Total non-interest expense for the third quarter of 2008 was $7,628,000, an increase of $241,000 (or 3.3%) from $7,387,000 in the third quarter of 2007. The largest increase was in salaries and employee benefits which went up $202,000, or 4.7%. Annualized non-interest expense as a percentage of total average assets decreased to 2.72% for the third quarter of 2008, compared to 2.85% for the same period in 2007, continuing a positive trend in the effort to control operating expenses as the Corporation grows and expands. The annualized percentage of 2.72% is the lowest the Corporation has reported since 1988. Year-to-date non-interest expense for the first three-quarters of 2008 was $22,696,000, an increase of $644,000 (or 2.9%) from the $22,052,000 for the same period in 2007. Again, the majority of the increase is in salaries and employee benefits which rose $508,000 (or 4.0%), due to
an increase in the number of employees. Annualized non-interest expense as a percentage of total average assets also decreased to 2.77% for the first nine months of 2008, compared to 2.87% for the same period in 2007.
INCOME TAXES
Income tax expense totaled $658,000 for the third quarter of 2008, as compared to $408,000 for the third quarter of 2007. The effective tax rate was 23.1% for the three month period ended September 30, 2008 and 19.0% for the three month period ended September 30, 2007. Income tax expense totaled $1,836,000 for the first nine months of 2008, as compared to $806,000 for the first nine months of 2007. The effective tax rate was 22.6% for the nine month period ended September 30, 2008 and 14.6% for the nine month period ended September 30, 2007. The higher effective tax rate in 2008 is due to a higher pre-tax income.
ANALYSIS OF FINANCIAL CONDITION
Total assets at September 30, 2008 increased to $1,123,572,000 from $1,080,702,000 at December 31, 2007 (an increase of $42.9 million or 4.0%). Investment balances totaled $245,791,000 at September 30, 2008, compared to $232,673,000 at December 31, 2007 (an increase of $13.1 million or 5.6%). Total deposits increased to $937,446,000 at September 30, 2008 from $891,407,000 at December 31, 2007 (an increase of $46.0 million or 5.2%). Comparing categories of deposits at September 30, 2008 to December 31, 2007, interest-bearing demand deposits increased $18.3 million (or 7.6%), time deposits increased $31.3 million (or 6.4%), and savings deposits increased $1.5 million (or 2.5%), while demand deposits decreased $5.0 million (or 4.9%). Borrowings, consisting of customer repurchase agreements, notes payable, treasury, tax, and loan (TT&L) deposits, and Federal Home Loan Bank
advances, decreased from $109,089,000 at December 31, 2007 to $107,765,000 at September 30, 2008 (a decrease of $1.3 million or 1.2%).
Loan balances, net of unearned interest, increased to $762,109,000 at September 30, 2008, compared to $722,647,000 at December 31, 2007 (an increase of $39.5 million or 5.5%). Non-performing loans increased to $16,383,000 or 2.15% of net loans at September 30, 2008, as compared to $7,434,000 or 1.03% of net loans at December 31, 2007. Although non-performing loans have increased in terms of total dollars since year-end, the majority of the increase occurred in the first quarter of 2008 and is comprised of two larger credits with substantial collateral. All loans are individually evaluated and management continues to maintain adequate reserves in the allowance for loan losses.
19
ASSET QUALITY
For the nine months ended September 30, 2008, the subsidiary bank charged off $915,000 of loans and had recoveries of $141,000, compared to charge-offs of $569,000 and recoveries of $187,000 during the nine months ended September 30, 2007. The allowance for loan losses is based on factors that include the overall composition of the loan portfolio, types of loans, underlying collateral, past loss experience, loan delinquencies, substandard and doubtful credits, and such other factors that, in managements reasonable judgment, warrant consideration. The adequacy of the allowance is monitored monthly. At September 30, 2008, the allowance was $3,842,000 which is 23.5% of non-performing loans and 0.50% of total loans, compared with $3,248,000 which was 43.7% of non-performing loans and 0.45% of total loans at December 31, 2007. Although the balance of non-performing loans has increased,
management has reviewed these loans and deemed they are adequately collateralized.
At September 30, 2008 non-accrual loans were $15,167,000 compared to $7,361,000 at December 31, 2007. Impaired loans totaled $10,903,000 at September 30, 2008 compared to $4,523,000 at December 31, 2007. The total amount of loans ninety days or more past due and still accruing interest at September 30, 2008 was $1,215,000 compared to $73,000 at December 31, 2007. There was a specific loan loss reserve of $140,000 established for impaired loans as of September 30, 2008 compared to a specific loan loss reserve of $207,000 at December 31, 2007. PNBCs management analyzes the allowance for loan losses monthly and believes the current level of allowance is adequate to meet probable losses as of September 30, 2008.
CAPITAL RESOURCES
Federal regulations require all financial institutions to evaluate capital adequacy by the risk-based capital method, which makes capital requirements more sensitive to the differences in the level of risk assets. At September 30, 2008, total risk-based capital of PNBC was 8.44%, compared to 8.41% at December 31, 2007. The Tier 1 capital ratio decreased slightly from 6.16% at December 31, 2007, to 6.14% at September 30, 2008. Total stockholders' equity to total assets at September 30, 2008 decreased to 6.17% from 6.35% at December 31, 2007.
The Company is currently evaluating the possibility of raising capital and the opportunities under the recently announced Capital Purchase Program (CPP) of the U.S. Department of the Treasury (the Treasury). Under the CPP, qualified U.S. banking organizations whose applications to participate are approved would sell preferred stock and grant warrants purchasing common stock to the Treasury. The Company is currently evaluating whether it will apply for participation in the CPP and any effects participation would have on the Companys capital structure. There are a variety of factors to be evaluated, including the cost of the capital to be provided and restrictions that would be imposed on the Company by participating in the CPP (such as restrictions on dividend increases and stock buy-backs), as well as the significant opportunities of the program. The Company
does not expect to make further announcements with respect to participation in the CPP unless and until it decides to participate.
20
LIQUIDITY
Liquidity is measured by a financial institutions ability to raise funds through deposits, borrowed funds, capital, or the sale of assets. Additional sources of liquidity include cash flow from the repayment of loans and the maturity of investment securities. Major uses of cash include the origination of loans and purchase of investment securities. Cash flows used in investing activities, offset by those provided by financing and operating activities, resulted in a net decrease in cash and cash equivalents of $9,415,000 from December 31, 2007 to September 30, 2008. This decrease was primarily due to a net increase in loans and investments, offset by an increase in deposits. For more detailed information, see PNBCs Consolidated Statements of Cash Flows.
In response to the overall economy, the Company has made a concerted effort during 2008 to increase its available liquidity sources to levels which management believes are appropriate given the current state of the economy and the banking industry. As a result, the remaining borrowing sources available to the Company have increased to $95.6 million as of September 30, 2008 compared to $60.9 million as of December 31, 2007.
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Corporation generates agribusiness, commercial, mortgage and consumer loans to customers located primarily in North Central Illinois. The Corporations loans are generally secured by specific items of collateral including real property, consumer assets and business assets. Although the Corporation has a diversified loan portfolio, a substantial portion of its debtors ability to honor their contracts is dependent upon economic conditions in the agricultural industry.
In the normal course of business to meet the financing needs of its customers, the subsidiary bank is party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the subsidiary bank has in particular classes of financial instruments.
The subsidiary banks exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The subsidiary bank uses the same credit policies in making commitments and conditional obligations as they do for on-balance-sheet instruments. At September 30, 2008, commitments to extend credit and standby letters of credit were approximately $162,998,000 and $6,597,000 respectively.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The subsidiary bank evaluates each customers creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, by the subsidiary bank upon extension of credit is based on managements credit evaluation of the counterparty. Collateral held varies, but may include real estate, accounts receivable, inventory, property, plant and equipment, and income-producing properties.
21
Standby letters of credit are conditional commitments issued by the subsidiary bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers. The subsidiary bank secures the standby letters of credit with the same collateral used to secure the loan. The maximum amount of credit that would be extended under standby letters of credit is equal to the off-balance sheet contract amount. The standby letters of credit have terms that expire in one year or less.
MERGERS AND ACQUISITIONS
On February 23, 2007, the Company completed the acquisition, for $10.2 million in cash, of the fixed assets and loans while assuming the deposit liabilities of the Plainfield, Illinois branch of HomeStar Bank in order to expand its market presence in this area. The Company financed the purchase price with existing cash and federal funds sold on the balance sheet at the time of purchase. Since the completion of the merger, the Plainfield location operates as a branch of the Companys subsidiary bank.
The transaction has been accounted for as a purchase, and the results of operations of Plainfield since the acquisition date have been included in the consolidated financial statements.
LAND HELD FOR SALE
In 2004, the Corporation purchased approximately 14 acres of land in Aurora, Illinois in anticipation of the construction of a new branch facility. Construction of the facility was completed in May, 2006 with the remaining acreage sub-divided in two lots and the necessary infrastructure completed. These lots, with a cost basis of $1,344,000, were determined to be held for sale as of March 31, 2007. A real estate appraisal has been completed indicating the market value of each lot to be approximately $2,000,000. Accordingly, these lots were removed from the land balance and are now shown on the Corporations balance sheet as land held-for-sale, at the lower of cost or market.
LEGAL PROCEEDINGS
There are various claims pending against the Corporations subsidiary bank, arising in the normal course of business. Management believes, based upon consultation with legal counsel, that liabilities arising from these proceedings, if any, will not be material to the Corporations financial position or results of operation.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There has been no material change in market risk since December 31, 2007, as reported in PNBCs 2007 Annual Report on Form 10-K.
EFFECTS OF INFLATION
The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America and practices within the banking industry which require the measurement of financial condition and operating results in terms of historical dollars, without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institutions performance than the effects of general levels of inflation.
22
PRINCETON NATIONAL BANCORP, INC. AND SUBSIDIARY
The following table sets forth (in thousands) details of average balances, interest income and expense, and resulting annualized yields/costs for the Corporation for the periods indicated, reported on a fully taxable equivalent basis, using a tax rate of 34%.
|
|
Nine Months Ended, September 30, 2008
|
|
Nine Months Ended, September 30, 2007
|
|
|
|
Average
Balance
|
|
Interest
|
|
Yield/
Cost
|
|
Average
Balance
|
|
Interest
|
|
Yield/
Cost
|
|
Average Interest-Earning Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing deposits
|
|
$
|
2,872
|
|
$
|
46
|
|
|
2.14%
|
|
$
|
2,208
|
|
$
|
85
|
|
|
5.15%
|
|
Taxable investment securities
|
|
|
142,115
|
|
|
5,063
|
|
|
4.76%
|
|
|
145,095
|
|
|
5,211
|
|
|
4.80%
|
|
Tax-exempt investment securities
|
|
|
93,179
|
|
|
4,616
|
|
|
6.62%
|
|
|
100,568
|
|
|
4,942
|
|
|
6.57%
|
|
Federal funds sold
|
|
|
4,222
|
|
|
66
|
|
|
2.09%
|
|
|
6,414
|
|
|
246
|
|
|
5.13%
|
|
Net loans
|
|
|
725,138
|
|
|
36,182
|
|
|
6.66%
|
|
|
657,233
|
|
|
36,949
|
|
|
7.52%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
|
967,526
|
|
|
45,973
|
|
|
6.35%
|
|
|
911,518
|
|
|
47,433
|
|
|
6.96%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average non-interest earning assets
|
|
|
125,445
|
|
|
|
|
|
|
|
|
116,726
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total average assets
|
|
$
|
1,092,971
|
|
|
|
|
|
|
|
$
|
1,028,244
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Interest-Bearing Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing demand deposits
|
|
$
|
255,116
|
|
$
|
3,523
|
|
|
1.84%
|
|
$
|
233,016
|
|
$
|
4,951
|
|
|
2.84%
|
|
Savings deposits
|
|
|
62,229
|
|
|
52
|
|
|
0.11%
|
|
|
64,890
|
|
|
202
|
|
|
0.42%
|
|
Time deposits
|
|
|
495,282
|
|
|
14,675
|
|
|
3.96%
|
|
|
478,101
|
|
|
17,624
|
|
|
4.93%
|
|
Interest-bearing demand notes issued to the U.S. Treasury
|
|
|
937
|
|
|
14
|
|
|
1.99%
|
|
|
1,072
|
|
|
39
|
|
|
4.86%
|
|
Federal funds purchased
|
|
|
6,075
|
|
|
124
|
|
|
2.72%
|
|
|
759
|
|
|
31
|
|
|
5.46%
|
|
Customer repurchase agreements
|
|
|
36,196
|
|
|
543
|
|
|
2.00%
|
|
|
31,663
|
|
|
1,102
|
|
|
4.65%
|
|
Advances from Federal Home Loan Bank
|
|
|
15,530
|
|
|
406
|
|
|
3.49%
|
|
|
6,975
|
|
|
271
|
|
|
5.19%
|
|
Trust preferred securities
|
|
|
25,000
|
|
|
1,065
|
|
|
5.69%
|
|
|
25,000
|
|
|
1,065
|
|
|
5.70%
|
|
Note payable
|
|
|
15,043
|
|
|
506
|
|
|
4.50%
|
|
|
10,575
|
|
|
569
|
|
|
7.19%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-bearing liabilities
|
|
|
911,408
|
|
|
20,908
|
|
|
3.06%
|
|
|
852,051
|
|
|
25,854
|
|
|
4.06%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net yield on average interest-earning assets
|
|
|
|
|
$
|
25,065
|
|
|
3.46%
|
|
|
|
|
$
|
21,579
|
|
|
3.17%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average non-interest-bearing liabilities
|
|
|
112,431
|
|
|
|
|
|
|
|
|
110,926
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average stockholders' equity
|
|
|
69,132
|
|
|
|
|
|
|
|
|
65,267
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total average liabilities and stockholders' equity
|
|
$
|
1,092,971
|
|
|
|
|
|
|
|
$
|
1,028,244
|
|
|
|
|
|
|
|
The following table reconciles tax-equivalent net interest income (as shown above) to net interest income as reported on the Consolidated Statements of Income.
|
|
For the Nine Months Ended
September 30,
|
|
|
|
2008
|
|
2007
|
|
Net interest income as stated
|
|
$
|
23,443
|
|
$
|
19,829
|
|
Tax equivalent adjustment-investments
|
|
|
1,569
|
|
|
1,680
|
|
Tax equivalent adjustment-loans
|
|
|
53
|
|
|
70
|
|
|
|
|
|
|
|
|
|
Tax equivalent net interest income
|
|
$
|
25,065
|
|
$
|
21,579
|
|
23
Schedule 7.
Controls and Procedures
(a)
|
Disclosure controls and procedures. We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2008. Our disclosure controls and procedures are the controls and other procedures that we designed to ensure that we record, process, summarize and report in a timely manner the information we must disclose in reports that we file with or submit to the SEC. Tony J. Sorcic, President and Chief Executive Officer, and Todd D. Fanning, Senior Vice-President and Chief Financial Officer, reviewed and
participated in this evaluation. Based on this evaluation, Messrs. Sorcic and Fanning concluded that, as of the date of their evaluation, our disclosure controls were effective.
|
(b)
|
Internal controls. There have not been any significant changes in our internal accounting controls or in other factors during the quarter ended September 30, 2008 that could significantly affect those controls.
|
24
INDEX TO EXHIBITS
Exhibit
Number
|
Exhibit
|
|
|
31.1
|
Certification of Tony J. Sorcic required by Rule 13a-14(a).
|
|
|
31.2
|
Certification of Todd D. Fanning required by Rule 13a-14(a).
|
|
|
32.1
|
Certification of Tony J. Sorcic required by Rule 13a-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.
|
|
|
32.2
|
Certification of Todd D. Fanning required by Rule 13a-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.
|
25
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