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FIRST OTTAWA BANCSHARES, INC - Quarter Report: 2003 June (Form 10-Q)

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

ý                                 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2003

 

OR

 

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For transition period from                        to                       

 

Commission file number 005-57237

 

FIRST OTTAWA BANCSHARES, INC.

(Exact name of Registrant as specified in its charter)

 

Delaware

 

36-4331185

(State or other jurisdiction
of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

701-705 LaSalle Street
Ottawa, Illinois

 

61350

(Address of principal executive offices)

 

(ZIP Code)

 

 

 

(815) 434-0044

(Registrant’s telephone number,
including area code)

 

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 (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                                           Yes   ý  No  o

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act)        Yes   o  No  ý

 

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of the latest practicable date:  As of August 14, 2003, the Registrant had outstanding 655,327 shares of common stock, $1.00 par value per share.

 

 



 

FIRST OTTAWA BANCSHARES, INC.

 

Form 10-Q Quarterly Report

 

Table of Contents

 

PART I

 

 

Item 1.

Condensed Consolidated Financial Statements

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

Item 4.

Controls and Procedures

 

 

PART II

 

 

Item 1.

Legal Proceedings

Item 2.

Changes in Securities and Use of Proceeds

Item 3.

Defaults Upon Senior Securities

Item 4.

Submission of Matters to a Vote of Security Holders

Item 5.

Other Information

Item 6.

Exhibits and Reports on Form 8-K

Item 7.

Signatures

 

2



 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

(Unaudited)

 

 

 

June 30,
2003

 

December 31,
2002

 

ASSETS

 

 

 

 

 

Cash and cash equivalents

 

$

11,338

 

$

8,606

 

 

 

 

 

 

 

Certificates of deposit

 

10,323

 

12,985

 

Securities available-for-sale

 

89,372

 

98,885

 

Loans held for sale

 

1,008

 

1,811

 

Loans, less allowance for loan losses of $1,165 and $1,167

 

112,596

 

108,476

 

Bank premises and equipment, net

 

5,756

 

4,555

 

Interest receivable and other assets

 

5,102

 

5,344

 

 

 

 

 

 

 

Total assets

 

$

235,495

 

$

240,662

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Liabilities

 

 

 

 

 

Deposits

 

 

 

 

 

Demand – non-interest-bearing

 

$

18,840

 

$

19,475

 

NOW accounts

 

51,235

 

54,537

 

Money market accounts

 

26,022

 

9,186

 

Savings

 

20,086

 

19,513

 

Time, $100,000 and over

 

17,755

 

23,813

 

Other time

 

63,993

 

67,243

 

Total deposits

 

197,931

 

193,767

 

 

 

 

 

 

 

Federal funds purchased

 

7,000

 

14,700

 

Securities sold under agreements to repurchase

 

134

 

1,622

 

Borrowings

 

267

 

652

 

Interest payable and other liabilities

 

4,062

 

4,738

 

Total liabilities

 

209,394

 

215,479

 

 

 

 

 

 

 

Commitments and contingent liabiliies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Preferred stock - $1 par value, 20,000 shares
Authorized; none issued

 

 

 

Common stock - $1 par value, 750,000 shares
authorized and issued

 

750

 

750

 

Additional paid-in capital

 

4,000

 

4,000

 

Retained earnings

 

24,100

 

23,491

 

Treasury stock, at cost, 94,673 and 93,044 shares

 

(5,361

)

(5,270

)

Accumulated other comprehensive income

 

2,612

 

2,212

 

Total shareholders’ equity

 

26,101

 

25,183

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

235,495

 

$

240,662

 

 

See accompanying notes to condensed consolidated financial statements.

 

3



 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

 (In thousands, except share and per share data)

(Unaudited)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

Interest income

 

 

 

 

 

 

 

 

 

Loans (including fee income)

 

$

2,003

 

$

2,011

 

$

3,968

 

$

4,032

 

Securities

 

 

 

 

 

 

 

 

 

Taxable

 

839

 

1,021

 

1,748

 

2,079

 

Exempt from federal income tax

 

190

 

237

 

386

 

465

 

Certificates of deposit

 

96

 

65

 

201

 

75

 

Federal funds sold

 

 

 

 

1

 

Total interest income

 

3,128

 

3,334

 

6,303

 

6,652

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

NOW account deposits

 

118

 

87

 

241

 

162

 

Money market deposit accounts

 

32

 

44

 

61

 

85

 

Savings deposits

 

57

 

85

 

119

 

165

 

Time deposits

 

828

 

1,053

 

1,734

 

2,233

 

Repurchase agreements

 

1

 

143

 

8

 

301

 

Borrowings

 

1

 

29

 

4

 

58

 

Federal funds purchased

 

74

 

22

 

131

 

37

 

Total interest expense

 

1,111

 

1,463

 

2,298

 

3,041

 

 

 

 

 

 

 

 

 

 

 

NET INTEREST INCOME

 

2,017

 

1,871

 

4,005

 

3,611

 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

30

 

30

 

60

 

60

 

 

 

 

 

 

 

 

 

 

 

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

 

1,987

 

1,841

 

3,945

 

3,551

 

Noninterest income

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

194

 

183

 

383

 

366

 

Trust and farm management fee income

 

114

 

114

 

228

 

228

 

Gain on loan sales

 

273

 

47

 

493

 

107

 

Other income

 

147

 

154

 

250

 

321

 

Total noninterest income

 

728

 

498

 

1,354

 

1,022

 

 

 

 

 

 

 

 

 

 

 

Noninterest expenses

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

1,055

 

937

 

2,022

 

1,900

 

Occupancy and equipment expense

 

229

 

210

 

455

 

410

 

Data processing expense

 

106

 

106

 

220

 

223

 

Supplies

 

26

 

33

 

57

 

64

 

Advertising and promotions

 

18

 

25

 

35

 

49

 

Professional fees

 

88

 

124

 

153

 

212

 

Other expenses

 

300

 

282

 

634

 

477

 

Total noninterest expenses

 

1,822

 

1,717

 

3,576

 

3,335

 

 

 

 

 

 

 

 

 

 

 

INCOME BEFORE INCOME TAXES

 

893

 

622

 

1,723

 

1,238

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

241

 

139

 

457

 

233

 

 

 

 

 

 

 

 

 

 

 

NET INCOME

 

$

652

 

$

483

 

$

1,266

 

$

1,005

 

 

 

 

 

 

 

 

 

 

 

Earnings per share-basic and diluted

 

$

0.99

 

$

0.73

 

$

1.93

 

$

1.53

 

 

 

 

 

 

 

 

 

 

 

Average shares outstanding-basic and diluted

 

656,429

 

658,356

 

656,691

 

658,356

 

 

See accompanying notes to condensed consolidated financial statements.

 

4



 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

Six Months ended June 30, 2002 and 2001

(In thousands, except per share data)

(Unaudited)

 

 

 

Common
Stock

 

Additional
Paid-In
Capital

 

Retained
Earnings

 

Treasury
Stock

 

Accumulated
Other
Comprehensive
Income (Loss)

 

Total
Share-
holders’
Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2003

 

$

750

 

$

4,000

 

$

23,491

 

$

(5,270

)

$

2,212

 

$

25,183

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

1,266

 

 

 

1,266

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized net gain on securities available-for-sale, net of reclassifications and tax effects

 

 

 

 

 

400

 

400

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

1,666

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared ($1 per share)

 

 

 

(657

)

 

 

(657

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchase of 1,629 Treasury shares

 

 

 

 

(91

)

 

(91

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2003

 

$

750

 

$

4,000

 

$

24,100

 

$

(5,361

)

$

2,612

 

$

26,101

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2002

 

$

750

 

$

4,000

 

$

23,178

 

$

(5,196

)

$

175

 

$

22,907

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

1,005

 

 

 

1,005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized net gain on securities available-for-sale, net of reclassifications and tax effects

 

 

 

 

 

1,318

 

1,318

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

2,323

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared ($1 per share)

 

 

 

(658

)

 

 

(658

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2002

 

$

750

 

$

4,000

 

$

23,525

 

$

(5,196

)

$

1,493

 

$

24,572

 

 

See accompanying notes to condensed consolidated financial statements.

 

5



 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Six Months ended June 30, 2003 and 2002

(In thousands)

(Unaudited)

 

 

 

2003

 

2002

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

1,266

 

$

1,005

 

Adjustments to reconcile net income to net cash from operating activities

 

 

 

 

 

Change in deferred loan fees

 

(3

)

(3

)

Provision for loan losses

 

60

 

60

 

Depreciation and amortization

 

164

 

149

 

Premium amortization on securities, net

 

96

 

45

 

Net real estate loans originated for sale

 

1,296

 

815

 

Gain on loan sales

 

(493

)

(107

)

Gain on sale/call of securities available-for-sale

 

 

(1

)

Loss on sale of other real estate owned

 

13

 

5

 

Change in interest receivable and other assets

 

55

 

363

 

Change in interest payable and other liabilities

 

(224

)

(1,043

)

Net cash from operating activities

 

2,230

 

1,288

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Proceeds from sales of securities available-for-sale

 

 

252

 

Proceeds from maturities of securities

 

10,204

 

7,230

 

Purchases of securities available-for-sale

 

(180

)

(3,510

)

Proceeds from maturities of certificates of deposit

 

3,062

 

 

Purchases of certificates of deposit

 

(400

)

(3,467

)

Net change in loans receivable

 

(4,177

)

(590

)

Proceeds from sale of other real estate owned

 

166

 

70

 

Property and equipment expenditures

 

(1,357

)

(1,492

)

Net cash from investing activities

 

7,318

 

(1,507

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Change in deposits

 

4,164

 

(3,001

)

Change in federal funds purchased

 

(7,700

)

3,100

 

Change in other borrowings

 

(385

)

400

 

Change in securities sold under agreements to repurchase

 

(1,488

)

(1,966

)

Purchase of treasury shares

 

(91

)

 

Dividends paid

 

(1,316

)

(1,325

)

Net cash from financing activities

 

(6,816

)

(2,792

)

 

 

 

 

 

 

Change in cash and cash equivalents

 

2,732

 

(3,011

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

8,606

 

7,933

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

 

$

11,338

 

$

4,922

 

 

See accompanying notes to condensed consolidated financial statements.

 

6



 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINACIAL STATEMENTS

(Table dollars in thousands)

June 30, 2003 and 2002

 

NOTE 1 – BASIS OF PRESENTATION

 

The accounting policies followed in the preparation of the interim condensed consolidated financial statements are consistent with those used in the preparation of annual consolidated financial statements.  The interim condensed consolidated financial statements reflect all normal and recurring adjustments, which are necessary, in the opinion of management, for a fair statement of results for the interim periods presented.  Results for the three months and six months ended June 30, 2003 are not necessarily indicative of the results that may be expected for the year ended December 31, 2003.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for the interim financial period and with the instructions to Form 10-Q.  Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s annual report on Form 10-K for 2002 filed with the U.S. Securities and Exchange Commission.  The condensed consolidated balance sheet of the Company as of December 31, 2002 has been derived from the audited consolidated balance sheet as of that date.

 

During 2001, First Ottawa Bancshares, Inc. (Company) organized a wholly-owned subsidiary, First Ottawa Financial Corporation, to sell insurance and investment products.  There was no significant activity at this subsidiary through June 30, 2003.

 

NOTE 2 – EARNINGS PER SHARE

 

The number of shares used to compute basic and diluted earnings per share were as follows:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Net income (in thousands)

 

$

652

 

$

483

 

$

1,266

 

$

1,005

 

Weighted Average Shares outstanding

 

656,429

 

658,356

 

656,691

 

658,356

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options

 

 

 

 

 

Shares used to compute diluted earnings per share

 

656,429

 

658,356

 

656,691

 

658,356

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.99

 

$

0.73

 

$

1.93

 

$

1.53

 

Diluted

 

0.99

 

0.73

 

1.93

 

1.53

 

 

7



 

Options to purchase 6,750 shares at June 30, 2003 were not included in the earnings per share calculation as they were anti-dilutive.

 

NOTE 3 – CAPITAL RATIOS

 

At the end of the period,  the Company’s and Bank’s capital ratios were the same and were:

 

 

 

June 30, 2003

 

December 31, 2002

 

 

 

Amount

 

Ratio

 

Amount

 

Ratio

 

 

 

 

 

 

 

 

 

 

 

Total capital (to risk-weighted  assets)

 

$

24,337

 

17.3

%

$

23,542

 

17.5

%

Tier I capital (to risk-weighted assets)

 

23,172

 

16.5

%

22,375

 

16.6

%

Tier I capital (to average assets)

 

23,172

 

9.9

%

22,375

 

9.5

%

 

At June 30, 2003, the Company and the Bank were categorized as well capitalized and management is not aware of any conditions or events since the most recent notification that would change the Company’s or Bank’s categories.

 

8



 

NOTE 4 - DERIVATIVES

 

The Company uses derivatives to fix future cash flows for interest payments on some of its floating rate certificates of deposit.  In this regard, the Company has entered into an interest rate swap with the Federal Home Loan Bank of Chicago to fix the interest rate on a specific certificate of deposit product.  At June 30, 2003, the Company had $2.3 million of certificates of deposit, which mature in 2006, 2007, and 2008, in which it pays the Federal Home Loan Bank a weighted average interest rate of 2.91% and will receive an interest rate from the Federal Home Loan Bank based on the appreciation of the S&P 500 Index.  This interest received from the Federal Home Loan Bank will be paid to the customer.  The assets and liabilities in this transaction are being netted and the expense recorded in interest expense on deposits.

 

In addition to the above, the Company also purchased $5.3 million of certificates of deposit, which are included in the certificates of deposit caption on the consolidated balance sheet.  These investments mature throughout 2006, 2007, and 2008.  The investments that individually do not exceed $100,000 are secured by the FDIC.  Investments that do individually exceed $100,000 are guaranteed by a standby letter of credit issued by the Federal Home Loan Bank of Pittsburgh with an interest rate of 0%.  The initial investment is not at risk, but the return on the investment is based on a calculation of the appreciation in the S&P 500 Index.  The fair value of this embedded derivative is recorded in investment certificates of deposit and the fair value adjustment is included in other income.  At June 30, 2003, the  Bank had allocated $981,000 to this asset and recorded a valuation allowance of $247,000, which is classified with the certificates of deposit caption on the consolidated balance sheet.

 

9



 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis is intended as a review of significant factors affecting the financial condition and results of operations of the Company for the periods indicated.  The discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes.  In addition to historical information, the following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties.  The Company’s actual results could differ significantly from those anticipated in these forward-looking statements as a result of certain factors discussed elsewhere in this report.

 

CRITICAL ACCOUNTING POLICIES

 

The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry.  The Company’s significant accounting policies are described in detail in the notes to the Company’s consolidated financial statements for the year ended December 31, 2002. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective, or complex.

 

Allowance for Credit Losses- The allowance for credit losses provides coverage for probable losses inherent in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for credit losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management’s estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge-offs.

 

The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for homogeneous consumer loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences, and historical losses, adjusted for current trends, for each homogeneous category or group of loans. The allowance for credit losses relating to impaired loans is based on the loan’s

 

10



 

observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan’s effective interest rate.

 

Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures.  The estimates are based upon the Company’s evaluation of imprecision risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment.

 

Mortgage Servicing Rights- Mortgage servicing rights (“MSRs”) associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. For purposes of measuring impairment, the servicing rights are compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates. Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets.

 

Derivatives- As a part of the Company’s funding strategy, derivative financial instruments, all of which are interest rate swap arrangements, are used to reduce exposure to changes in interest rates for certain financial instruments.  These derivatives are accounted for by recognizing the fair value of the contracts on the balance sheet.  The valuation of these derivatives is considered critical because carrying assets and liabilities at fair value inherently results in more financial statement volatility.  The fair values and the information used to record valuation adjustments for the interest rate swaps and related deposit products are provided by third parties.

 

Additionally, the Company has purchased certificate of deposits which contain an equity related embedded derivative component.  The initial investment in the certificate of deposit is not at risk but the return on the investment is based on appreciation in the S&P 500 Index.

 

11



 

Accordingly, the fair value of the embedded derivative is recorded at fair value as an adjustment to the certificate of deposit and interest income.

 

Stock Compensation- Grants under the Company’s  stock incentive plan are accounted for under the provisions of Statement of Accounting Standards (SFAS) No. 123, applying the fair value method and the use of an option pricing model to estimate the value of the options granted. The stock options are granted with an exercise price equal to the market price at the date of grant. Resulting compensation expense,  under  the stock options is measured and recorded based on the estimated value of the options.

 

12



 

CONSOLIDATED FINANCIAL CONDITION

 

Total assets at June 30, 2003 were $235.5 million contrasted to $240.7 million at December 31, 2002, a decrease of $5.2 million, or 2.1%.  This decrease was the result of a decrease in securities available for sale, certificates of deposits at other financial institutions, modest decreases in  loans held for sale and other assets, partially offset by an increase in cash and cash equivalents, loans and bank premises and equipment. Cash increased as a result of an increase in the balance kept at the Federal Reserve as a reserve requirement. This increased reserve was needed due to a spike in municipality transaction accounts during the month of June. Loans increased $4.1 million, primarily due to a $10.1 million increase in the commercial loan portfolio which was partially offset by decreases in the real estate and installment portfolios. The increase in loans was funded by a decrease in securities and certificates of deposits at other financial institutions. Securities available for sale decreased by  $9.5 million while certificates of deposits at other financial institutions decreased by $2.7 million as a result of maturities during the quarter. In addition to a funding source for loans, maturities also were used to pay down federal funds purchased balances. Loans held for sale decreased modestly by $803,000 as customers continued refinancing mortgage loans in reaction to the current rate environment during the first six months of the year.  Premises and equipment increased by $1.2 million due to capital expenditures on land in Yorkville, Illinois and the construction on a new Morris, Illinois branch facility. The Bank anticipates additional 2003 capital expenditures of approximately $150,000 to complete this branch facility, which opened for business on July 21, 2003.

 

The Company has purchased real estate in Yorkville, Illinois with the intention of establishing a full service branch facility in that community. Construction on the facility is anticipated to commence during the second quarter of 2004, with an expected completion date during the first quarter of 2005.

 

Total liabilities at June 30, 2003 were $209.4 million compared to $215.5 million at December 31, 2002, a decrease of $6.1 million, or 2.8%. This decrease was a result of  a decrease in federal funds purchased, repurchase agreements, other borrowings and other liabilities, partially offset by an increase in deposits.  Deposits increased by $4.2 million,  from $193.8 million at December 31, 2002, to $197.9 million at June 30, 2003, primarily due to increases in local municipality and county funds resulting from real estate tax payments.  Federal funds purchased totaled $7.0 million at June 30, 2003, a $7.7 million decrease from December 31, 2002. Other liabilities decreased by $676,000, primarily due to the reduction of dividends payable from $1.3 million as of December 31, 2002, to $657,000 as of June 30, 2003.  Securities sold under agreements to repurchase decreased $1.4 million to $134,000 as of June 30, 2003. This decrease was due to the maturity of an agreement with a local municipality.

 

Total equity was $26.1 million at June 30, 2003 compared to $25.2 million at December 31, 2002.  This increase was the result of $1.3 million of additional retained earnings from net income for the period ended June 30, 2003 and an increase of $400,000, net of tax, in the Company’s investment portfolio due to decreasing interest rates. These increases were offset by a $91,000 purchase of Treasury shares and the declaration of dividends payable in July 2003.

 

13



 

CONSOLIDATED RESULTS OF OPERATIONS

 

Net income for the second quarter of 2003 was $652,000, or $.99 per share, a 35.0% increase compared to $483,000, or $.73 per share, in the second quarter of 2002.  The increase in net income for the quarter was primarily the result of an increase in net interest income of $146,000, and an increase in non-interest income of $230,000. These changes were partially offset by an increase in non interest expense of $105,000, and a $102,000 increase in the provision for income taxes.  This increase in the Company’s tax provision reflected both an increase in pre-tax income and a continued migration from tax exempt to taxable investments held in the securities portfolio.

 

During the six months ended June 30, 2003, net income was $1.27 million, or $1.93 per share, compared to $1.01 million, or $1.53 per share during the first six months of 2002.  This 25.7% increase in net income for the six month period was primarily due to a $394,000 increase in net interest income, or 10.9%, and an increase in non-interest income of $332,000, or 32.5%. Increases in income were partially offset by an increase in non-interest expense of $241,000, or 7.2%, and an increase in income tax expense of $224,000, or 96.1%. This increase in the Company’s tax provision reflected both an increase in pre-tax income and a migration from tax exempt to taxable investments held in the securities portfolio.

 

The annualized return on average assets was 1.08% for the six months ended June 30, 2003, compared to .87% in  2002.   The annualized return on average equity increased to 10.9% for the six months ended June 30, 2003, from 8.78% in 2002.

 

NET INTEREST INCOME

 

Net interest income was $2.0 million and $1.9 million for the three months ended June 30, 2003 and 2002.  Total interest income declined to $3.1 million for the three months ended June 30, 2003 from $3.3 million for the same period ended June 30, 2002, a 6.1% decrease.  This decrease was primarily the result of a decrease in interest income from securities to $1.0 million for the three months ended June 30, 2003 from $1.3 million for the same period a year earlier. This decrease was mitigated by an increase in interest income from investment certificates of deposits of $31,000 and a similar decline in interest expense, to $1.1 million for the three months ended June 30, 2003 from $1.5 million for the same period ended June 30, 2002, a 26.6% decrease.

 

Net interest income for the six months ended June 30, 2003 and 2002 was $4.0 and $3.6 million, respectively. The Company’s net interest margin was 3.73% for the six months ended June 30, 2003 and 3.52% a year earlier.  The yield on average earning assets decreased to 5.84% for the six months ended June 30, 2003 from 6.34% for the same period ended June 30, 2002, a decline of 50 basis points.  This decrease was partially offset by a corresponding decrease in the cost of funds to 2.46% from 3.34% paid for the same period ended June 30, 2002, an 88 basis point decline. These decreases were reflective of  the declining rate environment throughout 2002 and the low rate environment which was sustained during  the first six months of 2003.

 

14



 

PROVISION FOR LOAN LOSSES

 

The provision for loan losses remained constant at $30,000 in the second quarter of 2003 compared to the same period in 2002. As of June 30, 2003, the allowance for loan losses totaled $1.2 million, or 1.02% of total loans, which is a slight decrease from 1.06% as of December 31, 2002.  Nonaccrual loans decreased from $364,000 at December 31, 2002 to $255,000 at June 30, 2003. Nonperforming loans, including nonaccrual loans, decreased $215,000 to $906,000 over the same period.

 

The amounts of the provision and allowance for loan losses are influenced by current economic conditions, actual loss experience, industry trends and other factors, including real estate values in the Company’s market area and management’s assessment of current collection risks within the loan portfolio. Along with other financial institutions, management shares a concern for the possible continued weak economy for the remainder of 2003. Should the current economic climate continue, borrowers may experience difficulty, and the level of non-performing loans, charge- offs, and delinquencies could rise and require increases in the provision. The allowance for loan losses represents management’s estimate of probable incurred losses based on information available as of the date of the financial statements.  The allowance for loan losses is based on management’s evaluation of the collectibility of the loan portfolio, including past loan loss experience, known and inherent risks in the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, and economic conditions.

 

Management has concluded that the allowance for loan losses is adequate at June  30, 2003. However, there can be no assurance that the allowance for loan losses will be adequate to cover all losses.

 

NONINTEREST INCOME

 

The Company’s noninterest income totaled $728,000 for the three months ended June 30, 2003 compared to $498,000 for the same period in 2002, an increase of $230,000 or 46.2%. The increase in noninterest income was primarily due to increased mortgage refinancing activity in the low rate environment. Gains on loan sales to the secondary market increased $226,000 to $273,000 in 2003 compared to 2002. Service charges on deposit accounts increased modestly by $11,000, or 6%, to $194,000. Trust and farm management fee income remained constant at $114,000 in 2003 compared to the same period in 2002.  Other income decreased $6,000 to $147,000, largely due to a decrease in income related to bank owned life insurance policies.

 

For the six months ended June 30, 2003, non-interest income increased by 32.5% or $332,000 to $1.3 million.  Service charges on deposit accounts increased modestly by $17,000, or 4.6%.  Gains on loan sales to the secondary market increased $386,000 due to increased origination and refinancing volume, and other fees and commissions decreased $70,000 due to decreased income related to bank owned life insurance. The increase in gains on sale of loans resulted primarily from the continuing low interest rate environment. While interest rates remain at

 

15



 

historically low levels, management does not anticipate that the level of gains on sale of loans will continue throughout the entire year.

 

NONINTEREST EXPENSE

 

The Company’s non-interest expense was $1.8 and $1.7 million for the three months ended June 30, 2003 and 2002.  Salaries and benefits, which is the largest component of non-interest expense, increased $118,000, or 12.6%, to $1.1 million.  Increases in occupancy and equipment expense of $19,000 and other expenses of $18,000 were offset to some extent by decreases in professional fees of $36,000, supplies expense of $7,000, and advertising expense of $7,000. Increased salaries and benefits were primarily a result of additional personnel hired to staff the Morris, Illinois facilility, which opened in July 2003. The increase in occupancy and equipment expenses was due primarily to increased depreciation on capital expenditures related to the renovation of the main banking facility.  Increases in other expenses resulted from increased mortgage banking expenses of $33,000,  an increase in director life insurance expense of $18,000, and other expenses related to index powered certificates of deposit of $12,000. These increases were partially offset by decreases in other real estate owned expense and losses on sale of other real estate and repossessed autos of $25,000,  in addition to decreased credit card losses of $21,000.

 

For the six months ended June 30, 2003, non-interest expense increased $241,000 to $3.6 million, or 7.2%, compared to the year earlier period.  Salaries and benefits increased $122,000, or 6.4%, to $2.0 million.  Professional fees, supplies expense, data processing, advertising and promotion expense declined $83,000 in total due to a disciplined approach to controlling costs.    Other expenses increased $157,000 primarily due to increases in mortgage banking related expenses, an increase in director life insurance expense and other expenses related to index powered certificates of deposit, which were partially offset by reductions in expenses related to repossessed assets and credit card losses.

 

LIQUIDITY AND CAPITAL RESOURCES

 

The Company’s primary sources of funds are deposits, repurchase agreements, and proceeds from principal and interest payments on loans and securities.  While maturities and scheduled amortization of loans and securities and calls of securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions, and competition.  The Company generally manages the pricing of its deposits to be competitive and to increase core deposit relationships.

 

Liquidity management is both a daily and long-term responsibility of management.  The Company adjusts its investments in liquid assets based upon management’s assessment of  (i) expected loan demand, (ii) expected deposit flows, (iii) yields available on interest-earning deposits and securities, and (iv) the objectives of its asset/liability management program.  Excess liquid assets are invested generally in interest-earning overnight deposits and short- and intermediate-term U.S. government and agency obligations.

 

16



 

The Company’s most liquid assets are cash and short-term investments.  The levels of these assets are dependent on the Company’s operating, financing, lending, and investing activities during any given year.  At June 30, 2003, cash and short-term investments totaled $29.5 million.  The Company has other sources of liquidity if a need for additional funds arises, including securities maturing within one year and the repayment of loans.  The Company may also utilize the sale of securities available-for-sale, federal funds lines of credit from correspondent banks, and borrowings from the Federal Home Loan Bank of Chicago and Bank One.

 

The following table discloses contractual obligations and commercial commitments of the Company as of June 30, 2003:

 

 

 

Total

 

Less Than
1 Year

 

1 – 3 Years

 

4 – 5 Years

 

After
5 Years

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds purchased

 

$

7,000

 

$

7,000

 

$

 

$

 

$

 

Securities sold under agreements to repurchase

 

134

 

134

 

 

 

 

Note payable

 

267

 

267

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

7,401

 

$

7,401

 

$

 

$

 

$

 

 

 

 

Total
Amounts
Committed

 

Less Than
1 Year

 

1 – 3 Years

 

4 – 5 Years

 

Over
5 Years

 

 

 

 

 

 

 

 

 

 

 

 

 

Lines of credit(1)

 

$

13,466

 

$

5,325

 

$

765

 

$

1,122

 

$

6,254

 

Standby letters of credit(1)

 

165

 

165

 

 

 

 

Other commitments to extend credit(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

13,631

 

$

5,490

 

$

765

 

$

1,122

 

$

6,254

 

 


(1)  Represents amounts committed to customers.

 

17



 

IMPACT OF INFLATION AND CHANGING PRICES

 

The financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.  The primary impact of inflation on the operations of the Company is reflected in increased operating costs.  Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature.  As a result, interest rates, generally, have a more significant impact on a financial institution’s performance than does inflation.  Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

 

RECENT DEVELOPMENTS

 

On July 18, 2003, the Company announced that the Bank entered into a definitive agreement with First Midwest Bancorp, Inc., to purchase the two banking branches of First Midwest Bank located in Streator, Illinois.   The transaction will consist of approximately $73,000,000 in deposits and approximately $15,000,000 in loans as well as the two branch locations in Streator.  The transaction is projected to close in the fourth quarter, following receipt of regulatory approval.

 

SAFE HARBOR STATEMENT

 

This document contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company.  Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions.  Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

 

The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain.  Factors which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, the following:

                                         The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company’s assets.

 

18



 

                                         The economic impact of past and any future terrorist attacks, acts of war or threats thereof and the response of the United States to any such threats and attacks.

 

                                         The effects of, and changes in, federal, state and local laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters.

 

                                         The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company’s assets) and the policies of the Board of Governors of the Federal Reserve System.

 

                                         The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector.

 

                                         The inability of the Company to obtain new customers and to retain existing customers.

 

                                         The timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet.

 

                                         Technological changes implemented by the Company and by other parties, including third party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to the Company and its customers.

 

                                         The ability of the Company to develop and maintain secure and reliable electronic systems.

 

                                         The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner.

 

                                         Consumer spending and saving habits which may change in a manner that affects the Company’s business adversely.

 

                                         Business combinations and the integration of acquired businesses which may be more difficult or expensive than expected.

 

                                         The costs, effects and outcomes of existing or future litigation.

 

                                         Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board.

 

19



 

                                         The ability of the Company to manage the risks associated with the foregoing as well as anticipated.

 

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.  Additional information concerning the Company and its business, including other factors that could materially affect the Company’s financial results, is included in the Company’s filings with the Securities and Exchange Commission.

 

20



 

ITEM 3:   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company’s overall interest rate sensitivity is demonstrated by net income analysis and “Gap” analysis.  Net income analysis measures the change in net income in the event of hypothetical changes in interest rates.  This analysis assesses the risk of change in net income in the event of sudden and sustained 2.0% increases and decreases in market interest rates.  The tables below present the Company’s projected changes in annualized net income for the various rate shock levels at June 30, 2003 and June 30, 2002.

 

 

 

2003 Net Income

 

 

 

Amount

 

Change

 

Change

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

+200 bp

 

$

2,194

 

$

(59

)

(2.62

)%

Base

 

2,253

 

 

 

-200 bp

 

2,049

 

(204

)

(9.03

)%

 

 

 

2002 Net Income

 

 

 

Amount

 

Change

 

Change

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

+200 bp

 

$

2,102

 

$

(253

)

(10.7

)%

Base

 

2,355

 

 

 

-200 bp

 

2,571

 

216

 

9.2

%

 

As shown above, at June 30, 2003, the effect of an immediate 200 basis point increase in interest rates would decrease the Company’s net income by 2.62% or approximately $59,000.  The effect of an immediate 200 basis point decrease in rates would decrease the Company’s net interest income by 9.03% or approximately $204,000.  However, the Company does not anticipate market interest rates decreasing an additional 200 basis points, so these results may not be acheivable.  Net income sensitivity has decreased since June 30, 2002.

 

21



 

ITEM 4:   CONTROLS AND PROCEDURES

 

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of June 30, 2003. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls.

 

22



 

PART II

 

ITEM 1.                    LEGAL PROCEEDINGS

 

There are no material pending legal proceedings to which the Company or its subsidiaries are a party other than ordinary routine litigation incidental to their respective businesses.

 

ITEM 2.                    CHANGES IN SECURITIES

 

None

 

ITEM 3.                    DEFAULTS UPON SENIOR SECURITIES

 

None

 

ITEM 4.                    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

Election of Directors

 

At the Annual Meeting of Stockholders on May 21, 2003 Bradley J. Armstrong,  Donald J. Harris, and Thomas P. Rooney were elected to serve as Class I directors until the 2006 Annual Meeting of Stockholders. Joachim J. Brown, John L. Cantlin and Patty Godfrey continue to serve as Class II directors with a term expiring in 2004 and Thomas E. Haeberle, Erika L Schmidt and William J Walsh continue to serve as Class III directors with a term expiring in 2005.  The voting for each Class I director was as follows:

 

 

 

Votes For

 

Votes Withheld

 

Bradley J. Armstrong

 

525,517

 

13,386

 

Donald J. Harris

 

529,363

 

9,540

 

Thomas P. Rooney

 

522,677

 

16,226

 

 

ITEM 5.                    OTHER INFORMATION

 

None

 

ITEM 6.                    EXHIBITS AND REPORTS ON FORM 8-K

 

Exhibits

 

31.1            Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)

31.2            Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)

 

23



 

32.1      Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2    Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

Reports on Form 8-K

 

A report on Form 8-K was filed on April 25, 2003 pursuant to Item 12, which reported, in the form of a press release, the Corporation’s financial results for the quarter ended March 31, 2003.

 

A report on Form 8-K was filed on May 1, 2003 under Item 4, which reported the Company’s change in independent public accountants.

 

A report on Form 8-K was filed on July 18, 2003 pursuant to Item 5, which reported, in the form of a press release, that the Corporation’s subsidiary bank, First National Bank of Ottawa, entered into a definitive agreement with First Midwest Bank to purchase two banking branches of First Midwest Bank located in Streator, Illinois.

 

A report on Form 8-K was filed on July 25, 2003 pursuant to Item 12, which reported, in the form of a press release, the Corporation’s financial results for the quarter ended June 30, 2003.

 

 

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.

 

 

 

 

 

 

FIRST OTTAWA BANCSHARES, INC.

 

 

 

 

(Registrant)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

/S/ JOACHIM J. BROWN

 

 

 

 

 

Joachim J. Brown

 

 

 

 

President (Chief Executive Officer)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

/S/ VINCENT G. EASI

 

 

 

 

 

Vincent G. Easi

 

 

 

 

Chief Financial Officer

 

24