Old Second Bancorp - 10-Q quarterly report FY

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2004

OR

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

For transition period from            to            

Commission File Number 0 -10537

OLD SECOND BANCORP, INC.

(Exact name of Registrant as specified in its charter)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý  No o

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: As of May 1, 2004, the Registrant had outstanding 6,706,107 shares of common stock, $1.00 par value per share.

OLD SECOND BANCORP, INC.

Form 10-Q Quarterly Report

Table of Contents

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PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

Old Second Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share data)

See accompanying notes to consolidated financial statements.

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Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Income

(In thousands, except share data)

See accompanying notes to consolidated financial statements.

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Old Second Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Three Months Ended March 31, 2004 and 2003

(In thousands)

See accompanying notes to consolidated financial statements.

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Old Second Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 1 – Summary of Significant Accounting Policies

The accounting policies followed in the preparation of interim financial statements are consistent with those used in the preparation of annual financial information. The interim financial statements reflect all normal and recurring adjustments, which are necessary, in the opinion of management, for a fair statement of results for the interim period presented.  Results for the period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.  These interim financial statements should be read in conjunction with the audited financial statements and notes included in the Company’s 2003 Form 10-K.  Unless otherwise indicated, amounts in the tables contained in these Notes are in thousands.

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements. Future changes in information may affect these estimates, assumptions, and judgments, which, in turn, may affect amounts, reported in the financial statements.

All significant accounting policies are presented in Note 1 to the consolidated financial statements for the year ended December 31, 2003. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined.

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Note 2 – Securities

Securities available for sale are summarized as follows:

Note 3 – Loans

Major classifications of loans were as follows:

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Note 4 – Allowance for Loan Losses

Changes in the allowance for loan losses as of  March 31, are summarized as follows:

Note 5 – Deposits

Major classifications of deposits were as follows:

Note 6 – Borrowings

The Company had a $30 million line of credit available with Marshall & Ilsley under which there was an outstanding balance of $500,000 as of March 31, 2004, and also had a $20 million line of credit available with Marshall & Ilsley under which there was an outstanding balance of $500,000 as of December 31, 2003.  A revolving business note dated May 1, 2003 secures the line of credit and is guaranteed by the Company.   The note provides that any outstanding principal will bear interest at our option; at the rate of either 1% over the previous month average Federal Reserve targeted rate (federal funds rate) or 0.90% over the adjusted interbank rate with a minimum interest rate of 2.20%.  This borrowing is for general corporate purposes.

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The Company enters into sales of securities under agreements to repurchase (repurchase agreements).  These repurchase agreements are treated as financings.  The dollar amounts of securities underlying the agreements remain in the asset accounts.  Securities sold under agreements to repurchase consisted of U.S. government agencies at March 31, 2004 and December 31, 2003.

The Company borrowings at the FHLB are limited to the lesser of 35% of total assets or 60% of the book value of certain mortgage loans. In addition, these notes are collateralized by FHLB stock of $3.7 million at March 31, 2004 and December 31, 2003.

The Company is a Treasury Tax & Loan (TT&L) depository for the Federal Reserve Bank (FRB), and as such, they accept TT&L deposits. The Company is allowed to hold these deposits for the FRB until they are called. The interest rate is the federal funds rate less 25 basis points. U.S. Treasury Securities with a face value greater than or equal to the amount borrowed are pledged as a condition of borrowing TT&L deposits. As of March 31, 2004 and December 31, 2003, the TT&L deposits were $1.3 million and $3.1 million, respectively.

At March 31, 2004 and December 31, 2003, respectively, short-term borrowings totaled $158.7 million at a weighted average rate of .96% and $154.4 million at a weighted average rate of 1.2%.   The increase in short-term borrowings was primarily the result of asset growth during 2004 that exceeded deposit growth. During 2004, loans and securities grew $56.8 million while deposits grew $48.0 million.

The following table reflects categories of short-term borrowings having average balances during the period greater than 30% of stockholders’ equity of the Company at the end of the period. For the year ended December 31, 2003, securities sold under repurchase agreements met the criteria. For the quarter ended March 31, 2004, securities sold under repurchase agreements and federal funds sold met the criteria.   Information presented is as of or for the periods indicated:

Note 7– Cumulative Trust Preferred Securities

During June 2003, the Company completed its tender offer for shares of its common stock, in which 723,053 shares were repurchased at $42.50 per share.  The total cash payment required to complete the tender offer was approximately $30.7 million, which was funded by the sale of trust preferred securities.  The Company completed the sale of $27.5 million of

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cumulative trust preferred securities by its subsidiary, Old Second Capital Trust I in June 2003.  An additional $4.1 million of cumulative trust preferred securities was sold in the first week of July 2003.  The costs associated with the tender offer of the cumulative trust preferred securities are being amortized over 30 years using the straight-line method.  Cash distributions on the securities are payable quarterly at an annual rate of 7.80% and are included in interest expense in the consolidated financial statements.

Note 8– Long-Term Incentive Plan

The Long-Term Incentive Plan the “Incentive Plan” currently authorizes the issuance of up to 666,000 shares of the Company’s common stock, including the granting of qualified stock options, nonqualified stock options, restricted stock and stock appreciation rights. Stock based awards may be granted to selected directors and officers or employees at the discretion of the board of directors. The Incentive Plan requires the exercise price of any incentive stock option issued to an employee to be at least equal to the fair market value of Company common stock on the date the option is granted. All stock options are granted for a maximum term of ten years, with vesting occurring during the first three years.

Nonqualified stock options may be granted to directors based on a formula. These options, along with other awards under the Incentive Plan, may be granted subject to a vesting requirement, and would become fully vested upon a merger or change in control of the Company. Since December 31, 1998, there have been no nonqualified stock options, stock appreciation rights, or restricted stock issued under the Incentive Plan.

A summary of activity in the Incentive Plan and options outstanding is included below:

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The Company accounts for stock options in accordance with APB No. 25, as allowed under SFAS No. 123.  No expense for stock options is recorded, as the grant price equals the market price of the stock at grant date.  There were no stock options granted in 2004.

The following pro forma information presents net income and earnings per share had the fair value method of S F A S No. 123 been used to measure compensation cost for stock option plans.

The pro forma effects were computed using option-pricing models with the following assumptions:

Note 9 – Earnings Per Share

Earnings per share is included below (share data not in thousands):

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Note 10 – Comprehensive Income

Comprehensive income is included below:

Note 11 – Retirement Plans

The Company has a tax-qualified noncontributory defined benefit retirement plan covering substantially all full-time and regular part-time employees of the Company. Generally, benefits are based on years of service and compensation. Certain participants in the defined benefit plan are also covered by an unfunded supplemental retirement plan. The purpose of the supplemental retirement plan is to extend full retirement benefits to individuals without regard to statutory limitations under tax-qualified plans.

The Company maintains tax-qualified contributory and non-contributory profit sharing plans covering substantially all full-time and regular part-time employees. The expense of these plans was $419,000 and $444,000 in the first quarter of 2004 and 2003, respectively.

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Item 2.   Managements’ Discussion and Analysis of Financial Condition and Results for Operations

Overview

Old Second Bancorp is a financial services company with its main headquarters located in Aurora, Illinois.  The Company has offices located in Kane, Kendall, DeKalb, DuPage and LaSalle counties in Illinois.  The Company provides financial services through its three subsidiary banks at its twenty-three banking locations.  Old Second Mortgage, which also conducts business as “Maple Park Mortgage”, provides mortgage-banking services at its four offices.  Old Second Financial, Inc provides insurance products.  The Old Second National Bank of Aurora, the Company’s lead subsidiary bank, also engages in trust operations.

Results of Operations

Net income for the first quarter of 2004 was $6.07 million, or $ 0.90 diluted earnings per share, compared with $5.21 million, or $ 0.70 diluted earnings per share in the first quarter of 2003.  The result was a 16.57% increase in earnings, or 28.57% on a per share basis. Earnings were enhanced by strong asset growth, the gain on sale of securities, the reduction of the loan loss provision and a decrease in the tax provision.  The return on equity increased to 20.22% in the first three months of 2004, from 15.57% for the same period of 2003.  In June 2003, the Company completed its tender offer for shares of its common stock, in which 723,053 shares were repurchased, thereby reducing the average shares outstanding in 2004 and increasing earnings per share and return on equity.

Net Interest Income

The increase in net income for the three-month period was primarily the result of an increase in net interest income.  Net interest income was $16.8 million and $14.6 million during the three months ended March 31, 2004 and 2003, respectively, an increase of 15.2%.

Management, in order to evaluate and measure performance, uses certain non-GAAP performance measures and ratios. These include taxable-equivalent net interest income (including its individual components) and net interest margin (including its individual components). Management believes that these measures and ratios provide users of the financial information with a more accurate view of the performance of the interest-earning assets and interest-bearing liabilities and of The Company’s operating efficiency for comparison purposes. Other financial holding companies may define or calculate these measures and ratios differently. See the table below for supplemental data and the corresponding reconciliation to GAAP financial measures for the three months ended March 31, 2004 and 2003.

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The following table sets forth certain information relating to the Company’s average consolidated balance sheets and reflects the yield on average earning assets and cost of average liabilities for the periods indicated. The rates are determined by dividing the related interest by the average balance of assets or liabilities. Average balances are derived from daily balances.

ANALYSIS OF AVERAGE BALANCES,

TAX EQUIVALENT INTEREST AND RATES

For periods ended March 31, 2004 and 2003

Notes:             Nonaccrual loans are included in the above stated average balances.
Tax equivalent basis is calculated using a marginal tax rate of 35%.

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Yields on certain asset categories and the net interest margin of the Company and its banking subsidiaries are reviewed on a fully taxable-equivalent basis (“FTE”). In this non-GAAP presentation, net interest income is adjusted to reflect tax-exempt interest income on an equivalent before-tax basis. This measure ensures comparability of net interest income arising from both taxable and tax-exempt sources.

Provision for Loan Losses

The Company did not make a provision for loan losses during the first quarter compared to a provision of $855,000 during the first quarter of the previous year. The determination by management to maintain the level of the allowance for loan losses at the year-end level was based on a number of factors, including the quality of the loan portfolio and past favorable loan loss experience. Provisions for loan losses are made to provide for probable and estimable losses inherent in the loan portfolio.  The provision reflects a number of factors, including the size of the loan portfolio, the amount of past due accruing loans (90 days or more), the amount of non-accrual loans and management’s overall view on current credit quality.  Net recoveries for the first quarter of 2004 were $10,000 compared with net charge-offs of $369,000 in the first quarter of 2003.  Total loan charge-offs were $75,000 during the first three months of 2004, compared with $572,000 during the first three months of 2003, while recoveries for the same periods were $85,000 and $203,000, respectively.

The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated statement of condition.

One measure of the adequacy of the allowance for loan losses is the ratio of the allowance to total loans. The allowance for loan losses as a percentage of total loans was 1.32% as of March 31, 2004, compared to 1.39% as of December 31, 2003 and 1.46% as of March 31, 2003.  In

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management’s judgment, an adequate allowance for estimated losses has been established; however, there can be no assurance that such loss will not exceed the estimated amounts in the future.

Nonperforming loans of $2.2 million as of March 31, 2004, were down from $2.6 million as of December 31, 2003. Nonperforming loans include loans in nonaccrual status, renegotiated loans, and loans past due ninety days or more and still accruing.  Nonaccrual loans decreased from $2.3 million as of December 31, 2003 to $2.0 million as of March 31, 2004.  The allowance for loan losses as a percentage of nonperforming loans was 826.68% at March 31, 2004 as compared to 691.65% as of December 31, 2003.  Asset quality has remained strong, as demonstrated by net charge-offs decreasing from $369,000 in the first quarter of 2003 to net recoveries of $10,000 in the first quarter of 2004.

Past due and nonaccrual loans for periods ended March 31, 2004 and December 31, 2003 were as follows:

Noninterest Income

Noninterest income was $6.2 million during the first quarter of 2004 and $7.4 million in the first quarter of 2003, a decrease of $1.2 million, or 16.20%.  A decrease in loan originations in the first quarter of 2004 led to a decrease in the gain on sale of loans of $1.9 million, or 60.97% and a decrease in secondary mortgage fees of $255,000 or 56.42%.  During the first quarter of 2004, increased activity resulted in a gain on the sale of securities of $640,000, compared with $34,000 in the first quarter 2003.  Service charges on deposits increased $90,000, or 5.56% for the three-month period.  Trust assets under management increased from $746.8 million at March 31, 2003 to $863.0 million at March 31, 2004 resulting in an increase in trust income of  $111,000 or 8.8% for the first quarter of 2004.

Noninterest Expense

Noninterest expense was $13.8 million for the first three months of 2004, an increase of $613,000, or 4.66%, from $13.2 million in the first three months of 2003.  Salaries and benefits, which is the largest component of noninterest expense, decreased $109,000, or 1.28% from the same quarter of 2003.  The full-time equivalent number of employees was 535 as of March 31, 2004, as compared with 522 one year earlier.  In addition to increased staffing and merit increases, commissions and incentives tied to earnings performance also increased.  Employee benefit expenses increased as well, primarily due to higher employee healthcare insurance, retirement benefits, and payroll taxes associated with the salary increases.  Net occupancy

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expenses increased $97,000, or 11.43%, and furniture and equipment expenses decreased $44,000 or 4.14% from the first quarter of the prior year.  As the Company continues to expand into and develop new markets, related facility and employee expenses have increased accordingly.

Other expense, which consists primarily of postage, processing fees, professional fees and marketing fees, increased from $2.6 million in the first quarter of 2003 to $3.3 million in the first quarter of 2004 due to the increased expenses related to expansion into and development of new markets.

On September 24, 2001, Sheryl H. Kuzman brought suit against Old Second Bank-Yorkville, a wholly owned subsidiary of Old Second Bancorp Inc. and formerly known as Yorkville National Bank, in the 12^th Judicial Circuit Court, Will County, Illinois.  The plaintiff alleged defamation by the bank and a bank official and sought monetary damages.  On March 30, 2004, a jury verdict in favor of the plaintiff was entered awarding approximately $700,000 in compensatory damages and $1.5 million in punitive damages. Old Second intends to file post-trial motions, including a request to overturn the verdict or grant a new trial, or, in the alternative, reduce the amount awarded by the jury.  If those motions are not granted, Old Second expects to appeal to the Third Appellate District of the State of Illinois.    Old Second has not taken a charge against earnings in its financial statements for the quarter ended March 31, 2004 related to this matter.

Income Taxes

The Company’s provision for Federal and State of Illinois income taxes was $3.2 million and $2.8 million for the first quarter of 2004 and 2003 respectively. The first quarter average effective income tax rate for 2004 and 2003 was 34.6% and 35.1%, respectively.

Financial Condition

Assets

Total assets were $1.90 billion at March 31, 2004, an increase of $61.6 million from $1.84 billion at December 31, 2003.

Loans

Total loans were $1.39 billion as of March 31, 2004, an increase of $71.7 million or 5.43% for the three-month period, from $1.32 billion as of December 31, 2003. The largest increases in loan classifications were in real estate construction loans, which increased $52.1 million, or 23.8%. These changes reflected the continuing loan demand in the markets in which the Company operates.  The loan portfolio generally reflects the profile of the communities in which the Company operates. Because the Company is located in growing areas, real estate lending (including commercial, residential, and construction) is a significant portion of the portfolio. These categories comprised 82.1% of the portfolio as of December 31, 2003 and 83.8% of the portfolio as of March 31, 2004.

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Securities

Securities totaled $391.0 million as of March 31, 2004 a decrease of $20.0 million from $411.0 million as of December 31, 2003.  During March 2004, the Company purchased $20 million in bank-owned life insurance (BOLI) that was reported in other assets on the financial statements. The BOLI purchase was funded by the sale of $20 million of securities, which resulted in a net gain of $629,000.   The net unrealized gains, net of deferred taxes, in the portfolio increased from  $3.0 million as of December 31, 2003 to $4.3 million as of March 31, 2004.

Deposits and Borrowings

Total deposits were $1.57 billion as of March 31, 2004, an increase of $48.0 million from $1.52 billion as of December 31, 2003.  Demand deposits decreased $3.8 million during the first three months from $214.4 million to $210.7 million or 1.76%.  At the same time, savings deposits, which include money market accounts, decreased $10.3 million or 1.4% from $737.8 million to $727.5 million.  Time deposits increased $62.1 million from $572.4 million to $634.5 million or 10.9% during the same period.  Given the lower interest rate environment in which retail time deposits were maturing, pricing and sales strategies targeted growth in transactional deposit accounts and customer reinvestment of maturing time deposit balances in longer-term maturities.  Successful selling efforts in these areas resulted in an increase in new account relationships and core funding sources.

Securities sold under repurchase agreements, which are typically of short-term duration, decreased from $47.8 million as of December 31, 2003, to $35.2 million as of March 31, 2004. Other short-term borrowings increased from $106.0 million to $123.0 million due to a Federal Home Loan advance of $26.5 million.  The Company is currently maintaining liquid assets and delivering consistent growth in core funding to provide funding for loan growth.

Capital

The Company and its three subsidiary banks are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines provide for five classifications, the highest of which is well capitalized. The Company and its subsidiary banks were categorized as well capitalized as of March 31, 2004.

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The accompanying table shows the capital ratios of the Company and Old Second National Bank, the Company’s lead subsidiary bank, as of March 31, 2004.

Capital levels and minimum required levels:

During June 2003, the Company completed its tender offer for shares of its common stock, in which 723,053 shares were repurchased at $42.50 per share.  The total cash payment required to complete the tender offer was approximately $31.6 million, which was funded by the issuance of cumulative trust preferred securities by its subsidiary, Old Second Capital Trust I (Nasdaq:OSBCP).  The costs associated with the tender offer of the cumulative trust preferred securities are being amortized over 30 years using the straight-line method.  Cash distributions on the securities are payable quarterly at an annual rate of 7.80%, and are included in interest expense in the consolidated financial statements.

Liquidity and Market Risk

Liquidity is the Company’s ability to fund its operations, to meet depositor withdrawals, to provide for customer’s credit needs, to meet maturing obligations and its existing commitments, to withstand fluctuations in deposit levels, and to meet maturing obligations and existing commitments.  The liquidity of the Company principally depends on cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and its ability to borrow funds in the money or capital markets.

Net cash outflows from operating activities were $10.4 million in the first three months of 2004, compared with net cash inflows of $26.4 million in the first three months of 2003. The

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decrease in cash inflows was related to the increase in loans held for sale of $5.1 million.  The cash outflow in accrued interest and other assets was directly related to the $20 million purchase of BOLI recorded in other assets. The cash outflows in accrued interest and other liabilities were related to the changes in income taxes payable.  Interest received, net of interest paid, was the principal use of operating cash outflows in both periods reported.  Management of investing and financing activities, as well as market conditions, determines the level and the stability of net interest cash flows.  Management’s policy is to mitigate the impact of changes in market interest rates to the extent possible, so that balance sheet growth is the principal determinant of growth in net interest cash flows.

Net cash outflows from investing activities were $50.8 million in the three months ended March 31, 2004, compared to $54.4 million a year earlier. In the first three months of 2004, securities transactions accounted for a net inflow of $22.1 million, and net principal disbursed on loans accounted for net outflows of $71.7 million. In the first three months of 2003, securities transactions accounted for a net inflow of $1.3 million, and net principal disbursed on loans accounted for net outflows of $54.3 million.  Cash outflows for property and equipment were $907,000 in 2004 compared to $1.5 million for the same three months of 2003.

Cash inflows from financing activities included an increase in deposits of $48.0 million and a decrease in fed funds purchased and repurchase agreements of $12.7 million in the first three months of 2004, offset by a $17.0 million increase in other short-term borrowings.  This compares with a net cash inflow of $7.7 million associated with an increase in deposits of $5.4 million, and an increase in repurchase agreements of $7.5 million, offset by a reduction to other short-term borrowings of $4.2 million during the first three months of 2003.

Interest Rate Risk

The impact of movements in general market interest rates on a financial institution’s financial condition, including capital adequacy, earnings, and liquidity, is known as interest rate risk. Interest rate risk is the Company’s primary market risk. As a financial institution, accepting and managing this risk is an inherent aspect of the Company’s business. However, safe and sound management of interest rate risk requires that it be maintained at prudent levels.

The Company analyzes interest rate risk by examining the extent to which assets and liabilities are interest rate sensitive. The interest sensitivity gap is defined as the difference between the amount of interest earning assets maturing or repricing within a specific time period, and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest sensitive assets exceeds the amount of interest sensitive liabilities. A gap is considered negative when the amount of interest sensitive liabilities exceeds the amount of interest sensitive assets. During a period of rising interest rates, a negative gap would tend to result in a decrease in net interest income, while a positive gap would tend to positively affect net interest income. The Company’s policy is to manage the balance sheet so that fluctuations in the net interest margin are minimized, regardless of the level of interest rates.

The accompanying table does not necessarily indicate the future impact of general interest rate movements on the Company’s net interest income, because the repricing of certain assets and liabilities is discretionary, and is subject to competitive and other pressures. As a result, assets and liabilities indicated as repricing within the same period may in fact reprice at different times

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and at different rate levels. Assets and liabilities are reported in the earliest time frame in which maturity or repricing may occur. Although securities available for sale are reported in the earliest time frame in which maturity or repricing may occur, these securities may be sold in response to changes in interest rates or liquidity needs.

Expected Maturity of Interest-Earning Assets and Interest-Bearing Liabilities

3/31/2004

Recent Regulatory Developments

On March 31, 2004, Illinois Governor Blagojevich signed an Executive Order that would create a new state agency called the Department of Financial and Professional Regulation (the ”DFPR”).  As issued, the Executive Order provides that the DFPR would replace the Office of Banks and Real Estate, the Department of Financial Institutions, the Department of Insurance and the Department of Professional Regulation.  The DFPR would be established on July 1, 2004, unless the Executive Order is challenged.  At this time, it is not possible to predict the impact that the creation of the DFPR would have on the Company and its subsidiaries.

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Item 4.   Controls and Procedures

An evaluation was performed under the supervision and participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of March 31, 2004. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective. There have been no significant changes in the Company’s internal controls, or in other factors that could significantly affect internal controls.

SPECIAL NOTE CONCERNING FORWARD-LOOKING STATEMENTS

This document contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company.  Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions.

Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

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

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

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

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

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

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

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

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

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

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

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

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