ITEM 1: BUSINESS
UPBANCORP, INC.
Upbancorp, Inc. ("Upbancorp" or the "Company"), is a multi-bank holding company organized in 1983 under the laws of the State of Delaware. Upbancorp owns all of the outstanding common stock of Uptown National Bank of Chicago ("Uptown"), organized in 1929 and located in Chicago, Illinois, and Heritage Bank ("Heritage"), organized in 1977 and located in Phoenix, Arizona. (Uptown and Heritage are referred to as the "Subsidiary Banks".) Upbancorp does not engage in any activities other than providing administrative services and acting as a holding company for its Subsidiary Banks.
The Company is a publicly traded banking company with total assets of $325 million at year-end 1999 and its headquarters are in Chicago, Illinois. The majority of the operational responsibilities of each of the Subsidiary Banks rests with their respective Officers and Directors.
The Company and its Subsidiary Banks employed approximately 149 full-time equivalent employees at December 31, 1999.
Based on the Company's approach to decision making, it has decided that its business is comprised of a single segment.
SUBSIDIARY BANKS
The Company's affiliates consist of two full-service community banks, which operate six banking offices in northern Chicago and metropolitan Phoenix. Approximately 77% of its banking assets are related to Uptown with the remainder related to Heritage.
Both Subsidiary Banks are engaged in the general commercial banking business in addition to offering a complete range of retail banking services. The Subsidiary Banks conduct a general banking business which embraces all of the usual functions, both commercial and consumer, and which they may lawfully provide, including, but not limited to: the acceptance of deposits to demand, savings and time accounts and the servicing of such accounts; commercial, industrial, consumer and real estate lending; safe deposit box operations; and other banking services tailored for both commercial and retail clients.
Uptown has one wholly-owned subsidiary, Broadway Clark Building Corporation ("BCBC"), which is an Illinois corporation. BCBC owns all of the real estate that is used in connection with the operation of Uptown's business with the exception of three facilities, which are leased.
In February, 2000, Uptown applied to the Office of the Comptroller of the Currency ("OCC") to merge Heritage with and into and under the charter of Uptown. Following the consummation of the merger, the offices of Heritage will operate as branches of Uptown. Heritage will retain its name in the Phoenix area. This is in response to our ongoing effort to further enhance operational efficiencies and improve profitability. All current locations will remain fully operational with no resulting adverse changes to our products and services offered.
SUPERVISION AND REGULATION
The Company and its Subsidiary Banks are subject to regulation and supervision by various governmental regulatory authorities including, but not limited to, the Board of Governors of the Federal Reserve System (the "FRB"), the OCC, the Federal Deposit Insurance Corporation (the "FDIC"), the Arizona State Banking Department, the Securities and Exchange Commission (the "SEC"), the Internal Revenue Service and state taxing authorities. Financial institutions and their holding companies are extensively regulated under federal and state law. The effect of such statutes, regulations and policies can be significant and cannot be predicted with a high degree of certainty.
Federal and state laws and regulations generally applicable to financial institutions, such as the Company and the Subsidiary Banks, regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. This supervision and regulation is intended primarily for the protection of the FDIC's Bank Insurance Fund and the depositors, rather than the shareholders of financial institutions.
The Company is subject to supervision and regulation by the FRB, under the Bank Holding Company Act of 1956, as amended.
Uptown is chartered under the National Bank Act, as amended, and is subject to the examination, supervision, reporting and enforcement requirements of the OCC, as the chartering authority for national banks, and the FDIC as the administrator of the Bank Insurance Fund. The Bank is a member of the Federal Reserve System.
Heritage is chartered under the banking laws of Arizona and is subject to the examination, supervision, reporting and enforcement requirements of the Arizona State Banking Commission under the banking laws of Arizona and the FDIC under the Federal Deposit Insurance Act, as amended. Once the two subsidiary banks are merged, all banks will be supervised by the OCC.
The deposits of the Subsidiary Banks are insured by the Bank Insurance Fund of the FDIC to the extent permitted by law.
The Company's common stock is registered with the SEC under the Securities Exchange Act of 1934, as amended. Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under such act.
GOVERNMENTAL MONETARY POLICIES AND ECONOMIC CONDITIONS
The earnings of the Company are affected in important respects by general economic conditions and also by the fiscal and monetary policies of the federal government and its agencies. In particular, the FRB regulates the national supply of bank credit in order to achieve, among other things, maximum employment and a stable price level. Among the instruments of monetary policy used by the FRB to implement these objectives are: open market transactions in United States government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth of bank loans, investments, and deposits, and they may also affect interest rates charged on loans or paid for deposits.
Interest rate sensitivity has a major impact on the yields earned on assets of the Subsidiary Banks. As market rates change, yields earned on assets may not necessarily move to the same degree as rates paid on liabilities. For this reason, the Subsidiary Banks attempt to minimize earnings volatility related to fluctuations in interest rates through the use of formal asset/liability management programs which identify imbalances between the repricing of earning assets and funding sources, among other things.
In addition to the policy of the FRB, the Company's earnings are also affected by the FDIC insurance premiums and the annual fees charged by the various regulatory authorities. The Company cannot fully predict the nature or the extent of any effect which such fiscal and monetary policies may have on its business and earnings.
COMPETITION
The principal methods of competition between commercial banks is generally expressed in terms of price, including interest rates paid on deposits and interest rates charged on borrowings, fees charged on fiduciary services, quality of services to customers, ease of access to services, and the offering of additional services. More recently, technological advances such as PC banking, telebanking, point-of-sale debit cards
and electronic data interchange have also resulted in intensified competition with traditional banking distribution systems.
Both Illinois and Arizona are highly competitive markets for banking and related financial services. Since these areas are the Company's primary focus markets, the Subsidiary Banks are exposed to varying types and levels of competition. In general, each Subsidiary Bank competes, anticipates and responds within each individual market area. Both Subsidiary Banks compete and rely heavily on the high level of quality service provided to our customers. The Company has seen the level of competition and number of competitors in its market places increase in recent years and expects a continuation of these competitive market conditions.
CAPITAL GUIDELINES
The FRB, the OCC and the FDIC have risk-based capital guidelines which provide a framework for assessing the adequacy of the capital of banks and bank holding companies (collectively "banking institutions"). These guidelines apply to all banking institutions regardless of size and are used in the examination and supervisory process as well as in the analysis of applications to be acted upon by the regulatory authorities. These guidelines require banking institutions to maintain capital based on the credit risk of their operations.
The risk-based capital guidelines are designed to require the maintenance of capital commensurate with both on and off-balance sheet credit risks. The minimum ratios established by the guidelines are based on both Tier 1 and total capital to total risk-based assets. Total risk-based assets are calculated by assigning each on-balance sheet asset and off-balance sheet item to one of four risk categories depending on the nature of each item. The amount of the items in each category is then multiplied by the risk-weight assigned to that category (0%, 20%, 50% or 100%). Total risk based assets equals the sum of the resulting amounts. Tier 1 capital is generally defined as shareholders' equity less intangible assets and total capital is generally defined to include Tier 1 capital plus limited levels of the allowance for loan losses.
In addition to the risk-based capital requirements, the FRB, the OCC and the FDIC require institutions to maintain a minimum leveraged-capital ratio to supplement the risk-based capital guidelines. The leverage ratio is intended to ensure that adequate capital is maintained against risks other than credit risk.
The Company and the Subsidiary Banks exceed the minimum required capital guidelines for both risk-based capital ratios and the leverage ratio at December 31, 1999. A further discussion of the capital guidelines is in the Capital Resources section included under Item 7 of this Form 10-K.
DIVIDENDS
GENERAL
In addition to the capital guidelines provided in the discussion above, there are various national and state banking regulations which limit the ability of the Subsidiary Banks to pay dividends. This limits the ability of the Company to pay dividends. Since the Company is a legal entity, separate and distinct from its affiliates, its dividends are not subject to such bank regulatory guidelines. The holders of the Company's common stock are entitled to receive such dividends as are declared by the Board of Directors. For a further discussion of dividends, see Note 12 "Restrictions on Retained Earnings" in the Notes to Consolidated Financial Statements included under Item 8 of this Form 10-K.
NATIONAL BANKING ASSOCIATION RESTRICTIONS
Uptown is a national banking association and is limited with respect to the amount of dividends which it can pay to its shareholders under Sections 56 and 60 of the National Bank Act.
Section 56 restricts a national bank from paying dividends if it would impair the institution's capital by barring any payments in excess of "net profits then on hand". Section 56 further requires that banks deduct
losses and bad debts from "net profits then on hand". It also specifies that a portion of a bank's capital surplus account may be included as "net profits then on hand" to the extent that it represents earnings from prior periods.
Section 60 requires the OCC's approval if the total of all dividends declared in any calendar year will exceed the institution's net profits of that year combined with its retained net profits of the preceding two years, less any required transfers to surplus. In calculating its net profits under Section 60 a national bank may not add back provisions made to its allowance for loan losses nor deduct net charge-offs.
ARIZONA STATE-CHARTERED BANK RESTRICTIONS
Under the provisions of the Arizona Bank Code, dividends may not be declared by state-chartered banks unless they are made in compliance within the banking laws of Arizona. Additionally, the payment of dividends by a state-chartered bank whose deposits are insured by the Bank Insurance Fund, is affected by the requirement to maintain minimum capital pursuant to the capital adequacy guidelines issued by the FDIC.
ITEM 2:
ITEM 2: PROPERTIES
The following table summarizes the Company and Subsidiary Banks' properties by location:
At December 31, 1999, the properties and equipment of the Company had an aggregate net book value of approximately $6.0 million.
Note 1: These locations are owned by Uptown's wholly-owned subsidiary, BCBC. Uptown utilizes approximately 49,000 square feet of its main office and the rest of the facility is leased out by BCBC to independent third parties.
ITEM 3:
ITEM 3: LEGAL PROCEEDINGS
Neither the Company nor its Subsidiary Banks are party to any litigation, which in the judgment of management after consultation with counsel, would have a material effect on the financial position or results of operations of the Company or the Subsidiary Banks.
ITEM 4:
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no items submitted to a vote of security holders during the fourth quarter of 1999.
PART II
ITEM 5:
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the Over-The-Counter market under the symbol UPBN. As of December 31, 1999, there were 318 shareholders of record. The following table sets forth common stock information during each quarter of 1999 and 1998. This information has been adjusted to reflect the Company's four-for-one stock split in October, 1998.
A discussion regarding the regulatory restrictions applicable to the Subsidiary Banks' ability to pay dividends is included in the Dividends Section under Item 1 of this Form 10-K and Note 12 in the Notes to Consolidated Financial Statements included under Item 8 of this Form 10-K.
ITEM 6:
ITEM 6: SELECTED FINANCIAL DATA
The following Selected Financial Data is not covered by the report of independent public accountants and should be read in conjunction with the consolidated financial statements and accompanying notes included elsewhere in this Form 10-K. A more detailed discussion and analysis of factors affecting the Company's financial position and operating results is presented in Management's Discussion and Analysis of Financial Condition and Results of Operations found under Item 7
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The following management's discussion and analysis of financial condition and results of operations should be read in conjunction with the Company's Consolidated Financial Statements and Notes to Consolidated Financial Statements presented in Item 8 of this Form 10-K as well as the Selected Financial Data presented in Item 6 of this Form 10-K.
This discussion and analysis is intended to address significant factors affecting the Company's consolidated statements of condition and statements of income for the past three years. The discussion is designed to provide shareholders with a comprehensive review of the operating results and financial condition of the Company.
SUMMARY
The Company's consolidated net income for 1999 totaled $2,577 or $3.00 per share. This is compared to net income and earnings per share of $2,300 or $2.63 and $1,977 or $2.24 for 1998 and 1997, respectively. The results of 1999 represent a 12% improvement in net income from 1998 after a 16% improvement in 1998 over 1997. As we noted last year and, again, consistent in the current year, the earnings improvement is mostly attributable to increased net interest income.
The operating performance of bank holding companies is often measured and comparisons made based on net income to average assets and net income to average equity. The Company's return on average shareholders' equity for 1999 was 11.22% as compared to 10.44% in 1998 and 9.98% in 1997. Return on average assets for 1999 was .87% as compared to .91% in 1998 and .87% in 1997.
Nonperforming loans decreased as a percentage of outstanding loans during the past three year period. Nonperforming loans totaled $907 or .36% of net loans at December 31, 1999 as compared to $1,309 or .67% in 1998 and $1,148 or .69% in 1997.
Upbancorp continues to maintain a strong capital base at December 31, 1999. Consolidated capital levels as well as the individual Subsidiary Banks' capital ratios exceed minimum capital requirements.
NET INTEREST INCOME
Net interest income, which is the difference between interest and fees earned on assets and the interest paid on deposits and other funding sources, is the primary source of earnings for the Company. This component represents 82% of the Company's net revenues in 1999. A detailed analysis highlighting the changes in net interest income is provided in Table 2. Interest earned on tax-exempt loans and investments is adjusted for comparative purposes to a taxable equivalent basis using the federal tax rate of 34%, resulting in net interest income FTE.
Net interest income on a fully taxable equivalent basis totaled $15,238 in 1999 compared to $13,115 in 1998 and $11,720 in 1997. The significant increase in net interest income in 1999 includes an increase of $2,503 due to volume increases in 1999 following a $1,844 increase due to volume in 1998. Rate movements negatively impacted the overall improvement in net interest income by $315 after negatively impacting net interest income by $395 in 1998.
The 1999 volume increase was fueled by the earning assets added to the balance sheet. Average interest earning assets increased by $40,597 or 17.29%. The majority of that increase is the result of growth in average loan balances due in large part to the strong economic conditions, including the real estate markets in both the Chicago and Phoenix metropolitan areas. In addition, we recognize continued success of Zook Pilot Services, the aircraft lending division. The loan growth was funded via a more aggressive pricing
strategy with regard to time deposits and a greater utilization of borrowed funds as well as maturities and selective sales in our investment portfolio.
Net interest margin represents net interest income as a percentage of total interest earning assets. The Company attempts to favorably impact net interest income through investment decisions on interest earning assets and monitoring interest rates its banking subsidiaries offer, particularly rates for time deposits and short-term borrowings. The Company's net interest spread measured on a fully taxable equivalent basis decreased slightly to 5.53% in 1999 from 5.58% in 1998.
Table 1 summarizes Upbancorp's average earning assets and funding sources over the last three years. Additionally, the table shows interest income and expense related to each category of assets and funding sources and the yields earned and the rates paid on such assets and funding sources.
TABLE 1
NET INTEREST INCOME AND MARGIN ANALYSIS
(1) Interest income and yields on non-taxable securities are reflected on a tax equivalent basis based upon a statutory Federal income tax rate of 34% for 1999, 1998 and 1997.
(2) Loans and securities on a non-accrual basis for the recognition of interest income are included in loans, net of unearned discount, and investment securities for purposes of this analysis.
(3) Loan fees included in the above interest income computations total $1,133, $907, and $773 for the years ended December 31, 1999, 1998, and 1997, respectively. At December 31, 1999, 1998, and 1997, deferred loan and commitment fee income, net of direct loan origination costs, totaled $438, $235, and $244, respectively.
Table 2 analyzes the changes in interest income, interest expense and net interest income that result from changes in volumes of earning assets and funding sources, as well as fluctuations in interest rates. Changes noted in the volume/rate column represent variances attributable jointly to changes in volume and rate.
TABLE 2 CHANGES IN NET INTEREST INCOME APPLICABLE TO VOLUMES AND INTEREST RATES
(1) Interest income and yields on non-taxable securities are reflected on a tax equivalent basis based upon a statutory Federal income tax rate of 34% for 1999, for 1998 and 1997.
FUNDS MANAGEMENT ANALYSIS AND INTEREST RATE SENSITIVITY
The interest earning asset portfolio of community banks is typically the leading determinate of performance for the Company. This is because the largest percentage of total income for the Company is attributable to net interest income. The policies and practices for managing liquidity risk and interest rate risk are set by the Subsidiary Banks' Funds Management Committees ("FMC's") whose goal is to ensure maximum returns within safe and sound risk parameters. The FMC's monitor exposures in view of market developments and the Subsidiary Banks' financial conditions, set guidance for interest rate risk management decisions, ensure consistency in the measurement of risk and monitor liquidity and capital adequacy. In this capacity, the FMC's place limits on the level of investments in various assets and off-balance sheet instruments, as well as on the funding levels for loans and deposits. In addition, the FMC's establish pricing policies for the Subsidiary Banks' products and services.
Interest rate risk is the degree to which market interest rate fluctuations can effect net interest income. The Company not only responds to this interest rate risk, but also tries to anticipate and build strategies based on the current interest rate and maturity characteristics of the various balance sheet categories of assets and liabilities. This is done through a formalized funds management process and while there are several ways in which to analyze interest rate risk, the traditional method is called a "gap" analysis. A gap analysis is a static management tool used to identify mismatches or gaps in the repricing of assets and liabilities within specified periods of time.
The Company's gap analysis as of December 31, 1999 is presented in Table 3. Earning assets and interest bearing liabilities are presented within selected time intervals based upon their repricing and maturity characteristics. In a perfectly matched gap analysis, an equal amount of rate sensitive assets and liabilities would be reflected as repricing within each given time interval. A positive interest rate sensitivity gap indicates more assets than liabilities will reprice in that time period, while a negative gap indicates more liabilities will reprice. Generally, a positive gap position, or asset sensitive position, has a favorable impact on net interest income in periods of rising interest rates. Conversely, a negative gap would generally imply a favorable impact on net interest income in periods of declining interest rates.
TABLE 3 REMAINING MATURITY OR EARLIEST POSSIBLE PRICING
(1) Loans and securities on a nonaccrual basis are not included as a part of this analysis.
Table 3 shows the under-one-year net liability position at December 31, 1999 was ($79,609) (24.51% of total assets), compared to the under-one-year net liability position of ($45,722) at December 31, 1998 (16.97% of total assets). A significant under-one-year net liability position would indicate that the Company's net interest income is exposed to rising short-term interest rates, while a significant net asset position would mean an exposure to declining short-term interest rates. Upbancorp and the Subsidiary Banks follow a policy of maintaining a relatively balanced mix of rate-sensitive assets and liabilities, making each side of the balance sheet equally flexible in reacting to changes in market interest rates so that net interest income will not be materially affected in periods of rising or falling interest rates.
SECURITIES PORTFOLIO
The following table shows the Company's available-for-sale investment securities' maturity distribution and corresponding tax-equivalent yields at December 31, 1999:
TABLE 4 SECURITIES AVAILABLE-FOR-SALE MATURITY DISTRIBUTION AND PORTFOLIO YIELDS
Of the $5,700 of collateralized mortgage obligations and other mortgage-backed securities depicted above, all were issued or guaranteed by various U.S. Government sponsored agencies.
LOAN PORTFOLIO
The following table shows the major classifications of loans at December 31:
TABLE 5 LOAN PORTFOLIO
The commercial loan maturities and sensitivity to changes in interest rates at December 31, 1999, are shown in the following table:
TABLE 6 COMMERCIAL LOAN MATURITIES AND SENSITIVITIES TO CHANGES IN INTEREST RATES
LIQUIDITY MANAGEMENT
A key element of the Company's FMC process is the management of liquidity. Funds are needed by the Subsidiary Banks to meet the needs of their depositors, borrowers and for regulatory requirements. Liquid funds, however, generally have very low earnings potential and thus careful control of the Subsidiary Banks' liquidity position is needed. Monitoring of this liquidity position is done daily to ensure constant adequacy and to maintain optimal levels of liquidity on the balance sheet. Another source of liquidity is off balance sheet, in the form of pre-approved loan commitments from the Federal Home Loan Bank and various correspondent banks. For a further review of the Company's sources and uses of funds, see the Consolidated Statements of Cash Flows included under Item 8 of this Form 10-K.
The Company requires adequate liquidity to pay its expenses and shareholder dividends. Liquidity is provided to the Company from the Subsidiary Banks in the form of dividends. Other liquidity is provided by cash balances in banks, maturing investments and interest on investments. For a discussion of dividend payments, please see Note 12 in the Notes to Consolidated Financial Statements included under Item 8 of this Form 10-K. One method of analyzing the Company's liquidity position is through a careful review of available funding sources. The following table provides information as it pertains to funding sources and reflects a year-to-year comparison of the sources of the Company's liability funding based upon year-end balances.
TABLE 7 FUNDING SOURCES - YEAR-END BALANCES
Total funding sources increased 22.39% at December 31, 1999 from prior year levels. Core deposits increased 13.11% from December 31, 1998 balances while other time deposits $100 or more grew at an 85.93% rate. A recap of other time deposits $100 and over is presented in the following table. For a review of total other time deposit maturities, see Note 6 in the Notes to Consolidated Financial Statements included under Item 8 of this Form 10-K. A recap of borrowed funds can be found in Note 7 in the Notes to Consolidated Financial Statements included under Item 8 of this Form 10-K.
TABLE 8 REMAINING MATURITY OF OTHER TIME DEPOSITS - $100,000 AND OVER
Borrowing facilities are available to the Subsidiary Banks through various correspondent banks in the amount of $25,000. These lines are established for the purpose of borrowing on an overnight basis in the form of Federal Funds. In addition, Uptown has borrowing capacity with the Federal Home Loan Bank of Chicago in the amount of $19,000 for short and long-term borrowings. These borrowings are to be secured by qualifying 1-4 family first mortgages, private mortgage backed securities or U.S. Treasury and Agency Obligations.
CAPITAL RESOURCES
A strong capital structure is vital for many reasons, one of which is to allow the Company the opportunity for future growth. Upbancorp has developed a policy to manage its capital structure and that of its Subsidiary Banks in accordance with regulatory guidelines and to ensure appropriate use of this resource. The Company's capital policy requires that the Company and its Subsidiary Banks maintain a capital ratio in excess of the minimum regulatory guidelines. At December 31, 1999, all entities exceeded regulatory established minimums as defined for financial institutions. Please see Note 13 in the Notes to Consolidated Financial Statements included under Item 8 of this Form 10-K.
Total shareholders equity decreased 0.50% to $22,524 at December 31, 1999. Total equity as a percentage of assets was 6.94% at the end of 1999 versus 8.40% a year earlier. Included in shareholders' equity is the net unrealized loss on securities classified as available-for-sale, which amounted to $910 at the end of 1999 against a gain of $253 as of the end of 1998.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the full collection of the loan principal is unlikely. The level of the provision for loan losses charged to operating expense as well as the balances maintained in the allowance for loan losses is dependent upon many factors, including loan growth, changes in the composition of the loan portfolio, net charge-off levels, delinquencies, collateral values and management's assessment of current and prospective economic conditions in the Company's primary market areas.
The Subsidiary Banks measure the allowance for loan losses on a quarterly or more frequent basis using three measures of reserve adequacy. The first measurement compares the allowance as a percentage of the total loan portfolio. The second test measures the allowance against various loan pools, or types, using historical and peer group reserve percentages for expectations of possible loan losses on each category. The third is a detailed evaluation by all loan officers of classified or non-performing loans to ensure that an adequate allowance has been established for these individual assets.
The allowance for loan losses is comprised of both allocated and unallocated allowances in order to quantify future loss potential. The allocated position represents management's assessment as to potential loss exposure based on both actual loan losses experienced historically and independent credit ratings on individual credits. The unallocated portion is that which is not specifically allocated to a particular loan or general loan category. At December 31, 1999, the allowance for loan losses was comprised of $1,869 and $1,245 of allocated and unallocated reserves, respectively.
TABLE 9 ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
As indicated by this table, the provision for loan losses amounted to $885 for 1999 compared to $580 in 1998 and $410 in 1997. This increase in the 1999 provision is due to the continued growth in the Company's loan portfolio.
The allowance for loan losses amounted to $3,114 for 1999 compared to $2,499 in 1998 and $2,010 in 1997. Allowance levels are the result of the Company's analysis of potential loan losses and the adequacy level as defined by management's internal analysis.
NONPERFORMING ASSETS
One measurement used by management in assessing the risk inherent in the loan portfolio is the level of nonperforming assets. Nonperforming assets consist of both nonaccrual loans, investments and other real estate owned. Nonaccrual loans are those loans which have been determined to have reasonable doubt as to the timely collectibility of interest or principal. Other real estate owned ("OREO") represents real property which has been acquired through foreclosure or real estate which a Subsidiary Bank has obtained possession of in satisfaction of a debt. OREO is carried at the lower of the recorded investment value of the loan or the estimated fair market value, less estimated disposal costs, of the related real estate. Past due loans are loans whose principal and interest payments are delinquent 90 days or more and are still accruing interest.
The following table summarizes nonperforming assets and past due loans for the past five years as well as certain information related to interest income on nonaccrual loans:
TABLE 10 ANALYSIS OF NONPERFORMING ASSETS AND PAST DUE LOANS
Nonperforming assets have decreased for four consecutive years and have reached their lowest level in 15 years. This trend is a result of a strong economy and the effectiveness of the Subsidiary Banks' loan administration and workout procedures. As shown in Table 10, at December 31, 1999, nonperforming assets totaled $907, a $402 decrease from 1998. As a result, the percentage of nonperforming assets to total assets was reduced 42.86% to 0.28%.
NONINTEREST INCOME
Noninterest income consists primarily of service charges on customer deposit accounts and fees earned from mortgage banking activities. Total noninterest income increased 1.87% to $3,213 in 1999 compared to 1998. The continued improvement in noninterest income reflects the continued diversification of our sources of revenue in addition to normal increases related to growth. The following table analyzes the various sources of noninterest income for the years ended December 31, 1997 through 1999.
TABLE 11 NONINTEREST INCOME COMPONENTS
Service charges on deposit accounts, the largest component of noninterest income, consists of fees on both interest bearing and noninterest bearing deposit accounts and charges for items such as insufficient funds, overdrafts and stop payment requests. These charges increased 20.46% in 1999 over 1998 levels.
Mortgage banking activities at Heritage have produced revenues from the sale of mortgage loans into the secondary market. Income from mortgage loans sold in the secondary market was a significant contributor to Heritage's core earnings performance. Heritage does not retain servicing rights to those mortgage loans which it sells. Mortgage banking fee income of $831, a decrease of 33.94%, was recognized in 1999 along with interest income of $86. As of December, 1999, the mortgage banking division of Heritage was sold. Heritage will continue to offer a variety of residential mortgage products.
Net gain (loss) on securities result from the sale of securities from the investment portfolio. For a review of gains and losses related to the investment portfolio, see Note 3 in the Notes to Consolidated Financial Statements included under Item 8 of this Form 10-K.
NONINTEREST EXPENSE
Total noninterest expense increased $1,409 or 11.80%, in 1999 after increasing $1,180, or 10.97% in 1998. This is reflective of the incremental increase in salaries and benefits that result from the necessary staffing increases due to the loan and deposit growth pattern as well as a new branch facility. In addition, staffing was increased in connection with the participation of various commercial loans to other banking institutions. Another component of this increase is the financial impact of the Company's technological advancements.
A key indicator of a bank's ability to maintain low overhead while generating net income is the bank's efficiency ratio. A lower ratio indicates a bank's ability to maintain a lower cost operation in comparison to the resulting income produced. The Company's efficiency ratio continues to improve; for the year-ended December 31, 1999, the Company had a 73% efficiency ratio as compared to 74% for the prior year's period. The following table analyzes the various components of noninterest expense for the years ended December 31, 1997 through 1999.
TABLE 12 NONINTEREST EXPENSE COMPONENTS
An increase of $820 was recognized in noninterest expense other than salaries and employee benefits, from $5,026 at December 31, 1998 to $5,846 at December 31, 1999. The increase in data processing expense resulted from a full operating year of a new LAN/WAN network along with the outsourcing of data processing for Uptown. Management continues to focus on cost containment and this control of expenses remains a priority as a part of our broader goal of maximizing long-term profitability.
FORWARD LOOKING STATEMENTS
Statements made about the Company's future economic performance, strategic plans or objectives, revenue or earnings projections, or other financial items and similar statements are not guarantees of future performance, but are forward looking statements. By their nature, these statements are subject to numerous uncertainties that could cause actual results to differ materially from those in the statements. Important factors that might cause the Company's actual results to differ materially include, but are not limited to, the following:
- Federal and state legislative and regulatory developments; - Changes in management's estimate of the adequacy of the allowance for loan losses (and/or other significant estimates such as OREO, deferred tax valuation allowance, etc.); - Changes in the level and direction of loan delinquencies and write-offs; - Interest rate movements and their impact on customer behavior and Upbancorp's net interest margin; - The impact of repricing and competitors' pricing initiatives on loan and deposit products; - Upbancorp's ability to adapt successfully to technological changes to meet customers' needs and developments in the marketplace; - Upbancorp's ability to access cost effective funding; - Economic conditions; - Year 2000 related complications and - Recently enacted financial modernization legislation.
YEAR 2000 COMPLIANCE
We have tested our products and believe that they are year 2000 compliant. We have also inquired of significant vendors of our internal systems as to their year 2000 readiness and have tested our material internal systems. We believe that, based on these tests and assurances of our vendors, we will not incur material costs to resolve year 2000 issues for our products and internal systems. Furthermore, to date we have not experienced any year 2000 problems and our customers or vendors have not informed us of any material year 2000 problems. If it comes to our attention that there are any year 2000 problems with our products or that some of our third-party hardware and software used in our internal systems are not year 2000 compliant, then we will endeavor to make modifications to our products and internal systems, or purchase new internal systems, to quickly respond to the problem. The costs already incurred by us to date related to year 2000 compliance are not material, and we do not anticipate incurring additional material costs related to year 2000 compliance.
ITEM 7A:
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ON MARKET RISK
While Table 3, illustrated on page 13 is a useful tool for management to assess the general positioning of the Company's balance sheet, management uses an additional measurement tool to evaluate its asset/liability sensitivity which determines exposure to changes in interest rates by measuring the change in net interest income as a percentage of Capital, due to changes in rates over a one-year time horizon.
Management measures such change assuming an immediate and sustained parallel shift in rates of 50, 100 and 200 basis points, both upward and downward. The model uses scheduled amortization, call date or final maturity as appropriate on all non-rate sensitive assets. The model uses repricing frequency on all variable rate assets and liabilities, it also uses a 5-year decay analysis on all non-rate sensitive deposits. Prepayment rates on fixed rate loans have been adjusted up or down by 10% per year to incorporate historical experience in both an up-rate and down-rate environment. Utilizing this measurement concept, the interest rate risk of the Company, expressed as change in net interest income as a percentage of capital over a 1-year time horizon due to changes in interest rates, at December 31, 1999 and 1998, was as follows:
ITEM 8:
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
UPBANCORP, INC. CONSOLIDATED STATEMENTS OF CONDITION DECEMBER 31, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.
UPBANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.
UPBANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOW YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS)
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.
UPBANCORP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. UPBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS:
Upbancorp, Inc. ("Upbancorp" or the "Company"), is a multi-bank holding company, organized in 1983 under the laws of the State of Delaware. The Company owns all of the outstanding common stock of Uptown National Bank of Chicago ("Uptown"), organized in 1929 and located in Chicago, Illinois, and Heritage Bank ("Heritage"), organized in 1977 and located in Phoenix, Arizona. Upbancorp does not engage in any activities other than providing administrative services and acting as a holding company for its Subsidiary Banks.
The Company's affiliates consist of two full-service community banks, which operate six banking offices and one loan production offices in northern Chicago and metropolitan Phoenix. Both Subsidiary Banks are engaged in the general commercial banking business in addition to offering a complete range of retail banking services. The Subsidiary Banks conduct general banking business which embraces all of
the usual functions, both commercial and consumer, and which they may lawfully provide, including, but not limited to: the acceptance of deposits to demand, savings, and time accounts and the servicing of such accounts; commercial, industrial, consumer and real estate lending; collections; safe deposit box operations; and other banking services tailored for both commercial and retail clients.
Uptown's wholly-owned subsidiary, Broadway Clark Building Corporation ("BCBC"), is an Illinois corporation and owns all of the real estate that is used in connection with the operation of Uptown's business with the exception of three facilities, which are leased.
In February, 2000, Uptown applied to the Office of the Comptroller of the Currency ("OCC") to merge Heritage with and into and under the charter of Uptown. Following the consummation of the merger, the offices of Heritage will operate as branches of Uptown. Heritage will retain its name in the Phoenix area.
PRINCIPLES OF CONSOLIDATION:
The consolidated financial statements include the accounts of Upbancorp and its wholly-owned subsidiaries Uptown (including its wholly-owned subsidiary BCBC) and Heritage after elimination of all intercompany balances and transactions.
BASIS OF FINANCIAL STATEMENT PRESENTATION:
The accounting and reporting policies of the Company conform to generally accepted accounting principles. In preparing the accompanying consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and the accompanying notes. Significant estimates which are particularly susceptible to change in a short period of time include the determination of the allowance for loan losses. Actual results could differ from those estimates.
Based on the Company's approach to decision making, it has decided that its business is comprised of a single segment and that Statement of Financial Accounting Standards No. 131 therefore has no impact on its consolidated financial statements.
SECURITIES:
Securities classified as held-to-maturity are those debt securities for which the Subsidiary Banks have both the positive intent and ability to hold to maturity and are reported at amortized cost. Amortization of premiums and accretion of discounts, computed by the interest method over their contractual lives, is included in interest income.
Securities classified as available-for-sale are those debt securities that the Subsidiary Banks intend to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Subsidiary Bank's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors.
Securities available-for-sale are reported at fair value with unrealized gains or losses reported as a separate component of other comprehensive income net of the related deferred tax effect. The amortization of premiums and accretion of discounts, computed by the interest method over their contractual lives, are recognized in interest income.
Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings.
Declines in the fair value of individual securities classified as either held-to-maturity or available-for-sale below their amortized cost that are determined to be other than temporary, result in write-downs of the individual securities to their fair value with the resulting write-downs included in current earnings as realized losses.
MORTGAGES HELD-FOR-SALE:
The Company routinely sells to investors its originated residential mortgage loans and retains no servicing rights relating to these mortgages sold. Mortgage activity includes both mortgages held-for-sale which are held for a period of 5-10 days, all with pre-purchase agreements, in addition to loans sold directly into the secondary market. Mortgages held-for-sale are carried at the lower of cost or market for a period of up to ten days with interest income recognized for that period. For purposes of this report, mortgages held-for-sale and mortgage banking fees relate only to these two types of mortgage activities; not to mortgages which are originated, booked and serviced by the Company. All sales are made without recourse.
LOANS AND ALLOWANCE FOR LOAN LOSSES:
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances reduced by any charge-offs or specific valuation accounts and net of unearned discount, deferred loan fees and the allowance for loan losses.
Loan origination and commitment fees are deferred and the net amount is accreted as an adjustment of the loan yield over the contractual life of the related loans. Commitment fees based upon a percentage of a customer's unused line of credit and fees related to standby letters of credit are recognized over the commitment period.
Interest is accrued daily on the outstanding balances. The accrual of interest is discontinued on loans past due 90 days or more. For impaired loans, accrual of interest is discontinued when management believes, after considering collection efforts and other factors, that the borrower's financial condition is such that collection of interest is doubtful. Interest income on these loans is recognized to the extent interest payments are received and the principal is considered fully collectible.
A loan is impaired when it is probable the Subsidiary Bank will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or at the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment, as well as any subsequent changes, is recorded through a valuation allowance included in the allowance for loan losses. The Company considers consumer loans and residential real estate loans to be smaller homogeneous loans that are not considered as impaired loans. All other loan types are accounted for as impaired loans when they meet the above criteria.
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb estimated losses on existing loans, based on an evaluation of the collectibility of loans and prior loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower's ability to pay. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, various regulatory agencies periodically review the allowance for loan losses. These agencies may require the Banks to make additions to the allowance for loan losses based on their judgments of collectibility after reviewing the information available to them at the time of their examination.
PREMISES AND EQUIPMENT:
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed principally by the straight-line method over their estimated useful lives.
INTANGIBLE ASSETS:
Intangible assets consist of goodwill and other intangible assets which are being amortized on a straight-line basis over estimated lives of 3 to 15 years. Intangible assets, net of accumulated amortization, are included in other assets in the consolidated statements of condition.
INCOME TAXES:
Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
EARNINGS PER COMMON SHARE:
Basic earnings per share is computed by dividing net income for the year by the average number of shares outstanding during the year. Dilutive earnings per share do not differ from basic earnings per share.
STOCK SPLIT:
Effective October 20, 1998, the Company increased its authorized shares of common stock from 300,000 to 3,000,000 and reduced the par value from $10 to $1. In addition, the common stock was split on a four-to-one basis. All references in the accompanying financial statements to number of shares and per share amounts have been retroactively restated to reflect these changes.
RECLASSIFICATIONS:
Certain amounts in the 1998 and 1997 consolidated financial statements have been reclassified to conform with the 1999 presentation. Such reclassifications have no effect on previously reported net income.
EMERGING ACCOUNTING STANDARDS:
In June, 1998, the Financial Accounting Standards Board (FASB) issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133). FAS 133 requires companies to record derivatives on the balance sheet as assets or liabilities at fair value. Depending on the use of the derivative and whether it qualifies for hedge accounting, gains or losses resulting from changes in the values of those derivatives would either be recorded as a component of net income or as a change in stockholder's equity. In June 1999, the FASB issued FAS 137 which deferred the effective date of FAS 133 to fiscal years beginning after June 15, 2000. Management does not anticipate that the adoption of the new Statement will have a significant effect on the Company's earnings or financial position.
NOTE 2. RESTRICTIONS ON CASH AND DUE FROM BANKS
The Subsidiary Banks are required to maintain reserve balances in cash or on deposit with the Federal Reserve Bank, based on a percentage of deposits. The total of these reserve balances was approximately $2,380 and $2,047 at December 31, 1999 and 1998.
NOTE 3. SECURITIES
The Company had no HELD-TO-MATURITY securities at December 31, 1999. The amortized cost and fair value of securities HELD-TO-MATURITY at December 31, 1998 were:
The amortized cost and fair value of securities AVAILABLE-FOR-SALE are as follows at December 31:
The amortized cost and fair value of securities AVAILABLE-FOR-SALE at December 31, 1999, by contractual maturity, are shown below. Expected maturities in mortgage-backed securities may differ from contractual maturities because the mortgages underlying the securities may be called or repaid with or without prepayment penalties. Equity securities have no stated maturity. Therefore, neither type of these securities is included in the maturity categories in the following maturity summary.
Gross gains realized were $37 in 1999, $15 in 1998 and $19 in 1997. Gross losses realized were $36 in 1999, $43 in 1998 and $126 in 1997.
Investment securities carried at approximately $30,682 and $26,515 at December 31, 1999 and 1998, respectively, were pledged to secure public and trust deposits and for other purposes as required or permitted by law.
NOTE 4. LOANS
Major classifications of loans are as follows at December 31:
Changes in the allowance for loan losses account during the years ended December 31, 1999, 1998 and 1997 are summarized below:
As of December 31, 1999 and 1998, the Company's recorded investment in impaired loans and the related valuation allowance are as follows:
The valuation allowance is included in the allowance for loan losses on the balance sheet. The average recorded investment in impaired loans for years-ended December 31, 1999 and 1998, was $795 and $402, respectively. No interest income was recognized in 1999 and 1998 on impaired loans.
NOTE 5. PREMISES AND EQUIPMENT
The following is a summary of bank premises and equipment at December 31:
Depreciation expense on premises and equipment totaled $1,196, $1,054, and $923 for 1999, 1998 and 1997, respectively.
The buildings, in which the main facilities of each bank are located, have stores and offices which are rented. Total rent received was $1,132, $1,037 and $974 in 1999, 1998 and 1997, respectively and is recorded as a reduction of net occupancy expense.
NOTE 6. OTHER TIME DEPOSITS
The aggregate amount of certificates of deposits of $100 or more totaled $36,972 and $19,884 at December 31, 1999 and 1998.
Maturities of other time deposits are summarized as follows at December 31:
NOTE 7. BORROWED FUNDS
At December 31, 1999 and 1998, borrowed funds consisted of :
Uptown has an arrangement with the Federal Home Loan Bank of Chicago whereby the FHLB will make advances to the Bank with repayment terms from overnight to ten years. The Bank is eligible to obtain credit up to 20 times the member Bank's holding of Federal Home Loan Capital Stock; these eligible borrowings amount to $19,000.
As required under the agreement, the advances can be collateralized by the following: qualifying 1-4 family first mortgages, private mortgage-backed securities or U.S. Treasury and Agency obligations. Uptown has pledged a combination of U.S. Treasury and Agency mortgage-backed securities.
NOTE 8. PENSION PLAN
The Company has a defined benefit plan covering substantially all employees. The plan is based on years of service and the employee's average compensation during all years of employment. The Company's funding policy is to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974 ("ERISA"), plus additional amounts as appropriate. In addition, the Company adopted a Supplemental Executive Retirement Plan (the "SERP") for certain executive officers, effective February 17, 1998.
The following table provides a reconciliation of the changes in the Plans' benefit obligations and fair value of assets over the two year period ended December 31, 1999 and a statement of the Plans' funded status as of December 31 of both years:
The net amount recognized is recorded in the financial statements in other assets.
As of December 31, 1999, the benefit obligations of the defined benefit plan and the SERP were $5,709 and $686, respectively, and the fair value of plan assets of the defined benefit plan and the SERP were $8,283 and $-0-, respectively.
The following table provides the components of net periodic benefit cost for the plans fiscal years 1999, 1998 and 1997:
The assumptions used in the measurement of the Company's benefit obligation are shown in the following table:
NOTE 9. INCOME TAXES
The provision for income taxes for the years ended December 31, 1999, 1998 and 1997 is comprised of the following amounts:
The components of the net deferred tax assets which are included in other assets, are as follows:
Management has determined that a valuation allowance is not required at December 31, 1999 and 1998.
The following table reconciles the statutory Federal income tax rate with the effective income tax as a percent of pretax income.
NOTE 10. RELATED PARTIES
The Subsidiary Banks have entered into transactions with their directors and their affiliates (related parties). The aggregate amount of loans to such related parties at December 31, 1999 and 1998 was $3,466 and $2,805, respectively. These loans were made using the same criteria and at interest rates and terms that would be comparable to loans granted to a borrower who is not an executive officer or director. During 1999, new loans and advances to such related parties amounted to $3,410 and repayments amounted to $2,749.
NOTE 11. COMMITMENTS, CONTINGENCIES AND CREDIT RISK
The Subsidiary Banks are parties to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of their customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The contract amounts of these instruments reflect the extent of involvement a bank has in particular classes of financial instruments.
The Subsidiary Banks' exposure to credit loss in the event of nonperformance by the other party for commitments to extend credit and standby and commercial letters of credit is presented by the contractual amount of those instruments. The Subsidiary Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments.
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 Banks evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Subsidiary Banks upon an extension of credit is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, marketable securities, inventory, property, plant, and equipment, and income-producing commercial properties and residential properties.
Standby letters of credit are conditional commitments issued by the Subsidiary Banks to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Subsidiary Banks hold various types of collateral (primarily certificates of deposit) to support those commitments for which collateral is deemed necessary. Most of the letters of credit expire within twelve months.
The Company leases certain office facilities under various operating lease agreements that provide for payment of taxes, insurance and maintenance costs. These leases generally include renewal options. The future minimum rental commitments at December 31, 1999 are as follows:
In the ordinary course of business, the Banks have various outstanding commitments and contingent liabilities that are not reflected in the accompanying consolidated financial statements. In addition, the Company and its Subsidiary Banks are defendants in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial condition of the Company.
In addition to financial instruments with off-balance-sheet risk, the Company, to a certain extent, is exposed to varying risks associated with concentrations of credit. Concentrations of credit risk generally exist if a number of counterparties are engaged in similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by economic or other conditions.
The Company conducts substantially all of its lending activities throughout northeastern Illinois and the greater Phoenix metropolitan area. As of December 31, 1999, loans to customers in Arizona were approximately $61 million. Loans granted to businesses are primarily secured by business assets, owner-occupied real estate or personal assets of commercial borrowers. Loans to individuals are primarily secured by automobiles, residential real estate or other personal assets. Since the Company's borrowers and its loan collateral have geographic concentration in the greater Chicago and greater Phoenix metropolitan areas, the Company could have exposure to a decline in those local economies and real estate markets. However, management believes that the diversity of its customer base and local economies, its knowledge of the local markets, and its proximity to customers limits the risk of exposure to adverse economic conditions.
As of December 31, 1999, the Company's loan portfolio included $53,531 of loans secured by aircraft. Credit losses arising from aircraft loans compare favorably with the Company's credit loss experience on its loan portfolio as a whole.
NOTE 12. RESTRICTIONS ON RETAINED EARNINGS
Uptown and Heritage are subject to certain restrictions on the amount of dividends that they may declare without prior regulatory approval. At December 31, 1999, $2,529 of Uptown earnings were available for dividend declaration without prior regulatory approval. Under the provisions of the Arizona Bank Code, dividends may not be declared unless they are made in compliance within the banking laws of Arizona.
NOTE 13. REGULATORY MATTERS
The Company and the Banks are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can cause regulators to initiate certain mandatory - - and possibly additional discretionary - action that, if undertaken could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Banks must meet specific capital guidelines that involve quantitative measures of the Company's and the Banks' assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's and the Banks' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Banks to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes the Company and the Banks meet all capital adequacy requirements to which they are subject to at December 31, 1999.
At December 31, 1999, all entities exceeded regulatory established minimums as defined for financial institutions. To be categorized as adequately capitalized, the Banks must maintain minimum total risk-based, Tier 1 risk based, and Tier 1 leverage ratios as set forth in the table below. As of year-end, Heritage Bank exceeded regulatory established capital minimums, however, did not exceed the category for "well" capitalized institutions. As a result, the Bank may not accept brokered deposits without prior approval from the regulatory authorities. As a matter of fact, the Bank does not accept brokered deposits. There are no conditions or events since that notification that management believes have changed the Banks' category.
The Company's ratios are presented in the following table:
NOTE 14. FINANCIAL INSTRUMENTS
FAIR VALUE OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used by the Company in estimating its fair value of its financial instruments:
CASH AND DUE FROM BANKS AND FEDERAL FUNDS SOLD: The carrying amounts reported in the balance sheet for cash and due from banks and federal funds sold approximate their fair values.
SECURITIES HELD-TO-MATURITY AND AVAILABLE-FOR-SALE: Fair values of securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
LOANS AND MORTGAGES HELD-FOR-SALE: The fair values of the loan portfolio are estimated based upon discounted cash flow analyses that apply using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.
DEPOSIT LIABILITIES: The fair values disclosed for deposits with no defined maturities is equal to their carrying amounts which represent the amount payable on demand. The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair value at the reporting date. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
BORROWED FUNDS: The carrying amounts of borrowings under repurchase agreements and other short-term borrowings approximate their fair values.
ACCRUED INTEREST: The carrying amounts of accrued interest approximate their fair values.
OFF-BALANCE SHEET INSTRUMENTS: Fair values for the Company's off-balance sheet lending commitments (letters of credit and commitments to extend credit) are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The fair value for such commitments is nominal.
The estimated fair values of the Company's financial instruments were as follows at December 31,
NOTE 15. UPBANCORP, INC. - PARENT ONLY FINANCIAL STATEMENTS
The Parent Company's condensed financial information, which follows, conforms with the accounting policies described in the preceding notes:
STATEMENTS OF CONDITION
STATEMENTS OF INCOME
NOTE 15. UPBANCORP, INC. - PARENT ONLY FINANCIAL STATEMENTS
(Continued)
STATEMENTS OF CASH FLOWS
REPORT OF MANAGEMENT ON RESPONSIBILITY FOR FINANCIAL REPORTING UPBANCORP, INC. AND SUBSIDIARIES
To the Shareholders of Upbancorp, Inc.:
The accompanying consolidated financial statements were prepared by Management, who is responsible for the integrity and objectivity of the data presented. In the opinion of Management, the financial statements, which necessarily include amounts based on Management's best estimates and judgments, have been prepared in conformity with generally accepted accounting principles appropriate to the circumstances.
Management depends upon the Company's system of internal controls in meeting its responsibilities for reliable financial statements. This system is designed to provide reasonable assurance that assets are safeguarded and that transactions are properly recorded and executed in accordance with Management's authorization. Judgments are required to assess and balance the relative cost and the expected benefits of these controls. As an integral part of the system of internal controls, the Bank Subsidiaries contract with a professional staff of Independent Internal Auditors who conduct operational, financial, and special audits, and coordinate audit coverage with the Independent Auditors.
The consolidated financial statements have been audited by our Independent Auditors, McGladrey & Pullen LLP, who render an independent professional opinion on Management's financial statements.
The Audit Committee of Upbancorp, Inc.'s Board of Directors, composed solely of outside directors, meets regularly with the Independent Internal Auditors, the Independent Auditors and Management to assess the scope of the annual examination plan and to discuss audit, internal control and financial reporting issues, including major changes in accounting policies and reporting practices. The Independent Internal Auditors and the Independent Auditors have free access to the Audit Committee, without Management present, to discuss the results of their audit work and their evaluations of the adequacy of internal controls and the quality of financial reporting.
Sincerely,
/s/ Richard K. Ostrom
Richard K. Ostrom Chairman of the Board President and Chief Executive Officer
/s/ Kathleen L. Harris
Kathleen L. Harris Senior Vice President & Chief Financial Officer
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of Upbancorp, Inc.:
We have audited the accompanying consolidated statements of condition of Upbancorp, Inc. and subsidiaries as of December 31, 1999 and 1998 and the related consolidated statements of income, cash flows and changes in shareholders' equity for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Upbancorp, Inc. and subsidiaries as of December 31, 1999 and 1998 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with generally accepted accounting principles.
/s/ McGladrey & Pullen LLP
McGladrey & Pullen LLP
Schaumburg, Illinois March 10, 2000
ITEM 9:
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
PART III
ITEM 10:
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the Directors and Executive Officers of the Company, their family relationships and their business experience is contained in the "Information about Directors and Nominees" and "Executive Officers" sections of the Proxy Statement for the 2000 Annual Meeting of Shareholders of the Company to be held on April 18, 2000, which is incorporated herein by reference.
ITEM 11:
ITEM 11: EXECUTIVE COMPENSATION
Information regarding compensation of the Executive Officers of the Company is contained in the "Executive Compensation" section of the Proxy Statement for the 2000 Annual Meeting of Shareholders of the Company to be held on April 18, 2000, which is incorporated herein by reference.
ITEM 12:
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and management is contained in the "Security Ownership of Certain Beneficial Owners and Management" section of the Proxy Statement for the 2000 Annual Meeting of Shareholders of the Company to be held on April 18, 2000, which is incorporated herein by reference.
ITEM 13:
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions of the Company is contained in the "Certain Relationships and Related Transactions" section of the Proxy Statement for the 2000 Annual Meeting of Shareholders of the Company to be held on April 18, 2000, which is incorporated herein by reference. Further information with respect to loans to the Directors and Executive Officers of the Company is prov7ided in Note 10 in the Notes to Consolidated Financial Statements included under Item 8 of this Form 10-K.
PART IV
ITEM 14:
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following exhibits, financial statements and financial statement schedules are filed as part of this report:
FINANCIAL STATEMENTS
Consolidated Statements of Condition - December 31, 1999 and 1998
Consolidated Statements of Income - Years ended December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows - Years ended December 31, 1999, 1998 and 1997
Consolidated Statements of Changes in Shareholders' Equity - Years ended December 31, 1999, 1998 and 1997
Notes to Consolidated Financial Statements
Report of Independent Public Accountants
FINANCIAL STATEMENT SCHEDULES
All schedules normally required by Form 10-K are omitted since they are either not applicable or the required information is shown in the financial statements or notes thereto.
EXHIBITS
(3) Amended Certificate of Incorporation and by-laws (filed as an Exhibit to the Registrant's 1998 Form 10K and incorporated herein by reference).
(10.1) Employment Agreement between Upbancorp, Inc. and Richard K. Ostrom is attached hereto as Exhibit A.
Employment Agreement between Heritage Bank, Upbancorp, Inc. and John E. Fahrendorf, Jr. (filed as an Exhibit to the Registrant's 1998 Form 10-K and incorporated herein by reference).
Employment Agreement between Uptown National Bank of Chicago, Upbancorp, Inc. and Robert P. Griffiths (filed as an Exhibit to the Registrant's 1998 Form 10-K and incorporated herein by reference).
(10.2) Indemnity Agreement between Upbancorp, Inc. and its Directors and Officers (filed as an Exhibit to the Registrant's 1992 Form 10-K and incorporated herein by reference).
(22) Subsidiaries of the Registrant (see Item 1 which contains this information).
(28) Proxy Statement for the 2000 Annual Meeting is attached hereto as Exhibit B.
(b) REPORTS ON FORM 8-K - No reports on Form 8-K were filed during the fourth quarter of 1999.
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
Date: March 10, 2000 UPBANCORP, INC. ------------------------ (The Registrant)
/s/ Richard K. Ostrom ------------------------ Richard K. Ostrom Chairman of the Board, President and Chief Executive Officer
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 THEIR CAPACITIES ON MARCH 10, 2000.