**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC  20549**

 

**FORM 10-Q**

** **

| **ý** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                          |
|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                   |
|       | **For the  quarterly period ended June 30, 2003**                                                                                                                                                                                      |
|       |                                                                                                                                                                                                                                   |
| **OR**     |
|       |                                                                                                                                                                                                                                   |   |
| **o**      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                         |
| ** ** |                                                                                                                                                                                                                                   |
|       | **For the  transition period  from                to                ** |

 

**Commission file number  0-19368**

 

| **COMMUNITY FIRST BANKSHARES, INC.**                             |
|------------------------------------------------------------------|
| (Exact  name of registrant as specified in its charter)          |
|                                                             |   |   |
| **Delaware**                                                     |   | **46-0391436** |
| (State  or other jurisdiction of  incorporation or organization) |   | (I.R.S.  Employer Identification No.) |
|                                                             |   |   |
| **520 Main Avenue  Fargo, ND**                                   |   | **58124** |
| (Address  of principal executive offices)                        |   | (Zip  Code) |
|                                                             |   |   |
| **(701) 298-5600**                                               |
| (Registrant’s  telephone number, including area code)       |

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days:  YES  ý  NO  o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act):YES  ý  NO  o

 

At August 8, 2003, 37,913,469 shares ofCommon Stock were outstanding.

 

 

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COMMUNITYFIRST BANKSHARES, INC.

 

FORM10-Q

 

QUARTERENDED JUNE 30, 2003

 

INDEX

 
| PART I -                      | FINANCIAL INFORMATION: |
|-------------------------------|------------------------|
|                          |                   |
|                          | Item 1.                | Condensed Consolidated Financial  Statements and Notes |
|                          |                   |   |   |
|                          | Item  2.               | Management’s  Discussion and Analysis of Financial Condition  and Results of Operations |
|                          |                   |   |   |
|                          | Item  3.               | Quantitative  and Qualitative Disclosure About Market Risk |   |
|                          |                   |   |   |
|                          | Item 4.                | Controls and  Procedures |   |
|                          |                   |   |   |
| PART II - OTHER  INFORMATION: |                   |
|                          |                   |   |   |
|                          | Item 1.                | Legal Proceedings |   |
|                          |                   |   |   |
|                          | Item 2.                | Changes in Securities |   |
|                          |                   |   |   |
|                          | Item 3.                | Defaults Upon  Senior Securities |   |
|                          |                   |   |   |
|                          | Item  4.               | Submission  of Matters to a Vote of Security Holders |   |
|                          |                   |   |   |
|                          | Item 5.                | Other Information |   |
|                          |                   |   |   |
|                          | Item 6.                | Exhibits and  Reports on Form 8-K |   |
|                          |                   |   |   |
| SIGNATURES AND CERTIFICATIONS |
|                               |                        |  |  |  |  |

 

2

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COMMUNITY FIRST BANKSHARES, INC.

CONDENSED CONSOLIDATEDSTATEMENTS OFFINANCIAL CONDITION

 
| **(Dollars  in thousands, except per share data)**                                                                               |   | **June 30,  2003** |      | **December  31,  2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|-----------|-------------------------|--------|
|                                                                                                                             |   | **(unaudited)**    |      |                    |   |
| ASSETS                                                                                                                           |   |               |      |                    |   |
| Cash and due from banks                                                                                                          |   | $                  | 223,522   |                    | $      | 242,887 |   |
| Federal funds sold and securities purchased under agreements to  resell                                                          |   | 6,750              |      | —                  |   |
| Interest-bearing deposits                                                                                                        |   | 5,390              |      | 4,613                   |   |
| Available-for-sale securities                                                                                                    |   | 1,588,644          |      | 1,672,445               |   |
| Held-to-maturity securities (fair value: 6/30/03 - $81,744, 12/31/02  - $80,165)                                                 |   | 81,744             |      | 80,165                  |   |
| Loans                                                                                                                            |   | 3,425,902          |      | 3,577,893               |   |
| Less: Allowance for loan losses                                                                                                  |   | (54,187            | )         | (56,156                 | )      |
| Net loans                                                                                                                        |   | 3,371,715          |      | 3,521,737               |   |
| Bank premises and equipment, net                                                                                                 |   | 132,581            |      | 132,122                 |   |
| Accrued interest receivable                                                                                                      |   | 31,481             |      | 34,863                  |   |
| Goodwill                                                                                                                         |   | 63,448             |      | 62,903                  |   |
| Other intangible assets                                                                                                          |   | 31,240             |      | 32,577                  |   |
| Other assets                                                                                                                     |   | 49,611             |      | 42,858                  |   |
| Total assets                                                                                                                     |   | $                  | 5,586,126 |                    | $      | 5,827,170 |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                        |   |               |      |                    |   |
| Deposits:                                                                                                                        |   |               |      |                    |   |
| Noninterest-bearing                                                                                                              |   | $                  | 461,652   |                    | $      | 470,900 |   |
| Interest-bearing:                                                                                                                |   |               |      |                    |   |
| Savings and NOW accounts                                                                                                         |   | 2,444,297          |      | 2,424,943               |   |
| Time accounts over $100,000                                                                                                      |   | 551,390            |      | 670,187                 |   |
| Other time accounts                                                                                                              |   | 1,003,909          |      | 1,103,716               |   |
| Total deposits                                                                                                                   |   | 4,461,248          |      | 4,669,746               |   |
| Federal funds purchased and securities sold under agreements to  repurchase                                                      |   | 376,244            |      | 377,230                 |   |
| Other short-term borrowings                                                                                                      |   | 83,329             |      | 76,260                  |   |
| Long-term debt                                                                                                                   |   | 112,500            |      | 127,500                 |   |
| Accrued interest payable                                                                                                         |   | 16,755             |      | 18,987                  |   |
| Other liabilities                                                                                                                |   | 34,090             |      | 58,998                  |   |
| Total liabilities                                                                                                                |   | 5,084,166          |      | 5,328,721               |   |
| Company-obligated mandatorily redeemable preferred securities of  subsidiary trusts                                              |   | 120,000            |      | 120,000                 |   |
| Shareholders’ equity:                                                                                                       |   |               |      |                    |   |
| Common stock, par value $.01 per share:  Authorized Shares – 80,000,000  Issued Shares – 51,021,896                    |   | 510                |      | 510                     |   |
| Capital surplus                                                                                                                  |   | 194,365            |      | 193,887                 |   |
| Retained earnings                                                                                                                |   | 413,690            |      | 393,550                 |   |
| Unrealized gain on available-for-sale securities, net of tax                                                                     |   | 20,284             |      | 23,826                  |   |
| Less cost of common stock in treasury –  June 30, 2003 – 12,763,499 shares  December 31, 2002 – 12,343,096 shares |   | (246,889           | )         | (233,324                | )      |
| Total shareholders’ equity                                                                                                  |   | 381,960            |      | 378,449                 |   |
| Total liabilities and shareholders’ equity                                                                                  |   | $                  | 5,586,126 |                    | $      | 5,827,170 |   |

 

*See accompanying notes*.

 

3

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COMMUNITYFIRST BANKSHARES, INC.

CONDENSEDCONSOLIDATED STATEMENTS OF INCOME

 
| **(Dollars in thousands, except per share data)**                                  |   | **For the  Three Months Ended  June 30,** |   | **For the Six  Months Ended  June 30,** |   |
|------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|-----------------------------------------|--------|
| **(Unaudited)**                                                                    |   | **2003**                                  |   | **2002**                                |   | **2003** |   | **2002** |   |
| Interest income:                                                                   |   |                                      |   |                                    |   |   |   |   |   |
| Loans                                                                              |   | $                                         | 61,410 |                                    | $      | 69,721 |   | $ | 124,620 |   | $ | 140,480 |   |
| Investment securities                                                              |   | 18,522                                    |   | 20,942                                  |   | 38,158 |   | 41,899 |   |
| Interest-bearing deposits                                                          |   | 16                                        |   | 9                                       |   | 28 |   | 18 |   |
| Federal funds sold and resale agreements                                           |   | 1                                         |   | 12                                      |   | 1 |   | 27 |   |
| Total interest income                                                              |   | 79,949                                    |   | 90,684                                  |   | 162,807 |   | 182,424 |   |
| Interest expense:                                                                  |   |                                      |   |                                    |   |   |   |   |   |
| Deposits                                                                           |   | 12,662                                    |   | 18,590                                  |   | 27,369 |   | 40,158 |   |
| Short-term and other borrowings                                                    |   | 1,480                                     |   | 1,812                                   |   | 2,838 |   | 3,407 |   |
| Long-term debt                                                                     |   | 1,746                                     |   | 1,986                                   |   | 3,645 |   | 3,977 |   |
| Total interest expense                                                             |   | 15,888                                    |   | 22,388                                  |   | 33,852 |   | 47,542 |   |
| Net interest income                                                                |   | 64,061                                    |   | 68,296                                  |   | 128,955 |   | 134,882 |   |
| Provision for loan losses                                                          |   | 3,487                                     |   | 3,297                                   |   | 6,974 |   | 6,612 |   |
| Net interest income after provision for loan losses                                |   | 60,574                                    |   | 64,999                                  |   | 121,981 |   | 128,270 |   |
| Noninterest income:                                                                |   |                                      |   |                                    |   |   |   |   |   |
| Service charges on deposit accounts                                                |   | 9,999                                     |   | 10,097                                  |   | 19,379 |   | 19,754 |   |
| Insurance commissions                                                              |   | 3,364                                     |   | 3,330                                   |   | 7,445 |   | 6,607 |   |
| Fees from fiduciary activities                                                     |   | 1,449                                     |   | 1,403                                   |   | 2,727 |   | 2,829 |   |
| Security sales commissions                                                         |   | 2,310                                     |   | 3,467                                   |   | 4,361 |   | 5,590 |   |
| Net gain (loss) on sales of available-for-sale securities                          |   | 1,795                                     |   | (188                                    | )      | 2,259 |   | (171 | ) |
| Other                                                                              |   | 3,221                                     |   | 2,522                                   |   | 6,894 |   | 5,022 |   |
| Total noninterest income                                                           |   | 22,138                                    |   | 20,631                                  |   | 43,065 |   | 39,631 |   |
| Noninterest expense:                                                               |   |                                      |   |                                    |   |   |   |   |   |
| Salaries and employee benefits                                                     |   | 28,246                                    |   | 29,269                                  |   | 56,160 |   | 57,759 |   |
| Net occupancy                                                                      |   | 8,435                                     |   | 8,109                                   |   | 17,043 |   | 15,983 |   |
| FDIC insurance                                                                     |   | 185                                       |   | 205                                     |   | 376 |   | 417 |   |
| Legal and accounting                                                               |   | 879                                       |   | 915                                     |   | 1,286 |   | 1,652 |   |
| Other professional services                                                        |   | 1,217                                     |   | 1,030                                   |   | 2,106 |   | 1,907 |   |
| Advertising                                                                        |   | 1,023                                     |   | 1,028                                   |   | 1,953 |   | 1,993 |   |
| Telephone                                                                          |   | 1,628                                     |   | 1,430                                   |   | 3,154 |   | 2,958 |   |
| Data processing                                                                    |   | 1,860                                     |   | 1,764                                   |   | 3,578 |   | 3,569 |   |
| Company-obligated mandatorily redeemable preferred securities of  subsidiary trust |   | 2,399                                     |   | 2,892                                   |   | 5,190 |   | 5,507 |   |
| Amortization of intangibles                                                        |   | 840                                       |   | 836                                     |   | 1,671 |   | 1,654 |   |
| Other                                                                              |   | 7,684                                     |   | 8,223                                   |   | 15,359 |   | 15,411 |   |
| Total noninterest expense                                                          |   | 54,396                                    |   | 55,701                                  |   | 107,876 |   | 108,810 |   |
|                                                                               |   |                                      |   |                                    |   |   |   |   |   |
| Income before income taxes                                                         |   | 28,316                                    |   | 29,929                                  |   | 57,170 |   | 59,091 |   |
| Provision for income taxes                                                         |   | 9,230                                     |   | 10,072                                  |   | 18,683 |   | 19,973 |   |
| Net income                                                                         |   | $                                         | 19,086 |                                    | $      | 19,857 |   | $ | 38,487 |   | $ | 39,118 |   |

 

*Seeaccompanying notes*

4

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| **(Dollars in thousands, except per share data)** |   | **For the  Three Months Ended  June 30,** |   | **For the  Six Months Ended  June 30,** |   |
|---------------------------------------------------|--------|-------------------------------------------|--------|-----------------------------------------|--------|
| **(Unaudited)**                                   |   | **2003**                                  |   | **2002**                                |   | **2003** |   | **2002** |   |
|                                              |   |                                      |   |                                    |   |   |   |   |   |
| Earnings per common and common equivalent share:  |   |                                      |   |                                    |   |   |   |   |   |
| Basic net  income                                 |   | $                                         | 0.50   |                                    | $      | 0.50 |   | $ | 1.00 |   | $ | 0.98 |   |
| Diluted net  income                               |   | $                                         | 0.49   |                                    | $      | 0.49 |   | $ | 0.99 |   | $ | 0.96 |   |
|                                              |   |                                      |   |                                    |   |   |   |   |   |
| Average common shares outstanding:                |   |                                      |   |                                    |   |   |   |   |   |
| Basic                                             |   | 38,371,159                                |   | 39,772,344                              |   | 38,485,552 |   | 39,877,633 |   |
| Diluted                                           |   | 38,928,709                                |   | 40,515,906                              |   | 39,019,638 |   | 40,579,858 |   |
|                                              |   |                                      |   |                                    |   |   |   |   |   |
| Dividends  per share                              |   | $                                         | 0.22   |                                    | $      | 0.19 |   | $ | 0.44 |   | $ | 0.38 |   |

 

 
| **STATEMENTS OF COMPREHENSIVE INCOME**                                       |   |
|------------------------------------------------------------------------------|--------|
|                                                                         |   |   |   |   |   |   |   |   |   |
| **(Dollars in thousands)**                                                   |   | **For the Three Months Ended  June 30,** | ** ** | **For the Six Months Ended  June 30,** |   |
| **(Unaudited)**                                                              |   | **2003** |   | **2002** |   | **2003** |   | **2002** |   |
|                                                                         |   |   |   |   |   |   |   |   |   |
| Net income                                                                   |   | $ | 19,086 |   | $ | 19,857 |   | $ | 38,487 |   | $ | 39,118 |   |
| Other comprehensive income (loss), net of tax:                               |   |   |   |   |   |   |   |   |   |
| Unrealized gains (losses) on securities:                                     |   |   |   |   |   |   |   |   |   |
| Unrealized holding gains (losses) arising during period                      |   | 1,972 |   | 14,450 |   | (2,187 | ) | 10,527 |   |
| Less: Reclassification adjustment for (gains) losses included in net  income |   | (1,077 | ) | 114 |   | (1,355 | ) | 103 |   |
| Other comprehensive income (loss)                                            |   | 895 |   | 14,564 |   | (3,542 | ) | 10,630 |   |
| Comprehensive income                                                         |   | $ | 19,981 |   | $ | 34,421 |   | $ | 34,945 |   | $ | 49,748 |   |

 

*Seeaccompanying notes*.

5

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COMMUNITYFIRST BANKSHARES, INC.

CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS

 
| **(In thousands)**                                                                 |   | **For the Six  Months Ended  June 30,** |    |
|------------------------------------------------------------------------------------|--------|-----------------------------------------|---------|
| **(Unaudited)**                                                                    |   | **2003**                                |    | **2002** |   |
| **Cash flows from operating activities:**                                          |   |                                    |    |   |   |
| Net income                                                                         |   | $                                       | 38,487  |   | $ | 39,118 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |   |                                    |    |   |   |
| Provision for loan losses                                                          |   | 6,974                                   |    | 6,612 |   |
| Depreciation                                                                       |   | 5,869                                   |    | 7,017 |   |
| Amortization of intangibles                                                        |   | 1,671                                   |    | 1,654 |   |
| Net amortization of premiums (discounts) on securities                             |   | 3,619                                   |    | 600 |   |
| Decrease in interest receivable                                                    |   | 3,382                                   |    | 3,687 |   |
| Decrease in interest payable                                                       |   | (2,232                                  | )       | (9,952 | ) |
| Decrease in due to broker                                                          |   | (22,414                                 | )       | — |   |
| Other — net                                                                   |   | (7,804                                  | )       | (3,294 | ) |
| Net cash provided by operating activities                                          |   | 27,552                                  |    | 45,442 |   |
|                                                                               |   |                                    |    |   |   |
| **Cash flows from investing activities:**                                          |   |                                    |    |   |   |
| Net increase in interest-bearing deposits                                          |   | (777                                    | )       | (1,509 | ) |
| Purchases of available-for-sale securities                                         |   | (816,567                                | )       | (644,385 | ) |
| Maturities of available-for-sale securities                                        |   | 714,554                                 |    | 698,460 |   |
| Sales of available-for-sale securities, net of gains                               |   | 176,331                                 |    | 8,047 |   |
| Purchases of held-to-maturity securities                                           |   | (1,579                                  | )       | (1,638 | ) |
| Net decrease in loans                                                              |   | 143,048                                 |    | 77,892 |   |
| Net increase in bank premises and equipment                                        |   | (6,328                                  | )       | (7,881 | ) |
| Net cash provided by investing activities                                          |   | 208,682                                 |    | 128,986 |   |
|                                                                               |   |                                    |    |   |   |
| **Cash flows from financing activities:**                                          |   |                                    |    |   |   |
| Net increase (decrease) in demand deposits, NOW accounts and savings  accounts     |   | 10,106                                  |    | (102,159 | ) |
| Net decrease in time accounts                                                      |   | (218,604                                | )       | (121,184 | ) |
| Net increase in short-term & other borrowings                                  |   | 6,083                                   |    | 63,581 |   |
| Net decrease in long-term debt                                                     |   | (15,000                                 | )       | (3,994 | ) |
| Net decrease in Company-obligated mandatorily redeemable preferred  securities     |   | —                                  |    | (1,118 | ) |
| Purchase of common stock held in treasury                                          |   | (18,599                                 | )       | (24,223 | ) |
| Sale of common stock held in treasury                                              |   | 4,100                                   |    | 4,224 |   |
| Common stock dividends paid                                                        |   | (16,935                                 | )       | (15,151 | ) |
| Net cash used in financing activities                                              |   | (248,849                                | )       | (200,024 | ) |
| Net decrease in cash and cash equivalents                                          |   | (12,615                                 | )       | (25,596 | ) |
| Cash and cash equivalents at beginning of period                                   |   | 242,887                                 |    | 248,260 |   |
| Cash and cash equivalents at end of period                                         |   | $                                       | 230,272 |   | $ | 222,664 |   |

 

6

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COMMUNITYFIRST BANKSHARES, INC.

 

NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

June30, 2003

 

**Note A -BASIS OF PRESENTATION**

 

Theaccompanying unaudited condensed consolidated financial statements, whichinclude the accounts of Community First Bankshares, Inc. (the ‘Company’), itswholly-owned data processing, credit origination and insurance agencysubsidiaries, and its wholly-owned subsidiary bank, have been prepared in accordancewith accounting principles generally accepted in the United States for interimfinancial information.  Accordingly,they do not include all of the information and footnotes required by generallyaccepted accounting principles for complete financial statements.  In the opinion of management, alladjustments considered necessary for fair presentation have been included.

 

**Earnings Per Common Share**

 

Basicearnings per common share is calculated by dividing net income by the weightedaverage number of shares of common stock outstanding.

 

Diluted earnings per common share is calculated by adjusting theweighted average number of shares of common stock outstanding for shares thatwould be issued assuming the exercise of stock options and warrants during eachperiod.  Such adjustments to theweighted average number of shares of common stock outstanding are made onlywhen such adjustments dilute earnings per share.

 

**Note B –ACQUISITIONS**

 

Throughits insurance subsidiary, the Company completed the purchase of three insuranceagencies during the second quarter. These included the June 2, 2003 purchase of the Larry Levitt InsuranceAgency, located in Rock Springs, Wyoming; the May 1, 2003 purchase of KraftInsurance Services, Inc. an insurance agency in Grand Junction, Colorado; andthe April 1, 2003 purchase of Carr Agency, an insurance agency in Thornton,Colorado.

 

**Note C -ACCOUNTING CHANGES**

 

In November 2002, theFinancial Accounting Standards Board (“FASB”) issued Interpretation No.45,  (FIN 45) Guarantor’s Accounting andDisclosure for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers. FIN 45 requires certain guarantees to be recorded at fair value andapplies to contracts or indemnification agreements that contingently requirethe guarantor to make payments to the guaranteed party based on changes in anunderlying condition that is related to an asset, liability or equity securityof the guaranteed party. Examples of contracts meeting these characteristicsinclude standby and performance letters of credit. The recognition requirementsof FIN 45 are to be applied prospectively to guarantees issued or modifiedsubsequent to December 31, 2002. FIN 45 also expands the disclosures to be madeby guarantors, effective as of December 31, 2002, to include the nature of theguarantee, the maximum potential amount of future payments that the guarantorcould be required to make under the guarantee, and the current amount of theliability, if any, for the guarantor’s obligation under the guarantee. Significantguarantees that have been entered into by the Company are disclosed in Note H,Financial Instruments with Off-Balance-Sheet Risk.  The adoption of FIN 45 did not have a material impact on theCompany’s results of operations, financial position or liquidity.

 

In January2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation of VariableInterest Entities.  FIN 46 clarifies theapplication of Accounting Research Bulletin No. 51, Consolidated FinancialStatement, to certain entities in which equity investors do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties.  The recognition and measurement

 

7

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provisions of thisInterpretation are effective for newly created variable interest entitiesformed after January 31, 2003, and for existing variable interest entities, onthe first interim or annual reporting period beginning after June 15,2003.  The Company adopted thedisclosure provisions of FIN 46 effective December 31, 2002.  The Company will adopt the provisions of FIN46 for existing variable interest entities on July 1, 2003.  At this time, management believes adoptionof FIN 46 with regard to existing variable interest entities will not have amaterial effect on the Company’s financial statements. The Company hasdetermined that the provisions of FIN 46 may require de-consolidation of thesubsidiary trusts, which issued Company-obligated mandatorily redeemablepreferred securities (“Trust Preferred Securities”).  Prior to the adoption of FIN 46, the Company consolidated thetrusts and the balance sheet included the Trust Preferred Securities of thetrusts.  At adoption of FIN 46, thetrusts may be de-consolidated and the junior subordinated debentures of theCompany owned by the trusts would be disclosed.  The Trust Preferred Securities currently qualify as Tier 1capital of the Company for regulatory capital purposes.  The banking regulatory agencies have notissued any guidance which would change the capital treatment for TrustPreferred Securities based on the impact of the adoption of FIN 46.

 

In December 2002, the FASBissued Statement No. 148 (FAS 148), Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment to FASB Statement 123. In addition, FAS148 amends the disclosure requirements of FASB Statement No. 123 (FAS 123),Accounting for Stock-Based Compensation, to require prominent disclosures inboth annual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults.  The Company adopted thedisclosure provisions of FAS 148 effective March 31, 2003.

 

In May 2003, the FASB issuedStatement No. 150 (“FAS 150”), “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity,” which establishesstandards for how an issuer classifies and measures certain financialinstruments with characteristics of both liabilities and equities.  FAS 150 is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise is effectiveat the beginning of the first interim period beginning after June 15,2003.  Upon adoption of FAS 150 on July1, 2003, the Company will begin classifying its Trust Preferred Securities asliabilities.  These have previously notbeen reported as liabilities on the statement of financial condition.  Periodic payments on such securities will bereported as interest expense.  Thebanking regulatory agencies have not issued any guidance which would change thecapital treatment of these securities based on the impact of the adoption ofSFAS 150.

 

**Note D –STOCK BASED COMPENSATION**

 

At June 30,2003, the Company had one stock-based employee compensation plan.  The Company accounts for this plan under therecognition and measurement principles of APB Opinion No. 25, Accounting forStock Issued to Employees, and related interpretations.  No stock-based employee compensation cost isreflected in net income, as all options granted under this plan have anexercise price equal to the market value of the underlying common stock on thedate of grant.  The following tableillustrates the effect on net income and earnings per share if the Company hadapplied the fair value recognition provisions of FAS 123 to stock-basedemployee compensation:

 
|                                              |                                                                                                                                   | **Three  Months  Ended June 30** |   | **Six Months  Ended June 30** |   |
|---------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------|----------------------------------|--------|-------------------------------|--------|
| **(Dollars in thousands, except per share data)** |                                                                                                                                   | **2003**                         |   | **2002**                      |   | **2003** |   | **2002** |   |
| Net income, as reported                           |                                                                                                                                   | $                                | 19,086 |                          | $      | 19,857 |   | $ | 38,487 |   | $ | 39,118 |   |
| Deduct:                                           | Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects. |                             | (928   | )                             | (707   | ) | (1,590 | ) | (1,262 | ) |
|                                              |                                                                                                                                   |                             |   |                          |   |   |   |   |   |
| Pro forma net income                              |                                                                                                                                   | $                                | 18,158 |                          | $      | 19,150 |   | $ | 36,897 |   | $ | 37,856 |   |
|                                              |                                                                                                                                   |                             |   |                          |   |   |   |   |   |
| Earnings per share:                               |                                                                                                                                   |                             |   |                          |   |   |   |   |   |
| Basic – as reported                          |                                                                                                                                   | $                                | 0.50   |                          | $      | 0.50 |   | $ | 1.00 |   | $ | 0.98 |   |
| Basic – pro forma                            |                                                                                                                                   | $                                | 0.47   |                          | $      | 0.48 |   | $ | 0.96 |   | $ | 0.95 |   |
|                                              |                                                                                                                                   |                             |   |                          |   |   |   |   |   |
| Diluted – as reported                        |                                                                                                                                   | $                                | 0.49   |                          | $      | 0.49 |   | $ | 0.99 |   | $ | 0.96 |   |
| Diluted – pro forma                          |                                                                                                                                   | $                                | 0.47   |                          | $      | 0.47 |   | $ | 0.95 |   | $ | 0.93 |   |
|                                                   |                                                                                                                                        |                                  |        |                               |        |  |  |  |  |  |  |  |  |  |

 

8

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The fair valueof the options was estimated at the grant date using a Black-Scholesoption-pricing model. Option valuation models require the input of highlysubjective assumptions. Because the Company’s employee stock options havecharacteristics significantly different from traded options, and becausechanges in the subjective input assumptions can materially affect the fairvalue estimate, in management’s opinion, the existing models do not necessarilyprovide a reliable single measure of the fair value of its employee stock options.

 

Thefollowing weighted-average assumptions were used in the valuation model:

 
|                    |   | **Three  Months  Ended June 30** |   | **Six Months  Ended June 30** |   |
|-------------------------|--------|----------------------------------|--------|-------------------------------|--------|
|                    |   | **2003**                         |   | **2002**                      |   | **2003** |   | **2002** |   |
| Risk free interest rate |   | 2.83%  to 3.72                   | %      | 3.61                          | %      | 2.23%  to 3.72 | % | 3.61 | % |
| Dividend yield          |   | 3.44                             | %      | 3.17                          | %      | 3.33%  to 3.44 | % | 3.17 | % |
| Price volatility        |   | .256                             |   | .265                          |   | .256  to .257 |   | .265 |   |
| Expected life (years)   |   | 7.5                              |   | 7.5                           |   | 7.5 |   | 7.5 |   |

 

**Note E-INVESTMENTS**

 

Thefollowing is a summary of available-for-sale and held-to-maturity securities atJune 30, 2003 (in thousands):

 
|                                |   | **Available-for-Sale  Securities** |      |
|-------------------------------------|--------|------------------------------------|-----------|
|                                |   | **Amortized****Cost**              |      | **Gross  Unrealized****Gains** |   | **Gross  Unrealized****Losses** |   | **Estimated  Fair****Value** |   |
| United States Treasury              |   | $                                  | 37,189    |   | $ | 663 |   | $ | — |   | $ | 37,852 |   |
| United States Government agencies   |   | 345,468                            |      | 5,630 |   | 418 |   | 350,680 |   |
| Mortgage-backed securities          |   | 1,029,863                          |      | 21,242 |   | 532 |   | 1,050,573 |   |
| Collateralized mortgage obligations |   | 2,760                              |      | 18 |   | 1 |   | 2,777 |   |
| State and political securities      |   | 60,532                             |      | 3,878 |   | — |   | 64,410 |   |
| Other securities                    |   | 79,250                             |      | 4,280 |   | 1,178 |   | 82,352 |   |
|                                |   | $                                  | 1,555,062 |   | $ | 35,711 |   | $ | 2,129 |   | $ | 1,588,644 |   |

 
|              |   | **Held-to-Maturity Securities** | ** ** |
|-------------------|--------|---------------------------------|------------|
|              |   | **Amortized  Cost**             |       | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Fair  Value** |   |
| Other  securities |   | $                               | 81,744     |   | $ | — |   | $ | — |   | $ | 81,744 |   |
|              |   | $                               | 81,744     |   | $ | — |   | $ | — |   | $ | 81,744 |   |

 

Proceeds from the sale ofavailable-for-sale securities during the three months ended June 30, 2003 and2002 were $116,501,000 and $1,412,000, respectively.  Gross gains of $1,795,000 and $30,000 were realized on salesduring 2003 and 2002, respectively. Gross losses of $0 and $218,000 were realized on sales during 2003 and2002, respectively.  Gains and losses ondisposition of these securities were computed using the specific identificationmethod.

 

9

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**Note F -LOANS**

 

The composition of the loanportfolio at June 30, 2003 was as follows (in thousands):

 
| Real estate                    |   | $         | 1,567,732 |   |
|--------------------------------|--------|-----------|-----------|--------|
| Real estate construction       |   | 368,914   |      |
| Commercial                     |   | 656,350   |      |
| Consumer and other             |   | 640,769   |      |
| Agriculture                    |   | 192,137   |      |
|                           |   | 3,425,902 |      |
| Less allowance for loan losses |   | (54,187   | )         |
| Net loans                      |   | $         | 3,371,715 |   |

 

**Note G -FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK**

 

In the normal course ofbusiness, the Company is party to financial instruments with off-balance sheetrisk to meet the financing needs of its customers and to manage its interestrate risk.  These financial instrumentsinclude commitments to extend credit and letters of credit.  Since the conditions requiring the Companyto fund letters of credit may not occur and since customers may not utilize thetotal loan commitments, the Company expects its liquidity requirements to beless than the outstanding commitments. The contract or notional amounts of these financial instruments at June30, 2003 were as follows (in thousands):

 
| Commitments to extend credit             |   | $      | 642,005 |   |
|------------------------------------------|--------|--------|---------|--------|
| Standby and commercial letters of credit |   | 33,415 |    |

** **

**Note H –GUARANTEES OF INDEBTEDNESS OF OTHERS**

 

Standby letters of creditare conditional commitments the Company issues to guarantee the performance ofa customer to a third-party. The guarantees frequently support public andprivate borrowing arrangements, including commercial paper issuances, bondfinancings and other similar transactions. In the event of a customer’snonperformance, the Company’s credit loss exposure is the same as in anyextension of credit, up to the letter’s contractual amount. Management assessesthe borrower’s credit to determine the necessary collateral, which may includemarketable securities, real estate, accounts receivable and inventory. Themaximum potential future payments guaranteed by the Company under standbyletter of credit arrangements at June 30, 2003, is approximately $23 millionwith a weighted average term of approximately 11 months. The fair value of standbyletters of credit is not material to the Company’s financial statements.

 

**Note I-SUBORDINATED NOTES**

 

                Long-term debt at June 30, 2003 included $50million of 7.30% Subordinated Notes issued in June 1997. These notes are dueJune 30, 2004, with interest payable semi-annually. At June 30, 2003, thesubsidiary bank had a $25 million unsecured subordinated term note, maturing onDecember 22, 2007.  The subsidiary banknote bears an interest rate of LIBOR, plus 140 basis points.

** **

 

10

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**Note J -INCOME TAXES**

 

The reconciliation betweenthe provision for income taxes and the amount computed by applying thestatutory federal income tax rate was as follows (in thousands):

 
|                                         |   | **For the  six months ended,June 30, 2003** |   |
|----------------------------------------------|--------|---------------------------------------------|--------|
| 35% of pretax income                         |   | $                                           | 20,010 |   |
| State income tax, net of federal tax benefit |   | 992                                         |   |
| Tax-exempt interest                          |   | (1,758                                      | )      |
| Other                                        |   | (561                                        | )      |
| Provision for income taxes                   |   | $                                           | 18,683 |   |

 

**Note K –TRUST PREFERRED SECURITIES**

 

On March 4,2003, the Company issued $60 million of 7.60% Cumulative Capital Securities,through CFB Capital IV, a Delaware statutory trust subsidiary organized inFebruary 2003.  The proceeds of theoffering were invested by CFB Capital IV in Junior Subordinated Debentures ofthe Company.  The Company used the netproceeds to redeem on April 4, 2003, all of the 8.20% Junior SubordinatedDebentures that it issued in 1997, thereby triggering the redemption of all2,400,000 of the 8.20% Cumulative Capital Securities issued by CFB II, aDelaware statutory trust.  Thedebentures will mature not earlier than March 15, 2008, and not later thanMarch 15, 2033.  At June 30, 2003, $120million in capital securities qualified as Tier I capital under capitalguidelines of the Federal Reserve. Refer to Note C – Accounting Changes for a discussion of the pendingadoption of FIN 46 and Statement 150 and their impact on the recording andreporting of these securities on the Company’s financial statements.

 

**Note L -SUPPLEMENTAL DISCLOSURES TO CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| **Six months ended June 30 (in thousands)**             |   | **2003** |   | **2002** |   |
|---------------------------------------------------------|--------|----------|--------|----------|--------|
| Unrealized (loss) gain on available-for-sale securities |   | $        | (5,864 | )        | $      | 17,600 |   |
|                                                         |        |          |        |          |        |  |  |

 

11

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

**Basis ofPresentation**

 

The following is adiscussion of the Company’s financial condition as of June 30, 2003 andDecember 31, 2002, and its results of operations for the six month periodsended June 30, 2003 and 2002.

 

**StrategicInitiatives**

 

During 2002 and 2003, theCompany has continued to implement a series of strategic initiatives that itannounced in 2001 that are designed to improve customer service and strengthenits position as a provider of diversified financial services. Initiativesincluded a redefinition of the Company’s delivery model and the sale or closureof selected banking offices.

 

Under theredesigned delivery structure, the Company is implementing a centralizedconsumer credit process, which, when fully operational, will offer a completerange of decision, origination, documentation and collection services to allCompany offices through a Fargo, North Dakota, location. As of June 30, 2003,all indirect consumer underwriting, administration, documentation andcollection have been centralized. Centralization of the underwriting, administration, documentation andcollection of direct consumer loans, as well as documentation of commercial andagricultural loans, are expected to be completed by the second quarter of 2004.

 

The Companyalso has recently initiated a strategy, which consists of a market extensionmodel, wherein the Company intends to open additional offices in selectedgrowth or emerging growth markets that the Company believes show promise forgrowth.  Additional offices are expectedto be within the 12-state area within which the Company currentlyoperates.  Services provided at the newlocations will be determined by the opportunities identified in that area, andmay include business, retail, investment sales, insurance products, mortgageproducts and wealth management.  TheCompany expects to announce the initial market extension opportunities laterthis year.  The addition of these marketextensions is not expected to have a material impact on the Company’s financialperformance during 2003 and 2004.

# ** **

# **Critical Accounting Policies**

 

The Companyhas established various accounting policies that govern the application ofaccounting principles generally accepted in the United States in thepreparation of the Company’s financial statements. The significant accountingpolicies of the Company are described in the footnotes to the consolidatedfinancial statements included in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2002. Certain accounting policies involve significant judgments andassumptions by management that have a material impact on the carrying value ofcertain assets and liabilities; management considers such accounting policiesto be critical accounting policies.  Thejudgments and assumptions used by management are based on historical experienceand other factors, which are believed to be reasonable under thecircumstances.  Because of the nature ofthe judgments and assumptions made by management, actual results could differfrom these judgments and estimates that could have a material impact on thecarrying values of assets and liabilities and the results of operations of theCompany.  The Company believes that itscritical accounting policies include the allowance for loan losses, goodwillimpairment and income taxes.

 

The Companybelieves the allowance for loan losses is a critical accounting policy thatrequires the most significant judgment and estimates used in the preparation ofits consolidated financial statements. The current level of the allowance forloan losses is a result of management’s assessment of the risks within theportfolio based on the information revealed in credit evaluation processes.This assessment of risk takes into account the composition of the loanportfolio, previous loan experience, current economic conditions and otherfactors that, in management’s judgment, deserve recognition. An allowance isrecorded for individual loan categories based on the relative risk characteristicsof the loan portfolios. Commercial, commercial real estate, construction andagricultural amounts are based on a quarterly review of the individual loansoutstanding, including outstanding commitments to lend.

 

12

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Residential real estate andconsumer amounts are based on a quarterly analysis of the performance of therespective portfolios, including historical and expected delinquency andcharge-off statistics.  Ultimate lossesmay vary from current estimates, and as adjustments become necessary, theallowance for loan losses is adjusted in the periods in which such lossesbecome known or fail to occur. Actual loan charge-offs and subsequentrecoveries are deducted from and added to the allowance, respectively.  The Company’s recorded allowance for loanlosses and related provisions for loan losses could be materially differentthan the amounts recorded under different conditions or using differentassumptions.

 

The Company believes theannual testing for impairment of goodwill is a critical accounting policy thatrequires significant judgment and estimates. The Company performed its initialimpairment test during the first quarter of 2002 and its initial annualimpairment test during the fourth quarter of 2002.  Both tests indicated no impairment existed, thus no adjustment tothe carrying amount of goodwill was recorded. The Company will perform its annual impairment test during the fourthquarter each year.  The Company uses amulti-period discounted earnings model to determine if the equity fair value ofthe underlying reporting unit is equal to or greater than the current bookvalue.  The model is based onmanagement’s estimate of the Company’s projected earnings stream over thefollowing five years. The valuation model includes various management estimatesand assumptions and thus, to the extent these estimates and assumptions varyfrom actual future results, are subject to error and may not be indicative ofactual impairment.

 

The Companyalso believes the estimation of its income tax liability is a criticalaccounting policy that requires significant judgment and estimates on the partof management.  The Company estimatesits income tax liability based on an estimate of its current and deferred taxeswhich are based on its estimates of taxable income.  The Company makes its estimate based on its interpretations ofthe existing income tax laws as they relate to the Company’s activities.  Such interpretations could differ from thoseof the taxing authorities. Periodically, the Company is examined by variousfederal and state tax authorities.  Inthe event management’s estimates and assumptions vary from the views of thetaxing authorities, adjustments to the periodic tax accruals may be necessary.

 

The Company’saccounting policies for the allowance for loan losses, testing for theimpairment of goodwill and estimation of its income tax liability are outlinedin the Company’s Form 10-K for the year ended December 31, 2002.  The Company further believes that there havebeen no significant changes to the methodology used in the assessment of theseestimates and judgments, since the prior year end.

 

**Overview**

 

For the threemonths ended June 30, 2003, net income was $19.1 million, a decrease of$771,000 or 3.9% from the $19.9 million during the 2002 period.  Basic earnings per common share for thethree months ended June 30, 2003 and for the three months ended June 30, 2002were $0.50.  Diluted earnings per sharefor the three months ended June 30, 2003 were $0.49.

 

Return onaverage assets and return on common equity for the three months ended June 30,2003 were 1.36% and 20.45%, respectively, as compared to the 2002 ratios of1.42% and 22.26%.  The decrease inreturn on assets and return on equity is principally due to the decrease in netincome.

 

For the sixmonths ended June 30, 2003, net income was $38.5 million, a decrease of$631,000 or 1.6% from $39.1 million during the 2002 period.  Basic earnings per common share for the sixmonths ended June 30, 2003 were $1.00, compared to $0.98 in the same period in2002.  Diluted earnings per share forthe six months ended June 30, 2003 were $0.99. The increase in earnings per share is due to the 3.8% decrease in theaverage shares outstanding, offset in part by the decrease in core earnings.

 

Return on average assets andreturn on common equity for the six months ended June 30, 2003 were 1.37% and20.73%, respectively, as compared to the 2002 ratios of 1.40% and 22.16%.  The decrease in return on assets and returnon equity is principally due to a decrease in net income.

 

13

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**Results ofOperations**

 

**Net Interest Income**

 

Net interestincome for the three months ended June 30, 2003 was $64.1 million, a decreaseof $4.2 million, or 6.2%, from the net interest income of $68.3 million earnedduring the 2002 period. The decrease was principally due to the combination ofa $10.7 million reduction in interest income and a $6.5 million decrease ininterest expense resulting from the continued low interest rate environment anda change in the earning asset mix. During the second quarter of 2003, loanscomprised 67% of total average earning assets, down from 71% during thecomparable period in 2002.  The decreasein the percentage of loans in the earning asset mix reflects the Company’sstrategy of focusing on loan quality, rather than seeking to build loan volumeand possible increases in nonperforming assets in a challenging economicenvironment.** **The net interest margin of 5.11% for the period ended June30, 2003 was down from 5.48% for the 2002 period.  The Company anticipates continue downward pressure on its netinterest margin as a result of the current interest rate environment.  If the Company continues to experience anincrease in rates on the long end of the yield curve, net interest margin couldbegin to show greater stability as prepayments slow, premium amortization slowsand cash flow is reinvested at higher rates. The sluggish economy makes growth of the loan portfolio challenging.  Record low interest rates, mortgage-backedsecurity prepayments and fewer high yielding investment opportunities areexpected to contribute to margin pressure.

 

Net interestincome for the six months ended June 30, 2002 was $129.0 million, a decrease of$5.9 million, or 4.4%, from the net interest income of $134.9 million earnedduring the corresponding 2002 period. The decrease was principally due to thecombination of a $19.6 million reduction in interest income and a $13.6 milliondecrease in interest expense resulting from a $51.1 million increase in averageearning assets, coupled with an 29 basis point decrease in net interestmargin.  The net interest margin of5.13% for the period ended June 30, 2003 was down from 5.42% for the corresponding2002 period.

 

**Provision for Loan Losses**

 

The provision for loanlosses for the three months ended June 30, 2003 was $3.5 million, an increaseof $190,000, or 5.8%, from the $3.3 million provision during the 2002 period.Net charge-offs were $4.2 million or .49 percent (annualized) of average loansfor the second quarter of 2003, compared to $3.1 million or .34 percent for thesecond quarter of 2002.  The secondquarter 2003 increase in net-charge offs is attributed in part by the partialcharge-off of two loans, which are classified as non-performing loans.Nonperforming assets at June 30, 2003 were $32.2 million, an increase of $8.2million, or 34.2% from $24.0 million at June 30, 2002**.**  The increase innonperforming assets is attributed primarily to two credits and based upon theCompany’s monthly review of its loan portfolio, management believes is notindicative of any systemic asset quality deterioration.  Nonperforming assets comprised .58 percentand .43 percent of total assets at June 30, 2003 and June 30, 2002,respectively.

 

The provision for loanlosses for the six months ended June 30, 2002 was $7.0 million, an increase of$362,000, or 5.5%, from the $6.6 million provision during the corresponding2002 period.

 

#### **Noninterest Income**

 

Noninterestincome for the three months ended June 30, 2003 was $22.1 million, an increaseof $1.5 million, or 7.3%, from the 2002 level of $20.6 million. Insurancecommissions, which continue to demonstrate strong growth, were $3.4 million forthe 2003 quarter, a slight increase of $34,000 or 1.0% from the $3.3 millionrecorded in the 2002 quarter. Insurance commission growth is partially due tothe addition of four agencies during 2002, which at the time of acquisition hadestimated annual commission revenue of $1.1 million.  During the second quarter of 2003, the Company, through itsinsurance subsidiary, acquired two insurance agencies in Colorado and one inWyoming, which at the time of acquisition had approximately $763,000 in annualcommission revenue.  Commissions on thesale of investment securities were $2.3 million for the quarter ended June 30,2003 and a decrease of $1.2

 

14

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million, or 33.4% from $3.5million for the quarter ended June 30, 2002. While this reflects a challenging investment securities salesenvironment, the second quarter of 2003 was the third highest quarter ever incommissions on the sales of investment products.  The highest quarter was the second quarter of 2002. In line witha 1.8% decrease in average deposits during the three months ended June 30,2003, compared to the 2002 period, service charges on deposit accountsdecreased $98,000 or 1.0%, to $10.0 million as of June 30, 2003, compared to$10.1 million during the 2002 period. Other income increased $699,000 or 27.7% from $2.5 million in 2002 to$3.2 million in 2003.  Non interestincome in the three-month period ended June 30, 2003, included an increase of$2.0 million in net gains on the sale of investment securities, over the 2002period.  The security gains offsetapproximately $530,000 of prepayment penalties incurred to prepay long-termFederal Home Loan bank advances and a modest portfolio restructuring to limitpotential prepayment risk exposure.

 

Noninterestincome for the six months ended June 30, 2003 was $43.1 million, an increase of$3.4 million, or 8.7%, from the 2002 level of $39.6 million.  Other income increased $1.9 million,principally due to a $1.0 million increase in premiums on the sale of SBA loansand the mortgage business of the Company’s joint venture.  Investment sales commissions decreased $1.2million, or 22.0%.  Insurancecommissions increased $838,000 or 12.7%. These increases were offset in part by a $375,000, or 1.9% decrease inservice charges on deposit accounts. The 2003 period included a $2.3 million gain on the sale of investmentsecurities, compared to a $171,000 loss in the corresponding 2002 period.  The increase in gain on the sale ofinvestment securities was in part due to the Company’s sale of selectedmortgage-backed securities in an effort to mitigate investment portfolioprepayment risk.

 

**Noninterest Expense**

 

Noninterest expense for thethree months ended June 30, 2003 was $54.4 million, a decrease of $1.3 million,or 2.3%, from the level of $55.7 million during the 2002 period.  The decrease reflects the Company’scontinued focus on expense control. Salary and benefits for the three months ended June 30, 2003 was $28.2million, a decrease of $1.0 million or 3.5% from $29.3 million at June 30,2002.  The reduction is the result ofoperating efficiencies related to strategic initiatives implemented during 2002and the Company’s focus on noninterest expense control.  Net occupancy increased $326,000 or 4.0%from $8.1 million during the three-month period ended June 30, 2002 to $8.4million for the three-month period ended June 30, 2003.  This increase reflects increaseddepreciation expense as a result of equipment purchases associated with theCompany’s initiatives related to improving delivery channels. Company-obligatedmandatorily redeemable preferred security expense decreased $493,000, or 17.0%to $2.4 million at June 30, 2003, from $2.9 million at June 30, 2002.  This decrease is attributed to a reductionin expense associated with the issuance of the 7.60% junior subordinateddebentures issued in March 2003, which bear a lower rate than the 8.20% juniorsubordinated debentures which were redeemed with the proceeds.

 

Noninterest expense for thesix months ended June 30, 2003 was $107.9 million, a decrease of $934,000, or0.9%, from the level of $108.8 million during the 2002 period.   The decrease was principally due to the$1.6 million decrease in salary and benefits, offset by the $1.0 million increasein net occupancy expense, both a result of operating efficiencies realizedthrough the implementation of initiatives announced in prior years.  These decreases were partially offset by a$530,000 early payment penalty, paid during the second quarter of 2003, whenthe Company elected to pay off various Federal Home Loan Bank borrowings, whichcarried higher than market interest rates.

 

**Provision for Income Taxes**

 

The provision for incometaxes for the three months ended June 30, 2003 was $9.2 million, a decrease of$842,000, or 8.4%, from the 2002 level of $10.1 million. The decrease was dueprincipally to the decrease in pre-tax net income.  The effective tax rate for the three months ended June 30, 2003was 32.60%, as compared to 33.65% for the three months ended June 30, 2002.

 

15

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The provision for incometaxes for the six months ended June 30, 2003 was $18.7 million, a decrease of$1.3 million, or 6.5%, from the 2002 level of $20.0 million.  The decrease was due primarily to thedecrease in pre-tax net income.

 

**FinancialCondition**

 

**Loans**

 

Total loans were $3.4billion at June 30, 2003, a decrease of $152 million, or 4.2% from $3.6 billionat December 31, 2002.  The decreasereflects management’s continued reluctance to maintain loan volume at theexpense of loan quality.  While theCompany continues to seek quality loan opportunities, the current economicenvironment does not provide sufficient opportunities to re-deploy cash flowgenerated from existing loan repayments. The Company continues to stress disciplined loan underwriting and strongcredit administration.

 

The following table presentsthe Company’s balance of each major category of loans:

 
|                           |   | **June 30, 2003**          |      | **December 31, 2002**       |   |
|--------------------------------|--------|----------------------------|-----------|-----------------------------|--------|
|                           |   | **Amount**                 |      | **Percent of  Total Loans** |   | **Amount** |   | **Percent of  Total Loans** |   |
|                           |   | **(Dollars in Thousands)** |      |
| Loan category:                 |   |                       |      |                        |   |   |   |   |   |
| Real estate                    |   | $                          | 1,567,732 |                        | 45.7   | % | $ | 1,568,710 |   | 43.8 | % |
| Real estate construction       |   | 368,914                    |      | 10.8                        | %      | 439,536 |   | 12.3 | % |
| Commercial                     |   | 656,350                    |      | 19.2                        | %      | 723,530 |   | 20.2 | % |
| Consumer and other             |   | 640,769                    |      | 18.7                        | %      | 625,429 |   | 17.5 | % |
| Agricultural                   |   | 192,137                    |      | 5.6                         | %      | 220,688 |   | 6.2 | % |
| Total loans                    |   | 3,425,902                  |      | 100.0                       | %      | 3,577,893 |   | 100.0 | % |
| Less allowance for loan losses |   | (54,187                    | )         |                        |   | (56,156 | ) |   |   |
| Total                          |   | $                          | 3,371,715 |                        |   |   | $ | 3,521,737 |   |   |   |

 

#### **Nonperforming Assets**

 

At June 30,2003, nonperforming assets were $32.2 million, an increase of $3.3 million or11.4% from the $28.9 million level at December 31, 2002. At June 30, 2003,nonperforming loans as a percent of total loans were .75%, up from the December31, 2002 level of .64%.  The increase innonperforming assets is attributed primarily to two credits, an agri-businesscredit and a construction contractor credit. Based on a review of the loan portfolio, management believes this is notindicative of any systemic asset quality deterioration. OREO was $6.5 millionat June 30, 2003, an increase of $499,000, or 8.3% from $6.0 million atDecember 31, 2002.  The increase in OREOwas due principally to the addition of one commercial property carried at afair value of $752,000.

 

Nonperforming assets of theCompany are summarized in the following table:

 
| **(Dollars  in thousands)**                            |   | **June 30,2003** |   | **December 31, 2002** |   |
|--------------------------------------------------------|--------|------------------|--------|-----------------------|--------|
| Loans                                                  |   |             |   |                  |   |
| Nonaccrual loans                                       |   | $                | 25,543 |                  | $      | 22,728 |   |
| Restructured loans                                     |   | 205              |   | 220                   |   |
| Nonperforming loans                                    |   | 25,748           |   | 22,948                |   |
| Other real  estate owned                               |   | 6,489            |   | 5,990                 |   |
| Nonperforming assets                                   |   | $                | 32,237 |                  | $      | 28,938 |   |
| Loans 90 days or more past due but still accruing      |   | $                | 2,603  |                  | $      | 4,258 |   |
| Nonperforming loans as a percentage of total loans     |   | .75              | %      | .64                   | %      |
| Nonperforming assets as a percentage of total assets   |   | .58              | %      | .50                   | %      |
| Nonperforming assets as a percentage of loans and OREO |   | .94              | %      | .81                   | %      |

 

16

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#### **Allowance for Loan Losses**

 

At June 30, 2003 theallowance for loan losses was $54.2 million, a decrease of $1.4 million fromthe June 30, 2002 balance of $55.6 million. Net charge-offs during the three months ended June 30, 2003 were $4.2million, an increase of $1.1 million or 35.5% from the $3.1 million during thethree months ended June 30, 2002. The increase in net charge-offs was dueprincipally to the partial charge-off of two specific credits, an agri-businessloan and a construction contractor credit, which, based on a review of the loanportfolio, management believes is not indicative of systemic asset qualitydeterioration. While net charge-offs and nonperforming assets increased duringthe second quarter of 2003, management believes the current allowance for loanlosses is appropriate based on management’s assessment of potential losses withinthe remaining nonperforming asset portfolio and the reduction in total loansoutstanding.

 

At June 30, 2003, theallowance for loan losses as a percentage of total loans was 1.58%, an increasefrom the June 30, 2002 level of 1.52%.

 

The following table setsforth the Company’s allowance for loan losses:

 
|                                                    |   | **June 30,** |      |
|---------------------------------------------------------|--------|--------------|-----------|
| **(Dollars  in thousands)**                             |   | **2003**     |      | **2002** |   |
| Balance at beginning of period                          |   | $            | 54,895    |   | $ | 55,401 |   |
| Charge-offs:                                            |   |         |      |   |   |
| Real estate                                             |   | 309          |      | 637 |   |
| Real estate construction                                |   | 17           |      | 47 |   |
| Commercial                                              |   | 1,782        |      | 1,781 |   |
| Consumer and other                                      |   | 2,315        |      | 2,290 |   |
| Agricultural                                            |   | 1,288        |      | 103 |   |
| Total charge-offs                                       |   | 5,711        |      | 4,858 |   |
| Recoveries:                                             |   |         |      |   |   |
| Real estate                                             |   | 35           |      | 54 |   |
| Real estate construction                                |   | —       |      | 4 |   |
| Commercial                                              |   | 326          |      | 37 |   |
| Consumer and other                                      |   | 1,153        |      | 1,570 |   |
| Agricultural                                            |   | 2            |      | 47 |   |
| Total recoveries                                        |   | 1,516        |      | 1,712 |   |
| Net charge-offs                                         |   | 4,195        |      | 3,146 |   |
| Provision  charged to operations                        |   | 3,487        |      | 3,297 |   |
| Balance at  end of period                               |   | $            | 54,187    |   | $ | 55,552 |   |
| Allowance as a percentage of total loans                |   | 1.58         | %         | 1.52 | % |
| Annualized net charge-offs to average loans outstanding |   | 0.49         | %         | 0.34 | % |
|                                                    |   |         |      |   |   |
| Total Loans                                             |   | $            | 3,425,902 |   | $ | 3,652,749 |   |
| Average Loans                                           |   | 3,456,376    |      | 3,664,634 |   |

 

#### ** **

**Investments**

 

The investment portfolio,including available-for-sale securities and held-to-maturity securities, was$1.7 billion at June 30, 2003, a decrease of $82 million or 4.7% from $1.8billion at December 31, 2002.  At June30, 2003, the investment portfolio represented 29.9% of total assets, comparedwith 30.1% at December 31, 2002.  Inaddition to investment securities, the Company had investments ininterest-bearing deposits of $5.4 million at June 30, 2003, an increase of$777,000, or 16.8% from $4.6 million at December 31, 2002.

 

**Deposits**

 

Total deposits were $4.5billion at June 30, 2003, a decrease of $209 million, or 4.5%, from $4.7billion at December 31, 2002. Noninterest-bearing deposits at June 30, 2003 were $462 million, adecrease of $9 million, or 2.0%, from $471 million at December 31, 2002.  The decrease in total deposits

 

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and noninterest bearing deposits wasprincipally due to the continued low interest rate environment and theCompany’s focus on maintaining interest bearing liabilities at interest ratelevels which contribute to a strong net interest margin. The Company’s coredeposits which are all deposits, excluding time accounts over $100,000, as apercent of total deposits were 87.6% and 85.6% as of June 30, 2003 and December31, 2002, respectively. Interest-bearing deposits were $4.0 billion at June 30, 2003, a decreaseof $199,000 or 4.7% from $4.2 billion at December 31, 2002.

 

**Borrowings**

 

Short-term borrowings of theCompany were $83.3 million as of June 30, 2003, an increase of $7 million, or9.2%, from $76.3 million as of December 31, 2002.  The increase is due primarily to the fluctuation in the level ofdaily deposits and its impact on short-term liquidity, and reflects theCompany’s strategy of funding short-term liquidity needs in the mostcost-effective manner.

 

Long-term debt of theCompany was $112.5 million as of June 30, 2003, a decrease of $15 million, or11.8%, from the $127.5 million as of December 31, 2002.  The $15 million decrease is primarily theresult of the Company repurchasing $10 million of its 7.30% Subordinated Notesissued in June 1997 and maturing June 30, 2004.  As a result, the Company was able to reduce its borrowing costswhile maintaining capital adequacy.  The7.30% Notes no longer qualify as Tier 2 Capital, as they mature in less than oneyear.

 

**Asset and Liability Management**

 

*LIQUIDITYMANAGEMENT*

 

Liquiditymanagement is an effort of management to provide a continuing flow of funds tomeet its financial commitments, customer borrowing needs and deposit withdrawalrequirements. The liquidity position of the Company and its subsidiary bank ismonitored by the Asset and Liability Management Committee (“ALCO”) of theCompany. The largest category of assets representing a ready source ofliquidity for the Company is its short-term financial instruments, whichinclude federal funds sold, interest-bearing deposits at other financialinstitutions, U.S. Treasury securities and other securities maturing within oneyear. Liquidity is also provided through the regularly scheduled maturities ofassets. The investment portfolio contains a number of high quality issues withvarying maturities and regular principal payments. Maturities in the loanportfolio also provide a steady flow of funds, and strict adherence to thecredit policies of the Company helps ensure the collectability of these loans.The liquidity position of the Company is also greatly enhanced by itssignificant base of core deposits.

 

In the normal course ofbusiness, the Company is party to financial instruments with off-balance-sheetrisk. Because many of the commitments are expected to expire without beingdrawn upon, total commitment amounts do not necessarily represent the Company’sfuture liquidity requirements. These instruments are further described in NoteG - Financial Instruments With Off Balance-Sheet Risk.

 

The liquidity ratio is onemeasure of a bank’s ability to meet its current obligations and is defined asthe percentage of liquid assets to deposits. Liquid assets include cash and duefrom banks, unpledged investment securities with maturities of less than oneyear and federal funds sold. At June 30, 2003 and December 31, 2002, theliquidity ratio was 5.33% and 8.32%, respectively. The level of loans maturingwithin one year greatly add to the Company’s liquidity position. Includingloans maturing within one year, the liquidity ratio was 23.94% and 27.94%,respectively, for the same periods.

 

The Company has revolvinglines of credit with its primary lenders, which provide for borrowing up to $85million. These lines would be utilized to finance stock repurchase activity,underwrite commercial paper, and fund other operating expenses. At June 30,2003, the Company had $47 million in commercial paper outstanding, supported bythe Company’s revolving line of credit.

 

The Company maintainsavailable lines of federal funds borrowings at the Federal Reserve Bank ofMinneapolis. The Company’s subsidiary bank has the ability to borrow anaggregate of $388 million in

 

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federal funds from eleven nonaffiliatedfinancial institutions. At June 30, 2003, the Company had $85 millionoutstanding on these lines.

 

The Company also has a $263million line of credit from the Federal Reserve under its new Primary Creditprogram, which permits financial institutions with collateralized lines ofcredit at the Federal Reserve to borrow funds on a short-term basis.  Funds are priced at a spread above thefederal funds target rate and are available on an as needed basis.  At June 30, 2003, there was no balance owingon this line.

 

Additionally, the Company’ssubsidiary bank is a member of the Federal Home Loan Bank (“FHLB”) System. Aspart of membership, the Company’s subsidiary bank purchased a modest amount ofstock of FHLB and obtained advance lines of credit which represent an aggregateof $451 million in additional funding capacity.  At June 30, 2003, the Company had $44 million outstanding on thisline.

 

Subsequent to quarter end,the Company obtained another federal fund line with a nonaffiliated financialinstitution. This new line provides for additional overnight borrowing capacityof $25 million.

 

INTEREST RATESENSITIVITY

 

Interest rate sensitivityindicates the exposure of a financial institution’s earnings to futurefluctuations in interest rates. Management of interest rate sensitivity isaccomplished through the composition of loans and investments and by adjustingthe maturities on earning assets and interest-bearing liabilities. Ratesensitivity and liquidity are related since both are affected by maturingassets and liabilities. However, interest rate sensitivity also takes intoconsideration those assets and liabilities with interest rates that are subjectto change prior to maturity.

 

ALCO attempts to structurethe Company’s balance sheet to provide for an approximately equal amount ofrate sensitive assets and rate sensitive liabilities. In addition tofacilitating liquidity needs, this strategy assists management in maintainingrelative stability in net interest income despite unexpected fluctuations ininterest rates. ALCO uses three methods for measuring and managing interestrate risk: Repricing Mismatch Analysis, Balance Sheet Simulation Modeling andEquity Fair Value Modeling.

 

RepricingMismatch Analysis

 

Management performs a RepricingMismatch Analysis (“Gap Analysis”) which represents a point in time netposition of assets, liabilities and off-balance sheet instruments subject torepricing in specified time periods. Gap Analysis is performed quarterly.  However, management believes Gap Analysisalone does not accurately measure the magnitude of changes in net interestincome since changes in interest rate do not impact all categories of assets,liabilities and off-balance sheet instruments equally or simultaneously.

 

Balance Sheet SimulationModeling

 

Balance Sheet SimulationModeling allows management to analyze the short-term (12 months or less) impactof interest rate fluctuations on projected earnings.  Using financial simulation computer software, management hasbuilt a model that projects a number of interest rate scenarios.  Each scenario captures the impact ofcontractual obligations embedded in the Company’s assets and liabilities.  These contractual obligations includematurities, loan and security payments, repricing dates, interest rate caps,and interest rate floors.  Theprojection results also measure the impact of various management assumptionsincluding loan and deposit volume targets, security and loan prepayments,pricing spreads and implied repricing caps and floors on variable ratenon-maturity deposits. Management completes an earnings simulationquarterly.  The simulation process isthe Company’s primary interest rate risk management tool.

 

Whilemanagement strives to use the best assumptions possible in the simulationprocess, all assumptions are uncertain by definition.   Due to numerous market factors, and the potential for changes

 

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in management strategy overtime, actual results may deviate from model projections.

 

Based on the results of thesimulation model as of June 30, 2003, management would expect net interestincome to increase 0.81%, assuming a 100 basis point rate increase in marketrates.  The increase in net interestincome is attributable to a sharp decline in prepayment pressure and premiumamortization expense as rates increase. Assuming rates dropped 100 basis points, management would expect netinterest income to decline 4.35%.  Thisdecline exceeds the ALCO guidelines of 1.40%. Under this declining ratescenario, because of projected security prepayments and the assumed floor ontransaction account pricing, assets reprice faster than liabilities.

 

Severalfactors mitigate the Company’s projected exposure to declining rates.  First, management-established riskguidelines are measured against instantaneous rate shocks.  Gradual rate shifts over several monthsreduce the level of projected risk under both rising and declining ratescenarios.  Also, the current modelassumes that there is no room to downprice non-maturity transactiondeposits.  Management has effectivelyfloored these liability accounts at current levels in its model.  As an abundance of caution, managementbelieves this is an appropriate assumption for risk management purposes, butmanagement believes there would be the potential for some downpricing on thissizeable volume of liabilities.

 

In addition toearnings at risk, the simulation process is also used as a tool in liquidityand capital management.  Managementmodels the impact of interest rate fluctuation on the anticipated cash flowsfrom various financial instruments, ultimately measuring the impact thatchanging rates will have on the Company’s liquidity profile.  Management also reviews the implications ofstrategies that impact asset mix and capital levels, measuring several keyregulatory capital ratios under various interest rate scenarios.

 

Equity FairValue Modeling

 

BecauseBalance Sheet Simulation Modeling is dependent on accurate volume forecasts,its usefulness as a risk management tool is limited to relatively short timeframes.  As a complement to thesimulation process, management uses Equity Fair Value Modeling to measurelong-term interest rate risk exposure. This method estimates the impact of interest rate changes on thediscounted future cash flows of the Company’s current assets, liabilities andoff-balance sheet instruments.  Thisrisk model does not incorporate projected volume assumptions.

 

Similar to thesimulation process, fair value results are heavily driven by managementassumptions.  While management strivesto use the best assumptions possible, due to numerous market factors, actualresults may deviate from model projections.

 

Based on themodel results from June 30, 2003, management would expect equity fair value todecline 3.88% assuming a 100 basis point increase in rates.  This exposure is within the ALCO establishedguidelines of 10.00%.  Assuming ratesdeclined 100 basis points, the model projects a decline in equity fair value of2.51%.  This exposure is also within theALCO established policy guidelines of 10.00%.

 

The Company does not engagein the speculative use of derivative financial instruments.

 

**Capital Management**

 

Shareholders’ equity was$382 million at June 30, 2003, an increase of $4 million, or 1.1% from $378million at December 31, 2002. Unrealized gain on available-for-sale securities, net of taxes,decreased $3.5 million, or 14.9% from $23.8 million at December 31, 2002 to$20.3 million at June 30, 2003.  At June30, 2003, the Company’s Tier 1 capital, total risk-based capital and leverageratios were 9.77%, 11.63%, and 6.98%, respectively, compared to minimumrequired levels of 4%, 8% and 3%, respectively (subject to change and thediscretion of regulatory authorities to impose higher standards in individualcases).  Ratios of 6%, 10%, and 5%,respectively, are generally regarded as well capitalized ratios.  At June 30, 2003, the Company had risk-weightedassets of $4.0 billion.  The June 30,2003 capital ratios

 

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include both the $60 million 7.60% JuniorSubordinated Debentures issued March 4, 2003 and the $60 million 8.125% JuniorSubordinated Debentures issued March 27, 2002. Capital and leverage ratios remain substantially within minimumregulatory capital limits for a well-capitalized institution.

 

On March 4, 2003, theCompany issued $60 million in 7.60% Cumulative Capital Securities, through CFBCapital IV, a statutory trust subsidiary organized in February 2003.  All $60 million of the capital securitiesqualify as Tier I Capital for regulatory capital calculation purposes.  The proceeds from the offering were used onApril 4, 2003 to redeem the $60 million of 8.20% junior subordinated debenturesthat were issued in December 1997.  TheCompany has unconditionally guaranteed the obligations of CFB Capital IV underthe 7.60% cumulative capital securities.

 

#### **Stock Repurchases**

 

During the second quarter of2003, the Company repurchased 357,000 shares of its common stock at pricesranging from $26.30 to $28.29. On April 24, 2003, the Company announced thatthe Board of Directors approved an additional common stock repurchaseauthorization wherein the Company may repurchase up to an additional 3 millionshares of its common stock outstanding. The shares will be repurchased primarily on the open market, with timingdependent on market condition and any pending acquisitions.  The Company has 3,402,000 shares that remainauthorized for repurchase under existing authorizations.  Since the first quarter of 2000, the Companyhas repurchased a total of 13.4 million shares of its common stock, whichrepresents approximately 27% of the shares outstanding.

 

**Off-BalanceSheet Arrangements, Contractual Obligations and Other Commercial Commitments**

 

**Off-Balance Sheet Arrangements**

 

In the normal course ofbusiness, the Company enters into various business arrangements wherein it maybe required by the terms of the arrangement to guarantee or invest additionalcapital as a result of investment opportunities and financial performance.

 

***Mortgage Loan Joint Venture:***  TheCompany, through its subsidiary bank, and Wells Fargo & Company formed ajoint venture mortgage company for the purpose of providing mortgageorigination, documentation, servicing process and support for substantially allthe residential mortgage business of the Company.  The Company has 50% ownership and 50% voting rights over theaffairs of the joint venture and accordingly records its investment and itscontinuing share of the income or loss of the joint venture under the equitymethod of accounting.  As a 50% holderof the joint venture, the Company may be required to increase its investment inthe joint venture in the event additional investment capital wererequired.  As of June 30, 2003, theCompany’s investment in the joint venture totaled $476,000.

 

***Federal Reserve Stock:***  TheCompany’s affiliate bank is required by Federal banking regulations to be amember of the Federal Reserve System. As a member of the Federal Reserve System, the Company may be requiredto maintain stock ownership in the Federal Reserve System in an amount equal tosix percent of the affiliate bank’s paid-in capital and surplus.  The affiliate bank is required and currentlyhas purchased an amount of common stock equal to three percent, or one-half thebank’s subscription amount.  At thediscretion of the Federal Reserve System, the bank may be required to increaseits investment to an amount equal to the full six percent of its total paid-incapital and surplus.  At June 30, 2003,the Company’s investment in the Federal Reserve System totaled $9.6 million.

 

**Contractual Obligations and Other Commercial Commitments:**

 

In the normal course ofbusiness, the Company arranges financing through entering into debt arrangementswith various creditors for the purpose of financing specific assets orproviding a funding source.   Thecontract or notional amounts of these financing arrangements at June 30, 2003,as well as the maturity of these commitments are (in thousands):

 

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|                          |   | **Payment Due by Period** |    |
|-------------------------------|--------|---------------------------|---------|
| **Contractual  Obligations**  |   | **Total**                 |    | **Less than  1 Year** |   | **1-3  Years** |   | **3-5  Years** |   | **More than  5 Years** |   |
|                          |   |                      |    |   |   |   |   |   |   |   |   |
| Long Term Debt                |   | $                         | 112,500 |   | $ | 19,500 |   | $ | 58,000 |   | $ | 31,000 |   | $ | 4,000 |   |
| Capital Lease Obligations     |   | 6,854                     |    | 1,356 |   | 3,081 |   | 2,263 |   | 154 |   |
| Operating Leases              |   | 7,140                     |    | 2,319 |   | 1,568 |   | 1,098 |   | 2,155 |   |
|                          |   |                      |    |   |   |   |   |   |   |   |   |
| Total Contractual Obligations |   | $                         | 126,494 |   | $ | 23,175 |   | $ | 62,649 |   | $ | 34,361 |   | $ | 6,309 |   |

 

***Long Term Debt:***  AtJune 30, 2003, the Company had long term debt outstanding of $112.5million.    Long-term debt includes $50million of unsecured subordinated notes payable, bearing interest at a rate of7.30%, payable semi-annually, that mature June 30, 2004.  The subordinated notes, whose terms includecertain covenants pertaining to regulatory compliance, financial performance,timely reporting, failure to pay principal at maturity, failure to makescheduled payments, and bankruptcy, insolvency or reorganization of theCompany, may not be paid early. The subsidiary bank had Federal Home Loan Bankadvances totaling $37.5 million outstanding at June 30, 2003.  Also at June 30, 2003, the subsidiary bankhad a $25 million unsecured subordinated term note payable to a non-affiliatedbank, with a maturity date of December 22, 2007.  The subsidiary bank note payable is subject to covenants thatinclude, remaining in compliance with all regulatory agency requirements,providing timely financial information and providing access to certain Companyrecords.

 

***Capital Lease Obligations:***  TheCompany frequently acquires the rights to equipment used in the operation ofthe Company by entering into long-term capital leases.  At June 30, 2003, the Company was liable forthe payment of lease schedules associated with the acquisition of equipment andpremises totaling $5,759,000, exclusive of finance charges.  The effect of capital leases recorded atJune 30, 2003 are summarized in the table above.

 

***Operating Leases:***  Inthe normal course of business the Company enters into operating leasearrangements for the use of premises and equipment.  Operating leases include rental agreements with tenants providingfacilities through which the Company delivers its products and services.

 

***Company-Obligated Mandatorily RedeemablePreferred Securities: ***At June 30, 2003, the Company hasunconditionally guaranteed the obligation of CFB Capital IV, under the $60,million, 7.60% Cumulative Capital Securities issued March 4, 2003, and theobligation of CFB Capital III, under the $60 million, 8.125% Cumulative CapitalSecurities issued March 27, 2002. The $60 million Capital IV securities, whichmature March 15, 2033 may be redeemed any time on or after March 15, 2008.  The $60 million Capital III securities,which mature April 15, 2032 may be redeemed any time on or after April 15,2007.

 

In the normal course ofbusiness, the Company is party to financial instruments with off-balance-sheetrisk. These transactions enable customers to meet their financing needs. Thesefinancial instruments include commitments to extend credit and letters ofcredit. The contract or notional amounts of these financial instruments at June30, 2003, as well as the maturity of these commitment are (in thousands):

 
|                             |   | **Amount of commitment expiring per period** |    |
|----------------------------------|--------|----------------------------------------------|---------|
| **Other Commercial Commitments** |   | **Total**                                    |    | **Less than  1 Year** |   | **1-3  Years** |   | **3-5  Years** |   | **More than  5 Years** |   |
|                             |   |                                         |    |   |   |   |   |   |   |   |   |
| Commitments to Extend Credit     |   | $                                            | 642,005 |   | $ | 424,178 |   | $ | 44,039 |   | $ | 26,093 |   | $ | 147,695 |   |
| Standby Letters of Credit        |   | 23,044                                       |    | 19,524 |   | 2,549 |   | 209 |   | 762 |   |
| Commercial Letters of Credit     |   | 10,371                                       |    | 9,841 |   | 380 |   | 90 |   | 60 |   |
|                             |   |                                         |    |   |   |   |   |   |   |   |   |
| Total Commercial Commitments     |   | $                                            | 675,420 |   | $ | 453,543 |   | $ | 46,968 |   | $ | 26,392 |   | $ | 148,517 |   |

 

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***Commitments to extend credit*******are legally binding and have fixed expirationdates or other termination clauses. The Company’s exposure to credit loss oncommitments to extend credit, in the event of nonperformance by thecounterparty, is represented by the contractual amounts of the commitments. TheCompany monitors its credit risk for commitments to extend credit by applyingthe same credit policies in making commitments as it does for loans and byobtaining collateral to secure commitments based on management’s creditassessment of the counterparty. Collateral held by the Company may includemarketable securities, receivables, inventory, agricultural commodities,equipment and real estate. Because many of the commitments are expected toexpire without being drawn upon, total commitment amounts do not necessarilyrepresent the Company’s future liquidity requirements. In addition, the Companyalso offers various consumer credit line products to its customers that arecancelable upon notification by the Company, which are included above incommitments to extend credit.

 

***Standby letters of credit*** are conditional commitments issued by theCompany to guarantee the financial performance of a customer to a third party.Those guarantees are primarily issued to support public and private borrowingarrangements.

 

***Commercial letters of credit*** are issued by the Company on behalf ofcustomers to ensure payments of amounts owed or collection of amountsreceivable in connection with trade transactions. The Company’s exposure tocredit loss in the event of nonperformance by the counterparty is thecontractual amount of the letter of credit and represents the same exposure asthat involved in extending loans.

 

#### **Forward-looking Statements**

 

This Form 10-Q contains forward-looking statements under the PrivateSecurities Litigation Reform Act of 1995 that are subject to certain risks anduncertainties that could cause actual results to differ materially fromhistorical earnings and those presently anticipated or projected. The Companywishes to caution readers not to place undue reliance on any suchforward-looking statements, which speak only as of the date made.  Forward-looking statements can be identifiedby the fact that they do not relate strictly to historical or current facts.They often include words such as “believe,” “expect,” “anticipate,” “intend,”“plan,” “estimate,” or words of similar meaning, or future or conditional verbssuch as “will,” “would,” “should,” “could” or “may.” Factors that could causeactual results to differ from the results discussed in the forward-lookingstatements include, but are not limited to: risk of loans and investments, including dependence on local economicconditions; competition for the company’s customers from other providers offinancial services; possible adverse effects of changes in interest rates;balance sheet and critical ratio risks related to the share repurchase program;risks related to the company’s acquisition and market extension strategy,including risks of adversely changing results of operations and factorsaffecting the company’s ability to consummate further acquisitions or extendits market, and other risks detailed in the company’s filings with theSecurities and Exchange Commission including the risks identified in theCompany’s Form 10-K filed with the Commission on March 19, 2003, all of whichare difficult to predict and many of which are beyond the control of thecompany.

 

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**Item3.  Quantitative and QualitativeDisclosure About Market Risk**

 

There have been no materialchanges in market risk exposures that affect the quantitative and qualitativedisclosures presented as of December 31, 2002 in the Company’s Form 10-K andAnnual Report.

 

**Item4.  Controls and Procedures**

 

**Quarterly evaluation of the Company’sDisclosure Controls and Internal Controls.**  As of the end of the fiscal quarter coveredby this quarterly report on Form 10-Q, the Company evaluated the effectivenessof the design and operation of its “disclosure controls and procedures” (the“Disclosure Controls”), and its “internal controls and procedures for financialreporting” (the “Internal Controls”). This evaluation (the “Controls Evaluation”) was done under thesupervision and with the participation of management, including the ChiefExecutive Officer (“CEO”) and Chief Financial Officer (“CFO”).  Rules adopted by the Securities and ExchangeCommission (the “SEC” or “Commission”) require that in this section of thisquarterly report, we present the conclusions of the CEO and the CFO about theeffectiveness of the Company’s Disclosure Controls and Internal Controls basedon and as of the date of the Controls Evaluation.

 

**CEO and CFO Certifications.** Appearing in this quarterly report are two separate forms of“Certifications” of the CEO and the CFO. The first form of Certification, immediately following the Signaturessection, is required in accord with Section 302 of the Sarbanes-Oxley Act of2002 (the “Section 302 Certification”). This section of Form 10-Q contains information concerning the ControlsEvaluation referred to in the Section 302 Certifications and this informationshould be read in conjunction with the Section 302 Certifications for a morecomplete understanding of the topics presented.  The second Certification is pursuant to Section 906 ofSarbanes-Oxley and concerns compliance and disclosure under the SecuritiesExchange Act of 1934.

 

**Disclosure Controls and Internal Controls.** Disclosure Controls are procedures that are designed to ensure thatinformation required to be disclosed in our reports filed under the SecuritiesExchange Act of 1934 (the “Exchange Act”), such as this quarterly report, isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms. Disclosure Controls are also designed to ensure that such information isaccumulated and communicated to the Company’s management, including the CEO andCFO, as appropriate to allow timely decisions regarding requireddisclosure.  Internal Controls areprocedures designed to provide reasonable assurance that (1) the Company’stransactions are properly authorized; (2) the Company’s assets are safeguardedagainst unauthorized or improper use; and (3) the Company’s transactions areproperly recorded and reported, all of which assists the preparation offinancial statements in conformity with generally accepted accountingprinciples.

 

**Limitations on the Effectiveness of Controls.**  TheCompany’s management, including the CEO and CFO, does not expect that theDisclosure Controls or the Internal Controls will prevent all error and allfraud.  A control system, no matter howwell conceived and operated, can provide only reasonable, not absolute,assurance that the objectives of the control system are met.  Further, the design of a control system mustreflect the fact that there are resource constraints, and the benefits ofcontrols must be considered relative to their costs.  Because of the inherent limitations in all control systems noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within the Company have been detected.  These inherent limitations include therealities that judgments in decision-making can be faulty, and that breakdownscan occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe control.  The design of any systemof controls also is based in part upon certain assumptions about the likelihoodof future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions; over time,control may become inadequate because of changes in conditions, or the degreeof compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

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**Scope of the Controls Evaluation.**  TheCEO/CFO evaluation of Disclosure Controls and Internal Controls included areview of the controls’ objectives and design, the controls’ implementation bythe Company and the effect of the controls on the information generated for usein this quarterly report.  In the courseof the Controls Evaluation, we sought to identify data errors, controlsproblems or acts of fraud and to confirm that appropriate corrective action,including process improvements, were being undertaken.  This type of evaluation will be done on aquarterly and annual basis so that the conclusions concerning controlseffectiveness can be reported in the Company’s quarterly reports on Form 10-Qand in the Company’s Annual Report on Form 10-K.  Internal Controls are also evaluated on an ongoing basis by ourInternal Audit Department, by other personnel in the Company and by theCompany’s independent auditors in connection with their audit and reviewactivities.  The overall goals of thesevarious evaluation activities are to monitor our Disclosure Controls and ourInternal Controls and to make modifications as necessary; the Company’s intentin this regard is that the Disclosure Controls and the Internal Controls willbe maintained as dynamic systems that change (including with improvements andcorrections) as conditions warrant.

 

Among othermatters, the Company sought in the evaluation to determine whether there wereany “significant deficiencies” or “material weakness” in the Company’s InternalControls, or whether the Company had identified any acts of fraud involvingpersonnel who a have significant role in the Company’s Internal Controls.  This information was important both for theControls Evaluation generally and because items 5 and 6 in the Section 302Certifications of the CEO and CFO require that the CEO and CFO disclose suchinformation to our Board’s Audit Committee and to the independent auditors andto report on related matters in this section of the quarterly report.  In the professional auditing literature,“significant deficiencies” are referred to as “reportable conditions”; theseare control issues that could have a significant adverse effect on the abilityto record, process, summarize and report financial data in the financialstatements.  A “material weakness” isdefined as a particularly serious reportable condition where the internalcontrol does not reduce to a relatively low level the risk that misstatementscaused by error or fraud may occur in amounts that would be material inrelation to the financial statements and not be detected within a timely periodby employees in the normal course of performing their assigned functions.  The Company has sought to deal with othercontrols matters in the Controls Evaluation, and in each case if a problem wasidentified, the Company considered what revision, improvement and/or correctionto make in accord with its on-going procedures.

 

**Conclusions. **The Company’s CEO and CFO have reviewed theeffectiveness of the Company’s disclosure controls and procedures as of the endof the fiscal quarter ended June 30, 2003. Based upon this review, these officers believe that the Company’sdisclosure controls and procedures are effective in ensuring that material informationrelated to the Company is made known to them by others within the Company.

 

There were no significantchanges in the Company’s internal control over financial reporting thatoccurred in the quarter ended June 30, 2003 that have materially affected, orare reasonably likely to affect, the Company’s internal controls over financialreporting, including any corrected actions with regard to significantdeficiencies and material weaknesses.

 

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**PART II - OTHER INFORMATION**

 

Item 1.            Legal Proceedings:

 

None.

 

Item 2.            Changes in Securities:

 

On April 4, 2003, theCompany redeemed its $60 million 8.20% junior subordinated debentures whichtriggered the redemption of CFB Capital II’s 8.20% Cumulative CapitalSecurities that CFB Capital II issued in December 1997.  The Company funded the redemption from theproceeds of its issuance of 7.60% Cumulative Capital Securities of CFB CapitalIV on March 4, 2003.

 

Item 3.            Defaults upon Senior Securities:

 

None.

 

Item 4.            Submission of Matters to a Vote of SecurityHolders:

 

The Company held its AnnualMeeting of Shareholders on April 22, 2002. The shareholders took the following actions:

 

(i)                         The shareholders elected ten directors tohold office until the next Annual Meeting of Shareholders or until theirsuccessors are elected.  Theshareholders present in person or by proxy cast the following numbers of votesin connection with the election of directors, resulting in the election of allof the nominees.

 
|               |   | **Votes For** |   | **Votes Withheld** |   |
|--------------------|--------|---------------|--------|--------------------|--------|
| Mark A. Anderson   |   | 34,945,197    |   | 228,640            |   |
| Patrick Delaney    |   | 34,877,454    |   | 296,384            |   |
| John H. Flittie    |   | 29,668,170    |   | 5,505,667          |   |
| Thomas Gallagher   |   | 29,565,605    |   | 5,608,232          |   |
| Darrell G. Knudson |   | 34,202,398    |   | 971,439            |   |
| Dennis M. Mathisen |   | 34,985,028    |   | 188,809            |   |
| Rahn Porter        |   | 29,564,468    |   | 5,609,369          |   |
| Marilyn Seymann    |   | 34,196,195    |   | 977,642            |   |
| Harvey L. Wollman  |   | 29,485,829    |   | 5,688,008          |   |
| Lauris N. Molbert  |   | 29,526,110    |   | 5,647,727          |   |

 

(ii)                      The shareholders ratified and approved theadoption of certain amendments to the 1996 Stock Option Plan.  29,229,246 votes were cast for theresolution; 5,412,970 were cast against the resolution.

 

(iii)                   The shareholders ratified and approved theelection of Ernst & Young LLP as the independent public accountants for theCompany for the current fiscal year. 26,694,050 votes were cast for the resolution; 8,436,106 votes were castagainst the resolution.

 

Item 5.            Other Information:

 

At their August 5, 2003meeting, the Company’s Board of Directors named two additional members to theBoard of Directors, Dawn R. Elm and Karen M. Meyer.  Elm is Professor of Management at the University of St. Thomas inSt. Paul, Minnesota.  Meyer is vice presidentof administration at The Toro Company in Bloomington, Minnesota.

 

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Item 6.            Exhibits and Reports on Form 8-K:

 
| (a)    | Exhibits:                                                                                                                                                                                                                                                                                               |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                    |
|   | 31.1                                                                                                                                                                                                                                                                                                    | Certification pursuant to  13a-14 and 15-d-14 of the Exchange Act. |
|   |                                                                                                                                                                                                                                                                                                    |
|   | 31.2                                                                                                                                                                                                                                                                                                    | Certification pursuant to  13a-14 and 15-d-14 of the Exchange Act. |
|   |                                                                                                                                                                                                                                                                                                    |
|   | 32                                                                                                                                                                                                                                                                                                      | Certification pursuant to  18 U.S.C. § 1350. |
|   |                                                                                                                                                                                                                                                                                                    |   |
|   | 99                                                                                                                                                                                                                                                                                                      | Statement re computation  of ratios. |
|   |                                                                                                                                                                                                                                                                                                    |
| (b)    | Reports on Form 8-K:                                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                    |
|   | On March 6, 2003, the  Company filed a Form 8-K related to the offering of 7.60% Cumulative Capital  Securities of CFB Capital IV, and the redemption of 8.20% Cumulative Capital  Securities of CFB Capital II.                                                                                        |
|   |                                                                                                                                                                                                                                                                                                    |
|   | In addition  during the quarter, the Company furnished to the Commission the following  reports on Form 8-K under Item 12.                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                                                    |
|   | On April 17, 2003, the  Company filed a Form 8-K related to a press release dated April 17, 2003  announcing the Company’s results for the quarter ended March 31, 2003.                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                    |
|   | On June 4,  2003, the Company filed a Form 8-K related to a slide presentation that the  Company’s Chief Executive Officer and Executive Vice President delivered in  Chicago, Illinois at conferences sponsored by Howe Barnes and Keefe, Bruyette  & Woods, Inc. on June 4 and June 5, 2003. |

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
|                       |   |   | **COMMUNITY  FIRST BANKSHARES, INC.**  |
|----------------------------|--------|--------|----------------------------------------|
|                       |   |   |                                   |
|                       |   |   |                                   |
| Date:  August 8, 2003 |   |   | /s/ Mark A. Anderson              |   |
|                       |   |   | Mark A. Anderson                       |
|                       |   |   | President and Chief  Executive Officer |
|                       |   |   |                                   |
|                       |   |   |                                   |
| Date:  August 8, 2003 |   |   | /s/ Craig A. Weiss                |   |
|                       |   |   | Craig A. Weiss                         |
|                       |   |   | Chief Financial Officer                |
|                            |        |        |                                        |  |  |

 

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