10-Q 1 june10q.txt FIRST BANKING CENTER, INC. JUNE 2004 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT 1934 For the quarterly period ended June 30, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-11132 FIRST BANKING CENTER, INC. (Exact name of registrant as specified in its charter) Wisconsin 39-1391327 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 400 Milwaukee Ave., Burlington, WI 53105 (Address of principal executive offices) (Zip Code) (262) 763-3581 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [ ] No [ X ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of July 28, 2004, Common stock, $1.00 par value, 1,492,836 shares outstanding. FIRST BANKING CENTER, INC AND SUBSIDIARY TABLE OF CONTENTS June 30, 2004 Part I Financial Information Page ---- Item 1 Consolidated Financial Statements Unaudited Consolidated Balance Sheets, June 30, 2004 and December 31, 2003 3 Unaudited Consolidated Statements of Income, For the three and six month periods ended June 30, 2004 and 2003 4 Unaudited Consolidated Statements of Cash Flows, For the six months ended June 30, 2004 and 2003 5 Notes to Unaudited Consolidated Financial Statements 6-9 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 10-19 Item 3 Quantitative and Qualitative Disclosures about Market Risk 20 Item 4 Controls and Procedures 21 Part II Other Information Item 1 Legal Proceedings 21 Item 2 Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 21 Item 3 Defaults upon Senior Securities 22 Item 4 Submission of Matters to a Vote of Security Holders 22 Item 5 Other Information 22 Item 6 Exhibits and Reports on Form 8-K 22 Signatures 23 PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements FIRST BANKING CENTER, INC. AND SUBSIDIARY UNAUDITED CONSOLIDATED BALANCE SHEETS

FIRST BANKING CENTER, INC. AND SUBSIDIARY UNAUDITED CONSOLIDATED STATEMENTS OF INCOME

FIRST BANKING CENTER, INC. AND SUBSIDIARY UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

FIRST BANKING CENTER, INC AND SUBSIDIARY NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 NOTE 1 - Basis of Presentation The unaudited consolidated financial statements include the accounts of First Banking Center, Inc. (the "Company") and First Banking Center, its wholly owned subsidiary. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the financial position, results of operation and cash flows for the interim periods have been made. The results of operations for the three and six months ended June 30, 2004 are not necessarily indicative of the results to be expected for the entire fiscal year. The unaudited interim financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and industry practice. Certain information in footnote disclosure normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America and industry practice has been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's December 31, 2003 audited financial statements. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions which affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements, as well as the reported amounts of income and expenses during the reported periods. Actual results could differ from those estimates. NOTE 2 - Earnings per Share The following information calculates the computation of earnings per share on a basic and diluted basis:

NOTE 3 - Comprehensive Income The following table presents our comprehensive income:

NOTE 4 - Stock-based Compensation Plan: For the six months ended June 30, 2004, and June 30, 2003, the Company had one stock-based compensation plan for officers and key employees. The Company accounts for this plan under the recognitions and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in the income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Financial Accounting Standards Board (FASB) Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation:

In determining compensation cost using the fair value method prescribed in Statement No. 123, the value of each grant is estimated at the grant date with the following weighted-average assumptions used for grants on June 30, 2004, and June 30, 2003, respectively: dividend yield of 1.7 percent and 1.7 percent; expected price volatility of 5.1 percent and 5.2 percent, blended risk-free interest rates of 4.9 percent and 3.5 percent; and expected lives of 10 years, respectively. NOTE 5 - Commitments and Contingencies Information in the following table provides a summary of the Company's other contractual obligations and commercial commitments as of June 30, 2004, as well as that information for its depository products:

Notes a. Excluding the "off balance sheet" lending commitments discussed below. b. Excludes demand, savings, and money market deposits c. See Note 8 in the Notes to Consolidated Financial Statements for the year ended December 31, 2003 for a description of the Company's various short-term borrowings. Many short-term borrowings such as federal funds purchased and security repurchase agreements are expected to be reissued and, therefore, do not necessarily represent an immediate need for cash. d. See Note 9 in the Notes to Consolidated Financial Statements for the year ended December 31, 2003 for a description of the Company's various other borrowings. e. Other long-term obligations consisted primarily of salary continuation agreements and benefit plans. See Exhibits 10.1, 10.2, 10.3 and 10.4 to the Form 10-K as of December 31, 2003 for a detailed description of the Company's salary continuation agreements and benefit plans. In the ordinary course of business, the Company is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the consolidated financial statements. The Company is party to financial instruments with off-balance-sheet risk in the ordinary course of its banking business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, financial guarantees, and standby letters of credit. They involve, to varying degrees, elements of credit risk in excess of amounts recognized on the consolidated balance sheets. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and issuing letters of credit as they do for on-balance-sheet instruments. Information in the following table provides a summary of the contract or notional amount of the Company's exposure to off-balance-sheet risk as of June 30:

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third-party. Those guarantees are primarily issued to support public and private borrowing arrangements and, generally, have terms of one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds collateral, which may include accounts receivable, inventory, property, equipment, and income-producing properties, supporting those commitments if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third-party, the Bank would be required to fund the commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount shown earlier in the summary. If the commitment is funded the Bank would be entitled to seek recovery from the customer. At June 30, 2004 and December 31, 2003, no amounts have been recorded as liabilities for the Bank's potential obligations under these guarantees. NOTE 6 - Derivative Instruments At June 30, 2004, the Company was entered in an interest rate swap transaction which resulted in the Company converting $10 million of fixed rate brokered CD's into variable rate debt. This swap transaction requires the payment of interest by the Company at a variable interest rate payment based on the one month LIBOR rate adjusted monthly. In turn, the Company receives a fixed rate interest payment equal to 5.0% using an actual/365 day basis. Summary information about the interest rate swap at June 30 is as follows:

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward Looking Statements- Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995, and include this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations are generally identifiable by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project" or similar expressions. First Banking Center's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse affect on our operations and future prospects include, but are not limited to, changes in: interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in our market area, our implementation of new technologies, our ability to develop and maintain secure and reliable electronic systems and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. FIRST BANKING CENTER, INC AND SUBSIDIARY MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS As of June 30, 2004 The following discussion provides additional analysis of the financial condition and results of operations of the Company for the three and the six months ended June 30, 2004. This discussion focuses on the significant factors that affected the Company's earnings so far in 2004, with comparisons to 2003. As of June 30, 2004, First Banking Center (the "Bank") was the only direct subsidiary of the Company and its operations contributed nearly all of the revenue for the year. The Company provides various support functions for the Bank and receives payment from the Bank for these services. These intercompany payments are eliminated for the purpose of these consolidated financial statements. The Bank has three wholly owned subsidiaries, FBC Financial Services, Corp., a brokerage and financial services subsidiary, FBC-Burlington, Inc., an investment subsidiary located in Nevada and Burco Holdings, LLC, a real estate subsidiary for the purpose of holding and liquidating property acquired as other real estate. Overview As of June 30, 2004, total Company assets were $565.4 million, increasing 3.95% from $543.9 million as of December 31, 2003. Net income for the quarter ended June 30, 2004 was $1.5 million or $0.98 per diluted share, decreasing $123,000 or 7.53% from $1.6 million or $1.07 per diluted share in the second quarter of 2003. Net income for the six months ended June 30, 2004 was $3.0 million or $1.92 per diluted share, decreasing $61,000 or 2.00% from $3.0 million or $1.98 per diluted share in the first six months of 2003. The significant items resulting in these results are discussed below. Financial Condition Loans Loans outstanding were $445.1 million and $407.9 million on June 30, 2004 and December 31, 2003 respectively. This represented an increase of $37.2 million or 9.1%. The increase was primarily the result of continued strong demand for commercial loans secured by real estate and construction and land development loans. The increase in agricultural real estate loans was primarily the reclassification of farm residential property from residential real estate to agricultural real estate. Our loan demand outpaced the growth in deposits in the first six months of 2004; therefore, the Company also sold some investment securities and borrowed additional funds to fund a portion of this increased loan demand. The following table summarizes the changes to date in the major loan classifications:

Allowance for Loan Losses One measure of the adequacy of the allowance for loan losses is the ratio of the allowance for loan losses to total loans. The allowance for loan losses was $4.7 million or 1.05% of gross loans on June 30, 2004, compared with $4.6 million or 1.13% of gross loans on December 31, 2003. Net charge-offs were $21,000 or .01% of gross loans and $46,000 or .01% for the six months ended June 30, 2004 and 2003, respectively. The allowance for loan losses was 166.64% of non-accrual loans at June 30, 2004 as compared to 226.21% at December 31, 2003. See below for further information regarding the increase in non-accrual loans and "Results of Operations-Provision for Loan Losses" for matters relating to the determination of the provision for loan losses in the first six months of 2004. The allowance for loan losses is established through a provision for loan losses charged to expense. See "Provision for Loan Losses" below for information on the provision during the periods. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. It is management's belief that the allowance for loan losses is adequate to cover probable credit losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio. However, there can be no assurance that the allowance for loan losses will be adequate to cover all losses that actually occur. In accordance with FASB Statements 5 and 114, the allowance is provided for losses that have been incurred as of the balance sheet date. The allowance is based on past events and current economic conditions, and does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. Management reviews a calculation of the allowance for loan losses on a quarterly basis. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions or trends, potential exposure in the loan portfolio or other factors. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. A loan is impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. In addition, various regulatory agencies periodically review the allowance for loan losses. These agencies may require the Bank to make additions to the allowance for loan losses based on their judgments of collectibility based on information available to them at the time of their examination. The following table provides a detailed analysis of changes in the indicated periods in the allowance for estimated loan losses:

Non-accrual, Past Due and Renegotiated Loans

The policy of the Company is to place a loan on non-accrual status if: (a) payment in full of interest and principal is not expected, or (b) principal or interest has been in default for a period of 90 days or more unless the obligation is both in the process of collection and well secured. Well secured is defined as collateral with sufficient market value to repay principal and all accrued interest. A debt is in the process of collection if collection of the debt is proceeding in due course either through legal action, including judgment enforcement procedures, or in appropriate circumstances, through collection efforts not involving legal action which are reasonably expected to result in repayment of the debt or in its restoration to current status. The non-accrual loans consisted primarily of $1.9 million of residential real estate loans, $350,000 of farmland, $213,000 of agricultural production loans, and $190,000 of commercial loans. The increase during the first six months of 2004 was the result of non-accrual residential real estate loans increasing $511,000, non-accrual farmland loans increasing $274,000, and non-accrual agricultural production loans increasing $210,000, offset by non-accrual commercial real estate loans of $300,000. The bulk of the increase relates to factors involving specific loans. As of June 30, 2004, the Company had loans totaling $26.1 million (in addition to those listed as non-accrual, past due or restructured) that were identified by the Bank's internal asset rating system as classified assets and loans which management has determined require additional monitoring. This represented an increase of $7.7 million or 41.8% from December 31, 2003. The increase was primarily the result of the Company modifying its standards, beginning in the first quarter of 2004, whereby it now identifies potential problem loans earlier in the process than in the past. By identifying the loans earlier, they can be monitored more closely with the idea that action can be taken before they become problem loans. A portion of the increase, $1.2 million, represented a change in the way the Company treats the guaranteed portion of a loan. Beginning with the first quarter of 2004, the Company included the guaranteed portion of a classified loan in the classified loan total. The Company believes it has adequate reserves for anticipated losses that could result from the increase in classified assets; however, there can be no assurance that the allowance for loan losses will be adequate to cover all losses that actually occur. Management is not aware of any significant loans, group of loans or segments of the loan portfolio not included above, where full collectibility cannot reasonably be expected. Management has committed resources and is focusing on efforts designed to control the amount of classified assets. The Company does not have a substantial portion of its loans concentrated in one or a few industries nor does it have any foreign loans outstanding as of June 30, 2004. The Company's loans are concentrated geographically in the Wisconsin counties of Racine, Walworth, Kenosha, Lafayette and Green. Investments securities - Available for Sale The fair value of the securities available-for-sale portfolio at June 30, 2004, decreased $14.1 million or 17.1% from December 31, 2003. During the period, the Company sold securities in the investment portfolio in part to fund the increase in loans. For the purposes of this discussion, changes in investment security balances are based on amortized costs. The decrease came from three areas of the portfolio. The Company purchased $35.0 million of U.S. government agency securities and $3.6 million of municipal securities. The Company sold $4.6 million of U.S. government agency notes and $1.7 million of municipal securities. There were maturities and calls of $42.3 million of U.S. government agency notes and U.S. government agency mortgage-backed securities and $2.7 million of municipal securities. Deposits Total deposits were $417.7 million on June 30, 2004 compared to $407.5 million on December 31, 2003. This is an increase of $10.2 million or 2.5%. Most of the increase was in money market accounts as deposits shifted from demand and time deposits; however, deposits showed a net gain because the Company issued a $10 million brokered time deposit. Brokered deposits are deposits generated outside of the Company's market area. They are sold by a broker to individuals who have no other relationships with the Company. The brokered deposits have a 7.5 year maturity which exposes the Company to interest rate risk for a period of time longer than the Company is accustomed to when issuing time deposits in its market. To offset this risk, the deposits are callable every six months and the Company has also entered into a callable interest rate swap that effectively converts this 7.5 year fixed rate liability to a one month LIBOR based variable rate liability. See Item 1, "NOTE 6 - Derivative Instruments" for more information regarding the swap. The following table summarizes changes during 2004 in the major classifications of deposts:

Borrowed Funds Total borrowed funds were $89.5 million on June 30, 2004, compared to $78.8 million on December 31, 2003. This was an increase of $10.7 million or 13.6%. Securities sold under agreement to repurchase and Federal Home Loan borrowings each decreased $6.0 million as maturities were not replaced. The Company replaced these funds with brokered time deposits. Federal funds borrowed increased by $22.7 million to fund the demand for loans. The following table summarizes changes during 2004 in the major classifications of borrowed funds:

Further information regarding our FHLB borrowings as of December 31, 2003 is included in Note 9 of our Consolidated Financial Statements in our annual report on Form 10-K for the year ended December 31, 2003. Capital resources As of June 30, 2004, the Company's stockholders' equity increased $939,000 or 1.8% from December 31, 2003. Net income of $3.0 million was the primary reason for the increase. In addition, the Company issued $176,000 of common stock through its incentive stock option plan. These increases were partially offset by the Company's repurchase of $634,000 of common stock into treasury, cash dividends of $643,000 (or $.43 per share for the period ended June 30, 2004), and a decrease in accummulated other comprehensive income of $956,000, to $334,000 at June 30, 2004 from $1.3 million at year end. Under the Federal Reserve Board's risk-based guidelines, capital is measured against the Company's subsidiary bank's risk-weighted assets. The Company's tier 1 capital (common stockholders' equity less goodwill) to risk-weighted assets was 11.6% at June 30, 2004, well above the 4% minimum required. Total capital to risk-adjusted assets was 12.7%; also well above the 8% minimum requirement. The leverage ratio was at 9.5% compared to the 4% minimum requirement. According to FDIC capital guidelines, the Company and the Bank were considered to be "well capitalized," at June 30, 2004. Asset/liability management The principal function of asset/liability management is to manage the balance sheet mix, maturities, repricing characteristics and pricing components to provide an adequate and stable net interest margin with an acceptable level of risk over time and through interest rate cycles. Interest-sensitive assets and liabilities are those that are subject to repricing within a specific relevant time horizon. The Bank measures interest-sensitive assets and liabilities, and their relationship with each other at terms of immediate, quarterly intervals up to 1 year, and over 1 year. Changes in net interest income, other than volume related, arise when interest rates on assets reprice in a time frame or interest rate environment that is different from the repricing period for liabilities. Changes in net interest income also arise from changes in the mix of interest earning assets and interest-bearing liabilities. The Bank's strategy with respect to asset/liability management is to maximize net interest income while limiting its exposure to a potential downward movement. This strategy is implemented by the Bank's management, which takes action based upon its analysis of a number of factors, including the Bank's present positioning, its desired future positioning, economic forecasts, and its goals. It is the Bank's desire to maintain a cumulative GAP of positive or negative 15% of rate sensitive assets at the 1-year time frame. The percentage at June 30, 2004 was a positive 18%, which compared to a positive 20% as of December 31, 2003. Although these ratios were outside the Bank's target range, and the Bank would therefore be somewhat exposed to declining rates, management felt the ratios were appropriate due to management's projection for future interest rates. Liquidity Liquidity measures the ability to meet maturing obligations and existing commitments, to withstand fluctuations in deposit levels, to fund operations, and to provide for customers' credit needs. One source of liquidity is cash and short-term assets, such as interest-bearing deposits in other banks and federal funds sold, which totaled $19.8 million at June 30, 2004, compared with $23.3 million at December 31, 2003. The Bank has a variety of sources of short-term liquidity available to it, including federal funds purchased from correspondent banks, sales of securities available for sale, FHLB advances, lines of credit and loan participations or sales. As in the second quarter, the Bank can also use brokered deposits to raise additional cash. See "Financial Condition - Deposits" above. During the second quarter of 2004, the Bank became increasingly dependent upon borrowed funds as its loans outstanding increased at a higher rate than deposits. While management believes that these types of borrowings are available on reasonable terms, there can be no assurance they will continue to be. The Bank also generates liquidity from the regular principal payments and prepayments made on its portfolio of loans and mortgage-backed securities and, if appropriate, by selling available for sale securities. Although changes in interest rates could negatively impact liquidity, management feels the Bank has adequate sources to meet its liquidity needs. Any effects that changes in interest rates have on income should have minimal impact on liquidity. The cash position of the Bank is determined by activity in three primary classifications: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. As a net result of these activities, the Bank's cash decreased slightly for the six months of 2004. Net cash provided by operating activities was $3.7 million. This was primarily a result of net income, normal increases and decreases in operations offset by net secondary market loan proceeds over originating secondary market loans. Net cash used in investing activities, consisting primarily of loan funding and purchases of securities, was $27.9 million. Net cash provided by financing activities, consisting primarily of a $16.6 million increase in short term borrowings and deposit growth of $10.2 million, was $19.8 million for the six months ended June 30, 2004. For the six months ending June 30, 2003, net cash provided by operating activities was $3.7 million. This was primarily a result of net secondary market loan proceeds over originating secondary market loans. Net cash provided by investing activities, consisting primarily of federal funds sold and proceeds from security transactions, was $4.6 million. Net cash used in financing activities, consisting primarily of decreased deposits and short term borrowings, was $11.7 million. Off-Balance Sheet Liabilities and Contractual Obligations Because the Company is a holding company for a financial institution, it inherently has lending and other off-balance sheet financial commitments. It also has substantial contractual obligations to pay monies deposited with it, in addition to the types of long-term contractual obligations which other companies incur. Information regarding the Company's off-balance sheet arrangements and a summary of future contractual commitments is included in Note 5 - Commitments and Contingencies in the interim financial statements included in this report in Item 1. The information included in Note 5 is incorporated by reference in this management's discussion and analysis. Impact of Inflation and Changing Prices The consolidated financial statements and the accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, nearly all of our assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on our performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. Results of operations Net Interest Income Net interest income is the difference between interest income and fees on loans and interest expense, and is the largest contributing factor to net income for the Company. All discussions of rate are on an annualized tax-equivalent basis, which accounts for income earned on nontaxable loans and securities that are not fully subject to federal taxes. Net interest income was $5.0 million in the second quarter of 2004, an increase of $282,000 from $4.7 million in the period in 2003. For the six month period ended June 30, 2004, net interest income was $9.8 million, an increase of $762,000 from $9.1 million in that period in 2003. Net interest margin as a percentage of average earning assets (includes loans placed on nonaccrual status) declined slightly to 3.95% from 4.10% and to 3.94% from 4.11% for the three months and six months ended June 30, 2004 and 2003, respectively. The major component of interest income and fees on loans is the income generated by loans. Although average yield declined to 5.40% from 6.00% and to 5.47% from 5.96% for the three months and six months ended June 30, 2004 and 2003, respectively, interest income and fees on loans increased as a result of increased average loan balances. The major components of interest expense are interest paid on certificates of deposit (time deposits) and on money market deposits. The average Interest rate declined to 1.59% from 1.99% and to 1.62% from 2.01% for the three months and six months ended June 30, 2004 and 2003, respectively. Interest expense decreased due to decreased rates paid on increased average balances. The following table summarizes the changes and reasons for the changes in interest earned and paid during the three and six months ended June 30, 2004 and 2003:

(a) The interest and average yield for nontaxable loans and investments are presented on an annualized federal taxable equivalent basis assuming a 34% tax rate. (b) Interest and fees on loans decreased $600,000 and $1.1 million for the three and six months ending June 30, 2003 respectively due to a reclassification of gains on the sales of loans. Provision for Loan Losses For the six months ended June 30, 2004, $100,000 was charged to current earnings and added to the allowance for loan losses compared to $90,000 during the first six months of 2003. In the second quarter of 2004, $50,000 was expensed to the provision, as compared to no addition in the comparable period in 2003. Net charge-offs decreased slightly to $21,000 from $46,000 for the six months ended June 30, 2004 as compared to the six months ended June 30, 2003. At this time however, non-accrual loans increased $318,000 and classified loans increased $471,000 during the second quarter of 2004, and increased $777,000 and $7.5 million, in the first six months of 2004. As a result of the increase in total loans and non-performing and classified assets, charges to earnings rose during the six months ended June 30, 2004 versus 2003. Management believes the exposure to loss on the increased non-performing and classified loans is minimal and that there is adequate collateral to cover the loan balances. See "Allowance for Loan Losses" below for a description of the processes which the Company uses in determining the amount of the provision and the allowance for loan losses. Non-interest Income Non-interest income decreased $146,000 or 9.6% for the three months ended June 30, 2004 compared to the three months ended June 30, 2003. The decrease was primarily the result of decreased gains from the sale of loans. Non-interest income decreased $183,000 or 6.3% for the six months ended June 30, 2004 compared to the six months ended June 30, 2003. The decrease was primarily the result of $626,000 in decreased gains from the sales of loans offset by $123,000 of gains from the sale of securities and $74,000 of income from other real estate owned and increases of $80,000 from trust fees and $93,000 from service charges on deposit accounts. The decreased income from the sale of loans was the result of increased interest rates on fixed rate residental real estate loans. The increased interest rates caused a decline in the volume of fixed rate residental real estate loans which the Company sells to the secondary market. Non-interest Expense Non-interest expense increased $244,000 or 6.2% and $589,000 or 7.6% for the three and six months ended June 30, 2004 compared to the three and six months ended June 30, 2003. Salaries and benefit costs, which is the largest component of non-interest expense, accounted for $88,000 and $269,000 of the increase for the three and six months ended June 30, 2004 compared to the three and six months ended June 30, 2003. The increase in salaries and benefit costs can be attributed primarily to normal wage increases and increased health insurance costs. Occupancy expense increased $32,000 and $78,000 for the three and six months ended June 30, 2004 compared to the three and six months ended June 30, 2003 due to increases in real estate taxes, depreciation and utilities. Other expense increased $103,000 and $185,000 for the three and six months ended June 30, 2004 compared to the three and six months ended June 30, 2003. The bulk of the increase is twofold. Professional service fees increased due to additional regulatory requirements. Amortization expense increased due to the acquisition of a branch in the second quarter of 2003. Income Taxes Income tax expense for the six months ending June 30, 2004 was $1,171,000 compared to $1,130,000 for the six months ending June 30, 2003. The effective tax rate increased to 28.3% for the six months ending June 30, 2004 compared to 27.2% for the six months ending June 30, 2003. The increase was primarily a result of an increase in taxable interest income. Like many Wisconsin financial institutions, the Bank has a non-Wisconsin subsidiary which holds and manages investments assets, the income from which has not yet been subject to Wisconsin tax. The Wisconsin Department of Revenue instituted an audit program, including an audit of the Bank, specifically aimed at out of state bank subsidiaries and indicated that it may withdraw favorable rulings previously issued in connection with such subsidiaries. As a result of these developments, the Department may take the position that some or all of the income of the out of state subsidiary is taxable in Wisconsin, which will likely be challenged by financial institutions in the state. If the Department is successful in its efforts, it could result in a substantial negative impact on the earnings of the Bank. In late July 2004, the Department sent letters to financial institutions in Wisconsin (whether or not undergoing an audit) reporting on settlements involving 17 banks and their out-of-state investment subsidiaries. The letter provided a summary of the Department's currently available settlement parameters. For prior periods they include: restrictions on the types of subsidiary income excluded from Wisconsin taxation; assessment of certain back taxes for a limited period of time; limitations on net operating loss carryforwards and interest deductions related to subsidiary loans; and interest (but not penalties) on past-due taxes. For 2004 and going forward, the letter states similar provisions, including limits on subsidiaries' assets. Settlement on the terms outlined would result in the rescission of prior letter rulings, and purport to be binding going forward except for future legislation or change by mutual agreement. Implicit in the letter appears to be an acceptance of the general proposition that some out-of-state investment subsidiary income is not subject to Wisconsin taxes. At this time, no assessment has yet been made by the Department against the Bank nor has the Company determined how it intends to respond. The letter did not provide sufficient detail to permit the Company to assess what effects the acceptance of such a settlement offer might have upon it, nor does the Company have sufficient information to determine what the Department's position would be if an assessment were made and the Company were to challenge it. The Company intends to seek to obtain that detail and to evaluate the impact of such a settlement after it receives more specific details. Critical Accounting Policies Allowance for Loan Losses Management believes the allowance for loan losses accounting policy is critical to the portrayal and understanding of our financial condition and results of operations. As such, selection and application of this "critical accounting policy" inherently involves judgments, estimates, and uncertainties that are susceptible to change. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results or operations is a reasonable likelihood. For further detail, see the explanations under "Financial Condition-Loans" above. Income Taxes See Note 1 of the notes to our audited consolidated financial statements for the year ended December 31, 2003 for our income tax accounting policy. Income tax expense recorded in the consolidated income statement involves interpretation and application of certain accounting pronouncements and federal and state tax codes, and is, therefore, considered a critical accounting policy. We undergo examinations by various regulatory taxing authorities. Such agencies may require that changes in the amount of tax expense or valuation allowance be recognized when their interpretations differ from those of management, based on their judgments about information available to them at the time of their examinations. In addition, as noted above, the Bank is undergoing a state tax audit relating to the activities and holdings of one of its subsidiaries; we must make judgments as to the expected effect of that audit. See "Results of Operations-Income Taxes" and Note 12 of the notes to our audited consolidated financial statements for the year ended December 31, 2003 for more income tax information. Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company, like other financial institutions, is subject to direct and indirect market risk. Direct market risk exists from changes in interest rates. The Company's net income is dependent on its net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or reprice on a different basis than interest-earning assets. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net income. In an attempt to manage its exposure to changes in interest rates, management monitors interest rate risk. The Asset/Liability Committee meets quarterly to review the interest rate risk position and profitability, and to make or recommend adjustments. Management also reviews the securities portfolio, formulates investment strategies, and oversees the timing and implementation of transactions to assure attainment of the Company's objectives in the most effective manner. Notwithstanding our interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income. In adjusting the asset/liability position, management attempts to manage interest rate risk while maintaining or enhancing net interest margins. At times, depending on the level of general interest rates, the relationship between long-term and short-term interest rates, market conditions and competitive factors, management may decide to increase interest rate risk position somewhat in order to increase the net interest margin. The Company's results of operations and net portfolio values remain vulnerable to increases in interest rates and to fluctuations in the difference between long-term and short-term interest rates. One approach used to quantify interest rate risk is the net portfolio value ("NPV") analysis. In essence, this analysis calculates the difference between the present value of liabilities and the present value of expected cash flows from assets and off-balance-sheet contracts. The most recent NPV analysis, as of June 30, 2004, projected that net portfolio value would decrease by approximately 1.80% if interest rates would rise 200 basis points and would decrease by approximately 0.49% if interest rates would rise 100 basis points over the next year. It projects an increase in net portfolio value of approximately 3.47% if interest rates would drop 200 basis points and an increase of approximately 1.65% if interest rates would drop 100 basis points. Both simulations are within board-established policy limits. The Company has not experienced any material changes to its market risk position since December 31, 2003, as disclosed in the Company's 2003 Form 10-K Annual Report. The Company's policy is to limit the effect of a 200 basis point rate shock to plus or minus 20% of projected net interest income and to minus 20% of the market value of portfolio equity. The Company does not currently engage in trading activities to control interest rates. Even though such activities may be permitted with the approval of the Board of Directors, The Company does not intend to engage in such activities in the immediate future. However, the Company has engaged in the use of derivative instruments for the period ended June 30, 2004 and intends to engage in such activities going forward. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities. Item 4. Controls and Procedures The Company maintains disclosure controls and procedures designed to ensure that the information the Company must disclose in its filings with the Securities and Exchange Commission is recorded, processed, summarized and reported on a timely basis. The Company's principal executive officer and principal financial officer have reviewed and evaluated the Company's disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this report (the "Evaluation Date"). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures are effective in bringing to their attention, on a timely basis, material information relating to the Company required to be included in the Company's periodic filings under the Exchange Act. There have not been any changes in the Company's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the Company's most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Part II-OTHER INFORMATION Item 1. Legal Proceedings None Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. (e) The following table sets forth information on the Company's repurchase of shares of its common stock during the quarter ended June 30, 2004: Issuer Purchases of Equity Securities

Item 3. Defaults upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders On April 20, 2004, the Company held its 2004 annual meeting of shareholders. The only matter for action at the meeting was the election of three directors for the class of directors whose terms expired at the meeting. The following management nominees for directors were the only nominees; they were re-elected by the votes indicated to serve for terms expiring at the 2007 annual meeting.

In addition, the following directors continued in office for terms expiring at the 2005 annual meeting of shareholders: Brantly Chappell, Dr. Robert Fait, Melvin Wendt and Charles R. Wellington. The following directors continue in office for terms expiring at the annual meeting of shareholders in 2006: Keith Blumer, John M. Ernster and John S. Smith In addition, subsequent to the 2004 annual meeting of shareholders, the following persons were elected by the board as additional directors of the Company for terms expiring at the annual meetings of shareholders in the years indicated following their names: James Schuster (2007), James V. Scherrer, Sr. (2005), Frank Cannella, Jr. (2007) and Richard Torhorst (2006). Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 31.1 Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15(d)-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (exhibit is being filed herewith). 31.2 Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15(d)-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (exhibit is being filed herewith). 32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (exhibit is being filed herewith). 32.2 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (exhibit is being filed herewith). (b) Reports on Form 8-K None FIRST BANKING CENTER, INC AND SUBSIDIARIES SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1943, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. First Banking Center, Inc. August 6, 2004 /s/ Brantly Chappell Date ----------------------- Brantly Chappell Chief Executive Officer August 6, 2004 /s/ James Schuster ----------------------- James Schuster Chief Financial Officer

FIRST BANKING CENTER INC 10-Q