**U.S. Securities and Exchange Commission**

 

**Washington, D.C. 20549**

 

**FORM 10-QSB**

 

**ý****QUARTERLY REPORT UNDERSECTION 13 OF 15 (D) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**Forthe quarterly period ended March 31, 2003**

 

**OR**

 

**o****TRANSITION REPORT UNDERSECTION 13 OF 15 (D) OF THE SECURTIESEXCHANGE ACT**

 

**Forthe transition periodfrom              to              .**

 

**Commission File No. 000-25231**

 

**NorthernStar Financial, Inc.**

(Exact name ofregistrant as specified in its charter)

 

| **Minnesota**            |   | **41-1912467**       |
|--------------------------|--------|----------------------|
| (State of Incorporation) |   | (IRS Employer ID  #) |

 

**1650 Madison AvenueMankato, MN  56001**

(Address ofPrincipal Executive Offices)

 

**507-387-2265**

(Issuer’sTelephone Number, Including Area Code)

 

Check whether theissuer (1) filed all reports required to be filed by Sections 13 or 15(d) oftheExchange Act during the past 12 months (or such shorter period that theregistrant was requiredto file such reports), and (2) has been subject to such filing requirements forthe past 90 days.

Yes   ý     No   o.

 

State the numberof shares outstanding of each of the issuer’s classes of common equity as ofthe latest practicable date.

 

**Class:  Common Stock, par value $.01 per shareOutstanding shares at May 7, 2003: 510,506**

 

 

----

 

**Northern Star Financial, Inc. andSubsidiary**

 

**Index to Form 10-QSB**

**March 31, 2003**

 
| PART I.    | FINANCIAL INFORMATION |
|------------|-----------------------|
|       |                  |
| Item 1.    |                  | Summary of Financial  Data |   |
|       |                  |   |   |
|       |                  | Consolidated  Statements of Financial Condition at March 31, 2003 (unaudited) and June 30,  2002 (audited) |   |
|       |                  |   |   |
|       |                  | Unaudited  Consolidated Statements of Operation for the three and nine months ended  March 31, 2003 and 2002 |   |
|       |                  |   |   |
|       |                  | Unaudited  Consolidated Statement of Cash Flows for the three and nine months ended  March 31, 2003 and 2002 |   |
|       |                  |   |   |
|       |                  | Notes  to Condensed Consolidated Financial Statements (unaudited) |   |
|       |                  |   |   |
| Item  2.   |                  | Management’s  Discussion and Analysis or Plan of Operation |   |
|       |                  |   |   |
| Item  3.   |                  | Quantitative  and Qualitative Disclosures about Market Risk |   |
|       |                  |   |   |
| Item 4.    |                  | Controls and Procedures |   |
|       |                  |   |   |
| PART  II.  | OTHER  INFORMATION    |
|       |                  |   |
| Item 1.    |                  | Legal Proceedings |
|       |                  |   |
| Item 2.    |                  | Changes in  Securities |
|       |                  |   |
| Item  3.   |                  | Default 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 |
|            |                       |  |  |  |

 

2

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### **ITEM 1.  SUMMARY OF FINANCIAL DATA**

 

**Northern Star Financial, Inc. Summaryof Financial Data**

 

The following tablesummarizes certain historical financial data of Northern Star Financial, Inc.and its subsidiary on a consolidated basis as of and for the three and ninemonths ended March 31, 2003 and 2002. You should read this table in conjunction with our financial statementsand related notes appearing elsewhere in this document.

 
|                                                                 |   | **For the  Three Months  Ended March 31,** |    | **As of or  for the Nine Months  Ended March 31,** |   |
|----------------------------------------------------------------------|--------|--------------------------------------------|---------|----------------------------------------------------|--------|
|                                                                 |   | **2003**                                   |    | **2002**                                           |   | **2003** |   | **2002** |   |
| Statement of Income:                                                 |   |                                       |    |                                               |   |   |   |   |   |
| Interest income                                                      |   | $                                          | 694,204 |                                               | $      | 682,265 |   | $ | 2,142,750 |   | $ | 2,074,220 |   |
| Interest expense                                                     |   | 341,303                                    |    | 420,420                                            |   | 1,117,122 |   | 1,406,102 |   |
| Net interest income                                                  |   | 352,901                                    |    | 261,845                                            |   | 1,025,628 |   | 668,118 |   |
| Provision for loan  losses                                           |   | 34,900                                     |    | 18,000                                             |   | 63,600 |   | 351,300 |   |
| Other non-interest  income                                           |   | 265,269                                    |    | 73,512                                             |   | 738,110 |   | 341,248 |   |
| Non-interest expense                                                 |   | 539,841                                    |    | 429,078                                            |   | 1,700,580 |   | 1,227,292 |   |
| Income (loss) before  income tax expense                             |   | 43,429                                     |    | (111,721                                           | )      | (442 | ) | (569,226 | ) |
| Income tax expense  (benefit)                                        |   | —                                     |    | —                                             |   | — |   | — |   |
| Net income (loss)                                                    |   | $                                          | 43,429  |                                               | $      | (111,721 | ) | $ | (442 | ) | $ | (569,226 | ) |
| Balance Sheet:                                                       |   |                                       |    |                                               |   |   |   |   |   |
| Assets                                                               |   |                                       |    |                                               |   | 49,995,985 |   | 43,834,870 |   |
| Allowance for loan  losses                                           |   |                                       |    |                                               |   | 718,045 |   | 571,191 |   |
| Deposits                                                             |   |                                       |    |                                               |   | 40,937,680 |   | 34,825,473 |   |
| Shareholders’ equity                                            |   |                                       |    |                                               |   | 2,099,289 |   | 2,337,219 |   |
|                                                                 |   |                                       |    |                                               |   |   |   |   |   |
| Per Share Data:                                                      |   |                                       |    |                                               |   |   |   |   |   |
| Net income (loss) -  basic                                           |   | $                                          | 0.09    |                                               | $      | (0.23 | ) | $ | (0.00 | ) | $ | (1.19 | ) |
| Net income (loss) -  diluted                                         |   | $                                          | 0.09    |                                               | $      | (0.23 | ) | $ | (0.00 | ) | $ | (1.19 | ) |
| Book value                                                           |   |                                       |    |                                               |   | 4.11 |   | 4.87 |   |
|                                                                 |   |                                       |    |                                               |   |   |   |   |   |
| Other Data                                                           |   |                                       |    |                                               |   |   |   |   |   |
| Average shares  outstanding - basic                                  |   | 498,439                                    |    | 479,506                                            |   | 488,681 |   | 479,506 |   |
| Average shares  outstanding - diluted                                |   | 498,439                                    |    | 479,506                                            |   | 488,681 |   | 479,506 |   |
|                                                                 |   |                                       |    |                                               |   |   |   |   |   |
| Financial Ratios:                                                    |   |                                       |    |                                               |   |   |   |   |   |
| Equity to assets                                                     |   |                                       |    |                                               |   | 4.08 | % | 5.33 | % |
| Return on average assets                                             |   |                                       |    |                                               |   | 0.00 | % | (1.32 | )% |
| Return on average  stockholders’ equity                         |   |                                       |    |                                               |   | (0.02 | )% | (22.00 | )% |
| Net interest margin                                                  |   |                                       |    |                                               |   | 3.10 | % | 2.48 | % |
| Tier 1 leverage ratio                                                |   |                                       |    |                                               |   | 8.46 | % | 8.77 | % |
| Tier 1 capital to  risk-weighted assets                              |   |                                       |    |                                               |   | 11.16 | % | 11.65 | % |
| Total capital to risk-weighted  assets                               |   |                                       |    |                                               |   | 12.42 | % | 12.90 | % |
|                                                                 |   |                                       |    |                                               |   |   |   |   |   |
| Asset Quality Ratios:                                                |   |                                       |    |                                               |   |   |   |   |   |
| Nonperforming assets to  total assets                                |   |                                       |    |                                               |   | 4.26 | % | 1.75 | % |
| Nonperforming assets to  total loans and and other real estate owned |   |                                       |    |                                               |   | 5.60 | % | 2.46 | % |
| Allowance for loan losses  to total loans                            |   |                                       |    |                                               |   | 1.89 | % | 1.83 | % |

 

3

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## **NorthernStar Financial, Inc. and Subsidiary**

Consolidated Statementsof Financial Condition

 
|                                                                                           |   | **March 31, 2003** |       | **June 30, 2002** |   |
|------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------|--------|
|                                                                                           |   | **(Unaudited)**    |       | **(Audited)**     |   |
| **ASSETS**                                                                                     |   |               |       |              |   |
|                                                                                           |   |               |       |              |   |
| Cash and due from banks                                                                        |   | $                  | 3,209,426  |              | $      | 2,348,081 |   |
| Federal funds sold                                                                             |   | —             |       | 1,037,000         |   |
| Securities available for sale, at fair value                                                   |   | 6,473,869          |       | 9,598,520         |   |
| FHLB and UBB stock, at cost                                                                    |   | 306,300            |       | 238,800           |   |
| Loans held for sale                                                                            |   | 1,741,843          |       | 625,735           |   |
| Loans receivable, net of allowance for loan and  lease losses of $718,045 and $661,170         |   | 37,348,362         |       | 33,836,692        |   |
| Property and equipment, net of depreciation                                                    |   | 526,021            |       | 535,938           |   |
| Accrued interest receivable and other assets                                                   |   | 390,164            |       | 351,771           |   |
| **Total Assets**                                                                               |   | $                  | 49,995,985 |              | $      | 48,572,537 |   |
|                                                                                           |   |               |       |              |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                 |   |               |       |              |   |
| **Liabilities:**                                                                               |   |               |       |              |   |
| Demand deposits                                                                                |   | $                  | 4,715,328  |              | $      | 4,574,282 |   |
| NOW and money market                                                                           |   | 8,570,502          |       | 7,718,574         |   |
| Savings                                                                                        |   | 5,011,947          |       | 4,533,290         |   |
| Time deposits                                                                                  |   | 22,639,903         |       | 22,763,583        |   |
| Total deposits                                                                                 |   | 40,937,680         |       | 39,589,729        |   |
| Notes payable and other borrowings                                                             |   | 5,037,000          |       | 5,275,000         |   |
| Convertible subordinated notes payable                                                         |   | 1,550,000          |       | 1,400,000         |   |
| Accrued interest payable and other                                                             |   | 372,016            |       | 384,144           |   |
| Total Liabilities                                                                              |   | 47,896,696         |       | 46,648,873        |   |
|                                                                                           |   |               |       |              |   |
| **Shareholders’ Equity:**                                                                 |   |               |       |              |   |
| Common Stock, $.01 par value, 15,000,000 shares  authorized; 510,506 and 479,506 shares issued |   | 5,105              |       | 4,795             |   |
| Undesignated stock, par value $.01 per share;  5,000,000 shares authorized, no shares issued   |   | —             |       | —            |   |
| Additional paid in capital                                                                     |   | 4,328,694          |       | 4,158,504         |   |
| Accumulated deficit                                                                            |   | (2,280,801         | )          | (2,280,359        | )      |
| Unearned stock compensation                                                                    |   | (9,005             | )          | (12,004           | )      |
| Accumulated other comprehensive income                                                         |   | 55,296             |       | 52,728            |   |
| **Total Shareholders’ Equity**                                                            |   | 2,099,289          |       | 1,923,664         |   |
| **Total Liabilities and  Shareholders’ Equity**                                           |   | $                  | 49,995,985 |              | $      | 48,572,537 |   |

 

See Notes toConsolidated Financial Statements

 

4

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## **NorthernStar Financial, Inc. and Subsidiary**

Unaudited ConsolidatedStatements of Operations

 
|                                                      |   | **For the  Three Months  Ended March 31,** |    | **For the  Nine Months  Ended March 31,** |   |
|-----------------------------------------------------------|--------|--------------------------------------------|---------|-------------------------------------------|--------|
|                                                      |   | **2003**                                   |    | **2002**                                  |   | **2003** |   | **2002** |   |
| **Interest  income**                                      |   |                                       |    |                                      |   |   |   |   |   |
| Loans receivable                                          |   | $                                          | 620,225 |                                      | $      | 546,094 |   | $ | 1,881,633 |   | $ | 1,579,754 |   |
| Securities available for  sale                            |   | 64,260                                     |    | 133,355                                   |   | 232,419 |   | 434,506 |   |
| Federal funds sold                                        |   | 9,719                                      |    | 2,816                                     |   | 28,698 |   | 59,960 |   |
| Total interest income                                     |   | 694,204                                    |    | 682,265                                   |   | 2,142,750 |   | 2,074,220 |   |
|                                                      |   |                                       |    |                                      |   |   |   |   |   |
| **Interest  expense**                                     |   |                                       |    |                                      |   |   |   |   |   |
| Deposits                                                  |   | 268,118                                    |    | 340,522                                   |   | 888,780 |   | 1,183,200 |   |
| Borrowed funds                                            |   | 73,185                                     |    | 79,898                                    |   | 228,342 |   | 222,902 |   |
| Total interest expense                                    |   | 341,303                                    |    | 420,420                                   |   | 1,117,122 |   | 1,406,102 |   |
|                                                      |   |                                       |    |                                      |   |   |   |   |   |
| Net interest income                                       |   | 352,901                                    |    | 261,845                                   |   | 1,025,628 |   | 668,118 |   |
| Provision for loan  losses                                |   | 34,900                                     |    | 18,000                                    |   | 63,600 |   | 351,300 |   |
|                                                      |   |                                       |    |                                      |   |   |   |   |   |
| Net interest income  after provision for loan loss        |   | 318,001                                    |    | 243,845                                   |   | 962,028 |   | 316,818 |   |
|                                                      |   |                                       |    |                                      |   |   |   |   |   |
| **Noninterest  income**                                   |   |                                       |    |                                      |   |   |   |   |   |
| Other fees and service  charges                           |   | 84,270                                     |    | 30,636                                    |   | 172,204 |   | 99,084 |   |
| Gain on sale of  securities                               |   | —                                     |    | —                                    |   | 3,504 |   | 58,042 |   |
| Gain on sale of loans                                     |   | 180,999                                    |    | 42,876                                    |   | 562,402 |   | 184,122 |   |
| Total non interest  income                                |   | 265,269                                    |    | 73,512                                    |   | 738,110 |   | 341,248 |   |
|                                                      |   |                                       |    |                                      |   |   |   |   |   |
| **Noninterest  expense**                                  |   |                                       |    |                                      |   |   |   |   |   |
| Compensation and  employee benefits                       |   | 247,509                                    |    | 215,473                                   |   | 762,508 |   | 577,659 |   |
| Board fees                                                |   | 24,000                                     |    | 21,000                                    |   | 78,500 |   | 68,250 |   |
| Occupancy                                                 |   | 45,104                                     |    | 39,823                                    |   | 129,960 |   | 114,672 |   |
| Legal and accounting                                      |   | 58,648                                     |    | 9,904                                     |   | 194,704 |   | 44,042 |   |
| Printing & supplies                                   |   | 17,742                                     |    | 21,214                                    |   | 62,386 |   | 63,653 |   |
| Property and equipment  depreciation                      |   | 19,162                                     |    | 19,441                                    |   | 56,016 |   | 55,900 |   |
| Data processing                                           |   | 37,398                                     |    | 31,780                                    |   | 112,914 |   | 73,692 |   |
| Other                                                     |   | 90,278                                     |    | 70,443                                    |   | 303,592 |   | 229,424 |   |
| Total non interest  expense                               |   | 539,841                                    |    | 429,078                                   |   | 1,700,580 |   | 1,227,292 |   |
|                                                      |   |                                       |    |                                      |   |   |   |   |   |
| **Income  (loss) before income tax benefit**              |   | 43,429                                     |    | (111,721                                  | )      | (442 | ) | (569,226 | ) |
| Income tax benefit                                        |   | —                                     |    | —                                    |   | — |   | — |   |
|                                                      |   |                                       |    |                                      |   |   |   |   |   |
| **Net  income (loss)**                                    |   | $                                          | 43,429  |                                      | $      | (111,721 | ) | $ | (442 | ) | $ | (569,226 | ) |
|                                                      |   |                                       |    |                                      |   |   |   |   |   |
| **Net  income (loss) per common share**                   |   |                                       |    |                                      |   |   |   |   |   |
| Basic and diluted income (loss) per share of common stock |   | $                                          | 0.09    |                                      | $      | (0.23 | ) | $ | (0.00 | ) | $ | (1.19 | ) |

 

See Notes toConsolidated Financial Statements

 

5

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## **NorthernStar Financial, Inc. and Subsidiary**

Unaudited ConsolidatedStatements of Cash Flows

 
|                                                                                       |   | **For the  Three Months  Ended March 31,** |      | **For the  Nine Months  Ended March 31,** |   |
|--------------------------------------------------------------------------------------------|--------|--------------------------------------------|-----------|-------------------------------------------|--------|
|                                                                                       |   | **2003**                                   |      | **2002**                                  |   | **2003** |   | **2002** |   |
| Cash flows from  operating activities:                                                     |   |                                       |      |                                      |   |   |   |   |   |
| Net income (loss)                                                                          |   | $                                          | 43,429    |                                      | $      | (111,721 | ) | $ | (442 | ) | $ | (569,226 | ) |
| Adjustments to reconcile  net loss to net cash provided by (used in) operating activities: |   |                                       |      |                                      |   |   |   |   |   |
| Depreciation                                                                               |   | 22,389                                     |      | 22,566                                    |   | 65,509 |   | 66,951 |   |
| Provision for loan  losses                                                                 |   | 34,900                                     |      | 18,000                                    |   | 63,600 |   | 351,300 |   |
| Net amortization and  accretion of premium and discounts                                   |   | 2,063                                      |      | 22,735                                    |   | 3,218 |   | 17,540 |   |
| Deferred loan fees and  costs, net                                                         |   | (70,940                                    | )         | (14,836                                   | )      | (30,128 | ) | (55,212 | ) |
| Earned stock  compensation                                                                 |   | 1,001                                      |      | 999                                       |   | 2,999 |   | 2,997 |   |
| Gain on sale of  available for sale securities                                             |   | —                                     |      | —                                    |   | (3,504 | ) | (58,042 | ) |
| (Increase) decrease in:                                                                    |   |                                       |      |                                      |   |   |   |   |   |
| Loans held for sale                                                                        |   | (80,753                                    | )         | 556,022                                   |   | (1,116,108 | ) | 550,249 |   |
| Accrued interest  receivable                                                               |   | 4,807                                      |      | 28,695                                    |   | 4,237 |   | 18,525 |   |
| Other assets                                                                               |   | 60,002                                     |      | (25,887                                   | )      | 71,134 |   | (21,132 | ) |
| Increase (decrease) in:                                                                    |   |                                       |      |                                      |   |   |   |   |   |
| Accrued interest payable  and other liabilities                                            |   | (144,720                                   | )         | 15,559                                    |   | (13,840 | ) | (63,908 | ) |
| Net cash provided by  (used in) operating activities                                       |   | (127,822                                   | )         | 512,132                                   |   | (953,325 | ) | 240,042 |   |
|                                                                                       |   |                                       |      |                                      |   |   |   |   |   |
| Cash flows from  investing activities:                                                     |   |                                       |      |                                      |   |   |   |   |   |
| Purchases of  available-for-sale securities                                                |   | (2,247,999                                 | )         | (495,781                                  | )      | (3,757,374 | ) | (8,760,529 | ) |
| Proceeds from maturities  of available-for-sale securities                                 |   | —                                     |      | 621,360                                   |   | 500,000 |   | 969,184 |   |
| Proceeds from sales of  available-for-sale securities                                      |   | 417,371                                    |      | 500,000                                   |   | 6,386,591 |   | 8,107,840 |   |
| Purchase of FHLB &  UBB stock                                                          |   | (22,500                                    | )         | —                                    |   | (67,500 | ) | (100,000 | ) |
| Net (increase) decrease  in federal funds sold                                             |   | 4,112,000                                  |      | (750,000                                  | )      | 1,037,000 |   | 1,767,000 |   |
| Loan origination’s and  principal payments on loans, net                              |   | (1,632,297                                 | )         | 306,799                                   |   | (3,658,906 | ) | (7,317,721 | ) |
| Purchase of property and  equipment                                                        |   | (22,714                                    | )         | (3,809                                    | )      | (55,592 | ) | (254,363 | ) |
| Net cash provided by  (used in) investing activities                                       |   | 603,861                                    |      | 178,569                                   |   | 384,219 |   | (5,588,589 | ) |
|                                                                                       |   |                                       |      |                                      |   |   |   |   |   |
| Cash flows from  financing activities:                                                     |   |                                       |      |                                      |   |   |   |   |   |
| Proceeds from issuance  of common stock, net                                               |   | 88,000                                     |      | —                                    |   | 170,500 |   | — |   |
| Net increase (decrease)  in non-interest bearing demand and savings deposit accounts       |   | (168,059                                   | )         | 666,215                                   |   | 1,471,631 |   | 4,366,930 |   |
| Net (decrease) increase  in time deposits                                                  |   | (111,128                                   | )         | (1,744,946                                | )      | (123,680 | ) | (2,358,521 | ) |
| Proceeds from borrowings                                                                   |   | 112,000                                    |      | —                                    |   | 212,000 |   | 3,400,000 |   |
| Payment on borrowings                                                                      |   | —                                     |      | —                                    |   | (300,000 | ) | — |   |
| Net cash provided by  (used in) financing activities                                       |   | (79,187                                    | )         | (1,078,731                                | )      | 1,430,451 |   | 5,408,409 |   |
| Net increase (decrease)  in cash and cash equivalents                                      |   | 396,852                                    |      | (388,030                                  | )      | 861,345 |   | 59,862 |   |
| Cash and cash  equivalents, beginning                                                      |   | 2,812,574                                  |      | 1,318,025                                 |   | 2,348,081 |   | 870,133 |   |
| Cash and cash  equivalents, ending                                                         |   | $                                          | 3,209,426 |                                      | $      | 929,995 |   | $ | 3,209,426 |   | $ | 929,995 |   |
|                                                                                       |   |                                       |      |                                      |   |   |   |   |   |
| Supplemental disclosure  of cash flow information:                                         |   |                                       |      |                                      |   |   |   |   |   |
| Cash paid for interest                                                                     |   | $                                          | 324,817   |                                      | $      | 435,979 |   | $ | 1,127,785 |   | $ | 1,342,194 |   |

 

See Notes toConsolidated Financial Statements

 

6

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## **NORTHERN STAR FINANCIAL, INC AND SUBSIDIARY**

## **NOTES TO CONDENSEDCONDOLIDATED FINANCIAL STATEMENTS**

**March 31, 2003 (Unaudited)**

 

Note 1:   PRINCIPLES OF CONSOLIDATION

 

The unaudited consolidated financial statements as ofand for the three and nine month periods ended March 31, 2003 include theaccounts of Northern Star Financial, Inc. (the “Company”) and its wholly ownedsubsidiary Northern Star Bank (the “Bank”). All significant inter-company accounts and transactions have beeneliminated in consolidation.

 

Note 2:   BASIS OF PRESENTATION

 

The accompanying unaudited interim consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America for interimfinancial information.  Accordingly,they do not include all information and disclosures required by generallyaccepted accounting principles for complete financial statements.  The accompanying consolidated financialstatements do not purport to contain all the necessary financial disclosuresrequired by generally accepted accounting principles that might otherwise bynecessary in the circumstances and should be read with the fiscal 2002consolidated financial statements and notes of Northern Star Financial, Inc.and Subsidiary included in their annual report as of and for the year endedJune 30, 2002.

 

In the opinion of management, all adjustments(consisting of normal recurring accruals) considered necessary for fairpresentations have been included.  Theresults of operations for three and nine months ended March 31, 2003 and 2002,are not necessarily indicative of the results that may be expected for theentire fiscal year or any other interim period.

 

Note 3:   EARNINGS PER SHARE

 

The earnings per share amounts were computed using theweighted average number of shares outstanding during the periodspresented.  For the three March 31, 2003and 2002 the weighted average number of shares outstanding for basic anddiluted earnings per share computation were 498,439 and 479,506 respectively.For the nine March 31, 2003 and 2002 the weighted average number of sharesoutstanding for basic and diluted earnings per share computation were 488,681and 479,506 respectively. As of March 31, 2003 and 2002 of the potential commonshares of 309,548 and 222,838 respectively, related to stock options, warrants,and convertible subordinated notes payable, 301,611 and 210,398, respectively,were exercisable and anti-dilutive.

 

During the quarter endedMarch 31, 2003, the Company issued 6,100 stock options with an exercise priceof $5.00 and an expiration date of March 26, 2013.  These stock options are included in the totals indicated in theprior paragraph.

 

7

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Note 4:   COMPREHENSIVE INCOME (LOSS)

 
|                                                                   |   | **For the Nine Months  Ended March 31,** |   |
|------------------------------------------------------------------------|--------|------------------------------------------|--------|
|                                                                   |   | **2003**                                 |   | **2002** |   |
| Accumulated comprehensive income (loss) is  composed of the following: |   |                                     |   |   |   |
|                                                                   |   |                                     |   |   |   |
| Unrealized gains (losses) on securities                                |   |                                     |   |   |   |
| Beginning balance                                                      |   | $                                        | 52,728 |   | $ | 26,328 |   |
| Current-period change net of tax                                       |   | 2,568                                    |   | (78,136 | ) |
| Ending balance                                                         |   | 55,296                                   |   | $ | (51,808 | ) |
|                                                                   |   |                                     |   |   |   |
| Comprehensive income (loss) consists of the  following:                |   |                                     |   |   |   |
| Net loss                                                               |   | $                                        | (442   | ) | $ | (569,226 | ) |
| Other comprehensive income (loss)                                      |   | 2,568                                    |   | (78,136 | ) |
| Comprehensive income (loss)                                            |   | $                                        | 2,126  |   | $ | (647,362 | ) |

 

Note 5:   STOCK OPTION ACCOUNTING

 

The Company accounts for stock options under theintrinsic value method of recognition and measurement principles of APB OpinionNo. 25, *Accounting for Stock Issued toEmployees*, and related interpretations.  No stock-based employee compensation cost is reflected in netincome, as all options granted under those plans had an exercise price equal tothe market value of the underlying common stock on the date of the grant.  Statement of Financial Accounting StandardsNo. 148, *Accounting for Stock-BasedCompensation* – *Transition andDisclosure*, is effective for the interim period beginning afterDecember 15, 2002 and requires pro-forma net income and earnings per sharedisclosures on a quarterly basis.  Thefollowing table illustrates the effect on net income and earnings per share asif the company had applied the fair value recognition provisions of FASB StatementNo. 123, *Accounting for Stock BasedCompensation*, to stock-based employee compensation.

 
|                                                                                                                                      |   | **Three Months  Ended March 31** |    | **Nine Months  Ended March 31** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|---------|---------------------------------|--------|
|                                                                                                                                      |   | **2003**                         |    | **2002**                        |   | **2003** |   | **2002** |   |
|                                                                                                                                      |   | **(in thousands)**               |    |
|                                                                                                                                      |   |                             |    |                            |   |   |   |   |   |
| Net income, as reported                                                                                                                   |   | $                                | 43,429  |                            | $      | (111,721 | ) | $ | (442 | ) | $ | (569,226 | ) |
| Deduct:                                                                                                                                   |   |                             |    |                            |   |   |   |   |   |
| Total stock-based employee compensation expense  determined under the fair value based method for all awards, net of related  tax effects |   | —                           |    | 8,675                           |   | 32,889 |   | 47,022 |   |
|                                                                                                                                      |   |                             |    |                            |   |   |   |   |   |
| Pro-forma net income                                                                                                                      |   | $                                | 43,429  |                            | $      | (120,378 | )  | $ | (33,331 | ) | $ | (616,248 | ) |
|                                                                                                                                      |   |                             |    |                            |   |   |   |   |   |
| Earnings per share:                                                                                                                       |   |                             |    |                            |   |   |   |   |   |
| Basic, as reported                                                                                                                        |   | $                                | 0.09    |                            | $      | (0.23 | ) | $ | (0.00 | ) | $ | (1.19 | ) |
| Basic, pro-forma                                                                                                                          |   | $                                | 0.09    |                            | $      | (0.25 | )  | $ | (0.07 | ) | $ | (1.29 | ) |
| Diluted, as reported                                                                                                                      |   | $                                | 0.09    |                            | $      | (0.23 | ) | $ | (0.00 | ) | $ | (1.19 | ) |
| Diluted, pro-forma                                                                                                                        |   | $                                | 0.09    |                            | $      | (0.25 | )  | $ | (0.07 | ) | $ | (1.29 | ) |
|                                                                                                                                      |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| Basic shares                                                                                                                              |   |                             | 489,439 |                            |   | 479,505 |   |   | 488,681 |   |   | 479,506 |   |
| Diluted shares                                                                                                                            |   |                             | 489,439 |                            |   | 479,505 |   |   | 488,681 |   |   | 479,506 |   |

 

8

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**ITEM 2:  MANAGEMENT’S DISCUSSION AND ANALYSISOR PLAN OF OPERATION**

 

NorthernStar Financial, Inc. is the bank holding company of Northern Star Bank (the“Bank”).  Since the principal businessof the Company is the Bank, the following discussion pertains mainly to theBank.

 

The following is management’sdiscussion and analysis of the major factors that influenced the financialperformance of the Bank for the three months and the nine months ended March31, 2003.  This analysis should be read in conjunction with the Company’s2002 Annual Report as filed on form 10KSB and with the unaudited financialstatements and notes as set forth in this report.

 

Certain statements contained in this Report,including, without limitation, statements containing the words “believes”,“anticipates”, “intends”, “expects”, and words of similar import, constitute“forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934.  Such forward looking statements involve known and unknown risks,uncertainties and other factors that may cause the actual results, performanceor achievements of the Company to be materially different from any futureresults, performance or achievements expressed or implied by suchforward-looking statements.  Such factors include, among others, thefollowing: general economic and business conditions in those areas in which theCompany operates, demographic changes, competition, fluctuations in interest rates,changes in business strategy or development plans, changes in governmentalregulation, credit quality, the availability of capital to fund the expansionof the Company’s business, economic, political and global changes.  The Company disclaims any obligation toupdate any such factors or to publicly announce the results of any revisions toany of the forward-looking statements contained herein to reflect future eventsor developments.

 

This discussion should be read in conjunction with thefinancial statements of the Company, including the notes thereto, appearingelsewhere in this report.

 

**RESULTS OF OPERATIONS**

 

**Net Income**

Net income increased to $43,429 for the three monthsended March 31, 2003 compared to a loss of $111,721 for the three months endedMarch 31, 2002.  Basic earnings per share were $0.09 and $(0.23) for thethree months ended March 31, 2003 and 2002, respectively.  Dilutedearnings per share were $0.09 and $(0.23) for the three months ended March 31,2003 and 2002, respectively.  Net loss decreased to $442 for the ninemonths ended March 31, 2003 compared to a loss of $569,226 for the nine monthsended March 31, 2002.  Basic earnings per share were $0.00 and $(1.19) forthe nine months ended March 31, 2003 and 2002, respectively.  Dilutedearnings per share were $0.00 and $(1.19) for the nine months ended March 31,2003 and 2002, respectively.  The increase in net income was mainly due tothe increases in net interest income, non-interest income and a decrease in theprovision for loan losses, which were partially offset by increases in otheroperating expenses.  Net interest income increased due to an increase inaverage interest earning assets and net interest margin.  Non-interest income increased due to anincrease in the amount of residential mortgage loans sold.  Non-interest expenses increased during thethree months ended March 31, 2003 due to expenses incurred in connection withcontinued growth in our Mankato customer base and due to the growth arising outof the Bank’s

 

9

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expansion into the St Cloud market and also due to the indirect costincurred in connection with increased loan production.

 

Thereturn on average equity was 2.15% for the three months ended March 31, 2003compared to (5.22)% for the three months ended March 31, 2002.  Return onaverage assets for the three months ended March 31, 2003 was .09% compared to(.23)% for the three months ended March 31, 2002.  The return on averageequity was (0.02)% for the nine months ended March 31, 2003 compared to(22.00)% for the nine months ended March 31, 2002.  Return on averageassets for the nine months ended March 31, 2003 was (0.00)% compared to (1.32)%for the nine months ended March 31, 2002.  The increase in the return onaverage assets from 2002 to 2003 was due to the increase in net income notedabove, which is the result of the 8.81% growth in average interest earningassets and an increase of 89 basis points in net interest margin, combined withthe 116.30% increase in non-interest income, and partially offset by the 38.56%increase in non-interest expense.

 

**Interest Income**

Netinterest income is a significant component of the Bank’s income fromoperations.  Net interest income is the difference between the grossinterest earned on the loan and investment portfolios and the interest paid ondeposits and other borrowings.  Net interest income depends on the volumeof and interest rate earned on interest earning assets and the volume of andinterest rate paid on interest bearing liabilities.

 

Interestincome for the three months ended March 31, 2003 increased to $694 thousand,compared to $682 thousand for the three months ended March 31, 2002.  Thisincrease was due to the increase in average interest earning assets from $42.18million for the three months ended March 31, 2002 to $45.51 million for thethree months ended March 31, 2003, and was partially offset by decreases ininterest rates during 2002 which resulted in a .37% decrease in the yield oninterest earning assets for the three months ended March 31, 2003 when comparedto the three months ended March 31, 2002. The yield on interest earning assets decreased to 6.10% for the threemonths ended March 31, 2003 compared to 6.47% for the three months ended March31, 2002.

 

Interestincome for the nine months ended March 31, 2003 increased to $2.14 million,compared to $2.01 million for the nine months ended March 31, 2002.  Thisincrease was due to the increase in the average balance of interest earningassets and was partially offset by a decrease in the yield on interest earningassets. Average interest earning assets increased to $44.88 million for thenine months ended March 31, 2003 compared to $41.24 million for the nine monthsended March 31, 2002.  The yield on interest earning assets decreased to6.37% for the nine months ended March 31, 2003 compared to 6.71% for the ninemonths ended March 31, 2002.

 

TheBank’s portfolio of interest earning assets is comprised of the followingprimary components: cash and securities (15%), real estate, construction (8%),real estate, other (41%) consumer (22%) and commercial  (15%) loans.

 

**Interest Expense**

Interestexpense for the three months ended March 31, 2003 decreased to $341 thousandcompared to $420 thousand for the three months ended March 31, 2002.  Thisdecrease was due to the decline in interest rates and was partially offset byan increase in average deposits and other borrowings.  Due to the declinein interest rates, the cost of deposits declined from 4.16%

 

10

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for the three months ended March 31, 2002 to2.94% for the three months ended March 31, 2003.  Average borrowingsincreased to $6.53 million with a cost of 4.49% for the three months endedMarch 31, 2003, compared to $6.30 million with a cost of 5.07% for the threemonths ended March 31, 2002.  Averageinterest-bearing liabilities increased to $43.02 million for the three monthsended March 31, 2003 compared to $39.07 million for the three months endedMarch 31, 2002.

 

Interestexpense for the nine months ended March 31, 2003 decreased to $1.12 millioncompared to $1.41 million for the nine months ended March 31, 2002.  Thisdecrease was due to the decline in interest rates generally, and was partiallyoffset by an increase in average deposits and other borrowings.  Due tothe decline in interest rates, the cost of deposits declined to 3.29% for thenine months ended March 31, 2003 from 4.83% for the nine months ended March 31,2003.  The largest component of interest bearing liabilities is timedeposits.  Average time deposits increased to $22.77 million with a costof 4.15% for the nine months ended March 31, 2003 compared to $22.58 millionwith a cost of 5.78% for the nine months ended March 31,2002.  Average interest-bearing liabilitiesincreased to $42.55 million for the nine months ended March 31, 2003 comparedto $38.01 million for the nine months ended March 31, 2002.

 

The increase in average interestbearing liabilities is a result of the Bank’s expansion into the St. Cloudmarket and to the continued growth of its customer base in the Mankato market.

 

**Net interest income before provisionfor estimated loan losses**

Netinterest income before provision for estimated loan losses for the three monthsended March 31, 2003 was $352,901, compared to $261,845 for the three monthsended March 31, 2002.  Average interest earning assets were $45.51 millionfor the three months ended March 31, 2003 with a net interest margin of 3.10%compared to $42.18 million with a net interest margin of 2.48% for the threemonths ended March 31, 2002.

 

Netinterest income before provision for estimated loan losses for the nine monthsended March 31, 2003 was $1.03 million, compared to $0.67 million for the ninemonths ended March 31, 2002.  Average interest earning assets were $44.88million for the nine months ended March 31, 2003 with a net interest margin of3.05% compared to $41.24 million with a net interest margin of 2.16% for thenine months ended March 31, 2002.

 

Theincreases in net interest income were primarily due to the increase in averageinterest earning assets coupled with an increase in the net interest margin.

 

**Provision for Estimated Loan Losses**

Dueto the growth in loans the provision for estimated loan losses totaled $34,900for the three months ended March 31, 2003 compared to $18,000 for the threemonths ended March 31, 2002.  The provision for estimated loan lossestotaled $63,600 for the nine months ended March 31,2003 compared to $351,300for the nine months ended March 31, 2002.

 

**Other Operating Income**

Otheroperating income represents non-interest types of revenue and is comprised ofnet gain on sale of loans, loan servicing fees, customer service charges andother fee income.  Other operatingincome was $265,269 for the three months ended March 31, 2003 compared to$73,512 for the three months ended March 31, 2002.

 

TheBank’s current policy is to sell in the secondary market all residentialmortgage loans

 

11

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with a fixed interest rate and with a term ofmore than five years.  Mortgage loansoriginated and intended for sale are carried at the lower of cost or estimatedmarket value in the aggregate.  Netunrealized losses are recognized through a valuation allowance by charges toincome.  Gains or losses on the sale ofloans are recorded in noninterest income, based on the net proceeds receivedand the recorded investment in the loan. Net gain on sale of loans increased from $42,876 for the three monthsended March 31, 2002 to $180,999 for the three months ended March 31,2003.  Net gain on sale of loans increased from $184,122 for the ninemonths ended March 31, 2002 to $562,402 for the nine months ended March 31,2003.

 

Duringthe three months ended March 31, 2003, the Bank originated for sale $11.86million in residential mortgage loans compared to $3.55 million during thethree months ended March 31, 2002.  The Bank originated $38.61 million inmortgage loans during the nine months ended March 31, 2003 compared to $15.29million during the nine months ended March 31, 2002.  The Bank sold $11.86million, or approximately 100%, of the residential real estate loans originatedduring the three months ended March 31, 2003 compared to $15.29 million orapproximately 100%, of the residential real estate loans originated during thethree months ended March 31, 2002.  Management estimates thatapproximately forty percent of the Bank’s current volume of residentialmortgage lending is cyclical in nature and is the result of higher levels ofresidential mortgage lending activity associated with the present low interestrate environment.

 

Otherfee income and service charges increased from $30,626 for the three monthsended March 31, 2002 to $84,270 for the three months ended March 31,2003.  The increase is the result of a 11.37% increase in average savingsand interest bearing accounts from $32.8 million for the three months endedMarch 31, 2002 to $36.5 million for the three months ended March 31, 2003.

 

Otherfee income and service charges increased to $172,204 for the nine months endedMarch 31, 2003, compared to $99,084 for the nine months ended March 31, 2002.

 

**Noninterest Expenses**

Otheroperating expenses are non-interest types of expenses and are incurred by theCompany and the Bank in its normal course of business.  Salaries andemployee benefits, occupancy, telephone, premises and equipment, marketing andpromotions, data processing, professional services, director/officer/employeeexpenses, office, and other expenses are the major categories of otheroperating expenses.  Noninterest expenses increased to $539,841 for thethree months ended March 31, 2003 compared to $429,078 for the three monthsended March 31, 2002.  Other operating expenses increased to $1.70 millionfor the nine months ended March 31, 2003 compared to $1.23 million for the ninemonths ended March 31, 2002.  During the nine months ended March 31, 2003,the Company and Bank incurred legal expenses totaling $103,124 due to theirinvolvement in litigation arising out of the personal business affairs offormer Company and Bank director Frank Gazzola.

 

The increase in other operating expenses is primarilydue to the increase in salaries and employee benefits to $247,509 for the threemonths ended March 31, 2003 compared to $215,473 for the three months endedMarch 31, 2002.  For the nine months ended March 31, 2003, salaries andemployee benefits were $762,508 compared to $577,659 for the nine months endedMarch 31, 2002.  The Bank opened a branch office late in the first quarterof the fiscal year ending June 30, 2002.  As a result of the increasedloan origination and improved profitability, commissions, incentives andservice awards have increased by $14,616 when comparing the quarter ended March31, 2003 to March 31, 2002.  For the nine months ended

 

12

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March 31, 2003, commissions, incentives and service awards haveincreased by $83,337 when compared with the nine months ended March 31,2002.  Full time equivalent employees increased to eighteen as of March31, 2003 compared to seventeen as of March 31, 2002.  In addition,employee insurance benefits rates increased by 12% from 2002 to 2003.

 

TheBank’s efficiency ratio, which is the ratio of operating expenses to netinterest income before provision for loan losses plus non-interest income andexcluding gain or loss on repossessed assets, decreased (improved) to 87% forthe three months ended March 31, 2003 compared to 128% for the three monthsended March 31, 2002.  For the nine months ended March 31, 2003, theBank’s efficiency ratio was 96% compared to 122% for the nine months endedMarch 31, 2002.  The decrease in efficiency ratio was due to the increasein net interest and other operating income, partially offset by the increase inoperating expenses. The increase in operating expenses is primarily due to theexpansion of the Bank’s business.

 

**Provision for Income Taxes**

Theeffective income tax rate for the Company was 0 % for the three and nine monthsended March 31, 2003 because the tax benefit of the net operating loss isreduced by a deferred tax asset valuation allowance in accordance withgenerally accepted accounting principles. The Company’s deferred tax assets have been reduced to $0 by a valuationaccount due to the uncertainty of the Company’s ability to make use of theunderlying net operating loss carry forwards.

 

**FINANCIAL CONDITION**

 

**Summary of Changes in ConsolidatedBalance Sheets**

**March 31, 2003 compared to March 31,2002 and June 30, 2002**

 

Totalassets of the Bank increased to almost $50.0 million as of March 31, 2003compared to $43.83 million as of March 31, 2002 and $48.57 million as of June30, 2002 representing an increase of $6.17 million or 14.1% from March 31,2002 to March 31, 2003.  This increasewas primarily the result of the Bank’s internally generated loan growth fundedby an increase in deposits.

 

Deposits,increased to $40.94 million as of March 31, 2003 compared to $34.83 million ofMarch 31, 2002 and were $39.59 million as of June 30, 2002.  Cash andcash equivalents increased to $3.21 million as of March 31, 2003 compared to$.93 million as of March 31, 2002 and were $2.35 million as of June 30,2002.  The increase in cash and cash equivalents was due to the decreasein investment securities combined with an increase in net loans.

 

Shareholders’equity was $2.10 million as of March 31, 2003 compared to $2.34 million as ofMarch 31, 2002 and was $1.92 million as of June 30, 2002.

 

**Investments**

The Bank’s investment portfolio consists primarily ofsecurities issued by agencies of the United States and overnight investments inthe Federal Funds market. US Government agency securities and mortgaged backsecurities totaled $5.97 million as of March 31, 2003 compared to $8.78 millionas of March 31, 2002 and were $6.58 million as of June 30, 2002. Average Federal Funds sold for the nine months ended March 31, 2003 were $2.87million, compared to $2.35 million for the nine months ended March 31, 2002.

 

13

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**Loans**

Loanbalances, net of the allowance for loan losses, increased to $37.35 million asof March 31, 2003 compared to $30.47 million as of March 31, 2002 and $33.84million as of June 30 2002.  Strong demand for loans resulted in a 22.6%growth rate in net loans since March 31, 2002.

 

**Non-performing Assets.**

Nonperformingassets consist of nonperforming loans and other real estate owned (“OREO”) andother repossessed assets.  Nonperforming loans are those loans which have(i) been placed on nonaccrual status, (ii) been subject to troubled debtrestructurings, or (iii) become contractually past due 90 days or more withrespect to principal or interest and have not been restructured or placed onnonaccrual status.

 

**Nonaccrual Loans.**

Nonaccrualloans are impaired loans where the original contractual amount may not be fullycollectible.  The Bank measures its impaired loans by using the fair valueof the collateral if the loan is collateral-dependent and the present value ofthe expected future cash flows discounted at the loan’s effective interest rateif the loan is not collateral-dependent.  The Bank places loans onnonaccrual status that are delinquent 90 days or more or when a reasonabledoubt exists as to the collectibility of all payments due under the terms ofthe loan.  As of March 31, 2003, theBank had ten loans on nonaccrual status totaling $2.13 million.  As ofMarch 31, 2002, the Bank had three loans on nonaccrual status totaling $.76million.  As of June 30, 2002, the Bank had seven loans on nonaccrualstatus totaling $1.81 million.

 

**Classified Assets.**

Fromtime to time, management has reason to believe that certain borrowers will notrepay their loans within the parameters of the present repayment terms, eventhough, in some cases, the loans are current at the time. These loans aregraded in the classified loan grades of “substandard,” “doubtful,” or “loss”and include non-performing loans.  Each classified loan is monitoredmonthly.  Classified assets (consisting of nonaccrual loans, loans gradedas substandard or lower and other repossessed assets) at March 31, 2003 were$2.16 million compared to $.79 million as of March 31, 2002 and were $1.84million at June 30, 2002.

 

**Allowance for Loan Losses.**

TheBank has established a methodology for the determination of provisions for loanlosses.  The methodology is set forth in a formal policy and takes intoconsideration the need for an overall allowance for loan losses as well asspecific allowances that are tied to individual loans.  The Bank’smethodology for assessing the appropriateness of the allowance consists ofseveral key elements, which include the formula allowance and a specificallowance for identified problem loans.

 

Inoriginating loans, the Bank recognizes that losses will be experienced and thatthe risk of loss will vary with, among other things, the type of loan beingmade, the creditworthiness of the borrower over the term of the loan, generaleconomic conditions and, in the case of a secured loan, the quality of the collateralsecuring the loan.  The allowance is increased by provisions chargedagainst earnings and reduced by net loan charge-offs.  Loans are chargedoff when they are deemed to be uncollectable, or partially charged off whenportions of a loan are deemed to be uncollectable.   Recoveries aregenerally recorded only when cash payments are received.

 

Theallowance for loan losses is maintained to cover losses inherent in the loanportfolio.  The responsibility for the review of the Bank’s assets and thedetermination of the adequacy of the general valuation allowance lies with theDirector’s Loan Committee.  This committee

 

14

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assigns the loss reserve ratio for each type ofasset and reviews the adequacy of the allowance at least quarterly based on anevaluation of the portfolio, past experience, prevailing market conditions,amount of government guarantees, concentration in loan types and other relevantfactors.  Specific valuation allowances are established to absorb losseson loans for which full collectability may not be reasonably assured.  Theamount of the specific allowance is based on the estimated value of thecollateral securing the impaired loans and other analyses pertinent to eachsituation.  Estimates of identifiable losses are reviewed continually and,generally, a provision for losses is charged against operations on a monthlybasis as necessary to maintain the allowance at an appropriate level. Management presents an analysis of the allowance for loan losses to the Bank’sboard of directors on a quarterly basis.

 

TheDirectors’ loan committee meets quarterly to review and monitor conditions inthe portfolio and to determine the appropriate allowance for loan losses. To the extent that any of these conditions are evidenced by identifiableproblem credit or portfolio segment as of the evaluation date, the committee’sestimate of such condition may be reflected as a specific allowance applicableto such credit or portfolio segment.  By assessing the probable estimatedlosses inherent in the loan portfolio on a quarterly basis, the Bank is able toadjust specific and inherent loss estimates based upon the most recentinformation that has become available.

 

Asof March 31, 2003 the balance in the allowance for loans losses was $718,045compared to $571,191 as of March 31, 2002 and $661,170 as of June 30,2002. The allowance for loan losses as a percentage of total gross loanswas 1.89% as of March 31, 2003 compared to 1.83% as of March 31, 2002 and 1.93%as of June 30, 2002.  The allowance for loan losses as a percentage ofnonaccrual loans was 34% as of March 31, 2003 compared to 68% as of March 31,2002 and was 36% as of June 30, 2002. Management believes the allowance atMarch 31, 2003 is adequate based upon its ongoing analysis of the loanportfolio, historical loss trends, general economic conditions and otherfactors. For further information, see Part II Item 1:****“Legal Proceedings”.

 

**Deposits and Borrowings**

Totaldeposits increased to $40.94 million as of March 31, 2003 compared to $34.83million as of March 31, 2002 and $39.59 million as of June 30, 2002. Interest bearing and non-interest bearing deposits increased to $36.22 millionand $4.72 million, respectively, as of March 31, 2003 compared to $31.90million and $2.93 million, respectively, as of March 31, 2002 and $35.02million and $4.57 million, respectively, as of June 30, 2002.  Theincrease in deposit was used to fund loans held for investment and loans heldfor sale.  Retail deposits increased as part of the Bank’s overallexpansion, including the addition of the St. Cloud banking offices in 2002.

 

Otherborrowings totaled $5.04 million as of March 31, 2003, compared to $5.28million as of March 31, 2002 and $5.28 million as of June 30, 2002. Included in other borrowings are advances from the FHLB and other banks. The Bank established a line of credit with the FHLB collateralized by loans andsecurities.  Funds from the credit line were used to purchase governmentsecurities and increase liquidity at the Bank.

 

In addition to the FHLBadvances, other lines of credit are utilized to increase capital at theBank.  The Company borrowed $600,000from an unaffiliated lender and contributed the proceeds to the equity capitalof the Bank. In addition, the Company has issued $1.55 million ofunsecured subordinated notes payable, the proceeds of which was used to provideequity capital to the bank and to pay the operating expenses of theCompany.  The holders of the unsecurednotes have the right to convert at any time prior to maturity all or any partof the notes into shares

 

15

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of common stock of the Company at the conversionrate.  The conversion rate is adjustedif the number of shares changes.

 

**Capital**

TheCompany’s capital increased to $4.33 million as of March 31,2003 compared to$4.16 million as of March 31, 2002 and was $4.16 million as of June 30,2002.  The increase in capital, net of operating results, was due to theissuance of 31,000 shares of common stock for $170,500.

 

Managementconsiders capital requirements as part of its strategic planning process. Growth for the calendar year is expected to be approximately 10%.  Basedon current projections, management believes that the Bank will continue toremain well capitalized during 2003.  Future asset growth is dependentupon many factors, including the Bank’s access to capital markets, earningsgrowth, and overall economic conditions.  The ability to obtain capital isdependent upon the capital markets as well as performance of the Bank. Management regularly evaluates sources of capital and the timing required toaccomplish its strategic objectives.

 

AtMarch 31, 2003 and March 31, 2002, all capital ratios were above all currentFederal capital guidelines for a “well capitalized” bank.   As ofMarch 31, 2003, the Bank’s regulatory Total Capital to risk-weighted assetsratio was 12.07% compared to 12.90% as of March 31, 2002.  The Bank’sregulatory Tier 1 Capital to risk-weighted assets ratio was 10.81% as of March31, 2003 compared to 11.65% as of March 31, 2002.  The Bank’s regulatoryTier 1 Capital to average assets ratio was 10.23% as of June 30, 2002.

 

**Dividends.**

Whetheror not the Board of Directors will determine stock dividends or any cashdividends will be paid in the future depends upon their consideration ofvarious factors.  The Company’s and the Bank’s profitability andregulatory capital ratios in addition to other financial conditions will be keyfactors considered by the Board of Directors in making such determinationsregarding the payment of dividends. There are state and federal statutory andregulatory requirements limiting the amount of dividends that may be paid tothe Company by our Bank.  Generally, abank may pay cash dividends out of current operating earnings to the extentthat the current rate of earnings retention is consistent with our Bank’scapital needs, asset quality, and overall financial condition.  The governing regulatory agency has theauthority to prohibit our Bank from engaging in business practices that thegoverning authority considers to be unsafe or unsound.  It is possible, depending upon the financialcondition of our Bank, that the governing regulatory agency may determine thatthe payment of dividends to the Company by our Bank might, under somecircumstances, be such an unsafe and unsound practice.

 

Neither the Company nor the Bank has plans to pay anycash dividends to its shareholders in the foreseeable future.

 

**Liquidity**

TheBank closely monitors its liquidity so that the cash requirements for loans anddeposit withdrawals are met in an economical manner.  Management monitorsliquidity in relation to trends of loans and deposits for short term andlong-term requirements.  Liquidity sources are cash, deposits with otherbanks, overnight Federal Funds investments, un-pledged  investment securities, and the ability tosell loans. As of March 31, 2003 liquid assets as a percentage of depositswere 11.34% compared to 15.69% as of March 31, 2002.

 

16

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**AVERAGE BALANCES, YIELDS AND RATES**

The following table sets forth,for the three and nine months ended March 31, 2003 and 2002, the weightedaverage yields earned, the weighted average rates paid, the interest ratespread and the net yield on earning assets and interest-bearing liabilities, onan annualized basis.

 
|                                                                              |   | **For the  Three Months Ended** |       |
|-----------------------------------------------------------------------------------|--------|---------------------------------|------------|
|                                                                              |   | **March 31,  2003**             |       | **March 31,  2002** |   |
|                                                                              |   | **Average  Balance**            |       | **Interest** |   | **Average  Yield or  Rates** |   | **Average  Balance** |   | **Interest** |   | **Average  Yield or  Rates** |   |
| **Assets**                                                                        |   |                            |       |   |   |   |   |   |   |   |   |   |   |
| Loans receivable                                                                  |   | $                               | 36,164,518 |   | $ | 620,225 |   | 6.86 | % | $ | 31,450,127 |   | $ | 546,094 |   | 6.95 | % |
| Investment securities                                                             |   | 5,925,454                       |       | 64,260 |   | 4.34 | % | 9,978,561 |   | 133,355 |   | 5.35 | % |
| Federal funds sold                                                                |   | 3,416,667                       |       | 9,719 |   | 1.14 | % | 754,411 |   | 2,816 |   | 1.49 | % |
| Total interest-earning  assets                                                    |   | 45,506,639                      |       | 694,204 |   | 6.10 | % | 42,183,099 |   | 682,265 |   | 6.47 | % |
| Non-interest-earning  assets                                                      |   | 3,923,669                       |       |   |   |   |   | 2,031,783 |   |   |   |   |   |
| Total assets                                                                      |   | $                               | 49,430,308 |   |   |   |   |   | $ | 44,214,882 |   |   |   |   |   |
| **Liabilities  and Stockholders’ Equity**                                    |   |                            |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits                                                        |   | $                               | 36,491,693 |   | 268,118 |   | 2.94 | % | $ | 32,764,909 |   | 340,522 |   | 4.16 | % |
| Other liabilities                                                                 |   | 6,525,667                       |       | 73,185 |   | 4.49 | % | 6,300,511 |   | 79,898 |   | 5.07 | % |
| Total interest-bearing  liabilities                                               |   | 43,017,360                      |       | 341,303 |   | 3.17 | % | 39,065,420 |   | 420,420 |   | 4.30 | % |
| Non-interest-bearing  liabilities                                                 |   | 4,382,831                       |       |   |   |   |   | 3,181,971 |   |   |   |   |   |
| Total liabilities                                                                 |   | 47,400,191                      |       |   |   |   |   | 42,247,391 |   |   |   |   |   |
| Stockholders’ Equity                                                         |   | 2,030,117                       |       |   |   |   |   | 1,967,491 |   |   |   |   |   |
| Total liabilities and  stockholders’ equity                                  |   | $                               | 49,430,308 |   |   |   |   |   | $ | 44,214,882 |   |   |   |   |   |
| Net interest spread                                                               |   |                            |       |   |   | 2.93 | % |   |   |   |   | 2.17 | % |
| Net interest  income/margin                                                       |   |                            |       | $ | 352,901 |   | 3.10 | % |   |   | $ | 261,845 |   | 2.48 | % |
| Ratio of average  interest-earning assets to average interest-bearing liabilities |   | 1.06                            | x          |   |   |   |   | 1.08 | x |   |   |   |   |

 
|                                                                              |   | **For the  Nine Months Ended** |       |
|-----------------------------------------------------------------------------------|--------|--------------------------------|------------|
|                                                                              |   | **March 31,  2003**            |       | **March 31,  2002** |   |
|                                                                              |   | **Average  Balance**           |       | **Interest** |   | **Average  Yield or  Rates** |   | **Average  Balance** |   | **Interest** |   | **Average  Yield or  Rates** |   |
| **Assets**                                                                        |   |                           |       |   |   |   |   |   |   |   |   |   |   |
| Loans receivable                                                                  |   | $                              | 35,534,696 |   | $ | 1,881,633 |   | 7.06 | % | $ | 28,401,831 |   | $ | 1,579,754 |   | 7.42 | % |
| Investment securities                                                             |   | 6,478,429                      |       | 232,419 |   | 4.78 | % | 10,489,938 |   | 435,506 |   | 5.52 | % |
| Federal funds sold                                                                |   | 2,866,186                      |       | 28,698 |   | 1.34 | % | 2,352,389 |   | 59,960 |   | 3.40 | % |
| Total interest-earning  assets                                                    |   | 44,879,311                     |       | 2,142,750 |   | 6.37 | % | 41,244,158 |   | 2,075,220 |   | 6.71 | % |
| Non-interest-earning  assets                                                      |   | 4,108,765                      |       |   |   |   |   | 1,943,314 |   |   |   |   |   |
| Total assets                                                                      |   | $                              | 48,988,076 |   |   |   |   |   | $ | 43,187,472 |   |   |   |   |   |
| **Liabilities  and Stockholders’ Equity**                                    |   |                           |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits                                                        |   | $                              | 35,978,484 |   | 888,780 |   | 3.29 | % | $ | 32,678,167 |   | 1,183,200 |   | 4.83 | % |
| Other liabilities                                                                 |   | 6,575,568                      |       | 228,342 |   | 4.63 | % | 5,333,377 |   | 222,902 |   | 5.57 | % |
| Total interest-bearing  liabilities                                               |   | 42,554,052                     |       | 1,117,122 |   | 3.50 | % | 38,011,544 |   | 1,406,102 |   | 4.93 | % |
| Non-interest-bearing  liabilities                                                 |   | 4,461,470                      |       |   |   |   |   | 2,584,769 |   |   |   |   |   |
| Total liabilities                                                                 |   | 47,015,522                     |       |   |   |   |   | 40,596,313 |   |   |   |   |   |
| Stockholders’ equity                                                         |   | 1,972,554                      |       |   |   |   |   | 2,591,159 |   |   |   |   |   |
| Total liabilities and  stockholders’ equity                                  |   | $                              | 48,988,076 |   |   |   |   |   | $ | 43,187,472 |   |   |   |   |   |
| Net interest spread                                                               |   |                           |       |   |   | 2.87 | % |   |   |   |   | 1.78 | % |
| Net interest  income/margin                                                       |   |                           |       | $ | 1,025,628 |   | 3.05 | % |   |   | $ | 668,118 |   | 2.16 | % |
| Ratio of average  interest-earning assets to average interest-bearing liabilities |   | 1.05                           | x          |   |   |   |   | 1.09 | x |   |   |   |   |

 

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**INVESTMENT PORTFOLIO**

Contractual maturities andyields on the Company’s investments (all available for sale) are summarized inthe following table.  Expectedmaturities may differ from contractual maturities because issuers may have theright to call or prepay obligations with our without call or prepaymentpenalties

 
|                     |   | **March 31, 2003**     |   |
|--------------------------|--------|------------------------|--------|
|                     |   | **One  Year  or Less** |   | **Yield** |   | **After one  year thru  five years** |   | **Yield** |   | **After five  years thru  ten years** |   | **Yield** |   | **After 10  years** |   | **Yield** |   | **Total** |   | **Yield** |   |
|                     |   |                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Agencies            |   | $                      | — |   | 0.00 | % | $ | 508,438 |   | 3.31 | % | $ | 1,760,107 |   | 4.10 | % | $ | — |   | 0.00 | % | $ | 2,268,545 |   | 3.92 | % |
| Mortgage-back securities |   | —                 |   | 0.00 | % | — |   | 0.00 | % | 1,268,082 |   | 5.21 | % | 2,428,401 |   | 5.68 | % | 3,696,483 |   | 5.52 | % |
| Corporate bonds          |   | —                 |   | 0.00 | % | 508,841 |   | 6.06 | % | — |   | 0.00 | % | — |   | 0.00 | % | 508,841 |   | 6.06 | % |
|                     |   | $                      | — |   | 0.00 | % | $ | 1,017,279 |   | 4.69 | % | $ | 3,028,189 |   | 4.56 | % | $ | 2,428,401 |   | 5.68 | % | $ | 6,473,869 |   | 5.00 | % |

 

**LOAN PORTFOLIO**

The following table summarizesthe composition of the loan portfolio. Total gross loans including net of deferred loan fees and costsoutstanding at March 31, 2003 and June 30, 2002 were $38,066,407 and$34,497,862, respectively.  This tableexcludes loans held for sale as of March 31, 2003 and June 30, 2002 of$1,741,843 and $625,735 respectively. Loans held for sale are comprised of real estate mortgages.

 
|                           |   | **March 31, 2003** |       | **June 30, 2002**  |   |
|--------------------------------|--------|--------------------|------------|--------------------|--------|
|                           |   | **Amount**         |       | **%****of  Total** |   | **Amount** |   | **%****of  Total** |   |
|                           |   |               |       |               |   |   |   |   |   |
| Commercial & agricultural  |   | $                  | 6,761,696  |               | 17.81  | % | $ | 6,616,193 |   | 19.28 | % |
| Real estate - construction     |   | 3,525,628          |       | 9.29               | %      | 2,375,318 |   | 6.92 | % |
| Real estate - mortgages        |   | 18,062,754         |       | 47.57              | %      | 13,336,761 |   | 38.86 | % |
| Consumer loans                 |   | 9,582,283          |       | 25.24              | %      | 11,809,464 |   | 34.41 | % |
| Lease financing                |   | 37,551             |       | 0.09               | %      | 179,995 |   | 0.53 | % |
| Total loans                    |   | $                  | 37,969,912 |               | 100.00 | % | $ | 34,317,731 |   | 100.00 | % |
| Net deferred loan fees/(costs) |   | 96,495             |       |               |   | 180,131 |   |   |   |
| Less: allowance for loan loss  |   | (718,045           | )          |               |   | (661,170 | ) |   |   |
| Total net loans                |   | $                  | 37,348,362 |               |   |   | $ | 33,836,692 |   |   |   |

 

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### **MATURITIESAND SENSITIVITY OF LOANS TO CHANGES IN INTEREST RATES**

The information in the followingtable is based on the contractual maturities of individual loans, includingloans, which may be subject to renewal at their contractual maturity.  Renewal of such loans is subject to reviewand credit approval as well as modification of terms upon maturity.  Actual repayments of loans may differ frommaturities reflected below because borrowers have the right to repayobligations with or without prepayment penalties.  The following table summarizes loan maturities, by type at March31, 2003 and June 30, 2002.

 
|                                |   | **As of  March 31, 2003** |       |
|-------------------------------------|--------|---------------------------|------------|
|                                |   | **One Year  or Less**     |       | **After One  but  within Five Years** |   | **After  Five Years** |   | **Total** |   |
|                                |   |                      |       |   |   |   |   |   |   |
| Commercial &  agricultural      |   | $                         | 3,087,324  |   | $ | 2,122,287 |   | $ | 1,552,085 |   | $ | 6,761,696 |   |
| Real estate -  construction         |   | 2,752,109                 |       | 773,519 |   | — |   | $ | 3,525,628 |   |
| Real estate - mortgages             |   | 1,674,858                 |       | 12,403,631 |   | 3,984,265 |   | $ | 18,062,754 |   |
| Consumer loans                      |   | 2,238,721                 |       | 7,059,134 |   | 284,428 |   | $ | 9,582,283 |   |
| Lease financing                     |   | 1,182                     |       | 36,369 |   | — |   | $ | 37,551 |   |
| Total                               |   | $                         | 9,754,194  |   | $ | 22,394,940 |   | $ | 5,820,778 |   | $ | 37,969,912 |   |
|                                |   |                      |       |   |   |   |   |   |   |
| Loans maturing after one  year with |   |                      |       |   |   |   |   |   |   |
| Fixed interest rate                 |   | $                         | 24,444,642 |   |   |   |   |   |   |   |
| Floating interest rates             |   | $                         | 3,771,076  |   |   |   |   |   |   |   |

 
|                                |   | **As of  June 30, 2002** |       |
|-------------------------------------|--------|--------------------------|------------|
|                                |   | **One Year  or Less**    |       | **After One  but  within Five Years** |   | **After  Five Years** |   | **Total** |   |
|                                |   |                     |       |   |   |   |   |   |   |
| Commercial &  agricultural      |   | $                        | 2,728,795  |   | $ | 2,252,871 |   | $ | 1,634,527 |   | $ | 6,616,193 |   |
| Real estate -  construction         |   | 2,108,064                |       | 267,254 |   | — |   | 2,375,318 |   |
| Real estate - mortgages             |   | 2,295,594                |       | 9,126,974 |   | 1,914,193 |   | 13,336,761 |   |
| Consumer loans                      |   | 3,169,551                |       | 7,367,969 |   | 1,271,944 |   | 11,809,464 |   |
| Lease financing                     |   | 51,438                   |       | 128,557 |   | — |   | 179,995 |   |
| Total                               |   | $                        | 10,353,442 |   | $ | 19,143,625 |   | $ | 4,820,664 |   | $ | 34,317,731 |   |
|                                |   |                     |       |   |   |   |   |   |   |
| Loans maturing after one  year with |   |                     |       |   |   |   |   |   |   |
| Fixed interest rate                 |   | $                        | 19,929,853 |   |   |   |   |   |   |   |
| Floating interest rates             |   | $                        | 4,034,436  |   |   |   |   |   |   |   |
|                                     |        |                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

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**PROVISIONAND ALLOWANCE FOR LOAN LOSSES**

We have developed policies and procedures forevaluating the overall quality of its credit portfolio and the timelyidentification of potential credit problems. Additions to the allowance for loan losses will be made periodically tomaintain the allowance at an appropriate level based on management’s analysisof the potential risk in the loan portfolio.

 

At March 31, 2003, the allowance for loan losses was$718,045, or 1.89%, of $38,066,407 in loan receivables (net of loans held forsale).  The provision for loan losseswas made primarily as a result of management’s assessment of impaired loans andgeneral loan loss risk as our loan portfolio increases.

 
|                                                                                       |   | **Nine  Months Ended  March 31, 2003** |    | **Year  Ended  June 30, 2002** |   |
|--------------------------------------------------------------------------------------------|--------|----------------------------------------|---------|--------------------------------|--------|
|                                                                                       |   |                                   |    |                           |   |
| Balance at beginning of  period                                                            |   | $                                      | 661,170 |                           | $      | 234,989 |   |
| Charge-offs                                                                                |   | (14,330                                | )       | (359,751                       | )      |
| Recoveries                                                                                 |   | 7,605                                  |    | 857                            |   |
| Net charge-offs                                                                            |   | (6,725                                 | )       | (358,894                       | )      |
| Provision charged to  operations                                                           |   | 63,600                                 |    | 785,075                        |   |
|                                                                                       |   |                                   |    |                           |   |
| Balance at end of period                                                                   |   | $                                      | 718,045 |                           | $      | 661,170 |   |
|                                                                                       |   |                                   |    |                           |   |
| Ratio of net charge-offs  during the period to average loans outstanding during the period |   | 0.00                                   | %       | 1.22                           | %      |

 

At March 31, 2003 andJune 30, 2002 the allowance was allocated as follows:

 
|                          |   | **For the Nine Months Ended  March 31, 2003** |    | **For the Year Ended  June 30, 2002**                  |   |
|-------------------------------|--------|-----------------------------------------------|---------|--------------------------------------------------------|--------|
|                          |   | **Amount**                                    |    | **Percent of Loans  in Each Category  of Total Loans** |   | **Amount** |   | **Percent of Loans  in Each Category  of Total Loans** |   |
| Commercial & agricultural |   | $                                             | 48,667  |                                                   | 17.81  | % | $ | 42,318 |   | 19.28 | % |
| Real estate - construction    |   | 30,047                                        |    | 9.29                                                   | %      | 17,815 |   | 6.92 | % |
| Real estate - mortgages       |   | 120,481                                       |    | 47.57                                                  | %      | 85,373 |   | 38.86 | % |
| Consumer loans                |   | 518,568                                       |    | 25.24                                                  | %      | 514,123 |   | 34.41 | % |
| Lease financing               |   | 282                                           |    | 0.09                                                   | %      | 1,541 |   | 0.53 | % |
| Total                         |   | $                                             | 718,045 |                                                   | 100.00 | % | $ | 661,170 |   | 100.00 | % |

 

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**DEPOSITS**

The following is a table of deposits by category atMarch 31, 2003 and June 30, 2002.

 
|                              |   | **As  of March 31, 2003** |       |
|-----------------------------------|--------|---------------------------|------------|
|                              |   | **Ending  Balance**       |       | **Percentage  of Total  Deposits** |   | **Average  Balance** |   | **Percentage  of Total  Average  Deposits** |   | **Average  Rate  Paid** |   |
|                              |   |                      |       |   |   |   |   |   |   |   |   |
| Demand deposit                    |   | $                         | 4,715,328  |   | 11.52 | % | $ | 4,010,573 |   | 10.03 | % | 0.00 | % |
| Now and money market              |   | 8,570,502                 |       | 20.94 | % | 8,545,419 |   | 21.37 | % | 1.85 | % |
| Savings                           |   | 5,011,947                 |       | 12.24 | % | 4,662,563 |   | 11.66 | % | 1.74 | % |
| Time accounts less than $100,000  |   | 17,994,202                |       | 43.96 | % | 18,297,586 |   | 45.76 | % | 4.13 | % |
| Time accounts of $100,000 or more |   | 4,645,701                 |       | 11.34 | % | 4,472,916 |   | 11.18 | % | 4.25 | % |
| Total deposits                    |   | $                         | 40,937,680 |   | 100.00 | % | $ | 39,989,057 |   | 100.00 | % |   |   |

 
|                              |   | **As  of June 30, 2002** |       |
|-----------------------------------|--------|--------------------------|------------|
|                              |   | **Ending  Balance**      |       | **Percentage  of Total  Deposits** |   | **Average  Balance** |   | **Percentage  of Total  Average  Deposits** |   | **Average  Rate  Paid** |   |
|                              |   |                     |       |   |   |   |   |   |   |   |   |
| Demand deposit                    |   | $                        | 4,574,282  |   | 11.55 | % | $ | 2,395,080 |   | 6.81 | % | 0.00 | % |
| Now and money market              |   | 7,718,574                |       | 19.50 | % | 5,734,695 |   | 16.31 | % | 2.67 | % |
| Savings                           |   | 4,533,290                |       | 11.45 | % | 4,620,632 |   | 13.14 | % | 2.41 | % |
| Time accounts less than $100,000  |   | 18,622,280               |       | 47.04 | % | 18,763,158 |   | 53.37 | % | 5.48 | % |
| Time accounts of $100,000 or more |   | 4,141,303                |       | 10.46 | % | 3,641,798 |   | 10.37 | % | 5.80 | % |
| Total deposits                    |   | $                        | 39,589,729 |   | 100.00 | % | $ | 35,155,363 |   | 100.00 | % |   |   |

 

Maturities distribution of time deposits of$100,000.00 and over.

 
|                              |   | **As of  December 31, 2002** |      |
|-----------------------------------|--------|------------------------------|-----------|
|                              |   | **3 months  or less**        |      | **Over 3  months  thru 6 months** |   | **Over 6  months  thru 12 months** |   | **Over  12 months** |   | **Total** |   |
| Time Accounts of $100,00  or more |   | $                            | 1,136,543 |   | $ | 509,409 |   | $ | 1,261,306 |   | $ | 1,738,443 |   | $ | 4,645,701 |   |
|                                   |        |                              |           |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES: MARKETRISK**

 

Interest rate risk is the most significant market riskimpacting the Company.  The Bankmonitors and manages its interest rate risk using interest rate sensitivity“gap” analysis to measure the impact of market interest rate changes on netinterest income. See the Company’s 2002 annual report on Form 10-KSB fordisclosure of the quantitative and qualitative information regarding theinterest rate risk inherent in interest rate risk sensitive instruments as ofJune 30, 2002. There have been no changes in the assumptions used in monitoringinterest rate risk as of March 31, 2003. The impact of other types of marketrisk, such as foreign currency exchange risk and equity price risk, is deemedimmaterial. The Company does not maintain a portfolio of trading securities anddoes not intend to engage in such activities in the immediate future.

 

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**ITEM 4. CONTROLS AND PROCEDURES**

 

Evaluationof Disclosure Controls and Procedures. The Company maintains controls and procedures designed to ensure thatinformation required to be disclosed in the reports that the Company files orsubmits under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the rules andforms of the Securities and Exchange Commission. Based upon their evaluation ofthose controls and procedures performed within 90 days of the filing dateof this report, the Chief Executive Officer and Chief Financial Officer of theCompany concluded that the Company’s disclosure controls and procedures wereadequate.

 

Changesin Internal Controls.  The Company madeno significant changes in its internal controls or in other factors that couldsignificantly affect these controls subsequent to the date of the evaluation ofthose controls by the Chief Executive and Chief Financial officers.

 

22

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## **Part II**OTHER INFORMATION

 

**Item 1.  Legal Proceedings**

The Company and itswholly owned subsidiary bank, Northern Star Bank, are defendants in civilactions.

 

The Company was a defendant and third party plaintiffin a complaint originally filed on March 22, 2002 in the United StatesDistrict Court for the Western District of Wisconsin by Catalytic CombustionCorporation 401(k) Profit Sharing Plan and Catalytic Combustion Corporation(“Plaintiffs”).  On March 31, 2003 theCompany, the Third-Party Defendant, and the Plaintiffs entered into aconfidential final and binding mutual release of all claims and settlementagreement.  All expenses incurred inconnection with the settlement have been expensed.

 

Northern Star Bank is adefendant in a complaint filed on February 23, 2002 in United StatesDistrict Court, District of South Dakota Southern Division by Bridge Lenders,LLC; Jim Perry; Larry Ticknor; Doug English; Rollyn H. Samp; Courtney Anderson;Henry Carlson, Jr.; Michael M. Samp; Ernest Olson; Don Davis; JerryLanderville; Allen Lewis; Gary Viger; Glen Jamtgaard and Steve Herman(“Plaintiffs”).  The complaint arose outof a series of loans that Northern Star Bank made to Plaintiffs in 2000.  Plaintiffs used the proceeds of the loans tomake an investment in Bridge Lenders, LLC, and Bridge Lenders, LLC in turn usedthe funds to make an investment in Phenix Biocomposites, which has defaulted inits obligations to Plaintiffs.  NorthernStar Bank is a defendant in this action due to the fact that its formerdirector, Frank Gazzola, was also a director of Phenix Biocomposites.  The Plaintiffs allege that Mr. Gazzolafailed to inform the Plaintiffs that their investment in Phenix Biocompositeswas not secured.  The Plaintiffs claimthat Northern Star Bank had a fiduciary duty to the Plaintiffs because of Mr.Gazzola’s dual role as a director of both Northern Star Bank and PhenixBiocomposites, that Northern Star Bank violated this fiduciary duty and aseparate implied covenant of good faith and fair dealing when Mr. Gazzolaallegedly provided false information to Plaintiffs, and that the falseinformation allegedly provided by Mr. Gazzola constituted intentional orunintentional fraud by Northern Star Bank. Plaintiffs seek compensatory, general, special and punitivedamages.  Northern Star Bank denied thePlaintiffs’ allegations and has brought a motion to dismiss all claims for lackof personal jurisdiction. The Company is awaiting a response from the court.

 

The Company made certainloans to the former CFO during his tenure at the Company.  These loans are collateralized by securitiesowned by the former CFO.  The former CFOsubsequently filed for bankruptcy.  TheBankruptcy court claims that since certain of the collateral was conveyed tothe Bank within one year of the former CFO’s filing for bankruptcy and theformer CFO was an insider, they are preferential transfers and must bereversed.  The effect of a successfuloutcome by the Bankruptcy court would increase the risk of loss to the Companyon the loans to the former CFO.  As ofMarch 31, 2003, the principal balance of loans outstanding approximates$475,000.  These loans are considered bymanagement to be impaired, and a specific reserve relating to these loansapproximating $260,000 has been included in the allowance for loan losses.**(See Part II. Item 5 – Other Information)**

 

**Item 2  Changes in Securities**

Duringthe second quarter of the current fiscal year, the Board of Directors of theCompany authorized a private placement of 40,000 shares of its common stock ata price of

 

23

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$5.50 per share. The Company will not incur anyunderwriting or placement expenses in connection with this offering.  As of March 31, 2003, subscriptions to allof the authorized shares had been received.  As of March 31, 2003, paymentfor 31,000 shares of the 40,000 shares had been received.  The proceeds will be utilized to support ouron-going operations.

 

**Item 3  Defaults Upon Senior Securities**

 

Noneto report.

 

**Item 4  Submission of Matters to a Vote ofSecurity Holders**

 

Nomatters were submitted to the security holders.

 

**Item 5  Other information**

On May 5, 2003, the BankruptcyCourt approved a settlement agreement between the Bank and the Trustee in theBankruptcy Estate of Frank Gazzola.  Theagreement provides for the Bank to pay the Trustee the sum of three hundred andeighty thousand dollars ($380,000.00) in exchange for a release by the estateand trustee of all claims against Northern Star Bank, its current officers, itscurrent directors, and its attorneys including claims to certain assets of theestate held as collateral by the Bank.  The agreement also provides for a release by the Bank, its currentofficers, current directors and attorneys, of all claims against the BankruptcyEstate and the Trustee and their attorneys, except for the Bank’s Amended Claimupon the estate in the amount of $570,598.

 

**Item 6  Exhibits and Reports Form 8-K**

a) Exhibits

    See exhibit indeximmediately following Section 302 certifications

b) Reports on form 8-K

    During the quarter endedMarch 31, 2003, the Company filed one form 8-K as follows:

2/13/03 Press release with Second Quarter results ofNorthern Star Financial, Inc.

 

**SIGNATURES**

 

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 
|                     |   | NORTHERN STAR  FINANCIAL, INC.                                |
|--------------------------|--------|---------------------------------------------------------------|
|                     |   |                                                          |
| Date:  May 14, 2003 | By     | /s/  Thomas P. Stienessen                                     |   |
|                     |   | Thomas P.  Stienessen, President and  Chief Executive Officer |
|                     |   |                                                          |
| Date:  May 14, 2003 | By     | /s/  Gerald W. Eick                                           |   |
|                     |   | Gerald  W. Eick, Treasurer                                    |

 

24

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**CERTIFICATIONS**

 

I, Gerald Eick, Treasurer, certify that:

 

1.                                       Ihave reviewed this quarterly report on Form 10-QSB of Northern Star Financial,Inc. and Subsidiary;

 

2.             Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.             Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operation and cash flows of the registrant asof, and for, the periods presented in this quarterly report.

 

4.             Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRule 13a-14 and 15d-14) for the registrant and have:

 

a)             designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)            evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)             presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluations as of theEvaluation Date;

 

5.             Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)             allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrants ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)            anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.             Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  | 05/14/03 |                      | By: | /s/ Gerald W.  Eick |
|--------|----------|---------------------------|-----|---------------------|
|   |     | Gerald W. Eick, Treasurer |

 

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**CERTIFICATIONS**

 

I, Thomas P. Stienessen, President and CEO, certifythat:

 

1.             Ihave reviewed this quarterly report on Form 10-QSB of Northern Star Financial,Inc. and Subsidiary;

 

2.             Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.             Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operation and cash flows of the registrant asof, and for, the periods presented in this quarterly report.

 

4.             Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRule 13a-14 and 15d-14) for the registrant and have:

 

a)             designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)            evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)             presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluations as of theEvaluation Date;

 

5.             Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)             allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrants ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)            anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.             Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  | 05/14/03 |                                        | By: | /s/ Thomas P.  Stienessen |
|--------|----------|---------------------------------------------|-----|---------------------------|
|   |     | Thomas P. Stienessen, Presiden**t** and CEO |

 

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**EXHIBIT INDEX**

**NORTHERN STAR FINANCIAL, INC.**

**FORM 10-QSB FOR QUARTER ENDED MARCH31, 2003**

 

 
| **EXHIBIT** |   | **DESCRIPTION**                                                             |
|-------------|--------|-----------------------------------------------------------------------------|
|        |   |                                                                        |
| 99.1        |   | Certification of CFO Pursuant to Sec 906 of The Sarbanes-Oxley Act of  2002 |
|        |   |                                                                        |
| 99.2        |   | Certification of CEO Pursuant to Sec 906 of The Sarbanes-Oxley Act of  2002 |

 

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