is accrued as interest rates change
and is recognized over the life of the agreement in interest expense. The
SWAP agreement expires in December 2007 and essentially fixes the rate to be
paid at 5.72%. The notional amount is $7,000,000. Included in other
comprehensive income is a gain of $325,000, less $111,000 of deferred income
tax, relating to the fair market value of the SWAP agreement as of September
30, 2003. Risk management results for the nine months ended September 30,
2003 related to the balance sheet hedging of the company obligated
mandatorily redeemable preferred securities indicate that the hedge was 100%
effective and that there was no component of the derivative instrument's gain
or loss which was excluded from the assessment of hedge effectiveness.
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 sources of funds are deposits, scheduled amortization and
prepayment of loan principal, maturities of investment securities, short-term
borrowings and income from operations. Additional sources include purchasing
fed funds, sale of securities, sale of loans, borrowing from both the Federal
Reserve Bank and Federal Home Loan Bank, and dividends paid by Nevahawk, a
wholly owned subsidiary of the Bank.
The liquidity needs of the Company generally consist of payment of dividends
to its Stockholders, payments of principal and interest on borrowed funds and
subordinated debentures, and a limited amount of expenses. The sources of
funds to provide this liquidity are issuance of capital stock and dividends
from its subsidiary bank. Certain restrictions are imposed upon the Bank,
which could limit its ability to pay dividends if it did not have net
earnings or adequate capital in the future. The Company maintains adequate
liquidity to pay its expenses.
The following table summarizes The Company's significant contractual
obligations and other potential funding needs at September 30, 2003 (in
thousands):
Year Ended Time Long-term Operating
September 30, Deposits debt(1) Leases Total
------------- -------- ----------- --------- -----
2004 $ 87,731 $ 7,831 $ 161 $ 95,723
2005 42,214 18,250 161 60,625
2006 9,430 3,200 161 12,791
2007 9,270 1,700 161 11,131
2008 1,486 16,750 124 18,360
Thereafter 0 17,000 934 17,934
-------- ------- ------ --------
Total $150,131 $64,731 $1,702 $216,564
-------- ------- ------ --------
-------- ------- ------ --------
Commitments to extend credit $ 30,965
(1) Long-term debt includes company-obligated mandatorily redeemable
preferred securities.
OFF BALANCE SHEET ITEMS AND CONTINGENCIES
Off-balance sheet items consist of commitments to originate mortgage loans,
unused lines of credit and standby letters of credit totaling approximately
$30,965,000 as of September 30, 2003. This compares to $30,939,000 at
December 31, 2002. The Company's commitments to originate mortgage loans are
on a best effort basis; therefore there are no contingent liabilities
associated with them. The Bank has historically funded off-balance sheet
commitments with its primary sources of funds and management anticipates that
this will continue.
On August 18, 2000, the Bank filed a lawsuit in Waukesha County, Wisconsin,
against Fiserv, Inc., a former data processing services provider, for breach
of contract. The Bank was seeking to recover damages sustained due to a
processing error in which approximately $500,000 was improperly charged to the
Bank's check clearing account at the FHLB of Chicago. On February 14, 2003, a
jury delivered a verdict that Fiserv, Inc. did not breach its contract with
the Bank. Fiserv, Inc. has filed a counterclaim seeking approximately
$380,000 in reimbursement of legal fees. On May 12, 2003 a judge in the case
denied Fiserv's motion for reimbursement of legal fees. Fiserv has filed an
appeal of the judge's decision. The company plans to aggressively contest
their appeal of the initial decision and has not accrued the legal fee
reimbursement claimed by Fiserv.
ITEM 3. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES: The Company's management, with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Company's disclosure controls
and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"))
as of the end of the period covered by this report. Based on such
evaluation, the Company's Chief Executive Officer and Chief Financial Officer
have concluded that, as of the end of such period, the Company's disclosure
controls and procedures are effective in recording, processing, summarizing
and reporting, on a timely basis, information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act.
INTERNAL CONTROL OVER FINANCIAL REPORTING: There have not been any changes
in the Company's internal control over financial reporting (as such term is
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the
fiscal quarter to which this report relates that have materially affected, or
are reasonably likely to materially affect, the Company's internal control
over financial reporting.
PART II
OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
None.
ITEM 2 CHANGES IN SECURITIES
The Credit Agreement with US Bank National Association dated September
26, 2003 is hereby incorporated by reference to Blackhawk Bancorp,
Inc. Current Report on Form 8-K dated September 30, 2003.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5 OTHER INFORMATION
None.
ITEM 6. A) EXHIBITS
See Exhibit Index following the signature page in this report, which
is incorporated herein by this reference.
B) REPORTS ON FORM 8-K
There were two reports on Form 8-K filed during the third quarter of
2003. A report dated August 8, 2003 disclosed the Company's second
quarter 2003 results under provisions of Regulation FD. A report
dated September 18, 2003 disclosed the approval of the Agreement and
Plan of Merger by and among Blackhawk Bancorp, Inc. DunC Merger
corporation and DunC Corp. dated as of March 17, 2003 by DunC
shareholders under provisions of Regulation FD.
In addition, a report on Form 8-K dated September 30, 2003 was filed
on October 14, 2003 and provided details on the acquisition of assets
from DunC Corp. This filing also included a copy of the Credit
Agreement with US Bank National Association dated September 26, 2003
incorporated by reference into Part II, Item 2 of this report.
SIGNATURES
Pursuant to the requirements 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.
Blackhawk Bancorp, Inc.
----------------------------------------
(Registrant)
Date: November 7, 2003 /s/ R. Richard Bastian, III
----------------------------------------
R. Richard Bastian, III
President and Chief Executive Officer
/s/ Todd J. James
----------------------------------------
Todd J. James
Executive Vice President and Chief
Financial Officer
/s/ Thomas L. Lepinski
----------------------------------------
Thomas L. Lepinski, CPA
Principal Accounting Officer
BLACKHAWK BANCORP, INC.
INDEX TO EXHIBITS
Incorporated Filed
Exhibit Herein By Here-
Number Description Reference To: with
------- ----------- ------------- -----
3.1 Amended and Exhibit 3.1 to
restated Articles Amendment No. 1 to
of Incorporation Registrant's
of the Registrant Registration
Statement on Form
S-1 (Reg. No.
33-32351)
3.2 By-laws of Regis- Exhibit 3.2 to
trant as amended Amendment No. 1 to
Registrant's
Registration
Statement on Form
S-1 (Reg. No.
33-32351)
4 Credit Agreement with US Bank Form 8-K dated September
National Association dated 30, 2003
September 26, 2003
31.1 Certification of Chief Executive X
Officer Pursuant to Rule 13a-14(a)/
15d-14(a)
31.2 Certification of Chief Financial X
Officer Pursuant to Rule 13a-14(a)/
15d-14(a)
32.1 Certification Pursuant to 18
U. S. C. Section 1350, as
Adopted Pursuant to Section
906 of the Sarbanes-Oxley
Act of 2002 X
32.2 Certification Pursuant to 18
U. S. C. Section 1350, as
Adopted Pursuant to Section
906 of the Sarbanes-Oxley
Act of 2002 X