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Stockholders
3: EX-21 List of Subsidiaries HTML 6K
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1601 North Lewis Avenue Waukegan, Illinois60085
(847) 244-6000
(Address, including zip code, and telephone number, including area code, of principal executive office)
Securities registered pursuant to Section 12(g) of the Act
Common Stock $.40 par value
(Title of Class)
Indicate by check if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Exchange Act. YES o NO þ
Indicate by check if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Securities Exchange Act. YES o NO þ
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 þ NO o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, or a non-accelerarted
filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated
filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer þ Nonaccelerated filer o
Indicate by check whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
YES o NO þ
The aggregate market value of the voting shares held by nonaffiliates of the Registrant is
$73,512,833, as of June 30, 2005, based on the last sale price of the Registrant’s common stock on
June 30, 2005 of $27.15 per share. Solely for the purpose of this computation, it has been assumed
that executive officers and directors of the Registrant are “affiliates”.
Northern States Financial Corporation (the “Company”) cautions readers of this report that a
number of important factors could cause the Company’s actual results subsequent to December 31,2005 to differ materially from those expressed in forward-looking statements. Statements contained
in this report that are not historical facts may constitute forward-looking statements (within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended), which involve
significant risks and uncertainties. The Company intends such forward-looking statements to be
covered by the safe harbor provisions for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995, and is including this statement for purposes of invoking
these safe harbor provisions. Forward-looking statements, which are based on certain assumptions
and describe future plans, strategies and expectations of the Company, are generally identifiable
by the use of the words “believe,”“expect,”“intend,”“anticipate,”“estimate,”“project,”“plan,”
or similar expressions. The Company’s ability to predict results or the actual effect of future
plans or strategies is inherently uncertain and actual results may differ from those predicted. The
Company undertakes no obligation to update these forward-looking statements in the future. Factors
that could cause actual results to differ from those predicted and could affect the future
prospects of the Company and its subsidiaries include, but are not limited to, the potential for
further deterioration in the credit quality of the Company’s loan and lease portfolios, uncertainty
regarding the Company’s ability to ultimately recover on the surety bonds relating to the equipment
lease pools currently on nonaccrual status, unanticipated changes in interest rates, general
economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S.
Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or
composition of the Company’s investment portfolios, demand for loan products, deposit flows,
competition, demand for financial services in the Company’s market area, and changes in accounting
principles, policies and guidelines. These risks and uncertainties should be considered in
evaluating forward-looking statements.
The Company is a bank holding company organized in 1984 under the laws of Delaware, for the
purpose of becoming the parent bank holding company of the Bank of Waukegan. In 1991, the Company
acquired First Federal Bank, fsb (“First Federal” or the “Thrift”). In 1998 the Thrift was merged
with and into the Bank of Waukegan. On January 5, 2004, Northern States Financial Corporation
acquired First State Bank of Round Lake (“First State Bank”). On November 10, 2005 First State
Bank was merged with and into the Bank of Waukegan and the name of the merged entity was changed to
NorStates Bank (the “Bank’).
The Company is registered under the Bank Holding Company Act of 1956, as amended, and owns all
the outstanding stock of the Bank and First State Bank. At December 31, 2005, the Company had 356
registered stockholders of record, 4,295,105 shares of Common Stock outstanding, and total
consolidated assets of approximately $722 million. Aside from the stock of the Bank and cash, the
Company has no other substantial assets.
As a large, community-oriented, independent banking organization in Lake County in the State
of Illinois, the Company is well positioned to take advantage of the growth in communities in Lake
County, Illinois and the communities in the surrounding counties. The Company has continuously
served the community since 1919 when First Federal was chartered. The Company’s local management,
coupled
with its long record of service, has allowed it to compete successfully in the banking market.
The Company operates traditional community banks with conveniently located branches and a
professional staff.
Neither the Company nor the Bank has material patents, licenses or franchises except the
banking charters, which permit them to engage in banking and offer trust services pursuant to
applicable law.
The principal business of the Company, operating through the Bank, consists of attracting
deposits and securities sold under repurchase agreements from the general public, making commercial
loans, loans secured by residential and commercial real estate and consumer loans, and operating
mortgage banking and trust businesses.
The Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and all amendments to those reports are currently made available free of charge via the
Company’s internet website (www.nsfc.net) as soon as practicable after such material is
electronically filed with, or furnished to, the Securities and Exchange Commission (the
“Commission”).
Subsidiary Operations
NorStates Bank was chartered as a state bank in 1962 and is located in Waukegan, Illinois.
Waukegan is located approximately 37 miles north of Chicago, Illinois and has a population of
approximately 90,000. At December 31, 2005, NorStates Bank had total assets of approximately
$721.5 million, loans and leases of approximately $400.5 million, deposits of approximately $562.7
million and stockholder’s equity of approximately $72.4 million. The Bank has three branch offices
located in Waukegan, one office located in Antioch, Illinois, one office located in Gurnee,
Illinois, one office located in Winthrop Harbor, Illinois, one office in Round Lake Beach, Illinois
and one office in Round Lake, Illinois.
The Bank provides services to individuals, businesses and local governmental units in
northeastern Illinois and southeastern Wisconsin.
The Bank’s full service banking business includes the customary consumer and commercial
products and services which banks provide, including the following: demand, savings, and time
deposits, securities sold under repurchase agreements and individual retirement accounts;
commercial, consumer and real estate lending, including installment loans, home equity loans, lines
of credit and overdraft checking; safe deposit operations; trust services; and a variety of
additional services tailored to the needs of individual customers, such as the sale of traveler’s
checks, money orders, cashier’s checks and foreign currency, direct deposit, and other special
services.
Commercial and consumer loans are made to corporations, partnerships and individuals,
primarily on a secured basis. Commercial lending focuses on business, capital, construction,
inventory and real estate. The bank also make direct and indirect loans to consumers and
commercial customers. The Bank also originates and services commercial and residential mortgages.
The Bank’s trust department acts as executor, administrator, trustee, conservator, guardian,
custodian and agent. At December 31, 2005, the Trust Department had assets under management or
custodial arrangements of approximately $140 million. Its office is located at the Bank’s branch
office at 3233 Grand Avenue, Waukegan, Illinois.
During 2002 the Bank formed Northern States Community Development Corporation (“NSCDC”), a
wholly-owned subsidiary of the Bank. NSCDC assets consist of cash and of other real estate owned.
This subsidiary was formed for the purpose of developing and selling a parcel of other real estate
owned as part of the City of Waukegan’s lakefront development plans. At December 31, 2005, assets
of NSCDC totaled $1.8 million, which includes cash of $38,000, and the property valued at
$1,783,000, and were consolidated into the NorState Bank’s financial statements.
COMPANY OPERATING STRATEGY
Corporate policy, strategy and goals are established by the Board of Directors of the Company.
Pursuant to the Company’s philosophy, the Company also establishes operational and administrative
policies for the Bank. Within this framework, the Bank focuses on providing personalized services
and quality products to customers to meet the needs of the communities in which they operate.
As part of its community banking approach, the Company encourages the officers of the Bank to
actively participate in community organizations. In addition, within credit and rate of return
parameters, the Company attempts to ensure that the Bank meets the credit needs of the community.
In addition, the Bank invests in local municipal securities.
Lending Activities
General - The Bank provides a range of commercial and retail lending services to corporations,
partnerships and individuals, including, but not limited to, commercial business loans, commercial
and residential real estate construction and mortgage loans, consumer loans, revolving lines of
credit and letters of credit. The installment loan department makes direct and indirect loans to
consumers and commercial customers. The mortgage department originates and services commercial and
residential mortgages. The Bank’s mortgage banking operation originates mortgage loans on behalf
of other financial institutions that fund and own the loans.
The Bank aggressively markets its services to qualified borrowers in both the commercial and
consumer sectors. The Bank’s commercial lending officers actively solicit the business of new
companies entering the surrounding market as well as long-standing members of the business
community. Through personalized professional service and competitive pricing, the Bank has been
successful in attracting new commercial lending customers. At the same time, the Bank actively
advertises its consumer loan products and continually attempt to make its lending officers more
accessible.
Commercial Loans - The Bank seeks new commercial loans in its market area and much of the
increase in these loans in recent years can be attributed to the successful solicitation of new
business. The Bank has also purchased commercial loans or portions of commercial loans from other
financial institutions and investment banking firms. The Bank’s lending areas of emphasis include,
but are not limited to, loans to manufacturers, building contractors, developers, hotels, business
services companies and retailers. The Bank provides a wide range of commercial business loans,
including lines of credit for working capital purposes and term loans for the acquisition of
equipment and other purposes. Collateral for these loans generally includes accounts receivable,
inventory, equipment and real estate. Loans may be made on an unsecured basis where warranted by
the overall financial condition of the borrower. Terms of commercial business loans generally
range from one to five years. The majority of the Bank’s commercial business loans have floating
interest rates or re-price within one year. The primary repayment risk for commercial loans is the
failure of the business due to economic or financial factors. In most cases, the Bank
collateralizes these loans and/or taken personal guarantees to help assure repayment.
The Bank regularly provides financing to developers who have demonstrated a favorable record
of performance for the construction of homes. Sales of these homes have remained very strong in
Lake County due to the continued growth in population.
Mortgage Banking - From 1991 until 1998, the Bank funded conforming long-term residential
mortgage loans and sold them in the secondary market with servicing retained. Since 1998, the
Bank’s mortgage banking operation originates mortgage loans for a fee on behalf of other financial
institutions that fund and own the loans. The Bank does not retain servicing on these originated
mortgage loans. The Bank has a portfolio of serviced mortgages of approximately $3.8 million at
December 31, 2005.
Consumer Lending - The Bank’s consumer lending department provide all types of consumer loans
including motor vehicle, home improvement, home equity, unsecured loans and small personal credit
lines.
Trust Activities
The Bank’s trust and investment services department has been providing trust services to the
community for over 20 years. As of December 31, 2005, the Bank had approximately $140 million of
trust assets under management and provides a full complement of trust services for individuals and
corporations, including land trust services.
To build on the trust department’s mainstay of personal trust administration, the trust
department’s focus is in two major areas: (i) investment management for individuals and (ii)
administration and investment services for employee benefit plans.
COMPETITION
The Company and its banking subsidiary encounter significant competition in all of their
activities. The Chicago metropolitan area and suburban Lake County have a high density of
financial institutions, many of which are significantly larger and have substantially greater
financial resources than the Company and its subsidiaries, and all of which are competitors of the
Company and its subsidiaries to varying degrees. In Lake County, Illinois there are 46 commercial
banks and savings institutions. The Company and its subsidiary are subject to competition from
various financial institutions, including state and national banks, state and federal savings
associations, credit unions, certain non-banking consumer lenders, and other companies or firms,
including brokerage firms and mortgage brokers, that provide similar services in northeastern
Illinois. The Bank also competes with money market funds and with insurance companies with respect
to its individual retirement accounts.
Competition has increased as a result of the continuing reduction in the effective
restrictions on the interstate operations of financial institutions. The Company and its
subsidiary face additional competition for deposits from short-term money market mutual funds and
other corporate and government securities funds. Since the elimination of federal interest rate
controls on deposits, the competition from other financial institutions for deposits has increased.
The primary factors influencing competition for deposits are interest rates, service, and
convenience of office locations. The Company competes for loans principally through the range and
quality of the services it provides, interest rate and loan fee terms. The Company believes that
its long-standing presence in the community and personal service philosophy enhances its ability to
compete favorably in attracting and retaining individual and business customers. The Company
actively solicits
deposit-related clients and competes for deposits by offering customers personal attention,
professional service and competitive interest rates.
EMPLOYEES
The Company and its subsidiaries employed 181 full-time equivalent employees as of December31, 2005. None of the Company’s employees is represented by any collective bargaining group. The
Company offers a variety of employee benefits and management considers its employee relations to be
good.
GOVERNMENTAL MONETARY POLICY AND ECONOMIC CONDITIONS
The earnings and growth of the Company are affected not only by general economic conditions,
but also by the fiscal and monetary policies of the federal government and its agencies. In
particular, the Federal Reserve Board regulates monetary and credit conditions and interest rates
in order to influence general economic conditions, primarily through open-market operations in U.S.
Government securities, varying the discount rate on bank borrowings, and setting reserve
requirements against bank deposits.
These policies have a significant influence on overall growth and distribution of the
Company’s loans, investments and deposits, and affect interest rates charged on loans and earned on
investments or paid for deposits. The monetary policies of the Federal Reserve Board are expected
to continue their substantial influence on the operating results of Bank. The general effect, if
any, of such policies upon the future business and earnings of the Company and its subsidiary
cannot accurately be predicted.
SUPERVISION AND REGULATION
Financial institutions and their holding companies are extensively regulated under federal and
state laws. As a result, the business, financial condition and prospects of the Company and its
bank subsidiary can be materially affected not only by management decisions and general economic
conditions, but also by applicable statutes and regulations and other regulatory pronouncements and
policies promulgated by regulatory agencies with jurisdiction over the Company and the Bank, such
as the Board of Governors of the Federal Reserve System (“FRB”), the Federal Deposit Insurance
Corporation (“FDIC”) and the Illinois Department of Financial and Professional Regulation. Such
statutes, regulations and other pronouncements and policies are intended to protect depositors and
the FDIC’s deposit insurance funds, rather than stockholders.
The Company and the Bank are “affiliates” within the meaning of the Federal Reserve Act so
that the Bank is subject to certain restrictions with respect to loans to the Company and certain
other transactions with the Company or involving its securities.
The Company is a bank holding company subject to the Bank Holding Company Act of 1956, as
amended (the “Act”), and to regulation by the FRB. The Act limits the activities which may be
engaged in by bank holding companies and their nonbank subsidiaries, with certain exceptions, to
those so closely related to banking or managing or controlling banks as to be a proper incident
thereto. Also, under the Act and the FRB’s regulations, a bank holding company, as well as certain
of its subsidiaries, are prohibited from engaging in certain tie-in arrangements in connection with
any extension of credit or provision of any property or services. The Act also prohibits bank
holding companies from acquiring substantially all the assets of or owning more than 5% of the
voting shares of any bank or nonbanking company, which is not already majority owned, without the
prior approval of the FRB.
The Gramm-Leach-Bliley Act (the “GLB Act”), signed into law on November 12, 1999,
significantly changed financial services regulation by expanding permissible nonbanking activities
of bank holding companies and removing barriers to affiliations among banks, insurance companies,
securities firms and other financial services entities. These new activities can be conducted
through a holding company structure or, subject to certain limitations, through a financial
subsidiary of a bank. The GLB Act repeals the anti-affiliation provisions of the Glass-Stegall Act
and revises the Act. The GLB Act permits qualifying holding companies, called “financial holding
companies,” to engage in, or to affiliate with companies engaged in, a full range of financial
activities including banking, insurance activities (including insurance underwriting and portfolio
investing), securities activities and merchant banking. A bank holding company’s subsidiary banks
must be “well-capitalized” and “well-managed” and have at least a “satisfactory” Community
Reinvestment Act rating for the bank holding company to elect, and maintain, status as a financial
holding company.
The Reigle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Act”)
permits a bank holding company to acquire, with FRB approval, a bank located in a state other than
the bank holding company’s home state, without regard to whether the transaction is permitted under
any state law, except that a host state may establish, by statute, the minimum age of its banks (up
to a maximum of 5 years) subject to acquisition by out-of-state bank holding companies. The FRB
may not approve the acquisition if the applicant bank holding company, upon consummation, would
control more than 10% of total U.S. insured depository institution deposits or more than 30% of the
host state’s total insured depository institution deposits. The Interstate Act also permits a
bank, with the approval of the appropriate Federal bank regulatory agency, to establish a de novo
branch in a state, other than the bank’s home state, in which the bank does not presently maintain
a branch if the host state has enacted a law that applies equally to all banks and expressly
permits all out-of-state banks to branch de novo into the host state. Banks having different home
states may, with approval of the appropriate Federal bank regulatory agency, merge across state
lines, unless the home state of a participating bank has opted-out of the Interstate Act prior to
June 1, 1997. In addition the Interstate Act permits any bank subsidiary of a bank holding company
to receive deposits, renew time deposits, close loans, service loans and receive payments on loans
and other obligations as agent for a bank or thrift affiliate, whether such affiliate is located in
a different state or in the same state. Illinois law allows the Bank to establish branches
anywhere in the state.
The Illinois Bank Holding Company Act permits Illinois bank holding companies to acquire
control of banks in any state and permits bank holding companies whose principal place of business
is in another state to acquire control of Illinois banks or bank holding companies upon
satisfactory application to the Illinois Department of Financial and Professional Regulation. In
reviewing any such application, the Illinois Department of Financial and Professional Regulation
will review, among other things, compliance by the applicant with the requirements of the Community
Reinvestment Act (the “CRA”) and other information designed to determine such banks’ abilities to
meet community credit needs.
The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) amended the
Act to authorize the FRB to allow bank holding companies to acquire any savings association
(whether healthy, failed or failing) and removed “tandem operations” restrictions, which previously
prohibited savings associations from being operated in tandem with a bank holding company’s other
subsidiaries. As a result, bank holding companies have expanded opportunities to acquire savings
associations.
Under FIRREA, an insured depository institution which is commonly controlled with another
insured depository institution shall generally be liable for any loss incurred, or reasonably
anticipated to be incurred, by the FDIC in connection with the default of such commonly controlled
institution, or for any assistance provided by the FDIC to such commonly controlled institution,
which is in danger of default. The term “default” is defined to mean the appointment of a
conservator or receiver for such institution. Such liability is subordinated in right of payment
to deposit liabilities, secured obligations, any other general or senior liability and any
obligation subordinated to depositors and or other general creditors, other than obligations owed
to any affiliate of the depository institution (with certain exceptions) and any obligations to
stockholders in such capacity.
The Bank is subject to regulation by the FDIC, as well as by the Illinois Department of
Financial and Professional Regulation.
Federal Reserve policy provides that a bank holding company should not pay dividends unless
(i) the bank holding company’s net income over the prior year is sufficient to fully fund the
dividends and (ii) the prospective rate of earnings retention appears consistent with the capital
needs, asset quality and overall financial condition of the bank holding company and its
subsidiaries. Additionally, the Federal Reserve possesses enforcement powers over bank holding
companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or
unsound practices or violations of applicable statutes and regulations. Among these powers is the
ability to prohibit or limit the payment of dividends by bank holding companies.
Delaware law also places certain limitations on the ability of the Company to pay dividends.
For example, the Company may not pay dividends to its shareholders if, after giving effect to the
dividend, the Company would not be able to pay its debts as they become due. Since a major
potential source of the Company’s revenue is dividends the Company expects to receive from the
Bank, the Company’s ability to pay dividends is likely to be dependent on the amount of dividends
paid by the Bank. No assurance can be given that the Bank will, in any circumstances, pay
dividends to the Company. Various statutes and regulations impose restrictions on the payment of
dividends by the Bank, as described below.
Under the Illinois Banking Act (the “IBA”), the Company’s subsidiary bank is permitted to
declare and pay dividends in amounts up to the amount of its accumulated net profits provided that
it shall retain in its additional paid-in capital at least one-tenth of its net profits since the
date of the declaration of its most recent previous dividend until such additions to additional
paid-in capital, in the aggregate, equal at least the paid-in capital of the Bank. In no event may
the Bank, while it continues its banking business, pay dividends in excess of its net profits then
on hand (after deductions for losses and bad debts).
Under the FDIC’s current risk-based insurance assessment system, each insured depository
institution is placed in one of nine risk categories based on its level of capital and other
relevant information. Each insured depository institution’s insurance assessment rate is then
determined by the risk category in which it has been classified by the FDIC. Under the assessment
schedule applicable for the second semi-annual assessment period of 2005 to BIF-insured
institutions (such as the banks), assessment rates ranged from 0% to 0.27% of deposits. In
addition, each of the banks is subject to “FICO assessments” to repay obligations issued by a
federally chartered corporation to provide financing for resolving the thrift crises of the 1980s.
For the first quarter of 2006, the FICO assessment rate for the Bank is 1.32%. In addition, on
February 1, 2006, the Federal Deposit Insurance Reform Act of 2005 (the “Insurance Reform Act”) was
signed into law. The Insurance Reform Act calls for the merger of the bank insurance fund and
savings association insurance fund into a single deposit insurance fund (“DIF”), which is to take
place by July 1, 2006. In addition, the Insurance Reform Act increases the deposit insurance
coverage limit to $250,000 for certain retirement accounts (mostly IRA’s, Keogh accounts, “457”
Plans for state employees and 401(k) accounts) and indexes future insurance coverage to inflation
beginning in 2011. The Insurance Reform Act also allows the FDIC to raise or lower the designated
reserve ratio
between 1.15% and 1.50% on an annual basis. It also authorizes certain one-time premium
assessment credits to insured institutions, awards DIF dividends under certain circumstances, and
authorizes the FDIC to revise the current risk-based system for determining assessments. The FDIC
is required to promulgate regulations implementing the requirements of the Insurance Reform Act by
November 2006. Until the FDIC promulgates these regulations, it is uncertain what, if any, impact
this legislation will have on our operations.
The Federal bank regulators have adopted risk-based capital guidelines for holding companies
and banks. The minimum ratio of qualifying total capital to risk-weighted assets, including
certain off-balance sheet items (Total Capital Ratio), is 8%, and the minimum ratio of that portion
of total capital that is comprised of common stock, related additional paid-in capital, retained
earnings, noncumulative perpetual preferred stock, minority interests and, for bank holding
companies, a limited amount of qualifying cumulative perpetual preferred stock, less certain
intangibles including goodwill (Tier 1 capital), to risk-weighted assets is 4%. The balance of
total capital may consist of other preferred stock, certain other instruments, and limited amounts
of subordinated debt and the loan and lease loss allowance.
The Federal Reserve Board risk-based capital standards contemplate that evaluation of capital
adequacy will take account of a wide range of other factors, including overall interest rate
exposure; liquidity, funding and market risks; the quality and level of earnings; investment, loan
portfolio, and other concentrations of credit; certain risks arising from nontraditional
activities; the quality of loans and investments; the effectiveness of loan and investment
policies; and management’s overall ability to monitor and control financial and operating risks
including the risks presented by concentrations of credit and nontraditional activities.
In addition, the Federal Reserve has established minimum Leverage Ratio (Tier 1 capital to
quarterly average total assets) guidelines for bank holding companies and banks. These guidelines
provide for a minimum Leverage Ratio of 4% for bank holding companies and banks. The guidelines
also provide that banking organizations experiencing internal growth or making acquisitions will be
expected to maintain strong capital positions substantially above the minimum supervisory levels
without significant reliance on intangible assets. Furthermore, the guidelines indicate that the
Federal Reserve Board will continue to consider a “Tangible Tier 1 Leverage Ratio” in evaluating
proposals for expansion or new activities. The Tangible Tier 1 Leverage Ratio is the ratio of Tier
1 capital, less intangibles not deducted from Tier 1 capital, to quarterly average total assets. At
December 31, 2005, the Company had a Tangible Tier 1 Leverage Ratio of 9.74%%.
The Bank, on May 17, 2005, approved and signed a memorandum of understanding (“MOU”) with the
Federal Deposit Insurance Corporation and the Illinois Department of Financial and Professional
Regulation. The MOU requires the Bank to restore Tangible Tier 1 Leverage Ratio to 8% should this
ratio fall below the 8% level. At December 31, 2005, the Company had a Tangible Tier 1 Leverage
Ratio of 9.74% and the Bank’s Tangible Tier 1 Leverage Ratio was 8.61%. For more detailed
information
3% for banks with the highest CAMEL (supervisory) rating.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”)
substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance
Act and made revisions to several other federal banking statutes. In general, FDICIA subjects
depository institutions to significantly increased regulation and supervision. Among other things,
FDICIA requires federal bank regulatory authorities to take “prompt corrective action” with respect
to depository institutions that do not meet minimum capital requirements, and imposes certain
restrictions upon depository institutions which meet minimum capital requirements but are not “well
capitalized” for purposes of FDICIA. FDICIA and the regulations adopted under it establish five
capital categories as shown above, with the category for any institution determined by the lowest
of any of these ratios shown above.
An insured depository institution may be deemed to be in a capital category that is lower than
is indicated by its capital ratios if it receives an unsatisfactory rating by its examiners with
respect to its assets, management, earnings or liquidity.
Under FDICIA, a bank that is not well capitalized is generally prohibited from accepting or
renewing brokered deposits and offering interest rates on deposits significantly higher than the
prevailing rate in its normal market area or nationally (depending upon where the deposits are
solicited); in addition, “pass through” insurance coverage may not be available for certain
employee benefit accounts.
FDICIA generally prohibits a depository institution from making any capital distribution
(including payment of a dividend) or paying any management fee to its holding company if the
depository institution would thereafter be undercapitalized. Undercapitalized depository
institutions are subject to limitations on growth and are required to submit a capital restoration
plan, which must be guaranteed by the institution’s parent company. Institutions that fail to
submit an acceptable plan, or that are significantly undercapitalized, are subject to a host of
more drastic regulatory restrictions and measures.
The Company is considered “well capitalized” as defined under the regulations of the Federal
Reserve. The Bank is considered “well capitalized” according to FDICIA guidelines as of December31, 2005.
Federal and state statutes and regulations provide financial institution regulatory agencies
with great flexibility to undertake enforcement action against an institution that fails to comply
with regulatory requirements, particularly capital requirements. Possible enforcement actions
range from the imposition of a capital plan and capital directive to, in the most severe cases,
placing the institution into conservatorship or receivership or terminating deposit insurance.
FDICIA directs that each federal banking agency prescribe standards for depository
institutions or depository institutions’ holding companies relating to internal controls,
information systems, internal audit systems, loan documentation, credit underwriting, interest rate
exposure, asset growth, compensation, a maximum ratio of classified assets to capital, minimum
earnings sufficient to absorb losses and other standards as they deem appropriate. Many
regulations implementing these directives have been adopted by the agencies.
As an insured depository institution, the Bank is subject to regulations requiring depository
institutions to maintain reserves against a specified percentage of transaction accounts (primarily
NOW and regular checking). Reserves are maintained in the form of vault cash or non-interest
bearing deposits with the FRB. The FRB regulations generally require 3% reserves on the first
$48.3 million of transaction accounts; however, the first $7.8 million of these otherwise
reservable balances (subject to adjustments by the FRB) are exempted from the 3% reserve
requirement. Net transaction balances over $48.3 million are subject to a reserve requirement of
10%. The Bank is in compliance with the forgoing requirements.
Under the Bank Secrecy Act (“BSA”), a financial institution is required to have systems in
place to detect certain transactions, based on the size and nature of the transaction. Financial
institutions are generally required to report cash transactions involving more than $10,000 to the
United States Treasury. In addition, financial institutions are required to file suspicious
activity reports for transactions that involve more than $5,000 and which the financial institution
knows, suspects or has reason to suspect involves illegal funds, is designed to evade the
requirements of the BSA or has no lawful purpose. In addition, the BSA requires banks to comply
with recently adopted customer identification procedures when opening accounts for new customers.
The USA PATRIOT Act of 2001, enacted in response to the September 11, 2001 terrorist attacks,
requires bank regulators to consider a financial institution’s compliance with the BSA when
reviewing applications.
Under the Community Reinvestment Act (“CRA”), a financial institution has a continuing and
affirmative obligation, consistent with the safe and sound operation of such institution, to serve
the “convenience and needs” of the communities in which they are chartered to do business,
including low and moderate income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an institution’s discretion
to develop the types of products and services that it believes are best suited to its particular
community as long as they are consistent with the CRA. The CRA requires each federal banking
agency, in connection with its examination of a financial institution, to assess and assign one of
four ratings to the institution’s record of meeting the credit needs of its community and to take
such record into account in its evaluation of certain applications by the institution, including
applications for charters, branches and other deposit facilities, relocations, mergers,
consolidations and acquisitions of assets or assumptions of liabilities. The CRA also requires
that all institutions make public disclosure of their CRA ratings. The Bank received a
“satisfactory” rating on its most recent CRA examination in March 2004.
Our business, financial condition and results of operations are subject to various risks,
including those discussed below, which may affect the value of our common stock. Set forth below
are certain risk factors which we believe to be relevant to an understanding of our business. This
list should not be considered a comprehensive list of all potential risks and uncertainties. You
should also refer to the other information included or incorporated by reference in this Form 10-K,
including our consolidated financial statements and related notes for the year ended December 31,2005.
Significant risk factors include:
Interest rate risk — Our earnings and profitability depend significantly on our net interest
income, which is the difference between the interest earned on loans and investments and the
interest paid on deposits and borrowings. Since interest rates can fluctuate in response to
general economic conditions and the policies of various governmental and regulatory agencies,
including the Federal Reserve Board, our asset-liability management strategy may not be able to
prevent changes in interest rates from having a material adverse effect on our earnings.
Geographic risk — We operate primarily in the Chicago market and a prolonged economic
downturn in this market could have a negative impact on earnings.
Credit Risk — Our loan customers may not repay their loans according to their terms and the
collateral may be insufficient to repay the loan. Management makes various assumptions in
determining the adequacy of the allowance for loan and lease losses and if those assumptions are
incorrect, the result could have an adverse affect on earnings. See “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” for discussion of our allowance for loan
and lease losses.
Regulatory Risk — We are subject to extensive federal and state legislation and supervision
which governs nearly every aspect of our business. The burden of compliance has in the past and
will continue to have an impact on the banking industry and changes to these laws could affect our
ability to deliver or expand our services. See “Supervision and Regulation”.
Industry Risk — We operate in a rapidly changing environment having numerous competitors
including other banks and insurance companies, securities dealers, trust and investment companies
and mortgage bankers. Our profitability depends upon our continued success in competing in the
Chicago market.
Operational Risk — We are subject to operations risks, including, but not limited to, an
interruption or breach in security of information systems, customer or employee fraud and
catastrophic failures. While we maintain a system of internal controls and insurance coverage
where applicable, an event may occur that has an adverse affect on earnings.
Personnel Risk — Our success depends upon the continued service of our senior management team
and our ability to attract and retain qualified financial services personnel. Loss of key
personnel could negatively impact our earnings through loss of their customer relationships and the
potential difficulty promptly replacing officers in this competitive environment.
The Bank conducts its operations through its main office and seven branches. The Company’s
office is located in the main office of the Bank. All of such offices are owned by the Bank and
are located in Lake County, Illinois. The Company believes that its current facilities are adequate
for the conduct of its business.
The following table sets forth information relating to each of NorStates Bank’s offices:
Due to the nature of their business, the Company and its subsidiaries are often subject to
various legal actions. Other than as described below, these legal actions, whether pending or
threatened, arise through the normal course of business and are not considered unusual or material.
Between November 2000 and August 2001, the Company purchased commercial lease pools from
Commercial Money Center, a now bankrupt equipment leasing company. These lease pools, with
outstanding balances of $9.4 million at December 31, 2005, are secured by assignments of payment
streams, underlying equipment and surety bonds. A large part of our underwriting decision was
based on the guarantees of the sureties. These lease pools are included as impaired loans and
leases at December 31, 2003, 2004 and 2005. The amount of specific reserve allocated to these
leases is $2,400,000. Upon default of these lease pools, the Company made demand for payment from
Illinois Union Insurance Company (“IU”) a wholly owned subsidiary of Ace Limited Insurance Company
(“ACE”) and RLI Insurance Company (“RLI”) under the relevant surety bonds. IU, ACE and RLI (the
“Sureties”) have failed to make the payments required under the surety bonds. As a result, in
April 2002, the Company filed suit against each of the Sureties. The Company’s complaints alleged
that the Sureties are liable for payment due to the Company under the terms of the bonds. ACE, IU
and RLI are seeking to rescind on the surety bonds alleging that the originator of the leases
fraudulently induced the insurers to issue the surety bonds, and that the bonds are therefore void.
The Company has reviewed these matters with its legal counsel and believes that it has valid
claims as the Sureties undertook the responsibility for all credit and fraud underwriting, and
waived all defenses associated with the bonds, including defenses of fraud. In September 2005, the
Company filed Motions for Judgement on the Pleadings in its CMC litigations against the sureties.
At that time, the court granted the Motion on the Pleadings against ACE/IU; however the Bank’s
motion against the RLI surety was denied. On October 31, 2005, the court directed all parties
involved in the CMC litigation to engage in mediation. The Company will continue to assert all the
rights and remedies available to it to obtain payment under the bonds. There can be no assurance
as to the exact amounts that the Company will ultimately succeed in collecting, if any.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
PART II
Item 5. Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
The information set forth under the captions “Stock Market Information”; “Price Summary”; and
“Cash Dividends” in the 2005 Annual Report to Stockholders (filed as Exhibit 13 to this report) is
incorporated herein by reference.
The following table sets forth information in connection with purchases made by, or on behalf
of, the Company of shares of the Company’s common stock during the quarterly period ended December31, 2005.
On April 17, 2002, the Company’s Board of Directors authorized the repurchase of up
to 200,000 shares of the Company’s common stock either in open market or private
transactions. On February 19, 2003, the Company’s Board of Directors authorized the
repurchase of an additional 200,000 shares. (No time limit has been set for the
completion of the repurchase programs.)
The information set forth under the caption “Selected Consolidated Financial Data” in the 2005
Annual Report to Stockholders (filed as Exhibit 13 to this report) is incorporated herein by
reference.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The information set forth under the caption “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” in the 2005 Annual Report to Stockholders (filed as Exhibit 13
to this report) is incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information set forth under the caption “Quantitative and Qualitative Disclosures about
Market Risk” in the 2005 Annual Report to Stockholders (filed as Exhibit 13 to this report) is
incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements and related notes including the information in the
unaudited Note 17, “Quarterly Financial Data (Unaudited)” of the Company and the Independent
Auditors’ Report as set forth in the 2005 Annual Report to Stockholders (filed as Exhibit 13 to
this report) are incorporated herein by reference.
The portions of the 2005 Annual Report to Stockholders which are not specifically incorporated
by reference as a part of this Form 10-K are not deemed to be a part of this report.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 9A. Controls and Procedures
Disclosure Control and Procedures
As of the end of the period covered by this report, an evaluation was carried out under the
supervision and with the participation of Northern States Financial Corporation’s management,
including our Chairman of the Board and President and Vice President and Treasurer, of the
effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934). Based on and as of the date of their evaluation, our
Chairman of the Board and President and Vice President and Treasurer have concluded that the
Company’s disclosure controls and procedures are effective, in all material respects, to ensure
that information required to be disclosed by Northern States Financial Corporation in reports that
it files or submits under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in Commission rules and forms.
Report
by Management on Internal Control over Financial Reporting
The management of Northern States Financial Corporation (the “Company”) is responsible for
establishing and maintaining adequate internal control over financial reporting. The Company’s
internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of the financial statements
for external purposes in accordance with accounting principles generally accepted in the United
States of America. The Company’s internal control over financial reporting includes those policies
and procedures that (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with accounting principles generally accepted in the United
States of America, and that receipts and expenditures of the Company are being made only in
accordance with authorizations of management and directors of the Company; and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. All internal control systems, no matter how well designed, have inherent
limitations, including the possibility of human error and the circumvention of overriding controls.
Accordingly, even effective internal control over financial reporting can only provide reasonable
assurance with respect to financial statement preparation. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may
deteriorate.
Management has assessed the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2005, based on the framework set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (“COSO”) in “Internal Control-Integrated Framework”. Based
on that assessment, management concluded that, as of December 31, 2005, the Company’s internal
control over financial reporting was effective based on the criteria established in “Internal
Control-Integrated Framework”.
Management’s assessment of the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2005, has been audited by Crowe
Chizek and Company LLC, an independent
registered public accounting firm. As stated in their attestation report dated March 27, 2006,
they express an unqualified opinion on management’s assessment and on the effectiveness of the
Company’s internal control over financial reporting as of December 31, 2005.
Report
of Independent Registered Public Accounting Firm
We have audited management’s assessment, included in the accompanying “Report by Management on
Internal Control over Financial Reporting”, that Northern States Financial Corporation maintained
effective internal control over financial reporting as of December 31, 2005, based on criteria
established in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Northern States Financial Corporation’s
management is responsible for maintaining effective internal control over financial reporting and
for its assessment of the effectiveness of internal control over financial reporting. Our
responsibility is to
express an opinion on management’s assessment and an opinion on the effectiveness of the
Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management’s assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinion.
A company’s internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting
principles. A company’s internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s assets that could have
a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Northern States Financial Corporation maintained
effective internal control over financial reporting as of December 31, 2005, is fairly stated, in
all material respects, based on criteria established in “Internal Control-Integrated Framework”
issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). Also, in our
opinion, Northern States Financial Corporation maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2005, based on criteria established in
“Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Northern States Financial
Corporation as of December 31, 2005 and 2004, and the related consolidated statements of income,
stockholders’ equity , cash flows, and comprehensive income for each of the three years in the
period ended December 31, 2005 and our report dated March 27, 2006 expressed an unqualified opinion
on those financial statements.
There were no changes in the Company’s internal control over financial reporting during the
three months ended December 31, 2005 that have materially affected, or are reasonably likely to
materially affect, the Company’s internal control over financial reporting.
Item 9B. Other Information
None.
PART III
Item 10. Directors and Executive Officers of the Company
DIRECTORS - The information called for by this item with respect to Directors of the Company
is set forth under the caption “Directors” in the Company’s definitive proxy statement, relating to
its 2006 Annual Meeting of Stockholders (the “Proxy Statement”), to be filed within 120 days of
December 31, 2005 and is incorporated herein by reference as if set forth in full herein as
permitted by the General Instruction G(3) to Form 10-K.
EXECUTIVE OFFICERS - The Company’s only executive officer is Mr. Fred Abdula, the President of
the Company. The information called for by this item with respect to Mr. Abdula is set forth under
the caption “Directors” in the Company’s Proxy Statement and is incorporated herein by reference as
if set forth in full herein as permitted by the General Instruction G(3) to Form 10-K.
The information set forth under “Section 16(a) Beneficial Ownership Reporting Compliance” in
the Company’s Proxy Statement is incorporated herein by reference as if set forth in full herein as
permitted by the General Instruction G(3) to Form 10-K.
The Company has adopted a code of ethics as required by the Nasdaq listing standards and the
rules of the SEC. This code applies to the directors and officers of the Company and its
subsidiaries. The Company will file on Form 8-K any amendments to, or waivers from, the code of
ethics applicable to any of its directors or executive officers.
Item 11. Executive Compensation
The information called for by this item is set forth under the caption “Executive
Compensation” and “Summary Compensation Table” in the Company’s Proxy Statement and is incorporated
herein by reference as if set forth in full herein as permitted by the General Instruction G(3) to
Form 10-K.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
The information set forth under the caption “Security Ownership of Certain Beneficial Owners
and Management” in the Company’s Proxy Statement is incorporated herein by reference as if set
forth in full herein as permitted by the General Instruction G(3) to Form 10-K.
The Company currently has no equity compensation plans and accordingly, there are no
outstanding options, warrants or rights to purchase any of the Company’s equity securities.
Item 13. Certain Relationships and Related Transactions
The information called for by this item is set forth under the caption “Compensation Committee
Interlocks and Insider Participation” in the Company’s Proxy Statement and is incorporated herein
by reference as if set forth in full herein as permitted by the General Instruction G(3) to Form
10-K.
Item 14. Principal Accounting Fees and Services
The information called for by this item is set forth under the caption “Selection of
Independent Auditors” in the Company’s Proxy Statement and is incorporated herein by reference as
if set forth in full herein as permitted by the General Instruction G(3) to Form 10-K.
Statement of Computation of per share earnings. Contained in Notes 1 and 14 to
the consolidated financial statements disclosed in the 2005 Annual Report to
Stockholders (filed as Exhibit 13 to this report) is incorporated herein by reference
13
Copy of portions of the Company’s Annual Report to Stockholders for the year
ended December 31, 2005. This exhibit, except for portions thereof that have been
specifically incorporated by reference into this report, is furnished for the
information of the Commission and shall not be deemed “filed” as part hereof.
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto
duly authorized, on this 27th day of March 2006.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the capacities and on this
27th day of March 2006.
Each director of the Registrant, whose signature appears below, hereby appoints Fred Abdula
and Thomas M. Nemeth and each of them severally, as his attorney-in-fact, to sign in his name and
on his behalf, as a director of the Registrant, and to file with the Commission any and all
Amendments to this Report on Form 10-K, on this 27th day of March 2006.
Statement of Computation of per share earnings. Contained in Notes 1 and 14 to the
consolidated financial statements, disclosed in the 2005 Annual Report to
Stockholders (filed as Exhibit 13 to this report) and incorporated herein by
reference
13
Copy of portions of the Company’s Annual Report to Stockholders for the year ended
December 31, 2004. This exhibit, except for portions thereof that have been
specifically incorporated by reference into this Report, is furnished for the
information of the Commission and shall not be deemed “filed” as part hereof