BNCCORP Inc.
Annual Report 2010

Plain-text annual report

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 2011 annual meeting of stockholders will be held on Wednesday, June 15, 2011 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 OTC Markets under the symbol: “BNCC.” There were 72 record holders of the Company’s common stock at March 11, 2011. COMMON STOCK PRICES For the Years Ended December 31, Low 2010(1) 2009(1) High High Low $8.50 $5.30 First Quarter $4.00 $1.80 $5.60 $8.50 Second Quarter $3.19 $1.80 $5.00 $8.00 $2.25 $1.40 Third Quarter $1.95 $5.50 $2.00 $1.41 Fourth Quarter (1) The quotes represent the high and low closing sales prices as reported by OTC Markets. 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 18 locations. BNC also conducts mortgage banking from 10 locations in Arizona, Minnesota, Iowa, Kansas, Nebraska and Missouri. 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 BNCCORP, Inc. Annual Report 2010 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 FirstStrategic LLC DIRECTORS BNC National Bank Julie L. Andresen Gregory K. Cleveland Shawn Cleveland Timothy J. Franz David Hoekstra Mark E. Peiler Scott Spillman SUBSIDIARIES BNC National Bank Headquarters: 20175 North 67th Ave Glendale, AZ 85308 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 240 Investors Bldg (Baker Center) 733 Marquette Avenue South 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 Perimeter 17550 North Perimeter Drive Scottsdale, AZ 85255 Mortgage Banking Branches: Scottsdale 8330 East Hartford Drive Scottsdale, AZ 85255 Wichita 7200 West 13th Wichita, KS 67212 Wichita 1718 North Webb Road Wichita, KS 67206 Andover 511 North Andover Road Andover, Kansas 67002 Overland Park 7007 College Boulevard Overland Park, KS 66211 Topeka 2110 SW Belle Avenue Topeka, KS 66614 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 79 To Our Stockholders, Customers, Employees and Friends: As we entered 2011 the overall economic environment showed tentative signs of stabilization after several years of turbulence. Th at said, a robust recovery is not yet in evidence. Unemployment continues to be stubbornly high. Many corporations remain reluctant to invest and are choosing to hold record levels of cash. Consumer spending is cautious and the housing market remains problematic. At the same time, global conditions have dramatically altered the landscape for businesses and governments. In response to world-wide economic uncertainties, legislative and regulatory authorities have unleashed a fl ood of new regulations that will have a signifi cant impact on fi nancial institutions. While it is certain these new regulations will be burdensome, our industry and consumers of fi nancial products are not likely to fully comprehend the full impact of the new regulatory environment for quite some time. Th roughout this challenging period, our approach at BNC has been to focus sharply on addressing credit issues, maintaining liquidity and managing capital. For example, we reduced nonperforming assets by almost one-third in the past year and our yearend cash balances exceed $100 million. Clearly, this focus has served us well and continues to provide relative stability at a time when economic outlook remains uncertain. Improving Credit Quality BNC has taken prudent and appropriate actions to deal with the elevated levels of nonperforming assets that we, and many fi nancial institutions, faced as a result of the recession. We have benefi ted from our ongoing and rigorous scrutiny of asset quality, as well as our decision in 2009 to increase the provision for loan losses. Our credit quality trends improved in 2010, as refl ected in the signifi cant decreases in nonperforming assets (which decreased by $12.6 million, or 29%) and nonperforming loans (which decreased by $18.0 million, or 50%). Our provisions for credit losses and other real estate costs also declined signifi cantly in 2010 while the allowance for credit losses as a percentage of loans and leases held for investment improved. Strengthening Our Capital Foundation In November 2010, we entered into an agreement to sell certain loans and deposits in our Arizona and Minnesota markets to another banking institution. Th is transaction positions BNC for the future by enhancing the Bank’s capital ratios; we project our leverage ratio will be approximately 9% and our total risk based ratio will be approximately 15%. It is important to note that we will continue to off er a full range of banking and mortgage banking services in our Arizona and Minnesota communities following the sale. Equally important, if not more importantly, the transaction also does not impact our operations in North Dakota. We look forward to participating in growth opportunities in all our markets, particularly North Dakota – where we are committed to expanding our resources and growing our presence. GREGORY K. CLEVELAND President and Chief Executive Offi cer “As we entered 2011 the overall economic environment showed tentative signs of stabilization after several years of turbulence.” BNCCORP, INC. Annual Report 2010 Responding to a Challenge In May 2010, we reported that the Company had discovered fraudulent activity by an external company that was servicing residential mortgage loans for BNC. Since that time we have been diligently addressing this matter. We commenced investigations, which have confi rmed that the fraudulent activity was limited to the external servicing company and that no bank employees were involved in this wrongful conduct by the servicing company. In the second quarter, we determined the scope of the fraud losses and recorded a loss. Since then, we have fi led a legal claim against our insurance carriers and we fi rmly believe our claim is strong. Th is matter is discussed in further detail in Note 4 of our Consolidated Financial Statements. Our people responded to this challenge with incredible resolve. As a result, there has been limited impact on our day-to-day business or on our capacity to deliver superior service to our customers. 2011 Outlook We continue to believe that the operating and regulatory environment will remain unsettled for the foreseeable future. While some regions are showing economic vitality – including our own North Dakota market – this is more the exception than the rule. Th erefore, we are convinced that our strategy which hones in on credit quality, liquidity and capital remains right for the times. We will continue to focus on reducing nonperforming assets where possible and maintaining reserves when necessary. We will manage our investment portfolio to ensure that the Company has suffi cient liquidity. And we will manage our capital to support our business. At the same time, we will continue to deliver the attentive customer service that is a tradition at BNC – and a signifi cant competitive advantage in a changing fi nancial marketplace. Our ability to address the challenges of recent years is a refl ection of the dedication of our employees, the loyalty of our customers and shareholders, and the sound guidance of our Board of Directors. I thank all of you for your support and look forward to building BNC in the future. Sincerely, GREGORY K. CLEVELAND President and Chief Executive Offi cer BNCCORP, INC. Annual Report 2010 BNCCORP, INC. INDEX TO YEAR END FINANCIAL REPORT December 31, 2010 TABLE OF CONTENTS Selected Financial Data ...................................................................................................... Business ............................................................................................................................. Management’s Discussion and Analysis of Financial Condition and Results of Operations ...................................................................................................................... Quantitative and Qualitative Disclosures about Market Risk ............................................ Consolidated Financial Statements .................................................................................... 3 6 7 28 32 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 Fraud loss on assets serviced by others Non-interest expense, excluding fraud loss on assets serviced by others Income tax expense (benefit) 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-mortgage banking Participating interests in mortgage loans Loans and leases held for investment, net of unearned income Other loans held for sale, net Allowance for credit losses(2) Allowance for credit losses(3) Total deposits(2) Core deposits(2) 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 Basic earnings (loss) per common share 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(2) Allowance for credit losses to total loans(3) Allowance for credit losses to total nonperforming loans(2) Allowance for credit losses to total nonperforming loans(3) (1) Loss from continuing operations was $(3.069) million for 2007. Net income for 2007 was $1.980 million. (2) Excluding impact of pending sale (3) Including impact of pending sale For the Years Ended December 31, 2010 2009 2008 2007(1) 2006 $ $ $ 33,510 $ 10,238 23,272 5,750 23,973 26,231 37,257 72 (22,065) $ 44,588 14,899 29,689 27,000 16,013 - 39,103 (1,625) (18,776) $ $ 46,026 $ 19,215 26,811 7,750 10,395 - 26,501 737 2,218 $ 44,241 $ 21,994 22,247 3,750 3,853 - 28,147 (2,728) (3,069)(1) $ 747,069 $ 137,032 - 2,862 29,116 4,888 350,501 70,501 (16,476) (14,765) 661,111 594,152 16,329 - - 868,083 $ 212,661 - 3,048 24,130 38,534 517,108 - (18,047) - 755,963 640,169 10,190 15,000 - 861,498 $ 209,857 - 5,989 13,403 28,584 542,753 - (8,751) - 675,321 575,637 16,844 84,500 - 699,591 $ 122,899 - 4,918 - 24,357 497,556 - (6,599) - 541,874 541,874 5,365 61,400 - 24,134 16,835 5.09 $ 5.09 $ 22,890 36,980 11.24 $ 11.24 $ $ $ 23,025 53,947 16.35 $ 16.23 $ 23,075 59,730 17.11 $ 16.99 $ 42,408 23,606 18,802 210 5,138 - 23,075 (363) 1,018 692,276 182,974 24,000 5,003 1,669 56,125 333,934 - (3,370) - 529,252 529,054 9,709 62,200 1,167 22,711 55,602 15.44 7.15 (2.79)% (90.47)% 134.38% 3.20% 3.14% $ (7.13) $ (7.13) 3,281,719 3,281,719 3,304,339 (2.09)% (38.88)% 85.56% 3.58% 3.37% $ (6.14) $ (6.14) 3,261,831 3,273,722 3,290,219 0.28% 3.85% 71.22% 3.64% 3.46% (0.47)% (5.25)% 107.85% 3.81% 3.31% $ 0.67 $ (0.89) (0.89) $ 3,456,993 3,515,852 3,491,337 0.67 $ 3,291,697 3,319,225 3,299,163 0.14% 1.92% 96.39% 3.04% 2.73% $ 0.29 0.29 $ 3,473,670 3,514,709 3,600,467 4.09% 5.10% (1.530)% 3.62% 3.84% 92% 83% 4.97% 6.94% (3.235)% 3.11% - 50% - 3.84% 4.22% (1.066)% 1.50% - 38% - 0.77% 1.09% (0.129)% 1.26% - 122% - 0.02% 0.03% (0.008)% 0.86% - 3,304% - 3 Quarterly Financial Data Interest income Interest expense Net interest income Provision for credit losses Net interest income after provision for credit losses Non-interest income First Quarter Second Quarter 2010 Third Quarter (Unaudited) Fourth Quarter YTD $ 9,289 $ 8,451 $ 8,133 $ 7,637 $ 33,510 2,951 2,638 2,356 2,293 10,238 6,338 5,813 5,777 5,344 23,272 2,000 1,500 1,250 1,000 5,750 4,338 4,313 4,527 4,344 17,522 6,286 5,560 5,603 6,524 23,973 Fraud loss on assets serviced by others - 26,231 - - 26,231 Non-interest expense, excluding fraud loss on assets serviced by others 8,482 8,743 9,692 10,340 37,257 Income (loss) before income taxes 2,142 (25,101) 438 528 (21,993) Income tax expense (benefit) (48) 120 - - 72 NET INCOME (LOSS) $ 2,190 $ (25,221) $ 438 $ 528 $ (22,065) Preferred stock costs Net income (loss) available to common shareholders (324) (331) (337) (341) (1,333) $ 1,866 $ (25,552) $ 101 $ 187 $ (23,398) Basic earnings (loss) per common share $ 0.57 $ (7.79) Diluted earnings (loss) per common share $ 0.57 $ (7.79) $ $ 0.03 $ 0.06 $ 0.03 $ 0.06 $ (7.13) (7.13) Average common shares: Basic Diluted 3,281,719 3,281,719 3,281,719 3,281,719 3,281,719 3,281,719 3,281,719 3,281,719 3,281,719 3,281,719 4 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) NET INCOME (LOSS) Preferred stock costs Net income (loss) available to common shareholders 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) $ 616 $ 523 $ (21,890) $ 1,975 $ (18,776) (266) (327) (330) (331) (1,254) $ 350 $ 196 $ (22,220) $ 1,644 $ (20,030) Basic earnings (loss) per common share $ 0.11 $ Diluted earnings (loss) per common share $ 0.11 $ 0.06 0.06 $ $ (6.81) (6.81) $ $ 0.50 0.50 $ $ (6.14) (6.14) Average common shares: Basic Diluted 3,261,831 3,261,831 3,261,831 3,275,279 3,261,831 3,274,595 3,290,400 3,269,355 3,275,279 3,273,722 5 Business General BNCCORP, INC. (BNCCORP or the Company) is a bank holding company 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 18 locations. BNC also conducts mortgage banking from 10 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: • • • • • Emphasize deposit growth; Manage credit risk; Provide individualized, high-level customer service; Offer diversified products and services; and Expand opportunistically. 6 Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview The following table summarizes selected income statement data and earnings (loss) per share data (in thousands, except per share data): SELECTED INCOME STATEMENT DATA Interest income Interest expense Net interest income Provision for credit losses Non-interest income Fraud loss on assets serviced by others Non-interest expense, excluding fraud loss on assets serviced by others Loss before income taxes Income tax expense (benefit) Net loss Preferred stock costs 2010 2009 $ $ 33,510 10,238 23,272 5,750 23,973 26,231 37,257 (21,993) 72 (22,065) (1,333) 44,588 14,899 29,689 27,000 16,013 - 39,103 (20,401) (1,625) (18,776) (1,254) Net loss available to common shareholders $ (23,398) $ (20,030) EARNINGS PER SHARE DATA Basic loss per common share Diluted loss per common share The following is an overview of recent periods: $ $ (7.13) (7.13) $ $ (6.14) (6.14) • The loss in 2010 is attributed to a fraud committed by a third party servicer of loans owned by BNC. See Note 4 of our Consolidated Financial Statements. • The losses in 2009 are primarily attributed to provisions for credit losses and ORE write-downs and costs related to nonperforming loans and foreclosed assets. For more information see discussion of loans, the allowance for credit losses and OREO that follows in the MD&A as well as Notes 8, 9 and 10 of our Consolidated Financial Statements. • Net interest income decreased in 2010 due to lower rates and reduced asset balances. For more information see discussion of net interest income that follows in the MD&A. • Non-interest income has been higher in recent years primarily due to growth in mortgage banking operations. For more information see discussion of non-interest income that follows in the MD&A. • Non-interest expenses significantly increased by the fraud loss on assets serviced by others in 2010 and include higher costs for foreclosed assets, mortgage banking operations and regulatory costs. See Note 4 of our Consolidated Financial Statements. In November 2010, we announced an agreement to sell loans, other assets and deposits in our Arizona and Minnesota markets. See Note 3 of our Consolidated Financial Statements. • 7 General Net loss in 2010 was $(22.065) million, or $(7.13) per diluted share, compared to a net loss of $(18.776) million, or $(6.14) per diluted share in 2009. 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): 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, 2010 Average balance Interest Average earned yield or or owed cost Average balance 2009 Interest earned or owed Average yield or cost Average balance 2008 Interest Average yield or earned cost or owed (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-mortgage banking Participating interests in mortgage loans Loans and leases held for investment 47,470 $ 111 8,631 167,572 93 2,111 1,263 29,039 665 20,144 22,747 478,492 0.23% $ 5.15% 4.41% 4.35% 3.30% 4.75% 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 $ 1 9,864 172,383 839 16,994 220 3,586 1,408 24,688 33,694 525,311 1.05% 5.72% 4.94% 6.13% 5.70% 6.41% Allowance for credit losses (17,201) - (11,962) - (7,105) - Total interest-earning assets Non-interest-earning assets: Cash and due from banks Other Total assets 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 727,627 33,510 4.61% 828,856 44,588 5.38% 735,952 46,026 6.25% 9,929 53,146 $ 790,702 9,749 61,611 $ 900,216 10,481 47,835 $ 794,268 $ 282,880 11,156 1,729 11 0.61% $ 0.10% 266,537 11,685 2,379 13 0.89% $ 0.11% 244,279 9,859 4,074 33 1.67% 0.33% 241,036 6,070 2.52% 324,902 8,653 2.66% 232,367 8,981 45,083 998 2.21% 47,358 1,341 2.83% 58,378 2,011 580,155 8,808 1.52% 650,482 12,386 1.90% 544,883 15,099 11,163 2,899 10 73 112 1 0.65% 3.86% 10.00% 17,953 51,738 58 179 1,078 3 1.00% 2.08% 5.17% 7,049 87,159 519 144 2,291 25 23,491 1,244 5.30% 22,686 1,253 5.52% 22,734 1,656 3.87% 3.44% 2.77% 2.04% 2.63% 4.82% 7.29% 2.90% Total interest-bearing liabilities 617,718 10,238 1.66% 742,917 14,899 2.01% 662,344 19,215 Non-interest-bearing demand accounts Total deposits and interest-bearing liabilities Other non-interest-bearing liabilities Total liabilities Stockholders’ equity Total liabilities and stockholders’ 117,459 735,177 9,272 744,449 46,253 77,736 820,653 8,679 829,332 70,884 66,388 728,732 7,928 736,660 57,608 equity $ 790,702 $ 900,216 $ 794,268 Net interest income $ 23,272 $ 29,689 $ 26,811 Net interest spread Net interest margin Ratio of average interest-earning assets to average interest-bearing liabilities 2.95% 3.20% 3.37% 3.58% 3.35% 3.64% 117.79% 111.57% 111.11% 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, 2010 Compared to 2009 2009 Compared to 2008 Change Due to Change Due to Volume Rate Total Volume (in thousands) Rate (in thousands) Total $ 95 (3,326) (272) $ 7 (2,440) (44) $ 102 $ 10 3,340 (442) (5,766) (316) $ (2) 1,193 12 $ 8 4,533 (430) Interest Earned on Interest- Earning Assets Federal funds sold/interest- bearing due from Taxable investments Tax-exempt investments Loans held for sale–mortgage banking 251 (170) 81 1,114 (152) 962 Participating interests in mortgage loans Loans held for investment Total increase (decrease) in (362) (3,315) (285) (1,217) (647) (4,532) 255 1,362 (351) (7,777) (96) (6,415) interest income (6,929) (4,149) (11,078) 5,639 (7,077) (1,438) 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 interest expense Increase (decrease) in net interest 138 (1) (788) (1) (650) (2) 343 5 (2,038) (25) (1,695) (20) (2,133) (62) (56) (1,474) (4) 45 (450) (281) (50) 508 2 (54) (2,583) (343) (106) (966) (2) (9) 2,952 (345) 137 (803) (24) (3) (3,280) (325) (102) (410) 2 (400) (328) (670) 35 (1,213) (22) (403) (3,547) (1,114) (4,661) 2,262 (6,578) (4,316) income $ (3,382) $ (3,035) $ (6,417) $ 3,377 $ (499) $ 2,878 Net interest income was $23.272 million in 2010 compared to $29.689 million in 2009, a decrease of $(6.417) million or (21.6)%. The net interest margin decreased to 3.20% for the year ended December 31, 2010, from 3.58% in 2009. In 2010 lower rates and lower balances of assets and liabilities combined to reduce net interest income. Net interest income in 2010 was also lower than in 2009 as we recognized income of $1.550 million in 2009 related to an interest rate floor which expired very early in 2010. Nonperforming assets have also negatively impacted net interest income in recent periods. During 2010, cash balances were very significant for most of the year in order to maintain the liquidity needed to finance the sale of deposits discussed in Note 3 of our Consolidated Financial Statements. 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 2009 because we 9 believed the yield on investments was attractive compared to other assets. Increases in nonperforming assets reduced interest income. Interest expense decreased in 2009 primarily due to lower interest rates. Increases in the balances of deposits partially offset the decline in rates. 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. Non-interest Income The following table presents the major categories of our non-interest income (dollars are in thousands): Bank charges and service fees Wealth management revenues Mortgage banking revenues Gains (losses) on sales of loans, net Gains on sales of securities, net Other Total non-interest income For the Years Ended December 31, Increase ( Decrease) 2010 – 2009 2010 2009 $ % $ $ 2,533 2,133 13,424 371 4,390 1,122 23,973 $ $ 2,332 2,056 8,390 (339) 2,850 724 16,013 $ 201 7 5,034 710 1,540 398 $ 7,960 9 % 4 % (a) 60 % (b) (209) % (c) 54 % (d) 55 % (e) 50 % (a) Although wealth management revenues increased, we exited two lines of business in 2010. Our ESOP revenues and fees for managing documents on insurance products sold by others declined. As a result, we expect wealth management revenues to trend lower in future periods. (b) Mortgage banking revenues increased because we have been expanding these operations in recent years. Low interest rates and governmental support for the housing market have also contributed to higher mortgage banking revenues in recent periods. It is uncertain how long these favorable conditions will continue. In 2009 we sold commercial real estate loans at a loss to reduce our credit exposure. In 2010 we began to sell SBA loans at gains. We anticipate more sales of SBA loans in 2011. (c) (d) Gains on sales of securities, net vary depending on the nature and volume of transactions. (e) In 2010 we sold a branch for a gain. 10 Non-interest Expense The following table presents the major categories of our non-interest expense (dollars are in thousands): For the Years Ended December 31, 2010 2009 Increase (Decrease) 2010– 2009 $ % Salaries and employee benefits Professional services Other real estate costs Occupancy Data processing fees Regulatory costs Marketing and promotion Depreciation and amortization Office supplies and postage Fraud loss on assets serviced by others Other Total non-interest expense Efficiency ratio $ 16,080 5,068 2,707 2,885 2,697 1,951 1,372 1,333 603 26,231 2,561 $ 63,488 134.38% $ 15,008 3,064 8,169 2,508 2,330 1,466 1,277 1,465 611 - 3,205 $ 39,103 85.56% $ $ 1,072 2,004 (5,462) 377 367 485 95 (132) (8) 26,231 (644) 24,385 48.82% 7 % 65 % (a) (67) % (b) 15 % (c) 16 % (d) 33 % (e) 7 % (9) % (1) % 100 % (f) (20) % (g) 62 % (a) Professional services increased because of legal fees associated with problem credits, services required by mortgage banking operations and costs related to the fraud loss on assets serviced by others. (b) Other real estate costs will vary depending on the level of foreclosed assets and valuation allowances recorded to reduce the carrying value of foreclosed properties. (c) Occupancy has increased due to more mortgage banking locations (d) Data processing fees increased due to the increased mortgage banking activity. (e) Regulatory assessments for deposit insurance and regular examinations have been increasing significantly in recent periods. (f) For information related to the fraud loss see Note 4 of our Consolidated Financial Statements. (g) Other expenses decreased primarily due to an impairment of goodwill aggregating $409 thousand in the third quarter of 2009. Income Tax Expense Tax expense of $72 thousand was recognized in 2010. Although the Company has net operating loss carryforwards aggregating $3.657 million for federal tax purposes, a provision for taxes was recorded for state tax obligations. Due to tax loss carryforwards and attributes related to net deferred tax assets, the Company is not likely to record income tax expense for several profitable periods. In 2009, the tax benefit was $1.625 million, or 8.0% of pre-tax losses. 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. 11 Financial Condition Assets The following table presents our assets by category (dollars are in thousands): As of December 31, 2010 2009 Increase (Decrease) 2010 – 2009 $ % Cash and cash equivalents $ 112,847 $ 35,362 $ 77,485 219 % (a) Investment securities available for sale 137,032 212,661 (75,629) (36) % (b) Federal Reserve Bank and Federal Home Loan Bank of Des Moines stock Loans held for sale-mortgage banking Participating interests in mortgage loans Loans and leases held for investment, net Other loans held for sale Other real estate, net Premises and equipment, net Interest receivable Other assets Premises and equipment held for sale, net 2,862 29,116 4,888 335,736 70,501 12,706 16,684 2,138 19,790 2,769 3,048 24,130 38,534 499,061 (186) (6) % (c) 4,986 21 % (d) (33,646) (87) % (e) (163,325) (33) % (f) - 70,501 100 % (g) 7,253 20,422 2,970 5,453 75 % (h) (3,738) (18) % (i) (832) (28) % (j) 24,642 (4,852) (20) % (k) - 2,769 100 % (i) Total assets $ 747,069 $ 868,083 $ (121,014) (14) % (a) We have been increasing liquid assets as part of a focus on managing liquidity and maintaining funds to finance the sale of deposits. As a result, cash balances increased. Cash balances can also vary significantly on a daily basis. (b) Investments decreased due to sales and repayments. Proceeds have been held in cash and cash equivalents. (c) Investments in these stocks are mandated by third parities. Our required investment decreased due to reduced FHLB advances. (d) Loans held for sale–mortgage banking have increased as we expanded mortgage banking operations. (e) Participating interests in mortgage loans represent loans purchased from counterparties who service the assets for us. In 2010 the balances decreased because one of the counterparties committed fraud. These balances will vary depending on the volume of loans originated by the counterparties. See Note 4 of our Consolidated Financial Statements. (f) 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. (g) In November 2010, we entered into an agreement to sell certain loans. See Note 3 of our Consolidated Financial Statements. (h) ORE increased due to more foreclosure activity. See Note 10 of our Consolidated Financial Statements.. (i) As part of the agreement to sell certain assets and liabilities as announced in November, 2010, we agreed to sell certain premises and equipment. See Note 3 of our Consolidated Financial Statements. (j) Accrued interest receivable decreased due to lower rates and lower balances of earning assets. (k) Other assets decreased due to the receipt of tax refunds in 2010 related to loss carryback periods. 12 Investment Securities Available for Sale The following table presents the composition of the available-for-sale investment portfolio (in thousands): Investment Portfolio Composition 2010 December 31, 2009 2008 Amortized cost Estimated fair market value Amortized cost Estimated fair market value Amortized cost Estimated fair market Value $ 965 $ 1,000 $ 1,223 $ 1,262 $ 1,505 $ 1,543 1,863 1,978 2,500 2,599 2,891 2,917 89,056 89,689 86,600 87,017 23,037 23,170 930 997 1,797 1,887 37,896 39,024 39,518 1,911 41,255 2,113 118,375 2,521 117,211 2,685 138,851 13,482 129,185 14,018 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 $ 134,243 $ 137,032 $ 213,016 $ 212,661 $ 217,662 $ 209,857 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, 2010 (dollars are in thousands): Investment Portfolio 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 obligations(2) (3) State and municipal bonds(2) Total book value of investment $ - 0.00% $ - 0.00% - 0.00% - 0.00% - 0.00% - - - - - 0.00% $ 965 5.52% $ - 0.00% $ 965 5.52% 0.00% - 0.00% 1,863 6.50% 1,863 6.55% 0.00% 5,142 0.91% 83,914 2.65% 89,056 2.55% 0.00% 184 7.56% 746 6.06% 930 6.35% 0.00% 3,660 8.16% 35,858 8.82% 39,518 8.76% - 0.00% - 0.00% 1,139 7.55% 772 8.02% 1,911 7.74% securities $ - 0.00% $ - 0.00% $ 11,090 4.50% $ 123,153 4.56% $ 134,243 4.55% Unrealized holding gain on securities available for sale Total investment in securities available for sale 2,789 $ 137,032 4.46% (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 As of December 31, 2010, we had $137.0 million of available-for-sale securities in the investment portfolio compared to $212.7 million and $209.9 million at December 31, 2009 and 2008, respectively. In 2010, investment securities decreased through sales and principal paydowns in order to manage liquidity and capital. Net unrealized losses decreased and the portfolio had net unrealized gains as of December 31, 2010. The unrealized gains are due to the narrowing of credit spread, the return of principal on securities, and the general decline in market interest rates. During 2010, we realized $4.390 million of gains on sales of securities. See Notes 1 and 6 of our Consolidated Financial Statements for a discussion of impairment assessments. At December 31, 2010, we held four securities, other than U.S. Government Agency CMOs, that exceeded 10% of stockholders’ equity. The total carrying value of these four securities was $20.7 million. A significant portion of our investment securities portfolio was pledged as collateral. See Note 6 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 $1.8 million of Federal Reserve Bank (“FRB”) stock as of December 31, 2010 and $1.3 million as of December 31, 2009, and $1.1 million and $1.8 million of FHLB of Des Moines stock as of December 31, 2010 and 2009, respectively. Loan Portfolio The following table presents the composition of our loan portfolio (dollars are in thousands): 2010 2009 2008 2007 2006 December 31, Loans and Leases, excluding Loans Held for Sale- Mortgage Banking Other Loans Held for Sale Total Loans and Leases Held for Total Loans and Leases Held for Total Loans and Leases Held for Total Loans and Leases Held for Total Loans and Leases Held for Investment % Investment % Investment % Investment % Investment % Commercial and industrial $ 93,859 $ 17,242 $ 76,617 22.5 $ 124,773 23.2 $ 138,671 24.6 $ 125,555 24.4 $ 100,127 25.9 Real estate mortgage 262,597 50,745 211,852 62.2 266,051 49.5 265,360 47.2 181,000 35.1 124,551 32.2 Real estate construction Participating interests in mortgage loans Agricultural Other 44,289 3,303 40,986 12.0 96,327 17.9 108,713 19.3 167,345 32.5 89,619 23.2 4,888 - 4,888 1.4 38,534 7.2 28,584 5.1 24,357 4.7 56,125 14.5 15,114 - 15,114 4.4 23,142 4.3 22,023 3.9 17,074 3.3 14,286 3.7 7,211 982 6,229 1.8 7,397 1.4 8,793 1.5 7,693 1.5 6,037 1.6 Total principal amount of loans 427,958 Unearned income and net 72,272 355,686 104.4 556,224 103.5 572,144 101.6 523,024 101.5 390,745 101.0 unamortized deferred fees and costs Loans, net of unearned income and unamortized fees and costs (357) (60) (297) (0.1) (582) (0.1) (807) (0.1) (1,111) (0.2) (686) (0.2) 427,601 72,212 355,389 104.3 555,642 103.4 571,337 101.5 521,913 101.3 390,059 100.9 Less allowance for credit losses (16,476) (1,711) (14,765) (4.3) (18,047) (3.4) (8,751) (1.5) (6,599) (1.3) (3,370) (0.9) Net loans $ 411,125 $ 70,501 $ 340,624 100.0 $ 537,595 100.0 $ 562,586 100.0 $ 515,314 100.0 $ 386,689 100.0 14 Change in Loan Portfolio Composition As of December 31, Increase (Decrease) 2010 – 2009 2010 2009 $ % Loans and Leases, excluding Loans Held for Sale- Mortgage Banking Other Loans Held for Sale Total Loans and Leases Held for Investment Total Loans and Leases Held for Investment Commercial and industrial $ 93,859 $ 17,242 $ 76,617 $ 124,773 $ (48,156) (39)% Real estate mortgage Real estate construction 262,597 50,745 211,852 266,051 (54,199) (20)% 44,289 3,303 40,986 96,327 (55,341) (57)% Participating interests in mortgage loans 4,888 - 4,888 38,534 (33,646) (87)% Agricultural Other Total principal amount of loans Unearned income and net unamortized deferred fees and costs Loans, net of unearned income and unamortized fees and costs 15,114 - 15,114 23,142 (8,028) (35)% 7,211 982 6,229 7,397 (1,168) (16)% 427,958 72,272 355,686 556,224 (200,538) (36)% (357) (60) (297) (582) 285 (49)% 427,601 72,212 355,389 555,642 (200,253) (36)% Less allowance for credit losses (16,476) (1,711) (14,765) (18,047) 3,282 (18)% Net loans $ 411,125 $ 70,501 $ 340,624 $ 537,595 $ (196,971) (37)% (a) (a) (b) (c) (a) (a) Loan balances have generally decreased due to repayments, charge-offs and our efforts to reduce credit exposure. Loans held for investment have also declined as a result of an agreement entered into in November 2010 to sell certain loans. See Note 3 of our Consolidated Financial Statements. (b) Construction loans have decreased because certain projects under construction have been completed and certain problem loans were charged-off during the year. (c) Participating interests in mortgage loans represent loans purchased from counterparties who service the assets for us. In 2010, the balances decreased because one of the counterparties committed fraud. These balances will vary depending on the volume of loans originated by the counterparties. See Note 4 of our Consolidated Financial Statements. 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. 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) $ 2010 2009 2008 2007 2006 259,939 330,204 315,469 201,776 188,994 15 Concentrations of Credit The following tables summarize the location of our borrowers as of December 31 (in thousands): 2010 Loans and Leases, excluding Loans Held for Sale- Mortgage Banking Other Loans Held for Sale Total Loans and Leases Held for Investment 2009 Total Loans and Leases Held for Investment $ 172,698 $ 2,116 $ 170,582 48 % $ 199,831 36 % 126,461 71,943 56,856 36,206 31,125 2,825 90,255 25 40,818 12 54,031 15 154,007 125,579 76,807 28 22 14 427,958 72,272 355,686 100 % 556,224 100 % North Dakota Minnesota Arizona Other Total gross loans held for investment Unearned income and net unamortized deferred fees and costs Allowance for credit losses (16,476) (1,711) (14,765) (357) (60) (297) (582) (18,047) Net loans and leases $ 411,125 $ 70,501 $ 340,624 $ 537,595 16 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): Loans and Leases, excluding Loans Held for Sale- Mortgage Banking 2010 Other Loans Held for Sale Total Loans and Leases Held for Investment 2009 Total Loans and Leases Held for Investment North Dakota $ 162,364 $ - $ 162,364 46 % $ 184,282 33 % Arizona California Minnesota Texas Kentucky Idaho Wisconsin Colorado Georgia Other Total gross loans held for investment Unearned income and net unamortized deferred fees and costs 84,966 31,736 56,985 28,108 10,717 9,095 7,515 6,333 6,323 23,816 33,335 40 29,537 1,347 - - 515 - 1,674 5,824 51,631 31,696 27,448 26,761 10,717 9,095 7,000 6,333 4,649 17,992 14 9 8 7 3 3 2 2 1 5 134,967 39,848 81,514 28,944 11,927 9,292 9,840 - 6,465 49,145 24 7 15 5 2 2 2 - 1 9 427,958 72,272 355,686 100 % 556,224 100 % (357) (60) (297) (582) (18,047) Allowance for credit losses (16,476) (1,711) (14,765) Net loans and leases $ 411,125 $ 70,501 $ 340,624 $ 537,595 17 The following table presents loans by type within our three primary states as of December 31 (in thousands): Loans and Leases, excluding Loans Held for Sale- Mortgage Banking 2010 Other Loans Held for Sale Total Loans and Leases Held for Investment 2009 Total Loans and Leases Held for Investment North Dakota Commercial and industrial $ 80,536 $ - $ 80,536 $ 84,400 Construction Agricultural Land and land development Owner-occupied commercial real estate Non-owner-occupied commercial real estate Small business administration Consumer/participating interests 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/participating interests 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/participating interests Subtotal $ $ $ $ 1,029 13,673 10,682 24,941 12,567 3,116 15,820 162,364 9,243 - - 8,621 19,286 28,560 8,937 10,319 84,966 3,656 2,002 30 7,903 16,555 19,524 885 6,430 $ $ $ $ - - - 1,029 13,673 10,682 4,572 22,422 12,321 - 24,941 27,960 - 12,567 12,419 - - 3,116 15,820 - $ 162,364 8,637 $ 606 - - - - - 8,621 $ $ 2,434 17,754 184,282 19,740 2,136 - 18,541 18,472 814 23,508 1,763 26,797 32,497 $ $ 1,491 2,972 7,446 7,347 33,335 $ 51,631 3,029 $ 627 - 2,002 - 3,303 15,819 2,102 827 4,457 30 4,600 736 17,422 58 1,973 5,042 33,503 134,967 10,589 4,698 33 12,641 18,675 25,203 1,025 8,650 $ 56,985 $ 29,537 $ 27,448 $ 81,514 18 Loan Maturities The following table sets forth the remaining maturities of loans in our portfolio as of December 31, 2010 (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 Loans and Leases Held for Investment $ 37,288 64,431 18,138 $ 25,081 65,097 6,014 $ 1,075 39,966 12,412 $ 7,342 $ 5,831 23,851 4,101 18,507 321 $ 76,617 211,852 40,986 4,888 4,838 1,907 $ 131,490 - 6,410 3,326 $ 105,928 - 705 290 $ 54,448 - - 625 100 2,536 606 $ 26,895 $ 36,925 4,888 15,114 6,229 $ 355,686 (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 inherent in the loan and lease portfolio as of each balance sheet date. The provision for credit losses for the year ended December 31, 2010 was $5.750 million as compared to $27.000 million in 2009. The higher provision for credit losses in recent periods reflects macroeconomic forces which impaired the ability of borrowers to repay debt which resulted in higher credit losses throughout the financial industry. During 2009, our nonperforming loans increased significantly and our provision for credit losses increased accordingly. In 2010, the balance of our nonperforming loans decreased significantly which contributed to the decrease in our provision for credit losses. 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. 19 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 Transferred to other loans held for sale Balance of allowance for credit losses, end of 2010 2009 2008 2007 2006 $ 18,047 $ 8,751 $ 6,599 $ 3,370 $ 3,188 (3,732) (735) (3,238) - (81) (7,786) 19 309 127 - 10 465 (7,321) (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) 5,750 27,000 7,750 3,750 16,476 18,047 (1,711) - 8,751 - 6,599 - (19) - - - (32) (51) 3 - - - 20 23 (28) 210 3,370 - period $ 14,765 $ 18,047 $ 8,751 $ 6,599 $ 3,370 Ratio of net charge-offs to average total loans Ratio of net charge-offs to average loans and (1.387)% (2.948)% (0.507)% (0.121)% (0.008)% leases held for investment (1.530)% (3.235)% (0.534)% (0.129)% (0.008)% Average gross loans and leases held for investment Ratio of allowance for credit losses to loans and leases held for investment(1) Ratio of allowance for credit losses to loans and leases held for investment(2) Ratio of allowance for credit losses to total nonperforming loans(1) Ratio of allowance for credit losses to total nonperforming loans(2) Allowance for credit losses to total loans(1) Allowance for credit losses to total loans(2) (1) Excluding impact of pending sale (2) Including impact of pending sale $ 478,492 $ 547,336 $ 525,311 $ 402,615 $ 334,058 4.70% 4.21% 92% 83% 3.62% 3.84% 3.49% 1.61% 1.33% 1.01% - 50% - 3.11% - - 38% - 1.50% - - - 122% 3,304% - 1.26% - - 0.86% - The allowance for credit losses has been elevated in recent periods because of an increase in nonperforming assets and deteriorating economic conditions. See Notes 1 and 9 of our Consolidated Financial Statements and “Critical Accounting Policies” for further information concerning accounting policies associated with the allowance for credit losses. 20 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) December 31, 2010 2009 2008 2007 2006 Loans in Category as a Percentage of Total Gross Loans and Leases Held for Investment Total Loans and Leases Held for Investment Allowance Loans in Category as a Percentage of Total Gross Loans and Leases Held for Investment Total Loans and Leases Held for Investment Allowance Loans in Category as a Percentage of Total Gross Loans and Leases Held for Investment Loans in Category as a Percentage of Total Gross Loans and Leases Held for Investment Total Loans and Leases Held for Investment Allowance Loans in Category as a Percentage of Total Gross Loans and Leases Held for Investment Total Loans and Leases Held for Investment Allowance Total Loans and Leases Held for Investment Allowance Loans and Leases Allowance Other Loans Held for Sale Allowance Commercial and industrial (a) Real estate mortgage (b) Real estate $ 1,653 $ 575 $ 1,078 22% $ 5,779 23% $ 1,268 24% $ 1,410 24% $ 1,602 26% 12,493 1,087 11,406 60% 6,672 48% 2,829 47% 1,956 35% 838 32% construction (a) 2,031 36 1,995 11% 4,692 17% 4,293 19% 2,740 32% 534 23% Participating interests in mortgage loans 14 - 14 Agricultural 174 - 174 111 13 98 Other Total 1% 4% 2% 105 704 95 7% 4% 1% 86 180 95 5% 4% 1% 85 276 132 5% 3% 1% 140 14% 171 85 4% 1% $ 16,476 $ 1,711 $ 14,765 100% $ 18,047 100% $ 8,751 100% $ 6,599 100% $ 3,370 100% (a) The portion of the allowance allocated to these types of loans decreased in recent periods due to lower principal balances for these loan types. (b) The portion of our allowance allocated to these types of loans increased in recent 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 established the allowance for credit losses to cover for estimated losses inherent to the loans and lease portfolio at December 31, 2010. 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. 21 Nonperforming Loans and Assets The following table sets forth nonperforming assets, the allowance for credit losses and certain related ratios (dollars are in thousands): Nonperforming loans: Loans 90 days or more delinquent and still accruing interest Non-accrual 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 total nonperforming loans(1) Ratio of allowance for credit losses to total nonperforming loans(2) (1) Excluding impact of pending sale (2) Including impact of pending sale 2010 2009 December 31, 2008 2007 2006 $ - 17,862 17,862 12,706 $ 30,568 14,765 $ 3.93% $ 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% $ $ 5.10% 4.09% 6.94% 4.97% 4.22% 3.84% 1.09% 0.77% 0.03% 0.02% 92% 50% 38% 122% 3,304% 83% - - - - Nonperforming Loans The following table sets forth information concerning our nonperforming loans as of December 31 (dollars are in thousands): 2010 2009 Balance, beginning of period Additions to nonperforming Charge-offs Reclassified back to performing Principal payments received Transferred to other real estate owned Balance, end of period $ $ 35,890 7,385 (3,991) (5,208) (4,882) (11,332) 17,862 $ $ 23,225 31,268 (8,421) (301) (1,749) (8,132) 35,890 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 2010 2009 $ 1,601 $ 1,827 427 23 $ 1,174 $ 1,804 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 22 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. 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 December 31 (in thousands): Restructured Loans Total Accrual Non-accrual $ 2010 2009 2008 2007 2006 $ 34,264 $ 14,337 2,379 2,585 54 17,390 1,291 - - - 16,874 13,046 2,379 2,585 54 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 10 of our Consolidated Financial Statements for information on other real estate owned. Impaired loans See Note 8 of our Consolidated Financial Statements for information on impaired loans. 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 $12.4 million and $22.0 million at December 31, 2010 and 2009, 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. 23 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 Non-interest-bearing held for sale Interest-bearing held for sale 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, 2010 2009 Increase (Decrease) 2010 – 2009 $ % $ 91,478 $ 98,658 $ (7,180) (7) % (a) 243,332 39,580 179,275 34,610 72,836 16,329 - - 24,134 852 4,704 2,618 709,748 37,321 280,571 52,222 324,512 - - 10,190 15,000 - 22,890 1,468 2,946 2,361 810,818 57,265 (37,239) (12,642) (145,237) 34,610 72,836 6,139 (15,000) - 1,244 (616) 1,758 257 (101,070) (19,944) (13) % (a) (24) % (b) (45) % (b) 100 % 100 % 60 % (c) (100) % (d) - % 5 % (42) % 60 % (e) 11 % (12) % (35) % stockholders’ equity $ 747,069 $ 868,083 $ (121,014) (14) % (a) These deposits decreased due to pending sale of certain deposits. See Note 3 of our Consolidated Financial Statements. These types of accounts fluctuate daily due to the cash management activities of our customers. (b) We have lowered rates paid on certificates of deposits in order to reduce the size of our balance sheet. (c) Short-term borrowings are primarily customer repurchase agreements. These balances can vary significantly depending on customer preferences. (d) FHLB advances have decreased as the growth in deposits has been used to reduce borrowings. (e) In 2010, we suspended payment on our dividends to preferred stockholders. Approximately $1.1 million of this increase relates to dividends accrued and not paid. 24 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, 2010 Percent of deposits Wgtd. avg. rate Average balance 2009 Percent of deposits Average balance 2008 Wgtd. avg. rate Average balance Percent Wgtd. avg. rate of deposits $ 282,880 11,156 40.55% 1.60% 0.61% $ 266,537 11,685 0.10% 36.60% 1.61% 0.89% 0.11% $ 244,279 9,859 39.96% 1.67% 1.61% 0.33% 241,036 45,083 34.55% 6.46% 2.52% 2.21% 324,902 47,358 286,119 41.01% 2.47% 372,260 44.62% 6.50% 51.12% 2.66% 2.83% 232,367 58,378 38.01% 3.87% 9.55% 3.44% 2.68% 290,745 47.56% 3.78% 580,155 83.16% 1.52% 650,482 89.33% 1.90% 544,883 89.14% 2.77% 117,459 16.84% - 77,736 10.67% - 66,388 10.86% - 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 $ 697,614 100.00% 1.26% $ 728,218 100.00% 1.70% $ 611,271 100.00% 2.47% Time deposits, in denominations of $100,000 and over, totaled $39.6 million at December 31, 2010 as compared to $52.2 million at December 31, 2009. The following table sets forth the amount and maturities of time deposits of $100,000 and over as of December 31, 2010 (in thousands): Time Deposits of $100,000 and Over Deposits Maturing in: 3 months or less Over 3 months through 6 months Over 6 months through 12 months Over 12 months $ Time Deposits 8,387 8,523 18,193 9,312 44,415 $ Held for Sale $ 1,463 140 2,274 958 4,835 $ Time Deposits, net 6,924 8,383 15,919 8,354 39,580 $ $ 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 2010 2009 2008 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 $ $ $ 16,329 0.48% 16,329 11,163 0.65% $ $ $ 10,190 0.70% 23,818 17,953 1.00% $ $ $ 16,844 0.88% 16,844 7,049 2.04% Note 13 of our Consolidated Financial Statements summarizes the general terms of our short-term borrowings outstanding at December 31, 2010 and 2009. 25 FHLB advances totaled $0 million and $15.0 million at December 31, 2010 and 2009, respectively, while long- term borrowings totaled $0, for the same periods. Notes 14 and 15 of our Consolidated Financial Statements summarize the general terms of our FHLB advances and other borrowings at December 31, 2010 and 2009. Guaranteed Preferred Beneficial Interests in Company’s Subordinated Debentures See Note 16 of our Consolidated Financial Statements for a description of the subordinated debentures. Capital Resources and Expenditures Tier 1 leverage (Consolidated) Tier 1 risk-based capital (Consolidated) Total risk-based capital (Consolidated) Tangible common equity (Consolidated) Tier 1 leverage (BNC National Bank) Tier 1 risk-based capital (BNC National Bank) Total risk-based capital (BNC National Bank) 2010 2006 2009 8.58% 2008 2007 6.17% 9.01% 12.01% 7.12% 9.49% 12.32% 11.15% 12.58% 9.49% 13.28% 14.15% 12.95% 14.26% 10.89% 6.21% 2.24% 8.47% 3.72% 9.34% 12.57% 7.70% 7.53% 11.57% 12.25% 11.56% 13.18% 10.26% 12.85% 13.52% 12.81% 14.26% 10.94% 4.23% 8.54% 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 21 and 22 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. See Note 21 of our Consolidated Financial Statements. 26 At December 31, 2010, the aggregate contractual obligations (excluding bank deposits) 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 Commitments to sell loans Annual rental commitments under non-cancelable operating leases Total $ 16,329 28,734 $ - - $ - - $ 24,134 $ 40,463 28,734 - 665 $ 45,728 385 $ 385 285 285 $ 1,822 3,157 25,956 $ 72,354 $ 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 $ 90,225 $ 3,918 $ 2,496 $ 544 $ 97,183 2,394 $ 92,619 1,335 $ 5,253 - $ 2,496 3,729 $ 544 $ 100,912 - 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. 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 loss of income. 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 also manage for anticipated future funding needs and liquidity risk by projecting sources and uses of funds under normal as well as stressed environments. We have a targeted range of liquidity metrics and manage our operations such that these targets can be achieved. We believe 27 our policies and guidelines will provide for 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. Available borrowing capacity from the FHLB was approximately $76.1 million as of December 31, 2010. See Note 14 of our Consolidated Financial Statements. 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 Notes 1 and 18 of our Consolidated Financial Statements for a summary of our accounting policies pertaining to such instruments. 28 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, 2010 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, 2010 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, 2010, 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 2010 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 $ 22,327 $ 22,292 $ 35 0.16% - - $ $ 23,028 736 $ $ 23,549 1,257 $ $ 23,808 $ 23,992 1,516 $ 1,700 3.30% 5.64% 6.80% 7.63% 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, 2010 (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. The pending divestiture discussed in Note 3 of our Consolidated Financial Statements is expected to reduce net interest income, but interest rate sensitivity after the pending divestiture is expected to be similar to the table presented above. 29 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, 2010. 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, 2010 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 $ 112,847 $ - $ - $ - $ 112,847 Investment securities FRB and FHLB stock Fed Funds Sold 12,864 32,433 51,806 39,929 137,032 2,862 - - - 2,862 - - - - - Loans held for sale-mortgage banking, fixed rate - 29,116 - - 29,116 Loans held for sale-mortgage banking, floating rate - - - - - Other loans held for sale, fixed rate 73 3,776 29,348 4,599 37,796 Other loans held for sale, floating rate 28,202 637 3,866 - 32,705 Loans held for investment, fixed rate 37,828 49,289 71,235 10,692 169,044 Loans held for investment, floating rate 171,414 1,500 13,431 - 186,345 Total interest-earning assets $ 366,090 $ 116,751 $ 169,686 $ 55,220 $ 707,747 Interest-bearing liabilities: Interest checking and money market accounts $ 232,586 $ - $ - $ - $ 232,586 Interest checking and money market accounts held for sale Savings Savings held for sale Time deposits under $100,000 Time deposits $100,000 and over 46,798 - - - 46,798 11,709 - - - 11,709 963 - - - 963 30,233 60,421 38,319 50,302 179,275 4,510 25,759 9,311 - 39,580 Time deposits under $100,000 held for sale 17,577 2,611 52 - 20,240 Time deposits $100,000 and over held for sale 3,877 958 - - 4,835 Short-term borrowings FHLB advances Other borrowings Subordinated debentures 16,329 - - - 16,329 - - - - - - - - - - 15,000 - - 9,134 24,134 Total interest-bearing liabilities $ 379,582 $ 89,749 $ 47,682 $ 59,436 $ 576,449 Interest rate gap $ (13,492) $ 27,002 $ 122,004 $ (4,216) $ 131,298 Cumulative interest rate gap at December 31, 2010 $ (13,492) $ 13,510 $ 135,514 $ 131,298 Cumulative interest rate gap to total assets (1.81%) 1.81% 18.14% 17.58% 30 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. 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, 2010 and do not contemplate any actions we might undertake in response to changes in market interest rates. 31 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Independent Auditors’ Report Consolidated Balance Sheets as of December 31, 2010 and 2009 Consolidated Statements of Operations for the years ended December 31, 2010 and 2009 Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2010 and 2009 Page 33 34 35 36 Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2010 and 2009 37 Consolidated Statements of Cash Flows for the years ended December 31, 2010 and 2009 Notes to Consolidated Financial Statements 38 40 32 Independent Auditors’ Report The Board of Directors and Stockholders BNCCORP, INC.: We have audited the accompanying consolidated balance sheets of BNCCORP, INC. and subsidiaries (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of BNCCORP, INC. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles. Omaha, Nebraska March 22, 2011 “ KPMG LLP Suite 1501 222 South 15th Street Omaha, NE 68102-1610 Suite 1600 233 South 13th Street Lincoln, NE 68508-2041 KPMG LLP is a Delaware limited liability partnership, the U.S. member firm of KPMG International Cooperative (“KPMG International”), a Swiss entity. Financial Statements FINANCIAL INFORMATION BNCCORP, INC. AND SUBSIDIARIES Consolidated Balance Sheets As of December 31 (In thousands, except share data) ASSETS 2010 2009 CASH AND CASH EQUIVALENTS INVESTMENT SECURITIES AVAILABLE FOR SALE FEDERAL RESERVE BANK AND FEDERAL HOME LOAN BANK STOCK LOANS HELD FOR SALE-MORTGAGE BANKING PARTICIPATING INTERESTS IN MORTGAGE LOANS LOANS AND LEASES HELD FOR INVESTMENT ALLOWANCE FOR CREDIT LOSSES Net loans and leases held for investment OTHER LOANS HELD FOR SALE, net OTHER REAL ESTATE, net PREMISES AND EQUIPMENT, net INTEREST RECEIVABLE OTHER ASSETS PREMISES AND EQUIPMENT HELD FOR SALE, net 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 Non-interest-bearing held for sale Interest-bearing held for sale 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 outstanding; Preferred Stock - 9% Series B 1,005 shares outstanding; Common stock, $.01 par value – Authorized 35,000,000 shares; 3,304,339 and 3,290,219 shares issued and outstanding Capital surplus – common stock Retained earnings (deficit) Treasury stock (364,314 and 363,434 shares, respectively) Accumulated other comprehensive gain (loss), net Total stockholders’ equity Total liabilities and stockholders’ equity $ $ 112,847 137,032 2,862 29,116 4,888 350,501 (14,765) 340,624 70,501 12,706 16,684 2,138 19,790 2,769 747,069 $ $ 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 $ 91,478 $ 98,658 243,332 39,580 179,275 34,610 72,836 661,111 16,329 - - 24,134 852 4,704 2,618 709,748 280,571 52,222 324,512 - - 755,963 10,190 15,000 - 22,890 1,468 2,946 2,361 810,818 19,411 1,075 19,187 1,098 33 27,036 (7,322) (5,069) 2,157 37,321 747,069 $ 33 26,885 16,078 (5,068) (948) 57,265 868,083 $ See accompanying notes to consolidated financial statements. 34 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 securities, net Other Total non-interest income NON-INTEREST EXPENSE: Salaries and employee benefits Professional services Other real estate costs Occupancy Data processing fees Regulatory costs Marketing and promotion Depreciation and amortization Office supplies and postage Fraud loss on assets serviced by others Other Total non-interest expense Loss before income taxes Income tax expense (benefit) NET LOSS Preferred stock costs Net loss available to common shareholders Basic loss per common share Diluted loss per common share 2010 2009 $ 24,675 $ 29,774 8,613 93 129 33,510 8,808 73 113 - 1,244 10,238 23,272 5,750 14,261 409 144 44,588 12,386 179 1,078 3 1,253 14,899 29,689 27,000 17,522 2,689 2,533 2,133 13,424 371 4,390 1,122 23,973 16,080 5,068 2,707 2,885 2,697 1,951 1,372 1,333 603 26,231 2,561 63,488 (21,993) 72 (22,065) (1,333) (23,398) (7.13) (7.13) $ $ $ $ 2,332 2,056 8,390 (339) 2,850 724 16,013 15,008 3,064 8,169 2,508 2,330 1,466 1,277 1,465 611 - 3,205 39,103 (20,401) (1,625) (18,776) (1,254) (20,030) (6.14) (6.14) $ $ $ $ See accompanying notes to consolidated financial statements. 35 BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (Loss) For the Years Ended December 31 (In thousands) NET LOSS Unrealized gain (loss) on cash flow 2010 2009 $ (22,065) $ (18,776) hedge, net $ - $ (375) Amortization of deferred gain in other comprehensive income Unrealized gain on securities available for sale Reclassification adjustment for gains included in net income Other comprehensive income, before tax (40) 7,535 (4,390) 3,105 Income tax (expense) benefit related to items of other comprehensive income - (1,126) 10,299 (2,850) 5,948 (3,098) Other comprehensive income 3,105 3,105 2,850 2,850 TOTAL COMPREHENSIVE LOSS $ (18,960) $ (15,926) See accompanying notes to consolidated financial statements. 36  BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders’ Equity For the Years Ended December 31 (In thousands) Capital Surplus Accumulated Other Preferred Stock Common Stock Common Retained Treasury Comprehensive Shares Amount Shares Amount Stock Earnings Stock Income (Loss) Total BALANCE, December 31, 2008 - $ - 3,299,163 $ 33 $ 26,628 $ 36,104 $ (5,020) $ (3,798) $ 53,947 Net loss - - - - - (18,776) - - (18,776) Other comprehensive income - - - - - - - 2,850 2,850 Preferred stock issued 21,098 21,098 - - - - - - 21,098 Discount on preferred stock, net Preferred stock amortization, net Dividend on preferred stock Impact of share-based compensation - - - - (1,005) - - - - - - (1,005) 192 - - - (192) - - - - - - - (1,058) - - (1,058) - (8,944) - 257 - (48) - 209 BALANCE, December 31, 2009 21,098 $ 20,285 3,290,219 $ 33 $ 26,885 $ 16,078 $ (5,068) $ (948) $ 57,265 Net loss - - - - - (22,065) - - (22,065) Other comprehensive income - - - - - - - 3,105 3,105 Preferred stock amortization, net Dividend on preferred stock Impact of share-based compensation - - - 201 - - - (201) - - - - - - - (1,134) - - (1,134) - 14,120 - 151 - (1) - 150 BALANCE, December 31, 2010 21,098 $ 20,486 3,304,339 $ 33 $ 27,036 $ (7,322) $ (5,069) $ 2,157 $ 37,321 See accompanying notes to consolidated financial statements 37  BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Years Ended December 31 (In thousands) OPERATING ACTIVITIES: Net loss 2010 2009 $ (22,065) $ (18,776) Adjustments to reconcile net income to net cash provided by 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 Loss on disposals of bank premises and equipment, net Fraud loss on assets serviced by others Loss on sale of other real estate Bank premises and equipment, net charges associated with branch closure Gain on sale of branch Net realized gain on sales of investment securities Provision (benefit) for deferred income taxes Change in other liabilities, net (Gains) losses on sale of loans, net Proceeds from sales of loans Originations of loans held for sale Proceeds from sales of loans held for sale Fair value adjustment for loans held for sale Net cash provided by 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 decrease (increase) in participating interests in mortgage loans Net decrease (increase) in loans held for investment Proceeds from sales of other real estate Additions to bank premises and equipment Proceeds from sales of bank premises and equipment Net cash provided by (used in) investing activities 5,750 2,383 1,333 (269) 150 7,123 - 28 26,231 126 103 (403) (4,390) (1,243) 986 (371) 4,264 (662,095) 656,844 265 14,750 (49,946) 84,450 49,620 (556) 742 7,415 71,848 3,370 (604) 109 166,448 27,000 8,057 1,465 (2,836) 257 (5,656) 409 - - (1) - - (2,850) 2,473 (1,532) 339 10,565 (491,027) 480,279 21 8,187 (138,560) 71,553 76,021 - 2,941 (9,950) (11,094) 3,012 (1,091) 13 (7,155) See accompanying notes to consolidated financial statements. 38 BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, continued For the Years Ended December 31 (In thousands) FINANCING ACTIVITIES: Net (decrease) 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 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 taxes paid (received) 2010 2009 (94,852) 6,139 (20,000) 5,000 - - (103,713) 77,485 35,362 $ 112,847 $ 80,643 (6,654) (1,087,300) 1,017,800 20,093 (821) 23,761 24,793 10,569 35,362 $ 10,855 $ $ (6,166) $ 15,110 2,498 SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Additions to other real estate in settlement of loans $ 11,332 $ Transfer of net loans held for investment to loans held for sale $ 70,501 $ $ 2,769 $ Transfer of premises and equipment to premises and equipment held for sale Transfer of non-interest bearing deposits to non-interest bearing deposits held for sale $ 34,610 $ $ 72,836 $ Transfer of interest bearing deposits to interest bearing deposits held for sale 8,132 - - - - See accompanying notes to consolidated financial statements. 39 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 18 locations. The Bank also conducts mortgage banking from 10 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. Significant items subject to such estimates and assumptions include the useful lives of premises and equipment, allowance for credit losses, valuation of other real estate, income taxes and valuation and impairment of investment securities. 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 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: 40 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 impairment criteria 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 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. 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. For nonperforming or impaired loans, appraisals are generally performed annually or whenever circumstances warrant a new appraisal. Management regularly evaluates the appraised value and costs to liquidate in order to estimate fair value. 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. 41 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. 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: • Recent and expected performance of the securities; • Financial condition of issuers or guarantors; • Recent cash flows; • Seniority of invested tranches and subordinated credit support; • Vintage of origination; • Location of collateral; • Ratings of securities; • Value of underlying collateral; • Delinquency and foreclosure data; • Historical losses and estimated severity of future losses; • Credit surveillance data which summarize retrospective performance; and • 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 amended the accounting for other-than-temporary impairments into credit-related and other factors. Any credit- related impairments are realized through a charge to earnings. The amount of non-credit related impairments is recognized through comprehensive income, net of income taxes. Note 6 to these consolidated financial statements includes a summary of investment securities in a loss position at December 31, 2010 and 2009. 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. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. The Company determines fair value based on assumptions that market participants would use in pricing an asset or liability in the principal or most advantageous market. 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 42 unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. 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. 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, 2010 and 2009, 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, 2010 or 2009. 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-Mortgage Banking Loans held for sale-mortgage banking 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 (i.e. we own the loans) from 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 counterparties service BNC’s assets while they are outstanding. 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. 43 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 cash flows. 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. 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. 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 other real estate costs. 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. 44 During the years ended December 31, 2010 and 2009, an impairment charge of $0 and $409 thousand, respectively was recorded related to goodwill. Other Loans Held for Sale, Premises and Equipment Held for Sale and Deposits Held For Sale Other loans held for sale, premises and equipment held for sale and deposits held for sale are carried at the lower of the carrying amount or fair value less costs to sell. The Company does not record depreciation expense on long-lived assets held for sale. 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. 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-Mortgage Banking. Loans held for sale-mortgage banking 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. The estimated fair values are not exit prices. Other Loans Held for Sale. The fair value of other loans held for sale is determined by the agreed upon contractual selling price. 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. 45 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. Deposits Held for Sale. The fair value of deposits held for sale is determined by the agreed upon contractual price. 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. 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. The Company enters into interest rate lock commitments on certain mortgage loans, which are commitments to originate loans whereby the interest rate on the loan is determined prior to funding. The Company also has corresponding forward sales contracts related to these interest rate lock commitments. Both the mortgage loan commitments and the related forward sales contracts are accounted for as derivatives and carried at fair value with changes in fair value recorded in income. 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 46 were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. Such potential dilutive instruments include stock options and contingently issuable stock. Note 25 to these consolidated financial statements includes disclosure of the Company’s EPS calculations. 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, 2010, the Company had four stock-based employee compensation plans, which are described more fully in Note 28 to these consolidated financial statements. RECENTLY ISSUED OR ADOPTED ACCOUNTING PRONOUNCEMENTS FASB ASC 810, Consolidation, 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 were effective January 1, 2009. The adoption of ASC 810 did not have a material impact on our consolidated financial statements. 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 were effective for financial asset transfers occurring after December 31, 2009. The adoption of ASC 860 did not have a material impact on our consolidated financial statements. FASB ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820), Improving Disclosures and Fair Value Measurements, requires new investment fair market disclosures in order to increase the transparency in the financial reporting of investments. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010. The adoption of this ASU in 2010 did not have a material impact on the Company’s consolidated financial statements. FASB ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, requires significant new disclosures about the allowance for credit losses and the credit quality of financing receivables. The requirements are intended to enhance transparency regarding credit losses and the credit quality of loan and lease receivables. Under this statement, allowance for credit losses and fair value are to be disclosed by portfolio segment, while credit quality information, impaired financing receivables and nonaccrual status are to be presented by class of financing receivable. Disclosure of the nature and extent, the financial impact and segment information of troubled debt restructurings will also be required. The disclosures are to be presented at the level of disaggregation that management uses when assessing and monitoring the portfolio’s 47 risk and performance. This ASU is effective for reporting periods after December 15, 2011 for non-public companies. FASB ASU No. 2010-18, Receivables (Topic 310): Effect of a Loan Modification When the Loan Is Part of a Pool That is Accounted for as a Single Asset, clarifies the accounting for acquired loans that have evidence of a deterioration in credit quality since origination (referred to as “Subtopic 310-30 Loans”). Under this ASU, an entity may not apply troubled debt restructuring (“TDR”) accounting guidance to individual Subtopic 310-30 loans that are part of a pool, even if the modification of those loans would otherwise be considered a troubled debt restructuring. Once a pool is established, individual loans should not be removed from the pool unless the entity sells, forecloses, or writes off the loan. Entities would continue to consider whether the pool of loans is impaired if expected cash flows for the pool change. Subtopic 310-30 loans that are accounted for individually would continue to be subject to TDR accounting guidance. A one-time election to terminate accounting for loans as a pool, which may be made on a pool-by-pool basis, is provided upon adoption of the ASU. This ASU is effective for annual periods ending on or after July 15, 2010 and should be applied prospectively. Adoption of this ASU did not have a material effect on the Company's consolidated financial statements. RECLASSIFICATIONS Certain amounts in the consolidated 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. 48 NOTE 2. Regulatory Capital and Current Operating Environment BNCCORP and the Bank are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet capital requirements mandated by regulators can initiate certain mandatory and additional discretionary actions by regulators. Such actions, if undertaken, could have a direct material adverse effect on the Company’s financial condition and results of operations. 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. With increasing frequency, regulators are imposing capital requirements that are specific to individual institutions. The requirements are generally above the statutory ratios. Actual capital amounts and ratios of BNCCORP and the Bank as of December 31 are presented in the tables below (dollars in thousands): 2010 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 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 Actual To be Well Capitalized Amount Ratio Amount Ratio $ 65,601 63,380 13.23 % 12.80 $ N/A 49,515 N/A 10.0 % 46,885 57,106 9.46 11.53 46,885 57,106 37,226 59,622 6.17 7.53 4.98 8.00 N/A 29,709 N/A 37,932 N/A N/A N/A 6.0 N/A 5.0 N/A N/A 16,740 2.24 N/A N/A $ 89,102 85,195 14.15 % 13.52 N/A 63,017 N/A 10.0 % 77,617 77,192 12.32 12.25 77,617 77,192 57,018 74,989 8.58 8.54 6.57 8.65 N/A 37,810 N/A 45,187 N/A N/A N/A 6.0 N/A 5.0 N/A N/A 36,733 4.23 N/A N/A In the current operating environment, management believes banking entities are regularly required to maintain capital ratios in excess of the statutory amounts required to remain well capitalized. We are managing capital accordingly. After the pending divestiture discussed in Note 3 the regulatory capital ratios of the Bank will improve. 49 As of December 31, 2010, 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. 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 policies and procedures implemented in 2010 adequately addressed the articles summarized above. However, more time is needed before the OCC will remove the articles. In April 2010, BNCCORP entered into a memorandum of understanding that restricts dividend payments and/or payment of interest on the holding company’s common stock, preferred stock, and debt. Payments of this nature are not permitted without prior written approval from the Federal Reserve Bank. The memorandum of understanding also restricts the holding company from increasing debt without prior written consent from the Federal Reserve. NOTE 3. Pending Divestiture On November 19, 2010, the Bank entered into a definitive agreement to sell certain loans, premises and equipment and deposits in the Company’s Minnesota and Arizona markets. The transaction was approved by regulators in January 2011 and was completed in March of 2011. The Bank is not prohibited from continuing to service these markets as a result of this transaction, although the Bank has agreed not to solicit certain customers for a limited period of time following the closing. After the sale, the Company will continue to offer a full complement of banking, mortgage banking and wealth management services in North Dakota, Minnesota and Arizona. As of December 31, 2010, the assets and liabilities included in the divestiture have been classified as held for sale. As of December 31, 2010, the carrying value of the loans held for sale related to the divestiture was $70.5 million. The total loans held for sale as of December 31, 2010 is $72.2 million and the allowance for losses allocated to these loans at year end is $1.7 million. The carrying value of premises and equipment held for sale related to the divestiture was $2.8 million. The carrying value of deposits held for sale related to the divestiture was $107.5 million. There is no gain or loss expected to be incurred as a result of the divestiture. NOTE 4. Fraud Loss on Assets Serviced by Others In April of 2010, the Company discovered fraudulent activity perpetrated by an external company that was engaged to service residential mortgage loans for BNC. Since the discovery of this activity, the Company and its advisors have been diligently working to determine the scope of the loss and identify any remedies that may be available. In the second quarter, the Company determined the scope of the losses and recorded a loss of $26.231 million. Our internal and external investigations have confirmed that this fraudulent activity was limited to this external servicing company and that no bank employees were involved in or were aware of this wrongful conduct by the servicing company. As such, we believe these losses are not indicative of other credit quality problems within our loan portfolio. 50 In mid-year 2010, we submitted claims under our fidelity insurance policies seeking to recover the insured portion of these losses. The policies together provide for total coverage of $15 million. However, as of mid-October, our insurance carriers commenced a declaratory judgment action against the Company in an Arizona federal court seeking a judicial determination that the losses associated with the servicing fraud are not covered by the policies. We have subsequently filed a counter claim against the insurance carriers for failure to honor the policies and for acting in bad faith. This litigation commenced in early 2011; and we anticipate discovery procedures will take all of 2011 to complete. We intend to vigorously pursue our claims to recover amounts due under the insurance policies and for losses incurred as a result of our belief that the carriers acted in bad faith. While management believes we have strong claims, there can be no assurances as to the outcome of this litigation, or if we will recover all or any portion of the insured amounts. NOTE 5. 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, 2010 and 2009. NOTE 6. 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, 2010 or 2009. 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 2010 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value $ 965 $ 35 $ - $ 1,000 1,863 116 (1) 1,978 89,056 930 39,518 1,911 908 67 (275) 89,689 - 997 1,889 202 (152) - 41,255 2,113 $ 134,243 $ 3,217 $ (428) $ 137,032 51 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 86,600 102 531 (3) 2,599 (114) 87,017 1,797 90 - 1,887 118,375 2,521 3,349 164 (4,513) - 117,211 2,685 $ 213,016 $ 4,275 $ (4,630) $ 212,661 The amortized cost and estimated fair market value of available-for-sale securities classified according to their contractual maturities at December 31, 2010, 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 $ $ - - 11,090 123,153 134,243 $ $ Estimated Fair Value - - 11,490 125,542 137,032 For many types of investments, the actual payment will vary significantly from contractual maturities. Securities carried at approximately $74.0 million and $129.0 million at December 31, 2010 and 2009, 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 $ 2010 84,450 4,791 (401) $ 2009 71,553 2,850 - 52 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 2010 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 (1) 1 57 (1) 5 19,822 (275) - - - 5 19,822 (275) - - - - - - - - - obligations 2 339 (3) 2 7,276 (149) State and municipal bonds - - - - - - 4 - 7,615 (152) - - Total temporarily impaired securities 7 $ 20,161 $ (278) 3 $ 7,333 $ (150) 10 $ 27,494 $ (428) Description of Securities # Fair Value Unrealized Loss # Fair Value Unrealized Loss # Fair Value Unrealized Loss Less than 12 months 12 months or more Total 2009 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) State and municipal bonds - - - 8 - 22,591 (2,798) 16 52,213 - - - - (4,513) - Total temporarily impaired securities 14 $ 64,016 $ (1,829) 9 $ 22,648 $ (2,801) 23 $ 86,664 $ (4,630) 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. 53 For the non-agency securities with unrealized losses at December 31, 2010, 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. 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 2010 or 2009. NOTE 7. 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 2010 1,772 1,090 2,862 $ $ 2009 1,297 1,751 3,048 $ $ There is no contractual maturity on these investments; the investments are required by counterparties. 54 NOTE 8. Loans and Leases Loan Portfolio Composition The composition of loans and leases is as follows at December 31 (in thousands): Loans and Leases, excluding Loans Held for Sale- Mortgage Banking 2010 Other Loans Held for Sale Total Loans and Leases Held for Investment 2009 Total Loans and Leases Held for Investment Commercial and industrial $ 93,859 $ 17,242 $ 76,617 $ 124,773 Real estate: Mortgage Construction 262,597 50,745 211,852 266,051 44,289 3,303 40,986 96,327 Participating interests in mortgage loans 4,888 - 4,888 38,534 Agricultural Other 15,114 - 15,114 23,142 7,211 982 6,229 7,397 Total gross loans held for investment 427,958 72,272 355,686 556,224 Unearned income and net unamortized deferred fees and costs (357) (60) (297) (582) Loans, net of unearned income and unamortized fees and costs Allowance for credit losses Net loans and leases 427,601 72,212 355,389 555,642 (16,476) (1,711) (14,765) (18,047) $ 411,125 $ 70,501 $ 340,624 $ 537,595 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. 55 Impaired Loans As of December 31, the Bank’s recorded investment in impaired loans and the related valuation allowance was as follows (in thousands): 2010 2009 Recorded Investment Valuation Allowance Recorded Investment Valuation Allowance Impaired loans - Valuation allowance required $ 17,819 $ 2,710 $ 33,821 $ 3,998 No valuation allowance required 43 - 2,377 - Total impaired loans $ 17,862 $ 2,710 $ 36,198 $ 3,998 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 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 $ 19,964 $ 37,766 Average recorded investment in impaired loans as a percentage of average total loans 3.73% 6.29% 2010 2009 Year Ended December 31, 2010 Year Ended December 31, 2009 Interest income recognized on impaired loans $ 208 $ Interest income recognized on a cash basis during the time of impairment - 1 1 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 - $ 1 17,862 35,889 Total nonperforming loans $ 17,862 $ 35,890 2010 2009 The table below summarizes the amounts of restructured loans as of the dates indicated (in thousands): Restructured loans December 31, 2010 $ 34,264 2009 $ 14,337 Loans to Related Parties Note 23 to these consolidated financial statements includes information relating to loans to executive officers, directors, principal shareholders and associates of such persons. 56 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 of unamortized deferred fees and costs. At December 31, 2010, the future minimum annual lease payments for direct finance lease obligations were as follows (in thousands): 2011 2012 2013 2014 2015 Thereafter Total future minimum lease payments Unguaranteed residual values Total all payments Unearned income Net outstanding principal amount $ $ 225 24 - - - - 249 243 492 (22) 470 Loans Pledged as Collateral The table below presents loans pledged as collateral to the Federal Home Loan Bank, Federal Reserve Bank, and the Bank of North Dakota as of December 31(in thousands): Commercial and industrial Real estate mortgage Real estate construction Agricultural Loans held for sale 2010 2009 $ 9,706 130,016 - 2,370 $ 5,770 139,317 3,897 - - $ 142,092 22,826 $ 171,810 NOTE 9. 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 Loan recoveries Transferred to other loans held for sale 2010 2009 $ 18,047 $ 5,750 8,751 27,000 (7,786) (17,876) 465 16,476 (1,711) 172 18,047 - Balance end of year $ 14,765 $ 18,047 57 NOTE 10. 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 2010 7,253 11,332 (3,370) (126) (2,383) 12,706 $ $ 2009 10,189 8,132 (3,012) 1 (8,057) 7,253 $ $ NOTE 11. 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 2010 5,220 11,393 1,611 9,133 27,357 (10,673) 16,684 $ $ 2009 6,692 12,957 1,807 9,440 30,896 (10,474) 20,422 $ $ Depreciation and amortization expense totaled approximately $1.3 million and $1.5 million for the years ended December 31, 2010 and 2009, respectively. NOTE 12. Deposits The scheduled maturities of time deposits as of December 31, 2010 are as follows (in thousands): 2011 2012 2013 2014 2015 Thereafter Time Deposits $ $ 145,946 24,019 5,314 10,946 7,403 50,302 243,930 Deposits- Held for Sale $ $ 21,454 3,196 373 52 - - 25,075 $ $ Time Deposits, net 124,492 20,823 4,941 10,894 7,403 50,302 218,855 At December 31, 2010 and 2009, the Bank had $67.0 million and $115.8 million, respectively, of time deposits that had been acquired through a broker. 58 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 2010 11 659 1,070 7,068 8,808 $ $ 2009 13 349 2,028 9,996 12,386 $ $ Deposits Received from Related Parties Note 23 to these consolidated financial statements includes information relating to deposits received from executive officers, directors, principal shareholders and associates of such persons. NOTE 13. 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 reserve borrowings-U. S. Treasury tax and loan retainer Repurchase agreements with customers, renewable daily, interest payable monthly, rates ranging from 0.25% to 0.90% in 2010, and 0.50% to 1.15% in 2009, secured by government agency collateralized mortgage obligations 2010 2009 $ 2,000 $ 1,315 14,329 8,875 $ 16,329 $ 10,190 The weighted average interest rate on short-term borrowings outstanding as of December 31, 2010 and 2009 was 0.48% and 0.70%, 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, 2010, $14.3 million of securities sold under repurchase agreements, with a weighted average interest rate of 0.56%, maturing in 2010, were collateralized by government agency collateralized mortgage obligations having a market value of $23.7 million and unamortized principal balances of $22.5 million. 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 market value of $19.5 million and unamortized principal balances of $19.4 million. 59 NOTE 14. Federal Home Loan Bank Advances FHLB advances consisted of the following at December 31 (in thousands): Year of Maturity 2010 2013 2015 Amount $ $ - - - - 2010 Weighted Average Rate 2009 Weighted Average Rate Amount - % $ - - - % - 15,000 - 15,000 - % 3.99 - 3.99 % As of December 31, 2010, the Bank had $0 of FHLB advances outstanding. On March 10, 2010 the Bank exercised its option to repay the $15.0 million advance maturing in 2013 that was outstanding as of December 31, 2009. The Bank exercised this option without a prepayment penalty. At December 31, 2010, the Bank has mortgage loans with unamortized principal balances of approximately $125.1 million and securities with unamortized principal balances of approximately $21.9 million which were pledged as collateral to the FHLB. The Bank has the ability to draw advances up to approximately $76 million based upon the mortgage loans and securities that are currently pledged, subject to a requirement to purchase additional FHLB stock. At December 31, 2010 the Bank’s ability to borrow funds from the FHLB is limited to borrowings of a short maturity, (i.e. 30 days or less). NOTE 15. Other Borrowings As of December 31, 2010, BNC National Bank had a secured federal funds line with the Bank of North Dakota. No funds were advanced on the line as of December 31, 2010 and 2009. Interest on the line if advanced upon would be at the federal funds rate. The line is secured by marketable securities with a carrying value of $6.2 million as of December 31, 2010 resulting in unused borrowing capacity of $5.0 million. NOTE 16. Guaranteed Preferred Beneficial Interest’s in Company’s Subordinated Debentures In July 2007, BNCCORP issued $15.0 million of floating rate subordinated debentures. The interest rate paid on the securities is equal to the three month LIBOR plus 1.40%. The interest rate at December 31, 2010 was 1.69% and the interest rate reset on January 3, 2011 to 1.70%. The subordinated debentures mature on October 1, 2037. On or after October 1, 2012, the subordinated debentures 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 subordinated debentures at 12.05%. The subordinated debentures are subject to mandatory redemption on July 19, 2030. On or after July 19, 2010, the subordinated debentures 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. Commencing in January 2010, BNCCORP deferred interest payments on its subordinated debentures as it is permitted pursuant to contractual terms of the agreements. While the subordinated debenture agreements permit interest to be deferred for up to 60 months, interest on the subordinated debentures continues to accrue during deferment and has been recorded in the consolidated financial statements at December 31, 2010. The agreements that contractually permit the deferral of interest on the subordinated debentures require that dividends on junior securities be suspended while interest payments on the subordinated debentures are deferred. 60 NOTE 17. 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 as of December 31, 2010 and 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, 2010 and 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 was contractually required to cease payment of dividends on the CPP preferred stock beginning with the quarterly payment due February 2010. 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 six consecutive quarters. The Company has recorded the accrued dividends in the consolidated financial statement as of December 31, 2010. 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, 2010, 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. 61 NOTE 18. 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. In prior periods, the Company entered 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 were 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 Company had an interest rate floor that matured in January 2010.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, 2010 and 2009 (in thousands): Tabular Disclosure of Fair Values of Derivative Instruments Asset Derivatives Liability Derivatives 2010 2009 2010 2009 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 Other Assets $ Total Derivatives Designated as Hedging Instruments $ Derivatives Not Designated as Hedging Instruments Interest Rate Floor Other Assets $ Total Derivatives Not Designated as Hedging Instruments $ - - - - Other Other Other Assets $ - Liabilities $ - Liabilities $ - $ - $ - $ - Other Other Other Assets $ 49 Liabilities $ - Liabilities $ - $ 49 $ - $ - 62 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 used interest rate floors as part of its interest rate risk management strategies. 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. 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 2010 2009 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) 2010 2009 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) 2010 2009 Interest Rate Floor $ Total $ - - $ 43 Interest Income $ Other Income $ 40 - 1,545 10 Other Income $ - $ (12) $ 43 $ 40 $ 1,555 $ - $ (12) 63 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. 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 were 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 Interest Rate Floor Other Income Total NOTE 19. Fair Value Measurements Amount of Gain or (Loss) Recognized in Income on Derivative 2010 2009 $ $ (7) $ 23 (7) $ 23 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-mortgage banking Commitments to originate mortgage loans 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-mortgage banking 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 2010 $ 137,032 29,116 488 $ 166,636 $ - - - $ - $ 137,032 29,116 488 $ 166,636 $ - - - $ - $ 470 $ 470 $ - $ - $ 470 $ 470 $ - $ - 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 $ - $ - 64 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, 2010 and 2009. 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 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): 2010 Impaired loans(1) Other real estate(2) Total Total 15,152 12,706 27,858 $ $ Level 1 - - - $ $ Level 2 15,152 12,706 27,858 $ $ Total gains/ Level 3 (losses) $ $ - - - $ $ (3,182) (2,509) (5,691) 2009 Impaired loans(1) Other real estate(2) Total Total 32,200 7,253 39,453 $ $ Level 1 - - - $ $ Level 2 Level 3 (losses) Total gains/ $ $ 32,200 7,253 39,453 $ $ $ $ (7,268) (8,056) (15,324) (1) Represents the carrying value and related write-downs of loans based on the appraised value of the collateral. (2) Represents the fair value of the collateral less estimated selling costs and are based upon appraised values. 65 NOTE 20. Fair Value of Financial Instruments The estimated fair values of the Company’s financial instruments are as follows as of December 31 (in thousands): Assets: Cash and cash equivalents Investment securities available for sale Federal Reserve Bank and Federal Home Loan Bank stock Loans held for sale-mortgage banking Participating interests in mortgage loans Loans and leases held for investment, net Other loans held for sale, net Accrued interest receivable Derivative financial instruments Other assets Other assets held for sale Liabilities and Stockholders’ Equity: Deposits, noninterest-bearing Deposits, interest-bearing Deposits, noninterest-bearing held for sale Deposits, interest-bearing held for sale Borrowings and advances Accrued interest payable Accrued expenses Guaranteed preferred beneficial interests in Company’s subordinated debentures Other liabilities Stockholders’ equity Financial instruments with off-balance-sheet risk: Commitments to extend credit Standby and commercial letters of credit Mortgage banking commitments to fund Mortgage banking commitments to sell loans 2010 2009 Carrying Amount Fair Value Carrying Amount Fair Value $ 112,847 137,032 $ 112,847 137,032 $ 35,362 212,661 $ 35,362 212,661 2,862 29,116 4,888 335,736 70,501 2,138 - 695,120 49,180 2,769 $ 747,069 $ 91,478 462,187 34,610 72,836 16,329 852 4,704 24,134 707,130 2,618 37,321 $ 747,069 2,862 29,116 4,888 334,413 70,501 2,138 - 693,797 3,048 24,130 38,534 499,061 - 2,970 216 815,982 52,101 - $ 868,083 91,478 461,944 34,610 72,836 16,329 852 4,704 $ 98,658 657,305 - - 25,190 1,468 2,946 $ $ 3,048 24,130 38,534 494,242 - 2,970 216 811,163 98,658 658,647 - - 25,278 1,468 2,946 $ $ 11,356 694,109 $ 22,890 808,457 2,361 11,266 798,263 $ 57,265 $ 868,083 $ $ 31 37 488 470 1,026 $ $ 64 41 427 675 1,207 66 NOTE 21. 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, 2010, 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, 2010, there was a $26.6 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, 2010, 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): 2010 2009 Fixed Rate Variable Rate Fixed Rate Variable Rate Commitments to extend credit $ 8,871 $ 45,058 $ 11,996 $ 60,819 Standby and commercial letters of credit 1,274 2,455 761 3,320 In addition to the amounts in the table above, our mortgage banking commitments to fund loans totaled $43.3 million for 2010 and $29.2 million for 2009. Also, our mortgage banking commitments to sell loans totaled $72.0 million for 2010 and $53.1 million for 2009. Mortgage Banking Obligations Through its mortgage banking operations, the Company originates and sells residential mortgage loans servicing released to third parties. These loans are sold without recourse to the Bank. However, standard industry practices require representations and warranties which generally require sellers to reimburse a portion of the sales proceeds if a sold loan defaults or pays off shortly after the sale of the loan (i.e. generally within four months of the sale.). The Company has recorded an obligation of $500 thousand and $326 thousand as of December 31, 2010 and 2009 67 for the estimated obligation reimbursement. Bank management believes the recorded obligation adequately addresses potential reimbursement obligations existing as of December 31, 2010 and 2009. NOTE 22. Guarantees and Contingent Consideration Guaranteed Preferred Beneficial Interests In Company’s Subordinated Debentures BNCCORP fully and unconditionally guarantees the Company’s subordinated debentures. Performance and Financial Standby Letters of Credit As of December 31, 2010 and 2009, the Bank had outstanding $2.3 million and $481 thousand of performance standby letters of credit and $7.2 million and $13.3 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 23. 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 was $674,000 and $1.8 million at December 31, 2010 and 2009, respectively. Originations in 2010 and 2009 totaled $375,000 and $425,000, respectively. Loan paydowns in 2010 and 2009 were $1.5 million and $818,000, respectively. The total amount of deposits received from these parties was $2.0 million and $1.4 million at December 31, 2010 and 2009, 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, 2010, BNCCORP and its affiliates were in compliance with these requirements. 68 NOTE 24. 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 2010 2009 $ - 120 120 $ (4,138) 40 (4,098) (7,222) (1,658) 8,832 (48) 72 $ (2,899) (1,165) 6,537 2,473 (1,625) $ 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 2010 (7,478) (1,110) (38) (177) 43 (8,760) 8,832 72 $ $ $ $ 2009 (6,936) (1,114) (138) (175) 201 (8,162) 6,537 (1,625) 69 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 Fraud loss on assets serviced by others 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 securities available for sale Discount accretion on securities Leases Premises and equipment Other Deferred tax liability Valuation allowance Net deferred tax asset 2010 2009 $ 6,673 5,709 257 - 2,659 612 2,672 335 18,917 1,066 1,603 173 604 259 3,705 15,212 (15,164) $ 4,701 - 279 135 1,469 551 2,596 536 10,267 6 1,759 216 561 199 2,741 7,526 (7,526) $ 48 $ - During 2010, the valuation allowance for net deferred tax assets was increased such that net deferred tax assets were reduced to $48,000. The valuation allowance was required because cumulative losses in the 36 month period ended December 31, 2010 exceeded earnings. The Company is able to carry forward federal tax net operating losses aggregating $3.657 million as of December 31, 2010. The carry forward period is 20 years. The Company is able to carry forward state tax net operating losses aggregating $17.8 million as of December 31, 2010. The net operating losses expire between 2011 and 2031. At December 31, 2010, 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 $13,000 of interest accrued at December 31, 2010 and no penalties. Interest included in tax expense for 2010 is approximately a benefit of $7,000. The Company does not expect its unrecognized tax benefits to significantly increase or decrease within the next twelve months. The Company files consolidated federal and unitary state income tax returns where allowed. Tax years ended December 31, 2007 through 2009 remain open to federal examination. During 2010, the Internal Revenue Service opened an examination of the Company’s 2009 federal income tax return. All issues have been settled, but a final report has not yet been issued. The expected results of this examination did not have a material impact on our consolidated financial statements. Tax years ended December 31, 2006 through 2009 remain open to state examinations. 70 NOTE 25. Loss Per Share The following table shows the amounts used in computing per share results (in thousands, except share and per share data): Net loss per share was calculated as follows: Denominator for basic loss per share: Average common shares outstanding Dilutive common stock options Diluted common shares Numerator: Net loss Preferred stock costs Net loss available to common shareholders Basic loss per common share Diluted loss per common share 2010 2009 3,281,719 0 3,281,719 3,261,831 11,891 3,273,722 $ $ $ $ (22,065) (1,333) (23,398) (7.13) (7.13) $ $ $ $ (18,776) (1,254) (20,030) (6.14) (6.14) At December 31, 2010 and 2009, options totaling 269,700 and 41,700, 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 $3.00 to $7.38. NOTE 26. 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 2010 and 2009, 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 $426,000 and $365,000 for 2010, and 2009, 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, 2010, the assets in the plan totaled $15.7 million and included $157,000 (106,407 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. 71 NOTE 27. 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, 2010 and 2009 was $1.729 million and $1.358 million, respectively, for facilities, and $40,000 and $49,000, respectively, for equipment and other items. At December 31, 2010, the total minimum annual base lease payments for operating leases were as follows (in thousands): 2011 2012 2013 2014 2015 Thereafter $ 665 219 166 141 144 1,822 NOTE 28. Share-Based Compensation The Company has four 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. Under the 2010 Stock Incentive Plan, the aggregate number of shares cannot exceed 250,000 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, 2010 are as follows: 1995 Stock Incentive Plan 2002 Stock Incentive Plan 2006 Stock Incentive Plan 2010 Stock Incentive Plan Total Total Shares Available 46,251 - 15,850 250,000 312,101 Maximum Restricted Shares Available 46,251 - 15,850 35,000 97,101 The Company recognized share-based compensation expense of $38,000 and $262,000 for the years ended December 31, 2010 and 2009, respectively, related to restricted stock. The tax benefits associated with share-based compensation would have been approximately $2,000 and $56,000 for the years ended December 31, 2010 and 2009, respectively if the Company had not been in a full valuation allowance. At December 31, 2010, the Company had $77,000 of unamortized restricted stock compensation. At December 31, 2009, the Company had $91,000 of unamortized restricted stock compensation. Restricted shares of stock granted generally have vesting and amortization periods of at least three years. 72 Following is a summary of restricted stock activities for the years ended December 31: 2010 Number Restricted Stock Shares 8,500 15,000 (3,000) - 20,500 Weighted Average Grant Date Fair Value $ 12.04 1.61 11.93 - 4.42 2009 Number Restricted Stock Shares Weighted Average Grant Date Fair Value 37,332 - (28,832) - 8,500 $ 12.35 - 12.44 - 12.04 Nonvested, beginning of year Granted Vested Forfeited Nonvested, end of year The Company granted 240,000 stock options on March 17, 2010. The stock options have a two year vesting period and a ten year contractual term. The exercise price is equal to the market price on grant date, which was $3.00. The fair value of each share option is estimated on the date of grant using a Black-Scholes methodology with the assumptions noted below: Expected volatility Dividend yield Risk-free interest rate – seven year treasury yield Expected life of stock option 32.56% 0.00% 3.201% 7 years The Company recognized share-based compensation expense of $111,000 and $0 for the years ended December 31, 2010 and 2009, respectively, related to share options. At December 31, 2010, the Company had $169,000 of unamortized compensation cost related to non-vested stock options granted. BNC has a policy of issuing shares from treasury shares already held when options are exercised. Following is a summary of fully vested stock options and options expected to vest as of December 31, 2010: Number Weighted-average exercise price Weighted-average remaining contractual term Stock Options Outstanding 269,700 $3.49 7.9 years Stock Options Currently Exercisable 41,700 $6.20 0.5 years Stock Options Vested and Expected to Vest 269,700 $3.49 7.9 years 73 Following is a summary of stock option transactions for the years ended December 31: 2010 2009 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 41,700 240,000 - (12,000) 269,700 41,700 $ 1.23 $ - $ 1.23 Weighted Average Exercise Price Options to Purchase Shares $ $ $ 6.20 3.00 - 3.00 3.49 6.20 44,200 - - (2,500) 41,700 41,700 $ - $ - $ 3.91 Following is a summary of the status of options outstanding at December 31, 2010: Weighted Average Exercise Price 6.34 - - 8.75 6.20 6.20 $ $ $ Options with exercise prices ranging from: $3.00 to $3.00 $5.94 to $7.38 Outstanding Options Weighted Average Remaining Number Contractual Life Weighted Average Exercise Price Exercisable Options Weighted Average Exercise Price Number 228,000 41,700 269,700 9.3 years 0.5 years $ 3.00 6.20 $ - 41,700 41,700 - 6.20 74 NOTE 29. 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) Assets: Cash and cash equivalents Investment securities available for sale Investment in subsidiaries Receivable from subsidiaries Other Total assets Liabilities and stockholders’ equity: Subordinated debentures Payable to subsidiaries Accrued expenses and other liabilities Total liabilities 2010 2009 $ $ $ 2,377 - 57,807 883 473 61,540 23,120 43 3,664 26,827 $ $ $ 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; 19,411 19,187 Preferred Stock - 9% Series B 1,005 shares issued and outstanding; 1,075 1,098 Common stock, $.01 par value – Authorized 35,000,000 shares; 3,304,339 and 3,290,219 shares issued and outstanding Capital surplus – common stock Retained earnings Treasury stock (364,314 and 363,434 shares, respectively) Accumulated other comprehensive income (loss), net of income taxes Total stockholders’ equity Total liabilities and stockholders’ equity 33 27,036 (7,322) (5,069) (451) 34,713 61,540 $ 33 26,885 16,078 (5,068) 1,012 59,225 91,259 $ 75 Parent Company Only Condensed Statements of Operations For the Years Ended December 31 (In thousands) Income: Management fee income Interest Gain on sale of securities Other Total income Expenses: Interest Salaries and benefits Legal and other professional Depreciation and amortization Other Total expenses Income (loss) before income tax benefit and equity in income of subsidiaries Income tax expense Income (loss) before equity in income of subsidiaries Equity in loss of subsidiaries Net loss 2010 2009 $ 1,596 $ 1,555 27 2,150 38 3,811 1,279 708 542 1 677 3,207 604 (582) 22 (22,087) 1,376 - 41 2,972 1,292 749 534 1 958 3,534 (562) (783) (1,345) (17,431) $ (22,065) $ (18,776) 76 Parent Company Only Condensed Statements of Cash Flows For the Years Ended December 31 (In thousands) Operating activities: Net loss Adjustments to reconcile net loss to net cash used in operating activities - Equity in undistributed loss of subsidiaries Depreciation and amortization Impairment of goodwill Share based compensation Other noncash expense Deferred income taxes Change in prepaid expenses and other receivables Net realized gain on sale of investment securities Change in accrued expenses and other liabilities Net cash used in operating activities Investing activities: Increase in investment in subsidiaries Proceeds from sale of investment securities Net cash (used in) provided by investing activities Financing activities: Proceeds from issuance of preferred stock Payment of preferred stock dividends 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 (received) NOTE 30. Subsequent Events 2010 2009 $ (22,065) $ (18,776) 22,087 3 - 150 - - 6,206 (2,150) (6,343) (2,112) (2,000) 2,150 150 - - - (1,962) 4,339 17,431 5 154 257 105 352 (6,950) - 5,961 (1,461) (15,001) - (15,001) 20,093 (1,058) 19,035 2,573 1,766 $ 2,377 $ 4,339 $ - $ 1,149 $ (5,972) $ 2,310 The Company has evaluated subsequent events from the balance sheet date through March 22, 2011, the date at which the financial statements were available to be issued, and determined there are no other items to disclose. 77 78 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 2011 annual meeting of stockholders will be held on Wednesday, June 15, 2011 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 OTC Markets under the symbol: “BNCC.” There were 72 record holders of the Company’s common stock at March 11, 2011. COMMON STOCK PRICES For the Years Ended December 31, Low 2010(1) 2009(1) High High Low $8.50 $5.30 First Quarter $4.00 $1.80 $5.60 $8.50 Second Quarter $3.19 $1.80 $5.00 $8.00 $2.25 $1.40 Third Quarter $1.95 $5.50 $2.00 $1.41 Fourth Quarter (1) The quotes represent the high and low closing sales prices as reported by OTC Markets. 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 18 locations. BNC also conducts mortgage banking from 10 locations in Arizona, Minnesota, Iowa, Kansas, Nebraska and Missouri. 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 BNCCORP, Inc. Annual Report 2010 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 FirstStrategic LLC DIRECTORS BNC National Bank Julie L. Andresen Gregory K. Cleveland Shawn Cleveland Timothy J. Franz David Hoekstra Mark E. Peiler Scott Spillman SUBSIDIARIES BNC National Bank Headquarters: 20175 North 67th Ave Glendale, AZ 85308 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 240 Investors Bldg (Baker Center) 733 Marquette Avenue South 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 Perimeter 17550 North Perimeter Drive Scottsdale, AZ 85255 Mortgage Banking Branches: Scottsdale 8330 East Hartford Drive Scottsdale, AZ 85255 Wichita 7200 West 13th Wichita, KS 67212 Wichita 1718 North Webb Road Wichita, KS 67206 Andover 511 North Andover Road Andover, Kansas 67002 Overland Park 7007 College Boulevard Overland Park, KS 66211 Topeka 2110 SW Belle Avenue Topeka, KS 66614 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 79 

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