UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------- FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarter ended March 31, 2003 Commission File No. 2-80070 ----------------- CASS INFORMATION SYSTEMS, INC. Incorporated under the laws of MISSOURI I.R.S. Employer Identification No. 43-1265338 13001 HOLLENBERG DRIVE, BRIDGETON, MISSOURI 63044 Telephone: (314) 506-5500 ----------------- Indicate by check mark whether the registrant 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, and has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| The number of shares outstanding of registrant's only class of stock as of April 30, 2003: Common stock, par value $.50 per share - 3,377,973 shares outstanding. - -------------------------------------------------------------------------------- This document constitutes part of a prospectus covering securities that have been registered under the Securities Act of 1933. - --------------------------------------------------------------------------------
TABLE OF CONTENTS PART I - Financial Information Item 1. CONSOLIDATED FINANCIAL STATEMENTS Consolidated Balance Sheets March 31, 2003 (unaudited) and December 31, 2002 ............ 3 Consolidated Statements of Income Three months ended March 31, 2003 and 2002 (unaudited) ...... 4 Consolidated Statements of Cash Flows Three months ended March 31, 2003 and 2002 (unaudited) ...... 5 Notes to Consolidated Financial Statements (unaudited) ........ 6 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ................................... 10 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .... 18 Item 4. DISCLOSURES AND CONTROLS ...................................... 18 PART II - Other Information - Items 1. - 6. ................................. 19 SIGNATURES ............................................................ 20 CERTIFICATIONS ........................................................ 21 Forward-looking Statements - Factors That May Affect Future Results This report may contain or incorporate by reference forward-looking statements made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are not guarantees of future performance and involve risks, uncertainties, and other factors, including those set forth in this paragraph. Important factors that could cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by those statements include, but are not limited to: the failure to successfully execute our corporate plan, the loss of key personnel or inability to attract additional qualified personnel, the loss of key customers, increasing competition, the inability to remain current with rapid technological change, risks related to acquisitions, risks associated with business cycles, utility and system interruptions or processing errors, rules and regulations governing financial institutions and changes in such rules and regulations, credit risk related to borrowers' ability to repay loans, concentration of loans to commercial enterprises, loans to churches and loans in the St. Louis Metropolitan area which creates risks associated with adverse factors that may affect these groups, risks associated with fluctuations in interest rates, and volatility of the price of our common stock. We undertake no obligation to publicly update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, or changes to future results over time. -2-
PART I. FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited) (Dollars in Thousands except Per Share Data) <TABLE> <CAPTION> March 31 December 31 2003 2002 <S> <C> <C> Assets Cash and due from banks $ 24,873 $ 24,279 Federal funds sold and other short-term investments 9,941 5,727 --------- --------- Cash and cash equivalents 34,814 30,006 --------- --------- Investment in debt and equity securities available-for-sale, at fair value 66,199 69,371 Loans 432,084 434,689 Less: Allowance for loan losses 5,387 5,293 --------- --------- Loans, net 426,697 429,396 --------- --------- Premises and equipment, net 15,449 15,359 Bank owned life insurance 10,291 10,178 Goodwill 3,150 223 Other intangible assets, net 2,148 379 Other assets 12,219 17,321 --------- --------- Total assets $ 570,967 $ 572,233 ========= ========= Liabilities and Shareholders' Equity Liabilities: Deposits: Noninterest-bearing $ 92,120 $ 109,352 Interest-bearing 135,814 134,166 --------- --------- Total deposits 227,934 243,518 Accounts and drafts payable 264,204 223,621 Short-term borrowings 10,009 37,438 Other liabilities 6,858 6,610 --------- --------- Total liabilities 509,005 511,187 --------- --------- Shareholders' Equity: Preferred stock, par value $.50 per share; 2,000,000 shares authorized and no shares issued -- -- Common stock, par value $.50 per share; 20,000,000 shares authorized and 4,160,110 shares issued 2,080 2,080 Additional paid-in capital 8,486 8,466 Retained earnings 65,417 64,607 Common shares in treasury, at cost (792,642 shares at March 31, 2003 and 796,278 shares at December 31, 2002) (15,205) (15,275) Unamortized stock bonus awards (105) (25) Accumulated other comprehensive income 1,289 1,193 --------- --------- Total shareholders' equity 61,962 61,046 --------- --------- Total liabilities and shareholders' equity $ 570,967 $ 572,233 ========= ========= </TABLE> See accompanying notes to unaudited consolidated financial statements. -3-
CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (Dollars in Thousands except Per Share Data) <TABLE> <CAPTION> Three Months Ended March 31 -------------------------- 2003 2002 <S> <C> <C> Interest Income: Interest and fees on loans $ 6,416 $ 6,227 Interest and dividends on debt and equity securities: Taxable 188 1,195 Exempt from federal income taxes 435 337 Interest on federal funds sold and other short-term investments 100 160 ---------- ---------- Total interest income 7,139 7,919 ---------- ---------- Interest Expense: Interest on deposits 451 548 Interest on short-term borrowings 9 3 ---------- ---------- Total interest expense 460 551 ---------- ---------- Net interest income 6,679 7,368 Provision for loan losses 90 90 ---------- ---------- Net interest income after provision for loan losses 6,589 7,278 ---------- ---------- Noninterest Income: Freight and utility payment and processing revenue 6,969 5,551 Software revenue 1,778 -- Bank service fees 426 412 Other 129 41 ---------- ---------- Total noninterest income 9,302 6,004 ---------- ---------- Noninterest Expense: Salaries and employee benefits 9,352 7,606 Occupancy expense 436 364 Equipment expense 1,161 1,089 Other 2,828 2,265 ---------- ---------- Total noninterest expense 13,777 11,324 ---------- ---------- Income before income tax expense 2,114 1,958 Income tax expense 596 612 ---------- ---------- Net income $ 1,518 $ 1,346 ========== ========== Earnings per share*: Basic $ .45 $ .40 Diluted $ .45 $ .40 Weighted average shares outstanding*: Basic 3,362,047 3,360,525 Effect of stock options and awards 33,758 21,924 Diluted 3,396,030 3,382,449 </TABLE> * Earnings per share and weighted average shares outstanding for three months ended March 31, 2002 have been restated to reflect the 5% stock dividend distributed in December 2002. See accompanying notes to consolidated financial statements. -4-
CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in Thousands) <TABLE> <CAPTION> Three Months Ended March 31 ----------------------- 2003 2002 -------- -------- <S> <C> <C> Cash Flows From Operating Activities: Net income $ 1,518 $ 1,346 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,191 961 Provision for loan losses 90 90 Amortization of stock bonus awards 10 8 Tax benefit from exercise of stock options and bonuses -- 186 Decrease (increase) in accrued interest receivable 129 (533) Deferred income tax benefit (46) (260) Increase in pension liability 292 230 Increase in income tax liability 275 405 Change in other assets 63 (195) Change in other liabilities (299) (391) Other operating activities, net 8 246 -------- -------- Net cash provided by operating activities 3,231 2,093 -------- -------- Cash Flows From Investing Activities: Proceeds from maturities of debt and equity securities available-for-sale 3,144 6,848 Purchase of debt and equity securities available-for-sale -- (39,388) Net decrease (increase) in loans 2,609 (2,484) Purchases of premises and equipment, net (1,039) (285) -------- -------- Net cash provided by (used in) investing activities 4,714 (35,309) -------- -------- Cash Flows From Financing Activities: Net decrease in noninterest-bearing demand deposits (17,232) (18,940) Net increase (decrease) in interest-bearing demand and savings deposits 758 (4,244) Net increase in time deposits 890 2,584 Net increase (decrease) in accounts and drafts payable 40,583 (3,097) Net decrease in short-term borrowings (27,429) -- Cash proceeds from exercise of stock options -- 348 Cash dividends paid (707) (641) Purchase of common shares for treasury -- (383) -------- -------- Net cash used in financing activities (3,137) (24,373) -------- -------- Net increase (decrease) in cash and cash equivalents 4,808 (57,589) Cash and cash equivalents at beginning of period 30,006 99,855 -------- -------- Cash and cash equivalents at end of period $ 34,814 $ 42,266 ======== ======== Supplemental information: Cash paid for interest $ 440 $ 546 Cash paid for income taxes 182 12 </TABLE> See accompanying notes to unaudited consolidated financial statements. -5-
CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1 - Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the period ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. For further information, refer to the consolidated financial statements and related footnotes included in the Cass Information System, Inc.'s ("the Company") Annual Report on Form 10-K for the year ended December 31, 2002. Certain amounts in the 2002 consolidated financial statements have been reclassified to conform to the 2003 presentation. Such reclassifications have no effect on previously reported net income or shareholders' equity. All share and per share data for 2002 has been restated to reflect the 5% stock dividend issued in December 2002. Note 2 - Impact of New Accounting Pronouncements In November 2002, the Financial Accounting Standards Board (FASB) issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34". This interpretation elaborates on the disclosures to be made by a guarantor in its financial statements about its obligation under guarantees issued. The interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the interpretation are applicable to guarantees issued or modified after December 31, 2002 and did not have a material effect on the Company's consolidated financial statements. The disclosure requirements are effective for financial statements of periods ending after December 15, 2002 and are included in Note 9 of this report. In December 2002, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123". This statement amends SFAS 123 "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in both the annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2002 and are included in Note 10 of this report. Note 3 - Loans by Type (In Thousands) March 31, 2003 December 31, 2002 - -------------------------------------------------------------------------------- Commercial and industrial $96,380 $101,116 Real estate: Mortgage 186,675 176,667 Mortgage - Churches & Related 98,439 105,458 Construction 2,004 3,101 Construction - Churches & Related 37,199 36,074 Industrial revenue bonds 5,730 5,773 Installment 2,009 1,918 Other 3,648 4,582 - -------------------------------------------------------------------------------- Total loans $432,084 $434,689 ================================================================================ -6-
Note 4 - Stock Repurchases The Board of Directors periodically authorizes the repurchase of shares of outstanding common stock. The Company had no repurchases in the three months ended March 31, 2003 and repurchased 15,664 shares for $383,000 during the three months ended March 31, 2002. Repurchases are made in the open market or through negotiated transactions from time to time depending on market conditions. Note 5 - Comprehensive Income For the three-month periods ended March 31, 2003 and 2002, unrealized gains and losses on debt and equity securities available-for-sale were the Company's only other comprehensive income component. Comprehensive income for the three-month periods ended March 31, 2003 and 2002 is summarized as follows: <TABLE> <CAPTION> Three Months Ended March 31 ------------------------- (In Thousands) 2003 2002 - ----------------------------------------------------------------------------------------------------------- <S> <C> <C> Net income $ 1,518 $ 1,346 Other comprehensive income: Net unrealized gain (loss) on debt and equity securities available-for-sale, net of tax 96 (505) - ----------------------------------------------------------------------------------------------------------- Total comprehensive income $ 1,614 $ 841 =========================================================================================================== </TABLE> Note 6 - Industry Segment Information The services provided by the Company are classified into four reportable segments: Transportation Information Services, Utility Information Services, Banking Services and Government Software Services. Each of these segments provides distinct services that are marketed through different channels. They are managed separately due to their unique service, processing and capital requirements. The Transportation Information Services unit provides freight invoice rating, payment, auditing, cost accounting and transportation information services to large corporate shippers. The Utility Information Services unit processes and pays utility invoices, including electricity, gas, water, telephone and refuse, for large corporate entities that have many locations or are heavy users of energy. The Banking Services unit provides banking services primarily to privately-held businesses and churches. The Government Software Services unit provides the public sector with integrated financial, property and human resource management systems. This unit represents the wholly-owned subsidiary, Government e-Management Solutions, Inc. (GEMS). For more information on this subsidiary refer to Note 7. The Company's accounting policies for segments are the same as those described in the summary of significant accounting policies in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. Management evaluates segment performance based on net income after allocations for corporate expenses and income taxes. Transactions between segments are accounted for at what management believes to be fair value. All three segments market their services within the United States and no revenue from any customer of any segment exceeds 10% of the Company's consolidated revenue. Summarized information about the Company's operations in each industry segment for the three month periods ended March, 2003 and 2002, is as follows: <TABLE> <CAPTION> Transportation Utility Governmental Corporate Information Information Banking Software and Elim- (In Thousands) Services Services Services Services inations Total - --------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Quarter Ended March 31, 2003 Total Revenues $ 7,765 $ 2,722 $ 3,753 $ 1,778 $ (127) $ 15,891 Net Income 177 262 1,047 32 -- 1,518 Total Assets 238,373 59,593 278,538 6,878 (12,415) 570,967 Goodwill 223 -- -- 2,927 -- 3,150 Other intangible assets, net -- -- -- 1,769 379 2,148 Quarter Ended March 31, 2002 Total Revenues $ 7,553 $ 2,204 $ 3,669 N/A $ (144) $ 13,282 Net Income 219 120 1,007 N/A -- 1,346 Total Assets 263,132 55,430 261,246 N/A (2,048) 577,760 Goodwill 223 -- -- -- -- 223 Other intangibles, net -- -- -- -- 586 586 - --------------------------------------------------------------------------------------------------------------------- </TABLE> -7-
Note 7 - Foreclosed assets On January 2, 2001, the Company foreclosed on certain operating assets to one borrower in order to protect its financial interest in that borrower. The Bank sold these assets to a wholly owned subsidiary, Government e-Management Solutions, Inc. (GEMS) and invested in and stabilized this business. From the date of foreclosure through December 31, 2002 these assets were accounted for as a foreclosed asset that is held for sale. The Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", effective January 1, 2002. SFAS 144 requires that if certain criteria are not met for long-lived asset (disposal) groups classified as held for sale by the end of the fiscal year in which SFAS 144 is initially applied, the related long-lived assets shall be reclassified as held and used. Therefore, on January 1, 2003, the Company reclassified these foreclosed assets as held and used and consolidated its operations into those of the Company. At the time of consolidation, total assets were $7,004,000, which included $2,927,000 of goodwill and $1,847,000 of other intangibles. Total liabilities at the time of consolidation were $1,706,000. The Bank has two foreclosed properties that it is carrying in other real estate owned at what management believes to be fair value less cost to sell. The first was foreclosed on August 8, 2001 and is being carried at $816,000. The second was foreclosed on December 19, 2002 and is being carried at $296,000. Other real estate owned is included with other assets in the accompanying consolidated balance sheets. Note 8 - Intangible Assets The Company accounts for intangible assets in accordance with SFAS 142, "Goodwill and Other Intangible Assets," which requires that intangibles with indefinite useful lives be tested annually for impairment and those with finite useful lives be amortized over their useful lives. Intangible assets for the periods ended March 31, 2003 and December 31, 2002 are as follows: (In Thousands) March 31, 2003 December 31, 2002 - ------------------------------------------------------------------------------- Goodwill $3,150 $ 223 Customer list 809 -- Software 960 -- Minimum pension liability 379 379 - ------------------------------------------------------------------------------- Other intangible assets, net 2,148 379 - ------------------------------------------------------------------------------- Total intangible assets $5,298 $ 602 - ------------------------------------------------------------------------------- Customer list and software are amortized over 15 years and 4 years, respectively. The minimum pension liability was recorded in accordance with SFAS 87, "Employers' Accounting for Pensions", which requires the Company to record an additional minimum pension liability by the amount of which the accumulated benefit obligation exceeds the sum of the fair value of plan assets and accrued amount previously recorded and offset this liability by an intangible asset to the extent of previously unrecognized prior service costs. The liability and corresponding intangible asset are adjusted annually. Amortization of intangible assets amounted to $78,000 for the three-month period ended March 31, 2003. There was no amortization of intangible assets recorded in 2002. Estimated amortization of intangibles over the next five years is as follows: $311,000 in 2003, 2004, 2005 and 2006 and $55,000 in 2007. -8-
Note 9 - Commitments and Contingencies The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, commercial letters of credit and standby letters of credit. The Company's maximum potential exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, commercial letters of credit and standby letters of credit is represented by the contractual amounts of those instruments. At March 31, 2003, no amounts have been accrued for any estimated losses for these 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. Commercial and standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These off-balance sheet financial instruments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The approximate remaining term of commercial and standby letters of credit range from less than 1 to 5 years. Since some of the financial instruments may expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. Commitments to extend credit and letters of credit are subject to the same underwriting standards as those financial instruments included on the consolidated balance sheets. The Company evaluates each customer's credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of the credit, is based on management's credit evaluation of the borrower. Collateral held varies, but is generally accounts receivable, inventory, residential or income-producing commercial property or equipment. In the event of nonperformance, the Company may obtain and liquidate the collateral to recover amounts paid under its guarantees on these financial instruments. The following table shows conditional commitments to extend credit, standby letters of credit and commercial letters of credit at March 31, 2003: <TABLE> <CAPTION> Amount of Commitment Expiration per Period ------------------------------------------ Less than 1-3 3-5 (In Thousands) Total 1 year Years Years - ---------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Unused loan commitments $29,067 $15,467 $13,600 $ -- Standby letters of credit 5,372 3,481 1,846 45 Commercial letters of credit 106 106 -- -- </TABLE> The Company and its subsidiaries are involved in various pending legal actions and proceedings in which claims for damages are asserted. Management, after discussion with legal counsel, believes the ultimate resolution of these legal actions and proceedings will not have a material effect upon the Company's consolidated financial position or results of operations. Note 10 - Stock-Based Compensation The Company maintains two stock-based compensation plans, a stock bonus plan and a stock option plan. Upon issuance of shares in the stock bonus plan a contra shareholders' equity amount is recorded for the fair value of the shares at the time of issuance and this amount is amortized to expense over the three-year vesting period. The stock option plan is accounted for under APB 25, "Accounting for Stock Issued to Employees", and accordingly the Company recognizes no compensation expense as the price of the Company's employee stock options equals the market price of the underlying stock on the date of grant. The Company elected not to adopt the recognition provisions of the SFAS 123, "Accounting for Stock-Based Compensation", as amended by SFAS 148. An entity that continues to apply APB 25 shall disclose certain pro forma information as if the fair value-based accounting method in SFAS 123 had been used to account for stock-based compensation costs. The required disclosure provisions of SFAS 123, as amended by SFAS 148, are provided in the table below. The Company uses the Black-Scholes option-pricing model to determine the fair value of the stock options at the date of grant. There were 3,636 shares granted in the First Quarter of 2003 and no shares granted in the First Quarter of 2002. The weighted average assumptions for shares granted in 2003 were: an expected life of 7 years, dividend yield of 3.39%, expected volatility of 15% and risk-free interest rate of 3.34%. The following table represents the effect on earnings and diluted earnings per share for the periods ended March 31, 2003 and 2002: -9-
Three Months Ended March 31 ------------------------- (In Thousands, except per share data) 2003 2002 - ------------------------------------------------------------------------------- Net income: As reported $ 1,518 $ 1,346 Add: Stock based compensation expense included in reported net income, net of tax 7 5 Less: Stock based compensation expense determined under the fair value based method for all awards, net of tax (18) (17) - ------------------------------------------------------------------------------- Pro forma net income $ 1,507 $ 1,334 - ------------------------------------------------------------------------------- Net income per common share: Basic, as reported $ .45 $ .40 Basic, proforma .45 .40 Diluted, as reported .45 .40 Diluted, proforma .44 .39 - ------------------------------------------------------------------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company operates in four primary business segments: Transportation Information Services, Utility Information Services and through the Company's wholly owned subsidiaries, Cass Commercial Bank ("the Bank"), Banking Services and Government e-Management Solutions, Inc. (GEMS), Government Software Services. The Company is a payment processing and information services company, whose operations include the processing and payment of freight and utility invoices, preparation of management information, auditing and rating of invoices and other payment-related activities for customers located throughout the United States. The Bank provides specialized banking services to privately-held businesses located primarily in the St. Louis, Missouri metropolitan area and church and church-related entities located in the St. Louis metropolitan area and selected cities throughout the United States. GEMS provides the public sector in the United States with integrated financial, property and human resource management systems. Critical Accounting Policies The Company has prepared all of the consolidated financial information in this report in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). In preparing the consolidated financial statements in accordance with U.S. GAAP, management makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurances that actual results will not differ from those estimates. Management has identified the accounting policy related to the allowance for loan losses as critical to the understanding of the Company's results of operations, since the application of this policy requires significant management assumptions and estimates that could result in materially different amounts to be reported if conditions or underlying circumstances were to change. The impact and any associated risks related to these policies on our business operations are discussed in the " Allowance and Provision for Loan Losses" section of this report. In addition, management evaluates certain long-term assets such as premises and equipment, goodwill, and foreclosed assets for impairment. Generally, recognition of impairment is required when events and circumstances indicate that the carrying amounts of these assets will not be recoverable in the future. If impairment occurs, various methods of measuring impairment may be called for depending on the circumstances and type of asset, including quoted market prices, estimates based on similar assets, and estimates based on valuation techniques such as discounted projected cash flows. Assets held for sale are carried at the lower of cost or fair value less costs to sell. The application of this policy also requires significant management assumptions and estimates that could result in materially different results if conditions or underlying circumstances change. Consolidation of Subsidiary On January 2, 2001, the Bank foreclosed on certain operating assets relating to one borrower in order to protect its financial interests. This borrower was a software company that provided the public sector with integrated -10-
financial, property and human resource management systems. The Bank sold these assets to a wholly owned subsidiary, Government e-Management Solutions, Inc. (GEMS) and invested in and stabilized this business. From the date of foreclosure through December 31, 2002 these assets have been accounted for as a foreclosed asset held for sale. Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", adopted by the Company on January 1, 2002, requires that if certain criteria are not met for long-lived asset (disposal) groups classified as held for sale by the end of the fiscal year in which SFAS 144 is initially applied, the related long-lived assets shall be reclassified as held and used. Therefore, as of January 1, 2003, the Company has reclassified the foreclosed assets relating to GEMS as held and used and consolidated its operations into those of the Company. Results of Operations The following paragraphs more fully discuss the results of operations and changes in financial condition for the three-month period ended March 31, 2003 (the "First Quarter of 2003") compared to the three-month period ended March 31, 2002 (the "First Quarter of 2002"). The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes and with the statistical information and financial data appearing in this report as well as the Company's 2002 Annual Report on Form 10-K. Results of operations for the First Quarter of 2003 are not necessarily indicative of the results to be attained for any other period. Net Income The Company's net income was $1,518,000 for the First Quarter of 2003, a $172,000 or 12.8% increase compared to net income of $1,346,000 for the First Quarter of 2002. Diluted earnings per share were $.45 for the First Quarter of 2003, a 12.5% increase compared to $.40 for the First Quarter of 2002. The increase in net income in the First Quarter of 2003 over the First Quarter of 2002 was primarily a result of an increase in payment and processing revenue. This was partially offset by a decrease in investment income, due to lower interest rates and an increase in salaries and benefits related to increased processing volume in the freight and utility processing divisions. Return on average assets for the First Quarter of 2003 was 1.04% compared to .93% for the First Quarter of 2002. Return on average equity for the First Quarter of 2003 was 10.13% compared to 9.85% for the First Quarter of 2002. Net Interest Income First Quarter of 2003 compared to First Quarter of 2002: The Company's tax-equivalent net interest income decreased 8.4% or $640,000 from $7,579,000 to $6,939,000. Average earning assets decreased .5% or $2,505,000 from $536,821,000 to $534,316,000. The tax-equivalent net interest margin decreased from 5.73% to 5.27%. The average tax-equivalent yield on earning assets decreased from 6.14% to 5.62%. The average rate paid on interest-bearing liabilities decreased from 1.66% to 1.32%. The average balances of loans increased $50,708,000 from $383,393,000 to $434,101,000, investment in debt and equity securities, at amortized cost, decreased $49,756,000 from $115,900,000 to $66,144,000, and federal funds sold and other short-term investments decreased $3,457,000 from $37,528,000 to $34,071,000. The average balance of noninterest-bearing demand deposit accounts decreased $9,485,000 from $104,378,000 to $94,893,000, interest-bearing liabilities increased $7,095,000 from $134,409,000 to $141,504,000 and accounts and drafts payable increased $846,000 from $286,854,000 to $287,700,000. The increase in average loan balances during this period was primarily attributable to the Bank's marketing efforts, both in the commercial and church and church-related areas. The decrease in taxable debt and equity securities and decrease in federal funds sold and other short term investments reflects management's asset allocation decisions given projected liquidity requirements, market interest rates and the attractiveness of alternative investments. Noninterest-bearing demand deposits have decreased primarily due to decreased balances maintained by existing customers. Interest-bearing liabilities increased due to increased deposits by existing customers and new deposit accounts. The moderate increase in average accounts and drafts payable relates to increases in invoice dollars paid reduced by a decrease in the amount of time funds were held by the Company for investment. The decreases experienced during the First Quarter of 2003 in net interest income and the net interest margin were due primarily to the decline in the general level of interest rates. The Company partially mitigated the -11-
effects of this decline in interest rates by adjusting the allocation of assets in its portfolio to longer-term, higher-yielding assets, increasing balances of tax-exempt securities and increasing the size of the loan portfolio. Nonetheless, the dramatic decline in interest rates adversely affected the Company's net interest income and margin. The Company is positively affected by increases in the level of interest rates due to the fact that its rate sensitive assets significantly exceed its rate sensitive liabilities. Conversely, the Company is adversely affected by decreases in the level of interest rates. This is primarily due to the noninterest-bearing liabilities generated by the Company in the form of accounts and drafts payable. For more information please refer to the tables on pages 12 and 13. Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rate and Interest Differential The following table shows the condensed average balance sheets for each of the periods reported, the interest income and expense on each category of interest-earning assets and interest-bearing liabilities, and the average yield on such categories of interest-earning assets and the average rates paid on such categories of interest-bearing liabilities for each of the periods reported. <TABLE> <CAPTION> First Quarter 2003 First Quarter 2002 ---------------------------------- ----------------------------------- Interest Interest Average Income/ Yield/ Average Income/ Yield/ (Dollars in Thousands) Balance Expense Rate Balance Expense Rate - ------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Assets(1) Earning assets: Loans(2),(3): Taxable $ 428,352 $ 6,345 6.01% $ 377,260 $ 6,151 6.61% Tax-exempt(4) 5,749 108 7.62 6,133 115 7.60 Debt and equity securities(5): Taxable 26,584 188 2.87 86,208 1,195 5.62 Tax-exempt(4) 39,560 658 6.75 29,692 509 6.95 Federal funds sold and other short-term investments 34,071 100 1.19 37,528 160 1.73 - ------------------------------------------------------------------------------------------------------------- Total earning assets 534,316 7,399 5.62 536,821 8,130 6.14 Nonearning assets: Cash and due from banks 18,976 23,073 Premises and equipment, net 15,833 16,596 Intangible assets 5,349 5,349 Other assets 22,141 9,507 Allowance for loan losses (5,327) (4,941) - ------------------------------------------------------------------------------------------------------------- Total assets $ 591,288 $ 586,405 - ------------------------------------------------------------------------------------------------------------- Liabilities And Shareholders' Equity(1) Interest-bearing liabilities: Interest-bearing demand deposits $ 54,777 $ 117 .87% $ 59,892 $ 178 1.21% Savings deposits 35,772 82 .93 45,447 156 1.39 Time deposits of $100 or more 42,666 213 2.02 23,605 166 2.85 Other time deposits 5,715 39 2.77 4,849 48 4.01 - ------------------------------------------------------------------------------------------------------------- Total interest-bearing deposits 138,930 451 1.32 133,793 548 1.66 Short-term borrowings 2,574 9 1.42 616 3 1.98 - ------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 141,504 460 1.32 134,409 551 1.66 Noninterest-bearing liabilities: Demand deposits 94,893 104,378 Accounts and drafts payable 287,700 286,854 Other liabilities 6,401 5,371 - ------------------------------------------------------------------------------------------------------------- Total liabilities 530,498 531,012 Shareholders' equity 60,790 55,393 Total liabilities and shareholders' equity $ 591,288 $ 586,405 - ------------------------------------------------------------------------------------------------------------- Net interest income $ 6,939 $ 7,579 Interest spread 4.30% 4.48% Net interest margin 5.27% 5.73% - ------------------------------------------------------------------------------------------------------------- </TABLE> -12-
1. Balances shown are daily averages. 2. For purposes of these computations, nonaccrual loans are included in the average loan amounts outstanding. Interest on nonaccrual loans is recorded when received as discussed further in Note 1 to the Company's 2002 Consolidated Financial Statements. 3. Interest income on loans includes net loan fees of $11,000 and $56,000 for the First Quarter of 2003 and 2002, respectively. 4. Interest income is presented on a tax-equivalent basis assuming a tax rate of 34%. The tax-equivalent adjustment was approximately $260,000 and $211,000 for the First Quarter of 2003 and 2002, respectively. 5. For purposes of these computations, yields on investment securities are computed as interest income divided by the average amortized cost of the investments. Analysis of Net Interest Income Changes The following table presents the changes in interest income and expense between periods due to changes in volume and interest rates. That portion of the change in interest attributable to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the absolute dollar amounts of the change in each. First Quarter 2003 Over 2002 ------------------------------------ (In Thousands) Volume Rate Total - -------------------------------------------------------------------------------- Increase (decrease) in interest income: Loans(1),(2): Taxable $ 788 $ (594) $ 194 Tax-exempt(3) (7) -- (7) Debt and equity securities: Taxable (590) (417) (1,007) Tax-exempt(3) 165 (16) 149 Federal funds sold and other short-term investments (14) (46) (60) - -------------------------------------------------------------------------------- Total interest income 342 (1,073) (731) - -------------------------------------------------------------------------------- Interest expense on: Interest-bearing demand deposits (14) (47) (61) Savings deposits (29) (45) (74) Time deposits of $100 or more 105 (58) 47 Other time deposits 8 (17) (9) Short-term borrowings 7 (1) 6 - -------------------------------------------------------------------------------- Total interest expense 77 (168) (91) - -------------------------------------------------------------------------------- Net interest income $ 265 $ (905) $ (640) =============================================================================== 1. Average balances include nonaccrual loans. 2. Interest income includes net loan fees. 3. Interest income is presented on a tax-equivalent basis assuming a tax rate of 34%. Allowance and Provision for Loan Losses A significant determinant of the Company's operating results is the provision for loan losses and the level of loans charged off. There was a $90,000 provision made for loan losses during both the First Quarter of 2003 and 2002. Net loans recovered for the First Quarter of 2003 were $4,000 compared to $10,000 for the First Quarter of 2002. The provision for loan losses can vary over time based on an ongoing assessment of the adequacy of the allowance for loan losses. The allowance for loan losses at March 31, 2003 was $5,387,000 and at December 31, 2002 was $5,293,000. The ratio of allowance for loan losses to total loans outstanding at March 31, 2003 was 1.25% compared to 1.22% at December 31, 2002. Nonperforming loans were $3,364,000 or .78% of total loans at March 31, 2003 -13-
compared to $9,194,000 or 2.12% of total loans at December 31, 2002. The decrease from December 31, 2002 is primarily due to two loans totaling $4,252,000 that were renegotiated in 2002 that are currently performing under their new terms and two loans totaling $4,891,000 that were contractually past due over 90 days at year-end and were fully paid-off during the First Quarter of 2003. These decreases were partially offset by other loans totaling $2,834,000 now classified as past due over 90 days. The largest of these has an outstanding balance of $2,000,000. This loan is to a company in the process of a change in control. It is expected that all past due interest will be brought current when this transaction is completed. At March 31, 2003, impaired loans totaled $9,520,000, which included $49,000 of nonaccrual loans compared with impaired loans at December 31, 2002 of $12,188,000, which included $51,000 of nonaccrual loans. The allowance for loan losses on impaired loans was $881,000 at March 31, 2003. The decrease in impaired loans from December 31, 2002 relates primarily to the decrease in loans contractually past due over 90 days as explained in the previous paragraph. The current balance of $4,250,000 of loans renegotiated in 2002 relates to two borrowers and although currently performing, are still considered impaired by management. The remaining balance of impaired loans relates to several other borrowers. One represents a borrower that has an outstanding balance of $1,528,000, which is collateralized by all business assets and has been current on all payments. This borrower has experienced financial difficulties due to general economic conditions. Should its condition not improve, a shortfall in collection of the full principal balance could result. The probable shortfall has been specifically reserved for in the allowance for loan losses. Another borrower has an outstanding balance of $791,000 collateralized by real estate and with a SBA guarantee. There has been delinquency in loan payments due to slower than expected lease-up of real estate property. The remaining balance is made up of smaller loans, one with a balance of $481,000 that was renegotiated in the First Quarter of 2003 and is current under the new terms of the agreement. The allowance for loan losses has been established and is maintained to absorb losses inherent in the loan portfolio. An ongoing assessment of risk of loss is performed to determine if the current balance of the allowance is adequate to cover probable losses in the portfolio. A charge or credit is made to expense to cover any deficiency or reduce any excess. The current methodology employed to determine the appropriate allowance consists of two components, specific and general. The Company develops specific valuation allowances on commercial, commercial real estate, and construction loans when a loan is considered to be impaired. A loan is impaired when, based on an evaluation of current information and events, it is probable that the Company will not be able to collect all amounts due (principal and interest) pursuant to the original contractual terms. The Company measures impairment based upon the present value of expected future cash flows discounted at the loan's original effective interest rate or the fair value of the collateral if the loan is collateral dependent. The general component relates to all other loans, which are evaluated based on loan grade. The loan grade assigned to each loan is typically evaluated on an annual basis, unless circumstances require interim evaluation. The Company assigns a reserve amount consistent with each loan's rating category. The reserve amount is based on loss experience over prescribed periods. In addition to the amounts derived from the loan grades, a portion is added to the general reserve to take into account other factors including national and local economic conditions, downturns in specific industries including loss in collateral value, trends in credit quality at the Company and the banking industry, and trends in risk rating changes. As part of their examination process, federal and state agencies review the Company's methodology for maintaining the allowance for loan losses and the balance in the account. These agencies may require the Company to increase the allowance for loan losses based on their judgments and interpretations about information available to them at the time of their examination. Summary of Asset Quality The following table presents information as of and for the three month periods ended March 31, 2003 and 2002 pertaining to the Company's provision for loan losses and analysis of the allowance for loan losses. -14-
<TABLE> <CAPTION> Three Months Ended March 31 ---------------------------- (Dollars in Thousands) 2003 2002 - --------------------------------------------------------------------------------------------------------------- <S> <C> <C> Allowance at beginning of period $ 5,293 $ 4,906 Provision charged to expense 90 90 Loans charged off (2) -- Recoveries on loans previously charged off 6 10 - --------------------------------------------------------------------------------------------------------------- Net loan recoveries 4 10 Allowance at end of period $ 5,387 $ 5,006 - --------------------------------------------------------------------------------------------------------------- Loans outstanding: Average $ 434,101 $ 383,393 March 31 432,084 383,946 Ratio of allowance for loan losses to loans outstanding: Average 1.24% 1.31% March 31 1.25% 1.30% Nonperforming loans: Nonaccrual loans $ 49 $ 513 Loans past due 90 days or more 2,834 840 Renegotiated loans 481 175 - --------------------------------------------------------------------------------------------------------------- Total non performing loans $ 3,364 $ 1,528 Other impaired loans $ 6,156 $ 4,484 Foreclosed assets $ 1,112 $ 5,690 - --------------------------------------------------------------------------------------------------------------- Nonperforming loans as a percent of average loans .77% .40% =============================================================================================================== </TABLE> Foreclosed assets at March 31, 2002 includes $5,102,000 related to operating assets of one business, which was foreclosed on by the Bank on January 2, 2001. This entity, Government e-Management Solutions, Inc., is a software company that provides the public sector with integrated financial, property and human resource management systems. As explained earlier, under the provision of SFAS 144, this group of assets was reclassified effective January 1, 2003 and the related operations have been consolidated into those of the Company. The Bank currently has two properties which it is carrying as other real estate owned at what management believes to be fair value less cost to sell. The first property was foreclosed on August 8, 2001 and is recorded at $816,000 and the second property was foreclosed on December 19, 2002 and is recorded at $296,000. Noninterest Income Noninterest income is principally derived from payment and processing fees. Processing volumes related to these fees for the three-month periods ended March 31, 2003 and 2002 are as follows: <TABLE> <CAPTION> Three Months Ended March 31 ------------------------------------------- % (In Thousands) 2003 2002 Change - --------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Transportation Information Services: Invoice Bill Volume 5,666 4,967 14.1% Invoice Dollar Volume $2,053,912 $1,756,964 16.9% Utility Information Services: Invoice Bill Volume 1,033 779 32.6% Invoice Dollar Volume $825,361 $612,091 34.8% </TABLE> Total noninterest income for the First Quarter of 2003 was $9,302,000, a $3,298,000 or 54.9% increase compared with the First Quarter of 2002. The Company's freight and utility payment and processing fees for the First Quarter of 2003 were $6,969,000, a $1,418,000 or 25.5% increase compared to the First Quarter of 2002. Fees generated from the Transportation Information Services Division in the First Quarter of 2003 were $4,969,000, an $837,000 or 20.3% increase compared to the First Quarter of 2002. Processing fees from the Utility Information Services Division in the First Quarter of 2003 were $2,000,000, a $582,000 or 41.0% increase compared to the First Quarter of 2002. The increases in fees from the Transportation Information Services Division during the First Quarter of 2003 were due to new customers and new services. These new customers and services more than offset the effects of the drop in national freight activity over last year's levels. The increases in fees from the Utility Information Services Division were primarily due to the addition of new customers from the marketing efforts of this new segment. The consolidation of the GEMS resulted in $1,778,000 in additional noninterest income. As explained earlier, the operating results of this wholly owned subsidiary were consolidated on January 1, 2003. Bank service fees for the First Quarter of 2003 were $426,000, a $14,000 or 3.4% increase compared to the First Quarter of 2002. Other noninterest income increased $88,000 from $41,000 in the First Quarter of 2002 to $129,000 in the First Quarter of 2003. This increase is primarily due to income recognized from the increase in the cash surrender value of bank owned life insurance purchased by the Company in the Third Quarter of 2002. -15-
Noninterest Expense Total noninterest expense for the First Quarter of 2003 was $13,777,000, a $2,453,000 or 21.7% increase compared to the First Quarter of 2002. Of this increase, $1,678,000 was related to the consolidation of GEMS. Salaries and benefits expense for the First Quarter of 2003 was $9,352,000, a $1,746,000 or 23.0% increase compared to the First Quarter of 2002. Of this increase, $1,024,000 relates to the consolidation of GEMS. The remaining increase was due primarily to an increased staff in both the transportation and utility processing divisions due to an increase in production and to increases in health, worker's compensation and short-term disability insurance and pension expense. Occupancy expense for the First Quarter of 2003 was $436,000, a $72,000 or 19.8% increase compared to the First Quarter of 2002. Of this increase, $59,000 relates to the consolidation of GEMS. The remaining increase relates primarily to increases in both utility expense and real estate taxes. Equipment expense for the First Quarter of 2003 was $1,161,000, an increase of $72,000 or 6.6% compared to the First Quarter of 2002. Equipment expenses related to the consolidation of GEMS were $105,000. The increase related to this consolidation was partially offset by a decrease in computer equipment maintenance from the consolidation of equipment within the transportation processing division. Other noninterest expense for the First Quarter of 2003 was $2,828,000, an increase of $563,000 or 24.9% compared to the First Quarter of 2002. The consolidation of GEMS contributed $490,000 to this increase, $78,000 of which is the amortization of customer list and software intangible assets. The remaining increase is primarily attributable to marketing and promotional expenses. Income tax expense for the First Quarter of 2003 was $596,000, a decrease of $16,000 or 2.6% compared to the First Quarter of 2002. GEMS contributed $19,000 to income tax expense in the First Quarter of 2003. This increase from GEMS was more than offset by a decrease due to a shift of investments from taxable securities to tax-exempt securities, which resulted in an effective tax rate for the First Quarter of 2003 of 28% compared with 31% in the First Quarter of 2002. Financial Condition Total assets at March 31, 2003 were $570,967,000, a decrease of $1,266,000 or .2% from December 31, 2002. Loans, net of the allowance for loan losses, at March 31, 2003 were $426,697,000, a decrease of $2,699,000 or .6% from December 31, 2002. Total investments in debt and equity securities at March 31, 2003 were $66,199,000, a $3,172,000 or 4.6% decrease from December 31, 2002. Federal funds sold and other short-term investments at March 31, 2003 were $9,941,000 a $4,214,000 or 73.6% increase from December 31, 2002. Total deposits at March 31, 2003 were $227,934,000, a $15,584,000 or 6.4% decrease from December 31, 2002. Accounts and drafts payable were $264,204,000, a $40,583,000 or 18.1% increase from December 31, 2002. Short-term borrowings at March 31, 2003 were $10,009,000, a $27,429,000 or 73.3% decrease from December 31, 2002. Total shareholders' equity at March 31, 2003 was $61,962,000, a $916,000 or 1.5% increase from December 31, 2002. The decrease in loans relates to the normal fluctuations in the loan portfolio that result from new advances, amortization of principal and payoffs. The decrease in debt and equity securities relates to maturing securities. The increase in federal funds sold and other short-term investments and decreases in deposits reflects normal daily and seasonal fluctuations. The ending balances of accounts and drafts payable increased due to both the fact that these balances will fluctuate from period-end to period-end due to the payment processing cycle, which results in lower balances on days when checks clear and higher balances on days when checks are issued and due to special funding arrangements the Company made with a few large customers at year-end. For this reason, average balances are a more meaningful measure of accounts and drafts payable (for average balances refer to the tables on pages 12 and 13). The increase in total shareholders' equity resulted from net income of $1,518,000; the amortization of the stock bonus plan of $10,000; and the increase in other comprehensive income of $96,000; offset by dividends paid of $707,000 ($.21 per share) and other items of $1,000. -16-
Liquidity and Capital Resources The balances of liquid assets consists of cash and cash equivalents, which include cash and due from banks, federal funds sold, and money market funds were $34,814,000 at March 31, 2003, an increase of $4,808,000 or 16.0% from December 31, 2002. At March 31, 2003 these assets represented 6.1% of total assets. These funds are the Company's and its subsidiaries' primary source of liquidity to meet future expected and unexpected loan demand, depositor withdrawals or reductions in accounts and drafts payable. Secondary sources of liquidity include the investment portfolio and borrowing lines. Total investment in debt and equity securities was $66,199,000 at March 31, 2003, a decrease of $3,172,000 or 4.6% from December 31, 2002. These assets represented 11.6% of total assets at March 31, 2003. Of this total, 62% were state and municipal securities, 29% were mortgage-backed securities, 7% were U.S. government agencies and 2% were other securities. Of the total portfolio, 3% matures in less than one year, 36% matures in one to five years and 61% matures in five or more years. The investment portfolio provides secondary liquidity through regularly scheduled maturities, the ability to sell securities and the ability to use these securities in conjunction with repurchase lines of credit. The Bank has unsecured lines at correspondent banks to purchase federal funds up to a maximum of $33,000,000. Additionally, the Company maintains secured lines of credit at unaffiliated financial institutions in the maximum amount of $53,905,000. The deposits of the Company's banking subsidiary have historically been stable, consisting of a sizable volume of core deposits related to customers that utilize many other commercial products of the bank. The accounts and drafts payable generated by the Company has also historically been a stable source of funds. Net cash provided by operating activities totaled $3,231,000 for the First Quarter of 2003, compared to $2,093,000 for the First Quarter of 2002. Net cash provided by investing activities was $4,714,000 for the First Quarter of 2003, compared with net cash used of $35,309,000 for the First Quarter of 2002. Net cash used in financing activities for the First Quarter of 2003 was $3,137,000, compared with $24,373,000 for the First Quarter of 2002. The increase in net cash provided by operating activities relates primarily to the consolidation of GEMS. Net cash provided by investing activities in the First Quarter of 2003 compared with net cash used in the First Quarter of 2002 relates primarily to the purchase of debt and equity securities in the First Quarter of 2002. The decrease in net cash used in financing activities in the First Quarter of 2003 relates primarily to the increase in accounts and drafts payable, which was offset by a decrease in deposits and short-term borrowings. Balances in accounts and drafts payable can vary significantly from day to day due to the Company's payment cycle and therefore balances on any one particular day are not necessarily reflective of balances throughout the year. The Company faces market risk to the extent that its net interest income and fair market value of equity are affected by changes in market interest rates. For information regarding the market risk of the Company's financial instruments, see Item 3. "QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK". Risk-based capital guidelines require the Company to meet a minimum total capital ratio of 8.0% of which at least 4.0% must consist of Tier 1 capital. Tier 1 capital generally consists of (a) common shareholders' equity (excluding the unrealized market value adjustments on the available-for-sale securities), (b) qualifying perpetual preferred stock and related surplus subject to certain limitations specified by the FDIC, (c) minority interests in the equity accounts of consolidated subsidiaries less (d) goodwill, (e) mortgage servicing rights within certain limits, and (f) any other intangible assets and investments in subsidiaries that the FDIC determines should be deducted from Tier 1 capital. The FDIC also requires a minimum leverage ratio of 3.0%, defined as the ratio of Tier 1 capital less purchased mortgage servicing rights to total assets, for banking organizations deemed the strongest and most highly rated by banking regulators. A higher minimum leverage ratio is required of less highly rated banking organizations. Total capital, a measure of capital adequacy, includes Tier 1 capital, allowance for loan losses, and debt considered equity for regulatory capital purposes. -17-
The Company and the Bank continue to exceed all regulatory capital requirements, as evidenced by the following capital amounts and ratios at March 31, 2003 and December 31, 2002: March 31, 2003 Amount Ratio - ------------------------------------------------------------------------------- Total capital (to risk-weighted assets) Cass Information Systems, Inc. $62,910,000 12.63% Cass Commercial Bank 29,200,000 11.61 Tier I capital (to risk-weighted assets) Cass Information Systems, Inc. $57,523,000 11.55% Cass Commercial Bank 26,093,000 10.37 Tier I capital (to average assets) Cass Information Systems, Inc. $57,523,000 9.78% Cass Commercial Bank 26,093,000 8.91 - ------------------------------------------------------------------------------- December 31, 2002 Amount Ratio - ------------------------------------------------------------------------------- Total capital (to risk-weighted assets) Cass Information Systems, Inc. $59,625,000 12.07% Cass Commercial Bank 27,425,000 10.94 Tier I capital (to risk-weighted assets) Cass Information Systems, Inc. $54,332,000 11.00% Cass Commercial Bank 24,412,000 9.74 Tier I capital (to average assets) Cass Information Systems, Inc. $54,332,000 9.16% Cass Commercial Bank 24,412,000 8.98 - ------------------------------------------------------------------------------- Inflation The Company's assets and liabilities are primarily monetary, consisting of cash, cash equivalents, securities, loans, payables and deposits. Monetary assets and liabilities are those that can be converted into a fixed number of dollars. The Company's consolidated balance sheet reflects a net positive monetary position (monetary assets exceed monetary liabilities). During periods of inflation, the holding of a net positive monetary position will result in an overall decline in the purchasing power of a company. Management believes that replacement costs of equipment, furniture, and leasehold improvements will not materially affect operations. The rate of inflation does affect certain expenses, such as those for employee compensation, which may not be readily recoverable in the price of the Company's services. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As described in the Company's Annual Report on Form 10-K for the year ended December 31, 2002, the Company manages its interest rate risk through measurement techniques that include gap analysis and a simulation model. As part of the risk management process, asset/liability management policies are established and monitored by management. The policy objective is to limit the change in annualized net interest income to 15% from an immediate and sustained parallel change in interest rates of 200 basis points. Based on the Company's most recent evaluation, management does not believe the Company's risk position at March 31, 2003 has changed materially from that at December 31, 2002. ITEM 4. DISCLOSURES AND CONTROLS The Company maintains controls and procedures designed to ensure that the information it is required to disclose in the reports it files with the SEC is recorded, processed, summarized and reported to management, including the Chief Executive Officer and Chief Financial Officer within the time periods specified in the rules of the SEC. The Company's Chief Executive and Chief Financial Officers have reviewed and evaluated these controls within 90 days of the filing of this report and based on their evaluation believe that these procedures are effective to ensure that the Company is able to collect, process and disclose the information it is required to disclose in the reports it files with the SEC within the required time periods. Since the date of the most recent evaluation of the Company's internal controls by the Chief Executive and Chief Financial Officers, there have been no significant changes in such controls or in other factors that could have significantly affected those controls, including any corrective actions. -18-
PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None ITEM 2. CHANGES IN SECURITIES None ITEM 3. DEFAULTS IN SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibit 3.2 Amended and Restated Bylaws of Registrant. Exhibit 10.1 Form of Directors' Indemnification Agreement. Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports of Form 8-K No reports on Form 8-K were filed in the quarter ended March 31, 2003. -19-
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CASS INFORMATION SYSTEMS, INC. DATE: May 14, 2003 By /s/ Lawrence A. Collett ---------------------------------------- Lawrence A. Collett Chairman and Chief Executive Officer DATE: May 14, 2003 By /s/ Eric H. Brunngraber ---------------------------------------- Eric H. Brunngraber Vice President-Secretary (Chief Financial and Accounting Officer) -20-
CERTIFICATIONS I, Lawrence A. Collett, Chairman and Chief Executive Officer of Cass Information Systems, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Cass Information Systems, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ Lawrence A. Collett - ------------------------------------ Lawrence A. Collett Chairman and Chief Executive Officer May 14, 2003 -21-
I, Eric H. Brunngraber, Chief Financial and Accounting Officer of Cass Information Systems, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Cass Information Systems, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ Eric H. Brunngraber - ---------------------------------------- Eric H. Brunngraber Vice President - Secretary (Chief Financial and Accounting Officer) May 14, 2003