BNCCORP Inc.
Annual Report 2009

Plain-text annual report

B N C C O R P A n n u a l R e p o r t 2 0 0 8 BNCCORP, INC. BNCCORP, Inc. BNCCORP, Inc. BNCCORP, INC. Corporate Data Investor Relations Gregory K. Cleveland, CPA President/CEO 602-852-3526 Timothy J. Franz, CPA Chief Financial Offi cer 612-305-2213 General Inquiries: BNCCORP, Inc. 322 East Main Avenue Bismarck, North Dakota 58501 Telephone (701) 250-3040 Facsimile (701) 222-3653 E-mail Inquiries: corp@bncbank.com Annual Meeting The 2010 annual meeting of stockholders will be held on Wednesday, June 16, 2010 at 8:30 a.m. (Central Daylight Time) at BNC National Bank, Second Floor Conference Room, 322 East Main Avenue, Bismarck, ND 58501. Independent Public Accountants KPMG LLP 233 South 13th Street Suite 1600 Lincoln, NE 68508 Securities Listing BNCCORP, Inc.’s common stock is traded on the Pink Sheets under the symbol: “BNCC.” There were 73 record holders of the Company’s common stock at March 6, 2009. COMMON STOCK PRICES For the Years Ended December 31, 2009(1) 2008(1) High Low High Low First Quarter Second Quarter Third Quarter Fourth Quarter $13.89 $11.75 $13.00 $9.05 $11.00 $7.80 $8.90 $5.15 $13.89 $11.75 $13.00 $9.05 $11.00 $7.80 $8.90 $5.15 (1) The quotes represent the high and low closing sales prices as reported by Pink Sheets. Stock Transfer Agent and Registrar American Stock Transfer & Trust Company 59 Maiden Lane, Plaza Level New York, NY 10038 (800) 937-5449 DIRECTORS BNCCORP, Inc. Mark W. Sheffert Chairman of the Board of BNCCORP, Inc. Chairman and Chief Executive Offi cer, Manchester Companies, Inc. Gregory K. Cleveland, CPA President and Chief Executive Offi cer Tracy Scott, CPA Retired Co-Founder of BNCCORP, Inc. Bradley D. Bonga Founder and President/CEO Bonga and Associates, LLC Gaylen Ghylin, CPA EVP, Secretary and CFO Tiller Corporation d/b/a Barton Sand & Gravel Co., Commercial Asphalt Co. and Barton Enterprises, Inc. Richard M. Johnsen, Jr. Chairman of the Board and Chief Executive Offi cer, Johnsen Trailer Sales, Inc. Michael O’Rourke Attorney/Author Stephen H. Roman Partner First Strategic LLC DIRECTORS BNC National Bank Julie L. Andresen Gregory K. Cleveland Shawn Cleveland Timothy J. Franz David Hoekstra Mark E. Peiler Scott Spillman B. Timothy Swanson SUBSIDIARIES BNC National Bank Headquarters: 2425 East Camelback Road Suite 100 Phoenix, AZ 85016 Bank Branches: Bismarck Main 322 East Main Avenue Bismarck, ND 58501 Bismarck South 219 South 3rd Street Bismarck, ND 58504 Bismarck North 801 East Century Avenue Bismarck, ND 58503 Primrose Assisted Living Apartments 1144 College Drive Bismarck, ND 58501 Waterford on West Century 1000 West Century Avenue Bismarck, ND 58503 Crosby 107 North Main Street Crosby, ND 58730 Garrison 92 North Main Garrison, ND 58540 Kenmare 103 1st Avenue SE Kenmare, ND 58746 Linton 104 North Broadway Linton, ND 58552 Stanley 210 South Main Stanley, ND 58784 Watford City 205 North Main Watford City, ND 58854 Minneapolis 333 South Seventh Street Minneapolis, MN 55402 Golden Valley 650 Douglas Drive Golden Valley, MN 55422 The Heathers Estate 2900 North Douglas Drive Crystal, MN 55422 The Heathers Manor 3000 North Douglas Drive Crystal, MN 55422 Scottsdale 17045 N. Scottsdale Road Scottsdale, AZ 85255 Glendale 20175 North 67th Avenue Glendale, AZ 85308 Mortgage Banking Branches: Scottsdale 8330 East Hartford Drive Scottsdale, AZ 85255 Wichita 7200 West 13th Wichita, KS 67212 Overland Park 7007 College Boulevard Overland Park, KS 66211 Davenport 3709 Harrison Street Davenport, IA 52806 Belton 17122 BelRay Place Belton, MO 64012 Lincoln 3600 Village Drive Lincoln, NE 68516 Grand Island 819 North Diers Avenue Grand Island, NE 68803 EXECUTIVE OFFICERS BNCCORP and Subsidiaries Gregory K. Cleveland, CPA President and Chief Executive Offi cer Timothy J. Franz, CPA Chief Financial Offi cer Shawn Cleveland, CPA Chief Operating Offi cer, BNC National Bank Dave Hoekstra, CPA Chief Credit Offi cer and President – BNC National Bank, North Dakota Market Mark E. Peiler, CFA Senior Vice President – Chief Investment Offi cer BNCCORP, Inc. Annual Report 2009 73 BNCCORP, Inc. (BNCCORP or the Company) is a bank holding company registered under the Bank Holding Company Act of 1956 headquartered in Bismarck, North Dakota. It is the parent company of BNC National Bank (the Bank). Th e Company operates community banking and wealth management businesses in Arizona, Minnesota and North Dakota from 20 locations. BNC also conducts mortgage banking from ten locations in Arizona, Minnesota, Iowa, Kansas, Nebraska and Missouri. To Our Stockholders, Customers, Employees and Friends: It is important to view BNCCORP’s performance in the context of the challenging 2009 economic climate, and the likelihood that conditions will remain unsettled during the coming year. At the onset of the current recession, markets were roiled by concerns of impending defaults in subprime credit. Fairly soon, it became apparent that the extent of the fi nancial mismanagement was much broader than the subprime component. As the exposures of major banks, insurance companies, investment fi rms and other fi nancial institutions became known, many questioned how far the risk of losses would spread. Not knowing the extent of the fi nancial mismanagement caused participants in the fi nancial services industry to lose confi dence in the ability of their counterparties to honor obligations. Th e resulting lack of trust nearly froze the fi nancial and credit markets in late 2008 and early 2009. Gradually the liquidity crisis eased, but the aftermath was a global economy operating at levels well below previous peaks. Th is decline has been manifested in high unemployment, elevated default rates on most types of credit, and reduced incomes for households, businesses and governments. Due to these factors, economic recovery is likely to be fragile, and the new economic base will likely be lower than what we have been used to – at least until the economy shakes off the “hangover eff ects” of the fi nancial mismanagement. FACING UP TO THE CHALLENGE In response to this diffi cult environment, we were determined to manage our capital aggressively, to take a prudent approach to asset quality, and to control costs. As a result, BNC remains fi nancially sound and, more than ever, is committed to serving our customers and communities. With respect to capital, we elected to participate in the U.S. Treasury Capital Purchase Program (CPP) because other forms of capital were generally not accessible by community banks. We also augmented our capital by reducing the size of the balance sheet and through gains on disposition of certain assets. As a result, we ended 2009 with Tier 1 capital of more than 8.5% and total risk based capital of more than 13.5%. Th at said, we do not believe that private institutions can operate eff ectively with the government as an investor, and repaying the CPP funds will be a priority when fi nancial conditions moderate. As the recession in 2009 led to elevated levels of non-performing assets for both BNC and the industry, we have endeavored to address our credit issues in a very direct fashion. In order to increase the allowance for loan losses and to address credit quality issues, we recorded a very large provision for loan losses in the third quarter. Based on the fourth quarter results and early 2010 activities, it appears that we were able to substantively address our issues. However, it would be imprudent to reduce our focus on asset quality, as we expect credit losses to persist as long as businesses and individuals remain economically challenged. To control costs, we asked our employees to make sacrifi ces, and salaries were frozen for virtually all employees in 2009. I am grateful to our people for accepting this hardship in a cooperative spirit. Our senior management team was not awarded bonuses for 2009 and their salaries remain frozen as 2010 begins. GREGORY K. CLEVELAND President and Chief Executive Offi cer “While 2009 was the most diffi cult environment BNC has faced since we began operating in 1988, we remained focused on the task at hand and made progress in several key areas of the business.” BNCCORP, Inc. Annual Report 2009 1 MAINTAINING OUR FOCUS While 2009 was the most diffi cult environment BNC has faced since we began operating in 1988, we remained focused on the task at hand and made progress in several key areas of the business. Core deposits increased during the year and provide a stable and cost-eff ective source of funding. We delivered growth in mortgage banking revenues. Our treasury operation contributed to an increase in our net interest income and generated gains that helped build our capital. We are also fortunate to have a diverse regional base, as our North Dakota operations have been virtually untouched by the economic challenges facing the rest of the country. Th e people of North Dakota are benefi tting from oil, agriculture and relatively low unemployment. Although the net loss attributable to common shareholders in 2009 was $(20.0) million, largely due to a $27 million provision for loan losses in the third quarter, BNC returned to profi tability in the fourth quarter with earnings of nearly $2.0 million. 2010 OUTLOOK AND OPERATING STRATEGY We fi rmly believe the operating environment in 2010 will continue to present serious challenges for community banks. Th e economy is likely to be constrained by high unemployment and the excessive debt levels of many businesses, individuals and governments. As a result, we anticipate credit issues will persist. To some extent, the current regulatory climate may limit the fl exibility of bank managements to respond to economic conditions. To counter these challenges, we will have a concentrated focus on credit administration and reducing nonperforming assets when the cost to eliminate a problem is acceptable. We will also manage capital aggressively by preserving assets available to fortify the bank and continuing to reduce the size of our balance sheet, thereby increasing the relative amount of capital. We will again focus on growing core deposits, building on our success in this area in 2009, and will extend initiatives aimed at increasing this key element of franchise value. We believe our expanding mortgage banking operations will continue to be a profi table element of our business in 2010. While housing in this country remains problematic and volume can be impacted by higher interest rates, we can create value in the residential lending business by running a tight ship. Our treasury function has capitalized on investment opportunities in recent periods and it appears this success will also continue in early 2010. While our treasury can create value by optimizing earnings, we also recognize that the need to maintain liquidity in this challenging period may oblige us to accept lower returns on the investment portfolio. Despite the challenges ahead, we take confi dence that thus far, we have successfully navigated an extremely diffi cult cycle. On behalf of the Board of Directors of BNC and our entire team, we want to thank our customers and shareholders for their support. We remain committed to building a strong sound BNC that is positioned to create long term value. Sincerely, GREGORY K. CLEVELAND President and Chief Executive Offi cer 2 BNCCORP, Inc. Annual Report 2009 BNCCORP, INC. INDEX TO YEAR END FINANCIAL REPORT December 31, 2009 TABLE OF CONTENTS Selected Financial Data ................................................................................................................. 4 Business ........................................................................................................................................ 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations ................................................................................................................................. 8 Quantitative and Qualitative Diclosures about Market Risk ...................................................... 28 BNCCORP, Inc. Annual Report 2009 3 Selected Financial Data The selected consolidated financial data presented below should be read in conjunction with our audited financial statements and the notes thereto (dollars in thousands, except share and per share data): Income Statement Data from Continuing Operations: Total interest income Total interest expense Net interest income Provision for credit losses Non-interest income Non-interest expense 2009 For the Years Ended December 31, 2006 2007 2008 2005 $ 44,588 $ 14,899 29,689 27,000 16,013 39,103 46,026 $ 19,215 26,811 7,750 10,395 26,501 44,241 $ 21,994 22,247 3,750 3,853 28,147 42,408 $ 23,606 18,802 210 5,138 23,075 37,264 19,718 17,546 250 5,823 21,859 Income tax expense (benefit) (1,625) 737 (2,728) (363) 238 Income (loss) from continuing operations Balance Sheet Data: (at end of period) Total assets Investments securities available for sale Federal Funds Sold Federal Reserve Bank and Federal Home Loan Bank stock Loans held for sale Participating interests in mortgage loans Loans and leases held for investment, net of unearned income Allowance for credit losses Total deposits Core deposits Short-term borrowings Federal Home Loan Bank advances Other borrowings Guaranteed preferred beneficial interests in Company’s subordinated debentures Common stockholders’ equity Book value per common share outstanding Tangible book value Earnings Performance / Share Data from Continuing Operations: Return (loss) on average total assets Return (loss) on average common stockholders’ equity Efficiency ratio Net interest margin Net interest spread $ (18,776) $ 2,218 $ (3,069) $ 1,018 $ 1,022 $ 868,083 $ 212,661 - 3,048 24,130 38,534 517,108 861,498 $ 209,857 - 5,989 13,403 28,584 542,753 699,591 $ 122,899 - 4,918 - 24,357 497,556 692,276 $ 182,974 24,000 5,003 1,669 56,125 333,934 (18,047) 755,963 640,169 10,190 15,000 - (8,751) 675,321 575,637 16,844 84,500 - (6,599) 541,874 541,874 5,365 61,400 - (3,370) 529,252 529,054 9,709 62,200 1,167 740,016 227,185 - 5,791 266 101,336 310,368 (3,188) 548,790 512,552 21,416 82,200 3,850 22,890 36,980 $ 11.24 $ $ 11.24 $ 23,025 53,947 16.35 $ 16.23 $ 23,075 59,730 17.11 $ 16.99 $ 22,711 55,602 15.44 $ 7.15 $ 22,648 51,612 14.97 6.63 (2.09)% (38.88)% 85.56% 3.58% 3.37% 0.28% 3.85% 71.22% 3.64% 3.46% (0.47)% (5.25)% 107.85% 3.81% 3.31% 0.14% 1.92% 96.39% 3.04% 2.73% 0.14% 2.14% 93.54% 2.79% 2.58% Basic earnings (loss) per common share $ (6.14) $ 0.67 $ (0.89) $ 0.29 $ 0.33 Diluted earnings (loss) per common share Average common shares outstanding Average common and common equivalent shares Shares outstanding at year end Other Key Ratios Nonperforming assets to total assets Nonperforming loans to loans and leases held for investment Net loan charge-offs to average loans and leases held for investment Allowance for credit losses to total loans Allowance for credit losses to total nonperforming loans Tier 1 leverage (Consolidated) Total risk-based capital (Consolidated) Tangible common equity (Consolidated) Tier 1 leverage (BNC National Bank) Total risk-based capital (BNC National Bank) $ (6.14) $ 3,261,831 3,273,722 3,290,219 0.67 $ 3,291,697 3,319,225 3,299,163 (0.89) $ 3,456,993 3,515,852 3,491,337 0.29 $ 0.33 2,988,440 3,048,139 3,447,945 3,473,670 3,514,709 3,600,467 4.97% 6.94% (3.235)% 3.11% 50% 8.58% 14.15% 4.23% 8.54% 13.52% 3.84% 4.22% (1.066)% 1.50% 38% 9.01% 12.95% 6.21% 9.34% 12.81% 0.77% 1.09% (0.129)% 1.26% 122% 12.01% 14.26% 8.47% 12.57% 14.26% 0.02% 0.03% (0.008)% 0.86% 3,304% 7.12% 10.89% 3.72% 7.70% 10.94% 0.02% 0.03% (0.130)% 0.77% 2,229% 5.90% 10.12% 3.09% 6.98% 10.67% 4 BNCCORP, Inc. Annual Report 2009 3 Quarterly Financial Data Interest income Interest expense Net interest income Provision for credit losses Net interest income (loss) after provision for credit losses Non-interest income Non-interest expense Income (loss) before income taxes Income tax expense (benefit) First Quarter Second Quarter 2009 Third Quarter (Unaudited) Fourth Quarter YTD $ 10,679 $ 11,413 $ 11,611 $ 10,885 $ 44,588 3,797 6,882 1,700 5,182 3,696 8,060 818 202 3,797 7,616 2,000 5,616 4,345 9,390 571 48 3,758 3,547 14,899 7,853 7,338 29,689 22,300 1,000 27,000 (14,447) 6,338 2,689 3,488 4,484 16,013 12,745 8,908 39,103 (23,704) 1,914 (20,401) (1,814) (61) (1,625) NET INCOME (LOSS) $ 616 $ 523 $ (21,890) $ 1,975 $ (18,776) Preferred stock costs Net income (loss) available to common shareholders (266) (327) (330) (331) (1,254) $ 350 $ 196 $ (22,220) $ 1,644 $ (20,030) Basic earnings (loss) per common share $ Diluted earnings (loss) per common share $ 0.11 $ 0.11 $ 0.06 0.06 $ $ (6.81) $ 0.50 $ (6.14) (6.81) $ 0.50 $ (6.14) Average common shares: Basic Diluted 3,261,831 3,261,831 3,261,831 3,275,279 3,274,595 3,290,400 3,269,355 3,275,279 3,261,831 3,273,722 BNCCORP, Inc. Annual Report 2009 5 4 Interest income Interest expense Net interest income Provision for credit losses Net interest income after provision for credit losses Non-interest income Non-interest expense First Quarter Second Quarter 2008 Third Quarter (Unaudited) Fourth Quarter YTD $ 11,385 $ 11,496 $ 11,694 $ 11,451 $ 46,026 5,113 4,731 4,884 4,487 19,215 6,272 6,765 6,810 6,964 26,811 800 2,000 1,800 3,150 7,750 5,472 4,765 5,010 3,814 19,061 2,300 3,358 2,409 2,328 10,395 5,739 7,078 6,875 6,809 26,501 Income (loss) before income taxes 2,033 1,045 544 (667) 2,955 Income tax expense (benefit) 671 345 39 (318) 737 NET INCOME (LOSS) $ 1,362 $ 700 $ 505 $ (349) $ 2,218 Preferred stock costs Net income (loss) available to common shareholders - - - - - $ 1,362 $ 700 $ 505 $ (349) $ 2,218 Basic earnings (loss) per common share $ 0.40 $ 0.22 $ 0.16 $ (0.11) $ Diluted earnings (loss) per common share $ 0.39 $ 0.21 $ 0.15 $ (0.11) $ 0.67 0.67 Average common shares: Basic Diluted 3,407,821 3,248,101 3,243,388 3,233,740 3,291,697 3,449,481 3,294,559 3,261,945 3,237,177 3,319,225 6 BNCCORP, Inc. Annual Report 2009 5 Business General BNCCORP, Inc. (BNCCORP or the Company) is a bank holding company registered under the Bank Holding Company Act of 1956 headquartered in Bismarck, North Dakota. It is the parent company of BNC National Bank (the Bank). The Company operates community banking and wealth management businesses in Arizona, Minnesota and North Dakota from 20 locations. BNC also conducts mortgage banking from ten locations in Arizona, Minnesota, Iowa, Kansas, Nebraska and Missouri. Operating Strategy In our banking and wealth management operations we provide relationship-based services to small and mid-sized businesses, business owners, professionals and consumers in our primary market areas of Arizona, Minnesota and North Dakota. Key elements of our operating strategy are: (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) Emphasize deposit growth; Provide individualized, high-level customer service; Offer diversified products and services; Expand opportunistically; and Manage credit risk. Since mid 2008, we have been expanding our mortgage banking operations. We believe this expansion is opportunistic because the cost of entry has been low, the division is profitable and these operations enhance our line of products. BNCCORP, Inc. Annual Report 2009 7 6 Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview The following table summarizes net income (loss) and basic and diluted earnings (loss) per share for the year ended December 31 (dollars are in thousands, except per share data): Net income (loss) attributable to common shareholders $ (20,030) $ 2,218 2009 2008 Net income (loss) per share Basic earnings (loss) per share Diluted earnings (loss) per share $ $ (6.14) $ 0.67 (6.14) $ 0.67 The following summarizes key information related to 2009: (cid:120) Net interest income increases by $2.9 million, or 10.7%; (cid:120) Non-interest income grows by $5.6 million, or 54.0%; (cid:120) Mortgage banking revenues increased by $6.3 million; (cid:120) Non-interest expense, excluding other real estate costs, increased by $4.9 million; (cid:120) (cid:120) Allowance for credit losses more than doubles and is $18.047 million, 3.49% of loans held for investment (cid:120) Core deposits increase $64.6 million, or 11.2%, in 2009 Provisions for loan and real estate losses aggregate $35.1 million General Net loss in 2009 was $(18.776) million, or $(6.14) per diluted share, compared to a net income of $2.218 million, or $0.67 per diluted share in 2008. Net Interest Income The following table sets forth information relating to our average balance sheet information, yields on interest- earning assets and costs on interest-bearing liabilities (dollars are in thousands): 8 BNCCORP, Inc. Annual Report 2009 7 Analysis of Changes in Net Interest Income For the Year ended December 31, For the Year ended December 31, For the Year ended December 31, 2009 Average balance Interest Average earned yield or or owed cost Average balance 2008 Interest earned or owed 2007 Average yield or Average Interest Average yield or earned cost balance or owed cost (dollars in thousands) (dollars in thousands) (dollars in thousands) Assets Federal funds sold/interest-bearing due from $ Taxable investments Tax-exempt investments Loans held for sale Participating interests in mortgage loans Loans and leases held for investment 5,755 $ 9 14,397 226,309 409 8,165 1,182 23,570 1,312 29,683 27,279 547,336 0.16% $ 6.36% 5.01% 5.01% 4.42% 4.98% 95 $ 172,383 16,994 3,586 24,688 525,311 1 9,864 839 220 1,408 33,694 1.05% $ 5.72% 4.94% 6.13% 5.70% 6.41% 14,616 $ 754 6,001 124,242 926 18,815 - 417 2,137 27,469 34,423 402,616 5.16% 4.83% 4.92% 0.00% 7.78% 8.55% Allowance for credit losses (11,962) - (7,105) - (4,335) - Total interest-earning assets Non-interest-earning assets: Assets from discontinued operations Cash and due from banks Other 828,856 44,588 5.38% 735,952 46,026 6.25% 583,840 44,241 7.58% 13 9,749 61,598 - 10,481 47,835 13,344 12,468 41,653 Total assets $ 900,216 $ 794,268 $ 651,305 Liabilities and Stockholders’ Equity Deposits: Interest checking and money market accounts Savings Certificates of deposit: Under $100,000 $100,000 and over Total interest-bearing deposits Borrowings: Short-term borrowings FHLB advances Other borrowings Subordinated debentures $ 266,537 11,685 2,379 13 0.89% $ 0.11% 244,279 9,859 4,074 33 1.67% $ 0.33% 249,246 8,399 8,007 66 3.21% 0.79% 324,902 8,653 2.66% 232,367 8,981 3.87% 149,010 7,141 47,358 1,341 2.83% 58,378 2,011 3.44% 44,824 2,319 650,482 12,386 1.90% 544,883 15,099 2.77% 451,479 17,533 17,953 51,738 58 179 1,078 3 1.00% 2.08% 5.17% 7,049 87,159 519 144 2,291 25 2.04% 2.63% 4.82% 8,706 32,991 131 398 1,915 11 22,686 1,253 5.52% 22,734 1,656 7.29% 22,641 2,137 4.79% 5.17% 3.88% 4.57% 5.80% 8.40% 9.44% 4.26% Total interest-bearing liabilities 742,917 14,899 2.01% 662,344 19,215 2.90% 515,948 21,994 Non-interest-bearing demand accounts Total deposits and interest-bearing liabilities Liabilities from discontinued operations Other non-interest-bearing liabilities Total liabilities Stockholders’ equity Total liabilities and stockholders’ 77,736 820,653 316 8,363 829,332 70,884 66,388 728,732 - 7,928 736,660 57,608 68,277 584,225 2,584 6,089 592,898 58,407 equity $ 900,216 $ 794,268 $ 651,305 Net interest income $ 29,689 $ 26,811 $ 22,247 Net interest spread Net interest margin Ratio of average interest-earning assets to average interest-bearing liabilities 3.37% 3.58% 3.35% 3.64% 3.32% 3.81% 111.57% 111.11% 113.16% BNCCORP, Inc. Annual Report 2009 9 8 The following table allocates changes in our interest income and interest expense between the changes related to volume and rates: For the Years Ended December 31, For the Years Ended December 31, 2009 Compared to 2008 2008 Compared to 2007 Change Due to Change Due to Volume Rate Total Volume (in thousands) Rate (in thousands) Total $ 10 3,340 (442) 1,114 $ (2) 1,193 12 (152) $ 8 $ (418) 2,616 (91) 97 4,533 (430) 962 $ (335) 1,247 4 123 $ (753) 3,863 (87) 220 255 1,362 (351) (7,777) (96) (6,415) (200) 9,051 (529) (9,780) (728) (729) Interest Earned on Interest- Earning Assets Federal funds sold/interest- bearing due from Taxable investments Tax-exempt investments Loans held for sale Participating interests in mortgage loans Loans held for investment Total increase (decrease) in interest income 5,639 (7,077) (1,438) 11,055 (9,270) 1,785 Interest Expense on Interest- Bearing Liabilities Interest checking and money market accounts Savings Certificates of Deposit: Under $100,000 $100,000 and over Short-term borrowings FHLB advances Other borrowings Subordinated debentures Total increase (decrease) in 343 5 (2,038) (25) (1,695) (20) (157) 14 (3,776) (47) (3,933) (33) 2,952 (345) 137 (803) (24) (3) (3,280) (325) (102) (410) 2 (400) (328) (670) 35 (1,213) (22) (403) 2,814 2,948 (65) 565 16 9 (974) (3,256) (189) (189) (2) (490) 1,840 (308) (254) 376 14 (481) interest expense 2,262 (6,578) (4,316) 6,144 (8,923) (2,779) Increase (decrease) in net interest income $ 3,377 $ (499) $ 2,878 $ 4,911 $ (347) $ 4,564 Net interest income was $29.689 million in 2009 compared to $26.811 million in 2008, an increase of $2.878 million or 10.7%. The net interest margin decreased to 3.58% for the year ended December 31, 2009, from 3.64% in 2008. Investment earnings and lower interest rates on liabilities combined to increase net interest income. Increases in non-accrual loans and other nonperforming assets compressed net interest margin. Interest income decreased in 2009 primarily due to the lower interest rate environment. The impact of lower interest rates was partially offset by an increase in investments. We emphasized investments in recent periods because the yield on investments was attractive compared to other assets. Increases in nonperforming assets reduced interest income. 10 BNCCORP, Inc. Annual Report 2009 9 Interest expense decreased in 2009 primarily due to lower interest rates in 2009. Increases in the balances of deposits partially offset the decline in rates. Net interest income was $26.811 million in 2008 compared to $22.247 million in 2007, an increase of $4.564 million or 20.5%. The net interest margin decreased to 3.64% for the year ended December 31, 2008, from 3.81% in 2007. Net interest income increased in 2008 primarily due higher balances of loans and investments and lower rates on deposits. The margin decreased in 2008, compared to 2007, because of increases in nonperforming assets. Non-interest Income The following table presents the major categories of our non-interest income (dollars are in thousands): For the Years Ended December 31, Increase ( Decrease) 2009 – 2008 2009 2008 $ % Bank charges and service fees Wealth management revenues Mortgage banking revenues Gains (losses) on sales of loans, net Gain on sales of premises and equipment Gains on sales of securities, net Other Total non-interest income $ $ 2,332 2,056 8,390 (339) - 2,850 724 16,013 $ $ 2,337 2,826 2,101 1,116 775 247 993 10,395 (5) (770) 6,289 (1,455) (775) 2,603 (269) $ 5,618 (0) % (27) % (a) 299 % (b) (130) % (c) (100) % (d) 1,054 % (e) (27) % 54 % (a) Wealth management revenues decreased because of fewer fees for managing documents on insurance products sold by others. We expect this trend to continue. (b) Mortgage banking revenues increased because we have been expanding these operations since the middle of 2008. In 2009, mortgage banking originations were robust because of lower interest rates. (c) Gains (losses) on sales of loans, net declined because the secondary market for commercial real estate loans functioned at reduced levels from mid 2008 throughout most of 2009. In order to reduce exposure to commercial real estate, we sold $18.5 million of loans late in 2009. One of the sales incurred a loss. In the second quarter of 2008, we sold a building previously occupied by our insurance segment and generated a gain. (d) (e) Gains on sales of securities, net vary depending on the nature and volume of transactions. In 2009, the value of securities increased primarily due to lower interest rates and we were able to sell securities at gains. BNCCORP, Inc. Annual Report 2009 11 10 Non-interest Expense The following table presents the major categories of our non-interest expense (dollars are in thousands): Salaries and employee benefits Professional services Other real estate costs Data processing fees Occupancy Marketing and promotion Regulatory assessments Depreciation and amortization Office supplies and postage Other Total non-interest expense Efficiency ratio For the Years Ended December 31, 2009 2008 Increase (Decrease) 2009 – 2008 $ % $ 15,008 3,064 8,169 2,330 2,508 1,277 1,466 1,465 611 3,205 $ 39,103 85.56% $ 14,673 1,177 515 2,202 2,140 1,127 400 1,375 533 2,359 $ 26,501 71.22% $ $ 335 1,887 7,654 128 368 150 1,066 90 78 846 12,602 14.34% 2 % 160 % (a) 1,486 % (b) 6 % 17 % (c) 13 % (d) 267 % (e) 7 % 15 % 36 % (f) 48 % (a) Professional services increased because of legal fees associated with problem credits and services required by mortgage banking operations. (b) Other real estate costs increased because of valuation allowances recorded to reduce the carrying value of foreclosed properties. (c) Occupancy has increased due to more mortgage banking locations. (d) Marketing costs increased due to new locations, mortgage banking and promotions for depository products. (e) The FDIC has increased assessments for most banks to replenish the depository insurance fund and also imposed a special assessment in June 2009 for all banks. Our portion of the special assessment was approximately $400 thousand. We expect regulatory assessments to increase in future periods. (f) Other expenses increased primarily due to an impairment of goodwill aggregating $409 thousand in the third quarter of 2009. Income Tax Expense The tax benefit in 2009 was $1.625 million, or 8.0%, of pre-tax losses 2009. This benefit reflects the net effect of tax benefits resulting from operating losses and the cost of recording a valuation allowance for net deferred tax assets. In the same period of 2008, tax expense was $737 thousand, resulting in an effective tax rate of 24.9%. There was no expense in 2008 associated with a valuation allowance for net deferred tax assets. 12 BNCCORP, Inc. Annual Report 2009 11 Financial Condition Assets The following table presents our assets by category (dollars are in thousands): As of December 31, 2009 2008 Increase (Decrease) 2009 – 2008 $ % Cash and cash equivalents $ 35,362 $ 10,569 $ 24,793 235 % (a) Investment securities available for sale 212,661 209,857 2,804 1 % Federal Reserve Bank and Federal Home Loan Bank of Des Moines stock Loans held for sale Participating interests in mortgage loans Loans and leases held for investment, net Other real estate, net Premises and equipment, net Interest receivable Other assets Total assets 3,048 24,130 38,534 499,061 7,253 20,422 2,970 24,642 5,989 13,403 28,584 534,002 10,189 20,810 3,263 (2,941) (49) % (b) 10,727 80 % (c) 9,950 35 % (d) (34,941) (7) % (e) (2,936) (29) % (f) (388) (293) (2) % (9) % (1) % 1 % $ 868,083 $ 861,498 $ 6,585 24,832 (190) (a) In 2009, we have been increasing liquid assets as part of a focus on managing liquidity. As a result, cash balances increased. Cash balances can vary significantly on a daily basis. (b) Investment in these stocks are mandated by third parities. Our required investment decreased with reduced FHLB advances. (c) Loans held for sale have increased as we expanded mortgage banking operations. (d) Participating interests in mortgage loans are collateralized by loans held for sale by mortgage banking counterparties. These balances will vary depending on the volume of loans originated by the counterparties. (e) Loans and leases held for investment have decreased as we have attempted to manage our credit exposure by reducing loans outstanding and increasing the allowance for credit losses. (f) OREO decreased due to valuation allowances and sales of foreclosed properties, late in 2009. BNCCORP, Inc. Annual Report 2009 13 12 Investment Securities Available for Sale The following table presents the composition of the available-for-sale investment portfolio (in thousands): Investment Portfolio Composition 2009 December 31, 2008 2007 Amortized cost Estimated fair market value Amortized cost Estimated fair market value Amortized cost Estimated fair market Value $ 1,223 $ 1,262 $ 1,505 $ 1,543 $ 1,799 $ 1,784 2,500 2,599 2,891 2,917 3,329 3,333 86,600 87,017 23,037 23,170 2,394 2,413 1,797 1,887 37,896 39,024 62,384 63,306 118,375 2,521 117,211 2,685 138,851 13,482 129,185 14,018 32,830 17,885 33,079 18,984 U.S. government agency mortgage-backed securities guaranteed by GNMA U.S. government agency mortgage-backed securities issued by FNMA Collateralized mortgage obligations guaranteed by GNMA Collateralized mortgage obligations issued by FNMA or FHLMC Other collateralized mortgage obligations State and municipal bonds Total investments $ 213,016 $ 212,661 $ 217,662 $ 209,857 $ 120,621 $ 122,899 See Note 1 of our Consolidated Financial Statements for management’s conclusion on other than temporary impairment. The following table presents contractual maturities for securities available for sale and yields thereon at December 31, 2009 (dollars are in thousands): Investment Portfolio - Maturity and Yields After 5 but within 10 years within 5 years Amount Yield (1) Amount Yield (1) Amount Yield (1) Within 1 year After 1 but After 10 years Amount Yield (1) Total Amount Yield (1) U.S. government agency mortgage-backed securities guaranteed by GNMA (2) (3) U.S. government agency mortgage-backed securities issued by FNMA (2) (3) Collateralized mortgage obligations guaranteed by GNMA (2) (3) Collateralized mortgage obligations issued by FNMA or FHLMC (2) (3) Other collateralized mortgage $ - 0.00% $ - 0.00% - 0.00% - - - 0.00% $ 1,223 5.56% $ - 0.00% $ 1,223 5.56% 0.00% 0.00% - - 0.00% 2,500 6.68% 2,500 6.68% 0.00% 86,600 2.78% 86,600 2.78% - 0.00% 51 2.70% 673 5.37% 1,073 6.52% 1,797 5.98% obligations (2) (3) - 0.00% - 0.00% 9,093 State and municipal bonds (2) Total book value of investment 702 8.23% - 0.00% 1,086 6.96% 6.93% 109,282 733 7.56% 7.36% 118,375 2,521 7.52% 7.42% securities $ 702 8.23% $ 51 2.70% $ 12,075 6.73% $ 200,188 5.47% $ 213,016 5.55% Unrealized holding loss on securities available for sale Total investment in securities available for sale (355) $ 212,661 5.56% (1) Yields include adjustments for tax-exempt income. (2) Based on amortized cost rather than fair value. (3) Maturities of mortgage-backed securities and collateralized obligations are based on contractual maturities. Actual maturities may vary because obligors may have the right to call or prepay obligations with or without call or prepayment penalties. 13 14 BNCCORP, Inc. Annual Report 2009 As of December 31, 2009, we had $212.7 million of available-for-sale securities in the investment portfolio compared to $209.9 and $122.9 million at December 31, 2008 and 2007, respectively. In 2009, investment securities were relatively flat. We increased our holdings of collateralized mortgage obligations guaranteed by GNMA while reducing our holdings of those issued by FNMA or FHLMC. Unrealized losses decreased as credit spreads narrowed from 2008. In addition we realized $2.850 million of realized gains on sales of securities. See Notes 1 and 4 of our Consolidated Financial Statements for a discussion of impairment assessments. Since early 2008 we have emphasized investment securities because yields on certain investments have been attractive compared to other assets. These assets can also offer more liquidity than other types of assets. At December 31, 2009, we held five securities, other than U.S. Government Agency CMOs that exceeded 10% of stockholders’ equity. The total carrying value of these five securities was $35.8 million. A significant portion of our investment securities portfolio was pledged as collateral. See Note 4 of our Consolidated Financial Statements for the amount of investments that serve as collateral. Federal Reserve Bank and Federal Home Loan Bank of Des Moines Stock Our equity securities consisted of $1.3 million of Federal Reserve Bank (“FRB”) stock as of December 31, 2009 and 2008, and $1.8 million and $4.7 million of FHLB of Des Moines stock as of December 31, 2009 and 2008, respectively. Loan Portfolio The following table presents the composition of our loan portfolio (dollars are in thousands): 2009 2008 December 31, 2007 2006 2005 Amount % Amount % Amount % Amount % Amount % Commercial and industrial $ 124,773 23.2 $ 138,671 24.6 $ 125,555 24.4 $ 100,127 25.9 $ 88,467 21.6 Real estate mortgage 266,051 49.5 265,360 47.2 181,000 35.1 124,551 32.2 122,785 30.1 Real estate construction Participating interests in mortgage loans 96,327 17.9 108,713 19.3 167,345 32.5 89,619 23.2 80,296 19.7 38,534 7.2 28,584 5.1 24,357 4.7 56,125 14.5 101,336 24.8 Agricultural 23,142 4.3 22,023 3.9 17,074 3.3 14,286 3.7 12,706 3.1 Other Total principal amount of 7,397 1.4 8,793 1.5 7,693 1.5 6,037 1.6 6,849 1.7 loans 556,224 103.5 572,144 101.6 523,024 101.5 390,745 101.0 412,439 101.0 Unearned income and net unamortized deferred fees and costs Loans, net of unearned income and unamortized fees and costs Less allowance for credit losses Net loans (582) (0.1) (807) (0.1) (1,111) (0.2) (686) (0.2) (735) (0.2) 555,642 103.4 571,337 101.5 521,913 101.3 390,059 100.9 411,704 100.8 (18,047) (3.4) (8,751) (1.5) (6,599) (1.3) (3,370) (0.9) (3,188) (0.8) $ 537,595 100.0 $ 562,586 100.0 $ 515,314 100.0 $ 386,689 100.0 $ 408,516 100.0 BNCCORP, Inc. Annual Report 2009 15 14 Change in Loan Portfolio Composition As of December 31, 2009 2008 Increase (Decrease) 2009 – 2008 $ % Commercial and industrial Real estate mortgage Real estate construction Participating interests in mortgage loans Agricultural Other Total principal amount of loans Unearned income and net unamortized deferred $ 124,773 $ 138,671 266,051 96,327 38,534 23,142 7,397 265,360 108,713 28,584 22,023 8,793 556,224 572,144 $ (13,898) 691 (12,386) 9,950 1,119 (1,396) (15,920) (10) % (a) 0 % (11) % (b) 35 % (c) 5 % (16) % (3) % fees and costs (582) (807) (225) (28) % Loans, net of unearned income and unamortized deferred fees and costs Less allowance for credit losses Net loans 555,642 571,337 (18,047) (8,751) $ 537,595 $ 562,586 (15,695) (9,296) $ (24,991) (3) 106 % (4) % (a) Commercial and industrial loans decreased as we sold a portfolio of SBA loans late in 2009 and charged off problematic loans throughout the year. (b) Construction loans have decreased because certain projects under construction have been completed and certain problematic loans were charged-off during the year. (c) Participating interests in mortgage loans are collateralized mortgage loans held for sale by mortgage banking counterparties. These loans will vary significantly depending on the volume of originations by the counterparties. Loan Participations Pursuant to our lending policy, loans may not exceed 85% of the Bank’s legal lending limit (except to the extent collateralized by U.S. Treasury securities or Bank deposits and, accordingly, excluded from the Bank’s legal lending limit) unless the Chief Credit Officer and the Executive Credit Committee grant prior approval. To accommodate customers whose financing needs exceed lending limits and internal loan concentration limits, the Bank sells loan participations to outside participants without recourse. The Bank generally retains the right to service the loans as well as the right to receive a portion of the interest income on the loans. Loan participations sold on a nonrecourse basis to outside financial institutions were as follows as of the dates indicated: Loan Participations Sold December 31, (in thousands) $ 2009 2008 2007 2006 2005 330,204 315,469 201,776 188,994 183,795 16 BNCCORP, Inc. Annual Report 2009 15 Concentrations of Credit The following tables summarize the location of our borrowers as of December 31 (in thousands): 2009 2008 Minnesota North Dakota Arizona Other Totals $ $ 199,831 154,007 125,579 76,807 556,224 36 % 28 22 14 100 % $ 185,947 173,509 145,643 67,045 $ 572,144 33 % 30 25 12 100 % Our borrowers use loan proceeds for projects in various geographic areas. The following table summarizes the locations where our borrowers are using loan proceeds as of December 31 (in thousands): North Dakota Arizona Minnesota California Texas Kentucky Wisconsin Idaho Georgia New York Arkansas South Dakota Other Totals 2009 2008 $ 184,282 134,967 81,514 39,848 28,944 11,927 9,840 9,292 6,465 5,270 5,199 5,111 33,565 $ 556,224 33 % 24 15 7 5 2 2 2 1 1 1 1 6 100 % $ 181,066 126,326 106,786 23,894 37,032 11,000 10,301 8,146 6,559 7,496 5,260 5,864 42,414 $ 572,144 32 % 22 19 4 6 2 2 1 1 1 1 1 8 100 % BNCCORP, Inc. Annual Report 2009 17 16 The following table presents loans by type within our three primary states as of December 31 (in thousands): North Dakota Commercial and industrial Construction Agricultural Land and land development Owner-occupied commercial real estate Non-owner-occupied commercial real estate Small business administration Consumer Subtotal Arizona Commercial and industrial Construction Agricultural Land and land development Owner-occupied commercial real estate Non-owner-occupied commercial real estate Small business administration Consumer Subtotal Minnesota Commercial and industrial Construction Agricultural Land and land development Owner-occupied commercial real estate Non-owner-occupied commercial real estate Small business administration Consumer Subtotal 2009 2008 84,400 4,572 22,422 12,321 27,960 12,419 2,434 17,754 184,282 19,740 2,136 - 18,541 23,508 32,497 5,042 33,503 134,967 10,589 4,698 33 12,641 18,675 25,203 1,025 8,650 81,514 $ $ $ $ $ $ 80,412 4,205 21,229 10,278 29,123 13,221 2,478 20,120 181,066 15,834 10,474 - 31,018 16,633 28,797 6,250 17,320 126,326 19,827 8,973 81 17,671 29,060 19,300 1,017 10,857 106,786 $ $ $ $ $ $ The bank has a concentration of loans exceeding 10% of the total loan portfolio in real estate loans. Within the real estate portfolio we also have concentrations of land and land development and construction loans as of December 31 (in thousands): Land and land development loans $ 47,986 8 % Construction loans Totals 19,143 3 $ 67,129 11 % $ $ 61,814 11 % 37,746 7 99,560 18 % 2009 2008 Construction loans include loans for which construction is complete and are expected to be refinanced to permanent loans within the foreseeable future. 18 BNCCORP, Inc. Annual Report 2009 17 Loan Maturities The following table sets forth the remaining maturities of loans in our portfolio as of December 31, 2009 (in thousands): Maturities of Loans (1) Commercial and industrial Real estate mortgage Real estate construction Participating interests in mortgage loans Agricultural Other Total principal amount of loans Over 1 year through 5 years One year or less Fixed rate Floating rate Over 5 years Fixed rate Floating rate Total $ 62,833 63,540 55,519 $ 34,033 74,950 13,201 $ 5,444 68,354 12,348 $ 13,667 25,200 559 $ 8,796 34,007 14,700 $ 124,773 266,051 96,327 38,534 12,485 2,545 235,456 $ - 7,076 3,750 $ 133,010 - 447 400 $ 86,993 - 873 158 $ 40,457 - 2,261 544 $ 60,308 38,534 23,142 7,397 $ 556,224 (1) Maturities are based on contractual maturities. Floating rate loans include loans that would reprice prior to maturity if base rates change. Actual maturities may differ from the contractual maturities shown above as a result of renewals and prepayments. Loan renewals are evaluated in substantially the same manner as new credit applications. Provision for Credit Losses We provide for credit losses to maintain our allowance for credit losses at a level adequate to cover estimated probable losses in the loan and lease portfolio as of each balance sheet date. The provision for credit losses for the year ended December 31, 2009 was $27.000 million as compared to $7.750 million in 2008. The higher provision for credit losses in 2009 reflects macro economic forces which impaired the ability of borrowers to repay debt which resulted in higher credit losses throughout the financial industry. Specific factors that contributed to our large provision include the migration of several credits to nonperforming status, decline in collateral values and efforts to restructure problem loans. Allowance for Credit Losses See a discussion of critical accounting policies in Note 1 of our Consolidated Financial Statements for a summary of the processes we use to estimate the allowance for credit losses. BNCCORP, Inc. Annual Report 2009 19 18 The following table summarizes activity in the allowance for credit losses and certain ratios: Analysis of Allowance for Credit Losses (dollars are in thousands) For the Years ended December 31, Balance of allowance for credit losses, beginning of period Charge-offs: Commercial and industrial Real estate mortgage Real estate construction Agricultural Other Total charge-offs Recoveries: Commercial and industrial Real estate mortgage Real estate construction Agricultural Other Total recoveries Net charge-offs Provision for credit losses charged to operations 2009 2008 2007 2006 2005 $ 8,751 $ 6,599 $ 3,370 $ 3,188 $ 3,335 (6,408) (2,258) (9,080) - (130) (17,876) 12 1 149 - 10 172 (17,704) (738) (426) (4,529) - (253) (5,946) 84 - 196 - 68 348 (5,598) (1,504) (500) - - (123) (2,127) 1,500 - - - 106 1,606 (521) (19) - - - (32) (51) 3 - - - 20 23 (28) (534) (24) - - (31) (589) 95 10 16 - 71 192 (397) 27,000 7,750 3,750 210 250 Balance of allowance for credit losses, end of period $ 18,047 $ 8,751 $ 6,599 $ 3,370 $ 3,188 Ratio of net charge-offs to average total loans Ratio of net charge-offs to average loans and (2.948)% (0.507)% (0.121)% (0.008)% (0.102)% leases held for investment (3.235)% (1.066)% (0.129)% (0.008)% (0.130)% Average gross loans and leases held for investment Ratio of allowance for credit losses to loans and leases held for investment Ratio of allowance for credit losses to total nonperforming loans $ 547,336 $ 525,311 $ 402,615 $ 334,058 $ 305,073 3.49% 1.61% 1.33% 1.01% 1.03% 50% 38% 122% 3,304% 2,229% The allowance for credit losses increased significantly in recent periods because of growth in the loan and lease portfolio, an increase in nonperforming assets and deteriorating economic conditions. The carrying value of non performing assets is supported by recent appraisals. See Notes 1 and 7 of our Consolidated Financial Statements and “Critical Accounting Policies” for further information concerning accounting policies associated with the allowance for credit losses. 20 BNCCORP, Inc. Annual Report 2009 19 The table below presents an allocation of the allowance for credit losses among the various loan categories and sets forth the percentage of loans in each category to gross loans. The allocation of the allowance for credit losses as shown in the table should neither be interpreted as an indication of future charge-offs, nor as an indication that charge-offs in future periods will necessarily occur in these amounts or in the indicated proportions. Allocation of the Allowance for Loan Losses (dollars are in thousands) 2009 2008 Loans in category as a percentage of total gross loans Amount of allowance Amount of allowance Loans in category as a percentage of total gross loans December 31, 2007 Loans in category as a percentage of total gross loans Amount of allowance 2006 2005 Loans in category as a percentage Amount of total of gross loans allowance Loans in category as a percentage of total gross loans Amount of allowance Commercial and industrial (a) Real estate mortgage (a) Real estate construction (a) Participating interests in mortgage loans Agricultural Other Total $ 5,779 23% $ 1,268 24% $ 1,410 24% $ 1,602 26% $ 1,632 6,672 48% 2,829 47% 1,956 35% 838 32% 846 4,692 17% 4,293 19% 2,740 32% 534 23% 467 105 704 95 7% 86 5% 85 5% 140 14% - 4% 180 4% 276 3% 171 4% 158 1% 95 1% 132 1% 85 1% 85 21% 30% 19% 25% 3% 2% $ 18,047 100% $ 8,751 100% $ 6,599 100% $ 3,370 100% $ 3,188 100% (a) The portion of our allowance allocated to these types of loans increased because of deterioration of the macro economy, devaluation of real estate and/or impaired ability of our borrowers to repay their obligations. Allowance for Credit Losses; Impact on Earnings. We have estimated the allowance for credit losses to cover for estimated losses inherent to the loans and lease portfolio at December 31, 2009. The allowance for credit losses is an estimate based upon several judgmental factors. We are not aware of known trends, commitments or other events that could reasonably occur that would materially affect our methodology or the assumptions used to estimate the allowance for credit losses. However, changes in qualitative and quantitative factors could occur at any time and such changes could be of a material nature. In addition, economic situations change, financial conditions of borrowers morph and other factors we consider in arriving at our estimates may evolve. To the extent that these matters have negative developments our future earnings could be reduced by high provisions for credit losses. BNCCORP, Inc. Annual Report 2009 21 20 Nonperforming Loans and Assets The following table sets forth nonperforming assets, the allowance for credit losses and certain related ratios (dollars are in thousands): 2009 2008 December 31, 2007 2006 2005 Nonperforming loans: Loans 90 days or more delinquent and still accruing interest Nonaccrual loans Total nonperforming loans Other real estate, net Total nonperforming assets Allowance for credit losses Ratio of total nonperforming loans to total loans Ratio of total nonperforming loans to loans and leases held for investment Ratio of total nonperforming assets to total assets Ratio of allowance for credit losses to nonperforming loans $ 1 35,889 35,890 7,253 $ 43,143 $ 18,047 6.19% $ 6 22,909 22,915 10,189 33,104 8,751 3.92% $ $ $ $ $ - 5,399 5,399 - 5,399 6,599 1.03% $ 2 100 102 - 102 3,370 0.03% $ $ $ - 143 143 - 143 3,188 0.03% $ $ 6.94% 4.97% 4.22% 3.84% 1.09% 0.77% 0.03% 0.02% 0.05% 0.02% 50% 38% 122% 3,304% 2,229% Past Due, Non-accrual and Restructured Loans The following table indicates the effect on income if interest on non-accrual and restructured loans outstanding at year end had been recognized at original contractual rates during the year ended December 31 (in thousands): Interest income that would have been recorded Interest income recorded Effect on interest income 2009 2008 $ 1,684 1 $ 1,661 1,247 $ 1,683 $ 414 Loans 90 days or more delinquent and still accruing interest include loans over 90 days past due which we believe, based on our specific analysis of the loans, do not present doubt about the collection of interest and principal in accordance with the loan contract. Loans in this category must be well secured and in the process of collection. Non-accrual loans include loans on which the accrual of interest has been discontinued. Accrual of interest is discontinued when we believe that the borrower’s financial condition is such that the collection of interest is doubtful. A delinquent loan is generally placed on non-accrual status when it becomes 90 days or more past due unless the loan is well secured and in the process of collection. When a loan is placed on non-accrual status, accrued but uncollected interest income applicable to the current reporting period is reversed against interest income. Accrued but uncollected interest income applicable to previous reporting periods is charged against the allowance for credit losses. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain. 22 BNCCORP, Inc. Annual Report 2009 21 Restructured loans are loans for which concessions, including a reduced interest rate or a deferral of interest or principal, have been granted due to the borrower’s weakened financial condition. Once a loan is restructured, interest is accrued at the restructured rates when no loss of principal is anticipated. A loan that has performed in accordance with restructured terms for one year is no longer reported as a restructured loan. The table below summarizes the amounts of restructured loans as of the dates indicated. All of the restructured loans were also non-accrual loans. Restructured Loans December 31, (in thousands) $ 2009 2008 2007 2006 2005 14,337 2,379 2,585 54 91 Other real estate owned and repossessed assets represent properties and other assets acquired through, or in lieu of, loan foreclosure. They are initially recorded at fair value less cost to sell at the date of acquisition establishing a new cost basis. Write-downs to fair value at the time of acquisition are charged to the allowance for credit losses. After foreclosure, we perform valuations periodically and the real estate is recorded at fair value less cost to sell. Reductions to other real estate owned and repossessed assets are considered valuation allowances. Expenses incurred to record valuation allowances subsequent to foreclosure are charged to non-interest expense. See Note 8 of our Consolidated Financial Statements for information on other real estate owned. Impaired loans See Note 6 of our Consolidated Financial Statements for impaired loans information. Potential Problem Loans The macro economic environment is very challenging and asset values are declining throughout most of the country. So long as these conditions persist, many loans are potentially problematic assets. Notwithstanding the prior paragraph, we attempt to quantify potential problem loans with more immediate credit risk. We estimate such loans totaled $22.0 million and $13.2 million at December 31, 2009 and 2008, respectively. A significant portion of these potential problem loans are not in default but may have characteristics such as recent adverse operating cash flows or general risk characteristics that the loan officer feels might jeopardize the future timely collection of principal and interest payments. The ultimate resolution of these credits is subject to changes in economic conditions and other factors. These loans are closely monitored to ensure that our position as creditor is protected to the fullest extent possible. BNCCORP, Inc. Annual Report 2009 23 22 Liabilities and Stockholders’ Equity The following table presents our liabilities and stockholders’ equity (dollars are in thousands): Deposits: Non-interest-bearing Interest-bearing- Savings, interest checking and money market Time deposits $100,000 and over Other time deposits Short-term borrowings FHLB advances Other borrowings Guaranteed preferred beneficial interests in Company's subordinated debentures Accrued interest payable Accrued expenses Other liabilities Total liabilities Stockholders' equity Total liabilities and As of December 31, 2009 2008 Increase (Decrease) 2009 – 2008 $ % $ 98,658 $ 68,996 $ 29,662 43 % (a) 280,571 52,222 324,512 10,190 15,000 - 22,890 1,468 2,946 2,361 810,818 57,265 266,851 42,342 297,132 16,844 84,500 - 23,025 1,679 3,325 2,857 807,551 53,947 13,720 9,880 27,380 (6,654) (69,500) - (135) (211) (379) (496) 3,267 3,318 5 % (a) 23 % (b) 9 % (c) (40) % (d) (82) % (e) - % (1) % (13) % (11) % (17) % 0 % 6 % stockholders’ equity $ 868,083 $ 861,498 $ 6,585 1 % (a) We have emphasized deposit growth and marketing initiatives focused on lower cost deposits. These types of accounts fluctuate daily due to the cash management activities of our customers. (b) Our customers have migrated to insured deposits as other investment vehicles have incurred losses. (c) We have used brokered certificate of deposits to fund our investment securities. (d) Short-term borrowings are primarily customer repurchase agreements. These balances can vary significantly depending on customer preferences. (e) FHLB advances have decreased as the growth in deposits has been used to reduce borrowings. 24 BNCCORP, Inc. Annual Report 2009 23 Deposits The following table sets forth, for the periods indicated, the distribution of our average deposit account balances and average cost of funds rates on each category of deposits (dollars are in thousands): Average Deposits and Deposits Costs For the Years Ended December 31, 2009 Percent of deposits Wgtd. avg. rate Average balance 2008 Percent of deposits Average balance Wgtd. avg. rate Average balance 2007 Percent Wgtd. avg. rate of deposits $ 266,537 11,685 36.60% 1.61% 0.89% $ 244,279 9,859 0.11% 39.96% 1.61% 1.67% 0.33% $ 249,246 8,399 47.95% 3.21% 1.62% 0.79% 324,902 47,358 44.62% 6.50% 2.66% 2.83% 232,367 58,378 372,260 51.12% 2.68% 290,745 38.01% 9.55% 47.56% 3.87% 3.44% 149,010 44,824 28.67% 4.79% 8.62% 5.17% 3.78% 193,834 37.29% 4.88% 650,482 89.33% 1.90% 544,883 89.14% 2.77% 451,479 86.86% 3.88% 77,736 10.67% - 66,388 10.86% - 68,277 13.14% - Interest checking and MMDAs Savings deposits Time deposits (CDs): CDs under $100,000 CDs $100,000 and over Total time deposits Total interest-bearing deposits Non-interest-bearing demand deposits Total deposits $ 728,218 100.00% 1.70% $ 611,271 100.00% 2.47% $ 519,756 100.00% 3.37% Time deposits, in denominations of $100,000 and more, totaled $52.2 million at December 31, 2009 as compared to $42.3 million at December 31, 2008. The following table sets forth the amount and maturities of time deposits of $100,000 and more as of December 31, 2009 (in thousands): Time Deposits of $100,000 and Over Maturing in: 3 months or less Over 3 months through 6 months Over 6 months through 12 months Over 12 months Total $ $ 14,470 12,283 16,146 9,323 52,222 Borrowed Funds The following table provides a summary of our short-term borrowings and related cost information as of, or for the years ended, December 31 (dollars are in thousands): Short-Term Borrowings 2009 2008 2007 Short-term borrowings outstanding at period end Weighted average interest rate at period end Maximum month end balance during the period Average borrowings outstanding for the period Weighted average interest rate for the period $ $ $ 10,190 0.70% 23,818 17,953 1.00% $ $ $ $ $ $ 16,844 0.88% 16,844 7,049 2.04% 5,365 3.64% 15,518 8,706 4.57% Note 11 of our Consolidated Financial Statements summarizes the general terms of our short-term borrowings outstanding at December 31, 2009 and 2008. BNCCORP, Inc. Annual Report 2009 25 24 FHLB advances totaled $15.0 million and $84.5 million at December 31, 2009 and 2008, respectively, while long-term borrowings totaled $0, for the same periods. Notes 12 and 13 of our Consolidated Financial Statements summarize the general terms of our FHLB advances and other borrowings at December 31, 2009 and 2008. Guaranteed Preferred Beneficial Interests in Company’s Subordinated Debentures See Note 14 of our Consolidated Financial Statements for a description of the subordinated debentures. Capital Resources and Expenditures See Note 2 of our Consolidated Financial Statements for a discussion of regulatory capital and the current operating environment. Off-Balance-Sheet Arrangements In the normal course of business, we are a party to various financial instruments with off-balance-sheet risk. These instruments include commitments to extend credit, commercial letters of credit, performance and financial standby letters of credit and interest rate swaps, caps and floors. Such instruments help us to meet the needs of our customers, manage our interest rate risk and effectuate various transactions. These instruments and commitments, which we enter into for purposes other than trading, carry varying degrees of credit, interest rate or liquidity risk. See Notes 17 and 19 of our Consolidated Financial Statements for a detailed description of each of these instruments. Contractual Obligations, Contingent Liabilities and Commitments We are a party to financial instruments with risks that can be subdivided into two categories: Cash financial instruments, generally characterized as on-balance-sheet items, include investments, loans, mortgage-backed securities, deposits and debt obligations. Credit-related financial instruments, generally characterized as off-balance-sheet items, include such instruments as commitments to extend credit, commercial letters of credit and performance and financial standby letters of credit. 26 BNCCORP, Inc. Annual Report 2009 25 At December 31, 2009, the aggregate contractual obligations (excluding bank deposits), contingent liabilities and commitments were as follows (in thousands): Contractual Obligations: year 1 to 3 years 3 to 5 years After 5 years Total Payments due by period Less than 1 Total borrowings $ 10,190 $ Commitments to sell loans Annual rental commitments under non-cancelable operating leases Total 23,876 - - $ 15,000 $ 22,890 $ 48,080 - - 23,876 1,302 $ 35,368 1,676 $ 1,676 278 $ 15,278 $ 1,967 5,223 24,857 $ 77,179 Other Commitments: Less than 1 year 1 to 3 years 3 to 5 years After 5 years Total Amount of Commitment - Expiration by Period Commitments to lend Standby and commercial letters of credit Total Liquidity Risk Management $ 89,546 $ 9,267 $ 3,056 $ 161 $ 102,030 1,362 $ 90,908 2,719 11,986 $ - $ 3,056 4,081 $ 161 $ 106,111 - Liquidity risk is the possibility of being unable to meet financial obligations in a timely manner. The objectives of liquidity management policies are to maintain adequate liquid assets and diversified liabilities. Diversification is provided by varying debt instruments, maturities and counterparties. The Consolidated Statements of Cash Flows in the Consolidated Financial Statements present data on cash and cash equivalents provided by and used in operating, investing and financing activities. We obtain funding and liquidity through repayments and sales of assets. In addition, we obtain liquidity and funding from core deposits, brokered deposits, repurchase agreements and overnight Federal funds. The Bank is a member of the FHLB of Des Moines, which provides an opportunity to borrow funds on a short term and long term basis. We have also obtained funding through the issuance of subordinated notes, subordinated debentures and long-term borrowings. We assess liquidity by our ability to raise cash when we need it at a reasonable cost and with a minimum of losses. Given the uncertain nature of our customers’ demands, as well as our desire to take advantage of earnings enhancement opportunities, we must have adequate sources of on- and off-balance-sheet funds that can be accessed as needed. We measure our liquidity position on a monthly basis. Key factors that determine our liquidity are the reliability or stability of our deposit base, the pledged/non-pledged status of our investments and potential loan demand. Our liquidity management system divides the balance sheet into liquid assets and short-term liabilities that are assumed to be vulnerable to non-replacement under abnormally stringent conditions. The excess of liquid assets over short-term liabilities is measured over a 30-day planning horizon. Assumptions for short-term liabilities vulnerable to non-replacement under abnormally stringent conditions are based on a historical analysis of the month-to-month percentage changes in deposits. In addition, we subject these assumptions to stress tests to measure the degree of volatility our liquidity position could manage over the 30-day horizon. The excess of liquid assets over short-term liabilities and other key factors such as expected loan demand as well as access to other sources of liquidity such as lines with the FHLB, Federal funds and those other supplemental sources listed above are tied together to provide a measure of our liquidity. We have a targeted range of liquidity metrics and manage our operations such that these targets can be achieved. We believe our policies and guidelines will provide for 26 BNCCORP, Inc. Annual Report 2009 27 adequate levels of liquidity to fund anticipated needs of on- and off-balance-sheet items. In addition, a contingency funding policy statement identifies actions to be taken in response to an adverse liquidity event, and forecasts of sources and uses of funds under stressed scenarios. As of December 31, 2009, the Bank had established Federal funds purchase programs with two banks, totaling $4 million. At December 31, 2009, the Bank had purchased Federal funds of $0 under these programs leaving $4 million available. The Federal funds purchase programs, if advanced upon, mature daily with interest rates that float at the Federal funds rate. Forward-Looking Statements Statements included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” which are not historical in nature are intended to be, and are hereby identified as “forward-looking statements” for purposes of the safe harbor provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We caution readers that these forward-looking statements, including without limitation, those relating to our future business prospects, revenues, working capital, liquidity, capital needs, interest costs, income and expenses, are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements due to several important factors. These factors include, but are not limited to: risks of loans and investments, including dependence on local and regional economic conditions; competition for our customers from other providers of financial services; possible adverse effects of changes in interest rates including the effects of such changes on derivative contracts and associated accounting consequences; risks associated with our acquisition and growth strategies; and other risks which are difficult to predict and many of which are beyond our control. Recently Issued and Adopted Accounting Pronouncements Note 1 of our Consolidated Financial Statements includes a summary of recently issued and adopted accounting pronouncements and their related or anticipated impact on the Company. Critical Accounting Policies Note 1 of our Consolidated Financial Statements includes a summary of our critical accounting policies and their related impact on the Company. Quantitative and Qualitative Disclosures About Market Risk Market risk represents the possibility that changes in future market rates or prices will have a negative impact on our earnings or value. Our principal market risk is interest rate risk. Interest rate risk arises from changes in interest rates. Interest rate risk can result from: (1) Repricing risk – timing differences in the maturity/repricing of assets, liabilities, and off-balance-sheet contracts; (2) Options risk – the effect of embedded options, such as loan prepayments, interest rate caps/floors, and deposit withdrawals; (3) Basis risk – risk resulting from unexpected changes in rates of similar maturity; and (4) Yield curve risk – risk resulting from unexpected changes in rates of different maturities from the same type of instrument. We have risk management policies to monitor and limit exposure to interest rate risk. Historically, we have not conducted trading activities as a means of managing interest rate risk. Our asset/liability management process is utilized to manage our interest rate risk. Our interest rate risk exposure is managed with the objective of managing the level and potential volatility of net interest income, bearing in mind that we are in the business of taking rate risk and that rate risk immunization is not entirely possible. Also, it is recognized that as exposure to interest rate risk is reduced, so too may the overall level of net interest income. In general, the assets and liabilities generated through ordinary business activities do not naturally create offsetting positions with respect to repricing or maturity characteristics. Access to the derivatives market can be an element in maintaining our interest rate risk position within policy guidelines. Using derivative instruments, principally interest rate floors, caps, and interest rate swaps, the interest rate sensitivity of specific transactions, as well as pools of assets or liabilities, can be adjusted to maintain the desired interest rate risk profile. See “-Loan Portfolio-Interest Rate Caps and Floors” “-Borrowings-Interest Rate Caps and Floors” 28 BNCCORP, Inc. Annual Report 2009 27 and Notes 1 and 16 of our Consolidated Financial Statements for a summary of our accounting policies pertaining to such instruments. Our primary tool for measuring and managing interest rate risk is net interest income simulation. This exercise includes our assumptions regarding the changes in interest rates and the impact on our current balance sheet. Interest rate caps and floors are included to the extent that they are exercised in the 12-month simulation period. Additionally, changes in prepayment behavior of the residential mortgage, CMOs, and mortgage-backed securities portfolios in each rate environment are captured using industry estimates of prepayment speeds for various coupon segments of the portfolio. For purposes of this simulation, projected month end balances of the various balance sheet accounts are held constant at their December 31, 2009 levels. Cash flows from a given account are reinvested back into the same account so as to keep the month end balance constant at its December 31, 2009 level. The static balance sheet assumption is made so as to project the interest rate risk to net interest income embedded in the existing balance sheet. We monitor the results of net interest income simulation on a quarterly basis. Each quarter net interest income is generally simulated for the upcoming 12-month horizon in seven interest scenarios. The scenarios generally modeled are parallel interest ramps of +/- 100bp, 200bp, and 300bp along with a rates unchanged scenario. Given the low level of interest rates as of December 31, 2009, the downward scenarios for interest rate movements is limited to -100bp, but a + 400bp scenario was also measured. The parallel movement of interest rates means all projected market interest rates move up or down by the same amount. A ramp in interest rates means that the projected change in market interest rates occurs over the 12-month horizon on a pro-rata basis. For example, in the +100bp scenario, the projected prime rate is projected to increase from 3.25% to 4.25% 12 months later. The prime rate in this example will increase 1/12th of the overall decrease of 100 basis points each month. The net interest income simulation result for the 12-month horizon that covers the calendar year of 2009 is shown below: Net Interest Income Simulation Movement in interest rates -100bp Unchanged +100bp +200bp +300bp +400bp $ $ Projected 12-month net interest income Dollar change from unchanged scenario Percentage change from unchanged scenario Policy guidelines (decline limited to) 27,998 $ 27,620 378 1.37% (5.00)% - - - $ $ 28,218 598 $ $ 28,897 1,277 $ $ 29,391 $ 30,036 1,771 $ 2,416 2.17% 4.62% 6.41% 8.75% (5.00)% (10.00)% (15.00)% (20.00)% Because one of the objectives of asset/liability management is to manage net interest income over a one-year planning horizon, policy guidelines are stated in terms of maximum potential percentage reduction in net interest income resulting from changes in interest rates over the 12-month period. It is no less important, however, to give attention to the absolute dollar level of projected net interest income over the 12-month period. Our general policy is to limit the percentage decrease in projected net interest income to 5, 10, 15, and 20 percent from the rates unchanged scenario for the +/- 100bp, 200bp, 300bp, and 400bp interest rate ramp scenarios, respectively. When a given scenario falls outside of these limits, we review the circumstances surrounding the exception and, considering the level of net interest income generated in the scenario and other related factors, may approve the exception to the general policy or recommend actions aimed at bringing the respective scenario within the general limits noted above. Since there are limitations inherent in any methodology used to estimate the exposure to changes in market interest rates, these analyses are not intended to be a forecast of the actual effect of changes in market interest rates such as those indicated above on the Company. Further, these analyses are based on our assets and liabilities as of December 31, 2009 (without forward adjustments for planned growth and anticipated business activities) and do not contemplate any actions we might undertake in response to changes in market interest rates. BNCCORP, Inc. Annual Report 2009 29 28 Static gap analysis is another tool that may be used for interest rate risk measurement. The net differences between the amount of assets, liabilities, equity and off-balance-sheet instruments repricing within a cumulative calendar period is typically referred to as the “rate sensitivity position” or “gap position.” The following table sets forth our rate sensitivity position as of December 31, 2009. Assets and liabilities are classified by the earliest possible repricing date or maturity, whichever occurs first. Interest Sensitivity Gap Analysis Estimated maturity or repricing at December 31, 2009 0–3 4–12 months months 1–5 years Over 5 years Total (dollars are in thousands) Interest-earning assets: Interest-bearing deposits with banks $ - $ - $ - $ - $ - Investment securities FRB and FHLB stock 13,431 38,962 110,706 49,562 212,661 3,048 - - - 3,048 Loans held for sale, fixed rate - - - - - Loans held for sale, floating rate - 62,664 - - 62,664 Loans held for investment, fixed rate 37,885 53,068 106,971 19,039 216,963 Loans held for investment, floating rate 270,922 7,370 20,093 1,760 300,145 Total interest-earning assets $ 325,286 $ 162,064 $ 237,770 $ 70,361 $ 795,481 Interest-bearing liabilities: Interest checking and money market accounts $ 269,875 $ - $ - $ - $ 269,875 Savings 10,696 - - - 10,696 Time deposits under $100,000 69,146 131,801 62,672 60,893 324,512 Time deposits $100,000 and over 14,469 28,430 8,335 988 52,222 Short-term borrowings 10,190 - - - 10,190 FHLB advances Other borrowings - - 15,000 - 15,000 - - - - - Subordinated debentures 15,000 - - 7,890 22,890 Total interest-bearing liabilities $ 389,376 $ 160,231 $ 86,007 $ 69,771 $ 705,385 Interest rate gap $ (64,090) $ 1,833 $ 151,763 $ 590 $ 90,096 Cumulative interest rate gap at December 31, 2009 $ (64,090) $ (62,257) $ 89,506 90,096 Cumulative interest rate gap to total assets (7.38%) (7.17%) 10.31% 10.38% The table assumes that all savings and interest-bearing demand deposits reprice in the earliest period presented. However, we believe a significant portion of these accounts constitute a core component and are generally not rate sensitive. Our position is supported by the fact that aggressive reductions in interest rates paid on these deposits historically have not caused notable reductions in balances in 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 and at different rate levels. 30 BNCCORP, Inc. Annual Report 2009 29 Static gap analysis does not fully capture the impact of embedded options, lagged interest rate changes, administered interest rate products, or certain off-balance-sheet sensitivities to interest rate movements. Therefore, this tool generally cannot be used in isolation to determine the level of interest rate risk exposure in banking institutions. Since there are limitations inherent in any methodology used to estimate the exposure to changes in market interest rates, these analyses are not intended to be a forecast of the actual effect of changes in market interest rates such as those indicated above on the Company. Further, these analyses are based on our assets and liabilities as of December 31, 2009 and do not contemplate any actions we might undertake in response to changes in market interest rates. BNCCORP, Inc. Annual Report 2009 31 30 32 BNCCORP, Inc. Annual Report 2009 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Independent Auditors’ Report Consolidated Balance Sheets as of December 31, 2009 and 2008 Consolidated Statements of Operations for the years ended December 31, 2009 and 2008 Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2009 and 2008 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2009 and 2008 Consolidated Statements of Cash Flows for the years ended December 31, 2009 and 2008 Notes to Consolidated Financial Statements Page 32 34 35 33 34 36 37 35 36 38 37 39 39 41 BNCCORP, Inc. Annual Report 2009 33 31 34 BNCCORP, Inc. Annual Report 2009 Financial Statements FINANCIAL INFORMATION BNCCORP, INC. AND SUBSIDIARIES Consolidated Balance Sheets As of December 31 (In thousands, except share data) ASSETS 2009 2008 CASH AND CASH EQUIVALENTS INVESTMENT SECURITIES AVAILABLE FOR SALE FEDERAL RESERVE BANK AND FEDERAL HOME LOAN BANK STOCK LOANS HELD FOR SALE PARTICIPATING INTERESTS IN MORTGAGE LOANS LOANS AND LEASES HELD FOR INVESTMENT ALLOWANCE FOR CREDIT LOSSES Net loans and leases held for investment OTHER REAL ESTATE, net PREMISES AND EQUIPMENT, net INTEREST RECEIVABLE OTHER ASSETS Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY DEPOSITS: Non-interest-bearing Interest-bearing – Savings, interest checking and money market Time deposits $100,000 and over Other time deposits Total deposits SHORT-TERM BORROWINGS FEDERAL HOME LOAN BANK ADVANCES OTHER BORROWINGS GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY’S SUBORDINATED DEBENTURES ACCRUED INTEREST PAYABLE ACCRUED EXPENSES OTHER LIABILITIES Total liabilities STOCKHOLDERS’ EQUITY: Preferred stock, $.01 par value. Authorized 2,000,000 shares: Preferred Stock – 5% Series A 20,093 shares issued and outstanding; Preferred Stock – 9% Series B 1,005 shares issued and outstanding; Common stock, $.01 par value. Authorized 10,000,000 shares; 3,290,219 and 3,299,163 shares issued and outstanding Capital surplus – common stock Retained earnings Treasury stock (363,434 and 357,738 shares, respectively) Accumulated other comprehensive (loss), net Total stockholders’ equity Total liabilities and stockholders’ equity $ $ 35,362 212,661 3,048 24,130 38,534 517,108 (18,047) 537,595 7,253 20,422 2,970 24,642 868,083 $ $ 10,569 209,857 5,989 13,403 28,584 542,753 (8,751) 562,586 10,189 20,810 3,263 24,832 861,498 $ 98,658 $ 68,996 280,571 52,222 324,512 755,963 10,190 15,000 - 22,890 1,468 2,946 2,361 810,818 266,851 42,342 297,132 675,321 16,844 84,500 - 23,025 1,679 3,325 2,857 807,551 19,187 1,098 - - 33 26,885 16,078 (5,068) (948) 57,265 868,083 $ 33 26,628 36,104 (5,020) (3,798) 53,947 861,498 $ BNCCORP, Inc. Annual Report 2009 35 See accompanying notes to consolidated financial statements. 33 BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Operations For the Years Ended December 31 (In thousands, except per share data) INTEREST INCOME: Interest and fees on loans Interest and dividends on investments - Taxable Tax-exempt Dividends Total interest income INTEREST EXPENSE: Deposits Short-term borrowings Federal Home Loan Bank advances Other borrowings Subordinated debentures Total interest expense Net interest income PROVISION FOR CREDIT LOSSES NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES NON-INTEREST INCOME: Bank charges and service fees Wealth management revenues Mortgage banking revenues Gains (losses) on sales of loans, net Gain on sales of premises and equipment Gain on sales of securities, net Other Total non-interest income NON-INTEREST EXPENSE: Salaries and employee benefits Professional services Other real estate costs Data processing fees Occupancy Marketing and promotion Regulatory assessments Depreciation and amortization Office supplies and postage Other Total non-interest expense Income (loss) before income taxes Income tax expense (benefit) NET INCOME (LOSS) Preferred stock costs Net income (loss) available to common shareholders Basic earnings (loss) per common share Diluted earnings (loss) per common share 2009 2008 $ 29,774 $ 35,322 14,261 409 144 44,588 12,386 179 1,078 3 1,253 14,899 29,689 27,000 2,689 2,332 2,056 8,390 (339) - 2,850 724 16,013 15,008 3,064 8,169 2,330 2,508 1,277 1,466 1,465 611 3,205 39,103 (20,401) (1,625) (18,776) (1,254) (20,030) (6.14) (6.14) $ $ $ $ $ $ $ $ 9,599 839 266 46,026 15,099 144 2,291 25 1,656 19,215 26,811 7,750 19,061 2,337 2,826 2,101 1,116 775 247 993 10,395 14,673 1,177 515 2,202 2,140 1,127 400 1,375 533 2,359 26,501 2,955 737 2,218 - 2,218 0.67 0.67 See accompanying notes to consolidated financial statements. 34 36 BNCCORP, Inc. Annual Report 2009 BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (Loss) For the Years Ended December 31 (In thousands) NET INCOME (LOSS) Unrealized gain (loss) on cash flow 2009 2008 $ (18,776) $ 2,218 hedge, net $ (375) $ 1,332 Amortization of deferred gain in other comprehensive income Unrealized gain (loss) on securities available for sale Reclassification adjustment for gains included in net income Other comprehensive income (loss), before tax Income tax (expense) benefit related to (1,126) 10,299 (2,850) 5,948 - (9,836) (247) (8,751) items of other comprehensive income (3,098) 3,294 Other comprehensive income (loss) 2,850 2,850 (5,457) (5,457) TOTAL COMPREHENSIVE LOSS $ (15,926) $ (3,239) See accompanying notes to consolidated financial statements. BNCCORP, Inc. Annual Report 2009 37 35  BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders’ Equity For the Years Ended December 31 (In thousands) Preferred Stock Common Stock Common Retained Treasury Comprehensive Shares Amount Shares Amount Stock Earnings Stock Income (Loss) Total BALANCE, December 31, 2007 - $ - 3,491,337 $ 35 $ 26,355 $ 34,105 $ (2,424) $ 1,659 $ 59,730 Capital Surplus Accumulated Other Net income - - - Other comprehensive loss - - Cumulative effect of change in accounting principle related to split-dollar life insurance policies Impact of share-based compensation - - - - 8,152 - - - - - - - 2,218 - - 2,218 - - - (5,457) (5,457) - (219) - - (219) 273 - - - 273 Purchase of common shares - - (200,326) (2) - - (2,596) - (2,598) BALANCE, December 31, 2008 - $ - 3,299,163 $ 33 $ 26,628 $ 36,104 $ (5,020) $ (3,798) $ 53,947 Net loss - - - Other comprehensive gain - - - Preferred stock issued 21,098 21,098 - Discount on preferred stock, net Preferred stock amortization, net Cash dividend on preferred stock Impact of share-based compensation - - - - (1,005) - 192 - - - - (8,944) - - - - - - - - (18,776) - - (18,776) - - - 2,850 2,850 - - - - 21,098 - - - - (1,005) - (192) - - - - (1,058) - - (1,058) 257 - (48) - 209 BALANCE, December 31, 2009 21,098 $ 20,285 3,290,219 $ 33 $ 26,885 $ 16,078 $ (5,068) $ (948) $ 57,265 See accompanying notes to consolidated financial statements 38 BNCCORP, Inc. Annual Report 2009 36  BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Years Ended December 31 (In thousands) OPERATING ACTIVITIES: Net income (loss) 2009 2008 $ (18,776) $ 2,218 Adjustments to reconcile net income (loss) to net cash used in operating activities - Provision for credit losses Provision for other real estate losses Depreciation and amortization Net amortization of premiums and (discounts) on investment securities and subordinated debentures Share-based compensation Change in interest receivable and other assets, net Impairment of goodwill (Gain) loss on sale of other real estate (Gain) on disposals of bank premises and equipment, net Net realized (gain) on sales of investment securities Provision for deferred income taxes Change in other liabilities, net Originations of loans to be participated Proceeds from participations of loans Funding of originations of loans held for sale Proceeds from sale of loans held for sale Fair value adjustment for loans held for sale Net cash used in operating activities INVESTING ACTIVITIES: Purchases of investment securities Proceeds from sales of investment securities Proceeds from maturities of investment securities Purchases of Federal Reserve and Federal Home Loan Bank Stock Sales of Federal Reserve and Federal Home Loan Bank Stock Net (increase) in participating interests in mortgage loans Net (increase) in loans held for investment Proceeds from sales of other real estate Additions to bank premises and equipment Sales of bank premises and equipment Net cash (used in) provided by investing activities See accompanying notes to consolidated financial statements. 27,000 8,057 1,465 (2,836) 257 (5,656) 409 (1) - (2,850) 2,473 (1,532) (67,173) 67,173 (491,027) 480,279 21 (2,717) (138,560) 71,553 76,021 - 2,941 (9,950) (190) 3,012 (1,091) 13 3,749 7,750 269 1,375 (1,164) 273 (4,146) - 38 (775) (247) (1,158) (138) (201,489) 201,489 (102,040) 88,905 (268) (9,108) (141,821) 14,209 31,981 (8,618) 7,547 (4,227) (61,511) 222 (2,990) 4,600 (160,608) BNCCORP, Inc. Annual Report 2009 39 37 BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, continued For the Years Ended December 31 (In thousands) FINANCING ACTIVITIES: Net increase in deposits Net increase (decrease) in short-term borrowings Repayments of Federal Home Loan Bank advances Proceeds from Federal Home Loan Bank advances Proceeds from issuance of preferred stock Dividends paid on preferred stock Purchase of treasury stock Net cash provided by financing activities NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS CASH AND CASH EQUIVALENTS, beginning of year CASH AND CASH EQUIVALENTS, end of year SUPPLEMENTAL CASH FLOW INFORMATION: Interest paid Income taxes paid 2009 2008 80,643 (6,654) (1,087,300) 1,017,800 20,093 (821) - 23,761 24,793 10,569 35,362 $ 133,448 11,479 (3,413,530) 3,436,630 - - (2,598) 165,429 (4,287) 14,856 10,569 15,110 2,498 $ $ 15,892 2,231 $ $ $ SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Additions to other real estate in settlement of loans $ 8,132 $ 10,717 See accompanying notes to consolidated financial statements. 40 BNCCORP, Inc. Annual Report 2009 38 BNCCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 1. Description of Business and Significant Accounting Policies Description of Business BNCCORP, Inc. (BNCCORP) is a registered bank holding company incorporated under the laws of Delaware. It is the parent company of BNC National Bank (together with its wholly owned subsidiary, BNC Insurance Services, Inc., collectively the Bank). The Company operates community banking and wealth management businesses in Arizona, Minnesota and North Dakota from 20 locations. The Bank also conducts mortgage banking from ten locations in Arizona, Minnesota, Iowa, Kansas, Nebraska and Missouri. The consolidated financial statements included herein are for BNCCORP and its subsidiaries. The accounting and reporting policies of BNCCORP and its subsidiaries (collectively, the Company) conform to U.S. generally accepted accounting principles and general practices within the financial services industry. The more significant accounting policies are summarized below. Principles of Consolidation The accompanying consolidated financial statements include the accounts of BNCCORP and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. Use of Estimates The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Ultimate results could differ from those estimates. CRITICAL ACCOUNTING POLICIES Critical accounting policies are significantly dependent on subjective assessments or estimates that may be susceptible to significant change. The following items have been identified as “critical accounting policies”. Allowance for Credit Losses The Bank maintains an estimate of its allowance for credit losses at a level considered adequate to provide for probable losses related to the loan and lease portfolio as of the balance sheet dates. The loan and lease portfolio and other credit exposures are reviewed regularly to evaluate the adequacy of the allowance for credit losses. The methodology used to establish the allowance for credit losses incorporates quantitative and qualitative risk considerations. Quantitative factors include our historical loss experience, delinquency information, charge-off trends, collateral values, changes in nonperforming loans and other factors. Quantitative factors also incorporate known information about individual borrowers, including sensitivity to interest rate movements or other quantifiable external factors. Qualitative factors include the general economic environment, the state of certain industries and factors unique to our market areas. Size, complexity of individual credits, loan structure, waivers of loan policies and pace of portfolio growth are other qualitative factors that are considered when we estimate the allowance for credit losses. Our methodology has been consistently applied. However, we enhance our methodology as circumstances dictate to keep pace with the complexity of the portfolio. The allowance for credit losses has three components as follows: Specific Reserves. The amount of specific reserves is determined through a loan-by-loan analysis of loans over a minimum size. Included in problem loans are non-accrual, or renegotiated, loans that meet the criteria as being “impaired” under the definition in FASB ASC 310. A loan is impaired when, based on current information, it is probable that a creditor will be unable to collect all amounts due according to the contractual BNCCORP, Inc. Annual Report 2009 41 39 terms of the loan agreement. Any allowance on impaired loans is generally based on one of three methods: the present value of expected cash flows at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral of the loan. Specific reserves may also be established for credits that have been internally classified as credits requiring management’s attention due to underlying problems in the borrower’s business or collateral concerns. Reserves for Homogeneous Loan Pools. The Bank makes a significant number of loans and leases that, due to their underlying similar characteristics, are assessed for loss as “homogeneous” pools. Included in the homogeneous pools are consumer loans and commercial loans, which have been excluded from the specific reserve allocation. The Bank segments the homogeneous pools by type and uses historical loss information to estimate a loss reserve for each pool. Qualitative Reserve. Management also allocates reserves for other circumstances pertaining to the measurement period. The factors considered include, but are not limited to, prevailing trends, economic conditions, geographic influence, industry segments within the portfolio, management’s assessment of credit risk inherent in the loan portfolio, delinquency data, historical loss experience and peer-group information. Monitoring loans and analysis of loss components are the principal means by which management determines estimated credit losses are reflected in the Bank’s allowance for credit losses on a timely basis. Management also considers regulatory guidance in addition to the Bank’s own experience. Various regulatory agencies, as an integral part of their examination process, periodically review the allowance for credit losses. Such agencies may require additions to the allowance based on their judgment about information available to them at the time of their examination. Loans, leases and other extensions of credit deemed uncollectible are charged off against the allowance for losses. Subsequent recoveries, if any, are credited to the allowance. Management’s estimate of the allowance for credit losses is highly dependent upon variables affecting valuation, including, appraisals of collateral, evaluations of performance as well as the amounts and timing of future cash flows expected to be received on impaired loans. These variables are reviewed periodically. Actual losses may vary from the current estimated allowance for credit losses. A provision for credit losses is made to adjust the allowance to the amount determined appropriate through application of the above processes. Income Taxes The Company files consolidated federal and unitary state income tax returns. The determination of current and deferred income taxes is based on analyses of many factors including interpretation of federal and state income tax laws, differences between tax and financial reporting basis of assets and liabilities, expected reversals of temporary differences, estimates of amounts due or owed and current financial accounting standards. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income taxes. Deferred income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. Management assesses net deferred tax assets to determine whether they are realizable based upon accounting standards and specific facts and circumstances. A valuation allowance is established to reduce net deferred tax assets to amounts that are more likely than not expected to be realized. 42 BNCCORP, Inc. Annual Report 2009 40 Other-Than-Temporary Impairment Declines in the fair value of individual available-for-sale or held-to-maturity securities below amortized cost, which are deemed other-than-temporary, could result in a charge to earnings and establishment of a new cost basis. Write-downs for other-than-temporary impairment are recorded in non-interest income as realized losses. The Company assesses available information about our securities to determine whether impairment is other-than- temporary. The information we consider includes, but is not limited to, the following: (cid:120) Recent and expected performance of the securities; (cid:120) Financial condition of issuers or guarantors; (cid:120) Recent cash flows; (cid:120) Seniority of invested tranches and subordinated credit support; (cid:120) Vintage of origination; (cid:120) Location of collateral; (cid:120) Ratings of securities; (cid:120) Value of underlying collateral; (cid:120) Delinquency and foreclosure data; (cid:120) Historical losses and estimated severity of future losses; (cid:120) Credit surveillance data which summarize retrospective performance; and (cid:120) Anticipated future cash flows and prospective performance assessments. Determining whether other-than-temporary impairment has occurred requires judgment of factors that may indicate an impairment loss has incurred. The Company adopted the guidance on other-than-temporary impairments Accounting Standards Codification (ASC) 320, Investments-Debt and Equity Securities, which changed the accounting for other-than-temporary impairments into credit-related and other factors. Any credit- related impairments are realized through a change to earnings. Note 4 to these consolidated financial statements includes a summary of investment securities in a loss position at December 31, 2009 and 2008. Fair Value Several accounting standards require recording assets and liabilities based on their fair values. Determining the fair value of assets and liabilities can be highly subjective. FASB ASC 820, Fair Value Measurements and Disclosures defines fair value and establishes a framework for measuring fair value of assets and liabilities using a hierarchy system consisting of three levels based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are: Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets that the Company has the ability to access. Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which significant assumptions are observable in the market. Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market and are used only to the extent that observable inputs are not available. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques. Management assigns a level to assets and liabilities accounted for at fair value and uses the methodologies prescribed by ASC 820 to determine fair value. BNCCORP, Inc. Annual Report 2009 43 41 OTHER SIGNIFICANT ACCOUNTING POLICIES Investment Securities Investment securities that the Bank intends to hold indefinitely as part of its asset/liability strategy, or that may be sold in response to changes in interest rates, or prepayment risk are classified as available for sale. Available for sale securities are carried at fair value. Net unrealized gains and losses, net of deferred income taxes, on securities available for sale are reported as a separate component of stockholders’ equity until realized (see Comprehensive Income). All securities were classified as available for sale as of December 31, 2009 and 2008, except for Federal Reserve Bank (FRB) and the Federal Home Loan Bank (FHLB) stock, which have an indeterminable maturity. Investment securities that the Bank intends to hold until maturity are carried at cost, adjusted for amortization of premiums and accretion of discounts using a level yield method over the period to maturity. There were no such securities as of December 31, 2009 or 2008. Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. Dividend and interest income is recognized when earned. Realized gains and losses on the sale of investment securities are determined using the specific-identification method and recognized in non-interest income on the trade date. Federal Reserve Bank and Federal Home Loan Bank of Des Moines Stock Investments in FRB and FHLB stock are carried at cost, which approximates fair value. Loans Held For Sale Loans held for sale are accounted for at fair value pursuant to the fair value option permitted by FASB ASC 825, Financial Instruments. Gains and losses from the changes in fair value are included in mortgage banking revenue. Participating Interests in Mortgage Loans The Bank purchases participating interests in mortgage loans owned by mortgage banking counterparties. The participating interests are generally outstanding for a short duration as funds are advanced to finance loans closed by the counterparties and are repaid when the counterparties sell the loans. The participating interests are stated at the aggregate amount of the loans financed by the counterparties. An allowance for losses is estimated on the participating interests and is included in the allowance for credit losses. Loans and Leases Loans and leases held for investment are stated at their outstanding principal amount net of unearned income, net of unamortized deferred fees and costs and an allowance for credit losses. Interest income is recognized on the accrual basis using the interest method prescribed in the loan agreement except when collectibility is in doubt. Loans and leases are reviewed regularly by management and are placed on non-accrual status, when the collection of interest or principal is 90 days or more past due, unless the loan or lease is adequately secured and in the process of collection. When a loan or lease is placed on non-accrual status, uncollected interest accrued in prior years is charged off against the allowance for credit losses, unless collection of the principal and interest is assured. Interest accrued in the current year is reversed against interest income in the current period. Interest payments received on non-accrual loans and leases are generally applied to principal unless the remaining principal balance has been determined to be fully collectible. Accrual of interest may be resumed when it is determined that all amounts due are expected to be collected and the loan has exhibited a sustained level of performance, generally at least six months. A loan is considered impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans are reviewed for impairment on an individual basis. Impaired loans are measured at the present value of expected future cash flows discounted at the loan’s initial effective interest rate. The fair value of collateral of an impaired collateral-dependent loan or an observable market price may be used as an alternative to discounting. If the measure of the impaired loan is less than the recorded investment in the loan, impairment will be recognized as a charge-off through the allowance for credit losses. 44 BNCCORP, Inc. Annual Report 2009 42 Restructured loans are loans for which concessions, including a reduced interest rate or a deferral of interest or principal, have been granted due to the borrower’s weakened financial condition. Once a loan is restructured, interest is accrued at the restructured rates when no loss of principal is anticipated. A loan that has performed in accordance with restructured terms for one year is no longer reported as a restructured loan. Cash receipts on impaired loans are generally applied to principal except when the loan is well collateralized or there are other circumstances that support recognition of interest. When an impaired loan is in non-accrual status, cash receipts are applied to principal. Loan Origination Fees and Costs; Other Lending Fees For Loans and Leases Held for Investment, origination fees and costs incurred to extend credit are deferred and amortized over the term of the loan as an adjustment to yield using the interest method, except where the net amount is deemed to be immaterial. The Company occasionally originates lines of credit where the customer is charged a non-usage fee if the line of credit is not used. In such instances, we periodically review use of lines on a retrospective basis and recognize non-usage fees in non-interest income. Loan Servicing and Transfers of Financial Assets The Bank sells commercial business loans to third parties. The loans are generally sold on a non-recourse basis. Sold loans are not included in the accompanying consolidated balance sheets. The Bank generally retains the right to service the loans as well as the right to receive a portion of the interest income on the loans. At December 31, 2009 and 2008, the Bank was servicing loans for the benefit of others with aggregate unpaid principal balances of $330.2 million and $315.5 million, respectively. In 2009 and 2008, $295.6 million and $285.6 million, respectively, are loans sold by the Bank for which balances and related payment streams cannot be reasonably estimated in order to determine the fair value of the servicing assets or liabilities and/or future interest income retained by the Bank. Upon sale, unearned net loan fees and/or costs are recognized in non-interest income and included in gains on sale of loans. The sales of loans are accounted for pursuant to FASB ASC 860, Transfers and Servicing. Premises and Equipment Land is carried at cost. Premises and equipment are reported at cost less accumulated depreciation and amortization. Depreciation and amortization for financial reporting purposes is charged to operating expense using the straight-line method over the estimated useful lives of the assets. Estimated useful lives are up to 40 years for buildings and three to 10 years for furniture and equipment. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the improvement. The costs of improvements are capitalized. Maintenance and repairs, as well as gains and losses on dispositions of premises and equipment, are included in non-interest income or expense as incurred. Other Real Estate Owned and Repossessed Property Real estate properties and other assets acquired through loan foreclosures are stated at the lower of carrying amount or fair value less estimated costs to sell. If the carrying amount of an asset acquired through foreclosure is in excess of the fair value less estimated costs to sell, the excess amount is charged to the allowance for credit losses. Fair value is primarily determined based upon appraisals of the assets involved and management periodically assesses appraised values to ascertain continued relevancy of the valuation. Subsequent declines in the estimated fair value, net operating results and gains and losses on disposition of the asset are included in other non-interest expense. Operating expenses of properties are charged to ORE expense. Impairment of Long-Lived Assets and Intangible Assets The Company reviews long-lived assets and intangible assets for impairment periodically or whenever events or changes in circumstances indicate that the carrying amount of any such asset may not be recoverable. If impairment is identified, the assets are written down to their fair value through a charge to non-interest expense. During 2009, an impairment charge of $409 thousand was recorded related to goodwill. No impairment losses were recorded during 2008. BNCCORP, Inc. Annual Report 2009 45 43 Securities Sold Under Agreements to Repurchase From time to time, the Bank enters into sales of securities under agreements to repurchase, generally for periods of less than 90 days. These agreements are treated as financings, and the obligations to repurchase securities sold are reflected as a liability in the consolidated balance sheets as short-term borrowings. The costs of securities underlying the agreements remain in the asset accounts. Fair Values of Financial Instruments The Company is required to disclose the estimated fair value of financial instruments. Fair value estimates are subjective in nature, involving uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Non-financial instruments are excluded from fair value of financial instrument disclosure requirements. The following methods and assumptions are used by the Company in estimating fair value disclosures for its financial instruments. Cash and Cash Equivalents, Non-interest-Bearing Deposits and Demand Deposits. The carrying amounts approximate fair value due to the short maturity of the instruments. The fair value of deposits with no stated maturity, such as interest checking, savings and money market accounts, is equal to the amount payable on demand at the reporting date. The intangible value of long-term customer relationships with depositors is not taken into account in the fair values disclosed. Investment Securities Available for Sale. The fair value of the Company’s securities are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which significant assumptions are observable in the market. Federal Reserve Bank and Federal Home Loan Bank Stock. The carrying amount of FRB and FHLB stock is their cost, which approximates fair value. Loans Held for Sale. Loans held for sale are accounted for at fair value pursuant to the fair value option permitted by FASB ASC 825, Financial Instruments. Participating Interests in Mortgage Loans, Loans and Leases Held for Investment. Fair values of these assets are estimated by discounting future cash flow payment streams using rates at which current loans to borrowers with similar credit ratings and similar loan maturities are being made. Accrued Interest Receivable. The fair value of accrued interest receivable equals the amount receivable due to the current nature of the amounts receivable. Derivative Financial Instruments. The fair value of the Company’s derivatives are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which significant assumptions are observable in the market. Interest-Bearing Deposits. Fair values of interest-bearing deposit liabilities are estimated by discounting future cash flow payment streams using rates at which comparable current deposits with comparable maturities are being issued. Borrowings and Advances. The carrying amount of short-term borrowings approximates fair value due to the short maturity and the instruments’ floating interest rates, which are tied to market conditions. The fair values of long-term borrowings are estimated by discounting future cash flow payment streams using rates at which comparable borrowings are currently being offered. Accrued Interest Payable. The fair value of accrued interest payable equals the amount payable due to the current nature of the amounts payable. 46 BNCCORP, Inc. Annual Report 2009 44 Guaranteed Preferred Beneficial Interests In Company’s Subordinated Debentures. The fair values of the Company’s subordinated debentures are estimated by discounting future cash flow payment streams using discount rates estimated to reflect those at which comparable instruments could currently be offered. Financial Instruments with Off-Balance-Sheet Risk. The fair values of the Company’s commitments to extend credit and commercial and standby letters of credit are estimated using fees currently charged to enter into similar agreements. Derivative Financial Instruments FASB ASC 815, Derivatives and Hedging, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Accordingly, the Company records all derivatives at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivative instruments that qualify for specific hedge accounting are recorded at fair value and classified either as a hedge of the fair value of a recognized asset or liability (fair value hedge) or as a hedge of the variability of cash flows to be received or paid related to a recognized asset or liability or a forecasted transaction (cash flow hedge). All relationships between hedging instruments and hedged items are formally documented, including the risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as hedges to specific assets or liabilities on the balance sheet. Changes in the fair value of a derivative that is highly effective and designated as a fair value hedge and the offsetting changes in the fair value of the hedged item are recorded in income. Changes in the fair value of a derivative that is highly effective and designated as a cash flow hedge are recognized in other comprehensive income until income from the cash flows of the hedged item are recognized. The Company performs an assessment, both at the inception of the hedge and on a quarterly basis thereafter, to determine whether these derivatives are highly effective in offsetting changes in the value of the hedged items. Any change in fair value resulting from hedge ineffectiveness is immediately recorded in income. Revenue Recognition The Company recognizes revenue on the accrual basis for interest and dividend income on loans, investment securities, Federal funds sold and interest-bearing cash and cash equivalent accounts. Non-interest income is recognized when it has been realized and has been earned. In accordance with existing accounting and industry standards, the Company considers revenue to be realized or realizable and earned when the following criteria have been met: persuasive evidence of an arrangement exists (generally, there is contractual documentation); delivery has occurred or services have been rendered; the seller’s price to the buyer is fixed or determinable; and collectibility is reasonably assured. Additionally, there can be no outstanding contingencies that could ultimately cause the revenue to be passed back to the payor. In instances where these criteria have not been met, receipts are deferred until such time as they can be recognized as revenue. Earnings (Loss) Per Share Basic earnings (loss) per share (EPS) excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the applicable period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Such potential dilutive instruments include stock options and contingently issuable stock. Note 23 to these consolidated financial statements includes disclosure of the Company’s EPS calculations. BNCCORP, Inc. Annual Report 2009 47 45 Comprehensive Income (Loss) Comprehensive income (loss) is the total of net income (loss) and other comprehensive income (loss), which for the Company, is generally comprised of unrealized gains and losses on securities available for sale and unrealized gains and losses on hedging instruments qualifying for cash flow hedge accounting treatment pursuant to FASB ASC 815. The Company separately presents consolidated statements of comprehensive income (loss). Cash and Cash Equivalents For purposes of the Consolidated Statements of Cash Flows, cash and cash equivalents include cash on hand, cash due from banks and federal funds sold. Share-Based Compensation FASB ASC 718 requires the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the grant date. At December 31, 2009, the Company had three stock-based employee compensation plans, which are described more fully in Note 26 to these consolidated financial statements. RECENTLY ISSUED OR ADOPTED ACCOUNTING PRONOUNCEMENTS In June 2009, the FASB issued ASC 105, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, which establishes the FASB Accounting Standards Codification (Codification) to become the single source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities, with the exception of guidance issued by the U.S. Securities and Exchange Commission (SEC) and its staff. All guidance contained in the Codification carries an equal level of authority. The provisions of ASC 105 are effective for interim and annual periods ending after September 15, 2009. As the Codification is not intended to change GAAP, the adoption of the provisions of ASC 105 did not have any impact on our consolidated financial statements. In April 2009, FASB ASC 820, Fair Value Measurements and Disclosures, was issued This ASC gives guidance for determining whether market activity for a financial asset or liability has significantly decreased, as well as for identifying circumstances that indicate that transactions are not orderly. This ASC reiterates that if a market is determined to be inactive and the related market price is deemed to be reflective of a “distressed sale” price, then management judgment may be required to estimate fair value. This ASC identifies factors to be considered when determining whether or not a market is inactive. This ASC was effective as of June 30, 2009, with early adoption permitted as of March 31, 2009. The effect of adopting this ASC was not material. FASB ASC 320, Investments-Debt and Equity Securities, determines whether impairment of debt securities is other-than-temporary. This ASC requires other-than-temporary impairment to be separated into the amount representing the decrease in cash flows expected to be collected from a security (referred to as credit losses), which is recognized in earnings, and the amount related to other factors, which is recognized in other comprehensive income. The non-credit loss component of the impairment can only be classified in other comprehensive income if the holder of the security concludes (a) that it does not intend to sell the security and (b) that it is more likely than not that it will not be required to sell the security before the security recovers its value. If these two conditions are not met, the non-credit loss component of the impairment must also be recognized in earnings. Upon adoption of this ASC, the entity is required to record a cumulative-effect adjustment, as of the beginning of the period of adoption, to reclassify the non-credit loss component of previously recognized other- than-temporary impairment from retained earnings to accumulated other comprehensive income. This ASC is effective as of June 30, 2009, with early adoption permitted as of March 31, 2009. The effect of adopting this ASC was not material. FASB ASC 715, Compensation-Retirement Benefits, requires recognition of a liability for future benefits. ASC 715 is effective for fiscal years beginning after December 15, 2007, with earlier application permitted. The Company adopted ASC 715 on January 1, 2008 and recognized a cumulative-effect adjustment to decrease retained earnings. 46 48 BNCCORP, Inc. Annual Report 2009 FASB ASC 810, Consolidation, establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This ASC applies to all for-profit entities that prepare consolidated financial statements, but affects only those entities that have an outstanding noncontrolling interest in subsidiaries or that deconsolidate a subsidiary. This ASC was effective for financial statements issued for fiscal years beginning after December 15, 2008, and for interim periods within those fiscal years. Adopting FASB ASC 810 on January 1, 2009 did not have a material impact on the Company’s results of operations or financial position. FASB ASC 810 also requires a qualitative rather than a quantitative analysis to determine the primary beneficiary of a variable interest entity (VIE) for consolidation purposes. The primary beneficiary of a VIE is the enterprise that has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and also has the obligation to absorb the losses of the VIE that could potentially be significant to the VIE or the right to receive benefits of the VIE that could potentially be significant to the VIE. The provisions of ASC 810 are effective January 1, 2010. We do not anticipate that the adoption of ASC 810 will have a material impact on our consolidated financial statements. FASB ASC 815, Derivatives and Hedging, applies to all entities and requires enhanced disclosures about an entity’s derivative hedging activities including how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. FASB ASC 815 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of derivatives and gains and losses on thereon, as well as disclosures about credit risk related to derivative instruments. This ASC was effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. FASB ASC 860, Transfers and Servicing, removes the concept of a qualifying special-purpose entity. It clarifies that a transferor must evaluate whether it has maintained effective control of a financial asset by considering its continuing direct or indirect involvement with the transferred financial asset. The provisions of ASC 860 are effective for financial asset transfers occurring after December 31, 2009. We do not anticipate that the adoption of ASC 860 will have a material impact on our consolidated financial statements. RECLASSIFICATIONS Certain amounts in the financial statements for the prior year have been reclassified to conform to the current year’s presentation. These reclassifications had no effect on net income or stockholders’ equity. BNCCORP, Inc. Annual Report 2009 49 47 NOTE 2. Regulatory Capital and Current Operating Environment Actual capital amounts and ratios of BNCCORP and the Bank as of December 31 are presented in the tables below (dollars in thousands): 2009 Total Capital (to risk-weighted assets): Consolidated BNC National Bank Tier 1 Capital (to risk-weighted assets): Consolidated BNC National Bank Tier 1 Capital (to average assets): Consolidated BNC National Bank Tangible Capital (to total assets): Consolidated tangible equity BNC National Bank Tangible Common Capital (to total assets): Consolidated tangible common equity 2008 Total Capital (to risk-weighted assets): Consolidated BNC National Bank Tier 1 Capital (to risk-weighted assets): Consolidated BNC National Bank Tier 1 Capital (to average assets): Consolidated BNC National Bank Tangible Capital (to total assets): Consolidated tangible equity BNC National Bank Tangible Common Capital (to total assets): Consolidated tangible common equity Actual Amount Ratio $ 89,102 85,195 14.15 % 13.52 77,617 77,192 77,617 77,192 57,018 74,989 12.32 12.25 8.58 8.54 6.57 8.65 36,733 4.23 $ 88,949 87,956 12.95 % 12.81 76,585 79,368 76,585 79,368 53,297 75,573 11.15 11.56 9.01 9.34 6.19 8.77 53,297 6.19 BNCCORP and the Bank are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial results. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, BNCCORP and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. As of December 31, 2009, the most recent notifications from the OCC categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. Management believes the Bank remains well- capitalized through the date for which subsequent events have been evaluated. 50 BNCCORP, Inc. Annual Report 2009 48 In February of 2010, the Bank entered into an agreement with the OCC with three articles primarily pertaining to credit administration. The agreement requires the Bank’s board of directors to address three articles that can be summarized as follows: (1) Develop, and implement a written program to identify and monitor credit and underwriting exceptions from loan policy; (2) Adopt, implement and ensure adherence to a written asset diversification program that limits concentrations of assets to prescribed limits; and (3) Adopt, implement and ensure adherence to work out plans designed to reduce criticized assets. The work out plans are to be updated quarterly. Management believes these articles are prudent and will strengthen credit administration. While the agreement allows 60 days to implement, management had substantially implemented the articles and submitted correspondence to the OCC documenting implementation by February 2010. NOTE 3. Restrictions on Cash and Cash Equivalents The Bank is required to maintain reserve balances in cash on hand or with the FRB. The required reserve balances were $25,000 as of December 31, 2009 and 2008. BNCCORP, Inc. Annual Report 2009 51 49 NOTE 4. Investment Securities Available For Sale Investment securities have been classified in the consolidated balance sheets according to management’s intent. The Company had no securities designated as trading or held-to-maturity in its portfolio at December 31, 2009 or 2008. The carrying amount of available-for-sale securities and their approximate fair values were as follows as of December 31 (in thousands): U.S. government agency mortgage-backed securities guaranteed by GNMA U.S. government agency mortgage-backed securities issued by FNMA Collateralized mortgage obligations guaranteed by GNMA Collateralized mortgage obligations issued by FNMA or FHLMC Other collateralized mortgage obligations State and municipal bonds U.S. government agency mortgage-backed securities guaranteed by GNMA U.S. government agency mortgage-backed securities issued by FNMA Collateralized mortgage obligations guaranteed by GNMA Collateralized mortgage obligations issued by FNMA or FHLMC Other collateralized mortgage obligations State and municipal bonds 2009 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value $ 1,223 $ 39 $ - $ 1,262 2,500 86,600 1,797 118,375 2,521 102 531 90 3,349 164 (3) 2,599 (114) 87,017 - 1,887 (4,513) 117,211 - 2,685 $ 213,016 $ 4,275 $ (4,630) $ 212,661 2008 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value $ 1,505 $ 39 $ (1) $ 1,543 2,891 23,037 33 177 (7) 2,917 (44) 23,170 37,896 1,128 - 39,024 138,851 13,482 233 541 (9,899) (5) 129,185 14,018 $ 217,662 $ 2,151 $ (9,956) $ 209,857 52 BNCCORP, Inc. Annual Report 2009 50 The amortized cost and estimated fair market value of available-for-sale securities classified according to their contractual maturities at December 31, 2009, were as follows (in thousands): Amortized Cost Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years Total $ $ 702 51 12,075 200,188 213,016 $ $ Estimated Fair Value 703 51 12,217 199,690 212,661 For many types of investments, the actual payment will vary significantly from contractual maturities. Securities carried at approximately $129.0 million and $197.5 million at December 31, 2009 and 2008, respectively, were pledged as collateral for public and trust deposits and borrowings, including borrowings from the FHLB and repurchase agreements with customers. Sales proceeds and gross realized gains and losses on available-for-sale securities were as follows for the years ended December 31 (in thousands): Sales proceeds Gross realized gains Gross realized losses $ 2009 71,553 2,850 - $ 2008 14,209 256 (9) The following table shows the Company’s investments’ gross unrealized losses and fair value; aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31 (in thousands): Less than 12 months 12 months or more 2009 Description of Securities # Fair Value Unrealized Loss # Fair Value Unrealized Loss # Total Fair Value Unrealized Loss U.S. government agency mortgage-backed securities guaranteed by GNMA U.S. government agency mortgage-backed securities issued by FNMA Collateralized mortgage obligations guaranteed by GNMA Collateralized mortgage obligations issued by FNMA or FHLMC Other collateralized mortgage - $ - $ - - $ - $ - - $ - $ - - - - 1 57 (3) 1 57 (3) 6 34,394 (114) - - - 6 34,394 (114) - - - - - - - - - obligations 8 29,622 (1,715) 8 22,591 (2,798) State and municipal bonds - - - - - - 16 - 52,213 (4,513) - - Total temporarily impaired securities 14 $ 64,016 $ (1,829) 9 $ 22,648 $ (2,801) 23 $ 86,664 $ (4,630) BNCCORP, Inc. Annual Report 2009 53 51 Description of Securities # Fair Value Unrealized Loss # Fair Value Unrealized Loss # Fair Value Unrealized Loss Less than 12 months 12 months or more Total 2008 U.S. government agency mortgage-backed securities guaranteed by GNMA U.S. government agency mortgage-backed securities issued by FNMA Collateralized mortgage obligations issued by FNMA or FHLMC Other collateralized mortgage obligations State and municipal bonds Total temporarily impaired securities - $ - $ - 1 $ 81 $ (1) 1 $ 81 $ (1) - - - 3 1,555 (7) 3 1,555 (7) 2 10,402 (44) - - - 2 10,402 (44) 26 2 109,322 (9,767) 892 (5) 1 - 2,490 (132) 27 111,812 - - 2 892 (9,899) (5) 30 $ 120,616 $ (9,816) 5 $ 4,126 $ (140) 35 $ 124,742 $ (9,956) Management regularly evaluates each security with unrealized losses to determine whether losses are other–than- temporary. When the evaluation is performed, management considers several factors including, but not limited to, the amount of the unrealized loss, the length of time the security has been in a loss position, guarantees provided by third parties, ratings on the security, cash flow from the security and collateral backing the security. We have been receiving principal payments on all securities since acquisition and the current credit support on all securities is higher than the credit support provided at the inception of the bond. For the non-agency securities with unrealized losses at December 31, 2009, the collateral is generally based on loans originated between 2001 and 2004, and as a result the loan to value ratios of the underlying loans generally indicates risk of loss is relatively low. For the securities that were structured in 2008 or later, we own early sequential bonds that are currently paying down and the securities are senior to subordinated securities. Principal payments on the subordinated securities are redirected to reduce principal on our securities until the securities have been paid in full. All securities owned are investment grade, except one. For this security, and a few other securities that have been in an unrealized loss position for a longer period, we obtained credit surveillance reports that provide prospective analysis of the securities performance under various scenarios. The credit surveillance reports do not currently project credit losses. There were no securities that management concluded were other-than-temporarily impaired in either 2009 or 2008. NOTE 5. Federal Reserve Bank and Federal Home Loan Bank of Des Moines Stock The carrying amounts of FRB and FHLB stock, which approximate their fair values, consisted of the following as of December 31 (in thousands): Federal Reserve Bank Stock, at cost Federal Home Loan Bank of Des Moines Stock, at cost Total 2009 1,297 1,751 3,048 $ $ 2008 1,297 4,692 5,989 $ $ There is no contractual maturity on these investments; the investments are required by counterparties. 54 BNCCORP, Inc. Annual Report 2009 52 NOTE 6. Loans and Leases Loan Portfolio Composition The composition of loans held for investment classified as we present on our regulatory reports are as follows at December 31 (in thousands): Commercial and industrial Real estate: Mortgage Construction Participating interests in mortgage loans Agricultural Other Total gross loans held for investment Unearned income and net unamortized deferred fees and costs Loans, net of unearned income and unamortized fees and costs Allowance for credit losses Net loans and leases 2009 $ 124,773 2008 $ 138,671 266,051 96,327 38,534 23,142 7,397 556,224 (582) 555,642 (18,047) $ 537,595 265,360 108,713 28,584 22,023 8,793 572,144 (807) 571,337 (8,751) $ 562,586 Commercial and industrial loan borrowers are generally small and mid-sized corporations, partnerships and sole proprietors in a wide variety of businesses. Real estate loans are fixed or variable rate and include both amortizing and revolving line-of-credit loans. Real estate mortgage loans include various types of loans for which the Bank holds real property as collateral. Agricultural loans include loans to grain and/or livestock producers, agricultural real estate loans, machinery and equipment and other types of loans. Loans to consumers are both secured and unsecured. Impaired Loans As of December 31, the Bank’s recorded investment in impaired loans and the related valuation allowance was as follows (in thousands): 2009 2008 Recorded Investment Valuation Allowance Recorded Investment Valuation Allowance Impaired loans - Valuation allowance required $ 33,821 $ 3,998 $ 17,355 $ 1,619 No valuation allowance required 2,377 - - - Total impaired loans $ 36,198 $ 3,998 $ 17,355 $ 1,619 Impaired loans include loans the Bank will not be able to collect all amounts due in accordance with the terms of the loan agreement. The Bank generally considers loans risk-graded substandard, risk rated doubtful, non-accrual and recently restructured loans, as impaired loans. BNCCORP, Inc. Annual Report 2009 55 53 The valuation allowance on impaired loans is included in the Bank’s allowance for credit losses. The following tables present information on impaired loans for the years ended December 31 (in thousands): Average recorded investment in impaired loans $ 37,766 $ 17,917 Average recorded investment in impaired loans as a percentage of average total loans 6.29% 3.41% 2009 2008 Year Ended December 31, 2009 Year Ended December 31, 2008 Interest income recognized on impaired loans $ Interest income recognized on a cash basis during the time of impairment $ 1 1 170 169 Nonperforming Loans As of December 31, the Bank’s nonperforming loans were as follows (in thousands): Loans 90 days or more delinquent and still accruing interest Non-accrual loans Total nonperforming loans 2009 2008 $ 1 35,889 $ 35,890 $ 6 22,909 $ 22,915 The table below summarizes the amounts of restructured loans as of the dates indicated. All of the restructured loans were also non-accrual loans. December 31, 2009 2008 (in thousands) Restructured loans $ 14,337 $ 2,379 Loans to Related Parties Note 21 to these consolidated financial statements includes information relating to loans to executive officers, directors, principal shareholders and associates of such persons. 56 BNCCORP, Inc. Annual Report 2009 54 Leases The Bank extends credit to borrowers under direct finance lease obligations. The direct finance lease obligations are stated at their outstanding principal amount net of unearned income and net unamortized deferred fees and costs. At December 31, 2009, the future minimum annual lease payments for direct finance lease obligations were as follows (in thousands): 2010 2011 2012 2013 2014 Thereafter Total future minimum lease payments Unguaranteed residual values Total all payments Unearned income Net outstanding principal amount $ $ 258 225 24 - - - 507 243 750 (56) 694 Loans Pledged as Collateral The table below presents loans pledged as collateral as of December 31(in thousands): Single and multi-family residential mortgage Commercial real estate first mortgage Home equity lines of credit Residential second mortgage Loans held for sale Total $ 2009 7,833 98,055 8,008 5,525 22,826 $ 2008 12,245 58,174 7,644 7,227 10,718 $ 142,247 $ 96,008 NOTE 7. Allowance for Credit Losses Transactions in the allowance for credit losses were as follows for the years ended December 31 (in thousands): Balance, beginning of year Provision for credit losses Loans charged off Loans recovered Balance, end of year 2009 8,751 27,000 (17,876) 172 18,047 $ $ 2008 6,599 7,750 (5,946) 348 8,751 $ $ BNCCORP, Inc. Annual Report 2009 57 55 NOTE 8. Other Real Estate Other real estate (ORE) includes property acquired through foreclosure, property in judgment and in-substance foreclosures. ORE is carried at fair value less estimated selling costs. Each property is evaluated regularly and the amounts provided to decrease the carrying amount are included in non-interest expense. A summary of the activity related to ORE is presented below for the years ended December 31 (in thousands): Balance, beginning of year Transfers from nonperforming loans Real estate sold Net gains (losses) on sale of assets Provision Balance, end of year 2009 10,189 8,132 (3,012) 1 (8,057) 7,253 $ $ 2008 - 10,718 (222) (38) (269) 10,189 $ $ NOTE 9. Premises and Equipment, net Premises and equipment, net consisted of the following at December 31 (in thousands): Land and improvements Buildings and improvements Leasehold improvements Furniture, fixtures and equipment Total cost Less accumulated depreciation and amortization Net premises, leasehold improvements and equipment $ $ 2009 6,692 12,957 1,807 9,440 30,896 (10,474) $ 20,422 $ 2008 6,692 12,914 1,795 8,643 30,044 (9,234) 20,810 Depreciation and amortization expense charged to continuing operations totaled approximately $1.5 million and $1.4 million for the years ended December 31, 2009 and 2008, respectively. During 2008, the Company sold a building and recognized a gain of $832,000. The Company also periodically sells equipment no longer used in operations. NOTE 10. Deposits The scheduled maturities of time deposits as of December 31, 2009 are as follows (in thousands): 2010 2011 2012 2013 2014 Thereafter $ $ 243,439 27,279 26,885 1,278 15,973 61,880 376,734 At December 31, 2009 and 2008, the Bank had $115.8 million and $99.7 million, respectively, of time deposits that had been acquired through a broker. 58 BNCCORP, Inc. Annual Report 2009 56 The following table shows a summary of interest expense by product type as of December 31 (in thousands): Savings Interest checking Money market Time deposits 2009 13 349 2,028 9,996 12,386 $ $ 2008 33 133 3,941 10,992 15,099 $ $ Deposits Received from Related Parties Note 21 to these consolidated financial statements includes information relating to deposits received from executive officers, directors, principal shareholders and associates of such persons. NOTE 11. Short-Term Borrowings The following table sets forth selected information for short-term borrowings (borrowings with an original maturity of less than one year) as of December 31 (in thousands): Federal funds purchased and U. S. Treasury tax and loan retainer Repurchase agreements with customers, renewable daily, interest payable monthly, rates ranging from 0.50% to 1.15%, and 0.25% to 1.70%, respectively, secured by government agency collateralized mortgage obligations 2009 2008 $ 1,315 $ 9,345 8,875 7,499 $ 10,190 $ 16,844 The weighted average interest rate on short-term borrowings outstanding as of December 31, 2009 and 2008 was 0.70% and 0.88%, respectively. Customer repurchase agreements are used by the Bank to acquire funds from customers where the customers are required, or desire, to have their funds supported by collateral consisting of government, government agency or other types of securities. The repurchase agreement is a promise to sell these securities to a customer at a certain price and repurchase them at a future date at that same price plus interest accrued at an agreed upon rate. The Bank uses customer repurchase agreements in its liquidity plan as well as an accommodation to customers. At December 31, 2009, $8.9 million of securities sold under repurchase agreements, with a weighted average interest rate of 0.80%, maturing in 2010, were collateralized by government agency collateralized mortgage obligations having a carrying value of $19.5 million, a market value of $19.5 million and unamortized principal balances of $19.4 million. At December 31, 2008, $7.5 million of securities sold under repurchase agreements, with a weighted average interest rate of 1.27%, maturing in 2009, were collateralized by government agency collateralized mortgage obligations having a carrying value of $20.0 million, a market value of $20.0 million and unamortized principal balances of $19.5 million. As of December 31, 2009, the Bank had established Federal funds purchase programs with two banks, totaling $4 million. At December 31, 2009, the Bank had purchased Federal funds of $0 under these programs leaving $4 million available. As of December 31, 2008, the Bank had established Federal funds purchase programs with two banks, totaling $9 million. At December 31, 2008, the Bank had purchased Federal funds of $7 million under these programs leaving $2 million available. The Federal funds purchase programs, if advanced upon, mature daily with interest rates that float at the Federal funds rate. BNCCORP, Inc. Annual Report 2009 59 57 NOTE 12. Federal Home Loan Bank Advances FHLB advances consisted of the following at December 31 (in thousands): Year of Maturity 2009 2013 2015 2009 2008 Weighted Average Rate - % 3.99 - 3.99 % Amount $ $ - 15,000 - 15,000 Weighted Average Rate 0.91 % 3.99 5.16 1.81 % $ Amount 62,500 15,000 7,000 84,500 As of December 31, 2009, the Bank had a $15.0 million FHLB advance maturing March 11, 2013. The Bank may repay this advance without a prepayment penalty, on March 10, 2010 and quarterly thereafter. On July 17, 2009, the Bank exercised its option to repay the $7 million advance maturing in 2015 that was outstanding as of December 31, 2008. The Bank exercised this option without a prepayment penalty. At December 31, 2009, the advances from the FHLB were collateralized by the Bank’s mortgage loans with unamortized principal balances of approximately $142.2 million. In addition, the advances from the FHLB were collateralized by securities with unamortized principal balances of approximately $66.3 million. The Bank has the ability to draw additional advances up to $110.6 million based upon the mortgage loans and securities that are currently pledged, subject to a requirement to purchase additional FHLB stock. NOTE 13. Other Borrowings As of December 31, 2009, BNCCORP had a $20.0 million established line of credit with the Bank of North Dakota (BND). Interest is payable quarterly at 30-day LIBOR plus 2.00%; maturity was February 15, 2010. No funds were drawn on the line as of December 31, 2009 or 2008. The line of credit has matured and management is working with BND to obtain a replacement line of credit. NOTE 14. Guaranteed Preferred Beneficial Interest’s in Company’s Subordinated Debentures In July 2007, BNCCORP issued $15.0 million of floating rate trust preferred securities. The interest rate paid on the securities is equal to three month LIBOR plus 1.40%. The interest rate at December 31, 2009 was 1.69% and the interest rate reset on January 2, 2010 to 1.65%. The trust preferred securities mature on October 1, 2037. On or after October 1, 2012, the trust preferred securities may be redeemed at par and the corresponding debentures may be prepaid at the option of BNCCORP, subject to approval by the Federal Reserve. In July 2000, BNCCORP issued $7.5 million of trust preferred securities at 12.05%. The trust preferred securities are subject to mandatory redemption on July 19, 2030. On or after July 19, 2010, the trust preferred securities may be redeemed and the corresponding debentures may be prepaid at the option of BNCCORP at declining redemption prices. Redemption is subject to approval by the Federal Reserve. In January 2010, BNCCORP deferred interest payments on its subordinated debentures as it is permitted pursuant to contractual terms of the indentures. While indentures permit interest to be deferred for up to 60 months, interest on the debentures continues to accrue during deferment. The indentures that contractually permit deferring interest on the subordinated debentures also require dividends on junior securities be suspended when interest on subordinated debentures are deferred. 60 BNCCORP, Inc. Annual Report 2009 58 NOTE 15. Stockholders’ Equity On January 16, 2009, BNCCORP received net proceeds of approximately $20.1 million through the sale of shares of non-voting senior preferred stock to the U.S. Department of the Treasury under the Capital Purchase Program (CPP). The Treasury Department also received a warrant exercisable for shares of an additional class of BNCCORP, Inc. preferred stock which has an aggregate liquidation preference of approximately $1.0 million. The Treasury Department exercised this warrant on January 16, 2009. As a result of participating in the CPP, there are two series of preferred stock outstanding. One series is perpetual, non-voting and pays dividends at 5% of its liquidation preference per annum until the fifth anniversary of the Treasury Department’s investment and thereafter pays a dividend of 9%. There are 20,093 shares of this series outstanding at December 31, 2009. Each share has a liquidation preference of $1,000 per share. This series of shares can not be redeemed without prior approval from regulatory authorities. The second series of preferred stock has the same voting rights and privileges as the other series, except that this series pays dividends at 9% of its liquidation preference per annum and may not be redeemed until the other series has been redeemed. There are 1,005 shares of this series outstanding at December 31, 2009. The relative fair value method was used to allocate the values of the two series of preferred stock. Management assumed both series of preferred stock would be redeemed in five years. A 6.51% discount rate was used to determine the values of the preferred stock. As a result of deferring interest on subordinated debentures, BNCCORP is contractually required to cease payment on the CPP preferred stock. The Treasury department is permitted to appoint a representative to the Board of Directors (the Board) of BNCCORP if dividend payments on the CPP preferred stock have not been made for two years. BNCCORP and the Bank are subject to certain minimum capital requirements (see Note 2 to these consolidated financial statements). BNCCORP is subject to certain restrictions on the amount of dividends it may declare without prior regulatory approval pursuant to the Federal Reserve Act. The terms of the preferred stock issued under the CPP precludes certain dividend payments to common shareholders and certain repurchases of outstanding shares of common stock until the preferred shares have been redeemed. Regulatory restrictions exist regarding the ability of the Bank to transfer funds to BNCCORP in the form of cash dividends. Approval of the Office of the Comptroller of the Currency (OCC), the Bank’s principal regulator, is required for the Bank to pay dividends to BNCCORP in excess of the Bank’s net profits from the current year plus retained net profits for the preceding two years. At December 31, 2009, the Bank would require prior regulatory approval to pay any dividends to BNCCORP. On May 30, 2001, BNCCORP’s Board adopted a rights plan intended to protect stockholder interests in the event BNCCORP becomes the subject of a takeover initiative that BNCCORP’s Board believes could deny BNCCORP’s stockholders the full value of their investment. This plan does not prohibit the Board from considering any offer that it deems advantageous to its stockholders. BNCCORP has no knowledge that anyone is considering a takeover. The rights were issued to each common stockholder of record on May 30, 2001, and they will be exercisable only if a person acquires, or announces a tender offer that would result in ownership of, 15% or more of BNCCORP’s outstanding common stock. The rights will expire on May 30, 2011, unless redeemed or exchanged at an earlier date. BNCCORP, Inc. Annual Report 2009 61 59 NOTE 16. Derivative Instruments and Hedging Activities Risk Management Objective of Using Derivatives The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company manages economic risks, including interest rate and liquidity risk, primarily by managing the amount, sources, and duration of its assets and liabilities and secondarily through the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to certain variable-rate loan assets. Fair Values of Derivative Instruments on the Consolidated Balance Sheets The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Balance Sheets as of December 31, 2009 and 2008 (in thousands): Tabular Disclosure of Fair Values of Derivative Instruments Asset Derivatives Liability Derivatives 2009 2008 2009 2008 Balance Sheet Fair Balance Sheet Balance Sheet Fair Balance Fair Sheet Fair Location Value Location Value Location Value Location Value Derivatives Designated as Hedging Instruments Interest Rate Floor Assets $ - Assets $ 1,896 Liabilities $ - Liabilities $ - Other Other Other Other Total Derivatives Designated as Hedging Instruments Derivatives Not Designated as Hedging Instruments $ - $ 1,896 $ - $ - Interest Rate Floor Assets $ 49 Assets $ - Liabilities $ - Liabilities $ - Other Other Other Other Total Derivatives Not Designated as Hedging Instruments $ 49 $ - $ - $ - 62 BNCCORP, Inc. Annual Report 2009 60 Cash Flow Hedges of Interest Rate Risk The Company’s objective in using interest rate derivatives is to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate floors as part of its interest rate risk management strategy. Interest rate floors involve the receipt of variable-rate amounts from a counterparty if interest rates fall below the strike rate on the contract in exchange for an up front premium. As of December 31, 2009, the Company had no interest rate floors that were designated as cash flow hedges of interest rate risk. During the second quarter of 2009, the Company’s $50 million interest rate floor failed to qualify for hedge accounting due to a mismatch between the floor notional and the aggregate principal amount of the designated loan pools; accordingly, all changes in the fair value of the floor subsequent to March 31, 2009 were recognized directly in earnings. Amounts recognized in earnings during the period April 1, 2009 to December 31, 2009 are disclosed under the heading “Derivatives Not Designated as Hedging Instruments” throughout this footnote. During the twelve months ended December 31, 2009, the Company recognized a loss of $12,440 for hedge ineffectiveness attributable to the mismatch that caused the floor to disqualify for hedge accounting during the second quarter of 2009. No hedge ineffectiveness was recognized during 2008. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest income as interest payments are received on the Company’s variable-rate assets. During the next twelve months, the Company estimates that $39,532 will be reclassified as an increase to interest income. Effect of Derivative Instruments on the Statements of Operations The tables below present the effect of the Company’s derivative financial instruments on the Statements of Operations for the years ended December 31 (in thousands): Amount of Gain or (Loss) Recognized in OCI on Derivative (Effective Portion) Derivatives in Cash Flow Hedging Relationships 2009 2008 Location of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) 2009 2008 Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective portion and Amount Excluded from Effectiveness Testing) Amount of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing) 2009 2008 Interest Rate Floor $ 43 $ 1,879 Interest Income $ 1,545 $ Other Income 10 Total $ 43 $ 1,879 $ 1,555 $ 652 - 652 Other Income $ (12) $ 105 $ (12) $ 105 BNCCORP, Inc. Annual Report 2009 63 61 Non-designated Hedges The Company does not use derivatives for trading or speculative purposes. Derivatives not designated as hedges are used to manage the Company’s exposure to interest rate movements and other identified risks but do not meet the strict hedge accounting requirements. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in earnings. As noted under “Cash Flow Hedges of Interest Rate Risk,” the Company’s $50 million interest rate floor disqualified for hedge accounting as of April 1, 2009; accordingly, the changes in fair value of the floor subsequent to March 31, 2009 have been recognized directly in earnings. The amount recorded in operations shown in the table below represents the net effect of changes in fair value of the interest rate floor and cash receipts for the years ended December 31 (in thousands): Derivatives Not Designated as Hedging Instruments Location of Gain or (Loss) Recognized in Income on Derivative Amount of Gain or (Loss) Recognized in Income on Derivative 2009 2008 Interest Rate Floor Other Income $ 23 $ - Total $ 23 $ - NOTE 17. Fair Value Measurements The following table summarizes the financial assets and liabilities of the Company for which fair values are determined on a recurring basis as of December 31 (in thousands): ASSETS Securities available for sale Loans held for sale Commitments to originate mortgage loans Interest rate floor Total assets at fair value LIABILITIES Commitments to sell mortgage loans Total liabilities at fair value ASSETS Securities available for sale Loans held for sale Commitments to originate mortgage loans Interest rate floor Total assets at fair value LIABILITIES Commitments to sell mortgage loans Total liabilities at fair value Total Level 1 Level 2 Level 3 2009 $ 212,661 24,130 427 49 $ 237,267 $ - - - - $ - $ 212,661 24,130 427 49 $ 237,267 $ - - - - $ - $ 675 $ 675 $ - - $ $ 675 $ 675 $ - $ - Total Level 1 Level 2 Level 3 2008 $ $ 209,857 13,403 429 1,896 225,585 $ - - - - $ - $ $ 209,857 13,403 429 1,896 225,585 $ - - - - $ - $ $ 697 697 $ - $ - $ $ 697 697 $ - $ - 64 BNCCORP, Inc. Annual Report 2009 62 Changes in the fair value of assets and liabilities determined on a recurring basis in the tables above had no net impact on our Consolidated Statements of Operations for the years ended December 31, 2009 and 2008. See Note 1 to these consolidated financial statements for definitions of Level 1, Level 2 and Level 3 inputs. The Company may also be required from time to time to measure certain other financial assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These adjustments to fair value usually result from the application of the lower of cost or market accounting or write-down of individual assets. For assets measured at fair value on a nonrecurring basis the following table provides the level of valuation assumptions used to determine the carrying value at December 31 (in thousands): 2009 Impaired loans(1) Other real estate(2) Total Total 32,200 7,253 39,453 $ $ Level 1 - - - $ $ Level 2 - - - $ $ Level 3 $ $ 32,200 7,253 39,453 2008 Impaired loans(1) Other real estate(2) Total Total 29,340 10,189 39,529 $ $ Level 1 - - - $ $ Level 2 - - - $ $ Level 3 $ $ 29,340 10,189 39,529 Represents the carrying value and related write-downs of loans based on the appraised value of the collateral. Represents the carrying value and related write-downs of loans based on the appraised value of the collateral. (1) (2) Represents the fair value of the collateral less estimated selling costs and are based upon appraised values. Total gains/ (losses) $ $ (7,268) (8,056) (15,324) Total gains/ (losses) $ $ (5,386) (307) (5,693) BNCCORP, Inc. Annual Report 2009 65 63 NOTE 18. Fair Value of Financial Instruments The estimated fair values of the Company’s financial instruments are as follows as of December 31 (in thousands): 2009 2008 Carrying Amount Fair Value Carrying Amount Fair Value $ 35,362 212,661 $ 35,362 212,661 $ 10,569 209,857 $ 10,569 209,857 Assets: Cash and cash equivalents Investment securities available for sale Federal Reserve Bank and Federal Home Loan Bank of Des Moines stock Loans held for sale Participating interests in mortgage loans Loans and leases held for investment, net Accrued interest receivable Derivative financial instruments Other assets Liabilities and Stockholders’ Equity: Deposits, non-interest-bearing Deposits, interest-bearing Borrowings and advances Accrued interest payable 3,048 24,130 38,534 499,061 2,970 216 815,982 52,101 $ 868,083 98,658 $ 657,305 25,190 1,468 Guaranteed preferred beneficial interests in Company’s subordinated debentures 22,890 Other liabilities Stockholders’ equity 5,307 57,265 $ 868,083 Financial instruments with off-balance-sheet risk: Commitments to extend credit Standby and commercial letters of credit Mortgage banking commitments to fund loans Mortgage banking commitments to sell loans 3,048 24,130 38,534 494,242 2,970 216 811,163 5,989 13,403 5,989 13,403 28,584 533,008 3,263 1,896 $ 806,569 28,584 534,002 3,263 1,896 807,563 53,935 $ 861,498 $ 98,658 658,647 25,278 1,468 $ 68,996 606,325 101,344 1,679 $ 68,996 608,275 101,833 1,679 11,266 795,317 $ 23,025 801,369 6,182 12,382 $ 793,165 53,947 $ 861,498 $ $ 64 41 427 675 1,207 $ $ 300 65 429 697 1,491 66 BNCCORP, Inc. Annual Report 2009 64 NOTE 19. Financial Instruments with Off-Balance-Sheet Risk In the normal course of business, the Company is a party to various financial instruments with off-balance-sheet risk, primarily to meet the needs of its customers as well as to manage its interest rate risk. These instruments, which are issued by the Company for purposes other than trading, carry varying degrees of credit, interest rate or liquidity risk in excess of the amounts reflected in the consolidated balance sheets. Commitments to Extend Credit Commitments to extend credit are agreements to lend to a customer, which are binding, provided there is no violation of any condition in the contract, and generally have fixed expiration dates or other termination clauses. The contractual amount represents the Bank’s exposure to credit loss in the event of default by the borrower. At December 31, 2009, based on current information, no losses were anticipated as a result of these commitments. The Bank manages this credit risk by using the same credit policies it applies to loans. Collateral is obtained to secure commitments based on management’s credit assessment of the borrower. The collateral may include marketable securities, receivables, inventory, equipment or real estate. Since the Bank expects many of the commitments to expire without being drawn, total commitment amounts do not necessarily represent the Bank’s future liquidity requirements related to such commitments. In our mortgage banking operations we commit to extend credit for purposes of originating residential loans. We underwrite these commitments to determine whether each loan meets criteria established by the secondary market for residential loans. Forward commitments represent commitments to sell loans to third party investors and are entered into in the normal course of business. The Company’s participating interests in mortgage loans is related to three counterparties. As of December 31, 2009, there was a $43.5 million limit to our loan commitment with these relationships. Standby and Commercial Letters of Credit Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Commercial letters of credit are issued on behalf of customers to ensure payment or collection in connection with trade transactions. In the event of a customer’s nonperformance, the Bank’s credit loss exposure is up to the letter’s contractual amount. At December 31, 2009, based on current information, no losses were anticipated as a result of these commitments. Management assesses the borrower’s credit to determine the necessary collateral, which may include marketable securities, real estate, accounts receivable and inventory. Since the conditions requiring the Bank to fund letters of credit may not occur, the Bank expects our liquidity requirements related to such letters of credit to be less than the total outstanding commitments. The contractual amounts of these financial instruments were as follows as of December 31 (in thousands): 2009 2008 Fixed Rate Variable Rate Fixed Rate Variable Rate Commitments to extend credit $ 11,996 $ 60,819 $ 20,613 $ 96,831 Standby and commercial letters of credit 761 3,320 244 6,265 In addition to the amounts in the table above, our mortgage banking commitments to fund loans totaled $29.2 million for 2009 and $25.9 million for 2008. Also, our mortgage banking commitments to sell loans totaled $53.1 million for 2009 and $39.0 million for 2008. NOTE 20. Guarantees and Contingent Consideration Guaranteed Preferred Beneficial Interests In Company’s Subordinated Debentures BNCCORP fully and unconditionally guarantees the Company’s subordinated debentures. BNCCORP, Inc. Annual Report 2009 67 65 Performance and Financial Standby Letters of Credit As of December 31, 2009 and 2008, the Bank had outstanding $481 thousand and $4.3 million of performance standby letters of credit and $13.3 million and $30.6 million of financial standby letters of credit. Performance standby letters of credit are irrevocable obligations to the beneficiary on the part of the Bank to make payment on account of any default by the account party in the performance of a nonfinancial or commercial obligation. Financial standby letters of credit are irrevocable obligations to the beneficiary on the part of the Bank to repay money for the account of the account party or to make payment on account of any indebtedness undertaken by the account party, in the event that the account party fails to fulfill its obligation to the beneficiary. Under these arrangements, the Bank could, in the event of the account party’s nonperformance, be required to pay a maximum of the amount of issued letters of credit. The Bank has recourse against the account party up to and including the amount of the performance standby letter of credit. The Bank evaluates each account party’s creditworthiness on a case-by-case basis and the amount of collateral obtained varies and is based on management’s credit evaluation of the account party. NOTE 21. Related-Party/Affiliate Transactions The Bank has entered into transactions with related parties, such as opening deposit accounts for and extending credit to, employees of the Company. The related party transactions have under terms substantially the same as those offered by the Bank to unrelated parties. In the normal course of business, loans are granted to, and deposits are received from, executive officers, directors, principal stockholders and associates of such persons. The aggregate dollar amount of these loans, which exceeded $60,000, was $1.8 million and $2.2 million at December 31, 2009 and 2008, respectively. Originations in 2009 and 2008 totaled $417,000 and $237,000, respectively. Loan paydowns in 2009 and 2008 were $792,000 and $28,000, respectively. The total amount of deposits received from these parties was $1.4 million and $1.1 million at December 31, 2009 and 2008, respectively. Loans to, and deposits received from, these parties were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collection. The Federal Reserve Act limits amounts of, and requires collateral on, extensions of credit by the Bank to BNCCORP, and with certain exceptions, its non-bank affiliates. There are also restrictions on the amounts of investment by the Bank in stocks and other subsidiaries of BNCCORP and such affiliates and restrictions on the acceptance of their securities as collateral for loans by the Bank. As of December 31, 2009, BNCCORP and its affiliates were in compliance with these requirements. NOTE 22. Income Taxes The expense (benefit) for income taxes on operations consists of the following for the years ended December 31 (in thousands): Current: Federal State Deferred: Federal State Valuation allowance Total 2009 2008 $ (4,138) 40 (4,098) $ 1,499 396 1,895 (2,899) (1,165) 6,537 2,473 (1,625) $ (958) (200) - (1,158) 737 $ 66 68 BNCCORP, Inc. Annual Report 2009 The expense (benefit) for federal income taxes on operations expected at the statutory rate differs from the actual expense (benefit) for the years ended December 31 (in thousands): Tax (benefit) at 34% statutory rate State taxes (net of Federal benefit) Tax-exempt interest Cash surrender values of bank-owned life insurance Other, net Deferred tax valuation allowance $ 2009 (6,936) (1,114) (138) $ (175) 201 (8,162) 6,537 (1,625) $ $ 2008 1,005 142 (267) (179) 36 737 - 737 Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that result in significant portions of the Company’s deferred tax assets and liabilities are as follows as of December 31 (in thousands): Deferred tax asset: Loans, primarily due to credit losses Branch premium acquisition costs Acquired intangibles Unrealized loss on securities available for sale Net operating loss carryforwards Alternative minimum tax credits Other real estate owned Other Deferred tax asset Deferred tax liability: Unrealized gain on cash flow hedges Discount accretion on securities Leases Premises and equipment Other Deferred tax liability Valuation allowance Net deferred tax asset 2009 2008 $ 4,701 28 279 135 1,469 551 2,596 508 10,267 6 1,759 216 561 199 2,741 7,526 (7,526) $ - $ 3,585 117 37 2,965 - - 904 782 8,390 511 930 373 577 148 2,539 5,851 (227) $ 5,624 During 2009, the valuation allowance for net deferred tax assets was increased such that net deferred tax assets were reduced to $0. The valuation allowance was required because cumulative losses in the 36 month period ended September 30, 2009 exceeded earnings. The Company is able to carry forward federal tax net operating losses aggregating $1.800 million as of December 31, 2009. The carry forward period is 20 years. At December 31, 2009, the Company had an unrecognized tax benefit of $97,000. If this benefit was recognized, it would affect the Company’s effective tax rate. The Company recognizes interest as a component of tax expense. We had approximately $14,000 of interest accrued at December 31, 2009 and no penalties. Interest included in tax expense for 2009 is approximately a benefit of $4,000. BNCCORP, Inc. Annual Report 2009 69 67 The Company files consolidated federal and unitary state income tax returns where allowed. Tax years ending December 31, 2006 through 2008 remain open to federal examination, although there are no examinations in progress at this time. Tax years ended December 31, 2005 through 2008 remain open to state examinations. It is reasonably possible the unrecognized tax benefit discussed above may be reduced by $28,000 within the next twelve months. This amount includes $6,000 of interest and no penalties. NOTE 23. Earnings (Loss) Per Share The following table shows the amounts used in computing per share results: Net income (loss) per share was calculated as follows: Denominator for basic earnings per share: Average common shares outstanding Dilutive common stock options Diluted common shares Numerator: Net income (loss) Preferred stock costs Net income (loss) available to common shareholders Basic earnings (loss) per common share Diluted earnings (loss) per common share 2009 2008 3,261,831 11,891 3,273,722 3,291,697 27,528 3,319,225 $ $ $ $ (18,776) (1,254) (20,030) (6.14) (6.14) $ $ $ $ 2,218 - 2,218 0.67 0.67 At December 31, 2009 and 2008, options totaling 41,700 and 12,200, respectively, were outstanding but not included in the computation of diluted EPS because their exercise prices were higher than the average price of the Company’s common stock. Exercise prices ranged from $5.94 to $7.38. NOTE 24. Benefit Plans BNCCORP has a qualified, tax-exempt 401(k) savings plan covering all employees of BNCCORP and its subsidiaries who meet specified age and service requirements. Under the plan, eligible employees may elect to defer up to 75% of compensation each year not to exceed the dollar limit set by law. At their discretion, BNCCORP and its subsidiaries may provide matching contributions to the plan. In 2009 and 2008, BNCCORP and its subsidiaries made matching contributions of up to 50% of eligible employee deferrals up to a maximum employer contribution of 5% of employee compensation. Generally, all participant contributions and earnings are fully and immediately vested. The Company makes its matching contribution during the first calendar quarter following the last day of each calendar year and an employee must be employed by the Company on the last day of the calendar year in order to receive the current year’s employer match. The anticipated matching contribution is expensed monthly over the course of the calendar year based on employee contributions made throughout the year. The Company made matching contributions of $365,000 and $387,000 for 2009, and 2008, respectively. Under the investment options available under the 401(k) savings plan prior to January 28, 2008, employees could elect to invest their salary deferrals in BNCCORP common stock. At December 31, 2009, the assets in the plan totaled $13.9 million and included $280,000 (108,690 shares) invested in BNCCORP common stock. On January 28, 2008, the Company voluntarily delisted from the NASDAQ Global Market and deregistered its common stock under the Securities Exchange Act of 1934 (as amended). As a result, the participants are prohibited from making new investments of the Company’s common stock in the plan. 70 BNCCORP, Inc. Annual Report 2009 68 NOTE 25. Commitments and Contingencies Employment Agreements and Noncompete Covenants The Company has entered into an employment agreement with its President and Chief Executive Officer (the President). However, the agreement governing the preferred stock issued to the Treasury department precludes payment of “golden parachutes” to senior executive officers of the Company so long as the preferred stock is outstanding. Leases The Bank has entered into operating lease agreements for certain facilities and equipment used in its operations. Rent expense for the years ended December 31, 2009 and 2008 was $1.358 million and $994,000, respectively, for facilities, and $49,000 and $39,000, respectively, for equipment and other items. At December 31, 2009, the total minimum annual base lease payments for operating leases were as follows (in thousands): 2010 2011 2012 2013 2014 Thereafter $ 1,302 1,039 637 137 141 1,967 NOTE 26. Share-Based Compensation The Company has three share-based plans for certain key employees and directors whereby shares of common stock have been reserved for awards in the form of stock options or restricted stock awards. Under the 1995 Stock Incentive Plan, the aggregate number of options and shares granted cannot exceed 250,000 shares. Under the 2002 Stock Incentive Plan, the aggregate number of shares cannot exceed 125,000 shares. Under the 2006 Stock Incentive Plan, the aggregate number of shares cannot exceed 200,000 shares. Pursuant to each plan, the compensation committee may grant options at prices equal to the fair value of the stock at the grant date. Total shares available and maximum restricted shares available as of December 31, 2009 are as follows: 1995 Stock Incentive Plan 2002 Stock Incentive Plan 2006 Stock Incentive Plan Total Total Shares Available 61,251 107,250 136,600 305,101 Maximum Restricted Shares Available 61,251 7,250 136,600 205,101 The Company recognized share-based compensation expense of $262,000 and $342,000 for the year ended December 31, 2009 and 2008, respectively, all of which related to restricted stock. The tax benefits associated with share-based compensation were approximately $56,000 and $108,000 for the year ended December 31, 2009 and 2008, respectively. At December 31, 2009, the Company had $91,000 of unamortized restricted stock compensation. At December 31, 2008, the Company had $352,000 of unamortized restricted stock compensation. Restricted shares of stock granted generally have vesting and amortization periods of at least three years. BNCCORP, Inc. Annual Report 2009 71 69 Following is a summary of restricted stock activities for the years ended December 31: 2009 2008 Number Restricted Stock Shares 37,332 - (28,832) - 8,500 Weighted Average $ Grant Date Fair Value 12.35 - 12.44 - 12.04 Number Restricted Stock Shares 51,766 19,500 (26,434) (7,500) 37,332 Weighted Average Grant Date Fair Value $ 12.50 11.03 12.46 9.60 12.35 Nonvested, beginning of year Granted Vested Forfeited Nonvested, end of year No stock options were granted during 2009 or 2008 and the Company had no unrecognized share-based compensation expense related to stock options during these periods. Following is a summary of stock option transactions for the years ended December 31: 2009 2008 Outstanding, beginning of year Granted Exercised Forfeited Outstanding, end of year Exercisable, end of year Weighted average fair value of Granted Exercised Forfeited Options to Purchase Shares Weighted Average Exercise Price Options to Purchase Shares 44,200 - - (2,500) 41,700 41,700 $ 6.34 - - 8.75 6.20 6.20 $ $ 107,700 - (8,000) (55,500) 44,200 44,200 $ - $ - $ 3.91 $ $ $ - 2.80 7.53 Following is a summary of the status of options outstanding at December 31, 2009: Weighted Average Exercise Price 11.76 - 5.94 17.04 6.34 6.34 $ $ $ Options with exercise prices ranging from: $5.94 to $7.38 Outstanding Options Weighted Average Remaining Number Contractual Life Weighted Average Exercise Price Exercisable Options Weighted Average Exercise Price Number 41,700 41,700 1.4 years $ 6.20 $ 41,700 41,700 6.20 72 BNCCORP, Inc. Annual Report 2009 70 NOTE 27. Condensed Financial Information-Parent Company Only Condensed financial information of BNCCORP on a parent company only basis is as follows: Parent Company Only Condensed Balance Sheets As of December 31 (In thousands, except per share data) 2009 2008 Assets: Cash and cash equivalents Investment securities available for sale Investment in subsidiaries Receivable from subsidiaries Deferred charges and intangible assets, net Other Total assets Liabilities and stockholders’ equity: Subordinated debentures Payable to subsidiaries Accrued expenses and other liabilities Total liabilities $ $ $ $ $ $ 4,339 1,463 77,894 159 - 7,404 91,259 23,118 7,135 1,781 32,034 Preferred stock, $.01 par value. Authorized 2,000,000 shares: Preferred Stock - 5% Series A 20,093 shares issued and outstanding; 19,187 Preferred Stock - 9% Series B 1,005 shares issued and outstanding; Common stock, $.01 par value. Authorized 10,000,000 shares; 3,290,219 and 3,299,163 shares issued and outstanding Capital surplus – common stock Retained earnings Treasury stock (363,434 and 357,738 shares, respectively) Accumulated other comprehensive income (loss), net of income taxes Total stockholders’ equity Total liabilities and stockholders’ equity 1,098 33 26,885 16,078 (5,068) 1,012 59,225 91,259 $ $ 1,766 - 76,526 570 154 446 79,462 23,115 487 1,913 25,515 - - 33 26,628 36,104 (5,020) (3,798) 53,947 79,462 BNCCORP, Inc. Annual Report 2009 73 71 Parent Company Only Condensed Statements of Operations For the Years Ended December 31 (In thousands) Income: Management fee income Interest Other Total income Expenses: Interest Salaries and benefits Legal and other professional Depreciation and amortization Other Total expenses Loss before income tax benefit and equity in income of subsidiaries Income tax expense (benefit) Loss before equity in income of subsidiaries Equity in income (loss) of subsidiaries Net income (loss) 2009 2008 $ 1,555 $ 1,599 1,376 41 2,972 1,292 749 534 1 958 3,534 (562) (783) (1,345) (17,431) 17 76 1,692 1,728 829 443 3 610 3,613 (1,921) 646 (1,275) 3,493 $ (18,776) $ 2,218 74 BNCCORP, Inc. Annual Report 2009 72 Parent Company Only Condensed Statements of Cash Flows For the Years Ended December 31 (In thousands) Operating activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash used in operating $ (18,776) $ 2,218 2009 2008 activities - Equity in undistributed income of subsidiaries Depreciation and amortization Impairment of goodwill Other noncash expense Deferred income taxes Change in prepaid expenses and other receivables Change in accrued expenses and other liabilities Net cash used in operating activities Investing activities: Increase (decrease) in investment in subsidiaries Net cash (used in) provided by investing activities Financing activities: Proceeds from issuance of preferred stock Payment of preferred stock dividends Proceeds from issuance of share-based compensation Purchase of treasury stock Net cash (used in) provided by financing activities Net increase in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Supplemental cash flow information: Interest paid Income tax payments received from the subsidiary bank, net of income taxes paid NOTE 28. Subsequent Events 17,431 5 154 105 352 (6,950) 5,961 (1,718) (15,001) (15,001) 20,093 (1,058) 257 - 19,292 2,573 1,766 (3,493) 6 - - 110 (61) (409) (1,629) 4,766 4,766 - - 273 (2,598) (2,325) 812 954 $ 4,339 $ 1,766 $ 1,149 $ 1,675 $ 2,310 $ 2,173 The Company has evaluated subsequent events from the balance sheet date through March 17, 2010, the date at which the financial statements were available to be issued, and determined there are no other items to disclose. BNCCORP, Inc. Annual Report 2009 75 73 76 BNCCORP, Inc. Annual Report 2009 Corporate Data Investor Relations Gregory K. Cleveland, CPA President/CEO 602-852-3526 Timothy J. Franz, CPA Chief Financial Offi cer 612-305-2213 General Inquiries: BNCCORP, Inc. 322 East Main Avenue Bismarck, North Dakota 58501 Telephone (701) 250-3040 Facsimile (701) 222-3653 E-mail Inquiries: corp@bncbank.com Annual Meeting The 2010 annual meeting of stockholders will be held on Wednesday, June 16, 2010 at 8:30 a.m. (Central Daylight Time) at BNC National Bank, Second Floor Conference Room, 322 East Main Avenue, Bismarck, ND 58501. Independent Public Accountants KPMG LLP 233 South 13th Street Suite 1600 Lincoln, NE 68508 Securities Listing BNCCORP, Inc.’s common stock is traded on the Pink Sheets under the symbol: “BNCC.” There were 73 record holders of the Company’s common stock at March 6, 2009. COMMON STOCK PRICES For the Years Ended December 31, 2009(1) 2008(1) High Low High Low First Quarter Second Quarter Third Quarter Fourth Quarter $13.89 $11.75 $13.00 $9.05 $11.00 $7.80 $8.90 $5.15 $13.89 $11.75 $13.00 $9.05 $11.00 $7.80 $8.90 $5.15 (1) The quotes represent the high and low closing sales prices as reported by Pink Sheets. Stock Transfer Agent and Registrar American Stock Transfer & Trust Company 59 Maiden Lane, Plaza Level New York, NY 10038 (800) 937-5449 DIRECTORS BNCCORP, Inc. Mark W. Sheffert Chairman of the Board of BNCCORP, Inc. Chairman and Chief Executive Offi cer, Manchester Companies, Inc. Gregory K. Cleveland, CPA President and Chief Executive Offi cer Tracy Scott, CPA Retired Co-Founder of BNCCORP, Inc. Bradley D. Bonga Founder and President/CEO Bonga and Associates, LLC Gaylen Ghylin, CPA EVP, Secretary and CFO Tiller Corporation d/b/a Barton Sand & Gravel Co., Commercial Asphalt Co. and Barton Enterprises, Inc. Richard M. Johnsen, Jr. Chairman of the Board and Chief Executive Offi cer, Johnsen Trailer Sales, Inc. Michael O’Rourke Attorney/Author Stephen H. Roman Partner First Strategic LLC DIRECTORS BNC National Bank Julie L. Andresen Gregory K. Cleveland Shawn Cleveland Timothy J. Franz David Hoekstra Mark E. Peiler Scott Spillman B. Timothy Swanson SUBSIDIARIES BNC National Bank Headquarters: 2425 East Camelback Road Suite 100 Phoenix, AZ 85016 Bank Branches: Bismarck Main 322 East Main Avenue Bismarck, ND 58501 Bismarck South 219 South 3rd Street Bismarck, ND 58504 Bismarck North 801 East Century Avenue Bismarck, ND 58503 Primrose Assisted Living Apartments 1144 College Drive Bismarck, ND 58501 Waterford on West Century 1000 West Century Avenue Bismarck, ND 58503 Crosby 107 North Main Street Crosby, ND 58730 Garrison 92 North Main Garrison, ND 58540 Kenmare 103 1st Avenue SE Kenmare, ND 58746 Linton 104 North Broadway Linton, ND 58552 Stanley 210 South Main Stanley, ND 58784 Watford City 205 North Main Watford City, ND 58854 Minneapolis 333 South Seventh Street Minneapolis, MN 55402 Golden Valley 650 Douglas Drive Golden Valley, MN 55422 The Heathers Estate 2900 North Douglas Drive Crystal, MN 55422 The Heathers Manor 3000 North Douglas Drive Crystal, MN 55422 Scottsdale 17045 N. Scottsdale Road Scottsdale, AZ 85255 Glendale 20175 North 67th Avenue Glendale, AZ 85308 Mortgage Banking Branches: Scottsdale 8330 East Hartford Drive Scottsdale, AZ 85255 Wichita 7200 West 13th Wichita, KS 67212 Overland Park 7007 College Boulevard Overland Park, KS 66211 Davenport 3709 Harrison Street Davenport, IA 52806 Belton 17122 BelRay Place Belton, MO 64012 Lincoln 3600 Village Drive Lincoln, NE 68516 Grand Island 819 North Diers Avenue Grand Island, NE 68803 EXECUTIVE OFFICERS BNCCORP and Subsidiaries Gregory K. Cleveland, CPA President and Chief Executive Offi cer Timothy J. Franz, CPA Chief Financial Offi cer Shawn Cleveland, CPA Chief Operating Offi cer, BNC National Bank Dave Hoekstra, CPA Chief Credit Offi cer and President – BNC National Bank, North Dakota Market Mark E. Peiler, CFA Senior Vice President – Chief Investment Offi cer BNCCORP, Inc. Annual Report 2009 73 BNCCORP, Inc. (BNCCORP or the Company) is a bank holding company registered under the Bank Holding Company Act of 1956 headquartered in Bismarck, North Dakota. It is the parent company of BNC National Bank (the Bank). Th e Company operates community banking and wealth management businesses in Arizona, Minnesota and North Dakota from 20 locations. BNC also conducts mortgage banking from ten locations in Arizona, Minnesota, Iowa, Kansas, Nebraska and Missouri. B N C C O R P A n n u a l R e p o r t 2 0 0 8 BNCCORP, INC. BNCCORP, Inc. BNCCORP, Inc. BNCCORP, INC. 

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